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THIRD DIVISION

COMMISSIONER OF INTERNAL
REVENUE,
Petitioner,

- versus -

G.R. No. 180066


Present:
YNARES-SANTIAGO, J.,
Chairperson,
CHICO-NAZARIO,
VELASCO, JR.,
NACHURA, and
PERALTA, JJ.
Promulgated:

PHILIPPINE AIRLINES, INC.,


Respondent.

_____________________

x- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -x
DECISION
CHICO-NAZARIO, J.:

Before this Court is a Petition for Review on Certiorari, under Rule 45 of the Revised
Rules of Court, seeking the reversal and setting aside of the Decision [1] dated 9
August 2007 and Resolution[2] dated 11 October 2007 of the Court of Tax Appeals
(CTA) en banc in CTA E.B. No. 246. The CTA en banc affirmed the Decision[3] dated
31 July 2006 of the CTA Second Division in C.T.A. Case No. 7010, ordering the
cancellation and withdrawal of Preliminary Assessment Notice (PAN) No. INC FY-331-01-000094 dated 3 September 2003 and Formal Letter of Demand dated 12
January 2004, issued by the Bureau of Internal Revenue (BIR) against respondent
Philippine Airlines, Inc. (PAL), for the payment of Minimum Corporate Income Tax
(MCIT) in the amount of P272,421,886.58.
There is no dispute as to the antecedent facts of this case.

PAL is a domestic corporation organized under the corporate laws of the Republic of
the Philippines; declared the national flag carrier of the country; and the grantee
under Presidential Decree No. 1590[4] of a franchise to establish, operate, and
maintain transport services for the carriage of passengers, mail, and property by
air, in and between any and all points and places throughout the Philippines, and
between the Philippines and other countries. [5]
For its fiscal year ending 31 March 2001 (FY 2000-2001), PAL allegedly incurred zero
taxable income,[6] which left it with unapplied creditable withholding tax [7] in the
amount of P2,334,377.95. PAL did not pay any MCIT for the period.
In a letter dated 12 July 2002, addressed to petitioner Commissioner of Internal
Revenue (CIR), PAL requested for the refund of its unapplied creditable withholding
tax for FY 2000-2001. PAL attached to its letter the following: (1) Schedule of
Creditable Tax Withheld at Source for FY 2000-2001; (2) Certificates of Creditable
Taxes Withheld; and (3) Audited Financial Statements.
Acting on the aforementioned letter of PAL, the Large Taxpayers Audit and
Investigation Division 1 (LTAID 1) of the BIR Large Taxpayers Service (LTS), issued on
16 August 2002, Tax Verification Notice No. 00201448, authorizing Revenue Officer
Jacinto Cueto, Jr. (Cueto) to verify the supporting documents and pertinent records
relative to the claim of PAL for refund of its unapplied creditable withholding tax for
FY 2000-20001. In a letter dated 19 August 2003, LTAID 1 Chief Armit S. Linsangan
invited PAL to an informal conference at the BIR National Office in Diliman, Quezon
City, on 27 August 2003, at 10:00 a.m., to discuss the results of the investigation
conducted by Revenue Officer Cueto, supervised by Revenue Officer Madelyn T.
Sacluti.
BIR officers and PAL representatives attended the scheduled informal
conference, during which the former relayed to the latter that the BIR was denying
the claim for refund of PAL and, instead, was assessing PAL for deficiency MCIT for
FY 2000-2001. The PAL representatives argued that PAL was not liable for MCIT
under its franchise.The BIR officers then informed the PAL representatives that the
matter would be referred to the BIR Legal Service for opinion.

The LTAID 1 issued, on 3 September 2003, PAN No. INC FY-3-31-01-000094,


which

was

received

by

PAL

on 23

October

2003. LTAID

assessed

PAL

forP262,474,732.54, representing deficiency MCIT for FY 2000-2001, plus interest


and compromise penalty, computed as follows:
Sales/Revenues from Operation
Less: Cost of Services
Gross Income from Operation
Add: Non-operating income
Total Gross Income for MCIT purposes
Rate of Tax
Tax Due
Add: 20% interest (8-16-00 to 10-31-03)
Compromise Penalty
Total Amount Due

P 38,798,721,685.00
30,316,679,013.00
8,482,042,672.00
465,111,368.00
9,947,154,040.00[8]
2%
178,943,080.80
83,506,651.74
25,000.00
P 262,474,732.54[9]

PAL protested PAN No. INC FY-3-31-01-000094 through a letter dated 4 November
2003 to the BIR LTS.
On 12 January 2004, the LTAID 1 sent PAL a Formal Letter of Demand for deficiency
MCIT for FY 2000-2001 in the amount of P271,421,88658, based on the following
calculation:
Sales/Revenues
from
Operation
Less: Cost of Services
Direct Costs -

P 38,798,721,685.00
P 30,749,761,01
7.00

Less: Non-deductible
interest expense
433,082,004.00
30,316,679,013.00
Gross
Income
from
P 8,482,042,672.00
Operation
Add:
Non-operating
465,111,368.00
Income
Total Gross Income for MCIT purposes
P 9,947,154,040.00
MCIT tax due
P 178,943,080.80
Interest 20% per annum 7/16/01 to 02/15/04
92,453,805.78
Compromise Penalty
25,000.00
Total MCIT due and demandable
P 271,421,886.58[10]

PAL received the foregoing Formal Letter of Demand on 12 February 2004,


prompting it to file with the BIR LTS a formal written protest dated 13 February
2004.
The BIR LTS rendered on 7 May 2004 its Final Decision on Disputed
Assessment, which was received by PAL on 26 May 2004. Invoking Revenue
Memorandum Circular (RMC) No. 66-2003, the BIR LTS denied with finality the
protest of PAL and reiterated the request that PAL immediately pay its deficiency
MCIT for FY 2000-2001, inclusive of penalties incident to delinquency.
PAL filed a Petition for Review with the CTA, which was docketed as C.T.A. Case No.
7010 and raffled to the CTA Second Division. The CTA Second Division promulgated
its Decision on 31 July 2006, ruling in favor of PAL. The dispositive portion of the
judgment of the CTA Second Division reads:
WHEREFORE, premises considered, the instant Petition for
Review is hereby GRANTED. Accordingly, Assessment Notice No. INC
FY-3-31-01-000094 and Formal Letter of Demand for the payment of
deficiency Minimum Corporate Income Tax in the amount
of P272,421,886.58 are hereby CANCELLED and WITHDRAWN.[11]

In a Resolution dated 2 January 2007, the CTA Second Division denied the
Motion for Reconsideration of the CIR.
It was then the turn of the CIR to file a Petition for Review with the CTA en banc,
docketed as C.T.A. E.B. No. 246. The CTA en banc found that the cited legal
provisions and jurisprudence are teeming with life with respect to the grant of tax
exemption too vivid to pass unnoticed, and that the Court in Division correctly ruled
in favor of the respondent [PAL] granting its petition for the cancellation of
Assessment Notice No. INC FY-3-31-01-000094 and Formal Letter of Demand for the
deficiency MCIT in the amount ofP272,421,886.58.[12] Consequently, the CTA en
banc denied the Petition of the CIR for lack of merit. The CTA en banc likewise
denied the Motion for Reconsideration of the CIR in a Resolution dated 11 October
2007.
Hence, the CIR comes before this Court via the instant Petition for Review
on Certiorari, based on the grounds stated hereunder:

THE COURT OF TAX APPEALS ERRED ON A QUESTION OF LAW IN ITS


ASSAILED DECISION BECAUSE:
(1) [PAL] CLEARLY OPTED TO BE COVERED BY THE INCOME TAX
PROVISION OF THE NATIONAL INTERNAL REVENUE CODE OF 1997
(NIRC OF 1997). (sic) AS AMENDED; HENCE, IT IS COVERED BY THE
MCIT PROVISION OF THE SAME CODE.
(2) THE MCIT DOES NOT BELONG TO THE CATEGORY OF OTHER TAXES
WHICH WOULD ENABLE RESPONDENT TO AVAIL ITSELF OF THE IN LIEU
(sic) OF ALL OTHER TAXES CLAUSE UNDER SECTION 13 OF P.D. NO.
1590 (CHARTER).
(3) THE MCIT PROVISION OF THE NIRC OF 1997 IS NOT AN AMENDMENT
OF [PALS] CHARTER.
(4) PAL IS NOT ONLY GIVEN THE PRIVILEGE TO CHOOSE BETWEEN
WHAT WILL GIVE IT THE BENEFIT OF A LOWER TAX, BUT ALSO THE
RESPONSIBILITY OF PAYING ITS SHARE OF THE TAX BURDEN, AS IS
EVIDENT IN SECTION 22 OF RA NO. 9337.
(5) A CLAIM FOR EXEMPTION FROM TAXATION IS NEVER PRESUMED;
[PAL] IS LIABLE FOR THE DEFICIENCY MCIT.[13]

There is only one vital issue that the Court must resolve in the Petition at bar, i.e.,
whether PAL is liable for deficiency MCIT for FY 2000-2001.
The Court answers in the negative.
Presidential Decree No. 1590, the franchise of PAL, contains provisions specifically
governing the taxation of said corporation, to wit:
Section 13. In consideration of the franchise and rights hereby
granted, the grantee shall pay to the Philippine Government during the
life of this franchise whichever of subsections (a) and (b)
hereunder will result in a lower tax:
(a) The basic corporate income tax based on the grantee's
annual net taxable income computed in accordance with the
provisions of the National Internal Revenue Code; or
(b) A franchise tax of two per cent (2%) of the gross revenues
derived by the grantee from all sources, without distinction as to
transport or nontransport operations; provided, that with respect to
international air-transport service, only the gross passenger, mail, and
freight revenues from its outgoing flights shall be subject to this tax.

The tax paid by the grantee under either of the above


alternatives shall be in lieu of all other taxes, duties, royalties,
registration, license, and other fees and charges of any kind, nature, or
description, imposed, levied, established, assessed, or collected by any
municipal, city, provincial, or national authority or government agency,
now or in the future, including but not limited to the following:
1. All taxes, duties, charges, royalties, or fees due on local
purchases by the grantee of aviation gas, fuel, and oil, whether refined
or in crude form, and whether such taxes, duties, charges, royalties, or
fees are directly due from or imposable upon the purchaser or the
seller, producer, manufacturer, or importer of said petroleum products
but are billed or passed on to the grantee either as part of the price or
cost thereof or by mutual agreement or other arrangement; provided,
that all such purchases by, sales or deliveries of aviation gas, fuel, and
oil to the grantee shall be for exclusive use in its transport and
nontransport operations and other activities incidental thereto;
2. All taxes, including compensating taxes, duties, charges,
royalties, or fees due on all importations by the grantee of aircraft,
engines, equipment, machinery, spare parts, accessories, commissary
and catering supplies, aviation gas, fuel, and oil, whether refined or in
crude form and other articles, supplies, or materials; provided, that
such articles or supplies or materials are imported for the use of the
grantee in its transport and nontransport operations and other
activities incidental thereto and are not locally available in reasonable
quantity, quality, or price;
3. All taxes on lease rentals, interest, fees, and other charges
payable to lessors, whether foreign or domestic, of aircraft, engines,
equipment, machinery, spare parts, and other property rented, leased,
or chartered by the grantee where the payment of such taxes is
assumed by the grantee;
4. All taxes on interest, fees, and other charges on foreign loans
obtained and other obligations incurred by the grantee where the
payment of such taxes is assumed by the grantee;
5. All taxes, fees, and other charges on the registration,
licensing, acquisition, and transfer of aircraft, equipment, motor
vehicles, and all other personal and real property of the grantee; and
6. The corporate development tax under Presidential Decree No.
1158-A.
The grantee, shall, however, pay
property in conformity with existing law.

the tax

on

its

real

For purposes of computing the basic corporate income


tax as provided herein, the grantee is authorized:
(a) To depreciate its assets to the extent of
than twice as fast the normal rate of depreciation; and

not

more

(b) To carry over as a deduction from taxable income any net


loss incurred in any year up to five years following the year of such
loss.
Section 14. The grantee shall pay either the franchise tax or
the basic corporate income tax on quarterly basis to the Commissioner
of Internal Revenue. Within sixty (60) days after the end of each of the
first three quarters of the taxable calendar or fiscal year, the quarterly
franchise or income-tax return shall be filed and payment of either the
franchise or income tax shall be made by the grantee.
A final or an adjustment return covering the operation of the
grantee for the preceding calendar or fiscal year shall be filed on or
before the fifteenth day of the fourth month following the close of the
calendar or fiscal year. The amount of the final franchise or income tax
to be paid by the grantee shall be the balance of the total franchise or
income tax shown in the final or adjustment return after deducting
therefrom the total quarterly franchise or income taxes already paid
during the preceding first three quarters of the same taxable year.
Any excess of the total quarterly payments over the actual
annual franchise of income tax due as shown in the final or adjustment
franchise or income-tax return shall either be refunded to the grantee
or credited against the grantee's quarterly franchise or income-tax
liability for the succeeding taxable year or years at the option of the
grantee.
The term "gross revenues" is herein defined as the total gross
income earned by the grantee from; (a) transport, nontransport, and
other services; (b) earnings realized from investments in moneymarket placements, bank deposits, investments in shares of stock and
other securities, and other investments; (c) total gains net of total
losses realized from the disposition of assets and foreign-exchange
transactions; and (d) gross income from other sources. (Emphases
ours.)

According to the afore-quoted provisions, the taxation of PAL, during the lifetime of
its franchise, shall be governed by two fundamental rules, particularly: (1) PAL shall
pay the Government either basic corporate income tax or franchise tax, whichever
is lower; and (2) the tax paid by PAL, under either of these alternatives, shall be in
lieu of all other taxes, duties, royalties, registration, license, and other fees and
charges, except only real property tax.
The basic corporate income tax of PAL shall be based on its annual net
taxable income, computed in accordance with the National Internal Revenue Code
(NIRC).Presidential

Decree

No.

1590

also

explicitly

authorizes

PAL,

in

the

computation of its basic corporate income tax, to (1) depreciate its assets twice as
fast the normal rate of depreciation; [14] and (2) carry over as a deduction from
taxable income any net loss incurred in any year up to five years following the year
of such loss.[15]
Franchise tax, on the other hand, shall be two per cent (2%) of the gross revenues
derived

by

PAL

from

all

sources,

whether

transport

or

nontransport

operations. However, with respect to international air-transport service, the


franchise tax shall only be imposed on the gross passenger, mail, and freight
revenues of PAL from its outgoing flights.
In its income tax return for FY 2000-2001, filed with the BIR, PAL reported no net
taxable income for the period, resulting in zero basic corporate income tax, which
would necessarily be lower than any franchise tax due from PAL for the same
period.
The CIR, though, assessed PAL for MCIT for FY 2000-2001. It is the position of the
CIR that the MCIT is income tax for which PAL is liable. The CIR reasons that Section
13(a) of Presidential Decree No. 1590 provides that the corporate income tax of PAL
shall be computed in accordance with the NIRC. And, since the NIRC of 1997
imposes MCIT, and PAL has not applied for relief from the said tax, then PAL is
subject to the same.
The Court is not persuaded. The arguments of the CIR are contrary to the plain
meaning and obvious intent of Presidential Decree No. 1590, the franchise of PAL.
Income tax on domestic corporations is covered by Section 27 of the NIRC of 1997,
[16]

pertinent provisions of which are reproduced below for easy reference:


SEC. 27. Rates of Income Tax on Domestic Corporations.
(A) In General Except as otherwise provided in this Code, an
income tax of thirty-five percent (35%) is hereby imposed upon
the taxable income derived during each taxable year from all sources
within and without the Philippines by every corporation, as defined in
Section 22(B) of this Code and taxable under this Title as a corporation,
organized in, or existing under the laws of the Philippines: Provided,
That effective January 1, 1998, the rate of income tax shall be thirtyfour percent (34%); effective January 1, 1999, the rate shall be thirtythree percent (33%); and effective January 1, 2000 and thereafter, the
rate shall be thirty-two percent (32%).

xxxx
(E) Minimum Corporate Income Tax on Domestic Corporations.
(1) Imposition of Tax. A minimum corporate income tax of two
percent (2%) of the gross income as of the end of the taxable year,
as defined herein, is hereby imposed on a corporation taxable under
this Title, beginning on the fourth taxable year immediately following
the year in which such corporation commenced its business
operations, when the minimum income tax is greater than the tax
computed under Subsection (A) of this Section for the taxable year.

Hence, a domestic corporation must pay whichever is higher of: (1) the income tax
under Section 27(A) of the NIRC of 1997, computed by applying the tax rate therein
to the taxable income of the corporation; or (2) the MCIT under Section 27(E), also
of

the

NIRC

of

1997,

equivalent

to

2%

of

the

gross

income

of

the

corporation. Although this may be the general rule in determining the income tax
due from a domestic corporation under the NIRC of 1997, it can only be applied to
PAL to the extent allowed by the provisions in the franchise of PAL specifically
governing its taxation.
After a conscientious study of Section 13 of Presidential Decree No. 1590, in relation
to Sections 27(A) and 27(E) of the NIRC of 1997, the Court, like the CTA en banc and
Second Division, concludes that PAL cannot be subjected to MCIT for FY 2000-2001.
First, Section 13(a) of Presidential Decree No. 1590 refers to basic corporate
income tax. In Commissioner of Internal Revenue v. Philippine Airlines, Inc.,[17] the
Court already settled that the basic corporate income tax, under Section 13(a) of
Presidential Decree No. 1590, relates to the general rate of 35% (reduced to 32% by
the year 2000) as stipulated in Section 27(A) of the NIRC of 1997.
Section 13(a) of Presidential Decree No. 1590 requires that the basic corporate
income tax be computed in accordance with the NIRC. This means that PAL shall
compute its basic corporate income tax using the rate and basis prescribed by the
NIRC of 1997 for the said tax. There is nothing in Section 13(a) of Presidential
Decree No. 1590 to support the contention of the CIR that PAL is subject to the
entire Title II of the NIRC of 1997, entitled Tax on Income.

Second, Section 13(a) of Presidential Decree No. 1590 further provides that the
basic corporate income tax of PAL shall be based on its annual net taxable
income. This is consistent with Section 27(A) of the NIRC of 1997, which provides
that the rate of basic corporate income tax, which is 32% beginning 1 January 2000,
shall be imposed on thetaxable income of the domestic corporation.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent
items of gross income specified in the said Code, less the deductions
and/or personal and additional exemptions, if any, authorized for such
types of income by the same Code or other special laws. The gross income,
referred to in Section 31, is described in Section 32 of the NIRC of 1997 as income
from whatever source, including compensation for services; the conduct of trade or
business or the exercise of profession; dealings in property; interests; rents;
royalties; dividends; annuities; prizes and winnings; pensions; and a partners
distributive share in the net income of a general professional partnership.
Pursuant to the NIRC of 1997, the taxable income of a domestic corporation may be
arrived at by subtracting from gross income deductions authorized, not just by the
NIRC of 1997,[18] but also by special laws. Presidential Decree No. 1590 may be
considered as one of such special laws authorizing PAL, in computing its annual net
taxable income, on which its basic corporate income tax shall be based, to deduct
from its gross income the following: (1) depreciation of assets at twice the normal
rate; and (2) net loss carry-over up to five years following the year of such loss.
In comparison, the 2% MCIT under Section 27(E) of the NIRC of 1997 shall be based
on the gross income of the domestic corporation. The Court notes that gross
income, as the basis for MCIT, is given a special definition under Section 27(E)(4) of
the NIRC of 1997, different from the general one under Section 34 of the same
Code.
According to the last paragraph of Section 27(E)(4) of the NIRC of 1997, gross
income of a domestic corporation engaged in the sale of service means gross
receipts,

less

sales

returns,

allowances,

discounts

and

cost

of

services. Cost of services refers to all direct costs and expenses necessarily
incurred to provide the services required by the customers and clients including (a)
salaries and employee benefits of personnel, consultants, and specialists directly

rendering the service; and (b) cost of facilities directly utilized in providing the
service, such as depreciation or rental of equipment used and cost of supplies.
[19]

Noticeably, inclusions in and exclusions/deductions from gross income for MCIT

purposes are limited to those directly arising from the conduct of the taxpayers
business. It is, thus, more limited than the gross income used in the computation of
basic corporate income tax.
In light of the foregoing, there is an apparent distinction under the NIRC of 1997
between taxable income, which is the basis for basic corporate income tax under
Section 27(A); and gross income, which is the basis for the MCIT under Section
27(E). The two terms have their respective technical meanings, and cannot be used
interchangeably. The same reasons prevent this Court from declaring that the basic
corporate income tax, for which PAL is liable under Section 13(a) of Presidential
Decree No. 1590, also covers MCIT under Section 27(E) of the NIRC of 1997, since
the basis for the first is the annual net taxable income, while the basis for the
second is gross income.
Third, even if the basic corporate income tax and the MCIT are both income taxes
under Section 27 of the NIRC of 1997, and one is paid in place of the other, the two
are distinct and separate taxes.
The Court again cites Commissioner of Internal Revenue v. Philippine Airlines, Inc.,
[20]

wherein it held that income tax on the passive income [21] of a domestic

corporation, under Section 27(D) of the NIRC of 1997, is different from the basic
corporate income tax on the taxable income of a domestic corporation, imposed by
Section 27(A), also of the NIRC of 1997. Section 13 of Presidential Decree No. 1590
gives PAL the option to pay basic corporate income tax or franchise tax, whichever
is lower; and the tax so paid shall be in lieu of all other taxes, except real property
tax. The income tax on the passive income of PAL falls within the category of all
other taxes from which PAL is exempted, and which, if already collected, should be
refunded to PAL.
The Court herein treats MCIT in much the same way. Although both are income
taxes, the MCIT is different from the basic corporate income tax, not just in the
rates, but also in the bases for their computation. Not being covered by Section
13(a) of Presidential Decree No. 1590, which makes PAL liable only for basic
corporate income tax, then MCIT is included in all other taxes from which PAL is
exempted.

That, under general circumstances, the MCIT is paid in place of the basic corporate
income tax, when the former is higher than the latter, does not mean that these two
income taxes are one and the same. The said taxes are merely paid in the
alternative, giving the Government the opportunity to collect the higher amount
between the two. The situation is not much different from Section 13 of Presidential
Decree No. 1590, which reversely allows PAL to pay, whichever is lower of the basic
corporate income tax or the franchise tax. It does not make the basic corporate
income tax indistinguishable from the franchise tax.
Given the fundamental differences between the basic corporate income tax and the
MCIT, presented in the preceding discussion, it is not baseless for this Court to rule
that, pursuant to the franchise of PAL, said corporation is subject to the first tax, yet
exempted from the second.
Fourth, the evident intent of Section 13 of Presidential Decree No. 1520 is to extend
to

PAL

tax

concessions

corporations. Section

13

of

not

ordinarily

Presidential

available

Decree

No.

to
1520

other
permits

domestic
PAL

to

pay whichever is lower of the basic corporate income tax or the franchise tax;
and the tax so paid shall be in lieu of all other taxes, except only real property
tax. Hence, under its franchise, PAL is to pay the least amount of tax possible.
Section 13 of Presidential Decree No. 1520 is not unusual. A public utility is granted
special tax treatment (including tax exceptions/exemptions) under its franchise, as
an inducement for the acceptance of the franchise and the rendition of public
service by the said public utility. [22] In this case, in addition to being a public utility
providing air-transport service, PAL is also the official flag carrier of the country.
The imposition of MCIT on PAL, as the CIR insists, would result in a situation that
contravenes the objective of Section 13 of Presidential Decree No. 1590. In effect,
PAL would not just have two, but three tax alternatives, namely, the basic corporate
income tax, MCIT, or franchise tax. More troublesome is the fact that, as between
the basic corporate income tax and the MCIT, PAL shall be made to pay whichever
is higher, irrefragably, in violation of the avowed intention of Section 13 of
Presidential Decree No. 1590 to make PAL pay for the lower amount of tax.
Fifth, the CIR posits that PAL may not invoke in the instant case the in lieu of all
other taxes clause in Section 13 of Presidential Decree No. 1520, if it did not pay
anything at all as basic corporate income tax or franchise tax. As a result, PAL

should be made liable for other taxes such as MCIT. This line of reasoning has been
dubbed as the Substitution Theory, and this is not the first time the CIR raised the
same. The Court already rejected the Substitution Theory in Commissioner of
Internal Revenue v. Philippine Airlines, Inc.,[23] to wit:
Substitution Theory
of the CIR Untenable
A careful reading of Section 13 rebuts the argument of
the CIR that the in lieu of all other taxes proviso is a mere
incentive that applies only when PAL actually pays
something. It is clear that PD 1590 intended to give respondent the
option to avail itself of Subsection (a) or (b) as consideration for its
franchise. Either option excludes the payment of other taxes and dues
imposed or collected by the national or the local government. PAL has
the option to choose the alternative that results in lower taxes. It is
not the fact of tax payment that exempts it, but the exercise of
its option.
Under Subsection (a), the basis for the tax rate is respondents
annual net taxable income, which (as earlier discussed) is computed by
subtracting allowable deductions and exemptions from gross
income. By basing the tax rate on the annual net taxable income, PD
1590 necessarily recognized the situation in which taxable income may
result in a negative amount and thus translate into a zero tax liability.
Notably, PAL was owned and operated by the government at the
time the franchise was last amended. It can reasonably be
contemplated that PD 1590 sought to assist the finances of the
government corporation in the form of lower taxes. When respondent
operates at a loss (as in the instant case), no taxes are due; in this
instances, it has a lower tax liability than that provided by Subsection
(b).
The fallacy of the CIRs argument is evident from the fact
that the payment of a measly sum of one peso would suffice to
exempt PAL from other taxes, whereas a zero liability arising
from its losses would not. There is no substantial distinction
between a zero tax and a one-peso tax liability. (Emphasis ours.)

Based on the same ratiocination, the Court finds the Substitution Theory
unacceptable in the present Petition.
The CIR alludes as well to Republic Act No. 9337, for reasons similar to those behind
the Substitution Theory. Section 22 of Republic Act No. 9337, more popularly known

as the Expanded Value Added Tax (E-VAT) Law, abolished the franchise tax imposed
by the charters of particularly identified public utilities, including Presidential Decree
No. 1590 of PAL. PAL may no longer exercise its options or alternatives under
Section 13 of Presidential Decree No. 1590, and is now liable for both corporate
income tax and the 12% VAT on its sale of services. The CIR alleges that Republic
Act No. 9337 reveals the intention of the Legislature to make PAL share the tax
burden of other domestic corporations.
The CIR seems to lose sight of the fact that the Petition at bar involves the liability
of PAL for MCIT for the fiscal year ending 31 March 2001. Republic Act No. 9337,
which took effect on 1 July 2005, cannot be applied retroactively [24] and any
amendment introduced by said statute affecting the taxation of PAL is immaterial in
the present case.
And sixth, Presidential Decree No. 1590 explicitly allows PAL, in computing its basic
corporate income tax, to carry over as deduction any net loss incurred in any year,
up to five years following the year of such loss. Therefore, Presidential Decree No.
1590 does not only consider the possibility that, at the end of a taxable period, PAL
shall end up with zero annual net taxable income (when its deductions exactly
equal its gross income), as what happened in the case at bar, but also the likelihood
that PAL shall incur net loss (when its deductions exceed its gross income). If PAL is
subjected to MCIT, the provision in Presidential Decree No. 1590 on net loss carryover will be rendered nugatory.Net loss carry-over is material only in computing the
annual net taxable income to be used as basis for the basic corporate income tax of
PAL; but PAL will never be able to avail itself of the basic corporate income tax
option when it is in a net loss position, because it will always then be compelled to
pay the necessarily higher MCIT.
Consequently, the insistence of the CIR to subject PAL to MCIT cannot be done
without contravening Presidential Decree No. 1520.
Between Presidential Decree No. 1520, on one hand, which is a special law
specifically governing the franchise of PAL, issued on 11 June 1978; and the NIRC of
1997, on the other, which is a general law on national internal revenue taxes, that
took effect on 1 January 1998, the former prevails. The rule is that on a specific
matter, the special law shall prevail over the general law, which shall be resorted to
only to supply deficiencies in the former. In addition, where there are two statutes,
the earlier special and the later general the terms of the general broad enough to

include the matter provided for in the special the fact that one is special and the
other is general creates a presumption that the special is to be considered as
remaining an exception to the general, one as a general law of the land, the other
as the law of a particular case. It is a canon of statutory construction that a later
statute, general in its terms and not expressly repealing a prior special statute, will
ordinarily not affect the special provisions of such earlier statute. [25]
Neither can it be said that the NIRC of 1997 repealed or amended Presidential
Decree No. 1590.
While Section 16 of Presidential Decree No. 1590 provides that the franchise is
granted to PAL with the understanding that it shall be subject to amendment,
alteration, or repeal by competent authority when the public interest so requires,
Section 24 of the same Decree also states that the franchise or any portion thereof
may only be modified, amended, or repealed expressly by a special law or
decree that shall specifically modify, amend, or repeal said franchise or any portion
thereof. No such special law or decree exists herein.
The CIR cannot rely on Section 7(B) of Republic Act No. 8424, which amended the
NIRC in 1997 and reads as follows:
Section 7. Repealing Clauses.
xxxx
(B) The provisions of the National Internal Revenue Code, as
amended, and all other laws, including charters of governmentowned or controlled corporations, decrees, orders, or regulations
or parts thereof, that are inconsistent with this Act are hereby repealed
or amended accordingly.

The CIR reasons that PAL was a government-owned and controlled corporation when
Presidential Decree No. 1590, its franchise or charter, was issued in 1978. Since PAL
was still operating under the very same charter when Republic Act No. 8424 took
effect in 1998, then the latter can repeal or amend the former by virtue of Section
7(B).
The Court disagrees.

A brief recount of the history of PAL is in order. PAL was established as a private
corporation under the general law of the Republic of the Philippines in February
1941. InNovember 1977, the government, through the Government Service
Insurance System (GSIS), acquired the majority shares in PAL. PAL was privatized
in January 1992 when the local consortium PR Holdings acquired a 67% stake
therein.[26]
It is true that when Presidential Decree No. 1590 was issued on 11 June 1978, PAL
was then a government-owned and controlled corporation; but when Republic Act
No. 8424, amending the NIRC, took effect on 1 January 1998, PAL was already a
private corporation for six years. The repealing clause under Section 7(B) of
Republic Act No. 8424 simply refers to charters of government-owned and
controlled corporations, which would simply and plainly mean corporations under
the ownership and control of the government at the time of effectivity of said
statute. It is already a stretch for the Court to read into said provision charters,
issued to what were then government-owned and controlled corporations that are
now private, but still operating under the same charters.
That the Legislature chose not to amend or repeal Presidential Decree No. 1590,
even after PAL was privatized, reveals the intent of the Legislature to let PAL
continue enjoying, as a private corporation, the very same rights and privileges
under the terms and conditions stated in said charter. From the moment PAL was
privatized, it had to be treated as a private corporation, and its charter became that
of a private corporation. It would be completely illogical to say that PAL is a private
corporation still operating under a charter of a government-owned and controlled
corporation.
The alternative argument of the CIR that the imposition of the MCIT is pursuant to
the amendment of the NIRC, and not of Presidential Decree No. 1590 is just as
specious. As has already been settled by this Court, the basic corporate income tax
under Section 13(a) of Presidential Decree No. 1590 relates to the general tax rate
under Section 27(A) of the NIRC of 1997, which is 32% by the year 2000, imposed
on taxable income. Thus, only provisions of the NIRC of 1997 necessary for the
computation of the basic corporate income tax apply to PAL. And even though
Republic Act No. 8424 amended the NIRC by introducing the MCIT, in what is now
Section 27(E) of the said Code, this amendment is actually irrelevant and should not

affect the taxation of PAL, since the MCIT is clearly distinct from the basic corporate
income tax referred to in Section 13(a) of Presidential Decree No. 1590, and from
which PAL is consequently exempt under the in lieu of all other taxes clause of its
charter.
The CIR calls the attention of the Court to RMC No. 66-2003, on Clarifying the
Taxability of Philippine Airlines (PAL) for Income Tax Purposes As Well As Other
Franchise Grantees Similarly Situated. According to RMC No. 66-2003:
Section 27(E) of the Code, as implemented by Revenue
Regulations No. 9-98, provides that MCIT of two percent (2%) of the
gross income as of the end of the taxable year (whether calendar or
fiscal year, depending on the accounting period employed) is imposed
upon any domestic corporation beginning the 4th taxable year
immediately following the taxable year in which such corporation
commenced its business operations. The MCIT shall be imposed
whenever such corporation has zero or negative taxable income or
whenever the amount of MCIT is greater than the normal income tax
due from such corporation.
With the advent of such provision beginning January 1, 1998, it
is certain that domestic corporations subject to normal income tax as
well as those choose to be subject thereto, such as PAL, are bound to
pay income tax regardless of whether they are operating at a profit or
loss.
Thus, in case of operating loss, PAL may either opt to subject
itself to minimum corporate income tax or to the 2% franchise tax,
whichever is lower. On the other hand, if PAL is operating at a profit,
the income tax liability shall be the lower amount between:
(1) normal income tax or MCIT whichever is higher; and
(2) 2% franchise tax.

The CIR attempts to sway this Court to adopt RMC No. 66-2003 since the
[c]onstruction by an executive branch of government of a particular law although
not binding upon the courts must be given weight as the construction comes from
the branch of the government called upon to implement the law. [27]
But the Court is unconvinced.

It is significant to note that RMC No. 66-2003 was issued only on 14 October 2003,
more than two years after FY 2000-2001 of PAL ended on 31 March 2001. This
violates the well-entrenched principle that statutes, including administrative rules
and regulations, operate prospectively only, unless the legislative intent to the
contrary is manifest by express terms or by necessary implication. [28]
Moreover, despite the claims of the CIR that RMC No. 66-2003 is just a clarificatory
and internal issuance, the Court observes that RMC No. 66-2003 does more than
just clarify a previous regulation and goes beyond mere internal administration. It
effectively increases the tax burden of PAL and other taxpayers who are similarly
situated,

making

them

liable

for

tax

for

which

they

were

not

liable

before. Therefore, RMC No. 66-2003 cannot be given effect without previous notice
or publication to those who will be affected thereby. In Commissioner of Internal
Revenue v. Court of Appeals,[29] the Court ratiocinated that:
It should be understandable that when an administrative rule is
merely interpretative in nature, its applicability needs nothing further
than its bare issuance for it gives no real consequence more than what
the law itself has already prescribed. When, upon the other hand,
the administrative rule goes beyond merely providing for the
means that can facilitate or render least cumbersome the
implementation of the law but substantially adds to or
increases the burden of those governed, it behooves the
agency to accord at least to those directly affected a chance to
be heard, and thereafter to be duly informed, before that new
issuance is given the force and effect of law.
A reading of RMC 37-93, particularly considering the
circumstances under which it has been issued, convinces us that the
circular cannot be viewed simply as a corrective measure (revoking in
the process the previous holdings of past Commissioners) or merely as
construing Section 142(c)(1) of the NIRC, as amended, but has, in fact
and most importantly, been made in order to place "Hope Luxury,"
"Premium More" and "Champion" within the classification of locally
manufactured cigarettes bearing foreign brands and to thereby have
them covered by RA 7654. Specifically, the new law would have its
amendatory provisions applied to locally manufactured cigarettes
which at the time of its effectivity were not so classified as bearing
foreign brands. Prior to the issuance of the questioned circular, "Hope
Luxury," "Premium More," and "Champion" cigarettes were in the
category of locally manufactured cigarettes not bearing foreign brand
subject to 45% ad valorem tax. Hence, without RMC 37-93, the
enactment of RA 7654, would have had no new tax rate consequence
on private respondent's products. Evidently, in order to place "Hope
Luxury," "Premium More," and "Champion" cigarettes within the scope

of the amendatory law and subject them to an increased tax rate, the
now disputed RMC 37-93 had to be issued. In so doing, the BIR not
simply interpreted the law; verily, it legislated under its quasilegislative authority. The due observance of the requirements
of notice, of hearing, and of publication should not have been
then ignored.
Indeed, the BIR itself, in its RMC 10-86, has observed and
provided:
"RMC NO. 10-86
Effectivity of Internal Revenue Rules and
Regulations "It has been observed that one of the problem
areas bearing on compliance with Internal Revenue Tax
rules and regulations is lack or insufficiency of due notice
to the tax paying public. Unless there is due notice,
due compliance therewith may not be reasonably
expected. And most importantly, their strict enforcement
could possibly suffer from legal infirmity in the light of the
constitutional provision on 'due process of law' and the
essence of the Civil Code provision concerning effectivity
of laws, whereby due notice is a basic requirement (Sec.
1, Art. IV, Constitution; Art. 2, New Civil Code).
"In order that there shall be a just enforcement of
rules and regulations, in conformity with the basic
element of due process, the following procedures
are hereby prescribed for the drafting, issuance and
implementation of the said Revenue Tax Issuances:
"(1).
This Circular shall apply only to (a) Revenue
Regulations; (b) Revenue Audit Memorandum Orders; and
(c) Revenue Memorandum Circulars and Revenue
Memorandum Orders bearing on internal revenue tax
rules and regulations.
"(2). Except when the law otherwise expressly
provides,
the
aforesaid
internal
revenue
tax
issuances shall not begin to be operative until after
due notice thereof may be fairly presumed.
"Due notice of the said issuances may be fairly
presumed only after the following procedures have been
taken:
"xxx xxx xxx "(5). Strict compliance with the
foregoing procedures is enjoined.13
Nothing on record could tell us that it was either impossible or
impracticable for the BIR to observe and comply with the above

requirements before giving effect to its questioned circular. (Emphases


ours.)

The Court, however, stops short of ruling on the validity of RMC No. 66-2003, for it is
not among the issues raised in the instant Petition. It only wishes to stress the
requirement of prior notice to PAL before RMC No. 66-2003 could have become
effective. Only after RMC No. 66-2003 was issued on 14 October 2003 could PAL
have been given notice of said circular, and only following such notice to PAL would
RMC No. 66-2003 have taken effect. Given this sequence, it is not possible to say
that RMC No. 66-2003 was already in effect and should have been strictly complied
with by PAL for its fiscal year which ended on 31 March 2001.
Even conceding that the construction of a statute by the CIR is to be given great
weight, the courts, which include the CTA, are not bound thereby if such
construction is erroneous or is clearly shown to be in conflict with the governing
statute or the Constitution or other laws. "It is the role of the Judiciary to refine and,
when necessary, correct constitutional (and/or statutory) interpretation, in the
context of the interactions of the three branches of the government." [30] It is
furthermore the rule of long standing that this Court will not set aside lightly the
conclusions reached by the CTA which, by the very nature of its functions, is
dedicated exclusively to the resolution of tax problems and has, accordingly,
developed an expertise on the subject, unless there has been an abuse or
improvident exercise of authority.[31] In the Petition at bar, the CTA en banc and in
division both adjudged that PAL is not liable for MCIT under Presidential Decree No.
1590, and this Court has no sufficient basis to reverse them.
As to the assertions of the CIR that exemption from tax is not presumed, and the
one claiming it must be able to show that it indubitably exists, the Court recalls its
pronouncements in Commissioner of Internal Revenue v. Court of Appeals [32]:
We disagree. Petitioner Commissioner of Internal Revenue erred in
applying the principles of tax exemption without first applying the wellsettled doctrine of strict interpretation in the imposition of
taxes. It is obviously both illogical and impractical to
determine who are exempted without first determining who
are covered by the aforesaid provision. The Commissioner should
have determined first if private respondent was covered by Section
205, applying the rule of strict interpretation of laws imposing taxes
and other burdens on the populace, before asking Ateneo to prove its
exemption therefrom. The Court takes this occasion to reiterate the
hornbook doctrine in the interpretation of tax laws that (a) statute will

not be construed as imposing a tax unless it does so clearly, expressly,


and unambiguously. x x x (A) tax cannot be imposed without clear and
express words for that purpose. Accordingly, the general rule of
requiring adherence to the letter in construing statutes applies
with peculiar strictness to tax laws and the provisions of a
taxing
act
are
not
to
be
extended
by
implication. Parenthetically, in answering the question of who
is subject to tax statutes, it is basic that in case of doubt, such
statutes are to be construed most strongly against the
government and in favor of the subjects or citizens because
burdens are not to be imposed nor presumed to be imposed
beyond what statutes expressly and clearly import. (Emphases
ours.)

For two decades following the grant of its franchise by Presidential Decree No. 1590
in 1978, PAL was only being held liable for the basic corporate income tax or
franchise tax, whichever was lower; and its payment of either tax was in lieu of all
other taxes, except real property tax, in accordance with the plain language of
Section 13 of the charter of PAL. Therefore, the exemption of PAL from all other
taxes was not just a presumption, but a previously established, accepted, and
respected fact, even for the BIR.
The MCIT was a new tax introduced by Republic Act No. 8424. Under the doctrine of
strict interpretation, the burden is upon the CIR to primarily prove that the new
MCIT provisions of the NIRC of 1997, clearly, expressly, and unambiguously extend
and apply to PAL, despite the latters existing tax exemption. To do this, the CIR must
convince the Court that the MCIT is a basic corporate income tax, [33] and is not
covered by the in lieu of all other taxes clause of Presidential Decree No.
1590. Since the CIR failed in this regard, the Court is left with no choice but to
consider the MCIT as one of all other taxes, from which PAL is exempt under the
explicit provisions of its charter.
Not being liable for MCIT in FY 2000-2001, it necessarily follows that PAL need not
apply for relief from said tax as the CIR maintains.
WHEREFORE,

premises

considered,

the

instant

Petition

for

Review

is

hereby DENIED, and the Decision dated 9 August 2007 and Resolution dated 11
October 2007 of the Court of Tax Appeals en banc in CTA E.B. No. 246 is
hereby AFFIRMED. No costs.

SO ORDERED.

Republic of the Philippines


SUPREME COURT
Manila
THIRD DIVISION
SOUTH AFRICAN AIRWAYS,
Petitioner,

G.R. No. 180356


Present:

- versus -

COMMISSIONER OF INTERNAL
REVENUE,
Respondent.

CORONA, J., Chairperson,


VELASCO, JR.,
LEONARDO-DE CASTRO,*
PERALTA, and
MENDOZA, JJ.
Promulgated:
February 16, 2010

x-----------------------------------------------------------------------------------------x
DECISION

VELASCO, JR., J.:


The Case

This Petition for Review on Certiorari under Rule 45 seeks the reversal of the
July 19, 2007 Decision[1] and October 30, 2007 Resolution [2] of the Court of Tax
Appeals (CTA) En Banc in CTA E.B. Case No. 210, entitled South African Airways v.
Commissioner of Internal Revenue. The assailed decision affirmed the Decision
dated May 10, 2006[3] and Resolution dated August 11, 2006 [4] rendered by the CTA
First Division.

The Facts
Petitioner South African Airways is a foreign corporation organized and existing
under and by virtue of the laws of the Republic of South Africa. Its principal office is
located atAirways Park, Jones Road, Johannesburg International Airport, South Africa.
In the Philippines, it is an internal air carrier having no landing rights in the
country. Petitioner has a general sales agent in the Philippines, Aerotel Limited
Corporation (Aerotel). Aerotel sells passage documents for compensation or
commission for petitioners off-line flights for the carriage of passengers and cargo
between ports or points outside the territorial jurisdiction of the Philippines.
Petitioner is not registered with the Securities and Exchange Commission as a
corporation, branch office, or partnership. It is not licensed to do business in
the Philippines.
For the taxable year 2000, petitioner filed separate quarterly and annual income tax
returns for its off-line flights, summarized as follows:

For Passenger

Sub-total
For Cargo

Period
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter

Date Filed
May 30, 2000
August 29, 2000
November 29,
2000
April 16, 2000

1st Quarter
2nd Quarter

May 30, 2000


August 29, 2000

PhP

PhP
PhP

2.5% Gross
Phil. Billings
222,531.25
424,046.95
422,466.00
453,182.91
1,522,227.11
81,531.00
50,169.65

3rd Quarter
4th Quarter

November 29,
2000
April 16, 2000

Sub-total
TOTAL

36,383.74
37,454.88
PhP

205,539.27
1,727,766.38

Thereafter, on February 5, 2003, petitioner filed with the Bureau of Internal


Revenue, Revenue District Office No. 47, a claim for the refund of the amount of PhP
1,727,766.38 as erroneously paid tax on Gross Philippine Billings (GPB) for the
taxable year 2000. Such claim was unheeded. Thus, on April 14, 2003, petitioner
filed a Petition for Review with the CTA for the refund of the abovementioned
amount. The case was docketed as CTA Case No. 6656.
On May 10, 2006, the CTA First Division issued a Decision denying the petition for
lack of merit. The CTA ruled that petitioner is a resident foreign corporation engaged
in trade or business in the Philippines. It further ruled that petitioner was not liable
to pay tax on its GPB under Section 28(A)(3)(a) of the National Internal Revenue
Code (NIRC) of 1997. The CTA, however, stated that petitioner is liable to pay a tax
of 32% on its income derived from the sales of passage documents in
the Philippines. On this ground, the CTA denied petitioners claim for a refund.
Petitioners Motion for Reconsideration of the above decision was denied by the CTA
First Division in a Resolution dated August 11, 2006.
Thus, petitioner filed a Petition for Review before the CTA En Banc, reiterating its
claim for a refund of its tax payment on its GPB. This was denied by the CTA in its
assailed decision. A subsequent Motion for Reconsideration by petitioner was also
denied in the assailed resolution of the CTA En Banc.
Hence, petitioner went to us.
The Issues
Whether or not petitioner, as an off-line international carrier
selling passage documents through an independent sales agent in the
Philippines, is engaged in trade or business in the Philippines subject to
the 32% income tax imposed by Section 28 (A)(1) of the 1997 NIRC.

Whether or not the income derived by petitioner from the sale of


passage documents covering petitioners off-line flights is Philippinesource income subject to Philippine income tax.
Whether or not petitioner is entitled to a refund or a tax credit of
erroneously paid tax on Gross Philippine Billings for the taxable year
2000 in the amount of P1,727,766.38.[5]
The Courts Ruling
This petition must be denied.
Petitioner Is Subject to Income Tax
at the Rate of 32% of Its Taxable Income
Preliminarily, we emphasize that petitioner is claiming that it is exempted
from being taxed for its sale of passage documents in the Philippines. Petitioner,
however, failed to sufficiently prove such contention.
In Commissioner

of

Internal

Revenue

v.

Acesite

(Philippines)

Hotel

Corporation,[6] we held, Since an action for a tax refund partakes of the nature of an
exemption, which cannot be allowed unless granted in the most explicit and
categorical language, it is strictly construed against the claimant who must
discharge such burden convincingly.
Petitioner has failed to overcome such burden.
In essence, petitioner calls upon this Court to determine the legal implication
of the amendment to Sec. 28(A)(3)(a) of the 1997 NIRC defining GPB. It is
petitioners contention that, with the new definition of GPB, it is no longer liable
under Sec. 28(A)(3)(a). Further, petitioner argues that because the 2 1/2% tax on
GPB is inapplicable to it, it is thereby excluded from the imposition of any income
tax.
Sec. 28(b)(2) of the 1939 NIRC provided:
(2) Resident Corporations. A corporation organized, authorized,
or existing under the laws of a foreign country, engaged in trade or
business within the Philippines, shall be taxable as provided in
subsection (a) of this section upon the total net income received in the
preceding
taxable
year
from
all
sources
within
the

Philippines: Provided, however, that international carriers shall pay a


tax of two and one-half percent on their gross Philippine billings.
This provision was later amended by Sec. 24(B)(2) of the 1977 NIRC, which
defined GPB as follows:
Gross Philippine billings include gross revenue realized from uplifts
anywhere in the world by any international carrier doing business in
the Philippines of passage documents sold therein, whether for
passenger, excess baggage or mail, provided the cargo or mail
originates from the Philippines.
In the 1986 and 1993 NIRCs, the definition of GPB was further changed to
read:
Gross Philippine Billings means gross revenue realized from uplifts of
passengers anywhere in the world and excess baggage, cargo and mail
originating from the Philippines, covered by passage documents sold in
the Philippines.
Essentially, prior to the 1997 NIRC, GPB referred to revenues from uplifts
anywhere in the world, provided that the passage documents were sold in
the Philippines. Legislature departed from such concept in the 1997 NIRC where GPB
is now defined under Sec. 28(A)(3)(a):
Gross Philippine Billings refers to the amount of gross revenue
derived from carriage of persons, excess baggage, cargo and mail
originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of
payment of the ticket or passage document.
Now, it is the place of sale that is irrelevant; as long as the uplifts of
passengers and cargo occur to or from the Philippines, income is included in GPB.
As correctly pointed out by petitioner, inasmuch as it does not maintain
flights to or from the Philippines, it is not taxable under Sec. 28(A)(3)(a) of the 1997
NIRC. This much was also found by the CTA. But petitioner further posits the view
that due to the non-applicability of Sec. 28(A)(3)(a) to it, it is precluded from paying
any other income tax for its sale of passage documents in the Philippines.
Such position is untenable.

In Commissioner

of

Internal

Corporation (British Overseas Airways),

Revenue
[7]

v.

British

Overseas

Airways

which was decided under similar factual

circumstances, this Court ruled that off-line air carriers having general sales agents
in the Philippines are engaged in or doing business in the Philippines and that their
income from sales of passage documents here is income from within the Philippines.
Thus, in that case, we held the off-line air carrier liable for the 32% tax on its
taxable income.
Petitioner argues, however, that because British Overseas Airways was
decided under the 1939 NIRC, it does not apply to the instant case, which must be
decided under the 1997 NIRC. Petitioner alleges that the 1939 NIRC taxes resident
foreign

corporations,

such

as

itself,

on

all

income

from

sources

within

the Philippines. Petitioners interpretation of Sec. 28(A)(3)(a) of the 1997 NIRC is


that, since it is an international carrier that does not maintain flights to or from the
Philippines, thereby having no GPB as defined, it is exempt from paying any income
tax at all. In other words, the existence of Sec. 28(A)(3)(a) according to petitioner
precludes the application of Sec. 28(A)(1) to it.
Its argument has no merit.
First, the difference cited by petitioner between the 1939 and 1997 NIRCs
with regard to the taxation of off-line air carriers is more apparent than real.
We point out that Sec. 28(A)(3)(a) of the 1997 NIRC does not, in any
categorical term, exempt all international air carriers from the coverage of Sec.
28(A)(1) of the 1997 NIRC. Certainly, had legislatures intentions been to completely
exclude all international air carriers from the application of the general rule under
Sec. 28(A)(1), it would have used the appropriate language to do so; but the
legislature did not. Thus, the logical interpretation of such provisions is that, if Sec.
28(A)(3)(a) is applicable to a taxpayer, then the general rule under Sec. 28(A)(1)
would not apply. If, however, Sec. 28(A)(3)(a) does not apply, a resident foreign
corporation, whether an international air carrier or not, would be liable for the tax
under Sec. 28(A)(1).
Clearly, no difference exists between British Overseas Airways and the instant
case, wherein petitioner claims that the former case does not apply. Thus, British

Overseas Airways applies to the instant case. The findings therein that an off-line air
carrier is doing business in the Philippines and that income from the sale of passage
documents here is Philippine-source income must be upheld.
Petitioner further reiterates its argument that the intention of Congress in
amending the definition of GPB is to exempt off-line air carriers from income tax by
citing the pronouncements made by Senator Juan Ponce Enrile during the
deliberations on the provisions of the 1997 NIRC. Such pronouncements, however,
are not controlling on this Court. We said in Espino v. Cleofe:[8]
A cardinal rule in the interpretation of statutes is that the
meaning and intention of the law-making body must be sought, first of
all, in the words of the statute itself, read and considered in their
natural, ordinary, commonly-accepted and most obvious significations,
according to good and approved usage and without resorting to forced
or subtle construction. Courts, therefore, as a rule, cannot presume
that the law-making body does not know the meaning of words and
rules of grammar. Consequently, the grammatical reading of a statute
must be presumed to yield its correct sense. x x x It is also a wellsettled doctrine in this jurisdiction that statements made by
individual members of Congress in the consideration of a bill
do not necessarily reflect the sense of that body and are,
consequently, not controlling in the interpretation of
law. (Emphasis supplied.)
Moreover, an examination of the subject provisions of the law would show
that petitioners interpretation of those provisions is erroneous.
Sec. 28(A)(1) and (A)(3)(a) provides:
SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporations. (1) In General. - Except as otherwise provided in this Code, a
corporation organized, authorized, or existing under the laws of any
foreign country, engaged in trade or business within the Philippines,
shall be subject to an income tax equivalent to thirty-five percent
(35%) of the taxable income derived in the preceding taxable year
from all sources within the Philippines: provided, That effective January
1, 1998, the rate of income tax shall be thirty-four percent (34%);
effective January 1, 1999, the rate shall be thirty-three percent (33%),
and effective January 1, 2000 and thereafter, the rate shall be thirtytwo percent (32%).

xxxx
(3) International Carrier. - An international carrier doing business
in the Philippines shall pay a tax of two and one-half percent (2 1/2%)
on its Gross Philippine Billings as defined hereunder:
(a) International Air Carrier. Gross Philippine Billings refers
to the amount of gross revenue derived from carriage of
persons, excess baggage, cargo and mail originating from the
Philippines in a continuous and uninterrupted flight, irrespective
of the place of sale or issue and the place of payment of the
ticket or passage document: Provided, That tickets revalidated,
exchanged and/or indorsed to another international airline form
part of the Gross Philippine Billings if the passenger boards a
plane in a port or point in the Philippines: Provided, further, That
for a flight which originates from the Philippines, but
transshipment of passenger takes place at any port outside the
Philippines on another airline, only the aliquot portion of the cost
of the ticket corresponding to the leg flown from the Philippines
to the point of transshipment shall form part of Gross Philippine
Billings.
Sec. 28(A)(1) of the 1997 NIRC is a general rule that resident foreign
corporations

are

liable

for

32%

tax

on

all

income

from

sources

within

the Philippines. Sec. 28(A)(3) is an exception to this general rule.


An exception is defined as that which would otherwise be included in the
provision from which it is excepted. It is a clause which exempts something from the
operation of a statue by express words. [9] Further, an exception need not be
introduced by the words except or unless. An exception will be construed as such if
it removes something from the operation of a provision of law. [10]
In the instant case, the general rule is that resident foreign corporations shall
be liable for a 32% income tax on their income from within the Philippines, except
for resident foreign corporations that are international carriers that derive income
from carriage of persons, excess baggage, cargo and mail originating from the
Philippines which shall be taxed at 2 1/2% of their Gross Philippine Billings.
Petitioner,

being

an

international

carrier

with

no

flights

originating

from

the Philippines, does not fall under the exception. As such, petitioner must fall under
the general rule. This principle is embodied in the Latin maxim, exception firmat
regulam in casibus non exceptis, which means, a thing not being excepted must be
regarded as coming within the purview of the general rule. [11]

To reiterate, the correct interpretation of the above provisions is that, if an


international air carrier maintains flights to and from the Philippines, it shall be
taxed at the rate of 2 1/2% of its Gross Philippine Billings, while international air
carriers that do not have flights to and from the Philippines but nonetheless earn
income from other activities in the country will be taxed at the rate of 32% of such
income.
As to the denial of petitioners claim for refund, the CTA denied the claim on
the basis that petitioner is liable for income tax under Sec. 28(A)(1) of the 1997
NIRC. Thus, petitioner raises the issue of whether the existence of such liability
would preclude their claim for a refund of tax paid on the basis of Sec. 28(A)(3)(a).
In answer to petitioners motion for reconsideration, the CTA First Division ruled in its
Resolution dated August 11, 2006, thus:
On the fourth argument, petitioner avers that a deficiency tax
assessment does not, in any way, disqualify a taxpayer from claiming a
tax refund since a refund claim can proceed independently of a tax
assessment and that the assessment cannot be offset by its claim for
refund.
Petitioners argument is erroneous. Petitioner premises its
argument on the existence of an assessment. In the assailed Decision,
this Court did not, in any way, assess petitioner of any deficiency
corporate income tax. The power to make assessments against
taxpayers is lodged with the respondent. For an assessment to be
made, respondent must observe the formalities provided in Revenue
Regulations No. 12-99. This Court merely pointed out that petitioner is
liable for the regular corporate income tax by virtue of Section 28(A)(3)
of the Tax Code. Thus, there is no assessment to speak of. [12]
Precisely, petitioner questions the offsetting of its payment of the tax under
Sec. 28(A)(3)(a) with their liability under Sec. 28(A)(1), considering that there has
not yet been any assessment of their obligation under the latter provision. Petitioner
argues that such offsetting is in the nature of legal compensation, which cannot be
applied under the circumstances present in this case.
Article 1279 of the Civil Code contains the elements of legal compensation, to
wit:

Art. 1279. In order that compensation may be proper, it is


necessary:
(1) That each one of the obligors be bound principally,
and that he be at the same time a principal creditor of the other;
(2) That both debts consist in a sum of money, or if the
things due are consumable, they be of the same kind, and also
of the same quality if the latter has been stated;
(3) That the two debts be due;
(4) That they be liquidated and demandable;
(5) That over neither of them there be any retention or
controversy, commenced by third persons and communicated in
due time to the debtor.
And we ruled in Philex Mining Corporation v. Commissioner of Internal
Revenue,[13] thus:
In several instances prior to the instant case, we have already
made the pronouncement that taxes cannot be subject to
compensation for the simple reason that the government and the
taxpayer are not creditors and debtors of each other. There is a
material distinction between a tax and debt. Debts are due to the
Government in its corporate capacity, while taxes are due to the
Government in its sovereign capacity. We find no cogent reason to
deviate from the aforementioned distinction.
Prescinding from this premise, in Francia v. Intermediate
Appellate Court, we categorically held that taxes cannot be subject to
set-off or compensation, thus:
We have consistently ruled that there can be no offsetting of taxes against the claims that the taxpayer may have
against the government. A person cannot refuse to pay a tax on
the ground that the government owes him an amount equal to
or greater than the tax being collected. The collection of a tax
cannot await the results of a lawsuit against the government.
The ruling in Francia has been applied to the subsequent case
of Caltex Philippines, Inc. v. Commission on Audit, which reiterated
that:
. . . a taxpayer may not offset taxes due from the claims
that he may have against the government. Taxes cannot be the
subject of compensation because the government and taxpayer
are not mutually creditors and debtors of each other and a claim
for taxes is not such a debt, demand, contract or judgment as is
allowed to be set-off.

Verily, petitioners argument is correct that the offsetting of its tax refund with
its alleged tax deficiency is unavailing under Art. 1279 of the Civil Code.
Commissioner of Internal Revenue v. Court of Tax Appeals,[14] however,
granted the offsetting of a tax refund with a tax deficiency in this wise:
Further, it is also worth noting that the Court of Tax Appeals
erred in denying petitioners supplemental motion for reconsideration
alleging bringing to said courts attention the existence of the
deficiency income and business tax assessment against Citytrust. The
fact of such deficiency assessment is intimately related to and
inextricably intertwined with the right of respondent bank to claim for a
tax refund for the same year. To award such refund despite the
existence of that deficiency assessment is an absurdity and a polarity
in conceptual effects. Herein private respondent cannot be entitled to
refund and at the same time be liable for a tax deficiency assessment
for the same year.
The grant of a refund is founded on the assumption that
the tax return is valid, that is, the facts stated therein are true
and correct. The deficiency assessment, although not yet final,
created a doubt as to and constitutes a challenge against the
truth and accuracy of the facts stated in said return which, by
itself and without unquestionable evidence, cannot be the
basis for the grant of the refund.
Section 82, Chapter IX of the National Internal Revenue Code of
1977, which was the applicable law when the claim of Citytrust was
filed, provides that (w)hen an assessment is made in case of any list,
statement, or return, which in the opinion of the Commissioner of
Internal Revenue was false or fraudulent or contained any
understatement or undervaluation, no tax collected under such
assessment shall be recovered by any suits unless it is proved that the
said list, statement, or return was not false nor fraudulent and did not
contain any understatement or undervaluation; but this provision shall
not apply to statements or returns made or to be made in good faith
regarding annual depreciation of oil or gas wells and mines.
Moreover, to grant the refund without determination of the
proper assessment and the tax due would inevitably result in
multiplicity of proceedings or suits. If the deficiency assessment should
subsequently be upheld, the Government will be forced to institute
anew a proceeding for the recovery of erroneously refunded taxes
which recourse must be filed within the prescriptive period of ten years
after discovery of the falsity, fraud or omission in the false or
fraudulent return involved. This would necessarily require and entail
additional efforts and expenses on the part of the Government, impose
a burden on and a drain of government funds, and impede or delay the
collection of much-needed revenue for governmental operations.

Thus, to avoid multiplicity of suits and unnecessary difficulties or


expenses, it is both logically necessary and legally appropriate that the
issue of the deficiency tax assessment against Citytrust be resolved
jointly with its claim for tax refund, to determine once and for all in a
single proceeding the true and correct amount of tax due or
refundable.
In fact, as the Court of Tax Appeals itself has heretofore
conceded, it would be only just and fair that the taxpayer and the
Government alike be given equal opportunities to avail of remedies
under the law to defeat each others claim and to determine all matters
of dispute between them in one single case. It is important to note that
in determining whether or not petitioner is entitled to the refund of the
amount paid, it would [be] necessary to determine how much the
Government is entitled to collect as taxes. This would necessarily
include the determination of the correct liability of the taxpayer and,
certainly, a determination of this case would constitute res judicata on
both parties as to all the matters subject thereof or necessarily
involved therein. (Emphasis supplied.)
Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the
1997 NIRC. The above pronouncements are, therefore, still applicable today.
Here, petitioners similar tax refund claim assumes that the tax return that it
filed was correct. Given, however, the finding of the CTA that petitioner, although
not liable under Sec. 28(A)(3)(a) of the 1997 NIRC, is liable under Sec. 28(A)(1), the
correctness of the return filed by petitioner is now put in doubt. As such, we cannot
grant the prayer for a refund.
Be that as it may, this Court is unable to affirm the assailed decision and
resolution of the CTA En Banc on the outright denial of petitioners claim for a
refund. Even though petitioner is not entitled to a refund due to the question on the
propriety of petitioners tax return subject of the instant controversy, it would not be
proper to deny such claim without making a determination of petitioners liability
under Sec. 28(A)(1).
It must be remembered that the tax under Sec. 28(A)(3)(a) is based on GPB,
while Sec. 28(A)(1) is based on taxable income, that is, gross income less
deductions and exemptions, if any. It cannot be assumed that petitioners liabilities
under the two provisions would be the same. There is a need to make a
determination of petitioners liability under Sec. 28(A)(1) to establish whether a tax

refund is forthcoming or that a tax deficiency exists. The assailed decision fails to
mention having computed for the tax due under Sec. 28(A)(1) and the records are
bereft of any evidence sufficient to establish petitioners taxable income. There is a
necessity to receive evidence to establish such amount vis--vis the claim for refund.
It is only after such amount is established that a tax refund or deficiency may be
correctly pronounced.
WHEREFORE, the assailed July 19, 2007 Decision and October 30, 2007
Resolution of the CTA En Banc in CTA E.B. Case No. 210 are SET ASIDE. The instant
case is REMANDED to the CTA En Banc for further proceedings and appropriate
action, more particularly, the reception of evidence for both parties and the
corresponding disposition of CTA E.B. Case No. 210 not otherwise inconsistent with
our judgment in this Decision.
SO ORDERED.

Republic of the Philippines


SUPREME COURT
Manila
SECOND DIVISION
G.R. No. 195909

September 26, 2012

COMMISSIONER OF INTERNAL REVENUE, PETITIONER,


vs.
ST. LUKE'S MEDICAL CENTER, INC., RESPONDENT.

x-----------------------x
G.R. No. 195960
ST. LUKE'S MEDICAL CENTER, INC., PETITIONER,
vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
DECISION
CARPIO, J.:
The Case
These are consolidated 1 petitions for review on certiorari under Rule 45 of the Rules
of Court assailing the Decision of 19 November 2010 of the Court of Tax Appeals
(CTA) En Banc and its Resolution 2 of 1 March 2011 in CTA Case No. 6746. This Court
resolves this case on a pure question of law, which involves the interpretation of
Section 27(B) vis--vis Section 30(E) and (G) of the National Internal Revenue Code
of the Philippines (NIRC), on the income tax treatment of proprietary non-profit
hospitals.
The Facts
St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as a non-stock and
non-profit corporation. Under its articles of incorporation, among its corporate
purposes are:
(a) To establish, equip, operate and maintain a non-stock, non-profit Christian,
benevolent, charitable and scientific hospital which shall give curative,
rehabilitative and spiritual care to the sick, diseased and disabled persons;
provided that purely medical and surgical services shall be performed by duly
licensed physicians and surgeons who may be freely and individually
contracted by patients;
(b) To provide a career of health science education and provide medical
services to the community through organized clinics in such specialties as the
facilities and resources of the corporation make possible;
(c) To carry on educational activities related to the maintenance and
promotion of health as well as provide facilities for scientific and medical
researches which, in the opinion of the Board of Trustees, may be justified by
the facilities, personnel, funds, or other requirements that are available;
(d) To cooperate with organized medical societies, agencies of both
government and private sector; establish rules and regulations consistent
with the highest professional ethics;
xxxx

On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke's
deficiency taxes amounting toP76,063,116.06 for 1998, comprised of deficiency
income tax, value-added tax, withholding tax on compensation and expanded
withholding tax. The BIR reduced the amount to P63,935,351.57 during trial in the
First Division of the CTA. 4
On 14 January 2003, St. Luke's filed an administrative protest with the BIR against
the deficiency tax assessments. The BIR did not act on the protest within the 180day period under Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.
The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals, should be
applicable to St. Luke's. According to the BIR, Section 27(B), introduced in 1997, "is
a new provision intended to amend the exemption on non-profit hospitals that were
previously categorized as non-stock, non-profit corporations under Section 26 of the
1997 Tax Code x x x." 5 It is a specific provision which prevails over the general
exemption on income tax granted under Section 30(E) and (G) for non-stock, nonprofit charitable institutions and civic organizations promoting social welfare. 6
The BIR claimed that St. Luke's was actually operating for profit in 1998 because
only 13% of its revenues came from charitable purposes. Moreover, the hospital's
board of trustees, officers and employees directly benefit from its profits and assets.
St. Luke's had total revenues of P1,730,367,965 or approximately P1.73 billion from
patient services in 1998. 7
St. Luke's contended that the BIR should not consider its total revenues, because its
free services to patients wasP218,187,498 or 65.20% of its 1998 operating income
(i.e., total revenues less operating expenses) ofP334,642,615. 8 St. Luke's also
claimed that its income does not inure to the benefit of any individual.
St. Luke's maintained that it is a non-stock and non-profit institution for charitable
and social welfare purposes under Section 30(E) and (G) of the NIRC. It argued that
the making of profit per se does not destroy its income tax exemption.
The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments
before the CTA that Section 27(B) applies to St. Luke's. The petition raises the sole
issue of whether the enactment of Section 27(B) takes proprietary non-profit
hospitals out of the income tax exemption under Section 30 of the NIRC and instead,
imposes a preferential rate of 10% on their taxable income. The BIR prays that St.
Luke's be ordered to payP57,659,981.19 as deficiency income and expanded
withholding tax for 1998 with surcharges and interest for late payment.
The petition of St. Luke's in G.R. No. 195960 raises factual matters on the treatment
and withholding of a part of its income, 9 as well as the payment of surcharge and
delinquency interest. There is no ground for this Court to undertake such a factual
review. Under the Constitution 10 and the Rules of Court, 11 this Court's review power
is generally limited to "cases in which only an error or question of law is
involved." 12 This Court cannot depart from this limitation if a party fails to invoke a
recognized exception.

The Ruling of the Court of Tax Appeals


The CTA En Banc Decision on 19 November 2010 affirmed in toto the CTA First
Division Decision dated 23 February 2009 which held:
WHEREFORE, the Amended Petition for Review [by St. Luke's] is hereby PARTIALLY
GRANTED. Accordingly, the 1998 deficiency VAT assessment issued by respondent
against petitioner in the amount of P110,000.00 is hereby CANCELLED and
WITHDRAWN. However, petitioner is hereby ORDERED to PAY deficiency income tax
and deficiency expanded withholding tax for the taxable year 1998 in the respective
amounts of P5,496,963.54 andP778,406.84 or in the sum of P6,275,370.38, x x x.
xxxx
In addition, petitioner is hereby ORDERED to PAY twenty percent (20%) delinquency
interest on the total amount of P6,275,370.38 counted from October 15, 2003 until
full payment thereof, pursuant to Section 249(C)(3) of the NIRC of 1997.
SO ORDERED.

13

The deficiency income tax of P5,496,963.54, ordered by the CTA En Banc to be paid,
arose from the failure of St. Luke's to prove that part of its income in 1998 (declared
as "Other Income-Net") 14 came from charitable activities. The CTA cancelled the
remainder of the P63,113,952.79 deficiency assessed by the BIR based on the 10%
tax rate under Section 27(B) of the NIRC, which the CTA En Banc held was not
applicable to St. Luke's. 15
The CTA ruled that St. Luke's is a non-stock and non-profit charitable institution
covered by Section 30(E) and (G) of the NIRC. This ruling would exempt all income
derived by St. Luke's from services to its patients, whether paying or non-paying.
The CTA reiterated its earlier decision in St. Luke's Medical Center, Inc. v.
Commissioner of Internal Revenue, 16 which examined the primary purposes of St.
Luke's under its articles of incorporation and various documents 17 identifying St.
Luke's as a charitable institution.
The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City, 18 which
states that "a charitable institution does not lose its charitable character and its
consequent exemption from taxation merely because recipients of its benefits who
are able to pay are required to do so, where funds derived in this manner are
devoted to the charitable purposes of the institution x x x." 19 The generation of
income from paying patients does not per se destroy the charitable nature of St.
Luke's.
Hospital de San Juan cited Jesus Sacred Heart College v. Collector of Internal
Revenue, 20 which ruled that the old NIRC (Commonwealth Act No. 466, as
amended) 21 "positively exempts from taxation those corporations or associations
which, otherwise, would be subject thereto, because of the existence of x x x net
income." 22 The NIRC of 1997 substantially reproduces the provision on charitable
institutions of the old NIRC. Thus, in rejecting the argument that tax exemption is

lost whenever there is net income, the Court in Jesus Sacred Heart College declared:
"[E]very responsible organization must be run to at least insure its existence, by
operating within the limits of its own resources, especially its regular income. In
other words, it should always strive, whenever possible, to have a surplus." 23
The CTA held that Section 27(B) of the present NIRC does not apply to St.
Luke's. 24 The CTA explained that to apply the 10% preferential rate, Section 27(B)
requires a hospital to be "non-profit." On the other hand, Congress specifically used
the word "non-stock" to qualify a charitable "corporation or association" in Section
30(E) of the NIRC. According to the CTA, this is unique in the present tax code,
indicating an intent to exempt this type of charitable organization from income tax.
Section 27(B) does not require that the hospital be "non-stock." The CTA stated, "it
is clear that non-stock, non-profit hospitals operated exclusively for charitable
purpose are exempt from income tax on income received by them as such, applying
the provision of Section 30(E) of the NIRC of 1997, as amended." 25
The Issue
The sole issue is whether St. Luke's is liable for deficiency income tax in 1998 under
Section 27(B) of the NIRC, which imposes a preferential tax rate of 10% on the
income of proprietary non-profit hospitals.
The Ruling of the Court
St. Luke's Petition in G.R. No. 195960
As a preliminary matter, this Court denies the petition of St. Luke's in G.R. No.
195960 because the petition raises factual issues. Under Section 1, Rule 45 of the
Rules of Court, "[t]he petition shall raise only questions of law which must be
distinctly set forth." St. Luke's cites Martinez v. Court of Appeals 26 which permits
factual review "when the Court of Appeals [in this case, the CTA] manifestly
overlooked certain relevant facts not disputed by the parties and which, if properly
considered, would justify a different conclusion." 27
This Court does not see how the CTA overlooked relevant facts. St. Luke's itself
stated that the CTA "disregarded the testimony of [its] witness, Romeo B. Mary,
being allegedly self-serving, to show the nature of the 'Other Income-Net' x x
x." 28 This is not a case of overlooking or failing to consider relevant evidence. The
CTA obviously considered the evidence and concluded that it is self-serving. The CTA
declared that it has "gone through the records of this case and found no other
evidence aside from the self-serving affidavit executed by [the] witnesses [of St.
Luke's] x x x." 29
The deficiency tax on "Other Income-Net" stands. Thus, St. Luke's is liable to pay
the 25% surcharge under Section 248(A)(3) of the NIRC. There is "[f]ailure to pay
the deficiency tax within the time prescribed for its payment in the notice of
assessment[.]" 30 St. Luke's is also liable to pay 20% delinquency interest under
Section 249(C)(3) of the NIRC. 31 As explained by the CTA En Banc, the amount
of P6,275,370.38 in the dispositive portion of the CTA First Division Decision

includes only deficiency interest under Section 249(A) and (B) of the NIRC and not
delinquency interest. 32
The Main Issue
The issue raised by the BIR is a purely legal one. It involves the effect of the
introduction of Section 27(B) in the NIRC of 1997 vis--vis Section 30(E) and (G) on
the income tax exemption of charitable and social welfare institutions. The 10%
income tax rate under Section 27(B) specifically pertains to proprietary educational
institutions and proprietary non-profit hospitals. The BIR argues that Congress
intended to remove the exemption that non-profit hospitals previously enjoyed
under Section 27(E) of the NIRC of 1977, which is now substantially reproduced in
Section 30(E) of the NIRC of 1997. 33 Section 27(B) of the present NIRC provides:
SEC. 27. Rates of Income Tax on Domestic Corporations. xxxx
(B) Proprietary Educational Institutions and Hospitals. - Proprietary educational
institutions and hospitals which are non-profit shall pay a tax of ten percent (10%)
on their taxable income except those covered by Subsection (D) hereof: Provided,
That if the gross income from unrelated trade, business or other activity exceeds
fifty percent (50%) of the total gross income derived by such educational
institutions or hospitals from all sources, the tax prescribed in Subsection (A) hereof
shall be imposed on the entire taxable income. For purposes of this Subsection, the
term 'unrelated trade, business or other activity' means any trade, business or other
activity, the conduct of which is not substantially related to the exercise or
performance by such educational institution or hospital of its primary purpose or
function. A 'proprietary educational institution' is any private school maintained and
administered by private individuals or groups with an issued permit to operate from
the Department of Education, Culture and Sports (DECS), or the Commission on
Higher Education (CHED), or the Technical Education and Skills Development
Authority (TESDA), as the case may be, in accordance with existing laws and
regulations. (Emphasis supplied)
St. Luke's claims tax exemption under Section 30(E) and (G) of the NIRC. It contends
that it is a charitable institution and an organization promoting social welfare. The
arguments of St. Luke's focus on the wording of Section 30(E) exempting from
income tax non-stock, non-profit charitable institutions. 34 St. Luke's asserts that the
legislative intent of introducing Section 27(B) was only to remove the exemption for
"proprietary non-profit" hospitals. 35 The relevant provisions of Section 30 state:
SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall
not be taxed under this Title in respect to income received by them as such:
xxxx
(E) Nonstock corporation or association organized and operated exclusively for
religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation

of veterans, no part of its net income or asset shall belong to or inure to the benefit
of any member, organizer, officer or any specific person;
xxxx
(G) Civic league or organization not organized for profit but operated exclusively for
the promotion of social welfare;
xxxx
Notwithstanding the provisions in the preceding paragraphs, the income of
whatever kind and character of the foregoing organizations from any of their
properties, real or personal, or from any of their activities conducted for profit
regardless of the disposition made of such income, shall be subject to tax imposed
under this Code. (Emphasis supplied)
The Court partly grants the petition of the BIR but on a different ground. We hold
that Section 27(B) of the NIRC does not remove the income tax exemption of
proprietary non-profit hospitals under Section 30(E) and (G). Section 27(B) on one
hand, and Section 30(E) and (G) on the other hand, can be construed together
without the removal of such tax exemption. The effect of the introduction of Section
27(B) is to subject the taxable income of two specific institutions, namely,
proprietary non-profit educational institutions 36 and proprietary non-profit hospitals,
among the institutions covered by Section 30, to the 10% preferential rate under
Section 27(B) instead of the ordinary 30% corporate rate under the last paragraph
of Section 30 in relation to Section 27(A)(1).
Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1)
proprietary non-profit educational institutions and (2) proprietary non-profit
hospitals. The only qualifications for hospitals are that they must be proprietary and
non-profit. "Proprietary" means private, following the definition of a "proprietary
educational institution" as "any private school maintained and administered by
private individuals or groups" with a government permit. "Non-profit" means no net
income or asset accrues to or benefits any member or specific person, with all the
net income or asset devoted to the institution's purposes and all its activities
conducted not for profit.
"Non-profit" does not necessarily mean "charitable." In Collector of Internal Revenue
v. Club Filipino Inc. de Cebu,37 this Court considered as non-profit a sports club
organized for recreation and entertainment of its stockholders and members. The
club was primarily funded by membership fees and dues. If it had profits, they were
used for overhead expenses and improving its golf course. 38 The club was non-profit
because of its purpose and there was no evidence that it was engaged in a profitmaking enterprise. 39
The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not
charitable. The Court defined "charity" in Lung Center of the Philippines v. Quezon
City 40 as "a gift, to be applied consistently with existing laws, for the benefit of an
indefinite number of persons, either by bringing their minds and hearts under the

influence of education or religion, by assisting them to establish themselves in life


or [by] otherwise lessening the burden of government." 41 A non-profit club for the
benefit of its members fails this test. An organization may be considered as nonprofit if it does not distribute any part of its income to stockholders or members.
However, despite its being a tax exempt institution, any income such institution
earns from activities conducted for profit is taxable, as expressly provided in the last
paragraph of Section 30.
To be a charitable institution, however, an organization must meet the substantive
test of charity in Lung Center. The issue in Lung Center concerns exemption from
real property tax and not income tax. However, it provides for the test of charity in
our jurisdiction. Charity is essentially a gift to an indefinite number of persons which
lessens the burden of government. In other words, charitable institutions provide for
free goods and services to the public which would otherwise fall on the shoulders of
government. Thus, as a matter of efficiency, the government forgoes taxes which
should have been spent to address public needs, because certain private entities
already assume a part of the burden. This is the rationale for the tax exemption of
charitable institutions. The loss of taxes by the government is compensated by its
relief from doing public works which would have been funded by appropriations
from the Treasury. 42
Charitable institutions, however, are not ipso facto entitled to a tax exemption. The
requirements for a tax exemption are specified by the law granting it. The power of
Congress to tax implies the power to exempt from tax. Congress can create tax
exemptions, subject to the constitutional provision that "[n]o law granting any tax
exemption shall be passed without the concurrence of a majority of all the Members
of Congress." 43 The requirements for a tax exemption are strictly construed against
the taxpayer 44 because an exemption restricts the collection of taxes necessary for
the existence of the government.
The Court in Lung Center declared that the Lung Center of the Philippines is a
charitable institution for the purpose of exemption from real property taxes. This
ruling uses the same premise as Hospital de San Juan 45and Jesus Sacred Heart
College 46 which says that receiving income from paying patients does not destroy
the charitable nature of a hospital.
As a general principle, a charitable institution does not lose its character as such
and its exemption from taxes simply because it derives income from paying
patients, whether out-patient, or confined in the hospital, or receives subsidies from
the government, so long as the money received is devoted or used altogether to the
charitable object which it is intended to achieve; and no money inures to the private
benefit of the persons managing or operating the institution. 47
For real property taxes, the incidental generation of income is permissible because
the test of exemption is the use of the property. The Constitution provides that
"[c]haritable institutions, churches and personages or convents appurtenant
thereto, mosques, non-profit cemeteries, and all lands, buildings, and
improvements, actually, directly, and exclusively used for religious, charitable, or
educational purposes shall be exempt from taxation." 48The test of exemption is not
strictly a requirement on the intrinsic nature or character of the institution. The test

requires that the institution use the property in a certain way, i.e. for a charitable
purpose. Thus, the Court held that the Lung Center of the Philippines did not lose its
charitable character when it used a portion of its lot for commercial purposes. The
effect of failing to meet the use requirement is simply to remove from the tax
exemption that portion of the property not devoted to charity.
The Constitution exempts charitable institutions only from real property taxes. In the
NIRC, Congress decided to extend the exemption to income taxes. However, the
way Congress crafted Section 30(E) of the NIRC is materially different from Section
28(3), Article VI of the Constitution. Section 30(E) of the NIRC defines the
corporation or association that is exempt from income tax. On the other hand,
Section 28(3), Article VI of the Constitution does not define a charitable institution,
but requires that the institution "actually, directly and exclusively" use the property
for a charitable purpose.
Section 30(E) of the NIRC provides that a charitable institution must be:
(1) A non-stock corporation or association;
(2) Organized exclusively for charitable purposes;
(3) Operated exclusively for charitable purposes; and
(4) No part of its net income or asset shall belong to or inure to the benefit of
any member, organizer, officer or any specific person.
Thus, both the organization and operations of the charitable institution must be
devoted "exclusively" for charitable purposes. The organization of the institution
refers to its corporate form, as shown by its articles of incorporation, by-laws and
other constitutive documents. Section 30(E) of the NIRC specifically requires that
the corporation or association be non-stock, which is defined by the Corporation
Code as "one where no part of its income is distributable as dividends to its
members, trustees, or officers" 49 and that any profit "obtain[ed] as an incident to its
operations shall, whenever necessary or proper, be used for the furtherance of the
purpose or purposes for which the corporation was organized." 50 However, under
Lung Center, any profit by a charitable institution must not only be plowed back
"whenever necessary or proper," but must be "devoted or used altogether to the
charitable object which it is intended to achieve." 51
The operations of the charitable institution generally refer to its regular activities.
Section 30(E) of the NIRC requires that these operations be exclusive to charity.
There is also a specific requirement that "no part of [the] net income or asset shall
belong to or inure to the benefit of any member, organizer, officer or any specific
person." The use of lands, buildings and improvements of the institution is but a
part of its operations.
There is no dispute that St. Luke's is organized as a non-stock and non-profit
charitable institution. However, this does not automatically exempt St. Luke's from
paying taxes. This only refers to the organization of St. Luke's. Even if St. Luke's

meets the test of charity, a charitable institution is not ipso facto tax exempt. To be
exempt from real property taxes, Section 28(3), Article VI of the Constitution
requires that a charitable institution use the property "actually, directly and
exclusively" for charitable purposes. To be exempt from income taxes, Section 30(E)
of the NIRC requires that a charitable institution must be "organized and operated
exclusively" for charitable purposes. Likewise, to be exempt from income taxes,
Section 30(G) of the NIRC requires that the institution be "operated exclusively" for
social welfare.
However, the last paragraph of Section 30 of the NIRC qualifies the words
"organized and operated exclusively" by providing that:
Notwithstanding the provisions in the preceding paragraphs, the income of
whatever kind and character of the foregoing organizations from any of their
properties, real or personal, or from any of their activities conducted for profit
regardless of the disposition made of such income, shall be subject to tax imposed
under this Code. (Emphasis supplied)
In short, the last paragraph of Section 30 provides that if a tax exempt charitable
institution conducts "any" activity for profit, such activity is not tax exempt even as
its not-for-profit activities remain tax exempt. This paragraph qualifies the
requirements in Section 30(E) that the "[n]on-stock corporation or association [must
be] organized and operated exclusively for x x x charitable x x x purposes x x x." It
likewise qualifies the requirement in Section 30(G) that the civic organization must
be "operated exclusively" for the promotion of social welfare.
Thus, even if the charitable institution must be "organized and operated
exclusively" for charitable purposes, it is nevertheless allowed to engage in
"activities conducted for profit" without losing its tax exempt status for its not-forprofit activities. The only consequence is that the "income of whatever kind and
character" of a charitable institution "from any of its activities conducted for profit,
regardless of the disposition made of such income, shall be subject to tax." Prior to
the introduction of Section 27(B), the tax rate on such income from for-profit
activities was the ordinary corporate rate under Section 27(A). With the introduction
of Section 27(B), the tax rate is now 10%.
In 1998, St. Luke's had total revenues of P1,730,367,965 from services to paying
patients. It cannot be disputed that a hospital which receives approximately P1.73
billion from paying patients is not an institution "operated exclusively" for charitable
purposes. Clearly, revenues from paying patients are income received from
"activities conducted for profit." 52 Indeed, St. Luke's admits that it derived profits
from its paying patients. St. Luke's declared P1,730,367,965 as "Revenues from
Services to Patients" in contrast to its "Free Services" expenditure ofP218,187,498.
In its Comment in G.R. No. 195909, St. Luke's showed the following "calculation" to
support its claim that 65.20% of its "income after expenses was allocated to free or
charitable services" in 1998. 53
REVENUES FROM SERVICES TO PATIENTS

P1,730,367,965.0
0

OPERATING EXPENSES
Professional care of patients
Administrative
Household and Property

P1,016,608,394.0
0
287,319,334.00
91,797,622.00
P1,395,725,350.0
0

INCOME FROM OPERATIONS


Free Services
INCOME FROM OPERATIONS, Net of FREE SERVICES

OTHER INCOME

EXCESS OF REVENUES OVER EXPENSES

P334,642,615.00

100%

-218,187,498.00 -65.20%
P116,455,117.00

34.80%

17,482,304.00

P133,937,421.0
0

In Lung Center, this Court declared:


"[e]xclusive" is defined as possessed and enjoyed to the exclusion of others;
debarred from participation or enjoyment; and "exclusively" is defined, "in a manner
to exclude; as enjoying a privilege exclusively." x x x The words "dominant use" or
"principal use" cannot be substituted for the words "used exclusively" without doing
violence to the Constitution and the law. Solely is synonymous with exclusively. 54
The Court cannot expand the meaning of the words "operated exclusively" without
violating the NIRC. Services to paying patients are activities conducted for profit.
They cannot be considered any other way. There is a "purpose to make profit over
and above the cost" of services. 55 The P1.73 billion total revenues from paying
patients is not even incidental to St. Luke's charity expenditure of P218,187,498 for
non-paying patients.
St. Luke's claims that its charity expenditure of P218,187,498 is 65.20% of its
operating income in 1998. However, if a part of the remaining 34.80% of the
operating income is reinvested in property, equipment or facilities used for services

to paying and non-paying patients, then it cannot be said that the income is
"devoted or used altogether to the charitable object which it is intended to
achieve." 56 The income is plowed back to the corporation not entirely for charitable
purposes, but for profit as well. In any case, the last paragraph of Section 30 of the
NIRC expressly qualifies that income from activities for profit is taxable "regardless
of the disposition made of such income."
Jesus Sacred Heart College declared that there is no official legislative record
explaining the phrase "any activity conducted for profit." However, it quoted a
deposition of Senator Mariano Jesus Cuenco, who was a member of the Committee
of Conference for the Senate, which introduced the phrase "or from any activity
conducted for profit."
P. Cuando ha hablado de la Universidad de Santo Toms que tiene un hospital, no
cree Vd. que es una actividad esencial dicho hospital para el funcionamiento del
colegio de medicina de dicha universidad?
xxxx
R. Si el hospital se limita a recibir enformos pobres, mi contestacin seria
afirmativa; pero considerando que el hospital tiene cuartos de pago, y a los mismos
generalmente van enfermos de buena posicin social econmica, lo que se paga
por estos enfermos debe estar sujeto a 'income tax', y es una de las razones que
hemos tenido para insertar las palabras o frase 'or from any activity conducted for
profit.' 57
The question was whether having a hospital is essential to an educational institution
like the College of Medicine of the University of Santo Tomas. Senator Cuenco
answered that if the hospital has paid rooms generally occupied by people of good
economic standing, then it should be subject to income tax. He said that this was
one of the reasons Congress inserted the phrase "or any activity conducted for
profit."
The question in Jesus Sacred Heart College involves an educational
institution. 58 However, it is applicable to charitable institutions because Senator
Cuenco's response shows an intent to focus on the activities of charitable
institutions. Activities for profit should not escape the reach of taxation. Being a
non-stock and non-profit corporation does not, by this reason alone, completely
exempt an institution from tax. An institution cannot use its corporate form to
prevent its profitable activities from being taxed.
The Court finds that St. Luke's is a corporation that is not "operated exclusively" for
charitable or social welfare purposes insofar as its revenues from paying patients
are concerned. This ruling is based not only on a strict interpretation of a provision
granting tax exemption, but also on the clear and plain text of Section 30(E) and
(G). Section 30(E) and (G) of the NIRC requires that an institution be "operated
exclusively" for charitable or social welfare purposes to be completely exempt from
income tax. An institution under Section 30(E) or (G) does not lose its tax exemption
if it earns income from its for-profit activities. Such income from for-profit activities,

under the last paragraph of Section 30, is merely subject to income tax, previously
at the ordinary corporate rate but now at the preferential 10% rate pursuant to
Section 27(B).
A tax exemption is effectively a social subsidy granted by the State because an
exempt institution is spared from sharing in the expenses of government and yet
benefits from them. Tax exemptions for charitable institutions should therefore be
limited to institutions beneficial to the public and those which improve social
welfare. A profit-making entity should not be allowed to exploit this subsidy to the
detriment of the government and other taxpayers.1wphi1
St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to
be completely tax exempt from all its income. However, it remains a proprietary
non-profit hospital under Section 27(B) of the NIRC as long as it does not distribute
any of its profits to its members and such profits are reinvested pursuant to its
corporate purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to the
preferential tax rate of 10% on its net income from its for-profit activities.
St. Luke's is therefore liable for deficiency income tax in 1998 under Section 27(B)
of the NIRC. However, St. Luke's has good reasons to rely on the letter dated 6 June
1990 by the BIR, which opined that St. Luke's is "a corporation for purely charitable
and social welfare purposes"59 and thus exempt from income tax. 60 In Michael J.
Lhuillier, Inc. v. Commissioner of Internal Revenue, 61 the Court said that "good faith
and honest belief that one is not subject to tax on the basis of previous
interpretation of government agencies tasked to implement the tax law, are
sufficient justification to delete the imposition of surcharges and interest." 62
WHEREFORE, the petition of the Commissioner of Internal Revenue in G.R. No.
195909 is PARTLY GRANTED. The Decision of the Court of Tax Appeals En Banc dated
19 November 2010 and its Resolution dated 1 March 2011 in CTA Case No. 6746 are
MODIFIED. St. Luke's Medical Center, Inc. is ORDERED TO PAY the deficiency income
tax in 1998 based on the 10% preferential income tax rate under Section 27(B) of
the National Internal Revenue Code. However, it is not liable for surcharges and
interest on such deficiency income tax under Sections 248 and 249 of the National
Internal Revenue Code. All other parts of the Decision and Resolution of the Court of
Tax Appeals are AFFIRMED.
The petition of St. Luke's Medical Center, Inc. in G.R. No. 195960 is DENIED for
violating Section 1, Rule 45 of the Rules of Court.
SO ORDERED.
Leonardo-De Castro*, Brion, Perez, and Perlas-Bernabe, JJ., concur.

G.R. No. 198756, January 13, 2015


BANCO DE ORO, BANK OF COMMERCE, CHINA BANKING CORPORATION,
METROPOLITAN BANK & TRUST COMPANY, PHILIPPINE BANK OF
COMMUNICATIONS, PHILIPPINE NATIONAL BANK, PHILIPPINE VETERANS
BANK AND PLANTERS DEVELOPMENT BANK, Petitioners,
RIZAL COMMERCIAL BANKING CORPORATION AND RCBC CAPITAL
CORPORATION, Petitioners,
CAUCUS OF DEVELOPMENT NGO NETWORKS, Petitioner-Intervenor,
v. REPUBLIC OF THE PHILIPPINES, THE COMMISSIONER OF INTERNAL
REVENUE, BUREAU OF INTERNAL REVENUE, SECRETARY OF FINANCE,
DEPARTMENT OF FINANCE, THE NATIONAL TREASURER AND BUREAU OF
TREASURY, Respondents.
DECISION
LEONEN, J.:
The case involves the proper tax treatment of the discount or interest income
arising from the P35 billion worth of 10-year zero-coupon treasury bonds issued by
the Bureau of Treasury on October 18, 2001 (denominated as the Poverty
Eradication and Alleviation Certificates or the PEACe Bonds by the Caucus of
Development NGO Networks).
On October 7, 2011, the Commissioner of Internal Revenue issued BIR Ruling No.
370-20111 (2011 BIR Ruling), declaring that the PEACe Bonds being deposit
substitutes are subject to the 20% final withholding tax. Pursuant to this ruling, the
Secretary of Finance directed the Bureau of Treasury to withhold a 20% final tax
from the face value of the PEACe Bonds upon their payment at maturity on October
18, 2011.
This is a petition for certiorari, prohibition and/or mandamus 2 filed by petitioners
under Rule 65 of the Rules of Court seeking to:chanroblesvirtuallawlibrary
a. ANNUL Respondent BIRs Ruling No. 370-2011 dated 7 October 2011 [and] other
related rulings issued by BIR of similar tenor and import, for being unconstitutional
and for having been issued without jurisdiction or with grave abuse of discretion
amounting to lack or excess of jurisdiction. . .;
b. PROHIBIT Respondents, particularly the BTr, from withholding or collecting the
20% FWT from the payment of the face value of the Government Bonds upon their
maturity;
c. COMMAND Respondents, particularly the BTr, to pay the full amount of the face

value of the Government Bonds upon maturity. . .; and


d. SECURE a temporary restraining order (TRO), and subsequently a writ of
preliminary injunction, enjoining Respondents, particularly the BIR and the BTr, from
withholding or collecting 20% FWT on the Government Bonds and the respondent
BIR from enforcing the assailed 2011 BIR Ruling, as well as other related rulings
issued by the BIR of similar tenor and import, pending the resolution by [the court]
of the merits of [the] Petition.3
Factual background
By letter4 dated March 23, 2001, the Caucus of Development NGO Networks (CODENGO) with the assistance of its financial advisors, Rizal Commercial Banking Corp.
(RCBC), RCBC Capital Corp. (RCBC Capital), CAPEX Finance and Investment
Corp. (CAPEX) and SEED Capital Ventures, Inc. (SEED),5 requested an approval
from the Department of Finance for the issuance by the Bureau of Treasury of 10year zero-coupon Treasury Certificates (T-notes). 6 The T-notes would initially be
purchased by a special purpose vehicle on behalf of CODE-NGO, repackaged and
sold at a premium to investors as the PEACe Bonds. 7 The net proceeds from the
sale of the Bonds will be used to endow a permanent fund (Hanapbuhay Fund) to
finance meritorious activities and projects of accredited non-government
organizations (NGOs) throughout the country.8chanRoblesvirtualLawlibrary
Prior to and around the time of the proposal of CODE-NGO, other proposals for the
issuance of zero-coupon bonds were also presented by banks and financial
institutions, such as First Metro Investment Corporation (proposal dated March 1,
2001),9 International Exchange Bank (proposal dated July 27, 2000), 10 Security Bank
Corporation and SB Capital Investment Corporation (proposal dated July 25,
2001),11 and ATR-Kim Eng Fixed Income, Inc. (proposal dated August 25, 1999). 12
[B]oth the proposals of First Metro Investment Corp. and ATR-Kim Eng Fixed Income
indicate that the interest income or discount earned on the proposed zero-coupon
bonds would be subject to the prevailing withholding
tax.13chanRoblesvirtualLawlibrary
A zero-coupon bond is a bond bought at a price substantially lower than its face
value (or at a deep discount), with the face value repaid at the time of maturity. 14 It
does not make periodic interest payments, or have so-called coupons, hence the
term zero-coupon bond.15 However, the discount to face value constitutes the
return to the bondholder.16chanRoblesvirtualLawlibrary
On May 31, 2001, the Bureau of Internal Revenue, in reply to CODE-NGOs letters
dated May 10, 15, and 25, 2001, issued BIR Ruling No. 020-2001 17 on the tax
treatment of the proposed PEACe Bonds. BIR Ruling No. 020-2001, signed by then
Commissioner of Internal Revenue Ren G. Baez confirmed that the PEACe Bonds
would not be classified as deposit substitutes and would not be subject to the
corresponding withholding tax:chanroblesvirtuallawlibrary
Thus, to be classified as deposit substitutes, the borrowing of funds must be
obtained from twenty (20) or more individuals or corporate lenders at any one
time. In the light of your representation that the PEACe Bonds will be issued only to

one entity, i.e., Code NGO, the same shall not be considered as deposit
substitutes falling within the purview of the above definition. Hence, the
withholding tax on deposit substitutes will not apply. 18 (Emphasis supplied)
The tax treatment of the proposed PEACe Bonds in BIR Ruling No. 020-2001 was
subsequently reiterated in BIR Ruling No. 035-2001 19 dated August 16, 2001 and BIR
Ruling No. DA-175-0120 dated September 29, 2001 (collectively, the 2001 Rulings).
In sum, these rulings pronounced that to be able to determine whether the financial
assets, i.e., debt instruments and securities are deposit substitutes, the 20 or more
individual or corporate lenders rule must apply. Moreover, the determination of the
phrase at any one time for purposes of determining the 20 or more lenders is to
be determined at the time of the original issuance. Such being the case, the PEACe
Bonds were not to be treated as deposit substitutes.
Meanwhile, in the memorandum21 dated July 4, 2001, Former Treasurer Eduardo
Sergio G. Edeza (Former Treasurer Edeza) questioned the propriety of issuing the
bonds directly to a special purpose vehicle considering that the latter was not a
Government Securities Eligible Dealer (GSED).22 Former Treasurer Edeza
recommended that the issuance of the Bonds be done through the ADAPS 23 and
that CODE-NGO should get a GSED to bid in [sic] its
behalf.24chanRoblesvirtualLawlibrary
Subsequently, in the notice to all GSEDs entitled Public Offering of Treasury
Bonds25 (Public Offering) dated October 9, 2001, the Bureau of Treasury announced
that P30.0B worth of 10-year Zero[-] Coupon Bonds [would] be auctioned on
October 16, 2001[.]26 The notice stated that the Bonds shall be issued to not
more than 19 buyers/lenders hence, the necessity of a manual auction for this
maiden issue.27 It also required the GSEDs to submit their bids not later than 12
noon on auction date and to disclose in their bid submissions the names of the
institutions bidding through them to ensure strict compliance with the 19 lender
limit.28 Lastly, it stated that the issue being limited to 19 lenders and while taxable
shall not be subject to the 20% final withholding
[tax].29chanRoblesvirtualLawlibrary
On October 12, 2001, the Bureau of Treasury released a memo 30 on the Formula for
the Zero-Coupon Bond. The memo stated in part that the formula (in determining
the purchase price and settlement amount) is only applicable to the zeroes that
are not subject to the 20% final withholding due to the 19 buyer/lender
limit.31chanRoblesvirtualLawlibrary
A day before the auction date or on October 15, 2001, the Bureau of Treasury issued
the Auction Guidelines for the 10-year Zero-Coupon Treasury Bond to be Issued on
October 16, 2001 (Auction Guidelines).32 The Auction Guidelines reiterated that
the Bonds to be auctioned are [n]ot subject to 20% withholding tax as the issue
will be limited to a maximum of 19 lenders in the primary market (pursuant to BIR
Revenue Regulation No. 020 2001).33 The Auction Guidelines, for the first time,
also stated that the Bonds are [e]ligible as liquidity reserves (pursuant to MB
Resolution No. 1545 dated 27 September 2001)[.] 34chanRoblesvirtualLawlibrary
On October 16, 2001, the Bureau of Treasury held an auction for the 10-year zero-

coupon bonds.35 Also on the same date, the Bureau of Treasury issued another
memorandum36 quoting excerpts of the ruling issued by the Bureau of Internal
Revenue concerning the Bonds exemption from 20% final withholding tax and the
opinion of the Monetary Board on reserve eligibility. 37chanRoblesvirtualLawlibrary
During the auction, there were 45 bids from 15 GSEDs. 38 The bidding range was
very wide, from as low as 12.248% to as high as 18.000%. 39 Nonetheless, the
Bureau of Treasury accepted the auction results. 40 The cut-off was at
12.75%.41chanRoblesvirtualLawlibrary
After the auction, RCBC which participated on behalf of CODE-NGO was declared as
the winning bidder having tendered the lowest bids. 42 Accordingly, on October 18,
2001, the Bureau of Treasury issued P35 billion worth of Bonds at yield-to-maturity
of 12.75% to RCBC for approximately P10.17 billion,43resulting in a discount of
approximately P24.83 billion.
Also on October 16, 2001, RCBC Capital entered into an underwriting
agreement44 with CODE-NGO, whereby RCBC Capital was appointed as the Issue
Manager and Lead Underwriter for the offering of the PEACe Bonds. 45 RCBC Capital
agreed to underwrite46 on a firm basis the offering, distribution and sale of the P35
billion Bonds at the price of P11,995,513,716.51. 47 In Section 7(r) of the
underwriting agreement, CODE-NGO represented that [a]ll income derived from
the Bonds, inclusive of premium on redemption and gains on the trading of the
same, are exempt from all forms of taxation as confirmed by Bureau of Internal
Revenue (BIR) letter rulings dated 31 May 2001 and 16 August 2001,
respectively.48chanRoblesvirtualLawlibrary
RCBC Capital sold the Government Bonds in the secondary market for an issue price
of P11,995,513,716.51. Petitioners purchased the PEACe Bonds on different
dates.49chanRoblesvirtualLawlibrary
BIR rulings
On October 7, 2011, the BIR issued the assailed 2011 BIR Ruling imposing a 20%
FWT on the Government Bonds and directing the BIR to withhold said final tax at the
maturity thereof, [allegedly without] consultation with Petitioners as bondholders,
and without conducting any hearing.50chanRoblesvirtualLawlibrary
It appears that the assailed 2011 BIR Ruling was issued in response to a query of
the Secretary of Finance on the proper tax treatment of the discount or interest
income derived from the Government Bonds. 51 The Bureau of Internal Revenue,
citing three (3) of its rulings rendered in 2004 and 2005, namely: BIR Ruling No.
007-0452 dated July 16, 2004; BIR Ruling No. DA-491-0453 dated September 13,
2004; and BIR Ruling No. 008-0554 dated July 28, 2005, declared the
following:chanroblesvirtuallawlibrary
The Php 24.3 billion discount on the issuance of the PEACe Bonds should be subject
to 20% Final Tax on interest income from deposit substitutes. It is now settled that
all treasury bonds (including PEACe Bonds), regardless of the number of
purchasers/lenders at the time of origination/issuance are considered deposit

substitutes. In the case of zero-coupon bonds, the discount (i.e. difference between
face value and purchase price/discounted value of the bond) is treated as interest
income of the purchaser/holder. Thus, the Php 24.3 interest income should have
been properly subject to the 20% Final Tax as provided in Section 27(D)(1) of the Tax
Code of 1997. . . .
....
However, at the time of the issuance of the PEACe Bonds in 2001, the BTr was not
able to collect the final tax on the discount/interest income realized by RCBC as a
result of the 2001 Rulings. Subsequently, the issuance of BIR Ruling No. 007-04
dated July 16, 2004 effectively modifies and supersedes the 2001 Rulings by stating
that the [1997] Tax Code is clear that the term public means borrowing from
twenty (20) or more individual or corporate lenders at any one time. The word
any plainly indicates that the period contemplated is the entire term of the bond,
and not merely the point of origination or issuance. . . . Thus, by taking the PEACe
bonds out of the ambit of deposits [sic] substitutes and exempting it from the 20%
Final Tax, an exemption in favour of the PEACe Bonds was created when no such
exemption is found in the law.55
On October 11, 2011, a Memo for Trading Participants No. 58-2011 was issued by
the Philippine Dealing System Holdings Corporation and Subsidiaries (PDS
Group). The Memo provides that in view of the pronouncement of the DOF and the
BIR on the applicability of the 20% FWT on the Government Bonds, no transfer of
the same shall be allowed to be recorded in the Registry of Scripless Securities
(ROSS) from 12 October 2011 until the redemption payment date on 18 October
2011. Thus, the bondholders of record appearing on the ROSS as of 18 October
2011, which include the Petitioners, shall be treated by the BTr as the beneficial
owners of such securities for the relevant [tax] payments to be imposed
thereon.56chanRoblesvirtualLawlibrary
On October 17, 2011, replying to an urgent query from the Bureau of Treasury, the
Bureau of Internal Revenue issued BIR Ruling No. DA 378-201157 clarifying that
the final withholding tax due on the discount or interest earned on the PEACe Bonds
should be imposed and withheld not only on RCBC/CODE NGO but also [on] all
subsequent holders of the Bonds. 58chanRoblesvirtualLawlibrary
On October 17, 2011, petitioners filed a petition for certiorari, prohibition, and/or
mandamus (with urgent application for a temporary restraining order and/or writ of
preliminary injunction)59 before this court.
On October 18, 2011, this court issued a temporary restraining order
(TRO)60 enjoining the implementation of BIR Ruling No. 370-2011 against the
[PEACe Bonds,] . . . subject to the condition that the 20% final withholding tax on
interest income therefrom shall be withheld by the petitioner banks and placed in
escrow pending resolution of [the] petition. 61chanRoblesvirtualLawlibrary
On October 28, 2011, RCBC and RCBC Capital filed a motion for leave of court to
intervene and to admit petition-in-intervention 62 dated October 27, 2011, which was
granted by this court on November 15, 2011. 63chanRoblesvirtualLawlibrary

Meanwhile, on November 9, 2011, petitioners filed their Manifestation with Urgent


Ex Parte Motion to Direct Respondents to Comply with the TRO. 64 They alleged that
on the same day that the temporary restraining order was issued, the Bureau of
Treasury paid to petitioners and other bondholders the amounts representing the
face value of the Bonds, net however of the amounts corresponding to the 20% final
withholding tax on interest income, and that the Bureau of Treasury refused to
release the amounts corresponding to the 20% final withholding
tax.65chanRoblesvirtualLawlibrary
On November 15, 2011, this court directed respondents to: (1) SHOW CAUSE why
they failed to comply with the October 18, 2011 resolution; and (2) COMPLY with the
Courts resolution in order that petitioners may place the corresponding funds in
escrow pending resolution of the petition. 66chanRoblesvirtualLawlibrary
On the same day, CODE-NGO filed a motion for leave to intervene (and to admit
attached petition-in-intervention with comment on the petition-in-intervention of
RCBC and RCBC Capital).67 The motion was granted by this court on November 22,
2011.68chanRoblesvirtualLawlibrary
On December 1, 2011, public respondents filed their compliance. 69 They explained
that: 1) the implementation of [BIR Ruling No. 370-2011], which has already been
performed on October 18, 2011 with the withholding of the 20% final withholding
tax on the face value of the PEACe bonds, is alreadyfait accompli . . . when the
Resolution and TRO were served to and received by respondents BTr and National
Treasurer [on October 19, 2011];70 and 2) the withheld amount has ipso
facto become public funds and cannot be disbursed or released to petitioners
without congressional appropriation.71 Respondents further aver that [i]nasmuch
as the . . . TRO has already become moot . . . the condition attached to it, i.e., that
the 20% final withholding tax on interest income therefrom shall be withheld by the
banks and placed in escrow . . . has also been rendered
moot[.]72chanRoblesvirtualLawlibrary
On December 6, 2011, this court noted respondents'
compliance.73chanRoblesvirtualLawlibrary
On February 22, 2012, respondents filed their consolidated comment 74 on the
petitions-in-intervention filed by RCBC and RCBC Capital and CODE-NGO.
On November 27, 2012, petitioners filed their Manifestation with Urgent Reiterative
Motion (To Direct Respondents to Comply with the Temporary Restraining
Order).75chanRoblesvirtualLawlibrary
On December 4, 2012, this court: (a) noted petitioners manifestation with urgent
reiterative motion (to direct respondents to comply with the temporary restraining
order); and (b) required respondents to comment
thereon.76chanRoblesvirtualLawlibrary
Respondents comment77 was filed on April 15, 2013, and petitioners filed their
reply78 on June 5, 2013.cralawred

Issues
The main issues to be resolved are:ChanRoblesVirtualawlibrary
I.

II.

Whether the PEACe Bonds are deposit substitutes and thus subject to 20%
final withholding tax under the 1997 National Internal Revenue Code. Related
to this question is the interpretation of the phrase borrowing from twenty
(20) or more individual or corporate lenders at any one time under Section
22(Y) of the 1997 National Internal Revenue Code, particularly on whether the
reckoning of the 20 lenders includes trading of the bonds in the secondary
market; and
If the PEACe Bonds are considered deposit substitutes, whether the
government or the Bureau of Internal Revenue is estopped from imposing
and/or collecting the 20% final withholding tax from the face value of these
Bonds
a.

Will the imposition of the 20% final withholding tax violate the nonimpairment clause of the Constitution?

b.

Will it constitute a deprivation of property without due process of law?

c.

Will it violate Section 245 of the 1997 National Internal Revenue Code
on non-retroactivity of rulings?
Arguments of petitioners, RCBC and RCBC
Capital, and CODE-NGO

Petitioners argue that [a]s the issuer of the Government Bonds acting through the
BTr, the Government is obligated . . . to pay the face value amount of PhP35 Billion
upon maturity without any deduction whatsoever. 79 They add that the
Government cannot impair the efficacy of the [Bonds] by arbitrarily, oppressively
and unreasonably imposing the withholding of 20% FWT upon the [Bonds] a mere
eleven (11) days before maturity and after several, consistent categorical
declarations that such bonds are exempt from the 20% FWT, without violating due
process80 and the constitutional principle on non-impairment of contracts. 81
Petitioners aver that at the time they purchased the Bonds, they had the right to
expect that they would receive the full face value of the Bonds upon maturity, in
view of the 2001 BIR Rulings.82 [R]egardless of whether or not the 2001 BIR
Rulings are correct, the fact remains that [they] relied [on] good faith
thereon.83chanRoblesvirtualLawlibrary
At any rate, petitioners insist that the PEACe Bonds are not deposit substitutes as
defined under Section 22(Y) of the 1997 National Internal Revenue Code because
there was only one lender (RCBC) to whom the Bureau of Treasury issued the
Bonds.84 They allege that the 2004, 2005, and 2011 BIR Rulings erroneously
interpreted that the number of investors that participate in the secondary market
is the determining factor in reckoning the existence or non-existence of twenty (20)
or more individual or corporate lenders.85 Furthermore, they contend that the

Bureau of Internal Revenue unduly expanded the definition of deposit substitutes


under Section 22 of the 1997 National Internal Revenue Code in concluding that
the mere issuance of government debt instruments and securities is deemed as
falling within the coverage of deposit substitutes[.] 86 Thus, [t]he 2011 BIR Ruling
clearly amount[ed] to an unauthorized act of administrative
legislation[.]87chanRoblesvirtualLawlibrary
Petitioners further argue that their income from the Bonds is a trading gain, which
is exempt from income tax.88 They insist that [t]hey are not lenders whose income
is considered as interest income or yield subject to the 20% FWT under Section 27
(D)(1) of the [1997 National Internal Revenue Code] 89 because they acquired the
Government Bonds in the secondary or tertiary
market.90chanRoblesvirtualLawlibrary
Even assuming without admitting that the Government Bonds are deposit
substitutes, petitioners argue that the collection of the final tax was barred by
prescription.91 They point out that under Section 7 of DOF Department Order No.
141-95,92 the final withholding tax should have been withheld at the time of their
issuance[.]93 Also, under Section 203 of the 1997 National Internal Revenue Code,
internal revenue taxes, such as the final tax, [should] be assessed within three (3)
years after the last day prescribed by law for the filing of the
return.94chanRoblesvirtualLawlibrary
Moreover, petitioners contend that the retroactive application of the 2011 BIR
Ruling without prior notice to them was in violation of their property rights, 95 their
constitutional right to due process96 as well as Section 246 of the 1997 National
Internal Revenue Code on non-retroactivity of rulings. 97 Allegedly, it would also
have an adverse effect of colossal magnitude on the investors, both local and
foreign, the Philippine capital market, and most importantly, the countrys standing
in the international commercial community.98 Petitioners explained that unless
enjoined, the governments threatened refusal to pay the full value of the
Government Bonds will negatively impact on the image of the country in terms of
protection for property rights (including financial assets), degree of legal protection
for lenders rights, and strength of investor protection. 99 They cited the countrys
ranking in the World Economic Forum: 75th in the world in its 20112012 Global
Competitiveness Index, 111thout of 142 countries worldwide and 2nd to the last
among ASEAN countries in terms of Strength of Investor Protection, and
105th worldwide and last among ASEAN countries in terms of Property Rights Index
and Legal Rights Index.100 It would also allegedly send a reverberating message to
the whole world that there is no certainty, predictability, and stability of financial
transactions in the capital markets[.]101 [T]he integrity of Government-issued
bonds and notes will be greatly shattered and the credit of the Philippine
Government will suffer102 if the sudden turnaround of the government will be
allowed,103 and it will reinforce investors perception that the level of regulatory risk
for contracts entered into by the Philippine Government is high, 104 thus resulting in
higher interest rate for government-issued debt instruments and lowered credit
rating.105chanRoblesvirtualLawlibrary
Petitioners-intervenors RCBC and RCBC Capital contend that respondent
Commissioner of Internal Revenue gravely and seriously abused her discretion in

the exercise of her rule-making power 106when she issued the assailed 2011 BIR
Ruling which ruled that all treasury bonds are deposit substitutes regardless of
the number of lenders, in clear disregard of the requirement of twenty (20) or more
lenders mandated under the NIRC. 107 They argue that [b]y her blanket and
arbitrary classification of treasury bonds as deposit substitutes, respondent CIR not
only amended and expanded the NIRC, but effectively imposed a new tax on
privately-placed treasury bonds.108 Petitioners-intervenors RCBC and RCBC Capital
further argue that the 2011 BIR Ruling will cause substantial impairment of their
vested rights109 under the Bonds since the ruling imposes new conditions by
subjecting the PEACe Bonds to the twenty percent (20%) final withholding tax
notwithstanding the fact that the terms and conditions thereof as previously
represented by the Government, through respondents BTr and BIR, expressly state
that it is not subject to final withholding tax upon their maturity. 110 They added
that [t]he exemption from the twenty percent (20%) final withholding tax [was] the
primary inducement and principal consideration for [their] participat[ion] in the
auction and underwriting of the PEACe Bonds. 111chanRoblesvirtualLawlibrary
Like petitioners, petitioners-intervenors RCBC and RCBC Capital also contend that
respondent Commissioner of Internal Revenue violated their rights to due process
when she arbitrarily issued the 2011 BIR Ruling without prior notice and hearing,
and the oppressive timing of such ruling deprived them of the opportunity to
challenge the same.112chanRoblesvirtualLawlibrary
Assuming the 20% final withholding tax was due on the PEACe Bonds, petitionersintervenors RCBC and RCBC Capital claim that respondents Bureau of Treasury and
CODE-NGO should be held liable as [these] parties explicitly represented . . . that
the said bonds are exempt from the final withholding
tax.113chanRoblesvirtualLawlibrary
Finally, petitioners-intervenors RCBC and RCBC Capital argue that the
implementation of the [2011 assailed BIR Ruling and BIR Ruling No. DA 378-2011]
will have pernicious effects on the integrity of existing securities, which is contrary
to the State policies of stabilizing the financial system and of developing capital
markets.114chanRoblesvirtualLawlibrary
For its part, CODE-NGO argues that: (a) the 2011 BIR Ruling and BIR Ruling No. DA
378-2011 are invalid because they contravene Section 22(Y) of the 1997 [NIRC]
when the said rulings disregarded the applicability of the 20 or more lender rule to
government debt instruments[;]115 (b) when [it] sold the PEACe Bonds in the
secondary market instead of holding them until maturity, [it] derived . . . long-term
trading gain[s], not interest income, which [are] exempt . . . under Section 32(B)(7)
(g) of the 1997 NIRC[;]116 (c) the tax exemption privilege relating to the issuance
of the PEACe Bonds . . . partakes of a contractual commitment granted by the
Government in exchange for a valid and material consideration [i.e., the issue price
paid and savings in borrowing cost derived by the Government,] thus protected by
the non-impairment clause of the 1987 Constitution[;] 117 and (d) the 2004, 2005,
and 2011 BIR Rulings did not validly revoke the 2001 BIR Rulings since no notice of
revocation was issued to [it], RCBC and [RCBC Capital] and petitioners[bondholders], nor was there any BIR administrative guidance issued and
published[.]118 CODE-NGO additionally argues that impleading it in a Rule 65

petition was improper because: (a) it involves determination of a factual


question;119 and (b) it is premature and states no cause of action as it amounts to an
anticipatory third-party claim.120chanRoblesvirtualLawlibrary
Arguments of respondents
Respondents argue that petitioners direct resort to this court to challenge the 2011
BIR Ruling violates the doctrines of exhaustion of administrative remedies and
hierarchy of courts, resulting in a lack of cause of action that justifies the dismissal
of the petition.121 According to them, the jurisdiction to review the rulings of the
[Commissioner of Internal Revenue], after the aggrieved party exhausted the
administrative remedies, pertains to the Court of Tax Appeals. 122 They point out
that a case similar to the present Petition was [in fact] filed with the CTA on
October 13, 2011[,] [docketed as] CTA Case No. 8351 [and] entitled, Rizal
Commercial Banking Corporation and RCBC Capital Corporation vs. Commissioner of
Internal Revenue, et al.123chanRoblesvirtualLawlibrary
Respondents further take issue on the timeliness of the filing of the petition and
petitions-in-intervention.124 They argue that under the guise of mainly assailing the
2011 BIR Ruling, petitioners are indirectly attacking the 2004 and 2005 BIR Rulings,
of which the attack is legally prohibited, and the petition insofar as it seeks to nullify
the 2004 and 2005 BIR Rulings was filed way out of time pursuant to Rule 65,
Section 4.125chanRoblesvirtualLawlibrary
Respondents contend that the discount/interest income derived from the PEACe
Bonds is not a trading gain but interest income subject to income tax. 126 They
explain that [w]ith the payment of the PhP35 Billion proceeds on maturity of the
PEACe Bonds, Petitioners receive an amount of money equivalent to about PhP24.8
Billion as payment for interest. Such interest is clearly an income of the Petitioners
considering that the same is a flow of wealth and not merely a return of capital the
capital initially invested in the Bonds being approximately PhP10.2
Billion[.]127chanRoblesvirtualLawlibrary
Maintaining that the imposition of the 20% final withholding tax on the PEACe Bonds
does not constitute an impairment of the obligations of contract, respondents aver
that: The BTr has no power to contractually grant a tax exemption in favour of
Petitioners thus the 2001 BIR Rulings cannot be considered a material term of the
Bonds[;]128 [t]here has been no change in the laws governing the taxability of
interest income from deposit substitutes and said laws are read into every
contract[;]129[t]he assailed BIR Rulings merely interpret the term deposit
substitute in accordance with the letter and spirit of the Tax Code[;] 130 [t]he
withholding of the 20% FWT does not result in a default by the Government as the
latter performed its obligations to the bondholders in full[;] 131 and [i]f there was a
breach of contract or a misrepresentation it was between RCBC/CODE-NGO/RCBC
Cap and the succeeding purchasers of the PEACe
Bonds.132chanRoblesvirtualLawlibrary
Similarly, respondents counter that the withholding of [t]he 20% final withholding
tax on the PEACe Bonds does not amount to a deprivation of property without due
process of law.133 Their imposition of the 20% final withholding tax is not arbitrary

because they were only performing a duty imposed by law; 134 [t]he 2011 BIR Ruling
is an interpretative rule which merely interprets the meaning of deposit substitutes
[and upheld] the earlier construction given to the term by the 2004 and 2005 BIR
Rulings.135 Hence, respondents argue that there was no need to observe the
requirements of notice, hearing, and publication[.] 136chanRoblesvirtualLawlibrary
Nonetheless, respondents add that there is every reason to believe that Petitioners
all major financial institutions equipped with both internal and external
accounting and compliance departments as well as access to both internal and
external legal counsel; actively involved in industry organizations such as the
Bankers Association of the Philippines and the Capital Market Development Council;
all actively taking part in the regular and special debt issuances of the BTr and
indeed regularly proposing products for issue by BTr had actual notice of the
2004 and 2005 BIR Rulings.137 Allegedly, the sudden and drastic drop including
virtually zero trading for extended periods of six months to almost a year in the
trading volume of the PEACe Bonds after the release of BIR Ruling No. 007-04 on
July 16, 2004 tend to indicate that market participants, including the Petitioners
herein, were aware of the ruling and its consequences for the PEACe
Bonds.138chanRoblesvirtualLawlibrary
Moreover, they contend that the assailed 2011 BIR Ruling is a valid exercise of the
Commissioner of Internal Revenues rule-making power; 139 that it and the 2004 and
2005 BIR Rulings did not unduly expand the definition of deposit substitutes by
creating an unwarranted exception to the requirement of having 20 or more
lenders/purchasers;140 and the word any in Section 22(Y) of the National Internal
Revenue Code plainly indicates that the period contemplated is the entire term of
the bond and not merely the point of origination or
issuance.141chanRoblesvirtualLawlibrary
Respondents further argue that a retroactive application of the 2011 BIR Ruling will
not unjustifiably prejudice petitioners.142 [W]ith or without the 2011 BIR Ruling,
Petitioners would be liable to pay a 20% final withholding tax just the same because
the PEACe Bonds in their possession are legally in the nature of deposit substitutes
subject to a 20% final withholding tax under the NIRC. 143 Section 7 of DOF
Department Order No. 141-95 also provides that income derived from Treasury
bonds is subject to the 20% final withholding tax. 144 [W]hile revenue regulations as
a general rule have no retroactive effect, if the revocation is due to the fact that the
regulation is erroneous or contrary to law, such revocation shall have retroactive
operation as to affect past transactions, because a wrong construction of the law
cannot give rise to a vested right that can be invoked by a
taxpayer.145chanRoblesvirtualLawlibrary
Finally, respondents submit that there are a number of variables and factors
affecting a capital market.146 [C]apital market itself is inherently unstable. 147
Thus, [p]etitioners argument that the 20% final withholding tax . . . will wreak
havoc on the financial stability of the country is a mere supposition that is not a
justiciable issue.148chanRoblesvirtualLawlibrary
On the prayer for the temporary restraining order, respondents argue that this order
could no longer be implemented [because] the acts sought to be enjoined are

already fait accompli.149 They add that to disburse the funds withheld to the
Petitioners at this time would violate Section 29[,] Article VI of the Constitution
prohibiting money being paid out of the Treasury except in pursuance of an
appropriation made by law[.]150 The remedy of petitioners is to claim a tax refund
under Section 204(c) of the Tax Code should their position be upheld by the
Honorable Court.151chanRoblesvirtualLawlibrary
Respondents also argue that the implementation of the TRO would violate Section
218 of the Tax Code in relation to Section 11 of Republic Act No. 1125 (as amended
by Section 9 of Republic Act No. 9282) which prohibits courts, except the Court of
Tax Appeals, from issuing injunctions to restrain the collection of any national
internal revenue tax imposed by the Tax Code. 152chanRoblesvirtualLawlibrary
Summary of arguments
In sum, petitioners and petitioners-intervenors, namely, RCBC, RCBC Capital, and
CODE-NGO argue that:
1. The 2011 BIR Ruling is ultra vires because it is contrary to the 1997 National
Internal Revenue Code when it declared that all government debt instruments
are deposit substitutes regardless of the 20-lender rule; and
2. The 2011 BIR Ruling cannot be applied retroactively because:
a) It will violate the contract clause;
o

It constitutes a unilateral amendment of a material term (tax exempt


status) in the Bonds, represented by the government as an inducement
and important consideration for the purchase of the Bonds;

b) It constitutes deprivation of property without due process because there


was no prior notice to bondholders and hearing and publication;
c) It violates the rule on non-retroactivity under the 1997 National Internal
Revenue Code;
d) It violates the constitutional provision on supporting activities of nongovernment organizations and development of the capital market; and
e) The assessment had already prescribed.
Respondents counter that:
1) Respondent Commissioner of Internal Revenue did not act with grave abuse of
discretion in issuing the challenged 2011 BIR Ruling:

a. The 2011 BIR Ruling, being an interpretative rule, was issued by virtue of the
Commissioner of Internal Revenues power to interpret the provisions of the
1997 National Internal Revenue Code and other tax laws;
b. Commissioner of Internal Revenue merely restates and confirms the
interpretations contained in previously issued BIR Ruling Nos. 007-2004, DA491-04, and 008-05, which have already effectively abandoned or revoked
the 2001 BIR Rulings;
c. Commissioner of Internal Revenue is not bound by his or her predecessors
rulings especially when the latters rulings are not in harmony with the law;
and
d. The wrong construction of the law that the 2001 BIR Rulings have perpetrated
cannot give rise to a vested right. Therefore, the 2011 BIR Ruling can be
given retroactive effect.
2) Rule 65 can be resorted to only if there is no appeal or any plain, speedy, and
adequate remedy in the ordinary course of law:
a. Petitioners had the basic remedy of filing a claim for refund of the 20% final
withholding tax they allege to have been wrongfully collected; and
b. Non-observance of the doctrine of exhaustion of administrative remedies and
of hierarchy of courts.
Courts ruling
Procedural Issues
Non-exhaustion of administrative
remedies proper
Under Section 4 of the 1997 National Internal Revenue Code, interpretative rulings
are reviewable by the Secretary of Finance.
SEC. 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax
Cases. - The power to interpret the provisions of this Code and other tax laws shall
be under the exclusive and original jurisdiction of the Commissioner, subject to
review by the Secretary of Finance. (Emphasis supplied)
Thus, it was held that [i]f superior administrative officers [can] grant the relief
prayed for, [then] special civil actions are generally not entertained. 153 The remedy
within the administrative machinery must be resorted to first and pursued to its
appropriate conclusion before the courts judicial power can be
sought.154chanRoblesvirtualLawlibrary

Nonetheless, jurisprudence allows certain exceptions to the rule on exhaustion of


administrative remedies:chanroblesvirtuallawlibrary
[The doctrine of exhaustion of administrative remedies] is a relative one and its
flexibility is called upon by the peculiarity and uniqueness of the factual and
circumstantial settings of a case. Hence, it is disregarded (1) when there is a
violation of due process, (2) when the issue involved is purely a legal question, 155 (3)
when the administrative action is patently illegal amounting to lack or excess of
jurisdiction,(4) when there is estoppel on the part of the administrative agency
concerned,(5) when there is irreparable injury, (6) when the respondent is a
department secretary whose acts as an alter ego of the President bears the implied
and assumed approval of the latter, (7) when to require exhaustion of
administrative remedies would be unreasonable, (8) when it would amount to a
nullification of a claim, (9) when the subject matter is a private land in land case
proceedings, (10) when the rule does not provide a plain, speedy and adequate
remedy, (11) when there are circumstances indicating the urgency of judicial
intervention.156 (Emphasis supplied, citations omitted)
The exceptions under (2) and (11) are present in this case. The question involved is
purely legal, namely: (a) the interpretation of the 20-lender rule in the definition of
the terms public and deposit substitutes under the 1997 National Internal Revenue
Code; and (b) whether the imposition of the 20% final withholding tax on the PEACe
Bonds upon maturity violates the constitutional provisions on non-impairment of
contracts and due process. Judicial intervention is likewise urgent with the
impending maturity of the PEACe Bonds on October 18, 2011.
The rule on exhaustion of administrative remedies also finds no application when
the exhaustion will result in an exercise in futility. 157chanRoblesvirtualLawlibrary
In this case, an appeal to the Secretary of Finance from the questioned 2011 BIR
Ruling would be a futile exercise because it was upon the request of the Secretary
of Finance that the 2011 BIR Ruling was issued by the Bureau of Internal Revenue.
It appears that the Secretary of Finance adopted the Commissioner of Internal
Revenues opinions as his own.158 This position was in fact confirmed in the
letter159 dated October 10, 2011 where he ordered the Bureau of Treasury to
withhold the amount corresponding to the 20% final withholding tax on the interest
or discounts allegedly due from the bondholders on the strength of the 2011 BIR
Ruling.
Doctrine on hierarchy of courts
We agree with respondents that the jurisdiction to review the rulings of the
Commissioner of Internal Revenue pertains to the Court of Tax Appeals. The
questioned BIR Ruling Nos. 370-2011 and DA 378-2011 were issued in connection
with the implementation of the 1997 National Internal Revenue Code on the
taxability of the interest income from zero-coupon bonds issued by the government.
Under Republic Act No. 1125 (An Act Creating the Court of Tax Appeals), as
amended by Republic Act No. 9282,160 such rulings of the Commissioner of Internal
Revenue are appealable to that court, thus:chanroblesvirtuallawlibrary

SEC. 7. Jurisdiction. - The CTA shall exercise:


a. Exclusive appellate jurisdiction to review by appeal, as herein provided:
1. Decisions of the Commissioner of Internal Revenue in cases involving
disputed assessments, refunds of internal revenue taxes, fees or other
charges, penalties in relation thereto, or other matters arising under the
National Internal Revenue or other laws administered by the Bureau of
Internal Revenue;
....
SEC. 11. Who May Appeal; Mode of Appeal; Effect of Appeal. - Any party adversely
affected by a decision, ruling or inaction of the Commissioner of Internal Revenue,
the Commissioner of Customs, the Secretary of Finance, the Secretary of Trade and
Industry or the Secretary of Agriculture or the Central Board of Assessment Appeals
or the Regional Trial Courts may file an appeal with the CTA within thirty (30) days
after the receipt of such decision or ruling or after the expiration of the period fixed
by law for action as referred to in Section 7(a)(2) herein.
....
SEC. 18. Appeal to the Court of Tax Appeals En Banc. - No civil proceeding involving
matters arising under the National Internal Revenue Code, the Tariff and Customs
Code or the Local Government Code shall be maintained, except as herein provided,
until and unless an appeal has been previously filed with the CTA and disposed of in
accordance with the provisions of this Act.
In Commissioner of Internal Revenue v. Leal,161 citing Rodriguez v. Blaquera,162 this
court emphasized the jurisdiction of the Court of Tax Appeals over rulings of the
Bureau of Internal Revenue, thus:chanroblesvirtuallawlibrary
While the Court of Appeals correctly took cognizance of the petition for certiorari,
however, let it be stressed that the jurisdiction to review the rulings of the
Commissioner of Internal Revenue pertains to the Court of Tax Appeals, not to the
RTC.
The questioned RMO No. 15-91 and RMC No. 43-91 are actually rulings or opinions
of the Commissioner implementing the Tax Code on the taxability of
pawnshops. . . .
....
Such revenue orders were issued pursuant to petitioner's powers under Section 245
of the Tax Code, which states:chanroblesvirtuallawlibrary
SEC. 245. Authority of the Secretary of Finance to promulgate rules and
regulations. The Secretary of Finance, upon recommendation of the
Commissioner, shall promulgate all needful rules and regulations for the effective
enforcement of the provisions of this Code.

The authority of the Secretary of Finance to determine articles similar or analogous


to those subject to a rate of sales tax under certain category enumerated in Section
163 and 165 of this Code shall be without prejudice to the power of the
Commissioner of Internal Revenue to make rulings or opinions in connection with
the implementation of the provisions of internal revenue laws, including ruling on
the classification of articles of sales and similar purposes. (Emphasis in the
original)
....
The Court, in Rodriguez, etc. vs. Blaquera, etc., ruled:chanroblesvirtuallawlibrary
Plaintiff maintains that this is not an appeal from a ruling of the Collector of
Internal Revenue, but merely an attempt to nullify General Circular No. V-148, which
does not adjudicate or settle any controversy, and that, accordingly, this case is not
within the jurisdiction of the Court of Tax Appeals.
We find no merit in this pretense. General Circular No. V-148 directs the officers
charged with the collection of taxes and license fees to adhere strictly to the
interpretation given by the defendant to the statutory provisions abovementioned,
as set forth in the Circular. The same incorporates, therefore, a decision of the
Collector of Internal Revenue (now Commissioner of Internal Revenue) on the
manner of enforcement of the said statute, the administration of which is entrusted
by law to the Bureau of Internal Revenue. As such, it comes within the purview of
Republic Act No. 1125, Section 7 of which provides that the Court of Tax Appeals
shall exercise exclusive appellate jurisdiction to review by appeal . . . decisions of
the Collector of Internal Revenue in . . . matters arising under the National Internal
Revenue Code or other law or part of the law administered by the Bureau of Internal
Revenue.163
In exceptional cases, however, this court entertained direct recourse to it when
dictated by public welfare and the advancement of public policy, or demanded by
the broader interest of justice, or the orders complained of were found to be patent
nullities, or the appeal was considered as clearly an inappropriate
remedy.164chanRoblesvirtualLawlibrary
In Philippine Rural Electric Cooperatives Association, Inc. (PHILRECA) v. The
Secretary, Department of Interior and Local Government, 165 this court noted that the
petition for prohibition was filed directly before it in disregard of the rule on
hierarchy of courts. However, [this court] opt[ed] to take primary jurisdiction over
the . . . petition and decide the same on its merits in view of the significant
constitutional issues raised by the parties dealing with the tax treatment of
cooperatives under existing laws and in the interest of speedy justice and prompt
disposition of the matter.166chanRoblesvirtualLawlibrary
Here, the nature and importance of the issues raised 167 to the investment and
banking industry with regard to a definitive declaration of whether government debt
instruments are deposit substitutes under existing laws, and the novelty thereof,
constitute exceptional and compelling circumstances to justify resort to this court in

the first instance.


The tax provision on deposit substitutes affects not only the PEACe Bonds but also
any other financial instrument or product that may be issued and traded in the
market. Due to the changing positions of the Bureau of Internal Revenue on this
issue, there is a need for a final ruling from this court to stabilize the expectations in
the financial market.
Finally, non-compliance with the rules on exhaustion of administrative remedies and
hierarchy of courts had been rendered moot by this courts issuance of the
temporary restraining order enjoining the implementation of the 2011 BIR Ruling.
The temporary restraining order effectively recognized the urgency and necessity of
direct resort to this court.
Substantive issues
Tax treatment of deposit substitutes
Under Sections 24(B)(1), 27(D)(1), and 28(A)(7) of the 1997 National Internal
Revenue Code, a final withholding tax at the rate of 20% is imposed on interest on
any currency bank deposit and yield or any other monetary benefit from deposit
substitutes and from trust funds and similar arrangements. These provisions
read:chanroblesvirtuallawlibrary
SEC. 24. Income Tax Rates.
....
(B) Rate of Tax on Certain Passive Income.
(1) Interests, Royalties, Prizes, and Other Winnings. - A final tax at the rate of
twenty percent (20%) is hereby imposed upon the amount of interest from any
currency bank deposit and yield or any other monetary benefit from deposit
substitutes and from trust funds and similar arrangements; . . . Provided, further,
That interest income from long-term deposit or investment in the form of savings,
common or individual trust funds, deposit substitutes, investment management
accounts and other investments evidenced by certificates in such form prescribed
by the Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed
under this Subsection: Provided, finally, That should the holder of the certificate preterminate the deposit or investment before the fifth (5th) year, a final tax shall be
imposed on the entire income and shall be deducted and withheld by the depository
bank from the proceeds of the long-term deposit or investment certificate based on
the remaining maturity thereof:chanroblesvirtuallawlibrary
Four (4) years to less than five (5) years - 5%;
Three (3) years to less than four (4) years - 12%; and
Less than three (3) years - 20%. (Emphasis supplied)
SEC. 27. Rates of Income Tax on Domestic Corporations. ....

(D) Rates of Tax on Certain Passive Incomes. (1) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes and from Trust Funds and Similar Arrangements, and Royalties. - A final
tax at the rate of twenty percent (20%) is hereby imposed upon the amount of
interest on currency bank deposit and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements received by
domestic corporations, and royalties, derived from sources within the Philippines:
Provided, however, That interest income derived by a domestic corporation from a
depository bank under the expanded foreign currency deposit system shall be
subject to a final income tax at the rate of seven and one-half percent (7 1/2%) of
such interest income. (Emphasis supplied)
SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporations. ....
(7) Tax on Certain Incomes Received by a Resident Foreign Corporation. (a) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes, Trust Funds and Similar Arrangements and Royalties. - Interest from
any currency bank deposit and yield or any other monetary benefit from deposit
substitutes and from trust funds and similar arrangements and royalties derived
from sources within the Philippines shall be subject to a final income tax at the rate
of twenty percent (20%) of such interest: Provided, however, That interest income
derived by a resident foreign corporation from a depository bank under the
expanded foreign currency deposit system shall be subject to a final income tax at
the rate of seven and one-half percent (7 1/2%) of such interest income. (Emphasis
supplied)
This tax treatment of interest from bank deposits and yield from deposit substitutes
was first introduced in the 1977 National Internal Revenue Code through
Presidential Decree No. 1739168issued in 1980. Later, Presidential Decree No. 1959,
effective on October 15, 1984, formally added the definition of deposit substitutes,
viz:chanroblesvirtuallawlibrary
(y) Deposit substitutes shall mean an alternative form of obtaining funds from the
public, other than deposits, through the issuance, endorsement, or acceptance of
debt instruments for the borrower's own account, for the purpose of relending or
purchasing of receivables and other obligations, or financing their own needs or the
needs of their agent or dealer. These promissory notes, repurchase agreements,
certificates of assignment or participation and similar instrument with recourse as
may be authorized by the Central Bank of the Philippines, for banks and non-bank
financial intermediaries or by the Securities and Exchange Commission of the
Philippines for commercial, industrial, finance companies and either non-financial
companies: Provided, however, that only debt instruments issued for inter-bank call
loans to cover deficiency in reserves against deposit liabilities including those
between or among banks and quasi-banks shall not be considered as deposit
substitute debt instruments. (Emphasis supplied)

Revenue Regulations No. 17-84, issued to implement Presidential Decree No. 1959,
adopted verbatim the same definition and specifically identified the following
borrowings as deposit substitutes:chanroblesvirtuallawlibrary
SECTION 2. Definitions of Terms. . . .
(h) Deposit substitutes shall mean
....
(a) All interbank borrowings by or among banks and non-bank financial institutions
authorized to engage in quasi-banking functions evidenced by deposit substitutes
instruments, except interbank call loans to cover deficiency in reserves against
deposit liabilities as evidenced by interbank loan advice or repayment transfer
tickets.
(b) All borrowings of the national and local government and its instrumentalities
including the Central Bank of the Philippines, evidenced by debt instruments
denoted as treasury bonds, bills, notes, certificates of indebtedness and similar
instruments.
(c) All borrowings of banks, non-bank financial intermediaries, finance companies,
investment companies, trust companies, including the trust department of banks
and investment houses, evidenced by deposit substitutes instruments. (Emphasis
supplied)
The definition of deposit substitutes was amended under the 1997 National Internal
Revenue Code with the addition of the qualifying phrase for public borrowing from
20 or more individual or corporate lenders at any one time. Under Section 22(Y),
deposit substitute is defined thus:chanroblesvirtuallawlibrary
SEC. 22. Definitions - When used in this Title:
....
(Y) The term deposit substitutes shall mean an alternative form of obtaining
funds from the public (the term 'public' means borrowing from twenty (20) or
more individual or corporate lenders at any one time) other than deposits,
through the issuance, endorsement, or acceptance of debt instruments for the
borrowers own account, for the purpose of relending or purchasing of receivables
and other obligations, or financing their own needs or the needs of their agent or
dealer. These instruments may include, but need not be limited to, bankers
acceptances, promissory notes, repurchase agreements, including reverse
repurchase agreements entered into by and between the Bangko Sentral ng
Pilipinas (BSP) and any authorized agent bank, certificates of assignment or
participation and similar instruments with recourse: Provided, however, That debt
instruments issued for interbank call loans with maturity of not more than five (5)
days to cover deficiency in reserves against deposit liabilities, including those

between or among banks and quasi-banks, shall not be considered as deposit


substitute debt instruments. (Emphasis supplied)
Under the 1997 National Internal Revenue Code, Congress specifically defined
public to mean twenty (20) or more individual or corporate lenders at any one
time. Hence, the number of lenders is determinative of whether a debt instrument
should be considered a deposit substitute and consequently subject to the 20% final
withholding tax.
20-lender rule
Petitioners contend that there [is] only one (1) lender (i.e. RCBC) to whom the BTr
issued the Government Bonds.169 On the other hand, respondents theorize that the
word any indicates that the period contemplated is the entire term of the bond
and not merely the point of origination or issuance[,] 170 such that if the debt
instruments were subsequently sold in secondary markets and so on, in such a way
that twenty (20) or more buyers eventually own the instruments, then it becomes
indubitable that funds would be obtained from the public as defined in Section
22(Y) of the NIRC.171 Indeed, in the context of the financial market, the words at
any one time create an ambiguity.
Financial markets
Financial markets provide the channel through which funds from the surplus units
(households and business firms that have savings or excess funds) flow to the
deficit units (mainly business firms and government that need funds to finance their
operations or growth). They bring suppliers and users of funds together and provide
the means by which the lenders transform their funds into financial assets, and the
borrowers receive these funds now considered as their financial liabilities. The
transfer of funds is represented by a security, such as stocks and bonds. Fund
suppliers earn a return on their investment; the return is necessary to ensure that
funds are supplied to the financial markets. 172chanRoblesvirtualLawlibrary
The financial markets that facilitate the transfer of debt securities are commonly
classified by the maturity of the securities[,] 173 namely: (1) the money
market, which facilitates the flow of short-term funds (with maturities of one year or
less); and (2) the capital market, which facilitates the flow of long-term funds (with
maturities of more than one year). 174chanRoblesvirtualLawlibrary
Whether referring to money market securities or capital market securities,
transactions occur either in the primary market or in the secondary market.175
Primary markets facilitate the issuance of new securities. Secondary
markets facilitate the trading of existing securities, which allows for a change in
the ownership of the securities.176 The transactions in primary markets exist
between issuers and investors, while secondary market transactions exist among
investors.177chanRoblesvirtualLawlibrary
Over time, the system of financial markets has evolved from simple to more
complex ways of carrying out financial transactions. 178 Still, all systems perform
one basic function: the quick mobilization of money from the lenders/investors to

the borrowers.179chanRoblesvirtualLawlibrary
Fund transfers are accomplished in three ways: (1) direct finance; (2) semidirect
finance; and (3) indirect finance.180chanRoblesvirtualLawlibrary
With direct financing, the borrower and lender meet each other and exchange
funds in return for financial assets181 (e.g., purchasing bonds directly from the
company issuing them). This method provides certain limitations such as: (a) both
borrower and lender must desire to exchange the same amount of funds at the
same time[;]182 and (b) both lender and borrower must frequently incur
substantial information costs simply to find each
other.183chanRoblesvirtualLawlibrary
In semidirect financing, a securities broker or dealer brings surplus and deficit
units together, thereby reducing information costs. 184 A broker185 is an individual
or financial institution who provides information concerning possible purchases and
sales of securities. Either a buyer or a seller of securities may contact a broker,
whose job is simply to bring buyers and sellers together. 186 Adealer187 also serves
as a middleman between buyers and sellers, but the dealer actually acquires the
sellers securities in the hope of selling them at a later time at a more favorable
price.188 Frequently, a dealer will split up a large issue of primary securities into
smaller units affordable by . . . buyers . . . and thereby expand the flow of savings
into investment.189 In semidirect financing, [t]he ultimate lender still winds up
holding the borrowers securities, and therefore the lender must be willing to accept
the risk, liquidity, and maturity characteristics of the borrowers [debt security].
There still must be a fundamental coincidence of wants and needs between [lenders
and borrowers] for semidirect financial transactions to take
place.190chanRoblesvirtualLawlibrary
The limitations of both direct and semidirect finance stimulated the development
of indirect financial transactions, carried out with the help of financial
intermediaries191 or financial institutions, like banks, investment banks, finance
companies, insurance companies, and mutual funds. 192 Financial intermediaries
accept funds from surplus units and channel the funds to deficit units. 193
Depository institutions [such as banks] accept deposits from surplus units and
provide credit to deficit units through loans and purchase of [debt] securities. 194
Nondepository institutions, like mutual funds, issue securities of their own (usually
in smaller and affordable denominations) to surplus units and at the same time
purchase debt securities of deficit units. 195 By pooling the resources of [small
savers, a financial intermediary] can service the credit needs of large firms
simultaneously.196chanRoblesvirtualLawlibrary
The financial market, therefore, is an agglomeration of financial transactions in
securities performed by market participants that works to transfer the funds from
the surplus units (or investors/lenders) to those who need them (deficit units or
borrowers).
Meaning of at any one time
Thus, from the point of view of the financial market, the phrase at any one time

for purposes of determining the 20 or more lenders would mean every transaction
executed in the primary or secondary market in connection with the purchase or
sale of securities.
For example, where the financial assets involved are government securities like
bonds, the reckoning of 20 or more lenders/investors is made at any transaction
in connection with the purchase or sale of the Government Bonds, such as:
1. Issuance by the Bureau of Treasury of the bonds to GSEDs in the primary
market;
2. Sale and distribution by GSEDs to various lenders/investors in the secondary
market;
3. Subsequent sale or trading by a bondholder to another lender/investor in the
secondary market usually through a broker or dealer; or
4. Sale by a financial intermediary-bondholder of its participation interests in the
bonds to individual or corporate lenders in the secondary market.
When, through any of the foregoing transactions, funds are simultaneously obtained
from 20 or more lenders/investors, there is deemed to be a public borrowing and
the bonds at that point in time are deemed deposit substitutes. Consequently, the
seller is required to withhold the 20% final withholding tax on the imputed interest
income from the bonds.
For debt instruments that are
not deposit substitutes, regular
income tax applies
It must be emphasized, however, that debt instruments that do not qualify as
deposit substitutes under the 1997 National Internal Revenue Code are subject to
the regular income tax.
The phrase all income derived from whatever source in Chapter VI, Computation
of Gross Income,Section 32(A) of the 1997 National Internal Revenue Code discloses
a legislative policy to include all income not expressly exempted as within the class
of taxable income under our laws.
The definition of gross income is broad enough to include all passive incomes
subject to specific tax rates or final taxes. 197 Hence, interest income from deposit
substitutes are necessarily part of taxable income. However, since these passive
incomes are already subject to different rates and taxed finally at source, they are
no longer included in the computation of gross income, which determines taxable
income.198 Stated otherwise . . . if there were no withholding tax system in place
in this country, this 20 percent portion of the passive income of [creditors/lenders]
would actually be paid to the [creditors/lenders] and then remitted by them to the
government in payment of their income tax. 199chanRoblesvirtualLawlibrary

This court, in Chamber of Real Estate and Builders Associations, Inc. v.


Romulo,200 explained the rationale behind the withholding tax
system:chanroblesvirtuallawlibrary
The withholding [of tax at source] was devised for three primary reasons: first, to
provide the taxpayer a convenient manner to meet his probable income tax liability;
second, to ensure the collection of income tax which can otherwise be lost or
substantially reduced through failure to file the corresponding returns[;] and third,
to improve the governments cash flow. This results in administrative savings,
prompt and efficient collection of taxes, prevention of delinquencies and reduction
of governmental effort to collect taxes through more complicated means and
remedies.201 (Citations omitted)
The application of the withholdings system to interest on bank deposits or yield
from deposit substitutes is essentially to maximize and expedite the collection of
income taxes by requiring its payment at the source. 202chanRoblesvirtualLawlibrary
Hence, when there are 20 or more lenders/investors in a transaction for a specific
bond issue, the seller is required to withhold the 20% final income tax on the
imputed interest income from the bonds.
Interest income v. gains from sale or redemption
The interest income earned from bonds is not synonymous with the gains
contemplated under Section 32(B)(7)(g)203 of the 1997 National Internal Revenue
Code, which exempts gains derived from trading, redemption, or retirement of longterm securities from ordinary income tax.
The term gain as used in Section 32(B)(7)(g) does not include interest, which
represents forbearance for the use of money. Gains from sale or exchange or
retirement of bonds or other certificate of indebtedness fall within the general
category of gains derived from dealings in property under Section 32(A)(3), while
interest from bonds or other certificate of indebtedness falls within the category of
interests under Section 32(A)(4).204 The use of the term gains from sale in
Section 32(B)(7)(g) shows the intent of Congress not to include interest as referred
under Sections 24, 25, 27, and 28 in the exemption. 205chanRoblesvirtualLawlibrary
Hence, the gains contemplated in Section 32(B)(7)(g) refers to: (1) gain realized
from the trading of the bonds before their maturity date, which is the difference
between the selling price of the bonds in the secondary market and the price at
which the bonds were purchased by the seller; and (2) gain realized by the last
holder of the bonds when the bonds are redeemed at maturity, which is the
difference between the proceeds from the retirement of the bonds and the price at
which such last holder acquired the bonds. For discounted instruments, like the
zero-coupon bonds, the trading gain shall be the excess of the selling price over the
book value or accreted value (original issue price plus accumulated discount from
the time of purchase up to the time of sale) of the
instruments.206chanRoblesvirtualLawlibrary
The Bureau of Internal

Revenue rulings
The Bureau of Internal Revenues interpretation as expressed in the three 2001 BIR
Rulings is not consistent with law. 207 Its interpretation of at any one time to mean
at the point of origination alone is unduly restrictive.
BIR Ruling No. 370-2011 is likewise erroneous insofar as it stated (relying on the
2004 and 2005 BIR Rulings) that all treasury bonds . . . regardless of the number of
purchasers/lenders at the time of origination/issuance are considered deposit
substitutes.208 Being the subject of this petition, it is, thus, declared void because
it completely disregarded the 20 or more lender rule added by Congress in the 1997
National Internal Revenue Code. It also created a distinction for government debt
instruments as against those issued by private corporations when there was none in
the law.
Tax statutes must be reasonably construed as to give effect to the whole act. Their
constituent provisions must be read together, endeavoring to make every part
effective, harmonious, and sensible.209 That construction which will leave every
word operative will be favored over one that leaves some word, clause, or sentence
meaningless and insignificant.210chanRoblesvirtualLawlibrary
It may be granted that the interpretation of the Commissioner of Internal Revenue
in charge of executing the 1997 National Internal Revenue Code is an authoritative
construction of great weight, but the principle is not absolute and may be overcome
by strong reasons to the contrary. If through a misapprehension of law an officer
has issued an erroneous interpretation, the error must be corrected when the true
construction is ascertained.
In Philippine Bank of Communications v. Commissioner of Internal Revenue,211 this
court upheld the nullification of Revenue Memorandum Circular (RMC) No. 7-85
issued by the Acting Commissioner of Internal Revenue because it was contrary to
the express provision of Section 230 of the 1977 National Internal Revenue Code
and, hence, [cannot] be given weight for to do so would, in effect, amend the
statute.212 Thus:chanroblesvirtuallawlibrary
When the Acting Commissioner of Internal Revenue issued RMC 7-85, changing the
prescriptive period of two years to ten years on claims of excess quarterly income
tax payments, such circular created a clear inconsistency with the provision of Sec.
230 of 1977 NIRC. In so doing, the BIR did not simply interpret the law; rather it
legislated guidelines contrary to the statute passed by Congress.
It bears repeating that Revenue memorandum-circulars are considered
administrative rulings (in the sense of more specific and less general interpretations
of tax laws) which are issued from time to time by the Commissioner of Internal
Revenue. It is widely accepted that the interpretation placed upon a statute by the
executive officers, whose duty is to enforce it, is entitled to great respect by the
courts. Nevertheless, such interpretation is not conclusive and will be ignored if
judicially found to be erroneous. Thus, courts will not countenance administrative
issuances that override, instead of remaining consistent and in harmony with, the
law they seek to apply and implement.213 (Citations omitted)

This court further held that [a] memorandum-circular of a bureau head could not
operate to vest a taxpayer with a shield against judicial action [because] there are
no vested rights to speak of respecting a wrong construction of the law by the
administrative officials and such wrong interpretation could not place the
Government in estoppel to correct or overrule the
same.214chanRoblesvirtualLawlibrary
In Commissioner of Internal Revenue v. Michel J. Lhuillier Pawnshop, Inc., 215 this
court nullified Revenue Memorandum Order (RMO) No. 15-91 and RMC No. 43-91,
which imposed a 5% lending investor's tax on pawnshops. 216 It was held that the
[Commissioner] cannot, in the exercise of [its interpretative] power, issue
administrative rulings or circulars not consistent with the law sought to be applied.
Indeed, administrative issuances must not override, supplant or modify the law, but
must remain consistent with the law they intend to carry out. Only Congress can
repeal or amend the law.217chanRoblesvirtualLawlibrary
In Misamis Oriental Association of Coco Traders, Inc. v. Department of Finance
Secretary,218 this court stated that the Commissioner of Internal Revenue is not
bound by the ruling of his predecessors, 219but, to the contrary, the overruling of
decisions is inherent in the interpretation of laws:chanroblesvirtuallawlibrary
[I]n considering a legislative rule a court is free to make three inquiries: (i) whether
the rule is within the delegated authority of the administrative agency; (ii) whether
it is reasonable; and (iii) whether it was issued pursuant to proper procedure. But
the court is not free to substitute its judgment as to the desirability or wisdom of the
rule for the legislative body, by its delegation of administrative judgment, has
committed those questions to administrative judgments and not to judicial
judgments. In the case of an interpretative rule, the inquiry is not into the validity
but into the correctness or propriety of the rule. As a matter of power a court, when
confronted with an interpretative rule, is free to (i) give the force of law to the rule;
(ii) go to the opposite extreme and substitute its judgment; or (iii) give some
intermediate degree of authoritative weight to the interpretative rule.
In the case at bar, we find no reason for holding that respondent Commissioner
erred in not considering copra as an agricultural food product within the meaning
of 103(b) of the NIRC. As the Solicitor General contends, copra per se is not food,
that is, it is not intended for human consumption. Simply stated, nobody eats copra
for food. That previous Commissioners considered it so, is not reason for holding
that the present interpretation is wrong. The Commissioner of Internal Revenue is
not bound by the ruling of his predecessors. To the contrary, the overruling of
decisions is inherent in the interpretation of laws.220 (Emphasis supplied, citations
omitted)
Tax treatment of income derived
from the PEACe Bonds
The transactions executed for the sale of the PEACe Bonds are:

1. The issuance of the P35 billion Bonds by the Bureau of Treasury to


RCBC/CODE-NGO at P10.2 billion; and
2. The sale and distribution by RCBC Capital (underwriter) on behalf of CODENGO of the PEACe Bonds to undisclosed investors at P11.996 billion.
It may seem that there was only one lender RCBC on behalf of CODE-NGO to
whom the PEACe Bonds were issued at the time of origination. However, a reading
of the underwriting agreement221and RCBC term sheet222 reveals that the settlement
dates for the sale and distribution by RCBC Capital (as underwriter for CODE-NGO)
of the PEACe Bonds to various undisclosed investors at a purchase price of
approximately P11.996 would fall on the same day, October 18, 2001, when the
PEACe Bonds were supposedly issued to CODE-NGO/RCBC. In reality, therefore, the
entire P10.2 billion borrowing received by the Bureau of Treasury in exchange for
the P35 billion worth of PEACe Bonds was sourced directly from the undisclosed
number of investors to whom RCBC Capital/CODE-NGO distributed the PEACe Bonds
all at the time of origination or issuance. At this point, however, we do not know
as to how many investors the PEACe Bonds were sold to by RCBC Capital.
Should there have been a simultaneous sale to 20 or more lenders/investors, the
PEACe Bonds are deemed deposit substitutes within the meaning of Section 22(Y) of
the 1997 National Internal Revenue Code and RCBC Capital/CODE-NGO would have
been obliged to pay the 20% final withholding tax on the interest or discount from
the PEACe Bonds. Further, the obligation to withhold the 20% final tax on the
corresponding interest from the PEACe Bonds would likewise be required of any
lender/investor had the latter turned around and sold said PEACe Bonds, whether in
whole or part, simultaneously to 20 or more lenders or investors.
We note, however, that under Section 24223 of the 1997 National Internal Revenue
Code, interest income received by individuals from long-term deposits or
investments with a holding period of not less than five (5) years is exempt from the
final tax.
Thus, should the PEACe Bonds be found to be within the coverage of deposit
substitutes, the proper procedure was for the Bureau of Treasury to pay the face
value of the PEACe Bonds to the bondholders and for the Bureau of Internal
Revenue to collect the unpaid final withholding tax directly from RCBC
Capital/CODE-NGO, or any lender or investor if such be the case, as the withholding
agents.
The collection of tax is not
barred by prescription
The three (3)-year prescriptive period under Section 203 of the 1997 National
Internal Revenue Code to assess and collect internal revenue taxes is extended to
10 years in cases of (1) fraudulent returns; (2) false returns with intent to evade tax;
and (3) failure to file a return, to be computed from the time of discovery of the
falsity, fraud, or omission. Section 203 states:chanroblesvirtuallawlibrary

SEC. 203. Period of Limitation Upon Assessment and Collection. - Except as


provided in Section 222, internal revenue taxes shall be assessed within three (3)
years after the last day prescribed by law for the filing of the return, and no
proceeding in court without assessment for the collection of such taxes shall be
begun after the expiration of such period: Provided, That in a case where a return is
filed beyond the period prescribed by law, the three (3)-year period shall be counted
from the day the return was filed. For purposes of this Section, a return filed before
the last day prescribed by law for the filing thereof shall be considered as filed on
such last day. (Emphasis supplied)
....
SEC. 222. Exceptions as to Period of Limitation of Assessment and
Collection of Taxes.
(a) In the case of a false or fraudulent return with intent to evade tax or of failure to
file a return, the tax may be assessed, or a proceeding in court for the collection of
such tax may be filed without assessment, at any time within ten (10) years after
the discovery of the falsity, fraud or omission: Provided, That in a fraud assessment
which has become final and executory, the fact of fraud shall be judicially taken
cognizance of in the civil or criminal action for the collection thereof.
Thus, should it be found that RCBC Capital/CODE-NGO sold the PEACe Bonds to 20
or more lenders/investors, the Bureau of Internal Revenue may still collect the
unpaid tax from RCBC Capital/CODE-NGO within 10 years after the discovery of the
omission.
In view of the foregoing, there is no need to pass upon the other issues raised by
petitioners and petitioners-intervenors.
Reiterative motion on the temporary restraining order
Respondents withholding of the
20% final withholding tax on
October 18, 2011 was justified
Under the Rules of Court, court orders are required to be served upon the parties
affected.224 Moreover, service may be made personally or by mail. 225 And,
[p]ersonal service is complete upon actual delivery [of the order.] 226 This courts
temporary restraining order was received only on October 19, 2011, or a day after
the PEACe Bonds had matured and the 20% final withholding tax on the interest
income from the same was withheld.
Publication of news reports in the print and broadcast media, as well as on the
internet, is not a recognized mode of service of pleadings, court orders, or
processes. Moreover, the news reports227cited by petitioners were posted minutes
before the close of office hours or late in the evening of October 18, 2011, and they
did not give the exact contents of the temporary restraining order.
[O]ne cannot be punished for violating an injunction or an order for an injunction

unless it is shown that such injunction or order was served on him personally or that
he had notice of the issuance or making of such injunction or
order.228chanRoblesvirtualLawlibrary
At any rate, [i]n case of doubt, a withholding agent may always protect himself or
herself by withholding the tax due229 and return the amount of the tax withheld
should it be finally determined that the income paid is not subject to withholding. 230
Hence, respondent Bureau of Treasury was justified in withholding the amount
corresponding to the 20% final withholding tax from the proceeds of the PEACe
Bonds, as it received this courts temporary restraining order only on October 19,
2011, or the day after this tax had been withheld.
Respondents retention of the
amounts withheld is a defiance of
the temporary restraining order
Nonetheless, respondents continued failure to release to petitioners the amount
corresponding to the 20% final withholding tax in order that it may be placed in
escrow as directed by this court constitutes a defiance of this courts temporary
restraining order.231chanRoblesvirtualLawlibrary
The temporary restraining order is not moot. The acts sought to be enjoined are
not fait accompli. For an act to be considered fait accompli, the act must have
already been fully accomplished and consummated. 232 It must be irreversible, e.g.,
demolition of properties,233 service of the penalty of imprisonment,234 and hearings
on cases.235 When the act sought to be enjoined has not yet been fully satisfied,
and/or is still continuing in nature,236 the defense of fait accompli cannot prosper.
The temporary restraining order enjoins the entire implementation of the 2011 BIR
Ruling that constitutes both the withholding and remittance of the 20% final
withholding tax to the Bureau of Internal Revenue. Even though the Bureau of
Treasury had already withheld the 20% final withholding tax 237 when it received the
temporary restraining order, it had yet to remit the monies it withheld to the Bureau
of Internal Revenue, a remittance which was due only on November 10, 2011. 238
The act enjoined by the temporary restraining order had not yet been fully satisfied
and was still continuing.
Under DOF-DBM Joint Circular No. 1-2000A239 dated July 31, 2001 which prescribes
to national government agencies such as the Bureau of Treasury the procedure for
the remittance of all taxes it withheld to the Bureau of Internal Revenue, a national
agency shall file before the Bureau of Internal Revenue a Tax Remittance Advice
(TRA) supported by withholding tax returns on or before the 10th day of the
following month after the said taxes had been withheld. 240 The Bureau of Internal
Revenue shall transmit an original copy of the TRA to the Bureau of
Treasury,241 which shall be the basis for recording the remittance of the tax
collection.242 The Bureau of Internal Revenue will then record the amount of taxes
reflected in the TRA as tax collection in the Journal of Tax Remittance by
government agencies based on its copies of the TRA. 243 Respondents did not submit
any withholding tax return or TRA to prove that the 20% final withholding tax was
indeed remitted by the Bureau of Treasury to the Bureau of Internal Revenue on

October 18, 2011.


Respondent Bureau of Treasurys Journal Entry Voucher No. 11-10-10395 244 dated
October 18, 2011 submitted to this court shows:chanroblesvirtuallawlibrary
Bonds Payable-L/T, Dom-Zero
Coupon T/Bonds
(Peace Bonds) 10 yr
Sinking Fund-Cash (BSF)
Due to BIR

Account Code Debit Amount


Credit Amount
442-360
35,000,000,000.
00

198-001
412-002

30,033,792,203.59
4,966,207,796.41

To record redemption of 10yr


Zero coupon (Peace Bond) net
of the 20% final withholding
tax pursuant to BIR Ruling No.
378-2011, value date, October
18, 2011 per BTr letter
authority and BSP Bank
Statements.
The foregoing journal entry, however, does not prove that the amount of
P4,966,207,796.41, representing the 20% final withholding tax on the PEACe Bonds,
was disbursed by it and remitted to the Bureau of Internal Revenue on October 18,
2011. The entries merely show that the monies corresponding to 20% final
withholding tax was set aside for remittance to the Bureau of Internal Revenue.
We recall the November 15, 2011 resolution issued by this court directing
respondents to show cause why they failed to comply with the [TRO]; and [to]
comply with the [TRO] in order that petitioners may place the corresponding funds
in escrow pending resolution of the petition. 245 The 20% final withholding tax was
effectively placed in custodia legis when this court ordered the deposit of the
amount in escrow. The Bureau of Treasury could still release the money withheld to
petitioners for the latter to place in escrow pursuant to this courts directive. There
was no legal obstacle to the release of the 20% final withholding tax to petitioners.
Congressional appropriation is not required for the servicing of public debts in view
of the automatic appropriations clause embodied in Presidential Decree Nos. 1177
and 1967.
Section 31 of Presidential Decree No. 1177 provides:chanroblesvirtuallawlibrary
Section 31. Automatic Appropriations. All expenditures for (a) personnel
retirement premiums, government service insurance, and other similar fixed
expenditures, (b) principal and interest on public debt, (c) national government
guarantees of obligations which are drawn upon, are automatically appropriated:
provided, that no obligations shall be incurred or payments made from funds thus

automatically appropriated except as issued in the form of regular budgetary


allotments.
Section 1 of Presidential Decree No. 1967 states:chanroblesvirtuallawlibrary
Section 1. There is hereby appropriated, out of any funds in the National Treasury
not otherwise appropriated, such amounts as may be necessary to effect payments
on foreign or domestic loans, or foreign or domestic loans whereon creditors make a
call on the direct and indirect guarantee of the Republic of the Philippines, obtained
by:
a. the Republic of the Philippines the proceeds of which were relent to governmentowned or controlled corporations and/or government financial institutions;
b. government-owned or controlled corporations and/or government financial
institutions the proceeds of which were relent to public or private institutions;
c. government-owned or controlled corporations and/or financial institutions and
guaranteed by the Republic of the Philippines;
d. other public or private institutions and guaranteed by government-owned or
controlled corporations and/or government financial institutions.
The amount of P35 billion that includes the monies corresponding to 20% final
withholding tax is a lawful and valid obligation of the Republic under the
Government Bonds. Since said obligation represents a public debt, the release of
the monies requires no legislative appropriation.
Section 2 of Republic Act No. 245 likewise provides that the money to be used for
the payment of Government Bonds may be lawfully taken from the continuing
appropriation out of any monies in the National Treasury and is not required to be
the subject of another appropriation legislation:chanroblesvirtuallawlibrary
SEC. 2. The Secretary of Finance shall cause to be paid out of any moneys in the
National Treasury not otherwise appropriated, or from any sinking funds provided
for the purpose by law, any interest falling due, or accruing, on any portion of the
public debt authorized by law. He shall also cause to be paid out of any such money,
or from any such sinking funds the principal amount of any obligations which have
matured, or which have been called for redemption or for which redemption has
been demanded in accordance with terms prescribed by him prior to date of
issue . . . In the case of interest-bearing obligations, he shall pay not less than their
face value; in the case of obligations issued at a discount he shall pay the face
value at maturity; or if redeemed prior to maturity, such portion of the face value as
is prescribed by the terms and conditions under which such obligations were
originally issued. There are hereby appropriated as a continuing appropriation out of
any moneys in the National Treasury not otherwise appropriated, such sums as may
be necessary from time to time to carry out the provisions of this section. The
Secretary of Finance shall transmit to Congress during the first month of each
regular session a detailed statement of all expenditures made under this section
during the calendar year immediately preceding.

Thus, DOF Department Order No. 141-95, as amended, states that payment for
Treasury bills and bonds shall be made through the National Treasurys account with
the Bangko Sentral ng Pilipinas, to wit:chanroblesvirtuallawlibrary
Section 38. Demand Deposit Account. The Treasurer of the Philippines maintains
a Demand Deposit Account with the Bangko Sentral ng Pilipinas to which all
proceeds from the sale of Treasury Bills and Bonds under R.A. No. 245, as amended,
shall be credited and all payments for redemption of Treasury Bills and Bonds shall
be charged.
Regarding these legislative enactments ordaining an automatic appropriations
provision for debt servicing, this court has held:chanroblesvirtuallawlibrary
Congress . . . deliberates or acts on the budget proposals of the President, and
Congress in the exercise of its own judgment and wisdom formulates an
appropriation act precisely following the process established by the Constitution,
which specifies that no money may be paid from the Treasury except in accordance
with an appropriation made by law.
Debt service is not included in the General Appropriation Act, since authorization
therefor already exists under RA Nos. 4860 and 245, as amended, and PD 1967.
Precisely in the light of this subsisting authorization as embodied in said Republic
Acts and PD for debt service, Congress does not concern itself with details for
implementation by the Executive, but largely with annual levels and approval
thereof upon due deliberations as part of the whole obligation program for the year.
Upon such approval, Congress has spoken and cannot be said to have delegated its
wisdom to the Executive, on whose part lies the implementation or execution of the
legislative wisdom.246(Citation omitted)
Respondent Bureau of Treasury had the duty to obey the temporary restraining
order issued by this court, which remained in full force and effect, until set aside,
vacated, or modified. Its conduct finds no justification and is
reprehensible.247chanRoblesvirtualLawlibrarychanrobleslaw
WHEREFORE, the petition for review and petitions-in-intervention are GRANTED.
BIR Ruling Nos. 370-2011 and DA 378-2011 are NULLIFIED.
Furthermore, respondent Bureau of Treasury is REPRIMANDED for its continued
retention of the amount corresponding to the 20% final withholding tax despite this
courts directive in the temporary restraining order and in the resolution dated
November 15, 2011 to deliver the amounts to the banks to be placed in escrow
pending resolution of this case.
Respondent Bureau of Treasury is hereby ORDERED to immediately release and pay
to the bondholders the amount corresponding to the 20% final withholding tax that
it withheld on October 18, 2011.
Sereno, C.J., Velasco, Jr., Leonardo-De Castro, Peralta, Bersamin, Del Castillo,
Villarama, Jr., Perez, Mendoza, Reyes, , and Perlas-Bernabe, JJ., concur.

Carpio, J., no part, former lawfirm was aprevious counsel to a party.


Brion, J., on leave.
Jardeleza, J., no part, prior action Solgen.

EN BANC
COMMISSIONER OF INTERNAL G. R. No. 163653
REVENUE,
Petitioner,

-versus-

FILINVEST
DEVELOPMENT
CORPORATION,
Respondent.
x-------------------------------------x

G. R. No. 167689

COMMISSIONER OF INTERNAL Present:


REVENUE,
Petitioner,
CORONA, C.J.,

CARPIO,
VELASCO, JR.,
LEONARDO-DE CASTRO,
BRION,
-versusPERALTA,
BERSAMIN,
DEL CASTILLO,
ABAD,
FILINVEST
DEVELOPMENT VILLARAMA, JR.,
CORPORATION,
PEREZ,
Respondent.
MENDOZA, and
SERENO,* JJ.

Promulgated:
July 19, 2011
x----------------------------------------------------------------------------------------------- x
DECISION

PEREZ, J.:
Assailed in these twin petitions for review on certiorari filed pursuant to Rule
45 of the 1997 Rules of Civil Procedure are the decisions rendered by the Court of
Appeals (CA) in the following cases: (a) Decision dated 16 December 2003 of the
then Special Fifth Division in CA-G.R. SP No. 72992; [1] and, (b) Decision dated 26
January 2005 of the then Fourteenth Division in CA-G.R. SP No. 74510. [2]
The Facts
The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc.
(FAI), respondent Filinvest Development Corporation (FDC) is a holding company
which also owned 67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). On
29 November 1996, FDC and FAI entered into a Deed of Exchange with FLI whereby
the former both transferred in favor of the latter parcels of land appraised
at P4,306,777,000.00. In exchange for said parcels which were intended to facilitate
development of medium-rise residential and commercial buildings, 463,094,301
shares of stock of FLI were issued to FDC and FAI. [3] As a result of the exchange, FLIs

ownership structure was changed to the extent reflected in the following


tabular prcis, viz.:
Number
and
Percentage of Shares
Held Prior to the
Exchange

Number of
Additional
Shares
Issued

Number
and
Percentage of Shares
Held
After
the
Exchange

FDC

2,537,358,000 67.42
%

42,217,00
0

2,579,575,000 61.03
%

FAI

00

420,877,000 9.96%

OTHERS

1,226,177,000 32.58
%

420,877,0
00
0

----------------- -----------

--------------

---------------

3,763,535,000 100%

463,094,3
01

4,226,629,000 (100%
)

Stockhold
er

1,226,177,000 29.01
%

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

the latter, together with FDC and FAI, complied with all the requirements imposed

in the ruling.[7]
On various dates during the years 1996 and 1997, in the meantime, FDC also
extended advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central
Corporation

(DSCC)

and

Filinvest

Capital,

Inc.

(FCI). [8] Duly

evidenced

by

instructional letters as well as cash and journal vouchers, said cash advances
amounted to P2,557,213,942.60 in 1996[9] and P3,360,889,677.48 in 1997.[10] On 15
November 1996, FDC also entered into a Shareholders Agreement with Reco Herrera

PTE Ltd. (RHPL) for the formation of a Singapore-based joint venture company called
Filinvest Asia Corporation (FAC), tasked to develop and manage FDCs 50%
ownership of its PBCom Office Tower Project (the Project). With their equity
participation in FAC respectively pegged at 60% and 40% in the Shareholders
Agreement, FDC subscribed to P500.7 million worth of shares in said joint venture
company to RHPLs subscription worth P433.8 million. Having paid its subscription by
executing a Deed of Assignment transferring to FAC a portion of its rights and
interest in the Project worth P500.7 million, FDC eventually reported a net loss
of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996. [11]
On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay
deficiency income and documentary stamp taxes, plus interests and compromise
penalties,[12] covered by the following Assessment Notices, viz.: (a) Assessment
Notice No. SP-INC-96-00018-2000 for deficiency income taxes in the sum
of P150,074,066.27 for 1996; (b) Assessment Notice No. SP-DST-96-00020-2000 for
deficiency documentary stamp taxes in the sum of P10,425,487.06 for 1996; (c)
Assessment Notice No. SP-INC-97-00019-2000 for deficiency income taxes in the
sum of P5,716,927.03 for 1997; and (d) Assessment Notice No. SP-DST-97-000212000 for deficiency documentary stamp taxes in the sum of P5,796,699.40 for 1997.
[13]

The foregoing deficiency taxes were assessed on the taxable gain supposedly

realized by FDC from the Deed of Exchange it executed with FAI and FLI, on the
dilution resulting from the Shareholders Agreement FDC executed with RHPL as well
as the arms-length interest rate and documentary stamp taxes imposable on the
advances FDC extended to its affiliates. [14]
On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand
for deficiency income taxes in the sum of P1,477,494,638.23 for the year 1997.
[15]

Covered by Assessment Notice No. SP-INC-97-0027-2000, [16] said deficiency tax

was also assessed on the taxable gain purportedly realized by FAI from the Deed of
Exchange it executed with FDC and FLI. [17] On 26 January 2000 or within the
reglementary period of thirty (30) days from notice of the assessment, both FDC
and FAI filed their respective requests for reconsideration/protest, on the ground
that the deficiency income and documentary stamp taxes assessed by the BIR were
bereft of factual and legal basis. [18]Having submitted the relevant supporting
documents pursuant to the 31 January 2000 directive from the BIR Appellate
Division, FDC and FAI filed on 11 September 2000 a letter requesting an early

resolution of their request for reconsideration/protest on the ground that the 180
days prescribed for the resolution thereof under Section 228 of the NIRC was going
to expire on 20 September 2000.[19]
In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve
their request for reconsideration/protest within the aforesaid period, FDC and FAI
filed on 17 October 2000 a petition for review with the Court of Tax Appeals (CTA)
pursuant to Section 228 of the 1997 NIRC. Docketed before said court as CTA Case
No. 6182, the petition alleged, among other matters, that as previously opined in
BIR Ruling No. S-34-046-97, no taxable gain should have been assessed from the
subject Deed of Exchange since FDC and FAI collectively gained further control of
FLI as a consequence of the exchange; that correlative to the CIR's lack of authority
to impute theoretical interests on the cash advances FDC extended in favor of its
affiliates, the rule is settled that interests cannot be demanded in the absence of a
stipulation to the effect; that not being promissory notes or certificates of
obligations, the instructional letters as well as the cash and journal vouchers
evidencing said cash advances were not subject to documentary stamp taxes; and,
that no income tax may be imposed on the prospective gain from the supposed
appreciation of FDC's shareholdings in FAC. As a consequence, FDC and FAC both
prayed that the subject assessments for deficiency income and documentary stamp
taxes for the years 1996 and 1997 be cancelled and annulled. [20]
On 4 December 2000, the CIR filed its answer, claiming that the transfer of property
in question should not be considered tax free since, with the resultant diminution of
its shares in FLI, FDC did not gain further control of said corporation. Likewise calling
attention to the fact that the cash advances FDC extended to its affiliates were
interest free despite the interest bearing loans it obtained from banking institutions,
the CIR invoked Section 43 of the old NIRC which, as implemented by Revenue
Regulations No. 2, Section 179 (b) and (c), gave him "the power to allocate,
distribute or apportion income or deductions between or among such organizations,
trades or business in order to prevent evasion of taxes." The CIR justified the
imposition of documentary stamp taxes on the instructional letters as well as cash
and journal vouchers for said cash advances on the strength of Section 180 of the
NIRC and Revenue Regulations No. 9-94 which provide that loan transactions are
subject to said tax irrespective of whether or not they are evidenced by a formal
agreement or by mere office memo. The CIR also argued that FDC realized taxable

gain arising from the dilution of its shares in FAC as a result of its Shareholders'
Agreement with RHPL.[21]
At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and
Issues[22] which was admitted in the 16 February 2001 resolution issued by the CTA.
With the further admission of the Formal Offer of Documentary Evidence
subsequently filed by FDC and FAI [23] and the conclusion of the testimony of Susana
Macabelda anent the cash advances FDC extended in favor of its affiliates, [24] the
CTA went on to render the Decision dated 10 September 2002 which, with the
exception of the deficiency income tax on the interest income FDC supposedly
realized from the advances it extended in favor of its affiliates, cancelled the rest of
deficiency income and documentary stamp taxes assessed against FDC and FAI for
the years 1996 and 1997,[25] thus:
WHEREFORE, in view of all the foregoing, the court finds the
instant petition partly meritorious. Accordingly, Assessment Notice No.
SP-INC-96-00018-2000 imposing deficiency income tax on FDC for
taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000 and
SP-DST-97-00021-2000 imposing deficiency documentary stamp tax on
FDC for taxable years 1996 and 1997, respectively and Assessment
Notice No. SP-INC-97-0027-2000 imposing deficiency income tax on FAI
for the taxable year 1997 are hereby CANCELLED and SET
ASIDE.However, [FDC] is hereby ORDERED to PAY the amount
of P5,691,972.03 as deficiency income tax for taxable year 1997. In
addition, petitioner is also ORDERED to PAY 20% delinquency interest
computed from February 16, 2000 until full payment thereof pursuant
to Section 249 (c) (3) of the Tax Code.[26]

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

US), i.e., Sec. 482, as implemented by Section 1.482-2 of 1965-1969 Regulations of


the Law of Federal Income Taxation.[27]
Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition
for review docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of
the 1997 Rules of Civil Procedure. Calling attention to the fact that the cash
advances it extended to its affiliates were interest-free in the absence of the
express stipulation on interest required under Article 1956 of the Civil Code, FDC
questioned the imposition of an arm's-length interest rate thereon on the ground,
among others, that the CIR's authority under Section 43 of the NIRC: (a) does not
include the power to impute imaginary interest on said transactions; (b) is directed
only against controlled taxpayers and not against mother or holding corporations;
and, (c) can only be invoked in cases of understatement of taxable net income or
evident tax evasion.[28] Upholding FDC's position, the CA's then Special Fifth Division
rendered the herein assailed decision dated 16 December 2003, [29] the decretal
portion of which states:
WHEREFORE, premises considered, the instant petition is
hereby GRANTED. The assailed Decision dated September 10, 2002
rendered by the Court of Tax Appeals in CTA Case No. 6182 directing
petitioner Filinvest Development Corporation to pay the amount
of P5,691,972.03 representing deficiency income tax on allegedly
undeclared interest income for the taxable year 1997, plus 20%
delinquency interest computed from February 16, 2000 until full
payment thereof is REVERSED and SET ASIDE and, a new one
entered annulling Assessment Notice No. SP-INC-97-00019-2000
imposing deficiency income tax on petitioner for taxable year 1997. No
pronouncement as to costs.[30]

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

The foregoing petition was, however, denied due course and dismissed for lack of

merit in the herein assailed decision dated 26 January 2005 [33] rendered by the CA's
then Fourteenth Division, upon the following findings and conclusions, to wit:
1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the
29 November 1996 Deed of Exchange resulted in the combined
control by FDC and FAI of more than 51% of the outstanding
shares of FLI, hence, no taxable gain can be recognized from the
transaction under Section 34 (c) (2) of the old NIRC;
2. The instructional letters as well as the cash and journal vouchers
evidencing the advances FDC extended to its affiliates are not
subject to documentary stamp taxes pursuant to BIR Ruling No.
116-98, dated 30 July 1998, since they do not partake the nature
of loan agreements;
3. Although BIR Ruling No. 116-98 had been subsequently modified by
BIR Ruling No. 108-99, dated 15 July 1999, to the effect that
documentary stamp taxes are imposable on inter-office memos
evidencing cash advances similar to those extended by FDC,
said latter ruling cannot be given retroactive application if to do
so would be prejudicial to the taxpayer;
4. FDC's alleged gain from the increase of its shareholdings in FAC as a
consequence of the Shareholders' Agreement it executed with
RHPL cannot be considered taxable income since, until actually
converted thru sale or disposition of said shares, they merely
represent unrealized increase in capital.[34]
Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the
CIR's petitions for review on certiorari assailing the 16 December 2003 decision in
CA-G.R. No. 72992 and the 26 January 2005 decision in CA-G.R. SP No. 74510 were
consolidated pursuant to the 1 March 2006 resolution issued by this Courts Third
Division.
The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:
THE COURT OF APPEALS ERRED IN REVERSING THE DECISION
OF THE COURT OF TAX APPEALS AND IN HOLDING THAT THE
ADVANCES EXTENDED BY RESPONDENT TO ITS AFFILIATES ARE
NOT SUBJECT TO INCOME TAX.[35]

In G.R. No. 167689, on the other hand, petitioner proffers the following issues for
resolution:
I
THE HONORABLE COURT OF APPEALS COMMITTED GRAVE
ABUSE OF DISCRETION IN HOLDING THAT THE EXCHANGE OF
SHARES OF STOCK FOR PROPERTY AMONG FILINVEST
DEVELOPMENT CORPORATION (FDC), FILINVEST ALABANG,
INCORPORATED (FAI) AND FILINVEST LAND INCORPORATED
(FLI) MET ALL THE REQUIREMENTS FOR THE NON-RECOGNITION
OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE OLD
NATIONAL INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40
(C) (2) (c) OF THE NIRC.
II
THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE
ERROR IN HOLDING THAT THE LETTERS OF INSTRUCTION OR
CASH VOUCHERS EXTENDED BY FDC TO ITS AFFILIATES ARE
NOT DEEMED LOAN AGREEMENTS SUBJECT TO DOCUMENTARY
STAMP TAXES UNDER SECTION 180 OF THE NIRC.
III
THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN
HOLDING THAT GAIN ON DILUTION AS A RESULT OF THE
INCREASE IN THE VALUE OF FDCS SHAREHOLDINGS IN FAC IS
NOT TAXABLE.[36]

The Courts Ruling


While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in
G.R. No. 167689 impressed with partial merit.
In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding
that theoretical interests can be imputed on the advances FDC extended to its
affiliates in 1996 and 1997 considering that, for said purpose, FDC resorted to
interest-bearing fund borrowings from commercial banks. Since considerable
interest expenses were deducted by FDC when said funds were borrowed, the CIR
theorizes that interest income should likewise be declared when the same funds
were sourced for the advances FDC extended to its affiliates. Invoking Section 43 of
the 1993 NIRC in relation to Section 179(b) of Revenue Regulation No. 2, the CIR

maintains that it is vested with the power to allocate, distribute or apportion income
or deductions between or among controlled organizations, trades or businesses
even in the absence of fraud, since said power is intended to prevent evasion of
taxes or clearly to reflect the income of any such organizations, trades or
businesses. In addition, the CIR asseverates that the CA should have accorded
weight and respect to the findings of the CTA which, as the specialized court
dedicated to the study and consideration of tax matters, can take judicial notice of
US income tax laws and regulations. [37]
Admittedly, Section 43 of the 1993 NIRC [38] provides that, (i)n any case of two
or more organizations, trades or businesses (whether or not incorporated and
whether or not organized in the Philippines) owned or controlled directly or
indirectly by the same interests, the Commissioner of Internal Revenue is authorized
to distribute, apportion or allocate gross income or deductions between or among
such organization, trade or business, if he determines that such distribution,
apportionment or allocation is necessary in order to prevent evasion of taxes or
clearly to reflect the income of any such organization, trade or business. In
amplification of the equivalent provision[39] under Commonwealth Act No. 466,
[40]

Sec. 179(b) of Revenue Regulation No. 2 states as follows:


Determination of the taxable net income of controlled
taxpayer. (A) DEFINITIONS. When used in this section
(1)
The term organization includes any kind, whether it
be a sole proprietorship, a partnership, a trust, an estate, or a
corporation or association, irrespective of the place where organized,
where operated, or where its trade or business is conducted, and
regardless of whether domestic or foreign, whether exempt or taxable,
or whether affiliated or not.
(2)
The terms trade or business include any trade or
business activity of any kind, regardless of whether or where
organized, whether owned individually or otherwise, and regardless of
the place where carried on.
(3)
The term controlled includes any kind of control,
direct or indirect, whether legally enforceable, and however exercisable
or exercised. It is the reality of the control which is decisive, not its
form or mode of exercise. A presumption of control arises if income or
deductions have been arbitrarily shifted.
(4)
The term controlled taxpayer means any one of two
or more organizations, trades, or businesses owned or controlled
directly or indirectly by the same interests.

(5)
The term group and group of controlled taxpayers
means the organizations, trades or businesses owned or controlled by
the same interests.
(6)
The term true net income means, in the case of a
controlled taxpayer, the net income (or as the case may be, any item
or element affecting net income) which would have resulted to the
controlled taxpayer, had it in the conduct of its affairs (or, as the case
may be, any item or element affecting net income) which would have
resulted to the controlled taxpayer, had it in the conduct of its affairs
(or, as the case may be, in the particular contract, transaction,
arrangement or other act) dealt with the other members or members
of the group at arms length. It does not mean the income, the
deductions, or the item or element of either, resulting to the controlled
taxpayer by reason of the particular contract, transaction, or
arrangement, the controlled taxpayer, or the interest controlling it,
chose to make (even though such contract, transaction, or
arrangement be legally binding upon the parties thereto).
(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax
Code is to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer, by determining, according to the standard of an
uncontrolled taxpayer, the true net income from the property and
business of a controlled taxpayer. The interests controlling a group of
controlled taxpayer are assumed to have complete power to cause
each controlled taxpayer so to conduct its affairs that its transactions
and accounting records truly reflect the net income from the property
and business of each of the controlled taxpayers. If, however, this has
not been done and the taxable net income are thereby understated,
the statute contemplates that the Commissioner of Internal Revenue
shall intervene, and, by making such distributions, apportionments, or
allocations as he may deem necessary of gross income or deductions,
or of any item or element affecting net income, between or among the
controlled taxpayers constituting the group, shall determine the true
net income of each controlled taxpayer. The standard to be applied in
every case is that of an uncontrolled taxpayer. Section 44 grants no
right to a controlled taxpayer to apply its provisions at will, nor does it
grant any right to compel the Commissioner of Internal Revenue to
apply its provisions.
(C) APPLICATION Transactions between controlled taxpayer and
another will be subjected to special scrutiny to ascertain whether the
common control is being used to reduce, avoid or escape taxes. In
determining the true net income of a controlled taxpayer, the
Commissioner of Internal Revenue is not restricted to the case of
improper accounting, to the case of a fraudulent, colorable, or sham
transaction, or to the case of a device designed to reduce or avoid tax
by shifting or distorting income or deductions. The authority to
determine true net income extends to any case in which either by
inadvertence or design the taxable net income in whole or in part, of a
controlled taxpayer, is other than it would have been had the taxpayer

in the conduct of his affairs been an uncontrolled taxpayer dealing at


arms length with another uncontrolled taxpayer. [41]
As may be gleaned from the definitions of the terms controlled and
"controlled taxpayer" under paragraphs (a) (3) and (4) of the foregoing provision, it
would appear that FDC and its affiliates come within the purview of Section 43 of
the 1993 NIRC. Aside from owning significant portions of the shares of stock of FLI,
FAI, DSCC and FCI, the fact that FDC extended substantial sums of money as cash
advances to its said affiliates for the purpose of providing them financial assistance
for their operational and capital expenditures seemingly indicate that the situation
sought to be addressed by the subject provision exists. From the tenor of paragraph
(c) of Section 179 of Revenue Regulation No. 2, it may also be seen that the CIR's
power to distribute, apportion or allocate gross income or deductions between or
among controlled taxpayers may be likewise exercised whether or not fraud inheres
in the transaction/s under scrutiny. For as long as the controlled taxpayer's taxable
income is not reflective of that which it would have realized had it been dealing at
arm's length with an uncontrolled taxpayer, the CIR can make the necessary
rectifications in order to prevent evasion of taxes.
Despite the broad parameters provided, however, we find that the CIR's
powers of distribution, apportionment or allocation of gross income and deductions
under Section 43 of the 1993 NIRC and Section 179 of Revenue Regulation No. 2
does not include the power to impute "theoretical interests" to the controlled
taxpayer's transactions. Pursuant to Section 28 of the 1993 NIRC, [42] after all, the
term gross income is understood to mean all income from whatever source derived,
including, but not limited to the following items: compensation for services,
including fees, commissions, and similar items; gross income derived from business;
gains derived from dealings in property; interest; rents; royalties; dividends;
annuities; prizes and winnings; pensions; and partners distributive share of the
gross income of general professional partnership. [43] While it has been held that the
phrase "from whatever source derived" indicates a legislative policy to include all
income not expressly exempted within the class of taxable income under our laws,
the term "income" has been variously interpreted to mean "cash received or its
equivalent", "the amount of money coming to a person within a specific time" or
"something distinct from principal or capital." [44] Otherwise stated, there must be
proof of the actual or, at the very least, probable receipt or realization by the

controlled taxpayer of the item of gross income sought to be distributed,


apportioned or allocated by the CIR.
Our circumspect perusal of the record yielded no evidence of actual or
possible showing that the advances FDC extended to its affiliates had resulted to
the interests subsequently assessed by the CIR. For all its harping upon the
supposed fact that FDC had resorted to borrowings from commercial banks, the CIR
had adduced no concrete proof that said funds were, indeed, the source of the
advances the former provided its affiliates. While admitting that FDC obtained
interest-bearing loans from commercial banks, [45] Susan Macabelda - FDC's Funds
Management Department Manager who was the sole witness presented before the
CTA - clarified that the subject advances were sourced from the corporation's rights
offering in 1995 as well as the sale of its investment in Bonifacio Land in 1997.
[46]

More significantly, said witness testified that said advances: (a) were extended to

give FLI, FAI, DSCC and FCI financial assistance for their operational and capital
expenditures; and, (b) were all temporarily in nature since they were repaid within
the duration of one week to three months and were evidenced by mere journal
entries, cash vouchers and instructional letters. [47]
Even if we were, therefore, to accord precipitate credulity to the CIR's bare
assertion that FDC had deducted substantial interest expense from its gross income,
there would still be no factual basis for the imputation of theoretical interests on the
subject advances and assess deficiency income taxes thereon. More so, when it is
borne in mind that, pursuant to Article 1956 of the Civil Code of the Philippines, no
interest shall be due unless it has been expressly stipulated in writing. Considering
that taxes, being burdens, are not to be presumed beyond what the applicable
statute expressly and clearly declares,[48] the rule is likewise settled that tax statutes
must be construed strictly against the government and liberally in favor of the
taxpayer.[49] Accordingly, the general rule of requiring adherence to the letter in
construing statutes applies with peculiar strictness to tax laws and the provisions of
a taxing act are not to be extended by implication. [50] While it is true that taxes are
the lifeblood of the government, it has been held that their assessment and
collection should be in accordance with law as any arbitrariness will negate the very
reason for government itself.[51]

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on
the imposition of deficiency income taxes on the transfer FDC and FAI effected in
exchange for the shares of stock of FLI. With respect to the Deed of Exchange
executed between FDC, FAI and FLI, Section 34 (c) (2) of the 1993 NIRC pertinently
provides as follows:
Sec. 34. Determination of amount of and recognition of
gain or loss.xxxx
(c) Exception x x x x
No gain or loss shall also be recognized if property is transferred to a
corporation by a person in exchange for shares of stock in such
corporation of which as a result of such exchange said person, alone or
together with others, not exceeding four persons, gains control of said
corporation; Provided, That stocks issued for services shall not be
considered as issued in return of property.

As even admitted in the 14 February 2001 Stipulation of Facts submitted by the


parties,[52] the requisites for the non-recognition of gain or loss under the foregoing
provision are as follows: (a) the transferee is a corporation; (b) the transferee
exchanges its shares of stock for property/ies of the transferor; (c) the transfer is
made by a person, acting alone or together with others, not exceeding four persons;
and, (d) as a result of the exchange the transferor, alone or together with others,
not exceeding four, gains control of the transferee. [53] Acting on the 13 January 1997
request filed by FLI, the BIR had, in fact, acknowledged the concurrence of the
foregoing requisites in the Deed of Exchange the former executed with FDC and FAI
by issuing BIR Ruling No. S-34-046-97. [54] With the BIR's reiteration of said ruling
upon the request for clarification filed by FLI, [55] there is also no dispute that said
transferee and transferors subsequently complied with the requirements provided
for the non-recognition of gain or loss from the exchange of property for tax, as
provided under Section 34 (c) (2) of the 1993 NIRC. [56]
Then as now, the CIR argues that taxable gain should be recognized for the
exchange considering that FDC's controlling interest in FLI was actually decreased
as a result thereof.For said purpose, the CIR calls attention to the fact that, prior to
the exchange, FDC owned 2,537,358,000 or 67.42% of FLI's 3,763,535,000
outstanding capital stock. Upon the issuance of 443,094,000 additional FLI shares

as a consequence of the exchange and with only 42,217,000 thereof accruing in


favor of FDC for a total of 2,579,575,000 shares, said corporations controlling
interest was supposedly reduced to 61%.03 when reckoned from the transferee's
aggregate 4,226,629,000 outstanding shares. Without owning a share from FLI's
initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of
420,877,000 FLI shares as a result of the exchange purportedly resulted in its
control of only 9.96% of said transferee corporation's 4,226,629,000 outstanding
shares. On the principle that the transaction did not qualify as a tax-free exchange
under Section 34 (c) (2) of the 1993 NIRC, the CIR asseverates that taxable gain in
the sum of P263,386,921.00 should be recognized on the part of FDC and in the
sum of P3,088,711,367.00 on the part of FAI.[57]
The paucity of merit in the CIR's position is, however, evident from the categorical
language of Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will
not be recognized in case the exchange of property for stocks results in the control
of the transferee by the transferor, alone or with other transferors not exceeding
four persons. Rather than isolating the same as proposed by the CIR, FDC's
2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000 outstanding shares
should, therefore, be appreciated in combination with the 420,877,000 new shares
issued

to

FAI

which

represents

9.96%

control

of

said

transferee

corporation. Together FDC's 2,579,575,000 shares (61.03%) and FAI's 420,877,000


shares (9.96%) clearly add up to 3,000,452,000 shares or 70.99% of FLI's
4,226,629,000 shares. Since the term "control" is clearly defined as "ownership of
stocks in a corporation possessing at least fifty-one percent of the total voting
power of classes of stocks entitled to one vote" under Section 34 (c) (6) [c] of the
1993 NIRC, the exchange of property for stocks between FDC FAI and FLI clearly
qualify as a tax-free transaction under paragraph 34 (c) (2) of the same provision.
Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then
Supreme Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their
book Tax Law and Jurisprudence, opined that said provision could be inapplicable if
control is already vested in the exchangor prior to exchange. [58] Aside from the fact
that that the 10 September 2002 Decision in CTA Case No. 6182 upholding the taxexempt status of the exchange between FDC, FAI and FLI was penned by no less
than Justice Acosta himself,[59] FDC and FAI significantly point out that said authors
have acknowledged that the position taken by the BIR is to the effect that "the law

would apply even when the exchangor already has control of the corporation at the
time of the exchange."[60] This was confirmed when, apprised in FLI's request for
clarification about the change of percentage of ownership of its outstanding capital
stock, the BIR opined as follows:
Please be informed that regardless of the foregoing, the
transferors, Filinvest Development Corp. and Filinvest Alabang, Inc. still
gained control of Filinvest Land, Inc. The term 'control' shall mean
ownership of stocks in a corporation by possessing at least 51% of the
total voting power of all classes of stocks entitled to vote. Control is
determined by the amount of stocks received, i.e., total subscribed,
whether for property or for services by the transferor or transferors. In
determining the 51% stock ownership, only those persons who
transferred property for stocks in the same transaction may be
counted up to the maximum of five (BIR Ruling No. 547-93 dated
December 29, 1993.[61]
At any rate, it also appears that the supposed reduction of FDC's shares in FLI
posited by the CIR is more apparent than real. As the uncontested owner of 80% of
the outstanding shares of FAI, it cannot be gainsaid that FDC ideally controls the
same percentage of the 420,877,000 shares issued to its said co-transferor which,
by itself, represents 7.968% of the outstanding shares of FLI. Considered alongside
FDC's 61.03% control of FLI as a consequence of the 29 November 1996 Deed of
Transfer, said 7.968% add up to an aggregate of 68.998% of said transferee
corporation's outstanding shares of stock which is evidently still greater than the
67.42% FDC initially held prior to the exchange. This much was admitted by the
parties in the 14 February 2001 Stipulation of Facts, Documents and Issues they
submitted to the CTA.[62] Inasmuch as the combined ownership of FDC and FAI of
FLI's outstanding capital stock adds up to a total of 70.99%, it stands to reason that
neither of said transferors can be held liable for deficiency income taxes the CIR
assessed on the supposed gain which resulted from the subject transfer.
On the other hand, insofar as documentary stamp taxes on loan agreements and
promissory notes are concerned, Section 180 of the NIRC provides follows:
Sec. 180. Stamp tax on all loan agreements, promissory notes,
bills of exchange, drafts, instruments and securities issued by
the government or any of its instrumentalities, certificates of
deposit bearing interest and others not payable on sight or
demand. On all loan agreements signed abroad wherein the object of
the contract is located or used in the Philippines; bill of exchange

(between points within the Philippines), drafts, instruments and


securities issued by the Government or any of its instrumentalities or
certificates of deposits drawing interest, or orders for the payment of
any sum of money otherwise than at sight or on demand, or on all
promissory notes, whether negotiable or non-negotiable, except bank
notes issued for circulation, and on each renewal of any such note,
there shall be collected a documentary stamp tax of Thirty centavos
(P0.30) on each two hundred pesos, or fractional part thereof, of the
face value of any such agreement, bill of exchange, draft, certificate of
deposit or note: Provided, That only one documentary stamp tax shall
be imposed on either loan agreement, or promissory notes issued to
secure such loan, whichever will yield a higher tax: Provided
however, That loan agreements or promissory notes the aggregate of
which does not exceed Two hundred fifty thousand pesos
(P250,000.00) executed by an individual for his purchase on
installment for his personal use or that of his family and not for
business, resale, barter or hire of a house, lot, motor vehicle, appliance
or furniture shall be exempt from the payment of documentary stamp
tax provided under this Section.
When read in conjunction with Section 173 of the 1993 NIRC, [63] the foregoing
provision concededly applies to "(a)ll loan agreements, whether made or signed in
the Philippines, or abroad when the obligation or right arises from Philippine sources
or

the

property

or

object

of

the

contract

is

located

or

used

in

the

Philippines." Correlatively, Section 3 (b) and Section 6 of Revenue Regulations No. 994 provide as follows:
Section 3. Definition of Terms. For purposes of these Regulations, the
following term shall mean:
(b) 'Loan agreement' refers to a contract in writing where one of the
parties delivers to another money or other consumable thing, upon the
condition that the same amount of the same kind and quality shall be
paid. The term shall include credit facilities, which may be evidenced
by credit memo, advice or drawings.
The terms 'Loan Agreement" under Section 180 and "Mortgage' under
Section 195, both of the Tax Code, as amended, generally refer to
distinct and separate instruments. A loan agreement shall be taxed
under Section 180, while a deed of mortgage shall be taxed under
Section 195."
"Section 6. Stamp on all Loan Agreements. All loan agreements
whether made or signed in the Philippines, or abroad when the
obligation or right arises from Philippine sources or the property or
object of the contract is located in the Philippines shall be subject to
the documentary stamp tax of thirty centavos (P0.30) on each two

hundred pesos, or fractional part thereof, of the face value of any such
agreements, pursuant to Section 180 in relation to Section 173 of the
Tax Code.
In cases where no formal agreements or promissory notes have
been executed to cover credit facilities, the documentary stamp tax
shall be based on the amount of drawings or availment of the facilities,
which may be evidenced by credit/debit memo, advice or drawings by
any form of check or withdrawal slip, under Section 180 of the Tax
Code.
Applying the aforesaid provisions to the case at bench, we find that the
instructional letters as well as the journal and cash vouchers evidencing the
advances FDC extended to its affiliates in 1996 and 1997 qualified as loan
agreements upon which documentary stamp taxes may be imposed. In keeping with
the caveat attendant to every BIR Ruling to the effect that it is valid only if the facts
claimed by the taxpayer are correct, we find that the CA reversibly erred in utilizing
BIR Ruling No. 116-98, dated 30 July 1998 which, strictly speaking, could be invoked
only by ASB Development Corporation, the taxpayer who sought the same. In said
ruling, the CIR opined that documents like those evidencing the advances FDC
extended to its affiliates are not subject to documentary stamp tax, to wit:
On the matter of whether or not the inter-office memo covering the
advances granted by an affiliate company is subject to documentary
stamp tax, it is informed that nothing in Regulations No. 26
(Documentary Stamp Tax Regulations) and Revenue Regulations No. 994 states that the same is subject to documentary stamp tax. Such
being the case, said inter-office memo evidencing the lendings or
borrowings which is neither a form of promissory note nor a certificate
of indebtedness issued by the corporation-affiliate or a certificate of
obligation, which are, more or less, categorized as 'securities', is not
subject to documentary stamp tax imposed under Section 180, 174
and 175 of the Tax Code of 1997, respectively. Rather, the inter-office
memo is being prepared for accounting purposes only in order to avoid
the co-mingling of funds of the corporate affiliates.

In its appeal before the CA, the CIR argued that the foregoing ruling was later
modified in BIR Ruling No. 108-99 dated 15 July 1999, which opined that inter-office
memos evidencing lendings or borrowings extended by a corporation to its affiliates
are akin to promissory notes, hence, subject to documentary stamp taxes. [64] In
brushing aside the foregoing argument, however, the CA applied Section 246 of the
1993 NIRC[65] from which proceeds the settled principle that rulings, circulars, rules

and regulations promulgated by the BIR have no retroactive application if to so


apply them would be prejudicial to the taxpayers. [66] Admittedly, this rule does not
apply: (a) where the taxpayer deliberately misstates or omits material facts from his
return or in any document required of him by the Bureau of Internal Revenue; (b)
where the facts subsequently gathered by the Bureau of Internal Revenue are
materially different from the facts on which the ruling is based; or (c) where the
taxpayer acted in bad faith.[67] Not being the taxpayer who, in the first instance,
sought a ruling from the CIR, however, FDC cannot invoke the foregoing principle on
non-retroactivity of BIR rulings.
Viewed in the light of the foregoing considerations, we find that both the CTA and
the CA erred in invalidating the assessments issued by the CIR for the deficiency
documentary stamp taxes due on the instructional letters as well as the journal and
cash vouchers evidencing the advances FDC extended to its affiliates in 1996 and
1997. In Assessment Notice No. SP-DST-96-00020-2000, the CIR correctly assessed
the sum of P6,400,693.62 for documentary stamp tax, P3,999,793.44 in interests
and P25,000.00 as compromise penalty, for a total of P10,425,487.06. Alongside the
sum

of P4,050,599.62

for

documentary

stamp

tax,

the

CIR

similarly

assessed P1,721,099.78 in interests and P25,000.00 as compromise penalty in


Assessment Notice No. SP-DST-97-00021-2000 or a total of P5,796,699.40. The
imposition of deficiency interest is justified under Sec. 249 (a) and (b) of the NIRC
which authorizes the assessment of the same at the rate of twenty percent (20%),
or such higher rate as may be prescribed by regulations, from the date prescribed
for the payment of the unpaid amount of tax until full payment. [68] The imposition of
the compromise penalty is, in turn, warranted under Sec. 250 [69] of the NIRC which
prescribes the imposition thereof in case of each failure to file an information or
return, statement or list, or keep any record or supply any information required on
the date prescribed therefor.
To our mind, no reversible error can, finally, be imputed against both the CTA and
the CA for invalidating the Assessment Notice issued by the CIR for the deficiency
income taxes FDC is supposed to have incurred as a consequence of the dilution of
its shares in FAC. Anent FDCs Shareholders Agreement with RHPL, the record shows
that the parties were in agreement about the following factual antecedents narrated
in the 14 February 2001 Stipulation of Facts, Documents and Issues they submitted
before the CTA,[70] viz.:

1.11. On November 15, 1996, FDC entered into a Shareholders


Agreement (SA) with Reco Herrera Pte. Ltd. (RHPL) for the formation of
a joint venture company named Filinvest Asia Corporation (FAC) which
is based in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7,
Answer).
1.12. FAC, the joint venture company formed by FDC and RHPL, is
tasked to develop and manage the 50% ownership interest of FDC in
its PBCom Office Tower Project (Project) with the Philippine Bank of
Communications (par. 6.12, Petition; par. 7, Answer).
1.13. Pursuant to the SA between FDC and RHPL, the equity
participation of FDC and RHPL in FAC was 60% and 40% respectively.
1.14. In accordance with the terms of the SA, FDC subscribed to P500.7
million worth of shares of stock representing a 60% equity participation
in FAC. In turn, RHPL subscribed to P433.8 million worth of shares of
stock of FAC representing a 40% equity participation in FAC.
1.15. In payment of its subscription in FAC, FDC executed a Deed
of Assignment transferring to FAC a portion of FDCs right and interests
in the Project to the extent of P500.7 million.
1.16. FDC reported a net loss of P190,695,061.00 in its Annual
Income Tax Return for the taxable year 1996.[71]

Alongside the principle that tax revenues are not intended to be liberally
construed,[72] the rule is settled that the findings and conclusions of the CTA are
accorded great respect and are generally upheld by this Court, unless there is a
clear showing of a reversible error or an improvident exercise of authority. [73] Absent
showing of such error here, we find no strong and cogent reasons to depart from
said rule with respect to the CTA's finding that no deficiency income tax can be
assessed on the gain on the supposed dilution and/or increase in the value of FDC's
shareholdings in FAC which the CIR, at any rate, failed to establish. Bearing in mind
the meaning of "gross income" as above discussed, it cannot be gainsaid, even
then, that a mere increase or appreciation in the value of said shares cannot be
considered income for taxation purposes. Since a mere advance in the value of the
property of a person or corporation in no sense constitute the income specified in
the revenue law, it has been held in the early case of Fisher vs. Trinidad,[74] that it
constitutes and can be treated merely as an increase of capital. Hence, the CIR has

no factual and legal basis in assessing income tax on the increase in the value of
FDC's shareholdings in FAC until the same is actually sold at a profit.
WHEREFORE, premises considered, the CIR's petition for review on certiorari in
G.R. No. 163653 is DENIED for lack of merit and the CAs 16 December 2003
Decision in G.R. No. 72992 is AFFIRMED in toto. The CIRs petition in G.R. No.
167689 is PARTIALLY GRANTED and the CAs 26 January 2005 Decision in CA-G.R.
SP No. 74510 isMODIFIED.
Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-9700021-2000 issued for deficiency documentary stamp taxes due on the instructional
letters as well as journal and cash vouchers evidencing the advances FDC extended
to its affiliates are declared valid.
The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC97-00019-2000 and SP-INC-97-0027-2000 issued for deficiency income assessed on
(a) the arms-length interest from said advances; (b) the gain from FDCs Deed of
Exchange with FAI and FLI; and (c) income from the dilution resulting from FDCs
Shareholders Agreement with RHPL is, however, upheld.
SO ORDERED.

Republic of the Philippines


SUPREME COURT
Manila
THIRD DIVISION
G.R. No. 71479 October 18, 1990
MELLON BANK, N.A., petitioner,
vs.
HON. CELSO L. MAGSINO, in his capacity as Presiding Judge of Branch CLIX
of the Regional Trial Court at Pasig; MELCHOR JAVIER, JR., VICTORIA
JAVIER; HEIRS OF HONORIO POBLADOR, JR., namely: Elsa Alunan Poblador,
Honorio Poblador III, Rafael Poblador, Manuel Poblador, Ma. Regina
Poblador, Ma. Concepcion Poblador & Ma. Dolores Poblador; F.C.
HAGEDORN & CO., INC.; DOMINGO JHOCSON, JR.; JOSE MARQUEZ; ROBERTO
GARINO; ELNOR INVESTMENT CO., INC.; PARAMOUNT FINANCE
CORPORATION; RAFAEL CABALLERO; and TRI-ARC INVESTMENT and
MANAGEMENT CO., INC.respondents.
Romulo, Mabanta, Buenaventura, Sayoc & De los Angeles for petitioner.
Jose Buendia for respondent Jose Marquez.
Raul L. Cornea & Associates for Jhocson and Garino.
Jesus L. Santos and Conrado Valera for Tri-Arc Investment, etc.
Bernardo D. Calderon for respondent ELNOR and Rafael Caballero.
Nazareno, Azada, Sabado & Dizon for Movants.
Balgos & Perez for Paramount Finance Corporation.
Meer, Meer & Meer for Hagedorn.
Alberto Villareza for F.C. Hagedorn & Co.

FERNAN, C.J.:

The issue in the instant special civil action of certiorari is whether or not, by virtue
of the principle of election of remedies, an action filed in California, U.S.A., to
recover real property located therein and to constitute a constructive trust on said
property precludes the filing in our jurisdiction of an action to recover the purchase
price of said real property.
On May 27, 1977, Dolores Ventosa requested the transfer of $1,000 from the First
National Bank of Moundsville, West Virginia, U.S.A. to Victoria Javier in Manila
through the Prudential Bank. Accordingly, the First National Bank requested the
petitioner, Mellon Bank, to effect the transfer. Unfortunately the wire sent by Mellon
Bank to Manufacturers Hanover Bank, a correspondent of Prudential Bank, indicated
the amount transferred as "US$1,000,000.00" instead of US$1,000.00. Hence
Manufacturers Hanover Bank transferred one million dollars less bank charges of
$6.30 to the Prudential Bank for the account of Victoria Javier.
On June 3, 1977, Javier opened a new dollar account (No. 343) in the Prudential
Bank and deposited $999,943.70. Immediately their, Victoria Javier and her
husband, Melchor Javier, Jr., made withdrawals from the account, deposited them in
several banks only to withdraw them later in an apparent plan to conceal, "launder"
and dissipate the erroneously sent amount.
On June 14, 1977, Javier withdrew $475,000 from account No. 343 and converted it
into eight cashier's checks made out to the following: (a) F.C. Hagedorn & Co., Inc.,
two cheeks for the total amount of P1,000,000; (b) Elnor Investment Co., Inc., two
checks for P1,000,000; (c) Paramount Finance Corporation, two checks for
P1,000,000; and (d) M. Javier, Jr., two checks for P496,000. The first six checks were
delivered to Jose Marquez and Honorio Poblador, Jr.
It appears that Melchor Javier, Jr. had requested Jose Marquez, a realtor, to look for
properties for sale in the United States. Marquez offered a 160-acre lot in the
Mojave desert in California City which was owned by Honorio Poblador, Jr. Javier,
without having seen the property, agreed to buy it for P3,236,800 (US$437,405)
although it was actually appraised at around $38,500. Consequently, as Poblador's
agent, Marquez executed in Makati a deed of absolute sale in favor of the Javiers
and had the document notarized in Manila before an associate of Poblador. Marquez
executed another deed of sale indicating receipt of the purchase price and sent the
deed to the Kern County Registrar in California for registration.
Inasmuch as Poblador had requested that the purchase price should not be paid
directly to him, the payment of P3,000,000 was coursed through Elnor Investment
Co., Inc., allegedly Poblador's personal holding company; Paramount Finance,
allegedly headed by Poblador's brother, and F.C. Hagedorn, allegedly a stock
brokerage with extensive dealings with Poblador. The payment was made through

the aforementioned six cashier's checks while the balance of P236,000 was paid in
cash by Javier who did not even ask for a receipt.
The two checks totalling P1,000,000 was delivered by Poblador to F.C. Hagedorn
with specific instructions to purchase Atlas, SMC and Philex shares. The four checks
for P2,000,000 with Elnor Investment and Paramount Finance as payees were
delivered to the latter to purchase "bearer" notes.
Meanwhile, in July, 1977, Mellon Bank filed a complaint docketed as No. 148056 in
the Superior Court of California, County of Kern, against Melchor Javier, Jane Doe
Javier, Honorio Poblador, Jrn, and Does I through V. In its first amended complaint to
impose constructive trust dated July 14, 1977, 1 Mellon Bank alleged that it had
mistakenly and inadvertently cause the transfer of the sum of $999,000.00 to Jane
Doe Javier; that it believes that the defendants had withdrawn said funds; that "the
defendants and each of them have used a portion of said funds to purchase real
property located in Kern County, California"; and that because of defendants'
knowledge of Mellon Bank's mistake and inadvertence and their use of the funds to
purchase the property, they and "each of them are involuntary or constructive
trustees of the real property and of any profits therefrom, with a duty to convey the
same to plaintiff forthwith." It prayed that the defendants and each of them be
declared as holders of the property in trust for the plaintiff; that defendants be
compelled to transfer legal title and possession of the property to the plaintiff; that
defendants be made to pay the costs of the suit, and that other reliefs be granted
them.
On July 29, 1977, Mellon Bank also filed in the Court of First Instance of Rizal,
Branch X, a complaint against the Javier spouses, Honorio Poblador, Jr., Domingo L.
Jhocson, Jr., Jose Marquez, Roberto Gario, Elnor Investment Co., Inc., F.C. Hagedorn
& Co., Inc. and Paramount Finance Corporation. After its amendment, Rafael
Caballero and Tri-Arc Investment & Management Company, Inc. were also named
defendants. 2
The amended and supplemental complaint alleged the facts set forth above and
added that Roberto Gario, chief accountant of Prudential Bank, and who was the
reference of Mrs. Ventosa's dollar remittances to Victoria Javier, immediately
informed the Javiers of the receipt of US$1,000,000.00; that knowing the financial
circumstances of Mrs. Ventosa and the fact that a mistake had been committed, the
Javiers, with undue haste, took unlawful advantage of the mistake, withdrew the
whole amount and transferred the same to a "343 dollar account"; that, aided and
abetted by Poblador and Domingo L. Jhocson, the Javiers "compounded and
completed the conversion" of the funds by withdrawing from the account dollars or
pesos equivalent to US $975,000; that by force of law, the Javiers had been
constituted trustees of an implied trust for the benefit of Mellon Bank with a clear
duty to return to said bank the moneys mistakenly paid to them; that, upon request

of Mellon Bank and Manufacturers Hanover Bank, Prudential Bank informed the
Javiers of the erroneous transmittal of one million dollars first orally and later by
letter-demand; that conferences between the representatives of the Javiers, led by
Jhocson and Poblador, in the latter's capacity as legal and financial counsel, and
representatives of Mellon Bank, proved futile as the Javiers claimed that most of the
moneys had been irretrievably spent; that the Javiers could only return the amount
if the Mellon Bank should agree to make an absolute quitclaim and waiver of future
rights against them, and that in a scheme to conceal and dissipate the funds,
through the active participation of Jose Marquez, the Javiers bought the California
property of Poblador.
It further alleged that trust fund moneys totalling P3,000,000.00 were made
payable to Hagedorn Paramount and Elnor; that Hagedorn on instructions of
Poblador, purchased shares of stock at a stock exchange for P1,000,000.00 but
later, it hastily sold said shares at a loss of approximately P150,000.00 to the
prejudice of the plaintiff; that proceeds of the sale were deposited by Hagedorn in
the name of Poblador and/or the law office of Poblador, Nazareno, Azada, Tomacruz
and Paredes; that dividends declared on the shares were delivered by Hagedorn to
Caballero after the complaint had been filed and thereafter, Caballero deposited the
dividends in his personal account; that after receiving the P1,000,000.00 trust
money, Paramount issued promissory notes upon maturity of which Paramount
released the amount to unknown persons; that Elnor also invested P1,000,000.00 in
Paramount for which the latter also issued promissory notes; that after the filing of
the complaint, counsel for plaintiff requested Paramount not to release the amount
after maturity; that in evident bad faith, Elnor transferred the non-negotiable
Paramount promissory notes to Tri-Arc. that when the notes matured, Paramount
delivered the proceeds of P1,000,000.00 to Tri-Arc; that Poblador knew or should
have known that the attorney's fees he received from the Javiers came from the
trust funds; and that despite formal demands even after the filing of the complaint,
the defendants refused to return the trust funds which they continued concealing
and dissipating.
It prayed that: (a) the Javiers, Poblador, Elnor, Jhocson and Gario be ordered to
account for and pay jointly and severally unto the plaintiff US$999,000.00 plus
increments, additions, fruits and interests earned by the funds from receipt thereof
until fully paid; (b) the other defendants be ordered to account for and pay unto the
plaintiff jointly and severally with the Javiers to the extent of the amounts which
each of them may have received directly or indirectly from the US$999,000.00 plus
increments, additions, fruits and interests; (c) Marquez be held jointly and severally
liable with Poblador for the amount received by the latter for the sale of the 160acre lot in California City; and (d) defendants be likewise held liable jointly and
severally for attomey's fees and litigation expenses plus exemplary damages.

In due course, the defendants filed their answers and hearing of the case ensued. In
his testimony, Jose Marquez stated that Prudential Bank and Trust Company checks
Nos. 2530 and 2531 in the respective amounts of P100,000 and P900,000 payable
to F. C. Hagedorn were delivered to him by Melchor Javier, Jr. as partial consideration
for the sale of Poblador's property in California. After receiving the checks, Hagedorn
purchased shares of Atlas Mining, Philex, Marcopper and San Miguel Corporation for
Account No. 3000, which, according to Fred Hagedorn belonged to the law office of
Poblador. 3
F.C. Hagedorn & Co., Inc. then sold the shares for P874,490.75 as evidenced by
HSBC check No. 339736 for P400,000 and HSBC check No. 339737 for P474,490.75
payable to "cash". Mellon Bank traced these checks to Account 2825-1 of the
Philippine Veterans Bank in the name of Cipriano Azada, Poblador's law partner and
counsel to the Javiers. 4
An employee of the Philippine Veterans Bank thereafter introduced the specimen
signature cards for Account No. 2825-1 thereby confirming Azada's ownership of the
account. Defendants objected to this testimony on the grounds of Azada's absence,
the confidentiality of the bank account, and the best evidence rule. The court
overruled the objection. Another employee of the Philippine Veterans Bank then
presented the ledger card for Account No. 2825-1, a check deposit slip and a daily
report of returned items. The defendants objected but they were again overruled by
the court.
Mellon Bank then subpoenaed Erlinda Baylosis of the Philippine Veterans Bank to
show that Azada deposited HSBC checks No. 339736 and 339737 amounting to
P874,490.75 in his personal current account with said bank. It also subpoenaed
Pilologo Red, Jr. of Hongkong & Shanghai Banking Corporation to prove that said
amount was returned by Azada to Hagedorn.
The testimonies of these witnesses were objected to by the defense on the grounds
of res inter alios acta, immateriality, irrelevancy and confidentiality. To resolve the
matter, the court ordered the parties to submit memoranda. The defendants'
objections were also discussed at the hearing on July 13, 1982. For the first time,
Poblador's counsel raised the matter of "election of remedies." 5
At the July 20, 1982 hearing, the lower court, then presided by Judge Eficio Acosta,
conditionally allowed the testimonies of Baylosis and Red. Baylosis afffirmed that
Azada deposited checks Nos. 339736 and 339737 in the total amount of
P874,490.75 in his personal account with the Philippine Veterans Bank but almost
simultaneously, Azada issued his PVB check for the same amount in favor of
Hagedorn Consequently, Azada's check initially bounced. For his part, Red testified
that Azada's check for P874,490.75 was received by the Hongkong & Shanghai
Banking Corporation and credited to the account of Hagedorn .

The defendants then moved to strike off the testimonies of Baylosis and Red from
the record. Defendant Paramount Finance Corporation, which is not a party to the
California case, thereafter filed its memorandum raising the matter of "election of
remedies". It averred that inasmuch as the Mellon Bank had filed in California an
action to impose constructive trust on the California property and to recover the
same, Mellon Bank can no longer try to regain the purchase price of the same
property through Civil Case No. 26899. The other defendants adopted Paramount's
stand.
After Mellon Bank filed its reply to the memorandum of Paramount, on September
10, 1982, Judge Acosta issued a resolution ordering that the testimonies of Baylosis
and Red and the documents they testified on, which were conditionally allowed, be
stricken from the records. 6 Judge Acosta explained:
After a judicious evaluation of the arguments of the parties the Court is
of the view that in cases where money held in trust was diverted by
the trustee, under the "rule of trust pursuit" the beneficiary "may elect
whether to accept the trust estate in its new form or hold the trustee
responsible for it in its original condition" (Lathrop vs. Hampton, 31 Cal.
17; Zodos vs. Marefalos 48 Idaho 291; Bahle vs. Hasselbrach 64 NW
Eq. 334, 51 Sections 508-76 Am Jur. 2d p. 475), and that "an election to
pursue one remedy waives and bars pursuit of any inconsistent
remedy"(76 Am Jur. 2d S253). The instant complaint among others is
for the recovery of the purchase price of the Kern property as held in
trust for the plaintiff while in the California case the plaintiff maintains
that the Kern property is held in trust for the plaintiff, which positions
are inconsistent with each other. Neither can the plaintiff now abandon
his complaint for the recovery of the Kern property and pursue his
complaint for the recovery of the purchase price of said property for "if
he has first sought to follow the res, the plaintiff cannot thereafter hold
the trustee personally responsible" and "when once there has been an
election to do one of two things, you cannot retract it and do the other
thing. The election once made is finally made." (Fowler vs. Bowvery
Savings Bank 113 N.Y. 450, 21 N.E. 172, 4 LRA 145, 10 Am. S.R. 479. 2
Silv. 280, 23, Abb. N. Cos. 133065 C. J. p. 980 Note 32).
The fact that the California case has been stayed pending
determination of the instant case only means that should this case be
dismissed, the California case can proceed to its final determination.
Furthermore, when the plaintiff filed the California case for the transfer
of legal title and possession of the Kern property to the plaintiff it in
effect ratified the transaction for "by taking the proceeds or product of
a wrongful transfer of trust property or funds, the beneficiary ratifies

the transaction" (Board of Commissioner vs. Strawn [CA6 Ohio] 157 F.


49, 76 Am Jur. 2d Section 253). Consequently the purchase price of the
California property received by defendant Poblador from Javier is no
longer the proper subject matter of litigation and the movement and
disposition of the purchase price is therefore within the scope of the
absolutely confidential nature of bank deposits as provided by Sec. 2,
R.A. 1405 as amended by PD No. 1792.
Mellon Bank moved for reconsideration, alleging that said order prevented the
presentation of evidence on the purchase price of the California property; that the
California case cannot be considered a waiver of the pursuit of the purchase price
as even if said case was filed fifteen days prior to the filing of the original complaint
in this case, except for the Javiers, no other defendants raised in their answers the
affirmative defense of the filing of the California case; that after the amendment of
the complaint, none of the defendants raised the matter of "election of remedies" in
their answers; that realizing this procedural error, Paramount sought the
amendment of its answer to reflect the "defence" of "election of remedies"; that,
disregarding its previous orders allowing evidence and testimonies on Account No.
2825-1, the court made a turnabout and ruled that the testimonies on said account
were irrelevant and confidential under Republic Act No. 1405; that Philippine law
and jurisprudence does not require the election of remedies for they favor availment
of all remedies; that even United States jurisprudence frowns upon election of
remedies if it will lead to an inequitable result; that, as held by this Court
in Radiowealth vs. Javier, 7 there can be no binding election of remedies before the
decision on the merits is had; that until Mellon Bank gets full recovery of the trust
moneys, any contention of election of remedy is premature, and that, the purchase
price being the subject of litigation, inquiring into its movement, including its
deposit in banks, is allowed under Republic Act No. 1405.
Defendants filed their respective comments and oppositions to the motion for
reconsideration. In its reply, the Mellon Bank presented proof to the effect that in
the California case, defendants filed motions to stake out the cross-complaint of
Mellon Bank, for summary judgment and to stay or dismiss the action on the ground
of inconvenient forum but the first two motions and the motion to dismiss were
denied "without prejudice to renew upon determination of the Philippine action."
The motion to stay proceedings was "granted until determination of the Philippine
action." 8
On October 28, 1983, the lower court, through Judge Acosta, denied the motion for
reconsideration and ordered the continuation of the hearing (Rollo, p. 182). The
plaintiff filed a motion for the reconsideration of both the September 10, 1982 and
October 28, 1983 orders. After the parties had filed comments, opposition and reply,
the court, through Judge Celso L. Magsino, denied Mellon Bank's second motion for

reconsideration on the ground that it was "prescribed by the 1983 Interim Rules of
Court" in an order dated July 9, 1985. 9
The court ruled that the determination of the relevancy of the testimonies of
Baylosis and Red was "premised directly and principally" on whether or not Mellon
Bank could still recover the purchase price of the California property
notwithstanding the filing of the case in California to recover title and possession of
the said property. After quoting the resolution of September 10, 1982, the Court
ruled that it was a "final order or a definitive judgment with respect to the claim of
plaintiff for the recovery" of the purchase price of the California property. It stated:
The adjudication in the Order of September 10, 1982 and the Order of
October 28, 1983, which has the effect of declaring that plaintiff has no
cause of action against the defendants for the recovery of the
proceeds of the sale of Kern property in the amount of Three Million
Three Hundred Fifty Thousand Pesos (P3,500,000.00 [sic]) for having
filed a complaint for the recovery of the Kern property in the Superior
Court of California, County of Kern is a final and definitive disposition of
the claim of the plaintiff to recover in the instant action the proceeds of
sale of said property against the defendants. The issue of "election of
remedy" by the plaintiff was lengthily and thoroughly discussed and
argued by the parties before the rendition of the resolution of
September 10, 1982, and in the motion for reconsideration and
oppositions thereto before its resolution in the Order of October 28,
1983. Such issue is a substantive one as it refers to the existence of
plaintiffs cause of action to recover the proceeds of the sale of the
Kern property in this action, and that issue was presented to the Court
as if a motion to dismiss or a preliminary hearing of an affirmative
defense on the ground that plaintiff has no cause of action, and was
resolved against plaintiff in the Order of September 10, 1982, after a
full hearing of all the parties. Said Order of September 10, 1982 has
the effect of putting an end to the controversy between the parties as
to the right of plaintiff to claim or recover the proceeds of the sale of
the Kern property from the defendants. It is therefore an adjudication
upon the merits. 10
Hence, Mellon Bank filed the instant petition for certiorari claiming that the
resolution of September 10, 1982 and the orders of October 28, 1983 and July 9,
1985 are void for being unlawful and oppressive exercises of legal authority,
subversive of the fair administration of justice, and in excess of jurisdiction. The
petition is founded on its allegations that: (a) the resolution of September 10, 1982
is interlocutory as it does not dispose of Civil Case No. 26899 completely: (b) the
evidence stricken from the records is relevant on the basis of the allegations of the
amended and supplemental complaint, and (c) the doctrine of election of remedies,

which has long been declared obsolete in the United States, is not applicable in this
case.
With the exception of the Javiers, all the respondents filed their respective
comments on the petition. Having failed to file said comment, the Javiers' counsel of
record, Azada, Tomacruz & Cacanindin, 11 was required to show cause why
disciplinary action should not be taken against it. And, having also failed to show
cause, it was fined P300.
In his motion for reconsideration of the resolution imposing said fine, Cipriano Azada
alleged that in Civil Case No. 26899, the Javiers were indeed represented by the law
firm of Poblador, Azada, Tomacruz & Cacanindin but he was never the lawyer of the
Javiers' in his personal capacity; that after the death of Honorio Poblador, Jr., he had
withdrawn from the partnership; that he is the counsel of the Administratrix of the
Estate of Honorio Poblador, Jr. for which he had filed a comment, and that should
the Court still require him to file comment for the Javiers despite the lack of clientlawyer relationship, he would adopt the comment he had filed for the said
Administratrix.12
In its effort to locate the Javiers so that their side could be heard, we required the
petitioner to furnish us with the Javiers' address as well as the name and address of
their counsel. 13 In compliance therewith, counsel for petitioner manifested that the
Javiers had two known addresses in San Juan, Metro Manila and in Sampaloc,
Manila; that since their conviction in Crim. Case No. CCC-VII 2369-P.C. of the Pasig
Regional Trial Court, the Javiers had gone into hiding and warrants for their arrest
still remain unserved; 14 that the Javiers' counsel of record in Civil Case No. 26899 is
Atty. Cipriano Azada; that the same counsel appeared for the Javiers in Criminal
Case No. 39851 of the Pasig Regional Trial Court which is a tax evasion case filed by
the Republic of the Philippines, and that during the hearings of the civil and tax
evasion cases against the Javiers, Atty. Cipriano Azada, Jr. represented them. 15
Inasmuch as copies of the resolution requiring comment on the petition and the
petition itself addressed to Melchor Javier were returned with the notations "moved"
and "deceased", the Court required that said copies be sent to Mrs. Javier herself
and that petitioner should inform the Court of the veracity of Javier's death. 16 A
copy of the resolution addressed to Mrs. Javier was returned also with the notation
"deceased." 17
Counsel for petitioner accordingly informed the Court that he learned that the
Javiers had fled the country and that he had no way of verifying whether Melchor
Javier had indeed died. 18
In view of these circumstances, the Javiers' comment on the petition shall be
dispensed with as the Court deems the pleadings filed by the parties sufficient

bases for resolving this case. The Javiers shall be served copies of this decision in
accordance with Section 6, Rule 13 of the Rules of Court by delivering said copies to
the clerk of court of the lower court, with proof of failure of both personal service
and service by mail.
We hold that the lower court gravely abused its discretion in ruling that the
resolution of September 10, 1982 is a "final and definitive disposition" of petitioner's
claim for the purchase price of the Kern property. The resolution is interlocutory and
means no more than what it states in its dispositive portion-the testimonies of
Baylosis and Red and the documents they testified on, should be stricken from the
record.
That the resolution discusses the common-law principle of election of remedies, a
subject matter which shall be dealt with later, is beside the point. It is interlocutory
because the issue resolved therein is merely the admissibility of the plaintiff's
evidence. 19 As such, it does not dispose of the case completely but leaves
something more to be done upon its merits. 20 There are things left undone in Civil
Case No. 26899 after the issuance of the September 10, 1982 resolution not only
because of its explicit dispositive portion but also due to the fact that even until
now, the case is still pending and being heard. 21
Furthermore, the lower court's holding in its July 9, 1985 order that petitioner's
second motion for reconsideration is proscribed by the 1983 Interim Rules of Court
which disallows such motion on a final order or judgment, should be rectified. As
explained above, the resolution of September 10, 1982 is not a final one. It also
contains conclusions on procedural matters which, if left unchecked, would
prejudice petitioner's substantive rights.
In effect, therefore, the July 9, 1985 order is a shortcut disposition of Civil Case No.
26899 in total disregard of petitioner's right to a thorough ventilation of its claims.
By putting a premium on procedural technicalities over the resolution of the merits
of the case, the lower court rode roughshod over the basic judicial tenet that
litigations should, as much as possible, be decided on their merits and not on
technicalities. 22 The trial court's patent grave abuse of discretion therefore forces
us to exercise supervisory authority to correct its errors notwithstanding the fact
that ordinarily, this Court would not entertain a petition for certiorari questioning
the legality and validity of an interlocutory order. 23
Respondents' principal objection to the testimonies of Baylosis and Red is their
alleged irrelevance to the issues raised in Civil Case No. 26899. The fallacy of this
objection comes to fore upon a scrutiny of the complaint. Petitioner's theory therein
is that after the Javiers had maliciously appropriated unto themselves $999,000, the
other private respondents conspired and participated in the concealment and

dissipation of said amount. The testimonies of Baylosis and Red are therefore
needed to establish the scheme to hide the erroneously sent amount.
Private respondents' protestations that to allow the questioned testimonies to
remain on record would be in violation of the provisions of Republic Act No. 1405 on
the secrecy of bank deposits, is unfounded. Section 2 of said law allows the
disclosure of bank deposits in cases where the money deposited is the subject
matter of the litigation. 24 Inasmuch as Civil Case No. 26899 is aimed at recovering
the amount converted by the Javiers for their own benefit, necessarily, an inquiry
into the whereabouts of the illegally acquired amount extends to whatever is
concealed by being held or recorded in the name of persons other than the one
responsible for the illegal acquisition. 25
We view respondents' reliance on the procedural principle of election of remedies as
part of their ploy to terminate Civil Case No. 26899 prematurely. With the exception
of the Javiers, respondents failed to raise it as a defense in their answers and
therefore, by virtue of Section 2, Rule 9 of the Rules of Court, such defense is
deemed waived.26 Notwithstanding its lengthy and thorough discussion during the
hearing and in pleadings subsequent to the answers, the issue of election of
remedies has not, contrary to the lower court's assertion, been elevated to a
"substantive one." Having been waived as a defense, it cannot be treated as if it has
been raised in a motion to dismiss based on the nonexistence of a cause of action.
Moreover, granting that the defense was properly raised, it is inapplicable in this
case. In its broad sense, election of remedies refers to the choice by a party to an
action of one of two or more coexisting remedial rights, where several such rights
arise out of the same facts, but the term has been generally limited to a choice by a
party between inconsistent remedial rights, the assertion of one being necessarily
repugnant to, or a repudiation of, the other. In its technical and more restricted
sense, election of remedies is the adoption of one of two or more coexisting
remedies, with the effect of precluding a resort to the others. 27
As a technical rule of procedure, the purpose of the doctrine of election of remedies
is not to prevent recourse to any remedy, but to prevent double redress for a single
wrong. 28 It is regarded as an application of the law of estoppel, upon the theory
that a party cannot, in the assertion of his right occupy inconsistent positions which
form the basis of his respective remedies. However, when a certain state of facts
under the law entitles a party to alternative remedies, both founded upon the
Identical state of facts, these remedies are not considered inconsistent remedies. In
such case, the invocation of one remedy is not an election which will bar the other,
unless the suit upon the remedy first invoked shall reach the stage of final
adjudication or unless by the invocation of the remedy first sought to be enforced,
the plaintiff shall have gained an advantage thereby or caused detriment or change
of situation to the other. 29 It must be pointed out that ordinarily, election of

remedies is not made until the judicial proceedings has gone to judgment on the
merits. 30
Consonant with these rulings, this Court, through Justice J.B.L. Reyes, opined that
while some American authorities hold that the mere initiation of proceedings
constitutes a binding choice of remedies that precludes pursuit of alternative
courses, the better rule is that no binding election occurs before a decision on the
merits is had or a detriment to the other party supervenes. 31 This is because the
principle of election of remedies is discordant with the modern procedural concepts
embodied in the Code of Civil Procedure which Permits a party to seek inconsistent
remedies in his claim for relief without being required to elect between them at the
pleading stage of the litigation. 32
It should be noted that the remedies pursued in the California case and in Civil Case
No. 26899 are not exactly repugnant or inconsistent with each other. If ever, they
are merely alternative in view of the inclusion of parties in the latter case who are
not named defendants in the former. The causes of action, although they all stem
from the erroneous transmittal of dollars, are distinct as shown by the complaints
lengthily set out above. The bar of an election of remedies does not apply to the
assertion of distinct causes of action against different persons arising out of
independent transactions. 33
As correctly pointed out by the petitioner, the doctrine of election of remedies is not
favored in the United States for being harsh. 34 Its application with regard to two
cases filed in two different jurisdictions is also circumscribed by jurisprudence on
abatement of suits. Thus, in Brooks Erection Co. v. William R. Montgomery &
Associates, Inc., 35 it is held:
The pendency of an action in the courts of one state or country is not a
bar to the institution of another action between the same parties and
for the same cause of action in a court of another state or country, nor
is it the duty of the court in which the latter action is brought to stay
the same pending a determination of the earlier action, even though
the court in which the earlier action is brought has jurisdiction
sufficient to dispose of the entire controversy. Nevertheless, sometimes
stated as a matter of comity not of right, it is usual for the court in
which the later action is brought to stay proceedings under such
circumstances until the earlier action is determined.
However, in view of the fact that the California court wherein the case for recovery
of the Kern property was first filed against the Javiers had stayed proceedings
therein until after the termination of Civil Case No. 26899, the court below can do
no less than expedite the disposition of said case.

We cannot dispose of this case without condemning in the strongest terms possible
the acts of chicanery so apparent from the records. The respective liabilities of the
respondents are still being determined by the court below. We must warn, however,
against the use of technicalities and obstructive tactics to delay a just settlement of
this case. The taking advantage of the petitioner's mistake to gain sudden and
undeserved wealth is marked by circumstances so brazen and shocking that any
further delay will reflect poorly on the kind of justice our courts dispense. The
possible involvement of lawyers in this sorry scheme stamps a black mark on the
legal profession. The Integrated Bar of the Philippines (IBP) must be made aware of
the ostensible participation, if not instigation, in the spiriting away of the missing
funds. The IBP must take the proper action at the appropriate time against all
lawyers involved in any misdeeds arising from this case.
WHEREFORE, the resolution of September 10, 1982 and the orders of October 28,
1982 and July 9, 1985 are hereby annulled. The lower court is ordered to proceed
with dispatch in the disposition of Civil case No. 26899, considering that thirteen
(13) years have gone by since the original erroneous remittance.
Service of this decision on the Javier spouses shall be in accordance with Section 6,
Rule 13 of the Rules of Court. A copy of this decision shall be served on the
Integrated Bar of the Philippines.
The decision is immediately executory. Costs against private respondents.
SO ORDERED.
Gutierrez, Jr., Feliciano, Bidin and Cortes,JJ., concur.