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G.R. No.

78953 July 31, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,


vs.
MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.

Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p

Central in this controversy is the issue as to whether or not a taxpayer who merely
states as a footnote in his income tax return that a sum of money that he
erroneously received and already spent is the subject of a pending litigation and
there did not declare it as income is liable to pay the 50% penalty for filing a
fraudulent return.

This question is the subject of the petition for review before the Court of the portion
of the Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A.
Case No. 3393, entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity
as Commissioner of Internal Revenue," which orders the deletion of the 50%
surcharge from Javier's deficiency income tax assessment on his income for 1977.

The respondent CTA in a Resolution 2 dated May 25, 1987, denied the
Commissioner's Motion for Reconsideration 3 and Motion for New Trial 4 on the
deletion of the 50% surcharge assessment or imposition.

The pertinent facts as are accurately stated in the petition of private respondent
Javier in the CTA and incorporated in the assailed decision now under review, read
as follows:

xxx xxx xxx

2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner (private
respondent herein), received from the Prudential Bank and Trust Company in Pasay
City the amount of US$999,973.70 remitted by her sister, Mrs. Dolores Ventosa,
through some banks in the United States, among which is Mellon Bank, N.A.

3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the Court
of First Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No.
26899), against the petitioner (private respondent herein), his wife and other
defendants, claiming that its remittance of US$1,000,000.00 was a clerical error and
should have been US$1,000.00 only, and praying that the excess amount of
US$999,000.00 be returned on the ground that the defendants are trustees of an
implied trust for the benefit of Mellon Bank with the clear, immediate, and
continuing duty to return the said amount from the moment it was received.

4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an
Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.)
charging the petitioner (private respondent herein) and his wife with the crime of
estafa, alleging that they misappropriated, misapplied, and converted to their own
personal use and benefit the amount of US$999,000.00 which they received under
an implied trust for the benefit of Mellon Bank and as a result of the mistake in the
remittance by the latter.

5. That on March 15, 1978, the petitioner (private respondent herein) filed his
Income Tax Return for the taxable year 1977 showing a gross income of P53,053.38
and a net income of P48,053.88 and stating in the footnote of the return that
"Taxpayer was recipient of some money received from abroad which he presumed
to be a gift but turned out to be an error and is now subject of litigation."

6. That on or before December 15, 1980, the petitioner (private respondent herein)
received a letter from the acting Commissioner of Internal Revenue dated
November 14, 1980, together with income assessment notices for the years 1976
and 1977, demanding that petitioner (private respondent herein) pay on or before

December 15, 1980 the amount of P1,615.96 and P9,287,297.51 as deficiency


assessments for the years 1976 and 1977 respectively. . . .

7. That on December 15, 1980, the petitioner (private respondent herein) wrote the
Bureau of Internal Revenue that he was paying the deficiency income assessment
for the year 1976 but denying that he had any undeclared income for the year 1977
and requested that the assessment for 1977 be made to await final court decision
on the case filed against him for filing an allegedly fraudulent return. . . .

8. That on November 11, 1981, the petitioner (private respondent herein) received
from Acting Commissioner of Internal Revenue Romulo Villa a letter dated October
8, 1981 stating in reply to his December 15, 1980 letter-protest that "the amount of
Mellon Bank's erroneous remittance which you were able to dispose, is definitely
taxable." . . . 5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on
December 10, 1981.

The respondent CTA, after the proper proceedings, rendered the challenged
decision. We quote the concluding portion:

We note that in the deficiency income tax assessment under consideration,


respondent (petitioner here) further requested petitioner (private respondent here)
to pay 50% surcharge as provided for in Section 72 of the Tax Code, in addition to
the deficiency income tax of P4,888,615.00 and interest due thereon. Since
petitioner (private respondent) filed his income tax return for taxable year 1977, the
50% surcharge was imposed, in all probability, by respondent (petitioner) because
he considered the return filed false or fraudulent. This additional requirement, to our
mind, is much less called for because petitioner (private respondent), as stated
earlier, reflected in as 1977 return as footnote that "Taxpayer was recipient of some
money received from abroad which he presumed to be gift but turned out to be an
error and is now subject of litigation."

From this, it can hardly be said that there was actual and intentional fraud,
consisting of deception willfully and deliberately done or resorted to by petitioner
(private respondent) in order to induce the Government to give up some legal right,
or the latter, due to a false return, was placed at a disadvantage so as to prevent its
lawful agents from proper assessment of tax liabilities. (Aznar vs. Court of Tax
Appeals, L-20569, August 23, 1974, 56 (sic) SCRA 519), because petitioner literally
"laid his cards on the table" for respondent to examine. Error or mistake of fact or
law is not fraud. (Insular Lumber vs. Collector, L-7100, April 28, 1956.). Besides,
Section 29 is not too plain and simple to understand. Since the question involved in
this case is of first impression in this jurisdiction, under the circumstances, the 50%
surcharge imposed in the deficiency assessment should be deleted. 7

The Commissioner of Internal Revenue, not satisfied with the respondent CTA's
ruling, elevated the matter to us, by the present petition, raising the main issue as
to:

WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY?
8

On the other hand, Javier candidly stated in his Memorandum, 9 that he "did not
appeal the decision which held him liable for the basic deficiency income tax
(excluding the 50% surcharge for fraud)." However, he submitted in the same
memorandum "that the issue may be raised in the case not for the purpose of
correcting or setting aside the decision which held him liable for deficiency income
tax, but only to show that there is no basis for the imposition of the surcharge." This
subsequent disavowal therefore renders moot and academic the posturings
articulated in as Comment 10 on the non-taxability of the amount he erroneously
received and the bulk of which he had already disbursed. In any event, an appeal at
that time (of the filing of the Comments) would have been already too late to be
seasonable. The petitioner, through the office of the Solicitor General, stresses that:

xxx xxx xxx

The record however is not ambivalent, as the record clearly shows that private
respondent is self-convinced, and so acted, that he is the beneficial owner, and of
which reason is liable to tax. Put another way, the studied insinuation that private
respondent may not be the beneficial owner of the money or income flowing to him

as enhanced by the studied claim that the amount is "subject of litigation" is belied
by the record and clearly exposed as a fraudulent ploy, as witness what transpired
upon receipt of the amount.

Here, it will be noted that the excess in the amount erroneously remitted by
MELLON BANK for the amount of private respondent's wife was $999,000.00 after
opening a dollar account with Prudential Bank in the amount of $999,993.70,
private respondent and his wife, with haste and dispatch, within a span of eleven
(11) electric days, specifically from June 3 to June 14, 1977, effected a total massive
withdrawal from the said dollar account in the sum of $975,000.00 or
P7,020,000.00. . . . 11

In reply, the private respondent argues:

xxx xxx xxx

The petitioner contends that the private respondent committed fraud by not
declaring the "mistaken remittance" in his income tax return and by merely making
a footnote thereon which read: "Taxpayer was the recipient of some money from
abroad which he presumed to be a gift but turned out to be an error and is now
subject of litigation." It is respectfully submitted that the said return was not
fraudulent. The footnote was practically an invitation to the petitioner to make an
investigation, and to make the proper assessment.

The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths v.
Comm., 50 F [2d] 782), that is, it must be stronger than the "mere preponderance of
evidence" which would be sufficient to sustain a judgment on the issue of
correctness of the deficiency itself apart from the fraud penalty. (Frank A. Neddas,
40 BTA 672). The following circumstances attendant to the case at bar show that in
filing the questioned return, the private respondent was guided, not by that "willful
and deliberate intent to prevent the Government from making a proper assessment"
which constitute fraud, but by an honest doubt as to whether or not the "mistaken
remittance" was subject to tax.

First, this Honorable Court will take judicial notice of the fact that so-called "million
dollar case" was given very, very wide publicity by media; and only one who is not

in his right mind would have entertained the idea that the BIR would not make an
assessment if the amount in question was indeed subject to the income tax.

Second, as the respondent Court ruled, "the question involved in this case is of first
impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even in the
United States, the authorities are not unanimous in holding that similar receipts are
subject to the income tax. It should be noted that the decision in the Rutkin case is
a five-to-four decision; and in the very case before this Honorable Court, one out of
three Judges of the respondent Court was of the opinion that the amount in question
is not taxable. Thus, even without the footnote, the failure to declare the "mistaken
remittance" is not fraudulent.

Third, when the private respondent filed his income tax return on March 15, 1978 he
was being sued by the Mellon Bank for the return of the money, and was being
prosecuted by the Government for estafa committed allegedly by his failure to
return the money and by converting it to his personal benefit. The basic tax
amounted to P4,899,377.00 (See p. 6 of the Petition) and could not have been paid
without using part of the mistaken remittance. Thus, it was not unreasonable for the
private respondent to simply state in his income tax return that the amount
received was still under litigation. If he had paid the tax, would that not constitute
estafa for using the funds for his own personal benefit? and would the Government
refund it to him if the courts ordered him to refund the money to the Mellon Bank?
12

xxx xxx xxx

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National
Internal Revenue Code), a taxpayer who files a false return is liable to pay the fraud
penalty of 50% of the tax due from him or of the deficiency tax in case payment has
been made on the basis of the return filed before the discovery of the falsity or
fraud.

We are persuaded considerably by the private respondent's contention that there is


no fraud in the filing of the return and agree fully with the Court of Tax Appeals'
interpretation of Javier's notation on his income tax return filed on March 15, 1978
thus: "Taxpayer was the recipient of some money from abroad which he presumed
to be a gift but turned out to be an error and is now subject of litigation that it was

an "error or mistake of fact or law" not constituting fraud, that such notation was
practically an invitation for investigation and that Javier had literally "laid his cards
on the table." 13

In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax
return was discussed in this manner:

. . . The fraud contemplated by law is actual and not constructive. It must be


intentional fraud, consisting of deception willfully and deliberately done or resorted
to in order to induce another to give up some legal right. Negligence, whether slight
or gross, is not equivalent to the fraud with intent to evade the tax contemplated by
law. It must amount to intentional wrong-doing with the sole object of avoiding the
tax. It necessarily follows that a mere mistake cannot be considered as fraudulent
intent, and if both petitioner and respondent Commissioner of Internal Revenue
committed mistakes in making entries in the returns and in the assessment,
respectively, under the inventory method of determining tax liability, it would be
unfair to treat the mistakes of the petitioner as tainted with fraud and those of the
respondent as made in good faith.

Fraud is never imputed and the courts never sustain findings of fraud upon
circumstances which, at most, create only suspicion and the mere understatement
of a tax is not itself proof of fraud for the purpose of tax evasion. 15

A "fraudulent return" is always an attempt to evade a tax, but a merely "false


return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16

In the case at bar, there was no actual and intentional fraud through willful and
deliberate misleading of the government agency concerned, the Bureau of Internal
Revenue, headed by the herein petitioner. The government was not induced to give
up some legal right and place itself at a disadvantage so as to prevent its lawful
agents from proper assessment of tax liabilities because Javier did not conceal
anything. Error or mistake of law is not fraud. The petitioner's zealousness to collect
taxes from the unearned windfall to Javier is highly commendable. Unfortunately,
the imposition of the fraud penalty in this case is not justified by the extant facts.
Javier may be guilty of swindling charges, perhaps even for greed by spending most
of the money he received, but the records lack a clear showing of fraud committed
because he did not conceal the fact that he had received an amount of money

although it was a "subject of litigation." As ruled by respondent Court of Tax


Appeals, the 50% surcharge imposed as fraud penalty by the petitioner against the
private respondent in the deficiency assessment should be deleted.

WHEREFORE, the petition is DENIED and the decision appealed from the Court of
Tax Appeals is AFFIRMED. No costs.

SO ORDERED.

Melencio-Herrera, Padilla and Regalado, JJ., concur.

Paras, J., took no part.

G.R. No. 48532 August 31, 1992

HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D. HERRERA, BENJAMIN T.


ILDEFONSO, ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP,
LEANDRO G. SANTILLAN, and JAIME A. SOQUES, petitioners,
vs.
THE HONORABLE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL
REVENUE, respondents.

G.R. No. 48533 August 31, 1992

ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY L. DIMAYUGA, JAIME E. DYLIACCO, MELQUIADES J. GAMBOA, JR., MANUEL L. GUZMAN, VICENTE D. HERRERA,
BENJAMIN T. ILDEFONSO, ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO
A. RIALP and JAIME A. SOQUES, petitioners,

vs.
THE HONORABLE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL
REVENUE, respondents.

Angara, Abello, Concepcion, Regala & Cruz for petitioners.

NOCON, J.:

Petitioners pray that his Court reverse the Decision of the public respondent Court
of Tax Appeals, promulgated September 26, 1977 1 denying petitioners' claim for
tax refunds, and order the Commissioner of Internal Revenue to refund to them their
income taxes which they claim to have been erroneously or illegally paid or
collected.

As summarized by the Solicitor General, the facts of the cases are as follows:

Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine
Manufacturing Corporation, with offices at Sarmiento Building, Ayala Avenue,
Makati, Rizal. Said corporation is a subsidiary of Procter & Gamble, a foreign
corporation based in Cincinnati, Ohio, U.S.A. During the years 1970 and 1971
petitioners were assigned, for certain periods, to other subsidiaries of Procter &
Gamble, outside of the Philippines, during which petitioners were paid U.S. dollars
as compensation for services in their foreign assignments. (Paragraphs III, Petitions
for Review, C.T.A. Cases Nos. 2511 and 2594, Exhs. D, D-1 to D-19). When
petitioners in C.T.A. Case No. 2511 filed their income tax returns for the year 1970,
they computed the tax due by applying the dollar-to-peso conversion on the basis of
the floating rate ordained under B.I.R. Ruling No. 70-027 dated May 14, 1970, as
follows:

From January 1 to February 20, 1970 at the conversion rate of P3.90 to U.S. $1.00;

From February 21 to December 31, 1970 at the conversion rate of P6.25 to U.S.
$1.00

Petitioners in C.T.A. Case No. 2594 likewise used the above conversion rate in
converting their dollar income for 1971 to Philippine peso. However, on February 8,
1973 and October 8, 1973, petitioners in said cases filed with the office of the
respondent Commissioner, amended income tax returns for the above-mentioned
years, this time using the par value of the peso as prescribed in Section 48 of
Republic Act No. 265 in relation to Section 6 of Commonwealth Act No. 265 in
relation to Section 6 of Commonwealth Act No. 699 as the basis for converting their
respective dollar income into Philippine pesos for purposes of computing and paying
the corresponding income tax due from them. The aforesaid computation as shown
in the amended income tax returns resulted in the alleged overpayments, refund
and/or tax credit. Accordingly, claims for refund of said over-payments were filed
with respondent Commissioner. Without awaiting the resolution of the Commissioner
of the Internal Revenue on their claims, petitioners filed their petitioner for review in
the above-mentioned cases.

Respondent Commissioner filed his Answer to petitioners' petition for review in


C.T.A. Case No. 2511 on July 31, 1973, while his Answer in C.T.A. Case No. 2594 was
filed on August 7, 1974.

Upon joint motion of the parties on the ground that these two cases involve
common question of law and facts, that respondent Court of Tax Appeals heard the
cases jointly. In its decision dated September 26, 1977, the respondent Court of Tax
Appeals held that the proper conversion rate for the purpose of reporting and
paying the Philippine income tax on the dollar earnings of petitioners are the rates
prescribed under Revenue Memorandum Circulars Nos. 7-71 and 41-71. Accordingly,
the claim for refund and/or tax credit of petitioners in the above-entitled cases was
denied and the petitions for review dismissed, with costs against petitioners. Hence,
this petition for review on certiorari. 2

Petitioners claim that public respondent Court of Tax Appeals erred in holding:

1. That petitioners' dollar earnings are receipts derived from foreign exchange
transactions.

2. That the proper rate of conversion of petitioners' dollar earnings for tax purposes
in the prevailing free market rate of exchange and not the par value of the peso;
and

3. That the use of the par value of the peso to convert petitioners' dollar earnings
for tax purposes into Philippine pesos is "unrealistic" and, therefore, the prevailing
free market rate should be the rate used.

Respondent Commissioner of Internal Revenue, on the other hand, refutes


petitioners' claims as follows:

At the outset, it is submitted that the subject matter of these two cases are
Philippine income tax for the calendar years 1970 (CTA Case No. 2511) and 1971
(CTA Case No. 2594) and, therefore, should be governed by the provisions of the
National Internal Revenue Code and its implementing rules and regulations, and not
by the provisions of Central Bank Circular No. 42 dated May 21, 1953, as contended
by petitioners.

Section 21 of the National Internal Revenue Code, before its amendment by


Presidential Decrees Nos. 69 and 323 which took effect on January 1, 1973 and
January 1, 1974, respectively, imposed a tax upon the taxable net income received
during each taxable year from all sources by a citizen of the Philippines, whether
residing here or abroad.

Petitioners are citizens of the Philippines temporarily residing abroad by virtue of


their employment. Thus, in their tax returns for the period involved herein, they
gave their legal residence/address as c/o Procter & Gamble PMC, Ayala Ave., Makati,
Rizal (Annexes "A" to "A-8" and Annexes "C" to "C-8", Petition for Review, CTA Nos.
2511 and 2594).

Petitioners being subject to Philippine income tax, their dollar earnings should be
converted into Philippine pesos in computing the income tax due therefrom, in
accordance with the provisions of Revenue Memorandum Circular No. 7-71 dated
February 11, 1971 for 1970 income and Revenue Memorandum Circular No. 41-71

dated December 21, 1971 for 1971 income, which reiterated BIR Ruling No. 70-027
dated May 4, 1970, to wit:

For internal revenue tax purposes, the free marker rate of conversion (Revenue
Circulars Nos. 7-71 and 41-71) should be applied in order to determine the true and
correct value in Philippine pesos of the income of petitioners. 3

After a careful examination of the records, the laws involved and the jurisprudence
on the matter, We are inclined to agree with respondents Court of Tax Appeals and
Commissioner of Internal Revenue and thus vote to deny the petition.

This basically an income tax case. For the proper resolution of these cases income
may be defined as an amount of money coming to a person or corporation within a
specified time, whether as payment for services, interest or profit from investment.
Unless otherwise specified, it means cash or its equivalent. 4 Income can also be
though of as flow of the fruits of one's labor. 5

Petitioners are correct as to their claim that their dollar earnings are not receipts
derived from foreign exchange transactions. For a foreign exchange transaction is
simply that a transaction in foreign exchange, foreign exchange being "the
conversion of an amount of money or currency of one country into an equivalent
amount of money or currency of another." 6 When petitioners were assigned to the
foreign subsidiaries of Procter & Gamble, they were earning in their assigned
nation's currency and were ALSO spending in said currency. There was no
conversion, therefore, from one currency to another.

Public respondent Court of Tax Appeals did err when it concluded that the dollar
incomes of petitioner fell under Section 2(f)(g) and (m) of C.B. Circular No. 42. 7

The issue now is, what exchange rate should be used to determine the peso
equivalent of the foreign earnings of petitioners for income tax purposes. Petitioners
claim that since the dollar earnings do not fall within the classification of foreign
exchange transactions, there occurred no actual inward remittances, and, therefore,
they are not included in the coverage of Central Bank Circular No. 289 which
provides for the specific instances when the par value of the peso shall not be the

conversion rate used. They conclude that their earnings should be converted for
income tax purposes using the par value of the Philippine peso.

Respondent Commissioner argues that CB Circular No. 289 speaks of receipts for
export products, receipts of sale of foreign exchange or foreign borrowings and
investments but not income tax. He also claims that he had to use the prevailing
free market rate of exchange in these cases because of the need to ascertain the
true and correct amount of income in Philippine peso of dollar earners for Philippine
income tax purposes.

A careful reading of said CB Circular No. 289 8 shows that the subject matters
involved therein are export products, invisibles, receipts of foreign exchange,
foreign exchange payments, new foreign borrowing and
investments nothing by way of income tax payments. Thus, petitioners are in
error by concluding that since C.B. Circular No. 289 does not apply to them, the par
value of the peso should be the guiding rate used for income tax purposes.

The dollar earnings of petitioners are the fruits of their labors in the foreign
subsidiaries of Procter & Gamble. It was a definite amount of money which came to
them within a specified period of time of two yeas as payment for their services.

Section 21 of the National Internal Revenue Code, amended up to August 4, 1969,


states as follows:

Sec. 21. Rates of tax on citizens or residents. A tax is hereby imposed upon the
taxable net income received during each taxable year from all sources by every
individual, whether a citizen of the Philippines residing therein or abroad or an alien
residing in the Philippines, determined in accordance with the following schedule:

xxx xxx xxx

And in the implementation for the proper enforcement of the National Internal
Revenue Code, Section 338 thereof empowers the Secretary of Finance to
"promulgate all needful rules and regulations" to effectively enforce its provisions. 9

Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71 10 and 41-71
11 were issued to prescribed a uniform rate of exchange from US dollars to
Philippine pesos for INTERNAL REVENUE TAX PURPOSES for the years 1970 and
1971, respectively. Said revenue circulars were a valid exercise of the authority
given to the Secretary of Finance by the Legislature which enacted the Internal
Revenue Code. And these are presumed to be a valid interpretation of said code
until revoked by the Secretary of Finance himself. 12

Petitioners argue that since there were no remittances and acceptances of their
salaries and wages in US dollars into the Philippines, they are exempt from the
coverage of such circulars. Petitioners forget that they are citizens of the
Philippines, and their income, within or without, and in these cases wholly without,
are subject to income tax. Sec. 21, NIRC, as amended, does not brook any
exemption.

Since petitioners have already paid their 1970 and 1971 income taxes under the
uniform rate of exchange prescribed under the aforestated Revenue Memorandum
Circulars, there is no reason for respondent Commissioner to refund any taxes to
petitioner as said Revenue Memorandum Circulars, being of long standing and not
contrary to law, are valid. 13

Although it has become a worn-out cliche, the fact still remains that "taxes are the
lifeblood of the government" and one of the duties of a Filipino citizen is to pay his
income tax.

WHEREFORE, the petitioners are denied for lack of merit. The dismissal by the
respondent Court of Tax Appeals of petitioners' claims for tax refunds for the income
tax period for 1970 and 1971 is AFFIRMED. Costs against petitioners.

SO ORDERED.

Narvasa, C.J., Padilla and Regalado, JJ., concur.

Melo, J., took no part.

Footnotes

1 Judge Amante Filler, ponente, concurred in by Judge Constantino C. Roaquin.

2 Rollo, pp. 98-100.

3 Id., pp. 100-101.

4 Fisher vs. Trinidad, 43 Phil. 973.

5 Madrigal vs. Rafferty, 38 Phil. 414.

6 Janda vs. Lepanto Consolidated Mining Co., 99 Phil. 197, 204.

7 Sec. 2. The following are foreign exchange transactions and as required by


Central Bank Circular No. 20 are subject to prior licensing by or on behalf of the
Central Bank:

xxx xxx xxx

(f) Any transaction by which a resident performs any service for a non-resident
other than tourists or temporary visitors. If the proper license is obtained, the
former shall demand and obtain payment for such service within ninety days in U.S.
dollars or in any other foreign currency acceptable to the Central Bank;

(g) Any transaction by which a resident performs for another resident service
rendered in a business or profession of the latter located outside the Philippines. If
proper license is obtained, the former shall demand and obtain payment of the fair
value of such service within ninety days from the date of the performance of the
aforesaid service, in U.S. dollar or in any other foreign currency acceptable to the
Central Bank;

xxx xxx xxx

(m) Any other transactions involving international financial implications.

8 Pursuant to the provisions of Republic Act No. 265, the Monetary Board, by
unanimous vote and with the approval of the President of the Philippines, and in
accordance with existing executive and international agreement to which the
Republic of the Philippines is a party, hereby promulgates the following regulations
on foreign exchange transactions.

Sec. 1. Eighty (80) per cent of all receipts from the leading export products, i.e.,
exports whose annual average value exceeded $75 million in the base period 196668, shall be surrendered to the Central Bank at the par value. The par value shall
not apply to the remaining twenty (20) per cent, which shall be held to authorized
agent banks at the prevailing free market rate. For purposes of this section, the
following are considered as the leading export products: logs, centrifugal sugar,
copra and copper (ore or concentrates).

Sec. 2. The par value likewise shall not apply to all receipts from all other export
products as well as from invisibles, which shall be sold to authorized agents of the
Central Bank of the Philippines at the prevailing free market rate.

Sec. 3. All receipts of foreign exchange by resident persons, firms, companies or


corporations shall represent not less than the full value of the transactions involved.
All such receipts shall be sold to authorized agents of the Central Bank of the
Philippines by the recipients within three business days following the receipt of such
foreign exchange and must be received in currencies prescribed to form part of the

international reserve. Resident persons, firms, companies or corporations shall not


delay taking ownership of their foreign exchange earnings except when such delay
is customary.

Sec. 4. The par value likewise shall not apply to all foreign exchange payments,
which shall be negotiated at the prevailing free market rate, except for outstanding
foreign obligations and letters of credit covered by forward exchange contracts.
Only authorized agent banks may sell foreign exchange for imports and invisible
disbursements.

Sec. 5. Authorized agent banks may sell foreign exchange for imports except those
falling under UC, SUC and NEC categories, without prior specific approval of the
Central Bank. Such imports may be financed by letters of credit, or under D/A and
open account arrangements subject or rules to be promulgated by the Monetary
Board. Monthly ceiling on foreign currency letters of credit and special time deposit
requirements (STD) are hereby lifted. Existing STDS shall be released as they
mature.

Sec. 6. The sale of foreign exchange for current invisible payments by authorized
agent banks shall be allowed, without prior specific approval of the Central Bank,
provided that amounts of more than $100.00 are substantiated by documentary
evidence attesting to the veracity of the purpose and the amount applied for, and
provided further that travel, remittance for educational expenses and student
maintenance, maintenance of dependents abroad of Philippine residents,
remittance of profits, dividends, and interests, royalties, film and other rentals shall
be subject to the regulations to be promulgated by the Monetary Board.

Sec. 7. New foreign borrowing and investments, and transfer of assets by emigrants
shall be subject to regulations to be promulgated by the Monetary Board.

Sec. 8. The free market rate shall not be administratively fixed but shall be
determined through transactions in the foreign exchange market on a day-to-day
basis. The authorities shall not intervene in the market except to the extent
necessary to compensate for excessive fluctuations but shall not operate against
the trend in the market.

Sec. 9. All provisions of existing circulars, memorandum and regulations of the


Central Bank governing transactions in foreign exchange inconsistent with the
provisions hereafter are hereby revoked.

Sec. 10. Strict observance of the provisions of this Circular is hereby enjoined, and
any person, firm, company or corporation, whether residing and/or located in the
Philippines or not, who, being bound to the observance of said provisions, or of such
other rules, terms and conditions, or directives which may be issued by the Central
Bank in the implementation of this Circular, shall fail or refuse to comply with or
abide by, or shall violate the same, shall be subject to the penal sanctions of the
Central Bank Act.

Sec. 11. This Circular shall take effect immediately.

FOR THE MONETARY BOARD:


(SGD) G.S. LICAROS
Governor

February 21, 1970.

9 Section 338, National Internal Revenue Code (1970), as amended; Philippine


Lawyer's Association vs. Agrava, 105 Phil. 173.

10 SUBJECT: Prescribing a uniform rate for U.S. Dollars to Philippine Pesos for
Internal Revenue Tax Purposes.

TO: All Internal Revenue Officers and other concerned:

For the Purpose of establishing a uniform rate of exchange to U.S. dollars to


Philippine pesos for internal revenue tax purposes for the year 1970, the following

schedule of exchange rates are hereby prescribed for reference and guidelines of all
concerned;

Schedule of Exchange Rates

1. In all cases of transactions involving remittances and acceptance of U.S. dollars


occurring during the period from January 1 to February 20, 1970, the official rate of
exchange of P3.90 to $1.00 shall be used.

2. In the case of transactions involving remittances or acceptance of U.S. dollars


occurring after February 20, 1970 the following rules shall govern:

(a) In the case of regular or habitual transactions involving remittances and


acceptances of U.S. dollars, such as salaries, royalty payments and the like, the
uniform rate of P6.25 to U.S. $1.00 shall be used; provided however, that in the
case of transactions involving the computation of advance sales or compensating
taxes, the rates used by the Bureau of Customs at the time of the payment of such
taxes shall prevail.

(b) In the case of an isolated or casual transaction involving remittances or


acceptance of U.S. dollars, such as dividends, occasional sales of property and the
like the exchange rate quoted by the Foreign Exchange Department of the Central
bank of the Philippines prevailing at the time of such remittances or acceptance
shall be used.

Enforcement and Publicity

All internal revenue officers and others charged with the enforcement of internal
revenue laws are enjoined to enforce the provisions of this circular accordingly and
to give as wide a publicity as possible.

(Sgd.) MISAEL P. VERA

Commissioner of Internal Revenue

APPROVED
(Sgd.) CESAR VIRATA
Secretary of Finance

11 SUBJECT: Prescribing a uniform exchange rate of U.S. dollars to Philippine pesos


for internal revenue tax purposes.

TO: All Internal Revenue Officers and others concerned:

For the purpose of establishing a uniform rate of exchange to U.S. dollars or other
foreign currencies to Philippine pesos for internal revenue tax purposes for the year
1971, the following schedule of exchange rates are hereby prescribed for reference
and guidelines of all concerned:

Schedule of Exchange Rates

In all cases of transactions involving remittances and acceptance of U.S. dollars and
other foreign currencies occurring during the year 1971, the following rules shall
govern:

(a) In the case of regular or habitual transactions involving remittances or


acceptances of US dollars or other foreign currencies such as salaries, wages, fees
or other renominations for personal services, royalties, rents, interests or other fixed
or determinable annual or periodical income, the uniform rate of P6.25 to U.S. $1.00
shall be used.

(b) In the case of transactions involving the computation of advance sales or


compensating taxes, the rate of exchange used by the Bureau of Customs at the
time of the payment of such taxes shall prevail.

(c) In the case of an isolated or casual transaction involving remittances of


acceptances of U.S. dollars or other foreign currencies such as dividends, interests,
capital gains or other gains from occasional sales of property and the like, the
exchange rate quoted by the Foreign Exchange Department of the Central Bank of
the Philippines prevailing at the time of such remittances or acceptance shall be
used.

(d) Where the currency involved is other than U.S. dollars, the foreign currency shall
first be converted to U.S. dollars at the prevailing rate of exchange between the two
currencies. The resulting amount shall then be converted to Philippine pesos in
accordance with the above-promulgated rules.

All internal revenue officers and others charged with the enforcement of internal
revenue laws are enjoined to enforce the provisions of this circular accordingly and
to give it as wide a publicity as possible.

(SGD.) MISAEL P. VERA


Commissioner of Internal Revenue

APPROVED:
(SGD.) CESAR VIRATA
Secretary of Finance

12 Hilado vs. Collector of Internal Revenue, 100 Phil. 288.

13 Commissioner of Internal Revenue vs. Ledesma, 31 SCRA 95.


G.R. No. L-68118 October 29, 1985

JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P.


OBILLOS, brothers and sisters, petitioners

vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

Demosthenes B. Gadioma for petitioners.

AQUINO, J.:

This case is about the income tax liability of four brothers and sisters who sold two
parcels of land which they had acquired from their father.

On March 2, 1973 Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. on two
lots with areas of 1,124 and 963 square meters located at Greenhills, San Juan,
Rizal. The next day he transferred his rights to his four children, the petitioners, to
enable them to build their residences. The company sold the two lots to petitioners
for P178,708.12 on March 13 (Exh. A and B, p. 44, Rollo). Presumably, the Torrens
titles issued to them would show that they were co-owners of the two lots.

In 1974, or after having held the two lots for more than a year, the petitioners
resold them to the Walled City Securities Corporation and Olga Cruz Canda for the
total sum of P313,050 (Exh. C and D). They derived from the sale a total profit of
P134,341.88 or P33,584 for each of them. They treated the profit as a capital gain
and paid an income tax on one-half thereof or of P16,792.

In April, 1980, or one day before the expiration of the five-year prescriptive period,
the Commissioner of Internal Revenue required the four petitioners to pay corporate
income tax on the total profit of P134,336 in addition to individual income tax on
their shares thereof He assessed P37,018 as corporate income tax, P18,509 as 50%
fraud surcharge and P15,547.56 as 42% accumulated interest, or a total of
P71,074.56.

Not only that. He considered the share of the profits of each petitioner in the sum of
P33,584 as a " taxable in full (not a mere capital gain of which is taxable) and
required them to pay deficiency income taxes aggregating P56,707.20 including the
50% fraud surcharge and the accumulated interest.

Thus, the petitioners are being held liable for deficiency income taxes and penalties
totalling P127,781.76 on their profit of P134,336, in addition to the tax on capital
gains already paid by them.

The Commissioner acted on the theory that the four petitioners had formed an
unregistered partnership or joint venture within the meaning of sections 24(a) and
84(b) of the Tax Code (Collector of Internal Revenue vs. Batangas Trans. Co., 102
Phil. 822).

The petitioners contested the assessments. Two Judges of the Tax Court sustained
the same. Judge Roaquin dissented. Hence, the instant appeal.

We hold that it is error to consider the petitioners as having formed a partnership


under article 1767 of the Civil Code simply because they allegedly contributed
P178,708.12 to buy the two lots, resold the same and divided the profit among
themselves.

To regard the petitioners as having formed a taxable unregistered partnership would


result in oppressive taxation and confirm the dictum that the power to tax involves
the power to destroy. That eventuality should be obviated.

As testified by Jose Obillos, Jr., they had no such intention. They were co-owners
pure and simple. To consider them as partners would obliterate the distinction
between a co-ownership and a partnership. The petitioners were not engaged in any
joint venture by reason of that isolated transaction.

Their original purpose was to divide the lots for residential purposes. If later on they
found it not feasible to build their residences on the lots because of the high cost of
construction, then they had no choice but to resell the same to dissolve the co-

ownership. The division of the profit was merely incidental to the dissolution of the
co-ownership which was in the nature of things a temporary state. It had to be
terminated sooner or later. Castan Tobeas says:

Como establecer el deslinde entre la comunidad ordinaria o copropiedad y la


sociedad?

El criterio diferencial-segun la doctrina mas generalizada-esta: por razon del origen,


en que la sociedad presupone necesariamente la convencion, mentras que la
comunidad puede existir y existe ordinariamente sin ela; y por razon del fin objecto,
en que el objeto de la sociedad es obtener lucro, mientras que el de la indivision es
solo mantener en su integridad la cosa comun y favorecer su conservacion.

Reflejo de este criterio es la sentencia de 15 de Octubre de 1940, en la que se dice


que si en nuestro Derecho positive se ofrecen a veces dificultades al tratar de fijar
la linea divisoria entre comunidad de bienes y contrato de sociedad, la moderna
orientacion de la doctrina cientifica seala como nota fundamental de
diferenciacion aparte del origen de fuente de que surgen, no siempre uniforme, la
finalidad perseguida por los interesados: lucro comun partible en la sociedad, y
mera conservacion y aprovechamiento en la comunidad. (Derecho Civil Espanol,
Vol. 2, Part 1, 10 Ed., 1971, 328- 329).

Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not
of itself establish a partnership, whether or not the persons sharing them have a
joint or common right or interest in any property from which the returns are
derived". There must be an unmistakable intention to form a partnership or joint
venture.*

Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil.
666, where 15 persons contributed small amounts to purchase a two-peso
sweepstakes ticket with the agreement that they would divide the prize The ticket
won the third prize of P50,000. The 15 persons were held liable for income tax as an
unregistered partnership.

The instant case is distinguishable from the cases where the parties engaged in
joint ventures for profit. Thus, in Oa vs.

** This view is supported by the following rulings of respondent Commissioner:

Co-owership distinguished from partnership.We find that the case at bar is


fundamentally similar to the De Leon case. Thus, like the De Leon heirs, the Longa
heirs inherited the 'hacienda' in question pro-indiviso from their deceased parents;
they did not contribute or invest additional ' capital to increase or expand the
inherited properties; they merely continued dedicating the property to the use to
which it had been put by their forebears; they individually reported in their tax
returns their corresponding shares in the income and expenses of the 'hacienda',
and they continued for many years the status of co-ownership in order, as conceded
by respondent, 'to preserve its (the 'hacienda') value and to continue the existing
contractual relations with the Central Azucarera de Bais for milling purposes. Longa
vs. Aranas, CTA Case No. 653, July 31, 1963).

All co-ownerships are not deemed unregistered pratnership.Co-Ownership who


own properties which produce income should not automatically be considered
partners of an unregistered partnership, or a corporation, within the purview of the
income tax law. To hold otherwise, would be to subject the income of all
co-ownerships of inherited properties to the tax on corporations, inasmuch as if a
property does not produce an income at all, it is not subject to any kind of income
tax, whether the income tax on individuals or the income tax on corporation. (De
Leon vs. CI R, CTA Case No. 738, September 11, 1961, cited in Araas, 1977 Tax
Code Annotated, Vol. 1, 1979 Ed., pp. 77-78).

Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after
an extrajudicial settlement the co-heirs used the inheritance or the incomes derived
therefrom as a common fund to produce profits for themselves, it was held that they
were taxable as an unregistered partnership.

It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA


198, where father and son purchased a lot and building, entrusted the
administration of the building to an administrator and divided equally the net
income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where
the three Evangelista sisters bought four pieces of real property which they leased
to various tenants and derived rentals therefrom. Clearly, the petitioners in these
two cases had formed an unregistered partnership.

In the instant case, what the Commissioner should have investigated was whether
the father donated the two lots to the petitioners and whether he paid the donor's
tax (See Art. 1448, Civil Code). We are not prejudging this matter. It might have
already prescribed.

WHEREFORE, the judgment of the Tax Court is reversed and set aside. The
assessments are cancelled. No costs.

SO ORDERED.

Abad Santos, Escolin, Cuevas and Alampay, JJ., concur.

Concepcion, Jr., is on leave.


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;

xxxx3

On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke's
deficiency taxes amounting to P76,063,116.06 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 was P218,187,498 or 65.20% of its 1998 operating income
(i.e., total revenues less operating expenses) of P334,642,615. 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 pay P57,659,981.19 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 and P778,406.84 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 nonprofit because of its purpose and there was no evidence that it was engaged in a
profit-making 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 45 and 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." 48 The 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 of P218,187,498.

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

P1,730,367,965.00

OPERATING EXPENSES

Professional care of patients


Administrative

P1,016,608,394.00

287,319,334.00

Household and Property

91,797,622.00

P1,395,725,350.00

INCOME FROM OPERATIONS


Free Services

P334,642,615.00

-218,187,498.00

100%

-65.20%

INCOME FROM OPERATIONS, Net of FREE SERVICES P116,455,117.00

OTHER INCOME

17,482,304.00

34.80%

EXCESS OF REVENUES OVER EXPENSES

P133,937,421.00

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.

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