COMMISSIONER OF INTERNAL REVENUE vs.

FILINVEST DEVELOPMENT CORPORATION

G.R. No. 167689

COMMISSIONER OF INTERNAL REVENUE vs. FILINVEST DEVELOPMENT CORPORATION

FACTS:

Filinvest Development Corp (FDC) is the owner of outstanding shares of both Filinvest Alabang, Inc. (FAI) and
Filinvest Land, Inc. (FLI) with 80% and 67.42%, respectively. Sometime in 1996, FDC and FAI entered into a Deed of
Exchange with FLI where both transferred parcels of land in exchange for shares of stocks of FLI. As a result, the
ownership structure of FLI changed whereby FDCs ownership decreased from 67.42% to 61.03% meanwhile FAI
now owned 9.96% of shares of FLI. FLI then requested from the BIR a ruling to the effect that no gain or loss should
be recognized on said transfer and BIR issued Ruling No. S-34-046-97 finding the exchange falling within Sec. 34 (c)
(2) (now Sec. 40 (c)(2)) of the NIRC. Furthermore, FDC extended advances in favor of its affiliates during 1996 and
1997 duly evidenced by instructional letters as well as cash and journal vouchers. Moreover, 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 Corp. (FAC). The equity participation of FDC was pegged at 60% subscribing to
P500.7M worth of shares of FAC.

FDC received assessment notices for deficiency income tax and deficiency stamp taxes. The foregoing deficiency
taxes were assessed on the taxable gain realized by FDC 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 and with the interest rate and documentary stamp taxes imposable on the advances executed
by FDC. FAI also received similar assessment on deficiency income tax relating to the deed of exchange. Both FDC
and FAI protested and after having failed to act on their protest they docketed their case with the CTA. They raised
the issue that pursuant to BIR Ruling No. S-34-046-97, no taxable gain should have been assessed from the deed of
exchange and that the BIR cannot impute theoretical interests on the cash advances of FDC in the absence of
stipulation and that not being promissory notes such are not subject to documentary stamp taxes.

CIR, for its part, raised that the said transfer of property resulted to a diminution of ownership by FDC of FLI rather
than gaining further control and as such should not be tax free. Furthermore, CIR invoked Sec. 43 (now Sec. 50) of
NIRC as implemented by RR No. 2, the CIR is given the "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." Also the
CIR justified the imposition of documentary stamp taxes on the instructional letters citing Sec. 180 of the NIRC and
RR No. 9-94 which provide that loan transactions are subject to tax irrespective of whether or not they are evidenced
by a formal agreement or by mere office memo. Lastly, it reiterated that there was dilution of its shares as a result of
its shareholders agreement with RHPL.

CTA decided in favor of FDC with the exception on the deficiency income tax on the interest income from the income
it supposedly realized from the advances to its affiliates, the rest of the assessment were cancelled. The CTA opined
that 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. Dissatisfied, FDC filed a petition for review with the Court of
Appeals claiming that the cash advances it extended to its affiliates were interest-free in the absence of express
stipulation. Moreover, it claimed that under Sec. 43 (now Sec. 50) the CIRs authority does not include the power to
impute imaginary interests, directed only to controlled corp and not to holding company and can be invoked only on
cases of understatement of taxable income or evident tax evasion.

The CA rendered a decision in favor of FDC cancelling said assessment. The CIR filed a petition for review with the
CA which subsequently denied for lack of merit.

The CA has the following conclusions:

1. The deed of exchange resulted in a combined control of more than 51% of FLI , hance no taxable gain;
2. The instructional letters do not partake the nature of loan agreements;
3. Although subsequently modified by BIR Ruling No. 108-99 to the effect that documentary stamp tax are now
imposable on interoffice memos, to give a retroactive application would be prejudicial to the taxpayer.;
4. FDCs alleged gain from the increase of its shareholding in FAC are mere unrealized increase in capital unless
converted thru sale are not taxable. Hence, this petition for review on certiorari.

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.

ISSUE/S:

(1) W/N FDC is liable for theoretical interest on said advances extended by it to its affiliates.
(2) W/N FDC met all the requirements for non-recognition of taxable gain under Sec. 34 (c) (2) (now Sec. 40 (C) (2)
of the NIRC and therefore, is not taxable.
(3) W/N the letters of instructions or cash vouchers are deemed loan agreements subject to documentary stamp tax.
(4) W/N the dilution as a result of increase of FDCs shareholding in FAC is taxable.

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.

FIRST ISSUE: NO.

Sec. 43 (now Sec. 50) of the NIRC does not include the power to impute theoretical interest to the CIRs powers of
distribution, apportionment or allocation of gross income and deductions. There must be proof of actual or probable
receipt or realization by the controlled taxpayer of the item of gross income sought to be distributed, apportioned or
allocated by the CIR. In the case at bar, records do not show that there was evidence that the advances extended
yielded interests. Even if FDC deducted substantial interest expenses from its gross income, there would still be no
basis for the imputation of theoretical interests on the subject advances. Under Art. 1956 of the Civil Code, no interest
shall be due unless it has been expressly stipulated in writing. Moreover, taxes being burdens are not to be presumed
and that tax statutes must be construed strictly against the government and liberally in favor of the taxpayer.

SECOND ISSUE: YES.

It was admitted in the stipulation of facts that the following are the requisites:
(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.

Moreover, it is not taxable because the exchange did not result to a decrease of the ownership of FDC in FLI rather
combining the interests of FDC and FAI result to 70.99% of FLIs outstanding shares. Since the term "control" is
clearly defined as "ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting
power of classes of stocks entitled to one vote then the said exchange clearly qualify as a tax-free transaction.
Therefore, both FDC and FAI cannot be held liable for deficiency income tax on said transfer.

THIRD ISSUE: Yes.

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.
apply them would be prejudicial to the taxpayers.

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. The principle of non-retroactivity of BIR rulings does not apply in favor of
FDR because it is not the taxpayer who in the first place, sought the said BIR ruling from the CIR.

FOURTH ISSUE: No.

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. A mere increase or appreciation in the value of said shares cannot be
considered income for taxation purposes. Besides, tax revenues should be strictly construed and that rulings of the
CTA should be accorded with respect and upheld by the Court absent any reversible errors.