G.R. No.
L-26911 January 27, 1981 On October 25, 1962, the Secretary of Finance ruled that the exemption provided in
ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION, petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
G.R. No. L-26924 January 27, 1981
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION and COURT
OF TAX APPEALS, respondents.
DE CASTRO, J.:
These are two (2) petitions for review from the decision of the Court of Tax Appeals of
October 25, 1966 in CTA Case No. 1312 entitled "Atlas Consolidated Mining and
Development Corporation vs. Commissioner of Internal Revenue." One (L-26911) was
filed by the Atlas Consolidated Mining & Development Corporation, and in the other L-
26924), the Commissioner of Internal Revenue is the petitioner.
This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax
assessments made by the Commissioner of Internal Revenue, hereinafter referred to as
Commissioner, where the Atlas Consolidated Mining and Development Corporation,
hereinafter referred to as Atlas, was assessed P546,295.16 for 1957 and P215,493.96
for 1958 deficiency income taxes.
Atlas is a corporation engaged in the mining industry registered under the laws of the
Philippines. On August 20, 1962, the Commissioner assessed against Atlas the sum of
P546,295.16 and P215,493.96 or a total of P761,789.12 as deficiency income taxes for
the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that
Atlas is not entitled to exemption from the income tax under Section 4 of Republic Act
909 1 because same covers only gold mines, the provision of which reads:
New mines, and old mines which resume operation, when certified to
as such by the Secretary of Agriculture and Natural Resources upon
the recommendation of the Director of Mines, shall be exempt from the
payment of income tax during the first three (3) years of actual
commercial production. Provided that, any such mine and/or mines
making a complete return of its capital investment at any time within
the said period, shall pay income tax from that year.
For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the
disallowance of items claimed by Atlas as deductible from gross income.
On October 9, 1962, Atlas protested the assessment asking for its reconsideration and
cancellation. 2 Acting on the protest, the Commissioner conducted a reinvestigation of
the case.
Republic Act 909 embraces all new mines and old mines whether gold or other
minerals. 3 Accordingly, the Commissioner recomputed Atlas deficiency income tax
liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the
Commissioner issued a revised assessment entirely eliminating the assessment of
P546,295.16 for the year 1957. The assessment for 1958 was reduced from
P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals,
assailing the disallowance of the following items claimed as deductible from its gross
income for 1958:
Transfer agent's fee.........................................................P59,477.42
Stockholders relation service fee....................................25,523.14
U.S. stock listing expenses..................................................8,326.70
Suit expenses..........................................................................6,666.65
Provision for contingencies..................................... .........60,000.00
Total....................................................................P159
,993.91
After hearing, the Court of Tax Appeals rendered a decision on October 25, 1966
allowing the above mentioned disallowed items, except the items denominated by Atlas
as stockholders relation service fee and suit expenses. 4Pertinent portions of the decision
of the Court of Tax Appeals read as follows:
Under the facts, circumstances and applicable law in this case, the
unallowable deduction from petitioner's gross income in 1958
amounted to P32,189.79.
Stockholders relation service fee.................................... P25,523.14
Suit and litigation expenses................................................ 6,666.65
Total................................................................................... P32,189.79
As the exemption of petitioner from the payment of corporate income
tax under Section 4, Republic Act 909, was good only up to the Ist
quarter of 1958 ending on March 31 of the same year, only three-fourth
(3/4) of the net taxable income of petitioner is subject to income tax,
computed as follows:
1958
Total net income for 1958.................................P1,968,898.27
Net income corresponding to
 taxable period April 1 to
Dec. 31, 1958, 3/4 of
P1,968,898.27..........................................................1,476,673.70
Add: 3/4 of promotion fees
of P25,523.14..............................................................P19,142.35
Litigation
expenses.........................................................................6, 666.65
Net income per decision..........................................11, 02,4 2.70
Tax due thereon.........................................................412,695.00
Less: Amount already assessed .............................405,468.00
DEFICIENCY INCOME TAX DUE............................P7,227.00
Add: 1/2 % monthly interest
from 6-20-59 to 6-20-62 (18%)....................................P1,300.89
TOTAL AMOUNT DUE & COLLECTIBLE............P8,526.22
From the Court of Tax Appeals' decision of October 25, 1966, both parties appealed to
this Court by way of two (2) separate petitions for review docketed as G. R. No. L-26911
(Atlas, petitioner) and G. R. No. L-29924 (Commissioner, petitioner).
G. R. No. L-26911—Atlas appealed only that portion of the Court of Tax Appeals'
decision disallowing the deduction from gross income of the so-called stockholders
relation service fee amounting to P25,523.14, making a lone assignment of error that —
THE COURT OF TAX APPEALS ERRED IN ITS CONCLUSION THAT
THE EXPENSE IN THE AMOUNT OF P25,523.14 PAID BY
PETITIONER IN 1958 AS ANNUAL PUBLIC RELATIONS EXPENSES
WAS INCURRED FOR ACQUISITION OF ADDITIONAL CAPITAL,
THE SAME NOT BEING SUPPORTED BY THE EVIDENCE.
It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as annual public
relations expenses is a deductible expense from gross income under Section 30 (a) (1)
of the National Internal Revenue Code. Atlas claimed that it was paid for services of a
public relations firm, P.K Macker & Co., a reputable public relations consultant in New
York City, U.S.A., hence, an ordinary and necessary business expense in order to
compete with other corporations also interested in the investment market in the United
States. 5 It is the stand of Atlas that information given out to the public in general and to
the stockholder in particular by the P.K MacKer & Co. concerning the operation of the
Atlas was aimed at creating a favorable image and goodwill to gain or maintain their
patronage.
The decisive question, therefore, in this particular appeal taken by Atlas to this Court is
whether or not the expenses paid for the services rendered by a public relations firm P.K
MacKer & Co. labelled as stockholders relation service fee is an allowable deduction as
business expense under Section 30 (a) (1) of the National Internal Revenue Code.
The principle is recognized that when a taxpayer claims a deduction, he must point to
some specific provision of the statute in which that deduction is authorized and must be
able to prove that he is entitled to the deduction which the law allows. As previously
adverted to, the law allowing expenses as deduction from gross income for purposes of
the income tax is Section 30 (a) (1) of the National Internal Revenue which allows a
deduction of "all the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business." An item of expenditure, in order to be
deductible under this section of the statute, must fall squarely within its language.
We come, then, to the statutory test of deductibility where it is axiomatic that to be
deductible as a business expense, three conditions are imposed, namely: (1) the
expense must be ordinary and necessary, (2) it must be paid or incurred within the
taxable year, and (3) it must be paid or incurred in carrying in a trade or business. 6 In
addition, not only must the taxpayer meet the business test, he must substantially prove
by evidence or records the deductions claimed under the law, otherwise, the same will be
disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and
necessary does not justify its deduction. 7
While it is true that there is a number of decisions in the United States delving on the
interpretation of the terms "ordinary and necessary" as used in the federal tax laws, no
adequate or satisfactory definition of those terms is possible. Similarly, this Court has
never attempted to define with precision the terms "ordinary and necessary." There are
however, certain guiding principles worthy of serious consideration in the proper
adjudication of conflicting claims. Ordinarily, an expense will be considered "necessary"
where the expenditure is appropriate and helpful in the development of the taxpayer's
business. 8 It is "ordinary" when it connotes a payment which is normal in relation to the
business of the taxpayer and the surrounding circumstances. 9 The term "ordinary" does
not require that the payments be habitual or normal in the sense that the same taxpayer
will have to make them often; the payment may be unique or non-recurring to the
particular taxpayer affected. 10
There is thus no hard and fast rule on the matter. The right to a deduction depends in
each case on the particular facts and the relation of the payment to the type of business
in which the taxpayer is engaged. The intention of the taxpayer often may be the
controlling fact in making the determination. 11 Assuming that the expenditure is ordinary
and necessary in the operation of the taxpayer's business, the answer to the question as
to whether the expenditure is an allowable deduction as a business expense must be
determined from the nature of the expenditure itself, which in turn depends on the extent
and permanency of the work accomplished by the expenditure. 12
It appears that on December 27, 1957, Atlas increased its capital stock from
P15,000,000 to P18,325,000. 13 It was claimed by Atlas that its shares of stock worth
P3,325,000 were sold in the United States because of the services rendered by the
public relations firm, P. K. Macker & Company. The Court of Tax Appeals ruled that the
information about Atlas given out and played up in the mass communication media
resulted in full subscription of the additional shares issued by Atlas; consequently, the
questioned item, stockholders relation service fee, was in effect spent for the acquisition
of additional capital, ergo, a capital expenditure.
We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K.
Macker & Co. as compensation for services carrying on the selling campaign in an effort
to sell Atlas' additional capital stock of P3,325,000 is not an ordinary expense in line with
the decision of U.S. Board of Tax Appeals in the case of Harrisburg Hospital Inc. vs.
Commissioner of Internal Revenue. 14 Accordingly, as found by the Court of Tax
Appeals, the said expense is not deductible from Atlas gross income in 1958 because
expenses relating to recapitalization and reorganization of the corporation (Missouri-
Kansas Pipe Line vs. Commissioner of Internal Revenue, 148 F. (2d), 460; Skenandos
Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. (2d) 268, Cert. denied 314
U.S. 6961), the cost of obtaining stock subscription (Simons Co., 8 BTA 631), promotion
expenses (Beneficial Industrial Loan Corp. vs. Handy, 92 F. (2d) 74), and commission or
fees paid for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308) are
capital expenditures.
That the expense in question was incurred to create a favorable image of the corporation
in order to gain or maintain the public's and its stockholders' patronage, does not make it
deductible as business expense. As held in the case of Welch vs. Helvering, 15 efforts to
establish reputation are akin to acquisition of capital assets and, therefore, expenses
related thereto are not business expense but capital expenditures.
We do not agree with the contention of Atlas that the conclusion of the Court of Tax
Appeals in holding that the expense of P25,523.14 was incurred for acquisition of
additional capital is not supported by the evidence. The burden of proof that the
expenses incurred are ordinary and necessary is on the taxpayer 16 and does not rest
upon the Government. To avail of the claimed deduction under Section 30(a) (1) of the
National Internal Revenue Code, it is incumbent upon the taxpayer to adduce substantial
evidence to establish a reasonably proximate relation petition between the expenses to
the ordinary conduct of the business of the taxpayer. A logical link or nexus between the
expense and the taxpayer's business must be established by the taxpayer.
G. R. No. L-26924-In his petition for review, the Commissioner of Internal Revenue
assigned as errors the following:
I income for 1958 are sanctioned by Section 30 (a) (1) of the National Internal Revenue
THE COURT OF TAX APPEALS ERRED IN ALLOWING THE
DEDUCTION FROM GROSS INCOME OF THE SO- CALLED
TRANSFER AGENT'S FEES ALLEGEDLY PAID BY RESPONDENT;
II
THE COURT OF TAX APPEALS ERRED IN ALLOWING THE
DEDUCTION FROM GROSS INCOME OF LISTING EXPENSES
ALLEGEDLY INCURRED BY RESPONDENT;
III
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE
AMOUNT OF P60,000 REPRESENTED BY RESPONDENT AS
"PROVISION FOR CONTINGENCIES" WAS ADDED BACK BY
RESPONDENT TO ITS GROSS INCOME IN COMPUTING THE
INCOME TAX DUE FROM IT FOR 1958;
IV
THE COURT OF TAX APPEALS ERRED IN DISALLOWING ONLY
THE AMOUNT OF P6,666.65 AS SUIT EXPENSES, THE CORRECT
AMOUNT THAT SHOULD HAVE BEEN DISALLOWED BEING
P17,499.98.
It is well to note that only in the Court of Tax Appeals did the Commissioner raise for the
first time (in his memorandum) the question of whether or not the business expenses
deducted from Atlas gross income in 1958 may be allowed in the absence of proof of
payments. 17 Before this Court, the Commissioner reiterated the same as ground against
deductibility when he claimed that the Court of Tax Appeals erred in allowing the
deduction of transfer agent's fee and stock listing fee from gross income in the absence
of proof of payment thereof.
The Commissioner contended that under Section 30 (a) (1) of the National Internal
Revenue Code, it is a requirement for an expense to be deductible from gross income
that it must have been "paid or incurred during the year" for which it is claimed; that in the
absence of convincing and satisfactory evidence of payment, the deduction from gross
income for the year 1958 income tax return cannot be sustained; and that the best
evidence to prove payment, if at all any has been made, would be the vouchers or
receipts issued therefor which ATLAS failed to present.
Atlas admitted that it failed to adduce evidence of payment of the deduction claimed in its
1958 income tax return, but explains the failure with the allegation that the Commissioner
did not raise that question of fact in his pleadings, or even in the report of the
investigating examiner and/or letters of demand and assessment notices of ATLAS which
gave rise to its appeal to the Court of Tax Appeal. 18 It was emphasized by Atlas that it
went to trial and finally submitted this case for decision on the assumption that inasmuch
as the fact of payment was never raised as a vital issue by the Commissioner in his
answer to the petition for review in the Court of Tax Appeal, the issues is limited only to
pure question of law—whether or not the expenses deducted by petitioner from its gross
Code.
On this issue of whether or not the Commissioner can raise the fact of payment for the
first time on appeal in its memorandum in the Court of Tax Appeal, we fully agree with
the ruling of the tax court that the Commissioner on appeal cannot be allowed to adopt a
theory distinct and different from that he has previously pursued, as shown by the BIR
records and the answer to the amended petition for review. 19 As this Court said in the
case of Commissioner of Customs vs. Valencia 20 such change in the nature of the case
may not be made on appeal, specially when the purpose of the latter is to seek a review
of the action taken by an administrative body, forming part of a coordinate branch of the
Government, such as the Executive department. In the case at bar, the Court of Tax
Appeal found that the fact of payment of the claimed deduction from gross income was
never controverted by the Commissioner even during the initial stages of routinary
administrative scrutiny conducted by BIR examiners. 21Specifically, in his answer to the
amended petition for review in the Court of Tax Appeal, the Commissioner did not deny
the fact of payment, merely contesting the legitimacy of the deduction on the ground that
same was not ordinary and necessary business expenses. 22
As consistently ruled by this Court, the findings of facts by the Court of Tax Appeal will
not be reviewed in the absence of showing of gross error or abuse. 23 We, therefore, hold
that it was too late for the Commissioner to raise the issue of fact of payment for the first
time in his memorandum in the Court of Tax Appeals and in this instant appeal to the
Supreme Court. If raised earlier, the matter ought to have been seriously delved into by
the Court of Tax Appeals. On this ground, we are of the opinion that under all the
attendant circumstances of the case, substantial justice would be served if the
Commissioner be held as precluded from now attempting to raise an issue to disallow
deduction of the item in question at this stage. Failure to assert a question within a
reasonable time warrants a presumption that the party entitled to assert it either has
abandoned or declined to assert it.
On the second assignment of error, aside from alleging lack of proof of payment of the
expense deducted, the Commissioner contended that such expense should be
disallowed for not being ordinary and necessary and not incurred in trade or business, as
required under Section 30 (a) (1) of the National Internal Revenue Code. He asserted
that said fees were therefore incurred not for the production of income but for the
acquisition petition of capital in view of the definition that an expense is deemed to be
incurred in trade or business if it was incurred for the production of income, or in the
expectation of producing income for the business. In support of his contention, the
Commissioner cited the ruling in Dome Mines, Ltd vs. Commisioner of Internal
Revenue 24 involving the same issue as in the case at bar where the U.S. Board of Tax
Appeal ruled that expenses for listing capital stock in the stock exchange are not ordinary
and necessary expenses incurred in carrying on the taxpayer's business which was gold
mining and selling, which business is strikingly similar to Atlas.
On the other hand, the Court of Tax Appeal relied on the ruling in the case
of Chesapeake Corporation of Virginia vs. Commissioner of Internal Revenue 25 where
the Tax Court allowed the deduction of stock exchange fee in dispute, which is an
annually recurring cost for the annual maintenance of the listing.
We find the Chesapeake decision controlling with the facts and circumstances of the
instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a
deduction not only because the expenditure did not meet the statutory test but also
because the same was paid only once, and the benefit acquired thereby continued
indefinitely, whereas, in the Chesapeake Corporation case, fee paid to the stock
exchange was annual and recurring. In the instant case, we deal with the stock listing fee
paid annually to a stock exchange for the privilege of having its stock listed. It must be
noted that the Court of Tax Appeal rejected the Dome Mines case because it involves a
payment made only once, hence, it was held therein that the single payment made to the
stock exchange was a capital expenditure, as distinguished from the instant case, where
payments were made annually. For this reason, we hold that said listing fee is an
ordinary and necessary business expense
On the third assignment of error, the Commissioner con- tended that the Court of Tax
Appeal erred when it held that the amount of P60,000 as "provisions for contingencies"
was in effect added back to Atlas income.
On this issue, this Court has consistently ruled in several cases adverted to earlier, that
in the absence of grave abuse of discretion or error on the part of the tax court its
findings of facts may not be disturbed by the Supreme Court. 26 It is not within the
province of this Court to resolve whether or not the P60,000 representing "provision for
contingencies" was in fact added to or deducted from the taxable income. As ruled by the
Court of Tax Appeals, the said amount was in effect added to Atlas taxable
income. 27 The same being factual in nature and supported by substantial evidence, such
findings should not be disturbed in this appeal.
Finally, in its fourth assignment of error, the Commissioner contended that the CTA erred
in disallowing only the amount of P6,666.65 as suit expenses instead of P17,499.98.
It appears that petitioner deducted from its 1958 gross income the amount of P23,333.30
as attorney's fees and litigation expenses in the defense of title to the Toledo Mining
properties purchased by Atlas from Mindanao Lode Mines Inc. in Civil Case No. 30566 of
the Court of First Instance of Manila for annulment of the sale of said mining properties.
On the ground that the litigation expense was a capital expenditure under Section 121 of
the Revenue Regulation No. 2, the investigating revenue examiner recommended the
disallowance of P13,333.30. The Commissioner, however, reduced this amount of
P6,666.65 which latter amount was affirmed by the respondent Court of Tax Appeals on
appeal.
There is no question that, as held by the Court of Tax Ap- peals, the litigation expenses
under consideration were incurred in defense of Atlas title to its mining properties. In line
with the decision of the U.S. Tax Court in the case of Safety Tube Corp. vs.
Commissioner of Internal Revenue, 28 it is well settled that litigation expenses incurred in
defense or protection of title are capital in nature and not deductible. Likewise, it was
ruled by the U.S. Tax Court that expenditures in defense of title of property constitute a
part of the cost of the property, and are not deductible as expense. 29
Surprisingly, however, the investigating revenue examiner recommended a partial
disallowance of P13,333.30 instead of the entire amount of P23,333.30, which, upon
review, was further reduced by the Commissioner of Internal Revenue. Whether it was
due to mistake, negligence or omission of the officials concerned, the arithmetical error
committed herein should not prejudice the Government. This Court will pass upon this
particular question since there is a clear error committed by officials concerned in the
computation of the deductible amount. As held in the case of Vera vs. Fernandez, 30 this
Court emphatically said that taxes are the lifeblood of the Government and their prompt
and certain availability are imperious need. Upon taxation depends the Government's
ability to serve the people for whose benefit taxes are collected. To safeguard such
interest, neglect or omission of government officials entrusted with the collection of taxes
should not be allowed to bring harm or detriment to the people, in the same manner as
private persons may be made to suffer individually on account of his own negligence, the
presumption being that they take good care of their personal affair. This should not hold
true to government officials with respect to matters not of their own personal concern.
This is the philosophy behind the government's exception, as a general rule, from the
operation of the principle of estoppel. 31
WHEREFORE, judgment appealed from is hereby affirmed with modification that the
amount of P17,499.98 (3/4 of P23,333.00) representing suit expenses be disallowed as
deduction instead of P6,666.65 only. With this amount as part of the net income, the
corresponding income tax shall be paid thereon, with interest of 6% per annum from
June 20, 1959 to June 20,1962.
SO ORDERED.
Makasiar, Fernandez, Guerrero and Melencio-Herrera, ,JJ., concur.
Teehankee, J., (Chairman), took no part.
G.R. No. L-26284 October 8, 1986
TOMAS CALASANZ, ET AL., petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE and the COURT OF TAX
APPEALS, respondents.
San Juan, Africa, Gonzales & San Agustin Law Office for petitioners.
FERNAN, J.:
Appeal taken by Spouses Tomas and Ursula Calasanz from the decision of the Court of
Tax Appeals in CTA No. 1275 dated June 7, 1966, holding them liable for the payment of
P3,561.24 as deficiency income tax and interest for the calendar year 1957 and P150.00
as real estate dealer's fixed tax.
Petitioner Ursula Calasanz inherited from her father Mariano de Torres an agricultural
land located in Cainta, Rizal, containing a total area of 1,678,000 square meters. In order
to liquidate her inheritance, Ursula Calasanz had the land surveyed and subdivided into
lots. Improvements, such as good roads, concrete gutters, drainage and lighting system,
were introduced to make the lots saleable. Soon after, the lots were sold to the public at
a profit.
In their joint income tax return for the year 1957 filed with the Bureau of Internal Revenue
on March 31, 1958, petitioners disclosed a profit of P31,060.06 realized from the sale of
the subdivided lots, and reported fifty per centum thereof or P15,530.03 as taxable
capital gains.
Upon an audit and review of the return thus filed, the Revenue Examiner adjudged
petitioners engaged in business as real estate dealers, as defined in Section 194 [s] 1 of
the National Internal Revenue Code, required them to pay the real estate dealer's
tax 2 and assessed a deficiency income tax on profits derived from the sale of the lots
based on the rates for ordinary income.
On September 29, 1962, petitioners received from respondent Commissioner of Internal
Revenue:
a. Demand No. 90-B-032293-57 in the amount of P160.00
representing real estate dealer's fixed tax of P150.00 and P10.00
compromise penalty for late payment; and
b. Assessment No. 90-5-35699 in the amount of P3,561.24 as
deficiency income tax on ordinary gain of P3,018.00 plus interest of P
543.24.
On October 17, 1962, petitioners filed with the Court of Tax Appeals a petition for review
contesting the aforementioned assessments.
On June 7, 1966, the Tax Court upheld the respondent Commissioner except for that
portion of the assessment regarding the compromise penalty of P10.00 for the reason
that in this jurisdiction, the same cannot be collected in the absence of a valid and
binding compromise agreement.
Hence, the present appeal.
The issues for consideration are:
a. Whether or not petitioners are real estate dealers liable for real
estate dealer's fixed tax; and
b. Whether the gains realized from the sale of the lots are taxable in
full as ordinary income or capital gains taxable at capital gain rates.
The issues are closely interrelated and will be taken jointly.
Petitioners assail their liabilities as "real estate dealers" and seek to bring the profits from
the sale of the lots under Section 34 [b] [2] 3 of the Tax Code.
The theory advanced by the petitioners is that inherited land is a capital asset within the
meaning of Section 34[a] [1] of the Tax Code and that an heir who liquidated his
inheritance cannot be said to have engaged in the real estate business and may not be
denied the preferential tax treatment given to gains from sale of capital assets, merely
because he disposed of it in the only possible and advantageous way.
Petitioners averred that the tract of land subject of the controversy was sold because of
their intention to effect a liquidation. They claimed that it was parcelled out into smaller
lots because its size proved difficult, if not impossible, of disposition in one single
transaction. They pointed out that once subdivided, certainly, the lots cannot be sold in
one isolated transaction. Petitioners, however, admitted that roads and other
improvements were introduced to facilitate its sale. 4
On the other hand, respondent Commissioner maintained that the imposition of the taxes
in question is in accordance with law since petitioners are deemed to be in the real estate
business for having been involved in a series of real estate transactions pursued for
profit. Respondent argued that property acquired by inheritance may be converted from
an investment property to a business property if, as in the present case, it was
subdivided, improved, and subsequently sold and the number, continuity and frequency
of the sales were such as to constitute "doing business." Respondent likewise contended
that inherited property is by itself neutral and the fact that the ultimate purpose is to
liquidate is of no moment for the important inquiry is what the taxpayer did with the
property. Respondent concluded that since the lots are ordinary assets, the profits
realized therefrom are ordinary gains, hence taxable in full.
We agree with the respondent.
The assets of a taxpayer are classified for income tax purposes into ordinary assets and
capital assets. Section 34[a] [1] of the National Internal Revenue Code broadly defines
capital assets as follows:
[1] Capital assets.-The term 'capital assets' means property held by the
taxpayer [whether or not connected with his trade or business], but
does not include, stock in trade of the taxpayer or other property of a
kind which would properly be included, in the inventory of the taxpayer
if on hand at the close of the taxable year, or property held by the
taxpayer primarily for sale to customers in the ordinary course of his
trade or business, or property used in the trade or business of a
character which is subject to the allowance for depreciation provided in
subsection [f] of section thirty; or real property used in the trade or
business of the taxpayer.
The statutory definition of capital assets is negative in nature. 5 If the asset is not among
the exceptions, it is a capital asset; conversely, assets falling within the exceptions are
ordinary assets. And necessarily, any gain resulting from the sale or exchange of an
asset is a capital gain or an ordinary gain depending on the kind of asset involved in the
transaction.
However, there is no rigid rule or fixed formula by which it can be determined with finality
whether property sold by a taxpayer was held primarily for sale to customers in the
ordinary course of his trade or business or whether it was sold as a capital
asset. 6 Although several factors or indices 7 have been recognized as helpful guides in
making a determination, none of these is decisive; neither is the presence nor the
absence of these factors conclusive. Each case must in the last analysis rest upon its
own peculiar facts and circumstances. 8
Also a property initially classified as a capital asset may thereafter be treated as an
ordinary asset if a combination of the factors indubitably tend to show that the activity
was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of
inherited real property usually gives capital gain or loss even though the property has to
be subdivided or improved or both to make it salable. However, if the inherited property is
substantially improved or very actively sold or both it may be treated as held primarily for
sale to customers in the ordinary course of the heir's business. 9
Upon an examination of the facts on record, We are convinced that the activities of
petitioners are indistinguishable from those invariably employed by one engaged in the
business of selling real estate.
One strong factor against petitioners' contention is the business element of development
which is very much in evidence. Petitioners did not sell the land in the condition in which
they acquired it. While the land was originally devoted to rice and fruit trees, 10 it was
subdivided into small lots and in the process converted into a residential subdivision and
given the name Don Mariano Subdivision. Extensive improvements like the laying out of
streets, construction of concrete gutters and installation of lighting system and drainage
facilities, among others, were undertaken to enhance the value of the lots and make
them more attractive to prospective buyers. The audited financial
statements 11 submitted together with the tax return in question disclosed that a
considerable amount was expended to cover the cost of improvements. As a matter of
fact, the estimated improvements of the lots sold reached P170,028.60 whereas the cost
of the land is only P 4,742.66. There is authority that a property ceases to be a capital
asset if the amount expended to improve it is double its original cost, for the extensive
improvement indicates that the seller held the property primarily for sale to customers in
the ordinary course of his business. 12
Another distinctive feature of the real estate business discernible from the records is the
existence of contracts receivables, which stood at P395,693.35 as of the year ended
December 31, 1957. The sizable amount of receivables in comparison with the sales
volume of P446,407.00 during the same period signifies that the lots were sold on
installment basis and suggests the number, continuity and frequency of the sales. Also of
significance is the circumstance that the lots were advertised 13 for sale to the public and
that sales and collection commissions were paid out during the period in question.
Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.
In Ehrman vs. Commissioner,14 the American court in clear and categorical terms
rejected the liquidation test in determining whether or not a taxpayer is carrying on a
trade or business The court observed that the fact that property is sold for purposes of
liquidation does not foreclose a determination that a "trade or business" is being
conducted by the seller. The court enunciated further:
We fail to see that the reasons behind a person's entering into a
business-whether it is to make money or whether it is to liquidate-
should be determinative of the question of whether or not the gains
resulting from the sales are ordinary gains or capital gains. The sole
question is-were the taxpayers in the business of subdividing real
estate? If they were, then it seems indisputable that the property sold
falls within the exception in the definition of capital assets . . . that is,
that it constituted 'property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or business.
Additionally, in Home Co., Inc. vs. Commissioner, 15 the court articulated on the matter in
this wise:
One may, of course, liquidate a capital asset. To do so, it is necessary
to sell. The sale may be conducted in the most advantageous manner
to the seller and he will not lose the benefits of the capital gain
provision of the statute unless he enters the real estate business and
carries on the sale in the manner in which such a business is ordinarily
conducted. In that event, the liquidation constitutes a business and a
 sale in the ordinary course of such a business and the preferred tax
status is lost.
In view of the foregoing, We hold that in the course of selling the subdivided lots,
petitioners engaged in the real estate business and accordingly, the gains from the sale
of the lots are ordinary income taxable in full.
WHEREFORE, the decision of the Court of Tax Appeals is affirmed. No costs.
SO ORDERED.
Feria (Chairman), Alampay, Gutierrez, Jr. and Paras, JJ., concur.
G.R. Nos. L-33665-68 February 27, 1987
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
VICENTE A. RUFINO and REMEDIOS S. RUFINO, ERNESTO D. RUFINO and
ELVIRA B. RUFINO, RAFAEL R. RUFINO and JULIETA A. RUFINO, MANUEL S.
GALVEZ and ESTER R. GALVEZ, and COURT OF TAX APPEALS, respondents.
Leonardo Abola for respondents.
CRUZ, J.:
Petition for review on certiorari of the decision of the Court of Tax Appeals absolving the
private respondents from liability for capital gains tax on the stocks received by them
from the Eastern Theatrical Inc. These were originally four cages involving appeals from
the decision of the Commissioner of Internal Revenue dated July 11, 1966, holding the
said respondents, Vicente A. Rufino and Remedies S. Rufino, Ernesto D. Rufino and
Elvira B. Rufino, Rafael R. Rufino and Julieta A. Rufino, and Manuel S. Galvez and Ester
R. Galvez, liable for deficiency income tax, surcharge and interest in the sums of
P44,294.88, P27,229.44, P58,082.60 and P58,074.24, respectively, for the year 1959.
The facts, as narrated by the Court of Tax Appeals, are as follows:
The private respondents were the majority stockholders of the defunct Eastern Theatrical
Co., Inc., a corporation organized in 1934, for a period of twenty-five years terminating on
January 25, 1959. It had an original capital stock of P500,000.00, which was increased in
1949 to P2,000,000.00, divided into 200,000 shares at P10.00 per share, and was
organized to engage in the business of operating theaters, opera houses, places of
amusement and other related business enterprises, more particularly the Lyric and
Capitol Theaters in Manila. The President of this corporation (hereinafter referred to as
the Old Corporation) during the year in question was Ernesto D. Rufino.
The private respondents are also the majority and controlling stockholders of another
corporation, the Eastern Theatrical Co Inc., which was organized on December 8, 1958,
for a term of 50 years, with an authorized capital stock of P200,000.00, each share
having a par value of P10.00. This corporation is engaged in the same kind of business
as the Old Corporation. The General-Manager of this corporation (hereinafter referred to
as the New Corporation) at the time was Vicente A. Rufino.
In a special meeting of stockholders of the Old Corporation on December 17, 1958, to
provide for the continuation of its business after the end of its corporate life, and upon the
recommendation of its board of directors, a resolution was passed authorizing the Old
Corporation to merge with the New Corporation by transferring its business, assets,
goodwill, and liabilities to the latter, which in exchange would issue and distribute to the
shareholders of the Old Corporation one share for each share held by them in the said
Corporation.
It was expressly declared that the merger of the Old Corporation with the New
Corporation was necessary to continue the exhibition of moving pictures at the Lyric and
Capitol Theaters even after the expiration of the corporate existence of the former, in
view of its pending booking contracts, not to mention its collective bargaining agreements
with its employees.
Pursuant to the said resolution, the Old Corporation, represented by Ernesto D. Rufino
as President, and the New Corporation, represented by Vicente A. Rufino as General
Manager, signed on January 9, 1959, a Deed of Assignment providing for the
conveyance and transfer of all the business, property, assets and goodwill of the Old
Corporation to the New Corporation in exchange for the latter's shares of stock to be
distributed among the shareholders on the basis of one stock for each stock held in the
Old Corporation except that no new and unissued shares would be issued to the
shareholders of the Old Corporation; the delivery by the New Corporation to the Old
Corporation of 125,005-3/4 shares to be distributed to the shareholders of the Old
Corporation as their corresponding shares of stock in the New Corporation; the
assumption by the New Corporation of all obligations and liabilities of the Old Corporation
under its bargaining agreement with the Cinema Stage & Radio Entertainment Free
Workers (FFW) which included the retention of all personnel in the latter's employ; and
the increase of the capitalization of the New Corporation in compliance with their
agreement. This agreement was made retroactive to January 1, 1959.
The aforesaid transfer was eventually made by the Old Corporation to the New
Corporation, which continued the operation of the Lyric and Capitol Theaters and
assumed all the obligations and liabilities of the Old Corporation beginning January 1,
1959.
The resolution of the Old Corporation of December 17, 1958, and the Deed of
Assignment of January 9, 1959, were approved in a resolution by the stockholders of the
New Corporation in their special meeting on January 12, 1959. In the same meeting, the
increased capitalization of the New Corporation to P2,000,000.00 was also divided into
200,000 shares at P10.00 par value each share, and the said increase was registered on
March 5, 1959, with the Securities and Exchange Commission, which approved the same
on August 20,1959.
As agreed, and in exchange for the properties, and other assets of the Old Corporation,
the New Corporation issued to the stockholders of the former stocks in the New
Corporation equal to the stocks each one held in the Old Corporation, as follows:
Mr. & Mrs. Vicente A. Rufino............... 17,083 shares
 Mr. & Mrs. Rafael R. Rufino ................. 16,881 shares
Mr. & Mrs. Ernesto D. Rufino .............. 18,347 shares
Mr. & Mrs. Manuel S. Galvez ............... 16,882 shares
It was this above-narrated series of transactions that the Bureau of Internal Revenue
examined later, resulting in the petitioner declaring that the merger of the aforesaid
corporations was not undertaken for a bona fide business purpose but merely to avoid
liability for the capital gains tax on the exchange of the old for the new shares of stock.
Accordingly, he imposed the deficiency assessments against the private respondents for
the amounts already mentioned. The private respondents' request for reconsideration
having been denied, they elevated the matter to the Court of Tax Appeals, which
reversed the petitioner.
We have given due course to the instant petition questioning the decision of the said
court holding that there was a valid merger between the Old Corporation and the New
Corporation and declaring that:
It is well established that where stocks for stocks were exchanged, and
distributed to the stockholders of the corporations, parties to the
merger or consolidation, pursuant to a plan of reorganization, such
exchange is exempt from capital gains tax . . .
In view of the foregoing, we are of the opinion and so hold that no
taxable gain was derived by petitioners from the exchange of their old
stocks solely for stocks of the New Corporation pursuant to Section
35(c) (2), in relation to (c) (5), of the National Internal Revenue Code,
as amended by Republic Act 1921. 1
The above-cited Section 35 of the Tax Code, on the proper interpretation and application
of which the resolution of this case depends, provides in material part as follows:
Sec. 35. Determination of gain or loss from the sale or other disposition
of property. — The gain derived or loss sustained from the sale or
other disposition of property, real, personal or mixed, shall be
determined in accordance with the following schedule:
xxx xxx xxx
(c) Exchange of property-
(1) General Rule. — Except as herein provided upon
the sale or exchange of property, the entire amount
of the gain or loss, as the case may be, shall be
recognized.
(2) Exceptions. — No gain or loss shall be
recognized if in pursuance of a plan of merger or
consolidation (a) a corporation which is a party to a
merger or consolidation, exchanges property solely
for stock in a corporation which is a party to the
merger or consolidation, (b) a shareholder
exchanges stock in a corporation which is a party to
the merger or consolidation solely for the stock of
another corporation, also a party to the merger or
consolidation, or (c) a security holder of a
corporation which is a party to the merger or
consolidation exchanges his securities in such
corporation solely for stock or securities in another
corporation, a party to the merger or consolidation.
xxx xxx xxx
(5) Definitions.-(a) x x x (b) The term "merger" or
"consolidation," when used in this section, shall be
understood to mean: (1) The ordinary merger or
consolidation, or (2) the acquisition by one
corporation of all or substantially all the properties of
another corporation solely for stock; Provided, That
for a transaction to be regarded as a merger or
consolidation within the purview of this section, it
must be undertaken for a bona fide business
purpose and not solely for the purpose of escaping
the burden of taxation; Provided further, That in
determining whether a bona fide business purpose
exists, each and every step of the transaction shall
be considered and the whole transaction or series of
transactions shall be treated as a single unit: ...
In support of its position that the Deed of Assignment was concluded by the private
respondents merely to evade the burden of taxation, the petitioner points to the fact that
the New Corporation did not actually issue stocks in exchange for the properties of the
Old Corporation at the time of the supposed merger on January 9, 1959. The exchange,
he says, was only on paper. The increase in capitalization of the New Corporation was
registered with the Securities and Exchange Commission only on March 5, 1959, or 37
days after the Old Corporation expired on January 25, 1959. Prior to such registration, it
was not possible for the New Corporation to effect the exchange provided for in the said
agreement because it was capitalized only at P200,000.00 as against the capitalization
of the Old Corporation at P2,000,000.00. Consequently, as there was no merger, the
automatic dissolution of the Old Corporation on its expiry date resulted in its liquidation,
for which the respondents are now liable in taxes on their capital gains.
For their part, the private respondents insist that there was a genuine merger between
the Old Corporation and the New Corporation pursuant to a plan aimed at enabling the
latter to continue the business of the former in the operation of places of amusement,
specifically the Capitol and Lyric Theaters. The plan was evolved through the series of
transactions above narrated, all of which could be treated as a single unit in accordance
with the requirements of Section 35. Obviously, all these steps did not have to be
completed at the time of the merger, as there were some of them, such as the increase
and distribution of the stock of the New Corporation, which necessarily had to come
afterwards. Moreover, the Old Corporation was dissolved on January 1, 1959, pursuant
to the Deed of Assignment, and not on January 25, 1959, its original expiry date. As the
properties of the Old Corporation were transferred to the New Corporation before that
expiry date, there could not have been any distribution of liquidating dividends by the Old
Corporation for which the private respondents should be held liable in taxes.
We sustain the Court of Tax Appeals. We hold that it did not err in finding that no taxable
gain was derived by the private respondents from the questioned transaction.
Contrary to the claim of the petitioner, there was a valid merger although the actual
transfer of the properties subject of the Deed of Assignment was not made on the date of
the merger. In the nature of things, this was not possible. Obviously, it was necessary for
the Old Corporation to surrender its net assets first to the New Corporation before the
latter could issue its own stock to the shareholders of the Old Corporation because the
New Corporation had to increase its capitalization for this purpose. This required the
adoption of the resolution to this effect at the special stockholders meeting of the New
Corporation on January 12, 1959, the registration of such issuance with the SEC on
March 5, 1959, and its approval by that body on August 20, 1959. All these took place
after the date of the merger but they were deemed part and parcel of, and indispensable
to the validity and enforceability of, the Deed of Assignment.
The Court finds no impediment to the exchange of property for stock between the two
corporations being considered to have been effected on the date of the merger. That, in
fact, was the intention, and the reason why the Deed of Assignment was made
retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set
forth in the merger agreement shall be deemed to be taking place simultaneously on
January 1, 1959, when the Deed of Assignment became operative.
The certificates of stock subsequently delivered by the New Corporation to the private
respondents were only evidence of the ownership of such stocks. Although these
certificates could be issued to them only after the approval by the SEC of the increase in
capitalization of the New Corporation, the title thereto, legally speaking, was transferred
to them on the date the merger took effect, in accordance with the Deed of Assignment.
The basic consideration, of course, is the purpose of the merger, as this would determine
whether the exchange of properties involved therein shall be subject or not to the capital
gains tax. The criterion laid down by the law is that the merger" must be undertaken for
a bona fide business purpose and not solely for the purpose of escaping the burden of
taxation." We must therefore seek and ascertain the intention of the parties in the light of
their conduct contemporaneously with, and especially after, the questioned merger
pursuant to the Deed of Assignment of January 9, 1959.
It has been suggested that one certain indication of a scheme to evade the capital gains
tax is the subsequent dissolution of the new corporation after the transfer to it of the
properties of the old corporation and the liquidation of the former soon thereafter. This
highly suspect development is likely to be a mere subterfuge aimed at circumventing the
requirements of Section 35 of the Tax Code while seeming to be a valid corporate
combination. Speaking of such a device, Justice Sutherland declared for the United
States Supreme Court in Helvering v. Gregory:
When subdivision (b) speaks of a transfer of assets by one corporation
to another, it means a transfer made 'in pursuance of a plan of
reorganization' (Section 112[g]) of corporate business; and not a
transfer of assets by one corporation to another in pursuance of a plan
having no relation to the business of either, as plainly is the case here.
Putting aside, then, the question of motive in respect of taxation
altogether, and fixing the character of proceeding by what actually
occurred, what do we find? Simply an operation having no business or
corporate purpose — a mere devise which put on the form of a
corporate reorganization as a disguise for concealing its real character,
and the sole object and accomplishment of which was the
consummation of a preconceived plan, not to reorganize a business or
any part of a business, but to transfer a parcel of corporate shares to
the petitioner. No doubt, a new and valid corporation was created. But
that corporation was nothing more than a contrivance to the end last
described. It was brought into existence for no other purpose; it
performed, as it was intended from the beginning it should perform, no
other function. When that limited function had been exercised, it
immediately was put to death.
In these circumstances, the facts speak for themselves and are
susceptible of but one interpretation. The whole undertaking, though
conducted according to the terms of subdivision (b), was in fact an
elaborate and devious form of conveyance masquerading as a
corporate reorganization and nothing else. The rule which excludes
from consideration the motive of tax avoidance is not pertinent to the
situation, because the transaction upon its face lies outside the plain
intent of the statute. To hold otherwise would be to exalt artifice above
reality and to deprive the statutory provision in question of all serious
purpose. 2
We see no such furtive intention in the instant case. It is clear, in fact, that the purpose of
the merger was to continue the business of the Old Corporation, whose corporate life
was about to expire, through the New Corporation to which all the assets and obligations
of the former had been transferred. What argues strongly, indeed, for the New
Corporation is that it was not dissolved after the merger agreement in 1959. On the
contrary, it continued to operate the places of amusement originally owned by the Old
Corporation and transfered to the New Corporation, particularly the Capitol and Lyric
Theaters, in accordance with the Deed of Assignment. The New Corporation, in fact,
continues to do so today after taking over the business of the Old Corporation twenty-
seven years ago.
It may be recalled at this point that under the original provisions of the old Corporation
Law, which was in effect when the merger agreement was concluded in 1959, it was not
possible for a corporation, by mere amendment of its charter, to extend its life beyond the
time fixed in the original articles; in fact, this was specifically prohibited by Section 18,
which provided that "any corporation may amend its articles of incorporation by a
majority vote of its board of directors or trustees and the vote or written assent of two-
thirds of its members, if it be a non-stock corporation, or if it be a stock corporation, by
the vote or written assent of the stockholders representing at least two-thirds of the
subscribed capital stock of the corporation ... : Provided, however, That the life of said
corporation shall not be extended by said amendment beyond the fixed in the original
articles ... "
This prohibition, which incidentally has since been deleted, made it necessary for the Old
and New Corporations to enter into the questioned merger, to enable the former to
continue its unfinished business through the latter.
The procedure for such merger was prescribed in Section 28 1/2 of the old Corporation WHEREFORE, the decision of the Court of Tax Appeals is affirmed in full, without any
Law which, although not expressly authorizing a merger by name (as the new pronouncement as to costs.
Corporation Code now does in its Section 77), provided that "a corporation may, by
action taken at any meeting of its board of directors, sell, lease, exchange, or otherwise SO ORDERED.
dispose of all or substantially all of its property and assets, including its goodwill, upon
such terms and conditions and for such considerations, which may be money, stocks,
bond, or other instruments for the payment of money or other property or other Yap (Chairman), Narvasa, Melencio-Herrera, Feliciano, Gancayco and sarmiento, JJ.,
considerations, as its board of directors deem expedient." The transaction contemplated concur.
in the old law covered the second type of merger defined by Section 35 of the Tax Code
as "the acquisition by one corporation of all or substantially all of the properties of Gregory v Helvering
another corporation solely for stock," which is precisely what happened in the present
case.
U.S. Supreme Court
What is also worth noting is that, as in the case of the Old Corporation when it was
dissolved on December 31, 1958, there has been no distribution of the assets of the New Gregory v. Helvering, 293 U.S. 465 (1935)
Corporation since then and up to now, as far as the record discloses. To date, the private
respondents have not derived any benefit from the merger of the Old Corporation and the
New Corporation almost three decades earlier that will make them subject to the capital Gregory v. Helvering
gains tax under Section 35. They are no more liable now than they were when the
merger took effect in 1959, as the merger, being genuine, exempted them under the law No. 127
from such tax.
Argued December 4, 5, 1934
By this decision, the government is, of course, not left entirely without recourse, at least
in the future. The fact is that the merger had merely deferred the claim for taxes, which Decided January 7, 1935
may be asserted by the government later, when gains are realized and benefits are
distributed among the stockholders as a result of the merger. In other words, the
corresponding taxes are not forever foreclosed or forfeited but may at the proper time 293 U.S. 465
and without prejudice to the government still be imposed upon the private respondents,
in accordance with Section 35(c) (4) of the Tax Code. Then, in assessing the tax, "the CERTIORARI TO THE CIRCUIT COURT OF APPEALS
basis of the property transferred in the hands of the transferee shall be the same as it
would be in the hands of the transferor, increased by the amount of gain recognized to
FOR THE SECOND CIRCUIT
the transferor on the transfer." The only inhibition now is that time has not yet come.

The reason for this conclusion is traceable to the purpose of the legislature in adopting
the provision of law in question. The basic Idea was to correct the Tax Code which, by
imposing taxes on corporate combinations and expansions, discouraged the same to the
detriment of economic progress, particularly the promotion of local industry. Speaking of
this problem, HB No. 7233, which was subsequently enacted into R.A. No. 1921
embodying Section 35 as now worded, declared in the Explanatory Note:
The exemption from the tax of the gain derived from exchanges of
stock solely for stock of another corporation resulting from corporate
mergers or consolidations under the above provisions, as amended,
was intended to encourage corporations in pooling, combining or
expanding their resources conducive to the economic development of
the country. 3
Our ruling then is that the merger in question involved a pooling of resources aimed at
the continuation and expansion of business and so came under the letter and intendment
of the National Internal Revenue Code, as amended by the abovecited law, exempting
from the capital gains tax exchanges of property effected under lawful corporate
combinations.
Syllabus
1. A corporation wholly owned by a taxpayer transferred 1000 shares of stock in another
corporation held by it among its assets to a new corporation, which thereupon issued all
of its shares to the
Page 293 U. S. 466
taxpayer. Within a few days, the new corporation was dissolved and was liquidated by
the distribution of the 1000 shares to the taxpayer, who immediately sold them for her
individual profit. No other business was transacted, or intended to be transacted, by the
new corporation. The whole plan was designed to conform to § 112 of the Revenue Act
of 1928 as a "reorganization," but for the sole purpose of transferring the shares in
question to the taxpayer, with a resulting tax liability less than that which would have
ensued from a direct transfer by way of dividend. Held: while the plan conformed to the
terms of the statute, there was no reorganization within the intent of the statute. P. 293 U.
S. 468.
2. By means which the law permits, a taxpayer has the right to decrease the amount of
what otherwise would be his taxes, or altogether to avoid them. P. 293 U. S. 469.
3. The rule which excludes from consideration the motive of tax avoidance is not
pertinent to the situation here, because the transaction upon its face lies outside the plain
intent of the statute. P. 293 U. S. 470.
69 F.2d 809 affirmed.
Certiorari to review a judgment reversing a decision of the Board of Tax Appeals, 27
B.T.A. 223, which set aside an order of the Commissioner determining a deficiency in
income tax.
Page 293 U. S. 467
MR. JUSTICE SUTHERLAND delivered the opinion of the Court.
Petitioner, in 1928, was the owner of all the stock of United Mortgage Corporation. That
corporation held among its assets 1,000 shares of the Monitor Securities Corporation.
For the sole purpose of procuring a transfer of these shares to herself in order to sell
them for her individual profit, and at the same time, diminish the amount of income tax
which would result from a direct transfer by way of dividend, she sought to bring about a
"reorganization" under § 112(g) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 816,
818, set forth later in this opinion. To that end, she caused the Averill Corporation to be
organized under the laws of Delaware on September 18, 1928. Three days later, the
United Mortgage Corporation transferred to the Averill Corporation the 1,000 shares of
Monitor stock, for which all the shares of the Averill Corporation were issued to the
petitioner. On September 24, the Averill Corporation was dissolved, and liquidated by
distributing all its assets, namely, the Monitor shares, to the petitioner. No other business
was ever transacted, or intended to be transacted, by that company. Petitioner
immediately sold the Monitor shares for $133,333.33. She returned for taxation, as
capital net gain, the sum of $76,007.88, based upon an apportioned cost of $57,325.45.
Further details are unnecessary. It is not disputed that, if the interposition of the so-called
reorganization was ineffective, petitioner became liable for a much larger tax as a result
of the transaction.
The Commissioner of Internal Revenue, being of opinion that the reorganization
attempted was without substance and must be disregarded, held that petitioner was
liable for a tax as though the United corporation had paid her a dividend consisting of the
amount realized from the sale of the Monitor shares. In a proceeding before the
Page 293 U. S. 468
Board of Tax Appeals, that body rejected the commissioner's view and upheld that of
petitioner. 27 B.T.A. 223. Upon a review of the latter decision, the Circuit Court of
Appeals sustained the commissioner and reversed the board, holding that there had
been no "reorganization" within the meaning of the statute. 69 F.2d 809. Petitioner
applied to this Court for a writ of certiorari, which the government, considering the
question one of importance, did not oppose. We granted the writ.
Section 112 of the Revenue Act of 1928 deals with the subject of gain or loss resulting
from the sale or exchange of property. Such gain or loss is to be recognized in computing
the tax, except as provided in that section. The provisions of the section, so far as they
are pertinent to the question here presented, follow:
"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in
pursuance of a plan of reorganization, to a shareholder in a corporation a party to the
reorganization, stock or securities in such corporation or in another corporation a party to
the reorganization, without the surrender by such shareholder of stock or securities in
such a corporation, no gain to the distributee from the receipt of such stock of securities
shall be recognized. . . ."
"(i) Definition of Reorganization. -- As used in this section . . ."
"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of
its assets to another corporation if immediately after the transfer the transferor or its
stockholders or both are in control of the corporation to which the assets are transferred.
. . ."
It is earnestly contended on behalf of the taxpayer that, since every element required by
the foregoing subdivision (B) is to be found in what was done, a statutory reorganization
was effected, and that the motive of the taxpayer thereby to escape payment of a tax will
not alter the result
Page 293 U. S. 469
or make unlawful what the statute allows. It is quite true that, if a reorganization in reality
was effected within the meaning of subdivision (B), the ulterior purpose mentioned will be
disregarded. The legal right of a taxpayer to decrease the amount of what otherwise
would be his taxes, or altogether avoid them, by means which the law permits, cannot be
doubted. United States v. Isham, 17 Wall. 496, 84 U. S. 506; Superior Oil Co. v.
Mississippi,280 U. S. 390, 280 U. S. 395-396; Jones v. Helvering, 63 App.D.C. 204, 71
F.2d 214, 217. But the question for determination is whether what was done, apart from
the tax motive, was the thing which the statute intended. The reasoning of the court
below in justification of a negative answer leaves little to be said.
When subdivision (B) speaks of a transfer of assets by one corporation to another, it
means a transfer made "in pursuance of a plan of reorganization" [§ 112(g)] of corporate
business, and not a transfer of assets by one corporation to another in pursuance of a
plan having no relation to the business of either, as plainly is the case here. Putting
aside, then, the question of motive in respect of taxation altogether, and fixing the
character of the proceeding by what actually occurred, what do we find? Simply an
operation having no business or corporate purpose -- a mere device which put on the
form of a corporate reorganization as a disguise for concealing its real character, and the
sole object and accomplishment of which was the consummation of a preconceived plan,
not to reorganize a business or any part of a business, but to transfer a parcel of
corporate shares to the petitioner. No doubt, a new and valid corporation was created.
But that corporation was nothing more than a contrivance to the end last described. It
was brought into existence for no other purpose; it performed, as it was intended from
the beginning it should perform, no other function.
Page 293 U. S. 470
When that limited function had been exercised, it immediately was put to death.
In these circumstances, the facts speak for themselves, and are susceptible of but one
interpretation. The whole undertaking, though conducted according to the terms of
subdivision (B), was in fact an elaborate and devious form of conveyance masquerading
as a corporate reorganization, and nothing else. The rule which excludes from
consideration the motive of tax avoidance is not pertinent to the situation, because the
transaction, upon its face, lies outside the plain intent of the statute. To hold otherwise
would be to exalt artifice above reality and to deprive the statutory provision in question
of all serious purpose.
Judgment affirmed.
G.R. No. L-65773-74 April 30, 1987
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX
APPEALS, respondents.
Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.
MELENCIO-HERRERA, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the
joint Decision of the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561,
dated 26 January 1983, which set aside petitioner's assessment of deficiency income
taxes against respondent British Overseas Airways Corporation (BOAC) for the fiscal
years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its Resolution of 18
November, 1983 denying reconsideration.
BOAC is a 100% British Government-owned corporation organized and existing under
the laws of the United Kingdom It is engaged in the international airline business and is a
member-signatory of the Interline Air Transport Association (IATA). As such it operates
air transportation service and sells transportation tickets over the routes of the other
airline members. During the periods covered by the disputed assessments, it is admitted
that BOAC had no landing rights for traffic purposes in the Philippines, and was not
granted a Certificate of public convenience and necessity to operate in the Philippines by
the Civil Aeronautics Board (CAB), except for a nine-month period, partly in 1961 and
partly in 1962, when it was granted a temporary landing permit by the CAB.
Consequently, it did not carry passengers and/or cargo to or from the Philippines,
although during the period covered by the assessments, it maintained a general sales
agent in the Philippines — Wamer Barnes and Company, Ltd., and later Qantas Airways
— which was responsible for selling BOAC tickets covering passengers and cargoes. 1
G.R. No. 65773 (CTA Case No. 2373, the First Case)
On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed
BOAC the aggregate amount of P2,498,358.56 for deficiency income taxes covering the
years 1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in
the issuance of a new assessment, dated 16 January 1970 for the years 1959 to 1967 in
the amount of P858,307.79. BOAC paid this new assessment under protest.
On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which
claim was denied by the CIR on 16 February 1972. But before said denial, BOAC had
already filed a petition for review with the Tax Court on 27 January 1972, assailing the
assessment and praying for the refund of the amount paid.
G.R. No. 65774 (CTA Case No. 2561, the Second Case)
On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and
penalty for the fiscal years 1968-1969 to 1970-1971 in the aggregate amount of
P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 as compromise
penalties for violation of Section 46 (requiring the filing of corporation returns) penalized
under Section 74 of the National Internal Revenue Code (NIRC).
On 25 November 1971, BOAC requested that the assessment be countermanded and
set aside. In a letter, dated 16 February 1972, however, the CIR not only denied the
BOAC request for refund in the First Case but also re-issued in the Second Case the
deficiency income tax assessment for P534,132.08 for the years 1969 to 1970-71 plus
P1,000.00 as compromise penalty under Section 74 of the Tax Code. BOAC's request
for reconsideration was denied by the CIR on 24 August 1973. This prompted BOAC to
file the Second Case before the Tax Court praying that it be absolved of liability for
deficiency income tax for the years 1969 to 1971.
This case was subsequently tried jointly with the First Case.
On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the
CIR. The Tax Court held that the proceeds of sales of BOAC passage tickets in the
Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, during
the period in question, do not constitute BOAC income from Philippine sources "since no
service of carriage of passengers or freight was performed by BOAC within the
Philippines" and, therefore, said income is not subject to Philippine income tax. The CTA
position was that income from transportation is income from services so that the place
where services are rendered determines the source. Thus, in the dispositive portion of its
Decision, the Tax Court ordered petitioner to credit BOAC with the sum of P858,307.79,
and to cancel the deficiency income tax assessments against BOAC in the amount of
P534,132.08 for the fiscal years 1968-69 to 1970-71.
Hence, this Petition for Review on certiorari of the Decision of the Tax Court.
The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:
1. Whether or not the revenue derived by private respondent British
Overseas Airways Corporation (BOAC) from sales of tickets in the
Philippines for air transportation, while having no landing rights here,
constitute income of BOAC from Philippine sources, and, accordingly,
taxable.
 2. Whether or not during the fiscal years in question BOAC s a resident
foreign corporation doing business in the Philippines or has an office or
place of business in the Philippines.
3. In the alternative that private respondent may not be considered a
resident foreign corporation but a non-resident foreign corporation,
then it is liable to Philippine income tax at the rate of thirty-five per cent
(35%) of its gross income received from all sources within the
Philippines.
Under Section 20 of the 1977 Tax Code:
(h) the term resident foreign corporation engaged in trade or business
within the Philippines or having an office or place of business therein.
(i) The term "non-resident foreign corporation" applies to a foreign
corporation not engaged in trade or business within the Philippines and
not having any office or place of business therein
It is our considered opinion that BOAC is a resident foreign corporation. There is no
specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business.
Each case must be judged in the light of its peculiar environmental circumstances. The
term implies a continuity of commercial dealings and arrangements, and contemplates, to
that extent, the performance of acts or works or the exercise of some of the functions
normally incident to, and in progressive prosecution of commercial gain or for the
purpose and object of the business organization. 2 "In order that a foreign corporation
may be regarded as doing business within a State, there must be continuity of conduct
and intention to establish a continuous business, such as the appointment of a local
agent, and not one of a temporary character. 3
BOAC, during the periods covered by the subject - assessments, maintained a general
sales agent in the Philippines, That general sales agent, from 1959 to 1971, "was
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of
trips — each trip in the series corresponding to a different airline company; (3) receiving
the fare from the whole trip; and (4) consequently allocating to the various airline
companies on the basis of their participation in the services rendered through the mode
of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA
Agreement." 4 Those activities were in exercise of the functions which are normally
incident to, and are in progressive pursuit of, the purpose and object of its organization
as an international air carrier. In fact, the regular sale of tickets, its main activity, is the
very lifeblood of the airline business, the generation of sales being the paramount
objective. There should be no doubt then that BOAC was "engaged in" business in the
Philippines through a local agent during the period covered by the assessments.
Accordingly, it is a resident foreign corporation subject to tax upon its total net income
received in the preceding taxable year from all sources within the Philippines. 5
Sec. 24. Rates of tax on corporations. — ...
(b) Tax on foreign corporations. — ...
(2) Resident corporations. — A corporation organized, authorized, or
existing under the laws of any foreign country, except a foreign fife
insurance company, 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. (Emphasis supplied)
Next, we address ourselves to the issue of whether or not the revenue from sales of
tickets by BOAC in the Philippines constitutes income from Philippine sources and,
accordingly, taxable under our income tax laws.
The Tax Code defines "gross income" thus:
"Gross income" includes gains, profits, and income derived from
salaries, wages or compensation for personal service of whatever kind
and in whatever form paid, or from profession, vocations,
trades, business, commerce, sales, or dealings in property, whether
real or personal, growing out of the ownership or use of or interest in
such property; also from interests, rents, dividends, securities, or
the transactions of any business carried on for gain or profile, or gains,
profits, and income derived from any source whatever (Sec. 29[3];
Emphasis supplied)
The definition is broad and comprehensive to include proceeds from sales of transport
documents. "The words 'income from any source whatever' disclose a legislative policy to
include all income not expressly exempted within the class of taxable income under our
laws." Income means "cash received or its equivalent"; it is the amount of money coming
to a person within a specific time ...; it means something distinct from principal or capital.
For, while capital is a fund, income is a flow. As used in our income tax law, "income"
refers to the flow of wealth. 6
The records show that the Philippine gross income of BOAC for the fiscal years 1968-69
to 1970-71 amounted to P10,428,368 .00. 7
Did such "flow of wealth" come from "sources within the Philippines",
The source of an income is the property, activity or service that produced the
income. 8 For the source of income to be considered as coming from the Philippines, it is
sufficient that the income is derived from activity within the Philippines. In BOAC's case,
the sale of tickets in the Philippines is the activity that produces the income. The tickets
exchanged hands here and payments for fares were also made here in Philippine
currency. The site of the source of payments is the Philippines. The flow of wealth
proceeded from, and occurred within, Philippine territory, enjoying the protection
accorded by the Philippine government. In consideration of such protection, the flow of
wealth should share the burden of supporting the government.
A transportation ticket is not a mere piece of paper. When issued by a common carrier, it
constitutes the contract between the ticket-holder and the carrier. It gives rise to the
obligation of the purchaser of the ticket to pay the fare and the corresponding obligation
of the carrier to transport the passenger upon the terms and conditions set forth thereon.
The ordinary ticket issued to members of the traveling public in general embraces within
its terms all the elements to constitute it a valid contract, binding upon the parties
entering into the relationship. 9
True, Section 37(a) of the Tax Code, which enumerates items of gross income from
sources within the Philippines, namely: (1) interest, (21) dividends, (3) service, (4) rentals
and royalties, (5) sale of real property, and (6) sale of personal property, does not
mention income from the sale of tickets for international transportation. However, that
does not render it less an income from sources within the Philippines. Section 37, by its
language, does not intend the enumeration to be exclusive. It merely directs that the
types of income listed therein be treated as income from sources within the Philippines. A
cursory reading of the section will show that it does not state that it is an all-inclusive
enumeration, and that no other kind of income may be so considered. " 10
BOAC, however, would impress upon this Court that income derived from transportation
is income for services, with the result that the place where the services are rendered
determines the source; and since BOAC's service of transportation is performed outside
the Philippines, the income derived is from sources without the Philippines and,
therefore, not taxable under our income tax laws. The Tax Court upholds that stand in
the joint Decision under review.
The absence of flight operations to and from the Philippines is not determinative of the
source of income or the site of income taxation. Admittedly, BOAC was an off-line
international airline at the time pertinent to this case. The test of taxability is the "source";
and the source of an income is that activity ... which produced the
income. 11 Unquestionably, the passage documentations in these cases were sold in the
Philippines and the revenue therefrom was derived from a activity regularly pursued
within the Philippines. business a And even if the BOAC tickets sold covered the
"transport of passengers and cargo to and from foreign cities", 12 it cannot alter the fact
that income from the sale of tickets was derived from the Philippines. The word "source"
conveys one essential idea, that of origin, and the origin of the income herein is the
Philippines. 13
It should be pointed out, however, that the assessments upheld herein apply only to the
fiscal years covered by the questioned deficiency income tax assessments in these
cases, or, from 1959 to 1967, 1968-69 to 1970-71. For, pursuant to Presidential Decree
No. 69, promulgated on 24 November, 1972, international carriers are now taxed as
follows:
... Provided, however, That international carriers shall pay a tax of 2-½
per cent on their cross Philippine billings. (Sec. 24[b] [21, Tax Code).
Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory
definition of the term "gross Philippine billings," thus:
... "Gross Philippine billings" includes 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. ...
The foregoing provision ensures that international airlines are taxed on their income from
Philippine sources. The 2-½ % tax on gross Philippine billings is an income tax. If it had
been intended as an excise or percentage tax it would have been place under Title V of
the Tax Code covering Taxes on Business.
Lastly, we find as untenable the BOAC argument that the dismissal for lack of merit by
this Court of the appeal in JAL vs. Commissioner of Internal Revenue (G.R. No. L-30041)
on February 3, 1969, is res judicata to the present case. The ruling by the Tax Court in
that case was to the effect that the mere sale of tickets, unaccompanied by the physical
act of carriage of transportation, does not render the taxpayer therein subject to the
common carrier's tax. As elucidated by the Tax Court, however, the common carrier's tax
is an excise tax, being a tax on the activity of transporting, conveying or removing
passengers and cargo from one place to another. It purports to tax the business of
transportation. 14 Being an excise tax, the same can be levied by the State only when
the acts, privileges or businesses are done or performed within the jurisdiction of the
Philippines. The subject matter of the case under consideration is income tax, a direct tax
on the income of persons and other entities "of whatever kind and in whatever form
derived from any source." Since the two cases treat of a different subject matter, the
decision in one cannot be res judicata to the other.
WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET
ASIDE. Private respondent, the British Overseas Airways Corporation (BOAC), is hereby
ordered to pay the amount of P534,132.08 as deficiency income tax for the fiscal years
1968-69 to 1970-71 plus 5% surcharge, and 1% monthly interest from April 16, 1972 for
a period not to exceed three (3) years in accordance with the Tax Code. The BOAC
claim for refund in the amount of P858,307.79 is hereby denied. Without costs.
SO ORDERED.
Paras, Gancayco, Padilla, Bidin, Sarmiento and Cortes, JJ., concur.
Fernan, J., took no part.
Separate Opinions
TEEHANKEE, C.J., concurring:
I concur with the Court's majority judgment upholding the assessments of deficiency
income taxes against respondent BOAC for the fiscal years 1959-1969 to 1970-1971 and
therefore setting aside the appealed joint decision of respondent Court of Tax Appeals. I
just wish to point out that the conflict between the majority opinion penned by Mr. Justice
Feliciano as to the proper characterization of the taxable income derived by respondent
BOAC from the sales in the Philippines of tickets foe BOAC form the issued by its
general sales agent in the Philippines gas become moot after November 24, 1972. Booth
opinions state that by amendment through P.D. No.69, promulgated on November 24,
1972, of section 24(b) (2) of the Tax Code providing dor the rate of income tax on foreign
corporations, international carriers such as respondent BOAC, have since then been
taxed at a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no
longer ant source of substantial conflict between the two opinions as to the present 2-½%
tax on their gross Philippine billings charged against such international carriers as herein
respondent foreign corporation.
FELICIANO, J., dissenting:
With great respect and reluctance, i record my dissent from the opinion of Mme. Justice
A.A. Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the
Court of Tax Appeals in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, is
correct and should be affirmed.
The fundamental issue raised in this petition for review is whether the British Overseas
Airways Corporation (BOAC), a foreign airline company which does not maintain any
flight operations to and from the Philippines, is liable for Philippine income taxation in
respect of "sales of air tickets" in the Philippines through a general sales agent, relating
to the carriage of passengers and cargo between two points both outside the Philippines.
1. The Solicitor General has defined as one of the issue in this case the question of:
2. Whether or not during the fiscal years in question 1 BOAC [was] a
resident foreign corporation doing business in the Philippines or [had]
an office or place of business in the Philippines.
It is important to note at the outset that the answer to the above-quoted issue is not
determinative of the lialibity of the BOAC to Philippine income taxation in respect of the
income here involved. The liability of BOAC to Philippine income taxation in respect of
such income depends, not on BOAC's status as a "resident foreign corporation" or
alternatively, as a "non-resident foreign corporation," but rather on whether or not such
income is derived from "source within the Philippines."
A "resident foreign corporation" or foreign corporation engaged in trade or business in
the Philippines or having an office or place of business in the Philippines is subject to
Philippine income taxation only in respect of income derived from sources within the
Philippines. Section 24 (b) (2) of the National Internal Revenue CODE ("Tax Code"), as
amended by Republic Act No. 2343, approved 20 June 1959, as it existed up to 3 August
1969, read as follows:
(2) Resident corporations. — A foreign corporation engaged in trade or
business with in the Philippines (expect foreign life insurance
companies) shall be taxable as provided in subsection (a) of this
section.
Section 24 (a) of the Tax Code in turn provides:
Rate of tax on corporations. — (a) Tax on domestic corporations. — ...
and a like tax shall be livied, collected, and paid annually upon the total
net income received in the preceeding taxable year from all sources
within the Philippines by every corporation organized, authorized, or
existing under the laws of any foreign country: ... . (Emphasis supplied)
Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when
it amended once more Section 24 (b) (2) of the Tax Code so as to read as follows:
(2) Resident Corporations. — A corporation, organized, authorized
or existing under the laws of any foreign counrty, except foreign life
insurance company, 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. (Emphasis supplied)
Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-
resident foreign corporations. Section 24 (b) (1) as amended by Republic Act No. 3825
approved 22 June 1963, read as follows:
(b) Tax on foreign corporations. — (1) Non-resident corporations. —
There shall be levied, collected and paid for each taxable year, in lieu
of the tax imposed by the preceding paragraph upon the amount
received by every foreign corporation not engaged in trade or business
within the Philippines, from all sources within the Philippines, as
interest, dividends, rents, salaries, wages, premium, annuities,
compensations, remunerations, emoluments, or other fixed or
determinative annual or periodical gains, profits and income a tax
equal to thirty per centum of such amount: provided, however, that
premiums shall not include reinsurance premiums. 2
Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and
therefore a resident foreign corporation, or not doing business in the Philippines and
therefore a non-resident foreign corporation, it is liable to income tax only to the extent
that it derives income from sources within the Philippines. The circumtances that a
foreign corporation is resident in the Philippines yields no inference that all or any part of
its income is Philippine source income. Similarly, the non-resident status of a foreign
corporation does not imply that it has no Philippine source income. Conversely, the
receipt of Philippine source income creates no presumption that the recipient foreign
corporation is a resident of the Philippines. The critical issue, for present purposes, is
therefore whether of not BOAC is deriving income from sources within the Philippines.
2. For purposes of income taxation, it is well to bear in mind that the "source of income"
relates not to the physical sourcing of a flow of money or the physical situs of
payment but rather to the "property, activity or service which produced the income."
In Howden and Co., Ltd. vs. Collector of Internal Revenue, 3 the court dealt with the issue
of the applicable source rule relating to reinsurance premiums paid by a local insurance
company to a foreign reinsurance company in respect of risks located in the Philippines.
The Court said:
The source of an income is the property, activity or services that
produced the income. The reinsurance premiums remitted to
appellants by virtue of the reinsurance contract, accordingly, had for
their source the undertaking to indemnify Commonwealth Insurance
Co. against liability. Said undertaking is the activity that produced the
 reinsurance premiums, and the same took place in the Philippines. —
[T]he reinsurance, the liabilities insured and the risk originally
underwritten by Commonwealth Insurance Co., upon which the
reinsurance premiums and indemnity were based, were all situated in
the Philippines. —4
The Court may be seen to be saying that it is the underlying prestation which is properly
regarded as the activity giving rise to the income that is sought to be taxed. In
the Howden case, that underlying prestation was theindemnification of the local
insurance company. Such indemnification could take place only in the Philippines where
the risks were located and where payment from the foreign reinsurance (in case the
casualty insured against occurs) would be received in Philippine pesos under the
reinsurance premiums paid by the local insurance companies constituted Philippine
source income of the foreign reinsurances.
The concept of "source of income" for purposes of income taxation originated in the
United States income tax system. The phrase "sources within the United States" was first
introduced into the U.S. tax system in 1916, and was subsequently embodied in the 1939
U.S. Tax Code. As is commonly known, our Tax Code (Commonwealth Act 466, as
amended) was patterned after the 1939 U.S. Tax Code. It therefore seems useful to refer
to a standard U.S. text on federal income taxation:
The Supreme Court has said, in a definition much quoted but often
debated, that income may be derived from three possible sources
only: (1) capital and/or (2) labor and/or (3) the sale of capital assets.
While the three elements of this attempt at definition need not be
accepted as all-inclusive, they serve as useful guides in any inquiry
into whether a particular item is from "source within the United States"
and suggest an investigation into the nature and location of the
activities or property which produce the income. If the income is from
labor (services) the place where the labor is done should be decisive; if
it is done in this counrty, the income should be from "source within the
United States." If the income is from capital, the place where the
capital is employed should be decisive; if it is employed in this country,
the income should be from "source within the United States". If the
income is from the sale of capital assets, the place where the sale is
made should be likewise decisive. Much confusion will be avoided by
regarding the term "source" in this fundamental light. It is not a place; it
is an activity or property. As such, it has a situs or location; and if that
situs or location is within the United States the resulting income is
taxable to nonresident aliens and foreign corporations. The intention of
Congress in the 1916 and subsequent statutes was to discard the
1909 and 1913 basis of taxing nonresident aliens and foreign
corporations and to make the test of taxability the "source", or situs of
the activities or property which produce the income . . . . Thus, if
income is to taxed, the recipient thereof must be resident within the
jurisdiction, or the property or activities out of which the income issue
or is derived must be situated within the jurisdiction so that the source
of the income may be said to have a situs in this country. The
underlying theory is that the consideration for taxation is protection of
life and propertyand that the income rightly to be levied upon to defray
the burdens of the United States Government is that income which is
created by activities and property protected by this Government or
obtained by persons enjoying that protection. 5
3. We turn now to the question what is the source of income rule applicable in the instant
case. There are two possibly relevant source of income rules that must be confronted; (a)
the source rule applicable in respect of contracts of service; and (b) the source rule
applicable in respect of sales of personal property.
Where a contract for the rendition of service is involved, the applicable source rule may
be simply stated as follows: the income is sourced in the place where the service
contracted for is rendered. Section 37 (a) (3) of our Tax Code reads as follows:
Section 37. Income for sources within the Philippines.
(a) Gross income from sources within the Philippines. — The following
items of gross income shall be treated as gross income from sources
within the Philippines:
xxx xxx xxx
(3) Services. — Compensation for labor or personal
services performed in the Philippines;... (Emphasis
supplied)
Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources
without the Philippines in the following manner:
(c) Gross income from sources without the Philippines. — The
following items of gross income shall be treated as income from
sources without the Philippines:
(3) Compensation for labor or personal services performed without the
Philippines; ... (Emphasis supplied)
It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only
in respect of services rendered by individual natural persons; they also apply to services
rendered by or through the medium of a juridical person. 6 Further, a contract of carriage
or of transportation is assimilated in our Tax Code and Revenue Regulations to a
contract for services. Thus, Section 37 (e) of the Tax Code provides as follows:
(e) Income form sources partly within and partly without the
Philippines. — Items of gross income, expenses, losses and
deductions, other than those specified in subsections (a) and (c) of this
section shall be allocated or apportioned to sources within or without
the Philippines, under the rules and regulations prescribed by the
Secretary of Finance. ... Gains, profits, and income
from (1) transportation or other services rendered partly within and
partly without the Philippines, or (2) from the sale of personnel property
produced (in whole or in part) by the taxpayer within and sold without
the Philippines, or produced (in whole or in part) by the taxpayer
 without and sold within the Philippines, shall be treated as derived
partly from sources within and partly from sources without the
Philippines. ... (Emphasis supplied)
It should be noted that the above underscored portion of Section 37 (e) was derived from
the 1939 U.S. Tax Code which "was based upon a recognition that transportation was a
service and that the source of the income derived therefrom was to be treated as being
the place where the service of transportation was rendered. 7
Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible,
implication that income derived from transportation or other services rendered entirely
outside the Philippines must be treated as derived entirely from sources without the
Philippines. This implication is reinforced by a consideration of certain provisions of
Revenue Regulations No. 2 entitled "Income Tax Regulations" as amended, first
promulgated by the Department of Finance on 10 February 1940. Section 155 of
Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part
as follows:
Section 155. Compensation for labor or personnel services. — Gross
income from sources within the Philippines includes compensation for
labor or personal services within the Philippines regardless of the
residence of the payer, of the place in which the contract for services
was made, or of the place of payment — (Emphasis supplied)
Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code)
deals with a particular species of foreign transportation companies — i.e.,
foreign steamship companies deriving income from sources partly within and partly
without the Philippines:
Section 163 Foreign steamship companies. — The return of foreign
steamship companies whose vessels touch parts of the
Philippines should include as gross income, the total receipts of all out-
going business whether freight or passengers. With the gross income
thus ascertained, the ratio existing between it and the gross income
from all ports, both within and without the Philippines of all vessels,
whether touching of the Philippines or not, should be determined as
the basis upon which allowable deductions may be computed, — .
(Emphasis supplied)
Another type of utility or service enterprise is dealt with in Section 164 of Revenue
Regulations No. 2 (again implementing Section 37 of the Tax Code) with provides as
follows:
Section 164. Telegraph and cable services. — A foreign corporation
carrying on the business of transmission of telegraph or cable
messages between points in the Philippines and points outside the
Philippines derives income partly form source within and partly from
sources without the Philippines.
... (Emphasis supplied)
Once more, a very strong inference arises under Sections 163 and 164 of Revenue
Regulations No. 2 that steamship and telegraph and cable services rendered between
points both outside the Philippines give rise to income wholly from sources outside the
Philippines, and therefore not subject to Philippine income taxation.
We turn to the "source of income" rules relating to the sale of personal property, upon the
one hand, and to the purchase and sale of personal property, upon the other hand.
We consider first sales of personal property. Income from the sale of personal property
by the producer or manufacturer of such personal property will be regarded as
sourced entirely within or entirely without the Philippines or as sourced partly within and
partly without the Philippines, depending upon two factors: (a) the place where the sale
of such personal property occurs; and (b) the place where such personal property was
produced or manufactured. If the personal property involved was both produced or
manufactured and sold outside the Philippines, the income derived therefrom will be
regarded as sourced entirely outside the Philippines, although the personal property had
been produced outside the Philippines, or if the sale of the property takes place outside
the Philippines and the personal was produced in the Philippines, then, the income
derived from the sale will be deemed partly as income sourced without the Philippines. In
other words, the income (and the related expenses, losses and deductions) will be
allocated between sources within and sources without the Philippines. Thus, Section 37
(e) of the Tax Code, although already quoted above, may be usefully quoted again:
(e) Income from sources partly within and partly without the
Philippines. ... Gains, profits and income from (1) transportation or
other services rendered partly within and partly without the Philippines;
or (2) from the sale of personal property produced (in whole or in part)
by the taxpayer within and sold without the Philippines, or produced (in
whole or in part) by the taxpayer without and sold within the
Philippines, shall be treated as derived partly from sources within and
partly from sources without the Philippines. ... (Emphasis supplied)
In contrast, income derived from the purchase and sale of personal property — i. e.,
trading — is, under the Tax Code, regarded as sourced wholly in the place where the
personal property is sold. Section 37 (e) of the Tax Code provides in part as follows:
(e) Income from sources partly within and partly without the Philippines
... Gains, profits and income derived from the purchase of personal
property within and its sale without the Philippines or from the
purchase of personal property without and its sale within the
Philippines, shall be treated as derived entirely from sources within the
country in which sold. (Emphasis supplied)
Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:
Section 159. Sale of personal property. Income derived from the
purchase and sale of personal property shall be treated as derived
entirely from the country in which sold. The word "sold" includes
"exchange." The "country" in which "sold" ordinarily means the place
where the property is marketed. This Section does not apply to income
from the sale personal property produced (in whole or in part) by the
taxpayer within and sold without the Philippines or produced (in whole
 or in part) by the taxpayer without and sold within the Philippines. (See
Section 162 of these regulations). (Emphasis supplied)
4. It will be seen that the basic problem is one of characterization of the transactions
entered into by BOAC in the Philippines. Those transactions may be characterized either
as sales of personal property (i. e., "sales of airline tickets") or as entering into a lease of
services or a contract of service or carriage. The applicable "source of income" rules
differ depending upon which characterization is given to the BOAC transactions.
The appropriate characterization, in my opinion, of the BOAC transactions is that of
entering into contracts of service, i.e., carriage of passengers or cargo between points
located outside the Philippines.
The phrase "sale of airline tickets," while widely used in popular parlance, does not
appear to be correct as a matter of tax law. The airline ticket in and of itself has no
monetary value, even as scrap paper. The value of the ticket lies wholly in the right
acquired by the "purchaser" — the passenger — to demand a prestation from BOAC,
which prestation consists of the carriage of the "purchaser" or passenger from the one
point to another outside the Philippines. The ticket is really the evidence of the contract of
carriage entered into between BOAC and the passenger. The money paid by the
passenger changes hands in the Philippines. But the passenger does not receive
undertaken to be delivered by BOAC. The "purchase price of the airline ticket" is quite
different from the purchase price of a physical good or commodity such as a pair of
shoes of a refrigerator or an automobile; it is really the compensation paid for the
undertaking of BOAC to transport the passenger or cargo outside the Philippines.
The characterization of the BOAC transactions either as sales of personal property or as
purchases and sales of personal property, appear entirely inappropriate from other
viewpoint. Consider first purchases and sales: is BOAC properly regarded as engaged in
trading — in the purchase and sale of personal property? Certainly, BOAC was not
purchasing tickets outside the Philippines and selling them in the Philippines. Consider
next sales: can BOAC be regarded as "selling" personal property produced or
manufactured by it? In a popular or journalistic sense, BOAC might be described as
"selling" "a product" — its service. However, for the technical purposes of the law on
income taxation, BOAC is in fact entering into contracts of service or carriage. The very
existance of "source rules" specifically and precisely applicable to the rendition of
services must preclude the application here of "source rules" applying generally to sales,
and purchases and sales, of personal property which can be invoked only by the grace of
popular language. On a slighty more abstract level, BOAC's income is more
appropriately characterized as derived from a "service", rather than from an "activity" (a
broader term than service and including the activity of selling) or from the here involved
is income taxation, and not a sales tax or an excise or privilege tax.
5. The taxation of international carriers is today effected under Section 24 (b) (2) of the
Tax Code, as amended by Presidential Decree No. 69, promulgated on 24 November
1972 and by Presidential Decree No. 1355, promulgated on 21 April 1978, in the
following manner:
(2) Resident corporations. — A corporation organized, authorized, or
existing under the laws of any 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
preceeding taxable year from all sources within the
Philippines: Provided, however, That international carriers shall pay a
tax of two and one-half per cent on their gross Philippine
billings. "Gross Philippines of passage documents sold therein,
whether for passenger, excess baggege or mail, provide the cargo or
mail originates from the Philippines. The gross revenue realized from
the said cargo or mail shall include the gross freight charge up to final
destination. Gross revenues from chartered flights originating from the
Philippines shall likewise form part of "gross Philippine billings"
regardless of the place of sale or payment of the passage documents.
For purposes of determining the taxability to revenues from chartered
flights, the term "originating from the Philippines" shall include flight of
passsengers who stay in the Philippines for more than forty-eight (48)
hours prior to embarkation. (Emphasis supplied)
Under the above-quoted proviso international carriers issuing for compensation passage
documentation in the Philippines for uplifts from any point in the world to any other point
in the world, are not charged any Philippine income tax on their Philippine billings (i.e.,
billings in respect of passenger or cargo originating from the Philippines). Under this new
approach, international carriers who service port or points in the Philippines are treated in
exactly the same way as international carriers not serving any port or point in the
Philippines. Thus, the source of income rule applicable, as above discussed, to
transportation or other services rendered partly within and partly without the Philippines,
or wholly without the Philippines, has been set aside. in place of Philippine income
taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of
billings in respect of passengers and cargo originating from the Philippines regardless of
where embarkation and debarkation would be taking place. This 2-½ per cent tax is
effectively a tax on gross receipts or an excise or privilege tax and not a tax on income.
Thereby, the Government has done away with the difficulties attending the allocation of
income and related expenses, losses and deductions. Because taxes are the very
lifeblood of government, the resulting potential "loss" or "gain" in the amount of taxes
collectible by the state is sometimes, with varying degrees of consciousness, considered
in choosing from among competing possible characterizations under or interpretation of
tax statutes. It is hence perhaps useful to point out that the determination of the
appropriate characterization here — that of contracts of air carriage rather than sales of
airline tickets — entails no down-the-road loss of income tax revenues to the
Government. In lieu thereof, the Government takes in revenues generated by the 2-½ per
cent tax on the gross Philippine billings or receipts of international carriers.
I would vote to affirm the decision of the Court of Tax Appeals.
G.R. No. L-54108 January 17, 1984
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
COURT OF TAX APPEALS and SMITH KLINE & FRENCH OVERSEAS CO.
(PHILIPPINE BRANCH), respondents.
The Solicitor General for petitioner.
Siguion Reyna, Montecillo & Ongsiako and J.C. Castañeda, Jr. and E.C. Alcantara for
respondents.

AQUINO, J.:
This case is about the refund of a 1971 income tax amounting to P324,255. Smith Kline
and French Overseas Company, a multinational firm domiciled in Philadelphia,
Pennsylvania, is licensed to do business in the Philippines. It is engaged in the
importation, manufacture and sale of pharmaceuticals drugs and chemicals.
In its 1971 original income tax return, Smith Kline declared a net taxable income of
P1,489,277 (Exh. A) and paid P511,247 as tax due. Among the deductions claimed from
gross income was P501,040 ($77,060) as its share of the head office overhead
expenses. However, in its amended return filed on March 1, 1973, there was an
overpayment of P324,255 "arising from underdeduction of home office overhead" (Exh.
E). It made a formal claim for the refund of the alleged overpayment.
It appears that sometime in October, 1972, Smith Kline received from its international
independent auditors, Peat, Marwick, Mitchell and Company, an authenticated
certification to the effect that the Philippine share in the unallocated overhead expenses
of the main office for the year ended December 31, 1971 was actually $219,547
(P1,427,484). It further stated in the certification that the allocation was made on the
basis of the percentage of gross income in the Philippines to gross income of the
corporation as a whole. By reason of the new adjustment, Smith Kline's tax liability was
greatly reduced from P511,247 to P186,992 resulting in an overpayment of P324,255.
On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on
its claim Smith Kline filed a petition for review with the Court of Tax Appeals.
In its decision of March 21, 1980, the Tax Court ordered the Commissioner to refund the
overpayment or grant a tax credit to Smith Kline. The Commissioner appealed to this
Court.
The governing law is found in section 37 of the old National Internal Revenue Code,
Commonwealth Act No. 466, which is reproduced in Presidential Decree No. 1158, the
National Internal Revenue Code of 1977 and which reads:
SEC. 37. Income form sources within the Philippines. —
xxx xxx xxx
(b) Net income from sources in the Philippines. — From the items of
gross income specified in subsection (a) of this section there shall be
deducted the expenses, losses, and other deductions properly
apportioned or allocated thereto and a ratable part of any expenses,
losses, or other deductions which cannot definitely be allocated to
some item or class of gross income. The remainder, if any, shall be
included in full as net income from sources within the Philippines.
xxx xxx xxx
Revenue Regulations No. 2 of the Department of Finance contains the following
provisions on the deductions to be made to determine the net income from Philippine
sources:
SEC. 160. Apportionment of deductions. — From the items specified in
section 37(a), as being derived specifically from sources within the
Philippines there shall be deducted the expenses, losses, and other
deductions properly apportioned or allocated thereto and a ratable part
of any other expenses, losses or deductions which can not definitely
be allocated to some item or class of gross income. The remainder
shall be included in full as net income from sources within the
Philippines. The ratable part is based upon the ratio of gross income
from sources within the Philippines to the total gross income.
Example: A non-resident alien individual whose taxable year is the
calendar year, derived gross income from all sources for 1939 of
P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of a domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000
Total P36,000
that is, one-fifth of the total gross income was from sources within the
Philippines. The remainder of the gross income was from sources
without the Philippines, determined under section 37(c).
The expenses of the taxpayer for the year amounted to P78,000. Of
these expenses the amount of P8,000 is properly allocated to income
from sources within the Philippines and the amount of P40,000 is
properly allocated to income from sources without the Philippines.
The remainder of the expense, P30,000, cannot be definitely allocated
to any class of income. A ratable part thereof, based upon the relation
of gross income from sources within the Philippines to the total gross
income, shall be deducted in computing net income from sources
within the Philippines. Thus, these are deducted from the P36,000 of
gross income from sources within the Philippines expenses amounting
to P14,000 [representing P8,000 properly apportioned to the income
from sources within the Philippines and P6,000, a ratable part (one-
fifth) of the expenses which could not be allocated to any item or class
of gross income.] The remainder, P22,000, is the net income from
sources within the Philippines.
From the foregoing provisions, it is manifest that where an expense is clearly related to
the production of Philippine-derived income or to Philippine operations (e.g. salaries of
Philippine personnel, rental of office building in the Philippines), that expense can be
deducted from the gross income acquired in the Philippines without resorting to
apportionment.
The overhead expenses incurred by the parent company in connection with finance,
administration, and research and development, all of which direct benefit its branches all
over the world, including the Philippines, fall under a different category however. These
are items which cannot be definitely allocated or Identified with the operations of the
Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under
section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can
claim as its deductible share a ratable part of such expenses based upon the ratio of the
local branch's gross income to the total gross income, worldwide, of the multinational
corporation.
In his petition for review, the Commissioner does not dispute the right of Smith Kline to
avail itself of section 37(b) of the Tax Code and section 160 of the regulations. But the
Commissioner maintains that such right is not absolute and that as there exists a
contract (in this case a service agreement) which Smith Kline has entered into with its
home office, prescribing the amount that a branch can deduct as its share of the main
office's overhead expenses, that contract is binding.
The Commissioner contends that since the share of the Philippine branch has been fixed
at $77,060, Smith Kline itself cannot claim more than the said amount. To allow Smith
Kline to deduct more than what was expressly provided in the agreement would be to
ignore its existence. It is a cardinal rule that a contract is the law between the contracting
parties and the stipulations therein must be respected unless these are proved to be
contrary to law, morals, good customs and public policy. There being allegedly no
showing to the contrary, the provisions thereof must be followed.
The Commissioner also argues that the Tax Court erred in relying on the certification of
Peat, Marwick, Mitchell and Company that Smith Kline is entitled to deduct P1,427,484
($219,547) as its allotted share and that Smith Kline has not presented any evidence to
show that the home office expenses chargeable to Philippine operations exceeded
$77,060.
On the other hand, Smith Kline submits that the contract between itself and its home
office cannot amend tax laws and regulations. The matter of allocated expenses which
are deductible under the law cannot be the subject of an agreement between private
parties nor can the Commissioner acquiesce in such an agreement.
Smith Kline had to amend its return because it is of common knowledge that audited
financial statements are generally completed three or four months after the close of the
accounting period. There being no financial statements yet when the certification of
January 11, 1972 was made the treasurer could not have correctly computed Smith
Kline's share in the home office overhead expenses in accordance with the gross income
formula prescribed in section 160 of the Revenue Regulations. What the treasurer
certified was a mere estimate.
Smith Kline likewise submits that it has presented ample evidence to support its claim for
refund. To this end, it has presented before the Tax Court the authenticated statement of
Peat, Marwick, Mitchell and Company to show that since the gross income of the
Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit report prepared by
Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole
was $6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses
was P1,427,484 ($219,547) (Exh. G to G-2, BIR Records, 4-5).
Clearly, the weight of evidence bolsters its position that the amount of P1,427,484
represents the correct ratable share, the same having been computed pursuant to
section 37(b) and section 160.
In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share
of the head office overhead expenses in its income tax returns for the years 1973 to
1981, it deducted its ratable share of the total overhead expenses of its head office for
those years as computed by the independent auditors hired by the parent company in
Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to
it.
We hold that Smith Kline's amended 1971 return is in conformity with the law and
regulations. The Tax Court correctly held that the refund or credit of the resulting
overpayment is in order.
WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.
SO ORDERED
Makasiar (Chairman), Concepcion, Jr., Guerrero, De Castro and Escolin, JJ., concur.
Abad Santos, J., took no part.
[CTA CASE PHILAM LIFE]
G.R. No. 137377 December 18, 2001
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MARUBENI CORPORATION, respondent.
PUNO, J.:
In this petition for review, the Commissioner of Internal Revenue assails the decision
dated January 15, 1999 of the Court of Appeals in CA-G.R. SP No. 42518 which affirmed
the decision dated July 29, 1996 of the Court of Tax Appeals in CTA Case No. 4109. The
tax court ordered the Commissioner of Internal Revenue to desist from collecting the
1985 deficiency income, branch profit remittance and contractor's taxes from Marubeni
Corporation after finding the latter to have properly availed of the tax amnesty under
Executive Orders Nos. 41 and 64, as amended.
Respondent Marubeni Corporation is a foreign corporation organized and existing under
the laws of Japan. It is engaged in general import and export trading, financing and the
construction business. It is duly registered to engage in such business in the Philippines Contractor's tax due thereon (4%) 38,690,792.00
and maintains a branch office in Manila.
Add: 50% surcharge for non-declaration 19,345,396.00
20% surcharge for late payment 9,672,698.00
Sometime in November 1985, petitioner Commissioner of Internal Revenue issued a
letter of authority to examine the books of accounts of the Manila branch office of Sub-total 67,708,886.00
respondent corporation for the fiscal year ending March 1985. In the course of the Add: 20% int. p.a.fr. 4-21-85 to 8-15-86 17,854,739.46
examination, petitioner found respondent to have undeclared income from two (2) TOTAL AMOUNT DUE P85,563,625.46
contracts in the Philippines, both of which were completed in 1984. One of the contracts
IV. DEFICIENCY COMMERCIAL BROKER'S TAX
was with the National Development Company (NDC) in connection with the construction
and installation of a wharf/port complex at the Leyte Industrial Development Estate in the FY ended March 31, 1985
municipality of Isabel, province of Leyte. The other contract was with the Philippine Undeclared share from commission income
Phosphate Fertilizer Corporation (Philphos) for the construction of an ammonia storage (denominated as "subsidy from Home Office") P24,683,114.50
complex also at the Leyte Industrial Development Estate. Tax due thereon 1,628,569.00
Add: 50% surcharge for non-declaration 814,284.50
On March 1, 1986, petitioner's revenue examiners recommended an assessment for
deficiency income, branch profit remittance, contractor's and commercial broker's taxes. 20% surcharge for late payment 407,142.25
Respondent questioned this assessment in a letter dated June 5, 1986. Sub-total 2,849,995.75
Add: 20% int. p.a.fr. 4-21-85 to 8-15-86 751,539.98
On August 27, 1986, respondent corporation received a letter dated August 15, 1986 TOTAL AMOUNT DUE P3,600,535.68
from petitioner assessing respondent several deficiency taxes. The assessed deficiency
internal revenue taxes, inclusive of surcharge and interest, were as follows:
The 50% surcharge was imposed for your client's failure to report for tax purposes the
aforesaid taxable revenues while the 25% surcharge was imposed because of your
I. DEFICIENCY INCOME TAX client's failure to pay on time the above deficiency percentage taxes.
FY ended March 31, 1985
Undeclared gross income (Philphos and NDC xxx xxx xxx"1
construction projects) P967,269,811.14
Less: Cost and expenses (50%) 483,634,905.57 Petitioner found that the NDC and Philphos contracts were made on a "turn-key" basis
Net undeclared income 483,634,905.57 and that the gross income from the two projects amounted to P967,269,811.14. Each
contract was for a piece of work and since the projects called for the construction and
Income tax due thereon 169,272,217.00 installation of facilities in the Philippines, the entire income therefrom constituted income
Add: 50% surcharge 84,636,108.50 from Philippine sources, hence, subject to internal revenue taxes. The assessment letter
20% int. p.a.fr. 7-15-85 to 8-15-86 36,675,646.90 further stated that the same was petitioner's final decision and that if respondent
disagreed with it, respondent may file an appeal with the Court of Tax Appeals within
TOTAL AMOUNT DUE P290,583,972.40
thirty (30) days from receipt of the assessment.
II. DEFICIENCY BRANCH PROFIT REMITTANCE TAX
FY ended March 31, 1985 On September 26, 1986, respondent filed two (2) petitions for review with the Court of
Undeclared gross income from Philphos and NDC Tax Appeals. The first petition, CTA Case No. 4109, questioned the deficiency income,
construction projects P483,634,905.57 branch profit remittance and contractor's tax assessments in petitioner's assessment
Less: Income tax thereon 169,272,217.00 letter. The second, CTA Case No. 4110, questioned the deficiency commercial broker's
assessment in the same letter.
Amount subject to Tax 314,362,688.57
Tax due thereon 47,154,403.00
Earlier, on August 2, 1986, Executive Order (E.O.) No. 412 declaring a one-time amnesty
Add: 50% surcharge 23,577,201.50 covering unpaid income taxes for the years 1981 to 1985 was issued. Under this E.O., a
20% int. p.a.fr. 4-26-85 to 8-15-86 12,305,360.66 taxpayer who wished to avail of the income tax amnesty should, on or before October 31,
TOTAL AMOUNT DUE P83,036,965.16 1986: (a) file a sworn statement declaring his net worth as of December 31, 1985; (b) file
a certified true copy of his statement declaring his net worth as of December 31, 1980 on
III. DEFICIENCY CONTRACTOR'S TAX record with the Bureau of Internal Revenue (BIR), or if no such record exists, file a
FY ended March 31, 1985 statement of said net worth subject to verification by the BIR; and (c) file a return and pay
Undeclared gross receipts/gross income from a tax equivalent to ten per cent (10%) of the increase in net worth from December 31,
Philphos and NDC construction projects P967,269,811.14 1980 to December 31, 1985.
In accordance with the terms of E.O. No. 41, respondent filed its tax amnesty return
dated October 30, 1986 and attached thereto its sworn statement of assets and liabilities
and net worth as of Fiscal Year (FY) 1981 and FY 1986. The return was received by the
BIR on November 3, 1986 and respondent paid the amount of P2,891,273.00 equivalent
to ten percent (10%) of its net worth increase between 1981 and 1986.
The period of the amnesty in E.O. No. 41 was later extended from October 31, 1986 to
December 5, 1986 by E.O. No. 54 dated November 4, 1986.
On November 17, 1986, the scope and coverage of E.O. No. 41 was expanded by
Executive Order (E.O.) No. 64. In addition to the income tax amnesty granted by E.O.
No. 41 for the years 1981 to 1985, E.O. No. 64 3 included estate and donor's taxes
under Title III and the tax on business under Chapter II, Title V of the National Internal
Revenue Code, also covering the years 1981 to 1985. E.O. No. 64 further provided that
the immunities and privileges under E.O. No. 41 were extended to the foregoing tax
liabilities, and the period within which the taxpayer could avail of the amnesty was
extended to December 15, 1986. Those taxpayers who already filed their amnesty return
under E.O. No. 41, as amended, could avail themselves of the benefits, immunities and
privileges under the new E.O. by filing an amended return and paying an additional 5%
on the increase in net worth to cover business, estate and donor's tax liabilities.
The period of amnesty under E.O. No. 64 was extended to January 31, 1987 by E.O No.
95 dated December 17, 1986.
On December 15, 1986, respondent filed a supplemental tax amnesty return under the
benefit of E.O. No. 64 and paid a further amount of P1,445,637.00 to the BIR equivalent
to five percent (5%) of the increase of its net worth between 1981 and 1986.
On July 29, 1996, almost ten (10) years after filing of the case, the Court of Tax Appeals
rendered a decision in CTA Case No. 4109. The tax court found that respondent had
properly availed of the tax amnesty under E.O. Nos. 41 and 64 and declared the
deficiency taxes subject of said case as deemed cancelled and withdrawn. The Court of
Tax Appeals disposed of as follows:
"WHEREFORE, the respondent Commissioner of Internal Revenue is hereby
ORDERED to DESIST from collecting the 1985 deficiency taxes it had
assessed against petitioner and the same are deemed considered [sic]
CANCELLED and WITHDRAWN by reason of the proper availment by petitioner
of the amnesty under Executive Order No. 41, as amended."4
Petitioner challenged the decision of the tax court by filing CA-G.R. SP No. 42518 with
the Court of Appeals.
On January 15, 1999, the Court of Appeals dismissed the petition and affirmed the
decision of the Court of Tax Appeals. Hence, this recourse.
Before us, petitioner raises the following issues:
"(1) Whether or not the Court of Appeals erred in affirming the Decision of the
Court of Tax Appeals which ruled that herein respondent's deficiency tax
liabilities were extinguished upon respondent's availment of tax amnesty under
Executive Orders Nos. 41 and 64.
(2) Whether or not respondent is liable to pay the income, branch profit
remittance, and contractor's taxes assessed by petitioner." 5
The main controversy in this case lies in the interpretation of the exception to the
amnesty coverage of E.O. Nos. 41 and 64. There are three (3) types of taxes involved
herein — income tax, branch profit remittance tax and contractor's tax. These taxes are
covered by the amnesties granted by E.O. Nos. 41 and 64. Petitioner claims, however,
that respondent is disqualified from availing of the said amnesties because the latter falls
under the exception in Section 4 (b) of E.O. No. 41.
Section 4 of E.O. No. 41 enumerates which taxpayers cannot avail of the amnesty
granted thereunder, viz:
"Sec. 4. Exceptions. — The following taxpayers may not avail themselves of the
amnesty herein granted:
a) Those falling under the provisions of Executive Order Nos. 1, 2 and 14;
b) Those with income tax cases already filed in Court as of the effectivity hereof;
c) Those with criminal cases involving violations of the income tax law already
filed in court as of the effectivity hereof;
d) Those that have withholding tax liabilities under the National Internal
Revenue Code, as amended, insofar as the said liabilities are concerned;
e) Those with tax cases pending investigation by the Bureau of Internal
Revenue as of the effectivity hereof as a result of information furnished under
Section 316 of the National Internal Revenue Code, as amended;
f) Those with pending cases involving unexplained or unlawfully acquired wealth
before the Sandiganbayan;
g) Those liable under Title Seven, Chapter Three (Frauds, Illegal Exactions and
Transactions) and Chapter Four (Malversation of Public Funds and Property) of
the Revised Penal Code, as amended."
Petitioner argues that at the time respondent filed for income tax amnesty on October 30,
1986, CTA Case No. 4109 had already been filed and was pending; before the Court of
Tax Appeals. Respondent therefore fell under the exception in Section 4 (b) of E.O. No.
41.
Petitioner's claim cannot be sustained. Section 4 (b) of E.O. No. 41 is very clear and
unambiguous. It excepts from income tax amnesty those taxpayers "with income tax
cases already filed in court as of the effectivity hereof." The point of reference is the date
of effectivity of E.O. No. 41. The filing of income tax cases in court must have been made
before and as of the date of effectivity of E.O. No. 41. Thus, for a taxpayer not to be
disqualified under Section 4 (b) there must have been no income tax cases filed in court
against him when E.O. No. 41 took effect. This is regardless of when the taxpayer filed
for income tax amnesty, provided of course he files it on or before the deadline for filing.
E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioning the 1985
deficiency income, branch profit remittance and contractor's tax assessments was filed
by respondent with the Court of Tax Appeals on September 26, 1986. When E.O. No. 41
became effective on August 22, 1986, CTA Case No. 4109 had not yet been filed in
court. Respondent corporation did not fall under the said exception in Section 4 (b),
hence, respondent was not disqualified from availing of the amnesty for income tax under
E.O. No. 41.
The same ruling also applies to the deficiency branch profit remittance tax assessment. A
branch profit remittance tax is defined and imposed in Section 24 (b) (2) (ii), Title II,
Chapter III of the National Internal Revenue Code.6 In the tax code, this tax falls under
Title II on Income Tax. It is a tax on income. Respondent therefore did not fall under the
exception in Section 4 (b) when it filed for amnesty of its deficiency branch profit
remittance tax assessment.
The difficulty herein is with respect to the contractor's tax assessment and respondent's
availment of the amnesty under E.O. No. 64. E.O. No. 64 expanded the coverage of E.O.
No. 41 by including estate and donor's taxes and tax on business. Estate and donor's
taxes fall under Title III of the Tax Code while business taxes fall under Chapter II, Title V
of the same. The contractor's tax is provided in Section 205, Chapter II, Title V of the Tax
Code; it is defined and imposed under the title on business taxes, and is therefore a tax
on business.7
When E.O. No. 64 took effect on November 17, 1986, it did not provide for exceptions to
the coverage of the amnesty for business, estate and donor's taxes. Instead, Section 8 of
E.O. No. 64 provided that:
"Section 8. The provisions of Executive Orders Nos. 41 and 54 which are not
contrary to or inconsistent with this amendatory Executive Order shall remain in
full force and effect."
By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 not contrary to or
inconsistent with the amendatory act were reenacted in E.O. No. 64. Thus, Section 4 of
E.O. No. 41 on the exceptions to amnesty coverage also applied to E.O. No. 64. With
respect to Section 4 (b) in particular, this provision excepts from tax amnesty coverage a
taxpayer who has "income tax cases already filed in court as of the effectivity hereof." As
to what Executive Order the exception refers to, respondent argues that because of the
words "income" and "hereof," they refer to Executive Order No. 41.8
In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot be construed
to refer to E.O. No. 41 and its date of effectivity. The general rule is that an amendatory
act operates prospectively.9 While an amendment is generally construed as becoming a
part of the original act as if it had always been contained therein, 10 it may not be given a
retroactive effect unless it is so provided expressly or by necessary implication and no
vested right or obligations of contract are thereby impaired. 11
There is nothing in E.O. No. 64 that provides that it should retroact to the date of
effectivity of E.O. No. 41, the original issuance. Neither is it necessarily implied from E.O.
No. 64 that it or any of its provisions should apply retroactively. Executive Order No. 64 is
a substantive amendment of E.O. No. 41. It does not merely change provisions in E.O.
No. 41. It supplements the original act by adding other taxes not covered in the first. 12 It
has been held that where a statute amending a tax law is silent as to whether it operates
retroactively, the amendment will not be given a retroactive effect so as to subject to tax
past transactions not subject to tax under the original act. 13 In an amendatory act, every
case of doubt must be resolved against its retroactive effect.14
Moreover, E.O. Nos. 41 and 64 are tax amnesty issuances. A tax amnesty is a general
pardon or intentional overlooking by the State of its authority to impose penalties on
persons otherwise guilty of evasion or violation of a revenue or tax law. 15 It partakes of
an absolute forgiveness or waiver by the government of its right to collect what is due it
and to give tax evaders who wish to relent a chance to start with a clean slate. 16 A tax
amnesty, much like a tax exemption, is never favored nor presumed in law.17 If granted,
the terms of the amnesty, like that of a tax exemption, must be construed strictly against
the taxpayer and liberally in favor of the taxing authority. 18 For the right of taxation is
inherent in government. The State cannot strip itself of the most essential power of
taxation by doubtful words. He who claims an exemption (or an amnesty) from the
common burden must justify his claim by the clearest grant of organic or state law. It
cannot be allowed to exist upon a vague implication. If a doubt arises as to the intent of
the legislature, that doubt must be resolved in favor of the state. 19
In the instant case, the vagueness in Section 4 (b) brought about by E.O. No. 64 should
therefore be construed strictly against the taxpayer. The term "income tax cases" should
be read as to refer to estate and donor's taxes and taxes on business while the word
"hereof," to E.O. No. 64. Since Executive Order No. 64 took effect on November 17,
1986, consequently, insofar as the taxes in E.O. No. 64 are concerned, the date of
effectivity referred to in Section 4 (b) of E.O. No. 41 should be November 17, 1986.
Respondent filed CTA Case No. 4109 on September 26, 1986. When E.O. No. 64 took
effect on November 17, 1986, CTA Case No. 4109 was already filed and pending in
court. By the time respondent filed its supplementary tax amnesty return on December
15, 1986, respondent already fell under the exception in Section 4 (b) of E.O. Nos. 41
and 64 and was disqualified from availing of the business tax amnesty granted therein.
It is respondent's other argument that assuming it did not validly avail of the amnesty
under the two Executive Orders, it is still not liable for the deficiency contractor's tax
because the income from the projects came from the "Offshore Portion" of the contracts.
The two contracts were divided into two parts, i.e., the Onshore Portion and the Offshore
Portion. All materials and equipment in the contract under the "Offshore Portion" were
manufactured and completed in Japan, not in the Philippines, and are therefore not
subject to Philippine taxes.
Before going into respondent's arguments, it is necessary to discuss the background of
the two contracts, examine their pertinent provisions and implementation.
The NDC and Philphos are two government corporations. In 1980, the NDC, as the
corporate investment arm of the Philippine Government, established the Philphos to
engage in the large-scale manufacture of phosphatic fertilizer for the local and foreign
markets.20 The Philphos plant complex which was envisioned to be the largest
phosphatic fertilizer operation in Asia, and among the largest in the world, covered an
area of 180 hectares within the 435-hectare Leyte Industrial Development Estate in the
municipality of Isabel, province of Leyte.
In 1982, the NDC opened for public bidding a project to construct and install a modern,
reliable, efficient and integrated wharf/port complex at the Leyte Industrial Development
Estate. The wharf/port complex was intended to be one of the major facilities for the
industrial plants at the Leyte Industrial Development Estate. It was to be specifically
adapted to the site for the handling of phosphate rock, bagged or bulk fertilizer products,
liquid materials and other products of Philphos, the Philippine Associated Smelting and
Refining Corporation (Pasar),21 and other industrial plants within the Estate. The bidding
was participated in by Marubeni Head Office in Japan.
Marubeni, Japan pre-qualified and on March 22, 1982, the NDC and respondent entered
into an agreement entitled "Turn-Key Contract for Leyte Industrial Estate Port
Development Project Between National Development Company and Marubeni
Corporation."22 The Port Development Project would consist of a wharf, berths,
causeways, mechanical and liquids unloading and loading systems, fuel oil depot, utilities
systems, storage and service buildings, offsite facilities, harbor service vessels,
navigational aid system, fire-fighting system, area lighting, mobile equipment, spare parts
and other related facilities.23 The scope of the works under the contract covered turn-key
supply, which included grants of licenses and the transfer of technology and know-
how,24 and:
". . . the design and engineering, supply and delivery, construction, erection and
installation, supervision, direction and control of testing and commissioning of
the Wharf-Port Complex as set forth in Annex I of this Contract, as well as the
coordination of tie-ins at boundaries and schedule of the use of a part or the
whole of the Wharf/Port Complex through the Owner, with the design and
construction of other facilities around the site. The scope of works shall also
include any activity, work and supply necessary for, incidental to or appropriate
under present international industrial port practice, for the timely and successful
implementation of the object of this Contract, whether or not expressly referred
to in the abovementioned Annex I."25
The contract price for the wharf/port complex was ¥12,790,389,000.00 and
P44,327,940.00. In the contract, the price in Japanese currency was broken down into
two portions: (1) the Japanese Yen Portion I; (2) the Japanese Yen Portion II, while the
price in Philippine currency was referred to as the Philippine Pesos Portion. The
Japanese Yen Portions I and II were financed in two (2) ways: (a) by yen credit loan
provided by the Overseas Economic Cooperation Fund (OECF); and (b) by supplier's
credit in favor of Marubeni from the Export-Import Bank of Japan. The OECF is a Fund
under the Ministry of Finance of Japan extended by the Japanese government as
assistance to foreign governments to promote economic development. 26 The OECF
extended to the Philippine Government a loan of ¥7,560,000,000.00 for the Leyte
Industrial Estate Port Development Project and authorized the NDC to implement the
same.27 The other type of financing is an indirect type where the supplier, i.e., Marubeni,
obtained a loan from the Export-Import Bank of Japan to advance payment to its sub-
contractors.28
Under the financing schemes, the Japanese Yen Portions I and II and the Philippine
Pesos Portion were further broken down and subdivided according to the materials,
equipment and services rendered on the project. The price breakdown and the
corresponding materials, equipment and services were contained in a list attached as
Annex III to the contract.29
A few months after execution of the NDC contract, Philphos opened for public bidding a
project to construct and install two ammonia storage tanks in Isabel. Like the NDC
contract, it was Marubeni Head Office in Japan that participated in and won the bidding.
Thus, on May 2, 1982, Philphos and respondent corporation entered into an agreement
entitled "Turn-Key Contract for Ammonia Storage Complex Between Philippine
Phosphate Fertilizer Corporation and Marubeni Corporation."30 The object of the contract
was to establish and place in operating condition a modern, reliable, efficient and
integrated ammonia storage complex adapted to the site for the receipt and storage of
liquid anhydrous ammonia31 and for the delivery of ammonia to an integrated fertilizer
plant adjacent to the storage complex and to vessels at the dock.32 The storage complex
was to consist of ammonia storage tanks, refrigeration system, ship unloading system,
transfer pumps, ammonia heating system, fire-fighting system, area lighting, spare parts,
and other related facilities.33 The scope of the works required for the completion of the
ammonia storage complex covered the supply, including grants of licenses and transfer
of technology and know-how,34 and:
". . . the design and engineering, supply and delivery, construction, erection and
installation, supervision, direction and control of testing and commissioning of
the Ammonia Storage Complex as set forth in Annex I of this Contract, as well
as the coordination of tie-ins at boundaries and schedule of the use of a part or
the whole of the Ammonia Storage Complex through the Owner with the design
and construction of other facilities at and around the Site. The scope of works
shall also include any activity, work and supply necessary for, incidental to or
appropriate under present international industrial practice, for the timely and
successful implementation of the object of this Contract, whether or not
expressly referred to in the abovementioned Annex I."35
The contract price for the project was ¥3,255,751,000.00 and P17,406,000.00. Like the
NDC contract, the price was divided into three portions. The price in Japanese currency
was broken down into the Japanese Yen Portion I and Japanese Yen Portion II while the
price in Philippine currency was classified as the Philippine Pesos Portion. Both
Japanese Yen Portions I and II were financed by supplier's credit from the Export-Import
Bank of Japan. The price stated in the three portions were further broken down into the
corresponding materials, equipment and services required for the project and their
individual prices. Like the NDC contract, the breakdown in the Philphos contract is
contained in a list attached to the latter as Annex III.36
The division of the price into Japanese Yen Portions I and II and the Philippine Pesos
Portion under the two contracts corresponds to the two parts into which the contracts
were classified — the Foreign Offshore Portion and the Philippine Onshore Portion. In
both contracts, the Japanese Yen Portion I corresponds to the Foreign Offshore
Portion.37 Japanese Yen Portion II and the Philippine Pesos Portion correspond to the
Philippine Onshore Portion.38
Under the Philippine Onshore Portion, respondent does not deny its liability for the
contractor's tax on the income from the two projects. In fact respondent claims, which
petitioner has not denied, that the income it derived from the Onshore Portion of the two
projects had been declared for tax purposes and the taxes thereon already paid to the
Philippine government.39 It is with regard to the gross receipts from the Foreign Offshore
Portion of the two contracts that the liabilities involved in the assessments subject of this
case arose. Petitioner argues that since the two agreements are turn-key,40 they call for
the supply of both materials and services to the client, they are contracts for a piece of
work and are indivisible. The situs of the two projects is in the Philippines, and the
materials provided and services rendered were all done and completed within the
territorial jurisdiction of the Philippines.41Accordingly, respondent's entire receipts from
the contracts, including its receipts from the Offshore Portion, constitute income from
Philippine sources. The total gross receipts covering both labor and materials should be
subjected to contractor's tax in accordance with the ruling in Commissioner of Internal
Revenue v. Engineering Equipment & Supply Co.42
A contractor's tax is imposed in the National Internal Revenue Code (NIRC) as follows:
"Sec. 205. Contractors, proprietors or operators of dockyards, and others. —A
contractor's tax of four percent of the gross receipts is hereby imposed on
proprietors or operators of the following business establishments and/or
persons engaged in the business of selling or rendering the following services
for a fee or compensation:
(a) General engineering, general building and specialty contractors, as
defined in Republic Act No. 4566;
xxx xxx xxx
(q) Other independent contractors. The term "independent contractors"
includes persons (juridical or natural) not enumerated above (but not
including individuals subject to the occupation tax under the Local Tax
Code) whose activity consists essentially of the sale of all kinds of
services for a fee regardless of whether or not the performance of the
service calls for the exercise or use of the physical or mental faculties
of such contractors or their employees. It does not include regional or
area headquarters established in the Philippines by multinational
corporations, including their alien executives, and which headquarters
do not earn or derive income from the Philippines and which act as
supervisory, communications and coordinating centers for their
affiliates, subsidiaries or branches in the Asia-Pacific Region.
xxx xxx xxx43
Under the afore-quoted provision, an independent contractor is a person whose activity
consists essentially of the sale of all kinds of services for a fee, regardless of whether or
not the performance of the service calls for the exercise or use of the physical or mental
faculties of such contractors or their employees. The word "contractor" refers to a person
who, in the pursuit of independent business, undertakes to do a specific job or piece of
work for other persons, using his own means and methods without submitting himself to
control as to the petty details.44
A contractor's tax is a tax imposed upon the privilege of engaging in business. 45 It is
generally in the nature of an excise tax on the exercise of a privilege of selling services or
labor rather than a sale on products;46 and is directly collectible from the person
exercising the privilege.47 Being an excise tax, it can be levied by the taxing authority
only when the acts, privileges or business are done or performed within the jurisdiction of
said authority.48 Like property taxes, it cannot be imposed on an occupation or privilege
outside the taxing district.49
In the case at bar, it is undisputed that respondent was an independent contractor under
the terms of the two subject contracts. Respondent, however, argues that the work
therein were not all performed in the Philippines because some of them were completed
in Japan in accordance with the provisions of the contracts.
An examination of Annex III to the two contracts reveals that the materials and
equipment to be made and the works and services to be performed by respondent are
indeed classified into two. The first part, entitled "Breakdown of Japanese Yen Portion I"
provides:
"Japanese Yen Portion I of the Contract Price has been subdivided according to
discrete portions of materials and equipment which will be shipped to Leyte as
units and lots. This subdivision of price is to be used by owner to verify invoice
for Progress Payments under Article 19.2.1 of the Contract. The agreed
subdivision of Japanese Yen Portion I is as follows:
xxx xxx xxx50
The subdivision of Japanese Yen Portion I covers materials and equipment while
Japanese Yen Portion II and the Philippine Pesos Portion enumerate other materials and
equipment and the construction and installation work on the project. In other words, the
supplies for the project are listed under Portion I while labor and other supplies are listed
under Portion II and the Philippine Pesos Portion. Mr. Takeshi Hojo, then General
Manager of the Industrial Plant Section II of the Industrial Plant Department of Marubeni
Corporation in Japan who supervised the implementation of the two projects, testified
that all the machines and equipment listed under Japanese Yen Portion I in Annex III
were manufactured in Japan.51 The machines and equipment were designed, engineered
and fabricated by Japanese firms sub-contracted by Marubeni from the list of sub-
contractors in the technical appendices to each contract.52 Marubeni sub-contracted a
majority of the equipment and supplies to Kawasaki Steel Corporation which did the
design, fabrication, engineering and manufacture thereof;53 Yashima & Co. Ltd. which
manufactured the mobile equipment; Bridgestone which provided the rubber fenders of
the mobile equipment;54 and B.S. Japan for the supply of radio equipment.55 The
engineering and design works made by Kawasaki Steel Corporation included the lay-out
of the plant facility and calculation of the design in accordance with the specifications
given by respondent.56 All sub-contractors and manufacturers are Japanese corporations
and are based in Japan and all engineering and design works were performed in that
country.57
The materials and equipment under Portion I of the NDC Port Project is primarily
composed of two (2) sets of ship unloader and loader; several boats and mobile
equipment.58 The ship unloader unloads bags or bulk products from the ship to the port
while the ship loader loads products from the port to the ship. The unloader and loader
are big steel structures on top of each is a large crane and a compartment for operation
of the crane. Two sets of these equipment were completely manufactured in Japan
according to the specifications of the project. After manufacture, they were rolled on to a
barge and transported to Isabel, Leyte.59 Upon reaching Isabel, the unloader and loader
were rolled off the barge and pulled to the pier to the spot where they were
installed.60 Their installation simply consisted of bolting them onto the pier.61
Like the ship unloader and loader, the three tugboats and a line boat were completely
manufactured in Japan. The boats sailed to Isabel on their own power. The mobile
equipment, consisting of three to four sets of tractors, cranes and dozers, trailers and
forklifts, were also manufactured and completed in Japan. They were loaded on to a
shipping vessel and unloaded at the Isabel Port. These pieces of equipment were all on
wheels and self-propelled. Once unloaded at the port, they were ready to be driven and
perform what they were designed to do.62
In addition to the foregoing, there are other items listed in Japanese Yen Portion I in
Annex III to the NDC contract. These other items consist of supplies and materials for
five (5) berths, two (2) roads, a causeway, a warehouse, a transit shed, an administration
building and a security building. Most of the materials consist of steel sheets, steel pipes,
channels and beams and other steel structures, navigational and communication as well
as electrical equipment.63
In connection with the Philphos contract, the major pieces of equipment supplied by
respondent were the ammonia storage tanks and refrigeration units. 64 The steel plates
for the tank were manufactured and cut in Japan according to drawings and
specifications and then shipped to Isabel. Once there, respondent's employees put the
steel plates together to form the storage tank. As to the refrigeration units, they were
completed and assembled in Japan and thereafter shipped to Isabel. The units were
simply installed there. 65 Annex III to the Philphos contract lists down under the
Japanese Yen Portion I the materials for the ammonia storage tank, incidental
equipment, piping facilities, electrical and instrumental apparatus, foundation material
and spare parts.
All the materials and equipment transported to the Philippines were inspected and tested
in Japan prior to shipment in accordance with the terms of the contracts. 66 The inspection
was made by representatives of respondent corporation, of NDC and Philphos. NDC, in
fact, contracted the services of a private consultancy firm to verify the correctness of the
tests on the machines and equipment67 while Philphos sent a representative to Japan to
inspect the storage equipment.68
The sub-contractors of the materials and equipment under Japanese Yen Portion I were
all paid by respondent in Japan. In his deposition upon oral examination, Kenjiro
Yamakawa, formerly the Assistant General Manager and Manager of the Steel Plant
Marketing Department, Engineering & Construction Division, Kawasaki Steel
Corporation, testified that the equipment and supplies for the two projects provided by
Kawasaki under Japanese Yen Portion I were paid by Marubeni in Japan. Receipts for
such payments were duly issued by Kawasaki in Japanese and English. 69 Yashima &
Co. Ltd. and B.S. Japan were likewise paid by Marubeni in Japan. 70
Between Marubeni and the two Philippine corporations, payments for all materials and
equipment under Japanese Yen Portion I were made to Marubeni by NDC and Philphos
also in Japan. The NDC, through the Philippine National Bank, established letters of
credit in favor of respondent through the Bank of Tokyo. The letters of credit were
financed by letters of commitment issued by the OECF with the Bank of Tokyo. The Bank
of Tokyo, upon respondent's submission of pertinent documents, released the amount in
the letters of credit in favor of respondent and credited the amount therein to
respondent's account within the same bank.71
Clearly, the service of "design and engineering, supply and delivery, construction,
erection and installation, supervision, direction and control of testing and commissioning,
coordination. . . "72 of the two projects involved two taxing jurisdictions. These acts
occurred in two countries — Japan and the Philippines. While the construction and
installation work were completed within the Philippines, the evidence is clear that some
pieces of equipment and supplies were completely designed and engineered in Japan.
The two sets of ship unloader and loader, the boats and mobile equipment for the NDC
project and the ammonia storage tanks and refrigeration units were made and completed
in Japan. They were already finished products when shipped to the Philippines. The
other construction supplies listed under the Offshore Portion such as the steel sheets,
pipes and structures, electrical and instrumental apparatus, these were not finished
products when shipped to the Philippines. They, however, were likewise fabricated and
manufactured by the sub-contractors in Japan. All services for the design, fabrication,
engineering and manufacture of the materials and equipment under Japanese Yen
Portion I were made and completed in Japan. These services were rendered outside the
taxing jurisdiction of the Philippines and are therefore not subject to contractor's tax.
Contrary to petitioner's claim, the case of Commissioner of Internal Revenue v.
Engineering Equipment & Supply Co73 is not in point. In that case, the Court found that
Engineering Equipment, although an independent contractor, was not engaged in the
manufacture of air conditioning units in the Philippines. Engineering Equipment designed,
supplied and installed centralized air-conditioning systems for clients who contracted its
services. Engineering, however, did not manufacture all the materials for the air-
conditioning system. It imported some items for the system it designed and
installed.74 The issues in that case dealt with services performed within the local taxing
jurisdiction. There was no foreign element involved in the supply of materials and
services.
With the foregoing discussion, it is unnecessary to discuss the other issues raised by the
parties.
IN VIEW WHEREOF, the petition is denied. The decision in CA-G.R. SP No. 42518 is
affirmed.
SO ORDERED.
Davide, Jr., C .J ., Kapunan, Pardo, and Ynares-Santiago, JJ ., concur.
[G.R. No. 147188. September 14, 2004]
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE ESTATE OF
BENIGNO P. TODA, JR., Represented by Special Co-administrators Lorna
Kapunan and Mario Luza Bautista, respondents.
DECISION Income Tax 1989
DAVIDE, JR., C.J.:
Net Income per return P75,987,725.00
Add: Additional gain on sale
This Court is called upon to determine in this case whether the tax planning scheme of real property taxable under
adopted by a corporation constitutes tax evasion that would justify an assessment of ordinary corporate income
deficiency income tax. but were substituted with
The petitioner seeks the reversal of the Decision[1] of the Court of Appeals of 31 individual capital gains
January 2001 in CA-G.R. SP No. 57799 affirming the 3 January 2000 Decision [2] of the (P200M 100M) 100,000,000.00
Court of Tax Appeals (CTA) in C.T.A. Case No. 5328,[3] which held that the respondent Total Net Taxable Income P175,987,725.00
per investigation
Estate of Benigno P. Toda, Jr. is not liable for the deficiency income tax of Cibeles
Insurance Corporation (CIC) in the amount of P79,099,999.22 for the year 1989, and
ordered the cancellation and setting aside of the assessment issued by Commissioner of Tax Due thereof at 35% P 61,595,703.75
Internal Revenue Liwayway Vinzons-Chato on 9 January 1995.
The case at bar stemmed from a Notice of Assessment sent to CIC by the Less: Payment already made
Commissioner of Internal Revenue for deficiency income tax arising from an alleged
simulated sale of a 16-storey commercial building known as Cibeles Building, situated on 1. Per return P26,595,704.00
two parcels of land on Ayala Avenue, Makati City. 2. Thru Capital Gains
Tax made by R.A.
On 2 March 1989, CIC authorized Benigno P. Toda, Jr., President and owner of Altonaga 10,000,000.00 36,595,704.00
99.991% of its issued and outstanding capital stock, to sell the Cibeles Building and the Balance of tax due P 24,999,999.75
two parcels of land on which the building stands for an amount of not less than P90 Add: 50% Surcharge 12,499,999.88
million.[4] 25% Surcharge 6,249,999.94
Total P 43,749,999.57
On 30 August 1989, Toda purportedly sold the property for P100 million to Rafael
Add: Interest 20% from
A. Altonaga, who, in turn, sold the same property on the same day to Royal Match Inc.
4/16/90-4/30/94 (.808) 35,349,999.65
(RMI) for P200 million. These two transactions were evidenced by Deeds of Absolute
TOTAL AMT. DUE & COLLECTIBLE P 79,099,999.22
Sale notarized on the same day by the same notary public. [5]
============
For the sale of the property to RMI, Altonaga paid capital gains tax in the amount
The Estate thereafter filed a letter of protest.[13]
of P10 million.[6]
On 16 April 1990, CIC filed its corporate annual income tax return[7] for the year In the letter dated 19 October 1995,[14] the Commissioner dismissed the protest,
stating that a fraudulent scheme was deliberately perpetuated by the CIC wholly owned
1989, declaring, among other things, its gain from the sale of real property in the amount
and controlled by Toda by covering up the additional gain of P100 million, which resulted
of P75,728.021. After crediting withholding taxes of P254,497.00, it
in the change in the income structure of the proceeds of the sale of the two parcels of
paid P26,341,207[8] for its net taxable income of P75,987,725.
land and the building thereon to an individual capital gains, thus evading the higher
On 12 July 1990, Toda sold his entire shares of stocks in CIC to Le Hun T. Choa corporate income tax rate of 35%.
for P12.5 million, as evidenced by a Deed of Sale of Shares of Stocks.[9] Three and a half
On 15 February 1996, the Estate filed a petition for review[15] with the CTA alleging
years later, or on 16 January 1994, Toda died.
that the Commissioner erred in holding the Estate liable for income tax deficiency; that
On 29 March 1994, the Bureau of Internal Revenue (BIR) sent an assessment the inference of fraud of the sale of the properties is unreasonable and unsupported; and
notice[10] and demand letter to the CIC for deficiency income tax for the year 1989 in the that the right of the Commissioner to assess CIC had already prescribed.
amount of P79,099,999.22.
In his Answer[16] and Amended Answer,[17] the Commissioner argued that the two
The new CIC asked for a reconsideration, asserting that the assessment should be transactions actually constituted a single sale of the property by CIC to RMI, and that
directed against the old CIC, and not against the new CIC, which is owned by an entirely Altonaga was neither the buyer of the property from CIC nor the seller of the same
different set of stockholders; moreover, Toda had undertaken to hold the buyer of his property to RMI. The additional gain of P100 million (the difference between the second
stockholdings and the CIC free from all tax liabilities for the fiscal years 1987-1989.[11] simulated sale for P200 million and the first simulated sale for P100 million) realized by
CIC was taxed at the rate of only 5% purportedly as capital gains tax of Altonaga, instead
On 27 January 1995, the Estate of Benigno P. Toda, Jr., represented by special co- of at the rate of 35% as corporate income tax of CIC. The income tax return filed by CIC
administrators Lorna Kapunan and Mario Luza Bautista, received a Notice of for 1989 with intent to evade payment of the tax was thus false or fraudulent. Since such
Assessment[12] dated 9 January 1995 from the Commissioner of Internal Revenue for falsity or fraud was discovered by the BIR only on 8 March 1991, the assessment issued
deficiency income tax for the year 1989 in the amount of P79,099,999.22, computed as on 9 January 1995 was well within the prescriptive period prescribed by Section 223 (a)
follows: of the National Internal Revenue Code of 1986, which provides that tax may be assessed
within ten years from the discovery of the falsity or fraud. With the sale being tainted with
fraud, the separate corporate personality of CIC should be disregarded. Toda, being the
registered owner of the 99.991% shares of stock of CIC and the beneficial owner of the
remaining 0.009% shares registered in the name of the individual directors of CIC,
should be held liable for the deficiency income tax, especially because the gains realized
from the sale were withdrawn by him as cash advances or paid to him as cash dividends.
Since he is already dead, his estate shall answer for his liability.
In its decision[18] of 3 January 2000, the CTA held that the Commissioner failed to
prove that CIC committed fraud to deprive the government of the taxes due it. It ruled
that even assuming that a pre-conceived scheme was adopted by CIC, the same
constituted mere tax avoidance, and not tax evasion. There being no proof of fraudulent
transaction, the applicable period for the BIR to assess CIC is that prescribed in Section
203 of the NIRC of 1986, which is three years after the last day prescribed by law for the
filing of the return. Thus, the governments right to assess CIC prescribed on 15 April
1993. The assessment issued on 9 January 1995 was, therefore, no longer valid. The
CTA also ruled that the mere ownership by Toda of 99.991% of the capital stock of CIC
was not in itself sufficient ground for piercing the separate corporate personality of CIC.
Hence, the CTA declared that the Estate is not liable for deficiency income tax
of P79,099,999.22 and, accordingly, cancelled and set aside the assessment issued by
the Commissioner on 9 January 1995.
In its motion for reconsideration,[19] the Commissioner insisted that the sale of the
property owned by CIC was the result of the connivance between Toda and Altonaga.
She further alleged that the latter was a representative, dummy, and a close business
associate of the former, having held his office in a property owned by CIC and derived
his salary from a foreign corporation (Aerobin, Inc.) duly owned by Toda for
representation services rendered. The CTA denied[20] the motion for reconsideration,
prompting the Commissioner to file a petition for review[21] with the Court of Appeals.
In its challenged Decision of 31 January 2001, the Court of Appeals affirmed the
decision of the CTA, reasoning that the CTA, being more advantageously situated and
having the necessary expertise in matters of taxation, is better situated to determine the
correctness, propriety, and legality of the income tax assessments assailed by the Toda
Estate.[22]
Unsatisfied with the decision of the Court of Appeals, the Commissioner filed the
present petition invoking the following grounds:
I. THE COURT OF APPEALS ERRED IN HOLDING THAT RESPONDENT
COMMITTED NO FRAUD WITH INTENT TO EVADE THE TAX ON THE
SALE OF THE PROPERTIES OF CIBELES INSURANCE
CORPORATION.
II. THE COURT OF APPEALS ERRED IN NOT DISREGARDING THE
SEPARATE CORPORATE PERSONALITY OF CIBELES INSURANCE
CORPORATION.
III. THE COURT OF APPEALS ERRED IN HOLDING THAT THE RIGHT OF
PETITIONER TO ASSESS RESPONDENT FOR DEFICIENCY INCOME
TAX FOR THE YEAR 1989 HAD PRESCRIBED.
The Commissioner reiterates her arguments in her previous pleadings and insists
that the sale by CIC of the Cibeles property was in connivance with its dummy Rafael
Altonaga, who was financially incapable of purchasing it. She further points out that the
documents themselves prove the fact of fraud in that (1) the two sales were done
simultaneously on the same date, 30 August 1989; (2) the Deed of Absolute Sale
between Altonaga and RMI was notarized ahead of the alleged sale between CIC and
Altonaga, with the former registered in the Notarial Register of Jocelyn H. Arreza
Pabelana as Doc. 91, Page 20, Book I, Series of 1989; and the latter, as Doc. No. 92,
Page 20, Book I, Series of 1989, of the same Notary Public; (3) as early as 4 May 1989,
CIC received P40 million from RMI, and not from Altonaga. The said amount was debited
by RMI in its trial balance as of 30 June 1989 as investment in Cibeles Building. The
substantial portion of P40 million was withdrawn by Toda through the declaration of cash
dividends to all its stockholders.
For its part, respondent Estate asserts that the Commissioner failed to present the
income tax return of Altonaga to prove that the latter is financially incapable of
purchasing the Cibeles property.
To resolve the grounds raised by the Commissioner, the following questions are
pertinent:
1. Is this a case of tax evasion or tax avoidance?
2. Has the period for assessment of deficiency income tax for the year 1989
prescribed? and
3. Can respondent Estate be held liable for the deficiency income tax of CIC
for the year 1989, if any?
We shall discuss these questions in seriatim.
Is this a case of tax evasion
or tax avoidance?
Tax avoidance and tax evasion are the two most common ways used by taxpayers
in escaping from taxation. Tax avoidance is the tax saving device within the means
sanctioned by law. This method should be used by the taxpayer in good faith and at arms
length. Tax evasion, on the other hand, is a scheme used outside of those lawful means
and when availed of, it usually subjects the taxpayer to further or additional civil or
criminal liabilities.[23]
Tax evasion connotes the integration of three factors: (1) the end to be
achieved, i.e., the payment of less than that known by the taxpayer to be legally due, or
the non-payment of tax when it is shown that a tax is due; (2) an accompanying state of
mind which is described as being evil, in bad faith, willfull,or deliberate and not
accidental; and (3) a course of action or failure of action which is unlawful. [24]
All these factors are present in the instant case. It is significant to note that as early
as 4 May 1989, prior to the purported sale of the Cibeles property by CIC to Altonaga on
30 August 1989, CIC received P40 million from RMI,[25] and not from Altonaga. That P40
million was debited by RMI and reflected in its trial balance[26] as other inv. Cibeles Bldg.
Also, as of 31 July 1989, another P40 million was debited and reflected in RMIs trial
balance as other inv. Cibeles Bldg. This would show that the real buyer of the properties
was RMI, and not the intermediary Altonaga.
 The investigation conducted by the BIR disclosed that Altonaga was a close
business associate and one of the many trusted corporate executives of Toda. This
information was revealed by Mr. Boy Prieto, the assistant accountant of CIC and an old
timer in the company. [27] But Mr. Prieto did not testify on this matter, hence, that
information remains to be hearsay and is thus inadmissible in evidence. It was not
verified either, since the letter-request for investigation of Altonaga was
unserved,[28] Altonaga having left for the United States of America in January 1990.
Nevertheless, that Altonaga was a mere conduit finds support in the admission of
respondent Estate that the sale to him was part of the tax planning scheme of CIC. That
admission is borne by the records. In its Memorandum, respondent Estate declared:
Petitioner, however, claims there was a change of structure of the proceeds of sale.
Admitted one hundred percent. But isnt this precisely the definition of tax planning?
Change the structure of the funds and pay a lower tax. Precisely, Sec. 40 (2) of the Tax
Code exists, allowing tax free transfers of property for stock, changing the structure of
the property and the tax to be paid. As long as it is done legally, changing the structure of
a transaction to achieve a lower tax is not against the law. It is absolutely allowed.
Tax planning is by definition to reduce, if not eliminate altogether, a tax. Surely petitioner
[sic] cannot be faulted for wanting to reduce the tax from 35% to 5%.[29][Underscoring
supplied].
The scheme resorted to by CIC in making it appear that there were two sales of the
subject properties, i.e., from CIC to Altonaga, and then from Altonaga to RMI cannot be
considered a legitimate tax planning. Such scheme is tainted with fraud.
Fraud in its general sense, is deemed to comprise anything calculated to deceive,
including all acts, omissions, and concealment involving a breach of legal or equitable
duty, trust or confidence justly reposed, resulting in the damage to another, or by which
an undue and unconscionable advantage is taken of another. [30]
Here, it is obvious that the objective of the sale to Altonaga was to reduce the
amount of tax to be paid especially that the transfer from him to RMI would then subject
the income to only 5% individual capital gains tax, and not the 35% corporate income tax.
Altonagas sole purpose of acquiring and transferring title of the subject properties on the
same day was to create a tax shelter. Altonaga never controlled the property and did not
enjoy the normal benefits and burdens of ownership. The sale to him was merely a tax
ploy, a sham, and without business purpose and economic substance. Doubtless, the
execution of the two sales was calculated to mislead the BIR with the end in view of
reducing the consequent income tax liability.
In a nutshell, the intermediary transaction, i.e., the sale of Altonaga, which was
prompted more on the mitigation of tax liabilities than for legitimate business purposes
constitutes one of tax evasion.[31]
Generally, a sale or exchange of assets will have an income tax incidence only
when it is consummated.[32] The incidence of taxation depends upon the substance of a
transaction. The tax consequences arising from gains from a sale of property are not
finally to be determined solely by the means employed to transfer legal title. Rather, the
transaction must be viewed as a whole, and each step from the commencement of
negotiations to the consummation of the sale is relevant. A sale by one person cannot be
transformed for tax purposes into a sale by another by using the latter as a conduit
through which to pass title. To permit the true nature of the transaction to be disguised by
mere formalisms, which exist solely to alter tax liabilities, would seriously impair the
effective administration of the tax policies of Congress. [33]
To allow a taxpayer to deny tax liability on the ground that the sale was made
through another and distinct entity when it is proved that the latter was merely a conduit
is to sanction a circumvention of our tax laws. Hence, the sale to Altonaga should be
disregarded for income tax purposes.[34] The two sale transactions should be treated as a
single direct sale by CIC to RMI.
Accordingly, the tax liability of CIC is governed by then Section 24 of the NIRC of
1986, as amended (now 27 (A) of the Tax Reform Act of 1997), which stated as follows:
Sec. 24. Rates of tax on corporations. (a) Tax on domestic corporations.- A tax is
hereby imposed upon the taxable net income received during each taxable year from all
sources by every corporation organized in, or existing under the laws of the Philippines,
and partnerships, no matter how created or organized but not including general
professional partnerships, in accordance with the following:
Twenty-five percent upon the amount by which the taxable net income does not exceed
one hundred thousand pesos; and
Thirty-five percent upon the amount by which the taxable net income exceeds one
hundred thousand pesos.
CIC is therefore liable to pay a 35% corporate tax for its taxable net income in 1989. The
5% individual capital gains tax provided for in Section 34 (h) of the NIRC of 1986 [35](now
6% under Section 24 (D) (1) of the Tax Reform Act of 1997) is inapplicable. Hence, the
assessment for the deficiency income tax issued by the BIR must be upheld.
Has the period of
assessment prescribed?
No. Section 269 of the NIRC of 1986 (now Section 222 of the Tax Reform Act of
1997) read:
Sec. 269. 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 after the collection of
such tax may be begun without assessment, at any time within ten 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 collection thereof .
Put differently, in cases of (1) fraudulent returns; (2) false returns with intent to
evade tax; and (3) failure to file a return, the period within which to assess tax is ten
years from discovery of the fraud, falsification or omission, as the case may be.
It is true that in a query dated 24 August 1989, Altonaga, through his counsel,
asked the Opinion of the BIR on the tax consequence of the two sale
transactions.[36] Thus, the BIR was amply informed of the transactions even prior to the
execution of the necessary documents to effect the transfer. Subsequently, the two sales
were openly made with the execution of public documents and the declaration of taxes
for 1989. However, these circumstances do not negate the existence of fraud. As earlier
discussed those two transactions were tainted with fraud. And even
assuming arguendo that there was no fraud, we find that the income tax return filed by
CIC for the year 1989 was false. It did not reflect the true or actual amount gained from
the sale of the Cibeles property. Obviously, such was done with intent to evade or reduce
tax liability.
As stated above, the prescriptive period to assess the correct taxes in case of false
returns is ten years from the discovery of the falsity. The false return was filed on 15 April
1990, and the falsity thereof was claimed to have been discovered only on 8 March
1991.[37] The assessment for the 1989 deficiency income tax of CIC was issued on 9
January 1995. Clearly, the issuance of the correct assessment for deficiency income tax
was well within the prescriptive period.
Is respondent Estate liable
for the 1989 deficiency
income tax of Cibeles
Insurance Corporation?
A corporation has a juridical personality distinct and separate from the persons
owning or composing it. Thus, the owners or stockholders of a corporation may not
generally be made to answer for the liabilities of a corporation and vice versa. There are,
however, certain instances in which personal liability may arise. It has been held in a
number of cases that personal liability of a corporate director, trustee, or officer along,
albeit not necessarily, with the corporation may validly attach when:
1. He assents to the (a) patently unlawful act of the corporation, (b) bad faith
or gross negligence in directing its affairs, or (c) conflict of interest,
resulting in damages to the corporation, its stockholders, or other persons;
2. He consents to the issuance of watered down stocks or, having knowledge
thereof, does not forthwith file with the corporate secretary his written
objection thereto;
3. He agrees to hold himself personally and solidarily liable with the
corporation; or
4. He is made, by specific provision of law, to personally answer for his
corporate action.[38]
It is worth noting that when the late Toda sold his shares of stock to Le Hun T.
Choa, he knowingly and voluntarily held himself personally liable for all the tax liabilities
of CIC and the buyer for the years 1987, 1988, and 1989. Paragraph g of the Deed of
Sale of Shares of Stocks specifically provides:
g. Except for transactions occurring in the ordinary course of business, Cibeles has no
liabilities or obligations, contingent or otherwise, for taxes, sums of money or insurance
claims other than those reported in its audited financial statement as of December 31,
1989, attached hereto as Annex B and made a part hereof. The business of Cibeles has
at all times been conducted in full compliance with all applicable laws, rules and
regulations. SELLER undertakes and agrees to hold the BUYER and Cibeles free
from any and all income tax liabilities of Cibeles for the fiscal years 1987, 1988 and
1989.[39] [Underscoring Supplied].
When the late Toda undertook and agreed to hold the BUYER and Cibeles free
from any all income tax liabilities of Cibeles for the fiscal years 1987, 1988, and 1989, he
thereby voluntarily held himself personally liable therefor. Respondent estate cannot,
therefore, deny liability for CICs deficiency income tax for the year 1989 by invoking the
separate corporate personality of CIC, since its obligation arose from Todas contractual
undertaking, as contained in the Deed of Sale of Shares of Stock.
WHEREFORE, in view of all the foregoing, the petition is hereby GRANTED. The
decision of the Court of Appeals of 31 January 2001 in CA-G.R. SP No. 57799 is
REVERSED and SET ASIDE, and another one is hereby rendered ordering respondent
Estate of Benigno P. Toda Jr. to pay P79,099,999.22 as deficiency income tax of Cibeles
Insurance Corporation for the year 1989, plus legal interest from 1 May 1994 until the
amount is fully paid.
Costs against respondent.
SO ORDERED.
Quisumbing, Ynares-Santiago, Carpio, and Azcuna, JJ., concur.
[CTA EB CRIMINAL CASE PDF]
[G.R. No. 127105. June 25, 1999]
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. S.C. JOHNSON AND
SON, INC., and COURT OF APPEALS, respondents.
DECISION
GONZAGA-REYES, J.:
This is a petition for review on certiorari under Rule 45 of the Rules of Court
seeking to set aside the decision of the Court of Appeals dated November 7, 1996 in CA-
GR SP No. 40802 affirming the decision of the Court of Tax Appeals in CTA Case No.
5136.
The antecedent facts as found by the Court of Tax Appeals are not disputed, to wit:
[Respondent], a domestic corporation organized and operating under the Philippine laws,
entered into a license agreement with SC Johnson and Son, United States of America
(USA), a non-resident foreign corporation based in the U.S.A. pursuant to which the
[respondent] was granted the right to use the trademark, patents and technology owned
by the latter including the right to manufacture, package and distribute the products
covered by the Agreement and secure assistance in management, marketing and
production from SC Johnson and Son, U. S. A.
The said License Agreement was duly registered with the Technology Transfer Board of
the Bureau of Patents, Trade Marks and Technology Transfer under Certificate of
Registration No. 8064 (Exh. A).
For the use of the trademark or technology, [respondent] was obliged to pay SC Johnson
and Son, USA royalties based on a percentage of net sales and subjected the same to
25% withholding tax on royalty payments which [respondent] paid for the period covering
July 1992 to May 1993 in the total amount of P1,603,443.00 (Exhs. B to L and
submarkings).
On October 29, 1993, [respondent] filed with the International Tax Affairs Division (ITAD)
of the BIR a claim for refund of overpaid withholding tax on royalties arguing that, the
antecedent facts attending [respondents] case fall squarely within the same
circumstances under which said MacGeorge and Gillete rulings were issued. Since the
agreement was approved by the Technology Transfer Board, the preferential tax rate of
10% should apply to the [respondent]. We therefore submit that royalties paid by the
[respondent] to SC Johnson and Son, USA is only subject to 10% withholding tax
pursuant to the most-favored nation clause of the RP-US Tax Treaty [Article 13
Paragraph 2 (b) (iii)] in relation to the RP-West Germany Tax Treaty [Article 12 (2) (b)]
(Petition for Review [filed with the Court of Appeals], par. 12). [Respondents] claim for
the refund of P963,266.00 was computed as follows:
Gross 25% 10%
Month/ Royalty Withholding Withholding
Year Fee Tax Paid Tax Balance
______ _______ __________ __________ ______
July 1992 559,878 139,970 55,988 83,982
August 567,935 141,984 56,794 85,190
September 595,956 148,989 59,596 89,393
October 634,405 158,601 63,441 95,161
November 620,885 155,221 62,089 93,133
December 383,276 95,819 36,328 57,491
Jan 1993 602,451 170,630 68,245 102,368
February 565,845 141,461 56,585 84,877
March 547,253 136,813 54,725 82,088
April 660,810 165,203 66,081 99,122
May 603,076 150,769 60,308 90,461
P6,421,770 P1,605,443 P642,177 P963,266[1]
======== ======== ======= =======
The Commissioner did not act on said claim for refund. Private respondent S.C.
Johnson & Son, Inc. (S.C. Johnson) then filed a petition for review before the Court of
Tax Appeals (CTA) where the case was docketed as CTA Case No. 5136, to claim a
refund of the overpaid withholding tax on royalty payments from July 1992 to May 1993.
On May 7, 1996, the Court of Tax Appeals rendered its decision in favor of S.C.
Johnson and ordered the Commissioner of Internal Revenue to issue a tax credit
certificate in the amount of P963,266.00 representing overpaid withholding tax on royalty
payments beginning July, 1992 to May, 1993.[2]
The Commissioner of Internal Revenue thus filed a petition for review with the Court
of Appeals which rendered the decision subject of this appeal on November 7, 1996
finding no merit in the petition and affirming in toto the CTA ruling.[3]
This petition for review was filed by the Commissioner of Internal Revenue raising
the following issue:
THE COURT OF APPEALS ERRED IN RULING THAT SC JOHNSON AND SON, USA
IS ENTITLED TO THE MOST FAVORED NATION TAX RATE OF 10% ON ROYALTIES
AS PROVIDED IN THE RP-US TAX TREATY IN RELATION TO THE RP-WEST
GERMANY TAX TREATY.
Petitioner contends that under Article 13(2) (b) (iii) of the RP-US Tax Treaty, which
is known as the most favored nation clause, the lowest rate of the Philippine tax at 10%
may be imposed on royalties derived by a resident of the United States from sources
within the Philippines only if the circumstances of the resident of the United States are
similar to those of the resident of West Germany. Since the RP-US Tax Treaty contains
no matching credit provision as that provided under Article 24 of the RP-West Germany
Tax Treaty, the tax on royalties under the RP-US Tax Treaty is not paid under similar
circumstances as those obtaining in the RP-West Germany Tax Treaty. Even assuming
that the phrase paid under similar circumstances refers to the payment of royalties, and
not taxes, as held by the Court of Appeals, still, the most favored nation clause cannot be
invoked for the reason that when a tax treaty contemplates circumstances attendant to
the payment of a tax, or royalty remittances for that matter, these must necessarily refer
to circumstances that are tax-related. Finally, petitioner argues that since S.C. Johnsons
invocation of the most favored nation clause is in the nature of a claim for exemption
from the application of the regular tax rate of 25% for royalties, the provisions of the
treaty must be construed strictly against it.
In its Comment, private respondent S.C. Johnson avers that the instant petition
should be denied (1) because it contains a defective certification against forum shopping
as required under SC Circular No. 28-91, that is, the certification was not executed by the
petitioner herself but by her counsel; and (2) that the most favored nation clause under
the RP-US Tax Treaty refers to royalties paid under similar circumstances as those
royalties subject to tax in other treaties; that the phrase paid under similar circumstances
does not refer to payment of the tax but to the subject matter of the tax, that is, royalties,
because the most favored nation clause is intended to allow the taxpayer in one state to
avail of more liberal provisions contained in another tax treaty wherein the country of
residence of such taxpayer is also a party thereto, subject to the basic condition that the
subject matter of taxation in that other tax treaty is the same as that in the original tax
treaty under which the taxpayer is liable; thus, the RP-US Tax Treaty speaks of royalties
of the same kind paid under similar circumstances. S.C. Johnson also contends that the
Commissioner is estopped from insisting on her interpretation that the phrase paid under
similar circumstances refers to the manner in which the tax is paid, for the reason that
said interpretation is embodied in Revenue Memorandum Circular (RMC) 39-92 which
was already abandoned by the Commissioners predecessor in 1993; and was expressly
revoked in BIR Ruling No. 052-95 which stated that royalties paid to an American
licensor are subject only to 10% withholding tax pursuant to Art 13(2)(b)(iii) of the RP-US
Tax Treaty in relation to the RP-West Germany Tax Treaty. Said ruling should be given
retroactive effect except if such is prejudicial to the taxpayer pursuant to Section 246 of
the National Internal Revenue Code.
Petitioner filed Reply alleging that the fact that the certification against forum
shopping was signed by petitioners counsel is not a fatal defect as to warrant the
dismissal of this petition since Circular No. 28-91 applies only to original actions and not
to appeals, as in the instant case. Moreover, the requirement that the certification should
be signed by petitioner and not by counsel does not apply to petitioner who has only the
Office of the Solicitor General as statutory counsel. Petitioner reiterates that even if the
phrase paid under similar circumstances embodied in the most favored nation clause of
the RP-US Tax Treaty refers to the payment of royalties and not taxes, still the presence
or absence of a matching credit provision in the said RP-US Tax Treaty would constitute
a material circumstance to such payment and would be determinative of the said clauses
application.
We address first the objection raised by private respondent that the certification
against forum shopping was not executed by the petitioner herself but by her counsel,
the Office of the Solicitor General (O.S.G.) through one of its Solicitors, Atty. Tomas M.
Navarro.
SC Circular No. 28-91 provides:
SUBJECT: ADDITIONAL REQUISITES FOR PETITIONS FILED WITH THE SUPREME
COURT AND THE COURT OF APPEALS TO PREVENT FORUM SHOPPING OR
MULTIPLE FILING OF PETITIONS AND COMPLAINTS
TO : xxx xxx xxx
The attention of the Court has been called to the filing of multiple petitions and
complaints involving the same issues in the Supreme Court, the Court of Appeals or
other tribunals or agencies, with the result that said courts, tribunals or agencies have to
resolve the same issues.
(1) To avoid the foregoing, in every petition filed with the Supreme Court or the Court of
Appeals, the petitioner aside from complying with pertinent provisions of the Rules of
Court and existing circulars, must certify under oath to all of the following facts or
undertakings: (a) he has not theretofore commenced any other action or proceeding
involving the same issues in the Supreme Court, the Court of Appeals, or any tribunal or
agency; xxx
(2) Any violation of this revised Circular will entail the following sanctions: (a) it shall be a
cause for the summary dismissal of the multiple petitions or complaints; xxx
The circular expressly requires that a certificate of non-forum shopping should be
attached to petitions filed before this Court and the Court of Appeals. Petitioners
allegation that Circular No. 28-91 applies only to original actions and not to appeals as in
the instant case is not supported by the text nor by the obvious intent of the Circular
which is to prevent multiple petitions that will result in the same issue being resolved by
different courts.
Anent the requirement that the party, not counsel, must certify under oath that he
has not commenced any other action involving the same issues in this Court or the Court
of Appeals or any other tribunal or agency, we are inclined to accept petitioners
submission that since the OSG is the only lawyer for the petitioner, which is a
government agency mandated under Section 35, Chapter 12, title III, Book IV of the 1987
Administrative Code[4] to be represented only by the Solicitor General, the certification
executed by the OSG in this case constitutes substantial compliance with Circular No.
28-91.
With respect to the merits of this petition, the main point of contention in this appeal
is the interpretation of Article 13 (2) (b) (iii) of the RP-US Tax Treaty regarding the rate of
tax to be imposed by the Philippines upon royalties received by a non-resident foreign
corporation. The provision states insofar as pertinent that-
1) Royalties derived by a resident of one of the Contracting States from
sources within the other Contracting State may be taxed by both
Contracting States.
2) However, the tax imposed by that Contracting State shall not exceed.
a) In the case of the United States, 15 percent of the gross amount of the royalties, and
b) In the case of the Philippines, the least of:
(i) 25 percent of the gross amount of the royalties;
(ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a
corporation registered with the Philippine Board of Investments and engaged in preferred
areas of activities; and
(iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind
paid under similar circumstances to a resident of a third State.
xxx xxx xxx
(italics supplied)
Respondent S. C. Johnson and Son, Inc. claims that on the basis of the quoted
provision, it is entitled to the concessional tax rate of 10 percent on royalties based on
Article 12 (2) (b) of the RP-Germany Tax Treaty which provides:
(2) However, such royalties may also be taxed in the Contracting State in
which they arise, and according to the law of that State, but the tax so
charged shall not exceed:
xxx
 b) 10 percent of the gross amount of royalties arising from the use of, or the
right to use, any patent, trademark, design or model, plan, secret formula
or process, or from the use of or the right to use, industrial, commercial, or
scientific equipment, or for information concerning industrial, commercial
or scientific experience.
For as long as the transfer of technology, under Philippine law, is subject to approval, the
limitation of the tax rate mentioned under b) shall, in the case of royalties arising in the
Republic of the Philippines, only apply if the contract giving rise to such royalties has
been approved by the Philippine competent authorities.
Unlike the RP-US Tax Treaty, the RP-Germany Tax Treaty allows a tax credit of 20
percent of the gross amount of such royalties against German income and corporation
tax for the taxes payable in the Philippines on such royalties where the tax rate is
reduced to 10 or 15 percent under such treaty. Article 24 of the RP-Germany Tax Treaty
states-
1) Tax shall be determined in the case of a resident of the Federal Republic of
Germany as follows:
xxxxxxxxx
b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall
be allowed as a credit against German income and corporation tax payable in respect of
the following items of income arising in the Republic of the Philippines, the tax paid under
the laws of the Philippines in accordance with this Agreement on:
xxxxxxxxx
dd) royalties, as defined in paragraph 3 of Article 12;
xxxxxxxxx
c) For the purpose of the credit referred in subparagraph b) the Philippine tax shall be
deemed to be
xxxxxxxxx
cc) in the case of royalties for which the tax is reduced to 10 or 15 per cent according to
paragraph 2 of Article 12, 20 percent of the gross amount of such royalties.
xxxxxxxxx
According to petitioner, the taxes upon royalties under the RP-US Tax Treaty are
not paid under circumstances similar to those in the RP-West Germany Tax Treaty since
there is no provision for a 20 percent matching credit in the former convention and
private respondent cannot invoke the concessional tax rate on the strength of the most
favored nation clause in the RP-US Tax Treaty. Petitioners position is explained thus:
Under the foregoing provision of the RP-West Germany Tax Treaty, the Philippine tax
paid on income from sources within the Philippines is allowed as a credit against German
income and corporation tax on the same income. In the case of royalties for which the tax
is reduced to 10 or 15 percent according to paragraph 2 of Article 12 of the RP-West
Germany Tax Treaty, the credit shall be 20% of the gross amount of such royalty. To
illustrate, the royalty income of a German resident from sources within the Philippines
arising from the use of, or the right to use, any patent, trade mark, design or model, plan,
secret formula or process, is taxed at 10% of the gross amount of said royalty under
certain conditions. The rate of 10% is imposed if credit against the German income and
corporation tax on said royalty is allowed in favor of the German resident. That means
the rate of 10% is granted to the German taxpayer if he is similarly granted a credit
against the income and corporation tax of West Germany. The clear intent of the
matching credit is to soften the impact of double taxation by different jurisdictions.
The RP-US Tax Treaty contains no similar matching credit as that provided under the
RP-West Germany Tax Treaty. Hence, the tax on royalties under the RP-US Tax Treaty
is not paid under similar circumstances as those obtaining in the RP-West Germany Tax
Treaty. Therefore, the most favored nation clause in the RP-West Germany Tax Treaty
cannot be availed of in interpreting the provisions of the RP-US Tax Treaty.[5]
The petition is meritorious.
We are unable to sustain the position of the Court of Tax Appeals, which was
upheld by the Court of Appeals, that the phrase paid under similar circumstances in
Article 13 (2) (b), (iii) of the RP-US Tax Treaty should be interpreted to refer to payment
of royalty, and not to the payment of the tax, for the reason that the phrase paid under
similar circumstances is followed by the phrase to a resident of a third state. The
respondent court held that Words are to be understood in the context in which they are
used, and since what is paid to a resident of a third state is not a tax but a royalty logic
instructs that the treaty provision in question should refer to royalties of the same kind
paid under similar circumstances.
The above construction is based principally on syntax or sentence structure but fails
to take into account the purpose animating the treaty provisions in point. To begin with,
we are not aware of any law or rule pertinent to the payment of royalties, and none has
been brought to our attention, which provides for the payment of royalties under
dissimilar circumstances. The tax rates on royalties and the circumstances of payment
thereof are the same for all the recipients of such royalties and there is no disparity
based on nationality in the circumstances of such payment. [6] On the other hand, a
cursory reading of the various tax treaties will show that there is no similarity in the
provisions on relief from or avoidance of double taxation [7] as this is a matter of
negotiation between the contracting parties.[8] As will be shown later, this dissimilarity is
true particularly in the treaties between the Philippines and the United States and
between the Philippines and West Germany.
The RP-US Tax Treaty is just one of a number of bilateral treaties which the
Philippines has entered into for the avoidance of double taxation. [9] The purpose of these
international agreements is to reconcile the national fiscal legislations of the contracting
parties in order to help the taxpayer avoid simultaneous taxation in two different
jurisdictions.[10] More precisely, the tax conventions are drafted with a view towards the
elimination of international juridical double taxation, which is defined as the imposition
of comparable taxes in two or more states on the same taxpayer in respect of the same
subject matter and for identical periods.[11], citing the Committee on Fiscal Affairs of the
Organization for Economic Co-operation and Development (OECD).11 The apparent
rationale for doing away with double taxation is to encourage the free flow of goods and
services and the movement of capital, technology and persons between countries,
conditions deemed vital in creating robust and dynamic economies. [12] Foreign
investments will only thrive in a fairly predictable and reasonable international investment
climate and the protection against double taxation is crucial in creating such a climate. [13]
Double taxation usually takes place when a person is resident of a contracting state
and derives income from, or owns capital in, the other contracting state and both states
impose tax on that income or capital. In order to eliminate double taxation, a tax treaty
resorts to several methods. First, it sets out the respective rights to tax of the state of
source or situs and of the state of residence with regard to certain classes of income or
capital. In some cases, an exclusive right to tax is conferred on one of the contracting
states; however, for other items of income or capital, both states are given the right to
tax, although the amount of tax that may be imposed by the state of source is limited.[14]
The second method for the elimination of double taxation applies whenever the
state of source is given a full or limited right to tax together with the state of residence. In
this case, the treaties make it incumbent upon the state of residence to allow relief in
order to avoid double taxation. There are two methods of relief- the exemption method
and the credit method. In the exemption method, the income or capital which is taxable in
the state of source or situs is exempted in the state of residence, although in some
instances it may be taken into account in determining the rate of tax applicable to the
taxpayers remaining income or capital. On the other hand, in the credit method, although
the income or capital which is taxed in the state of source is still taxable in the state of
residence, the tax paid in the former is credited against the tax levied in the latter. The
basic difference between the two methods is that in the exemption method, the focus is
on the income or capital itself, whereas the credit method focuses upon the tax. [15]
In negotiating tax treaties, the underlying rationale for reducing the tax rate is that
the Philippines will give up a part of the tax in the expectation that the tax given up for
this particular investment is not taxed by the other country. [16] Thus the petitioner
correctly opined that the phrase royalties paid under similar circumstances in the most
favored nation clause of the US-RP Tax Treaty necessarily contemplated circumstances
that are tax-related.
In the case at bar, the state of source is the Philippines because the royalties are
paid for the right to use property or rights, i.e. trademarks, patents and technology,
located within the Philippines.[17] The United States is the state of residence since the
taxpayer, S. C. Johnson and Son, U. S. A., is based there. Under the RP-US Tax Treaty,
the state of residence and the state of source are both permitted to tax the royalties, with
a restraint on the tax that may be collected by the state of source. [18] Furthermore, the
method employed to give relief from double taxation is the allowance of a tax credit to
citizens or residents of the United States (in an appropriate amount based upon the taxes
paid or accrued to the Philippines) against the United States tax, but such amount shall
not exceed the limitations provided by United States law for the taxable year. [19] Under
Article 13 thereof, the Philippines may impose one of three rates- 25 percent of the gross
amount of the royalties; 15 percent when the royalties are paid by a corporation
registered with the Philippine Board of Investments and engaged in preferred areas of
activities; or the lowest rate of Philippine tax that may be imposed on royalties of the
same kind paid under similar circumstances to a resident of a third state.
Given the purpose underlying tax treaties and the rationale for the most favored
nation clause, the concessional tax rate of 10 percent provided for in the RP-Germany
Tax Treaty should apply only if the taxes imposed upon royalties in the RP-US Tax
Treaty and in the RP-Germany Tax Treaty are paid under similar circumstances. This
would mean that private respondent must prove that the RP-US Tax Treaty grants similar
tax reliefs to residents of the United States in respect of the taxes imposable upon
royalties earned from sources within the Philippines as those allowed to their German
counterparts under the RP-Germany Tax Treaty.
The RP-US and the RP-West Germany Tax Treaties do not contain similar
provisions on tax crediting. Article 24 of the RP-Germany Tax Treaty, supra, expressly
allows crediting against German income and corporation tax of 20% of the gross amount
of royalties paid under the law of the Philippines. On the other hand, Article 23 of the RP-
US Tax Treaty, which is the counterpart provision with respect to relief for double
taxation, does not provide for similar crediting of 20% of the gross amount of royalties
paid. Said Article 23 reads:
Article 23
Relief from double taxation
Double taxation of income shall be avoided in the following manner:
1) In accordance with the provisions and subject to the limitations of the law of
the United States (as it may be amended from time to time without
changing the general principle thereof), the United States shall allow to a
citizen or resident of the United States as a credit against the United
States tax the appropriate amount of taxes paid or accrued to the
Philippines and, in the case of a United States corporation owning at least
10 percent of the voting stock of a Philippine corporation from which it
receives dividends in any taxable year, shall allow credit for the
appropriate amount of taxes paid or accrued to the Philippines by the
Philippine corporation paying such dividends with respect to the profits out
of which such dividends are paid. Such appropriate amount shall be based
upon the amount of tax paid or accrued to the Philippines, but the credit
shall not exceed the limitations (for the purpose of limiting the credit to the
United States tax on income from sources within the Philippines or on
income from sources outside the United States) provided by United States
law for the taxable year. xxx.
The reason for construing the phrase paid under similar circumstances as used in
Article 13 (2) (b) (iii) of the RP-US Tax Treaty as referring to taxes is anchored upon a
logical reading of the text in the light of the fundamental purpose of such treaty which is
to grant an incentive to the foreign investor by lowering the tax and at the same time
crediting against the domestic tax abroad a figure higher than what was collected in the
Philippines.
In one case, the Supreme Court pointed out that laws are not just mere
compositions, but have ends to be achieved and that the general purpose is a more
important aid to the meaning of a law than any rule which grammar may lay down. [20] It is
the duty of the courts to look to the object to be accomplished, the evils to be remedied,
or the purpose to be subserved, and should give the law a reasonable or liberal
construction which will best effectuate its purpose.[21] The Vienna Convention on the Law
of Treaties states that a treaty shall be interpreted in good faith in accordance with the
ordinary meaning to be given to the terms of the treaty in their context and in the light of
its object and purpose.[22]
As stated earlier, the ultimate reason for avoiding double taxation is to encourage
foreign investors to invest in the Philippines - a crucial economic goal for developing
countries.[23] The goal of double taxation conventions would be thwarted if such treaties
did not provide for effective measures to minimize, if not completely eliminate, the tax
burden laid upon the income or capital of the investor. Thus, if the rates of tax are
lowered by the state of source, in this case, by the Philippines, there should be a
concomitant commitment on the part of the state of residence to grant some form of tax
relief, whether this be in the form of a tax credit or exemption. [24] Otherwise, the tax which
could have been collected by the Philippine government will simply be collected by
another state, defeating the object of the tax treaty since the tax burden imposed upon
the investor would remain unrelieved. If the state of residence does not grant some form
of tax relief to the investor, no benefit would redound to the Philippines, i.e., increased
investment resulting from a favorable tax regime, should it impose a lower tax rate on the
royalty earnings of the investor, and it would be better to impose the regular rate rather
than lose much-needed revenues to another country.
At the same time, the intention behind the adoption of the provision on relief from
double taxation in the two tax treaties in question should be considered in light of the
purpose behind the most favored nation clause.
The purpose of a most favored nation clause is to grant to the contracting party
treatment not less favorable than that which has been or may be granted to the most
favored among other countries.[25] The most favored nation clause is intended to
establish the principle of equality of international treatment by providing that the citizens
or subjects of the contracting nations may enjoy the privileges accorded by either party to
those of the most favored nation.[26] The essence of the principle is to allow the taxpayer
in one state to avail of more liberal provisions granted in another tax treaty to which the
country of residence of such taxpayer is also a party provided that the subject matter of
taxation, in this case royalty income, is the same as that in the tax treaty under which the
taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12 (2) (b) of the
RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of
trademark, patent, and technology. The entitlement of the 10% rate by U.S. firms despite
the absence of a matching credit (20% for royalties) would derogate from the design
behind the most favored nation clause to grant equality of international treatment since
the tax burden laid upon the income of the investor is not the same in the two
countries. The similarity in the circumstances of payment of taxes is a condition for the
enjoyment of most favored nation treatment precisely to underscore the need for equality
of treatment.
We accordingly agree with petitioner that since the RP-US Tax Treaty does not give
a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as
allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed
entitled to the 10 percent rate granted under the latter treaty for the reason that there is
no payment of taxes on royalties under similar circumstances.
It bears stress that tax refunds are in the nature of tax exemptions. As such they
are regarded as in derogation of sovereign authority and to be construed strictissimi
juris against the person or entity claiming the exemption.[27] The burden of proof is upon
him who claims the exemption in his favor and he must be able to justify his claim by the
clearest grant of organic or statute law.[28] Private respondent is claiming for a refund of
the alleged overpayment of tax on royalties; however, there is nothing on record to
support a claim that the tax on royalties under the RP-US Tax Treaty is paid under
similar circumstances as the tax on royalties under the RP-West Germany Tax Treaty.
WHEREFORE, for all the foregoing, the instant petition is GRANTED. The decision
dated May 7, 1996 of the Court of Tax Appeals and the decision dated November 7,
1996 of the Court of Appeals are hereby SET ASIDE.
SO ORDERED.
Vitug, Panganiban, and Purisima JJ., concur.
Romero (Chairman), J., abroad, on official business leave.
G.R. No. 188550 August 19, 2013
DEUTSCHE BANK AG MANILA BRANCH, PETITIONER,
vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
DECISION
SERENO, CJ.:
This is a Petition for Review1 filed by Deutsche Bank AG Manila Branch (petitioner)
under Rule 45 of the 1997 Rules of Civil Procedure assailing the Court of Tax Appeals
En Banc (CTA En Banc) Decision2 dated 29 May 2009 and Resolution3 dated 1 July
2009 in C.T.A. EB No. 456.
THE FACTS
In accordance with Section 28(A)(5)4 of the National Internal Revenue Code (NIRC) of
1997, petitioner withheld and remitted to respondent on 21 October 2003 the amount of
PHP 67,688,553.51, which represented the fifteen percent (15%) branch profit remittance
tax (BPRT) on its regular banking unit (RBU) net income remitted to Deutsche Bank
Germany (DB Germany) for 2002 and prior taxable years.5
Believing that it made an overpayment of the BPRT, petitioner filed with the BIR Large
Taxpayers Assessment and Investigation Division on 4 October 2005 an administrative
claim for refund or issuance of its tax credit certificate in the total amount of PHP
22,562,851.17. On the same date, petitioner requested from the International Tax Affairs
Division (ITAD) a confirmation of its entitlement to the preferential tax rate of 10% under
the RP-Germany Tax Treaty.6
Alleging the inaction of the BIR on its administrative claim, petitioner filed a Petition for
Review7 with the CTA on 18 October 2005. Petitioner reiterated its claim for the refund or
issuance of its tax credit certificate for the amount of PHP 22,562,851.17 representing
the alleged excess BPRT paid on branch profits remittance to DB Germany.
THE CTA SECOND DIVISION RULING8
After trial on the merits, the CTA Second Division found that petitioner indeed paid the
total amount of PHP 67,688,553.51 representing the 15% BPRT on its RBU profits
amounting to PHP 451,257,023.29 for 2002 and prior taxable years. Records also
disclose that for the year 2003, petitioner remitted to DB Germany the amount of EURO
5,174,847.38 (or PHP 330,175,961.88 at the exchange rate of PHP 63.804:1 EURO),
which is net of the 15% BPRT.
However, the claim of petitioner for a refund was denied on the ground that the
application for a tax treaty relief was not filed with ITAD prior to the payment by the
former of its BPRT and actual remittance of its branch profits to DB Germany, or prior to
its availment of the preferential rate of ten percent (10%) under the RP-Germany Tax
Treaty provision. The court a quo held that petitioner violated the fifteen (15) day period
mandated under Section III paragraph (2) of Revenue Memorandum Order (RMO) No. 1-
2000.
Further, the CTA Second Division relied on Mirant (Philippines) Operations Corporation
(formerly Southern Energy Asia-Pacific Operations [Phils.], Inc.) v. Commissioner of
Internal Revenue9 (Mirant) where the CTA En Banc ruled that before the benefits of the
tax treaty may be extended to a foreign corporation wishing to avail itself thereof, the
latter should first invoke the provisions of the tax treaty and prove that they indeed apply
to the corporation.
THE CTA EN BANC RULING10
The CTA En Banc affirmed the CTA Second Division’s Decision dated 29 August 2008
and Resolution dated 14 January 2009. Citing Mirant, the CTA En Banc held that a ruling
from the ITAD of the BIR must be secured prior to the availment of a preferential tax rate
under a tax treaty. Applying the principle of stare decisis et non quieta movere, the CTA
En Banc took into consideration that this Court had denied the Petition in G.R. No.
168531 filed by Mirant for failure to sufficiently show any reversible error in the assailed
judgment.11 The CTA En Banc ruled that once a case has been decided in one way, any
other case involving exactly the same point at issue should be decided in the same
manner.
The court likewise ruled that the 15-day rule for tax treaty relief application under RMO
No. 1-2000 cannot be relaxed for petitioner, unlike in CBK Power Company Limited v.
Commissioner of Internal Revenue.12 In that case, the rule was relaxed and the claim for
refund of excess final withholding taxes was partially granted. While it issued a ruling to
CBK Power Company Limited after the payment of withholding taxes, the ITAD did not
issue any ruling to petitioner even if it filed a request for confirmation on 4 October 2005
that the remittance of branch profits to DB Germany is subject to a preferential tax rate of
10% pursuant to Article 10 of the RP-Germany Tax Treaty.
ISSUE
This Court is now confronted with the issue of whether the failure to strictly comply with
RMO No. 1-2000 will deprive persons or corporations of the benefit of a tax treaty.
THE COURT’S RULING
The Petition is meritorious.
Under Section 28(A)(5) of the NIRC, any profit remitted to its head office shall be subject
to a tax of 15% based on the total profits applied for or earmarked for remittance without
any deduction of the tax component. However, petitioner invokes paragraph 6, Article 10
of the RP-Germany Tax Treaty, which provides that where a resident of the Federal
Republic of Germany has a branch in the Republic of the Philippines, this branch may be
subjected to the branch profits remittance tax withheld at source in accordance with
Philippine law but shall not exceed 10% of the gross amount of the profits remitted by
that branch to the head office.
By virtue of the RP-Germany Tax Treaty, we are bound to extend to a branch in the
Philippines, remitting to its head office in Germany, the benefit of a preferential rate
equivalent to 10% BPRT.
On the other hand, the BIR issued RMO No. 1-2000, which requires that any availment of
the tax treaty relief must be preceded by an application with ITAD at least 15 days before
the transaction. The Order was issued to streamline the processing of the application of
tax treaty relief in order to improve efficiency and service to the taxpayers. Further, it also
aims to prevent the consequences of an erroneous interpretation and/or application of
the treaty provisions (i.e., filing a claim for a tax refund/credit for the overpayment of
taxes or for deficiency tax liabilities for underpayment). 13
The crux of the controversy lies in the implementation of RMO No. 1-2000.
Petitioner argues that, considering that it has met all the conditions under Article 10 of
the RP-Germany Tax Treaty, the CTA erred in denying its claim solely on the basis of
RMO No. 1-2000. The filing of a tax treaty relief application is not a condition precedent
to the availment of a preferential tax rate. Further, petitioner posits that, contrary to the
ruling of the CTA, Mirant is not a binding judicial precedent to deny a claim for refund
solely on the basis of noncompliance with RMO No. 1-2000.
Respondent counters that the requirement of prior application under RMO No. 1-2000 is
mandatory in character. RMO No. 1-2000 was issued pursuant to the unquestioned
authority of the Secretary of Finance to promulgate rules and regulations for the effective
implementation of the NIRC. Thus, courts cannot ignore administrative issuances which
partakes the nature of a statute and have in their favor a presumption of legality.
The CTA ruled that prior application for a tax treaty relief is mandatory, and
noncompliance with this prerequisite is fatal to the taxpayer’s availment of the
preferential tax rate.
We disagree.
A minute resolution is not a binding precedent
At the outset, this Court’s minute resolution on Mirant is not a binding precedent. The
Court has clarified this matter in Philippine Health Care Providers, Inc. v. Commissioner
of Internal Revenue14 as follows:
It is true that, although contained in a minute resolution, our dismissal of the petition was
a disposition of the merits of the case. When we dismissed the petition, we effectively
affirmed the CA ruling being questioned. As a result, our ruling in that case has already
become final. When a minute resolution denies or dismisses a petition for failure to
comply with formal and substantive requirements, the challenged decision, together with
its findings of fact and legal conclusions, are deemed sustained. But what is its effect on
other cases?
With respect to the same subject matter and the same issues concerning the same
parties, it constitutes res judicata. However, if other parties or another subject matter
(even with the same parties and issues) is involved, the minute resolution is not binding
precedent. Thus, in CIR v. Baier-Nickel, the Court noted that a previous case, CIR v.
Baier-Nickel involving the same parties and the same issues, was previously disposed of
by the Court thru a minute resolution dated February 17, 2003 sustaining the ruling of the
CA. Nonetheless, the Court ruled that the previous case "ha(d) no bearing" on the latter
case because the two cases involved different subject matters as they were concerned
with the taxable income of different taxable years.
Besides, there are substantial, not simply formal, distinctions between a minute
resolution and a decision. The constitutional requirement under the first paragraph of
Section 14, Article VIII of the Constitution that the facts and the law on which the
judgment is based must be expressed clearly and distinctly applies only to decisions, not
to minute resolutions. A minute resolution is signed only by the clerk of court by authority
of the justices, unlike a decision. It does not require the certification of the Chief Justice.
Moreover, unlike decisions, minute resolutions are not published in the Philippine
Reports. Finally, the proviso of Section 4(3) of Article VIII speaks of a decision. Indeed,
as a rule, this Court lays down doctrines or principles of law which constitute binding
precedent in a decision duly signed by the members of the Court and certified by the
Chief Justice. (Emphasis supplied)
Even if we had affirmed the CTA in Mirant, the doctrine laid down in that Decision cannot
bind this Court in cases of a similar nature. There are differences in parties, taxes,
taxable periods, and treaties involved; more importantly, the disposition of that case was
made only through a minute resolution.
Tax Treaty vs. RMO No. 1-2000
Our Constitution provides for adherence to the general principles of international law as
part of the law of the land.15The time-honored international principle of pacta sunt
servanda demands the performance in good faith of treaty obligations on the part of the
states that enter into the agreement. Every treaty in force is binding upon the parties, and
obligations under the treaty must be performed by them in good faith.16 More importantly,
treaties have the force and effect of law in this jurisdiction.17
Tax treaties are entered into "to reconcile the national fiscal legislations of the contracting
parties and, in turn, help the taxpayer avoid simultaneous taxations in two different
jurisdictions."18 CIR v. S.C. Johnson and Son, Inc. further clarifies that "tax conventions
are drafted with a view towards the elimination of international juridical double taxation,
which is defined as the imposition of comparable taxes in two or more states on the
same taxpayer in respect of the same subject matter and for identical periods. The
apparent rationale for doing away with double taxation is to encourage the free flow of
goods and services and the movement of capital, technology and persons between
countries, conditions deemed vital in creating robust and dynamic economies. Foreign
investments will only thrive in a fairly predictable and reasonable international investment
climate and the protection against double taxation is crucial in creating such a climate." 19
Simply put, tax treaties are entered into to minimize, if not eliminate the harshness of
international juridical double taxation, which is why they are also known as double tax
treaty or double tax agreements.
"A state that has contracted valid international obligations is bound to make in its
legislations those modifications that may be necessary to ensure the fulfillment of the
obligations undertaken."20 Thus, laws and issuances must ensure that the reliefs granted
under tax treaties are accorded to the parties entitled thereto. The BIR must not impose
additional requirements that would negate the availment of the reliefs provided for under
international agreements. More so, when the RP-Germany Tax Treaty does not provide
for any pre-requisite for the availment of the benefits under said agreement.
Likewise, it must be stressed that there is nothing in RMO No. 1-2000 which would
indicate a deprivation of entitlement to a tax treaty relief for failure to comply with the 15-
day period. We recognize the clear intention of the BIR in implementing RMO No. 1-
2000, but the CTA’s outright denial of a tax treaty relief for failure to strictly comply with
the prescribed period is not in harmony with the objectives of the contracting state to
ensure that the benefits granted under tax treaties are enjoyed by duly entitled persons
or corporations.
Bearing in mind the rationale of tax treaties, the period of application for the availment of
tax treaty relief as required by RMO No. 1-2000 should not operate to divest entitlement
to the relief as it would constitute a violation of the duty required by good faith in
complying with a tax treaty. The denial of the availment of tax relief for the failure of a
taxpayer to apply within the prescribed period under the administrative issuance would
impair the value of the tax treaty. At most, the application for a tax treaty relief from the
BIR should merely operate to confirm the entitlement of the taxpayer to the relief.
The obligation to comply with a tax treaty must take precedence over the objective of
RMO No. 1-2000.1âwphi1 Logically, noncompliance with tax treaties has negative
implications on international relations, and unduly discourages foreign investors. While
the consequences sought to be prevented by RMO No. 1-2000 involve an administrative
procedure, these may be remedied through other system management processes, e.g.,
the imposition of a fine or penalty. But we cannot totally deprive those who are entitled to
the benefit of a treaty for failure to strictly comply with an administrative issuance
requiring prior application for tax treaty relief.
Prior Application vs. Claim for Refund
Again, RMO No. 1-2000 was implemented to obviate any erroneous interpretation and/or
application of the treaty provisions. The objective of the BIR is to forestall assessments
against corporations who erroneously availed themselves of the benefits of the tax treaty
but are not legally entitled thereto, as well as to save such investors from the tedious
process of claims for a refund due to an inaccurate application of the tax treaty
provisions. However, as earlier discussed, noncompliance with the 15-day period for
prior application should not operate to automatically divest entitlement to the tax treaty
relief especially in claims for refund.
The underlying principle of prior application with the BIR becomes moot in refund cases,
such as the present case, where the very basis of the claim is erroneous or there is
excessive payment arising from non-availment of a tax treaty relief at the first instance. In
this case, petitioner should not be faulted for not complying with RMO No. 1-2000 prior to
the transaction. It could not have applied for a tax treaty relief within the period
prescribed, or 15 days prior to the payment of its BPRT, precisely because it erroneously
paid the BPRT not on the basis of the preferential tax rate under
the RP-Germany Tax Treaty, but on the regular rate as prescribed by the NIRC. Hence,
the prior application requirement becomes illogical. Therefore, the fact that petitioner
invoked the provisions of the RP-Germany Tax Treaty when it requested for a
confirmation from the ITAD before filing an administrative claim for a refund should be
deemed substantial compliance with RMO No. 1-2000.
Corollary thereto, Section 22921 of the NIRC provides the taxpayer a remedy for tax
recovery when there has been an erroneous payment of tax.1âwphi1 The outright denial
of petitioner’s claim for a refund, on the sole ground of failure to apply for a tax treaty
relief prior to the payment of the BPRT, would defeat the purpose of Section 229.
Petitioner is entitled to a refund
It is significant to emphasize that petitioner applied – though belatedly – for a tax treaty
relief, in substantial compliance with RMO No. 1-2000. A ruling by the BIR would have
confirmed whether petitioner was entitled to the lower rate of 10% BPRT pursuant to the
RP-Germany Tax Treaty.
WHEREFORE, premises considered, the instant Petition is GRANTED. Accordingly, the
Court of Tax Appeals En Banc Decision dated 29 May 2009 and Resolution dated 1 July
2009 are REVERSED and SET ASIDE. A new one is hereby entered ordering
respondent Commissioner of Internal Revenue to refund or issue a tax credit certificate in
favor of petitioner Deutsche Bank AG Manila Branch the amount of TWENTY TWO
MILLION FIVE HUNDRED SIXTY TWO THOUSAND EIGHT HUNDRED FIFTY ONE
PESOS AND SEVENTEEN CENTAVOS (PHP 22,562,851.17), Philippine currency,
representing the erroneously paid BPRT for 2002 and prior taxable years.
SO ORDERED.

Nevertheless, even without the BIR ruling, the CTA Second Division found as follows:

Based on the evidence presented, both documentary and testimonial, petitioner was able
to establish the following facts:

a. That petitioner is a branch office in the Philippines of Deutsche Bank AG, a

corporation organized and existing under the laws of the Federal Republic of
Germany;

b. That on October 21, 2003, it filed its Monthly Remittance Return of Final
Income Taxes Withheld under BIR Form No. 1601-F and remitted the amount of
₱67,688,553.51 as branch profits remittance tax with the BIR; and

c. That on October 29, 2003, the Bangko Sentral ng Pilipinas having issued a
clearance, petitioner remitted to Frankfurt Head Office the amount of
EUR5,174,847.38 (or ₱330,175,961.88 at 63.804 Peso/Euro) representing its
2002 profits remittance.22

The amount of PHP 67,688,553.51 paid by petitioner represented the 15% BPRT on its
RBU net income, due for remittance to DB Germany amounting to PHP 451,257,023.29
for 2002 and prior taxable years.23

Likewise, both the administrative and the judicial actions were filed within the two-year
prescriptive period pursuant to Section 229 of the NIRC.24

Clearly, there is no reason to deprive petitioner of the benefit of a preferential tax rate of
10% BPRT in accordance with the RP-Germany Tax Treaty.

Petitioner is liable to pay only the amount of PHP 45,125,702.34 on its RBU net income
amounting to PHP 451,257,023.29 for 2002 and prior taxable years, applying the 10%
BPRT. Thus, it is proper to grant petitioner a refund ofthe difference between the PHP
67,688,553.51 (15% BPRT) and PHP 45,125,702.34 (10% BPRT) or a total of PHP
22,562,851.17.