CHAPTER 4
entrance fee as nontaxable. The rent expense and travel
COLLECTOR VS HENDERSON
FACTS:
• Sps. Arthur Henderson and Marie Henderson filed their
annual income tax with the BIR. Arthur is president of
American International Underwriters for the Philippines,
Inc., which is a domestic corporation engaged in the
business of general non-life insurance, and represents a
group of American insurance companies engaged in the
business of general non-life insurance.
• The BIR demanded payment for alleged deficiency
taxes. In their computation, the BIR included as part of
taxable income: 1) Arthur’s allowances for rental,
residential expenses, subsistence, water, electricity and
telephone expenses 2) entrance fee to the Marikina Gun
and Country Club which was paid by his employer for his
account and 3) travelling allowance of his wife
• The taxpayers justifications are as follows:
1) as to allowances for rental and utilities, Arthur did not
receive money for the allowances. Instead, the apartment
is furnished and paid for by his employer-corporation (the
mother company of American International), for the
employer corporation’s purposes. The spouses had no
choice but to live in the expensive apartment, since the
company used it to entertain guests, to accommodate
officials, and to entertain customers. According to
taxpayers, only P 4,800 per year is the reasonable amount
that the spouses would be spending on rental if they were
not required to live in those apartments. Thus, it is the
amount they deem is subject to tax. The excess is to be
treated as expense of the company.
2) The entrance fee should not be considered income since
it is an expense of his employer, and membership therein
is merely incidental to his duties of increasing and
sustaining the business of his employer.
3) His wife merely accompanied him to New York on a
business trip as his secretary, and at the employer-
corporation’s request, for the wife to look at details of the
plans of a building that his employer intended to
construct. Such must not be considered taxable income.
• The Collector of Internal Revenue merely allowed the
expenses were still held to be taxable. The Court of Tax
Appeals ruled in favor of the taxpayers, that such
expenses must not be considered part of taxable income.
Letters of the wife while in New York concerning the
proposed building were presented as evidence.
ISSUE: Whether or not the rental allowances and
travel allowances furnished and given by the
employer-corporation are part of taxable income?
HELD: NO. Such claims are substantially supported
by evidence.
These claims are therefore NOT part of taxable income.
No part of the allowances in question redounded to their
personal benefit, nor were such amounts retained by them.
These bills were paid directly by the employer-
corporation to the creditors. The rental expenses and
subsistence allowances are to be considered not subject to
income tax. Arthur’s high executive position and social
standing, demanded and compelled the couple to live in a
more spacious and expensive quarters. Such ‘subsistence
allowance’ was a SEPARATE account from the account
for salaries and wages of employees. The company did
not charge rentals as deductible from the salaries of the
employees. These expenses are COMPANY EXPENSES,
not income by employees which are subject to tax.
CIR VS PAGCOR
FACTS:
Respondent Philippine Amusement and Gaming
Corporation (PAGCOR) has operated under a legislative
franchise granted by Presidential Decree No. 1869 (P.O.
No. 1869), its Charter,4 whose Section 13(2) provides
that:
(2) Income and other Taxes - (a) Franchise Holder:
No tax of any kind or form, income or otherwise, as
well as fees, charges or levies of whatever nature,
whether National or Local, shall he assessed and
collected under this Franchise from the Corporation;
nor shall any form of tax or charge attach in any way
to the earnings of the Corporation, except a Franchise
Tax of five percent (S(X1) of the gross revenue or
earnings derived by the Corporation from its
operation under this Franchise. Such tax shall be due
and payable quarterly to the National Government and
shall be in lieu of all kinds of taxes, levies, fees or
assessments of any kind, nature or description, levied,
established or collected by any municipal, provincial or
national government authority. (bold emphasis supplied)
Notwithstanding the aforesaid 5% franchise tax imposed,
the Bureau of Internal Revenue (BIR) issued several
assessments against PAGCOR for alleged deficiency
value-added tax (VAT), final withholding tax on fringe
benefits, and expanded withholding tax, as follows:
On December 18, 2002, PAGCOR filed a letter-protest
with the BIR against Assessment Notice No. 33-
1996/1997 /1998 and Assessment Notice No. 33-99.8
On March 31, 2003, PAGCOR filed a letter-protest
against Assessment Notice No. 33-2000, in which it
reiterated the asse1iions made in its December 18, 2002
letter-protest.9
In reply to both letters-protest, the BIR requested
PAGCOR to submit additional documents to enable the
conduct of the reinvestigation.10
The CIR did not act on PAGCOR’s letter-protest against
Assessment Notice No. 33-1996/1997 /1998 and
Assessment Notice No. 33-99 within the 180-day period
from the latter's submission of additional
11
documents. Hence, PAGCOR filed an appeal with the
Secretary of Justice on January 5, 2004 relative to
Assessment Notice No. 33-1996/1997 /1998 and
Assessment Notice No. 33-99.12
Meanwhile, in response to PAGCOR’s letter-protest
dated March 31, 2003, BIR Regional Director Teodorica
Arcega issued a letter dated December 15, 2003
reiterating the assessment for deficiency VAT for taxable
year 2000,13stating thusly:
In a memorandum to the Regional Director dated
December 15, 2003 the Chief Legal Division, this Region,
confirmed the taxability of PAGCOR under Section
108(A) of the 1997 Tax Code, as amended, effective Jan.
1, 1996 (VAT Review Committee Ruling No. 041-2001
).
In view of the confirmation of the Legal Division we
hereby reiterate the assessments forwarded to your office
under Final Assessment No. 33-2000 dated March 18,
2003 amounting to ₱2,097,426,943.00.
However, the BIR only recomputed the deficiency final
withholding tax on fringe benefits and expanded
withholding tax, and reduced the assessments to ₱l2,212,
199.85 and ₱6,959,525. l0, respectively.14
PAGCOR elevated its protest against Assessment Notice
No. 33-2000 to the CIR, but the 180-day period prescribed
by law also lapsed without any action on the part of the
CIR.15 Consequently, on August 4, 2004, PAGCOR
brought another appeal to the Secretary of Justice
covering Assessment Notice No. 33-2000.16
The Secretary of Justice consolidated PAGCOR's two
appeals.
After the parties traded pleadings, the Secretary of Justice
summoned them to a preliminary conference to
discuss, inter alia, any possible settlement or
compromise.17 When no amicable settlement was
reached, the consolidated appeals were considered
submitted for resolution.18
On December 22, 2006, Secretary of Justice Raul M.
Gonzales rendered the first assailed resolution declaring
PAGCOR exempt from the payment of all taxes except
the 5% franchise tax provided in its Charter.19
On March 12, 2007, Secretary Gonzales issued the second
assailed resolution denying the CIR's motion for
reconsideration.20
Hence, this special civil action for certiorari.
ISSUE:
whether or not PAGCOR is liable for the payment of
withholding taxes.
RULING:
YES:
The recomputed assessment for deficiency final
withholding taxes related to the car plan granted to
PAGCOR's employees and for its payment of
membership dues and fees.
Under Section 33 of the NIRC, FBT is imposed as:
A final tax of thirty-four percent (34%) effective January
1, 1998; thirty-three percent (33%) effective January 1,
1999; and thirty-two percent (32%) effective January 1,
2000 and thereafter, is hereby imposed on the grossed-up
monetary value of fringe benefit furnished or granted to
the employee (except rank and file employees as defined
herein) by the employer, whether an individual or a
corporation (unless the fringe benefit is required by the
nature of, or necessary to the trade, business or profession
of the employer, or when the fringe benefit is for the
convenience or advantage of the employer). The tax
herein imposed is payable by the employer which tax shall
be paid in the same manner as provided for under Section
57 (A) of this Code.
FBT is treated as a final income tax on the employee that
shall be withheld and paid by the employer on a calendar
quarterly basis.45 As such, PAGCOR is a mere
withholding agent inasmuch as the FBT is imposed on
PAGCOR's employees who receive the fringe benefit.
PAGCOR's liability as a withholding agent is not covered
by the tax exemptions under its Charter.
The car plan extended by PAGCOR to its qualified
officers is evidently considered a fringe benefit46 as
defined under Section 33 of the NIRC. To avoid the
imposition of the FBT on the benefit received by the
employee, and, consequently, to avoid the withholding of
the payment thereof by the employer, PAGCOR must
sufficiently establish that the fringe benefit is required by
the nature of, or is necessary to the trade, business or
profession of the employer, or when the fringe benefit is
for the convenience or advantage of the employer.
PAGCOR asserted that the car plan was granted "not only
because it was necessary to the nature of the trade of
PAGCOR but it was also granted for its
convenience."47 The records are lacking in proof as to
whether such benefit granted to PAGCOR's officers were,
in fact, necessary for PAGCOR's business or for its
convenience and advantage. Accordingly, PAGCOR
should have withheld the FBT from the officers who have
availed themselves of the benefits of the car plan and
remitted the same to the BIR.
As for the payment of the membership dues and fees, the
Court finds that this is not considered a fringe benefit that
is subject to FBT and which holds PAGCOR liable for
final withholding tax. According to PAGCOR, the
membership dues and fees are:
57. x x x expenses borne by [respondent] to cover various
memberships in social, athletic clubs and similar
organizations. x x x
58. Respondent's nature of business is casino operations
and it derives business from its customers who play at the
casinos. In furtherance of its business, PAGCOR usually
attends its VIP customers, amenities such as playing
rights to golf clubs. The membership of PAGCOR to
these golf clubs and other organizations are intended to
benefit respondent's customers and not its employees.
Aside from this, the membership is under the name of
PAGCOR, and as such, cannot be considered as fringe
benefits because it is the customers and not the employees
of PAGCOR who benefit from such memberships.48
Considering that the payments of membership dues and
fees are not borne by PAGCOR for its employees, they
cannot be considered as fringe benefits which are subject
to FBT under Section 33 of the NIRC. Hence, PAGCOR
is not liable to withhold FBT from its employees.
COM. VS SMITH (US CASE)
Syllabus
An employer gave to its employee as compensation for
his services an option to purchase shares of stock at a price
not less than the then value of the stock. The option had
no value at that time, and the compensation contemplated
by the parties was the transfer to the employee of the
shares of stock after their value had increased to more
than the option price.
Held, under § 22(a) of the Revenue Act of 1938 and of the
Internal Revenue Code, the employee received
"compensation for personal service," and hence taxable
income in each year in which stock was acquired, through
effective exercise of the option in that year, in the amount
of the difference between the pt.ion price and the then
market value of the stock.
COMMISSIONER VS CA
301 SCRA 152 – Business Organization – Corporation
Law – Trust Fund Doctrine
Don Andres Soriano (American), founder of A. Soriano
Corp. (ASC) had a total shareholdings of 185,154 shares.
Broken down, the shares comprise of 50,495 shares which
were of original issue when the corporation was founded
and 134,659 shares as stock dividend declarations. So in
1964 when Soriano died, half of the shares he held went
to his wife as her conjugal share (wife’s “legitime”) and
the other half (92,577 shares, which is further broken
down to 25,247.5 original issue shares and 82,752.5 stock
dividend shares) went to the estate. For sometime after his
death, his estate still continued to receive stock dividends
from ASC until it grew to at least 108,000 shares.
In 1968, ASC through its Board issued a resolution for the
redemption of shares from Soriano’s estate purportedly
for the planned “Filipinization” of ASC. Eventually,
108,000 shares were redeemed from the Soriano Estate.
In 1973, a tax audit was conducted. Eventually, the
Commissioner of Internal Revenue (CIR) issued an
assessment against ASC for deficiency withholding tax-
at-source. The CIR explained that when the redemption
was made, the estate profited (because ASC would have
to pay the estate to redeem), and so ASC would have
withheld tax payments from the Soriano Estate yet it
remitted no such withheld tax to the government.
ASC averred that it is not duty bound to withhold tax from
the estate because it redeemed the said shares for purposes
of “Filipinization” of ASC and also to reduce its
remittance abroad.
ISSUE: Whether or not ASC’s arguments are tenable.
HELD: No. The reason behind the redemption is not
material. The proceeds from a redemption is taxable and
ASC is duty bound to withhold the tax at source. The
Soriano Estate definitely profited from the redemption
and such profit is taxable, and again, ASC had the duty to
withhold the tax. There was a total of 108,000 shares
redeemed from the estate. 25,247.5 of that was original
issue from the capital of ASC. The rest (82,752.5) of the
shares are deemed to have been from stock dividend
shares. Sale of stock dividends is taxable. It is also to be
noted that in the absence of evidence to the contrary, the
Tax Code presumes that every distribution of corporate
property, in whole or in part, is made out of corporate
profits such as stock dividends.
It cannot be argued that all the 108,000 shares were
distributed from the capital of ASC and that the latter is
merely redeeming them as such. The capital cannot be
distributed in the form of redemption of stock dividends
without violating the trust fund doctrine — wherein the
capital stock, property and other assets of the corporation
are regarded as equity in trust for the payment of the
corporate creditors. Once capital, it is always capital. That
doctrine was intended for the protection of corporate
creditors.
BACHRACH VS. SIEFERT (XPN TO RULE THAT
STOCK DIVIDENDS ARE NOT TAXABLE AS THEY
ARE STIL UNREALIZED GAIN)
Facts:
The deceased E. M. Bachrach, who left no forced heir
except his widow Mary McDonald Bachrach, in his last
will and testament made various legacies in cash and
willed the remainder of his estate. The estate of E. M.
Bachrach, as owner of 108,000 shares of stock of the
Atok-Big Wedge Mining Co., Inc., received from the
latter 54,000 shares representing 50 per cent stock
dividend on the said 108,000 shares. On June 10, 1948,
Mary McDonald Bachrach, as usufructuary or life tenant
of the estate, petitioned the lower court to authorize the
Peoples Bank and Trust Company, as administrator of the
estate of E. M. Bachrach, to transfer to her the said 54,000
shares of stock dividend by indorsing and delivering to
her the corresponding certificate of stock, claiming that
said dividend, although paid out in the form of stock, is
fruit or income and therefore belonged to her as
usufructuary or life tenant. Sophie Siefert and Elisa
Elianoff, legal heirs of the deceased, opposed said petition
on the ground that the stock dividend in question was not
income but formed part of the capital and therefore
belonged not to the usufructuary but to the remainderman.
While appellants admit that a cash dividend is an income,
they contend that a stock dividend is not, but merely
represents an addition to the invested capital.
Issue:
Whether or not a dividend is an income and whether it
should go to the usufructuary.
Held:
The usufructuary shall be entitled to receive all the
natural, industrial, and civil fruits of the property in
usufruct. The 108,000 shares of stock are part of the
property in usufruct. The 54,000 shares of stock dividend
are civil fruits of the original investment. They represent
profits, and the delivery of the certificate of stock
covering said dividend is equivalent to the payment of
said profits. Said shares may be sold independently of the
original shares, just as the offspring of a domestic animal
may be sold independently of its mother. If the dividend
be in fact a profit, although declared in stock, it should be
held to be income. A dividend, whether in the form of
cash or stock, is income and, consequently, should go to
the usufructuary, taking into consideration that a stock
dividend as well as a cash dividend can be declared only
out of profits of the corporation, for if it were declared out
of the capital it would be a serious violation of the law.
Under the Massachusetts rule, a stock dividend is
considered part of the capital and belongs to the
remainderman; while under the Pennsylvania rule, all
earnings of a corporation, when declared as dividends in
whatever form, made during the lifetime of the
usufructuary, belong to the latter. The Pennsylvania rule
is more in accord with our statutory laws than the
Massachusetts rule.
COMMISSIONER VS MANNING (XPN TO RULE
THAT STOCK DIVIDENDS ARE NOT TAXABLE AS
THEY ARE STIL UNREALIZED GAIN)
FACTS:
Manila Trading and Supply Co. (MANTRASCO) had an
authorized capital stock of P2.5 million divided into
25,000 common shares: 24,700 were owned by Reese and
the rest at 100 shares each by the Respondents. Reese
entered into a trust agreement whereby it is stated that
upon Reese’s death, the company would purchase back all
of its shares. Reese died. MANTRASCO repurchased the
24,700 shares. Thereafter, a resolution was passed
authorizing that the 24,700 shares be declared as stock
dividends to be distributed to the stockholders. The BIR
ordered an examination of MANTRASCO’s books and
discovered that the 24,700 shares declared as dividends
were not disclosed by respondents as part of their taxable
income for the year 1958. Hence, the CIR issued notices
of assessment for deficiency income taxes to respondents.
Respondents protested but the CIR denied. Respondents
appealed to the CTA. The CTA ruled in their favor.
Hence, this petition by the CIR
ISSUE:
Whether the respondents are liable for deficiency income
taxes on the stock dividends?
HELD: Dividends means any distribution made by a
corporation to its shareholders out of its earnings or
profits. Stock dividends which represent transfer of
surplus to capital account is not subject to income tax. But
if a corporation redeems stock issued so as to make a
distribution, this is essentially equivalent to the
distribution of a taxable dividend the amount so
distributed in the redemption considered as taxable
income.
The distinctions between a stock dividend which does not
and one which does constitute taxable income to the
shareholders is that a stock dividend constitutes income if
its gives the shareholder an interest different from that
which his former stockholdings represented. On the other
hand, it does constitute income if the new shares confer
no different rights or interests than did the old shares.
Therefore, whenever the companies involved parted with
a portion of their earnings to bnuy the corporate holdings
of Reese, they were making a distribution of such
earnings to respondents. These amounts are thus subject
to income tax as a flow of cash benefits to respondents.
Hence, respondents are liable for deficiency income
taxes.
*CIR VS GOODYEAR PHILS. INC.
Respondent Goodyear PH redeemed the preferred shares
held by Goodyear Tire and Rubber Company (Goodyear
US), a corporation incorporated in the United States. The
preferred shares were redeemed at a price equivalent to its
aggregate par value plus accrued and unpaid dividends.
Before the payment of the redemption price, Goodyear
PH and Goodyear US jointly filed a Tax Treaty Relief
Application (TTRA) with the Bureau of Internal Revenue
(BIR) claiming tax exemption of the gain derived from
the redemption, pursuant to the Treaty.
However, notwithstanding the TTRA, by taking a
conservative position, Goodyear PH withheld and
remitted to the BIR a 15% FWHT2 on dividends based on
the difference between the redemption price and the
aggregate par value of the shares redeemed.
Goodyear PH filed a claim for refund of the 15% FWHT
with the BIR. Goodyear PH then filed a Petition for
Review with the CTA.
The Commissioner of Internal Revenue argued, among
other issues, that the excess of the redemption price over
the par value of the shares should be taxable as dividend,
subject to the 15% FWHT.
The CTA ruled that, as a general matter, when preferred
shares are redeemed and classified as treasury shares, the
net capital gain on the redemption is subject to the 5%-
10% CGT.3 For foreign corporations, such as Goodyear
US, the capital gain from sale of shares of stock not traded
in the stock exchange, that are reclassified as treasury
shares, is subject to the 5%-10% CGT, pursuant to Section
28(B)(5)(c) of the Tax Code, but subject to the provisions
of the Treaty. Article 14 of the Treaty provides for
exclusive resident country taxation on gains from the sale
of shares of stock of a Philippine company, provided the
Philippine corporation's assets do not consist principally
of real property interest located in the Philippines. This
criterion was met by Goodyear PH. Accordingly the net
capital gain derived by Goodyear US from the redemption
of its shares is exempt from the CGT.
The CTA ruled that the net capital gain (or the component
of the redemption price equivalent to the “accrued and
unpaid dividends”) cannot be treated as dividend subject
to the 15% FWHT, since an ordinary dividend is a
distribution in the nature of a recurring return of stock,
made in the ordinary course of business and with intent to
maintain the corporation as a going concern. On the other
hand, a distribution made when the corporation is winding
up its business or recapitalizing and narrowing its
activities may be treated as a complete or partial
liquidation and as payment for the stockholder's stock. In
those cases, the excess of the purchase price over the
original acquisition cost of the shares should be
considered as a capital gain and subject to ordinary
income tax rates.
Goodyear US's net capital gain could not be classified as
dividends since it did not come from the corporation's
unrestricted retained earnings or profits and did not
represent a recurring return on the shares redeemed.
Without the redemption, Goodyear US would not have
derived the net capital gain.
The CTA elaborated further that the only instance where
the gain derived from redemption may be treated as a
dividend is the case of redemption of stock dividends,
whether pursuant to a partial or complete liquidation.
Accordingly, if a corporation cancels or redeems stock
issued as a dividend at such time and in such manner as
to make the distribution and cancellation or redemption,
in whole or in part, essentially equivalent to the
distribution of a taxable dividend, the amount so
distributed in redemption or cancellation of the stock will
be considered as taxable income to the extent of earnings
or profits.
WISE & CO., INC VS. MEER
FACTS:
That during the year 1937, plaintiffs, except Mr. E.M.G.
Strickland (who, as husband of the plaintiff Mrs. E.M.G.
Strickland, is only a nominal party herein), were
stockholders of Manila Wine Merchants, Ltd., a foreign
corporation duly authorized to do business in the
Philippines.
That on May 27, 1937, the Board of Directors of Manila
Wine Merchants, Ltd., (hereinafter referred to as the
Hongkong Company), recommended to the stockholders
of the company that they adopt the resolutions necessary
to enable the company to sell its business and assets to
Manila Wine Merchants, Inc., a Philippine corporation
formed on May 27, 1937, (hereinafter referred to as the
Manila Company), for the sum of P400,000;
HK Company made a distribution of its earnings for the
year 1937 to its stockholders (Dividends declared and
paid on June 8, 1937). HK Company paid Philippine
income tax on the entire earnings from which the said
distributions were paid.
After the June 8 distribution, HK Company had :
P74, 182 – surplus resulting from the active conduct of
business
P270, 116 – total increased surplus as a result of the sale
of the business and assets
The stockholders by proper resolution directed that the
company be voluntarily liquidated and its capital
distributed among the stockholders; that the stockholders
at such meeting appointed a liquidator duly paid off the
remaining debts of the Hongkong Company and
distributed its capital among the stockholders including
plaintiffs; that the liquidator duly filed his accounting on
January 12, 1938, and in accordance with the provisions
of Hongkong Law, the Hongkong Company was duly
dissolved at the expiration of three moths from that date.
That plaintiffs duly filed Philippine income tax returns.
That defendant subsequently made the deficiency
assessments. That said plaintiffs duly paid the said
amounts demanded by defendant under written protest,
which was overruled in due course; that the plaintiffs have
since July 1, 1939 requested from defendant a refund of
the said amounts which defendant has refused and still
refuses to refund.
CONTENTIONS:
CIR-The amounts received by Wise & Co et al from the
HK Company were liquidating dividends (thus, subject to
normal tax)
Wise & Co et al say- The amounts were ordinary
dividends
ISSUES:
a)W/N the amounts received by Wise & Co et al from the
HK Company on which the taxes were assessed were
ordinary dividends or liquidating
dividends (LIQUIDATING DIVIDENDS)
b)W/N such liquidating dividends are taxable income
(YES)
RATIO:
a)The amounts received by the stockholders were
liquidating dividends
•The parties agreed in the deed of sale that the sale and complete or partial liquidation and as payment by the
transfer shall take effect as of June 1, 1937. Thus, the corporation to the stockholder for his stock. The
distribution of assets to the stockholders made after that corporation is, in the latter instances, wiping out all parts
date must have been considered by them as liquidating of the stockholders' interest in the company . . .. “
dividends.
b) Such liquidating dividends are taxable income
•The said distributions were NOT in the ordinary course
•Income tax law states that: “Where a corporation,
of business and with intent to maintain the corporation as
partnership, association, joint-account, or insurance
a going concern (in which case they would be ordinary
company distributes all of its assets in complete
dividends) BUT they were made after the liquidated of the
liquidation or dissolution, the gain realized or loss
business had been decided upon, which makes them
sustained by the stockholder, whether individual or
payments for the surrender and relinquishment of the
corporation, is a taxable income or a deductible loss as the
stockholder’s interest in the corporation, or liquidating
case may be.”
dividends.
•Amounts distributed in the liquidation of a corporation
•Ordinary connotation of liquidating dividend involves
shall be treated as payments in exchange for the stock or
the distribution of assets by a corporation to its
share, and any gain or profit realized thereby shall be
stockholders upon dissolution.
taxed to the distributee as other gains or profits.
•Wise & Co et al (stockholders) say: It was only on
•The stockholders received the distributions in question in
August 19, 1937, that the HK Company took the first
exchange for the surrender and relinquishment by them of
corporate steps towards liquidation.
their stock in the HK Company which was dissolved and
in process of complete liquidation.
•SC: It was expressly stipulated in the formal deed of sale •That money in the hands of the corporation formed a part
(see underlined portion in facts) that the sale or transfer of its income and was properly taxable to it under the
shall take effect on June 1, 1937. After that date, and until Income Tax Law.
completion of the transfer, the HK Company continued to
•When the corporation was dissolved and in process of
run the business in trust for the new owner, the Manila
complete liquidation and its shareholders surrendered
Company.
their stock to it and it paid the sums in question to them in
•The determining element is whether the distribution was exchange, a transaction took place.
in the ordinary course of business and with intent to
•The shareholder who received the consideration for the
maintain the corporation as a going concern, or after
stock earned that much money as income of his own,
deciding to quit with intent to liquidate the business.
which again was properly taxable to him under the
•The fact that the distributions were called ‘dividends’ Income Tax Law
and were made, in part, from earnings and profits, and that
The profits earned by the stockholders are income from
some of them were made before liquidation or dissolution
Philippine sources, and thus subject to Philippine tax
proceedings were commenced, is NOT controlling.
Stockholders say: the profit realized by them does not
constitute income from Philippine sources and is not
Liquidating dividend v Ordinary dividend subject to Philippine taxes since all steps in the carrying
out of this so-called sale took place outside the Philippines
• The distinction between a distribution in
liquidation and an ordinary dividend is factual; the result
in each case depending on the particular circumstances of
SC:
the case and the intent of the parties.
•The HK Company was at the time of the sale of its
• If the distribution is in the nature of a recurring
business in the Philippines, and the Manila Company was
return on stock it is an ordinary dividend.
a domestic corporation domiciled and doing business also
• However, if the corporation is really winding in the Philippines.
up its business or recapitalizing and narrowing its
•The HK Company was incorporated for the purpose of
activities, the distribution may properly be treated as in
carrying on business in the Philippines which is the
business of wine, beer, and spirit merchants and the other services; the conduct of trade or business or the exercise
objects set out in its memorandum of association. of a profession; dealings in property; interests; rents;
royalties; dividends; annuities; prizes and winnings;
•Hence, its earnings, profits, and assets, including those
pensions; and a partner’s distributive share in the net
from whose proceeds the distributions in question were
income of a general professional partnership. Sec. 34
made, the major part of which consisted in the purchase
enumerates the allowable deductions; Sec. 35, personal
price of thebusiness, had been earned and acquired in the
and additional exemptions.
Philippines.
The definition of gross income is broad enough to include
•As such, it is clear that said distributions were income
all passive incomes subject to specific rates or final taxes.
"from Philippine sources."
However, since these passive incomes are already subject
Judgment affirmed. to different rates and taxed finally at source, they are no
longer included in the computation of gross income,
which determines taxable income.
CIR VS PAL Thus, PAL’s franchise exempts it from paying any tax
Facts: other than the option it chooses: either the “basic
corporate income tax” or the 2% gross revenue tax.
A franchise is a legislative grant to operate a public utility.
In the present case, P.D. 1590 granted PAL an option to
pay the lower of two alternatives: (a) “the basic corporate
income tax based on PAL’s annual net taxable income
computed in accordance with the provisions of the NIRC”
or (b) “a franchise tax of 2% of gross revenues.”
Availment of either of these two alternatives shall exempt
the airline from the payment of “all other taxes” including
the 20 percent final withholding tax on bank deposits. On
Nov. 5, 1997, PAL’s AVP-Revenue filed with the CIR a
written request for refund in the amount of P2M, which
represents the total amount of 20% final withholding tax
withheld from the respondent by various withholding
agent banks. CTA ruled PAL was not entitled to refund.
The CA held that PAL was bound to pay only either (A)
or (B); that Sec. 13 of PD 1590 exempts respondent form
paying all other taxes, duties, royalties and other feeds of
any kind. Having chosen to pay its corporate income tax
liability, respondent should now be exempt from paying
all other taxes including the final withholding tax.
Issue: Whether the CA erred on a question of law ruling
that the “in lieu of all other taxes” provisions in Sec. 13
of PD No. 1590 applies even if there were in fact no taxes
paid under any of subsections (A) and (B) of the said
decree.
Held: Note that the tax liability of PAL under the option
it chose (Item ‘a’ of Sec. 13 of PD 1590) is to be
“computed in accordance with the provisions of the
NIRC”. “Taxable income” means the pertinent items of
gross income specified in the Tax Code, less the
deductions and/or personal and additional exemptions, if
any, authorized for these types of income. Under Sec. 32
of the Tax Code, gross income means income derived
from whatever source, including compensation for
CHAPTER 8
NDC VS COM. -page 159-160
COMMISSIONER VS BOAC
"The source of an income is the property, activity or
service that produced the income. For such source to be
considered as coming from the Philippines, it is sufficient
that the income is derived from activity within the
Philippines."
FACTS: Petitioner CIR seeks a review of the CTA's
decision setting aside petitioner's assessment of
deficiency income taxes against respondent British
Overseas Airways Corporation (BOAC) for the fiscal
years 1959 to 1971. BOAC is a 100% British
Government-owned corporation organized and existing
under the laws of the United Kingdom, and is engaged in
the international airline business. During the periods
covered by the disputed assessments, it is admitted that
BOAC had no landing rights for traffic purposes in the
Philippines. 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. The CTA sided with BOAC
citing that the proceeds of sales of BOAC tickets 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.
ISSUE: Are the revenues derived by BOAC from sales of
ticket for air transportation, while having no landing
rights here, constitute income of BOAC from Philippine
sources, and accordingly, taxable?
HELD: Yes. The source of an income is the property,
activity or service that produced the income. 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.
CALASANZ VS CIR
Facts:
Ursula Calasanz inherited from her father an agricultural
land. Improvements were introduced to make such land
saleable and later in it was sold to the public at a profit.
The Revenue examiner adjudged Ursula and her spouse
as engaged in business as real estate dealers and required
them to pay the real estate dealer’s tax.
Issue:
Whether or not the gains realized from the sale of the lots
are taxable in full as ordinary income or capital gains
taxable at capital gain rates
Ruling:
They are taxable as ordinary income. The activities of
Calasanz are indistinguishable from those invariably
employed by one engaged in the business of selling real
estate. One strong factor is the business element of
development which is very much in evidence. They did
not sell the land in the condition in which they acquired
it. Inherited land which an heir subdivides and makes
improvements several times higher than the original cost
of the land is not a capital asset but an ordinary asses.
Thus, in the course of selling the subdivided lots, they
engaged in the real estate business and accordingly the
gains from the sale of the lots are ordinary income taxable
in full.
TUASON JR. VS LINGAD
FACTS:
The mother of Taxpayer (Petitioner Antonio Tuason)
owned a 7 hectare parcel of land located in the City of
Manila. She subdivided the land into twenty-nine (29)
lots. Possession of the land was eventually inherited by
Taxpayer in 1948.
Taxpayer instructed his attorney-in-fact to sell the lots.
Twenty-eight (28) out of the twenty-nine parcels were all
sold easily. The attorney-in-fact was not able to sell the
twenty-ninth lot (hereinafter Lot 29) immediately because
it was located at a low elevation.
In 1952, Lot 29 was filled, subdivided and gravel roads
were constructed. The small lots were then sold over the
years on a uniform 10-year annual amortization basis. The
attorney-in-fact, did not employ any broker nor did he put
up advertisements in the matter of the sale thereof.
In 1953 and 1954 the Taxpayer reported his income
from the sale of the small lots (P102,050.79 and
P103,468.56, respectively) as long-term capital
gains. The CIR upheld Taxpayer's treatment of this tax.
In his 1957 tax return the Taxpayer as before treated
his income from the sale of the small lots (P119,072.18)
as capital gains. This treatment was initially approved by
the CIR, but by 1963, the CIR reversed itself and
considered the Taxpayer's profits from the sales of the lots
as ordinary gainsc
The CIR assesed a deficiency of P31,095.36 from the
Taxpayer.
Contention of Taxpayer: As he was engaged in the
business of leasing the lots he inherited from his mother
as well other real properties, his subsequent sales of the
mentioned lots cannot be recognized as sales of capital
assets but of “real property used in trade or business of the
taxpayer.”
ISSUE/S:
Whether or not the properties in question which the
Taxpayer had inherited and subsequently sold in small
lots to other persons should be regarded as capital assets.
HELD:
No. It is Ordinary Income
As thus defined by law, CAPITAL ASSETS include all
properties of a taxpayer whether or not connected with his
trade or business, except:
1. stock in trade or other property included in the
taxpayer's inventory;
2. property primarily for sale to customers in the
ordinary course of his trade or business;
3. property used in the trade or business of the
taxpayer and subject to depreciation allowance;
and
4. real property used in trade or business.
If the taxpayer sells or exchanges any of the properties
above, any gain or loss relative thereto is an ordinary gain
or an ordinary loss; the loss or gain from the sale or
exchange of all other properties of the taxpayer is a capital
gain or a capital loss.
Under Section 34(b)(2) of the old Tax Code, if a gain is
realized by a taxpayer (other than a corporation) from the
sale or exchange of capital assets held for more than 12
months, only 50% of the net capital gain shall be taken
into account in computing the net income.
The Tax Code's provisions on so-called long-term capital
gains constitutes a statute of partial exemption. In view of
the familiar and settled rule that tax exemptions are
construed in strictissimi juris against the taxpayer and
liberally in favor of the taxing authority, it is the
taxpayer's burden to bring himself clearly and squarely
within the terms of a tax-exempting statutory provision,
otherwise, all fair doubts will be resolved against him.
In the case at bar, after a thoroughgoing study of all the
circumstances, this Court is of the view and so holds that
Petitioner-Taxpayer's thesis is bereft of merit. Under the
circumstances, Taxpayer's sales of the several lots
forming part of his rental business cannot be characterized
as other than sales of non-capital assets. the sales
concluded on installment basis of the subdivided lots do
not deserve a different characterization for tax purposes.
This Court finds no error in the holding that the income
of the Taxpayer from the sales of the lots in question
should be considered as ordinary income.
CHINA BANKING CORP VS CA
Facts:
China Banking Corporation made a 53% equity
investment (P16,227,851.80) in the First CBC Capital – a
Hongkong subsidiary engaged in financing and
investment with “deposit-taking” function.
It was shown that CBC has become insolvent so China
Banking wrote-off its investment as worthless and treated
it as a bad debt or as an ordinary loss deductible from its
gross income.
CIR disallowed the deduction on the ground that the
investment should not be classified as being worthless. It
also held that assuming that the securities were worthless,
then they should be classified as a capital loss and not as
a bad debt since there was no indebtedness between China
Banking and CBC.
Issue:
Whether or not the investment should be classified as a
capital loss.
Held:
Yes. Section 29.d.4.B of the NIRC contains provisions
on securities becoming worthless. It conveys that capital
loss normally requires the concurrence of 2 conditions:
a. there is a sale or exchange
b. the thing sold or exchanges is a capital asset.
When securities become worthless, there is strictly no sale
or exchange but the law deems it to be a loss. These are
allowed to be deducted only to the extent of capital gains
and not from any other income of the taxpayer. A similar
kind of treatment is given by the NIRC on the retirement
of certificates of indebtedness with interest coupons or in
registered form, short sales and options to buy or sell
property where no sale or exchange strictly exists. In these
cases, The NIRC dispenses with the standard
requirements.
There is ordinary loss when the property sold is not a
capital asset.
In the case, CBC as an investee corporation, is a
subsidiary corporation of China Banking whose shares in
CBC are not intended for purchase or sale but as an
investment. An equity investment is a capital asset of the
investor. Unquestionably, any loss is a capital loss to the
investor.
--
Additional notes:
*The loss cannot be deductible as bad debt since the
shares of stock do not constitute a loan extended by it to
its subsidiary or a debt subject to obligatory repayment by
the latter.
CHAPTER 6 ISSUE: W/N the argument of PMFC is correct.
PILMICO-MAURI FOODS RULING:
CORP., Petitioner, v. COMMISSIONER OF
INTERNAL REVENUE, Respondent. NO.
The Court finds that the alleged differences between the
FACTS:
requirements of Section 29 of the 1977 NIRC invoked by
The books of accounts of [PMFC] pertaining to 1996 were PMFC, on one hand, and Section 238 relied upon by the
examined by the [CIR]. Assessment notices were the CTA, on the other, are more imagined than real.
issued demanding payment for deficiency withholding
The law intends for Sections 29 and 238 of the 1977 NIRC
tax, value added tax and income tax.
to be read together, and not for one provision to be
After receiving the assessments, PMFC filed a protest accorded preference over the other.
letter. Their liabilities were then reduced from 9 million
to 3 million pesos. It is undisputed that among the evidence adduced by
PMFC on it behalf are the official receipts of alleged
PMFC then filed a petition for review. They claim that
purchases of raw materials. Thus, the CTA cannot be
they should not be liable to pay the said deficiencies and
faulted for making references to the same, and for
that their receipts and sales invoices, which allegedly
applying Section 238 of the 1977 NIRC in rendering its
support their claim for income tax deduction, must be
judgment. Required or not, the official receipts were
allowed. [PMFC's] argues that there was no substantiation
submitted by PMFC as evidence. Inevitably, the said
requirement under the 1977 NIRC and thus, their claim
receipts were subjected to scrutiny, and the CTA
for tax deduction must be allowed.
exhaustively explained why it had found them wanting.
The CTA ruled that [PMFC] failed to comply with the
PMFC cites Atlas to contend that the statutory test, as
requirements of Section 238 of the NIRC of 1977, the
provided in Section 29 of the 1977 NIRC, is sufficient to
disallowance by the [CIR] of the claimed deduction for
allow the deductibility of a business expense from the
raw materials is proper. This is because the official
gross income. As long as the expense is: (a) both ordinary
receipts were not in the name of [PMFC] but in the name
and necessary; (b) incurred in carrying a business or trade;
of Golden Restaurant. And second, these receipts were
and (c) paid or incurred within the taxable year, then, it
issued by PFC and not the alleged seller, JTE.
shall be allowed as a deduction from the gross income.
CTA en banc affirmed the said decision. It ruled that the
It is clear that Section 29 of the 1977 NIRC does not
purpose of the law in requiring the preservation by the
exempt the taxpayer from substantiating claims for
purchaser of the official receipts or sales invoices for a
deductions. While official receipts are not the only pieces
period of three years is two-fold: 1) to enable said
of evidence which can prove deductible expenses, if
purchaser to substantiate his claimed deductions from presented, they shall be subjected to examination. PMFC
the gross income, and 2) to enable the Bureau of Internal
submitted official receipts as among its evidence, and the
Revenue to verify the accuracy of the gross income of the
CTA doubted their veracity. PMFC was, however, unable
seller from external sources such as the customers of said
to persuasively explain and prove through other
seller. Hence, [PMFC's] argument that there was no
documents the discrepancies in the said receipts.
substantiation requirement under the 1977 NIRC is
Consequently, the CTA disallowed the deductions
without basis.
claimed, and in its ruling, invoked Section 238 of the 1977
PMFC further argues that in determining the deductibility NIRC considering that official receipts are matters
of the purchase of raw materials from gross income, provided for in the said section.
Section 29 of the 1977 NIRC is the applicable provision.
The principle is recognized that when a taxpayer claims a
According to the said section, for the deduction to be
deduction, he must point to some specific provision of the
allowed, the expenses must be (a) both ordinary and
statute in which that deduction is authorized and must be
necessary; (b) incurred in carrying on a trade or business;
able to prove that he is entitled to the deduction which the
and (c) paid or incurred within the taxable year. PMFC,
law allows.
thus, claims that prior to the promulgation of the 1997
NIRC, the law does not require the production of official
receipts to prove an expense.
ATLAS CONSOLIDATED MINING AND
DEVELOPMENT CORP VS COM
FACTS: Petitioner corporation is engaged in the business
of mining, production, and sale of various mineral
products, such as gold, pyrite, and copper concentrates. It
is a VAT-registered taxpayer.
Petitioner corporation filed with the BIR the application
for the refund/credit of its input VAT on its purchases of
capital goods and on its zero-rated sales. When its
application for refund/credit remained unresolved by the
BIR, petitioner filed a Petition for Review with the CTA.
The CTA denied the claims on the grounds that for zero-
rating to apply, 70% of the company's sales must consists
of exports, that the same were not filed within the 2-year
prescriptive period (the claim for 1992 quarterly returns
were judicially filed only on April 20, 1994), and that
petitioner failed to submit substantial evidence to support
its claim for refund/credit.
The petitioner, on the other hand, contends that CTA
failed to consider the following: sales to PASAR and
PHILPOS within the Export Processing Zone Authority
(EPZA) as zero-rated export sales; the 2-year prescriptive
period should be counted from the date of filing of the last
adjustment return which was April 15, 1993, and not on
every end of the applicable quarters; and that the
certification of the independent CPA attesting to the
correctness of the contents of the summary of suppliers’
invoices or receipts examined, evaluated and audited by
said CPA should substantiate its claims.
ISSUES:
1. Whether or not the claims were filed within the 2-
year prescriptive period
2. Whether or not the claims for refund/credit of
input VAT of petitioner corporation have
sufficient legal bases
3. Whether or not petitioner sufficiently established
the factual bases for its applications for
refund/credit of input VAT
HELD:
1. YES. The filing of a quarterly income tax returns
required in Section 85 (now Section 68) and implemented
per BIR Form 1702-Q and payment of quarterly income
tax should only be considered mere installments of the
annual tax due. These quarterly tax payments which are
computed based on the cumulative figures of gross
receipts and deductions in order to arrive at a net taxable
income, should be treated as advances or portions of the
annual income tax due, to be adjusted at the end of the
calendar or fiscal year. This is reinforced by Section 87
(now Section 69) which provides for the filing of
adjustment returns and final payment of income tax.
Consequently, the two-year prescriptive period provided
in Section 292 (now Section 230) of the Tax Code should
be computed from the time of filing the Adjustment
Return or Annual Income Tax Return and final payment
of income tax.
2. YES. Section 106(b)(2), in relation to Section 100(a)(2)
of the Tax Code of 1977, as amended, allowed the
refund/credit of input VAT on export sales to enterprises
operating within export processing zones and registered
with the EPZA, since such export sales were deemed to
be effectively zero-rated sales.
Tax treatment of goods brought into the export
processing zones is only consistent with the Destination
Principle and Cross Border Doctrine to which the
Philippine VAT system adheres. According to the
Destination Principle, goods and services are taxed
only in the country where these are consumed. In
connection with the said principle, the Cross Border
Doctrine mandates that no VAT shall be imposed to
form part of the cost of the goods destined for
consumption outside the territorial border of the
taxing authority. Hence, actual export of goods and
services from the Philippines to a foreign country must
be free of VAT, while those destined for use or
consumption within the Philippines shall be imposed
with 10% VAT. Export processing zones are to be
managed as a separate customs territory from the rest
of the Philippines and, thus, for tax purposes, are
effectively considered as foreign territory. For this
reason, sales by persons from the Philippine customs
territory to those inside the export processing zones are
already taxed as exports.
3. NO. For a judicial claim for refund to prosper, however,
respondent must not only prove that it is a VAT registered
entity and that it filed its claims within the prescriptive
period. It must substantiate the input VAT paid by
purchase invoices or official receipts. This respondent
failed to do. Petitioner corporation failed to present
together with its application the required supporting
documents, whether before the BIR or the CTA.
Tax refunds are in the nature of tax
exemptions. It is regarded as in derogation of the
sovereign authority, and should be construed in
strictissimi juris against the person or entity claiming
the exemption. The taxpayer who claims for
exemption must justify his claim by the clearest grant
of organic or statute law and should not be permitted
to stand on vague implications.
VISAYAN CEBU TERMINAL CO. VS.
COLLECTOR
The Visayan Cebu Terminal Co. Inc., is a corporation
organized for the purpose of handling arrastre operations
in the port of Cebu. It was awarded the contract for the
said arrastre operations by the Bureau of Customs,
pursuant to Act No. 3002, as amended.
On March 1, 1952, appellant filed its income tax return
for 1951 reporting a gross income of P420,633.40 and
claimed deductions amounting to P379,036.95, leaving a
net income of P41,596.45 on which it paid income tax in
the sum of P8,319.29.
The sum of P379,036.95 claimed as deductions consisted
of various items including salaries, representation and
miscellaneous expenses. However, the said expenses
were disallowed by the Collector of Internal Revenue,
thus giving rise to a deficiency assessment.
Upon reconsideration, the Collector modified the
deficiency income tax assessment by allowing the
deduction from appellant's gross income of the salary and
miscellaneous expenses.
The Vusayan Cebu Terminal Co. Inc., maintains that said
court had acted arbitrarily in considering the
representation expenses in 1950, not those incurred in
1949 and 1952, in fixing the amount deductible in 1951
ISSUE: The only issue raised in this appeal relates to the
deductibility of the sum of P75,855.88 as representation
expenses.
HELD:
The Court of Tax Appeals, in the instant case, had been
patently fair and reasonable, if not liberal, in allowing
appellant to deduct a certain amount as representation
expenses on the basis of its gross income, net income and
representation expenses during the prior years, although
there was absolutely no concrete evidence of the sums
actually spent for purposes of representation. The
explanation to the effect that the supporting papers of
some of the expenses had been destroyed when the
house of appellant's treasurer was burned, it not
satisfactory, for appellant's records were supposed to
be kept in its offices, not in the residence of one of its
officers.
It appears: (a) that part of the alleged representation
expenses had never had any supporting paper; (b) that the
vouchers and chits covering other representation expenses
had been allegedly destroyed; (c) that there is no
documentary evidence on record of any of the
representation expenses in question; (d) that no
testimonial evidence has been introduced on any specific
item of said alleged expenses; (e) that there is no more
than oral proof to the effect that payments had been made
to appellant's officers for representation expenses
allegedly made by the latter and about the general nature
of such alleged expenses; (f) that the gross income in 1950
exceeded the gross income in 1951 and 1952, and (g) that
the representation expenses in 1948 amounted to P500
only. Under these circumstances, the lower court was
fully justified in concluding that the representation
expenses in 1951 should be slightly less than those
incurred in 1950.
WELCH VS HELVERING
Facts. Petitioner was the secretary of the E.L. Welch
Company which was involved in the grain business. The
went bankrupt and was discharged from its debts.
Petitioner entered into a contract with the Kellogg
Company to purchase grain for it on commission.
Petitioner decided to pay the debts of the Welch Company
in order to repair his credit and standing from the
bankruptcy of the Welch Company. The Commissioner
ruled that these payments of the debts were not deductible
from income as ordinary and necessary business
expenses. The Board of Tax Appeals sustained and the
Court of Appeals affirmed.
Issue. Are the expenses deductible as ordinary and
necessary business expenses?
Held. Justice Cardozo issued the opinion for the Supreme
Court of the United States in affirming the lower court and
holding that the expenses are not deductible as ordinary
and necessary business expenses.
Discussion. The Supreme Court found no evidence that
these expenditures were ordinary or necessary in the
world of business or in operating a business. Rather the
Court found this to be an extraordinary circumstance and
not commonly found or expected in any business.
HOSPITAL DE DIOS INC VS CIR
FACTS:
Petitioner is engaged in both taxable and non-taxable
operations. The income derived from the operations of the
hospital and the nursing school are exempt from income
tax while the rest of petitioner’s income are subject
thereto. Its taxable or non-operating income consists of
rentals, interests and dividends received from its
properties and investments. In the computation of its
taxable income for the years 1952 to 1955, petitioner
allowed all its taxable income to share in the allocation of
administrative expenses. Respondent, Commissioner of
Internal Revenue disallowed, however, the interests and
dividends from sharing in the allocation of administrative
expense on the ground that the expenses incurred in the
administration or management of petitioner’s investments
are not allowable business expenses inasmuch as they
were not incurred in ‘carrying on any trade or business’
within the contemplation of Section 30 (a) (1) of the
Revenue Code. Consequently, petitioner was assessed
deficiency income taxes for the years in question
The petitioner protested against the assessment and
requested the Commissioner to cancel and withdraw it.
After reviewing the assessment, the Commissioner
advised petitioner that the deficiency income tax
assessment against it was reduced to only P16,852.41.
Still the petitioner, through its auditors, insisted on the
cancellation of the revised assessment. The request was,
however, denied.
Petitioner sought a review of the assessment by the CTA,
which upheld the Commissioner holding that the
expenses incurred by the petitioner for handling its funds
or income consisting solely of dividends and interests,
were not expenses incurred in “carrying on any trade or
business,” hence, not deductible as business or
administrative expenses.
Petitioner filed a motion for reconsideration of the CTA
decision. When its motion was denied, it filed this petition
for review.
ISSUE:
Whether or not the dividends and interests are
expenses incurred in carrying on any trade or business,
hence, deductible as business expense under Section 30
(A) (I) of the Revenue Code.
RULING:
The Supreme Court ruled in the negative. The
CTA found that petitioner failed to establish by competent
proof that its receipt of interests and dividends constituted
the carrying on of a trade or business so as to warrant the
deductibility of the expenses incurred in their realization.
Petitioner could have easily required any of its
responsible officials to testify on this regard but it failed
to do so. Under these circumstances and coupled with the
fact that the interests and dividends here in question are
merely incidental income to petitioner’s main activity,
which is the operation of its hospital and nursing schools,
the conclusion becomes inevitable that petitioner’s
activities never go beyond that of a passive investor,
which under existing jurisprudence do not come within
the purview of carrying on any “trade or business”.
That factual finding is binding on this Court. And, as the
principle of allocating expenses is grounded on the
premise that the taxable income was derived from
carrying on a trade or business, as distinguished from
mere receipt of interests and dividends from one’s
investments, the CTA correctly ruled that said income
should not share in the allocation of administrative
expenses.
Hospital de San Juan De Dios, Inc., according to its
Articles of Incorporation, was established for purposes
“Which are benevolent, charitable and religious, and not
for financial gain”. It is not carrying on a trade or business
for the word “business” in its ordinary and common use
means “human efforts which have for their end living or
reward; it is not commonly used as descriptive of
charitable, religious, educational or social agencies” or
“any particular occupation or employment habitually
engaged in especially for livelihood or gain” or “activities
where profit is the purpose or livelihood is the motive.”
ESSO STANDARD, INC VS CIR.
FACTS:
ESSO deducted from its gross income for 1959, as part of
its ordinary and necessary business expenses, the amount
it had spent for drilling and exploration of its petroleum
concessions. The Commissioner disallowed the claim on
the ground that the expenses should be capitalized and
might be written off as a loss only when a “dry hole”
should result. Hence, ESSO filed an amended return
where it asked for the refund of P323,270 by reason of its
abandonment, as dry holes, of several of its oil wells. It
also claimed as ordinary and necessary expenses in the
same return amount representing margin fees it had paid
to the Central Bank on its profit remittances to its New
York Office.
ISSUE: Whether the margin fees may be considered
ordinary and necessary expenses when paid.
HELD:
For an item to be deductible as a business expense, the
expense must be ordinary and necessary; it must be paid
or incurred within the taxable year; and it must be paid or
incurred in carrying on a trade or business. In addition,
the taxpayer must substantially prove by evidence or
records the deductions claimed under law, otherwise, the
same will be disallowed. There has been no attempt to
define “ordinary and necessary” with precision. However,
as guiding principle in the proper adjudication of
conflicting claims, an expenses is considered necessary
where the expenditure is appropriate and helpful in the
development of the taxpayer’s business. It is ordinary
when it connotes a payment which is normal in relation to
the business of the taxpayer and the surrounding
circumstances. Assuming that the expenditure is ordinary
and necessary in the operation of the taxpayer’s business;
the expenditure, to be an allowable deduction as a
business expense, must be determined from the nature of
the expenditure itself, and on the extent and permanency
of the work accomplished by the expenditure. Herein,
ESSO has not shown that the remittance to the head office
of part of its profits was made in furtherance of its own
trade or business. The petitioner merely presumed that all
corporate expenses are necessary and appropriate in the
absence of a showing that they are illegal or ultra vires;
which is erroneous. Claims for deductions are a matter of
legislative grace and do not turn on mere equitable
considerations.
ATLAS CONSOLIDATED VS CIR
FACTS: For the year 1958, the Commissioner of Internal
Revenue assessed Atlas for deficiency income tax of
P761,789.12 which covers the disallowance of items
claimed, particularly the stockholders relation service fee
paid to P.K. Macker & Company, by Atlas as deductible
from gross income. It appears that on December 27, 1957,
Atlas increased its capital stock from P15,000,000 to
P18,325,000. 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.
On Appeal, 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.
ISSUE: 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.
RULING: No. 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
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, efforts to establish
reputation are akin to acquisition of capital assets and,
therefore, expenses related thereto are not business
expense but capital expenditures.
BASILAN ESTATES, INC VS CIR
DOCTRINE (FROM BOOK)
Receipts are the best proof for deduction. However, even
if no record/receipts are available, the oral testimony of a
cpa, if not contradicted by the government is sufficient.
Facts:
Basilan Estates, Inc. claimed deductions for the
depreciation of its assets on the basis of their acquisition
cost. As of January 1, 1950 it changed the depreciable
value of said assets by increasing it to conform with the
increase in cost for their replacement. Accordingly, from
1950 to 1953 it deducted from gross income the value of
depreciation computed on the reappraised value.
CIR disallowed the deductions claimed by petitioner,
consequently assessing the latter of deficiency income
taxes.
Issue:
Whether or not the depreciation shall be determined on
the acquisition cost rather than the reappraised value of
the assets
Held:
Yes. The following tax law provision allows a deduction
from gross income for depreciation but limits the recovery
to the capital invested in the asset being depreciated:
(1)In general. — A reasonable allowance for
deterioration of property arising out of its use or
employment in the business or trade, or out of its not
being used: Provided, That when the allowance
authorized under this subsection shall equal the capital
invested by the taxpayer . . . no further allowance shall be
made. . . .
The income tax law does not authorize the depreciation of
an asset beyond its acquisition cost. Hence, a deduction
over and above such cost cannot be claimed and allowed.
The reason is that deductions from gross income are
privileges, not matters of right. They are not created by
implication but upon clear expression in the law
[Gutierrez v. Collector of Internal Revenue, L-19537,
May 20, 1965].
Depreciation is the gradual diminution in the useful value
of tangible property resulting from wear and tear and
normal obsolescense. It commences with the acquisition
of the property and its owner is not bound to see his
property gradually waste, without making provision out
of earnings for its replacement.
The recovery, free of income tax, of an amount more than
the invested capital in an asset will transgress the
underlying purpose of a depreciation allowance. For then
what the taxpayer would recover will be, not only the
acquisition cost, but also some profit. Recovery in due
time thru depreciation of investment made is the
philosophy behind depreciation allowance; the idea of
profit on the investment made has never been the
underlying reason for the allowance of a deduction for
depreciation.
COM. VS ALGUE
Facts:
The Philippine Sugar Estate Development Company had
earlier appointed Algue Inc., as its agent, authorizing it to
sell its land, factories and oil manufacturing process.As
such,the corporation worked for the formation of the
Vegetable Oil Investment Corporation, until they were
able to purchased the PSEDC properties. For this sale,
Algue Inc., received as agent a commission of P126,
000.00, and it was from this commission that the P75,
000.00 promotional fees were paid to Alberto Guevara,
Jr., Eduardo Guevara, Isabel Guevara, Edith, O'Farell,
and Pablo Sanchez.
Commissioner of Internal Revenue contends that the
claimed deduction is not allowed because it was not an
ordinary reasonable or necessary business expense. The
Court of Tax Appeals had seen it differently. Agreeing
with Algue Inc., it held that the said amount had been
legitimately paid by the private respondent for actual
services rendered. The payment was in the form of
promotional fees.
Issue:
Whether or not the Collector of Internal Revenue
correctly disallowed the P75, 000.00 deduction claimed
by private respondent Algue Inc., as legitimate business
expenses in its income tax returns.
Ruling:
No, The Supreme Court agrees with the respondent court
that the amount of the promotional fees was not excessive.
The P75,000.00 was 60% of the total commission. This
was a reasonable proportion, considering that it was the
payees who did practically everything, from the formation
of the Vegetable Oil Investment Corporation to the actual
purchase by it of the Sugar Estate properties.
The claimed deduction by the private respondent was
permitted under the Internal Revenue Code and should
therefore not have been disallowed by the petitioner.
KUENZLE&STRIFE, INC VS COLLECOR
FACTS:
1. Kuenzle & Streiff for the years 1953, 1954 and 1955
filed its income tax return, declaring losses.
2. CIR filed for deficiency of income taxes against
Kuenzle & Streiff Inc. for the said years in the amounts of
P40,455.00, P11,248.00 and P16,228.00, respectively,
arising from the disallowance, as deductible expenses, of
the bonuses paid by the corporation to its officers, upon
the ground that they were not ordinary, nor necessary, nor
reasonable expenses within the purview of Section 30(a)
(1) of the National Internal Revenue Code.
3. The corporation filed with the Court of Tax Appeals a
petition for review contesting the assessments. CTA
favored the CIR, however lowered the tax due on 1954.
The corporation moved for reconsideration, but still lost.
4. The Corporation contends that the tax court, in arriving
at its conclusion, acted "in a purely arbitrary manner", and
erred in not considering individually the total
compensation paid to each of petitioner's officers and staff
members in determining the reasonableness of the
bonuses in question, and that it erred likewise in holding
that there was nothing in the record indicating that the
actuation of the respondent was unreasonable or unjust.
ISSUE: Whether or not the bonuses in question was
reasonable and just to be allowed as a deduction?
HELD: No.
RATIO: It is a general rule that `Bonuses to employees
made in good faith and as additional compensation for the
services actually rendered by the employees are
deductible, provided such payments, when added to the
stipulated salaries, do not exceed a reasonable
compensation for the services rendered. The condition
precedents to the deduction of bonuses to employees are:
(1) the payment of the bonuses is in fact compensation;
(2) it must be for personal services actually rendered; and
(3) bonuses, when added to the salaries, are `reasonable ...
when measured by the amount and quality of the services
performed with relation to the business of the particular
taxpayer. Here it is admitted that the bonuses are in fact
compensation and were paid for services actually
rendered. The only question is whether the payment of
said bonuses is reasonable.
There is no fixed test for determining the reasonableness
of a given bonus as compensation. This depends upon
many factors, one of them being the amount and quality
of the services performed with relation to the business.
Other tests suggested are: payment must be 'made in good
faith'; the character of the taxpayer's business, the volume
and amount of its net earnings, its locality, the type and
extent of the services rendered, the salary policy of the
corporation'; 'the size of the particular business'; 'the
employees' qualifications and contributions to the
business venture'; and 'general economic conditions.
However, 'in determining whether the particular salary or
compensation payment is reasonable, the situation must
be considered as a whole.
It seems clear from the record that, in arriving at its
main conclusion, the tax court considered, inter alia,
the following factors:
1) The paid officers, in the absence of evidence to the
contrary, that they were competent, on the other the record
discloses no evidence nor has petitioner ever made the
claim that all or some of them were gifted with some
special talent, or had undergone some extraordinary
training, or had accomplished any particular task, that
contributed materially to the success of petitioner's
business during the taxable years in question.
2) All the other employees received no pay increase in the
said years.
3) The bonuses were paid despite the fact that it had
suffered net losses for 3 years. Furthermore the
corporation cannot use the excuse that it is 'salary paid' to
an employee because the CIR does not question the basic
salaries paid by petitioner to the officers and employees,
but disallowed only the bonuses paid to petitioner's top
officers at the end of the taxable years in question.
C.M. HOSKINS & CO., INC VS CIR
Facts:
Hoskins, a domestic corporation engaged in the real estate
business as broker, managing agents and administrators,
filed its income tax return (ITR) showing a net income of
P92,540.25 and a tax liability of P18,508 which it paid.
CIR disallowed 4 items of deductions in the ITR. Court
of Tax Appeals upheld the disallowance of an item which
was paid to Mr. C. Hoskins representing 50% of
supervision fees earned and set aside the disallowance of
the other 3 items.
Issue:
Whether or not the disallowance of the 4 items were
proper.
Held:
NOT deductible. It did not pass the test of reasonableness
which is:
General rule, bonuses to employees made in good faith
and as additional compensation for services actually
rendered by the employees are deductible, provided such
payments, when added to the salaries do not exceed the
compensation for services rendered.
The conditions precedent to the deduction of bonuses to
employees are:
· Payment of bonuses is in fact compensation
· Must be for personal services actually rendered
· Bonuses when added to salaries are reasonable
when measured by the amount and quality of services
performed with relation to the business of the particular
taxpayer.
There is no fixed test for determining the reasonableness
of a given bonus as compensation. This depends upon
many factors.
In the case, Hoskins fails to pass the test. CTA was correct
in holding that the payment of the company to Mr.
Hoskins of the sum P99,977.91 as 50% share of
supervision fees received by the company was
inordinately large and could not be treated as an ordinary
and necessary expenses allowed for deduction.
AGUINALDO INDUSTRIES CORP. VS CIR
FACTS:
Aguinaldo Industries Corp. is engaged in the manufacture
of fishing nets, a tax-exempt industry, and the
manufacture of furniture. For accounting purposes, each
division is provided with separate books of accounts.
Previously, Aguinaldo Industries acquired a parcel of land
in Muntinglupa,Rizal, as site of the fishing net factory.
This transaction was entered in the books of the Fish Nets
Division of the Company.
Later, Aguinaldo Industries, it sold the said property, the
profit from this sale which was entered in the books of the
Fish Nets Division as miscellaneous income to
distinguish it from its tax-exempt income. Petitioner filed
two separate income tax returns and after investigation of
these returns, the examiners of the BIR found that the Fish
Nets Division deducted from its gross income P61,187.48
as additional remuneration paid to the officers of
Aguinaldo Industries. The examiner recommended the
disallowance of the deduction. It appears from the books
that such deduction was claimed as part of the selling
expenses of the land in Muntinglupa. Aguinaldo
Industries insists that said amount should be allowed as
deduction because it was paid to its officers as allowance
or bonus pursuant to Section 3 of its by-laws.
ISSUE:
Whether the bonus given to the officers of Aguinaldo
upon the sale of its Muntinglupa land is an ordinary and
necessary business expense deductible for income tax
purposes?
RULING:
No. In general, only those ordinary and necessary
expenses paid or incurred during the taxable year in
carrying on any trade or business, including a reasonable
allowance for personal services actually rendered can be
claimed as a deductible. The bonus given to the officers
of the Aguinaldo Industries as their share of the profit
realized from the sale of the land cannot be deemed a
deductible expense for tax purposes, even if the aforesaid
sale could be considered as a transact ion for Carrying on
the trade or business of the Aguinaldo Industries and the
grant of the bonus to the corporate officers pursuant to
Aguinaldo Industries’ by -laws could, as an intra-
corporate matter, be sustained.
Evidence show that the sale was effected through a broker
who was paid by Aguinaldo Industries a commission for
his services. On the other hand, there is absolutely no
evidence of any service actually rendered by Aguinaldo
Industries’ officers which could be the basis of a grant to
them of a bonus out of the profit derived from the sale.
This being so, the payment of a bonus to them out of the
gain realized from the sale cannot be considered as a
selling expense; nor can it be deemed reasonable and
necessary so as to make it deductible for tax purposes.
Thus, the extraordinary and unusual amounts paid by
Aguinaldo to these directors in the guise and form of
compensation for their supposed services as such, without
any relation to the measure of their actual services, cannot
be regarded as ordinary and necessary expenses within the
meaning of the law.
Whenever a controversy arises on the deductibility, for
purposes of income tax, of certain items for alleged
compensation of officers of the taxpayer, two (2)
questions become material, namely: (a)Have personal
services been actually rendered by said officers? (b) In the
affirmative case, what is the reasonable allowance
therefor
CIR VS GENERAL FOODS
Facts:
Respondent corporation General Foods (Phils), which is
engaged in the manufacture of “Tang”, “Calumet” and
“Kool-Aid”, filed its income tax return for the fiscal year
ending February 1985 and claimed as deduction, among
other business expenses, P9,461,246 for media
advertising for “Tang”.
The Commissioner disallowed 50% of the deduction
claimed and assessed deficiency income taxes of
P2,635,141.42 against General Foods, prompting the
latter to file an MR which was denied.
General Foods later on filed a petition for review at CA,
which reversed and set aside an earlier decision by CTA
dismissing the company’s appeal.
Issue:
W/N the subject media advertising expense for “Tang”
was ordinary and necessary expense fully deductible
under the NIRC
Held:
No. Tax exemptions must be construed in stricissimi juris
against the taxpayer and liberally in favor of the taxing
authority, and he who claims an exemption must be able
to justify his claim by the clearest grant of organic or
statute law. Deductions for income taxes partake of the
nature of tax exemptions; hence, if tax exemptions are
strictly construed, then deductions must also be strictly
construed.
To be deductible from gross income, the subject
advertising expense must comply with the following
requisites: (a) the expense must be ordinary and
necessary; (b) it must have been paid or incurred during
the taxable year; (c) it must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d)
it must be supported by receipts, records or other pertinent
papers.
While the subject advertising expense was paid or
incurred within the corresponding taxable year and was
incurred in carrying on a trade or business, hence
necessary, the parties’ views conflict as to whether or not
it was ordinary. To be deductible, an advertising expense
should not only be necessary but also ordinary.
The Commissioner maintains that the subject advertising
expense was not ordinary on the ground that it failed the
two conditions set by U.S. jurisprudence: first,
“reasonableness” of the amount incurred and second, the
amount incurred must not be a capital outlay to create
“goodwill” for the product and/or private respondent’s
business. Otherwise, the expense must be considered a
capital expenditure to be spread out over a reasonable
time.
There is yet to be a clear-cut criteria or fixed test for
determining the reasonableness of an advertising expense.
There being no hard and fast rule on the matter, the right
to a deduction depends on a number of factors such as but
not limited to: the type and size of business in which the
taxpayer is engaged; the volume and amount of its net
earnings; the nature of the expenditure itself; the intention
of the taxpayer and the general economic conditions. It is
the interplay of these, among other factors and properly
weighed, that will yield a proper evaluation.
The Court finds the subject expense for the advertisement
of a single product to be inordinately large. Therefore,
even if it is necessary, it cannot be considered an ordinary
expense deductible under then Section 29 (a) (1) (A) of
the NIRC.
Advertising is generally of two kinds: (1) advertising to
stimulate the current sale of merchandise or use of
services and (2) advertising designed to stimulate
the future sale of merchandise or use of services. The
second type involves expenditures incurred, in whole or
in part, to create or maintain some form of goodwill for
the taxpayer’s trade or business or for the industry or
profession of which the taxpayer is a member. If the
expenditures are for the advertising of the first kind, then,
except as to the question of the reasonableness of amount,
there is no doubt such expenditures are deductible as
business expenses. If, however, the expenditures are for
advertising of the second kind, then normally they should
be spread out over a reasonable period of time.
The company’s media advertising expense for the
promotion of a single product is doubtlessly unreasonable
considering it comprises almost one-half of the
company’s entire claim for marketing expenses for that
year under review. Petition granted, judgment reversed
and set aside.