G.R. No.

L-12287

August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO,

plaintiffs-appellants,
vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and
VENANCIO CONCEPCION, Deputy Collector of Internal Revenue,
defendants-appellees.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:
This appeal calls for consideration of the Income Tax Law, a law of
American origin, with reference to the Civil Code, a law of Spanish
origin.
STATEMENT OF THE CASE.
Vicente Madrigal and Susana Paterno were legally married prior to
January 1, 1914. The marriage was contracted under the provisions of
law concerning conjugal partnerships (sociedad de gananciales). On
February 25, 1915, Vicente Madrigal filed sworn declaration on the
prescribed form with the Collector of Internal Revenue, showing, as his
total net income for the year 1914, the sum of P296,302.73.
Subsequently Madrigal submitted the claim that the said P296,302.73 did
not represent his income for the year 1914, but was in fact the income of
the conjugal partnership existing between himself and his wife Susana
Paterno, and that in computing and assessing the additional income tax
provided by the Act of Congress of October 3, 1913, the income declared
by Vicente Madrigal should be divided into two equal parts, one-half to
be considered the income of Vicente Madrigal and the other half of
Susana Paterno. The general question had in the meantime been
submitted to the Attorney-General of the Philippine Islands who in an
opinion dated March 17, 1915, held with the petitioner Madrigal. The
revenue officers being still unsatisfied, the correspondence together with
this opinion was forwarded to Washington for a decision by the United
States Treasury Department. The United States Commissioner of Internal
Revenue reversed the opinion of the Attorney-General, and thus decided
against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been
decided adversely by the Collector of Internal Revenue, action was
begun by Vicente Madrigal and his wife Susana Paterno in the Court of
First Instance of the city of Manila against Collector of Internal Revenue
and the Deputy Collector of Internal Revenue for the recovery of the sum
of P3,786.08, alleged to have been wrongfully and illegally collected by
the defendants from the plaintiff, Vicente Madrigal, under the provisions
of the Act of Congress known as the Income Tax Law. The burden of the
complaint was that if the income tax for the year 1914 had been correctly
and lawfully computed there would have been due payable by each of the
plaintiffs the sum of P2,921.09, which taken together amounts of a total
of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected
from the plaintiff Vicente Madrigal, with the result that plaintiff Madrigal
has paid as income tax for the year 1914, P3,786.08, in excess of the sum
lawfully due and payable.
The answer of the defendants, together with an analysis of the tax
declaration, the pleadings, and the stipulation, sets forth the basis of
defendants' stand in the following way: The income of Vicente Madrigal
and his wife Susana Paterno of the year 1914 was made up of three
items: (1) P362,407.67, the profits made by Vicente Madrigal in his coal
and shipping business; (2) P4,086.50, the profits made by Susana Paterno
in her embroidery business; (3) P16,687.80, the profits made by Vicente
Madrigal in a pawnshop company. The sum of these three items is
P383,181.97, the gross income of Vicente Madrigal and Susana Paterno
for the year 1914. General deductions were claimed and allowed in the
sum of P86,879.24. The resulting net income was P296,302.73. For the
purpose of assessing the normal tax of one per cent on the net income
there were allowed as specific deductions the following: (1) P16,687.80,
the tax upon which was to be paid at source, and (2) P8,000, the specific
exemption granted to Vicente Madrigal and Susana Paterno, husband and
wife. The remainder, P271,614.93 was the sum upon which the normal
tax of one per cent was assessed. The normal tax thus arrived at was
P2,716.15.
The dispute between the plaintiffs and the defendants concerned the
additional tax provided for in the Income Tax Law. The trial court in an
exhausted decision found in favor of defendants, without costs.
ISSUES.

The contentions of plaintiffs and appellants having to do solely with the

additional income tax, is that is should be divided into two equal parts,
because of the conjugal partnership existing between them. The learned
argument of counsel is mostly based upon the provisions of the Civil
Code establishing the sociedad de gananciales. The counter contentions
of appellees are that the taxes imposed by the Income Tax Law are as the
name implies taxes upon income tax and not upon capital and property;
that the fact that Madrigal was a married man, and his marriage
contracted under the provisions governing the conjugal partnership, has
no bearing on income considered as income, and that the distinction must
be drawn between the ordinary form of commercial partnership and the
conjugal partnership of spouses resulting from the relation of marriage.
DECISION.
From the point of view of test of faculty in taxation, no less than five
answers have been given the course of history. The final stage has been
the selection of income as the norm of taxation. (See Seligman, "The
Income Tax," Introduction.) The Income Tax Law of the United States,
extended to the Philippine Islands, is the result of an effect on the part of
the legislators to put into statutory form this canon of taxation and of
social reform. The aim has been to mitigate the evils arising from
inequalities of wealth by a progressive scheme of taxation, which places
the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the
minimum of subsistence. With these exceptions, the income tax is
supposed to reach the earnings of the entire non-governmental property
of the country. Such is the background of the Income Tax Law.
Income as contrasted with capital or property is to be the test. The
essential difference between capital and income is that capital is a fund;
income is a flow. A fund of property existing at an instant of time is
called capital. A flow of services rendered by that capital by the payment
of money from it or any other benefit rendered by a fund of capital in
relation to such fund through a period of time is called an income.
Capital is wealth, while income is the service of wealth. (See Fisher,
"The Nature of Capital and Income.") The Supreme Court of Georgia
expresses the thought in the following figurative language: "The fact is
that property is a tree, income is the fruit; labor is a tree, income the fruit;
capital is a tree, income the fruit." (Waring vs. City of Savannah [1878],
60 Ga., 93.) A tax on income is not a tax on property. "Income," as here
used, can be defined as "profits or gains." (London County Council vs.

Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N.

S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income
Tax, second edition [1915], Chapter IV; Black on Income Taxes, second
edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U.S., 549;
and Towne vs. Eisner, decided by the United States Supreme Court,
January 7, 1918.)
A regulation of the United States Treasury Department relative to returns
by the husband and wife not living apart, contains the following:
The husband, as the head and legal representative of the household and
general custodian of its income, should make and render the return of the
aggregate income of himself and wife, and for the purpose of levying the
income tax it is assumed that he can ascertain the total amount of said
income. If a wife has a separate estate managed by herself as her own
separate property, and receives an income of more than $3,000, she may
make return of her own income, and if the husband has other net income,
making the aggregate of both incomes more than $4,000, the wife's
return should be attached to the return of her husband, or his income
should be included in her return, in order that a deduction of $4,000 may
be made from the aggregate of both incomes. The tax in such case,
however, will be imposed only upon so much of the aggregate income of
both shall exceed $4,000. If either husband or wife separately has an
income equal to or in excess of $3,000, a return of annual net income is
required under the law, and such return must include the income of both,
and in such case the return must be made even though the combined
income of both be less than $4,000. If the aggregate net income of both
exceeds $4,000, an annual return of their combined incomes must be
made in the manner stated, although neither one separately has an
income of $3,000 per annum. They are jointly and separately liable for
such return and for the payment of the tax. The single or married status
of the person claiming the specific exemption shall be determined as one
of the time of claiming such exemption which return is made, otherwise
the status at the close of the year."
With these general observations relative to the Income Tax Law in force
in the Philippine Islands, we turn for a moment to consider the provisions
of the Civil Code dealing with the conjugal partnership. Recently in two
elaborate decisions in which a long line of Spanish authorities were cited,
this court in speaking of the conjugal partnership, decided that "prior to
the liquidation the interest of the wife and in case of her death, of her
heirs, is an interest inchoate, a mere expectancy, which constitutes

neither a legal nor an equitable estate, and does not ripen into title until
there appears that there are assets in the community as a result of the
liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off.
Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz.,
1265.)
Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the
property of her husband Vicente Madrigal during the life of the conjugal
partnership. She has an interest in the ultimate property rights and in the
ultimate ownership of property acquired as income after such income has
become capital. Susana Paterno has no absolute right to one-half the
income of the conjugal partnership. Not being seized of a separate estate,
Susana Paterno cannot make a separate return in order to receive the
benefit of the exemption which would arise by reason of the additional
tax. As she has no estate and income, actually and legally vested in her
and entirely distinct from her husband's property, the income cannot
properly be considered the separate income of the wife for the purposes
of the additional tax. Moreover, the Income Tax Law does not look on
the spouses as individual partners in an ordinary partnership. The
husband and wife are only entitled to the exemption of P8,000
specifically granted by the law. The higher schedules of the additional
tax directed at the incomes of the wealthy may not be partially defeated
by reliance on provisions in our Civil Code dealing with the conjugal
partnership and having no application to the Income Tax Law. The aims
and purposes of the Income Tax Law must be given effect.
The point we are discussing has heretofore been considered by the
Attorney-General of the Philippine Islands and the United States
Treasury Department. The decision of the latter overruling the opinion of
the Attorney-General is as follows:
TREASURY DEPARTMENT, Washington.
Income Tax.
FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.
SIR: This office is in receipt of your letter of June 22, 1915, transmitting
copy of correspondence "from the Philippine authorities relative to the
method of submission of income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the

Bureau, advises that the Insular Auditor has been authorized to suspend
action on the warrants in question until an authoritative decision on the
points raised can be secured from the Treasury Department."
From the correspondence it appears that Gregorio Araneta, married and
living with his wife, had an income of an amount sufficient to require the
imposition of the net income was properly computed and then both
income and deductions and the specific exemption were divided in half
and two returns made, one return for each half in the names respectively
of the husband and wife, so that under the returns as filed there would be
an escape from the additional tax; that Araneta claims the returns are
correct on the ground under the Philippine law his wife is entitled to half
of his earnings; that Araneta has dominion over the income and under the
Philippine law, the right to determine its use and disposition; that in this
case the wife has no "separate estate" within the contemplation of the Act
of October 3, 1913, levying an income tax.
It appears further from the correspondence that upon the foregoing
explanation, tax was assessed against the entire net income against
Gregorio Araneta; that the tax was paid and an application for refund
made, and that the application for refund was rejected, whereupon the
matter was submitted to the Attorney-General of the Islands who holds
that the returns were correctly rendered, and that the refund should be
allowed; and thereupon the question at issue is submitted through the
Governor-General of the Islands and Bureau of Insular Affairs for the
advisory opinion of this office.
By paragraph M of the statute, its provisions are extended to the
Philippine Islands, to be administered as in the United States but by the
appropriate internal-revenue officers of the Philippine Government. You
are therefore advised that upon the facts as stated, this office holds that
for the Federal Income Tax (Act of October 3, 1913), the entire net
income in this case was taxable to Gregorio Araneta, both for the normal
and additional tax, and that the application for refund was properly
rejected.
The separate estate of a married woman within the contemplation of the
Income Tax Law is that which belongs to her solely and separate and
apart from her husband, and over which her husband has no right in
equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith

provide that each person of lawful age (not excused from so doing)
having a net income of $3,000 or over for the taxable year shall make a
return showing the facts; that from the net income so shown there shall
be deducted $3,000 where the person making the return is a single
person, or married and not living with consort, and $1,000 additional
where the person making the return is married and living with consort;
but that where the husband and wife both make returns (they living
together), the amount of deduction from the aggregate of their several
incomes shall not exceed $4,000.
The only occasion for a wife making a return is where she has income
from a sole and separate estate in excess of $3,000, but together they
have an income in excess of $4,000, in which the latter event either the
husband or wife may make the return but not both. In all instances the
income of husband and wife whether from separate estates or not, is
taken as a whole for the purpose of the normal tax. Where the wife has
income from a separate estate makes return made by her husband, while
the incomes are added together for the purpose of the normal tax they are
taken separately for the purpose of the additional tax. In this case,
however, the wife has no separate income within the contemplation of
the Income Tax Law.
Respectfully,
DAVID A. GATES.
Acting Commissioner.
In connection with the decision above quoted, it is well to recall a few
basic ideas. The Income Tax Law was drafted by the Congress of the
United States and has been by the Congress extended to the Philippine
Islands. Being thus a law of American origin and being peculiarly
intricate in its provisions, the authoritative decision of the official who is
charged with enforcing it has peculiar force for the Philippines. It has
come to be a well-settled rule that great weight should be given to the
construction placed upon a revenue law, whose meaning is doubtful, by
the department charged with its execution. (U.S. vs. Cerecedo Hermanos
y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2 Phil., 630;
Government of the Philippine Islands vs. Municipality of Binalonan, and
Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.) We

conclude that the judgment should be as it is hereby affirmed with costs

against appellants. So ordered.

G.R. No. L-17518

October 30, 1922

FREDERICK C. FISHER, plaintiff-appellant,

vs.
WENCESLAO TRINIDAD, Collector of
defendant-appellee.

245 U.S., 418; Doyle vs. Mitchell Bors. Co., 247 U.S., 179; Eisner vs.
Macomber, 252 U.S., 189; Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A.,
587; Kaufman vs. Charlottesville Woolen Mills, 93 Va., 673.
Internal

Revenue,

Fisher and De Witt and Antonio M. Opisso for appellants.

Acting Attorney-General Tuason for appellee.
JOHNSON, J.:
The only question presented by this appeal is: Are the "stock dividends"
in the present case "income" and taxable as such under the provisions of
section 25 of Act No. 2833? While the appellant presents other important
questions, under the view which we have taken of the facts and the law
applicable to the present case, we deem it unnecessary to discuss them
now.
The defendant demurred to the petition in the lower court. The facts are
therefore admitted. They are simple and may be stated as follows:
That during the year 1919 the Philippine American Drug Company was a
corporation duly organized and existing under the laws of the Philippine
Islands, doing business in the City of Manila; that he appellant was a
stockholder in said corporation; that said corporation, as result of the
business for that year, declared a "stock dividend"; that the proportionate
share of said stock divided of the appellant was P24,800; that the stock
dividend for that amount was issued to the appellant; that thereafter, in
the month of March, 1920, the appellant, upon demand of the appellee,
paid under protest, and voluntarily, unto the appellee the sum of P889.91
as income tax on said stock dividend. For the recovery of that sum
(P889.91) the present action was instituted. The defendant demurred to
the petition upon the ground that it did not state facts sufficient to
constitute cause of action. The demurrer was sustained and the plaintiff
appealed.
To sustain his appeal the appellant cites and relies on some decisions of
the Supreme Court of the United States as will as the decisions of the
supreme court of some of the states of the Union, in which the questions
before us, based upon similar statutes, was discussed. Among the most
important decisions may be mentioned the following: Towne vs. Eisner,

In each of said cases an effort was made to collect an "income tax" upon
"stock dividends" and in each case it was held that "stock dividends"
were capital and not an "income" and therefore not subject to the
"income tax" law.
The appellee admits the doctrine established in the case of Eisner vs.
Macomber (252 U.S., 189) that a "stock dividend" is not "income" but
argues that said Act No. 2833, in imposing the tax on the stock dividend,
does not violate the provisions of the Jones Law. The appellee further
argues that the statute of the United States providing for tax upon stock
dividends is different from the statute of the Philippine Islands, and
therefore the decision of the Supreme Court of the United States should
not be followed in interpreting the statute in force here.
For the purpose of ascertaining the difference in the said statutes
( (United States and Philippine Islands), providing for an income tax in
the United States as well as that in the Philippine Islands, the two statutes
are here quoted for the purpose of determining the difference, if any, in
the language of the two statutes.
Chapter 463 of an Act of Congress of September 8, 1916, in its title 1
provides for the collection of an "income tax." Section 2 of said Act
attempts to define what is an income. The definition follows:
That the term "dividends" as used in this title shall be held to mean any
distribution made or ordered to made by a corporation, . . . which stock
dividend shall be considered income, to the amount of its cash value.
Act No. 2833 of the Philippine Legislature is an Act establishing "an
income tax." Section 25 of said Act attempts to define the application of
the income tax. The definition follows:
The term "dividends" as used in this Law shall be held to mean any
distribution made or ordered to be made by a corporation, . . . out of its
earnings or profits accrued since March first, nineteen hundred and
thirteen, and payable to its shareholders, whether in cash or in stock of
the corporation, . . . . Stock dividend shall be considered income, to the
amount of the earnings or profits distributed.

It will be noted from a reading of the provisions of the two laws above
quoted that the writer of the law of the Philippine Islands must have had
before him the statute of the United States. No important argument can
be based upon the slight different in the wording of the two sections.
It is further argued by the appellee that there are no constitutional
limitations upon the power of the Philippine Legislature such as exist in
the United States, and in support of that contention, he cites a number of
decisions. There is no question that the Philippine Legislature may
provide for the payment of an income tax, but it cannot, under the guise
of an income tax, collect a tax on property which is not an "income." The
Philippine Legislature can not impose a tax upon "property" under a law
which provides for a tax upon "income" only. The Philippine Legislature
has no power to provide a tax upon "automobiles" only, and under that
law collect a tax upon a carreton or bull cart. Constitutional limitations,
that is to say, a statute expressly adopted for one purpose cannot, without
amendment, be applied to another purpose which is entirely distinct and
different. A statute providing for an income tax cannot be construed to
cover property which is not, in fact income. The Legislature cannot, by a
statutory declaration, change the real nature of a tax which it imposes. A
law which imposes an important tax on rice only cannot be construed to
an impose an importation tax on corn.
It is true that the statute in question provides for an income tax and
contains a further provision that "stock dividends" shall be considered
income and are therefore subject to income tax provided for in said law.
If "stock dividends" are not "income" then the law permits a tax upon
something not within the purpose and intent of the law.
It becomes necessary in this connection to ascertain what is an "income
in order that we may be able to determine whether "stock dividends" are
"income" in the sense that the word is used in the statute. Perhaps it
would be more logical to determine first what are "stock dividends" in
order that we may more clearly understand their relation to "income."
Generally speaking, stock dividends represent undistributed increase in
the capital of corporations or firms, joint stock companies, etc., etc., for a
particular period. They are used to show the increased interest or
proportional shares in the capital of each stockholder. In other words, the
inventory of the property of the corporation, etc., for particular period
shows an increase in its capital, so that the stock theretofore issued does
not show the real value of the stockholder's interest, and additional stock

is issued showing the increase in the actual capital, or property, or assets

of the corporation, etc.
To illustrate: A and B form a corporation with an authorized capital of
P10,000 for the purpose of opening and conducting a drug store, with
assets of the value of P2,000, and each contributes P1,000. Their entire
assets are invested in drugs and put upon the shelves in their place of
business. They commence business without a cent in the treasury. Every
dollar contributed is invested. Shares of stock to the amount of P1,000
are issued to each of the incorporators, which represent the actual
investment and entire assets of the corporation. Business for the first year
is good. Merchandise is sold, and purchased, to meet the demands of the
growing trade. At the end of the first year an inventory of the assets of
the corporation is made, and it is then ascertained that the assets or
capital of the corporation on hand amount to P4,000, with no debts, and
still not a cent in the treasury. All of the receipts during the year have
been reinvested in the business. Neither of the stockholders have
withdrawn a penny from the business during the year. Every peso
received for the sale of merchandise was immediately used in the
purchase of new stock new supplies. At the close of the year there is
not a centavo in the treasury, with which either A or B could buy a cup of
coffee or a pair of shoes for his family. At the beginning of the year they
were P2,000, and at the end of the year they were P4,000, and neither of
the stockholders have received a centavo from the business during the
year. At the close of the year, when it is discovered that the assets are
P4,000 and not P2,000, instead of selling the extra merchandise on hand
and thereby reducing the business to its original capital, they agree
among themselves to increase the capital they agree among themselves to
increase the capital issued and for that purpose issue additional stock in
the form of "stock dividends" or additional stock of P1,000 each, which
represents the actual increase of the shares of interest in the business. At
the beginning of the year each stockholder held one-half interest in the
capital. At the close of the year, and after the issue of the said stock
dividends, they each still have one-half interest in the business. The
capital of the corporation increased during the year, but has either of
them received an income? It is not denied, for the purpose of ordinary
taxation, that the taxable property of the corporation at the beginning of
the year was P2,000, that at the close of the year it was P4,000, and that
the tax rolls should be changed in accordance with the changed
conditions in the business. In other words, the ordinary tax should be
increased by P2,000.

Another illustration: C and D organized a corporation for agricultural

purposes with an authorized capital stock of P20,000 each contributing
P5,000. With that capital they purchased a farm and, with it, one hundred
head of cattle. Every peso contributed is invested. There is no money in
the treasury. Much time and labor was expanded during the year by the
stockholders on the farm in the way of improvements. Neither received a
centavo during the year from the farm or the cattle. At the beginning of
the year the assets of the corporation, including the farm and the cattle,
were P10,000, and at the close of the year and inventory of the property
of the corporation is made and it is then found that they have the same
farm with its improvements and two hundred head of cattle by natural
increase. At the end of the year it is also discovered that, by reason of
business changes, the farm and the cattle both have increased in value,
and that the value of the corporate property is now P20,000 instead of
P10,000 as it was at the beginning of the year. The incorporators instead
of reducing the property to its original capital, by selling off a part of its,
issue to themselves "stock dividends" to represent the proportional value
or interest of each of the stockholders in the increased capital at the close
of the year. There is still not a centavo in the treasury and neither has
withdrawn a peso from the business during the year. No part of the farm
or cattle has been sold and not a single peso was received out of the rents
or profits of the capital of the corporation by the stockholders.
Another illustration: A, an individual farmer, buys a farm with one
hundred head of cattle for the sum of P10,000. At the end of the first
year, by reason of business conditions and the increase of the value of
both real estate and personal property, it is discovered that the value of
the farm and the cattle is P20,000. A, during the year, has received
nothing from the farm or the cattle. His books at the beginning of the
year show that he had property of the value of P10,000. His books at the
close of the year show that he has property of the value of P20,000. A is
not a corporation. The assets of his business are not shown therefore by
certificates of stock. His books, however, show that the value of his
property has increased during the year by P10,000, under any theory of
business or law, be regarded as an "income" upon which the farmer can
be required to pay an income tax? Is there any difference in law in the
condition of A in this illustration and the condition of A and B in the
immediately preceding illustration? Can the increase of the value of the
property in either case be regarded as an "income" and be subjected to
the payment of the income tax under the law?

Each of the foregoing illustrations, it is asserted, is analogous to the case

before us and, in view of that fact, let us ascertain how lexicographers
and the courts have defined an "income." The New Standard Dictionary,
edition of 1915, defines an income as "the amount of money coming to a
person or corporation within a specified time whether as payment or
corporation within a specified time whether as payment for services,
interest, or profit from investment." Webster's International Dictionary
defines an income as "the receipt, salary; especially, the annual receipts
of a private person or a corporation from property." Bouvier, in his law
dictionary, says that an "income" in the federal constitution and income
tax act, is used in its common or ordinary meaning and not in its
technical, or economic sense. (146 Northwestern Reporter, 812) Mr.
Black, in his law dictionary, says "An income is the return in money
from one's business, labor, or capital invested; gains, profit or private
revenue." "An income tax is a tax on the yearly profits arising from
property , professions, trades, and offices."
The Supreme Court of the United States, in the case o Gray vs.
Darlington (82 U.S., 653), said in speaking of income that mere advance
in value in no sense constitutes the "income" specified in the revenue law
as "income" of the owner for the year in which the sale of the property
was made. Such advance constitutes and can be treated merely as an
increase of capital. (In re Graham's Estate, 198 Pa., 216; Appeal of
Braun, 105 Pa., 414.)
Mr. Justice Hughes, later Associate Justice of the Supreme Court of the
United States and now Secretary of State of the United States, in his
argument before the Supreme Court of the United States in the case of
Towne vs. Eisner, supra, defined an "income" in an income tax law,
unless it is otherwise specified, to mean cash or its equivalent. It does not
mean choses in action or unrealized increments in the value of the
property, and cites in support of the definition, the definition given by the
Supreme Court in the case of Gray vs. Darlington, supra.
In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for
the court, said: "Notwithstanding the thoughtful discussion that the case
received below, we cannot doubt that the dividend was capital as well for
the purposes of the Income Tax Law. . . . 'A stock dividend really takes
nothing from the property of the corporation, and adds nothing to the
interests of the shareholders. Its property is not diminished and their
interest are not increased. . . . The proportional interest of each
shareholder remains the same. . . .' In short, the corporation is no poorer

and the stockholder is no richer then they were before." (Gibbons vs.
Mahon, 136 U.S., 549, 559, 560; Logan County vs. U.S., 169 U.S., 255,
261).
In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice
Pitney, speaking for the court, said that the act employs the term
"income" in its natural and obvious sense, as importing something
distinct from principal or capital and conveying the idea of gain or
increase arising from corporate activity.
Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189),
again speaking for the court said: "An income may be defined as the gain
derived from capital, from labor, or from both combined, provided it be
understood to include profit gained through a sale or conversion of
capital assets."
For bookkeeping purposes, when stock dividends are declared, the
corporation or company acknowledges a liability, in form, to the
stockholders, equivalent to the aggregate par value of their stock,
evidenced by a "capital stock account." If profits have been made by the
corporation during a particular period and not divided, they create
additional bookkeeping liabilities under the head of "profit and loss,"
"undivided profits," "surplus account," etc., or the like. None of these,
however, gives to the stockholders as a body, much less to any one of
them, either a claim against the going concern or corporation, for any
particular sum of money, or a right to any particular portion of the asset,
or any shares sells or until the directors conclude that dividends shall be
made a part of the company's assets segregated from the common fund
for that purpose. The dividend normally is payable in money and when
so paid, then only does the stockholder realize a profit or gain, which
becomes his separate property, and thus derive an income from the
capital that he has invested. Until that, is done the increased assets
belong to the corporation and not to the individual stockholders.
When a corporation or company issues "stock dividends" it shows that
the company's accumulated profits have been capitalized, instead of
distributed to the stockholders or retained as surplus available for
distribution, in money or in kind, should opportunity offer. Far from
being a realization of profits of the stockholder, it tends rather to
postpone said realization, in that the fund represented by the new stock
has been transferred from surplus to assets, and no longer is available for
actual distribution. The essential and controlling fact is that the

stockholder has received nothing out of the company's assets for his
separate use and benefit; on the contrary, every dollar of his original
investment, together with whatever accretions and accumulations
resulting from employment of his money and that of the other
stockholders in the business of the company, still remains the property of
the company, and subject to business risks which may result in wiping
out of the entire investment. Having regard to the very truth of the
matter, to substance and not to form, the stockholder by virtue of the
stock dividend has in fact received nothing that answers the definition of
an "income." (Eisner vs. Macomber, 252 U.S., 189, 209, 211.)
The stockholder who receives a stock dividend has received nothing but
a representation of his increased interest in the capital of the corporation.
There has been no separation or segregation of his interest. All the
property or capital of the corporation still belongs to the corporation.
There has been no separation of the interest of the stockholder from the
general capital of the corporation. The stockholder, by virtue of the stock
dividend, has no separate or individual control over the interest
represented thereby, further than he had before the stock dividend was
issued. He cannot use it for the reason that it is still the property of the
corporation and not the property of the individual holder of stock
dividend. A certificate of stock represented by the stock dividend is
simply a statement of his proportional interest or participation in the
capital of the corporation. For bookkeeping purposes, a corporation, by
issuing stock dividend, acknowledges a liability in form to the
stockholders, evidenced by a capital stock account. The receipt of a stock
dividend in no way increases the money received of a stockholder nor his
cash account at the close of the year. It simply shows that there has been
an increase in the amount of the capital of the corporation during the
particular period, which may be due to an increased business or to a
natural increase of the value of the capital due to business, economic, or
other reasons. We believe that the Legislature, when it provided for an
"income tax," intended to tax only the "income" of corporations, firms or
individuals, as that term is generally used in its common acceptation; that
is that the income means money received, coming to a person or
corporation for services, interest, or profit from investments. We do not
believe that the Legislature intended that a mere increase in the value of
the capital or assets of a corporation, firm, or individual, should be taxed
as "income." Such property can be reached under the ordinary from of
taxation.

Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in
discussing the difference between "capital" and "income": "That the
fundamental relation of 'capital' to 'income' has been much discussed by
economists, the former being likened to the tree or the land, the latter to
the fruit or the crop; the former depicted as a reservoir supplied from
springs; the latter as the outlet stream, to be measured by its flow during
a period of time." It may be argued that a stockholder might sell the stock
dividend which he had acquired. If he does, then he has received, in fact,
an income and such income, like any other profit which he realizes from
the business, is an income and he may be taxed thereon.
There is a clear distinction between an extraordinary cash dividend, no
matter when earned, and stock dividends declared, as in the present case.
The one is a disbursement to the stockholder of accumulated earnings,
and the corporation at once parts irrevocably with all interest thereon.
The other involves no disbursement by the corporation. It parts with
nothing to the stockholder. The latter receives, not an actual dividend, but
certificate of stock which simply evidences his interest in the entire
capital, including such as by investment of accumulated profits has been
added to the original capital. They are not income to him, but represent
additions to the source of his income, namely, his invested capital.
(DeKoven vs. Alsop, 205, Ill., 309; 63 L.R.A. 587). Such a person is in
the same position, so far as his income is concerned, as the owner of
young domestic animal, one year old at the beginning of the year, which
is worth P50 and, which, at the end of the year, and by reason of its
growth, is worth P100. The value of his property has increased, but has
had an income during the year? It is true that he had taxable property at
the beginning of the year of the value of P50, and the same taxable
property at another period, of the value of P100, but he has had no
income in the common acceptation of that word. The increase in the
value of the property should be taken account of on the tax duplicate for
the purposes of ordinary taxation, but not as income for he has had none.
The question whether stock dividends are income, or capital, or assets
has frequently come before the courts in another form in cases of
inheritance. A is a stockholder in a large corporation. He dies leaving a
will by the terms of which he give to B during his lifetime the "income"
from said stock, with a further provision that C shall, at B's death,
become the owner of his share in the corporation. During B's life the
corporation issues a stock dividend. Does the stock dividend belong to B
as an income, or does it finally belong to C as a part of his share in the
capital or assets of the corporation, which had been left to him as a

remainder by A? While there has been some difference of opinion on that

question, we believe that a great weight of authorities hold that the stock
dividend is capital or assets belonging to C and not an income belonging
to B. In the case of D'Ooge vs. Leeds (176 Mass., 558, 560) it was held
that stock dividends in such cases were regarded as capital and not as
income (Gibbons vs. Mahon, 136 U.S., 549.)
In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The
distinction between the title of a corporation, and the interest of its
members or stockholders in the property of the corporation, is familiar
and well settled. The ownership of that property is in the corporation, and
not in the holders of shares of its stock. The interest of each stockholder
consists in the right to a proportionate part of the profits whenever
dividends are declared by the corporation, during its existence, under its
charter, and to a like proportion of the property remaining, upon the
termination or dissolution of the corporation, after payment of its debts."
(Minot vs. Paine, 99 Mass., 101; Greeff vs. Equitable Life Assurance
Society, 160 N. Y., 19.) In the case of Dekoven vs. Alsop (205 Ill ,309,
63 L. R. A. 587) Mr. Justice Wilkin said: "A dividend is defined as a
corporate profit set aside, declared, and ordered by the directors to be
paid to the stockholders on demand or at a fixed time. Until the dividend
is declared, these corporate profits belong to the corporation, not to the
stockholders, and are liable for corporate indebtedness.
There is a clear distinction between an extraordinary cash dividend, no
matter when earned, and stock dividends declared. The one is a
disbursement to the stockholders of accumulated earning, and the
corporation at once parts irrevocably with all interest thereon. The other
involves no disbursement by the corporation. It parts with nothing to the
stockholders. The latter receives, not an actual dividend, but certificates
of stock which evidence in a new proportion his interest in the entire
capital. When a cash becomes the absolute property of the stockholders
and cannot be reached by the creditors of the corporation in the absence
of fraud. A stock dividend however, still being the property of the
corporation and not the stockholder, it may be reached by an execution
against the corporation, and sold as a part of the property of the
corporation. In such a case, if all the property of the corporation is sold,
then the stockholder certainly could not be charged with having received
an income by virtue of the issuance of the stock dividend. Until the
dividend is declared and paid, the corporate profits still belong to the
corporation, not to the stockholders, and are liable for corporate
indebtedness. The rule is well established that cash dividend, whether

large or small, are regarded as "income" and all stock dividends, as

capital or assets (Cook on Corporation, Chapter 32, secs. 534, 536; Davis
vs. Jackson, 152 Mass., 58; Mills vs. Britton, 64 Conn., 4; 5 Am., and
Eng. Encycl. of Law, 2d ed., p. 738.)
If the ownership of the property represented by a stock dividend is still in
the corporation and to in the holder of such stock, then it is difficult to
understand how it can be regarded as income to the stockholder and not
as a part of the capital or assets of the corporation. (Gibbsons vs. Mahon,
supra.) the stockholder has received nothing but a representation of an
interest in the property of the corporation and, as a matter of fact, he may
never receive anything, depending upon the final outcome of the
business of the corporation. The entire assets of the corporation may be
consumed by mismanagement, or eaten up by debts and obligations, in
which case the holder of the stock dividend will never have received an
income from his investment in the corporation. A corporation may be
solvent and prosperous today and issue stock dividends in representation
of its increased assets, and tomorrow be absolutely insolvent by reason of
changes in business conditions, and in such a case the stockholder would
have received nothing from his investment. In such a case, if the holder
of the stock dividend is required to pay an income tax on the same, the
result would be that he has paid a tax upon an income which he never
received. Such a conclusion is absolutely contradictory to the idea of an
income. An income subject to taxation under the law must be an actual
income and not a promised or prospective income.
The appelle argues that there is nothing in section 25 of Act No 2833
which contravenes the provisions of the Jones Law. That may be
admitted. He further argues that the Act of Congress (U.S. Revenue Act
of 1918) expressly authorized the Philippine Legislatures to provide for
an income tax. That fact may also be admitted. But a careful reading of
that Act will show that, while it permitted a tax upon income, the same
provided that income shall include gains, profits, and income derived
from salaries, wages, or compensation for personal services, as well as
from interest, rent, dividends, securities, etc. The appellee emphasizes
the "income from dividends." Of course, income received as dividends is
taxable as an income but an income from "dividends" is a very different
thing from receipt of a "stock dividend." One is an actual receipt of
profits; the other is a receipt of a representation of the increased value of
the assets of corporation.

In all of the foregoing argument we have not overlooked the decisions of

a few of the courts in different parts of the world, which have reached a
different conclusion from the one which we have arrived at in the present
case. Inasmuch, however, as appeals may be taken from this court to the
Supreme Court of the United States, we feel bound to follow the same
doctrine announced by that court.
Having reached the conclusion, supported by the great weight of the
authority, that "stock dividends" are not "income," the same cannot be
taxes under that provision of Act No. 2833 which provides for a tax upon
income. Under the guise of an income tax, property which is not an
income cannot be taxed. When the assets of a corporation have increased
so as to justify the issuance of a stock dividend, the increase of the assets
should be taken account of the Government in the ordinary tax duplicates
for the purposes of assessment and collection of an additional tax. For all
of the foregoing reasons, we are of the opinion, and so decide, that the
judgment of the lower court should be revoked, and without any finding
as to costs, it is so ordered.
Araullo, C.J. Avancea, Villamor and Romualdez, JJ., concur

G.R. No. L-21570

July 26, 1966

LIMPAN INVESTMENT CORPORATION, petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, ET AL., respondents.
Vicente L. San Luis for petitioner.
Office of the Solicitor General A. A. Alafriz, Assistant Solicitor General
F. B. Rosete, Solicitor A. B. Afurong and Atty. V. G. Saldajeno for
respondents.
REYES, J.B.L., J.:
Appeal interposed by petitioner Limpan Investment Corporation against
a decision of the Court of Tax Appeals, in its CTA Case No. 699, holding
and ordering it (petitioner) to pay respondent Commissioner of Internal
Revenue the sums of P7,338.00 and P30,502.50, representing deficiency
income taxes, plus 50% surcharge and 1% monthly interest from June 30,
1959 to the date of payment, with cost.
The facts of this case are:
Petitioner, a domestic corporation duly registered since June 21, 1955, is
engaged in the business of leasing real properties. It commenced actual
business operations on July 1, 1955. Its principal stockholders are the
spouses Isabelo P. Lim and Purificacion Ceiza de Lim, who own and
control ninety-nine per cent (99%) of its total paid-up capital. Its
president and chairman of the board is the same Isabelo P.
Lim.1wph1.t
Its real properties consist of several lots and buildings, mostly situated in
Manila and in Pasay City, all of which were acquired from said Isabelo P.
Lim and his mother, Vicente Pantangco Vda. de Lim.
Petitioner corporation duly filed its 1956 and 1957 income tax returns,
reporting therein net incomes of P3,287.81 and P11,098.36, respectively,
for which it paid the corresponding taxes therefor in the sums of P657.00
and P2,220.00.
Sometime in 1958 and 1959, the examiners of the Bureau of Internal
Revenue conducted an investigation of petitioner's 1956 and 1957
income tax returns and, in the course thereof, they discovered and

ascertained that petitioner had underdeclared its rental incomes by

P20,199.00 and P81,690.00 during these taxable years and had claimed
excessive depreciation of its buildings in the sums of P4,260.00 and
P16,336.00 covering the same period. On the basis of these findings,
respondent Commissioner of Internal Revenue issued its letterassessment and demand for payment of deficiency income tax and
surcharge against petitioner corporation, computed as follows:
90-AR-C-348-58/56
Net income per audited return P 3,287.81
Add: Unallowable deductions:
Undeclared Rental Receipt
(Sched. A) . . . . . . . . . . . . . . . . . . . . P20,199.00
Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . . . 4,260.00
P24,459.00
Net income per investigation
P27,746.00
Tax due thereon P5,549.00
Less: Amount already assessed 657.00
BalanceP4,892.00
Add: 50% Surcharge 2,446.00
DEFICIENCY TAX DUE
P7,338.00
90-AR-C-1196-58/57
Net income per audited return P11,098.00
Add: Unallowable deductions:
Undeclared Rental Receipt (Sched. A) . . . . . . . . P81,690.00
Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . 16,338.00
P98,028.00
Net income per investigation
P109,126.00
Tax due thereon P22,555.00
Less: Amount already assessed 2,220.00
Balance20,335.00
Add: 50% Surcharge 10,167.50
DEFICIENCY TAX DUE
P30,502.50
Petitioner corporation requested respondent Commissioner of Internal
Revenue to reconsider the above assessment but the latter denied said
request and reiterated its original assessment and demand, plus 5%
surcharge and the 1% monthly interest from June 30, 1959 to the date of
payment; hence, the corporation filed its petition for review before the
Tax Appeals court, questioning the correctness and validity of the above
assessment of respondent Commissioner of Internal Revenue. It
disclaimed having received or collected the amount of P20,199.00, as
unreported rental income for 1956, or any part thereof, reasoning out that

'the previous owners of the leased building has (have) to collect part of
the total rentals in 1956 to apply to their payment of rental in the land in
the amount of P21,630.00" (par. 11, petition). It also denied having
received or collected the amount of P81,690.00, as unreported rental
income for 1957, or any part thereof, explaining that part of said amount
totalling P31,380.00 was not declared as income in its 1957 tax return
because its president, Isabelo P. Lim, who collected and received
P13,500.00 from certain tenants, did not turn the same over to petitioner
corporation in said year but did so only in 1959; that a certain tenant (Go
Tong) deposited in court his rentals amounting to P10,800.00, over
which the corporation had no actual or constructive control; and that a
sub-tenant paid P4,200.00 which ought not be declared as rental income.
Petitioner likewise alleged in its petition that the rates of depreciation
applied by respondent Commissioner of its buildings in the above
assessment are unfair and inaccurate.
Sole witness for petitioner corporation in the Tax Court was its
Secretary-Treasurer, Vicente G. Solis, who admitted that it had omitted to
report the sum of P12,100.00 as rental income in its 1956 tax return and
also the sum of P29,350.00 as rental income in its 1957 tax return.
However, with respect to the difference between this omitted income
(P12,100.00) and the sum (P20,199.00) found by respondent
Commissioner as undeclared in 1956, petitioner corporation, through the
same witness (Solis), tried to establish that it did not collect or receive
the same because, in view of the refusal of some tenants to recognize the
new owner, Isabelo P. Lim and Vicenta Pantangco Vda. de Lim, the
former owners, on one hand, and the same Isabelo P. Lim, as president of
petitioner corporation, on the other, had verbally agreed in 1956 to turn
over to petitioner corporation six per cent (6%) of the value of all its
properties, computed at P21,630.00, in exchange for whatever rentals the
Lims may collect from the tenants. And, with respect to the difference
between the admittedly undeclared sum of P29,350.00 and that found by
respondent Commissioner as unreported rental income, (P81,690.00) in
1957, the same witness Solis also tried to establish that petitioner
corporation did not receive or collect the same but that its president,
Isabelo P. Lim, collected part thereof and may have reported the same in
his own personal income tax return; that same Isabelo P. Lim collected
P13,500.00, which he turned over to petitioner in 1959 only; that a
certain tenant (Go Tong deposited in court his rentals (P10,800.00), over
which the corporation had no actual or constructive control and which

were withdrawn only in 1958; and that a sub-tenant paid P4,200.00

which ought not be declared as rental income in 1957.
With regard to the depreciation which respondent disallowed and
deducted from the returns filed by petitioner, the same witness tried to
establish that some of its buildings are old and out of style; hence, they
are entitled to higher rates of depreciation than those adopted by
respondent in his assessment.
Isabelo P. Lim was not presented as witness to corroborate the above
testimony of Vicente G. Solis.
On the other hand, Plaridel M. Mingoa, one of the BIR examiners who
personally conducted the investigation of the 1956 and 1957 income tax
returns of petitioner corporation, testified for the respondent that he
personally interviewed the tenants of petitioner and found that these
tenants had been regularly paying their rentals to the collectors of either
petitioner or its president, Isabelo P. Lim, but these payments were not
declared in the corresponding returns; and that in applying rates of
depreciation to petitioner's buildings, he adopted Bulletin "F" of the U.S.
Federal Internal Revenue Service.
On the basis of the evidence, the Tax Court upheld respondent
Commissioner's assessment and demand for deficiency income tax
which, as above stated in the beginning of this opinion, petitioner has
appealed to this Court.
Petitioner corporation pursues, the same theory advocated in the court
below and assigns the following alleged errors of the trial court in its
brief, to wit:
I. The respondent Court erred in holding that the petitioner had an
unreported rental income of P20,199.00 for the year 1956.
II. The respondent Court erred in holding that the petitioner had an
unreported rental income of P81,690.00 for the year 1957.
III. The respondent Court erred in holding that the depreciation in the
amount of P20,598.00 claimed by petitioner for the years 1956 and 1957
was excessive.
and prays that the appealed decision be reversed.

This appeal is manifestly unmeritorious. Petitioner having admitted,

through its own witness (Vicente G. Solis), that it had undeclared more
than one-half (1/2) of the amount (P12,100.00 out of P20,199.00) found
by the BIR examiners as unreported rental income for the year 1956 and
more than one-third (1/3) of the amount (P29,350.00 out of P81,690.00)
ascertained by the same examiners as unreported rental income for the
year 1957, contrary to its original claim to the revenue authorities, it was
incumbent upon it to establish the remainder of its pretensions by clear
and convincing evidence, that in the case is lacking.
With respect to the balance, which petitioner denied having unreported in
the disputed tax returns, the excuse that Isabelo P. Lim and Vicenta
Pantangco Vda. de Lim retained ownership of the lands and only later
transferred or disposed of the ownership of the buildings existing thereon
to petitioner corporation, so as to justify the alleged verbal agreement
whereby they would turn over to petitioner corporation six percent (6%)
of the value of its properties to be applied to the rentals of the land and in
exchange for whatever rentals they may collect from the tenants who
refused to recognize the new owner or vendee of the buildings, is not
only unusual but uncorroborated by the alleged transferors, or by any
document or unbiased evidence. Hence, the first assigned error is without
merit.
As to the second assigned error, petitioner's denial and explanation of the
non-receipt of the remaining unreported income for 1957 is not
substantiated by satisfactory corroboration. As above noted, Isabelo P.
Lim was not presented as witness to confirm accountant Solis nor was
his 1957 personal income tax return submitted in court to establish that
the rental income which he allegedly collected and received in 1957 were
reported therein.
The withdrawal in 1958 of the deposits in court pertaining to the 1957
rental income is no sufficient justification for the non-declaration of said
income in 1957, since the deposit was resorted to due to the refusal of
petitioner to accept the same, and was not the fault of its tenants; hence,
petitioner is deemed to have constructively received such rentals in 1957.
The payment by the sub-tenant in 1957 should have been reported as
rental income in said year, since it is income just the same regardless of
its source.

On the third assigned error, suffice it to state that this Court has already
held that "depreciation is a question of fact and is not measured by
theoretical yardstick, but should be determined by a consideration of
actual facts", and the findings of the Tax Court in this respect should not
be disturbed when not shown to be arbitrary or in abuse of discretion
(Commissioner of Internal Revenue vs. Priscila Estate, Inc., et al., L18282, May 29, 1964), and petitioner has not shown any arbitrariness or
abuse of discretion in the part of the Tax Court in finding that petitioner
claimed excessive depreciation in its returns. It appearing that the Tax
Court applied rates of depreciation in accordance with Bulletin "F" of the
U.S. Federal Internal Revenue Service, which this Court pronounced as
having strong persuasive effect in this jurisdiction, for having been the
result of scientific studies and observation for a long period in the United
States, after whose Income Tax Law ours is patterned (M. Zamora vs.
Collector of internal Revenue & Collector of Internal Revenue vs. M.
Zamora; E. Zamora vs. Collector of Internal Revenue and Collector of
Internal Revenue vs. E. Zamora, Nos. L-15280, L-15290, L-15289 and
L-15281, May 31, 1963), the foregoing error is devoid of merit.
Wherefore, the appealed decision should be, as it is hereby, affirmed.
With costs against petitioner-appellant, Limpan Investment Corporation.

G.R. No. 48532 August 31, 1992

HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D.
HERRERA, BENJAMIN T. ILDEFONSO, ALEXANDER LACSON,
JR., ADRIAN O. MICIANO, EDUARDO A. RIALP, LEANDRO G.
SANTILLAN, and JAIME A. SOQUES, petitioners,
vs.
THE
HONORABLE
COURT OF
TAX APPEALS
and
COMMISSIONER OF INTERNAL REVENUE, respondents.

Philippines, during which petitioners were paid U.S. dollars as

compensation for services in their foreign assignments. (Paragraphs III,
Petitions for Review, C.T.A. Cases Nos. 2511 and 2594, Exhs. D, D-1 to
D-19). When petitioners in C.T.A. Case No. 2511 filed their income tax
returns for the year 1970, they computed the tax due by applying the
dollar-to-peso conversion on the basis of the floating rate ordained under
B.I.R. Ruling No. 70-027 dated May 14, 1970, as follows:
From January 1 to February 20, 1970 at the conversion rate of P3.90 to
U.S. $1.00;

G.R. No. 48533 August 31, 1992

ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY L.
DIMAYUGA, JAIME E. DY-LIACCO, MELQUIADES J. GAMBOA,
JR., MANUEL L. GUZMAN, VICENTE D. HERRERA, BENJAMIN T.
ILDEFONSO, ALEXANDER LACSON, JR., ADRIAN O. MICIANO,
EDUARDO A. RIALP and JAIME A. SOQUES, petitioners,
vs.
THE
HONORABLE
COURT OF
TAX APPEALS
and
COMMISSIONER OF INTERNAL REVENUE, respondents.
Angara, Abello, Concepcion, Regala & Cruz for petitioners.

NOCON, J.:
Petitioners pray that his Court reverse the Decision of the public
respondent Court of Tax Appeals, promulgated September 26, 1977 1
denying petitioners' claim for tax refunds, and order the Commissioner of
Internal Revenue to refund to them their income taxes which they claim
to have been erroneously or illegally paid or collected.
As summarized by the Solicitor General, the facts of the cases are as
follows:
Petitioners are Filipino citizens and employees of Procter and Gamble,
Philippine Manufacturing Corporation, with offices at Sarmiento
Building, Ayala Avenue, Makati, Rizal. Said corporation is a subsidiary
of Procter & Gamble, a foreign corporation based in Cincinnati, Ohio,
U.S.A. During the years 1970 and 1971 petitioners were assigned, for
certain periods, to other subsidiaries of Procter & Gamble, outside of the

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

to U.S. $1.00
Petitioners in C.T.A. Case No. 2594 likewise used the above conversion
rate in converting their dollar income for 1971 to Philippine peso.
However, on February 8, 1973 and October 8, 1973, petitioners in said
cases filed with the office of the respondent Commissioner, amended
income tax returns for the above-mentioned years, this time using the par
value of the peso as prescribed in Section 48 of Republic Act No. 265 in
relation to Section 6 of Commonwealth Act No. 265 in relation to
Section 6 of Commonwealth Act No. 699 as the basis for converting their
respective dollar income into Philippine pesos for purposes of computing
and paying the corresponding income tax due from them. The aforesaid
computation as shown in the amended income tax returns resulted in the
alleged overpayments, refund and/or tax credit. Accordingly, claims for
refund of said over-payments were filed with respondent Commissioner.
Without awaiting the resolution of the Commissioner of the Internal
Revenue on their claims, petitioners filed their petitioner for review in
the above-mentioned cases.
Respondent Commissioner filed his Answer to petitioners' petition for
review in C.T.A. Case No. 2511 on July 31, 1973, while his Answer in
C.T.A. Case No. 2594 was filed on August 7, 1974.
Upon joint motion of the parties on the ground that these two cases
involve common question of law and facts, that respondent Court of Tax
Appeals heard the cases jointly. In its decision dated September 26, 1977,
the respondent Court of Tax Appeals held that the proper conversion rate
for the purpose of reporting and paying the Philippine income tax on the
dollar earnings of petitioners are the rates prescribed under Revenue
Memorandum Circulars Nos. 7-71 and 41-71. Accordingly, the claim for

refund and/or tax credit of petitioners in the above-entitled cases was

denied and the petitions for review dismissed, with costs against
petitioners. Hence, this petition for review on certiorari. 2
Petitioners claim that public respondent Court of Tax Appeals erred in
holding:
1.
That petitioners' dollar earnings are receipts derived from foreign
exchange transactions.
2.
That the proper rate of conversion of petitioners' dollar earnings
for tax purposes in the prevailing free market rate of exchange and not
the par value of the peso; and
3.
That the use of the par value of the peso to convert petitioners'
dollar earnings for tax purposes into Philippine pesos is "unrealistic" and,
therefore, the prevailing free market rate should be the rate used.
Respondent Commissioner of Internal Revenue, on the other hand,
refutes petitioners' claims as follows:
At the outset, it is submitted that the subject matter of these two cases are
Philippine income tax for the calendar years 1970 (CTA Case No. 2511)
and 1971 (CTA Case No. 2594) and, therefore, should be governed by
the provisions of the National Internal Revenue Code and its
implementing rules and regulations, and not by the provisions of Central
Bank Circular No. 42 dated May 21, 1953, as contended by petitioners.
Section 21 of the National Internal Revenue Code, before its amendment
by Presidential Decrees Nos. 69 and 323 which took effect on January 1,
1973 and January 1, 1974, respectively, imposed a tax upon the taxable
net income received during each taxable year from all sources by a
citizen of the Philippines, whether residing here or abroad.
Petitioners are citizens of the Philippines temporarily residing abroad by
virtue of their employment. Thus, in their tax returns for the period
involved herein, they gave their legal residence/address as c/o Procter &
Gamble PMC, Ayala Ave., Makati, Rizal (Annexes "A" to "A-8" and
Annexes "C" to "C-8", Petition for Review, CTA Nos. 2511 and 2594).
Petitioners being subject to Philippine income tax, their dollar earnings
should be converted into Philippine pesos in computing the income tax

due therefrom, in accordance with the provisions of Revenue

Memorandum Circular No. 7-71 dated February 11, 1971 for 1970
income and Revenue Memorandum Circular No. 41-71 dated December
21, 1971 for 1971 income, which reiterated BIR Ruling No. 70-027 dated
May 4, 1970, to wit:
For internal revenue tax purposes, the free marker rate of conversion
(Revenue Circulars Nos. 7-71 and 41-71) should be applied in order to
determine the true and correct value in Philippine pesos of the income of
petitioners. 3
After a careful examination of the records, the laws involved and the
jurisprudence on the matter, We are inclined to agree with respondents
Court of Tax Appeals and Commissioner of Internal Revenue and thus
vote to deny the petition.
This basically an income tax case. For the proper resolution of these
cases income may be defined as an amount of money coming to a person
or corporation within a specified time, whether as payment for services,
interest or profit from investment. Unless otherwise specified, it means
cash or its equivalent. 4 Income can also be though of as flow of the
fruits of one's labor. 5
Petitioners are correct as to their claim that their dollar earnings are not
receipts derived from foreign exchange transactions. For a foreign
exchange transaction is simply that a transaction in foreign exchange,
foreign exchange being "the conversion of an amount of money or
currency of one country into an equivalent amount of money or currency
of another." 6 When petitioners were assigned to the foreign subsidiaries
of Procter & Gamble, they were earning in their assigned nation's
currency and were ALSO spending in said currency. There was no
conversion, therefore, from one currency to another.
Public respondent Court of Tax Appeals did err when it concluded that
the dollar incomes of petitioner fell under Section 2(f)(g) and (m) of C.B.
Circular No. 42. 7
The issue now is, what exchange rate should be used to determine the
peso equivalent of the foreign earnings of petitioners for income tax
purposes. Petitioners claim that since the dollar earnings do not fall
within the classification of foreign exchange transactions, there occurred
no actual inward remittances, and, therefore, they are not included in the

coverage of Central Bank Circular No. 289 which provides for the
specific instances when the par value of the peso shall not be the
conversion rate used. They conclude that their earnings should be
converted for income tax purposes using the par value of the Philippine
peso.
Respondent Commissioner argues that CB Circular No. 289 speaks of
receipts for export products, receipts of sale of foreign exchange or
foreign borrowings and investments but not income tax. He also claims
that he had to use the prevailing free market rate of exchange in these
cases because of the need to ascertain the true and correct amount of
income in Philippine peso of dollar earners for Philippine income tax
purposes.
A careful reading of said CB Circular No. 289 8 shows that the subject
matters involved therein are export products, invisibles, receipts of
foreign exchange, foreign exchange payments, new foreign borrowing
and
investments nothing by way of income tax payments. Thus,
petitioners are in error by concluding that since C.B. Circular No. 289
does not apply to them, the par value of the peso should be the guiding
rate used for income tax purposes.
The dollar earnings of petitioners are the fruits of their labors in the
foreign subsidiaries of Procter & Gamble. It was a definite amount of
money which came to them within a specified period of time of two yeas
as payment for their services.
Section 21 of the National Internal Revenue Code, amended up to August
4, 1969, states as follows:
Sec. 21.Rates of tax on citizens or residents. A tax is hereby imposed
upon the taxable net income received during each taxable year from all
sources by every individual, whether a citizen of the Philippines residing
therein or abroad or an alien residing in the Philippines, determined in
accordance with the following schedule:
xxx

xxx

xxx

And in the implementation for the proper enforcement of the National

Internal Revenue Code, Section 338 thereof empowers the Secretary of

Finance to "promulgate all needful rules and regulations" to effectively

enforce its provisions. 9
Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71 10
and 41-71 11 were issued to prescribed a uniform rate of exchange from
US dollars to Philippine pesos for INTERNAL REVENUE TAX
PURPOSES for the years 1970 and 1971, respectively. Said revenue
circulars were a valid exercise of the authority given to the Secretary of
Finance by the Legislature which enacted the Internal Revenue Code.
And these are presumed to be a valid interpretation of said code until
revoked by the Secretary of Finance himself. 12
Petitioners argue that since there were no remittances and acceptances of
their salaries and wages in US dollars into the Philippines, they are
exempt from the coverage of such circulars. Petitioners forget that they
are citizens of the Philippines, and their income, within or without, and
in these cases wholly without, are subject to income tax. Sec. 21, NIRC,
as amended, does not brook any exemption.
Since petitioners have already paid their 1970 and 1971 income taxes
under the uniform rate of exchange prescribed under the aforestated
Revenue Memorandum Circulars, there is no reason for respondent
Commissioner to refund any taxes to petitioner as said Revenue
Memorandum Circulars, being of long standing and not contrary to law,
are valid. 13
Although it has become a worn-out cliche, the fact still remains that
"taxes are the lifeblood of the government" and one of the duties of a
Filipino citizen is to pay his income tax.
WHEREFORE, the petitioners are denied for lack of merit. The
dismissal by the respondent Court of Tax Appeals of petitioners' claims
for tax refunds for the income tax period for 1970 and 1971 is
AFFIRMED. Costs against petitioners.
SO ORDERED.

Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955)

Commissioner v. Glenshaw Glass Co.
No. 199

(e) The legislative history of the Internal Revenue Code of 1954 does not
require a different result. The definition of gross income was simplified,
but no effect upon its present broad scope was intended. P. 348 U. S. 432.
(f) Punitive damages cannot be classified as gifts, nor do they come
under any other exemption in the Code. P. 348 U. S. 432.

Argued February 28, 1955

211 F.2d 928 reversed.
Decided March 28, 1955*
Page 348 U. S. 427
348 U.S. 426
MR. CHIEF JUSTICE WARREN delivered the opinion of the Court.
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
Syllabus
Money received as exemplary damages for fraud or as the punitive twothirds portion of a treble damage antitrust recovery must be reported by a
taxpayer as "gross income" under 22(a) of the Internal Revenue Code
of 1939. Pp. 348 U. S. 427-433.
(a) In determining what constitutes "gross income" as defined in 22(a),
effect must be given to the catch-all language "gains or profits and
income derived from any source whatever." Pp. 348 U. S. 429-430.
(b) Eisner v. Macomber, 252 U. S. 189, distinguished. Pp. 348 U. S. 430431.
(c) The mere fact that such payments are extracted from the wrongdoers
as punishment for unlawful conduct cannot detract from their character
as taxable income to the recipients. P. 348 U. S. 431.
(d) A different result is not required by the fact that 22 (a) was
reenacted without change after the Board of Tax Appeals had held
punitive damages nontaxable in Highland Farms Corp., 42 B.T.A. 1314.
Pp. 348 U. S. 431-432.

This litigation involves two cases with independent factual backgrounds,

yet presenting the identical issue. The two cases were consolidated for
argument before the Court of Appeals for the Third Circuit, and were
heard en banc. The common question is whether money received as
exemplary damages for fraud or as the punitive two-thirds portion of a
treble damage antitrust recovery must be reported by a taxpayer as gross
income under 22(a) of the Internal Revenue Code of 1939. [Footnote 1]
In a single opinion, 211 F.2d 928, the Court of Appeals affirmed the Tax
Court's separate rulings in favor of the taxpayers. 18 T.C. 860; 19 T.C.
637. Because of the frequent recurrence of the question and differing
interpretations by the lower courts of this Court's decisions bearing upon
the problem, we granted the Commissioner of Internal Revenue's ensuing
petition for certiorari. 348 U.S. 813.
The facts of the cases were largely stipulated, and are not in dispute. So
far as pertinent, they are as follows:
Commissioner v. Glenshaw Glass Co. -- The Glenshaw Glass Company,
a Pennsylvania corporation, manufactures glass bottles and containers. It
was engaged in protracted litigation with the Hartford-Empire Company,
which manufactures machinery of a character used by Glenshaw. Among
the claims advanced by Glenshaw
Page 348 U. S. 428
were demands for exemplary damages for fraud [Footnote 2] and treble
damages for injury to its business by reason of Hartford's violation of the
federal antitrust laws. [Footnote 3] In December, 1947, the parties
concluded a settlement of all pending litigation by which Hartford paid

Glenshaw approximately $800,000. Through a method of allocation

which was approved by the Tax Court, 18 T.C. 860, 870-872, and which
is no longer in issue, it was ultimately determined that, of the total
settlement, $324,529.94 represented payment of punitive damages for
fraud and antitrust violations. Glenshaw did not report this portion of the
settlement as income for the tax year involved. The Commissioner
determined a deficiency, claiming as taxable the entire sum less only
deductible legal fees. As previously noted, the Tax Court and the Court
of Appeals upheld the taxpayer.
Commissioner v. William Goldman Theatres, Inc. -- William Goldman
Theatres, Inc., a Delaware corporation operating motion picture houses
in Pennsylvania, sued Loew's, Inc., alleging a violation of the federal
antitrust laws and seeking treble damages. After a holding that a violation
had occurred, William Goldman Theatres, Inc. v. Loew's Inc., 150 F.2d
738, the case was remanded to the trial court for a determination of
damages. It was found that Goldman had suffered a loss of profits equal
to $125,000, and was entitled to treble damages in the sum of $375,000.
William Goldman Theatres, Inc. v. Loew's, Inc., 69 F.Supp. 103, aff'd
164 F.2d 1021, cert. denied, 334 U.S. 811. Goldman reported only
$125,000 of the recovery as gross income, and claimed that the $250,000
Page 348 U. S. 429
balance constituted punitive damages, and, as such, was not taxable. The
Tax Court agreed, 19 T.C. 637, and the Court of Appeals, hearing this
with the Glenshaw case, affirmed. 211 F.2d 928.
It is conceded by the respondents that there is no constitutional barrier to
the imposition of a tax on punitive damages. Our question is one of
statutory construction: are these payments comprehended by 22(a)?
The sweeping scope of the controverted statute is readily apparent:
"SEC. 22. GROSS INCOME."
"(a) GENERAL DEFINITION. '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
professions, vocations, trades, businesses, commerce, or sales, or
dealings in property, whether real or personal, growing out of the
ownership or use of or interest in such property; also from interest, rent,

dividends, securities, or the transaction of any business carried on for

gain or profit, or gains or profits and income derived from any source
whatever. . . ."
(Emphasis added.) [Footnote 4]
This Court has frequently stated that this language was used by Congress
to exert in this field "the full measure of its taxing power." Helvering v.
Clifford, 309 U. S. 331, 309 U. S. 334; Helvering v. Midland Mutual Life
Ins. Co., 300 U. S. 216, 300 U. S. 223; Douglas v. Willcuts, 296 U. S. 1,
296 U. S. 9; Irwin v. Gavit, 268 U. S. 161, 268 U. S. 166. Respondents
contend that punitive damages, characterized as "windfalls" flowing from
the culpable conduct of third parties, are not within the scope of the
section. But Congress applied no limitations as to the source of taxable
receipts, nor restrictive
Page 348 U. S. 430
labels as to their nature. And the Court has given a liberal construction to
this broad phraseology in recognition of the intention of Congress to tax
all gains except those specifically exempted. Commissioner v. Jacobson,
336 U. S. 28, 336 U. S. 49; Helvering v. Stockholms Enskilda Bank, 293
U. S. 84, 293 U. S. 87-91. Thus, the fortuitous gain accruing to a lessor
by reason of the forfeiture of a lessee's improvements on the rented
property was taxed in Helvering v. Bruun, 309 U. S. 461. Cf. Robertson
v. United States, 343 U. S. 711; Rutkin v. United States, 343 U. S. 130;
United States v. Kirby Lumber Co., 284 U. S. 1. Such decisions
demonstrate that we cannot but ascribe content to the catchall provision
of 22(a), "gains or profits and income derived from any source
whatever." The importance of that phrase has been to frequently
recognized since its first appearance in the Revenue Act of 1913
[Footnote 5] to say now that it adds nothing to the meaning of "gross
income."
Nor can we accept respondents' contention that a narrower reading of
22(a) is required by the Court's characterization of income in Eisner v.
Macomber, 252 U. S. 189, 252 U. S. 207, as "the gain derived from
capital, from labor, or from both combined." [Footnote 6] The Court was
there endeavoring to determine whether the distribution of a corporate
stock dividend constituted a realized gain to the shareholder, or changed
"only the form, not the essence," of

Page 348 U. S. 431

his capital investment. Id. at 252 U. S. 210. It was held that the taxpayer
had "received nothing out of the company's assets for his separate use
and benefit." Id. at 252 U. S. 211. The distribution, therefore, was held
not a taxable event. In that context -- distinguishing gain from capital -the definition served a useful purpose. But it was not meant to provide a
touchstone to all future gross income questions. Helvering v. Bruun,
supra, at 309 U. S. 468-469; United States v. Kirby Lumber Co., supra, at
284 U. S. 3.
Here, we have instances of undeniable accessions to wealth, clearly
realized, and over which the taxpayers have complete dominion. The
mere fact that the payments were extracted from the wrongdoers as
punishment for unlawful conduct cannot detract from their character as
taxable income to the recipients. Respondents concede, as they must, that
the recoveries are taxable to the extent that they compensate for damages
actually incurred. It would be an anomaly that could not be justified in
the absence of clear congressional intent to say that a recovery for actual
damages is taxable, but not the additional amount extracted as
punishment for the same conduct which caused the injury. And we find
no such evidence of intent to exempt these payments.
It is urged that reenactment of 22(a) without change since the Board of
Tax Appeals held punitive damages nontaxable in Highland Farms Corp.,
42 B.T.A. 1314, indicates congressional satisfaction with that holding.
Reenactment -- particularly without the slightest affirmative indication
that Congress ever had the Highland Farms decision before it -- is an
unreliable indicium, at best. Helvering v. Wilshire Oil Co., 308 U. S. 90,
308 U. S. 100-101; Koshland v. Helvering, 298 U. S. 441, 298 U. S. 447.
Moreover, the Commissioner promptly published his nonacquiescence in
this portion of the Highland Farms holding, [Footnote 7] and has,
Page 348 U. S. 432
before and since, consistently maintained the position that these receipts
are taxable. [Footnote 8] It therefore cannot be said with certitude that
Congress intended to carve an exception out of 22(a)'s pervasive
coverage. Nor does the 1954 Code's [Footnote 9] legislative history, with
its reiteration of the proposition that statutory gross income is "allinclusive," [Footnote 10] give support to respondents' position. The
definition of gross income has been simplified, but no effect upon its

present broad scope was intended. [Footnote 11] Certainly punitive

damages cannot reasonably be classified as gifts, cf. Commissioner v.
Jacobson, 336 U. S. 28, 336 U. S. 47-52, nor do they come under any
other exemption provision in the Code. We would do violence to the
plain meaning of the statute and restrict a clear legislative attempt to
Page 348 U. S. 433
bring the taxing power to bear upon all receipts constitutionally taxable
were we to say that the payments in question here are not gross income.
See Helvering v. Midland Mutual Life Ins. Co., supra, at 300 U. S. 223.
Reversed.

Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929)

Old Colony Trust Co. v. Commissioner of Internal Revenue
No. 130
Argued January 10, 11, 1929
Reargued April 15, 1929
Decided June 3, 1929
279 U.S. 716
CERTIFICATE FROM CIRCUIT COURT OF APPEALS
FOR THE FIRST CIRCUIT

4. Assuming that, under 283(b) of the Revenue Act of 1926, a taxpayer

whose appeal to the Board of Tax Appeals was taken before the date of
that Act and decided adversely to him after it may resort both to the
circuit court of appeals by way of review and to the district court by way
of an action to recover the tax (having first paid it), this does not prevent
the circuit court of appeals, being a constitutional court, from having
jurisdiction under the Act, since, on the principle of res judicata, if both
remedies were pursued, the judgment first in time would be a final
adjudication conclusive on both courts. P. 279 U. S. 727.
5. A certificate by the circuit court of appeals of a question of law
involved in a review of a decision of the Board of Tax Appeals held
within the appellate jurisdiction of this Court under the Constitution. P.
279 U. S. 728.
6. Payment by an employer of the income taxes assessable against the
compensation of an employee, made in consideration of his services,
constitutes additional taxable income of the employee under the Revenue
Act of 1918. P. 279 U. S. 729.

Syllabus
Page 279 U. S. 717
1. A proceeding before the circuit court of appeals, under Revenue Act of
1926, 283(b), 1001 et seq., in which a taxpayer sought review of a
decision of the Board of Tax Appeals finding a deficiency in his income
tax return, held to present a " case or controversy " cognizable by that
court under the judicial article of the Constitution. Pp. 279 U. S. 722 et
seq.

7. The objection that this construction would lead to an absurdity not

contemplated by Congress if the employer were called upon to pay the
tax on the additional income and a further tax on that payment, and so
on, will not he considered, no attempt having been made by the Treasury
to collect further taxes upon the theory that payment of additional taxes
creates further income. P. 279 U. S. 730.

Xby DNSUnlocker
2. A proceeding begun by an administrative or executive determination
may be a "case or controversy" when it comes on review before a court if
it calls for the exercise of judicial power only; nor is it essential that there
should be power to award execution where the final judgment establishes
a duty of an executive department and is enforceable through action of
the department. P. 279 U. S. 722.
3. Under 1001-1005 of the Revenue Act of 1926, the courts
authorized to review decisions of the Board of Tax Appeals have power
to award execution of their final judgments. P. 279 U. S. 726.

Response to a question of law certified by the circuit court of appeals,

arising upon review of a decision of the Board of Tax Appeals approving
a finding by the Commissioner of Internal Revenue of deficiencies in
income tax returns. See 7 B.T.A. 648. This case was reargued and
decided with the one next following. *
Page 279 U. S. 718
MR. CHIEF JUSTICE TAFT delivered the opinion of the Court.
We have before us for consideration two questions certified from the
same circuit court of appeals, No. 130 and No. 129. They are presented
upon different statements of facts, and the cases reach the certifying

court in different ways, but the questions are so nearly alike that the
certifying judges deemed it convenient to present them in consolidated
form. We prefer to separate the questions, discuss and decide No. 130
first, and then consider No. 129.

and the following members of the staff, to-wit: Frank H. Carpenter,

Edwin L. Heath, Samuel R. Haines,

No. 130 comes here by certificate from the Circuit Court of Appeals for
the First Circuit. The action in that court was begun by a petition to
review a decision of the United

and William M. Lasbury, to the end that said persons and officers shall
receive their salaries or other compensation in full without deduction on
account of income taxes, state or federal, which taxes are to be paid out
of the treasury of this corporation."

Page 279 U. S. 720

Page 279 U. S. 719

This resolution was amended on March 25, 1918, as follows:
States Board of Tax Appeals. The petitioners are the executors of the will
of William M. Wood, deceased. On June 27, 1925, before Mr. Wood's
death, the Commissioner of Internal Revenue notified him by registered
mail of the determination of a deficiency in income tax against him for
the years 1919 and 1920, under the Revenue Act of 1918 (40 Stat. 1057).
The deficiency was revised by the Commissioner August 18, 1925. An
appeal was taken to the Board of Tax Appeals, which was filed October
27, 1925. A hearing before the Board, April 11, 1927, resulted in a
decision November 12, 1927. The Board approved the action of the
Commissioner, and found a deficiency in the federal income tax return of
Mr. Wood for the year 1919 of $708,781.93, and for the year 1920 of
$350,837.14. The petition for review was perfected December 23, 1927,
pursuant to the Revenue Act of 1926, 283(j), and 1001 to 1005, c.
27, 44 Stat. 9, 65, 109, and Rule 38 of the First Circuit Court of Appeals.

"Voted: That, referring to the vote passed by this board on August 3,

1916, in reference to income taxes, state and federal, payable upon the
salaries or compensation of the officers and certain employees of this
company, the method of computing said taxes shall be as follows, viz.:"
"The difference between what the total amount of his tax would be,
including his income from all sources, and the amount of his tax when
computed upon his income excluding such compensation or salaries paid
by this company."
Pursuant to these resolutions, the American Woolen Company paid to the
collector of internal revenue Mr. Wood's federal income and surtaxes due
to salary and commissions paid him by the company, as follows:

The facts certified to us are substantially as follows:

Taxes for 1918 paid in 1919 . . . . $681,169 88

William M. Wood was president of the American Woolen Company

during the years 1918, 1919, and 1920. In 1918 he received as salary and
commissions from the company $978,725, which he included in his
federal income tax return for 1918. In 1919, he received as salary and
commissions from the company $548,132.87, which he included in his
return for 1919.

Taxes for 1919 paid in 1920 . . . . 351,179 27

August 3, 1916, the American Woolen Company had adopted the

following resolution, which was in effect in 1919 and 1920:

The question certified by the circuit court of appeals for answer by this
Court is:

"Voted: That this company pay any and all income taxes, state and
Federal, that may hereafter become due and payable upon the salaries of
all the officers of the company, including the president, William M.
Wood; the comptroller, Parry C. Wiggin; the auditor, George R.Lawton,

"Did the payment by the employer of the income taxes assessable against
the employee constitute additional taxable income to such employee?"

The decision of the Board of Tax Appeals here sought to be reviewed

was that the income taxes of $681,169.88 and $351,179.27 paid by the
American Woolen Company for Mr. Wood were additional income to
him for the years 1919 and 1920.

The first point presented to us is that of the jurisdiction of this Court to

answer the question of law certified. It

to recover any amounts paid in pursuance of a decision of the Board, the

findings of the Board were prima facie evidence of the facts.

Page 279 U. S. 721

By the Revenue Act of 1926, this procedure was changed, and a direct
judicial review of the Board's decision was substituted.

requires us to examine the original statute providing for the Board of Tax
Appeals under the Revenue Act of 1924, and the amending act of 1926.
The Board of Tax Appeals, established by 900 of the Revenue Act of
1924, Tit. 9, c. 243, 43 Stat. 253, 336, was created by Congress to
provide taxpayers an opportunity to secure an independent review of the
Commissioner of Internal Revenue's determination of additional income
and estate taxes by the Board in advance of their paying the tax found by
the Commissioner to be due. Before the Act of 1924, the taxpayer could
only contest the Commissioner's determination of the amount of the tax
after its payment. The Board's duty under the Act of 1924 was to hear,
consider, and decide whether deficiencies reported by the Commissioner
were right.
Section 273 of that Act defined a "deficiency" to be the amount by which
the tax imposed exceeded the amount shown by the return of the
taxpayer after the return was increased by the amounts previously
assessed or disallowed. There was under the Act of 1924 no direct
judicial review of the proceedings before the Board of Tax Appeals. But
each party had the unhindered right to seek separate action by a court of
competent jurisdiction to test the correctness of the Board's action. Such
court proceedings were to be begun within one year after the final
decision of the Board.
Section 274(b) provided that, if the Board determined there was a
deficiency, the amount so determined should be assessed and paid upon
notice and demand from the collector. No part of the amount determined
as a deficiency by the Commissioner, but disallowed as a deficiency by
the Board, could be assessed, but the Commissioner was at liberty,
notwithstanding the decision of the Board against him, to bring a suit in a
proper court against the taxpayer to collect the alleged deficiency.
On the other hand, by 900(g), it was provided that, in any suit brought
by the Commissioner, or by the taxpayer
Page 279 U. S. 722

The Act of 1926 also enlarged the original jurisdiction of the Board of
Tax Appeals to consider deficiencies beyond those shown in the
Commissioner's notice, if the Commissioner made such a claim at or
before the hearing, 274(e), and also to determine that the taxpayer not
only did not owe the tax, but had overpaid. Section 284(e).
The chief change made by the Act of 1926 was the provision for direct
judicial review of the Board's decisions by the filing by the
Commissioner or the taxpayer of a petition for review in a circuit court
of appeals or the Court of Appeals of the District of Columbia under
rules adopted by such courts.
It is suggested that the proceedings before the circuit courts of appeals or
the district court of appeals on a petition to review are, and cannot be,
judicial, for they involve "no case or controversy," and, without this, a
circuit court of appeals, which is a constitutional court (Ex parte Bakelite
Corporation, ante, p. 279 U. S. 438) is incapable of exercising its judicial
function. This view of the nature of the proceedings we cannot sustain.
The case is analogous to the suits which are lodged in the circuit courts
of appeals upon petition or finding of an executive or administrative
tribunal. It is not important whether such a proceeding was originally
begun by an administrative or executive determination if, when it comes
to the court, whether legislative or constitutional, it calls for the exercise
of only the judicial power of the court upon which jurisdiction has been
conferred by law.
Page 279 U. S. 723
The jurisdiction in this cause is quite like that of circuit courts of appeals
in review of orders of the Federal Trade Commission. Federal Trade
Commission v. Eastman Kodak Co., 274 U. S. 619, 274 U. S. 623; Silver
Co. v. Federal Trade Commission, 292 F. 752. There are other instances
of a like kind which can be cited. United States v. Ritchie, 17 How. 525,
58 U. S. 534; Interstate Commerce Commission v. Brimson, 154 U. S.
447, 154 U. S. 469; Stephens v. Cherokee Nation, 174 U. S. 445, 174 U.

S. 477. See also Fong Yue Ting v. United States, 149 U. S. 698, 149 U. S.
714.

declares that the judicial power shall extend to all cases arising under the
Constitution, laws, and treaties of the United States."

It is not necessary that the proceeding, to be judicial, should be one

entirely de novo. It is enough that, before the judgment, which must be
final, has been invoked as an exercise of judicial power, it shall have
certain necessary features. What these are has been often declared by this
Court. Perhaps the most comprehensive definitions of them are set forth
in Muskrat v. United States, 219 U. S. 346, 219 U. S. 356, where this
Court entered into the inquiry what was the exercise of judicial power as
conferred by the Constitution. There was cited there a definition by Mr.
Justice Field in Re Pacific Railway Commission, 32 F. 241, 255, which
has been generally accepted as accurate. He said:

The circuit court of appeals is a constitutional court under the definition

of such courts as given in the Bakelite case, supra, and a case or
controversy may come before it provided it involves neither advisory nor
executive action by it.

"The judicial article of the Constitution mentions cases and

controversies. The term 'controversies,' if distinguishable at all from
'cases,' is so in that it is less comprehensive than the latter, and includes
only suits of a civil nature. Chisholm v. Georgia, 2 Dall. 431, 2 U. S.
432; 1 Tuck.Bl. Comm.App. 420, 421. By cases and controversies are
intended the claims of litigants brought before the courts for
determination by such regular proceedings as are established by law or
custom for the protection or enforcement of rights or the prevention,
redress, or punishment of wrongs. Whenever the claim of a party under
the Constitution, laws, or treaties of the United
Page 279 U. S. 724
States takes such a form that the judicial power is capable of acting upon
it, then it has become a case. The term implies the existence of present or
possible adverse parties whose contentions are submitted to the court for
adjudication."
In Osborn v. United States Bank, 9 Wheat. 738, Chief Justice Marshall
construed Article III of the Constitution as follows:
"This clause enables the judicial department to receive jurisdiction to the
full extent of the constitution, laws and treaties of the United States when
any question respecting them shall assume such a form that the judicial
power is capable of acting on it. That power is capable of acting only
when the subject is submitted to it by a party who asserts his rights in the
form prescribed by law. It then becomes a case, and the Constitution

In the case we have here, there are adverse parties. The United States or
its authorized official asserts its right to the the payment by a taxpayer of
a tax due from him to the government, and the taxpayer is resisting that
payment or is seeking to recover what he has already paid as taxes when
by law they were not properly due. That makes a case or controversy, and
the proper disposition of it is the exercise of judicial power. The courts
are either the circuit court of appeals or the District of Columbia Court of
Appeals. The subject matter of the controversy is the amount of the tax
claimed to be due or
Page 279 U. S. 725
refundable and its validity, and the judgment to be rendered is a judicial
judgment.
The Board of Tax Appeals is not a court. It is an executive or
administrative board, upon the decision of which the parties are given an
opportunity to base a petition for review to the courts after the
administrative inquiry of the Board has been had and decided.
It is next suggested that there is no adequate finality provided in respect
to the action of these courts. In the first place, it is not necessary, in order
to constitute a judicial judgment, that there should be both a
determination of the rights of the litigants and also power to issue formal
execution to carry the judgment into effect in the way that judgments for
money or for the possession of land usually are enforced. A judgment is
sometimes regarded as properly enforceable through the executive
departments, instead of through an award of execution by this Court,
where the effect of the judgment is to establish the duty of the
department to enforce it. La Abra Silver Mining Co. v. United States, 175
U. S. 423, 175 U. S. 457, 175 U. S. 461. The case of Fidelity National
Bank & Trust Co. v. Swope, 274 U. S. 123, 274 U. S. 132, shows clearly
that there are instances where the award of execution is not an
indispensable element of a constitutional case or controversy. In that

decision there are collected familiar examples of judicial proceedings

resulting in a final adjudication of the rights of litigants without it.

the result of these petitions for review in the several courts vested with
jurisdiction over them.

But, even if a formal execution be required, we think power to resort to it

is clearly shown with respect to the enforcement of the action of the
courts here involved by 1001 to 1005.

Page 279 U. S. 727

By the first, the decision of the Board of Tax Appeals rendered after the
passage of the Act of 1926 may be reviewed by the circuit court of
appeals or the district court of appeals if a petition for such review is
filed
Page 279 U. S. 726
either by the Commissioner or the taxpayer within six months after the
decision is rendered. The courts are to adopt rules for the filing of the
petition, the preparation of the record, and the conduct of the proceedings
upon such review. The review is not to operate as a stay of assessment or
collection of any portion of the amount of the deficiency determined by
the Board unless a petition for review is filed by the taxpayer, or unless
the taxpayer has filed a bond which when enforced will operate finally to
settle the rights of the parties as found by the courts.
By 1002, it is provided in what venue the decision may be reviewed. In
1003, the circuit courts of appeals and the court of appeals of the
district are given exclusive jurisdiction to review the decisions of the
Board, and it is declared that their judgments shall be final, except that
they shall be subject to review by the Supreme Court of the United
States, on certificate or by certiorari in the manner provided in 240 of
the Judicial Code as amended, and, in such review, the courts shall have
the power to affirm, or, if the decision of the Board is not in accordance
with law, to modify or reverse, the decision of the Board, with or without
remanding the case for a rehearing, as justice may require.
By 1004, the same courts are given power to impose damages in any
case where the decision of the Board is affirmed and it appears that the
petition was filed merely for delay.
By 1005, the decision of the Board is to become final in respect to all
the numerous instances which in the course of the review may naturally
end further litigation. In the provisions of these sections, the legislation
prescribes minute details for the enforcement of the judgments that are

The complete purpose of Congress to provide a final adjudication in such

proceedings, binding all the parties, is manifest, and demonstrates the
unsoundness of the objection.
We have before us, however, for actual inquiry a case different from one
just considered in the regular course of a petition for review of a decision
of the Board begun and decided all after the enactment of the Act of
1926. It is one in which the appeal to the Board of Tax Appeals had been
taken, but the appeal had not been decided by the Board before the
passage of the Act of 1926. That presents what involves a troublesome
exception or duplication in the procedure. This occurs because of the last
excepting clause of 283(b) of the amending act of 1926, which is as
follows:
"If, before the enactment of this Act, any person has appealed to the
Board of Tax Appeals under subdivision (a) of Section 274 of the
Revenue Act of 1924 . . . and the appeal is pending before the Board at
the time of the enactment of this Act, the Board shall have jurisdiction of
the appeal. In all such cases, the powers, duties, rights, and privileges of
the Commissioner and of the person who has brought the appeal, and the
jurisdiction of the Board and of the courts, shall be determined, and the
computation of the tax shall be made, in the same manner as provided in
subdivision (a) of this section, except as provided in subdivision (j) of
this section and except that the person liable for the tax shall not be
subject to the provisions of subdivision (d) of Section 284."
The provisions of 284(d) are those which deny to the taxpayer the
power to bring any suit for the recovery of the tax after he has adopted
the procedure of appealing to the Board of Tax Appeals or to the circuit
court of appeals.
By this last exception in 283(b), there seems still open to the taxpayers
who have filed a petition under the
Page 279 U. S. 728

law of 1924 and have not had a decision by the Board before the
enactment of the law of 1926, the right to pay the tax and sue for a
refund in the proper district court (paragraph 20 of 24 of the Judicial
Code, as amended by 1310(c), c. 136, 42 Stat. 311, U.S.Code, Title 28,
41). Emery v. United States, 27 F.2d 992, and Old Colony R. Co. v.
United States, 27 F.2d 994, hold that the petitioner still retains this earlier
remedy.
The truth seems to be that, in making provision to render conclusive
judgments on petitions for review in the circuit courts of appeals,
Congress was not willing, in cases where the Board of Tax Appeals had
not decided the issue before the passage of the Act of 1926, to cut off the
taxpayer from paying the tax and suing for a refund in the proper district
court. But the apparent conflict in such cases can be easily resolved by
the use of the principles of res judicata. If both remedies are pursued, the
one in a district court for refund and the other on a petition for review in
the circuit court of appeals, the judgment which is first rendered will then
put an end to the questions involved, and in effect make all proceedings
in the other court of no avail. Whichever judgment is first in time is
necessarily final to the extent to which it becomes a judgment. There is
no reason, therefore, in the case before us to decline to take jurisdiction.
See Bryar v. Campbell, 177 U. S. 649; Kline v. Burke Construction Co.,
260 U. S. 226, 260 U. S. 230; Stanton v. Embry, 93 U. S. 548, 93 U. S.
554.
Second. The jurisdiction here is based upon the certificate of a question
of law. That is whether the payment by the employer of the income taxes
assessed against the employee constitutes additional returnable taxable
income to such employee. The certification of such a question by the
circuit court of appeals is an invocation
Page 279 U. S. 729
of the appellate jurisdiction of this Court, and therefore within the
Constitution.
Third. Coming now to the merits of this case, we think the question
presented is whether a taxpayer, having induced a third person to pay his
income tax or having acquiesced in such payment as made in discharge
of an obligation to him, may avoid the making of a return thereof and the
payment of a corresponding tax. We think he may not do so. The
payment of the tax by the employers was in consideration of the services

rendered by the employee, and was again derived by the employee from
his labor. The form of the payment is expressly declared to make no
difference. Section 213, Revenue Act of 1918, c. 18, 40 Stat. 1065. It is
therefore immaterial that the taxes were directly paid over to the
government. The discharge by a third person of an obligation to him is
equivalent to receipt by the person taxed. The certificate shows that the
taxes were imposed upon the employee, that the taxes were actually paid
by the employer, and that the employee entered upon his duties in the
years in question under the express agreement that his income taxes
would be paid by his employer. This is evidenced by the terms of the
resolution passed August 3, 1916, more than one year prior to the year in
which the taxes were imposed. The taxes were paid upon a valuable
consideration -- namely, the services rendered by the employee and as
part of the compensation therefor. We think, therefore, that the payment
constituted income to the employee.
This result is sustained by many decisions. Providence & Worcester R.
Co., 5 B.T.A. 1186; Houston Belt & Terminal Ry. Co. v. Commissioner, 6
B.T.A. 1364; West End Street Railway Co. v. Malley, 246 F. 625;
Renesselaer & S. R. Co. v. Irwin, 249 F. 726; Northern R.
Page 279 U. S. 730
Co. of New Jersey v. Lowe, 250 F. 856; Houston Belt & Terminal Ry.
Co. v. United States, 250 F. 1; Blalock v. Georgia Ry. & Electric Co., 246
F. 387; Hamilton v. Kentucky & Indiana Terminal R. Co., 289 F. 20;
American Telegraph & Cable Co. v. United States, 61 Ct.Cls. 326;
United States v. Western Union Telegraph Co., 19 F.2d 157; Estate of
Levalley, 191 Wis. 356; Estate of Irwin, 196 Cal. 366.
Nor can it be argued that the payment of the tax in No. 130 was a gift.
The payment for services, even though entirely voluntary, was
nevertheless compensation within the statute. This is shown by the case
of Noel v. Parrott, 15 F.2d 669. There, it was resolved that a gratuitous
appropriation equal in amount to $3 per share on the outstanding stock of
the company be set aside out of the assets for distribution to certain
officers and employees of the company, and that the executive committee
be authorized to make such distribution as they deemed wise and proper.
The executive committee gave $35,000 to be paid to the plaintiff
taxpayer. The court said (p. 672):

"In no view of the evidence therefore can the $35,000 be regarded as a

gift. It was either compensation for services rendered or a gain or profit
derived from the sale of the stock of the corporation, or both, and, in any
view, it was taxable as income."
It is next argued against the payment of this tax that, if these payments
by the employer constitute income to the employee, the employee will be
called upon to pay the tax imposed upon this additional income, and that
the payment of the additional tax will create further income which will in
turn be subject to tax, with the result that there would be a tax upon a tax.
This, it is urged, is the result of the government's theory, when carried to
its
Page 279 U. S. 731
logical conclusion, and results in an absurdity which Congress could not
have contemplated.
In the first place, no attempt has been made by the Treasury to collect
further taxes upon the theory that the payment of the additional taxes
creates further income, and the question of a tax upon a tax was not
before the circuit court of appeals, and has not been certified to this
Court. We can settle questions of that sort when an attempt to impose a
tax upon a tax is undertaken, but not now. United States v. Sullivan, 274
U. S. 259, 274 U. S. 264; Yazoo & Mississippi Valley R. Co. v. Jackson
Vinegar Co., 226 U. S. 217, 226 U. S. 219. It is not, therefore, necessary
to answer the argument based upon an algebraic formula to reach the
amount of taxes due. The question in this case is, "Did the payment by
the employer of the income taxes assessable against the employee
constitute additional taxable income to such employee?" The answer
must be "Yes."
* After the first argument, the Court, on February 18, 1929, made the
following order:
"It is ordered that the above cause be restored to the docket for
reargument. The Court especially desires assistance of counsel in respect
of the following matters:"
"1. Was there power in Congress to confer jurisdiction upon the Circuit
Court of Appeals to review action by the Board of Tax Appeals?"

"2. Does the Circuit Court of Appeals act as a tribunal of original

jurisdiction when considering appeals from the Board of Tax Appeals? If
so, may it, under Title 28, United States Code, sec. 346, certify to this
Court questions deemed necessary for the proper decision of a pending
cause?"
"3. What has been the practice of taxing officers relative to assessments
where, by agreement between the parties, the tax laid upon the income
actually received by one of them has been paid by another?"
"4. Do applicable statutes authorize the taxing officers to estimate total
income by adding to the amount actually received by the taxpayer any
tax which another has paid thereon under agreement between the
parties?"
"It is suggested that counsel apply to the court below for an amendment,
so that the certificate will show distinctly when the original assessments
were made, and under what acts. Also when the appeals were taken to the
Board of Tax appeals; when they were decided, and when the appeals to
the circuit Court of Appeals were perfected."
Separate opinion of MR. JUSTICE McREYNOLDS.
The Board of Tax Appeals belongs to the executive department of the
government and performs administrative functions -- the assessment of
taxes. The statute attempts to grant a broad appeal to the courts, and
directs them to reconsider the Board's action -- to do or to say what it
should have done. This enjoins the use of executive power, not judicial.
The duty thus imposed upon the courts is wholly different from that
which arises upon the filing of a petition to annul or enforce the action of
the Interstate Commerce Commission or the Federal Trade Commission.
I think the circuit court of appeals was without jurisdiction.

Helvering v. Bruun, 309 U.S. 461 (1940)

Helvering v. Bruun

Certiorari, 308 U.S. 544, to review the affirmance of a decision of the

Board of Tax Appeals overruling the Commissioner's determination of a
deficiency in income tax.

No. 479

Page 309 U. S. 464

Argued February 28, 1940

MR. JUSTICE ROBERTS delivered the opinion of the Court.

Decided March 25, 1940

The controversy had its origin in the petitioner's assertion that the
respondent realized taxable gain from the forfeiture of a leasehold, the
tenant having erected a new building upon the premises. The court below
held that no income had been realized. [Footnote 1] Inconsistency of the
decisions on the subject led us to grant certiorari. 308 U.S. 544.

309 U.S. 461

CERTIORARI TO THE CIRCUIT COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
Syllabus
1. Where, upon termination of a lease, the lessor repossessed the real
estate and improvements, including a new building erected by the lessee,
an increase in value attributable to the new building was taxable under
the Revenue Act of 1932 as income of the lessor in the year of
repossession. P. 309 U. S. 467.

The Board of Tax Appeals made no independent findings. The cause was
submitted upon a stipulation of facts. From this it appears that, on July 1,
1915, the respondent, as owner, leased a lot of land and the building
thereon for a term of ninety-nine years.
The lease provided that the lessee might at any time, upon giving bond to
secure rentals accruing in the two ensuing years, remove or tear down
any building on the land, provided that no building should be removed or
torn down after the lease became forfeited, or during the last three and
one-half years of the term. The lessee was to surrender the land, upon
termination of the lease, with all buildings and improvements thereon.

Page 309 U. S. 462

2. Hewitt Realty Co. v. Commissioner, 76 F.2d 880, and decision of this
Court dealing with the taxability vel non of stock dividends,
distinguished. P. 309 U. S. 468.

In 1929, the tenant demolished and removed the existing building and
constructed a new one which had a useful life of not more than fifty
years. July 1, 1933, the lease was cancelled for default in payment of rent
and taxes, and the respondent regained possession of the land and
building.

Xby DNSUnlocker
The parties stipulated
3. Even though the gain in question be regarded as inseparable from the
capital, it is within the definition of gross income in 22(a) of the
Revenue Act of 1932, and, under the Sixteenth Amendment, may be
taxed without apportionment amongst the States. P. 309 U. S. 468.
105 F.2d 442 reversed.

"that as at said date, July 1, 1933, the building which had been erected
upon said premises by the lessee had a fair market value of $64,245.68,
and that the unamortized cost of the old building, which was removed
from the premises in 1929 to make way for the new building, was
$12,811.43, thus leaving a net fair market value as at July 1, 1933, of
$51,434.25, for
Page 309 U. S. 465

the aforesaid new building erected upon the premises by the lessee."
On the basis of these facts, the petitioner determined that, in 1933, the
respondent realized a net gain of $51,434.25. The Board overruled his
determination, and the Circuit Court of Appeals affirmed the Board's
decision.
The course of administrative practice and judicial decision in respect of
the question presented has not been uniform. In 1917, the Treasury ruled
that the adjusted value of improvements installed upon leased premises is
income to the lessor upon the termination of the lease. [Footnote 2] The
ruling was incorporated in two succeeding editions of the Treasury
Regulations. [Footnote 3] In 1919, the Circuit Court of Appeals for the
Ninth Circuit held, in Miller v. Gearin, 258 F. 225, that the regulation
was invalid, as the gain, if taxable at all, must be taxed as of the year
when the improvements were completed. [Footnote 4]
The regulations were accordingly amended to impose a tax upon the gain
in the year of completion of the improvements, measured by their
anticipated value at the termination of the lease and discounted for the
duration of the lease. Subsequently, the regulations permitted the lessor
to spread the depreciated value of the improvements over the remaining
life of the lease, reporting an aliquot part each year, with provision that,
upon premature termination, a tax should be imposed upon the excess of
the then value of the improvements over the amount theretofore returned.
[Footnote 5]
In 1935, the Circuit Court of Appeals for the Second Circuit decided, in
Hewitt Realty Co. v. Commissioner,
Page 309 U. S. 466
76 F.2d 880, that a landlord received no taxable income in a year, during
the term of the lease, in which his tenant erected a building on the leased
land. The court, while recognizing that the lessor need not receive money
to be taxable, based its decision that no taxable gain was realized in that
case on the fact that the improvement was not portable or detachable
from the land, and, if removed, would be worthless except as bricks,
iron, and mortar. It said, 76 F.2d at 884:

"The question, as we view it, is whether the value received is embodied

in something separately disposable, or whether it is so merged in the land
as to become financially a part of it, something which, though it
increases its value, has no value of its own when torn away."
This decision invalidated the regulations then in force. [Footnote 6]
In 1938, this court decided M.E. Blatt Co. v. United States, 305 U. S.
267. There, in connection with the execution of a lease, landlord and
tenant mutually agreed that each should make certain improvements to
the demised premises and that those made by the tenant should become
and remain the property of the landlord. The Commissioner valued the
improvements as of the date they were made, allowed depreciation
thereon to the termination of the leasehold, divided the depreciated value
by the number of years the lease had to run, and found the landlord
taxable for each year's aliquot portion thereof. His action was sustained
by the Court of Claims. The judgment was reversed on the ground that
the added value could not be considered rental accruing over the period
of the lease; that the facts found by the Court of Claims did not support
the conclusion of the Commissioner as to the value to be attributed to the
improvements
Page 309 U. S. 467
after a use throughout the term of the lease, and that, in the
circumstances disclosed, any enhancement in the value of the realty in
the tax year was not income realized by the lessor within the Revenue
Act.
The circumstances of the instant case differentiate it from the Blatt and
Hewitt cases, but the petitioner's contention that gain was realized when
the respondent, through forfeiture of the lease, obtained untrammeled
title, possession, and control of the premises, with the added increment of
value added by the new building, runs counter to the decision in the
Miller case and to the reasoning in the Hewitt case.
The respondent insists that the realty -- a capital asset at the date of the
execution of the lease -- remained such throughout the term and after its
expiration; that improvements affixed to the soil became part of the
realty indistinguishably blended in the capital asset; that such
improvements cannot be separately valued or treated as received in
exchange for the improvements which were on the land at the date of the

execution of the lease; that they are therefore in the same category as
improvements added by the respondent to his land, or accruals of value
due to extraneous and adventitious circumstances. Such added value, it is
argued, can be considered capital gain only upon the owner's disposition
of the asset. The position is that the economic gain consequent upon the
enhanced value of the recaptured asset is not gain derived from capital or
realized within the meaning of the Sixteenth Amendment, and may not
therefore be taxed without apportionment.
We hold that the petitioner was right in assessing the gain as realized in
1933.
We might rest our decision upon the narrow issue presented by the terms
of the stipulation. It does not appear what kind of a building was erected
by the tenant, or whether the building was readily removable from the
Page 309 U. S. 468
land. It is not stated whether the difference in the value between the
building removed and that erected in its place accurately reflects an
increase in the value of land and building considered as a single estate in
land. On the facts stipulated, without more, we should not be warranted
in holding that the presumption of the correctness of the Commissioner's
determination has been overborne.
The respondent insists, however, that the stipulation was intended to
assert that the sum of $51,434.25 was the measure of the resulting
enhancement in value of the real estate at the date of the cancellation of
the lease. The petitioner seems not to contest this view. Even upon this
assumption, we think that gain in the amount named was realized by the
respondent in the year of repossession.
The respondent cannot successfully contend that the definition of gross
income in Sec. 22(a) of the Revenue Act of 1932 [Footnote 7] is not
broad enough to embrace the gain in question. That definition follows
closely the Sixteenth Amendment. Essentially the respondent's position is
that the Amendment does not permit the taxation of such gain without
apportionment amongst the states. He relies upon what was said in
Hewitt Realty Co. v. Commissioner, supra, and upon expressions found
in the decisions of this court dealing with the taxability of stock
dividends to the effect that gain derived from capital must be something
of exchangeable value proceeding from property, severed from the

capital, however invested or employed, and received by the recipient for

his separate use, benefit, and disposal. [Footnote 8] He emphasizes the
necessity that the gain be separate from the capital and separately
disposable. These expressions, however,
Page 309 U. S. 469
were used to clarify the distinction between an ordinary dividend and a
stock dividend. They were meant to show that, in the case of a stock
dividend, the stockholder's interest in the corporate assets after receipt of
the dividend was the same as and inseverable from that which he owned
before the dividend was declared. We think they are not controlling here.
While it is true that economic gain is not always taxable as income, it is
settled that the realization of gain need not be in cash derived from the
sale of an asset. Gain may occur as a result of exchange of property,
payment of the taxpayer's indebtedness, relief from a liability, or other
profit realized from the completion of a transaction. [Footnote 9] The
fact that the gain is a portion of the value of property received by the
taxpayer in the transaction does not negative its realization.
Here, as a result of a business transaction, the respondent received back
his land with a new building on it, which added an ascertainable amount
to its value. It is not necessary to recognition of taxable gain that he
should be able to sever the improvement begetting the gain from his
original capital. If that were necessary, no income could arise from the
exchange of property, whereas such gain has always been recognized as
realized taxable gain.
Judgment reversed.

[G.R. No. 108576. January 20, 1999]

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE
COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO
CORP., respondents.
DECISION
MARTINEZ, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of
the decision of the Court of Appeals (CA)[1] which affirmed the ruling
of the Court of Tax Appeals (CTA)[2] that private respondent A. Soriano
Corporations (hereinafter ANSCOR) redemption and exchange of the
stocks of its foreign stockholders cannot be considered as essentially
equivalent to a distribution of taxable dividends under Section 83(b) of
the 1939 Internal Revenue Act[3]

shareholdings or 92,577[14] shares were transferred to his wife, Doa

Carmen Soriano, as her conjugal share. The other half formed part of his
estate.[15]
A day after Don Andres died, ANSCOR increased its capital stock to
P20M[16] and in 1966 further increased it to P30M.[17] In the same year
(December 1966), stock dividends worth 46,290 and 46,287 shares were
respectively received by the Don Andres estate[18] and Doa Carmen
from ANSCOR. Hence, increasing their accumulated shareholdings to
138,867 and 138,864[19] common shares each.[20]

The undisputed facts are as follows:

On December 28, 1967, Doa Carmen requested a ruling from the United
States Internal Revenue Service (IRS), inquiring if an exchange of
common with preferred shares may be considered as a tax avoidance
scheme[21] under Section 367 of the 1954 U.S. Revenue Act.[22] By
January 2, 1968, ANSCOR reclassified its existing 300,000 common
shares into 150,000 common and 150,000 preferred shares.[23]

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the
United States, formed the corporation A. Soriano Y Cia, predecessor of
ANSCOR, with a P1,000,000.00 capitalization divided into 10,000
common shares at a par value of P100/share. ANSCOR is wholly owned
and controlled by the family of Don Andres, who are all non-resident
aliens.[4] In 1937, Don Andres subscribed to 4,963 shares of the 5,000
shares originally issued.[5]

In a letter-reply dated February 1968, the IRS opined that the exchange is
only a recapitalization scheme and not tax avoidance.[24] Consequently,
[25] on March 31, 1968 Doa Carmen exchanged her whole 138,864
common shares for 138,860 of the newly reclassified preferred shares.
The estate of Don Andres in turn, exchanged 11,140 of its common
shares for the remaining 11,140 preferred shares, thus reducing its (the
estate) common shares to 127,727.[26]

On September 12, 1945, ANSCORs authorized capital stock was

increased to P2,500,000.00 divided into 25,000 common shares with the
same par value. Of the additional 15,000 shares, only 10,000 was issued
which were all subscribed by Don Andres, after the other stockholders
waived in favor of the former their pre-emptive rights to subscribe to the
new issues.[6] This increased his subscription to 14,963 common shares.
[7] A month later,[8] Don Andres transferred 1,250 shares each to his two
sons, Jose and Andres, Jr., as their initial investments in ANSCOR.[9]
Both sons are foreigners.[10]

On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed

28,000 common shares from the Don Andres estate. By November 1968,
the Board further increased ANSCORs capital stock to P75M divided
into 150,000 preferred shares and 600,000 common shares.[27] About a
year later, ANSCOR again redeemed 80,000 common shares from the
Don Andres estate,[28] further reducing the latters common
shareholdings to 19,727. As stated in the board Resolutions, ANSCORs
business purpose for both redemptions of stocks is to partially retire said
stocks as treasury shares in order to reduce the companys foreign
exchange remittances in case cash dividends are declared.[29]

By 1947, ANSCOR declared stock dividends. Other stock dividend

declarations were made between 1949 and December 20, 1963.[11] On
December 30, 1964 Don Andres died. As of that date, the records
revealed that he has a total shareholdings of 185,154 shares[12] - 50,495
of which are original issues and the balance of 134,659 shares as stock
dividend declarations.[13] Correspondingly, one-half of that

In 1973, after examining ANSCORs books of account and records,

Revenue examiners issued a report proposing that ANSCOR be assessed
for deficiency withholding tax-at-source, pursuant to Sections 53 and 54
of the 1939 Revenue Code,[30] for the year 1968 and the second quarter
of 1969 based on the transactions of exchange and redemption of stocks.

[31] The Bureau of Internal Revenue (BIR) made the corresponding

assessments despite the claim of ANSCOR that it availed of the tax
amnesty under Presidential Decree (P.D.) 23[32] which were amended by
P.D.s 67 and 157.[33] However, petitioner ruled that the invoked decrees
do not cover Sections 53 and 54 in relation to Article 83(b) of the 1939
Revenue Act under which ANSCOR was assessed.[34] ANSCORs
subsequent protest on the assessments was denied in 1983 by petitioner.
[35]
Subsequently, ANSCOR filed a petition for review with the CTA
assailing the tax assessments on the redemptions and exchange of stocks.
In its decision, the Tax Court reversed petitioners ruling, after finding
sufficient evidence to overcome the prima facie correctness of the
questioned assessments.[36] In a petition for review, the CA, as
mentioned, affirmed the ruling of the CTA.[37] Hence, this petition.
The bone of contention is the interpretation and application of Section
83(b) of the 1939 Revenue Act[38] which provides:
Sec. 83. Distribution of dividends or assets by corporations.
(b) Stock dividends A stock dividend representing the transfer of surplus
to capital account shall not be subject to tax. However, 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 shall be considered as taxable income to the extent it represents a
distribution of earnings or profits accumulated after March first, nineteen
hundred and thirteen. (Italics supplied).
Specifically, the issue is whether ANSCORs redemption of stocks from
its stockholder as well as the exchange of common with preferred shares
can be considered as essentially equivalent to the distribution of taxable
dividend, making the proceeds thereof taxable under the provisions of
the above-quoted law.
Petitioner contends that the exchange transaction is tantamount to
cancellation under Section 83(b) making the proceeds thereof taxable. It
also argues that the said Section applies to stock dividends which is the
bulk of stocks that ANSCOR redeemed. Further, petitioner claims that
under the net effect test, the estate of Don Andres gained from the

redemption. Accordingly, it was the duty of ANSCOR to withhold the

tax-at-source arising from the two transactions, pursuant to Section 53
and 54 of the 1939 Revenue Act.[39]
ANSCOR, however, avers that it has no duty to withhold any tax either
from the Don Andres estate or from Doa Carmen based on the two
transactions, because the same were done for legitimate business
purposes which are (a) to reduce its foreign exchange remittances in the
event the company would declare cash dividends,[40] and to (b)
subsequently filipinized ownership of ANSCOR, as allegedly envisioned
by Don Andres.[41] It likewise invoked the amnesty provisions of P.D.
67.
We must emphasize that the application of Sec. 83(b) depends on the
special factual circumstances of each case.[42] The findings of facts of a
special court (CTA) exercising particular expertise on the subject of tax,
generally binds this Court,[43] considering that it is substantially similar
to the findings of the CA which is the final arbiter of questions of facts.
[44] The issue in this case does not only deal with facts but whether the
law applies to a particular set of facts. Moreover, this Court is not
necessarily bound by the lower courts conclusions of law drawn from
such facts.[45]
AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D. 67[46]
provides:
I. In all cases of voluntary disclosures of previously untaxed income
and/or wealth such as earnings, receipts, gifts, bequests or any other
acquisitions from any source whatsoever which are taxable under the
National Internal Revenue Code, as amended, realized here or abroad by
any taxpayer, natural or juridical; the collection of all internal revenue
taxes including the increments or penalties or account of non-payment as
well as all civil, criminal or administrative liabilities arising from or
incident to such disclosures under the National Internal Revenue Code,
the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the
Revised Administrative Code, the Civil Service laws and regulations,
laws and regulations on Immigration and Deportation, or any other
applicable law or proclamation, are hereby condoned and, in lieu thereof,
a tax of ten (10%) per centum on such previously untaxed income or

wealth is hereby imposed, subject to the following conditions:

(conditions omitted) [Emphasis supplied].
The decree condones the collection of all internal revenue taxes
including the increments or penalties or account of non-payment as well
as all civil, criminal or administrative liabilities arising from or incident
to (voluntary) disclosures under the NIRC of previously untaxed income
and/or wealth realized here or abroad by any taxpayer, natural or
juridical.
May the withholding agent, in such capacity, be deemed a taxpayer for it
to avail of the amnesty? An income taxpayer covers all persons who
derive taxable income.[47] ANSCOR was assessed by petitioner for
deficiency withholding tax under Section 53 and 54 of the 1939 Code. As
such, it is being held liable in its capacity as a withholding agent and not
in its personality as a taxpayer.
In the operation of the withholding tax system, the withholding agent is
the payor, a separate entity acting no more than an agent of the
government for the collection of the tax[48] in order to ensure its
payments;[49] the payer is the taxpayer he is the person subject to tax
impose by law;[50] and the payee is the taxing authority.[51] In other
words, the withholding agent is merely a tax collector, not a taxpayer.
Under the withholding system, however, the agent-payor becomes a
payee by fiction of law. His (agent) liability is direct and independent
from the taxpayer,[52] because the income tax is still impose on and due
from the latter. The agent is not liable for the tax as no wealth flowed
into him he earned no income. The Tax Code only makes the agent
personally liable for the tax[53] (c) 1939 Tax Code, as amended by R.A.
No. 2343 which provides in part that xxx Every such person is made
personally liable for such tax xxx.53 arising from the breach of its legal
duty to withhold as distinguish from its duty to pay tax since:
the governments cause of action against the withholding agent is not for
the collection of income tax, but for the enforcement of the withholding
provision of Section 53 of the Tax Code, compliance with which is
imposed on the withholding agent and not upon the taxpayer.[54]
Not being a taxpayer, a withholding agent, like ANSCOR in this
transaction, is not protected by the amnesty under the decree.

Codal provisions on withholding tax are mandatory and must be

complied with by the withholding agent.[55] The taxpayer should not
answer for the non-performance by the withholding agent of its legal
duty to withhold unless there is collusion or bad faith. The former could
not be deemed to have evaded the tax had the withholding agent
performed its duty. This could be the situation for which the amnesty
decree was intended. Thus, to curtail tax evasion and give tax evaders a
chance to reform,[56] it was deemed administratively feasible to grant
tax amnesty in certain instances. In addition, a tax amnesty, much like a
tax exemption, is never favored nor presumed in law and if granted by a
statute, 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.[57] The rule on strictissimi juris equally applies.[58] So that,
any doubt in the application of an amnesty law/decree should be resolved
in favor of the taxing authority.
Furthermore, ANSCORs claim of amnesty cannot prosper. The
implementing rules of P.D. 370 which expanded amnesty on previously
untaxed income under P.D. 23 is very explicit, to wit:
Section 4. Cases not covered by amnesty. The following cases are not
covered by the amnesty subject of these regulations:
xxx xxx xxx
(2) Tax liabilities with or without assessments, on withholding tax at
source provided under Sections 53 and 54 of the National Internal
Revenue Code, as amended;[59]
ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code.
Thus, by specific provision of law, it is not covered by the amnesty.
TAX ON STOCK DIVIDENDS
General Rule
Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the
U.S. Revenue Code of 1928.[60] It laid down the general rule known as
the proportionate test[61] wherein stock dividends once issued form part
of the capital and, thus, subject to income tax.[62] Specifically, the
general rule states that:

A stock dividend representing the transfer of surplus to capital account

shall not be subject to tax.
Having been derived from a foreign law, resort to the jurisprudence of its
origin may shed light. Under the US Revenue Code, this provision
originally referred to stock dividends only, without any exception. Stock
dividends, strictly speaking, represent capital and do not constitute
income to its recipient.[63] So that the mere issuance thereof is not yet
subject to income tax[64] as they are nothing but an enrichment through
increase in value of capital investment.[65] As capital, the stock
dividends postpone the realization of profits because the fund
represented by the new stock has been transferred from surplus to capital
and no longer available for actual distribution.[66] Income in tax law is
an amount of money coming to a person within a specified time, whether
as payment for services, interest, or profit from investment.[67] It means
cash or its equivalent.[68] It is gain derived and severed from capital,[69]
from labor or from both combined[70] - so that to tax a stock dividend
would be to tax a capital increase rather than the income.[71] In a loose
sense, stock dividends issued by the corporation, are considered
unrealized gain, and cannot be subjected to income tax until that gain has
been realized. Before the realization, stock dividends are nothing but a
representation of an interest in the corporate properties.[72] As capital, it
is not yet subject to income tax. It should be noted that capital and
income are different. Capital is wealth or fund; whereas income is profit
or gain or the flow of wealth.[73] The determining factor for the
imposition of income tax is whether any gain or profit was derived from
a transaction.[74]
The Exception
However, 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 shall be considered as taxable
income to the extent it represents a distribution of earnings or profits
accumulated after March first, nineteen hundred and thirteen. (Emphasis
supplied).
In a response to the ruling of the American Supreme Court in the case of
Eisner v. Macomber[75] (that pro rata stock dividends are not taxable
income), the exempting clause above quoted was added because

corporations found a loophole in the original provision. They resorted to

devious means to circumvent the law and evade the tax. Corporate
earnings would be distributed under the guise of its initial capitalization
by declaring the stock dividends previously issued and later redeem said
dividends by paying cash to the stockholder. This process of issuanceredemption amounts to a distribution of taxable cash dividends which
was just delayed so as to escape the tax. It becomes a convenient
technical strategy to avoid the effects of taxation.
Thus, to plug the loophole the exempting clause was added. It provides
that the redemption or cancellation of stock dividends, depending on the
time and manner it was made is essentially equivalent to a distribution of
taxable dividends, making the proceeds thereof taxable income to the
extent it represents profits. The exception was designed to prevent the
issuance and cancellation or redemption of stock dividends, which is
fundamentally not taxable, from being made use of as a device for the
actual distribution of cash dividends, which is taxable.[76] Thus,
the provision had the obvious purpose of preventing a corporation from
avoiding dividend tax treatment by distributing earnings to its
shareholders in two transactions a pro rata stock dividend followed by a
pro rata redemption that would have the same economic consequences as
a simple dividend.[77]
Although redemption and cancellation are generally considered capital
transactions, as such, they are not subject to tax. However, it does not
necessarily mean that a shareholder may not realize a taxable gain from
such transactions.[78] Simply put, depending on the circumstances, the
proceeds of redemption of stock dividends are essentially distribution of
cash dividends, which when paid becomes the absolute property of the
stockholder. Thereafter, the latter becomes the exclusive owner thereof
and can exercise the freedom of choice[79] Having realized gain from
that redemption, the income earner cannot escape income tax.[80]
As qualified by the phrase such time and in such manner, the exception
was not intended to characterize as taxable dividend every distribution of
earnings arising from the redemption of stock dividends.[81] So that,
whether the amount distributed in the redemption should be treated as the
equivalent of a taxable dividend is a question of fact,[82] which is
determinable on the basis of the particular facts of the transaction in
question.[83] No decisive test can be used to determine the application of
the exemption under Section 83(b) The use of the words such manner

and essentially equivalent negative any idea that a weighted formula can
resolve a crucial issue Should the distribution be treated as taxable
dividend.[84] On this aspect, American courts developed certain
recognized criteria, which includes the following:[85]
1) the presence or absence of real business purpose,
2) the amount of earnings and profits available for the declaration of a
regular dividend and the corporations past record with respect to the
declaration of dividends,
3) the effect of the distribution as compared with the declaration of
regular dividend,
4) the lapse of time between issuance and redemption,[86]
5) the presence of a substantial surplus[87] and a generous supply of cash
which invites suspicion as does a meager policy in relation both to
current earnings and accumulated surplus.[88]
REDEMPTION AND CANCELLATION
For the exempting clause of Section 83(b) to apply, it is indispensable
that: (a) there is redemption or cancellation; (b) the transaction involves
stock dividends and (c) the time and manner of the transaction makes it
essentially equivalent to a distribution of taxable dividends. Of these, the
most important is the third.
Redemption is repurchase, a reacquisition of stock by a corporation
which issued the stock[89] in exchange for property, whether or not the
acquired stock is cancelled, retired or held in the treasury.[90]
Essentially, the corporation gets back some of its stock, distributes cash
or property to the shareholder in payment for the stock, and continues in
business as before. The redemption of stock dividends previously issued
is used as a veil for the constructive distribution of cash dividends. In the
instant case, there is no dispute that ANSCOR redeemed shares of stocks
from a stockholder (Don Andres) twice (28,000 and 80,000 common
shares). But where did the shares redeemed come from? If its source is
the original capital subscriptions upon establishment of the corporation
or from initial capital investment in an existing enterprise, its redemption
to the concurrent value of acquisition may not invite the application of
Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return
of capital. On the contrary, if the redeemed shares are from stock
dividend declarations other than as initial capital investment, the
proceeds of the redemption is additional wealth, for it is not merely a
return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may
be deemed as taxable dividends. Here, it is undisputed that at the time of
the last redemption, the original common shares owned by the estate
were only 25,247.5.[91] This means that from the total of 108,000 shares
redeemed from the estate, the balance of 82,752.5 (108,000 less
25,247.5) must have come from stock dividends. Besides, 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,[92] such as stock dividends. 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.[93] Once capital, it is always capital.
[94] That doctrine was intended for the protection of corporate creditors.
[95]
With respect to the third requisite, ANSCOR redeemed stock dividends
issued just 2 to 3 years earlier. The time alone that lapsed from the
issuance to the redemption is not a sufficient indicator to determine
taxability. It is a must to consider the factual circumstances as to the
manner of both the issuance and the redemption. The time element is a
factor to show a device to evade tax and the scheme of cancelling or
redeeming the same shares is a method usually adopted to accomplish
the end sought.[96] Was this transaction used as a continuing plan,
device or artifice to evade payment of tax? It is necessary to determine
the net effect of the transaction between the shareholder-income taxpayer
and the acquiring (redeeming) corporation.[97] The net effect test is not
evidence or testimony to be considered; it is rather an inference to be
drawn or a conclusion to be reached.[98] It is also important to know
whether the issuance of stock dividends was dictated by legitimate
business reasons, the presence of which might negate a tax evasion plan.
[99]
The issuance of stock dividends and its subsequent redemption must be
separate, distinct, and not related, for the redemption to be considered a
legitimate tax scheme.[100] Redemption cannot be used as a cloak to
distribute corporate earnings.[101] Otherwise, the apparent intention to
avoid tax becomes doubtful as the intention to evade becomes manifest.
It has been ruled that:
[A]n operation with no business or corporate purpose is 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 a stockholder.[102]
Depending on each case, the exempting provision of Sec. 83(b) of the
1939 Code may not be applicable if the redeemed shares were issued
with bona fide business purpose,[103] which is judged after each and
every step of the transaction have been considered and the whole
transaction does not amount to a tax evasion scheme.
ANSCOR invoked two reasons to justify the redemptions (1) the alleged
filipinization program and (2) the reduction of foreign exchange
remittances in case cash dividends are declared. The Court is not
concerned with the wisdom of these purposes but on their relevance to
the whole transaction which can be inferred from the outcome thereof.
Again, it is the net effect rather than the motives and plans of the
taxpayer or his corporation[104] that is the fundamental guide in
administering Sec. 83(b). This tax provision is aimed at the result.[105] It
also applies even if at the time of the issuance of the stock dividend,
there was no intention to redeem it as a means of distributing profit or
avoiding tax on dividends.[106] The existence of legitimate business
purposes in support of the redemption of stock dividends is immaterial in
income taxation. It has no relevance in determining dividend
equivalence.[107] Such purposes may be material only upon the issuance
of the stock dividends. The test of taxability under the exempting clause,
when it provides such time and manner as would make the redemption
essentially equivalent to the distribution of a taxable dividend, is whether
the redemption resulted into a flow of wealth. If no wealth is realized
from the redemption, there may not be a dividend equivalence treatment.
In the metaphor of Eisner v. Macomber, income is not deemed realize
until the fruit has fallen or been plucked from the tree.
The three elements in the imposition of income tax are: (1) there must be
gain or profit, (2) that the gain or profit is realized or received, actually
or constructively,[108] and (3) it is not exempted by law or treaty from
income tax. Any business purpose as to why or how the income was
earned by the taxpayer is not a requirement. Income tax is assessed on
income received from any property, activity or service that produces the
income because the Tax Code stands as an indifferent neutral party on the
matter of where income comes from.[109]

As stated above, the test of taxability under the exempting clause of

Section 83(b) is, whether income was realized through the redemption of
stock dividends. The redemption converts into money the stock
dividends which become a realized profit or gain and consequently, the
stockholders separate property.[110] Profits derived from the capital
invested cannot escape income tax. As realized income, the proceeds of
the redeemed stock dividends can be reached by income taxation
regardless of the existence of any business purpose for the redemption.
Otherwise, to rule that the said proceeds are exempt from income tax
when the redemption is supported by legitimate business reasons would
defeat the very purpose of imposing tax on income. Such argument
would open the door for income earners not to pay tax so long as the
person from whom the income was derived has legitimate business
reasons. In other words, the payment of tax under the exempting clause
of Section 83(b) would be made to depend not on the income of the
taxpayer but on the business purposes of a third party (the corporation
herein) from whom the income was earned. This is absurd, illogical and
impractical considering that the Bureau of Internal Revenue (BIR) would
be pestered with instances in determining the legitimacy of business
reasons that every income earner may interposed. It is not
administratively feasible and cannot therefore be allowed.
The ruling in the American cases cited and relied upon by ANSCOR that
the redeemed shares are the equivalent of dividend only if the shares
were not issued for genuine business purposes[111] or the redeemed
shares have been issued by a corporation bona fide[112] bears no
relevance in determining the non-taxability of the proceeds of
redemption. ANSCOR, relying heavily and applying said cases, argued
that so long as the redemption is supported by valid corporate purposes
the proceeds are not subject to tax.[113] The adoption by the courts
below [114] of such argument is misleading if not misplaced. A review of
the cited American cases shows that the presence or absence of genuine
business purposes may be material with respect to the issuance or
declaration of stock dividends but not on its subsequent redemption. The
issuance and the redemption of stocks are two different transactions.
Although the existence of legitimate corporate purposes may justify a
corporations acquisition of its own shares under Section 41 of the
Corporation Code,[115] such purposes cannot excuse the stockholder
from the effects of taxation arising from the redemption. If the issuance
of stock dividends is part of a tax evasion plan and thus, without
legitimate business reasons the redemption becomes suspicious which
may call for the application of the exempting clause. The substance of

the whole transaction, not its form, usually controls the tax
consequences.[116]
The two purposes invoked by ANSCOR under the facts of this case are
no excuse for its tax liability. First, the alleged filipinization plan cannot
be considered legitimate as it was not implemented until the BIR started
making assessments on the proceeds of the redemption. Such corporate
plan was not stated in nor supported by any Board Resolution but a mere
afterthought interposed by the counsel of ANSCOR. Being a separate
entity, the corporation can act only through its Board of Directors.[117]
The Board Resolutions authorizing the redemptions state only one
purpose reduction of foreign exchange remittances in case cash
dividends are declared. Not even this purpose can be given credence.
Records show that despite the existence of enormous corporate profits no
cash dividend was ever declared by ANSCOR from 1945 until the BIR
started making assessments in the early 1970s. Although a corporation
under certain exceptions, has the prerogative when to issue dividends, yet
when no cash dividends was issued for about three decades, this
circumstance negates the legitimacy of ANSCORs alleged purposes.
Moreover, to issue stock dividends is to increase the shareholdings of
ANSCORs foreign stockholders contrary to its filipinization plan. This
would also increase rather than reduce their need for foreign exchange
remittances in case of cash dividend declaration, considering that
ANSCOR is a family corporation where the majority shares at the time
of redemptions were held by Don Andres foreign heirs.
Secondly, assuming arguendo, that those business purposes are
legitimate, the same cannot be a valid excuse for the imposition of tax.
Otherwise, the taxpayers liability to pay income tax would be made to
depend upon a third person who did not earn the income being taxed.
Furthermore, even if the said purposes support the redemption and justify
the issuance of stock dividends, the same has no bearing whatsoever on
the imposition of the tax herein assessed because the proceeds of the
redemption are deemed taxable dividends since it was shown that income
was generated therefrom.
Thirdly, ANSCOR argued that to treat as taxable dividend the proceeds
of the redeemed stock dividends would be to impose on such stock an
undisclosed lien and would be extremely unfair to intervening
purchasers, i.e. those who buys the stock dividends after their issuance.
[118] Such argument, however, bears no relevance in this case as no
intervening buyer is involved. And even if there is an intervening buyer,

it is necessary to look into the factual milieu of the case if income was
realized from the transaction. Again, we reiterate that the dividend
equivalence test depends on such time and manner of the transaction and
its net effect. The undisclosed lien[119] may be unfair to a subsequent
stock buyer who has no capital interest in the company. But the
unfairness may not be true to an original subscriber like Don Andres,
who holds stock dividends as gains from his investments. The
subsequent buyer who buys stock dividends is investing capital. It just so
happen that what he bought is stock dividends. The effect of its (stock
dividends) redemption from that subsequent buyer is merely to return his
capital subscription, which is income if redeemed from the original
subscriber.
After considering the manner and the circumstances by which the
issuance and redemption of stock dividends were made, there is no other
conclusion but that the proceeds thereof are essentially considered
equivalent to a distribution of taxable dividends. As taxable dividend
under Section 83(b), it is part of the entire income subject to tax under
Section 22 in relation to Section 21[120] of the 1939 Code. Moreover,
under Section 29(a) of said Code, dividends are included in gross
income. As income, it is subject to income tax which is required to be
withheld at source. The 1997 Tax Code may have altered the situation
but it does not change this disposition.
EXCHANGE OF COMMON WITH PREFERRED SHARES[121]
Exchange is an act of taking or giving one thing for another[122]
involving reciprocal transfer[123] and is generally considered as a
taxable transaction. The exchange of common stocks with preferred
stocks, or preferred for common or a combination of either for both, may
not produce a recognized gain or loss, so long as the provisions of
Section 83(b) is not applicable. This is true in a trade between two (2)
persons as well as a trade between a stockholder and a corporation. In
general, this trade must be parts of merger, transfer to controlled
corporation, corporate acquisitions or corporate reorganizations. No
taxable gain or loss may be recognized on exchange of property, stock or
securities related to reorganizations.[124]
Both the Tax Court and the Court of Appeals found that ANSCOR
reclassified its shares into common and preferred, and that parts of the
common shares of the Don Andres estate and all of Doa Carmens shares
were exchanged for the whole 150, 000 preferred shares. Thereafter, both

the Don Andres estate and Doa Carmen remained as corporate

subscribers except that their subscriptions now include preferred shares.
There was no change in their proportional interest after the exchange.
There was no cash flow. Both stocks had the same par value. Under the
facts herein, any difference in their market value would be immaterial at
the time of exchange because no income is yet realized it was a mere
corporate paper transaction. It would have been different, if the exchange
transaction resulted into a flow of wealth, in which case income tax may
be imposed.[125]
Reclassification of shares does not always bring any substantial
alteration in the subscribers proportional interest. But the exchange is
different there would be a shifting of the balance of stock features, like
priority in dividend declarations or absence of voting rights. Yet neither
the reclassification nor exchange per se, yields realize income for tax
purposes. A common stock represents the residual ownership interest in
the corporation. It is a basic class of stock ordinarily and usually issued
without extraordinary rights or privileges and entitles the shareholder to a
pro rata division of profits.[126] Preferred stocks are those which entitle
the shareholder to some priority on dividends and asset distribution.[127]
Both shares are part of the corporations capital stock. Both stockholders
are no different from ordinary investors who take on the same investment
risks. Preferred and common shareholders participate in the same
venture, willing to share in the profits and losses of the enterprise.[128]
Moreover, under the doctrine of equality of shares all stocks issued by
the corporation are presumed equal with the same privileges and
liabilities, provided that the Articles of Incorporation is silent on such
differences.[129] In this case, the exchange of shares, without more,
produces no realized income to the subscriber. There is only a
modification of the subscribers rights and privileges - which is not a flow
of wealth for tax purposes. The issue of taxable dividend may arise only
once a subscriber disposes of his entire interest and not when there is still
maintenance of proprietary interest.[130]
WHEREFORE, premises considered, the decision of the Court of
Appeals is MODIFIED in that ANSCORs redemption of 82,752.5 stock
dividends is herein considered as essentially equivalent to a distribution
of taxable dividends for which it is LIABLE for the withholding tax-atsource. The decision is AFFIRMED in all other respects.
SO ORDERED.

G.R. No. 48231

p June 30, 1947

WISE & CO., INC., ET AL., plaintiffs-appellants,

vs.
BIBIANO L. MEER, Collector of Internal Revenue, defendant-appellee.
Ross, Selph, Carrascoso and Janda for appellants.
Office of the Solicitor General for appellee.

V. That section 25 (a) of the Income Tax Law makes distributions in

liquidation of a foreign corporation, dissolution proceedings of which
were conducted in a foreign country, taxable income to a non-resident
individual stockholder.
VI. That section 199 of the Income Tax regulations, providing that in a
distribution by a corporation in complete liquidation of its assets the gain
realized by a stockholder, whether individual or corporate, is taxable as a
dividend, is ineffective.

HILADO, J.:
VII. That the deficiency assessment was properly collected.
This is an appeal by Wise & Co., Inc. and its co-plaintiff from the
judgment of the Court of First Instance of Manila in civil case No. 56200
of said court, absolving the defendant Collector of Internal Revenue from
the complaint without costs. The complaint was for recovery of certain
amounts therein specified, which had been paid by said plaintiffs under
written protest to said defendant, who had previously assessed said
amounts against the respective plaintiffs by way of deficiency income
taxes for the year 1937, as detailed under paragraph 6 of defendant's
special defense (Record of Appeal, pp. 7-10). Appellants made eight
assignments of error, to wit:
The trial court erred in finding:
I. That the Manila Wine Merchants, Ltd., a Hongkong corporation, was
in liquidation beginning June 1, 1937, and that all dividends declared and
paid thereafter were distributions of all its assets in complete liquidation.
II. That all distributions made by the Hongkong corporation after June 1,
1937, were subject to both normal tax and surtax.
III. That income received by one corporation from another was taxable
under the Income Tax Law, and that Wise & Co., Inc., was taxable on the
distribution of its share of the same net profits on which the Hongkong
Company had already paid Philippine tax, despite the clear provisions of
section 10 of the Income Tax Law then in effect.
IV. That the non-resident individual stockholder appellants were subject
to both normal and additional tax on the distributions received despite
the clear provisions of section 5 (b) of the Income Tax Law then in
effect.

VIII. That the refunds claimed by plaintiffs were not in order, and in
rendering judgment absolving the Collector of Internal Revenue from
making such refunds.
The facts have been stipulated in writing, as quoted verbatim in the
decision of the trial court thus:
I
That the allegations of paragraphs I and II of the complaint are true and
correct.
II
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.
III
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 Philippine currency; that this sale was duly
authorized by the stockholders of the Hongkong Company at a meeting
held on July 22, 1937; that the contract of sale between the two

companies was executed on the same date, a copy of the contract being
attached hereto as Schedule "A"; and that the final resolutions
completing the said sale and transferring the business and assets of the
Hongkong Company to the Manila Company were adopted on August 3,
1937, on which date the Manila Company were adopted on August 3,
1937, on which date the Manila Company paid the Hongkong company
the P400,000 purchase price.
IV
That pursuant to a resolution by its Board of Directors purporting to
declare a dividend, the Hongkong Company made a distribution from its
earnings for the year 1937 to its stockholders, plaintiffs receiving the
following:
Declared and paid
June 8, 1937

P17,870.63
That the Hongkong Company has paid Philippine income tax on the
entire earnings from which the said distributions were paid.
V
That after deducting the said dividend of June 8, 1937, the surplus of the
Hongkong Company resulting from the active conduct of its business
was P74,182.12. That as a result of the sale of its business and assets to
the Manila Company, the surplus of the Hongkong Company was
increased to a total of P270,116.59.
That pursuant to resolutions of its Board of Directors, and of its
shareholders, purporting to declare dividends, copies of which are
attached hereto as Schedules "B" and "B-1", the Hongkong Company
distributed this surplus to its stockholders, plaintiffs receiving the
following sums on the following dates:

Wise & Co., Inc.

P7,677.82
Mr. J.F. MacGregor
2,554.86
Mr. N.C. MacGregor

Declared
July 22, 1937
Paid
August 4, 1937
Declared
July 22, 1937
Paid
October 28, 1937

2,369.48
Wise & Co., Inc.
Mr. C.J. Lafrentz
P113,851.85
529.51
P 2,198.24
Mrs. E.M.G. Strickland
Mr. J.F. MacGregor
2,369.48
37,885.20
Mrs. M.J.G. Mullins
731.48
2,369.48
Mr. N.C. MacGregor

35,137.03

VII

678.42
Mr. C.J. Lafrentz

That plaintiffs duly filed Philippine income tax returns. That defendant
subsequently made the following deficiency assessments against
plaintiffs:

7,851.86

WISE & COMPANY, INC.

151.61

Net income as per return

Mrs. E.M.G. Strickland

P87,649.67

35,137.03
678.42

Add: Deductions disallowed Loss on shares of

pstock in the Manila Wine Merchants, Ltd.
presulting from the liquidation of said firm

Mrs. M.J.G. Mullins

44,515.00

35,137.03

Income not declared:

Return of capital
Share of surplus

678.42
P265,000.00
P 5,116.59
That Philippine income tax had been paid by the Hongkong Company on
the said surplus from which the said distributions were made.
VI
That on August 19, 1937, at a special general meeting of the shareholders
of the Hongkong Company, 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.

P51,185.00
123,727.88
Total liquidating dividends received
Less value of shares as per books
P174,912.88
95,700.00
Profits realized on shares of stock in the
Manila Wine Merchants Ltd. resulting
from the liquidation of the said firm
P79,212.88
Accrued income tax as per return
5,258.98

41,171.52
Total
Total liquidating dividends received
P216,636.53
P58,203.77
Deduct accrued income tax
Less cost of shares
12,262.45
17,032.25
Net income as per investigation
204,374.08

Profit realized on shares of stock

in the Manila Wine Merchants., Ltd.
Resulting from the liquidation of said firm

6 per cent Normal tax

P41,171.52
12,262.45
Normal tax at 3 per cent
Less amount already paid
1,235.15
6,307.92
Additional tax due
Balance still due and collectible
549.59
7,003.47
Total normal and additional taxes
J. F. MACGREGOR
1,784.74
Net income as per return
Less: Amount already paid
P47,479.44
549.59
Deduct: Ordinary dividends
Balance still due and collectible
6,307.92
1,235.15
Net income as per investigation subject to
normal tax:
Return of capital
Share of surplus

N. C. MACGREGOR
Net income as per return
P44,177.06

P17,032,25

Deduct: Ordinary dividends

1,145.54
5,992.11
C. J. LAFRENTZ
Net income as per investigation subject to
normal tax:
Return of capital
Share of surplus

Net income as per return

P9,778.18
Deduct: Ordinary dividends

P15,796.75
38,184.95
Total liquidating dividends received.
Less cost of shares
P53,981.70
15,796.75
Profit realized on shares of stock in the
Manila Wine Merchants, Ltd. Resulting
from the liquidation of the said firm
P38,184.95
Normal tax at 3 per cent

1,245.20
Net income as per investigation subject to
normal tax:
Return of capital
Share of surplus
P3,530.00
8,532.98
Total liquidating dividends received
Less cost of shares
P12,062.98
3,530.00

1,145.55
Additional tax due

Profit realized on shares of stock in the

Manila Wine Merchants, Ltd. Resulting
from the liquidation of the said firm

483.54
P8,532.98
Total normal and additional taxes
3 per cent normal tax due and collectible
1,629.09
255.99
Less amount already paid
MRS. E. M. G. STRICKLAND
483.55
Net income as per return
Balance still due and collectible

P44,057.06

MRS. M. J. G. MULLINS

Deduct: Ordinary dividends

Net income per return

5,872.11
Net income as per investigation subject to
normal tax:

P44,057.06
Deduct: Ordinary dividends
5,872.11

Return of capital
Share of surplus
P15,796.75
38,184.95
Total liquidating dividends received
Less cost of shares

Net income as per investigation subject to

normal tax:
Return of capital
Share of surplus
P15,796.75
38,184.95

P53,981.70 15,796.75
Profit realized on shares of stock in the
Manila Wine Merchants, Ltd. Resulting
from the liquidation of the said firm

Total liquidating dividends received

Less cost of shares
P53,981.70
15,796.75

P38,184.95
Normal tax at 3 per cent

Profit realized on shares of stock in the

Manila Wine Merchants, Ltd. Resulting
from the liquidation of the said firm

1,145.55
P38,184.95
Additional tax due
Normal tax at 3 per cent
481.14
1,145.55
Total normal and additional taxes
Additional tax due
1,626.69
481.14
Balance still due and collectible
Total normal and additional taxes
1,145.54
1,626.69

Less amount already paid

481.15
Balance still due and collectible
P1,145.54
VIII
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.
IX
That this stipulation is equally the work of both parties and shall be fairly
interpreted to give effect to their intention that this case shall be decided
solely upon points of law.
X
The parties incorporate the Corporation Law and Companies Act of
Hongkong and the applicable decisions made thereunder, into this
stipulation by reference, and either party may at any stage in the
proceedings in this case cite applicable sections of the law and the
authorities decided thereunder as though the same had been duly proved
in evidence.
XI
That the parties hereto reserve the right to submit other and further
evidence at the trial of this case. (Record on Appeal, pp. 19-26.)
1. The first assignment of error. Appellants maintain that the amounts
received by them and on which the taxes in question were assessed and
collected were ordinary dividends; while upon the other hand, appellee
contends that they were liquidating dividends. If the first proposition is
correct, this assignment would be well-taken, otherwise, the decision of
the court upon the point must be upheld.

It appears that on May 27, 1937, the Board of Directors of the Manila
Wine Merchants, Ltd. (hereafter called the Hongkong Co.),
recommended to the stockholders of said company "that the Company
should be wound up voluntarily by the members and the business sold as
a going concern to a new company incorporated under the laws of the
Philippine Islands under the style of "The Manila Wine Merchants, Inc."
(Annex A defendant's answer, Record on Appeal, p. 12), and that they
adopt the resolutions necessary to enable the company to sell its business
and assets to said new company (hereafter called the Manila Company),
organized on that same date, for the price of P400,000, Philippine
currency; that the sale was duly authorized by the stockholders of the
Hongkong Co. at a meeting held on July 22, 1937; and that the contract
of sale between the two companies was executed on the same day, as
appears from the copy of the contract, Schedule A of the Stipulation of
Facts (par. III, Stipulation of Facts, Record on Appeal, pp. 19-20). It will
be noted that the Board of Directors of the Hongkong Co., in
recommending the sale, specifically mentioned "a new Company
incorporated under the laws of the Philippine Islands under the style of
"The Manila Wine Merchants, Inc." as the purchaser, which fact shows
that at the time of the recommendation the Manila Company had already
been formed, although on the very same day; and this and the further fact
that it was really the latter corporation that became the purchaser should
clearly point to the conclusion that the Manila Company was organized
for the express purpose of succeeding the Hongkong Co. The stipulated
facts would admit of no saner interpretation.
While it is true that the contract of sale was signed on July 22, 1937, it
contains in its paragraph 4 of the express provision that the transfer "will
take effect as on and from the first day of June, One thousand nine
hundred and thirty-seven, and until completion thereof, the Company
shall stand possessed of the property hereby agreed to be transferred and
shall carry on its business in trust for the Corporation" (Schedule A of
Stipulation of Facts, Record on Appeal, p. 15). "The Company" was the
Hongkong Company and "the Corporation" was the Manila Company.
For "the Company" to carry on business in trust for the "Corporation," it
was necessary for the latter to be the owner of the business. It is plain
that the parties considered the sale as made as on and from June 1, 1937
for the purposes of said sale and transfer, both parties agreed that the
deed of July 22, 1937, was to retroact to the first day of the preceding
month.

The cited provision could not have served any other purpose than to
consider the sale as made as of June 1, 1937. If it had not been for this
purpose, if the intention had been that the sale was to be effective upon
the date of the written contract or subsequently, said provision would
certainly never have been written, for how could the transfer or sale take
effect as of June 1, 1937, if it were to be considered as made at a later
date?
The first distribution made after June 1, 1937, of what plaintiffs call
ordinary dividends but what defendant denominates liquidating
dividends was declared and paid on June 8, 1937 (Stipulation, Paragraph
IV, Record on Appeal, p. 20). It will be recalled that the recommendation
of the Board of Directors of the Hongkong Company, at their meeting on
May 27, 1937, was first of all "that the company should be wound up
voluntarily by the members"(Record on Appeal, p.12), and in pursuance
of that purpose, it was further recommended that the Company's business
be sold as a going concern to the Manila Company (ibid). Complying
with the Companies Ordinance 1932 for companies registered in
Hongkong for the voluntary winding up by members, a Declaration of
Solvency was drawn up duly signed before the British Consul-General in
Manila by the same directors, and said declaration was returned to
Hongkong for filing with the Registrar of Companies (ibid.) Both
recommendations were in due course approved and ratified. The later
execution of the formal deed of sale and the successive distributions of
the amounts in question among the stockholders of the Hongkong
Company were obviously other steps in its complete liquidation. And
they leave no room for doubt in the mind of the court that said
distributions were not in the ordinary course of business and with intent
to maintain the corporation as a going concern in which case they
would have been distributions of ordinary dividends but after the
liquidation of the business had been decided upon, which makes them
payments for the surrender and relinquishment of the stockholders'
interest in the corporation, or so-called liquidating dividends.
More than with the distribution of June 8, 1937, is this true with those
declared on July 22, 1937, and paid on August 4 and October 28, 1937,
respectively (Stipulation of Facts, par. 5, Record on Appeal, p. 21). The
distributions thus declared on July 22, 1937, and paid on August 4 and
October 28, 1937, were from the surplus of the Hongkong Company
resulting from the active conduct of its business and amounting to
P74,182.12, which surplus was augmented to a total of P270,116.59 as a
result of the sale of its business and assets to the Manila Company

(ibid.). In both Schedules B and B-1 of the Stipulation of Facts (Record

on appeal, pp. 16-18), being minutes of directors' meetings of the
Hongkong Co., where authorization and instruction were given to declare
and pay in the form of "dividends" to the shareholders the amounts in
question, it was specifically provided that the surplus to be so distributed
be that resulting after providing for return of capital and necessary or
various expenses, as shown in the balance sheet prepared as of June 1,
1937, and in the reconstructed balance sheet of the same date presented
by the company's auditors, it having been resolved in Schedule B-1 that
"any balance remaining to be distributed when final liquidator's account
has been rendered and paid" (Record on Appeal, p. 18; emphasis
supplied). It thus becomes more evident that those distributions were to
be made in the course or as a result of the Hongkong Company's
liquidation and that said liquidation was to be complete and final. And
although the various resolutions above-mentioned speak of distributions
of dividends when referring to those already alluded to, "a distribution
does not necessarily become a dividend by reason of the fact that it is
called a dividend by the distributing corporation." (Holmes Federal
Taxes, 6th edition, 774.)
The ordinary connotation of liquidating dividend involves the
distribution of assets by a corporation to its stockholders upon
dissolution. (Klein, Federal Income Taxation, 253-254.)
But it is contended by plaintiffs that as of August 4, 1937, the Hongkong
Company "had taken no steps toward dissolution or liquidation and still
retained on hand liquid assets in excess of its capitalization." They also
assert that it was only on August 19, 1937, that said company took the
first corporate steps toward liquidation (Appellant's Brief, pp. 9-10). The
fact, however, is that since July 22, 1937, when the formal deed of sale
of all the properties, assets, and business of the Hongkong Company to
the Manila Company was made, it was expressly stipulated that the sale
or transfer shall take effect as of June 1, 1937. As already indicated, the
transfer of what was sold, like the sale itself, was, by the mutual
agreement of the parties, considered as made on and from that date, and
that, if thereafter and until final completion of the transfer, the Hongkong
Company continued to run the business, it did so in trust for the new
owner, the Manila Company. In the case of Canal-Commercial T. & S.
Bk. vs. Comm'r (63 Fed. [2d], 619, 620) it was held that:
. . . The determining element therefore is whether the distribution was in
the ordinary course of business and with intent to maintain the

corporation as a going concern, or after deciding to quit with intent to

liquidate the business. Proceedings actually begun to dissolve the
corporation or formal action taken to liquidate it are but evidentiary and
not indispensable. Tootle vs. Commissioner (C.C.A. 58 F. [2d, 576.) The
fact that the distribution is wholly from surplus and not from capital, and
therefore lawful as a dividend is only evidence. In Hellmich vs. Hellman,
and Tootle vs. Commissioner, supra, the distribution was wholly from
profits yet held to be one in liquidation . . . (Emphasis Supplied.)
In the case at bar, when in the deed of July 22, 1937, by authority of its
stockholders, the Hongkong Company thru its authorized representative
declared and agreed that the aforesaid sale and transfer shall take effect
as of June 1, 1937, and distribution from its assets to those same
stockholders made after June 1, 1937, altho before July 22, 1937, must
have been considered by them as liquidating dividends; for how could
they consistently deem all the business and assets of the corporation sold
as of June 1, 1937, and still say that said corporation, as a going concern,
distributed ordinary dividends to them thereafter?
In Holmby Corporation vs. Comm'r (83 Fed. [2d], 548-550), the court
said:
. . . the fact that the distributions were called "dividends" and were made,
in part, from earnings and profits, and that some of them were made
before liquidation or dissolution proceedings were commenced, is not
controlling. . . . The determining element is whether the distributions
were in the ordinary course of business and with intent to maintain the
corporation as a going concern, or after deciding to quit and with intent
to liquidate the business . . .. (Emphasis supplied.)
The directors or representatives of the Hongkong Company or the Manila
Company, or both, could of course not convert into ordinary dividends
what in law and in reality were not such. As aptly stated by Chief Justice
Shaw in Comm. vs. Hunt (38 Am. Dec., 354-355),
The law is not to be hoodwinked by colorable pretenses. It looks at truth
and reality through whatever disguise they may assume.
The amounts thus distributed among the plaintiffs were not in the nature
of a recurring return on stock in fact, they surrendered and
relinquished their stock in return for said distributions, thus ceasing to be
stockholders of the Hongkong Company, which in turn ceased to exist in

its own right as a going concern during its more or less brief
administration of the business as trustee for the Manila Company, and
finally disappeared even as such trustee.
The distinction between a distribution in liquidation and an ordinary
dividend is factual; the result in each case depending on the particular
circumstances of the case and the intent of the parties. If the distribution
is in the nature of a recurring return on stock it is an ordinary dividend.
However, if the corporation is really winding up its business or
recapitalizing and narrowing its activities, the distribution may properly
be treated as in complete or partial liquidation and as payment by the
corporation to the stockholder for his stock. The corporation is, in the
latter instances, wiping out all parts of the stockholders' interest in the
company . . .. (Montgomery, Federal Income Tax Handbook [19381939], 258; emphasis supplied.)
It is our considered opinion that we are not dealing here with "the legal
right of a taxpayer to decrease the amount of what otherwise will be his
taxes, or altogether avoid them, by means which the law permits" (St.
Louis Union Co. vs. U.S., 82 Fed. [2d], 61), but with a situation where
we have to apply in favor of the government the principle that the
"liability for taxes cannot be evaded by a transaction constituting a
colorable subterfuge" (61 C.J., 173), it being clear that the distributions
under consideration were not ordinary dividends and were taxable in the
manner, form and amounts decreed by the court below.
2. The second assignment of error. In disposing of the first assignment
of error, we held that the distributions in the instant case were not
ordinary dividends but payments for surrendered or relinquished stock in
a corporation in complete liquidation, sometimes called liquidating
dividends. The question is whether such amounts were taxable income.
The Income Tax Law, Act No. 2833 section 25 (a), as amended by
section 4 of Act. No. 3761, inter alia stipulated:
Where a corporation, partnership, association, joint-account, or insurance
company distributes all of its assets in complete liquidation or
dissolution, the gain realized or loss sustained by the stockholder,
whether individual or corporation, is a taxable income or a deductible
loss as the case may be. (Emphasis supplied.)
Partial source of the foregoing provision was section 201 (c) of the U.S.
Revenue Act of 1918, approved February 24, 1919, providing:

Amounts distributed in the liquidation of a corporation shall be treated as

payments in exchange for the stock or share, and any gain or profit
realized thereby shall be taxed to the distributee as other gains or profits.

In the same case the Supreme Court of the United States made the
following quotation, which is here relevant, from Treasury Regulations
45, article 1548:

It is a familiar rule of statutory construction that the judicial construction

attached to the sources of statutes adopted in a jurisdiction are of
authoritative value in the interpretation of such local laws. The Supreme
Court of the United States has had occasion to construe certain pertinent
parts of the Federal Revenue Act above-mentioned on February 20, 1928,
when it decided the case of Hellmich vs. Hellman (276 U.S., 233; 72
Law. ed., 544). The case involved the recovery of additional income
taxes assessed against the plaintiffs under protest. And its determination
hinged around the construction of parts of said act after which those of
our own law now under discussion were patterned. Justice Sanford said:

. . . So-called liquidation or dissolution dividends are not dividends

within the meaning of the statute, and amounts so distributed, whether or
not including any surplus earned since February 28, 1913, are to be
regarded as payments for the stock of the dissolved corporation. Any
excess so received over the cost of his stock to the stockholder, or over
its fair market value as of March 1, 1913, if acquired prior thereto, is a
taxable profit. A distribution in liquidation of the assets and business of a
corporation, which is a return to the stockholders of the value of his stock
upon a surrender of his interest in the corporation, is distinguishable from
a dividend paid by a going corporation out of current earnings or
accumulated surplus when declared by the directors in their discretion,
which is in the nature of a recurrent return upon the stock. (72 Law. ed.,
546.)

The question here is whether the gains realized by stockholders from the
amounts distributed in the liquidation of the assets of a dissolved
corporation, out of its earnings or profits accumulated since February 28,
1913, were taxable to them as other "gains or profits", or whether the
amounts so distributed were "dividends" exempt from the normal tax.
Section 201 (a) of the act defined the term "dividend" as "any
distribution made by a corporation . . . to its shareholders . . . whether in
cash or in other property .. out of its earnings or profits accumulated
since February 28, 1913 . . .." Section 201 (c) provided that "amounts
distributed in the liquidation of a corporation shall be treated as
payments in exchange for stock or shares, and any gain or profit realized
thereby shall be taxed to the distributee as other gains or profits."
Our law at the time of the transactions in question, in providing that
where a corporation, etc. distributes all its assets in complete liquidation
or dissolution, the gain realized or loss sustained by the stockholder is a
taxable income or a deductible loss as the case may be, in effect treated
such distributions as payments in exchange for the stock or share. Thus,
in making the deficiency assessments under consideration, the Collector,
among other items, made proper deduction of the "value of shares" or
"cost of shares" in the case of each individual plaintiff, assessing the tax
only on the resulting "profit realized" (Stipulation, par. VII, Record on
Appeal, pp. 22-25); and of course in case the value or cost of the shares
should exceed the distribution received by the stockholder, the resulting
difference will be treated as a "deductible loss."

The Income Tax Law of the Philippines in force at the time defined the
term "dividend" in section 25 (a), as amended, as "any distribution made
by a corporation . . . out of its earnings or profits accumulated since
March 1, 1913, and payable to its shareholders whether in cash or other
property." This definition is substantially the same as that given to the
same term by the U.S. Revenue Act of 1918 quoted by Justice Sanford in
the passage above inserted.
Plaintiffs contend that defendant's position would result in double
taxation. A similar contention has been adversely disposed of against the
taxpayer in the Hellmich case in these words:
The gains realized by the stockholders from the distribution of the assets
in liquidation were subject to the normal tax in like manner as if they had
sold their stock to third persons. The objection that this results in double
taxation of the accumulated earnings and profits is no more available in
the one case than it would have been in the other. See Merchants' Loan &
T. Co. vs. Smietanki, 255 U.S., 509; 65 Law. ed., 751; 15 A.L.R., 1305;
41 Sup. Ct. Rep., 386; Goodrich vs. Edwards, 255 U.S. 527; 65 Law. ed.,
758; 41 Sup. Ct. Rep., 390. When, as here, Congress clearly expressed its
intention, the statute must be sustained even though double taxation
results. See Patton vs. Brady , 184 U.S., 608; 46 Law ed., 713; 22 Sup.
Ct. Rep., 493; Cream of Wheat Co. vs. Grand Forks County, 253 U.S.,

325, 330; 64 Law. ed., 931, 934; 40 Sup. Ct. Rep., 558. (Hellmich vs.
Hellman, supra; 72 Law. ed., 547.)

section 201 (c) as payments made by the corporation in exchange for its
stock, which were taxable "as other gains or profits.

It should be borne in mind that plaintiffs received the distributions in

question in exchange for the surrender and relinquishment by them of
their stock in the Hongkong Company which was dissolved and in
process of complete liquidation. That money in the hands of the
corporation formed a part of its income and was properly taxable to it
under the then existing Income Tax Law. When the corporation was
dissolved and in process of complete liquidation and its shareholders
surrendered their stock to it and it paid the sums in question to them in
exchange, a transaction took place, which was no different in its essence
from a sale of the same stock to a third party who paid therefor. In either
case the shareholder who received the consideration for the stock earned
that much money as income of his own, which again was properly
taxable to him under the same Income Tax Law. In the case of the sale to
a third person, it is not perceived how the objection of double taxation
could have been successfully raised. Neither can we conceive how it
could be available where, as in this case, the stock was transferred back
to the dissolved corporation.

It is true that if section 201 (a) stood alone its broad definition of the
term "dividend" would apparently include distributions made to
stockholders in the liquidation of a corporation although this term, as
generally understood and used, refers to the recurrent return upon stock
paid to stockholders by a going corporation in the ordinary course of
business, which does not reduce their stockholdings and leaves them in a
position to enjoy future returns upon the same stock. (See Lynch vs.
Hornby, 247 U.S., 339, 344-346; and Langstaff vs. Lucas [D. C.], 9 Fed.
[2d], 691, 694.)

3. The third assignment of error. In view of what has been said in our
consideration of the second assignment of error, the third can be briefly
disposed of. Having held that the distributions involved herein were not
ordinary dividends but payments for stock surrendered and relinquished
by the shareholders to the dissolved corporation, or so-called liquidating
dividends, we have the road clear to declaring that under section 25 (a) of
the former Income Tax Law, as amended, said distributions were taxable
alike to Wise and Co., Inc. and to the other plaintiffs. We hold that both
the proviso of section 10 (a) of said Income Tax Law and section 198 of
Regulations No. 81 refer to ordinary dividends, not to distributions made
in complete liquidation or dissolution of a corporation which result in the
realization of a gain as specifically contemplated in section 25 (a) of the
same law, as amended, which as aforesaid expressly provides for the
taxability of such gain as income, whether the stockholder happens to be
an individual or a corporation. By analogy, we can cite the following
additional passages from the Hellmich case:
The controlling question is whether the amounts distributed to the
stockholders out of the earnings and profits accumulated by the
corporation since February 28, 1913, were to be treated under section
201 (a) as "dividends," which were exempt from the normal tax; or under

However, when section 201 (a) and section 201 (c) are read together,
under the long-established rule that the intention of the lawmakers is to
be deduced from a view of every material part of the statute (Kohlsaat vs.
Murphy, 96 U.S., 153, 159; 24 Law. ed., 846), we think it clear that the
general definition of a dividend in section 201 (a) was not intended to
apply to distributions made to stockholders in the liquidation of a
corporation, but that it was intended that such distributions should be
governed by section 201 (c), which, dealing specifically with such
liquidation, provided that the amounts distributed should "be treated as
payments in exchange for stock," and that any gain realized thereby
should be taxed to the stockholders "as other gains or profits." This
brings the two sections into entire harmony and gives to each its natural
meaning and due effect. . . . (Hellmich vs. Hellman, supra; emphasis
supplied.)
4. The fourth assignment of error. Under this assignment it is
contended by the non-resident individual stockholder appellants that they
were not subject to the normal tax as regards the distributions received
by them and involved in the instant case. They "reported these
distributions as dividends from profits on which Philippine income tax
had been paid . . .." (Appellants' brief, p. 21.) They assert that the
distributions were subject only to the additional tax; whereas the
Collector contends that they were subject to both the normal and the
additional tax. After what has been said above, it hardly needs stating
that the manner and form of reporting these distributions employed by
said appellants could not, under the Law, change their real nature as
payments for surrendered stock, or so-called liquidating dividends,
provided for in section 25 (a) of the then Income Tax Law. Such

distributions under the law were subject to both the normal and the
additional tax provided for.
. . . Loosely speaking, the distribution to the stockholders of a
corporation's assets, upon liquidation, might be termed a dividend; but
this is not what is generally meant and understood by that word. As
generally understood and used, a dividend is a return upon the stock of
its stockholders, paid to them by a going corporation without reducing
their stockholdings, leaving them in a position to enjoy future returns
upon the same stock . . .. In other words, it is earnings paid to him by the
corporation upon his invested capital therein, without wiping out his
capital. On the other hand, when a solvent corporation dissolves and
liquidates, it distributes to its stockholders not only any earnings it may
have on hand, but it also pays to them their invested capital, namely, the
amount which they had paid in for their stocks, thus wiping out their
interest in the company . . .. (Langstaff vs. Lucas, 9 Fed. [2d], 691, 694.)
5. The fifth assignment of error. This assignment is made in behalf of
those appellants who were non-resident alien individuals, and for them it
is in effect said that if the distributions received by them were to be
considered as a sale of their stock to the Hongkong Company, the profit
realized by them does not constitute income from Philippine sources and
is not subject to Philippine taxes, "since all steps in the carrying out of
this so-called sale took place outside the Philippines." (Appellants' brief,
p. 26.) We do not think this contention is tenable under the facts and
circumstances of record. The Hongkong Company was at the time of the
sale of its business in the Philippines, and the Manila Company was a
domestic corporation domiciled and doing business also in the
Philippines. Schedule A of the Stipulation of Facts (Record on Appeal, p.
13) declares, among other things, that the Hongkong Company was
incorporated for the purpose of carrying on in the Philippine Islands the
business of wine, beer, and spirit merchants and the other objects set out
in its memorandum of association. Hence, its earnings, profits, and
assets, including those from whose proceeds the distributions in question
were made, the major part of which consisted in the purchase price of the
business, had been earned and acquired in the Philippines. From aught
that appears in the record it is clear that said distributions were income
"from Philippine sources."
6. The sixth assignment of error. Section 199 of Regulations No. 81,
deleting immaterial parts, reads:

SEC. 199. Distributions in liquidation. In all cases where a

corporation . . . distributes all of its property or assets in complete
liquidation or dissolution, the gain realized from the transaction by the
stockholder . . . is taxable as a dividend to the extent that it is paid out of
earnings or profits of the corporation . . .. If the amount received by the
stockholder in liquidation is less than the cost or other basis of the stock,
a deductible loss is sustained.
This regulation would seem to support the contention that the
distributions in question, at least those proceeding from sources other
than the earnings or profits of the dissolved corporation, were not
taxable. Placing the above-quoted section of Regulations No. 81 side by
side with section 25 (a) of the amended Income Tax Law then in force,
we notice that while the regulation limits the taxability of the gain
realized by the stockholder "to the extent that it is paid out of earnings or
profits of the corporation, "section 25 (a) of the law, far from so limiting
its taxability, provides that the gain thus realized, is a "taxable income"
under the law so long as a gain is realized, it will be taxable income
whether the distribution comes from the earnings or profits of the
corporation or from the sale of all of its assets in general, so long as the
distribution is made "in complete liquidation or dissolution". The
regulation makes the gain taxable as a dividend, while the law makes it a
taxable income. An inevitable conflict between the two provisions seems
to exist, and in such a case, of course, the law prevails.
Treasury Department cannot impose or exempt from income taxes, and
regulations purporting to exempt from taxation income specifically taxes
would be void.
xxx

xxx

xxx

Any erroneous interpretation of revenue act by regulation of Treasury

Department would not estop government from asserting tax on income,
though taxpayer had been misled by such interpretation, and by it
induced to expose property to taxation. (Langstaff vs. Lucas, 9 Fed. [2d],
691.)
7 and 8. The seventh and eight assignments of error. In view of what
has been said above, these two assignments need no separate treatment.

For the foregoing consideration, the judgment appealed from will be

affirmed with the costs of both instances against the appellants. So
ordered.
Moran, C.J., Paras, Feria, Pablo, Perfecto, Bengzon, Briones, Hontiveros,
Padilla, and Tuason, JJ., concur.

RESOLUTION ON MOTION FOR RECONSIDERATION

July 28, 1947
HILADO, J.:
Plaintiffs and appellants have filed a motion for reconsideration dated
July 10, 1947. After carefully considering said motion, which makes
particular reference to appellants' fifth assignment of error, the Court
does not consider the arguments therein adduced tenable. Stripped to
their bare essentials, the movants' contentions are summarized in the
following propositions found on pages 3-4 of their motto, to wit:
Since appellants J.F. MacGregor, N.C. MacGregor, C.J. Lafrentz, E.M.G.
Strickland, and Mrs. M.J.G. Mullins were all non-resident aliens and
since the court has held that the transaction in this case amounted to a
sale or exchange of their shares in a foreign corporation, which sale or
exchange took place entirely outside of the Philippine Islands, it follows
that they have not derived income from the Philippine sources and are
not subject to the taxes which have been collected from them by
defendant.
xxx

xxx

xxx

. . . On the other hand if the income results from the sale or exchange of
the shares in question then the non-resident alien stockholders who
converted their shares abroad have received no income from Philippine
sources and are not subject to any tax whatsoever on their profits from
the transaction.
Leaving aside the other portions of the above-quoted propositions as
sufficiently covered in the court's decision, let us direct attention to those

parts thereof wherein it is pretended that the transaction took place

"entirely outside the Philippine Islands" or "abroad."
In the minutes, Schedule B of the stipulation of facts (Rec. on Appeal,
pp. 16-17), it appears that on July 22, 1937, an extraordinary meeting of
shareholders of the Manila Wine Merchants, Ltd. was held and in said
meeting, among other things, it was resolved that the Directors of said
company "be authorized and instructed to declare and pay in the form of
dividend to the shareholders the amount of any surplus existing after the
above-referred to sale has been consummated. This surplus, after
providing for return of capital and necessary expense, as shown in the
Balance Sheet prepared as of June 1, 1937, after giving effect to the sale
transaction above-referred to, amounts to approximately P270,000."
While Schedule B does not state the place where the meeting was held,
Schedule B-1 of the same stipulation of facts (Record on Appeal, pp. 1718) furnishes us the information that it was held in Manila. Schedule B-1
in this connection says:
Sale of Company: In accordance with resolution passed at an
Extraordinary Meeting of Shareholders held in Manila (underscoring
supplied) on July 22, 1937, at 3 o'clock, the Directors of the Manila Wine
Merchants Ltd., were authorized to sell the Company as a going concern
in accordance with sale agreement presented at the Meeting.
Later in the same Schedule B-1 we find that the declaration of dividends
authorized in the previous meeting, as stated in the minutes Schedule B,
was made by the Board of Directors of the same Manila Wine
Merchants, Ltd., of whose meeting on that same date, July 22, 1937,
Schedule B-1 constitutes the minutes. The pertinent parts to the minutes
of said meeting read as follows:
Dividend: The second matter before the Meeting was the question of
declaring a dividend to enable a distribution in cash to be made, the
dividend to be the entire amount standing at surplus after providing for
return of capital and various expenses in accordance with reconstructed
balance sheet as at June 1, 1937 presented by our auditors.
xxx

xxx

xxx

Resolved that as after the Manila Wine Merchants Ltd. has been sold for
the stipulated sum of P400,000 and money received, there will be after
providing for return of capital, payment of income tax and other charges,

a sum of approximately P270,000 standing at surplus account, a dividend

is now hereby declared in amount covering the entire balance remaining
at surplus account after the concern has been wound up, and we hereby
authorize the distribution of P265,000 as and when funds are available,
any balance remaining to be distributed when final Liquidator's account
has been rendered and paid."
Again, while the minutes Schedule B-1 do not reveal the place where
that board meeting was held, the fact stated therein that it was held on
July 22,1937, the self-same date of the extraordinary meeting of
shareholders referred to in the minutes Schedule B, at 3 o'clock
(presumably p.m.), as recorded in Schedule B-1, clearly shows that the
said board meeting was held also in Manila, and not in Hongkong or
elsewhere abroad, for J.F. Macgregor and E. Heybrook, both of whom
appear in both Schedules B and B-1 to have participated in both
meetings, could not, so far as the record discloses, very well be in Manila
and Hongkong or elsewhere abroad on that same date. There is no
showing, nor is it even pretended that these two gentlemen after the
meeting held in Manila on July 22, 1937, at 3 o'clock, took an airplane or
other mode of conveyance, as fast or faster, and hurried to Hongkong or
elsewhere abroad and attended the other meeting that very same day.
Indeed, that both meetings must have been held in Manila would seem to
be the only natural and logical supposition from the fact that the Manila
Wine Merchants, Ltd., was admittedly conducting its business in said
city and the Philippines in general (Schedule A, Rec. on Appeal, p. 13). It
seems clear, therefore, that the dividends in question were declared in the
Philippine Islands.
What was the legal effect of that declaration? Paragraph V of the
stipulation of facts (Rec. on Appeal, pp. 20-21) states that, pursuant to
these resolutions, "the Hongkong Company (the same Manila Wine
Merchants, Ltd.) distributed this surplus to its stockholders, plaintiffs
receiving (underscoring supplied) the following sums on the following
dates" (then follow plaintiffs' names with the respective amounts in
Philippine pesos received by them on the dates stated). It is not stated
that they received their dividends in Hongkong or other foreign money.
And in their own brief (p. 25) they say that the payments or distributions
thus received by them, as a result of the liquidation and sale of said
company, "were included as gross income in their Philippine income tax
returns". This fact further tends to show that those payments or
distributions were received in the Philippine Islands, either by plaintiffs
personally or through their proxies or agents. Besides, in paragraph V of

the stipulation of facts (Rec. on Appeal, p. 21) it appears that the

dividends or distributions pertaining to these individual plaintiffs as well
as that pertaining to their co-plaintiff Wise and Co., Inc., were paid on
the same dates, namely, August 24, 1937, and October 28, 1937; and it
being undisputed that Wise and Co., Inc. was domiciled and had its
principal office in Manila (complaint, par. I, Rec. on Appeal, p.2), in
which city it was presumably paid, it would seem obvious that the
concomitant payments thus made to the other plaintiffs were likewise
effected in the same place, whether the individual plaintiffs acted
personally or through proxies or agents. It should also be remembered
that while the "registered office" of the Manila Wine Merchants, Ltd. was
situated in the colony of Hongkong (Schedule A, Rec. on Appeal, p. 13),
the fact is that the only business for which it was incorporated was the
wine, beer, and spirit business, which had been and was being conducted
exclusively within the Philippine Islands, and from the record we deduce
that it had also office in Manila where, so far as the record discloses, the
payments were made. Finally, the fact that payment was made in
Philippine pesos would strongly corroborate the conclusion that it was
made in this country if it had been made in Hongkong or elsewhere
abroad, the reasonable assumption is that it would have been made in
Hongkong dollars or in the currency of such other place abroad.
. . . However, where a corporation has not only declared a dividend but
has specifically appropriated and set apart from its other assets a fund out
of which the dividend is to be paid, such action constitutes the assets to
set apart a trust fund in the hands of the corporation for the payment of
the stockholders to the exclusion of other creditors. . . . (18 C.J.S., p.
1115; emphasis supplied.)
As between successive owners of shares of stock in a corporation, the
general rule is that dividends belong to the persons who are the owners
of the stock at the time they are declared, without regard to the time
during which the dividends were earned, and this is true although the
dividends are made payable at a future date. (18 C.J.S., 119, sec. 470 [a];
emphasis supplied.)
There is no controversy about the legal proposition that dividends
declared belong to the owner of the stock at the time the dividend is
declared. (Livingstone County Bank vs. First State Bank, 136 Ky., 546,
554, cited in footnote 36, p. 818, 14 C.J.; emphasis supplied.)

The moment the dividend is declared, it becomes then separate and

distinct from the stock and the dividend falls to him who is proprietor of
the stock of which it was theretofore incident.
The doctrine is that a dividend is considered parcel of the mass of
corporate property until declared and therefore incident to and parcel of
the stock up to the time it is declared; and before its declaration, will pass
with the sale or devise of the stock. Whosoever owns the stock prior to
the declaration of a dividend, owns the dividend also. (McLaren vs.
Crescent Planning Mill Co., 117 Mo. A., 40, 47, cited in note 36, p. 818,
14 C.J.; emphasis supplied.)
In De Koven vs. Alsop (205 Ill., 309; 63 L.R.A., 587), the court said:
A dividend is defined as "a corporate profit set aside, declared, and
ordered by the directors to be paid to the stockholders on demand or at a
fixed time. Until the dividend is declared, these corporate profits belong
to the corporation, not to the stockholders, and are liable for corporate
indebtedness." (Emphasis supplied.)
We are fully satisfied from the facts and data furnished here by the
parties themselves that the dividends in question were paid to plaintiffs,
personally or thru their proxies or agents, in the Philippines. But aside
from this, from the moment they were declared and a definite fund
specified for their payment (all surplus remaining "after providing for
return of capital and various expenses") and all of this was done in the
Philippines to all legal intents and purposes they earned those
dividends in this country. From the record we deduce that the funds and
assets of the Manila Wine Merchants, Ltd., from which those dividends
proceeded, were in the Philippines where its business was located. So far
as the record discloses, its liquidation was effected in terms of Philippine
pesos, indicating that it was made here. And this in turn would lead to the
deduction that the funds and assets liquidated were here.
Motion denied. So ordered.

James v. United States, 366 U.S. 213 (1961)

James v. United States

MR. CHIEF JUSTICE WARREN announced the judgment of the Court

and an opinion in which MR. JUSTICE BRENNAN, and MR. JUSTICE
STEWART concur.

No. 63
Argued November 17, 1960

The issue before us in this case is whether embezzled funds are to be

included in the "gross income" of the embezzler in the year in which the
funds are misappropriated

Decided May 15, 1961

Page 366 U. S. 214
366 U.S. 213
under 22(a) of the Internal Revenue Code of 1939 [Footnote 1] and
61(a) of the Internal Revenue Code of 1954. [Footnote 2]
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
Syllabus
1. Embezzled money is taxable income of the embezzler in the year of
the embezzlement under 22(a) of the Internal Revenue Code of 1939,
which defines "gross income" as including "gains or profits and income
derived from any source whatever," and under 61(a) of the Internal
Revenue Code of 1954, which defines "gross income" as "all income
from whatever source derived." Commissioner v. Wilcox, 327 U. S. 404,
overruled. Pp. 366 U. S. 213-222.
Xby DNSUnlocker
2. After this Court's decision in Commissioner v. Wilcox, supra,
petitioner embezzled large sums of money during the years 1951 through
1954. He failed to report those amounts as gross income in his income
tax returns for those years, and he was convicted of "willfully"
attempting to evade the federal income tax due for each of the years 1951
through 1954, in violation of 145(b) of the Internal Revenue Code of
1939 and 7201 of the Internal Revenue Code of 1954.
Held: the judgment affirming the conviction is reversed, and the cause is
remanded with directions to dismiss the indictment. Pp. 366 U. S. 214215, 222.
273 F.2d 5, reversed.

The facts are not in dispute. The petitioner is a union official who, with
another person, embezzled in excess of $738,000 during the years 1951
through 1954 from his employer union and from an insurance company
with which the union was doing business. [Footnote 3] Petitioner failed
to report these amounts in his gross income in those years, and was
convicted for willfully attempting to evade the federal income tax due for
each of the years 1951 through 1954 in violation of 145(b) of the
Internal Revenue Code of 1939 [Footnote 4] and 7201 of the Internal
Revenue
Page 366 U. S. 215
Code of 1954. [Footnote 5] He was sentenced to a total of three years'
imprisonment. The Court of Appeals affirmed. 273 F.2d 5. Because of a
conflict with this Court's decision in Commissioner v. Wilcox, 327 U. S.
404, a case whose relevant facts are concededly the same as those in the
case now before us, we granted certiorari. 362 U.S. 974.
In Wilcox, the Court held that embezzled money does not constitute
taxable income to the embezzler in the year of the embezzlement under
22(a) of the Internal Revenue Code of 1939. Six years later, this Court
held, in Rutkin v. United States, 343 U. S. 130, that extorted money does
constitutes taxable income to the extortionist in the year that the money
is received under 22(a) of the Internal Revenue Code of 1939. In
Rutkin, the Court did not overrule Wilcox, but stated:
"We do not reach in this case the factual situation involved in
Commissioner v. Wilcox, 327 U. S. 404. We limit that case to its facts.

There, embezzled funds were held not to constitute taxable income to the
embezzler under 22(a)."
Id. at 343 U. S. 138. [Footnote 6] However, examination of the reasoning
used in Rutkin leads us inescapably to the conclusion that Wilcox was
thoroughly devitalized.
The basis for the Wilcox decision was
"that a taxable gain is conditioned upon (1) the presence of a claim of
right to the alleged gain and (2) the absence of a definite,
Page 366 U. S. 216
unconditional obligation to repay or return that which would otherwise
constitute a gain. Without some bona fide legal or equitable claim, even
though it be contingent or contested in nature, the taxpayer cannot be
said to have received any gain or profit within the reach of Section
22(a)."
Commissioner v. Wilcox, supra, at 327 U. S. 408. Since Wilcox
embezzled the money, held it "without any semblance of a bona fide
claim of right," ibid., and therefore "was at all times under an unqualified
duty and obligation to repay the money to his employer," ibid., the Court
found that the money embezzled was not includible within "gross
income." But Rutkin's legal claim was no greater than that of Wilcox. It
was specifically found "that petitioner had no basis for his claim . . . and
that he obtained it by extortion." Rutkin v. United States, supra, at 343 U.
S. 135. Both Wilcox and Rutkin obtained the money by means of a
criminal act; neither had a bona fide claim of right to the funds.
[Footnote 7] Nor was Rutkin's obligation to repay the extorted money to
the victim any less than that of Wilcox. The victim of an extortion, like
the victim of an embezzlement, has a right to restitution. Furthermore, it
is inconsequential that an embezzler may lack title to the sums he
appropriates, while an extortionist may gain a voidable title. Questions of
federal income taxation are not determined by such "attenuated
subtleties." Lucas v. Earl, 281 U. S. 111, 281 U. S. 114; Corliss v.
Page 366 U. S. 217
Bowers, 281 U. S. 376, 281 U. S. 378. Thus, the fact that Rutkin secured
the money with the consent of his victim, Rutkin v. United States, supra,

at p. 343 U. S. 138, is irrelevant. Likewise unimportant is the fact that the

sufferer of an extortion is less likely to seek restitution than one whose
funds are embezzled. What is important is that the right to recoupment
exists in both situations.
Examination of the relevant cases in the courts of appeals lends credence
to our conclusion that the Wilcox rationale was effectively vitiated by
this Court's decision in Rutkin. [Footnote 8] Although this case appears
to be the first to arise that is "on all fours" with Wilcox, the lower federal
courts, in deference to the undisturbed Wilcox holding, have earnestly
endeavored to find distinguishing facts in the cases before them which
would enable them to include sundry unlawful gains within "gross
income." [Footnote 9]
Page 366 U. S. 218
It had been a well established principle, long before either Rutkin or
Wilcox, that unlawful, as well as lawful, gains are comprehended within
the term "gross income." Section II B of the Income Tax Act of 1913
provided that
"the net income of a taxable person shall include gains, profits, and
income . . . from . . . the transaction of any lawful business carried on for
gain or profit, or gains or profits and income derived from any source
whatever. . . ."
(Emphasis supplied.) 38 Stat. 167. When the statute was amended in
1916, the one word "lawful" was omitted. This revealed, we think, the
obvious intent of that Congress to tax income derived from both legal
and illegal sources, to remove the incongruity of having the gains of the
honest laborer taxed and the gains of the dishonest immune. Rutkin v.
United States, supra, at 343 U. S. 138; United States v. Sullivan, 274 U.
S. 259, 274 U. S. 263. Thereafter, the Court held that gains from illicit
traffic in liquor are includible within "gross income." Ibid. See also
Johnson v. United States, 318 U. S. 189; United States v. Johnson, 319 U.
S. 503. And, the Court has pointed out, with approval, that there "has
been a widespread and settled administrative and judicial recognition of
the taxability of unlawful gains of many kinds," Rutkin v. United States,
supra, at 343 U. S. 137. These include protection payments made to
racketeers, ransom payments paid to kidnappers, bribes, money derived
from the sale of unlawful insurance policies, graft, black market gains,

funds obtained from the operation of lotteries, income from race track
bookmaking and illegal prize fight pictures. Ibid.
The starting point in all cases dealing with the question of the scope of
what is included in "gross income" begins with the basic premise that the
purpose of Congress was "to use the full measure of its taxing power."
Helvering
Page 366 U. S. 219
v. Clifford, 309 U. S. 331, 309 U. S. 334. And the Court has given a
liberal construction to the broad phraseology of the "gross income"
definition statutes in recognition of the intention of Congress to tax all
gains except those specifically exempted. Commissioner v. Jacobson,
336 U. S. 28, 336 U. S. 49; Helvering v. Stockholms Enskilda Bank, 293
U. S. 84, 293 U. S. 87-91. The language of 22(a) of the 1939 Code,
"gains or profits and income derived from any source whatever," and the
more simplified language of 61(a) of the 1954 Code, "all income from
whatever source derived," have been held to encompass all "accessions
to wealth, clearly realized, and over which the taxpayers have complete
dominion." Commissioner v. Glenshaw Glass Co., 348 U. S. 426, 348 U.
S. 431. A gain
"constitutes taxable income when its recipient has such control over it
that, as a practical matter, he derives readily realizable economic value
from it."
Rutkin v. United States, supra, at 343 U. S. 137. Under these broad
principles, we believe that petitioner's contention, that all unlawful gains
are taxable except those resulting from embezzlement, should fail.
When a taxpayer acquires earnings, lawfully or unlawfully, without the
consensual recognition, express or implied, of an obligation to repay and
without restriction as to their disposition,
"he has received income which he is required to return, even though it
may still be claimed that he is not entitled to retain the money, and even
though he may still be adjudged liable to restore its equivalent."
North American Oil Consolidated v. Burnet, supra, at 286 U. S. 424. In
such case, the taxpayer has "actual command over the property taxed-the
actual benefit for which the tax is paid," Corliss v. Bowers, supra. This

standard brings wrongful appropriations within the broad sweep of

"gross income;" it excludes loans. When a law-abiding taxpayer
mistakenly receives income in one year, which receipt is assailed and
found to be invalid in a subsequent
Page 366 U. S. 220
year, the taxpayer must nonetheless report the amount as "gross income"
in the year received. United States v. Lewis, supra; Healy v.
Commissioner, supra. We do not believe that Congress intended to treat a
lawbreaking taxpayer differently. Just as the honest taxpayer may deduct
any amount repaid in the year in which the repayment is made, the
Government points out that "If, when, and to the extent that the victim
recovers back the misappropriated funds, there is, of course, a reduction
in the embezzler's income." Brief for the United States, p. 24. [Footnote
10]
Petitioner contends that the Wilcox rule has been in existence since 1946;
that, if Congress had intended to change the rule, it would have done so;
that there was a general revision of the income tax laws in 1954 without
mention of the rule; that a bill to change it [Footnote 11] was introduced
in the Eighty-sixth Congress, but was not acted upon; that therefore we
may not change the rule now. But the fact that Congress has remained
silent or has reenacted a statute which we have construed, or that
congressional attempts to amend a rule announced by this Court have
failed, does not necessarily debar us from reexamining and correcting the
Court's own errors. Girouard v. United States, 328 U. S. 61, 328 U. S. 6970; Helvering v. Hallock, 309 U. S. 106, 309 U. S. 119-122. There may
have been any number of reasons why Congress acted as it did.
Helvering v. Hallock, supra. One of the reasons could well 8 and S.
221 be our subsequent decision in Rutkin which has been thought by
many to have repudiated Wilcox. Particularly might this be true in light
of the decisions of the Courts of Appeals which have been riding a
narrow rail between the two cases and further distinguishing them to the
disparagement of Wilcox. See notes 8 and | 8 and S. 213fn9|>9, supra.
We believe that Wilcox was wrongly decided, and we find nothing in
congressional history since then to persuade us that Congress intended to
legislate the rule. Thus, we believe that we should now correct the error
and the confusion resulting from it, certainly if we do so in a manner that
will not prejudice those who might have relied on it. Cf. Helvering v.
Hallock, supra, at 309 U. S. 119. We should not continue to confound

confusion, particularly when the result would be to perpetuate the

injustice of relieving embezzlers of the duty of paying income taxes on
the money they enrich themselves with through theft while honest people
pay their taxes on every conceivable type of income.
But we are dealing here with a felony conviction under statutes which
apply to any person who "willfully" fails to account for his tax or who
"willfully" attempts to evade his obligation. In Spies v. United States,
317 U. S. 492, 317 U. S. 499, the Court said that 145(b) of the 1939
Code embodied "the gravest of offenses against the revenues," and stated
that willfulness must therefore include an evil motive and want of
justification in view of all the circumstances. Id. at 317 U. S. 498.
Willfulness
"involves a specific intent which must be proven by independent
evidence, and which cannot be inferred from the mere understatement of
income."
Holland v. United States, 348 U. S. 121, 348 U. S. 139.
We believe that the element of willfulness could not be proven in a
criminal prosecution for failing to include embezzled funds in gross
income in the year of misappropriation so long as the statute contained
the gloss placed upon it by Wilcox at the time the alleged crime was Page
366 U. S. 222
committed. Therefore, we feel that petitioner's conviction may not stand,
and that the indictment against him must be dismissed.
Since MR. JUSTICE HARLAN, MR. JUSTICE FRANKFURTER, and
MR. JUSTICE CLARK agree with us concerning Wilcox, that case is
overruled. MR. JUSTICE BLACK, MR. JUSTICE DOUGLAS, and MR.
JUSTICE WHITTAKER believe that petitioner's conviction must be
reversed and the case dismissed for the reasons stated in their opinions.
Accordingly, the judgment of the Court of Appeals is reversed, and the
case is remanded to the District Court with directions to dismiss the
indictment.
It is so ordered.

G.R. No. 95022 March 23, 1992

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE HON. COURT OF APPEALS, THE COURT OF TAX APPEALS,
GCL RETIREMENT PLAN, represented by its Trustee-Director,
respondents.

MELENCIO-HERRERA, J.:
This case is said to be precedent setting. While the amount involved is
insignificant, the Solicitor General avers that there are about 85 claims of
the same nature pending in the Court of Tax Appeals and Bureau of
Internal Revenue totalling approximately P120M.
Petitioner, the Commissioner of Internal Revenue, seeks a reversal of the
Decision of respondent Court of Appeals, dated August 27, 1990, in CAG.R. SP No. 20426, entitled "Commissioner of Internal Revenue vs.
GCL Retirement Plan, represented by its Trustee-Director and the Court
of Tax Appeals," which affirmed the Decision of the latter Court, dated
15 December 1986, in Case No. 3888, ordering a refund, in the sum of
P11,302.19, to the GCL Retirement Plan representing the withholding tax
on income from money market placements and purchase of treasury bills,
imposed pursuant to Presidential Decree No. 1959.
There is no dispute with respect to the facts. Private Respondent, GCL
Retirement Plan (GCL, for brevity) is an employees' trust maintained by
the employer, GCL Inc., to provide retirement, pension, disability and
death benefits to its employees. The Plan as submitted was approved and
qualified as exempt from income tax by Petitioner Commissioner of
Internal Revenue in accordance with Rep. Act No. 4917. 1
In 1984, Respondent GCL made investsments and earned therefrom
interest income from which was witheld the fifteen per centum (15%)
final witholding tax imposed by Pres. Decree No. 1959, 2 which took
effect on 15 October 1984, to wit:
Date
Tax

Kind of Investment

Principal

Income Earned 15%

ACIC
12/05/84
Market Placement
P236,515.32
P1,312.66
10/22/84

234,632.75
9,815.89
11/19/84

225,886.51
10,629.22
11/23/84

344,448.64
17,313.33
12/05/84

324,633.81
15,077.44
COMBANK Treasury Bills
2,064.15

P11,302.19

P8,751.96
1,472.38
1,594.38
2,597.00
2,261.52

On 15 January 1985, Respondent GCL filed with Petitioner a claim for

refund in the amounts of P1,312.66 withheld by Anscor Capital and
Investment Corp., and P2,064.15 by Commercial Bank of Manila. On 12
February 1985, it filed a second claim for refund of the amount of
P7,925.00 withheld by Anscor, stating in both letters that it disagreed
with the collection of the 15% final withholding tax from the interest
income as it is an entity fully exempt from income tax as provided under
Rep. Act No. 4917 in relation to Section 56 (b) 3 of the Tax Code.
The refund requested having been denied, Respondent GCL elevated the
matter to respondent Court of Tax Appeals (CTA). The latter ruled in
favor of GCL, holding that employees' trusts are exempt from the 15%
final withholding tax on interest income and ordering a refund of the tax
withheld. Upon appeal, originally to this Court, but referred to
respondent Court of Appeals, the latter upheld the CTA Decision. Before
us now, Petitioner assails that disposition.
It appears that under Rep. Act No. 1983, which took effect on 22 June
1957, amending Sec. 56 (b) of the National Internal Revenue Code (Tax
Code, for brevity), employees' trusts were exempt from income tax. That
law provided:
Sec. 56 Imposition of tax. (a) Application of tax. The taxes
imposed by this Title upon individuals shall apply to the income of
estates or of any kind of property held in trust, including
xxx

xxx

xxx

(b)
Exception. The tax imposed by this Title shall not apply to
employees' trust which forms a part of a pension, stock bonus or profitsharing plan of an employer for the benefit of some or all of his

employees (1) if contributions are made to trust by such employer, or

employees, or both, for the purpose of distributing to such employees the
earnings and principal of the fund accumulated by the trust in accordance
with such
plan, . . .
On 3 June 1977, Pres. Decree No. 1156 provided, for the first time, for
the withholding from the interest on bank deposits at the source of a tax
of fifteen per cent (15%) of said interest. However, it also allowed a
specific exemption in its Section 53, as follows:
Sec. 53.Withholding of tax at source.
xxx

xxx

xxx

(c)
Withholding tax on interest on bank deposits. (1) Rate of
withholding tax. Every bank or banking institution shall deduct and
withhold from the interest on bank deposits (except interest paid or
credited to non-resident alien individuals and foreign corporations), a tax
equal to fifteen per cent of the said interest: Provided, however, That no
withholding of tax shall be made if the aggregate amount of the interest
on all deposit accounts maintained by a depositor alone or together with
another in any one bank at any time during the taxable period does not
exceed three hundred fifty pesos a year or eighty-seven pesos and fifty
centavos per quarter. For this purpose, interest on a deposit account
maintained by two persons shall be deemed to be equally owned by
them.
(2)
Treatment of bank deposit interest. The interest income shall
be included in the gross income in computing the depositor's income tax
liability in according with existing law.
(3)
Depositors enjoying tax exemption privileges or preferential tax
treatment. In all cases where the depositor is tax-exempt or is
enjoying preferential income tax treatment under existing laws, the
withholding tax imposed in this paragraph shall be refunded or credited
as the case may be upon submission to the Commissioner of Internal
Revenue of proof that the said depositor is a tax-exempt entity or enjoys
a preferential income tax treatment.
xxx

xxx

xxx

This exemption and preferential tax treatment were carried over in Pres.
Decree No. 1739, effective on 17 September 1980, which law also
subjected interest from bank deposits and yield from deposit substitutes
to a final tax of twenty per cent (20%). The pertinent provisions read:
Sec. 2. Section 21 of the same Code is hereby amended by adding a new
paragraph to read as follows:
Sec. 21.Rates of tax on citizens or residents.
xxx

xxx

xxx

Interest from Philippine Currency bank deposits and yield from deposit
substitutes whether received by citizens of the Philippines or by resident
alien individuals, shall be subject to the final tax as follows: (a) 15% of
the interest on savings deposits, and (b) 20% of the interest on time
deposits and yield from deposit substitutes, which shall be collected and
paid as provided in Sections 53 and 54 of this Code. Provided, That no
tax shall be imposed if the aggregate amount of the interest on all
Philippine Currency deposit accounts maintained by a depositor alone or
together with another in any one bank at any time during the taxable
period does not exceed Eight Hundred Pesos (P800.00) a year or Two
Hundred Pesos (P200.00) per quarter. Provided, further, That if the
recipient of such interest is exempt from income taxation, no tax shall be
imposed and that, if the recipient is enjoying preferential income tax
treatment, then the preferential tax rates so provided shall be imposed
(Emphasis supplied).
Sec. 3. Section 24 of the same Code is hereby amended by adding a new
subsection (cc) between subsections (c) and (d) to read as follows:
(cc)
Rates of tax on interest from deposits and yield from deposit
substitutes. Interest on Philippine Currency bank deposits and yield
from deposit substitutes received by domestic or resident foreign
corporations shall be subject to a final tax on the total amount thereof as
follows: (a) 15% of the interest on savings deposits; and (b) 20% of the
interest on time deposits and yield from deposit substitutes which shall
be collected and paid as provided in Sections 53 and 54 of this Code.
Provided, That if the recipient of such interest is exempt from income
taxation, no tax shall be imposed and that, if the recipient is enjoying
preferential income tax treatment, then the preferential tax rates so
provided shall be imposed (Emphasis supplied).

Sec. 9. Section 53(e) of the same Code is hereby amended to read as

follows:
Se. 53(e)
Withholding of final tax on interest on bank deposits and
yield from deposit substitutes.
(1)
Withholding of final tax. Every bank or non-bank financial
intermediary shall deduct and withhold from the interest on bank
deposits or yield from deposit substitutes a final tax equal to fifteen
(15%) per cent of the interest on savings deposits and twenty (20%) per
cent of the interest on time deposits or yield from deposit substitutes:
Provided, however, That no withholding tax shall be made if the
aggregate amount of the interest on all deposit accounts maintained by a
depositor alone or together with another in any one bank at any time
during the taxable period does not exceed Eight Hundred Pesos a year or
Two Hundred Pesos per quarter. For this purpose, interest on a deposit
account maintained by two persons shall be deemed to be equally owned
by them.
(2)
Depositors or placers/investors enjoying tax exemption
privileges or preferential tax treatment. In all cases where the
depositor or placer/investor is tax exempt or is enjoying preferential
income tax treatment under existing laws, the withholding tax imposed in
this paragraph shall be refunded or credited as the case may be upon
submission to the Commissioner of Internal Revenue of proof that the
said depositor, or placer/investor is a tax exempt entity or enjoys a
preferential income tax treatment.
Subsequently, however, on 15 October 1984, Pres. Decree No. 1959 was
issued, amending the aforestated provisions to read:
Sec. 2. Section 21(d) of this Code, as amended, is hereby further
amended to read as follows:
(d)
On interest from bank deposits and yield or any other monetary
benefit from deposit substitutes and from trust fund and similar
arrangements. Interest from Philippine Currency Bank deposits and
yield or any other monetary benefit from deposit substitutes and from
trust fund and similar arrangements whether received by citizens of the
Philippines, or by resident alien individuals, shall be subject to a 15%

final tax to be collected and paid as provided in Sections 53 and 54 of

this Code.
Sec. 3. Section 24(cc) of this Code, as amended, is hereby further
amended to read as follows:
(cc)
Rates of tax on interest from deposits and yield or any other
monetary benefit from deposit substitutes and from trust fund and similar
arrangements. Interest on Philippine Currency Bank deposits and
yield or any other monetary benefit from deposit substitutes and from
trust fund and similar arrangements received by domestic or resident
foreign corporations shall be subject to a 15% final tax to be collected
and paid as provided in Section 53 and 54 of this Code.
Sec. 4. Section 53 (d) (1) of this code is hereby amended to read as
follows:
Sec. 53 (d) (1). Withholding of Final Tax. Every bank or non-bank
financial intermediary or commercial. industrial, finance companies, and
other non-financial companies authorized by the Securities and Exchange
Commission to issue deposit substitutes shall deduct and withhold from
the interest on bank deposits or yield or any other monetary benefit from
deposit substitutes a final tax equal to fifteen per centum (15%) of the
interest on deposits or yield or any other monetary benefit from deposit
substitutes and from trust fund and similar arrangements.
It is to be noted that the exemption from withholding tax on interest on
bank deposits previously extended by Pres. Decree No. 1739 if the
recipient (individual or corporation) of the interest income is exempt
from income taxation, and the imposition of the preferential tax rates if
the recipient of the income is enjoying preferential income tax treatment,
were both abolished by Pres. Decree No. 1959. Petitioner thus submits
that the deletion of the exempting and preferential tax treatment
provisions under the old law is a clear manifestation that the single 15%
(now 20%) rate is impossible on all interest incomes from deposits,
deposit substitutes, trust funds and similar arrangements, regardless of
the tax status or character of the recipients thereof. In short, petitioner's
position is that from 15 October 1984 when Pres. Decree No. 1959 was
promulgated, employees' trusts ceased to be exempt and thereafter
became subject to the final withholding tax.

Upon the other hand, GCL contends that the tax exempt status of the
employees' trusts applies to all kinds of taxes, including the final
withholding tax on interest income. That exemption, according to GCL,
is derived from Section 56(b) and not from Section 21 (d) or 24 (cc) of
the Tax Code, as argued by Petitioner.
The sole issue for determination is whether or not the GCL Plan is
exempt from the final withholding tax on interest income from money
placements and purchase of treasury bills required by Pres. Decree No.
1959.
We uphold the exemption.
To begin with, it is significant to note that the GCL Plan was qualified as
exempt from income tax by the Commissioner of Internal Revenue in
accordance with Rep. Act No. 4917 approved on 17 June 1967. This law
specifically provided:
Sec. 1. Any provision of law to the contrary notwithstanding, the
retirement benefits received by officials and employees of private firms,
whether individual or corporate, in accordance with a reasonable private
benefit plan maintained by the employer shall be exempt from all taxes
and shall not be liable to attachment, levy or seizure by or under any
legal or equitable process whatsoever except to pay a debt of the official
or employee concerned to the private benefit plan or that arising from
liability imposed in a criminal action; . . . (emphasis ours).
In so far as employees' trusts are concerned, the foregoing provision
should be taken in relation to then Section 56(b) (now 53[b]) of the Tax
Code, as amended by Rep. Act No. 1983, supra, which took effect on 22
June 1957. This provision specifically exempted employee's trusts from
income tax and is repeated hereunder for emphasis:
Sec. 56.Imposition of Tax. (a) Application of tax. The taxes
imposed by this Title upon individuals shall apply to the income of
estates or of any kind of property held in trust.
xxx

xxx

xxx

(b)
Exception. The tax imposed by this Title shall not apply to
employee's trust which forms part of a pension, stock bonus or profitsharing plan of an employer for the benefit of some or all of his

employees . . .
The tax-exemption privilege of employees' trusts, as distinguished from
any other kind of property held in trust, springs from the foregoing
provision. It is unambiguous. Manifest therefrom is that the tax law has
singled out employees' trusts for tax exemption.
And rightly so, by virtue of the raison de'etre behind the creation of
employees' trusts. Employees' trusts or benefit plans normally provide
economic assistance to employees upon the occurrence of certain
contingencies, particularly, old age retirement, death, sickness, or
disability. It provides security against certain hazards to which members
of the Plan may be exposed. It is an independent and additional source of
protection for the working group. What is more, it is established for their
exclusive benefit and for no other purpose.
The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in
order to encourage the formation and establishment of such private Plans
for the benefit of laborers and employees outside of the Social Security
Act. Enlightening is a portion of the explanatory note to H.B. No. 6503,
now R.A. 1983, reading:
Considering that under Section 17 of the social Security Act, all
contributions collected and payments of sickness, unemployment,
retirement, disability and death benefits made thereunder together with
the income of the pension trust are exempt from any tax, assessment, fee,
or charge, it is proposed that a similar system providing for retirement,
etc. benefits for employees outside the Social Security Act be exempted
from income taxes. (Congressional Record, House of Representatives,
Vol. IV, Part. 2, No. 57, p. 1859, May 3, 1957; cited in Commissioner of
Internal Revenue v. Visayan Electric Co., et al., G.R. No. L-22611, 27
May 1968, 23 SCRA 715); emphasis supplied.
It is evident that tax-exemption is likewise to be enjoyed by the income
of the pension trust. Otherwise, taxation of those earnings would result in
a diminution accumulated income and reduce whatever the trust
beneficiaries would receive out of the trust fund. This would run afoul of
the very intendment of the law.
The deletion in Pres. Decree No. 1959 of the provisos regarding tax
exemption and preferential tax rates under the old law, therefore, can not
be deemed to extent to employees' trusts. Said Decree, being a general

law, can not repeal by implication a specific provision, Section 56(b)

now 53 [b]) in relation to Rep. Act No. 4917 granting exemption from
income tax to employees' trusts. Rep. Act 1983, which excepted
employees' trusts in its Section 56 (b) was effective on 22 June 1957
while Rep. Act No. 4917 was enacted on 17 June 1967, long before the
issuance of Pres. Decree No. 1959 on 15 October 1984. A subsequent
statute, general in character as to its terms and application, is not to be
construed as repealing a special or specific enactment, unless the
legislative purpose to do so is manifested. This is so even if the
provisions of the latter are sufficiently comprehensive to include what
was set forth in the special act (Villegas v. Subido, G.R. No. L-31711, 30
September 1971, 41 SCRA 190).
Notably, too, all the tax provisions herein treated of come under Title II
of the Tax Code on "Income Tax." Section 21 (d), as amended by Rep.
Act No. 1959, refers to the final tax on individuals and falls under
Chapter II; Section 24 (cc) to the final tax on corporations under Chapter
III; Section 53 on withholding of final tax to Returns and Payment of Tax
under Chapter VI; and Section 56 (b) to tax on Estates and Trusts
covered by Chapter VII, Section 56 (b), taken in conjunction with
Section 56 (a), supra, explicitly excepts employees' trusts from "the taxes
imposed by this Title." Since the final tax and the withholding thereof are
embraced within the title on "Income Tax," it follows that said trust must
be deemed exempt therefrom. Otherwise, the exception becomes
meaningless.
There can be no denying either that the final withholding tax is collected
from income in respect of which employees' trusts are declared exempt
(Sec. 56 [b], now 53 [b], Tax Code). The application of the withholdings
system to interest on bank deposits or yield from deposit substitutes is
essentially to maximize and expedite the collection of income taxes by
requiring its payment at the source. If an employees' trust like the GCL
enjoys a tax-exempt status from income, we see no logic in withholding
a certain percentage of that income which it is not supposed to pay in the
first place.
Petitioner also relies on Revenue Memorandum Circular 31-84, dated 30
October 1984, and Bureau of Internal Revenue Ruling No. 027-e-00000-005-85, dated 14 January 1985, as authorities for the argument that
Pres. Decree No. 1959 withdrew the exemption of employees' trusts from
the withholding of the final tax on interest income. Said Circular and
Ruling pronounced that the deletion of the exempting and preferential tax

treatment provisions by Pres. Decree No. 1959 is a clear manifestation

that the single 15% tax rate is imposable on all interest income regardless
of the tax status or character of the recipient thereof. But since we herein
rule that Pres. Decree No. 1959 did not have the effect of revoking the
tax exemption enjoyed by employees' trusts, reliance on those authorities
is now misplaced.
WHEREFORE, the Writ of Certiorari prayed for is DENIED. The
judgment of respondent Court of Appeals, affirming that of the Court of
Tax Appeals is UPHELD. No costs.
SO ORDERED.

G.R. No. 96016 October 17, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE COURT OF APPEALS and EFREN P. CASTANEDA, respondents.
Leovigildo Monasterial for private respondent.
R E S O L U T I O N PADILLA, J.:p
The issue to be resolved in this petition for review on certiorari is
whether or not terminal leave pay received by a government official or
employee on the occasion of his compulsory retirement from the
government service is subject to withholding (income) tax.
We resolve the issue in the negative.
Private respondent Efren P. Castaneda retired from the government
service as Revenue Attache in the Philippine Embassy in London,
England, on 10 December 1982 under the provisions of Section 12 (c) of
Commonwealth Act 186, as amended. Upon retirement, he received,
among other benefits, terminal leave pay from which petitioner
Commissioner of Internal Revenue withheld P12,557.13 allegedly
representing income tax thereon.
Castaneda filed a formal written claim with petitioner for a refund of the
P12,557.13, contending that the cash equivalent of his terminal leave is
exempt from income tax. To comply with the two-year prescriptive
period within which claims for refund may be filed, Castaneda filed on
16 July 1984 with the Court of Tax Appeals a Petition for Review,
seeking the refund of income tax withheld from his terminal leave pay.
The Court of Tax Appeals found for private respondent Castaneda and
ordered the Commissioner of Internal Revenue to refund Castaneda the
sum of P12,557.13 withheld as income tax. (,Annex "C", petition).
Petitioner appealed the above-mentioned Court of Tax Appeals decision
to this Court, which was docketed as G.R. No. 80320. In turn, we
referred the case to the Court of Appeals for resolution. The case was
docketed in the Court of Appeals as CA-G.R. SP No. 20482.

On 26 September 1990, the Court of Appeals dismissed the petition for

review and affirmed the decision of the Court of Tax Appeals. Hence, the
present recourse by the Commissioner of Internal Revenue.
The Solicitor General, acting on behalf of the Commissioner of Internal
Revenue, contends that the terminal leave pay is income derived from
employer-employee relationship, citing in support of his stand Section 28
of the National Internal Revenue Code; that as part of the compensation
for services rendered, terminal leave pay is actually part of gross income
of the recipient. Thus
. . . It (terminal leave pay) cannot be viewed as salary for purposes which
would reduce it. . . . there can thus be no "commutation of salary" when a
government retiree applies for terminal leave because he is not receiving
it as salary. What he applies for is a "commutation of leave credits." It is
an accumulation of credits intended for old age or separation from
service. . . .
The Court has already ruled that the terminal leave pay received by a
government official or employee is not subject to withholding (income)
tax. In the recent case of Jesus N. Borromeo vs. The Hon. Civil Service
Commission, et al., G.R. No. 96032, 31 July 1991, the Court explained
the rationale behind the employee's entitlement to an exemption from
withholding (income) tax on his terminal leave pay as follows:
. . . commutation of leave credits, more commonly known as terminal
leave, is applied for by an officer or employee who retires, resigns or is
separated from the service through no fault of his own. (Manual on
Leave Administration Course for Effectiveness published by the Civil
Service Commission, pages 16-17). In the exercise of sound personnel
policy, the Government encourages unused leaves to be accumulated.
The Government recognizes that for most public servants, retirement pay
is always less than generous if not meager and scrimpy. A modest nest
egg which the senior citizen may look forward to is thus avoided.
Terminal leave payments are given not only at the same time but also for
the same policy considerations governing retirement benefits.
In fine, not being part of the gross salary or income of a government
official or employee but a retirement benefit, terminal leave pay is not
subject to income tax.
ACCORDINGLY, the petition for review is hereby DENIED.

A.M. No. 90-6-015-SC October 18, 1990

RE: REQUEST OF ATTY. BERNARDO ZIALCITA FOR
RECONSIDERATION OF THE ACTION OF THE FINANCIAL AND
BUDGET OFFICE
RESOLUTION
GUTIERREZ, JR., J.:
On August 23, 1990, a resolution of the Court En Banc was issued
regarding the amounts claimed by Atty. Bernardo F. Zialcita on the
occasion of his retirement. The resolution states, among others:
The terminal leave pay of Atty. Zialcita received by virtue of his
compulsory retirement can never be considered a part of his salary
subject to the payment of income tax but falls under the phrase "other
similar benefits received by retiring employees and workers", within the
meaning of Section 1 of PD No. 220 and is thus exempt from the
payment of income tax. That the money value of his accrued leave
credits is not a part of his salary is further buttressed by Sec. 3 of PD No.
985, otherwise known as The "Budgetary Reform Decree on
Compensation and Position Classification of 1976" particularly Sec. 3 (a)
thereof, which makes it clear that the actual service is the period of time
for which pay has been received, excluding the period covered by
terminal leave.
The dispositive portion provides:
Accordingly, the Court Resolved to (1) ORDER the Fiscal Management
and Budget Office to REFUND Atty. Zialcita the amount of P59,502.33
which was deducted from his terminal leave pay as withholding tax; and
(2) DECLARE that henceforth no withholding tax shall be deducted by
any Office of this Court from the terminal leave pay benefits of all
retirees similarly situated including those who have already retired and
from whose retirement benefits such withholding taxes were deducted.
Sarmiento, J., is on leave.
On September 18, 1990, the Commissioner of Internal Revenue, as
intervenor-movant and through the Solicitor General, filed a motion for
clarification and/or reconsideration with this Court.

After careful deliberation, the Court resolved to deny the motion for
reconsideration and hereby holds that the money value of the
accumulated leave credits of Atty. Bernardo Zialcita are not taxable for
the following reasons:
1)
Atty. Zialcita opted to retire under the provisions of Republic Act
660, which is incorporated in Commonwealth Act No. 186. Section 12(c)
of CA 186 states:
... Officials and employees retired under this Act shall be entitled to the
commutation of the unused vacation leave and sick leave, based on the
highest rate received, which they may have to their credit at the time of
retirement.
Section 28(c) of the same Act, in turn, provides:
(c)
Except as herein otherwise provided, the Government Service
Insurance System, all benefits granted under this Act, and all its forms
and documents required of the members shall be exempt from all types
of taxes, documentary stamps, duties and contributions, fiscal or
municipal, direct or indirect, established or to be established; ...
(Emphasis supplied)
Applying the two aforesaid provisions, it can be concluded that the
amount received by Atty. Zialcita as a result of the conversion of these
unused leaves into cash is exempt from income tax.
2)
The commutation of leave credits is commonly known as
terminal leave. (Manual on Leave Administration Course for
Effectiveness, published by the Civil Service Commission, p. 17)
Terminal leave is applied for by an officer or employee who retires,
resigns or is separated from the service through no fault of his own.
(supra, p. 16) Since terminal leave is applied for by an officer or
employee who has already severed his connection with his employer and
who is no longer working, then it follows that the terminal leave pay,
which is the cash value of his accumulated leave credits, is no longer
compensation for services rendered. It can not be viewed as salary.

3)

Executive Order No. 1077, Section 1, provides:

Any officer or employee of the government who retires or voluntarily

resigns or is separated from the service through no fault of his own and
whose leave benefits are not covered by special law, shag be entitled to
the commutation of all the accumulated vacation and/or sick leaves to his
credit, exclusive of Saturdays, Sundays and holidays, without litigation
as to the number of days of vacation and sick leaves that he may
accumulate. (Emphasis supplied)
Meanwhile, Section 28(b) 7(b) of the National Internal Revenue Code
(NIRC) states:
Sec. 28 (b) Exclusions from gross income. The following items
shall not be included in gross income and shall be exempt from taxation
under this title:
xxx

xxx

xxx

(7)

Retirement benefits, pensions, gratuities, etc.

xxx

xxx

xxx

(b)
Any amount received by an official or employee or by his heirs
from the employer as a consequence of separation of such official or
employee from the service of the employer due to death, sickness or
other physical disability or for any cause beyond the control of the said
official or employee. (Emphasis supplied)
In the case of Atty. Zialcita, he rendered government service from March
13, 1962 up to February 15, 1990. The next day, or on February 16,
1990, he reached the compulsory retirement age of 65 years. Upon his
compulsory retirement, he is entitled to the commutation of his
accumulated leave credits to its money value. Within the purview of the
above-mentioned provisions of the NLRC, compulsory retirement may
be considered as a "cause beyond the control of the said official or
employee". Consequently, the amount that he received by way of
commutation of his accumulated leave credits as a result of his
compulsory retirement, or his terminal leave pay, fags within the

enumerated exclusions from gross income and is therefore not subject to

tax.
4.
The terminal leave pay of Atty. Zialcita may likewise be viewed
as a "retirement gratuity received by government officials and
employees" which is also another exclusion from gross income as
provided for in Section 28(b), 7(f) of the NLRC. A gratuity is that paid to
the beneficiary for past services rendered purely out of generosity of the
giver or grantor. (Peralta v. Auditor General, 100 Phil. 1051 [1957]) It is
a mere bounty given by the government in consideration or in
recognition of meritorious services and springs from the appreciation and
graciousness of the government. (Pirovano v. De la Rama Steamship Co.,
96 Phil. 335, 357 [1954]) When a government employee chooses to go to
work rather than absent himself and consume his leave credits, there is
no doubt that the government is thereby benefited by the employee's
uninterrupted and continuous service. It is in cognizance of this fact that
laws were passed entitling retiring government employees, among others,
to the commutation of their accumulated leave credits. That which is
given to him after retirement is out of the Government's generosity and
an appreciation for his having continued working when he could very
well have gone on vacation. Section 286 of Revised Administrative
Code, as amended by RA 1081, provides that "whenever any officer,
employee or laborer of the Government of the Philippines shall
voluntarily resign or be separated from the service through no fault of his
own, he shall be entitled to the commutation of all accumulated vacation
and/or sick leave to his credit: ..." (Emphasis supplied) Executive Order
No. 1077, mentioned above, later amended Section 286 by removing the
limitation on the number of leave days that may be accumulated and
explicitly allowing retiring government employees to commute their
accumulated leaves. The commutation of accumulated leave credits may
thus be considered a retirement gratuity, within the import of Section
28(b), 7(f) of the NLRC, since it is given only upon retirement and in
consideration of the retiree's meritorious services.
It is clear that the law expresses the government's appreciation for many
years of service already rendered and the clear intention to reward
faithful and often underpaid workers after the official relationship had
been terminated.

5)
Section 284 of the Revised Administrative Code grants to a
government employee 15 days vacation leave and 15 days sick leave for
every year of service. Hence, even if the government employee absents
himself and exhausts his leave credits, he is still deemed to have worked
and to have rendered services. His leave benefits are already imputed in,
and form part of, his salary which in turn is subjected to withholding tax
on income. He is taxed on the entirety of his salaries without any
deductions for any leaves not utilized. It follows then that the money
values corresponding to these leave benefits both the used and unused
have already been taxed during the year that they were earned. To tax
them again when the retiring employee receives their money value as a
form of government concern and appreciation plainly constitutes an
attempt to tax the employee a second time. This is tantamount to double
taxation.
The Commissioner of Internal Revenue seeks, in the alternative, to be
clarified with respect to the following:

With respect to the need for a written request for refund, we rule that
Atty. Zialcita need no longer file a formal request for refund since the
August 23, 1990 Resolution, which principally deals with his case,
already binds the intervenor-movant Commissioner of Internal Revenue.
However, with respect to other retirees allegedly similarly situated and
from whom withholding taxes on terminal leave pay have been deducted,
we rule that these retirees should file a written request for refund within
two years from the date of promulgation of this resolution. Fiscal
considerations do not allow that this matter be left hanging for an
indefinite period while retirees make up their minds as to whether or hot
they are entitled to refunds.
The Chief of the Finance Division of this Court likewise seeks
clarification with respect to the applicability of our August 23, 1990
Resolution to the following employees of this Court:
a)

a.
the applicability of the August 23, 1990 Resolution to other
government officials and employees; and
b.
to those who have already retired and from whose retirement
benefits withholding taxes have been deducted, whether or not the
deducted taxes are refundable even without a written request for refund
from the taxpayer-retiree.
The case of Atty. Bernardo Zialcita (entitled Administrative Matter No.
90-6-015-SC) is merely an administrative matter involving an employee
of this Court who applied for retirement benefits and who questioned the
deductions on the benefits given to him. Hence, our resolution applies
only to employees of the Judiciary. If we extend the effects of the
aforementioned resolution to all other government employees, in the
absence of an actual case and controversy, we would in principle be
rendering an advisory opinion. We cannot foresee at this time and for all
cases all factors bearing upon the rights of government workers of
varying categories from diverse offices. The authorities concerned will
have to determine and rule on each case as it arises. "Similarly situated"
is a most ambiguous and undefined term whose application cannot be
fixed in advance.

those who avail of optional retirement; and

b)
those who resign or are separated from the service through no
fault of their own.
The two groups mentioned above are also entitled to terminal leave pay
in accordance with Section 286 of the Revised Administrative Code, as
amended by RA 1081. In the light of our ruling that to tax terminal leave
pay would result in the taxation of benefits given after and as direct
consequences of retirement and would, in effect, constitute double
taxation, we rule that this resolution also applies to those who avail of
optional retirement and to those who resign or are separated from the
service through no fault of their own.
The Court understands the urgent need of Government to tap all possible
sources of revenue because of its heavy expenditures and the failure of
actual income to cover all disbursements. However, the solution is not
the levying of taxes on benefits and gratuities which by law are not
supposed to be taxed. The remedy is to either amend the retirement law
subject, of course, to constitutional constraints or to institute vastly
improved and effective tax collection efforts.

All salaried workers and wage earners, whether in the public or the
private sector, are taxed to the last centavo of their incomes throughout
the entirety of their working lives. The same cannot be said of factory
workers, leaders of industry, merchants, self-employed professionals,
movie stars, fishing magnates, bus and jeepney operators, vice lords,
theatre owners, and real estate lessors, to name only a few. A middle or
lower echelon employee who retires after thirty or forty years of service
helplessly sees his retirement pensions or benefits unavoidably and
rapidly decrease in value in only a few years even as his cost of living,
age, health, and other personal circumstances call for increased
expenditures. We fail to see the logic in viewing with eager eyes for
purposes of tax revenues the fruits of a working lifetime of labor simply
because fixed salaries and retirement benefits are so visible and so
convenient to levy upon. Retirees who are most deserving of compassion
and who can least carry the multifarious burdens of Government should
not be so readily encumbered on a strained interpretation of the law.
WHEREFORE, the Court Resolved to (1) DENY with FINALITY the
motion for reconsideration of the intervenor-movant and the Solicitor
General; and (2) DECLARE (a) that the August 23, 1990 Resolution on
A.M. No. 90-6-015-SC specifically applies only to employees and
officers of the Judiciary who retire, resign or are separated through no
fault of their own; and (b) that retirees and former employees of the
Judiciary; except Atty. Zialcita, from whose terminal leave pay
withholding taxes have been deducted, must file a written claim for
refund with the Commissioner of Internal Revenue within two years
from the date of promulgation of this resolution.
SO ORDERED.

G.R. No. 162775

October 27, 2006

INTERCONTINENTAL BROADCASTING CORPORATION (IBC),

represented by ATTY. RENATOQ. BELLO, in his capacity as CEO and
President, petitioner,
vs.
NOEMI B. AMARILLA, CORSINI R. LAGAHIT, ANATOLIO G.
OTADOY, and CANDIDO C. QUIONES, JR., respondents.

In the meantime, the four (4) employees retired from the company and
received, on staggered basis, their retirement benefits under the 1993
Collective Bargaining Agreement (CBA) between petitioner and the
bargaining unit of its employees.
Name of Employee
Date of Retirement
Retirement Benefit

DECISION
Candido C. Quiones, Jr.
CALLEJO, SR., J.:

October 16, 1995

Before us is a Petition for Review on Certiorari filed by petitioner

Intercontinental Broadcasting Corporation (IBC) assailing the Decision1
of the Court of Appeals in CA-G.R. SP No. 72414, which in turn
affirmed the Decision2 of the National Labor Relations Commission
(NLRC) in NLRC Case No. V-000660-2000.

P 766,532.97

On various dates, petitioner employed the following persons at its Cebu

station: Candido C. Quiones, Jr.; on February 1, 1975;3 Corsini R.
Lagahit, as Studio Technician, also on February 1, 1975;4 Anatolio G.
Otadoy, as Collector, on April 1, 1975;5 and Noemi Amarilla, as Traffic
Clerk, on July 1, 1975.6 On March 1, 1986, the government sequestered
the station, including its properties, funds and other assets, and took over
its management and operations from its owner, Roberto Benedicto.7
However, in December 1986, the government and Benedicto entered into
a temporary agreement under which the latter would retain its
management and operation. On November 3, 1990, the Presidential
Commission on Good Government (PCGG) and Benedicto executed a
Compromise Agreement,8 where Benedicto transferred and assigned all
his rights, shares and interests in petitioner station to the government.
The PCGG submitted the Agreement to the Sandiganbayan in Civil Case
No. 0034 entitled "Republic of the Philippines v. Roberto S. Benedicto,
et al."9

P 1,134,239.47

Noemi B. Amarilla
April 16, 1998

Corsini R. Lagahit
April 16, 1998
P 1,298,879.50
Anatolio G. Otadoy
February 29, 1996
P 751,914.30
In the meantime, a P1,500.00 salary increase was given to all employees
of the company, current and retired, effective July 1994. However, when
the four retirees demanded theirs, petitioner refused and instead informed
them via a letter that their differentials would be used to offset the tax

due on their retirement benefits in accordance with the National Internal

Revenue Code (NIRC). Amarilla was informed that the P71,480.00 of
the amount due to her would be used to offset her tax liability of
P340,641.42.10 Otadoy was also informed in a letter dated July 5, 1999,
that his salary differential of P170,250.61 would be used to pay his tax
liability which amounted to P127,987.57. Since no tax liability was
withheld from his retirement benefits, he even owed the company
P17,727.26 after the offsetting. Quiones was informed that he should
have retired compulsorily in 1992 at age 55 as provided in the CBA, and
that since he was already 58 when he retired, he was no longer entitled to
receive salary increases from 1992 to 1995. Consequently, he was
overpaid by P137,932.22 for the "extension" of his employment from
1992 to 1995, which amount he was obliged to return to the company. In
any event, his claim for salary differentials had expired pursuant to
Article 291 of the Labor Code of the Philippines.11 Lagahits claim for
salary differential of P73,165.23 was rejected by petitioner in a letter
dated July 6, 1999, on the ground that he had a tax liability of
P396,619.03; since the amount would be used as partial payment for his
tax liability, he still owed the company P323,453.80.12
The four (4) retirees filed separate complaints13 against IBC TV-13
Cebu and Station Manager Louella F. Cabaero for unfair labor practice
and non-payment of backwages before the NLRC, Regional Arbitration
Branch VII. As all of the complainants had the same causes of action,
their complaints were docketed as NLRC RAB-VII Case No. 10-162599.
The complainants averred that their retirement benefits are exempt from
income tax under Article 32 of the NIRC. Sections 28 and 72 of the
NIRC, which petitioner relied upon in withholding their differentials, do
not apply to them since these provisions deal with the applicable income
tax rates on foreign corporations and suits to recover taxes based on false
or fraudulent returns. They pointed out that, under Article VIII of the
CBA, only those employees who reached the age of 60 were considered
retired, and those under 60 had the option to retire, like Quiones and
Otadoy who retired at ages 58 and 51, respectively. They prayed that
they be paid their salary differentials, as follows:
Otadoy

P 170,250.61
Quiones
P 170,250.61
Lagahit
P 73,165.23
Amarilla
P 71,480.0014
For its part, petitioner averred that under Section 21 of the NIRC, the
retirement benefits received by employees from their employers
constitute taxable income. While retirement benefits are exempt from
taxes under Section 28(b) of said Code, the law requires that such
benefits received should be in accord with a reasonable retirement plan
duly registered with the Bureau of Internal Revenue (BIR) after
compliance with the requirements therein enumerated. Since its
retirement plan in the 1993 CBA was not approved by the BIR,
complainants were liable for income tax on their retirement benefits.
Petitioner claimed that it was mandated to withhold the income tax due
from the retirement benefits of said complainants. It was not estopped
from correcting the mistakes of its former officers. Under the law,
complainants are obliged to return what had been mistakenly delivered to
them.15
In reply, complainants averred that the claims for the retirement salary
differentials of Quiones and Otadoy had not prescribed because the said
CBA was implemented only in 1997. They pointed out that they filed
their claims with petitioner on April 3, 1999. They maintained that they
availed of the optional retirement because of petitioners inducement that
there would be no tax deductions. Petitioner IBC did not commit any
mistake in not withholding the taxes due on their retirement benefits as
shown by the fact that the PCCG, the Commission on Audit (COA) and
the Bureau of Internal Revenue (BIR) did not even require them to

explain such mistake. They pointed out that petitioner paid their
retirement benefits on a staggered basis, and nonetheless failed to deduct
any amount as taxes.16

The claim of complainants Anatolio Otadoy and Candido Quiones and

the case against respondent Louella F. Cabaero are dismissed for lack of
merit.

Petitioner countered that the retirement benefits received by the

complainants were based on the CBA between it and its bargaining units.
Under Sections 72 and 73 of the NIRC, it is obliged to deduct and
withhold taxes determined in accordance with the rules and regulations
to be prepared by the Secretary of Finance. It was its duty to withhold the
taxes on complainants retirement benefits, otherwise, it would be held
civilly and criminally liable under Sections 251, 254 and 255 of the
NIRC.

SO ORDERED.17

On February 14, 2000, the Labor Arbiter rendered judgment in favor of

the retirees. The fallo of the decision reads:

Petitioner appealed the decision of the Labor Arbiter to the NLRC,

arguing that the retirement benefits of Amarilla and Lagahit are not tax
exempt. It insisted that the Labor Arbiter erred in declaring as unlawful
the act of withholding the employees salary differentials as payment for
the latters tax liabilities.

WHEREFORE, premises considered, judgment is hereby rendered

ordering the respondent Intercontinental Broadcasting Corporation (IBC
TV-13 Cebu) to pay the complainants Noemi Amarilla and Corsini
Lagahit as follows:
1. Noemi E. Amarilla

The Labor Arbiter ruled that the claims of Quiones and Otadoy had
prescribed. The retirement benefits of complainants Lagahit and
Amarilla, on the other hand, were exempt from income tax under Section
28(b) of the NIRC. However, the differentials due to the two
complainants were computed three years backwards due to the law on
prescription.

Otadoy and Quiones no longer appealed the decision.

On May 21, 2002, the NLRC rendered its decision dismissing the appeal
and affirming that of the Labor Arbiter. The fallo of the decision reads:

P26,423.00

WHEREFORE, the Decision of the Labor Arbiter dated February 14,

2000 is hereby AFFIRMED. Respondents appeal is dismissed for lack of
merit.

2. Corsino R. Lagahit
SO ORDERED.18
P26,423.00
Total
P52,846.00

The NLRC held that the benefits of the retirement plan under the CBAs
between petitioner and its union members were subject to tax as the
scheme was not approved by the BIR. However, it had also been the
practice of petitioner to give retiring employees their retirement pay
without tax deductions and there was no justifiable reason for the
respondent to deviate from such practice. The NLRC concluded that
petitioner was deemed to have assumed the tax liabilities of the
complainants on their retirement benefits, hence, had no right to deduct
taxes from their salary differentials. The NLRC thus ratiocinated:

The sole concern of the law is that tax shall be imposed on retirement
benefits. The employer assuming the payment of tax on behalf of the
retiring employee to make the retirement attractive, does not contravene
the tax law, because it is not contrary to the law or public policy, morals
and good customs. It is significant to note that respondent did not refute
the complainants allegations in their Position Papers, to wit:
"Complainants Amarilla and Lagahit availed themselves of the offer of
the respondent company when they were induced and were made to
believe that respondent companys employees who avail of such early
retirement can avail of that exemption on their retirement benefits. Were
it not for the offer of no tax liability, complainants would not have
availed of such optional or early retirement."
It is worthy to note that the retirement benefits of the complainants did
not suffer any tax deductions when they were given at the first instance.
It is only after they claimed the salary differentials when the respondent
withheld the backwages for the payment of tax liabilities.
"From the facts it can be shown that the disbursement of retirement
benefits of the complainants were made on staggered basis, three (3) and
four (4) times. So, if the company, as it claimed, is really vent on
deducting the alleged taxes due the complainants, they have three or four
opportunities to do so."
The respondents history reveals that it was paying retirement pays to its
retiring employees without tax deductions as a matter of practice. There
is no justifiable reason for the respondent to deviate from that practice
now. It is deemed to have assumed the tax liabilities of the
complainants.19
Aggrieved, petitioner elevated the decision before the CA on the
following grounds:
1. THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION
TANTAMOUNT TO LACK OF JURISDICTION WHEN IT RULED
THAT WHILE PETITIONER MAY NOT HAVE A RETIREMENT
PLAN WHOSE BENEFITS THEREFROM ARE EXEMPTED FROM

TAXES UNDER SECTION 28 OF THE NIRC, BY VIRTUE OF ITS

PREVIOUS PRACTICE THAT IT ASSUMED THE PAYMENT OF
TAX LIABILITES, IT IS DEEMED TO HAVE ANSWERED FOR THE
TAX LIABILITES OF THE COMPLAINANTS, WHICH ULTIMATE
CONSEQUENCE, IF NOT RECTIFIED, SHALL CAUSE
IRREPARABLE DAMAGE AND INJURY TO THE PETITIONER
CORPORATION.
2. THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION
TANTAMOUNT TO LACK OR EXCESS OF JURISDICTION IN
AFFIRMING THE DECISION RENDERED BY THE LABOR
ARBITER ON FEBRUARY 14, 2000 WHICH GRANTED
RETIREMENT DIFFERENTIAL TO RESPONDENTS AMARILLA
AND LAGAHIT AS THESE ARE CONTRARY TO THE FACTS AND
RETIREMENT LAWS PARTICULARLY THE PROVISIONS
EMBODIED IN SECTIONS 21, 27, 28 OF THE NATIONAL
INTERNAL REVENUE CODE AND R.A. 7641 IMPLEMENTING
ARTICLE 287 OF THE LABOR CODE AS WELL AS SECTION 6 OF
THE IMPLEMENTING RULES OF RA 7641.
3. CONSEQUENT TO NLRCS RULING GRANTING RETIREMENT
DIFFERENTIAL TO RESPONDENTS AMARILLA AND LAGAHIT,
THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION
TANTAMOUNT TO LACK OR EXCESS OF JURISDICTION IN
HOLDING THAT PETITIONERS ACT OF WITHHOLDING
COMPLAINANTS BACKWAGES AS PAYMENT OF THEIR TAX
LIABILITIES IS ILLEGAL.20
On December 3, 2003, the CA rendered judgment dismissing the petition
for lack of merit.
The appellate court declared that the salary differentials of the
respondents are part of their taxable gross income, considering that the
CBA was not approved, much less submitted to the BIR. However,
petitioner could not withhold the corresponding tax liabilities of
respondents due to the then existing CBA, providing that such retirement
benefits would not be subjected to any tax deduction, and that any such
taxes would be for its account. The appellate court relied on the

allegations of respondents in their Position Paper before the Labor

Arbiter which petitioner failed to refute.
Petitioner filed a motion for reconsideration, which the appellate court
denied. Hence, the present petition, where petitioner avers that:
WITH ALL DUE RESPECT, THE COURT OF APPEALS
COMMITTED REVERSIBLE ERROR WHEN IT RULED THAT
SINCE IT HAS BEEN THE PURPORTED PRACTICE OF
PETITIONER IBC-13 NOT TO WITHHOLD TAXES DUE ON THE
SALARY DIFFERENTIAL AND THE RETIREMENT BENEFITS,
PETITIONER IBC-13 NECESSARILY ASSUMED PAYMENT OF
THE TAXES AND COULD NOT THEREFORE WITHHOLD THE
SAME NOTWITHSTANDING THE SUBSEQUENT DISCOVERY
THAT THE FAILURE TO WITHHOLD THE TAXES WAS DONE
DUE TO THE OMISSION, MISTAKE, FRAUD OR IRREGULARITY
COMMITTED BY PREVIOUS MANAGEMENT.
WITH ALL DUE RESPECT, THE HONORABLE COURT OF
APPEALS GLOSSED OVER THE FACT AND COMMITTED
REVERSIBLE ERROR WHEN IT AFFIRMED THE DECISION OF
THE NATIONAL LABOR RELATIONS COMMISSION DATED MAY
21, 2002 WHICH ORDERED PETITIONER IBC-13 TO PAY
RETIREMENT DIFFERENTIAL TO RESPONDENTS AMARILLA
AND LAGAHIT AS THESE ARE CONTRARY TO THE FACTS AND
RETIREMENT LAWS PARTICULARLY THE PROVISIONS
EMBODIED IN SECTIONS 21, 27, 28 OF THE NATIONAL
INTERNAL REVENUE CODE (AS AMENDED BY PRESIDENTIAL
DECREE NO. 1994)21
Petitioner insists that respondents are liable for taxes on their retirement
benefits because the retirement plan under the CBA was not approved by
the BIR. It insisted that it failed to comply with the requisites of Section
32 of the NIRC and Rule II, Section 6 of the Rules Implementing the
New Retirement Law which provides that retirement pay shall be tax
exempt upon compliance with the requirements under Section 2(b) of
Revenue Regulation No. 12-86 dated August 1, 1986.

Petitioner maintains that respondents failed to present any document as

proof that petitioner bound and obliged itself to pay the withholding
taxes on their retirement benefits. In fact, the Labor Arbiter did not make
any finding that petitioner had obliged itself to pay the withholding taxes
on respondents retirement benefits. The NLRCs reliance on the
statements in its Position Paper that it undertook to pay for respondents
withholding taxes is misplaced.
While petitioner admits that its "previous directors" had paid the
withholding taxes on the retirement benefits of respondents, it explains
that this practice was stopped when the new management took over. The
new management could not be expected to enforce and follow through
the illegal policy of the old management which is adverse to the interests
of the petitioner; hence, the decisions of the NLRC and the CA affirming
such undertaking should be reversed. It points out that it is a government
corporation, and as such, its officials and employees may be held liable
for violation of Section 3(a) of Republic Act Nos. 3019, and 6713.22
Moreover, its officers and employees are mandated to preserve the
companys assets, and may, likewise be held liable for failure to do so
under Section 31 of the Corporation Code.
The issues are (1) whether the retirement benefits of respondents are part
of their gross income; and (2) whether petitioner is estopped from
reneging on its agreement with respondent to pay for the taxes on said
retirement benefits.
We agree with petitioners contention that, under the CBA, it is not
obliged to pay for the taxes on the respondents retirement benefits. We
have carefully reviewed the CBA and find no provision where petitioner
obliged itself to pay the taxes on the retirement benefits of its employees.
We also agree with petitioners contention that, under the NIRC, the
retirement benefits of respondents are part of their gross income subject
to taxes. Section 28 (b) (7) (A) of the NIRC of 198623 provides:
Sec. 28. Gross Income.
xxxx

(b) Exclusions from gross income. - The following items shall not be
included in gross income and shall be exempt from taxation under this
Title:

(ii) The retiring official or employees must have been in the service of
the same employer for at least ten (10) years and is not less than fifty
(50) years of age at the time of retirement; and

xxxx

(iii) The retiring official or employee shall not have previously availed of
the privilege under the retirement benefit plan of the same or another
employer.

(7) Retirement benefits, pensions, gratuities, etc. - (A) Retirement

benefits received by officials and employees of private firms whether
individuals or corporate, in accordance with a reasonable private benefit
plan maintained by the employer: Provided, That the retiring official or
employee has been in the service of the same employer for at least ten
(10) years and is not less than fifty years of age at the time of his
retirement: Provided, further, That the benefits granted under this
subparagraph shall be availed of by an official or employee only once.
For purposes of this subsection, the term "reasonable private benefit
plan" means a pension, gratuity, stock bonus or profit-sharing plan
maintained by an employer for the benefit of some or all of his officials
or employees, where contributions are made by such employer for
officials or employees, or both, for the purpose of distributing to such
officials and employees the earnings and principal of the fund thus
accumulated, and wherein it is provided in said plan that at no time shall
any part of the corpus or income of the fund be used for, or be diverted
to, any purpose other than for the exclusive benefit of the said official
and employees.
Revenue Regulation No. 12-86, the implementing rules of the foregoing
provisions, provides:

Thus, for the retirement benefits to be exempt from the withholding tax,
the taxpayer is burdened to prove the concurrence of the following
elements: (1) a reasonable private benefit plan is maintained by the
employer; (2) the retiring official or employee has been in the service of
the same employer for at least 10 years; (3) the retiring official or
employee is not less than 50 years of age at the time of his retirement;
and (4) the benefit had been availed of only once.
Article VIII of the 1993 CBA provides for two kinds of retirement plans compulsory and optional. Thus:
ARTICLE VIII
RETIREMENT
Section 1: Compulsory Retirement Any employee who has reached the
age of Fifty Five (55) years shall be retired from the COMPANY and
shall be paid a retirement pay in accordance with the following schedule:
LENGTH OF SERVICE

(b) Pensions, retirements and separation pay. Pensions, retirement and

separation pay constitute compensation subject to withholding tax,
except the following:

RETIREMENT BENEFITS

(1) Retirement benefit received by official and employees of private

firms under a reasonable private benefit plan maintained by the
employer, if the following requirements are met:

15 days for every year of service

(i) The retirement plan must be approved by the Bureau of Internal

Revenue;

30 days for every year of service

1 year below 5 yrs.

5 years 9 years

10 years 14 years

50 days for every year of service

15 years 19 years
65 days for every year of service
20 years or more
80 days for every year of service
A supervisor who reached the age of Fifty (50) may at his/her option
retire with the same retirement benefits provided above.
Section 2: Optional Retirement Any covered employee, regardless of
age, who has rendered at least five (5) years of service to the COMPANY
may voluntarily retire and the COMPANY agrees to pay Long Service
Pay to said covered employee in accordance with the following schedule:

Section 3: Fraction of a Year In computing the retirement under Section

1 and 2 of this Article, a fraction of at least six (6) months shall be
considered as one whole year. Moreover, the COMPANY may exercise
the option of extending the employment of an employee.
Section 4: Severance of Employment Due to Illness When a supervisor
suffers from disease and/or permanent disability and her/his continued
employment is prohibited by law or prejudicial to her/his health of the
health of his co-employees, the COMPANY shall not terminate the
employment of the subject supervisor unless there is a certification by a
competent public health authority that the disease is of such a nature or at
such stage that it can not be cured within a period of six (6) months even
with proper medical treatment. The supervisor may be separated upon
payment by the COMPANY of separation pay pursuant to law, unless the
supervisor falls within the purview of either Sections 1 or 2 hereof. In
which case, the retirement benefits indicated therein shall apply,
whichever is higher.

RETIREMENT BENEFITS

Section 5: Loyalty Recognition The COMPANY shall recognize the

services of the supervisor/director who have reached the following
number of years upon retirement by granting him/her a plaque of
appreciation and any lasting gift:

5 9 years

10 years but below 15 years

15 days for every year of service

10 14 years

(P 3,000.00) worth

30 days for every year of service

15 years but below 20 years

15 19 years

50 days for every year of service

(P 7,000.00) worth

20 years and above

20 years and more

60 days for every year of service

LENGTH OF SERVICE

(P10,000.00) worth
Respondents were qualified to retire optionally from their employment
with petitioner. However, there is no evidence on record that the 1993
CBA had been approved or was ever presented to the BIR; hence, the
retirement benefits of respondents are taxable.
Under Section 80 of the NIRC, petitioner, as employer, was obliged to
withhold the taxes on said benefits and remit the same to the BIR.
Section 80. Liability for Tax.
(A) Employer. The employer shall be liable for the withholding and
remittance of the correct amount of tax required to be deducted and
withheld under this Chapter. If the employer fails to withhold and remit
the correct amount of tax as required to be withheld under the provision
of this Chapter, such tax shall be collected from the employer together
with the penalties or additions to the tax otherwise applicable in respect
to such failure to withhold and remit.
However, we agree with respondents contention that petitioner did not
withhold the taxes due on their retirement benefits because it had obliged
itself to pay the taxes due thereon. This was done to induce respondents
to agree to avail of the optional retirement scheme. Thus, in its petition in
this case, petitioner averred that:
While it may indeed be conceded that the previous dispensation of
petitioner IBC-13 footed the bill for the withholding taxes, upon
discovery by the new management, this was stopped altogether as this
was grossly prejudicial to the interest of the petitioner IBC-13. The
policy of withholding the taxes due on the differentials as a remedial
measure was a matter of sound business judgment and dictates of good
governance aimed at protecting the interests of the government.
Necessarily, the newly-appointed board and officers of the petitioner,
who learned about this grossly disadvantageous mistake committed by
the former management of petitioner IBC-13 cannot be expected to just
follow suit blindly. An illegal act simply cannot give rise to an
obligation. Accordingly, the new officers were correct in not honoring
this highly suspect practice and it is now their duty to rectify this

anomalous occurrence, otherwise, they become remiss in the

performance of their sworn responsibilities.
It need not be stressed that as board members and officers of the acquired
asset of the government, they are committed to preserve the assets
thereof. Their concomitant obligations spring not only from their
fiduciary responsibility as corporate officers but as well as public
officers.24
Respondents received their retirement benefits from the petitioner in
three staggered installments without any tax deduction for the simple
reason that petitioner had remitted the same to the BIR with the use of its
own funds conformably with its agreement with the retirees. It was only
when respondents demanded the payment of their salary differentials that
petitioner alleged, for the first time, that it had failed to present the 1993
CBA to the BIR for approval, rendering such retirement benefits not
exempt from taxes; consequently, they were obliged to refund to it the
amounts it had remitted to the BIR in payment of their taxes. Petitioner
used this "failure" as an afterthought, as an excuse for its refusal to remit
to the respondents their salary differentials. Patently, petitioner is
estopped from doing so. It cannot renege on its commitment to pay the
taxes on respondents retirement benefits on the pretext that the "new
management" had found the policy disadvantageous.
It must be stressed that the parties are free to enter into any contract
stipulation provided it is not illegal or contrary to public morals. When
such agreement freely and voluntarily entered into turns out to be
advantageous to a party, the courts cannot "rescue" the other party
without violating the constitutional right to contract. Courts are not
authorized to extricate the parties from the consequences of their acts.
Thus, the fact that the contract stipulations of the parties may turn out to
be financially disadvantageous to them will not relieve them of their
obligation under the agreement.25
An agreement to pay the taxes on the retirement benefits as an incentive
to prospective retirees and for them to avail of the optional retirement
scheme is not contrary to law or to public morals. Petitioner had agreed
to shoulder such taxes to entice them to voluntarily retire early, on its
belief that this would prove advantageous to it. Respondents agreed and

relied on the commitment of petitioner. For petitioner to renege on its

contract with respondents simply because its new management had found
the same disadvantageous would amount to a breach of contract. There is
even no evidence that any "new management" was ever installed by
petitioner after respondents retirement; nor is there evidence that the
Board of Directors of petitioner resolved to renege on its contract with
respondents and demand the reimbursement for the amounts remitted by
it to the BIR.
The well-entrenched rule is that estoppel may arise from a making of a
promise if it was intended that the promise should be relied upon and, in
fact, was relied upon, and if a refusal to sanction the perpetration of fraud
would result to injustice. The mere omission by the promisor to do
whatever he promises to do is sufficient forbearance to give rise to a
promissory estoppel.26
Petitioner cannot hide behind the fact that, under the compromise
agreement between the PCGG and Benedicto, the latter had assigned and
conveyed to the Republic of the Philippines his shares, interests and
rights in petitioner. Respondents retired only after the Court affirmed the
validity of the Compromise Agreement27 and the execution by petitioner
and the union of their 1993 CBA while Civil Case No. 0034 was still
pending in the Sandiganbayan. There is no showing that before
respondents demanded the payment of their salary differentials,
petitioner had rejected its commitment to shoulder the taxes on
respondents retirement benefits and sought its nullification before the
court; nor is there any showing that petitioners "new management" filed
any criminal or administrative charges against the former officers/board
of directors comprising the "old management" relative to the payment of
the taxes on respondents retirement benefits.
IN VIEW OF ALL THE FOREGOING, the petition is DENIED for lack
of merit. The Decision of the Court of Appeals in CA-G.R. SP No. 72414
is AFFIRMED. Costs against the petitioner.
SO ORDERED.

G.R. No. L-54908

January 22, 1990

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED
MINING AND DEVELOPMENT CORPORATION and the COURT OF
TAX APPEALS, respondents.
G.R. No. 80041 January 22, 1990
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED
MINING AND DEVELOPMENT CORPORATION and the COURT OF
TAX APPEALS, respondents.
Gadioma Law Offices for respondents.

REGALADO, J.:
These cases, involving the same issue being contested by the same
parties and having originated from the same factual antecedents
generating the claims for tax credit of private respondents, the same were
consolidated by resolution of this Court dated May 31, 1989 and are
jointly decided herein.
The records reflect that on April 17, 1970, Atlas Consolidated Mining
and Development Corporation (hereinafter, Atlas) entered into a Loan
and Sales Contract with Mitsubishi Metal Corporation (Mitsubishi, for
brevity), a Japanese corporation licensed to engage in business in the
Philippines, for purposes of the projected expansion of the productive
capacity of the former's mines in Toledo, Cebu. Under said contract,
Mitsubishi agreed to extend a loan to Atlas 'in the amount of
$20,000,000.00, United States currency, for the installation of a new
concentrator for copper production. Atlas, in turn undertook to sell to
Mitsubishi all the copper concentrates produced from said machine for a
period of fifteen (15) years. It was contemplated that $9,000,000.00 of

said loan was to be used for the purchase of the concentrator machinery
from Japan. 1
Mitsubishi thereafter applied for a loan with the Export-Import Bank of
Japan (Eximbank for short) obviously for purposes of its obligation
under said contract. Its loan application was approved on May 26, 1970
in the sum of 4,320,000,000.00, at about the same time as the approval
of its loan for 2,880,000,000.00 from a consortium of Japanese banks.
The total amount of both loans is equivalent to $20,000,000.00 in United
States currency at the then prevailing exchange rate. The records in the
Bureau of Internal Revenue show that the approval of the loan by
Eximbank to Mitsubishi was subject to the condition that Mitsubishi
would use the amount as a loan to Atlas and as a consideration for
importing copper concentrates from Atlas, and that Mitsubishi had to pay
back the total amount of loan by September 30, 1981. 2
Pursuant to the contract between Atlas and Mitsubishi, interest payments
were made by the former to the latter totalling P13,143,966.79 for the
years 1974 and 1975. The corresponding 15% tax thereon in the amount
of P1,971,595.01 was withheld pursuant to Section 24 (b) (1) and Section
53 (b) (2) of the National Internal Revenue Code, as amended by
Presidential Decree No. 131, and duly remitted to the Government. 3
On March 5, 1976, private respondents filed a claim for tax credit
requesting that the sum of P1,971,595.01 be applied against their existing
and future tax liabilities. Parenthetically, it was later noted by respondent
Court of Tax Appeals in its decision that on August 27, 1976, Mitsubishi
executed a waiver and disclaimer of its interest in the claim for tax credit
in favor of
Atlas. 4
The petitioner not having acted on the claim for tax credit, on April 23,
1976 private respondents filed a petition for review with respondent
court, docketed therein as CTA Case No. 2801. 5 The petition was
grounded on the claim that Mitsubishi was a mere agent of Eximbank,
which is a financing institution owned, controlled and financed by the
Japanese Government. Such governmental status of Eximbank, if it may
be so called, is the basis for private repondents' claim for exemption from
paying the tax on the interest payments on the loan as earlier stated. It

was further claimed that the interest payments on the loan from the
consortium of Japanese banks were likewise exempt because said loan
supposedly came from or were financed by Eximbank. The provision of
the National Internal Revenue Code relied upon is Section 29 (b) (7) (A),
6 which excludes from gross income:
(A)
Income received from their investments in the Philippines in
loans, stocks, bonds or other domestic securities, or from interest on their
deposits in banks in the Philippines by (1) foreign governments, (2)
financing institutions owned, controlled, or enjoying refinancing from
them, and (3) international or regional financing institutions established
by governments.
Petitioner filed an answer on July 9, 1976. The case was set for hearing
on April 6, 1977 but was later reset upon manifestation of petitioner that
the claim for tax credit of the alleged erroneous payment was still being
reviewed by the Appellate Division of the Bureau of Internal Revenue.
The records show that on November 16, 1976, the said division
recommended to petitioner the approval of private respondent's claim.
However, before action could be taken thereon, respondent court
scheduled the case for hearing on September 30, 1977, during which trial
private respondents presented their evidence while petitioner submitted
his case on the basis of the records of the Bureau of Internal Revenue and
the pleadings. 7
On April 18, 1980, respondent court promulgated its decision ordering
petitioner to grant a tax credit in favor of Atlas in the amount of
P1,971,595.01. Interestingly, the tax court held that petitioner admitted
the material averments of private respondents when he supposedly
prayed "for judgment on the pleadings without off-spring proof as to the
truth of his allegations." 8 Furthermore, the court declared that all papers
and documents pertaining to the loan of 4,320,000,000.00 obtained by
Mitsubishi from Eximbank show that this was the same amount given to
Atlas. It also observed that the money for the loans from the consortium
of private Japanese banks in the sum of 2,880,000,000.00 "originated"
from Eximbank. From these, respondent court concluded that the
ultimate creditor of Atlas was Eximbank with Mitsubishi acting as a
mere "arranger or conduit through which the loans flowed from the

creditor Export-Import Bank of Japan to the debtor Atlas Consolidated

Mining & Development Corporation." 9
A motion for reconsideration having been denied on August 20, 1980,
petitioner interposed an appeal to this Court, docketed herein as G.R. No.
54908.
While CTA Case No. 2801 was still pending before the tax court, the
corresponding 15% tax on the amount of P439,167.95 on the
P2,927,789.06 interest payments for the years 1977 and 1978 was
withheld and remitted to the Government. Atlas again filed a claim for
tax credit with the petitioner, repeating the same basis for exemption.
On June 25, 1979, Mitsubishi and Atlas filed a petition for review with
the Court of Tax Appeals docketed as CTA Case No. 3015. Petitioner
filed his answer thereto on August 14, 1979, and, in a letter to private
respondents dated November 12, 1979, denied said claim for tax credit
for lack of factual or legal basis. 10
On January 15, 1981, relying on its prior ruling in CTA Case No. 2801,
respondent court rendered judgment ordering the petitioner to credit
Atlas the aforesaid amount of tax paid. A motion for reconsideration,
filed on March 10, 1981, was denied by respondent court in a resolution
dated September 7, 1987. A notice of appeal was filed on September 22,
1987 by petitioner with respondent court and a petition for review was
filed with this Court on December 19, 1987. Said later case is now before
us as G.R. No. 80041 and is consolidated with G.R. No. 54908.
The principal issue in both petitions is whether or not the interest income
from the loans extended to Atlas by Mitsubishi is excludible from gross
income taxation pursuant to Section 29 b) (7) (A) of the tax code and,
therefore, exempt from withholding tax. Apropos thereto, the focal
question is whether or not Mitsubishi is a mere conduit of Eximbank
which will then be considered as the creditor whose investments in the
Philippines on loans are exempt from taxes under the code.
Prefatorily, it must be noted that respondent court erred in holding in
CTA Case No. 2801 that petitioner should be deemed to have admitted
the allegations of the private respondents when it submitted the case on

the basis of the pleadings and records of the bureau. There is nothing to
indicate such admission on the part of petitioner nor can we accept
respondent court's pronouncement that petitioner did not offer to prove
the truth of its allegations. The records of the Bureau of Internal Revenue
relevant to the case were duly submitted and admitted as petitioner's
supporting evidence. Additionally, a hearing was conducted, with
presentation of evidence, and the findings of respondent court were
based not only on the pleadings but on the evidence adduced by the
parties. There could, therefore, not have been a judgment on the
pleadings, with the theorized admissions imputed to petitioner, as
mistakenly held by respondent court.
Time and again, we have ruled that findings of fact of the Court of Tax
Appeals are entitled to the highest respect and can only be disturbed on
appeal if they are not supported by substantial evidence or if there is a
showing of gross error or abuse on the part of the tax court. 11 Thus,
ordinarily, we could give due consideration to the holding of respondent
court that Mitsubishi is a mere agent of Eximbank. Compelling
circumstances obtaining and proven in these cases, however, warrant a
departure from said general rule since we are convinced that there is a
misapprehension of facts on the part of the tax court to the extent that its
conclusions are speculative in nature.

specifically so stated, especially considering their experience and

expertise in financial transactions, not to speak of the amount involved
and its purchasing value in 1970.
A thorough analysis of the factual and legal ambience of these cases
impels us to give weight to the following arguments of petitioner:
The nature of the above contract shows that the same is not just a simple
contract of loan. It is not a mere creditor-debtor relationship. It is more of
a reciprocal obligation between ATLAS and MITSUBISHI where the
latter shall provide the funds in the installation of a new concentrator at
the former's Toledo mines in Cebu, while ATLAS in consideration of
which, shall sell to MITSUBISHI, for a term of 15 years, the entire
copper concentrate that will be produced by the installed concentrator.
Suffice it to say, the selling of the copper concentrate to MITSUBISHI
within the specified term was the consideration of the granting of the
amount of $20 million to ATLAS. MITSUBISHI, in order to fulfill its
part of the contract, had to obtain funds. Hence, it had to secure a loan or
loans from other sources. And from what sources, it is immaterial as far
as ATLAS in concerned. In this case, MITSUBISHI obtained the $20
million from the EXIMBANK, of Japan and the consortium of Japanese
banks financed through the EXIMBANK, of Japan.

The loan and sales contract between Mitsubishi and Atlas does not
contain any direct or inferential reference to Eximbank whatsoever. The
agreement is strictly between Mitsubishi as creditor in the contract of
loan and Atlas as the seller of the copper concentrates. From the
categorical language used in the document, one prestation was in
consideration of the other. The specific terms and the reciprocal nature of
their obligations make it implausible, if not vacuous to give credit to the
cavalier assertion that Mitsubishi was a mere agent in said transaction.

When MITSUBISHI therefore secured such loans, it was in its own

independent capacity as a private entity and not as a conduit of the
consortium of Japanese banks or the EXIMBANK of Japan. While the
loans were secured by MITSUBISHI primarily "as a loan to and in
consideration for importing copper concentrates from ATLAS," the fact
remains that it was a loan by EXIMBANK of Japan to MITSUBISHI and
not to ATLAS.

Surely, Eximbank had nothing to do with the sale of the copper

concentrates since all that Mitsubishi stated in its loan application with
the former was that the amount being procured would be used as a loan
to and in consideration for importing copper concentrates from Atlas. 12
Such an innocuous statement of purpose could not have been intended
for, nor could it legally constitute, a contract of agency. If that had been
the purpose as respondent court believes, said corporations would have

Thus, the transaction between MITSUBISHI and EXIMBANK of Japan

was a distinct and separate contract from that entered into by
MITSUBISHI and ATLAS. Surely, in the latter contract, it is not
EXIMBANK, that was intended to be benefited. It is MITSUBISHI
which stood to profit. Besides, the Loan and Sales Contract cannot be
any clearer. The only signatories to the same were MITSUBISHI and
ATLAS. Nowhere in the contract can it be inferred that MITSUBISHI

acted for and in behalf of EXIMBANK, of Japan nor of any entity,

private or public, for that matter.

its financial exposure, must see to it that the same are in line with the
provisions and objectives of its charter.

Corollary to this, it may well be stated that in this jurisdiction, wellsettled is the rule that when a contract of loan is completed, the money
ceases to be the property of the former owner and becomes the sole
property of the obligor (Tolentino and Manio vs. Gonzales Sy, 50 Phil.
558).

Respondents postulate that Mitsubishi had to be a conduit because

Eximbank's charter prevents it from making loans except to Japanese
individuals and corporations. We are not impressed. Not only is there a
failure to establish such submission by adequate evidence but it posits
the unfair and unexplained imputation that, for reasons subject only of
surmise, said financing institution would deliberately circumvent its own
charter to accommodate an alien borrower through a manipulated
subterfuge, but with it as a principal and the real obligee.

In the case at bar, when MITSUBISHI obtained the loan of $20 million
from EXIMBANK, of Japan, said amount ceased to be the property of
the bank and became the property of MITSUBISHI.
The conclusion is indubitable; MITSUBISHI, and NOT EXIMBANK, is
the sole creditor of ATLAS, the former being the owner of the $20
million upon completion of its loan contract with EXIMBANK of Japan.
The interest income of the loan paid by ATLAS to MITSUBISHI is
therefore entirely different from the interest income paid by
MITSUBISHI to EXIMBANK, of Japan. What was the subject of the
15% withholding tax is not the interest income paid by MITSUBISHI to
EXIMBANK, but the interest income earned by MITSUBISHI from the
loan to ATLAS. . . . 13
To repeat, the contract between Eximbank and Mitsubishi is entirely
different. It is complete in itself, does not appear to be suppletory or
collateral to another contract and is, therefore, not to be distorted by
other considerations aliunde. The application for the loan was approved
on May 20, 1970, or more than a month after the contract between
Mitsubishi and Atlas was entered into on April 17, 1970. It is true that
under the contract of loan with Eximbank, Mitsubishi agreed to use the
amount as a loan to and in consideration for importing copper
concentrates from Atlas, but all that this proves is the justification for the
loan as represented by Mitsubishi, a standard banking practice for
evaluating the prospects of due repayment. There is nothing wrong with
such stipulation as the parties in a contract are free to agree on such
lawful terms and conditions as they see fit. Limiting the disbursement of
the amount borrowed to a certain person or to a certain purpose is not
unusual, especially in the case of Eximbank which, aside from protecting

The allegation that the interest paid by Atlas was remitted in full by
Mitsubishi to Eximbank, assuming the truth thereof, is too tenuous and
conjectural to support the proposition that Mitsubishi is a mere conduit.
Furthermore, the remittance of the interest payments may also be
logically viewed as an arrangement in paying Mitsubishi's obligation to
Eximbank. Whatever arrangement was agreed upon by Eximbank and
Mitsubishi as to the manner or procedure for the payment of the latter's
obligation is their own concern. It should also be noted that Eximbank's
loan to Mitsubishi imposes interest at the rate of 75% per annum, while
Mitsubishis contract with Atlas merely states that the "interest on the
amount of the loan shall be the actual cost beginning from and including
other dates of releases against loan." 14
It is too settled a rule in this jurisdiction, as to dispense with the need for
citations, that laws granting exemption from tax are construed strictissimi
juris against the taxpayer and liberally in favor of the taxing power.
Taxation is the rule and exemption is the exception. The burden of proof
rests upon the party claiming exemption to prove that it is in fact covered
by the exemption so claimed, which onus petitioners have failed to
discharge. Significantly, private respondents are not even among the
entities which, under Section 29 (b) (7) (A) of the tax code, are entitled
to exemption and which should indispensably be the party in interest in
this case.
Definitely, the taxability of a party cannot be blandly glossed over on the
basis of a supposed "broad, pragmatic analysis" alone without substantial
supportive evidence, lest governmental operations suffer due to

diminution of much needed funds. Nor can we close this discussion

without taking cognizance of petitioner's warning, of pervasive relevance
at this time, that while international comity is invoked in this case on the
nebulous representation that the funds involved in the loans are those of a
foreign government, scrupulous care must be taken to avoid opening the
floodgates to the violation of our tax laws. Otherwise, the mere expedient
of having a Philippine corporation enter into a contract for loans or other
domestic securities with private foreign entities, which in turn will
negotiate independently with their governments, could be availed of to
take advantage of the tax exemption law under discussion.
WHEREFORE, the decisions of the Court of Tax Appeals in CTA Cases
Nos. 2801 and 3015, dated April 18, 1980 and January 15, 1981,
respectively, are hereby REVERSED and SET ASIDE.
SO ORDERED.

Marrita MURPHY and Daniel J. Leveille, Appellants v. INTERNAL

REVENUE SERVICE and United States of America, Appellees.
No.05-5139.
Decided: July 03, 2007
Before: GINSBURG, Chief Judge, and ROGERS and BROWN, Circuit
Judges.David K. Colapinto argued the cause for appellants. With him
on the briefs were Stephen M. Kohn and Michael D. Kohn. Richard R.
Renner was on the brief for amici curiae No FEAR Coalition, et al. in
support of appellants. Gilbert S. Rothenberg, Attorney, U.S. Department
of Justice, argued the cause for appellees. With him on the brief were
Jeffrey A. Taylor, U.S. Attorney, Richard T. Morrison, Deputy Assistant
Attorney General, and Kenneth L. Greene and Francesca U. Tamami,
Attorneys. Bridget M. Rowan, Attorney, entered an appearance.
On Rehearing
Marrita Murphy brought this suit to recover income taxes she paid on the
compensatory damages for emotional distress and loss of reputation she
was awarded in an administrative action she brought against her former
employer. Murphy contends that under 104(a)(2) of the Internal
Revenue Code (IRC), 26 U.S.C. 104(a)(2), her award should have
been excluded from her gross income because it was compensation
received on account of personal physical injuries or physical sickness.
She also maintains that, in any event, her award is not part of her gross
income as defined by 61 of the IRC, 26 U.S.C. 61. Finally, she
argues that taxing her award subjects her to an unapportioned direct tax
in violation of Article I, Section 9 of the Constitution of the United
States.
We reject Murphy's argument in all aspects. We hold, first, that
Murphy's compensation was not received on account of personal
physical injuries excludable from gross income under 104(a)(2).
Second, we conclude gross income as defined by 61 includes
compensatory damages for non-physical injuries. Third, we hold that a
tax upon such damages is within the Congress's power to tax.
I.Background
In 1994 Marrita Leveille (now Murphy) filed a complaint with the
Department of Labor alleging that her former employer, the New York
Air National Guard (NYANG), in violation of various whistle-blower
statutes, had blacklisted her and provided unfavorable references to
potential employers after she had complained to state authorities of
environmental hazards on a NYANG airbase. The Secretary of Labor

determined the NYANG had unlawfully discriminated and retaliated

against Murphy, ordered that any adverse references to the taxpayer in
the files of the Office of Personnel Management be withdrawn, and
remanded her case to an Administrative Law Judge for findings on
compensatory damages.
On remand Murphy submitted evidence that she had suffered both
mental and physical injuries as a result of the NYANG's blacklisting her.
A psychologist testified that Murphy had sustained both somatic and
emotional injuries, basing his conclusion in part upon medical and
dental records showing Murphy had bruxism, or teeth grinding often
associated with stress, which may cause permanent tooth damage.
Noting that Murphy also suffered from other physical manifestations of
stress including anxiety attacks, shortness of breath, and dizziness,
and that Murphy testified she could not concentrate, stopped talking to
friends, and no longer enjoyed anything in life, the ALJ recommended
compensatory damages totaling $70,000, of which $45,000 was for past
and future emotional distress, and $25,000 was for injury to
[Murphy's] vocational reputation from having been blacklisted. None
of the award was for lost wages or diminished earning capacity.
In 1999 the Department of Labor Administrative Review Board affirmed
the ALJ's findings and recommendations. See Leveille v. N.Y. Air Nat'l
Guard, 1999 WL 966951, at *2-*4 (Oct. 25, 1999). On her tax return
for 2000, Murphy included the $70,000 award in her gross income
pursuant to 61 of the IRC. See 26 U.S.C. 61(a) ([G]ross income
means all income from whatever source derived). As a result, she paid
$20,665 in taxes on the award.
Murphy later filed an amended return in which she sought a refund of the
$20,665 based upon 104(a)(2) of the IRC, which provides that gross
income does not include damages received on account of
personal physical injuries or physical sickness. In support of her
amended return, Murphy submitted copies of her dental and medical
records. Upon deciding Murphy had failed to demonstrate the
compensatory damages were attributable to physical injury or
physical sickness, the Internal Revenue Service denied her request for
a refund. Murphy thereafter sued the IRS and the United States in the
district court.
In her complaint Murphy sought a refund of the $20,665, plus applicable
interest, pursuant to the Sixteenth Amendment to the Constitution of the
United States, along with declaratory and injunctive relief against the

IRS pursuant to the Administrative Procedure Act and the Due Process
Clause of the Fifth Amendment. She argued her compensatory award
was in fact for physical personal injuries and therefore excluded from
gross income under 104(a)(2). In the alternative Murphy asserted
taxing her award was unconstitutional because the award was not
income within the meaning of the Sixteenth Amendment. The
Government moved to dismiss Murphy's suit as to the IRS, contending
the Service was not a proper defendant, and for summary judgment on all
claims.
The district court denied the Government's motion to dismiss, holding
that Murphy had the right to bring an action[] for declaratory judgments
or [a] mandatory injunction against an agency by its official title,
pursuant to 703 of the APA, 5 U.S.C. 703. Murphy v. IRS, 362
F.Supp.2d 206, 211-12, 218 (2005). The court then rejected all of
Murphy's claims on the merits and granted summary judgment for the
Government and the IRS. Id.
Murphy appealed the judgment of the district court with respect to her
claims under 104(a)(2) and the Sixteenth Amendment. In Murphy v.
IRS, 460 F.3d 79 (2006), we concluded Murphy's award was not exempt
from taxation pursuant to 104(a)(2), id. at 84, but also was not
income within the meaning of the Sixteenth Amendment, id. at 92, and
therefore reversed the decision of the district court. The Government
petitioned for rehearing en banc, arguing for the first time that, even if
Murphy's award is not income, there is no constitutional impediment to
taxing it because a tax on the award is not a direct tax and is imposed
uniformly. In view of the importance of the issue thus belatedly raised,
the panel sua sponte vacated its judgment and reheard the case. See
Consumers Union of U.S., Inc. v. Fed. Power Comm'n, 510 F.2d 656,
662 (D.C.Cir.1975) ([R]egarding the contents of briefs on appeal, we
may also consider points not raised in the briefs or in oral argument.
Our willingness to do so rests on a balancing of considerations of judicial
orderliness and efficiency against the need for the greatest possible
accuracy in judicial decisionmaking. The latter factor is of particular
weight when the decision affects the broad public interest.) (footnotes
omitted); see also Eli Lilly & Co. v. Home Ins. Co., 794 F.2d 710, 717
(D.C.Cir.1986) (The rule in this circuit is that litigants must raise their
claims on their initial appeal and not in subsequent hearings following a
remand. This is a specific application of the general waiver rule, which
bends only in exceptional circumstances, where injustice might

otherwise result.) (quoting Dist. of Columbia v. Air Florida, Inc., 750

F.2d 1077, 1085 (D.C.Cir.1984)) (citation omitted). In the present
opinion, we affirm the judgment of the district court based upon the
newly argued ground that Murphy's award, even if it is not income
within the meaning of the Sixteenth Amendment, is within the reach of
the congressional power to tax under Article I, Section 8 of the
Constitution.
II.Analysis
We review the district court's grant of summary judgment de novo, Flynn
v. R.C. Tile, 353 F.3d 953, 957 (D.C.Cir.2004), bearing in mind that
summary judgment is appropriate only if there is no genuine issue as to
any material fact and if the moving party is entitled to judgment as a
matter of law, Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106
S.Ct. 2505, 91 L.Ed.2d 202 (1986). Before addressing Murphy's claims
on their merits, however, we must determine whether the district court
erred in holding the IRS was a proper defendant.
A.The IRS as a Defendant
The Government contends the courts lack jurisdiction over Murphy's
claims against the IRS because the Congress has not waived that
agency's immunity from declaratory and injunctive actions pursuant to
28 U.S.C. 2201(a) (courts may grant declaratory relief except with
respect to Federal taxes) and 26 U.S.C. 7421(a) (no suit for the
purpose of restraining the assessment or collection of any tax shall be
maintained in any court by any person); and insofar as the Congress in
28 U.S.C. 1346(a)(1) has waived immunity from civil actions seeking
tax refunds, that provision on its face applies to civil action[s] against
the United States, not against the IRS. In reply Murphy argues only that
the Government forfeited the issue of sovereign immunity because it did
not cross-appeal the district court's denial of its motion to dismiss. See
Fed. R.App. P. 4(a)(3). Notwithstanding the Government's failure to
cross-appeal, however, the court must address a question concerning its
jurisdiction. See Occidental Petroleum Corp. v. SEC, 873 F.2d 325, 328
(D.C.Cir.1989) (As a preliminary matter we must address the
question of our jurisdiction to hear this appeal).
Murphy and the district court are correct that 703 of the APA does
create a right of action for equitable relief against a federal agency but, as
the Government correctly points out, the Congress has preserved the
immunity of the United States from declaratory and injunctive relief with
respect to all tax controversies except those pertaining to the

classification of organizations under 501(c) of the IRC. See 28 U.S.C.

2201(a); 26 U.S.C. 7421(a). As an agency of the Government, of
course, the IRS shares that immunity. See Settles v. U.S. Parole
Comm'n, 429 F.3d 1098, 1106 (D.C.Cir.2005) (agency retains the
immunity it is due as an arm of the federal sovereign). Insofar as the
Congress in 28 U.S.C. 1346(a)(1) has waived sovereign immunity
with respect to suits for tax refunds, that provision specifically
contemplates only actions against the United States. Therefore, we
hold the IRS, unlike the United States, may not be sued eo nomine in this
case.
B.Section 104(a)(2) of the IRC
Section 104(a) (Compensation for injuries or sickness) provides that
gross income [under 61 of the IRC] does not include the amount of
any damages (other than punitive damages) received on account of
personal physical injuries or physical sickness. 26 U.S.C. 104(a)(2).
Since 1996 it has further provided that, for purposes of this exclusion,
emotional distress shall not be treated as a physical injury or physical
sickness. Id. 104(a). The version of 104(a)(2) in effect prior to
1996 had excluded from gross income monies received in compensation
for personal injuries or sickness, which included both physical and
nonphysical injuries such as emotional distress. Id. 104(a)(2) (1995);
see United States v. Burke, 504 U.S. 229, 235 n. 6, 112 S.Ct. 1867, 119
L.Ed.2d 34 (1992) ( [section] 104(a)(2) in fact encompasses a broad
range of physical and nonphysical injuries to personal interests). In
Commissioner v. Schleier, 515 U.S. 323, 115 S.Ct. 2159, 132 L.Ed.2d
294 (1995), the Supreme Court held that before a taxpayer may exclude
compensatory damages from gross income pursuant to 104(a)(2), he
must first demonstrate that the underlying cause of action giving rise to
the recovery [was] based upon tort or tort type rights. Id. at 337, 115
S.Ct. 2159. The taxpayer has the same burden under the statute as
amended. See, e.g., Chamberlain v. United States, 401 F.3d 335, 341
(5th Cir.2005).
Murphy contends 104(a)(2), even as amended, excludes her particular
award from gross income. First, she asserts her award was based upon
tort type rights in the whistle-blower statutes the NYANG violated-a
position the Government does not challenge. Second, she claims she
was compensated for physical injuries, which claim the Government
does dispute.

Murphy points both to her psychologist's testimony that she had

experienced somatic and body injuries as a result of NYANG's
blacklisting [her], and to the American Heritage Dictionary, which
defines somatic as relating to, or affecting the body, especially as
distinguished from a body part, the mind, or the environment. Murphy
further argues the dental records she submitted to the IRS proved she has
suffered permanent damage to her teeth. Citing Walters v.
Mintec/International, 758 F.2d 73, 78 (3d Cir.1985), and Payne v. Gen.
Motors Corp., 731 F.Supp. 1465, 1474-75 (D.Kan.1990), Murphy
contends that substantial physical problems caused by emotional
distress are considered physical injuries or physical sickness.
Murphy further contends that neither 104 of the IRC nor the regulation
issued thereunder limits the physical disability exclusion to a physical
stimulus. In fact, as Murphy points out, the applicable regulation,
which provides that 104(a)(2) excludes from gross income the
amount of any damages received (whether by suit or agreement) on
account of personal injuries or sickness, 26 C.F.R. 1.104-1(c), does
not distinguish between physical injuries stemming from physical stimuli
and those arising from emotional trauma; rather, it tracks the pre-1996
text of 104(a)(2), which the IRS agrees excluded from gross income
compensation both for physical and for nonphysical injuries.
For its part, the Government argues Murphy's focus upon the word
physical in 104(a)(2) is misplaced; more important is the phrase on
account of. In O'Gilvie v. United States, 519 U.S. 79, 117 S.Ct. 452,
136 L.Ed.2d 454 (1996), the Supreme Court read that phrase to require a
strong[] causal connection, thereby making 104(a)(2) applicable
only to those personal injury lawsuit damages that were awarded by
reason of, or because of, the personal injuries. Id. at 83, 117 S.Ct. 452.
The Court specifically rejected a but-for formulation in favor of a
stronger causal connection. Id. at 82-83, 117 S.Ct. 452. The
Government therefore concludes Murphy must demonstrate she was
awarded damages because of her physical injuries, which the
Government claims she has failed to do.
Indeed, as the Government points out, the ALJ expressly recommended,
and the Board expressly awarded, compensatory damages because of
Murphy's nonphysical injuries. The Board analyzed the ALJ's
recommendation under the headings Compensatory damage for
emotional distress or mental anguish and Compensatory damage award
for injury to professional reputation, and noted such damages

compensate not only for direct pecuniary loss, but also for such harms
as impairment of reputation, personal humiliation, and mental anguish
and suffering. Leveille, 1999 WL 966951 at *2. In describing the ALJ's
proposed award as reasonable, the Board stated Murphy was to receive
$45,000 for mental pain and anguish and $25,000 for injury to
professional reputation. Although Murphy may have suffered from
bruxism or other physical symptoms of stress, the Board focused upon
Murphy's testimony that she experienced severe anxiety attacks,
inability to concentrate, a feeling that she no longer enjoyed anything in
life, and marital conflict and upon her psychologist's testimony about
the substantial effect the negative references had on [Murphy]. Id. at
*3. The Board made no reference to her bruxism, and acknowledged that
[a]ny attempt to set a monetary value on intangible damages such as
mental pain and anguish involves a subjective judgment, id. at *4,
before concluding the ALJ's recommendation was reasonable. The
Government therefore argues there was no direct causal link between
the damages award at issue and [Murphy's] bruxism.
Murphy responds that it is undisputed she suffered both somatic and
emotional injuries, and the ALJ and Board expressly cited to the
portion of her psychologist's testimony establishing that fact. She
contends the Board therefore relied upon her physical injuries in
determining her damages, making those injuries a direct cause of her
award in spite of the Board's labeling the award as one for emotional
distress.
Although the pre-1996 version of 104(a)(2) was at issue in O'Gilvie,
the Court's analysis of the phrase on account of, which phrase was
unchanged by the 1996 Amendments, remains controlling here.
Murphy no doubt suffered from certain physical manifestations of
emotional distress, but the record clearly indicates the Board awarded her
compensation only for mental pain and anguish and for injury to
professional reputation. Id. at *5. Although the Board cited her
psychologist, who had mentioned her physical aliments, in support of
Murphy's description of her mental anguish, we cannot say the Board,
notwithstanding its clear statements to the contrary, actually awarded
damages because of Murphy's bruxism and other physical manifestations
of stress. Id. at *3. At best-and this is doubtful-at best the Board and the
ALJ may have considered her physical injuries indicative of the severity
of the emotional distress for which the damages were awarded, but her
physical injuries themselves were not the reason for the award. The

Board thus having left no room for doubt about the grounds for her
award, we conclude Murphy's damages were not awarded by reason of,
or because of, [physical] personal injuries, O'Gilvie, 519 U.S. at 83,
117 S.Ct. 452. Therefore, 104(a)(2) does not permit Murphy to
exclude her award from gross income. *
C.Section 61 of the IRC
Murphy and the Government agree that for Murphy's award to be
taxable, it must be part of her gross income as defined by 61(a) of
the IRC, which states in relevant part: gross income means all income
from whatever source derived. The Supreme Court has interpreted the
section broadly to extend to all economic gains not otherwise
exempted. Comm'r v. Banks, 543 U.S. 426, 433, 125 S.Ct. 826, 160
L.Ed.2d 859 (2005); see also, e.g., James v. United States, 366 U.S. 213,
219, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961) ( Section 61 encompasses all
accessions to wealth) (internal quotation mark omitted); Comm'r v.
Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 99 L.Ed. 483 (the
Court has given a liberal construction to [gross income] in recognition
of the intention of Congress to tax all gains except those specifically
exempted). Gross income in 61(a) is at least as broad as the
meaning of incomes in the Sixteenth Amendment. * See Glenshaw
Glass, 348 U.S. at 429, 432 n. 11, 75 S.Ct. 473 (quoting H.R.Rep. No.
83-1337, at A18 (1954), reprinted in 1954 U.S.C.C.A.N. 4017, 4155);
Helvering v. Bruun, 309 U.S. 461, 468, 60 S.Ct. 631, 84 L.Ed. 864
(1940).
Murphy argues her award is not a gain or an accession to wealth and
therefore not part of gross income. Noting the Supreme Court has long
recognized the principle that a restoration of capital [i]s not income;
hence it [falls] outside the definition of income upon which the law
impose[s] a tax, O'Gilvie, 519 U.S. at 84, 117 S.Ct. 452; see, e.g.,
Doyle v. Mitchell Bros. Co., 247 U.S. 179, 187-88, 38 S.Ct. 467, 62
L.Ed. 1054 (1918); S. Pac. Co. v. Lowe, 247 U.S. 330, 335, 38 S.Ct.
540, 62 L.Ed. 1142 (1918), Murphy contends a damage award for
personal injuries-including nonphysical injuries-should be viewed as a
return of a particular form of capital-human capital, as it were. See
Gary S. Becker, Human Capital (1st ed.1964); Gary S. Becker, The
Economic Way of Looking at Life, Nobel Lecture (Dec. 9, 1992), in
Nobel Lectures in Economic Sciences 1991-1995, at 43-45 (Torsten
Persson ed., 1997). In her view, the Supreme Court in Glenshaw Glass
acknowledged the relevance of the human capital concept for tax

purposes. There, in holding that punitive damages for personal injury

were gross income under the predecessor to 61, the Court stated:
The long history of holding personal injury recoveries nontaxable on
the theory that they roughly correspond to a return of capital cannot
support exemption of punitive damages following injury to property
Damages for personal injury are by definition compensatory only.
Punitive damages, on the other hand, cannot be considered a restoration
of capital for taxation purposes.
348 U.S. at 432 n. 8, 75 S.Ct. 473. By implication, Murphy argues,
damages for personal injury are a restoration of capital.
As further support, Murphy cites various administrative rulings issued
shortly after passage of the Sixteenth Amendment that concluded
recoveries from personal injuries were not income, such as this 1918
Opinion of the Attorney General:
Without affirming that the human body is in a technical sense the
capital invested in an accident policy, in a broad, natural sense the
proceeds of the policy do but substitute, so far as they go, capital which
is the source of future periodical income. They merely take the place of
capital in human ability which was destroyed by the accident. They are
therefore capital as distinguished from income receipts.
31 Op. Att'y Gen. 304, 308; see T.D. 2747, 20 Treas. Dec. Int. Rev. 457
(1918); Sol. Op. 132, I-1 C.B. 92, 93-94 (1922) ([M]oney received
on account of defamation of personal character does not constitute
income within the meaning of the sixteenth amendment and the statutes
enacted thereunder). She also cites a House Report on the bill that
became the Revenue Act of 1918. H.R.Rep. No. 65-767, at 9-10 (1918)
(Under the present law it is doubtful whether amounts received as
compensation for personal injury are required to be included in gross
income); see also Dotson v. United States, 87 F.3d 682, 685 (5th
Cir.1996) (concluding on basis of House Report that the Congress first
enacted the personal injury compensation exclusion when such
payments were considered the return of human capital, and thus not
constitutionally taxable income under the 16th amendment).
Finally, Murphy argues her interpretation of 61 is reflected in the
common law of tort and the provisions in various environmental statutes
and Title VII of the Civil Rights Act of 1964, all of which provide for
make whole relief. See, e.g., 42 U.S.C. 1981a; 15 U.S.C. 2622.
If a recovery of damages designed to make whole the plaintiff is
taxable, she reasons, then one who receives the award has not been made

whole after tax. Section 61 should not be read to create a conflict

between the tax code and the make whole purpose of the various
statutes.
The Government disputes Murphy's interpretation on all fronts. First,
noting the definition [of gross income in the IRC] extends broadly to all
economic gains, Banks, 543 U.S. at 433, 125 S.Ct. 826, the Government
asserts Murphy undeniably had economic gain because she was better
off financially after receiving the damages award than she was prior to
receiving it. Second, the Government argues that the case law Murphy
cites does not support the proposition that the Congress lacks the power
to tax as income recoveries for personal injuries. In its view, to the
extent the Supreme Court has addressed at all the taxability of
compensatory damages, see, e.g., O'Gilvie, 519 U.S. at 86, 117 S.Ct.
452; Glenshaw Glass, 348 U.S. at 432 n. 8, 75 S.Ct. 473, it was merely
articulating the Congress's rationale at the time for not taxing such
damages, not the Court's own view whether such damages could
constitutionally be taxed.
Third, the Government challenges the relevance of the administrative
rulings Murphy cites from around the time the Sixteenth Amendment
was ratified; Treasury decisions dating from even closer to the time of
ratification treated damages received on account of personal injury as
income. See T.D. 2135, 17 Treas. Dec. Int. Rev. 39, 42 (1915); T.D.
2690, Reg. No. 33 (Rev.), art. 4, 20 Treas. Dec. Int. Rev. 126, 130 (1918).
Furthermore, administrative rulings from the time suggest that, even if
recoveries for physical personal injuries were not considered part of
income, recoveries for nonphysical personal injuries were. See Sol.
Mem. 957, 1 C.B. 65 (1919) (damages for libel subject to income tax);
Sol. Mem. 1384, 2 C.B. 71 (1920) (recovery of damages from alienation
of wife's affections not regarded as return of capital, hence taxable).
Although the Treasury changed its position in 1922, see Sol. Op. 132, I-1
C.B. at 93-94, it did so only after the Supreme Court's decision in Eisner
v. Macomber, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521 (1920), which
the Court later viewed as having established a definition of income that
served a useful purpose [but] was not meant to provide a touchstone to
all future gross income questions. Glenshaw Glass, 348 U.S. at 43031, 75 S.Ct. 473. As for Murphy's contention that reading 61 to
include her damages would be in tension with the common law and
various statutes providing for make whole relief, the Government

denies there is any tension and suggests Murphy is trying to turn a

disagreement over tax policy into a constitutional issue.
Finally, the Government argues that even if the concept of human capital
is built into 61, Murphy's award is nonetheless taxable because
Murphy has no tax basis in her human capital. Under the IRC, a
taxpayer's gain upon the disposition of property is the difference between
the amount realized from the disposition and his basis in the property,
26 U.S.C. 1001, defined as the cost of such property, id. 1012,
adjusted for expenditures, receipts, losses, or other items, properly
chargeable to [a] capital account, id. 1016(a)(1). The Government
asserts, The Code does not allow individuals to claim a basis in their
human capital; accordingly, Murphy's gain is the full value of the
award. See Roemer v. Comm'r, 716 F.2d 693, 696 n. 2 (9th Cir.1983)
(Since there is no tax basis in a person's health and other personal
interests, money received as compensation for an injury to those interests
might be considered a realized accession to wealth) (dictum).
Although Murphy and the Government focus primarily upon whether
Murphy's award falls within the definition of income first used in
Glenshaw Glass,* coming within that definition is not the only way in
which 61(a) could be held to encompass her award. Principles of
statutory interpretation could show 61(a) includes Murphy's award in
her gross income regardless whether it was an accession to wealth, as
Glenshaw Glass requires. For example, if 61(a) were amended
specifically to include in gross income $100,000 in addition to all other
gross income, then that additional sum would be a part of gross income
under 61 even though no actual gain was associated with it. In other
words, although the Congress cannot make a thing income which is not
so in fact, Burk-Waggoner Oil Ass'n v. Hopkins, 269 U.S. 110, 114, 46
S.Ct. 48, 70 L.Ed. 183 (1925), it can label a thing income and tax it, so
long as it acts within its constitutional authority, which includes not only
the Sixteenth Amendment but also Article I, Sections 8 and 9. See Penn
Mut. Indem. Co. v. Comm'r, 277 F.2d 16, 20 (3d Cir.1960) (Congress
has the power to impose taxes generally, and if the particular imposition
does not run afoul of any constitutional restrictions then the tax is lawful,
call it what you will) (footnote omitted). Accordingly, rather than ask
whether Murphy's award was an accession to her wealth, we go to the
heart of the matter, which is whether her award is properly included
within the definition of gross income in 61(a), to wit, all income from
whatever source derived.

Looking at 61(a) by itself, one sees no indication that it covers

Murphy's award unless the award is income as defined by Glenshaw
Glass and later cases. Damages received for emotional distress are not
listed among the examples of income in 61 and, as Murphy points out,
an ambiguity in the meaning of a revenue-raising statute should be
resolved in favor of the taxpayer. See, e.g., Hassett v. Welch, 303 U.S.
303, 314, 58 S.Ct. 559, 82 L.Ed. 858 (1938); Gould v. Gould, 245 U.S.
151, 153, 38 S.Ct. 53, 62 L.Ed. 211 (1917); see also United Dominion
Indus., Inc. v. United States, 532 U.S. 822, 839, 121 S.Ct. 1934, 150
L.Ed.2d 45 (2001) (Thomas, J., concurring); id. at 839 n. 1, 121 S.Ct.
1934 (Stevens, J., dissenting); 3A Norman J. Singer, Sutherland Statutes
& Statutory Construction 66:1 (6th ed.2003). A statute is to be read
as a whole, however, see, e.g., Alaska Dep't of Envtl. Conservation v.
EPA, 540 U.S. 461, 489 n. 13, 124 S.Ct. 983, 157 L.Ed.2d 967 (2004),
and reading 61 in combination with 104(a)(2) of the Internal
Revenue Code presents a very different picture-a picture so clear that we
have no occasion to apply the canon favoring the interpretation of
ambiguous revenue-raising statutes in favor of the taxpayer.
As noted above, in 1996 the Congress amended 104(a) to narrow
the exclusion to amounts received on account of personal physical
injuries or physical sickness from personal injuries or sickness, and
explicitly to provide that emotional distress shall not be treated as a
physical injury or physical sickness, thus making clear that an award
received on account of emotional distress is not excluded from gross
income under 104(a)(2). Small Business Job Protection Act of 1996,
Pub.L. 104-188, 1605, 110 Stat. 1755, 1838. As this amendment,
which narrows the exclusion, would have no effect whatsoever if such
damages were not included within the ambit of 61, and as we must
presume that [w]hen Congress acts to amend a statute, it intends its
amendment to have real and substantial effect, Stone v. INS, 514 U.S.
386, 397, 115 S.Ct. 1537, 131 L.Ed.2d 465 (1995), the 1996 amendment
of 104(a) strongly suggests 61 should be read to include an award
for damages from nonphysical harms. * Although it is unclear whether
61 covered such an award before 1996, we need not address that
question here; even if the provision did not do so prior to 1996, the
presumption indicates the Congress implicitly amended 61 to cover
such an award when it amended 104(a).
We realize, of course, that amendments by implication, like repeals by
implication, are disfavored. United States v. Welden, 377 U.S. 95, 103

n. 12, 84 S.Ct. 1082, 12 L.Ed.2d 152 (1964); Cheney R.R. Co. v. R.R.
Ret. Bd., 50 F.3d 1071, 1078 (D.C.Cir.1995). The Supreme Court has
also noted, however, that the classic judicial task of reconciling many
laws enacted over time, and getting them to make sense in combination,
necessarily assumes that the implications of a statute may be altered by
the implications of a later statute. United States v. Fausto, 484 U.S.
439, 453, 108 S.Ct. 668, 98 L.Ed.2d 830 (1988); see also FDA v. Brown
& Williamson Tobacco Corp., 529 U.S. 120, 133, 120 S.Ct. 1291, 146
L.Ed.2d 121 (2000) ([T]he meaning of one statute may be affected by
other Acts, particularly where Congress has spoken subsequently and
more specifically to the topic at hand); Almendarez-Torres v. United
States, 523 U.S. 224, 237, 118 S.Ct. 1219, 140 L.Ed.2d 350 (1998)
(suggesting later enacted laws depend[ing] for their effectiveness upon
clarification, or a change in the meaning of an earlier statute provide a
forward looking legislative mandate, guidance, or direct suggestion
about how courts should interpret the earlier provisions); cf. Franklin v.
Gwinnett County Pub. Sch., 503 U.S. 60, 72-73, 112 S.Ct. 1028, 117
L.Ed.2d 208 (1992) (amendment of Title IX abrogating States' Eleventh
Amendment immunity validated Court's prior holding that Title IX
created implied right of action); id. at 78, 112 S.Ct. 1028 (Scalia, J.,
concurring in judgment) (amendment to Title IX was an implicit
acknowledgment that damages are available).
This classic judicial task is before us now. For the 1996 amendment
of 104(a) to make sense, gross income in 61(a) must, and we
therefore hold it does, include an award for nonphysical damages such as
Murphy received, regardless whether the award is an accession to wealth.
Cf. Vermont Agency of Natural Res. v. United States ex rel. Stevens,
529 U.S. 765, 786 & n. 17, 120 S.Ct. 1858, 146 L.Ed.2d 836 (2000)
(determining meaning of person in False Claims Act, which was
originally enacted in 1863, based in part upon definition of person in
Program Fraud Civil Remedies Act of 1986, which was designed to
operate in tandem with the [earlier Act]).
D.The Congress's Power to Tax
The taxing power of the Congress is established by Article I, Section 8 of
the Constitution: The Congress shall have power to lay and collect
taxes, duties, imposts and excises. There are two limitations on this
power. First, as the same section goes on to provide, all duties,
imposts and excises shall be uniform throughout the United States.
Second, as provided in Section 9 of that same Article, No capitation, or

other direct, tax shall be laid, unless in proportion to the census or

enumeration herein before directed to be taken. See also U.S. Const.
art. I, 2, cl. 3 (direct taxes shall be apportioned among the several
states which may be included within this union, according to their
respective numbers).* We now consider whether the tax laid upon
Murphy's award violates either of these two constraints.
1.A Direct Tax?
Over the years, courts have considered numerous claims that one or
another nonapportioned tax is a direct tax and therefore unconstitutional.
Although these cases have not definitively marked the boundary
between taxes that must be apportioned and taxes that need not be, see
Bromley v. McCaughn, 280 U.S. 124, 136, 50 S.Ct. 46, 74 L.Ed. 226
(1929); Spreckels Sugar Ref. Co. v. McClain, 192 U.S. 397, 413, 24
S.Ct. 376, 48 L.Ed. 496 (1904) (dividing line between taxes that are
direct and those which are to be regarded simply as excises is often
very difficult to be expressed in words), some characteristics of each
may be discerned.
Only three taxes are definitely known to be direct: (1) a capitation, U.S.
Const. art. I, 9, (2) a tax upon real property, and (3) a tax upon
personal property. See Fernandez v. Wiener, 326 U.S. 340, 352, 66
S.Ct. 178, 90 L.Ed. 116 (1945) (Congress may tax real estate or chattels
if the tax is apportioned); Pollock v. Farmers' Loan & Trust Co., 158
U.S. 601, 637, 15 S.Ct. 912, 39 L.Ed. 1108 (1895) (Pollock II). ** Such
direct taxes are laid upon one's general ownership of property,
Bromley, 280 U.S. at 136, 50 S.Ct. 46; see also Flint v. Stone Tracy Co.,
220 U.S. 107, 149, 31 S.Ct. 342, 55 L.Ed. 389 (1911), as contrasted with
excise taxes laid upon a particular use or enjoyment of property or the
shifting from one to another of any power or privilege incidental to the
ownership or enjoyment of property. Fernandez, 326 U.S. at 352, 66
S.Ct. 178; see also Thomas v. United States, 192 U.S. 363, 370, 24 S.Ct.
305, 48 L.Ed. 481 (1904) (excises cover duties imposed on importation,
consumption, manufacture and sale of certain commodities, privileges,
particular business transactions, vocations, occupations and the like).
More specifically, excise taxes include, in addition to taxes upon
consumable items, see Patton v. Brady, 184 U.S. 608, 617-18, 22 S.Ct.
493, 46 L.Ed. 713 (1902), taxes upon the sale of grain on an exchange,
Nicol v. Ames, 173 U.S. 509, 519, 19 S.Ct. 522, 43 L.Ed. 786 (1899), the
sale of corporate stock, Thomas, 192 U.S. at 371, 24 S.Ct. 305, doing
business in corporate form, Flint, 220 U.S. at 151, 31 S.Ct. 342, gross

receipts from the business of refining sugar, Spreckels, 192 U.S. at

411, 24 S.Ct. 376, the transfer of property at death, Knowlton v. Moore,
178 U.S. 41, 81-82, 20 S.Ct. 747, 44 L.Ed. 969 (1900), gifts, Bromley,
280 U.S. at 138, 50 S.Ct. 46, and income from employment, see Pollock
v. Farmers' Loan & Trust Co., 157 U.S. 429, 579, 15 S.Ct. 673, 39 L.Ed.
759 (1895) ( Pollock I) (citing Springer v. United States, 102 U.S. 586,
26 L.Ed. 253 (1881)).
Murphy and the amici supporting her argue the dividing line between
direct and indirect taxes is based upon the ultimate incidence of the tax;
if the tax cannot be shifted to someone else, as a capitation cannot, then it
is a direct tax; but if the burden can be passed along through a higher
price, as a sales tax upon a consumable good can be, then the tax is
indirect. This, she argues, was the distinction drawn when the
Constitution was ratified. See Albert Gallatin, A Sketch of the Finances
of the United States (1796), reprinted in 3 The Writings of Albert
Gallatin 74-75 (Henry Adams ed., Philadelphia, J.P. Lippincott & Co.
1879) (The most generally received opinion is, that by direct taxes
those are meant which are raised on the capital or revenue of the
people; by indirect, such as are raised on their expense); The Federalist
No. 36, at 225 (Alexander Hamilton) (Jacob E. Cooke ed., 1961)
(internal taxes[] may be subdivided into those of the direct and those of
the indirect kind by which must be understood duties and excises on
articles of consumption). But see Gallatin, supra, at 74 ([Direct tax]
is used, by different writers, and even by the same writers, in different
parts of their writings, in a variety of senses, according to that view of
the subject they were taking); Edwin R.A. Seligman, The Income Tax
540 (photo. reprint 1970) (2d ed.1914) (there are almost as many
classifications of direct and indirect taxes are there are authors).
Moreover, the amici argue, this understanding of the distinction explains
the different restrictions imposed respectively upon the power of the
Congress to tax directly (apportionment) and via excise (uniformity).
Duties, imposts, and excise taxes, which were expected to constitute the
bulk of the new federal government's revenue, see Erik M. Jensen, The
Apportionment of Direct Taxes: Are Consumption Taxes
Constitutional?, 97 Colum. L.Rev. 2334, 2382 (1997), have a built-in
safeguard against oppressively high rates: Higher taxes result in higher
prices and therefore fewer sales and ultimately lower tax revenues. See
The Federalist No. 21, supra, at 134-35 (Alexander Hamilton). Taxes
that cannot be shifted, in contrast, lack this self-regulating feature, and

were therefore constrained by the more stringent requirement of

apportionment. See id. at 135 (In a branch of taxation where no limits
to the discretion of the government are to be found in the nature of
things, the establishment of a fixed rule may be attended with fewer
inconveniences than to leave that discretion altogether at large); see
also Jensen, supra, at 2382-84.
Finally, the amici contend their understanding of a direct tax was
confirmed in Pollock II, where the Supreme Court noted that the words
duties, imposts, and excises' are put in antithesis to direct taxes, 158
U.S. at 622, 15 S.Ct. 912, for which it cited The Federalist No. 36
(Hamilton). Pollock II, 158 U.S. at 624-25, 15 S.Ct. 912. As it is
clear that Murphy cannot shift her tax burden to anyone else, per Murphy
and the amici, it must be a direct tax.
The Government, unsurprisingly, backs a different approach; by its
lights, only taxes that are capable of apportionment in the first instance,
specifically, capitation taxes and taxes on land, are direct taxes. The
Government maintains that this is how the term was generally
understood at the time. See Calvin H. Johnson, Fixing the
Constitutional Absurdity of the Apportionment of Direct Tax, 21 Const.
Comm. 295, 314 (2004). Moreover, it suggests, this understanding is
more in line with the underlying purpose of the tax and the
apportionment clauses, which were drafted in the intense light of
experience under the Articles of Confederation.
The Articles did not grant the Continental Congress the power to raise
revenue directly; it could only requisition funds from the States. See
Articles of Confederation art. VIII (1781); Bruce Ackerman, Taxation
and the Constitution, 99 Colum. L.Rev. 1, 6-7 (1999). This led to
problems when the States, as they often did, refused to remit funds. See
Calvin H. Johnson, The Constitutional Meaning of Apportionment of
Direct Taxes, 80 Tax Notes 591, 593-94 (1998). The Constitution
redressed this problem by giving the new national government plenary
taxing power. See Ackerman, supra, at 7. In the Government's view, it
therefore makes no sense to treat direct taxes as encompassing taxes
for which apportionment is effectively impossible, because the Framers
could not have intended to give Congress plenary taxing power, on the
one hand, and then so limit that power by requiring apportionment for a
broad category of taxes, on the other. This view is, according to the
Government, buttressed by evidence that the purpose of the
apportionment clauses was not in fact to constrain the power to tax, but

rather to placate opponents of the compromise over representation of the

slave states in the House, as embodied in the Three-fifths Clause. * See
Ackerman, supra, at 10-11. See generally Seligman, supra, at 548-55.
As the Government interprets the historical record, the apportionment
limitation was more symbolic than anything else: it appeased the antislavery sentiment of the North and offered a practical advantage to the
South as long as the scope of direct taxes was limited. See Ackerman,
supra, at 10. But see Erik M. Jensen, Taxation and the Constitution:
How to Read the Direct Tax Clauses, 15 J.L. & Pol. 687, 704 (1999)
(One of the reasons [the direct tax restriction] worked as a compromise
was that it had teeth-it made direct taxes difficult to impose-and it had
teeth however slaves were counted).
The Government's view of the clauses is further supported by the near
contemporaneous decision of the Supreme Court in Hylton v. United
States, 3 U.S. (3 Dall.) 171, 1 L.Ed. 556 (1796), holding that a national
tax upon carriages was not a direct tax, and thus not subject to
apportionment. Justices Chase and Iredell opined that a direct tax
was one that, unlike the carriage tax, as a practical matter could be
apportioned among the States, id. at 174 (Chase, J.); id. at 181 (Iredell,
J.), while Justice Paterson, noting the connection between apportionment
and slavery, condemned apportionment as radically wrong and not to
be extended by construction, id. at 177-78. * As for Murphy's reliance
upon Pollock II, the Government contends that although it has never
been overruled, every aspect of its reasoning has been eroded, see, e.g.,
Stanton v. Baltic Mining Co., 240 U.S. 103, 112-13, 36 S.Ct. 278, 60
L.Ed. 546 (1916), and notes that in Pollock II itself the Court
acknowledged that taxation on business, privileges, or employments has
assumed the guise of an excise tax, 158 U.S. at 635, 15 S.Ct. 912.
Pollock II, in the Government's view, is therefore too weak a reed to
support Murphy's broad definition of direct tax and certainly does not
make a tax on the conversion of human capital into money
problematic.
Murphy replies that the Government's historical analysis does not
respond to the contemporaneous sources she and the amici identified
showing that taxes imposed upon individuals are direct taxes. As for
Hylton, Murphy argues nothing in that decision precludes her position;
the Justices viewed the carriage tax there at issue as a tax upon an
expense, see 3 U.S. (3 Dall.) at 175 (Chase, J.); see also id. at 180-81
(Paterson, J.), which she agrees is not a direct tax. See Pollock II, 158

U.S. at 626-27, 15 S.Ct. 912. To the extent Hylton is inconsistent with

her position, however, Murphy contends her references to the Federalist
are more authoritative evidence of the Framers' understanding of the
term.
Murphy makes no attempt to reconcile her definition with the long line
of cases identifying various taxes as excise taxes, although several of
them seem to refute her position directly. In particular, we do not see
how a known excise, such as the estate tax, see, e.g., New York Trust Co.
v. Eisner, 256 U.S. 345, 349, 41 S.Ct. 506, 65 L.Ed. 963 (1921);
Knowlton, 178 U.S. at 81-83, 20 S.Ct. 747, or a tax upon income from
employment, see Pollock II, 158 U.S. at 635, 15 S.Ct. 912; Pollock I,
157 U.S. at 579, 15 S.Ct. 673; cf. Steward Mach. Co. v. Davis, 301 U.S.
548, 580-81, 57 S.Ct. 883, 81 L.Ed. 1279 (1937) (tax upon employers
based upon wages paid to employees is an excise), can be shifted to
another person, absent which they seem to be in irreconcilable conflict
with her position that a tax that cannot be shifted to someone else is a
direct tax. Though it could be argued that the incidence of an estate tax
is inevitably shifted to the beneficiaries, we see at work none of the
restraint upon excessive taxation that Murphy claims such shifting is
supposed to provide; the tax is triggered by an event, death, that cannot
be shifted or avoided. In any event, Knowlton addressed the argument
that Pollock I and II made ability to shift the hallmark of a direct tax, and
rejected it. 178 U.S. at 81-82, 20 S.Ct. 747. Regardless what the
original understanding may have been, therefore, we are bound to follow
the Supreme Court, which has strongly intimated that Murphy's position
is not the law.
That said, neither need we adopt the Government's position that direct
taxes are only those capable of satisfying the constraint of
apportionment. In the abstract, such a constraint is no constraint at all;
virtually any tax may be apportioned by establishing different rates in
different states. See Pollock II, 158 U.S. at 632-33, 15 S.Ct. 912. If
the Government's position is instead that by capable of apportionment
it means capable of apportionment in a manner that does not unfairly
tax some individuals more than others, then it is difficult to see how a
land tax, which is widely understood to be a direct tax, could be
apportioned by population without similarly imposing significantly nonuniform rates. See Hylton, 3 U.S. (3 Dall.) at 178-79 (Paterson, J.);
Johnson, Constitutional Absurdity, supra, at 328. But see, e.g., Hylton,

3 U.S. (3 Dall.) at 183 (Iredell, J.) (contending land tax is capable of

apportionment).
We find it more appropriate to analyze this case based upon the
precedents and therefore to ask whether the tax laid upon Murphy's
award is more akin, on the one hand, to a capitation or a tax upon one's
ownership of property, or, on the other hand, more like a tax upon a use
of property, a privilege, an activity, or a transaction, see Thomas, 192
U.S. at 370, 24 S.Ct. 305. Even if we assume one's human capital
should be treated as personal property, it does not appear that this tax is
upon ownership; rather, as the Government points out, Murphy is taxed
only after she receives a compensatory award, which makes the tax seem
to be laid upon a transaction. See Tyler v. United States, 281 U.S. 497,
502, 50 S.Ct. 356, 74 L.Ed. 991 (1930) (A tax laid upon the happening
of an event, as distinguished from its tangible fruits, is an indirect tax
which Congress, in respect of some events undoubtedly may
impose); Simmons v. United States, 308 F.2d 160, 166 (4th Cir.1962)
(tax upon receipt of money is not a direct tax); cf. Penn Mut., 277 F.2d at
20. Murphy's situation seems akin to an involuntary conversion of
assets; she was forced to surrender some part of her mental health and
reputation in return for monetary damages. Cf. 26 U.S.C. 1033
(property involuntarily converted into money is taxed to extent of gain
recognized).
At oral argument Murphy resisted this formulation on the ground that the
receipt of an award in lieu of lost mental health or reputation is not a
transaction. This view is tenable, however, only if one decouples
Murphy's injury (emotional distress and lost reputation) from her
monetary award, but that is not beneficial to Murphy's cause, for then
Murphy has nothing to offset the obvious accession to her wealth, which
is taxable as income. Murphy also suggested at oral argument that there
was no transaction because she did not profit. Whether she profited is
irrelevant, however, to whether a tax upon an award of damages is a
direct tax requiring apportionment; profit is relevant only to whether, if
it is a direct tax, it nevertheless need not be apportioned because the
object of the tax is income within the meaning of the Sixteenth
Amendment. Cf. Spreckels, 192 U.S. at 412-13, 24 S.Ct. 376 (tax upon
gross receipts associated with business of refining sugar not a direct tax);
Penn Mut., 277 F.2d at 20 (tax upon gross receipts deemed valid indirect
tax despite taxpayer's net loss).

So we return to the question: Is a tax upon this particular kind of

transaction equivalent to a tax upon a person or his property? Cf.
Bromley, 280 U.S. at 138, 50 S.Ct. 46 (assuming without deciding that a
tax levied upon all the uses to which property may be put, or upon the
exercise of a single power indispensable to the enjoyment of all others
over it, would be in effect a tax upon property). Murphy did not
receive her damages pursuant to a business activity, cf. Flint, 220 U.S. at
151, 31 S.Ct. 342; Spreckels, 192 U.S. at 411, 24 S.Ct. 376, and we
therefore do not view this tax as an excise under that theory. See
Stratton's Independence, Ltd. v. Howbert, 231 U.S. 399, 414-15, 34 S.Ct.
136, 58 L.Ed. 285 (1913) (The sale outright of a mining property might
be fairly described as a mere conversion of the capital from land into
money). On the other hand, as noted above, the Supreme Court
several times has held a tax not related to business activity is nonetheless
an excise. And the tax at issue here is similar to those.
Bromley, in which a gift tax was deemed an excise, is particularly
instructive: The Court noted it was a tax laid only upon the exercise of
a single one of those powers incident to ownership, 280 U.S. at 136, 50
S.Ct. 46, which distinguished it from a tax which falls upon the owner
merely because he is owner, regardless of the use or disposition made of
his property, id. at 137, 50 S.Ct. 46. A gift is the functional equivalent
of a below-market sale; it therefore stands to reason that if, as Bromley
holds, a gift tax, or a tax upon a below-market sale, is a tax laid not upon
ownership but upon the exercise of a power incident to ownership,
then a tax upon the sale of property at fair market value is similarly laid
upon an incidental power and not upon ownership, and hence is an
excise. Therefore, even if we were to accept Murphy's argument that
the human capital concept is reflected in the Sixteenth Amendment, a tax
upon the involuntary conversion of that capital would still be an excise
and not subject to the requirement of apportionment. But see Nicol,
173 U.S. at 521, 19 S.Ct. 522 (indicating pre-Bromley that tax upon
every sale made in any place is really and practically upon
property).
In any event, even if a tax upon the sale of property is a direct tax upon
the property itself, we do not believe Murphy's situation involves a tax
upon the sale itself, considered separate and apart from the place and
the circumstances of the sale. Id. at 520, 19 S.Ct. 522. Instead, as in
Nicol, this tax is more akin to a duty upon the facilities made use of and
actually employed in the transaction. Id. at 519, 19 S.Ct. 522. To be

sure, the facility used in Nicol was a commodities exchange whereas the
facility used by Murphy was the legal system, but that hardly seems a
significant distinction. The tax may be laid upon the proceeds received
when one vindicates a statutory right, but the right is nonetheless a
creature of law, which Knowlton identifies as a privilege taxable by
excise. 178 U.S. at 55, 20 S.Ct. 747 (right to take property by
inheritance is granted by law and therefore taxable as upon a privilege);
*
cf. Steward, 301 U.S. at 580-81, 57 S.Ct. 883 ([N]atural rights, so
called, are as much subject to taxation as rights of less importance. An
excise is not limited to vocations or activities that may be prohibited
altogether It extends to vocations or activities pursued as of common
right.) (footnote omitted).
2.Uniformity
The Congress may not implement an excise tax that is not uniform
throughout the United States. U.S. Const. art. I, 8, cl. 1. A tax is
uniform when it operates with the same force and effect in every place
where the subject of it is found. United States v. Ptasynski, 462 U.S.

74, 82, 103 S.Ct. 2239, 76 L.Ed.2d 427 (1983) (internal quotation marks
omitted); see also Knowlton, 178 U.S. at 84-86, 106, 20 S.Ct. 747. The
tax laid upon an award of damages for a nonphysical personal injury
operates with the same force and effect throughout the United States
and therefore satisfies the requirement of uniformity.
III.Conclusion
For the foregoing reasons, we conclude (1) Murphy's compensatory
award was not received on account of personal physical injuries, and
therefore is not exempt from taxation pursuant to 104(a)(2) of the IRC;
(2) the award is part of her gross income, as defined by 61 of the
IRC; and (3) the tax upon the award is an excise and not a direct tax
subject to the apportionment requirement of Article I, Section 9 of the
Constitution. The tax is uniform throughout the United States and
therefore passes constitutional muster. The judgment of the district
court is accordingly
Affirmed.