NON-IMPAIRMENT CLAUSE

SMART COMMUNICATIONS, INC., v. THE CITY OF DAVAO

G.R. NO. 155491; September 16, 2008
NACHURA, J.:

On February 18, 2002, Smart filed a special civil action for declaratory relief for the
ascertainment of its rights and obligations under the Tax Code of the City of Davao, particularly
Section 1, Article 10 which reads:

Notwithstanding any exemption granted by any law or other special law, there is
hereby imposed a tax on businesses enjoying a franchise, at a rate of seventy-five percent
(75%) of one percent (1%) of the gross annual receipts for the preceding calendar year
based on the income or receipts realized within the territorial jurisdiction of Davao City.

Smart contends that its telecenter in Davao City is exempt from payment of franchise tax
on the following grounds: (a) the issuance of its franchise under R.A. No. 7294 subsequent to
R.A. No. 7160 shows the clear legislative intent to exempt it from the provisions of R.A. 7160;
(b) Section 137 of R.A. No. 7160 can only apply to exemptions already existing at the time of its
effectivity and not to future exemptions; (c) the power of the City of Davao to impose a franchise
tax is subject to statutory limitations such as the "in lieu of all taxes" clause found in Section 9 of
R.A. No. 7294; and (d) the imposition of franchise tax by the City of Davao would amount to a
violation of the constitutional provision against impairment of contracts.

Respondents invoked the power granted by the Constitution to local government units to
create their own sources of revenue.

On the issue of violation of the non-impairment clause, the trial court cited Mactan Cebu
International Airport Authority v. Marcos, and declared that the citys power to tax is based not
merely on a valid delegation of legislative power but on the direct authority granted to it by the
fundamental law. It added that while such power may be subject to restrictions or conditions
imposed by Congress, any such legislated limitation must be consistent with the basic policy of
local autonomy.

Issue: WON the issuance of franchise tax violates the non-impairment clause of the
constitution?

HELD:

NO. The franchise of Smart does not expressly provide for exemption from local taxes.
Absent the express provision on such exemption under the franchise, we are constrained to rule
against it. The "in lieu of all taxes" clause in Section 9 of R.A. No. 7294 leaves much room for
interpretation. Due to this ambiguity in the law, the doubt must be resolved against the grant of
tax exemption.

Smarts franchise was granted with the express condition that it is subject to amendment,
alteration, or repeal. As held in Tolentino v. Secretary of Finance:

It is enough to say that the parties to a contract cannot, through the exercise of prophetic
discernment, fetter the exercise of the taxing power of the State. For not only are existing laws
read into contracts in order to fix obligations as between parties, but the reservation of essential
attributes of sovereign power is also read into contracts as a basic postulate of the legal order.
The policy of protecting contracts against impairment presupposes the maintenance of a
government which retains adequate authority to secure the peace and good order of society.

In truth, the Contract Clause has never been thought as a limitation on the exercise of the
States power of taxation save only where a tax exemption has been granted for a valid
consideration.

The Rules as applied to passive Income: Dividends

COMMISSIONER OF INTERNAL REVENUE vs. THE COURT OF APPEALS, COURT

OF TAX APPEALS and A. SORIANO CORP
G.R. No. 108576 January 20, 1999

MARTINEZ, J.:

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. In 1937, Don Andres subscribed to
4,963 shares of the 5,000 shares originally issued.

ANSCOR's 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. This increased his subscription to
14,963 common shares. Don Andres then transferred 1,250 shares each to his two sons, Jose and
Andres, Jr., as their initial investments in ANSCOR.

ANSCOR declared stock dividends in 1947. Other stock dividend declarations were
made between 1949 and December 20, 1963. On December 30, 1964 Don Andres died. Records
revealed that he has total shareholdings of 185,154 shares 50,495 of which are original issues
and 134.659 shares as stock dividend declarations. One-half of those shareholdings or 92,577
shares were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half
formed part of his estate.

A day after Don Andres died, ANSCOR increased its capital stock to P20M and in 1966
further increased it to P30M. In the same year, stock dividends worth 46,290 and 46,287 shares
were respectively received by the Don Andres estate and Doa Carmen from ANSCOR,
increasing their accumulated shareholdings to 138,867 and 138,864.

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 under Section 367 of the 1954 U.S. Revenue Act.
ANSCOR then reclassified its existing 300,000 common shares into 150,000 common and
150,000 preferred shares.

The IRS opined that the exchange is only a recapitalization scheme and not tax
avoidance. Consequently, 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
common shares to 127,727.

Pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the
Don Andres' estate. The Board further increased ANSCOR's capital stock to P75M divided into
150,000 preferred shares and 600,000 common shares. A year later, ANSCOR redeemed 80,000
common shares from the Don Andres' estate, further reducing its common shareholdings to
19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both redemptions of
stocks is to partially retire said stocks as treasury shares in order to reduce the company's foreign
exchange remittances in case cash dividends are declared.

In 1973, after examining ANSCOR's 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, for the year 1968 and the second
quarter of 1969 based on the transactions of exchange 31 and redemption of stocks. The BIR
made the corresponding assessments despite the claim of ANSCOR that it availed of the tax
amnesty under P.D. 23 which were amended by P.D.'s 67 and 157.

ISSUE:

Whether or not ANSCOR's 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 taxable?

RULING:
 Profits derived from the capital invested cannot escape income tax. 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 stockholder's separate property. 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.

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 are
essentially considered equivalent to a distribution of taxable dividends.

A "taxable dividend" is part of the entire income subject to tax under Section 22 in
relation to Section 21 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 reclassification by ANSCOR of its shares into common and preferred resulted to no
change in the proportional interest after the exchange. There was no cash flow. 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. Preferred stocks are those which entitle the shareholder to some priority
on dividends and asset distribution. In this case, the exchange of shares, without more, produces
no realized income to the subscriber. There is only a modification of the subscriber's 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.

ANSCOR's redemption of 82,752.5 stock dividends is considered as essentially

equivalent to a distribution of taxable dividends for which it is liable for the withholding tax-at-
source.

If the property sold is an ordinary property

COMMISSIONER OF INTERNAL REVENUE vs. UNITED COCONUT PLANTERS

BANK

G.R. No. 179063; October 23, 2009

ABAD, J.:

FACTS:

United Coconut Planters Bank (UCPB) granted P68,840,000.00 and P335,000,000.00

loans to George C. Co, Go Tong Electrical Supply Co., Inc., and Tesco Realty Co. to be secured
by several real estate mortgages. When the latter later failed to pay, UCPB filed a petition for
extrajudicial foreclosure. Public auction sale was then held to which the UCPB won the bid.

The notary public submitted the Certificate of Sale to the Executive Judge of RTC for his
approval but the judge returned it with instruction to the notary public to explain an
inconsistency in the tax declaration of one mortgaged property. The judge further ordered to
show proof of payment of the Sheriffs percentage of the bid price. The notary public complied
and the judge approved on March 1, 2002.

On June 18, 2002 UCPB presented the certificate of sale to the Register of Deeds of
Manila for annotation on the transfer certificates of title of the foreclosed properties. The bank
paid creditable withholding taxes (CWT) of P28,640,700.00 and documentary stamp taxes (DST)
of P7,160,165. It then submitted an affidavit of consolidation of ownership to the BIR with proof
of tax payments and other documents in support of the banks application for a tax clearance
certificate and certificate authorizing registration.

CIR, however, charged UCPB with late payment of DST and CWT, citing Section 2.58 of
Revenue Regulation 2-98, which stated that the CWT must be paid within 10 days after the end
of each month, and Section 5 of Revenue Regulation 06-01, which required payment of DST
within five days after the close of the month when the taxable document was made, signed,
accepted or transferred. These taxes accrued upon the lapse of the redemption period of the
mortgaged properties. The CIR pointed out that the mortgagor, a juridical person, had three
months after foreclosure within which to redeem the properties.

The CIR alleged that the three-month redemption period was to be counted from the date
of the foreclosure sale - from December 31, 2001 or on March 31, 2002. UCPB paid only on July
5, 2002. CIR then issued a Pre-Assessment Notice and, subsequently, a Final Assessment Notice
to UCPB for deficiency CWT of P8,617,210.00 and deficiency DST of P2,173,051.75.

UCPB protested claiming that the redemption period lapsed on June 1, 2002 or three
months after the executive judge of Manila approved the issuance of the certificate of sale under
Section 47 of the General Banking Law. CIR denied the protest, prompting UCPB to file a
petition for review with the CTA.

CTA set aside the decision of the CIR and held that the redemption period lapsed three
months after the executive judge approved the certificate of sale. "Foreclosure" under the law
referred to the whole process of foreclosure which included the approval and issuance of the
certificate of sale. On appeal to the CTA En Banc in affirmed the decision.

Issue: Whether or not the three-month redemption period for juridical persons should be
reckoned from the date of the auction sale.
Ruling:

If the property is an ordinary asset of the mortgagor, the creditable expanded withholding
tax shall be due and paid within ten (10) days following the end of the month in which the
redemption period expires. Moreover, the payment of the documentary stamp tax and the filing
of the return thereof shall have to be made within five (5) days from the end of the month when
the redemption period expires.

UCPB had until July 10, 2002 to pay the CWT and July 5, 2002 to pay the DST. Since it
paid both taxes on July 5, 2002, it is not liable for deficiencies. Thus, the Court finds no reason to
reverse the decision of the CTA. For purposes of reckoning the one-year redemption period in
the case of individual mortgagors, or the three-month redemption period for juridical
persons/mortgagors, the same shall be reckoned from the date of the confirmation of the auction
sale which is the date when the certificate of sale is issued.