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THE MANILA WINE MERCHANTS, INC. vs.

THE COMMISSIONER OF
INTERNAL REVENUE

Facts:

The Commissioner of Internal Revenue found the Manila Wine


Merchants, Inc. of having unreasonably accumulated surplus of
P428,934.32 for the calendar year 1947 to 1957, in excess of the
reasonable needs of the business subject to the 25% surtax imposed by
Section 25 of the Tax Code.
Thus, the CIR demanded upon the petitioner payment of
P126,536.12 as 25% surtax and interest on the latter's unreasonable
accumulation of profits and surplus for the year 1957. Respondent
found that the accumulated surplus in question were invested to 'unrelated
business' which were not considered in the 'immediate needs' of the
Company such that the 25% surtax be imposed therefrom."

Petitioner appealed to the Court of Tax Appeals.

With regards to the alleged substantial investment of surplus or profits


in unrelated business, the Court of Tax Appeals held that the investment of
petitioner with Acme Commercial Co., Inc., Union Insurance Society of
Canton and with the Wack Wack Golf and Country Club are harmless
accumulation of surplus and, therefore, not subject to the 25% surtax
provided in Section 25 of the Tax Code. As to the U.S.A.

Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals


ruled that its purchase was in no way related to petitioner's business
of importing and selling wines, whisky, liquors and distilled spirits.
Respondent Court was convinced that the surplus of P347,217.50 which
was invested in the U.S.A. Treasury Bonds was availed of by petitioner for
the purpose of preventing the imposition of the surtax upon petitioner's
shareholders by permitting its earnings and profits to accumulate beyond
the reasonable needs of business.

Issue:
(1) Whether the purchase of the U.S.A. Treasury bonds by petitioner in
1951 can be construed as an investment to an unrelated business and
hence, such was availed of by petitioner for the purpose of preventing the
imposition of the surtax upon petitioner's shareholders by permitting its
earnings and profits to accumulate beyond the reasonable needs of the
business. YES

(2) Whether the penalty tax of twenty-five percent (25%) can be imposed
on such improper accumulation in 1957 despite the fact that the
accumulation occurred in 1951.

YES, An accumulation of earnings or profits (including undistributed


earnings or profits of prior years) is unreasonable if it is not required
for the purpose of the business, considering all the circumstances of
the case.

To determine the "reasonable needs" of the business in order to justify an


accumulation of earnings, the Courts of the United States have invented
the so-called "Immediacy Test" which construed the words "reasonable
needs of the business" to mean the immediate needs of the business, and
it was generally held that if the corporation did not prove an immediate
need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and
the penalty tax would apply.

American cases likewise hold that investment of the earnings and


profits of the corporation in stock or securities of an unrelated business
usually indicates an accumulation beyond the reasonable needs of the
business. The purchase of the U.S.A. Treasury bonds were in no way
related to petitioner's business of importing and selling wines whisky,
liquors and distilled spirits, and thus construed as an investment beyond
the reasonable needs of the business. The records further reveal that from
May 1951 when petitioner purchased the U.S.A. Treasury shares, until
1962 when it finally liquidated the same, it (petitioner) never had the
occasion to use the said shares in aiding or financing its importation. This
militates against the purpose enunciated earlier by petitioner that the
shares were purchased to finance its importation business.

To justify an accumulation of earnings and profits for the


reasonably anticipated future needs, such accumulation must be
used within a reasonable time after the close of the taxable year.
In order to determine whether profits are accumulated for the
reasonable needs of the business as to avoid the surtax upon
shareholders, the controlling intention of the taxpayer is that which is
manifested at the time of accumulation not subsequently declared
intentions which are merely the product of afterthought.

A speculative and indefinite purpose will not suffice. The mere


recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled with
action taken towards its consummation are essential. Viewed on the
foregoing analysis and tested under the "immediacy doctrine,"

We are convinced that the Court of Tax Appeals is correct in finding that the
investment made by petitioner in the U.S.A. Treasury shares in 1951 was
an accumulation of profits in excess of the reasonable needs of petitioner's
business. As to the contention that that the surtax of 25% should be based
on the surplus accumulated in 1951 and not in 1957, the rule is now settled
in Our jurisprudence that undistributed earnings or profits of prior years are
taken into consideration in determining unreasonable accumulation for
purposes of the 25% surtax.

Decision of the Court of Tax Appeals AFFIRMED.


CIR VS. ANTONIO TUASON, INC. and the CTA

Facts:

On February 27, 1981, the Commissioner of Internal Revenue,


assessed Antonio Tuason, Inc.

1.P37,491.83 as deficiency income tax for the years 1975,1976, and 1978.

2.P161.49 as Deficiency corporate quarterly income tax for the first quarter.

3.P1,151,146.98 as 25% surtax on unreasonable accumulation of


surplus for the years 1975-1978.

Antonio Tuason, Inc did not object to the first and second items and
paid the amounts demanded.However, it protested the assessment on a
25% surtax on the third item on the ground that theaccumulation of
surplus profits during the years in question was solely for
the purpose of expanding itsbusiness operations as real estate
broker. The request for reinvestigation was granted on condition thata
waiver of the statute of limitations should be filed by the private respondent.
The latter replied thatthere was no need of a waiver of the statute
of limitations because the right of the Government toassess said tax does
not prescribe.

No investigation was conducted nor a decision rendered on Antonio


Tuazon Inc.'s protest. In themeantime, the Revenue Commissioner issued
warrants of distraint and levy to enforce collection of thetotal amount
originally assessed including the amounts already paid.

Antonio Tuason, Inc filed a petition for review in the CTA with a
request that pending determination ofthe case on the merits, an order be
issued restraining the Commissioner and/or his representatives
fromenforcing the warrants of distraint and levy

The private respondent filed a petition for review in the CTA, which set
aside the CIRs assessment.
Issue:

WON the alleged surplus constituted an unreasonable accumulation of


profits subject to the 25% surtax

Held:

YES. The touchstone of liability is the purpose behind the


accumulation of the income and not the consequences of the
accumulation. Thus, if the failure to pay dividends were for the purpose of
using the undistributed earnings and profits for the reasonable needs of the
business, that purpose would not fall within the interdiction of the statute.

Sec. 25. Additional tax on corporation improperly accumulating


profits or surplus.

(a) Imposition of tax. If any corporation, except banks, insurance


companies, or personal holding companies, whether domestic or foreign, is
formed or availed of for the purpose of preventing the imposition of the tax
upon its shareholders or members or the shareholders or members of
another corporation, through the medium of permitting its gains and profits
to accumulate instead of being divided or distributed, there is levied and
assessed against such corporation, for each taxable year, a tax equal to
twenty-five per centum of the undistributed portion of its accumulated
profits or surplus which shall be in addition to the tax imposed by section
twentyfour, and shall be computed, collected and paid in the same manner
and subject to the same provisions of law, including penalties, as that tax.

(b) Prima facie evidence. The fact that any corporation is a mere
holding company shall be prima facie evidence of a purpose to avoid the
tax upon its shareholders or members. Similar presumption will lie in the
case of an investment company where at any time during the taxable year
more than fifty per centum in value of its outstanding stock is owned,
directly or indirectly, by one person.

The CTA conceded that the CIRs determination that Antonio was a
mere holding or investment company, was presumptively correct, for the
corporation did not involve itself in the development of subdivisions but
merely subdivided its own lots and sold them for bigger profits. It derived its
income mostly from interest, dividends and rental realized from the sale of
realty. Another circumstance supporting that presumption is that 99.99% in
value of the outstanding stock of Antonio Tuason, Inc., is owned by Antonio
Tuason himself.

The CIR conclusively presumed that when the corporation


accumulated (instead of distributing to the shareholders) a surplus of over
P3 million fron its earnings in 1975 up to 1978, the purpose was to avoid
the imposition of the progressive income tax on its shareholders. However,
while the investments for expansion as alleged by private respondent were
actually made, the corporation did not use up its surplus profits. The
enormous discrepancy between the alleged investment cost and the
declared market value of two pieces of real estate purchased by the
corporation was not denied nor explained. It is plain to see that the
company's failure to distribute dividends to its stockholders in 1975-1978
was for reasons other than the reasonable needs of the business, thereby
falling within the interdiction of Section 25 of the Tax Code of 1977.

Since the company as of the time of the assessment in 1981, had


invested in its business operations only P 773,720 out of its
accumulated surplus profits of P3,263,305.88 for 1975- 1978, its
remaining accumulated surplus profits of P2,489,858.88 are subject to
the 25% surtax.
Cyanamid Philippines vs. CA, CTA, and CIR

Facts :

Cyanamid Phils. is a corporation organized under Philippine laws. It is a


wholly owned subsidiary of American Cyanamid based in the USA. It is
engaged in the manufacture of pharmaceutical products and
chemicals, a wholesaler of imported finished goods, and an importer.

The CIR sent an assessment letter to Cyanamid Phils. and


demanded the payment of deficiency in come tax for taxable year
1981 which Cyanamid Phils. protested:

(a) 25% surtax assessment;


(b) deficiency income tax;
(c) deficiency percentage assessment.

CIR refused to allow the cancellation of the assessment notices. During


the pendency of the case on appeal to the CTA, both parties agreed to
compromise by reduction the deficiency income assessment. But the surtax
on improperly accumulated profits remained unresolved.

Cyanamid Phils. claimed that the assessment representing the


25% surtax had no legal basis for the following reasons:

(a) petitioner accumulated its earnings and profits for reasonable business
requirements to meet working capital needs and retirement of
indebtedness,

(b) petitioner is wholly owned subsidiary of American Cyanamid, a


corporation organized under the laws of USA, whose shares of stock are
listed and traded in New York Stock Exchange.

This being the case, no individual shareholder of petitioner could have


evaded or prevented the imposition of individual income taxes by
Cyanamid Phils. accumulation of earnings and profits, instead contribution
of the same.

CTA denied said petition.

Issue:

Whether Cyanamid Phils. is liable for the accumulated earnings tax for the
year 1981

Held:

Yes. PD 1739 amended the NIRC and enumerated the corporations


exempt from the imposition of improperly accumulated tax:

(a) banks;
(b) non-bank financial intermediaries;
(c) insurance companies; and
(d) corporations organized primarily and authorized by the Central Bank to
hold shares of stocks of banks.

Cyanamid Phils. does not fall among those exempt classes.


Besides, the laws granting exemption form 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 the exemption to prove that it is, in fact,
covered by the exemption so claimed. This is a burden which Cyanamid
Phils. has failed to discharge. Unless rebutted, all presumptions are
generally indulged in favor of the correctness of the CIRs assessment and
against the taxpayer.

With Cyanamid Phils. failure to prove the CIR incorrect, clearly and
conclusively, this court is constrained to uphold the correctness of tax
courts ruling as affirmed by the CA.
ARTHUR HENDERSON, petitioner,
vs.
COLLECTOR OF INTERNAL REVENUE, respondent.

FACTS:
Sps. Arthur Henderson and Marie Henderson filed their annual income tax
with the BIR. Arthur is president of American International Underwriters for
the Philippines, Inc., which is a domestic corporation engaged in the
business of general non-life insurance, and represents a group of American
insurance companies engaged in the business of general non-life
insurance. Arthurs employer-corporation granted him an apartment where
he entertained officials, guests and customers of his employer-corporation,
and successively occupied by him as president thereof. In 1952, petitioner's
wife, Mrs. Marie Henderson, upon request o Mr. C. V. Starr, chairman of the
parent corporation of the American International Underwriters for the
Philippines, Inc., undertook a trip to New York in connection with the
purchase of a lot in Dewey Boulevardby petitioner's employer-corporatio,
the construction of a building thereon, the drawing of prospectus and plans
for said building, and other related matters.

The spousesHenderson filed with the Bureau of Internal Revenue returns


of annual net income for the years 1948 to 1952. The BIR demanded
payment for alleged deficiency taxes because in their computation, Bureau
of InternalRevenue considered as part of their taxable income thetaxpayer-
husband's allowances for rental, residential expenses,subsistence, water,
electricity and telephone; bonuspaid to him; withholding tax and entrance
fee to the Marikinagun and Country Bluc paid by his employer for
hisaccount; and travelling allowance of his wife. On 26 and27 January 1954
the taxpayers asked for reconsideration reasoning that:

1) as to allowances for rental and utilities, Arthur did not receive money for
the allowances. Instead, the apartment is furnished and paid for by his
employer-corporation (the mother company of American International), for
the employer corporations purposes. The spouses had no choice but to
live in the expensive apartment, since the company used it to entertain
guests, to accommodate officials, and to entertain customers. According to
taxpayers, only P 4,800 per year is the reasonable amount that the
spouses would be spending on rental if they were not required to live in
those apartments. Thus, it is the amount they deem is subject to tax. The
excess is to be treated as expense of the company.
2) The entrance fee should not be considered income since it is an
expense of his employer, and membership therein is merely incidental to
his duties of increasing and sustaining the business of his employer.

3) His wife merely accompanied him to New York on a business trip as his
secretary, and at the employer-corporations request, for the wife to look at
details of the plans of a building that his employer intended to construct.
Such must not be considered taxable income.
The Collector of Internal Revenue merely allowed the entrance fee as
nontaxable. The rent expense and travel expenses were still held to be
taxable. The Court of Tax Appeals ruled in favor of the taxpayers, that such
expenses must not be considered part of taxable income. Letters of the
wife while in New York concerning the proposed building were presented as
evidence.

ISSUE: Whether or not the rental allowances and travel allowances


furnished and given by the employer-corporation are part of taxable
income?

HELD: NO. Such claims are substantially supported by evidence.


These claims are therefore NOT part of taxable income. No part of the
allowances in question redounded to their personal benefit, nor were such
amounts retained by them. These bills were paid directly by the employer-
corporation to the creditors. The rental expenses and subsistence
allowances are to be considered not subject to income tax. Arthurs high
executive position and social standing, demanded and compelled the
couple to live in a more spacious and expensive quarters. Such
subsistence allowance was a SEPARATE account from the account for
salaries and wages of employees. The company did not charge rentals as
deductible from the salaries of the employees. These expenses are
COMPANY EXPENSES, not income by employees which are subject to
tax.
NB: The taxpayers are childless and are the only two in the family. The
quarters, therefore, that they occupied at the Embassy Apartments
consisting of a large sala, three bedrooms, dining room, two bathrooms,
kitchen and a large porch, and at the Rosaria Apartments consisting of a
kitchen, sala dining room, two bedrooms and a bathroom, exceeded their
personal needs. But the exigencies of the husband-taxpayer's high
executive position, not to mention social standing, demanded and
compelled them to live in amore spacious and pretentious quarters like the
ones they had occupied. Although entertaining and putting up houseguests
and guests of the husbnad-taxpayer's employer-corporation were not his
predominand occupation as president, yet he and his wife had to entertain
and put up houseguests in their apartments. That is why his employer-
corporation had to grant him allowances for rental and utilities in addition to
his annual basic salary to take care of those extra expenses for rental and
utilities in excess of their personal needs. Hence, the fact that the
taxpayers had to live or did not have to live in the apartments chosen by
the husband-taxpayer's employer-corporation is of no moment, for no part
of the allowances in question redounded to their personal benefit or was
retained by them. Neverthelss, the taxpayers are entitled only to a ratable
value of the allowances in question, and only the amount of P4,800
annually, the reasonable amount they would have spent for house rental
and utilities such as light, water, telephone, etc., should be the amount
subject to tax, and the excess considered as expenses of the corporation.
Likewise, the findings of the Court of Tax Appeals that the wife-taxpayer
had to make the trip to New York at the behest of her husband's employer-
corporation to help in drawing up the plans and specificatins of a proposed
building, is also supported by the evidence. The parts of the letters written
by the wife-taxpayer to her husband while in New York and the letter written
by the husband-taxpayer to Mr. C. V. Starr support the said findings. No
part of the allowance for travelling expenses redounded to the benefit of the
taxpayers. Neither was a part thereof retained by them. The fact that she
had herself operated on for tumors while in New York was but incidental to
her stay there and she must have merely taken advantage of her presence
in that city to undergo the operation.

The taxpayers claim that the Court of Tax Appeals erred in considering the
amounts of P1,400 and P1,849.32, or a total of P3,249.32, for "manager's
residential expense" in 1948 as taxable income despite the fact "that they
were of the same nature as the rentals for the apartment, they being
expenses for utilities, such as light, water and telephone necessarily
incidental to the apartment furnished to him by his employer."

Buenaventura Loberiza, acting head of the accouting department of the


American International Underwriters for the Philippines, Inc., testified that
rentals, utilities, water, telephone and electric bills of executives of the
corporation were entered in the books of account as "subsistence
allowances and expenses;" that there was a separate account for salaries
and wages of employees and officers; and that expenses for rentals and
other utilities were not charged to salary accounts.

The taxpayers' claim is supported by the evidence. The total amount "for
manager's residential expense" in 1948 should be treated as rentals for
apartments and utilities and should not form part of the ratable value
subject to tax.

The computation made by the taxpayers is correct. The judgment under


review is modified as above indicated. The Collector of Internal Revenue is
ordered to refund to the taxpayers the sum of P5,986.61, without
pronouncement as to costs.
COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. THE COURT
OF APPEALS and EFREN P. CASTAEDA, Respondents.

LeovigildoMonasterial for Private Respondent.

FACTS:

Private respondent Efren P. Castaneda retired from the government service


in 1982. 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 decided in favor of Castaneda and ordered the
CIR to refund Castaneda the sum of P12,557.13 withheld as income tax.
Petitioner appealed the above-mentioned Court of Tax Appeals decision to
this Court. In turn, we referred the case to the Court of Appeals for
resolution. 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 NIRC.

ISSUE:
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.

HELD:

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.

Terminal Leave Pay received by a government official or employee is not subject to


withholding Income tax. In the exercise of sound personnel policy, the Government
encourages unused leaveSto be accumulated. The Government recognizes that
retirement pay for public servants is less thangenerous, if not meager or scrimpy.
Terminal leave payments are given thus not only at the sametime but also for the
same policy considerations governing retirement benefits. Not being part of thegross
salary or income of a government official or employee but a retirement benefit,
terminal leavepay is not subject to income tax.
Eisner v Macomber, 252 US 89

FACTS:

On January 1, 1916, the Standard Oil Company of California, a corporation


of that state, out of an authorized capital stock of $100,000,000, had shares
of stock outstanding, par value $100 each, amounting in round figures to
$50,000,000. In addition, it had surplus and undivided profits invested in
plant, property, and business and required for the purposes of the
corporation, amounting to about $45,000,000, of which about $20,000,000
had been earned prior to March 1, 1913, the balance thereafter. In January,
1916, in order to readjust the capitalization, the board of directors decided
to issue additional shares sufficient to constitute a stock dividend of 50
percent of the outstanding stock, and to transfer from surplus account to
capital stock account an amount equivalent to such issue. Appropriate
resolutions were adopted, an amount equivalent to the par value of the
proposed new stock was transferred accordingly, and the new stock duly
issued against it and divided among the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock,
received certificates for 1, 100 additional shares, of which 18.07 percent, or
198.77 shares, par value $19,877, were treated as representing surplus
earned between March 1, 1913, and January 1, 1916. She was called upon
to pay, and did pay under protest, a tax imposed under the Revenue Act of
1916, based upon a supposed income of $19,877 because of the new
shares, and, an appeal to the Commissioner of Internal Revenue having
been disallowed, she brought action against the Collector to recover the
tax. In her complaint, she alleged the above facts and contended that, in
imposing such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3,
and Article I, 9, cl. 4, of the Constitution of the United States, requiring
direct taxes to be apportioned according to population, and that the stock
dividend was not income within the meaning of the Sixteenth Amendment.
A general demurrer to the complaint was overruled upon the authority
of Towne v. Eisner, 245 U. S. 418, and, defendant having failed to plead
further, final judgment went against him. To review it, the present writ of
error is prosecuted.

ISSUES:

Whether a tax on stock dividends is a tax on capital increase, and not on


income

HELD:

No.
Such a dividend is not to be regarded as "income" or "dividends" within the
meaning of the Act of 1913, we are unable to see how it can be brought
within the meaning of "incomes" in the Sixteenth Amendment, it being very
clear that Congress intended in that act to exert its power to the extent
permitted by the amendment. In Towne v. Eisner, it was not contended that
any construction of the statute could make it narrower than the
constitutional grant; rather the contrary.

The fact that the dividend was charged against profits earned before the
Act of 1913 took effect, even before the amendment was adopted, was
neither relied upon nor alluded to in our consideration of the merits in that
case. Not only so, but had we considered that a stock dividend constituted
income in any true sense, it would have been held taxable under the Act of
1913 notwithstanding it was based upon profits earned before the
amendment. We ruled at the same term, in Lynch v. Hornby, 247 U. S. 339,
that a cash dividend extraordinary in amount, and in Peabody v.
Eisner, 247 U. S. 347, that a dividend paid in stock of another company,
were taxable as income although based upon earnings that accrued before
adoption of the amendment. In the former case, concerning "corporate
profits that accumulated before the act took effect," we declared (pp. 247 U.
S. 343-344):

"Just as we deem the legislative intent manifest to tax the stockholder with
respect to such accumulations only if and when, and to the extent that, his
interest in them comes to fruition as income, that is, in dividends declared,
so we can perceive no constitutional obstacle that stands in the way of
carrying out this intent when dividends are declared out of a preexisting
surplus. . . . Congress was at liberty under the amendment to tax as
income, without apportionment, everything that became income, in the
ordinary sense of the word, after the adoption of the amendment, including
dividends received in the ordinary course by a stockholder from a
corporation, even though they were extraordinary in amount and might
appear upon analysis to be a mere realization in possession of an inchoate
and contingent interest that the stockholder had in a surplus of corporate
assets previously existing."

Brief as it is, it indicates the characteristic and distinguishing attribute of


income essential for a correct solution of the present controversy. The
government, although basing its argument upon the definition as quoted,
placed chief emphasis upon the word "gain," which was extended to
include a variety of meanings; while the significance of the next three words
was either overlooked or misconceived. "Derived from capital;" "the gain
derived from capital," etc. Here, we have the essential matter: not a
gain accruing to capital; not a growth or increment of value in the
investment; but a gain, a profit, something of exchangeable
value, proceeding from the property, severed from the capital, however
invested or employed, and coming in, being "derived" -- that
is, received or drawn by the recipient (the taxpayer) for his separate use,
benefit and disposal -- that is income derived from property. Nothing else
answers the description.

The same fundamental conception is clearly set forth in the Sixteenth


Amendment -- "incomes, from whatever source derived" -- the essential
thought being expressed with a conciseness and lucidity entirely in
harmony with the form and style of the Constitution.

Can a stock dividend, considering its essential character, be brought within


the definition? To answer this, regard must be had to the nature of a
corporation and the stockholder's relation to it. We refer, of course, to a
corporation such as the one in the case at bar, organized for profit, and
having a capital stock divided into shares to which a nominal or par value is
attributed.

Certainly the interest of the stockholder is a capital interest, and his


certificates of stock are but the evidence of it. They state the number of
shares to which he is entitled and indicate their par value and how the
stock may be transferred. They show that he or his assignors, immediate or
remote, have contributed capital to the enterprise, that he is entitled to a
corresponding interest proportionate to the whole, entitled to have the
property and business of the company devoted during the corporate
existence to attainment of the common objects, entitled to vote at
stockholders' meetings, to receive dividends out of the corporation's profits
if and when declared, and, in the event of liquidation, to receive a
proportionate share of the net assets, if any, remaining after paying
creditors. Short of liquidation, or until dividend declared, he has no right to
withdraw any part of either capital or profits from the common enterprise;
on the contrary, his interest pertains not to any part, divisible or indivisible,
but to the entire assets, business, and affairs of the company. Nor is it the
interest of an owner in the assets themselves, since the corporation has full
title, legal and equitable, to the whole. The stockholder has the right to
have the assets employed in the enterprise, with the incidental rights
mentioned; but, as stockholder, he has no right to withdraw, only the right to
persist, subject to the risks of the enterprise, and looking only to dividends
for his return. If he desires to dissociate himself from the company, he can
do so only by disposing of his stock.

For bookkeeping purposes, the 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 and not
divided, they create additional bookkeeping liabilities under the head of
"profit and loss," "undivided profits," "surplus account," 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 for any particular sum of
money or a right to any particular portion of the assets or any share in them
unless or until the directors conclude that dividends shall be made and a
part of the company's assets segregated from the common fund for the
purpose. The dividend normally is payable in money, under exceptional
circumstances in some other divisible property, and when so paid, then
only (excluding, of course, a possible advantageous sale of his stock or
winding-up of the company) does the stockholder realize a profit or gain
which becomes his separate property, and thus derive income from the
capital that he or his predecessor has invested.

In the present case, the corporation had surplus and undivided profits
invested in plant, property, and business, and required for the purposes of
the corporation, amounting to about $45,000,000, in addition to outstanding
capital stock of $50,000,000. In this, the case is not extraordinary. The
profits of a corporation, as they appear upon the balance sheet at the end
of the year, need not be in the form of money on hand in excess of what is
required to meet current liabilities and finance current operations of the
company. Often, especially in a growing business, only a part, sometimes a
small part, of the year's profits is in property capable of division, the
remainder having been absorbed in the acquisition of increased plant,
equipment, stock in trade, or accounts receivable, or in decrease of
outstanding liabilities. When only a part is available for dividends, the
balance of the year's profits is carried to the credit of undivided profits, or
surplus, or some other account having like significance. If thereafter the
company finds itself in funds beyond current needs, it may declare
dividends out of such surplus or undivided profits; otherwise it may go on
for years conducting a successful business, but requiring more and more
working capital because of the extension of its operations, and therefore
unable to declare dividends approximating the amount of its profits. Thus,
the surplus may increase until it equals or even exceeds the par value of
the outstanding capital stock. This may be adjusted upon the books in the
mode adopted in the case at bar -- by declaring a "stock dividend." This,
however, is no more than a book adjustment, in essence -- not a dividend,
but rather the opposite; no part of the assets of the company is separated
from the common fund, nothing distributed except paper certificates that
evidence an antecedent increase in the value of the stockholder's capital
interest resulting from an accumulation of profits by the company, but
profits so far absorbed in the business as to render it impracticable to
separate them for withdrawal and distribution. In order to make the
adjustment, a charge is made against surplus account with corresponding
credit to capital stock account, equal to the proposed "dividend;" the new
stock is issued against this and the certificates delivered to the existing
stockholders in proportion to their previous holdings. This, however, is
merely bookkeeping that does not affect the aggregate assets of the
corporation or its outstanding liabilities; it affects only the form, not the
essence, of the "liability" acknowledged by the corporation to its own
shareholders, and this through a readjustment of accounts on one side of
the balance sheet only, increasing "capital stock" at the expense of
"surplus"; it does not alter the preexisting proportionate interest of any
stockholder or increase the intrinsic value of his holding or of the aggregate
holdings of the other stockholders as they stood before. The new
certificates simply increase the number of the shares, with consequent
dilution of the value of each share.
A "stock dividend" 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 such realization, in that the fund represented by the new
stock has been transferred from surplus to capital, 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 have resulted 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 the entire investment. Having regard to the very
truth of the matter, to substance and not to form, he has received nothing
that answers the definition of income within the meaning of the Sixteenth
Amendment.

Being concerned only with the true character and effect of such a dividend
when lawfully made, we lay aside the question whether, in a particular
case, a stock dividend may be authorized by the local law governing the
corporation, or whether the capitalization of profits may be the result of
correct judgment and proper business policy on the part of its
management, and a due regard for the interests of the stockholders. And
we are considering the taxability of bona fidestock dividends only.

We are clear that not only does a stock dividend really take nothing from
the property of the corporation and add nothing to that of the shareholder,
but that the antecedent accumulation of profits evidenced thereby, while
indicating that the shareholder is the richer because of an increase of his
capital, at the same time shows he has not realized or received any income
in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock
dividend, and so he may, if he can find a buyer. It is equally true that, if he
does sell, and in doing so realizes a profit, such profit, like any other, is
income, and, so far as it may have arisen since the Sixteenth Amendment,
is taxable by Congress without apportionment. The same would be true
were he to sell some of his original shares at a profit. But if a shareholder
sells dividend stock, he necessarily disposes of a part of his capital interest,
just as if he should sell a part of his old stock, either before or after the
dividend. What he retains no longer entitles him to the same proportion of
future dividends as before the sale. His part in the control of the company
likewise is diminished. Thus, if one holding $60,000 out of a total $100,000
of the capital stock of a corporation should receive in common with other
stockholders a 50 percent stock dividend, and should sell his part, he
thereby would be reduced from a majority to a minority stockholder, having
six-fifteenths instead of six-tenths of the total stock outstanding. A
corresponding and proportionate decrease in capital interest and in voting
power would befall a minority holder should he sell dividend stock, it being
in the nature of things impossible for one to dispose of any part of such an
issue without a proportionate disturbance of the distribution of the entire
capital stock and a like diminution of the seller's comparative voting power
-- that "right preservative of rights" in the control of a corporation.

Yet, without selling, the shareholder, unless possessed of other resources,


has not the wherewithal to pay an income tax upon the dividend stock.
Nothing could more clearly show that to tax a stock dividend is to tax a
capital increase, and not income, than this demonstration that, in the nature
of things, it requires conversion of capital in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the


fundamental error already mentioned -- a failure to appraise correctly the
force of the term "income" as used in the Sixteenth Amendment, or at least
to give practical effect to it. Thus, the government contends that the tax "is
levied on income derived from corporate earnings," when in truth the
stockholder has "derived" nothing except paper certificates, which, so far
as they have any effect, deny him present participation in such earnings. It
contends that the tax may be laid when earnings "are received by the
stockholder," whereas he has received none; that the profits are
"distributed by means of a stock dividend," although a stock dividend
distributes no profits; that, under the Act of 1916, "the tax is on the
stockholder's share in corporate earnings," when in truth a stockholder has
no such share, and receives none in a stock dividend; that "the profits are
segregated from his former capital, and he has a separate certificate
representing his invested profits or gains," whereas there has been no
segregation of profits, nor has he any separate certificate representing a
personal gain, since the certificates, new and old, are alike in what they
represent -- a capital interest in the entire concerns of the corporation.

We have no doubt of the power or duty of a court to look through the form
of the corporation and determine the question of the stockholder's right in
order to ascertain whether he has received income taxable by Congress
without apportionment. But, looking through the form,

we cannot disregard the essential truth disclosed, ignore the substantial


difference between corporation and stockholder, treat the entire
organization as unreal, look upon stockholders as partners when they are
not such, treat them as having in equity a right to a partition of the
corporate assets when they have none, and indulge the fiction that they
have received and realized a share of the profits of the company which in
truth they have neither received nor realized. We must treat the corporation
as a substantial entity separate from the stockholder not only because such
is the practical fact, but because it is only by recognizing such
separateness that any dividend -- even one paid in money or property --
can be regarded as income of the stockholder. Did we regard corporation
and stockholders as altogether identical, there would be no income except
as the corporation acquired it, and while this would be taxable against the
corporation as income under appropriate provisions of law, the individual
stockholders could not be separately and additionally taxed with respect to
their several shares even when divided, since, if there were entire identity
between them and the company, they could not be regarded as receiving
anything from it, any more than if one's money were to be removed from
one pocket to another.

Conceding that the mere issue of a stock dividend makes the recipient no
richer than before, the government nevertheless contends that the new
certificates measure the extent to which the gains accumulated by the
corporation have made him the richer. There are two insuperable difficulties
with this. In the first place, it would depend upon how long he had held the
stock whether the stock dividend indicated the extent to which he had been
enriched by the operations of the company; unless he had held it
throughout such operations, the measure would not hold true. Secondly,
and more important for present purposes, enrichment through increase in
value of capital investment is not income in any proper meaning of the
term.

The complaint contains averments respecting the market prices of stock


such as plaintiff held, based upon sales before and after the stock dividend,
tending to show that the receipt of the additional shares did not
substantially change the market value of her entire holdings. This tends to
show that, in this instance, market quotations reflected intrinsic values -- a
thing they do not always do. But we regard the market prices of the
securities as an unsafe criterion in an inquiry such as the present, when the
question must be not what will the thing sell for, but what is it in truth and in
essence.

It is said there is no difference in principle between a simple stock dividend


and a case where stockholders use money received as cash dividends to
purchase additional stock contemporaneously issued by the corporation.
But an actual cash dividend, with a real option to the stockholder either to
keep the money for his own or to reinvest it in new shares, would be as far
removed as possible from a true stock dividend, such as the one we have
under consideration, where nothing of value is taken from the company's
assets and transferred to the individual ownership of the several
stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend


of the corporation's own shares and one made by distributing shares
owned by it in the stock of another company calls for no comment beyond
the statement that the latter distributes assets of the company among the
shareholders, while the former does not, and for no citation of authority
except Peabody v. Eisner, 247 U. S. 347, 247 U. S. 349-350.

RULING:
We are constrained to hold that the judgment of the district court must be
affirmed, first, because the question at issue is controlled by Towne v.
Eisner, supra; secondly, because a reexamination of the question with the
additional light thrown upon it by elaborate arguments has confirmed the
view that the underlying ground of that decision is sound, that it disposes of
the question here presented, and that other fundamental considerations
lead to the same result.
G.R. No. 96016 October 17, 1991
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE COURT OF APPEALS and EFREN P. CASTANEDA, respondents.

FACTS:

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.

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
petition was raised before the High Court.

ISSUE:

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.

RULING:

No, the High Court resolved the issue in the negative.

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.

ESSO STANDARD EATERN, INC. vs. CIR


G.R. NOS. L-28508-9

FACTS:

Petitioner ESSO deducted from its gross income for 1959, as part of
its ordinary and necessary business expenses, the amount it had spent for
drilling and exploration of its petroleum concessions but it was disallowed
by respondent CIR on the ground that the expenses should be capitalized
and might be written off as a loss only when a dry hole should result.
Petitioner filed an amended return where it asked for the refund. Likewise,
claimed as ordinary and necessary expenses in the same return
representing margin fees paid to the Central Bank on its profit remittances
to NY office. The CIR granted a tax credit but disallowing the claimed
deduction for margin fees paid.
The CR also assessed a deficiency income tax for the year 1960,
plus 18% interest. This arose from the disallowance of the margin fees paid
by petitioner.
ESSO settled the deficiencies by applying the tax credit representing
its overpayment on its income tax for 1959 and paying under protest the
additional amount of P213,201.92. It claimed the refund as overpayment on
the interest on its deficiency income tax. It argued that the 18% should
have been imposed not on the total deficiency.
The claimed was denied by the CIR, and insisted on charging 18%
interest on the entire amount of deficiency tax. Likewise, denied the claims
of ESSO for refund of the overpayment of its 1959 and 1960 income taxes,
holding that the margin fees paid could not be considered taxes or allowed
deductible business expenses. Petitioner appealed but no to avail.

ISSUE:
WON the margin fees are deductible from gross income.

HELD:
In applying statutory test of deductibility, to be deductible as business
expense, three conditions are imposed: (1) the expense must be ordinary
and necessary, (2) it must be paid or incurred within the taxable year, and
(3) it must be paid or incurred in carrying on a trade or business. In
addition, not only must the taxpayer meet the business test, he must
substantially prove by evidence records the deductions claimed under the
law, otherwise, the same will be disallowed. The mere allegation of the
taxpayer that an item of expense is ordinary and necessary does not justify
its deduction.
NECESSARY where the expenditure is appropriate and helpful in the
development of the taxpayers business. ORDINARY when it connotes a
payment which is normal in relation to business of the taxpayer and the
surrounding circumstances.
Since the margin fees in question were incurred for the remittance of
funds to petitioners Head Office in NY, which is separate and distinct
income taxpayer from branch in the Philippines, for its disposal abroad, it
can never be said therefore that the margin fees were appropriate and
helpful in the development of petitioners business in the Philippines
exclusively or were incurred for purposes proper to the conduct of the
affairs of petitioners branch in the Philippines exclusively or for the purpose
of realizing a profit or of minimizing a loss in the Philippines exclusively.
ESSO has not shown that the remittance to the head office of part of
its profits was made in furtherance of its own trade or business. It is clear
that petitioner, having assumed an expense properly attributable to its head
office, cannot now claim this as an ordinary and necessary expense paid or
incurred in carrying on its own trade or business.
MARIANO ZAMORA vs. CIR
G.R. NO. L-15290

FACTS:
Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora,
Manila filed his income tax returns. The Collector of Internal Revenue found
that the promotion expenses incurred by his wife for the promotion of the
Bay View Hotel and Farmacia Zamora were not allowable deductions.
Mariano Zamora contends that the whole amount of the promotion
expenses in his income tax returns, should be allowed and not merely one-
half of it, on the ground that, while not all the itemized expenses are
supported by receipts. The absence of some supporting receipts has been
sufficiently and satisfactorily established.

ISSUE:
In the absence of receipts, WON to allow as deduction all or merely
one-half of the promotion expenses of Mrs. Zamora claimed in Mariano
Zamoras income tax returns.

HELD:
One-half only. Claims for the deduction of promotion expenses,
entertainment expenses must also be substantiated or supported by record
showing in details the amount and nature of the expenses incurred.
Considering that the application of Mrs. Zamora for dollar allocation shows
that she went abroad on a combined medical and business trip not all of
her expenses came under the category of ordinary and necessary
expenses part thereof constituted her personal expenses. There having
been no means by which to ascertain which expense was her personal
benefit, the Collector and the CTA in their decisions, considered 50% of the
said amount as business expense and the other 50%, as her personal
expenses. While in situations like the present, absolute certainty is usually
not possible.
C.M Hoskin vs. CIR
G.R. No. L-24059, November 28, 1969

FACTS:
Petitioner is a domestic corporation engaged in the real estate
business as brokers,managingagents and administrators, filed its income
tax return for the fiscal year endingSeptember 30, 1957. Upon verification,
the CIR disallowed four items of deduction andassessed against it an
income tax deficiency in the amount of P28,054.00 plus interests.The Court
of Tax Appeals upheld the respondents disallowance of the 50%
supervisionfees paid to Mr. Hoskins, its founder and principal
stockholder. .Petitioner questions the CTAs findings that the disallowed
payment to Hoskins was aninordinately large one, which bore a close
relationship to the recipients dominantstockholdings and therefore
amounted to a distribution of its earnings and profits.
ISSUE:
WON the share received by petitioner was inordinately large and
could not be accorded the treatment of ordinary and necessary expenses
allowed as deductible items in the Tax Code.
HELD:
The petition has no merit. Considering that in addition being
Chairman of theBoard of Directors of petitioner corporation, Hoskins owned
99.6% of its total authorizedcapital stock, was also salesman- broker for his
company receiving a 50% share of thesales commissions earned by
petitioner, besides monthly salary and other allowances and benefits, the
Tax court correctly ruler that the payment to Hoskins of his share in
thesupervision fees received by petitioner as managing agent of the real
estate projects of Paradise Farms and Realty Investments (of which he is
also a stockholder) wasinordinately large and could not be accorded the
treatment of ordinary and necessaryexpenses allowed as deductible items
in the Tax Code. The fact that such payment wasauthorized by petitioners
Board of Directors is of no moment, since Hoskins wieldtremendous power
and influence as Board chairman and controlling stockholder.Officers extra
fees, bonuses and commissions are upheld by the Court as not being
within the purview of ordinary and necessary expenses and not passing
the test of reasonable compensation thus are not deductible items.
In Kuenzle v CIR, the Court ruledthat Bonuses to employees made
in good faith and as additional compensation for theservices actually
rendered by the employees are deductible, provided such payments,when
added to the stipulated salaries, do not exceed a reasonable compensation
for theservices rendered. The conditions precedent to the deduction of
bonuses to employees are: (1) the payment of the bonuses is in fact
compensation; 2) it must be for personalservices actually rendered; and 3)
the bonuses, when added to the salaries, arereasonablewhen measured
by the amount and quality of the services performed withrelation to the
business of the particular taxpayer.There is no fixed test for determining
the reasonableness of a given bonus ascompensations. This depends
upon many factors, among them being the amount andquality of the
services performed with relation to the business. In determining
whether the particular salary or compensation payment is reasonable,
the situation must beconsidered as a whole.The employer has the right to
fix the compensation of its officers and employees but the question of the
allowance or disallowance thereof as deductible expense for income tax
purposes is subject to the determination of the Commissioner. The right of
thecorporation to fix the amounts of remuneration are not absolute. It
cannot be exercisedfor the purpose of evading payment of taxes
legitimately due to the State.Accordingly, the decision appealed from is
hereby affirmed, with costs against petitioner.

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