Madrigal vs Rafferty

Facts: Vicente Madrigal and Susan Paterno are legally married under a conjugal partnership. Madrigal
filed a sworn declartion of total net income of P296,302.73 for 1914. However, Madrigal claimed that
P296,302.73 did not represent his income but was in fact the income of the conjugal partnership. He
further claimed 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 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 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.

Issue: Whether in applying the additional income tax the net income must be divided into two equal
parts because it is a conjugal partnership of gains?

Ruling: No. 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. A tax on income is not a tax on property. "Income," as here used, can be
defined as "profits or gains."

We turn for a moment to consider the provisions of the Civil Code dealing with the conjugal
partnership.

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.