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INCOME TAXATION Sec. 83. Distribution of dividends or assets by corporations.

IX. Income (b) Stock dividends A stock dividend representing the


a. Definition, Income vs. Capital transfer of surplus to capital account shall not be subject to
tax. However, if a corporation cancels or redeems stock
COMMISSIONER OF INTERNAL REVENUE vs. COURT OF issued as a dividend at such time and in such manner as to
APPEALS make the distribution and cancellation or redemption, in
whole or in part, essentially equivalent to the distribution of
By: Alona Suzell B. Ruyeras a taxable dividend, the amount so distributed in redemption
or cancellation of the stock shall be considered as taxable
*Caveat: Long and Complicated Case. Several emphasis were income to the extent it represents a distribution of earnings
supplied to aid in understanding  or profits accumulated after March first, nineteen hundred
and thirteen. (Italics supplied).
Facts:
*CIR’s Contention: Petitioner contends that the exchange
Sometime in the 1930s, Don Andres Soriano, a citizen and resident transaction is tantamount to cancellation under Section 83(b) making
of the United States, formed the corporation A. Soriano Y Cia, the proceeds thereof taxable. It also argues that the said Section
predecessor of ANSCOR. ANSCOR is wholly owned and controlled applies to stock dividends which is the bulk of stocks that ANSCOR
by the family of Don Andres, who are all non-resident aliens. In 1937, redeemed. Further, petitioner claims that under the net effect test,
Don Andres subscribed to 4,963 shares of the 5,000 shares originally the estate of Don Andres gained from the redemption. Accordingly, it
issued. 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
Several times, ANSOCOR declared stock dividends. Revenue Act.
On December 28, 1967, Doa Carmen requested a ruling from the *ANSOCOR’s contention: ANSCOR, however, avers that it has no
United States Internal Revenue Service (IRS), inquiring if an duty to withhold any tax either from the Don Andres estate or from
exchange of common with preferred shares may be considered as a Doa Carmen based on the two transactions, because the same were
tax avoidance scheme under Section 367 of the 1954 U.S. Revenue done for legitimate business purposes which are (a) to reduce its
Act. By January 2, 1968, ANSCOR reclassified its existing 300,000 foreign exchange remittances in the event the company would
common shares into 150,000 common and 150,000 preferred shares. declare cash dividends, and to (b) subsequently filipinized ownership
of ANSCOR, as allegedly envisioned by Don Andres.
In a letter-reply dated February 1968, the IRS opined that the
exchange is only a recapitalization scheme and not tax avoidance. Issue:
Consequently, on March 31, 1968 Doa Carmen exchanged her
whole 138,864 common shares for 138,860 of the newly W/N ANSCORs redemption of stocks from its stockholder as
reclassified preferred shares. The estate of Don Andres in turn, well as the exchange of common with preferred shares can be
exchanged 11,140 of its common shares for the remaining considered as essentially equivalent to the distribution of
11,140 preferred shares, thus reducing its (the estate) common taxable dividend, making the proceeds thereof taxable under the
shares to 127,727. provisions of the above-quoted law.
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 Ruling:
stock to P75M divided into 150,000 preferred shares and 600,000
common shares. About a year later, ANSCOR again redeemed AS TO REDEMPTION – TAXABLE; AS TO EXCHANGE TO
80,000 common shares from the Don Andres estate, further PREFERRED STOCKS – NOT TAXABLE
reducing the latters common shareholdings to 19,727. As stated in
the board Resolutions, ANSCORs business purpose for both TAX ON STOCK DIVIDENDS
redemptions of stocks is to partially retire said stocks as treasury
shares in order to reduce the company‘s foreign exchange *GENERAL RULE: A stock dividend representing the transfer of
remittances in case cash dividends are declared. surplus to capital account shall not be subject to tax.

In 1973, after examining ANSCORs books of account and records, Stock dividends, strictly speaking, represent capital and do
Revenue examiners issued a report proposing that ANSCOR be not constitute income to its recipient. So that the mere issuance
assessed for deficiency withholding tax-at-source, pursuant to thereof is not yet subject to income tax as they are nothing but an
Sections 53 and 54 of the 1939 Revenue Code, for the year 1968 enrichment through increase in value of capital investment.
and the second quarter of 1969 based on the transactions of
exchange and redemption of stocks. In a loose sense, stock dividends issued by the corporation,
are considered unrealized gain, and cannot be subjected to income
The bone of contention is the interpretation and application of tax until that gain has been realized. Before the realization, stock
Section 83(b) of the 1939 Revenue Act which provides: dividends are nothing but a representation of an interest in the
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corporate properties. As capital, it is not yet subject to income tax. transaction between the shareholder-income taxpayer and the
It should be noted that capital and income are different. Capital acquiring (redeeming) corporation. It is also important to know
is wealth or fund; whereas income is profit or gain or the flow of whether the issuance of stock dividends was dictated by legitimate
wealth. The determining factor for the imposition of income tax business reasons, the presence of which might negate a tax evasion
is whether any gain or profit was derived from a transaction. plan.

*EXCEPTION: If a corporation cancels or redeems stock issued ANSCOR invoked two reasons to justify the redemptions
as a dividend at such time and in such manner as to make the (1) the alleged filipinization program and (2) the reduction of foreign
distribution and cancellation or redemption, in whole or in part, exchange remittances in case cash dividends are declared.
essentially equivalent to the distribution of a taxable dividend,
the amount so distributed in redemption or cancellation of the The two purposes invoked by ANSCOR under the facts of
stock shall be considered as taxable income to the extent it this case are no excuse for its tax liability. First, the alleged
represents a distribution of earnings or profits. filipinization plan cannot be considered legitimate as it was not
implemented until the BIR started making assessments on the
Redemption and cancellation are generally considered capital proceeds of the redemption. Secondly, assuming arguendo, that
transactions, as such, they are not subject to tax. However, it does those business purposes are legitimate, the same cannot be a valid
not necessarily mean that a shareholder may not realize a taxable excuse for the imposition of tax. Otherwise, the taxpayers liability to
gain from such transactions. Simply put, depending on the pay income tax would be made to depend upon a third person who
circumstances, the proceeds of redemption of stock dividends are did not earn the income being taxed.
essentially distribution of cash dividends, which when paid becomes
the absolute property of the stockholder. Having realized gain from The three elements in the imposition of income tax are:
that redemption, the income earner cannot escape income tax. (1) there must be gain or profit, (2) that the gain or profit is
realized or received, actually or constructively, and (3) it is not
No decisive test can be used to determine the application of the exempted by law or treaty from income tax. Any business
exemption under Section 83(b). On this aspect, American courts purpose as to why or how the income was earned by the
developed certain recognized criteria, which includes the following: taxpayer is not a requirement.

1) The presence or absence of real business purpose, After considering the manner and the circumstances by
which the issuance and redemption of stock dividends were made,
2) The amount of earnings and profits available for the there is no other conclusion but that the proceeds thereof are
declaration of a regular dividend and the corporations past essentially considered equivalent to a distribution of taxable
record with respect to the declaration of dividends, dividends.

3) The effect of the distribution as compared with the *EXCHANGE OF COMMON WITH PREFERRED SHARES
declaration of regular dividend,
The exchange of common stocks with preferred stocks, or
4) The lapse of time between issuance and redemption, preferred for common or a combination of either for both, may not
produce a recognized gain or loss, so long as the provisions of
5) The presence of a substantial surplus and a generous Section 83(b) is not applicable.
supply of cash which invites suspicion as does a meager
policy in relation both to current earnings and accumulated Both the Tax Court and the Court of Appeals found that
surplus. ANSCOR reclassified its shares into common and preferred, and that
parts of the common shares of the Don Andres estate and all of Doa
*REDEMPTION AND CANCELLATION Carmens shares were exchanged for the whole 150, 000 preferred
shares. Thereafter, both the Don Andres estate and Doa Carmen
For the exempting clause of Section 83(b) to apply, it is remained as corporate subscribers except that their subscriptions
indispensable that: (a) there is redemption or cancellation; (b) the now include preferred shares. There was no change in their
transaction involves stock dividends and (c) the time and manner of proportional interest after the exchange. There was no cash flow.
the transaction makes it essentially equivalent to a distribution of Both stocks had the same par value. Under the facts herein, any
taxable dividends. Of these, the most important is the third. difference in their market value would be immaterial at the time of
exchange because no income is yet realized it was a mere corporate
With respect to the third requisite, ANSCOR redeemed
paper transaction. It would have been different, if the exchange
stock dividends issued just 2 to 3 years earlier. The time alone that
transaction resulted into a flow of wealth, in which case income tax
lapsed from the issuance to the redemption is not a sufficient
may be imposed.
indicator to determine taxability. It is a must to consider the factual
circumstances as to the manner of both the issuance and the There is only a modification of the subscribers rights and
redemption. The time element is a factor to show a device to evade privileges - which is not a flow of wealth for tax purposes. The issue
tax and the scheme of cancelling or redeeming the same shares is a of taxable dividend may arise only once a subscriber disposes of his
method usually adopted to accomplish the end sought. Was this entire interest and not when there is still maintenance of proprietary
transaction used as a continuing plan, device or artifice to evade interest.
payment of tax? It is necessary to determine the net effect of the
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half his declared income in computing for his tax since he is arguing
that he has a conjugal partnership with his wife. However, the court
C. When income is taxable ruled that the one that should be taxed is the income which is the
flow of the capital, thus it should not be divided into 2.
MADRIGAL vs. RAFFETY

By: Emmy Buniel


FISHER vs TRINIDAD (1922)
Facts:
By: Kim Lorenzo Calatrava
Vicente Madrigal and Susana Paterno were legally married prior to
Januray 1, 1914. The marriage was contracted under the provisions
Facts:
of law concerning conjugal partnership. In 1915, Madrigal filed a
declaration of his net income for year 1914, the sum of P296,302.73.
Frederick Fisher was a stockholder of Philippine American Drug
Vicente Madrigal was contending that the said declared income does
not represent his income for the year 1914 as it was the income of Company, a domestic corporation. For the year 1919 he declared a
his conjugal partnership with Paterno. He said that in computing for ―stock dividend‖ in the amount of P24,800 for which he was
his additional income tax, the amount declared should be divided by subsequently taxed by the respondent Collector of Internal Revenue
2. The revenue officer was not satisfied with Madrigal‘s explanation for the sum of P889.91 as income tax. Fisher paid under protest and
and ultimately, the United States Commissioner of Internal Revenue brought action for recovery. Trinidad demurred which was sustained
decided against the claim of Madrigal. hence this appeal.
Madrigal paid under protest, and the couple decided to recover the
Issue:
sum of P3,786.08 alleged to have been wrongfully and illegally
assessed and collected by the CIR.
W/N stock dividends are income taxable under Sec. 25 of Act No.
Issue: 2833 (The Income Tax Law)

Whether or not the income reported by Madrigal on 1915 should be HELD:


divided into 2 in computing for the additional income tax.
No. It is well-settled that stock dividends represent undistributed
Ruling: increase in the capital of corporations or firms, joint stock companies,
etc., for a particular period. The inventory of the property of the
No! The point of view of the CIR is that the Income Tax Law, as the
name implies, taxes upon income and not upon capital and property. corporation for particular period shows an increase in its capital, so
The essential difference between capital and income is that capital is that the stock theretofore issued does not show the real value of the
a fund; income is a flow. stockholder's interest, and additional stock is issued showing the
increase in the actual capital, or property, or assets of the
A fund of property existing at an instant of time is called capital. A corporation.
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 In the case of Gray vs. Darlington (82 U.S., 653), the US Supreme
such fund through a period of time is called income. Capital is wealth,
while income is the service of wealth. Court held that mere advance in value does not constitute the
"income" specified in the revenue law as "income" of the owner for
Paterno has an inchoate right in the property of her husband the year in which the sale of the property was made. Such advance
Madrigal during the lifetime of the conjugal property. She has an constitutes and can be treated merely as an increase of capital.
interest in the ultimate ownership of property acquired as income of
the conjugal partnership. Not being seized of the separate estate, In the case of Towne vs. Eisner, income was defined in an income
Paterno cannot make a separate return in order to receive the benefit tax law to mean cash or its equivalent, unless it is otherwise specified.
of the exemption which would arise by reason of the additional tax.
It does not mean unrealized increments in the value of the property.
As she has no estate or income, actually and legally vested in her A stock dividend really takes nothing from the property of the
and entirely distinct from her husband property, the income cannot corporation, and adds nothing to the interests of the shareholders. Its
properly be considered the separate income of the wife for the property is not diminished and their interests are not increased. The
purpose of the additional tax. The income tax law does not look on proportional interest of each shareholder remains the same. In short,
the spouses as individual partners in an ordinary partnership. the corporation is no poorer and the stockholder is no richer than
As Paterno has no estate and income, actually and legally vested in they were before.
her and entirely distinct from her husband‘s property, the income
cannot properly be considered the separate income of the wife for In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179), Mr.
the purposes of the additional tax. To recapitulate, Vicente wants to Justice Pitney, said that the term "income" in its natural and obvious
sense, imports something distinct from principal or capital and
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conveying the idea of gain or increase arising from corporate corporation, and sold as a part of the property of the corporation. In
activity. such a case, if all the property of the corporation is sold, then the
stockholder certainly could not be charged with having received an
In the case of Eisner vs. Macomber (252 U.S., 189), income was income by virtue of the issuance of the stock dividend. Until the
defined as the gain derived from capital, from labor, or from both dividend is declared and paid, the corporate profits still belong to the
combined, provided it be understood to include profit gained through corporation, not to the stockholders, and are liable for corporate
a sale or conversion of capital assets. indebtedness. The rule is well established that cash dividend,
whether large or small, are regarded as "income" and all stock
When a corporation or company issues "stock dividends" it shows
dividends, as capital or assets.
that the company's accumulated profits have been capitalized,
instead of distributed to the stockholders or retained as surplus If the ownership of the property represented by a stock dividend is
available for distribution, in money or in kind, should opportunity offer. still in the corporation and not in the holder of such stock, then it is
The essential and controlling fact is that the stockholder has received difficult to understand how it can be regarded as income to the
nothing out of the company's assets for his separate use and benefit; stockholder and not as a part of the capital or assets of the
on the contrary, every dollar of his original investment, together with corporation. If the holder of the stock dividend is required to pay an
whatever accretions and accumulations resulting from employment of income tax on the same, the result would be that he has paid a tax
his money and that of the other stockholders in the business of the upon an income which he never received. Such a conclusion is
company, still remains the property of the company, and subject absolutely contradictory to the idea of an income.
to business risks which may result in wiping out of the entire
investment. The stockholder by virtue of the stock dividend has in As stock dividends are not "income," the same cannot be considered
fact received nothing that answers the definition of an "income." taxes under that provision of Act No. 2833.

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 CONWI vs. COURT OF TAX APPEALS
interest. All the property or capital of the corporation still belongs to
By: Peter Vega
the corporation. There has been no separation of the interest of the
stockholder from the general capital of the corporation. Ratio Decidendi
The stockholder, by virtue of the stock dividend, has no separate or Income of Filipino citizens temporarily residing in a foreign country,
individual control over the interest represented thereby, further than even if totally derived from outside the Philippines, is subject to tax
he had before the stock dividend was issued. He cannot use it for the by virtue of Sec. 21, NIRC, viz: ―A tax is hereby imposed upon the
reason that it is still the property of the corporation and not the taxable net income received x x x from all sources by every individual,
property of the individual holder of stock dividend. A certificate of whether a citizen of the Philippines residing therein or abroad x x x‖
stock represented by the stock dividend is simply a statement of his (italics mine)
proportional interest or participation in the capital of the corporation.
The receipt of a stock dividend in no way increases the money Facts:
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 Hernando Conwi et al. (Conwi et al.) are employees of Procter &
of the capital of the corporation during the particular period, which Gamble Philippine Manufacturing Corporation, a local subsidiary of
may be due to an increased business or to a natural increase of the U.S.-based
Procter & Gamble.
value of the capital due to business, economic, or other reasons. We
believe that the Legislature, when it provided for an "income tax," Conwi et al. were temporarily assigned to subsidiaries of
intended to tax only the "income" of corporations, firms or individuals, Procter & Gamble outside of the Philippines, where they were
as that term is generally used in its common acceptation; that is that paid in U.S. dollars.
the income means money received, coming to a person or
corporation for services, interest, or profit from investments. We do It is claimed that they earned and spent their money exclusively
not believe that the Legislature intended that a mere increase in the abroad, and that they did not remit money back into the
Philippines during the time they were outside of the country earning
value of the capital or assets of a corporation, firm, or individual,
in dollars.
should be taxed as "income."
In the years 1970 and 1971, Conwi et al., since they were earning in
A stock dividend, still being the property of the corporation and not U.S. currency, in order to pay their income tax liabilities in Philippine
the stockholder, may be reached by an execution against the peso, used the prevailing free market rate of conversion
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prescribed under a Bureau of Internal Revenue ruling and two Petition of Conwi et al. DENIED. The denial of their claim for tax
Revenue Memorandum Circulars. However, in 1973, Conwi et al. refund and/or credit by the CTA is AFFIRMED.
filed with the Commissioner of Internal Revenue (CIR) amended
income tax returns for the said years, this time using the par value
of the peso as conversion rate. The adjustment caused a
disparity between what was initially paid and what they were now ii. Realization
claiming to be their actual tax liabilities. Consequently, they asked 2. Actual vs. Constructive Receipt
for a refund of the “overpayment.”
LIMPAN INVESTMENT CORPORATION vs. CIR
Even before the CIR could rule on the matter, Conwi et al. filed a
petition for review before the Court of Tax Appeals (CTA), which By: Kelvin John Du
eventually denied their claim for tax refund and/or tax credit.
Facts:
Aggrieved, Conwi et al., via a petition for review, elevated the matter
to the Supreme Court. Limpan is a domestic corporation engaged in the business of leasing
real properties. Its principal stockholders are the spouses Isabelo P.
Lim and Purificacion Ceñiza de Lim, who own and control 99% of its
Issues & Arguments total paid-up capital.

W/N the ruling and circulars above apply to Conwi et al. Limpan duly filed its 1956 and 1957 income tax returns reporting
therein net incomes of P3,287.81 and P11,098.36, respectively. BIR
(Note: Conti et al. argue that since there were no remittances and conducted an investigation and discovered and ascertained that
acceptances of their salaries and wages in U.S. dollars into the Limpan had underdeclared its rental incomes by P20,199.00 (1956)
Philippines, they are exempt from the coverage of such ruling and and P81,690.00 (1957) and had claimed excessive depreciation of its
circulars.) buildings. CIR issued its letter-assessment and demand for payment
of deficiency income tax and surcharge.
Held & Rationale
YES, the said ruling and circulars apply to Conwi et al. Limpan, through its Secretary-Treasurer, Vicente G. Solis, admitted
that it had omitted to report P12,100.00 as rental income in its 1956
―Income‖ may be defined as ―an amount of money coming to a tax return and P29,350.00 in 1957. However, with respect to the
person or corporation within a specified time, whether as payment for difference between the admittedly undeclared sum of P29,350.00
services, interest, or profit from investment. x x x ‗Income‘ can also and that found by CIR as unreported rental income (P81,690.00) in
be thought of as a flow of the fruits of one‘s labor.‖ (See pages 87-88 1957, Solis also tried to establish that Limpan did not receive or
of the case) collect the same but that its president, Isabelo, collected part thereof
and may have reported the same in his own personal income tax
The dollar earnings of Conwi et al. are fruits of their labor in the return; that Isabelo collected P13,500.00, which he turned over to
foreign subsidiaries of Procter & Gamble. They were given a definite petitioner in 1959 only; that a certain tenant (Go Tong) deposited in
amount of money which came to them within a specified period of court his rentals (P10,800.00), over which the corporation had no
time as payment for their services. actual or constructive control and which were withdrawn only in 1958;
Sec. 21, NIRC, states: ―A tax is hereby imposed upon the taxable net and that a sub-tenant paid P4,200.00 which ought not be declared as
income received x x x from all sources by every individual, rental income in 1957.
whether a citizen of the Philippines residing therein or abroad x
x x‖ Issue:

As such, their income is taxable even if there were no inward WON Limpan is deemed to have constructively received rentals for
remittances during the time they were earning in dollars abroad. 1957 and therefore should be liable for the unreported rental income
for 1957
The ruling and the circulars are a valid exercise of power on the
part of the Secretary of Finance by virtue of Sec. 338, NIRC, which Ruling:
empowers him “to promulgate all needful rules and regulations”
to effectively enforce its provisions. Yes. Limpan's denial and explanation of the non-receipt of the
remaining unreported income for 1957 is not substantiated by
Besides, they have already paid their taxes using the prescribed satisfactory corroboration. Isabelo was not presented as witness to
rate of conversion. There is no need for the CIR to give them a confirm accountant Solis nor was his 1957 personal income tax
tax refund and/or credit. return submitted in court to establish that the rental income which he
allegedly collected and received in 1957 were reported therein.

Fallo The withdrawal in 1958 of the deposits in court pertaining to the 1957
rental income is no sufficient justification for the non-declaration of

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said income in 1957, since the deposit was resorted to due to the P53,613,000.00. Therefore, SMI-Ed Philippines must still pay the
refusal of Limpan to accept the same, and was not the fault of its balance of P8,935,500.00 as deficiency tax.
tenants; hence, Limpan is deemed to have constructively received
such rentals in 1957. The payment by the sub-tenant in 1957 should SMI-Ed Philippines filed a petition for review before the SC praying
have been reported as rental income in said year, since it is income for the grant of its claim for refund and the reversal of the Court of
just the same regardless of its source.
Tax Appeals En Banc‘s decision.

c.Tax Treatment
Issue:
iii. Capital Gains Tax
2. Real Property (Domestic Corp.)
W/N the sale of SMI’s equipment and machineries is subject to a
SMI-ED PHILIPPINES vs CIR 6% capital gains tax? (NO)

By: Rea Romero

Facts: Ruling:
The CTA found that the properties of SMI were subject to capital
SMI-Ed Philippines is a PEZA-registered corporation authorized ―to gains tax. For petitioner‘s properties to be subjected to capital gains
engage in the business of manufacturing ultra high-density tax, the properties must form part of petitioner‘s capital assets.
microprocessor unit package. After its registration SMI-Ed Philippines
constructed buildings and purchased machineries and equipment. Section 39(A)(1) of the National Internal Revenue Code of 1997
SMI-Ed Philippines ―failed to commence operations.” Its factory defines ―capital assets‖:
was temporarily closed, it sold its buildings and some of its
installed machineries and equipment to Ibiden Philippines, Inc., SEC. 39. Capital Gains and Losses. -
another PEZA-registered enterprise. SMI was subsequently
dissolved. (A) Definitions. - As used in this Title -

In its quarterly income tax return for year 2000, SMI-Ed Philippines (1) Capital Assets. - the term ‗capital assets‘ means
subjected the entire gross sales of its properties to 5% final tax property held by the taxpayer (whether or not connected
on PEZA-registered corporations. SMI-Ed Philippines paid taxes with his trade or business), but does not include stock in
amounting to P44,677,500.00. trade of the taxpayer or other property of a kind which
would properly be included in the inventory of the taxpayer
After requesting the cancellation of its PEZA registration and if on hand at the close of the taxable year, or property held
amending its articles of incorporation to shorten its corporate term, by the taxpayer primarily for sale to customers in the
SMI-Ed Philippines filed an administrative claim for the refund of ordinary course of his trade or business, or property used
P44,677,500.00 with the Bureau of Internal Revenue (BIR). SMI-Ed in the trade or business, of a character which is subject to
Philippines alleged that the amount was erroneously paid. It also the allowance for depreciation provided in Subsection (F)
alleged that it incurred a net loss of P2,233,464,538.00. of Section 34; or real property used in trade or business of
the taxpayer.
The BIR did not act on SMI-Ed Philippines‘ claim, which prompted
the latter to file a petition for review before the Court of Tax Appeals. Thus, ―capital assets‖ refers to taxpayer‘s property that is NOT any of
Court of Tax Appeals Second Division found that the fiscal incentives the following:
given to PEZA-registered enterprises may be availed only by PEZA-
registered enterprises that had already commenced operations. 1. Stock in trade;
Since SMI-Ed Philippines had not commenced operations, it was not 2. Property that should be included in the taxpayer‘s inventory
entitled to the incentives of either the income tax holiday or the 5% at the close of the taxable year;
preferential tax rate. Payment of the 5% preferential tax amounting to 3. Property held for sale in the ordinary course of the
P44,677,500.00 was erroneous. taxpayer‘s business;
4. Depreciable property used in the trade or business; and
The Court of Tax Appeals Second Division subjected the sale of SMI- 5. Real property used in the trade or business.
Ed Philippines‘ assets to 6% capital gains tax under Section 27(D)(5)
of the same Code and Section 2 of Revenue Regulations No. 8-98. It The properties involved in this case include petitioner‘s buildings,
was found liable for capital gains tax amounting to equipment, and machineries. They are not among the exclusions
enumerated in Section 39(A)(1) of the National Internal Revenue
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Code of 1997. Based on the definition of capital assets under business of a corporation and are treated as capital assets,
Section 39 of the National Internal Revenue Code of 1997, they based on the gross selling price of fair market value as
are capital assets. determined in accordance with Section 6(E) of this Code,
whichever is higher, of such lands and/or buildings.
Respondent (CIR) insists that since petitioner‘s machineries and (Emphasis supplied)
equipment are classified as capital assets, their sales should be
subject to capital gains tax. Respondent is mistaken.
Therefore, only the presumed gain from the sale of petitioner’s
Capital gains of individuals and corporations from the sale of real land and/or building may be subjected to the 6% capital gains
properties are taxed differently.Individuals are taxed on capital gains tax. The income from the sale of petitioner’s machineries and
from sale of all real properties located in the Philippines and equipment is subject to the provisions on normal corporate
classified as capital assets. Thus: income tax.

SEC. 24. Income Tax Rates. To determine, therefore, if petitioner is entitled to refund, the amount
of capital gains tax for the sold land and/or building of petitioner and
(D) Capital Gains from Sale of Real Property. – the amount of corporate income tax for the sale of petitioner‘s
machineries and equipment should be deducted from the total final
(1) In General. - The provisions of Section 39(B) tax paid.
notwithstanding, a final tax of six percent (6%) based on
the gross selling price or current fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, is hereby imposed upon capital gains 4. Interests
presumed to have been realized from the sale, exchange,
DUMAGUETE CATHEDRAL CREDIT COOPERATIVE [DCCCO],
or other disposition of real property located in the
Represented by Felicidad L. Ruiz vs. COMMISSIONER OF
Philippines, classified as capital assets, including pacto de
INTERNAL REVENUE
retro sales and other forms of conditional sales, by
individuals, including estates and trusts: Provided, That the By: Ray Gingco
tax liability, if any, on gains from sales or other dispositions
of real property to the government or any of its political Facts:
subdivisions or agencies or to government-owned or
controlled corporations shall be determined either under Dumaguete Cathedral Credit Cooperative (DCCCO) is a cooperative
Section 24 (A) or under this Subsection, at the option of the duly registered with the the Cooperative Development Agency (CDA).
taxpayer On 27 November 2001 the BIR issued Letters of Authority
authorizing BIR Officers Rambuyon and Cubillan to examine
For corporations, the National Internal Revenue Code of 1997 treats DCCCO‘s books of accounts and other accounting recirds for internal
the sale of land and buildings, and the sale of machineries and revenue taxes for the taxable years 1999 and 2000.
equipment, differently. Domestic corporations are imposed a 6%
DCCCO received Preliminary Assessment Notices for deficiency
capital gains tax only on the presumed gain realized from the sale of
withholding taxes. The deficiency withholding taxes cover the
lands and/or buildings. The National Internal Revenue Code of 1997
payments of the honorarium of the Board of Directors, security and
does not impose the 6% capital gains tax on the gains realized from
janitorial services, legal and professional fees, and interest on
the sale of machineries and equipment. Section 27(D)(5) of the
savings and time deposits of its members. DCCCO contended that it
National Internal Revenue Code of 1997 provides:
should not be made to pay the withholding taxes for the interest on
SEC. 27. Rates of Income tax on Domestic savings and time deposit as well as the delinquency interest pursuant
Corporations. - to Section 24 (b) (1) of the NIRC which states:
. . . .
SECTION 24. Income Tax Rates. —
(D) Rates of Tax on Certain Passive Incomes. -
. . . . xxxx
(5) Capital Gains Realized from the Sale, Exchange or
Disposition of Lands and/or Buildings. - A final tax of six (B) Rate of Tax on Certain Passive Income: —
percent (6%) is hereby imposed on the gain presumed to
have been realized on the sale, exchange or disposition of (1) Interests, Royalties, Prizes, and Other Winnings. — A final
tax at the rate of twenty percent (20%) is hereby imposed
lands and/or buildings which are not actually used in the
upon the amount of interest from any currency bank
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deposit and yield or any other monetary benefit from 3. Withholding taxes from compensation of employees
deposit substitutes and from trust funds and similar and savings account and time deposits of members.”
arrangements; x x x
The letter ruling further stated that:

This provision according to DCCCO applies only to banks and ―Since interest from any Philippine currency bank
not to cooperatives, since the phrase "similar arrangements" is deposit and yield or any other monetary benefit from
preceded by terms referring to banking transactions that have deposit substitutes are paid by banks, you are not
deposit peculiarities. Petitioner thus posits that the savings and time the party required to withhold the corresponding tax
deposits of members of cooperatives are not included in the on the aforesaid savings account and time deposits
enumeration, and thus not subject to the 20% final tax. To bolster its of your members.‖
position, petitioner cites BIR Ruling No. 551-888 and BIR Ruling DA-
591-2006 where the BIR ruled that interests from deposits The CTA En Banc stated that the ruling does not hold true if the
maintained by members of cooperative are not subject to withholding savings and time deposits are being maintained in the cooperative,
tax under Section 24(B)(1) of the NIRC. Petitioner further contends for in this case, it is the cooperative which becomes the payor-
that pursuant to Article XII, Section 15 of the Constitution and Article corporation, a separate entity acting no more than an agent of the
2 of Republic Act No. 6938 (RA 6938) or the Cooperative Code of the government for the collection of taxes, liable to withhold the
Philippines, cooperatives enjoy a preferential tax treatment which corresponding taxes on the interests earned.
exempts their members from the application of Section 24(B)(1) of
the NIRC. The Supreme Court however held that there is nothing in the ruling to
suggest that it applies only when deposits are maintained in a bank.
As counter-argument the CIR invoked the legal maxim ― Ubi lex non Rather, the ruling clearly states, without any qualification, that since
distinguit nec nos distinguere debemos‖ (where the law does not interest from any Philippine currency bank deposit and yield or any
distinguish, the courts should not distinguish.) CIR maintains t hat other monetary benefit from deposit substitutes are paid by banks,
Section 24 (b) (1) of the NIRC applies to cooperatives as the phrase cooperatives are not required to withhold the corresponding tax on
―similar arrangements‖ is not limited to banks but includes the interest from savings and time deposits of their members. This
cooperatives that are depositaries of their members. Regarding this interpretation was reiterated in BIR Ruling [DA-591-2006] dated
exemption relied upon by DCCCO, the CIR avers to the rule that tax October 5, 2006, which was issued by Assistant Commissioner
exemptions are highly disfavored and construed strictissimi juris James H. Roldan upon the request of the cooperatives for a
against the taxpayer and liberally in favor of the taxing power. confirmatory ruling on several issues, among which is the alleged
exemption of interest income on members‘ deposit (over and above
Issue: the share capital holdings) from the 20% final withholding tax.

Whether or not DCCCO is liable for the payment of the withholding The National Internal Revenue Code states that a "final tax at the
taxes on the interest on savings and time deposits. rate of twenty percent (20%) is hereby imposed upon the amount of
interest on currency bank deposit and yield or any other monetary
Ruling:
benefit from the deposit substitutes and from trust funds and similar
Yes. DCCCO is not liable for the payment of withholding taxes on the arrangement x x x" for individuals under Section 24(B)(1) and for
interest on savings and time deposits. domestic corporations under Section 27(D)(1). Considering the
members’ deposits with the cooperatives are not currency bank
deposits nor deposit substitutes, Section 24(B)(1) and Section
27(D)(1), therefore, do not apply to members of cooperatives
The BIR through Commissioner Tan declared in BIR Ruling No. 551- and to deposits of primaries with federations, respectively.
888 that:
BIR Ruling No. 551-888 and BIR Ruling [DA-591-2006] are in perfect
―Based on the foregoing representations, you now request in harmony with the Constitution and the laws they seek to implement.
effect a ruling as to whether or not you are exempt from the Accordingly, the interpretation in BIR Ruling No. 551-888 that
following: cooperatives are not required to withhold the corresponding tax on
the interest from savings and time deposits of their members, which
1. Payment of sales tax was reiterated in BIR Ruling [DA-591-2006], applies to the instant
case.
2. Filing and payment of income tax
Members of cooperatives deserve a preferential tax treatment
pursuant to RA 6938, as amended by RA 9520. Given that petitioner
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is a credit cooperative duly registered with the Cooperative corporation cancels or redeems stock issued as a
Development Authority (CDA), Section 24(B)(1) of the NIRC must be dividend at such time and in such manner as to
read together with RA 6938, as amended by RA 9520. 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
7. Dividends
cancellation of the stock shall be considered as
CIR vs. SORIANO taxable income to the extent it represents a
distribution of earnings or profits accumulated
By: Katherina Gumboc after March first, nineteen hundred and thirteen.

Facts: CIR contends that:

ANSCOR, presently called "A. Soriano Y Cia", is a corporation wholly 1. The exchange transaction is tantamount to
owned and controlled by the family of Don Andres Soriano (US cancellation under Section 83(b) making the
citizen) who are all non-resident aliens. ANSCOR has P1M proceeds thereof taxable;
2. It also argues that Section 83 applies to stock
capitalization divided into 10k common shares at a par value of
dividends which is the bulk of stocks that ANSCOR
P100/share. In 1937, Don Andres subscribed to 4,963 shares of the redeemed;
5k shares originally issued. Later on, ANSCOR‘s authorized capital 3. Under the net effect test, the estate of Don Andres
stock was increased to P2,500M divided into 25k common shares gained from the redemption. Accordingly, it was the
with the same par value. When Don Andres died, he has a total duty of ANSCOR to withhold the tax-at-source
shareholdings of 185,154 shares – 50,495 of which are original arising from the two transactions, pursuant to
issues and the balance of 134,659 shares as stock dividend Section 53 and 54 of the 1939 Revenue Act
declarations. Correspondingly, one-half of that shareholdings or
92,577 shares were transferred to his wife, Doña Carmen Soriano, ANSCOR countered that:
as her conjugal share. The other half formed part of his estate.
Throughout the year, ANSCOR increased its capital stock and its 1. It has no duty to withhold any tax either from the Don
accumulated shareholdings. Andres estate or from Doña Carmen based on the two
transactions, because the same were done for legitimate
On January 2, 1968, ANSCOR reclassified its existing 300k common business purposes which are:
shares into 150k common and 150k preferred shares. Upon inquiry a. To reduce its foreign exchange remittances in the
from the United States Internal Revenue Service (USIR) that an event the company would declare cash dividends,
and
exchange of common with preferred shares is only a recapitalization
b. To subsequently "Filipinized" ownership of
scheme and not tax avoidance, Doña Carmen exchanged her whole ANSCOR, as allegedly, envisioned by Don
138,864 common shares for 138,860 of the newly reclassified Andres.
preferred shares.
Issue:
Pursuant to a Board Resolution, ANSCOR started redeeming
common shares from Don Andres‘s estates. ANSCOR‘s business W/N ANSCOR‘s redemption of stocks from its stockholder as well
purpose for both redemptions of stocks is to partially retire said as the exchange of common with preferred shares can be
stocks as treasury shares in order to reduce the company‘s foreign considered as essentially equivalent to the distribution of taxable
exchange remittances in case cash dividends are declared. dividend, making the proceeds thereof taxable under Section 83.

Basing from such, CIR assessed ANSCOR for deficiency withholding Ruling:
tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue
Code, in relation to Section 83(b), based on the transactions of YES. Section 83(b) of the 1939 NIRC was taken from Section
exchange and redemption of stocks. 115(g)(1) of the U.S. Revenue Code of 1928 laid down the general
rule known as the proportionate test wherein stock dividends once
Sec. 83. Distribution of dividends or assets by issued form part of the capital and, thus, subject to income tax.
corporations.
GR: A stock dividend representing the transfer of surplus to capital
(b) Stock dividends. A stock dividend account shall not be subject to tax.
representing the transfer of surplus to capital
account shall not be subject to tax. However, if a In a loose sense, stock dividends issued by the corporation, are
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considered unrealized gain, and cannot be subjected to income tax In 1952 the MANTRASCO had an authorized capital stock of
until that gain has been realized. Before the realization, stock P2,500,000 divided into 25,000 common shares; 24,700 of these
dividends are nothing but a representation of an interest in the were owned by Julius S. Reese, and the rest, at 100 shares each, by
corporate properties. As capital, it is not yet subject to income tax. It the three respondents.
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. On February 29, 1952, in view of Reese‘s desire that upon his death
The determining factor for the imposition of income tax is whether MANTRASCO and its two subsidiaries, MANTRASCO (Guam), Inc.
any gain or profit was derived from a transaction. and the Port Motors, Inc., would continue under the management of
the respondents, a trust agreement on his and the respondents‘
EXC: The exception is if a corporation cancels or redeems stock interests in MANTRASCO was executed by and among Reese
issued as a dividend at such time and in such manner as to make the (therein referred to as OWNER), MANTRASCO (therein referred to
distribution and cancellation or redemption, in whole or in part, as COMPANY), the law firm of Ross, Selph, Carrascoso and Janda
essentially equivalent to the distribution of a taxable dividend, the (therein referred to as TRUSTEES), and the respondents (therein
amount so distributed in redemption or cancellation of the stock shall referred to as MANAGERS).
be considered as taxable income to the extent it represents a
distribution of earnings or profits accumulated after March first, On October 19, 1954 Reese died. The projected transfer of his
nineteen hundred and thirteen. shares in the name of MANTRASCO could not, however, be
immediately effected for lack of sufficient funds to cover initial
It provides that the redemption or cancellation of stock dividends, payment on the shares.
depending on the time and manner it was made is essentially
equivalent to a distribution of taxable dividends, making the proceeds On February 2, 1955, after MANTRASCO made a partial payment of
thereof taxable income to the extent it represents profits. The Reese‘s shares, the certificate for the 24,700 shares in Reese‘s
exception was designed to prevent the issuance and cancellation or name was cancelled and a new certificate was issued in the name of
redemption of stock dividends, which is fundamentally not taxable, MANTRASCO. On the same date, and in the meantime that Reese‘s
from being made use of as a device for the actual distribution of cash interest had not been fully paid, the new certificate was endorsed to
dividends, which is taxable. the law firm of Ross, Selph, Carrascoso and Janda, as trustees for
and in behalf of MANTRASCO.
Although redemption and cancellation are generally considered
capital transactions, as such, they are not subject to tax. However, it On December 22, 1958, at a special meeting of MANTRASCO
does not necessarily mean that a shareholder may not realize a stockholders, the following resolution was passed:
taxable gain from such transactions. Simply put, depending on the
"RESOLVED, that the 24,700 shares in the Treasury be reverted
circumstances, the proceeds of redemption of stock dividends are
back to the capital account of the company as a stock dividend to be
essentially distribution of cash dividends, which when paid becomes
distributed to shareholders of record at the close of business on
the absolute property of the stockholder. Thereafter, the latter
December 22, 1958, in accordance with the action of the Board of
becomes the exclusive owner thereof and can exercise the freedom
Directors at its meeting on December 19, 1958 which action is
of choice. Having realized gain from that redemption, the income
hereby approved and confirmed."
earner cannot escape income tax.
On November 25, 1963 the entire purchase price of Reese‘s interest
CIR vs. MANNING in MANTRASCO was finally paid in full by the latter, On May 4, 1964
the trust agreement was terminated and the trustees delivered to
By: Lyzzaik L. Laguialam MANTRASCO all the shares which they were holding in trust.

Facts: Meanwhile, on September 14, 1962, an examination of


MANTRASCO‘s books was ordered by the Bureau of Internal
This is a petition for review of the decision of the Court of Tax Revenue. The examination disclosed that (a) as of December 31,
Appeals, in CTA case 1626, which set aside the income tax 1958 the 24,700 shares declared as dividends had been
assessments issued by the Commissioner of Internal Revenue proportionately distributed to the respondents, representing a total
against John L. Manning, W.D. McDonald and E.E. Simmons book value or acquisition cost of P7,973,660; (b) the respondents
(hereinafter referred to as the respondents), for alleged undeclared failed to declare the said stock dividends as part of their taxable
stock dividends received in 1958 from the Manila Trading and Supply income.
Co. (hereinafter referred to as the MANTRASCO) valued at
P7,973,660. On the basis of their examination, the BIR examiners concluded that
the distribution of Reese‘s shares as stock dividends was in effect a
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distribution of the "asset or property of the corporation as may be and the issuance to the stockholders of additional shares of stock
gleaned from the payment of cash for the redemption of said stock representing the profits so capitalized."
and distributing the same as stock dividend."
The declaration by the respondents and Reese‘s trustees of
The respondents unsuccessfully challenged the foregoing MANTRASCO‘s alleged treasury stock dividends in favor of the
assessments and, failing to secure a favorable reconsideration, former, brings, however, into clear focus the ultimate purpose which
appealed to the Court of Tax Appeals. the parties to the trust instrument aimed to realize: to make the
respondents the sole owners of Reese‘s interest in MANTRASCO by
On October 30, 1967 the CTA rendered judgment absolving the utilizing the periodic earnings of that company and its subsidiaries to
respondents from any liability for receiving the questioned stock directly subsidize their purchase of the said interests, and by making
dividends on the ground that their respective one-third interest in it appear outwardly, through the formal declaration of non-existent
MANTRASCO remained the same before and after the declaration of stock dividends in the treasury, that they have not received any
stock dividends and only the number of shares held by each of them income from those firms when, in fact, by that declaration they
had changed. secured to themselves the means to turn around as full owners of
Reese‘s shares. In other words, the respondents, using the trust
Issue: Whether or not the stock dividend is taxable.
instrument as a convenient technical device, bestowed unto
Ruling: themselves the full worth and value of Reese‘s corporate holdings
with the use of the very earnings of the companies. Such package
Yes. The parties differ on the taxability of the "treasury" stock device, obviously not designed to carry out the usual stock dividend
dividends received by the respondents. purpose of corporate expansion reinvestment, e.g. the acquisition of
additional facilities and other capital budget items, but exclusively for
The respondents anchor their argument on the same basis as the expanding the capital base of the respondents in MANTRASCO,
Court of Tax Appeals; whereas the Commissioner maintains that the cannot be allowed to deflect the respondents‘ responsibilities toward
full value (P7,973,660) of the shares redeemed from Reese by our income tax laws. The conclusion is thus ineluctable that
MANTRASCO which were subsequently distributed to the whenever the companies involved herein parted with a portion of
respondents as stock dividends in 1958 should be taxed as income their earnings "to buy" the corporate holdings of Reese, they were in
of the respondents for that year, the said distribution being in effect a ultimate effect and result making a distribution of such earnings to
distribution of cash. The respondents‘ interests in MANTRASCO, he the respondents. All these amounts are consequently subject to
further argues, were only .4% prior to the declaration of the stock income tax as being, in truth and in fact, a flow of cash benefits to the
dividends in 1958, but rose to 33 1/3% each after the said declaration. respondents.

In submitting their respective contentions, it is the assumption of both We are of the opinion, however, that the Commissioner erred in
parties that the 24,700 shares declared as stock dividends were assessing the respondents the total acquisition cost (P7,973,660) of
treasury shares. We are however convinced, after a careful study of the alleged treasury stock dividends in one lump sum. The record
the trust agreement, that the said shares were not, on December 22, shows that the earnings of MANTRASCO over a period of years
1958 or at any time before or after that date, treasury shares. The were used to gradually wipe out the holdings therein of Reese.
reasons are quite plain. Consequently, those earnings, which we hold, under the facts
disclosed in the case at bar, as in effect having been distributed to
"‗A stock dividend always involves a transfer of surplus (or profit) to
the respondents, should be taxed for each of the corresponding
capital stock.‘ Graham and Katz, Accounting in Law Practice, 2d ed.
years when payments were made to Reese‘s estate on account of
1938, No. 70. As the court said in United States v. Siegel, 8 Cir.,
his 24,700 shares. With regard to payments made with
1931, 52 F 2d 63, 65, 78 ALR 672: ‗A stock dividend is a conversion
MANTRASCO earnings in 1958 and the years before, while indeed
of surplus or undivided profits into capital stock, which is distributed
those earnings were utilized in those years to gradually pay off the
to stockholders in lieu of a cash dividend.‘ Congress itself has
value of Reese‘s holdings in MANTRASCO, there is no evidence
defined the term ‗dividend‘ in No. 115(a) of the Act as meaning any
from which it can be inferred that prior to the passage of the
distribution made by a corporation to its shareholders, whether in
stockholders‘ resolution of December 22, 1958 the contributed equity
money or in other property, out of its earnings or profits. In Eisner v.
of each of the respondents rose correspondingly. It was only by
Macomber, 1920, 252 US 189, 40 S Ct 189, 64 L Ed 521, 9 ALR
virtue of the authority contained in the said resolution that the
1570, both the prevailing and the dissenting opinions recognized that
respondents actually, albeit illegally, appropriated and partitioned
within the meaning of the revenue acts the essence of a stock
among themselves the stockholders‘ equity representing Reese‘s
dividend was the segregation out of surplus account of a definite
interests in MANTRASCO. As those payments accrued in favor of
portion of the corporate earnings as part of the permanent capital
the respondents in 1958 they are and should be liable, for income tax
resources of the corporation by the device of capitalizing the same,
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purposes, to the extent of the aggregate amount paid, from 1955 to Said distributions were not in the ordinary course of
1958, by MANTRASCO to buy off Reese‘s shares. 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
WISE & CO., INC. vs. MEER
makes them payments for the surrender and
By: Marry Suan relinquishment of the stockholders' interest in the
corporation, or so-called liquidating dividends. The
Facts: determining element therefore is whether the distribution
was in the ordinary course of business and with intent to
On June 1, 1937, Manila Wine Merchants, Ltd., a Hong Kong maintain the corporation as a going concern, or after
company, was liquidated and its capital stock was distributed to its deciding to quit with intent to liquidate the business.
stockholders, one of which is the petitioner, Wise & Co. Inc. Proceedings actually begun to dissolve the corporation or
formal action taken to liquidate it are but evidentiary and
As part of its liquidation, the corporation was sold to Manila Wine
not indispensable.
Merchants., Inc. for P400,000. The said earnings, declared as
dividends, were distributed to its stockholders. The Hong Kong
The distinction between a distribution in liquidation and an
company then paid the income tax for the entire earnings.
ordinary dividend is factual; the result in each case
As a result of the sale of its business and assets, a surplus was depending on the particular circumstances of the case and
realized by the Hong Kong company after deducting the dividends. the intent of the parties. If the distribution is in the nature of
This surplus was also distributed to its stockholders. The Hong Kong a recurring return on stock it is an ordinary dividend.
company also paid the income tax for the said surplus. However, if the corporation is really winding up its business
or recapitalizing and narrowing its activities, the distribution
The petitioners then filed their respective income tax returns. may properly be treated as in complete or partial liquidation
Commissioner Meer, then, made a deficiency assessment charging and as payment by the corporation to the stockholder for
the individual stockholders for taxes on the shares distributed to them his stock.
despite the fact that income tax was already paid by the Hong Kong
company. The petitioners paid the assessed amount in protest. In the case at bar, it was stipulated in the deed of sale that
the sale and transfer of the corporation shall take effect on
Petitioners maintain that the amounts received by them and on which June 1, 1937 while distribution took place on June 8. They
the taxes in question were assessed and collected were ordinary could not consistently deem all the business and assets of
dividends; while upon the other hand, Commissioner Meer contends the corporation sold as of June 1, 1937, and still say that
that they were liquidating dividends. said corporation, as a going concern, distributed ordinary
dividends to them thereafter.
Petitioners also contend that the earnings cannot be considered as
income from the Philippines because the sale was made outside the
2) Yes. Petitioners received the said distributions in exchange
Philippines and is not subject to Philippine tax law for the surrender and relinquishment by them of their stock
in the liquidated corporation. That money in the hands of
Issues: the corporation formed a part of its income and was
properly taxable to it under the Income Tax Law. When the
1) WON the amount received by the petitioners were ordinary corporation was dissolved in the process of complete
dividends or liquidating dividends liquidation and its shareholders surrendered their stock to it
2) WON such dividends were taxable and it paid the sums in question to them in exchange, a
3) WON the profits realized by the non-resident alien transaction took place. The shareholder who received the
individual appellants constitute income from the Philippines consideration for the stock earned received that money as
considering that the sale took place outside the Philippines income of his own, which again was properly taxable to him
under the Income Tax Law.
Ruling:
3) Yes. At the time of the sale, the Hong Kong company was
1) The amount received were liquidating dividends. engaged in its business in the Philippines. Its successor
Liquidating dividends involve the distribution of assets by a was a domestic corporation and doing business also in the
corporation to its stockholders upon dissolution. Philippines. It must be taken into consideration that the
Hong Kong company was incorporated for the purpose of
carrying business in the Philippine Islands. Hence, its
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earnings, profits and assets, including those from whose YES. Terminal leave is applied for by an officer or employee who
proceeds the distribution was made, had been earned and retires, resigns or is separated from the service through no fault of
acquired in the Philippines. It is clear that the distributions his own. Since terminal leave is applied for by an officer or employee
in questions were income ―from Philippine sources‖, hence, who has already severed his connection with his employer and who
taxable under Philippine law. 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.

Section 28(b) 7(b) of the NIRC — Exclusions from gross income. —


The following items shall not be included in gross income and shall
e. Exclusions be exempt from taxation under this title:
1. Retirement Benefits
(7) Retirement benefits, pensions, gratuities, etc.
RE: REQUEST OF ATTY. BERNARDO ZIALCITA
(b) Any amount received by an official or employee or by his
By: JM Banal heirs from the employer as a consequence of separation of
such official or employee from the service of the employer
Facts: due to death, sickness or other physical disability or for any
cause beyond the control of the said official or employee.
The commutation of leave credits is commonly known as terminal
leave. Within the purview of the provisions of the NLRC, compulsory
retirement may be considered as a "cause beyond the control of the
Atty. Zialcita, he rendered government service from March 13, 1962 said official or employee". Consequently, the amount that he received
up to February 15, 1990. The next day, or on February 16, 1990, he by way of commutation of his accumulated leave credits as a result
reached the compulsory retirement age of 65 years. Atty. Zialcita of his compulsory retirement, or his terminal leave pay, fags within
retired under the RA 660, which is incorporated in CA 186. Section the enumerated exclusions from gross income and is therefore not
12(c) states: subject to tax.

... Officials and employees retired under this Act shall be ISSUE: RETIREMENT BENEFITS
entitled to the commutation of the unused vacation leave and
sick leave, based on the highest rate received, which they The terminal leave pay of Atty. Zialcita may likewise be viewed as a
may have to their credit at the time of retirement. "retirement gratuity received by government officials and employees"
which is also another exclusion from gross income as provided for in
Section 28(c) of the same Act, in turn, provides: Section 28(b), 7(f) of the NLRC. 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
(c) Except as herein otherwise provided, the GSIS, all
benefited by the employee's uninterrupted and continuous service. It
benefits granted under this Act, and all its forms and
is in cognizance of this fact that laws were passed entitling retiring
documents required of the members shall be exempt from all
government employees, among others, to the commutation of their
types of taxes, do ... xxx..
accumulated leave credits.
On August 23, 1990, the Court En Banc issued a resolution which
Section 286 of Revised Administrative Code, as amended by RA
states, among others:
1081, provides that "whenever any officer, employee or laborer of the
Government of the Philippines shall voluntarily resign or be
The terminal leave pay of Atty. Zialcita received by virtue of separated from the service through no fault of his own, he shall
his compulsory retirement can never be considered a part of be entitled to the commutation of all accumulated vacation and/or
his salary subject to the payment of income tax but falls sick leave to his credit: ..." Executive Order No. 1077, removed the
under the phrase "other similar benefits received by retiring limitation on the number of leave days that may be accumulated and
employees and workers", within the meaning of Section 1 of explicitly allowing retiring government employees to commute their
PD No. 220 and is thus exempt from the payment of income accumulated leaves. The commutation of accumulated leave credits
tax. may thus be considered a retirement gratuity.

Issue #1: Section 284 of the Revised Administrative Code grants to a


Whether terminal leave pay by virtue of compulsory retirement is government employee 15 days vacation leave and 15 days sick
exempt from taxation? leave for every year of service. Hence, even if the government
employee absents himself and exhausts his leave credits, he is
Ruling: still deemed to have worked and to have rendered services. His
leave benefits are already imputed in, and form part of, his salary
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which in turn is subjected to withholding tax on income. He is taxed PAGCOR‘s contention that the law violated the constitution is not
on the entirety of his salaries without any deductions for any leaves tenable. The equal protection clause provides that all persons or
not utilized. It follows then that the money values corresponding to things similarly situated should be treated alike, both as to rights
these leave benefits both the used and unused have already been
conferred and responsibilities imposed.
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 The general rule is: ALL GOCC‘s are subject to income taxation.
to tax the employee a second time. This is tantamount to double However, certain classes of GOCC‘s may be exempt from income
taxation. taxation based on the following requisites for a valid classification
under the principle of equal protection:

1) It must be based on substantial distinctions.


2. Income Derived by Government or Its Political Subdivisions 2) It must be germane to the purposes of the law.
a. Withdrawal of Tax Exemption of PAGCOR 3) It must not be limited to existing conditions only.
4) It must apply equally to all members of the class.
PAGCOR vs. BIR
By: Ana Grace Lapu The Supreme Court (SC) held that the omission of PAGCOR from
the list of tax-exempt GOCCs by RA 9337 does not violate the right
Facts: to equal protection of the laws under Section 1, Article III of the
Constitution, because PAGCOR‘s exemption from payment of
The Philippine Amusement and Gaming Corporation (PAGCOR) was corporate income tax was not based on classification showing
created by P.D. No. 1067-A in 1977. Obviously, it is a government substantial distinctions; rather, it was granted upon the corporation‘s
owned and controlled corporation (GOCC). own request to be exempted from corporate income tax.

In 1998, R.A. 8424 or the National Internal Revenue Code of 1997 Legislative records likewise reveal that the legislative intention is to
(NIRC) became effective. Section 27 thereof provides that GOCC‘s require PAGCOR to pay corporate income tax.
are NOT EXEMPT from paying income taxation but it exempted the
following GOCCs: With regard to the issue that the removal of PAGCOR from the
1. GSIS exempted list violates the non-impairment clause contained in
2. SSS Section 10, Article III of the Constitution — which provides that no
3. PHILHEALTH law impairing the obligation of contracts shall be passed — the SC
4. PCSO explained that following its previous ruling in the case of Manila
5. PAGCOR
Electric Company v. Province of Laguna 366 Phil. 428(1999), this
But in May 2005, R.A. 9337, a law amending certain provisions of does not apply.
R.A. 8424, was passed. Section 1 thereof excluded PAGCOR from
the exempt GOCCs hence PAGCOR was subjected to pay income Franchises such as that granted to PAGCOR partake of the nature of
taxation. In September 2005, the Bureau of Internal Revenue issued a grant, and is thus beyond the purview of the non-impairment clause
the implementing rules and regulations (IRR) for R.A. 9337. In the of the Constitution. As regards the liability of PAGCOR to VAT, the
said IRR, it identified PAGCOR as subject to a 10% value added tax SC finds (Section 4. 108-3) of Revenue Regulations No. (RR) 16-
(VAT) upon items covered by Section 108 of the NIRC (Sale of 2005, which subjects PAGCOR and its licensees and franchisees to
Services and Use or Lease of Properties). VAT, null and void for being contrary to the National Internal
Revenue Code (NIRC), as amended by RA 9337.
PAGCOR questions the constitutionality of Section 1 of R.A. 9337 as
well as the IRR. PAGCOR avers that the said provision violates the According to the SC, RA 9337 does not contain any provision that
equal protection clause. PAGCOR argues that it is similarly situated subjects PAGCOR to VAT. Instead, the SC finds support to the
with SSS, GSIS, PCSO, and PHILHEALTH, hence it should not be VAT exemption of PAGCOR under Section 109(k) of the Tax
excluded from the exemption. Code, which provides that transactions exempt under
international agreements to which the Philippines is a signatory
Issue: or under special laws [except Presidential Decree No. (PD) 529]
Whether or not PAGCOR should be subjected to income taxation. are exempt from VAT. Considering that PAGCOR‘s charter, i.e.,
PD1869 — which grants PAGCOR exemption from taxes — is a
Ruling: Yes. special law, it is exempt from payment of VAT. Accordingly, the SC
held that the BIR exceeded its authority in subjecting PAGCOR to
VAT, and thus declared RR 16-05 null and void — insofar as it
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subjects PAGCOR to VAT — for being contrary to the NIRC, as Philippines alleged that the amount was erroneously paid. It also
amended by RA 9337. alleged that it incurred a net loss of P2,233,464,538.00.
PAGCOR is subject to income tax but remains exempt from the
imposition of value-added tax. The BIR did not act on SMI-Ed Philippines‘ claim, which prompted
the latter to file a petition for review before the Court of Tax Appeals.
With the amendment by R.A. No. 9337 of Section 27 (c) of the Court of Tax Appeals Second Division found that the fiscal incentives
National Internal Revenue Code of 1997 by omitting PAGCOR from given to PEZA-registered enterprises may be availed only by PEZA-
the list of government corporations exempt for income tax, the registered enterprises that had already commenced operations.
legislative intent is to require PAGCOR to pay corporate income tax. Since SMI-Ed Philippines had not commenced operations, it was not
However, nowhere in R.A. No. 9337 is it provided that PAGCOR can entitled to the incentives of either the income tax holiday or the 5%
be subjected to VAT. Thus, the provision of RR No. 16-2005, which preferential tax rate. Payment of the 5% preferential tax amounting to
the respondent BIR issued to implement the VAT law, subjecting P44,677,500.00 was erroneous.
PAGCOR to 10% VAT is invalid for being contrary to R.A. No. 9337.
The Court of Tax Appeals Second Division subjected the sale of SMI-
Ed Philippines‘ assets to 6% capital gains tax under Section 27(D)(5)
of the same Code and Section 2 of Revenue Regulations No. 8-98. It
was found liable for capital gains tax amounting to
P53,613,000.00. Therefore, SMI-Ed Philippines must still pay the
balance of P8,935,500.00 as deficiency tax.

SMI-Ed Philippines filed a petition for review before the SC praying


for the grant of its claim for refund and the reversal of the Court of
Tax Appeals En Banc‘s decision.

Issue:
f. Income Tax Rates
2. Non-resident aliens engaged in trade or business
W/N the sale of SMI’s assets is subject to a 6% capital gains
(Capital Gains-Real Property)
tax? (YES, but only with respect to the land and buildings)
SMI-ED PHILIPPINES vs. CIR
Ruling:
By: Rea Romero
A Philippine Economic Zone Authority (PEZA)-registered corporation
Facts: that has never commenced operations may not avail the tax
incentives and preferential rates given to PEZA-registered
SMI-Ed Philippines is a PEZA-registered corporation authorized ―to enterprises. Such corporation is subject to ordinary tax rates under
engage in the business of manufacturing ultra high-density the National Internal Revenue Code of 1997. In this case, SMI never
microprocessor unit package. After its registration SMI-Ed Philippines commenced its operations.
constructed buildings and purchased machineries and equipment.
SMI-Ed Philippines ―failed to commence operations.” Its factory
was temporarily closed, it sold its buildings and some of its The CTA found that the properties of SMI were subject to capital
installed machineries and equipment to Ibiden Philippines, Inc., gains tax. For petitioner‘s properties to be subjected to capital gains
another PEZA-registered enterprise. SMI was subsequently tax, the properties must form part of petitioner‘s capital assets.
dissolved.
Section 39(A)(1) of the National Internal Revenue Code of 1997
In its quarterly income tax return for year 2000, SMI-Ed Philippines defines ―capital assets‖:
subjected the entire gross sales of its properties to 5% final tax
on PEZA-registered corporations. SMI-Ed Philippines paid taxes SEC. 39. Capital Gains and Losses. -
amounting to P44,677,500.00.
(A) Definitions. - As used in this Title -
After requesting the cancellation of its PEZA registration and
amending its articles of incorporation to shorten its corporate term, (1) Capital Assets. - the term ‗capital assets‘ means
SMI-Ed Philippines filed an administrative claim for the refund of property held by the taxpayer (whether or not connected
P44,677,500.00 with the Bureau of Internal Revenue (BIR). SMI-Ed with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which would
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properly be included in the inventory of the taxpayer if on For corporations, the National Internal Revenue Code of 1997 treats
hand at the close of the taxable year, or property held by the the sale of land and buildings, and the sale of machineries and
taxpayer primarily for sale to customers in the ordinary equipment, differently. Domestic corporations are imposed a 6%
course of his trade or business, or property used in the trade capital gains tax only on the presumed gain realized from the sale of
or business, of a character which is subject to the allowance lands and/or buildings. The National Internal Revenue Code of 1997
for depreciation provided in Subsection (F) of Section 34; or does not impose the 6% capital gains tax on the gains realized from
real property used in trade or business of the taxpayer. the sale of machineries and equipment. Section 27(D)(5) of the
National Internal Revenue Code of 1997 provides:
Thus, ―capital assets‖ refers to taxpayer‘s property that is NOT any of
the following: SEC. 27. Rates of Income tax on Domestic Corporations.
-
1. Stock in trade; . . . .
2. Property that should be included in the taxpayer‘s inventory (D) Rates of Tax on Certain Passive Incomes. -
at the close of the taxable year; . . . .
3. Property held for sale in the ordinary course of the
(5) Capital Gains Realized from the Sale, Exchange or
taxpayer‘s business;
4. Depreciable property used in the trade or business; and Disposition of Lands and/or Buildings. - A final tax of six
5. Real property used in the trade or business. percent (6%) is hereby imposed on the gain presumed to
have been realized on the sale, exchange or disposition of
The properties involved in this case include petitioner‘s buildings, lands and/or buildings which are not actually used in the
equipment, and machineries. They are not among the exclusions business of a corporation and are treated as capital assets,
enumerated in Section 39(A)(1) of the National Internal Revenue based on the gross selling price of fair market value as
Code of 1997. Based on the definition of capital assets under determined in accordance with Section 6(E) of this Code,
Section 39 of the National Internal Revenue Code of 1997, they whichever is higher, of such lands and/or buildings.
are capital assets. (Emphasis supplied)

Respondent (CIR) insists that since petitioner‘s machineries and


Therefore, only the presumed gain from the sale of petitioner‘s land
equipment are classified as capital assets, their sales should be
and/or building may be subjected to the 6% capital gains tax. The
subject to capital gains tax. Respondent is mistaken.
income from the sale of petitioner‘s machineries and equipment is
Capital gains of individuals and corporations from the sale of real subject to the provisions on normal corporate income tax.
properties are taxed differently.Individuals are taxed on capital gains
from sale of all real properties located in the Philippines and To determine, therefore, if petitioner is entitled to refund, the amount
classified as capital assets. Thus: of capital gains tax for the sold land and/or building of petitioner and
the amount of corporate income tax for the sale of petitioner‘s
SEC. 24. Income Tax Rates. machineries and equipment should be deducted from the total final
tax paid.
(D) Capital Gains from Sale of Real Property. –

(1) In General. - The provisions of Section


39(B) notwithstanding, a final tax of six percent (6%) based
on the gross selling price or current fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, is hereby imposed upon capital gains
presumed to have been realized from the sale, exchange, or
other disposition of real property located in the Philippines,
classified as capital assets, including pacto de retro sales
and other forms of conditional sales, by individuals, including
estates and trusts: Provided, That the tax liability, if any, on
gains from sales or other dispositions of real property to the
government or any of its political subdivisions or agencies or iii. Corporations
to government-owned or controlled corporations shall be 1. Domestic Corporations (Special Domestic Corp. –
determined either under Section 24 (A) or under this Proprietary Educational Institutions and Hospitals)
Subsection, at the option of the taxpayer
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CIR vs. ST. LUKE'S conduct of which is not substantially related to the exercise or
performance by such educational institution or hospital of its primary
By: C.I. Jala purpose or function. A 'proprietary educational institution' is any
private school maintained and administered by private individuals or
Facts: groups with an issued permit to operate from the Department of
(Re: Sec.30) Education, Culture and Sports (DECS), or the Commission on Higher
Education (CHED), or the Technical Education and Skills
St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as Development Authority (TESDA), as the case may be, in accordance
a non-stock and non-profit corporation. with existing laws and regulations. (Emphasis supplied)

On 16 December 2002, the Bureau of Internal Revenue (BIR) St. Luke's contention: BIR should not consider its total revenues,
assessed St. Luke's deficiency taxes amounting toP76,063,116.06 because its free services to patients wasP218,187,498 or 65.20% of
for 1998, comprised of deficiency income tax, value-added tax, its 1998 operating income (i.e., total revenues less operating
withholding tax on compensation and expanded withholding tax – expenses) ofP334,642,615. St. Luke's also claimed that its income
which was later on reduced to P63,935,351.57 during trial in the First does not inure to the benefit of any individual.
Division of the CTA.
St. Luke's maintained that it is a non-stock and non-profit institution
On 14 January 2003, St. Luke's filed an administrative protest with for charitable and social welfare purposes under Section 30(E) and
the BIR against the deficiency tax assessments. (G) of the NIRC. It argued that the making of profit per se does not
destroy its income tax exemption.
BIR‘s contention: Section 27(B) of the NIRC, which imposes a 10% St. Luke's claims tax exemption under Section 30(E) and (G) of the
preferential tax rate on the income of proprietary non-profit hospitals, NIRC. It contends that it is a charitable institution and an organization
should be applicable to St. Luke's. According to the BIR, Section promoting social welfare. The arguments of St. Luke's focus on the
27(B), introduced in 1997, "is a new provision intended to amend the wording of Section 30(E) exempting from income tax non-stock, non-
exemption on non-profit hospitals that were previously categorized as profit charitable institutions. 34 St. Luke's asserts that the legislative
non-stock, non-profit corporations under Section 26 of the 1997 Tax intent of introducing Section 27(B) was only to remove the exemption
Code x x x." It is a specific provision which prevails over the general for "proprietary non-profit" hospitals. The relevant provisions of
exemption on income tax granted under Section 30(E) and (G) for Section 30 state:
non-stock, non-profit charitable institutions and civic organizations
promoting social welfare. SEC. 30. Exemptions from Tax on Corporations. - The following
organizations shall not be taxed under this Title in respect to income
The BIR claimed that St. Luke's was actually operating for profit in received by them as such:
1998 because only 13% of its revenues came from charitable xxxx
purposes. Moreover, the hospital's board of trustees, officers and (E) Nonstock corporation or association organized and operated
employees directly benefit from its profits and assets. St. Luke's had exclusively for religious, charitable, scientific, athletic, or cultural
total revenues of P1,730,367,965 or approximately P1.73 billion from purposes, or for the rehabilitation of veterans, no part of its net
patient services in 1998. income or asset shall belong to or inure to the benefit of any
member, organizer, officer or any specific person;
BIR raised the effect of the introduction of Section 27(B) in the NIRC xxxx
of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption (G) Civic league or organization not organized for profit but operated
of charitable and social welfare institutions. The 10% income tax rate exclusively for the promotion of social welfare;
under Section 27(B) specifically pertains to proprietary educational xxxx
institutions and proprietary non-profit hospitals. The BIR argues that Notwithstanding the provisions in the preceding paragraphs, the
Congress intended to remove the exemption that non-profit hospitals income of whatever kind and character of the foregoing organizations
previously enjoyed under Section 27(E) of the NIRC of 1977, which is from any of their properties, real or personal, or from any of their
now substantially reproduced in Section 30(E) of the NIRC of activities conducted for profit regardless of the disposition made of
1997. Section 27(B) of the present NIRC provides: such income, shall be subject to tax imposed under this Code.
(Emphasis supplied)
SEC. 27. Rates of Income Tax on Domestic Corporations. -
xxxx The CTA ruling: St. Luke's is a non-stock and non-profit charitable
(B) Proprietary Educational Institutions and Hospitals. - Proprietary institution covered by Section 30(E) and (G) of the NIRC. This ruling
educational institutions and hospitals which are non-profit shall pay a would exempt all income derived by St. Luke's from services to its
tax of ten percent (10%) on their taxable income except those patients, whether paying or non-paying. The CTA reiterated its earlier
covered by Subsection (D) hereof: Provided, That if the gross income decision in St. Luke's Medical Center, Inc. v. Commissioner of
from unrelated trade, business or other activity exceeds fifty percent Internal Revenue, which examined the primary purposes of St.
(50%) of the total gross income derived by such educational Luke's under its articles of incorporation and various
institutions or hospitals from all sources, the tax prescribed in documents identifying St. Luke's as a charitable institution.
Subsection (A) hereof shall be imposed on the entire taxable income.
For purposes of this Subsection, the term 'unrelated trade, business
or other activity' means any trade, business or other activity, the
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The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. 27(B) of the NIRC as long as it does not distribute any of its profits to
Pasay City, which states that "a charitable institution does not lose its members and such profits are reinvested pursuant to its corporate
its charitable character and its consequent exemption from taxation purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to
merely because recipients of its benefits who are able to pay are the preferential tax rate of 10% on its net income from its for-profit
required to do so, where funds derived in this manner are devoted to activities.
the charitable purposes of the institution x x x." The generation of St. Luke's is therefore liable for deficiency income tax in 1998 under
income from paying patients does not per se destroy the charitable Section 27(B) of the NIRC.
nature of St. Luke's.

The CTA held that Section 27(B) of the present NIRC does not apply iii. Corporations
to St. Luke's. The CTA explained that to apply the 10% preferential 2. Domestic Corporations (Capital Gains)
rate, Section 27(B) requires a hospital to be "non-profit." On the other
hand, Congress specifically used the word "non-stock" to qualify a SMI-ED PHILIPPINES vs CIR
charitable "corporation or association" in Section 30(E) of the NIRC.
Note! See same case under
Issue: c. Tax Treatment
Whether St. Luke's is liable for deficiency income tax in 1998 under iii. Capital Gains Tax
Section 27(B) of the NIRC, which imposes a preferential tax rate of 2. Real Property (Domestic Corp.)
10% on the income of proprietary non-profit hospitals.

Ruling: YES

Section 27(B) of the NIRC does not remove the income tax
exemption of proprietary non-profit hospitals under Section 30(E) and iii. Corporations
(G). Section 27(B) on one hand, and Section 30(E) and (G) on the 3. Foreign Corporation
other hand, can be construed together without the removal of such a. Resident Foreign Corp. (International
tax exemption. The effect of the introduction of Section 27(B) is to Carriers)
subject the taxable income of two specific institutions, namely,
proprietary non-profit educational institutions and proprietary non- SOUTH AFRICAN AIRWAYS vs. CIR
profit hospitals, among the institutions covered by Section 30, to the By: Ellan Tingson
10% preferential rate under Section 27(B) instead of the ordinary Facts:
30% corporate rate under the last paragraph of Section 30 in relation
to Section 27(A)(1). Petitioner South African Airways is a foreign corporation organized
and existing under and by virtue of the laws of the Republic of South
Section 27(B) of the NIRC imposes a 10% preferential tax rate on the
Africa. Petitioner has a general sales agent in the Philippines, Aerotel
income of (1) proprietary non-profit educational institutions and (2)
proprietary non-profit hospitals. The only qualifications for hospitals Limited Corporation (Aerotel). Aerotel sells passage documents for
are that they must be proprietary and non-profit. "Proprietary" means compensation or commission for petitioners off-line flights for the
private, following the definition of a "proprietary educational carriage of passengers and cargo between ports or points outside
institution" as "any private school maintained and administered by the territorial jurisdiction of the Philippines. Petitioner is not registered
private individuals or groups" with a government permit. "Non-profit" with the Securities and Exchange Commission as a corporation,
means no net income or asset accrues to or benefits any member or branch office, or partnership. It is not licensed to do business in the
specific person, with all the net income or asset devoted to the
Philippines.
institution's purposes and all its activities conducted not for profit.

Thus, even if the charitable institution must be "organized and For the taxable year 2000, petitioner filed separate quarterly and
operated exclusively" for charitable purposes, it is nevertheless annual income tax returns for its off-line flights.
allowed to engage in "activities conducted for profit" without losing its
tax exempt status for its not-for-profit activities. The only On February 5, 2003, petitioner filed with the Bureau of Internal
consequence is that the "income of whatever kind and character" of a Revenue, Revenue District Office No. 47, a claim for the refund of
charitable institution "from any of its activities conducted for profit, the amount of PhP 1,727,766.38 as erroneously paid tax on Gross
regardless of the disposition made of such income, shall be subject Philippine Billings (GPB) for the taxable year 2000. Such claim was
to tax." Prior to the introduction of Section 27(B), the tax rate on such unheeded. Thus, petitioner filed a Petition for Review with the CTA
income from for-profit activities was the ordinary corporate rate under
for the refund of the abovementioned amount.
Section 27(A). With the introduction of Section 27(B), the tax rate is
now 10%.
The CTA ruled that petitioner is a resident foreign corporation
St. Luke's fails to meet the requirements under Section 30(E) and (G) engaged in trade or business in the Philippines. It further ruled that
of the NIRC to be completely tax exempt from all its income. petitioner was not liable to pay tax on its GPB under Section
However, it remains a proprietary non-profit hospital under Section 28(A)(3)(a) of the National Internal Revenue Code (NIRC) of 1997.
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The CTA, however, stated that petitioner is liable to pay a tax of 32% having general sales agents in the Philippines are engaged in or
on its income derived from the sales of passage documents in the doing business in the Philippines and that their income from sales of
Philippines. On this ground, the CTA denied petitioners claim for a passage documents here is income from within the Philippines. Thus,
refund. in that case, we held the off-line air carrier liable for the 32% tax on
its taxable income.
Issue:

Whether or not petitioner, as an off-line international carrier selling


passage documents through an independent sales agent in the Petitioners interpretation of Sec. 28(A)(3)(a) of the 1997 NIRC is that,
Philippines, is engaged in trade or business in the Philippines subject since it is an international carrier that does not maintain flights to or
to the 32% income tax imposed by Section 28 (A)(1) of the 1997 from the Philippines, thereby having no GPB as defined, it is exempt
NIRC. from paying any income tax at all. In other words, the existence of
Sec. 28(A)(3)(a) according to petitioner precludes the application of
Sec. 28(A)(1) to it.
Ruling:
Yes, the petitioner is liable for the 32% income tax. We point out that Sec. 28(A)(3)(a) of the 1997 NIRC does not, in any
categorical term, exempt all international air carriers from the
Preliminarily, we emphasize that petitioner is claiming that it is
coverage of Sec. 28(A)(1) of the 1997 NIRC. Certainly, had
exempted from being taxed for its sale of passage documents in the
legislatures intentions been to completely exclude all international air
Philippines. Petitioner, however, failed to sufficiently prove such
carriers from the application of the general rule under Sec. 28(A)(1),
contention.
it would have used the appropriate language to do so; but the
Since an action for a tax refund partakes of the nature of an legislature did not. Thus, the logical interpretation of such provisions
exemption, which cannot be allowed unless granted in the most is that, if Sec. 28(A)(3)(a) is applicable to a taxpayer, then the
explicit and categorical language, it is strictly construed against the general rule under Sec. 28(A)(1) would not apply. If, however, Sec.
claimant who must discharge such burden convincingly. 28(A)(3)(a) does not apply, a resident foreign corporation, whether
an international air carrier or not, would be liable for the tax under
It is petitioners contention that, with the new definition of GPB, it is no Sec. 28(A)(1).
longer liable under Sec. 28(A)(3)(a). Further, petitioner argues that
because the 2 1/2% tax on GPB is inapplicable to it, it is thereby In the instant case, the general rule is that resident foreign
excluded from the imposition of any income tax. corporations shall be liable for a 32% income tax on their income
from within the Philippines, except for resident foreign corporations
The 1997 NIRC where Gross Philippine Billing is now defined under that are international carriers that derive income from carriage of
Sec. 28(A)(3)(a): persons, excess baggage, cargo and mail originating from the
Philippines which shall be taxed at 2 1/2% of their Gross Philippine
Gross Philippine Billings refers to the amount of gross revenue Billings. Petitioner, being an international carrier with no flights
derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines, does not fall under the exception. As
originating from the Philippines in a continuous and uninterrupted such, petitioner must fall under the general rule.
flight, irrespective of the place of sale or issue and the place of
payment of the ticket or passage document.
To reiterate, the correct interpretation of the above provisions is that,
Now, it is the place of sale that is irrelevant; as long as the uplifts of if an international air carrier maintains flights to and from the
passengers and cargo occur to or from the Philippines, income is Philippines, it shall be taxed at the rate of 2 1/2% of its Gross
included in GPB. Philippine Billings, while international air carriers that do not have
flights to and from the Philippines but nonetheless earn income from
As correctly pointed out by petitioner, inasmuch as it does not other activities in the country will be taxed at the rate of 32% of such
maintain flights to or from the Philippines, it is not taxable under Sec. income.
28(A)(3)(a) of the 1997 NIRC. But petitioner further posits the view
that due to the non-applicability of Sec. 28(A)(3)(a) to it, it is
precluded from paying any other income tax for its sale of passage
documents in the Philippines. Such position is untenable.

In Commissioner of Internal Revenue v. British Overseas Airways


Corporation (British Overseas Airways), which was decided under
similar factual circumstances, this Court ruled that off-line air carriers
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environmental circumstances. The term implies a continuity of
CIR vs. BRITISH OVERSEAS commercial dealings and arrangements, and contemplates, to that
By: Maria Jessa G. Noble extent, the performance of acts or works or the exercise of some of
the functions normally incident to, and in progressive prosecution of
Facts: commercial gain or for the purpose and object of the business
organization.
British Overseas Airways Corporation (BOAC) is a 100% British
Government-owned corporation organized and existing under the
laws of the United Kingdom. It is engaged in the international airline (2) YES. The source of an income is the property, activity or service
business and is a member-signatory of the Interline Air Transport that produced the income. For the source of income to be
Association (IATA). As such it operates air transportation service and considered as coming from the Philippines, it is sufficient that the
sells transportation tickets over the routes of the other airline income is derived from activity within the Philippines. In BOAC's case,
members. During the periods covered by the disputed assessments, the sale of tickets in the Philippines is the activity that produces the
it is admitted that BOAC had no landing rights for traffic purposes in income. The tickets exchanged hands here and payments for fares
the Philippines, and was not granted a Certificate of public were also made here in Philippine currency. The site of the source of
convenience and necessity to operate in the Philippines by the Civil payments is the Philippines. The flow of wealth proceeded from, and
Aeronautics Board (CAB), except for a nine-month period, partly in occurred within, Philippine territory.
1961 and partly in 1962, when it was granted a temporary landing
permit by the CAB. Consequently, it did not carry passengers and/or Unquestionably, the passage documentations in these cases were
cargo to or from the Philippines, although during the period covered sold in the Philippines and the revenue therefrom was derived from
by the assessments, it maintained a general sales agent in the an activity regularly pursued within the Philippines. And even if the
Philippines — Wamer Barnes and Company, Ltd., and later Qantas BOAC tickets sold covered the "transport of passengers and cargo to
Airways — which was responsible for selling BOAC tickets covering and from foreign cities", it cannot alter the fact that income from the
passengers and cargoes. sale of tickets was derived from the Philippines. The word "source"
conveys one essential idea, that of origin, and the origin of the
The CIR assessed BOAC for deficiency taxes covering the years income herein is the Philippines.
1959 to 1967 and fiscal years 1968-1969 to 1970-1971.
The assessments upheld herein apply only to the fiscal years
BOAC contended that income derived from transportation is income covered by the questioned deficiency income tax assessments in
for services, with the result that the place where the services are these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For,
rendered determines the source. Since BOAC's service of pursuant to Presidential Decree No. 69, promulgated on 24
transportation is performed outside the Philippines, the income November, 1972, international carriers are now taxed as follows:
derived is from sources without the Philippines and, therefore, not ... Provided, however, That international carriers shall pay a
taxable under our income tax laws. tax of 2-½ per cent on their cross Philippine billings. (Sec.
24[b] [21, Tax Code).
Issues:
(1) Whether or not BOAC is a resident foreign corporation Presidential Decree No. 1355, promulgated on 21 April, 1978,
provided a statutory definition of the term "gross Philippine billings,"
(2) Whether or not the revenue from sales of tickets by BOAC in the thus:
Philippines constitutes income from Philippine sources and,
accordingly, taxable under the Philippine income tax laws ... "Gross Philippine billings" includes gross revenue realized
from uplifts anywhere in the world by any international carrier
doing business in the Philippines of passage documents sold
therein, whether for passenger, excess baggage or mail
Ruling: provided the cargo or mail originates from the Philippines. ...

(1) YES. Under Section 20 of the 1977 Tax Code: The foregoing provision ensures that international airlines are taxed
on their income from Philippine sources. The 2-½ % tax on gross
(h) the term resident foreign corporation engaged in trade or Philippine billings is an income tax. If it had been intended as an
business within the Philippines or having an office or place of excise or percentage tax it would have been place under Title V of
business therein. the Tax Code covering Taxes on Business.

(i) The term "non-resident foreign corporation" applies to Note: The provision is now Section 28 (A) (3) of the NIRC which
a foreign corporation not engaged in trade or states that:
business within the Philippines and not having any
office or place of business therein SEC. 28. Rates of Income Tax on Foreign Corporations. –

BOAC is a resident foreign corporation. There is no specific criterion (A) Tax on Resident Foreign Corporations. –
as to what constitutes "doing" or "engaging in" or "transacting"
business. Each case must be judged in the light of its peculiar
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(3) International Carrier. - An international carrier doing 27(B), introduced in 1997, "is a new provision intended to amend the
business in the Philippines shall pay a tax of two and one-half exemption on non-profit hospitals that were previously categorized as
percent (2 1/2%) on its "Gross Philippine Billings" as defined non-stock, non-profit corporations under Section 26 of the 1997 Tax
hereunder: Code x x x." It is a specific provision which prevails over the general
exemption on income tax granted under Section 30(E) and (G) for
(a) International Air Carrier. - "Gross Philippine non-stock, non-profit charitable institutions and civic organizations
Billings" refers to the amount of gross revenue promoting social welfare.
derived from carriage of persons, excess baggage,
cargo and mail originating from the Philippines in a The BIR claimed that St. Luke's was actually operating for profit in
continuous and uninterrupted flight, irrespective of 1998 because only 13% of its revenues came from charitable
the place of sale or issue and the place of payment purposes. Moreover, the hospital's board of trustees, officers and
of the ticket or passage document; Provided, That employees directly benefit from its profits and assets. St. Luke's had
tickets revalidated, exchanged and/or indorsed to total revenues of P1,730,367,965 or approximately P1.73 billion from
another international airline form part of the Gross patient services in 1998.
Philippine Billings if the passenger boards a plane in
a port or point in the Philippine; :Provided, further, BIR raised the effect of the introduction of Section 27(B) in the NIRC
That for a flight which originates from the Philippines, of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption
but transhipment of passenger takes place at any of charitable and social welfare institutions. The 10% income tax rate
port outside the Philippines on another airline, only under Section 27(B) specifically pertains to proprietary educational
the aliquot portion of the cost of the ticket institutions and proprietary non-profit hospitals. The BIR argues that
corresponding to the leg flown from the Philippines Congress intended to remove the exemption that non-profit hospitals
to the point of transhipment shall form part of Gross previously enjoyed under Section 27(E) of the NIRC of 1977, which is
Philippine Billings. now substantially reproduced in Section 30(E) of the NIRC of 1997.

St. Luke's contention: BIR should not consider its total revenues,
because its free services to patients wasP218,187,498 or 65.20% of
its 1998 operating income (i.e., total revenues less operating
expenses) ofP334,642,615. St. Luke's also claimed that its income
does not inure to the benefit of any individual.

St. Luke's maintained that it is a non-stock and non-profit institution


for charitable and social welfare purposes under Section 30(E) and
(G) of the NIRC. It argued that the making of profit per se does not
destroy its income tax exemption.
St. Luke's claims tax exemption under Section 30(E) and (G) of the
NIRC. It contends that it is a charitable institution and an organization
5. Exemptions from Tax on Corporations (Sec. 30) promoting social welfare. The arguments of St. Luke's focus on the
wording of Section 30(E) exempting from income tax non-stock, non-
CIR vs. ST. LUKE'S profit charitable institutions. St. Luke's asserts that the legislative
By: C.I. Jala intent of introducing Section 27(B) was only to remove the exemption
for "proprietary non-profit" hospitals.
Facts:
Issue:
(copied from sec. 27 discussion) Whether St. Luke's is tax exempt in all its income as provided under
St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as Section 30(E) and (G) of the NIRC.
a non-stock and non-profit corporation.
Ruling: NO
On 16 December 2002, the Bureau of Internal Revenue (BIR)
assessed St. Luke's deficiency taxes amounting toP76,063,116.06 The Constitution exempts charitable institutions only from real
for 1998, comprised of deficiency income tax, value-added tax, property taxes. In the NIRC, Congress decided to extend the
withholding tax on compensation and expanded withholding tax – exemption to income taxes. However, the way Congress crafted
which was later on reduced to P63,935,351.57 during trial in the First Section 30(E) of the NIRC is materially different from Section 28(3),
Division of the CTA. Article VI of the Constitution. Section 30(E) of the NIRC defines the
corporation or association that is exempt from income tax. On the
On 14 January 2003, St. Luke's filed an administrative protest with other hand, Section 28(3), Article VI of the Constitution does not
the BIR against the deficiency tax assessments. define a charitable institution, but requires that the institution "actually,
directly and exclusively" use the property for a charitable purpose.
BIR‘s contention: Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals, Section 30(E) of the NIRC provides that a charitable institution must
should be applicable to St. Luke's. According to the BIR, Section be:
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(1) A non-stock corporation or association; organized and operated exclusively for x x x charitable x x x
(2) Organized exclusively for charitable purposes; purposes x x x." It likewise qualifies the requirement in Section 30(G)
(3) Operated exclusively for charitable purposes; and that the civic organization must be "operated exclusively" for the
(4) No part of its net income or asset shall belong to or promotion of social welfare.
inure to the benefit of any member, organizer, officer or any
specific person. Thus, even if the charitable institution must be "organized and
operated exclusively" for charitable purposes, it is nevertheless
Thus, both the organization and operations of the charitable allowed to engage in "activities conducted for profit" without losing its
institution must be devoted "exclusively" for charitable purposes. The tax exempt status for its not-for-profit activities. The only
organization of the institution refers to its corporate form, as shown consequence is that the "income of whatever kind and character" of a
by its articles of incorporation, by-laws and other constitutive charitable institution "from any of its activities conducted for profit,
documents. Section 30(E) of the NIRC specifically requires that the regardless of the disposition made of such income, shall be subject
corporation or association be non-stock, which is defined by the to tax." Prior to the introduction of Section 27(B), the tax rate on such
Corporation Code as "one where no part of its income is distributable income from for-profit activities was the ordinary corporate rate under
as dividends to its members, trustees, or officers" 49 and that any Section 27(A). With the introduction of Section 27(B), the tax rate is
profit "obtain[ed] as an incident to its operations shall, whenever now 10%.
necessary or proper, be used for the furtherance of the purpose or
purposes for which the corporation was organized." 50 However, The Court finds that St. Luke's is a corporation that is not "operated
under Lung Center, any profit by a charitable institution must not only exclusively" for charitable or social welfare purposes insofar as its
be plowed back "whenever necessary or proper," but must be revenues from paying patients are concerned. This ruling is based
"devoted or used altogether to the charitable object which it is not only on a strict interpretation of a provision granting tax
intended to achieve." exemption, but also on the clear and plain text of Section 30(E) and
(G). Section 30(E) and (G) of the NIRC requires that an institution be
The operations of the charitable institution generally refer to its "operated exclusively" for charitable or social welfare purposes to be
regular activities. Section 30(E) of the NIRC requires that these completely exempt from income tax. An institution under Section
operations be exclusive to charity. There is also a specific 30(E) or (G) does not lose its tax exemption if it earns income from
requirement that "no part of [the] net income or asset shall belong to its for-profit activities. Such income from for-profit activities, under the
or inure to the benefit of any member, organizer, officer or any last paragraph of Section 30, is merely subject to income tax,
specific person." The use of lands, buildings and improvements of previously at the ordinary corporate rate but now at the preferential
the institution is but a part of its operations. 10% rate pursuant to Section 27(B).

There is no dispute that St. Luke's is organized as a non-stock and A tax exemption is effectively a social subsidy granted by the State
non-profit charitable institution. However, this does not automatically because an exempt institution is spared from sharing in the expenses
exempt St. Luke's from paying taxes. This only refers to the of government and yet benefits from them. Tax exemptions for
organization of St. Luke's. Even if St. Luke's meets the test of charity, charitable institutions should therefore be limited to institutions
a charitable institution is not ipso facto tax exempt. To be exempt beneficial to the public and those which improve social welfare. A
from real property taxes, Section 28(3), Article VI of the Constitution profit-making entity should not be allowed to exploit this subsidy to
requires that a charitable institution use the property "actually, the detriment of the government and other taxpayers.
directly and exclusively" for charitable purposes. To be exempt from
income taxes, Section 30(E) of the NIRC requires that a charitable St. Luke's fails to meet the requirements under Section 30(E) and (G)
institution must be "organized and operated exclusively" for of the NIRC to be completely tax exempt from all its income.
charitable purposes. Likewise, to be exempt from income taxes, However, it remains a proprietary non-profit hospital under Section
Section 30(G) of the NIRC requires that the institution be "operated 27(B) of the NIRC as long as it does not distribute any of its profits to
exclusively" for social welfare. its members and such profits are reinvested pursuant to its corporate
purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to
However, the last paragraph of Section 30 of the NIRC qualifies the the preferential tax rate of 10% on its net income from its for-profit
words "organized and operated exclusively" by providing that: activities.

Notwithstanding the provisions in the preceding paragraphs, the St. Luke's is therefore liable for deficiency income tax in 1998 under
income of whatever kind and character of the foregoing organizations Section 27(B) of the NIRC.
from any of their properties, real or personal, or from any of their
activities conducted for profit regardless of the disposition made of
such income, shall be subject to tax imposed under this Code.
(Emphasis supplied)

In short, the last paragraph of Section 30 provides that if a tax


exempt charitable institution conducts "any" activity for profit, such
activity is not tax exempt even as its not-for-profit activities remain
tax exempt. This paragraph qualifies the requirements in Section
30(E) that the "[n]on-stock corporation or association [must be]
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GCL contention - the tax exempt status of the employees' trusts
iv. Exclusions applies to all kinds of taxes, including the final withholding tax on
7. Retirement Benefits, pensions, gratuities, separation interest income. That exemption, according to GCL, is derived from
pay, etc.
Section 56(b) and not from Section 21 (d) or 24 (cc) of the Tax Code.
COMMISSIONER OF INTERNAL REVENUE vs. THE HON. COURT
Issue: Whether GCL is exempted from Income Tax
OF APPEALS, THE COURT OF TAX APPEALS, GCL
RETIREMENT PLAN Ruling:

By: Mabelle Acosta GCL Plan was qualified as exempt from income tax by the
Commissioner of Internal Revenue in accordance with Rep. Act
Facts:
No. 4917 approved on 17 June 1967. In so far as employees' trusts
GCL Retirement Plan is an employees' trust maintained by the are concerned, the foregoing provision should be taken in relation to
employer, GCL Inc., to provide retirement, pension, disability and then Section 56(b) (now 53[b]) of the Tax Code, as amended by Rep.
death benefits to its employees. The Plan as submitted was Act No.1983, which took effect on 22 June 1957.
approved and qualified as exempt from income tax by CIR in
The tax-exemption privilege of employees' trusts, as distinguished
accordance with Rep. Act No. 4917. In 1984, GCL made investments
from any other kind of property held in trust, springs from the
and earned therefrom interest income from which was withheld the
foregoing provision. It is unambiguous. Manifest therefrom is that the
fifteen per centum (15%) final withholding tax imposed by Pres.
tax law has singled out employees' trusts for tax exemption.
Decree No. 1959, which took effect on 15 October 1984GCL filed
with CIR a claim for refund in the amounts of P1,312.66 withheld by Employees' trusts or benefit plans normally provide economic
Anscor Capital and Investment Corp., and P2,064.15 by Commercial assistance to employees upon the occurrence of certain
Bank of Manila.On 12 February 1985, it filed a second claim for contingencies, particularly, old age retirement, death, sickness, or
refund of the amount of P7,925.00withheld by Anscor, stating in both disability. It provides security against certain hazards to which
letters that it disagreed with the collection of the 15%final withholding members of the Plan may be exposed. It is an independent and
tax from the interest income as it is an entity fully exempt from additional source of protection for the working group.
income tax as provided under Rep. Act No. 4917 in relation to
Section 56 (b) of the Tax Code. What is more, it is established for their exclusive benefit and for no
other purpose. The deletion in Pres. Decree No. 1959 of the provisos
CIR – denied the refund, elevated the matter to CTA regarding tax exemption and preferential tax rates under the old law,
therefore, cannot be deemed to extent to employees' trusts. Said
CTA - ruled in favor of GCL, holding that employees' trusts are
Decree, being a general law, cannot repeal by implication a specific
exempt from the 15%final withholding tax on interest income and
provision, Section 56(b) now 53 [b]) in relation to Rep. Act No. 4917
ordering a refund of the tax withheld.
granting exemption from income tax to employees' trusts. Rep. Act
CA - upheld the CTA Decision. 1983, which excepted employees' trusts in its Section 56 (b) was
effective on 22 June 1957 while Rep. Act No.4917 was enacted on
CIR‘s Contention - the exemption from withholding tax on interest on 17 June 1967, long before the issuance of Pres. Decree No. 1959on
bank deposits previously extended by Pres. Decree No. 1739 if the 15 October 1984. A subsequent statute, general in character as to its
recipient (individual or corporation)of the interest income is exempt terms and application, is not to be construed as repealing a special
from income taxation, and the imposition of the preferential tax rates or specific enactment, unless the legislative purpose to do so is
if the recipient of the income is enjoying preferential income tax manifested. This is so even if the provisions of the latter are
treatment, were both abolished by Pres. Decree No. 1959. CIR thus sufficiently comprehensive to include what was set forth in the
submits that the deletion of the exempting and preferential tax special act.
treatment provisions under the old law is a clear manifestation that
the single 15% (now 20%) rate is impossible on all interest incomes There can be no denying either that the final withholding tax is
from deposits, deposit substitutes, trust funds and similar collected from income in respect of which employees' trusts are
arrangements, regardless of the tax status or character of the declared exempt (Sec. 56 [b], now 53 [b], Tax Code). The application
recipients thereof. In short, CIR‘s position is that from 15 October of the withholdings system to interest on bank deposits or yield from
1984 when Pres. Decree No. 1959 was promulgated, employees' deposit substitutes is essentially to maximize and expedite the
trusts ceased to be exempt and thereafter became subject to the final collection of income taxes by requiring its payment at the source. If
withholding tax. 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.
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SC ruled that Pres. Decree No. 1959 did not have the effect of citizen may look forward too is thus avoided. Terminal leave
revoking the tax exemption enjoyed by employees' trusts; reliance on payments are given not only at the same time but also for the same
those authorities is now misplaced. policy considering retirement benefits.‖

COMMISSIONER OF INTERNAL REVENUE vs. CA & EFREN RE: REQUEST OF ATTY. BERNARDO ZIALCITA
CASTANEDA
Note! See same case under:
By: Kathleen Rose Ching e. Exclusions
1. Retirement Benefits
Facts:

Respondent Castaneda retired from the government service as


Revenue Attache in the Philippine Embassy in London. Upon
retirement, he received, among other benefits, terminal leave pay
from which CIR withheld P12,557.13 allegedly representing income
tax thereon.

Castaneda filed a formal written claim with CIR for a refund of


P12,557.13, contending that the cash equivalent of his terminal leave
is exempt from income tax.

CTA ruled in favor of Castaneda and ordered CIR to refund the sum
of P12,557.13 withheld as income tax. CA affirmed.

CIR‘s contention: That the terminal leave pay is income derived from
employer-employee relationship; that as part of the compensation for
services rendered, terminal leave pay is actually part of gross income
of the recipient.

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. SC ruled that the terminal leave pay received by a government


official or employee is not subject to withholding (income) tax. The
terminal leave pay is not part of the gross salary or income of a
government official or employee, but a retirement benefit, which is
not subject to income tax.

The rationale behind the employee‘s entitlement to an exemption


from withholding (income) tax on his terminal leave pay is 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. 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

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