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G.R. No. 153793. August 29, 2006.

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COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. JULIANE BAIER-NICKEL, as represented by
Marina Q. Guzman (Attorney-in-fact), respondent.
Taxation; Legal Research; Act No. 2833, which took effect on 1 January 1920, was the first Philippine
income tax law enacted by the Philippine Legislature and which law substantially reproduced the U.S.
Revenue Law of 1916 as amended by U.S. Revenue Law of 1917; Being a law of American origin, the
authoritarian decisions of the official charged with enforcing it in the U.S. have peculiar persuasive force in
the Philippines.—The first Philippine income tax law enacted by the Philippine Legislature was Act No.
2833, which took effect on January 1, 1920. Under Section 1 thereof, nonresident aliens are likewise subject
to tax on income “from all sources within the Philippine Islands,” thus—SECTION 1. (a) There shall be
levied, assessed, collected, and paid annually upon the entire net income received in the preceding
calendar year from all sources by every individual, a citizen or resident of the Philippine Islands, a tax of
two per centum upon such income; and a like tax shall be levied, assessed, collected, and paid annually
upon the entire net income received in the preceding calendar year from all sources within the Philippine
Islands by every individual, a nonresident alien, including interest on bonds, notes, or other interest-bearing
obligations of residents, corporate or otherwise. Act No. 2833 substantially reproduced the United States
(U.S.) Revenue Law of 1916 as amended by U.S. Revenue Law of 1917. Being a law of American origin,
the authoritative decisions of the official charged with enforcing it in the U.S. have peculiar persuasive force
in the Philippines.
Same; It is the situs of the activity which determines whether an income is taxable in the Philippines.—Both
the petitioner and respondent cited the case of Commissioner of Internal Revenue v. British Overseas
Airways Corporation, 149 SCRA 395 (1987), in support of their arguments, but the correct interpretation of
the said case favors the theory of respondent that it is the situs of the activity that determines whether such
income is taxable in the Philippines.
_______________

* FIRST DIVISION.
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SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Baier-Nickel
The conflict between the majority and the dissenting opinion in the said case has nothing to do with the
underlying principle of the law on sourcing of income. In fact, both applied the case of Alexander Howden
& Co., Ltd. v. Collector of Internal Revenue, 13 SCRA 601 (1965). The divergence in opinion centered on
whether the sale of tickets in the Philippines is to be construed as the “activity” that produced the income,
as viewed by the majority, or merely the physical source of the income, as ratiocinated by Justice Florentino
P. Feliciano in his dissent. The majority, through Justice Ameurfina Melencio-Herrera, as ponente,
interpreted the sale of tickets as a business activity that gave rise to the income of BOAC. Petitioner cannot
therefore invoke said case to support its view that source of income is the physical source of the money
earned. If such was the interpretation of the majority, the Court would have simply stated that source of
income is not the business activity of BOAC but the place where the person or entity disbursing the income
is located or where BOAC physically received the same. But such was not the import of the ruling of the
Court. It even explained in detail the business activity undertaken by BOAC in the Philippines to pinpoint
the taxable activity and to justify its conclusion that BOAC is subject to Philippine income taxation.
Same; Words and Phrases; “Source of income” relates to the property, activity or service that produced the
income.—The Court reiterates the rule that “source of income” relates to the property, activity or service
that produced the income. With respect to rendition of labor or personal service, as in the instant case, it is
the place where the labor or service was performed that determines the source of the income. There is
therefore no merit in petitioner’s interpretation which equates source of income in labor or personal service
with the residence of the payor or the place of payment of the income.
Same; Tax Refunds; The settled rule is that tax refunds are in the nature of tax exemptions and are to be
construed strictissimi juris against the taxpayer.—Having disposed of the doctrine applicable in this case,
we will now determine whether respondent was able to establish the factual circumstances showing that
her income is exempt from Philippine income taxation. The decisive factual consideration here is not the
capacity in which respondent received the income, but the sufficiency of evidence to prove that the services
she rendered were performed in Germany. Though not raised as an
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issue, the Court is clothed with authority to address the same because the resolution thereof will settle the
vital question posed in this controversy. The settled rule is that tax refunds are in the nature of tax
exemptions and are to be construed strictissimi juris against the taxpayer. To those therefore, who claim a
refund rest the burden of proving that the transaction subjected to tax is actually exempt from taxation.
Same; Judgments; Res Judicata; Elements; Res judicata does not apply where an earlier case and the
present case deal with income earned and activities performed for different taxable years.—The Court notes
that in Commissioner of Internal Revenue v. BaierNickel, a previous case for refund of income withheld
from respondent’s remunerations for services rendered abroad, the Court in a Minute Resolution dated
February 17, 2003, sustained the ruling of the Court of Appeals that respondent is entitled to refund the
sum withheld from her sales commission income for the year 1994. This ruling has no bearing in the instant
controversy because the subject matter thereof is the income of respondent for the year 1994 while, the
instant case deals with her income in 1995. Otherwise, stated, res judicata has no application here. Its
elements are: (1) there must be a final judgment or order; (2) the court that rendered the judgment must
have jurisdiction over the subject matter and the parties; (3) it must be a judgment on the merits; (4) there
must be between the two cases identity of parties, of subject matter, and of causes of action.The instant
case, however, did not satisfy the fourth requisite because there is no identity as to the subject matter of
the previous and present case of respondent which deals with income earned and activities performed for
different taxable years.
PETITION for review on certiorari of the decision and resolution of the Court of Appeals.

The facts are stated in the opinion of the Court.


The Solicitor General for petitioner.
V.C. Mamalateo & Associates for respondent.
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SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Baier-Nickel
YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18, 2002 Decision1 of the
Court of Appeals in CA-G.R. SP No. 59794, which granted the tax refund of respondent Juliane Baier-
Nickel and reversed the June 28, 2000 Decision2 of the Court of Tax Appeals (CTA) in C.T.A. Case No.
5633. Petitioner also assails the May 8, 2002 Resolution3 of the Court of Appeals denying its motion for
reconsideration.
The facts show that respondent Juliane Baier-Nickel, a non-resident German citizen, is the President of
JUBANITEX, Inc., a domestic corporation engaged in “[m]anufacturing, marketing on wholesale only,
buying or otherwise acquiring, holding, importing and exporting, selling and disposing embroidered textile
products.”4 Through JUBANITEX’s General Manager, Marina Q. Guzman, the corporation appointed and
engaged the services of respondent as commission agent. It was agreed that respondent will receive 10%
sales commission on all sales actually concluded and collected through her efforts.5
In 1995, respondent received the amount of P1,707,772.64, representing her sales commission income
from which JUBANITEX withheld the corresponding 10% withholding tax amounting to P170,777.26, and
remitted the same to the Bureau of Internal Revenue (BIR). On October 17, 1997, re-
_______________

1 Penned by Associate Justice Salvador J. Valdez, Jr. and concurred in by Associate Justices Mercedes
Gozo-Dadole and Juan Q. Enriquez, Jr.; Rollo, pp. 47-57.
2 Penned by Presiding Judge Ernesto D. Acosta, with Associate Judges Ramon O. De Veyra, concurring
and Amancio Q. Saga, dissenting; Rollo, pp. 78-91.
3 Rollo, pp. 59-61.
4 General Information Sheet of JUBANITEX, Inc., Rollo, p. 211.
5 Rollo, p. 100.
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spondent filed her 1995 income tax return reporting a taxable income of P1,707,772.64 and a tax due of
P170,777.26.6
On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26 alleged to have been
mistakenly withheld and remitted by JUBANITEX to the BIR. Respondent contended that her sales
commission income is not taxable in the Philippines because the same was a compensation for her services
rendered in Germany and therefore considered as income from sources outside the Philippines.
The next day, April 15, 1998, she filed a petition for review with the CTA contending that no action was
taken by the BIR on her claim for refund.7 On June 28, 2000, the CTA rendered a decision denying her
claim. It held that the commissions received by respondent were actually her remuneration in the
performance of her duties as President of JUBANITEX and not as a mere sales agent thereof. The income
derived by respondent is therefore an income taxable in the Philippines because JUBANITEX is a domestic
corporation.
On petition with the Court of Appeals, the latter reversed the Decision of the CTA, holding that respondent
received the commissions as sales agent of JUBANITEX and not as President thereof. And since the
“source” of income means the activity or service that produce the income, the sales commission received
by respondent is not taxable in the Philippines because it arose from the marketing activities performed by
respondent in Germany. The dispositive portion of the appellate court’s Decision, reads:
“WHEREFORE, premises considered, the assailed decision of the Court of Tax Appeals dated June 28,
2000 is hereby REVERSED and SET ASIDE and the respondent court is hereby directed to grant petitioner
a tax refund in the amount of Php 170,777.26.
SO ORDERED.”8
_______________

6 Exhibit “A,” Folder of Exhibits, unpaged.


7 Petition for Review with the CTA, Records, p. 4.
8 Rollo, p. 57.
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SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Baier-Nickel
Petitioner filed a motion for reconsideration but was denied.9 Hence, the instant recourse.
Petitioner maintains that the income earned by respondent is taxable in the Philippines because the source
thereof is JUBANITEX, a domestic corporation located in the City of Makati. It thus implied that source of
income means the physical source where the income came from. It further argued that since respondent is
the President of JUBANITEX, any remuneration she received from said corporation should be construed
as payment of her overall managerial services to the company and should not be interpreted as a
compensation for a distinct and separate service as a sales commission agent.
Respondent, on the other hand, claims that the income she received was payment for her marketing
services. She contended that income of nonresident aliens like her is subject to tax only if the source of the
income is within the Philippines. Source, according to respondent is the situs of the activity which produced
the income. And since the source of her income were her marketing activities in Germany, the income she
derived from said activities is not subject to Philippine income taxation.
The issue here is whether respondent’s sales commission income is taxable in the Philippines.
Pertinent portion of the National Internal Revenue Code (NIRC), states:
SEC. 25. Tax on Nonresident Alien Individual.—
(A) Nonresident Alien Engaged in Trade or Business Within the Philippines.—
(1) In General.—A nonresident alien individual engaged in trade or business in the Philippines shall be
subject to an income tax in the same manner as an individual citizen and a resident alien individual, on
taxable income received from all
_______________

9 Resolution dated May 8, 2002; Rollo, pp. 59-61.


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sources within the Philippines. A nonresident alien individual who shall come to the Philippines and stay
therein for an aggregate period of more than one hundred eighty (180) days during any calendar year shall
be deemed a ‘nonresident alien doing business in the Philippines,’ Section 22(G) of this Code
notwithstanding.
xxxx
(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines.—There shall be
levied, collected and paid for each taxable year upon the entire income received from all sources within the
Philippines by every nonresident alien individual not engaged in trade or business within the Philippines x
x x a tax equal to twenty-five percent (25%) of such income. x x x
Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or not engaged in trade or
business, are subject to Philippine income taxation on their income received from all sources within the
Philippines. Thus, the keyword in determining the taxability of non-resident aliens is the income’s “source.”
In construing the meaning of “source” in Section 25 of the NIRC, resort must be had on the origin of the
provision.
The first Philippine income tax law enacted by the Philippine Legislature was Act No. 2833,10 which took
effect on January 1, 1920.11 Under Section 1 thereof, nonresident aliens are likewise subject to tax on
income “from all sources within the Philippine Islands,” thus—
SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon the entire net income
received in the preceding calendar year from all sources by every individual, a citizen or resident of the
Philippine Islands, a tax of two per centum upon such
_______________

10 An Act establishing the income tax law, making other provisions relating to said tax, and amending
certain sections of Act Numbered Twenty-seven hundred and eleven.
11 F. Dalupan, National Internal Revenue Code Annotated, 1964 ed., vol. 1, p. 25.
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SUPREME COURT REPORTS ANNOTATED
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income; and a like tax shall be levied, assessed, collected, and paid annually upon the entire net income
received in the preceding calendar year from all sources within the Philippine Islands by every individual, a
nonresident alien, including interest on bonds, notes, or other interest-bearing obligations of residents,
corporate or otherwise.
Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of 1916 as amended by U.S.
Revenue Law of 1917.12 Being a law of American origin, the authoritative decisions of the official charged
with enforcing it in the U.S. have peculiar persuasive force in the Philippines.13
The Internal Revenue Code of the U.S. enumerates specific types of income to be treated as from sources
within the U.S. and specifies when similar types of income are to be treated as from sources outside the
U.S.14 Under the said Code, compensation for labor and personal services performed in the U.S., is
generally treated as income from U.S. sources; while compensation for said services performed outside
the U.S., is treated as income from sources outside the U.S.15 A similar provision is found in Section 42 of
our NIRC, thus:
SEC. 42. x x x
(A) Gross Income From Sources Within the Philippines. x x x
xxxx
(3) Services.—Compensation for labor or personal services performed in the Philippines;
xxxx
(C) Gross Income From Sources Without the Philippines. x x x
xxxx
_______________

12 Id.
13 J. Arañas, Annotations and Jurisprudence on the National Internal Revenue Code, as Amended, 1963
ed., vol. 1, p. 34.
14 34 Am. Jur. 2d, ¶ 30651, p. 453 (2000).
15 34 Am. Jur. 2d, ¶ 30654, p. 453 (2000).
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(3) Compensation for labor or personal services performed without the Philippines;
The following discussions on sourcing of income under the Internal Revenue Code of the U.S., are
instructive:
“The Supreme Court has said, in a definition much quoted but often debated, that income may be derived
from three possible sources only: (1) capital and/or (2) labor; and/or (3) the sale of capital assets. While the
three elements of this attempt at definition need not be accepted as all-inclusive, they serve as useful guides
in any inquiry into whether a particular item is from “sources within the United States” and suggest an
investigation into the nature and location of the activities or property which produce the income.
If the income is from labor the place where the labor is done should be decisive; if it is done in this country,
the income should be from “sources within the United States.” If the income is from capital, the place where
the capital is employed should be decisive; if it is employed in this country, the income should be from
“sources within the United States.” If the income is from the sale of capital assets, the place where the sale
is made should be likewise decisive.
Much confusion will be avoided by regarding the term “source” in this fundamental light. It is not a place, it
is an activity or property. As such, it has a situs or location, and if that situs or location is within the United
States the resulting income is taxable to nonresident aliens and foreign corporations.
The intention of Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913 basis of
taxing nonresident aliens and foreign corporations and to make the test of taxability the “source,” or situs
of the activities or property which produce the income. The result is that, on the one hand, nonresident
aliens and nonresident foreign corporations are prevented from deriving income from the United States free
from tax, and, on the other hand, there is no undue imposition of a tax when the activities do not take place
in, and the property producing income is not employed in, this country. Thus, if income is to be taxed, the
recipient thereof must be resident within the jurisdiction, or the property or activities out of which the income
issues or is derived must be situated within the jurisdiction so that the source of the income may be said to
have a situs in this country.
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SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Baier-Nickel
The underlying theory is that the consideration for taxation is protection of life and property and that the
income rightly to be levied upon to defray the burdens of the United States Government is that income
which is created by activities and property protected by this Government or obtained by persons enjoying
that protection.”16
The important factor therefore which determines the source of income of personal services is not the
residence of the payor, or the place where the contract for service is entered into, or the place of payment,
but the place where the services were actually rendered.17
In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue,18 the Court addressed the issue on the
applicable source rule relating to reinsurance premiums paid by a local insurance company to a foreign
insurance company in respect of risks located in the Philippines. It was held therein that the undertaking of
the foreign insurance company to indem-nify the local insurance company is the activity that produced the
income. Since the activity took place in the Philippines, the income derived therefrom is taxable in our
jurisdiction. Citing Mertens, The Law of Federal Income Taxation, the Court emphasized that the technical
meaning of source of income is the property, activity or service that produced the same. Thus:
“The source of an income is the property, activity or service that produced the income. The reinsurance
premiums remitted to appellants by virtue of the reinsurance contracts, accordingly, had
_______________

16 12 J. Mertens, The Law of Federal Income Taxation, Section 45C:04, pp. 45C-12 to 45C-13 (1996). The
1957 edition thereof was cited in the dissenting opinion of Justice Florentino P. Feliciano in Commissioner
of Internal Revenue v. British Overseas Airways Corporation, G.R. Nos. L-65773-74, April 30, 1987, 149
SCRA 395, 415-416.
17 12 J. Mertens, The Law of Federal Income Taxation, Section 45C:11, p. 45C-32 (1996).
18 121 Phil. 579; 13 SCRA 601 (1965).
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for their source the undertaking to indemnify Commonwealth Insurance Co. against liability. Said
undertaking is the activity that produced the reinsurance premiums, and the same took place in the
Philippines. x x x the reinsured, the liabilities insured and the risk originally underwritten by Commonwealth
Insurance Co., upon which the reinsurance premiums and indemnity were based, were all situated in the
Philippines. x x x”19
In Commissioner of Internal Revenue v. British Overseas Airways Corporation (BOAC),20 the issue was
whether BOAC, a foreign airline company which does not maintain any flight to and from the Philippines is
liable for Philippine income taxation in respect of sales of air tickets in the Philippines, through a general
sales agent relating to the carriage of passengers and cargo between two points both outside the
Philippines. Ruling in the affirmative, the Court applied the case of Alexander Howden & Co., Ltd. v.
Collector of Internal Revenue, and reiterated the rule that the source of income is that “activity” which
produced the income. It was held that the “sale of tickets” in the Philippines is the “activity” that produced
the income and therefore BOAC should pay income tax in the Philippines because it undertook an income
producing activity in the country.
Both the petitioner and respondent cited the case of Commissioner of Internal Revenue v. British Overseas
Airways Corporation in support of their arguments, but the correct interpretation of the said case favors the
theory of respondent that it is the situs of the activity that determines whether such income is taxable in the
Philippines. The conflict between the majority and the dissenting opinion in the said case has nothing to do
with the underlying principle of the law on sourcing of income. In fact, both applied the case of Alexander
Howden & Co., Ltd. v. Collector of Internal Revenue.The divergence in opinion centered on whether the
sale of tickets in the Philippines is to be construed as the “activity” that
_______________

19 Id., at p. 583; p. 604.


20 Supra note 16.
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Commissioner of Internal Revenue vs. Baier-Nickel
produced the income, as viewed by the majority, or merely the physical source of the income, as
ratiocinated by Justice Florentino P. Feliciano in his dissent. The majority, through Justice Ameurfina
Melencio-Herrera, as ponente, interpreted the sale of tickets as a business activity that gave rise to the
income of BOAC. Petitioner cannot therefore invoke said case to support its view that source of income is
the physical source of the money earned. If such was the interpretation of the majority, the Court would
have simply stated that source of income is not the business activity of BOAC but the place where the
person or entity disbursing the income is located or where BOAC physically received the same. But such
was not the import of the ruling of the Court. It even explained in detail the business activity undertaken by
BOAC in the Philippines to pinpoint the taxable activity and to justify its conclusion that BOAC is subject to
Philippine income taxation. Thus—
“BOAC, during the periods covered by the subject assessments, maintained a general sales agent in the
Philippines. That general sales agent, from 1959 to 1971, “was engaged in (1) selling and issuing tickets;
(2) breaking down the whole trip into series of trips—each trip in the series corresponding to a different
airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various
airline companies on the basis of their participation in the services rendered through the mode of interline
settlement as prescribed by Article VI of the Resolution No. 850 of the IATA Agreement.” Those activities
were in exercise of the functions which are normally incident to, and are in progressive pursuit of, the
purpose and object of its organization as an international air carrier. In fact, the regular sale of tickets, its
main activity, is the very lifeblood of the airline business, the generation of sales being the paramount
objective. There should be no doubt then that BOAC was “engaged in” business in the Philippines through
a local agent during the period covered by the assessments. x x x21
xxxx
_______________

21 Id., at pp. 405-406.


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“The source of an income is the property, activity or service that produced the income. For the source of
income to be considered as coming from the Philippines, it is sufficient that the income is derived from
activity within the Philippines. In BOAC’s case, the sale of tickets in the Philippines is the activity that
produces the income. The tickets exchanged hands here and payments for fares were also made here in
Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded
from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of wealth should share the burden of supporting
the government.
“A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the
contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser of the ticket
to pay the fare and the corresponding obligation of the carrier to transport the passenger upon the terms
and conditions set forth thereon. The ordinary ticket issued to members of the traveling public in general
embraces within its terms all the elements to constitute it a valid contract, binding upon the parties entering
into the relationship.”22
The Court reiterates the rule that “source of income” relates to the property, activity or service that produced
the income. With respect to rendition of labor or personal service, as in the instant case, it is the place
where the labor or service was performed that determines the source of the income. There is therefore no
merit in petitioner’s interpretation which equates source of income in labor or personal service with the
residence of the payor or the place of payment of the income.
Having disposed of the doctrine applicable in this case, we will now determine whether respondent was
able to establish the factual circumstances showing that her income is exempt from Philippine income
taxation.
_______________

22 Id., at pp. 407-408.


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The decisive factual consideration here is not the capacity in which respondent received the income, but
the sufficiency of evidence to prove that the services she rendered were performed in Germany. Though
not raised as an issue, the Court is clothed with authority to address the same because the resolution
thereof will settle the vital question posed in this controversy.23
The settled rule is that tax refunds are in the nature of tax exemptions and are to be construed strictissimi
juris against the taxpayer.24 To those therefore, who claim a refund rest the burden of proving that the
transaction subjected to tax is actually exempt from taxation.
In the instant case, the appointment letter of respondent as agent of JUBANITEX stipulated that the activity
or the service which would entitle her to 10% commission income, are “sales actually concluded and
collected through [her] efforts.”25 What she presented as evidence to prove that she performed income
producing activities abroad, were copies of documents she allegedly faxed to JUBANITEX and bearing
instructions as to the sizes of, or designs and fabrics to be used in the finished products as well as samples
of sales orders purportedly relayed to her by clients. However, these documents do not show whether the
instructions or orders faxed ripened into concluded or collected sales in Germany. At the very least, these
pieces of evidence show that while respondent was in Germany, she sent instructions/orders to
JUBANITEX. As to whether these instructions/orders gave rise to consummated sales and whether these
sales were truly concluded in Germany, respondent presented no such evidence. Neither did she establish
reasonable connection between the
_______________

23 Velarde v. Social Justice Society, G.R. No. 159357, April 28, 2004, 428 SCRA 283, 312.
24 Calamba Steel Center, Inc. v. Commissioner of Internal Revenue, G.R. No. 151857, April 28, 2005, 457
SCRA 482, 500.
25 Rollo, p. 100.
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orders/instructions faxed and the reported monthly sales purported to have transpired in Germany.
The paucity of respondent’s evidence was even noted by Atty. Minerva Pacheco, petitioner’s counsel at the
hearing before the Court of Tax Appeals. She pointed out that respondent presented no contracts or orders
signed by the customers in Germany to prove the sale transactions therein.26 Likewise, in her Comment
to the Formal Offer of respondent’s evidence, she objected to the admission of the faxed documents bearing
instruction/orders marked as Exhibits “R,”27 “V,” “W,” and “X,”28 for being self-serving.29 The concern
raised by petitioner’s counsel as to the absence of substantial evidence that would constitute proof that the
sale transactions for which respondent was paid commission actually transpired outside the Philippines, is
relevant because respondent stayed in the Philippines for 89 days in 1995. Except for the months of July
and September 1995, respondent was in the Philippines in the months of March, May, June, and August
1995,30 the same months when she earned commission income for services allegedly performed abroad.
Furthermore, respondent presented no evidence to prove that JUBANITEX does not sell embroidered
products in the Philippines and that her appointment as commission agent is exclusively for Germany and
other European markets.
In sum, we find that the faxed documents presented by respondent did not constitute substantial evidence,
or that relevant evidence that a reasonable mind might accept as adequate to support the conclusion31
that it was in Germany where she performed the income producing service which
_______________

26 TSN, November 10, 1998, pp. 49-55.


27 Rollo, pp. 95-99.
28 Folder of Exhibits, unpaged.
29 Records, pp. 74-75.
30 Respondent’s Formal Offer of Evidence, Rollo, p. 202.
31 Transglobe International, Inc. v. Court of Appeals, 361 Phil. 727, 738; 302 SCRA 57, 68 (1999).
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gave rise to the reported monthly sales in the months of March and May to September of 1995. She thus
failed to discharge the burden of proving that her income was from sources outside the Philippines and
exempt from the application of our income tax law. Hence, the claim for tax refund should be denied.
The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel,32 a previous case for refund of
income withheld from respondent’s remunerations for services rendered abroad, the Court in a Minute
Resolution dated February 17, 2003,33 sustained the ruling of the Court of Appeals that respondent is
entitled to refund the sum withheld from her sales commission income for the year 1994. This ruling has no
bearing in the instant controversy because the subject matter thereof is the income of respondent for the
year 1994 while, the instant case deals with her income in 1995. Otherwise, stated, res judicata has no
application here. Its elements are: (1) there must be a final judgment or order; (2) the court that rendered
the judgment must have jurisdiction over the subject matter and the parties; (3) it must be a judgment on
the merits; (4) there must be between the two cases identity of parties, of subject matter, and of causes of
action.34 The instant case, however, did not satisfy the fourth requisite because there is no identity as to
the subject matter of the previous and present case of respondent which deals with income earned and
activities performed for different taxable years.
WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision and May 8, 2002 Resolution
of the Court of Appeals in CA-G.R. SP No. 59794, are REVERSED and SET ASIDE. The June 28, 2000
Decision of the Court of Tax Appeals in C.T.A. Case No. 5633, which denied respondent’s
_______________

32 G.R. No. 156305.


33 It became final and executory on March 31, 2003.
34 Barbacina v. Court of Appeals, G.R. No. 135365, August 31, 2004, 437 SCRA 300, 307.
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103
Commissioner of Internal Revenue vs. Baier-Nickel
claim for refund of income tax paid for the year 1995 is REINSTATED.
SO ORDERED.
Panganiban (C.J., Chairperson), Austria-Martinez, Callejo, Sr. and Chico-Nazario, JJ., concur.
Petition granted, judgment and resolution reversed and set aside.
Notes.—Tax refunds are in the nature of tax exemptions, and as such they are regarded as in derogation
of sovereign authority and to be construed strictissimi juris against the person or entity claiming the
exemption. (Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc., 309 SCRA 87 [1999])
It is settled that tax exemptions should be strictly construed against those claiming to be qualified thereto.
(Commissioner of Internal Revenue vs. Court of Tax Appeals, 328 SCRA 822 [2000])
G.R. No. 109289. October 3, 1994.*
RUFINO R. TAN, petitioner, vs. RAMON R. DEL ROSARIO, JR., as SECRETARY OF FINANCE & JOSE
U. ONG, as COMMISSIONER OF INTERNAL REVENUE, respondents.
G.R. No. 109446. October 3, 1994.*
CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES, CARLO A. CARAG, MANUELITO O.
CABALLES, ELPIDIO C. JAMORA, JR. and BENJAMIN A. SOMERA, JR., petitioners, vs. RAMON R. DEL
ROSARIO, in his capacity as SECRETARY OF FINANCE and JOSE U. ONG, in his capacity as
COMMISSIONER OF INTERNAL REVENUE, respondents.
Taxation; Simplified Net Income Taxation (“SNIT”); Republic Act No. 7496 did not adopt a gross income,
but have retained the net income, taxation scheme.—On the basis of the above language of the law, it
would be difficult to accept petitioner’s view that the amendatory law should be considered as having now
adopted a gross income, instead of as having still retained the net income, taxation scheme. The allowance
for deductible items, it is true, may have significantly been reduced by the questioned law in comparison
with that which has prevailed prior to the amendment; limiting, however, allowable deductions from gross
income is neither discordant with, nor opposed to, the net income tax concept. The fact of the matter is still
that various deductions, which are by no means inconsequential, continue to be well provided under the
new law.
Same; Same; Constitutional Law; Titles of Bills; Objectives of the constitutional provision on titles of bills.—
Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-rolling legislation
intended to unite the members of the legislature who favor any one of unrelated subjects in support of the
whole act, (b) to avoid surprises or even fraud upon the legislature, and (c) to fairly apprise the people,
through such publications of its proceedings as are usually made, of the subjects of legislation. The above
objectives of the fundamental law appear to us to have been sufficiently met. Anything else would be to
require a virtual compendium of the law which could not have been the intendment of the constitutional
mandate.
_______________

* EN BANC.
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Tan vs. Del Rosario, Jr.
Same; Same; Same; Uniformity of taxation merely requires that all subjects or objects of taxation, similarly
situated, are to be treated alike both in privileges and liabilities.—Uniformity of taxation, like the kindred
concept of equal protection, merely requires that all subjects or objects of taxation, similarly situated, are
to be treated alike both in privileges and liabilities (Juan Luna Subdivision vs. Sarmiento, 91 Phil. 371).
Uniformity does not forfend classification as long as: (1) the standards that are used therefor are substantial
and not arbitrary, (2) the categorization is germane to achieve the legislative purpose, (3) the law applies,
all things being equal, to both present and future conditions, and (4) the classification applies equally well
to all those belonging to the same class (Pepsi Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR,
197 SCRA 52).
Same; Same; Same; The legislative intent is to increasingly shift the income tax system towards the
schedular approach in the income taxation of individual taxpayers and to maintain, by and large, the present
global treatment on taxable corporations.—What may instead be perceived to be apparent from the
amendatory law is the legislative intent to increasingly shift the income tax system towards the schedular
approach in the income taxation of individual taxpayers and to maintain, by and large, the present global
treatment on taxable corporations.
Same; Same; Same; Words and Phrases; Schedular Approach, Defined.—Schedular approach is a system
employed where the income tax treatment varies and made to depend on the kind or category of taxable
income of the taxpayer.
Same; Same; Same; Same; Global Treatment, Defined.—Global treatment is a system where the tax
treatment views indifferently the tax base and generally treats in common all categories of taxable income
of the taxpayer.
Same; Same; Same; Separation of Powers; With the legislature primarily lies the discretion to determine
the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation, and the
Supreme Court cannot freely delve into those matters.—Petitioner gives a fairly extensive discussion on
the merits of the law, illustrating, in the process, what he believes to be an imbalance between the tax
liabilities of those covered by the amendatory law and those who are not. With the legislature primarily lies
the discretion to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs
(place) of taxation. This court cannot freely delve into those matters which, by constitutional fiat, rightly rest
on legislative judgment. Of course, where a tax measure becomes so unconscionable and unjust
326

326
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
as to amount to confiscation of property, courts will not hesitate to strike it down, for, despite all its plenitude,
the power to tax cannot override constitutional proscriptions. This stage, however, has not been
demonstrated to have been reached within any appreciable distance in this controversy before us.
Same; Same; Same; Due Process; The due process clause may correctly be invoked only when there is a
clear contravention of inherent or constitutional limitations in the exercise of the tax power.—Having arrived
at this conclusion, the plea of petitioner to have the law declared unconstitutional for being violative of due
process must perforce fail. The due process clause may correctly be invoked only when there is a clear
contravention of inherent or constitutional limitations in the exercise of the tax power. No such transgression
is so evident to us.
Same; Same; Same; Partnerships; A general professional partnership, unlike an ordinary business
partnership, is not itself an income taxpayer, as the income tax is imposed not on the professional
partnership but on the partners themselves in their individual capacity.—The Court, first of all, should like
to correct the apparent misconception that general professional partnerships are subject to the payment of
income tax or that there is a difference in the tax treatment between individuals engaged in business or in
the practice of their respective professions and partners in general professional partnerships. The fact of
the matter is that a general professional partnership, unlike an ordinary business partnership (which is
treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself
an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt,
but on the partners themselves in their individual capacity computed on their distributive shares of
partnership profits.
Same; Same; Same; Same; Words and Phrases; “Income Tax-payers,” Defined; The Tax Code, in levying
the tax, adopts the most comprehensive tax situs of nationality and residence of the taxpayer and of the
generally accepted and internationally recognized income taxable base.—We can well appreciate the
concern taken by petitioners if perhaps we were to consider Republic Act No. 7496 as an entirely
independent, not merely as an amendatory, piece of legislation. The view can easily become myopic,
however, when the law is understood, as it should be, as only forming part of, and subject to, the whole
income tax concept and precepts long obtaining under the National Internal Revenue Code. To elaborate
a little, the phrase “income taxpayers” is an all embracing term used in the Tax Code, and it practically
covers all persons who derive taxable income. The law, in levying the tax, adopts
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327
Tan vs. Del Rosario, Jr.
the most comprehensive tax situs of nationality and residence of the taxpayer (that renders citizens,
regardless of residence, and resident aliens subject to income tax liability on their income from all sources)
and of the generally accepted and internationally recognized income taxable base (that can subject non-
resident aliens and foreign corporations to income tax on their income from Philippine sources). In the
process, the Code classifies taxpayers into four main groups, namely: (1) Individuals, (2) Corporations, (3)
Estates under Judicial Settlement and (4) Irrevocable Trusts (irrevocable both as to corpus and as to
income).
Same; Same; Same; Same; Partnerships under the Tax Code, Classified; Ordinarily, partnerships are
subject to income tax which are by law assimilated to be within the context of, and so legally contemplated
as, corporations.—Partnerships are, under the Code, either “taxable partnerships” or “exempt
partnerships.” Ordinarily, partnerships, no matter how created or organized, are subject to income tax (and
thus alluded to as “taxable partnerships”) which, for purposes of the above categorization, are by law
assimilated to be within the context of, and so legally contemplated as, corporations. Except for few
variances, such as in the application of the “constructive receipt rule” in the derivation of income, the income
tax approach is alike to both juridical persons.
Same; Same; Same; Same; SNIT is not intended or envisioned to cover corporations and partnerships
which are independently subject to the payment of income tax.—Obviously, SNIT is not intended or
envisioned, as so correctly pointed out in the discussions in Congress during its deliberations on Republic
Act 7496, aforequoted, to cover corporations and partnerships which are independently subject to the
payment of income tax.
Same; Same; Same; Same; “Exempt partnerships” are not similarly identified as corporations nor even
considered as independent taxable entities for income tax purposes.—“Exempt partnerships,” upon the
other hand, are not similarly identified as corporations nor even considered as independent taxable entities
for income tax purposes. A general professional partnership is such an example. Here, the partners
themselves, not the partnership (although it is still obligated to file an income tax return [mainly for
administration and data]), are liable for the payment of income tax in their individual capacity computed on
their respective and distributive shares of profits. In the determination of the tax liability, a partner does so
as an individual, and there is no choice on the matter. In fine, under the Tax Code on income taxation, the
general professional partnership is deemed to be no more than a mere mechanism or a flow-through entity
in the generation of income
328

328
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
by, and the ultimate distribution of such income to, respectively, each of the individual partners.
Same; Same; Same; Same; Section 6 of Revenue Regulation No. 2-93 consistent with the Tax Code as
modified by Republic Act No. 7496.—Section 6 of Revenue Regulation No. 2-93 did not alter, but merely
confirmed, the above standing rule as now so modified by Republic Act No. 7496 on basically the extent of
allowable deductions applicable to all individual income taxpayers on their non-compensation income.
There is no evident intention of the law, either before or after the amendatory legislation, to place in an
unequal footing or in significant variance the income tax treatment of professionals who practice their
respective professions individually and of those who do it through a general professional partnership.
SPECIAL CIVIL ACTIONS in the Supreme Court. Prohibition.

The facts are stated in the opinion of the Court.


Rufino R. Tan for and in his own behalf.
Carag, Caballes, Jamora & Zomera Law Offices for petitioners in G.R. No. 109446.
VITUG, J.:

These two consolidated special civil actions for prohibition challenge, in G.R. No. 109289, the
constitutionality of Republic Act No. 7496, also commonly known as the Simplified Net Income Taxation
Scheme (“SNIT”), amending certain provisions of the National Internal Revenue Code and, in G.R. No.
109446, the validity of Section 6, Revenue Regulations No. 2-93, promulgated by public respondents
pursuant to said law.
Petitioners claim to be taxpayers adversely affected by the continued implementation of the amendatory
legislation.
In G.R. No. 109289, it is asserted that the enactment of Republic Act No. 7496 violates the following
provisions of the Constitution:
“Article VI, Section 26(1)—Every bill passed by the Congress shall embrace only one subject which shall
be expressed in the title thereof.”
“Article VI, Section 28(1)—The rule of taxation shall be uniform and equitable. The Congress shall evolve
a progressive system of taxation.”
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Tan vs. Del Rosario, Jr.
“Article III, Section 1—No person shall be deprived of x x x property without due process of law, nor shall
any person be denied the equal protection of the laws.”
In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No. 2-93, argue that public
respondents have exceeded their rule-making authority in applying SNIT to general professional
partnerships.
The Solicitor General espouses the position taken by public respondents.
The Court has given due course to both petitions. The parties, in compliance with the Court’s directive,
have filed their respective memoranda.
G.R. No. 109289
Petitioner contends that the title of House Bill No. 34314, progenitor of Republic Act No. 7496, is a misnomer
or, at least, deficient for being merely entitled, “Simplified Net Income Taxation Scheme for the Self-
Employed and Professionals Engaged in the Practice of their Profession” (Petition in G.R. No. 109289).
The full text of the title actually reads:
“An Act Adopting the Simplified Net Income Taxation Scheme For The Self-Employed and Professionals
Engaged In The Practice of Their Profession, Amending Sections 21 and 29 of the National Internal
Revenue Code, as Amended.”
The pertinent provisions of Sections 21 and 29, so referred to, of the National Internal Revenue Code, as
now amended, provide:
“Section 21. Tax on citizens or residents.—
“x x x xxx
“(f) Simplified Net Income Tax for the Self-Employed and/or Professionals Engaged in the Practice of
Profession.—A tax is hereby imposed upon the taxable net income as determined in Section 27 received
during each taxable year from all sources, other than income covered by paragraphs (b), (c), (d) and (e) of
this section by every individual whether a citizen of the Philippines or an alien residing in the Philippines
who is self-employed or practices his profession herein, determined in accordance with the following
schedule:
330

330
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
“Not over P10,000
3%
Over P 10,000 but not over
P 30,000 P 300 + 9% of excess over P 10,000
Over P 30,000 but not over
P120,000 P 2,100 + 15% of excess over P 30,000
Over P120,000 but not over P350,000
P15,600 + 20% of excess over P120,000
Over P350,000
P61,600 + 30% of excess over P350,000”
“SECTION 29. Deductions from gross income.—In computing taxable income subject to tax under Sections
21(a), 24(a), (b) and (c); and 25 (a)(1), there shall be allowed as deductions the items specified in
paragraphs (a) to (i) of this section: Provided, however, That in computing taxable income subject to tax
under Section 21 (f) in the case of individuals engaged in business or practice of profession, only the
following direct costs shall be allowed as deductions:
“(a) Raw materials, supplies and direct labor;
“(b) Salaries of employees directly engaged in activities in the course of or pursuant to the business or
practice of their profession;
“(c) Telecommunications, electricity, fuel, light and water;
“(d) Business rentals;
“(e) Depreciation;
“(f) Contributions made to the Government and accredited relief organizations for the rehabilitation of
calamity stricken areas declared by the President; and
“(g) Interest paid or accrued within a taxable year on loans contracted from accredited financial institutions
which must be proven to have been incurred in connection with the conduct of a taxpayer’s profession,
trade or business.
“For individuals whose cost of goods sold and direct costs are difficult to determine, a maximum of forty per
cent (40%) of their gross receipts shall be allowed as deductions to answer for business or professional
expenses as the case may be.”
On the basis of the above language of the law, it would be difficult to accept petitioner’s view that the
amendatory law should be considered as having now adopted a gross income, instead of as having still
retained the net income, taxation scheme. The allowance for deductible items, it is true, may have
significantly been reduced by the questioned law in comparison with that which has prevailed prior to the
amendment; limiting, however, allowable deductions from gross income is neither discordant with, nor
opposed to, the net income tax concept. The fact of the matter is still that various deductions, which are by
no means inconsequential, continue to be well provided under the new law.
Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-rolling legislation
intended to unite the
331

VOL. 237, OCTOBER 3, 1994


331
Tan vs. Del Rosario, Jr.
members of the legislature who favor any one of unrelated subjects in support of the whole act, (b) to avoid
surprises or even fraud upon the legislature, and (c) to fairly apprise the people, through such publications
of its proceedings as are usually made, of the subjects of legislation.1 The above objectives of the
fundamental law appear to us to have been sufficiently met. Anything else would be to require a virtual
compendium of the law which could not have been the intendment of the constitutional mandate.
Petitioner intimates that Republic Act No. 7496 desecrates the constitutional requirement that taxation “shall
be uniform and equitable” in that the law would now attempt to tax single proprietorships and professionals
differently from the manner it imposes the tax on corporations and partnerships. The contention clearly
forgets, however, that such a system of income taxation has long been the prevailing rule even prior to
Republic Act No. 7496.
Uniformity of taxation, like the kindred concept of equal protection, merely requires that all subjects or
objects of taxation, similarly situated, are to be treated alike both in privileges and liabilities (Juan Luna
Subdivision vs. Sarmiento, 91 Phil. 371). Uniformity does not forfend classification as long as: (1) the
standards that are used therefor are substantial and not arbitrary, (2) the categorization is germane to
achieve the legislative purpose, (3) the law applies, all things being equal, to both present and future
conditions, and (4) the classification applies equally well to all those belonging to the same class (Pepsi
Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 52).
What may instead be perceived to be apparent from the amendatory law is the legislative intent to
increasingly shift the income tax system towards the schedular approach2 in the income taxation of
individual taxpayers and to maintain, by and large, the present global treatment3 on taxable corporations.
We certainly
_______________

1 Justice Isagani A. Cruz on Philippine Political Law 1993 edition, pp. 146-147, citing with approval Cooley
on Constitutional Limitations.
2 A system employed where the income tax treatment varies and made to depend on the kind or category
of taxable income of the taxpayer.
3 A system where the tax treatment views indifferently the tax base and generally treats in common all
categories of taxable income of the taxpayer.
332

332
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
do not view this classification to be arbitrary and inappropriate.
Petitioner gives a fairly extensive discussion on the merits of the law, illustrating, in the process, what he
believes to be an imbalance between the tax liabilities of those covered by the amendatory law and those
who are not. With the legislature primarily lies the discretion to determine the nature (kind), object (purpose),
extent (rate), coverage (subjects) and situs (place) of taxation. This court cannot freely delve into those
matters which, by constitutional fiat, rightly rest on legislative judgment. Of course, where a tax measure
becomes so unconscionable and unjust as to amount to confiscation of property, courts will not hesitate to
strike it down, for, despite all its plenitude, the power to tax cannot override constitutional proscriptions.
This stage, however, has not been demonstrated to have been reached within any appreciable distance in
this controversy before us.
Having arrived at this conclusion, the plea of petitioner to have the law declared unconstitutional for being
violative of due process must perforce fail. The due process clause may correctly be invoked only when
there is a clear contravention of inherent or constitutional limitations in the exercise of the tax power. No
such transgression is so evident to us.
G.R. No. 109446
The several propositions advanced by petitioners revolve around the question of whether or not public
respondents have exceeded their authority in promulgating Section 6, Revenue Regulations No. 2-93, to
carry out Republic Act No. 7496.
The questioned regulation reads:
“Sec. 6. General Professional Partnership—The general professional partnership (GPP) and the partners
comprising the GPP are covered by R.A. No. 7496. Thus, in determining the net profit of the partnership,
only the direct costs mentioned in said law are to be deducted from partnership income. Also, the expenses
paid or incurred by partners in their individual capacities in the practice of their profession which are not
reimbursed or paid by the partnership but are not considered as direct cost, are not deductible from his
gross income.”
The real objection of petitioners is focused on the administrative interpretation of public respondents that
would apply SNIT to partners in general professional partnerships. Petitioners cite
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333
Tan vs. Del Rosario, Jr.
the pertinent deliberations in Congress during its enactment of Republic Act No. 7496, also quoted by the
Honorable Hernando B. Perez, minority floor leader of the House of Representatives, in the latter’s privilege
speech by way of commenting on the questioned implementing regulation of public respondents following
the effectivity of the law, thusly:
“ ‘MR. ALBANO, Now Mr. Speaker, I would like to get the correct impression on this bill. Do we speak here
of individuals who are earning, I mean, who earn through business enterprises and therefore, should file
an income tax return? ‘MR. PEREZ. That is correct, Mr. Speaker. This does not apply to corporations. It
applies only to individuals.’
“(See Deliberations on H.B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis ours)
“ ‘Other deliberations support this position, to wit:
‘MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from Batangas say that this bill is intended
to increase collections as far as individuals are concerned and to make collection of taxes equitable?
‘MR. PEREZ. That is correct, Mr. Speaker.’
“(Id. at 6:40 P.M.; Emphasis ours)
“In fact, in the sponsorship speech of Senator Mamintal Tamano on the Senate version of the SNITS, it is
categorically stated, thus:
“ ‘This bill, Mr. President, is not applicable to business corporations or to partnerships; it is only with respect
to individuals and professionals.’ (Emphasis ours)”
The Court, first of all, should like to correct the apparent misconception that general professional
partnerships are subject to the payment of income tax or that there is a difference in the tax treatment
between individuals engaged in business or in the practice of their respective professions and partners in
general professional partnerships. The fact of the matter is that a general professional partnership, unlike
an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject
to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the
professional
334

334
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on
their distributive shares of partnership profits. Section 23 of the Tax Code, which has not been amended at
all by Republic Act 7496, is explicit:
“SECTION 23. Tax liability of members of general professional partnerships.—(a) Persons exercising a
common profession in general partnership shall be liable for income tax only in their individual capacity,
and the share in the net profits of the general professional partnership to which any taxable partner would
be entitled whether distributed or otherwise, shall be returned for taxation and the tax paid in accordance
with the provisions of this Title.
“(b) In determining his distributive share in the net income of the partnership, each partner—
“(1) Shall take into account separately his distributive share of the partnership’s income, gain, loss,
deduction, or credit to the extent provided by the pertinent provisions of this Code, and
“(2) Shall be deemed to have elected the itemized deductions, unless he declares his distributive share of
the gross income undiminished by his share of the deductions.”
There is, then and now, no distinction in income tax liability between a person who practices his profession
alone or individually and one who does it through partnership (whether registered or not) with others in the
exercise of a common profession. Indeed, outside of the gross compensation income tax and the final tax
on passive investment income, under the present income tax system all individuals deriving income from
any source whatsoever are treated in almost invariably the same manner and under a common set of rules.
We can well appreciate the concern taken by petitioners if perhaps we were to consider Republic Act No.
7496 as an entirely independent, not merely as an amendatory, piece of legislation. The view can easily
become myopic, however, when the law is understood, as it should be, as only forming part of, and subject
to, the whole income tax concept and precepts long obtaining under the National Internal Revenue Code.
To elaborate a little, the phrase “income taxpayers” is an all embracing term used in the Tax Code, and it
practically covers all persons who derive taxable income. The law, in levying the tax, adopts the most
comprehensive tax situs of nationality and residence of the
335

VOL. 237, OCTOBER 3, 1994


335
Tan vs. Del Rosario, Jr.
taxpayer (that renders citizens, regardless of residence, and resident aliens subject to income tax liability
on their income from all sources) and of the generally accepted and internationally recognized income
taxable base (that can subject non-resident aliens and foreign corporations to income tax on their income
from Philippine sources). In the process, the Code classifies taxpayers into four main groups, namely: (1)
Individuals, (2) Corporations, (3) Estates under Judicial Settlement and (4) Irrevocable Trusts (irrevocable
both as to corpus and as to income).
Partnerships are, under the Code, either “taxable partnerships” or “exempt partnerships.” Ordinarily,
partnerships, no matter how created or organized, are subject to income tax (and thus alluded to as “taxable
partnerships”) which, for purposes of the above categorization, are by law assimilated to be within the
context of, and so legally contemplated as, corporations. Except for few variances, such as in the
application of the “constructive receipt rule” in the derivation of income, the income tax approach is alike to
both juridical persons. Obviously, SNIT is not intended or envisioned, as so correctly pointed out in the
discussions in Congress during its deliberations on Republic Act 7496, aforequoted, to cover corporations
and partnerships which are independently subject to the payment of income tax.
“Exempt partnerships,” upon the other hand, are not similarly identified as corporations nor even considered
as independent taxable entities for income tax purposes. A general professional partnership is such an
example.4 Here, the partners themselves, not the partnership (although it is still obligated to file an income
tax return [mainly for administration and data]), are liable for
_______________
4 A general professional partnership, in this context, must be formed for the sole purpose of exercising a
common profession, no part of the income of which is derived from its engaging in any trade business;
otherwise, it is subject to tax as an ordinary business partnership or, which is to say, as a corporation and
thereby subject to the corporate income tax. The only other exempt partnership is a joint venture for
undertaking construction projects or engaging in petroleum operations pursuant to an operating agreement
under a service contract with the government (see Sections 20, 23 and 24, National Internal Revenue
Code).
336

336
SUPREME COURT REPORTS ANNOTATED
Tan vs. Del Rosario, Jr.
the payment of income tax in their individual capacity computed on their respective and distributive shares
of profits. In the determination of the tax liability, a partner does so as an individual, and there is no choice
on the matter. In fine, under the Tax Code on income taxation, the general professional partnership is
deemed to be no more than a mere mechanism or a flow-through entity in the generation of income by, and
the ultimate distribution of such income to, respectively, each of the individual partners.
Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the above standing rule as
now so modified by Republic Act No. 7496 on basically the extent of allowable deductions applicable to all
individual income taxpayers on their noncompensation income. There is no evident intention of the law,
either before or after the amendatory legislation, to place in an unequal footing or in significant variance the
income tax treatment of professionals who practice their respective professions individually and of those
who do it through a general professional partnership.
WHEREFORE, the petitions are DISMISSED. No special pronouncement on costs.
SO ORDERED.
Narvasa (C.J.), Cruz, Feliciano, Regalado, Davide, Jr., Romero, Bellosillo, Melo, Quiason, Puno,
Kapunan and Mendoza, JJ., concur.
Padilla and Bidin, JJ., On leave.
Petitions dismissed.
Note.—The law does not look with favor on tax exemptions and he who would seek to be thus privileged
must justify it by words too plain to be mistaken and too categorical to be misinterpreted. (Reagan vs.
Commissioner of Internal Revenue, 30 SCRA 968 [1969])
[No. 12287. August 7, 1918.]
VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs and appellants, vs. JAMES J.
RAPFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy Collector of Internal
Revenue, defendants and appellees.
1.TAXATION; INCOME TAX; PURPOSES.—The Income Tax Law of the United States in force in the
Philippine Islands has selected income as the test of faculty in taxation. The aim has been to mitigate the
evils arising from the inequalities of wealth by a progressive scheme of taxation, which places the burden
on those best able to pay. To carry out this idea, public considerations have demanded an exemption
roughly equivalent to the minimum of subsistence. With these exceptions, the Income Tax Law is supposed
to reach the earnings of the' entire nongovernmental property of the country.
2.ID.; ID.; INCOME CONTRASTED WITH CAPITAL AND PROPERTY.—Income as contrasted with capital
or property is to be the test. The essential difference between capital and income is that capital is a fund;
income is a flow. Capital is wealth, while income is the service of wealth. "The fact is that property is a tree,
income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring vs. City of
Savannah [1878], 60 Ga., 93.)
3.ID.; ID.; "INCOME," DEFINED.—Income means profits or gains.
4.ID.; ID.; CONJUGAL PARTNERSHIPS.—The decisions of this court in Nable Jose vs. Nable Jose [1916],
15 Off. Gaz., 871, and Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265, approved and
followed. The provisions of the Civil Cqde concerning conjugal partnerships have no application to the
Income Tax Law.
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VOL. 38, AUGUST 7, 1918


415
Madrigal and Paterno vs. Rafferty and Concepcion.
5.ID.; ID.; ID.—M and P were legally married prior to January 1, 1914. The marriage was contracted under
the provisions concerning conjugal partnerships. The claim is submitted that the income shown on the form
presented for 1914 was in fact the income of the conjugal partnership existing between M and P, and that
in computing and assessing the additional income tax, the income declared by M should be divided into
two equal parts, one-half to be considered the income of M and the other half the income of P. Held: That
P, the wife of M, has an inchoate right in the property of her husband M during the life of the conjugal
partnership, but that P has no absolute right to onehalf of the income of the conjugal partnership.
6.ID.; ID.; ID.—The higher schedules of the additional tax provided by the Income Tax Law directed at the
incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil Code dealing
with the conjugal partnership. The aims and purposes of the Income Tax Law must be given effect.
7.ID.; ID.; ID.—The Income Tax Law does not look on the spouses as individual partners in an ordinary
partnership.
8.ID.; ID.; STATUTORY CONSTRUCTION.—The Income Tax Law, being a law of American origin and
being peculiarly intricate in its provisions, the authoritative decision of the, official charged with enforcing it
has peculiar force for the Philippines. Great weight should be given to the construction placed upon a
revenue law, whose meaning is doubtful, by the department charged with its execution.
APPEAL from a judgment of the Court of First Instance of Manila. Campbell, J.
The facts are stated in the opinion of the court.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to the
Civil Code, a law of Spanish origin.
STATEMENT OF THE CASE.
Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The marriage was
contracted under the provisions of law concerning conjugal partner-
416

416
PHILIPPINE REPORTS ANNOTATED
Madrigal and Paterno vs. Rafferty and Concepcion.
ships (sociedad de gananciales). On February 25, 1915, Vicente Madrigal filed a sworn declaration on the
prescribed form with the Collector of Internal Revenue, showing, as his total net income for the year 1914,
the sum of P296,302.73. Subsequently Madrigal submitted the claim that the said ?=296,302.73 did not
represent his income for the year 1914, but was in fact the income of the conjugal partnership existing
between himself and his wife Susana Paterno, and that in computing and assessing the additional income
tax provided by the Act of Congress of October 3, 1913, the income declared by Vicente Madrigal should
be divided into two equal parts, one-half to be considered, the income of Vicente Madrigal and the other
half the income of Susana Paterno. The general question had in the meantime been submitted to the
Attorney-Greneral of the Philippine Islands who in an opinion dated March 17, 1915, held with the petitioner
Madrigal. The revenue officers being still unsatisfied, the correspondence together with this opinion was
forwarded to Washington for a decision by the United States Treasury Department. The United States
Commissioner of Interaal Revenue reversed the opinion of the Attorney-General, and thus decided against
the claim of Madrigal.
After payment under protest, and after the protest of Madrigal had been decided adversely by the Collector
of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana Paterno in the Court of
First Instance of the city of Manila against the Collector of Internal Revenue and the Deputy Collector of
Internal Revenue for the recovery of the sum of P3,786.08, alleged to have been wrongfully and illegally
assessed and collected by the defendants from the plaintiff, Vicente Madrigal, under the provisions of the
Act of Congress known as the Income Tax Law. The burden of the complaint was that if the income tax for
the year 1914 had been correctly and lawfully computed there would have been due and payable by each
of the plaintiffs the sum of P2,921.09, which taken together amounts to a total of P5,842.18 instead of
P9,668.21, erroneously and unlawfully collected from the
417

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417
Madrigal and Paterno vs. Rafferty and Concepcion.
plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid' as income tax for the year 1914,
P3,786.08, in excess of the sum lawfully due and payable.
The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and the
stipulation, sets forth the basis of defendants' stand in the following way: The income of Vicente Madrigal
and his wife Susana Paterno for the year 1914 was made up of three items: (1) P362,407.67, the profits
made by Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits made by Susana
Paterno in her embroidery business; (3) P16,687.80, the profits made by Vicente Madrigal in a pawnshop
company. The sum of these three items is ¥=383,181.97, the gross income of Vicente Madrigal and Susana
Paterno for the year 1914. General deductions were claimed and allowed in the sum of P86,879.24. The
resulting net income was P296,302.73. For the purpose of assessing the normal tax of one per cent on the
net income there were allowed as specific deductions the following: (1) P16,687.80, the tax upon which
was to be paid at source, and (2) P8,000, the specific exemption granted to Vicente Madrigal and Susana
Paterno, husband and wife. The remainder, P271,614.93 was the sum upon which the normal tax of one
per cent was assessed. The normal tax thus arrived at was P2,716.15.
The dispute between the plaintiffs and the defendants concerned the additional tax provided for in the
Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without costs.
ISSUES.
The contentions of plaintiffs and appellants, having to do solely with the additional income tax, is that it
should be divided into two equal parts, because of the conjugal partnership existing between them. The
learned argument o£ counsel is mostly based upon the provisions of the Civil Code establishing the
sociedad de gananciales. The counter contentions of appeDee. are that the taxes imposed by
418

418
PHILIPPINE REPORTS ANNOTATED
Madrigal and Paterno vs. Rafferty and Conception.
the Income Tax Law are as the name implies taxes upon income and not upon capital and property; that
the fact that Madrigal was a married man, and his marriage contracted under the provisions governing the
conjugal partnership, has no bearing on income considered as income, and that the distinction must be
drawn between the ordinary form of commercial partnership and the conjugal partnership of spouses
resulting from the relation of marriage.
DECISION.
From the point of view of test of faculty in taxation, no less than five answers have been given in the course
of history. The final stage has been the selection of income as the norm of taxation. (See Seligman, "The
Income Tax," Introduction.) The Income Tax Law of the United States, extended to the Philippine Islands,
is the result of an effect on the part of legislators to put into statutory form this canon of taxation and of
social reform. The aim has been to mitigate the evils arising from inequalities of wealth by a progressive
scheme of taxation, which places the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the minimum of subsistence. With these
exceptions, the income tax is supposed to reach the earnings of the entire non governmental property of
the country. Such is the background of the Income Tax Law.
Income as contrasted with capital or property is to be the test. The essential difference between capital and
income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is called
capital. A flow of services rendered by that capital by the payment of money from it or any other benefit
rendered by a fund of capital in relation to such fund through a period of time is called income. Capital is
wealth, while income is the service of wealth. (See Fisher, "The Nature of Capital and Income.") The
Supreme Court of Georgia expresses the thought in the following figurative language: "The fact is that
property is a tree, income is the fruit; labor is a tree,
419

VOL. 38, AUGIJST 7, 1918


419
Madrigal and Paterno vs. Rafferty and Concepcion.
income the fruit; capital is a tree, income the f ruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax
on income is not a tax on property. "Income," as here used, can be defined as "profits or gains." (London
County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week.
Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition [1915-], Chapter IV; Black on
Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U. S., 549; and Towne
vs. Eisner, decided by the United States Supreme Court, January 7, 1918.)
A regulation of the United States Treasury Department relative to returns by the husband and wife not living
apart, contains the following:
"The husband, as the head and legal representative of the household and general custodian of its income,
should make and render the return of the aggregate income of himself and wife, and for the purpose of
levying the income tax it is assumed that he can ascertain the total amount of said income. If a wife has a
separate estate managed by herself as her own separate property, and receives an income of more than
$3,000, she may make return of her own income, and if the husband has other net income, making the
aggregate of both incomes more than $4,000, the wife's return should be attached to the return of her
husband, or his income should be included in her return, in order that a deduction of $4,000 may be made
from the aggregate of both incomes. The tax in such case, however, will be imposed only upon so much of
the aggregate income of both as shall exceed $4,000. If either husband or wife separately has an income
equal to or in excess of $3,000, a return of annual net income is required under the law, and such return
must include the income of both, and in such case the return must be made even though the combined
income of both be less than $4,000. If the aggregate net income of both exceeds $4,000, an annual return
of their combined incomes must be made in the manner stated, although neither one separately has an
income of $3,000
420

420
PHILIPPINE REPORTS ANNOTATED
Madrigal and Paterno vs. Rafferty and Concepcion.
per annum. They are jointly and separately liable for such return and f or the payment of the tax. The single
or married status of the person claiming the specific exemption shall be determined as of the time of
claiming such exemption if such claim be made within the year for which return is made, otherwise the
status at the close of the year."
With these general observations relative to the Income Tax Law in force in the Philippine Islands, we turn
for a moment to consider the provisions of the Civil Code dealing with the conjugal partnership. Recently in
two elaborate decisions in which a long line of Spanish authoritie& were cited, this court, in speaking of the
conjugal partnership, decided that "prior to the liquidation, the interest of the wife, and in case of her death,
of her heirs, is an interest inchoate, a mere expectancy, which constitutes neither a legal nor an equitable
estate, and does not ripen into title until there appears that there are assets in the community as a result of
the liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and
Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)
Susana Paterao, wife of Vicente Madrigal, has an inchoate right in the property of her husband Vicente
Madrig-al during the life of the conjugal partnership. She has an interest in the ultimate property rights and
in the ultimate ownership of property acquired as income after such income has become capital. Susana
Paterno has no absolute right to one-half the income of the conjugal partnership. Not being seized of a
separate estate, Susana Paterno cannot make a separate return in order to receive the benefit of the
exemption which would arise by reason of the additional tax. As she has no estate and income, actually
and legally vested in her and entirely distinct from her husband's property, the income cannot properly be
considered the separate income of the wife for the purposes of the additional tax. Moreover, the Income
Tax Law does not look on the spouses as individual partners in an ordinary partnership. The husband and
wife are only entitled to the exemption of P8,000, specifically granted by the law.
421

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421
Madrigal and Paterno vs. Rafferty and Concepcion.
The higher schedules of the additional tax directed at the incomes of the wealthy may not be partially
defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership and having no
application to the Income Tax Law. The aims and purposes of the Income Tax Law must be given effect.
The point we are discussing has heretofore been considered by the Attorney-General of the Philippine
Islands and the United States Treasury Department. The decision of the latter overruling the opinion of the
Attorney-General is as f ollows:
"TREASURY DEPARTMENT, Washington.
"Income Tax.
"FRANK MC!NTYRE,

"Chief, Bureau of Insular Affairs, War Depwrtment,


"Washington, D. C.
"SlR: .This office is in receipt of your letter of June 22, 1915, transmitting copy of correspondence 'from the
Philippine authorities relative to the method of submission of income tax returns by married persons/
"You advise that The Governor-General, in forwarding the papers to the Bureau, advises that the Insular
Auditor has been authorized to suspend action on the warrants in question until an authoritative decision
on the points raised can be secured from the Treasury Department.'
"From the correspondence it appears that Gregorio Araneta, married and living with his wife, had an income
of an amount sufficient to require the imposition of the additional tax provided by the statute; that the net
income was properly computed and then both income and deductions and the specific exemption were
divided in half and two returns made, one return f or each half in the names respectively of the husband
and wife, so that under the returns as filed there would be an escape from the additional tax; that Araneta
claims the returns are correct on the ground that under the Philippine law his wife is entitled to half of his
earnings; that Araneta has dominion over the income and under the Philippine law, the right to determine
its
422

422
PHILIPPINE REPORTS ANNOTATED
Madrigal and Paterno vs. Rafferty and Concepcion.
use and disposition; that in this case the wife has no 'separate estate' within the contemplation of the Act
of October 3, 1913, levying an income tax.
"It appears further from the correspondence that upon the foregoing explanation, tax was assessed against
the entire net income against Gregorio Araneta; that the tax was paid and an application for refund made,
and that the application for refund was rejected, whereupon the matter was submitted to the Attorney-
General of the Islands who holds that the returns were correctly rendered, and that the refund, should be
allowed; and thereupon the question at issue is submitted through the Governor-General of the Islands and
Bureau of Insular Affairs for the advisory opinion of this office.
"By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be administered as
in the United States but by the appropriate internal-revenue officers of the Philippine Government. You are
therefore advised that upon the facts as stated, this office holds that for the Federa! Income Tax (Act of
October 3, 1913), the entire net income in this case was taxable to Gregorio Araneta, both for the normal
and additional tax, and that the application for refund was properly rejected.
"The separate estate of a married woman within the contemplation of the Income Tax Law is that which
belongs to her solely and separate and apart from her husband, and over which her husband has no right
in equity. It may consist of lands or chattels.
"The statute and the regulations promulgated in aceordance therewith provide that each person of lawful
age (not excused from so doing) having a net income of $3,000 or over for the taxable year shall make a
return showing the facts; that from the net income so shown there shall be deducted $3,000 where the
person making the return is a single person, or married and not living with consort, and $1,000 additional
where the person making the return is married and living with consort; but that where the husband and wife
both make returns (they living together), the
423

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423
Madrigal and Paterno vs. Rafferty and Concepcion.
amount of deduction from the aggregate of their several incomes shall not exceed $4,000.
"The only occasion for a wife making a return is where she has income from a sole and separate estate in
excess of $3,000, or where the husband and wife neither separately have an income of $3,000, but together
they have an income in excess of $4,000, in which latter event either the husband or wife may make the
return but not both. In all instances the income of husband and wife whether from separate estates or not,
is taken as a whole for the purpose of the normal tax. Where the wife has income from a separate estate
and makes return thereof, or where her income is separately shown in the return made by her husband,
while the incomes are added together for the purpose of the normal tax they are taken separately for the
purpose of the additional tax. In this case, however, the wife has no separate income within the
contemplation of the Income Tax Law.
"Respectfully,
"DAVID A. GATES,
"Acting Commissioner."

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax Law
was drafted by the Congress of the United States and has been by the Congress extended to the Philippine
Islands. Being thus a law of American origin and being peculiarly intricate in its provisions, the authoritative
decision of the official who is charged with enforcing it has peculiar force for the Philippines. It has come to
be a well-settled rule that great weight should be given to the construction placed upon a revenue law,
whose meaning is doubtful, by the department charged with its execution. (U. S. vs. Cerecedo .Hermanos
y Cia. [1907], 209 U. S., 338; In re Allen [1903J, 2 Phil., 630; Government of the Philippine Islands vs.
Municipality of Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.)
424

424
PHILIPPINE REPORTS ANNOTATED
Agoncillo and Marino vs. Javier.
We conclude that the judgment should be as it is hereby affirmed with costs against appellants. So ordered.
Torres, Johnson, Carson, Street, and Fisher, JJ., concur.
Judgment affirmed.
No. L-68118. October 29, 1985.*
JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P. OBILLOS,
brothers and sisters, petitioners, vs. COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS, respondents.
Taxation; The dictum that the power to tax involves the power to destroy should be obviated.—To regard
the petitioners as having formed a taxable unregistered partnership would result in oppressive
________________

* SECOND DIVISION.
437

VOL. 139, OCTOBER 29, 1985


437
Obillos, Jr. vs. Commissioner of Internal Revenue
taxation and confirm the dictum that the power to tax involves the power to destroy. That eventuality should
be obviated.
Same; Partnership; Co-ownership; Where the father sold his rights over two parcels of land to his four
children so they can build their residence, but the latter after one (1) year sold them and paid the capital
gains, they should not be treated to have formed an unregistered partnership and taxed corporate income
tax on the sale and dividend income tax on their shares of the profit's from the sale.—Their original purpose
was to divide the lots for residential purposes. If later on they found it not feasible to build their residences
on the lots because of the high cost of construction, then they had no choice but to resell the same to
dissolve the coownership. The division of the profit was merely incidental to the dissolution of the co-
ownership which was in the nature of things a temporary state. It had to be terminated sooner or later.
Same; Same; Same; Mere sharing of gross income from an isolated transaction does not establish a
partnership.—Article 1769(3) of' the Civil Code provides that ''the sharing of gross returns does not of itself
establish a partnership, whether or not the persons sharing them have a j oint or common right or interest
in any property from which the returns are derived". There must be an unmistakable intention to form a
partnership or joint venture.
PETITION to review the judgment of the Court of Tax Appeals.

The facts are stated in the opinion of the Court.


Demosthenes B. Gadioma for petitioners.
AQUINO, J..

This case is about the income tax liability of four brothers and sisters who sold two parcels of land which
they had acquired from their father.
On March 2. 1973 Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. on two lots with areas of
1,124 and 963 square meters located at Greenhills, San Juan, Rizal. The next day he transferred his rights
to his four children, the petitioners, to enable them to build their residences. The company sold the two lots
to petitioners for P178,708.12 on March 13
438

438
SUPREME COURT REPORTS ANNOTATED
Obillos, Jr. vs. Commissioner of Internal Revenue
(Exh. A and B, p. 44, Rollo). Presumably, the Torrens titles issued to them would show that they were co-
owners of the two lots.
In 1974, or after having held the two lots for more than a year, the petitioners resold them to the Walled
City Securities Corporation and Olga Cruz Canda for the total sum of P313,050 (Exh. C and D). They
derived from the sale a total profit of P134,341.88 or P33,584 for each of them. They treated the profit as a
capital gain and paid an income tax on one-half thereof or on P16,792.
In April, 1980, or one day before the expiration of the fiveyear prescriptive period, the Commissioner of
Internal Revenue required the four petitioners to pay corporate income tax on the total profit of P134,336
in addition to individual income tax on their shares thereof. He assessed P37,018 as corporate income tax,
P18,509 as 50% fraud surcharge and P15,547.56 as 42% accumulated interest, or a total of P71,074.56.
Not only that. He considered the share of the profits of each petitioner in the sum of P33,584 as a
"distributive dividend" taxable in full (not a mere capital gain of which ½ is taxable) and required them to
pay deficiency income taxes aggregating P56,707.20 including the 50% fraud surcharge and the
accumulated interest.
Thus, the petitioners are being held liable for deficiency income taxes and penalties totalling P127,781.76
on their profit of P134,336, in addition to the tax on capital gains already paid by them.
The Commissioner acted on the theory that the four petitioners had formed an unregistered partnership or
joint venture within the meaning of sections 24(a) and 84(b) of the Tax Code (Collector of Internal Revenue
vs. Batangas Trans. Co., 102 Phil. 822).
The petitioners contested the assessments, Two Judges of the Tax Court sustained the same. Judge
Roaquin dissented. Hence, the instant appeal.
We hold that it is error to consider the petitioners as having formed a partnership under article 1767 of the
Civil Code
439

VOL. 139, OCTOBER 29, 1985


439
Obillos, Jr. vs. Commissioner of Internal Revenue
simply because they allegedly contributed P178,708.12 to buy the two lots, resold the same and divided
the profit among themselves.
To regard the petitioners as having formed a taxable unregistered partnership would result in oppressive
taxation and confirm the dictum that the power to tax involves the power to destroy. That eventuality should
be obviated.
As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure and simple. To
consider them as partners would obliterate the distinction between a coownership and a partnership. The
petitioners were not engaged in any joint venture by reason of that isolated transaction.
Their original purpose was to divide the lots for residential purposes. If later on they found it not feasible to
build their residences on the lots because of the high cost of construction, then they had no choice but to
resell the same to dissolve the co-ownership. The division of the profit was merely incidental to the
dissolution of the co-ownership which was in the nature of things a temporary state. It had to be terminated
sooner or later. Castan Tobeñas says:
"Cómo establecer el deslinde entre la comunidad ordinaria o copropiedad y la sociedad?
"El criterio diferencial—según la doctrina más generalizada—está: por razón del origen, en que la sociedad
presupone necesariamente la convención, mientras que la comunidad puede existir y existe
ordinariamente sin ella; y por razón del fin u objecto, en que el objeto de la sociedad es obtener lucro,
mientras que el de la indivisión es sólo mantener en su integridad la cosa común y favorecer su
conservación.
"Reflejo de este criterio es la sentencia de 15 de octubre de 1940, en la que se dice que si en nuestro
Derecho positivo se ofrecen a veces dificultades al tratar de fijar la linea divisoria entre comunidad de
bienes y contrato de sociedad, la moderna orientación de la doctrina cientifíca señala como nota
fundamental de diferenciación, aparte del origen o fuente de que surgen, no siempre uniforme, la finalidad
perseguida por los interesados: lucro común partible en la sociedad, y mera conservación y
aprovechamiento en la comunidad." (Derecho Civil Español, Vol. 2, Part 1,10 Ed, 1971, 328-329).
440

440
SUPREME COURT REPORTS ANNOTATED
Obillos, Jr. vs. Commissioner of lnternal Revenue
Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of itself establish a
partnership, whether or not the persons sharing them have a joint or common right or interest in any property
from which the returns are derived". There must be an unmistakable intention to form a partnership or joint
venture.**
Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil. 666 where 15 persons
contributed small amounts to purchase a two-peso sweepstakes ticket with the agreement that they would
divide the prize. The ticket won the third prize of P50,000. The 15 persons were held liable for income tax
as an unregistered partnership.
The instant case is distinguishable from the cases where the parties engaged in joint ventures for profit.
Thus, in Oña vs.
** This view is supported by the following rulings of respondent Commissioner:
"Co-ownership distinguished from partnership.—We find that the case at bar is fundamentally similar to the
De Leon case. Thus, like the De Leon heirs, the Longa heirs inherited the 'hacienda' in question pro-indiviso
from their deceased parents; they did not contribute or invest additional capital to increase or expand the
inherited properties; they merely continued dedicating the property to the use to which it had been put by
their forebears; they individually reported in their tax returns their corresponding shares in the income and
expenses of the 'hacienda', and they continued for many years the status of co-ownership in order, as
conceded by respondent, 'to preserve its (the 'hacienda') value and to continue the existing contractual
relations with the Central Azucarera de Bais for milling purposes/ " (Longa vs. Aranas, CTA Case No. 653,
July 31, 1963).
"All co-ownerships are not deemed unregistered partnership.—Co-heirs who own properties which produce
income should not automatically be considered partners of an unregistered partnership, or a corporation,
within the purview of the income tax law. To hold otherwise, would be to subject the income of all
coownerships of inherited properties to the tax on corporations, inasmuch as if a property does not produce
an income at all, it is not subject to any kind of income tax, whether the income tax on individuals or the
income tax on corporation." (De Leon vs. CIR, CTA Case No. 738, September 11, 1961, cited in Arañas,
1977 Tax Code Annotated, Vol. 1, 1979 Ed., pp. 77-78),
441

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441
Obillos, Jr. vs. Commissioner of lnternal Revenue
Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after an extrajudicial
settlement the coheirs used the inheritance or the incomes derived therefrom as a common fund to produce
profits for themselves, it was held that they were taxable as an unregistered partnership.
It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198 where father and
son purchased a lot and building, entrusted the administration of the building to an administrator and divided
equally the net income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140 where the
three Evangelista sisters bought four pieces of real property which they leased to various tenants and
derived rentals therefrom. Clearly, the petitioners in these two cases had formed an unregistered
partnership.
In the instant case, what the Commissioner should have investigated was whether the father donated the
two lots to the petitioners and whether he paid the donor's tax (See art. 1448, Civil Code), We are not
prejudging this matter. It might have already prescribed.
WHEREFORE, the judgment of the Tax Court is reversed and set aside. The assessments are cancelled.
No costs.
SO ORDERED.
Abad Santos, Escolin, Cuevas and Alampay, JJ., concur.
Concepcion, Jr., on leave.
Judgment reversed and set aside.
Notes.—Taxes being the chief source of revenue for the Government to keep it running must be paid
immediately and without delay. (Collector of Internal Revenue vs. Yuseco, 3 SCRA 313.)
As the sale of the bakery in question was not a single asset but of individual assets that made up the
business, it was incumbent upon the owner to point out what part of the price he had received could be
fairly attributed to each asset so that the capital and/or ordinary gains taxes properly payable upon the sale
of the business could be ascertained, His failure to do so is
442

442
SUPREME COURT REPORTS ANNOTATED
Obillos, Jr. vs. Commissioner of lnternal Revenue
sufficient reason for denying his petition for refund of the taxes he paid. (Ferrer vs. Commissioner of Internal
Revenue, 5 SCRA 1022.)
Mere sharing of gross returns does not establish a partnership, since in a partnership, the partners share
net profits after satisfying all the partnership's liabilities (See Article 1839, Civil Code.)
The receipt, however, of a share in the net profits establishes a prima facie evidence to partnership which,
however, may be rebutted by proof that what has been received were not profits. Thus, the receipt of share
in the profits as (a) payment of a debt by installment or otherwise, as (b) wages of an employee or rent to
a landlord, as (c) annuity to a widow or representative of the deceased partner, as (d) interest on a loan, or
as (e) a consideration for the sale of goodwill, cannot be considered as indicative of establishment of a
partnership.
By the weight of authority, an agreement to share both profits and the losses tends strongly to establish the
existence of a partnership, and conversely, lack of such agreement tends strongly to negative the existence
of a partnership. (40 Am. Jur., Sec. 39.)
The participation in profits is undoubtedly prima facie evidence of a partnership, as well as generally as
under the Uniform Partnership Act, and, in the absence of contradictory evidence, will control. But the
presumption of partnership arising from a participation in profits may be rebutted, and outweighed by other
circumstances, such as evidence that the participation was referable to some other reason, such as
compensation for services rendered as agent, broker, salesman or otherwise. (40 Am. Jur., Sec. 38, pp.
151-152.)
LORENZO T. OÑA,and HEIRS OF JULIA BUNALES,namely: RODOLFO B. OÑA,MARIANO B. OÑA,LUZ
B. OÑA,VIRGINIA B. OÑA,and LORENZO B. OÑA,JR., petitioners, vs. THE COMMISSIONER OF
INTERNAL REVENUE,respondent.
Taxation; Partnership; When co-ownership converted to co-partnership.—For tax purposes, the co-
ownership of inherited properties is automatically converted into an unregistered partnership the moment
the said common properties and/or the incomes derived therefrom are used as a common fund with intent
to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a
project partition either duly executed in an extra-judicial settlement or approved by the court in the
corresponding testate or intestate proceeding. The reason is simple. From the moment of such partition,
the heirs are entitled already to their respective definite shares of the estate and the incomes thereof, for
each of them to manage and dispose of as exclusively his own without the intervention of the other heirs,
and, accordingly, he becomes liable individually for all taxes in connection therewith. If after such partition,
he allows his share to be held in common with his co-heirs under a single management to be used with the
intent of making profit thereby in proportion to his share, there can be no doubt that, even if no document
or instrument were executed for the purpose, for tax purposes, at least, an unregistered partnership is
formed.
Same; Same; Corporation; Partnerships considered corporation for tax purposes.—For purposes of the tax
on corporations, the National Internal Revenue Code, includes partnerships—with the exception only of
duly registered general co-partnerships—within the purview of the term “corporation.”
Same; Same; When income derived from inherited properties deemed part of partnership income.—The
income derived from inherited properties may be considered as individual income of the respective heirs
only so long as the inheritance or estate is not distributed or, at least, partitioned, but the moment their
respective known shares are used as part of the common assets of the heirs to be used in making profits,
it is but proper that the income of such shares should be considered as part of the taxable income of an
unregistered partnership.
Same; Same; Effect on unregistered partnership profits of
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Oña vs. Commissioner of Internal Revenue
individual income tax paid.—The partnership profits distributable to the partners should be reduced by the
amounts of income tax assessed against the partnership. Consequently, each of the petioners in his
individual capacity overpaid his income tax for the years in question. But as the individual income tax
liabilities of petitioners are not in issue in the instant proceeding, it is not proper for the Court to pass upon
the same.
Same; Same; Where right to refund of overpaid individual income tax has prescribed.—A taxpayer who did
not pay the tax due on the income from an unregistered partnership, of which he is a partner, due to an
erroneous belief that no partnership, but only a co-ownership, existed between him and his co-heirs, and
who due to the payment of the individual income tax corresponding to his share in the unregistered
partnership profits, on the balance, overpaid his income tax has the right to be reimbursed what he has
erroneously paid. However, the law is very clear that the claim and action for such reimbursement are
subject to the bar of prescription.
PETITION for review from a decision of the Court of Tax Appeals. Umali, J.

The facts are stated in the opinion of the Court.


Orlando Velasco for petitioners.
Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felici&imo R. Rosete and Special Attorney
Purificacion Ureta for respondent.
BAKHEDO, J.:

Petition for review of the decision of the Court of Tax Appeals in CTA Case No. 617, similarly entitled as
above, holding that petitioners have constituted an unregistered partnership and are, therefore, subject to
the payment of the deficiency corporate income taxes assessed against them by respondent Commissioner
of Internal Revenue for the years 1955 and 1956 in the total sum of P21,891.00, plus 5% surcharge and
1% monthly interest from December 15, 1958, subject to the provisions of Section 51 (e) (2) of the Internal
Revenue Code, as amended by Section 8 of Republic Act No. 2848 and the costs of the suit,1 as well
________________

1 In other words, the assessment was affirmed except for the sum of P100.00 which was the total of two
P50-items purportedly
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SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
as the resolution of said court denying petitioners’ motion for reconsideration of said decision.
The facts are stated in the decision of the Tax Court as follows:
“Julia Bunales died on March 23, 1944, leaving as heirs her surviving spouse. Lorenzo T. Oña and her five
children. In 1948, Civil Case No. 4519 was instituted in the Court of First Instance of Manila for the
settlement of her estate. Later, Lorenzo T. Oña, the surviving spouse was appointed administrator of the
estate of said deceased (Exhibit 3, pp. 34-41, BIR rec). On April 14, 1949, the administrator submitted the
project of partition, which was approved by the Court on May 16, 1949 (See Exhibit K). Because three of
the heirs, namely Luz, Virginia and Lorenzo, Jr., all surnamed Oña, were still minors when the project of
partition was approved, Lorenzo T. Oña, their father and administrator of the estate, filed a petition in Civil
Case No. 9637 of the Court of First Instance of Manila for appointment as guardian of said minors. On
November 14, 1949, the Court appointed him guardian of the persons and property of the aforenamed
minors (See p. 3, BIR rec).
“The project of partition (Exhibit K; see also pp. 77-70, BIR rec.) shows that the heirs have undivided one-
half (1/2) interest in ten parcels of land with a total assessed value of P87,860.00, six houses with a total
assessed value of P17,590.00 and an undetermined amount to be collected from the War Damage
Commission. Later, they received from said Commission the amount of P50,000.00, more or less. This
amount was not divided among them but was used in the rehabilitation of properties owned by them in
common (t.s.n., p. 46). Of the ten parcels of land aforementioned, two were acquired after the death of the
decedent with money borrowed from the Philippine Trust Company in the amount of P72,173.00 (t.s.n., p.
24; Exhibit 3, pp. 34-31, BIR rec).
“The project of partition also shows that the estate shares equally with Lorenzo T. Oña, the administrator
thereof, in the obligation of P94,973.00, consisting of loans contracted by the latter with the approval of the
Court (see p. 3 of Exhibit K; or see p. 74, BIR rec).
“Although the project of partition was approved by the Court on May 16, 1949. no attempt was made to
divide the properties therein listed. Instead, the properties remained under the
________________

for “Compromise for non-filing” which the Tax Court held to be unjustified, since there was no compromise
agreement to speak of.
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Oña vs. Commissioner of Internal Revenue
management of Lorenzo T. Oña who used said properties in business by leasing or selling them and
investing the income derived therefrom and the proceeds from the sales thereof in real properties and
securities. As a result, petitioners’ properties and investments gradually increased from P105,450.00 in
1949 to P480.005.20 in 1956 as can be gleaned from the following year-end balances:
Year
Investment Account
Land Account
Building Account
1949

P87,860
P 17,590.00
1950
P 24,657.65
128,566.72
96,076.26
1951
51,301.31
120,349.28
110,605.11
1952
67,927.52
87,065.28
152,674.39
1953
61,258.27
84,925.68
161.46b.83
1954
63,623.37
99,001.20
167,962.04
1955
100,786.00
120,249.78
169,262.52
1956
175,028.68
135,714.68
169,262.52
(See Exhibits 3 & K; t.s.n., pp. 22, 25-26, 40, 50, 102-104)

“From said investments and properties petitioners derived such incomes as profits from installment sales
of subdivided lots, profits from sales of stocks, dividends, rentals and interests (see p. 3 of Exhibit 3; p. 32,
BIR rec; t.s.n., pp. 37-38). The said incomes are recorded in the books of account kept by Lorenzo T. Oña,
where ‘the corresponding shares of the petitioners in the net income for the year are also known. Every
year, petitioners returned for income tax purposes their shares in the net income derived from said
properties and securities and/or from transactions involving them (Exhibit 3, supra; t.s.n., pp. 25-26);
However, petitioners did not actually receive their shares in the yearly income. (t.s.n., pp. 25-26, 40, 98;
100). The income was always left in the hands of Lorenzo T. Oña who, as heretofore pointed out, invested
them in real properties and securities. (See Exhibit 3, ts.n., pp. 50, 102-104).
“On the basis of the foregoing facts, respondent (Commissioner of Internal Revenue) decided that
petitioners formed an unregistered partnership and therefore, subject to the corporate income tax, pursuant
to Section 24, in relation to Section 84(b), of the Tax Code. Accordingly, he assessed against the petitioners
the amounts of P8,092.00 and P13,899.00 as corporate income taxes for 1955 and 1956, respectively.
(See Exhibit 5, amended by Exhibit 17, pp. 50 and 86, BIR rec.). Petitioners protested against the
assessment and asked for reconsideration
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78
SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
of the ruling of respondent that they have formed an unregistered partnership. Finding no merit in
petitioners’ request, respondent denied it (See Exhibit 17, p. 86, BIR rec). (See pp. 1-4, Memorandum for
Respondent, June 12, 1961).
“The original assessment was as follows:
“1955
“N et incom e as p er i nves ti gati on ...............................
P40.209.89
Income tax due thereon .................................................
8,042.00
25% surcharge .................................................................
2,010.50
Compromise for non-filing ..........................................
50.00
Total ..................................................................................
P10,102.50
“1956
“N et incom e as p er i nves ti gati on ...............................
P69,245.23
Income tax due thereon .................................................
13,849.00
25% surcharge .................................................................
3,462.25
Compromise for non-filing ............................... , ............
50.00
Total ..................................................................................
~P17,361.25
(Sec Exhibit 13, page 50, BIR records)

“Upon further consideration of the case, the 25% surcharge was eliminated in line with the ruling of the
Supreme Court in Collector v. Batangas Transportation Co., G.R. No. L-9692, Jan. 6, 1958, so that the
questioned assessment refers solely to the income tax proper for the years 1955 and 1956 and the
‘Compromise for non-filing,’ the latter item obviously referring to the compromise in lieu of the criminal
liability for failure of petitioners to file the corporate income tax returns for said years. (See Exh. 17, page
86, BIR records).” (Pp. 1-5, Annex C to Petition)
Petitioners have assigned the following as alleged errors of the Tax Court:
“I

“THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE PETITIONERS FORMED AN
UNREGISTERED PARTNERSHIP;
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Oña, vs. Commissioner of Internal Revenue
“THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE PETITIONERS WERE CO-
OWNERS OF THE PROPERTIES INHERITED AND (THE) PROFITS DERIVED FROM TRANSACTIONS
THEREFROM (sic);
“III

“THE COURT OF TAX APPEALS ERRED IN HOLDING THAT PETITIONERS WERE LIABLE FOR
CORPORATE INCOME TAXES FOR 1955 AND 1956 AS AN UNREGISTERED PARTNERSHIP;
“IV

“ON THE ASSUMPTION THAT THE PETITIONERS CONSTITUTED AN UNREGISTERED


PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE PETITIONERS
WERE AN UNREGISTERED PARTNERSHIP TO THE EXTENT ONLY THAT THEY INVESTED THE
PROFITS FROM THE PROPERTIES OWNED IN COMMON AND THE LOANS RECEIVED USING THE
INHERITED PROPERTIES AS COLLATERALS;
“ON THE ASSUMPTION THAT THERE WAS AN UNREGISTERED PARTNERSHIP, THE COURT OF
TAX APPEALS ERRED IN NOT DEDUCTING THE VARIOUS AMOUNTS PAID BY THE PETITIONERS
AS INDIVIDUAL INCOME TAX ON THEIR RESPECTIVE SHARES OP THE PROFITS ACCRUING FROM
THE PROPERTIES OWNED IN COMMON, FROM THE DEFICIENCY TAX OF THE UNREGISTERED
PARTNERSHIP.”
In other words, petitioners pose for our resolution the following questions: (1) Under the facts found by the
Court of Tax Appeals, should petitioners be considered as co-owners of the properties inherited by them
from the deceased Julia Buñales and the profits derived from transactions involving the same, or, must they
be deemed to have formed an unregistered partnership subject to tax under Sections 24 and 84(b) of the
National Internal Revenue Code? ‘2) Assuming they have formed an unregistered partnership, should this
not be only in the sense that they invested as a common fund the profits earned by the pro-
80

80
SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
perties owned by them in common and the loans granted to them upon the security of the said properties,
with the result that as far as their respective shares in the inheritance are concerned, the total income
thereof should be considered as that of co-owners and not of the unregistered partnership? And (3)
assuming again that they are taxable as an unregistered partnership, should not the various amounts
already paid by them for the same years 1955 and 1956 as individual income taxes on their respective
shares of the profits accruing from the properties they owned in common be deducted from the deficiency
corporate taxes, herein involved, assessed against such unregistered partnership by the respondent
Commissioner?
Pondering on these questions, the first thing that has struck the Court is that whereas petitioners’
predecessor in interest died way back on March 23, 1944 and the project of partition of her estate was
judicially approved as early as May 16, 1949, and presumably petitioners have been holding their respective
shares in their inheritance since those dates admittedly under the administration or management of the
head of the family, the widower and father Lorenzo T. Oña, the assessment in question refers to the later
years 1955 and 1956. We believe this point to be important because, apparently, at the start, or in the years
1944 to 1954, the respondent Commissioner of Internal Revenue did treat petitioners as co-owners, not
liable to corporate tax, and it was only from 1955 that he considered them as having formed an unregistered
partnership. At least, there is nothing in the record indicating that an earlier assessment had already been
made. Such being the case, and We see no reason how it could be otherwise, it is easily understandable
why petitioners’ position that they are co-owners and not unregistered co-partners, for the purposes of the
impugned assessment, cannot be upheld. Truth to tell, petitioners should find comfort in the fact that they
were not similarly assessed earlier by the Bureau of Internal Revenue.
The Tax Court found that instead of actually distributing
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Oña vs. Commissioner of Internal Revenue
the estate of the deceased among themselves pursuant to the project of partition approved in 1949, “the
properties remained under the management of Lorenzo T. Oña who used said properties in business by
leasing or selling them and investing the income derived therefrom and the proceeds from the sales thereof
in real properties and securities,” as a result of which said properties and investments steadily increased
yearly from P87,860.00 in “land account” and P17,590.00 in “building account’ ‘in 1949 to P175,028.68 in
“investment account,” P135,714.68 in “land account” and P169,262.52 in “building account” in 1956. And
all these became possible because, admittedly, petitioners never actually received any share of the income
or profits from Lorenzo T. Oña, and instead, they allowed him to continue using said shares as part of the
common fund for their ventures, even as they paid the corresponding income taxes on the basis of their
respective shares of the profits of their common business as reported by the said Lorenzo T. Oña.
It is thus incontrovertible that petitioners did not, contrary to their contention, merely limit themselves to
holding the properties inherited by them. Indeed, it is admitted that during the material years herein involved,
some of the said properties were sold at considerable profit, and that with said profit, petitioners engaged,
thru Lorenzo T. Oña, in the purchase and sale of corporate securities. It is likewise admitted that all the
profits from these ventures were divided among petitioners proportionately in accordance with their
respective shares in the inheritance. In these circumstances, it is Our considered view that from the moment
petitioners allowed not only the incomes from their respective shares of the inheritance but even the
inherited properties themselves to be used by Lorenzo T. Oña as a common fund in undertaking several1
transactions or in business, with the intention of deriving profit to be shared by them proportionally, such
act was tantamount to actually contributing such incomes to a common fund and, in effect, they thereby
formed an unregistered partnership within the purview of the abovementioned provisions of the Tax
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SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
Code.
It is but logical that in cases of inheritance, there should be a period when the heirs can be considered as
co-owners rather than unregistered co-partners within the contemplation of our corporate tax laws
aforementioned. Before the partition and distribution of the estate of the deceased, all the income thereof
does belong commonly to all the heirs, obviously, without them becoming thereby unregistered co-partners,
but it does not necessarily follow that such status as co-owners continues until the inheritance is actually
and physically distributed among the heirs, for it is easily conceivable that after knowing their respective
shares in the partition, they might decide to continue holding said shares under the common management
of the administrator or executor or of anyone chosen by them and engage in business on that basis. Withal,
if this were to be allowed, it would be the easiest thing for heirs in any inheritance to circumvent and render
meaningless Sections 24 and 84 (b) of the National Internal Revenue Code.
It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for holding the
appellants therein to be unregistered co-partners for tax purposes, that their common fund “was not
something they found already in existence” and that “[i]t was not a property inherited by them pro indiviso,”
but it is certainly far fetched to argue therefrom, as petitioners are doing here, that ergo, in all instances
where an inheritance is not actually divided, there can be no unregistered co-partnership. As already
indicated, for tax purposes, the co-ownership of inherited properties is automatically converted into an
unregistered partnership the moment the said common properties and/or the incomes derived therefrom
are used as a common fund with intent to produce profits for the heirs in proportion to their respective
shades in the inheritance as determined in a project partition either duly executed in an extrajudicial
settlement or approved by the court in the corresponding testate or intestate proceeding. The reason for
this is simple. From the moment of such par-
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83
Oña vs. Commissioner of Internal Revenue
tition, the heirs are entitled already to their respective definite shares of the estate and the incomes thereof,
for each of them to manage and dispose of as exclusively his own without the intervention of the other
heirs, and, accordingly he becomes liable individually for all taxes in connection therewith. If after such
partition, he allows his share to be held in common with his co-heirs under a single management to be used
with the intent of making profit thereby in proportion to his share, there can be no doubt that, even if no
document or instrument were executed for the purpose, for tax purposes, at least, an unregistered
partnership is formed. This is exactly what happened to petitioners in this case.
In this connection, petitioners’ reliance on Article 1769, paragraph (3), of the Civil Code, providing that: “The
sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them
have a joint or common right or interest in any property from which the returns are derived,” and, for that
matter, on any other provision of said code on partnerships is unavailing. In Evangelista, supra, this Court
clearly differentiated the concept of partnerships under the Civil Code from that of unregistered partnerships
which are considered as “corporations” under Sections 24 and 84(b) of the National Internal Revenue Code.
Mr. Justice Roberto Concepcion, now Chief Justice, elucidated on this point thus:
“To begin with, the tax in question is one imposed upon ‘corporations’, which, strictly speaking, are distinct
and different from ‘partnerships’. When our Internal Revenue Code includes ‘partnerships’ among the
entities subject to the tax on ‘corporations’, said Code must allude, therefore, to organizations which are
not necessarily ‘partnerships’, in the technical sense of the term. Thus, for instance, section 24 of said Code
exempts from the aforementioned tax ‘duly registered general partnerships’, which constitute precisely one
of the most typical forms of partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said
Code, ‘the term corporation includes partnerships, no matter how created or organized.’ This qualifying
expression clearly indicates that a joint venture need not be undertaken in any of the standard forms, or in
conformity
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84
SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
with the usual requirements of the law on partnerships, in order that one could be deemed constituted for
purposes of the tax on corporation. Again, pursuant to said section 84(b), the term ‘corporation’ includes,
among other, ‘joint accounts, (cuentas en participation)’ and ‘associations’, none of which has a legal
personality of its own, independent of that of its members. Accordingly, the lawmaker could not have
regarded that personality as a condition essential to the existence of the partnerships therein referred to.
In fact, as above stated, ‘duly registered general co-partnerships’—which are possessed of the
aforementioned personality—have been expressly excluded by law (sections 24 and 84 [b]) from the
connotation of the term ‘corporation.’ x x x
“xxx xxx xxx
“Similarly, the American Law
‘xxx provides its own concept of a partnership. Under the term ‘partnership’ it includes not only a partnership
as known as common law but, as well, a syndicate, group, pool, joint venture, or other unincorporated
organization which carries on any business, financial operation^ or venture, and which is not, within the
meaning of the Code, a trust, estate, or a corporation, x x x.’ (7A Merten’s Law of Federal Income Taxation,
p. 789; italics ours.)
‘The term “partnership” includes a syndicate, group, pool, joint venture or other unincorporated organization,
through or by means of which any business, financial operation, or venture is carried on. x x x.’ (8 Merten’s
Law of Federal Income Taxation, p. 562 Note 63; italics ours.)
“For purposes of the tax on corporations, our National Internal Revenue Code, includes these
partnerships—with the exception only of duly registered general copartnerships—within the purview of the
term ‘corporation.’ It is, therefore, clear to our mind that petitioners herein constitute a partnership, insofar
as said Code is concerned, and are subject to the income tax for corporations.”
We reiterated this view, thru Mr. Justice Fernando, In Reyes vs. Commissioner of Internal Revenue, G. R.
Nos. L-24020-21, July 29, 1968, 24 SCRA 198, wherein the Court ruled against a theory of co-ownership
pursued by appellants therein.
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Oña vs. Commissioner of Internal Revenue
As regards the second question raised by petitioners about the segregation, for the purposes of the
corporate taxes in question, of their inherited properties from those acquired by them subsequently, We
consider as justified the following ratiocination of the Tax Court in denying their motion for reconsideration:
“In connection with the second ground, it is alleged that, if there was an unregistered partnership, the
holding should be limited to the business engaged in apart from the properties inherited by petitioners. In
other words, the taxable income of the partnership should be limited to the income derived from the
acquisition and sale of real properties and corporate securities and should not include the income derived
from the inherited properties. It is admitted that the inherited properties and the income derived therefrom
were used in the business of buying and selling other real properties and corporate securities. Accordingly,
the partnership income must include not only the income derived from the purchase and sale of other
properties but also the income of the inherited properties.”
Besides, as already observed earlier, the income derived from inherited properties may be considered as
individual income of the respective heirs only so long as the inheritance or estate is not distributed or, at
least, partitioned, but the moment their respective known shares are used as part of the common assets of
the heirs to be used in making profits, it is but proper that the income of such shares should be considered
as the part of the taxable income of an unregistered partnership. This, We, hold, is the clear intent of the
law.
Likewise, the third question of petitioners appears to have adequately resolved by the Tax Court-in the
aforementioned resolution denying petitioners’ motion for reconsideration of the decision of said court.
Pertinently, the court ruled this wise:
“In support of the third ground, counsel for petitioners allege:
‘Even if we were to yield to the decision of this Honorable Court that the herein petitioners have formed an
unregistered partnership and, therefore, have to be taxed as such, it might be recalled that the petitioners
in their individual income tax returns reported their shares of the of the unregistered partnership. W e think
it only
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SUPREME COURT REPORTS ANNOTATED
Oña vs. Commissioner of Internal Revenue
fair and equitable that the various amounts paid by the individual petitioners as income tax on their
respective shares of the unregistered partnership should be deducted from the deficiency income tax found
by this Honorable Court against the unregistered partnership.’ (page 7, Memorandum for the Petitioner in
Support of Their Motion for Reconsideration, Oct. 28, 1961.)
In other words, it is the position of petitioners that the taxable income of the partnership must be reduced
by the amounts of income tax paid by each petitioner on his share of partnership profits. This is not correct;
rather, it should be the other way around. The partnership profits distributable to the partners (petitioners
herein) should be reduced by the amounts of income tax assessed against the partnership. Consequently,
each of the petitioners in his individual capacity overpaid his income tax for the years in question, but the
income tax due from the partnership has been correctly assessed. Since the individual income tax liabilities
of petitioners are not in issue in this proceeding, it is not proper for the Court to pass upon the same.”
Petitioners insist that it was error for the Tax Court to so rule that whatever excess they might have paid as
individual income tax cannot be credited as part payment of the taxes herein in question. It is argued that
to sanction the view of the Tax Court is to oblige petitioners to pay double income tax on the same income,
and, worse, considering the time that has lapsed since they paid their individual income taxes, they may
already be barred by prescription from recovering their overpayments in a separate action. We do not agree.
As We see it, the case of petitioners as regards the point under discussion is simply that of a taxpayer who
has paid the wrong tax, assuming that the failure to pay the corporate taxes in question was not deliberate.
Of course, such taxpayer has the right to be reimbursed what he has erroneously paid, but the law is very
clear that the claim and action for such reimbursement are subject to the bar of prescription. And since the
period for the recovery of the excess income taxes in the case of herein petitioners has already lapsed, it
would not seem right to virtually disregard prescription merely upon the ground that the reason for the delay
is precisely because the taxpayers failed to make the proper return and
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Bulakeña Restaurant & Caterer vs. Court of Industrial Relations
payment of the corporate taxes legally due from them. In principle, it is but proper not to allow any relaxation
of the tax laws in favor of persons who are not exactly above suspicion in their conduct vis-a-vis their tax
obligation to the State.
IN VIEW OF ALL THE FOREGOING, the judgment of the Court of Tax Appeals appealed from is affirmed,
with costs against petitioners.
Makalintal, Zaldivar, Fernando, Makasiar and Antonio, JJ., concur.
Concepcion, C.J., is on official leave.
Reyes, J.B.L., Actg. C.J., and Teehankee, JJ., in the result.
Castro, J., took no part.
Judgment affirmed.
Notes.—A joint emergency operation or sole management or joint venture, such as the operation of the
business affairs of two transportation companies is a partnership and if unregistered as such is taxable as
a corporation. (Collector of Internal Revenue vs. Batangas Transportation Co. and Laguna-Tayabas Bus
Co., L-9692, Jan. 6,1958).
The rule that exemption of a corporation from income tax does not have the effect of exempting its
stockholders, also applies to partnerships. Thus, dividends received by a stock-holder are subject to income
tax, even though the corporation earning such dividends is distinct from that of its stockholders. (See Manila
Gas Corp. vs. Collector of Internal Revenue, 62 Phil. 895; Gatchalian vs. Collector of Internal Revenue, 67
Phil. 668; Philippine Telephone and Telegraph Co. vs. Collector of Internal Revenue, 58 Phil. 639).
No. L-26284. October 9, 1986. *
TOMAS CALASANZ, ET AL., petitioners, vs. THE COMMISSIONER OF INTERNAL REVENUE and the
COURT OF TAX APPEALS, respondents.
Taxation; There is no fix formula to determine where a piece of property is capital asset or ordinary asset.—
However, there is no
_______________

* SECOND DIVISION
665

VOL. 144, OCTOBER 9, 1986


665
Calasanz vs. Commissioner of Internal Revenue
rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer
was held primarily for sale to customers in the ordinary course of his trade or business or whether it was
sold as a capital asset. Although several factors or indices have been recognized as helpful guides in
making a determination, none of these is decisive; neither is the presence nor the absence of these factors
conclusive. Each case must in the last analysis rest upon its own peculiar facts and circumstances.
Same; Property initially classified as capital asset may later become an ordinary asset and vice versa.—
Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a
combination of the factors indubitably tend to show that the activity was in furtherance of or in the course
of the taxpayer’s trade or business. Thus, a sale of inherited real property usually gives capital gain or loss
even though the property has to be subdivided or improved or both to make it salable. However, if the
inherited property is substantially improved or very actively sold or both it may be treated as held primarily
for sale to customers in the ordinary course of the heir’s business.
Same; Inherited land which an heir subdivides, and wherein he makes improvements several times higher
than the original cost of the land, is not a capital asset, but an ordinary asset.—One strong factor against
petitioners’ contention is the business element of development which is very much in evidence. Petitioners
did not sell the land in the condition in which they acquired it. While the land was originally devoted to rice
and fruit trees, it was subdivided into small lots and in the process converted into a residential subdivision
and given the name Don Mariano Subdivision. Extensive improvements like the laying out of streets,
construction of concrete gutters and installation of lighting system and drainage facilities, among others,
were undertaken to enhance the value of the lots and make them more attractive to prospective buyers.
The audited financial statements submitted together with the tax return in question disclosed that a
considerable amount was expended to cover the cost of improvements. As a matter of fact, the estimated
improvements of the lots sold reached P170,028.60 whereas the cost of the land is only P4,742.66. There
is authority that a property ceases to be a capital asset if the amount expended to improve it is double its
original cost, for the extensive improvement indicates that the seller held the property primarily for sale to
customers in the ordinary course of his business.
666

666
SUPREME COURT REPORTS ANNOTATED
Calasanz vs. Commissioner of Internal Revenue
Same; Inherited land which is subdivided and sold on installments and advertised for sale is not anymore
a capital asset.—Another distinctive feature of the real estate business discernible from the records is the
existence of contracts receivables, which stood at P395,693.35 as of the year ended December 31, 1957.
The sizable amount of receivables in comparison with the sales volume of P446,407.00 during the same
period signifies that the lots were sold on installment basis and suggests the number, continuity and
frequency of the sales. Also of significance is the circumstance that the lots were advertised for sale to the
public and that sales and collection commissions were paid out during the period in question.
APPEAL from the decision of the Court of Tax Appeals.

The facts are stated in the opinion of the Court.


San Juan, Africa, Gonzales & San Agustin Law Office for petitioners.
FERNAN, J.:
Appeal taken by Spouses Tomas and Ursula Calasanz from the decision of the Court of Tax Appeals in
CTA No. 1275 dated June 7, 1966, holding them liable for the payment of P3,561.24 as deficiency income
tax and interest for the calendar year 1957 and P150.00 as real estate dealer’s fixed tax.
Petitioner Ursula Calasanz inherited from her father Mariano de Torres an agricultural land located in
Cainta, Rizal, containing a total area of 1,678,000 square meters. In order to liquidate her inheritance,
Ursula Calasanz had the land surveyed and subdivided into lots. Improvements, such as good roads,
concrete gutters, drainage and lighting system, were introduced to make the lots saleable. Soon after, the
lots were sold to the public at a profit.
In their joint income tax return for the year 1957 filed with the Bureau of Internal Revenue on March 31,
1958, petitioners disclosed a profit of P31,060.06 realized from the sale of the subdivided lots, and reported
fifty per centum thereof or P15,530.03 as taxable capital gains.
Upon an audit and review of the return thus filed, the Revenue Examiner adjudged petitioners engaged in
business
667

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Calasanz vs. Commissioner of Internal Revenue
as real estate dealers, as defined in Section 194 [s]1 of the National Internal Revenue Code, required them
to pay the real estate dealer’s tax2 and assessed a deficiency income tax on profits derived from the sale
of the lots based on the rates for ordinary income.
On September 29, 1962, petitioners received from respondent Commissioner of Internal Revenue:
a. Demand No. 90-B-032293-57 in the amount of P160.00 representing real estate dealer’s fixed tax of
P150.00 and P10.00 compromise penalty for late payment; and
b. Assessment No. 90-5-35699 in the amount of P3,561.24 as deficiency income tax on ordinary gain of
P3,018.00 plus interest of P543.24.
On October 17, 1962, petitioners filed with the Court of Tax Appeals a petition for review contesting the
aforementioned assessments.
On June 7, 1966, the Tax Court upheld the respondent Commissioner except for that portion of the
assessment regarding the compromise penalty of P10.00 for the reason that in this jurisdiction, the same
cannot be collected in the absence of a valid and binding compromise agreement.
Hence, the present appeal.
The issues for consideration are:
a. Whether or not petitioners are real estate dealers liable for real estate dealer’s fixed tax; and
b. Whether the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains
taxable at capital gain rates.
_______________

1 “Real estate dealer” includes any person engaged in the business of buying, selling, exchanging, leasing,
or renting property as principal and holding himself out as a full or part-time dealer in real estate or as an
owner of rental property or properties rented or offered to rent for an aggregate amount of four thousand
pesos or more a year.”
2 Section 182[3] [s] of the National Internal Revenue Code which prescribes an annual fixed tax on real
estate dealers.
668

668
SUPREME COURT REPORTS ANNOTATED
Calasanz vs. Commissioner of Internal Revenue
The issues are closely interrelated and will be taken jointly.
Petitioners assail their liabilities as “real estate dealers” and seek to bring the profits from the sale of the
lots under Section 34 [b] [2]3 of the Tax Code.
The theory advanced by the petitioners is that inherited land is a capital asset within the meaning of Section
34[a] [1] of the Tax Code and that an heir who liquidated his inheritance cannot be said to have engaged
in the real estate business and may not be denied the preferential tax treatment given to gains from sale of
capital assets, merely because he disposed of it in the only possible and advantageous way.
Petitioners averred that the tract of land subject of the controversy was sold because of their intention to
effect a liquidation. They claimed that it was parcelled out into smaller lots because its size proved difficult,
if not impossible, of disposition in one single transaction. They pointed out that once subdivided, certainly,
the lots cannot be sold in one isolated transaction. Petitioners, however, admitted that roads and other
improvements were introduced to facilitate its sale.4
On the other hand, respondent Commissioner maintained that the imposition of the taxes in question is in
accordance with law since petitioners are deemed to be in the real estate business for having been involved
in a series of real estate transactions pursued for profit. Respondent argued that property acquired by
inheritance may be converted from an investment property to a business property if, as in the present case,
it was subdivided, improved, and subsequently sold and the number, continuity and frequency of the sales
were such as to constitute “doing business.” Respondent likewise contended that
_______________

3 “Sec. 34[b] Percentage taken into account.—In case of a taxpayer, other than a corporation, only the
following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be
taken into account in computing net capital gain, net capital loss, and net income:
[1] One hundred per centum if the capital asset has been held for nor more than twelve months;
[2] Fifty per centum if the capital asset has been held for more than twelve months.”
4 P. 6. Brief for Petitioners-Appellants, p. 48, Rollo.
669

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Calasanz vs. Commissioner of Internal Revenue
inherited property is by itself neutral and the fact that the ultimate purpose is to liquidate is of no moment
for the important inquiry is what the taxpayer did with the property. Respondent concluded that since the
lots are ordinary assets, the profits realized therefrom are ordinary gains, hence taxable in full.
We agree with the respondent.
The assets of a taxpayer are classified for income tax purposes into ordinary assets and capital assets.
Section 34[a] [1] of the National Internal Revenue Code broadly defines capital assets as follows:
“[1] Capital assets.—The term ‘capital assets’ means property held by the taxpayer [whether or not
connected with his trade or business], but does not include, stock in trade of the taxpayer or other property
of a kind which would properly be included, in the inventory of the taxpayer if on hand at the close of the
taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade or business, or property used in the trade or business of a character which is subject to the allowance
for depreciation provided in subsection [f] of section thirty; or real property used in the trade or business of
the taxpayer.”
The statutory definition of capital assets is negative in nature.5 If the asset is not among the exceptions, it
is a capital asset; conversely, assets falling within the exceptions are ordinary assets. And necessarily, any
gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the
kind of asset involved in the transaction.
However, there is no rigid rule or fixed formula by which it can be determined with finality whether property
sold by a taxpayer was held primarily for sale to customers in the ordinary course of his trade or business
or whether it was sold as a capital asset.6 Although several factors or indices7 have been
_______________

5 Nolledo, Commentaries and Jurisprudence on the National Internal Revenue Code of the Philippines,
1973 ed., p. 314.
6 Victory Housing No. 2 vs. Commissioner, 205 F. 2d 371.
7 Tuason, Jr. vs. Lingad, 58 SCRA 170 citing Klarkowski, TCM 1965-328. Aff’d 385 F[2d] 398 [Ca-7, 1967]
“which held that in deter-
670

670
SUPREME COURT REPORTS ANNOTATED
Calasanz vs. Commissioner of Internal Revenue
recognized as helpful guides in making a determination, none of these is decisive; neither is the presence
nor the absence of these factors conclusive. Each case must in the last analysis rest upon its own peculiar
facts and circumstances.8
Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a
combination of the factors indubitably tend to show that the activity was in furtherance of or in the course
of the taxpayer’s trade or business. Thus, a sale of inherited real property usually gives capital gain or loss
even though the property has to be subdivided or improved or both to make it salable. However, if the
inherited property is substantially improved or very actively sold or both it may be treated as held primarily
for sale to customers in the ordinary course of the heir’s business.9
Upon an examination of the facts on record, We are convinced that the activities of petitioners are
indistinguishable from those invariably employed by one engaged in the business of selling real estate.
One strong factor against petitioners’ contention is the business element of development which is very
much in evidence. Petitioners did not sell the land in the condition in
_______________

mining the correct boundary between these two types of assets the following must be considered:
[1] the purpose for which the property was initially acquired;
[2] the purpose for which the property was subsequently held;
[3] the extent to which improvements, if any, were made to the property by the taxpayer;
[4] the frequency, number and continuity of sales;
[5] the extent and nature of the transactions involved;
[6] the ordinary business of the taxpayer;
[7] the extent of advertising, promotion, or other activities used in soliciting buyers for the sale of the
property;
[8] the listing of property with brokers; and
[9] the purpose for which the property was held at the time of sale.”
8 Victory Housing No. 2 vs. Commissioner, Supra; Mauldin vs. Commissioner, 195 F. 2d 714.
9 34 Am Jur 2d., p. 92.
671

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Calasanz vs. Commissioner of Internal Revenue
which they acquired it. While the land was originally devoted to rice and fruit trees,10 it was subdivided into
small lots and in the process converted into a residential subdivision and given the name Don Mariano
Subdivision. Extensive improvements like the laying out of streets, construction of concrete gutters and
installation of lighting system and drainage facilities, among others, were undertaken to enhance the value
of the lots and make them more attractive to prospective buyers. The audited financial statements11
submitted together with the tax return in question disclosed that a considerable amount was expended to
cover the cost of improvements. As a matter of fact, the estimated improvements of the lots sold reached
P170,028.60 whereas the cost of the land is only P4,742.66. There is authority that a property ceases to
be a capital asset if the amount expended to improve it is double its original cost, for the extensive
improvement indicates that the seller held the property primarily for sale to customers in the ordinary course
of his business.12
Another distinctive feature of the real estate business discernible from the records is the existence of
contracts receivables, which stood at P395,693.35 as of the year ended December 31, 1957. The sizable
amount of receivables in comparison with the sales volume of P446,407.00 during the same period signifies
that the lots were sold on installment basis and suggests the number, continuity and frequency of the sales.
Also of significance is the circumstance that the lots were advertised13 for sale to the public and that sales
and collection commissions were paid out during the period in question.
Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.
In Ehrman vs. Commissioner,14 the American court in clear and categorical terms rejected the liquidation
test in determining whether or not a taxpayer is carrying on a trade or busi-
_______________
10 P. 26, BIR Records.
11 PP. 3-4, BIR Records.
12 34 Am Jur 2d., p. 89.
13 P. 35, BIR Records.
14 9 Cir., 120 F. 2d 607. Also see Richards vs. Commissioner, 9 Cir., 81 F. 2d 369, and Commissioner vs.
Boeing, 106 F. 2d 305.
672

672
SUPREME COURT REPORTS ANNOTATED
Calasanz vs. Commissioner of Internal Revenue
ness. The court observed that the fact that property is sold for purposes of liquidation does not foreclose a
determination that a “trade or business” is being conducted by the seller. The court enunciated further:
“We fail to see that the reasons behind a person’s entering into a business—whether it is to make money
or whether it is to liquidate—should be determinative of the question of whether or not the gains resulting
from the sales are ordinary gains or capital gains. The sole question is—were the taxpayers in the business
of subdividing real estate? If they were, then it seems indisputable that the property sold falls within the
exception in the definition of capital assets . . . that is, that it constituted ‘property held by the taxpayer
primarily for sale to customers in the ordinary course of his trade or business.’ ”
Additionally, in Home Co., Inc. vs. Commissioner,15 the court articulated on the matter in this wise:
“One may, of course, liquidate a capital asset. To do so, it is necessary to sell. The sale may be conducted
in the most advantageous manner to the seller and he will not lose the benefits of the capital gain provision
of the statute unless he enters the real estate business and carries on the sale in the manner in which such
a business is ordinarily conducted. In that event, the liquidation constitutes a business and a sale in the
ordinary course of such a business and the preferred tax status is lost.”
In view of the foregoing, We hold that in the course of selling the subdivided lots, petitioners engaged in the
real estate business and accordingly, the gains from the sale of the lots are ordinary income taxable in full.
WHEREFORE, the decision of the Court of Tax Appeals is affirmed. No costs.
SO ORDERED.
Feria (Chairman), Alampay, Gutierrez, Jr. and Paras, JJ., concur.
Decision affirmed.
G.R. No. 165617. February 25, 2011.*
SUPREME TRANSLINER, INC., MOISES C. ALVAREZ and PAULITA S. ALVAREZ, petitioners, vs. BPI
FAMILY SAVINGS BANK, INC., respondent.
G.R. No. 165837. February 25, 2011.*
BPI FAMILY SAVINGS BANK, INC., petitioner, vs. SUPREME TRANSLINER, INC., MOISES C. ALVAREZ
and PAULITA S. ALVAREZ, respondents.
Foreclosure of Mortgage; Presidential Decree (P.D.) No. 1529; Under Section 63 of Presidential Decree
No. 1529 otherwise known as the Property Registration Decree, if no right of redemption exists, the
certificate of title of the mortgagor shall be cancelled, and a new certificate issued in the name of the
purchaser; Where the right of redemption exists, the certificate of title of the mortgagor shall not be
cancelled, but the certificate of sale and the order confirming the sale shall be registered by brief
memorandum thereof made by the Register of Deeds upon the certificate of title.—Under Section 63 of
Presidential Decree No. 1529 otherwise known as the Property Registration Decree, if no right of
redemption exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in
the name of the purchaser. But where the right of redemption exists, the certificate of title of the mortgagor
shall not be cancelled, but the certificate of sale and the order confirming the sale shall be registered by
brief memorandum thereof made by the Register of Deeds upon the certificate of title. In the event the
property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a
brief memorandum thereof shall be made by the Register of Deeds on the certificate of title.
Same; Same; In foreclosure sale, there is no actual transfer of the mortgaged real property until after the
expiration of the one-year redemption period as provided in Act No. 3135 and title thereto is consolidated
in the name of the mortgagee in case of non-redemption.—It is therefore clear that in foreclosure sale, there
is no
_______________

* THIRD DIVISION.
60

60
SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
actual transfer of the mortgaged real property until after the expiration of the one-year redemption period
as provided in Act No. 3135 and title thereto is consolidated in the name of the mortgagee in case of non-
redemption. In the interim, the mortgagor is given the option whether or not to redeem the real property.
The issuance of the Certificate of Sale does not by itself transfer ownership.
Same; Same; Considering that herein petitioners-mortgagors exercised their right of redemption before the
expiration of the statutory one-year period, petitioner bank is not liable to pay the capital gains tax due on
the extrajudicial foreclosure sale.—Considering that herein petitioners-mortgagors exercised their right of
redemption before the expiration of the statutory one-year period, petitioner bank is not liable to pay the
capital gains tax due on the extrajudicial foreclosure sale. There was no actual transfer of title from the
owners-mortgagors to the foreclosing bank. Hence, the inclusion of the said charge in the total redemption
price was unwarranted and the corresponding amount paid by the petitioners-mortgagors should be
returned to them.
PETITION for review on certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
Natalio T. Paril, Jr. for Supreme Transliner, Inc., et al.
Rodolfo G. Palattao & Associates collaborating counsel for Supreme Transliner, Inc.
Felipe, Atienza, De Lumen, Coloma, Lopez, Tria & Associates for BPI Family Savings Bank.
VILLARAMA, JR., J.:
This case involves the question of the correct redemption price payable to a mortgagee bank as purchaser
of the property in a foreclosure sale.
On April 24, 1995, Supreme Transliner, Inc. represented by its Managing Director, Moises C. Alvarez, and
Paulita S. Alvarez, obtained a loan in the amount of P9,853,000.00 from
61

VOL. 644, FEBRUARY 25, 2011


61
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
BPI Family Savings Bank with a 714-square meter lot covered by Transfer Certificate of Title No. T-79193
in the name of Moises C. Alvarez and Paulita S. Alvarez, as collateral.1
For non-payment of the loan, the mortgage was extrajudicially foreclosed and the property was sold to the
bank as the highest bidder in the public auction conducted by the Office of the Provincial Sheriff of Lucena
City. On August 7, 1996, a Certificate of Sale2 was issued in favor of the bank and the same was registered
on October 1, 1996.
Before the expiration of the one-year redemption period, the mortgagors notified the bank of their intention
to redeem the property. Accordingly, the following Statement of Account3 was prepared by the bank
indicating the total amount due under the mortgage loan agreement:
xxxx
Balance of Principal
Add: Interest Due
Late Payment Charges
MRI
Fire Insurance
Foreclosure Expenses

P 9,551,827.64 1,417,761.24
155,546.25 0.00 0.00
155,817.23
Sub-total
Less: Unapplied Payment

P 11,280,952.36
908,241.01
Total Amount Due As Of 08/07/96
(Auction Date)
10,372,711.35
Add: Attorney’s Fees (15%) 1,555,906.70
Liquidated Damages
(15%)
1,555,906.70
Interest on P 10,372,
711.35 from 08/07/96 to 04/07/97 (243 days) at 17.25% p.a.

1,207,772.58

xxxx

_______________

1 Records, pp. 48-52.


2 Id., at p. 9.
3 Id., at p. 14.
62

62
SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
Asset Acquired Expenses:

Documentary Stamps 155,595.00


Capital Gains Tax 518,635.57
Foreclosure Fee 207,534.23
Registration and Filing Fee 23,718.00
Add’l. Registration & Filing
Fee 660.00 906,142.79
Interest on P 906,142.79 from
08/07/96 to 04/07/97 (243 days)
at 17.25% p.a. 105,509.00
Cancellation Fee 300.00

Total Amount Due As Of 04/0


7/97
(Subject to Audit)

P15,704,249.12

xxxx
The mortgagors requested for the elimination of liquidated damages and reduction of attorney’s fees and
interest (1% per month) but the bank refused. On May 21, 1997, the mortgagors redeemed the property by
paying the sum of P15,704,249.12. A Certificate of Redemption4 was issued by the bank on May 27, 1997.
On June 11, 1997, the mortgagors filed a complaint against the bank to recover the allegedly unlawful and
excessive charges totaling P5,331,237.77, with prayer for damages and attorney’s fees, docketed as Civil
Case No. 97-72 of the Regional Trial Court of Lucena City, Branch 57.
In its Answer with Special and Affirmative Defenses and Counterclaim, the bank asserted that the
redemption price reflecting the stipulated interest, charges and/or expenses, is valid, legal and in
accordance with documents duly signed by the mortgagors. The bank further contended that the claims
_______________

4 Id., at p. 18.
63

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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
are deemed waived and the mortgagors are already estopped from questioning the terms and conditions
of their contract.
On September 30, 1997, the bank filed a motion to set the case for hearing on the special and affirmative
defenses by way of motion to dismiss. The trial court denied the motion on January 8, 1998 and also denied
the bank’s motion for reconsideration. The bank elevated the matter to the Court of Appeals (CA-G.R. SP
No. 47588) which dismissed the petition for certiorari on February 26, 1999.
On February 14, 2002, the trial court rendered its decision5 dismissing the complaint and the bank’s
counterclaims. The trial court held that plaintiffs-mortgagors are bound by the terms of the mortgage loan
documents which clearly provided for the payment of the following interest, charges and expenses: 18%
p.a. on the loan, 3% post-default penalty, 15% liquidated damages, 15% attorney’s fees and collection and
legal costs. Plaintiffs-mortgagors’ claim that they paid the redemption price demanded by the defendant
bank under extreme pressure was rejected by the trial court since there was active negotiation for the final
redemption price between the bank’s representatives and plaintiffs-mortgagors who at the time had legal
advice from their counsel, together with Orient Development Banking Corporation which committed to
finance the redemption.
According to the trial court, plaintiffs-mortgagors are estopped from questioning the correctness of the
redemption price as they had freely and voluntarily signed the letter-agreement prepared by the defendant
bank, and along with Orient Bank expressed their conformity to the terms and conditions therein, thus:
_______________

5 Id., at pp. 393-401. Penned by Judge Rafael R. Lagos.


64

64
SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
May 14, 1997
ORIENT DEVELOPMENT BANKING CORPORATION
7th Floor Ever Gotesco Corporate Center
C.M. Recto Avenue corner Matapang Street
Manila
Attention: MS. AIDA C. DELA ROSA
enior Vice-President
Gentlemen:
This refers to your undertaking to settle the account of SUPREME TRANS LINER, INC. and spouses
MOISES C. ALVAREZ and PAULITA S. ALVAREZ, covering the real estate property located in the
Poblacion, City of Lucena under TCT No. T-79193 which was foreclosed by BPI FAMILY SAVINGS BANK,
INC.
With regard to the proposed refinancing of the account, we interpose no objection to the annotation of your
mortgage lien thereon subject to the following conditions:
1. That all expenses for the registration of the annotation of mortgage and other incidental registration
and cancellation expenses shall be borne by the borrower.
2. That you will recognize our mortgage liens as first and superior until the loan with us is fully paid.
3. That you will annotate your mortgage lien and pay us the full amount to close the loan within five (5)
working days from the receipt of the titles. If within this period, you have not registered the same and paid
us in full, you will immediately and unconditionally return the titles to us without need of demand, free from
liens/encumbrances other than our lien.
4. That in case of loss of titles, you will undertake and shoulder the cost of re-issuance of a new owner’s
titles.
5. That we will issue the Certificate of Redemption after full payment of P15,704,249.12. representing the
outstanding balance of the loan as of May 15, 1997 including interest and other charges thereof within
65

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65
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
a period of five (5) working days after clearance of the check payment.
6. That we will release the title and the Certificate of Redemption and other pertinent papers only to your
authorized representative with complete authorization and identification.
7. That all expenses related to the cancellation of your annotated mortgage lien should the Bank be not
fully paid on the period above indicated shall be charged to you.
If you find the foregoing conditions acceptable, please indicate your conformity on the space provided below
and return to us the duplicate copy.
Very truly yours,
BPI FAMILY BANK
BY:
(SGD.) LOLITA C. CARRIDO
Manager
CONFORME:
ORIENT DEVELOPMENT BANKING CORPORATION
(SGD.) AIDA C. DELA ROSA
Senior Vice President
CONFORME:
SUPREME TRANS LINER, INC.
(SGD.) MOISES C. ALVAREZ/PAULITA S. ALVAREZ
Mortgagors6
(Underscoring in the original; emphasis supplied.)
As to plaintiffs-mortgagors’ contention that the amounts representing attorney’s fees and liquidated
damages were already included in the P10,372,711.35 bid price, the trial
_______________
6 Id., at pp. 46-47.
66

66
SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
court said this was belied by their own evidence, the Statement of Account showing the breakdown of the
redemption price as computed by the defendant bank.
The mortgagors appealed to the CA (CA-G.R. CV No. 74761) which, by Decision7 dated April 6, 2004
reversed the trial court and decreed as follows:
“WHEREFORE, foregoing considered, the appealed decision is hereby REVERSED and SET ASIDE. A
new one is hereby entered as follows:
1. Plaintiffs-appellants’ complaint for damages against defendant-appellee is hereby REINSTATED;
2. Defendant-appellee is hereby ORDERED to return to plaintiffs-appellees (sic) the invalidly collected
amount of P3,111,813.40 plus six (6) percent legal interest from May 21, 1997 until fully returned;
3. Defendant-appellee is hereby ORDERED to pay plaintiffs-appellees (sic) the amount of P100,000.00
as moral damages, P100,000.00 as exemplary damages and P100,000.00 as attorney’s fees;
4. Costs against defendant-appellee.
SO ORDERED.”8
The CA ruled that attorney’s fees and liquidated damages were already included in the bid price of
P10,372,711.35 as per the recitals in the Certificate of Sale that said amount was paid to the foreclosing
mortgagee to satisfy not only the principal loan but also “interest and penalty charges, cost of publication
and expenses of the foreclosure proceedings.” These “penalty charges” consist of 15% attorney’s fees and
15% liquidated damages which the bank imposes as penalty in cases of violation of the terms of the
mortgage deed. The
_______________

7 Rollo (G.R. No. 165617), pp. 23-36. Penned by Associate Justice Eugenio S. Labitoria and concurred in
by Associate Justices Mercedes Gozo-Dadole and Rosmari D. Carandang.
8 Id., at p. 36.
67

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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
total redemption price thus should only be P12,592,435.72 and the bank should return the amount of
P3,111,813.40 representing attorney’s fees and liquidated damages. The appellate court further stated that
the mortgagors cannot be deemed estopped to question the propriety of the charges because from the very
start they had repeatedly questioned the imposition of attorney’s fees and liquidated damages and were
merely constrained to pay the demanded redemption price for fear that the redemption period will expire
without them redeeming their property.9
By Resolution10 dated October 12, 2004, the CA denied the parties’ respective motions for reconsideration.
Hence, these petitions separately filed by the mortgagors and the bank.
In G.R. No. 165617, the petitioners-mortgagors raise the single issue of whether the foreclosing mortgagee
should pay capital gains tax upon execution of the certificate of sale, and if paid by the mortgagee, whether
the same should be shouldered by the redemptioner. They specifically prayed for the return of all asset-
acquired expenses consisting of documentary stamps tax, capital gains tax, foreclosure fee, registration
and filing fee, and additional registration and filing fee totaling P906,142.79, with 6% interest thereon from
May 21, 1997.11
On the other hand, the petitioner bank in G.R. No. 165837 assails the CA in holding that—
“1. … the Certificate of Sale, the bid price of P10,372,711.35 includes penalty charges and as such for
purposes of computing the redemption price petitioner can no longer impose upon the private
_______________

9 Id., at pp. 30-34.


10 Id., at pp. 41-42. Penned by Associate Justice Eugenio S. Labitoria and concurred in by Associate
Justices Edgardo P. Cruz and Rosmari D. Carandang.
11 Id., at pp. 11, 15 and 18.
68

68
SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
respondents the penalty charges in the form of 15% attorney’s fees and the 15% liquidated damages in the
aggregate amount of P3,111,813.40, although the evidence presented by the parties show otherwise.
2. … private respondents cannot be considered to be under estoppel to question the propriety of the
aforestated penalty charges despite the fact that, as found by the Honorable Trial Court, “there was very
active negotiation between the parties in the computation of the redemption price” culminating into the
signing freely and voluntarily by the petitioner, the private respondents and Orient Bank, which financed the
redemption of the foreclosed property, of Exhibit “3”, wherein they mutually agreed that the redemption
price is in the sum of P15,704,249.12.
3. … petitioner [to] pay private respondents damages in the aggregate amount of P300,000.00 on the
ground that the former acted in bad faith in the imposition upon them of the aforestated penalty charges,
when in truth it is entitled thereto as the law and the contract expressly provide and that private respondents
agreed to pay the same.”12
On the correct computation of the redemption price, Section 78 of Republic Act No. 337, otherwise known
as the General Banking Act, governs in cases where the mortgagee is a bank.13 Said provision reads:
“SEC. 78. x x x In the event of foreclosure, whether judicially or extrajudicially, of any mortgage on real
estate which is security for any loan granted before the passage of this Act or under the provisions of this
Act, the mortgagor or debtor whose real property has been sold at public auction, judicially or extrajudicially,
for the full or
_______________

12 Rollo (G.R. No. 165837), pp. 13-14.


13 Tecklo v. Rural Bank of Pamplona, Inc., G.R. No. 171201, June 18, 2010, 621 SCRA 262, 273, citing
Heirs of Norberto J. Quisumbing v. Philippine National Bank, G.R. No. 178242, January 20, 2009, 576
SCRA 762, 772; Union Bank of the Philippines v. Court of Appeals, G.R. No. 134068, June 25, 2001, 359
SCRA 480, 490, citing Ponce de Leon v. Rehabilitation Finance Corporation, No. L-24571, December 18,
1970, 36 SCRA 289 and Sy v. Court of Appeals, G.R. No. 83139, April 12, 1989, 172 SCRA 125.
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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
partial payment of an obligation to any bank, banking or credit institution, within the purview of this Act shall
have the right, within one year after the sale of the real estate as a result of the foreclosure of the respective
mortgage, to redeem the property by paying the amount fixed by the court in the order of execution, or the
amount due under the mortgage deed, as the case may be, with interest thereon at the rate specified in the
mortgage, and all the costs, and judicial and other expenses incurred by the bank or institution concerned
by reason of the execution and sale and as a result of the custody of said property less the income received
from the property.” x x x x (Emphasis supplied.)
Under the Mortgage Loan Agreement,14 petitioners-mortgagors undertook to pay the attorney’s fees and
the costs of registration and foreclosure. The following contract terms would show that the said items are
separate and distinct from the bid price which represents only the outstanding loan balance with stipulated
interest thereon.
“23. Application of Proceeds of Foreclosure Sale. The proceeds of sale of the mortgaged property/ies
shall be applied as follows:
a) To the payment of the expenses and cost of foreclosure and sale, including the attorney’s fees as
herein provided;
b) To the satisfaction of all interest and charges accruing upon the obligations herein and hereby secured.
c) To the satisfaction of the principal amount of the obligations herein and hereby secured.
d) To the satisfaction of all other obligations then owed by the Borrower/Mortgagor to the Bank or any of
its subsidiaries/affiliates such as, but not limited to BPI Credit Corporation; or to Bank of the Philippine
Islands or any of its subsidiaries/affiliates such as, but not limited to BPI Leasing Corporation, BPI Express
Card Corporation, BPI Securities Corporation and BPI Agricultural Development Bank; and
_______________

14 Records, pp. 48-51.


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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
e) The balance, if any, to be due to the Borrower/Mortgagor.
xxxx
31. Attorney’s Fees: In case the Bank should engage the services of counsel to enforce its rights under
this Agreement, the Borrower/Mortgagor shall pay an amount equivalent to fifteen (15%) percent of the total
amount claimed by the Bank, which in no case shall be less than P2,000.00, Philippine currency, plus costs,
collection expenses and disbursements allowed by law, all of which shall be secured by this mortgage.15
Additionally, the Disclosure Statement on Loan/Credit Transaction16 also duly signed by the petitioners-
mortgagors provides:
10. ADDITIONAL CHARGES IN CASE CERTAIN STIPULATIONS ARE NOT MET BY THE BORROWER
a. Post Default Penalty 3.00% per month
b. Attorney’s Services 15% of sum due but not less than P2,000.00
c. Liquidated Damages 15% of sum due but not less than P10,000.00
d.Collection & Legal Cost As provided by the Rules of Court
e. Others (Specify)
As correctly found by the trial court, that attorney’s fees and liquidated damages were not yet included in
the bid price of P10,372,711.35 is clearly shown by the Statement of Account as of April 4, 1997 prepared
by the petitioner bank and given to petitioners-mortgagors. On the other hand, par. 23 of the Mortgage Loan
Agreement indicated that asset acquired expenses were to be added to the redemption price as part of
“costs and other expenses incurred” by the mortgagee bank in connection with the foreclosure sale.
_______________

15 Id., at p. 50.
16 Id., at p. 45.
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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
Coming now to the issue of capital gains tax, we find merit in petitioners-mortgagors’ argument that there
is no legal basis for the inclusion of this charge in the redemption price. Under Revenue Regulations (RR)
No. 13-85 (December 12, 1985), every sale or exchange or other disposition of real property classified as
capital asset under Section 34(a)17 of the Tax Code shall be subject to the final capital gains tax. The term
sale includes pacto de retro and other forms of conditional sale. Section 2.2 of Revenue Memorandum
Order (RMO) No. 29-86 (as amended by RMO No. 16-88 and as further amended by RMO Nos. 27-89 and
6-92) states that these conditional sales “necessarily include mortgage foreclosure sales (judicial and
extrajudicial foreclosure sales).” Further, for real property foreclosed by a bank on or after September 3,
1986, the capital gains tax and documentary stamp tax must be paid before title to the property can be
consolidated in favor of the bank.18
Under Section 63 of Presidential Decree No. 1529 otherwise known as the Property Registration Decree,
if no right of
_______________

17 Now Sec. 39(A) of the National Internal Revenue Code of 1997.


SEC. 39. Capital Gains and Losses.—
(A) Definitions.—As used in this Title –
(1) Capital Assets.—The term “capital assets” means property held by the taxpayer (whether or not
connected with his trade or business), but does not include stock in trade of the taxpayer or other property
of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the
taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade or business, or property used in the trade or business, of a character which is subject to the allowance
for depreciation provided in Subsection (F) of Section 34; or real property used in trade or business of the
taxpayer.
18 De Leon and De Leon, Jr., The National Internal Revenue Code Annotated, 2003 Ed., Vol. 1, pp. 130-
131, citing BIR Ruling No. 134, July 12, 1990.
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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
redemption exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in
the name of the purchaser. But where the right of redemption exists, the certificate of title of the mortgagor
shall not be cancelled, but the certificate of sale and the order confirming the sale shall be registered by
brief memorandum thereof made by the Register of Deeds upon the certificate of title. In the event the
property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a
brief memorandum thereof shall be made by the Register of Deeds on the certificate of title.
It is therefore clear that in foreclosure sale, there is no actual transfer of the mortgaged real property until
after the expiration of the one-year redemption period as provided in Act No. 3135 and title thereto is
consolidated in the name of the mortgagee in case of non-redemption. In the interim, the mortgagor is given
the option whether or not to redeem the real property. The issuance of the Certificate of Sale does not by
itself transfer ownership.19
RR No. 4-99 issued on March 16, 1999, further amends RMO No. 6-92 relative to the payment of Capital
Gains Tax and Documentary Stamp Tax on extrajudicial foreclosure sale of capital assets initiated by
banks, finance and insurance companies.
“SEC. 3. CAPITAL GAINS TAX.—
(1) In case the mortgagor exercises his right of redemption within one year from the issuance of the
certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the
mortgagor and no sale or transfer of real property was realized. x x x
(2) In case of non-redemption, the capital gains [tax] on the foreclosure sale imposed under Secs.
24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest
bidder but only upon the expiration of the one-year period of re-
_______________

19 BIR Ruling [DA-062-06] February 28, 2006.


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Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
demption provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within
thirty (30) days from the expiration of the said one-year redemption period.
SEC. 4. DOCUMENTARY STAMP TAX.—
(1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the
P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997 because no land or realty
was sold or transferred for a consideration.
(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and
paid by the person making, signing, issuing, accepting, or transferring the real property wherever the
document is made, signed, issued, accepted or transferred where the property is situated in the Philippines.
x x x” (Emphasis supplied.)
Although the subject foreclosure sale and redemption took place before the effectivity of RR No. 4-99, its
provisions may be given retroactive effect in this case.
Section 246 of the NIRC of 1997 states:
“SEC. 246. Non-Retroactivity of Rulings.—Any revocation, modification, or reversal of any of the rules
and regulations promulgated in accordance with the preceding Sections or any of the rulings or circulars
promulgated by the Commissioner shall not be given retroactive application if the revocation, modification,
or reversal will be prejudicial to the taxpayers, except in the following cases:
(a) where the taxpayer deliberately misstates or omits material facts from his return or in any document
required of him by the Bureau of Internal Revenue;
(b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially different from
the facts on which the ruling is based; or
(c) where the taxpayer acted in bad faith.”
In this case, the retroactive application of RR No. 4-99 is more consistent with the policy of aiding the
exercise of the
74

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SUPREME COURT REPORTS ANNOTATED
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
right of redemption. As the Court of Tax Appeals concluded in one case, RR No. 4-99 “has curbed the
inequity of imposing a capital gains tax even before the expiration of the redemption period [since] there is
yet no transfer of title and no profit or gain is realized by the mortgagor at the time of foreclosure sale but
only upon expiration of the redemption period.”20 In his commentaries, De Leon expressed the view that
while revenue regulations as a general rule have no retroactive effect, if the revocation is due to the fact
that the regulation is erroneous or contrary to law, such revocation shall have retroactive operation as to
affect past transactions, because a wrong construction of the law cannot give rise to a vested right that can
be invoked by a taxpayer.21
Considering that herein petitioners-mortgagors exercised their right of redemption before the expiration of
the statutory one-year period, petitioner bank is not liable to pay the capital gains tax due on the extrajudicial
foreclosure sale. There was no actual transfer of title from the owners-mortgagors to the foreclosing bank.
Hence, the inclusion of the said charge in the total redemption price was unwarranted and the
corresponding amount paid by the petitioners-mortgagors should be returned to them.
WHEREFORE, premises considered, both petitions are PARTLY GRANTED.
In G.R. No. 165617, BPI Family Savings Bank, Inc. is hereby ordered to RETURN the amounts representing
capital gains and documentary stamp taxes as reflected in the Statement of Account To Redeem as of April
7, 1997, to petitioners Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez, and to retain only
the sum provided in RR No. 4-99 as documentary stamps tax due on the foreclosure sale.
_______________

20 Spouses Alfredo & Imelda Diaz v. BIR, C.T.A. Case No. 6244, March 5, 2003.
21 De Leon and De Leon, Jr., supra, Vol. 2, p. 540.
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75
Supreme Transliner, Inc. vs. BPI Family Savings Bank, Inc.
In G.R. No. 165837, petitioner BPI Family Savings Bank, Inc. is hereby declared entitled to the attorney’s
fees and liquidated damages included in the total redemption price paid by Supreme Transliner, Inc.,
Moises C. Alvarez and Paulita Alvarez. The sums awarded as moral and exemplary damages, attorney’s
fees and costs in favor of Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez are DELETED.
The Decision dated April 6, 2004 of the Court of Appeals in CA-G.R. CV No. 74761 is accordingly
MODIFIED.
SO ORDERED.
Brion** (Actg. Chairperson), Bersamin, Abad*** and Sereno, JJ., concur.
Petitions partly granted.
Note.—Upon the expiration of the redemption period, the right of the purchaser to the possession of the
foreclosed property becomes absolute. (Fernandez vs. Espinoza, 551 SCRA 136 [2008])
G.R. No. 168118. August 28, 2006.*
THE MANILA BANKING CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE,
respondent.
Taxation; The intent of Congress relative to the minimum corporate income tax is to grant a four (4)-year
suspension of tax payment to newly formed corporations.—The intent of Congress relative to the minimum
corporate income tax is to grant a four (4)-year suspension of tax payment to newly formed corporations.
Corporations still starting their business operations have to stabilize their venture in order to obtain a
stronghold in the industry. It does not come as a surprise then when many companies reported losses in
their initial years of operations.
Same; Thrift Banks; It is clear from Revenue Regulations No. 4-95 that the date of commencement of
operations of a thrift bank is the date it was registered with the Securities and Exchange Commission or
the date when the Certificate of Authority to Operate was issued to it by the Monetary Board of the Bangko
Sentral ng Pilipinas, whichever comes later.—Petitioner bank was registered with the BIR in 1961.
However, in 1987, it was found insolvent by the Monetary Board of the BSP and was placed under
receivership. After twelve (12) years, or on June 23, 1999, the BSP issued to it a Certificate of Authority to
Operate as a thrift bank. Earlier, or on January 21, 1999, it registered with the BIR. Then it filed with the
SEC its Articles of Incorporation which was approved on June 22, 1999. It is clear from the above-quoted
provision of Revenue Regulations No. 4-95 that the date of commencement of operations of a thrift bank is
the date it was registered with the SEC or the date when the Certificate of Authority to Operate was issued
to it by the Monetary Board of the BSP, whichever comes later.
Same; Same; Regulations No. 4-95, not Revenue Regulations No. 4-98, applies to a thrift bank; Petitioner,
being a thrift bank, is entitled to a grace period of four (4) years counted from the date when it was
authorized by the BSP to operate as a thrift bank.—Let it be stressed that Revenue Regulations No. 9-98,
implementing R.A. No. 8424 imposing the minimum corporate income tax on corporations, provides that for
purposes of this tax, the date when business operations commence is the year in which the domestic
corporation registered with the BIR. However, under Revenue Regulations No. 4-95, the date of
commencement of operations of thrift banks, such as herein
_______________

* SECOND DIVISION.
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Manila Banking Corporation vs. Commissioner
of Internal Revenue
petitioner, is the date the particular thrift bank was registered with the SEC or the date when the Certificate
of Authority to Operate was issued to it by the Monetary Board of the BSP, whichever comes later. Clearly
then, Revenue Regulations No. 4-95, not Revenue Regulations No. 9-98, applies to petitioner, being a thrift
bank. It is, therefore, entitled to a grace period of four (4) years counted from June 23, 1999 when it was
authorized by the BSP to operate as a thrift bank. Consequently, it should only pay its minimum corporate
income tax after four (4) years from 1999.
PETITION for review on certiorari of a decision of the Court of Ap-peals.

The facts are stated in the opinion of the Court.


Puyat, Jacinto & Santos for petitioner.
Jose Songco co-counsel for petitioner.
Wilmer B. Dekit for respondent.
SANDOVAL-GUTIERREZ, J.:

Before us is a Petition for Review on Certiorari1 assailing the Deci-sion2 of the Court of Appeals dated May
11, 2005 in CA-G.R. SP No. 77177, entitled “The Manila Banking Corporation, petitioner, versus
Commissioner of Internal Revenue, respondent.”
The Manila Banking Corporation, petitioner, was incorporated in 1961 and since then had engaged in the
commercial banking industry until 1987. On May 22, 1987, the Monetary Board of the Bangko Sentral ng
Pilipinas (BSP) issued Resolution No. 505, pursuant to Section 29 of Republic Act (R.A.) No. 265 (the
Central Bank Act),3
_______________

1 Under Rule 45 of the 1997 Revised Rules of Civil Procedure, as amended.


2 Penned by Associate Justice Eugenio S. Labitoria (retired) and concurred in by Associate Justice Eliezer
R. de los Santos and Associate Justice Arturo D. Brion (now Secretary of Labor).
3 Sec. 29. Proceedings upon insolvency.—Whenever, upon examination by the head of the appropriate
supervising or examining department or his examiners or agents into the condition of any bank or non-bank
financial intermediary performing quasi-banking functions, it shall be disclosed that
784

784
SUPREME COURT REPORTS ANNOTATED
Manila Banking Corporation vs. Commissioner
of Internal Revenue
prohibiting petitioner from engaging in business by reason of insolvency. Thus, petitioner ceased operations
that year and its assets and liabilities were placed under the charge of a government-appointed receiver.
Meanwhile, R.A. No. 8424,4 otherwise known as the Comprehensive Tax Reform Act of 1997, became
effective on January 1, 1998. One of the changes introduced by this law is the imposition of the minimum
corporate income tax on domestic and resident foreign corporations. Implementing this law is Revenue
Regulations No. 9-98 stating that the law allows a four (4) year period from the time the corporations were
registered with the Bureau of Internal Revenue (BIR) during which the minimum corporate income tax
should not be imposed.
On June 23, 1999, after 12 years since petitioner stopped its business operations, the BSP authorized it to
operate as a thrift bank. The following year, specifically on April 7, 2000, it filed with the BIR its annual
corporate income tax return and paid P33,816,164.00 for taxable year 1999.
Prior to the filing of its income tax return, or on December 28, 1999, petitioner sent a letter to the BIR
requesting a ruling on whether it is entitled to the four (4)-year grace period reckoned from 1999. In other
words, petitioner’s position is that since it resumed
_______________

the condition of the same is one of insolvency, or that its continuance in business would involve probable
loss to its depositors or creditors, it shall be the duty of the department head concerned forthwith, in writing,
to inform the Monetary Board of the facts, and the Board may, upon finding the statements of the
department head to be true, forbid the institution to do business in the Philippines and shall designate an
official of the Central Bank or a person of recognized competence in banking or finance, as receiver to
immediately take charge of its assets and liabilities, as expeditiously as possible collect and gather all the
assets and administer the same for the benefit of its creditors, exercising all the powers necessary for these
purposes including, but not limited to, bringing suits and foreclosing mortgages in the name of the bank or
non-bank financial intermediary performing quasi-banking functions.
xxx
4 An Act Amending the National Internal Revenue Code, as amended.
785

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Manila Banking Corporation vs. Commissioner
of Internal Revenue
operations in 1999, it will pay its minimum corporate income tax only after four (4) years thereafter.
On February 22, 2001, the BIR issued BIR Ruling No. 007-20015 stating that petitioner is entitled to the
four (4)-year grace period. Since it reopened in 1999, the minimum corporate income tax may be imposed
“not earlier than 2002, i.e. the fourth taxable year beginning 1999.” The relevant portions of the BIR Ruling
state:
“In reply, we hereby confirm that the law and regulations allow new corporations as well as existing
corporations a leeway or adjustment period of four years counted from the year of commencement of
business operations (reckoned at the time of registration by the corporation with the BIR) during which the
MCIT (minimum corporate income tax) does not apply. If new corporations, as well as existing corporations
such as those registered with the BIR in 1994 or earlier, are granted a 4-year grace period, we see no
reason why TMBC, a corporation that has ceased business activities due to involuntary closure for more
than a decade and is now only starting again to place its business back in order, may not be given the same
opportunity. It should be stressed that although TMBC had been registered with the BIR before 1994, yet it
did not have any business from 1987 to June 1999 due to its involuntary closure. This Office is therefore of
an opinion, that for purposes of justice, equity and consistent with the intent of the law, TMBC’s reopening
last July 1999 is akin to the commencement of business operations of a new corporation, in consideration
of which the law allows a 4-year period during which MCIT is not to be applied. Hence, MCIT may be
imposed upon TMBC not earlier than 2002, i.e., the fourth taxable year beginning 1999 which is the year
when TMBC reopened.
Likewise, we find merit in your position that for having just come out of receivership proceedings, which not
only resulted in substantial losses but actually brought about a complete cessation of all businesses, TMBC
may be qualified to ask for suspension of the MCIT. The law provides that the Secretary of Finance, upon
the recommendation of the Commissioner, may suspend the imposition of the MCIT on any corporation
which suffers losses on account of prolonged labor dispute, or because of force majeure, or because of
legitimate business reverses. [NIRC, Sec. 27(E)(3)] Revenue Regulations 9-98 defines the term “legitimate
business reverses” to include substantial losses sustained due to fire, robbery, theft or embezzlement, or
for other economic reasons as determined by the Secretary of Finance. Cessation of business
_______________

5 Rollo, pp. 79-81.


786

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SUPREME COURT REPORTS ANNOTATED
Manila Banking Corporation vs. Commissioner
of Internal Revenue
activities as a result of being placed under involuntary receivership may be one such economic reason. But
to be a basis for the recognition of the suspension of MCIT, such a situation should be properly defined and
included in the regulations, which this Office intends to do. Pending such inclusion, the same cannot yet be
invoked. Nevertheless, it is the position of this Office that the counting of the fourth taxable year, insofar as
TMBC is concerned, begins in the year 1999 when TMBC reopened such that it will be only subject to MCIT
beginning the year 2002.
Pursuant to the above Ruling, petitioner filed with the BIR a claim for refund of the sum of P33,816,164.00
erroneously paid as minimum corporate income tax for taxable year 1999.
Due to the inaction of the BIR on its claim, petitioner filed with the Court of Tax Appeals (CTA) a petition for
review.
On April 21, 2003, the CTA denied the petition, finding that peti-tioner’s payment of the amount of
P33,816,164.00 corresponding to its minimum corporate income tax for taxable year 1999 is in order. The
CTA held that petitioner is not entitled to the four (4)-year grace period because it is not a new corporation.
It has continued to be the same corporation, registered with the Securities and Exchange Commission
(SEC) and the BIR, despite being placed under receivership, thus:
Moreover, it must be emphasized that when herein petitioner was placed under receivership, there was
merely an interruption of its business operations. However, its corporate existence was never affected. The
general rule is that the appointment of the receiver does not terminate the charter or work a dissolution of
the corporation, even though the receivership is a permanent one. In other words, the corporation continues
to exist as a legal entity, clothed with its franchises (65 Am. Jur. 2d, pp. 973-974). Petitioner, for all intents
and purposes, remained to be the same corporation, registered with the SEC and with the BIR. While it
may continue to perform its corporate functions, all its properties and assets were under the control and
custody of a receiver, and its dealings with the public is somehow limited, if not momentarily suspended. x
xx
On June 11, 2003, petitioner filed with the Court of Appeals a petition for review. On May 11, 2005, the
appellate court rendered a Decision affirming the assailed judgment of the CTA.
787
VOL. 499, AUGUST 28, 2006
787
Manila Banking Corporation vs. Commissioner
of Internal Revenue
Thus, this petition for review on certiorari.
The main issue for our resolution is whether petitioner is entitled to a refund of its minimum corporate
income tax paid to the BIR for taxable year 1999.
Petitioner contends that the Court of Tax Appeals erred in holding that it is not entitled to the four (4)-year
grace period provided by law suspending the payment of its minimum corporate income tax since it is not
a newly created corporation, having been registered as early as 1961.
For his part, the Commissioner of Internal Revenue (CIR), respondent, maintains that pursuant to R.A. No.
8424, petitioner should pay its minimum corporate income tax beginning January 1, 1998 as it did not close
its business operations in 1987 but merely suspended the same. Even if placed under receivership, its
corporate existence was never affected. Thus, it falls under the category of an existing corporation
recommencing its banking business operations.
Section 27(E) of the Tax Code provides:
Sec. 27. Rates of Income Tax on Domestic Corporations.—x x x
(E) Minimum Corporate Income Tax on Domestic Corporations.—
(1) Imposition of Tax.—A minimum corporate income tax of two percent (2%) of the gross income as of the
end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title,
beginning on the fourth taxable year immediately following the year in which such corporation commenced
its business operations, when the minimum corporate income tax is greater than the tax computed under
Subsection (A) of this Section for the taxable year.
(2) Carry Forward of Excess Minimum Tax.—Any excess of the minimum corporate income tax over the
normal income tax as computed under Subsection (A) of this Section shall be carried forward and credited
against the normal income tax for the three (3) immediately succeeding taxable years.
xxx
Upon the other hand, Revenue Regulation No. 9-98 specifies the period when a corporation becomes
subject to the minimum corporate income tax, thus:
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SUPREME COURT REPORTS ANNOTATED
Manila Banking Corporation vs. Commissioner
of Internal Revenue
(5) Specific Rules for Determining the Period When a Corporation Becomes Subject to the MCIT (minimum
corporate income tax)—
For purposes of the MCIT, the taxable year in which business operations commenced shall be the year in
which the domestic corporation registered with the Bureau of Internal Revenue (BIR).
Firms which were registered with BIR in 1994 and earlier years shall be covered by the MCIT beginning
January 1, 1998.
xxx
The intent of Congress relative to the minimum corporate income tax is to grant a four (4)-year suspension
of tax payment to newly formed corporations. Corporations still starting their business operations have to
stabilize their venture in order to obtain a stronghold in the industry. It does not come as a surprise then
when many companies reported losses in their initial years of operations. The following are excerpts from
the Senate deliberations:
Senator Romulo: x x x Let me go now to the minimum corporate income tax, which is on page 45 of the
Journal, which is to minimize tax evasion on those corporations which have been declaring losses year in
and year out. Here, the tax rate is three-fourths, three quarter of a percent or .75% applied to corporations
that do not report any taxable income on the fourth year of their business operation. Therefore, those that
do not report income on the first, second and third year are not included here.
Senator Enrile: We assume that this is the period of stabilization of new company that is starting in business.
Senator Romulo: That is right.
Thus, in order to allow new corporations to grow and develop at the initial stages of their operations, the
lawmaking body saw the need to provide a grace period of four years from their registration before they
pay their minimum corporate income tax.
Significantly, on February 23, 1995, Congress enacted R.A. No. 7906, otherwise known as the “Thrift Banks
Act of 1995.” It took effect on March 18, 1995. This law provides for the regulation of the organization and
operations of thrift banks. Under Section 3, thrift banks include savings and mortgage banks, private
development
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Manila Banking Corporation vs. Commissioner
of Internal Revenue
banks, and stock savings and loans associations organized under existing laws.
On June 15, 1999, the BIR issued Revenue Regulation No. 4-95 implementing certain provisions of the
said R.A. No. 7906. Section 6 provides:
Sec. 6. Period of exemption.—All thrift banks created and organized under the provisions of the Act shall
be exempt from the payment of all taxes, fees, and charges of whatever nature and description, except the
corporate income tax imposed under Title II of the NIRC and as specified in Section 2(A) of these
regulations, for a period of five (5) years from the date of commencement of operations; while for thrift
banks which are already existing and operating as of the date of effectivity of the Act (March 18, 1995), the
tax exemption shall be for a period of five (5) years reckoned from the date of such effectivity.
For purposes of these regulations, “date of commencement of opera-tions” shall be understood to mean
the date when the thrift bank was registered with the Securities and Exchange Commission or the date
when the Certificate of Authority to Operate was issued by the Monetary Board of the Bangko Sentral ng
Pilipinas, whichever comes later.
xxx
As mentioned earlier, petitioner bank was registered with the BIR in 1961. However, in 1987, it was found
insolvent by the Monetary Board of the BSP and was placed under receivership. After twelve (12) years, or
on June 23, 1999, the BSP issued to it a Certificate of Authority to Operate as a thrift bank. Earlier, or on
January 21, 1999, it registered with the BIR. Then it filed with the SEC its Articles of Incorporation which
was approved on June 22, 1999.
It is clear from the above-quoted provision of Revenue Regulations No. 4-95 that the date of
commencement of operations of a thrift bank is the date it was registered with the SEC or the date when
the Certificate of Authority to Operate was issued to it by the Monetary Board of the BSP, whichever comes
later.
Let it be stressed that Revenue Regulations No. 9-98, implementing R.A. No. 8424 imposing the minimum
corporate income tax on corporations, provides that for purposes of this tax, the date when business
operations commence is the year in which the domestic cor-
790

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SUPREME COURT REPORTS ANNOTATED
Manila Banking Corporation vs. Commissioner
of Internal Revenue
poration registered with the BIR. However, under Revenue Regulations No. 4-95, the date of
commencement of operations of thrift banks, such as herein petitioner, is the date the particular thrift bank
was registered with the SEC or the date when the Certificate of Authority to Operate was issued to it by the
Monetary Board of the BSP, whichever comes later.
Clearly then, Revenue Regulations No. 4-95, not Revenue Regulations No. 9-98, applies to petitioner, being
a thrift bank. It is, therefore, entitled to a grace period of four (4) years counted from June 23, 1999 when it
was authorized by the BSP to operate as a thrift bank. Consequently, it should only pay its minimum
corporate income tax after four (4) years from 1999.
WHEREFORE, we GRANT the petition. The assailed Decision of the Court of Appeals in CA-G.R. SP No.
77177 is hereby REVERSED. Respondent Commissioner of Internal Revenue is directed to refund to
petitioner bank the sum of P33,816,164.00 prematurely paid as minimum corporate income tax.
SO ORDERED.
Puno (Chairperson), Azcuna and Garcia, JJ., concur.
Corona, J., On Leave.
Petition granted, assailed decision reversed and set aside.
Notes.—Executive Order No. 41 has been designed to be in the nature of a general grant of tax amnesty
subject to the cases specifically excepted by it. (Commissioner of Internal Revenue vs. Court of Ap-peals,
240 SCRA 368 [1995])
Nowhere in the rules of the BIR does it state that all communications must pass through the hierarchy of
officers—there is nothing irregular with the fact that a taxpayer’s letter claiming for tax credit in ad valorem
taxes was directly sent to the Office of the Chief of the Excise Tax Division. (Pareño vs. Sandiganbayan,
256 SCRA 242 [1996])
G.R. No. 179259. September 25, 2013.*
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. PHILIPPINE AIRLINES, INC. (PAL),
respondent.
Taxation; Domestic Corporations; A domestic corporation must pay whichever is the higher of: (1) the
income tax under Section 27(A) of the National Internal Revenue Code (NIRC) of 1997, as amended,
computed by applying the tax rate therein to the taxable income of the corporation; or (2) the Minimum
Corporate Income Tax (MCIT) under Section 27(E), also of the same Code, equivalent to 2% of the gross
income of the corporation.―A domestic corporation must pay whichever is the higher of: (1) the income tax
under Section 27(A) of the NIRC of 1997, as amended, computed by applying the tax rate therein to the
taxable income of the corporation; or (2) the MCIT under Section 27(E), also of the same Code, equivalent
to 2% of the gross income of the corporation. The Court would like to underscore that although this may be
the general rule in determining the income tax due from a domestic corporation under the provisions of the
NIRC of 1997, as amended, such rule can only be applied to respondent only as to the extent allowed by
the provisions of its franchise.
_______________
* SECOND DIVISION.
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Same; Franchise Tax; During the lifetime of the franchise of respondent, its taxation shall be strictly
governed by two fundamental rules, to wit: (1) respondent shall pay the Government either the basic
corporate income tax or franchise tax, whichever is lower; and (2) the tax paid by respondent, under either
of these alternatives, shall be in lieu of all other taxes, duties, royalties, registration, license, and other fees
and charges, except only real property tax.―During the lifetime of the franchise of respondent, its taxation
shall be strictly governed by two fundamental rules, to wit: (1) respondent shall pay the Government either
the basic corporate income tax or franchise tax, whichever is lower; and (2) the tax paid by respondent,
under either of these alternatives, shall be in lieu of all other taxes, duties, royalties, registration, license,
and other fees and charges, except only real property tax. Parenthetically, the basic corporate income tax
of respondent shall be based on its annual net taxable income, computed in accordance with the NIRC of
1997, as amended. PD 1590 also explicitly authorizes respondent, in the computation of its basic corporate
income tax, to: (1) depreciate its assets twice as fast the normal rate of depreciation; and (2) carry over as
a deduction from taxable income any net loss incurred in any year up to five years following the year of
such loss. The franchise tax, on the other hand, shall be 2% of the gross revenues derived by respondent
from all sources, whether transport or nontransport operations. However, with respect to international air-
transport service, the franchise tax shall only be imposed on the gross passenger, mail, and freight
revenues of respondent from its outgoing flights.
PETITION for review on certiorari of the decision and resolution of the Court of Tax Appeals.
The facts are stated in the opinion of the Court.
Office of the Solicitor General for petitioner.
Jaclyn Marie S. Arellano-Tan and Oscar C. Ventanilla, Jr. for respondent.
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Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
PEREZ, J.:
Before the Court is a Petition for Review on Certiorari seeking to reverse and set aside the 19 July 2007
Decision1 and 23 August 2007 Resolution2 of the Court of Tax Appeals (CTA) En Banc in CTA EB No. 271
which affirmed the cancellation and withdrawal of Assessment Notice No. INC-FY-99-2000-000085 and
Formal Letter of Demand for the payment by the respondent Philippine Airlines, Inc. (respondent), of
deficiency Minimum Corporate Income Tax (MCIT) in the amount of P326,778,723.35, covering the fiscal
year ending 31 March 2000.
The Facts
The factual antecedents of the case are undisputed:
Petitioner, the Commissioner of Internal Revenue, has the power to assess and collect national internal
revenue taxes, fees, and charges, including the 2% per centum MCIT imposed under Section 27(E) of the
National Internal Revenue Code (NIRC) of 1997, as amended. Respondent, on the other hand, is a
domestic corporation duly organized and existing under and by virtue of the laws of the Philippines.
For the fiscal year that ended 31 March 2000, respondent filed on 17 July 2000 its Tentative Corporate
Income Tax Return, reflecting a creditable tax withheld for the fourth quarter amounting to P524,957.00,
and a zero taxable income for said year. Hence, respondent filed on 16 July 2001 a written claim for refund
before the petitioner.
As a consequence thereof, respondent received on 10 September 2001 the Letter of Authority No.
200000002247 from
_______________
1 Rollo, pp. 43-62; Penned by Associate Justice Lovell R. Bautista with Presiding Justice Ernesto D. Acosta
and Associate Justices Juanito C. Castañeda, Jr., Erlinda P. Uy and Olga Palanca-Enriquez, concurring.
2 Id., at pp. 64-67.
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the Bureau of Internal Revenue (BIR) Large Taxpayers Service, dated 3 September 2001, authorizing the
revenue officers named therein to examine respondent’s books of accounts and other accounting records
for the purpose of evaluating respondent’s “Claim for Refund on Creditable Withholding Tax — Income Tax”
covering the fiscal year ending 31 March 2000.
Numerous correspondences between respondent and the Group Supervisor of the BIR Large Taxpayers
Service, the revenue officers examining its accounting records, and the Chief of LT Audit & Investigation
Division I of the BIR ensued, particularly as to the submission of various supporting documents and
presentation of records.
On 16 July 2003, respondent received a “Summary of Creditable Withholding Tax at Source Certified by
RAD Fiscal Year Ending March 31, 2000,” together with a computation labelled “Compromise Penalties for
Late Filing of Return.” Likewise, on same date, respondent received a letter dated 8 July 2003 issued by
the Chief of LT Audit & Investigation Division I, informing the former that the results of the investigation of
its claim for refund on creditable withholding tax for fiscal year ending 31 March 2000 had already been
submitted, and that an informal conference was set on 17 July 2003 to be held on the latter’s office.
On 11 August 2003, respondent received from the same revenue officers a computation of their initial
deficiency MCIT assessment in the amount of P537,477,867.64. Consequently, respondent received on 20
October 2003 a Preliminary Assessment Notice and Details of Assessment issued by the Large Taxpayers
Service dated 22 September 2003, assessing respondent deficiency MCIT including interest, in the
aggregate amount of P315,566,368.68. A written protest to said preliminary assessment was filed by
respondent on 3 November 2003.
Thereafter, on 16 December 2003, respondent received a Formal Letter of Demand and Details of
Assessment dated 1
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Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
December 2003 from the Large Taxpayers Service demanding the payment of the total amount of
P326,778,723.35, inclusive of interest, as contained in Assessment Notice No. INC-FY-99-2000-000085.
In response thereto, respondent filed its formal written protest on 13 January 2004 reiterating the following
defenses: (1) that it is exempt from, or is not subject to, the 2% MCIT by virtue of its charter, Presidential
Decree No. (PD) 1590;3 and (2) that the three-year period allowed by law for the BIR to assess deficiency
internal revenue taxes for the taxable year ending 31 March 2000 had already lapsed on 15 July 2003.
Since no final action has been taken by petitioner on respondent’s formal written protest, respondent filed
a Petition for Review before the Second Division of the CTA on 4 August 2004 docketed as CTA Case No.
7029.
The Ruling of the CTA Second Division
In a Decision dated 22 August 2006,4 the CTA Second Division granted respondent’s petition and
accordingly ordered for the cancellation and withdrawal of Assessment Notice No. INC-FY-99-2000-000085
and Formal Letter of Demand for the payment of deficiency MCIT in the amount of P326,778,723.35,
covering the fiscal year ending 31 March 2000, issued against respondent.
The CTA Second Division made the following factual and legal findings, to wit:
(a) Section 13 of PD 1590 acquiring and limiting the extent of the tax liability of respondent under its
_______________
3 An Act Granting a New Franchise to Philippine Airlines, Inc. to Establish, Operate, and Maintain Air-
Transport Services in the Philippines and Other Countries, which took effect on 11 June 1978.
4 Rollo, pp. 69-90; Penned by Associate Justice Olga Palanca-Enriquez with Associate Justices Juanito C.
Castañeda, Jr. and Erlinda P. Uy, concurring.
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Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
franchise is coached in a clear, plain and unambiguous manner, and needs no further interpretation or
construction;
(b) Section 13 clearly provides that respondent is liable only for either the basic corporate income tax
based on its annual net taxable income, or the 2% franchise tax based on gross revenue, whichever is
lower;
(c) Respondent-grantee must only choose between the two alternatives mentioned in Section 13 in the
payment of its tax liability to the government, and its choice must be that which will result in a lower tax
liability;
(d) Since the income tax return of respondent reflected a zero taxable income for the fiscal year ending
31 March 2000, obviously being lower than the 2% franchise tax, its choice of the former is definitely a
better alternative as basis for its tax liability to the government;5
(e) The basic corporate income tax mentioned in Section 13 of PD 1590 does not refer to the MCIT under
Section 27(E) of the NIRC of 1997, as amended, but particularly to the applicable rate of 32% income tax
under Section 27(A) of the same Code, on the taxable income of domestic corporations;
(f) The MCIT is regarded to belong to “other taxes” as it was not included in the choices provided by the
franchise. To hold otherwise would be to give another option to respondent which is evidently not within the
ambit of PD 1590;6
(g) The “in lieu of all other taxes” clause under Section 13 of respondent’s legislative franchise exempts
it from all taxes necessary in the conduct of its busi-
_______________
5 Id., at pp. 81-83.
6 Id., at p. 88.
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Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
ness covered by the franchise, except the tax on its real property for which respondent is expressly made
payable;7 and
(h) The rationale or purpose for the exemption from all other taxes except the income tax and real property
tax granted to respondent upon the payment of the basic corporate income tax or the 2% franchise tax is
that such tax exemption is part of inducement for the acceptance of the franchise and the rendition of public
service by the grantee.8
Simply put, it pronounced that the only qualification provided for in the law is the option given to respondent
to choose between the taxes which will yield the lesser liability. Thus, if as a result of the exercise of the
option, the respondent ends up without any tax liability, it should not be held liable for any other tax, such
as the MCIT, except for real property tax.9
On 30 January 2007, the CTA Second Division denied petitioner’s Motion for Reconsideration for lack of
merit.10
Aggrieved, petitioner appealed to the CTA En Banc by filing a Petition for Review pursuant to Section 18
of Repub-lic Act (RA) No. 9282 (should be RA No. 1125, as amended by RA No. 9282)11 on 1 March 2007,
docketed as CTA EB No. 271.12
_______________
7 Id., at p. 84.
8 Id., at p. 86.
9 Id., at pp. 86-87.
10 Id., at pp. 111-113.
11 RA No. 1125, otherwise known as “An Act Creating the Court of Tax Appeals,” as amended by RA No.
9282, also known as “An Act Expanding the Jurisdiction of the Court of Tax Appeals (CTA), Elevating its
Rank to the Level of a Collegiate Court with Special Jurisdiction and Enlarging its Membership, Amending
for the Purpose Certain Sections of Republic Act No. 1125, As Amended, Otherwise Known As the Law
Creating the Court of Tax Appeals, and for Other Purposes”, which took effect on 23 April 2004.
12 Rollo, pp. 114-140.
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The Ruling of the CTA En Banc
The CTA En Banc affirmed both the aforesaid Decision and Resolution rendered by the CTA Second
Division in CTA Case No. 7029, ruling that under Section 13 of PD 1590, respondent, as consideration for
the franchise, is indeed granted the privilege to choose between two options in the payment of its tax liability
to the government. Naturally, its choice will be that which will result in a lower tax liability since such choice
is “in lieu of all other taxes” imposed by all government entities in the country.13
The only exception is the real property tax. The appellate court pointed out that even if respondent opted
to be covered by the Income Tax provisions of the NIRC, it does not follow that it is covered by the MCIT
provisions of the same Code. There is nothing in PD 1590 which obliges the respondent to pay other taxes,
much less the MCIT, in case it suffers a net operating loss. Otherwise, it would negate the tax relief granted
under Section 13 of its franchise and would render it useless. The tax relief allows respondent to carry over
as a deduction from taxable income any net loss incurred in any year up to five years following the year of
such loss.14
Likewise, it elucidated that the MCIT is not the basic corporate income tax referred to in Section 13 of PD
1590. There is a distinction between the MCIT and the basic corporate income tax. The MCIT under Section
27(E)(1) of the NIRC of 1997, as amended, is imposed upon gross income; while the basic corporate
income tax refers to the 32% income tax on the taxable income of domestic corporations under Section
27(A) of the same Code. In other words, the court a quo ruled that since the MCIT is imposed upon gross
income, it cannot be made to apply to respondent by virtue of the express provi-
_______________
13 Id., at p. 52; CTA En Banc Decision dated 19 July 2007.
14 Id., at pp. 54-55 citing Commissioner of Internal Revenue v. Philippine Airlines, Inc., 535 Phil. 95; 504
SCRA 90 (2006).
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sion in its franchise that its basic corporate income tax shall be based on its annual net taxable income.
Hence, it is in this sense that the MCIT qualifies as “other taxes” from which the respondent had been
granted tax exemption by its franchise.15
Moreover, the provision on MCIT, Section 27(E) of the NIRC of 1997, as amended, did not repeal
respondent’s franchise considering that it is a general law which cannot impliedly repeal, alter, or amend
PD 1590, being a special law. Neither can Revenue Memorandum Circular (RMC) No. 66-2003 amend
respondent’s franchise as it is merely an administrative issuance.
Lastly, there is no provision in RA No. 842416 which provides and specifies that the MCIT shall be in
addition to the taxes for which respondent is liable. To rule otherwise would be violative of Section 24 of
PD 1590 which states that respondent’s franchise may only be modified, amended, or repealed expressly
by a special law or decree that shall specifically modify, amend or repeal the franchise or any section or
provision thereof. Therefore, in the absence of a law expressly repealing PD 1590 at the time the subject
assessment was issued and for the period covered by the assessment, respondent’s tax exemption
privilege under the “in lieu of all other taxes” clause of Section 13 thereof must be applied.
Upon denial of petitioner’s Motion for Reconsideration of the 19 July 2007 Decision of the CTA En Banc, it
filed this Petition for Review on Certiorari before this Court seeking the reversal of the aforementioned
Decision and the 23 August 2007 Resolution17 rendered in CTA EB No. 271.
_______________
15 Rollo, pp. 55-56.
16 The Tax Reform Act of 1997, which took effect on 1 January 1998.
17 Rollo, pp. 64-67.
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The Issues
The issues submitted before this Court for consideration are as follows:
(1) Whether or not the CTA En Banc erred in holding that the MCIT is properly categorized as “other
taxes” pursuant to respondent’s charter; and
(2) Whether or not the CTA En Banc erred in ruling that respondent is not liable for the 2% MCIT deficiency
for the fiscal year ending 31 March 2000.18
The abovementioned issues may be consolidated and restated as follows: whether or not the CTA En Banc
erred when it affirmed the cancellation of Assessment Notice No. INC-FY-99-2000-000085 and Formal
Letter of Demand issued by petitioner against respondent for the payment of deficiency MCIT in the amount
of P326,778,723.35, covering the fiscal year ending 31 March 2000.
In support thereof, petitioner submits the following arguments: (a) respondent clearly opted to be covered
by the income tax provision of the NIRC of 1997, as amended; hence, it is covered by the MCIT provision
of the same Code and liable to pay the same; (b) the MCIT does not belong to the category of “other taxes”
which may enable respondent to avail of the “in lieu of all other taxes” clause under Section 13 of PD 1590
because it is a category of an income tax pursuant to Section 27(E)(1) of the NIRC of 1997, as amended;
(c) the MCIT provision of the NIRC of 1997, as amended, is not an amendment of respondent’s charter, but
an amendment of the same Code. Hence, respondent’s obligation to pay the MCIT is not the result of an
implied amendment of PD 1590, but rather, the consequence of respondent’s option of paying income tax
rather than franchise tax; (d) respondent is not only given the
_______________
18 Id., at p. 19.
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privilege to choose between what will give it the benefit of a lower tax, but also the responsibility of paying
its share of the tax burden. Otherwise stated, it is the legislative intent to give respondent a privilege in the
form of an option in paying its taxes which would result in paying a lower tax liability, but not in dispensing
the sharing of a tax burden to which every taxpayer is obligated to bear; and (e) a claim for exemption from
taxation is never presumed; thus, respondent is liable for the deficiency MCIT.
Respondent, in its Comment thereto, counters among others, that there is nothing in PD 1590 which obliges
respondent to pay other taxes, much less the MCIT, in case it suffers a net operating loss. Since the MCIT
is not the basic corporate income tax, nor the 2% franchise tax, nor the real property tax mentioned by
Section 13 thereof, then it is but logical to conclude that the MCIT belongs to the category of “other taxes”
for which respondent is not liable.
Our Ruling
Respondent’s exemption from the MCIT is already a settled matter.
Section 27 of the NIRC of 1997, as amended, provides as follows:
SEC. 27. Rates of Income Tax on Domestic Corporations.—
(A) In General.—Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is
hereby imposed upon the taxable income derived during each taxable year from all sources within and
without the Philippines by every corporation, as defined in Section 22(B) of this Code and taxable under
this Title as a corporation, organized in, or existing under the law of the Philippines: Provided, That effective
January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the
rate shall be thirty-three percent (33%); and effective
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January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%).
xxxx
(E) Minimum Corporate Income Tax on Domestic Corporations.—
(1) Imposition of Tax—A minimum corporate income tax of two percent (2%) of the gross income as of
the end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title,
beginning on the fourth taxable year immediately following the year in which such corporation commenced
its business operations, when the minimum income tax is greater than the tax computed under Subsection
(A) of this Section for the taxable year. (Emphasis supplied)
Based on the foregoing, a domestic corporation must pay whichever is the higher of: (1) the income tax
under Section 27(A) of the NIRC of 1997, as amended, computed by applying the tax rate therein to the
taxable income of the corporation; or (2) the MCIT under Section 27(E), also of the same Code, equivalent
to 2% of the gross income of the corporation. The Court would like to underscore that although this may be
the general rule in determining the income tax due from a domestic corporation under the provisions of the
NIRC of 1997, as amended, such rule can only be applied to respondent only as to the extent allowed by
the provisions of its franchise.
Relevant thereto, PD 1590, the franchise of respondent, contains the following pertinent provisions
governing its taxation:
Section 13. In consideration of the franchise and rights hereby granted, the grantee shall pay to the
Philippine Government during the life of this franchise whichever of subsections (a) and (b) hereunder will
result in a lower tax:
(a) The basic corporate income tax based on the grantee’s annual net taxable income computed in
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accordance with the provisions of the National Internal Revenue Code; or
(b) A franchise tax of two per cent (2%) of the gross revenues derived by the grantee from all sources,
without distinction as to transport or nontransport operations; provided, that with respect to international air-
transport service, only the gross passenger, mail, and freight revenues from its outgoing flights shall be
subject to this tax.
The tax paid by the grantee under either of the above alternatives shall be in lieu of all other taxes, duties,
royalties, registration, license, and other fees and charges of any kind, nature, or description, imposed,
levied, established, assessed, or collected by any municipal, city, provincial, or national authority or
government agency, now or in the future, including but not limited to the following:
xxxx
The grantee, shall, however, pay the tax on its real property in conformity with existing law.
For purposes of computing the basic corporate income tax as provided herein, the grantee is authorized:
(a) To depreciate its assets to the extent of not more than twice as fast the normal rate of depreciation;
and
(b) To carry over as a deduction from taxable income any net loss incurred in any year up to five years
following the year of such loss.
Section 14. The grantee shall pay either the franchise tax or the basic corporate income tax on quarterly
basis to the Commissioner of Internal Revenue. Within sixty (60) days after the end of each of the first three
quarters of the taxable calendar or fiscal year, the quarterly franchise or income-tax return shall be filed and
payment of either the franchise or income tax shall be made by the grantee.
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A final or an adjustment return covering the operation of the grantee for the preceding calendar or fiscal
year shall be filed on or before the fifteenth day of the fourth month following the close of the calendar or
fiscal year. The amount of the fiscal franchise or income tax to be paid by the grantee shall be the balance
of the total franchise or income tax shown in the final or adjustment return after deducting therefrom the
total quarterly franchise or income taxes already paid during the preceding first three quarters of the same
taxable year.
Any excess of the total quarterly payments over the actual annual franchise of income tax due as shown in
the final or adjustment franchise or income-tax return shall either be refunded to the grantee or credited
against the grantee’s quarterly franchise or income-tax liability for the succeeding taxable year or years at
the option of the grantee.
The term “gross revenue” is herein defined as the total gross income earned by the grantee; (a) transport,
nontransport, and other services; (b) earnings realized from investments in money-market placements,
bank deposits, investments in shares of stock and other securities, and other investments; (c) total gains
net of total losses realized from the disposition of assets and foreign-exchange transactions; and (d) gross
income from other sources. (Emphasis supplied)
From the foregoing provisions, during the lifetime of the franchise of respondent, its taxation shall be strictly
governed by two fundamental rules, to wit: (1) respondent shall pay the Government either the basic
corporate income tax or franchise tax, whichever is lower; and (2) the tax paid by respondent, under either
of these alternatives, shall be in lieu of all other taxes, duties, royalties, registration, license, and other fees
and charges, except only real property tax.
Parenthetically, the basic corporate income tax of respondent shall be based on its annual net taxable
income, computed in accordance with the NIRC of 1997, as amended. PD 1590 also explicitly authorizes
respondent, in the computation
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of its basic corporate income tax, to: (1) depreciate its assets twice as fast the normal rate of depreciation;19
and (2) carry over as a deduction from taxable income any net loss incurred in any year up to five years
following the year of such loss.20
The franchise tax, on the other hand, shall be 2% of the gross revenues derived by respondent from all
sources, whether transport or nontransport operations. However, with respect to international air-transport
service, the franchise tax shall only be imposed on the gross passenger, mail, and freight revenues of
respondent from its outgoing flights.21
Accordingly, considering the foregoing precepts, this Court had the opportunity to finally settle this matter
and categorically enunciated in Commissioner of Internal Revenue v. Philippine Airlines, Inc.,22 that
respondent cannot be subjected to MCIT for the following reasons:
First, Section 13(a) of [PD] 1590 refers to “basic corporate income tax.” In Commissioner of Internal
Revenue v. Philippine Airlines, Inc.,23 the Court already settled that the “basic corporate income tax,” under
Section 13(a) of [PD] 1590, relates to the general rate of 35% (reduced to 32% by the year 2000) as
stipulated in Section 27(A) of the NIRC of 1997.
_______________
19 Section 34(F) of the NIRC of 1997, as amended.—As a general rule, there shall be allowed as a
depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable
allowance obsolescence) of property used in the trade or business.
20 In general, losses shall be deducted from gross income in the same taxable year said losses were
incurred. The recognized exception under Section 39(D) of the NIRC of 1997, as amended, allowing net
capital loss carryover, may only be availed of by a taxpayer “other than a corporation.”
21 Commissioner of Internal Revenue v. Philippine Airlines, Inc., G.R. No. 180066, 7 July 2009, 592 SCRA
237, 250.
22 Id., at pp. 252-268.
23 535 Phil. 95; 504 SCRA 90 (2006).
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Section 13(a) of [PD] 1590 requires that the basic corporate income tax be computed in accordance with
the NIRC. This means that PAL shall compute its basic corporate income tax using the rate and basis
prescribed by the NIRC of 1997 for the said tax. There is nothing in Section 13(a) of [PD] 1590 to support
the contention of the CIR that PAL is subject to the entire Title II of the NIRC of 1997, entitled “Tax on
Income.”
Second, Section 13(a) of Presidential Decree No. 1590 further provides that the basic corporate income
tax of PAL shall be based on its annual net taxable income. This is consistent with Section 27(A) of the
NIRC of 1997, which provides that the rate of basic corporate income tax, which is 32% beginning 1 January
2000, shall be imposed on the taxable income of the domestic corporation.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent items of gross income
specified in the said Code, less the deductions and/or personal and additional exemptions, if any,
authorized for such types of income by the same Code or other special laws. The gross income, referred
to in Section 31, is described in Section 32 of the NIRC of 1997 as income from whatever source, including
compensation for services; the conduct of trade or business or the exercise of profession; dealings in
property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partner’s
distributive share in the net income of a general professional partnership.
Pursuant to the NIRC of 1997, the taxable income of a domestic corporation may be arrived at by
subtracting from gross income deductions authorized, not just by the NIRC of 1997, but also by special
laws. [PD] 1590 may be considered as one of such special laws authorizing PAL, in computing its annual
net taxable income, on which its basic corporate income tax shall be based, to deduct from its gross income
the following: (1) depreciation of assets at twice the normal rate; and (2) net loss carry-over up to five years
following the year of such loss.
304

304
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
In comparison, the 2% MCIT under Section 27(E) of the NIRC of 1997 shall be based on the gross income
of the domestic corporation. The Court notes that gross income, as the basis for MCIT, is given a special
definition under Section 27(E)(4) of the NIRC of 1997, different from the general one under Section 34 of
the same Code.
According to the last paragraph of Section 27(E)(4) of the NIRC of 1997, gross income of a domestic
corporation engaged in the sale of service means gross receipts, less sales returns, allowances, discounts
and cost of services. “Cost of services” refers to all direct costs and expenses necessarily incurred to
provide the services required by the customers and clients including (a) salaries and employee benefits of
personnel, consultants, and specialists directly rendering the service; and (b) cost of facilities directly
utilized in providing the service, such as depreciation or rental of equipment used and cost of supplies.
Noticeably, inclusions in and exclusions/deduc-tions from gross income for MCIT purposes are limited to
those directly arising from the conduct of the taxpayer’s business. It is, thus, more limited than the gross
income used in the computation of basic corporate income tax.
In light of the foregoing, there is an apparent distinction under the NIRC of 1997 between taxable income,
which is the basis for basic corporate income tax under Section 27(A); and gross income, which is the basis
for the MCIT under Section 27(E). The two terms have their respective technical meanings, and cannot be
used interchangeably. The same reasons prevent this Court from declaring that the basic corporate income
tax, for which PAL is liable under Section 13(a) of [PD] 1590, also covers MCIT under Section 27(E) of the
NIRC of 1997, since the basis for the first is the annual net taxable income, while the basis for the second
is gross income.
Third, even if the basic corporate income tax and the MCIT are both income taxes under Section 27 of the
NIRC of 1997, and one is paid in place of the other, the two are distinct and separate taxes.
305

VOL. 706, SEPTEMBER 25, 2013


305
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
The Court again cites Commissioner of Internal Revenue v. Philippine Airlines, Inc.,24 wherein it held that
income tax on the passive income of a domestic corporation, under Section 27(D) of the NIRC of 1997, is
different from the basic corporate income tax on the taxable income of a domestic corporation, imposed by
Section 27(A), also of the NIRC of 1997. Section 13 of [PD] 1590 gives PAL the option to pay basic
corporate income tax or franchise tax, whichever is lower; and the tax so paid shall be in lieu of all other
taxes, except real property tax. The income tax on the passive income of PAL falls within the category of
“all other taxes” from which PAL is exempted, and which, if already collected, should be refunded to PAL.
The Court herein treats MCIT in much the same way. Although both are income taxes, the MCIT is different
from the basic corporate income tax, not just in the rates, but also in the bases for their computation. Not
being covered by Section 13(a) of [PD] 1590, which makes PAL liable only for basic corporate income tax,
then MCIT is included in “all other taxes” from which PAL is exempted.
That, under general circumstances, the MCIT is paid in place of the basic corporate income tax, when the
former is higher than the latter, does not mean that these two income taxes are one and the same. The
said taxes are merely paid in the alternative, giving the Government the opportunity to collect the higher
amount between the two. The situation is not much different from Section 13 of [PD] 1590, which reversely
allows PAL to pay, whichever is lower of the basic corporate income tax or the franchise tax. It does not
make the basic corporate income tax indistinguishable from the franchise tax.
Given the fundamental differences between the basic corporate income tax and the MCIT, presented in the
preceding discussion, it is not baseless for this Court to rule that, pursuant to the
_______________
24 Id.
306

306
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
franchise of PAL, said corporation is subject to the first tax, yet exempted from the second.
Fourth, the evident intent of Section 13 of [PD] 1520 (sic) is to extend to PAL tax concessions not ordinarily
available to other domestic corporations. Section 13 of [PD] 1520 (sic) permits PAL to pay whichever is
lower of the basic corporate income tax or the franchise tax; and the tax so paid shall be in lieu of all other
taxes, except only real property tax. Hence, under its franchise, PAL is to pay the least amount of tax
possible.
Section 13 of [PD] 1520 (sic) is not unusual. A public utility is granted special tax treatment (including tax
exceptions/exemptions) under its franchise, as an inducement for the acceptance of the franchise and the
rendition of public service by the said public utility. In this case, in addition to being a public utility providing
air-transport service, PAL is also the official flag carrier of the country.
The imposition of MCIT on PAL, as the CIR insists, would result in a situation that contravenes the objective
of Section 13 of [PD] 1590. In effect, PAL would not just have two, but three tax alternatives, namely, the
basic corporate income tax, MCIT, or franchise tax. More troublesome is the fact that, as between the basic
corporate income tax and the MCIT, PAL shall be made to pay whichever is higher, irrefragably, in violation
of the avowed intention of Section 13 of [PD] 1590 to make PAL pay for the lower amount of tax.
Fifth, the CIR posits that PAL may not invoke in the instant case the “in lieu of all other taxes” clause in
Section 13 of [PD] No. 1520 (sic), if it did not pay anything at all as basic corporate income tax or franchise
tax. As a result, PAL should be made liable for “other taxes” such as MCIT. This line of reasoning has been
dubbed as the Substitution Theory, and this is not the first time the CIR raised the same. The Court already
re-
307

VOL. 706, SEPTEMBER 25, 2013


307
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
jected the Substitution Theory in Commissioner of Internal Revenue v. Philippine Airlines, Inc.,25 to wit:
“Substitution Theory”
of the CIR Untenable
A careful reading of Section 13 rebuts the argument of the CIR that the “in lieu of all other taxes” proviso is
a mere incentive that applies only when PAL actually pays something. It is clear that PD 1590 intended to
give respondent the option to avail itself of Subsection (a) or (b) as consideration for its franchise. Either
option excludes the payment of other taxes and dues imposed or collected by the national or the local
government. PAL has the option to choose the alternative that results in lower taxes. It is not the fact of tax
payment that exempts it, but the exercise of its option.
Under Subsection (a), the basis for the tax rate is respondent’s annual net taxable income, which (as earlier
discussed) is computed by subtracting allowable deductions and exemptions from gross income. By basing
the tax rate on the annual net taxable income, PD 1590 necessarily recognized the situation in which taxable
income may result in a negative amount and thus translate into a zero tax liability.
Notably, PAL was owned and operated by the government at the time the franchise was last amended. It
can reasonably be contemplated that PD 1590 sought to assist the finances of the government corporation
in the form of lower taxes. When respondent operates at a loss (as in the instant case), no taxes are due;
in this instances, it has a lower tax liability than that provided by Subsection (b).
_______________
25 Id.
308

308
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
The fallacy of the CIR’s argument is evident from the fact that the payment of a measly sum of one peso
would suffice to exempt PAL from other taxes, whereas a zero liability arising from its losses would not.
There is no substantial distinction between a zero tax and a one-peso tax liability. (Emphasis theirs)
Based on the same ratiocination, the Court finds the Substitution Theory unacceptable in the present
Petition.
The CIR alludes as well to Republic Act No. 9337, for reasons similar to those behind the Substitution
Theory. Section 22 of Republic Act No. 9337, more popularly known as the Expanded Value Added Tax
(E-VAT) Law, abolished the franchise tax imposed by the charters of particularly identified public utilities,
including [PD] 1590 of PAL. PAL may no longer exercise its options or alternatives under Section 13 of [PD]
1590, and is now liable for both corporate income tax and the 12% VAT on its sale of services. The CIR
alleges that Republic Act No. 9337 reveals the intention of the Legislature to make PAL share the tax
burden of other domestic corporations.
The CIR seems to lose sight of the fact that the Petition at bar involves the liability of PAL for MCIT for the
fiscal year ending 31 March 2001. Republic Act No. 9337, which took effect on 1 July 2005, cannot be
applied retroactively and any amendment introduced by said statute affecting the taxation of PAL is
immaterial in the present case.
And sixth, [PD] 1590 explicitly allows PAL, in computing its basic corporate income tax, to carry over as
deduction any net loss incurred in any year, up to five years following the year of such loss. Therefore, [PD]
1590 does not only consider the possibility that, at the end of a taxable period, PAL shall end up with zero
annual net taxable income (when its deductions exactly equal its gross income), as what happened in the
case at bar, but
309

VOL. 706, SEPTEMBER 25, 2013


309
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
also the likelihood that PAL shall incur net loss (when its deductions exceed its gross income). If PAL is
subjected to MCIT, the provision in [PD] 1590 on net loss carry-over will be rendered nugatory. Net loss
carry-over is material only in computing the annual net taxable income to be used as basis for the basic
corporate income tax of PAL; but PAL will never be able to avail itself of the basic corporate income tax
option when it is in a net loss position, because it will always then be compelled to pay the necessarily
higher MCIT.
Consequently, the insistence of the CIR to subject PAL to MCIT cannot be done without contravening [PD]
1520 (sic).
Between [PD] 1520 (sic), on one hand, which is a special law specifically governing the franchise of PAL,
issued on 11 June 1978; and the NIRC of 1997, on the other, which is a general law on national internal
revenue taxes, that took effect on 1 January 1998, the former prevails. The rule is that on a specific matter,
the special law shall prevail over the general law, which shall be resorted to only to supply deficiencies in
the former. In addition, where there are two statutes, the earlier special and the later general — the terms
of the general broad enough to include the matter provided for in the special — the fact that one is special
and the other is general creates a presumption that the special is to be considered as remaining an
exception to the general, one as a general law of the land, the other as the law of a particular case. It is a
canon of statutory construction that a later statute, general in its terms and not expressly repealing a prior
special statute, will ordinarily not affect the special provisions of such earlier statute.
xxxx
The MCIT was a new tax introduced by Republic Act No. 8424. Under the doctrine of strict interpretation,
the burden is upon the CIR to primarily prove that the new MCIT provisions of the NIRC of 1997, clearly,
expressly, and unambiguously extend and apply to PAL,
310

310
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
despite the latter’s existing tax exemption. To do this, the CIR must convince the Court that the MCIT is a
basic corporate income tax, and is not covered by the “in lieu of all other taxes” clause of [PD] 1590. Since
the CIR failed in this regard, the Court is left with no choice but to consider the MCIT as one of “all other
taxes,” from which PAL is exempt under the explicit provisions of its charter. (Emphasis supplied)
Based on the foregoing pronouncements, it is clear that respondent is exempt from the MCIT imposed
under Section 27(E) of the NIRC of 1997, as amended. Thus, respondent cannot be held liable for the
assessed deficiency MCIT of P326,778,723.35 for fiscal year ending 31 March 2000.
More importantly, as to petitioner’s contention that respondent needs to actually pay a certain amount as
basic corporate income tax or franchise tax before it can enjoy the tax exemption granted to it since it should
retain the responsibility of paying its share of the tax burden, this Court has categorically ruled in the above-
cited cases that it is not the fact of tax payment that exempts it, but the exercise of its option.
Notably, in another case involving the same parties,26 the Court further expressed that a strict interpretation
of the word “pay” in Section 13 of PD 1590 would effectively render nugatory the other rights categorically
conferred upon the respondent by its franchise. Hence, there being no qualification to the exercise of its
options under Section 13, then respondent is free to choose basic corporate income tax, even if it would
have zero liability for the same in light of its net loss position for the taxable year.
By way of reiteration, although it appears that respondent is not completely exempt from all forms of taxes
under PD 1590 considering that Section 13 thereof requires it to pay,
_______________
26 See Commissioner of Internal Revenue v. Philippine Airlines, Inc., G.R. No. 180043, 14 July 2009, 592
SCRA 730, 740-741.
311

VOL. 706, SEPTEMBER 25, 2013


311
Commissioner of Internal Revenue vs. Philippine Airlines, Inc. (PAL)
either the lower amount of the basic corporate income tax or franchise tax (which are both direct taxes), at
its option, mere exercise of such option already relieves respondent of liability for all other taxes and/or
duties, whether direct or indirect taxes. This is an expression of the same thought in Our ruling that, to
repeat, it is not the fact of tax payment that exempts it, but the exercise of its option.
All told, the CTA En Banc was correct in dismissing the petition in CTA EB No. 271, and affirming the CTA
Second Division’s Decision and Resolution dated 22 August 2006 and 30 January 2007, respectively, in
CTA Case No. 7029.
WHEREFORE, the petition is DENIED for lack of merit. No costs.
SO ORDERED.
Carpio (Chairperson), Del Castillo, Perlas-Bernabe and Leonen,** JJ., concur.
Petition denied.
Notes.―A franchise tax is a tax on the privilege of transacting business in the state and exercising corporate
franchises granted by the state. (City of Iriga vs. Camarines Sur III Electric Cooperative, Inc. (CASURECO
III), 680 SCRA 236 [2012])
The Local Government Code withdrew tax exemption privileges previously given to natural or juridical
persons, and granted local government units the power to impose franchise tax. (Cagayan Electric Power
and Light Co., Inc. vs. City of Cagayan de Oro, 685 SCRA 609 [2012])
G.R. No. 170257. September 7, 2011.*
RIZAL COMMERCIAL BANKING CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL
REVENUE, respondent.
Estoppel; A party is precluded from denying his own acts, admissions or representations to the prejudice
of the other party in order to prevent fraud and falsehood.—Under Article 1431 of the Civil Code, the doctrine
of estoppel is anchored on the rule that “an admission or representation is rendered conclusive upon the
person making it, and cannot be denied or disproved as against the person relying thereon.” A party is
precluded from denying his own acts, admissions or representations to the prejudice of the other party in
order to prevent fraud and falsehood.
Taxation; Withholding Tax System; The withholding agent is liable only insofar as he failed to perform his
duty to withhold the tax and remit the same to the government—the liability for the tax, however, remains
with the taxpayer because the gain was realized and received by him; The taxpayer shares the
responsibility of making certain that the tax is properly withheld by the withholding agent, so as to avoid any
penalty that may arise from the non-payment of the withholding tax due.—Based on the foregoing, the
liability of the withholding agent is independent from that of the taxpayer. The former cannot be made liable
for the tax due because it is the latter who earned the income subject to withholding tax. The withholding
agent is liable only insofar as he failed to perform his duty to withhold the tax and remit the same to the
government. The liability for the tax, however, remains with the taxpayer because the gain was realized
and received by him. While the payor-borrower can be held accountable for its negligence in performing its
duty to withhold the amount of tax due on the transaction, RCBC, as the taxpayer and the one which earned
income on the transaction, remains liable for the payment of tax as the taxpayer shares the responsibility
of making certain that the tax is properly withheld by the withholding agent, so as to avoid any penalty that
may arise from the non-payment of the withholding tax due. RCBC cannot evade its liability
_______________
* THIRD DIVISION.
71

VOL. 657, SEPTEMBER 7, 2011


71
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
for FCDU Onshore Tax by shifting the blame on the payor-borrower as the withholding agent.
Same; Courts; Court of Tax Appeals (CTA); The Court of Tax Appeals (CTA), as a specialized court
dedicated exclusively to the study and resolution of tax problems, has developed an expertise on the subject
of taxation—its decision shall not be lightly set aside on appeal, unless the Supreme Court finds that the
questioned decision is not supported by substantial evidence or there is a showing of abuse or improvident
exercise of authority on the part of the Tax Court.—As a final note, this Court has consistently held that
findings and conclusions of the CTA shall be accorded the highest respect and shall be presumed valid, in
the absence of any clear and convincing proof to the contrary. The CTA, as a specialized court dedicated
exclusively to the study and resolution of tax problems, has developed an expertise on the subject of
taxation. As such, its decisions shall not be lightly set aside on appeal, unless this Court finds that the
questioned decision is not supported by substantial evidence or there is a showing of abuse or improvident
exercise of authority on the part of the Tax Court.
PETITION for review on certiorari of the decision and resolution of the Court of Tax Appeals.
The facts are stated in the opinion of the Court.
Lapuz-Ureta, Ramos, Arches, Cruz & Manlangit Law Offices for petitioner.
Office of the Solicitor General for respondent.
MENDOZA, J.:
This is a petition for review on certiorari under Rule 45 seeking to set aside the July 27, 2005 Decision1
and October
_______________
1 Penned by Associate Justice Olga Palanca-Enriquez and concurred in by Presiding Justice Ernesto D.
Acosta and Associate Justices Juanito C. Castañeda, Jr., Lovell R. Bautista, Erlinda P. Uy and Caesar A.
Casanova; Rollo, pp. 44-66.
72

72
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
26, 2005 Resolution2 of the Court of Tax Appeals En Banc (CTA-En Banc) in C.T.A. E.B. No. 83 entitled
“Rizal Commercial Banking Corporation v. Commissioner of Internal Revenue.”
The Facts

Petitioner Rizal Commercial Banking Corporation (RCBC) is a corporation engaged in general banking
operations. It seasonably filed its Corporation Annual Income Tax Returns for Foreign Currency Deposit
Unit for the calendar years 1994 and 1995.3
On August 15, 1996, RCBC received Letter of Authority No. 133959 issued by then Commissioner of
Internal Revenue (CIR) Liwayway Vinzons-Chato, authorizing a special audit team to examine the books
of accounts and other accounting records for all internal revenue taxes from January 1, 1994 to December
31, 1995.4
On January 23, 1997, RCBC executed two Waivers of the Defense of Prescription Under the Statute of
Limitations of the National Internal Revenue Code covering the internal revenue taxes due for the years
1994 and 1995, effectively extending the period of the Bureau of Internal Revenue (BIR) to assess up to
December 31, 2000.5
Subsequently, on January 27, 2000, RCBC received a Formal Letter of Demand together with Assessment
Notices from the BIR for the following deficiency tax assessments:6
_______________
2 Id., at pp. 67-68.
3 Id., at pp. 69-70.
4 Id.
5 Id.
6 Id., at pp. 70-71.
73

VOL. 657, SEPTEMBER 7, 2011


73
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
Particulars Basic Tax Interest Compromise Penalties Total
Deficiency Inco-
me Tax

1995 (ST-INC-95-0199-2000) P252,150,988.01 P191,496,585.96 P 25,000.00


P443,672,573.97
1994 (ST-INC-94-0200-2000) 216,478,397.90 207,819,261.99 25,000.00 424,322,659.89
Deficiency Gross
Receipts Tax

1995 (ST-GRT-95-0201-2000) 13,697,083.68 12,428,696.21 2,819,745.52 28,945,525.41


1994 (ST-GRT-94-0202-2000) 2,488,462.38 2,755,716.42 25,000.00 5,269,178.80
Deficiency
Final Withhol-
ding Tax

1995 (ST-EWT-95-0203-2000) 64,365,610.12 58,757,866.78 25,000.00 123,148,477.15


1994 (ST-EWT-94-0204-2000) 53,058,075.25 59,047,096.34 25,000.00 112,130,171.59
Deficiency Final
Tax on FCDU
Onshore Income

1995 (ST-OT-95-0205-2000) 81,508,718.20 61,901,963,.52 25,000.00 143,435,681.72


1994 (ST-OT-94-0206-2000) 34,429,503.10 33,052,322.98 25,000.00 67,506,826.08
Deficiency
Expanded
Withholding Tax

1995 (ST-EWT-95-0207-2000) 5,051,415.22 4,583,640.33 113,000.00 9,748,055.55


1994 (ST-EWT-94-0208-2000) 4,482,740.35 4,067,626.31 78,200.00 8,628,566.66
Deficiency
Documentary
Stamp Tax

1995 (ST-DST1-95-0209-2000) 351,900,539.39 315,804,946.26 250,000.00 667,955,485.65


1995 (ST-DST2-95-0210-2000) 367,207,105.29 331,535,844.68 300,000.00 699,042,949.97
1994 (ST-DST3-94-0211-2000) 460,370,640.05 512,193,460.02 300,000.00 972,864,100.07
1994 (ST-DST4-94-0212-2000) 223,037,675.89 240,050,706.09 300,000.00 463,388,381.98
TOTALS P2,130,226,954.83 P2,035,495,733.89 P4,335,945.52 P4,170,058,634.49
74

74
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
Disagreeing with the said deficiency tax assessment, RCBC filed a protest on February 24, 2000 and later
submitted the relevant documentary evidence to support it. Much later on November 20, 2000, it filed a
petition for review before the CTA, pursuant to Section 228 of the 1997 Tax Code.7
On December 6, 2000, RCBC received another Formal Letter of Demand with Assessment Notices dated
October 20, 2000, following the reinvestigation it requested, which drastically reduced the original amount
of deficiency taxes to the following:8
Particulars Basic Tax Interest Surcharge &/ Compromise Total
Deficiency Income Tax

1995 (INC-95-000003) P374,348.45 P346,656.92 P721,005.37


1994 (INC-94-000002) 1,392,366.28 1,568,605.52 2,960,971.80
Deficiency Gross Receipts Tax
1995 (GRT-95-000004) 2,000,926.96 3,322,589.63 P1,367,222.04 6,690,738.63
1994 (GRT-94-000003) 138,368.61 161,872.32 300,240.93
Deficiency Final Withholding Tax
1995 (FT-95-000005) 362,203.47 351,287.75 713,491.22
1994 (FT-94-000004) 188,746.43 220,807.47 409,553.90
Deficiency Final Tax on FCDU Onshore Income
1995 (OT-95-000006) 81,508,718.20 79,052,291.08 160,561,009.28
1994 (OT-94-000005) 34,429,503.10 40,277,802.26 74,707,305.36
Deficiency Expanded Withholding Tax
1995 (EWT-95-000004) 520,869.72 505,171.80 25,000.00 1,051,041.03
1994 (EWT-94-000003) 297,949.95 348,560.63 25,000.00 671,510.58
Deficiency Documentary Stamp Tax
1995 (DST-95-000006) 599,890.72 149,972.68 749,863.40
_______________
7 Id., at pp. 71-72.
8 Id., at p. 72.
75

VOL. 657, SEPTEMBER 7, 2011


75
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
1995 (DST2-95-000002) 24,953,842.46 6,238,460.62 31,192,303.08
1994 (DST-94-000005) 905,064.74 226,266.18 1,131,330.92
1994 (DST2-94-000001) 17,040,104.84 4,260,026.21 21,300,131.05
TOTALS P164,712,903.44 P126,155,645.38 P12,291,947.73 P303,160,496.55
On the same day, RCBC paid the following deficiency taxes as assessed by the BIR:9
Particulars 1994 1995 Total
Deficiency Income Tax P2,965,549.44 P 722,236.11 P3,687,785.55
Deficiency Gross Receipts Tax 300,695.84 6,701,893.17 7,002,589.01
Deficiency Final Withholding Tax 410,174.44 714,682.02 1,124,856.46
Deficiency Expanded Withholding Tax 672,490.14 1,052,753.48 1,725,243.62
Deficiency Documentary Stamp Tax 1,131,330.92 749,863.40 1,881,194.32
TOTALS P5,480,240.78 P9,941,428.18 P15,421,668.96
RCBC, however, refused to pay the following assessments for deficiency onshore tax and documentary
stamp tax which remained to be the subjects of its petition for review:10
Particulars 1994 1995 Total
Deficiency Final Tax on FCDU Onshore Income
Basic P34,429,503.10 P81,508,718.20 P115,938,221.30
Interest 40,277,802.26 79,052,291.08 119,330,093.34
_______________
9 Id., at p. 73.
10 Id.
76

76
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
Sub Total P74,707,305.36 P160,561,009.28 P235,268,314.64
Deficiency Documentary Stamp Tax
Basic P17,040,104.84 P 24,953,842.46 P 41,993,947.30
Surcharge 4,260,026.21 6,238,460.62 10,498,486.83
Sub Total P21,300,131.05 P 31,192,303.08 P 52,492,434.13
TOTALS P96,007,436.41 P191,753,312.36 P287,760,748.77
RCBC argued that the waivers of the Statute of Limitations which it executed on January 23, 1997 were not
valid because the same were not signed or conformed to by the respondent CIR as required under Section
222(b) of the Tax Code.11 As regards the deficiency FCDU onshore tax, RCBC contended that because
the onshore tax was collected in the form of a final withholding tax, it was the borrower, constituted by law
as the withholding agent, that was primarily liable for the remittance of the said tax.12
On December 15, 2004, the First Division of the Court of Tax Appeals (CTA-First Division) promulgated its
Decision13 which partially granted the petition for review. It considered as closed and terminated the
assessments for deficiency income tax, deficiency gross receipts tax, deficiency final withholding tax,
deficiency expanded withholding tax, and deficiency documentary stamp tax (not an industry issue) for
1994 and 1995.14 It, however, upheld the assessment for deficiency final tax on FCDU onshore income
and deficiency documentary stamp tax for 1994 and 1995 and ordered RCBC to pay the following amounts
plus 20% delinquency tax:15
_______________
11 Id., at p. 100.
12 Id., at p. 104.
13 Id., at pp. 69-87. Penned by Presiding Justice Ernesto D. Acosta and concurred in by Associate Justices
Lovell R. Bautista and Caesar A. Casanova.
14 Id., at p. 86.
15 Id.
77

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77
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
Particulars 1994 1995 Total
Deficiency Final Tax on FCDU Onshore Income
Basic P22,356,324.43 P16,067,952.86 P115,938, 221.30
Interest 26,153,837.08 15,583,713.19 119,330,093.34
Sub Total 48,510,161.51 31,651,666.05 119,330,093.34
Deficiency Documentary Stamp Tax (Industry Issue)
Basic P17,040,104.84 P24,953,842.46 P 41,993,947.30
Surcharge 4,260,026.21 6,238,460.62 10,498,486.83
Sub Total 21,300,131.05 31,192,303.08 52,492,434.13
TOTALS P69,810,292.56 P62,843,969.13 P171,822,527.47
Unsatisfied, RCBC filed its Motion for Reconsideration on January 21, 2005, arguing that: (1) the CTA erred
in its addition of the total amount of deficiency taxes and the correct amount should only be
P132,654,261.69 and not P171,822,527.47; (2) the CTA erred in holding that RCBC was estopped from
questioning the validity of the waivers; (3) it was the payor-borrower as withholding tax agent, and not
RCBC, who was liable to pay the final tax on FCDU, and (4) RCBC’s special savings account was not
subject to documentary stamp tax.16
In its Resolution17 dated April 11, 2005, the CTA-First Division substantially upheld its earlier ruling, except
for its inadvertence in the addition of the total amount of deficiency taxes. As such, it modified its earlier
decision and ordered RCBC to pay the amount of P132,654,261.69 plus 20% delinquency tax.18
_______________
16 Id., at p. 89.
17 Id., at pp. 88-94.
18 Id., at p. 94.
78

78
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
RCBC elevated the case to the CTA-En Banc where it raised the following issues:
I.
Whether or not the right of the respondent to assess deficiency onshore tax and documentary stamp tax
for taxable year 1994 and 1995 had already prescribed when it issued the formal letter of demand and
assessment notices for the said taxable years.
II.
Whether or not petitioner is liable for deficiency onshore tax for taxable year 1994 and 1995.
III.
Whether or not petitioner’s special savings account is subject to documentary stamp tax under then Section
180 of the 1993 Tax Code.19
The CTA-En Banc, in its assailed Decision, denied the petition for lack of merit. It ruled that by receiving,
accepting and paying portions of the reduced assessment, RCBC bound itself to the new assessment,
implying that it recognized the validity of the waivers.20 RCBC could not assail the validity of the waivers
after it had received and accepted certain benefits as a result of the execution of the said waivers.21 As to
the deficiency onshore tax, it held that because the payor-borrower was merely designated by law to
withhold and remit the said tax, it would then follow that the tax should be imposed on RCBC as the payee-
bank.22 Finally, in relation to the assessment of the deficiency documentary stamp tax on petitioner’s
special savings account, it held that petitioner’s special sav-
_______________
19 Id., at pp. 50-51.
20 Id., at p. 55.
21 Id.
22 Id., at p. 59.
79

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Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
ings account was a certificate of deposit and, as such, was subject to documentary stamp tax.23
Hence, this petition.
While awaiting the decision of this Court, RCBC filed its Manifestation dated July 22, 2009, informing the
Court that this petition, relative to the DST deficiency assessment, had been rendered moot and academic
by its payment of the tax deficiencies on Documentary Stamp Tax (DST) on Special Savings Account (SSA)
for taxable years 1994 and 1995 after the BIR approved its applications for tax abatement.24
In its November 17, 2009 Comment to the Manifestation, the CIR pointed out that the only remaining issues
raised in the present petition were those pertaining to RCBC’s deficiency tax on FCDU Onshore Income for
taxable years 1994 and 1995 in the aggregate amount of P80,161,827.56 plus 20% delinquency interest
per annum. The CIR prayed that RCBC be considered to have withdrawn its appeal with respect to the
CTA-En Banc ruling on its DST on SSA deficiency for taxable years 1994 and 1995 and that the questioned
CTA decision regarding RCBC’s deficiency tax on FCDU Onshore Income for the same period be
affirmed.25
The Issues

Thus, only the following issues remain to be resolved by this Court:


Whether petitioner, by paying the other tax assessment covered by the waivers of the statute of limitations,
is rendered estopped from questioning the validity of the said waivers with respect to the assessment of
deficiency onshore tax.26
_______________
23 Id., at p. 65.
24 Id., at pp. 218-220.
25 Id., at pp. 233-235.
26 Id., at p. 15.
80

80
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
and
Whether petitioner, as payee-bank, can be held liable for deficiency onshore tax, which is mandated by law
to be collected at source in the form of a final withholding tax.27
The Court’s Ruling

Petitioner is estopped from


questioning the validity of the waivers
RCBC assails the validity of the waivers of the statute of limitations on the ground that the said waivers
were merely attested to by Sixto Esquivias, then Coordinator for the CIR, and that he failed to indicate
acceptance or agreement of the CIR, as required under Section 223 (b) of the 1977 Tax Code.28 RCBC
further argues that the principle of estoppel cannot be applied against it because its payment of the other
tax assessments does not signify a clear intention on its part to give up its right to question the validity of
the waivers.29
The Court disagrees.
Under Article 1431 of the Civil Code, the doctrine of estoppel is anchored on the rule that “an admission or
representation is rendered conclusive upon the person making it, and cannot be denied or disproved as
against the person relying thereon.” A party is precluded from denying his own acts, admissions or
representations to the prejudice of the other party in order to prevent fraud and falsehood.30
Estoppel is clearly applicable to the case at bench. RCBC, through its partial payment of the revised
assessments issued within the extended period as provided for in the questioned waivers, impliedly
admitted the validity of those waivers. Had
_______________
27 Id.
28 Id., at p. 173.
29 Id., at p. 176.
30 Tolentino, Arturo M. Commentaries and Jurisprudence on the Civil Code of the Philippines, Vol. 4, p.
660.
81
VOL. 657, SEPTEMBER 7, 2011
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Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
petitioner truly believed that the waivers were invalid and that the assessments were issued beyond the
prescriptive period, then it should not have paid the reduced amount of taxes in the revised assessment.
RCBC’s subsequent action effectively belies its insistence that the waivers are invalid. The records show
that on December 6, 2000, upon receipt of the revised assessment, RCBC immediately made payment on
the uncontested taxes. Thus, RCBC is estopped from questioning the validity of the waivers. To hold
otherwise and allow a party to gainsay its own act or deny rights which it had previously recognized would
run counter to the principle of equity which this institution holds dear.31
Liability for Deficiency
Onshore Withholding Tax
RCBC is convinced that it is the payor-borrower, as withholding agent, who is directly liable for the payment
of onshore tax, citing Section 2.57(A) of Revenue Regulations No. 2-98 which states:
(A) Final Withholding Tax.—Under the final withholding tax system the amount of income tax withheld by
the withholding agent is constituted as a full and final payment of the income tax due from the payee on the
said income. The liability for payment of the tax rests primarily on the payor as a withholding agent. Thus,
in case of his failure to withhold the tax or in case of under withholding, the deficiency tax shall be collected
from the payor/withholding agent. The payee is not required to file an income tax return for the particular
income. (Emphasis supplied)
The petitioner is mistaken.
Before any further discussion, it should be pointed out that RCBC erred in citing the abovementioned
Revenue Regulations No. 2-98 because the same governs collection at source on income paid only on or
after January 1, 1998. The defi-
_______________
31 Id.
82

82
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
ciency withholding tax subject of this petition was supposed to have been withheld on income paid during
the taxable years of 1994 and 1995. Hence, Revenue Regulations No. 2-98 obviously does not apply in
this case.
In Chamber of Real Estate and Builders’ Associations, Inc. v. The Executive Secretary,32 the Court has
explained that the purpose of the withholding tax system is three-fold: (1) to provide the taxpayer with a
convenient way of paying his tax liability; (2) to ensure the collection of tax, and (3) to improve the
government’s cashflow. Under the withholding tax system, the payor is the taxpayer upon whom the tax is
imposed, while the withholding agent simply acts as an agent or a collector of the government to ensure
the collection of taxes.33
It is, therefore, indisputable that the withholding agent is merely a tax collector and not a taxpayer, as
elucidated by this Court in the case of Commissioner of Internal Revenue v. Court of Appeals,34 to wit:
In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting
no more than an agent of the government for the collection of the tax in order to ensure its payments; the
payer is the taxpayer—he is the person subject to tax imposed by law; and the payee is the taxing authority.
In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system,
however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent
from the taxpayer, because the income tax is still imposed on and due from the latter. The agent is not
liable for the tax as no wealth flowed into him—he earned no income. The Tax Code only makes the agent
personally liable for the tax arising from the breach of its legal duty to withhold as distinguished from its
duty to pay tax since:
_______________
32 G.R. No. 160756, March 9, 2010, 614 SCRA 605, 632-633.
33 Bank of America NT & SA v. Court of Appeals, G.R. Nos. 103092 and 103106, July 21, 1994, 234 SCRA
302, 310.
34 361 Phil. 103; 301 SCRA 152 (1999).
83

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83
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
“the government’s cause of action against the withholding agent is not for the collection of income tax, but
for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is
imposed on the withholding agent and not upon the taxpayer.”35 (Emphases supplied)
Based on the foregoing, the liability of the withholding agent is independent from that of the taxpayer. The
former cannot be made liable for the tax due because it is the latter who earned the income subject to
withholding tax. The withholding agent is liable only insofar as he failed to perform his duty to withhold the
tax and remit the same to the government. The liability for the tax, however, remains with the taxpayer
because the gain was realized and received by him.
While the payor-borrower can be held accountable for its negligence in performing its duty to withhold the
amount of tax due on the transaction, RCBC, as the taxpayer and the one which earned income on the
transaction, remains liable for the payment of tax as the taxpayer shares the responsibility of making certain
that the tax is properly withheld by the withholding agent, so as to avoid any penalty that may arise from
the non-payment of the withholding tax due.
RCBC cannot evade its liability for FCDU Onshore Tax by shifting the blame on the payor-borrower as the
withholding agent. As such, it is liable for payment of deficiency onshore tax on interest income derived
from foreign currency loans, pursuant to Section 24(e)(3) of the National Internal Revenue Code of 1993:
_______________
35 Commissioner of Internal Revenue v. Court of Appeals, 361 Phil. 103, 117-118; 301 SCRA 152, 170-
171 (1999), citing Commissioner of Internal Revenue v. Malayan Insurance, 129 Phil. 165, 170; 21 SCRA
944, 949 (1967), citing Jai Alai v. Republic, L-17462, May 29, 1967; 1967B PHILD 460.
84

84
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
“Sec. 24. Rates of tax on domestic corporations.
xxxx
(e) Tax on certain incomes derived by domestic corporations
xxxx
(3) Tax on income derived under the Expanded Foreign Currency Deposit System.—Income derived by
a depository bank under the expanded foreign currency deposit system from foreign currency transactions
with nonresidents, offshore banking units in the Philippines, local commercial banks including branches of
foreign banks that may be authorized by the Central Bank to transact business with foreign currency
depository system units and other depository banks under the expanded foreign currency deposit system
shall be exempt from all taxes, except taxable income from such transactions as may be specified by the
Secretary of Finance, upon recommendation of the Monetary Board to be subject to the usual income tax
payable by banks: Provided, That interest income from foreign currency loans granted by such depository
banks under said expanded system to residents (other than offshore banking units in the Philippines or
other depository banks under the expanded system) shall be subject to a 10% tax.” (Emphasis supplied)
As a final note, this Court has consistently held that findings and conclusions of the CTA shall be accorded
the highest respect and shall be presumed valid, in the absence of any clear and convincing proof to the
contrary.36 The CTA, as a specialized court dedicated exclusively to the study and resolution of tax
problems, has developed an expertise on the
_______________
36 Panasonic Communications Imaging Corporation of the Philippines (formerly Matsushita Business
Machine Corporation of the Philippines) v. Commissioner of Internal Revenue, G.R. No. 178090, February
8, 2010, 612 SCRA 28, 38, citing Commissioner of Internal Revenue v. Cebu Toyo Corporation, 491 Phil.
625, 640; 451 SCRA 447, 463 (2005); Commissioner of Internal Revenue v. Court of Appeals, Atlas
Consolidated Mining and Development Corporation, 312 Phil. 337; 242 SCRA 655 (1995), citing Luzon
Stevedoring Corporation v. Court of Tax Appeals, et al., 246 Phil. 666; 163 SCRA 647 (1988).
85
VOL. 657, SEPTEMBER 7, 2011
85
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
subject of taxation.37 As such, its decisions shall not be lightly set aside on appeal, unless this Court finds
that the questioned decision is not supported by substantial evidence or there is a showing of abuse or
improvident exercise of authority on the part of the Tax Court.38
WHEREFORE, the petition is DENIED.
SO ORDERED.
Velasco, Jr. (Chairperson), Peralta, Abad and Villarama, Jr.,** JJ., concur.
Petition denied.
Notes.—When the law itself does not explicitly provide that a refund under RA 1435 may be based on
higher rates which were nonexistent at the time of its enactment, this Court cannot presume otherwise—a
legislative lacuna cannot be filled by judicial fiat. (Aras-Asan Timber Co., Inc. vs. Commissioner of Internal
Revenue, 363 SCRA 332 [2001])
An estoppel may arise from the making of a promise even though without consideration, if it was intended
that the promise should be relied upon and in fact it was relied upon,
_______________
37 Commissioner of Internal Revenue v. Court of Appeals, 363 Phil. 239, 246; 303 SCRA 614, 621 (1999),
citing Commissioner of Internal Revenue v. Wander Philippines, Inc., 243 Phil. 717; 160 SCRA 573 (1988).
38 Toshiba Information Equipment (Phils.), Inc. v. Commissioner of Internal Revenue, G.R. No. 157594,
March 9, 2010, 614 SCRA 526, 561-562, citing Barcelon, Roxas Securities, Inc. (now known as UBP
Securities, Inc.) v. Commissioner of Internal Revenue, G.R. No. 150764, August 7, 2006, 498 SCRA
126,135-136 and Commissioner of Internal Revenue v. Cebu Toyo Corporation, 491 Phil. 625, 640; 451
SCRA 447, 463 (2005).
** Designated as additional member in lieu of Associate Justice Maria Lourdes P. A. Sereno, per Special
Order No. 1076 dated September 6, 2011.
86

86
SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Commissioner of Internal Revenue
and if a refusal to enforce it would be virtually to sanction the perpetration of fraud or would result in other
injustice. (Terminal Facilities and Services Corporation vs. Philippine Ports Authority, 378 SCRA 82 [2002])
No. L-68375. April 15, 1988.*
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. WANDER PHILIPPINES, INC. AND THE
COURT OF TAX APPEALS, respondents.
Taxation; Evidence; Rule that issues not raised in the lower court cannot be raised for the first time on
appeal well settled.—It will be noted, however, that Petitioner’s above-entitled argument is being raised for
the first time in this Court. It was never raised at the administrative level, or at the Court of Tax Appeals. To
allow a litigant to assume a different posture when he comes before the court and challenge the position
he had accepted at the administrative level, would be to sanction a procedure whereby the Court-which is
supposed to review administrative determinations-would not review, but determine and decide for the first
time, a question not raised at the administrative forum. Thus, it is well settled that under the same underlying
principle of prior exhaustion of administrative remedies, on the judicial level, issues not raised in the lower
court cannot be raised for the first time on appeal.
Same; Dividends; Submission that Wander being a withholding agent of the government cannot claim
reimbursement of the alleged over paid taxes is untenable; Wander is the proper entity who should claim
for the refund or credit of overpaid withholding tax on dividends paid or remitted by Glaro.—In any event,
the submission of petitioner that Wander is but a withholding agent of the government and therefore cannot
claim reimbursement of the alleged overpaid taxes, is untenable. It will be recalled, that said corporation is
first and foremost a wholly owned subsidiary of Glaro. The fact that it became a withholding agent of the
government which was not by choice but by compulsion under Section 53 (b) of the Tax Code, cannot by
any stretch of the imagination be considered as an abdication of its responsibility to its mother company.
Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that “the obligation imposed
thereunder upon the withholding agent is compulsory.” It is a device to insure the collection by the Philippine
Government of taxes on incomes, derived from sources in the Philippines, by aliens who are outside the
taxing jurisdiction of this Court (Commissioner of Internal Revenue vs. Malayan Insurance Co., Inc., 21
SCRA 944). In fact, Wander may be assessed for deficiency withholding tax at source, plus penalties
consisting of surcharge and interest (Section 54, NLRC). Therefore, as the
________________

* THlRD DIVISION.
574

574
SUPREME COURT REPORTS ANNOTATED
Comm’r. of InternalRevenue vs, WanderPhilippines, Inc.
Philippine counterpart. Wander is the proper entity who should claim for the refund or credit of overpaid
withholding tax on dividends paid or remitted by Glaro.
Same; Same; Switzerland does not impose any income tax on dividends received by Swiss Corporation
from corporation dominated in foreign countries.—Closely intertwined with the first assignment of error is
the issue of whether or not Switzerland, the foreign country where Glaro is domiciled, grants to Glaro a tax
credit against the tax due it, equivalent to 20%, or the difference between the regular 35% rate and the
preferential 15% rate. The dispute in this issue lies on the fact that Switzerland does not impose any income
tax on dividends received by Swiss corporation from corporations domiciled in foreign countries.
Same; Same; Same; Fact the Switzerland did not impose any tax on the dividends received by Glaro from
the Philippines should be considered as a full satisfaction of the given condition.—While it may be true that
claims for refund are construed strictly against the claimant, nevertheless, the fact that Switzerland did not
impose any tax or the dividends received by Glaro from the Philippines should be considered as a full
satisfaction of the given condition. For, as aptly stated by respondent Court, to deny private respondent the
privilege to withhold only 15% tax provided for under Presidential Decree No. 369, amending Section 24
(b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and definitely will adversely
affect foreign corporations’ interest here and discourage them from investing capital in our country.
PETITION for certiorari to review the decision of the Court of Tax Appeals. Roaquin, J.

The facts are stated in the opinion of the Court.


The Solicitor General for petitioner.
FelieisimQ R. Quiogue and Cirilo P. Noel for respondents,
BIDIN, J.:
This is a petition for review on certiorari of the January 19, 1984 Decision of the Court of Tax Appeals** in
C.T.A. Case No.
________________

** Penned by Associate Judge Constante C. Roaquin and concurred to by Amante Filler, Presiding Judge;
and Alex Z. Reyes, Associate Judge.
575

VOL. 160, APRIL 15, 1988


575
Comm’r. of lnternal Revenue vs. Wander Philippines, Inc.
2884, entitled Wander Philippines, Inc. vs. Commissioner of Internal Revenue, holding that Wander
Philippines, Inc. is entitled to the preferential rate of 15% withholding tax on the dividends remitted to its
foreign parent company, the Glaro S.A. Ltd. of Switzerland, a non-resident foreign corporation.
Herein private respondent, Wander Philippines, Inc. (Wander, for short), is a domestic corporation
organized under Philippine laws. It is wholly-owned subsidiary of the Glaro S.A. Ltd. (Glaro, for short), a
Swiss corporation not engaged in trade or business in the Philippines.
On July 18,1975, Wander filed its withholding tax return for the second quarter ending June 30, 1975 and
remitted to its parent company, Glaro dividends in the amount of P222,000.00, on which 35% withholding
tax thereof in the amount of P77,700.00 was withheld and paid to the Bureau of Internal Revenue.
Again, on July 14, 1976, Wander filed a withholding tax return for the second quarter ending June 30, 1976
on the dividends it remitted to Glaro amounting to P355,200.00, on which 35% tax in the amount of
P124,320.00 was withheld and paid to the Bureau of Internal Revenue.
On July 5,1977, Wander filed with the Appellate Division of the Internal Revenue a claim for refund and/or
tax credit in the amount ofPl 15,400.00, contending that it is liable only to 15% withholding tax in accordance
with Section 24 (b) (1) of the Tax Code, as amended by Presidential Decree Nos. 369 and 778, and not on
the basis of 35% which was withheld and paid to and collected by the government.
Petitioner herein, having failed to act on the above-said claim for refund, on July 15, 1977, Wander filed a
petition with respondent Court of Tax Appeals.
On October 6,1977, petitioner filed his Answer.
On January 19,1984, respondent Court of Tax Appeals rendered a Decision, the decretal portion of which
reads:
“WHEREFORE, respondent is hereby ordered to grant a refund and/or tax credit to petitioner in the amount
ofPll 5,440.00 representing overpaid withholding tax on dividends remitted by it to the Glaro S.A. Ltd. of
Switzerland during the second quarter of the years 1975 and 1976."
576

576
SUPREME COURT REPORTS ANNOTATED
Comm’r. of lnternal Revenue vs. Wander Philippines, Inc.
On March 7, 1984, petitioner filed a Motion for Reconsideration but the same was denied in a Resolution
dated August 13, 1984. Hence, the instant petition.
Petitioner raised two (2) assignment of errors, to wit:
I.

ASSUMING THAT THE TAX REFUND IN THE CASE AT BAR IS ALLOWABLE AT ALL, THE COURT OF
TAX APPEALS ERRED IN HOLDING THAT THE HEREIN RESPONDENT WANDER PHILIPPINES, INC.
IS ENTITLED TO THE SAID REFUND.
II

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT SWITZERLAND, THE HOME COUNTRY
OF GLARO S.A. LTD. (THE PARENT COMPANY OF THE HEREIN RESPONDENT WANDER
PHILIPPINES, INC.), GRANTS TO SAID GLARO S.A. LTD. AGAINST ITS SWISS INCOME TAX
LIABILITY A TAX CREDIT EQUIVALENT TO THE 20 PERCENTAGE-POINT PORTION (OF THE 35
PERCENT PHILIPPINE DIVIDEND TAX) SPARED OR WAIVED OR OTHERWISE DEEMED AS IF PAID
IN THE PHILIPPINES UNDER SECTION 24 (b) (1) OF THE PHILIPPINE TAX CODE.
The sole issue in this case is whether or not private respondent Wander is entitled to the preferential rate
of 15% withholding tax on dividends declared and remitted to its parent corporation, Glaro.
From this issue, two questions were posed by petitioner: (1) Whether or not Wander is the proper party to
claim the refund; and (2) Whether or not Switzerland allows as tax credit the “deemed paid” 20% Philippine
Tax on such dividends.
Petitioner maintains and argues that it is Glaro, the tax payer, and not Wander, the remitter or payor of the
dividend income and a mere withholding agent for and in behalf of the Philippine Government, which should
be legally entitled to receive the refund if any.
It will be noted, however, that Petitioner’s above-entitled argument is being raised for the first time in this
Court. It was never raised at the administrative level, or at the Court of Tax Appeals. To allow a litigant to
assume a different posture when he comes before the court and challenge the position he had ac-
577

VOL. 160, APRIL 15, 1988


577
Comm’r. of lnternal Revenue vs. Wander Philippines, Inc.
cepted at the administrative level, would be to sanction a procedure whereby the Court—which is supposed
to review administrative determinations—would not review, but determine and decide for the first time, a
question not raised at the administrative forum. Thus, it is well settled that under the same underlying
principle of prior exhaustion of administrative remedies, on the judicial level, issues not raised in the lower
court cannot be raised for the first time on appeal (Aguinaldo Industries Corporation vs. Commissioner of
Internal Revenue, 112 SCRA 136; Pampanga Sugar Dev. Co,, Inc. vs. CIR, 114 SCRA 725; Garcia vs.
Court of Appeals, 102 SCRA 597; Matialonzo vs. Servidad, 107 SCRA 726.
In any event, the submission of petitioner that Wander is but a withholding agent of the government and
therefore cannot claim reimbursement of the alleged overpaid taxes, is untenable. It will be recalled, that
said corporation is first and foremost a wholly owned subsidiary of Glaro. The fact that it became a
withholding agent of the government which was not by choice but by compulsion under Section 53 (b) of
the Tax Code, cannot by any stretch of the imagination be considered as an abdication of its responsibility
to its mother company. Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that
“the obligation imposed thereunder upon the withholding agent is compulsory.” It is a device to insure the
collection by the Philippine Government of taxes on incomes, derived from sources in the Philippines, by
aliens who are outside the taxing jurisdiction of this Court (Commissioner of Internal Revenue vs. Malayan
Insurance Co., Inc., 21 SCRA 944). In fact, Wander may be assessed for deficiency withholding tax at
source, plus penalties consisting of surcharge and interest (Section 54, NLRC). Therefore, as the Philippine
counterpart, Wander is the proper entity who should claim for the refund or credit of overpaid withholding
tax on dividends paid or remitted by Glaro.
Closely intertwined with the first assignment of error is the issue of whether or not Switzerland, the foreign
country where Glaro is domiciled, grants to Glaro a tax credit against the tax due it, equivalent to 20%, or
the difference between the regular 35% rate of the preferential 15% rate. The dispute in this issue lies on
the fact that Switzerland does not impose any income
578

578
SUPREME COURT REPORTS ANNOTATED
Comm’r. of lnternal Revenue vs, Wander Philippines, Inc,
tax on dividends received by Swiss corporation from corporations domiciled in foreign countries.
Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this case, reads:
“Sec. 1. The first paragraph of subsection (b) of Section 24 of the National Internal Revenue Code, as
amended, is hereby further amended to read as follows:
'(b) Tax on foreign corporations.-(1) Non-resident corporation.-A foreign corporation not engaged in trade
or business in the Philippines, including a foreign life insurance company not engaged in the life insurance
business in the Philippines, shall pay a tax equal to 35% of the gross income received during its taxable
year from all sources within the Philippines, as interest (except interest on foreign loans which shall be
subject to 15% tax), dividends, premiums, annuities, compensations, remuneration for technical services
or otherwise, emoluments or other fixed or determinable, annual, periodical or casual gains, profits, and
income, and capital gains: x x x Provided, still further That on dividends received from a domestic
corporation liable to tax under this Chapter, the tax shall be 15% of the dividends received, which shall be
collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in
which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the
nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% which
represents the difference between the regular tax (35%) on corporations and the tax (15%) dividends as
provided in this section: x x x.’ "
From the above-quoted provision, the dividends received from a domestic corporation liable to tax, the tax
shall be 15% of the dividends received, subject to the condition that the country in which the non-resident
foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign
corporation taxes deemed to have been paid in the Philippines equivalent to 20% which represents the
difference between the regular tax (35%) on corporations and the tax (15%) dividends.
In the instant case, Switzerland did not impose any tax on the dividends received by Glaro. Accordingly,
Wander claims that full credit is granted and not merely credit equivalent to 20%. Petitioner, on the other
hand, avers the tax sparing credit
579

VOL. 160, APRIL 15, 1988


579
Comm’r. of Internal Revenue vs. Wander Philippines, Inc.
is applicable only if the country of the parent corporation allows a foreign tax credit not only for the 15
percentage-point portion actually paid but also for the equivalent twenty percentagepoint portion spared,
waived or otherwise deemed as if paid in the Philippines;'that private respondent does not cite anywhere a
Swiss law to the effect that in case where a foreign tax, such as the Philippine 35% dividend tax, is spared,
waived or otherwise considered as if paid in whole or in part by the foreign country, a Swiss foreign-tax
credit would be allowed for the whole or for the part, as the case may be, of the foreign tax so spared or
waived or considered as if paid by the foreign country.
While it may be true that claims for refund are construed strictly against the claimant, nevertheless, the fact
that Switzerland did not impose any tax or the dividends received by Glaro from the Philippines should be
considered as a full satisfaction of the given condition. For, as aptly stated by respondent Court, to deny
private respondent the privilege to withhold only 15% tax provided for under Presidential Decree No. 369,
amending Section 24 (b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and
definitely will adversely affect foreign corporations’ interest here and discourage them from investing capital
in our country.
Besides, it is significant to note that the conclusion reached by respondent Court is but a confirmation of
the May 19,1977 ruling of petitioner that “since the Swiss Government does not impose any tax on the
dividends to be received by the said parent corporation in the Philippines, the condition imposed under the
above-mentioned section is satisfied. Accordingly, the withholding tax rate of 15% is hereby affirmed.”
Moreover, as a matter of principle, this Court will not set aside the conclusion reached by an agency such
as the Court of Tax Appeals which is, by the very nature of its function, dedicated exclusively to the study
and consideration of tax problems and has necessarily developed an expertise on the subject unless there
has been an abuse or improvident exercise of authority (Reyes vs. Commissioner of Internal Revenue, 24
SCRA198, which is not present in the instant case.
WHEREFORE, the petition filed is DISMISSED for lack of merit.
SO ORDERED.
580

580
SUPREME COURT REPORTS ANNOTATED
People vs. Melicor
Fernan (Chairman), Gutierrez, Jr., Feliciano and Cortés, JJ., concur.
Petition dismissed.
Note.—Findings of fact of Court of Tax Appeals are entitled to great respect. (De Joya us. Raymundo, 101
SCRA 495.)
G.R. No. 216130. August 3, 2016.*

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. GOODYEAR PHILIPPINES, INC., respondent.


Taxation; Tax Refund; Section 229 of the Tax Code states that judicial claims for refund must be filed within
two (2) years from the date of payment of the tax or penalty.—Section 229 of the Tax Code states that
judicial claims for refund must be filed within two (2) years from the date of payment of the tax or penalty,
providing
_______________

* FIRST DIVISION.

490

490
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
further that the same may not be maintained until a claim for refund or credit has been duly filed with the
Commissioner of Internal Revenue (CIR).
Same; Same; The primary purpose of filing an administrative claim was to serve as a notice of warning to
the Commissioner of Internal Revenue (CIR) that court action would follow unless the tax or penalty alleged
to have been collected erroneously or illegally is refunded.—The primary purpose of filing an administrative
claim was to serve as a notice of warning to the CIR that court action would follow unless the tax or penalty
alleged to have been collected erroneously or illegally is refunded. To clarify, Section 229 of the Tax Code
— [then Section 306 of the old Tax Code] — however does not mean that the taxpayer must await the final
resolution of its administrative claim for refund, since doing so would be tantamount to the taxpayer’s
forfeiture of its right to seek judicial recourse should the two (2)-year prescriptive period expire without the
appropriate judicial claim being filed.
RP-US Tax Treaty; Under Article 11(5) of the Republic of the Philippines-United States of America (RP-
US) Tax Treaty, the term “dividends” should be understood according to the taxation law of the State in
which the corporation making the distribution is a resident.—Under Article 11(5) of the RP-US Tax Treaty,
the term “dividends” should be understood according to the taxation law of the State in which the corporation
making the distribution is a resident, which, in this case, pertains to respondent, a resident of the Philippines.
Accordingly, attention should be drawn to the statutory definition of what constitutes “dividends,” pursuant
to Section 73(A) of the Tax Code which provides that “[t]he term ‘dividends’ x x x means any distribution
made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders,
whether in money or in other property.”
PETITION for review on certiorari of the decision and resolution of the Court of Tax Appeals En Banc.
The facts are stated in the opinion of the Court.
The Solicitor General for petitioner.

490

490
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
Follosco, Morallos & Herce for respondent.

PERLAS-BERNABE, J.:

Assailed in this petition for review on certiorari1 are the Decision2 dated August 14, 2014 and the
Resolution3 dated January 5, 2015 of the Court of Tax Appeals (CTA) En Banc in C.T.A. E.B. No. 1041,
which affirmed the Decision4 dated March 25, 2013 and the Resolution5 dated June 26, 2013 of the CTA
Second Division (CTA Division) in CTA Case No. 8188, ordering petitioner Commissioner of Internal
Revenue (petitioner) to refund or issue a tax credit certificate (TCC) in the sum of P14,659,847.10 to
respondent Goodyear Philippines, Inc. (respondent), representing erroneously withheld and remitted final
withholding tax (FWT).

The Facts

Respondent is a domestic corporation duly organized and existing under the laws of the Philippines, and
registered with the Bureau of Internal Revenue (BIR) as a large taxpayer with Taxpayer Identification
Number 000-409-561-000.6 On
_______________

1 Rollo, pp. 9-23.


2 Id., at pp. 25-52. Penned by Associate Justice Esperanza R. Fabon-Victorino, with Presiding Justice
Roman G. Del Rosario and Associate Justices Juanito C. Castañeda, Jr., Erlinda P. Uy, Caesar A.
Casanova, Cielito N. Mindaro-Grulla, Amelia R. Cotangco-Mana-lastas, and Ma. Belen M. Ringpis-Liban,
concurring.
3 Id., at pp. 53-56. Penned by Associate Justice Esperanza R. Fabon-Victorino, with Presiding Justice
Roman G. Del Rosario and Associate Justices Juanito C. Castañeda, Jr., Lovell R. Bautista, Erlinda P. Uy,
Caesar A. Casanova, Cielito N. Mindaro-Grulla, Amelia R. Cotangco-Manalastas, and Ma. Belen M.
Ringpis-Liban, concurring.
4 Id., at pp. 63-104. Penned by Associate Justice Cielito N. Mindaro-Grulla, with Associate Justices Juanito
C. Castañeda, Jr. and Caesar A. Casanova, concurring.
5 Resolved by the CTA Special Second Division. Id., at pp. 105-107.
6 Id., at pp. 63-64.

492

492
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
August 19, 2003, the authorized capital stock of respondent was increased from P400,000,000.00 divided
into 4,000,000 shares with a par value of P100.00 each, to P1,731,863,000.00 divided into 4,000,000
common shares and 13,318,630 preferred shares with a par value of P100.00 each. Consequently, all the
preferred shares were solely and exclusively subscribed by Goodyear Tire and Rubber Company (GTRC),
which was a foreign company organized and existing under the laws of the State of Ohio, United States of
America (US) and is unregistered in the Philippines.7
On May 30, 2008, the Board of Directors of respondent authorized the redemption of GTRC’s 3,729,216
preferred shares on October 15, 2008 at the redemption price of P470,653,914.00, broken down as follows:
P372,921,600.00 representing the aggregate par value and P97,732,314.00, representing accrued and
unpaid dividends.8
On October 15, 2008, respondent filed an application for relief from double taxation before the International
Tax Affairs Division of the BIR to confirm that the redemption was not subject to Philippine income tax,
pursuant to the Republic of the Philippines (RP)-US Tax Treaty.9 This notwithstanding, respondent still took
the conservative approach, and thus, withheld and remitted the sum of P14,659,847.10 to the BIR on
November 3, 2008, representing fifteen percent (15%) FWT, computed based on the difference of the
redemption price and aggregate par value of the shares.10
On October 21, 2010, respondent filed an administrative claim for refund or issuance of TCC, representing
15% FWT
_______________

7 Id., at p. 64.
8 Id., at pp. 64-65.
9 Entitled “Convention between the Government of the Republic of the Philippines and the Government
of the United States of America with Respect to Taxes on Income,” which entered into force on October 16,
1982.
10 Rollo, p. 65.

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493
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
in the sum of P14,659,847.10 before the BIR. Thereafter, or on November 3, 2010, it filed a judicial claim,
by way of petition for review, before the CTA, docketed as CTA Case No. 8188.11
For her part, petitioner maintained that respondent’s claim must be denied, considering that: (a) it failed to
exhaust administrative remedies by prematurely filing its petition before the CTA; and (b) it failed to submit
complete supporting documents before the BIR.12

The CTA Division’s Ruling

In a Decision13 dated March 25, 2013, the CTA Division granted the petition and thereby ordered petitioner
to refund or issue a TCC in the sum of P14,659,847.10 to respondent for being erroneously withheld and
remitted as FWT.14 Concerning the procedural issue, the CTA Division ruled that it was appropriate for
respondent to dispense with the administrative remedy before the BIR, considering that court action should
be instituted within two (2) years after the payment of the tax regardless of the pendency of the
administrative claim; otherwise, the taxpayer would be barred from recovering the same.15
On the merits, the CTA Division found that the redemption of the 3,729,216 shares issued to GTRC —
which were then converted to treasury shares — was not subject to Philippine income tax. The CTA Division
elucidated that while the general rule is that the net capital gain obtained by a nonresident foreign
corporation, such as GTRC, in the redemption of shares would be subjected to tax rates of five percent
(5%) and
_______________

11 Id., at pp. 84-85.


12 Id., at pp. 28 and 66-70.
13 Id., at pp. 63-104.
14 Id., at pp. 103-104.
15 Id., at pp. 87-88.

494

494
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
ten percent (10%) under Section 28(B)(5)(c)16 of the National Internal Revenue Code, as amended (Tax
Code), the provisions, however, of the RP-US Tax Treaty would also apply in determining the tax
implications of the redemption of GTRC’s preferred shares because it is a resident of the US.17 It pointed
out that under Article 1418 of the RP-US Tax Treaty, any gain
_______________

16 SEC. 28. Rates of Income Tax on Foreign Corporations.—


xxxx
(B) Tax on Nonresident Foreign Corporation.—
xxxx
(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation.—
xxxx
(c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange.—A final tax at the rates
prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the
sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold,
or disposed of through the stock exchange:
Not over P100,000 .......................................5%
On any amount in excess of P100,000 .....10%
(Id., at pp. 93-94)
17 Id., at p. 94.
18 Article 14 of the RP-US Tax Treaty states:
Article 14
CAPITAL GAINS
1. Gains from the alienation of tangible personal (movable) property forming part of the business property
of a permanent establishment which a resident of a Contracting State has in the other Contracting State or
of tangible personal (movable) property pertaining to a fixed base available to a resident of a Contracting
State in the other Contracting State for the purpose of performing independent personal services, including
such gains from the alienation of such a permanent establishment (alone or together with the whole
enterprise) or of such a fixed base, may be taxed in the other State. However, gains

495

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495
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
derived by a US resident (i.e., GTRC) from the alienation of its properties (i.e., the preferred shares), other
than those described in paragraph 1 thereof, shall only be taxable in the US. Nonetheless, the CTA Division
remained mindful of the Reservation Clause19 in the same treaty which provided that the gains derived by
a US resident from the disposition of shares in a domestic corporation may be taxed in the Philippines,
provided that the latter’s assets principally20 consist of real property. After evaluating the Audited Financial
Statements (AFS) of respondent for the years 2007 and 2008, and noting that the value of its real properties
— i.e., property, plant, and equipment — comprise less than 50% of its total assets, the CTA Division held
that respondent’s assets did not principally consist of real property and, hence, exempt from capital gains
tax under Section 28(B)(5)(c) of the Tax Code.21
The CTA Division then determined whether the net capital gain derived by GTRC would be subjected to
15% FWT imposed on intercorporate dividends under Section 28(B)(5)(b)22
_______________

derived by a resident of a Contracting State from the alienation of ships, aircraft or containers operated by
such resident in international traffic shall be taxable only in that State, and gains described in Article 13
(Royalties) shall be taxable only in accordance with the provisions of Article 13 (Royalties).
2. Gains from the alienation of any property other than those mentioned in paragraph 1 or in Article 7
(Income from Real Property) shall be taxable only in the Contracting State of which the alienator is a
resident.
(Id., at p. 94)
19 Id., at p. 95.
20 “Principally” means more than 50% of the entire assets in terms of value. Id., at p. 96.
21 Id., at pp. 91-97.
22 (b) Intercorporate Dividends.—A final withholding tax at the rate of fifteen percent (15%) is hereby
imposed on the amount of cash and/or property dividends received from a domestic corporation,

496

496
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
of the Tax Code. Citing the RP-US Tax Treaty, the CTA Division noted that dividend income shall be
determined by the law of the state in which the distributing corporation is a resident,23 which in the
Philippines’ case, would be Section 73(A)24 of the Tax Code, defining dividends for income tax purposes
as distributions to shareholders arising out of its earnings or profits. Accordingly, the CTA Division held
that the net capital gain of GTRC could not be regarded as “dividends,” considering that it did not come
from respondent’s unrestricted earnings or profits, as the records would show that it did not have any
unrestricted earnings from the years 2003-2009 to cover any dividend payouts.25 Finally, the CTA Division
explained that there is only one instance in the Tax
_______________

which shall be collected and paid as provided in Section 57(A) of this Code, subject to the condition that
the country in which the nonresident foreign corporation is domiciled, shall allow a credit against the tax
due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent
to twenty percent (20%), which represents the difference between the regular income tax of thirty-five
percent (35%) and the fifteen percent (15%) tax on dividends as provided in this subparagraph: Provided,
that effective January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent (15%),
which represents the difference between the regular income tax of thirty percent (30%) and the fifteen
percent (15%) tax on dividends. (Id., at pp. 97-98)
23 Id., at p. 98.
24 SEC. 73. Distribution of Dividends or Assets by Corporations.—
(A) Definition of Dividends.—The term ‘‘dividends” when used in this Title means any distribution made
by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether
in money or in other property.
Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or
loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss,
as the case may be.
(Id., at p. 99)
25 Id., at pp. 97-100.

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Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
Code which treated the gains derived from redemptions or buy back of shares as dividends, and this is
found in Section 73(B),26 which contemplated the issuance of stock dividends. The CTA Division, however,
dispelled the application of this provision, considering that the shares which respondent redeemed were
neither stock dividends nor were they redeemed using unrestricted retained earnings. In sum, the CTA
Division ruled that absent any law which specifically treats the gain derived by GTRC as dividends, the
same could not be subjected to 15% FWT under Section 28(B)(5)(b).27
Dissatisfied, petitioner moved for reconsideration,28 which was, however, denied in a Resolution29 dated
June 26, 2013. Thereafter, she appealed30 to the CTA En Banc.

The CTA En Banc’s Ruling

In a Decision31 dated August 14, 2014, the CTA En Banc affirmed the findings of the CTA Division. Echoing
the ruling of the CTA Division, the CTA En Banc found that respondent was compelled to seek judicial
recourse after thirteen (13)
_______________

26 SEC. 73. Distribution of Dividends or Assets by Corporations.—


xxxx
(B) Stock Dividend.—A stock dividend representing the transfer of surplus to capital account shall not be
subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and
in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation
of the stock shall be considered as taxable income to the extent that it represents a distribution of earnings
or profits. (Id., at p. 101)
27 Id., at pp. 101-102.
28 Not attached to the Rollo.
29 Rollo, pp. 105-107.
30 Not attached to the Rollo.
31 Rollo, pp. 25-52.

498

498
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
days from filing its administrative claim so as not to forfeit its right to appeal to the CTA. Anent the tax
treatment of the redemption price paid by respondent to GTRC, the CTA En Banc fully agreed with the
disposition of the CTA Division, ruling that the net capital gain received by GTRC was not subject to
Philippine income tax.32
Undaunted, petitioner filed a motion for reconsideration,33 which was, however, denied in a Resolution34
dated January 5, 2015; hence, this petition.

The Issues Before the Court

The issues raised by petitioner in this case are: (a) whether or not the judicial claim of respondent should
be dismissed for non-exhaustion of administrative remedies; and (b) whether or not the CTA En Banc
correctly ruled that the gain derived by GTRC was not subject to 15% FWT on dividends.

The Court’s Ruling

The petition is devoid of merit.

I.

At the onset, petitioner contends that by filing the administrative and judicial claims only 13 days apart,
respondent, in effect, pursued an empty remedy before the BIR, and thereby deprived the latter of the
opportunity to ascertain the validity of the claim. In this regard, petitioner maintained that the mere filing of
the administrative claim before the BIR did not outrightly satisfy the requirement of exhaustion of
administrative remedy.35
_______________

32 Id., at pp. 35-50.


33 Not attached to the Rollo.
34 Rollo, pp. 53-56.
35 Id., at p. 17.

499

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499
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
The contentions are untenable.
Section 229 of the Tax Code states that judicial claims for refund must be filed within two (2) years from the
date of payment of the tax or penalty, providing further that the same may not be maintained until a claim
for refund or credit has been duly filed with the Commissioner of Internal Revenue (CIR), viz.:
SEC. 229. Recovery of Tax Erroneously or Illegally Collected.—No suit or proceeding shall be
maintained in any court for the recovery of any national internal revenue tax hereafter alleged to have been
erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without
authority, or of any sum alleged to have been excessively or in any manner wrongfully collected, until a
claim for refund or credit has been duly filed with the Commissioner; but such suit or proceeding may be
maintained, whether or not such tax, penalty, or sum has been paid under protest or duress.
In any case, no such suit or proceeding shall be filed after the expiration of two (2) years from the date of
payment of the tax or penalty regardless of any supervening cause that may arise after payment x x x.
(Emphases and underscoring supplied)

Verily, the primary purpose of filing an administrative claim was to serve as a notice of warning to the CIR
that court action would follow unless the tax or penalty alleged to have been collected erroneously or illegally
is refunded. To clarify, Section 229 of the Tax Code — [then Section 306 of the old Tax Code] — however
does not mean that the taxpayer must await the final resolution of its administrative claim for refund, since
doing so would be tantamount to the taxpayer’s forfeiture of its right to seek judicial recourse should the
two (2)-year prescriptive period expire without the

500

500
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
appropriate judicial claim being filed. In CBK Power Company Limited v. CIR,36 the Court enunciated:
In the foregoing instances, attention must be drawn to the Court’s ruling in P.J. Kiener Co., Ltd. v. David
(Kiener), wherein it was held that in no wise does the law, i.e., Section 306 of the old Tax Code (now,
Section 229 of the NIRC), imply that the Collector of Internal Revenue first act upon the taxpayer’s claim,
and that the taxpayer shall not go to court before he is notified of the Collector’s action. In Kiener, the Court
went on to say that the claim with the Collector of Internal Revenue was intended primarily as a notice of
warning that unless the tax or penalty alleged to have been collected erroneously or illegally is refunded,
court action will follow x x x.37 (Emphases and underscoring supplied)

In the case at bar, records show that both the administrative and judicial claims for refund of respondent
for its erroneous withholding and remittance of FWT were indubitably filed within the two-year prescriptive
period.38 Notably, Section 229 of the Tax Code, as worded, only required that an administrative claim
should first be filed. It bears stressing that respondent could not be faulted for resorting to court action,
considering that the prescriptive period stated therein was about to expire. Had respondent awaited the
action of petitioner knowing fully well that the prescriptive period was about to lapse, it would have
resultantly forfeited its right to seek a judicial review of its claim, thereby suffering irreparable damage.
_______________

36 G.R. Nos. 193383-84 & 193407-08, January 14, 2015, 746 SCRA 93.
37 Id., at pp. 110-111; citation omitted.
38 Date of payment was November 3, 2008, while the administrative and judicial claims were respectively
filed on October 21, 2010 and November 3, 2010. Rollo, pp. 27-28.

501

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501
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
Thus, in view of the aforesaid circumstances, respondent correctly and timely sought judicial redress,
notwithstanding that its administrative and judicial claims were filed only 13 days apart.

II.
For another, petitioner asserts that the net capital gain derived by GTRC from the redemption of its
3,729,216 preferred shares should be subject to 15% FWT on dividends. She claims that while the payment
of the original subscription price could not be taxed as it represented a return of capital, the additional
amount, however, or the component of the redemption price representing the amount of P97,732,314.00
should not be treated as a mere premium and part of the subscription price, but as accumulated dividend
in arrears, and, hence, subject to 15% FWT.39
Again, the assertions are wrong.
The imposition of 15% FWT on intercorporate dividends received by a nonresident foreign corporation is
found in Section 28(B)(5)(b) of the Tax Code which reads:
SEC. 28. Rates of Income Tax on Foreign Corporations.—
xxxx
(B) Tax on Nonresident Foreign Corporation.—
xxxx
(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation.—
(b) Intercorporate Dividends.—A final withholding tax at the rate of fifteen percent (15%) is hereby
imposed on the amount of cash and/or property divi-
_______________

39 Id., at pp. 14-17.

502

502
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
dends received from a domestic corporation, which shall be collected and paid as provided in Section 57(A)
of this Code, subject to the condition that the country in which the nonresident foreign corporation is
domiciled, shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed
to have been paid in the Philippines equivalent to twenty percent (20%), which represents the difference
between the regular income tax of thirty-five percent (35%) and the fifteen percent (15%) tax on dividends
as provided in this subparagraph: Provided, That effective January 1, 2009, the credit against the tax due
shall be equivalent to fifteen percent (15%), which represents the difference between the regular income
tax of thirty percent (30%) and the fifteen percent (15%) tax on dividends.

x x x x (Emphasis and underscoring supplied)

It must be noted, however, that GTRC is a nonresident foreign corporation, specifically a resident of the
US. Thus, pursuant to the cardinal principle that treaties have the force and effect of law in this
jurisdiction,40 the RP-US Tax Treaty complementarily governs the tax implications of respondent’s
transactions with GTRC.
Under Article 11(5)41 of the RP-US Tax Treaty, the term “dividends” should be understood according to
the taxation
_______________

40 Deutsche Bank AG Manila Branch v. CIR, 716 Phil. 676, 686; 704 SCRA 216, 227 (2013).
41 Article 11(5) of the RP-US Tax Treaty reads:
Article 11
Dividends
xxxx
5. The term “dividends” as used in this Convention means income from shares, mining shares, founders’
shares or other

503
VOL. 799, AUGUST 3, 2016
503
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
law of the State in which the corporation making the distribution is a resident, which, in this case, pertains
to respondent, a resident of the Philippines. Accordingly, attention should be drawn to the statutory
definition of what constitutes “dividends,” pursuant to Section 73(A)42 of the Tax Code which provides that
“[t]he term ‘dividends’ x x x means any distribution made by a corporation to its shareholders out of its
earnings or profits and payable to its shareholders, whether in money or in other property.”
In light of the foregoing, the Court therefore holds that the redemption price representing the amount of
P97,732,314.00 received by GTRC could not be treated as accumulated dividends in arrears that could be
subjected to 15% FWT. Verily, respondent’s AFS covering the years 2003 to 2009 show that it did not have
unrestricted retained earnings, and in fact, operated from a position of deficit.43 Thus, absent the availability
of unrestricted retained earnings, the board of directors of respondent had no power to issue divi-
_______________

rights, not being debt-claims, participating in profits, as well as income from other corporate rights
assimilated to income from shares by the taxation law of the State of which the corporation making the
distribution is a resident. (Id., at p. 98)
42 Section 73(A) of the Tax Code states:
SEC. 73. Distribution of Dividends or Assets by Corporations.—
(A) Definition of Dividends.—The term “dividends” when used in this Title means any distribution made
by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether
in money or in other property.
Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or
loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss,
as the case may be. (Emphases and underscoring supplied)
43 Rollo, p. 118.

504

504
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
dends.44 Consistent with Section 73(A) of the Tax Code, this rule on dividend declaration — i.e., that it is
dependent upon the availability of unrestricted retained earnings — was further edified in Section 43 of The
Corporation Code of the Philippines45 which reads:
Section 43. Power to Declare Dividends.—The board of directors of a stock corporation may declare
dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock
to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due
on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and expenses,
while stock dividends shall be withheld from the delinquent stockholder until his unpaid subscription is fully
paid: Provided, further, That no stock dividend shall be issued without the approval of stockholders
representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or special meeting
duly called for the purpose.

x x x x (Emphasis and underscoring supplied)

It is also worth mentioning that one of the primary features of an ordinary dividend is that the distribution
should be in the nature of a recurring return on stock46 which, however, does not obtain in this case. As
aptly pointed out by the CTA En Banc, the amount of P97,732,314.00 received by GTRC did not represent
a periodic distribution of dividend,
_______________
44 See Crucillo v. Office of the Ombudsman, 552 Phil. 699, 624; 525 SCRA 636, 665 (2007); and Republic
Planters Bank v. Agana, Sr., 336 Phil. 1, 9-11; 269 SCRA 1, 10 (1997).
45 Batas Pambansa Bilang 68 (May 1, 1980).
46 See Wise & Co., Inc. v. Meer, 78 Phil. 655 (1947).

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Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
but rather a payment by respondent for the redemption47 of GTRC’s 3,729,216 preferred shares. In Wise
& Co., Inc. v. Meer:48
The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock —
in fact, they surrendered and relinquished their stock in return for said distributions, thus ceasing to be
stockholders of the Hongkong Company, which in turn ceased to exist in its own right as a going concern
during its more or less brief administration of the business as trustee for the Manila Company, and finally
disappeared even as such trustee.
“The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each
case depending on the particular circumstances of the case and the intent of the parties. If the distribution
is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really
winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated
as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The
corporation is, in the latter instances, wiping out all parts of the stockholders’ interest in the company * * *.”
(Montgomery, Federal Income Tax Handbook [1938-1939], 258 x x x)49 (Emphases and underscoring
supplied)
_______________

47 “Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in exchange
for property, whether or not the acquired stock is cancelled, retired or held in the treasury.” (CIR v. Court of
Appeals, 361 Phil. 103, 124; 301 SCRA 152, 177 [1999]; citations omitted)
48 Supra note 46.
49 Id., at p. 669.

506

506
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. Goodyear Philippines, Inc.
All told, the amount of P97,732,314.00 received by GTRC from respondent for the redemption of its
3,729,216 preferred shares were not accumulated dividends in arrears. Contrary to petitioner’s claims, it is
therefore not subject to 15% FWT on dividends in accordance with Section 28(B)(5)(b) of the Tax Code.
WHEREFORE, the petition is DENIED. The Decision dated August 14, 2014 and the Resolution dated
January 5, 2015 of the Court of Tax Appeals En Banc in C.T.A. E.B. No. 1041 are hereby AFFIRMED.
SO ORDERED.
Leonardo-De Castro (Acting Chairperson), Bersamin, Jardeleza** and Caguioa, JJ., concur.
Petition denied, judgment and resolution affirmed.
Note.—It is not the duty of the government to disprove a taxpayer’s claim for refund; the burden of
establishing the factual basis of a claim for a refund rests on the taxpayer. (Commissioner of Internal
Revenue vs. Far East Bank & Trust Company [now Bank of the Philippine Islands], 615 SCRA 417 [2010])
Nos. L-65773-74. April 30, 1987.*
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. BRITISH OVERSEAS AIRWAYS
CORPORATION and COURT OF TAX APPEALS, respondents.
Taxation; Words and Phrases; "Doing" or "Engaging in" or "transacting" business have no specific meaning.
Each case has to be judged by its peculiar circumstances.—lt is our considered opinion that BOAC is a
resident foreign corporation, There is no specific criterion as to what constitutes "doing" or "engaging in" or
"transacting" business. Each case must be judged in the light of its peculiar environmental circumstances.
The term implies a continuity of commercial dealings and arrangements, and contemplates, to that extent,
the performance of acts or works or the exercise of some of the functions normally incident to, and in
progressive prosecution of commercial gain or for the purpose and object of the business organization. "In
order that a foreign corporation may be regarded as doing business within a State, there must be continuity
of conduct and intention to establish a continuous business, such as the appointment of a local agent, and
not one of a temporary character.'
Same; An international airline, like BOAC, which has appointed a ticket sales agent in the Philippines and
which allocates fares received to various airlines on the basis of their participation in the services rendered.
although BOAC does not operate any airplane in the Philippines, is a resident foreign corporation subject
to tax on income received from Philippine sources.—BOAC, during the periods covered by the subject
assessments, maintained a general sales agent in the Philippines. That general sales agent, from 1959 to
1971, "was
________________

* EN BANC.
396

396
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. British Overseas Airways Corporation
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of trips—each trip in
the series corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4)
consequently allocating to the various airline companies on the basis of their participation in the services
rendered through the mode of interline settlement as prescribed by Article VI of the Resolution No. 850 of
the IATA Agreement." Those activities were in exercise of the functions which are normally incident to, and
are in progressive pursuit of the purpose and object of its organization as an international air carrier. In fact,
the regular sale of tickets, its main activity, is the very lifeblood of the airline business, the generation of
sales being the paramount objective. There should be no doubt then that BOAC was "engaged in" business
in the Philippines through a local agent during the period covered by the assessments. Accordingly, it is a
resident foreign corporation subject to tax upon its total net income received in the preceding taxable year
from all sources within the Philippines.
Same; Words and Phrases; Definition of "gross income" in the Tax Code is broad enough to include
proceeds from sales of airline tickets in the Philippines even if no service or airlifting of passenger or cargo
by an airline is done by its planes in the Philippines.—The source of an income is the property, activity or
service that produced the income. For the source of income to be considered as coming from the
Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case,
the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands
here and payments for fares were also made here in Philippine currency. The situs of the source of
payments is the Philippines. The flow of wealth proceeded from, and occurred within, Philippine territory,
enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow
of wealth should share the burden of supporting the government.
Same; Same.—BOAC, however, would impress upon this Court that income derived from transportation is
income for services, with the result that the place where the services are rendered determines the source;
and since BOAC's service of transportation is performed outside the Philippines, the income derived is from
sources without the Philippines and, therefore, not taxable under our income tax laws. The Tax Court
upholds that stand in the joint Decision under review. The absence of flight operations to and from the
Philippines
397
VOL. 149, APRIL 30, 1987
397
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
is not determinative of the source of income or the situs of income taxation. Admittedly, BOAC was an off-
line international airline at the time pertinent to this case. The test of taxability is the "source"; and the
source of an income is that activity x x x which produced the income. Unquestionably, the passage
documentations in these cases were sold in the Philippines and the revenue therefrom was derived from a
business activity regularly pursued within the Philippines. And even if the BOAC tickets sold covered the
"transport of passengers and cargo to and from foreign cities," it cannot alter the fact that income from the
sale of tickets was derived from the Philippines. The word "source" conveys one essential idea, that of
origin, and the origin of the income herein is the Philippines.
Same; Under P.D. 69 and P.D. 1355, international air carriers are subject to income tax of 2½% of their
gross Philippine billings.—The foregoing provision ensures that international airlines are taxed on their
income from Philippine sources. The 2½% tax on gross Philippine billings is an income tax. If it had been
intended as an excise or percentage tax it would have been place under Title V of the Tax Code covering
Taxes on Business.
Same; Same; The common carrier's tax, an excise tax, where can be levied only when the act, business or
privilege is performed in the Philippines is different from the income tax.—Lastly, we find as untenable the
BO AC argument that the dismissal for lack of merit by this Court of the Appeal in JAL vs. Commissioner
of Internal Revenue (G.R. No. L-30041) on February 3, 1969, is res judicata to the present case. The ruling
by the Tax Court in that case was to the effect that the mere sale of tickets, unaccompanied by the physical
act of carriage of transportation, does not render the taxpayer therein subject to the common carrier's tax,
As elucidated by the Tax Court, however, the common carrier's tax is an excise tax, being a tax on the
activity of transporting, conveying or removing passengers and cargo from one place to another. It purports
to tax the business of transportation. Being an excise tax, the same can be levied by the State only when
the acts, privileges or businesses are done or performed within the jurisdiction of the Philippines. The
subject matter of the case under consideration is income tax, a direct tax on the income of persons and
other entities "of whatever kind and in whatever form derived from any source." Since the two cases treat
of a different subject matter, the decision in one cannot be res judicata to the other.
398

398
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
TEEHANKEE, C.J., concurring:

Taxation; The differences of opinion between the majority and the dissenting members of the court has now
become moot and academic.—I just wish to point out that the conflict between the majority opinion penned
by Mme. Justice Melencio-Herrera and the dissenting opinion penned by Mr. Justice Feliciano as to the
proper characterization of the taxable income derived by respondent BOAC from the sales in the Philippines
of tickets for BOAC flights as sold and issued by its general sales agent in the Philippines has become moot
after November 24, 1972. Both opinions state that by amendment through P.D. No. 69, promulgated on
November 24, 1972, of section 24(b) (2) of the Tax Code providing for the rate of income tax on foreign
corporations international carriers such as respondent BOAC, have since then been taxed at a reduced
rate of 2-1/2% on their gross Philippine billings. There is, therefore, no longer any source of substantial
conflict between the two opinions as to the present 2-½% tax on their gross Philippine billings charged
against such international carriers as herein respondent f oreign corporation.
FELICIANO, J., dissenting:

Taxation; Whether a foreign corporation is a resident or nonresident corporation, it is taxable only on income
from Philippine sources.—Clearly, whether the foreign corporate taxpayer is doing business in the
Philippines and therefore a resident foreign corporation, or not doing business in the Philippines and
therefore a nonresident foreign corporation, it is liable to income tax only to the extent that it derives income
from sources within the Philippines. The circumstance that a foreign corporation is resident in the
Philippines yields no inference that all or any part of its income is Philippine source income. Similarly, the
non-resident status of a foreign corporation does not imply that it has no Philippine source income.
Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign
corporation is a resident of the Philippines. The critical issue, for present purposes, is therefore whether or
not BOAC is deriving income from sources within the Philippines.
Same; Source of income relates to the property, activity or service which produced the income, not to the
flow of money or site of payment.—For purposes of income taxation, it is well to bear in mind that the
"source of income" relates not to the physical sourcing of a
399

VOL. 149, APRIL 30, 1987


399
Commissioner of Internal Revenue vs. British Overseas Airways Corporation
flow of money or the physical situs of payment but rather to the "property, activity or service which produced
the income." In Howden and Co., Ltd. vs. Collector of Internal Revenue, the Court dealt with the issue of
the applicable source rule relating to reinsurance premiums paid by a local insurance company to a foreign
reinsurance company in respect of risks located in the Philippines.
Same; Where income taxation of services is involved, the income is sourced in the place where the service
is rendered.—Where a contract for the rendition of service is involved, the applicable source rule may be
simply stated as follows: the income is sourced in the place where the service contracted for is rendered.
Section 37 (a) (3) of our Tax Code reads as follows: "Section 37. Income from sources within the Philippines.
(a) Gross income from sources within the Philippines.—The following items of gross income shall be treated
as gross income from sources within the Philippines: (3) Services.—Compensation for labor or personal
services performed in the Philippines; x x x" (Italics supplied)
Same; Income from transportation or other services done outside the Philippines must be treated as derived
entirely from sources outside the Philippines.—Section 37 (e) of the Tax Code quoted above carries a
strong, well-nigh irresistible, implication that income derived from transportation or other services rendered
entirely outside the Philippines must be treated as derived entirely from sources without the Philippines.
This implication is reinforced by a consideration of certain provisions of Revenue Regulations No. 2 entitled
"Income Tax Regulations," as amended, first promulgated by the Department of Finance on 10 February
1940. Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in
part as follows: "Section 155. Compensation for labor or per-sonal services.—Gross income from sources
within the Philippines includes compensation for labor or personal services within the Philippines regardless
of the residence of the payor, of the place in which the contract for services was made, or of the place of
payment—" Italics supplied)
Same; Income of a foreign airline for carriage of passengers and cargo between points located outside the
Philippines is not an income from sources within the Philippines although the tickets are sold here, such
tickets being merely an evidence of the contract of carriage.—The appropriate characterization, in my
opinion, of the
400

400
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
BOAC transactions is that of entering into contracts of service, i.e., carriage of passengers or cargo between
points located outside the Philippines. The phrase "sale of airline tickets/' while widely used in popular
parlance, does not appear to be correct as a matter of tax law. The airline ticket in and of itself has no
monetary value, even as scrap paper. The value of the ticket lies wholly in the right acquired by the
"purchaser"—the passenger—to demand a prestation from BOAC, which prestation consists of the carriage
of the "purchaser" or passenger from one point to another outside the Philippines. The ticket is really the
evidence of the contract of carriage entered into between BOAC and the passenger. The money paid by
the passenger changes hands in the Philippines. But the passenger does not receive in the Philippines the
consideration therefor—the service undertaken to be delivered by BOAC. The "purchase price of the airline
ticket" is quite different from the purchase price of a physical good or commodity such as a pair of shoes or
a refrigerator or an automobile; it is really the compensation paid for the undertaking of BOAC to transport
the passenger or cargo outside the Philippines.
Same; Same.—The characterization of the BOAC transactions either as sales of personal property or as
purchases and sales of personal property, appear entirely inappropriate from another viewpoint. Consider
first purchases and sales: is BOAC properly regarded as engaged in trading—in the purchase and sale of
personal property? Certainly, BOAC was not purchasing tickets outside the Philippines and selling them in
the Philippines. Consider next sales: can BOAC be regarded as "selling" personal property produced or
manufactured by it? In a popular or journalistic sense, BOAC might be described as "selling" "a product"—
its services. However, for the technical purposes of the law on income taxation, BOAC is in fact entering
into contracts of service or carriage. The very existence of "source" rules" specifically and precisely
applicable to the rendition of services must preclude the application here of "source rules" applying
generally to sales, and purchases and sales, of personal property which can be invoked only by the grace
of popular language. On a slightly more abstract level, BOAC's income is more appropriately characterized
as derived from a "service", rather than from an "activity" (a broader term than service and including the
activity of selling) or from the use of "property." Finally, it is well to recall that what is here involved is income
taxation, and not a sales tax or an excise or privilege tax.
401

VOL. 149, APRIL 30, 1987


401
Commissioner of Internal Revenue vs. British Overseas Airways Corporation
Same; Under P.D. 1355 international carriers issuing passage documentation in the Philippines for uplifts
between points outside the Philippines are not charged any Philippine income tax on their Philippine billings.
In place thereof, a 2½% excise tax on billings in respect of passengers and cargoes originating from the
Philippines regardless of embarkation or debarkation, is imposed.—Under the above-quoted proviso,
international carriers issuing for compensation passage documentation in the Philippines for uplifts from
any point in the world to any other point in the world, are not charged any Philippine income tax on their
Philippine billings (i.e., billings in respect of passenger or cargo originating from the Philippines). Under this
new approach, international carriers who service ports or points in the Philippines are treated in exactly the
same way as international carriers not servicing any port or point in the Philippines. Thus, the source of
income rule applicable, as above discussed, to transportation or other services rendered partly within and
partly without the Philippines, or wholly without the Philippines, has been set aside. In place of Philippine
income taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings in
respect of passengers and cargo originating from the Philippines regardless of where embarkation and
debarkation would be taking place. This 2-½ per cent tax is effectively a tax on gross receipts or an excise
or privilege tax and not a tax on income. Thereby, the Government has done away with the difficulties
attending the allocation of income and related expenses, losses and deductions. Because taxes are the
very lifeblood of government, the resulting potential "loss" or "gain" in the amount of taxes collectible by the
state is sometimes, with varying degrees of consciousness, considered in choosing from among competing
possible characterizations under or interpretations of tax statutes. It is hence perhaps useful to point out
that the determination of the appropriate characterization here—that of contracts of air carriage rather than
sales of airline tickets—entails no downthe road loss of income tax revenues to the Government. In lieu
thereof, the Government takes in revenues generated by the 2-½ per cent tax on the gross Philippine
billings or receipts of international carriers.
PETITION for certiorari to review the decision of the Court of Tax Appeals.

The facts are stated in the opinion of the Court.


402

402
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.
MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on Certiorari of the joint Decision of the
Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, which set aside
petitioner's assessment of deficiency income taxes against respondent British Overseas Airways
Corporation (BOAC) for the fiscal years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its
Resolution of 18 November, 1983 denying reconsideration.
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 business and is a member-signatory of the Interline
Air Transport Association (IATA). As such, it operates air transportation service and sells transportation
tickets over the routes of the other airline members. During the periods covered by the disputed
assessments, it is admitted that BOAC had no landing rights for traffic purposes in the Philippines, and was
not granted a Certificate of public convenience and necessity to operate in the Philippines by the Civil
Aeronautics Board (CAB), except for a nine-month period, partly in 1961 and partly in 1962, when it was
granted a temporary landing permit by the CAB. Consequently, it did not carry passengers and/or cargo to
or from the Philippines, although during the period covered by the assessments, it maintained a general
sales agent in the Philippines—Warner Barnes and Company, Ltd., and later Qantas Airways—which was
responsible for selling BOAC tickets covering passengers and cargoes. 1
G.R. No. 65773 (CTA Case No. 2373, the First Case)

On 7 May 1968, petitioner Commissioner of Internal


________________

1 Partial Stipulation of Facts, Annex "E" and Annex "4", pp. 74-77 and 87-90, Rollo.
403

VOL. 149, APRIL 30, 1987


403
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
Revenue (CIR, for brevity) assessed BOAC the aggregate amount of P2,498,358.56 for deficiency income
taxes covering the years 1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in
the issuance of a new assessment, dated 16 January 1970 for the years 1959 to 1967 in the amount of
P858,307.79. BOAC paid this new assessment under protest.
On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which claim was denied
by the CIR on 16 February 1972. But before said denial, BOAC had already filed a petition for review with
the Tax Court on 27 January 1972, assailing the assessment and praying for the refund of the amount paid.
G.R. No. 65774 (CTA Case No. 2561, the Second Case)

On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal
years 19681969 to 1970-1971 in the aggregate amount of P549,327.43, and the additional amounts of
P1,000.00 and P1,800.00 as compromise penalties for violation of Section 46 (requiring the filing of
corporation returns) penalized under Section 74 of the National Internal Revenue Code (NIRC).
On 25 November 1971, BOAC requested that the assessment be countermanded and set aside. In a letter,
dated 16 February 1972, however, the CIR not only denied the BOAC request for refund in the First Case
but also re-issued in the Second Case the deficiency income tax assessment for P534,132.08 for the years
1969 to 1970-71 plus P1,000.00 as compromise penalty under Section 74 of the Tax Code. BOAC's request
for reconsideration was denied by the CIR on 24 August 1973. This prompted BOAC to file the Second
Case bef ore the Tax Court praying that it be absolved of liability for deficiency income tax for the years
1969 to 1971.
This case was subsequently tried jointly with the First Case.
On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the ClR. The Tax Court
held that the proceeds of sales of BOAC passage tickets in the Philippines
404

404
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
by Warner Barnes and Company, Ltd., and later by Qantas Airways, during the period in question, do not
constitute BOAC income from Philippine sources "since no service of carriage of passengers or freight was
performed by BOAC within the Philippines" and, therefore, said income is not subject to Philippine income
tax. The CTA position was that income from transportation is income from services so that the place where
services are rendered determines the source. Thus, in the dispositive portion of its Decision, the Tax Court
ordered petitioner to credit BOAC with the sum of P858,307.79, and to cancel the deficiency income tax
assessments against BOAC in the amount of P534,132.08 for the fiscal years 1968-69 to 197071.
Hence, this Petition for Review on Certiorari of the Decision of the Tax Court.
The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:
"1. Whether or not the revenue derived by private respondent British Overseas Airways Corporation (BOAC)
from sales of tickets in the Philippines for air transportation, while having no landing rights here, constitute
income of BOAC from Philippine sources, and, accordingly, taxable.
"2. Whether or not during the fiscal years in question BOAC is a resident foreign corporation doing business
in the Philippines or has an of fice or place of business in the Philippines.
"3. In the alternative that private respondent may not be considered a resident foreign corporation but a
non-resident foreign corporation, then it is liable to Philippine income tax at the rate of thirty-five per cent
(35%) of its gross income received from all sources within the Philippines.''
Under Section 20 of the 1977 Tax Code:
"(h) the term 'resident foreign corporation' applies to a foreign corporation engaged in trade or business
within the Philippines or having an of fice or place of business therein.
"(i) The term 'non-resident foreign corporation' applies to a
405

VOL. 149, APRIL 30, 1987


405
Commissioner of Internal Revenue vs. British Overseas Airways Corporation
foreign corporation not engaged in trade or business within the Philippines and not having any office or
place of business therein."
It is our considered opinion that BOAC is a resident foreign corporation. There is no specific criterion as to
what constitutes "doing" or "engaging in" or "transacting" business. Each case must be judged in the light
of its peculiar environmental circumstances. The term implies a continuity of commercial dealings and
arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some
of the functions normally incident to, and in progressive prosecution of commercial gain or for the purpose
and object of the business organization.2 "In order that a foreign corporation may be regarded as doing
business within a State, there must be continuity of conduct and intention to establish a continuous
business, such as the appointment of a local agent, and not one of a temporary character.'3
BOAC, during the periods covered by the subject assessments, maintained a general sales agent in the
Philippines. That general sales agent, from 1959 to 1971, "was engaged in (1) selling and issuing tickets;
(2) breaking down the whole trip into series of trips—each trip in the series corresponding to a different
airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various
airline companies on the basis of their participation in the services rendered through the mode of interline
settlement as prescribed by Article VI of the Resolution No. 850 of the IATA Agreement."4 Those activities
were in exercise of the functions which are normally incident to, and are in progressive pursuit of, the
purpose and object of its organization as an international air carrier. In fact, the regular sale of tickets, its
main activity, is the very lifeblood of the airline business, the
________________

2 The Mentholatum Co., Inc., et al. vs. Anacleto Mangaliman, et al, 72 Phil. 524 (1941); Section 1, R.A. No.
5455.
3 Pacific Micronesian Line, Inc. vs. Del Rosario and Peligon, 96 Phil. 23, 30, citing Thompson on
Corporations, Vol. 8, 3rd ed., pp. 844-847 and Fisher's Philippine Law of Stock Corporation, p. 415.
4 P. 11, BOAC Memorandum; p. 261, Rollo.
406

406
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
generation of sales being the paramount objective. There
should be no doubt then that BOAC was "engaged in" business in the Philippines through a local agent
during the period covered by the assessments. Accordingly, it is a resident foreign corporation subject to
tax upon its total net income received in the preceding taxable year from all sources within the Philippines.5
"Sec. 24. Rates of tax on corporations.—x x x
"(b) Tax on foreign corporations.—x x x
"(2) Resident corporations.—A corporation organized, authorized, or existing under the laws of any foreign
country, except a foreign life insurance company, engaged in trade or business within the Philippines, shall
be taxable as provided in subsection (a) of this section upon the total net income received in the preceding
taxable year from all sources within the Philippines. (Italics ours)
Next, we address ourselves to the issue of whether or not the revenue from sales of tickets by BOAC in the
Philippines constitutes income from Philippine sources and, accordingly, taxable under our income tax laws.
The Tax Code defines "gross income" thus:
" 'Gross income' includes gains, profits, and income derived from salaries, wages or compensation for
personal service of whatever kind and in whatever form paid, or from profession, vocations, trades,
business, commerce, sales, or dealings in property, whether real or personal, growing out of the ownership
or use of or interest in such property; also from interests, rents, dividends, securities, or the transactions of
any business carried on for gain or profit, or gains, profits, and income derived from any source whatever"
(Sec. 29[3]; Italics supplied)
The definition is broad and comprehensive to include proceeds from sales of transport documents. "The
words 'income from any source whatever' disclose a legislative policy to include all income not expressly
exempted within the class of
________________

5 Section 24(b), (2), Tax Code, as amended by R.A. 6110, approved on 4 August 1969.
407

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Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
taxable income under our laws." Income means "cash received or its equivalent"; it is the amount of money
coming to a person within a specific time x x x; it means something distinct from principal or capital For,
while capital is a fund, income is a flow. As used in our income tax law, "income" refers to the flow of
wealth.6
The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to 1970-71
amounted to P10,428,368.00.7
Did such "flow of wealth" come from "sources within the Philippines"?
The source of an income is the property, activity or service that produced the income.8 For the source of
income to be considered as coming from the Philippines, it is sufficient that the income is derived from
activity within the Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity that
produces the income. The tickets exchanged hands here and payments for fares were also made here in
Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded
from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of wealth should share the burden of supporting
the government.
A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the
contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser of the ticket
to pay the fare and the corresponding obligation of the carrier to transport the passenger upon the terms
and conditions set forth thereon. The ordinary ticket issued to members of the travelling public in
________________

6 Madrigal and Paternol vs. Rafferty and Concepcion, 38 Phil. 414(1918).


7 Memorandum for Petitioner, p. 22; p. 299, Rollo.
8 Mertens, Jr., Jacob, Law on Federal Income Taxation, Vol. 8, Section 45.27; cited in Howden & Co., Ltd.
vs. Collector of Internal Revenue, 13 SCRA 601 (1965).
408

408
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
general embraces within its terms all the elements to constitute it a valid contract, binding upon the parties
entering into the relationship.9
True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources within the
Philippines, namely: (1) interest, (2) dividends, (3) service, (4) rentals and royalties, (5) sale of real property,
and (6) sale of personal property, does not mention income from the sale of tickets for international
transportation. However, that does not render it less an income from sources within the Philippines. Section
37, by its language, does not intend the enumeration to be exclusive. It merely directs that the types of
income listed therein be treated as income from sources within the Philippines. A cursory reading of the
section will show that it does not state that it is an all-inclusive enumeration. and that no other kind of income
may be so considered.10
BOAC, however, would impress upon this Court that income derived from transportation is income for
services, with the result that the place where the services are rendered determines the source; and since
BOAC's service of transportation is performed outside the Philippines, the income derived is from sources
without the Philippines and, therefore, not taxable under our income tax laws. The Tax Court upholds that
stand in the j oint Decision under review.
The absence of flight operations to and from the Philippines is not determinative of the source of income or
the situs of income taxation. Admittedly, BOAC was an off-line international airline at the time pertinent to
this case. The test of taxability is the "source"; and the source of an income is that activity x x x which
produced the income.11 Unquestionably, the passage documentations in these cases were sold in the
Philippines and the revenue therefrom was derived from a
________________

9 14 Am Jur 2d 813.
10 British Trader's Insurance Co., Ltd. vs. Commissioner of Internal Revenue, 13 SCRA 719 (1965).
11 Howden & Co., Ltd. vs. Collector of Internal Revenue, 13 SCRA 601 (1965).
409

VOL. 149, APRIL 30, 1987


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Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
business activity regularly pursued within the Philippines. And even if the BOAC tickets sold covered the
"transport of passengers and cargo to and from foreign cities",12 it cannot alter the fact that income from
the sale of tickets was derived from the Philippines. The word "source" conveys one essential idea, that of
origin, and the origin of the income herein is the Philippines.13
It should be pointed out, however, that the assessments upheld herein apply only to the fiscal years covered
by the questioned deficiency income tax assessments in these cases, or, from 1959 to 1967, 1968-69 to
1970-71. For, pursuant to Presidential Decree No. 69, promulgated on 24 November, 1972, international
carriers are now taxed as follows:
"x x x Provided, however, That international carriers shall pay a tax of 2-½ per cent on their gross Philippine
billings." (Sec, 24[b] [2], TaxCode).
Presidential Decree No. 1355, promulgated on 21 April, 1978. provided a statutory definition of the term
"gross Philippine billings,'' thus:
"x x x '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, provided the cargo or mail originates from the Philippines. x x x"
The foregoing provision ensures that international airlines are taxed on their income from Philippine
sources. The 2½% tax on gross Philippine billings is an income tax. If it had been intended as an excise or
percentage tax it would have been place under Title V of the Tax Code covering Taxes on Business.
Lastly, we find as untenable the BOAC argument that the
________________

12 Partial Stipulation of Facts, paragraph 5, p. 89, Rollo.


13 Manila Gas Corporation vs. Collector of Internal Revenue, 62 Phil. 895 (1935).
410

410
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
dismissal for lack of merit by this Court of the appeal in J AL vs. Commissioner of Internal Revenue (G.R.
No. L-30041) on February 3, 1969, is res judicata to the present case. The ruling by the Tax Court in that
case was to the effect that the mere sale of tickets, unaccompanied by the physical act of carriage of
transportation, does not render the taxpayer therein subject to the common carrier's tax. As elucidated by
the Tax Court, however, the common carrier's tax is an excise tax, being a tax on the activity of transporting,
conveying or removing passengers and cargo from one place to another. It purports to tax the business of
transportation.14 Being an excise tax, the same can be levied by the State only when the acts, privileges
or businesses are done or performed within the jurisdiction of the Philippines. The subject matter of the
case under consideration is income tax, a direct tax on the income of persons and other entities "of whatever
kind and in whatever form derived from any source." Since the two cases treat of a different subject matter,
the decision in one cannot be res judicata to the other.
WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET ASIDE. Private
respondent, the British Overseas Airways Corporation (BOAC), is hereby ordered to pay the amount of
P534,132.08 as deficiency income tax for the fiscal years 1968-69 to 1970-71 plus 5% surcharge, and 1%
monthly interest from April 16, 1972 for a period not to exceed three (3) years in accordance with the Tax
Code. The BOAC claim for refund in the amount of P858,307.79 is hereby denied. Without costs.
SO ORDERED.
Paras, Gancayco, Padilla, Bidin, Sarmiento and Cortes, JJ., concur.
Teehankee, C. J., files a brief concurrence.
Fernan, J., took no part, his brother-in-law being a member of the law firm representing private respondents.
________________

14 Commissioner of Internal Revenue vs. U.S. Lines, Co., 5 SCRA 175 (1962).
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Narvasa, Gutierrez, Jr., and Cruz, JJ., joins Mr. Justice Feliciano's dissent.
Feliciano, J., please see separate dissenting opinion.
Teehankee, C.J. I certify that Justice Yap, presently on leave, voted for the above judgment and concurred
with the majority opinion.
TEEHANKEE, C.J.:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes against
respondent BOAC for the fiscal years 1959-1967, 1968-1969 to 1970-1971 and therefore setting aside the
appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the conflict between
the majority opinion penned by Mme. Justice Melencio-Herrera and the dissenting opinion penned by Mr.
Justice Feliciano as to the proper characterization of the taxable income derived by respondent BOAC from
the sales in the Philippines of tickets for BOAC flights as sold and issued by its general sales agent in the
Philippines has become moot after November 24, 1972. Both opinions state that by amendment through
P.D. No. 69, promulgated on November 24, 1972, of section 24(b) (2) of the Tax Code providing for the
rate of income tax on foreign corporations, international carriers such as respondent BOAC, have since
then been taxed at a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer
any source of substantial conflict between the two opinions as to the present 2-½% tax on their gross
Philippine billings charged against such international carriers as herein respondent foreign corporation.
FELICIANO, J., dissenting:

With great respect and reluctance, I record my dissent from the opinion of Mme. Justice A.A. Melencio-
Herrera speaking for the majority. In my opinion, the joint decision of the Court of Tax Appeals in CTA
Cases Nos. 2373 and 2561, dated 26 January 1983, is correct and should be affirmed.
412

412
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
The fundamental issue raised in this petition for review is whether the British Overseas Airways Corporation
(BOAC), a foreign airline company which does not maintain any flight operations to and from the Philippines,
is liable for Philippine income taxation in respect of "sales of air tickets" in the Philippines through a general
sales agent, relating to the carriage of passengers and cargo between two points both outside the
Philippines.
1. The Solicitor General has defined as one of the issues in this case the question of:
"2. Whether or not during the fiscal years in question1 BOAC [was] a resident foreign corporation doing
business in the Philippines or [had] an office or place of business in the Philippines."
It is important to note at the outset that the answer to the above-quoted issue is not determinative of the
liability of the BOAC to Philippine income taxation in respect of the income here involved, The liability of
BOAC to Philippine income taxation in respect of such income depends, not on BOAC's status as a
"resident foreign corporation'' or alternatively, as a "nonresident foreign.corporation," but rather on whether
or not such income is derived from "sources within the Philippines."
A "resident foreign corporation" or a foreign corporation engaged in trade or business in the Philippines or
having an office or place of business in the Philippines is subject to Philippine income taxation only in
respect of income derived from sources within the Philippines. Section 24 (b) (2) of the National Internal
Revenue Code ("Tax Code"), as amended by Republic Act No. 2343, approved 20 June 1959, as it existed
up to 3 August 1969, read as follows:
"(2) Resident corporations.—A foreign corporation engaged in trade or business within the Philippines
(except foreign life insurance companies) shall be taxable as provided in subsection (a) of this section."
________________

1 I.e., 1959-1969 and 1971.


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Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
Section 24 (a) of the Tax Code in turn provides:
"Rate of tax on corporations.—(a) Tax on domestic corporations.—x x x and a like tax shall be levied,
collected, and paid annually upon the total net income received in the preceeding taxable year from all
sources within the Philippines by every corporation organized, authorized, or existing under the laws of any
foreign country: x x x." (Italics supplied)
Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it amended once
more Section 24 (b) (2) of the Tax Code so as to read as follows:
"(2) Resident Corporations.—A corporation, organized, authorized or existing under the laws of any foreign
country, except foreign life insurance company, engaged in trade or business within the Philippines, shall
be taxable as provided in subsection (a) of this section upon the total net income received in the preceding
taxable year from all sources within the Philippines," (Italics supplied)
Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign
corporations. Section 24 (b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read as
follows:
"(b) Tax on foreign corporations.—(1) Non-resident corporations.—There shall be levied, collected and paid
for each taxable year, in lieu of the tax imposed by the preceding paragraph upon the amount received by
every foreign corporation not engaged in trade or business within the Philippines, from all sources within
the Philippines, as interests, dividends, rents, salaries, wages, premiums, annuities, compensations,
remunerations, emoluments, or other fixed or determinative annual or periodical gains, profits and incomes
a tax equal to thirty per centum of such amount: provided, however, that premiums shall not include
reinsurance premiums."2
Clearly, whether the foreign corporate taxpayer is doing
________________

2 Underscoring supplied, Republic Act No. 6110 continued the above-quoted subparagraph, except that it
raised the tax rate from 30% to 35%
414

414
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
business in the Philippines and therefore a resident foreign corporation, or not doing business in the
Philippines and therefore a non-resident foreign corporation, it is liable to income tax only to the extent that
it derives income from sources within the Philippines. The circumstance that a foreign corporation is
resident in the Philippines yields no inference that all or any part of its income is Philippine source income.
Similarly, the non-resident status of a foreign corporation does not imply that it has no Philippine source
income. Conversely, the receipt of Philippine source income creates no presumption that the recipient
foreign corporation is a resident of the Philippines. The critical issue, for present purposes, is therefore
whether or not BOAC is deriving income from sources within the Philippines.
2, For purposes of income taxation. it is well to bear in mind that the "source of income" relates not to the
physical sourcing of a flow of money or the physical situs of payment but rather to the "property, activity or
service which produced the income." In Howden and Co., Ltd. vs. Collector of Internal Revenue,3 the Court
dealt with the issue of the applicable source rule relating to reinsurance premiums paid by a local insurance
company to a foreign reinsurance company in respect of risks located in the Philippines. The Court said:
"The source of an income is the property, activity or service that produced the income. The reinsurance
premiums remitted to appellants by virtue of the reinsurance contracts, accordingly, had for their source the
undertaking to indemnify Commonwealth Insurance Co. against liability. Said undertaking is the activity that
produced the reinsurance premiums, and the same took place in the Philippines.—[T]he reinsured, the
liabilities insured and the risks originally underwritten by Commonwealth Insurance Co., upon which the
reinsurance premiums and indemnity were based, were all situated in the Philippines.—"4
The Court may be seen to be saying that it is the underlying
________________

3 13 SCRA 601 (1965).


4 13 SCRA, at 604; underscoring supplied.
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Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
prestation which is properly regarded as the activity giving rise to the income that is sought to be taxed. In
the Howden case, that underly ing prestation was the indemnification of the local insurance company. Such
indemnification could take place only in the Philippines where the risks were located and where payment
from the foreign reinsurer (in case the casualty insured against occurs) would be received in Philippine
pesos under the reinsurance contract. The Court held accordingly that the reinsurance premiums paid by
the local insurance companies constituted Philippine source income of the foreign reinsurers.
The concept of "source of income" for purposes of income taxation originated in the United States income
tax system. The phrase "sources within the United States" was first introduced into the U.S, tax system in
1916, and was subsequently embodied in the 1939 U.S. Tax Code. As is commonly known, our Tax Code
(Commonwealth Act 466, as amended) was patterned after the 1939 U.S. Tax Code. It therefore seems
useful to refer to a standard U.S. text on federal income taxation:
"The Supreme Court has said, in a definition much quoted but often debated, that income may be derived
from three possible sources only: (1) capital and/or (2) labor and/or (3) the sale of capital assets. While the
three elements of this attempt at definition need not be accepted as all-inclusive, they serve as useful guides
in any inquiry into whether a particular item is from 'sources within the United States' and suggest an
investigation into the nature and location of the activities or property which produce the income. If the
income is from labor (services) the place where the labor is done should be decisive; if it is done in this
country, the income should be from 'sources within the United States.' If the income is from capital, the
place where the capital is employed should be decisive; if it is employed in this country, the income should
be from 'sources within the United States.' If the income is from the sale of capital assets, the place where
the sale is made should be likewise decisive. Much confusion will be avoided by regarding the term 'source'
in this fundamental light It is not a place; it is an activity or property. As such, it has a situs or location; and
if that situs or location is within the United States the resulting income is taxable to non-resident aliens and
foreign corporations. The intention of Congress in the 1916 and
416

416
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
subsequent statutes was to discard the 1909 and 1913 basis of taxing non-resident aliens and foreign
corporations and to make the test of taxability the 'source,' or situs of the activities or property which produce
the income.... Thus, if income is to be taxed, the recipient thereof must be resident within the jurisdiction,
or the property or activities out of which the income issues or is derived must be situated within the
jurisdiction so that the source of the income may be said to have a situs in this country. The underlying
theory is that the consideration for taxation is protection of life and property and that the income rightly to
be levied upon to defray the burdens of the United States Government is that income which is created by
activities and property protected by this Government or obtained by persons enjoying that protection. "5
3. We turn now to the question of what is the source of income rule applicable in the instant case. There
are two possibly relevant source 01 income rules that must be confronted: (a) the source rule applicable in
respect of contracts of service; and (b) the source rule applicable in respect of sales of personal property.
Where a contract for the rendition of service is involved, the applicable source rule may be simply stated
as follows: the income is sourced in the place where the service contracted for is rendered. Section 37 (a)
(3) of our Tax Code reads as follows:
"Section 37. Income from sources within the Philippines.
(a) Gross income from sources within the Philippines.—The following items of gross income shall be treated
as gross income from sources within the Philippines:
x x x
(3) Services.—Compensation for labor or personal services performed in the Philippines; x x x" (Italics
supplied)
Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the
Philippines in the following manner:
________________

5 8 Mertens, Law of Federal Income Taxation, Section 45.27 (1957); underscoring supplied; footnotes
omitted.
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Commissioner of Internal Revenue vs. British Overseas Airways Corporation
"(c) Gross income from sources without the Philippines.—The following items of gross income shall be
treated as income from sources without the Philippines:
(3) Compensation for labor or personal services performed without the Philippines; x x x" (Italics supplied)
It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of services
rendered by individual natural persons; they also apply to services rendered by or through the medium of
a juridical person.6 Further, a contract of carriage or of transportation is assimilated in our Tax Code and
Revenue Regulations to a contract for services. Thus, Section 37 (e) of the Tax Code provides as follows:
"(e) Income from sources partly within and partly without the Philippines.—ltems of gross income, expenses,
losses and deductions, other than those specified in subsections (a) and (c) of this section shall be allocated
or apportioned to sources within or without the Philippines, under the rules and regulations prescribed by
the Secretary of Finance. x x x Gains, profits, and income from (1) transportation or other services rendered
partly within and partly without the Philippines, or (2) from the sale of personal property produced (in whole
or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the
taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and
partly from sources without the Philippines. x x x" (Italics supplied)
It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939 U.S.
Tax Code which "was based upon a recognition that transportation was a service and that the source of
the income derived therefrom was to be treated as being the place where the service of trans-
________________

6 Commissioner v. Hawaiian Philippine Co., 100 F. 2d 988, 991 (9th Cir. 1939), where the Court also
observed that the sugar milling services rendered by the respondent were not any less in the nature of
"personal" services merely because "they were performed, in part, through the use of machinery, or
because of the magnitude of the taxpayers operations," Id.
418

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SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
portation was rendered.''7
Section 37 (e) of the Tax Code quoted above carries a strong, well-nigh irresistible, implication that income
derived from transportation or other services rendered entirely outside the Philippines must be treated as
derived entirely from sources without the Philippines. This implication is reinforced by a consideration of
certain provisions of Revenue Regulations No. 2 entitled "Income Tax Regulations," as amended, first
promulgated by the Department of Finance on 10 February 1940. Section 155 of Revenue Regulations No.
2 (implementing Section 37 of the Tax Code) provides in part as follows:
"Section 155. Compensation for labor or personal services.—Gross income from sources within the
Philippines includes compensation for labor or personal services within the Philippines regardless of the
residence of the payor, of the place in which the contract for services was made, or of the place of
payment.—" (Italics supplied)
Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a
particular species of foreign transportation companies—i.e., foreign steamship companies deriving income
from sources partly within and partly without the Philippines:
"Section 163. Foreign steamship companies.—The returns of foreign steamship companies whose vessels
touch ports of the Philippines should include as gross income, the total receipts of all outgoing business
whether freight or passengers. With the gross income thus ascertained, the ratio existing between it and
the gross income
________________

7 8 Mertens, Id., Section 45.43, which goes on to state that: "It was the intention of Congress under the
1921 law to place the taxation of transportation companies upon a sounder and more scientific basis (rather
than the species of franchise tax previously imposed upon non-residents in general), and so the principle
was adopted of considering income derived from transportation to be income for services, with the result
that the place where the services were rendered determined the source. The result was income from
sources partly within and partly without the United States." Id.) (Italics supplied)
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Commissioner of Internal Revenue vs. British Overseas Airways Corporation
from all ports, both within and without the Philippines of all vessels, whether touching ports of the Philippines
or not, should be determined as the basis upon which allowable deductions may be computed.—." (Italics
supplied)
Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2 (again
implementing Section 37 of the Tax Code) which provides as follows:
"Section 164. Telegraph and cable services.—A foreign corporation carrying on the business of
transmission of telegraph or cable messages between points in the Philippines and points outside the
Philippines derives income partly from sources within and partly from sources without the Philippines.
x x x" (Italics supplied)
Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No. 2 that
steamship and tele-graph and cable services rendered between points both outside the Philippines give
rise to income wholly from sources outside the Philippines, and therefore not subject to Philippine income
taxation.
We turn to the "source of income" rules relating to the sale of personal property, upon the one hand, and to
the purchase and sale of personal property, upon the other hand.
We consider first sales of personal property. Income from the sale of personal property by the producer or
manufacturer of such personal property will be regarded as sourced entirely within or entirely without the
Philippines or as sourced partly within and partly without the Philippines, depending upon two factors: (a)
the place where the sale of such personal property occurs; and (b) the place where such personal property
was produced or manufactured. If the personal property involved was both produced or manufactured and
sold outside the Philippines, the income derived therefrom will be regarded as sourced entirely outside the
Philippines. If, however, the sale took place within the Philippines, although the personal property had been
produced outside the Philippines, or if the sale
420

420
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
of the property takes place outside the Philippines and the personal property was produced in the
Philippines, then, the income derived from the sale will be deemed partly as income sourced within and
partly as income sourced without the Philippines. In other words, the income (and the related expenses,
losses and deductions) will be allocated between sources within and sources without the Philippines. Thus,
Section 37 (e) of the Tax Code, although already quoted above, may be usefully quoted again:
"(e) Income from sources partly within and partly without the Philippines. x x x Gains, profits and income
from (1) transportation or other services rendered partly within and partly without the Philippines; or (2) from
the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the
Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall
be treated as derived partly from sources within and partly from sources without the Philippines. x x x"
(Italics supplied)
In contrast, income derived from the purchase and sale of personal property—i.e., trading—is, under the
Tax Code, regarded as sourced wholly in the place where the personal property is sold. Section 37 (e) of
the Tax Code provides in part as follows:
"(e) Income from sources partly within and partly without the Philippines x x x Gains, profits and income
derived from the purchase of personal property within and its sale without the Philippines or from the
purchase of personal property without and its sale within the Philippines, shall be treated as derived entirely
from sources within the country in which sold," (Italics supplied)
Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:
"Section 159. Sale of personal property, Income derived from the purchase and sale of personal property
shall be treated as derived entirely from the country in which sold The word 'sold' includes 'exchange.' The
'country' in which 'sold' ordinarily means the place
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Commissioner of Internal Revenue vs. British Overseas Airways Corporation
where the property is marketed. This Section does not apply to income from the sale of personal property
produced (in whole or in part) by the taxpayer within and sold without the Philippines or produced (in whole
or in part) by the taxpayer without and sold within the Philippines. (See Section 162 of these regulations).
(Italics supplied)
4. It will be seen that the basic problem is one of characterization of the transactions entered into by BOAC
in the Philippines. Those transactions may be characterized either as sales of personal property (i.e., "sales
of airline tickets") or as entering into a lease of services or a contract of service or carriage. The applicable
"source of income" rules differ depending upon which characterization is given to the BOAC transactions.
The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into contracts
of service, i.e., carriage of passengers or cargo between points located outside the Philippines.
The phrase "sale of airline tickets," while widely used in popular parlance, does not appear to be correct as
a matter of tax law. The airline ticket in and of itself has no monetary value, even as scrap paper. The value
of the ticket lies wholly in the right acquired by the "purchaser"—the passenger—to demand a prestation
from BOAC, which prestation consists of the carriage of the "purchaser" or passenger from one point to
another outside the Philippines. The ticket is really the evidence of the contract of carriage entered into
between BOAC and the passenger. The money paid by the passenger changes hands in the Philippines.
But the passenger does not receive in the Philippines the consideration therefor—the service undertaken
to be delivered by BOAC. The "purchase price of the airline ticket" is quite different from the purchase price
of a physical good or commodity such as a pair of shoes or a refrigerator or an automobile; it is really the
compensation paid for the undertaking of BOAC to transport the passenger or cargo outside the Philippines.
The characterization of the BOAC transactions either as sales of personal property or as purchases and
sales of personal
422

422
SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
property, appear entirely inappropriate from another viewpoint Consider first purchases and sales: is BOAC
properly regarded as engaged in trading—in the purchase and sale of personal property? Certainly, BOAC
was not purchasing tickets outside the Philippines and selling them in the Philippines. Consider next sales:
can BOAC be regarded as "selling" personal property produced or manufactured by it? In a popular or
journalistic sense, BOAC might be described as "selling" "a product"—its services. However, for the
technical purposes of the law on income taxation, BOAC is in fact entering into contracts of service or
carriage. The very existence of "source" rules" specifically and precisely applicable to the rendition of
services must preclude the application here of "source rules" applying generally to sales, and purchases
and sales, of personal property which can be invoked only by the grace of popular language. On a slightly
more abstract level, BOAC's income is more appropriately characterized as derived from a "service??,
rather than from an "activity" (a broader term than service and including the activity of selling) or from the
use of "property." Finally, it is well to recall that what is here involved is income taxation, and not a sales
tax or an excise or privilege tax.
5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as
amended by Presidential Decree No. 69, promulgated on 24 November 1972 and by Presidential Decree
No. 1355, promulgated on 21 April 1978, in the following manner:
"(2) Resident corporations.—A corporation organized, authorized. or existing under the laws of any foreign
country. engaged in trade or business within the Philippines, shall be taxable as provided in subsection (a)
of this section upon the total net income received in the preceding taxable year from all sources within the
Philippines: Provided, however, That international carriers shall pay a tax of two and one-half per cent on
their gross Philippine billings. 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, provided the cargo or mail originates from
the
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Commissioner of lnternal Revenue vs. British Overseas Airways Corporation
Philippines. The gross revenue realized from the said cargo or mail shall include the gross freight charge
up to final destination. Gross revenues from chartered flights originating from the Philippines shall likewise
form part of 'gross Philippine billings' regardless of the place of sale or payment of the passage documents.
For purposes of determining the taxability of revenues from chartered flights, the term 'originating from the
Philippines' shall include flight of passengers who stay in the Philippines for more than forty-eight (48) hours
prior to embarkation." (Italics supplied)
Under the above-quoted proviso, international carriers issuing for compensation passage documentation
in the Philippines for uplifts from any point in the world to any other point in the world, are not charged any
Philippine income tax on their Philippine billings (i.e., billings in respect of passenger or cargo originating
from the Philippines). Under this new approach, international carriers who service ports or points in the
Philippines are treated in exactly the same way as international carriers not servicing any port or point in
the Philippines. Thus, the source of income rule applicable, as above discussed, to transportation or other
services rendered partly within and partly without the Philippines, or wholly without the Philippines, has
been set aside. In place of Philippine income taxation, the Tax Code now imposes this 2½ per cent tax
computed on the basis of billings in respect of passengers and cargo originating from the Philippines
regardless of where embarkation and debarkation would be taking place. This 2-½ per cent tax is effectively
a tax on gross receipts or an excise or privilege tax and not a tax on income. Thereby, the Government has
done away with the difficulties attending the allocation of income and related expenses, losses and
deductions, Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in
the amount of taxes collectible by the state is sometimes, with varying degrees of consciousness,
considered in choosing from among competing possible characterizations under or interpretations of tax
statutes, It is hence perhaps useful to point out that the determination of the appropriate characterization
here—that of contracts of air carriage rather than sales of airline tickets
424

424
SUPREME COURT REPORTS ANNOTATED
United CMC Textile Workers Union vs. Labor Arbiter
—entails no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government
takes in revenues generated by the 2-½ per cent tax on the gross Philippine billings or receipts of
international carriers.
I would vote to affirm the decision of the Court of Tax Appeals.
Decision set aside.
Notes.—Taxes being the chief source of revenue for the Government to keep it running must be paid
immediately and without delay. (Collector of Internal Revenue vs. Yuseco, 3 SCRA 315.)
Taxability of a foreign corporation's income depends upon the locus of the activity, property or service giving
rise thereto. (British Traders Insurance Co., Ltd. vs. Commissioner of lnternal Revenue, 13 SCRA 713.)
Since the items of income not belonging to its Philippine business are not taxable to its Philippine branch,
they should be excluded in determining the head expenses allowable to a Philippine branch of a foreign
corporation. (Commissioner of Internal Revenue vs. Phoenix Assurance Co., Ltd., 14 SCRA 52.)
G.R. No. 169507. January 11, 2016.*

AIR CANADA, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.


Taxation; Air Transportation; Petitioner, as an offline international carrier with no landing rights in the
Philippines, is not liable to tax on Gross Philippine Billings under Section 28(A)(3) of the 1997 National
Internal Revenue Code (NIRC).—At the outset, we affirm the Court of Tax Appeals’ ruling that petitioner,
as an offline international carrier with no landing rights in the Philippines, is not liable to tax on Gross
Philippine Billings under Section 28(A)(3) of the 1997 National Internal Revenue Code: SEC. 28. Rates of
Income Tax on Foreign Corporations.—(A) Tax on Resident Foreign Corporations.—. . . . (3) International
Carrier.—An international carrier doing business in the Philippines shall pay a tax of two and one-half
percent (2 1/2%) on its ‘Gross Philippine Billings’ as defined hereunder: (a) International Air Carrier.—
‘Gross Philippine Billings’ refers to the amount of gross revenue derived from carriage of persons, excess
baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight,
irrespective of the place of sale or issue and the place of payment of the ticket or passage document:
Provided, That tickets revalidated, exchanged and/or indorsed to another international airline form part of
the Gross Philippine Billings if the passenger boards a plane in a port or point in the Philippines: Provided,
further, That for a flight which originates from the Philippines, but transshipment of passenger takes place
at any port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket
corresponding to the leg flown from the Philippines to the point of transshipment shall form part of Gross
Philippine Billings. (Emphasis supplied) Under the foregoing provision, the tax attaches only when the
carriage of persons, excess baggage, cargo, and mail originated from the Philippines in a continuous and
uninterrupted flight, regardless of where the passage documents were sold. Not having flights to and from
the Philippines, petitioner is clearly not liable for the Gross Philippine Billings tax.
_______________

* SECOND DIVISION.

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Same; Resident Foreign Corporation; Petitioner falls within the definition of resident foreign corporation
under Section 28(A)(1) of the 1997 National Internal Revenue Code (NIRC), thus, it may be subject to thirty-
two percent (32%) tax on its taxable income.—Petitioner, an offline carrier, is a resident foreign corporation
for income tax purposes. Petitioner falls within the definition of resident foreign corporation under Section
28(A)(1) of the 1997 National Internal Revenue Code, thus, it may be subject to 32% tax on its taxable
income. x x x The definition of “resident foreign corporation” has not substantially changed through-out the
amendments of the National Internal Revenue Code. All versions refer to “a foreign corporation engaged
in trade or business within the Philippines.” Commonwealth Act No. 466, known as the National Internal
Revenue Code and approved on June 15, 1939, defined “resident foreign corporation” as applying to “a
foreign corporation engaged in trade or business within the Philippines or having an office or place of
business therein.” Section 24(b)(2) of the National Internal Revenue Code, as amended by Republic Act
No. 6110, approved on August 4, 1969, reads: Sec. 24. Rates of tax on corporations.—. . . (b) Tax on
foreign corporations.—. . . (2) Resident corporations.—A corporation organized, authorized, or existing
under the laws of any foreign country, except a foreign life insurance company, engaged in trade or
business within the Philippines, shall be taxable as provided in subsection (a) of this section upon the total
net income received in the preceding taxable year from all sources within the Philippines.
Same; Same; Doing Business; Words and Phrases; The Implementing Rules and Regulations (IRR) of
Republic Act (RA) No. 7042 clarifies that “doing business” includes “appointing representatives or
distributors, operating under full control of the foreign corporation, domiciled in the Philippines or who in
any calendar year stay in the country for a period or periods totaling one hundred eighty (180) days or
more.”—Republic Act No. 7042 or the Foreign Investments Act of 1991 also provides guidance with its
definition of “doing business” with regard to foreign corporations. Section 3(d) of the law enumerates the
activities that constitute doing business: d. the phrase “doing business” shall include soliciting orders,
service contracts, opening offices, whether called “liaison” offices or branches; appointing representatives
or distributors domiciled in the Philippines or who in any calendar year stay in the country for a period or
periods totalling one hundred eighty (180) days or more; participating in the

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management, supervision or control of any domestic business, firm, entity or corporation in the Philippines;
and any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate
to that extent the performance of acts or works, or the exercise of some of the functions normally incident
to, and in progressive prosecution of, commercial gain or of the purpose and object of the business
organization: Provided, however, That the phrase “doing business” shall not be deemed to include mere
investment as a shareholder by a foreign entity in domestic corporations duly registered to do business,
and/or the exercise of rights as such investor; nor having a nominee director or officer to represent its
interests in such corporation; nor appointing a representative or distributor domiciled in the Philippines
which transacts business in its own name and for its own account[.] (Emphasis supplied) While Section
3(d) above states that “appointing a representative or distributor domiciled in the Philippines which transacts
business in its own name and for its own account” is not considered as “doing business,” the Implementing
Rules and Regulations of Republic Act No. 7042 clarifies that “doing business” includes “appointing
representatives or distributors, operating under full control of the foreign corporation, domiciled in the
Philippines or who in any calendar year stay in the country for a period or periods totaling one hundred
eighty (180) days or more[.]”
Air Transportation; Offline Carrier; Words and Phrases; An offline carrier is “any foreign air carrier not
certificated by the [Civil Aeronautics] Board, but who maintains office or who has designated or appointed
agents or employees in the Philippines, who sells or offers for sale any air transportation in behalf of said
foreign air carrier and/or others, or negotiate for, or holds itself out by solicitation, advertisement, or
otherwise sells, provides, furnishes, contracts, or arranges for such transportation.”—An offline carrier is
“any foreign air carrier not certificated by the [Civil Aeronautics] Board, but who maintains office or who has
designated or appointed agents or employees in the Philippines, who sells or offers for sale any air
transportation in behalf of said foreign air carrier and/or others, or negotiate for, or holds itself out by
solicitation, advertisement, or otherwise sells, provides, furnishes, contracts, or arranges for such
transportation.” “Anyone desiring to engage in the activities of an offline carrier [must] apply to the [Civil
Aeronautics] Board for such authority.” Each offline carrier must file with the Civil Aeronautics

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Air Canada vs. Commissioner of Internal Revenue
Board a monthly report containing information on the tickets sold, such as the origin and destination of the
passengers, carriers involved, and commissions received. Petitioner is undoubtedly “doing business” or
“engaged in trade or business” in the Philippines.
Taxation; Resident Foreign Corporation; Petitioner is a resident foreign corporation that is taxable on its
income derived from sources within the Philippines.—Aerotel performs acts or works or exercises functions
that are incidental and beneficial to the purpose of petitioner’s business. The activities of Aerotel bring direct
receipts or profits to petitioner. There is nothing on record to show that Aerotel solicited orders alone and
for its own account and without interference from, let alone direction of, petitioner. On the contrary, Aerotel
cannot “enter into any contract on behalf of [petitioner Air Canada] without the express written consent of
[the latter,]” and it must perform its functions according to the standards required by petitioner. Through
Aerotel, petitioner is able to engage in an economic activity in the Philippines. Further, petitioner was issued
by the Civil Aeronautics Board an authority to operate as an offline carrier in the Philippines for a period of
five years, or from April 24, 2000 until April 24, 2005. Petitioner is a resident foreign corporation that is
taxable on its income derived from sources within the Philippines. Petitioner’s income from sale of airline
tickets, through Aerotel, is income realized from the pursuit of its business activities in the Philippines.
Same; Same; Air Transportation; International air carrier[s] maintain[ing] flights to and from the Philippines
. . . shall be taxed at the rate of two and one-half percent (2 1⁄2%) of its Gross Philippine Billings[;] while
international air carriers that do not have flights to and from the Philippines but nonetheless earn income
from other activities in the country [like sale of airline tickets] will be taxed at the rate of thirty-two percent
(32%) of such [taxable] income.—In the earlier case of South African Airways v. Commissioner of Internal
Revenue, 612 SCRA 665 (2010), this court held that Section 28(A)(3)(a) does not categorically exempt all
international air carriers from the coverage of Section 28(A)(1). Thus, if Section 28(A)(3)(a) is applicable to
a taxpayer, then the general rule under Section 28(A)(1) does not apply. If, however, Section 28(A)(3)(a)
does not apply, an international air carrier would be liable for the tax under Section 28(A)(1). This court in
South African Airways declared that the correct interpretation of

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these provisions is that: “international air carrier[s] maintain[ing] flights to and from the Philippines . . . shall
be taxed at the rate of 2 1/2% of its Gross Philippine Billings[;] while international air carriers that do not
have flights to and from the Philippines but nonetheless earn income from other activities in the country
[like sale of airline tickets] will be taxed at the rate of 32% of such [taxable] income.”
Same; Tax Treaties; Words and Phrases; A tax treaty is an agreement entered into between sovereign
states “for purposes of eliminating double taxation on income and capital, preventing fiscal evasion,
promoting mutual trade and investment, and according fair and equitable tax treatment to foreign residents
or nationals.”—A tax treaty is an agreement entered into between sovereign states “for purposes of
eliminating double taxation on income and capital, preventing fiscal evasion, promoting mutual trade and
investment, and according fair and equitable tax treatment to foreign residents or nationals.” Commissioner
of Internal Revenue v. S.C. Johnson and Son, Inc., 309 SCRA 87 (1999), explained the purpose of a tax
treaty: The purpose of these international agreements is to reconcile the national fiscal legislations of the
contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions.
More precisely, the tax conventions are drafted with a view towards the elimination of international juridical
double taxation, which is defined as the imposition of comparable taxes in two or more states on the same
taxpayer in respect of the same subject matter and for identical periods. The apparent rationale for doing
away with double taxation is to encourage the free flow of goods and services and the movement of capital,
technology and persons between countries, conditions deemed vital in creating robust and dynamic
economies. Foreign investments will only thrive in a fairly predictable and reasonable international
investment climate and the protection against double taxation is crucial in creating such a climate.
Same; Same; Pacta Sunt Servanda; Words and Phrases; Pacta sunt servanda is a fundamental
international law principle that requires agreeing parties to comply with their treaty obligations in good
faith.—Observance of any treaty obligation binding upon the government of the Philippines is anchored on
the constitutional provision that the Philippines “adopts the generally accepted princi-

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Air Canada vs. Commissioner of Internal Revenue
ples of international law as part of the law of the land[.]” Pacta sunt servanda is a fundamental international
law principle that requires agreeing parties to comply with their treaty obligations in good faith.
Same; Same; Same; The application of the provisions of the National Internal Revenue Code (NIRC) must
be subject to the provisions of tax treaties entered into by the Philippines with foreign countries.—The
application of the provisions of the National Internal Revenue Code must be subject to the provisions of tax
treaties entered into by the Philippines with foreign countries. In Deutsche Bank AG Manila Branch v.
Commissioner of Internal Revenue, 704 SCRA 216 (2013), this court stressed the binding effects of tax
treaties. It dealt with the issue of “whether the failure to strictly comply with [Revenue Memorandum Order]
RMO No. 1-2000 will deprive persons or corporations of the benefit of a tax treaty.”
Air Transportation; General Sales Agent; Words and Phrases; Section 3 of Republic Act (RA) No. 776, as
amended, also known as The Civil Aeronautics Act of the Philippines, defines a general sales agent as “a
person, not a bona fide employee of an air carrier, who pursuant to an authority from an airline, by itself or
through an agent, sells or offers for sale any air transportation, or negotiates for, or holds himself out by
solicitation, advertisement or otherwise as one who sells, provides, furnishes, contracts or arranges for,
such air transportation.”—Section 3 of Republic Act No. 776, as amended, also known as The Civil
Aeronautics Act of the Philippines, defines a general sales agent as “a person, not a bona fide employee
of an air carrier, who pursuant to an authority from an airline, by itself or through an agent, sells or offers
for sale any air transportation, or negotiates for, or holds himself out by solicitation, advertisement or
otherwise as one who sells, provides, furnishes, contracts or arranges for, such air transportation.” General
sales agents and their property, property rights, equipment, facilities, and franchise are subject to the
regulation and control of the Civil Aeronautics Board. A permit or authorization issued by the Civil
Aeronautics Board is required before a general sales agent may engage in such an activity.
Same; Same; Aerotel is a dependent agent of petitioner pursuant to the terms of the Passenger General
Sales Agency Agreement executed between the parties.—Aerotel is a dependent agent of petitioner
pursuant to the terms of the Passenger General Sales Agency

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Agreement executed between the parties. It has the authority or power to conclude contracts or bind
petitioner to contracts entered into in the Philippines. A third party liability on contracts of Aerotel is to
petitioner as the principal, and not to Aerotel, and liability to such third party is enforceable against petitioner.
While Aerotel maintains a certain independence and its activities may not be devoted wholly to petitioner,
nonetheless, when representing petitioner pursuant to the Agreement, it must carry out its functions solely
for the benefit of petitioner and according to the latter’s Manual and written instructions. Aerotel is required
to submit its annual sales plan for petitioner’s approval. In essence, Aerotel extends to the Philippines the
transportation business of petitioner. It is a conduit or outlet through which petitioner’s airline tickets are
sold.
Taxation; Income Taxation; Income attributable to Aerotel or from business activities effected by petitioner
through Aerotel may be taxed in the Philippines.—Under Article VII (Business Profits) of the Republic of the
Philippines-Canada Tax Treaty, the “business profits” of an enterprise of a Contracting State is “taxable
only in that State[,] unless the enterprise carries on business in the other Contracting State through a
permanent establishment[.]” Thus, income attributable to Aerotel or from business activities effected by
petitioner through Aerotel may be taxed in the Philippines. However, pursuant to the last paragraph of
Article VII in relation to Article VIII (Shipping and Air Transport) of the same Treaty, the tax imposed on
income derived from the operation of ships or aircraft in international traffic should not exceed 1 1/2% of
gross revenues derived from Philippine sources.
Same; Tax Treaties; Tax treaties form part of the law of the land, and jurisprudence has applied the statutory
construction principle that specific laws prevail over general ones.—While petitioner is taxable as a resident
foreign corporation under Section 28(A)(1) of the 1997 National Internal Revenue Code on its taxable
income from sale of airline tickets in the Philippines, it could only be taxed at a maximum of 1 1/2% of gross
revenues, pursuant to Article VIII of the Republic of the Philippines-Canada Tax Treaty that applies to
petitioner as a “foreign corporation organized and existing under the laws of Canada[.]” Tax treaties form
part of the law of the land, and jurisprudence has applied the statutory construction principle that specific
laws prevail over general ones. The Republic of the Philip-

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pines-Canada Tax Treaty was ratified on December 21, 1977 and became valid and effective on that date.
On the other hand, the applicable provisions relating to the taxability of resident foreign corporations and
the rate of such tax found in the National Internal Revenue Code became effective on January 1, 1998.
Ordinarily, the later provision governs over the earlier one. In this case, however, the provisions of the
Republic of the Philippines-Canada Tax Treaty are more specific than the provisions found in the National
Internal Revenue Code.
Same; Tax Refund; In an action for the refund of taxes allegedly erroneously paid, the Court of Tax Appeals
(CTA) may determine whether there are taxes that should have been paid in lieu of the taxes paid.—In
SMI-ED Philippines Technology, Inc. v. Commissioner of Internal Revenue, 739 SCRA 691 (2014), we have
ruled that “[i]n an action for the refund of taxes allegedly erroneously paid, the Court of Tax Appeals may
determine whether there are taxes that should have been paid in lieu of the taxes paid.” The determination
of the proper category of tax that should have been paid is incidental and necessary to resolve the issue of
whether a refund should be granted.
Same; “Tax” and “Debt,” Distinguished.—Philex Mining Corporation v. Commissioner of Internal Revenue,
294 SCRA 687 (1998), ruled that “[t]here is a material distinction between a tax and debt. Debts are due to
the Government in its corporate capacity, while taxes are due to the Government in its sovereign capacity.”
Rejecting Philex Mining’s assertion that the imposition of surcharge and interest was unjustified because it
had no obligation to pay the excise tax liabilities within the prescribed period since, after all, it still had
pending claims for VAT input credit/refund with the Bureau of Internal Revenue.
Same; Offsetting; The taxpayer cannot simply refuse to pay tax on the ground that the tax liabilities were
offset against any alleged claim the taxpayer may have against the government.—In sum, the rulings in
those cases were to the effect that the taxpayer cannot simply refuse to pay tax on the ground that the tax
liabilities were offset against any alleged claim the taxpayer may have against the government. Such would
merely be in keeping with the basic policy on prompt collection of taxes as the lifeblood of the government.
Here, what is involved is a denial of a taxpayer’s refund claim on

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account of the Court of Tax Appeals’ finding of its liability for another tax in lieu of the Gross Philippine
Billings tax that was allegedly erroneously paid.
PETITION for review on certiorari of the decision and resolution of the Court of Tax Appeals.
The facts are stated in the opinion of the Court.
Quisumbing, Torres for petitioner.
The Solicitor General for respondent.
LEONEN, J.:

An offline international air carrier selling passage tickets in the Philippines, through a general sales agent,
is a resident foreign corporation doing business in the Philippines. As such, it is taxable under Section
28(A)(1), and not Section 28(A)(3) of the 1997 National Internal Revenue Code, subject to any applicable
tax treaty to which the Philippines is a signatory. Pursuant to Article 8 of the Republic of the Philippines-
Canada Tax Treaty, Air Canada may only be imposed a maximum tax of 1 1/2% of its gross revenues
earned from the sale of its tickets in the Philippines.
This is a Petition for Review1 appealing the August 26, 2005 Decision2 of the Court of Tax Appeals En
Banc, which in turn affirmed the December 22, 2004 Decision3 and April 8,
_______________

1 Rollo, pp. 9-40. The Petition was filed pursuant to Rule 45 of the Rules of Court.
2 Id., at pp. 57-72. The Decision was penned by Associate Justice Olga Palanca-Enriquez and concurred
in by Presiding Justice Ernesto D. Acosta and Associate Justices Lovell R. Bautista, Erlinda P. Uy, and
Caesar A. Casanova. Associate Justice Juanito C. Castañeda, Jr. voluntarily inhibited himself.
3 Id., at pp. 41-51. The Decision was penned by Associate Justice Lovell R. Bautista and concurred in by
Presiding Justice Ernesto D. Acosta and Associate Justice Caesar A. Casanova.

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Air Canada vs. Commissioner of Internal Revenue
2005 Resolution4 of the Court of Tax Appeals First Division denying Air Canada’s claim for refund.
Air Canada is a “foreign corporation organized and existing under the laws of Canada[.]”5 On April 24,
2000, it was granted an authority to operate as an offline carrier by the Civil Aeronautics Board, subject to
certain conditions, which authority would expire on April 24, 2005.6 “As an offline carrier, [Air Canada] does
not have flights originating from or coming to the Philippines [and does not] operate any airplane [in] the
Philippines[.]”7
On July 1, 1999, Air Canada engaged the services of Aerotel Ltd., Corp. (Aerotel) as its general sales agent
in the Philippines.8 Aerotel “sells [Air Canada’s] passage documents in the Philippines.”9
For the period ranging from the third quarter of 2000 to the second quarter of 2002, Air Canada, through
Aerotel, filed quarterly and annual income tax returns and paid the income tax on Gross Philippine Billings
in the total amount of P5,185,676.77,10 detailed as follows:

_______________

4 Id., at pp. 52-56. The Resolution was signed by Presiding Justice Ernesto D. Acosta and Associate
Justices Lovell R. Bautista and Caesar A. Casanova.
5 Id., at p. 59, Court of Tax Appeals En Banc Decision.
6 Id., at p. 78, Civil Aeronautics Board Executive Director’s Letter.
7 Id., at p. 300, Air Canada’s Memorandum.
8 Id., at pp. 118-140, Passenger General Sales Agency Agreement Between Air Canada and Aerotel Ltd.,
Corp.
9 Id., at p. 300, Air Canada’s Memorandum.
10 Id., at pp. 59-60, Court of Tax Appeals En Banc Decision.

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Air Canada vs. Commissioner of Internal Revenue
3rd Qtr 2001 November 29, 2001 765,021.28
Annual ITR 2001 April 15, 2002 328,193.93
1st Qtr 2002 May 30, 2002 P594,850.13
2nd Qtr 2002 August 29, 2002 1,164,664.11
TOTAL
P5,185,676.7711

On November 28, 2002, Air Canada filed a written claim for refund of alleged erroneously paid income
taxes amounting to P5,185,676.77 before the Bureau of Internal Revenue,12 Revenue District Office No.
47-East Makati.13 It found basis from the revised definition14 of Gross Philippine Billings under Section
28(A)(3)(a) of the 1997 National Internal Revenue Code:

SEC. 28. Rates of Income Tax on Foreign Corporations.—


(A) Tax on Resident Foreign Corporations.—
....
_______________

11 Id.
12 Id., at p. 60.
13 Id., at p. 13, Petition.
14 Pres. Decree No. 1355 (1978), Sec. 1 defines Gross Philippine Billings as: “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, provided the cargo or mail originates from the Philippines. The gross revenue realized from the said
cargo or mail shall include the gross freight charge up to final destination. Gross revenues from chartered
flights originating from the Philippines shall likewise form part of “gross Philippine billings” regardless of the
place of sale or payment of the passage documents. For purposes of determining the taxability of revenues
from chartered flights, the term “originating from the Philippines” shall include flight of passengers who stay
in the Philippines for more than forty-eight (48) hours prior to embarkation. (Emphasis supplied)

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(3) International Carrier.—An international carrier doing business in the Philippines shall pay a tax of two
and one-half percent (2 1/2%) on its ‘Gross Philippine Billings’ as defined hereunder:
(a) International Air Carrier.—‘Gross Philippine Billings’ refers to the amount of gross revenue derived
from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous
and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or
passage document: Provided, That tickets revalidated, exchanged and/or indorsed to another international
airline form part of the Gross Philippine Billings if the passenger boards a plane in a port or point in the
Philippines: Provided, further, That for a flight which originates from the Philippines, but transshipment of
passenger takes place at any port outside the Philippines on another airline, only the aliquot portion of the
cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment shall form
part of Gross Philippine Billings. (Emphasis supplied)

To prevent the running of the prescriptive period, Air Canada filed a Petition for Review before the Court of
Tax Appeals on November 29, 2002.15 The case was docketed as CTA Case No. 6572.16
On December 22, 2004, the Court of Tax Appeals First Division rendered its Decision denying the Petition
for Review and, hence, the claim for refund.17 It found that Air Canada was engaged in business in the
Philippines through a local agent that sells airline tickets on its behalf. As such, it should be taxed as a
resident foreign corporation at the regular rate
_______________

15 Rollo, p. 60, Court of Tax Appeals En Banc Decision.


16 Id., at p. 41, Court of Tax Appeals First Division Decision.
17 Id., at p. 51.

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Air Canada vs. Commissioner of Internal Revenue
of 32%.18 Further, according to the Court of Tax Appeals First Division, Air Canada was deemed to have
established a “permanent establishment”19 in the Philippines under Article V(2)(i) of the Republic of the
Philippines-Canada Tax Treaty20 by the appointment of the local sales agent, “in which [the] petitioner
uses its premises as an outlet where sales of [airline] tickets are made[.]”21
Air Canada seasonably filed a Motion for Reconsideration, but the Motion was denied in the Court of Tax
Appeals First Division’s Resolution dated April 8, 2005 for lack of merit.22 The First Division held that while
Air Canada was not liable for tax on its Gross Philippine Billings under Section 28(A)(3), it was nevertheless
liable to pay the 32% corporate income tax on income derived from the sale of airline tickets within the
Philippines pursuant to Section 28(A)(1).23
On May 9, 2005, Air Canada appealed to the Court of Tax Appeals En Banc.24 The appeal was docketed
as C.T.A. E.B. No. 86.25
In the Decision dated August 26, 2005, the Court of Tax Appeals En Banc affirmed the findings of the First
Division.26 The En Banc ruled that Air Canada is subject to tax as a resident foreign corporation doing
business in the Philippines since it sold airline tickets in the Philippines.27 The Court of Tax Appeals En
Banc disposed thus:
_______________

18 Id., at pp. 47-48.


19 Id., at p. 51.
20 Id., at p. 50.
21 Id., at p. 51.
22 Id., at pp. 53 and 56, Court of Tax Appeals First Division Resolution.
23 Id., at p. 54.
24 Id., at p. 16, Petition.
25 Id.
26 Id., at p. 71, Court of Tax Appeals En Banc Decision.
27 Id., at pp. 67-68.

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WHEREFORE, premises considered, the instant petition is hereby DENIED DUE COURSE, and
accordingly, DISMISSED for lack of merit.28

Hence, this Petition for Review29 was filed.


The issues for our consideration are:
First, whether petitioner Air Canada, as an offline international carrier selling passage documents through
a general sales agent in the Philippines, is a resident foreign corporation within the meaning of Section
28(A)(1) of the 1997 National Internal Revenue Code;
Second, whether petitioner Air Canada is subject to the
2 1/2% tax on Gross Philippine Billings pursuant to Section 28(A)(3). If not, whether an offline international
carrier selling passage documents through a general sales agent can be subject to the regular corporate
income tax of 32%30 on taxable income pursuant to Section 28(A)(1);
Third, whether the Republic of the Philippines-Canada Tax Treaty applies, specifically:
a. Whether the Republic of the Philippines-Canada Tax Treaty is enforceable;
b. Whether the appointment of a local general sales agent in the Philippines falls under the definition of
“permanent establishment” under Article V(2)(i) of
_______________

28 Id., at p. 71.
29 The Petition was received by the court on October 20, 2005. Respondent filed its Comment (id., at pp.
252-261) on August 6, 2007. Subsequently, pursuant to the court’s Resolution (id., at pp. 282-283) dated
November 28, 2007, petitioner filed its Memorandum (id., at pp. 284-328) on February 21, 2008 and
respondent filed its Manifestation (id., at pp. 349-350) on January 5, 2009, stating that it is adopting its
Comment as its Memorandum.
30 Pursuant to Rep. Act No. 9337 (2005), the rate is reduced to 30% beginning January 1, 2009.
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Air Canada vs. Commissioner of Internal Revenue
the Republic of the Philippines-Canada Tax Treaty; and
Lastly, whether petitioner Air Canada is entitled to the refund of P5,185,676.77 pertaining allegedly to
erroneously paid tax on Gross Philippine Billings from the third quarter of 2000 to the second quarter of
2002.
Petitioner claims that the general provision imposing the regular corporate income tax on resident foreign
corporations provided under Section 28(A)(1) of the 1997 National Internal Revenue Code does not apply
to “international carriers,”31 which are especially classified and taxed under Section 28(A)(3).32 It adds
that the fact that it is no longer subject to Gross Philippine Billings tax as ruled in the assailed Court of Tax
Appeals Decision “does not render it ipso facto subject to 32% income tax on taxable income as a resident
foreign corporation.”33 Petitioner argues that to impose the 32% regular corporate income tax on its income
would violate the Philippine government’s covenant under Article VIII of the Republic of the Philippines-
Canada Tax Treaty not to impose a tax higher than 1 1/2% of the carrier’s gross revenue derived from
sources within the Philippines.34 It would also allegedly result in “inequitable tax treatment of online and
offline international air carriers[.]”35
Also, petitioner states that the income it derived from the sale of airline tickets in the Philippines was income
from services and not income from sales of personal property.36 Petitioner cites the deliberations of the
Bicameral Conference Committee on House Bill No. 9077 (which eventually became the 1997 National
Internal Revenue Code), particularly Sena-
_______________

31 Rollo, p. 22, Petition, and p. 307, Air Canada’s Memorandum.


32 Id.
33 Id., at p. 28, Petition.
34 Id., at pp. 23-24, Petition, and p. 315, Air Canada’s Memorandum.
35 Id., at p. 319, Air Canada’s Memorandum.
36 Id., at pp. 28-29, Petition.

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SUPREME COURT REPORTS ANNOTATED
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tor Juan Ponce Enrile’s statement,37 to reveal the “legislative intent to treat the revenue derived from air
carriage as income from services, and that the carriage of passenger or cargo as the activity that generates
the income.”38 Accordingly, applying the principle on the situs of taxation in taxation of services, petitioner
claims that its income derived “from services rendered outside the Philippines [was] not subject to Philippine
income taxation.”39
Petitioner further contends that by the appointment of Aerotel as its general sales agent, petitioner cannot
be considered to have a “permanent establishment”40 in the Philippines pursuant to Article V(6) of the
Republic of the Philippines-Canada Tax Treaty.41 It points out that Aerotel is an “independent general sales
agent that acts as such for . . . other international airline companies in the ordinary course of its business.”42
Aerotel sells passage tickets on behalf of petitioner and receives a commission for its services.43 Petitioner
states that even the Bureau of Internal Revenue — through VAT Ruling No. 003-04 dated February 14,
2004 — has conceded that an offline international air carrier, having no flight operations to and from the
Philippines, is not deemed engaged in business in the Philippines by merely appointing a
_______________

37 Id., at p. 29. According to Senator Juan Ponce Enrile, “the gross Philippine billings of international air
carriers must refer to flown revenue because this is an income from services and this will make the
determination of the tax base a lot easier by following the same rule in determining the liability of the carrier
for common carrier’s tax.” (Minutes of the Bicameral Conference Committee on House Bill No. 9077
[Comprehensive Tax Reform Program], 10 October 1997, pp. 19-20)
38 Id.
39 Id., at p. 313, Air Canada’s Memorandum.
40 Id., at p. 35, Petition.
41 Id., Petition, and p. 322, Air Canada’s Memorandum.
42 Id., at p. 321, Air Canada’s Memorandum.
43 Id., at p. 35, Petition.

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general sales agent.44 Finally, petitioner maintains that its “claim for refund of erroneously paid Gross
Philippine Billings cannot be denied on the ground that [it] is subject to income tax under Section 28(A)(1)”45
since it has not been assessed at all by the Bureau of Internal Revenue for any income tax liability.46
On the other hand, respondent maintains that petitioner is subject to the 32% corporate income tax as a
resident foreign corporation doing business in the Philippines. Petitioner’s total payment of P5,185,676.77
allegedly shows that petitioner was earning a sizable income from the sale of its plane tickets within the
Philippines during the relevant period.47 Respondent further points out that this court in Commissioner of
Internal Revenue v. American Airlines, Inc.,48 which in turn cited the cases involving the British Overseas
Airways Corporation and Air India, had already settled that “foreign airline companies which sold tickets in
the Philippines through their local agents . . . [are] considered resident foreign corporations engaged in
trade or business in the country.”49 It also cites Revenue Regulations No. 6-78 dated April 25, 1978, which
defined the phrase “doing business in the Philippines” as including “regular sale of tickets in the Philippines
by offline international airlines either by themselves or through their agents.”50
Respondent further contends that petitioner is not entitled to its claim for refund because the amount of
P5,185,676.77 it paid as tax from the third quarter of 2000 to the second quar-
_______________

44 Id., at pp. 35-36, Petition, and pp. 322-323, Air Canada’s Memorandum.
45 Id., at p. 37, Petition, and p. 325, Air Canada’s Memorandum.
46 Id., Petition, and pp. 325-326, Air Canada’s Memorandum.
47 Id., at p. 256, Commissioner of Internal Revenue’s Comment.
48 259 Phil. 757; 180 SCRA 274 (1989) [Per J. Regalado, Second Division].
49 Rollo, p. 258, Commissioner of Internal Revenue’s Comment.
50 Id., at p. 257.

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ter of 2001 was still short of the 32% income tax due for the period.51 Petitioner cannot allegedly claim
good faith in its failure to pay the right amount of tax since the National Internal Revenue Code became
operative on January 1, 1998 and by 2000, petitioner should have already been aware of the implications
of Section 28(A)(3) and the decided cases of this court’s ruling on the taxability of offline international
carriers selling passage tickets in the Philippines.52

I
At the outset, we affirm the Court of Tax Appeals’ ruling that petitioner, as an offline international carrier
with no landing rights in the Philippines, is not liable to tax on Gross Philippine Billings under Section
28(A)(3) of the 1997 National Internal Revenue Code:

SEC. 28. Rates of Income Tax on Foreign Corporations.—


(A) Tax on Resident Foreign Corporations.—
....
(3) International Carrier.—An international carrier doing business in the Philippines shall pay a tax of two
and one-half percent (2 1/2%) on its ‘Gross Philippine Billings’ as defined hereunder:
(a) International Air Carrier.—‘Gross Philippine Billings’ refers to the amount of gross revenue derived
from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous
and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or
passage document: Provided, That tickets revalidated, exchanged and/or indorsed to another international
airline form part of the Gross
_______________

51 Id., at p. 260.
52 Id., at pp. 260-261.

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Philippine Billings if the passenger boards a plane in a port or point in the Philippines: Provided, further,
That for a flight which originates from the Philippines, but transshipment of passenger takes place at any
port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket corresponding
to the leg flown from the Philippines to the point of transshipment shall form part of Gross Philippine Billings.
(Emphasis supplied)

Under the foregoing provision, the tax attaches only when the carriage of persons, excess baggage, cargo,
and mail originated from the Philippines in a continuous and uninterrupted flight, regardless of where the
passage documents were sold.
Not having flights to and from the Philippines, petitioner is clearly not liable for the Gross Philippine Billings
tax.

II

Petitioner, an offline carrier, is a resident foreign corporation for income tax purposes. Petitioner falls within
the definition of resident foreign corporation under Section 28(A)(1) of the 1997 National Internal Revenue
Code, thus, it may be subject to 32%53 tax on its taxable income:

SEC. 28. Rates of Income Tax on Foreign Corporations.—


(A) Tax on Resident Foreign Corporations.—
(1) In General.—Except as otherwise provided in this Code, a corporation organized, authorized, or
existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be
subject to an income tax equiva-
_______________

53 Pursuant to Rep. Act No. 9337 (2005), the rate is reduced to 30% beginning January 1, 2009.

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lent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources
within the Philippines: Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four
percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and effective January
1, 2000 and there-after, the rate shall be thirty-two percent (32%).54 (Emphasis supplied)

The definition of “resident foreign corporation” has not substantially changed throughout the amendments
of the National Internal Revenue Code. All versions refer to “a foreign corporation engaged in trade or
business within the Philippines.”
Commonwealth Act No. 466, known as the National Internal Revenue Code and approved on June 15,
1939, defined “resident foreign corporation” as applying to “a foreign corporation engaged in trade or
business within the Philippines or having an office or place of business therein.”55

Section 24(b)(2) of the National Internal Revenue Code, as amended by Republic Act No. 6110, approved
on August 4, 1969, reads:
Sec. 24. Rates of tax on corporations.—. . .
(b) Tax on foreign corporations.—. . .
(2) Resident corporations.—A corporation organized, authorized, or existing under the laws of any foreign
country, except a foreign life insurance company, engaged in trade or business within the Philippines, shall
be taxable as provided in subsection (a) of this section upon the total net income received in the preceding
taxable year
_______________

54 Id.
55 Com. Act No. 466 (1939), Sec. 84(g).

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from all sources within the Philippines.56 (Emphasis supplied)

Presidential Decree No. 1158-A took effect on June 3, 1977 amending certain sections of the 1939 National
Internal Revenue Code. Section 24(b)(2) on foreign resident corporations was amended, but it still provides
that “[a] corporation organized, authorized, or existing under the laws of any foreign country, engaged in
trade or business within the Philippines, shall be taxable as provided in subsection (a) of this section upon
the total net income received in the preceding taxable year from all sources within the Philippines[.]”57
As early as 1987, this court in Commissioner of Internal Revenue v. British Overseas Airways
Corporation58 declared British Overseas Airways Corporation, an international air carrier with no landing
rights in the Philippines, as a resident foreign corporation engaged in business in the Philippines through
its local sales agent that sold and issued tickets for the airline company.59 This court discussed that:

There is no specific criterion as to what constitutes “doing” or “engaging in” or “transacting” business. Each
case must be judged in the light of its peculiar environmental circumstances. The term implies a continuity
of commer-cial dealings and arrangements, and contemplates, to that extent, the performance of acts or
works or the exercise of some of the functions nor-

_______________

56 Commissioner of Internal Revenue v. British Overseas Airways Corporation, 233 Phil. 406, 421; 149
SCRA 395, 406 (1987) [Per J. Melencio-Herrera, En Banc], citing Tax Code, Sec. 24(b)(2), as amended by
Rep. Act No. 6110 (1969).
57 Pres. Decree No. 1158-A (1977), Sec. 1.
58 Commissioner of Internal Revenue v. British Overseas Airways Corporation, supra, cited in
Commissioner of Internal Revenue v. Air India, 241 Phil. 689, 694-696; 157 SCRA 648, 652 (1988) [Per J.
Gancayco, First Division].
59 Id., at pp. 420-421; p. 404.

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mally incident to, and in progressive prosecution of commercial gain or for the purpose and object of the
business organization. “In order that a foreign cor­poration may be regarded as doing business within a
State, there must be continuity of conduct and intention to establish a continuous business, such as the
appointment of a local agent, and not one of a temporary character.[”]
BOAC, during the periods covered by the subject-assessments, maintained a general sales agent in the
Philippines. That general sales agent, from 1959 to 1971, “was engaged in (1) selling and issuing tickets;
(2) breaking down the whole trip into series of trips — each trip in the series corresponding to a different
airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various
airline companies on the basis of their participation in the services rendered through the mode of interline
settlement as prescribed by Article VI of the Resolution No. 850 of the IATA Agreement.” Those activities
were in exercise of the functions which are normally incident to, and are in progressive pursuit of, the
purpose and object of its organization as an international air carrier. In fact, the regular sale of tickets, its
main activity, is the very lifeblood of the airline business, the generation of sales being the paramount
objective. There should be no doubt then that BOAC was “engaged in” business in the Philippines through
a local agent during the period covered by the assessments. Accordingly, it is a resident foreign corporation
subject to tax upon its total net income received in the preceding taxable year from all sources within the
Philippines.60 (Emphasis supplied, citations omitted)

Republic Act No. 7042 or the Foreign Investments Act of 1991 also provides guidance with its definition of
“doing business” with regard to foreign corporations. Section 3(d) of the law enumerates the activities that
constitute doing business:
_______________

60 Id.

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d. the phrase “doing business” shall include soliciting orders, service contracts, opening offices, whether
called “liaison” offices or branches; appointing representatives or distributors domiciled in the Philippines
or who in any calendar year stay in the country for a period or periods totalling one hundred eighty (180)
days or more; participating in the management, supervision or control of any domestic business, firm, entity
or corporation in the Philippines; and any other act or acts that imply a continuity of commercial dealings or
arrangements, and contemplate to that extent the performance of acts or works, or the exercise of some of
the functions normally incident to, and in progressive prosecution of, commercial gain or of the purpose and
object of the business organization: Provided, however, That the phrase “doing business” shall not be
deemed to include mere investment as a shareholder by a foreign entity in domestic corporations duly
registered to do business, and/or the exercise of rights as such investor; nor having a nominee director or
officer to represent its interests in such corporation; nor appointing a representative or distributor domiciled
in the Philippines which transacts business in its own name and for its own account[.]61 (Emphasis
supplied)
While Section 3(d) above states that “appointing a representative or distributor domiciled in the Philippines
which transacts business in its own name and for its own account” is not considered as “doing business,”
the Implementing Rules and Regulations of Republic Act No. 7042 clarifies that “doing business” includes
“appointing representatives or distributors, operating under full control of the foreign corporation, domiciled
in the Philippines or who in any calendar year stay
_______________

61 Rep. Act No. 7042 (1991), Sec. 3(d).

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in the country for a period or periods totaling one hundred eighty (180) days or more[.]”62
An offline carrier is “any foreign air carrier not certificated by the [Civil Aeronautics] Board, but who maintains
office or who has designated or appointed agents or employees in the Philippines, who sells or offers for
sale any air transportation in behalf of said foreign air carrier and/or others, or negotiate for, or holds itself
out by solicitation, advertisement, or otherwise sells, provides, furnishes, contracts, or arranges for such
transportation.”63
“Anyone desiring to engage in the activities of an offline carrier [must] apply to the [Civil Aeronautics] Board
for such authority.”64 Each offline carrier must file with the Civil Aeronautics Board a monthly report
containing information on the tickets sold, such as the origin and destination of the passengers, carriers
involved, and commissions received.65
Petitioner is undoubtedly “doing business” or “engaged in trade or business” in the Philippines.
Aerotel performs acts or works or exercises functions that are incidental and beneficial to the purpose of
petitioner’s business. The activities of Aerotel bring direct receipts or profits to petitioner.66 There is nothing
on record to show that Aerotel solicited orders alone and for its own account and
_______________

62 Implementing Rules and Regulations of Rep. Act No. 7042 (1991), Sec. 1(f).
63 Civil Aeronautics Board Economic Regulation No. 4, Chap. I, Sec. 2(b).
64 Civil Aeronautics Board Economic Regulation No. 4, Chap. III, Sec. 26.
65 Civil Aeronautics Board Economic Regulation No. 4, Chap. III, Sec. 30.
66 Cf. Cargill, Inc. v. Intra Strata Assurance Corporation, 629 Phil. 320, 332; 615 SCRA 304, 314 (2010)
[Per J. Carpio, Second Division], citing National Sugar Trading Corporation v. Court of Appeals, 316 Phil.
562, 568-569; 246 SCRA 465, 469 (1995) [Per J. Quiason, First Division].

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without interference from, let alone direction of, petitioner. On the contrary, Aerotel cannot “enter into any
contract on behalf of [petitioner Air Canada] without the express written consent of [the latter,]”67 and it
must perform its functions according to the standards required by petitioner.68 Through Aerotel, petitioner
is able to engage in an economic activity in the Philippines.
Further, petitioner was issued by the Civil Aeronautics Board an authority to operate as an offline carrier in
the Philippines for a period of five years, or from April 24, 2000 until April 24, 2005.69
Petitioner is, therefore, a resident foreign corporation that is taxable on its income derived from sources
within the Philippines. Petitioner’s income from sale of airline tickets, through Aerotel, is income realized
from the pursuit of its business activities in the Philippines.

III
However, the application of the regular 32% tax rate under Section 28(A)(1) of the 1997 National Internal
Revenue Code must consider the existence of an effective tax treaty between the Philippines and the home
country of the foreign air carrier.
In the earlier case of South African Airways v. Commissioner of Internal Revenue,70 this court held that
Section 28(A)(3)(a) does not categorically exempt all international air carriers from the coverage of Section
28(A)(1). Thus, if Section
_______________

67 Rollo, p. 122, Passenger General Sales Agency Agreement Between Air Canada and Aerotel Ltd.,
Corp.
68 Id., at p. 126.
69 Id., at p. 78, Civil Aeronautics Board Executive Director Guia Martinez’s letter to Aerotel Limited
Corporation.
70 626 Phil. 566; 612 SCRA 665 (2010) [Per J. Velasco, Jr., Third Division]. The case was also cited in
United Airlines, Inc. v. Commissioner of Internal Revenue, 646 Phil. 184, 193; 631 SCRA 567, 576 (2010)
[Per J. Villarama, Jr., Third Division].

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28(A)(3)(a) is applicable to a taxpayer, then the general rule under Section 28(A)(1) does not apply. If,
however, Section 28(A)(3)(a) does not apply, an international air carrier would be liable for the tax under
Section 28(A)(1).71
This court in South African Airways declared that the correct interpretation of these provisions is that:
“international air carrier[s] maintain[ing] flights to and from the Philippines . . . shall be taxed at the rate of
2 1/2% of its Gross Philippine Billings[;] while international air carriers that do not have flights to and from
the Philippines but nonetheless earn income from other activities in the country [like sale of airline tickets]
will be taxed at the rate of 32% of such [taxable] income.”72
In this case, there is a tax treaty that must be taken into consideration to determine the proper tax rate.
A tax treaty is an agreement entered into between sovereign states “for purposes of eliminating double
taxation on income and capital, preventing fiscal evasion, promoting mutual trade and investment, and
according fair and equitable tax treatment to foreign residents or nationals.”73 Commissioner of Internal
Revenue v. S.C. Johnson and Son, Inc.74 explained the purpose of a tax treaty:

The purpose of these international agreements is to reconcile the national fiscal legislations of the
contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions.
More precisely, the tax conventions are drafted with a view towards the
_______________

71 Id., at pp. 574-575; p. 675.


72 Id., at p. 575; p. 675.
73 J. Paras, Dissenting Opinion in Commissioner of Internal Revenue v. Procter & Gamble Philippine
Manufacturing Corporation, G.R. No. 66838, December 2, 1991, 204 SCRA 377, 411 [Per J. Feliciano, En
Banc].
74 368 Phil. 388; 309 SCRA 87 (1999) [Per J. Gonzaga-Reyes, Third Division].

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elimination of international juridical double taxation, which is defined as the imposition of comparable taxes
in two or more states on the same taxpayer in respect of the same subject matter and for identical periods.
The apparent rationale for doing away with double taxation is to encourage the free flow of goods and
services and the movement of capital, technology and persons between countries, conditions deemed vital
in creating robust and dynamic economies. Foreign investments will only thrive in a fairly predictable and
reasonable international investment climate and the protection against double taxation is crucial in creating
such a climate.75 (Emphasis in the original, citations omitted)

Observance of any treaty obligation binding upon the government of the Philippines is anchored on the
constitutional provision that the Philippines “adopts the generally accepted principles of international law as
part of the law of the land[.]”76 Pacta sunt servanda is a fundamental international law principle that requires
agreeing parties to comply with their treaty obligations in good faith.77
_______________

75 Id., at pp. 404-405; pp. 101-102.


76 Const., Art. II, Sec. 2.
77 Tañada v. Angara, 338 Phil. 546, 591-592; 272 SCRA 18, 66 (1997) [Per J. Panganiban, En Banc]:
“[W]hile sovereignty has traditionally been deemed absolute and all-encompassing on the domestic level,
it is however subject to restrictions and limitations voluntarily agreed to by the Philippines, expressly or
impliedly, as a member of the family of nations. Unquestionably, the Constitution did not envision a hermit-
type isolation of the country from the rest of the world. In its Declaration of Principles and State Policies,
the Constitution “adopts the generally accepted principles of international law as part of the law of the land,
and adheres to the policy of peace, equality, justice, freedom, cooperation and amity, with all nations.” By
the doctrine of incorporation, the country is bound by generally accepted principles of international law,
which are considered to be automatically part of our own laws. One of the oldest and most fundamental
rules in international law is pacta sunt servanda — inter-

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Hence, the application of the provisions of the National Inter-nal Revenue Code must be subject to the
provisions of tax treaties entered into by the Philippines with foreign countries.
In Deutsche Bank AG Manila Branch v. Commissioner of Internal Revenue,78 this court stressed the
binding effects of tax treaties. It dealt with the issue of “whether the failure to strictly comply with [Revenue
Memorandum Order] RMO No. 1-200079 will deprive persons or corporations of the benefit of a tax
treaty.”80 Upholding the tax treaty over the administrative issuance, this court reasoned thus:

Our Constitution provides for adherence to the general principles of international law as part of the law of
the land. The time-honored international principle of pacta sunt servanda demands the performance in good
faith of treaty obligations on the part of the states that enter into the agreement. Every treaty in force is
binding
_______________

national agreements must be performed in good faith. “A treaty engagement is not a mere moral obligation
but creates a legally binding obligation on the parties. . . . A state which has contracted valid international
obligations is bound to make in its legislations such modifications as may be necessary to ensure the
fulfillment of the obligations undertaken.” (Citations omitted)
78 G.R. No. 188550, August 28, 2013, 704 SCRA 216 [Per CJ. Sereno, First Division]. Also cited in CBK
Power Company Limited v. Commissioner of Internal Revenue, G.R. Nos. 193383-84, January 14, 2015,
746 SCRA 93, 102 [Per J. Perlas-Bernabe, First Division].
79 Id., at p. 223. The Bureau of Internal Revenue “issued RMO No. 1-2000, which requires that any
availment of the tax treaty relief must be preceded by an application with ITAD at least 15 days before the
transaction. The Order was issued to streamline the processing of the application of tax treaty relief in order
to improve efficiency and service to the taxpayers. Further, it also aims to prevent the consequences of an
erroneous interpretation and/or application of the treaty provisions (i.e., filing a claim for a tax refund/credit
for the overpayment of taxes or for deficiency tax liabilities for underpayment).” (Citation omitted)
80 Id.

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upon the parties, and obligations under the treaty must be performed by them in good faith. More
importantly, treaties have the force and effect of law in this jurisdiction.
Tax treaties are entered into “to reconcile the national fiscal legislations of the contracting parties and, in
turn, help the taxpayer avoid simultaneous taxations in two different jurisdictions.” CIR v. S.C. Johnson and
Son, Inc. further clarifies that “tax conventions are drafted with a view towards the elimination of
international juridical double taxation, which is defined as the imposition of comparable taxes in two or more
states on the same taxpayer in respect of the same subject matter and for identical periods. The apparent
rationale for doing away with double taxation is to encourage the free flow of goods and services and the
movement of capital, technology and persons between countries, conditions deemed vital in creating robust
and dynamic economies. Foreign investments will only thrive in a fairly predictable and reasonable
international investment climate and the protection against double taxation is crucial in creating such a
climate.” Simply put, tax treaties are entered into to minimize, if not eliminate the harshness of international
juridical double taxation, which is why they are also known as double tax treaty or double tax agreements.
“A state that has contracted valid international obligations is bound to make in its legislations those
modifications that may be necessary to ensure the fulfillment of the obligations undertaken.” Thus, laws
and issuances must ensure that the reliefs granted under tax treaties are accorded to the parties entitled
thereto. The BIR must not impose additional requirements that would negate the availment of the reliefs
provided for under international agreements. More so, when the RP-Germany Tax Treaty does not provide
for any prerequisite for the availment of the benefits under said agreement.
....
Bearing in mind the rationale of tax treaties, the period of application for the availment of tax treaty relief as
required by RMO No. 1-2000 should not operate to di-

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vest entitlement to the relief as it would constitute a violation of the duty required by good faith in complying
with a tax treaty. The denial of the availment of tax relief for the failure of a taxpayer to apply within the
prescribed period under the administrative issuance would impair the value of the tax treaty. At most, the
application for a tax treaty relief from the BIR should merely operate to confirm the entitlement of the
taxpayer to the relief.
The obligation to comply with a tax treaty must take precedence over the objective of RMO No. 1-2000.
Logically, noncompliance with tax treaties has negative implications on international relations, and unduly
discourages foreign investors. While the consequences sought to be prevented by RMO No. 1-2000 involve
an administrative procedure, these may be remedied through other system management processes, e.g.,
the imposition of a fine or penalty. But we cannot totally deprive those who are entitled to the benefit of a
treaty for failure to strictly comply with an administrative issuance requiring prior application for tax treaty
relief.81 (Emphasis supplied, citations omitted)

On March 11, 1976, the representatives82 for the government of the Republic of the Philippines and for the
government of Canada signed the Convention between the Philippines and Canada for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Republic of the
Philippines-Canada Tax Treaty). This treaty entered into force on December 21, 1977.
_______________

81 Id., at pp. 227-228.


82 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, March 11, 1976 (1977)
<http://www.bir.gov.ph/images/bir_files/international_tax_affairs/Canada%20treaty.pdf> (visited July 21,
2015). Cesar Virata signed for the government of the Republic of the Philippines, while Donald Jamieson
signed for the government of Canada.

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Article V83 of the Republic of the Philippines-Canada Tax Treaty defines “permanent establishment” as a
“fixed place of
_______________

83 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. V provides:
Article V
Permanent Establishment
1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business
in which the business of the enterprise is wholly or partly carried on.
2. The term “permanent establishment” shall include especially:
a) a place of management;
b) a branch;
c) an office;
d) a factory;
e) a workshop;
f) a mine, quarry or other place of extraction of natural resources;
g) a building or construction site or supervisory activities in connection therewith, where such activities
continue for a period more than six months;
h) an assembly or installation project which exists for more than three months;
i) premises used as a sales outlet;
j) a warehouse, in relation to a person providing storage facilities for others.
3. The term “permanent establishment” shall not be deemed to include:
a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise
belonging to the enterprise;
b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose
of storage, display or delivery;
c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose
of processing by another enterprise;

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_______________
d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise,
or for collecting information for the enterprise;
e) the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of
information, for scientific research, or for similar activities which have a preparatory or auxiliary character,
for the enterprise.
4. A person acting in a Contracting State on behalf of an enterprise of the other Contracting State (other
than an agent of independent status to whom paragraph 6 applies) shall be deemed to be a permanent
establishment in the first-mentioned State if:
a) he has and habitually exercises in that State an authority to conclude contracts on behalf of the
enterprise, unless his activities are limited to the purchase of goods or merchandise for that enterprise; or
b) he has no such authority, but habitually maintains in the first-mentioned State a stock of goods or
merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise.
5. An insurance enterprise of a Contracting State shall, except in regard to reinsurance, be deemed to have
a permanent establishment in the other State if it collects premiums in the territory of that State or insures
risks situated therein through an employee or through a representative who is not an agent of independent
status within the meaning of paragraph 6.
6. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other
Contracting State merely because it carries on business in that other State through a broker, general
commission agent or any other agent of an independent status, where such persons are acting in the
ordinary course of their business.
7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company
which is a resident of the other Contracting State, or which carries on business in that other State (whether
through a permanent establishment or otherwise), shall not of itself constitute for either company a
permanent establishment of the other. (Emphasis supplied)

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business in which the business of the enterprise is wholly or partly carried on.”84
Even though there is no fixed place of business, an enterprise of a Contracting State is deemed to have a
permanent establishment in the other Contracting State if under certain conditions there is a person acting
for it.
Specifically, Article V(4) of the Republic of the Philippines-Canada Tax Treaty states that “[a] person acting
in a Contracting State on behalf of an enterprise of the other Contracting State (other than an agent of
independent status to whom paragraph 6 applies) shall be deemed to be a permanent establishment in the
first-mentioned State if . . . he has and habitually exercises in that State an authority to conclude contracts
on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for that
enterprise[.]” The provision seems to refer to one who would be considered an agent under Article 186885
of the Civil Code of the Philippines.
On the other hand, Article V(6) provides that “[a]n enterprise of a Contracting State shall not be deemed to
have a permanent establishment in the other Contracting State merely because it carries on business in
that other State through a broker, general commission agent or any other agent of an independent status,
where such persons are acting in the ordinary course of their business.”
_______________

84 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. V(1).
85 Civil Code, Art. 1868 provides:
Article 1868. By the contract of agency a person binds himself to render some service or to do something
in representation or on behalf of another, with the consent or authority of the latter.

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Considering Article XV86 of the same Treaty, which covers dependent personal services, the term
“dependent” would imply a relationship between the principal and the agent that is akin to an employer-
employee relationship.
_______________

86 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. XV provides:
Article XV
Dependent Personal Services
1. Subject to the provisions of Articles XVI, XVIII and XIX, salaries, wages and other similar remuneration
derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State
unless the employment is exercised in the other Contracting State. If the employment is so exercised, such
remuneration as is derived therefrom may be taxed in that other State.
2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State
in respect of an employment exercised in the other Contracting State shall be taxable only in the first-
mentioned State if the recipient is present in the other Contracting State for a period or periods not
exceeding in the aggregate 183 days in the calendar year concerned, and either
a) the remuneration earned in the other Contracting State in the calendar year concerned does not exceed
two thousand five hundred Canadian dollars ($2,500) or its equivalent in Philippine pesos or such other
amount as may be specified and agreed in letters exchanged between the competent authorities of the
Contracting States; or
b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
such remuneration is not borne by a permanent establishment or a fixed base which the employer has in
the other State.
3. Notwithstanding the preceding provisions of this Article, remuneration in respect of employment as a
member of the regular crew or complement of a ship or aircraft operated in international traffic by an
enterprise of a Contracting State, shall be taxable only in that State.

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Thus, an agent may be considered to be dependent on the principal where the latter exercises
comprehensive control and detailed instructions over the means and results of the activities of the agent.87
Section 3 of Republic Act No. 776, as amended, also known as The Civil Aeronautics Act of the Philippines,
defines a general sales agent as “a person, not a bona fide employee of an air carrier, who pursuant to an
authority from an airline, by itself or through an agent, sells or offers for sale any air transportation, or
negotiates for, or holds himself out by solicitation, advertisement or otherwise as one who sells, provides,
furnishes, contracts or arranges for, such air transportation.”88 General sales agents and their property,
property
_______________

87 Among the four elements of an employer-employee relationship (i.e., [i] the selection and engagement
of the employee; [ii] the payment of wages; [iii] the power of dismissal; and [iv] the power of control of the
employees conduct), the control test is regarded as the most important. Under this test, an employer-
employee relationship exists if the employer has reserved the right to control the employee not only as to
the result of the work done but also as to the means and methods by which the same is to be accomplished.
See Fuji Television Network, Inc. v. Espiritu, G.R. Nos. 204944-45, December 3, 2014, 744 SCRA 31, 80
[Per J. Leonen, Second Division]; Royale Homes Marketing Corporation v. Alcantara, G.R. No. 195190,
July 28, 2014, 731 SCRA 147, 162 [Per J. Del Castillo, Second Division]; Tongko v. The Manufacturers Life
Insurance Co. (Phils.), Inc., 655 Phil. 384, 400-401; 640 SCRA 395, 433 (2011) [Per J. Brion, En Banc];
Sonza v. ABS-CBN Broadcasting Corporation, G.R. No. 138051, June 10, 2004, 431 SCRA 583, 594-595
[Per J. Carpio, First Division]; Sara v. Agarrado, 248 Phil. 847, 851; 166 SCRA 625, 629 (1988) [Per CJ.
Fernan, Third Division], and Investment Planning Corporation of the Philippines v. Social Security System,
129 Phil. 143, 147; 21 SCRA 924, 926-927 (1967) [Per J. Makalintal, En Banc], cited in Insular Life
Assurance Co., Ltd. v. National Labor Relations Commission, 259 Phil. 65, 72; 179 SCRA 459, 464 (1989)
[Per J. Narvasa, First Division].
88 Rep. Act No. 776 (1952), Sec. 1(jj), as amended by Pres. Decree No. 1462 (1978), Sec. 1.

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rights, equipment, facilities, and franchise are subject to the regulation and control of the Civil Aeronautics
Board.89 A permit or authorization issued by the Civil Aeronautics Board is required before a general sales
agent may engage in such an activity.90
Through the appointment of Aerotel as its local sales agent, petitioner is deemed to have created a
“permanent establishment” in the Philippines as defined under the Republic of the Philippines-Canada Tax
Treaty.
Petitioner appointed Aerotel as its passenger general sales agent to perform the sale of transportation on
petitioner and handle reservations, appointment, and supervision of International Air Transport Association-
approved and petitioner-approved sales agents, including the following services:

ARTICLE 7
GSA SERVICES

The GSA [Aerotel Ltd., Corp.] shall perform on behalf of AC [Air Canada] the following services:
a) Be the fiduciary of AC and in such capacity act solely and entirely for the benefit of AC in every matter
relating to this Agreement;
....
c) Promotion of passenger transportation on AC;
....
e) Without the need for endorsement by AC, arrange for the reissuance, in the Territory of the GSA
[Philippines], of traffic documents issued by AC outside the said territory of the GSA [Philippines], as
required by the passenger(s);
_______________

89 Rep. Act No. 776 (1952), Sec. 10(A), as amended by Pres. Decree No. 1462 (1978), Sec. 6.
90 Rep. Act No. 776 (1952), Sec. 11, as amended by Pres. Decree No. 1462 (1978), Sec. 7.

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....
h) Distribution among passenger sales agents and display of timetables, fare sheets, tariffs and publicity
material provided by AC in accordance with the reasonable requirements of AC;
....
j) Distribution of official press releases provided by AC to media and reference of any press or public
relations inquiries to AC;
....
o) Submission for AC’s approval, of an annual written sales plan on or before a date to be determined by
AC and in a form acceptable to AC;
....
q) Submission of proposals for AC’s approval of passenger sales agent incentive plans at a reasonable
time in advance of proposed implementation;
r) Provision of assistance on request, in its relations with Governmental and other authorities, offices and
agencies in the Territory [Philippines];
....
u) Follow AC guidelines for the handling of baggage claims and customer complaints and, unless
otherwise stated in the guidelines, refer all such claims and complaints to AC.91

Under the terms of the Passenger General Sales Agency Agreement, Aerotel will “provide at its own
expense and acceptable to [petitioner Air Canada], adequate and suitable premises, qualified staff,
equipment, documentation, facilities and supervision and in consideration of the remuneration and
expenses payable[,] [will] defray all costs and expenses of and
_______________

91 Rollo, pp. 124-125, Passenger General Sales Agency Agreement Between Air Canada and Aerotel
Ltd., Corp.

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incidental to the Agency.”92 “[I]t is the sole employer of its employees and . . . is responsible for [their]
actions . . . or those of any subcontractor.”93 In remuneration for its services, Aerotel would be paid by
petitioner a commission on sales of transportation plus override commission on flown revenues.94 Aerotel
would also be reimbursed “for all authorized expenses supported by original supplier invoices.”95
Aerotel is required to keep “separate books and records of account, including supporting documents,
regarding all tran­sactions at, through or in any way connected with [petitioner Air Canada] business.”96
“If representing more than one carrier, [Aerotel must] represent all carriers in an unbiased way.”97 Aerotel
cannot “accept additional appointments as General Sales Agent of any other carrier without the prior written
consent of [petitioner Air Canada].”98
The Passenger General Sales Agency Agreement “may be terminated by either party without cause upon
[no] less than 60 days’ prior notice in writing[.]”99 In case of breach of any provisions of the Agreement,
petitioner may require Aerotel “to cure the breach in 30 days failing which [petitioner Air Canada] may
terminate [the] Agreement[.]”100
The following terms are indicative of Aerotel’s dependent status:
First, Aerotel must give petitioner written notice “within 7 days of the date [it] acquires or takes control of
another entity
_______________

92 Id., at p. 126.
93 Id., at p. 122.
94 Id., at p. 127.
95 Id., at p. 128.
96 Id., at p. 130.
97 Id., at p. 122.
98 Id.
99 Id., at p. 137.
100 Id.

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or merges with or is acquired or controlled by another person or entity[.]”101 Except with the written consent
of petitioner, Aerotel must not acquire a substantial interest in the ownership, management, or profits of a
passenger sales agent affiliated with the International Air Transport Association or a nonaffiliated passenger
sales agent nor shall an affiliated passenger sales agent acquire a substantial interest in Aerotel as to
influence its commercial policy and/or management deci-sions.102 Aerotel must also provide petitioner
“with a report on any interests held by [it], its owners, directors, officers, employees and their immediate
families in companies and other entities in the aviation industry or . . . industries related to it[.]”103 Petitioner
may require that any interest be divested within a set period of time.104
Second, in carrying out the services, Aerotel cannot enter into any contract on behalf of petitioner without
the express written consent of the latter;105 it must act according to the standards required by
petitioner;106 “follow the terms and provisions of the [petitioner Air Canada] GSA Manual [and all] written
instructions of [petitioner Air Canada;]”107 and “[i]n the absence of an applicable provision in the Manual
or instructions, [Aerotel must] carry out its functions in accordance with [its own] standard practices and
procedures[.]”108
Third, Aerotel must only “issue traffic documents approved by [petitioner Air Canada] for all transportation
over [its] services[.]”109 All use of petitioner’s name, logo, and marks must be with the written consent of
petitioner and according
_______________

101 Id., at p. 122.


102 Id., at p. 123.
103 Id.
104 Id.
105 Id., at p. 122.
106 Id., at p. 126.
107 Id.
108 Id.
109 Id., at p. 129.

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to petitioner’s corporate standards and guidelines set out in the Manual.110
Fourth, all claims, liabilities, fines, and expenses arising from or in connection with the transportation sold
by Aerotel are for the account of petitioner, except in the case of negligence of Aerotel.111
Aerotel is a dependent agent of petitioner pursuant to the terms of the Passenger General Sales Agency
Agreement executed between the parties. It has the authority or power to conclude contracts or bind
petitioner to contracts entered into in the Philippines. A third party liability on contracts of Aerotel is to
petitioner as the principal, and not to Aerotel, and liability to such third party is enforceable against petitioner.
While Aerotel maintains a certain independence and its activities may not be devoted wholly to petitioner,
nonetheless, when representing petitioner pursuant to the Agreement, it must carry out its functions solely
for the benefit of petitioner and according to the latter’s Manual and written instructions. Aerotel is required
to submit its annual sales plan for petitioner’s approval.
In essence, Aerotel extends to the Philippines the transportation business of petitioner. It is a conduit or
outlet through which petitioner’s airline tickets are sold.112
_______________

110 Id., at p. 131.


111 Id., at p. 132.
112 Cf. Steelcase, Inc. v. Design International Selections, Inc., G.R. No. 171995, April 18, 2012, 670 SCRA
64 [Per J. Mendoza, Third Division]. This court held that “the appointment of a distributor in the Philippines
is not sufficient to constitute ‘doing business’ unless it is under the full control of the foreign corporation. On
the other hand, if the distributor is an independent entity which buys and distributes products, other than
those of the foreign corporation, for its own name and its own account, the latter cannot be considered to
be doing business in the Philippines. It should be kept in mind that the determination of whether a foreign
corporation is doing business in the Philippines must be judged in light of the

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Under Article VII (Business Profits) of the Republic of the Philippines-Canada Tax Treaty, the “business
profits” of an enterprise of a Contracting State is “taxable only in that State[,] unless the enterprise carries
on business in the other Contracting State through a permanent establishment[.]”113
_______________

attendant circumstances.” (Id., at p. 74, citations omitted) This court found that Design International
Selections, Inc. “was an independent contractor, distributing various products of Steelcase and of other
companies, acting in its own name and for its own account.” (Id., at p. 75) “As a result, Steelcase cannot
be considered to be doing business in the Philippines by its act of appointing a distributor as it falls under
one of the exceptions under R.A. No. 7042.” (Id., at p. 77)
113 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. VII provides:
Article VII
Business Profits
1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise
carries on business in the other Contracting State through a permanent establishment situated therein. If
the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed
in the other State but only so much of them as is attributable to:
a) that permanent establishment; or
b) sales of goods or merchandise of the same or similar kind as those sold, or from other business activities
of the same or similar kind as those affected, through that permanent establishment.
2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business
in the other Contracting State through a permanent establishment situated therein, there shall be attributed
to that permanent establishment profits which it might be expected to make if it were a distinct and separate
enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly
independently with the enterprise of which it is a permanent establishment.

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Thus, income attributable to Aerotel or from business activities effected by petitioner through Aerotel may
be taxed in the Philippines. However, pursuant to the last paragraph114 of Article VII in relation to Article
VIII115 (Shipping and Air
_______________

3. In the determination of the profits of a permanent establishment, there shall be allowed those deductible
expenses which are incurred for the purposes of the permanent establishment including executive and
general administrative expenses, whether incurred in the State in which the permanent establishment is
situated or elsewhere.
4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that
permanent establishment of goods or merchandise for the enterprise.
5. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment
shall be determined by the same method year by year unless there is good and sufficient reason to the
contrary.
6. Where profits include items of income which are dealt with separately in other Articles of this Convention,
then, the provisions of those Articles shall not be affected by the provisions of this Article.
114 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. VII, par. 6 provides:
6. Where profits include items of income which are dealt with separately in other Articles of this Convention,
then, the provisions of those Articles shall not be affected by the provisions of this Article.
115 Convention with Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Art. VIII provides:
Article VIII
Shipping and Air Transport
1. Profits derived by an enterprise of a Contracting State from the operation of ships or aircraft shall be
taxable only in that State.
2. Notwithstanding the provisions of paragraph 1, profits from sources within a Contracting State derived
by an enterprise of

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Transport) of the same Treaty, the tax imposed on income derived from the operation of ships or aircraft in
international traffic should not exceed 1 1/2% of gross revenues derived from Philippine sources.

IV

While petitioner is taxable as a resident foreign corporation under Section 28(A)(1) of the 1997 National
Internal Revenue Code on its taxable income116 from sale of airline tickets in the Philippines, it could only
be taxed at a maximum of 1 1/2% of gross revenues, pursuant to Article VIII of the Republic of the
Philippines-Canada Tax Treaty that applies to petitioner as a “foreign corporation organized and existing
under the laws of Canada[.]”117
Tax treaties form part of the law of the land,118 and jurisprudence has applied the statutory construction
principle that specific laws prevail over general ones.119
_______________

the other Contracting State from the operation of ships or aircraft in international traffic may be taxed in the
first-mentioned State but the tax so charged shall not exceed the lesser of
a) one and one-half percent of the gross revenues derived from sources in that State; and
b) the lowest rate of Philippine tax imposed on such profits derived by an enterprise of a third State.
116 Tax Code, Sec. 31 provides:
SEC. 31. Taxable Income Defined.—The term ‘taxable income’ means the pertinent items of gross
income specified in this Code, less the deductions and/or personal and additional exemptions, if any,
authorized for such types of income by this Code or other special laws.
117 Rollo, p. 59, Court of Tax Appeals En Banc Decision.
118 Const., Art. II, Sec. 2.
119 Lex specialis derogat generali; see BAYAN (Bagong Alyansang Makabayan) v. Zamora, 396 Phil. 623,
652; 342 SCRA 449, 483 (2000) [Per J. Buena, En Banc], citing Manila Railroad Co. v. Collec-

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The Republic of the Philippines-Canada Tax Treaty was ratified on December 21, 1977 and became valid
and effective on that date. On the other hand, the applicable provisions120 relating to the taxability of
resident foreign corporations and the rate of such tax found in the National Internal Revenue Code became
effective on January 1, 1998.121 Ordinarily, the later provision governs over the earlier one.122 In this
case, however, the provisions of the Republic of the Philippines-Canada Tax Treaty are more specific than
the provisions found in the National Internal Revenue Code.
These rules of interpretation apply even though one of the sources is a treaty and not simply a statute.
Article VII, Section 21 of the Constitution provides:
SECTION 21. No treaty or international agreement shall be valid and effective unless concurred in by at
least two-thirds of all the Members of the Senate.

This provision states the second of two ways through which international obligations become binding. Article
II, Section 2 of the Constitution deals with international obligations that are incorporated, while Article VII,
Section 21 deals with international obligations that become binding through ratification.
_______________

tor of Customs, 52 Phil. 950, 952 (1929) [Per J. Malcolm, En Banc] and Leveriza v. Intermediate Appellate
Court, 241 Phil. 285, 299; 157 SCRA 282, 294 (1988) [Per J. Bidin, Third Division], cited in Republic v.
Sandiganbayan, First Division, 255 Phil. 71, 83-84; 173 SCRA 72, 85 (1989) [Per J. Gutierrez, Jr., En Banc].
120 Tax Code, Sec. 28(A)(1), as amended by Rep. Act No. 9337 (2005), Sec. 2.
121 See Bureau of Internal Revenue website <http://www.bir.gov.ph/index.php/tax-code.html> (visited July
21, 2015).
122 See Herman v. Radio Corporation of the Philippines, 50 Phil. 490, 498 (1927) [Per J. Street, En Banc]
in that the later legislative expression prevails when two statutes apply.

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“Valid and effective” means that treaty provisions that define rights and duties as well as definite prestations
have effects equivalent to a statute. Thus, these specific treaty provisions may amend statutory provisions.
Statutory provisions may also amend these types of treaty obligations.
We only deal here with bilateral treaty state obligations that are not international obligations erga omnes.
We are also not required to rule in this case on the effect of international customary norms especially those
with jus cogens character.
The second paragraph of Article VIII states that “profits from sources within a Contracting State derived by
an enterprise of the other Contracting State from the operation of ships or aircraft in international traffic may
be taxed in the first-mentioned State but the tax so charged shall not exceed the lesser of a) one and one-
half percent of the gross revenues derived from sources in that State; and b) the lowest rate of Philippine
tax imposed on such profits derived by an enterprise of a third State.”
The Agreement between the government of the Republic of the Philippines and the government of Canada
on Air Transport, entered into on January 14, 1997, reiterates the effectivity of Article VIII of the Republic
of the Philippines-Canada Tax Treaty:

ARTICLE XVI
(Taxation)

The Contracting Parties shall act in accordance with the provisions of Article VIII of the Convention between
the Philippines and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, signed at Manila on March 31, 1976 and entered into force on December
21, 1977, and
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any amendments thereto, in respect of the operation of aircraft in international traffic.123

Petitioner’s income from sale of ticket for international carriage of passenger is income derived from
international operation of aircraft. The sale of tickets is closely related to the international operation of
aircraft that it is considered incidental thereto.
“[B]y reason of our bilateral negotiations with [Canada], we have agreed to have our right to tax limited to a
certain extent[.]”124 Thus, we are bound to extend to a Canadian air carrier doing business in the
Philippines through a local sales agent the benefit of a lower tax equivalent to 1 1/2% on business profits
derived from sale of international air transportation.

Finally, we reject petitioner’s contention that the Court of Tax Appeals erred in denying its claim for refund
of erroneously paid Gross Philippine Billings tax on the ground that it is subject to income tax under Section
28(A)(1) of the National Internal Revenue Code because (a) it has not been assessed at all by the Bureau
of Internal Revenue for any income tax liability;125 and (b) internal revenue taxes cannot be the subject of
setoff or compensation,126 citing Republic v. Mambulao
_______________

123 Agreement Between the Government of Canada and the Government of the Republic of the Philippines
on Air Transport, Global Affairs Canada <http://www.treaty-accord.gc.ca/text-texte.aspx?id=100250>
(visited July 21, 2015).
124 Marubeni Corporation v. Commissioner of Internal Revenue, 258 Phil. 295, 306; 177 SCRA 500, 510
(1989) [Per CJ. Fernan, Third Division].
125 Rollo, pp. 325-326, Air Canada’s Memorandum.
126 Id., at pp. 323-325.

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Lumber Co., et al.127 and Francia v. Intermediate Appellate Court.128
In SMI-ED Philippines Technology, Inc. v. Commissioner of Internal Revenue,129 we have ruled that “[i]n
an action for the refund of taxes allegedly erroneously paid, the Court of Tax Appeals may determine
whether there are taxes that should have been paid in lieu of the taxes paid.”130 The determination of the
proper category of tax that should have been paid is incidental and necessary to resolve the issue of
whether a refund should be granted.131 Thus:

Petitioner argued that the Court of Tax Appeals had no jurisdiction to subject it to 6% capital gains tax or
other taxes at the first instance. The Court of Tax Appeals has no power to make an assessment.
As earlier established, the Court of Tax Appeals has no assessment powers. In stating that petitioner’s
transactions are subject to capital gains tax, however, the Court of Tax Appeals was not making an
assessment. It was merely determining the proper category of tax that petitioner should have paid, in view
of its claim that it erroneously imposed upon itself and paid the 5% final tax imposed upon PEZA-registered
enterprises.
The determination of the proper category of tax that petitioner should have paid is an incidental matter
necessary for the resolution of the principal issue, which is whether petitioner was entitled to a refund.
The issue of petitioner’s claim for tax refund is intertwined with the issue of the proper taxes that are due
_______________

127 114 Phil. 549, 554-555; 4 SCRA 622, 626 (1962) [Per J. Barrera, En Banc].
128 245 Phil. 717, 722-723; 162 SCRA 753, 758-759 (1988) [Per J. Gutierrez, Jr., Third Division].
129 G.R. No. 175410, November 12, 2014, 739 SCRA 691 [Per J. Leonen, Second Division].
130 Id., at p. 695.
131 Id.

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from petitioner. A claim for tax refund carries the assumption that the tax returns filed were correct. If the
tax return filed was not proper, the correctness of the amount paid and, therefore, the claim for refund
become questionable. In that case, the court must determine if a taxpayer claiming refund of erroneously
paid taxes is more properly liable for taxes other than that paid.
In South African Airways v. Commissioner of Internal Revenue, South African Airways claimed for refund
of its erroneously paid 2 1/2% taxes on its gross Philippine billings. This court did not immediately grant
South African’s claim for refund. This is because although this court found that South African Airways was
not subject to the 2 1/2% tax on its gross Philippine billings, this court also found that it was subject to 32%
tax on its taxable income.
In this case, petitioner’s claim that it erroneously paid the 5% final tax is an admission that the quarterly tax
return it filed in 2000 was improper. Hence, to determine if petitioner was entitled to the refund being
claimed, the Court of Tax Appeals has the duty to determine if petitioner was indeed not liable for the 5%
final tax and, instead, liable for taxes other than the 5% final tax. As in South African Airways, petitioner’s
request for refund can neither be granted nor denied outright without such determination.
If the taxpayer is found liable for taxes other than the erroneously paid 5% final tax, the amount of the
taxpayer’s liability should be computed and deducted from the refundable amount.
Any liability in excess of the refundable amount, however, may not be collected in a case involving solely
the issue of the taxpayer’s entitlement to refund. The question of tax deficiency is distinct and unrelated to
the question of petitioner’s entitlement to refund. Tax deficiencies should be subject to assessment
procedures and the rules of prescription. The court cannot be expected to perform the BIR’s duties
whenever it fails to do so either through neglect or oversight. Neither can court processes

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be used as a tool to circumvent laws protecting the rights of taxpayers.132

Hence, the Court of Tax Appeals properly denied petitioner’s claim for refund of allegedly erroneously paid
tax on its Gross Philippine Billings, on the ground that it was liable instead for the regular 32% tax on its
taxable income received from sources within the Philippines. Its determination of petitioner’s liability for the
32% regular income tax was made merely for the purpose of ascertaining petitioner’s entitlement to a tax
refund and not for imposing any deficiency tax.
In this regard, the matter of setoff raised by petitioner is not an issue. Besides, the cases cited are based
on different circumstances. In both cited cases,133 the taxpayer claimed that his (its) tax liability was offset
by his (its) claim against the government.
Specifically, in Republic v. Mambulao Lumber Co., et al., Mambulao Lumber contended that the amounts
it paid to the government as reforestation charges from 1947 to 1956, not having been used in the
reforestation of the area covered by its license, may be setoff or applied to the payment of forest charges
still due and owing from it.134 Rejecting Mambulao’s claim of legal compensation, this court ruled:

[A]ppellant and appellee are not mutually creditors and debtors of each other. Consequently, the law on
compensation is inapplicable. On this point, the trial court correctly observed:
Under Article 1278, NCC, compensation should take place when two persons in their own right are creditors
and debtors of each
_______________

132 Id., at pp. 699-707.


133 Republic v. Mambulao Lumber Co., supra note 127 at p. 552; pp. 626-627 and Francia v. Intermediate
Appellate Court, supra note 128 at p. 722; p. 758.
134 Id.

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other. With respect to the forest charges which the defendant Mambulao Lumber Company has paid to the
government, they are in the coffers of the government as taxes collected, and the government does not
owe anything to defendant Mambulao Lumber Company. So, it is crystal clear that the Republic of the
Philippines and the Mambulao Lumber Company are not creditors and debtors of each other, because
compensation refers to mutual debts. * * *
And the weight of authority is to the effect that internal revenue taxes, such as the forest charges in question,
can not be the subject of setoff or compensation.
A claim for taxes is not such a debt, demand, contract or judgment as is allowed to be setoff under the
statutes of setoff, which are construed uniformly, in the light of public policy, to exclude the remedy in an
action or any indebtedness of the state or municipality to one who is liable to the state or municipality for
taxes. Neither are they a proper subject of recoupment since they do not arise out of the contract or
transaction sued on. * * * (80 C.J.S. 73-74)
The general rule, based on grounds of public policy is well-settled that no setoff is admissible against
demands for taxes levied for general or local governmental purposes. The reason on which the general rule
is based, is that taxes are not in the nature of contracts between the party and party but grow out of a duty
to, and are the positive acts of the government, to the making and enforcing of which, the personal consent
of individual taxpayers is not required. * * * If the taxpayer can properly refuse to pay his tax when called
upon by the Collector, because he has a claim against the governmental body which is not included in the
tax levy, it is plain that some legitimate and necessary expenditure must be

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curtailed. If the taxpayer’s claim is disputed, the collection of the tax must await and abide the result of a
lawsuit, and meanwhile the financial affairs of the government will be thrown into great confusion. (47 Am.
Jur. 766-767)135 (Emphasis supplied)

In Francia, this court did not allow legal compensation since not all requisites of legal compensation
provided under Article 1279 were present.136 In that case, a portion of Francia’s property in Pasay was
expropriated by the national government,137 which did not immediately pay Francia. In the meantime, he
failed to pay the real property tax due on his remaining property to the local government of Pasay, which
later on would auction the property on account of such delinquency.138 He then moved to set aside the
auction sale and argued, among others, that his real property tax delinquency was extinguished by legal
compensation on account of his unpaid claim against the national government.139 This court ruled against
Francia:

There is no legal basis for the contention. By legal compensation, obligations of persons, who in their own
right are reciprocally debtors and creditors of each other, are extinguished (Art. 1278, Civil Code). The
circumstances of the case do not satisfy the requirements provided by Article 1279, to wit:
(1) that each one of the obligors be bound principally and that he be at the same time a principal creditor
of the other;
xxx xxx xxx
_______________

135 Id., at pp. 554-555; pp. 626-627.


136 Francia v. Intermediate Appellate Court, supra note 128 at p. 722; p. 758.
137 Id., at p. 719; p. 756.
138 Id., at p. 720; p. 756.
139 Id., at p. 722; p. 758.

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Air Canada vs. Commissioner of Internal Revenue
(3) that the two debts be due.
xxx xxx xxx
This principal contention of the petitioner has no merit. We have consistently ruled that there can be no
offsetting of taxes against the claims that the taxpayer may have against the government. A person cannot
refuse to pay a tax on the ground that the government owes him an amount equal to or greater than the tax
being collected. The collection of a tax cannot await the results of a lawsuit against the government.
....
There are other factors which compel us to rule against the petitioner. The tax was due to the city
government while the expropriation was effected by the national government. Moreover, the amount of
P4,116.00 paid by the national government for the 125-square-meter portion of his lot was deposited with
the Philippine National Bank long before the sale at public auction of his remaining property. Notice of the
deposit dated September 28, 1977 was received by the petitioner on September 30, 1977. The petitioner
admitted in his testimony that he knew about the P4,116.00 deposited with the bank but he did not withdraw
it. It would have been an easy matter to withdraw P2,400.00 from the deposit so that he could pay the tax
obligation thus aborting the sale at public auction.140

The ruling in Francia was applied to the subsequent cases of Caltex Philippines, Inc. v. Commission on
Audit141 and Philex Mining Corporation v. Commissioner of Internal Revenue.142 In Caltex, this court
reiterated:
_______________

140 Id., at pp. 722-723; pp. 758-759.


141 Caltex Philippines, Inc. v. Commission on Audit, G.R. No. 92585, May 8, 1992, 208 SCRA 726 [Per J.
Davide, Jr., En Banc].
142 356 Phil. 189; 294 SCRA 687 (1998) [Per J. Romero, Third Division].

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[A] taxpayer may not offset taxes due from the claims that he may have against the government. Taxes
cannot be the subject of compensation because the government and taxpayer are not mutually creditors
and debtors of each other and a claim for taxes is not such a debt, demand, contract or judgment as is
allowed to be setoff.143 (Citations omitted)

Philex Mining ruled that “[t]here is a material distinction between a tax and debt. Debts are due to the
Government in its corporate capacity, while taxes are due to the Government in its sovereign capacity.”144
Rejecting Philex Mining’s assertion that the imposition of surcharge and interest was unjustified because it
had no obligation to pay the excise tax liabilities within the prescribed period since, after all, it still had
pending claims for VAT input credit/refund with the Bureau of Internal Revenue, this court explained:

To be sure, we cannot allow Philex to refuse the payment of its tax liabilities on the ground that it has a
pending tax claim for refund or credit against the government which has not yet been granted. It must be
noted that a distinguishing feature of a tax is that it is compulsory rather than a matter of bargain. Hence, a
tax does not depend upon the consent of the taxpayer. If any taxpayer can defer the payment of taxes by
raising the defense that it still has a pending claim for refund or credit, this would adversely affect the
government revenue system. A taxpayer cannot refuse to pay his taxes when they fall due simply because
he has a claim against the government or that the collection of the tax is contingent on the result of the
lawsuit it filed against the government. Moreover, Philex’s theory that would automati-
_______________

143 Supra note 141 at p. 756.


144 Philex Mining Corporation v. Commissioner of Internal Revenue, supra note 142 at p. 198; p. 695,
citing Commissioner of Internal Revenue v. Palanca, Jr., 124 Phil. 1102, 1107; 18 SCRA 496, 499-500
(1966) [Per J. Regala, En Banc].

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Air Canada vs. Commissioner of Internal Revenue
cally apply its VAT input credit/refund against its tax liabilities can easily give rise to confusion and abuse,
depriving the government of authority over the manner by which taxpayers credit and offset their tax
liabilities.145 (Citations omitted)

In sum, the rulings in those cases were to the effect that the taxpayer cannot simply refuse to pay tax on
the ground that the tax liabilities were offset against any alleged claim the taxpayer may have against the
government. Such would merely be in keeping with the basic policy on prompt collection of taxes as the
lifeblood of the government.
Here, what is involved is a denial of a taxpayer’s refund claim on account of the Court of Tax Appeals’
finding of its liability for another tax in lieu of the Gross Philippine Billings tax that was allegedly erroneously
paid.
Squarely applicable is South African Airways where this court rejected similar arguments on the denial of
claim for tax refund:

Commissioner of Internal Revenue v. Court of Tax Appeals, however, granted the offsetting of a tax refund
with a tax deficiency in this wise:
Further, it is also worth noting that the Court of Tax Appeals erred in denying petitioner’s supplemental
motion for reconsideration alleging bringing to said court’s attention the existence of the deficiency income
and business tax assessment against Citytrust. The fact of such deficiency assessment is intimately related
to and inextricably intertwined with the right of respondent bank to claim for a tax refund for the same year.
To award such refund despite the existence of that deficiency assessment is an absurdity and a polarity in
_______________

145 Id., at p. 200; p. 697.


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conceptual effects. Herein private respondent cannot be entitled to refund and at the same time be liable
for a tax deficiency assessment for the same year.
The grant of a refund is founded on the assumption that the tax return is valid, that is, the facts stated
therein are true and correct. The deficiency assessment, although not yet final, created a doubt as to and
constitutes a challenge against the truth and accuracy of the facts stated in said return which, by itself and
without unquestionable evidence, cannot be the basis for the grant of the refund.
Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the applicable law when
the claim of Citytrust was filed, provides that “(w)hen an assessment is made in case of any list, statement,
or return, which in the opinion of the Commissioner of Internal Revenue was false or fraudulent or contained
any understatement or undervaluation, no tax collected under such assessment shall be recovered by any
suits unless it is proved that the said list, statement, or return was not false nor fraudulent and did not
contain any understatement or undervaluation; but this provision shall not apply to statements or returns
made or to be made in good faith regarding annual depreciation of oil or gas wells and mines.”
Moreover, to grant the refund without determination of the proper assessment and the tax due would
inevitably result in multiplicity of proceedings or suits. If the deficiency assessment should subsequently be
upheld, the Government will be forced to institute anew a proceeding for the recovery of erroneously
refunded taxes which recourse must be filed within the prescriptive period of ten years after discovery of
the falsity, fraud or

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Air Canada vs. Commissioner of Internal Revenue
omission in the false or fraudulent return involved. This would necessarily require and entail additional
efforts and expenses on the part of the Government, impose a burden on and a drain of government funds,
and impede or delay the collection of much needed revenue for governmental operations.
Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both logically necessary
and legally appropriate that the issue of the deficiency tax assessment against Citytrust be resolved jointly
with its claim for tax refund, to determine once and for all in a single proceeding the true and correct amount
of tax due or refundable.
In fact, as the Court of Tax Appeals itself has heretofore conceded, it would be only just and fair that the
taxpayer and the Government alike be given equal opportunities to avail of remedies under the law to defeat
each other’s claim and to determine all matters of dispute between them in one single case. It is important
to note that in determining whether or not petitioner is entitled to the refund of the amount paid, it would
[be] necessary to determine how much the Government is entitled to collect as taxes. This would
necessarily include the determination of the correct liability of the taxpayer and, certainly, a determination
of this case would constitute res judicata on both parties as to all the matters subject thereof or necessarily
involved therein.
Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997 NIRC. The above
pronouncements are, therefore, still applicable today.
Here, petitioner’s similar tax refund claim assumes that the tax return that it filed was correct. Given,
however, the finding of the CTA that petitioner, although not liable under Sec. 28(A)(3)(a) of the 1997 NIRC,
is liable

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Air Canada vs. Commissioner of Internal Revenue
under Sec. 28(A)(1), the correctness of the return filed by petitioner is now put in doubt. As such, we cannot
grant the prayer for a refund.146 (Emphasis supplied, citation omitted)

In the subsequent case of United Airlines, Inc. v. Commissioner of Internal Revenue,147 this court upheld
the denial of the claim for refund based on the Court of Tax Appeals’ finding that the taxpayer had, through
erroneous deductions on its gross income, underpaid its Gross Philippine Billing tax on cargo revenues for
1999, and the amount of underpayment was even greater than the refund sought for erroneously paid Gross
Philippine Billings tax on passenger revenues for the same taxable period.148
In this case, the P5,185,676.77 Gross Philippine Billings tax paid by petitioner was computed at the rate of
1 1/2% of its gross revenues amounting to P345,711,806.08149 from the third quarter of 2000 to the second
quarter of 2002. It is quite apparent that the tax imposable under Section 28(A)(1) of the 1997 National
Internal Revenue Code [32% of taxable income, that is, gross income less deductions] will exceed the
maximum ceiling of 1 1/2% of gross revenues as decreed in Article VIII of the Republic of the Philippines-
-Canada Tax Treaty. Hence, no refund is forthcoming.
WHEREFORE, the Petition is DENIED. The Decision dated August 26, 2005 and Resolution dated April 8,
2005 of the Court of Tax Appeals En Banc are AFFIRMED.
_______________

146 South African Airways v. Commissioner of Internal Revenue, supra note 70 at p. 577; pp. 681-683.
147 United Airlines, Inc v. Commissioner of Internal Revenue, supra note 70.
148 Id., at pp. 198-199; pp. 571-572.
149 Rollo, pp. 79-105, Air Canada’s Quarterly and Annual Income Tax Returns.

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Air Canada vs. Commissioner of Internal Revenue
SO ORDERED.
Carpio (Chairperson), Brion, Del Castillo and Mendoza, JJ., concur.
Petition denied, judgment and resolution affirmed.
Notes.—Tax treaties are entered into to minimize, if not eliminate the harshness of international juridical
double taxation, which is why they are also known as double tax treaty or double tax agreements. (Deutsche
Bank AG Manila Branch vs. Commissioner of Internal Revenue, 704 SCRA 216 [2013])
A plain application of Section 3(d) of the Foreign Investments Act leads to no other conclusion than that
Saudia is a foreign corporation doing business in the Philippines. As such, Saudia may be sued in the
Philippines and is subject to the jurisdiction of Philippine tribunals. (Saudi Arabian Airlines [Saudia] vs.
Rebesencio, 746 SCRA 140 [2015])
G.R. No. 195909. September 26, 2012.*
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. ST. LUKE’S MEDICAL CENTER, INC.,
respondent.
G.R. No. 195960. September 26, 2012.*
ST. LUKE’S MEDICAL CENTER, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE,
respondent.
Taxation; Tax Exemptions; The Supreme Court holds that Section 27(B) of the National Internal Revenue
Code (NIRC) does not remove the income tax exemption of proprietary non-profit hospitals under Section
30(E) and (G).―The Court partly grants the petition of the BIR but on a different ground. We hold that
Section 27(B) of the NIRC does not remove the income tax exemption of proprietary non-profit hospitals
under Section 30(E) and (G). Section 27(B) on one hand, and Section 30(E) and (G) on the other hand,
can be construed together without the removal of such tax exemption. The effect of the introduction of
Section 27(B) is to subject the taxable income of two specific institutions, namely, proprietary non-profit
educational institutions and proprietary non-profit hospitals, among the institutions covered by Section 30,
to the 10% preferential rate under Section 27(B) instead of the ordinary 30% corporate rate under the last
paragraph of Section 30 in relation to Section 27(A)(1).
Same; Preferential Tax Rate; Section 27(B) of the National Internal Revenue Code (NIRC) imposes a 10%
preferential tax rate on the income of (1) proprietary non-profit educational institutions and (2) proprietary
non-profit hospitals.―Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1)
proprietary non-profit educational institutions and (2) proprietary non-profit hospitals. The only qualifications
for hospitals are that they must be proprietary and non-profit. “Proprietary” means private, following the
definition of a “proprietary educational institution” as “any private school maintained and administered by
private individuals or groups” with a government permit. “Non-profit” means no net in-
_______________
* SECOND DIVISION.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
come or asset accrues to or benefits any member or specific person, with all the net income or asset
devoted to the institution’s purposes and all its activities conducted not for profit.
Same; “Non-profit” does not necessarily mean “charitable.”―“Non-profit” does not necessarily mean
“charitable.” In Collector of Internal Revenue v. Club Filipino Inc. de Cebu, 5 SCRA 321 (1962), this Court
considered as non-profit a sports club organized for recreation and entertainment of its stockholders and
members. The club was primarily funded by membership fees and dues. If it had profits, they were used for
overhead expenses and improving its golf course. The club was non-profit because of its purpose and there
was no evidence that it was engaged in a profit-making enterprise.
Same; Tax Exemptions; Charity is essentially a gift to an indefinite number of persons which lessens the
burden of government. In other words, charitable institutions provide for free goods and services to the
public which would otherwise fall on the shoulders of government; The government forgoes taxes which
should have been spent to address public needs, because certain private entities already assume a part of
the burden.―To be a charitable institution, however, an organization must meet the substantive test of
charity in Lung Center of the Philippines vs. Quezon City, 433 SCRA 119 (2004). The issue in Lung Center
concerns exemption from real property tax and not income tax. However, it provides for the test of charity
in our jurisdiction. Charity is essentially a gift to an indefinite number of persons which lessens the burden
of government. In other words, charitable institutions provide for free goods and services to the public which
would otherwise fall on the shoulders of government. Thus, as a matter of efficiency, the government
forgoes taxes which should have been spent to address public needs, because certain private entities
already assume a part of the burden. This is the rationale for the tax exemption of charitable institutions.
The loss of taxes by the government is compensated by its relief from doing public works which would have
been funded by appropriations from the Treasury.
Same; Same; Charitable institutions are not ipso facto entitled to a tax exemption. The requirements for a
tax exemption are specified by the law granting it.―Charitable institutions, however, are not ipso facto
entitled to a tax exemption. The requirements for
68
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SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
a tax exemption are specified by the law granting it. The power of Congress to tax implies the power to
exempt from tax. Congress can create tax exemptions, subject to the constitutional provision that “[n]o law
granting any tax exemption shall be passed without the concurrence of a majority of all the Members of
Congress.” The requirements for a tax exemption are strictly construed against the taxpayer because an
exemption restricts the collection of taxes necessary for the existence of the government.
Same; Same; Income Taxation; Real Estate Taxes; For real property taxes, the incidental generation of
income is permissible because the test of exemption is the use of the property; The effect of failing to meet
the use requirement is simply to remove from the tax exemption that portion of the property not devoted to
charity.―For real property taxes, the incidental generation of income is permissible because the test of
exemption is the use of the property. The Constitution provides that “[c]haritable institutions, churches and
personages or convents appurtenant thereto, mosques, non-profit cemeteries, and all lands, buildings, and
improvements, actually, directly, and exclusively used for religious, charitable, or educational purposes
shall be exempt from taxation.” The test of exemption is not strictly a requirement on the intrinsic nature or
character of the institution. The test requires that the institution use the property in a certain way, i.e. for a
charitable purpose. Thus, the Court held that the Lung Center of the Philippines did not lose its charitable
character when it used a portion of its lot for commercial purposes. The effect of failing to meet the use
requirement is simply to remove from the tax exemption that portion of the property not devoted to charity.
Same; Same; The Constitution exempts charitable institutions only from real property taxes. In the National
Internal Revenue Code (NIRC), Congress decided to extend the exemption to income taxes.―The
Constitution exempts charitable institutions only from real property taxes. In the NIRC, Congress decided
to extend the exemption to income taxes. However, the way Congress crafted Section 30(E) of the NIRC
is materially different from Section 28(3), Article VI of the Constitution. Section 30(E) of the NIRC defines
the corporation or association that is exempt from income tax. On the other hand, Section 28(3), Article VI
of the Constitution does not define a charitable institution, but requires that the institution
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
“actually, directly and exclusively” use the property for a charitable purpose.
Same; Same; Real Estate Taxes; Income Taxation; To be exempt from real property taxes, Section 28(3),
Article VI of the Constitution requires that a charitable institution use the property “actually, directly and
exclusively” for charitable purposes. To be exempt from income taxes, Section 30(E) of the National Internal
Revenue Code (NIRC) requires that a charitable institution must be “organized and operated exclusively”
for charitable purposes. Likewise, to be exempt from income taxes, Section 30(G) of the National Internal
Revenue Code (NIRC) requires that the institution be “operated exclusively” for social welfare.―There is
no dispute that St. Luke’s is organized as a non-stock and non-profit charitable institution. However, this
does not automatically exempt St. Luke’s from paying taxes. This only refers to the organization of St.
Luke’s. Even if St. Luke’s meets the test of charity, a charitable institution is not ipso facto tax exempt. To
be exempt from real property taxes, Section 28(3), Article VI of the Constitution requires that a charitable
institution use the property “actually, directly and exclusively” for charitable purposes. To be exempt from
income taxes, Section 30(E) of the NIRC requires that a charitable institution must be “organized and
operated exclusively” for charitable purposes. Likewise, to be exempt from income taxes, Section 30(G) of
the NIRC requires that the institution be “operated exclusively” for social welfare.
Same; Same; Even if the charitable institution must be “organized and operated exclusively” for charitable
purposes, it is nevertheless allowed to engage in “activities conducted for profit” without losing its tax
exempt status for its not-for-profit activities.―Even if the charitable institution must be “organized and
operated exclusively” for charitable purposes, it is nevertheless allowed to engage in “activities conducted
for profit” without losing its tax exempt status for its not-for-profit activities. The only consequence is that
the “income of whatever kind and character” of a charitable institution “from any of its activities conducted
for profit, regardless of the disposition made of such income, shall be subject to tax.” Prior to the introduction
of Section 27(B), the tax rate on such income from for-profit activities was the ordinary corporate rate under
Section 27(A). With the introduction of Section 27(B), the tax rate is now 10%.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
Same; Income Taxation; Preferential Tax Rate; The Supreme Court finds that St. Luke’s is a corporation
that is not “operated exclusively” for charitable or social welfare purposes insofar as its revenues from
paying patients are concerned; Such income from for-profit activities, under the last paragraph of Section
30, is merely subject to income tax, previously at the ordinary corporate rate but now at the preferential
10% rate pursuant to Section 27(B).―The Court finds that St. Luke’s is a corporation that is not “operated
exclusively” for charitable or social welfare purposes insofar as its revenues from paying patients are
concerned. This ruling is based not only on a strict interpretation of a provision granting tax 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 “operated exclusively” for charitable or social welfare purposes to be completely exempt
from income tax. An institution under Section 30(E) or (G) does not lose its tax exemption if it earns income
from its for-profit activities. Such income from for-profit activities, under the last paragraph of Section 30, is
merely subject to income tax, previously at the ordinary corporate rate but now at the preferential 10% rate
pursuant to Section 27(B).
Same; Tax Exemptions; A tax exemption is effectively a social subsidy granted by the State because an
exempt institution is spared from sharing in the expenses of government and yet benefits from them.―A
tax exemption is effectively a social subsidy granted by the State because an exempt institution is spared
from sharing in the expenses of government and yet benefits from them. Tax exemptions for charitable
institutions should therefore be limited to institutions beneficial to the public and those which improve social
welfare. A profit-making entity should not be allowed to exploit this subsidy to the detriment of the
government and other taxpayers.
PETITIONS for review on certiorari of the decision and resolution of the Court of Tax Appeals.
The facts are stated in the opinion of the Court.
Office of the Solicitor General for petitioner.
Quasha, Ancheta, Peña & Nolasco for St. Luke’s Medical Center, Inc.
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CARPIO, J.:
The Case

These are consolidated1 petitions for review on certiorari under Rule 45 of the Rules of Court assailing the
Decision of 19 November 2010 of the Court of Tax Appeals (CTA) En Banc and its Resolution2 of 1 March
2011 in CTA Case No. 6746. This Court resolves this case on a pure question of law, which involves the
interpretation of Section 27(B) vis-à-vis Section 30(E) and (G) of the National Internal Revenue Code of the
Philippines (NIRC), on the income tax treatment of proprietary non-profit hospitals.
The Facts

St. Luke’s Medical Center, Inc. (St. Luke’s) is a hospital organized as a non-stock and non-profit
corporation. Under its articles of incorporation, among its corporate purposes are:
(a) To establish, equip, operate and maintain a non-stock, non-profit Christian, benevolent, charitable and
scientific hospital which shall give curative, rehabilitative and spiritual care to the sick, diseased and
disabled persons; provided that purely medical and surgical services shall be performed by duly licensed
physicians and surgeons who may be freely and individually contracted by patients;
(b) To provide a career of health science education and provide medical services to the community
through organized clinics in such specialties as the facilities and resources of the corporation make
possible;
(c) To carry on educational activities related to the maintenance and promotion of health as well as provide
facilities for scientific and
_______________
1 The consolidation of the petitions is pursuant to the Resolution of this Court dated 4 April 2011. Rollo
(G.R. No. 195960), p. 9.
2 This Resolution denied the motions filed by both parties to reconsider the CTA En Banc Decision dated
19 November 2010.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
medical researches which, in the opinion of the Board of Trustees, may be justified by the facilities,
personnel, funds, or other requirements that are available;
(d) To cooperate with organized medical societies, agencies of both government and private sector;
establish rules and regulations consistent with the highest professional ethics;
x x x x3
On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke’s deficiency taxes
amounting to P76,063,116.06 for 1998, comprised of deficiency income tax, value-added tax, withholding
tax on compensation and expanded withholding tax. The BIR reduced the amount to P63,935,351.57 during
trial in the First Division of the CTA.4
On 14 January 2003, St. Luke’s filed an administrative protest with the BIR against the deficiency tax
assessments. The BIR did not act on the protest within the 180-day period under Section 228 of the NIRC.
Thus, St. Luke’s appealed to the CTA.
The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10% preferential tax rate
on the income of proprietary non-profit hospitals, should be applicable to St. Luke’s. According to the BIR,
Section 27(B), introduced in 1997, “is a new provision intended to amend the exemption on non-profit
hospitals that were previously categorized as non-stock, non-profit corporations under Section 26 of the
1997 Tax Code x x x.”5 It is a specific provision which prevails
_______________
3 CTA First Division Decision dated 23 February 2009, citing the earlier decision in St. Luke’s Medical
Center, Inc. v. Commissioner of Internal Revenue, CTA Case No. 6993, 21 November 2008. Rollo (G.R.
No. 195909), p. 68.
4 This prompted St. Luke’s to file an Amended Petition for Review on 12 December 2003 before the First
Division of the CTA.
5 CTA First Division Decision, citing the Answer filed by the BIR before the CTA. Rollo (G.R. No. 195909),
p. 62.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
over the general exemption on income tax granted under Section 30(E) and (G) for non-stock, non-profit
charitable institutions and civic organizations promoting social welfare.6
The BIR claimed that St. Luke’s was actually operating for profit in 1998 because only 13% of its revenues
came from charitable purposes. Moreover, the hospital’s board of trustees, officers and employees directly
benefit from its profits and assets. St. Luke’s had total revenues of P1,730,367,965 or approximately P1.73
billion from patient services in 1998.7
St. Luke’s contended that the BIR should not consider its total revenues, because its free services to
patients was P218,187,498 or 65.20% of its 1998 operating income (i.e., total revenues less operating
expenses) of P334,642,615.8 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.
The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments before the CTA that
Section 27(B) applies to St. Luke’s. The petition raises the sole issue of whether the enactment of Section
27(B) takes proprietary non-profit hospitals out of the income tax exemption under Section 30 of the NIRC
and instead, imposes a preferential rate of 10% on their taxable income. The BIR prays that St. Luke’s be
ordered to pay P57,659,981.19 as deficiency income and expanded withholding tax for 1998 with
surcharges and interest for late payment.
_______________
6 Id., at p. 63.
7 Id., at pp. 65-67.
8 Id., at p. 67. The operating expenses of St. Luke’s consisted of professional care of patients,
administrative, household and property expenses.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
The petition of St. Luke’s in G.R. No. 195960 raises factual matters on the treatment and withholding of a
part of its income,9 as well as the payment of surcharge and delinquency interest. There is no ground for
this Court to undertake such a factual review. Under the Constitution10 and the Rules of Court,11 this
Court’s review power is generally limited to “cases in which only an error or question of law is involved.”12
This Court cannot depart from this limitation if a party fails to invoke a recognized exception.
The Ruling of the Court of Tax Appeals

The CTA En Banc Decision on 19 November 2010 affirmed in toto the CTA First Division Decision dated
23 February 2009 which held:
WHEREFORE, the Amended Petition for Review [by St. Luke’s] is hereby PARTIALLY GRANTED.
Accordingly, the 1998 deficiency VAT assessment issued by respondent against petitioner in the amount
of P110,000.00 is hereby CANCELLED and WITHDRAWN. However, petitioner is hereby ORDERED to
PAY deficiency income tax and deficiency expanded withholding tax for the taxable year 1998 in the
respective amounts of P5,496,963.54 and P778,406.84 or in the sum of P6,275,370.38, x x x.
xxxx
In addition, petitioner is hereby ORDERED to PAY twenty percent (20%) delinquency interest on the total
amount of
_______________
9 This income in the amount of P17,482,304 was declared by St. Luke’s as “Other Income-Net” in its 1998
Income Tax Return/Audited Statements of Revenues and Expenses.
10 Constitution, Art. VIII, Sec. 5(2)(e). Except for criminal cases where the penalty imposed is reclusion
perpetua or higher, the enumeration under Article VIII, Section 5(1) and (2) of the Constitution generally
involves a question of law.
11 Rules of Court, Rule 45, Sec. 1.
12 Constitution, Art. VIII, Sec. 5(2)(e). See note 10.
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P6,275,370.38 counted from October 15, 2003 until full payment thereof, pursuant to Section 249(C)(3) of
the NIRC of 1997.
SO ORDERED.13
The deficiency income tax of P5,496,963.54, ordered by the CTA En Banc to be paid, arose from the failure
of St. Luke’s to prove that part of its income in 1998 (declared as “Other Income-Net”)14 came from
charitable activities. The CTA cancelled the remainder of the P63,113,952.79 deficiency assessed by the
BIR based on the 10% tax rate under Section 27(B) of the NIRC, which the CTA En Banc held was not
applicable to St. Luke’s.15
The CTA ruled that St. Luke’s is a non-stock and non-profit charitable institution covered by Section 30(E)
and (G) of the NIRC. This ruling would exempt all income derived by St. Luke’s from services to its patients,
whether paying or non-paying. The CTA reiterated its earlier decision in St. Luke’s Medical Center, Inc. v.
Commissioner of Internal Revenue,16 which examined the primary purposes of St. Luke’s under its articles
of incorporation and various documents17 identifying St. Luke’s as a charitable institution.
The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City,18 which states that “a
charitable institution does not lose its charitable character and its consequent ex-
_______________
13 Rollo (G.R. No. 195909), pp. 82-83. Emphases in the original.
14 See note 9. This is one of the errors assigned by St. Luke’s in its petition before this Court.
15 Rollo (G.R. No. 195909), p. 65. The revised total deficiency income tax assessed by the BIR is
P63,113,952.79, which includes the deficiency under “Other Income-Net.”
16 CTA Case No. 6993, 21 November 2008.
17 These are documentary evidence which, among others, show that government agencies such as the
Department of Social Welfare and Development and the Philippine Charity Sweepstakes Office recognize
St. Luke’s as a charitable institution.
18 123 Phil. 38; 16 SCRA 226 (1966).
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emption from taxation merely because recipients of its benefits who are able to pay are required to do so,
where funds derived in this manner are devoted to the charitable purposes of the institution x x x.”19 The
generation of income from paying patients does not per se destroy the charitable nature of St. Luke’s.
Hospital de San Juan cited Jesus Sacred Heart College v. Collector of Internal Revenue,20 which ruled
that the old NIRC (Commonwealth Act No. 466, as amended)21 “positively exempts from taxation those
corporations or associations which, otherwise, would be subject thereto, because of the existence of x x x
net income.”22 The NIRC of 1997 substantially reproduces the provision on charitable institutions of the old
NIRC. Thus, in rejecting the argument that tax exemption is lost whenever there is net income, the Court in
Jesus Sacred Heart College declared: “[E]very responsible organization must be run to at least insure its
existence, by operating within the limits of its own resources, especially its regular
_______________
19 Id., at p. 41; p. 229 citing 51 Am. Jur. 607.
20 95 Phil. 16 (1954).
21 Commonwealth Act No. 466, as amended by Republic Act No. 82, Sec. 27 provides: Exemption from
tax on corporation.―The following organizations shall not be taxed under this Title in respect to income
received by them as such―
xxxx
(e) Corporation or association organized and operated exclusively for religious, charitable, scientific,
athletic, cultural, or educational purposes, or for the rehabilitation of veterans no part of the net income of
which inures to the benefit of any private stockholder or individual: Provided, however, That the income of
whatever kind and character from any of its properties, real or personal, or from any activity conducted for
profit regardless of the disposition made of such income, shall be liable to the tax imposed under this Code[.]
22 Jesus Sacred Heart College v. Collector of Internal Revenue, supra note 20 at p. 21.
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income. In other words, it should always strive, whenever possible, to have a surplus.”23
The CTA held that Section 27(B) of the present NIRC does not apply to St. Luke’s.24 The CTA explained
that to apply the 10% preferential 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 charitable “corporation or association”
in Section 30(E) of the NIRC. According to the CTA, this is unique in the present tax code, indicating an
intent to exempt this type of charitable organization from income tax. Section 27(B) does not require that
the hospital be “non-stock.” The CTA stated, “it is clear that non-stock, non-profit hospitals operated
exclusively for charitable purpose are exempt from income tax on income received by them as such,
applying the provision of Section 30(E) of the NIRC of 1997, as amended.”25
The Issue

The sole issue is whether St. Luke’s is liable for deficiency income tax in 1998 under Section 27(B) of the
NIRC, which imposes a preferential tax rate of 10% on the income of proprietary non-profit hospitals.
The Ruling of the Court

St. Luke’s Petition in G.R. No. 195960


As a preliminary matter, this Court denies the petition of St. Luke’s in G.R. No. 195960 because the petition
raises factual issues. Under Section 1, Rule 45 of the Rules of Court,
_______________
23 Id.
24 The CTA adopted its earlier interpretation in St. Luke’s Medical Center, Inc. v. Commissioner of Internal
Revenue. Supra note 16.
25 Rollo (G.R. No. 195909), p. 76. Italics in the original.
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“[t]he petition shall raise only questions of law which must be distinctly set forth.” St. Luke’s cites Martinez
v. Court of Appeals26 which permits factual review “when the Court of Appeals [in this case, the CTA]
manifestly overlooked certain relevant facts not disputed by the parties and which, if properly considered,
would justify a different conclusion.”27
This Court does not see how the CTA overlooked relevant facts. St. Luke’s itself stated that the CTA
“disregarded the testimony of [its] witness, Romeo B. Mary, being allegedly self-serving, to show the nature
of the ‘Other Income-Net’ x x x.”28 This is not a case of overlooking or failing to consider relevant evidence.
The CTA obviously considered the evidence and concluded that it is self-serving. The CTA declared that it
has “gone through the records of this case and found no other evidence aside from the self-serving affidavit
executed by [the] witnesses [of St. Luke’s] x x x.”29
The deficiency tax on “Other Income-Net” stands. Thus, St. Luke’s is liable to pay the 25% surcharge under
Section 248(A)(3) of the NIRC. There is “[f]ailure to pay the deficiency tax within the time prescribed for its
payment in the notice of assessment[.]”30 St. Luke’s is also liable to pay 20% delinquency interest under
Section 249(C)(3) of the NIRC.31 As explained by the CTA En Banc, the amount of P6,275,370.38 in the
dispositive portion of the CTA First Division Decision
_______________
26 410 Phil. 241; 358 SCRA 38 (2001).
27 Id., at p. 257; pp. 49-50; Rollo (G.R. No. 195960), pp. 15-16.
28 Rollo (G.R. No. 195960), p. 24.
29 Id., at p. 50.
30 NIRC, Sec. 248(A)(3).
31 NIRC, Sec. 249(C)(3) provides: “A deficiency tax, or any surcharge or interest thereon on the due date
appearing in the notice and demand of the Commissioner, there shall be assessed and collected on the
unpaid amount, interest at the rate prescribed in Subsection (A) hereof until the amount is fully paid, which
interest shall form part of the tax.”
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includes only deficiency interest under Section 249(A) and (B) of the NIRC and not delinquency interest.32
The Main Issue
The issue raised by the BIR is a purely legal one. It involves the effect of the introduction of Section 27(B)
in the NIRC of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption of charitable and social
welfare institutions. The 10% income tax rate under Section 27(B) specifically pertains to proprietary
educational institutions and proprietary non-profit hospitals. The BIR argues that Congress intended to
remove the exemption that non-profit hospitals previously enjoyed under Section 27(E) of the NIRC of 1977,
which is now substantially reproduced in Section 30(E) of the NIRC of 1997.33 Section 27(B) of the present
NIRC provides:
_______________
32 CTA En Banc Resolution dated 1 March 2011. Rollo (G.R. No. 195909), p. 56.
Section 249 of the NIRC provides:
(A) In General.―There shall be assessed and collected on any unpaid amount of tax, interest at the rate
of twenty percent (20%) per annum, or such higher rate as may be prescribed by rules and regulations,
from the date prescribed for its payment until the amount is fully paid.
(B) Deficiency Interest.―Any deficiency in the tax due, as the term is defined in this Code, shall be subject
to the interest prescribed in Subsection (A) hereof, which interest shall be assessed and collected from the
date prescribed for its payment until the full payment thereof.
xxxx
33 Id., at pp. 21-27. Section 27(E) of the NIRC of 1977 provides:
Sec. 27. Exemptions from tax on corporations.―The following organizations shall not be taxed under this
Title in respect to income received by them as such―
xxxx
(E) Corporation or association organized and operated exclusively for religious, charitable, scientific,
athletic, or cultural pur-
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SEC. 27. Rates of Income Tax on Domestic Corporations.―
xxxx
(B) Proprietary Educational Institutions and Hospitals.―
Proprietary educational institutions and hospitals which are non-profit shall pay a tax of ten percent (10%)
on their taxable income except those covered by Subsection (D) hereof: Provided, That if the gross income
from unrelated trade, business or other activity exceeds fifty percent (50%) of the total gross income derived
by such educational institutions or hospitals from all sources, the tax prescribed in 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 conduct of which is not
substantially related to the exercise or performance by such educational institution or hospital of its primary
purpose or function. A ‘proprietary educational institution’ is any private school maintained and administered
by private individuals or groups with an issued permit to operate from the Department of Education, Culture
and Sports (DECS), or the Commission on Higher Education (CHED), or the Technical Education and Skills
Development Authority (TESDA), as the case may be, in accordance with existing laws and regulations.
(Emphasis supplied)
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 promoting social welfare. The arguments of St. Luke’s focus on the wording
of Section 30(E) exempting from income tax non-stock, non-profit charitable institutions.34 St. Luke’s
asserts that the legislative intent of introducing Section 27(B) was only to remove the exemption for “proprie-
_______________
poses, or for the rehabilitation of veterans, no part of the net income of which inures to the benefit of any
private stockholder or individual.
xxxx
34 See Comment of St. Luke’s dated 19 September 2011 in G.R. No. 195909. Id., at pp. 105-116.
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tary non-profit” hospitals.35 The relevant provisions of Section 30 state:
SEC. 30. Exemptions from Tax on Corporations.―The following organizations shall not be taxed under
this Title in respect to income received by them as such:
xxxx
(E) Nonstock corporation or association organized and operated exclusively for religious, charitable,
scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset
shall belong to or inure to the benefit of any member, organizer, officer or any specific person;
xxxx
(G) Civic league or organization not organized for profit but operated exclusively for the promotion of
social welfare;
xxxx
Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of
the foregoing organizations 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)
The Court partly grants the petition of the BIR but on a different ground. We hold that Section 27(B) of the
NIRC does not remove the income tax exemption of proprietary non-profit hospitals under Section 30(E)
and (G). Section 27(B) on one hand, and Section 30(E) and (G) on the other hand, can be construed
together without the removal of such tax exemption. The effect of the introduction of Section 27(B) is to
subject the taxable income of two specific institutions, namely, proprietary non-profit educational
institutions36 and proprietary non-profit hospitals, among the institutions covered by
_______________
35 Id., at pp. 106-108.
36 Cf. NIRC, Sec. 30(H).
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Section 30, to the 10% preferential rate under Section 27(B) instead of the ordinary 30% corporate rate
under the last paragraph of Section 30 in relation to Section 27(A)(1).
Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1) proprietary non-profit
educational institutions and (2) proprietary non-profit hospitals. The only qualifications for hospitals are that
they must be proprietary and non-profit. “Proprietary” means private, following the definition of a “proprietary
educational institution” as “any private school maintained and administered by private individuals or groups”
with a government permit. “Non-profit” means no net income or asset accrues to or benefits any member
or specific person, with all the net income or asset devoted to the institution’s purposes and all its activities
conducted not for profit.
“Non-profit” does not necessarily mean “charitable.” In Collector of Internal Revenue v. Club Filipino Inc. de
Cebu,37 this Court considered as non-profit a sports club organized for recreation and entertainment of its
stockholders and members. The club was primarily funded by membership fees and dues. If it had profits,
they were used for overhead expenses and improving its golf course.38 The club was non-profit because
of its purpose and there was no evidence that it was engaged in a profit-making enterprise.39
The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not charitable. The Court defined
“charity” in Lung Center of the Philippines v. Quezon City40 as “a gift, to be applied consistently with existing
laws, for the benefit of an indefinite number of persons, either by bringing their minds and hearts under the
influence of education or religion, by assisting them to establish themselves in life or [by] oth-
_______________
37 115 Phil. 310; 5 SCRA 321 (1962).
38 Id., at p. 311; p. 322.
39 Id., at p. 314; p. 324.
40 G.R. No. 144104, 29 June 2004, 433 SCRA 119.
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erwise lessening the burden of government.”41 A non-profit club for the benefit of its members fails this
test. An organization may be considered as non-profit if it does not distribute any part of its income to
stockholders or members. However, despite its being a tax exempt institution, any income such institution
earns from activities conducted for profit is taxable, as expressly provided in the last paragraph of Section
30.
To be a charitable institution, however, an organization must meet the substantive test of charity in Lung
Center. The issue in Lung Center concerns exemption from real property tax and not income tax. However,
it provides for the test of charity in our jurisdiction. Charity is essentially a gift to an indefinite number of
persons which lessens the burden of government. In other words, charitable institutions provide for free
goods and services to the public which would otherwise fall on the shoulders of government. Thus, as a
matter of efficiency, the government forgoes taxes which should have been spent to address public needs,
because certain private entities already assume a part of the burden. This is the rationale for the tax
exemption of charitable institutions. The loss of taxes by the government is compensated by its relief from
doing public works which would have been funded by appropriations from the Treasury.42
Charitable institutions, however, are not ipso facto entitled to a tax exemption. The requirements for a tax
exemption are specified by the law granting it. The power of Congress to tax implies the power to exempt
from tax. Congress can create tax exemptions, subject to the constitutional
_______________
41 Id., at pp. 128-129. Emphasis supplied.
42 For further discussion of the Subsidy Theory of Tax Exemption, see H. Hansmann, The Rationale for
Exempting Nonprofit Organizations from Corporate Income Taxation, 91 YALE L. J. 54 (1981) at 66-75.
See also M. Hall & J. Colombo, The Charitable Status of Nonprofit Hospitals: Toward a Donative Theory of
Tax Exemption, 66 WASH. L. REV. 307 (1991).
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provision that “[n]o law granting any tax exemption shall be passed without the concurrence of a majority
of all the Members of Congress.”43 The requirements for a tax exemption are strictly construed against the
taxpayer44 because an exemption restricts the collection of taxes necessary for the existence of the
government.
The Court in Lung Center declared that the Lung Center of the Philippines is a charitable institution for the
purpose of exemption from real property taxes. This ruling uses the same premise as Hospital de San
Juan45 and Jesus Sacred Heart College46 which says that receiving income from paying patients does not
destroy the charitable nature of a hospital.
As a general principle, a charitable institution does not lose its character as such and its exemption from
taxes simply because it derives income from paying patients, whether out-patient, or confined in the
hospital, or receives subsidies from the government, so long as the money received is devoted or used
altogether to the charitable object which it is intended to achieve; and no money inures to the private benefit
of the persons managing or operating the institution.47
For real property taxes, the incidental generation of income is permissible because the test of exemption is
the use of the property. The Constitution provides that “[c]haritable institutions, churches and personages
or convents appurtenant
_______________
43 Constitution, Art. VI, Sec. 28(4).
44 Commissioner of Internal Revenue v. The Philippine American Accident Insurance Company, Inc., 493
Phil. 785; 453 SCRA 668 (2005); Lung Center of the Philippines v. Quezon City, supra note 40 at pp. 133-
134; Mactan Cebu International Airport Authority v. Marcos, 330 Phil. 392; 261 SCRA 667 (1996); Manila
Electric Company v. Vera, 160-A Phil. 498; 67 SCRA 351 (1975).
45 Supra note 18.
46 Supra note 20.
47 Lung Center of the Philippines v. Quezon City, supra note 40 at pp. 131-132. Citation omitted.
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thereto, mosques, non-profit cemeteries, and all lands, buildings, and improvements, actually, directly, and
exclusively used for religious, charitable, or educational purposes shall be exempt from taxation.”48 The
test of exemption is not strictly a requirement on the intrinsic nature or character of the institution. The test
requires that the institution use the property in a certain way, i.e. for a charitable purpose. Thus, the Court
held that the Lung Center of the Philippines did not lose its charitable character when it used a portion of
its lot for commercial purposes. The effect of failing to meet the use requirement is simply to remove from
the tax exemption that portion of the property not devoted to charity.
The Constitution exempts charitable institutions only from real property taxes. In the NIRC, Congress
decided to extend the exemption to income taxes. However, the way Congress crafted Section 30(E) of the
NIRC is materially different from Section 28(3), Article VI of the Constitution. Section 30(E) of the NIRC
defines the corporation or association that is exempt from income tax. On the other hand, Section 28(3),
Article VI of the Constitution does not define a charitable institution, but requires that the institution “actually,
directly and exclusively” use the property for a charitable purpose.
Section 30(E) of the NIRC provides that a charitable institution must be:
(1) A non-stock corporation or association;
(2) Organized exclusively for charitable purposes;
(3) Operated exclusively for charitable purposes; and
(4) No part of its net income or asset shall belong to or inure to the benefit of any member, organizer,
officer or any specific person.
_______________
48 Constitution, Art. VI, Sec. 28(3).
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Thus, both the organization and operations of the charitable institution must be devoted “exclusively” for
charitable purposes. The organization of the institution refers to its corporate form, as shown by its articles
of incorporation, by-laws and other constitutive documents. Section 30(E) of the NIRC specifically requires
that the corporation or association be non-stock, which is defined by the Corporation Code as “one where
no part of its income is distributable as dividends to its members, trustees, or officers”49 and that any profit
“obtain[ed] as an incident to its operations shall, whenever necessary or proper, be used for the furtherance
of the purpose or purposes for which the corporation was organized.”50 However, under Lung Center, any
profit by a charitable institution must not only be plowed back “whenever necessary or proper,” but must be
“devoted or used altogether to the charitable object which it is intended to achieve.”51
The operations of the charitable institution generally refer to its regular activities. Section 30(E) of the NIRC
requires that these operations be exclusive to charity. There is also a specific requirement that “no part of
[the] net income or asset shall belong to or inure to the benefit of any member, organizer, officer or any
specific person.” The use of lands, buildings and improvements of the institution is but a part of its
operations.
There is no dispute that St. Luke’s is organized as a non-stock and non-profit charitable institution.
However, this does not automatically exempt St. Luke’s from paying taxes. This only refers to the
organization of St. Luke’s. Even if St. Luke’s meets the test of charity, a charitable institution is not ipso
facto tax exempt. To be exempt from real property taxes, Section 28(3), Article VI of the Constitution
requires that a charitable institution use the property “actually, directly and
_______________
49 Corporation Code (B.P. Blg. 68), Sec. 87.
50 Id.
51 Supra note 40. Emphasis supplied.
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exclusively” for charitable purposes. To be exempt from income taxes, Section 30(E) of the NIRC requires
that a charitable institution must be “organized and operated exclusively” for charitable purposes. Likewise,
to be exempt from income taxes, Section 30(G) of the NIRC requires that the institution be “operated
exclusively” for social welfare.
However, the last paragraph of Section 30 of the NIRC qualifies the words “organized and operated
exclusively” by providing that:
Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of
the foregoing organizations 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] organized and operated exclusively for x x x charitable x x x purposes x x x.” It likewise qualifies the
requirement in Section 30(G) that the civic organization must be “operated exclusively” for the promotion
of social welfare.
Thus, even if the charitable institution must be “organized and operated exclusively” for charitable purposes,
it is nevertheless allowed to engage in “activities conducted for profit” without losing its tax exempt status
for its not-for-profit activities. The only consequence is that the “income of whatever kind and character” of
a charitable institution “from any of its activities conducted for profit, regardless of the disposition made of
such income, shall be subject to tax.” Prior to the introduction of Section 27(B), the tax rate on such income
from for-profit activities was the ordinary
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corporate rate under Section 27(A). With the introduction of Section 27(B), the tax rate is now 10%.
In 1998, St. Luke’s had total revenues of P1,730,367,965 from services to paying patients. It cannot be
disputed that a hospital which receives approximately P1.73 billion from paying patients is not an institution
“operated exclusively” for charitable purposes. Clearly, revenues from paying patients are income received
from “activities conducted for profit.”52 Indeed, St. Luke’s admits that it derived profits from its paying
patients. St. Luke’s declared P1,730,367,965 as “Revenues from Services to Patients” in contrast to its
“Free Services” expenditure of P218,187,498. In its Comment in G.R. No. 195909, St. Luke’s showed the
following “calculation” to support its claim that 65.20% of its “income after expenses was allocated to free
or charitable services” in 1998.53
REVENUES FROM SERVICES TO PATIENTS P1,730,367,965.00
OPERATING EXPENSES
_______________
52 Since the exemption is proportional to the revenue of the institution, Hall & Colombo say that “a general
tax exemption suffers from the same ‘upside down’ effect as many tax deductions: those entities with the
highest net revenues or the greatest value of otherwise-taxable property receive the greatest amount of
subsidy, yet these are the entities that least need support. From the standpoint of equity among different
tax-exempt entities, the result of the general tax exemption is that entities that are the ‘poorest’ in either an
income or property tax sense, and thus most in need of government assistance to serve impoverished and
uninsured patients, receive the least government assistance. Because uncompensated care is an expense
item, those hospitals with the most net revenues are more likely to have actually rendered the least free
care, all other things being equal.” Hall & Colombo, supra note 42 at pp. 355-356. Citations omitted.
53 Comment of St. Luke’s dated 19 September 2011. Rollo (G.R. No. 195909), p. 113.
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Professional care of patients P1,016,608,394.00
Administrative 287,319,334.00
Household and Property 91,797,622.00
P1,395,725,350.00

INCOME FROM OPERATIONS P334,642,615.00 100%


Free Services -218,187,498.00 -65.20%
INCOME FROM OPERATIONS, Net of FREE SERVICES P116,455,117.00 34.80%

OTHER INCOME 17,482,304.00

EXCESS OF REVENUES OVER EXPENSES P133,937,421.00


In Lung Center, this Court declared:
“[e]xclusive” is defined as possessed and enjoyed to the exclusion of others; debarred from participation or
enjoyment; and “exclusively” is defined, “in a manner to exclude; as enjoying a privilege exclusively.” x x x
The words “dominant use” or “principal use” cannot be substituted for the words “used exclusively” without
doing violence to the Constitution and the law. Solely is synonymous with exclusively.54
The Court cannot expand the meaning of the words “operated exclusively” without violating the NIRC.
Services to paying patients are activities conducted for profit. They cannot be considered any other way.
There is a “purpose
_______________
54 Supra note 40 at p. 137. Emphasis supplied; citations omitted.
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to make profit over and above the cost” of services.55 The P1.73 billion total revenues from paying patients
is not even incidental to St. Luke’s charity expenditure of P218,187,498 for non-paying patients.
St. Luke’s claims that its charity expenditure of P218,187,498 is 65.20% of its operating income in 1998.
However, if a part of the remaining 34.80% of the operating income is reinvested in property, equipment or
facilities used for services to paying and non-paying patients, then it cannot be said that the income is
“devoted or used altogether to the charitable object which it is intended to achieve.”56 The income is plowed
back to the corporation not entirely for charitable purposes, but for profit as well. In any case, the last
paragraph of Section 30 of the NIRC expressly qualifies that income from activities for profit is taxable
“regardless of the disposition made of such income.”
Jesus Sacred Heart College declared that there is no official legislative record explaining the phrase “any
activity conducted for profit.” However, it quoted a deposition of Senator Mariano Jesus Cuenco, who was
a member of the Committee of Conference for the Senate, which introduced the phrase “or from any activity
conducted for profit.”
P. Cuando ha hablado de la Universidad de Santo Tomás que tiene un hospital, no cree Vd. que es una
actividad esencial dicho hospital para el funcionamiento del colegio de medicina de dicha universidad?
xxxx
R. Si el hospital se limita a recibir enformos pobres, mi contestación seria afirmativa; pero considerando
que el hospital tiene cuartos de pago, y a los mismos generalmente van enfermos de buena posición social
económica, lo que se paga por estos enfermos debe estar sujeto
_______________
55 Jesus Sacred Heart College v. Collector of Internal Revenue, supra note 20 at pp. 20-21.
56 Lung Center of the Philippines v. Quezon City, supra note 40.
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Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
a ‘income tax’, y es una de las razones que hemos tenido para insertar las palabras o frase ‘or from any
activity conducted for profit.’57
The question was whether having a hospital is essential to an educational institution like the College of
Medicine of the University of Santo Tomas. Senator Cuenco answered that if the hospital has paid rooms
generally occupied by people of good economic standing, then it should be subject to income tax. He said
that this was one of the reasons Congress inserted the phrase “or any activity conducted for profit.”
The question in Jesus Sacred Heart College involves an educational institution.58 However, it is applicable
to charitable institutions because Senator Cuenco’s response shows an intent to focus on the activities of
charitable institutions. Activities for profit should not escape the reach of taxation. Being a non-stock and
non-profit corporation does not, by this reason alone, completely exempt an institution from tax. An
institution cannot use its corporate form to prevent its profitable activities from being taxed.
The Court finds that St. Luke’s is a corporation that is not “operated exclusively” for charitable or social
welfare purposes insofar as its revenues from paying patients are con-
_______________
57 Supra note 20 at p. 29.
58 Supra note 20 at p. 23. Jesus Sacred Heart College distinguished an educational institution from a
charitable institution: “More important still, the law applied in the case relied upon by [the BIR] exempted
from taxation only such educational institutions as were established for charitable or philanthropic purposes.
Consequently, the amount of fees charged or the intent to collect more than the cost of operation or
instruction was material to the determination of such purpose. Upon the other hand, under Section 27(e) of
[the old] National Internal Revenue Code, as amended, an institution operated exclusively for educational
purposes need not have, in addition thereto, a charitable or philanthropic character, to be exempt from
taxation, provided only that no part of its net income ‘inures to the benefit of any private stockholder or
individual.’” (Italics in the original; emphasis supplied)
92

92
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
cerned. This ruling is based not only on a strict interpretation of a provision granting tax 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 “operated exclusively” for charitable or social welfare purposes to be completely exempt from
income tax. An institution under Section 30(E) or (G) does not lose its tax exemption if it earns income from
its for-profit activities. Such income from for-profit activities, under the last paragraph of Section 30, is
merely subject to income tax, previously at the ordinary corporate rate but now at the preferential 10% rate
pursuant to Section 27(B).
A tax exemption is effectively a social subsidy granted by the State because an exempt institution is spared
from sharing in the expenses of government and yet benefits from them. Tax exemptions for charitable
institutions should therefore be limited to institutions beneficial to the public and those which improve social
welfare. A profit-making entity should not be allowed to exploit this subsidy to the detriment of the
government and other taxpayers.
St. Luke’s fails to meet the requirements under Section 30(E) and (G) of the NIRC to be completely tax
exempt from all its income. However, it remains a proprietary non-profit hospital under Section 27(B) of the
NIRC as long as it does not distribute any of its profits to its members and such profits are reinvested
pursuant to its corporate purposes. St. Luke’s, as a proprietary non-profit hospital, is entitled to the
preferential tax rate of 10% on its net income from its for-profit activities.
St. Luke’s is therefore liable for deficiency income tax in 1998 under Section 27(B) of the NIRC. However,
St. Luke’s has good reasons to rely on the letter dated 6 June 1990 by the BIR, which opined that St. Luke’s
is “a corporation for purely charitable and social welfare purposes”59 and thus
_______________
59 Italics supplied.
93

VOL. 682, SEPTEMBER 26, 2012


93
Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
exempt from income tax.60 In Michael J. Lhuillier, Inc. v. Commissioner of Internal Revenue,61 the Court
said that “good faith and honest belief that one is not subject to tax on the basis of previous interpretation
of government agencies tasked to implement the tax law, are sufficient justification to delete the imposition
of surcharges and interest.”62
WHEREFORE, the petition of the Commissioner of Internal Revenue in G.R. No. 195909 is PARTLY
GRANTED. The Decision of the Court of Tax Appeals En Banc dated 19 November 2010 and its Resolution
dated 1 March 2011 in CTA Case No. 6746 are MODIFIED. St. Luke’s Medical Center, Inc. is ORDERED
TO PAY the deficiency income tax in 1998 based on the 10% preferential income tax rate under Section
27(B) of the National Internal Revenue Code. However, it is not liable for surcharges and interest on such
deficiency income tax under Sections 248 and 249 of the National Internal Revenue Code. All other parts
of the Decision and Resolution of the Court of Tax Appeals are AFFIRMED.
The petition of St. Luke’s Medical Center, Inc. in G.R. No. 195960 is DENIED for violating Section 1, Rule
45 of the Rules of Court.
SO ORDERED.
Leonardo-De Castro,** Brion, Perez and Perlas-Bernabe, JJ., concur.
Petition partly granted, judgment and resolution modified.
_______________
60 See CTA First Division Decision dated 23 February 2009. Rollo (G.R. No. 195909), p. 69.
61 533 Phil. 101; 501 SCRA 450 (2006).
62 Id., at pp. 108-109; p. 460.
** Designated Acting Member per Special Order No. 1308 dated 21 September 2012.
94

94
SUPREME COURT REPORTS ANNOTATED
Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc.
Notes.―There is no vested right in a tax exemption, more so when the latest expression of legislative intent
renders its continuance doubtful. (Republic vs. Caguioa, 536 SCRA 193 [2007])
Gross income of a domestic corporation engaged in the sale of service means gross receipts, less sales
returns, allowances, discounts and cost of services. (Commissioner of Internal Revenue vs. Philippine
Airlines, Inc., 592 SCRA 237 [2009])
G.R. No. 182722. January 22, 2010.*
DUMAGUETE CATHEDRAL CREDIT COOPERATIVE [DCCCO], Represented by Felicidad L. Ruiz, its
General Manager, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.
Taxation; Cooperatives; Cooperatives are not required to withhold taxes on interest from savings and time
deposits of their members.—On November 16, 1988, the BIR declared in BIR Ruling No. 551-888 that
cooperatives are not required to withhold taxes on interest from savings and time deposits of their members.
Same; Same; To encourage the formation of cooperatives and to create an atmosphere conducive to their
growth and development, the State extends all forms of assistance to them, one of which is providing
cooperatives a preferential tax treatment.—Under Article 2 of RA 6938, as amended by RA 9520, it is a
declared policy of the State to foster the creation and growth of cooperatives as a practical vehicle for
promoting self-reliance and harnessing people power towards the attainment of economic development
and social justice. Thus, to encourage the formation of cooperatives and to create an atmosphere conducive
to their growth and development, the State extends all forms of assistance to them, one of which is providing
cooperatives a preferential tax treatment.
Same; Same; Although the tax exemption only mentions cooperatives, this should be construed to include
the members pursuant to Article 126 of Republic Act No. 6938.—This exemption extends to members of
cooperatives. It must be emphasized that cooperatives exist for the benefit of their members. In fact, the
primary objective of every cooperative is to provide goods and services to its members to enable them to
attain increased income, savings, investments, and productivity. Therefore, limiting the application of the
tax exemption to cooperatives would go against the very purpose of a credit cooperative. Extending the
exemption to members of cooperatives, on the other hand, would be consistent with the intent of the
legislature. Thus, although the tax exemption only mentions cooperatives, this
_______________

* SECOND DIVISION.

653

should be construed to include the members, pursuant to Article 126 of RA 6938.


PETITION for review on certiorari of the decision and resolution of the Court of Tax Appeals.
The facts are stated in the opinion of the Court.
Mercado & Partners Law Firm for petitioner.
The Solicitor General for respondent.

DEL CASTILLO, J.:

The clashing interests of the State and the taxpayers are again pitted against each other. Two basic
principles, the State’s inherent power of taxation and its declared policy of fostering the creation and growth
of cooperatives come into play. However, the one that embodies the spirit of the law and the true intent of
the legislature prevails.
This Petition for Review on Certiorari under Section 11 of Republic Act (RA) No. 9282,1 in relation to Rule
45 of the Rules of Court, seeks to set aside the December 18, 2007 Decision2 of the Court of Tax Appeals
(CTA), ordering petitioner to pay deficiency withholding taxes on interest from savings and time deposits of
its members for taxable years 1999 and 2000, pursuant to Section 24(B)(1) of the National Internal Revenue
Code of 1997 (NIRC), as well as the delinquency interest of 20% per annum under Section 249(C) of the
same
_______________

1 An Act Expanding the Jurisdiction of the Court of Tax Appeals (CTA), Elevating its Rank to the Level of a
Collegiate Court with Special Jurisdiction and Enlarging its Membership, Amending for the Purpose Certain
Sections of Republic Act No. 1125, As Amended, otherwise known as the Law Creating the Court of Tax
Appeals, and for Other Purposes.
2 Rollo, pp. 45-64; penned by Associate Justice Olga Palanca-Enriquez and concurred in by Presiding
Justice Ernesto D. Acosta and Associate Justices Juanito C. Castañeda, Jr., Lovell R. Bautista, Erlinda P.
Uy and Caesar A. Casanova.

654

Code. It also assails the April 11, 2008 Resolution3 denying petitioner’s Motion for Reconsideration.

Factual Antecedents

Petitioner Dumaguete Cathedral Credit Cooperative (DCCCO) is a credit cooperative duly registered with
and regulated by the Cooperative Development Authority (CDA).4 It was established on February 17, 19685
with the following objectives and purposes: (1) to increase the income and purchasing power of the
members; (2) to pool the resources of the members by encouraging savings and promoting thrift to mobilize
capital formation for development activities; and (3) to extend loans to members for provident and
productive purposes.6 It has the power (1) to draw, make, accept, endorse, guarantee, execute, and issue
promissory notes, mortgages, bills of exchange, drafts, warrants, certificates and all kinds of obligations
and instruments in connection with and in furtherance of its business operations; and (2) to issue bonds,
debentures, and other obligations; to contract indebtedness; and to secure the same with a mortgage or
deed of trust, or pledge or lien on any or all of its real and personal properties.7
On November 27, 2001, the Bureau of Internal Revenue (BIR) Operations Group Deputy Commissioner,
Lilian B. Hefti, issued Letters of Authority Nos. 63222 and 63223, authorizing BIR Officers Tomas
Rambuyon and Tarcisio Cubillan of Revenue Region No. 12, Bacolod City, to examine petitioner’s books
of accounts and other accounting records for all internal revenue taxes for the taxable years 1999 and
2000.8
_______________

3 Id., at pp. 80-81.


4 Id., at p. 47.
5 Id., at p. 7.
6 Id., at p. 57.
7 Id.
8 Id., at p. 118.

655

Proceedings before the BIR Regional Office

On June 26, 2002, petitioner received two Pre-Assessment Notices for deficiency withholding taxes for
taxable years 1999 and 2000 which were protested by petitioner on July 23, 2002.9 Thereafter, on October
16, 2002, petitioner received two other Pre-Assessment Notices for deficiency withholding taxes also for
taxable years 1999 and 2000.10 The deficiency withholding taxes cover the payments of the honorarium
of the Board of Directors, security and janitorial services, legal and professional fees, and interest on
savings and time deposits of its members.
On October 22, 2002, petitioner informed BIR Regional Director Sonia L. Flores that it would only pay the
deficiency withholding taxes corresponding to the honorarium of the Board of Directors, security and
janitorial services, legal and professional fees for the year 1999 in the amount of P87,977.86, excluding
penalties and interest.11
In another letter dated November 8, 2002, petitioner also informed the BIR Assistant Regional Director,
Rogelio B. Zambarrano, that it would pay the withholding taxes due on the honorarium and per diems of
the Board of Directors, security and janitorial services, commissions and legal & professional fees for the
year 2000 in the amount of P119,889.37, excluding penalties and interest, and that it would avail of the
Voluntary Assessment and Abatement Program (VAAP) of the BIR under Revenue Regulations No. 17-
2002.12
On November 29, 2002, petitioner availed of the VAAP and paid the amounts of P105,574.62 and
P143,867.2413 corresponding to the withholding taxes on the payments for the
_______________

9 Id., at p. 48.
10 Id.
11 Id., at pp. 48-49.
12 Id., at p. 49.
13 Id., at pp. 49-50.

656

compensation, honorarium of the Board of Directors, security and janitorial services, and legal and
professional services, for the years 1999 and 2000, respectively.
On April 24, 2003, petitioner received from the BIR Regional Director, Sonia L. Flores, Letters of Demand
Nos. 00027-2003 and 00026-2003, with attached Transcripts of Assessment and Audit
Results/Assessment Notices, ordering petitioner to pay the deficiency withholding taxes, inclusive of
penalties, for the years 1999 and 2000 in the amounts of P1,489,065.30 and P1,462,644.90, respectively.14

Proceedings before the Commis-


sioner of Internal Revenue

On May 9, 2003, petitioner protested the Letters of Demand and Assessment Notices with the
Commissioner of Internal Revenue (CIR).15 However, the latter failed to act on the protest within the
prescribed 180-day period. Hence, on December 3, 2003, petitioner filed a Petition for Review before the
CTA, docketed as C.T.A. Case No. 6827.16

Proceedings before the CTA First Division

The case was raffled to the First Division of the CTA which rendered its Decision on February 6, 2007,
disposing of the case in this wise:
“IN VIEW OF ALL THE FOREGOING, the Petition for Review is hereby PARTIALLY GRANTED.
Assessment Notice Nos. 00026-2003 and 00027-2003 are hereby MODIFIED and the assessment for
deficiency withholding taxes on the honorarium and per diems of petitioner’s Board of Directors, security
and janitorial services, commissions and legal and professional fees are hereby CAN-
_______________

14 Id., at pp. 50-51.


15 Id., at p. 51.
16 Id.

657

CELLED. However, the assessments for deficiency withholding taxes on interests are hereby AFFIRMED.
Accordingly, petitioner is ORDERED TO PAY the respondent the respective amounts of P1,280,145.89 and
P1,357,881.14 representing deficiency withholding taxes on interests from savings and time deposits of its
members for the taxable years 1999 and 2000. In addition, petitioner is ordered to pay the 20% delinquency
interest from May 26, 2003 until the amount of deficiency withholding taxes are fully paid pursuant to Section
249 (C) of the Tax Code.
SO ORDERED.”17
Dissatisfied, petitioner moved for a partial reconsideration, but it was denied by the First Division in its
Resolution dated May 29, 2007.18

Proceedings before the CTA En Banc


On July 3, 2007, petitioner filed a Petition for Review with the CTA En Banc,19 interposing the lone issue
of whether or not petitioner is liable to pay the deficiency withholding taxes on interest from savings and
time deposits of its members for taxable years 1999 and 2000, and the consequent delinquency interest of
20% per annum.20
Finding no reversible error in the Decision dated February 6, 2007 and the Resolution dated May 29, 2007
of the CTA First Division, the CTA En Banc denied the Petition for Review21 as well as petitioner’s Motion
for Reconsideration.22
The CTA En Banc held that Section 57 of the NIRC requires the withholding of tax at source. Pursuant
thereto, Revenue Regulations No. 2-98 was issued enumerating the
_______________

17 Id., at pp. 46-47.


18 Id., at p. 51.
19 Id., at p. 11.
20 Id., at p. 52.
21 Id., at p. 63.
22 Id., at pp. 80-81.

658

income payments subject to final withholding tax, among which is “interest from any peso bank deposit and
yield, or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements
x x x.” According to the CTA En Banc, petitioner’s business falls under the phrase “similar arrangements;”
as such, it should have withheld the corresponding 20% final tax on the interest from the deposits of its
members.

Issue

Hence, the present recourse, where petitioner raises the issue of whether or not it is liable to pay the
deficiency withholding taxes on interest from savings and time deposits of its members for the taxable years
1999 and 2000, as well as the delinquency interest of 20% per annum.

Petitioner’s Arguments

Petitioner argues that Section 24(B)(1) of the NIRC which reads in part, to wit:
“SECTION 24. Income Tax Rates.—
xxxx
(B)Rate of Tax on Certain Passive Income:—
(1)Interests, Royalties, Prizes, and Other Winnings.—A final tax at the rate of twenty percent (20%) is
hereby imposed upon the amount of interest from any currency bank deposit and yield or any other
monetary benefit from deposit substitutes and from trust funds and similar arrangements; x x x”

applies only to banks and not to cooperatives, since the phrase “similar arrangements” is preceded by terms
referring to banking transactions that have deposit peculiarities. Petitioner thus posits that the savings and
time deposits of members of cooperatives are not included in the enumeration, and thus not subject to the
20% final tax. To bolster its position,

659
petitioner cites BIR Ruling No. 551-88823 and BIR Ruling [DA-591-2006]24 where the BIR ruled that
interests from deposits maintained by members of cooperative are not subject to withholding tax under
Section 24(B)(1) of the NIRC. Petitioner further contends that pursuant to Article XII, Section 15 of the
Constitution25 and Article 2 of Republic Act No. 6938 (RA 6938) or the Cooperative Code of the
Philippines,26 cooperatives enjoy a preferential tax treatment which exempts their members from the
application of Section 24(B)(1) of the NIRC.
_______________

23 Id., at pp. 18-19.


24 Id., at pp. 75-78.
25 SEC. 15. The Congress shall create an agency to promote the viability and growth of cooperatives as
instruments for social justice and economic development.
26 ART. 2. Declaration of Policy.—It is the declared policy of the State to foster the creation and growth
of cooperatives as a practical vehicle for promoting self-reliance and harnessing people power towards the
attainment of economic development and social justice. The State shall encourage the private sector to
undertake the actual formation and organization of cooperatives and shall create an atmosphere that is
conducive to the growth and development of these cooperatives.
Toward this end, the Government and all its branches, subdivisions, instrumentalities and agencies shall
ensure the provision of technical guidance, financial assistance and other services to enable said
cooperatives to develop into viable and responsive economic enterprises and thereby bring about a strong
cooperative movement that is free from any conditions that might infringe upon the autonomy or
organizational integrity of cooperatives.
Further, the State recognizes the principle of subsidiarity under which the cooperative sector will initiate
and regulate within its own ranks the promotion and organization, training and research, audit and support
services relative to cooperatives with government assistance where necessary.
(Now amended by Republic Act No. 9520 or the Philippine Cooperative Code of 2008.)

660

Respondent’s Arguments

As a counter-argument, respondent invokes the legal maxim “Ubi lex non distinguit nec nos distinguere
debemos” (where the law does not distinguish, the courts should not distinguish). Respondent maintains
that Section 24(B)(1) of the NIRC applies to cooperatives as the phrase “similar arrangements” is not limited
to banks, but includes cooperatives that are depositaries of their members. Regarding the exemption relied
upon by petitioner, respondent adverts to the jurisprudential rule that tax exemptions are highly disfavored
and construed strictissimi juris against the taxpayer and liberally in favor of the taxing power. In this
connection, respondent likewise points out that the deficiency tax assessments were issued against
petitioner not as a taxpayer but as a withholding agent.

Our Ruling

The petition has merit.

Petitioner’s invocation of BIR Ruling


No. 551-888, reiterated in BIR Ruling
[DA-591-2006], is proper.

On November 16, 1988, the BIR declared in BIR Ruling No. 551-888 that cooperatives are not required to
withhold taxes on interest from savings and time deposits of their members. The pertinent BIR Ruling reads:
November 16, 1988
BIR RULING NO. 551-888
24 369-88 551-888

Gentlemen:

This refers to your letter dated September 5, 1988 stating that you are a corporation established under P.D.
No. 175 and duly registered with the Bureau of Cooperatives Development as full fledged cooperative of
good standing with Certificate of Registration No. FF 563-

661

RR dated August 8, 1985; and that one of your objectives is to provide and strengthen cooperative endeavor
and extend assistance to members and non-members through credit scheme both in cash and in kind.

Based on the foregoing representations, you now request in effect a ruling as to whether or not you are
exempt from the following:

1.Payment of sales tax


2.Filing and payment of income tax
3.Withholding taxes from compensation of employees and savings account and time deposits of members.”
(Underscoring ours)

In reply, please be informed that Executive Order No. 93 which took effect on March 10, 1987 withdrew all
tax exemptions and preferential privileges e.g., income tax and sales tax, granted to cooperatives under
P.D. No. 175 which were previously withdrawn by P.D. No. 1955 effective October 15, 1984 and restored
by P.D. No. 2008 effective January 8, 1986. However, implementation of said Executive Order insofar as
electric, agricultural, irrigation and waterworks cooperatives are concerned was suspended until June 30,
1987. (Memorandum Order No. 65 dated January 21, 1987 of the President) Accordingly, your tax
exemption privilege expired as of June 30, 1987. Such being the case, you are now subject to income and
sales taxes.

Moreover, under Section 72(a) of the Tax Code, as amended, every employer making payment of wages
shall deduct and withhold upon such wages a tax at the rates prescribed by Section 21(a) in relation to
section 71, Chapter X, Title II, of the same Code as amended by Batas Pambansa Blg. 135 and
implemented by Revenue Regulations No. 6-82 as amended. Accordingly, as an employer you are required
to withhold the corresponding tax due from the compensation of your employees.

Furthermore, under Section 50(a) of the Tax Code, as amended, the tax imposed or prescribed by Section
21(c) of the same Code on specified items of income shall be withheld by payor-corporation and/or person
and paid in the same manner and subject to the same conditions as provided in Section 51 of the Tax Code,
as amended. Such being the case, and since interest from any Philippine currency bank deposit and yield
or any other monetary benefit from deposit substi-

662

tutes are paid by banks, you are not the party required to withhold the corresponding tax on the aforesaid
savings account and time deposits of your members. (Underscoring ours)

Very truly yours,


(SGD.) BIENVENIDO A. TAN, JR.
Commissioner

The CTA First Division, however, disregarded the above quoted ruling in determining whether petitioner is
liable to pay the deficiency withholding taxes on interest from the deposits of its members. It ratiocinated in
this wise:
“This Court does not agree. As correctly pointed out by respondent in his Memorandum, nothing in the
above quoted resolution will give the conclusion that savings account and time deposits of members of a
cooperative are tax-exempt. What is entirely clear is the opinion of the Commissioner that the proper party
to withhold the corresponding taxes on certain specified items of income is the payor-corporation and/or
person. In the same way, in the case of interests earned from Philippine currency deposits made in a bank,
then it is the bank which is liable to withhold the corresponding taxes considering that the bank is the payor-
corporation. Thus, the ruling that a cooperative is not the proper party to withhold the corresponding taxes
on the aforementioned accounts is correct. However, this ruling does not hold true if the savings and time
deposits are being maintained in the cooperative, for in this case, it is the cooperative which becomes the
payor-corporation, a separate entity acting no more than an agent of the government for the collection of
taxes, liable to withhold the corresponding taxes on the interests earned.”27 (Underscoring ours)

The CTA En Banc affirmed the above-quoted Decision and found petitioner’s invocation of BIR Ruling No.
551-88 misplaced. According to the CTA En Banc, the BIR Ruling was based on the premise that the
savings and time deposits were placed by the members of the cooperative in the bank.28 Con-
_______________

27 Rollo, pp. 62-63.


28 Id., at p. 62.

663

sequently, it ruled that the BIR Ruling does not apply when the deposits are maintained in the cooperative
such as the instant case.
We disagree.
There is nothing in the ruling to suggest that it applies only when deposits are maintained in a bank. Rather,
the ruling clearly states, without any qualification, that since interest from any Philippine currency bank
deposit and yield or any other monetary benefit from deposit substitutes are paid by banks, cooperatives
are not required to withhold the corresponding tax on the interest from savings and time deposits of their
members. This interpretation was reiterated in BIR Ruling [DA-591-2006] dated October 5, 2006, which
was issued by Assistant Commissioner James H. Roldan upon the request of the cooperatives for a
confirmatory ruling on several issues, among which is the alleged exemption of interest income on
members’ deposit (over and above the share capital holdings) from the 20% final withholding tax. In the
said ruling, the BIR opined that:
xxxx
3. Exemption of interest income on members’ deposit (over and above the share capital holdings) from
the 20% Final Withholding Tax.
The National Internal Revenue Code states that a “final tax at the rate of twenty percent (20%) is hereby
imposed upon the amount of interest on currency bank deposit and yield or any other monetary benefit from
the deposit substitutes and from trust funds and similar arrangement x x x” for individuals under Section
24(B)(1) and for 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 and to deposits of primaries with federations,
respectively.

664

It bears stressing that interpretations of administrative agencies in charge of enforcing a law are entitled to
great weight and consideration by the courts, unless such interpretations are in a sharp conflict with the
governing statute or the Constitution and other laws.29 In this case, BIR Ruling No. 551-888 and BIR Ruling
[DA-591-2006] are in perfect harmony with the Constitution and the laws they seek to implement.
Accordingly, the interpretation in BIR Ruling No. 551-888 that cooperatives are not required to withhold the
corresponding tax on the interest from savings and time deposits of their members, which was reiterated in
BIR Ruling [DA-591-2006], applies to the instant case.
Members of cooperatives deserve a
preferential tax treatment pursuant to
RA 6938, as amended by RA 9520.

Given that petitioner is a credit cooperative duly registered with the Cooperative Development Authority
(CDA), Section 24(B)(1) of the NIRC must be read together with RA 6938, as amended by RA 9520.
Under Article 2 of RA 6938, as amended by RA 9520, it is a declared policy of the State to foster the creation
and growth of cooperatives as a practical vehicle for promoting self-reliance and harnessing people power
towards the attainment of economic development and social justice. Thus, to encourage the formation of
cooperatives and to create an atmosphere conducive to their growth and development, the State extends
all forms of assistance to them, one of which is providing cooperatives a preferential tax treatment.
The legislative intent to give cooperatives a preferential tax treatment is apparent in Articles 61 and 62 of
RA 6938, which read:
_______________

29 Nestlé Philippines, Inc. v. Court of Appeals, G.R. No. 86738, November 13, 1991, 203 SCRA 504, 510.

665

“ART. 61. Tax Treatment of Cooperatives.—Duly registered cooperatives under this Code which do not
transact any business with non-members or the general public shall not be subject to any government taxes
and fees imposed under the Internal Revenue Laws and other tax laws. Cooperatives not falling under this
article shall be governed by the succeeding section.
ART. 62. Tax and Other Exemptions.—Cooperatives transacting business with both members and
nonmembers shall not be subject to tax on their transactions to members. Notwithstanding the provision of
any law or regulation to the contrary, such cooperatives dealing with nonmembers shall enjoy the following
tax exemptions; x x x.”

This exemption extends to members of cooperatives. It must be emphasized that cooperatives exist for the
benefit of their members. In fact, the primary objective of every cooperative is to provide goods and services
to its members to enable them to attain increased income, savings, investments, and productivity.30
Therefore, limiting the application of the tax exemption to cooperatives would go against the very purpose
of a credit cooperative. Extending the exemption to members of cooperatives, on the other hand, would be
consistent with the intent of the legislature. Thus, although the tax exemption only mentions cooperatives,
this should be construed to include the members, pursuant to Article 126 of RA 6938, which provides:
“ART. 126. Interpretation and Construction.—In case of doubt as to the meaning of any provision of this
Code or the regulations issued in pursuance thereof, the same shall be resolved liberally in favor of the
cooperatives and their members.”

We need not belabor that what is within the spirit is within the law even if it is not within the letter of the law
because
_______________

30 Republic act No. 6938, Article 7.

666

the spirit prevails over the letter.31 Apropos is the ruling in the case of Alonzo v. Intermediate Appellate
Court,32 to wit:
“But as has also been aptly observed, we test a law by its results; and likewise, we may add, by its purposes.
It is a cardinal rule that, in seeking the meaning of the law, the first concern of the judge should be to
discover in its provisions the intent of the lawmaker. Unquestionably, the law should never be interpreted
in such a way as to cause injustice as this is never within the legislative intent. An indispensable part of that
intent, in fact, for we presume the good motives of the legislature, is to render justice.
Thus, we interpret and apply the law not independently of but in consonance with justice. Law and justice
are inseparable, and we must keep them so. To be sure, there are some laws that, while generally valid,
may seem arbitrary when applied in a particular case because of its peculiar circumstances. In such a
situation, we are not bound, because only of our nature and functions, to apply them just the same, [is]
slavish obedience to their language. What we do instead is find a balance between the word and the will,
that justice may be done even as the law is obeyed.
As judges, we are not automatons. We do not and must not unfeelingly apply the law as it is worded,
yielding like robots to the literal command without regard to its cause and consequence. “Courts are apt to
err by sticking too closely to the words of a law,” so we are warned, by Justice Holmes again, “where these
words import a policy that goes beyond them.” While we admittedly may not legislate, we nevertheless have
the power to interpret the law in such a way as to reflect the will of the legislature. While we may not read
into the law a purpose that is not there, we nevertheless have the right to read out of it the reason for its
enactment. In doing so, we defer not to “the letter that killeth” but to “the spirit that vivifieth,” to give effect
to the lawmaker’s will.
The spirit, rather than the letter of a statute determines its construction, hence, a statute must be read
according to its spirit or intent. For what is within the spirit is within the stat-
_______________

31 Tañada and Macapagal v. Cuenco, et al., 103 Phil. 1051, 1086 (1957).
32 234 Phil. 267, 272-273; 150 SCRA 259, 264-266 (1987).

667

ute although it is not within the letter thereof, and that which is within the letter but not within the spirit is not
within the statute. Stated differently, a thing which is within the intent of the lawmaker is as much within the
statute as if within the letter; and a thing which is within the letter of the statute is not within the statute
unless within the intent of the lawmakers.” (Underscoring ours)

It is also worthy to note that the tax exemption in RA 6938 was retained in RA 9520. The only difference is
that Article 61 of RA 9520 (formerly Section 62 of RA 6938) now expressly states that transactions of
members with the cooperatives are not subject to any taxes and fees. Thus:
“ART. 61. Tax and Other Exemptions. Cooperatives transacting business with both members and non-
members shall not be subjected to tax on their transactions with members. In relation to this, the
transactions of members with the cooperative shall not be subject to any taxes and fees, including but not
limited to final taxes on members’ deposits and documentary tax. Notwithstanding the provisions of any law
or regulation to the contrary, such cooperatives dealing with nonmembers shall enjoy the following tax
exemptions: (Underscoring ours)
x x x x”

This amendment in Article 61 of RA 9520, specifically providing that members of cooperatives are not
subject to final taxes on their deposits, affirms the interpretation of the BIR that Section 24(B)(1) of the
NIRC does not apply to cooperatives and confirms that such ruling carries out the legislative intent. Under
the principle of legislative approval of administrative interpretation by reenactment, the reenactment of a
statute substantially unchanged is persuasive indication of the adoption by Congress of a prior executive
construction.33
_______________

33 Commissioner of Internal Revenue v. American Express International, Inc. (Philippine Branch), 500 Phil.
586; 462 SCRA 197 (2005).

668
Moreover, no less than our Constitution guarantees the protection of cooperatives. Section 15, Article XII
of the Constitution considers cooperatives as instruments for social justice and economic development. At
the same time, Section 10 of Article II of the Constitution declares that it is a policy of the State to promote
social justice in all phases of national development. In relation thereto, Section 2 of Article XIII of the
Constitution states that the promotion of social justice shall include the commitment to create economic
opportunities based on freedom of initiative and self-reliance. Bearing in mind the foregoing provisions, we
find that an interpretation exempting the members of cooperatives from the imposition of the final tax under
Section 24(B)(1) of the NIRC is more in keeping with the letter and spirit of our Constitution.
All told, we hold that petitioner is not liable to pay the assessed deficiency withholding taxes on interest
from the savings and time deposits of its members, as well as the delinquency interest of 20% per annum.
In closing, cooperatives, including their members, deserve a preferential tax treatment because of the vital
role they play in the attainment of economic development and social justice. Thus, although taxes are the
lifeblood of the government, the State’s power to tax must give way to foster the creation and growth of
cooperatives. To borrow the words of Justice Isagani A. Cruz: “The power of taxation, while indispensable,
is not absolute and may be subordinated to the demands of social justice.”34
WHEREFORE, the Petition is hereby GRANTED. The assailed December 18, 2007 Decision of the Court
of Tax Appeals and the April 11, 2008 Resolution are REVERSED and SET ASIDE. Accordingly, the
assessments for deficiency withholding taxes on interest from the savings and time deposits of petitioner’s
members for the taxable years 1999 and
_______________

34 Dissenting Opinion of Justice Isagani A. Cruz in Republic of the Philippines v. Judge Peralta, 234 Phil.
40, 59; 150 SCRA 37 (1987).

669

2000 as well as the delinquency interest of 20% per annum are hereby CANCELLED.
SO ORDERED.
Carpio (Chairperson), Brion, Abad and Perez, JJ., concur.
Petition granted, judgment and resolution reversed and set aside.
Note.—As a general rule, tax exemptions are construed strictissimi juris against the taxpayer and liberally
in favor of the taxing authority. (Republic vs. Caguioa, 536 SCRA 193 [2007])
No. L-26145. February 20, 1984.*
THE MANILA WINE MERCHANTS, INC., petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE,
respondent.
Taxation; Statutes; American case law interpretation of tax statute copied from American statutes proper.—
As correctly pointed out by the Court of Tax Appeals, inasmuch as the provisions of Section 25 of the
National Internal Revenue Code were bodily lifted from Section 102 of the U.S. Internal Revenue Code of
1939, including the regulations issued in connection therewith, it would be proper to resort to applicable
cases decided by the American Federal Courts for guidance and enlightenment.
Same; Prerequisite for imposition of 25% surtax on improperly accumulated corporate profits.—A
prerequisite to the imposition of the tax has been that the corporation be formed or availed of for the purpose
of avoiding the income tax (or surtax) on its shareholders, or on the shareholders of any other corporation
by permitting the earnings and profits of the corporation to accumulate instead of dividing them among or
distributing them to the shareholders. If the earnings and profits were distributed, the shareholders would
be required to pay an income tax thereon whereas, if the distribution were not made to them, they would
incur no tax in respect to the undistributed earnings and profits of the corporation. The touchstone of liability
is the purpose behind the accumulation of the income and not the consequences of the accumulation. Thus,
if the failure to pay dividends is due to some other cause, such as the use of undistributed earnings and
profits for the reasonable needs of the business, such purpose does not fall within the interdiction of the
statute.
Same, Bonds; To avoid surtax on profits taxpayer must prove purchase of bonds within reasonable needs
of its business.—To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase
of the U.S.A. Treasury Bonds in 1951 with a face value of $175,000.00 was an investment within the
reasonable needs of the Corporation.
_______________

* SECOND DIVISION.
484

484
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
Same; “Immediacy Test” to determine whether corporate investments in bonds part of “reasonable needs”
of business for tax purposes.—To determine the “reasonable needs” of the business in order to justify an
accumulation of earnings, the Courts of the United States have invented the so-called “Immediacy Test”
which construed the words “reasonable needs of the business” to mean the immediate needs of the
business, and it was generally held that if the corporation did not prove an immediate need for the
accumulation of the earnings and profits, the accumulation was not for the reasonable needs of the
business, and the penalty tax would apply. American cases likewise hold that investment of the earnings
and profits of the corporation in stock or securities of an unrelated business usually indicates an
accumulation beyond the reasonable needs of the business.
Same; Judgment; Evidence; Findings of CTA investment in bonds not related to reasonable corporate
business needs factual and binding on Supreme Court.—The finding of the Court of Tax Appeals that the
purchase of the U.S.A. Treasury bonds were in no way related to petitioner’s business of importing and
selling wines whisky, liquors and distilled spirits, and thus construed as an investment beyond the
reasonable needs of “the business is binding on Us, the same being factual. Furthermore, the wisdom
behind this finding cannot be doubted. The case of J.M. Perry & Co. vs. Commissioner of Internal Revenue
supports the same.
Same; Where corporation bought bonds in 1951, and until 1961 never used it to aid its importations, same
militates against argument that the bonds were bought for purposes of financing its importation.—The
records further reveal that from May 1951 when petitioner purchased the U.S.A. Treasury shares, until 1962
when it finally liquidated the same, it (petitioner) never had the occasion to use the said shares in aiding or
financing its importation. This militates against the purpose enunciated earlier by petitioner that the shares
were purchased to finance its importation business. To justify an accumulation of earnings and profits for
the reasonably anticipated future needs, such accumulation must be used within a reasonable time after
the close of the taxable year.
Same; The taxpayer’s theory that it held on to its bonds for several years to wait for 60% of its stocks to be
owned by Filipinos so it can purchase its own lot and building is too indefinite.—These
485

VOL. 127, FEBRUARY 20, 1984


485
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
arguments of petitioner indicate that it considers the U.S.A. Treasury shares not only for the purpose of
aiding or financing its importation but likewise for the purpose of buying a lot and constructing a building
thereon in the near future, but conditioned upon the completion of the 60% citizenship requirement of stock
ownership of the Company in order to qualify it to purchase and own a lot. The time when the company
would be able to establish itself to meet the said requirement and the decision to pursue the same are
dependent upon various future contingencies. Whether these contingencies would unfold favorably to the
Company and if so, whether the Company would decide later to utilize the U.S.A. Treasury shares
according to its plan, remains to be seen. From these assertions of petitioner, We cannot gather anything
definite or certain. This, We cannot approve.
Same; To determine if profits are reasonably accumulated for business needs, the controlling intention is
that manifested at the time of accumulation and not later ones.—In order to determine whether profits are
accumulated for the reasonable needs of the business as to avoid the surtax upon shareholders, the
controlling intention of the taxpayer is that which is manifested at the time of accumulation not subsequently
declared intentions which are merely the product of afterthought. A speculative and indefinite purpose will
not suffice. The mere recognition of a future problem and the discussion of possible and alternative
solutions is not sufficient. Definiteness of plan coupled with action taken towards its consummation are
essential.
Same; Surplus accumulated in prior years (1951 et seq.) subject to surtax in later years (1957).—The rule
is now settled in Our jurisprudence that undistributed earnings or profits of prior years are taken into
consideration in determining unreasonable accumulation for purposes of the 25% surtax.
PETITION for certiorari to review the decision of the Court of Tax Appeals.

The facts are stated in the opinion of the Court.


Rafael D. Salcedo for petitioner.
The Solicitor General for respondent.
486

486
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
GUERRERO, J.:

In this Petition for Review on Certiorari, petitioner, the Manila Wine Merchants, Inc., disputes the decision
of the Court of Tax Appeals ordering it (petitioner) to pay respondent, the Commissioner of Internal
Revenue, the amount of P86,804.38 as 25% surtax plus interest which represents the additional tax due
petitioner for improperly accumulating profits or surplus in the taxable year 1957 under Sec. 25 of the
National Internal Revenue Code.
The Court of Tax Appeals made the following finding of facts, to wit:
“Petitioner, a domestic corporation organized in 1937, is principally engaged in the importation and sale of
whisky, wines, liquors and distilled spirits. Its original subscribed and paid capital was P500,000.00. Its
capital of P500,000.00 was reduced to P250,000.00 in 1950 with the approval of the Securities and
Exchange Commission but the reduction of the capital was never implemented. On June 21, 1958,
petitioner’s capital was increased to P1,000,000.00 with the approval of the said Commission.
On December 31, 1957, herein respondent caused the examination of herein petitioner’s book of account
and found the latter of having unreasonably accumulated surplus of P428,934.32 for the calendar year
1947 to 1957, in excess of the reasonable needs of the business subject to the 25% surtax imposed by
Section 25 of the Tax Code.
On February 26, 1963, the Commissioner of Internal Revenue demanded upon the Manila Wine Merchants,
Inc. payment of P126,536.12 as 25% surtax and interest on the latter’s unreasonable accumulation of profits
and surplus for the year 1957, computed as follows:
Unreasonable accumulation of surtax ..............................
P428,934.42
25% surtax due thereon ....................................................
P107,234.00
Add: 1/2% monthly interest from June 20,
1959 to June 20, 1962 ..............................................
9,302.12
TOTAL AMOUNT DUE AND COLLECTIBLE
P126,536.12
487

VOL. 127, FEBRUARY 20, 1984


487
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
Respondent contends that petitioner has accumulated earnings beyond the reasonable needs of its
business because the average ratio of the cash dividends declared and paid by petitioner from 1947 to
1957 was 40.33% of the total surplus available for distribution at the end of each calendar year. On the
other hand, petitioner contends that in 1957, it distributed 100% of its net earnings after income tax and
part of the surplus for prior years. Respondent further submits that the accumulated earnings tax should be
based on 25% of the total surplus available at the end of each calendar year while petitioner maintains that
the 25% surtax is imposed on the total surplus or net income for the year after deducting therefrom the
income tax due.
The records show the following analysis of petitioner’s net income, cash dividends and earned surplus for
the years 1946 to 1957:1
Year
Net Income After Income Tax
Total Cash Dividends Paid
Percentage of Dividends to Net Income After Income Tax
Balance of Earned Surplus
1946
P 613,790.00
P 200,000.
32.58%
P 234,104.81
1947
425,719.87
360,000.
84.56%
195,167.10
1948
415,591.83
375,000.
90.23%
272,991.38
1949
335,058.06
200,000.
59.69%
893,113.42
1950
399,698.09
600,000.
150.11%
234,987.07
1951
346,257.26
300,000.
86.64%
281,244.33
1952
196,161.97
200,000.
101.96%
277,406.30
1953
169,714.04
200,000.
117.85%
301,138.84
1954
238,124.85
250,000.
104.99%
289,262.69
1955
312,284.74
200,000.
64.04%
401,548.43
1956
374,240.28
300,000.
80.16%
475,788.71
1957
353,145.71
400,000.
113.27%
428,934.42

P4,179,787.36
P3,585,000.
85.77%
P3,785,688.50
Another basis of respondent in assessing petitioner for accumulated earnings tax is its substantial
investment of surplus or profits in unrelated business. These investments are itemized as follows:
_______________

1 Exhibit “C”.
488

488
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
1.
Acme Commercial Co., Inc.
P 27,501.00
2.
Union Insurance Society
of Canton
1,145.76
3.
U.S.A. Treasury Bond
347,217.50
4.
Wack Wack Golf &

Country Club
1.00

P375,865.26
As to the investment of P27,501.00 made by petitioner in the Acme Commercial Co., Inc., Mr. N.R.E.
Hawkins, president of the petitioner corporation2 explained as follows:
‘The first item consists of shares of Acme Commercial Co., Inc. which the Company acquired in 1947 and
1949. In the said years, we thought it prudent to invest in a business which patronizes us. As a supermarket,
Acme Commercial Co., Inc. is one of our best customers. The investment has proven to be beneficial to
the stockholders of this Company. As an example, the Company received cash dividends in 1961 totalling
P16,875.00 which was included in its income tax return for the said year.’
As to the investments of petitioner in Union Insurance Society of Canton and Wack Wack Golf Club in the
sums of P1,145.76 and P1.00, respectively, the same official of the petitioner-corporation stated that:3
The second and fourth items are small amounts which we believe would not affect this case substantially.
As regards the Union Insurance Society of Canton shares, this was a pre-war investment, when Wise &
Co., Inc., Manila Wine Merchants and the said insurance firm were common stockholders of the Wise Bldg.
Co., Inc. and the three companies were all housed in the same building. Union Insurance invested in Wise
Bldg. Co., Inc. but invited Manila Wine Merchants, Inc. to buy a few of its shares.’
As to the U.S.A. Treasury Bonds amounting to P347,217.50, Mr. Hawkins explained as follows:4
_______________

2 Exhibit “D”.
3 Exhibit “E”.
4 Exhibit “B”.
489

VOL. 127, FEBRUARY 20, 1984


489
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
‘With regards to the U.S.A. Treasury Bills in the amount of P347,217.50, in 1950, our balance sheet for the
said year shows the Company had deposited in current account in various banks P629,403.64 which was
not earning any interest. We decided to utilize part of this money as reserve to finance our importations and
to take care of future expansion including acquisition of a lot and the construction of our own office building
and bottling plant.
At that time, we believed that a dollar reserve abroad would be useful to the Company in meeting immediate
urgent orders of its local customers. In order that the money may earn interest, the Company, on May 31,
1951 purchased US Treasury bills with 90-day maturity and earning approximately 1% interest with the face
value of US$175,000.00. US Treasury Bills are easily convertible into cash and for the said reason they
may be better classified as cash rather than investments.
The Treasury Bills in question were held as such for many years in view of our expectation that the Central
Bank inspite of the controls would allow no-dollar licenses importations. However, since the Central Bank
did not relax its policy with respect thereto, we decided sometime in 1957 to hold the bills for a few more
years in view of our plan to buy a lot and construct a building of our own. According to the lease agreement
over the building formerly occupied by us in Dasmariñas St., the lease was to expire sometime in 1957. At
that time, the Company was not yet qualified to own real property in the Philippines. We therefore waited
until 60% of the stocks of the Company would be owned by Filipino citizens before making definite plans.
Then in 1959 when the Company was already more than 60% Filipino owned, we commenced looking for
a suitable location and then finally in 1961, we bought the main lot with an old building on Otis St., Paco,
our present site, for P665,000.00. Adjoining smaller lots were bought later. After the purchase of the main
property, we proceeded with the remodelling of the old building and the construction of additions, which
were completed at a cost of P143,896.00 in April, 1962.
In view of the needs of the business of this Company and the purchase of the Otis lots and the construction
of the improvements thereon, most of its available funds including the Treasury Bills had been utilized, but
inspite of the said
490

490
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
expenses the Company consistently declared dividends to its stockholders. The Treasury Bills were
liquidated on February 15, 1962.’
Respondent found that the accumulated surplus in question were invested to ‘unrelated business’ which
were “not considered in the ‘immediate needs’ of the Company such that the 25% surtax be imposed
therefrom.”
Petitioner appealed to the Court of Tax Appeals.
On the basis of the tabulated figures, supra, the Court of Tax Appeals found that the average percentage
of cash dividends distributed was 85.77% for a period of 11 years from 1946 to 1957 and not only 40.33%
of the total surplus available for distribution at the end of each calendar year actually distributed by the
petitioner to its stockholders, which is indicative of the view that the Manila Wine Merchants, Inc. was not
formed for the purpose of preventing the imposition of income tax upon its shareholders.5
With regards to the alleged substantial investment of surplus or profits in unrelated business, the Court of
Tax Appeals held that the investment of petitioner with Acme Commercial Co., Inc., Union Insurance
Society of Canton and with the Wack Wack Golf and Country Club are harmless accumulation of surplus
and, therefore, not subject to the 25% surtax provided in Section 25 of the Tax Code.6
As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals ruled that its
purchase was in no way related to petitioner’s business of importing and selling wines, whisky, liquors and
distilled spirits. Respondent Court was convinced that the surplus of P347,217.50 which was invested in
the U.S.A. Treasury Bonds was availed of by petitioner for the purpose of preventing the imposition of the
surtax upon petitioner’s shareholders by permitting its earnings and profits to accumulate beyond the
reasonable needs of business. Hence, the Court of Tax Appeals modified respondent’s
_______________

5 CTA Decision, pp. 9-11.


6 Ibid., pp. 12-13.
491

VOL. 127, FEBRUARY 20, 1984


491
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
decision by imposing upon petitioner the 25% surtax for 1957 only in the amount of P86,804.38 computed
as follows:
Unreasonable accumulation
of surplus
P347,217.50
25% surtax due thereon
P 86,804.387
On May 30, 1966, the Court of Tax Appeals denied the motion for reconsideration filed by petitioner on
March 30, 1966. Hence, this petition.
Petition assigns the following errors:
I
The Court of Tax Appeals erred in holding that petitioner was availed of for the purpose of preventing the
imposition of a surtax on its shareholders.
II

The Court of Tax Appeals erred in holding that petitioner’s purchase of U.S.A. Treasury Bills in 1951 was
an investment in unrelated business subject to the 25% surtax in 1957 as surplus profits improperly
accumulated in the latter years.
III

The Court of Tax Appeals erred in not finding that petitioner did not accumulate its surplus profits improperly
in 1957, and in not holding that such surplus profits, including the so-called unrelated investments, were
necessary for its reasonable business needs.
IV

The Court of Tax Appeals erred in not holding that petitioner had overcome the prima facie presumption
provided for in Section 25(c) of the Revenue Code.
V

The Court of Tax Appeals erred in finding petitioner liable for


_______________

7 Ibid., pp. 18-20.


492

492
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
the payment of the surtax of P86,804.38 and in denying petitioner’s Motion for Reconsideration and/or New
Trial.
The issues in this case can be summarized as follows: (1) whether the purchase of the U.S.A. Treasury
bonds by petitioner in 1951 can be construed as an investment to an unrelated business and hence, such
was availed of by petitioner for the purpose of preventing the imposition of the surtax upon petitioner’s
shareholders by permitting its earnings and profits to accumulate beyond the reasonable needs of the
business, and if so, (2) whether the penalty tax of twenty-five percent (25%) can be imposed on such
improper accumulation in 1957 despite the fact that the accumulation occurred in 1951.
The pertinent provision of the National Internal Revenue Code reads as follows:
“Sec. 25. Additional tax on corporations improperly accumulating profits or surplus.—(a) Imposition of
Tax.—If any corporation, except banks, insurance companies, or personal holding companies whether
domestic or foreign, is formed or availed of for the purpose of preventing the imposition of the tax upon its
shareholders or members or the shareholders or members of another corporation, through the medium of
permitting its gains and profits to accumulate instead of being divided or distributed, there is levied and
assessed against such corporation, for each taxable year, a tax equal to twenty-five per centum of the
undistributed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four and shall be computed, collected and paid in the same manner and subject to the same
provisions of law, including penalties, as that tax: Provided, that no such tax shall be levied upon any
accumulated profits or surplus, if they are invested in any dollar-producing or dollar-saving industry or in
the purchase of bonds issued by the Central Bank of the Philippines.
xxx xxx xxx
(c) Evidence determinative of purpose.—The fact that the earnings of profits of a corporation are permitted
to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid
the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence,
shall prove the contrary.” (As amended by Republic Act No. 1823).
493

VOL. 127, FEBRUARY 20, 1984


493
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
As correctly pointed out by the Court of Tax Appeals, inasmuch as the provisions of Section 25 of the
National Internal Revenue Code were bodily lifted from Section 102 of the U.S. Internal Revenue Code of
1939, including the regulations issued in connection therewith, it would be proper to resort to applicable
cases decided by the American Federal Courts for guidance and enlightenment.
A prerequisite to the imposition of the tax has been that the corporation be formed or availed of for the
purpose of avoiding the income tax (or surtax) on its shareholders, or on the shareholders of any other
corporation by permitting the earnings and profits of the corporation to accumulate instead of dividing them
among or distributing them to the shareholders. If the earnings and profits were distributed, the
shareholders would be required to pay an income tax thereon whereas, if the distribution were not made to
them, they would incur no tax in respect to the undistributed earnings and profits of the corporation.8 The
touchstone of liability is the purpose behind the accumulation of the income and not the consequences of
the accumulation.9 Thus, if the failure to pay dividends is due to some other cause, such as the use of
undistributed earnings and profits for the reasonable needs of the business, such purpose does not fall
within the interdiction of the statute.10
An accumulation of earnings or profits (including undistributed earnings or profits of prior years) is
unreasonable if it is not required for the purpose of the business, considering all the circumstances of the
case.11
In purchasing the U.S.A. Treasury Bonds, in 1951, petitioner argues that these bonds were so purchased
(1) in order to finance their importation; and that a dollar reserve abroad would be useful to the Company
in meeting urgent
_______________

8 Mertens, Law of Federal Income Taxation, Vol. 7, Chapter 39, p. 44.


9 Ibid., p. 47.
10 Ibid., p. 45.
11 Sec. 21, Revenue Regulations No. 2.
494

494
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
orders of its local customers and (2) to take care of future expansion including the acquisition of a lot and
the construction of their office building and bottling plant.
We find no merit in the petition.
To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase of the U.S.A.
Treasury Bonds in 1951 with a face value of $175,000.00 was an investment within the reasonable needs
of the Corporation.
To determine the “reasonable needs” of the business in order to justify an accumulation of earnings, the
Courts of the United States have invented the so-called “Immediacy Test” which construed the words
“reasonable needs of the business” to mean the immediate needs of the business, and it was generally
held that if the corporation did not prove an immediate need for the accumulation of the earnings and profits,
the accumulation was not for the reasonable needs of the business, and the penalty tax would apply.12
American cases likewise hold that investment of the earnings and profits of the corporation in stock or
securities of an unrelated business usually indicates an accumulation beyond the reasonable needs of the
business.13
The finding of the Court of Tax Appeals that the purchase of the U.S.A. Treasury bonds were in no way
related to petitioner’s business of importing and selling wines whisky, liquors and distilled spirits, and thus
construed as an investment beyond the reasonable needs of the business14 is binding on Us, the same
being factual.15 Furthermore, the
_______________

12 Mertens, Law of Federal Income Taxation, Vol. 7, Chapter 39, p. 103.


13 Helvering vs. Chicago Stockyards Co., 318 US 693; Helvering vs. National Grocery Co., 304 US 282.
14 Court of Tax Appeals’ Decision, pp. 15-16.
15 Renato Raymundo vs. Hon. De Joya, 101 SCRA 495; Comm. of Internal Revenue vs. Cadwallader
Pacific Co., 73 SCRA 59; Vive Chemicals Products, Inc. vs. Comm., 60 SCRA 52; Nasiad vs. CTA, 61
SCRA 238; Aznar vs. CTA, 58 SCRA 519; Coca Cola Export Corp. vs. Comm., 56 SCRA 5; Comm. of
Internal Revenue vs. Priscila Estate Inc., 11 SCRA 130.
495

VOL. 127, FEBRUARY 20, 1984


495
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
wisdom behind this finding cannot be doubted. The case of J.M. Perry & Co. vs. Commissioner of Internal
Revenue16 supports the same. In that case, the U.S. Court said the following:
“It appears that the taxpayer corporation was engaged in the business of cold storage and warehousing in
Yahima, Washington. It maintained a cold storage plant, divided into four units, having a total capacity of
490,000 boxes of fruits. It presented evidence to the effect that various alterations and repairs to its plant
were contemplated in the tax years, x x x
It also appeared that in spite of the fact that the taxpayer contended that it heeded to maintain this large
cash reserve on hand, it proceeded to make various investments which had no relation to its storage
business. In 1934, it purchased mining stock which it sold in 1935 at a profit of US $47,995.29. x x x
All these things may reasonably have appealed to the Board as incompatible with a purpose to strengthen
the financial position of the taxpayer and to provide for needed alteration.”
The records further reveal that from May 1951 when petitioner purchased the U.S.A. Treasury shares, until
1962 when it finally liquidated the same, it (petitioner) never had the occasion to use the said shares in
aiding or financing its importation. This militates against the purpose enunciated earlier by petitioner that
the shares were purchased to finance its importation business. To justify an accumulation of earnings and
profits for the reasonably anticipated future needs, such accumulation must be used within a reasonable
time after the close of the taxable year.17
Petitioner advanced the argument that the U.S.A. Treasury shares were held for a few more years from
1957, in view of a plan to buy a lot and construct a building of their own; that at that time (1957), the
Company was not yet qualified to own real property in the Philippines, hence it (petitioner) had to wait until
sixty percent (60%) of the stocks of the Company
_______________

16 120 F 2d 123.
17 Mertens, Ibid., p. 104.
496

496
SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
would be owned by Filipino citizens before making definite plans.18
These arguments of petitioner indicate that it considers the U.S.A. Treasury shares not only for the purpose
of aiding or financing its importation but likewise for the purpose of buying a lot and constructing a building
thereon in the near future, but conditioned upon the completion of the 60% citizenship requirement of stock
ownership of the Company in order to qualify it to purchase and own a lot. The time when the company
would be able to establish itself to meet the said requirement and the decision to pursue the same are
dependent upon various future contingencies. Whether these contingencies would unfold favorably to the
Company and if so, whether the Company would decide later to utilize the U.S.A. Treasury shares
according to its plan, remains to be seen. From these assertions of petitioner, We cannot gather anything
definite or certain. This, We cannot approve.
In order to determine whether profits are accumulated for the reasonable needs of the business as to avoid
the surtax upon shareholders, the controlling intention of the taxpayer is that which is manifested at the
time of accumulation not subsequently declared intentions which are merely the product of afterthought.19
A speculative and indefinite purpose will not suffice. The mere recognition of a future problem and the
discussion of possible and alternative solutions is not sufficient. Definiteness of plan coupled with action
taken towards its consummation are essential.20
The Court of Tax Appeals correctly made the following ruling:21
_______________

18 Exhibit “B”.
19 Basilan Estates, Inc. vs. Comm. of Internal Revenue, 21 SCRA 17 citing Jacob Mertens, Jr., The Law
of Federal Income Taxation, Vol. 7, Cumulative Supplement, p. 213; Smoot Sand & Gravel Corp. vs.
Comm., 241 F 2d 197.
20 Fuel Carriers, Inc. vs. US 202 F supp. 497; Smoot Sand & Gravel Corp. vs. Comm., supra.
21 CTA Decision, p. 17.
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“As to the statement of Mr. Hawkins in Exh. “B” regarding the expansion program of the petitioner by
purchasing a lot and building of its own, we find no justifiable reason for the retention in 1957 or thereafter
of the US Treasury Bonds which were purchased in 1951.
xxx xxx xxx
“Moreover, if there was any thought for the purchase of a lot and building for the needs of petitioner’s
business, the corporation may not with impunity permit its earnings to pile up merely because at some
future time certain outlays would have to be made. Profits may only be accumulated for the reasonable
needs of the business, and implicit in this is further requirement of a reasonable time.”
Viewed on the foregoing analysis and tested under the “immediacy doctrine.” We are convinced that the
Court of Tax Appeals is correct in finding that the investment made by petitioner in the U.S.A. Treasury
shares in 1951 was an accumulation of profits in excess of the reasonable needs of petitioner’s business.
Finally, petitioner asserts that the surplus profits allegedly accumulated in the form of U.S.A. Treasury
shares in 1951 by it (petitioner) should not be subject to the surtax in 1957. In other words, petitioner claims
that the surtax of 25% should be based on the surplus accumulated in 1951 and not in 1957.
This is devoid of merit.
The rule is now settled in Our jurisprudence that undistributed earnings or profits of prior years are taken
into consideration in determining unreasonable accumulation for purposes of the 25% surtax.22 The case
of Basilan Estates, Inc. vs. Commissioner of Internal Revenue23 further strengthen this rule, and We quote:
“Petitioner questions why the examiner covered the period from 1948-1953 when the taxable year on review
was 1953. The surplus of P347,507.01 was taken by the examiner from the balance sheet of the petitioner
for 1953. To check the figure arrived at, the examiner traced the accumulation process from 1947 until
1953, and
________________

22 Sec. 21, Revenue Regulations No. 2.


23 21 SCRA 27.
498

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SUPREME COURT REPORTS ANNOTATED
Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue
petitioner’s figure stood out to be correct. There was no error in the process applied, for previous
accumulations should be considered in determining unreasonable accumulation for the year concerned. In
determining whether accumulations of earnings or profits in a particular year are within the reasonable
needs of a corporation, it is necessary to take into account prior accumulations, since accumulations prior
to the year involved may have been sufficient to cover the business needs and additional accumulations
during the year involved would not reasonably be necessary.’ ”
WHEREFORE, IN VIEW OF THE FOREGOING, the decision of the Court of Tax Appeals is AFFIRMED in
toto, with costs against petitioner.
SO ORDERED.
Makasiar (Chairman), Aquino, Concepcion, Jr., Abad Santos, De Castro and Escolin, JJ., concur.
Decision affirmed.
Notes.—The right of the Collector of Internal Revenue to collect a deficiency assessment for periods not
covered by any tax return prescribes in ten years after the discovery of the taxpayer’s failure to file the
required returns. (Billozos vs. Court of Tax Appeals, 13 SCRA 469.)
Period of prescription to assess deficiency income tax commences from the filing of amended return, not
the original income tax return. (Commissioner of Internal Revenue vs. Phoenix Assurance Co., Ltd., 14
SCRA 52.)
G.R. No. 108067. January 20, 2000.*
CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE COURT OF TAX
APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.
Taxation; Income Tax; Accumulated Earnings Tax; Corporation Law; The tax on improper accumulation of
surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said
earnings by shareholders could, in turn, be taxed.—The provision discouraged tax avoidance through
corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid
on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is
essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings
by shareholders could, in turn, be taxed.
Same; Same; Same; Statutory Construction; Laws granting exemption from tax are construed strictissimi
juris against the taxpayer and liberally in favor of the taxing power.—The amendatory provision of Section
25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of
improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and
(d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares
of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration
is that the express mention of one person, thing, act, or consequence is construed to exclude all others.
Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor
of the taxing power. Taxation is the rule and exemption is the exception. The burden of proof rests upon
the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed, a burden
which petitioner here has failed to discharge.
Same; Same; Same; Words and Phrases; “Bardahl” Formula and “Operating Cycle,” Explained.—Another
point raised by the petitioner in objecting to the assessment, is that increase of working capital by a
corporation justifies accumulating income. Petitioner
________________

* SECOND DIVISION.
640

640
SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
asserts that respondent court erred in concluding that Cyanamid need not infuse additional working capital
reserve because it had considerable liquid funds based on the 2.21:1 ratio of current assets to current
liabilities. Petitioner relies on the so-called “Bardahl” formula, which allowed retention, as working capital
reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The “Bardahl”
formula was developed to measure corporate liquidity. The formula requires an examination of whether the
taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses
reasonably anticipated, plus enough to operate the business during one operating cycle. Operating cycle
is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory
into sales, including the time it takes to collect payment for the sales.
Same; Same; Same; As stressed by American authorities, although the “Bardahl” formula is well-
established and routinely applied by the courts, it is not a precise rule—it is used only for administrative
convenience.—We note, however, that the companies where the “Bardahl” formula was applied, had
operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR, the company’s
operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United
States, the corporation’s operating cycle was only 56.87 days, or 15.58% of the year. In the case of
Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need
sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business.
There are variations in the application of the “Bardahl” formula, such as average operating cycle or peak
operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot
be predicted with accuracy. As stressed by American authorities, although the “Bardahl” formula is well-
established and routinely applied by the courts, it is not a precise rule. It is used only for administrative
convenience. Petitioner’s application of the “Bardahl” formula merely creates a false illusion of exactitude.
Same; Same; Same; The ratio of current assets to current liabilities is used to determine the sufficiency of
working capital.—Other formulas are also used, e.g. the ratio of current assets to current liabilities and the
adoption of the industry standard. The ratio of current assets to current liabilities is used to determine the
suffi-
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641
Cyanamid Philippines, Inc. vs. Court of Appeals
ciency of working capital. Ideally, the working capital should equal the current liabilities and there must be
2 units of current assets for every unit of current liability, hence the so-called “2 to 1” rule.
Same; Same; Same; In order to determine whether profits are accumulated for the reasonable needs of
the business to avoid the surtax upon shareholders, it must be shown that the controlling intention of the
taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which are mere
afterthoughts.—If the CIR determined that the corporation avoided the tax on shareholders by permitting
earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving
the determination wrong, together with the corresponding burden of first going forward with evidence, is on
the taxpayer. This applies even if the corporation is not a mere holding or investment company and does
not have an unreasonable accumulation of earnings or profits. In order to determine whether profits are
accumulated for the reasonable needs of the business to avoid the surtax upon shareholders, it must be
shown that the controlling intention of the taxpayer is manifested at the time of accumulation, not intentions
declared subsequently, which are mere afterthoughts.
Same; Same; Same; Words and Phrases; “Immediacy Test,” Explained.—The accumulated profits must
be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not
establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs
of the business. In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue, we ruled: “To
determine the ‘reasonable needs’ of the business in order to justify an accumulation of earnings, the Courts
of the United States have invented the so-called ‘Immediacy Test’ which construed the words ‘reasonable
needs of the business’ to mean the immediate needs of the business, and it was generally held that if the
corporation did not prove an immediate need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and the penalty tax would apply. (Mertens,
Law of Federal Income Taxation, Vol. 7, Chapter 39, p. 103).
Same; Same; Same; Courts; The Supreme Court will not set aside lightly the conclusion reached by the
Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to
642

642
SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
the consideration of tax problems and has necessarily developed an expertise on the subject, unless there
has been an abuse or improvident exercise of authority.—The Tax Court opted to determine the working
capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs
of a business depend upon the nature of the business, its credit policies, the amount of inventories, the rate
of turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business,
and similar factors. Petitioner, by adhering to the “Bardahl” formula, failed to impress the tax court with the
required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to
establish that the profits accumulated were not beyond the reasonable needs of the company, remained
on the taxpayer. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals
which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and
has necessarily developed an expertise on the subject, unless there has been an abuse or improvident
exercise of authority. Unless rebutted, all presumptions generally are indulged in favor of the correctness
of the CIR’s assessment against the taxpayer. With petitioner’s failure to prove the CIR incorrect, clearly
and conclusively, this Court is constrained to uphold the correctness of tax court’s ruling as affirmed by the
Court of Appeals.
PETITION for review on certiorari of a decision of the Court of Appeals.

The facts are stated in the opinion of the Court.


Romulo, Mabanta, Buenaventura, Sayoc & De los Angeles for petitioner.
The Solicitor General for respondents.
QUISUMBING, J.:

Petitioner disputes the decision1 of the Court of Appeals which affirmed the decision2 of the Court of Tax
Appeals,
_________________

1 Rollo, pp. 25-34.


2 CA Rollo, pp. 19-28.
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Cyanamid Philippines, Inc. vs. Court of Appeals
ordering petitioner to pay respondent Commissioner of Internal Revenue the amount of three million, seven
hundred seventy-four thousand, eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as
25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from
January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal Revenue Code.
The Court of Tax Appeals made the following factual findings:
Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly owned
subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of
pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an importer/indentor.
On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment of
deficiency income tax of one hundred nineteen thousand eight hundred seventeen (P119,817.00) pesos
for taxable year 1981, as follows:
“Net income disclosed by the return as audited
14,575,210.00
Add: Discrepancies:

Professional fees/yr.
17018
262,877.00

per investigation

110,399.37

Total Adjustment ..............................................................................................


152,477.00
Net income per Investigation ............................................................................
14,727,687.00
Less: Personal and additional exemptions ..........................................................
_____________
Amount subject to tax ........................................................................................
14,727,687.00
Income tax due thereon
25% Surtax 2,385,231.50
3,237,495.00
Less: Amount already assessed ...........................................................................
5,161,788.00
BALANCE ........................................................................................................
75,709.00
______ monthly interest from .....................................
1,389,636.00 ..........
44,108.00
___________ ....................................................................................................
_____________
Compromise penalties .......................................................................................
_____________
TOTAL AMOUNT DUE ...............................................
3,774,867.50 .........
119,817.00”3
________________

3 Records, CA Rollo, p. 24.


644

644
SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax Assessment of
P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency Percentage
Assessment of P8,846.72.4 Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co.,
claimed, among others, that the surtax for the undue accumulation of earnings was not proper because the
said profits were retained to increase petitioner’s working capital and it would be used for reasonable
business needs of the company. Petitioner contended that it availed of the tax amnesty under Executive
Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by the law.
On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the
assessment notices and rendered its resolution, as follows:
“It appears that your client availed of Executive Order No. 41 under File No. 32A-F-000455-41B as certified
and confirmed by our Tax Amnesty Implementation Office on October 6, 1987.
In reply thereto, I have the honor to inform you that the availment of the tax amnesty under Executive Order
No. 41, as amended is sufficient basis, in appropriate cases, for the cancellation of the assessment issued
after August 21, 1986. (Revenue Memorandum Order No. 4-87) Said availment does not, therefore, result
in cancellation of assessments issued before August 21, 1986, as in the instant case. In other words, the
assessments in this case issued on January 30, 1985 despite your client’s availment of the tax amnesty
under Executive Order No. 41, as amended still subsist.
Such being the case, you are therefore, requested to urge your client to pay this Office the aforementioned
deficiency income tax and surtax on undue accumulation of surplus in the respective amounts of
P119,817.00 and P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30) days from
receipt hereof, otherwise this office will be constrained to enforce collection thereof thru summary remedies
prescribed by law.
This constitutes the final decision of this Office on this matter.”5
_______________

4 Id. at 25.
5 Id. at 27.
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Cyanamid Philippines, Inc. vs. Court of Appeals
Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both parties
agreed to compromise the 1981 deficiency income tax assessment of P119,817.00. Petitioner paid a
reduced amount—twenty-six thousand, five hundred seventy-seven pesos (P26,577.00)—as compromise
settlement. However, the surtax on improperly accumulated profits remained unresolved.
Petitioner claimed that CIR’s assessment representing the 25% surtax on its accumulated earnings for the
year 1981 had no legal basis for the following reasons: (a) petitioner accumulated its earnings and profits
for reasonable business requirements to meet working capital needs and retirement of indebtedness; (b)
petitioner is a wholly owned subsidiary of American Cyanamid Company, a corporation organized under
the laws of the State of Maine, in the United States of America, whose shares of stock are listed and traded
in New York Stock Exchange. This being the case, no individual shareholder of petitioner could have
evaded or prevented the imposition of individual income taxes by petitioner’s accumulation of earnings and
profits, instead of distribution of the same.
In denying the petition, the Court of Tax Appeals made the following pronouncements:
“Petitioner contends that it did not declare dividends for the year 1981 in order to use the accumulated
earnings as working capital reserve to meet its “reasonable business needs.” The law permits a stock
corporation to set aside a portion of its retained earnings for specified purposes (citing Section 43,
paragraph 2 of the Corporation Code of the Philippines). In the case at bar, however, petitioner’s purpose
for accumulating its earnings does not fall within the ambit of any of these specified purposes.
More compelling is the finding that there was no need for petitioner to set aside a portion of its retained
earnings as working capital reserve as it claims since it had considerable liquid funds. A thorough review
of petitioner’s financial statement (particularly the Balance Sheet, p. 127, BIR Records) reveals that the
corporation had considerable liquid funds consisting of cash accounts receivable, inventory and even its
sales for the period is adequate to meet the normal needs of the business. This can be determined by
computing the current asset to liability ratio of the company:
646

646
SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
current ratio
=
current assets/current liabilities

=
P47,052,535.00/P21,275,544.00

=
2.21:1
The significance of this ratio is to serve as a primary test of a company's solvency to meet current obligations
from current asssts as a going concern or a measure of adequacy of working capital.
xxx
We further reject petitioner’s argument that “the accumulated earnings tax does not apply to a publicly-held
corporation” citing American jurisprudence to support its position. The reference finds no application in the
case at bar because under Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated
September 17, 1980), the exceptions to the accumulated earnings tax are expressly enumerated, to wit:
Bank, non-bank financial intermediaries, corporations organized primarily, and authorized by the Central
Bank of the Philippines to hold shares of stock of banks, insurance companies, or personal holding
companies, whether domestic or foreign. The law on the matter is clear and specific. Hence, there is no
need to resort to applicable cases decided by the American Federal Courts for guidance and enlightenment
as to whether the provision of Section 25 of the NIRC should apply to petitioner.
Equally clear and specific are the provisions of E.O. 41 particularly with respect to its effectivity and
coverage. . .
. . . Said availment does not result in cancellation of assessments issued before August 21, 1986 as
petitioner seeks to do in the case at bar. Therefore, the assessments in this case, issued on January 30,
1985 despite petitioner’s availment of the tax amnesty under E.O. 41 as amended, still subsist.”
xxx
WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay respondent Commissioner of
Internal Revenue the sum of P3,774,867.50 representing 25% surtax on improper accumulation of profits
for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987.”6
Petitioner appealed the Court of Tax Appeal’s decision to the Court of Appeals. Affirming the CTA decision,
the appellate court said:
________________

6 Id. at 24-28.
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Cyanamid Philippines, Inc. vs. Court of Appeals
“In reviewing the instant petition and the arguments raised herein, We find no compelling reason to reverse
the findings of the respondent Court. The respondent Court’s decision is supported by evidence, such as
petitioner corporation’s financial statement and balance sheets (p. 127, BIR Records). On the other hand
the petitioner corporation could only come up with an alternative formula lifted from a decision rendered by
a foreign court (Bardahl Mfg. Corp. vs. Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its
particular financial position, the petitioner corporation attempts to justify its accumulated surplus earnings.
To Our mind, the petitioner corporation’s alternative formula cannot overturn the persuasive findings and
conclusion of the respondent Court based, as it is, on the applicable laws and jurisprudence, as well as
standards in the computation of taxes and penalties practiced in this jurisdiction.
WHEREFORE, in view of the foregoing, the instant petition is hereby DISMISSED and the decision of the
Court of Tax Appeals dated August 6, 1992 in C.T.A. Case No. 4250 is AFFIRMED in toto.”7
Hence, petitioner now comes before us and assigns as sole issue:
WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE PETITIONER IS LIABLE FOR
THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981.8
Section 259 of the old National Internal Revenue Code of 1977 states:
________________

7 Rollo, p. 33.
8 Id. at 9.
9 The tax on improperly accumulated income tax underwent changes since the time of assessment of
herein petitioner, in 1985, until the enactment of the present tax code, the 1997 NIRC. This provision was
subsequently repealed by Executive Order No. 37 which took effect on January 1, 1986. The reason for the
repeal was explained by the Commissioner of Internal Revenue through Revenue Memorandum Circular
No. 26-86 as follows: “The tax on improper accumulation of surplus is essentially a penalty tax designed to
compel corporations to distribute corporate earnings so that the
648

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SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
“Sec. 25. Additional tax on corporation improperly accumulating profits or surplus—
“(a)Imposition of tax.—If any corporation is formed or availed of for the purpose of preventing the imposition
of the tax upon its shareholders or members or the shareholders or members of another corporation,
through the medium of permitting its gains and profits to accumulate instead of being divided or distributed,
there is levied and assessed against such corporation, for each taxable year, a tax equal to twenty-five per-
centum of the undistributed portion of its accumulated profits or surplus which shall be in addition to the tax
imposed by section twenty-four, and shall be computed, collected and paid in the same manner and subject
to the same provisions of law, including penalties, as that tax.
“(b)Prima facie evidence.—The fact that any corporation is mere holding company shall be prima facie
evidence of a purpose to avoid the tax upon its shareholders or members. Similar presumption will lie in
the case of an investment company where at any time during the taxable year more than fifty per centum
in value of its outstanding stock is owned, directly or indirectly, by one person.
“(c)Evidence determinative of purpose.—The fact that the earnings or profits of a corporation are permitted
to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid
the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence,
shall prove the contrary.
“(d)Exception—The provisions of this sections shall not apply to banks, non-bank financial intermediaries,
corporation organized primarily, and authorized by the Central Bank of the Philippines to hold shares of
stock of banks, insurance companies, whether domestic or foreign.
________________
said earnings will be taxed to the shareholders. The exemption of dividends from income tax renders the
improperly accumulated surplus tax meaningless. Accordingly, the provisions of the tax on improper
accumulation or surplus are repealed and replaced with provisions to govern the taxation of foreign
corporation which are lifted from Section 24(b).” (Annotation, Improper Accumulation of Corporate Surplus
or Profit by Severiano S. Tabios, 173 SCRA, pp. 403-408.) However, Section 29 of the New 1997 NIRC
provides for the revival of the imposition of improperly accumulated earnings tax. The exemption from this
rule now includes publicly held corporation (par. B, 2, Section 29, 1997 NIRC).
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Cyanamid Philippines, Inc. vs. Court of Appeals
The provision discouraged tax avoidance through corporate surplus accumulation. When corporations do
not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders.
The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations
to distribute earnings so that the said earnings by shareholders could, in turn, be taxed.
Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated earnings tax
does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned company.10 Specifically,
petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit
Court of Appeals had taken the position that the accumulated earnings tax could only apply to a closely
held corporation.
A review of American taxation history on accumulated earnings tax will show that the application of the
accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and
the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the
Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to
closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be
imposed on widely held corporations including those not controlled by a few shareholders or groups of
shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held
corporations.11 In 1984, American legislation nullified the Ninth Circuit’s Golconda ruling and made
________________

10 A publicly owned corporation is one where the outstanding stock is owned by more than 1,500 persons
and not more than 10% of either the total combined voting power, or, the total value of all classes of its
outstanding stock was owned at the close of the taxable year, by any one individual, either directly or
indirectly, under the provision for attribution of ownership.
11 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.05.
650

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SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
it clear that the accumulated earnings tax is not limited to closely held corporations.12 Clearly, Golconda is
no longer a reliable precedent.
The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the
corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial
intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the
Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those
exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or
consequence is construed to exclude all others.13 Laws granting exemption from tax are construed
strictissimi juris against the taxpayer and liberally in favor of the taxing power.14 Taxation is the rule and
exemption is the exception.15 The burden of proof rests upon the party claiming exemption to prove that it
is, in fact, covered by the exemption so claimed,16 a burden which petitioner here has failed to discharge.
Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by
a corporation justifies accumulating income. Petitioner asserts that respondent court erred in concluding
that Cyanamid need not infuse additional working capital reserve because it had considerable liquid funds
based on the 2.21:1 ratio of current assets to current liabilities. Petitioner relies on the so-called “Bardahl”
formula, which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the
________________

12 Ibid.
13 Commissioner of Customs vs. Court of Tax Appeals, 224 SCRA 665, 669-670 (1993); Centeno vs.
Villalon-Pornillos, 236 SCRA 197 (1994).
14 Commissioner of Internal Revenue vs. Mitsubishi Metal Corporation, 181 SCRA 214, 223-224 (1990).
15 Ibid.
16 Ibid.
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company through one operating cycle. The “Bardahl”17 formula was developed to measure corporate
liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all
of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the
business during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw
materials, raw materials into inventory, and inventory into sales, including the time it takes to collect
payment for the sales.18
Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working
capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts that Cyanamid had a
working capital deficit of P7,986,633.00.19 Therefore, the P9,540,926.00 accumulated income as of 1981
may be validly accumulated to increase the petitioner’s working capital for the succeeding year.
We note, however, that the companies where the “Bardahl” formula was applied, had operating cycles much
shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR,20 the company’s operating cycle was only
3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States,21 the corporation’s
operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle
was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least
three quarters of the year, to cover the operating costs of the business. There are variations in the
application of the “Bardahl” formula, such as average operating cycle or peak operating cycle. In times
when there is no recurrence of a business cycle, the working
________________

17 Bardahl Manufacturing Corp. vs. Commissioner, 24 TCM 1030.


18 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.133.
19 Rollo, p. 118.
20 614 F 2d 860.
21 535 F 2d 1225.
652

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SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
capital needs cannot be predicted with accuracy. As stressed by American authorities, although the
“Bardahl” formula is well-established and routinely applied by the courts, it is not a precise rule. It is used
only for administrative convenience.22 Petitioner’s application of the “Bardahl” formula merely creates a
false illusion of exactitude.
Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the
industry standard.23 The ratio of current assets to current liabilities is used to determine the sufficiency of
working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of
current assets for every unit of current liability, hence the so-called “2 to 1” rule.24
As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities.
That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was
expected to increase further when more funds were generated from the succeeding year’s sales. Available
income covered expenses or indebtedness for that year, and there appeared no reason to expect an
impending ‘working capital deficit’ which could have necessitated an increase in working capital, as
rationalized by petitioner.
In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,25 we held that:
“. . .[T]here is no need to have such a large amount at the beginning of the following year because during
the year, current assets are converted into cash and with the income realized from the business as the year
goes, these expenses may well be taken care of. [citation omitted]. Thus, it is erroneous to say that the
taxpayer is entitled to retain enough liquid net assets in amounts approximately
_________________

22 10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.132.
23 Id. at Sec. 39.128.
24 19 Fletcher Cyclopedia Corporations, Chapter 68, Corporation Practice, Section 9248 (1975).
25 21 SCRA 17 (1967).
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Cyanamid Philippines, Inc. vs. Court of Appeals
equal to current operating needs for the year to cover ‘cost of goods sold and operating expenses’: for ‘it
excludes proper consideration of funds generated by the collection of notes receivable as trade accounts
during the course of the year.’ ”26
If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits
to accumulate, and the taxpayer contested such a determination, the burden of proving the determination
wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This
applies even if the corporation is not a mere holding or investment company and does not have an
unreasonable accumulation of earnings or profits.27
In order to determine whether profits are accumulated for the reasonable needs of the business to avoid
the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifested
at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts.28
Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable
year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such
accumulation of profit was for the immediate needs of the business.
In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,29 we ruled:
“To determine the ‘reasonable needs’ of the business in order to justify an accumulation of earnings, the
Courts of the United States have invented the so-called ‘Immediacy Test’ which construed the words
‘reasonable needs of the business’ to mean the immediate needs of the business, and it was generally held
that if the corpora-
________________

26 Id. at 27.
27 Nolledo and Nolledo, The National Internal Revenue Code of the Philippines, Annotated (1982).
28 Basilan Estates, Inc. vs. Commissioner of Internal Revenue, 21 SCRA 17, 26 (1967), citing Jacob
Mertens, Jr., The Law of Federal Income Taxation, Vol. 7, Cumulative Supplement, p. 213.
29 127 SCRA 483 (1984).
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SUPREME COURT REPORTS ANNOTATED
Cyanamid Philippines, Inc. vs. Court of Appeals
tion did not prove an immediate need for the accumulation of the earnings and profits, the accumulation
was not for the reasonable needs of the business, and the penalty tax would apply. (Mertens, Law of Federal
Income Taxation, Vol. 7, Chapter 39, p. 103).30
In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio
between current assets to current liabilities. The working capital needs of a business depend upon the
nature of the business, its credit policies, the amount of inventories, the rate of turnover, the amount of
accounts receivable, the collection rate, the availability of credit to the business, and similar factors.
Petitioner, by adhering to the “Bardahl” formula, failed to impress the tax court with the required definiteness
envisioned by the statute. We agree with the tax court that the burden of proof to establish that the profits
accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. This Court
will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its
function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an
expertise on the subject, unless there has been an abuse or improvident exercise of authority.31 Unless
rebutted, all presumptions generally are indulged in favor of the correctness of the CIR’s assessment
against the taxpayer. With petitioner’s failure to prove the CIR incorrect, clearly and conclusively, this Court
is constrained to uphold the correctness of tax court’s ruling as affirmed by the Court of Appeals.
WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals, sustaining that of
the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.
________________

30 Id. at 494.
31 Commissioner of Internal Revenue vs. Court of Appeals, 271 SCRA 605, 608 (1997).
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Domingo vs. Sandiganbayan
SO ORDERED.
Bellosillo (Chairman), Mendoza, Buena and De Leon, Jr., JJ., concur.
Petitions denied.
Notes.—Citizens of the Philippines are taxed on their income from within and without the Philippines.
(Conwi vs. Court of Tax Appeals, 213 SCRA 83 [1992])
The Court of Tax Appeals is a highly specialized body specifically created for the purpose of reviewing tax
cases and, through its expertise; it is undeniably competent to determine the issue of whether or not the
debt is deductible through the evidence presented before it. (Philippine Refining Company vs. Court of
Appeals, 256 SCRA 667 [1996])
G.R. No. 184450. January 24, 2017.*

JAIME N. SORIANO, MICHAEL VERNON M. GUERRERO, MARY ANN L. REYES, MARAH SHARYN M.
DE CASTRO and CRIS P. TENORIO, petitioners, vs. SECRETARY OF FINANCE and the
COMMISSIONER OF INTERNAL REVENUE, respondents.

G.R. No. 184508. January 24, 2017.*

SENATOR MANUEL A. ROXAS, petitioner, vs. MARGARITO B. TEVES, in his capacity as Secretary of
the Department of Finance and LILIAN B. HEFTI, in her capacity as Commis-
_______________

* EN BANC.

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Soriano vs. Secretary of Finance

sioner of the Bureau of Internal Revenue, respondents.

G.R. No. 184538. January 24, 2017.*

TRADE UNION CONGRESS OF THE PHILIPPINES (TUCP), represented by its President, DEMOCRITO
T. MENDOZA, petitioner, vs. MARGARITO B. TEVES, in his capacity as Secretary of the Department of
Finance and LILIAN B. HEFTI, in her capacity as Commissioner of the Bureau of Internal Revenue,
respondents.

G.R. No. 185234. January 24, 2017.*

SENATOR FRANCIS JOSEPH G. ESCUDERO, TAX MANAGEMENT ASSOCIATION OF THE


PHILIPPINES, INC. and ERNESTO G. EBRO, petitioners, vs. MARGARITO B. TEVES, in his capacity as
Secretary of the Department of Finance and SIXTO S. ESQUIVIAS IV, in his capacity as Commissioner of
the Bureau of Internal Revenue, respondents.
Taxation; Umali v. Estanislao, 209 SCRA 446 (1992), supports the Supreme Court’s (SC’s) stance that
Republic Act (RA) No. 9504 should be applied on a full-year basis for the entire taxable year 2008.—Umali
v. Estanislao, 209 SCRA 446 (1992), supports this Court’s stance that R.A. 9504 should be applied on a
full-year basis for the entire taxable year 2008. In Umali, Congress enacted R.A. 7167 amending the 1977
National Internal Revenue Code (NIRC). The amounts of basic personal and additional exemptions given
to individual income taxpayers were adjusted to the poverty threshold level. R.A. 7167 came into law on 30
January 1992. Controversy arose when the Commission of Internal Revenue (CIR) promulgated RR 1-92
stating that the regulation shall take effect on compensation income earned beginning 1 January 1992. The
issue posed was whether the increased personal and additional exemptions could be applied to
compensation income earned or received during calendar year 1991, given that R.A. 7167 came into law
only on 30 January 1992, when taxable year 1991 had already closed. This Court ruled in the affirmative,
considering that the increased exemptions were

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Soriano vs. Secretary of Finance
already available on or before 15 April 1992, the date for the filing of individual income tax returns. Further,
the law itself provided that the new set of personal and additional exemptions would be immediately
available upon its effectivity. While R.A. 7167 had not yet become effective during calendar year 1991, the
Court found that it was a piece of social legislation that was in part intended to alleviate the economic plight
of the lower-income taxpayers. For that purpose, the new law provided for adjustments “to the poverty
threshold level” prevailing at the time of the enactment of the law.
Same; The taxable income of an individual taxpayer shall be computed on the basis of the calendar year.—
The taxable income of an individual taxpayer shall be computed on the basis of the calendar year. The
taxpayer is required to file an income tax return on the 15th of April of each year covering income of the
preceding taxable year. The tax due thereon shall be paid at the time the return is filed. It stands to reason
that the new set of personal and additional exemptions, adjusted as a form of social legislation to address
the prevailing poverty threshold, should be given effect at the most opportune time as the Court ruled in
Umali v. Estanislao, 209 SCRA 446 (1992).
Same; Prospectivity of Laws; In Umali v. Estanislao, 209 SCRA 446 (1992), the Supreme Court (SC) ruled
that the application of the law was prospective, even if the amending law took effect after the close of the
taxable year in question, but before the deadline for the filing of the return and payment of the taxes due
for that year.—In the present case, the increased exemptions were already available much earlier than the
required time of filing of the return on 15 April 2009. R.A. 9504 came into law on 6 July 2008, more than
nine months before the deadline for the filing of the income tax return for taxable year 2008. Hence,
individual taxpayers were entitled to claim the increased amounts for the entire year 2008. This was true
despite the fact that incomes were already earned or received prior to the law’s effectivity on 6 July 2008.
Even more compelling is the fact that R.A. 9504 became effective during the taxable year in question. In
Umali v. Estanislao, 209 SCRA 446 (1992), the Court ruled that the application of the law was prospective,
even if the amending law took effect after the close of the taxable year in question, but before the deadline
for the filing of the return and payment of the taxes due for that year. Here, not only did R.A. 9504 take
effect before the deadline for the filing of the return and payment for the taxes due for taxable year 2008, it
took effect

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Soriano vs. Secretary of Finance
way before the close of that taxable year. Therefore, the operation of the new set of personal and additional
exemption in the present case was all the more prospective.
Same; The policy of full taxable year treatment, especially of the personal and additional exemptions, is
clear under Section 35, particularly paragraph C of Republic Act (RA) No. 8424 or the 1997 Tax Code.—
We have perused R.A. 9504, and we see nothing that expressly provides or even suggests a prorated
application of the exemptions for taxable year 2008. On the other hand, the policy of full taxable year
treatment, especially of the personal and additional exemptions, is clear under Section 35, particularly
paragraph C of R.A. 8424 or the 1997 Tax Code.
Same; While Section 23 of the 1977 Tax Code underwent changes, the provision on full taxable year
treatment in case of the taxpayer’s change of status was left untouched.—While Section 23 of the 1977
Tax Code underwent changes, the provision on full taxable year treatment in case of the taxpayer’s change
of status was left untouched. Executive Order No. 37, issued on 31 July 1986, retained the change of status
provision verbatim. The provision appeared under Section 30(1)(3) of the NIRC, as amended: (3) Change
of status.—If the taxpayer married or should have additional dependents as defined above during the
taxable year, the taxpayer may claim the corresponding personal and additional exemptions, as the case
may be, in full for such year. If the taxpayer should die during the taxable year, his estate may still claim
the personal and additional exemptions for himself and his dependents as if he died at the close of such
year. If the spouse or any of the dependents should die or if any of such dependents becomes twenty-one
years old during the taxable year, the taxpayer may still claim the same exemptions as if they died, or if
such dependents become twenty-one years old at the close of such year.
Same; The legislative policy of full taxable year treatment of the personal and additional exemptions has
been in our jurisdiction continuously since 1969. The prorating approach has long since been abandoned.—
The legislative policy of full taxable year treatment of the personal and additional exemptions has been in
our jurisdiction

320

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SUPREME COURT REPORTS ANNOTATED
Soriano vs. Secretary of Finance
continuously since 1969. The prorating approach has long since been abandoned. Had Congress intended
to revert to that scheme, then it should have so stated in clear and unmistakable terms. There is nothing,
however, in R.A. 9504 that provides for the reinstatement of the prorating scheme. On the contrary, the
change-of-status provision utilizing the full-year scheme in the 1997 Tax Code was left untouched by R.A.
9504.
Same; There is no legal basis for the Bureau of Internal Revenue (BIR) to reintroduce the prorating of the
new personal and additional exemptions.—There is, of course, nothing to prevent Congress from again
adopting a policy that prorates the effectivity of basic personal and additional exemptions. This policy,
however, must be explicitly provided for by law to amend the prevailing law, which provides for full-year
treatment. As already pointed out, R.A. 9504 is totally silent on the matter. This silence cannot be presumed
by the BIR as providing for a half-year application of the new exemption levels. Such presumption is unjust,
as incomes do not remain the same from month to month, especially for the MWEs. Therefore, there is no
legal basis for the BIR to reintroduce the prorating of the new personal and additional exemptions. In so
doing, respondents overstepped the bounds of their rule-making power. It is an established rule that
administrative regulations are valid only when these are consistent with the law. Respondents cannot
amend, by mere regulation, the laws they administer. To do so would violate the principle of non--
delegability of legislative powers.
Same; Tax Exemption; Minimum Wage Earner; Words and Phrases; To be exempt, one must be a Minimum
Wage Earner (MWE), a term that is clearly defined. Section 22(HH) says he/she must be one who is paid
the statutory minimum wage if he/she works in the private sector, or not more than the statutory minimum
wage in the nonagricultural sector where he/she is assigned, if he/she is a government employee.—To be
exempt, one must be an MWE, a term that is clearly defined. Section 22(HH) says he/she must be one who
is paid the statutory minimum wage if he/she works in the private sector, or not more than the statutory
minimum wage in the nonagricultural sector where he/she is assigned, if he/she is a government employee.
Thus, one is either an MWE or he/she is not. Simply put, MWE is the status acquired upon passing the
litmus test — whether one receives wages not exceeding the prescribed minimum wage.

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Same; Same; Same; The minimum wage exempted by Republic Act (RA) No. 9504 is that which is referred
to in the Labor Code. It is distinct and different from other payments including allowances, honoraria,
commissions, allowances or benefits that an employer may pay or provide an employee.—While the Labor
Code’s definition of “wage” appears to encompass any payments of any designation that an employer pays
his or her employees, the concept of minimum wage is distinct. “Minimum wage” is wage mandated; one
that employers may not freely choose on their own to designate in any which way. In Article 99, minimum
wage rates are to be prescribed by the Regional Tripartite Wages and Productivity Boards. In Articles 102
to 105, specific instructions are given in relation to the payment of wages. They must be paid in legal tender
at least once every two weeks, or twice a month, at intervals not exceeding 16 days, directly to the worker,
except in case of force majeure or death of the worker. These are the wages for which a minimum is
prescribed. Thus, the minimum wage exempted by R.A. 9504 is that which is referred to in the Labor Code.
It is distinct and different from other payments including allowances, honoraria, commissions, allowances
or benefits that an employer may pay or provide an employee.
Same; Same; Same; The law exempts from income taxation the most basic compensation an employee
receives — the amount afforded to the lowest paid employees by the mandate of law.—Additional
compensation in the form of overtime pay is mandated for work beyond the normal hours based on the
employee’s regular wage. Those working between ten o’clock in the evening and six o’clock in the morning
are required to be paid a night shift differential based on their regular wage. Holiday/premium pay is
mandated whether one works on regular holidays or on one’s scheduled rest days and special holidays. In
all of these cases, additional compensation is mandated, and computed based on the employee’s regular
wage. R.A. 9504 is explicit as to the coverage of the exemption: the wages that are not in excess of the
minimum wage as determined by the wage boards, including the corresponding holiday, overtime, night
differential and hazard pays. In other words, the law exempts from income taxation the most basic
compensation an employee receives — the amount afforded to the lowest paid employees by the mandate
of law. In a way, the legislature grants to these lowest paid employees additional income by no longer
demanding from them a contribution for the operations of government. This is the essence of R.A. 9504 as

322

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SUPREME COURT REPORTS ANNOTATED
Soriano vs. Secretary of Finance
a social legislation. The government, by way of the tax exemption, affords increased purchasing power to
this sector of the working class.
Administrative Agencies; An administrative agency may not enlarge, alter or restrict a provision of law. It
cannot add to the requirements provided by law. To do so constitutes lawmaking, which is generally
reserved for Congress.—An administrative agency may not enlarge, alter or restrict a provision of law. It
cannot add to the requirements provided by law. To do so constitutes lawmaking, which is generally
reserved for Congress. In CIR v. Fortune Tobacco, 559 SCRA 160 (2008), we applied the plain meaning
rule when the Commissioner of Internal Revenue ventured into unauthorized administrative lawmaking:
[A]n administrative agency issuing regulations may not enlarge, alter or restrict the provisions of the law it
administers, and it cannot engraft additional requirements not contemplated by the legislature. The Court
emphasized that tax administrators are not allowed to expand or contract the legislative mandate and that
the “plain meaning rule” or verba legis in statutory construction should be applied such that where the words
of a statute are clear, plain and free from ambiguity, it must be given its literal meaning and applied without
attempted interpretation. As we have previously declared, rule-making power must be confined to details
for regulating the mode or proceedings in order to carry into effect the law as it has been enacted, and it
cannot be extended to amend or expand the statutory requirements or to embrace matters not covered by
the statute. Administrative regulations must always be in harmony with the provisions of the law because
any resulting discrepancy between the two will always be resolved in favor of the basic law.
Taxation; Minimum Wage Earner; Tax Exemptions; Workers who receive the statutory minimum wage their
basic pay remain Minimum Wage Earners (MWEs). The receipt of any other income during the year does
not disqualify them as MWEs. They remain MWEs, entitled to exemption as such, but the taxable income
they receive other than as MWEs may be subjected to appropriate taxes.—In sum, the proper interpretation
of R.A. 9504 is that it imposes taxes only on the taxable income received in excess of the minimum wage,
but the MWEs will not lose their exemption as such. Workers

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Soriano vs. Secretary of Finance
who receive the statutory minimum wage their basic pay remain MWEs. The receipt of any other income
during the year does not disqualify them as MWEs. They remain MWEs, entitled to exemption as such, but
the taxable income they receive other than as MWEs may be subjected to appropriate taxes.
Same; Tax Exemptions; Liberal Interpretation; The canon is tempered by several exceptions, one of which
is when the taxpayer falls within the purview of the exemption by clear legislative intent. In this situation,
the rule of liberal interpretation applies in favor of the grantee and against the government.—We are mindful
of the strict construction rule when it comes to the interpretation of tax exemption laws. The canon, however,
is tempered by several exceptions, one of which is when the taxpayer falls within the purview of the
exemption by clear legislative intent. In this situation, the rule of liberal interpretation applies in favor of the
grantee and against the government. In this case, there is a clear legislative intent to exempt the minimum
wage received by an MWE who earns additional income on top of the minimum wage. As previously
discussed, this intent can be seen from both the law and the deliberations. Accordingly, we see no reason
why we should not liberally interpret R.A. 9504 in favor of the taxpayers.
Same; Bracket Creep; Words and Phrases; “Bracket creep,” “the process by which inflation pushes
individuals into higher tax brackets.”—When tax tables do not get adjusted, inflation has a profound impact
in terms of tax burden. “Bracket creep,” “the process by which inflation pushes individuals into higher tax
brackets,” occurs, and its deleterious results may be explained as follows: [A]n individual whose dollar
income increases from one year to the next might be obliged to pay tax at a higher marginal rate (say 25%
instead of 15%) on the increase, this being a natural consequence of rate progression. If, however, due to
inflation the benefit of the increase is wiped out by a corresponding increase in the cost of living, the effect
would be a heavier tax burden with no real improvement in the taxpayer’s economic position. Wage and
salary-earners are especially vulnerable. Even if a worker gets a raise in wages this year, the raise will be
illusory if the prices of consumer goods rise in the same proportion. If her marginal tax rate also increased,
the result would actually be a decrease in the taxpayer’s real disposable income.

324

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SUPREME COURT REPORTS ANNOTATED
Soriano vs. Secretary of Finance
Same; Tax Exemptions; Republic Act (RA) No. 9504 provides relief by declaring that an Minimum Wage
Earner (MWE), one who is paid the statutory minimum wage (SMW), is exempt from tax on that income, as
well as on the associated statutory payments for hazardous, holiday, overtime and night work.—R.A. 9504
provides relief by declaring that an MWE, one who is paid the statutory minimum wage (SMW), is exempt
from tax on that income, as well as on the associated statutory payments for hazardous, holiday, overtime
and night work. RR 10-2008, however, unjustly removes this tax relief. While R.A. 9504 grants MWEs zero
tax rights from the beginning or for the whole year 2008, RR 10-2008 declares that certain workers — even
if they are being paid the SMW, “shall not enjoy the privilege.” Following RR 10-2008’s “disqualification”
injunction, the MWE will continue to be pushed towards the higher tax brackets and higher rates. As Table
2 shows, as of June 2016, an MWE would already belong to the 4th highest tax bracket of 20% (see also
Table 3), resulting in a tax burden of 9.9%. This means that for every P100 the MWE earns, the government
takes back P9.90.
SPECIAL CIVIL ACTIONS in the Supreme Court. Certiorari, Prohibition and Mandamus.
The facts are stated in the opinion of the Court.
Jaime N. Soriano for himself and all the other petitioners.
Poblador, Bautista & Reyes for petitioners in G.R. No. 185234.
Cadiz & Tabayoyong for petitioner in G.R. No. 184508.
SERENO, CJ.:

Before us are consolidated Petitions for Certiorari, Prohibition and Mandamus, under Rule 65 of the 1997
Revised Rules of Court. These Petitions seek to nullify certain provisions of Revenue Regulation No. (RR)
10-2008. The RR was issued by the Bureau of Internal Revenue (BIR) on 24 September 2008 to implement
the provisions of Republic Act No. (R.A.) 9504. The law granted, among others, income tax exemption for

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Soriano vs. Secretary of Finance
minimum wage earners (MWEs), as well as an increase in personal and additional exemptions for individual
taxpayers.
Petitioners assail the subject RR as an unauthorized departure from the legislative intent of R.A. 9504. The
regulation allegedly restricts the implementation of the MWEs’ income tax exemption only to the period
starting from 6 July 2008, instead of applying the exemption to the entire year 2008. They further challenge
the BIR’s adoption of the prorated application of the new set of personal and additional exemptions for
taxable year 2008. They also contest the validity of the RR’s alleged imposition of a condition for the
availment by MWEs of the exemption provided by R.A. 9504. Supposedly, in the event they receive other
benefits in excess of P30,000, they can no longer avail themselves of that exemption. Petitioners contend
that the law provides for the unconditional exemption of MWEs from income tax and, thus, pray that the RR
be nullified.

Antecedent Facts

R.A. 9504

On 19 May 2008, the Senate filed its Senate Committee Report No. 53 on Senate Bill No. (S.B.) 2293. On
21 May 2008, former President Gloria M. Arroyo certified the passage of the bill as urgent through a letter
addressed to then Senate President Manuel Villar. On the same day, the bill was passed on second reading
in the Senate and, on 27 May 2008, on third reading. The following day, 28 May 2008, the Senate sent S.B.
2293 to the House of Representatives for the latter’s concurrence.
On 04 June 2008, S.B. 2293 was adopted by the House of Representatives as an amendment to House
Bill No. (H.B.) 3971.
On 17 June 2008, R.A. 9504 entitled “An Act Amending Sections 22, 24, 34, 35, 51, and 79 of Republic Act
No. 8424,

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Soriano vs. Secretary of Finance
as Amended, Otherwise Known as the National Internal Revenue Code of 1997,” was approved and signed
into law by President Arroyo. The following are the salient features of the new law:
1. It increased the basic personal exemption from P20,000 for a single individual, P25,000 for the head of
the family, and P32,000 for a married individual to P50,000 for each individual.
2. It increased the additional exemption for each dependent not exceeding four from P8,000 to P25,000.
3. It raised the Optional Standard Deduction (OSD) for individual taxpayers from 10% of gross income to
40% of the gross receipts or gross sales.
4. It introduced the OSD to corporate taxpayers at no more than 40% of their gross income.
5. It granted MWEs exemption from payment of income tax on their minimum wage, holiday pay, overtime
pay, night shift differential pay and hazard pay.1

Section 9 of the law provides that it shall take effect 15 days following its publication in the Official Gazette
or in at least two newspapers of general circulation. Accordingly, R.A. 9504 was published in the Manila
Bulletin and Malaya on 21
_______________

1 R.A. 9504, Section 2. Section 24(A) of Republic Act No. 8424, as amended, otherwise known as the
National Internal Revenue Code of 1997, is hereby further amended to read as follows:
xxxx
Provided, That minimum wage earners as defined in Section 22 (HH) of this Code shall be exempt from the
payment of income tax on their taxable income: Provided, further, That the holiday pay, overtime pay, night
shift differential and hazard pay received by such minimum wage earners shall likewise be exempt from
income tax.
xxxx
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June 2008. On 6 July 2008, the end of the 15-day period, the law took effect.

RR 10-2008

On 24 September 2008, the BIR issued RR 10-2008, dated 08 July 2008, implementing the provisions of
R.A. 9504. The relevant portions of the said RR read as follows:
SECTION 1. Section 2.78.1 of RR 2-98, as amended, is hereby further amended to read as follows:
Sec. 2.78.1. Withholding of Income Tax on Compensation Income.—
xxxx
The amount of ‘de minimis’ benefits conforming to the ceiling herein prescribed shall not be considered in
determining the P30,000.00 ceiling of ‘other benefits’ excluded from gross income under Section 32(b)(7)(e)
of the Code. Provided that, the excess of the ‘de minimis’ benefits over their respective ceilings prescribed
by these regulations shall be considered as part of ‘other benefits’ and the employee receiving it will be
subject to tax only on the excess over the P30,000.00 ceiling. Provided, further, that MWEs receiving ‘other
benefits’ exceeding the P30,000.00 limit shall be taxable on the excess benefits, as well as on his salaries,
wages and allowances, just like an employee receiving compensation income beyond the SMW.
xxxx
(B) Exemptions from Withholding Tax on Compensation.—The following income payments are exempted
from the requirements of withholding tax on compensation:
xxxx
(13) Compensation income of MWEs who work in the private sector and being paid the Statutory Minimum
Wage (SMW), as fixed by Regional Tripartite Wage and

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Productivity Board (RTWPB)/National Wages and Productivity Commission (NWPC), applicable to the
place where he/she is assigned.
The aforesaid income shall likewise be exempted from income tax.
‘Statutory Minimum Wage’ (SMW) shall refer to the rate fixed by the Regional Tripartite Wage and
Productivity Board (RTWPB), as defined by the Bureau of Labor and Employment Statistics (BLES) of the
Department of Labor and Employment (DOLE). The RTWPB of each region shall determine the wage rates
in the different regions based on established criteria and shall be the basis of exemption from income tax
for this purpose.
Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the aforementioned MWE
shall likewise be covered by the above exemption. Provided, however, that an employee who
receives/earns additional compensation such as commissions, honoraria, fringe benefits, benefits in excess
of the allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than
the SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege
of being a MWE and, therefore, his/her entire earnings are not exempt from income tax, and consequently,
from withholding tax.
MWEs receiving other income, such as income from the conduct of trade, business, or practice of
profession, except income subject to final tax, in addition to compensation income are not exempted from
income tax on their entire income earned during the taxable year. This rule, notwithstanding, the SMW,
holiday pay, overtime pay, night shift differential pay and hazard pay shall still be exempt from withholding
tax.
For purposes of these regulations, hazard pay shall mean the amount paid by the employer to MWEs who
were actually assigned to danger or strife-torn areas, disease-infested places, or in distressed or isolated
stations and camps, which expose them to great danger of conta-

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Soriano vs. Secretary of Finance
gion or peril to life. Any hazard pay paid to MWEs which does not satisfy the above criteria is deemed
subject to income tax and consequently, to withholding tax.
xxxx
SECTION 3. Section 2.79 of RR 2-98, as amended, is hereby further amended to read as follows:
Sec. 2.79. Income Tax Collected at Source on Com-pensation Income.—
(A) Requirement of Withholding.—Every employer must withhold from compensation paid an amount
computed in accordance with these Regulations. Provided, that no withholding of tax shall be required on
the SMW, including holiday pay, overtime pay, night shift differential and hazard pay of MWEs in the
private/public sectors as defined in these Regulations. Provided, further, that an employee who receives
additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the
allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than the
SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege of
being a MWE and, therefore, his/her entire earnings are not exempt from income tax and, consequently,
shall be subject to withholding tax.
xxxx
For the year 2008, however, being the initial year of implementation of R.A. 9504, there shall be a transitory
withholding tax table for the period from July 6 to December 31, 2008 (Annex “D”) determined by prorating
the annual personal and additional exemptions under R.A. 9504 over a period of six months. Thus, for
individuals, regardless of personal status, the prorated personal exemption is P25,000, and for each
qualified dependent child (QDC), P12,500.
xxxx
SECTION 9. Effectivity.—

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These Regulations shall take effect beginning July 6, 2008. (Emphases supplied)

The issuance and effectivity of RR 10-2008 implementing R.A. 9504 spawned the present Petitions.

G.R. No. 184450

Petitioners Jaime N. Soriano, et al. primarily assail Section 3 of RR 10-2008 providing for the prorated
application of the personal and additional exemptions for taxable year 2008 to begin only effective 6 July
2008 for being contrary to Section 4 of Republic Act No. 9504.2
Petitioners argue that the prorated application of the personal and additional exemptions under RR 10-2008
is not “the legislative intendment in this jurisdiction.”3 They stress that Congress has always maintained a
policy of “full taxable year treatment”4 as regards the application of tax exemption laws. They allege further
that R.A. 9504 did not provide for a prorated application of the new set of personal and additional
exemptions.5

G.R. No. 184508


Then Senator Manuel Roxas, as principal author of R.A. 9504, also argues for a full taxable year treatment
of the income tax benefits of the new law. He relies on what he says is clear legislative intent. In his
“Explanatory Note of Senate Bill No. 103,” he stresses “the very spirit of enacting the subject tax exemption
law”6 as follows:
_______________

2 Rollo (G.R. No. 184450), p. 14.


3 Id., at p. 9.
4 Id.
5 Id., at p. 8.
6 Rollo (G.R. No. 184508), p. 16.

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With the poor, every little bit counts, and by lifting their burden of paying income tax, we give them
opportunities to put their money to daily essentials as well as savings. Minimum wage earners can no longer
afford to be taxed and to be placed in the cumbersome income tax process in the same manner as higher-
earning employees. It is our obligation to ease their burdens in any way we can.7 (Emphasis Supplied)

Apart from raising the issue of legislative intent, Senator Roxas brings up the following legal points to
support his case for the full-year application of R.A. 9504’s income tax benefits. He says that the pro rata
application of the assailed RR deprives MWEs of the financial relief extended to them by the law;8 that
Umali v. Estanislao9 serves as jurisprudential basis for his position that R.A. 9504 should be applied on a
full-year basis to taxable year 2008;10 and that the social justice provisions of the 1987 Constitution,
particularly Articles II and XIII, mandate a full application of the law according to the spirit of R.A. 9504.11
_______________

7 Id.
8 Rollo (G.R. No. 184450), p. 18.
9 G.R. Nos. 104037 & 104069, 29 May 1992, 209 SCRA 446.
10 Rollo (G.R. No. 184450), p. 18.
11 Petitioner Sen. Roxas cites the following provisions of the 1987 Constitution:
Article II
DECLARATION OF PRINCIPLES AND STATE POLICIES
xxxx
Section 9. The State shall promote a just and dynamic social order that will ensure the prosperity and
independence of the nation and free the people from poverty through policies that provide adequate social
services, promote full employment, a rising standard of living, and an improved quality of life for all.

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_______________

Section 10. The State shall promote social justice in all phases of national development.
xxxx
Section 18. The State affirms labor as a primary social economic force. It shall protect the rights of
workers and promote their welfare.
Article XIII:
SOCIAL JUSTICE AND HUMAN RIGHTS
Section 1. The Congress shall give highest priority to the enactment of measures that protect and
enhance the right of all the people to human dignity, reduce social, economic, and political inequalities, and
remove cultural inequities by equitably diffusing wealth and political power for the common good.
To this end, the State shall regulate the acquisition, ownership, use, and disposition of property and its
increments.
Section 2. The promotion of social justice shall include the commitment to create economic opportunities
based on freedom of initiative and self-reliance.
LABOR
Section 3. The State shall afford full protection to labor, local and overseas, organized and unorganized,
and promote full employment and equality of employment opportunities for all.
It shall guarantee the rights of all workers to self-organization, collective bargaining and negotiations, and
peaceful concerted activities, including the right to strike in accordance with law. They shall be entitled to
security of tenure, humane conditions of work, and a living wage. They shall also participate in policy and
decision-making processes affecting their rights and benefits as may be provided by law.
The State shall promote the principle of shared responsibility between workers and employers and the
preferential use of voluntary modes in settling disputes, including conciliation,

333
On the scope of exemption of MWEs under R.A. 9504, Senator Roxas argues that the exemption of MWEs
is absolute, regardless of the amount of the other benefits they receive. Thus, he posits that the Department
of Finance (DOF) and the BIR committed grave abuse of discretion amounting to lack and/or excess of
jurisdiction. They supposedly did so when they provided in Section 1 of RR 10-2008 the condition that an
MWE who receives “other benefits” exceeding the P30,000 limit would lose the tax exemption.12 He further
contends that the real intent of the law is to grant income tax exemption to the MWE without any limitation
or qualification, and that while it would be reasonable to tax the benefits in excess of P30,000, it is
unreasonable and unlawful to tax both the excess benefits and the salaries, wages and allowances.13

G.R. No. 184538

Petitioner Trade Union Congress of the Philippine contends that the provisions of R.A. 9504 provide for the
application of the tax exemption for the full calendar year 2008. It also espouses the interpretation that R.A.
9504 provides for the unqualified tax exemption of the income of MWEs regardless of the other benefits
they receive.14 In conclusion, it says that RR 10-2008, which is only an implementing rule, amends the
original intent of R.A. 9504, which is the substantive law, and is thus null and void.
_______________

and shall enforce their mutual compliance therewith to foster industrial peace.
The State shall regulate the relations between workers and employers, recognizing the right of labor to its
just share in the fruits of production and the right of enterprises to reasonable returns to investments, and
to expansion and growth.
xxxx
12 Rollo (G.R. No. 184508), p. 23.
13 Id., at p. 24.
14 Rollo (G.R. No. 184538), pp. 11-12.

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G.R. No. 185234


Petitioners Senator Francis Joseph Escudero, the Tax Management Association of the Philippines, Inc.,
and Ernesto Ebro allege that R.A. 9504 unconditionally grants MWEs exemption from income tax on their
taxable income, as well as increased personal and additional exemptions for other individual taxpayers, for
the whole year 2008. They note that the assailed RR 10-2008 restricts the start of the exemptions to 6 July
2008 and provides that those MWEs who received “other benefits” in excess of P30,000 are not exempt
from income taxation. Petitioners believe this RR is a “patent nullity”15 and therefore void.

Comment of the OSG

The Office of the Solicitor General (OSG) filed a Consolidated Comment16 and took the position that the
application of R.A. 9504 was intended to be prospective, and not retroactive. This was supposedly the
general rule under the rules of statutory construction: law will only be applied retroactively if it clearly
provides for retroactivity, which is not provided in this instance.17
The OSG contends that Umali v. Estanislao is not applicable to the present case. It explains that R.A. 7167,
the subject of that case, was intended to adjust the personal exemption levels to the poverty threshold
prevailing in 1991. Hence, the Court in that case held that R.A. 7167 had been given a retroactive effect.
The OSG believes that the grant of personal exemptions no longer took into account the poverty threshold
level under R.A. 9504, because the amounts of personal exemption far exceeded the poverty threshold
levels.18
_______________

15 Rollo (G.R. No. 185234), p. 7.


16 Rollo (G.R. No. 184450), pp. 99-149; (G.R. No. 184538), pp. 80-128; and (G.R. No. 185234), pp. 97-
146.
17 Id., at p. 90.
18 Id., at pp. 101-103.

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The OSG further argues that the legislative intent of non-retroactivity was effectively confirmed by the
“Conforme” of Senator Escudero, Chairperson of the Senate Committee on Ways and Means, on the draft
revenue regulation that became RR 10-2008.

Issues

Assailing the validity of RR 10-2008, all four Petitions raise common issues, which may be distilled into
three major ones:
First, whether the increased personal and additional exemptions provided by R.A. 9504 should be applied
to the entire taxable year 2008 or prorated, considering that R.A. 9504 took effect only on 6 July 2008.
Second, whether an MWE is exempt for the entire taxable year 2008 or from 6 July 2008 only.
Third, whether Sections 1 and 3 of RR 10-2008 are consistent with the law in providing that an MWE who
receives other benefits in excess of the statutory limit of P30,00019 is no longer entitled to the exemption
provided by R.A. 9504.
_______________

19 As provided under Section 32(7)(e) of R.A. 8428, which reads:


(e) 13th Month Pay and Other Benefits.—Gross benefits received by officials and employees of public
and private entities: Provided, however, That the total exclusion under this subparagraph shall not exceed
Thirty thousand pesos (P30,000) which shall cover:
(i) Benefits received by officials and employees of the national and local government pursuant to Republic
Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by
Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential Decree No. 851, as amended
by Memorandum Order No. 28, dated August 13, 1986; and

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The Court’s Ruling

I.

Whether the increased personal and additional exemptions provided by R.A. 9504 should be applied to the
entire taxable year 2008 or prorated, considering that the law took effect only on 6 July 2008
The personal and additional exemptions established by R.A. 9504 should be applied to the entire taxable
year 2008.

Umali is applicable.

Umali v. Estanislao20 supports this Court’s stance that R.A. 9504 should be applied on a full-year basis for
the entire taxable year 2008.21 In Umali, Congress enacted R.A. 7167 amending the 1977 National Internal
Revenue Code (NIRC). The amounts of basic personal and additional exemptions given to individual
income taxpayers were adjusted to the poverty threshold level. R.A. 7167 came into law on 30 January
1992. Controversy arose when the Commission of Internal Revenue (CIR) promulgated RR 1-92 stating
that the regulation shall take effect on compensation income earned beginning 1 January 1992. The issue
posed was whether the increased personal and additional exemptions could be applied to compensation
income earned or received during calendar
_______________

(iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the ceiling
of Thirty thousand pesos (P30,000) may be increased through rules and regulations issued by the Secretary
of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the
same of the inflation rate at the end of the taxable year.
20 Umali v. Estanislao, supra note 9.
21 Rollo (G.R. No. 184450), pp. 18-19.

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year 1991, given that R.A. 7167 came into law only on 30 January 1992, when taxable year 1991 had
already closed.
This Court ruled in the affirmative, considering that the increased exemptions were already available on or
before 15 April 1992, the date for the filing of individual income tax returns. Further, the law itself provided
that the new set of personal and additional exemptions would be immediately available upon its effectivity.
While R.A. 7167 had not yet become effective during calendar year 1991, the Court found that it was a
piece of social legislation that was in part intended to alleviate the economic plight of the lower-income
taxpayers. For that purpose, the new law provided for adjustments “to the poverty threshold level” prevailing
at the time of the enactment of the law. The relevant discussion is quoted below:
[T]he Court is of the considered view that Rep. Act 7167 should cover or extend to compensation income
earned or received during calendar year 1991.
Sec. 29, par. (L), Item No. 4 of the National Internal Revenue Code, as amended, provides:

Upon the recommendation of the Secretary of Finance, the President shall automatically adjust not more
often than once every three years, the personal and additional exemptions taking into account, among
others, the movement in consumer price indices, levels of minimum wages, and bare subsistence levels.

As the personal and additional exemptions of individual taxpayers were last adjusted in 1986, the President,
upon the recommendation of the Secretary of Finance, could have adjusted the personal and additional
exemptions in 1989 by increasing the same even without any legislation providing for such adjustment. But
the President did not.
However, House Bill 28970, which was subsequently enacted by Congress as Rep. Act 7167, was in-

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troduced in the House of Representatives in 1989 although its passage was delayed and it did not become
effective law until 30 January 1992. A perusal, however, of the sponsorship remarks of Congressman
Hernando B. Perez, Chairman of the House Committee on Ways and Means, on House Bill 28970, provides
an indication of the intent of Congress in enacting Rep. Act 7167. The pertinent legislative journal contains
the following:
At the outset, Mr. Perez explained that the Bill provides for increased personal additional exemptions to
individuals in view of the higher standard of living.
The Bill, he stated, limits the amount of income of individuals subject to income tax to enable them to spend
for basic necessities and have more disposable income.
xxxx
Mr. Perez added that inflation has raised the basic necessities and that it had been three years since the
last exemption adjustment in 1986.
xxxx
Subsequently, Mr. Perez stressed the necessity of passing the measure to mitigate the effects of the current
inflation and of the implementation of the salary standardization law. Stating that it is imperative for the
government to take measures to ease the burden of the individual income tax filers, Mr. Perez then cited
specific examples of how the measure can help assuage the burden to the taxpayers.
He then reiterated that the increase in the prices of commodities has eroded the purchasing power of the
peso despite the recent salary increases and emphasized that the Bill will serve to compensate the adverse
effects of inflation on the taxpayers. x x x (Journal of

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Soriano vs. Secretary of Finance
the House of Representatives, May 23, 1990, pp. 32-33).
It will also be observed that Rep. Act 7167 speaks of the adjustments that it provides for, as adjustments
“to the poverty threshold level.” Certainly, “the poverty threshold level” is the poverty threshold level at the
time Rep. Act 7167 was enacted by Congress, not poverty threshold levels in futuro, at which time there
may be need of further adjustments in personal exemptions. Moreover, the Court can not lose sight of the
fact that these personal and additional exemptions are fixed amounts to which an individual taxpayer is
entitled, as a means to cushion the devastating effects of high prices and a depreciated purchasing power
of the currency. In the end, it is the lower-income and the middle-income groups of taxpayers (not the high-
income taxpayers) who stand to benefit most from the increase of personal and additional exemptions
provided for by Rep. Act 7167. To that extent, the act is a social legislation intended to alleviate in part the
present economic plight of the lower income taxpayers. It is intended to remedy the inadequacy of the
heretofore existing personal and additional exemptions for individual taxpayers.
And then, Rep. Act 7167 says that the increased personal exemptions that it provides for shall be available
thenceforth, that is, after Rep. Act 7167 shall have become effective. In other words, these exemptions are
available upon the filing of personal income tax returns which is, under the National Internal Revenue Code,
done not later than the 15th day of April after the end of a calendar year. Thus, under Rep. Act 7167, which
became effective, as aforestated, on 30 January 1992, the increased exemptions are literally available on
or before 15 April 1992 (though not before 30 January 1992). But these increased exemptions can be
available on 15 April 1992 only in respect of compensation income earned or received during the calendar
year 1991.

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The personal exemptions as increased by Rep. Act 7167 cannot be regarded as available in respect of
compensation income received during the 1990 calendar year; the tax due in respect of said income had
already accrued, and been presumably paid, by 15 April 1991 and by 15 July 1991, at which time Rep. Act
7167 had not been enacted. To make Rep. Act 7167 refer back to income received during 1990 would
require language explicitly retroactive in purport and effect, language that would have to authorize the
payment of refunds of taxes paid on 15 April 1991 and 15 July 1991: such language is simply not found in
Rep. Act 7167.
The personal exemptions as increased by Rep. Act 7167 cannot be regarded as available only in respect
of compensation income received during 1992, as the Implementing Revenue Regulations No. 1-92 purport
to provide. Revenue Regulations No. 1-92 would in effect postpone the availability of the increased
exemptions to 1 January-15 April 1993, and thus literally defer the effectivity of Rep. Act 7167 to 1 January
1993. Thus, the implementing regulations collide frontally with Section 3 of Rep. Act 7167 which states that
the statute “shall take effect upon its approval.” The objective of the Secretary of Finance and the
Commissioner of Internal Revenue in postponing through Revenue Regulations No. 1-92 the legal
effectivity of Rep. Act 7167 is, of course, entirely understandable — to defer to 1993 the reduction of
governmental tax revenues which irresistibly follows from the application of Rep. Act 7167. But the law-
making authority has spoken and the Court can not refuse to apply the law-maker’s words. Whether or not
the government can afford the drop in tax revenues resulting from such increased exemptions was for
Congress (not this Court) to decide.22 (Emphases supplied)

In this case, Senator Francis Escudero’s sponsorship speech for Senate Bill No. 2293 reveals two important
points
_______________

22 Umali v. Estanislao, supra note 9 at pp. 451-454.

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Soriano vs. Secretary of Finance
about R.A. 9504: (1) it is a piece of social legislation; and (2) its intent is to make the proposed law
immediately applicable, that is, to taxable year 2008:
Mr. President, distinguished colleagues, Senate Bill No. 2293 seeks, among others, to exempt minimum
wage earners from the payment of income and/or withholding tax. It is an attempt to help our people cope
with the rising costs of commodities that seem to be going up unhampered these past few months.
Mr. President, a few days ago, the Regional Tripartite and Wages Productivity Board granted an increase
of P20 per day as far as minimum wage earners are concerned. By way of impact, Senate Bill No. 2293
would grant our workers an additional salary or take-home pay of approximately P34 per day, given the
exemption that will be granted to all minimum wage earners. It might be also worthy of note that on the part
of the public sector, the Senate Committee on Ways and Means included, as amongst those who will be
exempted from the payment of income tax and/or withholding tax, government workers receiving Salary
Grade V. We did not make any distinction so as to include Steps 1 to 8 of Salary Grade V as long as one
is employed in the public sector or in government.
In contradistinction with House Bill No. 3971 approved by the House of Representatives pertaining to a
similar subject matter, the House of Representatives, very much like the Senate, adopted the same levels
of exemptions which are:
From an allowable personal exemption for a single individual of P20,000, to a head of family of P25,000, to
a married individual of P32,000, both the House and the Senate versions contain a higher personal
exemption of P50,000.
Also, by way of personal additional exemption as far as dependents are concerned, up to four, the House,
very much like the Senate, recommended a higher ceiling of P25,000 for each dependent not exceeding
four,

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thereby increasing the maximum additional exemptions and personal additional exemptions to as high as
P200,000, depending on one’s status in life.
The House also, very much like the Senate, recommended by way of trying to address the revenue loss on
the part of the government, an optional standard deduction (OSD) on gross sales, and/or gross receipts as
far as individual taxpayers are concerned. However, the House, unlike the Senate, recommended a
Simplified Net Income Tax Scheme (SNITS) in order to address the remaining balance of the revenue loss.
By way of contrast, the Senate Committee on Ways and Means recommended, in lieu of SNITS, an optional
standard deduction of 40% for corporations as far as their gross income is concerned.
Mr. President, if we total the revenue loss as well as the gain brought about by the 40% OSD on individuals
on gross sales and receipts and 40% on gross income as far as corporations are concerned, with a
conservative availment rate as computed by the Department of Finance, the government would still enjoy
a gain of P.78 billion or P780 million if we use the high side of the computation however improbable it may
be.
For the record, we would like to state that if the availment rate is computed at 15% for individuals and 10%
for corporations, the potential high side of a revenue gain would amount to approximately P18.08 billion.
Mr. President, we have received many suggestions increasing the rate of personal exemptions and
personal additional exemptions. We have likewise received various suggestions pertaining to the expansion
of the coverage of the tax exemption granted to minimum wage earners to encompass as well other income
brackets.
However, the only suggestion other than or outside the provisions contained in House Bill No. 3971 that
the Senate Committee on Ways and Means adopted, was an expansion of the exemption to cover overtime,
holiday, nightshirt differential, and hazard pay also being enjoyed by minimum wage earners. It entailed an
additional

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Soriano vs. Secretary of Finance
revenue loss of P1 billion approximately on the part of the government. However, Mr. President, that was
taken into account when I stated earlier that there will still be a revenue gain on the conservative side on
the part of government of P780 million.
Mr. President, [my distinguished colleagues in the Senate, we wish to provide a higher exemption for our
countrymen because of the incessant and constant increase in the price of goods. Nonetheless, not only
Our Committee, but also the Senate and Congress, must act responsibly in recognizing that much as we
would like to give all forms of help that we can and must provide to our people, we also need to recognize
the need of the government to defray its expenses in providing services to the public. This is the most that
we can give at this time because the government operates on a tight budget and is short on funds when it
comes to the discharge of its main expenses.]23
Mr. President, time will perhaps come and we can improve on this version, but at present, this is
_______________

23 Translated in the vernacular. The original paragraph is quoted below:


Mr. President, mga kagalang-galang kong kasamahan dito sa Senado, gusto sana naming ibigay ang mas
mataas na exemption para sa ating mga kababayan dahil na rin sa walang tigil at walang humpay na
pagtaas ng presyo ng bilihin. Subalit kinakailangang maging responsible, hindi lamang ng ating Komite
kundi pati na rin ang Senado at ang Kongreso sa pagkilala, na bagaman nais nating ibigay ang lahat ng
tulong na puwede at dapat nating ibigay sa ating mga kababayan, kinakailangan din nating kilalanin ang
pangangailangan ng gobyerno pagdating sa pagtustos ng mga gastusing ito na may kinalaman sa
pagbibigay ng serbisyo sa ating mga kababayan. Ito po ang pinakamataas na puwede nating ibigay sa
kasalukuyang panahon dahil na rin mahigpit sa pondo ngayon at gipit sa pondo ang pamahalaan pagdating
sa pagtustos ng mga pangunahing gastusin nito.

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the best, I believe, that we can give our people. But by way of comparison, it is still P10 higher than what
the wage boards were able to give minimum wage earners. Given that, we were able to increase their take-
home pay by the amount equivalent to the tax exemption we have granted.
We urge our colleagues, Mr. President, to pass this bill in earnest so that we can immediately grant relief
to our people.
Thank you, Mr. President. (Emphases Supplied)24

Clearly, Senator Escudero expressed a sense of urgency for passing what would subsequently become
R.A. 9504. He was candid enough to admit that the bill needed improvement, but because time was of the
essence, he urged the Senate to pass the bill immediately. The idea was immediate tax relief to the
individual taxpayers, particularly low compensation earners, and an increase in their take-home pay.25
Senator Miriam Defensor-Santiago also remarked during the deliberations that “the increase in personal
exemption from P20,000 to P50,000 is timely and appropriate given the -
_______________

24 IV Records, Senate 14th Congress 1st Session 218-219, 20 May 2008.


25 During the interpellation by Senator Juan Ponce-Enrile, Senator Escudero said that the increased
personal and additional exemptions translates to a tax-free income of P200,000 to a family of six. The
pertinent legislative journal reads:
In reply to Senator Emile’s queries, Senator Escudero stated that the proposed measure seeks to increase
the current personal exemption for a married individual from P32,000 to P50,000 and the current additional
exemption per children from P8,000 to P25,000, so a couple with four children would have a total nontaxable
income of P200,000, translation to an additional income of P104,000 for the family. x x x (II Journal, Senate
14th Congress 1st Session 1471, 20 May 2008).
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Soriano vs. Secretary of Finance
increased cost of living. Also, the increase in the additional exemption for dependent children is necessary
and timely.”26
Finally, we consider the President’s certification of the necessity of the immediate enactment of Senate Bill
No. 2293. That certification became the basis for the Senate to dispense with the three-day rule27 for
passing a bill. It evinced the intent of the President to afford wage earners immediate tax relief from the
impact of a worldwide increase in the prices of commodities. Specifically, the certification stated that the
purpose was to “address the urgent need to cushion the adverse impact of the global escalation of
commodity prices upon the most vulnerable within the low income group by providing expanded income tax
relief.”28
In sum, R.A. 9504, like R.A. 7167 in Umali, was a piece of social legislation clearly intended to afford
immediate tax relief to individual taxpayers, particularly low-income compensation earners. Indeed, if R.A.
9504 was to take effect beginning taxable year 2009 or half of the year 2008 only, then the intent of
Congress to address the increase in the cost of living in 2008 would have been negated.
Therefore, following Umali, the test is whether the new set of personal and additional exemptions was
available at the
_______________

26 IV Records, Senate Fourteenth Congress First Session 291, 20 May 2008.


27 Article VI, Section 26(2) of the 1987 Constitution states:
(2) No bill passed by either House shall become a law unless it has passed three readings on separate
days, and printed copies thereof in its final form have been distributed to its Members three days before its
passage, except when the President certifies to the necessity of its immediate enactment to meet a public
calamity or emergency. Upon the last reading of a bill, no amendment thereto shall be allowed, and the
vote thereon shall be taken immediately thereafter, and the yeas and nays entered in the Journal.
28 IV Records, Senate 14th Congress 1st Session 319, 27 May 2008.

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time of the filing of the income tax return. In other words, while the status of the individual taxpayers is
determined at the close of the taxable year,29 their personal and additional exemptions — and
consequently the computation of their taxable income — are reckoned when the tax becomes due, and not
while the income is being earned or received.
The NIRC is clear on these matters. The taxable income of an individual taxpayer shall be computed on
the basis of the calendar year.30 The taxpayer is required to file an income tax return on the 15th of April
of each year covering income of the preceding taxable year.31 The tax due thereon shall be paid at the
time the return is filed.32
It stands to reason that the new set of personal and additional exemptions, adjusted as a form of social
legislation to address the prevailing poverty threshold, should be given effect at the most opportune time
as the Court ruled in Umali.
The test provided by Umali is consistent with Ingalls v. Trinidad,33 in which the Court dealt with the matter
of a married person’s reduced exemption. As early as 1923, the Court already provided the reference point
for determining the taxable income:
[T]hese statutes dealing with the manner of collecting the income tax and with the deductions to be made
in favor of the taxpayer have reference to the time when the return is filed and the tax assessed. If Act No.
2926 took, as it did take, effect on January 1, 1921, its provisions must be applied to income tax returns
filed, and assessments made from that date. This is the reason why Act No. 2833, and Act No. 2926, in
their respective first sec-
_______________

29 Section 35(C), Republic Act No. 8424 (1997).


30 Section 43, Republic Act No. 8424 (1997).
31 Section 51(C), Republic Act No. 8424 (1997).
32 Section 56, Republic Act No. 8424 (1997).
33 Ingalls v. Trinidad, 46 Phil. 807, 808-809 (1923).

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tions, refer to income received during the preceding civil year. (Italics in the original)

There, the exemption was reduced, not increased, and the Court effectively ruled that income tax due from
the individual taxpayer is properly determined upon the filing of the return. This is done after the end of the
taxable year, when all the incomes for the immediately preceding taxable year and the corresponding
personal exemptions and/or deductions therefor have been considered. Therefore, the taxpayer was made
to pay a higher tax for his income earned during 1920, even if the reduced exemption took effect on 1
January 1921.
In the present case, the increased exemptions were already available much earlier than the required time
of filing of the return on 15 April 2009. R.A. 9504 came into law on 6 July 2008, more than nine months
before the deadline for the filing of the income tax return for taxable year 2008. Hence, individual taxpayers
were entitled to claim the increased amounts for the entire year 2008. This was true despite the fact that
incomes were already earned or received prior to the law’s effectivity on 6 July 2008.
Even more compelling is the fact that R.A. 9504 became effective during the taxable year in question. In
Umali, the Court ruled that the application of the law was prospective, even if the amending law took effect
after the close of the taxable year in question, but before the deadline for the filing of the return and payment
of the taxes due for that year. Here, not only did R.A. 9504 take effect before the deadline for the filing of
the return and payment for the taxes due for taxable year 2008, it took effect way before the close of that
taxable year. Therefore, the operation of the new set of personal and additional exemption in the present
case was all the more prospective.
Additionally, as will be discussed later, the rule of full taxable year treatment for the availment of personal
and additional exemptions was established, not by the amendments

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introduced by R.A. 9504, but by the provisions of the 1997 Tax Code itself. The new law merely introduced
a change in the amounts of the basic and additional personal exemptions. Hence, the fact that R.A. 9504
took effect only on 6 July 2008 is irrelevant.

The present case is substan-


tially identical with Umali
and not with Pansacola.

Respondents argue that Umali is not applicable to the present case. They contend that the increase in
personal and additional exemptions were necessary in that case to conform to the 1991 poverty threshold
level; but that in the present case, the amounts under R.A. 9504 far exceed the poverty threshold level. To
support their case, respondents cite figures allegedly coming from the National Statistical Coordination
Board. According to those figures, in 2007, or one year before the effectivity of R.A. 9504, the poverty
threshold per capita was P14,866 or P89,196 for a family of six.34
We are not persuaded.
The variance raised by respondents borders on the superficial. The message of Umali is that there must
be an event recognized by Congress that occasions the immediate application of the increased amounts
of personal and additional exemptions. In Umali, that event was the failure to adjust the personal and
additional exemptions to the prevailing poverty threshold level. In this case, the legislators specified the
increase in the price of commodities as the basis for the immediate availability of the new amounts of
personal and additional exemptions.
We find the facts of this case to be substantially identical to those of Umali.
_______________

34 Rollo (G.R. No. 184450), p. 145.

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First, both cases involve an amendment to the prevailing tax code. The present petitions call for the
interpretation of the effective date of the increase in personal and additional exemptions. Otherwise stated,
the present case deals with an amendment (R.A. 9504) to the prevailing tax code (R.A. 8424 or the 1997
Tax Code). Like the present case, Umali involved an amendment to the then prevailing tax code — it
interpreted the effective date of R.A. 7167, an amendment to the 1977 NIRC, which also increased personal
and additional exemptions.
Second, the amending law in both cases reflects an intent to make the new set of personal and additional
exemptions immediately available after the effectivity of the law. As already pointed out, in Umali, R.A. 7167
involved social legislation intended to adjust personal and additional exemptions. The adjustment was made
in keeping with the poverty threshold level prevailing at the time.
Third, both cases involve social legislation intended to cure a social evil — R.A. 7167 was meant to adjust
personal and additional exemptions in relation to the poverty threshold level, while R.A. 9504 was geared
towards addressing the impact of the global increase in the price of goods.
Fourth, in both cases, it was clear that the intent of the legislature was to hasten the enactment of the law
to make its beneficial relief immediately available.

Pansacola is not applicable.

In lieu of Umali, the OSG relies on our ruling in Pansacola v. Commissioner of Internal Revenue.35 In that
case, the 1997 Tax Code (R.A. 8424) took effect on 1 January 1998, and the petitioner therein pleaded for
the application of the new set of
_______________

35 537 Phil. 296; 507 SCRA 81 (2006). The OSG raised this argument in its Comment filed in G.R. No.
184450 on 19 February 2009; See Rollo (G.R. No. 184450), pp. 83-106.

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personal and additional exemptions provided thereunder to taxable year 1997. R.A. 8424 explicitly provided
for its effectivity on 1 January 1998, but it did not provide for any retroactive application.
We ruled against the application of the new set of personal and additional exemptions to the previous
taxable year 1997, in which the filing and payment of the income tax was due on 15 April 1998, even if the
NIRC had already taken effect on 1 January 1998. This court explained that the NIRC could not be given
retroactive application, given the specific mandate of the law that it shall take effect on 1 January 1998; and
given the absence of any reference to the application of personal and additional exemptions to income
earned prior to 1 January 1998. We further stated that what the law considers for the purpose of determining
the income tax due is the status at the close of the taxable year, as opposed to the time of filing of the return
and payment of the corresponding tax.
The facts of this case are not identical with those of Pansacola.
First, Pansacola interpreted the effectivity of an entirely new tax code — R.A. 8424, the Tax Reform Act of
1997. The present case, like Umali, involves a mere amendment of some specific provisions of the
prevailing tax code: R.A. 7167 amending then P.D. 1158 (the 1977 NIRC) in Umali and R.A. 9504 amending
R.A. 8424 herein.
Second, in Pansacola, the new tax code specifically provided for an effective date — the beginning of the
following year — that was to apply to all its provisions, including new tax rates, new taxes, new
requirements, as well as new exemptions. The tax code did not make any exception to the effectivity of the
subject exemptions, even if transitory provisions36 specifically provided for different effectivity dates for
certain provisions.
_______________

36 See Republic Act No. 8424 (1997), Section 5 (Transitory Provisions) and Section 7 (Repealing Clauses).

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Hence, the Court did not find any legislative intent to make the new rates of personal and additional
exemptions available to the income earned in the year previous to R.A. 8424’s effectivity. In the present
case, as previously discussed, there was a clear intent on the part of Congress to make the new amounts
of personal and additional exemptions immediately available for the entire taxable year 2008. R.A. 9504
does not even need a provision providing for retroactive application because, as mentioned above, it is
actually prospective — the new law took effect during the taxable year in question.
Third, in Pansacola, the retroactive application of the new rates of personal and additional exemptions
would result in an absurdity — new tax rates under the new law would not apply, but a new set of personal
and additional exemptions could be availed of. This situation does not obtain in this case, however,
precisely because the new law does not involve an entirely new tax code. The new law is merely an
amendment to the rates of personal and additional exemptions.
Nonetheless, R.A. 9504 can still be made applicable to taxable year 2008, even if we apply the Pansacola
test. We stress that Pansacola considers the close of the taxable year as the reckoning date for the
effectivity of the new exemptions. In that case, the Court refused the application of the new set of personal
exemptions, since they were not yet available at the close of the taxable year. In this case, however, at the
close of the taxable year, the new set of exemptions was already available. In fact, it was already available
during the taxable year — as early as 6 July 2008 — when the new law took effect.
There may appear to be some dissonance between the Court’s declarations in Umali and those in
Pansacola, which held:
Clearly from the above quoted provisions, what the law should consider for the purpose of determining the
tax due from an individual taxpayer is his status and qualified dependents at the close of the taxable year
and not

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Soriano vs. Secretary of Finance
at the time the return is filed and the tax due thereon is paid. Now comes Section 35(C) of the NIRC which
provides:
xxxx
Emphasis must be made that Section 35(C) of the NIRC allows a taxpayer to still claim the corresponding
full amount of exemption for a taxable year, e.g., if he marries; have additional dependents; he, his spouse,
or any of his dependents die; and if any of his dependents marry, turn 21 years old; or become gainfully
employed. It is as if the changes in his or his dependents status took place at the close of the taxable year.
Consequently, his correct taxable income and his corresponding allowable deductions, e.g., personal and
additional deductions, if any, had already been determined as of the end of the calendar year.
x x x. Since the NIRC took effect on January 1, 1998, the increased amounts of personal and additional
exemptions under Section 35, can only be allowed as deductions from the individual taxpayers gross or net
income, as the case maybe, for the taxable year 1998 to be filed in 1999. The NIRC made no reference
that the personal and additional exemptions shall apply on income earned before January 1, 1998.37

It must be remembered, however, that the Court therein emphasized that Umali was interpreting a social
legislation:
In Umali, we noted that despite being given authority by Section 29(1)(4) of the National Internal Revenue
Code of 1977 to adjust these exemptions, no adjustments were made to cover 1989. Note that Rep. Act
No. 7167 is entitled “An Act Adjusting the Basic Personal and Additional Exemptions Allowable to
Individuals for Income Tax Purposes to the Poverty Threshold Level,
_______________

37 Pansacola v. Commissioner of Internal Revenue, supra note 35 at pp. 306-307; pp. 90-91.

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Amending for the Purpose Section 29, Paragraph (L), Items (1) and (2)(A), of the National Internal Revenue
Code, as Amended, and for Other Purposes.” Thus, we said in Umali, that the adjustment provided by Rep.
Act No. 7167 effective 1992, should consider the poverty threshold level in 1991, the time it was enacted.
And we observed therein that since the exemptions would especially benefit lower and middle-income
taxpayers, the exemption should be made to cover the past year 1991. To such an extent, Rep. Act No.
7167 was a social legislation intended to remedy the non-adjustment in 1989. And as cited in Umali, this
legislative intent is also clear in the records of the House of Representatives Journal.
This is not so in the case at bar. There is nothing in the NIRC that expresses any such intent. The policy
declarations in its enactment do not indicate it was a social legislation that adjusted personal and additional
exemptions according to the poverty threshold level nor is there any indication that its application should
retroact. x x x.38 (Emphasis Supplied)

Therefore, the seemingly inconsistent pronouncements in Umali and Pansacola are more apparent than
real. The circumstances of the cases and the laws interpreted, as well as the legislative intents thereof,
were different.

The policy in this juris-


diction is full taxable
year treatment.

We have perused R.A. 9504, and we see nothing that expressly provides or even suggests a prorated
application of the exemptions for taxable year 2008. On the other hand, the policy of full taxable year
treatment, especially of the personal and additional exemptions, is clear under Section 35, particularly
paragraph C of R.A. 8424 or the 1997 Tax Code:
_______________
38 Id., at pp. 307-308; pp. 91-92.

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Soriano vs. Secretary of Finance
SEC. 35. Allowance of Personal Exemption for Individual Taxpayer.—
(A) In General.—For purposes of determining the tax provided in Section 24(A) of this Title, there shall be
allowed a basic personal exemption as follows:
xxxx
(B) Additional Exemption for Dependents.—There shall be allowed an additional exemption of . . . for each
dependent not exceeding four (4).
xxxx
(C) Change of Status.—If the taxpayer marries or should have additional dependent(s) as defined above
during the taxable year, the taxpayer may claim the corresponding additional exemption, as the case may
be, in full for such year.
If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions
for himself and his dependent(s) as if he died at the close of such year.
If the spouse or any of the dependents dies or if any of such dependents marries, becomes twenty-one (21)
years old or becomes gainfully employed during the taxable year, the taxpayer may still claim the same
exemptions as if the spouse or any of the dependents died, or as if such dependents married, became
twenty-one (21) years old or became gainfully employed at the close of such year. (Emphases supplied)

Note that paragraph C does not allow the prorating of the personal and additional exemptions provided in
paragraphs A and B, even in case a status changing event occurs during the taxable year. Rather, it allows
the fullest benefit to the individual taxpayer. This manner of reckoning the taxpayer’s status for purposes of
the personal and additional exemptions clearly demonstrates the legislative intention; that is, for the state
to give the taxpayer the maximum exemptions that can

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Soriano vs. Secretary of Finance
be availed, notwithstanding the fact that the latter’s actual status would qualify only for a lower exemption
if prorating were employed.
We therefore see no reason why we should make any distinction between the income earned prior to the
effectivity of the amendment (from 1 January 2008 to 5 July 2008) and that earned thereafter (from 6 July
2008 to 31 December 2008) as none is indicated in the law. The principle that the courts should not
distinguish when the law itself does not distinguish squarely applies to this case.39
We note that the prorating of personal and additional exemptions was employed in the 1939 Tax Code.
Section 23(d) of that law states:
Change of status.—If the status of the taxpayer insofar as it affects the personal and additional exemptions
for himself or his dependents, changes during the taxable year, the amount of the personal and additional
exemptions shall be apportioned, under rules and regulations prescribed by the Secretary of Finance, in
accordance with the number of months before and after such change. For the purpose of such
apportionment a fractional part of a month shall be disregarded unless it amounts to more than half a month,
in which case it shall be considered as a month.40 (Emphasis supplied)

On 22 September 1950, R.A. 590 amended Section 23(d) of the 1939 Tax Code by restricting the operation
of the prorating of personal exemptions. As amended, Section 23(d) reads:
(d) Change of status.—If the status of the taxpayer insofar as it affects the personal and additional
exemption for himself or his dependents, changes during
_______________

39 See Philippine British Assurance Co., Inc. v. Intermediate Appellate Court, 234 Phil. 512; 150 SCRA
520 (1987).
40 National Internal Revenue Code, Commonwealth Act No. 466 (1939).

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Soriano vs. Secretary of Finance
the taxable year by reason of his death, the amount of the personal and additional exemptions shall be
apportioned, under rules and regulations prescribed by the Secretary of Finance, in accordance with the
number of months before and after such change. For the purpose of such apportionment a fractional part
of a month shall be disregarded unless it amounts to more than half a month, in which case it shall be
considered as a month.41 (Emphasis supplied)

Nevertheless, in 1969, R.A. 6110 ended the operation of the prorating scheme in our jurisdiction when it
amended Section 23(d) of the 1939 Tax Code and adopted a full taxable year treatment of the personal
and additional exemptions. Section 23(d), as amended, reads:
(d) Change of status.—
If the taxpayer married or should have additional dependents as defined in subsection (c) above during the
taxable year the taxpayer may claim the corresponding personal exemptions in full for such year.
If the taxpayer should die during the taxable year, his estate may still claim the personal and additional
deductions for himself and his dependents as if he died at the close of such year.
If the spouse or any of the dependents should die during the year, the taxpayer may still claim the same
deductions as if they died at the close of such year.

P.D. 69 followed in 1972, and it retained the full taxable year scheme. Section 23(d) thereof reads as
follows:
(d) Change of status.—If the taxpayer marries or should have additional dependents as defined in
subsection (c) above during the taxable year the taxpayer may claim
_______________

41 Amending the NIRC Re: Income Tax, Republic Act No. 590 (1950).

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the corresponding personal exemptions in full for such year.


If the taxpayer should die during the taxable year, his estate may still claim the personal and additional
deductions for himself and his dependents as if he died at the close of such year.
If the spouse or any of the dependents should die or become twenty-one years old during the taxable year,
the taxpayer may still claim the same exemptions as if they died, or as if such dependents became twenty-
one years old at the close of such year.

The 1977 Tax Code continued the policy of full taxable year treatment. Section 23(d) thereof states:
(d) Change of status.—If the taxpayer married or should have additional dependents as defined in
subsection (c) above during the taxable year, the taxpayer may claim the corresponding personal
exemption in full for such year.
If the taxpayer should die during the taxable year, his estate may still claim the personal and additional
exemptions for himself and his dependents as if he died at the close of such year.
If the spouse or any of the dependents should die or become twenty-one years old during the taxable year,
the taxpayer may still claim the same exemptions as if they died, or as if such dependents became twenty-
one years old at the close of such year.

While Section 23 of the 1977 Tax Code underwent changes, the provision on full taxable year treatment in
case of the taxpayer’s change of status was left untouched.42 Executive
_______________

42 See An Act Amending Certain Provisions of the National Internal Revenue Code of 1977, as Amended,
and for Other Purposes, Batas Pambansa Blg. 135, (1981), Amendments to Section 23 and Section 45 of
the NIRC of 1977, as Amended, Granting

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SUPREME COURT REPORTS ANNOTATED
Soriano vs. Secretary of Finance
Order No. 37, issued on 31 July 1986, retained the change of status provision verbatim. The provision
appeared under Section 30(1)(3) of the NIRC, as amended:
(3) Change of status.—If the taxpayer married or should have additional dependents as defined above
during the taxable year, the taxpayer may claim the corresponding personal and additional exemptions, as
the case may be, in full for such year.
If the taxpayer should die during the taxable year, his estate may still claim the personal and additional
exemptions for himself and his dependents as if he died at the close of such year.
If the spouse or any of the dependents should die or if any of such dependents becomes twenty-one years
old during the taxable year, the taxpayer may still claim the same exemptions as if they died, or if such
dependents become twenty-one years old at the close of such year.

Therefore, the legislative policy of full taxable year treatment of the personal and additional exemptions has
been in our jurisdiction continuously since 1969. The prorating approach has long since been abandoned.
Had Congress intended to revert to that scheme, then it should have so stated in clear and unmistakable
terms. There is nothing, however, in R.A. 9504 that provides for the reinstatement of the prorating scheme.
On the contrary, the change-of-status provision utilizing the full-year scheme in the 1997 Tax Code was left
untouched by R.A. 9504.
We now arrive at this important point: the policy of full taxable year treatment is established, not by the
amendments introduced by R.A. 9504, but by the provisions of the 1997 Tax Code, which adopted the
policy from as early as 1969.
_______________

Special Additional Personal Exemption to Individual Taxpayers, P.D. No. 1868 (1983) and Executive Order
No. 999 (1985).

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There is, of course, nothing to prevent Congress from again adopting a policy that prorates the effectivity
of basic personal and additional exemptions. This policy, however, must be explicitly provided for by law to
amend the prevailing law, which provides for full-year treatment. As already pointed out, R.A. 9504 is totally
silent on the matter. This silence cannot be presumed by the BIR as providing for a half-year application of
the new exemption levels. Such presumption is unjust, as incomes do not remain the same from month to
month, especially for the MWEs.
Therefore, there is no legal basis for the BIR to reintroduce the prorating of the new personal and additional
exemptions. In so doing, respondents overstepped the bounds of their rule-making power. It is an
established rule that administrative regulations are valid only when these are consistent with the law.43
Respondents cannot amend, by mere regulation, the laws they administer.44 To do so would violate the
principle of non--delegability of legislative powers.45
The prorated application of the new set of personal and additional exemptions for the year 2008, which was
introduced by respondents, cannot even be justified under the exception to the canon of non-delegability;
that is, when Congress makes a delegation to the executive branch.46 The delegation would fail the two
accepted tests for a valid delegation of legislative power; the completeness test and the sufficient standard
test.47 The first test requires the law to be complete in all its terms and conditions, such that the only thing
the
_______________

43 Commissioner of Internal Revenue v. Fortune Tobacco Corporation, 581 Phil. 146; 559 SCRA 160
(2008).
44 Commissioner of Internal Revenue v. Central Luzon Drug Corporation, 496 Phil. 307; 456 SCRA 414
(2005).
45 Tatad v. Secretary of the Department of Energy, 346 Phil. 321; 281 SCRA 330 (1997).
46 Id.
47 Id.

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SUPREME COURT REPORTS ANNOTATED
Soriano vs. Secretary of Finance
delegate will have to do is to enforce it.48 The sufficient standard test requires adequate guidelines or
limitations in the law that map out the boundaries of the delegate’s authority and canalize the delegation.49
In this case, respondents went beyond enforcement of the law, given the absence of a provision in R.A.
9504 mandating the prorated application of the new amounts of personal and additional exemptions for
2008. Further, even assuming that the law intended a prorated application, there are no parameters set
forth in R.A. 9504 that would delimit the legislative power surrendered by Congress to the delegate. In
contrast, Section 23(d) of the 1939 Tax Code authorized not only the prorating of the exemptions in case
of change of status of the taxpayer, but also authorized the Secretary of Finance to prescribe the
corresponding rules and regulations.
II.
Whether an MWE is exempt for the entire taxable year 2008 or from 6 July 2008 only

The MWE is exempt for the entire taxable year 2008.


As in the case of the adjusted personal and additional exemptions, the MWE exemption should apply to the
entire taxable year 2008, and not only from 6 July 2008 onwards.
We see no reason why Umali cannot be made applicable to the MWE exemption, which is undoubtedly a
piece of social legislation. It was intended to alleviate the plight of the working class, especially the low-
income earners. In concrete terms, the exemption translates to a P34 per day benefit, as pointed out by
Senator Escudero in his sponsorship speech.50
As it stands, the calendar year 2008 remained as one taxable year for an individual taxpayer. Therefore,
RR 10-2008
_______________

48 Id.
49 Id.
50 See Umali v. Estanislao, supra note 9 at pp. 451-454.
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cannot declare the income earned by a minimum wage earner from 1 January 2008 to 5 July 2008 to be
taxable and those earned by him for the rest of that year to be tax-exempt. To do so would be to contradict
the NIRC and jurisprudence, as taxable income would then cease to be determined on a yearly basis.
Respondents point to the letter of former Commissioner of Internal Revenue Lilia B. Hefti dated 5 July 2008
and petitioner Sen. Escudero’s signature on the Conforme portion thereof. This letter and the conforme
supposedly establish the legislative intent not to make the benefits of R.A. 9504 effective as of 1 January
2008.
We are not convinced. The conforme is irrelevant in the determination of legislative intent.
We quote below the relevant portion of former Commissioner Hefti’s letter:
Attached herewith are salient features of the proposed regulations to implement RA 9504 x x x. We have
tabulated critical issues raised during the public hearing and comments received from the public which we
need immediate written resolution based on the inten[t]ion of the law more particularly the effectivity clause.
Due to the expediency and clamor of the public for its immediate implementation, may we request your
confirmation on the proposed recommendation within five (5) days from receipt hereof. Otherwise, we shall
construe your affirmation.51

We observe that a Matrix of Salient Features of Proposed Revenue Regulations per R.A. 9504 was
attached to the letter.52 The Matrix had a column entitled “Remarks” opposite the Recommended
Resolution. In that column, noted was a suggestion coming from petitioner TMAP:
_______________

51 Rollo (G.R. No. 185234), p. 132; Annex 1, p. 1.


52 Rollo (G.R. No. 184450), pp. 108-115.

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TMAP suggested that it should be retroactive considering that it was [for] the benefit of the majority and to
alleviate the plight of workers. Exemption should be applied for the whole taxable year as provided in the
NIRC. x x x Umali v. Estanislao [ruled] that the increase[d] exemption in 1992 [was applicable] [to] 1991.
Majority issues raised during the public hearing last July 1, 2008 and emails received suggested [a]
retroactive implementation.53 (Italics in the original)

The above remarks belie the claim that the conforme is evidence of the legislative intent to make the
benefits available only from 6 July 2008 onwards. There would have been no need to make the remarks if
the BIR had merely wanted to confirm was the availability of the law’s benefits to income earned starting 6
July 2008. Rather, the implication is that the BIR was requesting the conformity of petitioner Senator
Escudero to the proposed implementing rules, subject to the remarks contained in the Matrix. Certainly, it
cannot be said that Senator Escudero’s conforme is evidence of legislative intent to the effect that the
benefits of the law would not apply to income earned from 1 January 2008 to 5 July 2008.
Senator Escudero himself states in G.R. No. 185234:
In his bid to ensure that the BIR would observe the effectivity dates of the grant of tax exemptions and
increased basic personal and additional exemptions under Republic Act No. 9504, Petitioner Escudero, as
Co-Chairperson of the Congressional Oversight Committee on Comprehensive Tax Reform Program, and
his counterpart in the House of Representatives, Hon. Exequiel B. Javier, conveyed through a letter, dated
16 September 2008, to Respondent Teves the legislative intent that “Republic Act (RA) No. 9504 must be
made applicable to the entire taxable year 2008” considering that it was “a social legislation intended to
somehow alleviate the
_______________

53 Rollo (G.R. No. 185234), p. 133.

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plight of minimum wage earners or low-income taxpayers.” They also jointly expressed their “fervent hope
that the corresponding Revenue Regulations that will be issued reflect the true legislative intent and rightful
statutory interpretation of R.A. No. 9504.”54
Senator Escudero repeats in his Memorandum:
_______________

On 16 September 2008, the Chairpersons (one of them being herein Petitioner Sen. Escudero) of the
Congressional Oversight Committee on Comprehensive Tax Reform Program of both House of Congress
wrote Respondent DOF Sec. Margarito Teves, and requested that the revenue regulations (then yet still to
be issued)55 to implement Republic Act No. 9504 reflect the true intent and rightful statutory interpretation
thereof, specifically that the grant of tax exemption and increased basic personal and additional exemptions
be made available for the entire taxable year 2008. Yet, the DOF promulgated Rev. Reg. No. 10-2008 in
contravention of such legislative intent. x x x.56

We have gone through the records and we do not see anything that would to suggest that respondents
deny the senator’s assertion.
Clearly, Senator Escudero’s assertion is that the legislative intent is to make the MWE’s tax exemption and
the increased basic personal and additional exemptions available for the entire year 2008. In the face of
his assertions, respondents’ claim that his conforme to Commissioner Hefti’s letter was evidence of
legislative intent becomes baseless and specious. The remarks described above and the subsequent letter
sent
_______________

54 Id., at pp. 14-15; Petition, pp. 12-13.


55 RR 10-2008 was issued on 24 September 2008 (see <http://www.bir.gov.ph/index.php/archive/2008-
revenue-regulations.html> (last accessed on 23 November 2016).
56 Rollo (G.R. No. 185234), pp. 280-281; Memorandum, pp. 4-5.

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to DOF Secretary Teves, by no less than the Chairpersons of the Bi-cameral Congressional Oversight
Committee on Comprehensive Tax Reform Program, should have settled for respondents the matter of
what the legislature intended for R.A. 9504’s exemptions.
Accordingly, we agree with petitioners that RR 10-2008, insofar as it allows the availment of the MWE’s tax
exemption and the increased personal and additional exemptions beginning only on 6 July 2008 is in
contravention of the law it purports to implement.
A clarification is proper at this point. Our ruling that the MWE exemption is available for the entire taxable
year 2008 is premised on the fact of one’s status as an MWE; that is, whether the employee during the
entire year of 2008 was an MWE as defined by R.A. 9504. When the wages received exceed the minimum
wage anytime during the taxable year, the employee necessarily loses the MWE qualification. Therefore,
wages become taxable as the employee ceased to be an MWE. But the exemption of the employee from
tax on the income previously earned as an MWE remains.
This rule reflects the understanding of the Senate as gleaned from the exchange between Senator Miriam
Defensor-Santiago and Senator Escudero:
Asked by Senator Defensor-Santiago on how a person would be taxed if, during the year, he is promoted
from Salary Grade 5 to Salary Grade 6 in July and ceases to be a minimum wage employee, Senator
Escudero said that the tax computation would be based starting on the new salary in July.57

As the exemption is based on the employee’s status as an MWE, the operative phrase is when the
employee ceases to be
_______________

57 II Journal, Senate 14th Congress, 1st Session 1513, 26 May 2008; Rollo (G.R. No. 184508), p. 124,
Consolidated Comments.

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an MWE. Even beyond 2008, it is therefore possible for one employee to be exempt early in the year for
being an MWE for that period, and subsequently become taxable in the middle of the same year with respect
to the compensation income, as when the pay is increased higher than the minimum wage. The
improvement of one’s lot, however, cannot justly operate to make the employee liable for tax on the income
earned as an MWE.
Additionally, on the question of whether one who ceases to be an MWE may still be entitled to the personal
and additional exemptions, the answer must necessarily be yes. The MWE exemption is separate and
distinct from the personal and additional exemptions. One’s status as an MWE does not preclude enjoyment
of the personal and additional exemptions. Thus, when one is an MWE during a part of the year and later
earns higher than the minimum wage and becomes a non-MWE, only earnings for that period when one is
a non-MWE is subject to tax. It also necessarily follows that such an employee is entitled to the personal
and additional exemptions that any individual taxpayer with taxable gross income is entitled.
A different interpretation will actually render the MWE exemption a totally oppressive legislation. It would
be a total absurdity to disqualify an MWE from enjoying as much as P150,00058 in personal and additional
exemptions just because sometime in the year, he or she ceases to be an MWE by earning a little more in
wages. Laws cannot be interpreted with such absurd and unjust outcome. It is axiomatic that the legislature
is assumed to intend right and equity in the laws it passes.59
_______________

58 P25,000 for each dependent not exceeding four and the basic personal exemption of P50,000.
59 Commissioner of Internal Revenue v. TMX Sales, Inc., 82 Phil. 199; 205 SCRA 184 (1992).

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Critical, therefore, is how an employee ceases to become an MWE and thus ceases to be entitled to an
MWE’s exemption.
III.
Whether Sections 1 and 3 of RR 10-2008 are consistent with the law in declaring that an MWE who receives
other benefits in excess of the statutory limit of P30,000 is no longer entitled to the exemption provided by
R.A. 9504, is consistent with the law
Sections 1 and 3 of RR 10-2008 add a requirement not found in the law by effectively declaring that an
MWE who receives other benefits in excess of the statutory limit of P30,000 is no longer entitled to the
exemption provided by R.A. 9504.

The BIR added a require-


ment not found in the law.

The assailed Sections 1 and 3 of RR 10-2008 are reproduced hereunder for easier reference.
SECTION 1. Section 2.78.1 of RR 2-98, as amended, is hereby further amended to read as follows:
Sec. 2.78.1. Withholding of Income Tax on Compensation Income.—
(A) Compensation Income Defined.—x x x
xxxx
(3) Facilities and privileges of relatively small value.—Ordinarily, facilities, and privileges (such as
entertainment. medical services, or so-­called “courtesy” discounts on purchases), otherwise known as “de
minimis benefits,” furnished or offered by an employer to his employees, are not considered as
compensation subject to income tax and consequently to withhold-

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ing tax, if such facilities or privileges are of relatively small value and are offered or furnished by the
employer merely as means of promoting the health, goodwill, contentment, or efficiency of his employees.
The following shall be considered as “de minimis” benefits not subject to income tax, hence, not subject to
withholding tax on compensation income of both managerial and rank-and-file employees:
(a) Monetized unused vacation leave credits of employees not exceeding ten (10) days during the year and
the monetized value of leave credits paid to government officials and employees;
(b) Medical cash allowance to dependents of employees not exceeding P750.00 per employee per
semester or P125 per month;
(c) Rice subsidy of P1,500.00 or one (1) sack of 50-kg. rice per month amounting to not more than
P1,500.00;
(d) Uniforms and clothing allowance not exceeding P4,000.00 per annum;
(e) Actual yearly medical benefits not exceeding P10,000.00 per annum;
(f) Laundry allowance not exceeding P300.00 per month;
(g) Employees achievement awards, e.g., for length of service or safety achievement, which must be in
the form of a tangible personal property other than cash or gift certifi-

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cate, with an annual monetary value not exceeding P10,000.00 received by the employee under an
established written plan which does not discriminate in favor of highly paid employees;
(h) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000.00 per
employee per annum;
(i) Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on
account of illness, marriage, birth of a baby, etc.; and
(j) Daily meal allowance for overtime work not exceeding twenty--five percent (25%) of the basic minimum
wage.60
The amount of ‘de minimis’ benefits conforming to the ceiling herein prescribed shall not be considered in
determining the P30,000.00 ceiling of ‘other benefits’ excluded from gross income under Section 32(b)(7)(e)
of the Code. Provided that, the excess of the ‘de minimis’ benefits over their respective ceilings prescribed
by these regulations shall be considered as part of ‘other benefits’ and the employee receiving it will be
subject to tax only on the excess over the P30,000.00 ceiling. Provided, further, that MWEs re­ceiving ‘other
benefits’ exceeding the P30,000.00 limit shall be taxable on the excess benefits, as well as on his salaries,
wages and allowances, just like an em-
_______________

60 Total of the de minimis benefits, excluding items (a), (i) and (j), could amount to P51,350 annually.

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ployee receiving compensation income beyond the SMW.
Any amount given by the employer as benefits to its employees, whether classified as ‘de minimis’ benefits
or fringe benefits, shall constitute [a] deductible expense upon such employer.
Where compensation is paid in property other than money, the employer shall make necessary
arrangements to ensure that the amount of the tax required to be withheld is available for payment to the
Bureau of Internal Revenue.
xxxx
(B) Exemptions from Withholding Tax on Compensation.—The following income payments are exempted
from the requirements of withholding tax on compensation:
xxxx
(13) Compensation income of MWEs who work in the private sector and being paid the Statutory Minimum
Wage (SMW), as fixed by Regional Tripartite Wage and Productivity Board (RTWPB)/National Wages and
Productivity Commission (NWPC), applicable to the place where he/she is assigned.
The aforesaid income shall likewise be exempted from income tax.
“Statutory Minimum Wage” (SMW) shall refer to the rate fixed by the Regional Tripartite Wage and
Productivity Board (RTWPB), as defined by the Bureau of Labor and Employment Statistics (BLES) of the
Department of Labor and Employment (DOLE). The RTWPB of each region shall determine the wage rates
in the different regions based on established criteria and shall be the basis of exemption from income tax
for this purpose.

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Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the aforementioned MWE
shall likewise be covered by the above exemption. Provided, however, that an employee who
receives/earns additional compensation such as commissions, honoraria, fringe benefits, benefits in excess
of the allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than
the SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege
of being a MWE and, therefore, his/her entire earnings are not exempt form income tax, and consequently,
from withholding tax.
MWEs receiving other income, such as income from the conduct of trade, business, or practice of
profession, except income subject to final tax, in addition to compensation income are not exempted from
income tax on their entire income earned during the taxable year. This rule, notwithstanding, the [statutory
minimum wage], [h]oliday pay, overtime pay, night shift differential pay and hazard pay shall still be exempt
from withholding tax.
For purposes of these regulations, hazard pay shall mean x x x.
In case of hazardous employment, x x x.
The NWPC shall officially submit a Matrix of Wage Order by region x x x.
Any reduction or diminution of wages for purposes of exemption from income tax shall constitute
misrepresentation and therefore, shall result to the automatic disallowance of expense, i.e., compensation
and benefits account, on the part of the employer. The offenders may be criminally prosecuted under
existing laws.
(14) Compensation income of employees in the public sector with compensation in-

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come of not more than the SMW in the non-agricultural sector, as fixed by RTWPB/NWPC, applicable to
the place where he/she is assigned.
The aforesaid income shall likewise be exempted from income tax.
The basic salary of MWEs in the public sector shall be equated to the SMW in the non-agricultural sector
applicable to the place where he/she is assigned. The determination of the SMW in the public sector shall
likewise adopt the same procedures and consideration as those of the private sector.
Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the aforementioned MWE
in the public sector shall likewise be covered by the above exemption. Provided, however, that a public
sector employee who receives additional compensation such as commissions, honoraria, fringe benefits,
benefits in excess of the allowable statutory amount of P30,000.00, taxable allowances and other taxable
income other than the SMW, holiday pay, overtime pay, night shift differential pay and hazard pay shall not
enjoy the privilege of being a MWE and, therefore, his/her entire earnings are not exempt from income tax
and, consequently, from withholding tax.
MWEs receiving other income, such as income from the conduct of trade, business, or practice of
profession, except income subject to final tax, in addition to compensation income are not exempted from
income tax on their entire income earned during the taxable year. This rule, notwithstanding, the SMW,
Holiday pay, overtime pay, night shift differential pay and hazard pay shall still be exempt from withholding
tax.
For purposes of these regulations, hazard pay shall mean x x x.

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In case of hazardous employment, x x x.
xxxx
SECTION 3. Section 2.79 of RR 2-98, as amended, is hereby further amended to read as follows:
Sec. 2.79. Income Tax Collected at Source on Compensation Income.—

(A) Requirement of Withholding.—Every employer must withhold from compensation paid an amount
computed in accordance with these Regulations. Provided, that no withholding of tax shall be required on
the SMW, including holiday pay, overtime pay, night shift differential and hazard pay of MWEs in the
private/public sectors as defined in these Regulations. Provided, further, that an employee who receives
additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the
allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than the
SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege of
being a MWE and, therefore, his/her entire earnings are not exempt from income tax and, consequently,
shall be subject to withholding tax.
xxxx
For the year 2008, however, being the initial year of implementation of R.A. 9504, there shall be a transitory
withholding tax table for the period from July 6 to December 31, 2008 (Annex “D”) determined by prorating
the annual personal and additional exemptions under R.A. 9504 over a period of six months. Thus, for
individuals, regardless of personal status, the prorated personal exemption is P25,000, and for each
qualified dependent child (QDC), P12,500.

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On the other hand, the pertinent provisions of law, which are supposed to be implemented by the above
quoted sections of RR 10-2008, read as follows:
SECTION 1. Section 22 of Republic Act No. 8424, as amended, otherwise known as the National Internal
Revenue Code of 1997, is hereby further amended by adding the following definitions after Subsection (FF)
to read as follows:
Section 22. Definitions.—When used in this Title:61
(A) x x x;
(FF) x x x;
(GG) The term ‘statutory minimum wage’ shall refer to the rate fixed by the Regional Tripartite Wage and
Productivity Board, as defined by the Bureau of Labor and Employment Statistics (BLES) of the Department
of Labor and Employment (DOLE);
(HH) The term ‘minimum wage earner’ shall refer to a worker in the private sector paid the statutory
minimum wage, or to an employee in the public sector with compensation income of not more than the
statutory minimum wage in the nonagricultural sector where he/she is assigned.
SECTION 2. Section 24(A) of Republic Act No. 8424, as amended, otherwise known as the National
Internal Revenue Code of 1997, is hereby further amended to read as follows:
SEC. 24. Income Tax Rates.—
(A) Rates of Income Tax on Individual Citizen and Individual Resident Alien of the Philippines.—
_______________

61 Title II, Tax on Income, R.A. 8424, as amended.

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(1) x x x;
x x x x; and
(c) On the taxable income defined in Section 31 of this Code, other than income subject to tax under
Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the
Philippines by an individual alien who is a resident of the Philippines.
(2) Rates of Tax on Taxable Income of Individuals.—The tax shall be computed in accordance with and
at the rates established in the following schedule:
xxxx
For married individuals, the husband and wife, subject to the provision of Section 51(D) hereof, shall
compute separately their individual income tax based on their respective total taxable income: Provided,
That if any income cannot be definitely attributed to or identified as income exclusively earned or realized
by either of the spouses, the same shall be divided equally between the spouses for the purpose of
determining their respective taxable income.
Provided, That minimum wage earners as defined in Section 22(HH) of this Code shall be exempt from the
payment of income tax on their taxable income: Provided, further, That the holiday pay, overtime pay, night
shift differential pay and hazard pay received by such minimum wage earners shall likewise be exempt from
income tax.
xxxx
SECTION 5. Section 51(A)(2) of Republic Act No. 8424, as amended, otherwise known as the National
In-

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ternal Revenue Code of 1997, is hereby further amended to read as follows:
SEC. 51. Individual Return.—
(A) Requirements.—
(1) Except as provided in paragraph (2) of this Subsection, the following individuals are required to file an
income tax return:
(a) x x x.
x x x x.
(2) The following individuals shall not be required to file an income tax return:
(a) x x x;
(b)