company used it to entertain guests, to accommodate officials, and to

COLLECTOR V. HENDERSON entertain customers. According to taxpayers, only P 4,800 per year is
the reasonable amount that the spouses would be spending on rental
Rental and Travel Allowance are not Part of Taxable Income if they were not required to live in those apartments. Thus, it is the
amount they deem is subject to tax. The excess is to be treated as
expense of the company.

Rental allowances and travel allowances by a company are not part of

taxable income.
2) The entrance fee should not be considered income since it is an
expense of his employer, and membership therein is merely incidental
to his duties of increasing and sustaining the business of his employer.
FACTS:

3) His wife merely accompanied him to New York on a business trip as

• Sps. Arthur Henderson and Marie Henderson filed their annual his secretary, and at the employer-corporation’s request, for the wife to
income tax with the BIR. Arthur is president of American International look at details of the plans of a building that his employer intended to
Underwriters for the Philippines, Inc., which is a domestic corporation construct. Such must not be considered taxable income.
engaged in the business of general non-life insurance, and represents
a group of American insurance companies engaged in the business of
general non-life insurance.

• The Collector of Internal Revenue merely allowed the entrance fee as

• The BIR demanded payment for alleged deficiency taxes. In their
computation, the BIR included as part of taxable income: 1) Arthur’s
allowances for rental, residential expenses, subsistence, water,
electricity and telephone expenses 2) entrance fee to the Marikina Gun
and Country Club which was paid by his employer for his account and
3) travelling allowance of his wife
nontaxable. The rent expense and travel expenses were still held to be
taxable. The Court of Tax Appeals ruled in favor of the taxpayers, that
such expenses must not be considered part of taxable income. Letters
of the wife while in New York concerning the proposed building were
presented as evidence.

• The taxpayers justifications are as follows:

ISSUE: Whether or not the rental allowances and travel allowances
furnished and given by the employer-corporation are part of taxable
income?
1) as to allowances for rental and utilities, Arthur did not receive money
for the allowances. Instead, the apartment is furnished and paid for by
his employer-corporation (the mother company of American
International), for the employer corporation’s purposes. The spouses
had no choice but to live in the expensive apartment, since the
HELD: NO. Such claims are substantially supported by evidence.

These claims are therefore NOT part of taxable income. No part of the
allowances in question redounded to their personal benefit, nor were
such amounts retained by them. These bills were paid directly by the
employer-corporation to the creditors. The rental expenses and
subsistence allowances are to be considered not subject to income tax.
Arthur’s high executive position and social standing, demanded and
compelled the couple to live in a more spacious and expensive
quarters. Such ‘subsistence allowance’ was a SEPARATE account
from the account for salaries and wages of employees. The company
did not charge rentals as deductible from the salaries of the employees.
These expenses are COMPANY EXPENSES, not income by
employees which are subject to tax.

GENERAL RULE: A stock dividend representing the transfer of surplus
to capital account shall not be subject to tax.
EXCEPTION: The redemption or cancellation of stock dividends,
depending on the "time" and "manner" it was made, is essentially
equivalent to a distribution of taxable dividends," making the proceeds
thereof "taxable income" "to the extent it represents profits".
FACTS: -- reversal of the decision of the CA
• Don Andres Soriano, a citizen and resident of the United States,
formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR,
with a P1,000,000.00 capitalization divided into 10,000 common shares
at a par value of P100/share. ANSCOR is wholly owned and controlled
by the family of Don Andres, who are all nonresident aliens.
• In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares
originally issued. In 1945, ANSCOR's authorized capital stock was
increased to P2,500,000.00 divided into 25,000 common shares with
the same par value. Don Andres' increased his subscription to 14,963
common shares. A month later, Don Andres transferred 1,250 shares
each to his two sons, Jose and Andres, Jr., as their initial investments
in ANSCOR. Both sons are foreigners.
• From 1947-1963, ANSCOR declared stock dividends. On December
30, 1964 Don Andres died. As of that date, the records revealed that
he has a total shareholdings of 185,154 shares. Correspondingly, one-
half of that shareholdings or 92,577 shares were transferred to his wife,
Doña Carmen Soriano, as her conjugal share. The other half formed
part of his estate.
• A day after Don Andres died, ANSCOR increased its capital stock to
P20M and in 1966 further increased it to P30M. Stock dividends worth
46,290 and 46,287 shares were respectively received by the Don
Andres estate and Doña Carmen from ANSCOR. Hence, increasing
their accumulated shareholdings to 138,867 and 138,864 common
shares each.
• On June 30, 1968, pursuant to a Board Resolution, ANSCOR
redeemed 28,000 common shares from the Don Andres' estate. By
November 1968, the Board further increased ANSCOR's capital stock
to P75M. About a year later, ANSCOR again redeemed 80,000
common shares from the Don Andres' estate. As stated in the Board
Resolutions, ANSCOR's business purpose for both redemptions of
stocks is to partially retire said stocks as treasury shares in order to
reduce the company's foreign exchange remittances in case cash
dividends are declared.
• In 1973, after examining ANSCOR's books of account and records,
Revenue examiners issued a report proposing that ANSCOR be
assessed for deficiency withholding tax-at-source, pursuant to Sections
53 and 54 of the 1939 Revenue Code for the year 1968 and the second
quarter of 1969 based on the transactions of exchange and redemption
of stocks.
ISSUE:
• Whether or not ANSCOR's redemption of stocks from its stockholder
as well as the exchange of common with preferred shares can be
considered as "essentially equivalent to the distribution of taxable
dividend" making the proceeds thereof taxable.
HELD:
• YES. The bone of contention is the interpretation and application of
Section 83(b) of the 1939 Revenue Act 38 which provides:

• Sec. 83. Distribution of dividends or assets by corporations. — (b)
Stock dividends — 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 it represents
a distribution of earnings or profits accumulated after March first,
nineteen hundred and thirteen.
• Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of
the U.S. Revenue Code of 1928. It laid down the general rule known as
the proportionate test wherein stock dividends once issued form part of
the capital and, thus, subject to income tax. Specifically, the general
rule states that: A stock dividend representing the transfer of surplus to
capital account shall not be subject to tax.
• Stock dividends, strictly speaking, represent capital and do not
constitute income to its recipient. So that the mere issuance thereof is
not yet subject to income tax as they are nothing but an "enrichment
through increase in value of capital investment."
• The exception provides that the redemption or cancellation of stock
dividends, depending on the "time" and "manner" it was made, is
essentially equivalent to a distribution of taxable dividends," making the
proceeds thereof "taxable income" "to the extent it represents profits".
The exception was designed to prevent the issuance and cancellation
or redemption of stock dividends, which is fundamentally not taxable,
from being made use of as a device for the actual distribution of cash
dividends, which is taxable.
• Simply put, depending on the circumstances, the proceeds of
redemption of stock dividends are essentially distribution of cash
dividends, which when paid becomes the absolute property of the
stockholder. Thereafter, the latter becomes the exclusive owner thereof
and can exercise the freedom of choice. Having realized gain from that
redemption, the income earner cannot escape income tax. For the
exempting clause of Section, 83(b) to apply, it is indispensable that: (a)
there is redemption or cancellation; (b) the transaction involves stock
dividends and (c) the "time and manner" of the transaction makes it
"essentially equivalent to a distribution of taxable dividends."
• Redemption is repurchase, a reacquisition of stock by a corporation
which issued the stock 89 in exchange for property, whether or not the
acquired stock is cancelled, retired or held in the treasury. 90
Essentially, the corporation gets back some of its stock, distributes
cash or property to the shareholder in payment for the stock, and
continues in business as before. In the case, ANSCOR redeemed
shares twice. But where did the shares redeemed come from? If its
source is the original capital subscriptions upon establishment of the
corporation or from initial capital investment in an existing enterprise,
its redemption to the concurrent value of acquisition may not invite the
application of Sec. 83(b) under the 1939 Tax Code, as it is not income
but a mere return of capital. On the contrary, if the redeemed shares
are from stock dividend declarations other than as initial capital
investment, the proceeds of the redemption is additional wealth, for it
is not merely a return of capital but a gain thereon.
• It is not the stock dividends but the proceeds of its redemption that
may be deemed as taxable dividends. At the time of the last
redemption, the original common shares owned by the estate were only
25,247.5 91 This means that from the total of 108,000 shares redeemed
from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must
have come from stock dividends. In the absence of evidence to the
contrary, the Tax Code presumes that every distribution of corporate
property, in whole or in part, is made out of corporate profits such as
stock dividends. The capital cannot be distributed in the form of
redemption of stock dividends without violating the trust fund doctrine.
• With respect to the third requisite, ANSCOR redeemed stock
dividends issued just 2 to 3 years earlier. The time alone that lapsed
from the issuance to the redemption is not a sufficient indicator to
determine taxability. It is a must to consider the factual circumstances
as to the manner of both the issuance and the redemption. The
issuance of stock dividends and its subsequent redemption must be
separate, distinct, and not related, for the redemption to be considered
a legitimate tax scheme. Redemption cannot be used as a cloak to
distribute corporate earnings.
• Even if the said purposes support the redemption and justify the
issuance of stock dividends, the same has no bearing whatsoever on
the imposition of the tax herein assessed because the proceeds of the
redemption are deemed taxable dividends since it was shown that
income was generated therefrom.

• ANSCOR invoked two reasons to justify the redemptions — (1) the • The proceeds thereof are essentially considered equivalent to a
alleged "filipinization" program and (2) the reduction of foreign distribution of taxable dividends. As "taxable dividend" under Section
exchange remittances in case cash dividends are declared. The Court 83(b), it is part of the "entire income" subject to tax under Section 22 in
is not concerned with the wisdom of these purposes but on their relation to Section 21 120 of the 1939 Code. Moreover, under Section
relevance to the whole transaction which can be inferred from the 29(a) of said Code, dividends are included in "gross income". As
outcome thereof. It is the "net effect rather than the motives and plans income, it is subject to income tax which is required to be withheld at
of the taxpayer or his corporation". The test of taxability under the source.
exempting clause, when it provides "such time and manner" as would
make the redemption "essentially equivalent to the distribution of a
taxable dividend", is whether the redemption resulted into a flow of
wealth. If no wealth is realized from the redemption, there may not be
a dividend equivalence treatment.

• The test of taxability under the exempting clause of Section 83(b) is,
whether income was realized through the redemption of stock
dividends. The redemption converts into money the stock dividends
which become a realized profit or gain and consequently, the
stockholder's separate property. Profits derived from the capital
invested cannot escape income tax. As realized income, the proceeds
of the redeemed stock dividends can be reached by income taxation
regardless of the existence of any business purpose for the redemption.
Otherwise, to rule that the said proceeds are exempt from income tax
when the redemption is supported by legitimate business reasons
would defeat the very purpose of imposing tax on income.

• The issuance and the redemption of stocks are two different

transactions. Although the existence of legitimate corporate purposes
may justify a corporation's acquisition of its own shares under Section
41 of the Corporation Code, such purposes cannot excuse the
stockholder from the effects of taxation arising from the redemption.
 G.R. No. 108576 January 20, 1999
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE COURT OF APPEALS, COURT OF TAX APPEALS and A.
SORIANO CORP., respondents.
MARTINEZ, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal
of the decision of the Court of Appeals (CA) 1 which affirmed the ruling
of the Court of Tax Appeals (CTA) 2 that private respondent A. Soriano
Corporation's (hereinafter ANSCOR) redemption and exchange of the
stocks of its foreign stockholders cannot be considered as "essentially
equivalent to a distribution of taxable dividends" under, Section 83(b)
of the 1939 Internal Revenue Act. 3
The undisputed facts are as follows:
Sometime in the 1930s, Don Andres Soriano, a citizen and resident of
the United States, formed the corporation "A. Soriano Y Cia",
predecessor of ANSCOR, with a P1,000,000.00 capitalization divided
into 10,000 common shares at a par value of P100/share. ANSCOR is
wholly owned and controlled by the family of Don Andres, who are all
non-resident aliens. 4 In 1937, Don Andres subscribed to 4,963 shares
of the 5,000 shares originally issued. 5
On September 12, 1945, ANSCOR's authorized capital stock was
increased to P2,500,000.00 divided into 25,000 common shares with
the same par value of the additional 15,000 shares, only 10,000 was
issued which were all subscribed by Don Andres, after the other
stockholders waived in favor of the former their pre-emptive rights to
subscribe to the new issues. 6 This increased his subscription to 14,963
common shares. 7 A month later, 8 Don Andres transferred 1,250
shares each to his two sons, Jose and Andres, Jr., as their initial
investments in ANSCOR. 9 Both sons are foreigners. 10
By 1947, ANSCOR declared stock dividends. Other stock dividend
declarations were made between 1949 and December 20, 1963. 11 On
December 30, 1964 Don Andres died. As of that date, the records
revealed that he has a total shareholdings of 185,154 shares 12 —
50,495 of which are original issues and the balance of 134.659 shares
as stock dividend declarations. 13 Correspondingly, one-half of that
shareholdings or 92,577 14 shares were transferred to his wife, Doña
Carmen Soriano, as her conjugal share. The other half formed part of
his estate. 15
A day after Don Andres died, ANSCOR increased its capital stock to
P20M 16 and in 1966 further increased it to P30M. 17 In the same year
(December 1966), stock dividends worth 46,290 and 46,287 shares
were respectively received by the Don Andres estate 18 and Doña
Carmen from ANSCOR. Hence, increasing their accumulated
shareholdings to 138,867 and 138,864 19 common shares each. 20
On December 28, 1967, Doña Carmen requested a ruling from the
United States Internal Revenue Service (IRS), inquiring if an exchange
of common with preferred shares may be considered as a tax
avoidance scheme 21 under Section 367 of the 1954 U.S. Revenue
Act. 22 By January 2, 1968, ANSCOR reclassified its existing 300,000
common shares into 150,000 common and 150,000 preferred
shares. 23
In a letter-reply dated February 1968, the IRS opined that the exchange
is only a recapitalization scheme and not tax
avoidance. 24 Consequently, 25 on March 31, 1968 Doña Carmen
exchanged her whole 138,864 common shares for 138,860 of the newly
reclassified preferred shares. The estate of Don Andres in turn,
exchanged 11,140 of its common shares, for the remaining 11,140
preferred shares, thus reducing its (the estate) common shares to
127,727. 26
On June 30, 1968, pursuant to a Board Resolution, ANSCOR
redeemed 28,000 common shares from the Don Andres' estate. By
November 1968, the Board further increased ANSCOR's capital stock
to P75M divided into 150,000 preferred shares and 600,000 common
shares. 27 About a year later, ANSCOR again redeemed 80,000
common shares from the Don Andres' estate, 28 further reducing the
latter's common shareholdings to 19,727. As stated in the Board
Resolutions, ANSCOR's business purpose for both redemptions of
stocks is to partially retire said stocks as treasury shares in order to
reduce the company's foreign exchange remittances in case cash
dividends are declared. 29
In 1973, after examining ANSCOR's books of account and records,
Revenue examiners issued a report proposing that ANSCOR be
assessed for deficiency withholding tax-at-source, pursuant to Sections
53 and 54 of the 1939 Revenue Code, 30 for the year 1968 and the
second quarter of 1969 based on the transactions of exchange 31 and
redemption of stocks. 31 The Bureau of Internal Revenue (BIR) made
the corresponding assessments despite the claim of ANSCOR that it
availed of the tax amnesty under Presidential Decree
(P.D.) 23 32 which were amended by P.D.'s 67 and 157. 33 However,
petitioner ruled that the invoked decrees do not cover Sections 53 and
54 in relation to Article 83(b) of the 1939 Revenue Act under which
ANSCOR was assessed. 34 ANSCOR's subsequent protest on the
assessments was denied in 1983 by petitioner. 35
Subsequently, ANSCOR filed a petition for review with the CTA
assailing the tax assessments on the redemptions and exchange of
stocks. In its decision, the Tax Court reversed petitioner's ruling, after
finding sufficient evidence to overcome the prima facie correctness of
the questioned assessments. 36 In a petition for review the CA as
mentioned, affirmed the ruling of the CTA. 37 Hence, this petition.
The bone of contention is the interpretation and application of Section
83(b) of the 1939 Revenue Act 38 which provides:
Sec. 83. Distribution of dividends or assets by corporations. —
(b) Stock dividends — 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 it represents a distribution of earnings or profits accumulated
after March first, nineteen hundred and thirteen. (Emphasis supplied)
Specifically, the issue is whether ANSCOR's redemption of stocks from
its stockholder as well as the exchange of common with preferred
shares can be considered as "essentially equivalent to the distribution
of taxable dividend" making the proceeds thereof taxable under the
provisions of the above-quoted law.
Petitioner contends that the exchange transaction a tantamount to
"cancellation" under Section 83(b) making the proceeds thereof
taxable. It also argues that the Section applies to stock dividends which
is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims
that under the "net effect test," the estate of Don Andres gained from
the redemption. Accordingly, it was the duty of ANSCOR to withhold
the tax-at-source arising from the two transactions, pursuant to Section
53 and 54 of the 1939 Revenue Act. 39
ANSCOR, however, avers that it has no duty to withhold any tax either
from the Don Andres estate or from Doña Carmen based on the two
transactions, because the same were done for legitimate business
purposes which are (a) to reduce its foreign exchange remittances in
the event the company would declare cash dividends, 40 and to (b)
subsequently "filipinized" ownership of ANSCOR, as allegedly,
envisioned by Don Andres. 41 It likewise invoked the amnesty
provisions of P.D. 67.
We must emphasize that the application of Sec. 83(b) depends on the
special factual circumstances of each case. 42 The findings of facts of
a special court (CTA) exercising particular expertise on the subject of
tax, generally binds this Court, 43 considering that it is substantially
similar to the findings of the CA which is the final arbiter of questions of
facts. 44 The issue in this case does not only deal with facts but whether
the law applies to a particular set of facts. Moreover, this Court is not
necessarily bound by the lower courts' conclusions of law drawn from
such facts. 45
AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D.
67 46 provides:
1. In all cases of voluntary disclosures of previously untaxed income
and/or wealth such as earnings, receipts, gifts, bequests or any other
acquisitions from any source whatsoever which are taxable under the
National Internal Revenue Code, as amended, realized here or abroad
by any taxpayer, natural or judicial; the collection of all internal revenue
taxes including the increments or penalties or account of non-payment
as well as all civil, criminal or administrative liabilities arising from or
incident to such disclosures under the National Internal Revenue Code,
the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the
Revised Administrative Code, the Civil Service laws and regulations,
laws and regulations on Immigration and Deportation, or any other
applicable law or proclamation, are hereby condoned and, in lieu
thereof, a tax of ten (10%) per centum on such previously untaxed
income or wealth, is hereby imposed, subject to the following
conditions: (conditions omitted) [Emphasis supplied].
The decree condones "the collection of all internal revenue taxes
including the increments or penalties or account of non-payment as well
as all civil, criminal or administrative liable arising from or incident to"
(voluntary) disclosures under the NIRC of previously untaxed income
and/or wealth "realized here or abroad by any taxpayer, natural or
juridical."
May the withholding agent, in such capacity, be deemed a taxpayer for
it to avail of the amnesty? An income taxpayer covers all persons who
derive taxable income. 47 ANSCOR was assessed by petitioner for
deficiency withholding tax under Section 53 and 54 of the 1939 Code.
As such, it is being held liable in its capacity as a withholding agent and
not its personality as a taxpayer.
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 48 in order to ensure its
payments; 49 the payer is the taxpayer — he is the person subject to
tax impose by law; 50 and the payee is the taxing authority. 51 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, 52 because the income tax is still impose 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 53 arising from the breach of its legal duty to
withhold as distinguish from its duty to pay tax since:
the government's cause of action against the withholding 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. 54
Not being a taxpayer, a withholding agent, like ANSCOR in this
transaction is not protected by the amnesty under the decree.
Codal provisions on withholding tax are mandatory and must be
complied with by the withholding agent. 55 The taxpayer should not
answer for the non-performance by the withholding agent of its legal
duty to withhold unless there is collusion or bad faith. The former could
not be deemed to have evaded the tax had the withholding agent
performed its duty. This could be the situation for which the amnesty
decree was intended. Thus, to curtail tax evasion and give tax evaders
a chance to reform, 56 it was deemed administratively feasible to grant
tax amnesty in certain instances. In addition, a "tax amnesty, much like
a tax exemption, is never favored nor presumed in law and if granted
by a statute, the term of the amnesty like that of a tax exemption must
be construed strictly against the taxpayer and liberally in favor of the
taxing authority.57 The rule on strictissimi juris equally applies. 58 So
that, any doubt in the application of an amnesty law/decree should be
resolved in favor of the taxing authority.
Furthermore, ANSCOR's claim of amnesty cannot prosper. The
implementing rules of P.D. 370 which expanded amnesty on previously
untaxed income under P.D. 23 is very explicit, to wit:
Sec. 4. Cases not covered by amnesty. — The following cases are not
covered by the amnesty subject of these regulations:
xxx xxx xxx
(2) Tax liabilities with or without assessments, on withholding tax at
source provided under Section 53 and 54 of the National Internal
Revenue Code, as amended; 59
ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax
Code. Thus, by specific provision of law, it is not covered by the
amnesty.
TAX ON STOCK DIVIDENDS
General Rule
Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of
the U.S. Revenue Code of 1928. 60 It laid down the general rule known
as the proportionate test 61 wherein stock dividends once issued form
part of the capital and, thus, subject to income tax.62 Specifically, the
general rule states that:
A stock dividend representing the transfer of surplus to capital account
shall not be subject to tax.
Having been derived from a foreign law, resort to the jurisprudence of
its origin may shed light. Under the US Revenue Code, this provision
originally referred to "stock dividends" only, without any exception.
Stock dividends, strictly speaking, represent capital and do not
constitute income to its
recipient. 63 So that the mere issuance thereof is not yet subject to
income tax 64 as they are nothing but an "enrichment through increase
in value of capital
investment." 65 As capital, the stock dividends postpone the realization
of profits because the "fund represented by the new stock has been
transferred from surplus to capital and no longer available for actual
distribution." 66 Income in tax law is "an amount of money coming to a
person within a specified time, whether as payment for services,
interest, or profit from investment." 67 It means cash or its
equivalent. 68 It is gain derived and severed from capital, 69 from labor
or from both combined 70 — so that to tax a stock dividend would be to
tax a capital increase rather than the income. 71 In a loose sense, stock
dividends issued by the corporation, are considered unrealized gain,
and cannot be subjected to income tax until that gain has been realized.
Before the realization, stock dividends are nothing but a representation
of an interest in the corporate properties. 72 As capital, it is not yet
subject to income tax. It should be noted that capital and income are
different. Capital is wealth or fund; whereas income is profit or gain or
the flow of wealth. 73 The determining factor for the imposition of income
tax is whether any gain or profit was derived from a transaction. 74
The Exception
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 it represents a distribution
of earnings or profits accumulated after March first, nineteen hundred
and thirteen. (Emphasis supplied).
In a response to the ruling of the American Supreme Court in the case
of Eisner v. Macomber 75 (that pro rata stock dividends are not taxable
income), the exempting clause above quoted was added because
provision corporation found a loophole in the original provision. They
resorted to devious means to circumvent the law and evade the tax.
Corporate earnings would be distributed under the guise of its initial
capitalization by declaring the stock dividends previously issued and
later redeem said dividends by paying cash to the stockholder. This
process of issuance-redemption amounts to a distribution of taxable
cash dividends which was lust delayed so as to escape the tax. It
becomes a convenient technical strategy to avoid the effects of
taxation.
Thus, to plug the loophole — the exempting clause was added. It
provides that the redemption or cancellation of stock dividends,
depending on the "time" and "manner" it was made, is essentially
equivalent to a distribution of taxable dividends," making the proceeds
thereof "taxable income" "to the extent it represents profits". The
exception was designed to prevent the issuance and cancellation or
redemption of stock dividends, which is fundamentally not taxable, from
being made use of as a device for the actual distribution of cash
dividends, which is taxable. 76 Thus,
the provision had the obvious purpose of preventing a corporation from
avoiding dividend tax treatment by distributing earnings to its
shareholders in two transactions — a pro rata stock dividend followed
by a pro rata redemption — that would have the same economic
consequences as a simple dividend. 77
Although redemption and cancellation are generally considered capital
transactions, as such. they are not subject to tax. However, it does not
necessarily mean that a shareholder may not realize a taxable gain
from such transactions. 78 Simply put, depending on the circumstances,
the proceeds of redemption of stock dividends are essentially
distribution of cash dividends, which when paid becomes the absolute
property of the stockholder. Thereafter, the latter becomes the
exclusive owner thereof and can exercise the freedom of
choice. 79 Having realized gain from that redemption, the income earner
cannot escape income tax. 80
As qualified by the phrase "such time and in such manner," the
exception was not intended to characterize as taxable dividend every
distribution of earnings arising from the redemption of stock
dividend. 81 So that, whether the amount distributed in the redemption
should be treated as the equivalent of a "taxable dividend" is a question
of fact, 82 which is determinable on "the basis of the particular facts of
the transaction in question. 83 No decisive test can be used to
determine the application of the exemption under Section 83(b). The
use of the words "such manner" and "essentially equivalent" negative
any idea that a weighted formula can resolve a crucial issue — Should
the distribution be treated as taxable dividend. 84 On this aspect,
American courts developed certain recognized criteria, which includes
the following: 85
1) the presence or absence of real business purpose,
2) the amount of earnings and profits available for the declaration of a
regular dividends and the corporation's past record with respect to the
declaration of dividends,
3) the effect of the distribution, as compared with the declaration of
regular dividend,
4) the lapse of time between issuance and redemption, 86
5) the presence of a substantial surplus 87 and a generous supply of
cash which invites suspicion as does a meager policy in relation both
to current earnings and accumulated surplus, 88
REDEMPTION AND CANCELLATION
For the exempting clause of Section, 83(b) to apply, it is indispensable
that: (a) there is redemption or cancellation; (b) the transaction involves
stock dividends and (c) the "time and manner" of the transaction makes
it "essentially equivalent to a distribution of taxable dividends." Of these,
the most important is the third.
Redemption is repurchase, a reacquisition of stock by a corporation
which issued the stock 89 in exchange for property, whether or not the
acquired stock is cancelled, retired or held in the
treasury. 90 Essentially, the corporation gets back some of its stock,
distributes cash or property to the shareholder in payment for the stock,
and continues in business as before. The redemption of stock dividends
previously issued is used as a veil for the constructive distribution of
cash dividends. In the instant case, there is no dispute that ANSCOR
redeemed shares of stocks from a stockholder (Don Andres) twice
(28,000 and 80,000 common shares). But where did the shares
redeemed come from? If its source is the original capital subscriptions
upon establishment of the corporation or from initial capital investment
in an existing enterprise, its redemption to the concurrent value of
acquisition may not invite the application of Sec. 83(b) under the 1939
Tax Code, as it is not income but a mere return of capital. On the
contrary, if the redeemed shares are from stock dividend declarations
other than as initial capital investment, the proceeds of the redemption
is additional wealth, for it is not merely a return of capital but a gain
thereon.
It is not the stock dividends but the proceeds of its redemption that may
be deemed as taxable dividends. Here, it is undisputed that at the time
of the last redemption, the original common shares owned by the estate
were only 25,247.5 91 This means that from the total of 108,000 shares
redeemed from the estate, the balance of 82,752.5 (108,000 less
25,247.5) must have come from stock dividends. Besides, in the
absence of evidence to the contrary, the Tax Code presumes that every
distribution of corporate property, in whole or in part, is made out of
corporate profits 92 such as stock dividends. The capital cannot be
distributed in the form of redemption of stock dividends without violating
the trust fund doctrine — wherein the capital stock, property and other
assets of the corporation are regarded as equity in trust for the payment
of the corporate creditors. 93 Once capital, it is always capital. 94 That
doctrine was intended for the protection of corporate creditors. 95
With respect to the third requisite, ANSCOR redeemed stock dividends
issued just 2 to 3 years earlier. The time alone that lapsed from the
issuance to the redemption is not a sufficient indicator to determine
taxability. It is a must to consider the factual circumstances as to the
manner of both the issuance and the redemption. The "time" element
is a factor to show a device to evade tax and the scheme of cancelling
or redeeming the same shares is a method usually adopted to
accomplish the end sought. 96 Was this transaction used as a
"continuing plan," "device" or "artifice" to evade payment of tax? It is
necessary to determine the "net effect" of the transaction between the
shareholder-income taxpayer and the acquiring (redeeming)
corporation. 97 The "net effect" test is not evidence or testimony to be
considered; it is rather an inference to be drawn or a conclusion to be
reached. 98 It is also important to know whether the issuance of stock
dividends was dictated by legitimate business reasons, the presence of
which might negate a tax evasion plan. 99
The issuance of stock dividends and its subsequent redemption must
be separate, distinct, and not related, for the redemption to be
considered a legitimate tax scheme. 100 Redemption cannot be used as
a cloak to distribute corporate earnings. 101 Otherwise, the apparent
intention to avoid tax becomes doubtful as the intention to evade
becomes manifest. It has been ruled that:
[A]n operation with no business or corporate purpose — is a mere
devise which put on the form of a corporate reorganization as a disguise
for concealing its real character, and the sole object and
accomplishment of which was the consummation of a preconceived
plan, not to reorganize a business or any part of a business, but to
transfer a parcel of corporate shares to a stockholder. 102
Depending on each case, the exempting provision of Sec. 83(b) of the
1939 Code may not be applicable if the redeemed shares were issued
with bona fide business purpose, 103 which is judged after each and
every step of the transaction have been considered and the whole
transaction does not amount to a tax evasion scheme.
ANSCOR invoked two reasons to justify the redemptions — (1) the
alleged "filipinization" program and (2) the reduction of foreign
exchange remittances in case cash dividends are declared. The Court
is not concerned with the wisdom of these purposes but on their
relevance to the whole transaction which can be inferred from the
outcome thereof. Again, it is the "net effect rather than the motives and
plans of the taxpayer or his corporation" 104 that is the fundamental
guide in administering Sec. 83(b). This tax provision is aimed at the
result. 105 It also applies even if at the time of the issuance of the stock
dividend, there was no intention to redeem it as a means of distributing
profit or avoiding tax on dividends. 106 The existence of legitimate
business purposes in support of the redemption of stock dividends is
immaterial in income taxation. It has no relevance in determining
"dividend equivalence". 107 Such purposes may be material only upon
the issuance of the stock dividends. The test of taxability under the
exempting clause, when it provides "such time and manner" as would
make the redemption "essentially equivalent to the distribution of a
taxable dividend", is whether the redemption resulted into a flow of
wealth. If no wealth is realized from the redemption, there may not be
a dividend equivalence treatment. In the metaphor of Eisner v.
Macomber, income is not deemed "realize" until the fruit has fallen or
been plucked from the tree.
The three elements in the imposition of income tax are: (1) there must
be gain or and profit, (2) that the gain or profit is realized or received,
actually or constructively, 108 and (3) it is not exempted by law or treaty
from income tax. Any business purpose as to why or how the income
was earned by the taxpayer is not a requirement. Income tax is
assessed on income received from any property, activity or service that
produces the income because the Tax Code stands as an indifferent
neutral party on the matter of where income comes
from. 109
As stated above, the test of taxability under the exempting clause of
Section 83(b) is, whether income was realized through the redemption
of stock dividends. The redemption converts into money the stock
dividends which become a realized profit or gain and consequently, the
stockholder's separate property. 110 Profits derived from the capital
invested cannot escape income tax. As realized income, the proceeds
of the redeemed stock dividends can be reached by income taxation
regardless of the existence of any business purpose for the redemption.
Otherwise, to rule that the said proceeds are exempt from income tax
when the redemption is supported by legitimate business reasons
would defeat the very purpose of imposing tax on income. Such
argument would open the door for income earners not to pay tax so
long as the person from whom the income was derived has legitimate
business reasons. In other words, the payment of tax under the
exempting clause of Section 83(b) would be made to depend not on the
income of the taxpayer, but on the business purposes of a third party
(the corporation herein) from whom the income was earned. This is
absurd, illogical and impractical considering that the Bureau of Internal
Revenue (BIR) would be pestered with instances in determining the
legitimacy of business reasons that every income earner may
interposed. It is not administratively feasible and cannot therefore be
allowed.
The ruling in the American cases cited and relied upon by ANSCOR
that "the redeemed shares are the equivalent of dividend only if the
shares were not issued for genuine business purposes", 111 or the
"redeemed shares have been issued by a corporation bona
fide" 112 bears no relevance in determining the non-taxability of the
proceeds of redemption ANSCOR, relying heavily and applying said
cases, argued that so long as the redemption is supported by valid
corporate purposes the proceeds are not subject to tax. 113 The
adoption by the courts below 114 of such argument is misleading if not
misplaced. A review of the cited American cases shows that the
presence or absence of "genuine business purposes" may be material
with respect to the issuance or declaration of stock dividends but not
on its subsequent redemption. The issuance and the redemption of
stocks are two different transactions. Although the existence of
legitimate corporate purposes may justify a corporation's acquisition of
its own shares under Section 41 of the Corporation Code, 115 such
purposes cannot excuse the stockholder from the effects of taxation
arising from the redemption. If the issuance of stock dividends is part
of a tax evasion plan and thus, without legitimate business reasons, the
redemption becomes suspicious which exempting clause. The
substance of the whole transaction, not its form, usually controls the tax
consequences. 116
The two purposes invoked by ANSCOR, under the facts of this case
are no excuse for its tax liability. First, the alleged "filipinization" plan
cannot be considered legitimate as it was not implemented until the BIR
started making assessments on the proceeds of the redemption. Such
corporate plan was not stated in nor supported by any Board Resolution
but a mere afterthought interposed by the counsel of ANSCOR. Being
a separate entity, the corporation can act only through its Board of
Directors. 117 The Board Resolutions authorizing the redemptions state
only one purpose — reduction of foreign exchange remittances in case
cash dividends are declared. Not even this purpose can be given
credence. Records show that despite the existence of enormous
corporate profits no cash dividend was ever declared by ANSCOR from
1945 until the BIR started making assessments in the early 1970's.
Although a corporation under certain exceptions, has the prerogative
when to issue dividends, yet when no cash dividends was issued for
about three decades, this circumstance negates the legitimacy of
ANSCOR's alleged purposes. Moreover, to issue stock dividends is to
increase the shareholdings of ANSCOR's foreign stockholders contrary
to its "filipinization" plan. This would also increase rather than reduce
their need for foreign exchange remittances in case of cash dividend
declaration, considering that ANSCOR is a family corporation where
the majority shares at the time of redemptions were held by Don
Andres' foreign heirs.
Secondly, assuming arguendo, that those business purposes are
legitimate, the same cannot be a valid excuse for the imposition of tax.
Otherwise, the taxpayer's liability to pay income tax would be made to
depend upon a third person who did not earn the income being taxed.
Furthermore, even if the said purposes support the redemption and
justify the issuance of stock dividends, the same has no bearing
whatsoever on the imposition of the tax herein assessed because the
proceeds of the redemption are deemed taxable dividends since it was
shown that income was generated therefrom.
Thirdly, ANSCOR argued that to treat as "taxable dividend" the
proceeds of the redeemed stock dividends would be to impose on such
stock an undisclosed lien and would be extremely unfair to intervening
purchase, i.e. those who buys the stock dividends after their
issuance. 118 Such argument, however, bears no relevance in this case
as no intervening buyer is involved. And even if there is an intervening
buyer, it is necessary to look into the factual milieu of the case if income
was realized from the transaction. Again, we reiterate that the dividend
equivalence test depends on such "time and manner" of the transaction
and its net effect. The undisclosed lien 119 may be unfair to a
subsequent stock buyer who has no capital interest in the company.
But the unfairness may not be true to an original subscriber like Don
Andres, who holds stock dividends as gains from his investments. The
subsequent buyer who buys stock dividends is investing capital. It just
so happen that what he bought is stock dividends. The effect of its
(stock dividends) redemption from that subsequent buyer is merely to
return his capital subscription, which is income if redeemed from the
original subscriber.
After considering the manner and the circumstances by which the
issuance and redemption of stock dividends were made, there is no
other conclusion but that the proceeds thereof are essentially
considered equivalent to a distribution of taxable dividends. As "taxable
dividend" under Section 83(b), it is part of the "entire income" subject
to tax under Section 22 in relation to Section 21 120 of the 1939 Code.
Moreover, under Section 29(a) of said Code, dividends are included in
"gross income". As income, it is subject to income tax which is required
to be withheld at source. The 1997 Tax Code may have altered the
situation but it does not change this disposition.
EXCHANGE OF COMMON WITH PREFERRED SHARES 121
Exchange is an act of taking or giving one thing for another
involving 122 reciprocal transfer 123 and is generally considered as a
taxable transaction. The exchange of common stocks with preferred
stocks, or preferred for common or a combination of either for both, may
not produce a recognized gain or loss, so long as the provisions of In this case, the exchange of shares, without more, produces no
Section 83(b) is not applicable. This is true in a trade between two (2) realized income to the subscriber. There is only a modification of the
persons as well as a trade between a stockholder and a corporation. In subscriber's rights and privileges — which is not a flow of wealth for tax
general, this trade must be parts of merger, transfer to controlled purposes. The issue of taxable dividend may arise only once a
corporation, corporate acquisitions or corporate reorganizations. No subscriber disposes of his entire interest and not when there is still
taxable gain or loss may be recognized on exchange of property, stock maintenance of proprietary interest. 130
or securities related to reorganizations. 124
WHEREFORE, premises considered, the decision of the Court of
Both the Tax Court and the Court of Appeals found that ANSCOR Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5 stock
reclassified its shares into common and preferred, and that parts of the dividends is herein considered as essentially equivalent to a distribution
common shares of the Don Andres estate and all of Doña Carmen's of taxable dividends for which it is LIABLE for the withholding tax-at-
shares were exchanged for the whole 150.000 preferred shares. source. The decision is AFFIRMED in all other respects.
Thereafter, both the Don Andres estate and Doña Carmen remained
as corporate subscribers except that their subscriptions now include SO ORDERED.
preferred shares. There was no change in their proportional interest
after the exchange. There was no cash flow. Both stocks had the same
par value. Under the facts herein, any difference in their market value
would be immaterial at the time of exchange because no income is yet
realized — it was a mere corporate paper transaction. It would have
been different, if the exchange transaction resulted into a flow of wealth,
in which case income tax may be imposed. 125

Reclassification of shares does not always bring any substantial

alteration in the subscriber's proportional interest. But the exchange is
different — there would be a shifting of the balance of stock features,
like priority in dividend declarations or absence of voting rights. Yet
neither the reclassification nor exchange per se, yields realize income
for tax purposes. A common stock represents the residual ownership
interest in the corporation. It is a basic class of stock ordinarily and
usually issued without extraordinary rights or privileges and entitles the
shareholder to a pro rata division of profits. 126 Preferred stocks are
those which entitle the shareholder to some priority on dividends and
asset distribution. 127

Both shares are part of the corporation's capital stock. Both

stockholders are no different from ordinary investors who take on the
same investment risks. Preferred and common shareholders
participate in the same venture, willing to share in the profits and losses
of the enterprise. 128 Moreover, under the doctrine of equality of shares
— all stocks issued by the corporation are presumed equal with the
same privileges and liabilities, provided that the Articles of
Incorporation is silent on such differences. 129

Bañas Jr. v. Court of Appeals
[G.R. No. 102967. February 10, 2000]
FACTS
Petitioner entered into a deed of sale purportedly on installment. He
discounted the promissory note covering the future installments for
purposes of taxation.
ISSUE
Whether or not the promissory note should be declared cash
transaction for purposes of taxation.
RULING
YES. A negotiable instrument is deemed a substitute for money and for
value. According to Sec. 25 of NIL: “value is any consideration sufficient
to support a simple contract. An antecedent or pre-existing debt
constitutes value; and is deemed such whether the instrument is
payable on demand or at a future time”. Although the proceed of a
discounted promissory note is not considered part of the initial
payment, it is still taxable income for the year it was converted into
cash.
BIBIANO V. BAÑAS v. CA, GR No. 102967, 2000-02-10
Facts:
On February 20, 1976, petitioner, Bibiano V. Bañas Jr. sold to AYALA,
128,265 square meters of land located at Bayanan, Muntinlupa, for
P2,308,770.00
The Deed of
Sale provided that upon the signing of the contract AYALA shall pay
P461,754.00
The balance of
(P1,847,016.00... was to be paid in four equal... consecutive annual
installments, with
12%... interest per annum on the outstanding balance. AYALA issued
one promissory note covering four equal annual installments. Each
periodic payment of P461,754.00 pesos shall be payable starting on
February 20, 1977, and... every year thereafter, or until February 20,
1980
The same day, petitioner discounted the promissory note with AYALA,
for its face value of P1,847,016.00, evidenced by a Deed of Assignment
signed by the petitioner and AYALA. AYALA issued nine (9) checks to
petitioner, all dated February 20, 1976, drawn against Bank of the
Philippine Islands with the uniform amount of
P205,224.00
In his 1976 Income Tax Return, petitioner reported the P461,754 initial
payment as income from disposition of capital asset.
In the succeeding years, until 1979, petitioner reported a uniform
income of
P230,877.00... as gain from sale of capital asset. In his 1980 income
tax amnesty return, petitioner also reported... the same amount of
P230,877.00 as the realized gain on disposition of capital asset for the
year.
On April 11, 1978, then Revenue Director Mauro Calaguio authorized
tax examiners, Rodolfo Tuazon and Procopio Talon to examine the
books and records of petitioner for the year 1976. They discovered that
petitioner had no outstanding receivable from the 1976 land sale to
AYALA... and concluded that the sale was cash and the entire profit
should have been taxable in 1976 since the income was wholly derived
in 1976.
Tuazon and Talon filed their audit report and declared a discrepancy of
P2,095,915.00... in petitioner's 1976 net income. They recommended
deficiency tax assessment for P2,473,673.00
Meantime, Aquilino Larin succeeded Calaguio as Regional Director of
Manila Region IV-A. After reviewing the examiners' report, Larin
directed the revision of the audit report, with instruction to consider the
land as capital asset. The tax due was only
50%... of the... total gain from sale of the property held by the taxpayer
beyond twelve months pursuant to Section 34[5] of the 1977
NIRC
The deficiency tax assessment was reduced to
P936,598.50, inclusive of surcharges and penalties for the year 1976.
On June 27, 1980, respondent Larin sent a letter to petitioner informing
him of the income tax deficiency that must be settled immediately.
On September 26, 1980, petitioner acknowledged receipt of the letter
but insisted that the sale of his land to AYALA was on installment.
On June 8, 1981, the matter was endorsed to the Acting Chief of the
Legal Branch of the National Office of the BIR. The Chief of the Tax
Fraud Unit recommended the prosecution of a criminal case for
conspiring to file false and fraudulent returns, in violation of Section 51
of... the Tax Code against petitioner and his accountants, Andres P.
Alejandre and Conrado Bañas.
On June 17, 1981, Larin filed a criminal complaint for tax evasion
against the petitioner.
On July 2, 1981, petitioner filed an Amnesty Tax Return under P. D.
1740 and paid the amount of
P41,729.81
On November 2, 1981, petitioner again filed an Amnesty Tax Return
under P.D. 1840 and paid an... additional amount of P1,525.62
In both, petitioner did not recognize that his sale of land to AYALA was
on cash basis.
Reacting to the complaint for tax evasion and the news reports,
petitioner filed with the RTC... an action[6] for damages against
respondents Larin, Tuazon and Talon for extortion and malicious
publication of the BIR's tax audit report. He claimed... that the filing of
criminal complaints against him for violation of tax laws were improper
because he had already availed of two tax amnesty decrees,
Presidential Decree Nos. 1740 and 1840.
The trial court decided in favor of the respondents and awarded Larin
damages, as already stated. Petitioner seasonably appealed to the
Court of Appeals. In its decision of November 29, 1991, the respondent
court affirmed the trial court's decision
Issues:
Whether respondent court erred in finding that petitioner's income from
the sale of land in 1976 should be declared as a cash transaction in his
tax return for the same year
Ruling:
As a general rule, the whole profit accruing from a sale of property is
taxable as income in the year the sale is made. But, if not all of the sale
price is received during such year, and a statute provides that income
shall be taxable in the year in which it is "received," the... profit from an
installment sale is to be apportioned between or among the years in
which such installments are paid and received.
Section 43 and Sec. 175 says that among the entities who may use the
above-mentioned installment method is a seller of real property who
disposes his property on installment, provided that the initial payment
does not exceed 25% of the selling price. They also state what may
be... regarded as installment payment and what constitutes initial
payment. Initial payment means the payment received in cash or
property excluding evidences of indebtedness due and payable in
subsequent years, like promissory notes or mortgages, given of the
purchaser during the... taxable year of sale. Initial payment does not
include amounts received by the vendor in the year of sale from the
disposition to a third person of notes given by the vendee as part of the
purchase price which are due and payable in subsequent years.[14]
Such disposition or discounting of receivable is material only as to the
computation of the initial payment. If the initial payment is within 25%
of total contract price, exclusive of the proceeds of discounted notes,
the sale qualifies as an installment sale,... otherwise it is a deferred
sale.

Although the proceed of a discounted promissory note is not

considered part of the initial payment, it is still taxable income for the
year it was converted into cash. The subsequent payments or
liquidation of certificates of indebtedness is reported using the
installment method... in computing the proportionate income[16] to be
returned, during the respective year it was realized. Non-dealer sales
of real or personal property may be reported as income under the
installment method provided that the obligation is still outstanding at...
the close of that year. If the seller disposes the entire installment
obligation by discounting the bill or the promissory note, he necessarily
must report the balance of the income from the discounting not only
income from the initial installment payment.

Where an installment obligation is discounted at a bank or finance

company, a taxable disposition results, even if the seller guarantees its
payment, continues to collect on the installment obligation, or handles
repossession of merchandise in case of default.

Although the proceeds of a discounted promissory note is not

considered... initial payment, still it must be included as taxable income
on the year it was converted to cash. When petitioner had the
promissory notes covering the succeeding installment payments of the
land issued by AYALA, discounted by AYALA itself, on the same day
of the sale, he lost... entitlement to report the sale as a sale on
installment since, a taxable disposition resulted and petitioner was
required by law to report in his returns the income derived from the
discounting. What petitioner did is tantamount to an attempt to
circumvent the rule on payment of... income taxes gained from the sale
of the land to AYALA for the year 1976.
 G.R. No. 102967 February 10, 2000 Philippine Islands with the uniform amount of two hundred five
thousand, two hundred twenty-four (P205,224.00) pesos.
BIBIANO V. BAÑAS, JR., petitioner,
vs. In his 1976 Income Tax Return, petitioner reported the P461,754 initial
COURT OF APPEALS, AQUILINO T. LARIN, RODOLFO TUAZON payment as income from disposition of capital asset.2
AND PROCOPIO TALON, respondents.
Selling Price of Land P2,308,770.00
QUISUMBING, J.:
3
For review is the Decision of the Court of Appeals in CA-C.R. CV No. Less Initial Payment 461,754.00
17251 promulgated on November 29, 1991. It affirmed in toto the
judgment of the Regional Trial Court (RTC), Branch 39, Manila, in Civil
Case No. 82-12107. Said judgment disposed as follows:
Unrealized Gain P1,847,016.00
FOR ALL THE FOREGOING CONSIDERATIONS, this Court hereby
renders judgment DISMISSING the complaint against all the
defendants and ordering plaintiff [herein petitioner] to pay defendant
Larin the amount of P200,000.00 (Two Hundred Thousand Pesos) as
actual and compensatory damages; P200,000.00 as moral damages; 1976 Declaration of Income on Disposition of Capital Asset
and P50,000.00 as exemplary damages and attorneys fees of subject to Tax:
P100,000.00.1
Initial Payment P461,754.00
The facts, which we find supported by the records, have been
summarized by the Court of Appeals as follows:
Less: Cost of land and other incidental
On February 20, 1976, petitioner, Bibiano V. Bañas Jr. sold to Ayala ( 76,547.90)
Expenses
Investment Corporation (AYALA), 128,265 square meters of land
located at Bayanan, Muntinlupa, for two million, three hundred eight
thousand, seven hundred seventy (P2,308,770.00) pesos. The Deed of
Sale provided that upon the signing of the contract AYALA shall pay
four hundred sixty-one thousand, seven hundred fifty-four Income P385,206.10
(P461,754.00) pesos. The balance of one million, eight hundred forty-
seven thousand and sixteen (P1,847,016.00) pesos was to be paid in
four equal consecutive annual installments, with twelve (12%) percent
interest per annum on the outstanding balance. AYALA issued one Income subject to tax (P385,206. 10 x
P192,603.65
promissory note covering four equal annual installments. Each periodic 50%)
payment of P461,754.00 pesos shall be payable starting on February
20, 1977, and every year thereafter, or until February 20, 1980.
In the succeeding years, until 1979, petitioner reported a uniform
The same day, petitioner discounted the promissory note with AYALA, income of two hundred thirty thousand, eight hundred seventy-seven
for its face value of P1,847,016.00, evidenced by a Deed of Assignment (P230,877.00) pesos4 as gain from sale of capital asset. In his 1980
signed by the petitioner and AYALA. AYALA issued nine (9) checks to income tax amnesty return, petitioner also reported the same amount
petitioner, all dated February 20, 1976, drawn against Bank of the
of P230,877.00 as the realized gain on disposition of capital asset for
the year.
On April 11, 1978, then Revenue Director Mauro Calaguio authorized
tax examiners, Rodolfo Tuazon and Procopio Talon to examine the
books and records of petitioner for the year 1976. They discovered that
petitioner had no outstanding receivable from the 1976 land sale to
AYALA and concluded that the sale was cash and the entire profit
should have been taxable in 1976 since the income was wholly derived
in 1976.
Tuazon and Talon filed their audit report and declared a discrepancy of
two million, ninety-five thousand, nine hundred fifteen (P2,095,915.00)
pesos in petitioner's 1976 net income. They recommended deficiency
tax assessment for two million, four hundred seventy-three thousand,
six hundred seventy-three (P2,473,673.00) pesos.
Meantime, Aquilino Larin succeeded Calaguio as Regional Director of
Manila Region IV-A. After reviewing the examiners' report, Larin
directed the revision of the audit report, with instruction to consider the
land as capital asset. The tax due was only fifty (50%) percent of the
total gain from sale of the property held by the taxpayer beyond twelve
months pursuant to Section 345 of the 1977 National Internal Revenue
Code (NIRC). The deficiency tax assessment was reduced to nine
hundred thirty six thousand, five hundred ninety-eight pesos and fifty
centavos (P936,598.50), inclusive of surcharges and penalties for the
year 1976.
On June 27, 1980, respondent Larin sent a letter to petitioner informing
of the income tax deficiency that must be settled him immediately.
On September 26, 1980, petitioner acknowledged receipt of the letter
but insisted that the sale of his land to AYALA was on installment.
On June 8, 1981, the matter was endorsed to the Acting Chief of the
Legal Branch of the National Office of the BIR. The Chief of the Tax
Fraud Unit recommended the prosecution of a criminal case for
conspiring to file false and fraudulent returns, in violation of Section 51
of the Tax Code against petitioner and his accountants, Andres P.
Alejandre and Conrado Bañas.
On June 17, 1981, Larin filed a criminal complaint for tax evasion
against the petitioner.
On July 1, 1981, news items appeared in the now defunct Evening
Express with the headline: "BIR Charges Realtor" and another in the
defunct Evening Post with a news item: "BIR raps Realtor, 2
accountants." Another news item also appeared in the July 2, 1981,
issue of the Bulletin Today entitled: "3-face P1-M tax evasion raps." All
news items mentioned petitioner's false income tax return concerning
the sale of land to AYALA.
On July 2, 1981, petitioner filed an Amnesty Tax Return under P.D.
1740 and paid the amount of forty-one thousand, seven hundred
twenty-nine pesos and eighty-one centavos (P41,729.81). On
November 2, 1981, petitioner again filed an Amnesty Tax Return under
P.D. 1840 and paid an additional amount of one thousand, five hundred
twenty-five pesos and sixty-two centavos (P1,525.62). In both,
petitioner did not recognize that his sale of land to AYALA was on cash
basis.
Reacting to the complaint for tax evasion and the news reports,
petitioner filed with the RTC of Manila an action6 for damages against
respondents Larin, Tuazon and Talon for extortion and malicious
publication of the BIR's tax audit report. He claimed that the filing of
criminal complaints against him for violation of tax laws were improper
because he had already availed of two tax amnesty decrees,
Presidential Decree Nos. 1740 and 1840.
The trial court decided in favor of the respondents and awarded Larin
damages, as already stated. Petitioner seasonably appealed to the
Court of Appeals. In its decision of November 29, 1991, the respondent
court affirmed the trial court's decision, thus:
The finding of the court a quo that plaintiff-appellant's actions against
defendant-appellee Larin were unwarranted and baseless and as a
result thereof, defendant-appellee Larin was subjected to unnecessary
anxiety and humiliation is therefore supported by the evidence on
record.1âwphi1.nêt
Defendant-appellee Larin acted only in pursuance of the authority
granted to him. In fact, the criminal charges filed against him in the
Tanodbayan and in the City Fiscal's Office were all dismissed.
WHEREFORE, the appealed judgment is hereby AFFIRMED in toto.7
Hence this petition, wherein petitioner raises before us the following
queries:
I. WHETHER THE COURT OF APPEALS ERRED IN ITS
INTERPRETATION OF PERTINENT TAX LAWS, THUS IT FAILED TO
APPRECIATE THE CORRECTNESS AND ACCURACY OF
PETITIONER'S RETURN OF THE INCOME DERIVED FROM THE
SALE OF THE LAND TO AYALA.
II. WHETHER THE RESPONDENT COURT ERRED IN NOT FINDING
THAT THERE WAS AN ALLEGED ATTEMPT TO EXTORT [MONEY
FROM] PETITIONER BY PRIVATE RESPONDENTS.
III. WHETHER THE RESPONDENT COURT ERRED IN ITS
INTERPRETATION OF PRESIDENTIAL DECREE NOS. 1740 AND
1840, AMONG OTHERS, PETITIONER'S IMMUNITY FROM
CRIMINAL PROSECUTION.
IV. WHETHER THE RESPONDENT COURT ERRED IN ITS
INTERPRETATION OF WELL-ESTABLISHED DOCTRINES OF THIS
HONORABLE COURT AS REGARDS THE AWARD OF ACTUAL,
MORAL AND EXEMPLARY DAMAGES IN FAVOR OF RESPONDENT
LARIN.
In essence, petitioner asks the Court to resolve seriatim the following
issues:
1. Whether respondent court erred in ruling that there was no extortion
attempt by BIR officials;
2. Whether respondent court erred in holding that P.D. 1740 and 1840
granting tax amnesties did not grant immunity from tax suits;
3. Whether respondent court erred in finding that petitioner's income
from the sale of land in 1976 should be declared as a cash transaction
in his tax return for the same year (because the buyer discounted the
promissory note issued to the seller on future installment payments of
the sale, on the same day of the sale);
4. Whether respondent court erred and committed grave abuse of
discretion in awarding damages to respondent Larin.
The first issue, on whether the Court of Appeals erred in finding that
there was no extortion, involves a determination of fact. The Court of
Appeals observed,
The only evidence to establish the alleged extortion attempt by
defendants-appellees is the plaintiff-appellant's self serving
declarations.
As found by the court a quo, "said attempt was known to plaintiff-
appellant's son-in-law and counsel on record, yet, said counsel did not
take the witness stand to corroborate the testimony of plaintiff."8
As repeatedly held, findings of fact by the Court of Appeals especially
if they affirm factual findings of the trial court will not be disturbed by
this Court, unless these findings are not supported by
evidence.9 Similarly, neither should we disturb a finding of the trial court
and appellate court that an allegation is not supported by evidence on
record. Thus, we agree with the conclusion of respondent court that
herein private respondents, on the basis of evidence, could not be held
liable for extortion.
On the second issue of whether P.D. Nos. 1740 and 1840 which
granted tax amnesties also granted immunity from criminal prosecution
against tax offenses, the pertinent sections of these laws state:
P.D. No. 1740. CONDONING PENALTIES FOR CERTAIN
VIOLATIONS OF THE INCOME TAX LAW UPON VOLUNTARY
DISCLOSURE OF UNDECLARED INCOME FOR INCOME TAX
PURPOSES AND REQUIRING PERIODIC SUBMISSION OF NET
WORTH STATEMENT.
xxx xxx xxx
Sec. 1. Voluntary Disclosure of Correct Taxable Income. — Any
individual who, for any or all of the taxable years 1974 to 1979, had
failed to file a return is hereby, allowed to file a return for each of the
aforesaid taxable years and accurately declare therein the true and
correct income, deductions and exemptions and pay the income tax
due per return. Likewise, any individual who filed a false or fraudulent
return for any taxable year in the period mentioned above may amend
his return and pay the correct amount of tax due after deducting the
taxes already paid, if any, in the original declaration. (emphasis ours)
xxx xxx xxx
Sec. 5. Immunity from Penalties. — Any individual who voluntarily files
a return under this Decree and pays the income tax due thereon shall
be immune from the penalties, civil or criminal, under the National
Internal Revenue Code arising from failure to pay the correct income
tax with respect to the taxable years from which an amended return
was filed or for which an original return was filed in cases where no
return has been filed for any of the taxable years 1974 to
1979: Provided, however, That these immunities shall not apply in
cases where the amount of net taxable income declared under this
Decree is understated to the extent of 25% or more of the correct net
taxable income. (emphasis ours)
P.D. NO. 1840 — GRANTING A TAX AMNESTY ON UNTAXED
INCOME AND/OR WEALTH EARNED OR ACQUIRED DURING THE
TAXABLE YEARS 1974 TO 1980 AND REQUIRING THE FILING OF
THE STATEMENT OF ASSETS, LIABILITIES, AND NET WORTH.
Sec. 1. Coverage. — In case of voluntary disclosure of previously
untaxed income and/or wealth such as earnings, receipts, gifts,
bequests or any other acquisition from any source whatsoever, realized
here or abroad, by any individual taxpayer, which are taxable under the
National Internal Revenue Code, as amended, the assessment and
collection of all internal revenue taxes, including the increments or
penalties on account of non-payment, as well as all civil, criminal or
administrative liabilities arising from or incident thereto under the
National Internal Revenue Code, are hereby condoned provided that
the individual taxpayer shall pay. (emphasis ours) . . .
Sec. 2. Conditions for Immunity. — The immunity granted under
Section one of this Decree shall apply only under the following
conditions:
a) Such previously untaxed income and/or wealth must have been
earned or realized in any of the years 1974 to 1980;
b) The taxpayer must file an amnesty return on or before November 30,
1981, and fully pay the tax due thereon;
c) The amnesty tax paid by the taxpayer under this Decree shall not be
less than P1,000.00 per taxable year; and
d) The taxpayer must file a statement of assets, liabilities and net worth
as of December 31, 1980, as required under Section 6 hereof.
(emphasis ours)
It will be recalled that petitioner entered into a deed of sale purportedly
on installment. On the same day, he discounted the promissory note
covering the future installments. The discounting seems questionable
because ordinarily, when a bill is discounted, the lender (e.g. banks,
financial institution) charges or deducts a certain percentage from the
principal value as its compensation. Here, the discounting was done by
the buyer. On July 2, 1981, two weeks after the filing of the tax evasion
complaint against him by respondent Larin on June 17, 1981, petitioner
availed of the tax amnesty under P.D. No. 1740. His amended tax
return for the years 1974 - 1979 was filed with the BIR office of
Valenzuela, Bulacan, instead of Manila where the petitioner's principal
office was located. He again availed of the tax amnesty under P.D. No.
1840. His disclosure, however, did not include the income from his sale
of land to AYALA on cash basis. Instead he insisted that such sale was
on installment. He did not amend his income tax return. He did not pay
the tax which was considerably increased by the income derived from
the discounting. He did not meet the twin requirements of P.D. 1740
and 1840, declaration of his untaxed income and full payment of tax
due thereon. Clearly, the petitioner is not entitled to the benefits of P.D.
Nos. 1740 and 1840. The mere filing of tax amnesty return under P.D.
1740 and 1840 does not ipso facto shield him from immunity against
prosecution. Tax amnesty is a general pardon to taxpayers who want
to start a clean tax slate. It also gives the government a chance to
collect uncollected tax from tax evaders without having to go through
the tedious process of a tax case. To avail of a tax amnesty granted by
the government, and to be immune from suit on its delinquencies, the
tax payer must have voluntarily disclosed his previously untaxed
income and must have paid the corresponding tax on such previously
untaxed income.10
It also bears noting that a tax amnesty, much like a tax exemption, is
never favored nor presumed in law and if granted by statute, the terms
of the amnesty like that of a tax exemption must be construed strictly
against the taxpayer and liberally in favor of the taxing
authority.11 Hence, on this matter, it is our view that petitioner's claim of
immunity from prosecution under the shield of availing tax amnesty is
untenable.
On the third issue, petitioner asserts that his sale of the land to AYALA
was not on cash basis but on installment as clearly specified in the
Deed of Sale which states:
That for and in consideration of the sum of TWO MILLION THREE
HUNDRED EIGHT THOUSAND SEVEN HUNDRED SEVENTY
(P2,308,770.00) PESOS Philippine Currency, to be paid as follows:
1. P461,754.00, upon the signing of the Deed of Sale; and,
2. The balance of P1,847,016.00, to be paid in four (4) equal,
consecutive, annual installments with interest thereon at the rate of
twelve percent (12%) per annum, beginning on February 20, 1976, said
installments to be evidenced by four (4) negotiable promissory notes.12
Petitioner resorts to Section 43 of the NIRC and Sec. 175 of Revenue
Regulation No. 2 to support his claim.
Sec. 43 of the 1977 NIRC states,
Installment basis. — (a) Dealers in personal property. — . . .
(b) Sales of realty and casual sales of personalty — In the case (1) of
a casual sale or other casual disposition of personal property (other
than 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), for
a price exceeding one thousand pesos, or (2) of a sale or other
disposition of real property if in either case the initial payments do not
exceed twenty-five percentum of the selling price, the income may,
under regulations prescribed by the Minister of Finance, be returned on
the basis and in the manner above prescribed in this section. As used
in this section the term "initial payment" means the payments received
in cash or property other than evidences of indebtedness of the
purchaser during the taxable period in which the sale or other
disposition is made. . . . (emphasis ours)
Revenue Regulation No. 2, Section 175 provides,
Sale of real property involving deferred payments. — Under section 43
deferred-payment sales of real property include (1) agreements of
purchase and sale which contemplate that a conveyance is not to be
made at the outset, but only after all or a substantial portion of the
selling price has been paid, and (b) sales in which there is an immediate
transfer of title, the vendor being protected by a mortgage or other lien
as to deferred payments. Such sales either under (a) or (b), fall into two
classes when considered with respect to the terms of sale, as follows:
(1) Sales of property on the installment plan, that is, sales in which the
payments received in cash or property other than evidences of
indebtedness of the purchaser during the taxable year in which the sale
is made do not exceed 25 per cent of the selling price;
(2) Deferred-payment sales not on the installment plan, that is sales in
which the payments received in cash or property other than evidences
of indebtedness of the purchaser during the taxable year in which the
sale is made exceed 25 per cent of the selling price;
In the sale of mortgaged property the amount of the mortgage, whether
the property is merely taken subject to the mortgage or whether the
mortgage is assumed by the purchaser, shall be included as a part of
the "selling price" but the amount of the mortgage, to the extent it does
not exceed the basis to the vendor of the property sold, shall not be
considered as a part of the "initial payments" or of the "total contract
price," as those terms are used in section 43 of the Code, in sections
174 and 176 of these regulations, and in this section. The term "initial
payments" does not include amounts received by the vendor in the year
of sale from the disposition to a third person of notes given by the
vendee as part of the purchase price which are due and payable in
subsequent years. Commissions and other selling expenses paid or
incurred by the vendor are not to be deducted or taken into account in
determining the amount of the "initial payments," the "total contract
price," or the "selling price." The term "initial payments" contemplates
at least one other payment in addition to the initial payment. If the entire
purchase price is to be paid in a lump sum in a later year, there being
no payment during the year, the income may not be returned on the
installment basis. Income may not be returned on the installment basis
where no payment in cash or property, other than evidences of
indebtedness of the purchaser, is received during the first year, the
purchaser having promised to make two or more payments, in later
years.
Petitioner asserts that Sec. 43 allows him to return as income in the
taxable years involved, the respective installments as provided by the
deed of sale between him and AYALA. Consequently, he religiously
reported his yearly income from sale of capital asset, subject to tax, as
follows:
Year 1977 (50% of P461,754) P230,877.00
1978 230,877.00
1979 230,877.00
1980 230,877.00
Petitioner says that his tax declarations are acceptable modes of
payment under Section 175 of the Revenue Regulations (RR) No. 2.
The term "initial payment", he argues, does not include amounts
received by the vendor which are part of the complete purchase price,
still due and payable in subsequent years. Thus, the proceeds of the
promissory notes, not yet due which he discounted to AYALA should
not be included as income realized in 1976. Petitioner states that the
original agreement in the Deed of Sale should not be affected by the
subsequent discounting of the bill.
On the other hand, respondents assert that taxation is a matter of
substance and not of form. Returns are scrutinized to determine if
transactions are what they are and not declared to evade taxes.
Considering the progressive nature of our income taxation, when
income is spread over several installment payments through the years,
the taxable income goes down and the tax due correspondingly
decreases. When payment is in lump sum the tax for the year
proportionately increases. Ultimately, a declaration that a sale is on
installment diminishes government taxes for the year of initial
installment as against a declaration of cash sale where taxes to the
government is larger.
As a general rule, the whole profit accruing from a sale of property is
taxable as income in the year the sale is made. But, if not all of the sale
price is received during such year, and a statute provides that income
shall be taxable in the year in which it is "received," the profit from an
installment sale is to be apportioned between or among the years in
which such installments are paid and received.13
Sec. 43 and Sec. 175 says that among the entities who may use the
above-mentioned installment method is a seller of real property who
disposes his property on installment, provided that the initial payment
does not exceed 25% of the selling price. They also state what may be
regarded as installment payment and what constitutes initial payment.
Initial payment means the payment received in cash or property
excluding evidences of indebtedness due and payable in subsequent
years, like promissory notes or mortgages, given of the purchaser
during the taxable year of sale. Initial payment does not include
amounts received by the vendor in the year of sale from the disposition
to a third person of notes given by the vendee as part of the purchase
price which are due and payable in subsequent years.14 Such
disposition or discounting of receivable is material only as to the
computation of the initial payment. If the initial payment is within 25%
of total contract price, exclusive of the proceeds of discounted notes,
the sale qualifies as an installment sale, otherwise it is a deferred sale.15
Although the proceed of a discounted promissory note is not
considered part of the initial payment, it is still taxable income for the
year it was converted into cash. The subsequent payments or
liquidation of certificates of indebtedness is reported using the
installment method in computing the proportionate income16 to be
returned, during the respective year it was realized. Non-dealer sales
of real or personal property may be reported as income under the
installment method provided that the obligation is still outstanding at the
close of that year. If the seller disposes the entire installment obligation
by discounting the bill or the promissory note, he necessarily must
report the balance of the income from the discounting not only income
from the initial installment payment.
Where an installment obligation is discounted at a bank or finance
company, a taxable disposition results, even if the seller guarantees its
payment, continues to collect on the installment obligation, or handles
repossession of merchandise in case of default.17 This rule prevails in
the United States.18 Since our income tax laws are of American
origin,19 interpretations by American courts an our parallel tax laws
have persuasive effect on the interpretation of these laws.20 Thus, by
analogy, all the more would a taxable disposition result when the
discounting of the promissory note is done by the seller himself. Clearly,
the indebtedness of the buyer is discharged, while the seller acquires
money for the settlement of his receivables. Logically then, the income
should be reported at the time of the actual gain. For income tax
purposes, income is an actual gain or an actual increase of
wealth.21 Although the proceeds of a discounted promissory note is not
considered initial payment, still it must be included as taxable income
on the year it was converted to cash. When petitioner had the
promissory notes covering the succeeding installment payments of the
land issued by AYALA, discounted by AYALA itself, on the same day
of the sale, he lost entitlement to report the sale as a sale on installment
since, a taxable disposition resulted and petitioner was required by law
to report in his returns the income derived from the discounting. What
petitioner did is tantamount to an attempt to circumvent the rule on
payment of income taxes gained from the sale of the land to AYALA for
the year 1976.
Lastly, petitioner questions the damages awarded to respondent Larin.
Any person who seeks to be awarded actual or compensatory damages
due to acts of another has the burden of proving said damages as well
as the amount thereof.22 Larin says the extortion cases filed against him
hampered his immediate promotion, caused him strong anxiety and
social humiliation. The trial court awarded him two hundred thousand
(P200,000,00) pesos as actual damages. However, the appellate court
stated that, despite pendency of this case, Larin was given a promotion
at the BIR. Said respondent court:
We find nothing on record, aside from defendant-appellee Larin's
statements (TSN, pp. 6-7, 11 December 1985), to show that he suffered
loss of seniority that allegedly barred his promotion. In fact, he was
promoted to his present position despite the pendency of the instant
case (TSN, pp. 35-39, 04 November 1985).23
Moreover, the records of the case contain no statement whatsoever of
the amount of the actual damages sustained by the respondents.
Actual damages cannot be allowed unless supported by evidence on
the record.24 The court cannot rely on speculation, conjectures or
guesswork as to the fact and amount of damages.25 To justify a grant
of actual or compensatory damages, it is necessary to prove with a
reasonable degree of certainty, the actual amount of loss.26 Since we
have no basis with which to assess, with certainty, the actual or
compensatory damages counter-claimed by respondent Larin, the
award of such damages should be deleted.
Moral damages may be recovered in cases involving acts referred to in
Article 2127 of the Civil Code.28 As a rule, a public official may not
recover damages for charges of falsehood related to his official conduct
unless he proves that the statement was made with actual malice.
In Babst, et. al. vs. National Intelligence Board, et. al., 132 SCRA 316,
330 (1984), we reiterated the test for actual malice as set forth in the
landmark American case of New York Times vs. Sullivan,29 which we
have long adopted, in defamation and libel cases, viz.:
. . . with knowledge that it was false or with reckless disregard of
whether it was false or not.
We appreciate petitioner's claim that he filed his 1976 return in good
faith and that he had honestly believed that the law allowed him to
declare the sale of the land, in installment. We can further grant that
the pertinent tax laws needed construction, as we have earlier done.
That petitioner was offended by the headlines alluding to him as tax
evader is also fully understandable. All these, however, do not justify
what amounted to a baseless prosecution of respondent Larin.
Petitioner presented no evidence to prove Larin extorted money from
him. He even admitted that he never met nor talked to respondent Larin.
When the tax investigation against the petitioner started, Larin was not
yet the Regional Director of BIR Region IV-A, Manila. On respondent
Larin's instruction, petitioner's tax assessment was considered one
involving a sale of capital asset, the income from which was subjected
to only fifty percent (50%) assessment, thus reducing the original tax
assessment by half. These circumstances may be taken to show that
Larin's involvement in extortion was not indubitable. Yet, petitioner went
on to file the extortion cases against Larin in different fora. This is where
actual malice could attach on petitioner's part. Significantly, the trial
court did not err in dismissing petitioner's complaints, a ruling affirmed
by the Court of Appeals.
Keeping all these in mind, we are constrained to agree that there is
sufficient basis for the award of moral and exemplary damages in favor
of respondent Larin. The appellate court believed respondent Larin
when he said he suffered anxiety and humiliation because of the
unfounded charges against him. Petitioner's actions against Larin were
found "unwarranted and baseless," and the criminal charges filed
against him in the Tanodbayan and City Fiscal's Office were all
dismissed.30 Hence, there is adequate support for respondent court's
conclusion that moral damages have been proved.
Now, however, what would be a fair amount to be paid as compensation
for moral damages also requires determination. Each case must be
governed by its own peculiar circumstances.31 On this score, Del
Rosario vs. Court of Appeals,32 cites several cases where no actual
damages were adjudicated, and where moral and exemplary damages
were reduced for being "too excessive," thus:
In the case of PNB v. C.A., [256 SCRA 309 (1996)], this Court quoted
with approval the following observation from RCPI v. Rodriguez, viz:
** **. Nevertheless, we find the award of P100,000.00 as moral
damages in favor of respondent Rodriguez excessive and
unconscionable. In the case of Prudenciado v. Alliance Transport
System, Inc. (148 SCRA 440 [1987]) we said: . . . [I]t is undisputed that
the trial courts are given discretion to determine the amount of moral
damages (Alcantara v. Surro, 93 Phil. 472) and that the Court of
Appeals can only modify or change the amount awarded when they are
palpably and scandalously excessive "so as to indicate that it was the
result of passion, prejudice or corruption on the part of the trial court"
(Gellada v. Warner Barnes & Co., Inc., 57 O.G. [4] 7347, 7358; Sadie
v. Bacharach Motors Co., Inc., 57 O.G. [4] 636 and Adone v. Bacharach
Motor Co., Inc., 57 O.G. 656). But in more recent cases where the
awards of moral and exemplary damages are far too excessive
compared to the actual loses sustained by the aggrieved party, this
Court ruled that they should be reduced to more reasonable amounts.
. . . . (Emphasis ours.)
In other words, the moral damages awarded must be commensurate
with the loss or injury suffered.
government officials. Thus, conformably with our declaration that moral
damages are not intended to enrich anyone,33 we hereby reduce the
moral damages award in this case from two hundred thousand
(P200,000.00) pesos to seventy five thousand (P75,000.00) pesos,
while the exemplary damage is set at P25,000.00 only.
The law allows the award of attorney's fees when exemplary damages
are awarded, and when the party to a suit was compelled to incur
expenses to protect his interest.34 Though government officers are
usually represented by the Solicitor General in cases connected with
the performance of official functions, considering the nature of the
charges, herein respondent Larin was compelled to hire a private
lawyer for the conduct of his defense as well as the successful pursuit
of his counterclaims. In our view, given the circumstances of this case,
there is ample ground to award in his favor P50,000,00 as reasonable
attorney's fees.
WHEREFORE, the assailed decision of the Court of Appeals dated
November 29, 1991, is hereby AFFIRMED with MODIFICATION so that
the award of actual damages are deleted; and that petitioner is hereby
ORDERED to pay to respondent Larin moral damages in the amount
of P75,000.00, exemplary damages in the amount of P25,000.00, and
attorney's fees in the amount of P50,000.00 only.1âwphi1.nêt
No pronouncement as to costs.
SO ORDERED.

In the same case (PNB v. CA), this Court found the amount of
exemplary damages required to be paid (P1,000,000,00) "too
excessive" and reduced it to an "equitable level" (P25,000.00).

It will be noted that in above cases, the parties who were awarded moral
damages were not public officials. Considering that here, the award is
in favor of a government official in connection with his official function,
it is with caution that we affirm granting moral damages, for it might
open the floodgates for government officials counter-claiming damages
in suits filed against them in connection with their functions. Moreover,
we must be careful lest the amounts awarded make citizens hesitate to
expose corruption in the government, for fear of lawsuits from vindictive
 SECOND DIVISION its corporate income tax return. As a consequence, respondent did not
pay income tax for 1995.
G.R. No. 148512 June 26, 2006
Subsequently, on December 27, 1996, claiming that according to Sec.
COMMISSIONER OF INTERNAL REVENUE, Petitioner, 4(a) of R.A. No. 7432, the amount of P219,778 should be applied as a
vs. tax credit, respondent filed a claim for refund in the amount
CENTRAL LUZON DRUG CORPORATION, Respondent. of P150,193, thus:

DECISION
Net Sales P 37,014,807.00
AZCUNA, J.:
Add: Cost of 20% Discount to Senior 219,778.00
This is a petition for review under Rule 45 of the Rules of Court seeking Citizens
the nullification of the Decision, dated May 31, 2001, of the Court of
Appeals (CA) in CA-G.R. SP No. 60057, entitled "Central Luzon Drug
Corporation v. Commissioner of Internal Revenue," granting herein
respondent Central Luzon Drug Corporation’s claim for tax credit equal Gross Sales P 37,234,585.00
to the amount of the 20% discount that it extended to senior citizens on
the latter’s purchase of medicines pursuant to Section 4(a) of Republic
Less: Cost of Sales
Act (R.A.) No. 7432, entitled "An Act to Maximize the Contribution of
Senior Citizens to Nation Building, Grant Benefits and Special
Privileges and for other Purposes" otherwise known as the Senior Merchandise
Citizens Act. P 1,232,740.00
Inventory, beg

The antecedents are as follows:

Purchases 41,145,138.00
Central Luzon Drug Corporation has been a retailer of medicines and
other pharmaceutical products since December 19, 1994. In 1995, it
opened three (3) drugstores as a franchisee under the business name 8,521,557.00 33,856,621.00
Merchandise
and style of "Mercury Drug." Inventory, end

For the period January 1995 to December 1995, in conformity to the

mandate of Sec. 4(a) of R.A. No. 7432, petitioner granted a 20% Gross Profit P 3,377,964.00
discount on the sale of medicines to qualified senior citizens amounting
to P219,778.
Miscellaneous Income 39,014.00
Pursuant to Revenue Regulations No. 2-941 implementing R.A. No.
7432, which states that the discount given to senior citizens shall be
deducted by the establishment from its gross sales for value-added tax
and other percentage tax purposes, respondent deducted the total
Total Income 3,416,978.00
amount of P219,778 from its gross income for the taxable year 1995.
For said taxable period, respondent reported a net loss of P20,963 in
 Thus, respondent filed with the CA a Petition for Review on August 3,
Operating Expenses 3,199,230.00 2000.

On May 31, 2001, the CA rendered a Decision stating that Section 229
of the Tax Code does not apply in this case. It concluded that the 20%
discount given to senior citizens which is treated as a tax credit
Net Income Before Tax P 217,748.00 pursuant to Sec. 4(a) of R.A. No. 7432 is considered just compensation
and, as such, may be carried over to the next taxable period if there is
no current tax liability. In view of this, the CA held:
Income Tax (35%) 69,585.00
WHEREFORE, the instant petition is hereby GRANTED and the
Less: Tax Credit decision of the CTA dated 24 April 2000 and its resolution dated 06 July
2000 are SET ASIDE. A new one is entered granting petitioner’s claim
for tax credit in the amount of Php: 150,193.00. No costs.
(Cost of 20% Discount to Senior 219,778.00
Citizens) SO ORDERED.4

Hence, this petition raising the sole issue of whether the 20% sales
discount granted by respondent to qualified senior citizens pursuant to
Income Tax Payable (P 150,193.00) Sec. 4(a) of R.A. No. 7432 may be claimed as a tax credit or as a
deduction from gross sales in accordance with Sec. 2(1) of Revenue
Income Tax Actually Paid -0- Regulations No. 2-94.

Sec. 4(a) of R.A. No. 7432 provides:

Tax Refundable/Overpaid Income Tax (P 150,193.00)
Sec. 4. Privileges for the Senior citizens. – The senior citizens shall be
entitled to the following:
As shown above, the amount of P150,193 claimed as a refund
represents the tax credit allegedly due to respondent under R.A. No.
(a) the grant of twenty percent (20%) discount from all establishments
7432. Since the Commissioner of Internal Revenue "was not able to
relative to utilization of transportations services, hotels and similar
decide the claim for refund on time,"2 respondent filed a Petition for
lodging establishments, restaurants and recreation centers and
Review with the Court of Tax Appeals (CTA) on March 18, 1998.
purchase of medicines anywhere in the country: Provided, That private
establishments may claim the cost as tax credit.
On April 24, 2000, the CTA dismissed the petition, declaring that even
if the law treats the 20% sales discounts granted to senior citizens as a
The CA and the CTA correctly ruled that based on the plain wording of
tax credit, the same cannot apply when there is no tax liability or the
the law discounts given under R.A. No. 7432 should be treated as tax
amount of the tax credit is greater than the tax due. In the latter case,
credits, not deductions from income.
the tax credit will only be to the extent of the tax liability.3 Also, no refund
can be granted as no tax was erroneously, illegally and actually It is a fundamental rule in statutory construction that the legislative
collected based on the provisions of Section 230, now Section 229, of intent must be determined from the language of the statute itself
the Tax Code. Furthermore, the law does not state that a refund can be especially when the words and phrases therein are clear and
claimed by the private establishment concerned as an alternative to the unequivocal. The statute in such a case must be taken to mean exactly
tax credit.
what it says.5 Its literal meaning should be followed;6 to depart from the It must also be stressed that unlike in Sec. 229 of the Tax Code wherein
meaning expressed by the words is to alter the statute.7 the remedy of refund is available to the taxpayer, Sec. 4 of the law
speaks only of a tax credit, not a refund.
The above provision explicitly employed the word "tax credit." Nothing
in the provision suggests for it to mean a "deduction" from gross sales. As earlier mentioned, the tax credit benefit granted to the
To construe it otherwise would be a departure from the clear mandate establishments can be deemed as their just compensation for private
of the law. property taken by the State for public use. The privilege enjoyed by the
senior citizens does not come directly from the State, but rather from
Thus, the 20% discount required by the Act to be given to senior the private establishments concerned.12
citizens is a tax credit, not a deduction from the gross sales of the
establishment concerned. As a corollary to this, the definition of ‘tax WHEREFORE, the petition is DENIED. The Decision of the Court of
credit’ found in Section 2(1) of Revenue Regulations No. 2-94 is Appeals in CA-G.R. SP No. 60057, dated May 31, 2001, is AFFIRMED.
erroneous as it refers to tax credit as the amount representing the 20%
discount that "shall be deducted by the said establishment from their
gross sales for value added tax and other percentage tax purposes."
This definition is contrary to what our lawmakers had envisioned with
regard to the treatment of the discount granted to senior citizens.

Accordingly, when the law says that the cost of the discount may be
claimed as a tax credit, it means that the amount -- when claimed –
shall be treated as a reduction from any tax liability.8 The law cannot be
amended by a mere regulation. The administrative agencies issuing
these regulations may not enlarge, alter or restrict the provisions of the
law they administer.9 In fact, a regulation that "operates to create a rule
out of harmony with the statute is a mere nullity."10

Finally, for purposes of clarity, Sec. 22911 of the Tax Code does not
apply to cases that fall under Sec. 4 of R.A. No. 7432 because the
former provision governs exclusively all kinds of refund or credit of
internal revenue taxes that were erroneously or illegally imposed and
collected pursuant to the Tax Code while the latter extends the tax
credit benefit to the private establishments concerned even before tax
payments have been made. The tax credit that is contemplated under
the Act is a form of just compensation, not a remedy for taxes that were
erroneously or illegally assessed and collected. In the same vein, prior
payment of any tax liability is not a precondition before a taxable entity
can benefit from the tax credit. The credit may be availed of upon
payment of the tax due, if any. Where there is no tax liability or where
a private establishment reports a net loss for the period, the tax credit
can be availed of and carried over to the next taxable year.
THIRD DIVISION
G.R. No. 172231 February 12, 2007
COMMISSIONER OF INTERNAL REVENUE, Petitioner,
vs.
ISABELA CULTURAL CORPORATION, Respondent.
DECISION
YNARES-SANTIAGO, J.:
Petitioner Commissioner of Internal Revenue (CIR) assails the
September 30, 2005 Decision1 of the Court of Appeals in CA-G.R. SP
No. 78426 affirming the February 26, 2003 Decision2 of the Court of
Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set
aside the Assessment Notices for deficiency income tax and expanded
withholding tax issued by the Bureau of Internal Revenue (BIR) against
respondent Isabela Cultural Corporation (ICC).
The facts show that on February 23, 1990, ICC, a domestic corporation,
received from the BIR Assessment Notice No. FAS-1-86-90-000680 for
deficiency income tax in the amount of P333,196.86, and Assessment
Notice No. FAS-1-86-90-000681 for deficiency expanded withholding
tax in the amount of P4,897.79, inclusive of surcharges and interest,
both for the taxable year 1986.
The deficiency income tax of P333,196.86, arose from:
(1) The BIR’s disallowance of ICC’s claimed expense deductions for
professional and security services billed to and paid by ICC in 1986, to
wit:
(a) Expenses for the auditing services of SGV & Co.,3 for the year
ending December 31, 1985;4
(b) Expenses for the legal services [inclusive of retainer fees] of the law
firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for
the years 1984 and 1985.5
(c) Expense for security services of El Tigre Security & Investigation
Agency for the months of April and May 1986.6
(2) The alleged understatement of ICC’s interest income on the three
promissory notes due from Realty Investment, Inc.
The deficiency expanded withholding tax of P4,897.79 (inclusive of
interest and surcharge) was allegedly due to the failure of ICC to
withhold 1% expanded withholding tax on its claimed P244,890.00
deduction for security services.7
On March 23, 1990, ICC sought a reconsideration of the subject
assessments. On February 9, 1995, however, it received a final notice
before seizure demanding payment of the amounts stated in the said
notices. Hence, it brought the case to the CTA which held that the
petition is premature because the final notice of assessment cannot be
considered as a final decision appealable to the tax court. This was
reversed by the Court of Appeals holding that a demand letter of the
BIR reiterating the payment of deficiency tax, amounts to a final
decision on the protested assessment and may therefore be
questioned before the CTA. This conclusion was sustained by this
Court on July 1, 2001, in G.R. No. 135210.8 The case was thus
remanded to the CTA for further proceedings.
On February 26, 2003, the CTA rendered a decision canceling and
setting aside the assessment notices issued against ICC. It held that
the claimed deductions for professional and security services were
properly claimed by ICC in 1986 because it was only in the said year
when the bills demanding payment were sent to ICC. Hence, even if
some of these professional services were rendered to ICC in 1984 or
1985, it could not declare the same as deduction for the said years as
the amount thereof could not be determined at that time.
The CTA also held that ICC did not understate its interest income on
the subject promissory notes. It found that it was the BIR which made
an overstatement of said income when it compounded the interest
income receivable by ICC from the promissory notes of Realty
Investment, Inc., despite the absence of a stipulation in the contract
providing for a compounded interest; nor of a circumstance, like delay
in payment or breach of contract, that would justify the application of
compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% expanded
withholding tax on its claimed deduction for security services as shown
by the various payment orders and confirmation receipts it presented
as evidence. The dispositive portion of the CTA’s Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No.
FAS-1-86-90-000680 for deficiency income tax in the amount of
P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for
deficiency expanded withholding tax in the amount of P4,897.79,
inclusive of surcharges and interest, both for the taxable year 1986, are
hereby CANCELLED and SET ASIDE.
SO ORDERED.9
Petitioner filed a petition for review with the Court of Appeals, which
affirmed the CTA decision,10 holding that although the professional
services (legal and auditing services) were rendered to ICC in 1984 and
1985, the cost of the services was not yet determinable at that time,
hence, it could be considered as deductible expenses only in 1986
when ICC received the billing statements for said services. It further
ruled that ICC did not understate its interest income from the
promissory notes of Realty Investment, Inc., and that ICC properly
withheld and remitted taxes on the payments for security services for
the taxable year 1986.
Hence, petitioner, through the Office of the Solicitor General, filed the
instant petition contending that since ICC is using the accrual method
of accounting, the expenses for the professional services that accrued
in 1984 and 1985, should have been declared as deductions from
income during the said years and the failure of ICC to do so bars it from
claiming said expenses as deduction for the taxable year 1986. As to
the alleged deficiency interest income and failure to withhold expanded
withholding tax assessment, petitioner invoked the presumption that
the assessment notices issued by the BIR are valid.
The issue for resolution is whether the Court of Appeals correctly: (1)
sustained the deduction of the expenses for professional and security
services from ICC’s gross income; and (2) held that ICC did not
understate its interest income from the promissory notes of Realty
Investment, Inc; and that ICC withheld the required 1% withholding tax
from the deductions for security services.
The requisites for the deductibility of ordinary and necessary trade,
business, or professional expenses, like expenses paid for legal and
auditing services, are: (a) the expense must be ordinary and necessary;
(b) it must have been paid or incurred during the taxable year; (c) it
must have been paid or incurred in carrying on the trade or business of
the taxpayer; and (d) it must be supported by receipts, records or other
pertinent papers.11
The requisite that it must have been paid or incurred during the taxable
year is further qualified by Section 45 of the National Internal Revenue
Code (NIRC) which states that: "[t]he deduction provided for in this Title
shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or
incurred’, dependent upon the method of accounting upon the basis of
which the net income is computed x x x".
Accounting methods for tax purposes comprise a set of rules for
determining when and how to report income and deductions.12 In the
instant case, the accounting method used by ICC is the accrual method.
Revenue Audit Memorandum Order No. 1-2000, provides that under
the accrual method of accounting, expenses not being claimed as
deductions by a taxpayer in the current year when they are incurred
cannot be claimed as deduction from income for the succeeding year.
Thus, a taxpayer who is authorized to deduct certain expenses and
other allowable deductions for the current year but failed to do so
cannot deduct the same for the next year.13
The accrual method relies upon the taxpayer’s right to receive amounts
or its obligation to pay them, in opposition to actual receipt or payment,
which characterizes the cash method of accounting. Amounts of
income accrue where the right to receive them become fixed, where
there is created an enforceable liability. Similarly, liabilities are accrued
when fixed and determinable in amount, without regard to
indeterminacy merely of time of payment.14
For a taxpayer using the accrual method, the determinative question is,
when do the facts present themselves in such a manner that the
taxpayer must recognize income or expense? The accrual of income
and expense is permitted when the all-events test has been met. This
test requires: (1) fixing of a right to income or liability to pay; and (2) the
availability of the reasonable accurate determination of such income or
liability.
The all-events test requires the right to income or liability be fixed, and
the amount of such income or liability be determined with reasonable
accuracy. However, the test does not demand that the amount of
income or liability be known absolutely, only that a taxpayer has at his
disposal the information necessary to compute the amount with
reasonable accuracy. The all-events test is satisfied where computation
remains uncertain, if its basis is unchangeable; the test is satisfied
where a computation may be unknown, but is not as much as
unknowable, within the taxable year. The amount of liability does not
have to be determined exactly; it must be determined with
"reasonable accuracy." Accordingly, the term "reasonable
accuracy" implies something less than an exact or completely
accurate amount.[15]
The propriety of an accrual must be judged by the facts that a
taxpayer knew, or could reasonably be expected to have known,
at the closing of its books for the taxable year.[16] Accrual method
of accounting presents largely a question of fact; such that the taxpayer
bears the burden of proof of establishing the accrual of an item of
income or deduction.17
Corollarily, it is a governing principle in taxation that tax exemptions
must be construed in strictissimi juris against the taxpayer and liberally
in favor of the taxing authority; and one who claims an exemption must
be able to justify the same by the clearest grant of organic or statute
law. An exemption from the common burden cannot be permitted to
exist upon vague implications. And since a deduction for income tax
purposes partakes of the nature of a tax exemption, then it must also
be strictly construed.18
In the instant case, the expenses for professional fees consist of
expenses for legal and auditing services. The expenses for legal
services pertain to the 1984 and 1985 legal and retainer fees of the law
firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and
for reimbursement of the expenses of said firm in connection with ICC’s
tax problems for the year 1984. As testified by the Treasurer of ICC,
the firm has been its counsel since the 1960’s.19 From the nature of the
claimed deductions and the span of time during which the firm was
retained, ICC can be expected to have reasonably known the retainer
fees charged by the firm as well as the compensation for its legal
services. The failure to determine the exact amount of the expense
during the taxable year when they could have been claimed as
deductions cannot thus be attributed solely to the delayed billing of
these liabilities by the firm. For one, ICC, in the exercise of due
diligence could have inquired into the amount of their obligation to the
firm, especially so that it is using the accrual method of accounting. For
another, it could have reasonably determined the amount of legal and
retainer fees owing to its familiarity with the rates charged by their long
time legal consultant.
As previously stated, the accrual method presents largely a question of
fact and that the taxpayer bears the burden of establishing the accrual
of an expense or income. However, ICC failed to discharge this burden.
As to when the firm’s performance of its services in connection with the
1984 tax problems were completed, or whether ICC exercised
reasonable diligence to inquire about the amount of its liability, or
whether it does or does not possess the information necessary to
compute the amount of said liability with reasonable accuracy, are
questions of fact which ICC never established. It simply relied on the
defense of delayed billing by the firm and the company, which under
the circumstances, is not sufficient to exempt it from being charged with
knowledge of the reasonable amount of the expenses for legal and
auditing services.
In the same vein, the professional fees of SGV & Co. for auditing the
financial statements of ICC for the year 1985 cannot be validly claimed
as expense deductions in 1986. This is so because ICC failed to
present evidence showing that even with only "reasonable accuracy,"
as the standard to ascertain its liability to SGV & Co. in the year 1985,
it cannot determine the professional fees which said company would
charge for its services.
ICC thus failed to discharge the burden of proving that the claimed
expense deductions for the professional services were allowable
deductions for the taxable year 1986. Hence, per Revenue Audit
Memorandum Order No. 1-2000, they cannot be validly deducted from
its gross income for the said year and were therefore properly
disallowed by the BIR.
As to the expenses for security services, the records show that these
expenses were incurred by ICC in 198620 and could therefore be
properly claimed as deductions for the said year.
Anent the purported understatement of interest income from the
promissory notes of Realty Investment, Inc., we sustain the findings of
the CTA and the Court of Appeals that no such understatement exists
and that only simple interest computation and not a compounded one
should have been applied by the BIR. There is indeed no stipulation
between the latter and ICC on the application of compounded
interest.21 Under Article 1959 of the Civil Code, unless there is a
stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC
truly withheld the required withholding tax from its claimed deductions
for security services and remitted the same to the BIR is supported by
payment order and confirmation receipts.22 Hence, the Assessment
Notice for deficiency expanded withholding tax was properly cancelled
and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of

P333,196.86 for deficiency income tax should be cancelled and set
aside but only insofar as the claimed deductions of ICC for security
services. Said Assessment is valid as to the BIR’s disallowance of
ICC’s expenses for professional services. The Court of Appeal’s
cancellation of Assessment Notice No. FAS-1-86-90-000681 in the
amount of P4,897.79 for deficiency expanded withholding tax, is
sustained.

WHEREFORE, the petition is PARTIALLY GRANTED. The September

30, 2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426, is
AFFIRMED with the MODIFICATION that Assessment Notice No. FAS-
1-86-90-000680, which disallowed the expense deduction of Isabela
Cultural Corporation for professional and security services, is declared
valid only insofar as the expenses for the professional fees of SGV &
Co. and of the law firm, Bengzon Zarraga Narciso Cudala Pecson
Azcuna & Bengson, are concerned. The decision is affirmed in all other
respects.

The case is remanded to the BIR for the computation of Isabela Cultural
Corporation’s liability under Assessment Notice No. FAS-1-86-90-
000680.
THIRD DIVISION
G.R. No. 143672 April 24, 2003
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
GENERAL FOODS (PHILS.), INC., respondent.
CORONA, J.:
Petitioner Commissioner of Internal Revenue (Commissioner) assails
the resolution1 of the Court of Appeals reversing the decision2 of the
Court of Tax Appeals which in turn denied the protest filed by
respondent General Foods (Phils.), Inc., regarding the assessment
made against the latter for deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation,
which is engaged in the manufacture of beverages such as "Tang,"
"Calumet" and "Kool-Aid," filed its income tax return for the fiscal year
ending February 28, 1985. In said tax return, respondent corporation
claimed as deduction, among other business expenses, the amount
of P9,461,246 for media advertising for "Tang."
On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of
the deduction claimed by respondent corporation. Consequently,
respondent corporation was assessed deficiency income taxes in the
amount of P2,635, 141.42. The latter filed a motion for reconsideration
but the same was denied.
On September 29, 1989, respondent corporation appealed to the Court
of Tax Appeals but the appeal was dismissed:
With such a gargantuan expense for the advertisement of a singular
product, which even excludes "other advertising and promotions"
expenses, we are not prepared to accept that such amount is
reasonable "to stimulate the current sale of merchandise" regardless of
Petitioner’s explanation that such expense "does not connote
unreasonableness considering the grave economic situation taking
place after the Aquino assassination characterized by capital fight,
strong deterioration of the purchasing power of the Philippine peso and
the slacking demand for consumer products" (Petitioner’s
Memorandum, CTA Records, p. 273). We are not convinced with such
an explanation. The staggering expense led us to believe that such
expenditure was incurred "to create or maintain some form of good will
for the taxpayer’s trade or business or for the industry or profession of
which the taxpayer is a member." The term "good will" can hardly be
said to have any precise signification; it is generally used to denote the
benefit arising from connection and reputation (Words and Phrases,
Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III. App. 294). As held in
the case of Welch vs. Helvering, efforts to establish reputation are akin
to acquisition of capital assets and, therefore, expenses related thereto
are not business expenses but capital expenditures. (Atlas Mining and
Development Corp. vs. Commissioner of Internal Revenue, supra). For
sure such expenditure was meant not only to generate present sales
but more for future and prospective benefits. Hence, "abnormally large
expenditures for advertising are usually to be spread over the period of
years during which the benefits of the expenditures are received"
(Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).
WHEREFORE, in all the foregoing, and finding no error in the case
appealed from, we hereby RESOLVE to DISMISS the instant petition
for lack of merit and ORDER the Petitioner to pay the respondent
Commissioner the assessed amount of P2,635,141.42 representing its
deficiency income tax liability for the fiscal year ended February 28,
1985."3
Aggrieved, respondent corporation filed a petition for review at the
Court of Appeals which rendered a decision reversing and setting aside
the decision of the Court of Tax Appeals:
Since it has not been sufficiently established that the item it claimed as
a deduction is excessive, the same should be allowed.
WHEREFORE, the petition of petitioner General Foods (Philippines),
Inc. is hereby GRANTED. Accordingly, the Decision, dated 8 February
1994 of respondent Court of Tax Appeals is REVERSED and SET
ASIDE and the letter, dated 31 May 1988 of respondent Commissioner
of Internal Revenue is CANCELLED.
SO ORDERED.4
Thus, the instant petition, wherein the Commissioner presents for the
Court’s consideration a lone issue: whether or not the subject media
advertising expense for "Tang" incurred by respondent corporation was
an ordinary and necessary expense fully deductible under the National
Internal Revenue Code (NIRC).
It is a governing principle in taxation that tax exemptions must be
construed in strictissimi juris against the taxpayer and liberally in favor
of the taxing authority;5 and he who claims an exemption must be able
to justify his claim by the clearest grant of organic or statute law. An
exemption from the common burden cannot be permitted to exist upon
vague implications.6
Deductions for income tax purposes partake of the nature of tax
exemptions; hence, if tax exemptions are strictly construed, then
deductions must also be strictly construed.
We then proceed to resolve the singular issue in the case at bar. Was
the media advertising expense for "Tang" paid or incurred by
respondent corporation for the fiscal year ending February 28, 1985
"necessary and ordinary," hence, fully deductible under the NIRC? Or
was it a capital expenditure, paid in order to create "goodwill and
reputation" for respondent corporation and/or its products, which
should have been amortized over a reasonable period?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
(A) Expenses.-
(1) Ordinary and necessary trade, business or professional expenses.-
(a) In general.- There shall be allowed as deduction from gross income
all ordinary and necessary expenses paid or incurred during the taxable
year in carrying on, or which are directly attributable to, the
development, management, operation and/or conduct of the trade,
business or exercise of a profession.
Simply put, to be deductible from gross income, the subject advertising
expense must comply with the following requisites: (a) the expense
must be ordinary and necessary; (b) it must have been paid or incurred
during the taxable year; (c) it must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d) it must be
supported by receipts, records or other pertinent papers.7
The parties are in agreement that the subject advertising expense was
paid or incurred within the corresponding taxable year and was incurred
in carrying on a trade or business. Hence, it was necessary. However,
their views conflict as to whether or not it was ordinary. To be
deductible, an advertising expense should not only be necessary but
also ordinary. These two requirements must be met.
The Commissioner maintains that the subject advertising expense was
not ordinary on the ground that it failed the two conditions set by U.S.
jurisprudence: first, "reasonableness" of the amount incurred and
second, the amount incurred must not be a capital outlay to create
"goodwill" for the product and/or private respondent’s business.
Otherwise, the expense must be considered a capital expenditure to be
spread out over a reasonable time.
We agree.
There is yet to be a clear-cut criteria or fixed test for determining the
reasonableness of an advertising expense. There being no hard and
fast rule on the matter, the right to a deduction depends on a number
of factors such as but not limited to: the type and size of business in
which the taxpayer is engaged; the volume and amount of its net
earnings; the nature of the expenditure itself; the intention of the
taxpayer and the general economic conditions. It is the interplay of
these, among other factors and properly weighed, that will yield a
proper evaluation.
In the case at bar, the P9,461,246 claimed as media advertising
expense for "Tang" alone was almost one-half of its total claim for
"marketing expenses." Aside from that, respondent-corporation also
claimed P2,678,328 as "other advertising and promotions expense"
and another P1,548,614, for consumer promotion.
Furthermore, the subject P9,461,246 media advertising expense for
"Tang" was almost double the amount of respondent corporation’s
P4,640,636 general and administrative expenses.
We find the subject expense for the advertisement of a single product
to be inordinately large. Therefore, even if it is necessary, it cannot be
considered an ordinary expense deductible under then Section 29 (a)
(1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate
the current sale of merchandise or use of services and (2) advertising
designed to stimulate the future sale of merchandise or use of services.
The second type involves expenditures incurred, in whole or in part, to
create or maintain some form of goodwill for the taxpayer’s trade or
business or for the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising of the first kind,
then, except as to the question of the reasonableness of amount, there
is no doubt such expenditures are deductible as business expenses. If,
however, the expenditures are for advertising of the second kind, then
normally they should be spread out over a reasonable period of time.
We agree with the Court of Tax Appeals that the subject advertising
expense was of the second kind. Not only was the amount staggering;
the respondent corporation itself also admitted, in its letter protest8 to
the Commissioner of Internal Revenue’s assessment, that the subject
media expense was incurred in order to protect respondent
corporation’s brand franchise, a critical point during the period under
review.
The protection of brand franchise is analogous to the maintenance of
goodwill or title to one’s property. This is a capital expenditure which
should be spread out over a reasonable period of time.9
Respondent corporation’s venture to protect its brand franchise was
tantamount to efforts to establish a reputation. This was akin to the
acquisition of capital assets and therefore expenses related thereto
were not to be considered as business expenses but as capital
expenditures.10
True, it is the taxpayer’s prerogative to determine the amount of
advertising expenses it will incur and where to apply them.11 Said
prerogative, however, is subject to certain considerations. The first
relates to the extent to which the expenditures are actually capital
outlays; this necessitates an inquiry into the nature or purpose of such
expenditures.12 The second, which must be applied in harmony with the
first, relates to whether the expenditures are ordinary and necessary.
Concomitantly, for an expense to be considered ordinary, it must be
reasonable in amount. The Court of Tax Appeals ruled that respondent
corporation failed to meet the two foregoing limitations.
We find said ruling to be well founded. Respondent corporation incurred
the subject advertising expense in order to protect its brand franchise.
We consider this as a capital outlay since it created goodwill for its
business and/or product. The P9,461,246 media advertising expense
for the promotion of a single product, almost one-half of petitioner
corporation’s entire claim for marketing expenses for that year under
review, inclusive of other advertising and promotion expenses of
P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly
unreasonable.
It has been a long standing policy and practice of the Court to respect
the conclusions of quasi-judicial agencies such as the Court of Tax
Appeals, a highly specialized body specifically created for the purpose
of reviewing tax cases. The CTA, by the nature of its functions, is
dedicated exclusively to the study and consideration of tax problems. It
has necessarily developed an expertise on the subject. We extend due
consideration to its opinion unless there is an abuse or improvident
exercise of authority.13 Since there is none in the case at bar, the Court
adheres to the findings of the CTA.
Accordingly, we find that the Court of Appeals committed reversible
error when it declared the subject media advertising expense to be
deductible as an ordinary and necessary expense on the ground that
"it has not been established that the item being claimed as deduction is
excessive." It is not incumbent upon the taxing authority to prove that
the amount of items being claimed is unreasonable. The burden of
proof to establish the validity of claimed deductions is on the
taxpayer.14 In the present case, that burden was not discharged
satisfactorily.
WHEREFORE, premises considered, the instant petition is GRANTED.
The assailed decision of the Court of Appeals is hereby REVERSED
and SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code,
respondent General Foods (Phils.), Inc. is hereby ordered to pay its
deficiency income tax in the amount of P2,635,141.42, plus 25%
surcharge for late payment and 20% annual interest computed from
August 25, 1989, the date of the denial of its protest, until the same is
fully paid.
G.R. No. L-24059 November 28, 1969
C. M. HOSKINS & CO., INC., petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
Ross, Salcedo, Del Rosario, Bito and Misa for petitioner.
Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor
General Felicisimo R. Rosete and Special Attorney Michaelina R.
Balasbas for respondent.
TEEHANKEE, J.:
We uphold in this taxpayer's appeal the Tax Court's ruling that payment
by the taxpayer to its controlling stockholder of 50% of its supervision
fees or the amount of P99,977.91 is not a deductible ordinary and
necessary expense and should be treated as a distribution of earnings
and profits of the taxpayer.
Petitioner, a domestic corporation engaged in the real estate business
as brokers, managing agents and administrators, filed its income tax
return for its fiscal year ending September 30, 1957 showing a net
income of P92,540.25 and a tax liability due thereon of P18,508.00,
which it paid in due course. Upon verification of its return, respondent
Commissioner of Internal Revenue, disallowed four items of deduction
in petitioner's tax returns and assessed against it an income tax
deficiency in the amount of P28,054.00 plus interests. The Court of Tax
Appeals upon reviewing the assessment at the taxpayer's petition,
upheld respondent's disallowance of the principal item of petitioner's
having paid to Mr. C. M. Hoskins, its founder and controlling stockholder
the amount of P99,977.91 representing 50% of supervision fees earned
by it and set aside respondent's disallowance of three other minor
items. The Tax Court therefore determined petitioner's tax deficiency to
be in the amount of P27,145.00 and on November 8, 1964 rendered
judgment against it, as follows:
WHEREFORE, premises considered, the decision of the respondent is
hereby modified. Petitioner is ordered to pay to the latter or his
representative the sum of P27,145.00, representing deficiency income
tax for the year 1957, plus interest at 1/2% per month from June 20,
1959 to be computed in accordance with the provisions of Section 51(d)
of the National Internal Revenue Code. If the deficiency tax is not paid
within thirty (30) days from the date this decision becomes final,
petitioner is also ordered to pay surcharge and interest as provided for
in Section 51 (e) of the Tax Code, without costs.
Petitioner questions in this appeal the Tax Court's findings that the
disallowed payment to Hoskins was an inordinately large one, which
bore a close relationship to the recipient's dominant stockholdings and
therefore amounted in law to a distribution of its earnings and profits.
We find no merit in petitioner's appeal.
As found by the Tax Court, "petitioner was founded by Mr. C. M.
Hoskins in 1937, with a capital stock of 1,000 shares at a par value of
P1.00 each share; that of these 1,000 shares, Mr. C. M. Hoskins owns
996 shares (the other 4 shares being held by the other four officers of
the corporation), which constitute exactly 99.6% of the total authorized
capital stock (p. 92, t.s.n.); that during the first four years of its
existence, Mr. C. M. Hoskins was the President, but during the taxable
period in question, that is, from October 1, 1956 to September 30, 1957,
he was the chairman of the Board of Directors and salesman-broker for
the company (p. 93, t.s.n.); that as chairman of the Board of Directors,
he received a salary of P3,750.00 a month, plus a salary bonus of about
P40,000.00 a year (p. 94, t.s.n.); that he was also a stockholder and
officer of the Paradise Farms, Inc. and Realty Investments, Inc., from
which petitioner derived a large portion of its income in the form of
supervision fees and commissions earned on sales of lots (pp. 97-99,
t.s.n.; Financial Statements, attached to Exhibit '1', p. 11, BIR rec.); that
as chairman of the Board of Directors of petitioner, his duties were: "To
act as a salesman; as a director, preside over meetings and to get all
of the real estate business I could for the company by negotiating sales,
purchases, making appraisals, raising funds to finance real estate
operations where that was necessary' (p. 96, t.s.n.); that he was familiar
with the contract entered into by the petitioner with the Paradise Farms,
Inc. and the Realty Investments, Inc. by the terms of which petitioner
was 'to program the development, arrange financing, plan the proposed
subdivision as outlined in the prospectus of Paradise Farms, Inc.,
arrange contract for road constructions, with the provision of water
supply to all of the lots and in general to serve as managing agents for
the Paradise Farms, Inc. and subsequently for the Realty Investment,
Inc." (pp. 96-97. t.s.n.)
Considering that in addition to being Chairman of the board of directors
of petitioner corporation, which bears his name, Hoskins, who owned
99.6% of its total authorized capital stock while the four other officers-
stockholders of the firm owned a total of four-tenths of 1%, or one-tenth
of 1% each, with their respective nominal shareholdings of one share
each was also salesman-broker for his company, receiving a 50%
share of the sales commissions earned by petitioner, besides his
monthly salary of P3,750.00 amounting to an annual compensation of
P45,000.00 and an annual salary bonus of P40,000.00, plus free use
of the company car and receipt of other similar allowances and benefits,
the Tax Court correctly ruled that the payment by petitioner to Hoskins
of the additional sum of P99,977.91 as his equal or 50% share of the
8% supervision fees received by petitioner as managing agents of the
real estate, subdivision projects of Paradise Farms, Inc. and Realty
Investments, Inc. was inordinately large and could not be accorded the
treatment of ordinary and necessary expenses allowed as deductible
items within the purview of Section 30 (a) (i) of the Tax Code.
If such payment of P99,977.91 were to be allowed as a deductible item,
then Hoskins would receive on these three items alone (salary, bonus
and supervision fee) a total of P184,977.91, which would be double the
petitioner's reported net income for the year of P92,540.25. As correctly
observed by respondent. If independently, a one-time P100,000.00-fee
to plan and lay down the rules for supervision of a subdivision project
were to be paid to an experienced realtor such as Hoskins, its fairness
and deductibility by the taxpayer could be conceded; but here 50% of
the supervision fee of petitioner was being paid by it to Hoskins every
year since 1955 up to 1963 and for as long as its contract with the
subdivision owner subsisted, regardless of whether services were
actually rendered by Hoskins, since his services to petitioner included
such planning and supervision and were already handsomely paid for
by petitioner.
The fact that such payment was authorized by a standing resolution of
petitioner's board of directors, since "Hoskins had personally conceived
and planned the project" cannot change the picture. There could be no
question that as Chairman of the board and practically an absolutely
controlling stockholder of petitioner, holding 99.6% of its stock, Hoskins
wielded tremendous power and influence in the formulation and making
of the company's policies and decisions. Even just as board chairman,
going by petitioner's own enumeration of the powers of the office,
Hoskins, could exercise great power and influence within the
corporation, such as directing the policy of the corporation, delegating
powers to the president and advising the corporation in determining
executive salaries, bonus plans and pensions, dividend policies, etc.1
Petitioner's invoking of its policy since its incorporation of sharing
equally sales commissions with its salesmen, in accordance with its
board resolution of June 18, 1946, is equally untenable. Petitioner's
Sales Regulations provide:
Compensation of Salesmen
8. Schedule I — In the case of sales to prospects discovered and
worked by a salesman, even though the closing is done by or with the
help of the Sales Manager or other members of the staff, the salesmen
get one-half (1/2) of the total commission received by the Company, but
not exceeding five percent (5%). In the case of subdivisions, when the
office commission covers general supervision, the 1/2-rule does not
apply, the salesman's share being stipulated in the case of each
subdivision. In most cases the salesman's share is 4%. (Exh. "N-1").2
It will be readily seen therefrom that when the petitioner's commission
covers general supervision, it is provided that the 1/2 rule of equal
sharing of the sales commissions does not apply and that the
salesman's share is stipulated in the case of each subdivision.
Furthermore, what is involved here is not Hoskins' salesman's share in
the petitioner's 12% sales commission, which he presumably collected
also from petitioner without respondent's questioning it, but a 50%
share besides in petitioner's planning and supervision fee of 8% of the
gross sales, as mentioned above. This is evident from petitioner's
board's resolution of July 14, 1953 (Exhibit 7), wherein it is recited that
in addition to petitioner's sales commission of 12% of gross sales, the
subdivision owners were paying to petitioner 8% of gross sales as
supervision fee, and a collection fee of 5% of gross collections, or total
fees of 25% of gross sales.
The case before us is similar to previous cases of disallowances as
deductible items of officers' extra fees, bonuses and commissions,
upheld by this Court as not being within the purview of ordinary and
necessary expenses and not passing the test of reasonable
compensation.3 In Kuenzle & Streiff, Inc. vs. Commissioner of Internal
Revenue decided by this Court on May 29, 1969,4 we reaffirmed the
test of reasonableness, enunciated in the earlier 1967 case involving
the same parties, that: "It is a general rule that 'Bonuses to employees
made in good faith and as additional compensation for the services
actually rendered by the employees are deductible, provided such
payments, when added to the stipulated salaries, do not exceed a
reasonable compensation for the services rendered' (4 Mertens Law of
Federal Income Taxation, Sec. 25.50, p. 410). The conditions
precedent to the deduction of bonuses to employees are: (1) the
payment of the bonuses is in fact compensation; (2) it must be for
personal services actually rendered; and (3) the bonuses, when added
to the salaries, are 'reasonable . . . when measured by the amount and
quality of the services performed with relation to the business of the
particular taxpayer' (Idem., Sec. 25, 44, p. 395).
"There is no fixed test for determining the reasonableness of a given
bonus as compensation. This depends upon many factors, one of them
being 'the amount and quality of the services performed with relation to
the business.' Other tests suggested are: payment must be 'made in
good faith'; 'the character of the taxpayer's business, the volume and
amount of its net earnings, its locality, the type and extent of the
services rendered, the salary policy of the corporation'; 'the size of the
particular business'; 'the employees' qualifications and contributions to
the business venture'; and 'general economic conditions' (4 Mertens,
Law of Federal Income Taxation, Secs. 25.44, 25.49, 25.50, 25.51, pp.
407-412). However, 'in determining whether the particular salary or
compensation payment is reasonable, the situation must be considered
as whole. Ordinarily, no single factor is decisive. . . . it is important to
keep in mind that it seldom happens that the application of one test can
give satisfactory answer, and that ordinarily it is the interplay of several
factors, properly weighted for the particular case, which must furnish
the final answer."
Petitioner's case fails to pass the test. On the right of the employer as
against respondent Commissioner to fix the compensation of its officers
and employees, we there held further that while the employer's right
may be conceded, the question of the allowance or disallowance
thereof as deductible expenses for income tax purposes is subject to
determination by respondent Commissioner of Internal Revenue. Thus:
"As far as petitioner's contention that as employer it has the right to fix
the compensation of its officers and employees and that it was in the
exercise of such right that it deemed proper to pay the bonuses in
question, all that We need say is this: that right may be conceded, but
for income tax purposes the employer cannot legally claim such
bonuses as deductible expenses unless they are shown to be
reasonable. To hold otherwise would open the gate of rampant tax
evasion.
"Lastly, We must not lose sight of the fact that the question of allowing
or disallowing as deductible expenses the amounts paid to corporate
officers by way of bonus is determined by respondent exclusively for
income tax purposes. Concededly, he has no authority to fix the
amounts to be paid to corporate officers by way of basic salary, bonus
or additional remuneration — a matter that lies more or less exclusively
within the sound discretion of the corporation itself. But this right of the
corporation is, of course, not absolute. It cannot exercise it for the
purpose of evading payment of taxes legitimately due to the State."
Finally, it should be noted that we have here a case practically of a sole
proprietorship of C. M. Hoskins, who however chose to incorporate his
business with himself holding virtually absolute control thereof with
99.6% of its stock with four other nominal shareholders holding one
share each. Having chosen to use the corporate form with its legal
advantages of a separate corporate personality as distinguished from
his individual personality, the corporation so created, i.e., petitioner, is
bound to comport itself in accordance with corporate norms and comply
with its corporate obligations. Specifically, it is bound to pay the income
tax imposed by law on corporations and may not legally be permitted,
by way of corporate resolutions authorizing payment of inordinately
large commissions and fees to its controlling stockholder, to dilute and
diminish its corresponding corporate tax liability.
ACCORDINGLY, the decision appealed from is hereby affirmed, with
costs in both instances against petitioner.
G.R. No. L-13325 April 20, 1961
SANTIAGO GANCAYCO, petitioner,
vs.
THE COLLECTOR OF INTERNAL REVENUE, respondent.
Benjamin J. Molina for petitioner.
Office of the Solicitor General and Special Attorney Antonio A. Garces
for respondent.
CONCEPCION, J.:
Petitioner Santiago Gancayco seeks the review of a decision of the
Court of Tax Appeals, requiring him to pay P16,860.31, plus surcharge
and interest, by way of deficiency income tax for the year 1949.
On May 10, 1950, Gancayco filed his income tax return for the year
1949. Two (2) days later, respondent Collector of Internal Revenue
issued the corresponding notice advising him that his income tax
liability for that year amounted P9,793.62, which he paid on May 15,
1950. A year later, on May 14, 1951, respondent wrote the
communication Exhibit C, notifying Gancayco, inter alia, that, upon
investigation, there was still due from him, a efficiency income tax for
the year 1949, the sum of P29,554.05. Gancayco sought a
reconsideration, which was part granted by respondent, who in a letter
dated April 8, 1953 (Exhibit D), informed petitioner that his income tax
defendant efficiency for 1949 amounted to P16,860.31. Gancayco
urged another reconsideration (Exhibit O), but no action taken on this
request, although he had sent several communications calling
respondent's attention thereto.
On April 15, 1956, respondent issued a warrant of distraint and levy
against the properties of Gancayco for the satisfaction of his deficiency
income tax liability, and accordingly, the municipal treasurer of
Catanauan, Quezon issued on May 29, 1956, a notice of sale of said
property at public auction on June 19, 1956. Upon petition of Gancayco
filed on June 16, 1956, the Court of Tax Appeal issued a resolution
ordering the cancellation of the sale and directing that the same be
readvertised at a future date, in accordance with the procedure
established by the National Internal Revenue Code. Subsequently, or
on June 22, 1956, Gancayco filed an amended petition praying that
said Court:
(a) Issue a writ of preliminary injunction, enjoining the respondents from
enforcing the collection of the alleged tax liability due from the petitioner
through summary proceeding pending determination of the present
case;
(b) After a review of the present case adjudge that the right of the
government to enforce collection of any liability due on this account had
already prescribed;
(c) That even assuming that prescription had not set in the objections
of petitioner to the disallowance of the entertainment, representation
and farming expenses be allowed;
xxx xxx xxx
In his answer respondent admitted some allegations the amended
petition, denied other allegations thereof an set up some special
defenses. Thereafter Gancayco received from the municipal treasurer
of Catanauan, Quezon, another notice of auction sale of his properties,
to take place on August 29, 1956. On motion of Gancayco, the Court of
Tax Appeals, by resolution dated August 27, 1956, "cancelled" the
aforementioned sale and enjoined respondent and the municipal
treasurer of Catanauan, Quezon, from proceeding with the same. After
appropriate proceedings, the Court of Tax Appeals rendered, on
November 14, 1957, the decision adverted to above.
Gancayco maintains that the right to collect the deficiency income tax
in question is barred by the statute of limitations. In this connection, it
should be noted, however, that there are two (2) civil remedies for the
collection of internal revenue taxes, namely: (a) by distraint of personal
property and levy upon real property; and (b) by "judicial action"
(Commonwealth Act 456, section 316). The first may not be availed of
except within three (3) years after the "return is due or has been made
..." (Tax Code, section 51 [d] ). After the expiration of said Period,
income taxes may not be legally and validly collected by distraint and/or
levy (Collector of Internal Revenue v. Avelino, L-9202, November 19,
1956; Collector of Internal Revenue v. Reyes, L-8685, January 31,
1957; Collector of Internal Revenue v. Zulueta, L-8840, February 8,
1957; Sambrano v. Court of Tax Appeals, L-8652, March 30, 1957).
Gancayco's income tax return for 1949 was filed on May 10, 1950; so
that the warrant of distraint and levy issued on May 15, 1956, long after
the expiration of said three-year period, was illegal and void, and so
was the attempt to sell his properties in pursuance of said warrant.
The "judicial action" mentioned in the Tax Code may be resorted to
within five (5) years from the date the return has been filed, if there has
been no assessment, or within five (5) years from the date of the
assessment made within the statutory period, or within the period
agreed upon, in writing, by the Collector of Internal Revenue and the
taxpayer. before the expiration of said five-year period, or within such
extension of said stipulated period as may have been agreed upon, in
writing, made before the expiration of the period previously situated,
except that in the case of a false or fraudulent return with intent to evade
tax or of a failure to file a return, the judicial action may be begun at any
time within ten (10) years after the discovery of the falsity, fraud or
omission (Sections 331 and 332 of the Tax Code). In the case at bar,
respondent made three (3) assessments: (a) the original assessment
of P9,793.62, made on May 12, 1950; (b) the first deficiency income tax
assessment of May 14, 1951, for P29,554.05; and (c) the amended
deficiency income tax assessment of April 8, 1953, for P16,860.31.
Gancayco argues that the five-year period for the judicial action should
be counted from May 12, 1950, the date of the original assessment,
because the income tax for 1949, he says, could have been collected
from him since then. Said assessment was, however, not for the
deficiency income tax involved in this proceedings, but for P9,793.62,
which he paid forthwith. Hence, there never had been any cause for a
judicial action against him, and, per force, no statute of limitations to
speak of, in connection with said sum of P9,793.62.
Neither could said statute have begun to run from May 14, 1951, the
date of the first deficiency income tax assessment or P29,554.05,
because the same was, upon Gancayco's request, reconsidered or
modified by the assessment made on April 8, 1953, for P16,860.31.
Indeed, this last assessment is what Gancayco contested in the
amended petition filed by him with the Court of Tax Appeals. The
amount involved in such assessment which Gancayco refused to pay
and respondent tried to collect by warrant of distraint and/or levy, is the
one in issue between the parties. Hence, the five-year period
aforementioned should be counted from April 8, 1953, so that the
statute of limitations does not bar the present proceedings, instituted
on April 12, 1956, if the same is a judicial action, as contemplated in
section 316 of the Tax Code, which petitioner denies, upon the ground
that
a. "The Court of Tax Appeals does not have original jurisdiction to
entertain an action for the collection of the tax due;
b. "The proper party to commence the judicial action to collect the tax
due is the government, and
c. "The remedies provided by law for the collection of the tax are
exclusive."
Said Section 316 provides:
The civil remedies for the collection of internal revenue taxes, fees, or
charges, and any increment thereto resulting from delinquency shall be
(a) by distraint of goods, chattels, or effects, and other personal
property of whatever character, including stocks and other securities,
debts, credits, bank accounts, and interest in and rights to personal
property, and by levy upon real property; and (b) by judicial action.
Either of these remedies or both simultaneously may be pursued in the
discretion of the authorities charged with the collection of such taxes.
No exemption shall be allowed against the internal revenue taxes in
any case.
Petitioner contends that the judicial action referred to in this provision
is commenced by filing, with a court of first instance, of a complaint for
the collection of taxes. This was true at the time of the approval of
Commonwealth Act No. 456, on June 15, 1939. However, Republic Act
No. 1125 has vested the Court of Tax Appeals, not only with exclusive
appellate jurisdiction to review decisions of the Collector (now
Commissioner) of Internal Revenue in cases involving disputed
assessments, like the one at bar, but, also, with authority to decide "all
cases involving disputed assessments of Internal Revenue taxes or
customs duties pending determination before the court of first instance"
at the time of the approval of said Act, on June 16, 1954 (Section 22,
Republic Act No. 1125). Moreover, this jurisdiction to decide all cases
involving disputed assessments of internal revenue taxes and customs
duties necessarily implies the power to authorize and sanction the
collection of the taxes and duties involved in such assessments as may
be upheld by the Court of Tax Appeals. At any rate, the same now has
the authority formerly vested in courts of first instance to hear and
decide cases involving disputed assessments of internal revenue taxes
and customs duties. Inasmuch as those cases filed with courts of first
instance constituted judicial actions, such is, likewise, the nature of the
proceedings before the Court of Tax Appeals, insofar as sections 316
and 332 of the Tax Code are concerned.
The question whether the sum of P16,860.31 is due from Gancayco as
deficiency income tax for 1949 hinges on the validity of his claim for
deduction of two (2) items, namely: (a) for farming expenses,
P27,459.00; and (b) for representation expenses, P8,933.45.
Section 30 of the Tax Code partly reads:
(a) Expenses:
(1) In General — All the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business,
including a reasonable allowance for salaries or other compensation for
personal services actually rendered; traveling expenses while away
from home in the pursuit of a trade or business; and rentals or other
payments required to be made as a condition to the continued use or
possession, for the purposes of the trade or business, of property to
which the taxpayer has not taken or is not taking title or in which he has
no equity. (Emphasis supplied.)
Referring to the item of P27,459, for farming expenses allegedly
incurred by Gancayco, the decision appealed from has the following to
say:
No evidence has been presented as to the nature of the said "farming
expenses" other than the bare statement of petitioner that they were
spent for the "development and cultivation of (his) property". No
specification has been made as to the actual amount spent for
purchase of tools, equipment or materials, or the amount spent for
improvement. Respondent claims that the entire amount was spent
exclusively for clearing and developing the farm which were necessary
to place it in a productive state. It is not, therefore, an ordinary expense
but a capitol expenditure. Accordingly, it is not deductible but it may be
amortized, in accordance with section 75 of Revenue Regulations No.
2, cited above. See also, section 31 of the Revenue Code which
provides that in computing net income, no deduction shall in any case
be allowed in respect of any amount paid out for new buildings or for
permanent improvements, or betterments made to increase the
value of any property or estate. (Emphasis supplied.)
We concur in this view, which is a necessary consequence of section
31 of the Tax Code, pursuant to which:
(a) General Rule — In computing net income no deduction shall
in any case be allowed in respect of —
(1) Personal, living, or family expenses;
(2) Any amount paid out for new buildings or for permanent
improvements, or betterments made to increase the value of any
property or estate;
(3) Any amount expended in restoring property or in making good the
exhaustion thereof for which an allowance is or has been made; or
(4) Premiums paid on any life insurance policy covering the life of any
officer or employee, or any person financially interested in any trade or
business carried on by the taxpayer, individual or corporate, when the
taxpayer is directly or indirectly a beneficiary under such policy.
(Emphasis supplied.)
Said view is, likewise, in accord with the consensus of the authorities
on the subject.
Expenses incident to the acquisition of property follow the same rule as
applied to payments made as direct consideration for the property. For
example, commission paid in acquiring property are considered as
representing part of the cost of the property acquired. The same
treatment is to be accorded to amounts expended for maps, abstracts,
legal opinions on titles, recording fees and surveys. Other non-
deductible expenses include amounts paid in connection with
geological explorations, development and subdividing of real
estate; clearing and grading; restoration of soil, drilling wells,
architects's fees and similar types of expenditures. (4 Merten's Law of
Federal Income Taxation, Sec. 25.20, pp. 348-349; see also sec. 75 of
the income Regulation of the B.I.R.; Emphasis supplied.)
The cost of farm machinery, equipment and farm building represents a
capital investment and is not an allowable deduction as an item of
expense. Amounts expended in the development of farms, orchards,
and ranches prior to the time when the productive state is reached may Padilla, Bautista Angelo, Labrador, Reyes, J.B.L., Barrera and Dizon,
be regarded as investments of capital. (Merten's Law of Federal Income JJ., concur.
Taxation, supra, sec. 25.108, p. 525.)

Expenses for clearing off and grading lots acquired is

a capital expenditure, representing part of the cost of the land and was
not deductible as an expense. (Liberty Banking Co. v. Heiner 37 F [2d]
703 [8AFTR 100111] [CCA 3rd]; The B.L. Marble Chair Company v.
U.S., 15 AFTR 746).

An item of expenditure, in order to be deductible under this section of

the statute providing for the deduction
of ordinary and necessary business expenses, must
fall squarely within the language of the statutory provision. This section
is intended primarily, although not always necessarily, to cover
expenditures of a recurring nature where the benefit derived from the
payment is realized and exhausted within the taxable year.
Accordingly, if the result of the expenditure is the acquisition of an
asset which has an economically useful life beyond the taxable year,
no deduction of such payment may be obtained under the provisions of
the statute. In such cases, to the extent that a deduction is allowable, it
must be obtained under the provisions of the statute which permit
deductions for amortization, depreciation, depletion or loss. (W.B.
Harbeson Co. 24 BTA, 542; Clark Thread Co., 28 BTA 1128 aff'd 100
F [2d] 257 [CCA 3rd, 1938]; 4 Merten's Law of Federal Income
Taxation, Sec. 25.17, pp. 337-338.)

Gancayco's claim for representation expenses aggregated P31,753.97,

of which P22,820.52 was allowed, and P8,933.45 disallowed. Such
disallowance is justified by the record, for, apart from the absence of
receipts, invoices or vouchers of the expenditures in question,
petitioner could not specify the items constituting the same, or when or
on whom or on what they were incurred. The case of Cohan v.
Commissioner, 39 F (2d) 540, cited by petitioner is not in point, because
in that case there was evidence on the amounts spent and the persons
entertained and the necessity of entertaining them, although there were
no receipts an vouchers of the expenditures involved therein. Such is
not the case of petitioner herein.

Being in accordance with the facts and law, the decision of the Court of
Tax Appeals is hereby affirmed therefore, with costs against petitioner
Santiago Cancayco. It is so ordered.
G.R. Nos. 106949-50 December 1, 1995 35% Transaction tax due

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES thereon 16,020,147.00

(PICOP), petitioner,
vs. Add: 25% surcharge 4,005,036.75
COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE
and COURT OF TAX APPEALS, respondents. ——————

G.R. Nos. 106984-85 December 1, 1995 T o t a l P 20,025,183.75

COMMISSIONER INTERNAL REVENUE, petitioner, Add:

vs.
PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE 14% int. fr.
COURT OF APPEALS and THE COURT OF TAX
APPEALS, respondents. 1-20-78 to

7-31-80 P 7,093,302.57

FELICIANO, J.: 20% int, fr.

The Paper Industries Corporation of the Philippines ("Picop"), which is 8-1-80 to

petitioner in G.R. Nos. 106949-50 and private respondent in G.R. Nos.
106984-85, is a Philippine corporation registered with the Board of 3-31-83 10,675,523.58
Investments ("BOI") as a preferred pioneer enterprise with respect to
its integrated pulp and paper mill, and as a preferred non- ——————
pioneer enterprise with respect to its integrated plywood and veneer
mills. 17,768,826.15

On 21 April 1983, Picop received from the Commissioner of Internal ——————

Revenue ("CIR") two (2) letters of assessment and demand both dated
31 March 1983: (a) one for deficiency transaction tax and for P 37,794,009.90
documentary and science stamp tax; and (b) the other for deficiency
Documentary and Science Stamps Tax
income tax for 1977, for an aggregate amount of P88,763,255.00.
These assessments were computed as follows:
Total face value of
Transaction Tax
debentures P100,000,000.00
Interest payments on
Documentary Stamps
money market
Tax Due
borrowings P 45,771,849.00
(P0.30 x P100,000.000 )
———————
( P200 ) P 150,000.00 of machinery & other

Science Stamps Tax Due equipment 42,840,131.00

(P0.30 x P100,000,000 ) 3) Unexplained financial

( P200 ) P 150,000.00 guarantee expense 1,237,421.00

—————— 4) Understatement

T o t a l P 300,000.00 of sales 2,391,644.00

Add: Compromise for 5) Overstatement of

non-affixture 300.00 cost of sales 604,018.00

—————— ——————

300,300.00 P91,406,194.00

—————— Net income per investigation P91,664,360.00

TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90 Income tax due thereon 34,734,559.00

=========== Less: Tax already assessed per return 80,358.00

Deficiency Income Tax for 1977 ——————

Net income per return P 258,166.00 Deficiency P34,654,201.00

Add: Unallowable deductions Add:

1) Disallowed deductions 14% int. fr.

availed of under 4-15-78 to

R.A. No. 5186 P 44,332,980.00 7-31-81 P 11,128,503.56

2) Capitalized interest 20% int. fr.

expenses on funds 8-1-80 to

used for acquisition 4-15-81 4,886,242.34

——————
P16,014,745.90
——————
TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1
===========
On 26 April 1983, Picop protested the assessment of deficiency
transaction tax and documentary and science stamp taxes. Picop also
protested on 21 May 1983 the deficiency income tax assessment for
1977. These protests were not formally acted upon by respondent CIR.
On 26 September 1984, the CIR issued a warrant of distraint on
personal property and a warrant of levy on real property against Picop,
to enforce collection of the contested assessments; in effect, the CIR
denied Picop's protests.
Thereupon, Picop went before the Court of Tax Appeals ("CTA")
appealing the assessments. After trial, the CTA rendered a decision
dated 15 August 1989, modifying the findings of the CIR and holding
Picop liable for the reduced aggregate amount of P20,133,762.33,
which was itemized in the dispositive portion of the decision as follows:
35% Transaction Tax P 16,020,113.20
Documentary & Science
Stamp Tax 300,300.00
Deficiency Income Tax Due 3,813,349.33
——————
TOTAL AMOUNT DUE AND PAYABLE P 20,133,762.53 2
===========
Picop and the CIR both went to the Supreme Court on separate
Petitions for Review of the above decision of the CTA. In two (2)
Resolutions dated 7 February 1990 and 19 February 1990,
respectively, the Court referred the two (2) Petitions to the Court of
Appeals. The Court of Appeals consolidated the two (2) cases and
rendered a decision, dated 31 August 1992, which further reduced the
liability of Picop to P6,338,354.70. The dispositive portion of the Court
of Appeals decision reads as follows:
WHEREFORE, the appeal of the Commissioner of Internal Revenue is
denied for lack of merit. The judgment against PICOP is modified, as
follows:
1. PICOP is declared liable for the 35% transaction tax in the amount
of P3,578,543.51;
2. PICOP is absolved from the payment of documentary and science
stamp tax of P300,000.00 and the compromise penalty of P300.00;
3. PICOP shall pay 20% interest per annum on the deficiency income
tax of P1,481,579.15, for a period of three (3) years from 21 May 1983,
or in the total amount of P888,947.49, and a surcharge of 10% on the
latter amount, or P88,984.75.
No pronouncement as to costs.
SO ORDERED.
Picop and the CIR once more filed separate Petitions for Review before
the Supreme Court. These cases were consolidated and, on 23 August
1993, the Court resolved to give due course to both Petitions in G.R.
Nos. 106949-50 and 106984-85 and required the parties to file their
Memoranda.
Picop now maintains that it is not liable at all to pay any of the
assessments or any part thereof. It assails the propriety of the thirty-
five percent (35%) deficiency transaction tax which the Court of
Appeals held due from it in the amount of P3,578,543.51. Picop also
questions the imposition by the Court of Appeals of the deficiency
income tax of P1,481,579.15, resulting from disallowance of certain
claimed financial guarantee expenses and claimed year-end
adjustments of sales and cost of sales figures by Picop's external
auditors. 3
The CIR, upon the other hand, insists that the Court of Appeals erred
in finding Picop not liable for surcharge and interest on unpaid
transaction tax and for documentary and science stamp taxes and in
allowing Picop to claim as deductible expenses:
(a) the net operating losses of another corporation (i.e., Rustan Pulp
and Paper Mills, Inc.); and
(b) interest payments on loans for the purchase of machinery and
equipment.
The CIR also claims that Picop should be held liable for interest at
fourteen percent (14%) per annum from 15 April 1978 for three (3)
years, and interest at twenty percent (20%) per annum for a maximum
of three (3) years; and for a surcharge of ten percent (10%), on Picop's
deficiency income tax. Finally, the CIR contends that Picop is liable for
the corporate development tax equivalent to five percent (5%) of its
correct 1977 net income.
The issues which we must here address may be sorted out and
grouped in the following manner:
I. Whether Picop is liable for:
(1) the thirty-five percent (35%) transaction tax;
(2) interest and surcharge on unpaid transaction tax; and
(3) documentary and science stamp taxes;
II. Whether Picop is entitled to deductions against income of:
(1) interest payments on loans for the purchase of machinery and
equipment;
(2) net operating losses incurred by the Rustan Pulp and Paper Mills,
Inc.; and
(3) certain claimed financial guarantee expenses; and
III. (1) Whether Picop had understated its sales and overstated its cost
of sales for 1977; and
(2) Whether Picop is liable for the corporate development tax of five
percent (5%) of its net income for 1977.
We will consider these issues in the foregoing sequence.
I.
(1) Whether Picop is liable
for the thirty-five percent
(35%) transaction tax.
With the authorization of the Securities and Exchange Commission,
Picop issued commercial paper consisting of serially numbered
promissory notes with the total face value of P229,864,000.00 and a
maturity period of one (1) year, i.e., from 24 December 1977 to 23
December 1978. These promissory notes were purchased by various
commercial banks and financial institutions. On these promissory
notes, Picop paid interest in the aggregate amount of P45,771,849.00.
In respect of these interest payments, the CIR required Picop to pay
the thirty-five percent (35%) transaction tax.
The CIR based this assessment on Presidential Decree No. 1154 dated
3 June 1977, which reads in part as follows:
Sec. 1. The National Internal Revenue Code, as amended, is hereby
further amended by adding a new section thereto to read as follows:
Sec. 195-C. Tax on certain interest. — There shall be levied, assessed,
collected and paid on every commercial paper issued in the primary
market as principal instrument, a transaction tax equivalent to thirty-five
percent (35%) based on the gross amount of interest thereto as defined
hereunder, which shall be paid by the borrower/issuer: Provided,
however, that in the case of a long-term commercial paper whose
maturity exceeds more than one year, the borrower shall pay the tax
based on the amount of interest corresponding to one year, and
thereafter shall pay the tax upon accrual or actual payment (whichever
is earlier) of the untaxed portion of the interest which corresponds to a
period not exceeding one year.
The transaction tax imposed in this section shall be a final tax to be paid
by the borrower and shall be allowed as a deductible item for purposes
of computing the borrower's taxable income.
For purposes of this tax —
(a) "Commercial paper" shall be defined as an instrument evidencing
indebtedness of any person or entity, including banks and non-banks
performing quasi-banking functions, which is issued, endorsed, sold,
transferred or in any manner conveyed to another person or entity,
either with or without recourse and irrespective of
maturity. Principally, commercial papers are promissory notes and/or
similar instruments issued in the primary market and shall not include
repurchase agreements, certificates of assignments, certificates of
participations, and such other debt instruments issued in the secondary
market.
(b) The term "interest" shall mean the difference between what the
principal borrower received and the amount it paid upon maturity of the
commercial paper which shall, in no case, be lower than the interest
rate prevailing at the time of the issuance or renewal of the commercial
paper. Interest shall be deemed synonymous with discount and shall
include all fees, commissions, premiums and other payments which
form integral parts of the charges imposed as a consequence of the
use of money.
In all cases, where no interest rate is stated or if the rate stated is lower
than the prevailing interest rate at the time of the issuance or renewal
of commercial paper, the Commissioner of Internal Revenue, upon
consultation with the Monetary Board of the Central Bank of the
Philippines, shall adjust the interest rate in accordance herewith, and
assess the tax on the basis thereof.
The tax herein imposed shall be remitted by the borrower to the
Commissioner of Internal Revenue or his Collection Agent in the
municipality where such borrower has its principal place of business
within five (5) working days from the issuance of the commercial paper.
In the case of long term commercial paper, the tax upon the untaxed
portion of the interest which corresponds to a period not exceeding one
year shall be paid upon accrual payment, whichever is earlier.
(Emphasis supplied)
Both the CTA and the Court of Appeals sustained the assessment of
transaction tax.
In the instant Petition, Picop reiterates its claim that it is exempt from
the payment of the transaction tax by virtue of its tax exemption under
R.A. No. 5186, as amended, known as the Investment Incentives Act,
which in the form it existed in 1977-1978, read in relevant part as
follows:
Sec. 8. Incentives to a Pioneer Enterprise. In addition to the incentives
provided in the preceding section, pioneer enterprises shall be granted
the following incentive benefits:
(a) Tax Exemption. Exemption from all taxes under the National
Internal Revenue Code, except income tax, from the date the area of
investment is included in the Investment Priorities Plan to the following
extent:
(1) One hundred per cent (100%) for the first five years;
(2) Seventy-five per cent (75%) for the sixth through the eighth years;
(3) Fifty per cent (50%) for the ninth and tenth years;
(4) Twenty per cent (20%) for the eleventh and twelfth years; and
(5) Ten per cent (10%) for the thirteenth through the fifteenth year.
xxx xxx xxx 4
We agree with the CTA and the Court of Appeals that Picop's tax
exemption under R.A. No. 5186, as amended, does not include
exemption from the thirty-five percent (35%) transaction tax. In the first
place, the thirty-five percent (35%) transaction tax 5 is an income tax,
that is, it is a tax on the interest income of the lenders or creditors.
In Western Minolco Corporation v. Commissioner of Internal
Revenue, 6 the petitioner corporation borrowed funds from several
financial institutions from June 1977 to October 1977 and paid the
corresponding thirty-five (35%) transaction tax thereon in the amount
of P1,317,801.03, pursuant to Section 210 (b) of the 1977 Tax Code.
Western Minolco applied for refund of that amount alleging it was
exempt from the thirty-five (35%) transaction tax by reason of Section
79-A of C.A. No. 137, as amended, which granted new mines and old
mines resuming operation "five (5) years complete tax exemptions,
except income tax, from the time of its actual bonafide orders for
equipment for commercial production." In denying the claim for refund,
this Court held:
The petitioner's contentions deserve scant consideration. The 35%
transaction tax is imposed on interest income from commercial papers
issued in the primary money market. Being a tax on interest, it is a tax
on income.
As correctly ruled by the respondent Court of Tax Appeals:
Accordingly, we need not and do not think it necessary to discuss
further the nature of the transaction tax more than to say that the
incipient scheme in the issuance of Letter of Instructions No. 340 on
November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational
simplicity and effective administration in capturing the interest-income
"windfall" from money market operations as a new source of revenue,
has lost none of its animating principle in parturition of amendatory
Presidential Decree No. 1154, now Section 210 (b) of the Tax
Code. The tax thus imposed is actually a tax on interest earnings of the
lenders or placers who are actually the taxpayers in whose income is
imposed. Thus "the borrower withholds the tax of 35% from the interest
he would have to pay the lender so that he (borrower) can pay the 35%
of the interest to the Government." (Citation omitted) . . . . Suffice it to
state that the broad consensus of fiscal and monetary authorities is that
"even if nominally, the borrower is made to pay the tax, actually, the tax
is on the interest earning of the immediate and all prior lenders/placers
of the money. . . ." (Rollo, pp. 36-37)
The 35% transaction tax is an income tax on interest earnings to the
lenders or placers. The latter are actually the taxpayers. Therefore, the
tax cannot be a tax imposed upon the petitioner. In other words, the
petitioner who borrowed funds from several financial institutions by
issuing commercial papers merely withheld the 35% transaction tax
before paying to the financial institutions the interests earned by them
and later remitted the same to the respondent Commissioner of Internal
Revenue. The tax could have been collected by a different procedure
but the statute chose this method. Whatever collecting procedure is
adopted does not change the nature of the tax.
xxx xxx xxx 7
(Emphasis supplied)
Much the same issue was passed upon in Marinduque Mining Industrial
Corporation v. Commissioner of Internal Revenue 8 and resolved in the
same way:
It is very obvious that the transaction tax, which is a tax on interest
derived from commercial paper issued in the money market, is not a
tax contemplated in the above-quoted legal provisions. The petitioner
admits that it is subject to income tax. Its tax exemption should be
strictly construed.
We hold that petitioner's claim for refund was justifiably denied. The
transaction tax, although nominally categorized as a business tax, is in
reality a withholding tax as positively stated in LOI No. 340. The
petitioner could have shifted the tax to the lenders or recipients of the
interest. It did not choose to do so. It cannot be heard now to complain
about the tax. LOI No. 340 is an extraneous or extrinsic aid to the
construction of section 210 (b).
xxx xxx xxx 9
(Emphasis supplied)
It is thus clear that the transaction tax is an income tax and as such, in
any event, falls outside the scope of the tax exemption granted to
registered pioneer enterprises by Section 8 of R.A. No. 5186, as
amended. Picop was the withholding agent, obliged to withhold thirty-
five percent (35%) of the interest payable to its lenders and to remit the
amounts so withheld to the Bureau of Internal Revenue ("BIR"). As a
withholding agent, Picop is made personally liable for the thirty-five
percent (35%) transaction tax 10 and if it did not actually withhold thirty-
five percent (35%) of the interest monies it had paid to its lenders, Picop
had only itself to blame.
Picop claims that it had relied on a ruling, dated 6 October 1977, issued
by the CIR, which held that Picop was not liable for the thirty-five (35%)
transaction tax in respect of debenture bonds issued by Picop. Prior to
the issuance of the promissory notes involved in the instant case, Picop
had also issued debenture bonds P100,000,000.00 in aggregate face
value. The managing underwriter of this debenture bond issue, Bancom
Development Corporation, requested a formal ruling from the Bureau
of Internal Revenue on the liability of Picop for the thirty-five percent
(35%) transaction tax in respect of such bonds. The ruling rendered by
the then Acting Commissioner of Internal Revenue, Efren I. Plana,
stated in relevant part:
It is represented that PICOP will be offering to the public primary bonds
in the aggregate principal sum of one hundred million pesos
(P100,000,000.00); that the bonds will be issued as debentures in
denominations of one thousand pesos (P1,000.00) or multiples, to
mature in ten (10) years at 14% interest per annum payable semi-
annually; that the bonds are convertible into common stock of the
issuer at the option of the bond holder at an agreed conversion price;
that the issue will be covered by a "Trust Indenture" with a duly
authorized trust corporation as required by the Securities and
Exchange Commission, which trustee will act for and in behalf of the
debenture bond holders as beneficiaries; that once issued, the bonds
cannot be preterminated by the holder and cannot be redeemed by the
issuer until after eight (8) years from date of issue; that the debenture
bonds will be subordinated to present and future debts of PICOP; and
that said bonds are intended to be listed in the stock exchanges, which
will place them alongside listed equity issues.
In reply, I have the honor to inform you that although the bonds
hereinabove described are commercial papers which will be issued in
the primary market, however, it is clear from the abovestated facts that
said bonds will not be issued as money market instruments. Such being
the case, and considering that the purposes of Presidential Decree No.
1154, as can be gleaned from Letter of Instruction No. 340, dated
November 21, 1975, are (a) to regulate money market transactions and
(b) to ensure the collection of the tax on interest derived from money
market transactions by imposing a withholding tax thereon, said bonds
do not come within the purview of the "commercial papers" intended to
be subjected to the 35% transaction tax prescribed in Presidential
Decree No. 1154, as implemented by Revenue Regulations No. 7-77.
(See Section 2 of said Regulation) Accordingly, PICOP is not subject
to 35% transaction tax on its issues of the aforesaid bonds. However,
those investing in said bonds should be made aware of the fact that the
transaction tax is not being imposed on the issuer of said bonds by
printing or stamping thereon, in bold letters, the following statement:
"ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154.
BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR
INCOME TAX." 11 (Emphases supplied)
In the above quoted ruling, the CIR basically held that Picop's
debenture bonds did not constitute "commercial papers" within the
meaning of P.D. No. 1154, and that, as such, those bonds were not
subject to the thirty-five percent (35%) transaction tax imposed by P.D.
No. 1154.
The above ruling, however, is not applicable in respect of the
promissory notes which are the subject matter of the instant case. It
must be noted that the debenture bonds which were the subject matter
of Commissioner Plana's ruling were long-term bonds maturing in ten
(10) years and which could not be pre-terminated and could not be
redeemed by Picop until after eight (8) years from date of issue; the
bonds were moreover subordinated to present and future debts of
Picop and convertible into common stock of Picop at the option of the
bondholder. In contrast, the promissory notes involved in the instant
case are short-term instruments bearing a one-year maturity period.
These promissory notes constitute the very archtype of money market
instruments. For money market instruments are precisely, by custom
and usage of the financial markets, short-term instruments with a tenor
of one (1) year or less. 12 Assuming, therefore, (without passing upon)
the correctness of the 6 October 1977 BIR ruling, Picop's short-term
promissory notes must be distinguished, and treated differently, from
Picop's long-term debenture bonds.
We conclude that Picop was properly held liable for the thirty-five
percent (35%) transaction tax due in respect of interest payments on
its money market borrowings.
At the same time, we agree with the Court of Appeals that the
transaction tax may be levied only in respect of the interest earnings of
Picop's money market lenders accruing after P.D. No. 1154 went into
effect, and not in respect of all the 1977 interest earnings of such
lenders. The Court of Appeals pointed out that:
PICOP, however contends that even if the tax has to be paid, it should
be imposed only for the interests earned after 20 September 1977 when
PD 1154 creating the tax became effective. We find merit in this
contention. It appears that the tax was levied on interest earnings from
January to October, 1977. However, as found by the lower court, PD
1154 was published in the Official Gazette only on 5 September 1977,
and became effective only fifteen (15) days after the publication, or on
20 September 1977, no other effectivity date having been provided by
the PD. Based on the Worksheet prepared by the Commissioner's
office, the interests earned from 20 September to October 1977 was
P10,224,410.03. Thirty-five (35%) per cent of this is P3,578,543.51
which is all PICOP should pay as transaction tax. 13 (Emphasis
supplied)
P.D. No. 1154 is not, in other words, to be given retroactive effect by
imposing the thirty-five percent (35%) transaction tax in respect of
interest earnings which accrued before the effectivity date of P.D. No.
1154, there being nothing in the statute to suggest that the legislative
authority intended to bring about such retroactive imposition of the tax.
(2) Whether Picop is liable
for interest and surcharge
on unpaid transaction tax.
With respect to the transaction tax due, the CIR prays that Picop be
held liable for a twenty-five percent (25%) surcharge and for interest at
the rate of fourteen percent (14%) per annum from the date prescribed
for its payment. In so praying, the CIR relies upon Section 10 of
Revenue Regulation 7-77 dated 3 June 1977, 14 issued by the
Secretary of Finance. This Section reads:
Sec. 10. Penalties. — Where the amount shown by the taxpayer to be
due on its return or part of such payment is not paid on or before the
date prescribed for its payment, the amount of the tax shall be
increased by twenty-five (25%) per centum, the increment to be a part
of the tax and the entire amount shall be subject to interest at the rate
of fourteen (14%) per centum per annum from the date prescribed for
its payment.
In the case of willful neglect to file the return within the period
prescribed herein or in case a false or fraudulent return is willfully
made, there shall be added to the tax or to the deficiency tax in case
any payment has been made on the basis of such return before the
discovery of the falsity or fraud, a surcharge of fifty (50%) per centum
of its amount. The amount so added to any tax shall be collected at the
same time and in the same manner and as part of the tax unless the
tax has been paid before the discovery of the falsity or fraud, in which
case the amount so added shall be collected in the same manner as
the tax.
In addition to the above administrative penalties, the criminal and civil
penalties as provided for under Section 337 of the Tax Code of 1977
shall be imposed for violation of any provision of Presidential Decree
No. 1154. 15 (Emphases supplied)
The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the
same Code, invoked by the Secretary of Finance in issuing Revenue
Regulation 7-77, set out, in comprehensive terms, the rule-making
authority of the Secretary of Finance:
Sec. 326. Authority of Secretary of Finance to Promulgate Rules and
Regulations. — The Secretary of Finance, upon recommendation of the
Commissioner of Internal Revenue, shall promulgate all needful rules
and regulations for the effective enforcement of the provisions of this
Code. (Emphasis supplied)
Section 4 of the same Code contains a list of subjects or areas to be
dealt with by the Secretary of Finance through the medium of an
exercise of his quasi-legislative or rule-making authority. This list,
however, while it purports to be open-ended, does not include the
imposition of administrative or civil penalties such as the payment of
amounts additional to the tax due. Thus, in order that it may be held to
be legally effective in respect of Picop in the present case, Section 10
of Revenue Regulation 7-77 must embody or rest upon some provision
in the Tax Code itself which imposes surcharge and penalty interest for
failure to make a transaction tax payment when due.
P.D. No. 1154 did not itself impose, nor did it expressly authorize the
imposition of, a surcharge and penalty interest in case of failure to pay
the thirty-five percent (35%) transaction tax when due. Neither did
Section 210 (b) of the 1977 Tax Code which re-enacted Section 195-C
inserted into the Tax Code by P.D. No. 1154.
The CIR, both in its petition before the Court of Appeals and its Petition
in the instant case, points to Section 51 (e) of the 1977 Tax Code as its
source of authority for assessing a surcharge and penalty interest in
respect of the thirty-five percent (35%) transaction tax due from Picop.
This Section needs to be quoted in extenso:
Sec. 51. Payment and Assessment of Income Tax. —
(c) Definition of deficiency. — As used in this Chapter in respect of a
tax imposed by this Title, the term "deficiency" means:
(1) The amount by which the tax imposed by this Title exceeds the
amount shown as the tax by the taxpayer upon his return; but the
amount so shown on the return shall first be increased by the amounts
previously assessed (or collected without assessment) as a deficiency,
and decreased by the amount previously abated, credited, returned, or
otherwise in respect of such tax; . . .
xxx xxx xxx
(e) Additions to the tax in case of non-payment. —
(1) Tax shown on the return. — Where the amount determined by the
taxpayer as the tax imposed by this Title or any installment thereof, or
any part of such amount or installment is not paid on or before the date
prescribed for its payment, there shall be collected as a part of the tax,
interest upon such unpaid amount at the rate of fourteen per centum
per annum from the date prescribed for its payment until it is
paid: Provided, That the maximum amount that may be collected as
interest on deficiency shall in no case exceed the amount
corresponding to a period of three years, the present provisions
regarding prescription to the contrary notwithstanding.
(2) Deficiency. — Where a deficiency, or any interest assessed in
connection therewith under paragraph (d) of this section, or any
addition to the taxes provided for in Section seventy-two of this Code is
not paid in full within thirty days from the date of notice and demand
from the Commissioner of Internal Revenue, there shall be collected
upon the unpaid amount as part of the tax, interest at the rate of
fourteen per centum per annum from the date of such notice and
demand until it is paid: Provided, That the maximum amount that may
be collected as interest on deficiency shall in no case exceed the
amount corresponding to a period of three years, the present provisions
regarding prescription to the contrary notwithstanding.
(3) Surcharge. — If any amount of tax included in the notice and
demand from the Commissioner of Internal Revenue is not paid in full
within thirty days after such notice and demand, there shall be collected
in addition to the interest prescribed herein and in paragraph (d) above
and as part of the tax a surcharge of five per centum of the amount of
tax unpaid. (Emphases supplied)
Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2) above,
provides:
Sec. 72. Surcharges for failure to render returns and for rendering false
and fraudulent returns. — In case of willful neglect to file the return or
list required by this Title within the time prescribed by law, or in case a
false or fraudulent return or list is wilfully made, the Commissioner of
Internal Revenue shall add to the tax or to the deficiency tax, in case
any payment has been made on the basis of such return before the
discovery of the falsity or fraud, as surcharge of fifty per centum of the
amount of such tax or deficiency tax. In case of any failure to make and
file a return or list within the time prescribed by law or by the
Commissioner or other Internal Revenue Officer, not due to willful
neglect, the Commissioner of Internal Revenue shall add to the
tax twenty-five per centum of its amount, except that, when a return is
voluntarily and without notice from the Commissioner or other officer
filed after such time, and it is shown that the failure to file it was due to
a reasonable cause, no such addition shall be made to the tax. The
amount so added to any tax shall be collected at the same time, in the
same manner and as part of the tax unless the tax has been paid before
the discovery of the neglect, falsity, or fraud, in which case the amount
so added shall be collected in the same manner as the tax. (Emphases
supplied)
It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977
Tax Code, authorize the imposition of surcharge and interest only in
respect of a "tax imposed by this Title," that is to say, Title II on "Income
Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes
a surcharge only in case of failure to file a return or list "required by this
Title," that is, Title II on "Income Tax." The thirty-five percent (35%)
transaction tax is, however, imposed in the 1977 Tax Code by Section
210 (b) thereof which Section is embraced in Title V on "Taxes on
Business" of that Code. Thus, while the thirty-five percent (35%)
transaction tax is in truth a tax imposed on interest income earned by
lenders or creditors purchasing commercial paper on the money
market, the relevant provisions, i.e., Section 210 (b), were not inserted
in Title II of the 1977 Tax Code. The end result is that the thirty-five
percent (35%) transaction tax is not one of the taxes in respect of which
Section 51 (e) authorized the imposition of surcharge and interest and
Section 72 the imposition of a fraud surcharge.
It is not without reluctance that we reach the above conclusion on the
basis of what may well have been an inadvertent error in legislative
draftsmanship, a type of error common enough during the period of
Martial Law in our country. Nevertheless, we are compelled to adopt
this conclusion. We consider that the authority to impose what the
present Tax Code calls (in Section 248) civil penalties consisting of
additions to the tax due, must be expressly given in the enabling
statute, in language too clear to be mistaken. The grant of that authority
is not lightly to be assumed to have been made to administrative
officials, even to one as highly placed as the Secretary of Finance.
The state of the present law tends to reinforce our conclusion that
Section 51 (c) and (e) of the 1977 Tax Code did not authorize the
imposition of a surcharge and penalty interest for failure to pay the
thirty-five percent (35%) transaction tax imposed under Section 210 (b)
of the same Code. The corresponding provision in the current Tax
Code very clearly embraces failure to pay all taxes imposed in the Tax
Code, without any regard to the Title of the Code where provisions
imposing particular taxes are textually located. Section 247 (a) of the
NIRC, as amended, reads:
Title X
Statutory Offenses and Penalties
Chapter I
Additions to the Tax
Sec. 247. General Provisions. — (a) The additions to the tax or
deficiency tax prescribed in this Chapter shall apply to all taxes, fees
and charges imposed in this Code. The amount so added to the tax
shall be collected at the same time, in the same manner and as part of
the tax. . . .
Sec. 248. Civil Penalties. — (a) There shall be imposed, in addition to
the tax required to be paid, penalty equivalent to twenty-five percent
(25%) of the amount due, in the following cases:
xxx xxx xxx
(3) failure to pay the tax within the time prescribed for its payment; or
xxx xxx xxx
(c) the penalties imposed hereunder shall form part of the tax and the
entire amount shall be subject to the interest prescribed in Section 249.
Sec. 249. Interest. — (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
regulations, from the date prescribed for payment until the amount is
fully paid. . . . (Emphases supplied)
In other words, Section 247 (a) of the current NIRC supplies what did
not exist back in 1977 when Picop's liability for the thirty-five percent
(35%) transaction tax became fixed. We do not believe we can fill that
legislative lacuna by judicial fiat. There is nothing to suggest that
Section 247 (a) of the present Tax Code, which was inserted in 1985,
was intended to be given retroactive application by the legislative
authority. 16
(3) Whether Picop is Liable
for Documentary and
Science Stamp Taxes.
As noted earlier, Picop issued sometime in 1977 long-term
subordinated convertible debenture bonds with an aggregate face
value of P100,000,000.00. Picop stated, and this was not disputed by
the CIR, that the proceeds of the debenture bonds were in fact utilized
to finance the BOI-registered operations of Picop. The CIR assessed
documentary and science stamp taxes, amounting to P300,000.00, on
the issuance of Picop's debenture bonds. It is claimed by Picop that its
tax exemption — "exemption from all taxes under the National Internal
Revenue Code, except income tax" on a declining basis over a certain
period of time — includes exemption from the documentary and
science stamp taxes imposed under the NIRC.
The CIR, upon the other hand, stresses that the tax exemption under
the Investment Incentives Act may be granted or recognized only to the
extent that the claimant Picop was engaged in registered
operations, i.e., operations forming part of its integrated pulp and paper
project. 17 The borrowing of funds from the public, in the submission of
the CIR, was not an activity included in Picop's registered operations.
The CTA adopted the view of the CIR and held that "the issuance of
convertible debenture bonds [was] not synonymous [with] the
manufactur[ing] operations of an integrated pulp and paper mill." 18
The Court of Appeals took a less rigid view of the ambit of the tax
exemption granted to registered pioneer enterprises. Said the Court of
Appeals:
. . . PICOP's explanation that the debenture bonds were issued to
finance its registered operation is logical and is unrebutted. We are
aware that tax exemptions must be applied strictly against the
beneficiary in order to deter their abuse. It would indeed be altogether
a different matter if there is a showing that the issuance of the
debenture bonds had no bearing whatsoever on the registered
operations PICOP and that they were issued in connection with a totally
different business undertaking of PICOP other than its registered
operation. There is, however, a dearth of evidence in this regard. It
cannot be denied that PICOP needed funds for its operations. One of
the means it used to raise said funds was to issue debenture
bonds. Since the money raised thereby was to be used in its registered
operation, PICOP should enjoy the incentives granted to it by R.A.
5186, one of which is the exemption from payment of all taxes under
the National Internal Revenue Code, except income taxes, otherwise
the purpose of the incentives would be defeated. Documentary and
science stamp taxes on debenture bonds are certainly not income
taxes. 19 (Emphasis supplied)
Tax exemptions are, to be sure, to be "strictly construed," that is, they
are not to be extended beyond the ordinary and reasonable intendment
of the language actually used by the legislative authority in granting the
exemption. The issuance of debenture bonds is certainly conceptually
distinct from pulping and paper manufacturing operations. But no one
contends that issuance of bonds was a principal or regular business
activity of Picop; only banks or other financial institutions are in the
regular business of raising money by issuing bonds or other
instruments to the general public. We consider that the actual
dedication of the proceeds of the bonds to the carrying out of Picop's
registered operations constituted a sufficient nexus with such
registered operations so as to exempt Picop from stamp taxes
ordinarily imposed upon or in connection with issuance of such bonds.
We agree, therefore, with the Court of Appeals on this matter that the
CTA and the CIR had erred in rejecting Picop's claim for exemption
from stamp taxes.
It remains only to note that after commencement of the present litigation
before the CTA, the BIR took the position that the tax exemption
granted by R.A. No. 5186, as amended, does include exemption from
documentary stamp taxes on transactions entered into by BOI-
registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for
instance, held that a registered preferred pioneer enterprise engaged
in the manufacture of integrated circuits, magnetic heads, printed circuit
boards, etc., is exempt from the payment of documentary stamp taxes.
The Commissioner said:
You now request a ruling that as a preferred pioneer enterprise, you
are exempt from the payment of Documentary Stamp Tax (DST).
In reply, please be informed that your request is hereby granted.
Pursuant to Section 46 (a) of Presidential Decree No. 1789, pioneer
enterprises registered with the BOI are exempt from all taxes under the
National Internal Revenue Code, except from all taxes under the
National Internal Revenue Code, except income tax, from the date the
area of investment is included in the Investment Priorities Plan to the
following extent:
xxx xxx xxx
Accordingly, your company is exempt from the payment of
documentary stamp tax to the extent of the percentage aforestated on
transactions connected with the registered business activity. (BIR
Ruling No. 111-81) However, if said transactions conducted by you
require the execution of a taxable document with other parties, said
parties who are not exempt shall be the one directly liable for the tax.
(Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other
words, said parties shall be liable to the same percentage
corresponding to your tax exemption. (Emphasis supplied)
Similarly, in BIR Ruling No. 013, dated 6 February 1989, the
Commissioner held that a registered pioneer enterprise producing
polyester filament yarn was entitled to exemption "from the
documentary stamp tax on [its] sale of real property in Makati up to
December 31, 1989." It appears clear to the Court that the CIR,
administratively at least, no longer insists on the position it originally
took in the instant case before the CTA.
II
(1) Whether Picop is entitled
to deduct against current
income interest payments
on loans for the purchase
of machinery and equipment.
In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in
order to finance the purchase of machinery and equipment needed for
its operations. In its 1977 Income Tax Return, Picop claimed interest
payments made in 1977, amounting to P42,840,131.00, on these loans
as a deduction from its 1977 gross income.
The CIR disallowed this deduction upon the ground that, because the
loans had been incurred for the purchase of machinery and equipment,
the interest payments on those loans should have been capitalized
instead and claimed as a depreciation deduction taking into account
the adjusted basis of the machinery and equipment (original acquisition
cost plus interest charges) over the useful life of such assets.
Both the CTA and the Court of Appeals sustained the position of Picop
and held that the interest deduction claimed by Picop was proper and
allowable. In the instant Petition, the CIR insists on its original position.
We begin by noting that interest payments on loans incurred by a
taxpayer (whether BOI-registered or not) are allowed by the NIRC as
deductions against the taxpayer's gross income. Section 30 of the 1977
Tax Code provided as follows:
Sec. 30. Deduction from Gross Income. — The following may be
deducted from gross income:
(a) Expenses:
xxx xxx xxx
(b) Interest:
(1) In general. — The amount of interest paid within the taxable year
on indebtedness, except on indebtedness incurred or continued to
purchase or carry obligations the interest upon which is exempt from
taxation as income under this Title: . . . (Emphasis supplied)
Thus, the general rule is that interest expenses are deductible against
gross income and this certainly includes interest paid under loans
incurred in connection with the carrying on of the business of the
taxpayer. 20 In the instant case, the CIR does not dispute that the
interest payments were made by Picop on loans incurred in connection
with the carrying on of the registered operations of Picop, i.e., the
financing of the purchase of machinery and equipment actually used in
the registered operations of Picop. Neither does the CIR deny that such
interest payments were legally due and demandable under the terms
of such loans, and in fact paid by Picop during the tax year 1977.
The CIR has been unable to point to any provision of the 1977 Tax
Code or any other Statute that requires the disallowance of the interest
payments made by Picop. The CIR invokes Section 79 of Revenue
Regulations No. 2 as amended which reads as follows:
Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or
other purposes on account of capital or surplus invested in the
business, which does not represent a charge arising under an interest-
bearing obligation, is not allowable deduction from gross income.
(Emphases supplied)
We read the above provision of Revenue Regulations No. 2 as referring
to so called "theoretical interest," that is to say, interest "calculated" or
computed (and not incurred or paid) for the purpose of determining the
"opportunity cost" of investing funds in a given business. Such
"theoretical" or imputed interest does not arise from a legally
demandable interest-bearing obligation incurred by the taxpayer who
however wishes to find out, e.g., whether he would have been better off
by lending out his funds and earning interest rather than investing such
funds in his business. One thing that Section 79 quoted above makes
clear is that interest which does constitute a charge arising under an
interest-bearing obligation is an allowable deduction from gross
income.
It is claimed by the CIR that Section 79 of Revenue Regulations No. 2
was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and
Carrying Charges Chargeable to Capital Account and Treated as
Capital Items" of the U.S. Income Tax Regulations, which paragraph
reads as follows:
(B) Taxes and Carrying Charges. — The items thus chargeable to
capital accounts are —
(11) In the case of real property, whether improved or unimproved and
whether productive or nonproductive.
(a) Interest on a loan (but not theoretical interest of a taxpayer using his
own funds). 21
The truncated excerpt of the U.S. Income Tax Regulations quoted by
the CIR needs to be related to the relevant provisions of the U.S.
Internal Revenue Code, which provisions deal with the general topic of
adjusted basis for determining allowable gain or loss on sales or
exchanges of property and allowable depreciation and depletion of
capital assets of the taxpayer:
Present Rule. The Internal Revenue Code, and the Regulations
promulgated thereunder provide that "No deduction shall be allowed for
amounts paid or accrued for such taxes and carrying charges as,
under regulations prescribed by the Secretary or his delegate, are
chargeable to capital account with respect to property, if the taxpayer
elects, in accordance with such regulations, to treat such taxes
or charges as so chargeable."
At the same time, under the adjustment of basis provisions which have
just been discussed, it is provided that adjustment shall be made for all
"expenditures, receipts, losses, or other items" properly chargeable to
a capital account, thus including taxes and carrying charges;
however, an exception exists, in which event such adjustment to the
capital account is not made, with respect to taxes and carrying charges
which the taxpayer has not elected to capitalize but for which a
deduction instead has been taken. 22 (Emphasis supplied)
The "carrying charges" which may be capitalized under the above
quoted provisions of the U.S. Internal Revenue Code include, as the
CIR has pointed out, interest on a loan "(but not theoretical interest of
a taxpayer using his own funds)." What the CIR failed to point out is
that such "carrying charges" may, at the election of the taxpayer, either
be (a) capitalized in which case the cost basis of the capital assets,
e.g., machinery and equipment, will be adjusted by adding the amount
of such interest payments or alternatively, be (b) deducted from gross
income of the taxpayer. Should the taxpayer elect to deduct the interest
payments against its gross income, the taxpayer cannot at the same
time capitalize the interest payments. In other words, the taxpayer
is not entitled to both the deduction from gross income and the adjusted
(increased) basis for determining gain or loss and the allowable
depreciation charge. The U.S. Internal Revenue Code does not prohibit
the deduction of interest on a loan obtained for purchasing machinery
and equipment against gross income, unless the taxpayer has also or
previously capitalized the same interest payments and thereby
adjusted the cost basis of such assets.
We have already noted that our 1977 NIRC does not prohibit the
deduction of interest on a loan incurred for acquiring machinery and
equipment. Neither does our 1977 NIRC compel the capitalization of
interest payments on such a loan. The 1977 Tax Code is simply silent
on a taxpayer's right to elect one or the other tax treatment of such
interest payments. Accordingly, the general rule that interest payments
on a legally demandable loan are deductible from gross income must
be applied.
The CIR argues finally that to allow Picop to deduct its interest
payments against its gross income would be to encourage fraudulent
claims to double deductions from gross income:
[t]o allow a deduction of incidental expense/cost incurred in the
purchase of fixed asset in the year it was incurred would invite tax
evasion through fraudulent application of double deductions from gross
income. 23 (Emphases supplied)
The Court is not persuaded. So far as the records of the instant cases
show, Picop has not claimed to be entitled to double deduction of its
1977 interest payments. The CIR has neither alleged nor proved that
Picop had previously adjusted its cost basis for the machinery and
equipment purchased with the loan proceeds by capitalizing the interest
payments here involved. The Court will not assume that the CIR would
be unable or unwilling to disallow "a double deduction" should Picop,
having deducted its interest cost from its gross income, also attempt
subsequently to adjust upward the cost basis of the machinery and
equipment purchased and claim, e.g., increased deductions for
depreciation.
We conclude that the CTA and the Court of Appeals did not err in
allowing the deductions of Picop's 1977 interest payments on its loans
for capital equipment against its gross income for 1977.
(2) Whether Picop is entitled
to deduct against current
income net operating losses
incurred by Rustan Pulp
and Paper Mills, Inc.
On 18 January 1977, Picop entered into a merger agreement with the
Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing
Corporation ("RMC"). Under this agreement, the rights, properties,
privileges, powers and franchises of RPPM and RMC were to be
transferred, assigned and conveyed to Picop as the surviving
corporation. The entire subscribed and outstanding capital stock of
RPPM and RMC would be exchanged for 2,891,476 fully paid up Class
"A" common stock of Picop (with a par value of P10.00) and 149,848
shares of preferred stock of Picop (with a par value of P10.00), to be
issued by Picop, the result being that Picop would wholly own both
RPPM and RMC while the stockholders of RPPM and RMC would join
the ranks of Picop's shareholders. In addition, Picop paid off the
obligations of RPPM to the Development Bank of the Philippines
("DBP") in the amount of P68,240,340.00, by issuing 6,824,034 shares
of preferred stock (with a par value of P10.00) to the DBP. The merger
agreement was approved in 1977 by the creditors and stockholders of
Picop, RPPM and RMC and by the Securities and Exchange
Commission. Thereupon, on 30 November 1977, apparently the
effective date of merger, RPPM and RMC were dissolved. The Board
of Investments approved the merger agreement on 12 January 1978.
It appears that RPPM and RMC were, like Picop, BOI-registered
companies. Immediately before merger effective date, RPPM had over
preceding years accumulated losses in the total amount of
P81,159,904.00. In its 1977 Income Tax Return, Picop claimed
P44,196,106.00 of RPPM's accumulated losses as a deduction against
Picop's 1977 gross income. 24
Upon the other hand, even before the effective date of merger, on 30
August 1977, Picop sold all the outstanding shares of RMC stock to
San Miguel Corporation for the sum of P38,900,000.00, and reported a
gain of P9,294,849.00 from this transaction. 25
In claiming such deduction, Picop relies on section 7 (c) of R.A. No.
5186 which provides as follows:
Sec. 7. Incentives to Registered Enterprise. — A registered
enterprise, to the extent engaged in a preferred area of investment,
shall be granted the following incentive benefits:
xxx xxx xxx
(c) Net Operating Loss Carry-over. — A net operating loss incurred in
any of the first ten years of operations may be carried over as a
deduction from taxable income for the six years immediately following
the year of such loss. The entire amount of the loss shall be carried
over to the first of the six taxable years following the loss, and any
portion of such loss which exceeds the taxable income of such first year
shall be deducted in like manner from the taxable income of the next
remaining five years. The net operating loss shall be computed in
accordance with the provisions of the National Internal Revenue Code,
any provision of this Act to the contrary notwithstanding, except that
income not taxable either in whole or in part under this or other laws
shall be included in gross income. (Emphasis supplied)
Picop had secured a letter-opinion from the BOI dated 21 February
1977 — that is, after the date of the agreement of merger but before
the merger became effective — relating to the deductibility of the
previous losses of RPPM under Section 7 (c) of R.A. No. 5186 as
amended. The pertinent portions of this BOI opinion, signed by BOI
Governor Cesar Lanuza, read as follows:
2) PICOP will not be allowed to carry over the losses of Rustan prior to
the legal dissolution of the latter because at that time the two (2)
companies still had separate legal personalities;
3) After BOI approval of the merger, PICOP can no longer apply for the
registration of the registered capacity of Rustan because with the
approved merger, such registered capacity of Rustan transferred to
PICOP will have the same registration date as that of Rustan. In this
case, the previous losses of Rustan may be carried over by PICOP,
because with the merger, PICOP assumes all the rights and obligations
of Rustan subject, however, to the period prescribed for carrying over
of such
losses. 26 (Emphasis supplied)
Curiously enough, Picop did not also seek a ruling on this matter,
clearly a matter of tax law, from the Bureau of Internal Revenue. Picop
chose to rely solely on the BOI letter-opinion.
The CIR disallowed all the deductions claimed on the basis of RPPM's
losses, apparently on two (2) grounds. Firstly, the previous losses were
incurred by "another taxpayer," RPPM, and not by Picop in connection
with Picop's own registered operations. The CIR took the view that
Picop, RPPM and RMC were merged into one (1) corporate personality
only on 12 January 1978, upon approval of the merger agreement by
the BOI. Thus, during the taxable year 1977, Picop on the one hand
and RPPM and RMC on the other, still had their separate juridical
personalities. Secondly, the CIR alleged that these losses had been
incurred by RPPM "from the borrowing of funds" and not from carrying
out of RPPM's registered operations. We focus on the first ground. 27
The CTA upheld the deduction claimed by Picop; its reasoning,
however, is less than crystal clear, especially in respect of its view of
what the U.S. tax law was on this matter. In any event, the CTA
apparently fell back on the BOI opinion of 21 February 1977 referred to
above. The CTA said:
Respondent further averred that the incentives granted under Section
7 of R.A. No. 5186 shall be available only to the extent in which they
are engaged in registered operations, citing Section 1 of Rule IX of the
Basic Rules and Regulations to Implement the Intent and Provisions of
the Investment Incentives Act, R.A. No. 5186.
We disagree with respondent. The purpose of the merger was to
rationalize the container board industry and not to take advantage of
the net losses incurred by RPPMI prior to the stock swap. Thus, when
stock of a corporation is purchased in order to take advantage of the
corporation's net operating loss incurred in years prior to the purchase,
the corporation thereafter entering into a trade or business different
from that in which it was previously engaged, the net operating loss
carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5,
Mertens, Law of Federal Income Taxation, Chap. 29.11a, p.
103]. 28 Furthermore, once the BOI approved the merger agreement,
the registered capacity of Rustan shall be transferred to PICOP, and
the previous losses of Rustan may be carried over by PICOP by
operation of law. [BOI ruling dated February 21, 1977 (Exh. J-1)] It is
clear therefrom, that the deduction availed of under Section 7(c) of R.A.
No. 5186 was only proper." (pp. 38-43, Rollo of SP No.
20070) 29 (Emphasis supplied)
In respect of the above underscored portion of the CTA decision, we
must note that the CTA in fact overlooked the statement made by
petitioner's counsel before the CTA that:
Among the attractions of the merger to Picop was the accumulated net
operating loss carry-over of RMC that it might possibly use to relieve it
(Picop) from its income taxes, under Section 7 (c) of R.A. 5186. Said
section provides:
xxx xxx xxx
With this benefit in mind, Picop addressed three (3) questions to the
BOI in a letter dated November 25, 1976. The BOI replied on February
21, 1977 directly answering the three (3) queries. 30 (Emphasis
supplied)
The size of RPPM's accumulated losses as of the date of the merger
— more than P81,000,000.00 — must have constituted a powerful
attraction indeed for Picop.
The Court of Appeals followed the result reached by the CTA. The
Court of Appeals, much like the CTA, concluded that since RPPM was
dissolved on 30 November 1977, its accumulated losses were
appropriately carried over by Picop in the latter's 1977 Income Tax
Return "because by that time RPPMI and Picop were no longer
separate and different taxpayers." 31
After prolonged consideration and analysis of this matter, the Court is
unable to agree with the CTA and Court of Appeals on the deductibility
of RPPM's accumulated losses against Picop's 1977 gross income.
It is important to note at the outset that in our jurisdiction, the ordinary
rule — that is, the rule applicable in respect of
corporations not registered with the BOI as a preferred pioneer
enterprise — is that net operating losses cannot be carried over. Under
our Tax Code, both in 1977 and at present, losses may be deducted
from gross income only if such losses were actually sustained in the
same year that they are deducted or charged off. Section 30 of the 1977
Tax Code provides:
Sec. 30. Deductions from Gross Income. — In computing net income,
there shall be allowed as deduction —
xxx xxx xxx
(d) Losses:
(1) By Individuals. — In the case of an individual, losses actually
sustained during the taxable year and not compensated for by an
insurance or otherwise —
(A) If incurred in trade or business;
xxx xxx xxx
(2) By Corporations. — In a case of a corporation, all losses actually
sustained and charged off within the taxable year and not compensated
for by insurance or otherwise.
(3) By Non-resident Aliens or Foreign Corporations. — In the case of a
non-resident alien individual or a foreign corporation, the losses
deductible are those actually sustained during the year incurred in
business or trade conducted within the Philippines, . . . 32 (Emphasis
supplied)
Section 76 of the Philippine Income Tax Regulations (Revenue
Regulation No. 2, as amended) is even more explicit and detailed:
Sec. 76. When charges are deductible. — Each year's return, so far as
practicable, both as to gross income and deductions therefrom should
be complete in itself, and taxpayers are expected to make every
reasonable effort to ascertain the facts necessary to make a correct
return. The expenses, liabilities, or deficit of one year cannot be used
to reduce the income of a subsequent year. A taxpayer has the right to
deduct all authorized allowances and it follows that if he does not within
any year deduct certain of his expenses, losses, interests, taxes, or
other charges,
he can not deduct them from the income of the next or any succeeding
year. . . .
xxx xxx xxx
. . . . If subsequent to its occurrence, however, a taxpayer first
ascertains the amount of a loss sustained during a prior taxable
year which has not been deducted from gross income, he may
render an amended return for such preceding taxable year including
such amount of loss in the deduction from gross income and may in
proper cases file a claim for refund of the excess paid by reason of the
failure to deduct such loss in the original return. A loss from theft or
embezzlement occurring in one year and discovered in another is
ordinarily deductible for the year in which sustained. (Emphases
supplied)
It is thus clear that under our law, and outside the special realm of BOI-
registered enterprises, there is no such thing as a carry-over of net
operating loss. To the contrary, losses must be deducted against
current income in the taxable year when such losses were incurred.
Moreover, such losses may be charged off only against income earned
in the same taxable year when the losses were incurred.
Thus it is that R.A. No. 5186 introduced the carry-over of net operating
losses as a very special incentive to be granted only to registered
pioneer enterprises and only with respect to their registered operations.
The statutory purpose here may be seen to be the encouragement of
the establishment and continued operation of pioneer industries by
allowing the registered enterprise to accumulate its operating losses
which may be expected during the early years of the enterprise and to
permit the enterprise to offset such losses against income earned by it
in later years after successful establishment and regular operations. To
promote its economic development goals, the Republic foregoes or
defers taxing the income of the pioneer enterprise until after that
enterprise has recovered or offset its earlier losses. We consider that
the statutory purpose can be served only if the accumulated operating
losses are carried over and charged off against income subsequently
earned and accumulated by the same enterprise engaged in the same
registered operations.
In the instant case, to allow the deduction claimed by Picop would be
to permit one corporation or enterprise, Picop, to benefit from the
operating losses accumulated by another corporation or enterprise,
RPPM. RPPM far from benefiting from the tax incentive granted by the
BOI statute, in fact gave up the struggle and went out of existence and
its former stockholders joined the much larger group of Picop's
stockholders. To grant Picop's claimed deduction would be to permit
Picop to shelter its otherwise taxable income (an objective which Picop
had from the very beginning) which had not been earned by the
registered enterprise which had suffered the accumulated losses. In
effect, to grant Picop's claimed deduction would be to permit Picop to
purchase a tax deduction and RPPM to peddle its accumulated
operating losses. Under the CTA and Court of Appeals decisions, Picop
would benefit by immunizing P44,196,106.00 of its income from
taxation thereof although Picop had not run the risks and incurred the
losses which had been encountered and suffered by RPPM.
Conversely, the income that would be shielded from taxation is not
income that was, after much effort, eventually generated by the same
registered operations which earlier had sustained losses. We consider
and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which
either requires or permits such a result. Indeed, that result makes non-
sense of the legislative purpose which may be seen clearly to be
projected by Section 7 (c), R.A. No. 5186.
The CTA and the Court of Appeals allowed the offsetting of RPPM's
accumulated operating losses against Picop's 1977 gross income,
basically because towards the end of the taxable year 1977, upon the
arrival of the effective date of merger, only one (1) corporation, Picop,
remained. The losses suffered by RPPM's registered operations and
the gross income generated by Picop's own registered operations now
came under one and the same corporate roof. We consider that this
circumstance relates much more to form than to substance. We do not
believe that that single purely technical factor is enough to authorize
and justify the deduction claimed by Picop. Picop's claim for deduction
is not only bereft of statutory basis; it does violence to the legislative
intent which animates the tax incentive granted by Section 7 (c) of R.A.
No. 5186. In granting the extraordinary privilege and incentive of a net
operating loss carry-over to BOI-registered pioneer enterprises, the
legislature could not have intended to require the Republic to forego tax
revenues in order to benefit a corporation which had run no risks and
suffered no losses, but had merely purchased another's losses.
Both the CTA and the Court of Appeals appeared much impressed not
only with corporate technicalities but also with the U.S. tax law on this
matter. It should suffice, however, simply to note that in U.S. tax law,
the availability to companies generally of operating loss carry-overs and
of operating loss carry-backs is expressly provided and regulated in
great detail by statute. 33 In our jurisdiction, save for Section 7 (c) of
R.A. No. 5186, no statute recognizes or permits loss carry-overs and
loss carry-backs. Indeed, as already noted, our tax law expressly
rejects the very notion of loss carry-overs and carry-backs.
We conclude that the deduction claimed by Picop in the amount of
P44,196,106.00 in its 1977 Income Tax Return must be disallowed.
(3) Whether Picop is entitled
to deduct against current
income certain claimed
financial guarantee expenses.
In its Income Tax Return for 1977, Picop also claimed a deduction in
the amount of P1,237,421.00 as financial guarantee expenses.
This deduction is said to relate to chattel and real estate mortgages
required from Picop by the Philippine National Bank ("PNB") and DBP
as guarantors of loans incurred by Picop from foreign creditors.
According to Picop, the claimed deduction represents registration fees
and other expenses incidental to registration of mortgages in favor of
DBP and PNB.
In support of this claimed deduction, Picop allegedly showed its own
vouchers to BIR Examiners to prove disbursements to the Register of
Deeds of Tandag, Surigao del Sur, of particular amounts. In the
proceedings before the CTA, however, Picop did not submit in evidence
such vouchers and instead presented one of its employees to testify
that the amount claimed had been disbursed for the registration of
chattel and real estate mortgages.
The CIR disallowed this claimed deduction upon the ground of
insufficiency of evidence. This disallowance was sustained by the CTA
and the Court of Appeals. The CTA said:
No records are available to support the abovementioned expenses.
The vouchers merely showed that the amounts were paid to the
Register of Deeds and simply cash account. Without the supporting
papers such as the invoices or official receipts of the Register of Deeds,
these vouchers standing alone cannot prove that the payments made
were for the accrued expenses in question. The best evidence of
payment is the official receipts issued by the Register of Deeds. The
testimony of petitioner's witness that the official receipts and cash
vouchers were shown to the Bureau of Internal Revenue will not suffice
if no records could be presented in court for proper marking and In its assessment for deficiency income tax for 1977, the CIR claimed
identification. 34 Emphasis supplied) that Picop had understated its sales by P2,391,644.00 and, upon the
other hand, overstated its cost of sales by P604,018.00. Thereupon,
The Court of Appeals added: the CIR added back both sums to Picop's net income figure per its own
return.
The mere testimony of a witness for PICOP and the cash vouchers do
not suffice to establish its claim that registration fees were paid to the The 1977 Income Tax Return of Picop set forth the following figures:
Register of Deeds for the registration of real estate and chattel
mortgages in favor of Development Bank of the Philippines and the Sales (per Picop's Income Tax Return):
Philippine National Bank as guarantors of PICOP's loans. The witness
could very well have been merely repeating what he was instructed to Paper P 537,656,719.00
say regardless of the truth, while the cash vouchers, which we do not
find on file, are not said to provide the necessary details regarding the Timber P 263,158,132.00
nature and purpose of the expenses reflected therein. PICOP should
have presented, through the guarantors, its owner's copy of the ———————
registered titles with the lien inscribed thereon as well as an official
receipt from the Register of Deeds evidencing payment of the Total Sales P 800,814,851.00
registration fee. 35 (Emphasis supplied)
============
We must support the CTA and the Court of Appeals in their foregoing
rulings. A taxpayer has the burden of proving entitlement to a claimed Upon the other hand, Picop's Books of Accounts reflected higher sales
deduction. 36 In the instant case, even Picop's own vouchers were not figures:
submitted in evidence and the BIR Examiners denied that such
vouchers and other documents had been exhibited to them. Moreover, Sales (per Picop's Books of Accounts):
cash vouchers can only confirm the fact of disbursement but not
necessarily the purpose thereof. 37 The best evidence that Picop should Paper P 537,656,719.00
have presented to support its claimed deduction were the invoices and
official receipts issued by the Register of Deeds. Picop not only failed Timber P 265,549,776.00
to present such documents; it also failed to explain the loss thereof,
———————
assuming they had existed before. 38 Under the best evidence
rule, 39 therefore, the testimony of Picop's employee was inadmissible
Total Sales P 803,206,495.00
and was in any case entitled to very little, if any, credence.
============
We consider that entitlement to Picop's claimed deduction of
P1,237,421.00 was not adequately shown and that such deduction The above figures thus show a discrepancy between the sales figures
must be disallowed.
reflected in Picop's Books of Accounts and the sales figures reported
in its 1977 Income Tax Return, amounting to: P2,391,644.00.
III
The CIR also contended that Picop's cost of sales set out in its 1977
(1) Whether Picop had understated
Income Tax Return, when compared with the cost figures in its Books
its sales and overstated its
of Accounts, was overstated:
cost of sales for 1977.
Cost of Sales
(per Income Tax Return) P607,246,084.00
Cost of Sales
(per Books of Accounts) P606,642,066.00
———————
Discrepancy P 604,018.00
============
Picop did not deny the existence of the above noted discrepancies. In
the proceedings before the CTA, Picop presented one of its officials to
explain the foregoing discrepancies. That explanation is perhaps best
presented in Picop's own words as set forth in its Memorandum before
this Court:
. . . that the adjustment discussed in the testimony of the witness,
represent the best and most objective method of determining in pesos
the amount of the correct and actual export sales during the year. It was
this correct and actual export sales and costs of sales that were
reflected in the income tax return and in the audited financial
statements. These corrections did not result in realization of income
and should not give rise to any deficiency tax.
xxx xxx xxx
What are the facts of this case on this matter? Why were adjustments
necessary at the year-end?
Because of PICOP's procedure of recording its export sales (reckoned
in U.S. dollars) on the basis of a fixed rate, day to day and month to
month, regardless of the actual exchange rate and without waiting
when the actual proceeds are received. In other words, PICOP
recorded its export sales at a pre-determined fixed exchange rate. That
pre-determined rate was decided upon at the beginning of the year and
continued to be used throughout the year.
At the end of the year, the external auditors made an examination. In
that examination, the auditors determined with accuracy the actual
dollar proceeds of the export sales received. What exchange rate was
used by the auditors to convert these actual dollar proceeds into
Philippine pesos? They used the average of the differences between
(a) the recorded fixed exchange rate and (b) the exchange rate at the
time the proceeds were actually received. It was this rate at time of
receipt of the proceeds that determined the amount of pesos credited
by the Central Bank (through the agent banks) in favor of PICOP. These
accumulated differences were averaged by the external auditors and
this was what was used at the year-end for income tax and other
government-report purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40
The above explanation, unfortunately, at least to the mind of the Court,
raises more questions than it resolves. Firstly, the explanation assumes
that all of Picop's sales were export sales for which U.S. dollars (or
other foreign exchange) were received. It also assumes that the
expenses summed up as "cost of sales" were all dollar expenses and
that no peso expenses had been incurred. Picop's explanation further
assumes that a substantial part of Picop's dollar proceeds for its export
sales were not actually surrendered to the domestic banking system
and seasonably converted into pesos; had all such dollar proceeds
been converted into pesos, then the peso figures could have been
simply added up to reflect the actual peso value of Picop's export sales.
Picop offered no evidence in respect of these assumptions, no
explanation why and how a "pre-determined fixed exchange rate" was
chosen at the beginning of the year and maintained throughout.
Perhaps more importantly, Picop was unable to explain why its Books
of Accounts did not pick up the same adjustments that Picop's External
Auditors were alleged to have made for purposes of Picop's Income
Tax Return. Picop attempted to explain away the failure of its Books of
Accounts to reflect the same adjustments (no correcting entries,
apparently) simply by quoting a passage from a case where this Court
refused to ascribe much probative value to the Books of Accounts of a
corporate taxpayer in a tax case. 41 What appears to have eluded
Picop, however, is that its Books of Accounts, which are kept by its own
employees and are prepared under its control and supervision, reflect
what may be deemed to be admissions against interest in the instant
case. For Picop's Books of Accounts precisely show higher sales
figures and lower cost of sales figures than Picop's Income Tax Return.
It is insisted by Picop that its Auditors' adjustments simply present the
"best and most objective" method of reflecting in pesos the "correct
and ACTUAL export sales" 42 and that the adjustments or "corrections"
"did not result in realization of [additional] income and should not give
rise to any deficiency tax." The correctness of this contention is not self-
evident. So far as the record of this case shows, Picop did not submit
in evidence the aggregate amount of its U.S. dollar proceeds of its
export sales; neither did it show the Philippine pesos it had actually
received or been credited for such U.S. dollar proceeds. It is clear to
this Court that the testimonial evidence submitted by Picop fell far short
of demonstrating the correctness of its explanation.
Upon the other hand, the CIR has made out at least a prima facie case
that Picop had understated its sales and overstated its cost of sales as
set out in its Income Tax Return. For the CIR has a right to assume that
Picop's Books of Accounts speak the truth in this case since, as already
noted, they embody what must appear to be admissions against Picop's
own interest.
Accordingly, we must affirm the findings of the Court of Appeals and
the CTA.
(2) Whether Picop is liable for
the corporate development
tax of five percent (5%)
of its income for 1977.
The five percent (5%) corporate development tax is an additional
corporate income tax imposed in Section 24 (e) of the 1977 Tax Code
which reads in relevant part as follows:
(e) Corporate development tax. — In addition to the tax imposed in
subsection (a) of this section, an additional tax in an amount equivalent
to 5 per cent of the same taxable net income shall be paid by a domestic
or a resident foreign corporation; Provided, That this additional tax shall
be imposed only if the net income exceeds 10 per cent of the net worth,
in case of a domestic corporation, or net assets in the Philippines in
case of a resident foreign corporation: . . . .
The additional corporate income tax imposed in this subsection shall
be collected and paid at the same time and in the same manner as the
tax imposed in subsection (a) of this section.
Since this five percent (5%) corporate development tax is
an income tax, Picop is not exempted from it under the provisions of
Section 8 (a) of R.A. No. 5186.
For purposes of determining whether the net income of a corporation
exceeds ten percent (10%) of its net worth, the term "net worth" means
the stockholders' equity represented by the excess of the total assets
over liabilities as reflected in the corporation's balance sheet provided
such balance sheet has been prepared in accordance with generally
accepted accounting principles employed in keeping the books of the
corporation. 43
The adjusted net income of Picop for 1977, as will be seen below, is
P48,687,355.00. Its net worth figure or total stockholders' equity as
reflected in its Audited Financial Statements for 1977 is
P464,749,528.00. Since its adjusted net income for 1977 thus
exceeded ten percent (10%) of its net worth, Picop must be held liable
for the five percent (5%) corporate development tax in the amount of
P2,434,367.75.
Recapitulating, we hold:
(1) Picop is liable for the thirty-five percent (35%) transaction tax in the
amount of P3,578,543.51.
(2) Picop is not liable for interest and surcharge on unpaid transaction
tax.
(3) Picop is exempt from payment of documentary and science stamp
taxes in the amount of P300,000.00 and the compromise penalty of
P300.00.
(4) Picop is entitled to its claimed deduction of P42,840,131.00 for
interest payments on loans for, among other things, the purchase of
machinery and equipment.
(5) Picop's claimed deduction in the amount of P44,196,106.00 for the
operating losses previously incurred by RPPM, is disallowed for lack of
merit.
(6) Picop's claimed deduction for certain financial guarantee expenses
in the amount P1,237,421.00 is disallowed for failure adequately to
prove such expenses.
(7) Picop has understated its sales by P2,391,644.00 and overstated
its cost of sales by P604,018.00, for 1977.
(8) Picop is liable for the corporate development tax of five percent (5%)
of its adjusted net income for 1977 in the amount of P2,434,367.75.
Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled Deficiency Income Tax P 16,560,216.00
to hold Picop liable for deficiency income tax for the year 1977
computed as follows: Add:

Deficiency Income Tax Five percent (5%) Corporate

Development Tax P 2,434,367.00
Net Income Per Return P 258,166.00
Total Deficiency Income Tax P 18,994,583.00
Add:
===========
Unallowable Deductions
Add:
(1) Deduction of net
operating losses Five percent (5%) surcharge 45 P 949,729.15
incurred by RPPM P 44,196,106.00
——————
(2) Unexplained financial
guarantee expenses P 1,237,421.00 Total Deficiency Income Tax

(3) Understatement of with surcharge P 19,944,312.15

Sales P 2,391,644.00
Add:
(4) Overstatement of
Cost of Sales P 604,018.00 Fourteen percent (14%)

—————— interest from 15 April

Total P 48,429,189.00 1978 to 14 April 1981 46 P 8,376,610.80

—————— Fourteen percent (14%)

Net Income as Adjusted P 48,687,355.00 interest from 21 April

=========== 1983 to 20 April 1986 47 P 11,894,787.00

Income Tax Due Thereon 44 P 17,030,574.00 ——————

Less: Total Deficiency Income Tax

Tax Already Assessed per Due and Payable P 40,215,709.00

Return 80,358.00
===========
——————
WHEREFORE, for all the foregoing, the Decision of the Court of
Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay
the CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1) Thirty-five percent (35%)

transaction tax P 3,578,543.51

(2) Total Deficiency Income

Tax Due 40,215,709.00

———————

Aggregate Amount Due and Payable P 43,794,252.51

============

No pronouncement as to costs.

SO ORDERED.

Narvasa, C.J., Regalado, Davide, Jr., Romero, Bellosillo, Melo, Puno,

\
CIR vs. Itogon Suyoc Mines

Respondent Itogon-Suyoc Mines, a mining corporation duly organized

and existing under Philippine laws fild its income tax return.

Fiscal year (1956-1960) paid PhP 13, 155.20 as the first installment of
the income tax due. Then filed an amended income tax return
reporting a net loss of PhP 331,707.33

Fiscal year (1960-1961) setting forth its income tax liability of PhP
97.345 but deducting the amount of PhP 13,155.20 representing
alleged tax credit for over-payment of the preceding fiscal year 1959-
1960.

Petitioner assessed against the respondent the amount of PhP

1,512.83 as 1% monthly interest. The basis for such an assessment
was the absence of legal right to deduct said amount before the
refund or tax credit thereof was approved by petitioner CIR.

ISSUE: WON respondent corporation is liable to pay the sum of

PhP1,512.83 as 1% monthly interest for delinquency in the payment
of income tax.?

HELD:
NIRC provides that interest upon the amount determined as a
deficiency shall be assessed and shall be paid upon notice and
demand from the CIR at the specified. If in any preceding year the tax
payer was entitled to a refund of any amount due as tax, such
amount, if not yet refunded, maybe deducted from the tax to be paid
Gancayco vs.Collector

Gancyaco files his income tax return for the year 1949. Respondent
issued a warrant of distraint and levy against the properties of
Gancayco for the satisfaction of his deficiency income tax liability, and
accordingly, the municipal treasurer issued a notice of sale of said
property at public auction. Gancayco filed a petition to cancel the sale
and direct that the same be re-advertised at a future date

ISSUE: Whether the sum of PhP 16,860.31 is due from Gancayco as

deficiency income tax for 1949 hinges on the validity of his claim for
deduction:
a) farming expense PhP 27,459
b) representation expenses PhP 8,933.45

HELD:
a)Farming Expenses - no evidence has been presnted as to the
nature of the said farming expenses other than the care statement of
petitioner that they were spent for the development and cultivation of
his property.

No specification has been made as to the actual amount spent for

purchase of tools, equipment or materials or the amount spent for
improvement.

b) Representation expense
PhP 22, 820 is allowed
PhP 8,993.45 is disallowed because of the absence of recipt, invoices
or vouchers of the expenditures in question, petitioner could not
sspecify the items constituting the same when or on whom or on what
they were incurred.
Commissioner of Internal Revenue
Facts:
Hoskins, a domestic corporation engaged in the real estate business
as broker, managing agents and administrators, filed its income tax
return (ITR) showing a net income of P92,540.25 and a tax liability of
P18,508 which it paid.
In the case, Hoskins fails to pass the test. CTA was correct in holding
that the payment of the company to Mr. Hoskins of the sum
P99,977.91 as 50% share of supervision fees received by the
company was inordinately large and could not be treated as an
ordinary and necessary expenses allowed for deduction.

CIR disallowed 4 items of deductions in the ITR. Court of Tax Appeals

upheld the disallowance of an item which was paid to Mr. C. Hoskins
representing 50% of supervision fees earned and set aside the
disallowance of the other 3 items.

Issue:

Whether or not the disallowance of the 4 items were proper.

Held:

NOT deductible. It did not pass the test of reasonableness which is:

General rule, bonuses to employees made in good faith and as

additional compensation for services actually rendered by the
employees are deductible, provided such payments, when added to
the salaries do not exceed the compensation for services rendered.

The conditions precedent to the deduction of bonuses to employees

are:

· Payment of bonuses is in fact compensation

· Must be for personal services actually rendered

· Bonuses when added to salaries are reasonable when

measured by the amount and quality of services performed with
relation to the business of the particular taxpayer.

There is no fixed test for determining the reasonableness of a given

bonus as compensation. This depends upon many factors.
CIR V GENERAL FOODS
GR No. 143672| April 24, 2003 | J. Corona
Test of Reasonableness
Facts:
Respondent corporation General Foods (Phils), which is engaged in the
manufacture of “Tang”, “Calumet” and “Kool-Aid”, filed its income tax
return for the fiscal year ending February 1985 and claimed as
deduction, among other business expenses, P9,461,246 for media
advertising for “Tang”.
The Commissioner disallowed 50% of the deduction claimed and
assessed deficiency income taxes of P2,635,141.42 against General
Foods, prompting the latter to file an MR which was denied.
General Foods later on filed a petition for review at CA, which reversed
and set aside an earlier decision by CTA dismissing the company’s
appeal.
Issue:
W/N the subject media advertising expense for “Tang” was ordinary
and necessary expense fully deductible under the NIRC
Held:
No. Tax exemptions must be construed in stricissimi juris against the
taxpayer and liberally in favor of the taxing authority, and he who claims
an exemption must be able to justify his claim by the clearest grant of
organic or statute law. Deductions for income taxes partake of the
nature of tax exemptions; hence, if tax exemptions are strictly
construed, then deductions must also be strictly construed.
To be deductible from gross income, the subject advertising expense
must comply with the following requisites: (a) the expense must be
ordinary and necessary; (b) it must have been paid or incurred during
the taxable year; (c) it must have been paid or incurred in carrying on
the trade or business of the taxpayer; and (d) it must be supported by
receipts, records or other pertinent papers.
While the subject advertising expense was paid or incurred within the
corresponding taxable year and was incurred in carrying on a trade or
business, hence necessary, the parties’ views conflict as to whether or
not it was ordinary. To be deductible, an advertising expense should
not only be necessary but also ordinary.
The Commissioner maintains that the subject advertising expense was
not ordinary on the ground that it failed the two conditions set by U.S.
jurisprudence: first, “reasonableness” of the amount incurred and
second, the amount incurred must not be a capital outlay to create
“goodwill” for the product and/or private respondent’s business.
Otherwise, the expense must be considered a capital expenditure to be
spread out over a reasonable time.
There is yet to be a clear-cut criteria or fixed test for determining the
reasonableness of an advertising expense. There being no hard and
fast rule on the matter, the right to a deduction depends on a number
of factors such as but not limited to: the type and size of business in
which the taxpayer is engaged; the volume and amount of its net
earnings; the nature of the expenditure itself; the intention of the
taxpayer and the general economic conditions. It is the interplay of
these, among other factors and properly weighed, that will yield a
proper evaluation.
The Court finds the subject expense for the advertisement of a single
product to be inordinately large. Therefore, even if it is necessary, it
cannot be considered an ordinary expense deductible under then
Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate
the current sale of merchandise or use of services and (2) advertising
designed to stimulate the future sale of merchandise or use of services.
The second type involves expenditures incurred, in whole or in part, to
create or maintain some form of goodwill for the taxpayer’s trade or
business or for the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising of the first kind,
then, except as to the question of the reasonableness of amount, there
is no doubt such expenditures are deductible as business expenses. If,
however, the expenditures are for advertising of the second kind, then
normally they should be spread out over a reasonable period of time.
The company’s media advertising expense for the promotion of a single
product is doubtlessly unreasonable considering it comprises almost
one-half of the company’s entire claim for marketing expenses for that
year under review. Petition granted, judgment reversed and set
aside.
CIR V. Isabela Cultural Corp. (2007)
THIRD DIVISION
G.R. No. 172231 February 12, 2007
YNARES-SANTIAGO, J.
Lessons Applicable: Accrual method, burden of proof in accrual
method, deductibility of ordinary and necessary trade, business, or
professional expenses, all events test
Laws Applicable:
FACTS:
BIR disallowed Isabela Cultural Corp. deductible expenses for
services which were rendered in 1984 and 1985 but only billed, paid
and claimed as a deduction on 1986.
After CA sent its demand letters, Isabela protested.
CTA found it proper to be claimed in 1986 and affirmed by CA
ISSUE: W/N Isabela who uses accrual method can claim on 1986 only
HELD: case is remanded to the BIR for the computation of Isabela
Cultural Corporation’s liability under Assessment Notice No. FAS-1-86-
90-000680.
NO
The requisites for the deductibility of ordinary and necessary trade,
business, or professional expenses, like expenses paid for legal and
auditing services, are:
(a) the expense must be ordinary and necessary;
(b) it must have been paid or incurred during the taxable year; - qualified
by Section 45 of the National Internal Revenue Code (NIRC) which
states that: "[t]he deduction provided for in this Title shall be taken for
the taxable year in which ‘paid or accrued’ or ‘paid or incurred’,
dependent upon the method of accounting upon the basis of which the
net income is computed
(c) it must have been paid or incurred in carrying on the trade or
business of the taxpayer; and
(d) it must be supported by receipts, records or other pertinent papers.
Revenue Audit Memorandum Order No. 1-2000, provides that under
the accrual method of accounting, expenses not being claimed as
deductions by a taxpayer in the current year when they are incurred
cannot be claimed as deduction from income for the succeeding year.
Thus, a taxpayer who is authorized to deduct certain expenses and
other allowable deductions for the current year but failed to do so
cannot deduct the same for the next year.
The accrual method relies upon the taxpayer’s right to receive amounts
or its obligation to pay them, in opposition to actual receipt or payment,
which characterizes the cash method of accounting. Amounts of
income accrue where the right to receive them become fixed, where
there is created an enforceable liability. Similarly, liabilities are accrued
when fixed and determinable in amount, without regard to
indeterminacy merely of time of payment.
The accrual of income and expense is permitted when the all-events
test has been met. This test requires: (1) fixing of a right to income or
liability to pay; and (2) the availability of the reasonable accurate
determination of such income or liability.
The all-events test requires the right to income or liability be fixed, and
the amount of such income or liability be determined with reasonable
accuracy. However, the test does not demand that the amount of
income or liability be known absolutely, only that a taxpayer has at his
disposal the information necessary to compute the amount with
reasonable accuracy. The all-events test is satisfied where computation
remains uncertain, if its basis is unchangeable; the test is satisfied
where a computation may be unknown, but is not as much as
unknowable, within the taxable year. The amount of liability does not
have to be determined exactly; it must be determined with "reasonable
accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate amount.
The propriety of an accrual must be judged by the facts that a taxpayer
knew, or could reasonably be expected to have known, at the closing
of its books for the taxable year.
Accrual method of accounting presents largely a question of fact; such
that the taxpayer bears the burden of proof of establishing the accrual
of an item of income or deduction.

In the instant case, the expenses for professional fees consist of

expenses for legal and auditing services. The expenses for legal
services pertain to the 1984 and 1985 legal and retainer fees of the law
firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and
for reimbursement of the expenses of said firm in connection with ICC’s
tax problems for the year 1984. As testified by the Treasurer of ICC,
the firm has been its counsel since the 1960’s. - failed to prove the
burden

Labels: 2007, Accrual method, all events test, burden of proof in

accrual method, Case Digest, CIR v. Isabela Cultural
Corp., expenses, February 12, G.R. No. 172231, tax case digest
PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES
(PICOP) v. CA, CIR and CTA, G.R. Nos. 106949-50 (1995)
Facts:
Paper Industries Corporation of the Philippines (PICOP) is a Philippine
corporation registered with the Board of Investments (BOI) as a
preferred pioneer enterprise with respect to its integrated pulp and
paper mill, and as a preferred non-pioneer enterprise with respect to its
integrated plywood and veneer mills. Petitioner received from the
Commissioner of Internal Revenue (CIR) two (2) letters of assessment
and demand (a) one for deficiency transaction tax and for documentary
and science stamp tax; and (b) the other for deficiency income tax for
1977, for an aggregate amount of PhP88,763,255.00.
PICOP protested the assessment of deficiency transaction tax , the
documentary and science stamp taxes, and the deficiency income tax
assessment. CIR did not formally act upon these protests, but issued a
warrant of distraint on personal property and a warrant of levy on real
property against PICOP, to enforce collection of the contested
assessments, thereby denying PICOP's protests. Thereupon, PICOP
went before (CTA) appealing the assessments.
On 15 August 1989, CTA rendered a decision, modifying the CIR’s
findings and holding PICOP liable for the reduced aggregate amount of
P20,133,762.33. Both parties went to the Supreme Court, which
referred the case to the Court of Appeals (CA).
CA denied the appeal of the CIR and modified the judgment against
PICOP holding it liable for transaction tax and absolved it from payment
of documentary and science stamp tax and compromise penalty. It
also held PICOP liable for deficiency of income tax.
Issues:
1. Whether PICOP is liable for transaction tax
2. Whether PICOP is liable for documentary and science stamp tax
3. Whether PICOP is liable for deficiency income tax
Held:
1. YES. PICOP reiterates that it is exempt from the payment of the
transaction tax by virtue of its tax exemption under R.A. No. 5186, as
amended, known as the Investment Incentives Act, which in the form it
existed in 1977-1978, read in relevant part as follows: "SECTION 8.
Incentives to a Pioneer Enterprise. — In addition to the incentives
provided in the preceding section, pioneer enterprises shall be granted
the following incentive benefits: (a) Tax Exemption. Exemption from all
taxes under the National Internal Revenue Code, except income tax,
from the date of investment is included in the Investment Priorities Plan
x x x”. The Supreme Court holds that that PICOP's tax exemption under
R.A. No. 5186, as amended, does not include exemption from the thirty-
five percent (35%) transaction tax. In the first place, the thirty-five
percent (35%) transaction tax is an income tax, a tax on the interest
income of the lenders or creditors as held by the Supreme Court in the
case of Western Minolco Corporation v. Commissioner of Internal
Revenue. The 35% transaction tax is an income tax on interest
earnings to the lenders or placers. The latter are actually the taxpayers.
Therefore, the tax cannot be a tax imposed upon the petitioner. In other
words, the petitioner who borrowed funds from several financial
institutions by issuing commercial papers merely withheld the 35%
transaction tax before paying to the financial institutions the interest
earned by them and later remitted the same to the respondent CIR. The
tax could have been collected by a different procedure but the statute
chose this method. Whatever collecting procedure is adopted does not
change the nature of the tax. It is thus clear that the transaction tax is
an income tax and as such, in any event, falls outside the scope of the
tax exemption granted to registered pioneer enterprises by Section 8 of
R.A. No. 5186, as amended. PICOP was the withholding agent, obliged
to withhold thirty-five percent (35%) of the interest payable to its lenders
and to remit the amounts so withheld to the Bureau of Internal Revenue
("BIR"). As a withholding, agent, PICOP is made personally liable for
the thirty-five percent (35%) transaction tax 10 and if it did not actually
withhold thirty-five percent (35%) of the interest monies it had paid to
its lenders, PICOP had only itself to blame.
2. NO. The CIR assessed documentary and science stamp taxes,
amounting to PhP300,000.00, on the issuance of PICOP's debenture
bonds. Tax exemptions are, to be sure, to be "strictly construed," that
is, they are not to be extended beyond the ordinary and reasonable
intendment of the language actually used by the legislative authority in
granting the exemption. The issuance of debenture bonds is certainly
conceptually distinct from pulping and paper manufacturing operations.
But no one contends that issuance of bonds was a principal or regular Aggregate Amount Due and Payable P 43,794,252.51
business activity of PICOP; only banks or other financial institutions are
in the regular business of raising money by issuing bonds or other
instruments to the general public. The actual dedication of the proceeds
of the bonds to the carrying out of PICOP's registered operations
constituted a sufficient nexus with such registered operations so as to
exempt PICOP from taxes ordinarily imposed upon or in connection
with issuance of such bonds. The Supreme Court agrees with the Court
of Appeals on this matter that the CTA and the CIR had erred in
rejecting PICOP's claim for exemption from stamp taxes.

3. YES. PICOP did not deny the existence of discrepancy in their

Income Tax Return and Books of Account owing to their procedure of
recording its export sales (reckoned in U.S. dollars) on the basis of a
fixed rate, day to day and month to month, regardless of the actual
exchange rate and without waiting when the actual proceeds are
received. In other words, PICOP recorded its export sales at a pre-
determined fixed exchange rate. That pre-determined rate was decided
upon at the beginning of the year and continued to be used throughout
the year. Because of this, the CIR has made out at least a prima facie
case that PICOP had understated its sales and overstated its cost of
sales as set out in its Income Tax Return. For the CIR has a right to
assume that PICOP's Books of Accounts speak the truth in this case
since, as already noted, they embody what must appear to be
admissions against PICOP's own interest.

Dispositive:

WHEREFORE, for all the foregoing, the Decision of the Court of

Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay
the CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1) Thirty-five percent (35%) transaction

tax P 3,578,543.51

(2) Total Deficiency Income Tax

Due P 40,215,709.00
 Commissioner of Internal Revenue vs. Central Luzon Drug
Corporation
G.R. No. 159647 April 15, 2005
Facts:
Respondents operated six drugstores under the business name
Mercury Drug. From January to December 1996 respondent granted
20% sales discount to qualified senior citizens on their purchases of
medicines pursuant to RA 7432 for a total of ₱ 904,769.
A tax credit generally refers to an amount that is “subtracted directly
from one’s total tax liability.” It is an “allowance against the tax itself”
or “a deduction from what is owed” by a taxpayer to the government.
A tax credit should be understood in relation to other tax concepts.
One of these is tax deduction – which is subtraction “from income for
tax purposes,” or an amount that is “allowed by law to reduce income
prior to the application of the tax rate to compute the amount of tax
which is due.” In other words, whereas a tax credit reduces the tax
due, tax deduction reduces the income subject to tax in order to arrive
at the taxable income.

On April 15, 1997, respondent filed its annual Income Tax Return for
taxable year 1996 declaring therein net losses. On Jan. 16, 1998
respondent filed with petitioner a claim for tax refund/credit of ₱
904,769.00 allegedly arising from the 20% sales discount. Unable to
obtain affirmative response from petitioner, respondent elevated its
claim to the Court of Tax Appeals. The court dismissed the same but
upon reconsideration, the latter reversed its earlier ruling and ordered
petitioner to issue a Tax Credit Certificate in favor of respondent citing
CA GR SP No. 60057 (May 31, 2001, Central Luzon Drug Corp. vs.
CIR) citing that Sec. 229 of RA 7432 deals exclusively with illegally
collected or erroneously paid taxes but that there are other situations
which may warrant a tax credit/refund.
A tax credit is used to reduce directly the tax that is due, there ought
to be a tax liability before the tax credit can be applied. Without that
liability, any tax credit application will be useless. There will be no
reason for deducting the latter when there is, to begin with, no existing
obligation to the government. However, as will be presented shortly,
the existence of a tax credit or its grant by law is not the same as the
availment or use of such credit. While the grant is mandatory, the
availment or use is not. If a net loss is reported by, and no other taxes
are currently due from, a business establishment, there will obviously
be no tax liability against which any tax credit can be applied. For the
establishment to choose the immediate availment of a tax credit will
be premature and impracticable.

CA affirmed Court of Tax Appeal's decision reasoning that RA 7432

required neither a tax liability nor a payment of taxes by private
establishments prior to the availment of a tax credit. Moreover, such
credit is not tantamount to an unintended benefit from the law, but
rather a just compensation for the taking of private property for public
use.

Issue:
Whether or not respondent, despite incurring a net loss, may still
claim the 20% sales discount as a tax credit.

Ruling:
Yes, it is clear that Sec. 4a of RA 7432 grants to senior citizens the
privilege of obtaining a 20% discount on their purchase of medicine
from any private establishment in the country. The latter may then
claim the cost of the discount as a tax credit. Such credit can be
claimed even if the establishment operates at a loss.