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Republic of the Philippines SUPREME COURT Manila EN BANC

G.R. No. L-61632 August 16, 1983 WESTERN MINOLCO CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. Raul Correa and Cenon Sorreta for petitioner. The Solicitor General for respondents.

GUTIERREZ JR., J.:


This is a petition for review on certiorari of a Court of Tax Appeal's decision denying the petitioner's claim for the refund of P1,317,801.03, representing Money market transaction taxes which the petitioner paid from June 3, 1977 to August 5, 1977, and the resolution denying its motion for reconsideration. Petitioner is a domestic corporation engaged in mining, particularly copper concentrates for export mined from mineral lands in Atok and Kibungan, Benguet. In October 1972, upon application for tax exemption filed with the Bureau of Mines, the petitioner was granted Certificate of Qualification for Tax Exemption No. 34. On December 24, 1976, the petitioner was also granted by the Securities and Exchange Commission, under Certificate of Renewal No. R-1056, authority to borrow money and issue commercial papers. Pursuant to this authority, the petitioner borrowed funds from several financial institutions from June, 1977 to October 1977 and paid the corresponding 35% transaction tax due thereon in the amount of

P1,317,801.03, The tax was paid pursuant to Section 210 (b) of the National Internal Revenue Code of 1977. On February 16, 1978, the petitioner applied for the refund of the P1,317,801.03 alleging that it was not liable to pay the 35% transaction tax under its Certificate of Qualification for Tax Exemption No. 34 issued by the Secretary of Agriculture and Natural Resources, and pursuant to Section 79-A of Commonwealth Act No. 137, otherwise known as The Mining Act and Presidential Decree No. 463, the Mineral Resources Development Decree of 1974, as implemented by Consolidated Mines Administrative Order of the Secretary of Natural Resources dated May 17, 1974. On February 19, 1979, the respondent Commissioner of internal Revenue denied the petitioner's claim for refund. On May 29, 1979, the petitioner filed a petition for review with the respondent Court of Tax Appeals. On August 28, 1979, the Commissioner of Internal Revenue filed his answer alleging inter alia that: xxx xxx xxx (a) The 35% transaction tax is actually a tax on the interest earnings of the lender who is actually the taxpayer on whose income, the tax is imposed; (b) Petitioner did not pay the 35", transaction tax in its own behalf, as this liability has been fully shifted to and paid for the account of the lender: (c) Petitioner merely acted as withholding agent in paying (d) the 35% transaction tax based on the gross interest income of the (e) lender; (d) Petitioner's exemption from taxes granted under Sections 52 and 53 of Presidential Decree No. 463 relates to importations of machineries, tools and equipment to be used in the mining operations and

taxes on mining claims, improvement thereon and mineral products, whereas the 35% transaction tax is levied on transactions pertaining to commercial papers issued in the primary money market as principal instruments; in other words, Sections 52 and 53 of P.D. 463 do not apply to this case of petitioner. After due hearing but before the respondent court could render its decision, the petitioner filed a pleading entitled "Request for Judicial Notice and Request for Admission" alleging that the subject tax was paid in the nature of a business tax, that petitioner's claim for refund is based on its exemption from business taxes, and that its exemption is protected by existing tax exemptions granted it under the mining law. On January 29, 1982, the respondent court denied the petitioner's "Request for Judicial Notice and Request for Admission. " On May 21, 1982, the respondent court rendered its decision dismissing the petition for review for lack of merit. The petitioner raised the following assignments of errors: Assignment of error No. 1 THAT THE TAX COURT ERRONEOUSLY CONCLUDED BY SUPPORTING RESPONDENT COMMISSIONER'S CONTENTION THAT THE 35% TRANSACTION TAX ON COMMERCIAL PAPER (INVOLVED IN THIS CASE) IS AN INCOME TAX IMPOSED UPON THE INTEREST EARNINGS OF THE MONEY LENDER WHO (ACCORDING TO THE TAX COURT) IS ACTUALLY THE TAX PAYER ON WHOSE INCOME THE 35r7(, TAX IS IMPOSED. Assignment of Error No. 2 THAT THE TAX COURT ERRED IN THAT ITS CONCLUSIONS CONTRAVENE THE MANDATES IN SAID P.D. No. 1154 (particularly SEC. 2 OF WHICH) AMENDING SECTION 291b) OF THE 1977 REVENUE CODE BY EXCLUDING FROM GROSS INCOME' THE 'INTEREST EARNED ON

COMMERCIAL PAPER ISSUED IN THE PRIMARY MARKET (WHICH) SHALL NOT BE INCLUDED IN THE DETERMINATION OF GROSS INCOME OF THE LENDER FOR PURPOSES OF INCOME TAXATION Assignment of Error No. 3 THAT THE TAX COURT ERRED IN CONFUSING TWO DISTINCT AND SEPARATE ASPECTS OF THE TAXATION AND THE PERSONS OF THE TAX PAYER AS IF THEY ARE ONE AND THE SAME PERSON, WHEN THE LAW TREATS THEM AS TOTALLY DISTINCT AND SEPARATE PERSONS AND ASPECTS THEREOF.-NAMELY: (A) THE INCIDENCE OF THE TAX AND THE PERSON LEGALLY LIABLE FOR THE TAX; AND THE (B) 'ACTUAL PAYOR' OR 'RESULTING PAYOR' OF THE 35, of TRANSACTION TAX. Assignment of Error No. 4 THAT THE TAX COURT ERRED IN RULING THAT THE 35% TRANSACTION TAX IS AN INCOME TAX FROM WHICH MINOLCO IS NOT EXEMPT AND NOT A BUSINESS TAX. Assignment of Error No. 5 THAT THE TAX COURT ERRED IN CONFUSING THE 'INCIDENT OF THE TAX AND THE ACTUAL PAYOR' OR 'RESULTING PAYOR' OF THE 35% TRANSACTION TAX; THAT CONFUSION OF THE TWO SEPARATE PERSONS HAS RESULTED INTO THE ERRONEOUS CONCLUSION THAT THE 35% TRANSACTION TAX IS AN INCOME TAX IMPOSED UPON THE INTEREST EARNED BY THE MONEY LENDER INVOLVED IN THE ISSUANCE OF THE COMMERCIAL PAPER UPON WHICH INTEREST INCOME IS PAID OR COLLECTED: THAT THIS ERROR HAS RESULTED IN RESPONDENT COMMISSIONER'S AND SHE TAX COURT'S) VIEW THAT PETITIONER MINOLCO IS A WITHHOLDING

AGENT IN RESPECT OF THE INCOME TAX DUE TO BE WITHHELD ON INTEREST INCOME OF MONEY LENDER. Assign ment of Error No.6 THAT THE TAX COURT ERRED IN FAILING TO RECOGNIZE THAT PETITIONER MINOLCO IS A QUALIFIED MINING LESSEE AND DEVELOPER UNDER THE MINING LAW (C.A. No. t37, As Amended), AND UNDER THE MINERAL RESOURCES DEVELOPMENT DECREE OF 1974 (P.D. No. 463, As Amended); THAT AS SUCH PETITIONER IS EXEMPTED FROM ALL TAXES (EXEMPT INCOME TAX) PURSUANT TO THE LAW AND THE IMPLEMENTING REGULATIONS THEREOF (CONSOLIDATED MINES ADMINISTRATIVE ORDER, DATED AND EFFECTIVE MAY 17,1975); FURTHER, THAT THE TAX COURT HAS ERRONEOUSLY RULED TO IMPOSE THE INCOME TAX UPON MINOLCO WHICH IS BASED ON SECTION 24 OF THE REVENUE CODE AND MAY NOT BE THE SUBJECT OF THE LITIGATION AS PART OF PETITIONER'S APPEAL BEFORE THE TAX COURT. Assignment of Error No. 7 THAT RESPONDENT I HAVE FAILED TO CONSIDER THE 'WHEREAS CLAUSES OF THE ENABLING ACT IMPOSING THE 35% TRANSACTION TAX LAW (P.D. No. 1154) IN THE APPLICATION OF THE LAW, TOGETHER WITH THE IMPLEMENTING REGULATIONS THEREOF AS WELL AS THE 'WHEREAS CLAUSES OF THE REPEALING LAW (P.D. No. 1739) WHICH RECOGNIZES PETITIONER'S RIGHT OF RELIEF AGAINST THE TRANSACTION TAX (SEE PEOPLE VS. PURISIMA, I,-42050-66; NOV. 20,1978; 86 SCRA 542).

The errors raised by the petitioner are grounded on one main issue, whether or not the petitioner is exempt from the 35% transaction tax. We find the alleged errors without merit. The petitioner claims exemption from the 35% transaction tax on the basis of the following statutory provisions: (1) Sec. 1 of Republic Act No. 3823, amending Commonwealth Act No. 137, otherwise known as the Mining Act" which reads: Sec. 1. There is hereby inserted after Section seventy-nine, Chapter VI of the Mining Act, a new section which shall read as follows: Sec. 79-A. However, new mines, and old mines which resume operation, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, shall be granted five years complete tax exemptions, except income tax, from the time of its actual bona fide orders for equipment for commercial production. If any of the tax-exempt articles acquired under this provision are sold, transferred or otherwise disposed of within a period of five years from such tax-exempt acquisition, all taxes and duties which would have been due at the time of such acquisition shall become due and payable, together with all interests and surcharges, and which amount shall constitute a lien on these properties. (2) Sec. I of Presidential Decree No. 237, amending the Tax Code, which reads:

Section 1. The last paragraph of Section One hundred ninety of Commonwealth Act Numbered Four hundred sixty-six, otherwise known as the 'National Internal Revenue Code' is further amended to read as follows: Sec. 190. Compensating Tax. xxx xxx xxx The provisions of existing laws to the contrary notwithstanding exemption from this tax shall be limited to the following: xxx xxx xxx 4. Machineries, equipment, tools for production, plants to convert mineral ores into saleable form, spare parts, supplies, materials, accessories, explosives, chemicals, and transportation and communication facilities imported by and for the use of new mines and old mines which resume operations, when certified, to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, for a period ending five (5) years frorn the first date of actual commercial production of saleable mineral

products: Provided Th at such articles are not locally available in reasonable quantity quality and price and are necessary or incidental in the proper operation of the mine: xxx xxx xxx (3) Sec. 1 of P. D. No. 238, further amending the Tax Code, which reads: Section 1. Section One hundred five of Republic Act Numbered Nineteen hundred and thirty-seven, otherwise known as the 'Tariff and Customs Code of the Philippines,' is further amended by inserting two new paragraphs '(u) and '(v)' therein after paragraph '(t)' thereof which shall read as follows: Sec. 105. Conditionally-Free Importations xxx xxx xxx ... Machineries, equipment, tools for production, plants to convert mineral ores into saleable form, spare parts, supplies, materials, accessories, explosives, chemicals, and transportation and communication facilities imported by and for the use of new mines and old mines which resume operations, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, for a period ending five (5) years from the first date of actual commercial production of saleable mineral product; Provided That such articles are not locally available in reasonable quantity, quality and price and

are necessary or incidental in the proper operation of the mine. (4) Secs. 52 and 53 of Presidential Decree No. 463, amending Section 79-A, Commonwealth Act No. 137, which read: Sec. 52. Power to Levy Taxes on Mines. Mining Operations and Mineral Products. Any law to the contrary notwithstanding, no province, city, municipality, barrio or municipal district shall levy and collect taxes, fees, rentals, royalties or charges of any kind whatsoever on mines, mining claims, mineral products, or on any operation, process or activity connected therewith. Sec. 53. Tax Exemptions. Machineries equipment, tools for production, plants to convert mineral ores into saleable form, spare parts, supplies, materials, accessories, explosives, chemicals and transportation and communication facilities imported by and for the use of new mines and old mines which resume operation, when certified as such by the Secretary upon recommendation of the Director, are exempt from the payment of customs duties and all taxes except income tax for a period starting from exploration and ending five (5) years from the first date of actual commercial .production of saleable mineral products: Provided, That such articles are not locally available in reasonable quantity, quality and price and are necessary or incidental in the proper operation of the mine. xxx xxx xxx

All mining claims, improvements thereon and mineral products derived therefrom shall likewise be exempt from the payment of all taxes, except income tax, for the same period provided for in the first paragraph of this section. xxx xxx xxx The statutory provisions on tax exemptions clearly exclude the 35% transaction tax. Section 1 of Presidential Decree No. 237 on Compensating Tax, Section I of P.D. No. 238 on Conditionally Free Importations, and Section 53 of P.D. No. 463 all refer to tax exemptions for importations of machineries, tools for production, plants to convert mineral ores into saleable form, spare parts, supplies, materials, accessories, explosives, chemicals and transportation and communication facilities, to be used in mining operations. Section 53 of P.D. No. 463 likewise refers to tax exemptions for mining claims and improvements thereon, and mineral products, except income tax. The petitioner's Certificate of Qualification for Tax Exemption No. 34 exempts "... from payment of all taxes except income tax, payable by him in the conduct of his business and in the importation of machineries, spare parts and or equipment listed in the stamped "Annex I " which are considered to be indispensable in the operation and will be used by said operator lessee exclusively in the mineral land mentioned above. Clearly, the transaction tax of P1,317,801.03 paid by the petitioner was not actually imposed upon it in the conduct of its mining business or in the importation of machinery, spare parts and or equipment listed in the stamped "ANNEX I" of its certificate of qualification for tax exemption and which are indespensable in the operation and used exclusively on petitioner's mineral land. Petitioner submits that inasmuch as taxes in general constitute allowable deductions from gross income in the determination of taxable net income, the 35% transaction tax is a business tax and not an income tax because the Revenue Code itself classifies it as "Business Tax" under Title V, and that P. D. No. 1154 expressly states that the transaction tax shall be allowed as a deductible item for purposes of determining the borrower's taxable income.

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 earrings of the lenders or placers who are actually the taxpayer,, 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." (President Marcos, Times Journal, June 17, 1977 cited in Respondent's Memorandum p. 6) ... Suffice it to state that the broad concensus 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 an 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 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.

Furthermore, whether or not certain taxes are on income is not necessarily determined by their deductibility or non-deductibility from gross income. As correctly observed by the Solicitor General, income in the form of dividends, capital gains on real property pursuant to Batas Pambansa Blg, 37, shares of stock pursuant to Presidential Decree 1739, and interests on savings in bank accounts, for instance, are incomes, yet they are not includible in the gross income when income taxes are paid because these are subject to final withholding taxes. The petitioner also submits that the 35% transaction tax is a business tax because it is imposed under Title V, entitled -,Taxes on Business" and classified specially under Chapter II, entitled "Tax on Business." The location of the 35%, tax in the Tax Code does not necessarily determine its nature, Again, we agree with the Solicitor General that the legislative body must have realized later that. the subject tax was inappropriately included among the taxes on business because Section 210 of the Tax Code has been repealed by Presidential Decree No. 1739, which now imposes a tax of 20% on interests from deposits and yields from deposit substitutes such as commercial papers issued in the primary market as principal instrument and provides for them in Section 24(cc) under Chapter III, Tax on Corporations, Title II-Income. Tax. Petitioner Western Minolco Corporation has failed to justify its claimed exemption from the 35,7c, transaction tax. The decision of the Commissioner of Internal Revenue denying the petitioner's claim for refund is affirmed. It bears repeating that the law looks with disfavor on tax exemptions and he who would seek to be thus privileged must justify it by words too plain to be mistaken and too categorical to be misinterpreted. (Commissioner of Internal Revenue U. P. J Kiener Company Ltd, International Construction Corporation et al., L,-24754, July 18, 1975, 65 SCRA 142). WHEREFORE, the instant petition is DENIED for lack of merit. The decision of the respondent Court of Tax Appeals is AFFIRMED: In toto. SO ORDERED.

Republic of the Philippines SUPREME COURT Manila EN BANC

G.R. No. L-22443 May 29, 1971 THE COMMISSIONER OF CUSTOMS, petitioner, vs. PHILIPPINE ACETYLENE COMPANY, and THE COURT OF TAX APPEALS, respondents. Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete and Solicitor Sumilang V. Bernardo for petitioner. Ponce Enrile, Siguion Reyna, Montecillo & Belo for respondent Philippine Acetylene Company.

MAKALINTAL, J.:
This is a petition filed by the Commissioner of Customs for review of the decision of the Court of Tax Appeals in its Case No. 1147, ordering the herein petitioner to refund to the Philippine Acetylene Co., Inc. the amount of P3,683.00 which it had paid under protest as special import tax on one (1) custom built liquefied petroleum gas tank. The facts were stipulated by the parties as follows: 1. That the Philippine Acetylene Company is a corporation duly organized and existing under the laws of the Philippines; 2. That said company is engaged in the manufacture of oxygen, acetylene and nitrogen and packaging of liquefied petroleum gas in cylinders and tanks;

3. That sometime in 1957 the protestant imported from the United States one custom-built liquefied petroleum gas tank which arrived via the S/S 'PLEASANT VILLE' under Register No. 1356, and declared in Import Entry No. 94060, series of 1957; and . 4. That the amount of P3,683.00 was assessed thereon as special import tax and which (sic) was paid under protest by the importer-protestant as evidenced by Official Receipt No. 12690 dated February 25, 1958. According to Charles L. Butler, manager of the Philippine Acetylene Co., Inc., the imported custom-built liquefied petroleum gas tank is simply a large cylinder which is used as container for liquefied petroleum gas obtained from the CALTEX Refinery in Bauan, Batangas and transported to the company's plant in Manila. The gas does not undergo any chemical change and is sold to consumers in the same state as when it was acquired from the refinery, except that before it is sold the gas is pumped into smaller cylinders, which are labeled with the company's trademark "Philigas." Under the foregoing facts the issue presented for resolution is purely one of law, namely, whether or not the Philippine Acetylene Co., Inc., insofar as its packaging operation of liquefied petroleum gas is concerned, may be considered engaged in an industry as contemplated in section 6 of Republic Act No. 1394 and therefore exempt from the payment of the special import tax in respect of the gas tank in question. Section 6 of Republic Act No. 1394, insofar as it is pertinent to the issue, provides: Section 6. The tax provided for in section one of this Act shall not be imposed against the importation into the Philippines of machinery and/or raw materials to be used by new and necessary industries as determined in accordance with Republic Act numbered Nine Hundred and One; ...; machinery, equipment, accessories and spare parts, for the use of industries, miners, mining enterprises planters and farmers; ...

In finding that the Philippine Acetylene Co., Inc. is engaged in industry within the meaning of the abovequoted provision, the Tax Court held that the term industry should be understood in its ordinary and general definition, which is any enterprise employing relatively large amounts of capital and/or labor. On such premise the Tax Court concluded that inasmuch as the Philippine Acetylene Co., Inc. employs considerable labor and capital in packaging liquefied petroleum gas purchased by it and selling the same for profit, it is engaged in industry and hence is exempt from the payment of the special import tax in connection with the tank used as container. The following observations in the brief for the petitioner are apropos: ... in the exempting provisions of Republic Act No. 1394, the exempted items are divided into separate and specific enumerations. The term 'industries' is used in two distinct groups. The first group of exempted industries refers exclusively to those falling under the new and necessary industries as defined in Republic Act No. 901. In the second, the term "industries" is classed together with the terms miners, mining enterprises, planters and farmers. ... If Congress really intended to give the term "industries" its ordinary and general meaning and thus grant tax exemption to all ventures and trades falling under the said ordinary and general definition, it should have eliminated the words "new and necessary industries' and 'mining enterprises" since these two ventures are already covered by the term "industries" in its ordinary and general meaning. On the other hand, the fact that the language of the law specifically segregates new and necessary industries under Republic Act No. 901 among those entitled to the tax exemption, in effect, restricts the meaning and scope of the word "industries." The argument appears logical and reasonable. Since the term "industries" as used in the law for the second time is classified together with the terms "miners, mining enterprises, planters and farmers", the obvious legislative intent is to confine the meaning of the term to activities that tend to produce or create or manufacture, such as those of miners, mining enterprises, ]planters and farmers. The Tax Court's interpretation would lead to a Patent inconsistency, in that while the first part of the law confines the exemption to new

and necessary industries, another part would extend the exemption to all other industries, regardless of their nature, as long as they employ labor and capital for profit-making purposes. In granting the exemption, it would have been illogical for Congress to specify importations needed by new and necessary industries -- as the term is defined by law and in the same breath allow a similar exemption to all other industries in general. The respondents make much of the interpretation of the term "industries" by the Secretary of Finance in his First Indorsement dated November 19, 1956, to wit: Any Productive enterprise which employs relatively large amounts of capital and/or labor falls under the term 'industries' as used in Section 6 of Republic Act No. 1394. Assuming ng the correctness of such interpretation, what should be noted is that it stresses the productive aspect of the enterprise. The operation for which the respondent company employs the gas tank in question does not involve manufacturing or production. It is nothing but packaging; the liquefied gas, when obtained from the refinery, has to be placed in some kind of container for transportation to Manila. When sold to consumers, it undergoes no change or transformation, but is merely placed in smaller cylinders for convenience. The process is certainly not production in any sense. The phrasing of Section 6 of Republic Act No. 1394, to be sure, is rather vague and infelicitious, particularly in the repetition of the word "industries." It is such lack of precision in the law that gives rise to litigious controversies concerning its proper application. One of the established rules of statutory construction, however, is that tax exemptions are held strictly against the taxpayer, and if not expressly mentioned in the law must be within its purview by clear legislative intent. In the present case the construction adhered to by the respondents in reference to the scope of the term "industries" as employed for the second time in Section 6 of Republic Act No. 1394 is contrary to such rule. For if the term were all inclusive, and meant industries in general, that is, those which involve relatively large amounts of capital and/or labor regardless of their productive or nonproductive nature, there would be no point in making a separate classification with respect to "new and necessary industries" for purposes of the tax exemption. We hold, therefore, that to be entitled to exemption under the second classification in the statute the

industry concerned, in connection with the activity for which the importation is made, must be engaged in some productive enterprise, not in merely packaging an already finished product to facilitate its transportation. In a comparable case this Court has held that the tax exemption in connection with the processing of gasoline and the manufacture of lubricating oil does not extend to pump parts imported by the processor and leased to gasoline stations for their use in servicing customers' vehicles, overruling the argument of the petitioner therein that the marketing of its gasoline product "is corollary to or incidental to its industrial operations." (ESSO Standard, Eastern, Inc. vs. Acting Commissioner of Customs, 18 SCRA 488). WHEREFORE, the decision of the Court of Tax Appeals is reversed and that of the Collector of Customs of Manila and the Commissioner of Customs upheld. Costs against respondent Philippine Acetylene Co., Inc.

Republic of the Philippines SUPREME COURT Manila THIRD DIVISION G.R. No. 71122 March 25, 1988 COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs. ARNOLDUS CARPENTRY SHOP, INC. and COURT OF TAX APPEALS, Respondents.

CORTES, J.: Assailed in this petition is the decision of the Court of Tax Appeals in CTA case No. 3357 entitled "ARNOLDUS CARPENTRY SHOP, INC. v. COMMISSIONER OF INTERNAL REVENUE."
c han robles v irt ual law l ibra ry

The facts are simple.

chan roble svirtualawl ibra ry

chan robles v irt ual law libra ry

Arnoldus Carpentry Shop, Inc. (private respondent herein) is a domestic corporation which has been in existence since 1960. It has for its secondary purpose the "preparing, processing, buying, selling, exporting, importing, manufacturing, trading and dealing in cabinet shop products, wood and metal home and office furniture, cabinets, doors, windows, etc., including their component parts and materials, of any and all nature and description" (Rollo, pp. 160-161). These furniture, cabinets and other woodwork were sold locally and exported abroad.
chanroble svirtualawl ibra ry chan roble s virtual law l ibra ry

For this business venture, private respondent kept samples or models of its woodwork on display from where its customers may refer to when placing their orders.
chanro b lesvirtualawl ibra ry chan roble s virtual law l ibra ry

Sometime in March 1979, the examiners of the petitioner Commissioner of Internal Revenue conducted an investigation of the business tax liabilities of private respondent pursuant to Letter of Authority No. 08307 NA dated November 23, 1978. As per the examination, the total gross sales of private respondent for the year 1977 from both its local and foreign dealings amounted to P5,162,787.59 (Rollo. p. 60). From this amount, private respondent reported in its quarterly percentage tax returns P2,471,981.62 for its gross local sales. The balance of P2,690,805.97, which is 52% of the

total gross sales, was considered as its gross export sales (CTA Decision, p. 12).
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Based on such an examination, BIR examiners Honesto A. Vergel de Dios and Voltaire Trinidad made a report to the Commissioner classifying private respondent as an "other independent contractor" under Sec. 205 (16) [now Sec. 169 (q)] of the Tax Code. The relevant portion of the report reads: Examination of the records show that per purchase orders, which are hereby attached, of the taxpayer's customers during the period under review, subject corporation should be considered a contractor and not a manufacturer. The corporation renders service in the course of an independent occupation representing the will of his employer only as to the result of his work, and not as to the means by which it is accomplished, (Luzon Stevedoring Co. v. Trinidad, 43 Phil. 803). Hence, in the computation of the percentage tax, the 3% contractor's tax should be imposed instead of the 7% manufacturer's tax. [Rollo, p. 591 (Emphasis supplied.)
chanrobles v i rtual law lib rary

xxx xxx xxx As a result thereof, the examiners assessed private respondent for deficiency tax in the amount of EIGHTY EIGHT THOUSAND NINE HUNDRED SEVENTY TWO PESOS AND TWENTY THREE CENTAVOS ( P88,972.23 ). Later, on January 31, 1981, private respondent received a letter/notice of tax deficiency assessment inclusive of charges and interest for the year 1977 in the amount of ONE HUNDRED EIGHT THOUSAND SEVEN HUNDRED TWENTY PESOS AND NINETY TWO CENTAVOS ( P 108,720.92 ). This tax deficiency was a consequence of the 3% tax imposed on private respondent's gross export sales which, in turn, resulted from the examiners' finding that categorized private respondent as a contractor (CTA decision, p.2).
chan roblesv irt ualawli bra ry c hanrobles vi rt ual law li brary

Against this assessment, private respondent filed on February 19, 1981 a protest with the petitioner Commissioner of Internal Revenue. In the protest letter, private respondent's manager maintained that the carpentry shop is a manufacturer and therefor entitled to tax exemption on its gross export sales under Section 202 (e) of the National Internal Revenue Code. He explained that it was the 7% tax exemption on export sales which prompted private respondent to exploit the foreign market which resulted in the increase of its foreign sales to at least 52% of its total gross sales in 1977 (CTA decision, pp. 1213).
chanroblesv irt ualawli bra ry chan rob les vi rtual law lib rary

On June 23, 1981, private respondent received the final decision of the petitioner stating:

It is the stand of this Office that you are considered a contractor an not a manufacturer.Records show that you manufacture woodworks only upon previous order from supposed manufacturers and only in accordance with the latter's own design, model number, color, etc. [Rollo p. 64] (Emphasis supplied.) On July 22, 1981, private respondent appealed to the Court of Tax Appeals alleging that the decision of the Commissioner was contrary to law and the facts of the case.
chanroblesv irt ualawli bra ry chan rob les vi rtual law lib rary

On April 22, 1985, respondent Court of Tax Appeals rendered the questioned decision holding that private respondent was a manufacturer thereby reversing the decision of the petitioner.

chanro blesvi rt ualawlib ra ry chan roble s virtual law lib rary

Hence, this petition for review wherein petitioner raises the sole issue of. Whether or not the Court of Tax Appeals erred in holding that private respondent is a manufacturer and not a contractor and therefore not liable for the amount of P108,720.92, as deficiency contractor's tax, inclusive of surcharge and interest, for the year 1977. The petition is without merit.
chanroble svirtualawl ibra ry chan roble s virtual law l ib rary

1. Private respondent is a "manufacturer" as defined in the Tax Code and not a "contractor" under Section 205(e) of the Tax Code as petitioner would have this Court decide. (a) Section 205 (16) [now Sec. 170 (q)] of the Tax Code defines "independent contractors" as:
chan rob les vi rtual law lib rary

... persons (juridical and natural) not enumerated above (but not including individuals subject to the occupation tax under Section 12 of the Local Tax Code) whose activity consists essentially of the sale of all kinds of services for a fee regardless of whether or not the performance of the service calls for the exercise or use of the physical or mental faculties of such contractors or their employees. (Emphasis supplied.) Private respondent's business does not fall under this definition.
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Petitioner contends that the fact that private respondent "designs and makes samples or models that are 'displayed' or presented or 'submitted' to prospective buyers who 'might choose' therefrom" signifies that what private respondent is selling is a kind of service its shop is capable of rendering in terms of woodwork skills and craftsmanship (Brief for Petitioner, p. 6). He further stresses the point that if there are no orders placed for goods as represented by the

sample or model, the shop does not produce anything; on the other hand, if there are orders placed, the shop goes into fall production to fill up the quantity ordered (Petitioner's Brief, p. 7).
c hanroblesv irt uala wlibra ry c hanrobles vi rt ual law li bra ry

The facts of the case do not support petitioner's claim. Petitioner is ignoring the fact that private respondent sells goods which it keeps in stock and not services. As the respondent Tax Court had found: xxx xxx xxx
chan robles v irt ual law l ibra ry

Petitioner [private respondent herein] claims, and the records bear petitioner out, that it had a ready stock of its shop products for sale to its foreign and local buyers. As a matter of fact, the purchase orders from its foreign buyers showed that they ordered by referring to the models designated by petitioner. Even purchases by local buyers for television cabinets (Exhs. '2 to13', pp. 1-13, BIR records) were by orders for existing models except only for some adjustments in sizes and accessories utilized.
chanrob lesvi rtua lawlib rary cha nrob les vi rtual law lib rary

With regard to the television cabinets, petitioner presented three witnesses its bookkeeper, production manager and manager who testified that samples of television cabinets were designed and made by petitioner, from which models the television companies such as Hitachi National and others might choose, then specified whatever innovations they desired. If found to be saleable, some television cabinets were manufactured for display and sold to the general public. These cabinets were not exported but only sold locally. (t.s.n., pp. 2235, February 18,1982; t.s.n., pp. 7-10, March 25, 1982; t.s.n., pp. 3-6, August 10, 1983.)
chan roble s virtual law lib rary

xxx xxx xxx

chan robles v irt ual law l ibra ry

In the case of petitioner's other woodwork products such as barometer cases, knife racks, church furniture, school furniture, knock down chairs, etc., petitioner's above-mentioned witnesses testified that these were manufactured without previous orders. Samples were displayed, and if in stock, were available for immediate sale to local and foreign customers. Such testimony was not contradicted by respondent (petitioner herein). And in all the purchase orders presented as exhibits, whether from foreign or local buyers, reference was made to the model number of the product being ordered or to the sample submitted by petitioner.
chanro blesvi rt ualawlib ra ry c hanro bles vi rtua l law lib ra ry

Respondent's examiners, in their memorandum to the Commissioner of Internal Revenue, stated that petitioner manufactured only upon previous orders from customers and "only in accordance with the latter's own design, model number, color, etc." (Exh. '1', p. 27, BIR

records.) Their bare statement that the model numbers and designs were the customers' own, unaccompanied by adequate evidence, is difficult to believe. It ignores commonly accepted and recognized business practices that it is not the customer but the manufacturer who furnishes the samples or models from which the customers select when placing their orders, The evidence adduced by petitioner to prove that the model numbers and designs were its own is more convincing [CTA decision, pp. 6-8.] (Emphasis supplied)
chanroble s virtual law lib rary

xxx xxx xxx This Court finds no reason to disagree with the Tax Court's finding of fact. It has been consistently held that while the decisions of the Court of Tax Appeals are appealable to the Supreme Court, the former's finding of fact are entitled to the highest respect. The factual findings can only be disturbed on the part of the tax court [Collector of Intern. al Revenue v. Henderson, L-12954, February 28, 1961, 1 SCRA 649; Aznar v. Court of Tax Appeals, L-20569, Aug. 23, 1974, 58 SCRA 519; Raymundo v. de Joya, L-27733, Dec. 3, 1980, 101 SCRA 495; Industrial Textiles Manufacturing Co. of the Phils. , Inc. v. Commissioner of Internal Revenue, L-27718 and L-27768, May 27,1985,136 SCRA 549.]
chan roble s virtua l law lib rary

(b) Neither can Article 1467 of the New Civil Code help petitioner's cause. Article 1467 states:
chan roble s virtual law l ib rary

A contract for the delivery at a certain price of an article Which the vendor in the ordinary course of his business manufactures or procures for the - general market, whether the same is on hand at the time or not, is a contract of sale, but if the goods are to be manufactured specially for the customer and upon his special order, and not for the general market, it is a contract for a piece of work.
chan roble svirtualawl i brary cha nrob les vi rtual law lib rary

Petitioner alleged that what exists prior to any order is but the sample model only, nothing more, nothing less and the ordered quantity would never have come into existence but for the particular order as represented by the sample or model [Brief for Petitioner, pp. 9-101.]
law libra ry

chanrobles vi rt ual

Petitioner wants to impress upon this Court that under Article 1467, the true test of whether or not the contract is a piece of work (and thus classifying private respondent as a contractor) or a contract of sale (which would classify private respondent as a manufacturer) is the mere existence of the product at the time of the perfection of the contract such that if the thing already exists, the contract is of sale, if not, it is work.
chan roble svirtualawl ibra ry chan roble s virtual law l ibra ry

This is not the test followed in this jurisdiction. As can be clearly seen from the wordings of Art. 1467, what determines whether the contract is one of work or of sale is whether the thing has been manufactured specially for the customer and upon his special order." Thus, if the thing is specially done at the order of another, this is a contract for a piece of work. If, on the other hand, the thing is manufactured or procured for the general market in the ordinary course of one's business, it is a b contract of sale.
chanro blesvi rt ualawlib ra ry cha nro bles vi rtua l law lib ra ry

Jurisprudence has followed this criterion. As held in Commissioner of Internal Revenue v. Engineering Equipment and Supply Co. (L-27044 and L-27452, June 30, 1975, 64 SCRA 590, 597), "the distinction between a contract of sale and one for work, labor and materials is tested by the inquiry whether the thing transferred is one not in existence andwhich never would have existed but for the order of the party desiring to acquire it, or a thing which would have existed and has been the subject of sale to some other persons even if the order had not been given." (Emphasis supplied.) And in a BIR ruling, which as per Sec. 326 (now Sec. 277) of the Tax Court the Commissioner has the power to make and which, as per settled jurisprudence is entitled to the greatest weight as an administrative view [National Federation of Sugar Workers (NFSW) v. Ovejera, G.R. No. 59743, May 31, 1982, 114 SCRA 354, 391; Sierra Madre Trust v. Hon. Sec. of Agriculture and Natural Resources, Nos. 32370 and 32767, April 20, 1983,121 SCRA 384; Espanol v. Chairman and Members of the Board of Administrators, Phil. Veterans Administration, L-44616, June 29, 1985, 137 SCRA 3141, "one who has ready for the sale to the general public finished furniture is a manufacturer, and the mere fact that he did not have on hand a particular piece or pieces of furniture ordered does not make him a contractor only" (BIR Ruling No. 33-1, series of 1960). Likewise, xxx xxx xxx
chan robles v irt ual law l ibra ry

When the vendor enters into a contract for the delivery of an article which in the ordinary course of his business he manufactures or procures for the general market at a price certain (Art. 1458) such contract is one of sale even if at the time of contracting he may not have such article on hand. Such articles fall within the meaning of "future goods" mentioned in Art. 1462, par. 1. [5 Padilla, Civil Law: Civil Code Annotated 139 (1974)
chanrobles vi rtua l law lib rary

xxx xxx xxx These considerations were what precisely moved the respondent Court of Tax Appeals to rule that 'the fact that [private respondent] kept models of its products... indicate that these products were for sale to

the general public and not for special orders,' citing Celestino Co and Co. v. Collector of Internal Revenue [99 Phil, 841 (1956)]. (CTA Decision, pp. 8-9.)
cha nrob les vi rtua l law lib rary

Petitioner alleges that the error of the respondent Tax Court was due to the 'heavy albeit misplaced and indiscriminate reliance on the case of Celestino Co and Co. v. Collector of Internal Revenue [99 Phil. 841, 842 (1956)] which is not a case in point' 1 Brief for Petitioner, pp. 1415). The Commissioner of Internal Revenue made capital of the difference between the kinds of business establishments involved a FACTORY in the Celestino Co case and a CARPENTRY SHOP in this case (Brief for Petitioner, pp. 14-18). Petitioner seems to have missed the whole point in the former case.
chan roblesv irtualawli bra ry c han robles v irt ual law li bra ry

True, the former case did mention the fact of the business concern being a FACTORY, Thus: xxx xxx xxx
chan robles v irt ual law l ibra ry

... I cannot believe that petitioner company would take, as in fact it has taken, all the trouble and expense of registering a special trade name for its sash business and then orders company stationery carrying the bold print "Oriental Sash Factory (Celestino Co and Company, Prop.) 926 Raon St., Quiapo, Manila, Tel. No. 33076, Manufacturers of all kinds of doors, windows, sashes furniture, etc. used season dried and kiln-dried lumber, of the best quality workmanship" solely for the purpose of supplying the need for doors, windows and sash of its special and limited customers. One will note that petitioner has chosen for its trade name and has offered itself to the public as a FACTORY, which means it is out to do business in its chosen lines on a big scale. As a general rule, sash factories receive orders for doors and windows of special design only in particular cases but the bulk of their sales is derived from ready-made doors and windows of standard sizes for the average home. [Emphasis supplied.]
chanroble s virtual law l ibra ry

xxx xxx xxx However, these findings were merely attendant facts to show what the Court was really driving at - the habitualityof the production of the goods involved for the general public. In the instant case, it may be that what is involved is a CARPENTRY SHOP. But, in the same vein, there are also attendant facts herein to show habituality of the production for the general public.
chanroble svirtualawl ibra ry chan robles v irt ual law l ibra ry

In this wise, it is noteworthy to again cite the findings of fact of the respondent Tax Court: xxx xxx xxx
chan robles v irt ual law l ibra ry

Petitioner [private respondent herein] claims, and the records bear petitioner out, that it had a ready stock of its shop products for sale to its foreign and local buyers. As a matter of fact, the purchase orders from its foreign buyers showed that they ordered by referring to the models designed by petitioner. Even purchases by local buyers for television cabinets... were by orders for existing models. ...
cha nro blesvi rtua lawlib rary cha nrob les vi rtua l law lib rary

With regard to the television cabinets, petitioner presented three witnesses... who testified that samples of television cabinets were designed and made by petitioner, from which models the television companies ... might choose, then specified whatever innovations they desired. If found to be saleable, some television cabinets were manufactured for display and sold to the general public. xxx xxx xxx
chan robles v irt ual law l ibra ry

In the case of petitioner's other woodwork products... these were manufactured without previous orders. Samples were displayed, and if in stock, were available for immediate sale to local and foreign customers. (CTA decision, pp. 6-8.1 [Emphasis supplied.] (c) The private respondent not being a "contractor" as defined by the Tax Code or of the New Civil Code, is it a 'manufacturer' as countered by the carpentry shop?
chan rob les vi rtual law lib rary

Sec. 187 (x) [now Sec. 157 (x)] of the Tax Code defines a manufacturer' as follows: "Manufacturer" includes every person who by physical or chemical process alters the exterior texture or form or inner substance of any raw material or manufactured or partially manufactured product in such manner as to prepare it for a special use or uses to which it could not have been in its original condition, or who by any such process alters the quality or any such raw material or manufactured or partially manufactured product so as to reduce it to marketable shape or prepare it for any of the uses of industry, or who by any such process combines any such raw material or manufactured or partially manufactured products with other materials or products of the same or different kinds and in such manner that the finished product of such process or manufacture can be put to a special use or uses to which such raw material or manufactured or partially manufactured products in their original condition would not have been put, and who in

addition alters such raw material or manufactured or partially manufactured products, or combines the same to produce such finished products for the purpose of their sale or distribution to others and not for his own use or consumption. It is a basic rule in statutory construction that when the language of the law is clear and unequivocal, the law must be taken to mean exactly what it says [Banawa et al. v. Mirano et al., L-24750, May 16, 1980, 97 SCRA 517, 533].
chan roblesv irt ualawli bra ry c hanrobles vi rt ual law li bra ry

The term "manufacturer" had been considered in its ordinary and general usage. The term has been construed broadly to include such processes as buying and converting duck eggs to salted eggs ('balut") [Ngo Shiek v. Collector of Internal Revenue, 100 Phil. 60 (1956)1; the processing of unhusked kapok into clean kapok fiber [Oriental Kapok Industries v. Commissioner of Internal Revenue, L-17837, Jan. 31, 1963, 7 SCRA 132]; or making charcoal out of firewood Bermejo v. Collector of Internal Revenue, 87 Phil. 96 (1950)].
chanroblesv irt ualawli bra ry chan roble s virtual law l ib rary

2. As the Court of Tax Appeals did not err in holding that private respondent is a "manufacturer," then private respondent is entitled to the tax exemption under See. 202 (d) and (e) mow Sec. 167 (d) and (e)] of the Tax Code which states: Sec. 202. Articles not subject to percentage tax on sales. The following shall be exempt from the percentage taxes imposed in Sections 194, 195, 196, 197, 198, 199, and 201:
chan robles v irt ual law li bra ry

xxx xxx xxx

chan robles v irt ual law l ibra ry

(d) Articles shipped or exported by the manufacturer or producer, irrespective of any shipping arrangement that may be agreed upon which may influence or determine the transfer of ownership of the articles so exported.
chanrob lesvi rtualaw lib rary chan roble s virtual law lib rary

(e) Articles sold by "registered export producers" to (1) other" registered export producers" (2) "registered export traders' or (3) foreign tourists or travelers, which are considered as "export sales." The law is clear on this point. It is conceded that as a rule, as argued by petitioner, any claim for tax exemption from tax statutes is strictly construed against the taxpayer and it is contingent upon private respondent as taxpayer to establish a clear right to tax exemption [Brief for Petitioners, p. 181. Tax exemptions are strictly construed against the grantee and generally in favor of the taxing authority [City of Baguio v. Busuego, L-29772, Sept. 18, 1980, 100 SCRA 1161; they are looked upon with disfavor [Western Minolco Corp. v. Commissioner

Internal Revenue, G.R. No. 61632, Aug. 16,1983,124 1211. They are held strictly against the taxpayer and if expressly mentioned in the law, must at least be within its purview by clear legislative intent [Commissioner of Customs v. Phil., Acetylene Co., L-22443, May 29, 1971, 39 SCRA 70, Light and Power Co. v. Commissioner of Customs, G.R. L-28739 and L-28902, March 29, 1972, 44 SCRA 122].
chanroblesv irt ualawli bra ry c hanro bles vi rt ual law li bra ry

Conversely therefore, if there is an express mention or if the taxpayer falls within the purview of the exemption by clear legislative intent, then the rule on strict construction will not apply. In the present case the respondent Tax Court did not err in classifying private respondent as a "manufacturer". Clearly, the 'latter falls with the term 'manufacturer' mentioned in Art. 202 (d) and (e) of the Tax Code. As the only question raised by petitioner in relation to this tax exemption claim by private respondent is the classification of the latter as a manufacturer, this Court affirms the holding of respondent Tax Court that private respondent is entitled to the percentage tax exemption on its export sales.
chanrob lesvi rtua lawlib rary chan rob les vi rtual law lib rary

There is nothing illegal in taking advantage of tax exemptions. When the private respondent was still exporting less and producing locally more, the petitioner did not question its classification as a manufacturer. But when in 1977 the private respondent produced locally less and exported more, petitioner did a turnabout and imposed the contractor's tax. By classifying the private respondent as a contractor, petitioner would likewise take away the tax exemptions granted under Sec. 202 for manufacturers. Petitioner's action finds no support in the applicable law.
cha nrob lesvi rtua lawlib rary chan roble s virtual law l ibra ry

WHEREFORE, the Court hereby DENIES the Petition for lack of merit and AFFIRMS the Court of Tax Appeals decision in CTA Case No. 3357.
chanroblesv irt ualawli bra ry c hanro bles vi rt ual law li bra ry

SO ORDERED. Fernan (Chairman), Gutierrez, Jr., Feliciano and Bidin, concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-23226 November 28, 1967

ALHAMBRA CIGAR and CIGARETTE MANUFACTURING COMPANY, petitioner-appellant, vs. THE COMMISSIONER OF INTERNAL REVENUE, respondentappellee. Gamboa and Gamboa for petitioner-appellant. Office of the Solicitor General for respondent-appellee. FERNANDO, J.: This Court, in this petition for the review of a decision of the Court of Tax Appeals is not faced with a problem of undue complexity. The law governing the matter has been authoritatively expounded in an opinion by the then Justice, now Chief Justice, Concepcion in Alhambra Cigar v. Collector of Internal Revenue,1 a case involving the same parties over a similar question but covering an earlier period of time. The limits of a power of respondent Commissioner of Internal Revenue to allow deductions from the gross income "the ordinary and necessary expenses paid or increased during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries and other compensation for personal services actually rendered . . ."2 had thus been authoritatively expounded. What remains to be decided in this litigation is whether the decision of the Court of Tax Appeals sought to be reviewed reflected with fidelity the doctrine thus announced or deviated therefrom. According to the petition for review, Alhambra Cigar & Cigarette Manufacturing Company, petitioner-appellant, "is a corporation duly organized and existing under the laws of the Philippines, with principal office at 31 Tayuman street, Tondo, Manila; and the respondent-appellee is the duly appointed and qualified

Commissioner of Internal Revenue, vested with authority to act as such for the Government of the Republic of the Philippines, . . . .3 In the petition for review it was contended that the Court of Tax Appeals, in affirming the action taken by respondent-appellee Commissioner of Internal Revenue, erred "(a) In holding that A. P. Kuenzle and H.A. Streiff who were the President and VicePresident, respectively, of the petitioner-appellant, were entitled to a salary of only P6,000.00 each year, for 1954, 1955, 1956 and 1957, and a bonus equal to the reduced bonus of W. Eggmann for each of said years; and disallowing as deductions the portions of their salary and bonus in excess of said amounts; (b) In disallowing, as deductions, all the directors' fees and commissions paid by the petitioner-appellant to A.P. Kuenzle and H.A. Streiff; (c) In holding that the petitioner-appellant is liable for the alleged deficiency income taxes in question."4 It is indisputable as noted in the brief for petitioner-appellant that the deductions disallowed by respondent-appellee, Commissioner of Internal Revenue, for the year 1954 to 1957 designated as salaries, officers; bonus, officers; commissions to managers and directors' fees "relate exclusively to the compensations paid by the petitioner-appellant in 1954, 1955, 1956 and 1957, to A. P. Kuenzle and H.A. Streiff who were, during the said years, as they had been in prior years and still are, directors and the president and vice-president, respectively, of the petitioner-appellant. . . ."5 Under the category of salaries, officers of the fixed annual compensation of A. P. Kuenzle and H. A. Streiff in the amount of P15,000.00 each "the respondent-appellee allowed for each of them a salary of only P6,000.00 and disallow the balance of P9,000.00, or a total disallowance of P18,00.0,0 for both of them, for each of the years in question."6 Under that of the bonus, officers of the amount under such category paid to the above gentlemen for the year 1954 of P14,750.00 each, "the respondentappellee allowed each of them a bonus of only P5,850.00, and disallowed the balance of P8,900.00 or a total disallowance of P17,800.00 for both of them."7 For the year 1955, the bonus being paid, once again, amounting to P14,750.00 to each of them, "the respondent-appellee allowed for each of them, a bonus of only P7,000.00, and disallowed the balance of P7,750.00 each, or a

total disallowance of P15,500.00 for both of them."8 For the year 1956, again the amount, not suffering any change for each, "the respondent-appellee allowed for each of them a bonus of only P5,500.00 and disallowed the balance of P9,250.00 each, or a total disallowance of P18,500.00 for both of them."9 Lastly, for the year 1957, of a similar amount payable to each in the concept of bonus, "the respondent-appellee allowed for each of them a bonus of only P6,500.00, and disallowed the balance of P8,250.00 each, or a total disallowance of P16,500.00 for both of them."10 As to the deduction in the concept of commissions to managers, the brief for the petitioner appellant states: "The commissions paid by the petitioner-appellant to A. P. Kuenzle and H. A. Streiff in the amount of P13,607.61 each in 1954, or a total of P27,215.22 for both of them; P14,097.62 each in 1955, or a total of P28,195.24 for both of them; P13,180.87 each in 1956, or a total of P26,361.74 for both of them; and P13,144.29 each in 1957, or a total of P26,288.48 for both of them, were entirely disallowed by the respondent-appellee."11 Concerning the directors' fees paid to both officials by petitionerappellant, it is noted in the brief that "in the amount of P11,504.71 each in 1954, or a total of P23,009.42 for both of them; P10,693.02 each in 1955, or a total of P21,386.04 for both of them; P10,360.23 each in 1956, or a total of P20,720.46 for both of them; and P9,716.63 each in 1957, or a total of P19,433.26 for both of them were also entirely disallowed by the respondentappellee."12 In the decision of the respondent Court of Tax Appeals sought to be reviewed, there was an appraisal of the evidence on which respondent-appellee Commissioner of Internal Revenue based the above deduction on salaries and bonuses: "The evidence shows that prior to 1954, Messrs. A. P. Kuenzle and H. A. Streiff President and Vice-President, respectively, of petitioner corporation, were each paid an annual salary P6,000.00 and a bonus of about four times as much as the annual salary. In Alhambra Cigar and Cigarette Manufacturing Company v. Coll. of Int. Rev. C.T.A. No. 142 January 31, 1957 (affd. in G.R. Nos. L12026 & L-12131, May 29, 1959), this Court held that considering the nature of the services performed by Messrs. Kuenzle and Streiff the salary of P6,000.00 paid to each of them was

reasonable and, therefore, deductions is ordinary and necessary business expense. The bonus paid to each of said officers was however reduced to the amount equivalent to that paid to Mr. W. Eggmann, the resident Treasurer and Manager of petitioner. Following the decision of the Supreme Court in G. R. Nos. L12026 & L- 12131, . . ., respondent allowed as deduction P6,000.00 as salary to Messrs. Kuenzle and Streiff and a bonus equivalent to that paid annually to Mr. Eggmann from 1954 to 1957, as indicated above."13 Then the decision of respondent Court of Tax Appeals in affirming what respondent-appellee did explained why: "Upon the evidence of record, we find no justification to reverse or modify the decision of respondent with respect to the disallowance of a portion of the salaries and bonuses paid to Messrs. Kuenzle and Streiff. Petitioner seeks to justify the increase in the salaries of Messrs. Kuenzle and Streiff on the ground of increased costs of living. The said officers of petitioner are, however, non-residents of the Philippines."14 It may be stated in this connection that the brief for petitionerappellant did not actually dispute the fact of non-residence of the aforesaid officials. Thus: "A. P. Kuenzle or H. A. Streiff usually came to the Philippines every two years, and generally stayed from five to eight weeks (t.s.n., pp. 203-204). During the years in question, H. A. Streiff was in the Philippines from January 27 to March 20, 1954. He was personally present at the special meeting of the board of directors of the petitioner-appellant on February 19, 1954 and at the regular meeting on February 27, 1954, the minutes of all of which he signed as Vice-President (Exhibits Q, Q1 and Q-2). He was also personally present at the semi-annual meeting of stockholders of the petitioner-appellant on February 19, 1954, the minutes of which he also signed as vice-president (Exh. R). A. P. Kuenzle was in the Philippines from February 3 to March 8, 1956 (t.s.n., pp. 204-205). He was personally present at the special meeting of the board of directors on February 22, and on February 23, 1956, and at the semi-annual general meeting of stockholders on February 23, 1956, the minutes of all of which he signed as President (Exhs. Q-8, Q-9. and R-4). H. A. Streiff came again to the Philippines in 1958, and he personally attended the special meeting of the board of directors on March 7, 1968, the minutes of which he also, signed as Vice-President (Exh. Q-16)."15

There was in the brief of petitioner-appellant stress laid on those work performed by them, both in and outside the Philippines. "During their stay in the Philippines, A. P. Kuenzle or H. A. Streiff inspected the install petitions of the petitioner-appellant, and discussed with the local management, personnel and management matters, long-range planning and policies of the company (t.s.n., pp. 205-206). Aside from these visits of A. P. Kuenzle and H. A. Streiff to the Philippines, there were other personal consultations between them and the local management. There were about seven staff members in the local management, and each of them went on home leave every four years and for consultations in Switzerland with the general managers, AP Kuenzle and H. A. Streiff. These home leaves each lasted for six months. In this way, at least one staff member went on home leave every year and for consultations with the general manager. . . ."16 As to commissions and directors' fees, it is the finding of the Court of Tax Appeals: "In connection with the commissions paid to Messrs. Kuenzle and Streiff there is no evidence of any particular service rendered by them to petitioner to warrant payment of commissions. Counsel for petitioner sought to prove the various types of services performed by said officers, but the services mentioned are those for which they have been more than adequately compensated in the form of salaries and bonuses. As regards the directors' fees, it is admitted that Messrs. Kuenzle and Streiff "usually came to the Philippines every two years, and generally stayed from five to eight weeks." (Page 17, Memorandum for Petitioner.) We cannot see any justification for the payment of director's fees of about P10,000.00 to each of said officers for coming to the Philippines to visit their corporation once in two years. Being non-resident President and Vice-President of Petitioner corporation of which they are the controlling stockholders, we are more inclined to believe that said commissions and directors' fees, payment of which was based on a certain percentage of the annual profits of petitioner, are in the nature of dividend distributions,"17 Considering how carefully the Court of Tax Appeals considered the matter of the disallowances in the light of Section 30 of the National Internal Revenue Code, the task for petitioner-appellant in proving that it erred in holding that A. P. Kuenzle and H. A.

Streiff were entitled only to the salary of P6,000.00 each a year, for 1954, 1955, 1956 and 1957, and a bonus equal to the reduced bonus of one of its officials a certain W. Eggmann, for each of said years, and in disallowing as deductions the directors' fees and commissions paid by it to them, was far from easy. Nor could it be said that petitioner-appellant did succeed in such effort As mentioned earlier, the previous case of Alhambra Cigar & Cigarette Manufacturing Company v. The Collector of Internal Revenue,18has laid down the applicable principle of law. In the language of then Justice, now Chief Justice, Concepcion: "In the light of the tenor of the foregoing provision, whenever a controversy arises on the deductibility, for purposes of income tax, of certain items for alleged compensation of officers of the taxpayer, two (2) questions become material, namely: (a) Have "personal services" been "actually rendered" by said officers? (b) In the affirmative case, what is the "reasonable allowance" therefore? When the Collector of Internal Revenue disallowed the fees, bonuses and commissions aforementioned, and the company appealed therefrom, it became necessary for the [Court of Tax Appeals] to determine whether said officer had correctly applied section 30 of the Tax Code, and this, in turn, required the consideration of the two (2) questions already adverted to. In the circumstances surrounding the case, we are of the opinion that the [Court of Tax Appeals] has correctly construed and applied said provision." So it is now. This appeal too cannot prosper. Even if there were no such previous decision, it would still follow, in the light of the controlling doctrines, that the Court of Tax Appeals must be sustained. The well written brief for petitionerappellant citing Botany Worsted Bills v. United States,19 states: "Whether the amounts disallowed by the respondent-appellee in the respective years were reasonable compensation for personal services, is a question of fact to be determined from all the evidence."20 That the question thus involved is inherently factual, appears to be undeniable. This Court is bound by the finding of facts of the Court of Tax Appeals, especially so, where as here, the evidence in support thereof is more than substantial, only questions of law thus being left open to it for determination.21 Without ignoring this various factors which petitioner-appellant would have this Court consider in passing upon the determination made by the Court of Tax Appeals but with

full recognition of the fact that the two officials were non-residents, it cannot be said that it committed the alleged errors, calling for the interposition of the corrective authority of this Court. Nor as a matter of principle is it advisable for this Court to set aside the conclusion reached by an agency such as the Court of Tax Appeals which is, by the very nature of its function, dedicated exclusively to the study and consideration of tax problems and has necessarily developed an expertise on the subject unless, as did not happen here, there has been an abuse or improvident exercise of its authority. WHEREFORE, the decision of the Court of Tax Appeals is affirmed, with costs against petitioner-appellant.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-18840 May 29, 1969

KUENZLE & STREIFF, INC., petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE, respondent. Angel S. Gamboa for petitioner. Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Jose P. Alejandro and Special Attorney Virgilio C. Saldajeno for respondent. DIZON, J.: Petition filed by Kuenzle & Streiff Inc. for the review of the decision of the Court of Tax Appeals in C.T.A. Case No. 551 sustaining the assessments of the respondent issued against it, for deficiency income taxes for the years 1953, 1954 and 1955 in the amounts of P40,455.00, P11,248.00 and P16,228.00, respectively, arising from the disallowance, as deductible expenses, of the bonuses paid by petitioner to its officers, upon the ground that they were not ordinary, nor necessary, nor reasonable expenses within the purview of Section 30(a) (1) of the National Internal Revenue Code. Petitioner, a domestic corporation, filed its income tax returns for the taxable years 1953, 1954 and 1955, declaring net losses of P2,085.84, P4,953.91 and P9,246.07 respectively. Upon a verification thereof, the respondent, on September 9, 1957, assessed against it the deficiency income taxes in question, arrived at as follows: For the year 1953, by disallowing as deductions all amounts paid that year by the petitioner as bonus to its officers and staffmembers in the aggregate sum of P175,140.00, this resulting in a net taxable income of petitioner amounting to P173,054.16; for the

taxable years 1954 and 1955, the similar disallowance as deductions of a portion of the bonuses paid by petitioner in said years to its officers and staff-members in the aggregate sums of P88,193.33 for 1954 and P90,385.00 for 1955, resulted likewise in a net taxable income for petitioner in the sum of P83,239.42 for 1954 and P81,138.93 for 1955. On July 9, 1958 petitioner filed with the Court of Tax Appeals a petition for review contesting the aforementioned assessments (C.T.A. Case No. 551), and on April 28, 1961, said Court rendered judgment as follows: "FOR THE FOREGOING CONSIDERATIONS, the decision appealed from is hereby affirmed with respect to deficiency assessment for the years 1953 and 1955. As regards the deficiency assessment for the year 1954, the same is hereby modified in the sense that the amount due from petitioner is P11,248.00, instead of P16,648.00. Accordingly, petitioner is ordered to pay within thirty days from the date this decision becomes final the sums of P40,455.00 and P16,228.00, plus 5% surcharge and 1% monthly interest from October 1, 1957 until paid. It is likewise ordered to pay the sum of P11,248.00 within the same period, and, if not so paid, there shall be added thereto 5% surcharge and 1% monthly interest from the date of delinquency to the date of payment. With costs against petitioner." Petitioner moved for a reconsideration of the abovequoted decision, and on August 21, 1961, the court amended the same to include the following at the end thereof:
... In both cases, the maximum amount of interest shall not exceed the amount corresponding to a period of three years, pursuant to Section 51(e) (2) of the National Internal Revenue Code, as amended by Section 8 of Republic Act No. 2343. With costs against petitioner.

Having found that the bonuses in question were paid for services actually rendered by the recipients thereof, the tax court proceeded to consider the question of "whether or not they are reasonable". In this connection it construed Section 30(a) (1) of the Revenue Code as allowing the deduction from gross income of all the ordinary and necessary expenses incurred during the

taxable year in carrying on the trade or business of the taxpayer, including a reasonable allowance for salaries or other compensation for personal services actually rendered. We agree with the view thus expressed, as well as with court's conclusion that the bonuses in question were not reasonable considering all material and relevant factors. Petitioner contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner", and erred in not considering individually the total compensation paid to each of petitioner's officers and staff members in determining the reasonableness of the bonuses in question, and that it erred likewise in holding that there was nothing in the record indicating that the actuation of the respondent was unreasonable or unjust. It is not true, as petitioner claims to support its view, that the respondent and the tax court based their ruling exclusively upon the fact that petitioner had suffered net losses in its business operations during the years when the bonuses in question were paid. The truth appears to be that, in arriving at such conclusion, the respondent and the tax court gave due consideration to all the material factors that led this Court to decide an earlier case of petitioner itself involving the same issue and where the test for determining the reasonableness of bonuses and additional compensation for services actually rendered were laid down by Us as follows:
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 condition precedents 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) 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). Here it is admitted that the bonuses are in fact compensation and were paid for services actually rendered. The only question is whether the payment of said bonuses is reasonable.

There plaintiff 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 a 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 a satisfactory answer, and that ordinarily it is the interplay of several factors, properly weighted for the particular case, which must furnish the final answer (Idem)." Kuenzle & Streiff v. Coll. of Int. Rev., G. R. Nos. L-12010 & L-12113, Oct. 20, 1959.)
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Making a distinction between petitioner's previous case and the present, the tax court said that while it is true that in the former (C.T.A. No. 169, December 29, 1956, G.R. Nos. L-12010 and L12113, October 20, 1959, involving taxable years 1950 to 1952 (We allowed and considered deductible bonuses in amounts bigger than the ones allowed by respondent in the case at bar, that was due to the fact that petitioner had earned huge profits during the years 1950-52. So much so that, the payment of such bonuses notwithstanding, petitioner still had substantial net profits distributable as dividends among its stockholders. In the present case, on the other hand, it is clear that the ultimate and inevitable result of the payment of the questioned bonuses would be net losses for petitioner during the taxable years in which they were paid. It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following factors:

In the first place, for the years 1953, 1954 and 1955 the petitioner paid to its following top officers: A. P. Kuenzle, H. A. Streiff, A. Jung, G. Gattaneo, A. Schatzmann, F. E. Rein, M. Klinger, A. Huber, S. Meili, M. Triaca, J. Ortiz, H. Vogt, W. Ramp, W. Strehler, H. R. Jung, K. Schedler, P. C. Curtis, R. Oefeli, substantial amounts as salaries and bonuses ranging from P9,000.00 yearly as a minimum (except in the case) and P50,000.00 as maximum. All these officials headed various departments of petitioner's business. While it must be assumed, on the one hand, in the absence of evidence to the contrary, that they were competent, on the other the record discloses no evidence nor has petitioner ever made the claim that all or some of them were gifted with some special talent, or had undergone some extraordinary training, or had accomplished any particular task, that contributed materially to the success of petitioner's business during the taxable years in question. In the second place, working under the above-named officials and constituting what we might call the staff of petitioner's working personnel, were a good number of other employees mostly Filipinos (T.s.n., pp. 222-223) all of whom, according to the record (Idem. 223), received no pay increase at all during the same years. In the third place, the above salaries and bonuses were paid to petitioner's top officials mentioned heretofore, in spite of the fact that according to its income tax returns for the relevant years, it had suffered net losses as follows: P2,085.84, P4,953.91, P9,246.07 for the years 1953, 1954 and 1955, respectively. In fact, petitioner's financial statements further show that its gross assets suffered a gradual decrease for the same years (Exh. B-1, p. 58, B.I.R., records, Exh. D-1, p. 36 id., Exh. F-1, p. 14 id.), and that a similar downward trend took place in its surplus and capital position during the same period of time. That the charge of arbitrariness against respondent is without merit is further shown by the following considerations: Petitioner admits that the amounts it paid to its top officers in 1953 as bonus or "additional remuneration" were taken either from operating funds, that is, funds from the year's business operations, or from its general reserve. Normally, the amounts

taken from the first source should have constituted profits of the corporation distributable as dividends amongst its shareholders. Instead it would appear that they were diverted from this purpose and used to pay the bonuses for the year 1953. In the case of the amounts taken from the general reserve it seems clear that the company had to resort to the use of such reserve funds because the item of expense to be met could not be considered as ordinary or necessary and was therefore beyond the purview of the provisions of Section 30(a) (1) of the National Internal Revenue Code. This being so, We cannot see our way clear to holding that the respondent acted arbitrarily in disallowing as deductible expenses the amounts thus paid as bonus or "additional remuneration". Neither does the total disallowance of the bonuses paid to some officers and the partial disallowance of those paid to others show that respondent acted unjustly and unreasonably. The record sufficiently shows that the total disallowance was more or less due to the fact that the affected officers had previously received substantial increases in their basic salaries. Petitioner justifies payment of these bonuses to its top officials by saying that its general salary policy was to give a low salary but to grant substantial bonuses at the end of each year, so that its officers may receive considerable lump sums with which to purchase whatever expensive objects or items they might need. While We are not prepared to hold that such policy is unreasonable, still We believe that its application should not result in producing a net loss for the employer at the end of the year, for if that were to be the case, the scheme may be utilized to freely achieve some other purpose evade payment of taxes. The authority relied upon by petitioner (Mertens Law of Federal Income Taxation, Vol. IV, p. 418) does not apply to the present case, because it refers to the salary paid to an employee, which may be claimed as a deductible amount. In the case before Us the respondent does not question the basic salaries paid by petitioner to the officers and employees, but disallowed only the bonuses paid to petitioner's top officers at the end of the taxable years in question.

In further support of its appeal petitioner claims that the amounts disallowed by the respondent should be considered as legitimate business expenses as their payment was made in good faith. In bringing up this point, petitioner treads on dangerous ground. In the first place, good faith cannot decide whether a business is reasonable or unreasonable for purposes of income tax deduction. In the second place, petitioner's good faith in the matter at issue is not overly manifest, considering that the questioned bonuses were fixed and paid at the end the years in question at a time, therefore, when petitioner fully knew that it was going to suffer a net loss in its business operations. 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 bonus in question, all that We need say is this: that right maybe 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 to 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. WHEREFORE, the appealed decision being in accordance with law, the same is hereby affirmed, with costs. Reyes, J.B.L., Makalintal, Zaldivar, Sanchez, Fernando, Capistrano, Teehankee and Barredo, JJ., concur. Concepcion, C.J., and Castro, J., are on leave

Republic of the Philippines SUPREME COURT Manila FIRST DIVISION

G.R. No. L-31305 May 10, 1990 HOSPITAL DE SAN JUAN DE DIOS, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent. Valdez, Ereso, Polido & Associates for petitioner. GRIO-AQUINO, J.: In a letter dated January 15, 1959, the Commissioner of Internal Revenue assessed and demanded from the petitioner, Hospital De San Juan De Dios, Inc., payment of P51,462 as deficiency income taxes for 1952 to 1955. The petitioner protested against the assessment and requested the Commissioner to cancel and withdraw it. After reviewing the assessment, the Commissioner advised petitioner on November 8, 1960 that the deficiency income tax assessment against it was reduced to only P16,852.41. Still the petitioner, through its auditors, insisted on the cancellation of the revised assessment. The request was, however, denied. On September 18, 1965, petitioner sought a review of the assessment by the Court of Tax Appeals (hereafter "CTA"). In a decision dated August 29, 1969, the CTA upheld the Commissioner. It held that the expenses incurred by the petitioner for handling its funds or income consisting solely of dividends and interests, were not expenses incurred in "carrying on any trade or business," hence, not deductible as business or administrative expenses. Petitioner filed a motion for reconsideration of the CTA decision. When its motion was denied, it filed this petition for review.

The background of the controversy is stated in the decision of the CTA as follows: There is no dispute that petitioner is engaged in both taxable and non-taxable operations. The income derived from the operations of the hospital and the nursing school are exempt from income tax while the rest of petitioner's income are subject thereto. Its taxable or non-operating income consists of rentals, interests and dividendS received from its properties and investments. In the computation of its taxable income for the years 1952 to 1955, petitioner allowed all its taxable income to share in the allocation of administrative expenses. Respondent disallowed, however, theinterests and dividends from sharing in the allocation of administrative expense on the ground that the expenses incurred in the administration or management of petitioner's investments are not allowable business expenses inasmuch as they were not incurred in 'carrying on any trade or business' within the contemplation of Section 30 (a) (1) of the Revenue Code. Consequently, petitioner was assessed deficiency income taxes for the years in question. (pp. 4546, Rollo.) The applicable law is Section 30 of the Revenue Code which provides: Sec. 30. Deductions from Gross Income. In computing net income there shad be allowed as deduction (A) Expenses: (i) 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 . . . (Emphasis supplied). (p. 46, Rollo.)

The Court of Tax Appeals found, however, that: . . . petitioner failed to establish by competent proof that its receipt of interests and dividends constituted the carrying on of a "trade or business" so as to warrant the deductibility of the expenses incurred in their realization. No evidence whatsoever was presented by petitioner to show how it handled its investment, the manner it bought, sold and reinvested its securities, how it made decisions, and whether it consulted brokers, investment or statistical services. Neither is there any showing of the extent of its activities in stocks or bonds, and participation, if any, direct or indirect, in the management of the corporations where it made investments. In effect, there is total absence of any indication of a businesslike management or operation of its interests and dividends. (See Roebling vs. Comm. of Int. Rev., 37 BTA 82). Instead, petitioner merely relied on the assumption that "if it is to handle its investment portfolio profitably", it has either to engage the services of an investment banker or administer it from within but the latter necessarily involves studying the securities market, the tax aspects of the investments, hiring accountants, collectors, clerical help, etc. without showing that it was actually performing these varied activities. Petitioner could have easily required any of its responsible officials to testify on this regard but it failed to do so. Under these circumstances and coupled with the fact that the interests and dividends here in question are merely incidental income to petitioner's main activity, which is the operation of its hospital and nursing schools, the conclusion becomes inevitable that petitioner's activities never go beyond that of a passive investor, which under existing jurisprudence do not come within the purview of carrying on any "trade or business". (pp. 4748, Rollo.) The Court of Tax Appeals found that the interests and dividends received by the petitioner "were merely incidental income to petitioner's main activity, which is the operation of its hospital and nursing schools [hence] the conclusion is inevitable that petitioner's activities never went beyond that of a passive investor, which under

existing jurisprudence do not come within the purview of carrying on any 'trade or business'." (pp. 47-48, Rollo) That factual finding is binding on this Court. And, as the principle of allocating expenses is grounded on the premise that the taxable income was derived from carrying on a trade or business, as distinguished from mere receipt of interests and dividends from one's investments, the Court of Tax Appeals correctly ruled that said income should not share in the allocation of administrative expenses (p. 49, Rollo). Hospital de San Juan De Dios, Inc., according to its Articles of Incorporation, was established for purposes "Which are benevolent, charitable and religious, and not for financial gain" (p. 12, Petitioner's Brief). It is not carrying on a trade or business for the word "business" in its ordinary and common use means "human efforts which have for their end living or reward; it is not commonly used as descriptive of charitable, religious, educational or social agencies" or "any particular occupation or employment habitually engaged in especially for livelihood or gain" or "activities where profit is the purpose or livelihood is the motive." (Collector of Internal Revenue vs. Manila Lodge BPOE 105 Phil. 986). The fact that petitioner was assessed a real estate dealer's fixed tax of P640 on its rental income does not alter its status as a charitable, non-stock, non-profit corporation. WHEREFORE, finding no reversible error in the decision of the Court of Tax Appeals, the same is affirmed in toto. Costs against the petitioner. This decision is immediately executory. SO ORDERED. Narvasa, Cruz and Medialdea, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-15290 May 31, 1963

MARIANO ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. ----------------------------G.R. No. L-15280 May 31, 1963

COLLECTOR OF INTERNAL REVENUE, petitioner, vs. MARIANO ZAMORA, respondent. ----------------------------G.R. No. L-15289 May 31, 1963

ESPERANZA A. ZAMORA, as Special Administratrix of Estate of FELICIDAD ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. ----------------------------G.R. No. L-15281 May 31, 1963

COLLECTOR OF INTERNAL REVENUE, petitioner, vs. ESPERANZA A. ZAMORA, as Special Administratrix, etc. respondent.

Office of the Solicitor General for petitioner. Rodegelio M. Jalandoni for respondents. PAREDES, J.: In the above-entitled cases, a joint decision was rendered by the lower court because they involved practically the same issues. We do so, likewise, for the same reason. Cases Nos. L-15290 and L-15280 Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and 1952. The Collector of Internal Revenue found that he failed to file his return of the capital gains derived from the sale of certain real properties and claimed deductions which were not allowable. The collector required him to pay the sums of P43,758.50 and P7,625.00, as deficiency income tax for the years 1951 and 1952, respectively (C.T.A. Case No. 234, now L-15290). On appeal by Zamora, the Court of Tax Appeals on December 29, 1958, modified the decision appealed from and ordered him to pay the reduced total sum of P30,258.00 (P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952, respectively), within thirty (30) days from the date the decision becomes final, plus the corresponding surcharges and interest in case of delinquency, pursuant to section 51(e), Int. Revenue Code. With costs against petitioner. Having failed to obtain a reconsideration of the decision, Mariano Zamora appealed (L-15290), alleging that the Court of Tax Appeals erred
(1) In dissallowing P10,478.50, as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora (which is of P20,957.00, supposed business expenses): (2) In disallowing 3-% per annum as the rate of depreciation of the Bay View Hotel Building;

(3) In disregarding the price stated in the deed of sale, as the costs of a Manila property, for the purpose of determining alleged capital gains; and (4) In applying the Ballantyne scale of values in determining the cost of said property.

The Collector of Internal Revenue (L-15280) also appealed, claiming that the Court of Tax Appeals erred
(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the said real property in question during the Japanese occupation, partly in Philippine currency and partly in Japanese war notes, and (2) In not holding that Mariano Zamora is liable for the payment of the sums of P43,758.00 and P7,625.00 as deficiency income taxes, for the years 1951 and 1952, plus the 5% surcharge and 1% monthly interest, from the date said amounts became due to the date of actual payment. Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court, without prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts.
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Cases Nos. L-15289 and L-15281 Mariano Zamora and his deceased sister Felicidad Zamora, bought a piece of land located in Manila on May 16, 1944, for P132,000.00 and sold it for P75,000.00 on March 5, 1951. They also purchased a lot located in Quezon City for P68,959.00 on January 19, 1944, which they sold for P94,000 on February 9, 1951. The CTA ordered the estate of the late Felicidad Zamora (represented by Esperanza A. Zamora, as special administratrix of her estate), to pay the sum of P235.50, representing alleged deficiency income tax and surcharge due from said estate. Esperanza A. Zamora appealed and alleged that the CTA erred:

The Commissioner of Internal Revenue likewise appealed from the decision, claiming that the lower court erred:
(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the real property involved during the Japanese occupation, partly in genuine Philippine currency and partly in Japanese war notes; and (2) In not holding that Esperanza A. Zamora, as administratrix, is liable for the payment of the sum of P613.00 as deficiency income tax and 50% surcharge for 1951, plus 50% surcharge and 1% monthly interest from the date said amount became due, to the date of actual payment.

It is alleged by Mariano Zamora that the CTA erred in disallowing P10,478.50 as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora. He contends that the whole amount of P20,957.00 as promotion expenses in his 1951 income tax returns, should be allowed and not merely one-half of it or P10,478.50, on the ground that, while not all the itemized expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. For, as alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano), during her travel to Japan and the United States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however, found that for said trip Mrs. Zamora obtained only the sum of P5,000.00 from the Central Bank and that in her application for dollar allocation, she stated that she was going abroad on a combined medical and business trip, which facts were not denied by Mariano Zamora. No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00 given to his wife which she spent abroad. No explanation had been made either that the statement contained in Mrs. Zamora's application for dollar allocation that she was going abroad on a combined medical and business trip, was not correct. The alleged expenses were not supported by receipts. Mrs. Zamora could not even remember how much money she had when she left abroad in 1951, and how the alleged amount of P20,957.00 was spent.

Section 30, of the Tax Code, provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year, in carrying on any trade or business (Vol. 4, Mertens, Law of Federal Income Taxation, sec. 25.03, p. 307). Since promotion expenses constitute one of the deductions in conducting a business, same must testify these requirements. Claim for the deduction of promotion expenses or entertainment expenses must also be substantiated or supported by record showing in detail the amount and nature of the expenses incurred (N.H. Van Socklan, Jr. v. Comm. of Int. Rev.; 33 BTA 544). Considering, as heretofore stated, that the application of Mrs. Zamora for dollar allocation shows that she went abroad on a combined medical and business trip, not all of her expenses came under the category of ordinary and necessary expenses; part thereof constituted her personal expenses. There having been no means by which to ascertain which expense was incurred by her in connection with the business of Mariano Zamora and which was incurred for her personal benefit, the Collector and the CTA in their decisions, considered 50% of the said amount of P20,957.00 as business expenses and the other 50%, as her personal expenses. We hold that said allocation is very fair to Mariano Zamora, there having been no receipt whatsoever, submitted to explain the alleged business expenses, or proof of the connection which said expenses had to the business or the reasonableness of the said amount of P20,957.00. While in situations like the present, absolute certainty is usually no possible, the CTA should make as close an approximation as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making. In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev., G.R. No. L-12798, May 30, 1960, it was declared that representation expenses fall under the category of business expenses which are allowable deductions from gross income, if they meet the conditions prescribed by law, particularly section 30 (a) [1], of the Tax Code; that to be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in amount; that when some of the representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but others were without vouchers or chits, documents or supporting papers; that

there is no more than oral proof to the effect that payments have been made for representation expenses allegedly made by the taxpayer and about the general nature of such alleged expenses; that accordingly, it is not possible to determine the actual amount covered by supporting papers and the amount without supporting papers, the court should determine from all available data, the amount properly deductible as representation expenses. In view hereof, We are of the opinion that the CTA, did not commit error in allowing as promotion expenses of Mrs. Zamora claimed in Mariano Zamora's 1951 income tax returns, merely one-half or P10,478.50. Petitioner Mariano Zamora alleges that the CTA erred in disallowing 3-% per annum as the rate of depreciation of the Bay View Hotel Building but only 2-%. In justifying depreciation deduction of 3-%, Mariano Zamora contends that (1) the Ermita District, where the Bay View Hotel is located, is now becoming a commercial district; (2) the hotel has no room for improvement; and (3) the changing modes in architecture, styles of furniture and decorative designs, "must meet the taste of a fickle public". It is a fact, however, that the CTA, in estimating the reasonable rate of depreciation allowance for hotels made of concrete and steel at 2%, the three factors just mentioned had been taken into account already. Said the CTA
Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of the building for business purposes depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the rate of change in population, the shifting of land values, as well as the extent and maintenance and rehabilitation. It is allowed a depreciation rate of 2-% corresponding to a normal useful life of only 40 years (1955 PH Federal Taxes, Par 14 160-K). Consequently, the stand of the petitioners can not be sustained.

As the lower court based its findings on Bulletin F, petitioner Zamora, argues that the same should have been first proved as a law, to be subject to judicial notice. Bulletin F, is a publication of the US Federal Internal Revenue Service, which was made after a study of the lives of the properties. In the words of the lower court:

"It contains the list of depreciable assets, the estimated average useful lives thereof and the rates of depreciation allowable for each kind of property. (See 1955 PH Federal Taxes, Par. 14, 160 to Par. 14, 163-0). It is true that Bulletin F has no binding force, but it has a strong persuasive effect considering that the same has been the result of scientific studies and observation for a long period in the United States after whose Income Tax Law ours is patterned." Verily, courts are permitted to look into and investigate the antecedents or the legislative history of the statutes involved (Director of Lands v. Abaya, et al., 63 Phil. 559). Zamora also contends that his basis for applying the 3-% rate is the testimony of its witness Mariano Katipunan, who cited a book entitled "Hotel Management Principles and Practice" by Lucius Boomer, President, Hotel Waldorf Astoria Corporation. As well commented by the Solicitor General, "while the petitioner would deny us the right to use Bulletin F, he would insist on using as authority, a book in Hotel management written by a man who knew more about hotels than about taxation. All that the witness did (Katipunan) . . . is to read excerpts from the said book (t.s.n. pp. 99-101), which admittedly were based on the decision of the U.S. Tax Courts, made in 1928 (t.s.n. p. 106)". In view hereof, We hold that the 2-% rate of depreciation of the Bay View Hotel building, is approximately correct. The next items in dispute are the undeclared capital gains derived from the sales in 1951 of certain real properties in Malate, Manila and in Quezon City, acquired during the Japanese occupation. The Manila property (Esperanza Zamora v. Coll. of Int. Rev., Case No. L-15289). The CTA held in this case, that the cost basis of property acquired in Japanese war notes is the equivalent of the war notes in genuine Philippine currency in accordance with the Ballantyne Scale of values, and that the determination of the gain derived or loss sustained in the sale of such property is not affected by the decline at the time of sale, in the purchasing power of the Philippine currency. It was found by the CTA that the purchase price of P132,000.00 was not entirely paid in Japanese War notes but thereof or P66,000.00 was in Philippine currency, and that during certain periods of the enemy occupation, the value of the Japanese war notes was very much less than the value of the genuine Philippine currency. On this point, the CTA declared

Finally, it is alleged that the purchase price of P132,000.00 was not entirely paid in Japanese war notes, Mariano Zamora, co-owner of the property in question, testified that P66,000.00 was paid in Philippine currency and the other P66,000.00 was paid in Japanese war notes. No evidence was presented by respondent to rebut the testimony of Mariano Zamora; it is assailed merely as being improbable. We have examined this question thoroughly and we are inclined to give credence to the allegation that a portion of the purchase price of the property was paid in Philippine money. In the first place, it appears that the Zamoras owned the Farmacia Zamora which continued to engage in business during the war years and that a considerable portion of its sales was paid for in genuine Philippine currency. This circumstance enabled the Zamoras to accumulate Philippine money which they used in acquiring the property in question and another property in Quezon City. In the second place, P132,000.00 in Japanese war notes in May, 1944 is equivalent to only P11,000.00. The property in question had at the time an assessed value of P27,031.00 (in Philippine currency). Considering the well known fact that the assessed value of real property is very much below the fair market value, it is incredible that said property should have been sold by the owner thereof for less than one-half of its assessed value. These facts have convinced us of the veracity of the allegation that of the purchase price of P132,000.00 the sum of P66,000.00 was paid in Philippine currency, so that only the sum of P66,000.00 was paid in Japanese War notes.

This being the case, the Ballantyne Scale of values, which was the result of an impartial scientific study, adopted and given judicial recognition, should be applied. As the value of the Japanese war notes in May, 1944 when the Manila property was bought, was 1 of the genuine Philippine Peso (Ballantyne Scale), and since the gain derived or loss sustained in the disposition of this property is to reckoned in terms of Philippine Peso, the value of the Japanese war notes used in the purchase of the property, must be reduced in terms of the genuine Philippine Peso to determine the cost of acquisition. It, therefore, results that since the sum of P66,000.00 in Japanese war notes in May, 1944 is equivalent to P5,500.00 in Philippine currency (P66,000.00 divided by 12), the acquisition cost of the property in question is P66,000.00 plus P5,500.00 or P71,500.00 and that as

the property was sold for P75,000.00 in 1951, the owners thereof Mariano and Felicidad Zamora derived a capital gain of P3,500.00 or P1,750.00 each. The Quezon City Property (Mariano Zamora v. Coll. of Customs, Case No. 15290). The Zamoras alleged that the entire purchase price of P68,959.00 was paid in Philippine currency. The collector, on the other hand, contends that the purchase price of P68,959.00 was paid in Japanese war notes. The CTA, however, giving credence to Zamora's version, said
. . . If , as contended by respondent, the purchase price of P68,959.00 was paid in Japanese war notes, the purchase price in Philippine currency would be only P17,239.75 (P68,959.00 divided by 4, 34.00 in war notes being equivalent to P1.00 in Philippine currency). The assessed value of said property in Philippine currency at the time of acquisition was P46,910.00. It is quite incredible that real property with an assessed value of P46,910.00 should have been sold by the owner thereof in Japanese war notes with an equivalent value in Philippine currency of only P17,239.75. We are more inclined to believe the allegation that it was purchased for P68,959.00 in genuine Philippine currency. Since the property was sold for P94,000.00 on February 9, 1951, the gain derived from the sale is P15,361.75, after deducting from the selling price the cost of acquisition in the sum of P68,959.00 and the expense of sale in the sum of P9,679.25.

The above appraisal is correct, and We have no plausible reason to disturb the same. Consequently, the total undeclared income of petitioners derived from the sales of the Manila and Quezon City properties in 1951 is P17,111.75 (P1,750.00 plus P15,361.75), 50% of which in the sum of P8,555.88 is taxable, the said properties being capital assets held for more than one year. IN VIEW HEREOF, the petition in each of the above-entitled cases is dismissed, and the decision appealed from is affirmed, without special pronouncement as to costs.

Republic of the Philippines SUPREME COURT Manila EN BANC 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 incarrying 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 forclearing 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, orbetterments 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 toincrease 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 nondeductible 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 be regarded as investments of capital. (Merten's Law of Federal Income 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. Padilla, Bautista Angelo, Labrador, Reyes, J.B.L., Barrera and Dizon, JJ., concur.

Republic of the Philippines SUPREME COURT Manila FIRST DIVISION


G.R. No. L-26911 January 27, 1981 ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent. G.R. No. L-26924 January 27, 1981 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION and COURT OF TAX APPEALS,respondents.

DE CASTRO, J.:
These are two (2) petitions for review from the decision of the Court of Tax Appeals of October 25, 1966 in CTA Case No. 1312 entitled "Atlas Consolidated Mining and Development Corporation vs. Commissioner of Internal Revenue." One (L-26911) was filed by the Atlas Consolidated Mining & Development Corporation, and in the other L-26924), the Commissioner of Internal Revenue is the petitioner. This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the Commissioner of Internal Revenue, hereinafter referred to as Commissioner, where the Atlas Consolidated Mining and Development Corporation, hereinafter referred to as Atlas, was assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiency income taxes.

Atlas is a corporation engaged in the mining industry registered under the laws of the Philippines. On August 20, 1962, the Commissioner assessed against Atlas the sum of P546,295.16

and P215,493.96 or a total of P761,789.12 as deficiency income taxes for the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that Atlas is not entitled to exemption from the income tax under Section 4 of Republic Act 9091 because same covers only gold mines, the provision of which reads:
New mines, and old mines which resume operation, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, shall be exempt from the payment of income tax during the first three (3) years of actual commercial production. Provided that, any such mine and/or mines making a complete return of its capital investment at any time within the said period, shall pay income tax from that year. For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the disallowance of items claimed by Atlas as deductible from gross income.

On October 9, 1962, Atlas protested the assessment asking for its reconsideration and cancellation. 2 Acting on the protest, the Commissioner conducted a reinvestigation of the case. On October 25, 1962, the Secretary of Finance ruled that the exemption provided in Republic Act 909 embraces all new mines and old mines whether gold or other minerals. 3 Accordingly, the Commissioner recomputed Atlas deficiency income tax liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the Commissioner issued a revised assessment entirely eliminating the assessment of P546,295.16 for the year 1957. The assessment for 1958 was reduced from P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals, assailing the disallowance of the following items claimed as deductible from its gross income for 1958:
Transfer agent's fee.........................................................P59,477.42 Stockholders relation service fee....................................25,523.14

U.S. stock listing expenses..................................................8,326.70 Suit expenses...................................................................... ....6,666.65 Provision for contingencies..................................... .........60,000.00 Total..................................................... ...............P159,993.91

After hearing, the Court of Tax Appeals rendered a decision on October 25, 1966 allowing the above mentioned disallowed items, except the items denominated by Atlas as stockholders relation service fee and suit expenses. 4Pertinent portions of the decision of the Court of Tax Appeals read as follows:
Under the facts, circumstances and applicable law in this case, the unallowable deduction from petitioner's gross income in 1958 amounted to P32,189.79. Stockholders relation service fee.................................... P25,523.14 Suit and litigation expenses................................................ 6,666.65 Total.............................................................................. ..... P32,189.79 As the exemption of petitioner from the payment of corporate income tax under Section 4, Republic Act 909, was good only up to the Ist quarter of 1958 ending on March 31 of the same year, only threefourth (3/4) of the net taxable income of petitioner is subject to income tax, computed as follows: 1958

Total net income for 1958.................................P1,968,898.27 Net income corresponding to taxable period April 1 to Dec. 31, 1958, 3/4 of P1,968,898.27..........................................................1, 476,673.70 Add: 3/4 of promotion fees of P25,523.14..............................................................P1 9,142.35 Litigation expenses...................................................................... ...6, 666.65 Net income per decision..........................................11, 02,4 2.70 Tax due thereon.........................................................412,695.0 0 Less: Amount already assessed .............................405,468.00 DEFICIENCY INCOME TAX DUE............................P7,227.00 Add: 1/2 % monthly interest from 6-20-59 to 6-20-62 (18%)....................................P1,300.89

TOTAL AMOUNT DUE & COLLECTIBLE............P8,526.22 From the Court of Tax Appeals' decision of October 25, 1966, both parties appealed to this Court by way of two (2) separate petitions for review docketed as G. R. No. L-26911 (Atlas, petitioner) and G. R. No. L-29924 (Commissioner, petitioner). G. R. No. L-26911Atlas appealed only that portion of the Court of Tax Appeals' decision disallowing the deduction from gross income of the so-called stockholders relation service fee amounting to P25,523.14, making a lone assignment of error that THE COURT OF TAX APPEALS ERRED IN ITS CONCLUSION THAT THE EXPENSE IN THE AMOUNT OF P25,523.14 PAID BY PETITIONER IN 1958 AS ANNUAL PUBLIC RELATIONS EXPENSES WAS INCURRED FOR ACQUISITION OF ADDITIONAL CAPITAL, THE SAME NOT BEING SUPPORTED BY THE EVIDENCE.

It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as annual public relations expenses is a deductible expense from gross income under Section 30 (a) (1) of the National Internal Revenue Code. Atlas claimed that it was paid for services of a public relations firm, P.K Macker & Co., a reputable public relations consultant in New York City, U.S.A., hence, an ordinary and necessary business expense in order to compete with other corporations also interested in the investment market in the United States. 5 It is the stand of Atlas that information given out to the public in general and to the stockholder in particular by the P.K MacKer & Co. concerning the operation of the Atlas was aimed at creating a favorable image and goodwill to gain or maintain their patronage.
The decisive question, therefore, in this particular appeal taken by Atlas to this Court is whether or not the expenses paid for the services rendered by a public relations firm P.K MacKer & Co. labelled as stockholders relation service fee is an allowable deduction as business expense under Section 30 (a) (1) of the National Internal Revenue Code.

The principle is recognized that when a taxpayer claims a deduction, he must point to some specific provision of the statute in which that deduction is authorized and must be able to prove that he is entitled to the deduction which the law allows. As previously adverted to, the law allowing expenses as deduction from gross income for purposes of the income tax is Section 30 (a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." An item of expenditure, in order to be deductible under this section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying in a trade or business. 6 In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction. 7 While it is true that there is a number of decisions in the United States delving on the interpretation of the terms "ordinary and necessary" as used in the federal tax laws, no adequate or satisfactory definition of those terms is possible. Similarly, this Court has never attempted to define with precision the terms "ordinary and necessary." There are however, certain guiding principles worthy of serious consideration in the proper adjudication of conflicting claims. Ordinarily, an expense will be considered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business. 8 It is "ordinary" when it connotes a payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. 9 The term "ordinary" does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. 10 There is thus no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the

relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. 11 Assuming that the expenditure is ordinary and necessary in the operation of the taxpayer's business, the answer to the question as to whether the expenditure is an allowable deduction as a business expense must be determined from the nature of the expenditure itself, which in turn depends on the extent and permanency of the work accomplished by the expenditure. 12 It appears that on December 27, 1957, Atlas increased its capital stock from P15,000,000 to P18,325,000. 13 It was claimed by Atlas that its shares of stock worth P3,325,000 were sold in the United States because of the services rendered by the public relations firm, P. K. Macker & Company. The Court of Tax Appeals ruled that the information about Atlas given out and played up in the mass communication media resulted in full subscription of the additional shares issued by Atlas; consequently, the questioned item, stockholders relation service fee, was in effect spent for the acquisition of additional capital, ergo, a capital expenditure. We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K. Macker & Co. as compensation for services carrying on the selling campaign in an effort to sell Atlas' additional capital stock of P3,325,000 is not an ordinary expense in line with the decision of U.S. Board of Tax Appeals in the case ofHarrisburg Hospital Inc. vs. Commissioner of Internal Revenue. 14 Accordingly, as found by the Court of Tax Appeals, the said expense is not deductible from Atlas gross income in 1958 because expenses relating to recapitalization and reorganization of the corporation (Missouri-Kansas Pipe Line vs. Commissioner of Internal Revenue, 148 F. (2d), 460; Skenandos Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. (2d) 268, Cert. denied 314 U.S. 6961), the cost of obtaining stock subscription (Simons Co., 8 BTA 631), promotion expenses (Beneficial Industrial Loan Corp. vs. Handy, 92 F. (2d) 74), and commission or fees paid for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308) are capital expenditures. That the expense in question was incurred to create a favorable image of the corporation in order to gain or maintain the public's and its stockholders' patronage, does not make it deductible as

business expense. As held in the case of Welch vs. Helvering, 15 efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. We do not agree with the contention of Atlas that the conclusion of the Court of Tax Appeals in holding that the expense of P25,523.14 was incurred for acquisition of additional capital is not supported by the evidence. The burden of proof that the expenses incurred are ordinary and necessary is on the taxpayer 16 and does not rest upon the Government. To avail of the claimed deduction under Section 30(a) (1) of the National Internal Revenue Code, it is incumbent upon the taxpayer to adduce substantial evidence to establish a reasonably proximate relation petition between the expenses to the ordinary conduct of the business of the taxpayer. A logical link or nexus between the expense and the taxpayer's business must be established by the taxpayer.
G. R. No. L-26924-In his petition for review, the Commissioner of Internal Revenue assigned as errors the following: I THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF THE SO- CALLED TRANSFER AGENT'S FEES ALLEGEDLY PAID BY RESPONDENT; II THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF LISTING EXPENSES ALLEGEDLY INCURRED BY RESPONDENT; III THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE AMOUNT OF P60,000 REPRESENTED BY RESPONDENT AS

"PROVISION FOR CONTINGENCIES" WAS ADDED BACK BY RESPONDENT TO ITS GROSS INCOME IN COMPUTING THE INCOME TAX DUE FROM IT FOR 1958; IV THE COURT OF TAX APPEALS ERRED IN DISALLOWING ONLY THE AMOUNT OF P6,666.65 AS SUIT EXPENSES, THE CORRECT AMOUNT THAT SHOULD HAVE BEEN DISALLOWED BEING P17,499.98.

It is well to note that only in the Court of Tax Appeals did the Commissioner raise for the first time (in his memorandum) the question of whether or not the business expenses deducted from Atlas gross income in 1958 may be allowed in the absence of proof of payments. 17 Before this Court, the Commissioner reiterated the same as ground against deductibility when he claimed that the Court of Tax Appeals erred in allowing the deduction of transfer agent's fee and stock listing fee from gross income in the absence of proof of payment thereof.
The Commissioner contended that under Section 30 (a) (1) of the National Internal Revenue Code, it is a requirement for an expense to be deductible from gross income that it must have been "paid or incurred during the year" for which it is claimed; that in the absence of convincing and satisfactory evidence of payment, the deduction from gross income for the year 1958 income tax return cannot be sustained; and that the best evidence to prove payment, if at all any has been made, would be the vouchers or receipts issued therefor which ATLAS failed to present.

Atlas admitted that it failed to adduce evidence of payment of the deduction claimed in its 1958 income tax return, but explains the failure with the allegation that the Commissioner did not raise that question of fact in his pleadings, or even in the report of the investigating examiner and/or letters of demand and assessment notices of ATLAS which gave rise to its appeal to the Court of Tax Appeal. 18 It was emphasized by Atlas that it went to trial and finally submitted this case for decision on the assumption that inasmuch as the fact of payment was never raised as a vital issue by the Commissioner in his answer to the petition for review in the

Court of Tax Appeal, the issues is limited only to pure question of lawwhether or not the expenses deducted by petitioner from its gross income for 1958 are sanctioned by Section 30 (a) (1) of the National Internal Revenue Code. On this issue of whether or not the Commissioner can raise the fact of payment for the first time on appeal in its memorandum in the Court of Tax Appeal, we fully agree with the ruling of the tax court that the Commissioner on appeal cannot be allowed to adopt a theory distinct and different from that he has previously pursued, as shown by the BIR records and the answer to the amended petition for review. 19 As this Court said in the case of Commissioner of Customs vs. Valencia 20 such change in the nature of the case may not be made on appeal, specially when the purpose of the latter is to seek a review of the action taken by an administrative body, forming part of a coordinate branch of the Government, such as the Executive department. In the case at bar, the Court of Tax Appeal found that the fact of payment of the claimed deduction from gross income was never controverted by the Commissioner even during the initial stages of routinary administrative scrutiny conducted by BIR examiners.21 Specifically, in his answer to the amended petition for review in the Court of Tax Appeal, the Commissioner did not deny the fact of payment, merely contesting the legitimacy of the deduction on the ground that same was not ordinary and necessary business expenses. 22 As consistently ruled by this Court, the findings of facts by the Court of Tax Appeal will not be reviewed in the absence of showing of gross error or abuse. 23 We, therefore, hold that it was too late for the Commissioner to raise the issue of fact of payment for the first time in his memorandum in the Court of Tax Appeals and in this instant appeal to the Supreme Court. If raised earlier, the matter ought to have been seriously delved into by the Court of Tax Appeals. On this ground, we are of the opinion that under all the attendant circumstances of the case, substantial justice would be served if the Commissioner be held as precluded from now attempting to raise an issue to disallow deduction of the item in question at this stage. Failure to assert a question within a reasonable time warrants a presumption that the party entitled to assert it either has abandoned or declined to assert it.

On the second assignment of error, aside from alleging lack of proof of payment of the expense deducted, the Commissioner contended that such expense should be disallowed for not being ordinary and necessary and not incurred in trade or business, as required under Section 30 (a) (1) of the National Internal Revenue Code. He asserted that said fees were therefore incurred not for the production of income but for the acquisition petition of capital in view of the definition that an expense is deemed to be incurred in trade or business if it was incurred for the production of income, or in the expectation of producing income for the business. In support of his contention, the Commissioner cited the ruling in Dome Mines, Ltd vs. Commisioner of Internal Revenue 24 involving the same issue as in the case at bar where the U.S. Board of Tax Appeal ruled that expenses for listing capital stock in the stock exchange are not ordinary and necessary expenses incurred in carrying on the taxpayer's business which was gold mining and selling, which business is strikingly similar to Atlas. On the other hand, the Court of Tax Appeal relied on the ruling in the case of Chesapeake Corporation of Virginia vs. Commissioner of Internal Revenue 25 where the Tax Court allowed the deduction of stock exchange fee in dispute, which is an annually recurring cost for the annual maintenance of the listing.
We find the Chesapeake decision controlling with the facts and circumstances of the instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a deduction not only because the expenditure did not meet the statutory test but also because the same was paid only once, and the benefit acquired thereby continued indefinitely, whereas, in the Chesapeake Corporation case, fee paid to the stock exchange was annual and recurring. In the instant case, we deal with the stock listing fee paid annually to a stock exchange for the privilege of having its stock listed. It must be noted that the Court of Tax Appeal rejected the Dome Mines casebecause it involves a payment made only once, hence, it was held therein that the single payment made to the stock exchange was a capital expenditure, as distinguished from the instant case, where payments were made annually. For this reason, we hold that said listing fee is an ordinary and necessary business expense On the third assignment of error, the Commissioner con- tended that the Court of Tax Appeal erred when it held that the amount of

P60,000 as "provisions for contingencies" was in effect added back to Atlas income.

On this issue, this Court has consistently ruled in several cases adverted to earlier, that in the absence of grave abuse of discretion or error on the part of the tax court its findings of facts may not be disturbed by the Supreme Court. 26 It is not within the province of this Court to resolve whether or not the P60,000 representing "provision for contingencies" was in fact added to or deducted from the taxable income. As ruled by the Court of Tax Appeals, the said amount was in effect added to Atlas taxable income. 27 The same being factual in nature and supported by substantial evidence, such findings should not be disturbed in this appeal.
Finally, in its fourth assignment of error, the Commissioner contended that the CTA erred in disallowing only the amount of P6,666.65 as suit expenses instead of P17,499.98. It appears that petitioner deducted from its 1958 gross income the amount of P23,333.30 as attorney's fees and litigation expenses in the defense of title to the Toledo Mining properties purchased by Atlas from Mindanao Lode Mines Inc. in Civil Case No. 30566 of the Court of First Instance of Manila for annulment of the sale of said mining properties. On the ground that the litigation expense was a capital expenditure under Section 121 of the Revenue Regulation No. 2, the investigating revenue examiner recommended the disallowance of P13,333.30. The Commissioner, however, reduced this amount of P6,666.65 which latter amount was affirmed by the respondent Court of Tax Appeals on appeal.

There is no question that, as held by the Court of Tax Ap- peals, the litigation expenses under consideration were incurred in defense of Atlas title to its mining properties. In line with the decision of the U.S. Tax Court in the case of Safety Tube Corp. vs. Commissioner of Internal Revenue, 28 it is well settled that litigation expenses incurred in defense or protection of title are capital in nature and not deductible. Likewise, it was ruled by the U.S. Tax Court that expenditures in defense of title of property constitute a part of the cost of the property, and are not deductible as expense. 29

Surprisingly, however, the investigating revenue examiner recommended a partial disallowance of P13,333.30 instead of the entire amount of P23,333.30, which, upon review, was further reduced by the Commissioner of Internal Revenue. Whether it was due to mistake, negligence or omission of the officials concerned, the arithmetical error committed herein should not prejudice the Government. This Court will pass upon this particular question since there is a clear error committed by officials concerned in the computation of the deductible amount. As held in the case of Vera vs. Fernandez, 30 this Court emphatically said that taxes are the lifeblood of the Government and their prompt and certain availability are imperious need. Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected. To safeguard such interest, neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harm or detriment to the people, in the same manner as private persons may be made to suffer individually on account of his own negligence, the presumption being that they take good care of their personal affair. This should not hold true to government officials with respect to matters not of their own personal concern. This is the philosophy behind the government's exception, as a general rule, from the operation of the principle of estoppel.31
WHEREFORE, judgment appealed from is hereby affirmed with modification that the amount of P17,499.98 (3/4 of P23,333.00) representing suit expenses be disallowed as deduction instead of P6,666.65 only. With this amount as part of the net income, the corresponding income tax shall be paid thereon, with interest of 6% per annum from June 20, 1959 to June 20,1962. SO ORDERED.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-16626 October 29, 1966

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. CARLOS PALANCA, JR., respondent. Office of the Solicitor General for petitioner. Manuel B. San Jose for respondent. REGALA, J.: This is an appeal by the Government from the decision of the Court of Tax Appeals in CTA Case No. 571 ordering the petitioner to refund to the respondent the amount of P20,624.01 representing alleged over-payment of income taxes for the calendar year 1955. The facts are:
Sometime in July, 1950, the late Don Carlos Palanca, Sr. donated in favor of his son, the petitioner, herein shares of stock in La Tondea, Inc. amounting to 12,500 shares. For failure to file a return on the donation within the statutory period, the petitioner was assessed the sums of P97,691.23, P24,442.81 and P47,868.70 as gift tax, 25% surcharge and interest, respectively, which he paid on June 22, 1955. On March 1, 1956, the petitioner filed with the Bureau of Internal Revenue his income tax return for the calendar year 1955, claiming, among others, a deduction for interest amounting to P9,706.45 and reporting a taxable income of P65,982.12. On the basis of this return, he was assessed the sum of P21,052.91, as income tax, which he paid, as follows: Taxes withheld by La Tondea Inc. from Mr. Palanca's wages

Payment under Income Tax Receipt No. 677395 dated May 11, 1956 Payment under Income Tax Receipt dated August 14, 1956

Subsequently, on November 10, 1956, the petitioner filed an amended return for the calendar year 1955, claiming therein an additional deduction in the amount of P47,868.70 representing interest paid on the donee's gift tax, thereby reporting a taxable net income of P18,113.42 and a tax due thereon in the sum of P3,167.00. The claim for deduction was based on the provisions of Section 30(b) (1) of the Tax Code, which authorizes the deduction from gross income of interest paid within the taxable year on indebtedness. A claim for the refund of alleged overpaid income taxes for the year 1955 amounting to P17,885.01, which is the difference between the amount of P21,052.01 he paid as income taxes under his original return and of P3,167.00, was filed together with this amended return. In a communication dated June 20, 1957, the respondent (BIR) denied the claim for refund. On August 27, 1957, the petitioner reiterated his claim for refund, and at the same time requested that the case be elevated to the Appellate Division of the Bureau of Internal Revenue for decision. The reiterated claim was denied on October 14, 1957. On November 2, 1957, the petitioner requested that the case be referred to the Conference Staff of the Bureau of Internal Revenue for review. Later, on November 6, 1957, he requested the respondent to hold his action on the case in abeyance until after the Court of Tax Appeals renders its division on a similar case. And on November 7, 1957, the respondent denied the claim for the refund of the sum of P17,885.01. Meanwhile, the Bureau of Internal Revenue considered the transfer of 12,500 shares of stock of La Tondea Inc. to be a transfer in contemplation of death pursuant to Section 88(b) of the National Internal Revenue Code. Consequently, the

respondent assessed against the petitioner the sum of P191,591.62 as estate and inheritance taxes on the transfer of said 12,500 shares of stock. The amount of P17,002.74 paid on June 22, 1955 by the petitioner as gift tax, including interest and surcharge, under Official Receipt No. 2855 was applied to his estate and inheritance tax liability. On the tax liability of P191,591.62, the petitioner paid the amount of P60,581.80 as interest for delinquency as follows: 1% monthly interest on P76,724.38 September 2, 1952 to February 16, 1955 1% monthly interest on P71,264.77 February 16, 1955 to March 31, 1955 1% monthly interest on P114,867.24 September 2, 1952 to April 16, 1953 1% monthly interest on P50,832.77 March 31, 1955 to June 22, 1955 1% monthly interest on P119,155.23 April 16, 1953 to June 22, 1955 Total P22,633.69 1,068.97 4,287.99 1,372.48 31,218.67 P60,581.80

On August 12, 1958, the petitioner once more filed an amended income tax return for the calendar year 1955, claiming, in addition to the interest deduction of P9,076.45 appearing in his original return, a deduction in the amount of P60,581.80, representing interest on the estate and inheritance taxes on the 12,500 shares of stock, thereby reporting a net taxable income for 1955 in the amount of P5,400.32 and an income tax due thereon in the sum of P428.00. Attached to this amended return was a letter of the petitioner, dated August 11, 1958, wherein he requested the refund of P20,624.01 which is the difference between the amounts of P21,052.01 he paid as income tax under his original return and of P428.00. Without waiting for the respondent's decision on this claim for refund, the petitioner filed his petition for review before this Court on August 13, 1958. On July 24, 1959, the respondent

denied the petitioner's request for the refund of the sum of P20,624.01.

The Commissioner of Internal Revenue now seeks the reversal of the Court of Tax Appeal's ruling on the aforementioned petition for review. Specifically, he takes issue with the said court's determination that the amount paid by respondent Palanca for interest on his delinquent estate and inheritance tax is deductible from the gross income for that year under Section 30 (b) (1) of the Revenue Code, and, that said respondent's claim for refund therefor has not prescribed. On the first point, the Commissioner urges that a tax is not an indebtedness. Citing American cases, he argues that there is a material and fundamental distinction between a "tax" and a "debt." (Meriwether v. Garrett, 102 U.S. 427; Liberty Mutual Ins. Co. v. Johnson Shipyards Corporation, 5 AFTR pp. 5504, 5507; City of Camden v. Allen, 26 N.J. Law, p. 398). He adopts the view that "debts are due to the government in its corporate capacity, while taxes are due to the government in its sovereign capacity. A debt is a sum of money due upon contract express or implied or one which is evidenced by a judgment. Taxes are imposts levied by government for its support or some special purpose which the government has recognized." In view of the distinction, then, the Commissioner submits that the deductibility of "interest on indebtedness" from a person's income tax under Section 30(b) (1) cannot extend to "interest on taxes." We find for the respondent. While "taxes" and "debts" are distinguishable legal concepts, in certain cases as in the suit at bar, on account of their nature, the distinction becomes inconsequential. This qualification is recognized even in the United States. Thus,
The term "debt" is properly used in a comprehensive sense as embracing not merely money due by contract, but whatever one is bound to render to another, either for contract or the requirements of the law. (Camden vs. Fink Coule and Coke Co., 61 ALR 584). Where statutes impose a personal liability for a tax, the tax becomes at least in a broad sense, a debt. (Idem.)

Some American authorities hold that, especially for remedial purposes, Federal taxes are debts. (Tax Commission vs. National Malleable Castings Co., 35 ALR 1448)

In our jurisdiction, the rule is settled that although taxes already due have not, strictly speaking, the same concept as debts, they are, however obligations that may be considered as such. (Sambrano vs. Court of Tax Appeals, G.R. no. L-8652, March 30, 1957). In a more recent case Commissioner of Internal Revenue vs. Prieto, G.R. No. L-13912, September 30, 1960, we explicitly announced that while the distinction between "taxes" and "debts" was recognized in this jurisdiction, the variance in their legal conception does not extend to the interests paid on them, at least insofar as Section 30 (b) (1) of the National Internal Revenue Code is concerned. Thus,
Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be deducted. The only question to be determined, as stated by the parties, is whether or not such interest was paid upon an indebtedness within the contemplation of Section 30(b) (1) of the Tax Code, the pertinent part of which reads: Sec. 30. Deductions from gross income In computing net income there shall be allowed as deductions xxx "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. xxx xxx

The term "indebtedness" as used in the Tax Code of the United States containing similar provisions as in the above-quoted section has been defined as the unconditional and legally enforceable obligation for the payment of money. (Federal Taxes Vol. 2, p. 13, 019, Prentice Hall, Inc.; Mertens' Law of Federal Income Taxation, Vol. 4, p. 542.) Within the meaning of that definition, it is apparent that a tax may be considered an indebtedness. . . . (Emphasis supplied) "It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30 (b) of the Tax Code above-quoted."

We do not see any element in this case which can justify a departure from or abandonment of the doctrine in the Prieto case above. In both this and the said case, the taxpayer sought the allowance as deductible items from the gross income of the amounts paid by them as interests on delinquent tax liabilities. Of course, what was involved in the cited case was the donor's tax while the present suit pertains to interest paid on the estate and inheritance tax. This difference, however, submits no appreciable consequence to the rationale of this Court's previous determination that interests on taxes should be considered as interests on indebtedness within the meaning of Section 30(b) (1) of the Tax Code. The interpretation we have placed upon the said section was predicated on the congressional intent, not on the nature of the tax for which the interest was paid. On the issue of prescription: There were actually two claims for refund filed by the herein respondent, Carlos Palanca, Jr., anent the case at bar. The first one was on November 10, 1956, when he filed a claim for refund on the interest paid by him on the donee's gift tax of P17,885.10, as originally demanded by the Bureau of Internal Revenue. The second one was the one filed by him on August 12, 1958, which was a claim for refund on the interest paid by him on the estate and inheritance tax assessed by the same Bureau in the amount of P20,624.01. Actually, this second assessment by the Bureau was for the same transaction as that for which they assessed respondent Palanca the above donee's gift tax. The Bureau, however, on further consideration,

decided that the donation of the stocks in question was made in contemplation of death, and hence, should be assessed as an inheritance. Thus the second assessment. The first claim was denied by the petitioner for the first time on June 20, 1957. Thereafter, the said denial was twice reiterated, on October 14, 1957 and November 7, 1957, upon respondent Palanca's plea for the reconsideration of the ruling of June 20, 1957. The second claim was filed with the Court of Tax Appeals on August 13, 1958, or even before the same had been denied by the petitioner. Respondent Palanca's second claim was denied by the latter on July 24, 1959. The petitioner contends that under Section 11 of Republic Act 1124,1 the herein claimant's claim for refund has prescribed since the same was filed outside the thirty-day period provided for therein. According to the petitioner, the said prescriptive period commenced to run on October 14, 1947 when the denial by the Bureau of Internal Revenue of the respondent Palanca's claim for refund, under his letter of November 10, 1956, became final. Considering that the case was filed with the Court of Tax Appeals only on August 13, 1958, then it is urged that the same had prescribed. The petitioner also invokes prescription, at least with respect to the sum of P17,112.21, under Section 306 of the Tax Code.2 He claims that for the calendar year 1955, respondent Palanca paid his income tax as follows:
Taxes withheld by La Tondea Inc. from Mr. Palanca's wages Payment under Income Tax Receipt No. 677395 dated May 11, 1956 Payment under Income Tax Receipt No. 742334 dated August 14, 1956

Therefore, the petitioner contends, the amounts paid by claimant Palanca under his withheld tax and under Receipt No. 677395 dated May 11, 1956 may no longer be refunded since the claim

therefor was filed in court only on August 13, 1958, or beyond two years of their payment. We find the petitioner's contention on prescription untenable. In the first place, the 30-day period under Section 11 of Republic Act 1125 did not even commence to run in this incident. It should be recalled that while the herein petitioner originally assessed the respondent-claimant for alleged gift tax liabilities, the said assessment was subsequently abandoned and in its lieu, a new one was prepared and served on the respondent-taxpayer. In this new assessment, the petitioner charged the said respondent with an entirely new liability and for a substantially different amount from the first. While initially the petitioner assessed the respondent for donee's gift tax in the amount of P170,002.74, in the subsequent assessment the latter was asked to pay P191,591.62 for delinquent estate and inheritance tax. Considering that it is the interest paid on this latter-assessed estate and inheritance tax that respondent Palanca is claiming refund for, then the thirty-day period under the abovementioned section of Republic Act 1125 should be computed from the receipt of the final denial by the Bureau of Internal Revenue of the said claim. As has earlier been recited, respondent Palanca's claim in this incident was filed with the Court of Tax Appeals even before it had been denied by the herein petitioner or the Bureau of Internal Revenue. The case was filed with the said court on August 13, 1958 while the petitioner denied the claim subject of the said case only on July 24, 1959. In the second place, the claim at bar refers to the alleged overpayment by respondent Palanca of his 1955 income tax. Inasmuch as the said account was paid by him by installment, then the computation of the two-year prescriptive period, under Section 306 of the National Internal Revenue Code, should be from the date of the last installment. (Antonio Prieto, et al. vs. Collector of Internal Revenue, G.R. No. L-11976, August 29, 1961) Respondent Palanca paid the last installment on his 1955 income tax account on August 14, 1956. His claim for refund of the alleged overpayment on it was filed with the court on August 13, 1958. It was, therefore, still timely instituted. WHEREFORE, the decision appealed from is affirmed in full, without pronouncement on costs.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-15802 September 30, 1960

REPUBLIC OF THE PHILIPPINES, plaintiff-appellee, vs. ENRIQUE MAGALONA, JR., ET AL., defendants-appellants. Teofilo A. Abejo and Tomas de Guzman for appellants. Asst. Solicitor General J.P. Alejandro and Atty. B.A. Atienza for appellee. BARRERA, J.: This is an appeal taken originally to the Court of Appeals but which was certified to us because one of the issues raised by appellants is the supposed lack of jurisdiction of the Court of First Instance of Manila over the subject matter. The case involves the collection of income tax due from appellants spouses Enrique Magalona, Jr. and Teresita Durango, thereon at 1% per month from April 16, 1953 to the date of full payment, and costs. It appears that on April 30, 1951, appellants Magalona, Jr. and Durango, filed with the Bureau of Internal Revenue, a joint income tax return for the calendar year 1950. After examination and audit of said return, said office assessed the income tax payable by appellants at P2,964.00. Accordingly, Income Tax Assessment Notice Ear-23187-52150 dated March 18, 1953, was sent to appellants, demanding payment of said amount to the City Treasurer of Manila, on or before April 15, 1953. Said notice was received by appellants on the same day it was sent. No payment was made thereon and, on April 14, 1954, appellant Magalona, Jr. needing to have a tax clearance in connection with his going abroad, posted a surety bond, with

himself as principal and the Luzon Surety Co., Inc. as surety, to guaranty the payment of said tax. On December 17, 1955, the Collector of Internal Revenue sent a letter to the Luzon Surety Co., Inc., informing it of appellant Magalona, Jr.'s failure to pay the tax, and requesting settlement on or before December 31, 1955, otherwise he (Collector) would recommend immediate forfeiture of the bond without further notice. On January 28, 1957, the Chief of the Collection Branch, Bureau of Internal Revenue, sent a letter to appellant Magalona, Jr. himself, reminding him of his said unpaid tax liability, and advising him that if payment thereof is not made to the City Treasurer of Manila within 10 days from receipt of said letter, immediate forfeiture of the bond would be recommended. Said official also sent a similar letter of the same date to the Luzon Surety Co., Inc. Not having received any reply to these letters, the Collector of Internal Revenue, on April 24, 1957, filed the present complaint with the Court of First Instance of Manila. On May 6, 1957, after the filing of the complaint, appellant Magalona, Jr. sent a letter to appellee Collector of Internal Revenue, requesting that he be allowed to pay said tax in 3 installments, and stating that "the delay in the payment of this tax is only due to a misunderstanding on (his) my part, coupled with the continuous pressure of work." This request was denied by appellee. On May 9, 1957, the appellants filed their answer, alleging as special defense that upon filing of the bond in favor of the appellee on April 14, 1954, they "were led to believe that the determination of the exact amount of their income tax liability to the plaintiff (appellee) would be reviewed and reassessed" and that they would be notified of the amount of their income tax after said reassessment, and that they had no intention of avoiding payment thereof. Appellants stated also that they "are ready and willing to pay their tax liability in the sum of P2,964.00 without surcharge and interests."

On May 22, 1957, appellee amended its complaint alleging, as paragraph 8 thereof, the contents of the letter dated December 17, 1955, addressed to the Luzon Surety Co., Inc. On May 28, 1957, Luzon Surety Co., Inc. filed an amended answer, alleging as special defense that the condition precedent appearing in the bond namely, a final adjudication that appellant Magalona , Jr. is finally liable in the sum of P2,964.00 has not yet been complied with; hence, the action was premature. It prayed for the dismissal of the complaint. On September 13, 1957, appellants filed an amended answer alleging, in addition to the special defense contained in their answer filed on May 9, 1957, that the present action has already prescribed, and that the Court has no jurisdiction over the case. On September 16, 1957, appellee filed a reply, stating that the action against appellants is in accordance with Article 1144 of the new Civil Code and Section 51 (e) of the National Internal Revenue Code and, thereof, has not prescribed; and that the court has jurisdiction, pursuant to Section 44, paragraph (c) of the Judiciary Act. Issues having been the joined, the case was tried and, after trial, the court, on January 30, 1958, rendered a decision which reads, in part, as follows:
Defendant Luzon Surety Co., Inc. adopted the evidence for defendants Enrique Magalona, Jr. and Teresita Durango, as its own evidence. Defendants Enrique Magalona, Jr. and Teresita Durango raise the following issues: (1) that this Court has no jurisdiction to take cognizance of the present action: (2) that this present action has already prescribed; and (3) that, because they have not been officially notified of the final determination of their tax liability as embodied in the surety bond, they should not be made to pay further a surcharge of 5% on the amount of P2,964.00 and 1% monthly interest thereon. Defendant Luzon Surety Co., Inc., puts up the issue that the plaintiff has no cause of action against it, because the condition precedent contained in the surety bond, which states "in case it should be finally decided that Enrique

Magalona, Jr., is liable for the payment of the said amount of P2,964.00 has not yet been complied with.
1awphl.nt

With respect to the first issue, the Court resolves that it has jurisdiction to take cognizance of the present action. As early as March 18, 1953, the date of their receipt of the Income Tax Assessment Notice, defendant spouses, Enrique Magalona, Jr. and Teresita Durango, had knowledge of their tax liability under their joint Income Tax Return for 1950 in the amount of P2,964.00. From that date, they had 30 days period within which to dispute the assessment by appeal to the Court of Tax Appeals and having failed to do so, the amount assessed became final, hence undisputed, as of April 19, 1953, the next day after the thirty days' period to appeal has elapsed. The defendants spouses, however, contend that there has not been a final determination of their tax liability because they have never received a reply to their letter sent to the Collector of Internal Revenue requesting for a reconsideration and re-assessment of the amount mentioned in the Income Tax Assessment Notice (Exhibit C). The fact that defendant Magalona, Jr. failed to produce at the hearing a copy of his alleged letter to the Collector of Internal Revenue, that he never received a reply thereto, and that he did not send a follow-up letter to inquire as to the action taken on his alleged request for a reassessment, support the conclusion that he had not written and sent such a letter to the Collector of Internal Revenue. Their contention too that the surety bond, as provided in its clause marked Exhibit 3-A, is proof that they had actually requested for a reconsideration and reassessment of their tax liability, is without merit. A careful perusal of said surety bond shows that it was executed primarily to guarantee the payment of the amount of P2,964.00 in order that a tax clearance could be issued to defendant Enrique Magalona, Jr. who was then scheduled to go abroad, and not to guarantee any amount that would later on be finally assessed, because if it were for the latter purpose, there would be no reason in putting up a surety bond for any amounts, as it appears from the joint Income Tax Return (Exh. A) that they are tax exempt. Besides, the bond is purely an undertaking of the signatories thereto, and the plaintiff is only concerned with the assurance of payment of the tax mentioned therein.

With respect to the second issue, the Court resolves that the present action has not prescribed. In the instance case, the period of prescription commenced on April 16, 1953, the date following April 15, 1953, which is the last date the defendants were given to pay the amount of P2,964.00 mentioned in the Income Tax Assessment Notice (Exhibit C). It appearing that this case was filed on April 24, 1957, it was, therefore, brought within the period of five years, prescribed by law for the collection of income taxes. Having arrived at the conclusion that the assessment in the amount of P2,964.00 became final as of April 19, 1953, for the reasons above adverted to, the third and fourth issues raised, respectively, by defendants spouses and defendant Luzon Surety Co., Inc. are without merit. In view of all the foregoing consideration, the Court hereby renders judgment in favor of the plaintiff and against the defendants, ordering the defendants Luzon Surety Co., Inc. and Enrique Magalona, Jr. to pay to the plaintiff, jointly and severally, the sum of P2,964.00 in accordance with the terms of surety bond (Exhibit D) executed by them; and the defendants Enrique Magalona, Jr. and Teresita Durango to pay the plaintiff 5% surcharge on the amount of P2,964.00 and 1% interest thereon from April 16, 1953, to the date full payment, and the costs of the suit. So ordered.

Not satisfied with this decision, appellants Magalona, Jr. and Durango 1 appealed to the Court of Appeals, but as already stated, said court, in its resolution of July 29, 1959, certified the case to us, on the ground that it involves only questions of law. Appellants claim that the lower court erred in holding that the income tax assessment notice (Exh. C) in question, was a final income tax assessment of their income for the calendar year 1950 and consequently, in taking cognizance of the case. The claim is devoid of merit. It is not disputed that the income tax assessment notice in question was sent by the Collector of Internal Revenue to appellants on March 18, 1953, and received by them on the same date. Pursuant to Section 7 of

Republic Act No. 1125, appellants had 30 days from said date, within which to dispute said assessment, by appealing to the Court of Tax Appeals. Having failed to do so, as found by the trial court, 2the assessment became final, executory, and demandable (Republic vs. Vda. del Rosario, et al., 105 Phil., 277; 57 Off. Gaz. [31] 5543). It is, however, argued for appellants that the surety bond filed by appellant Magalona, Jr. with the Bureau of Internal Revenue on April 14, 1954, indicates that said assessment was disputed. We find nothing in said surety bond indicating a disputed assessment. The provision in paragraph 2 thereof (Exh. 3-A), to the effect that appellant Magalona, Jr. "claims and believes that he is not liable for the payment of the said taxes," is no proof that appellant had, in fact, disputed the assessment in question. It is nothing more than an expression of appellant's belief and conviction, personal to him and not binding on appellee, that he was not liable for the payment of said taxes. In this regard, we agree with the trial court that the surety bond in question "was executed primarily to guarantee the payment of the amount of P2,964.00, in order that a tax clearance could be issued" to appellant Magalona, Jr., who was then scheduled to go abroad, and "not to guarantee any amount that would later on be finally assessed, because if it were for the latter purpose, there would no reason in putting up a surety bond for any amount, as it appears from the point Income Tax Return (Exh. A) that they (appellants) are tax exempt." Except for the bare assertion and testimony of appellant Magalona, Jr. that he had requested for reconsideration of the assessment, there is no absolutely no evidence showing that the assessment notice is otherwise than final and definitive. If it is true, as claimed by appellant Magalona, Jr. that he sent a letter to appellee, he should have subpoenaed the latter to produce the same, and if appellee failed to do so, he could have presented a copy thereof. This, he did not even attempt to do. On the other hand, the clear and unequivocal letters of demand subsequently sent to him and the surety company, did not indicate at all that there was a dispute as to the correctness of the assessment of tax due. In fact, as late as May 6, 1957, even after the filing of the complaint, appellant Magalona, Jr. did not question the assessment but only offered to pay the tax in 3 installments. We agree with the lower court that this is not a case of disputed assessment.

Having reached the conclusion that the income tax assessment in question was a final assessment of appellants' income tax liability for the calendar year 1950, it follows that the Court of First Instance had jurisdiction to hear the case of St. Stephen's Association, et al vs. The Collector of Internal Revenue (104 Phil., 314; 44 Off. Gaz. [13] 2243) invoked by appellant, is inapplicable to the instant case. In the cited case, unlike in the one at bar, the taxpayer (St. Stephen's Association) did really question the assessment made by the Collector of Internal Revenue. In fact, there were several communications which transpired between said taxpayer and said official, regarding its request for reconsideration of the assessment. Appellants have not urged in this appeal the defense of prescription which is clearly without merit. Whereof, finding no error in the decision appealed from, the same is hereby affirmed in all respects, with costs against the defendants-appellants. So ordered. Paras, C.J., Bengzon, Bautista Angelo, Labrador, Concepcion, Reyes, J.B.L., Gutierrez David, Paredes and Dizon, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-13912 September 30, 1960

THE COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. CONSUELO L. VDA. DE PRIETO, respondent. Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and Special Atty. B. Gatdula, Jr. for petitioner. Formilleza and Latorre for respondent. GUTIERREZ DAVID, J.: This is an appeal from a decision of the Court of tax Appeals reversing the decision of the Commissioner of Internal Revenue which held herein respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of P21,410.38 as deficiency income tax, plus penalties and monthly interest. The case was submitted for decision in the court below upon a stipulation of facts, which for brevity is summarized as follows: On December 4, 1945, the respondent conveyed by way of gifts to her four children, namely, Antonio, Benito, Carmen and Mauro, all surnamed Prieto, real property with a total assessed value of P892,497.50. After the filing of the gift tax returns on or about February 1, 1954, the petitioner Commissioner of Internal Revenue appraised the real property donated for gift tax purposes at P1,231,268.00, and assessed the total sum of P117,706.50 as donor's gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by respondent on April 29, 1954, the sum of P55,978.65 represents the total interest on account of deliquency. This sum of P55,978.65 was claimed as deduction, among others, by respondent in her 1954 income tax return. Petitioner, however, disallowed the claim and as a consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid

P55,978.65, including interest up to March 31, 1957, surcharge and compromise for the late payment. Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be declared. The only question to be determined, as stated by the parties, is whether or not such interest was paid upon an indebtedness within the contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of which reads:
SEC. 30 Deductions from gross income. In computing net income there shall be allowed as deductions 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. xxx xxx

The term "indebtedness" as used in the Tax Code of the United States containing similar provisions as in the above-quoted section has been defined as an unconditional and legally enforceable obligation for the payment of money. (Federal Taxes Vol. 2, p. 13,019, Prentice-Hall, Inc.; Merten's Law of Federal Income Taxation, Vol. 4, p. 542.) Within the meaning of that definition, it is apparent that a tax may be considered an indebtedness. As stated by this Court in the case of Santiago Sambrano vs. Court of Tax Appeals and Collector of Internal Revenue (101 Phil., 1; 53 Off. Gaz., 4839)
1awphl .nt

Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be considered as such. The term "debt" is properly used in a comprehensive sense as embracing not merely money due by contract but whatever one is bound to render to another, either for contract, or the requirement of the law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584) Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt. (Idem). A tax is a debt for which a creditor's bill may be brought in a proper case. (State vs. Georgia Co., 19 LRA 485).

It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30(b) of the Tax Code above quoted. The above conclusion finds support in the established jurisprudence in the United States after whose laws our Income Tax Law has been patterned. Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended 1 , which contains similarly worded provisions as sec. 30(b) of our Tax Code, the uniform ruling is that interest on taxes is interest on indebtedness and is deductible. (U.S. vs. Jaffray, 306 U.S. 276. See also Lustigvs. U.S., 138 F. Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34 AFTR 151; Penrosevs. U.S. 18 F. Supp. 413, 18 AFTR 1289; Max Thomas Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax Appeals Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States Reports, p. 255; Armour vs. Commissioner of Internal Revenue, 6 Tax Court of the United States Reports, p. 359; The Koppers Coal Co. vs. Commissioner of Internal Revenue, 7 Tax Court of United States Reports, p. 1209; Toy vs.Commissioner of Internal Revenue; Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and Howard Fire Brick Co. vs. Commissioner of Internal Revenue, 3 Tax Court of United States Reports, p. 62). The rule applies even though the tax is nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec.

163, 13,022; see also Merten's Law of Federal Income Taxation, Vol. 5, pp. 23-24.) To sustain the proposition that the interest payment in question is not deductible for the purpose of computing respondent's net income, petitioner relies heavily on section 80 of Revenue Regulation No. 2 (known as Income Tax Regulation) promulgated by the Department of Finance, which provides that "the word `taxes' means taxes proper and no deductions should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency." The court below, however, held section 80 as inapplicable to the instant case because while it implements sections 30(c) of the Tax Code governing deduction of taxes, the respondent taxpayer seeks to come under section 30(b) of the same Code providing for deduction of interest on indebtedness. We find the lower court's ruling to be correct. Contrary to petitioner's belief, the portion of section 80 of Revenue Regulation No. 2 under consideration has been part and parcel of the development to the law on deduction of taxes in the United States. (See Capital Bldg. and Loan Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says: "Penalties are to be distinguished from taxes and they are not deductible under the heading of taxs." . . . Interest on state taxes is not deductible as taxes." (Vol. 5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing cases.) This notwithstanding, courts in that jurisdiction, however, have invariably held that interest on deficiency taxes are deductible, not as taxes, but as interest. (U.S. vs. Jaffray, et al., supra; see also Mertens, sec. 26.09, Vol. 4, p. 552, and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore, merely incorporated the established application of the tax deduction statute in the United States, where deduction of "taxes" has always been limited to taxes proper and has never included interest on delinquent taxes, penalties and surcharges. To give to the quoted portion of section 80 of our Income Tax Regulations the meaning that the petitioner gives it would run counter to the provision of section 30(b) of the Tax Code and the construction given to it by courts in the United States. Such effect would thus make the regulation invalid for a "regulation which operates to create a rule out of harmony with the statute, is a mere nullity." (Lynch vs. Tilden Produce Co., 265 U.S. 315;

Miller vs. U.S., 294 U.S. 435.) As already stated, section 80 implements only section 30(c) of the Tax Code, or the provision allowing deduction of taxes, while herein respondent seeks to be allowed deduction under section 30(b), which provides for deduction of interest on indebtedness. In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest payment as deduction under section 30(b) of the same Code. In view of the foregoing, the decision sought to be reviewed is affirmed, without pronouncement as to costs. Bengzon, Bautista Angelo, Labrador, Barrera, Paredes, and Dizon, JJ., concur. Paras, C. J., Concepcion, and Reyes, J.B.L., JJ., concur in the result.

Republic of the Philippines SUPREME COURT Manila EN BANC

G.R. Nos. 106949-50 December 1, 1995 PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, vs. COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS,respondents. G.R. Nos. 106984-85 December 1, 1995 COMMISSIONER INTERNAL REVENUE, petitioner, vs. PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX APPEALS, respondents.

FELICIANO, J.:
The Paper Industries Corporation of the Philippines ("Picop"), which is 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 Investments ("BOI") as a preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferrednonpioneer enterprise with respect to its integrated plywood and veneer mills. 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 documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount ofP88,763,255.00. These assessments were computed as follows:

Transaction Tax
Interest payments on

money market borrowings P 45,771,849.00 35% Transaction tax due thereon 16,020,147.00 Add: 25% surcharge 4,005,036.75 T o t a l P 20,025,183.75 Add: 14% int. fr. 1-20-78 to 7-31-80 P 7,093,302.57 20% int, fr. 8-1-80 to 3-31-83 10,675,523.58 17,768,826.15 P 37,794,009.90

Documentary and Science Stamps Tax Total face value of debentures P100,000,000.00 Documentary Stamps Tax Due (P0.30 x P100,000.000 ) ( P200 ) P 150,000.00 Science Stamps Tax Due (P0.30 x P100,000,000 ) ( P200 ) P 150,000.00 T o t a l P 300,000.00 Add: Compromise for non-affixture 300.00 300,300.00 TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90 =========== Deficiency Income Tax for 1977

Net income per return P 258,166.00 Add: Unallowable deductions 1) Disallowed deductions availed of under R.A. No. 5186 P 44,332,980.00 2) Capitalized interest expenses on funds used for acquisition of machinery & other equipment 42,840,131.00 3) Unexplained financial guarantee expense 1,237,421.00 4) Understatement of sales 2,391,644.00 5) Overstatement of cost of sales 604,018.00 P91,406,194.00 Net income per investigation P91,664,360.00 Income tax due thereon 34,734,559.00 Less: Tax already assessed per return 80,358.00

Deficiency P34,654,201.00 Add: 14% int. fr. 4-15-78 to 7-31-81 P 11,128,503.56 20% int. fr. 8-1-80 to 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 notesand/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 actualbonafide 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 madepersonally 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 thirtyfive (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 11 EARNING FOR INCOME TAX." (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 13 transaction tax. (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 theentire 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, asurcharge 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. 15 1154. (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 openended, 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 19 debenture bonds are certainly not income taxes. (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 notarise 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 21 own funds).

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 22 taken. (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 oralternatively, 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 evasionthrough fraudulent application of double deductions from gross 23 income. (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 26 losses. (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 28 Taxation, Chap. 29.11a, p. 103]. 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. 29 20070) (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 30 directly answering the three (3) queries. (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 yearand 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 nonresident alien individual or a foreign corporation, the losses deductible are those actually sustained during the year incurred in business or trade 32 conducted within the Philippines, . . . (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 offonly 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 34 marking and identification. Emphasis supplied)

The Court of Appeals added:


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 Register of Deeds for the registration of real estate and chattel mortgages in favor of Development Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The witness could very well have been merely repeating what he was instructed to 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 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 35 registration fee. (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 deduction. 36 In the instant case, even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. 37The best evidence that Picop should have presented to

support its claimed deduction were the invoices and official receipts issued by the Register of Deeds. Picop not only failed 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 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 must be disallowed. III (1) Whether Picop had understated its sales and overstated its cost of sales for 1977. In its assessment for deficiency income tax for 1977, the CIR claimed 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 CIR added back both sums to Picop's net income figure per its own return. The 1977 Income Tax Return of Picop set forth the following figures: Sales (per Picop's Income Tax Return): Paper P 537,656,719.00 Timber P 263,158,132.00 Total Sales P 800,814,851.00 ============ Upon the other hand, Picop's Books of Accounts reflected higher sales figures: Sales (per Picop's Books of Accounts):

Paper P 537,656,719.00 Timber P 265,549,776.00 Total Sales P 803,206,495.00 ============ The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00. The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when compared with the cost figures in its Books of Accounts, was overstated: 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 yearend for income tax and other government-report purposes. (T.s.n., Oct. 40 17/85, pp. 20-25)

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 to hold Picop liable for deficiency income tax for the year 1977 computed as follows: Deficiency Income Tax
Net Income Per Return P 258,166.00

Add: Unallowable Deductions (1) Deduction of net operating losses incurred by RPPM P 44,196,106.00 (2) Unexplained financial guarantee expenses P 1,237,421.00 (3) Understatement of Sales P 2,391,644.00 (4) Overstatement of Cost of Sales P 604,018.00 Total P 48,429,189.00 Net Income as Adjusted P 48,687,355.00 ===========
Income Tax Due Thereon
44

P 17,030,574.00

Less: Tax Already Assessed per Return 80,358.00 Deficiency Income Tax P 16,560,216.00 Add: Five percent (5%) Corporate Development Tax P 2,434,367.00

Total Deficiency Income Tax P 18,994,583.00 =========== Add:


Five percent (5%) surcharge
45

P 949,729.15

Total Deficiency Income Tax with surcharge P 19,944,312.15 Add: Fourteen percent (14%) interest from 15 April
1978 to 14 April 1981
46

P 8,376,610.80

Fourteen percent (14%) interest from 21 April


1983 to 20 April 1986
47

P 11,894,787.00

Total Deficiency Income Tax Due and Payable P 40,215,709.00 =========== 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, Kapunan, Mendoza, Francisco, Hermosisima, Jr. and Panganiban, JJ., concur. Padilla, J., took no part.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-12174 April 26, 1962

MARIA B. CASTRO, petitioner, vs. THE COLLECTOR OF INTERNAL REVENUE, respondent. Rosendo J. Tansinsin and Manuel O. Chan for petitioner. Office of the Solicitor General and Special Attorney Librada del Rosario-Natividad for respondent. REYES, J.B.L., J.: Appeal from a decision of the Court of Tax Appeals (in its C.T.A. Case 141) holding petitioner Maria B. Castro liable under the War Profits Tax Law, Republic Act No. 55, and ordering her to pay a deficiency war profits tax (including surcharges and interest) in the amount of P1,360,514.66, and costs. The background of this case is set forth in great detail in the decision appealed from. We quote:
Petitioner Maria B. Castro, who is authorized to manage her own property, is a duly licensed merchant. Pursuant to the provisions of Section 4 (b) and (c) of Republic Act No. 55, she filed with the Bureau of Internal Revenue on February 28, 1947, her war profits tax returns which showed a net worth on February 26, 1945 in the amount of P431,884.00 and a net worth on December 8, 1941 in the sum of P409,581.57. Although there is indicated an increase in net worth in the amount of P22,302.43, she is totally exempted from paying any war profits tax therefor as the deduction of six per centum (6%) per annum of the net worth on December 8, 1941 therefrom would show only a taxable increase in net worth in the amount of P5,574.61 which is not taxable under the said law.

On November 22, 1947, however, Criminal Case No. 4976 was filed against her in the Court of First Instance of Manila for violation of Section 4, in connection with Section 8, of the War Profits Tax Law, for allegedly defrauding the Republic of the Philippines in the total amount of P1,048,687.76. The criminal action, was filed at the instance of respondent and simultaneous with the filing of said action, the petitioner received for the first time the notice of assessment dated November 19, 1947 by registered mail from the Collector of Internal Revenue. The said letter of demand was based on the report of Supervising Examiner Felipe Aquino of the Bureau of Internal Revenue, who recommended that the petitioner be assessed and made to pay the sum of P1,048,687.76 as war profits tax and surcharge, computed as follows: . P 885,694.63 Increase in net worth Cumulative tax on P500,000 90% tax on P385,694.63 Total Tax Add 50% surcharge Total amount due and collectible P 352,000.00 347,125.17 P 699,125.17 349,562.59 P1,048,687.76

Petitioner through counsel filed a motion to quash the criminal action against her and during the pendency of the same, she amended on December 20, 1947, her original war profits tax returns making it to appear that her true net worth on February 26, 1945 was P315,438.32 while her net worth on December 8, 1941 was left unchanged at P409,581.57. According to the amended return, there was therefore a decrease in net worth in the amount of P94,143.25 instead of an increase of P22,302.43 as originally reported. On February 9, 1948, the motion of petitioner to quash the information was denied by the Court of First Instance of

Manila. At the sheduled hearing of the case on the merits on March 7, 1949, the City Fiscal of Manila manifested in open court that after a re-investigation of the case "the amount of the tax due and for which the accused stands charged for evading payment is only about P700,000.00, instead of P1,048,687.76 as stated in the information." However, at the continuation of the hearing of the case on February 22, 1950, Supervising Examiner Felipe Aquino of the Bureau of Internal Revenue, who testified for the prosecution, declared in answer to questions propounded by the City Fiscal "that as a result of a detailed reinvestigation conducted by his office, it was found out that no war profits tax was due from the accused in connection with the present case." Whereupon, City Fiscal Angeles moved for the dismissal of the case. Finding the petition for dismissal to be well taken, the Court of First Instance of Manila, in an Order dated February 22, 1950, dismissed Criminal Case No. 4976 against petitioner. After the dismissal of the Criminal Case, another report was submitted by the same Supervising Examiner Felipe Aquino to his superiors wherein he changed his previous stand taken before the Court of First Instance of Manila, on the basis of which report another letter of demand for P2,008,293.53 as war profits tax was issued against petitioner on January 24, 1950. Barely one month thereafter, another report was again submitted by the same Supervising Examiner Felipe Aquino to his superiors, on the basis of which another letter of demand for war profits tax was issued by respondent against petitioner for the sum of P2,229,976.94 or an increase of P221,683.31 over that assessment of January 24, 1950. The case was again referred to the City Fiscal's Office for another prosecution based on the earlier demand but the same was again dropped. Following insistent requests of petitioner for reinvestigation of her case, the then Secretary of Finance Pio Pedrosa created a committee on April 11, 1950 to review or re-examine the assessment for war profits tax issued against the petitioner. This committee, otherwise known as the Pedrosa Committee, was chairmanned by Atty. Artemio M. Lobrin of the Bureau of Internal Revenue, with Messrs. Melecio R. Domingo and Roman M. Umali of the same office, Vivencio L. de Peralta of the General Auditing Office and Jose P. Alejandro of the Office of the Solicitor General, as members. After a thorough

investigation of the case, the Pedrosa Committee on September 12, 1950, submitted its report, recommending the collection of the amount of P3,593,950.78 as war profits tax due from petitioner inclusive of surcharge and interests, broken down as follows: . Taxable increase in net worth War profits tax due thereon 50% surcharge Total war profits tax and surcharge 15% surcharge 1% monthly interest thereon from April 1947 to September 30, 1950 (42%) Total amount collectible on September 30, 1950 P1,762,203.95 P1,526,093.75 763,406.88 P2,289,140.63 343,371.09 961,439.06

P3,593,950.78

The findings and recommendations of the Pedrosa Committee were forwarded to the President of the Philippines for approval and on September 22, 1950, the President approved the same in toto. Accordingly, on September 23, 1950 the respondent demanded from the petitioner Maria B. Castro the payment of the total amount of P3,593,950.78 as war profits tax computed in detail as follows: .
Net worth on February 26, 1945 as per amended war profits tax returns Add: (a) Undeclared cash on February 25, 1945: As per this report Amount declared

P 315,438.32. P1,871,542.13 64,097.52

1,807

(b) Overdeclared accounts payable: As per amended return Amount per this report Net worth on February 26, 1945 Less: Net worth on December 8, 1941: Net worth as per amended return Less: Accounts payable Increase in net worth as per this report

P 106,000.00 30,000.00

76

P2,198

P 409,581.57 43,547.22

P 366

P1,832

Less: 6% per annum on P366,034.35 from December 8, 1941 to February 26, 1945 Taxable increase in net worth War profits tax due thereon:. On P 50,000.00 (P6,000 exempt) On 30,000.00 50% 60% 70% 80% 90% 95%

70

P1,762

P 22

30

On 200,000.00 On 200,000.00 On 500,000.00 On 762,203.95 P 1,762,203.95 50% surcharge 15% surcharge 1% monthly interest from April 1, 1947 to September 30, 1950 (42%)

140

160

450

724

P1,526

763

343

961

Total war profits tax and 50% surcharge (carried forward) Total amount collectible on September 30, 1950

P2,289

P3,593

In order to enforce collection of this last mentioned assessment of P3,593,950.78, the respondent caused to be advertised on October 18, 1950, the sale at public auction on November 22, and 27, 1950, of various real properties of petitioner to satisfy the war profits tax assessed against her. The petitioner, in order to stop the scheduled sale at public auction, filed on October 18, 1950, before the Court of First Instance of Manila a petition for preliminary injunction (Civil Case No. 12356) against the Collector of Internal Revenue, praying, among others, that an order be issued enjoining said official from proceeding with the collection by summary methods of the war profits tax demanded. Over the objection of respondent that the Court of First Instance had no jurisdiction to entertain the complaint nor to issue a writ of injunction, the said Court entered an order dated November 8, 1950 declaring that it had authority proceed with the case but denied the petition for preliminary injunction. Inasmuch as no preliminary injunction was issued by the Court, respondent proceeded with the distraint and levy and sale at public auction of the properties of petitioner. These properties, which are situated in the Cities of Manila, Pasay and Tagaytay and in the Municipalities of Caloocan and Makati, Rizal, and Moncada, Tarlac, and described more particularly in Exhibits C, C-1, C-2, C-3, C-4 and C-5 of the petition for injunction filed with this Court, were offered for sale on November 22, and 27, 1950 as scheduled, to answer for the war profits tax liability of petitioner to the Republic of the Philippines in the assessed sum of P3,593,950.78, inclusive of surcharges and interest from April 1, 1947 to September 30, 1950. For lack of bidders on the scheduled dates of sale, the following properties (except those in Tagaytay) with their corresponding assessed value, were forfeited to the Government under Section 328 of the National Internal Revenue Code: .
Property Assessed Value

Manila Balintawak Pasay Makati Tarlac Tagaytay

P233,460.00 521,390.00 18,320.00 4,830.00 12,530.00 62,930.00

In another sale at public auction on April 23, 1954, the property of petitioner situated in Caloocan, Rizal, with an assessed value of P4,990.00 was also offered for sale to answer for her war profits tax liability. There being no bidders in this sale as in the previous sale, this last mentioned real property of petitioner was also forfeited to the Government. The petitioner has not exercised her right of legal redemption with respect to all these real properties with a total assessed value of P858,440.00 which were sold at public auction by the respondent and forfeited in favor of the Government for lack of bidders. Parenthetically, it may be stated that the hearing of Civil Case No. 12356 before the Court of First Instance of Manila for Preliminary Injunction was not continued to its final determination by said court as the Supreme Court in a decision promulgated on October 31, 1951 declared the lower court without jurisdiction to proceed with the trial. (Saturnino David v. The Honorable Simeon Ramos and Maria B. Castro, G.R. No. L-4300).. In the course of the summary methods employed by the respondent to enforce the collection of the war profits tax liability of petitioner, the respondent also distrained and advertised for sale the properties of the Marvel Building Corporation in which the petitioner had a substantial interest. To counter-act the move, the said corporation through counsel filed on November 31, 1950, Civil Case No. 12555 in the Court of First Instance of Manila wherein it sought to enjoin the respondent Collector of Internal Revenue from selling at public auction its various properties described in the complaint. While the corporation was able to secure the injunction from the lower court, the same was

dissolved by the Supreme Court in its decision in G.R. No. L-5081, Marvel Building Corporation v. Saturnino David, promulgated on February 24, 1954. Petitioner Maria B. Castro was declared therein as the sole and exclusive owner of all shares of stock of the Marvel Building Corporation and all the other partners are her dummies. In the meantime, petitioner filed on December 10, 1951, Civil Case No. 15316 with the Court of First Instance of Manila against the respondent Collector of Internal Revenue for the recovery of the properties advertised for saleon November 22 and 27, 1950 which for lack of bidders were forfeited to theGovernment. However, before the case could be tried on the merits before said Court, the Court of Tax Appeals was created by Republic Act No. 1125 and pursuant to Section 22 thereof, the record of the case was remanded for finaldisposition to this Court. This last mentioned case is now pending hearing before this Court. At this juncture, it should be stated that again on December 22, 1951, an additional war profits tax was assessed against the petitioner in the sum of P20,425.00 based allegedly on certain amounts receivable which petitioner received from Magdalena Estate, Inc. Consequently, the total war profits taxliability of petitioner, exclusive of surcharge and interest, as found by the Pedrosa Committee was increased to P1,546,518.75, itemized as follows: .
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Tax due as per Pedrosa Committee Additional war profits tax on account of undeclared amount receivable from the Magdalena Estates, Inc. Total war profits tax exclusive of surcharge and interest.

P1,526

20

P1,546

To satisfy, fully the amount of the war profits tax assessed against petitioner, the respondent on September 29, 1954, caused to be advertised for sale at public auction for November 2, 1954, other real properties of petitioner situated in Manila. These properties are described in detail in Appendix B of the petition for review filed with this Court. According to the "Amended Notice of Sale"

(Appendix B, Petition for Review), the properties were seized, distrained and levied upon from petitioner "in satisfaction of internal revenue taxes and penalties amounting to P4,539,556.26, computed as of April 30, 1954" due from her in favor of the Republic of the Philippines. For lack of bidders at the time of the scheduled sale on November 2, 1954, the properties in question were forfeited to the Government under Section 328 of the National Internal Revenue Code for the total amount of P3,547,892.41 which was allegedly the balance of petitioner's tax liability as of that date. Before the expiration of the one-year period provided for in Section 328 of the National Internal Revenue Code within which petitioner may redeem the real properties forfeited in favor of the Government in the sale at public auction held on November 2, 1954, the petitioner filed with this Court on September 30, 1955, a petition for the annulment of said sale and forfeiture on the ground that her properties were advertised for sale on tax claim of the Government far in excess of the alleged war profits tax, surcharges and penalties fixed by respondent. Respondent filed his opposition to the petition and after due hearing where evidence was adduced in support of the petition as well as opposition thereto, this Court, in a resolution dated October 31, 1955, declared the auction sale of November 2, 1954 as well as the resulting forfeiture, null and void and of no legal force and effect because of the admitted discrepancy in the amount of tax stated in the notice of sale for which the properties were auctioned and the actual amount of tax assessed and demanded. The said resolution being without prejudice to such action and proceedings a respondent may take in accordance with law, respondent demanded from petitioner the amount of P3,594,881.51 not later than November 10, 1955 or he would again proceed with the resale of her properties on December 12, 1955. To stop the sale, petitioner filed a petition for injunction with this Court on November 22, 1955 requesting that respondent be enjoined from proceeding with the resale of her properties scheduled on December 12, 1955; that the said properties be released to her; and that she be declared not liable for the war profits tax assessed and demanded of her. After due hearing of this petition and the opposition thereto, this Court, in a resolution dated December 10, 1955, denied the injunction and held in

abeyance the determination of other questions until after the case shall have been heard on the merits. The properties were therefore advertised for sale on December 12, 1955 to answer for a war profits tax liability of petitioner to the Republic of the Philippines for the alleged amount of P3,594,307.51 computed as of that date. For lack of bidders, the same were forfeited to the Government. Those properties and the amounts for which they were forfeited are as follows:.
Aguinaldo Building Wise & Co. Building Zobel Mansion Shellborne Hotel Total Add: Prior forfeitures P2,026,517.10 670,291.47 408,501.24 489,491.70 P3,594,801.51 888,440.00 P4,453,241.51

After due hearing and reception of evidence, the Tax Court annulled the last tax sale of December, 1955, covering the found Manila buildings, on account of irregularities in the notices of sale; but for the rest, it found against petitioner and assessed her tax liability as follows: .
"Net worth on Feb. 26, 1945 as per amended war profits tax return Add: (a) Underdeclared cash on February 26, 1945: As per Pedrosa Committee report Amount declared (b) Accounts Payable: As per amended return

P 315

P1,871,542.13 64,097.52 P 106,000.00

1,807

Amount per Pedrosa Committee Report-P30,000.00 Accounts payable to Lao Kang Suy recognized by Court-P76,000.00 Net worth on Feb. 26, 1945 Less: Net worth on December 8, 1941: Net worth as per amended return Less Accounts payable P43,547.22 Increase in net worth Less 6% per annum on P366,034.35 from Dec. 8, 1941 to Feb. 26, 1945 Taxable increase in net worth Add: Undeclared accounts receivable from Magdalena Estate, Inc. as of Feb. 26, 1945 that was discovered in June, 1951 only Total taxable increase in net worth War Profits tax due thereon: On P50,000.00 (P6,000.00 Exempt) @ 50% 50,000.00 200,000.00 200,000.00 500,000.00 707,703.95 @ 60% @ 70% @ 80% @ 90% @ 95%

106.000.00

P2,122

P 409,581.57 366,034.35 P1,756,848.58 70,644.63 P1,686,203.95

21,500.00 P1,707,703.95

P 22,000.00 30,000.00 140,000.00 160,000.00 450,000.00 672,318.75

Total . . . . . . . . . . . . . P1,474,318.75

50% surcharge on P1,474,318.75 15% surcharge on P1,474,318.75 1% monthly on P1,474,318.75 from 4/l/47 to 11/22/50 Total amount collectible on 11/22/50 . . . . . . . . Less: Values of properties sold: On Nov. 22, 1950 On Nov. 27, 1950 April 20, 1954 Total due as of December 12, 1955 P1,556,000 150,900 9,980

P 737

221

644

P3,077

1,716

P1,360

From this decision, Maria Castro appealed to this Court.. The nineteen alleged errors committed by the Court of Tax Appeals and discussed by appellant in her printed brief actually revolve around four main defenses: (a) that the War Profits Tax Law (R.A. No. 55) is unconstitutional and void; (b) that said law was improperly applied to the case of the appellant; (c) that even if appellant were subject to the tax liability declared by the court below, such liability was totally extinguished by the levy and forfeiture of certain properties of hers; and (d) that appellant's acquittal in the criminal case instituted against her for violation of the War Profits Tax Law is a bar to the collection of the taxes assessed, and specially of the 50% surcharge. (a) Petitioner's attack on the constitutionality of Republic Act No. 55, commonly known as the War Profits Tax Law, on account of its retrospective operation (Errors XVIII), is now foreclosed by our decision in Republic vs.Oasan Vda. de Fernandez, G.R. No. L-9141, September 25, 1956, wherein thisCourt upheld the validity of the statute; and no reasons are alleged that would justify a departure from the ruling made in that case.. (b) Petitioner Castro complains (Errors I and VI) that the Tax Court had declared subject to the war profits tax her cash transactions

from June, 1945to December 31, 1946, when Republic Act No. 55 levies that tax only on the value of the taxpayer's assets (including real and personal property and/orcash in banks) as of February 26, 1945, minus his liabilities.. This argument misconceives the process whereby the Tax Court (and the Pedrosa Committee) arrived at the petitioner's net worth as of February 26,1945. Because of the difficulty in determining the taxpayer's cash on hand on said date (since her books and records did not show her invested capital in 1945), said tax authorities adopted the method of starting from her reported cash on hand on December 31, 1946, and working backwards to February,1945, by adding to the reported cash the disbursements made by Castro during1945 and 1946, and then deducting her receipts from the same period. We see nothing fundamentally erroneous in this method for, as pointed out in the appealed decision, "if cash on hand at the beginning of the period, plus receipts during the period minus disbursements during the period, equals cash on hand at the end of the period, the converse must necessarily be true.". Such method is in effect but an application (in reverse) of the inventory or networth system that, contrary to appellants contention (Error XIII), has been approved by this Court in Perez vs. Collector of Internal Revenue, G.R. No. L-10507, May 30, 1958; Collector vs. A. P. Reyes, L-11534, November 25, 1958; and Commissioner of Internal Revenue vs. Avelino, L-14847, September 19, 1961. The analysis of petitioner's transactions for 1945 and 1946 merely laid the basis for determining the undisclosed cash funds in her possession as of February 26, 1945 (amounting to P1,807,444.61), and it is this cash thatwas found subject to the war profits tax. It is urged, however, that even if this finding were correct, still, under Republic Act No. 55, only "cash in banks" is expressly mentioned as taxable, and appellant infers that cash on hand not so deposited was not intended to be subject to war profits tax. This thesis appears unmeritorious: cash heldby the taxpayer on February 26, 1945 clearly falls under the description of "assets, including real and personal property" that section 2 of the Act

expressly order included in determining the taxable net worth. If "cash in banks" is expressly mentioned by the Act, it is not because cash on hand was intended to be excluded, but because "cash in banks" is not, strictly, speaking, part of the assets of the taxpayer, but assets of the banks where the cash is deposited. It is well established that a so-called "bank deposit" is in reality a loan to the bank, the latter acquiring title to the amount "deposited", subject to its withdrawal (or recall of the loan) on the dates specified. Taxpayer's "assets", therefore, would not per se include cash deposited in banks by the taxpayer; and its inclusion had to be expressly prescribed by the statute in order to remove all doubt as to its taxability. Petitioner endeavored to show (Errors VII to XI) that part of the amount of cash thus arrived at actually originated in receipts from transactions made by her after February 26, 1945 but which were not disclosed in the books and accounts. Aside from the fact that this claim in her behalf contradicted her admission to the Pedrosa Committee that all her 1946 receipts were recorded in her books (v. Respondent's Exhibit 6-A), it lay within the exclusive discretion of the Tax Court to believe or not to believe her evidence and statements, and those of her witnesses regarding the source of the cash in question; and the rule is well settled that in cases of this kind, only errors of law, and not rulings on the weight of evidence, are reviewable by this Court. The same principle precludes us from interfering with the Tax Court's refusal to credit the other deductions claimed by petitioner as amounts obtained from loans from various individuals. The Court of Tax Appeals found those items unproved, except the P76,000.00 payable to Lao Kang Suy, which is accepted, although it had been rejected by the Pedrosa Committee. Similarly, the finding that the petitioner had disbursed in 1946 P1,025,000.00 on account of her subscription to the stock of the Marvel Building Corporation (Error XII) may not be disturbed by us. (c) The third main ground of appeal is predicated on the acquittal of petitioner in case No. 4976 of the Court of First Instance of Manila, wherein she was criminally prosecuted for failure to render a true and accurate return of the war profits tax due from her, with intent to evade payment of the tax. She contends (Assignments of

Error II to IV) that the acquittal should operate as a bar to the imposition of the tax and specially the 50% surcharge provided by section 6 of the War Profits law (R.A. No. 55), invoking the ruling in Coffey v. U.S., 29 L. Ed. 436. With regard to the tax proper, the state correctly points out in its brief that the acquittal in the criminal case could not operate to discharge petitioner from the duty to pay the tax, since that duty is imposed by statute prior to and independently of any attempts on the part of the taxpayer to evade payment. The obligation to pay the tax is not a mere consequence of the felonious acts charged in the information, nor is it a mere civil liability derived from crime that would be wiped out by the judicial declaration that the criminal acts charged did not exist. As to the 50% surcharge, the very United States Supreme Court that rendered the Coffey decision has subsequently pointed out that additions of this kind to the main tax are not penalties but civil administrative sanctions, provided primarily as a safeguard for the protection of the state revenue and to reimburse the government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud (Helvering vs. Mitchell, 303 U.S. 390, 82 L. Ed. 917; Spies vs. U.S. 317 U.S. 492). This is made plain by the fact that such surcharges are enforceable, like the primary tax itself, by distraint or civil suit, and that they are provided in a section of R.A. No. 55 (section 5) that is separate and distinct from that providing for criminal prosecution (section 7). We conclude that the defense of jeopardy and estoppel by reason of the petitioner's acquittal is untenable and without merit. Whether or not there was fraud committed by the taxpayer justifying the imposition of the surcharge is an issue of fact to be inferred from the evidence and surrounding circumstances; and the finding of its existence by the Tax Court is conclusive upon us. (Gutierrez v. Collector, G.R. No. L-9771, May 31, 1951 ; Perez vs. Collector, supra). (d) The fourth main ground adduced on behalf of the petitioner (Errors II and XlV) is that the sale and forfeiture to the government (due to lack of bidders) of the properties of petitioner in Manila, Balintawak, Pasay, Makati, Tarlac, Tagaytay and Caloocan which had been levied upon by the respondent Collector of Internal Revenue and advertised for sale in 1950 and 1954, constitutes a

full discharge of petitioner's tax liabilities. In so arguing, she relies on the provisions of paragraph 1 of Section 328 of the Internal Revenue Code, reading as follows: .
SEC. 328. Forfeiture to Government for Want of Bidder. - In case there is no bidder for real property exposed for sale as herein above provided or if the highest bid is for an amount insufficient to pay the taxes, penalties, and costs, the provincial or city treasurer shall declare the property forfeited to the Government in satisfaction of the claim in question and within two days thereafter shall make a return of his proceedings and the forfeiture, which shall be spread upon the records of his office,

and appellant contends that in the provision to the effect that in the absence of bidders, the property is to be "forfeited to the Government in satisfaction of the claim in question", the term "satisfaction" signifies nothing but full discharge of the taxes, penalties, and costs claimed by the state. Carried to its logical conclusion, this theory would permit a clever taxpayer, who is able to conceal most or the more valuable part of his property from the revenue officers, to escape payment of his tax liability by sacrificing an insignificant portion of his holdings; and we can not agree that in providing that the forfeiture of the taxpayer's distrained or levied property, for lack of adequate bids, should operate in satisfaction of the total tax claims even beyond the value of the property forfeited. That the satisfaction prescribed in section 328 of the Revenue Code was intended to mean only a discharge pro tanto is confirmed by the provisions of section 330 of the Revenue Code to the effect that "remedy by distraint of personal property and levy on realty may be repeated if necessary until the full amount due including all expenses, is collected". This section makes no distinction between forfeitures to the Government and sales to third persons, and we are satisfied that no distinction was intended and that none is warranted. Nor do we see that the petitioner has any ground for complaining that the properties forfeited were undervalued (Error XV). The relation between assessed value and market price being variable, it is not a matter of notice. However, the Court of Tax Appeals appraised the forfeited properties at double their assessed evaluation, and thereby credited her with a part payment on

account of her tax liability in the amount of P1,716,880.00. There is no adequate evidence that they were worth more, petitioner's own estimates of value being obviously unreliable, due to her direct interest in the matter under investigation. Since the burden of proof lay evidently on the taxpayer, she is not in a position to complain in this regard. It may be noted in this connection that the validity of the levy and sale of her properties in November of 1950 and April 1954 is assailed by appellant in her fifth assignment of error; but as this point was not raised in the Court below, the same can not be entertained for the first time on appeal. (e) As pointed out by the counsel for the Government, appellant's stand that the undeclared cash should be averaged or spread out for the years 1945, 1946 and 1947 (Error XVI) assumes that what was being subjected to tax was her undeclared income during said years, which is not correct, as previously declared in this opinion. If her expenditures during 1945 and 1946 were scrutinized and analyzed, it was merely to determine the actual value of her taxable net worth as of February 26, 1945, that was subject to the war profits tax, as representing accumulated profits earned during the occupation years. Finally, no argument is needed to show that unless taxes are to be left at the discretion of the taxpayer, she can not be allowed to seek refuge or relief by pleading (Error XVII) the alleged inefficient and erratic manner in which her books of account and supporting papers had been prepared, contrary to the requirements of the revenue laws; and that it is incredible that a trader like the appellant should be able to do business running into millions of pesos without knowing exactly her financial condition. Appellant's alleged Error XIX, being merely pro forma, requires no discussion. Finding no reversible error in the decision appealed from, we hereby affirm the same, with costs against appellant. Bengzon, C.J., Padilla, Bautista Angelo, Labrador, Concepcion, Paredes and Dizon, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-25299 July 29, 1969

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. ITOGON-SUYOC MINES, INC., and THE COURT OF TAX APPEALS, respondents. Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney Oscar S. de Castro for petitioner. Ramon O. Reynoso, Jr. and Melchor R. Flores for respondents. FERNANDO, J.: The question presented for determination in this petition for the review of a decision of the Court of Tax Appeals, one that is of first impression, would not have arisen had respondent ItogonSuyoc Mines, Inc., the taxpayer involved, duly paid in full its liability according to its income tax return for the fiscal year 196061. Instead, it deducted right away the amount represented by claim for refund filed eight (8) months back, for the previous year's income tax, for which it was not liable at all, so it alleged, as it suffered a loss instead, a claim subsequently favorably acted on by petitioner Commissioner of Internal Revenue but after the date of such payment of the 1960-1961 tax. Accordingly, an interest in the amount of P1,512.83 was charged by petitioner Commissioner of Internal Revenue on the sum withheld on the ground that no deduction on such refund should be allowed before its approval. When the matter was taken up before the Court of Tax Appeals, the above assessment representing interest was set aside in the decision of September 30, 1965. That is the decision now an appeal by petitioner Commissioner of Internal Revenue. We sustain the Court of Tax Appeals.

Respondent Itogon-Suyoc Mines, Inc., a mining corporation duly organized and existing in accordance with the laws of the Philippines, filed on January 13, 1961, its income tax return for the fiscal year 1959-1960. It declared a taxable income of P114,368.04 and a tax due thereon amounting to P26,310.41, for which it paid on the same day, the amount of P13,155.20 as the first installment of the income tax due. On May 17, 1961, petitioner filed an amended income tax return, reporting therein a net loss of P331,707.33. It thus sought a refund from the Commissioner of Internal Revenue, now the petitioner.
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On February 14, 1962, respondent Itogon-Suyoc Mines, Inc. filed its income tax return for the fiscal year 1960-1961, setting forth its income tax liability to the tune of P97,345.00, but deducting the amount of P13,155.20 representing alleged tax credit for overpayment of the preceding fiscal year 1959-1960. 0n December 18, 1962, petitioner Commissioner of Internal Revenue assessed against the respondent the amount of P1,512.83 as 1% monthly interest on the aforesaid amount of P13,155.20 from January 16, 1962 to December 31, 1962. 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 Commissioner of Internal Revenue. 1 Such an assessment was contested by respondent before the Court of Tax Appeals. As already noted, it prevailed. The decision of September 30, 1965, now on appeal, explains why. Thus: "Respondent assessed against the petitioner the amount of P1,512.83 as 1% monthly interest on the sum of P13,155.20 from January 16, 1962 to December 31, 1962 on the ground that petitioner had no legal right to deduct the said amount from its income tax liability for the fiscal year 1960-1961 until the refund or tax credit thereof has been approved by respondent. As aforestated, petitioner paid the amount of P13,155.20 as first installment on its reported income tax liability for the fiscal year 1959-1960. But, it turned out that instead of deriving a net gain, it sustained a net loss during the said fiscal year. Accordingly, it filed an amended income tax return and a claim for the refund of the sum of P13,155.20, which sum it subsequently, deducted from its income tax liability for the succeeding fiscal year 1960-1961. The overpayment for the fiscal year 1959-1960 and the deduction of the overpaid amount from its 1960-1961 tax liability are not denied

by respondent. In this circumstance, we find it unfair and unjust for the Commissioner to exact an interest on the said sum of P13,155.20, which, after all, was paid to and received by the government even before the incidence of the tax in question." 2 That is the question before us in this petition for review by the Commissioner of Internal Revenue. He argues that the Court of Tax Appeals should not have absolved respondent corporation "from liability to pay the sum of P1,512.83 as 1% monthly interest for delinquency in the payment of income tax for the fiscal year 1960-1961." 3 As noted at the outset, we find such contention far from persuasive. It could not be error for the Court of Tax Appeals, considering the admitted fact of overpayment, entitling respondent to refund, to hold that petitioner should not repose an interest on the aforesaid sum of P13,155.20 "which after all was paid to and received by the government even before the incidence of the tax in question." It would be, according to the Court of Tax Appeals, "unfair and unjust" to do so. We agree but we go farther. The imposition of such an interest by petitioner is not supported by law. The National Internal Revenue Code provides that interest upon the amount determined as a deficiency shall be assessed and shall be paid upon notice and demand from the Commissioner of Internal Revenue at the specified. 4 It is made clear, however, in an earlier provision found in the same section that if in any preceding year, the taxpayer was entitled to a refund of any amount due as tax, such amount, if not yet refunded, may be deducted from the tax to be paid. 5 There is no question respondent was entitled to a refund. Instead of waiting for the sum involved to be delivered to it, it deducted the said amount from the tax that it had to pay. That it had a right to do according to the law. It is true a doubt could have arisen due to the fact that as of the time such a deduction was made, the Commissioner of Internal Revenue had not as yet approved such a refund. It is an admitted fact though that respondent was clearly entitled to it, and petitioner did not allege otherwise. Nor could he do so. Under all the circumstances disclosed therefore, the applicability of the legal provision allowing

such a deduction from the amount of the tax to be paid cannot be disputed. This conclusion is in accordance with the principle announced in Castro v. Collector of Internal Revenue. 6While the case is not directly in point, it yields an implication that makes even more formidable the case for respondent taxpayer. As there held, the imposition of the monthly interest was considered as not constituting a penalty "but a just compensation to the state for the delay in paying the tax, and for the concomitant use by the taxpayer of funds that rightfully should be in the government's hands ...." What is therefore sought to be avoided is for the taxpayer to make use of funds that should have been paid to the government. Here, in view of the overpayment for the fiscal year 1959-1960, the sum of P13,155.20 had already formed part of the public funds. It cannot be said, therefore, that respondent taxpayer was guilty of any delay enabling it to utilize a sum of money that should have been in the government treasury. How then, as a matter of pure law, even if we lay to one side the demands of fairness and justice, which to the Court of Tax Appeals seem to be uppermost, can its decision be overturned? Accordingly, we find no valid ground for this appeal. WHEREFORE, the decision of September 30, 1965 of the Court of Tax Appeals is affirmed. Without pronouncement as to costs.
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Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Capistrano and Teehankee, JJ., concur. Barredo, J., took no part.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-19537 May 20, 1965

The late LINO GUTIERREZ substituted by ANDREA C. VDA. DE GUTIERREZ, ANTONIO D. GUTIERREZ, GUILLERMO D. GUTIERREZ, SANTIAGO D. GUTIERREZ and TOMAS D. GUTIERREZ,petitioners, vs. COLLECTOR (now COMMISSIONER) OF INTERNAL REVENUE, respondent. Rosendo J. Tansinsin, Sr., Rosendo Tansinsin, Jr. and Juan C. Nabong, Jr.for petitioners. Office of the Solicitor General for respondent. BENGZON, J.P., J.: Lino Gutierrez was primarily engaged in the business of leasing real property for which he paid estate broker's privilege tax. He filed his income tax returns for the years 1951, 1952, 1953 and 1954 on the following dates:
Year 1951 1952 1953 1954 Date Filed March 1, 1952 February 28, 1953 February 22, 1954 February 23, 1955

and paid the corresponding tax declared therein. On July 10, 1956 the Commissioner (formerly Collector) of Internal Revenue assessed against Gutierrez the following defiency income tax:

1951 . . . . . . . . . . . . . . 1952 . . . . . . . . . . . . . . 1953 . . . . . . . . . . . . . . 1954 . . . . . . . . . . . . . . Total . . . . . . . . . . . . . .

P 1,400.00 672.00 5,161.00 4,608.00 P 11,841.00 ==========

The above defiency tax came about by the disallowance of deductions from gross income representing depreciation, expenses Gutierrez allegely incurred in carrying on his business, and the addition to gross income of receipts which he did not report in his income tax returns. The disallowed business expenses which were considered by the Commissioner either as personal or capital expenditures consisted of:
1951 Personal expenses: Transportation expenses to attend funeral of various persons Repair of car and salary of driver Expenses in attending National Convention of Filipino Businessmen in Baguio Alms to indigent family Capital expenditures: Electrical fixtures and supplies Transportation and other expenses to watch laborers in construction work Realty tax not paid by former owner of property acquired by Gutierrez 100.00 516.00 350.00 P 96.50 59.80 121.35 15.00

Litigation expenses to collect rental and eject lessee Other disallowed deductions: Fines and penalties for late payment of taxes 1952 Personal expenses: Car expenses, salary of driver and car depreciation Contribution to Lydia Samson and G. Trinidad Officers' jewels and aprons donated to Biak-na-Bato Lodge No. 7, Free Masons Luncheon of Homeowners' Association Ticket to opera "Aida" 1953 Personal expenses: Car expenses, salary of driver, car depreciation Cruise to Corregidor with Homeowners' Association Contribution to alms to various individuals Tickets to operas Capital expenditures: Cost of one set of Comments on the Rules of Court by Moran 1954

702.65

64.48

P1,454.37 52.00 280.00 5.50 15.00

P 1,409.24 43.00 70.00 28.00

P 145.00

Personal expenses: P 1,413.67 115.00 55.00

Car expenses, salary of driver and car depreciation Furniture given as commission in connection with business transaction Cost of iron door of Gutierrez' residence Capital expenditures:

Painting of rental apartments Carpentry and lumber for rental apartments Tinsmith and plumbing for rental apartments Cement, tiles, gravel, sand and masonry for rental apartments Iron bars, venetian blind, water pumps for rental apartments Relocation and registration of property used in taxpayer's business He also claimed the depreciation of his residence as follows: 1952 . . . . . . P 992.22 1953 . . . . . . 1954 . . . . . . 942.61 895.45

P 908.00 335.83 605.25 199.48 1,340.00 1,758.12

The following are the items of income which Gutierrez did not declare in his income tax returns: 1951

Income of wife (admitted by Gutierrez) 1953 Overstatement of purchase price of real estate Understatement of profits from sale of real estate 1954 Understatement of profits from sale of real estate

P 2,749.90.

P 8,476.92 5,803.74

P 5,444.24

The overstatement of purchase price of real estate refers to the sale of two pieces of property in 1953. In 1943 Gutierrez bought a parcel of land situated along Padre Faura St. in Manila for P35,000.00. Sometime in 1953, he sold the same for P30,400.00. Expenses of sale amounted to P631.80. In his return he claimed a loss of P5,231.80. 1 However, the Commissioner, including the said property was bought in Japanese military notes, converting the buying price to its equivalent in PhilippineCommonwealth peso by the use of the Ballantyne Scale of Values. At P1.30 Japanese military notes per Commonwealth peso, the acquisition cost of P35,000.00 Japanese military notes was valued at P26,923.00 PhilippineCommonwealth peso. Accordingly, the Commissioner determined a profit of P3,476.92 after restoring to Gutierrez' gross income the P5,231.80 deductionfor loss. In another transaction, Gutierrez sold a piece of land for P1,200.00. Alleging the said property was purchased for P1,200.00, he reported no profit hereunder. However, after verifying the deed of acquisition, the Commissioner discovered the purchase price to be only P800.00. Consequently, he determined a profit of P400.00 which was added to the gross income for 1953.
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The understatement of profit from the sale of real estate may be explained thus: In 1953 and 1954 Gutierrez sold four other properties upon which he made substantial profits.2Convinced that said properties were capital assets, he declared only 50% of the

profits from their sale. However, treating said properties as ordinary assets (as property held and used byGutierrez in his business), the Commissioner taxed 100% of the profits from their disposition pursuant to Section 35 of the Tax Code. Having unsuccessfully questioned the legality and correctness of the aforesaid assessment, Gutierrez instituted on February 17, 1958, the Commissioner issued a warrant of distraint and levy on one of Gutierrez' real properties but desisted from enforcing the same when Gutierrez filed a bond to assure payment of his tax liability. In a decision dated January 28, 1962, the Court of Tax Appeals upheld in toto the assessment of the Commissioner of Internal Revenue. Hence, this appeal. On October 18, 1962, Lino Guttierrez died and he was substituted by Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, his heirs,as party petitioners. The issues are: (1) Are the taxpayer's aforementioned claims for deduction proper and allowable? (2) May the Ballantyne Scale of Values be applied indetermining the acquisition cost in 1943 of a real property sold in 1953, for income tax purposes? (3) Are real properties used in the trade or business of the taxpayer capital or ordinary assets? (4) Has the right of the Commissioner of Internal Revenue to collect the deficiency income tax for the years 1951 and 1952 prescribed? (5) Has the right of the Commissioner of Internal Revenue to collect by distraint and levy the deficiency income tax for 1953 prescribed? If not, may the taxpayer's rea lproperty be distrained and levied upon without first exhausting his personal property? We come first to question whether or not the deductions claimed by Gutierrez are allowable. Section 30(a) of the Tax Code allows business expenses tobe deducted from gross income. We quote:
SEC. 30. Deductions from gross income. In computing net income there shall be allowed as deductions (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; travelling 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 be continued use of possession, for the purposes of the trade or business, or property to which the taxpayer has not taken or is not taking title or in which he has no equity.

To be deductible, therefore, an expense must be (1) ordinary and necessary;(2) paid or incurred within the taxable year; and, (3) paid or incurred in carrying on a trade or business. 3 The transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission tickets to operas were expenses relative to his personal and social activities rather than to his business of leasing real estate. Likewise, the procurement and installation of an iron door to is residence is purely a personal expense. Personal, living, or family expenses are not deductible. 4 On the other hand, the cost of furniture given by the taxpayer as commission in furtherance of a business transaction, the expenses incurred in attending the National Convention of Filipino Businessmen, luncheon meeting and cruise to Corregidor of the Homeowners' Association were shown to have been made in the pursuit of his business. Commissions given in consideration for bringing about a profitable transaction are part of the cost of the business transaction and are deductible. The record shows that Gutierrez was an officer of the Junior Chamber of Commerce which sponsored the National Convention of Filipino Businessmen. He was also the president of the Homeowners' Association, an organization established by those engaged in the real estate trade. Having proved that his membership thereof and activities in connection therewith were solely to enhance his business, the expenses incurred thereunder are deductible as ordinary and necessary business expenses.

With respect to the taxpayer's claim for deduction for car expenses, salary of his driver and car depreciation, one-third of the same was disallowed by the Commissioner on the ground that the taxpayer used his car and driver both for personal and business purposes. There is no clear showing, however, that the car was devoted more for the taxpayer's business than for his personal and business needs. 5 According to the evidence, the taxpayer's car was utilized both for personal and business needs. We therefore find it reasonable to allow as deduction one-half of the driver's salary, car expenses and depreciation. The electrical supplies, paint, lumber, plumbing, cement, tiles, gravel, masonry and labor used to repair the taxpayer's rental apartments did not increase the value of such apartments, or prolong their life. They merely kept the apartments in an ordinary operating condition. Hence, the expenses incurred therefor are deductible as necessary expenditures for the maintenance of the taxpayer's business. Similarly, the litigation expenses defrayed by Gutierrez to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business. It is routinary and necessary for one in the leasing business to collect rentals and to eject tenants who refuse to pay their accounts. The following are not deductible business expenses but should be integrated into the cost of the capital assets for which they were incurred and depreciated yearly: (1) Expenses in watching over laborers in construction work. Watching over laborers is an activity more akin to the construction work than to running the taxpayer's business. Hence, the expenses incurred therefor should form part of the construction cost. (2) Real estate tax which remained unpaid by the former owner of Gutierrez' rental property but which the latter paid, is an additional cost to acquire such property and ought therefore to be treated as part of the property's purchase price. (3) The iron bars, venetian blind and water pump augmented the value of the, apartments where they were installed. Their cost is not a maintenance charge, 6 hence, not deductible.. 7 (4) Expenses for the relocation, survey and registration of property tend to strengthen title over the property, hence, they should be considered as addition to the costs of such property. (5) The set of "Comments on the Rules of Court" having

a life span of more than one year should be depreciated ratably during its whole life span instead of its total cost being deducted in one year. Coming to the claim for depreciation of Gutierrez' residence, we find the same not deductible. A taxpayer may deduct from gross income a reasonable allowance for deterioration of property arising out of its use or employment in business or trade. 8 Gutierrez' residence was not used in his trade or business. Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30 allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld. Moreover, when acts are condemned, by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment..9 As regards the alms to an indigent family and various individuals, contributions to Lydia Yamson and G. Trinidad and a donation consisting of officers' jewels and aprons to Biak-na-Bato Lodge No. 7, the same are not deductible from gross income inasmuch as their recipients have not been shown to be among those specified by law. Contributions are deductible when given to the Government of the Philippines, or any of its political subdivisions for exclusively public purposes, to domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational purposes, or for the rehabilitation of veterans, or to societies for the prevention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual. 10 We come to the question of whether or not the Ballantyne Scale of Values can be applied to tax cases. Sometime in 1943 Gutierrez bought a piece of real estate in Manila for a price of P35,000.00. In 1953 he sold said property for P30,400.00, thereby incurring a loss which he claimed as deduction in his income tax return for 1953. The Commissioner of

Internal Revenue, convinced that the purchase price of the property in 1943 was in Japanese military notes, converted said purchase price into Philippine Commonwealth pesos by the use of the Ballantyne Scale of Values. As a result, the Commissioner found Gutierrez to have profited, instead of lost in the sale. Firstly, Gutierrez maintains that the purchase price was paid for in Commonwealth pesos. On the other hand the Commissioner insists that inasmuch as the prevailing currency in the City of Manila in 1943 was the Japanese military issue, the transaction could have been in said military notes. The evidence offered by Gutierrez, consisting of the testimony of his son to the effect that it was he who carried the bundle of Commonwealth pesos and Japanese military notes when his father purchased the property, did not convince the Tax Court. No cogent reason to alter the court a quo's finding of fact in this regard has been given. There is no definite showing that Gutierrez paid for the property in Commonwealth pesos. Considering that in 1943 the medium of exchange in Manila was the Japanese military notes, the use of which the Japanese Military Government enforced with stringent measures, we are inclined to concur with the finding that the purchase price was in Japanese military notes. We are specifically mindful of the fact that Gutierrez sold the property in 1953 for only P30,400.00 at a time when the price of real estate in the City of Manila was much greater than in 1943. It is further contended by Gutierrez that the money he used to pay for the purchase of the property in question came from the proceeds of merchandise acquired prior to World War II but which he sold after Manila was occupied by the Japanese military forces, hence, the purchase price should be deemed to have been made in Commonwealth pesos inasmuch as the aforesaid merchandise was purchased in Commonwealth pesos. This contention, if true, strengthens our conclusion that the real estate in question was bought in Japanese military notes. For, at the time Gutierrez sold his merchandise, the prevailing currency in the City of Manila was the Japanese military money. Consequently, the proceeds therefrom, which were used to buy the real estate in question, were Japanese military notes. Gutierrez assails the use of the Ballantyne Scale of Values in converting the purchase price of the real estate in question from

Japanese military notes to Philippine Commonwealth pesos on the ground that (1) the Ballantyne Scale of Values was intended only for transactions entered into by parties voluntarily during the Japanese occupation, wherein a portion of the contract was left unperformed until liberation of the Philippines by the Americans; (2) that such Scale of Values cannot be the basis of a tax, for it is not a law. In determining the gain or loss from the sale of property the purchase price and the selling price ought to be in the same currency. Since in this case the purchase price was in Japanese military notes and the selling price was in our present legal tender, the Japanese military notes should be converted to the present currency. Since the only standard scale recognized by courts for the purpose is the Ballantyne Scale of Values, we find it compelling to use such table of values rather than adopt an arbitrary scale. It may not be amiss to state in this connection that the Ballantyne Scale of Values is not being used herein as the authority to impose the tax, but only as a medium of computing the tax base upon which the tax is to be imposed. It is furthermore proffered by the taxpayer that in determining gain or loss, the real value of the Commonwealth peso at the time the property was purchased and the value of the Republic peso at the time. the same property was sold should be considered. The Commonwealth peso and the Republic peso are the same currency, with the same intrinsic value, sanctioned by the same authorities. Both are legal tender and accepted at face value regardless of fluctuation in their buying power. The 1941 Commonwealth peso when used to buy in 1963 or in 1965 is accorded the same value: one peso. In his income tax returns for 1953 and 1954, Gutierrez reported only 50% of profits he realized from the sale of real properties during the years 1953 and 1954 on the ground that said properties were capital assets. Profits from the sale of capital assets are taxable to the extent of 50% thereof pursuant to Section 34 of the Tax Code. Section 34 provides:

SEC. 34. Capital gains and losses. (a) Definitions. As used in this title (1) Capital assets. The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in subsection (f) of section thirty; or real property used in the trade or business of the taxpayer. xxx xxx xxx

(b) Percentage taken into account. In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of capital asset hall be taken into account in computing net capital gain, net capital loss, and net income: (1) One hundred per centum if the capital asset has been held for not more than twelve months; (2) Fifty per centum if the capital asset has been held for not more than twelve months.

Section 34, before it was amended by Republic Act 82 in 1947, considered as capital assets real property used in the trade or business of a taxpayer. However, with the passage of Republic Act 82, Congress classified "real property used in the trade or business of the taxpayer" is ordinary asset. The explanatory note to Republic Act 82 says "... the words "or real property used in the trade or business of the taxpayer" have been included among the non-capital assets. This has the effect of withdrawing the gain or loss from the sale or exchange of real property used in the trade or business of the taxpayer from the operation of the capital gains and losses provisions. As such real property is used in the trade or business of the taxpayer, it is logical that the gain or loss from the sale or exchange thereof should be treated as ordinary income or loss. 11 Accordingly, the real estate, admittedly used by

Gutierrez in his business, which he sold in 1953 and 1954 should be treated as ordinary assets and the gain from the sale thereof, as ordinary gain, hence, fully taxable. 12 With regard to the issue of the prescription of the Commissioner's right to collect deficiency tax for 1951 and 1952, Gutierrez claims that the counting of the 5-year period to collect income tax should start from the time the income tax returns were filed. He, therefore, urges us to declare the Commissioner's right to collect the deficiency tax for 1951 and 1952 to have prescribed, the income tax returns for 1951 and 1952 having been filed in March 1952 and on February 28, 1953, respectively, and the action to collect the tax having been instituted on March 5, 1958 when the Commissioner filed his answer to the petition for review in C.T.A. Case No. 504. On the other hand, the Commissioner argues that the running of the prescriptive period to collect commences from the time of assessment. Inasmuch as the tax for 1951 and 1952 were assessed only on July 10, 1956, less than five years lapsed when he filed his answer on March 5, 1958. The period of limitation to collect income tax is counted from the assessment of the tax as provided for in paragraph (c) of Section 332 quoted below:
SEC. 332(c). Where the assessment of any internal revenue tax has been made within the period of limitation above prescribed such tax may be collected by distraint or levy or by a proceeding in court, but only if begun (1) within five years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by the Collector of Internal Revenue and the taxpayer before the expiration of such five-year period. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

Inasmuch as the assessment for deficiency income tax was made on July 10, 1956 which is 7 months and 25 days prior to the action for collection, the right of the Commissioner to collect such tax has not prescribed.

The next issue relates to the prescription of the right of the Commissioner of Internal Revenue to collect the deficiency tax for 1954 by distraint and levy. The pertinent provision of the Tax Code states:
SEC. 51(d). Refusal or neglect to make returns; fraudulent returns, etc. In cases of refusal or neglect to make a return and in cases of erroneous, false, or fraudulent returns, the Collector of Internal Revenue shall, upon the discovery thereof, at any time within three years after said return is due or has been made, make a return upon information obtained as provided for in this code or by existing law, or require the necessary corrections to be made, and the assessment made by the Collector of Internal Revenue thereon shall be paid by such person or corporation immediately upon notification of the amount of such assessment.

On February 23, 1955 Gutierrez filed his income tax return for 1954 and on February 24, 1958 the Commissioner of Internal Revenue issued a warrant of distraint and levy to collect the tax due thereunder. Gutierrez contends that the Commissioner's right to issue said warrant is barred, for the same was issued more than 3 years from the time he filed his income tax return. On the other hand, the Commissioner of Internal Revenue maintains that his right did not lapse inasmuch as from the last day prescribed by law for the filing of the 1954 return to the date when he issued the warrant of distraint and levy, less than 3 years passed. The question now is: should the counting of the prescriptive period commence from the actual filing of the return or from the last day prescribed by law for the filing thereof? We observe that Section 51(d) speaks of erroneous, false or fraudulent returns, and refusal or neglect of the taxpayer to file a return. It also provides for two dates from which to count the threeyear prescriptive period, namely, the date when the return is due and the date the return has been made. We are inclined to conclude that the date when the return is due refers to cases where the taxpayer refused or neglected to file a return, and the date when the return has been made refers to instances where the taxpayer filed erroneous, false or fraudulent returns. Since Gutierrez filed an income tax return, the three-year prescriptive

period should be counted from the time he filed such return. From February 23, 1955 when the income tax return for 1954 was filed, to February 24, 1958, when the warrant of distraint and levy was issued, 3 years and 2 days elapsed. The right of the Commissioner to issue said warrant of distraint and levy having lapsed by two days, the warrant issued is null and void. The above finding has made academic the question of whether or not the warrant of distraint and levy can be enforced against the taxpayer's real property without first exhausting his personal properties. In resume the tax liability of Lino Gutierrez for 1951, 1952, 1953 and 1954 may be computed as follows:
1951 Net income per investigation Add: Disallowed deductions for salary of driver and car expenses

P29,471.81 29.90 P29,501.81

Less: Allowable deductions: Expenses in attending National Convention of Filipino Businessmen Repair of rental apartments Net income Less: Personal exemption Amount subject to tax Tax due thereon Less tax already paid Deficiency income tax due 1952

P 121.35 802.65

924.00 P30,425.71 3,600.00 P26,825.71 P 5,668.00 3,981.00 P 1,687.00 ==========

Net income per investigation Add: Disallowed deductions: Salary of driver Car expenses Car depreciation P 260.67 401.51 65.00

P21,632.22

727.18 P22,359.40

Less Allowable deduction: Luncheon, Homeowners' Association Net income Less: Personal exemption Amount subject to tax Tax due thereon Less tax already paid Deficiency income tax due 1953 Net income per investigation Add: Disallowed deductions: Salary of driver Car expenses Car depreciation P 140.00 406.00 58.50

5.50 P22,364.90 3,600.00 P18,764.90 P 3,324.00 2,476.00 848.00 ========== P69,180.91

604.50 P69,785.40

Less: Allowable deduction: Cruise to Corregidor with Homeowners' Association Net Income Less: Personal exemption Amount subject to tax

42.00 P69,828 40 3,600.00 P66,228.40

Tax due thereon Less tax already paid Deficiency income tax due 1954 Net income per investigation Add: Disallowed deductions: Salary of driver Car expenses Car depreciation P 140.00 414.18 72.65

P15,179.00 9,805.00 P 5,374.00 ========== P43,881.92

626.83 P44,508.75

Less: Allowable deductions: Furniture given in connection with business transaction Repairs of rental apartments Net income Less: Personal exemption Amount subject to tax Tax due thereon Less tax already paid Deficiency income tax due

P 115.00 2,048.56

2,163.56 P42,345.19 3,000.00 P39,345.19 P 9,984.00 5,964.00 P 4,020.00 ==========

SUMMARY 1951 . . . . . . . . . . . . . . . . 1952 . . . . . . . . . . . . . . . . 1953 . . . . . . . . . . . . . . . . 1954 . . . . . . . . . . . . . . . . P 1,687.00 848.00 5,374.00 4,020.00

TOTAL . . . . . . . . . . P 11,929.00 =========

WHEREFORE, the decision appealed from is modified and Lino Gutierrez and/or his heirs, namely, Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, are ordered to pay the sums of P1,687.00, P848.00, P5,374.00, and P4,020.00, as deficiency income tax for the years 1951, 1952, 1953 and 1954, respectively, or a total of P11,929.00, plus the statutory penalties in case of delinquency. No costs. So ordered. Bengzon, C.J., Bautista Angelo, Concepcion, Reyes, J.B.L., Barrera, Paredes, Dizon, Makalintal and Zaldivar, JJ., concur. Regala, J., took no part.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-19667 November 29, 1966

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. AMERICAN RUBBER COMPANY and COURT OF TAX APPEALS, respondents. G.R. No. L-19801-03 November 29, 1966

AMERICAN RUBBER COMPANY, petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE, ET AL., respondents. Nos. L-19667: Office of the Solicitor General for petitioner. Ozaeta, Gibbs and Ozaeta for respondents. Nos. L-19801-03: Ozaeta, Gibbs and Ozaeta for petitioner. Office of the Solicitor General for respondents. REYES, J.B.L., J.: These cases are brought on appeal from the Court of Tax Appeals by the State (G.R. No. L-19667) as well as by the American Rubber Company (G.R. Nos. L-19801, 19802, 19803). The factual background is the same in all four cases, and is not in controversy, having been stipulated between the parties. Petitioner, American Rubber Company, a domestic corporation, from January 1, 1955 to December 1, 1958, was engaged in producing rubber from its approximately 900 hectare rubber tree plantation, which it owned and operated in Latuan, Isabela, City of

Basilan. Its products, known in the market as Preserved Latex, Pale Crepe No. 1, Pale Crepe No. 2, Ribbed Smoked Sheets Nos. 1 and 2, Flat Bark Rubber, 2X Brown Crepe and 3X Brown Crepe, are turned out in the following manner: The initial step common to the production of all the foregoing rubber products is tapping, i.e., the collection of latex (rubber juice) from rubber trees. This is done by the daily cutting, early in the morning, of a spiral incision in the bark of rubber trees and placing a cup below the lower end of the incision to receive the flow of latex. The collecting cup is filled after two hours. The tapper then collects the latex into buckets and carries them to the collecting shed. The tapper subsequently pours the latex collected into big milk cans. The filled milk cans are then taken in motor vehicles to a coagulating shed, also within the premises of petitioner's plantation, where the latex is strained into coagulating tanks to remove foreign matter such as leaves and dirt. After these initial steps, the processes vary in the production of the various rubber products mentioned above. Said processes are described hereunder. Preserved Rubber Latex Fresh latex is diluted with 5 to 5-1/4 ounces of ammonia per gallon of latex. The mixture is thoroughly stirred and then poured into metal drums. The addition of ammonia preserves the latex in liquid form and prevents its deterioration or its acquisition of a repulsive smell, and at the same time preserves its uniform color. Latex which has been thus artificially preserved in its liquid form generally lasts for about a month without spoiling. On the other hand, fresh latex in its original state lasts for only about two hours, after which it becomes spoiled. Petitioner sells preserved latex only upon previous orders of customers who supply empty metal drum containers. Pale Crepe Nos. 1 and 2 and Ribbed Smoked Sheets Nos. 1 and 2 To produce Pale Crepe Nos. 1 and 2 and Ribbed Smoked Sheets Nos. 1 and 2, the petitioner adds to the latex in the coagulating tank about 15 or 16 ounces of glacial acetic acid per gallon of

latex. The mixture is stirred thoroughly. Thereafter aluminum partitions are placed crosswise inside the tank so that the latex will coagulate into uniform slabs. Acetic acid is added to the latex to hasten coagulation which otherwise takes place naturally, and to preserve its fresh state and color. The similarity in the production of Pale Crepe Nos. 1 and 2 and Ribbed Smoked Sheets Nos. 1 and 2 ends at the point of removing the coagulum (coagulated rubber sheets) from the coagulating tanks. To produce Pale Crepe No. 1, the coagulum is passed through a series of rollers until the desired thickness is attained, whereupon it is removed to the air-drying house situated inside petitioner's plantation and hung for a period of about twelve or thirteen days to dry. There are no mechanical driers used; the air-drying is done naturally. As soon as the Pale Crepe is dried, the sheets are sorted; those which are of uniform pale color are classified as Pale Crepe No. 2, whereupon they are baled and stored, ready for market. Ribbed & Smoked Sheets Nos. 1 and 2 are produced practically in the same manner as Pale Crepe, except that the coagulum is passed only once through a roller provided with ribs after which the flattened and ribbed coagulum is removed to petitioner's smoke-house where it is hung and cured by exposure to heat and smoke from wood fires for about six or seven days. The resulting smoked sheets are sorted and classified dependent upon color and opaqueness into ribbed smoked sheets (RSS) No. 1 and No. 2, baled, and stored ready for the market. No mechanical equipment is used in generating the smoke in the smoke-house. The petitioner's rollers are powered by engines although they could be turned by hand as it is done in small rubber plantations. If Pale Crepe Nos. 1 and 2 and Ribbed Smoked Sheets Nos. 1 and 2 are not air-dried and smoked they deteriorate, get spoiled, and the color varies. Flat Bark Rubber Each morning after a tapper makes a fresh incision in the bark of a rubber tree, he gathers the latex dripping from the ground around the tree, called "ground rubber", as well as the dried latex from the incisions made the previous day, called "bark rubber".

Ground and bark rubber are not intentionally produced. No chemicals are added to the latex transformed into ground and bark rubber. This kind of dried latex is spoiled and has a bad odor. Ground and bark rubber when gathered in sufficient quantities are passed numerous times through the rollers or mills until they form a uniform mass or sheet which, finally is called Flat Bark Rubber. No chemical is used to coagulate the dried ground and bark rubber because they are already coagulated. They are formed into sheets by means only of pressure of the mills or rollers through which they are passed. Flat Bark Rubber commands the lowest prices in the rubber market. 3X Brown Crepe Every morning, before a fresh incision is made in the bark of the rubber trees, the tapper collects not only ground and bark rubber but removes and collects the latex in the cups, known as "cup rubber". The cup rubber coagulates and dries through natural processes and, when gathered in sufficient quantities, is milled and rolled through a series of rollers until by force of pressure it is formed into a mass of the desired thickness called "3X Brown Crepe." Like ground and bark rubber, no chemicals are added to cup rubber to produce 3X Brown Crepe. Cup rubber in its original form, like ground and bark rubber, is spoiled and has a bad odor. 2X Brown Crepe 2X Brown Crepe is obtained by milling or rolling the excess pieces of coagulated rubber latex which had been cut or trimmed from the from the ribbed smoked sheets No. 2 into a uniform mass. 2X Brown Crepe is produced in the same manner as the other sheets of crepe rubber, i.e., without the addition of any chemicals. Petitioner during the said period sold its foregoing rubber products locally and as prescribed by the respondent's regulations declared same for tax purposes which respondent accordingly assessed. Petitioner paid, under protest, the corresponding sales taxes thereon claiming exemption therefrom under Section 188 (b) of the National Internal Revenue Code.

The following sales taxes on the aforementioned rubber products were paid under protest
From Jan. 1, 1955 to Dec. 31, 1956 From Jan. 1, 1957 to June 30, 1957 From July 1, 1957 to Dec. 31, 1958 P83,193.48 P20,504.99 P52,378.90

It is further stipulated that the sales tax collected from petitioner American Rubber Company on the local sales of its rubber products, following Internal Revenue General Circulars Nos. 431 and 440, had been separately itemized and billed by petitioner Company in the invoices issued to the customers, that paid both the value of the rubber articles and the separately itemized sales tax, from January 1, 1955 to August 2, 1957. After paying under protest, the petitioner claimed refund of the sales taxes paid by it on the ground that under section 188, paragraph b, of the Internal Revenue Code, as amended,1 its rubber products were agricultural products exempt from sales tax, and upon refusal of the Commissioner of Internal Revenue, brought the case on appeal to the Court of Tax Appeals (C.T.A. Nos. 356, 440,, 632). The respondent Commissioner interposed defenses, denying that petitioner's products were agricultural ones within the exemption; claiming that there had been no exhaustion of administrative remedies; and argued that the sales tax having been passed to the buyers during the period that elapsed from January 1, 1955 to August 2, 1957, the petitioner did not have personality to demand, sue for and recover the aforesaid sales taxes, plus interest. In its decision, now under appeal, the Tax Court held Preserved Latex, Flat Bark Rubber, and 3X Brown Crepe to be agricultural products, "because the labor employed in the processing thereof is agricultural labor", and hence, the sales of such products were exempt from sales tax, but declared Pale Crepe No. 1, Ribbed Smoked Sheets Nos. 1 and 3, as well as 2X Brown Crepe (which is obtained from rolling excess pieces of Smoked Sheets) to be

manufactured products, sales of which were subject to the tax. It overruled the defense of non-exhaustion of administrative remedies and upheld the Revenue Commissioner's stand that petitioner Company was not entitled to recover the sales tax that had been separately billed to its customers, and paid by the latter. Hence, it dismissed the appeal in C.T.A. Nos. 356 and 440 and ordered respondent Commissioner to refund only P3,916.49 without interest, or costs. Both parties then duly appealed to this. The issues posed on these appeals are:
(1) Whether the plaintiff's rubber products above described should be considered agricultural or manufactured for purposes of their subjection to the sales tax; (2) Whether plaintiff is or is not entitled to recover the sales tax paid by it, but passed on to and paid by the buyers of its products; and (3) Whether plaintiff is or is not entitled to interest on the sales tax paid by it under protest, in case recovery thereof is allowed.

The first issue, in our opinion, is governed by the principles laid down by this Court in Philippine Packing Corporation vs. Collector of Internal Revenue, 100 Phil. 545 et seq. We there ruled that the exemption from sales tax established in section 188 (b) of the Internal Revenue Tax Code in favor of sales of agricultural products, whether in their original form or not, made by the producer or owner of the land where produced is not taken away merely because the produce undergoes processing at the hand of said producer or owner for the purpose of working his product into a more convenient and valuable form suited to meet the demand of an expanded market; that the exemption was not designed in favor of the small agricultural producer, already exempted by the subsequent paragraphs of the same section 188, but that said exemption is not incompatible with large scale agricultural production that incidentally required resort to preservative processes designed to increase or prolong marketability of the product.

In the case before us, the parties have stipulated that fresh latex directly obtained from the rubber tree, which is clearly an agricultural product, becomes spoiled after only two hours. It has, therefore, a severely limited marketability. The addition of ammonia prevents its deterioration for about a month, and we see no reason why this preservative process should wrest away from the preserved latex the protective mantle of the tax exemption. Taking also into account the great distance that separates the plaintiff's plantation from the main rubber processing centers in Japan, the United States and Europe, and the difficulty in handling products in liquid form, it can be discerned without difficulty that preserved, latex, with its 30-day spoilage limit, is still severely handicapped for export and dollar earning purposes. To overcome these shortcomings, and extend its useful life almost indefinitely, it becomes necessary to separate and solidify the rubber granules diffused in the latex, and hence, according to the stipulation of facts and the evidence, acetic acid is added to hasten coagulation. There is nothing on record to show that the acetic acid in way produces anything that was not originally in the source, the liquid latex. The coagulum is then rolled and compacted and afterwards air dried to make Pale Crepe(1 and 2), or else cured and smoked to produce rubber sheets. Once again we see nothing in this processing to alter the agricultural nature of the result; what takes place is merely an accelerated coagulation and dessication that would naturally occur anyway, only within a longer period of time, coupled with greater spoilage of the product. Thus the operations carried out by plaintiff appear to be purely preservative in nature, made necessary, by its production of fresh rubber latex in a large scale. they are purely incidental to the latter, just as the canning of skinned and cored pineapples in syrup was held to be incidental to the large-scale cultivation of the fruit in the Philippine Packing Corporation case (ante). Being necessary to suit the product to the demands of the market, the operations in both cases should lead to the same result, nontaxability of the sales of the respective agricultural products. In not so holding, the Tax Court was in error. Even less justifiable is the position taken by the Revenue Commissioner in his appeal against the finding of the Tax Court

that Flat Bark 3X Brown Crepe rubber are agricultural products. According to the record, these sheets result from the drippings and waste rubber that have dried naturally, that are rolled and compacted into the desired thickness, without any other processing. As to 2X Brown Crepe which is compacted out of the trimmings and waste left over from the production of ribbed smoked sheets, no reason is seen why it should be treated differently from the ribbed smoked sheets themselves. In his appeal, the Revenue Commissioner contends that all of plaintiff's products should be deemed manufactured articles, on the strength of section 194 (n) of the Revenue Code defining a "manufacturer" as
every person who by physical or chemical process alters the exterior texture or form or inner substances of any raw material or manufactured or partially manufactured product in such manner as to prepare it for a special use or uses to which it could not have been put to in its original condition, or who . . . alters the quality of any such raw material . . . as to reduce it to marketable shape . . . .

But, as pointed out in the Philippine Packing Corporation case, this definition is not applicable to the exemption of agricultural products, "whether in their original form or not". The use of this last phrase in the statute clearly indicates that the agricultural product may be altered in texture or form without being divested of the exemption (cas cit. 100 Phil., p. 548). The exception would be sales of agricultural products while Republic Act No. 1612 was in effect because under this Act the freedom from sales tax became restricted to agricultural products "in their original form" only. So that plaintiff's sales from August 24, 1956 (approval of Republic Act 1612) to June 22, 1957 (when Republic Act 1856 became effective and restored the exemption to agricultural products "whether in their original form or not") became properly taxable. Under paragraphs (A)2 and B(4) of the additional stipulation of facts (CTA Rec. pp. 261-262, G.R. L-19801), the sales tax properly collected during this period of plaintiff's transactions amounted to P18,187.19 from August 24 to December 31, 1956;

and P18,888.28 from January 1 to June 21, 1957, or a total of P37,075.47. This last amount is, therefore non-recoverable.2 The second issue in this appeal concerns the holding of the Court of Tax Appeals that the plaintiff Company is not entitled to recover the sales tax paid by it from January, 1955 to August 2, 1957, because during that period the plaintiff had separately invoiced and billed the corresponding sales tax to the buyers of its products. In so holding, the Tax Court relied on our decisions in Medina vs. City of Baguio, 91 Phil. 854; Mendoza, Santos & Co. vs. Municipality of Meycawayan, L-6069-6070, April 30, 1954 (94 Phil. 1047); and Zosimo Rojas & Bros. vs. City of Cavite, L-10730, May 27, 1958. The basic ruling is that of Medina vs. City of Baguio, supra, where this Court affirmed the ruling of the court of First Instance to the effect that
"The amount collected from the theatergoers as additional price of admission tickets is not the property of plaintiffs or any of them. It is paid by the public. If anybody has the right to claim it, it is those who paid it. Only owners of property has the right to claim said property. The cine owner acted as mere agents of the city in collecting additional price charged in the sale of admission tickets." (Medina vs. City of Baguio, 91 Phil. 854) (Emphasis supplied)

We agree with the plaintiff-appellant that the Medina ruling is not applicable to the present case, since the municipal taxes therein imposed were taxes on the admission tickets sold, so that, in effect, they were levies upon the theatergoers who bought them; so much so that (as the decision expressly ruled) the tax was collected by the theater owners as agents of the respective municipal treasurers. This does not obtain in the case at bar. The Medina ruling was merely followed in Rojas & Bros. vs. Cavite, supra; and in Mendoza, Santos & Co. vs. Municipality of Meycawayan, 94 Phil. 1047. By contrast with the municipal taxes involved in the preceding cases, the sales tax is by law imposed directly, not on the thing sold, but on the act (sale) of the manufacturer, producer or importer (Op. of the Secretary of Justice, June 15, 1946; 47

C.J.S., p. 1141), who is exclusively made liable for its timely payment. There is no proof that the tax paid by plaintiff is the very money paid by its customers. Where the tax money paid by the plaintiff came from is really no concern of the Government, but solely a matter between the plaintiff and its customers. Anyway, once recovered, the plaintiff must hold the refund taxes in trust for the individual purchasers who advanced payment thereof, and whose names must appear in plaintiff's records. Moreover, the separate billing of the sales tax in appellant's invoices was a direct result of the respondent Commissioner's General Circular No. 440, providing that
if a manufacturer, producer, or importer, in fixing the gross selling price of an article sold by him, has included an amount intended to cover the sales tax in the gross selling price of the article, the sales tax shall be based on the gross selling price less the amount intended to cover the tax, if the same is billed to the purchaser as a separate item in the invoice. . . . (Emphasis supplied)

In other words, the separate itemization of the sales tax in the invoices was permitted to avoid the taxpayer being compelled to pay a sales tax on the tax itself. It does not seem either just or proper that a step suggested by the Internal Revenue authorities themselves to protect the taxpayer from paying a double tax should now be used to block his action to recover taxes collected without legal sanction. Finally, a more important reason that militates against extensive and indiscriminate application of the Medina vs. City of Baguio ruling is that it would tend to perpetuate illegal taxation; for the individual customers to whom the tax is ultimately shifted will ordinarily not care to sue for its recovery, in view of the small amount paid by each and the high cost of litigation for the reclaiming of an illegal tax. In so far, therefore, as it favors the imposition, collection and retention of illegal taxes, and encourages a multiplicity of suits, the Tax Court's ruling under appeal violates morals and public policy. The plaintiff Company also urges that the refund of the taxes should include interest thereon. While this Court has allowed

recovery of interest in some cases, it has done so only in cases of patent arbitrariness on the part of the Revenue authorities; and in this instance we agree with the Tax Court that no such patent arbitrariness has been shown. IN VIEW OF THE FOREGOING, the decision of the Court of Tax Appeals is affirmed in Case G.R. No. L-19667 and modified in cases G.R. Nos. L-19801, L-19802 and L-19803, by declaring the sales taxes therein involved to have been improperly denied levied and collected and ordering respondent Commissioner of Internal Revenue to refund the same, except the taxes corresponding to the period from August 24, 1956 to June 22, 1957, during which Republic Act No. 1612 was in force. The amount of P37,075.47 paid by the taxpayer for this period is hereby declared properly collected and not refundable. Without special pronouncement as to costs. Concepcion, C.J., Barrera, Dizon, Regala, Makalintal, Bengzon, J.P., Zaldivar and Sanchez, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. Nos. L-18169, L-18262 & L-21434 July 31, 1964

COMMISSIONER OF INTERNAL REVENUES, petitioner, vs. V.E. LEDNICKY and MARIA VALERO LEDNICKY, respondents. Office of the Solicitor General for petitioner. Ozaeta, Gibbs and Ozaeta for respondents. REYES, J.B.L., J.: The above-captioned cases were elevated to this Court under separate petitions by the Commissioner for review of the corresponding decisions of the Court of Tax Appeals. Since these cases involve the same parties and issues akin to each case presented, they are herein decided jointly. The respondents, V. E. Lednicky and Maria Valero Lednicky, are husband and wife, respectively, both American citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years in question. In compliance with local law, the aforesaid respondents, on 27 March 1957, filed their income tax return for 1956, reporting therein a gross income of P1,017,287. 65 and a net income of P733,809.44 on which the amount of P317,395.4 was assessed after deducting P4,805.59 as withholding tax. Pursuant to the petitioner's assessment notice, the respondents paid the total amount of P326,247.41, inclusive of the withheld taxes, on 15 April 1957. On 17 March 1959, the respondents Lednickys filed an amended income tax return for 1956. The amendment consists in a claimed deduction of P205,939.24 paid in 1956 to the United States government as federal income tax for 1956. Simultaneously with

the filing of the amended return, the respondents requested the refund of P112,437.90. When the petitioner Commissioner of Internal Revenue failed to answer the claim for refund, the respondents filed their petition with the Tax Court on 11 April 1959 as CTA Case No. 646, which is now G. R. No. L-18286 in the Supreme Court. G. R. No. L-18169 (formerly CTA Case No. 570) is also a claim for refund in the amount of P150,269.00, as alleged overpaid income tax for 1955, the facts of which are as follows: On 28 February 1956, the same respondents-spouses filed their domestic income tax return for 1955, reporting a gross income of P1,771,124.63 and a net income of P1,052,550.67. On 19 April 1956, they filed an amended income tax return, the amendment upon the original being a lesser net income of P1,012,554.51, and, on the basis of this amended return, they paid P570,252.00, inclusive of withholding taxes. After audit, the petitioner determined a deficiency of P16,116.00, which amount, the respondents paid on 5 December 1956. Back in 1955, however, the Lednickys filed with the U.S. Internal Revenue Agent in Manila their federal income tax return for the years 1947, 1951, 1952, 1953, and 1954 on income from Philippine sources on a cash basis. Payment of these federal income taxes, including penalties and delinquency interest in the amount of P264,588.82, were made in 1955 to the U.S. Director of Internal Revenue, Baltimore, Maryland, through the National City Bank of New York, Manila Branch. Exchange and bank charges in remitting payment totaled P4,143.91. Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court, without prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts.
1wph1.t

On 11 August 1958, the said respondents amended their Philippine income tax return for 1955 to include the following deductions:

U.S. Federal income taxes Interest accrued up to May 15, 1955 Exchange and bank charges Total

P471,867.32 40,333.92 4,143.91 P516,345.15

and therewith filed a claim for refund of the sum of P166,384.00, which was later reduced to P150,269.00. The respondents Lednicky brought suit in the Tax Court, which was docketed therein as CTA Case No. 570. In G. R. No. 21434 (CTA Case No. 783), the facts are similar, but refer to respondents Lednickys' income tax return for 1957, filed on 28 February 1958, and for which respondents paid a total sum of P196,799.65. In 1959, they filed an amended return for 1957, claiming deduction of P190,755.80, representing taxes paid to the U.S. Government on income derived wholly from Philippine sources. On the strength thereof, respondents seek refund of P90 520.75 as overpayment. The Tax Court again decided for respondents. The common issue in all three cases, and one that is of first impression in this jurisdiction, is whether a citizen of the United States residing in the Philippines, who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the United States government for the taxable year on the strength of section 30 (C-1) of the Philippine Internal Revenue Code, reading as follows:
SEC. 30. Deduction from gross income. In computing net income there shall be allowed as deductions (a) ... (b) ... (c) Taxes:

(1) In general. Taxes paid or accrued within the taxable year, except (A) The income tax provided for under this Title; (B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for foreign countries); (C) Estate, inheritance and gift taxes; and (D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed. (Emphasis supplied) The Tax Court held that they may be deducted because of the undenied fact that the respondent spouses did not "signify" in their income tax return a desire to avail themselves of the benefits of paragraph 3 (B) of the subsection, which reads: Par. (c) (3) Credits against tax for taxes of foreign countries. If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with (A) ...; (B) Alien resident of the Philippines. In the case of an alien resident of the Philippines, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such alien resident is a citizen or subject, in imposing

such taxes, allows a similar credit to citizens of the Philippines residing in such country; It is well to note that the tax credit so authorized is limited under paragraph 4 (A and B) of the same subsection, in the following terms: Par. (c) (4) Limitation on credit. The amount of the credit taken under this section shall be subject to each of the following limitations: (A) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources within such country taxable under this Title bears to his entire net income for the same taxable year; and (B) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources without the Philippines taxable under this Title bears to his entire net income for the same taxable year. We agree with appellant Commissioner that the Construction and wording of Section 30 (c) (1) (B) of the Internal Revenue Act shows the law's intent that the right to deduct income taxes paid to foreign government from the taxpayer's gross income is given only as an alternative or substitute to his right to claim a tax credit for such foreign income taxes under section 30 (c) (3) and (4); so that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from deducting the foreign income taxes from his gross income. For it is obvious that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) (relating to credits for

taxes paid to foreign countries), the statute assumes that the taxpayer in question also may signify his desire to claim a tax credit and waive the deduction; otherwise, the foreign taxes would always be deductible, and their mention in the list of nondeductible items in Section 30(c) might as well have been omitted, or at least expressly limited to taxes on income from sources outside the Philippine Islands. Had the law intended that foreign income taxes could be deducted from gross income in any event,regardless of the taxpayer's right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayer's waiving the deduction; in which Case the right to reduction under subsection (c-1-B) would have been made absolute or unconditional (by omitting foreign taxes from the enumeration of nondeductions), while the right to a tax credit under subsection (c-3) would have been expressly conditioned upon the taxpayer's not claiming any deduction under subsection (c-1). In other words, if the law had been intended to operate as contended by the respondent taxpayers and by the Court of Tax Appeals section 30 (subsection (c-1) instead of providing as at present: SEC. 30. Deduction from gross income. In computing net income there shall be allowed as deductions (a) ... (b) ... (c) Taxes: (1) In general. Taxes paid or accrued within the taxable year, except (A) The income tax provided for under this Title; (B) Income, war-profits, and excess profits taxes imposed by the authority

of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries); (C) Estate, inheritance and gift taxes; and (D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

would have merely provided:


SEC. 30. Decision from grow income. In computing net income there shall be allowed as deductions: (a) ... (b) ... (c) Taxes paid or accrued within the taxable year, EXCEPT (A) The income tax provided for in this Title; (B) Omitted or else worded as follows: Income, war profits and excess profits taxes imposed by authority of any foreign country on income earned within the Philippines if the taxpayer does not claim the benefits under paragraph 3 of this subsection; (C) Estate, inheritance or gift taxes; (D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

while subsection (c-3) would have been made conditional in the following or equivalent terms:
(3) Credits against tax for taxes of foreign countries. If the taxpayer has not deducted such taxes from his gross income but signifies in his return his desire to have the benefits of this paragraph, the tax imposed by Title shall be credited with ... (etc.).

Petitioners admit in their brief that the purpose of the law is to prevent the taxpayer from claiming twice the benefits of his payment of foreign taxes, by deduction from gross income (subs. c-1) and by tax credit (subs. c-3). This danger of double credit certainly can not exist if the taxpayer can not claim benefit under either of these headings at his option, so that he must be entitled to a tax credit (respondent taxpayers admittedly are not so entitled because all their income is derived from Philippine sources), or the option to deduct from gross income disappears altogether. Much stress is laid on the thesis that if the respondent taxpayers are not allowed to deduct the income taxes they are required to pay to the government of the United States in their return for Philippine income tax, they would be subjected to double taxation. What respondents fail to observe is that double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same governmental entity (cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the taxpayers would have to pay two taxes on the same income, the Philippine government only receives the proceeds of one tax. As between the Philippines, where the income was earned and where the taxpayer is domiciled, and the United States, where that income was not earned and where the taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income should accrue to the benefit of the Philippines. Any relief from the alleged double taxation should come from the United States, and not from the Philippines, since the former's right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production of the wealth that is being taxed. Aside from not conforming to the fundamental doctrine of income taxation that the right of a government to tax income emanates

from its partnership in the production of income, by providing the protection, resources, incentive, and proper climate for such production, the interpretation given by the respondents to the revenue law provision in question operates, in its application, to place a resident alien with only domestic sources of income in an equal, if not in a better, position than one who has both domestic and foreign sources of income, a situation which is manifestly unfair and short of logic. Finally, to allow an alien resident to deduct from his gross income whatever taxes he pays to his own government amounts to conferring on the latter the power to reduce the tax income of the Philippine government simply by increasing the tax rates on the alien resident. Everytime the rate of taxation imposed upon an alien resident is increased by his own government, his deduction from Philippine taxes would correspondingly increase, and the proceeds for the Philippines diminished, thereby subordinating our own taxes to those levied by a foreign government. Such a result is incompatible with the status of the Philippines as an independent and sovereign state. IN VIEW OF THE FOREGOING, the decisions of the Court of Tax Appeals are reversed, and, the disallowance of the refunds claimed by the respondents Lednicky is affirmed, with costs against said respondents-appellees. Bengzon, C.J., Padilla, Bautista Angelo, Labrador, Concepcion, Paredes, Regala and Makalintal, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-12401 October 31, 1960

MARCELO STEEL CORPORATION, petitioner, vs. COLLECTOR OF INTERNAL REVENUE, respondent. Meer, Meer & Meer for petitioner. Asst. Solicitor General J.P. Alejandro and Atty. S. J. Javier for respondent. PADILLA, J.: This is a petition to review under section 18, Republic Act No. 1125, a judgement of the Court of Tax Appeals upholding the assessment made by the respondent for income tax due during the years 1952 and 1953 from the petitioner (C.T.A. Case No. 172). The parties have entered into stipulation of facts which the Court summarized as follows:
The petitioner is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with offices at Malabon, Rizal. It is engaged in three (3) industrial activities, namely, (1) manufacture of wire fence, (2) manufacture of nails, and (3) manufacture of steel bars, rods and other allied steel products. enjoined the benefits of the tax exemption under Republic Act No. 35. On May 21, 1953, the petitioner filed an income tax return for the year 1952, reflecting a net income of P34,386.58 realized solely from its business of manufacturing wire fence, an activity which is not tax exempt, and on March 31, 1954, it filed its income tax return for the year 1953, showing a net income of P58,329.00 realized from the same sources, i.e., the manufacture of wire fence.

On basis of the said income tax return filed by the petitioner for the year 1952 and 1953 which did not reflect the financial of its tax exempt business activities, the respondent assessed the total sum of P12,750. Accordingly, the petitioner paid the said amount assessed against it on following dates: Tax Year 1952 1952 1952 Date May 30, 1953 August 15, 1953 May 5, 1954 Amount. P3,458.50 3,458.50 5,833.00 P12,750.00

TOTAL ..............................

On October 1, 1954, the petitioner filed amended income tax returns for taxable years 1952 and 1953, showing that bit suffered a net loss of P871,407.37 in 1952, and P10,956.29 in 1953. The said losses were arrived at by consolidating the gross income and expenses and/or deductions of the petitioner in all its business activities, as follows: For the year 1952 Net Income, taxable industry: Wire fence Net loss,. tax exempt industries: Nails Steel bars TOTAL NET LOSS For the year 1953 Net income, taxable industry: (P620,722.73) (285,071.22) (905,793.95) (P871,407.37) P34,386.58.

Wire fence Steel; bars TOTAL NET LOSS

(P60,950.20) (102,335.20) (163,285.40) (P104,956.29)

On October 1, 1954, the petitioner, claiming that instead of earning the net income shown in its original income tax returns for 1952 and 1953, it sustained the losses shown in its amended income tax returns for refund of the income taxes for the said years amounting to P12,750.00 which it allegedly paid to the respondent. After more than ten months of waiting without any action being taken by the respondent on the claim for refund, and in order to protect its right under Section 306 of the National Internal Revenue Code, the petitioner, on August 13, 1955, filed with this Court the instant petition for review.

There are two issues to be resolved in this case, namely, (1) whether or not the petitioner may be allowed to deduct from the profits realized from its taxable business activities, the losses sustained by its tax except industries, and (2) whether or not the action for refund, with regard to the sum of P3,458.50 which was of the Tax Code. The Court of Tax Appeals held that "petitioner cannot deduct from the profits realized from its taxable industries, the losses sustained by its tax exempt business activities, . . ." The duration of the petitioner's tax exemption with respect to the manufacture of nails is from 25 June 1949 to 25 June 1953 (Exhibit 7), later adjusted to be from 11 August 1949 to 11 August 1953, and with respect to the manufacture of steel bars, rods and other allied steel product, is from 16 March 1951 to 16 March 1955 (Exhibit 6). The exemption refers to the following internal revenue taxes: the fixed and privilege tax on business, the percentage tax on the sales of manufactured products, in respect to which exemption was granted, the compensating tax on the articles, goods or materials exclusively used in the new and necessary industry, the documentary stamp tax and the income

tax with respect to the not income derived from the exempt industry (Exhibits 6 and 7). The petitioner's theory is that since it is a corporation organized with a single capital that answer for all its financial obligation including those incurred in the tax exempt industries, the gross income derived from both its taxable or non-exempt and taxexempt industries, and the allowable deductions from said incomes, should be consolidated and its income tax liability should be based on the difference between the consolidated gross incomes and the consolidated allowable deductions. It relies on the provisions of action 24, Commonwealth Act No. 466, as amended, providing that "there shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding taxable year from all sources by every corporation organized in, or existing under the laws of the Philippines." a graduated tax (Emphasis supplied), and of section 30, subsection (d), paragraph (2) of the same Act providing that in computing the net income of a corporation, all losses actually sustained by it and charged off within the taxable year and not compensated for by insurance or otherwise, are allowed as deductions. Republic Act No. 35, the law under which the petitioner was granted tax exemption for the manufacture of nails and steel bars, rods and other allied steel products, provides:.
SECTION 1. Any person, partnership, company, or corporation who or which shall engage in anew and necessary industry shall, for a period of four years from the date of the organization of such industry, be entitled to exemption from the payment of all internal revenue taxes directly payable by such person, partnership, company, or corporation in respect to said industry. SEC. 2. The President of the Philippines, shall, upon recommendation of the Secretary of Finance, periodically determine the qualifications that the industries should possess to be entitled to the benefits of this Act. SEC. 3. This Act shall take effect upon its approval. (Approved, September 30, 1946.)

The purpose of aim of Republic Act No. 35 is to encourage the establishment or exploitation of new and necessary industries to promote the economic growth of the country. It is a form of subsidy granted by the Government to encourageous staking their capital in an unknown venture. An entrepreneur engaging in a new and necessary industry faces uncertainly and assumes a risk bigger than one engaging in a venture already known and developed. Like a settler in an unexplored land who is just blazing a trial in a virgin forest, he needs all the encouragement and assistance from the Government. He needs capital to buy his implements, to pay his laborers and to sustain him and his family. Comparable to the farmers who had just planted the seeds of fruit bearing trees in his orchard, he does not except an immediate return on his investment. Usually loss is incurred rather than profit made. It is for these reasons that the law grants him tax exemptionto lighten onerous financial burdens and reduce losses. However these may be, Republic Act No. 35 has confined the privilege of tax exemption only to new and necessary industries. It did not intend to grant the tax exemption benefit to an entrepreneur engaged at the same time in a taxable or nonpayment industry and a new and necessary industry, by allowing him to deduct his gains or profits derived from the operation of the first from the losses incurred in the operation of the second. Unlike a new and necessary industry, a taxable or non-exempt industry is already a going concern, deriving profits from its operation, and deserving no subsidy from the Government. It is but fair that it be required to give to the Government a share in its profits in the form of taxes. The fact that the petitioner is a corporate organized with a single capital that answer for all its financial obligations including those incurred in the tax exempt industries is of no moment. The intent of the law is to treat taxable or non-exempt industries as separate and distinct from new and necessary industries which are taxexempt for purposes of taxation. Section 7, Executive Order No. 341, series of 1950, issued by the President of the Philippines pursuant to section 2, Republic Act No. 35, provides:
Any industry granted tax exemption under the provisions of Republic Act No. 35 shall report to the Secretary of Finance at the end of every fiscal rear a complete list and a correct valuation of all real and personal property of its industrial

plant of factory: shall file a separate income tax return; shall keep separetely the accounting records relative to the industry declared exempt; shall keep such records and submit such sworn statements as may be prescribed from time to time by the Secretary of Finance;1(Emphasis supplied.)

And when Congress revised the provision of Republic Act No. 35 by enacting onto law Republic Act No. 901 it incorporate similar provisions and provided that "Any industry granted tax exemption under of Republic Act No. 35" shall "file a separate income tax return."2 The petitioner states that it is not liable to pay income tax on its industries of manufacturing nails and steel bars, ros and other allied steel product for the reason that it had incurred loss in their operation and not because it is exempt under the provision of Republic Act No. 35. It argues that by being allowed to deduct its gains derived from the operation of its taxable or non-exempt industry of manufacturing wire fence, from the losses incurred in the operation of its tax-exempt industries of manufacturing nails and steels bars, rod and other allied steel products, it would not receive the benefit of double exemption under Republic Act No. 35 is to lighten the onerous financial burden and reduce the losses of the entrepeneur, yet it is not designed to assure him of a return on his capital invested. As already stated, the law intended to treat to treat taxable or non-excempt industry as separate and distinct from new and necessary industry, which is tax exempt, and did not mean to grant an entrepreneur, engaged at the same time in a taxable or non-exempt industry and a new and necessary industry, the benefit or privilege of deducting his gains or profit derived from the operation of the first from the losses incurred in the operation of the second. Moreover, aside from its exemption from the payment of income tax on its profits derived from the operation of new and necessary industries, the petitioner is exempt from the payment of other internal revenue taxes directly payable by it, such as the fixed and privilege tax on business, the percentage tax on the fixed and privilege tax on business, the percentage tax on the sales of manufactured products, in respect to which exemption is granted, the compensating tax on the articles, goods or material exclusively used in the new and necessary industry, and the documentary stamp tax (Exhibits 6

and 7). These exemption alone are enough to lighten its onerous financial burden and reduce losses. The petitioner claims that unlike the United States Internal Revenue Code which expressly forbids the deduction of
Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not only any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this chapter [(Section 24 (a) (5)].

our National Internal Revenue Code does not contain a similar prohibition. When in 1939 Commonwealth Act No. 466, the National Internal Revenue Code, was enacted into law, the idea of granting tax exemption to new and necessary industries in the Philippines had not yet been thought of because there were no new and necessary industries being established or exploited. It was only in 1946, after the last World War, and after the Philippines became sovereign nation, that the establishment or exploitation of new and necessary industries was stimulated. Hence the absence of a similar provision in out National Internal Revenue Code. This absence, however, cannot be capitalized upon by the petitioner in support of its theory. For, as already stated, when Congress enacted Republic Act No. 35 into law, it intended to segregate income derived from the operation of new and necessary industries from that derived from the operation of taxable or non-exempt industries. For the foregoing reasons, the judgement under review is affirmed, with costs against the petitioner. Paras, C.J., Bengzon, Bautista Angelo, Labrador, Reyes, J.B.L., Barrera, Gutierrez David, Paredes, and Dizon, JJ., concur

Republic of the Philippines SUPREME COURT Manila EN BANC


G.R. No. L-21520 December 11, 1967

PLARIDEL SURETY and INSURANCE COMPANY, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent. Gil R. Carlos and Associates for petitioner. Office of the Solicitor General for respondent. BENGZON, J.P., J.: Petitioner Plaridel Surety & Insurance Co., is a domestic corporation engaged in the bonding business. On November 9, 1950, petitioner, as surety, and Constancio San Jose, as principal, solidarily executed a performance bond in the penal sum of P30,600.00 in favor of the P. L. Galang Machinery Co., Inc., to secure the performance of San Jose's contractual obligation to produce and supply logs to the latter. To afford itself adequate protection against loss or damage on the performance bond, petitioner required San Jose and one Ramon Cuervo to execute an indemnity agreement obligating themselves, solidarily, to indemnify petitioner for whatever liability it may incur by reason of said performance bond. Accordingly, San Jose constituted a chattel mortgage on logging machineries and other movables in petitioner's favor1 while Ramon Cuervo executed a real estate mortgage.2 San Jose later failed to deliver the logs to Galang Machinery3 and the latter sued on the performance bond. On October 1, 1952, the Court of First Instance adjudged San Jose and petitioner liable; it also directed San Jose and Cuervo to reimburse petitioner for whatever amount it would pay Galang Machinery. The Court of Appeals, on June 17, 1955, affirmed the judgment of the lower court. The same judgment was likewise affirmed by this Court4 on

January 11, 1957 except for a slight modification apropos the award of attorney's fees. On February 19 and March 20, 1957, petitioner effected payment in favor of Galang Machinery in the total sum of P44,490.00 pursuant to the final decision. In its income tax return for the year 1957, petitioner claimed the said amount of P44,490.00 as deductible loss from its gross income and, accordingly, paid the amount of P136.00 as its income tax for 1957. The Commissioner of Internal Revenue disallowed the claimed deduction of P44,490.00 and assessed against petitioner the sum of P8,898.00, plus interest, as deficiency income tax for the year 1957. Petitioner filed its protest which was denied. Whereupon, appeal was taken to the Tax Court, petitioner insisting that the P44,490.00 which it paid to Galang Machinery was a deductible loss. The Tax Court dismissed the appeal, ruling that petitioner was duly compensated for otherwise than by insurance thru the mortgages in its favor executed by San Jose and Cuervo and it had not yet exhausted all its available remedies, especially as against Cuervo, to minimize its loss. When its motion to reconsider was denied, petitioner elevated the present appeal. Of the sum of P44,490.00, the amount of P30,600.00 which is the principal sum stipulated in the performance bond is being claimed as loss deduction under Sec. 30 (d) (2) of the Tax Code and P10,000.00 which is the interest that had accrued on the principal sum is now being claimed as interest deduction under Sec. 30 (b) (1). Loss is deductible only in the taxable year it actually happens or is sustained. However, if it is compensable by insurance or otherwise, deduction for the loss suffered is postponed to a subsequent year, which, to be precise, is that year in which it appears that no compensation at all can be had, or that there is a remaining or net loss, i.e., no full compensation.5

There is no question that the year in which the petitioner Insurance Co. effected payment to Galang Machinery pursuant to a final decision occurred in 1957. However, under the same court decision, San Jose and Cuervo were obligated to reimburse petitioner for whatever payments it would make to Galang Machinery. Clearly, petitioner's loss is compensable otherwise (than by insurance). It should follow, then, that the loss deduction can not be claimed in 1957.
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Now, petitioner's submission is that its case is an exception. Citing Cu Unjieng Sons, Inc. v. Board of Tax Appeals,6 and American cases also, petitioner argues that even if there is a right to compensation by insurance or otherwise, the deduction can be taken in the year of actual loss where the possibility of recovery is remote. The pronouncement, however to this effect in the Cu Unjieng case is not as authoritative as petitioner would have it since it was there found that the taxpayer had no legal right to compensation either by insurance or otherwise.7 And the American cases cited8 are not in point. None of them involved a taxpayer who had, as in the present case, obtained a final judgment against third persons for reimbursement of payments made. In those cases, there was either no legally enforceable right at all or such claimed right was still to be, or being, litigated. On the other hand, the rule is that loss deduction will be denied if there is a measurable right to compensation for the loss, with ultimate collection reasonably clear. So where there is reasonable ground for reimbursement, the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had.9 In other words, as the Tax Court put it, the taxpayer (petitioner) must exhaust his remedies first to recover or reduce his loss. It is on record that petitioner had not exhausted its remedies, especially against Ramon Cuervo who was solidarily liable with San Jose for reimbursement to it. Upon being prodded by the Tax Court to go after Cuervo, Hermogenes Dimaguiba, president of petitioner corporation, said that they would10 but no evidence was submitted that anything was really done on the matter. Moreover, petitioner's evidence on remote possibility of recovery is fatally wanting. Its right to reimbursement is not only secured by the mortgages executed by San Jose and Cuervo but also by a final

and executory judgment in the civil case itself. Thus, other properties of San Jose and Cuervo were subject to levy and execution. But no writ of execution, satisfied or unsatisfied, was ever submitted. Neither has it been established that Cuervo was insolvent. The only evidence on record on the point is Dimaguiba's testimony that he does not really know if Cuervo has other properties.11 This is not substantial proof of insolvency. Thus, it was too premature for petitioner to claim a loss deduction.
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But assuming that there was no reasonable expectation of recovery, still no loss deduction can be had. Sec. 30 (d) (2) of the Tax Code requires a charge-off as one of the conditions for loss deduction:
In the case of a corporation, all losses actually sustained and charged-off within the taxable year and not compensated for by insurance or otherwise. (Emphasis supplied)

Mertens12 states only four (4) requisites because the United States Internal Revenue Code of 193913 has no charge-off requirement. Sec. 23(f) thereof provides merely:
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In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.

Petitioner, who had the burden of proof14 failed to adduce evidence that there was a charge-off in connection with the P44,490.00or P30,600.00 which it paid to Galang Machinery. In connection with the claimed interest deduction of P10,000.00, the Solicitor General correctly points out that this question was never raised before the Tax Court. Petitioner, thru counsel, had admitted before said court15 and in the memorandum it filed16 that the only issue in the case was whether the entire P44,490.00 paid by it was or was not a deductible loss under Sec. 30 (d) (2) of the Tax Code. Even in petitioner's return, the P44,490.00 was claimed wholly as losses on its bond.17 The alleged interest deduction not having been properly litigated as an issue before the Tax Court, it is now too late to raise and assert it before this Court.

WHEREFORE, the appealed decision is, as it is hereby, affirmed. Costs against petitioner Plaridel Surety & Insurance Co. So ordered. Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Angeles and Fernando, JJ.,concur. Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-18611 January 30, 1964

THE CITY LUMBER, INC., petitioner, vs. THE HON. MELENCIO R. DOMINGO, Commissioner of Internal Revenue and THE HON. COURT OF TAX APPEALS, respondents. Medina and Medina for petitioner. Office of the Solicitor General for respondents. LABRADOR, J.: Petitioner seeks the review of a decision of the Court Tax Appeals, upholding an assessment by respondent on an additional income of P16,678.63 representing minor deductions from the alleged expenses, on undisclosed sales of plywood, nails and GI sheets amounting to P7,902.07, and on a cash credit balance of P7,896.80. Petitioner claims that the respondent court erred in not holding that plywood and GI sheets were actually lost in a fire occuring in the city and in not considering the credit cash balance as a loan secured by petitioner. On the first issue petitioner introduced as a witnesses in his favor the Chief of Police of the City of Dumaguete to testify on the existence of a fire in the city by reason of which the store of petitioner was looted of plywood and kegs of nails. But said witness declared that they recovery only 100 pieces of plywood

and 5 kegs of nails, but these were returned to petitioner. The Court below, however, rejected the alleged loss of plywood because said loss was never reported in the books of petitioner; and neither was such loss reported in the income tax return of petitioner for the year, submitted some months after the alleged loss. We hold that the conduct of petitioner in not reporting said loss in his book of account or in his income tax turn proves that the alleged loss had not been suffered. On the alleged loan of the sum of around P8,000.00 which petitioner claims to be the cash credit balance appearing petitioner claims to be his book of account, petitioner's book of account failed to show such a loan also. Neither were any receipts or other evidence produced to show that said amount was a loan secured by petitioner, or that a loan was ever secured. In view of these We find that the respondent court did commit the error charged. The third error is the alleged violation of an order of Commissioner granting Regional Directors authority close tax cases involving deficiency assessments not exceeding P10,000.00 in taxes and penalties for it appears that after a re-investigation of the tax liability of petitioner by the corresponding regional director the latter reviewed the case and reduced the assessment from P5,028.00 to P176.00. The order in question (Memorandum Order No. V-634 dated July 3, 1956) was applicable only to subordinate officers of the Bureau of Internal Revenue and could not bind the Commissioner himself, who has been entrusted by law to make final assessments. The Commissioner cannot delegate this power to make a final assessment to his subordinate. Delegatus non potest delegare; the person to whom an office or duty is delegated cannot lawfully devolve the duty on another. The existence of the alleged error is, therefore, denied.
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WHEREFORE, the decision is hereby affirmed, with costs. So ordered. Padilla, Bautista Angelo, Concepcion, Barrera, Paredes, Dizon, Regala and Makalintal, JJ., concur. Bengzon, C.J., and Reyes, J.B.L., J., took no part.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-18282 May 29, 1964

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. PRISCILA ESTATE, INC., and THE COURT OF APPEALS, respondents. Office of the Solicitor General for petitioner. Sison, Dominguez and Mijares for respondents. REYES, J.B.L., J.: Review of the decision of the Court of Tax Appeals in its case No. 334 ordering the petitioner, Commissioner of Internal Revenue to refund to the respondent, Priscila Estate, Inc., a domestic corporation engaged in the business of leasing real estate, the sum of P3,045.19, as overpaid income tax for 1950. The corporation duly filed its income tax returns for the years 1949, 1950 and 1951. On 13 June 1952, however, it amended its income tax returns for 1951 and paid the tax corresponding to the assessment made by the petitioner on the basis of the returns, as amended; and on 13 September 1952, the company claimed a refund of P4,941.00 as overpaid income tax for the year 1950 for having deducted from gross income only the sum of P6,013.85 instead of P39,673.25 as its loss in the sale of a lot and building. Thereupon, the Commissioner of Internal Revenue conducted an investigation of the company's income tax returns for 1949 through 1951 and, thereafter, granted a tax credit of P1,443.00 for 1950 but assessed on 3 November 1953 deficiency income taxes of P3,575.49 for 1949 and P22,166.10 for 1951. The Priscila Estate, Inc., contested the deficiency assessments and when the Commissioner of Internal Revenue refused to reconsider them, the former brought suit to the tax court which

after trial, rendered the decision that, in 1961, the Commissioner elevated to this Supreme Court for review. The first assignment of error refers to the allowance of a deduction in the 1949 income tax returns of the respondent corporation the amount of P11,237.35 representing the cost of a "barong-barong" (a make-shift building), situated at the corner of Azcarraga Street and Rizal Avenue, Manila, which was demolished on 31 December 1949 and a new one built in its place. The petitioner claims that the value of the demolished building should not be deducted from gross income but added to the cost of the building replacing it because its demolition or removal was to make way for the erection of another in its place.
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The foregoing argument is erroneous inasmuch as the tax court found that the removal of the "barong-barong", instead of being voluntary, was forced upon the corporation by the city engineer because the structure was a fire hazard; that the rental income of the old building was about P3,730.00 per month, and that the corporation had no funds but had to borrow, in order to construct a new building. All these facts, taken together, belie any intention on the part of the corporation to demolish the old building merely for the purpose of erecting another in its place. Since the demolished building was not compensated for by insurance or otherwise, its loss should be charged off as deduction from gross income. (Sec. 30[2], Internal Revenue Code.) The second to the fifth assignments of error pertain to depreciation. Particularly contested by the petitioner is the basis for depreciation of Building Priscila No. 3. This building, with an assessed value of P70,343.00 but with a construction cost of P110,600.00, was acquired by the respondent corporation from the spouses, Carlos Moran Sison and Priscila F. Sison, in exchange for shares of stock. According to the petitioner, the basis for commuting the depreciation of this building should be limited to the capital invested, which is the assessed value. On the other hand, the respondent based its computation on its construction cost, revaluing the property on this basis by a board resolution in order to "give justice to the Sison spouse Since this revaluation would import an obligation of the corporation to pay the Sison spouses,

as vendors, the difference between the assessed value and the revalued construction cost, as provided in resolution Exhibit F-1 (otherwise the revaluation would make no sense), the corporate investment would ultimately be the construction cost which is undisputed), and depreciation logically had to be on that basis. That the revaluation may import additional profit to the vendor spouses is a matter related to their own income tax, and not to that of respondent corporation. The Collector also questions the rates of depreciation which the tax court applied to the other properties, consisting of store and office building, houses, a garage, library books, furniture and fixtures and transportation equipment. Depreciation is a question of fact,1 and is "not measured by a theoretical yardstick, but should be determined by a consideration of the actual facts ... ." (Landon vs. CIR of State of Kansas, 260 Fed. 433 [1920]], quoted in Sec. 23.32, Mertens, Federal Income Taxation). The petitioner himself on page 26 of his appeal brief, asserts that "what consist of the depreciable amount (sic) is elusive and is a question of fact." Since the petitioner does not claim that the tax court, in applying certain rates and basis to arrive at the allowed amounts of depreciation of the various properties, was, arbitrary or had abused its discretion, and since the Supreme Court, before the Revised Rules, limited its review of decisions of the Court of Tax Appeals to questions of law only (Sanchez v. Commissioner of Customs, L-8556, 30 Sept. 1957; Gutierrez v. Court of Tax Appeals, L-9738 & L-9771, 31 May 1957), the findings of the tax court on the depreciation of the several assets should not be disturbed. In the sixth and last assignment of error, the petitioner argues that the refund to the respondent is barred by the two-year prescriptive period under Section 306 of the Internal Revenue Code because the action for refund was filed on 5 December 1956 while the respondent's 1950 income tax was paid on 15 August 1951. The petitioner's argument would have been tenable but for his failure to plead prescription in a motion to dismiss or as a defense in his answer, said failure is deemed a waiver of the defense of prescription (Sec. 10, Rule 9, Rules of Court).

Finding no reversible error in the decision under review, the same is hereby affirmed. No costs. Bengzon, C.J., Bautista Angelo, Concepcion, Barrera, Paredes, Regala and Makalintal, JJ., concur. Padilla, Labrador and Dizon, JJ., took no part.

Republic of the Philippines SUPREME COURT Manila EN BANC


G.R. No. L-22265 December 22, 1967

COLLECTOR OF INTERNAL REVENUE, petitioner, vs. GOODRICH INTERNATIONAL RUBBER CO., respondent. Manuel O. Chan for respondent. Manuel O. Chan for respondent. CONCEPCION, C.J.: Appeal by the Government from a decision of the Court of Tax Appeals, setting aside the assessments made by the Commissioner of Internal Revenue, in the sums of P14,128.00 and P8,439.00, as deficiency income taxes allegedly due from respondent Goodrich International Rubber Company hereinafter referred to as Goodrich for the years 1951 and 1952, respectively. These assessments were based on disallowed deductions, claimed by Goodrich, consisting of several alleged bad debts, in the aggregate sum of P50,455.41, for the year 1951, and the sum of P30,138.88, as representation expenses allegedly incurred in the year 1952. Goodrich had appealed from said assessments to the Court of Tax Appeals, which, after appropriate proceedings, rendered, on June 8, 1963, a decision allowing the deduction for bad debts, but disallowing the alleged representation expenses. On motion for reconsideration and new trial, filed by Goodrich, on November 19, 1963, the Court of Tax Appeals amended its aforementioned decision and allowed said deductions for representation expenses. Hence, this appeal by the Government. The alleged representation expenses are:

1. Expenses at Elks Club 2. Manila Polo Club 3. Army and Navy Club 4. Manila Golf Club 5. Wack Wack Golf Club, Casino Espaol, etc. TOTAL

P10,959.21 4,947.35 2,812.95 4,478.45 6,940.92 P30,138.88

The claim for deduction thereof is based upon receipts issued, not by the entities in which the alleged expenses had been incurred, but by the officers of Goodrich who allegedly paid them. The claim must be rejected. If the expenses had really been incurred, receipts or chits would have been issued by the entities to which the payments had been made, and it would have been easy for Goodrich or its officers to produce such receipts. These issued by said officers merely attest to their claim that they had incurred and paid said expenses. They do not establish payment of said alleged expenses to the entities in which the same are said to have been incurred. The Court of Tax Appeals erred, therefore, in allowing the deduction thereof.
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The alleged bad debts are:


1. Portillo's Auto Seat Cover 2. Visayan Rapid Transit 3. Bataan Auto Seat Cover 4. Tres Amigos Auto Supply 5. P. C. Teodoro
l aw phil

P630.31 17,810.26 373.13 1,370.31 650.00 386.42 796.26

6. Ordnance Service, P.A. 7. Ordnance Service, P.C.

8. National land Settlement Administration 9. National Coconut Corporation 10. Interior Caltex Service Station 11. San Juan Auto Supply 12. P A C S A 13. Philippine Naval Patrol 14. Surplus Property Commission 15. Alverez Auto Supply 16. Lion Shoe Store 17. Ruiz Highway Transit 18. Esquire Auto Seat Cover TOTAL

3,020.76 644.74 1,505.87 4,530.64 45.36 14.18 277.68 285.62 1,686.93 2,350.00 3,536.94 P50,455.41*

The issue, in connection with these debts is whether or not the same had been properly deducted as bad debts for the year 1951. In this connection, we find: Portillo's Auto Seat Cover (P730.00): This debt was incurred in 1950. In 1951, the debtor paid P70.00, leaving a balance of P630.31. That same year, the account was written off as bad debt (Exhibit 3-C-4). Counsel for Goodrich had merely sent two (2) letters of demand in 1951 (Exh. B-14). In 1952, the debtor paid the full balance (Exhibit A). Visayan Rapid Transit (P17,810.26): This debt was, also, incurred in 1950. In 1951, it was charged off as bad debt, after the debtor had paid P275.21. No other payment had been made. Taxpayer's Accountant testified that, according to its branch manager in Cebu, he had been unable to collect the balance. The debtor had merely promised and kept on promising
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to pay. Taxpayer's counsel stated that the debtor had gone out of business and became insolvent, but no proof to this effect. was introduced. Bataan Auto Seat Cover (P373.13): This is the balance of a debt of P474.13 contracted in 1949. In 1951, the debtor paid P100.00. That same year, the balance of P373.13 was charged off as bad debt. The next year, the debtor paid the additional sum of P50.00. Tres Amigos Auto Supply (P1,370.31): This account had been outstanding since 1949. Counsel for the taxpayer had merely sent demand letters (Exh. B-13) without success. P. C. Teodoro (P650.00): In 1949, the account was P751.91. In 1951, the debtor paid P101.91, thus leaving a balance of P650.00, which the taxpayer charged off as bad debt in the same year. In 1952, the debtor made another payment of P150.00. Ordinance Service, P.A. (P386.42): In 1949, the outstanding account of this government agency was P817.55. Goodrich's counsel sent demand letters (Exh. B-8). In 1951, it paid Goodrich P431.13. The balance of P386.42 was written off as bad debt that same year. Ordinance Service, P.C. (P796.26): In 1950, the account was P796.26. It was referred to counsel for collection. In 1951, the account was written off as a debt. In 1952, the debtor paid it in full.
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National Land Settlement Administration (P3,020.76): The outstanding account in 1949 was P7,041.51. Collection letters were sent (Exh. B-7). In 1951, the debtor paid P4,020.75, leaving

a balance of P3,020.76, which was written off, that same year, as a bad debt. This office was under liquidation, and its Board of Liquidators promised to pay when funds shall become available. National Coconut Corporation (P644.74): This account had been outstanding since 1949. Collection letters were sent (Exh. B-12) without success. It was written off as bad debt in 1951, while the corporation was under a Board of Liquidators, which promised to pay upon availability of funds. In 1961, the debt was fully paid. Interior Caltex Service Station (P1,505.87): The original account was P2,705.87, when, in 1950, it was turned over for collection to counsel for Goodrich (p. 156, CTA Records). Counsel began sending letters of collection in April 1950. Interior Caltex made partial payments, so that as of December, 1951, the balance outstanding was P1,505.87. The debtor paid P200, in 1952; P113.20, in 1954; P750.00, in 1961; and P300.00.00 in 1962. The account had been written off as bad debt in 1951.
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The claim for deduction of these ten (10) debts should be rejected. Goodrich has not established either that the debts are actually worthless or that it had reasonable grounds to believe them to be so in 1951. Our statute permits the deduction of debts "actually ascertained to be worthless within the taxable year," obviously to prevent arbitrary action by the taxpayer, to unduly avoid tax liability. The requirement of ascertainment of worthlessness requires proof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthlessness, in the year for which the deduction is sought; and (2) that, in so doing, he acted in good faith.1 Good faith on the part of the taxpayer is not enough. He must show, also, that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him.2 Respondent herein has not adequately made such showing.

The payments made, some in full, after some of the foregoing accounts had been characterized as bad debts, merely stresses the undue haste with which the same had been written off. At any rate, respondent has not proven that said debts were worthless. There is no evidence that the debtors can not pay them. It should be noted also that, in violation of Revenue Regulations No. 2, Section 102, respondent had not attached to its income tax returns a statement showing the propriety of the deductions therein made for alleged bad debts.
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Upon the other hand, we find that the following accounts were properly written off: San Juan Auto Supply (P4,530.64): This account was contracted in 1950. Referred, for collection, to respondent's counsel, the latter secured no payment. In November, 1950, the corresponding suit for collection was filed (Exh. C). The debtor's counsel was allowed to withdraw, as such, the debtor having failed to meet him. In fact, the debtor did not appear at the hearing of the case. Judgment was rendered in 1951 for the creditor (Exh. C-2). The corresponding writ of execution (Exh. C-3) was returned unsatisfied, for no properties could be attached or levied upon.
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PACSA Philippine Naval Patrol Surplus Property Commission Alvarez Auto Supply

(P45.36), (P14.18), (P277.68), (P285.62):

These four (4) accounts were 2 or 3 years old in 1951. After the collectors of the creditor had failed to collect the same, its counsel wrote letters of demand (Exhs. B-10, B-11, B-6 and B-2) to no avail. Considering the small amounts involved in these accounts, the taxpayer was justified in feeling that the unsuccessful efforts therefore exerted to collect the same sufficed to warrant their being written off.3

Lion Shoe Store Ruiz Highway Transit Esquire Auto Seat Cover

(P11,686.93), (P2,350.00), and (P3,536.94):

These three (3) accounts were among those referred to counsel for Goodrich for collection. Up to 1951, when they were written off, counsel had sent 17 Letters of demand to Lion Shoe Store (Exh. B); 16 demand letters to Ruiz Highway Transit (Exh. B-1); and 6 letters of demand to Esquire Auto Seat Cover (Exit. B-5) In 1951, Lion Shoe Store, Ruiz Highway Transit, and Esquire Auto Seat Cover had made partial payments in the sums of P1,050.00, P400.00, and P300.00 respectively. Subsequent to the write-off, additional small payments were made and accounted for as income of Goodrich. Counsel interviewed the debtors, investigated their ability to pay and threatened law suits. He found that the debtors were in strained financial condition and had no attachable or leviable property. Moreover, Lion Shoe Store was burned twice, in 1948 and 1949. Thereafter, it continued to do business on limited scale. Later; it went out of business. Ruiz Highway Transit, had more debts than assets. Counsel, therefore, advised respondent to write off these accounts as bad debts without going to court, for it would be "foolish to spend good money after bad." The deduction of these eight (8) accounts, aggregating P22,627.35, as bad debts should be allowed. WHEREFORE, the decision appealed from should be, as it is hereby, modified, in the sense that respondent's alleged representation expenses are totally disallowed, and its claim for bad debts allowed up to the sum of P22,627.35 only. Without special pronouncement as to costs. It is so ordered. Reyes, J.B.L., Dizon, Makalintal, Bengzon, JJ., Zaldivar, Sanchez, Castro, Angeles and Fernando, JJ., concur

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-21551 September 30, 1969

FERNANDEZ HERMANOS, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. ----------------------------G.R. No. L-21557 September 30, 1969

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. FERNANDEZ HERMANOS, INC., and COURT OF TAX APPEALS, respondents. ----------------------------G.R. No. L-24972 September 30, 1969

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. FERNANDEZ HERMANOS INC., and the COURT OF TAX APPEALS, respondents. ----------------------------G.R. No. L-24978 September 30, 1969

FERNANDEZ HERMANOS, INC., petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE, and HON. ROMAN A. UMALI, COURT OF TAX APPEALS,respondents. L-21551:

Rafael Dinglasan for petitioner. Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong and Special Attorney Virgilio G. Saldajeno for respondent. L-21557: Office of the Solicitor General for petitioner. Rafael Dinglasan for respondent Fernandez Hermanos, Inc. L-24972: Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney Virgilio G. Saldajeno for petitioner. Rafael Dinglasan for respondent Fernandez Hermanos, Inc. L-24978: Rafael Dinglasan for petitioner. Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Antonio G. Ibarra and Special Attorney Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.: These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax liability for the years 1950 to 1954 and for the year 1957. Both the taxpayer and the Commissioner of Internal Revenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax Court's decisions, insofar as their respective contentions on particular tax items were therein resolved against them. Since the issues raised are interrelated, the Court resolves the four appeals in this joint decision. Cases L-21551 and L-21557

The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of engaging in business as an "investment company" with main office at Manila. Upon verification of the taxpayer's income tax returns for the period in question, the Commissioner of Internal Revenue assessed against the taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and P14,451.00 as alleged deficiency income taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said assessments were the result of alleged discrepancies found upon the examination and verification of the taxpayer's income tax returns for the said years, summarized by the Tax Court in its decision of June 10, 1963 in CTA Case No. 787, as follows:
1. Losses a. Losses in Mati Lumber Co. (1950) P 8,050.00

b. Losses in or bad debts of Palawan Manganese Mines, Inc. (1951) 353,134.25 c. Losses in Balamban Coal Mines 1950 1951 8,989.76 27,732.66

d. Losses in Hacienda Dalupiri 1950 1951 1952 1953 1954 17,418.95 29,125.82 26,744.81 21,932.62 42,938.56

e. Losses in Hacienda Samal 1951 1952 8,380.25 7,621.73

2. Excessive depreciation of Houses 1950 1951 1952 1953 1954 P 8,180.40 8,768.11 18,002.16 13,655.25 29,314.98

3. Taxable increase in net worth 1950 1951 P 30,050.00 1,382.85

4. Gain realized from sale of real property in 1950 P 11,147.2611 The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2 of the above summary, but overruled the Commissioner's disallowances of all the remaining items. It therefore modified the deficiency assessments accordingly, found the total deficiency income taxes due from the taxpayer for the years under review to amount to P123,436.00 instead of P166,063.00 as originally assessed by the Commissioner, and rendered the following judgment: RESUME 1950 1951 1952 1953 1954 Total P2,748.00 108,724.00 3,600.00 2,501.00 5,863.00 P123,436.00

WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the sum of P123,436.00 within 30 days from the date this decision

becomes final. If the said amount, or any part thereof, is not paid within said period, there shall be added to the unpaid amount as surcharge of 5%, plus interest as provided in Section 51 of the National Internal Revenue Code, as amended. With costs against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)

Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to the disputed items of disallowances enumerated in the Tax Court's summary reproduced above, and second, whether or not the government's right to collect the deficiency income taxes in question has already prescribed. On the first issue, we will discuss the disputed items of disallowances seriatim. 1. Re allowances/disallowances of losses. (a) Allowance of losses in Mati Lumber Co. (1950). The Commissioner of Internal Revenue questions the Tax Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of P8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1, 1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly established. The Commissioner contends that although the said Company was no longer in operation in 1950, it still had its sawmill and equipment which must be of considerable value. The Court, however, found that "the company ceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where he subsequently died. When the company eased to operate, it had no assets, in other words, completely insolvent. This information as to the insolvency of the Company reached (the taxpayer) in 1950," when it properly claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of the National Internal Revenue Code. 2 We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the stock as worthless securities. Assuming that the Company would later

somehow realize some proceeds from its sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds would later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer would then properly be reportable as income of the taxpayer in the year it is received. (b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). The taxpayer appeals from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which it had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings on this item follow:
Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the controlling stockholders of petitioner corporation, requested financial help from petitioner to enable it to resume it mining operations in Coron, Palawan. The request for financial assistance was readily and unanimously approved by the Board of Directors of petitioner, and thereafter a memorandum agreement was executed on August 12, 1945, embodying the terms and conditions under which the financial assistance was to be extended, the pertinent provisions of which are as follows: "WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has agreed to extend to the SECOND PARTY the requested financial help by way of accommodation advances and for this purpose has authorized its President, Mr. Ramon J. Fernandez to cause the release of funds to the SECOND PARTY. "WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to extend to the SECOND PARTY, the latter has agreed to pay to the former fifteen per centum (15%) of its net profits. "NOW THEREFORE, for and in consideration of the above premises, the parties hereto have agreed and covenanted that in consideration of the financial help to be extended by the FIRST PARTY to the SECOND PARTY to enable the latter to resume

its mining operations in Coron, Palawan, the SECOND PARTY has agreed and undertaken as it hereby agrees and undertakes to pay to the FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)

Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly advances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these advances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By 1951, petitioner became convinced that those advances could no longer be recovered. While it continued to give advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the basis of the total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum of P85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136139, Id)." (Page 4, Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950 and 1951 in the hope that it might be able to recover the same, as in fact it continued to give advances up to 1952. From these facts, and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advances corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, was the sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as losses or bad debts? It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid. It is true that some testimonial evidence was presented to show that there was some agreement that the advances would be repaid, but no documentary evidence was presented to this effect. The memorandum agreement signed by the parties appears to be very clear that the consideration for the advances made by petitioner was 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits, there was no obligation to repay those advances. It has been held that the voluntary advances made without expectation of repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329,

citing W. F. Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC. 1593. Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan Manganese Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under the memorandum agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner 15% of its net profits, not the advances. No bad debt could arise where there is no valid and subsisting debt. Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said year, yet the debt is not deductible in 1951 as a worthless debt. It appears that the debtor was still in operation in 1951 and 1952, as petitioner continued to give advances in those years. It has been held that if the debtor corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is not considered worthless and therefore not deductible. 3 The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt." 4 We sustain the government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record shows that the board of directors of the two companies since August, 1945, were identical and that the only capital of Palawan Manganese Mines, Inc. is the amount of P100,000.00 entered in the taxpayer's balance sheet as its investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer made such large advances to the subsidiary, despite the latter's admittedly poor financial condition. The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that under their memorandum agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no earnings, there was no

obligation to repay those advances, becomes immaterial, in the light of our resolution of the question. The Tax Court correctly held that the subsidiary company was still in operation in 1951 and 1952 and the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or investment could not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. Furthermore, neither under Section 30 (d) (2) of our Tax Code providing for deduction by corporations of losses actually sustained and charged off during the taxable year nor under Section 30 (e) (1) thereof providing for deduction of bad debts actually ascertained to be worthless and charged off within the taxable year, can there be a partial writing off of a loss or bad debt, as was sought to be done here by the taxpayer. For such losses or bad debts must be ascertained to be so and written off during the taxable year, are therefore deductible in full or not at all, in the absence of any express provision in the Tax Code authorizing partial deductions. The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the year 1951, as the subsidiary was still in operation in 1951 and 1952. The taxpayer, on the other hand, claims that its advances were irretrievably lost because of the staggering losses suffered by its subsidiary in 1951 and that its advances after 1949 were "only limited to the purpose of salvaging whatever ore was already available, and for the purpose of paying the wages of the laborers who needed help." 7 The correctness of the Tax Court's ruling in sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent events shown in Cases L24972 and L-24978 involving the taxpayer's 1957 income tax liability. (Infra, paragraph 6.) It will there be seen that by 1956, the obligation of the taxpayer's subsidiary to it had been reduced from P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January 1, 1956 that the subsidiary decided to cease operations. 8 (c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). The Court sustains the Tax Court's disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns for said years. The Tax Court correctly held that the losses "are

deductible in 1952, when the mines were abandoned, and not in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions should be allowed as losses for the corresponding years that they were incurred, because it made no sales of coal during said years, since the promised road or outlet through which the coal could be transported from the mines to the provincial road was not constructed, cannot be sustained. Some definite event must fix the time when the loss is sustained, and here it was the event of actual abandonment of the mines in 1952. The Tax Court held that the losses, totalling P36,722.42 were properly deductible in 1952, but the appealed judgment does not show that the taxpayer was credited therefor in the determination of its tax liability for said year. This additional deduction of P36,722.42 from the taxpayer's taxable income in 1952 would result in the elimination of the deficiency tax liability for said year in the sum of P3,600.00 as determined by the Tax Court in the appealed judgment. (d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). The Tax Court overruled the Commissioner's disallowance of these items of losses thus:
Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950, P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These deductions were disallowed by respondent on the ground that the farm was operated solely for pleasure or as a hobby and not for profit. This conclusion is based on the fact that the farm was operated continuously at a loss.
1awphl.nt

From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business and not pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not appear that the farm was used by petitioner for entertainment, social activities, or other non-business purposes. Therefore, it is entitled to deduct expenses and losses in connection with the operation of said farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, p.164)

Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes farmers to determine their gross income on the basis of inventories. Said regulations provide: "If gross income is ascertained by inventories, no deduction can be made for livestock or products lost during the year, whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the amount of livestock or products on hand at the close of the year." Evidently, petitioner determined its income or losses in the operation of said farm on the basis of inventories. We quote from the memorandum of counsel for petitioner: "The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive, the corresponding yearly losses sustained in the operation of Hacienda Dalupiri, which losses represent the excess of its yearly expenditures over the receipts; that is, the losses represent the difference between the sales of livestock and the actual cash disbursements or expenses." (Pages 2122, Memorandum for Petitioner.) As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its operation, which losses were determined by means of inventories authorized under Section 100 of Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said losses. The same is true with respect to loss sustained in the operation of the Hacienda Samal for the years 1951 and 1952. 10

The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory method of accounting. He concedes, however, "that the regulations referred to does not specify how the inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the taxpayer ... which merely consisted of an alleged physical count of the number of the livestock in Hacienda Dalupiri for the years involved." 11 The Tax Court was satisfied with the method adopted

by the taxpayer as a farmer breeding livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its findings. 2. Disallowance of excessive depreciation of buildings (1950-1954). During the years 1950 to 1954, the taxpayer claimed a depreciation allowance for its buildings at the annual rate of 10%. The Commissioner claimed that the reasonable depreciation rate is only 3% per annum, and, hence, disallowed as excessive the amount claimed as depreciation allowance in excess of 3% annually. We sustain the Tax Court's finding that the taxpayer did not submit adequate proof of the correctness of the taxpayer's claim that the depreciable assets or buildings in question had a useful life only of 10 years so as to justify its 10% depreciation per annum claim, such finding being supported by the record. The taxpayer's contention that it has many zero or one-peso assets, 12representing very old and fully depreciated assets serves but to support the Commissioner's position that a 10% annual depreciation rate was excessive. 3. Taxable increase in net worth (1950-1951). The Tax Court set aside the Commissioner's treatment as taxable income of certain increases in the taxpayer's net worth. It found that:
For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated by respondent as taxable income of petitioner for said years. It appears that petitioner had an account with the Manila Insurance Company, the records bearing on which were lost. When its records were reconstituted the amount of P349,800.00 was set up as its liability to the Manila Insurance Company. It was discovered later that the correct liability was only 319,750.00, or a difference of P30,050.00, so that the records were adjusted so as to show the correct liability. The correction or adjustment was made in 1950. Respondent contends that the reduction of petitioner's liability to Manila Insurance Company resulted in the increase of petitioner's net worth to the extent of P30,050.00 which is taxable. This is erroneous. The principle underlying the taxability of an increase in the net worth of a taxpayer rests on the theory

that such an increase in net worth, if unreported and not explained by the taxpayer, comes from income derived from a taxable source. (See Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, Nov. 25, 1958.) In this case, the increase in the net worth of petitioner for 1950 to the extent of P30,050.00 was not the result of the receipt by it of taxable income. It was merely the outcome of the correction of an error in the entry in its books relating to its indebtedness to the Manila Insurance Company. The Income Tax Law imposes a tax on income; it does not tax any or every increase in net worth whether or not derived from income. Surely, the said sum of P30,050.00 was not income to petitioner, and it was error for respondent to assess a deficiency income tax on said amount.

The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum of P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in petitioner's books as outstanding liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior years, so that the necessary adjustments were made to correct the errors. If there was an increase in net worth of the petitioner, the increase in net worth was not the result of receipt by petitioner of taxable income." 13 The Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings. Certainly, these increases in the taxpayer's net worth were not taxable increases in net worth, as they were not the result of the receipt by it of unreported or unexplained taxable income, but were shown to be merely the result of the correction of errors in its entries in its books relating to its indebtednesses to certain creditors, which had been erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax Court's action must be affirmed. 4. Gain realized from sale of real property (1950). We likewise sustain as being in accordance with the evidence the Tax Court's reversal of the Commissioner's assessment on all alleged unreported gain in the sum of P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As found by the Tax Court, the evidence shows that this property was acquired in 1926 for P11,852.74, and was sold in 1950 for P60,000.00, apparently, resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a discrepancy of P11,147.26. 15 It

was sufficiently proved from the taxpayer's books that after acquiring the property, the taxpayer had made improvements totalling P11,147.26, 16 accounting for the apparent discrepancy in the reported gain. In other words, this figure added to the original acquisition cost of P11,852.74 results in a total cost of P23,000.00, and the gain derived from the sale of the property for P60,000.00 was correctly reported by the taxpayer at P37,000.00. On the second issue of prescription, the taxpayer's contention that the Commissioner's action to recover its tax liability should be deemed to have prescribed for failure on the part of the Commissioner to file a complaint for collection against it in an appropriate civil action, as contradistinguished from the answer filed by the Commissioner to its petition for review of the questioned assessments in the case a quo has long been rejected by this Court. This Court has consistently held that "a judicial action for the collection of a tax is begun by the filing of a complaint with the proper court of first instance, or where the assessment is appealed to the Court of Tax Appeals, by filing an answer to the taxpayer's petition for review wherein payment of the tax is prayed for."17 This is but logical for where the taxpayer avails of the right to appeal the tax assessment to the Court of Tax Appeals, the said Court is vested with the authority to pronounce judgment as to the taxpayer's liability to the exclusion of any other court. In the present case, regardless of whether the assessments were made on February 24 and 27, 1956, as claimed by the Commissioner, or on December 27, 1955 as claimed by the taxpayer, the government's right to collect the taxes due has clearly not prescribed, as the taxpayer's appeal or petition for review was filed with the Tax Court on May 4, 1960, with the Commissioner filing on May 20, 1960 his Answer with a prayer for payment of the taxes due, long before the expiration of the fiveyear period to effect collection by judicial action counted from the date of assessment. Cases L-24972 and L-24978 These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its corresponding income tax return, the Commissioner assessed it for deficiency income tax in the amount of P38,918.76, computed as follows:

Net income per return Add: Unallowable deductions: (1) Net loss claimed on Ha. Dalupiri (2) Amortization of Contractual right claimed as an expense under Mines Operations Net income per investigation Tax due thereon Less: Amount already assessed Balance Add: 1/2% monthly interest from 6-20-59 to 6-20-62 TOTAL AMOUNT DUE AND COLLECTIBLE

P29,178.70 89,547.33 48,481.62 P167,297.65 38,818.00 5,836.00 P32,982.00 5,936.76


1 8 P38,918.76

The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its Hacienda Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62, which allegedly represented 1/5 of the cost of the "contractual right" over the mines of its subsidiary, Palawan Manganese Mines, Inc. which the taxpayer had acquired. It found the taxpayer liable for deficiency income tax for the year 1957 in the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the following judgment:
WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to pay to respondent the amount of P9,696.00 as deficiency income tax for the year 1957, plus the corresponding interest provided in Section 51 of the Revenue Code. If the deficiency tax is not paid in full within thirty (30) days from the date this decision becomes final and executory, petitioner shall pay a surcharge of five per cent (5%) of the unpaid amount, plus interest at the rate of one per cent (1%) a month, computed from the date this decision becomes final until paid, provided that the maximum amount that may be collected as interest shall not exceed the amount corresponding to a period of three (3) years. Without pronouncement as to costs. 19

Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision. 5. Allowance of losses in Hacienda Dalupiri (1957). The Tax Court cited its previous decision overruling the Commissioner's disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it was convinced that the hacienda was operated for business and not for pleasure. And in this appeal, the Commissioner cites his arguments in his appellant's brief in Case No. L-21557. The Tax Court, in setting aside the Commissioner's principal objections, which were directed to the accounting method used by the taxpayer found that:
It is true that petitioner followed the cash basis method of reporting income and expenses in the operation of the Hacienda Dalupiri and used the accrual method with respect to its mine operations. This method of accounting, otherwise known as the hybrid method, followed by petitioner is not without justification. ... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code provisions permit, however, the use of a hybrid method of accounting, combining a cash and accrual method, under circumstances and requirements to be set out in Regulations to be issued. Also, if a taxpayer is engaged in more than one trade or business he may use a different method of accounting for each trade or business. And a taxpayer may report income from a business on accrual basis and his personal income on the cash basis.' (See Mertens, Law of Federal Income Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p. 26.) 20 The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having failed to show the contrary, we reiterate our ruling [supra, paragraph 1 (d) and (e)] that we find no compelling reason to disturb its findings.

6. Disallowance of amortization of alleged "contractual rights." The reasons for sustaining this disallowance are thus given by the Tax Court:
It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of Directors on January 19, 1956, approved a resolution, the pertinent portions of which read as follows: "RESOLVED, as it is hereby resolved, that the corporation's current assets composed of ores, fuel, and oil, materials and supplies, spare parts and canteen supplies appearing in the inventory and balance sheet of the Corporation as of December 31, 1955, with an aggregate value of P97,636.98, contractual rights for the operation of various mining claims in Palawan with a value of P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a total value of P340,045.02 be, as they are hereby ceded and transferred to Fernandez Hermanos, Inc., as partial settlement of the indebtedness of the corporation to said Fernandez Hermanos Inc. in the amount of P442,895.23." (Exh. E, p. 17, CTA rec.) On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus: "WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has decided to cease operation on January 1, 1956 and in order to satisfy at least a part of its indebtedness to the Corporation, it has proposed to transfer its current assets in the amount of NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100 (P97,636.98) as per its balance sheet as of December 31, 1955, its contractual rights valued at ONE HUNDRED THOUSAND PESOS (P100,000.00) and its title over various mining claims valued at ONE HUNDRED FORTY TWO THOUSAND FOUR HUNDRED EIGHT PESOS & 10/100 (P142,408.10) or a total evaluation of THREE HUNDRED FORTY THOUSAND FORTY FIVE PESOS & 08/100

(P340,045.08) which shall be applied in partial settlement of its obligation to the Corporation in the amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT HUNDRED EIGHTY FIVE PESOS & 23/100 (P442,885.23)," (Exh. E-1, p. 18, CTA rec.) Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual rights (P100,000.00) and the value of its mining claims (P142,408.10). Respondent disallowed the deduction on the following grounds: (1) that the Palawan Manganese Mines, Inc. could not transfer P242,408.10 worth of assets to petitioner because the balance sheet of the said corporation for 1955 shows that it had only current as worth P97,636.96; and (2) that the alleged amortization of "contractual rights" is not allowed by the Revenue Code. The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act No. 2698, which provided in part: "(g) Depletion of oil and gas wells and mines.: "(1) In general. ... (B) in the case of mines, a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof, which has been mined and sold during the year for which the return and computation are made. The allowances shall be made under rules and regulations to be prescribed by the Secretary of Finance: Provided, That when the allowances shall equal the capital invested, ... no further allowance shall be made." Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which it actually transferred to the petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said amount from its gross income for the year 1957 because such deduction in the form of depletion charge was not sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.

xxx

xxx

xxx

The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the memorandum of its mining engineer (Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves of the Busuange Mines (Mines transferred by the Palawan Manganese Mines, Inc. to the petitioner) would be exhausted in five (5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of the alleged cost of the mines corresponding to the year 1957 and every year thereafter for a period of 5 years. The said memorandum merely showed the estimated ore reserves of the mines and it probable selling price. No evidence whatsoever was presented to show the produced mine and for how much they were sold during the year for which the return and computation were made. This is necessary in order to determine the amount of depletion that can be legally deducted from petitioner's gross income. The method employed by petitioner in making an outright deduction of 1/5 of the cost of the mines is not authorized under Section 30(g) (1) (B) of the Revenue Code. Respondent's disallowance of the alleged "contractual rights" amounting to P48,481.62 must therefore be sustained. 21

The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to mining claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of this "capital investment" every year. regardless of whether it had actually mined the product and sold the products. The very authorities cited in its brief give the correct concept of depletion charges that they "allow for the exhaustion of the capital value of the deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross income before the net income can be determined, so the estimated cost of the reserve used up is allowed." 22 The alleged "capital investment" method invoked by the taxpayer is not a method of depletion, but the Tax Code provision, prior to its amendment by Section 1, of Republic Act No. 2698, which took effect on June 18, 1960, expressly provided that "when the allowances shall equal the capital invested ... no further allowances shall be made;" in other words, the "capital investment" was but the limitation of the amount of depletion that

could be claimed. The outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it were a "straight line" rate of depreciation, was correctly held by the Tax Court not to be authorized by the Tax Code. ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551 and L-21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer for the year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The judgment of the Court of Tax Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in toto. No costs. So ordered. Concepcion, C.J., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Fernando, Capistrano and Barredo, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC G.R. No. L-22492 September 5, 1967

BASILAN ESTATES, INC., petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE and THE COURT OF TAX APPEALS, respondents. Felix A. Gulfin and Antonio S. Alano for petitioner. Office of the Solicitor General for respondents.

BENGZON, J.P., J.: A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc., with principal offices in Basilan City, filed on March 24, 1954 its income tax returns for 1953 and paid an income tax of P8,028. On February 26, 1959, the Commissioner of Internal Revenue, per examiners' report of February 19, 1959, assessed Basilan Estates, Inc., a deficiency income tax of P3,912 for 1953 and P86,876.85 as 25% surtax on unreasonably accumulated profits as of 1953 pursuant to Section 25 of the Tax Code. On non-payment of the assessed amount, a warrant of distraint and levy was issued but the same was not executed because Basilan Estates, Inc. succeeded in getting the Deputy Commissioner of Internal Revenue to order the Director of the district in Zamboanga City to hold execution and maintain constructive embargo instead. Because of its refusal to waive the period of prescription, the corporation's request for reinvestigation was not given due course, and on December 2, 1960, notice was served the corporation that the warrant of distraint and levy would be executed. On December 20, 1960, Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for review of the

Commissioner's assessment, alleging prescription of the period for assessment and collection; error in disallowing claimed depreciations, travelling and miscellaneous expenses; and error in finding the existence of unreasonably accumulated profits and the imposition of 25% surtax thereon. On October 31, 1963, the Court of Tax Appeals found that there was no prescription and affirmed the deficiency assessment in toto. On February 21, 1964, the case was appealed to Us by the taxpayer, upon the following issues: 1. Has the Commissioner's right to collect deficiency income tax prescribed? 2. Was the disallowance of items claimed as deductible proper? 3. Have there been unreasonably accumulated profits? If so, should the 25% surtax be imposed on the balance of the entire surplus from 1947-1953, or only for 1953? 4. Is the petitioner exempt from the penalty tax under Republic Act 1823 amending Section 25 of the Tax Code? PRESCRIPTION There is no dispute that the assessment of the deficiency tax was made on February 26, 1959; but the petitioner claims that it never received notice of such assessment or if it did, it received the notice beyond the five-year prescriptive period. To show prescription, the annotation on the notice (Exhibit 10, No. 52, ACR, p. 54-A of the BIR records) "No accompanying letter 11/25/" is advanced as indicative of the fact that receipt of the notice was after March 24, 1959, the last date of the five-year period within which to assess deficiency tax, since the original returns were filed on March 24, 1954. Although the evidence is not clear on this point, We cannot accept this interpretation of the petitioner, considering the presence of circumstances that lead Us to presume regularity in the performance of official functions. The notice of assessment

shows the assessment to have been made on February 26, 1959, well within the five-year period. On the right side of the notice is also stamped "Feb. 26, 1959" denoting the date of release, according to Bureau of Internal Revenue practice. The Commissioner himself in his letter (Exh. H, p. 84 of BIR records) answering petitioner's request to lift, the warrant of distraint and levy, asserts that notice had been sent to petitioner. In the letter of the Regional Director forwarding the case to the Chief of the Investigation Division which the latter received on March 10, 1959 (p. 71 of the BIR records), notice of assessment was said to have been sent to petitioner. Subsequently, the Chief of the Investigation Division indorsed on March 18, 1959 (p. 24 of the BIR records) the case to the Chief of the Law Division. There it was alleged that notice was already sent to petitioner on February 26, 1959. These circumstances pointing to official performance of duty must necessarily prevail over petitioner's contrary interpretation. Besides, even granting that notice had been received by the petitioner late, as alleged, under Section 331 of the Tax Code requiring five years within which to assessdeficiency taxes, the assessment is deemed made when notice to this effect is released, mailed or sent by the Collector to the taxpayer and it is not required that the notice be received by the taxpayer within the aforementioned five-year period.1 ASSESSMENT The questioned assessment is as follows:
Net Income per return Add: Over-claimed depreciation Mis. expenses disallowed Officer's travelling expenses disallowed Net Income per Investigation 20% tax on P59,702.96 Less: Tax already assessed Deficiency income tax Add: Additional tax of 25% on P347,507.01 P40,142.90 P10,500.49 6,759.17 2,300.40 19,560.06 P59,702.96 11,940.00 8,028.00 P3,912.00 86,876.75

Tax Due & Collectible

P90,788.75 =========

The Commissioner disallowed:


Over-claimed depreciation Miscellaneous expenses Officer's travelling expenses P10,500.49 6,759.17 2,300.40

DEDUCTIONS A. Depreciation. Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 on the basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of said assets by increasing it to conform with the increase in cost for their replacement. Accordingly, from 1950 to 1953 it deducted from gross income the value of depreciation computed on the reappraised value. In 1953, the year involved in this case, taxpayer claimed the following depreciation deduction:
Reappraised assets New assets consisting of hospital building and equipment Total depreciation P47,342.53 3,910.45 P51,252.98

Upon investigation and examination of taxpayer's books and papers, the Commissioner of Internal Revenue found that the reappraised assets depreciated in 1953 were the same ones upon which depreciation was claimed in 1952. And for the year 1952, the Commissioner had already determined, with taxpayer's concurrence, the depreciation allowable on said assets to be P36,842.04, computed on their acquisition cost at rates fixed by the taxpayer. Hence, the Commissioner pegged the deductible depreciation for 1953 on the same old assets at P36,842.04 and disallowed the excess thereof in the amount of P10,500.49.

The question for resolution therefore is whether depreciation shall be determined on the acquisition cost or on the reappraised value of the assets. Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal obsolescense. The term is also applied to amortization of the value of intangible assets, the use of which in the trade or business is definitely limited in duration.2 Depreciation commences with the acquisition of the property and its owner is not bound to see his property gradually waste, without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years, the original investment remains as it was in the beginning. It is not only the right of a company to make such a provision, but it is its duty to its bond and stockholders, and, in the case of a public service corporation, at least, its plain duty to the public.3 Accordingly, the law permits the taxpayer to recover gradually his capital investment in wasting assets free from income tax.4Precisely, Section 30 (f) (1) which states:
(1)In general. A reasonable allowance for deterioration of property arising out of its use or employment in the business or trade, or out of its not being used: Provided, That when the allowance authorized under this subsection shall equal the capital invested by the taxpayer . . . no further allowance shall be made. . . .

allows a deduction from gross income for depreciation but limits the recovery to the capital invested in the asset being depreciated. The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that deductions from gross income are privileges,5 not matters of right.6 They are not created by implication but upon clear expression in the law.7 Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the

underlying purpose of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery in due time thru depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit on the investment made has never been the underlying reason for the allowance of a deduction for depreciation. Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has no justification in the law. The determination, therefore, of the Commissioner of Internal Revenue disallowing said amount, affirmed by the Court of Tax Appeals, is sustained. B. Expenses. The next item involves disallowed expenses incurred in 1953, broken as follows:
Miscellaneous expenses Officer's travelling expenses Total P6,759.17 2,300.40 P9,059.57

These were disallowed on the ground that the nature of these expenses could not be satisfactorily explained nor could the same be supported by appropriate papers. Felix Gulfin, petitioner's accountant, explained the P6,759.17 was actual expenses credited to the account of the president of the corporation incurred in the interest of the corporation during the president's trip to Manila (pp. 33-34 of TSN of Dec. 5, 1962); he stated that the P2,300.40 was the president's travelling expenses to and from Manila as to the vouchers and receipts of these, he said the same were made but got burned during the Basilan fire on March 30, 1962 (p. 40 of same TSN). Petitioner further argues that when it sent its records to Manila in February, 1959, the papers in support of these miscellaneous and travelling expenses were not included for the reason that by February 9, 1959, when the Bureau of Internal Revenue decided to investigate, petitioner had no more obligation to keep the same since five years had lapsed from the time these expenses were incurred (p. 41 of same TSN). On this ground, the petitioner may

be sustained, for under Section 337 of the Tax Code, receipts and papers supporting such expenses need be kept by the taxpayer for a period of five years from the last entry. At the time of the investigation, said five years had lapsed. Taxpayer's stand on this issue is therefore sustained. UNREASONABLY ACCUMULATED PROFITS Section 25 of the Tax Code which imposes a surtax on profits unreasonably accumulated, provides:
Sec. 25. Additional tax on corporations improperly accumulating profits or surplus (a) Imposition of tax. If any corporation, except banks, insurance companies, or personal holding companies, whether domestic or foreign, is formed or availed of for the purpose of preventing the imposition of the tax upon its shareholders or members or the shareholders or members of another corporation, through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there is levied and assessed against such corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by section twenty-four, and shall be computed, collected and paid in the same manner and subject to the same provisions of law, including penalties, as that tax.
1awphl.nt

The Commissioner found that in violation of the abovequoted section, petitioner had unreasonably accumulated profits as of 1953 in the amount of P347,507.01, based on the following circumstances (Examiner's Report pp. 62-68 of BIR records):
1. Strong financial position of the petitioner as of December 31, 1953. Assets were P388,617.00 while the liabilities amounted to only P61,117.31 or a ratio of 6:1. 2. As of 1953, the corporation had considerable capital adequate to meet the reasonable needs of the business amounting to P327,499.69 (assets less liabilities).

3. The P200,000 reserved for electrification of drier and mechanization and the P50,000 reserved for malaria control were reverted to its surplus in 1953. 4. Withdrawal by shareholders, of large sums of money as personal loans. 5. Investment of undistributed earnings in assets having no proximate connection with the business as hospital building and equipment worth P59,794.72. 6. In 1953, with an increase of surplus amounting to P677,232.01, the capital stock was increased to P500,000 although there was no need for such increase.

Petitioner tried to show that in considering the surplus, the examiner did not take into account the possible expenses for cultivation, labor, fertilitation, drainage, irrigation, repair, etc. (pp. 235-237 of TSN of Dec. 7, 1962). As aptly answered by the examiner himself, however, they were already included as part of the working capital (pp. 237-238 of TSN of Dec. 7, 1962). In the unreasonable accumulation of P347,507.01 are included P200,000 for electrification of driers and mechanization and P50,000 for malaria control which were reserved way back in 1948 (p. 67 of the BIR records) but reverted to the general fund only in 1953. If there were any plans for these amounts to be used in further expansion through projects, it did not appear in the records as was properly indicated in 1948 when such amounts were reserved. Thus, while in 1948 it was already clear that the money was intended to go to future projects, in 1953 upon reversion to the general fund, no such intention was shown. Such reversion therefore gave occasion for the Government to consider the same for tax purposes. The P250,000 reverted to the general fund was sought to be explained as later used elsewhere: "part of it in the Hilano Industries, Inc. in building the factory site and buildings to house technical men . . . part of it was spent in the facilities for the waterworks system and for industrialization of the coconut industry" (p. 117 of TSN of Dec. 6, 1962). This is not sufficient explanation. Persuasive jurisprudence on the matter such as those in the United States from where our tax law was derived,8 has it that: "In order to determine whether profits were

accumulated for the reasonable needs of the business or to avoid the surtax upon shareholders, the controlling intention of the taxpayer is that which is manifested at the time of the accumulation, not subsequently declared intentions which are merely the products of after-thought."9 The reversion here was made because the reserved amount was not enough for the projects intended, without any intent to channel the same to some particular future projects in mind. Petitioner argues that since it has P560,717.44 as its expenses for the year 1953, a surplus of P347,507.01 is not unreasonably accumulated. As rightly contended by the Government, there is no need to have such a large amount at the beginning of the following year because during the year, current assets are converted into cash and with the income realized from the business as the year goes, these expenses may well be taken care of (pp. 238 of TSN of Dec. 7, 1962). Thus, it is erroneous to say that the taxpayer is entitled to retain enough liquid net assets in amounts approximately equal to current operating needs for the year to cover "cost of goods sold and operating expenses" for "it excludes proper consideration of funds generated by the collection of notes receivable as trade accounts during the course of the year."10 In fact, just because the fatal accumulations are less than 70% of the annual operating expenses of the year, it does not mean that the accumulations are reasonable as a matter of law."11 Petitioner tried to show that investments were made with Basilan Coconut Producers Cooperative Association and Basilan Hospital (pp. 103-105 of TSN of Dec. 6, 1962) totalling P59,794.72 as of December 31, 1953. This shows all the more the unreasonable accumulation. As of December 31, 1953 already P59,794.72 was spent yet as of that date there was still a surplus of P347,507.01. Petitioner questions why the examiner covered the period from 1948-1953 when the taxable year on review was 1953. The surplus of P347,507.01 was taken by the examiner from the balance sheet of petitioner for 1953. To check the figure arrived at, the examiner traced the accumulation process from 1947 until 1953, and petitioner's figure stood out to be correct. There was no error in the process applied, for previous accumulations should be considered in determining unreasonable accumulations for the

year concerned. "In determining whether accumulations of earnings or profits in a particular year are within the reasonable needs of a corporation, it is neccessary to take into account prior accumulations, since accumulations prior to the year involved may have been sufficient to cover the business needs and additional accumulations during the year involved would not reasonably be necessary."12 Another factor that stands out to show unreasonable accumulation is the fact that large amounts were withdrawn by or advanced to the stockholders. For the year 1953 alone these totalled P197,229.26. Yet the surplus of P347,507.01 was left as of December 31, 1953. We find unacceptable petitioner's explanation that these were advances made in furtherance of the business purposes of the petitioner. As correctly held by the Court of Tax Appeals, while certain expenses of the corporation were credited against these amounts, the unspent balance was retained by the stockholders without refunding them to petitioner at the end of each year. These advances were in fact indirect loans to the stockholders indicating the unreasonable accumulation of surplus beyond the needs of the business. ALLEGED EXEMPTION Petitioner wishes to avail of the exempting proviso in Sec. 25 of the Internal Revenue Code as amended by R.A. 1823, approved June 22, 1957, whereby accumulated profits or surplus if invested in any dollar-producing or dollar-earning industry or in the purchase of bonds issued by the Central Bank, may not be subject to the 25% surtax. We have but to point out that the unreasonable accumulation was in 1953. The exemption was by virtue of Republic Act 1823 which amended Sec. 25 only on June 22, 1957 more than three years after the period covered by the assessment. In resume, Basilan Estates, Inc. is liable for the payment of deficiency income tax and surtax for the year 1953 in the amount of P88,977.42, computed as follows:
Net Income per return Add: Over-claimed P40,142.90 10,500.49

depreciation Net income per finding 20% tax on P50,643.39 Less: Tax already assessed Deficiency income tax Add: 25% surtax on P347,507.01 Total tax due and collectible P50,643.39 P10,128.67 8,028.00 P2,100.67 86,876.75 P88,977.42 ===========

WHEREFORE, the judgment appealed from is modified to the extent that petitioner is allowed its deductions for travelling and miscellaneous expenses, but affirmed insofar as the petitioner is liable for P2,100.67 as deficiency income tax for 1953 and P86,876.75 as 25% surtax on the unreasonably accumulated profit of P347,507.01. No costs. So ordered. Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Angeles and Fernando, JJ., concur.

Republic of the Philippines SUPREME COURT Manila EN BANC

G.R. No. L-24893 March 26, 1971 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. A. SORIANO Y CIA. and THE COURT OF TAX APPEALS, respondents. Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney Michaelina Ramos-Balasbas for petitioner. Gadioma & Josue for respondent A. Soriano y Cia.

DIZON, J.:
This is an appeal taken by the Commissioner of Internal Revenue from a decision of the Court of Tax Appeals in C.T.A. Case No. 1364 entitled "A. Soriano y Cia. vs. Commissioner of Internal Revenue" ordering the latter to give the former a tax credit in the amount of P18,099.00 as overpaid income tax for the year 1960. It appears that A. Soriano y Cia., hereinafter referred to as the Taxpayer, owned a piece of land located in Intramuros, City of Manila, on which it proposed to construct an office building. To carry out the project it had the necessary plans drawn in 1960 by Architect J. M. Zaragoza, and entered into a pile-driving contract that same year with the construction firm of A. M. Oreta & Co. hereinafter referred to as the Contractor. The pile-driving was actually done in 1960. After these preparations and before the construction of the proposed office building itself could get started, the Taxpayer sold the property

to J. M. Tuason & Co. on April 13, 1960 under a contract that required it to meet certain specifications relative to the load bearing factor of the timber piles driven. The balance of P49,329.55 due on the Contractor's fees, including the cost of testing timber piles in the amount of P4,000.00, was paid only on June 16, 1961 after the Contractor had concluded negotiations with the City Engineer of Manila for the settlement of the problem brought by J. M. Tuason & Co. regarding the allowable load bearing factor for the timber piles at the job site, and after said Contractor had secured a certification by the Office of the City Engineer of Manila in connection therewith. It also appears that in the year 1961, the Taxpayer completed payment to the architect, Mr. Zaragoza, of the latter's fees for services rendered, the same consisting of the unpaid balance of P10,000.00, plus P1,000.00 reimbursement for disbursements made by the latter in connection with the Intramuros property. On April 17, 1961, the Taxpayer filed its 1960 Income Tax Return and in due time paid the income tax due in accordance therewith. On October 4, 1961, it filed an amended Income Tax Return for the year 1960 showing a refundable amount of P15,099.00 due to the inclusion of expenses paid on June 1 and June 16, 1961 amounting to P50,329.55, expenses allegedly incurred for pile-driving and architect's fees which the Taxpayer claimed were part of the cost of its Intramuros property sold, as already stated, on April 13, 1960. On the same day, a request for the refund of the said amount was filed. Again, on March 12, 1963, the Taxpayer filed a second amended return showing this time a refundable amount of P18,099.00 based on expenses already included in the previous amended Income Tax Return, plus another item of expense in the amount of P10,000.00 paid as architect's fees on March 15, 1961, upon the claim that all said expenses formed part of the cost of the Intramuros property aforesaid. A request for the refund of the total amount of P18,099.00 was also made. As correctly stated in the brief filed by the Office of the Solicitor General on behalf of petitioner, the sole issue to be resolved in this appeal is whether or not, in determining the income tax due from the Taxpayer for the year 1960 in connection with the profit it had realized from the sale of its Intramuros property on April 13, 1960, said Taxpayer is entitled to deduct, as part of the cost, from the gross

selling price, the sum of P49,329.55 paid as service fee for piledriving, and the additional sum of P11,000.00 as architect's fee. In connection with the above issue the following facts are relevant and of decisive importance: 1) The pile-driving contract was entered into, and the services of Architect Zaragoza were engaged in the year 1960. The pile-driving was actually done, and the plans for the proposed office building were made in the same year (1960). 2) The Pile-driving services as well as the architect's services benefited and increased the value of the property. The logical conclusion that one may draw from the above facts is that the expenses in question constitute capital expenditures which the owner or Taxpayer was entitled to consider as part of the total cost of its property in determining the amount of the profit it had realized in the sale thereof to J. M. Tuason & Co. That payment of these questioned items was made only in 1961 does not alter the fact that the contracts from which the obligation to pay arose were entered into in 1960 and the services contracted for were rendered in the same year. The obligation to pay for said services, therefore, clearly dated back to 1960. We have held heretofore that expenditures for replacements, alterations, improvements or additions which either prolong the life of the property or increase its value are capital in nature (Alhambra Cigar etc. vs. Collector, etc., G.R. No. L-12026, and L-12131, May 29, 1959) and having arrived at the conclusion that the expenditures referred to above increased the value of the property, the same must be considered as capital expenditures that formed part of the cost of the Taxpayer's Intramuros property. We, therefore, agree with the Court of Tax Appeals that said Taxpayer was entitled to the tax credit applied for. WHEREFORE, the appealed decision is hereby affirmed, without costs. Concepcion C.J., Reyes, J.B.L., Makalintal, Zaldivar, Castro, Fernando, Teehankee, Barredo, Villamor and Makasiar, JJ., concur.

Republic of the Philippines SUPREME COURT Manila FIRST DIVISION


G.R. No. L-26911 January 27, 1981 ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent. G.R. No. L-26924 January 27, 1981 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION and COURT OF TAX APPEALS,respondents.

DE CASTRO, J.:
These are two (2) petitions for review from the decision of the Court of Tax Appeals of October 25, 1966 in CTA Case No. 1312 entitled "Atlas Consolidated Mining and Development Corporation vs. Commissioner of Internal Revenue." One (L-26911) was filed by the Atlas Consolidated Mining & Development Corporation, and in the other L-26924), the Commissioner of Internal Revenue is the petitioner. This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the Commissioner of Internal Revenue, hereinafter referred to as Commissioner, where the Atlas Consolidated Mining and Development Corporation, hereinafter referred to as Atlas, was assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiency income taxes.

Atlas is a corporation engaged in the mining industry registered under the laws of the Philippines. On August 20, 1962, the Commissioner assessed against Atlas the sum of P546,295.16

and P215,493.96 or a total of P761,789.12 as deficiency income taxes for the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that Atlas is not entitled to exemption from the income tax under Section 4 of Republic Act 9091 because same covers only gold mines, the provision of which reads:
New mines, and old mines which resume operation, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, shall be exempt from the payment of income tax during the first three (3) years of actual commercial production. Provided that, any such mine and/or mines making a complete return of its capital investment at any time within the said period, shall pay income tax from that year. For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the disallowance of items claimed by Atlas as deductible from gross income.

On October 9, 1962, Atlas protested the assessment asking for its reconsideration and cancellation. 2 Acting on the protest, the Commissioner conducted a reinvestigation of the case. On October 25, 1962, the Secretary of Finance ruled that the exemption provided in Republic Act 909 embraces all new mines and old mines whether gold or other minerals. 3 Accordingly, the Commissioner recomputed Atlas deficiency income tax liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the Commissioner issued a revised assessment entirely eliminating the assessment of P546,295.16 for the year 1957. The assessment for 1958 was reduced from P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals, assailing the disallowance of the following items claimed as deductible from its gross income for 1958:
Transfer agent's fee.........................................................P59,477.42 Stockholders relation service fee....................................25,523.14

U.S. stock listing expenses..................................................8,326.70 Suit expenses...................................................................... ....6,666.65 Provision for contingencies..................................... .........60,000.00 Total..................................................... ...............P159,993.91

After hearing, the Court of Tax Appeals rendered a decision on October 25, 1966 allowing the above mentioned disallowed items, except the items denominated by Atlas as stockholders relation service fee and suit expenses. 4Pertinent portions of the decision of the Court of Tax Appeals read as follows:
Under the facts, circumstances and applicable law in this case, the unallowable deduction from petitioner's gross income in 1958 amounted to P32,189.79. Stockholders relation service fee.................................... P25,523.14 Suit and litigation expenses................................................ 6,666.65 Total.............................................................................. ..... P32,189.79 As the exemption of petitioner from the payment of corporate income tax under Section 4, Republic Act 909, was good only up to the Ist quarter of 1958 ending on March 31 of the same year, only threefourth (3/4) of the net taxable income of petitioner is subject to income tax, computed as follows: 1958

Total net income for 1958.................................P1,968,898.27 Net income corresponding to taxable period April 1 to Dec. 31, 1958, 3/4 of P1,968,898.27..........................................................1, 476,673.70 Add: 3/4 of promotion fees of P25,523.14..............................................................P1 9,142.35 Litigation expenses...................................................................... ...6, 666.65 Net income per decision..........................................11, 02,4 2.70 Tax due thereon.........................................................412,695.0 0 Less: Amount already assessed .............................405,468.00 DEFICIENCY INCOME TAX DUE............................P7,227.00 Add: 1/2 % monthly interest from 6-20-59 to 6-20-62 (18%)....................................P1,300.89

TOTAL AMOUNT DUE & COLLECTIBLE............P8,526.22 From the Court of Tax Appeals' decision of October 25, 1966, both parties appealed to this Court by way of two (2) separate petitions for review docketed as G. R. No. L-26911 (Atlas, petitioner) and G. R. No. L-29924 (Commissioner, petitioner). G. R. No. L-26911Atlas appealed only that portion of the Court of Tax Appeals' decision disallowing the deduction from gross income of the so-called stockholders relation service fee amounting to P25,523.14, making a lone assignment of error that THE COURT OF TAX APPEALS ERRED IN ITS CONCLUSION THAT THE EXPENSE IN THE AMOUNT OF P25,523.14 PAID BY PETITIONER IN 1958 AS ANNUAL PUBLIC RELATIONS EXPENSES WAS INCURRED FOR ACQUISITION OF ADDITIONAL CAPITAL, THE SAME NOT BEING SUPPORTED BY THE EVIDENCE.

It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as annual public relations expenses is a deductible expense from gross income under Section 30 (a) (1) of the National Internal Revenue Code. Atlas claimed that it was paid for services of a public relations firm, P.K Macker & Co., a reputable public relations consultant in New York City, U.S.A., hence, an ordinary and necessary business expense in order to compete with other corporations also interested in the investment market in the United States. 5 It is the stand of Atlas that information given out to the public in general and to the stockholder in particular by the P.K MacKer & Co. concerning the operation of the Atlas was aimed at creating a favorable image and goodwill to gain or maintain their patronage.
The decisive question, therefore, in this particular appeal taken by Atlas to this Court is whether or not the expenses paid for the services rendered by a public relations firm P.K MacKer & Co. labelled as stockholders relation service fee is an allowable deduction as business expense under Section 30 (a) (1) of the National Internal Revenue Code.

The principle is recognized that when a taxpayer claims a deduction, he must point to some specific provision of the statute in which that deduction is authorized and must be able to prove that he is entitled to the deduction which the law allows. As previously adverted to, the law allowing expenses as deduction from gross income for purposes of the income tax is Section 30 (a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." An item of expenditure, in order to be deductible under this section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, three conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying in a trade or business. 6 In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction. 7 While it is true that there is a number of decisions in the United States delving on the interpretation of the terms "ordinary and necessary" as used in the federal tax laws, no adequate or satisfactory definition of those terms is possible. Similarly, this Court has never attempted to define with precision the terms "ordinary and necessary." There are however, certain guiding principles worthy of serious consideration in the proper adjudication of conflicting claims. Ordinarily, an expense will be considered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business. 8 It is "ordinary" when it connotes a payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. 9 The term "ordinary" does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. 10 There is thus no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts and the

relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination. 11 Assuming that the expenditure is ordinary and necessary in the operation of the taxpayer's business, the answer to the question as to whether the expenditure is an allowable deduction as a business expense must be determined from the nature of the expenditure itself, which in turn depends on the extent and permanency of the work accomplished by the expenditure. 12 It appears that on December 27, 1957, Atlas increased its capital stock from P15,000,000 to P18,325,000. 13 It was claimed by Atlas that its shares of stock worth P3,325,000 were sold in the United States because of the services rendered by the public relations firm, P. K. Macker & Company. The Court of Tax Appeals ruled that the information about Atlas given out and played up in the mass communication media resulted in full subscription of the additional shares issued by Atlas; consequently, the questioned item, stockholders relation service fee, was in effect spent for the acquisition of additional capital, ergo, a capital expenditure. We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K. Macker & Co. as compensation for services carrying on the selling campaign in an effort to sell Atlas' additional capital stock of P3,325,000 is not an ordinary expense in line with the decision of U.S. Board of Tax Appeals in the case ofHarrisburg Hospital Inc. vs. Commissioner of Internal Revenue. 14 Accordingly, as found by the Court of Tax Appeals, the said expense is not deductible from Atlas gross income in 1958 because expenses relating to recapitalization and reorganization of the corporation (Missouri-Kansas Pipe Line vs. Commissioner of Internal Revenue, 148 F. (2d), 460; Skenandos Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. (2d) 268, Cert. denied 314 U.S. 6961), the cost of obtaining stock subscription (Simons Co., 8 BTA 631), promotion expenses (Beneficial Industrial Loan Corp. vs. Handy, 92 F. (2d) 74), and commission or fees paid for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308) are capital expenditures. That the expense in question was incurred to create a favorable image of the corporation in order to gain or maintain the public's and its stockholders' patronage, does not make it deductible as

business expense. As held in the case of Welch vs. Helvering, 15 efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. We do not agree with the contention of Atlas that the conclusion of the Court of Tax Appeals in holding that the expense of P25,523.14 was incurred for acquisition of additional capital is not supported by the evidence. The burden of proof that the expenses incurred are ordinary and necessary is on the taxpayer 16 and does not rest upon the Government. To avail of the claimed deduction under Section 30(a) (1) of the National Internal Revenue Code, it is incumbent upon the taxpayer to adduce substantial evidence to establish a reasonably proximate relation petition between the expenses to the ordinary conduct of the business of the taxpayer. A logical link or nexus between the expense and the taxpayer's business must be established by the taxpayer.
G. R. No. L-26924-In his petition for review, the Commissioner of Internal Revenue assigned as errors the following: I THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF THE SO- CALLED TRANSFER AGENT'S FEES ALLEGEDLY PAID BY RESPONDENT; II THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OF LISTING EXPENSES ALLEGEDLY INCURRED BY RESPONDENT; III THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE AMOUNT OF P60,000 REPRESENTED BY RESPONDENT AS

"PROVISION FOR CONTINGENCIES" WAS ADDED BACK BY RESPONDENT TO ITS GROSS INCOME IN COMPUTING THE INCOME TAX DUE FROM IT FOR 1958; IV THE COURT OF TAX APPEALS ERRED IN DISALLOWING ONLY THE AMOUNT OF P6,666.65 AS SUIT EXPENSES, THE CORRECT AMOUNT THAT SHOULD HAVE BEEN DISALLOWED BEING P17,499.98.

It is well to note that only in the Court of Tax Appeals did the Commissioner raise for the first time (in his memorandum) the question of whether or not the business expenses deducted from Atlas gross income in 1958 may be allowed in the absence of proof of payments. 17 Before this Court, the Commissioner reiterated the same as ground against deductibility when he claimed that the Court of Tax Appeals erred in allowing the deduction of transfer agent's fee and stock listing fee from gross income in the absence of proof of payment thereof.
The Commissioner contended that under Section 30 (a) (1) of the National Internal Revenue Code, it is a requirement for an expense to be deductible from gross income that it must have been "paid or incurred during the year" for which it is claimed; that in the absence of convincing and satisfactory evidence of payment, the deduction from gross income for the year 1958 income tax return cannot be sustained; and that the best evidence to prove payment, if at all any has been made, would be the vouchers or receipts issued therefor which ATLAS failed to present.

Atlas admitted that it failed to adduce evidence of payment of the deduction claimed in its 1958 income tax return, but explains the failure with the allegation that the Commissioner did not raise that question of fact in his pleadings, or even in the report of the investigating examiner and/or letters of demand and assessment notices of ATLAS which gave rise to its appeal to the Court of Tax Appeal. 18 It was emphasized by Atlas that it went to trial and finally submitted this case for decision on the assumption that inasmuch as the fact of payment was never raised as a vital issue by the Commissioner in his answer to the petition for review in the

Court of Tax Appeal, the issues is limited only to pure question of lawwhether or not the expenses deducted by petitioner from its gross income for 1958 are sanctioned by Section 30 (a) (1) of the National Internal Revenue Code. On this issue of whether or not the Commissioner can raise the fact of payment for the first time on appeal in its memorandum in the Court of Tax Appeal, we fully agree with the ruling of the tax court that the Commissioner on appeal cannot be allowed to adopt a theory distinct and different from that he has previously pursued, as shown by the BIR records and the answer to the amended petition for review. 19 As this Court said in the case of Commissioner of Customs vs. Valencia 20 such change in the nature of the case may not be made on appeal, specially when the purpose of the latter is to seek a review of the action taken by an administrative body, forming part of a coordinate branch of the Government, such as the Executive department. In the case at bar, the Court of Tax Appeal found that the fact of payment of the claimed deduction from gross income was never controverted by the Commissioner even during the initial stages of routinary administrative scrutiny conducted by BIR examiners.21 Specifically, in his answer to the amended petition for review in the Court of Tax Appeal, the Commissioner did not deny the fact of payment, merely contesting the legitimacy of the deduction on the ground that same was not ordinary and necessary business expenses. 22 As consistently ruled by this Court, the findings of facts by the Court of Tax Appeal will not be reviewed in the absence of showing of gross error or abuse. 23 We, therefore, hold that it was too late for the Commissioner to raise the issue of fact of payment for the first time in his memorandum in the Court of Tax Appeals and in this instant appeal to the Supreme Court. If raised earlier, the matter ought to have been seriously delved into by the Court of Tax Appeals. On this ground, we are of the opinion that under all the attendant circumstances of the case, substantial justice would be served if the Commissioner be held as precluded from now attempting to raise an issue to disallow deduction of the item in question at this stage. Failure to assert a question within a reasonable time warrants a presumption that the party entitled to assert it either has abandoned or declined to assert it.

On the second assignment of error, aside from alleging lack of proof of payment of the expense deducted, the Commissioner contended that such expense should be disallowed for not being ordinary and necessary and not incurred in trade or business, as required under Section 30 (a) (1) of the National Internal Revenue Code. He asserted that said fees were therefore incurred not for the production of income but for the acquisition petition of capital in view of the definition that an expense is deemed to be incurred in trade or business if it was incurred for the production of income, or in the expectation of producing income for the business. In support of his contention, the Commissioner cited the ruling in Dome Mines, Ltd vs. Commisioner of Internal Revenue 24 involving the same issue as in the case at bar where the U.S. Board of Tax Appeal ruled that expenses for listing capital stock in the stock exchange are not ordinary and necessary expenses incurred in carrying on the taxpayer's business which was gold mining and selling, which business is strikingly similar to Atlas. On the other hand, the Court of Tax Appeal relied on the ruling in the case of Chesapeake Corporation of Virginia vs. Commissioner of Internal Revenue 25 where the Tax Court allowed the deduction of stock exchange fee in dispute, which is an annually recurring cost for the annual maintenance of the listing.
We find the Chesapeake decision controlling with the facts and circumstances of the instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a deduction not only because the expenditure did not meet the statutory test but also because the same was paid only once, and the benefit acquired thereby continued indefinitely, whereas, in the Chesapeake Corporation case, fee paid to the stock exchange was annual and recurring. In the instant case, we deal with the stock listing fee paid annually to a stock exchange for the privilege of having its stock listed. It must be noted that the Court of Tax Appeal rejected the Dome Mines casebecause it involves a payment made only once, hence, it was held therein that the single payment made to the stock exchange was a capital expenditure, as distinguished from the instant case, where payments were made annually. For this reason, we hold that said listing fee is an ordinary and necessary business expense On the third assignment of error, the Commissioner con- tended that the Court of Tax Appeal erred when it held that the amount of

P60,000 as "provisions for contingencies" was in effect added back to Atlas income.

On this issue, this Court has consistently ruled in several cases adverted to earlier, that in the absence of grave abuse of discretion or error on the part of the tax court its findings of facts may not be disturbed by the Supreme Court. 26 It is not within the province of this Court to resolve whether or not the P60,000 representing "provision for contingencies" was in fact added to or deducted from the taxable income. As ruled by the Court of Tax Appeals, the said amount was in effect added to Atlas taxable income. 27 The same being factual in nature and supported by substantial evidence, such findings should not be disturbed in this appeal.
Finally, in its fourth assignment of error, the Commissioner contended that the CTA erred in disallowing only the amount of P6,666.65 as suit expenses instead of P17,499.98. It appears that petitioner deducted from its 1958 gross income the amount of P23,333.30 as attorney's fees and litigation expenses in the defense of title to the Toledo Mining properties purchased by Atlas from Mindanao Lode Mines Inc. in Civil Case No. 30566 of the Court of First Instance of Manila for annulment of the sale of said mining properties. On the ground that the litigation expense was a capital expenditure under Section 121 of the Revenue Regulation No. 2, the investigating revenue examiner recommended the disallowance of P13,333.30. The Commissioner, however, reduced this amount of P6,666.65 which latter amount was affirmed by the respondent Court of Tax Appeals on appeal.

There is no question that, as held by the Court of Tax Ap- peals, the litigation expenses under consideration were incurred in defense of Atlas title to its mining properties. In line with the decision of the U.S. Tax Court in the case of Safety Tube Corp. vs. Commissioner of Internal Revenue, 28 it is well settled that litigation expenses incurred in defense or protection of title are capital in nature and not deductible. Likewise, it was ruled by the U.S. Tax Court that expenditures in defense of title of property constitute a part of the cost of the property, and are not deductible as expense. 29

Surprisingly, however, the investigating revenue examiner recommended a partial disallowance of P13,333.30 instead of the entire amount of P23,333.30, which, upon review, was further reduced by the Commissioner of Internal Revenue. Whether it was due to mistake, negligence or omission of the officials concerned, the arithmetical error committed herein should not prejudice the Government. This Court will pass upon this particular question since there is a clear error committed by officials concerned in the computation of the deductible amount. As held in the case of Vera vs. Fernandez, 30 this Court emphatically said that taxes are the lifeblood of the Government and their prompt and certain availability are imperious need. Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected. To safeguard such interest, neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harm or detriment to the people, in the same manner as private persons may be made to suffer individually on account of his own negligence, the presumption being that they take good care of their personal affair. This should not hold true to government officials with respect to matters not of their own personal concern. This is the philosophy behind the government's exception, as a general rule, from the operation of the principle of estoppel.31
WHEREFORE, judgment appealed from is hereby affirmed with modification that the amount of P17,499.98 (3/4 of P23,333.00) representing suit expenses be disallowed as deduction instead of P6,666.65 only. With this amount as part of the net income, the corresponding income tax shall be paid thereon, with interest of 6% per annum from June 20, 1959 to June 20,1962. SO ORDERED.