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1. Requirements for deductibility Collector of Internal Revenue v. Goodrich Sandra xxx 4.

. RR 5-99, March 10, 1999, requirements for deductibility of bad debts including banks PHILEX MINING vs. COMMISSIONER OF INTERNAL REVENUE (April 16, 2008) PONENTE: Ynares-Santiago RATIO: Deductions for income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed. To enjoy deductions for bad debts, the taxpayer must show that there was a valid debt to begin with. FACTS: 1. Philex Mining entered into an agreement with Baguio Gold Mining Company for the former to manage and operate the latter's mining claim, known as the Sto. Nino mine. The parties' agreement was denominated as "Power of Attorney" and provided for the following terms: 4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from time to time may be required by the MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be deemed, for internal audit purposes, as the owner's account in the Sto. Nino PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino PROJECT, shall be added to such owner's account. x x x x 2.

xxxx Philex Mining made advances of cash and property in accordance with paragraph 5 of the agreement. However, the mine suffered continuing losses over the years which resulted to petitioner's withdrawal as manager of the mine on January 28, 1982 and in the eventual cessation of mine operations on February 20, 1982. a. The parties executed a "Compromise with Dation in Payment" wherein Baguio Gold admitted an indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold's tangible assets to petitioner, transferring to the latter Baguio Gold's equitable title in its Philodrill assets and finally settling the remaining liability through properties that Baguio Gold may acquire in the future. Later, the parties executed an "Amendment to Compromise with Dation in Payment where the parties determined that Baguio Gold's indebtedness to petitioner actually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as guarantor. This time, Baguio Gold undertook to pay petitioner in two segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.

b.

c.

12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay income tax on their compensation, while the PRINCIPAL shall pay income tax on the net profit of the Sto. Nino PROJECT after deduction therefrom of the MANAGERS' compensation.

3.

Petitioner then wrote off in its 1982 books of account the remaining outstanding indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982 operations.

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16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the future, may incur other obligations in favor of the MANAGERS. This Power of Attorney has been executed as security for the payment and satisfaction of all such obligations of the PRINCIPAL in favor of the MANAGERS and as a means to fulfill the same. Therefore, this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS' account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been paid and satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36-month notice to the MANAGERS.

a. b. c.

In its 1982 annual income tax return, petitioner deducted from its gross income the amount of P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and allowances. However, the Bureau of Internal Revenue (BIR) disallowed the amount as deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39. Petitioner protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt; (b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year when it was determined to be worthless.

b.

c.

7. a. b. c. d. The bad debt deduction represented advances made by petitioner which, pursuant to the management contract, formed part of Baguio Gold's "pecuniary obligations" to petitioner. It also included payments made by petitioner as guarantor of Baguio Gold's long-term loans which legally entitled petitioner to be subrogated to the rights of the original creditor. Petitioner also asserted that due to Baguio Gold's irreversible losses, it became evident that it would not be able to recover the advances and payments it had made in behalf of Baguio Gold. For a debt to be considered worthless, petitioner claimed that it was neither required to institute a judicial action for collection against the debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable means to collect.

Hence, upon denial of its motion for reconsideration, petitioner took this recourse under Rule 45 of the Rules of Court, alleging that: a. The Court of Appeals erred in construing that the advances made by Philex in the management of the Sto. Nino Mine pursuant to the Power of Attorney partook of the nature of an investment rather than a loan. The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the development of the Sto. Nino Mine notwithstanding the clear absence of any intent on the part of Philex and Baguio Gold to form a partnership. The Court of Appeals erred in relying only on the Power of Attorney and in completely disregarding the Compromise Agreement and the Amended Compromise Agreement when it construed the nature of the advances made by Philex. The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts write-off.

b.

c.

5.

BIR denied petitioner's protest for lack of legal and factual basis. a. It held that the alleged debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt considering that, under the management contract, petitioner was to be paid fifty percent (50%) of the project's net profit. Petitioner appealed before the Court of Tax Appeals. CTA rendered judgment against Philex, affirming the deficiency income tax assessment and ordering Philex to pay the amount plus delinquency interest. 8.

d.

Petitioner insists that in determining the nature of its business relationship with Baguio Gold, SC should not only rely on the "Power of Attorney", but also on the subsequent "Compromise with Dation in Payment" and "Amended Compromise with Dation in Payment" that the parties executed in 1982. a. These documents, allegedly evinced the parties' intent to treat the advances and payments as a loan and establish a creditor-debtor relationship between them.

b. c.

6.

CTA rejected petitioner's assertion that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead characterized the advances as petitioner's investment in a partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. a. The CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a partnership agreement. Since the

HELD: The petition lacks merit. [Bear with this please. The Courts reasoning is long because it had to characterize the relationship between Philex and Baguio Gold to come up with the ratio at the end.] 1. SC agrees with the lower courts in holding that the "Power of Attorney" is the instrument that is material in determining the true nature of the business relationship between petitioner and Baguio Gold.

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4.

Petitioner emphasized that the debt arose out of a valid management contract it entered into with Baguio Gold.

d.

advanced amount partook of the nature of an investment, it could not be deducted as a bad debt from petitioner's gross income. It likewise held that the amount paid by petitioner for the longterm loan obligations of Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were made, Baguio Gold was not in default since its loans were not yet due and demandable. What petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America showing that it was merely demanding payment of the installment and interests due. Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-payment. The Court of Appeals affirmed the decision of the CTA.

a.

b.

c. d.

c. d. e.

e.

2.

An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed intended by the parties. Under a contract of partnership, two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. a. While a corporation, like petitioner, cannot generally enter into a contract of partnership unless authorized by law or its charter, it has been held that it may enter into a joint venture which is akin to a particular partnership. Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had intended to create a partnership and establish a common fund for the purpose. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.

5.

b.

In this case, the totality of the circumstances and the stipulations in the parties' agreement indubitably lead to the conclusion that a partnership was formed between petitioner and Baguio Gold. a. b. First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination of the parties' business relations, "the ratio which the MANAGER'S account has to the owner's account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims" shall be transferred to petitioner. As pointed out by the Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine's assets upon dissolution of the parties' business relations. There was nothing in the agreement that would require Baguio Gold to make payments of the advances to petitioner as would be recognized as an item of obligation or "accounts payable" for Baguio Gold.

3.

Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money, property and industry to the common fund known as the Sto. Nio mine. a. b. c. Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute equally to the joint venture assets under their respective accounts. Baguio Gold would contribute P11M under its owner's account plus any of its income that is left in the project, in addition to its actual mining claim. Petitioner's contribution would consist of its expertise in the management and operation of mines, as well as the manager's account which is comprised of P11M in funds and property and petitioner's "compensation" as manager that cannot be paid in cash.

c. d.

6.

Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of the Sto. Nio mine upon termination, a provision that is more consistent with a partnership than a creditor-debtor relationship.

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Before resort may be had to the two compromise agreements, the parties' contractual intent must first be discovered from the expressed language of the primary contract under which the parties' business relations were founded. It should be noted that the compromise agreements were mere collateral documents executed by the parties pursuant to the termination of their business relationship created under the "Power of Attorney". On the other hand, it is the Power of Attorney which established the juridical relation of the parties and defined the parameters of their dealings with one another. The compromise agreements were executed eleven years after the "Power of Attorney" and merely laid out a plan or procedure by which petitioner could recover the advances and payments it made under the "Power of Attorney". The parties entered into the compromise agreements as a consequence of the dissolution of their business relationship. It did not define that relationship or indicate its real character.

4.

The wording of the parties' agreement as to petitioner's contribution to the common fund does not detract from the fact that petitioner transferred its funds and property to the project as specified in paragraph 5, thus rendering effective the other stipulations of the contract, particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until termination of the parties' business relations. a. Petitioner became bound by its contributions once the transfers were made. The contributions acquired an obligatory nature as soon as petitioner had chosen to exercise its option under paragraph 5. The non-revocation or non-withdrawal under paragraph 5(c) applies to the advances made by petitioner who is supposedly the agent and not the principal under the contract. Thus, it cannot be inferred from the stipulation that the parties' relation under the agreement is one of agency coupled with an interest and not a partnership. Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one of agency and not a partnership. Although the said provision states that "this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS' account," it does not necessarily follow that the parties entered into an agency contract coupled with an interest that cannot be withdrawn by Baguio Gold.

b.

b. a. It should be pointed out that in a contract of loan, a person who receives a loan or money or any fungible thing acquires ownership thereof and is bound to pay the creditor an equal amount of the same kind and quality. In this case, however, there was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it had advanced, but only the return of an amount pegged at a ratio which the manager's account had to the owner's account. c. d.

b.

To begin with, petitioner was the manager of the project and had put substantial sums into the venture in order to ensure its viability and profitability. By pegging its compensation to profits, petitioner also stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an ordinary employee.

10. SC finds that petitioner's "compensation" under paragraph 12 of the agreement actually constitutes its share in the net profits of the partnership. a. b. c. Petitioner would not be entitled to an equal share in the income of the mine if it were just an employee of Baguio Gold. It is not surprising that petitioner was to receive a 50% share in the net profits, considering that the "Power of Attorney" also provided for an almost equal contribution of the parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the notion that the parties' relations were indeed of partners and not employer-employee.

7.

a.

b.

The "Power of Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate share of the mine assets to be computed at a ratio that the manager's account had to the owner's account. Except to provide a basis for claiming the advances as a bad debt deduction, there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for any amount over and above the proportion agreed upon in the "Power of Attorney".

8.

CTA correctly observed that it was unlikely for a business corporation to lend hundreds of millions of pesos to another corporation with neither security, or collateral, nor a specific deed evidencing the terms and conditions of such loans. a. The parties also did not provide a specific maturity date for the advances to become due and demandable, and the manner of payment was unclear. All these point to the inevitable conclusion that the advances were not loans but capital contributions to a partnership. The strongest indication that petitioner was a partner in the Sto Nio mine is the fact that it would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement. The entirety of the parties' contractual stipulations simply leads to no other conclusion than that petitioner's "compensation" is actually its share in the income of the joint venture. Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in the profits of a business is prima facie evidence that he is a partner in the business."

11. The lower courts did not err in treating petitioner's advances as investments in a partnership known as the Sto. Nino mine. a. The advances were not "debts" of Baguio Gold to petitioner inasmuch as the latter was under no unconditional obligation to return the same to the former under the "Power of Attorney". b. As for the amounts that petitioner paid as guarantor to Baguio Gold's creditors, we find no reason to depart from the tax court's factual finding that Baguio Gold's debts were not yet due and demandable at the time that petitioner paid the same. c. Petitioner pre-paid Baguio Gold's outstanding loans to its bank creditors and this conclusion is supported by the evidence on record. 12. Petitioner thus cannot claim the advances as a bad debt deduction from its gross income. a. Deductions for income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed. [WHAT IS IMPORTANT!] b. In this case, petitioner failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could be deducted from its gross income. Consequently, it could not claim the advances as a valid bad debt deduction. WHEREFORE, the petition is DENIED. The decision of the Court of Appeals is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency interest computed from February 10, 1995, which is the due date given for the payment of the deficiency income tax, up to the actual date of payment. -Jan

b. c. d.

9.

Petitioner asserts, however, that no such inference can be drawn against it since its share in the profits of the Sto Nio project was in the nature of compensation or "wages of an employee", under the exception provided in Article 1769 (4) (b). a. CTA correctly noted that petitioner was not an employee of Baguio Gold who will be paid "wages" pursuant to an employer-employee relationship.

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SC finds no contractual basis for the execution of the two compromise agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly arose from the termination of their business relations over the Sto. Nino mine.

R. DEPRECIATION 1. Depreciation base ZAMORA v. COLLECTOR OF INTERNAL REVENUE (May 31, 1963) MARIANO ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. NOTE: Im not sure why this is assigned under depreciation expense because the discussion for depreciation is really not substantial at all. It discusses other issues like promotional expenses and capital gains, which I think is more relevant in this case and Im pretty sure if maam discusses this in class shell focus more on those issues rather than the depreciation expense. DOCTRINE: ... [T]he 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. NATURE: Appeal from CTA PONENTE: PAREDES, J.: FACTS: 1st case 1. Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and 1952. 2. 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. 3. 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. On appeal, the decision was modified 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 2nd case 4. 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. 5. 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. ISSUES: 1. WON the deductions for promotional expenses should have been allowed. NO 2. WON the CIR erred in disallowing 3% per annum as the rate of depreciation. NO 3. WON the CIR erred in disregarding the price stated in the deed of sale as the cost in determining the alleged capital gains. NO.

HELD/RATIO/RULING: 1. PROMOTION EXPENSES AS DEDUCTION: PETITIONERS ARGUMENT: - 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 - 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. CIR/CTA ARGUMENT: - The CTA 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 - 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. COURTS RULING: 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. 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. In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev., 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 and 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.

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2. DEPRECIATION EXPENSE PETITIONERS ARGUMENT: 1. CTA erred in disallowing 3-% per annum as the rate of depreciation of the Bay View Hotel Building but only 2-%. 2. Justification for the 3% rate: (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". COURTS RULING: The CTA in arriving with the said rate had already considered the justifications submitted by the petitioner: 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 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 3. CAPITAL GAINS ON SALE OF PROPERTIES (two properties in dispute [a] the Manila property and [b] the Quezon City property) NOTE: 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.

[b] QUEZON CITY PROPERTY PETITIONER: The entire purchase price of P68,959.00 was paid in Philippine currency. CTA/CIR: The purchase price of P68,959.00 was paid in Japanese war notes. COURTS RULING: Agreed with the CTA 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. HELD: 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.

[a] MANILA PROPERTY PETITIONER ARGUMENT (inferred from the computation/decision): Purchased the property in Philippine Peso and not Japanese war notes (Note: Japanese war notes have smaller value than Peso.) The acquisition cost (purchase price) was P132, 000 and it was later sold for P75, 000. So in effect, they are arguing that there was no gain because: P132, 000 P75, 000 = LOSS (so, lugi pa, gets?) CTA/CIR ARGUMENT: The purchase price of P132,000.00 was not entirely paid in Japanese war notes. They came up with that conclusion because: (1) 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. (2) 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

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(3) 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. COURTS RULING: 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), 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 - 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.

DISPOSITION: 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. VOTE: EN BANC; Bengzon, C.J., Padilla, Bautista Angelo, Concepcion, Reyes, J.B.L., Dizon, Regala and Makalintal, JJ., concur. Labrador and Barrera, JJ., took no part. -David xxx Y. ITEMS NOT DEDUCTIBLE Atlas Consolidated Mining vs CIR (Jan 27, 1981) Doctrine: The statutory test of deductibility (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. 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 Ponente: De Castro Facts: This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the CIR where Atlas, a mining company, 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 909 1 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.

After some bargaining with the CIR and the Secretary of Finance, the Secretary of Finance issued a memo saying that RA 909 covers all mines whether for gold or not. Thus, the tax liability assessment was recomputed and lowered to P159K. However the recomputed tax liability included Transfer agent's fee, Stockholders relation service fee, U.S. stock listing expenses, Suit expenses, Provision for contingencies. Case was then filed in the CTA. CTA once again lowered the liability assessment and considered as deductible the transfer agents fee, U.S. stock listing expenses, and provision for contingencies. It did not however allow the deduction of the Stockholders relation service fee which is at issue.

Issue: Is the stockholder relation service fee a deductible business expense? Ruling: Ratio: 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." The statutory test of deductibility (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. 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. 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 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

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Atlass Argument: 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.

business in which the taxpayer is engaged. The intention of the taxpayer often may be the controlling fact in making the determination 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. The said expense is not deductible from Atlas gross income in 1958 because expenses relating to recapitalization and reorganization of the corporation the cost of obtaining stock subscription, promotion expenses, and commission or fees paid for the sale of stock reorganization 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. -Kester xxx Definition of ordinary income CALASANZ v. CIR (October 8, 1986) IMPORTANT : The statutory definition of capital assets is negative in nature. If the asset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the kind of asset involved in the transaction. However, there is no rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer was held primarily for sale to customers in the ordinary course of his trade or business or whether it was sold as a capital asset.

Although several factors or indices have been recognized as helpful guides in making a determination, none of these is decisive; neither is the presence nor the absence of these factors conclusive. Each case must in the last analysis rest upon its own peculiar facts and circumstances. Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of the factors indubitably tend to show that the activity was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capital gain or loss even though the property has to be subdivided or improved or both to make it salable. However, if the inherited property is substantially improved or very actively sold or both it may be treated as held primarily for sale to customers in the ordinary course of the heir's business.

FACTS Ursula Calasanz inherited from her father an agricultural land in Cainta To liquidate their inheritance, they subdivided the lots and introduced improvements such as roads, concrete gutters, drainage and lighting system to make them saleable. Petitioners joint income tax return : o Profit P31,060.06 from the sale of the lots o 50% = P15,530.03 as taxable capital gains Revenue Examiner adjudged the petitioners as engaged in business of real estate dealers thus, assessed Real Estate Dealers Tax and a deficiency income tax on profits.

ISSUE (1) WON petitioners are real estate dealers liable for real es tate dealers fixed tax (2) WON the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains taxable at capital gain rates. HELD Petitioners engaged in the real estate business and the gains from the sale of the lots are ordinary income taxable in full Arguments of Petitioners : 1- Inherited land is considered a capital asset ; mere liquidation of an inheritance cannot be said to have engaged in the real estate business and be denied the preferential tax treatment merely because the manner of disposal is in the most advantageous way. 2- Subdivision into smaller lots and the introduction of improvements were done merely to facilitate the sale Argument of CIR : 1- Petitioners are deemed to be in the real estate business for being involved in a series of real estate transactions for profit.

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Real property acquired through inheritance may be converted to a business property when if certain factors are present (e.g. number, continuity and frequency of the sale) The fact that the ultimate purpose is to liquidate the inheritance is of no moment ; the important questions is what the taxpayer did to the property.

COURT : 1- Activities of the petitioners are similar to those employed by one engaged in the business of real estate. 2The business element of development is evidence against the contention of the petitioners. Petitioners did not sell the land in the same condition which they acquired it Extensive improvements were made in order to enhance the value of the lot and make it more attractive to prospective buyers ; the improved land is even named Don Mariano Subdivision Property ceases to be a capital asset if the amount expended to improve it doubles that of its original cost ; the extensive improvement indicates that the seller held the property for the sale to customers in the ordinary course of business The sizeable amount receivables in comparison to sales volume during the same period signifies that the lots were sold on installment basis and suggests the number, continuity and frequency of the sales. Lots were also advertised for sale to the public ; sales and collection commissions were paid out The fact that the property is sold for purposes of liquidation does not foreclose the determination that a trade or business is being conducted by the seller. -Mae xxx 1. Computation of gain or loss Commissioner of Internal Revenue, petitioner, vs. Aquafresh Seafood Inc., respondents. (October 20, 2010) NOTES: Kind of tax: DST (documentary stamp tax) and CGT (capital gains tax) DOCTRINE: Under Section 27(D)(5) of the NIRC of 1997, a CGT of six (6%) percent is imposed on the gains presumed to have been realized in the sale, exchange or disposition of lands and/or buildings which are not actively used in the business of a corporation and which are treated as capital assets based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the NIRC, whichever is higher.

x x x "zonal valuation was established with the objective of having an efficient tax administration by minimizing the use of discretion in the determination of the tax based on the part of the administrator on one hand and the taxpayer on the other hand." Zonal value is determined for the purpose of establishing a more realistic basis for real property valuation. Since internal revenue taxes, such as CGT and DST, are assessed on the basis of valuation, the zonal valuation existing at the time of the sale should be taken into account. NATURE: Petition for review a decision of CTA PONENTE: Peralta; 2nd Division FACTS: 1. Aquafresh Seafoods solf to Philis Seafood two parcels of land located at Barrio Banica, Roxas City for P3.1 M. Aquafresh paid the corresponding CGT (Capital Gains Tax) of P186,000 and DST (Documentary Stamp Tax) of P46,500. 2. However, BIR received a report that the purchase price of the sale was undervalued for tax purposes. They conducted an investigation and concluded that the subject properties were commercial and had a high zonal value (P2000). They sent deficiency assessment notices to Aquafresh for the tax deficiencies. The deficiencies were based on the supposed selling price following the P2000 zonal value. 3. Aquafresh protested but its protest was denied. Aquafresh filed a petition for review with the CTA seeking reversal of the decision. Aquafresh argued that since the properties were located in Barrio Banica, classified as residential area and given a zonal value of P650per sq/m in the 1995 Revised Zonal Values of Real Property, the prescribed zonal value should prevail. Aquafresh contends that the BIR had no business re-classifying the subject properties to commercial. CTA decided in favor of Aquafresh, stating that while the CIR is given authority to determine the zonal values, the same is not without limitation- it should be done in consultation with competent appraisers from both the public and private sector (Sec. 6e, NIRC). 4. CIR now assails the CTA decision, saying the requirement of consultation is mandatory only when it is prescribing real property values- that is when a formulation or change is made in the schedule of zonal values. CIR argues that what they did was not to prescribe zonal value, but merely to classify the same as commercial and apply the corresponding zonal value for such classification based on the existing schedule of zonal values. Second, CIR also argues that their act was pursuant to their Zonal Valuation Guidelines. According to CIR, the guidelines provide that All real properties, regardless of actual use, located in a street/barangay zone, the use of which are predominantly commercial shall be classified as Commercial for purposes of zonal valuation. ISSUES: (1) W/N the CIR is correct in re-classifying the subject properties from residential to commercial, consequently raising the zonal value of the properties. Held/Ratio: 1. NO. On the other hand, under Section 196 of the NIRC, DST is based on the consideration contracted to be paid or on its fair market value determined in accordance with Section 6(E) of the NIRC, whichever is higher.

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COMMISSIONER OF INTERNAL REVENUE v VICENTE RUFINO (February 27, 1987) DOCTRINE: The basic consideration of course, is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The criterion laid down by the law is that the merger must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation. It has been suggested that one certain indication of a scheme to evade the capital gains tax is the subsequent dissolution of the new corporation after the transfer to it of the properties of the old corporation and the liquidation of the former soon after. We see no such furtive intention in the instant case. It is clear, in fact, that the purpose of the merger was to continue the business of the Old Corporation, whose corporate life was about to expire, through the New Corporation to which all the assets and obligations of the former had been transferred. what argues strongly, indeed, for the New Corporation is that it was not dissolved after the merger. On the contrary, it continued to operate the places of amusement originally owned by the Old Corporation. NATURE: Petition for certiorari PONENTE: Cruz, J. SHORT FACTS: Private respondents were majority stockholder of an old theatre corporation, which will end its corporate life in 1959. Private respondents were also majority stockholders in a new corporation (organized in 1958) which operated on the same business. They decided to merge the two in order to continue the business of the old corporation. They signed a Deed of assignment wherein the Old Corporations business, assets, etc. were transferred to the New Corporation. Then the capitalization of the New Corporation was increased. And then shares from New Corporation were distributed/issued to the shareholders of the Old Corporation. New Corp continued with the business of the Old Corp. CIR examined and said that this was a ploy to avoid liability, imposing upon them deficiency taxes.

While the CIR has the authority to prescribe real property values and divide the Philippines into zones, the law is clear that the same has to be done upon consultation with competent appraisers both from the public and private sectors. It is undisputed that at the time of the sale of the subject properties found in Barrio Banica, Roxas City, the same were classified as residential. The petitioner cannot unilaterally classify the same to commercial without first conducting a re-evaluation of the zonal values as mandated under Section 6(E) of the NIRC. As to the contention that consultation is needed only when there is a change in the prescribed zonal values, and what they did was merely to classify the properties to commercial and apply the zonal values, it should be noted that ALL the properties in Barrio Banica were classified as residential, under the 1995 Revised Zonal Values. The act of classifying the subject properties into commercial involves a re-classification and revision of the prescribed zonal values. While the CIR is given the authority to determine the fair market value of the subject properties for the purpose of computing internal revenue taxes, such authority is not without restriction or limitation. The first sentence of Section 6(E) sets the limitation or condition in the exercise of such power by requiring respondent to consult with competent appraisers both from private and public sectors. As to the second contention, the Guidelines provision being invoked may only be used as basis when the real property is located in an area or zone where the properties are not yet classified and their respective zonal valuation are not yet determined. The BIR itself expressed this view in a BIR Ruling. Such is not the situation in the case. This Court agrees with the observation of the CTA that "zonal valuation was established with the objective of having an efficient tax administration by minimizing the use of discretion in the determination of the tax based on the part of the administrator on one hand and the taxpayer on the other hand." Zonal value is determined for the purpose of establishing a more realistic basis for real property valuation. Since internal revenue taxes, such as CGT and DST, are assessed on the basis of valuation, the zonal valuation existing at the time of the sale should be taken into account. If petitioner feels that the properties in Barrio Banica should also be classified as commercial, then petitioner should work for its revision in accordance with Revenue Memorandum Order No. 58-69. The burden was on petitioner to prove that the classification and zonal valuation in Barrio Banica have been revised in accordance with

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Thus, in determining the value of CGT and DST arising from the sale of a property, the power of the CIR to assess is subject to Section 6(E) of the NIRC, which provides: Section 6. Power of the Commissioner to Make Assessments and Prescribe Additional Requirements for Tax Administration and Enforcement. xxxx (E) Authority of the Commissioner to Prescribe Real Property Values The Commissioner is hereby authorized to divide the Philippines into different zones or area and shall, upon consultation with competent appraisers both from the private and public sectors, determine the fair market value of real properties located in each zone or area. For purposes of computing internal revenue tax, the value of the property shall be, whichever is higher of: (1) the fair market value as determined by the Commissioner; or (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors.

the prevailing memorandum. In the absence of proof to the contrary, the 1995 Revised Zonal Values of Real Properties must be followed. COURTS RULING: Petition denied. DISPOSITION: CTA Decision affirmed. VOTE: Carpio, De Castro, Sereno and Mendonza concur. xxx i. Merger or consolidation

-Ann

9.

4.

5.

It was expressly declared that the merger of the Old Corporation with the New Corporation was necessary to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even after the expiration of the corporate existence of the former, in view of its pending booking contracts, not to mention its collective bargaining agreements with its employees. Pursuant to the said resolution, the Old Corporation and the New Corporation, signed on January 9, 1959, a Deed of Assignment a. providing for the conveyance and transfer of all the business, property, assets and goodwill of the Old Corporation to the New Corporation in exchange for the latter's shares of stock to be distributed among the shareholders on the basis of one stock for each stock held in the Old Corporation except that no new and unissued shares would be issued to the shareholders of the Old Corporation; b. the delivery by the New Corporation to the Old Corporation of 125,005-3/4 shares to be distributed to the shareholders of the Old Corporation as their corresponding shares of stock in the New Corporation; c. the assumption by the New Corporation of all obligations and liabilities of the Old Corporation under its bargaining agreement with the Cinema Stage & Radio Entertainment Free Workers (FFW) which included the retention of all personnel in the latter's employ; d. The increase of the capitalization of the New Corporation in compliance with their agreement. This agreement was made retroactive to January 1, 1959.

It was this above-narrated series of transactions that the Bureau of Internal Revenue examined later. The petitioner declared that the merger of the aforesaid corporations was not undertaken for a bona fide business purpose but merely to avoid liability for the capital gains tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the deficiency assessments against the private respondents for the amounts already mentioned. 10. Private respondents MR to the CIR was denied. They eleva ted it to the CA, which reversed the decision in favor of the private respondents. CIR: the New Corporation did not actually issue stocks in exchange for the properties of the Old Corporation at the time of the supposed merger on January 9, 1959. The exchange, he says, was only on paper. The increase in capitalization of the New Corporation was registered with the Securities and Exchange Commission only 37 days after the Old Corporation expired on January 25, 1959. Prior to such registration, it was not possible for the New Corporation to effect the exchange provided for in the said agreement because it was capitalized only at P200,000.00 as against the capitalization of the Old Corporation at P2,000,000.00. Consequently, as there was no merger, the automatic dissolution of the Old Corporation on its expiry date resulted in its liquidation, for which the respondents are now liable in taxes on their capital gains. RUFINO: there was a genuine merger between the Old Corporation and the New Corporation pursuant to a plan aimed at enabling the latter to continue the business of the former in the operation of places of amusement, specifically the Capitol and Lyric Theaters. The plan was evolved through the series of transactions above narrated, all of which could be treated as a single unit in accordance with the requirements of Section 35. Obviously, all these steps did not have to be completed at the time of the merger, as there were some of them, such as the increase and distribution of the stock of the New Corporation, which necessarily had to come afterwards. Moreover, the Old Corporation was dissolved on January 1, 1959, pursuant to the Deed of Assignment, and not on January 25, 1959, its original expiry date. As the properties of the Old Corporation were transferred to the New Corporation before that expiry date, there could not have been any distribution of liquidating dividends by the Old Corporation for which the private respondents should be held liable in taxes.

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FACTS: 1. OLD CORPORATION: The private respondents were the majority stockholders of the defunct Eastern Theatrical Co., Inc., a corporation organized in 1934, for a term of 25 years terminating on January 25, 1959. It operated theatres, opera houses and other places of amusement, including Lyric and Capitol Theaters. a. In 1949, it had an authorized capital stock of P2,000,000.00, divided into 200,000 shares at P10.00 per share b. The President of this corporation during the year in question was Ernesto D. Rufino. 2. NEW CORPORATION: The private respondents are also the majority and controlling stockholders of another corporation, the Eastern Theatrical Co Inc., which was organized on December 8, 1958, for a term of 50 years. This corporation is engaged in the same kind of business as the Old Corporation. a. It had an authorized capital stock of P200,000.00 each share having a par value of P10.00. b. The General-Manager at the time was Vicente A. Rufino. 3. In a special meeting of stockholders of the Old Corporation on December 17, 1958, to provide for the continuation of its business after the end of its corporate life, and upon the recommendation of its board of directors, a resolution was passed authorizing the Old Corporation to merge with the New Corporation by transferring its business, assets, goodwill, and liabilities to the latter, which in exchange would issue and distribute to the shareholders of the Old Corporation one share for each share held by them in the said Corporation.

6. 7.

8.

The aforesaid transfer was eventually made which continued the operation of the theaters and assumed all the obligations and liabilities of the Old Corporation. The resolution and deed of assignment was approved by the board of the New Corporation. The increased capitalization of the New Corporation to P2,000,000.00 was also divided into 200,000 shares at P10.00 par value each share, and the increase was registered with the Securities and Exchange Commission, on March 5, 1959. As agreed, and in exchange for the properties, and other assets of the Old Corporation, the New Corporation issued to the stockholders of the former stocks in the New Corporation equal to the stocks each one held in the Old Corporation, as follows: Mr. & Mrs. Vicente A. Rufino............... 17,083 shares Mr. & Mrs. Rafael R. Rufino ................. 16,881 shares Mr. & Mrs. Ernesto D. Rufino .............. 18,347 shares Mr. & Mrs. Manuel S. Galvez ............... 16,882 shares

ISSUE: 1. 2.

WON that there was a valid merger between the Old Corporation and the New Corporation. YES WON taxable gain was derived by petitioners from the exchange of their old stocks and distributed to stockholders, pursuant to a plan of reorganization. NO

Under the Corporation Code existing at the time of merger, a corporation cannot extend the terms of its existence. This prohibition, which incidentally has since been deleted, made it necessary for the Old and New Corporations to enter into the questioned merger, to enable the former to continue its unfinished business through the latter. The transaction contemplated in the old law covered the second type of merger defined by Section 35 of the Tax Code as "the acquisition by one corporation of all or substantially all of the properties of another corporation solely for stock," which is precisely what happened in the present case. What is also worth noting is that, as in the case of the Old Corporation when it was dissolved on December 31, 1958, there has been no distribution of the assets of the New Corporation since then and up to now, as far as the record discloses. To date, the private respondents have not derived any benefit from the merger of the Old Corporation and the New Corporation almost three decades earlier that will make them subject to the capital gains tax under Section 35. They are no more liable now than they were when the merger took effect in 1959, as the merger, being genuine, exempted them under the law from such tax. GOVERNMENT NOT LEFT WITHOUT RECOURSE By this decision, the government is, of course, not left entirely without recourse, at least in the future. The fact is that the merger had merely deferred the claim for taxes, which may be asserted by the government later, when gains are realized and benefits are distributed among the stockholders as a result of the merger. The reason for this conclusion is traceable to the purpose of the legislature in adopting the provision of law in question. The basic idea was to correct the Tax Code which, by imposing taxes on corporate combinations and expansions, discouraged the same to the detriment of economic progress, particularly the promotion of local industry. Speaking of this problem, HB No. 7233, which was subsequently enacted into R.A. No. 1921 embodying Section 35 as now worded, declared in the Explanatory Note: The exemption from the tax of the gain derived from exchanges of stock solely for stock of another corporation resulting from corporate mergers or consolidations under the above provisions, as amended, was intended to encourage corporations in pooling, combining or expanding their resources conducive to the economic development of the country. The merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the letter and intendment of the National Internal Revenue Code, as amended by the abovecited law, exempting from the capital gains tax exchanges of property effected under lawful corporate combinations. DISPOSITION: WHEREFORE, the decision of the Court of Tax Appeals is affirmed in full, without any pronouncement as to costs. VOTING: 1st Division. Yap (Chairman), Narvasa, Melencio-Herrera, Feliciano, Gancayco and sarmiento, JJ., concur. -Jenin

RATIO: (See Sec 35 of the NIRC) There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger. RETROACTIVITY OF TRANSACTIONS Obviously, it was necessary for the Old Corporation to surrender its net assets first to the New Corporation before the latter could issue its own stock to the shareholders of the Old Corporation because the New Corporation had to increase its capitalization for this purpose. All these took place after the date of the merger but they were deemed part and parcel of and indispensable to the validity and enforceability of, the Deed of Assignment. The Court finds no impediment to the exchange of property for stock between the two corporations being considered to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1, 1959, when the Deed of Assignment became operative. Certificates of stock issued were only evidence of ownership, but could only be issued after approval of the increase in capitalization. However, the title to them was transferred on the date the merger took effect, in accordance with the Deed of Assignment. PURPOSE OF THE MERGER The criterion laid down by the law is that the merger" must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation." One certain indication of a scheme to evade the capital gains tax is the subsequent dissolution of the new corporation after the transfer to it of the properties of the old corporation and the liquidation of the former soon thereafter. This highly suspect development is likely to be a mere subterfuge aimed at circumventing the requirements of Section 35 of the Tax Code while seeming to be a valid corporate combination NO FURTIVE INTENTION IN INSTANT CASE We see no such furtive intention in the instant case. The purpose of the merger was to continue the business of the Old Corporation, whose corporate life was about to expire, through the New Corporation to which all the assets and obligations of the former had been transferred. The New Corp was not dissolved the merger agreement in 1959. On the contrary, it continued to operate the places of amusement originally owned by the Old Corporation. In fact, it continues to do so today after taking over the business of the Old Corporation twenty-seven years ago. OLD CORPORATION CODE NECESSITATED SUCH SERIES OF TRANSACTIONS

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6. Business purpose GREGORY V. HELVERING 293 US 465 7 January 1935 Sutherland, J. FACTS: Gregory owned all of the shares of stock in United Mortgage Co. (United). United in turn owned 1.000 shares of stock of Monitor Securities Corp. (Monitor) In 1928, Gregory created a company, Averill Corp. (Averill). Three days after doing so, she had United transfer all transfer its Monitor stock to Averill and she had Averill issue all its shares to her Gregory now owned 100% of United, which no longer owned Monitor shares, and 100% of Averill, which only owned 1,000 shares of Monitor On September 24, Gregory dissolved Averill and had all its assets distributed to herself On the same day, she sold the Monitor shares to a third party for $133,333.33, but claiming cost of $57,325.45, she claimed that she should be taxed on a capital net gain on $76,007.88 On her 1928 Federal income tax return, Mrs. Gregory treated the transaction as a tax-free corporate reorganization However, the Commissioner (Helvering) argued that in terms of economic substance there really was no business reorganization He ruled that Gregory simply used the legal formalities of reorganization to dispose of shares without having to pay income tax on the gain that otherwise would have been deemed to have been realized The Commissioner determined that Gregory had understated her 1928 income tax by over $10,000 On appeal to the Board of Tax Appeals, the commissioner was overruled. However, this was reversed on appeal to the Court of Appeals for the Second Circuit Hence this present action

HELD/RATIO 1. YES Section 112 of the Revenue Act of 1928 provides:

"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock of securities shall be recognized. . . ." "(i) Definition of Reorganization. -- As used in this section . . ." "(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. . . ."

It is established that if reorganization was indeed effected, the right of the taxpayer to reduce the amount of tax to be paid, within the means allowed by law, is to be upheld

However when subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made "in pursuance of a plan of reorganization" of corporate business, and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either

In this case, there was no plan of reorganization as contemplated by the statute. In this case, the transactions had no business or corporate purpose

It was a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner

While a new and valid corporation was created that corporation was nothing more than a contrivance to the end previously described

ISSUE: 1. W/N Gregory is liable for the underpayment of income tax?

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It was brought into existence for no other purpose and it performed. When that limited function had been exercised, it immediately was put to death The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else.

The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction, upon its face, lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

It further stated in the certification that the allocation was made on the basis of the percentage of gross income in the Philippines to gross income of the corporation as a whole. [what really matters] By reason of the new adjustment, Smith Kline's tax liability was greatly reduced from P511,247 to P186,992 resulting in an overpayment of P324,255. Respondent then filed a petition with the CTA even though it had a pending case with the CIR. CTA ordered the CIR to refund the overpayment and grant a tax credit to the respondent. o CIR now appealed, hence the present case.

Thus in sum, the scheme adopted by Gregory was nothing more than a devise to avoid the payment of just taxes. Hence the deficiency assessed by the Commissioner is proper

LAWS: The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No. 466, which is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and which reads: SEC. 37. Income form sources within the Philippines. xxx xxx xxx (b) Net income from sources in the Philippines. From the items of gross income specified in subsection (a) of this section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the Philippines. xxx xxx xxx Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be made to determine the net income from Philippine sources: SEC. 160. Apportionment of deductions. From the items specified in section 37(a), as being derived specifically from sources within the Philippines there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income. EXAMPLE PROVIDED BY THE CASE: A non-resident alien individual whose taxable year is the calendar year, derived gross income from all sources for 1939 of P180,000, including therein: Interest on bonds of a domestic corporation P9,000 Dividends on stock of a domestic corporation 4,000 Royalty for the use of patents within the Philippines 12,000 Gain from sale of real property located within the Philippines 11,000

DISPOSITION: Judgement AFFIRMED -Raffy xxx 2. Taxable income from sources within the Philippines CIR vs. CTA and SMITH KLINE & FRENCH OVERSEAS CO. (January 17, 1984) DOCTRINE: (This is essentially an example of computing deductions, but if maam asks say this) Where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment. NATURE: Smith Kline asking for a tax refund due to underdeduction. PONENTE: Aquino, J. FACTS: Respondent company is a multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the Philippines. It is engaged in the importation, manufacture and sale of pharmaceuticals drugs and chemicals. o In its 1971 original income tax return, respondent claimed deductions from gross income of P501,040 ($77,060) as its share of the head office overhead expenses; o However, respondent now claims that there was an underdeduction of home office overheard, hence it made a request for refund of the overpayment with the CIR; o Respondent had received from its international auditors , an authenticated certification to the effect that the Philippine share in the unallocated overhead expenses of the main office for the year.

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EXPLANTION OF PROVISIONS From the foregoing provisions, it is manifest that where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment. The overhead expenses incurred by the parent company in connection with finance, administration, and research and development, all of which direct benefit its branches all over the world, including the Philippines, fall under a different category however. o These are items which cannot be definitely allocated or Identified with the operations of the Philippine branch. o For 1971, the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational corporation. CIR CONTENDS: The Commissioner contends that since the share of the Philippine branch has been fixed at $77,060, Smith Kline itself cannot claim more than the said amount The Commissioner also argues that the Tax Court erred in relying on the certification of Peat, Marwick, Mitchell and Company that Smith Kline is entitled to deduct P1,427,484 ($219,547) as its allotted share and that Smith Kline has not presented any evidence to show that the home office expenses chargeable to Philippine operations exceeded $77,060. RESPONDENT CONTENDS Smith Kline submits that the contract between itself and its home office cannot amend tax laws and regulations. Smith Kline had to amend its return because it is of common knowledge that audited financial statements are generally completed three or four months after the close of

COURT: The weight of evidence bolsters its position that the amount of P1,427,484 represents the correct ratable share, the same having been computed pursuant to section 37(b) and section 160. In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share of the head office overhead expenses in its income tax returns for the years 1973 to 1981, it deducted its ratable share of the total overhead expenses of its head office for those years as computed by the independent auditors hired by the parent company in Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to it. DISPOSITIVE: We hold that Smith Kline's amended 1971 return is in conformity with the law and regulations. The Tax Court correctly held that the refund or credit of the resulting overpayment is in order. WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs. -Ice xxx 6. Definition of royalties Philamlife v. CTA Ivan CIR vs. Marubeni Corp (Dec. 18, 2001) DISCLAIMER: Please read the orig of this one. I dont know if this digest will be of any real help. D: Definition of Terms: Branch Profit Remittance Tax- Any profit remitted by a branch to its head office shall be subject to a tax of fifteen (15%)

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Total P36,000 that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross income was from sources without the Philippines, determined under section 37(c). The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of P8,000 is properly allocated to income from sources within the Philippines and the amount of P40,000 is properly allocated to income from sources without the Philippines. The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A ratable part thereof, based upon the relation of gross income from sources within the Philippines to the total gross income, shall be deducted in computing net income from sources within the Philippines. Thus, these are deducted from the P36,000 of gross income from sources within the Philippines expenses amounting to P14,000 [representing P8,000 properly apportioned to the income from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses which could not be allocated to any item or class of gross income.] The remainder, P22,000, is the net income from sources within the Philippines.

the accounting period. There being no financial statements yet when the certification of January 11, 1972 was made the treasurer could not have correctly computed Smith Kline's share in the home office overhead expenses in accordance with the gross income formula prescribed in section 160 of the Revenue Regulations. What the treasurer certified was a mere estimate. Smith Kline likewise submits that it has presented ample evidence to support its claim for refund. o To this end, it has presented before the Tax Court the authenticated statement of Peat, Marwick, Mitchell and Company to show that since the gross income of the Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit report prepared by Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole was $6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses was P1,427,484 ($219,547) (Exh. G to G-2, BIR Records, 4-5).

Contractors tax A contractors tax is a tax imposed upon the privilege of engaging in business. It is generally in the nature of an excise tax Income tax- Tax on income PONENTE: PUNO, J. FACTS: Marubeni Corporation is a foreign corporation organized and existing under the laws of Japan, engaged in general import + export trading + financing + construction business. It is duly registered to engage in such business in the Philippines and maintains a branch office in Manila. Sometime in November 1985, CIR issued a letter of authority to examine the books of accounts of the Manila branch office for the fiscal year ending March 1985. They found respondent to have undeclared income from 2 contracts in the Philippines, both of which were completed in 1984. Contracts: (1) with the National Development Company (NDC) for the construction and installation of a wharf/port complex at the Leyte Industrial Development Estate (LIDE) in Isabel, Leyte. (2) with the Philippine Phosphate Fertilizer Corporation (Philphos) for the construction of an ammonia storage complex also at the LIDE. March 1, 1986 - CIR revenue examiners recommended an assessment for deficiency income, branch profit remittance, contractors and commercial brokers taxes. The assessed deficiency internal revenue taxes, inclusive of surcharge and interest, were as follows: (For March 31, 1985) Deficiency Income Tax: P 290,583,972.40, Deficiency Branch Profit Remittance Tax: P 83,036,965.16, Deficiency Commercial Brokers Tax: P 3,600,535.68 (see case for computation) CIR found that the NDC and Philphos contracts were made on a turn-key basis and that the gross income from the two projects amounted to P967,269,811.14. Each contract was for a piece of work and since the projects called for the construction and installation of facilities in the Philippines, the entire income therefrom constituted income from Philippine sources, hence, subject to internal revenue taxes. The assessment letter further stated that the same was petitioners final decision and that if respondent disagreed with it, respondent may file an appeal with the Court of Tax Appeals within thirty (30) days from receipt of the assessment. On September 26, 1986, respondent filed two (2) petitions for review with the Court of Tax Appeals. CTA Case No. 4109, questioned the deficiency income, branch profit remittance and contractors tax assessments in petitioners

assessment letter. CTA Case No. 4110, questioned the deficiency commercial brokers assessment in the same letter. (NEXT PART IS ABOUT TAX AMNESTY, which weve already [and unnecessarily THOROUGHLY] discussed. Okay to skip, but I kept this here in case she asks again. :D) August 2, 1986 Executive Order (E.O.) No. 41 declaring a one-time amnesty covering unpaid income taxes for the years 1981 to 1985 was issued. E.O., a taxpayer who wished to avail of the income tax amnesty should, on or before October 31, 1986 upon submission of certain requirements (see original for requirements) In accordance with the terms of E.O. No. 41, respondent filed its tax amnesty return dated October 30, 1986 and attached thereto its sworn statement of assets and liabilities and net worth as of Fiscal Year (FY) 1981 and FY 1986. The return was received by the BIR on November 3, 1986 and respondent paid the amount of P2,891,273.00 equivalent to ten percent (10%) of its net worth increase between 1981 and 1986. The period of the amnesty in E.O. No. 41 was later extended from October 31, 1986 to December 5, 1986 by E.O. No. 54 dated November 4, 1986. On November 17, 1986, the scope and coverage of E.O. No. 41 was expanded by Executive Order (E.O.) No. 64. In addition to the income tax amnesty granted by E.O. No. 41 for the years 1981 to 1985, E.O. No. 64 included estate and donors taxes under Title III and the tax on business un der Chapter II, Title V of the National Internal Revenue Code, also covering the years 1981 to 1985. E.O. No. 64 further provided that the immunities and privileges under E.O. No. 41 were extended to the foregoing tax liabilities, and the period within which the taxpayer could avail of the amnesty was extended to December 15, 1986. Those taxpayers who already filed their amnesty return under E.O. No. 41, as amended, could avail themselves of the benefits, immunities and privileges under the new E.O. by filing an amended return and paying an additional 5% on the increase in net worth to cover business, estate and donors tax liabilities. The period of amnesty under E.O. No. 64 was extended to January 31, 1987 by E.O No. 95 dated December 17, 1986. On December 15, 1986, respondent filed a supplemental tax amnesty return under the benefit of E.O. No. 64 and paid a further amount of P1,445,637.00 to the BIR equivalent to five percent (5%) of the increase of its net worth between 1981 and 1986.

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On July 29, 1996, The CTA rendered a decision finding tha respondent had properly availed of the tax amnesty under E.O. Nos. 41 and 64 and declared the deficiency taxes subject of said case as deemed cancelled and withdrawn. Petitioner challenged the decision of the tax court with the CA CA dismissed + affirmed CTA

ISSUES:

Petitioners claim cannot be sustained. Section 4 (b) of E.O. No. 41 is very clear and unambiguous. It excepts from income tax amnesty those taxpayers with income tax cases already filed in court as of the effectivity hereof. The point of reference is the date of effectivity of E.O. No. 41. The filing of income tax cases in court must have been made before and as of the date of effectivity of E.O. No. 41. Thus, for a taxpayer not to be disqualified under Section 4 (b) there must have been no income tax cases filed in court against him when E.O. No. 41 took effect. This is regardless of when the taxpayer filed for income tax amnesty, provided of course he files it on or before the deadline for filing. E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioning the 1985 deficiency income, branch profit remittance and contractors tax assessments was filed by respondent with the Court of Tax Appeals on September 26, 1986. When E.O. No. 41 became effective on August 22, 1986, CTA Case No. 4109 had not yet been filed in court. Respondent corporation did not fall under the said exception in Section 4 (b), hence, respondent was not disqualified from availing of the amnesty for income tax under E.O. No. 41. The same ruling also applies to the deficiency branch profit remittance tax assessment. A branch profit remittance tax is defined and imposed in Section 24 (b) (2) (ii), Title II, Chapter III of the National Internal Revenue Code. In the tax code, this tax falls under Title II on Income Tax. It is a tax on income. Respondent therefore did not fall under the exception in Section 4 (b) when it filed for amnesty of its deficiency branch profit remittance tax assessment. 2. The difficulty herein is with respect to the contractors tax assessment and respondents availment of the amnesty under E.O. No. 64. E.O. No. 64 expanded the coverage of E.O. No. 41 by including estate and donors taxes and tax on business.. The contractors tax is provided in Section 205, Chapter II, Title V of the Tax Code; it is defined and imposed under the title on business taxes, and is therefore a tax on business. When E.O. No. 64 took effect on November 17, 1986, it did not provide for exceptions to the coverage of the amnesty for business, estate and donors taxes. Instead, Section 8 of E.O. No. 64 provided that Section 8. The provisions of Executive Orders Nos. 41 and 54 which are not contrary to or inconsistent with this amendatory Executive Order shall remain in full force and effect. By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 not contrary to or inconsistent with the amendatory act were reenacted in E.O. No. 64. Thus, Section 4 of E.O. No. 41 on the exceptions to amnesty coverage also applied to E.O. No. 64. With respect to Section 4 (b) in particular, this provision excepts from tax amnesty coverage a taxpayer who has income tax cases already filed in court as of the effectivity hereof. As to what Executive Order the exception refers to, respondent argues that because of the words income and hereof, they refer to Executive Order No. 41.

W/N: Contractors tax is included in the tax amnesty considering that E.O. 64 amended E.O. 41 by including business tax in the coverage of tax amnesty W/N: Assuming that the contractors tax was not covered in the tax amnesty such tax was still exempted because it arose out of offshore activities HELD: 1. 2. 3. Yes. This applies to both the income and branch remittance tax No. It does not have retroactive effect. There was already a pending case in the CTA. The exception in E.O. 41 applies regardless if the words expressly used wasincome Yes. The Onshore activities were already declared and unquestioned. The Offshore activities were not subject to tax as they were completed in Japan.

RATIO: 1. The main controversy in this case lies in the interpretation of the exception to the amnesty coverage of E.O. Nos. 41 and 64. There are three (3) types of taxes involved herein income tax, branch profit remittance tax and contractors tax. These taxes are covered by the amnesties granted by E.O. Nos. 41 and 64. Petitioner claims, however, that respondent is disqualified from availing of the said amnesties because the latter falls under the exception in Section 4 (b) of E.O. No. 41: b) Those with income tax cases already filed in Court as of the effectivity hereof; Petitioner argues that at the time respondent filed for income tax amnesty on October 30, 1986, The CTA Case had already been filed and was pending.

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W/N: Marubeni corp could avail of the tax amnesty granted by E.O.41 and E.O. 64, considering that one of the exceptions under E.O. 41 of corps who can apply for amnesty are those with income tax cases already filed in the CTA as of its effectivity?

In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot be construed to refer to E.O. No. 41 and its date of effectivity. The general rule is that an amendatory act operates prospectively. While an amendment is generally construed as becoming a part of the original act as if it had always been contained therein, it may not be given a retroactive effect unless it is so provided expressly or by necessary implication and no vested right or obligations of contract are thereby impaired. There is nothing in E.O. No. 64 that provides that it should retroact to the date of effectivity of E.O. No. 41, the original issuance. Neither is it implied. Executive Order No. 64 is a substantive amendment of E.O. No. 41. It does not merely change provisions in E.O. No. 41. It supplements the original act by adding other taxes not covered in the first. It has been held that where a statute amending a tax law is silent as to whether it operates retroactively, the amendment will not be given a retroactive effect so as to subject to tax past transactions not subject to tax under the original act. In an amendatory act, every case of doubt must be resolved against its retroactive effect. Moreover, E.O. Nos. 41 and 64 are tax amnesty issuances. A tax amnesty is a general pardon or intentional overlooking by the State of its authority to impose penalties on persons otherwise guilty of evasion or violation of a revenue or tax law. It partakes of an absolute forgiveness or waiver by the government of its right to collect what is due it and to give tax evaders who wish to relent a chance to start with a clean slate. A tax amnesty, much like a tax exemption, is never favored nor presumed in law. If granted, the terms of the amnesty, like that of a tax exemption, must be construed strictly against the taxpayer and liberally in favor of the taxing authority. For the right of taxation is inherent in government. The State cannot strip itself of the most essential power of taxation by doubtful words. He who claims an exemption (or an amnesty) from the common burden must justify his claim by the clearest grant of organic or state law. It cannot be allowed to exist upon a vague implication. If a doubt arises as to the intent of the legislature, that doubt must be resolved in favor of the state. The vagueness in Section 4 (b) brought about by E.O. No. 64 should therefore be construed strictly against the taxpayer. The term income tax cases should be read as to refer to estate and donors taxes and taxes on business while the word hereof, to E.O. No. 64. Since Executive Order No. 64 took effect on November 17, 1986, consequently, insofar as the taxes in E.O. No. 64 are concerned, the date of effectivity referred to in Section 4 (b) of E.O. No. 41 should be November 17, 1986. Respondent filed CTA Case No. 4109 on September 26, 1986. When E.O. No. 64 took effect on November 17, 1986, CTA Case No. 4109 was already filed and pending in court. 3. MARUBENIs argument: Assuming it (Marubeni) did not validly avail of the amnesty under the two Executive Orders, it is still not liable for the deficiency contractors tax because the income from the projects came from the Offshore Portion of the contracts. The two contracts were divided into two parts, i.e., the Onshore Portion and the Offshore Portion. All materials and equipment in the contract under the Offshore Portion were manufactured and

completed in Japan, not in the Philippines, and are therefore not subject to Philippine taxes.

Under the Philippine Onshore Portion, Marubeni does not deny its liability for the contractors tax on the income from the two projects. In fact respondent claims, which petitioner has not denied, that the income it derived from the Onshore Portion of the two projects had been declared for tax purposes and the taxes thereon already paid to the Philippine government.

The situs of the two projects is in the Philippines, and the materials provided and services rendered were all done and completed within the territorial jurisdiction of the Philippines. Accordingly, respondents entire receipts from the contracts, including its receipts from the Offshore Portion, constitute income from Philippine sources. The total gross receipts covering both labor and materials should be subjected to contractors tax in accordance with the ruling in Commissioner of Internal Revenue v. Engineering Equipment & Supply A contractors tax is imposed in the National Internal Revenue Code (NIRC) as follows: Sec. 205. Contractors, proprietors or operators of dockyards, and others.A contractors tax of four percent of the gross receipts is hereby imposed on proprietors or operators of the following business establishments and/or persons engaged in the business of selling or rendering the following services for a fee or compensation: (a) General engineering, general building and specialty contractors, as defined in Republic Act No. 4566; xxx (q) Other independent contractors. The term independent contractors includes persons (juridical or natural) not enumerated above (but not including individuals subject to the occupation tax under 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

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It is with regard to the gross receipts from the Foreign Offshore Portion of the two contracts that the liabilities involved in the assessments subject of this case arose. Petitioner argues that since the two agreements are turn-key, they call for the supply of both materials and services to the client, they are contracts for a piece of work and are indivisible.

the physical or mental faculties of such contractors or their employees. It does not include regional or area headquarters established in the Philippines by multinational corporations, including their alien executives, and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating centers for their affiliates, subsidiaries or branches in the Asia-Pacific Region. xxx Under the afore-quoted provision, an independent contractor is a person 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. The word contractor refers to a person who, in the pursuit of independent business, undertakes to do a specific job or piece of work for other persons, using his own means and methods without submitting himself to control as to the petty details. A contractors tax is a tax imposed upon the privilege of engaging in business. It is generally in the nature of an excise tax on the exercise of a privilege of selling services or labor rather than a sale on products; and is directly collectible from the person exercising the privilege. Being an excise tax, it can be levied by the taxing authority only when the acts, privileges or business are done or performed within the jurisdiction of said authority. Like property taxes, it cannot be imposed on an occupation or privilege outside the taxing district. The court examined the history of the relations between Marubeni and the two Philippine corporations and their contract and held that: These acts occurred in two countries Japan and the Philippines. While the construction and installation work were completed within the Philippines, the evidence is clear that some pieces of equipment and supplies were completely designed and engineered in Japan. The two sets of ship unloader and loader, the boats and mobile equipment for the NDC project and the ammonia storage tanks and refrigeration units were made and completed in Japan. They were already finished products when shipped to the Philippines. The other construction supplies listed under the Offshore Portion such as the steel sheets, pipes and structures, electrical and instrumental apparatus, these were not finished products when shipped to the Philippines. They, however, were likewise fabricated and manufactured by the sub-contractors in Japan. All services for the design, fabrication, engineering and manufacture of the materials and equipment under Japanese Yen Portion I were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the Philippines and are therefore not subject to contractors tax. DISPOSITIVE: IN VIEW WHEREOF, the petition is denied. The decision in CA-G.R. SP No. 42518 is affirmed. SO ORDERED.

VOTE: Davide, Jr., C.J., (Chairman), Kapunan, Pardo, and Ynares-Santiago, JJ., concur. NOTE: PLEASE READ THE ORIG!!! -Kriszanne (modified Jamies orig digest) xxx iii. Accounting method (cash [actual or constructive] or accrual) Hybrid method CONSOLIDATED MINES, INC, petitioner, -versusCOURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE respondents. And COMMISSIONER OF INTERNAL REVENUE, petitioner, -versusCONSOLIDATED MINES, INC, respondents. (August 29, 1974 | G.R. Nos. L-18843 and L-18844 | First Division) DOCTRINE: XXX With respect to methods of accounting, the Tax Code states: Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income the computation shall be made in accordance with such methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the income ... Sec. 39. Period in which items of gross income included. The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the methods of accounting permitted under section 38, any such amounts are to be properly accounted for as of a different period ... Sec. 40. Period for which deductions and credits taken. The deductions provided for in this Title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred" dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions should be taken as of a different period. XXX FOOTNOTE 4:

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The 1954 Code of the United States added new provisions setting out the methods of accounting that may be used for tax purposes. These are: (1) the cash receipts and disbursements method; (2) an accrual method; (3) any other method permitted by the Code provisions, such as the completed contract method or the installment method; and (4) any combination of these methods permitted under the Regulations of the Treasury Department. It should be noted that these provisions explicitly allow the use of a hybrid method of accounting in accordance with regulations to be issued by the Treasury Department. (2 Mertens, The Law of Federal Income Taxation, 1961 ed., Chapter 12, pp. 18-19. For the exact wording of the U.S. Tax Code, see Sec. 446 IRC 26 USCA 446, p. 398. The Philippine Tax Code does not have a provision similar thereto.) XXX TYPE OF TAX INVOLVED: Income Tax NATURE: These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases No. 565 and 578. PONENTE: MAKALINTAL, C.J. FACTS: These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases No. 565 and 578, both entitled "Consolidated Mines, Inc. vs. Commissioner of Internal Revenue," ordering the Consolidated Mines, Inc., hereinafter referred to as the Company, to pay the Commissioner of Internal Revenue the amounts of P79,812.93, P51,528.24 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P202,733.99, plus 5% surcharge and 1% monthly interest from the date of finality of the decision. The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953 and 1956. In 1957 examiners of the Bureau of Internal Revenue investigated the income tax returns filed by the Company because on August 10, 1954, its auditor, Felipe Ollada claimed the refund of the sum of P107,472.00 representing alleged overpayments of income taxes for the year 1951. After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share in the company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax purposes the Company had reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956 (1) the Company had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported by evidence. In view of said reports the Commissioner of Internal Revenue sent the Company a letter of demand requiring it to pay certain deficiency income taxes for the years 1951 to 1954, inclusive, and for the year 1956. Deficiency income tax assessment notices for said years were also sent to the Company. The Company requested a reconsideration of the

assessment, but the Commissioner refused to reconsider, hence the Company appealed to the Court of Tax Appeals. The assessments for 1951 to 1954 were contested in CTA Case No. 565, while that for 1956 was contested in CTA Case No. 578. Upon agreement of the parties the two cases were heard and decided jointly. On May 6, 1961 the Tax Court rendered judgment ordering the Company to pay the amounts of P107,846.56, P134,033.01 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively. The Tax Court nullified the assessments for the years 1951 and 1952 on the ground that they were issued beyond the five-year period prescribed by Section 331 of the National Internal Revenue Code. However, on August 7, 1961, upon motion of the Company, the Tax Court reconsidered its decision and further reduced the deficiency income tax liabilities of the Company to P79,812.93, P51,528.24 and P71,382.82 for the years 1953, 1954 and 1956, respectively. In this amended decision the Tax Court subscribed to the theory of the Company that Benguet Consolidated Mining Company, hereafter referred to as Benguet, had no right to share in "Accounts Receivable," hence one-half thereof may not be accrued as an expense of the Company for a given year. XXX The Company has certain mining claims located in Masinloc, Zambales. Because it wanted to relieve itself of the work and expense necessary for developing the claims, the Company, on July 9, 1934, entered into an agreement (Exhibit L) with Benguet, a domestic anonymous partnership engaged in the production and marketing of chromite, whereby the latter undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims. The pertinent provisions of their agreement, as amended by the supplemental agreements of September 14, 1939 (Exhibit L-1) and October 2, 1941 (Exhibit L-2), are as follows: IV. Benguet further agrees to provide such funds from its own resources as are in its judgment necessary for the exploration and development of said claims and properties, for the purchase and construction of said concentrator plant and for the installation of the proper transportation facilities as provided in paragraphs I, II and III hereof until such time as the said properties are on a profit producing basis and agrees thereafter to expand additional funds from its own resources, if the income from the said claims is insufficient therefor, in the exploration and development of said properties or in the enlargement or extension of said concentration and transportation facilities if in its judgment good mining practice requires such additional expenditures. Such expenditures from its own resources prior to the time the said properties are put on a profit producing basis shall be reimbursed as provided in paragraph VIII hereof. Expenditures from its own resources thereafter shall be charged against the subsequent gross income of the properties as provided in paragraph X hereof. VII. As soon as practicable after the close of each month Benguet shall furnish Consolidated with a statement showing its expenditures made and ore settlements received under this agreement for the preceding month which statement shall betaken as accepted by Consolidated unless exception is taken thereto or to any item thereof

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within ten days in writing in which case the dispute shall be settled by agreement or by arbitration as provided in paragraph XXII hereof. VIII. While Benguet is being reimbursed for all its expenditures, advances and disbursements hereunder as evidenced by said statements of accounts, the net profits resulting from the operation of the aforesaid claims or properties shall be divided ninety per cent (90%) to Benguet and ten per cent (10%) to Consolidated. Such division of net profits shall be based on the receipts, and expenditures during each calendar year, and shall continue until such time as the ninety per cent (90%) of the net profits pertaining to Benguet hereunder shall equal the amount of such expenditures, advances and disbursements. The net profits shall be computed as provided in Paragraph X hereof. X. After Benguet has been fully reimbursed for its expenditures, advances and disbursements as aforesaid the net profits from the operation shall be divided between Benguet and Consolidated share and share alike, it being understood however, that the net profits as the term is used in this agreement shall be computed by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of this agreement. XIII. It is understood that Benguet shall receive no compensation for services rendered as manager or technical consultants in connection with the carrying out of this agreement. It may, however, charge against the operation actual additional expenses incurred in its Manila Office in connection with the carrying out of the terms of this agreement including traveling expenses of consulting staff to the mines. Such expenses, however, shall not exceed the sum of One Thousand Pesos (P1,000.00) per month. Otherwise, the sole compensation of Benguet shall be its proportion of the net profits of the operation as herein above set forth. XIV. All payments due Consolidated by Benguet under the terms of this agreement with respect to expenditures made and ore settlements received during the preceding calendar month, shall be payable on or before the twentieth day of each month. There is no question with respect to the 90%-10% sharing of profits while Benguet was being reimbursed the expenses disbursed during the period it was trying to put the mines on a profit-producing basis. It appears that by 1953 Benguet had completely recouped said advances, because they were then dividing the profits share and share alike. ISSUE: (a) Did the company use a hybrid method of accounting?

A. MAIN ISSUE XXX With respect to methods of accounting, the Tax Code states: Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income the computation shall be made in accordance with such methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the income ... Sec. 39. Period in which items of gross income included. The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the methods of accounting permitted under section 38, any such amounts are to be properly accounted for as of a different period ... Sec. 40. Period for which deductions and credits taken. The deductions provided for in this Title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred" dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions should be taken as of a different period. It is said that accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions. The U.S. Internal Revenue Code allows each taxpayer to adopt the accounting method most suitable to his business, and requires only that taxable income generally be based on the method of accounting regularly employed in keeping the taxpayer's books, provided that the method clearly reflects income. The Company used the accrual method of accounting in computing its income. One of its expenses is the amount-paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem, therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis. XXX The following table (summary, Exhibit A, of examiner's report of January 28, 1967, Exh. 8) prepared for the Commissioner graphically illustrates the effect of the inclusion of one-half of "Accounts Receivable" as expense in the computation of the net income of the Company:

HELD: (a) NO. The Company used the accrual method of accounting in computing its income. One of its expenses is the amount-paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem, therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis. REASONING:

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SUMMARY: Original share of Benguet Additional share Rec'bles of

1951 1,313,640.26 383,829.87

1952 3,521,751,94 677,504.76

1953 2,340,624.59 577,394.66

1954 2,622,968.58 282,724.76

received during the calendar month shall be payable on or before the twentieth of each month." The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from the terms of the agreement? The statement of accounts (par. VIII) and the payment part (XIV) that Benguet must make are both with respect to "expenditures made and ore settlements received." "Expenditures" are payments of money. This is the meaning intended by the parties, considering the provision that Benguet agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources" were to be reimbursed first as provided in par. VIII, and later as provided in par. X. "Settlement" does not necessarily mean payment or satisfaction, though it may mean that; it frequently means adjustment or arrangement. The term "settlement" may be used in the sense of "payment," or it may be used in the sense of "adjustment" or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance between contending parties," depending upon the circumstances under which, and the connection in which, use of the term is made. In the term "ore settlements received," the word "settlement" was not used in the concept of "adjustment," "arrangement" or "ascertainment of a balance between contending parties," since all these are "made," not "received." "Payment," then, is the more appropriate equivalent of, and interchangeable with, the term "Settlement." Hence, "ore settlements received" means "ore payments received," which excludes "Accounts Receivable." Thus, both par. VIII and par. XIV refer to "payment," either received or paid by Benguet. According to par. X, the 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of the agreement." The term "gross profit" was not defined. In the accrual method of accounting "gross income" would include both "cash receipts" and "Accounts Receivable." But the term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be defined in such a way as to ascertain the sense in which the parties have used it in contracting. According to par. VIII the "division of net profits shall be based on the receipts and expenditures." The term "expenditures" we have already analyzed. As used, receipts" means "money received." The same par. VIII uses the term "expenditures, advances and disbursements." "Disbursements" means "payment," while the word "advances" when used in a contract ordinarily means money furnished with an expectation that it shall be returned. 16 It is thus clear from par. VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing arrangement) only "cash payments" received and "cash disbursements" made by Benguet were to be considered. On the presumption that the parties were consistent in the use of the term, the same meaning must be given to "net profits" as used in par. X, and "gross income," accordingly, must be equated with "cash receipts." The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual receipts over disbursements, without considering "Accounts Receivable" and "Accounts Payable" as factors in the computation. Benguet then did not have a right to share in "Accounts Receivable," and, correspondingly, the Company did not have the liability to pay Benguet any part of that item. And a deduction cannot be accrued until an actual liability is incurred, even if payment has not been made.

Total share of Benguet Less: Receipts due from prior year operation Share Benguet adjusted (Acc'rd) of as

1,697,470.13 269,619.00

4,199,256.70 383,829.87

2,918,009.25 677,504.76

2,905,693.34 577,384.66

1,427,851.13

3,815,426.83

2,240,504.49

2,328,308.68

Less: Participation of Benguet already deducted Additional Expense (Income)

1,313,640.26

3,521,751.94

2,340,624.59

2,622,968.58

114,210.87

293,674.89

(100,120.10)

(294,659.90)

In the aforesaid table "Additional share on Rec'bles" is one-half of "Total Rec'bles minus "Total Payables." It indicates, from the Commissioner's viewpoint, that there were years when the Company had been overstating its income (1951 and 1952) and there were years when it had been understating its income (1953 and 1954). The Commissioner is not interested in the taxes for 1951 and 1952 (which had prescribed anyway) when the Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the "Accounts Receivable" was less than that of the previous year, and the Company, therefore, appears to have deducted, as expense, compensation to Benguet bigger (than what the Commissioner claims is due) by one-half of the difference between the year's "Accounts Receivable" and the previous year's "Accounts Receivable," thus apparently understating its income to that extent. According to the agreement between the Company and Benguet the net profits "shall be computed by deducting from gross income all operating expenses and all expenses of any nature whatsoever." Periodically, Benguet was to furnish the Company with the statement of accounts for a given month "as soon as practicable after the close" of that month. The Company had ten days from receipt of the statement to register its objections thereto. Thereafter, the statement was considered binding on the Company. And all payments due the Company "with respect to the expenditures made and ore settlements

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Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing said one-half as a deduction. The Company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting. XXX In resume, this Court finds: (1) that the Company was not using a "hybrid" method of accounting in the preparation of its income tax returns, but was consistent in its use of the accrual method of accounting; XXX DISPOSITIVE: WHEREFORE, the appealed decision is hereby MODIFIED by ordering Consolidated Mines, Inc. to pay the Commissioner of Internal Revenue the amounts of P76,254.92, P48,511.56 and P66,881.14 as deficiency income taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P191,647.62 under the terms specified by the Tax Court, without pronouncement as to costs. VOTES: Castro, Makasiar, Esguerra and Muoz Palma, JJ., concur. Teehankee, J., took no part. NO DISSENTING/CONCURRING OPINION. -Poy

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Here we have to distinguish between (1) the method of accounting used by the Company in determining its net income for tax purposes; and (2) the method of computation agreed upon between the Company and Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation the basis were "cash receipts" and "cash payments." Once determined in accordance with the stipulated bases and procedure, then the amount due Benguet for each month accrued at the end of that month, whether the Company had made payment or not (see par. XIV of the agreement). To make the Company deduct as an expense one-half of the "Accounts Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated by them.