Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-12287

August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO
CONCEPCION, Deputy Collector of Internal Revenue, defendants-appellees.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:
This appeal calls for consideration of the Income Tax Law, a law of American
origin, with reference to the Civil Code, a law of Spanish origin.
STATEMENT OF THE CASE.
Vicente Madrigal and Susana Paterno were legally married prior to January 1,
1914. The marriage was contracted under the provisions of law concerning
conjugal partnerships (sociedad de gananciales). On February 25, 1915, Vicente
Madrigal filed sworn declaration on the prescribed form with the Collector of
Internal Revenue, showing, as his total net income for the year 1914, the sum of
P296,302.73. Subsequently Madrigal submitted the claim that the said
P296,302.73 did not represent his income for the year 1914, but was in fact the
income of the conjugal partnership existing between himself and his wife Susana
Paterno, and that in computing and assessing the additional income tax provided
by the Act of Congress of October 3, 1913, the income declared by Vicente
Madrigal should be divided into two equal parts, one-half to be considered the
income of Vicente Madrigal and the other half of Susana Paterno. The general
question had in the meantime been submitted to the Attorney-General of the

Philippine Islands who in an opinion dated March 17, 1915, held with the
petitioner Madrigal. The revenue officers being still unsatisfied, the
correspondence together with this opinion was forwarded to Washington for a
decision by the United States Treasury Department. The United States
Commissioner of Internal Revenue reversed the opinion of the Attorney-General,
and thus decided against the claim of Madrigal.
After payment under protest, and after the protest of Madrigal had been decided
adversely by the Collector of Internal Revenue, action was begun by Vicente
Madrigal and his wife Susana Paterno in the Court of First Instance of the city of
Manila against Collector of Internal Revenue and the Deputy Collector of Internal
Revenue for the recovery of the sum of P3,786.08, alleged to have been
wrongfully and illegally collected by the defendants from the plaintiff, Vicente
Madrigal, under the provisions of the Act of Congress known as the Income Tax
Law. The burden of the complaint was that if the income tax for the year 1914
had been correctly and lawfully computed there would have been due payable by
each of the plaintiffs the sum of P2,921.09, which taken together amounts of a
total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected
from the plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid
as income tax for the year 1914, P3,786.08, in excess of the sum lawfully due
and payable.
The answer of the defendants, together with an analysis of the tax declaration,
the pleadings, and the stipulation, sets forth the basis of defendants' stand in the
following way: The income of Vicente Madrigal and his wife Susana Paterno of
the year 1914 was made up of three items: (1) P362,407.67, the profits made by
Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits
made by Susana Paterno in her embroidery business; (3) P16,687.80, the profits
made by Vicente Madrigal in a pawnshop company. The sum of these three
items is P383,181.97, the gross income of Vicente Madrigal and Susana Paterno
for the year 1914. General deductions were claimed and allowed in the sum of
P86,879.24. The resulting net income was P296,302.73. For the purpose of
assessing the normal tax of one per cent on the net income there were allowed
as specific deductions the following: (1) P16,687.80, the tax upon which was to
be paid at source, and (2) P8,000, the specific exemption granted to Vicente
Madrigal and Susana Paterno, husband and wife. The remainder, P271,614.93

was the sum upon which the normal tax of one per cent was assessed. The
normal tax thus arrived at was P2,716.15.
The dispute between the plaintiffs and the defendants concerned the additional
tax provided for in the Income Tax Law. The trial court in an exhausted decision
found in favor of defendants, without costs.
ISSUES.
The contentions of plaintiffs and appellants having to do solely with the additional
income tax, is that is should be divided into two equal parts, because of the
conjugal partnership existing between them. The learned argument of counsel is
mostly based upon the provisions of the Civil Code establishing the sociedad de
gananciales. The counter contentions of appellees are that the taxes imposed by
the Income Tax Law are as the name implies taxes upon income tax and not
upon capital and property; that the fact that Madrigal was a married man, and his
marriage contracted under the provisions governing the conjugal partnership, has
no bearing on income considered as income, and that the distinction must be
drawn between the ordinary form of commercial partnership and the conjugal
partnership of spouses resulting from the relation of marriage.
DECISION.
From the point of view of test of faculty in taxation, no less than five answers
have been given the course of history. The final stage has been the selection of
income as the norm of taxation. (See Seligman, "The Income Tax," Introduction.)
The Income Tax Law of the United States, extended to the Philippine Islands, is
the result of an effect on the part of the legislators to put into statutory form this
canon of taxation and of social reform. The aim has been to mitigate the evils
arising from inequalities of wealth by a progressive scheme of taxation, which
places the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the minimum
of subsistence. With these exceptions, the income tax is supposed to reach the
earnings of the entire non-governmental property of the country. Such is the
background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential

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

separately has an income of $3,000 per annum. They are jointly and separately
liable for such return and for the payment of the tax. The single or married status
of the person claiming the specific exemption shall be determined as one of the
time of claiming such exemption which return is made, otherwise the status at the
close of the year."
With these general observations relative to the Income Tax Law in force in the
Philippine Islands, we turn for a moment to consider the provisions of the Civil
Code dealing with the conjugal partnership. Recently in two elaborate decisions
in which a long line of Spanish authorities were cited, this court in speaking of the
conjugal partnership, decided that "prior to the liquidation the interest of the wife
and in case of her death, of her heirs, is an interest inchoate, a mere expectancy,
which constitutes neither a legal nor an equitable estate, and does not ripen into
title until there appears that there are assets in the community as a result of the
liquidation and settlement." (Nable Josevs. Nable Jose [1916], 15 Off. Gaz., 871;
Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)
Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of
her husband Vicente Madrigal during the life of the conjugal partnership. She has
an interest in the ultimate property rights and in the ultimate ownership of
property acquired as income after such income has become capital. Susana
Paterno has no absolute right to one-half the income of the conjugal partnership.
Not being seized of a separate estate, Susana Paterno cannot make a separate
return in order to receive the benefit of the exemption which would arise by
reason of the additional tax. As she has no estate and income, actually and
legally vested in her and entirely distinct from her husband's property, the income
cannot properly be considered the separate income of the wife for the purposes
of the additional tax. Moreover, the Income Tax Law does not look on the
spouses as individual partners in an ordinary partnership. The husband and wife
are only entitled to the exemption of P8,000 specifically granted by the law. The
higher schedules of the additional tax directed at the incomes of the wealthy may
not be partially defeated by reliance on provisions in our Civil Code dealing with
the conjugal partnership and having no application to the Income Tax Law. The
aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the AttorneyGeneral of the Philippine Islands and the United States Treasury Department.
The decision of the latter overruling the opinion of the Attorney-General is as
follows:
TREASURY
DEPARTMENT, Washington.
Income Tax.
FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.
SIR: This office is in receipt of your letter of June 22, 1915, transmitting
copy of correspondence "from the Philippine authorities relative to the
method of submission of income tax returns by marred person."
You advise that "The Governor-General, in forwarding the papers to the
Bureau, advises that the Insular Auditor has been authorized to suspend
action on the warrants in question until an authoritative decision on the
points raised can be secured from the Treasury Department."
From the correspondence it appears that Gregorio Araneta, married and
living with his wife, had an income of an amount sufficient to require the
imposition of the net income was properly computed and then both
income and deductions and the specific exemption were divided in half
and two returns made, one return for each half in the names respectively
of the husband and wife, so that under the returns as filed there would be
an escape from the additional tax; that Araneta claims the returns are
correct on the ground under the Philippine law his wife is entitled to half
of his earnings; that Araneta has dominion over the income and under the
Philippine law, the right to determine its use and disposition; that in this
case the wife has no "separate estate" within the contemplation of the Act
of October 3, 1913, levying an income tax.

It appears further from the correspondence that upon the foregoing

explanation, tax was assessed against the entire net income against
Gregorio Araneta; that the tax was paid and an application for refund
made, and that the application for refund was rejected, whereupon the
matter was submitted to the Attorney-General of the Islands who holds
that the returns were correctly rendered, and that the refund should be
allowed; and thereupon the question at issue is submitted through the
Governor-General of the Islands and Bureau of Insular Affairs for the
advisory opinion of this office.
By paragraph M of the statute, its provisions are extended to the
Philippine Islands, to be administered as in the United States but by the
appropriate internal-revenue officers of the Philippine Government. You
are therefore advised that upon the facts as stated, this office holds that
for the Federal Income Tax (Act of October 3, 1913), the entire net
income in this case was taxable to Gregorio Araneta, both for the normal
and additional tax, and that the application for refund was properly
rejected.
The separate estate of a married woman within the contemplation of the
Income Tax Law is that which belongs to her solely and separate and
apart from her husband, and over which her husband has no right in
equity. It may consist of lands or chattels.
The statute and the regulations promulgated in accordance therewith
provide that each person of lawful age (not excused from so doing)
having a net income of $3,000 or over for the taxable year shall make a
return showing the facts; that from the net income so shown there shall
be deducted $3,000 where the person making the return is a single
person, or married and not living with consort, and $1,000 additional
where the person making the return is married and living with consort; but
that where the husband and wife both make returns (they living together),
the amount of deduction from the aggregate of their several incomes
shall not exceed $4,000.

The only occasion for a wife making a return is where she has income
from a sole and separate estate in excess of $3,000, but together they
have an income in excess of $4,000, in which the latter event either the
husband or wife may make the return but not both. In all instances the
income of husband and wife whether from separate estates or not, is
taken as a whole for the purpose of the normal tax. Where the wife has
income from a separate estate makes return made by her husband, while
the incomes are added together for the purpose of the normal tax they
are taken separately for the purpose of the additional tax. In this case,
however, the wife has no separate income within the contemplation of the
Income Tax Law.
Respectfully,

DAVID A. GATES.
Acting Commissioner.

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