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DONORS TAX

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G.R. |No.
1 210987, November 24, 2014, THE PHILIPPINE AMERICAN LIFE AND GENERAL

INSURANCE COMPANY, Petitioner, vs. THE SECRETARY OF FINANCE and THE


COMMISSIONER OF INTERNAL REVENUE, Respondents.
FACTS: Petitioner The Philippine American Life and General Insurance Company
(Philamlife) used to own 498,590 Class A shares in Philam Care Health Systems, Inc.
(PhilamCare), representing 49.89% of the latter's outstanding capital stock. In 2009,
petitioner, in a bid to divest itself of its interests in the health maintenance
organization industry, offered to sell its shareholdings in PhilamCare through
competitive bidding. Thus, on September 24, 2009, petitioner's Class A shares were
sold for USD 2,190,000, or PhP 104,259,330 based on the prevailing exchange rate
at the time of the sale, to STI Investments, Inc., who emerged as the highest bidder.
After the sale was completed and the necessary documentary stamp and capital
gains taxes were paid, Philamlife filed an application for a certificate authorizing
registration/tax clearance with the (BIR) Large Taxpayers Service Division to
facilitate the transfer of the shares. Months later, petitioner was informed that it
needed to secure a BIR ruling in connection with its application due to potential
donors tax liability. In compliance, petitioner, on January 4, 2012, requested a ruling
to confirm that the sale was not subject to donors tax, pointing out, in its request,
the following: that the transaction cannot attract donors tax liability since there was
no donative intent and, ergo, no taxable donation, citing BIR Ruling that the shares
were sold at their actual fair market value and at arms length; that as long as the
transaction conducted is at arms lengthsuch that a bona fide business
arrangement of the dealings is done in the ordinary course of businessa sale for
less than an adequate consideration is not subject to donors tax; and that donors
tax does not apply to sale of shares sold in an open bidding process.

CIR: denied Philamlifes request. As determined by the Commissioner, the selling


price of the shares thus sold was lower than their book value based on the financial
statements of PhilamCare as of the end of 2008. As such, the Commisioner held,
donors tax became imposable on the price difference pursuant to Sec. 100 of the
(NIRC), viz:
SEC. 100. Transfer for Less Than Adequate and full Consideration.- Where
property, other than real property referred to in Section 24(D), is
transferred for less than an adequate and full consideration in money or
moneys worth, then the amount by which the fair market value of the
property exceeded the value of the consideration shall, for the purpose of
the tax imposed by this Chapter, be deemed a gift, and shall be included in
computing the amount of gifts made during the calendar year.
Implemented by Revenue Regulation 6-2008 (RR 6-2008), which provides:

SEC. 7. SALE, BARTER OR EXCHANGE OF SHARES OF STOCK NOT TRADED


THROUGH A LOCAL STOCK EXCHANGE PURSUANT TO SECS. 24(C), 25(A)(3),
25(B), 27(D)(2), 28(A)(7)(c), 28(B)(5)(c) OF THE TAX CODE, AS AMENDED.
xxxx
(c) Determination of Amount and Recognition of Gain or Loss
(c.1) In the case of cash sale, the selling price shall be the consideration
per deed of sale.
xxxx
(c.1.4) In case the fair market value of the shares of stock sold, bartered,
or exchanged is greater than the amount of money and/or fair market
value of the property received, the excess of the fair market value of the
shares of stock sold, bartered or exchanged over the amount of money and
the fair market value of the property, if any, received as consideration
shall be deemed a gift subject to the donors tax under Section 100 of the
Tax Code, as amended.
xxxx
(c.2) Definition of fair market valueof Shares of Stock. For purposes of
this Section, fair market value of the share of stock sold shall be:
xxxx
(c.2.2) In the case of shares of stock not listed and traded in the local
stock exchanges, the book value of the shares of stock as shown in the
financial statements duly certified by an independent certified public
accountant nearest to the date of sale shall be the fair market value.

Commissioner ruled that the difference between the book value and the selling
price in the sales transaction is taxable donation subject to a 30% donors tax under
Section 99(B) of the NIRC.7 Respondent Commissioner likewise held that BIR Ruling
on which petitioner anchored its claim, has already been revoked by (RMC) No. 252011.
Respondent Secretary: affirmed the Commissioners assailed ruling in its entirety.
CA: Petition for Review under Rule 43 is DISMISSED for lack of jurisdiction.
In disposing of the CA petition, the appellate court ratiocinated that it is the Court of
Tax Appeals (CTA), pursuant to Sec. 7(a)(1) of Republic Act No. 1125 (RA 1125), as
amended, which has jurisdiction over the issues raised. The outright dismissal, so
the CA held, is predicated on the postulate that BIR Ruling No. 015-12 was issued in
the exercise of the Commissioners power to interpret the NIRC and other tax laws.

Consequently, requesting for its review can be categorized as "other matters arising
Pagethe NIRC or other laws administered by the BIR," which is under the
under
jurisdiction
| 2 of the CTA, not the CA.
Motion for Reconsideration denied.
ISSUES:
1. Whether or not the CA erred in dismissing the Petition for lack of jurisdiction; and

2. Whether or not the price difference in petitioners adverted sale of shares in


PhilamCare attracts donors tax.
HELD: The petition is unmeritorious. Reviews by the Secretary of Finance pursuant
to Sec. 4 of the NIRC are appealable to the CTA.
Preliminarily, it bears stressing that there is no dispute that what is involved herein
is the respondent Commissioners exercise of power under the first paragraph of
Sec. 4 of the NIRCthe power to interpret tax laws. This, in fact, was recognized by
the appellate court itself, but erroneously held that her action in the exercise of such
power is appealable directly to the CTA. As correctly pointed out by petitioner, Sec. 4
of the NIRC readily provides that the Commissioners power to interpret the
provisions of this Code and other tax laws is subject to review by the Secretary of
Finance. The issue that now arises is thiswhere does one seek immediate recourse
from the adverse ruling of the Secretary of Finance in its exercise of its power of
review under Sec. 4?
1.) No, it did not. Admittedly, there is no provision in law that expressly provides
where exactly the ruling of the Secretary of Finance under the adverted NIRC
provision is appealable to. However, SC finds that Sec. 7(a)(1) of RA 1125, as
amended, addresses the seeming gap in the law as it vests the CTA, albeit impliedly,
with jurisdiction over the CA petition as "other matters" arising under the NIRC or
other laws administered by the BIR. As stated:
Sec. 7. Jurisdiction.- The CTA shall exercise:
a. Exclusive appellate jurisdiction to review by appeal, as herein provided:
1. Decisions of the Commissioner of Internal Revenue in cases involving disputed
assessments, refunds of internal revenue taxes, fees or other charges, penalties in
relation thereto, or other matters arising under the National Internal Revenue or
other laws administered by the Bureau of Internal Revenue.
Even though the provision suggests that it only covers rulings of the Commissioner,
SC hold that it is, nonetheless, sufficient enough to include appeals from the
Secretarys review under Sec. 4 of the NIRC.

It is axiomatic that laws should be given a reasonable interpretation which does not
defeat the very purpose for which they were passed.17 Courts should not follow the
letter of a statute when to do so would depart from the true intent of the legislature
or would otherwise yield conclusions inconsistent with the purpose of the act. This
Court has, in many cases involving the construction of statutes, cautioned against
narrowly interpreting a statute as to defeat the purpose of the legislator, and
rejected the literal interpretation of statutes if to do so would lead to unjust or
absurd results.19

Indeed, to leave undetermined the mode of appeal from the Secretary of Finance
would be an injustice to taxpayers prejudiced by his adverse rulings. To remedy this
situation, SC imply from the purpose of RA 1125 and its amendatory laws that the
CTA is the proper forum with which to institute the appeal. This is not, and should
not, in any way, be taken as a derogation of the power of the Office of President but
merely as recognition that matters calling for technical knowledge should be
handled by the agency or quasi-judicial body with specialization over the
controversy. As the specialized quasi-judicial agency mandated to adjudicate tax,
customs, and assessment cases, there can be no other court of appellate jurisdiction
that can decide the issues raised in the CA petition, which involves the tax
treatment of the shares of stocks sold.
The appellate power of the CTA includes certiorari.
The respective teachings in British American Tobacco and Asia International
Auctioneers, at first blush, appear to bear no conflictthat when the validity or
constitutionality of an administrative rule or regulation is assailed, the regular courts
have jurisdiction; and if what is assailed are rulings or opinions of the Commissioner
on tax treatments, jurisdiction over the controversy is lodged with the CTA. The
problem with the above postulates, however, is that they failed to take into
consideration one crucial pointa taxpayer can raise both issues simultaneously.
(City of Manila v. Grecia-Cuerdo) the Court en banc has ruled that the CTA now
has the power of certiorari in cases within its appellate jurisdiction. To elucidate:
The prevailing doctrine is that the authority to issue writs of certiorari involves the
exercise of original jurisdiction which must be expressly conferred by the
Constitution or by law and cannot be implied from the mere existence of appellate
jurisdiction. Thus, x x x this Court has ruled against the jurisdiction of courts or
tribunals over petitions for certiorari on the ground that there is no law which
expressly gives these tribunals such power. Itmust be observed, however, that x x x
these rulings pertain not to regular courts but to tribunals exercising quasijudicial
powers. With respect tothe Sandiganbayan, Republic Act No. 8249 now provides that
the special criminal court has exclusive original jurisdiction over petitions for the
issuance of the writs of mandamus, prohibition, certiorari, habeas corpus,
injunctions, and other ancillary writs and processes in aid of its appellate jurisdiction.

In the same manner, Section 5 (1), Article VIII of the 1987 Constitution grants power
toPage
the Supreme Court, in the exercise of its original jurisdiction, to issue writs of
certiorari,
| 3 prohibition and mandamus. With respect to the Court of Appeals, Section
9 (1) of Batas Pambansa Blg. 129 (BP 129) gives the appellate court, also in the
exercise of its original jurisdiction, the power to issue, among others, a writ of
certiorari, whether or not in aid of its appellate jurisdiction. As to Regional Trial
Courts, the power to issue a writ of certiorari, in the exercise of their original
jurisdiction, is provided under Section 21 of BP 129.
The foregoing notwithstanding, while there is no express grant of such power, with
respect to the CTA, Section 1, Article VIII of the 1987 Constitution provides,
nonetheless, that judicial power shall be vested in one Supreme Court and in such
lower courts as may be established by law and that judicial power includes the duty
of the courts of justice to settle actual controversies involving rights which are
legally demandable and enforceable, and to determine whether or not there has
been a grave abuse of discretion amounting to lack or excess of jurisdiction on the
part of any branch or instrumentality of the Government.

On the strength of the above constitutional provisions, it can be fairly interpreted


that the power of the CTA includes that of determining whether or not there has
been grave abuse of discretion amounting to lack or excess of jurisdiction on the
part of the RTC in issuing an interlocutory order in cases falling within the exclusive
appellate jurisdiction of the tax court. It, thus, follows that the CTA, by constitutional
mandate, is vested with jurisdiction to issue writs of certiorari in these cases.
Indeed, in order for any appellate court to effectively exercise its appellate
jurisdiction, it must have the authority to issue, among others, a writ of certiorari. In
transferring exclusive jurisdiction over appealed tax cases to the CTA, it can
reasonably be assumed that the law intended to transfer also such power as is
deemed necessary, if not indispensable, in aid of such appellate jurisdiction. There is
no perceivable reason why the transfer should only be considered as partial, not
total. (emphasis added)
Evidently, City of Manila can be considered as a departure from Ursal in that in spite
of there being no express grant in law, the CTA is deemed granted with powers of
certiorari by implication. Moreover, City of Manila diametrically opposes British
American Tobacco to the effect that it is now within the power of the CTA, through its
power of certiorari, to rule on the validity of a particular administrative rule or
regulation so long as it is within its appellate jurisdiction. Hence, it can now rule not
only on the propriety of an assessment or tax treatment of a certain transaction, but
also on the validity of the revenue regulation or revenue memorandum circular on
which the said assessment is based.
Guided by the doctrinal teaching in resolving the case at bar, the fact that the CA
petition not only contested the applicability of Sec. 100 of the NIRC over the sales
transaction but likewise questioned the validity of Sec. 7 of RR 06-08 and RMC 25-11

does not divest the CTA of its jurisdiction over the controversy, contrary to
petitioner's arguments.
2.) The price difference is subject to donor's tax.
Petitioner's substantive arguments are unavailing. The absence of donative intent, if
that be the case, does not exempt the sales of stock transaction from donor's tax
since Sec. 100 of the NIRC categorically states that the amount by which the fair
market value of the property exceeded the value of the consideration shall be
deemed a gift.1wphi1 Thus, even if there is no actual donation, the difference in
price is considered a donation by fiction of law.
Moreover, Sec. 7(c.2.2) of RR 06-08 does not alter Sec. 100 of the NIRC but merely
sets the parameters for determining the "fair market value" of a sale of stocks. Such
issuance was made pursuant to the Commissioner's power to interpret tax laws and
to promulgate rules and regulations for their implementation.
Lastly, petitioner is mistaken in stating that RMC 25-11, having been issued after the
sale, was being applied retroactively in contravention to Sec. 246 of the NIRC.26
Instead, it merely called for the strict application of Sec. 100, which was already in
force the moment the NIRC was enacted.
Petition is DISMISSED. The Resolutions of the CA are AFFIRMED.
INCOME TAX
Eisner v. Macomber, 252 U.S. 189 (1920)
FACTS: On January 1, 1916, the Standard Oil Company of California, a corporation of
that state, out of an authorized capital stock of $100,000,000, had shares of stock
outstanding, par value $100 each, amounting in round figures to $50,000,000. In
addition, it had surplus and undivided profits invested in plant, property, and
business and required for the purposes of the corporation, amounting to about
$45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913,
the balance thereafter. In January, 1916, in order to readjust the capitalization, the
board of directors decided to issue additional shares sufficient to constitute a stock
dividend of 50 percent of the outstanding stock, and to transfer from surplus
account to capital stock account an amount equivalent to such issue. Appropriate
resolutions were adopted, an amount equivalent to the par value of the proposed
new stock was transferred accordingly, and the new stock duly issued against it and
divided among the stockholders.
Defendant in error, being the owner of 2,200 shares of the old stock, received
certificates for 1, 100 additional shares, of which 18.07 percent, or 198.77 shares,
par value $19,877, were treated as representing surplus earned between March 1,
1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a
tax imposed under the Revenue Act of 1916, based upon a supposed income of
$19,877 because of the new shares, and, an appeal to the Commissioner of Internal
Revenue having been disallowed, she brought action against the Collector to recover

the tax. In her complaint, she alleged the above facts and contended that, in
Page such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3, and Article
imposing
I, 9,
| 4cl. 4, of the Constitution of the United States, requiring direct taxes to be
apportioned according to population, and that the stock dividend was not income
within the meaning of the Sixteenth Amendment. A general demurrer to the
complaint was overruled upon the authority of Towne v. Eisner, 245 U. S. 418, and,
defendant having failed to plead further, final judgment went against him. To review
it, the present writ of error is prosecuted.
The Court constrained to hold that the judgment of the district court must be
affirmed, first, because the question at issue is controlled by Towne v. Eisner, supra;
secondly, because a reexamination of the question with the additional light thrown
upon it by elaborate arguments has confirmed the view that the underlying ground
of that decision is sound, that it disposes of the question here presented, and that
other fundamental considerations lead to the same result.
Towne v. Eisner, the question was whether a stock dividend made in 1914 against
surplus earned prior to January 1, 1913, was taxable against the stockholder under
the Act which provided that net income should include "dividends," and also "gains
or profits and income derived from any source whatever." Suit having been brought
by a stockholder to recover the tax assessed against him by reason of the dividend,
the district court sustained a demurrer to the complaint. The court treated the
construction of the act as inseparable from the interpretation of the Sixteenth
Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., and quoted
the Amendment, proceeded very properly to say:
"It is manifest that the stock dividend in question cannot be reached by the Income
Tax Act and could not, even though Congress expressly declared it to be taxable as
income, unless it is in fact income."
Gibbons v. Mahon "stock dividends" had received a definition sufficiently clear to
be controlling, treated the language of this Court in that case as obiter dictum in
respect of the matter then before it, and examined the question as res nova, with
the result stated. Rejected the reasoning of the district court, saying:
"A stock dividend really takes nothing from the property of the corporation, and adds
nothing to the interests of the shareholders. Its property is not diminished, and their
interests are not increased. . . . The proportional interest of each shareholder
remains the same. The only change is in the evidence which represents that
interest, the new shares and the original shares together representing the same
proportional interest that the original shares represented before the issue of the new
ones."
"In short, the corporation is no poorer and the stockholder is no richer than they
were before. Logan County v. United States, if the plaintiff gained any small
advantage by the change, it certainly was not an advantage of $417,450, the sum
upon which he was taxed. . . . What has happened is that the plaintiff's old
certificates have been split up in effect and have diminished in value to the extent of
the value of the new."

The fact that the dividend was charged against profits earned before the Act of 1913
took effect, even before the amendment was adopted, was neither relied upon nor
alluded to in our consideration of the merits in that case. Not only so, but had we
considered that a stock dividend constituted income in any true sense, it would have
been held taxable under the Act of 1913 notwithstanding it was based upon profits
earned before the amendment. Lynch v. Hornby - that a cash dividend
extraordinary in amount, and in Peabody v. Eisner - that a dividend paid in stock
of another company, were taxable as income although based upon earnings that
accrued before adoption of the amendment. In the former case, concerning
"corporate profits that accumulated before the act took effect," it declared:
"Just as we deem the legislative intent manifest to tax the stockholder with respect
to such accumulations only if and when, and to the extent that, his interest in them
comes to fruition as income, that is, in dividends declared, so we can perceive no
constitutional obstacle that stands in the way of carrying out this intent when
dividends are declared out of a preexisting surplus. . . . Congress was at liberty
under the amendment to tax as income, without apportionment, everything that
became income, in the ordinary sense of the word, after the adoption of the
amendment, including dividends received in the ordinary course by a stockholder
from a corporation, even though they were extraordinary in amount and might
appear upon analysis to be a mere realization in possession of an inchoate and
contingent interest that the stockholder had in a surplus of corporate assets
previously existing."
Peabody v. Eisner - decision of the district court in Towne v. Eisner had been
reversed "only upon the ground that it related to a stock dividend which in fact took
nothing from the property of the corporation and added nothing to the interest of
the shareholder, but merely changed the evidence which represented that interest,"
and we distinguished the Peabody case from the Towne case upon the ground that
"the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution
in specie of a portion of the assets of the Union Pacific."
Congress in the Revenue Act of 1916 declared that a "stock dividend shall be
considered income, to the amount of its cash value.
ISSUE: Whether or not stock dividend can be regarded as income and hence
taxable under income tax.

in
general,

you

don't

have

to

report

gain

until

you

sell

the

property (aka "severance is a prerequisite to realization").


HELD: Regard must be had to the nature of a corporation and the stockholder's
relation to it. A corporation organized for profit, and having a capital stock divided
into shares to which a nominal or par value is attributed.

"The Congress shall have power to lay and collect taxes on incomes, from whatever
Pagederived, without apportionment among the several states and without regard
source
to any
| 5census or enumeration."
As repeatedly held, this did not extend the taxing power to new subjects, but merely
removed the necessity which otherwise might exist for an apportionment among the
states of taxes laid on income. A proper regard for its genesis, as well as its very
clear language, requires also that this amendment shall not be extended by loose
construction, so as to repeal or modify, except as applied to income, those
provisions of the Constitution that require an apportionment according to population
for direct taxes upon property, real and personal. This limitation still has an
appropriate and important function, and is not to be overridden by Congress or
disregarded by the courts.
In order, therefore, that the clauses cited from Article I of the Constitution may have
proper force and effect, save only as modified by the amendment, and that the
latter also may have proper effect, it becomes essential to distinguish between what
is and what is not "income," as the term is there used, and to apply the distinction,
as cases arise, according to truth and substance, without regard to form. Congress
cannot by any definition it may adopt conclude the matter, since it cannot by
legislation alter the Constitution, from which alone it derives its power to legislate,
and within whose limitations alone that power can be lawfully exercised.
The fundamental relation of "capital" to "income" has been much discussed by
economists, the former being likened to the tree or the land, the latter to the fruit or
the crop; the former depicted as a reservoir supplied from springs, the latter as the
outlet stream, to be measured by its flow during a period of time.
"Income may be defined as the gain derived from capital, from labor, or from both
combined," provided it be understood to include profit gained through a sale or
conversion of capital assets, to which it was applied in the Doyle case. Here, we
have the essential matter: not a gain accruing to capital; not a growth or increment
of value in the investment; but a gain, a profit, something of exchangeable value,
proceeding from the property, severed from the capital, however invested or
employed, and coming in, being "derived" -- that is, received or drawn by the
recipient (the taxpayer) for his separate use, benefit and disposal -- that is income
derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment -"incomes, from whatever source derived" -- the essential thought being expressed
with a conciseness and lucidity entirely in harmony with the form and style of the
Constitution.
Certainly the interest of the stockholder is a capital interest, and his certificates of
stock are but the evidence of it. They state the number of shares to which he is
entitled and indicate their par value and how the stock may be transferred. They
show that he or his assignors, immediate or remote, have contributed capital to the
enterprise, that he is entitled to a corresponding interest proportionate to the whole,
entitled to have the property and business of the company devoted during the

corporate existence to attainment of the common objects, entitled to vote at


stockholders' meetings, to receive dividends out of the corporation's profits if and
when declared, and, in the event of liquidation, to receive a proportionate share of
the net assets, if any, remaining after paying creditors. Short of liquidation, or until
dividend declared, he has no right to withdraw any part of either capital or profits
from the common enterprise; on the contrary, his interest pertains not to any part,
divisible or indivisible, but to the entire assets, business, and affairs of the company.
Nor is it the interest of an owner in the assets themselves, since the corporation has
full title, legal and equitable, to the whole. The stockholder has the right to have the
assets employed in the enterprise, with the incidental rights mentioned; but, as
stockholder, he has no right to withdraw, only the right to persist, subject to the
risks of the enterprise, and looking only to dividends for his return. If he desires to
dissociate himself from the company, he can do so only by disposing of his stock.

For bookkeeping purposes, the company acknowledges a liability in form to the


stockholders equivalent to the aggregate par value of their stock, evidenced by a
"capital stock account." If profits have been made and not divided, they create
additional bookkeeping liabilities under the head of "profit and loss," "undivided
profits," "surplus account," or the like. None of these, however, gives to the
stockholders as a body, much less to any one of them, either a claim against the
going concern for any particular sum of money or a right to any particular portion of
the assets or any share in them unless or until the directors conclude that dividends
shall be made and a part of the company's assets segregated from the common
fund for the purpose. The dividend normally is payable in money, under exceptional
circumstances in some other divisible property, and when so paid, then only
(excluding, of course, a possible advantageous sale of his stock or winding-up of the
company) does the stockholder realize a profit or gain which becomes his separate
property, and thus derive income from the capital that he or his predecessor has
invested.
In the present case, the corporation had surplus and undivided profits invested in
plant, property, and business, and required for the purposes of the corporation,
amounting to about $45,000,000, in addition to outstanding capital stock of
$50,000,000. In this, the case is not extraordinary. The profits of a corporation, as
they appear upon the balance sheet at the end of the year, need not be in the form
of money on hand in excess of what is required to meet current liabilities and
finance current operations of the company. Often, especially in a growing business,
only a part, sometimes a small part, of the year's profits is in property capable of
division, the remainder having been absorbed in the acquisition of increased plant,
equipment, stock in trade, or accounts receivable, or in decrease of outstanding
liabilities. When only a part is available for dividends, the balance of the year's
profits is carried to the credit of undivided profits, or surplus, or some other account
having like significance. If thereafter the company finds itself in funds beyond
current needs, it may declare dividends out of such surplus or undivided profits;
otherwise it may go on for years conducting a successful business, but requiring
more and more working capital because of the extension of its operations, and
therefore unable to declare dividends approximating the amount of its profits. Thus,

the surplus may increase until it equals or even exceeds the par value of the
Page
outstanding
capital stock. This may be adjusted upon the books in the mode
adopted
| 6 in the case at bar -- by declaring a "stock dividend." This, however, is no
more than a book adjustment, in essence -- not a dividend, but rather the opposite;
no part of the assets of the company is separated from the common fund, nothing
distributed except paper certificates that evidence an antecedent increase in the
value of the stockholder's capital interest resulting from an accumulation of profits
by the company, but profits so far absorbed in the business as to render it
impracticable to separate them for withdrawal and distribution. In order to make the
adjustment, a charge is made against surplus account with corresponding credit to
capital stock account, equal to the proposed "dividend;" the new stock is issued
against this and the certificates delivered to the existing stockholders in proportion
to their previous holdings. This, however, is merely bookkeeping that does not affect
the aggregate assets of the corporation or its outstanding liabilities; it affects only
the form, not the essence, of the "liability" acknowledged by the corporation to its
own shareholders, and this through a readjustment of accounts on one side of the
balance sheet only, increasing "capital stock" at the expense of "surplus"; it does not
alter the preexisting proportionate interest of any stockholder or increase the
intrinsic value of his holding or of the aggregate holdings of the other stockholders
as they stood before. The new certificates simply increase the number of the shares,
with consequent dilution of the value of each share.
A "stock dividend" shows that the company's accumulated profits have been
capitalized, instead of distributed to the stockholders or retained as surplus
available for distribution in money or in kind should opportunity offer. Far from being
a realization of profits of the stockholder, it tends rather to postpone such
realization, in that the fund represented by the new stock has been transferred from
surplus to capital, and no longer is available for actual distribution.
The essential and controlling fact is that the stockholder has received nothing out of
the company's assets for his separate use and benefit; on the contrary, every dollar
of his original investment, together with whatever accretions and accumulations
have resulted from employment of his money and that of the other stockholders in
the business of the company, still remains the property of the company, and subject
to business risks which may result in wiping out the entire investment. Having
regard to the very truth of the matter, to substance and not to form, he has received
nothing that answers the definition of income within the meaning of the Sixteenth
Amendment.

Being concerned only with the true character and effect of such a dividend when
lawfully made, we lay aside the question whether, in a particular case, a stock
dividend may be authorized by the local law governing the corporation, or whether
the capitalization of profits may be the result of correct judgment and proper
business policy on the part of its management, and a due regard for the interests of
the stockholders. And we are considering the taxability of bona fide stock dividends
only.

We are clear that not only does a stock dividend really take nothing from the
property of the corporation and add nothing to that of the shareholder, but that the
antecedent accumulation of profits evidenced thereby, while indicating that the
shareholder is the richer because of an increase of his capital, at the same time
shows he has not realized or received any income in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock dividend,
and so he may, if he can find a buyer. It is equally true that, if he does sell, and in
doing so realizes a profit, such profit, like any other, is income, and, so far as it may
have arisen since the Sixteenth Amendment, is taxable by Congress without
apportionment. The same would be true were he to sell some of his original shares
at a profit. But if a shareholder sells dividend stock, he necessarily disposes of a part
of his capital interest, just as if he should sell a part of his old stock, either before or
after the dividend. What he retains no longer entitles him to the same proportion of
future dividends as before the sale. His part in the control of the company likewise is
diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock
of a corporation should receive in common with other stockholders a 50 percent
stock dividend, and should sell his part, he thereby would be reduced from a
majority to a minority stockholder, having six-fifteenths instead of six-tenths of the
total stock outstanding. A corresponding and proportionate decrease in capital
interest and in voting power would befall a minority holder should he sell dividend
stock, it being in the nature of things impossible for one to dispose of any part of
such an issue without a proportionate disturbance of the distribution of the entire
capital stock and a like diminution of the seller's comparative voting power -- that
"right preservative of rights" in the control of a corporation.

Yet, without selling, the shareholder, unless possessed of other resources, has not
the wherewithal to pay an income tax upon the dividend stock. Nothing could more
clearly show that to tax a stock dividend is to tax a capital increase, and not income,
than this demonstration that, in the nature of things, it requires conversion of capital
in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the


fundamental error already mentioned -- a failure to appraise correctly the force of
the term "income" as used in the Sixteenth Amendment, or at least to give practical
effect to it. Thus, the government contends that the tax "is levied on income derived
from corporate earnings," when in truth the stockholder has "derived" nothing
except paper certificates, which, so far as they have any effect, deny him present
participation in such earnings. It contends that the tax may be laid when earnings
"are received by the stockholder," whereas he has received none; that the profits
are "distributed by means of a stock dividend," although a stock dividend distributes

no profits; that, under the Act of 1916, "the tax is on the stockholder's share in
Page earnings," when in truth a stockholder has no such share, and receives
corporate
none| in
7 a stock dividend; that "the profits are segregated from his former capital,
and he has a separate certificate representing his invested profits or gains," whereas
there has been no segregation of profits, nor has he any separate certificate
representing a personal gain, since the certificates, new and old, are alike in what
they represent -- a capital interest in the entire concerns of the corporation.

We have no doubt of the power or duty of a court to look through the form of the
corporation and determine the question of the stockholder's right in order to
ascertain whether he has received income taxable by Congress without
apportionment. But, looking through the form, we cannot disregard the essential
truth disclosed, ignore the substantial difference between corporation and
stockholder, treat the entire organization as unreal, look upon stockholders as
partners when they are not such, treat them as having in equity a right to a partition
of the corporate assets when they have none, and indulge the fiction that they have
received and realized a share of the profits of the company which in truth they have
neither received nor realized. We must treat the corporation as a substantial entity
separate from the stockholder not only because such is the practical fact, but
because it is only by recognizing such separateness that any dividend -- even one
paid in money or property -- can be regarded as income of the stockholder. Did we
regard corporation and stockholders as altogether identical, there would be no
income except as the corporation acquired it, and while this would be taxable
against the corporation as income under appropriate provisions of law, the individual
stockholders could not be separately and additionally taxed with respect to their
several shares even when divided, since, if there were entire identity between them
and the company, they could not be regarded as receiving anything from it, any
more than if one's money were to be removed from one pocket to another.

Conceding that the mere issue of a stock dividend makes the recipient no richer
than before, the government nevertheless contends that the new certificates
measure the extent to which the gains accumulated by the corporation have made
him the richer. There are two insuperable difficulties with this. In the first place, it
would depend upon how long he had held the stock whether the stock dividend
indicated the extent to which he had been enriched by the operations of the
company; unless he had held it throughout such operations, the measure would not
hold true. Secondly, and more important for present purposes, enrichment through
increase in value of capital investment is not income in any proper meaning of the
term.

The complaint contains averments respecting the market prices of stock such as
plaintiff held, based upon sales before and after the stock dividend, tending to show
that the receipt of the additional shares did not substantially change the market

value of her entire holdings. This tends to show that, in this instance, market
quotations reflected intrinsic values -- a thing they do not always do. But we regard
the market prices of the securities as an unsafe criterion in an inquiry such as the
present, when the question must be not what will the thing sell for, but what is it in
truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a


case where stockholders use money received as cash dividends to purchase
additional stock contemporaneously issued by the corporation. But an actual cash
dividend, with a real option to the stockholder either to keep the money for his own
or to reinvest it in new shares, would be as far removed as possible from a true
stock dividend, such as the one we have under consideration, where nothing of
value is taken from the company's assets and transferred to the individual
ownership of the several stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the
corporation's own shares and one made by distributing shares owned by it in the
stock of another company calls for no comment beyond the statement that the
latter distributes assets of the company among the shareholders, while the former
does not, and for no citation of authority except Peabody v. Eisner, 247 U. S. 347,
247 U. S. 349-350.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support
of the position of the government.

Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act
of Western Australia, which provided that "dividend" should include "every dividend,
profit, advantage, or gain intended to be paid or credited to or distributed among
any members or directors of any company," except, etc. There was a stock dividend,
the new shares being allotted among the shareholders pro rata, and the question
was whether this was a distribution of a dividend within the meaning of the act. The
Judicial Committee of the Privy Council sustained the dividend duty upon the ground
that, although "in ordinary language the new shares would not be called a dividend,
nor would the allotment of them be a distribution of a dividend," yet, within the
meaning of the act, such new shares were an "advantage" to the recipients. There
being no constitutional restriction upon the action of the lawmaking body, the case
presented merely a question of statutory construction, and manifestly the decision is
not a precedent for the guidance of this Court when acting under a duty to test an
act of Congress by the limitations of a written Constitution having superior force.

Page
In Tax
| 8Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the FortyFourth amendment to the Constitution of Massachusetts, which conferred upon the
legislature full power to tax incomes, "must be interpreted as including every item
which by any reasonable understanding can fairly be regarded as income" (pp. 526,
531), and that under it, a stock dividend was taxable as income, the court saying (p.
535):

The government relies upon Collector v. Hubbard, (1870)

"In essence, the thing which has been done is to distribute a symbol representing an
accumulation of profits, which, instead of being paid out in cash, is invested in the
business, thus augmenting its durable assets. In this aspect of the case, the
substance of the transaction is no different from what it would be if a cash dividend
had been declared with the privilege of subscription to an equivalent amount of new
shares. "

"The gains and profits of all companies, whether incorporated or partnership, other
than the companies specified in that section, shall be included in estimating the
annual gains, profits, or income of any person, entitled to the same, whether divided
or otherwise."

We cannot accept this reasoning. Evidently, in order to give a sufficiently broad


sweep to the new taxing provision, it was deemed necessary to take the symbol for
the substance, accumulation for distribution, capital accretion for its opposite, while
a case where money is paid into the hand of the stockholder with an option to buy
new shares with it, followed by acceptance of the option, was regarded as identical
in substance with a case where the stockholder receives no money and has no
option. The Massachusetts court was not under an obligation, like the one which
binds us, of applying a constitutional amendment in the light of other constitutional
provisions that stand in the way of extending it by construction.

Upon the second argument, the government, recognizing the force of the decision in
Towne v. Eisner, supra, and virtually abandoning the contention that a stock
dividend increases the interest of the stockholder or otherwise enriches him, insisted
as an alternative that, by the true construction of the Act of 1916, the tax is imposed
not upon the stock dividend, but rather upon the stockholder's share of the
undivided profits previously accumulated by the corporation, the tax being levied as
a matter of convenience at the time such profits become manifest through the stock
dividend. If so construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the
stock of corporations is beyond question, and that such interests might be valued in
view of the condition of the company, including its accumulated and undivided
profits, is equally clear. But that this would be taxation of property because of
ownership, and hence would require apportionment under the provisions of the
Constitution, is settled beyond peradventure by previous decisions of this Court.

12 Wall. 1, which arose under 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223,
282, providing that

The court held an individual taxable upon his proportion of the earnings of a
corporation although not declared as dividends and although invested in assets not
in their nature divisible. Conceding that the stockholder for certain purposes had no
title prior to dividend declared, the court nevertheless said (p. 79 U. S. 18):

"Grant all that, still it is true that the owner of a share of stock in a corporation holds
the share with all its incidents, and that among those incidents is the right to receive
all future dividends -- that is, his proportional share of all profits not then divided.
Profits are incident to the share to which the owner at once becomes entitled
provided he remains a member of the corporation until a dividend is made.
Regarded as an incident to the shares, undivided profits are property of the
shareholder, and as such are the proper subject of sale, gift, or devise. Undivided
profits invested in real estate, machinery, or raw material for the purpose of being
manufactured are investments in which the stockholders are interested, and when
such profits are actually appropriated to the payment of the debts of the
corporation, they serve to increase the market value of the shares, whether held by
the original subscribers or by assignees."

Insofar as this seems to uphold the right of Congress to tax without apportionment a
stockholder's interest in accumulated earnings prior to dividend declared, it must be
regarded as overruled by Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, 158 U.
S. 627-628, 158 U. S. 637. Conceding Collector v. Hubbard was inconsistent with the
doctrine of that case, because it sustained a direct tax upon property not
apportioned among the states, the government nevertheless insists that the
sixteenth Amendment removed this obstacle, so that now the Hubbard case is
authority for the power of Congress to levy a tax on the stockholder's share in the
accumulated profits of the corporation even before division by the declaration of a

dividend of any kind. Manifestly this argument must be rejected, since the
Page
amendment
applies to income only, and what is called the stockholder's share in the
accumulated
profits of the company is capital, not income. As we have pointed out,
|9
a stockholder has no individual share in accumulated profits, nor in any particular
part of the assets of the corporation, prior to dividend declared.

from the airport to their respective hotels, and from the latter to the airport upon
their departure from the Philippines, transporting them from their hotels to various
embarkation points for local tours, visits and excursions; securing permits for them
to visit places of interest; and arranging their cultural entertainment, shopping and
recreational activities.

Thus, from every point of view, we are brought irresistibly to the conclusion that
neither under the Sixteenth Amendment nor otherwise has Congress power to tax
without apportionment a true stock dividend made lawfully and in good faith, or the
accumulated profits behind it, as income of the stockholder. The Revenue Act of
1916, insofar as it imposes a tax upon the stockholder because of such dividend,
contravenes the provisions of Article I, 2, cl. 3, and Article I, 9, cl. 4, of the
Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment.

In order to ably supply these services to the foreign tourists, petitioner and its
correspondent counterpart tourist agencies abroad have agreed to offer a package
fee for the tourists. Although the fee to be paid by said tourists is quoted by the
petitioner, the payments of the hotel room accommodations, food and other
personal expenses of said tourists, as a rule, are paid directly either by tourists
themselves, or by their foreign travel agencies to the local hotels (pp. 77, t.s.n.,
February 2, 1981; Exhs. O & O-1, p. 29, CTA rec.; pp. 2425, t.s.n., ibid) and
restaurants or shops, as the case may be.

Judgment affirmed.
G.R. No. L-66416, March 21, 1990COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs. TOURS SPECIALISTS, INC., and THE COURT OF TAX APPEALS, respondents.

Gadioma Law Offices for private respondent.

GUTIERREZ, JR., J.:

This is a petition to review on certiorari the decision of the Court of Tax Appeals
which ruled that the money entrusted to private respondent Tours Specialists, Inc.,
earmarked and paid for hotel room charges of tourists, travelers and/or foreign
travel agencies does not form part of its gross receipts subject to the 3%
independent contractor's tax under the National Internal Revenue Code of 1977.

It is also the case that some tour agencies abroad request the local tour agencies,
such as the petitioner in the case, that the hotel room charges, in some specific
cases, be paid through them. (Exh. Q, Q-1, p. 29 CTA rec., p. 25, T.s.n., ibid, pp. 5-6,
17-18, t.s.n., Aug. 20, 1981.; See also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981, pp. 34, 11., t.s.n., Aug. 10, 1982). By this arrangement, the foreign tour agency entrusts
to the petitioner Tours Specialists, Inc., the fund for hotel room accommodation,
which in turn is paid by petitioner tour agency to the local hotel when billed. The
procedure observed is that the billing hotel sends the bill to the petitioner. The local
hotel identifies the individual tourist, or the particular groups of tourists by code
name or group designation and also the duration of their stay for purposes of
payment. Upon receipt of the bill, the petitioner then pays the local hotel with the
funds entrusted to it by the foreign tour correspondent agency.

Despite this arrangement, respondent Commissioner of Internal Revenue assessed


petitioner for deficiency 3% contractor's tax as independent contractor by including
the entrusted hotel room charges in its gross receipts from services for the years
1974 to 1976. Consequently, on December 6, 1979, petitioner received from
respondent the 3% deficiency independent contractor's tax assessment in the
amount of P122,946.93 for the years 1974 to 1976, inclusive, computed as follows:

We adopt the findings of facts of the Court of Tax Appeals as follows:


1974 deficiency percentage tax
For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived income
from its activities as a travel agency by servicing the needs of foreign tourists and
travelers and Filipino "Balikbayans" during their stay in this country. Some of the
services extended to the tourists consist of booking said tourists and travelers in
local hotels for their lodging and board needs; transporting these foreign tourists

per investigation P

3,995.63

Page
15%
surcharge for late payment
| 10

1976 deficiency percentage


998.91
per investigation P

54,276.42

25% surcharge for late payment


P

13,569.11

4,994.54

14% interest computed by quarters


P
up to 12-28-79

3,953.18P

67,845.53

8,847.72
14% interest computed by quarters

1975 deficiency percentage tax

per investigation P

up to 12-28-79

28,910.97

96,756.50

8,427.39

25% surcharge for late payment

2,106.85
Total amount due P

122,946.93

=========

In addition to the deficiency contractor's tax of P122,946.93, petitioner was


assessed to pay a compromise penalty of P500.00.

10,534.24

14% interest computed by quarters

up to 12-28-79

6,808.47P

17,342.71

Subsequently on December 11, 1979, petitioner formally protested the assessment


made by respondent on the ground that the money received and entrusted to it by
the tourists, earmarked to pay hotel room charges, were not considered and have
never been considered by it as part of its taxable gross receipts for purposes of
computing and paying its constractor's tax.

During one of the hearings in this case, a witness, Serafina Sazon, Certified Public
Page and in charge of the Accounting Department of petitioner, had testified,
Accountant
her| credibility
not having been destroyed on cross examination, categorically stated
11
that the amounts entrusted to it by the foreign tourist agencies intended for
payment of hotel room charges, were paid entirely to the hotel concerned, without
any portion thereof being diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25;
t.s.n., Aug. 20, 1981, pp. 5-9, 17-18). The testimony of Serafina Sazon was
corroborated by Gerardo Isada, General Manager of petitioner, declaring to the
effect that payments of hotel accommodation are made through petitioner without
any increase in the room charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the
reason why tourists pay their room charge, or through their foreign tourists
agencies, is the fact that the room charge is exempt from hotel room tax under P.D.
31. (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-examination, that if their
payment is made, thru petitioner's tour agency, the hotel cost or charges "is only an
act of accomodation on our (its) part" or that the "agent abroad instead of sending
several telexes and saving on bank charges they take the option to send money to
us to be held in trust to be endorsed to the hotel." (pp. 3-4, t.s.n. Aug. 10, 1982.)

Secondly, there is no showing and is not established by the evidence. that the
amounts received and "earmarked" are actually what had been paid out as hotel
room charges. The mere possibility that the amounts actually paid could be less
than the amounts received is sufficient to destroy the validity of the ruling. (Rollo,
pp. 26-27)

In effect, the petitioner's lone issue is based on alleged error in the findings of facts
of the respondent court.

Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written


protest, caused the issuance of a warrant of distraint and levy. (p. 51, BIR Rec.) And
later, respondent had petitioner's bank deposits garnished. (pp. 49-50, BIR Rec.)

The well-settled doctrine is that the findings of facts of the Court of Tax Appeals are
binding on this Court and absent strong reasons for this Court to delve into facts,
only questions of law are open for determination. (Nilsen v. Commissioner of
Customs, 89 SCRA 43 [1979]; Balbas v. Domingo, 21 SCRA 444 [1967]; Raymundo v.
De Joya, 101 SCRA 495 [1980]). In the recent case of Sy Po v. Court of Appeals, (164
SCRA 524 [1988]), we ruled that the factual findings of the Court of Tax Appeals are
binding upon this court and can only be disturbed on appeal if not supported by
substantial evidence.

Taking this action of respondent as the adverse and final decision on the disputed
assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)

In the instant case, we find no reason to disregard and deviate from the findings of
facts of the Court of Tax Appeals.

The petitioner raises the lone issue in this petition as follows:

As quoted earlier, the Court of Tax Appeals sufficiently explained the services of a
local travel agency, like the herein private respondent, rendered to foreign
customers. The respondent differentiated between the package fee offered by
both the local travel agency and its correspondent counterpart tourist agencies
abroad and the requests made by some tour agencies abroad to local tour agencies
wherein the hotel room charges in some specific cases, would be paid to the local
hotels through them. In the latter case, the correspondent court found as a fact ". . .
that the foreign tour agency entrusts to the petitioner Tours Specialists, Inc. the fund
for hotel room accommodation, which in turn is paid by petitioner tour agency to the
local hotel when billed." (Rollo, p. 42) The following procedure is followed: The billing
hotel sends the bill to the respondent; the local hotel then identifies the individual
tourist, or the particular group of tourist by code name or group designation plus the
duration of their stay for purposes of payment; upon receipt of the bill the private
respondent pays the local hotel with the funds entrusted to it by the foreign tour
correspondent agency.

WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL AGENCY


INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN TOUR AGENCIES,
INTENDED OR EARMARKED FOR HOTEL ACCOMMODATIONS FORM PART OF GROSS
RECEIPTS SUBJECT TO 3% CONTRACTOR'S TAX. (Rollo, p. 23)

The petitioner premises the issue raised on the following assumptions:

Firstly, the ruling overlooks the fact that the amounts received, intended for hotel
room accommodations, were received as part of the package fee and, therefore,
form part of "gross receipts" as defined by law.

Moreover, evidence presented by the private respondent shows that the amounts
Page to it by the foreign tourist agencies to pay the room charges of foreign
entrusted
tourists
| 12 in local hotels were not diverted to its funds; this arrangement was only an
act of accommodation on the part of the private respondent. This evidence was not
refuted.

Oct. 1976

Nov. 1976

409,019.17

In essence, the petitioner's assertion that the hotel room charges entrusted to the
private respondent were part of the package fee paid by foreign tourists to the
respondent is not correct. The evidence is clear to the effect that the amounts
entrusted to the private respondent were exclusively for payment of hotel room
charges of foreign tourists entrusted to it by foreign travel agencies.

Dec. 1976

142,761.55

As regards the petitioner's second assumption, the respondent court stated:

622,915.51

. . . [C]ontrary to the contention of respondent, the records show, firstly, in the


Examiners' Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December 1976
alone, the following sums made up the hotel room accommodations:

Grand Total
July 1976

71,134.80

904,995.29

102,702.97
=========

Aug. 1976

Sept. 1976

121,167.19

53,209.61

It is not true therefore, as stated by respondent, that there is no evidence proving


the amounts earmarked for hotel room charges. Since the BIR examiners could not
have manufactured the above figures representing "advances for hotel room
accommodations," these payments must have certainly been taken from the records
of petitioner, such as the invoices, hotel bills, official receipts and other pertinent
documents. (Rollo, pp. 48-49)

282,079.77

=========

The factual findings of the respondent court are supported by substantial evidence,
hence binding upon this Court.

With these clarifications, the issue to be threshed out is as stated by the respondent
court, to wit:

. . . [W]hether or not the hotel room charges held in trust for foreign tourists and
Page and/or correspondent foreign travel agencies and paid to local host hotels
travelers
form
part of the taxable gross receipts for purposes of the 3% contractor's tax.
| 13
(Rollo, p. 45)

The petitioner opines that the gross receipts which are subject to the 3%
contractor's tax pursuant to Section 191 (Section 205 of the National Internal
Revenue Code of 1977) of the Tax Code include the entire gross receipts of a
taxpayer undiminished by any amount. According to the petitioner, this
interpretation is in consonance with B.I.R. Ruling No. 68-027, dated 23 October, 1968
(implementing Section 191 of the Tax Code) which states that the 3% contractor's
tax prescribed by Section 191 of the Tax Code is imposed of the gross receipts of the
contractor, "no deduction whatever being allowed by said law." The petitioner
contends that the only exception to this rule is when there is a law or regulation
which would exempt such gross receipts from being subjected to the 3% contractor's
tax citing the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc.
(108 Phil. 821 [1960]). Thus, the petitioner argues that since there is no law or
regulation that money entrusted, earmarked and paid for hotel room charges should
not form part of the gross receipts, then the said hotel room charges are included in
the private respondent's gross receipts for purposes of the 3% contractor's tax.

winning horses. It cannot be considered as an item of expense because the sum


used for the payment of prizes is not taken from the funds of the club but from a
certain portion of the total bets especially earmarked for that purpose.

In view of all the foregoing, I am of the opinion that in the submission of the returns
for the amusement tax of 10% (now it is 20% of the "gross receipts", provided for in
Section 260 of the National Internal Revenue Code), the 5% of the total bets that is
set aside for prizes to owners of winning horses should not be included by the Manila
Jockey Club, Inc.

The Collector of the Internal Revenue, however had a different opinion on the matter
and demanded payment of amusement taxes. The Court of Tax Appeals reversed the
Collector.

We affirmed the decision of the Court of Tax Appeals and stated:

In the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (supra),
the Commissioner appealed two decisions of the Court of Tax Appeals disapproving
his levy of amusement taxes upon the Manila Jockey Club, a duly constituted
corporation authorized to hold horse races in Manila. The facts of the case show that
the monies sought to be taxed never really belonged to the club. The decision shows
that during the period November 1946 to 1950, the Manila Jockey Club paid
amusement tax on its commission but without including the 5-1/2% which pursuant
to Executive Order 320 and Republic Act 309 went to the Board of Races, the owner
of horses and jockeys. Section 260 of the Internal Revenue Code provides that the
amusement tax was payable by the operator on its "gross receipts". The Manila
Jockey Club, however, did not consider as part of its "gross receipts" subject to
amusement tax the amounts which it had to deliver to the Board on Races, the
horse owners and the jockeys. This view was fully sustained by three opinions of the
Secretary of Justice, to wit:

The Secretary's opinion was correct. The Government could not have meant to tax
as gross receipt of the Manila Jockey Club the 1/2% which it directs same Club to
turn over to the Board on Races. The latter being a Government institution, there
would be double taxation, which should be avoided unless the statute admits of no
other interpretation. In the same manner, the Government could not have intended
to consider as gross receipt the portion of the funds which it directed the Club to
give, or knew the Club would give, to winning horses and jockeys admittedly 5%.
It is true that the law says that out of the total wager funds 12-1/2% shall be set
aside as the "commission" of the race track owner, but the law itself takes official
notice, and actually approves or directs payment of the portion that goes to owners
of horses as prizes and bonuses of jockeys, which portion is admittedly 5% out of
that 12-1/2% commission. As it did not at that time contemplate the application of
"gross receipts" revenue principle, the law in making a distribution of the total wager
funds, took no trouble of separating one item from the other; and for convenience,
grouped three items under one common denomination.

There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the total bets
registered by the Totalizer. This portion represents its share or commission in the
total amount of money it handles and goes to the funds thereof as its own property
which it may legally disburse for its own purposes. The 5% does not belong to the
club. It is merely held in trust for distribution as prizes to the owners of winning
horses. It is destined for no other object than the payment of prizes and the club
cannot otherwise appropriate this portion without incurring liability to the owners of

Needless to say, gross receipts of the proprietor of the amusement place should not
include any money which although delivered to the amusement place has been
especially earmarked by law or regulation for some person other than the proprietor.
(The situation thus differs from one in which the owner of the amusement place, by
a private contract, with its employees or partners, agrees to reserve for them a
portion of the proceeds of the establishment. (See Wong & Lee v. Coll. 104 Phil. 469;
55 Off. Gaz. [51] 10539; Sy Chuico v. Coll., 107 Phil., 428; 59 Off. Gaz., [6] 896).

Page
In the
second case, the facts of the case are:
| 14

The Manila Jockey Club holds once a year a so called "special Novato race", wherein
only "novato" horses, (i.e. horses which are running for the first time in an official [of
the club] race), may take part. Owners of these horses must pay to the Club an
inscription fee of P1.00, and a declaration fee of P1.00 per horse. In addition, each of
them must contribute to a common fund (P10.00 per horse). The Club contributes an
equal amount P10.00 per horse) to such common fund, the total amount of which is
added to the 5% participation of horse owners already described herein-above in the
first case.

Since the institution of this yearly special novato race in 1950, the Manila Jockey
Club never paid amusement tax on the moneys thus contributed by horse owners
(P10.00 each) because it entertained the belief that in accordance with the three
opinions of the Secretary of Justice herein-above described, such contributions never
formed part of its gross receipts. On the inscription fee of the P1.00 per horse, it
paid the tax. It did not on the declaration fee of P1.00 because it was imposed by
the Municipal Ordinance of Manila and was turned over to the City officers.

The Collector of Internal Revenue required the Manila Jockey Club to pay amusement
tax on such contributed fund P10.00 per horse in the special novato race, holding
they were part of its gross receipts. The Manila Jockey Club protested and resorted
to the Court of Tax Appeals, where it obtained favorable judgment on the same
grounds sustained by said Court in connection with the 5% of the total wager funds
in the herein-mentioned first case; they were not receipts of the Club.

As demonstrated in the above-mentioned case, gross receipts subject to tax under


the Tax Code do not include monies or receipts entrusted to the taxpayer which do
not belong to them and do not redound to the taxpayer's benefit; and it is not
necessary that there must be a law or regulation which would exempt such monies
and receipts within the meaning of gross receipts under the Tax Code.

Parenthetically, the room charges entrusted by the foreign travel agencies to the
private respondent do not form part of its gross receipts within the definition of the
Tax Code. The said receipts never belonged to the private respondent. The private
respondent never benefited from their payment to the local hotels. As stated earlier,
this arrangement was only to accommodate the foreign travel agencies.

Another objection raised by the petitioner is to the respondent court's application of


Presidential Decree 31 which exempts foreign tourists from payment of hotel room
tax. Section 1 thereof provides:

Sec. 1. Foreign tourists and travelers shall be exempt from payment of any and all
hotel room tax for the entire period of their stay in the country.

The petitioner now alleges that P.D. 31 has no relevance to the case. He contends
that the tax under Section 191 of the Tax Code is in the nature of an excise tax; that
it is a tax on the exercise of the privilege to engage in business as a contractor and
that it is imposed on, and collectible from the person exercising the privilege. He
sums his arguments by stating that "while the burden may be shifted to the person
for whom the services are rendered by the contractor, the latter is not relieved from
payment of the tax." (Rollo, p. 28)

We resolved the issue in the following manner:

We think the reasons for upholding the Tax Court's decision in the first case apply to
this one. The ten-peso contribution never belonged to the Club. It was held by it as a
trust fund. And then, after all, when it received the ten-peso contribution, it at the
same time contributed ten pesos out of its own pocket, and thereafter distributed
both amounts as prizes to horse owners. It would seem unreasonable to regard the
ten-peso contribution of the horse owners as taxable receipt of the Club, since the
latter, at the same moment it received the contribution necessarily lost ten pesos
too.

The same arguments were submitted by the Commissioner of Internal Revenue in


the case of Commissioner of Internal Revenue v. John Gotamco & Son., Inc. (148
SCRA 36 [1987]), to justify his imposition of the 3% contractor's tax under Section
191 of the National Internal Revenue Code on the gross receipts John Gotamco &
Sons, Inc., realized from the construction of the World Health Organization (WHO)
office building in Manila. We rejected the petitioner's arguments and ruled:

We agree with the Court of Tax Appeals in rejecting this contention of the petitioner.
Said the respondent court:

"In context, direct taxes are those that are demanded from the very person who, it is
Page or desired, should pay them; while indirect taxes are those that are
intended
demanded
| 15 in the first instance from one person in the expectation and intention that
he can shift the burden to someone else. (Pollock v. Farmers, L & T Co., 1957 US
429, 15 S. Ct. 673, 39 Law. ed. 759). The contractor's tax is of course payable by the
contractor but in the last analysis it is the owner of the building that shoulders the
burden of the tax because the same is shifted by the contractor to the owner as a
matter of self-preservation. Thus, it is an indirect tax. And it is an indirect tax on the
WHO because, although it is payable by the petitioner, the latter can shift its burden
on the WHO. In the last analysis it is the WHO that will pay the tax indirectly through
the contractor and it certainly cannot be said that 'this tax has no bearing upon the
World Health Organization.'"

Petitioner claims that under the authority of the Philippine Acetylene Company
versus Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3% contractor's
tax falls directly on Gotamco and cannot be shifted to the WHO. The Court of Tax
Appeals, however, held that the said case is not controlling in this case, since the
Host Agreement specifically exempts the WHO from "indirect taxes." We agree. The
Philippine Acetylene case involved a tax on sales of goods which under the law had
to be paid by the manufacturer or producer; the fact that the manufacturer or
producer might have added the amount of the tax to the price of the goods did not
make the sales tax "a tax on the purchaser." The Court held that the sales tax must
be paid by the manufacturer or producer even if the sale is made to tax-exempt
entities like the National Power Corporation, an agency of the Philippine
Government, and to the Voice of America, an agency of the United States
Government.

The Host Agreement, in specifically exempting the WHO from "indirect taxes,"
contemplates taxes which, although not imposed upon or paid by the Organization
directly, form part of the price paid or to be paid by it.

Accordingly, the significance of P.D. 31 is clearly established in determining whether


or not hotel room charges of foreign tourists in local hotels are subject to the 3%
contractor's tax. As the respondent court aptly stated:

. . . If the hotel room charges entrusted to petitioner will be subjected to 3%


contractor's tax as what respondent would want to do in this case, that would in
effect do indirectly what P.D. 31 would not like hotel room charges of foreign tourists
to be subjected to hotel room tax. Although, respondent may claim that the 3%
contractor's tax is imposed upon a different incidence i.e. the gross receipts of
petitioner tourist agency which he asserts includes the hotel room charges entrusted

to it, the effect would be to impose a tax, and though different, it nonetheless
imposes a tax actually on room charges. One way or the other, it would not have the
effect of promoting tourism in the Philippines as that would increase the costs or
expenses by the addition of a hotel room tax in the overall expenses of said tourists.
(Rollo, pp. 51-52)

WHEREFORE, the instant petition is DENIED. The decision of the Court of Tax Appeals
is AFFIRMED. No pronouncement as to costs.
G.R. No. 78953, July 31, 1991, COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs. MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.

Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p

Central in this controversy is the issue as to whether or not a taxpayer who merely
states as a footnote in his income tax return that a sum of money that he
erroneously received and already spent is the subject of a pending litigation and
there did not declare it as income is liable to pay the 50% penalty for filing a
fraudulent return.

This question is the subject of the petition for review before the Court of the portion
of the Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case
No. 3393, entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as
Commissioner of Internal Revenue," which orders the deletion of the 50% surcharge
from Javier's deficiency income tax assessment on his income for 1977.

The respondent CTA in a Resolution 2 dated May 25, 1987, denied the
Commissioner's Motion for Reconsideration 3 and Motion for New Trial 4 on the
deletion of the 50% surcharge assessment or imposition.

The pertinent facts as are accurately stated in the petition of private respondent
Page
Javier
in the CTA and incorporated in the assailed decision now under review, read as
follows:
| 16

xxx

xxx

xxx

2.
That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner
(private respondent herein), received from the Prudential Bank and Trust Company
in Pasay City the amount of US$999,973.70 remitted by her sister, Mrs. Dolores
Ventosa, through some banks in the United States, among which is Mellon Bank, N.A.

3.
That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the
Court of First Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No.
26899), against the petitioner (private respondent herein), his wife and other
defendants, claiming that its remittance of US$1,000,000.00 was a clerical error and
should have been US$1,000.00 only, and praying that the excess amount of
US$999,000.00 be returned on the ground that the defendants are trustees of an
implied trust for the benefit of Mellon Bank with the clear, immediate, and
continuing duty to return the said amount from the moment it was received.

December 15, 1980 the amount of P1,615.96 and P9,287,297.51 as deficiency


assessments for the years 1976 and 1977 respectively. . . .

7.
That on December 15, 1980, the petitioner (private respondent herein)
wrote the Bureau of Internal Revenue that he was paying the deficiency income
assessment for the year 1976 but denying that he had any undeclared income for
the year 1977 and requested that the assessment for 1977 be made to await final
court decision on the case filed against him for filing an allegedly fraudulent return. .
..

8.
That on November 11, 1981, the petitioner (private respondent herein)
received from Acting Commissioner of Internal Revenue Romulo Villa a letter dated
October 8, 1981 stating in reply to his December 15, 1980 letter-protest that "the
amount of Mellon Bank's erroneous remittance which you were able to dispose, is
definitely taxable." . . . 5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on
December 10, 1981.
4.
That on or about November 5, 1977, the City Fiscal of Pasay City filed an
Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.)
charging the petitioner (private respondent herein) and his wife with the crime of
estafa, alleging that they misappropriated, misapplied, and converted to their own
personal use and benefit the amount of US$999,000.00 which they received under
an implied trust for the benefit of Mellon Bank and as a result of the mistake in the
remittance by the latter.

5.
That on March 15, 1978, the petitioner (private respondent herein) filed his
Income Tax Return for the taxable year 1977 showing a gross income of P53,053.38
and a net income of P48,053.88 and stating in the footnote of the return that
"Taxpayer was recipient of some money received from abroad which he presumed to
be a gift but turned out to be an error and is now subject of litigation."

6.
That on or before December 15, 1980, the petitioner (private respondent
herein) received a letter from the acting Commissioner of Internal Revenue dated
November 14, 1980, together with income assessment notices for the years 1976
and 1977, demanding that petitioner (private respondent herein) pay on or before

The respondent CTA, after the proper proceedings, rendered the challenged
decision. We quote the concluding portion:

We note that in the deficiency income tax assessment under consideration,


respondent (petitioner here) further requested petitioner (private respondent here)
to pay 50% surcharge as provided for in Section 72 of the Tax Code, in addition to
the deficiency income tax of P4,888,615.00 and interest due thereon. Since
petitioner (private respondent) filed his income tax return for taxable year 1977, the
50% surcharge was imposed, in all probability, by respondent (petitioner) because
he considered the return filed false or fraudulent. This additional requirement, to our
mind, is much less called for because petitioner (private respondent), as stated
earlier, reflected in as 1977 return as footnote that "Taxpayer was recipient of some
money received from abroad which he presumed to be gift but turned out to be an
error and is now subject of litigation."

From this, it can hardly be said that there was actual and intentional fraud,
Page of deception willfully and deliberately done or resorted to by petitioner
consisting
(private
| 17 respondent) in order to induce the Government to give up some legal right,
or the latter, due to a false return, was placed at a disadvantage so as to prevent its
lawful agents from proper assessment of tax liabilities. (Aznar vs. Court of Tax
Appeals, L-20569, August 23, 1974, 56 (sic) SCRA 519), because petitioner literally
"laid his cards on the table" for respondent to examine. Error or mistake of fact or
law is not fraud. (Insular Lumber vs. Collector, L-7100, April 28, 1956.). Besides,
Section 29 is not too plain and simple to understand. Since the question involved in
this case is of first impression in this jurisdiction, under the circumstances, the 50%
surcharge imposed in the deficiency assessment should be deleted. 7

The Commissioner of Internal Revenue, not satisfied with the respondent CTA's
ruling, elevated the matter to us, by the present petition, raising the main issue as
to:

by the record and clearly exposed as a fraudulent ploy, as witness what transpired
upon receipt of the amount.

Here, it will be noted that the excess in the amount erroneously remitted by MELLON
BANK for the amount of private respondent's wife was $999,000.00 after opening a
dollar account with Prudential Bank in the amount of $999,993.70, private
respondent and his wife, with haste and dispatch, within a span of eleven (11)
electric days, specifically from June 3 to June 14, 1977, effected a total massive
withdrawal from the said dollar account in the sum of $975,000.00 or
P7,020,000.00. . . . 11

In reply, the private respondent argues:

xxx

xxx

xxx

WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY?
8

On the other hand, Javier candidly stated in his Memorandum, 9 that he "did not
appeal the decision which held him liable for the basic deficiency income tax
(excluding the 50% surcharge for fraud)." However, he submitted in the same
memorandum "that the issue may be raised in the case not for the purpose of
correcting or setting aside the decision which held him liable for deficiency income
tax, but only to show that there is no basis for the imposition of the surcharge." This
subsequent disavowal therefore renders moot and academic the posturings
articulated in as Comment 10 on the non-taxability of the amount he erroneously
received and the bulk of which he had already disbursed. In any event, an appeal at
that time (of the filing of the Comments) would have been already too late to be
seasonable. The petitioner, through the office of the Solicitor General, stresses that:

xxx

xxx

xxx

The record however is not ambivalent, as the record clearly shows that private
respondent is self-convinced, and so acted, that he is the beneficial owner, and of
which reason is liable to tax. Put another way, the studied insinuation that private
respondent may not be the beneficial owner of the money or income flowing to him
as enhanced by the studied claim that the amount is "subject of litigation" is belied

The petitioner contends that the private respondent committed fraud by not
declaring the "mistaken remittance" in his income tax return and by merely making
a footnote thereon which read: "Taxpayer was the recipient of some money from
abroad which he presumed to be a gift but turned out to be an error and is now
subject of litigation." It is respectfully submitted that the said return was not
fraudulent. The footnote was practically an invitation to the petitioner to make an
investigation, and to make the proper assessment.

The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths v.
Comm., 50 F [2d] 782), that is, it must be stronger than the "mere preponderance of
evidence" which would be sufficient to sustain a judgment on the issue of
correctness of the deficiency itself apart from the fraud penalty. (Frank A. Neddas, 40
BTA 672). The following circumstances attendant to the case at bar show that in
filing the questioned return, the private respondent was guided, not by that "willful
and deliberate intent to prevent the Government from making a proper assessment"
which constitute fraud, but by an honest doubt as to whether or not the "mistaken
remittance" was subject to tax.

First, this Honorable Court will take judicial notice of the fact that so-called "million
dollar case" was given very, very wide publicity by media; and only one who is not in
his right mind would have entertained the idea that the BIR would not make an
assessment if the amount in question was indeed subject to the income tax.

Page
Second,
| 18 as the respondent Court ruled, "the question involved in this case is of first

impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even in the
United States, the authorities are not unanimous in holding that similar receipts are
subject to the income tax. It should be noted that the decision in the Rutkin case is a
five-to-four decision; and in the very case before this Honorable Court, one out of
three Judges of the respondent Court was of the opinion that the amount in question
is not taxable. Thus, even without the footnote, the failure to declare the "mistaken
remittance" is not fraudulent.

Third, when the private respondent filed his income tax return on March 15, 1978 he
was being sued by the Mellon Bank for the return of the money, and was being
prosecuted by the Government for estafa committed allegedly by his failure to
return the money and by converting it to his personal benefit. The basic tax
amounted to P4,899,377.00 (See p. 6 of the Petition) and could not have been paid
without using part of the mistaken remittance. Thus, it was not unreasonable for the
private respondent to simply state in his income tax return that the amount received
was still under litigation. If he had paid the tax, would that not constitute estafa for
using the funds for his own personal benefit? and would the Government refund it to
him if the courts ordered him to refund the money to the Mellon Bank? 12

xxx

xxx

xxx

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National
Internal Revenue Code), a taxpayer who files a false return is liable to pay the fraud
penalty of 50% of the tax due from him or of the deficiency tax in case payment has
been made on the basis of the return filed before the discovery of the falsity or
fraud.

We are persuaded considerably by the private respondent's contention that there is


no fraud in the filing of the return and agree fully with the Court of Tax Appeals'
interpretation of Javier's notation on his income tax return filed on March 15, 1978
thus: "Taxpayer was the recipient of some money from abroad which he presumed to
be a gift but turned out to be an error and is now subject of litigation that it was an
"error or mistake of fact or law" not constituting fraud, that such notation was
practically an invitation for investigation and that Javier had literally "laid his cards
on the table." 13

In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax return
was discussed in this manner:

. . . The fraud contemplated by law is actual and not constructive. It must be


intentional fraud, consisting of deception willfully and deliberately done or resorted
to in order to induce another to give up some legal right. Negligence, whether slight
or gross, is not equivalent to the fraud with intent to evade the tax contemplated by
law. It must amount to intentional wrong-doing with the sole object of avoiding the
tax. It necessarily follows that a mere mistake cannot be considered as fraudulent
intent, and if both petitioner and respondent Commissioner of Internal Revenue
committed mistakes in making entries in the returns and in the assessment,
respectively, under the inventory method of determining tax liability, it would be
unfair to treat the mistakes of the petitioner as tainted with fraud and those of the
respondent as made in good faith.

Fraud is never imputed and the courts never sustain findings of fraud upon
circumstances which, at most, create only suspicion and the mere understatement
of a tax is not itself proof of fraud for the purpose of tax evasion. 15

A "fraudulent return" is always an attempt to evade a tax, but a merely "false


return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16

In the case at bar, there was no actual and intentional fraud through willful and
deliberate misleading of the government agency concerned, the Bureau of Internal
Revenue, headed by the herein petitioner. The government was not induced to give
up some legal right and place itself at a disadvantage so as to prevent its lawful
agents from proper assessment of tax liabilities because Javier did not conceal
anything. Error or mistake of law is not fraud. The petitioner's zealousness to collect
taxes from the unearned windfall to Javier is highly commendable. Unfortunately,
the imposition of the fraud penalty in this case is not justified by the extant facts.
Javier may be guilty of swindling charges, perhaps even for greed by spending most
of the money he received, but the records lack a clear showing of fraud committed
because he did not conceal the fact that he had received an amount of money
although it was a "subject of litigation." As ruled by respondent Court of Tax Appeals,
the 50% surcharge imposed as fraud penalty by the petitioner against the private
respondent in the deficiency assessment should be deleted.

WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax
Appeals is AFFIRMED. No costs.