1

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.
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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,
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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 Jose vs. 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 Attorney-General 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.
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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.

Republic of the Philippines

SUPREME COURT
Manila

EN BANC

G.R. No. L-25043 April 26, 1968

ANTONIO ROXAS, EDUARDO ROXAS and ROXAS Y CIA., in their own respective behalf and as judicial co-
guardians of JOSE ROXAS, petitioners,
vs.
COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.

Leido, Andrada, Perez and Associates for petitioners.

Office of the Solicitor General for respondents.

BENGZON, J.P., J.:

Don Pedro Roxas and Dona Carmen Ayala, Spanish subjects, transmitted to their grandchildren by hereditary succession
the following properties:

(1) Agricultural lands with a total area of 19,000 hectares, situated in the municipality of Nasugbu, Batangas
province;

(2) A residential house and lot located at Wright St., Malate, Manila; and

(3) Shares of stocks in different corporations.

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To manage the above-mentioned properties, said children, namely, Antonio Roxas, Eduardo Roxas and Jose Roxas,
formed a partnership called Roxas y Compania.

AGRICULTURAL LANDS

At the conclusion of the Second World War, the tenants who have all been tilling the lands in Nasugbu for generations
expressed their desire to purchase from Roxas y Cia. the parcels which they actually occupied. For its part, the
Government, in consonance with the constitutional mandate to acquire big landed estates and apportion them among
landless tenants-farmers, persuaded the Roxas brothers to part with their landholdings. Conferences were held with the
farmers in the early part of 1948 and finally the Roxas brothers agreed to sell 13,500 hectares to the Government for
distribution to actual occupants for a price of P2,079,048.47 plus P300,000.00 for survey and subdivision expenses.

It turned out however that the Government did not have funds to cover the purchase price, and so a special arrangement
was made for the Rehabilitation Finance Corporation to advance to Roxas y Cia. the amount of P1,500,000.00 as loan.
Collateral for such loan were the lands proposed to be sold to the farmers. Under the arrangement, Roxas y Cia. allowed
the farmers to buy the lands for the same price but by installment, and contracted with the Rehabilitation Finance
Corporation to pay its loan from the proceeds of the yearly amortizations paid by the farmers.

In 1953 and 1955 Roxas y Cia. derived from said installment payments a net gain of P42,480.83 and P29,500.71. Fifty
percent of said net gain was reported for income tax purposes as gain on the sale of capital asset held for more than one
year pursuant to Section 34 of the Tax Code.

RESIDENTIAL HOUSE

During their bachelor days the Roxas brothers lived in the residential house at Wright St., Malate, Manila, which they
inherited from their grandparents. After Antonio and Eduardo got married, they resided somewhere else leaving only Jose
in the old house. In fairness to his brothers, Jose paid to Roxas y Cia. rentals for the house in the sum of P8,000.00 a
year.

ASSESSMENTS

On June 17, 1958, the Commissioner of Internal Revenue demanded from Roxas y Cia the payment of real estate
dealer's tax for 1952 in the amount of P150.00 plus P10.00 compromise penalty for late payment, and P150.00 tax for
dealers of securities for 1952 plus P10.00 compromise penalty for late payment. The assessment for real estate dealer's
tax was based on the fact that Roxas y Cia. received house rentals from Jose Roxas in the amount of P8,000.00.
Pursuant to Sec. 194 of the Tax Code, an owner of a real estate who derives a yearly rental income therefrom in the
amount of P3,000.00 or more is considered a real estate dealer and is liable to pay the corresponding fixed tax.

The Commissioner of Internal Revenue justified his demand for the fixed tax on dealers of securities against Roxas y Cia.,
on the fact that said partnership made profits from the purchase and sale of securities.

In the same assessment, the Commissioner assessed deficiency income taxes against the Roxas Brothers for the years
1953 and 1955, as follows:

1953 1955
Antonio Roxas P7,010.00 P5,813.00
Eduardo Roxas 7,281.00 5,828.00
Jose Roxas 6,323.00 5,588.00

The deficiency income taxes resulted from the inclusion as income of Roxas y Cia. of the unreported 50% of the net
profits for 1953 and 1955 derived from the sale of the Nasugbu farm lands to the tenants, and the disallowance of
deductions from gross income of various business expenses and contributions claimed by Roxas y Cia. and the Roxas
brothers. For the reason that Roxas y Cia. subdivided its Nasugbu farm lands and sold them to the farmers on installment,
the Commissioner considered the partnership as engaged in the business of real estate, hence, 100% of the profits
derived therefrom was taxed.

The following deductions were disallowed:

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ROXAS Y CIA.:
1953
Tickets for Banquet in honor of
P 40.00
S. Osmea
Gifts of San Miguel beer 28.00
Contributions to
Philippine Air Force Chapel 100.00
Manila Police Trust Fund 150.00

Philippines Herald's fund for Manila's

neediest families 100.00
1955
Contributions to Contribution to
Our Lady of Fatima Chapel, FEU 50.00
ANTONIO ROXAS:
1953
Contributions to
Pasay City Firemen Christmas Fund 25.00
Pasay City Police Dept. X'mas fund 50.00
1955
Contributions to
Baguio City Police Christmas fund 25.00
Pasay City Firemen Christmas fund 25.00
Pasay City Police Christmas fund 50.00
EDUARDO ROXAS:
1953
Contributions to
Hijas de Jesus' Retiro de Manresa 450.00
Philippines Herald's fund for Manila's
neediest families 100.00
1955
Contributions to Philippines
Herald's fund for Manila's
neediest families 120.00
JOSE ROXAS:
1955
Contributions to Philippines
Herald's fund for Manila's
neediest families 120.00
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The Roxas brothers protested the assessment but inasmuch as said protest was denied, they instituted an appeal in the
Court of Tax Appeals on January 9, 1961. The Tax Court heard the appeal and rendered judgment on July 31, 1965
sustaining the assessment except the demand for the payment of the fixed tax on dealer of securities and the
disallowance of the deductions for contributions to the Philippine Air Force Chapel and Hijas de Jesus' Retiro de Manresa.
The Tax Court's judgment reads:

WHEREFORE, the decision appealed from is hereby affirmed with respect to petitioners Antonio Roxas, Eduardo
Roxas, and Jose Roxas who are hereby ordered to pay the respondent Commissioner of Internal Revenue the
amounts of P12,808.00, P12,887.00 and P11,857.00, respectively, as deficiency income taxes for the years 1953
and 1955, plus 5% surcharge and 1% monthly interest as provided for in Sec. 51(a) of the Revenue Code; and
modified with respect to the partnership Roxas y Cia. in the sense that it should pay only P150.00, as real estate
dealer's tax. With costs against petitioners.

Not satisfied, Roxas y Cia. and the Roxas brothers appealed to this Court. The Commissioner of Internal Revenue did not
appeal.

The issues:

(1) Is the gain derived from the sale of the Nasugbu farm lands an ordinary gain, hence 100% taxable?

(2) Are the deductions for business expenses and contributions deductible?

(3) Is Roxas y Cia. liable for the payment of the fixed tax on real estate dealers?

The Commissioner of Internal Revenue contends that Roxas y Cia. could be considered a real estate dealer because it
engaged in the business of selling real estate. The business activity alluded to was the act of subdividing the Nasugbu
farm lands and selling them to the farmers-occupants on installment. To bolster his stand on the point, he cites one of the
purposes of Roxas y Cia. as contained in its articles of partnership, quoted below:

4. (a) La explotacion de fincas urbanes pertenecientes a la misma o que pueden pertenecer a ella en el futuro,
alquilandoles por los plazos y demas condiciones, estime convenientes y vendiendo aquellas que a juicio de sus
gerentes no deben conservarse;

The above-quoted purpose notwithstanding, the proposition of the Commissioner of Internal Revenue cannot be favorably
accepted by Us in this isolated transaction with its peculiar circumstances in spite of the fact that there were hundreds of
vendees. Although they paid for their respective holdings in installment for a period of ten years, it would nevertheless not
make the vendor Roxas y Cia. a real estate dealer during the ten-year amortization period.

It should be borne in mind that the sale of the Nasugbu farm lands to the very farmers who tilled them for generations was
not only in consonance with, but more in obedience to the request and pursuant to the policy of our Government to
allocate lands to the landless. It was the bounden duty of the Government to pay the agreed compensation after it had
persuaded Roxas y Cia. to sell its haciendas, and to subsequently subdivide them among the farmers at very reasonable
terms and prices. However, the Government could not comply with its duty for lack of funds. Obligingly, Roxas y Cia.
shouldered the Government's burden, went out of its way and sold lands directly to the farmers in the same way and
under the same terms as would have been the case had the Government done it itself. For this magnanimous act, the
municipal council of Nasugbu passed a resolution expressing the people's gratitude.

The power of taxation is sometimes called also the power to destroy. Therefore it should be exercised with caution to
minimize injury to the proprietary rights of a taxpayer. It must be exercised fairly, equally and uniformly, lest the tax
collector kill the "hen that lays the golden egg". And, in order to maintain the general public's trust and confidence in the
Government this power must be used justly and not treacherously. It does not conform with Our sense of justice in the
instant case for the Government to persuade the taxpayer to lend it a helping hand and later on to penalize him for duly
answering the urgent call.

In fine, Roxas y Cia. cannot be considered a real estate dealer for the sale in question. Hence, pursuant to Section 34 of
the Tax Code the lands sold to the farmers are capital assets, and the gain derived from the sale thereof is capital gain,
taxable only to the extent of 50%.

DISALLOWED DEDUCTIONS
8

Roxas y Cia. deducted from its gross income the amount of P40.00 for tickets to a banquet given in honor of Sergio
Osmena and P28.00 for San Miguel beer given as gifts to various persons. The deduction were claimed as representation
expenses. Representation expenses are deductible from gross income as expenditures incurred in carrying on a trade or
business under Section 30(a) of the Tax Code provided the taxpayer proves that they are reasonable in amount, ordinary
and necessary, and incurred in connection with his business. In the case at bar, the evidence does not show such link
between the expenses and the business of Roxas y Cia. The findings of the Court of Tax Appeals must therefore be
sustained.

The petitioners also claim deductions for contributions to the Pasay City Police, Pasay City Firemen, and Baguio City
Police Christmas funds, Manila Police Trust Fund, Philippines Herald's fund for Manila's neediest families and Our Lady of
Fatima chapel at Far Eastern University.

The contributions to the Christmas funds of the Pasay City Police, Pasay City Firemen and Baguio City Police are not
deductible for the reason that the Christmas funds were not spent for public purposes but as Christmas gifts to the
families of the members of said entities. Under Section 39(h), a contribution to a government entity is deductible when
used exclusively for public purposes. For this reason, the disallowance must be sustained. On the other hand, the
contribution to the Manila Police trust fund is an allowable deduction for said trust fund belongs to the Manila Police, a
government entity, intended to be used exclusively for its public functions.

The contributions to the Philippines Herald's fund for Manila's neediest families were disallowed on the ground that the
Philippines Herald is not a corporation or an association contemplated in Section 30 (h) of the Tax Code. It should be
noted however that the contributions were not made to the Philippines Herald but to a group of civic spirited citizens
organized by the Philippines Herald solely for charitable purposes. There is no question that the members of this group of
citizens do not receive profits, for all the funds they raised were for Manila's neediest families. Such a group of citizens
may be classified as an association organized exclusively for charitable purposes mentioned in Section 30(h) of the Tax
Code.

Rightly, the Commissioner of Internal Revenue disallowed the contribution to Our Lady of Fatima chapel at the Far
Eastern University on the ground that the said university gives dividends to its stockholders. Located within the premises
of the university, the chapel in question has not been shown to belong to the Catholic Church or any religious
organization. On the other hand, the lower court found that it belongs to the Far Eastern University, contributions to which
are not deductible under Section 30(h) of the Tax Code for the reason that the net income of said university injures to the
benefit of its stockholders. The disallowance should be sustained.

Lastly, Roxas y Cia. questions the imposition of the real estate dealer's fixed tax upon it, because although it earned a
rental income of P8,000.00 per annum in 1952, said rental income came from Jose Roxas, one of the partners. Section
194 of the Tax Code, in considering as real estate dealers owners of real estate receiving rentals of at least P3,000.00 a
year, does not provide any qualification as to the persons paying the rentals. The law, which states: 1wph1.t

. . . "Real estate dealer" includes any person engaged in the business of buying, selling, exchanging, leasing or
renting property on his own account as principal and holding himself out as a full or part-time dealer in real estate
or as an owner of rental property or properties rented or offered to rent for an aggregate amount of three
thousand pesos or more a year: . . . (Emphasis supplied) .

is too clear and explicit to admit construction. The findings of the Court of Tax Appeals or, this point is
sustained.1wph1.t

To Summarize, no deficiency income tax is due for 1953 from Antonio Roxas, Eduardo Roxas and Jose Roxas. For 1955
they are liable to pay deficiency income tax in the sum of P109.00, P91.00 and P49.00, respectively, computed as
follows: *

ANTONIO ROXAS
Net income per return P315,476.59
Add: 1/3 share, profits in Roxas y Cia. P 153,249.15
Less amount declared 146,135.46
Amount understated
P 7,113.69
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Contributions disallowed 115.00

P 7,228.69
Less 1/3 share of contributions
amounting to P21,126.06 disallowed
from partnership but allowed to partners 7,042.02 186.67

Net income per review P315,663.26

Less: Exemptions 4,200.00

Net taxable income P311,463.26

Tax due 154,169.00
Tax paid 154,060.00

Deficiency P 109.00
==========
EDUARDO ROXAS
P
Net income per return
304,166.92
Add: 1/3 share, profits in Roxas y Cia P 153,249.15
Less profits declared 146,052.58

Amount understated P 7,196.57

Less 1/3 share in contributions
amounting to P21,126.06 disallowed
from partnership but allowed to partners 7,042.02 155.55

Net income per review P304,322.47

Less: Exemptions 4,800.00

Net taxable income P299,592.47

Tax Due P147,250.00
Tax paid 147,159.00

Deficiency P91.00
===========
JOSE ROXAS
Net income per return P222,681.76
Add: 1/3 share, profits in Roxas y Cia. P153,429.15
Less amount reported 146,135.46

Amount understated 7,113.69

Less 1/3 share of contributions 7,042.02 71.67
10

disallowed from partnership but allowed

as deductions to partners

Net income per review P222,753.43

Less: Exemption 1,800.00

Net income subject to tax P220,953.43

Tax due P102,763.00
Tax paid 102,714.00

Deficiency P 49.00
===========

WHEREFORE, the decision appealed from is modified. Roxas y Cia. is hereby ordered to pay the sum of P150.00 as real
estate dealer's fixed tax for 1952, and Antonio Roxas, Eduardo Roxas and Jose Roxas are ordered to pay the respective
sums of P109.00, P91.00 and P49.00 as their individual deficiency income tax all corresponding for the year 1955. No
costs. So ordered.

Republic of the Philippines

SUPREME COURT
Manila

THIRD DIVISION

G.R. No. 172231 February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
ISABELA CULTURAL CORPORATION, Respondent.

DECISION

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision 1 of the Court of Appeals in
CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision 2 of the Court of Tax Appeals (CTA) in CTA Case No.
5211, which cancelled and set aside the Assessment Notices for deficiency income tax and expanded withholding tax
issued by the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment Notice No.
FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-
000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for
the taxable year 1986.

The deficiency income tax of P333,196.86, arose from:

(1) The BIRs disallowance of ICCs claimed expense deductions for professional and security services billed to
and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co., 3 for the year ending December 31, 1985;4

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso
Cudala Pecson Azcuna & Bengson for the years 1984 and 1985. 5
11

(c) Expense for security services of El Tigre Security & Investigation Agency for the months of April and
May 1986.6

(2) The alleged understatement of ICCs interest income on the three promissory notes due from Realty
Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly due to the
failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services. 7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995, however, it received
a final notice before seizure demanding payment of the amounts stated in the said notices. Hence, it brought the case to
the CTA which held that the petition is premature because the final notice of assessment cannot be considered as a final
decision appealable to the tax court. This was reversed by the Court of Appeals holding that a demand letter of the BIR
reiterating the payment of deficiency tax, amounts to a final decision on the protested assessment and may therefore be
questioned before the CTA. This conclusion was sustained by this Court on July 1, 2001, in G.R. No. 135210. 8 The case
was thus remanded to the CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices issued against
ICC. It held that the claimed deductions for professional and security services were properly claimed by ICC in 1986
because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these
professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years
as the amount thereof could not be determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory notes. It found that it was the
BIR which made an overstatement of said income when it compounded the interest income receivable by ICC from the
promissory notes of Realty Investment, Inc., despite the absence of a stipulation in the contract providing for a
compounded interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the application
of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for security
services as shown by the various payment orders and confirmation receipts it presented as evidence. The dispositive
portion of the CTAs Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the
amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the
amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and
SET ASIDE.

SO ORDERED.9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision, 10 holding that although the
professional services (legal and auditing services) were rendered to ICC in 1984 and 1985, the cost of the services was
not yet determinable at that time, hence, it could be considered as deductible expenses only in 1986 when ICC received
the billing statements for said services. It further ruled that ICC did not understate its interest income from the promissory
notes of Realty Investment, Inc., and that ICC properly withheld and remitted taxes on the payments for security services
for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that since ICC is using
the accrual method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have
been declared as deductions from income during the said years and the failure of ICC to do so bars it from claiming said
expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and failure to withhold
expanded withholding tax assessment, petitioner invoked the presumption that the assessment notices issued by the BIR
are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for
professional and security services from ICCs gross income; and (2) held that ICC did not understate its interest income
from the promissory notes of Realty Investment, Inc; and that ICC withheld the required 1% withholding tax from the
deductions for security services.
12

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses
paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or
incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the
taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. 11

The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the
National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the
taxable year in which paid or accrued or paid or incurred, dependent upon the method of accounting upon the basis of
which the net income is computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and
deductions.12 In the instant case, the accounting method used by ICC is the accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not
being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction
from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable
deductions for the current year but failed to do so cannot deduct the same for the next year. 13

The accrual method relies upon the taxpayers right to receive amounts or its obligation to pay them, in opposition to
actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right
to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed
and determinable in amount, without regard to indeterminacy merely of time of payment. 14

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a
manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the
all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of
the reasonable accurate determination of such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be
determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known
absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable
accuracy. The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is
satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount
of liability does not have to be determined exactly; it must be determined with "reasonable accuracy."
Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate
amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to
have known, at the closing of its books for the taxable year.[16] Accrual method of accounting presents largely a
question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or
deduction.17

Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the
taxpayer and liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same
by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon
vague implications. And since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must
also be strictly construed.18

In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses
for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala
Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICCs tax problems for
the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960s. 19 From the nature of
the claimed deductions and the span of time during which the firm was retained, ICC can be expected to have reasonably
known the retainer fees charged by the firm as well as the compensation for its legal services. The failure to determine the
exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be
attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could
have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting.
For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the
rates charged by their long time legal consultant.
13

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the burden of
establishing the accrual of an expense or income. However, ICC failed to discharge this burden. As to when the firms
performance of its services in connection with the 1984 tax problems were completed, or whether ICC exercised
reasonable diligence to inquire about the amount of its liability, or whether it does or does not possess the information
necessary to compute the amount of said liability with reasonable accuracy, are questions of fact which ICC never
established. It simply relied on the defense of delayed billing by the firm and the company, which under the circumstances,
is not sufficient to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal and
auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot
be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even
with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot
determine the professional fees which said company would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were
allowable deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot
be validly deducted from its gross income for the said year and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by ICC in 1986 20and could
therefore be properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty Investment, Inc., we sustain
the findings of the CTA and the Court of Appeals that no such understatement exists and that only simple interest
computation and not a compounded one should have been applied by the BIR. There is indeed no stipulation between the
latter and ICC on the application of compounded interest. 21 Under Article 1959 of the Civil Code, unless there is a
stipulation to the contrary, interest due should not further earn interest.

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

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income tax should be
cancelled and set aside but only insofar as the claimed deductions of ICC for security services. Said Assessment is valid
as to the BIRs disallowance of ICCs expenses for professional services. The Court of Appeals cancellation of
Assessment Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency expanded withholding tax, is
sustained.

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

The case is remanded to the BIR for the computation of Isabela Cultural Corporations liability under Assessment Notice
No. FAS-1-86-90-000680.

SO ORDERED.