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Republic of the Philippines gross income of P1,771,124.

63 and a net income of

SUPREME COURT P1,052,550.67. On 19 April 1956, they filed an amended
Manila income tax return, the amendment upon the original
being a lesser net income of P1,012,554.51, and, on the
EN BANC basis of this amended return, they paid P570,252.00,
inclusive of withholding taxes. After audit, the petitioner
determined a deficiency of P16,116.00, which amount,
G.R. Nos. L-18169, L-18262 & L-21434 July 31, 1964
the respondents paid on 5 December 1956.


Back in 1955, however, the Lednickys filed with the U.S.
Internal Revenue Agent in Manila their federal income
tax return for the years 1947, 1951, 1952, 1953, and 1954
LEDNICKY, respondents.
on income from Philippine sources on a cash basis.
Payment of these federal income taxes, including
Office of the Solicitor General for petitioner. penalties and delinquency interest in the amount of
Ozaeta, Gibbs and Ozaeta for respondents. P264,588.82, were made in 1955 to the U.S. Director of
Internal Revenue, Baltimore, Maryland, through the
REYES, J.B.L., J.: National City Bank of New York, Manila Branch. Exchange
and bank charges in remitting payment totaled
The above-captioned cases were elevated to this Court P4,143.91.
under separate petitions by the Commissioner for review
of the corresponding decisions of the Court of Tax Wherefore, the parties respectfully pray that the
Appeals. Since these cases involve the same parties and foregoing stipulation of facts be admitted and approved
issues akin to each case presented, they are herein by this Honorable Court, without prejudice to the parties
decided jointly. adducing other evidence to prove their case not
covered by this stipulation of facts.
The respondents, V. E. Lednicky and Maria Valero
Lednicky, are husband and wife, respectively, both On 11 August 1958, the said respondents amended their
American citizens residing in the Philippines, and have Philippine income tax return for 1955 to include the
derived all their income from Philippine sources for the following deductions:
taxable years in question.

U.S. Federal income taxes P471,867.32

In compliance with local law, the aforesaid respondents,
on 27 March 1957, filed their income tax return for 1956, Interest accrued up to May 15, 1955 40,333.92
reporting therein a gross income of P1,017,287. 65 and a
net income of P733,809.44 on which the amount of Exchange and bank charges 4,143.91
P317,395.4 was assessed after deducting P4,805.59 as
withholding tax. Pursuant to the petitioner's assessment
notice, the respondents paid the total amount of Total P516,345.15
P326,247.41, inclusive of the withheld taxes, on 15 April
and therewith filed a claim for refund of the sum of
P166,384.00, which was later reduced to P150,269.00.
On 17 March 1959, the respondents Lednickys filed an
amended income tax return for 1956. The amendment
consists in a claimed deduction of P205,939.24 paid in The respondents Lednicky brought suit in the Tax Court,
1956 to the United States government as federal income which was docketed therein as CTA Case No. 570.
tax for 1956. Simultaneously with the filing of the
amended return, the respondents requested the refund In G. R. No. 21434 (CTA Case No. 783), the facts are
of P112,437.90. similar, but refer to respondents Lednickys' income tax
return for 1957, filed on 28 February 1958, and for which
respondents paid a total sum of P196,799.65. In 1959, they
When the petitioner Commissioner of Internal Revenue
filed an amended return for 1957, claiming deduction of
failed to answer the claim for refund, the respondents
P190,755.80, representing taxes paid to the U.S.
filed their petition with the Tax Court on 11 April 1959 as
Government on income derived wholly from Philippine
CTA Case No. 646, which is now G. R. No. L-18286 in the
sources. On the strength thereof, respondents seek refund
Supreme Court.
of P90 520.75 as overpayment. The Tax Court again
decided for respondents.
G. R. No. L-18169 (formerly CTA Case No. 570) is also a
claim for refund in the amount of P150,269.00, as alleged
overpaid income tax for 1955, the facts of which are as The common issue in all three cases, and one that is of
follows: first impression in this jurisdiction, is whether a citizen of the
United States residing in the Philippines, who derives
income wholly from sources within the Republic of the
On 28 February 1956, the same respondents-spouses filed Philippines, may deduct from his gross income the
their domestic income tax return for 1955, reporting a
income taxes he has paid to the United States (A) The amount of the credit in respect to the tax paid or
government for the taxable year on the strength of accrued to any country shall not exceed the same
section 30 (C-1) of the Philippine Internal Revenue Code, proportion of the tax against which such credit is taken,
reading as follows: which the taxpayer's net income from sources within such
country taxable under this Title bears to his entire net
SEC. 30. Deduction from gross income. — In computing income for the same taxable year; and
net income there shall be allowed as deductions —
(B) The total amount of the credit shall not exceed the
(a) ... same proportion of the tax against which such credit is
taken, which the taxpayer's net income from sources
without the Philippines taxable under this Title bears to his
(b) ...
entire net income for the same taxable year.

(c) Taxes:
We agree with appellant Commissioner that the
Construction and wording of Section 30 (c) (1) (B) of the
(1) In general. — Taxes paid or accrued within the Internal Revenue Act shows the law's intent that the right
taxable year, except — to deduct income taxes paid to foreign government from
the taxpayer's gross income is given only as an alternative
(A) The income tax provided for under this Title; or substitute to his right to claim a tax credit for such
foreign income taxes under section 30 (c) (3) and (4); so
(B) Income, war-profits, and excess profits taxes imposed that unless the alien resident has a right to claim such tax
by the authority of any foreign country; but this deduction credit if he so chooses, he is precluded from deducting
shall be allowed in the case of a taxpayer who does not the foreign income taxes from his gross income. For it is
signify in his return his desire to have to any extent the obvious that in prescribing that such deduction shall be
benefits of paragraph (3) of this subsection (relating to allowed in the case of a taxpayer who does not signify in
credit for foreign countries); his return his desire to have to any extent the benefits of
paragraph (3) (relating to credits for taxes paid to foreign
countries), the statute assumes that the taxpayer in
(C) Estate, inheritance and gift taxes; and question also may signify his desire to claim a tax credit
and waive the deduction; otherwise, the foreign taxes
(D) Taxes assessed against local benefits of a kind would always be deductible, and their mention in the list
tending to increase the value of the property assessed. of non-deductible items in Section 30(c) might as well
(Emphasis supplied) have been omitted, or at least expressly limited to taxes
on income from sources outside the Philippine Islands.
The Tax Court held that they may be deducted because
of the undenied fact that the respondent spouses did not Had the law intended that foreign income taxes could be
"signify" in their income tax return a desire to avail deducted from gross income in any event,regardless of
themselves of the benefits of paragraph 3 (B) of the the taxpayer's right to claim a tax credit, it is the latter
subsection, which reads: right that should be conditioned upon the taxpayer's
waiving the deduction; in which Case the right to
Par. (c) (3) Credits against tax for taxes of foreign reduction under subsection (c-1-B) would have been
countries. — If the taxpayer signifies in his return his desire made absolute or unconditional (by omitting foreign
to have the benefits of this paragraph, the tax imposed taxes from the enumeration of non-deductions), while the
by this Title shall be credited with — right to a tax credit under subsection (c-3) would have
been expressly conditioned upon the taxpayer's not
claiming any deduction under subsection (c-1). In other
(A) ...;
words, if the law had been intended to operate as
contended by the respondent taxpayers and by the
(B) Alien resident of the Philippines. — In the case of an Court of Tax Appeals section 30 (subsection (c-1) instead
alien resident of the Philippines, the amount of any such of providing as at present:
taxes paid or accrued during the taxable year to any
foreign country, if the foreign country of which such alien
SEC. 30. Deduction from gross income. — In computing
resident is a citizen or subject, in imposing such taxes,
net income there shall be allowed as deductions —
allows a similar credit to citizens of the Philippines residing
in such country;
(a) ...
It is well to note that the tax credit so authorized is limited
under paragraph 4 (A and B) of the same subsection, in (b) ...
the following terms:
(c) Taxes:
Par. (c) (4) Limitation on credit. — The amount of the
credit taken under this section shall be subject to each of (1) In general. — Taxes paid or accrued within the
the following limitations: taxable year, except —
(A) The income tax provided for under this Title; Much stress is laid on the thesis that if the respondent
taxpayers are not allowed to deduct the income taxes
(B) Income, war-profits, and excess profits taxes imposed they are required to pay to the government of the United
by the authority of any foreign country; but this deduction States in their return for Philippine income tax, they would
shall be allowed in the case of a taxpayer who does not be subjected to double taxation. What respondents fail
signify in his return his desire to have to any extent the to observe is that double taxation becomes obnoxious
benefits of paragraph (3) of this subsection (relating to only where the taxpayer is taxed twice for the benefit of
credit for taxes of foreign countries); the same governmental entity (cf. Manila vs. Interisland
Gas Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs.
Meer, 89 Phil. 357). In the present case, while the
(C) Estate, inheritance and gift taxes; and
taxpayers would have to pay two taxes on the same
income, the Philippine government only receives the
(D) Taxes assessed against local benefits of a kind tending proceeds of one tax. As between the Philippines, where
to increase the value of the property assessed. the income was earned and where the taxpayer is
domiciled, and the United States, where that income
would have merely provided: was not earned and where the taxpayer did not reside, it
is indisputable that justice and equity demand that the
SEC. 30. Decision from grow income. — In computing net tax on the income should accrue to the benefit of the
income there shall be allowed as deductions: Philippines. Any relief from the alleged double taxation
should come from the United States, and not from the
Philippines, since the former's right to burden the taxpayer
(a) ... is solely predicated on his citizenship, without contributing
to the production of the wealth that is being taxed.
(b) ...
Aside from not conforming to the fundamental doctrine
(c) Taxes paid or accrued within the taxable year, EXCEPT of income taxation that the right of a government to tax
— income emanates from its partnership in the production
of income, by providing the protection, resources,
(A) The income tax provided for in this Title; incentive, and proper climate for such production, the
interpretation given by the respondents to the revenue
law provision in question operates, in its application, to
(B) Omitted or else worded as follows:
place a resident alien with only domestic sources of
income in an equal, if not in a better, position than one
Income, war profits and excess profits taxes imposed by who has both domestic and foreign sources of income, a
authority of any foreign country on income earned within situation which is manifestly unfair and short of logic.
the Philippines if the taxpayer does not claim the benefits
under paragraph 3 of this subsection;
Finally, to allow an alien resident to deduct from his gross
income whatever taxes he pays to his own government
(C) Estate, inheritance or gift taxes; amounts to conferring on the latter the power to reduce
the tax income of the Philippine government simply by
(D) Taxes assessed against local benefits of a kind tending increasing the tax rates on the alien resident. Everytime
to increase the value of the property assessed. the rate of taxation imposed upon an alien resident is
increased by his own government, his deduction from
while subsection (c-3) would have been made Philippine taxes would correspondingly increase, and the
conditional in the following or equivalent terms: proceeds for the Philippines diminished, thereby
subordinating our own taxes to those levied by a foreign
government. Such a result is incompatible with the status
(3) Credits against tax for taxes of foreign countries. — If
of the Philippines as an independent and sovereign state.
the taxpayer has not deducted such taxes from his gross
income but signifies in his return his desire to have the
benefits of this paragraph, the tax imposed by Title shall IN VIEW OF THE FOREGOING, the decisions of the Court of
be credited with ... (etc.). Tax Appeals are reversed, and, the disallowance of the
refunds claimed by the respondents Lednicky is affirmed,
with costs against said respondents-appellees
Petitioners admit in their brief that the purpose of the law
is to prevent the taxpayer from claiming twice the
benefits of his payment of foreign taxes, by deduction
from gross income (subs. c-1) and by tax credit (subs. c-
3). This danger of double credit certainly can not exist if
the taxpayer can not claim benefit under either of these
headings at his option, so that he must be entitled to a
tax credit (respondent taxpayers admittedly are not so
entitled because all their income is derived from
Philippine sources), or the option to deduct from gross
income disappears altogether.
Republic of the Philippines G.R. No. 65774 (CTA Case No. 2561, the Second Case)
Manila On 17 November 1971, BOAC was assessed deficiency
income taxes, interests, and penalty for the fiscal years
1968-1969 to 1970-1971 in the aggregate amount of
P549,327.43, and the additional amounts of P1,000.00 and
P1,800.00 as compromise penalties for violation of Section
G.R. No. L-65773-74 April 30, 1987 46 (requiring the filing of corporation returns) penalized
under Section 74 of the National Internal Revenue Code
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT On 25 November 1971, BOAC requested that the
OF TAX APPEALS, respondents. assessment be countermanded and set aside. In a letter,
dated 16 February 1972, however, the CIR not only
Petitioner Commissioner of Internal Revenue (CIR) seeks a denied the BOAC request for refund in the First Case but
review on certiorari of the joint Decision of the Court of also re-issued in the Second Case the deficiency income
Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, tax assessment for P534,132.08 for the years 1969 to 1970-
dated 26 January 1983, which set aside petitioner's 71 plus P1,000.00 as compromise penalty under Section
assessment of deficiency income taxes against 74 of the Tax Code. BOAC's request for reconsideration
respondent British Overseas Airways Corporation (BOAC) was denied by the CIR on 24 August 1973. This prompted
for the fiscal years 1959 to 1967, 1968-69 to 1970-71, BOAC to file the Second Case before the Tax Court
respectively, as well as its Resolution of 18 November, praying that it be absolved of liability for deficiency
1983 denying reconsideration. income tax for the years 1969 to 1971.

BOAC is a 100% British Government-owned corporation This case was subsequently tried jointly with the First Case.
organized and existing under the laws of the United
Kingdom It is engaged in the international airline business On 26 January 1983, the Tax Court rendered the assailed
and is a member-signatory of the Interline Air Transport joint Decision reversing the CIR. The Tax Court held that
Association (IATA). As such it operates air transportation the proceeds of sales of BOAC passage tickets in the
service and sells transportation tickets over the routes of Philippines by Warner Barnes and Company, Ltd., and
the other airline members. During the periods covered by later by Qantas Airways, during the period in question, do
the disputed assessments, it is admitted that BOAC had not constitute BOAC income from Philippine sources
no landing rights for traffic purposes in the Philippines, and "since no service of carriage of passengers or freight was
was not granted a Certificate of public convenience and performed by BOAC within the Philippines" and,
necessity to operate in the Philippines by the Civil therefore, said income is not subject to Philippine income
Aeronautics Board (CAB), except for a nine-month tax. The CTA position was that income from transportation
period, partly in 1961 and partly in 1962, when it was is income from services so that the place where services
granted a temporary landing permit by the CAB. are rendered determines the source. Thus, in the
Consequently, it did not carry passengers and/or cargo dispositive portion of its Decision, the Tax Court ordered
to or from the Philippines, although during the period petitioner to credit BOAC with the sum of P858,307.79,
covered by the assessments, it maintained a general and to cancel the deficiency income tax assessments
sales agent in the Philippines — Wamer Barnes and against BOAC in the amount of P534,132.08 for the fiscal
Company, Ltd., and later Qantas Airways — which was years 1968-69 to 1970-71.
responsible for selling BOAC tickets covering passengers
and cargoes. 1
Hence, this Petition for Review on certiorari of the
Decision of the Tax Court.
G.R. No. 65773 (CTA Case No. 2373, the First Case)
The Solicitor General, in representation of the CIR, has
On 7 May 1968, petitioner Commissioner of Internal aptly defined the issues, thus:
Revenue (CIR, for brevity) assessed BOAC the aggregate
amount of P2,498,358.56 for deficiency income taxes
1. Whether or not the revenue derived by private
covering the years 1959 to 1963. This was protested by
respondent British Overseas Airways Corporation (BOAC)
BOAC. Subsequent investigation resulted in the issuance
from sales of tickets in the Philippines for air transportation,
of a new assessment, dated 16 January 1970 for the years
while having no landing rights here, constitute income of
1959 to 1967 in the amount of P858,307.79. BOAC paid
BOAC from Philippine sources, and, accordingly, taxable.
this new assessment under protest.

2. Whether or not during the fiscal years in question BOAC

On 7 October 1970, BOAC filed a claim for refund of the
s a resident foreign corporation doing business in the
amount of P858,307.79, which claim was denied by the
Philippines or has an office or place of business in the
CIR on 16 February 1972. But before said denial, BOAC
had already filed a petition for review with the Tax Court
on 27 January 1972, assailing the assessment and praying
for the refund of the amount paid.
3. In the alternative that private respondent may not be (2) Resident corporations. — A corporation organized,
considered a resident foreign corporation but a non- authorized, or existing under the laws of any foreign
resident foreign corporation, then it is liable to Philippine country, except a foreign fife insurance company,
income tax at the rate of thirty-five per cent (35%) of its engaged in trade or business within the Philippines, shall
gross income received from all sources within the be taxable as provided in subsection (a) of this section
Philippines. upon the total net income received in the preceding
taxable year from all sources within the
Under Section 20 of the 1977 Tax Code: Philippines. (Emphasis supplied)

(h) the term resident foreign corporation engaged in Next, we address ourselves to the issue of whether or not
trade or business within the Philippines or having an office the revenue from sales of tickets by BOAC in the
or place of business therein. Philippines constitutes income from Philippine sources
and, accordingly, taxable under our income tax laws.
(i) The term "non-resident foreign corporation" applies to a
foreign corporation not engaged in trade or business The Tax Code defines "gross income" thus:
within the Philippines and not having any office or place
of business therein "Gross income" includes gains, profits, and income
derived from salaries, wages or compensation for
It is our considered opinion that BOAC is a resident foreign personal service of whatever kind and in whatever form
corporation. There is no specific criterion as to what paid, or from profession, vocations, trades,business,
constitutes "doing" or "engaging in" or "transacting" commerce, sales, or dealings in property, whether real or
business. Each case must be judged in the light of its personal, growing out of the ownership or use of or
peculiar environmental circumstances. The term implies a interest in such property; also from interests, rents,
continuity of commercial dealings and arrangements, dividends, securities, or the transactions of any business
and contemplates, to that extent, the performance of carried on for gain or profile, or gains, profits, and income
acts or works or the exercise of some of the functions derived from any source whatever (Sec. 29[3]; Emphasis
normally incident to, and in progressive prosecution of supplied)
commercial gain or for the purpose and object of the
business organization. 2 "In order that a foreign The definition is broad and comprehensive to include
corporation may be regarded as doing business within a proceeds from sales of transport documents. "The words
State, there must be continuity of conduct and intention 'income from any source whatever' disclose a legislative
to establish a continuous business, such as the policy to include all income not expressly exempted
appointment of a local agent, and not one of a within the class of taxable income under our laws."
temporary character. 3 Income means "cash received or its equivalent"; it is the
amount of money coming to a person within a specific
BOAC, during the periods covered by the subject - time ...; it means something distinct from principal or
assessments, maintained a general sales agent in the capital. For, while capital is a fund, income is a flow. As
Philippines, That general sales agent, from 1959 to 1971, used in our income tax law, "income" refers to the flow of
"was engaged in (1) selling and issuing tickets; (2) wealth. 6
breaking down the whole trip into series of trips — each
trip in the series corresponding to a different airline The records show that the Philippine gross income of
company; (3) receiving the fare from the whole trip; and BOAC for the fiscal years 1968-69 to 1970-71 amounted to
(4) consequently allocating to the various airline P10,428,368 .00. 7
companies on the basis of their participation in the
services rendered through the mode of interline Did such "flow of wealth" come from "sources within the
settlement as prescribed by Article VI of the Resolution Philippines",
No. 850 of the IATA Agreement." 4 Those activities were in
exercise of the functions which are normally incident to,
The source of an income is the property, activity or
and are in progressive pursuit of, the purpose and object
service that produced the income. 8 For the source of
of its organization as an international air carrier. In fact,
income to be considered as coming from the Philippines,
the regular sale of tickets, its main activity, is the very
it is sufficient that the income is derived from activity
lifeblood of the airline business, the generation of sales
within the Philippines. In BOAC's case, the sale of tickets in
being the paramount objective. There should be no
the Philippines is the activity that produces the income.
doubt then that BOAC was "engaged in" business in the
The tickets exchanged hands here and payments for
Philippines through a local agent during the period
fares were also made here in Philippine currency. The site
covered by the assessments. Accordingly, it is a resident
of the source of payments is the Philippines. The flow of
foreign corporation subject to tax upon its total net
wealth proceeded from, and occurred within, Philippine
income received in the preceding taxable year from all
territory, enjoying the protection accorded by the
sources within the Philippines. 5
Philippine government. In consideration of such
protection, the flow of wealth should share the burden of
Sec. 24. Rates of tax on corporations. — ... supporting the government.

(b) Tax on foreign corporations. — ...

A transportation ticket is not a mere piece of paper. ... Provided, however, That international carriers shall pay
When issued by a common carrier, it constitutes the a tax of 2-½ per cent on their cross Philippine billings.
contract between the ticket-holder and the carrier. It (Sec. 24[b] [21, Tax Code).
gives rise to the obligation of the purchaser of the ticket
to pay the fare and the corresponding obligation of the Presidential Decree No. 1355, promulgated on 21 April,
carrier to transport the passenger upon the terms and 1978, provided a statutory definition of the term "gross
conditions set forth thereon. The ordinary ticket issued to Philippine billings," thus:
members of the traveling public in general embraces
within its terms all the elements to constitute it a valid
... "Gross Philippine billings" includes gross revenue realized
contract, binding upon the parties entering into the
from uplifts anywhere in the world by any international
relationship. 9
carrier doing business in the Philippines of passage
documents sold therein, whether for passenger, excess
True, Section 37(a) of the Tax Code, which enumerates baggage or mail provided the cargo or mail originates
items of gross income from sources within the Philippines, from the Philippines. ...
namely: (1) interest, (21) dividends, (3) service, (4) rentals
and royalties, (5) sale of real property, and (6) sale of
The foregoing provision ensures that international airlines
personal property, does not mention income from the
are taxed on their income from Philippine sources. The 2-
sale of tickets for international transportation. However,
½ % tax on gross Philippine billings is an income tax. If it
that does not render it less an income from sources within
had been intended as an excise or percentage tax it
the Philippines. Section 37, by its language, does not
would have been place under Title V of the Tax Code
intend the enumeration to be exclusive. It merely directs
covering Taxes on Business.
that the types of income listed therein be treated as
income from sources within the Philippines. A cursory
reading of the section will show that it does not state that Lastly, we find as untenable the BOAC argument that the
it is an all-inclusive enumeration, and that no other kind of dismissal for lack of merit by this Court of the appeal inJAL
income may be so considered. " 10 vs. Commissioner of Internal Revenue (G.R. No. L-30041)
on February 3, 1969, is res judicata to the present case.
The ruling by the Tax Court in that case was to the effect
BOAC, however, would impress upon this Court that
that the mere sale of tickets, unaccompanied by the
income derived from transportation is income for services,
physical act of carriage of transportation, does not
with the result that the place where the services are
render the taxpayer therein subject to the common
rendered determines the source; and since BOAC's
carrier's tax. As elucidated by the Tax Court, however, the
service of transportation is performed outside the
common carrier's tax is an excise tax, being a tax on the
Philippines, the income derived is from sources without
activity of transporting, conveying or removing
the Philippines and, therefore, not taxable under our
passengers and cargo from one place to another. It
income tax laws. The Tax Court upholds that stand in the
purports to tax the business of transportation. 14 Being an
joint Decision under review.
excise tax, the same can be levied by the State only
when the acts, privileges or businesses are done or
The absence of flight operations to and from the performed within the jurisdiction of the Philippines. The
Philippines is not determinative of the source of income or subject matter of the case under consideration is income
the site of income taxation. Admittedly, BOAC was an off- tax, a direct tax on the income of persons and other
line international airline at the time pertinent to this case. entities "of whatever kind and in whatever form derived
The test of taxability is the "source"; and the source of an from any source." Since the two cases treat of a different
income is that activity ... which produced the subject matter, the decision in one cannot be res
income. 11Unquestionably, the passage documentations judicata to the other.
in these cases were sold in the Philippines and the
revenue therefrom was derived from a activity regularly
WHEREFORE, the appealed joint Decision of the Court of
pursued within the Philippines. business a And even if the
Tax Appeals is hereby SET ASIDE. Private respondent, the
BOAC tickets sold covered the "transport of passengers
British Overseas Airways Corporation (BOAC), is hereby
and cargo to and from foreign cities", 12it cannot alter
ordered to pay the amount of P534,132.08 as deficiency
the fact that income from the sale of tickets was derived
income tax for the fiscal years 1968-69 to 1970-71 plus 5%
from the Philippines. The word "source" conveys one
surcharge, and 1% monthly interest from April 16, 1972 for
essential idea, that of origin, and the origin of the income
a period not to exceed three (3) years in accordance
herein is the Philippines. 13
with the Tax Code. The BOAC claim for refund in the
amount of P858,307.79 is hereby denied. Without costs.
It should be pointed out, however, that the assessments
upheld herein apply only to the fiscal years covered by
the questioned deficiency income tax assessments in
these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For,
pursuant to Presidential Decree No. 69, promulgated on
24 November, 1972, international carriers are now taxed
as follows:
EN BANC clause as well because the CWT is being levied upon real
estate enterprises but not on other business enterprises,
CHAMBER OF REAL G.R. No. 160756 more particularly those in the manufacturing sector.
ASSOCIATIONS, INC., The issues to be resolved are as follows:
Petitioner, Present: (1) whether or not this Court should take
cognizance of the present case;
vs (2) whether or not the imposition of the MCIT on
domestic corporations is unconstitutional
SECRETARY ALBERTO ROMULO, (3) whether or not the imposition of CWT on
THE HON. ACTING SECRETARY OF income from sales of real properties
FINANCE JUANITA D. AMATONG, classified as ordinary assets under RRs 2-98,
and THE HON. COMMISSIONER OF 6-2001 and 7-2003, is unconstitutional.

Under the MCIT scheme, a corporation,

In this original petition beginning on its fourth year of operation, is assessed an
for certiorari and mandamus,[1] petitioner Chamber of MCIT of 2% of its gross income when such MCIT is greater
Real Estate and Builders Associations, Inc. is questioning than the normal corporate income tax imposed under
the constitutionality of Section 27 (E) of Republic Act (RA) Section 27(A).[4] If the regular income tax is higher than
8424[2] and the revenue regulations (RRs) issued by the the MCIT, the corporation does not pay the MCIT. Any
Bureau of Internal Revenue (BIR) to implement said excess of the MCIT over the normal tax shall be carried
provision and those involving creditable withholding forward and credited against the normal income tax for
taxes.[3] the three immediately succeeding taxable years. Section
27(E) of RA 8424 provides:
Petitioner is an association of real estate developers and
builders in the Philippines. It impleaded former Executive Section 27 (E). [MCIT] on Domestic
Secretary Alberto Romulo, then acting Secretary of Corporations. -
Finance Juanita D. Amatong and then Commissioner of
Internal Revenue Guillermo Parayno, Jr. as respondents. (1) Imposition of Tax. A [MCIT] of two percent
(2%) of the gross income as of the end of the
Petitioner assails the validity of the imposition of minimum taxable year, as defined herein, is hereby
corporate income tax (MCIT) on corporations and imposed on a corporation taxable under this
creditable withholding tax (CWT) on sales of real Title, beginning on the fourth taxable year
properties classified as ordinary assets. immediately following the year in which such
corporation commenced its business operations,
Section 27(E) of RA 8424 provides for MCIT on when the minimum income tax is greater than
domestic corporations and is implemented by RR 9- the tax computed under Subsection (A) of this
98. Petitioner argues that the MCIT violates the due Section for the taxable year.
process clause because it levies income tax even if there
is no realized gain. (2) Carry Forward of Excess Minimum Tax. Any
excess of the [MCIT] over the normal income tax
Petitioner also seeks to nullify Sections 2.57.2(J) (as as computed under Subsection (A) of this
amended by RR 6-2001) and 2.58.2 of RR 2-98, and Section shall be carried forward and credited
Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which against the normal income tax for the three (3)
prescribe the rules and procedures for the collection of immediately succeeding taxable years.
CWT on the sale of real properties categorized as
ordinary assets. Petitioner contends that these revenue (3) Relief from the [MCIT] under certain
regulations are contrary to law for two reasons: first, they conditions. The Secretary of Finance is hereby
ignore the different treatment by RA 8424 of ordinary authorized to suspend the imposition of the
assets and capital assets and second, respondent [MCIT] on any corporation which suffers losses on
Secretary of Finance has no authority to collect CWT, account of prolonged labor dispute, or because
much less, to base the CWT on the gross selling price or of force majeure, or because of legitimate
fair market value of the real properties classified as business reverses.
ordinary assets. The Secretary of Finance is hereby authorized to
promulgate, upon recommendation of the
Petitioner also asserts that the enumerated provisions of Commissioner, the necessary rules and
the subject revenue regulations violate the due process regulations that shall define the terms and
clause because, like the MCIT, the government collects conditions under which he may suspend the
income tax even when the net income has not yet been imposition of the [MCIT] in a meritorious case.
determined. They contravene the equal protection
(4) Gross Income Defined. For purposes of For purposes of these Regulations, the term,
applying the [MCIT] provided under Subsection normal income tax means the income tax rates
(E) hereof, the term gross income shall mean prescribed under Sec. 27(A) and Sec. 28(A)(1) of
gross sales less sales returns, discounts and the Code xxx at 32% effective January 1, 2000
allowances and cost of goods sold. Cost of and thereafter.
goods sold shall include all business expenses
directly incurred to produce the merchandise to xxx xxx xxx
bring them to their present location and use.
(2) Carry forward of excess [MCIT]. Any excess
For trading or merchandising concern, cost of of the [MCIT] over the normal income tax as
goods sold shall include the invoice cost of the computed under Sec. 27(A) of the Code shall
goods sold, plus import duties, freight in be carried forward on an annual basis and
transporting the goods to the place where the credited against the normal income tax for the
goods are actually sold including insurance three (3) immediately succeeding taxable years.
while the goods are in transit.
xxx xxx xxx
For a manufacturing concern, cost of goods
manufactured and sold shall include all costs of Meanwhile, on April 17, 1998, respondent Secretary,
production of finished goods, such as raw upon recommendation of respondent CIR, promulgated
materials used, direct labor and manufacturing RR 2-98 implementing certain provisions of RA 8424
overhead, freight cost, insurance premiums and involving the withholding of taxes.[6] Under Section
other costs incurred to bring the raw materials to 2.57.2(J) of RR No. 2-98, income payments from the sale,
the factory or warehouse. exchange or transfer of real property, other than capital
assets, by persons residing in the Philippines and
In the case of taxpayers engaged in the sale of habitually engaged in the real estate business were
service, gross income means gross receipts less subjected to CWT:
sales returns, allowances, discounts and cost of
services. Cost of services shall mean all direct Sec. 2.57.2. Income payment subject to [CWT]
costs and expenses necessarily incurred to and rates prescribed thereon:
provide the services required by the customers
and clients including (A) salaries and employee xxx xxx xxx
benefits of personnel, consultants and specialists
directly rendering the service and (B) cost of (J) Gross selling price or total amount of
facilities directly utilized in providing the service consideration or its equivalent paid to the
such as depreciation or rental of equipment seller/owner for the sale, exchange or transfer of.
used and cost of supplies: Provided, however, Real property, other than capital assets, sold by
that in the case of banks, cost of services shall an individual, corporation, estate, trust, trust fund
include interest expense. or pension fund and the seller/transferor is
habitually engaged in the real estate business in
accordance with the following schedule
On August 25, 1998, respondent Secretary of Finance
(Secretary), on the recommendation of the Commissioner Those which are exempt
of Internal Revenue (CIR), promulgated RR 9-98 from a withholding tax at
implementing Section 27(E).[5] The pertinent portions source as prescribed in
thereof read: Sec. 2.57.5 of these Exempt
Sec. 2.27(E) [MCIT] on Domestic Corporations. With a selling price of five
hundred thousand pesos
(P500,000.00) or less. 1.5%
(1) Imposition of the Tax. A [MCIT] of two
percent (2%) of the gross income as of the end With a selling price of
of the taxable year (whether calendar or fiscal more than five hundred
year, depending on the accounting period thousand pesos
(P500,000.00) but not
employed) is hereby imposed upon any
more than two million 3.0%
domestic corporation beginning the fourth (4 th) pesos (P2,000,000.00).
taxable year immediately following the taxable
year in which such corporation commenced its With selling price of more
business operations. The MCIT shall be imposed than two million pesos
whenever such corporation has zero or negative (P2,000,000.00) 5.0%
taxable income or whenever the amount of
minimum corporate income tax is greater than
the normal income tax due from such
Gross selling price shall mean the consideration with Section 6 (E) of the Code, as amended,
stated in the sales document or the fair market whichever is higher. In an exchange, the fair
value determined in accordance with Section 6 market value of the property received in
(E) of the Code, as amended, whichever is exchange shall be considered as the
higher. In an exchange, the fair market value of consideration.
the property received in exchange, as
determined in the Income Tax Regulations shall xxx xxx xxx
be used.
However, if the buyer is engaged in trade or
Where the consideration or part thereof is business, whether a corporation or otherwise,
payable on installment, no withholding tax is these rules shall apply:
required to be made on theperiodic installment
payments where the buyer is an individual not (i) If the sale is a sale of property on the
engaged in trade or business. In such a case, the installment plan (that is, payments in the
applicable rate of tax based on the entire year of sale do not exceed 25% of the
consideration shall be withheld on the last selling price), the tax shall be deducted
installment or installments to be paid to the seller. and withheld by the buyer on every
However, if the buyer is engaged in trade or
business, whether a corporation or otherwise, the (ii) If, on the other hand, the sale is on a
tax shall be deducted and withheld by the buyer cash basis or is a deferred-payment sale
on every installment. not on the installment plan (that is,
payments in the year of sale exceed
This provision was amended by RR 6-2001 on July 31, 25% of the selling price), the buyer shall
2001: withhold the tax based on the gross
selling price or fair market value of the
Sec. 2.57.2. Income payment subject to [CWT] property, whichever is higher, on the first
and rates prescribed thereon: installment.
xxx xxx xxx
In any case, no Certificate Authorizing
(J) Gross selling price or total amount of Registration (CAR) shall be issued to the buyer
consideration or its equivalent paid to the unless the [CWT] due on the sale, transfer or
seller/owner for the sale, exchange or transfer of exchange of real property other than capital
real property classified as ordinary asset. - A asset has been fully paid. (Underlined
[CWT] based on the gross selling price/total amendments in the original)
amount of consideration or the fair market value
determined in accordance with Section 6(E) of
the Code, whichever is higher, paid to the Section 2.58.2 of RR 2-98 implementing Section
seller/owner for the sale, transfer or exchange of 58(E) of RA 8424 provides that any sale, barter or
real property, other than capital asset, shall be exchange subject to the CWT will not be recorded by the
imposed upon the withholding agent,/buyer, in Registry of Deeds until the CIR has certified that such
accordance with the following schedule: transfers and conveyances have been reported and the
taxes thereof have been duly paid:[7]
Where the seller/transferor is exempt from [CWT] in
accordance with Sec. 2.57.5 of these regulations. Sec. 2.58.2. Registration with the Register
of Deeds. Deeds of conveyances of land or land
Upon the following values of real property, where and building/improvement thereon arising from
the seller/transferor is habitually engaged in the real sales, barters, or exchanges subject to the
estate business. creditable expanded withholding tax shall not
be recorded by the Register of Deeds unless the
With a selling price of Five Hundred Thousand Pesos [CIR] or his duly authorized representative has
(P500,000.00) or less. 1.5%
certified that such transfers and conveyances
have been reported and the expanded
With a selling price of more than Five Hundred withholding tax, inclusive of the documentary
Thousand Pesos (P500,000.00) but not more than stamp tax, due thereon have been fully paid
Two Million Pesos (P2,000,000.00). xxxx.
With a selling price of more than two Million
Pesos (P2,000,000.00). On February 11, 2003, RR No. 7-2003[8] was promulgated,
providing for the guidelines in determining whether a
xxx xxx xxx particular real property is a capital or an ordinary asset
for purposes of imposing the MCIT, among others. The
Gross selling price shall remain the pertinent portions thereof state:
consideration stated in the sales document or
the fair market value determined in accordance
Section 4. Applicable taxes on sale, adjudication; (3) the person challenging the validity of th
exchange or other disposition of real e act must have standing to do so; (4) the question of
property. - Gains/Income derived from constitutionality must have been raised at the earliest
sale, exchange, or other disposition of opportunity and (5) the issue of constitutionality must be
real properties shall, unless otherwise the very lis mota of the case.[9]
exempt, be subject to applicable taxes
imposed under the Code, depending Respondents aver that the first three requisites
on whether the subject properties are are absent in this case. According to them, there is no
classified as capital assets or ordinary actual case calling for the exercise of judicial power and
assets; it is not yet ripe for adjudication because [petitioner] did
not allege that CREBA, as a corporate entity, or any of its
a. In the case of individual citizen members, has been assessed by the BIR for the payment
(including estates and trusts), resident of [MCIT] or [CWT] on sales of real property. Neither did
aliens, and non-resident aliens engaged petitioner allege that its members have shut down their
in trade or business in the Philippines; businesses as a result of the payment of the MCIT or
CWT. Petitioner has raised concerns in mere abstract and
xxx xxx xxx hypothetical form without any actual, specific and
concrete instances cited that the assailed law and
(ii) The sale of real property revenue regulations have actually and adversely
located in the Philippines, classified as affected it. Lacking empirical data on which to base any
ordinary assets, shall be subject to the conclusion, any discussion on the constitutionality of the
[CWT] (expanded) under Sec. 2.57..2(J) MCIT or CWT on sales of real property is essentially an
of [RR 2-98], as amended, based on the academic exercise.
gross selling price or current fair market
value as determined in accordance Perceived or alleged hardship to
with Section 6(E) of the Code, taxpayers alone is not an adequate justification
whichever is higher, and consequently, for adjudicating abstract issues. Otherwise,
to the ordinary income tax imposed adjudication would be no different from the
under Sec. 24(A)(1)(c) or 25(A)(1) of the giving of advisory opinion that does not really
Code, as the case may be, based on settle legal issues.[10]
net taxable income.
An actual case or controversy involves a conflict
xxx xxx xxx of legal rights or an assertion of opposite legal claims
which is susceptible of judicial resolution as distinguished
c. In the case of domestic corporations. from a hypothetical or abstract difference or
dispute.[11] On the other hand, a question is considered
xxx xxx xxx ripe for adjudication when the act being challenged has
a direct adverse effect on the individual challenging it.[12]
(ii) The sale of land and/or building
classified as ordinary asset and other real Contrary to respondents assertion, we do not
property (other than land and/or building have to wait until petitioners members have shut down
treated as capital asset), regardless of the their operations as a result of the MCIT or CWT. The
classification thereof, all of which are located in assailed provisions are already being implemented. As
the Philippines, shall be subject to the [CWT] we stated in Didipio Earth-Savers Multi-Purpose
(expanded) under Sec. 2.57.2(J) of [RR 2-98], as Association, Incorporated (DESAMA) v. Gozun:[13]
amended, and consequently, to the ordinary
income tax under Sec. 27(A) of the Code. In lieu By the mere enactment of the
of the ordinary income tax, however, domestic questioned law or the approval of the
corporations may become subject to the [MCIT] challenged act, the dispute is said to have
under Sec. 27(E) of the Code, whichever is ripened into a judicial controversy even without
applicable. any other overt act. Indeed, even a singular
violation of the Constitution and/or the law is
xxx xxx xxx enough to awaken judicial duty.[14]

We shall now tackle the issues raised. If the assailed provisions are indeed unconstitutional,
there is no better time than the present to settle such
question once and for all.

EXISTENCE OF A JUSTICIABLE CONTROVERSY Respondents next argue that petitioner has no legal
standing to sue:
Courts will not assume jurisdiction over a
constitutional question unless the following requisites are Petitioner is an association of some of the
satisfied: (1) there must be an actual case calling for the real estate developers and builders in the
exercise of judicial review; (2) the question before the Philippines. Petitioners did not allege that [it] itself
court must be ripe for is in the real estate business. It did not allege any
material interest or any wrong that it may suffer convenience. This will go a long way in ensuring
from the enforcement of [the assailed that corporations will pay their just share in
provisions].[15] supporting our public life and our economic
Legal standing or locus standi is a party’s
personal and substantial interest in a case such that it has Domestic corporations owe their corporate
sustained or will sustain direct injury as a result of the existence and their privilege to do business to the
governmental act being challenged.[16] In Holy Spirit government. They also benefit from the efforts of the
Homeowners Association, Inc. v. Defensor,[17] we held government to improve the financial market and to
that the association had legal standing because its ensure a favorable business climate. It is therefore fair for
members stood to be injured by the enforcement of the the government to require them to make a reasonable
assailed provisions: contribution to the public expenses.

Petitioner association has the legal Congress intended to put a stop to the practice
standing to institute the instant petition xxx. There of corporations which, while having large turn-overs,
is no dispute that the individual members of report minimal or negative net income resulting in
petitioner association are residents of the NGC. minimal or zero income taxes year in and year out,
As such they are covered and stand to be either through under-declaration of income or over-deduction
benefited or injured by the enforcement of the of expenses otherwise called tax shelters.[23]
IRR, particularly as regards the selection process
of beneficiaries and lot allocation to qualified Mr. Javier (E.) [This] is what the Finance
beneficiaries. Thus, petitioner association may Dept. is trying to remedy, that is why they have
assail those provisions in the IRR which it believes proposed the [MCIT]. Because from experience
to be unfavorable to the rights of its members. xxx too, you have corporations which have been
Certainly, petitioner and its members have losing year in and year out and paid no tax. So, if
sustained direct injury arising from the the corporation has been losing for the past five
enforcement of the IRR in that they have been years to ten years, then that corporation has no
disqualified and eliminated from the selection business to be in business. It is dead. Why
process.[18] continue if you are losing year in and year out?
So, we have this provision to avoid this type of tax
shelters, Your Honor.[24]
In any event, this Court has the discretion to take
cognizance of a suit which does not satisfy the The primary purpose of any legitimate business is
requirements of an actual case, ripeness or legal standing to earn a profit. Continued and repeated losses after
when paramount public interest is involved.[19] The operations of a corporation or consistent reports of
questioned MCIT and CWT affect not only petitioners but minimal net income render its financial statements and its
practically all domestic corporate taxpayers in our tax payments suspect. For sure, certain tax avoidance
country. The transcendental importance of the issues schemes resorted to by corporations are allowed in our
raised and their overreaching significance to society jurisdiction. The MCIT serves to put a cap on such tax
make it proper for us to take cognizance of this shelters. As a tax on gross income, it prevents tax evasion
petition.[20] and minimizes tax avoidance schemes achieved through
sophisticated and artful manipulations of deductions and
CONCEPT AND RATIONALE OF THE MCIT other stratagems. Since the tax base was broader, the
tax rate was lowered.
The MCIT on domestic corporations is a new
concept introduced by RA 8424 to the Philippine taxation To further emphasize the corrective nature of the MCIT,
system. It came about as a result of the perceived the following safeguards were incorporated into the law:
inadequacy of the self-assessment system in capturing
the true income of corporations.[21] It was devised as a First, recognizing the birth pangs of businesses
relatively simple and effective revenue-raising instrument and the reality of the need to recoup initial major capital
compared to the normal income tax which is more expenditures, the imposition of the MCIT commences only
difficult to control and enforce. It is a means to on the fourth taxable year immediately following the year
ensure that everyone will make some minimum in which the corporation commenced its
contribution to the support of the public sector. The operations.[25] This grace period allows a new business to
congressional deliberations on this are illuminating: stabilize first and make its ventures viable before it is
subjected to the MCIT.[26]
Senator Enrile. Mr. President, we are not
unmindful of the practice of certain corporations Second, the law allows the carrying forward of
of reporting constantly a loss in their operations to any excess of the MCIT paid over the normal income tax
avoid the payment of taxes, and thus avoid which shall be credited against the normal income tax for
sharing in the cost of government. In this regard, the three immediately succeeding years.[27]
the Tax Reform Act introduces for the first time a
new concept called the [MCIT] so as to minimize Third, since certain businesses may be incurring
tax evasion, tax avoidance, tax manipulation in genuine repeated losses, the law authorizes the Secretary
the country and for administrative of Finance to suspend the imposition of MCIT if a
corporation suffers losses due to prolonged labor situs (place) of taxation.[36] It has the authority to
dispute, force majeure and legitimate business prescribe a certain tax at a specific rate for a particular
reverses.[28] public purpose on persons or things within its
jurisdiction. In other words, the legislature wields the
Even before the legislature introduced the MCIT power to define what tax shall be imposed, why it should
to the Philippine taxation system, several other countries be imposed, how much tax shall be imposed, against
already had their own system of minimum corporate whom (or what) it shall be imposed and where it shall be
income taxation. Our lawmakers noted that most imposed.
developing countries, particularly Latin American and
Asian countries, have the same form of safeguards as we As a general rule, the power to tax is plenary and
do. As pointed out during the committee hearings: unlimited in its range, acknowledging in its very nature no
limits, so that the principal check against its abuse is to be
[Mr. Medalla:] Note that most developing found only in the responsibility of the legislature (which
countries where you have of course quite a bit imposes the tax) to its constituency who are to pay
of room for underdeclaration of gross receipts it.[37] Nevertheless, it is circumscribed by constitutional
have this same form of safeguards. limitations. At the same time, like any other statute, tax
legislation carries a presumption of constitutionality.
In the case of Thailand, half a percent (0.5%),
theres a minimum of income tax of half a The constitutional safeguard of due process is
percent (0.5%) of gross assessable income. In embodied in the fiat [no] person shall be deprived of life,
Korea a 25% of taxable income before liberty or property without due process of law. In Sison, Jr.
deductions and exemptions. Of course the v. Ancheta, et al.,[38] we held that the due process clause
different countries have different basis for that may properly be invoked to invalidate, in appropriate
minimum income tax. cases, a revenue measure[39] when it amounts to a
confiscation of property.[40] But in the same case, we also
The other thing youll notice is the explained that we will not strike down a revenue measure
preponderance of Latin American countries that as unconstitutional (for being violative of the due process
employed this method. Okay, those are clause) on the mere allegation of arbitrariness by the
additional Latin American countries.[29] taxpayer.[41] There must be a factual foundation to such
an unconstitutional taint.[42] This merely adheres to the
authoritative doctrine that, where the due process clause
At present, the United States of America, Mexico, is invoked, considering that it is not a fixed rule but rather
Argentina, Tunisia, Panama and Hungary have their own a broad standard, there is a need for proof of such
versions of the MCIT.[30] persuasive character.[43]

MCIT IS NOT VIOLATIVE OF DUE PROCESS Petitioner is correct in saying that income is
distinct from capital.[44] Income means all the wealth
Petitioner claims that the MCIT under Section 27(E) of RA which flows into the taxpayer other than a mere return on
8424 is unconstitutional because it is highly oppressive, capital. Capital is a fund or property existing at one
arbitrary and confiscatory which amounts to deprivation distinct point in time while income denotes a flow of
of property without due process of law. It explains that wealth during a definite period of time.[45] Income is gain
gross income as defined under said provision only derived and severed from capital.[46] For income to be
considers the cost of goods sold and other direct taxable, the following requisites must exist:
expenses; other major expenditures, such as
administrative and interest expenses which are equally (1) there must be gain;
necessary to produce gross income, were not taken into (2) the gain must be realized or received and
account.[31] Thus, pegging the tax base of the MCIT to a (3) the gain must not be excluded by law or
corporations gross income is tantamount to a treaty from taxation.[47]
confiscation of capital because gross income, unlike net
income, is not realized gain.[32] Certainly, an income tax is arbitrary and confiscatory if it
taxes capital because capital is not income. In other
We disagree. words, it is income, not capital, which is subject to income
tax. However, the MCIT is not a tax on capital.
Taxes are the lifeblood of the
government. Without taxes, the government can neither The MCIT is imposed on gross income which is
exist nor endure. The exercise of taxing power derives its arrived at by deducting the capital spent by a
source from the very existence of the State whose social corporation in the sale of its goods, i.e., the cost of
contract with its citizens obliges it to promote public goods[48] and other direct expenses from gross
interest and the common good.[33] sales. Clearly, the capital is not being taxed.

Taxation is an inherent attribute of Furthermore, the MCIT is not an additional tax imposition.
sovereignty.[34] It is a power that is purely It is imposed in lieu of the normal net income tax, and
legislative.[35] Essentially, this means that in the legislature only if the normal income tax is suspiciously low. The MCIT
primarily lies the discretion to determine the nature (kind), merely approximates the amount of net income tax due
object (purpose), extent (rate), coverage (subjects) and from a corporation, pegging the rate at a very much
reduced 2% and uses as the base the corporations gross In sum, petitioner failed to support, by any
income. factual or legal basis, its allegation that the MCIT is
arbitrary and confiscatory. The Court cannot strike down
Besides, there is no legal objection to a broader tax base a law as unconstitutional simply because of its
or taxable income by eliminating all deductible items and yokes.[58] Taxation is necessarily burdensome because, by
at the same time reducing the applicable tax rate.[49] its nature, it adversely affects property rights.[59] The party
alleging the laws unconstitutionality has the burden to
Statutes taxing the gross "receipts," demonstrate the supposed violations in understandable
"earnings," or "income" of particular terms.[60]
corporations are found in many jurisdictions. Tax
thereon is generally held to be within the power
of a state to impose; or constitutional, unless it RR 9-98 MERELY CLARIFIES
interferes with interstate commerce or violates SECTION 27(E) OF RA 8424
the requirement as to uniformity of taxation.[50]
Petitioner alleges that RR 9-98 is a deprivation of
property without due process of law because the MCIT is
The United States has a similar alternative being imposed and collected even when there is
minimum tax (AMT) system which is generally actually a loss, or a zero or negative taxable income:
characterized by a lower tax rate but a broader tax
base.[51] Since our income tax laws are of American Sec. 2.27(E) [MCIT] on Domestic
origin, interpretations by American courts of our parallel Corporations.
tax laws have persuasive effect on the interpretation of
these laws.[52] Although our MCIT is not exactly the same (1) Imposition of the Tax. xxx The MCIT
as the AMT, the policy behind them and the procedure of shall be imposed whenever such
their implementation are comparable. On the question of corporation has zero or negative taxable
the AMTs constitutionality, the United States Court of income or whenever the amount of
Appeals for the Ninth Circuit stated in Okin v. [MCIT] is greater than the normal income
Commissioner:[53] tax due from such
corporation. (Emphasis supplied)
In enacting the minimum tax, Congress
attempted to remedy general taxpayer distrust RR 9-98, in declaring that MCIT should be
of the system growing from large numbers of imposed whenever such corporation has zero or negative
taxpayers with large incomes who were yet taxable income, merely defines the coverage of Section
paying no taxes. 27(E). This means that even if a corporation incurs a net
loss in its business operations or reports zero income after
xxx xxx xxx deducting its expenses, it is still subject to an MCIT of 2% of
its gross income. This is consistent with the law which
We thus join a number of other courts in imposes the MCIT on gross income notwithstanding the
upholding the constitutionality of the [AMT]. xxx amount of the net income. But the law also states that
[It] is a rational means of obtaining a broad- the MCIT is to be paid only if it is greater than the normal
based tax, and therefore is constitutional.[54] net income. Obviously, it may well be the case that the
MCIT would be less than the net income of the
corporation which posts a zero or negative taxable
The U.S. Court declared that the congressional intent to income.
ensure that corporate taxpayers would contribute a
minimum amount of taxes was a legitimate governmental We now proceed to the issues involving the CWT.
end to which the AMT bore a reasonable relation.[55]
American courts have also emphasized that Congress The withholding tax system is a procedure
has the power to condition, limit or deny deductions from through which taxes (including income taxes) are
gross income in order to arrive at the net that it chooses collected.[61] Under Section 57 of RA 8424, the types of
to tax.[56] This is because deductions are a matter of income subject to withholding tax are divided into three
legislative grace.[57] categories: (a) withholding of final tax on certain
incomes; (b) withholding of creditable tax at source and
Absent any other valid objection, the assignment (c) tax-free covenant bonds.Petitioner is concerned with
of gross income, instead of net income, as the tax base the second category (CWT) and maintains that the
of the MCIT, taken with the reduction of the tax rate from revenue regulations on the collection of CWT on sale of
32% to 2%, is not constitutionally objectionable. real estate categorized as ordinary assets are
Moreover, petitioner does not cite any actual,
specific and concrete negative experiences of its Petitioner, after enumerating the distinctions
members nor does it present empirical data to show that between capital and ordinary assets under RA 8424,
the implementation of the MCIT resulted in the contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and
confiscation of their property. Sections 4(a)(ii) and (c)(ii) of RR 7-2003 were promulgated
with grave abuse of discretion amounting to lack of
jurisdiction and patently in contravention of
law[62] because they ignore such distinctions. Petitioners provided for by law, at the rate of not less than
conclusion is based on the following premises: (a) the one percent (1%) but not more than thirty-two
revenue regulations use gross selling price (GSP) or fair percent (32%) thereof, which shall be credited
market value (FMV) of the real estate as basis for against the income tax liability of the taxpayer
determining the income tax for the sale of real estate for the taxable year.
classified as ordinary assets and (b) they mandate the
collection of income tax on a per transaction basis, i.e.,
upon consummation of the sale via the CWT, contrary to The questioned provisions of RR 2-98, as
RA 8424 which calls for the payment of the net income at amended, are well within the authority given by Section
the end of the taxable period.[63] 57(B) to the Secretary, i.e., the graduated rate of 1.5%-5%
Petitioner theorizes that since RA 8424 treats is between the 1%-32% range; the withholding tax is
capital assets and ordinary assets differently, respondents imposed on the income payable and the tax is
cannot disregard the distinctions set by the legislators as creditable against the income tax liability of the taxpayer
regards the tax base, modes of collection and payment for the taxable year.
of taxes on income from the sale of capital and ordinary
Petitioners arguments have no merit. INDIVIDUALS OR CORPORATIONS ENGAGED IN THE REAL


COLLECTION OF CWT ON SALES OF REAL PROPERTY Petitioner maintains that RR 2-98, as amended, arbitrarily
CONSIDERED AS ORDINARY ASSETS shifted the tax base of a real estate business income tax
from net income to GSP or FMV of the property sold.

The Secretary of Finance is granted, under Petitioner is wrong.

Section 244 of RA 8424, the authority to promulgate the
necessary rules and regulations for the effective The taxes withheld are in the nature of advance tax
enforcement of the provisions of the law. Such authority is payments by a taxpayer in order to extinguish its possible
subject to the limitation that the rules and regulations tax obligation. [69] They are installments on the annual tax
must not override, but must remain consistent and in which may be due at the end of the taxable year.[70]
harmony with, the law they seek to apply and
implement.[64] It is well-settled that an administrative Under RR 2-98, the tax base of the income tax
agency cannot amend an act of Congress.[65] from the sale of real property classified as ordinary assets
remains to be the entitys net income imposed under
We have long recognized that the method of withholding Section 24 (resident individuals) or Section 27 (domestic
tax at source is a procedure of collecting income tax corporations) in relation to Section 31 of RA 8424, i.e. gross
which is sanctioned by our tax laws.[66] The withholding income less allowable deductions. The CWT is to be
tax system was devised for three primary reasons: first, to deducted from the net income tax payable by the
provide the taxpayer a convenient manner to meet his taxpayer at the end of the taxable year.[71] Precisely,
probable income tax liability; second, to ensure the Section 4(a)(ii) and (c)(ii) of RR 7-2003 reiterate that the
collection of income tax which can otherwise be lost or tax base for the sale of real property classified as ordinary
substantially reduced through failure to file the assets remains to be the net taxable income:
corresponding returns and third, to improve the
governments cash flow.[67] This results in administrative Section 4. Applicable taxes on sale, exchange
savings, prompt and efficient collection of taxes, or other disposition of real property. -
prevention of delinquencies and reduction of Gains/Income derived from sale, exchange, or
governmental effort to collect taxes through more other disposition of real properties shall unless
complicated means and remedies.[68] otherwise exempt, be subject to applicable
taxes imposed under the Code, depending on
Respondent Secretary has the authority to whether the subject properties are classified as
require the withholding of a tax on items of income capital assets or ordinary assets;
payable to any person, national or juridical, residing in
the Philippines. Such authority is derived from Section xxx xxx xxx
57(B) of RA 8424 which provides:
a. In the case of individual citizens (including
SEC. 57. Withholding of Tax at Source. estates and trusts), resident aliens, and non-
resident aliens engaged in trade or business in
xxx xxx xxx the Philippines;

(B) Withholding of Creditable Tax at xxx xxx xxx

Source. The [Secretary] may, upon the
recommendation of the [CIR], require the (ii) The sale of real property located in the
withholding of a tax on the items of income Philippines, classified as ordinary assets, shall
payable to natural or juridical persons, residing in be subject to the [CWT] (expanded) under Sec.
the Philippines, by payor-corporation/persons as 2.57.2(j) of [RR 2-98], as amended, based on the
[GSP] or current [FMV] as determined in
accordance with Section 6(E) of the Code, FWT CWT
whichever is higher, and consequently, a) The amount a) Taxes withheld
to the ordinary income tax imposed under Sec. of income tax on certain income
24(A)(1)(c) or 25(A)(1) of the Code, as the case withheld by the payments are
may be, based on net taxable income. withholding intended to equal
agent is or at least
xxx xxx xxx constituted as a approximate the
full and final tax due of the
c. In the case of domestic corporations. payment of the payee on said
income tax due income.
The sale of land and/or building classified as from the payee
ordinary asset and other real property (other on the said
than land and/or building treated as capital income.
asset), regardless of the classification thereof, all
of which are located in the Philippines, shall b)The liability b) Payee of
be subject to the [CWT] (expanded) under Sec. for payment of income is required
2.57.2(J) of [RR 2-98], as amended, and the tax rests to report the
consequently, to the ordinary income tax under primarily on the income and/or
Sec. 27(A) of the Code. In lieu of the ordinary payor as a pay the difference
income tax, however, domestic corporations withholding between the tax
may become subject to the [MCIT] under Sec. agent. withheld and the
27(E) of the same Code, whichever is tax due on the
applicable. (Emphasis supplied) income. The
payee also has
Accordingly, at the end of the year, the taxpayer/seller the right to ask for
shall file its income tax return and credit the taxes a refund if the tax
withheld (by the withholding agent/buyer) against its tax withheld is more
due. If the tax due is greater than the tax withheld, then than the tax due.
the taxpayer shall pay the difference. If, on the other c) The payee is
hand, the tax due is less than the tax withheld, the not required to c) The income
taxpayer will be entitled to a refund or tax file an income recipient is still
credit. Undoubtedly, the taxpayer is taxed on its net tax return for the required to file an
income. particular income tax return,
The use of the GSP/FMV as basis to determine the income.[73] as prescribed in
withholding taxes is evidently for purposes of practicality Sec. 51 and Sec.
and convenience. Obviously, the withholding 52 of the NIRC, as
agent/buyer who is obligated to withhold the tax does amended.[74]
not know, nor is he privy to, how much the taxpayer/seller
will have as its net income at the end of the taxable As previously stated, FWT is imposed on the sale of capital
year. Instead, said withholding agents knowledge and assets. On the other hand, CWT is imposed on the sale of
privity are limited only to the particular transaction in ordinary assets. The inherent and substantial differences
which he is a party. In such a case, his basis can only be between FWT and CWT disprove petitioners contention
the GSP or FMV as these are the only factors reasonably that ordinary assets are being lumped together with, and
known or knowable by him in connection with the treated similarly as, capital assets in contravention of the
performance of his duties as a withholding agent. pertinent provisions of RA 8424.

Petitioner insists that the levy, collection and

NO BLURRING OF DISTINCTIONS BETWEEN ORDINARY payment of CWT at the time of transaction are contrary
ASSETS AND CAPITAL ASSETS to the provisions of RA 8424 on the manner and time of
filing of the return, payment and assessment of income
RR 2-98 imposes a graduated CWT on income based on tax involving ordinary assets.[75]
the GSP or FMV of the real property categorized as
ordinary assets. On the other hand, Section 27(D)(5) of RA The fact that the tax is withheld at source does
8424 imposes a final tax and flat rate of 6% on the gain not automatically mean that it is treated exactly the
presumed to be realized from the sale of a capital asset same way as capital gains. As aforementioned, the
based on its GSP or FMV. This final tax is also withheld at mechanics of the FWT are distinct from those of the CWT.
source.[72] The withholding agent/buyers act of collecting the tax at
the time of the transaction by withholding the tax due
The differences between the two forms of from the income payable is the essence of the
withholding tax, i.e., creditable and final, show that withholding tax method of tax collection.
ordinary assets are not treated in the same manner as
capital assets. Final withholding tax (FWT) and CWT are
distinguished as follows:
NO RULE THAT ONLY PASSIVE passive income. If that were the intent of Congress, it
INCOMES CAN BE SUBJECT TO CWT could have easily said so.

Petitioner submits that only passive income can Indeed, Section 57(A) and (B) are distinct. Section 57(A)
be subjected to withholding tax, whether final or refers to FWT while Section 57(B) pertains to CWT. The
creditable. According to petitioner, the whole of Section former covers the kinds of passive income enumerated
57 governs the withholding of income tax on passive therein and the latter encompasses any income other
income. The enumeration in Section 57(A) refers to than those listed in 57(A). Since the law itself makes
passive income being subjected to FWT. It follows that distinctions, it is wrong to regard 57(A) and 57(B) in the
Section 57(B) on CWT should also be limited to passive same way.
To repeat, the assailed provisions of RR 2-98, as
SEC. 57. Withholding of Tax at Source. amended, do not modify or deviate from the text of
Section 57(B). RR 2-98 merely implements the law by
(A) Withholding of Final Tax on Certain Incomes. specifying what income is subject to CWT. It has been
Subject to rules and regulations, the [Secretary] held that, where a statute does not require any particular
may promulgate, upon the recommendation of procedure to be followed by an administrative agency,
the [CIR], requiring the filing of income tax return the agency may adopt any reasonable method to carry
by certain income payees, the tax imposed or out its functions.[77] Similarly, considering that the law uses
prescribed by Sections 24(B)(1), 24(B)(2), 24(C), the general term income, the Secretary and CIR may
24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), specify the kinds of income the rules will apply to based
25(E); 27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5); on what is feasible. In addition, administrative rules and
28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), regulations ordinarily deserve to be given weight and
28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), respect by the courts[78] in view of the rule-making
28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of authority given to those who formulate them and their
this Code on specified items of income shall be specific expertise in their respective fields.
withheld by payor-corporation and/or person
and paid in the same manner and subject to the
same conditions as provided in Section 58 of this NO DEPRIVATION OF PROPERTY

(B) Withholding of Creditable Tax at Source. The Petitioner avers that the imposition of CWT on
[Secretary] may, upon the recommendation of GSP/FMV of real estate classified as ordinary assets
the [CIR], require the withholding of a tax on the deprives its members of their property without due
items of income payable to natural or juridical process of law because, in their line of business, gain is
persons, residing in the Philippines, by payor- never assured by mere receipt of the selling price. As a
corporation/persons as provided for by law, at result, the government is collecting tax from net income
the rate of not less than one percent (1%) but not not yet gained or earned.
more than thirty-two percent (32%) thereof, which
shall be credited against the income tax liability Again, it is stressed that the CWT is creditable against the
of the taxpayer for the taxable year. (Emphasis tax due from the seller of the property at the end of the
supplied) taxable year. The seller will be able to claim a tax refund
if its net income is less than the taxes withheld. Nothing is
This line of reasoning is non sequitur. taken that is not due so there is no confiscation of
property repugnant to the constitutional guarantee of
Section 57(A) expressly states that final tax can due process. More importantly, the due process
be imposed on certain kinds of income and enumerates requirement applies to the power to tax.[79] The CWT does
these as passive income. The BIR defines passive income not impose new taxes nor does it increase taxes.[80] It
by stating what it is not: relates entirely to the method and time of payment.

if the income is generated in the Petitioner protests that the refund remedy does
active pursuit and performance of the not make the CWT less burdensome because taxpayers
corporations primary purposes, the same have to wait years and may even resort to litigation
is not passive income[76] before they are granted a refund.[81] This argument is
misleading. The practical problems encountered in
It is income generated by the taxpayers assets. These claiming a tax refund do not affect the constitutionality
assets can be in the form of real properties that return and validity of the CWT as a method of collecting the tax.
rental income, shares of stock in a corporation that earn
dividends or interest income received from savings. Petitioner complains that the amount withheld
would have otherwise been used by the enterprise to pay
On the other hand, Section 57(B) provides that labor wages, materials, cost of money and other
the Secretary can require a CWT on income payable to expenses which can then save the entity from having to
natural or juridical persons, residing in the obtain loans entailing considerable interest expense.
Philippines. There is no requirement that this income be Petitioner also lists the expenses and pitfalls of the trade
which add to the burden of the realty industry: huge
investments and borrowings; long gestation bigger and its frequency of transaction limited, making it
period; sudden and unpredictable interest rate surges; less cumbersome for the parties to comply with the
continually spiraling development/construction costs; withholding tax scheme.
heavy taxes and prohibitive up-front regulatory fees from
at least 20 government agencies.[82] On the other hand, each manufacturing enterprise may
have tens of thousands of transactions with several
Petitioners lamentations will not support its attack thousand customers every month involving both minimal
on the constitutionality of the CWT. Petitioners complaints and substantial amounts. To require the customers of
are essentially matters of policy best addressed to the manufacturing enterprises, at present, to withhold the
executive and legislative branches of the taxes on each of their transactions with their tens or
government. Besides, the CWT is applied only on the hundreds of suppliers may result in an inefficient and
amounts actually received or receivable by the real unmanageable system of taxation and may well defeat
estate entity. Sales on installment are taxed on a per- the purpose of the withholding tax system.
installment basis.[83] Petitioners desire to utilize for its
operational and capital expenses money earmarked for Petitioner counters that there are other businesses
the payment of taxes may be a practical business option wherein expensive items are also sold
but it is not a fundamental right which can be demanded infrequently, e.g. heavy equipment, jewelry, furniture,
from the court or from the government. appliance and other capital goods yet these are not
similarly subjected to the CWT.[89] As already discussed,
NO VIOLATION OF EQUAL PROTECTION the Secretary may adopt any reasonable method to
carry out its functions.[90] Under Section 57(B), it may
Petitioner claims that the revenue regulations choose what to subject to CWT.
are violative of the equal protection clause because the
CWT is being levied only on real estate A reading of Section 2.57.2 (M) of RR 2-98 will also show
enterprises. Specifically, petitioner points out that that petitioners argument is not accurate. The sales of
manufacturing enterprises are not similarly imposed a manufacturers who have clients within the top 5,000
CWT on their sales, even if their manner of doing business corporations, as specified by the BIR, are also subject to
is not much different from that of a real estate CWT for their transactions with said 5,000 corporations.[91]
enterprise. Like a manufacturing concern, a real estate
business is involved in a continuous process of Lastly, petitioner assails Section 2.58.2 of RR 2-98,
production and it incurs costs and expenditures on a which provides that the Registry of Deeds should not
regular basis. The only difference is that goods produced effect the regisration of any document transferring real
by the real estate business are house and lot units.[84] property unless a certification is issued by the CIR that the
withholding tax has been paid. Petitioner proffers hardly
Again, we disagree. any reason to strike down this rule except to rely on its
contention that the CWT is unconstitutional. We have
The equal protection clause under the ruled that it is not. Furthermore, this provision uses almost
Constitution means that no person or class of persons shall exactly the same wording as Section 58(E) of RA 8424
be deprived of the same protection of laws which is and is unquestionably in accordance with it:
enjoyed by other persons or other classes in the same
place and in like circumstances.[85] Stated differently, all Sec. 58. Returns and Payment of Taxes Withheld at
persons belonging to the same class shall be taxed Source.
alike. It follows that the guaranty of the equal protection
of the laws is not violated by legislation based on a (E) Registration with Register of Deeds. - No registration of
reasonable classification. Classification, to be valid, must any document transferring real property shall be
(1) rest on substantial distinctions; (2) be germane to the effected by the Register of Deeds unless the [CIR] or his
purpose of the law; (3) not be limited to existing duly authorized representative has certified that such
conditions only and (4) apply equally to all members of transfer has been reported, and the capital gains or
the same class.[86] [CWT], if any, has been paid: xxxx any violation of this
provision by the Register of Deeds shall be subject to the
The taxing power has the authority to make reasonable penalties imposed under Section 269 of this Code.
classifications for purposes of taxation.[87] Inequalities (Emphasis supplied)
which result from a singling out of one particular class for
taxation, or exemption, infringe no constitutional
limitation.[88] The real estate industry is, by itself, a class CONCLUSION
and can be validly treated differently from other business
enterprises. The renowned genius Albert Einstein was once quoted as
saying [the] hardest thing in the world to understand is
Petitioner, in insisting that its industry should be treated the income tax.[92] When a party questions the
similarly as manufacturing enterprises, fails to realize that constitutionality of an income tax measure, it has to
what distinguishes the real estate business from other contend not only with Einstein’s observation but also with
manufacturing enterprises, for purposes of the imposition the vast and well-established jurisprudence in support of
of the CWT, is not their production processes but the the plenary powers of Congress to impose
prices of their goods sold and the number of transactions taxes. Petitioner has miserably failed to discharge its
involved. The income from the sale of a real property is
burden of convincing the Court that the imposition of In each of said cases an effort was made to collect an
MCIT and CWT is unconstitutional. "income tax" upon "stock dividends" and in each case it
was held that "stock dividends" were capital and not an
WHEREFORE, the petition is hereby DISMISSED. "income" and therefore not subject to the "income tax"
Costs against petitioner.
The appellee admits the doctrine established in the case
of Eisner vs. Macomber (252 U.S., 189) that a "stock
SO ORDERED. dividend" is not "income" but argues that said Act No.
2833, in imposing the tax on the stock dividend, does not
violate the provisions of the Jones Law. The appellee
further argues that the statute of the United States
providing for tax upon stock dividends is different from the
statute of the Philippine Islands, and therefore the
decision of the Supreme Court of the United States should
G.R. No. L-17518 October 30, 1922 not be followed in interpreting the statute in force here.

FREDERICK C. FISHER, plaintiff-appellant, For the purpose of ascertaining the difference in the said
vs. statutes ( (United States and Philippine Islands), providing
WENCESLAO TRINIDAD, Collector of Internal for an income tax in the United States as well as that in
Revenue, defendant-appellee. the Philippine Islands, the two statutes are here quoted
for the purpose of determining the difference, if any, in
The only question presented by this appeal is: Are the the language of the two statutes.
"stock dividends" in the present case "income" and
taxable as such under the provisions of section 25 of Act Chapter 463 of an Act of Congress of September 8, 1916,
No. 2833? While the appellant presents other important in its title 1 provides for the collection of an "income tax."
questions, under the view which we have taken of the Section 2 of said Act attempts to define what is an
facts and the law applicable to the present case, we income. The definition follows:
deem it unnecessary to discuss them now.
That the term "dividends" as used in this title shall be held
The defendant demurred to the petition in the lower to mean any distribution made or ordered to made by a
court. The facts are therefore admitted. They are simple corporation, . . . which stock dividend shall be considered
and may be stated as follows: income, to the amount of its cash value.

That during the year 1919 the Philippine American Drug Act No. 2833 of the Philippine Legislature is an Act
Company was a corporation duly organized and existing establishing "an income tax." Section 25 of said Act
under the laws of the Philippine Islands, doing business in attempts to define the application of the income tax. The
the City of Manila; that he appellant was a stockholder in definition follows:
said corporation; that said corporation, as result of the
business for that year, declared a "stock dividend"; that The term "dividends" as used in this Law shall be held to
the proportionate share of said stock divided of the mean any distribution made or ordered to be made by a
appellant was P24,800; that the stock dividend for that corporation, . . . out of its earnings or profits accrued since
amount was issued to the appellant; that thereafter, in March first, nineteen hundred and thirteen, and payable
the month of March, 1920, the appellant, upon demand to its shareholders, whether in cash or in stock of the
of the appellee, paid under protest, and voluntarily, unto corporation, . . . . Stock dividend shall be considered
the appellee the sum of P889.91 as income tax on said income, to the amount of the earnings or profits
stock dividend. For the recovery of that sum (P889.91) the distributed.
present action was instituted. The defendant demurred to
the petition upon the ground that it did not state facts
sufficient to constitute cause of action. The demurrer was It will be noted from a reading of the provisions of the two
sustained and the plaintiff appealed. laws above quoted that the writer of the law of the
Philippine Islands must have had before him the statute of
the United States. No important argument can be based
To sustain his appeal the appellant cites and relies on upon the slight different in the wording of the two
some decisions of the Supreme Court of the United States sections.
as will as the decisions of the supreme court of some of
the states of the Union, in which the questions before us,
based upon similar statutes, was discussed. Among the It is further argued by the appellee that there are no
most important decisions may be mentioned the constitutional limitations upon the power of the Philippine
following: Towne vs. Eisner, 245 U.S., 418; Doyle vs. Mitchell Legislature such as exist in the United States, and in
Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S., 189; support of that contention, he cites a number of
Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. decisions. There is no question that the Philippine
Charlottesville Woolen Mills, 93 Va., 673. Legislature may provide for the payment of an income
tax, but it cannot, under the guise of an income tax,
collect a tax on property which is not an "income." The
Philippine Legislature can not impose a tax upon new supplies. At the close of the year there is not a
"property" under a law which provides for a tax upon centavo in the treasury, with which either A or B could
"income" only. The Philippine Legislature has no power to buy a cup of coffee or a pair of shoes for his family. At the
provide a tax upon "automobiles" only, and under that beginning of the year they were P2,000, and at the end
law collect a tax upon acarreton or bull cart. of the year they were P4,000, and neither of the
Constitutional limitations, that is to say, a statute expressly stockholders have received a centavo from the business
adopted for one purpose cannot, without amendment, during the year. At the close of the year, when it is
be applied to another purpose which is entirely distinct discovered that the assets are P4,000 and not P2,000,
and different. A statute providing for an income tax instead of selling the extra merchandise on hand and
cannot be construed to cover property which is not, in thereby reducing the business to its original capital, they
fact income. The Legislature cannot, by a statutory agree among themselves to increase the capital they
declaration, change the real nature of a tax which it agree among themselves to increase the capital issued
imposes. A law which imposes an important tax on rice and for that purpose issue additional stock in the form of
only cannot be construed to an impose an importation "stock dividends" or additional stock of P1,000 each,
tax on corn. which represents the actual increase of the shares of
interest in the business. At the beginning of the year each
It is true that the statute in question provides for an stockholder held one-half interest in the capital. At the
income tax and contains a further provision that "stock close of the year, and after the issue of the said stock
dividends" shall be considered income and are therefore dividends, they each still have one-half interest in the
subject to income tax provided for in said law. If "stock business. The capital of the corporation increased during
dividends" are not "income" then the law permits a tax the year, but has either of them received an income? It is
upon something not within the purpose and intent of the not denied, for the purpose of ordinary taxation, that the
law. taxable property of the corporation at the beginning of
the year was P2,000, that at the close of the year it
was P4,000, and that the tax rolls should be changed in
It becomes necessary in this connection to ascertain
accordance with the changed conditions in the business.
what is an "income in order that we may be able to
In other words, the ordinary tax should be increased by
determine whether "stock dividends" are "income" in the
sense that the word is used in the statute. Perhaps it
would be more logical to determine first what are "stock
dividends" in order that we may more clearly understand Another illustration: C and D organized a corporation for
their relation to "income." Generally speaking, stock agricultural purposes with an authorized capital stock of
dividends represent undistributed increase in the capital P20,000 each contributing P5,000. With that capital they
of corporations or firms, joint stock companies, etc., etc., purchased a farm and, with it, one hundred head of
for a particular period. They are used to show the cattle. Every peso contributed is invested. There is no
increased interest or proportional shares in the capital of money in the treasury. Much time and labor was
each stockholder. In other words, the inventory of the expanded during the year by the stockholders on the
property of the corporation, etc., for particular period farm in the way of improvements. Neither received a
shows an increase in its capital, so that the stock centavo during the year from the farm or the cattle. At
theretofore issued does not show the real value of the the beginning of the year the assets of the corporation,
stockholder's interest, and additional stock is issued including the farm and the cattle, were P10,000, and at
showing the increase in the actual capital, or property, or the close of the year and inventory of the property of the
assets of the corporation, etc. corporation is made and it is then found that they have
the same farm with its improvements and two hundred
head of cattle by natural increase. At the end of the year
To illustrate: A and B form a corporation with an
it is also discovered that, by reason of business changes,
authorized capital of P10,000 for the purpose of opening
the farm and the cattle both have increased in value,
and conducting a drug store, with assets of the value of
and that the value of the corporate property is now
P2,000, and each contributes P1,000. Their entire assets
P20,000 instead of P10,000 as it was at the beginning of
are invested in drugs and put upon the shelves in their
the year. The incorporators instead of reducing the
place of business. They commence business without a
property to its original capital, by selling off a part of its,
cent in the treasury. Every dollar contributed is invested.
issue to themselves "stock dividends" to represent the
Shares of stock to the amount of P1,000 are issued to
proportional value or interest of each of the stockholders
each of the incorporators, which represent the actual
in the increased capital at the close of the year. There is
investment and entire assets of the corporation. Business
still not a centavo in the treasury and neither has
for the first year is good. Merchandise is sold, and
withdrawn a peso from the business during the year. No
purchased, to meet the demands of the growing trade.
part of the farm or cattle has been sold and not a single
At the end of the first year an inventory of the assets of
peso was received out of the rents or profits of the capital
the corporation is made, and it is then ascertained that
of the corporation by the stockholders.
the assets or capital of the corporation on hand amount
to P4,000, with no debts, and still not a cent in the
treasury. All of the receipts during the year have been Another illustration: A, an individual farmer, buys a farm
reinvested in the business. Neither of the stockholders with one hundred head of cattle for the sum of P10,000.
have withdrawn a penny from the business during the At the end of the first year, by reason of business
year. Every peso received for the sale of merchandise conditions and the increase of the value of both real
was immediately used in the purchase of new stock — estate and personal property, it is discovered that the
value of the farm and the cattle is P20,000. A, during the thoughtful discussion that the case received below, we
year, has received nothing from the farm or the cattle. His cannot doubt that the dividend was capital as well for
books at the beginning of the year show that he had the purposes of the Income Tax Law. . . . 'A stock dividend
property of the value of P10,000. His books at the close of really takes nothing from the property of the corporation,
the year show that he has property of the value of and adds nothing to the interests of the shareholders. Its
P20,000. A is not a corporation. The assets of his business property is not diminished and their interest are not
are not shown therefore by certificates of stock. His increased. . . . The proportional interest of each
books, however, show that the value of his property has shareholder remains the same. . . .' In short, the
increased during the year by P10,000, under any theory of corporation is no poorer and the stockholder is no richer
business or law, be regarded as an "income" upon which then they were before." (Gibbons vs. Mahon, 136 U.S.,
the farmer can be required to pay an income tax? Is 549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).
there any difference in law in the condition of A in this
illustration and the condition of A and B in the In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179,
immediately preceding illustration? Can the increase of Mr. Justice Pitney, speaking for the court, said that the
the value of the property in either case be regarded as act employs the term "income" in its natural and obvious
an "income" and be subjected to the payment of the sense, as importing something distinct from principal or
income tax under the law? capital and conveying the idea of gain or increase
arising from corporate activity.
Each of the foregoing illustrations, it is asserted, is
analogous to the case before us and, in view of that fact, Mr. Justice Pitney, in the case of Eisner vs. Macomber (252
let us ascertain how lexicographers and the courts have U.S., 189), again speaking for the court said: "An income
defined an "income." The New Standard Dictionary, may be defined as the gain derived from capital, from
edition of 1915, defines an income as "the amount of labor, or from both combined, provided it be understood
money coming to a person or corporation within a to include profit gained through a sale or conversion of
specified time whether as payment or corporation within capital assets."
a specified time whether as payment for services, interest,
or profit from investment." Webster's International
For bookkeeping purposes, when stock dividends are
Dictionary defines an income as "the receipt, salary;
declared, the corporation or company acknowledges a
especially, the annual receipts of a private person or a
liability, in form, to the stockholders, equivalent to the
corporation from property." Bouvier, in his law dictionary,
aggregate par value of their stock, evidenced by a
says that an "income" in the federal constitution and
"capital stock account." If profits have been made by the
income tax act, is used in its common or ordinary
corporation during a particular period and not divided,
meaning and not in its technical, or economic sense. (146
they create additional bookkeeping liabilities under the
Northwestern Reporter, 812) Mr. Black, in his law
head of "profit and loss," "undivided profits," "surplus
dictionary, says "An income is the returnin money from
account," etc., or the like. None of these, however, gives
one's business, labor, or capital invested; gains, profit or
to the stockholders as a body, much less to any one of
private revenue." "An income tax is a tax on the yearly
them, either a claim against the going concern or
profits arising from property , professions, trades, and
corporation, for any particular sum of money, or a right to
any particular portion of the asset, or any shares sells or
until the directors conclude that dividends shall be made
The Supreme Court of the United States, in the case o a part of the company's assets segregated from the
Gray vs. Darlington (82 U.S., 653), said in speaking of common fund for that purpose. The dividend normally is
income that mere advance in value in no sense payable in money and when so paid, then only does the
constitutes the "income" specified in the revenue law as stockholder realize a profit or gain, which becomes his
"income" of the owner for the year in which the sale of separate property, and thus derive an income from the
the property was made. Such advance constitutes and capital that he has invested. Until that, is done
can be treated merely as an increase of capital. (In theincreased assets belong to the corporation and not to
re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 the individual stockholders.
Pa., 414.)
When a corporation or company issues "stock dividends"
Mr. Justice Hughes, later Associate Justice of the Supreme it shows that the company's accumulated profits have
Court of the United States and now Secretary of State of been capitalized, instead of distributed to the
the United States, in his argument before the Supreme stockholders or retained as surplus available for
Court of the United States in the case of Towne vs. distribution, in money or in kind, should opportunity offer.
Eisner, supra, defined an "income" in an income tax law, Far from being a realization of profits of the stockholder, it
unless it is otherwise specified, to mean cash or its tends rather to postpone said realization, in that the fund
equivalent. It does not mean choses in action represented by the new stock has been transferred from
or unrealized increments in the value of the property, and surplus to assets, and no longer is available for actual
cites in support of the definition, the definition given by distribution. The essential and controlling fact is that the
the Supreme Court in the case of Gray vs. stockholder has received nothing out of the company's
Darlington, supra. assets for his separate use and benefit; on the contrary,
every dollar of his original investment, together with
In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, whatever accretions and accumulations resulting from
speaking for the court, said: "Notwithstanding the employment of his money and that of the other
stockholders in the business of the company, still remains disbursement to the stockholder of accumulated
the property of the company, and subject to business risks earnings, and the corporation at once parts irrevocably
which may result in wiping out of the entire investment. with all interest thereon. The other involves no
Having regard to the very truth of the matter, to disbursement by the corporation. It parts with nothing to
substance and not to form, the stockholder by virtue of the stockholder. The latter receives, not an actual
the stock dividend has in fact received nothing that dividend, but certificate of stock which simply evidences
answers the definition of an "income." (Eisner vs. his interest in the entire capital, including such as by
Macomber, 252 U.S., 189, 209, 211.) investment of accumulated profits has been added to
the original capital. They are not income to him, but
The stockholder who receives a stock dividend has represent additions to the source of his income, namely,
received nothing but a representation of his increased his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63
interest in the capital of the corporation. There has been L.R.A. 587). Such a person is in the same position, so far as
no separation or segregation of his interest. All the his income is concerned, as the owner of young domestic
property or capital of the corporation still belongs to the animal, one year old at the beginning of the year, which
corporation. There has been no separation of the interest is worth P50 and, which, at the end of the year, and by
of the stockholder from the general capital of the reason of its growth, is worth P100. The value of his
corporation. The stockholder, by virtue of the stock property has increased, but has had an income during
dividend, has no separate or individual control over the the year? It is true that he had taxable property at the
interest represented thereby, further than he had before beginning of the year of the value of P50, and the same
the stock dividend was issued. He cannot use it for the taxable property at another period, of the value of P100,
reason that it is still the property of the corporation and but he has had no income in the common acceptation
not the property of the individual holder of stock of that word. The increase in the value of the property
dividend. A certificate of stock represented by the stock should be taken account of on the tax duplicate for the
dividend is simply a statement of his proportional interest purposes of ordinary taxation, but not as income for he
or participation in the capital of the corporation. For has had none.
bookkeeping purposes, a corporation, by issuing stock
dividend, acknowledges a liability in form to the The question whether stock dividends are income, or
stockholders, evidenced by a capital stock account. The capital, or assets has frequently come before the courts
receipt of a stock dividend in no way increases the in another form — in cases of inheritance. A is a
money received of a stockholder nor his cash account at stockholder in a large corporation. He dies leaving a will
the close of the year. It simply shows that there has been by the terms of which he give to B during his lifetime the
an increase in the amount of the capital of the "income" from said stock, with a further provision that C
corporation during the particular period, which may be shall, at B's death, become the owner of his share in the
due to an increased business or to a natural increase of corporation. During B's life the corporation issues a stock
the value of the capital due to business, economic, or dividend. Does the stock dividend belong to B as an
other reasons. We believe that the Legislature, when it income, or does it finally belong to C as a part of his share
provided for an "income tax," intended to tax only the in the capital or assets of the corporation, which had
"income" of corporations, firms or individuals, as that term been left to him as a remainder by A? While there has
is generally used in its common acceptation; that is that been some difference of opinion on that question, we
the income means money received, coming to a person believe that a great weight of authorities hold that the
or corporation for services, interest, or profit from stock dividend is capital or assets belonging to C and not
investments. We do not believe that the Legislature an income belonging to B. In the case of D'Ooge vs.
intended that a mere increase in the value of the capital Leeds (176 Mass., 558, 560) it was held that stock
or assets of a corporation, firm, or individual, should be dividends in such cases were regarded as capital and
taxed as "income." Such property can be reached under not as income(Gibbons vs. Mahon, 136 U.S., 549.)
the ordinary from of taxation.
In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray
Mr. Justice Pitney, in the case of the Einer vs. said: "The distinction between the title of a corporation,
Macomber, supra, said in discussing the difference and the interest of its members or stockholders in the
between "capital" and "income": "That the fundamental property of the corporation, is familiar and well settled.
relation of 'capital' to 'income' has been much discussed The ownership of that property is in the corporation, and
by economists, the former being likened to the tree or the not in the holders of shares of its stock. The interest of
land, the latter to the fruit or the crop; the former each stockholder consists in the right to a proportionate
depicted as a reservoir supplied from springs; the latter as part of the profits whenever dividends are declared by
the outlet stream, to be measured by its flow during a the corporation, during its existence, under its charter,
period of time." It may be argued that a stockholder and to a like proportion of the property remaining, upon
might sell the stock dividend which he had acquired. If the termination or dissolution of the corporation, after
he does, then he has received, in fact, an income and payment of its debts." (Minot vs. Paine, 99 Mass., 101;
such income, like any other profit which he realizes from Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.)
the business, is an income and he may be taxed thereon. In the case of Dekoven vs. Alsop (205 Ill ,309, 63 L. R. A.
587) Mr. Justice Wilkin said: "A dividend is defined as a
There is a clear distinction between an extraordinary cash corporate profit set aside, declared, and ordered by the
dividend, no matter when earned, and stock dividends directors to be paid to the stockholders on demand or at
declared, as in the present case. The one is a a fixed time. Until the dividend is declared, these
corporate profits belong to the corporation, not to the authorized the Philippine Legislatures to provide for an
stockholders, and are liable for corporate indebtedness. income tax. That fact may also be admitted. But a
careful reading of that Act will show that, while it
There is a clear distinction between an extraordinary cash permitted a tax upon income, the same provided that
dividend, no matter when earned, and stock dividends income shall include gains, profits, and income derived
declared. The one is a disbursement to the stockholders from salaries, wages, or compensation for personal
of accumulated earning, and the corporation at once services, as well as from interest, rent, dividends, securities,
parts irrevocably with all interest thereon. The other etc. The appellee emphasizes the "income from
involves no disbursement by the corporation. It parts with dividends." Of course, income received as dividends is
nothing to the stockholders. The latter receives, not an taxable as an income but an income from "dividends" is a
actual dividend, but certificates of stock which evidence very different thing from receipt of a "stock dividend."
in a new proportion his interest in the entire capital. When One is an actual receipt of profits; the other is a receipt of
a cash becomes the absolute property of the a representation of the increased value of the assets of
stockholders and cannot be reached by the creditors of corporation.
the corporation in the absence of fraud. A stock dividend
however, still being the property of the corporation and In all of the foregoing argument we have not overlooked
not the stockholder, it may be reached by an execution the decisions of a few of the courts in different parts of
against the corporation, and sold as a part of the the world, which have reached a different conclusion
property of the corporation. In such a case, if all the from the one which we have arrived at in the present
property of the corporation is sold, then the stockholder case. Inasmuch, however, as appeals may be taken from
certainly could not be charged with having received an this court to the Supreme Court of the United States, we
income by virtue of the issuance of the stock dividend. feel bound to follow the same doctrine announced by
Until the dividend is declared and paid, the corporate that court.
profits still belong to the corporation, not to the
stockholders, and are liable for corporate indebtedness. Having reached the conclusion, supported by the great
The rule is well established that cash dividend, whether weight of the authority, that "stock dividends" are not
large or small, are regarded as "income" and all stock "income," the same cannot be taxes under that provision
dividends, as capital or assets (Cook on Corporation, of Act No. 2833 which provides for a tax upon income.
Chapter 32, secs. 534, 536; Davis vs. Jackson, 152 Mass., Under the guise of an income tax, property which is not
58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of an income cannot be taxed. When the assets of a
Law, 2d ed., p. 738.) corporation have increased so as to justify the issuance of
a stock dividend, the increase of the assets should be
If the ownership of the property represented by a stock taken account of the Government in the ordinary tax
dividend is still in the corporation and to in the holder of duplicates for the purposes of assessment and collection
such stock, then it is difficult to understand how it can be of an additional tax. For all of the foregoing reasons, we
regarded as income to the stockholder and not as a part are of the opinion, and so decide, that the judgment of
of the capital or assets of the corporation. (Gibbsons vs. the lower court should be revoked, and without any
Mahon, supra.) the stockholder has received nothing but finding as to costs, it is so ordered.
a representation of an interest in the property of the
corporation and, as a matter of fact, he may never
receive anything, depending upon the final outcome of
the business of the corporation. The entire assets of the
corporation may be consumed by mismanagement, or
eaten up by debts and obligations, in which case the
holder of the stock dividend will never have received an
income from his investment in the corporation. A
corporation may be solvent and prosperous today and
issue stock dividends in representation of its increased
assets, and tomorrow be absolutely insolvent by reason of
changes in business conditions, and in such a case the
stockholder would have received nothing from his
investment. In such a case, if the holder of the stock
dividend is required to pay an income tax on the same,
the result would be that he has paid a tax upon an
income which he never received. Such a conclusion is
absolutely contradictory to the idea of an income. An
income subject to taxation under the law must be an
actual income and not a promised or prospective

The appelle argues that there is nothing in section 25 of

Act No 2833 which contravenes the provisions of the
Jones Law. That may be admitted. He further argues that
the Act of Congress (U.S. Revenue Act of 1918) expressly
G.R. No. 48532 August 31, 1992 Petitioners in C.T.A. Case No. 2594 likewise used the
above conversion rate in converting their dollar income
HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D. for 1971 to Philippine peso. However, on February 8, 1973
HERRERA, BENJAMIN T. ILDEFONSO, ALEXANDER LACSON, and October 8, 1973, petitioners in said cases filed with
JR., ADRIAN O. MICIANO, EDUARDO A. RIALP, LEANDRO G. the office of the respondent Commissioner, amended
SANTILLAN, and JAIME A. SOQUES, petitioners, income tax returns for the above-mentioned years, this
vs. time using the par value of the peso as prescribed in
THE HONORABLE COURT OF TAX APPEALS and Section 48 of Republic Act No. 265 in relation to Section 6
COMMISSIONER OF INTERNAL REVENUE, respondents. of Commonwealth Act No. 265 in relation to Section 6 of
Commonwealth Act No. 699 as the basis for converting
their respective dollar income into Philippine pesos for
G.R. No. 48533 August 31, 1992
purposes of computing and paying the corresponding
income tax due from them. The aforesaid computation
ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY L. as shown in the amended income tax returns resulted in
DIMAYUGA, JAIME E. DY-LIACCO, MELQUIADES J. the alleged overpayments, refund and/or tax credit.
GAMBOA, JR., MANUEL L. GUZMAN, VICENTE D. HERRERA, Accordingly, claims for refund of said over-payments
BENJAMIN T. ILDEFONSO, ALEXANDER LACSON, JR., were filed with respondent Commissioner. Without
ADRIAN O. MICIANO, EDUARDO A. RIALP and JAIME A. awaiting the resolution of the Commissioner of the
SOQUES, petitioners, Internal Revenue on their claims, petitioners filed their
vs. petitioner for review in the above-mentioned cases.
Respondent Commissioner filed his Answer to petitioners'
petition for review in C.T.A. Case No. 2511 on July 31,
Angara, Abello, Concepcion, Regala & Cruz for 1973, while his Answer in C.T.A. Case No. 2594 was filed on
petitioners. August 7, 1974.

Upon joint motion of the parties on the ground that these

two cases involve common question of law and facts,
NOCON, J.: that respondent Court of Tax Appeals heard the cases
jointly. In its decision dated September 26, 1977, the
Petitioners pray that his Court reverse the Decision of the respondent Court of Tax Appeals held that the proper
public respondent Court of Tax Appeals, promulgated conversion rate for the purpose of reporting and paying
September 26, 19771 denying petitioners' claim for tax the Philippine income tax on the dollar earnings of
refunds, and order the Commissioner of Internal Revenue petitioners are the rates prescribed under Revenue
to refund to them their income taxes which they claim to Memorandum Circulars Nos. 7-71 and 41-71. Accordingly,
have been erroneously or illegally paid or collected. the claim for refund and/or tax credit of petitioners in the
above-entitled cases was denied and the petitions for
review dismissed, with costs against petitioners. Hence,
As summarized by the Solicitor General, the facts of the this petition for review oncertiorari. 2
cases are as follows:

Petitioners claim that public respondent Court of Tax

Petitioners are Filipino citizens and employees of Procter Appeals erred in holding:
and Gamble, Philippine Manufacturing Corporation, with
offices at Sarmiento Building, Ayala Avenue, Makati, Rizal.
Said corporation is a subsidiary of Procter & Gamble, a 1. That petitioners' dollar earnings are receipts derived
foreign corporation based in Cincinnati, Ohio, U.S.A. from foreign exchange transactions.
During the years 1970 and 1971 petitioners were assigned,
for certain periods, to other subsidiaries of Procter & 2. That the proper rate of conversion of petitioners' dollar
Gamble, outside of the Philippines, during which earnings for tax purposes in the prevailing free market
petitioners were paid U.S. dollars as compensation for rate of exchange and not the par value of the peso; and
services in their foreign assignments. (Paragraphs III,
Petitions for Review, C.T.A. Cases Nos. 2511 and 2594, 3. That the use of the par value of the peso to convert
Exhs. D, D-1 to D-19). When petitioners in C.T.A. Case No. petitioners' dollar earnings for tax purposes into Philippine
2511 filed their income tax returns for the year 1970, they pesos is "unrealistic" and, therefore, the prevailing free
computed the tax due by applying the dollar-to-peso market rate should be the rate used.
conversion on the basis of the floating rate ordained
under B.I.R. Ruling No. 70-027 dated May 14, 1970, as
Respondent Commissioner of Internal Revenue, on the
other hand, refutes petitioners' claims as follows:

From January 1 to February 20, 1970 at the conversion

At the outset, it is submitted that the subject matter of
rate of P3.90 to U.S. $1.00;
these two cases are Philippine income tax for the
calendar years 1970 (CTA Case No. 2511) and 1971 (CTA
From February 21 to December 31, 1970 at the conversion Case No. 2594) and, therefore, should be governed by
rate of P6.25 to U.S. $1.00 the provisions of the National Internal Revenue Code and
its implementing rules and regulations, and not by the Public respondent Court of Tax Appeals did err when it
provisions of Central Bank Circular No. 42 dated May 21, concluded that the dollar incomes of petitioner fell under
1953, as contended by petitioners. Section 2(f)(g) and (m) of C.B. Circular No. 42. 7

Section 21 of the National Internal Revenue Code, before The issue now is, what exchange rate should be used to
its amendment by Presidential Decrees Nos. 69 and 323 determine the peso equivalent of the foreign earnings of
which took effect on January 1, 1973 and January 1, petitioners for income tax purposes. Petitioners claim that
1974, respectively, imposed a tax upon the taxable net since the dollar earnings do not fall within the
income received during each taxable year from all classification of foreign exchange transactions, there
sources by a citizen of the Philippines, whether residing occurred no actual inward remittances, and, therefore,
here or abroad. they are not included in the coverage of Central Bank
Circular No. 289 which provides for the specific instances
Petitioners are citizens of the Philippines temporarily when the par value of the peso shall not be the
residing abroad by virtue of their employment. Thus, in conversion rate used. They conclude that their earnings
their tax returns for the period involved herein, they gave should be converted for income tax purposes using the
their legal residence/address as c/o Procter & Gamble par value of the Philippine peso.
PMC, Ayala Ave., Makati, Rizal (Annexes "A" to "A-8" and
Annexes "C" to "C-8", Petition for Review, CTA Nos. 2511 Respondent Commissioner argues that CB Circular No.
and 2594). 289 speaks of receipts for export products, receipts of sale
of foreign exchange or foreign borrowings and
Petitioners being subject to Philippine income tax, their investments but not income tax. He also claims that he
dollar earnings should be converted into Philippine pesos had to use the prevailing free market rate of exchange in
in computing the income tax due therefrom, in these cases because of the need to ascertain the true
accordance with the provisions of Revenue and correct amount of income in Philippine peso of dollar
Memorandum Circular No. 7-71 dated February 11, 1971 earners for Philippine income tax purposes.
for 1970 income and Revenue Memorandum Circular No.
41-71 dated December 21, 1971 for 1971 income, which A careful reading of said CB Circular No. 289 8 shows that
reiterated BIR Ruling No. 70-027 dated May 4, 1970, to wit: the subject matters involved therein are export products,
invisibles, receipts of foreign exchange, foreign exchange
For internal revenue tax purposes, the free marker rate of payments, new foreign borrowing and
conversion (Revenue Circulars Nos. 7-71 and 41-71) investments — nothing by way of income tax payments.
should be applied in order to determine the true and Thus, petitioners are in error by concluding that since C.B.
correct value in Philippine pesos of the income of Circular No. 289 does not apply to them, the par value of
petitioners. 3 the peso should be the guiding rate used for income tax
After a careful examination of the records, the laws
involved and the jurisprudence on the matter, We are The dollar earnings of petitioners are the fruits of their
inclined to agree with respondents Court of Tax Appeals labors in the foreign subsidiaries of Procter & Gamble. It
and Commissioner of Internal Revenue and thus vote to was a definite amount of money which came to them
deny the petition. within a specified period of time of two yeas as payment
for their services.
This basically an income tax case. For the proper
resolution of these cases income may be defined as an Section 21 of the National Internal Revenue Code,
amount of money coming to a person or corporation amended up to August 4, 1969, states as follows:
within a specified time, whether as payment for services,
interest or profit from investment. Unless otherwise Sec. 21. Rates of tax on citizens or
specified, it means cash or its equivalent. 4 Income can residents. — A tax is hereby imposed
also be though of as flow of the fruits of one's labor. 5 upon the taxable net income received
during each taxable year from all
Petitioners are correct as to their claim that their dollar sources by every individual, whether a
earnings are not receipts derived from foreign exchange citizen of the Philippines residing therein
transactions. For a foreign exchange transaction is simply or abroad or an alien residing in the
that — a transaction in foreign exchange, foreign Philippines, determined in accordance
exchange being "the conversion of an amount of money with the following schedule:
or currency of one country into an equivalent amount of
money or currency of another." 6 When petitioners were xxx xxx xxx
assigned to the foreign subsidiaries of Procter & Gamble,
they were earning in their assigned nation's currency and And in the implementation for the proper enforcement of
were ALSO spending in said currency. There was no the National Internal Revenue Code, Section 338 thereof
conversion, therefore, from one currency to another. empowers the Secretary of Finance to "promulgate all
needful rules and regulations" to effectively enforce its
provisions. 9
Pursuant to this authority, Revenue Memorandum Circular The Revenue Act of September 8, 1916, c. 463, 39 Stat.
Nos. 7-71 10 and 41-71 11 were issued to prescribed a 756, plainly evinces the purpose of Congress to impose
uniform rate of exchange from US dollars to Philippine such taxes, and is to that extent in conflict with Art. I, § 2,
pesos for INTERNAL REVENUE TAX PURPOSES for the years cl. 3, and Art. I, § 9, cl. 4, of the Constitution. Pp. 252 U. S.
1970 and 1971, respectively. Said revenue circulars were 199, 252 U. S. 217.
a valid exercise of the authority given to the Secretary of
Finance by the Legislature which enacted the Internal These provisions of the Constitution necessarily limit the
Revenue Code. And these are presumed to be a valid extension, by construction, of the Sixteenth Amendment.
interpretation of said code until revoked by the Secretary P. 252 U. S. 205.
of Finance himself. 12
What is or is not "income" within the meaning of the
Petitioners argue that since there were no remittances Amendment must be determined in each case
and acceptances of their salaries and wages in US dollars according to truth and substance, without regard to
into the Philippines, they are exempt from the coverage form. P. 252 U. S. 206.
of such circulars. Petitioners forget that they are citizens of
the Philippines, and their income, within or without, and in
Income may be defined as the gain derived from capital,
these cases wholly without, are subject to income tax.
from labor, or from both combined, including profit
Sec. 21, NIRC, as amended, does not brook any
gained through sale or conversion of capital.

Mere growth or increment of value in a capital

Since petitioners have already paid their 1970 and 1971
investment is not income; income is essentially a gain or
income taxes under the uniform rate of exchange
profit, in itself, of exchangeable value, proceeding from
prescribed under the aforestated Revenue Memorandum
capital, severed from it, and derived or received by the
Circulars, there is no reason for respondent Commissioner
taxpayer for his separate use, benefit, and disposal. Id.
to refund any taxes to petitioner as said Revenue
Memorandum Circulars, being of long standing and not
contrary to law, are valid. 13 A stock dividend, evincing merely a transfer of an
accumulated surplus to the capital account of the
corporation, takes nothing from the property of the
Although it has become a worn-out cliche, the fact still
corporation and adds nothing to that of the shareholder;
remains that "taxes are the lifeblood of the government"
a tax on such dividends is a tax an capital increase, and
and one of the duties of a Filipino citizen is to pay his
not on income, and, to be valid under the Constitution,
income tax.
such taxes must be apportioned according to population
in the several states. P. 252 U. S. 208.
WHEREFORE, the petitioners are denied for lack of merit.
The dismissal by the respondent Court of Tax Appeals of
petitioners' claims for tax refunds for the income tax
period for 1970 and 1971 is AFFIRMED. Costs against
petitioners. The case is stated in the opinion.

SO ORDERED. MR. JUSTICE PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the

Sixteenth Amendment, Congress has the power to tax, as
Eisner v. Macomber, 252 U.S. 189 (1920) income of the stockholder and without apportionment, a
stock dividend made lawfully and in good faith against
profits accumulated by the corporation since March 1,
Decided March 8, 1920

252 U.S. 189

It arises under the Revenue Act of September 8, 1916, 39
Stat. 756 et seq., which, in our opinion (notwithstanding a
ERROR TO THE DISTRICT COURT OF THE UNITED STATES contention of the government that will be noticed),
plainly evinces the purpose of Congress to tax stock

Syllabus The facts, in outline, are as follows:

Congress was not empowered by the Sixteenth On January 1, 1916, the Standard Oil Company of
Amendment to tax, as income of the stockholder, without California, a corporation of that state, out of an
apportionment, a stock dividend made lawfully and in authorized capital stock of $100,000,000, had shares of
good faith against profits accumulated by the stock outstanding, par value $100 each, amounting in
corporation since March 1, 1913. P.252 U. S. 201. Towne v. round figures to $50,000,000. In addition, it had surplus
Eisner, 245 U. S. 418. 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 "It is manifest that the stock dividend in question cannot
$20,000,000 had been earned prior to March 1, 1913, the be reached by the Income Tax Act and could not, even
balance thereafter. In January, 1916, in order to readjust though Congress expressly declared it to be taxable as
the capitalization, the board of directors decided to issue income, unless it is in fact income."
additional shares sufficient to constitute a stock dividend
of 50 percent of the outstanding stock, and to transfer It declined, however, to accede to the contention that,
from surplus account to capital stock account an in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had
amount equivalent to such issue. Appropriate resolutions received a definition sufficiently clear to be controlling,
were adopted, an amount equivalent to the par value of treated the language of this Court in that case as obiter
the proposed new stock was transferred accordingly, dictum in respect of the matter then before it (p. 706),
and the new stock duly issued against it and divided and examined the question as res nova, with the result
among the stockholders. stated. When the case came here, after overruling a
motion to dismiss made by the government upon the
Defendant in error, being the owner of 2,200 shares of the ground that the only question involved was the
old stock, received certificates for 1, 100 additional construction of the statute, and not its constitutionality,
shares, of which 18.07 percent, or 198.77 shares, par value we dealt upon the merits with the question of
$19,877, were treated as representing surplus earned construction only, but disposed of it upon consideration
between March 1, 1913, and January 1, 1916. She was of the essential nature of a stock dividend disregarding
called upon to pay, and did pay under protest, a tax the fact that the one in question was based upon surplus
imposed under the Revenue Act of 1916, based upon a earnings that accrued before the Sixteenth Amendment
supposed income of $19,877 because of the new shares, took effect. Not only so, but we rejected the reasoning of
and, an appeal to the Commissioner of Internal Revenue the district court, saying (245 U.S. 245 U. S. 426):
having been disallowed, she brought action against the
Collector to recover the tax. In her complaint, she "Notwithstanding the thoughtful discussion that the case
alleged the above facts and contended that, in received below we cannot doubt that the dividend was
imposing such a tax the Revenue Act of 1916 violated capital as well for the purposes of the Income Tax Law as
article 1, § 2, cl. 3, and Article I, § 9, cl. 4, of the for distribution between tenant for life and
Constitution of the United States, requiring direct taxes to remainderman. What was said by this Court upon the
be apportioned according to population, and that the latter question is equally true for the former."
stock dividend was not income within the meaning of the
Sixteenth Amendment. A general demurrer to the
"A stock dividend really takes nothing from the property
complaint was overruled upon the authority of Towne v.
of the corporation, and adds nothing to the interests of
Eisner, 245 U. S. 418, and, defendant having failed to
the shareholders. Its property is not diminished, and their
plead further, final judgment went against him. To review
interests are not increased. . . . The proportional interest of
it, the present writ of error is prosecuted.
each shareholder remains the same. The only change is
in the evidence which represents that interest, the new
The case was argued at the last term, and reargued at shares and the original shares together representing the
the present term, both orally and by additional briefs. same proportional interest that the original shares
represented before the issue of the new ones."
We are constrained to hold that the judgment of the
district court must be affirmed, first, because the question "Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In
at issue is controlled by Towne v. Eisner, supra; secondly, short, the corporation is no poorer and the stockholder is
because a reexamination of the question with the no richer than they were before. Logan County v. United
additional light thrown upon it by elaborate arguments States, 169 U. S. 255, 169 U. S. 261. If the plaintiff gained
has confirmed the view that the underlying ground of any small advantage by the change, it certainly was not
that decision is sound, that it disposes of the question an advantage of $417,450, the sum upon which he was
here presented, and that other fundamental taxed. . . . What has happened is that the plaintiff's old
considerations lead to the same result. certificates have been split up in effect and have
diminished in value to the extent of the value of the new."
In Towne v. Eisner, the question was whether a stock
dividend made in 1914 against surplus earned prior to This language aptly answered not only the reasoning of
January 1, 1913, was taxable against the stockholder the district court, but the argument of the Solicitor
under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, General in this Court, which discussed the essential nature
which provided (§ B, p. 167) that net income should of a stock dividend. And if, for the reasons thus expressed,
include "dividends," and also "gains or profits and income such a dividend is not to be regarded as "income" or
derived from any source whatever." Suit having been "dividends" within the meaning of the Act of 1913, we are
brought by a stockholder to recover the tax assessed unable to see how it can be brought within the meaning
against him by reason of the dividend, the district court of "incomes" in the Sixteenth Amendment, it being very
sustained a demurrer to the complaint. 242 F. 702. The clear that Congress intended in that act to exert its
court treated the construction of the act as inseparable power to the extent permitted by the amendment.
from the interpretation of the Sixteenth Amendment; and, In Towne v. Eisner, it was not contended that any
having referred to Pollock v. Farmers' Loan & Trust construction of the statute could make it narrower than
Co., 158 U. S. 601, and quoted the Amendment, the constitutional grant; rather the contrary.
proceeded very properly to say (p. 704):
The fact that the dividend was charged against profits Nevertheless, in view of the importance of the matter,
earned before the Act of 1913 took effect, even before and the fact that Congress in the Revenue Act of 1916
the amendment was adopted, was neither relied upon declared (39 Stat. 757) that a "stock dividend shall be
nor alluded to in our consideration of the merits in that considered income, to the amount of its cash value," we
case. Not only so, but had we considered that a stock will deal at length with the constitutional question,
dividend constituted income in any true sense, it would incidentally testing the soundness of our previous
have been held taxable under the Act of 1913 conclusion.
notwithstanding it was based upon profits earned before
the amendment. We ruled at the same term, in Lynch v. The Sixteenth Amendment must be construed in
Hornby, 247 U. S. 339, that a cash dividend extraordinary connection with the taxing clauses of the original
in amount, and in Peabody v. Eisner, 247 U. S. 347, that a Constitution and the effect attributed to them before the
dividend paid in stock of another company, were amendment was adopted. In Pollock v. Farmers' Loan &
taxable as income although based upon earnings that Trust Co., 158 U. S. 601, under the Act of August 27, 1894,
accrued before adoption of the amendment. In the c. 349, § 27, 28 Stat. 509, 553, it was held that taxes upon
former case, concerning "corporate profits that rents and profits of real estate and upon returns from
accumulated before the act took effect," we declared investments of personal property were in effect direct
(pp. 247 U. S. 343-344): taxes upon the property from which such income arose,
imposed by reason of ownership, and that Congress
"Just as we deem the legislative intent manifest to tax the could not impose such taxes without apportioning them
stockholder with respect to such accumulations only if among the states according to population, as required
and when, and to the extent that, his interest in them by Article I, § 2, cl. 3, and § 9, cl. 4, of the original
comes to fruition as income, that is, in dividends Constitution.
declared, so we can perceive no constitutional obstacle
that stands in the way of carrying out this intent when Afterwards, and evidently in recognition of the limitation
dividends are declared out of a preexisting surplus. . . . upon the taxing power of Congress thus determined, the
Congress was at liberty under the amendment to tax as Sixteenth Amendment was adopted, in words lucidly
income, without apportionment, everything that became expressing the object to be accomplished:
income, in the ordinary sense of the word, after the
adoption of the amendment, including dividends
"The Congress shall have power to lay and collect taxes
received in the ordinary course by a stockholder from a
on incomes, from whatever source derived, without
corporation, even though they were extraordinary in
apportionment among the several states and without
amount and might appear upon analysis to be a mere
regard to any census or enumeration."
realization in possession of an inchoate and contingent
interest that the stockholder had in a surplus of corporate
assets previously existing." 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
In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we
states of taxes laid on income. Brushaber v. Union Pacific
observed that the decision of the district court in Towne v.
R. Co., 240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic Mining
Eisner had been reversed
Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v.
Lowe, 247 U. S. 165, 247 U. S. 172-173.
"only upon the ground that it related to a stock dividend
which in fact took nothing from the property of the
A proper regard for its genesis, as well as its very clear
corporation and added nothing to the interest of the
language, requires also that this amendment shall not be
shareholder, but merely changed the evidence which
extended by loose construction, so as to repeal or
represented that interest," and we distinguished
modify, except as applied to income, those provisions of
the Peabody case from the Towne case upon the ground
the Constitution that require an apportionment
that "the dividend of Baltimore & Ohio shares was not a
according to population for direct taxes upon property,
stock dividend but a distribution in specie of a portion of
real and personal. This limitation still has an appropriate
the assets of the Union Pacific."
and important function, and is not to be overridden by
Congress or disregarded by the courts.
Therefore, Towne v. Eisner cannot be regarded as turning
upon the point that the surplus accrued to the company
In order, therefore, that the clauses cited from Article I of
before the act took effect and before adoption of the
the Constitution may have proper force and effect, save
amendment. And what we have quoted from the
only as modified by the amendment, and that the latter
opinion in that case cannot be regarded as obiter
also may have proper effect, it becomes essential to
dictum, it having furnished the entire basis for the
distinguish between what is and what is not "income," as
conclusion reached. We adhere to the view then
the term is there used, and to apply the distinction, as
expressed, and might rest the present case there not
cases arise, according to truth and substance, without
because that case in terms decided the constitutional
regard to form. Congress cannot by any definition it may
question, for it did not, but because the conclusion there
adopt conclude the matter, since it cannot by legislation
reached as to the essential nature of a stock dividend
alter the Constitution, from which alone it derives its
necessarily prevents its being regarded as income in any
power to legislate, and within whose limitations alone that
true sense.
power can be lawfully exercised.
The fundamental relation of "capital" to "income" has immediate or remote, have contributed capital to the
been much discussed by economists, the former being enterprise, that he is entitled to a corresponding interest
likened to the tree or the land, the latter to the fruit or the proportionate to the whole, entitled to have the property
crop; the former depicted as a reservoir supplied from and business of the company devoted during the
springs, the latter as the outlet stream, to be measured by corporate existence to attainment of the common
its flow during a period of time. For the present purpose, objects, entitled to vote at stockholders' meetings, to
we require only a clear definition of the term "income," as receive dividends out of the corporation's profits if and
used in common speech, in order to determine its when declared, and, in the event of liquidation, to
meaning in the amendment, and, having formed also a receive a proportionate share of the net assets, if any,
correct judgment as to the nature of a stock dividend, remaining after paying creditors. Short of liquidation, or
we shall find it easy to decide the matter at issue. until dividend declared, he has no right to withdraw any
part of either capital or profits from the common
After examining dictionaries in common use (Bouv. L.D.; enterprise; on the contrary, his interest pertains not to any
Standard Dict.; Webster's Internat. Dict.; Century Dict.), part, divisible or indivisible, but to the entire assets,
we find little to add to the succinct definition adopted in business, and affairs of the company. Nor is it the interest
two cases arising under the Corporation Tax Act of 1909 of an owner in the assets themselves, since the
(Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. corporation has full title, legal and equitable, to the
S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. whole. The stockholder has the right to have the assets
185), "Income may be defined as the gain derived from employed in the enterprise, with the incidental rights
capital, from labor, or from both combined," provided it mentioned; but, as stockholder, he has no right to
be understood to include profit gained through a sale or withdraw, only the right to persist, subject to the risks of
conversion of capital assets, to which it was applied in the enterprise, and looking only to dividends for his return.
the Doyle case, pp. 247 U. S. 183-185. If he desires to dissociate himself from the company, he
can do so only by disposing of his stock.
Brief as it is, it indicates the characteristic and
distinguishing attribute of income essential for a correct For bookkeeping purposes, the company acknowledges
solution of the present controversy. The government, a liability in form to the stockholders equivalent to the
although basing its argument upon the definition as aggregate par value of their stock, evidenced by a
quoted, placed chief emphasis upon the word "gain," "capital stock account." If profits have been made and
which was extended to include a variety of meanings; not divided, they create additional bookkeeping liabilities
while the significance of the next three words was either under the head of "profit and loss," "undivided profits,"
overlooked or misconceived. "Derived from capital;" "surplus account," or the like. None of these, however,
"the gain derived from capital," etc. Here, we have the gives to the stockholders as a body, much less to any one
essential matter: not a gain accruing to capital; not of them, either a claim against the going concern for any
a growth or increment of value in the investment; but a particular sum of money or a right to any particular
gain, a profit, something of exchangeable portion of the assets or any share in them unless or until
value, proceeding from the property, severed from the the directors conclude that dividends shall be made and
capital, however invested or employed, and coming a part of the company's assets segregated from the
in, being "derived" -- that is, received or drawn by the common fund for the purpose. The dividend normally is
recipient (the taxpayer) for his separate use, benefit and payable in money, under exceptional circumstances in
disposal -- that is income derived from property. Nothing some other divisible property, and when so paid, then
else answers the description. 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
The same fundamental conception is clearly set forth in
separate property, and thus derive income from the
the Sixteenth Amendment --
capital that he or his predecessor has invested.
"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 In the present case, the corporation had surplus and
Constitution. 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
Can a stock dividend, considering its essential character,
outstanding capital stock of $50,000,000. In this, the case
be brought within the definition? To answer this, regard
is not extraordinary. The profits of a corporation, as they
must be had to the nature of a corporation and the
appear upon the balance sheet at the end of the year,
stockholder's relation to it. We refer, of course, to a
need not be in the form of money on hand in excess of
corporation such as the one in the case at bar, organized
what is required to meet current liabilities and finance
for profit, and having a capital stock divided into shares
current operations of the company. Often, especially in a
to which a nominal or par value is attributed.
growing business, only a part, sometimes a small part, of
the year's profits is in property capable of division, the
Certainly the interest of the stockholder is a capital remainder having been absorbed in the acquisition of
interest, and his certificates of stock are but the evidence increased plant, equipment, stock in trade, or accounts
of it. They state the number of shares to which he is receivable, or in decrease of outstanding liabilities. When
entitled and indicate their par value and how the stock only a part is available for dividends, the balance of the
may be transferred. They show that he or his assignors, year's profits is carried to the credit of undivided profits, or
surplus, or some other account having like significance. If Being concerned only with the true character and effect
thereafter the company finds itself in funds beyond of such a dividend when lawfully made, we lay aside the
current needs, it may declare dividends out of such question whether, in a particular case, a stock dividend
surplus or undivided profits; otherwise it may go on for may be authorized by the local law governing the
years conducting a successful business, but requiring corporation, or whether the capitalization of profits may
more and more working capital because of the extension be the result of correct judgment and proper business
of its operations, and therefore unable to declare policy on the part of its management, and a due regard
dividends approximating the amount of its profits. Thus, for the interests of the stockholders. And we are
the surplus may increase until it equals or even exceeds considering the taxability of bona fidestock dividends
the par value of the outstanding capital stock. This may only.
be adjusted upon the books in the mode adopted in the
case at bar -- by declaring a "stock dividend." This, We are clear that not only does a stock dividend really
however, is no more than a book adjustment, in essence - take nothing from the property of the corporation and
- not a dividend, but rather the opposite; no part of the add nothing to that of the shareholder, but that the
assets of the company is separated from the common antecedent accumulation of profits evidenced thereby,
fund, nothing distributed except paper certificates that while indicating that the shareholder is the richer
evidence an antecedent increase in the value of the because of an increase of his capital, at the same time
stockholder's capital interest resulting from an shows he has not realized or received any income in the
accumulation of profits by the company, but profits so far transaction.
absorbed in the business as to render it impracticable to
separate them for withdrawal and distribution. In order to
It is said that a stockholder may sell the new shares
make the adjustment, a charge is made against surplus
acquired in the stock dividend, and so he may, if he can
account with corresponding credit to capital stock
find a buyer. It is equally true that, if he does sell, and in
account, equal to the proposed "dividend;" the new
doing so realizes a profit, such profit, like any other, is
stock is issued against this and the certificates delivered
income, and, so far as it may have arisen since the
to the existing stockholders in proportion to their previous
Sixteenth Amendment, is taxable by Congress without
holdings. This, however, is merely bookkeeping that does
apportionment. The same would be true were he to sell
not affect the aggregate assets of the corporation or its
some of his original shares at a profit. But if a shareholder
outstanding liabilities; it affects only the form, not the
sells dividend stock, he necessarily disposes of a part of
essence, of the "liability" acknowledged by the
his capital interest, just as if he should sell a part of his old
corporation to its own shareholders, and this through a
stock, either before or after the dividend. What he retains
readjustment of accounts on one side of the balance
no longer entitles him to the same proportion of future
sheet only, increasing "capital stock" at the expense of
dividends as before the sale. His part in the control of the
"surplus"; it does not alter the preexisting proportionate
company likewise is diminished. Thus, if one holding
interest of any stockholder or increase the intrinsic value
$60,000 out of a total $100,000 of the capital stock of a
of his holding or of the aggregate holdings of the other
corporation should receive in common with other
stockholders as they stood before. The new certificates
stockholders a 50 percent stock dividend, and should sell
simply increase the number of the shares, with
his part, he thereby would be reduced from a majority to
consequent dilution of the value of each share.
a minority stockholder, having six-fifteenths instead of six-
tenths of the total stock outstanding. A corresponding
A "stock dividend" shows that the company's and proportionate decrease in capital interest and in
accumulated profits have been capitalized, instead of voting power would befall a minority holder should he sell
distributed to the stockholders or retained as surplus dividend stock, it being in the nature of things impossible
available for distribution in money or in kind should for one to dispose of any part of such an issue without a
opportunity offer. Far from being a realization of profits of proportionate disturbance of the distribution of the entire
the stockholder, it tends rather to postpone such capital stock and a like diminution of the seller's
realization, in that the fund represented by the new stock comparative voting power -- that "right preservative of
has been transferred from surplus to capital, and no rights" in the control of a corporation.
longer is available for actual distribution.
Yet, without selling, the shareholder, unless possessed of
The essential and controlling fact is that the stockholder other resources, has not the wherewithal to pay an
has received nothing out of the company's assets for his income tax upon the dividend stock. Nothing could more
separate use and benefit; on the contrary, every dollar of clearly show that to tax a stock dividend is to tax a
his original investment, together with whatever accretions capital increase, and not income, than this
and accumulations have resulted from employment of his demonstration that, in the nature of things, it requires
money and that of the other stockholders in the business conversion of capital in order to pay the tax.
of the company, still remains the property of the
company, and subject to business risks which may result
Throughout the argument of the government, in a variety
in wiping out the entire investment. Having regard to the
of forms, runs the fundamental error already mentioned --
very truth of the matter, to substance and not to form, he
a failure to appraise correctly the force of the term
has received nothing that answers the definition of
"income" as used in the Sixteenth Amendment, or at least
income within the meaning of the Sixteenth Amendment.
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 The complaint contains averments respecting the market
as they have any effect, deny him present participation prices of stock such as plaintiff held, based upon sales
in such earnings. It contends that the tax may be laid before and after the stock dividend, tending to show that
when earnings "are received by the stockholder," the receipt of the additional shares did not substantially
whereas he has received none; that the profits are change the market value of her entire holdings. This tends
"distributed by means of a stock dividend," although a to show that, in this instance, market quotations reflected
stock dividend distributes no profits; that, under the Act of intrinsic values -- a thing they do not always do. But we
1916, "the tax is on the stockholder's share in corporate regard the market prices of the securities as an unsafe
earnings," when in truth a stockholder has no such share, criterion in an inquiry such as the present, when the
and receives none in a stock dividend; that "the profits question must be not what will the thing sell for, but what
are segregated from his former capital, and he has a is it in truth and in essence.
separate certificate representing his invested profits or
gains," whereas there has been no segregation of profits, It is said there is no difference in principle between a
nor has he any separate certificate representing a simple stock dividend and a case where stockholders use
personal gain, since the certificates, new and old, are money received as cash dividends to purchase
alike in what they represent -- a capital interest in the additional stock contemporaneously issued by the
entire concerns of the corporation. corporation. But an actual cash dividend, with a real
option to the stockholder either to keep the money for his
We have no doubt of the power or duty of a court to look own or to reinvest it in new shares, would be as far
through the form of the corporation and determine the removed as possible from a true stock dividend, such as
question of the stockholder's right in order to ascertain the one we have under consideration, where nothing of
whether he has received income taxable by Congress value is taken from the company's assets and transferred
without apportionment. But, looking through the form, we to the individual ownership of the several stockholders
cannot disregard the essential truth disclosed, ignore the and thereby subjected to their disposal.
substantial difference between corporation and
stockholder, treat the entire organization as unreal, look The government's reliance upon the supposed analogy
upon stockholders as partners when they are not such, between a dividend of the corporation's own shares and
treat them as having in equity a right to a partition of the one made by distributing shares owned by it in the stock
corporate assets when they have none, and indulge the of another company calls for no comment beyond the
fiction that they have received and realized a share of statement that the latter distributes assets of the
the profits of the company which in truth they have company among the shareholders, while the former does
neither received nor realized. We must treat the not, and for no citation of authority except Peabody v.
corporation as a substantial entity separate from the Eisner, 247 U. S. 347, 247 U. S. 349-350.
stockholder not only because such is the practical fact,
but because it is only by recognizing such separateness
Two recent decisions, proceeding from courts of high
that any dividend -- even one paid in money or property
jurisdiction, are cited in support of the position of the
-- 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 Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose
against the corporation as income under appropriate under the Dividend Duties Act of Western Australia, which
provisions of law, the individual stockholders could not be provided that "dividend" should include "every dividend,
separately and additionally taxed with respect to their profit, advantage, or gain intended to be paid or
several shares even when divided, since, if there were credited to or distributed among any members or
entire identity between them and the company, they directors of any company," except, etc. There was a
could not be regarded as receiving anything from it, any stock dividend, the new shares being allotted among the
more than if one's money were to be removed from one shareholders pro rata, and the question was whether this
pocket to another. 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,
Conceding that the mere issue of a stock dividend makes
although "in ordinary language the new shares would not
the recipient no richer than before, the government
be called a dividend, nor would the allotment of them be
nevertheless contends that the new certificates measure
a distribution of a dividend," yet, within the meaning of
the extent to which the gains accumulated by the
the act, such new shares were an "advantage" to the
corporation have made him the richer. There are two
recipients. There being no constitutional restriction upon
insuperable difficulties with this. In the first place, it would
the action of the lawmaking body, the case presented
depend upon how long he had held the stock whether
merely a question of statutory construction, and
the stock dividend indicated the extent to which he had
manifestly the decision is not a precedent for the
been enriched by the operations of the company; unless
guidance of this Court when acting under a duty to test
he had held it throughout such operations, the measure
an act of Congress by the limitations of a written
would not hold true. Secondly, and more important for
Constitution having superior force.
present purposes, enrichment through increase in value
of capital investment is not income in any proper
meaning of the term. In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it
was held that the Forty-Fourth amendment to the
Constitution of Massachusetts, which conferred upon the The court held an individual taxable upon his proportion
legislature full power to tax incomes, "must be interpreted of the earnings of a corporation although not declared
as including every item which by any reasonable as dividends and although invested in assets not in their
understanding can fairly be regarded as income" (pp. nature divisible. Conceding that the stockholder for
526, 531), and that under it, a stock dividend was taxable certain purposes had no title prior to dividend declared,
as income, the court saying (p. 535): the court nevertheless said (p. 79 U. S. 18):

"In essence, the thing which has been done is to distribute "Grant all that, still it is true that the owner of a share of
a symbol representing an accumulation of profits, which, stock in a corporation holds the share with all its incidents,
instead of being paid out in cash, is invested in the and that among those incidents is the right to receive all
business, thus augmenting its durable assets. In this aspect future dividends -- that is, his proportional share of all
of the case, the substance of the transaction is no profits not then divided. Profits are incident to the share to
different from what it would be if a cash dividend had which the owner at once becomes entitled provided he
been declared with the privilege of subscription to an remains a member of the corporation until a dividend is
equivalent amount of new shares. " made. Regarded as an incident to the shares, undivided
profits are property of the shareholder, and as such are
We cannot accept this reasoning. Evidently, in order to the proper subject of sale, gift, or devise. Undivided profits
give a sufficiently broad sweep to the new taxing invested in real estate, machinery, or raw material for the
provision, it was deemed necessary to take the symbol for purpose of being manufactured are investments in which
the substance, accumulation for distribution, capital the stockholders are interested, and when such profits are
accretion for its opposite, while a case where money is actually appropriated to the payment of the debts of the
paid into the hand of the stockholder with an option to corporation, they serve to increase the market value of
buy new shares with it, followed by acceptance of the the shares, whether held by the original subscribers or by
option, was regarded as identical in substance with a assignees."
case where the stockholder receives no money and has
no option. The Massachusetts court was not under an Insofar as this seems to uphold the right of Congress to tax
obligation, like the one which binds us, of applying a without apportionment a stockholder's interest in
constitutional amendment in the light of other accumulated earnings prior to dividend declared, it must
constitutional provisions that stand in the way of be regarded as overruled by Pollock v. Farmers' Loan &
extending it by construction. Trust Co.,158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637.
Conceding Collector v. Hubbard was inconsistent with
Upon the second argument, the government, the doctrine of that case, because it sustained a direct
recognizing the force of the decision in Towne v. Eisner, tax upon property not apportioned among the states, the
supra, and virtually abandoning the contention that a government nevertheless insists that the sixteenth
stock dividend increases the interest of the stockholder or Amendment removed this obstacle, so that now
otherwise enriches him, insisted as an alternative that, by the Hubbard case is authority for the power of Congress
the true construction of the Act of 1916, the tax is to levy a tax on the stockholder's share in the
imposed not upon the stock dividend, but rather upon accumulated profits of the corporation even before
the stockholder's share of the undivided profits previously division by the declaration of a dividend of any kind.
accumulated by the corporation, the tax being levied as Manifestly this argument must be rejected, since the
a matter of convenience at the time such profits become amendment applies to income only, and what is called
manifest through the stock dividend. If so construed, the stockholder's share in the accumulated profits of the
would the act be constitutional? company is capital, not income. As we have pointed out,
a stockholder has no individual share in accumulated
profits, nor in any particular part of the assets of the
That Congress has power to tax shareholders upon their
corporation, prior to dividend declared.
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 Thus, from every point of view, we are brought irresistibly
accumulated and undivided profits, is equally clear. But to the conclusion that neither under the Sixteenth
that this would be taxation of property because of Amendment nor otherwise has Congress power to tax
ownership, and hence would require apportionment without apportionment a true stock dividend made
under the provisions of the Constitution, is settled beyond lawfully and in good faith, or the accumulated profits
peradventure by previous decisions of this Court. 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
The government relies upon Collector v. Hubbard, (1870)
Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the
12 Wall. 1, which arose under § 117 of the Act of June 30,
Constitution, and to this extent is invalid notwithstanding
1864, c. 173, 13 Stat. 223, 282, providing that
the Sixteenth Amendment.

"The gains and profits of all companies, whether

Judgment affirmed.
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."
"Title I. -- Income Tax" the new stock, as is expected, he may endorse the
dividend check received to the corporation, and thus
"Part I. -- On Individuals" pay for the new stock. In order to ensure that all the new
stock so offered will be taken, the price at which it is
offered is fixed far below what it is believed will be its
"Sec. 2. (a) That, subject only to such exemptions and
market value. If the stockholder prefers ready money to
deductions as are hereinafter allowed, the net income of
an increase of his holdings of stock, he may sell his right to
a taxable person shall include gains, profits, and income
take new stock pro rata, which is evidenced by an
derived, . . . also from interest, rent, dividends, securities,
assignable instrument. In that event the purchaser of the
or the transaction of any business carried on for gain or
rights repays to the corporation, as the subscription price
profit, or gains or profits and income derived from any
of the new stock, an amount equal to that which it had
source whatever:Provided, that the term 'dividends' as
paid as a cash dividend to the stockholder.
used in this title shall be held to mean any distribution
made or ordered to be made by a corporation, . . . out of
its earnings or profits accrued since March first, nineteen Both of these methods of retaining accumulated profits
hundred and thirteen, and payable to its shareholders, while in effect distributing them as a dividend had been
whether, in cash or in stock of the corporation, . . . which in common use in the United States for many years prior
stock dividend shall be considered income, to the to the adoption of the Sixteenth Amendment. They were
amount of its cash value." recognized equivalents. Whether a particular corporation
employed one or the other method was determined
sometimes by requirements of the law under which the
MR. JUSTICE HOLMES, dissenting.
corporation was organized; sometimes it was determined
by preferences of the individual officials of the
I think that Towne v. Eisner, 245 U. S. 418, was right in its corporation, and sometimes by stock market conditions.
reasoning and result, and that, on sound principles, the Whichever method was employed, the resultant
stock dividend was not income. But it was clearly distribution of the new stock was commonly referred to as
intimated in that case that the construction of the statute a stock dividend. How these two methods have been
then before the Court might be different from that of the employed may be illustrated by the action in this respect
Constitution. 245 U.S. 245 U. S. 425. I think that the word (as reported in Moody's Manual, 1918 Industrial, and the
"incomes" in the Sixteenth Amendment should be read in Commercial and Financial Chronicle) of some of the
"a sense most obvious to the common understanding at Standard Oil companies since the disintegration pursuant
the time of its adoption." Bishop v. State, 149 Ind. 223, to the decision of this Court in 1911. Standard Oil Co. v.
230; State v. Butler, 70 Fla. 102, 133. For it was for public United States, 221 U. S. 1.
adoption that it was proposed. McCulloch v. Maryland, 4
Wheat. 316, 17 U. S. 407. The known purpose of this
(a) Standard Oil Co. (of Indiana), an Indiana corporation.
Amendment was to get rid of nice questions as to what
It had on December 31, 1911, $1,000,000 capital stock (all
might be direct taxes, and I cannot doubt that most
common), and a large surplus. On May 15, 1912, it
people not lawyers would suppose when they voted for it
increased its capital stock to $30,000,000, and paid a
that they put a question like the present to rest. I am of
simple stock dividend of 2,900 percent in stock. [Footnote
opinion that the Amendment justifies the tax. See Tax
Commissioner v. Putnam, 227 Mass. 522, 532, 533.

(b) Standard Oil Co. (of Nebraska), a Nebraska

MR. JUSTICE DAY concurs in this opinion.
corporation. It had on December 31, 1911, $600,000
capital stock (all common), and a substantial surplus. On
MR. JUSTICE BRANDEIS delivered the following opinion, in April 15, 1912, it paid a simple stock dividend of 33 1/3
which MR. JUSTICE CLARKE concurred. percent, increasing the outstanding capital to $800,000.
During the calendar year 1912, it paid cash dividends
Financiers, with the aid of lawyers, devised long ago two aggregating 20 percent, but it earned considerably
different methods by which a corporation can, without more, and had at the close of the year again a
increasing its indebtedness, keep for corporate purposes substantial surplus. On June 20, 1913, it declared a further
accumulated profits, and yet, in effect, distribute these stock dividend of 25 percent, thus increasing the capital
profits among its stockholders. One method is a simple to $1,000,000. [Footnote 2]
one. The capital stock is increased; the new stock is paid
up with the accumulated profits, and the new shares of (c) The Standard Oil Co. (of Kentucky), a Kentucky
paid-up stock are then distributed among the corporation. It had on December 31, 1913, $1,000,000
stockholders pro rata as a dividend. If the stockholder capital stock (all common) and $3,701,710 surplus. Of this
prefers ready money to increasing his holding of the stock surplus, $902,457 had been earned during the calendar
in the company, he sells the new stock received as a year 1913, the net profits of that year having been
dividend. The other method is slightly more complicated. $1,002,457 and the dividends paid only $100,000 (10
.arrangements are made for an increase of stock to be percent). On December 22, 1913, a cash dividend of
offered to stockholders pro rata at par, and at the same $200 per share was declared payable on February 14,
time for the payment of a cash dividend equal to the 1914, to stockholders of record January 31, 1914, and
amount which the stockholder will be required to pay to these stockholders were offered the right to subscribe for
the company, if he avails himself of the right to subscribe an equal amount of new stock at par and to apply the
for his pro rata of the new stock. If the stockholder takes cash dividend in payment therefor. The outstanding stock
was thus increased to $3,000,000. During the calendar the laws of California and having its principal place of
years 1914, 1915, and 1916, quarterly dividends were paid business in that state. During that year, she received from
on this stock at an annual rate of between 15 percent the company a stock dividend representing profits
and 20 percent, but the company's surplus increased by earned since March 1, 1913. The dividend was paid by
$2,347,614, so that, on December 31, 1916, it had a large direct issue of the stock to her according to the simple
surplus over its $3,000,000 capital stock. On December 15, method described above, pursued also by the Indiana
1916, the company issued a circular to the stockholders, and Nebraska companies. In 1917, she was taxed under
saying: the federal law on the stock dividend so received at its
par value of $100 a share, as income received during the
"The company's business for this year has shown a very year 1916. Such a stock dividend is income, as
good increase in volume and a proportionate increase in distinguished from capital, both under the law of New
profits, and it is estimated that, by January 1, 1917, the York and under the law of California, because in both
company will have a surplus of over $4,000,000. The states every dividend representing profits is deemed to
board feels justified in stating that, if the proposition to be income, whether paid in cash or in stock. It had been
increase the capital stock is acted on favorably, it will be so held in New York, where the question arose as
proper in the near future to declare a cash dividend of between life tenant and remainderman, Lowry v. Farmers'
100 percent and to allow the stockholders the Loan & Trust Co., 172 N.Y. 137; Matter of Osborne, 209 N.Y.
privilege pro rata according to their holdings, to purchase 450, and also, where the question arose in matters of
the new stock at par, the plan being to allow the taxation, People v. Glynn, 130 App.Div. 332, 198 N.Y. 605.
stockholders, if they desire, to use their cash dividend to It has been so held in California, where the question
pay for the new stock." appears to have arisen only in controversies between life
tenant and remainderman. Estate of Duffill, 58 Cal.Dec.
97, 180 Cal. 748.
The increase of stock was voted. The company then paid
a cash dividend of 100 percent, payable May 1, 1917,
again offering to such stockholders the right to subscribe It is conceded that, if the stock dividend paid to Mrs.
for an equal amount of new stock at par and to apply Macomber had been made by the more complicated
the cash dividend in payment therefor. method pursued by the Standard Oil Company of
Kentucky -- that is, issuing rights to take new stock pro
rata and paying to each stockholder simultaneously a
Moody's Manual, describing the transaction with
dividend in cash sufficient in amount to enable him to
exactness, says first that the stock was increased from
pay for this pro rata of new stock to be purchased -- the
$3,000,000 to $6,000,000, "a cash dividend of 100 percent,
dividend so paid to him would have been taxable as
payable May 1, 1917, being exchanged for one share of
income, whether he retained the cash or whether he
new stock, the equivalent of a 100 percent stock
returned it to the corporation in payment for his pro
dividend." But later in the report giving, as customary in
rata of new stock. But it is contended that, because the
the Manual, the dividend record of the company, the
simple method was adopted of having the new stock
Manual says: "A stock dividend of 200 percent was paid
issued direct to the stockholders as paid-up stock, the
February 14, 1914, and one of 100 percent on May 1,
new stock is not to be deemed income, whether she
1197." And, in reporting specifically the income account
retained it or converted it into cash by sale. If such a
of the company for a series of years ending December
different result can flow merely from the difference in the
31, covering net profits, dividends paid, and surplus for
method pursued, it must be because Congress is without
the year, it gives, as the aggregate of dividends for the
power to tax as income of the stockholder either the
year 1917, $660,000 (which was the aggregate paid on
stock received under the latter method or the proceeds
the quarterly cash dividend -- 5 percent January and
of its sale, for Congress has, by the provisions in the
April; 6 percent July and October), and adds in a note:
Revenue Act of 1916, expressly declared its purpose to
"In addition, a stock dividend of 100 percent was paid
make stock dividends, by whichever method paid,
during the year." [Footnote 3] The Wall Street Journal of
taxable as income.
May 2, 1917, p. 2, quotes the 1917 "high" price for
Standard Oil of Kentucky as "375 ex stock dividend."
The Sixteenth Amendment, proclaimed February 25, 1913,
It thus appears that, among financiers and investors, the
distribution of the stock, by whichever method effected,
is called a stock dividend; that the two methods by which "The Congress shall have power to lay and collect taxes
accumulated profits are legally retained for corporate on incomes, from whatever source derived, without
purposes and at the same time distributed as dividends apportionment among the several states, and without
are recognized by them to be equivalents, and that the regard to any census or enumeration."
financial results to the corporation and to the
stockholders of the two methods are substantially the The Revenue Act of September 8, 1916, c. 463, § 2a, 39
same, unless a difference results from the application of Stat. 756, 757, provided:
the federal income tax law.
"That the term 'dividends' as used in this title shall be held
Mrs. Macomber, a citizen and resident of New York, was, to mean any distribution made or ordered to be made by
in the year 1916, a stockholder in the Standard Oil a corporation, . . . out of its earnings or profits accrued
Company (of California), a corporation organized under since March first, nineteen hundred and thirteen, and
payable to its shareholders, whether in cash or in stock of be made from its own issues of bonds, or preferred stock
the corporation, . . . which stock dividend shall be created expressly for the purpose, it clearly would make
considered income, to the amount of its cash value." no difference, in the decision of the question whether the
dividend was a distribution of profits, that the securities
Hitherto, powers conferred upon Congress by the had to be created expressly for the purpose of
Constitution have been liberally construed, and have distribution. If a dividend paid in securities of that nature
been held to extend to every means appropriate to represents a distribution of profits, Congress may, of
attain the end sought. In determining the scope of the course, tax it as income of the stockholder. Is the result
power, the substance of the transaction, not its form, has different where the security distributed is common stock?
been regarded. Martin v. Hunter, 1 Wheat. 304, 14 U. S.
326; McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407, 17 Suppose that a corporation having power to buy and sell
U. S. 415; Brown v. Maryland, 12 Wheat. 419, 25 U. S. its own stock purchases, in the interval between its regular
446; Craig v. Missouri, 4 Pet. 410, 29 U. S. 433;Jarrolt v. dividend dates, with moneys derived from current profits,
Moberly, 103 U. S. 580, 103 U. S. 585-587; Legal Tender some of its own common stock as a temporary
Case, 110 U. S. 421, 110 U. S. 444; Lithograph Co. v. investment, intending at the time of purchase to sell it
Sarony,111 U. S. 53, 111 U. S. 58; United States v. Realty before the next dividend date and to use the proceeds in
Co., 163 U. S. 427, 163 U. S. 440-442; South Carolina v. paying dividends, but later, deeming it inadvisable either
United States, 199 U. S. 437, 199 U. S. 448-449. Is there to sell this stock or to raise by borrowing the money
anything in the phraseology of the Sixteenth Amendment necessary to pay the regular dividend in cash, declares a
or in the nature of corporate dividends which should lead dividend payable in this stock; can anyone doubt that, in
to a departure from these rules of construction and such a case, the dividend in common stock would be
compel this Court to hold that Congress is powerless to income of the stockholder and constitutionally taxable as
prevent a result so extraordinary as that here contended such? See Green v. Bissell, 79 Conn. 547; Leland v.
for by the stockholder? Hayden, 102 Mass. 542. And would it not likewise be
income of the stockholder subject to taxation if the
First. The term "income," when applied to the investment purpose of the company in buying the stock so
of the stockholder in a corporation, had, before the distributed had been from the beginning to take it off the
adoption of the Sixteenth Amendment, been commonly market and distribute it among the stockholders as a
understood to mean the returns from time to time dividend, and the company actually did so? And,
received by the stockholder from gains or earnings of the proceeding a short step further, suppose that a
corporation. A dividend received by a stockholder from a corporation decided to capitalize some of its
corporation may be either in distribution of capital assets accumulated profits by creating additional common
or in distribution of profits. Whether it is the one or the stock and selling the same to raise working capital, but
other is in no way affected by the medium in which it is after the stock has been issued and certificates therefor
paid, nor by the method or means through which the are delivered to the bankers for sale, general financial
particular thing distributed as a dividend was procured. If conditions make it undesirable to market the stock, and
the dividend is declared payable in cash, the money with the company concludes that it is wiser to husband, for
which to pay it is ordinarily taken from surplus cash in the working capital, the cash which it had intended to use in
treasury. But (if there are profits legally available for paying stockholders a dividend, and, instead, to pay the
distribution and the law under which the company was dividend in the common stock which it had planned to
incorporated so permits) the company may raise the sell; would not the stock so distributed be a distribution of
money by discounting negotiable paper, or by selling profits, and hence, when received, be income of the
bonds, scrip or stock of another corporation then in the stockholder and taxable as such? If this be conceded,
treasury, or by selling its own bonds, scrip or stock then in why should it not be equally income of the stockholder,
the treasury, or by selling its own bonds, scrip or stock and taxable as such, if the common stock created by
issued expressly for that purpose. How the money shall be capitalizing profits had been originally created for the
raised is wholly a matter of financial management. The express purpose of being distributed as a dividend to the
manner in which it is raised in no way affects the question stockholder who afterwards received it?
whether the dividend received by the stockholder is
income or capital, nor can it conceivably affect the Second. It has been said that a dividend payable in
question whether it is taxable as income. bonds or preferred stock created for the purpose of
distributing profits may be income and taxable as such,
Likewise whether a dividend declared payable from but that the case is different where the distribution is in
profits shall be paid in cash or in some other medium is common stock created for that purpose. Various reasons
also wholly a matter of financial management. If some are assigned for making this distinction. One is that the
other medium is decided upon, it is also wholly a question proportion of the stockholder's ownership to the
of financial management whether the distribution shall aggregate number of the shares of the company is not
be, for instance, in bonds, scrip or stock of another changed by the distribution. But that is equally true where
corporation or in issues of its own. And if the dividend is the dividend is paid in its bonds or in its preferred stock.
paid in its own issues, why should there be a difference in Furthermore, neither maintenance nor change in the
result dependent upon whether the distribution was proportionate ownership of a stockholder in a
made from such securities then in the treasury or from corporation has any bearing upon the question here
others to be created and issued by the company involved. Another reason assigned is that the value of the
expressly for that purpose? So far as the distribution may old stock held is reduced approximately by the value of
the new stock received, so that the stockholder, after v. United States, 236 U. S. 574. See Morawetz on
receipt of the stock dividend, has no more than he had Corporations, 2d ed., §§ 227-231; Cook on Corporations,
before it was paid. That is equally true whether the 7th ed., §§ 663, 664. The stockholder's interest in the
dividend be paid in cash or in other property -- for property of the corporation differs not fundamentally, but
instance, bonds, scrip, or preferred stock of the company. in form only, from the interest of a partner in the property
The payment from profits of a large cash dividend, and of the firm. There is much authority for the proposition
even a small one, customarily lowers the then market that, under our law, a partnership or joint stock company
value of stock because the undivided property is just as distinct and palpable an entity in the idea of the
represented by each share has been correspondingly law, as distinguished from the individuals composing it, as
reduced. The argument which appears to be most is a corporations. [Footnote 4] No reason appears, why
strongly urged for the stockholders is that, when a stock Congress, in legislating under a grant of power so
dividend is made, no portion of the assets of the comprehensive as that authorizing the levy of an income
company is thereby segregated for the stockholder. But tax, should be limited by the particular view of the
does the issue of new bonds or of preferred stock created relation of the stockholder to the corporation and its
for use as a dividend result in any segregation of assets for property which may, in the absence of legislation, have
the stockholder? In each case, he receives a piece of been taken by this Court. But we have no occasion to
paper which entitles him to certain rights in the undivided decide the question whether Congress might have taxed
property. Clearly, segregation of assets in a physical to the stockholder his undivided share of the corporation's
sense is not an essential of income. The year's gains of a earnings. For Congress has in this act limited the income
partner is taxable as income although there likewise no tax to that share of the stockholder in the earnings which
segregation of his share in the gains from that of his is, in effect, distributed by means of the stock dividend
partners is had. paid. In other words, to render the stockholder taxable,
there must be both earnings made and a dividend paid.
The objection that there has been no segregation is Neither earnings without dividend nor a dividend without
presented also in another form. It is argued that, until earnings subjects the stockholder to taxation under the
there is a segregation, the stockholder cannot know Revenue Act of 1916.
whether he has really received gains, since the gains may
be invested in plant or merchandise or other property, Fourth. The equivalency of all dividends representing
and perhaps be later lost. But is not this equally true of the profits, whether paid of all dividends in stock, is so
share of a partner in the year's profits of the firm or, complete that serious question of the taxability of stock
indeed, of the profits of the individual who is engaged in dividends would probably never have been made if
business alone? And is it not true also when dividends are Congress had undertaken to tax only those dividends
paid in cash? The gains of a business, whether which represented profits earned during the year in which
conducted by an individual, by a firm, or by a the dividend was paid or in the year preceding. But this
corporation are ordinarily reinvested in large part. Many a Court, construing liberally not only the constitutional grant
cash dividend honestly declared as a distribution of of power but also the revenue Act of 1913, held that
profits proves later to have been paid out of capital Congress might tax, and had taxed, to the stockholder
because errors in forecast prevent correct ascertainment dividends received during the year, although earned by
of values. Until a business adventure has been completely the company long before, and even prior to the
liquidated, it can never be determined with certainty adoption of the Sixteenth Amendment. Lynch v.
whether there have been profits unless the returns at least Hornby, 247 U. S. 339. [Footnote 5] That rule, if
exceeded the capital originally invested. Businessmen, indiscriminatingly applied to all stock dividends
dealing with the problem practically, fix necessarily representing profits earned, might, in view of corporate
periods and rules for determining whether there have practice, have worked considerable hardship and have
been net profits -- that is, income or gains. They protect raised serious questions. Many corporations, without
themselves from being seriously misled by adopting a legally capitalizing any part of their profits, had assigned
system of depreciation charges and reserves. Then they definitely some part or all of the annual balances
act upon their own determination whether profits have remaining after paying the usual cash dividends to the
been made. Congress, in legislating, has wisely adopted uses to which permanent capital is ordinarily applied.
their practices as its own rules of action. Some of the corporations doing this transferred such
balances on their books to "surplus" account --
Third. The government urges that it would have been distinguishing between such permanent "surplus" and the
within the power of Congress to have taxed as income of "undivided profits" account. Other corporations, without
the stockholder his pro rata share of undistributed profits this formality, had assumed that the annual
earned even if no stock dividend representing it had accumulating balances carried as undistributed profits
been paid. Strong reasons may be assigned for such a were to be treated as capital permanently invested in
view. See Collector v. Hubbard, 12 Wall. 1. The undivided the business. And still others, without definite assumption
share of a partner in the year's undistributed profits of his of any kind, had so used undivided profits for capital
firm is taxable as income of the partner although the purposes. To have made the revenue law apply
share in the gain is not evidenced by any action taken by retroactively so as to reach such accumulated profits, if
the firm. Why may not the stockholder's interest in the and whenever it should be deemed desirable to
gains of the company? The law finds no difficulty in capitalize them legally by the issue of additional stock
disregarding the corporate fiction whenever that is distributed as a dividend to stockholders, would have
deemed necessary to attain a just result. Linn Timber Co. worked great injustice. Congress endeavored in the
Revenue Act of 1916 to guard against any serious and belongs to the remainderman if it was an
hardship which might otherwise have arisen from making extraordinary dividend.
taxable stock dividends representing accumulated
profits. It did not limit the taxability to stock dividends 2. The so-called Massachusetts rule, declared in 1868
representing profits earned within the tax year or in the by Minot v. Paine, 99 Mass. 101, that a dividend
year preceding, but it did limit taxability to such dividends representing profits, whether regular, ordinary, or
representing profits earned since March 1, 1913. Thereby extraordinary, if in cash belongs to the life tenant, and if in
stockholders were given notice that their share also in stock belongs to the remainderman.
undistributed profits accumulating thereafter was at
some time to be taxed as income. And Congress sought
3. The so-called Pennsylvania rule, declared in 1857
by § 3 to discourage the postponement of distribution for
by Earp's Appeal, 28 Pa. 368, that, where a stock
the illegitimate purpose of evading liability to surtaxes.
dividend is paid, the court shall inquire into the
circumstances under which the fund had been earned
Fifth. The decision of this Court that earnings made before and accumulated out of which the dividend, whether a
the adoption of the Sixteenth Amendment, but paid out regular, an ordinary, or an extraordinary one, was paid. If
in cash dividend after its adoption, were taxable as it finds that the stock dividend was paid out of profits
income of the stockholder involved a very liberal earned since the decedent's death, the stock dividend
construction of the amendment. To hold now that belongs to the life tenant; if the court finds that the stock
earnings both made and paid out after the adoption of dividend was paid from capital or from profits earned
the Sixteenth Amendment cannot be taxed as income of before the decedent's death, the stock dividend belongs
the stockholder, if paid in the form of a stock dividend, to the remainderman.
involves an exceedingly narrow construction of it. As said
by Mr. Chief Justice Marshall in Brown v. Maryland, 12
This Court adopted in Gibbons v. Mahon as the rule of
Wheat. 419, 25 U. S. 446:
administration for the District of Columbia the so-called
Massachusetts rule, the opinion being delivered in 1890
"To construe the power so as to impair its efficacy would by Mr. Justice Gray. Since then, the same question has
tend to defeat an object in the attainment of which the come up for decision in many of the states. The so-called
American public took, and justly took, that strong interest Massachusetts rule, although approved by this Court, has
which arose from a full conviction of its necessity." found favor in only a few states. The so-called
Pennsylvania rule, on the other hand, has been adopted
No decision heretofore rendered by this Court requires us since by so many of the states (including New York and
to hold that Congress, in providing for the taxation of California) that it has come to be known as the
stock dividends, exceeded the power conferred upon it "American rule." Whether, in view of these facts and the
by the Sixteenth Amendment. The two cases mainly relied practical results of the operation of the two rules as
upon to show that this was beyond the power of shown by the experience of the 30 years which have
Congress are Towne v. Eisner, 245 U. S. 418, which elapsed since the decision in Gibbons v. Mahon, it might
involved a question not of constitutional power, but of be desirable for this Court to reconsider the question
statutory construction, and Gibbons v. Mahon, 136 U. S. there decided, as some other courts have done (see 29
549, which involved a question arising between life Harvard Law Review 551), we have no occasion to
tenant and remainderman. So far as concerns Towne v. consider in this case. For, as this Court there pointed out
Eisner, we have only to bear in mind what was there said (p. 136 U. S. 560), the question involved was one
(p. 245 U. S. 425): "But it is not necessarily true that income "between the owners of successive interests in particular
means the same thing in the Constitution and the [an] shares," and not, as in Bailey v. Railroad Co., 22 Wall. 604,
act." [Footnote 6] Gibbons v. Mahon is even less an a question "between the corporation and the
authority for a narrow construction of the power to tax government, and [which] depended upon the terms of a
incomes conferred by the Sixteenth Amendment. In that statute carefully framed to prevent corporations from
case, the court was required to determine how, in the evading payment of the tax upon their earnings."
administration of an estate in the District of Columbia, a
stock dividend, representing profits, received after the We have, however, not merely argument; we have
decedent's death, should be disposed of as between life examples which should convince us that "there is no
tenant and remainderman. The question was, in essence, inherent, necessary and immutable reason why stock
what shall the intention of the testator be presumed to dividends should always be treated as capital." Tax
have been? On this question, there was great diversity of Commissioner v. Putnam,227 Mass. 522, 533. The Supreme
opinion and practice in the courts of English-speaking Judicial Court of Massachusetts has steadfastly adhered,
countries. Three well defined rules were then competing despite ever-renewed protest, to the rule that every stock
for acceptance. Two of these involves an arbitrary rule of dividend is, as between life tenant and remainderman,
distribution, the third equitable apportionment. See Cook capital, and not income. But, in construing the
on Corporations, 7th ed., §§ 552-558. Massachusetts Income Tax Amendment, which is
substantially identical with the federal amendment, that
1. The so-called English rule, declared in 1799 by Brander court held that the legislature was thereby empowered
v. Brander, 4 Ves. Jr. 800, that a dividend representing to levy an income tax upon stock dividends representing
profits, whether in cash, stock or other property, belongs profits. The courts of England have, with some relaxation,
to the life tenant if it was a regular or ordinary dividend, adhered to their rule that every extraordinary dividend is,
as between life tenant and remainderman, to be
deemed capital. But, in 1913, the Judicial Committee of G.R. No. L-12287 August 7, 1918
the Privy Council held that a stock dividend representing
accumulated profits was taxable like an ordinary cash VICENTE MADRIGAL and his wife, SUSANA
dividend, Swan Brewery Co., Ltd. v. Rex,[1914] A.C. 231. In PATERNO, plaintiffs-appellants,
dismissing the appeal, these words of the Chief Justice of vs.
the Supreme Court of Western Australia were quoted (p. JAMES J. RAFFERTY, Collector of Internal Revenue, and
236), which show that the facts involved were identical VENANCIO CONCEPCION, Deputy Collector of Internal
with those in the case at bar: Revenue, defendants-appellees.

"Had the company distributed the �101,450 among the Gregorio Araneta for appellants.
shareholders, and had the shareholders repaid such sums Assistant Attorney Round for appellees.
to the company as the price of the 81, 160 new shares,
the duty on the �101,450 would clearly have been
payable. Is not this virtually the effect of what was
actually done? I think it is."
This appeal calls for consideration of the Income Tax Law,
a law of American origin, with reference to the Civil
Sixth. If stock dividends representing profits are held
Code, a law of Spanish origin.
exempt from taxation under the Sixteenth Amendment,
the owners of the most successful businesses in America
will, as the facts in this case illustrate, be able to escape STATEMENT OF THE CASE.
taxation on a large part of what is actually their income.
So far as their profits are represented by stock received as Vicente Madrigal and Susana Paterno were legally
dividends, they will pay these taxes not upon their married prior to January 1, 1914. The marriage was
income, but only upon the income of their income. That contracted under the provisions of law concerning
such a result was intended by the people of the United conjugal partnerships (sociedad de gananciales). On
States when adopting the Sixteenth Amendment is February 25, 1915, Vicente Madrigal filed sworn
inconceivable. Our sole duty is to ascertain their intent as declaration on the prescribed form with the Collector of
therein expressed. [Footnote 7] In terse, comprehensive Internal Revenue, showing, as his total net income for the
language befitting the Constitution, they empowered year 1914, the sum of P296,302.73. Subsequently Madrigal
Congress "to lay and collect taxes on incomes from submitted the claim that the said P296,302.73 did not
whatever source derived." They intended to include represent his income for the year 1914, but was in fact the
thereby everything which by reasonable understanding income of the conjugal partnership existing between
can fairly be regarded as income. That stock dividends himself and his wife Susana Paterno, and that in
representing profits are so regarded not only by the plain computing and assessing the additional income tax
people, but by investors and financiers and by most of provided by the Act of Congress of October 3, 1913, the
the courts of the country, is shown beyond peradventure income declared by Vicente Madrigal should be divided
by their acts and by their utterances. It seems to me into two equal parts, one-half to be considered the
clear, therefore, that Congress possesses the power income of Vicente Madrigal and the other half of Susana
which it exercised to make dividends representing profits Paterno. The general question had in the meantime been
taxable as income whether the medium in which the submitted to the Attorney-General of the Philippine
dividend is paid be cash or stock, and that it may define, Islands who in an opinion dated March 17, 1915, held with
as it has done, what dividends representing profits shall the petitioner Madrigal. The revenue officers being still
be deemed income. It surely is not clear that the unsatisfied, the correspondence together with this
enactment exceeds the power granted by the Sixteenth opinion was forwarded to Washington for a decision by
Amendment. And, as this Court has so often said, the the United States Treasury Department. The United States
high prerogative of declaring an act of Congress invalid Commissioner of Internal Revenue reversed the opinion of
should never be exercised except in a clear case. the Attorney-General, and thus decided against the
[Footnote 8] claim of Madrigal.

"It is but a decent respect due to the wisdom, the After payment under protest, and after the protest of
integrity, and the patriotism of the legislative body by Madrigal had been decided adversely by the Collector
which any law is passed to presume in favor of its validity of Internal Revenue, action was begun by Vicente
until its violation of the Constitution is proved beyond all Madrigal and his wife Susana Paterno in the Court of First
reasonable doubt." 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 wealth by a progressive scheme of taxation, which
plaintiff Vicente Madrigal, with the result that plaintiff places the burden on those best able to pay. To carry out
Madrigal has paid as income tax for the year 1914, this idea, public considerations have demanded an
P3,786.08, in excess of the sum lawfully due and payable. exemption roughly equivalent to the minimum of
subsistence. With these exceptions, the income tax is
The answer of the defendants, together with an analysis supposed to reach the earnings of the entire non-
of the tax declaration, the pleadings, and the stipulation, governmental property of the country. Such is the
sets forth the basis of defendants' stand in the following background of the Income Tax Law.
way: The income of Vicente Madrigal and his wife Susana
Paterno of the year 1914 was made up of three items: (1) Income as contrasted with capital or property is to be the
P362,407.67, the profits made by Vicente Madrigal in his test. The essential difference between capital and
coal and shipping business; (2) P4,086.50, the profits income is that capital is a fund; income is a flow. A fund
made by Susana Paterno in her embroidery business; (3) of property existing at an instant of time is called capital.
P16,687.80, the profits made by Vicente Madrigal in a A flow of services rendered by that capital by the
pawnshop company. The sum of these three items is payment of money from it or any other benefit rendered
P383,181.97, the gross income of Vicente Madrigal and by a fund of capital in relation to such fund through a
Susana Paterno for the year 1914. General deductions period of time is called an income. Capital is wealth,
were claimed and allowed in the sum of P86,879.24. The while income is the service of wealth. (See Fisher, "The
resulting net income was P296,302.73. For the purpose of Nature of Capital and Income.") The Supreme Court of
assessing the normal tax of one per cent on the net Georgia expresses the thought in the following figurative
income there were allowed as specific deductions the language: "The fact is that property is a tree, income is
following: (1) P16,687.80, the tax upon which was to be the fruit; labor is a tree, income the fruit; capital is a tree,
paid at source, and (2) P8,000, the specific exemption income the fruit." (Waring vs. City of Savannah [1878], 60
granted to Vicente Madrigal and Susana Paterno, Ga., 93.) A tax on income is not a tax on property.
husband and wife. The remainder, P271,614.93 was the "Income," as here used, can be defined as "profits or
sum upon which the normal tax of one per cent was gains." (London County Council vs. Attorney-General
assessed. The normal tax thus arrived at was P2,716.15. [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
The dispute between the plaintiffs and the defendants Income Tax, second edition [1915], Chapter IV; Black on
concerned the additional tax provided for in the Income Income Taxes, second edition [1915], Chapter VIII;
Tax Law. The trial court in an exhausted decision found in Gibbons vs. Mahon [1890], 136 U.S., 549; and
favor of defendants, without costs. 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
The contentions of plaintiffs and appellants having to do
apart, contains the following:
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 The husband, as the head and legal representative of the
argument of counsel is mostly based upon the provisions household and general custodian of its income, should
of the Civil Code establishing the sociedad de make and render the return of the aggregate income of
gananciales. The counter contentions of appellees are himself and wife, and for the purpose of levying the
that the taxes imposed by the Income Tax Law are as the income tax it is assumed that he can ascertain the total
name implies taxes upon income tax and not upon amount of said income. If a wife has a separate estate
capital and property; that the fact that Madrigal was a managed by herself as her own separate property, and
married man, and his marriage contracted under the receives an income of more than $3,000, she may make
provisions governing the conjugal partnership, has no return of her own income, and if the husband has other
bearing on income considered as income, and that the net income, making the aggregate of both incomes
distinction must be drawn between the ordinary form of more than $4,000, the wife's return should be attached to
commercial partnership and the conjugal partnership of the return of her husband, or his income should be
spouses resulting from the relation of marriage. 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
From the point of view of test of faculty in taxation, no less income equal to or in excess of $3,000, a return of annual
than five answers have been given the course of history. net income is required under the law, and such return
The final stage has been the selection of income as the must include the income of both, and in such case the
norm of taxation. (See Seligman, "The Income Tax," return must be made even though the combined income
Introduction.) The Income Tax Law of the United States, of both be less than $4,000. If the aggregate net income
extended to the Philippine Islands, is the result of an of both exceeds $4,000, an annual return of their
effect on the part of the legislators to put into statutory combined incomes must be made in the manner stated,
form this canon of taxation and of social reform. The aim although neither one separately has an income of $3,000
has been to mitigate the evils arising from inequalities of per annum. They are jointly and separately liable for such
return and for the payment of the tax. The single or SIR: This office is in receipt of your letter of June 22, 1915,
married status of the person claiming the specific transmitting copy of correspondence "from the Philippine
exemption shall be determined as one of the time of authorities relative to the method of submission of income
claiming such exemption which return is made, otherwise tax returns by marred person."
the status at the close of the year."
You advise that "The Governor-General, in forwarding the
With these general observations relative to the Income papers to the Bureau, advises that the Insular Auditor has
Tax Law in force in the Philippine Islands, we turn for a been authorized to suspend action on the warrants in
moment to consider the provisions of the Civil Code question until an authoritative decision on the points
dealing with the conjugal partnership. Recently in two raised can be secured from the Treasury Department."
elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the From the correspondence it appears that Gregorio
conjugal partnership, decided that "prior to the Araneta, married and living with his wife, had an income
liquidation the interest of the wife and in case of her of an amount sufficient to require the imposition of the
death, of her heirs, is an interest inchoate, a mere net income was properly computed and then both
expectancy, which constitutes neither a legal nor an income and deductions and the specific exemption were
equitable estate, and does not ripen into title until there divided in half and two returns made, one return for each
appears that there are assets in the community as a result half in the names respectively of the husband and wife,
of the liquidation and settlement." (Nable Jose vs. Nable so that under the returns as filed there would be an
Jose [1916], 15 Off. Gaz., 871; Manuel and escape from the additional tax; that Araneta claims the
Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.) returns are correct on the ground under the Philippine
law his wife is entitled to half of his earnings; that Araneta
Susana Paterno, wife of Vicente Madrigal, has an has dominion over the income and under the Philippine
inchoate right in the property of her husband Vicente law, the right to determine its use and disposition; that in
Madrigal during the life of the conjugal partnership. She this case the wife has no "separate estate" within the
has an interest in the ultimate property rights and in the contemplation of the Act of October 3, 1913, levying an
ultimate ownership of property acquired as income after income tax.
such income has become capital. Susana Paterno has no
absolute right to one-half the income of the conjugal It appears further from the correspondence that upon the
partnership. Not being seized of a separate estate, foregoing explanation, tax was assessed against the
Susana Paterno cannot make a separate return in order entire net income against Gregorio Araneta; that the tax
to receive the benefit of the exemption which would was paid and an application for refund made, and that
arise by reason of the additional tax. As she has no estate the application for refund was rejected, whereupon the
and income, actually and legally vested in her and matter was submitted to the Attorney-General of the
entirely distinct from her husband's property, the income Islands who holds that the returns were correctly
cannot properly be considered the separate income of rendered, and that the refund should be allowed; and
the wife for the purposes of the additional tax. Moreover, thereupon the question at issue is submitted through the
the Income Tax Law does not look on the spouses as Governor-General of the Islands and Bureau of Insular
individual partners in an ordinary partnership. The Affairs for the advisory opinion of this office.
husband and wife are only entitled to the exemption of
P8,000 specifically granted by the law. The higher
By paragraph M of the statute, its provisions are extended
schedules of the additional tax directed at the incomes
to the Philippine Islands, to be administered as in the
of the wealthy may not be partially defeated by reliance
United States but by the appropriate internal-revenue
on provisions in our Civil Code dealing with the conjugal
officers of the Philippine Government. You are therefore
partnership and having no application to the Income Tax
advised that upon the facts as stated, this office holds
Law. The aims and purposes of the Income Tax Law must
that for the Federal Income Tax (Act of October 3, 1913),
be given effect.
the entire net income in this case was taxable to
Gregorio Araneta, both for the normal and additional
The point we are discussing has heretofore been tax, and that the application for refund was properly
considered by the Attorney-General of the Philippine rejected.
Islands and the United States Treasury Department. The
decision of the latter overruling the opinion of the
The separate estate of a married woman within the
Attorney-General is as follows:
contemplation of the Income Tax Law is that which
belongs to her solely and separate and apart from her
TREASURY DEPARTMENT, Washington. husband, and over which her husband has no right in
equity. It may consist of lands or chattels.
Income Tax.
The statute and the regulations promulgated in
FRANK MCINTYRE, accordance therewith provide that each person of
Chief, Bureau of Insular Affairs, War Department, lawful age (not excused from so doing) having a net
Washington, D. C. 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 G.R. No. L-12174 April 26, 1962
living with consort, and $1,000 additional where the
person making the return is married and living with
MARIA B. CASTRO, petitioner,
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.
Rosendo J. Tansinsin and Manuel O. Chan for petitioner.
Office of the Solicitor General and Special Attorney
The only occasion for a wife making a return is where she
Librada del Rosario-Natividad for respondent.
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 REYES, J.B.L., J.:
wife may make the return but not both. In all instances
the income of husband and wife whether from separate Appeal from a decision of the Court of Tax Appeals (in its
estates or not, is taken as a whole for the purpose of the C.T.A. Case 141) holding petitioner Maria B. Castro liable
normal tax. Where the wife has income from a separate under the War Profits Tax Law, Republic Act No. 55, and
estate makes return made by her husband, while the ordering her to pay a deficiency war profits tax (including
incomes are added together for the purpose of the surcharges and interest) in the amount of P1,360,514.66,
normal tax they are taken separately for the purpose of and costs.
the additional tax. In this case, however, the wife has no
separate income within the contemplation of the Income The background of this case is set forth in great detail in
Tax Law. the decision appealed from. We quote:

Respectfully, Petitioner Maria B. Castro, who is authorized to

manage her own property, is a duly licensed
merchant. Pursuant to the provisions of Section 4
(b) and (c) of Republic Act No. 55, she filed with
Acting Commissioner.
the Bureau of Internal Revenue on February 28,
1947, her war profits tax returns which showed a
In connection with the decision above quoted, it net worth on February 26, 1945 in the amount of
is well to recall a few basic ideas. The Income Tax Law P431,884.00 and a net worth on December 8,
was drafted by the Congress of the United States and has 1941 in the sum of P409,581.57. Although there is
been by the Congress extended to the Philippine Islands. indicated an increase in net worth in the amount
Being thus a law of American origin and being peculiarly of P22,302.43, she is totally exempted from
intricate in its provisions, the authoritative decision of the paying any war profits tax therefor as the
official who is charged with enforcing it has peculiar deduction of six per centum (6%) per annum of
force for the Philippines. It has come to be a well-settled the net worth on December 8, 1941 therefrom
rule that great weight should be given to the construction would show only a taxable increase in net worth
placed upon a revenue law, whose meaning is doubtful, in the amount of P5,574.61 which is not taxable
by the department charged with its execution. under the said law.
(U.S. vs. Cerecedo Hermanos y Cia. [1907], 209 U.S.,
338; In re Allen [1903], 2 Phil., 630; Government of the On November 22, 1947, however, Criminal Case
Philippine Islands vs. Municipality of Binalonan, and No. 4976 was filed against her in the Court of First
Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., Instance of Manila for violation of Section 4, in
634.) We conclude that the judgment should be as it is connection with Section 8, of the War Profits Tax
hereby affirmed with costs against appellants. So Law, for allegedly defrauding the Republic of the
ordered. Philippines in the total amount of P1,048,687.76.
The criminal action, was filed at the instance of
respondent and simultaneous with the filing of
said action, the petitioner received for the first
time the notice of assessment dated November
19, 1947 by registered mail from the Collector of
Internal Revenue. The said letter of demand was
based on the report of Supervising Examiner
Felipe Aquino of the Bureau of Internal Revenue,
who recommended that the petitioner be
assessed and made to pay the sum of
P1,048,687.76 as war profits tax and surcharge,
computed as follows: .
P 885,694.63
Following insistent requests of petitioner for reinvestigation
Increase in net worth of her case, the then Secretary of Finance Pio Pedrosa
created a committee on April 11, 1950 to review or re-
Cumulative tax on P500,000 P 352,000.00 examine the assessment for war profits tax issued against
the petitioner. This committee, otherwise known as the
90% tax on P385,694.63 347,125.17 Pedrosa Committee, was chairmanned by Atty. Artemio
M. Lobrin of the Bureau of Internal Revenue, with Messrs.
Total Tax P 699,125.17 Melecio R. Domingo and Roman M. Umali of the same
office, Vivencio L. de Peralta of the General Auditing
Add 50% surcharge 349,562.59 Office and Jose P. Alejandro of the Office of the Solicitor
General, as members. After a thorough investigation of
the case, the Pedrosa Committee on September 12,
Total amount due and collectible P1,048,687.76
1950, submitted its report, recommending the collection
of the amount of P3,593,950.78 as war profits tax due from
petitioner inclusive of surcharge and interests, broken
Petitioner through counsel filed a motion to quash the down as follows: .
criminal action against her and during the pendency of
the same, she amended on December 20, 1947, her
Taxable increase in net worth P1,762,203.95
original war profits tax returns making it to appear that
her true net worth on February 26, 1945 was P315,438.32
while her net worth on December 8, 1941 was left War profits tax due thereon P1,526,093.75
unchanged at P409,581.57. According to the amended
return, there was therefore a decrease in net worth in the
amount of P94,143.25 instead of an increase of P22,302.43 50% surcharge 763,406.88
as originally reported. Total war profits tax and surcharge P2,289,140.63

On February 9, 1948, the motion of petitioner to quash the 15% surcharge 343,371.09
information was denied by the Court of First Instance of
1% monthly interest thereon from April 1947
Manila. At the sheduled hearing of the case on the merits to September 30, 1950 (42%)
on March 7, 1949, the City Fiscal of Manila manifested in
open court that after a re-investigation of the case "the Total amount collectible on
amount of the tax due and for which the accused stands September 30, 1950 P3,593,950.78
charged for evading payment is only about P700,000.00,
instead of P1,048,687.76 as stated in the information."
However, at the continuation of the hearing of the case The findings and recommendations of the Pedrosa
on February 22, 1950, Supervising Examiner Felipe Aquino Committee were forwarded to the President of the
of the Bureau of Internal Revenue, who testified for the Philippines for approval and on September 22, 1950, the
prosecution, declared in answer to questions President approved the same in toto.
propounded by the City Fiscal "that as a result of a
detailed reinvestigation conducted by his office, it was Accordingly, on September 23, 1950 the respondent
found out that no war profits tax was due from the demanded from the petitioner Maria B. Castro the
accused in connection with the present case." payment of the total amount of P3,593,950.78 as war
Whereupon, City Fiscal Angeles moved for the dismissal of profits tax computed in detail as follows: .
the case. Finding the petition for dismissal to be well
taken, the Court of First Instance of Manila, in an Order
dated February 22, 1950, dismissed Criminal Case No.
4976 against petitioner.

After the dismissal of the Criminal Case, another report

was submitted by the same Supervising Examiner Felipe
Aquino to his superiors wherein he changed his previous
stand taken before the Court of First Instance of Manila,
on the basis of which report another letter of demand for
P2,008,293.53 as war profits tax was issued against
petitioner on January 24, 1950. Barely one month
thereafter, another report was again submitted by the
same Supervising Examiner Felipe Aquino to his superiors,
on the basis of which another letter of demand for war
profits tax was issued by respondent against petitioner for
the sum of P2,229,976.94 or an increase of P221,683.31
over that assessment of January 24, 1950. The case was
again referred to the City Fiscal's Office for another
prosecution based on the earlier demand but the same
was again dropped.
In order to enforce collection of this last mentioned public auction by the respondent and forfeited in favor of
assessment of P3,593,950.78, the respondent caused to the Government for lack of bidders.
be advertised on October 18, 1950, the sale at public
auction on November 22, and 27, 1950, of various real Parenthetically, it may be stated that the hearing of Civil
properties of petitioner to satisfy the war profits tax Case No. 12356 before the Court of First Instance of
assessed against her. The petitioner, in order to stop the Manila for Preliminary Injunction was not continued to its
scheduled sale at public auction, filed on October 18, final determination by said court as the Supreme Court in
1950, before the Court of First Instance of Manila a a decision promulgated on October 31, 1951 declared
petition for preliminary injunction (Civil Case No. 12356) the lower court without jurisdiction to proceed with the
against the Collector of Internal Revenue, praying, trial. (Saturnino David v. The Honorable Simeon Ramos
among others, that an order be issued enjoining said and Maria B. Castro, G.R. No. L-4300)..
official from proceeding with the collection by summary
methods of the war profits tax demanded. Over the In the course of the summary methods employed by the
objection of respondent that the Court of First Instance respondent to enforce the collection of the war profits
had no jurisdiction to entertain the complaint nor to issue tax liability of petitioner, the respondent also distrained
a writ of injunction, the said Court entered an order and advertised for sale the properties of the Marvel
dated November 8, 1950 declaring that it had authority Building Corporation in which the petitioner had a
proceed with the case but denied the petition for substantial interest. To counter-act the move, the said
preliminary injunction. Inasmuch as no preliminary corporation through counsel filed on November 31, 1950,
injunction was issued by the Court, respondent Civil Case No. 12555 in the Court of First Instance of
proceeded with the distraint and levy and sale at public Manila wherein it sought to enjoin the respondent
auction of the properties of petitioner. These properties, Collector of Internal Revenue from selling at public
which are situated in the Cities of Manila, Pasay and auction its various properties described in the complaint.
Tagaytay and in the Municipalities of Caloocan and While the corporation was able to secure the injunction
Makati, Rizal, and Moncada, Tarlac, and described more from the lower court, the same was dissolved by the
particularly in Exhibits C, C-1, C-2, C-3, C-4 and C-5 of the Supreme Court in its decision in G.R. No. L-5081, Marvel
petition for injunction filed with this Court, were offered for Building Corporation v. Saturnino David, promulgated on
sale on November 22, and 27, 1950 as scheduled, to February 24, 1954. Petitioner Maria B. Castro was
answer for the war profits tax liability of petitioner to the declared therein as the sole and exclusive owner of all
Republic of the Philippines in the assessed sum of shares of stock of the Marvel Building Corporation and all
P3,593,950.78, inclusive of surcharges and interest from the other partners are her dummies.
April 1, 1947 to September 30, 1950.
In the meantime, petitioner filed on December 10, 1951,
For lack of bidders on the scheduled dates of sale, the Civil Case No. 15316 with the Court of First Instance of
following properties (except those in Tagaytay) with their Manila against the respondent Collector of Internal
corresponding assessed value, were forfeited to the Revenue for the recovery of the properties advertised for
Government under Section 328 of the National Internal saleon November 22 and 27, 1950 which for lack of
Revenue Code: . bidders were forfeited to theGovernment. However,
before the case could be tried on the merits before said
Court, the Court of Tax Appeals was created by Republic
Property Assessed Value
Act No. 1125 and pursuant to Section 22 thereof, the
Manila P233,460.00 record of the case was remanded for finaldisposition to
this Court. This last mentioned case is now pending
Balintawak 521,390.00 hearing before this Court.

Pasay 18,320.00 At this juncture, it should be stated that again on

December 22, 1951, an additional war profits tax was
Makati 4,830.00
assessed against the petitioner in the sum of P20,425.00
Tarlac 12,530.00 based allegedly on certain amounts receivable which
petitioner received from Magdalena Estate, Inc.
Tagaytay 62,930.00 Consequently, the total war profits taxliability of
petitioner, exclusive of surcharge and interest, as found
In another sale at public auction on April 23, 1954, the by the Pedrosa Committee was increased to
property of petitioner situated in Caloocan, Rizal, with an P1,546,518.75, itemized as follows:
assessed value of P4,990.00 was also offered for sale to
answer for her war profits tax liability. There being no
bidders in this sale as in the previous sale, this last To satisfy, fully the amount of the war profits tax assessed
mentioned real property of petitioner was also forfeited
Tax due as per Pedrosa Committee P1,526,093.75
to the Government.
Additional war profits tax on account of undeclared
The petitioner has not exercised her right of legal amount receivable from the Magdalena Estates,
redemption with respect to all these real properties with a Inc. 20,425.00
total assessed value of P858,440.00 which were sold at
Total war profits tax exclusive of surcharge and
against petitioner, the respondent on September 29,
Aguinaldo Building P2,026,517.10
1954, caused to be advertised for sale at public auction
for November 2, 1954, other real properties of petitioner Wise & Co. Building 670,291.47
situated in Manila. These properties are described in
detail in Appendix B of the petition for review filed with Zobel Mansion 408,501.24
this Court. According to the "Amended Notice of Sale"
(Appendix B, Petition for Review), the properties were Shellborne Hotel 489,491.70
seized, distrained and levied upon from petitioner "in
satisfaction of internal revenue taxes and penalties
amounting to P4,539,556.26, computed as of April 30, Total P3,594,801.51
1954" due from her in favor of the Republic of the
Add: Prior forfeitures 888,440.00
Philippines. For lack of bidders at the time of the
scheduled sale on November 2, 1954, the properties in
question were forfeited to the Government under Section P4,453,241.51
328 of the National Internal Revenue Code for the total
amount of P3,547,892.41 which was allegedly the
balance of petitioner's tax liability as of that date.
After due hearing and reception of evidence, the Tax
Before the expiration of the one-year period provided for Court annulled the last tax sale of December, 1955,
in Section 328 of the National Internal Revenue Code covering the found Manila buildings, on account of
within which petitioner may redeem the real properties irregularities in the notices of sale; but for the rest, it found
forfeited in favor of the Government in the sale at public against petitioner and assessed her tax liability as follows:
auction held on November 2, 1954, the petitioner filed
with this Court on September 30, 1955, a petition for the From this decision, Maria Castro appealed to this Court..
annulment of said sale and forfeiture on the ground that
her properties were advertised for sale on tax claim of the The nineteen alleged errors committed by the Court of
Government far in excess of the alleged war profits tax, Tax Appeals and discussed by appellant in her printed
surcharges and penalties fixed by respondent. brief actually revolve around four main defenses: (a) that
Respondent filed his opposition to the petition and after the War Profits Tax Law (R.A. No. 55) is unconstitutional
due hearing where evidence was adduced in support of and void; (b) that said law was improperly applied to the
the petition as well as opposition thereto, this Court, in a case of the appellant; (c) that even if appellant were
resolution dated October 31, 1955, declared the auction subject to the tax liability declared by the court below,
sale of November 2, 1954 as well as the resulting such liability was totally extinguished by the levy and
forfeiture, null and void and of no legal force and effect forfeiture of certain properties of hers; and (d) that
because of the admitted discrepancy in the amount of appellant's acquittal in the criminal case instituted
tax stated in the notice of sale for which the properties against her for violation of the War Profits Tax Law is a bar
were auctioned and the actual amount of tax assessed to the collection of the taxes assessed, and specially of
and demanded. the 50% surcharge. (a) Petitioner's attack on the
constitutionality of Republic Act No. 55, commonly known
The said resolution being without prejudice to such action as the War Profits Tax Law, on account of its retrospective
and proceedings a respondent may take in accordance operation (Errors XVIII), is now foreclosed by our decision
with law, respondent demanded from petitioner the in Republic vs.Oasan Vda. de Fernandez, G.R. No. L-9141,
amount of P3,594,881.51 not later than November 10, September 25, 1956, wherein thisCourt upheld the validity
1955 or he would again proceed with the resale of her of the statute; and no reasons are alleged that would
properties on December 12, 1955. To stop the sale, justify a departure from the ruling made in that case..
petitioner filed a petition for injunction with this Court on
November 22, 1955 requesting that respondent be (b) Petitioner Castro complains (Errors I and VI) that the
enjoined from proceeding with the resale of her Tax Court had declared subject to the war profits tax her
properties scheduled on December 12, 1955; that the cash transactions from June, 1945to December 31, 1946,
said properties be released to her; and that she be when Republic Act No. 55 levies that tax only on the
declared not liable for the war profits tax assessed and value of the taxpayer's assets (including real and
demanded of her. After due hearing of this petition and personal property and/orcash in banks) as of February 26,
the opposition thereto, this Court, in a resolution dated 1945, minus his liabilities..
December 10, 1955, denied the injunction and held in
abeyance the determination of other questions until after
the case shall have been heard on the merits. The This argument misconceives the process whereby the Tax
properties were therefore advertised for sale on Court (and the Pedrosa Committee) arrived at the
December 12, 1955 to answer for a war profits tax liability petitioner's net worth as of February 26,1945. Because of
of petitioner to the Republic of the Philippines for the the difficulty in determining the taxpayer's cash on hand
alleged amount of P3,594,307.51 computed as of that on said date (since her books and records did not show
date. For lack of bidders, the same were forfeited to the her invested capital in 1945), said tax authorities adopted
Government. Those properties and the amounts for which the method of starting from her reported cash on hand
they were forfeited are as follows:. on December 31, 1946, and working backwards to
February,1945, by adding to the reported cash the
disbursements made by Castro during1945 and 1946, and
then deducting her receipts from the same period. We although it had been rejected by the Pedrosa
see nothing fundamentally erroneous in this method for, Committee.
as pointed out in the appealed decision, "if cash on hand
at the beginning of the period, plus receipts during the Similarly, the finding that the petitioner had disbursed in
period minus disbursements during the period, equals 1946 P1,025,000.00 on account of her subscription to the
cash on hand at the end of the period, the converse stock of the Marvel Building Corporation (Error XII) may
must necessarily be true.". not be disturbed by us.

Such method is in effect but an application (in reverse) of (c) The third main ground of appeal is predicated on the
the inventory or networth system that, contrary to acquittal of petitioner in case No. 4976 of the Court of
appellants contention (Error XIII), has been approved by First Instance of Manila, wherein she was criminally
this Court in Perez vs. Collector of Internal Revenue, G.R. prosecuted for failure to render a true and accurate
No. L-10507, May 30, 1958; Collector vs. A. P. Reyes, L- return of the war profits tax due from her, with intent to
11534, November 25, 1958; and Commissioner of Internal evade payment of the tax. She contends (Assignments of
Revenue vs. Avelino, L-14847, September 19, 1961. Error II to IV) that the acquittal should operate as a bar to
the imposition of the tax and specially the 50% surcharge
The analysis of petitioner's transactions for 1945 and 1946 provided by section 6 of the War Profits law (R.A. No. 55),
merely laid the basis for determining the undisclosed cash invoking the ruling in Coffey v. U.S., 29 L. Ed. 436.
funds in her possession as of February 26, 1945
(amounting to P1,807,444.61), and it is this cash thatwas With regard to the tax proper, the state correctly points
found subject to the war profits tax. out in its brief that the acquittal in the criminal case could
not operate to discharge petitioner from the duty to pay
It is urged, however, that even if this finding were correct, the tax, since that duty is imposed by statute prior to and
still, under Republic Act No. 55, only "cash in banks" is independently of any attempts on the part of the
expressly mentioned as taxable, and appellant infers that taxpayer to evade payment. The obligation to pay the
cash on hand not so deposited was not intended to be tax is not a mere consequence of the felonious acts
subject to war profits tax. This thesis appears charged in the information, nor is it a mere civil liability
unmeritorious: cash heldby the taxpayer on February 26, derived from crime that would be wiped out by the
1945 clearly falls under the description of "assets, judicial declaration that the criminal acts charged did
including real and personal property" that section 2 of the not exist.
Act expressly order included in determining the taxable
net worth. If "cash in banks" is expressly mentioned by the As to the 50% surcharge, the very United States Supreme
Act, it is not because cash on hand was intended to be Court that rendered the Coffey decision has
excluded, but because "cash in banks" is not, strictly, subsequently pointed out that additions of this kind to the
speaking, part of the assets of the taxpayer, but assets of main tax are not penalties but civil administrative
the banks where the cash is deposited. It is well sanctions, provided primarily as a safeguard for the
established that a so-called "bank deposit" is in reality a protection of the state revenue and to reimburse the
loan to the bank, the latter acquiring title to the amount government for the heavy expense of investigation and
"deposited", subject to its withdrawal (or recall of the the loss resulting from the taxpayer's fraud (Helvering vs.
loan) on the dates specified. Taxpayer's "assets", Mitchell, 303 U.S. 390, 82 L. Ed. 917; Spies vs. U.S. 317 U.S.
therefore, would not per se include cash deposited in 492). This is made plain by the fact that such surcharges
banks by the taxpayer; and its inclusion had to be are enforceable, like the primary tax itself, by distraint or
expressly prescribed by the statute in order to remove all civil suit, and that they are provided in a section of R.A.
doubt as to its taxability. No. 55 (section 5) that is separate and distinct from that
providing for criminal prosecution (section 7). We
Petitioner endeavored to show (Errors VII to XI) that part conclude that the defense of jeopardy and estoppel by
of the amount of cash thus arrived at actually originated reason of the petitioner's acquittal is untenable and
in receipts from transactions made by her after February without merit. Whether or not there was fraud committed
26, 1945 but which were not disclosed in the books and by the taxpayer justifying the imposition of the surcharge
accounts. Aside from the fact that this claim in her behalf is an issue of fact to be inferred from the evidence and
contradicted her admission to the Pedrosa Committee surrounding circumstances; and the finding of its
that all her 1946 receipts were recorded in her books (v. existence by the Tax Court is conclusive upon us.
Respondent's Exhibit 6-A), it lay within the exclusive (Gutierrez v. Collector, G.R. No. L-9771, May 31, 1951 ;
discretion of the Tax Court to believe or not to believe her Perez vs. Collector, supra).
evidence and statements, and those of her witnesses
regarding the source of the cash in question; and the rule (d) The fourth main ground adduced on behalf of the
is well settled that in cases of this kind, only errors of law, petitioner (Errors II and XlV) is that the sale and forfeiture
and not rulings on the weight of evidence, are to the government (due to lack of bidders) of the
reviewable by this Court. The same principle precludes us properties of petitioner in Manila, Balintawak, Pasay,
from interfering with the Tax Court's refusal to credit the Makati, Tarlac, Tagaytay and Caloocan which had been
other deductions claimed by petitioner as amounts levied upon by the respondent Collector of Internal
obtained from loans from various individuals. The Court of Revenue and advertised for sale in 1950 and 1954,
Tax Appeals found those items unproved, except the constitutes a full discharge of petitioner's tax liabilities. In
P76,000.00 payable to Lao Kang Suy, which is accepted,
so arguing, she relies on the provisions of paragraph 1 of (e) As pointed out by the counsel for the Government,
Section 328 of the Internal Revenue Code, reading as appellant's stand that the undeclared cash should be
follows: . averaged or spread out for the years 1945, 1946 and 1947
(Error XVI) assumes that what was being subjected to tax
SEC. 328. Forfeiture to Government for Want of was her undeclared income during said years, which is
Bidder. - In case there is no bidder for real not correct, as previously declared in this opinion. If her
property exposed for sale as herein above expenditures during 1945 and 1946 were scrutinized and
provided or if the highest bid is for an amount analyzed, it was merely to determine the actual value of
insufficient to pay the taxes, penalties, and costs, her taxable net worth as of February 26, 1945, that was
the provincial or city treasurer shall declare the subject to the war profits tax, as representing
property forfeited to the Government in accumulated profits earned during the occupation
satisfaction of the claim in question and within years.
two days thereafter shall make a return of his
proceedings and the forfeiture, which shall be Finally, no argument is needed to show that unless taxes
spread upon the records of his office, are to be left at the discretion of the taxpayer, she can
not be allowed to seek refuge or relief by pleading (Error
and appellant contends that in the provision to the effect XVII) the alleged inefficient and erratic manner in which
that in the absence of bidders, the property is to be her books of account and supporting papers had been
"forfeited to the Government in satisfaction of the claim in prepared, contrary to the requirements of the revenue
question", the term "satisfaction" signifies nothing but full laws; and that it is incredible that a trader like the
discharge of the taxes, penalties, and costs claimed by appellant should be able to do business running into
the state. Carried to its logical conclusion, this theory millions of pesos without knowing exactly her financial
would permit a clever taxpayer, who is able to conceal condition.
most or the more valuable part of his property from the
revenue officers, to escape payment of his tax liability by Appellant's alleged Error XIX, being merely pro forma,
sacrificing an insignificant portion of his holdings; and we requires no discussion.
can not agree that in providing that the forfeiture of the
taxpayer's distrained or levied property, for lack of Finding no reversible error in the decision appealed from,
adequate bids, should operate in satisfaction of the total we hereby affirm the same, with costs against appellant.
tax claims even beyond the value of the property
forfeited. That the satisfaction prescribed in section 328 of
the Revenue Code was intended to mean only a
discharge pro tanto is confirmed by the provisions of
section 330 of the Revenue Code to the effect that
"remedy by distraint of personal property and levy on
realty may be repeated if necessary until the full
amount due including all expenses, is collected". This
section makes no distinction between forfeitures to the
Government and sales to third persons, and we are
satisfied that no distinction was intended and that none is

Nor do we see that the petitioner has any ground for

complaining that the properties forfeited were
undervalued (Error XV). The relation between assessed
value and market price being variable, it is not a matter
of notice. However, the Court of Tax Appeals appraised
the forfeited properties at double their assessed
evaluation, and thereby credited her with a part
payment on account of her tax liability in the amount of
P1,716,880.00. There is no adequate evidence that they
were worth more, petitioner's own estimates of value
being obviously unreliable, due to her direct interest in
the matter under investigation. Since the burden of proof
lay evidently on the taxpayer, she is not in a position to
complain in this regard.

It may be noted in this connection that the validity of the

levy and sale of her properties in November of 1950 and
April 1954 is assailed by appellant in her fifth assignment
of error; but as this point was not raised in the Court
below, the same can not be entertained for the first time
on appeal.
G.R. No. L-21551 September 30, 1969 Assistant Solicitor General Antonio G. Ibarra and Special
Attorney Virgilio G. Saldajeno for respondent.
APPEALS, respondents.
These four appears involve two decisions of the Court of
G.R. No. L-21557 September 30, 1969 Tax Appeals determining the taxpayer's income tax
liability for the years 1950 to 1954 and for the year 1957.
COMMISSIONER OF INTERNAL REVENUE, petitioner, Both the taxpayer and the Commissioner of Internal
vs. Revenue, as petitioner and respondent in the cases a
FERNANDEZ HERMANOS, INC., and COURT OF TAX quo respectively, appealed from the Tax Court's
APPEALS, respondents. decisions, insofar as their respective contentions on
particular tax items were therein resolved against them.
Since the issues raised are interrelated, the Court resolves
the four appeals in this joint decision.

G.R. No. L-24972 September 30, 1969

Cases L-21551 and L-21557


The taxpayer, Fernandez Hermanos, Inc., is a domestic
corporation organized for the principal purpose of
engaging in business as an "investment company" with
APPEALS, respondents.
main office at Manila. Upon verification of the taxpayer's
income tax returns for the period in question, the
----------------------------- Commissioner of Internal Revenue assessed against the
taxpayer the sums of P13,414.00, P119,613.00, P11,698.00,
G.R. No. L-24978 September 30, 1969 P6,887.00 and P14,451.00 as alleged deficiency income
taxes for the years 1950, 1951, 1952, 1953 and 1954,
FERNANDEZ HERMANOS, INC., petitioner, respectively. Said assessments were the result of alleged
vs. discrepancies found upon the examination and
THE COMMISSIONER OF INTERNAL REVENUE, and HON. verification of the taxpayer's income tax returns for the
ROMAN A. UMALI, COURT OF TAX APPEALS,respondents. said years, summarized by the Tax Court in its decision of
June 10, 1963 in CTA Case No. 787, as follows:
1. Losses —
Rafael Dinglasan for petitioner.
Office of the Solicitor General Arturo A. Alafriz, Solicitor a. Losses in Mati Lumber Co.
Alejandro B. Afurong and Special Attorney Virgilio G. (1950) P 8,050.00
Saldajeno for respondent.
b. Losses in or bad debts of Palawan
L-21557: Manganese Mines, Inc.
(1951) 353,134.25
Office of the Solicitor General for petitioner.
Rafael Dinglasan for respondent Fernandez Hermanos, c. Losses in Balamban Coal Mines —
1950 8,989.76
L-24972: 1951 27,732.66

Office of the Solicitor General Antonio P. Barredo, d. Losses in Hacienda Dalupiri —

Assistant Solicitor General Felicisimo R. Rosete and Special
Attorney Virgilio G. Saldajeno for petitioner.
Rafael Dinglasan for respondent Fernandez Hermanos, 1950 17,418.95
Inc. 1951 29,125.82
1952 26,744.81
L-24978: 1953 21,932.62
1954 42,938.56
Rafael Dinglasan for petitioner.
Office of the Solicitor General Antonio P. Barredo,
e. Losses in Hacienda Samal —
1951 8,380.25 disallowances enumerated in the Tax Court's summary
reproduced above, and second, whether or not the
1952 7,621.73
government's right to collect the deficiency income taxes
in question has already prescribed.
2. Excessive depreciation of Houses —
On the first issue, we will discuss the disputed items of
1950 P 8,180.40 disallowances seriatim.
1951 8,768.11
1. Re allowances/disallowances of losses.
1952 18,002.16
1953 13,655.25
(a) Allowance of losses in Mati Lumber Co. (1950). — The
1954 29,314.98 Commissioner of Internal Revenue questions the Tax
Court's allowance of the taxpayer's writing off as
3. Taxable increase in net worth — worthless securities in its 1950 return the sum of P8,050.00
representing the cost of shares of stock of Mati Lumber
Co. acquired by the taxpayer on January 1, 1948, on the
1950 P 30,050.00 ground that the worthlessness of said stock in the year
1951 1,382.85 1950 had not been clearly established. The Commissioner
contends that although the said Company was no longer
4. Gain realized from sale of real property in operation in 1950, it still had its sawmill and equipment
in 1950 P 11,147.2611 which must be of considerable value. The Court,
however, found that "the company ceased operations in
1949 when its Manager and owner, a certain Mr.
The Tax Court sustained the Commissioner's Rocamora, left for Spain ,where he subsequently died.
disallowances of Item 1, sub-items (b) and (e) When the company eased to operate, it had no assets, in
and Item 2 of the above summary, but overruled other words, completely insolvent. This information as to
the Commissioner's disallowances of all the the insolvency of the Company — reached (the
remaining items. It therefore modified the taxpayer) in 1950," when it properly claimed the loss as a
deficiency assessments accordingly, found the deduction in its 1950 tax return, pursuant to Section 30(d)
total deficiency income taxes due from the (4) (b) or Section 30 (e) (3) of the National Internal
taxpayer for the years under review to amount to Revenue Code. 2
P123,436.00 instead of P166,063.00 as originally
assessed by the Commissioner, and rendered the
following judgment: We find no reason to disturb this finding of the Tax Court.
There was adequate basis for the writing off of the stock
as worthless securities. Assuming that the Company would
RESUME later somehow realize some proceeds from its sawmill
and equipment, which were still existing as claimed by
1950 P2,748.00 the Commissioner, and that such proceeds would later
1951 108,724.00 be distributed to its stockholders such as the taxpayer, the
amount so received by the taxpayer would then properly
1952 3,600.00 be reportable as income of the taxpayer in the year it is
1953 2,501.00 received.
1954 5,863.00
(b) Disallowance of losses in or bad debts of Palawan
Total P123,436.00 Manganese Mines, Inc. (1951). — The taxpayer appeals
from the Tax Court's disallowance of its writing off in 1951
as a loss or bad debt the sum of P353,134.25, which it had
WHEREFORE, the decision appealed from is advanced or loaned to Palawan Manganese Mines, Inc.
hereby modified, and petitioner is ordered to pay The Tax Court's findings on this item follow:
the sum of P123,436.00 within 30 days from the
date this decision becomes final. If the said
Sometime in 1945, Palawan Manganese Mines,
amount, or any part thereof, is not paid within
Inc., the controlling stockholders of which are
said period, there shall be added to the unpaid
also the controlling stockholders of petitioner
amount as surcharge of 5%, plus interest as
corporation, requested financial help from
provided in Section 51 of the National Internal
petitioner to enable it to resume it mining
Revenue Code, as amended. With costs against
operations in Coron, Palawan. The request for
petitioner. (Pp. 75, 76, Taxpayer's Brief as
financial assistance was readily and unanimously
approved by the Board of Directors of petitioner,
and thereafter a memorandum agreement was
Both parties have appealed from the respective adverse executed on August 12, 1945, embodying the
rulings against them in the Tax Court's decision. Two main terms and conditions under which the financial
issues are raised by the parties: first, the correctness of the assistance was to be extended, the pertinent
Tax Court's rulings with respect to the disputed items of provisions of which are as follows:
"WHEREAS, the FIRST PARTY, by virtue of its clear that the consideration for the advances made by
resolution adopted on August 10, 1945, petitioner was 15% of the net profits of Palawan
has agreed to extend to the SECOND Manganese Mines, Inc. In other words, if there were no
PARTY the requested financial help by earnings or profits, there was no obligation to repay those
way of accommodation advances and advances. It has been held that the voluntary advances
for this purpose has authorized its made without expectation of repayment do not result in
President, Mr. Ramon J. Fernandez to deductible losses. 1955 PH Fed. Taxes, Par. 13, 329,
cause the release of funds to the citing W. F. Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR
SECOND PARTY. 395; George B. Markle, 17 TC. 1593.

"WHEREAS, to compensate the FIRST Is the said amount deductible as a bad debt? As already
PARTY for the advances that it has stated, petitioner gave advances to Palawan
agreed to extend to the SECOND PARTY, Manganese Mines, Inc., without expectation of
the latter has agreed to pay to the repayment. Petitioner could not sue for recovery under
former fifteen per centum (15%) of its net the memorandum agreement because the obligation of
profits. Palawan Manganese Mines, Inc. was to pay petitioner
15% of its net profits, not the advances. No bad debt
"NOW THEREFORE, for and in could arise where there is no valid and subsisting debt.
consideration of the above premises, the
parties hereto have agreed and Again, assuming that in this case there was a valid and
covenanted that in consideration of the subsisting debt and that the debtor was incapable of
financial help to be extended by the paying the debt in 1951, when petitioner wrote off the
FIRST PARTY to the SECOND PARTY to advances and deducted the amount in its return for said
enable the latter to resume its mining year, yet the debt is not deductible in 1951 as a worthless
operations in Coron, Palawan, the debt. It appears that the debtor was still in operation in
SECOND PARTY has agreed and 1951 and 1952, as petitioner continued to give advances
undertaken as it hereby agrees and in those years. It has been held that if the debtor
undertakes to pay to the FIRST PARTY corporation, although losing money or insolvent, was still
fifteen per centum (15%) of its net profits." operating at the end of the taxable year, the debt is not
(Exh. H-2) considered worthless and therefore not deductible. 3

Pursuant to the agreement mentioned above, petitioner The Tax Court's disallowance of the write-off was proper.
gave to Palawan Manganese Mines, Inc. yearly The Solicitor General has rightly pointed out that the
advances starting from 1945, which advances amounted taxpayer has taken an "ambiguous position " and "has not
to P587,308.07 by the end of 1951. Despite these definitely taken a stand on whether the amount involved
advances and the resumption of operations by Palawan is claimed as losses or as bad debts but insists that it is
Manganese Mines, Inc., it continued to suffer losses. By either a loss or a bad debt." 4 We sustain the government's
1951, petitioner became convinced that those advances position that the advances made by the taxpayer to its
could no longer be recovered. While it continued to give 100% subsidiary, Palawan Manganese Mines, Inc.
advances, it decided to write off as worthless the sum of amounting to P587,308,07 as of 1951 were investments
P353,134.25. This amount "was arrived at on the basis of and not loans. 5 The evidence on record shows that the
the total of advances made from 1945 to 1949 in the sum board of directors of the two companies since August,
of P438,981.39, from which amount the sum of P85,647.14 1945, were identical and that the only capital of Palawan
had to be deducted, the latter sum representing its pre- Manganese Mines, Inc. is the amount of P100,000.00
war assets. (t.s.n., pp. 136-139, Id)." (Page 4, entered in the taxpayer's balance sheet as its investment
Memorandum for Petitioner.) Petitioner decided to in its subsidiary company. 6 This fact explains the liberality
maintain the advances given in 1950 and 1951 in the with which the taxpayer made such large advances to
hope that it might be able to recover the same, as in fact the subsidiary, despite the latter's admittedly poor
it continued to give advances up to 1952. From these financial condition.
facts, and as admitted by petitioner itself, Palawan
Manganese Mines, Inc., was still in operation when the The taxpayer's contention that its advances were loans to
advances corresponding to the years 1945 to 1949 were its subsidiary as against the Tax Court's finding that under
written off the books of petitioner. Under the their memorandum agreement, the taxpayer did not
circumstances, was the sum of P353,134.25 properly expect to be repaid, since if the subsidiary had no
claimed by petitioner as deduction in its income tax earnings, there was no obligation to repay those
return for 1951, either as losses or bad debts? advances, becomes immaterial, in the light of our
resolution of the question. The Tax Court correctly held
It will be noted that in giving advances to Palawan that the subsidiary company was still in operation in 1951
Manganese Mine Inc., petitioner did not expect to be and 1952 and the taxpayer continued to give it
repaid. It is true that some testimonial evidence was advances in those years, and, therefore, the alleged
presented to show that there was some agreement that debt or investment could not properly be considered
the advances would be repaid, but no documentary worthless and deductible in 1951, as claimed by the
evidence was presented to this effect. The memorandum taxpayer. Furthermore, neither under Section 30 (d) (2) of
agreement signed by the parties appears to be very our Tax Code providing for deduction by corporations of
losses actually sustained and charged off during the Petitioner deducted losses in the operation of its
taxable year nor under Section 30 (e) (1) thereof Hacienda Dalupiri the sums of P17,418.95 in 1950,
providing for deduction of bad debts actually P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62
ascertained to be worthless and charged off within the in 1953, and P42,938.56 in 1954. These deductions
taxable year, can there be a partial writing off of a loss or were disallowed by respondent on the ground
bad debt, as was sought to be done here by the that the farm was operated solely for pleasure or
taxpayer. For such losses or bad debts must be as a hobby and not for profit. This conclusion is
ascertained to be so and written off during the taxable based on the fact that the farm was operated
year, are therefore deductible in full or not at all, in the continuously at a loss.1awphîl.nèt
absence of any express provision in the Tax Code
authorizing partial deductions. From the evidence, we are convinced that the
Hacienda Dalupiri was operated by petitioner for
The Tax Court held that the taxpayer's loss of its business and not pleasure. It was mainly a cattle
investment in its subsidiary could not be deducted for the farm, although a few race horses were also
year 1951, as the subsidiary was still in operation in 1951 raised. It does not appear that the farm was used
and 1952. The taxpayer, on the other hand, claims that its by petitioner for entertainment, social activities,
advances were irretrievably lost because of the or other non-business purposes. Therefore, it is
staggering losses suffered by its subsidiary in 1951 and entitled to deduct expenses and losses in
that its advances after 1949 were "only limited to the connection with the operation of said farm. (See
purpose of salvaging whatever ore was already 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M.
available, and for the purpose of paying the wages of 21103, CB 1939-1, p.164)
the laborers who needed help." 7 The correctness of the
Tax Court's ruling in sustaining the disallowance of the Section 100 of Revenue Regulations No. 2,
write-off in 1951 of the taxpayer's claimed losses is borne otherwise known as the Income Tax Regulations,
out by subsequent events shown in Cases L-24972 and L- authorizes farmers to determine their gross
24978 involving the taxpayer's 1957 income tax liability. income on the basis of inventories. Said
(Infra, paragraph 6.) It will there be seen that by 1956, the regulations provide:
obligation of the taxpayer's subsidiary to it had been
reduced from P587,398.97 in 1951 to P442,885.23 in 1956,
"If gross income is ascertained by
and that it was only on January 1, 1956 that the subsidiary
inventories, no deduction can be made
decided to cease operations. 8
for livestock or products lost during the
year, whether purchased for resale,
(c) Disallowance of losses in Balamban Coal Mines (1950 produced on the farm, as such losses will
and 1951). — The Court sustains the Tax Court's be reflected in the inventory by reducing
disallowance of the sums of P8,989.76 and P27,732.66 the amount of livestock or products on
spent by the taxpayer for the operation of its Balamban hand at the close of the year."
coal mines in Cebu in 1950 and 1951, respectively, and
claimed as losses in the taxpayer's returns for said years.
Evidently, petitioner determined its income or
The Tax Court correctly held that the losses "are
losses in the operation of said farm on the basis of
deductible in 1952, when the mines were abandoned,
inventories. We quote from the memorandum of
and not in 1950 and 1951, when they were still in
counsel for petitioner:
operation." 9 The taxpayer's claim that these expeditions
should be allowed as losses for the corresponding years
that they were incurred, because it made no sales of "The Taxpayer deducted from its income
coal during said years, since the promised road or outlet tax returns for the years from 1950 to 1954
through which the coal could be transported from the inclusive, the corresponding yearly losses
mines to the provincial road was not constructed, cannot sustained in the operation of Hacienda
be sustained. Some definite event must fix the time when Dalupiri, which losses represent the
the loss is sustained, and here it was the event of actual excess of its yearly expenditures over the
abandonment of the mines in 1952. The Tax Court held receipts; that is, the losses represent the
that the losses, totalling P36,722.42 were properly difference between the sales of livestock
deductible in 1952, but the appealed judgment does not and the actual cash disbursements or
show that the taxpayer was credited therefor in the expenses." (Pages 21-22, Memorandum
determination of its tax liability for said year. This for Petitioner.)
additional deduction of P36,722.42 from the taxpayer's
taxable income in 1952 would result in the elimination of As the Hacienda Dalupiri was operated by
the deficiency tax liability for said year in the sum of petitioner for business and since it sustained losses
P3,600.00 as determined by the Tax Court in the in its operation, which losses were determined by
appealed judgment. means of inventories authorized under Section
100 of Revenue Regulations No. 2, it was error for
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 respondent to have disallowed the deduction of
to 1954) and Hacienda Samal (1951-1952). — The Tax said losses. The same is true with respect to loss
Court overruled the Commissioner's disallowance of these sustained in the operation of the Hacienda
items of losses thus: Samal for the years 1951 and 1952. 10
The Commissioner questions that the losses sustained by May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 &
the taxpayer were properly based on the inventory L-11558, Nov. 25, 1958.) In this case, the increase
method of accounting. He concedes, however, "that the in the net worth of petitioner for 1950 to the
regulations referred to does not specify how the extent of P30,050.00 was not the result of the
inventories are to be made. The Tax Court, however, felt receipt by it of taxable income. It was merely the
satisfied with the evidence presented by the taxpayer ... outcome of the correction of an error in the entry
which merely consisted of an alleged physical count of in its books relating to its indebtedness to the
the number of the livestock in Hacienda Dalupiri for the Manila Insurance Company. The Income Tax Law
years involved." 11 The Tax Court was satisfied with the imposes a tax on income; it does not tax any or
method adopted by the taxpayer as a farmer breeding every increase in net worth whether or not
livestock, reporting on the basis of receipts and derived from income. Surely, the said sum of
disbursements. We find no Compelling reason to disturb P30,050.00 was not income to petitioner, and it
its findings. was error for respondent to assess a deficiency
income tax on said amount.
2. Disallowance of excessive depreciation of buildings
(1950-1954). — During the years 1950 to 1954, the The same holds true in the case of the alleged increase in
taxpayer claimed a depreciation allowance for its net worth of petitioner for the year 1951 in the sum of
buildings at the annual rate of 10%. The Commissioner P1,382.85. It appears that certain items (all amounting to
claimed that the reasonable depreciation rate is only 3% P1,382.85) remained in petitioner's books as outstanding
per annum, and, hence, disallowed as excessive the liabilities of trade creditors. These accounts were
amount claimed as depreciation allowance in excess of discovered in 1951 as having been paid in prior years, so
3% annually. We sustain the Tax Court's finding that the that the necessary adjustments were made to correct the
taxpayer did not submit adequate proof of the errors. If there was an increase in net worth of the
correctness of the taxpayer's claim that the depreciable petitioner, the increase in net worth was not the result of
assets or buildings in question had a useful life only of 10 receipt by petitioner of taxable income." 13 The
years so as to justify its 10% depreciation per annum Commissioner advances no valid grounds in his brief for
claim, such finding being supported by the record. The contesting the Tax Court's findings. Certainly, these
taxpayer's contention that it has many zero or one-peso increases in the taxpayer's net worth were not taxable
assets, 12representing very old and fully depreciated increases in net worth, as they were not the result of the
assets serves but to support the Commissioner's position receipt by it of unreported or unexplained taxable
that a 10% annual depreciation rate was excessive. income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its
3. Taxable increase in net worth (1950-1951). — The Tax indebtednesses to certain creditors, which had been
Court set aside the Commissioner's treatment as taxable erroneously overstated or listed as outstanding when they
income of certain increases in the taxpayer's net worth. It had in fact been duly paid. The Tax Court's action must
found that: be affirmed.

For the year 1950, respondent determined that 4. Gain realized from sale of real property (1950). — We
petitioner had an increase in net worth in the sum likewise sustain as being in accordance with the
of P30,050.00, and for the year 1951, the sum of evidence the Tax Court's reversal of the Commissioner's
P1,382.85. These amounts were treated by assessment on all alleged unreported gain in the sum of
respondent as taxable income of petitioner for P11,147.26 in the sale of a certain real property of the
said years. taxpayer in 1950. As found by the Tax Court, the
evidence shows that this property was acquired in 1926
for P11,852.74, and was sold in 1950 for P60,000.00,
It appears that petitioner had an account with
apparently, resulting in a gain of P48,147.26. 14 The
the Manila Insurance Company, the records
taxpayer reported in its return a gain of P37,000.00, or a
bearing on which were lost. When its records
discrepancy of P11,147.26. 15 It was sufficiently proved
were reconstituted the amount of P349,800.00
from the taxpayer's books that after acquiring the
was set up as its liability to the Manila Insurance
property, the taxpayer had made improvements totalling
Company. It was discovered later that the
P11,147.26, 16 accounting for the apparent discrepancy in
correct liability was only 319,750.00, or a
the reported gain. In other words, this figure added to the
difference of P30,050.00, so that the records were
original acquisition cost of P11,852.74 results in a total cost
adjusted so as to show the correct liability. The
of P23,000.00, and the gain derived from the sale of the
correction or adjustment was made in 1950.
property for P60,000.00 was correctly reported by the
Respondent contends that the reduction of
taxpayer at P37,000.00.
petitioner's liability to Manila Insurance Company
resulted in the increase of petitioner's net worth
to the extent of P30,050.00 which is taxable. This is On the second issue of prescription, the taxpayer's
erroneous. The principle underlying the taxability contention that the Commissioner's action to recover its
of an increase in the net worth of a taxpayer rests tax liability should be deemed to have prescribed for
on the theory that such an increase in net worth, failure on the part of the Commissioner to file a complaint
if unreported and not explained by the taxpayer, for collection against it in an appropriate civil action, as
comes from income derived from a taxable contradistinguished from the answer filed by the
source. (See Perez v. Araneta, G.R. No. L-9193, Commissioner to its petition for review of the questioned
assessments in the case a quo has long been rejected by deficiency income tax for the year 1957, plus the
this Court. This Court has consistently held that "a judicial corresponding interest provided in Section 51 of
action for the collection of a tax is begun by the filing of the Revenue Code. If the deficiency tax is not
a complaint with the proper court of first instance, paid in full within thirty (30) days from the date
or where the assessment is appealed to the Court of Tax this decision becomes final and executory,
Appeals, by filing an answer to the taxpayer's petition for petitioner shall pay a surcharge of five per cent
review wherein payment of the tax is prayed for." 17 This is (5%) of the unpaid amount, plus interest at the
but logical for where the taxpayer avails of the right to rate of one per cent (1%) a month, computed
appeal the tax assessment to the Court of Tax Appeals, from the date this decision becomes final until
the said Court is vested with the authority to pronounce paid, provided that the maximum amount that
judgment as to the taxpayer's liability to the exclusion of may be collected as interest shall not exceed the
any other court. In the present case, regardless of amount corresponding to a period of three (3)
whether the assessments were made on February 24 and years. Without pronouncement as to costs. 19
27, 1956, as claimed by the Commissioner, or on
December 27, 1955 as claimed by the taxpayer, the Both parties again appealed from the respective adverse
government's right to collect the taxes due has clearly rulings against them in the Tax Court's decision.
not prescribed, as the taxpayer's appeal or petition for
review was filed with the Tax Court on May 4, 1960, with
5. Allowance of losses in Hacienda Dalupiri (1957). — The
the Commissioner filing on May 20, 1960 his Answer with a
Tax Court cited its previous decision overruling the
prayer for payment of the taxes due, long before the
Commissioner's disallowance of losses suffered by the
expiration of the five-year period to effect collection by
taxpayer in the operation of its Hacienda Dalupiri, since it
judicial action counted from the date of assessment.
was convinced that the hacienda was operated for
business and not for pleasure. And in this appeal, the
Cases L-24972 and L-24978 Commissioner cites his arguments in his appellant's brief in
Case No. L-21557. The Tax Court, in setting aside the
These cases refer to the taxpayer's income tax liability for Commissioner's principal objections, which were directed
the year 1957. Upon examination of its corresponding to the accounting method used by the taxpayer found
income tax return, the Commissioner assessed it for that:
deficiency income tax in the amount of P38,918.76,
computed as follows: It is true that petitioner followed the cash basis
method of reporting income and expenses in the
Net income per return operation of the Hacienda Dalupiri and used the
accrual method with respect to its mine
Add: Unallowable deductions: operations. This method of accounting, otherwise
(1) Net loss claimed on Ha. Dalupiri 89,547.33known as the hybrid method, followed by
petitioner is not without justification.
(2) Amortization of Contractual right claimed as an
expense under Mines Operations 48,481.62
... A taxpayer may not, ordinarily,
combine the cash and accrual bases.
Net income per investigation P167,297.65
The 1954 Code provisions permit,
Tax due thereon 38,818.00 however, the use of a hybrid method of
accounting, combining a cash and
Less: Amount already assessed 5,836.00 accrual method, under circumstances
Balance P32,982.00 and requirements to be set out in
Regulations to be issued. Also, if a
Add: 1/2% monthly interest from 6-20-59 to 6-20-62 5,936.76
taxpayer is engaged in more than one
1 trade or business he may use a different
TOTAL AMOUNT DUE AND COLLECTIBLE 8 P38,918.76 method of accounting for each trade or
business. And a taxpayer may report
income from a business on accrual basis
The Tax Court overruled the Commissioner's disallowance
and his personal income on the cash
of the taxpayer's losses in the operation of its Hacienda
basis.' (See Mertens, Law of Federal
Dalupiri in the sum of P89,547.33 but sustained the
Income Taxation, Zimet & Stanley
disallowance of the sum of P48,481.62, which allegedly
Revision, Vol. 2, Sec. 12.08, p. 26.) 20
represented 1/5 of the cost of the "contractual right" over
the mines of its subsidiary, Palawan Manganese Mines,
Inc. which the taxpayer had acquired. It found the The Tax Court, having satisfied itself with the
taxpayer liable for deficiency income tax for the year adequacy of the taxpayer's accounting method
1957 in the amount of P9,696.00, instead of P32,982.00 as and procedure as properly reflecting the
originally assessed, and rendered the following judgment: taxpayer's income or losses, and the
Commissioner having failed to show the contrary,
we reiterate our ruling [supra, paragraph 1 (d)
WHEREFORE, the assessment appealed from is
and (e)] that we find no compelling reason to
hereby modified. Petitioner is hereby ordered to
disturb its findings.
pay to respondent the amount of P9,696.00 as
6. Disallowance of amortization of alleged "contractual disallowed the deduction on the following
rights." — The reasons for sustaining this disallowance are grounds: (1) that the Palawan Manganese Mines,
thus given by the Tax Court: Inc. could not transfer P242,408.10 worth of assets
to petitioner because the balance sheet of the
It appears that the Palawan Manganese Mines, said corporation for 1955 shows that it had only
Inc., during a special meeting of its Board of current as worth P97,636.96; and (2) that the
Directors on January 19, 1956, approved a alleged amortization of "contractual rights" is not
resolution, the pertinent portions of which read as allowed by the Revenue Code.
The law in point is Section 30(g) (1) (B) of the
"RESOLVED, as it is hereby resolved, that Revenue Code, before its amendment by
the corporation's current assets Republic Act No. 2698, which provided in part:
composed of ores, fuel, and oil, materials
and supplies, spare parts and canteen "(g) Depletion of oil and gas wells and
supplies appearing in the inventory and mines.:
balance sheet of the Corporation as of
December 31, 1955, with an aggregate "(1) In general. — ... (B) in the case of
value of P97,636.98, contractual rights for mines, a reasonable allowance for
the operation of various mining claims in depletion thereof not to exceed the
Palawan with a value of P100,000.00, its market value in the mine of the product
title on various mining claims in Palawan thereof, which has been mined and sold
with a value of P142,408.10 or a total during the year for which the return and
value of P340,045.02 be, as they are computation are made. The allowances
hereby ceded and transferred to shall be made under rules and
Fernandez Hermanos, Inc., as partial regulations to be prescribed by the
settlement of the indebtedness of the Secretary of Finance: Provided, That
corporation to said Fernandez Hermanos when the allowances shall equal the
Inc. in the amount of P442,895.23." (Exh. capital invested, ... no further allowance
E, p. 17, CTA rec.) shall be made."

On March 29, 1956, petitioner's corporation Assuming, arguendo, that the Palawan
accepted the above offer of transfer, thus: Manganese Mines, Inc. had assets worth
P242,408.10 which it actually transferred to the
"WHEREAS, the Palawan Manganese petitioner in 1956, the latter cannot just deduct
Mines, Inc., due to its yearly substantial one-fifth (1/5) of said amount from its gross
losses has decided to cease operation income for the year 1957 because such
on January 1, 1956 and in order to satisfy deduction in the form of depletion charge was
at least a part of its indebtedness to the not sanctioned by Section 30(g) (1) (B) of the
Corporation, it has proposed to transfer Revenue Code, as above-quoted.
its current assets in the amount of NINETY
SIX PESOS & 98/100 (P97,636.98) as per its
balance sheet as of December 31, 1955,
The sole basis of petitioner in claiming the
its contractual rights valued at ONE
amount of P48,481.62 as a deduction was the
memorandum of its mining engineer (Exh. 1, pp.
(P100,000.00) and its title over various
31-32, CTA rec.), who stated that the ore reserves
mining claims valued at ONE HUNDRED
of the Busuange Mines (Mines transferred by the
Palawan Manganese Mines, Inc. to the
EIGHT PESOS & 10/100 (P142,408.10) or a
petitioner) would be exhausted in five (5) years,
total evaluation of THREE HUNDRED
hence, the claim for P48,481.62 or one-fifth (1/5)
of the alleged cost of the mines corresponding to
08/100 (P340,045.08) which shall be
the year 1957 and every year thereafter for a
applied in partial settlement of its
period of 5 years. The said memorandum merely
obligation to the Corporation in the
showed the estimated ore reserves of the mines
and it probable selling price. No evidence
whatsoever was presented to show the
PESOS & 23/100 (P442,885.23)," (Exh. E-1,
produced mine and for how much they were
p. 18, CTA rec.)
sold during the year for which the return and
computation were made. This is necessary in
Petitioner determined the cost of the mines at order to determine the amount of depletion that
P242,408.10 by adding the value of the can be legally deducted from petitioner's gross
contractual rights (P100,000.00) and the value of income. The method employed by petitioner in
its mining claims (P142,408.10). Respondent making an outright deduction of 1/5 of the cost
of the mines is not authorized under Section 30(g) G.R. No. L-45544 April 25, 1939
(1) (B) of the Revenue Code. Respondent's
disallowance of the alleged "contractual rights"
amounting to P48,481.62 must therefore be
sustained. 21
The taxpayer insists in this appeal that it could use as a ECHARRI, oppositor-appellee.
method for depletion under the pertinent provision of the
Tax Code its "capital investment," representing the
Undersecretary of Justice Melencio for appellant.
alleged value of its contractual rights and titles to mining
Hilado and Hilado for appellee.
claims in the sum of P242,408.10 and thus deduct outright
one-fifth (1/5) of this "capital investment" every year.
regardless of whether it had actually mined the product LAUREL, J.:
and sold the products. The very authorities cited in its brief
give the correct concept of depletion charges that they This is an appeal by the Collector of Internal revenue from
"allow for the exhaustion of the capital value of the the order of the Court of First Instance of Occidental
deposits by production"; thus, "as the cost of the raw Negros, under date of may 26, 1936, the dispositive part
materials must be deducted from the gross income of which reads as follows:
before the net income can be determined, so the
estimated cost of the reserve used up is allowed." 22 The Y bajo esta computacion se declara que el
alleged "capital investment" method invoked by the Administrador de Rentas Internas solamente
taxpayer is not a method of depletion, but the Tax Code debe cobrar de este intestado la cantidad de
provision, prior to its amendment by Section 1, of P1,467.57, en lugar de la cantidad de P14,475.13,
Republic Act No. 2698, which took effect on June 18, ordenandose en su consecuencia al
1960, expressly provided that "when the allowances shall administrador de este intestado que pague
equal the capital invested ... no further allowances shall dicha suma de P1,467.59 al Gobierno de las Islas
be made;" in other words, the "capital investment" was Filipinas, por conducto del Tesorero Provincial de
but the limitation of the amount of depletion that could Negros Occidental, dentro del plazo de cinco
be claimed. The outright deduction by the taxpayer of dias.
1/5 of the cost of the mines, as if it were a "straight line"
rate of depreciation, was correctly held by the Tax Court
In probate proceedings in the matter of the intestate
not to be authorized by the Tax Code.
estate of Lorenzo Echarri, deceased, pending in the
Court of First Instance of Occidental Negros, the
ACCORDINGLY, the judgment of the Court of Tax provincial fiscal of said province, in behalf of the Insular
Appeals, subject of the appeals in Cases Nos. L-21551 Government, filed on February 18, 1931, a motion under
and L-21557, as modified by the crediting of the losses of date of February 10, of the same year, submitting
P36,722.42 disallowed in 1951 and 1952 to the taxpayer therewith annex A, which is proof of debt subscribed to
for the year 1953 as directed in paragraph 1 (c) of this by the Collector of Internal Revenue on January 12, 1931,
decision, is hereby affirmed. The judgment of the Court of in which it is claimed, that Lorenzo Echarri, deceased, is
Tax Appeals appealed from in Cases Nos. L-24972 and L- indebted to the Government of the Philippine Islands in
24978 is affirmed in toto. No costs. So ordered. the sum of P14,475.13 as income tax found to be due
from him for year 1927. On May 19, 1932, the Collector of
Internal Revenue, represented by the provincial fiscal of
said province, filed another motion in which he prayed
that the administratrix of the intestate estate be ordered
to pay to the Government of the Philippines the amount
of the income tax above referred to. On May 28, 1932,
the administratrix filed an answer to said motion in which
she challenged the validity of the assessment made by
the Collector of Internal Revenue and prayed that the
assessment be amended and, if necessary, the claim be
set for hearing for introduction of evidence. On the same
date, the administratrix filed additional memorandum in
which it is contended that annex B of her answer to the
motion of the Collector of Internal Revenue was not a
contract of sale. On January 30, 1934, the Collector of
Internal Revenue, in a motion submitted to the court,
raised the question of propriety of contesting the
assessment or the legality of the tax without the
administratrix paying first the tax under protest and
brining the corresponding action under section 1579 of
the Revised Administrative Code. On June 15, 1934, the
lower court upheld the contention of the Collector of
Internal Revenue and ordered the administratrix to pay to
the Government the sum of P14,475.13, under protest P1,467.57, instead of the sum of P14,475.13 which is the
authorizing her at the same time to institute the amount of the income tax assessed by the Collector of
corresponding judicial action to recover the amount paid Internal Revenue.
in accordance with the aforecited section 1579 of the
Revised Administrative Code. On July 7, 1934, the The questions raised in the first and second assignments
administratrix filed a motion for reconsideration, and on can be fairly disposed of by taking into account the time
July 18, 1934, the court reconsidered its order of June 15, of the discovery of the deficiency of the income-tax
1934, and set the claim of the Government for trial on the return, dated March 30, 1928, of Lorenzo Echarri,
merit. Both parties presented evidence. On May 26, 1936, deceased. According to the records of this case the
the lower court rendered its decision ordering the return was received in the office of the Collector of
administratrix to pay to the Collector of Internal Revenue Internal Revenue on March 31, 1928 (Exhibit C), and that
the sum of P1,467.57, instead of the P14,475.13, as the alleged errors in said return were the subject of
additional income tax. From this order the Collector of correspondence between the Collector of Internal
Internal Revenue, has appealed to this court. Revenue and the attorney for the administratrix of said
intestate even before January 5, 1931 (Annex A). It is
The appellant makes the following assignment of errors: therefore obvious that the error or deficiency of the
income-tax return was discovered within three years from
I. The lower court erred in holding that it has jurisdiction to the time that such erroneous declaration was made. In
receive evidence and decide on its merit the claim of the Collector of Customs vs. Haygood (G.R. No. 44038,
Government filed in these proceedings. promulgated on May 18, 1938), we said:

II. The lower court erred in not ordering the administratrix 1.º, que cuando el descubrimiento de
to pay the claim of the Government under protest and declaraciones erroneas de impuestos se hace
bring later an action for its recovery as provided for in dentro de los tres años siguientes a la fecha en
section 1579 of the Revised Administrative Code. que deben hacerse dichas declaraciones y el
declarante ha fallecido, la reclamacion para el
cobro del pago del impuesto tasado por el
III. The lower court erred in holding that the transaction
Administrador de Rentas Internas debe hacerse
involved in the document, Exhibit A, which refers to the
en la testamentaria o abintestato mediante
transfer of the properties known as "Hacienda Urbasa,"
mocion acompañada de una relacion jurada
with all the improvements existing thereon, by Lorenzo
por dicho Administrador de los impuestos
Echarri to the Central Azucarera del Danao, to pay the
adeudados y el Tribunal competente puede
value of 1,437 shares of stock of said central which Echarri
sumariamente ordenar al Administrador judicial
had subscribed, does not have the nature of a sale but of
sin previa vista el pago de la reclamacion si este
an exchange or barter.
tuviere fondos disponibles, teniendo en cuenta
las prelaciones establecidas en el articulo 753 del
IV. The lower court erred in holding that, considering the Codigo de Procedimiento Civil, pudiendo dicho
nature of the transaction involved in Exhibit A as administrador hacer el pago bajo protesta para
exchange, the net value that should be given to the recobrar en juicio aparte lo que hubiera pagado
"Hacienda Urbasa" is 143,700, and that the value of 1,437 indebidamente; y 2.º, que cuando el
shares, at the par value of P100 each, being P143,700, the descubrimiento de declaraciones erroneas tiene
result is that Lorenzo Echarri did not realize any gain lugar despues de los tres años contados desde la
subject to taxation. fecha en que se han hecho dichas
declaraciones, la reclamacion que presentare el
V. The lower court erred in not holding that the Administrador de Rentas Internas debe hacerse
transaction involved in Exhibit A partakes of the nature of tambien mediante mocion acompañada de
a sale whereby Lorenzo Echarri sold his "Hacienda una relacion jurada de impuestos no pagados,
Urbasa" together with all the improvements thereon, with teniendo dicha mocion caracter de una
an aggregate value of P238,838.31, to the Central demanda civil que debe tramitarse mediante
Azucarera del Danao, in payment of the 1,437 shares of presentacion de contestacion escrita y practica
stock subscribed by Echarri on condition that the central de prueba.
should assume the obligations of Echarri in the amount of
P256,878.31. The case of Pineda vs. Court of First Instance of Tayabas
and Collector of Internal Revenue (52 Phil., 803), relied
VI. The lower court erred in not holding that the profit upon by the petitioner-appellant is good authority on the
realized by Lorenzo Echarri from the sale of his "Hacienda proposition that the court having control over the
Urbasa" to the Central Azucarera del Danao in payment administration proceedings has jurisdiction to entertain
of his 1,437 shares of stock amounts to P161,740, being the claim presented by the government for taxes due
the difference between the selling price of P400,578.31 and to order the administrator to pay the tax should it find
and the cost price of "Hacienda Urbasa" in the amount of that the assessment was proper, and that the tax was
P238,838.31. legal, due and collectible. And the rule laid down in that
case must be understood in relation to the case
VII. The lower court erred in ordering the administratrix to of Collector of Customs vs. Haygood, supra, as to the
pay to the Collector of Internal Revenue the sum of procedure to be followed in a given case by the
government to effectuate the collection of the tax. G.R. No. L-66416 March 21, 1990
Categorically stated, where during the pendency of
judicial over the estate of a deceased person a claim for
taxes is presented by the government, the court has the
authority to order the payment by the administrator; but,
in the same way that it has authority to order payment or
APPEALS, respondents.
satisfaction, it also has the negative authority to deny the
same. While there are cases where courts are required to
perform certain duties mandatory and ministerial in This is a petition to review on certiorari the decision of the
character, the function of the court in a case of the Court of Tax Appeals which ruled that the money
present character is not one of them; and here, the court entrusted to private respondent Tours Specialists, Inc.,
cannot be an organism endowed with latitude of earmarked and paid for hotel room charges of tourists,
judgment in one direction, and converted into a mere travelers and/or foreign travel agencies does not form
mechanical contrivance in another direction. This part of its gross receipts subject to the 3% independent
principle is sound notwithstanding the unqualified contractor's tax under the National Internal Revenue
application suggested by the petitioner-appellant of Code of 1977.
section 1579 of the Revised Administrative Code in the
light of our pronouncements in Sarasola vs. Trinidad (40 We adopt the findings of facts of the Court of Tax
Phil., 252) and Churchill and Tait vs. Rafferty (32 Phil., 580). Appeals as follows:

The first and second assignments of error are therefore For the years 1974 to 1976, petitioner (Tours Specialists,
overruled. Inc.) had derived income from its activities as a travel
agency by servicing the needs of foreign tourists and
The other questions raised have reference to the nature travelers and Filipino "Balikbayans" during their stay in this
of the transaction marked as Exhibit A of the government. country. Some of the services extended to the tourists
The lower court concluded that the parties intended an consist of booking said tourists and travelers in local hotels
exchange of properties. In reality, for the purposes of the for their lodging and board needs; transporting these
application of the Income Tax Law whether the foreign tourists from the airport to their respective hotels,
transaction was a sale or an exchange is immaterial. The and from the latter to the airport upon their departure
determining factor was whether any gain or profit was from the Philippines, transporting them from their hotels to
derived therefrom (Act No. 2833, sec. 2, subpars. [c] and various embarkation points for local tours, visits and
[3]; Atkins' Estate vs. Lucas, 36 Fed. [2d], 611). excursions; securing permits for them to visit places of
interest; and arranging their cultural entertainment,
shopping and recreational activities.
Whether gain was derived from the transaction is a
question of fact. The determination of that question
presupposes review of the computation of the In order to ably supply these services to the foreign
assessment made by the Collector of Internal Revenue tourists, petitioner and its correspondent counterpart
no less than of the evidence presented by the parties. tourist agencies abroad have agreed to offer a package
The lower court reached the conclusion that in the fee for the tourists. Although the fee to be paid by said
transaction the deceased had neither realized any gain tourists is quoted by the petitioner, the payments of the
nor suffered any loss. We cannot alter this finding made hotel room accommodations, food and other personal
presumably after consideration of the evidence expenses of said tourists, as a rule, are paid directly either
presented before the lower court especially where we do by tourists themselves, or by their foreign travel agencies
not find any abuse or misapplication of the law. 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.
The appeal is dismissed without pronouncement
regarding costs. So ordered.
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. 3-4, 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 through petitioner without any increase in the room
Internal Revenue assessed petitioner for deficiency 3% charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the
contractor's tax as independent contractor by including reason why tourists pay their room charge, or through
the entrusted hotel room charges in its gross receipts from their foreign tourists agencies, is the fact that the room
services for the years 1974 to 1976. Consequently, on charge is exempt from hotel room tax under P.D. 31.
December 6, 1979, petitioner received from respondent (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-
the 3% deficiency independent contractor's tax examination, that if their payment is made, thru
assessment in the amount of P122,946.93 for the years petitioner's tour agency, the hotel cost or charges "is only
1974 to 1976, inclusive, computed as follows: an act of accomodation on our (its) part" or that the
"agent abroad instead of sending several telexes and
1974 deficiency percentage tax saving on bank charges they take the option to send
per investigation P 3,995.63 money to us to be held in trust to be endorsed to the
15% surcharge for late payment 998.91 hotel." (pp. 3-4, t.s.n.Aug. 10, 1982.)
P 4,994.54 Nevertheless, on June 2, 1980, respondent, without
14% interest computed by quarters deciding the petitioner's written protest, caused the
up to 12-28-79 3,953.18 issuance of a warrant of distraint and levy. (p. 51, BIR
P 8,847.72 Rec.) And later, respondent had petitioner's bank
1975 deficiency percentage tax deposits garnished. (pp. 49-50, BIR Rec.)
per investigation P 8,427.39
25% surcharge for late payment 2,106.85 Taking this action of respondent as the adverse and final
————— decision on the disputed assessment, petitioner
P 10,534.24 appealed to this Court. (Rollo, pp. 40-45)
14% interest computed by quarters
up to 12-28-79 6,808.47
The petitioner raises the lone issue in this petition as
P 17,342.71
1976 deficiency percentage
per investigation P 54,276.42 WHETHER AMOUNTS RECEIVED BY A
25% surcharge for late payment 13,569.11 LOCAL TOURIST AND TRAVEL AGENCY
14% interest computed by quarters INTENDED OR EARMARKED FOR HOTEL
up to 12-28-79 28,910.97 ACCOMMODATIONS FORM PART OF
————— ————— CONTRACTOR'S TAX. (Rollo, p. 23)
Total P122,946.93
The petitioner premises the issue raised on the following
In addition to the deficiency contractor's tax of
P122,946.93, petitioner was assessed to pay a Firstly, the ruling overlooks the fact that the amounts
compromise penalty of P500.00. received, intended for hotel room accommodations,
were received as part of the package fee and,
Subsequently on December 11, 1979, petitioner formally therefore, form part of "gross receipts" as defined by law.
protested the assessment made by respondent on the
ground that the money received and entrusted to it by Secondly, there is no showing and is not established by
the tourists, earmarked to pay hotel room charges, were the evidence. that the amounts received and
not considered and have never been considered by it as "earmarked" are actually what had been paid out as
part of its taxable gross receipts for purposes of hotel room charges. The mere possibility that the amounts
computing and paying its contractor's tax. actually paid could be less than the amounts received is
sufficient to destroy the validity of the ruling. (Rollo, pp.
During one of the hearings in this case, a witness, Serafina 26-27)
Sazon, Certified Public Accountant and in charge of the
Accounting Department of petitioner, had testified, her In effect, the petitioner's lone issue is based on alleged
credibility not having been destroyed on cross error in the findings of facts of the respondent court.
examination, categorically stated that the amounts
entrusted to it by the foreign tourist agencies intended for The well-settled doctrine is that the findings of facts of the
payment of hotel room charges, were paid entirely to the Court of Tax Appeals are binding on this Court and
hotel concerned, without any portion thereof being absent strong reasons for this Court to delve into facts,
diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25; only questions of law are open for determination. (Nilsen
t.s.n., Aug. 20, 1981, pp. 5-9, 17-18). The testimony of v. Commissioner of Customs, 89 SCRA 43 [1979]; Balbas v.
Serafina Sazon was corroborated by Gerardo Isada, Domingo, 21 SCRA 444 [1967]; Raymundo v. De Joya, 101
General Manager of petitioner, declaring to the effect SCRA 495 [1980]). In the recent case of Sy Po v. Court of
that payments of hotel accommodation are made
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 Oct. 1976 P 71,134.80
supported by substantial evidence. Nov. 1976 409,019.17
Dec. 1976 142,761.55
In the instant case, we find no reason to disregard and —————
deviate from the findings of facts of the Court of Tax 622,915.51
Appeals. —————
Grand Total P 904,995.29
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 It is not true therefore, as stated by respondent, that there
customers. The respondent differentiated between the is no evidence proving the amounts earmarked for hotel
package fee — offered by both the local travel agency room charges. Since the BIR examiners could not have
and its correspondent counterpart tourist agencies manufactured the above figures representing "advances
abroad and the requests made by some tour agencies for hotel room accommodations," these payments must
abroad to local tour agencies wherein the hotel room have certainly been taken from the records of petitioner,
charges in some specific cases, would be paid to the such as the invoices, hotel bills, official receipts and other
local hotels through them. In the latter case, the pertinent documents. (Rollo, pp. 48-49)
correspondent court found as a fact ". . . that the foreign
tour agency entrusts to the petitioner Tours Specialists, The factual findings of the respondent court are
Inc. the fund for hotel room accommodation, which in supported by substantial evidence, hence binding upon
turn is paid by petitioner tour agency to the local hotel this Court.
when billed." (Rollo, p. 42) The following procedure is
followed: The billing hotel sends the bill to the respondent; With these clarifications, the issue to be threshed out is as
the local hotel then identifies the individual tourist, or the stated by the respondent court, to wit:
particular group of tourist by code name or group
designation plus the duration of their stay for purposes of
. . . [W]hether or not the hotel room charges held in trust
payment; upon receipt of the bill the private respondent
for foreign tourists and travelers and/or correspondent
pays the local hotel with the funds entrusted to it by the
foreign travel agencies and paid to local host hotels form
foreign tour correspondent agency.
part of the taxable gross receipts for purposes of the 3%
contractor's tax. (Rollo, p. 45)
Moreover, evidence presented by the private respondent
shows that the amounts entrusted to it by the foreign
The petitioner opines that the gross receipts which are
tourist agencies to pay the room charges of foreign
subject to the 3% contractor's tax pursuant to Section 191
tourists in local hotels were not diverted to its funds; this
(Section 205 of the National Internal Revenue Code of
arrangement was only an act of accommodation on the
1977) of the Tax Code include the entire gross receipts of
part of the private respondent. This evidence was not
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
In essence, the petitioner's assertion that the hotel room (implementing Section 191 of the Tax Code) which states
charges entrusted to the private respondent were part of that the 3% contractor's tax prescribed by Section 191 of
the package fee paid by foreign tourists to the the Tax Code is imposed of the gross receipts of the
respondent is not correct. The evidence is clear to the contractor, "no deduction whatever being allowed by
effect that the amounts entrusted to the private said law." The petitioner contends that the only exception
respondent were exclusively for payment of hotel room to this rule is when there is a law or regulation which
charges of foreign tourists entrusted to it by foreign travel would exempt such gross receipts from being subjected
agencies. to the 3% contractor's tax citing the case of Commissioner
of Internal Revenue v. Manila Jockey Club, Inc. (108 Phil.
As regards the petitioner's second assumption, the 821 [1960]). Thus, the petitioner argues that since there is
respondent court stated: no law or regulation that money entrusted, earmarked
and paid for hotel room charges should not form part of
. . . [C]ontrary to the contention of respondent, the the gross receipts, then the said hotel room charges are
records show, firstly, in the Examiners' Worksheet (Exh. T, p. included in the private respondent's gross receipts for
22, BIR Rec.), that from July to December 1976 alone, the purposes of the 3% contractor's tax.
following sums made up the hotel room
accommodations: In the case of Commissioner of Internal Revenue
v. Manila Jockey Club, Inc. (supra), the Commissioner
July 1976 P 102,702.97 appealed two decisions of the Court of Tax Appeals
Aug. 1976 121,167.19 disapproving his levy of amusement taxes upon the
Sept. 1976 53,209.61 Manila Jockey Club, a duly constituted corporation
————— authorized to hold horse races in Manila. The facts of the
P 282,079.77 case show that the monies sought to be taxed never
really belonged to the club. The decision shows that admittedly 5% out of that 12-1/2% commission. As it did
during the period November 1946 to 1950, the Manila not at that time contemplate the application of "gross
Jockey Club paid amusement tax on its commission but receipts" revenue principle, the law in making a
without including the 5-1/2% which pursuant to Executive distribution of the total wager funds, took no trouble of
Order 320 and Republic Act 309 went to the Board of separating one item from the other; and for
Races, the owner of horses and jockeys. Section 260 of convenience, grouped three items under one common
the Internal Revenue Code provides that the amusement denomination.
tax was payable by the operator on its "gross receipts".
The Manila Jockey Club, however, did not consider as Needless to say, gross receipts of the proprietor of the
part of its "gross receipts" subject to amusement tax the amusement place should not include any money which
amounts which it had to deliver to the Board on Races, although delivered to the amusement place has been
the horse owners and the jockeys. This view was fully especially earmarked by law or regulation for some
sustained by three opinions of the Secretary of Justice, to person other than the proprietor. (The situation thus differs
wit: from one in which the owner of the amusement place, by
a private contract, with its employees or partners, agrees
There is no question that the Manila Jockey, Inc., owns to reserve for them a portion of the proceeds of the
only 7-1/2% of the total bets registered by the Totalizer. establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55
This portion represents its share or commission in the total Off. Gaz. [51] 10539; Sy Chuico v. Coll., 107 Phil., 428; 59
amount of money it handles and goes to the funds Off. Gaz., [6] 896).
thereof as its own property which it may legally disburse
for its own purposes. The 5% does not belong to the club. In the second case, the facts of the case are:
It is merely held in trust for distribution as prizes to the
owners of winning horses. It is destined for no other object
The Manila Jockey Club holds once a year a so called
than the payment of prizes and the club cannot
"special Novato race", wherein only "novato" horses, (i.e.
otherwise appropriate this portion without incurring
horses which are running for the first time in an official [of
liability to the owners of winning horses. It cannot be
the club] race), may take part. Owners of these horses
considered as an item of expense because the sum used
must pay to the Club an inscription fee of P1.00, and a
for the payment of prizes is not taken from the funds of
declaration fee of P1.00 per horse. In addition, each of
the club but from a certain portion of the total bets
them must contribute to a common fund (P10.00 per
especially earmarked for that purpose.
horse). The Club contributes an equal amount P10.00 per
horse) to such common fund, the total amount of which is
In view of all the foregoing, I am of the opinion that in the added to the 5% participation of horse owners already
submission of the returns for the amusement tax of 10% described herein-above in the first case.
(now it is 20% of the "gross receipts", provided for in
Section 260 of the National Internal Revenue Code), the
Since the institution of this yearly special novato race in
5% of the total bets that is set aside for prizes to owners of
1950, the Manila Jockey Club never paid amusement tax
winning horses should not be included by the Manila
on the moneys thus contributed by horse owners (P10.00
Jockey Club, Inc.
each) because it entertained the belief that in
accordance with the three opinions of the Secretary of
The Collector of the Internal Revenue, however had a Justice herein-above described, such contributions never
different opinion on the matter and demanded payment formed part of its gross receipts. On the inscription fee of
of amusement taxes. The Court of Tax Appeals reversed the P1.00 per horse, it paid the tax. It did not on the
the Collector. declaration fee of P1.00 because it was imposed by the
Municipal Ordinance of Manila and was turned over to
We affirmed the decision of the Court of Tax Appeals and the City officers.
The Collector of Internal Revenue required the Manila
The Secretary's opinion was correct. The Government Jockey Club to pay amusement tax on such contributed
could not have meant to tax as gross receipt of the fund P10.00 per horse in the special novato race, holding
Manila Jockey Club the 1/2% which it directs same Club they were part of its gross receipts. The Manila Jockey
to turn over to the Board on Races. The latter being a Club protested and resorted to the Court of Tax Appeals,
Government institution, there would be double taxation, where it obtained favorable judgment on the same
which should be avoided unless the statute admits of no grounds sustained by said Court in connection with the
other interpretation. In the same manner, the 5% of the total wager funds in the herein-mentioned first
Government could not have intended to consider as case; they were not receipts of the Club.
gross receipt the portion of the funds which it directed
the Club to give, or knew the Club would give, to winning We resolved the issue in the following manner:
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
We think the reasons for upholding the Tax Court's
aside as the "commission" of the race track owner, but
decision in the first case apply to this one. The ten-peso
the law itself takes official notice, and actually approves
contribution never belonged to the Club. It was held by it
or directs payment of the portion that goes to owners of
as a trust fund. And then, after all, when it received the
horses as prizes and bonuses of jockeys, which portion is
ten-peso contribution, it at the same time contributed ten
pesos out of its own pocket, and thereafter distributed someone else. (Pollock v. Farmers, L & T Co., 1957 US 429,
both amounts as prizes to horse owners. It would seem 15 S. Ct. 673, 39 Law. ed. 759). The contractor's tax is of
unreasonable to regard the ten-peso contribution of the course payable by the contractor but in the last analysis it
horse owners as taxable receipt of the Club, since the is the owner of the building that shoulders the burden of
latter, at the same moment it received the contribution the tax because the same is shifted by the contractor to
necessarily lost ten pesos too. the owner as a matter of self-preservation. Thus, it is an
indirect tax. And it is an indirect tax on the WHO because,
As demonstrated in the above-mentioned case, gross although it is payable by the petitioner, the latter can shift
receipts subject to tax under the Tax Code do not include its burden on the WHO. In the last analysis it is the WHO
monies or receipts entrusted to the taxpayer which do that will pay the tax indirectly through the contractor and
not belong to them and do not redound to the taxpayer's it certainly cannot be said that 'this tax has no bearing
benefit; and it is not necessary that there must be a law upon the World Health Organization.'"
or regulation which would exempt such monies and
receipts within the meaning of gross receipts under the Petitioner claims that under the authority of the Philippine
Tax Code. Acetylene Company versus Commissioner of Internal
Revenue, et al., (127 Phil. 461) the 3% contractor's tax falls
Parenthetically, the room charges entrusted by the directly on Gotamco and cannot be shifted to the WHO.
foreign travel agencies to the private respondent do not The Court of Tax Appeals, however, held that the said
form part of its gross receipts within the definition of the case is not controlling in this case, since the Host
Tax Code. The said receipts never belonged to the Agreement specifically exempts the WHO from "indirect
private respondent. The private respondent never taxes." We agree. The Philippine Acetylene case involved
benefited from their payment to the local hotels. As a tax on sales of goods which under the law had to be
stated earlier, this arrangement was only to paid by the manufacturer or producer; the fact that the
accommodate the foreign travel agencies. 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
Another objection raised by the petitioner is to the
the sales tax must be paid by the manufacturer or
respondent court's application of Presidential Decree 31
producer even if the sale is made to tax-exempt entities
which exempts foreign tourists from payment of hotel
like the National Power Corporation, an agency of the
room tax. Section 1 thereof provides:
Philippine Government, and to the Voice of America, an
agency of the United States Government.
Sec. 1. — Foreign tourists and travelers shall be exempt
from payment of any and all hotel room tax for the entire
The Host Agreement, in specifically exempting the WHO
period of their stay in the country.
from "indirect taxes," contemplates taxes which, although
not imposed upon or paid by the Organization directly,
The petitioner now alleges that P.D. 31 has no relevance form part of the price paid or to be paid by it.
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
Accordingly, the significance of P.D. 31 is clearly
a tax on the exercise of the privilege to engage in
established in determining whether or not hotel room
business as a contractor and that it is imposed on, and
charges of foreign tourists in local hotels are subject to
collectible from the person exercising the privilege. He
the 3% contractor's tax. As the respondent court aptly
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) . . . 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
The same arguments were submitted by the
indirectly what P.D. 31 would not like hotel room charges
Commissioner of Internal Revenue in the case
of foreign tourists to be subjected to hotel room tax.
of Commissioner of Internal Revenue v. John Gotamco &
Although, respondent may claim that the 3% contractor's
Son., Inc. (148 SCRA 36 [1987]), to justify his imposition of
tax is imposed upon a different incidence i.e. the gross
the 3% contractor's tax under Section 191 of the National
receipts of petitioner tourist agency which he asserts
Internal Revenue Code on the gross receipts John
includes the hotel room charges entrusted to it, the effect
Gotamco & Sons, Inc., realized from the construction of
would be to impose a tax, and though different, it
the World Health Organization (WHO) office building in
nonetheless imposes a tax actually on room charges.
Manila. We rejected the petitioner's arguments and ruled:
One way or the other, it would not have the effect of
promoting tourism in the Philippines as that would
We agree with the Court of Tax Appeals in rejecting this increase the costs or expenses by the addition of a hotel
contention of the petitioner. Said the respondent court: room tax in the overall expenses of said tourists. (Rollo, pp.
"In context, direct taxes are those that are demanded
from the very person who, it is intended or desired, should WHEREFORE, the instant petition is DENIED. The decision of
pay them; while indirect taxes are those that are the Court of Tax Appeals is AFFIRMED. No
demanded in the first instance from one person in the pronouncement as to costs.
expectation and intention that he can shift the burden to
SO ORDERED. 7. The objection that this construction would lead to an
absurdity not contemplated by Congress if the employer
were called upon to pay the tax on the additional
income and a further tax on that payment, and so on, will
Old Colony Trust Co. v. Commissioner of Internal Revenue not he considered, no attempt having been made by the
Treasury to collect further taxes upon the theory that
payment of additional taxes creates further income.
279 U.S. 716
P. 279 U. S. 730.

CERTIFICATE FROM CIRCUIT COURT OF APPEALS Response to a question of law certified by the circuit
court of appeals, arising upon review of a decision of the
FOR THE FIRST CIRCUIT Board of Tax Appeals approving a finding by the
Commissioner of Internal Revenue of deficiencies in
Syllabus income tax returns. See 7 B.T.A. 648. This case was
reargued and decided with the one next following. *
1. A proceeding before the circuit court of appeals,
under Revenue Act of 1926, §§ 283(b), 1001 et seq., in MR. CHIEF JUSTICE TAFT delivered the opinion of the
which a taxpayer sought review of a decision of the Court.
Board of Tax Appeals finding a deficiency in his income
tax return, held to present a " case or controversy " We have before us for consideration two questions
cognizable by that court under the judicial article of the certified from the same circuit court of appeals, No. 130
Constitution. Pp. 279 U. S. 722 et seq. and No. 129. They are presented upon different
statements of facts, and the cases reach the certifying
2. A proceeding begun by an administrative or executive court in different ways, but the questions are so nearly
determination may be a "case or controversy" when it alike that the certifying judges deemed it convenient to
comes on review before a court if it calls for the exercise present them in consolidated form. We prefer to separate
of judicial power only; nor is it essential that there should the questions, discuss and decide No. 130 first, and then
be power to award execution where the final judgment consider No. 129.
establishes a duty of an executive department and is
enforceable through action of the department. P. 279 U. No. 130 comes here by certificate from the Circuit Court
S. 722. of Appeals for the First Circuit. The action in that court
was begun by a petition to review a decision of the
3. Under §§ 1001-1005 of the Revenue Act of 1926, the United States Board of Tax Appeals. The petitioners are
courts authorized to review decisions of the Board of Tax the executors of the will of William M. Wood, deceased.
Appeals have power to award execution of their final On June 27, 1925, before Mr. Wood's death, the
judgments. P. 279 U. S. 726. Commissioner of Internal Revenue notified him by
registered mail of the determination of a deficiency in
4. Assuming that, under § 283(b) of the Revenue Act of income tax against him for the years 1919 and 1920,
1926, a taxpayer whose appeal to the Board of Tax under the Revenue Act of 1918 (40 Stat. 1057). The
Appeals was taken before the date of that Act and deficiency was revised by the Commissioner August 18,
decided adversely to him after it may resort both to the 1925. An appeal was taken to the Board of Tax Appeals,
circuit court of appeals by way of review and to the which was filed October 27, 1925. A hearing before the
district court by way of an action to recover the tax Board, April 11, 1927, resulted in a decision November 12,
(having first paid it), this does not prevent the circuit court 1927. The Board approved the action of the
of appeals, being a constitutional court, from having Commissioner, and found a deficiency in the federal
jurisdiction under the Act, since, on the principle of res income tax return of Mr. Wood for the year 1919 of
judicata, if both remedies were pursued, the judgment $708,781.93, and for the year 1920 of $350,837.14. The
first in time would be a final adjudication conclusive on petition for review was perfected December 23, 1927,
both courts. P. 279 U. S. 727. pursuant to the Revenue Act of 1926, § 283(j), and §§
1001 to 1005, c. 27, 44 Stat. 9, 65, 109, and Rule 38 of the
First Circuit Court of Appeals.
5. A certificate by the circuit court of appeals of a
question of law involved in a review of a decision of the
Board of Tax Appeals held within the appellate The facts certified to us are substantially as follows:
jurisdiction of this Court under the Constitution. P. 279 U. S.
728. William M. Wood was president of the American Woolen
Company during the years 1918, 1919, and 1920. In 1918
6. Payment by an employer of the income taxes he received as salary and commissions from the
assessable against the compensation of an employee, company $978,725, which he included in his federal
made in consideration of his services, constitutes income tax return for 1918. In 1919, he received as salary
additional taxable income of the employee under the and commissions from the company $548,132.87, which
Revenue Act of 1918. P. 279 U. S. 729. he included in his return for 1919.
August 3, 1916, the American Woolen Company had created by Congress to provide taxpayers an opportunity
adopted the following resolution, which was in effect in to secure an independent review of the Commissioner of
1919 and 1920: Internal Revenue's determination of additional income
and estate taxes by the Board in advance of their paying
"Voted: That this company pay any and all income taxes, the tax found by the Commissioner to be due. Before the
state and Federal, that may hereafter become due and Act of 1924, the taxpayer could only contest the
payable upon the salaries of all the officers of the Commissioner's determination of the amount of the tax
company, including the president, William M. Wood; the after its payment. The Board's duty under the Act of 1924
comptroller, Parry C. Wiggin; the auditor, George was to hear, consider, and decide whether deficiencies
R.Lawton, and the following members of the staff, to-wit: reported by the Commissioner were right.
Frank H. Carpenter, Edwin L. Heath, Samuel R. Haines,
and William M. Lasbury, to the end that said persons and Section 273 of that Act defined a "deficiency" to be the
officers shall receive their salaries or other compensation amount by which the tax imposed exceeded the amount
in full without deduction on account of income taxes, shown by the return of the taxpayer after the return was
state or federal, which taxes are to be paid out of the increased by the amounts previously assessed or
treasury of this corporation." disallowed. There was under the Act of 1924 no direct
judicial review of the proceedings before the Board of
This resolution was amended on March 25, 1918, as Tax Appeals. But each party had the unhindered right to
follows: seek separate action by a court of competent jurisdiction
to test the correctness of the Board's action. Such court
proceedings were to be begun within one year after the
"Voted: That, referring to the vote passed by this board on
final decision of the Board.
August 3, 1916, in reference to income taxes, state and
federal, payable upon the salaries or compensation of
the officers and certain employees of this company, the Section 274(b) provided that, if the Board determined
method of computing said taxes shall be as follows, viz.:" there was a deficiency, the amount so determined
should be assessed and paid upon notice and demand
from the collector. No part of the amount determined as
"The difference between what the total amount of his tax
a deficiency by the Commissioner, but disallowed as a
would be, including his income from all sources, and the
deficiency by the Board, could be assessed, but the
amount of his tax when computed upon his income
Commissioner was at liberty, notwithstanding the decision
excluding such compensation or salaries paid by this
of the Board against him, to bring a suit in a proper court
against the taxpayer to collect the alleged deficiency.

Pursuant to these resolutions, the American Woolen

On the other hand, by § 900(g), it was provided that, in
Company paid to the collector of internal revenue Mr.
any suit brought by the Commissioner, or by the taxpayer
Wood's federal income and surtaxes due to salary and
to recover any amounts paid in pursuance of a decision
commissions paid him by the company, as follows:
of the Board, the findings of the Board were prima
facie evidence of the facts.
Taxes for 1918 paid in 1919 . . . . $681,169 88
By the Revenue Act of 1926, this procedure was
Taxes for 1919 paid in 1920 . . . . 351,179 27 changed, and a direct judicial review of the Board's
decision was substituted.
The decision of the Board of Tax Appeals here sought to
be reviewed was that the income taxes of $681,169.88 The Act of 1926 also enlarged the original jurisdiction of
and $351,179.27 paid by the American Woolen Company the Board of Tax Appeals to consider deficiencies
for Mr. Wood were additional income to him for the years beyond those shown in the Commissioner's notice, if the
1919 and 1920. Commissioner made such a claim at or before the
hearing, § 274(e), and also to determine that the
The question certified by the circuit court of appeals for taxpayer not only did not owe the tax, but had overpaid.
answer by this Court is: Section 284(e).

"Did the payment by the employer of the income taxes The chief change made by the Act of 1926 was the
assessable against the employee constitute additional provision for direct judicial review of the Board's decisions
taxable income to such employee?" by the filing by the Commissioner or the taxpayer of a
petition for review in a circuit court of appeals or the
The first point presented to us is that of the jurisdiction of Court of Appeals of the District of Columbia under rules
this Court to answer the question of law certified. It adopted by such courts.
requires us to examine the original statute providing for
the Board of Tax Appeals under the Revenue Act of 1924, It is suggested that the proceedings before the circuit
and the amending act of 1926. courts of appeals or the district court of appeals on a
petition to review are, and cannot be, judicial, for they
The Board of Tax Appeals, established by § 900 of the involve "no case or controversy," and, without this, a
Revenue Act of 1924, Tit. 9, c. 243, 43 Stat. 253, 336, was circuit court of appeals, which is a constitutional court (Ex
parte Bakelite Corporation, ante, p. 279 U. S. 438) is respecting them shall assume such a form that the
incapable of exercising its judicial function. This view of judicial power is capable of acting on it. That power is
the nature of the proceedings we cannot sustain. capable of acting only when the subject is submitted to it
by a party who asserts his rights in the form prescribed by
The case is analogous to the suits which are lodged in the law. It then becomes a case, and the Constitution
circuit courts of appeals upon petition or finding of an declares that the judicial power shall extend to all cases
executive or administrative tribunal. It is not important arising under the Constitution, laws, and treaties of the
whether such a proceeding was originally begun by an United States."
administrative or executive determination if, when it
comes to the court, whether legislative or constitutional, it The circuit court of appeals is a constitutional court under
calls for the exercise of only the judicial power of the the definition of such courts as given in
court upon which jurisdiction has been conferred by law. the Bakelite case, supra,and a case or controversy may
come before it provided it involves neither advisory nor
The jurisdiction in this cause is quite like that of circuit executive action by it.
courts of appeals in review of orders of the Federal Trade
Commission. Federal Trade Commission v. Eastman Kodak In the case we have here, there are adverse parties. The
Co., 274 U. S. 619, 274 U. S. 623; Silver Co. v. Federal Trade United States or its authorized official asserts its right to the
Commission, 292 F. 752. There are other instances of a like the payment by a taxpayer of a tax due from him to the
kind which can be cited. United States v. Ritchie, 17 How. government, and the taxpayer is resisting that payment
525, 58 U. S. 534; Interstate Commerce Commission v. or is seeking to recover what he has already paid as taxes
Brimson, 154 U. S. 447, 154 U. S. 469; Stephens v. Cherokee when by law they were not properly due. That makes a
Nation, 174 U. S. 445, 174 U. S. 477. See also Fong Yue Ting case or controversy, and the proper disposition of it is the
v. United States, 149 U. S. 698, 149 U. S. 714. exercise of judicial power. The courts are either the circuit
court of appeals or the District of Columbia Court of
It is not necessary that the proceeding, to be judicial, Appeals. The subject matter of the controversy is the
should be one entirely de novo. It is enough that, before amount of the tax claimed to be due or refundable and
the judgment, which must be final, has been invoked as its validity, and the judgment to be rendered is a judicial
an exercise of judicial power, it shall have certain judgment.
necessary features. What these are has been often
declared by this Court. Perhaps the most comprehensive The Board of Tax Appeals is not a court. It is an executive
definitions of them are set forth in Muskrat v. United or administrative board, upon the decision of which the
States, 219 U. S. 346, 219 U. S. 356, where this Court parties are given an opportunity to base a petition for
entered into the inquiry what was the exercise of judicial review to the courts after the administrative inquiry of the
power as conferred by the Constitution. There was cited Board has been had and decided.
there a definition by Mr. Justice Field in Re Pacific Railway
Commission, 32 F. 241, 255, which has been generally It is next suggested that there is no adequate finality
accepted as accurate. He said: provided in respect to the action of these courts. In the
first place, it is not necessary, in order to constitute a
"The judicial article of the Constitution mentions cases judicial judgment, that there should be both a
and controversies. The term 'controversies,' if determination of the rights of the litigants and also power
distinguishable at all from 'cases,' is so in that it is less to issue formal execution to carry the judgment into
comprehensive than the latter, and includes only suits of effect in the way that judgments for money or for the
a civil nature. Chisholm v. Georgia, 2 Dall. 431, 2 U. S. 432; possession of land usually are enforced. A judgment is
1 Tuck.Bl. Comm.App. 420, 421. By cases and sometimes regarded as properly enforceable through the
controversies are intended the claims of litigants brought executive departments, instead of through an award of
before the courts for determination by such regular execution by this Court, where the effect of the judgment
proceedings as are established by law or custom for the is to establish the duty of the department to enforce it. La
protection or enforcement of rights or the prevention, Abra Silver Mining Co. v. United States, 175 U. S. 423, 175
redress, or punishment of wrongs. Whenever the claim of U. S. 457, 175 U. S. 461. The case of Fidelity National Bank
a party under the Constitution, laws, or treaties of the & Trust Co. v. Swope, 274 U. S. 123, 274 U. S. 132, shows
United States takes such a form that the judicial power is clearly that there are instances where the award of
capable of acting upon it, then it has become a case. execution is not an indispensable element of a
The term implies the existence of present or possible constitutional case or controversy. In that decision there
adverse parties whose contentions are submitted to the are collected familiar examples of judicial proceedings
court for adjudication." resulting in a final adjudication of the rights of litigants
without it.
In Osborn v. United States Bank, 9 Wheat. 738, Chief
Justice Marshall construed Article III of the Constitution as But, even if a formal execution be required, we think
follows: power to resort to it is clearly shown with respect to the
enforcement of the action of the courts here involved by
"This clause enables the judicial department to receive §§ 1001 to 1005.
jurisdiction to the full extent of the constitution, laws and
treaties of the United States when any question
By the first, the decision of the Board of Tax Appeals enactment of this Act, the Board shall have jurisdiction of
rendered after the passage of the Act of 1926 may be the appeal. In all such cases, the powers, duties, rights,
reviewed by the circuit court of appeals or the district and privileges of the Commissioner and of the person
court of appeals if a petition for such review is filed either who has brought the appeal, and the jurisdiction of the
by the Commissioner or the taxpayer within six months Board and of the courts, shall be determined, and the
after the decision is rendered. The courts are to adopt computation of the tax shall be made, in the same
rules for the filing of the petition, the preparation of the manner as provided in subdivision (a) of this section,
record, and the conduct of the proceedings upon such except as provided in subdivision (j) of this section and
review. The review is not to operate as a stay of except that the person liable for the tax shall not be
assessment or collection of any portion of the amount of subject to the provisions of subdivision (d) of Section 284."
the deficiency determined by the Board unless a petition
for review is filed by the taxpayer, or unless the taxpayer The provisions of § 284(d) are those which deny to the
has filed a bond which when enforced will operate finally taxpayer the power to bring any suit for the recovery of
to settle the rights of the parties as found by the courts. the tax after he has adopted the procedure of appealing
to the Board of Tax Appeals or to the circuit court of
By § 1002, it is provided in what venue the decision may appeals.
be reviewed. In § 1003, the circuit courts of appeals and
the court of appeals of the district are given exclusive By this last exception in 283(b), there seems still open to
jurisdiction to review the decisions of the Board, and it is the taxpayers who have filed a petition under the law of
declared that their judgments shall be final, except that 1924 and have not had a decision by the Board before
they shall be subject to review by the Supreme Court of the enactment of the law of 1926, the right to pay the tax
the United States, on certificate or by certiorari in the and sue for a refund in the proper district court
manner provided in § 240 of the Judicial Code as (paragraph 20 of § 24 of the Judicial Code, as amended
amended, and, in such review, the courts shall have the by § 1310(c), c. 136, 42 Stat. 311, U.S.Code, Title 28, §
power to affirm, or, if the decision of the Board is not in 41). Emery v. United States, 27 F.2d 992, and Old Colony
accordance with law, to modify or reverse, the decision R. Co. v. United States, 27 F.2d 994, hold that the
of the Board, with or without remanding the case for a petitioner still retains this earlier remedy.
rehearing, as justice may require.
The truth seems to be that, in making provision to render
By § 1004, the same courts are given power to impose conclusive judgments on petitions for review in the circuit
damages in any case where the decision of the Board is courts of appeals, Congress was not willing, in cases
affirmed and it appears that the petition was filed merely where the Board of Tax Appeals had not decided the
for delay. issue before the passage of the Act of 1926, to cut off the
taxpayer from paying the tax and suing for a refund in
By § 1005, the decision of the Board is to become final in the proper district court. But the apparent conflict in such
respect to all the numerous instances which in the course cases can be easily resolved by the use of the principles
of the review may naturally end further litigation. In the of res judicata. If both remedies are pursued, the one in a
provisions of these sections, the legislation prescribes district court for refund and the other on a petition for
minute details for the enforcement of the judgments that review in the circuit court of appeals, the judgment which
are the result of these petitions for review in the several is first rendered will then put an end to the questions
courts vested with jurisdiction over them. involved, and in effect make all proceedings in the other
court of no avail. Whichever judgment is first in time is
The complete purpose of Congress to provide a final necessarily final to the extent to which it becomes a
adjudication in such proceedings, binding all the parties, judgment. There is no reason, therefore, in the case
is manifest, and demonstrates the unsoundness of the before us to decline to take jurisdiction. See Bryar v.
objection. Campbell, 177 U. S. 649; Kline v. Burke Construction
Co., 260 U. S. 226, 260 U. S. 230; Stanton v. Embry, 93 U. S.
548, 93 U. S. 554.
We have before us, however, for actual inquiry a case
different from one just considered in the regular course of
a petition for review of a decision of the Board begun Second. The jurisdiction here is based upon the certificate
and decided all after the enactment of the Act of 1926. It of a question of law. That is whether the payment by the
is one in which the appeal to the Board of Tax Appeals employer of the income taxes assessed against the
had been taken, but the appeal had not been decided employee constitutes additional returnable taxable
by the Board before the passage of the Act of 1926. That income to such employee. The certification of such a
presents what involves a troublesome exception or question by the circuit court of appeals is an invocation
duplication in the procedure. This occurs because of the of the appellate jurisdiction of this Court, and therefore
last excepting clause of § 283(b) of the amending act of within the Constitution.
1926, which is as follows:
Third. Coming now to the merits of this case, we think the
"If, before the enactment of this Act, any person has question presented is whether a taxpayer, having
appealed to the Board of Tax Appeals under subdivision induced a third person to pay his income tax or having
(a) of Section 274 of the Revenue Act of 1924 . . . and the acquiesced in such payment as made in discharge of an
appeal is pending before the Board at the time of the obligation to him, may avoid the making of a return
thereof and the payment of a corresponding tax. We logical conclusion, and results in an absurdity which
think he may not do so. The payment of the tax by the Congress could not have contemplated.
employers was in consideration of the services rendered
by the employee, and was again derived by the In the first place, no attempt has been made by the
employee from his labor. The form of the payment is Treasury to collect further taxes upon the theory that the
expressly declared to make no difference. Section 213, payment of the additional taxes creates further income,
Revenue Act of 1918, c. 18, 40 Stat. 1065. It is therefore and the question of a tax upon a tax was not before the
immaterial that the taxes were directly paid over to the circuit court of appeals, and has not been certified to this
government. The discharge by a third person of an Court. We can settle questions of that sort when an
obligation to him is equivalent to receipt by the person attempt to impose a tax upon a tax is undertaken, but
taxed. The certificate shows that the taxes were imposed not now. United States v. Sullivan, 274 U. S. 259, 274 U. S.
upon the employee, that the taxes were actually paid by 264; Yazoo & Mississippi Valley R. Co. v. Jackson Vinegar
the employer, and that the employee entered upon his Co., 226 U. S. 217, 226 U. S. 219. It is not, therefore,
duties in the years in question under the express necessary to answer the argument based upon an
agreement that his income taxes would be paid by his algebraic formula to reach the amount of taxes due. The
employer. This is evidenced by the terms of the resolution question in this case is, "Did the payment by the employer
passed August 3, 1916, more than one year prior to the of the income taxes assessable against the employee
year in which the taxes were imposed. The taxes were constitute additional taxable income to such employee?"
paid upon a valuable consideration -- namely, the The answer must be "Yes."
services rendered by the employee and as part of the
compensation therefor. We think, therefore, that the
* After the first argument, the Court, on February 18, 1929,
payment constituted income to the employee.
made the following order:

This result is sustained by many decisions. Providence &

"It is ordered that the above cause be restored to the
Worcester R. Co., 5 B.T.A. 1186; Houston Belt & Terminal
docket for reargument. The Court especially desires
Ry. Co. v. Commissioner, 6 B.T.A. 1364; West End Street
assistance of counsel in respect of the following matters:"
Railway Co. v. Malley, 246 F. 625; Renesselaer & S. R. Co.
v. Irwin, 249 F. 726;Northern R. Co. of New Jersey v.
Lowe, 250 F. 856; Houston Belt & Terminal Ry. Co. v. United "1. Was there power in Congress to confer jurisdiction
States, 250 F. 1; Blalock v. Georgia Ry. & Electric Co., 246 upon the Circuit Court of Appeals to review action by the
F. 387; Hamilton v. Kentucky & Indiana Terminal R. Board of Tax Appeals?"
Co., 289 F. 20; American Telegraph & Cable Co. v. United
States, 61 Ct.Cls. 326; United States v. Western Union "2. Does the Circuit Court of Appeals act as a tribunal of
Telegraph Co., 19 F.2d 157; Estate of Levalley, 191 Wis. original jurisdiction when considering appeals from the
356; Estate of Irwin, 196 Cal. 366. Board of Tax Appeals? If so, may it, under Title 28, United
States Code, sec. 346, certify to this Court questions
Nor can it be argued that the payment of the tax in No. deemed necessary for the proper decision of a pending
130 was a gift. The payment for services, even though cause?"
entirely voluntary, was nevertheless compensation within
the statute. This is shown by the case of Noel v. Parrott, 15 "3. What has been the practice of taxing officers relative
F.2d 669. There, it was resolved that a gratuitous to assessments where, by agreement between the
appropriation equal in amount to $3 per share on the parties, the tax laid upon the income actually received
outstanding stock of the company be set aside out of the by one of them has been paid by another?"
assets for distribution to certain officers and employees of
the company, and that the executive committee be "4. Do applicable statutes authorize the taxing officers to
authorized to make such distribution as they deemed estimate total income by adding to the amount actually
wise and proper. The executive committee gave $35,000 received by the taxpayer any tax which another has paid
to be paid to the plaintiff taxpayer. The court said (p. thereon under agreement between the parties?"
"It is suggested that counsel apply to the court below for
"In no view of the evidence therefore can the $35,000 be an amendment, so that the certificate will show distinctly
regarded as a gift. It was either compensation for services when the original assessments were made, and under
rendered or a gain or profit derived from the sale of the what acts. Also when the appeals were taken to the
stock of the corporation, or both, and, in any view, it was Board of Tax appeals; when they were decided, and
taxable as income." when the appeals to the circuit Court of Appeals were
It is next argued against the payment of this tax that, if
these payments by the employer constitute income to
the employee, the employee will be called upon to pay
the tax imposed upon this additional income, and that
the payment of the additional tax will create further North American Oil Consolidated v. Burnet
income which will in turn be subject to tax, with the result
that there would be a tax upon a tax. This, it is urged, is 286 U.S. 417
the result of the government's theory, when carried to its
CERTIORARI TO THE CIRCUIT COURT OF APPEALS had not been included in its original return of income for
1916; but it was included in an amended return for that
FOR THE NINTH CIRCUIT year which was filed in 1918. Upon auditing the
company's income and profits tax returns for 1917, the
Commissioner of Internal Revenue determined a
deficiency based on other items. The company
appealed to the Board of Tax Appeals. There, in 1927, the
1. Section 13(c) of the Revenue Act of 1916, obliging Commissioner prayed that the deficiency already
receivers "operating the property and business of claimed should be increased so as to include a tax on
corporations" to make returns of net income "as and for the amount paid by the receiver to the company in 1917.
such corporations," applied only where a receiver was in The Board held that the profits were taxable to the
complete control of the entire properties and business of receiver as income of 1916, and hence made no finding
the corporation; otherwise, the return must be made by whether the company's accounts were kept on the cash
the corporation. P. 286 U. S. 422. receipts and disbursements basis or on the accrual basis.
12 B.T.A. 68. The Circuit Court of Appeals held that the
2. Part of an operating property was taken over by a profits were taxable to the company as income of 1917,
receiver in a suit challenging the owner's title. Held, that regardless of whether the company's returns were made
the owner need not report income as of the year when it on the cash or on the accrual basis. 50 F.2d 752. This
was collected by the receiver, while the right to it was in Court granted a writ of certiorari. 284 U.S. 614.
doubt, but must report it as income of the year when the
amount collected was paid over to him and the bill It is conceded that the net profits earned by the property
dismissed. P. 286 U. S. 423. during the receivership constituted income. The
company contends that they should have been reported
3. The fact that appeals from the decree were not by the receiver for taxation in 1916; that, if not returnable
determined in his favor until a later year did not defer the by him, they should have been returned by the company
time for returning the income. P. 286 U. S. 424. for 1916, because they constitute income of the
company accrued in that year, and that, if not taxable
50 F.2d 52 affirmed. as income of the company for 1916, they were taxable to
it as income for 1922, since the litigation was not finally
terminated in its favor until 1922.
Certiorari, 284 U.S. 614, to review a judgment reversing a
decision of the Board of Tax Appeals, 12 B.T.A. 68.
First. The income earned in 1916 and impounded by the
receiver in that year was not taxable to him, because he
MR. JUSTICE BRANDEIS delivered the opinion of the Court. was the receiver of only a part of the properties operated
by the company. Under § 13(c) of the Revenue Act of
The question for decision is whether the sum of 1916, * receivers who "are operating the property or
$171,979.22, received by the North American Oil business of corporations" were obliged to make returns "of
Consolidated in 1917, was taxable to it as income of that net income as and for such corporations," and "any
year. income tax due" was to be "assessed and collected in
the same manner as if assessed directly against the
The money was paid to the company under the following organizations of whose businesses or properties they have
circumstances: among many properties operated by it in custody and control." The phraseology of this section was
1916 was a section of oil land the legal title to which adopted without change in the Revenue Act of 1918, 40
stood in the name of the United States. Prior to that year, Stat. 1057, 1081, c. 18, § 239. The regulations of the
the government, claiming also the beneficial ownership, Treasury Department have consistently construed these
had instituted a suit to oust the company from possession, statutes as applying only to receivers in charge of the
and on February 2, 1916, it secured the appointment of a entire property or business of a corporation, and in all
receiver to operate the property, or supervise its other cases have required the corporations themselves to
operations, and to hold the net income thereof. The report their income. Treas.Regs. 33, arts. 26, 209;
money paid to the company in 1917 represented the net Treas.Regs. 45, Arts. 424, 622. That construction is clearly
profits which had been earned from that property in 1916 correct. The language of the section contemplates a
during the receivership. The money was paid to the substitution of the receiver for the corporation, and there
receiver as earned. After entry by the district court in 1917 can be such substitution only when the receiver is in
of the final decree dismissing the bill, the money was complete control of the properties and business of the
paid, in that year, by the receiver to the corporation. Moreover, there is no provision for the
company. United States v. North American Oil consolidation of the return of a receiver of part of a
Consolidated, 242 F. 723. The government took an corporation's property or business with the return of the
appeal (without supersedeas) to the Circuit Court of corporation itself. It may not be assumed that Congress
Appeals. In 1920, that court affirmed the decree. 264 F. intended to require the filing of two separate returns for
336. In 1922, a further appeal to this Court was dismissed the same year, each covering only a part of the
by stipulation. 258 U.S. 633. corporate income without making provision for
consolidation so that the tax could be based upon the
income as a whole.
The income earned from the property in 1916 had been
entered on the books of the company as its income. It
Second. The net profits were not taxable to the company
as income of 1916. For the company was not required in
1916 to report as income an amount which it might never
receive. See Burnet v. Logan, 283 U. S. 404, 283 U. S.
413. Compare Lucas v. American Code Co., 280 U. S.
445, 280 U. S. 452; Burnet v. Sanford & Brooks Co., 282 U. S.
359, 282 U. S. 363. There was no constructive receipt of
the profits by the company in that year, because at no
time during the year was there a right in the company to
demand that the receiver pay over the money.
Throughout 1916, it was uncertain who would be
declared entitled to the profits. It was not until 1917, when
the district court entered a final decree vacating the
receivership and dismissing the bill, that the company
became entitled to receive the money. Nor is it material,
for the purposes of this case, whether the company's
return was filed on the cash receipts and disbursements
basis, or on the accrual basis. In neither event was it
taxable in 1916 on account of income which it had not
yet received and which it might never receive.

Third. The net profits earned by the property in 1916 were

not income of the year 1922 -- the year in which the
litigation with the government was finally terminated.
They became income of the company in 1917, when it
first became entitled to them and when it actually
received them. If a taxpayer receives earnings under a
claim of right and without restriction as to its disposition,
he has received income which he is required to return,
even though it may still be claimed that he is not entitled
to retain the money, and even though he may still be
adjudged liable to restore its equivalent. See Board v.
Commissioner, 51 F.2d 73, 75, 76. Compare United States
v. S.S. White Dental Mang. Co., 274 U. S. 398, 274 U. S. 403.
If in 1922 the government had prevailed, and the
company had been obliged to refund the profits
received in 1917, it would have been entitled to a
deduction from the profits of 1922, not from those of any
earlier year. Compare Lucas v. American Code Co.,


* Act of September 8, 1916, 39 Stat. 756, 771, c. 463:

"In cases wherein receivers, trustees in bankruptcy, or

assignees are operating the property or business of
corporations . . . subject to tax imposed by this title, such
receivers, trustees, or assignees shall make returns of net
income as and for such corporations . . . in the same
manner and form as such organizations are hereinbefore
required to make returns, and any income tax due on the
basis of such returns made by receivers, trustees, or
assignees shall be assessed and collected in the same
manner as if assessed directly against the organizations of
whose businesses or properties they have custody and
Rutkin v. United States, 343 U.S. 130 (1952) $222,408.32, was due largely to his omission from his
original return of $250,000 received by him in cash from
CERTIORARI TO THE UNITED STATES COURT OF APPEALS Joseph Reinfeld. The United States claims that this sum
was obtained by petitioner by extortion, and, as such,
was taxable income. Petitioner contests both the fact
that the money was obtained by extortion and the
conclusion of law that it was taxable income if so
Syllabus obtained. He contends also that he did not willfully
attempt to evade or defeat the tax. Petitioner was found
1. Money obtained by extortion is income taxable to the guilty by a jury in the United States District Court for the
extortioner under § 22(a) of the Internal Revenue Code. District of New Jersey, fined $10,000 and sentenced to
Pp. 343 U. S. 131-139. four years in prison. The Court of Appeals affirmed, one
judge dissenting. 189 F.2d 431. We granted certiorari, 342
(a) An unlawful gain, as well as a lawful one, constitutes U.S. 808, so as to pass upon the alleged conflict between
taxable income when its recipient has such control over it that decision and the decision in Commissioner v.
that, as a practical matter, he derives readily realizable Wilcox, 327 U. S. 404.
economic value from it. P. 343 U. S. 137.
The facts are unusual, but there can be no doubt that,
2. Under the instructions given the jury in the prosecution under the instructions given the jury, we must regard its
of petitioner for willfully attempting to evade and defeat verdict as reflecting its conclusion that the $250,000 was
federal taxes, the verdict of the jury must be taken as obtained by petitioner by extortion. [Footnote 3] There
reflecting its conclusion that the money in question was was substantial evidence supporting that result. Reinfeld's
obtained by petitioner by extortion, and there was first association with petitioner was in 1929 with several
substantial evidence supporting that result. Pp. 132-137. others in a bootlegging operation known as the "High
seas venture." It was accomplished through the use of a
ship in the sale of whiskey at sea more than 12 miles from
3. The factual issue whether, under all the circumstances, shore. Reinfeld testified that petitioner contributed no
petitioner's omission of the amount in question from his tax money to the enterprise, but was taken in because
return constituted a willful attempt to evade and defeat Reinfeld's associates were afraid that otherwise they
the federal tax is not open to review here, since that issue would get "interference and trouble" from petitioner. His
is settled by the verdict of the jury supported by interest was recognized to be 6% but, when the venture
substantial evidence. Spies v. United States, 317 U. S. 492, was liquidated in 1933, he already was overdrawn, and
applied. P. 343 U. S. 135. no distribution was made to him. Without including
petitioner, the others then organized Browne Vintners Co.,
4. The case of Commissioner v. Wilcox, 327 U. S. 404, is Inc., a New York corporation, to engage in the liquor
limited to its facts. P. 343 U. S. 138. business. In 1936, petitioner, without making an
investment, claimed a 6% interest in Browne Vintners.
5. Congress has power under the Sixteenth Amendment Despite Reinfeld's denial of petitioner's claim, Reinfeld
to tax as income monies received by extortion. Pp. 343 U. paid him $60,000 and took from him an assignment of
S. 138-139. "any and all of such shares of capital stock in the said
Browne Vintners Co. Inc., that I am entitled to." In 1940, all
the Browne Vintners stock was sold for $7,500,000 to a
189 F.2d 431 affirmed.
purchaser, who also assumed $8,000,000 of the
company's debts. The shares of stock when sold stood in
Petitioner was convicted in the Federal District Court the names of, and were transferred by, "nominees" so as
under 26 U.S.C. § 145(b) for willfully attempting to evade to conceal the identity of Reinfeld and the other
or defeat federal taxes. The Court of Appeals affirmed. beneficial owners. A capital gains tax upon the profits
189 F.2d 431. This Court granted certiorari. 342 U.S. from these sales was paid by the respective nominees.
808. Affirmed, p. 343 U. S. 139. [Footnote 4] Petitioner was neither a stockholder of
record nor a beneficial owner of any of the stock of the
MR. JUSTICE BURTON delivered the opinion of the Court. company at any time.

The principal issue before us is whether money obtained In 1941, in response to petitioner's request, Reinfeld gave
by extortion is income taxable to the extortioner under § him about $10,000 to help buy a tavern. When petitioner
22(a) of the Internal Revenue Code. [Footnote 1] For the used the money for other purposes, Reinfeld refused to
reasons hereafter stated, we hold that it is. finance him further, and his "trouble" with petitioner
began. In 1942, petitioner again claimed that he had
The petitioner, Rutkin, was indicted under 26 U.S.C. § had an interest in Browne Vintners Company and that
145(b) [Footnote 2] for willfully attempting to evade and Reinfeld must give him $100,000 to help him pay his debts.
defeat a large part of his income and victory taxes for Upon Reinfeld's refusal, petitioner threatened to kill him.
1943. He was charged with filing a false and fraudulent From that time on, the record presents a lurid story of
return stating his net income to be $18,966.64, whereas he petitioner's unsatisfied demands upon Reinfeld for various
knew that it was $268,622.04. That difference, which sums up to $500,000, petitioner's threatening use of a gun,
would increase his tax liability from $6,843.93 to and his repeated statements that he would kill Reinfeld
and Reinfeld's family unless his demands were met. Such gains are taxable in the yearly period during which
Finally, on May 11, 1943, in New Jersey, Reinfeld paid they are realized. This statutory policy is invoked in the
petitioner $250,000 in cash. [Footnote 5] interest of orderly administration.

Throughout this melodrama, petitioner asserted that he "[C]ollection of the revenue cannot be delayed, nor
was entitled to the payments he demanded from should the Treasury be compelled to decide when a
Reinfeld because of petitioner's alleged former interest in possessor's claims are without legal warrant."
Browne Vinters Company. That interest never was
identified by petitioner. Reinfeld and others testified National City Bank v. Helvering, 98 F.2d 93, 96. There is no
positively that petitioner never had any such interest. adequate reason why assailable unlawful gains should be
Nevertheless, on May 11, Reinfeld handed to petitioner treated differently in this respect from assailable lawful
$250,000 in cash at the same time that Reinfeld paid gains. Certainly there is no reason for treating them more
$358,000 to Zwillman and Stacher representing their leniently. United States v. Sullivan, 274 U. S. 259, 274 U. S.
conceded interest in the proceeds of Browne Vintners 263.
stock. Petitioner, with Zwillman and Stacher, thereupon
signed a "general release." It did not state the amounts
There has been a widespread and settled administrative
paid, but it did purport to release Reinfeld, Browne
and judicial recognition of the taxability of unlawful gains
Vintners Company and others from all claims the signers
of many kinds under § 22(a). [Footnote 8] The application
had against them.
of this section to unlawful gains is obvious from its
legislative history. Section II, subd. B of the Income Tax Act
Under the jury's verdict, we accept the fact to be that of 1913 provided that
petitioner had no basis for his claim to this $250,000, and
that he obtained it by extortion. Accordingly, if proceeds
"the net income of a taxable person shall include gains,
of extortion constitute income taxable to the extortioner,
profits, and income . . . from . . . the transaction of
his omission of it from his tax return was unlawful. The
any lawfulbusiness carried on for gain or profit, or gains or
further factual issue whether, under all the surrounding
profits and income derived from any source whatever. . .
circumstances, petitioner's omission of the $250,000 from
his tax return amounted to a willful attempt to evade and
defeat the tax is not open to review here. That issue is
settled by the verdict of the jury supported by substantial (Emphasis supplied.) 38 Stat. 167. In 1916, this was
evidence. [Footnote 6] It remains for us to determine the amended by omitting the one word "lawful" with the
legal issue of whether money obtained by extortion is obvious intent thereafter to tax unlawful as well as lawful
taxable to the extortioner under § 22(a). gains, profits or income derived from any source
whatever. [Footnote 9]
Under the instructions to the jury, extortion here meant
that the $250,000 was paid to petitioner in response to his There is little doubt now that, where unlawful gains are
false claim thereto, his harassing demands therefor, and secured by the fraud of the taxpayer, they are taxable.
his repeated threats to kill Reinfeld and Reinfeld's family [Footnote 10] In the instant case, it is not questioned that
unless the payment were made. [Footnote 7] Petitioner the $250,000 would have been taxable to petitioner if he
was unable to induce Reinfeld to believe petitioner's false had obtained it by fraudulently inducing Reinfeld to
and fraudulent claims to the money to be true. He believe petitioner's false claims to be true. That being so,
induced Reinfeld to consent to pay the money by it would be an extraordinary result to hold here that
creating a fear in Reinfeld that harm otherwise would petitioner is to be tax free because his fraud was so
come to him and to his family. Reinfeld thereupon transparent that it did not mislead his victim and his victim
delivered his own money to petitioner. Petitioner's control paid him the money because of fear, instead of fraud.
over the cash so received was such that, in the absence
of Reinfeld's unlikely repudiation of the transaction and We do not reach in this case the factual situation
demand for the money's return, petitioner could enjoy its involved in Commissioner v. Wilcox, 327 U. S. 404. We limit
use as fully as though his title to it were unassailable. that case to its facts. There, embezzled funds were held
not to constitute taxable income to the embezzler under
An unlawful gain, as well as a lawful one, constitutes § 22(a). The issue here is whether money extorted from a
taxable income when its recipient has such control over it victim with his consent induced solely by harassing
that, as a practical matter, he derives readily realizable demands and threats of violence is included in the
economic value from it. Burnet v. Wells, 289 U. S. 670, 289 definition of gross income under § 22(a). We think the
U. S. 678; Corliss v. Bowers, 281 U. S. 376, 281 U. S. 378. That power of Congress to tax these receipts as income under
occurs when cash, as here, is delivered by its owner to the Sixteenth Amendment is unquestionable. The broad
the taxpayer in a manner which allows the recipient language of § 22(a) supports the declarations of this
freedom to dispose of it at will, even though it may have Court that Congress, in enacting that section, exercised
been obtained by fraud and his freedom to use it may be its full power to tax income. [Footnote 11] We therefore
assailable by someone with a better title to it. conclude that § 22(a) reaches these receipts.

We have considered the other contentions of petitioner,

but find them without merit sufficient to justify a reversal or
remand of the case.
The judgment of the Court of Appeals accordingly is The Revenue Act of 1918 approved February 24, 1919, c.
18, §§ 210, 211, 212(a), 213(a), 40 Stat. 1057, 1062, 1064,
Affirmed. 1065, imposes a tax upon the net income of every
individual including "income derived from salaries, wages,
or compensation for personal service . . . of whatever kind
Lucas v. Earl, 281 U.S. 111 (1930)
and in whatever form paid," § 213(a). The provisions of
the Revenue Act of 1921, c. 136, 42 Stat. 227, 233, 237,
281 U.S. 111 238, in sections bearing the same numbers are similar to
those of the above. A very forcible argument is presented
CERTIORARI TO THE CIRCUIT COURT OF APPEALS to the effect that the statute seeks to tax only income
beneficially received, and that, taking the question more
FOR THE NINTH CIRCUIT technically, the salary and fees became the joint
property of Earl and his wife on the very first instant on
which they were received. We well might hesitate upon
Syllabus the latter proposition, because, however the matter
might stand between husband and wife, he was the only
Under the Revenue Act of 1918, which taxes the income party to the contracts by which the salary and fees were
of every individual, including "income derived from earned, and it is somewhat hard to say that the last step
salaries, wages, or compensation for personal service . . . in the performance of those contracts could be taken by
of whatever kind and in whatever form paid," the income anyone but himself alone. But this case is not to be
of a husband by way of salary and attorney's fees is decided by attenuated subtleties. It turns on the import
taxable to him notwithstanding that, by a contract and reasonable construction of the taxing act. There is no
between him and his wife, assumed to be valid in doubt that the statute could tax salaries to those who
California where they reside, all their several earnings, earned them, and provide that the tax could not be
including salaries and fees, are to be received, held, and escaped by anticipatory arrangements and contracts,
owned by both as joint tenants. P. 281 U. S. 113. however skillfully devised, to prevent the salary when paid
from vesting even for a second in the man who earned it.
30 F.2d 898 reversed. That seems to us the import of the statute before us, and
we think that no distinction can be taken according to
the motives leading to the arrangement by which the
Certiorari, 280 U.S. 538, to review a judgment of the circuit
fruits are attributed to a different tree from that on which
court of appeals which reversed a decision of the Board
they grew.
of Tax Appeals upholding a tax upon the respondent's
Judgment reversed.
MR. JUSTICE HOLMES delivered the opinion of the Court.

This case presents the question whether the respondent,

Earl, could be taxed for the whole of the salary and
attorney's fees earned by him in the years 1920 and 1921,
or should be taxed for only a half of them in view of a
contract with his wife which we shall mention. The
Commissioner of Internal Revenue and the Board of Tax
Appeals imposed a tax upon the whole, but their
decision was reversed by the circuit court of appeals, 30
F.2d 898. A writ of certiorari was granted by this Court.

By the contract, made in 1901, Earl and his wife agreed

"that any property either of us now has or may hereafter
acquire . . . in any way, either by earnings (including
salaries, fees, etc.), or any rights by contract or otherwise,
during the existence of our marriage, or which we or
either of us may receive by gift, bequest, devise, or
inheritance, and all the proceeds, issues, and profits of
any and all such property shall be treated and
considered, and hereby is declared to be received, held,
taken, and owned by us as joint tenants, and not
otherwise, with the right of survivorship."

The validity of the contract is not questioned, and we

assume it to be unquestionable under the law of the
California, in which the parties lived. Nevertheless we are
of opinion that the Commissioner and Board of Tax
Appeals were right.
Helvering v. Horst, 311 U.S. 112 (1940) certiorari, 309 U.S. 650, because of the importance of the
question in the administration of the revenue laws and
CERTIORARI TO THE CIRCUIT COURT OF APPEALS because of an asserted conflict in principle of the
decision below with that of Lucas v. Earl, 281 U. S. 111,
and with that of decisions by other circuit courts of
appeals. See Bishop v. Commissioner, 54 F.2d 298; Dickey
v. Burnet, 56 F.2d 917, 921; Van Meter v. Commissioner, 61
Syllabus F.2d 817.

1. Where, in 1934 and 1935, an owner of negotiable The court below thought that, as the consideration for the
bonds, who reported income on the cash receipts basis, coupons had passed to the obligor, the donor had, by
detached from the bonds negotiable interest coupons the gift, parted with all control over them and their
before their due date and delivered them as a gift to his payment, and for that reason the case was
son, who, in the same year, collected them at distinguishable from Lucas v. Earl, supra, and Burnet v.
maturity, held that, under § 22 of the Revenue Act of Leininger, 285 U. S. 136, where the assignment of
1934, and in the year that the interest payments were compensation for services had preceded the rendition of
made, there was a realization of income, in the amount the services, and where the income was held taxable to
of such payments, taxable to the donor. P. 311 U. S. 117. the donor.

2. The dominant purpose of the income tax laws is the The holder of a coupon bond is the owner of two
taxation of income to those who earn or otherwise create independent and separable kinds of right. One is the right
the right to receive it and who enjoy the benefit of it to demand and receive at maturity the principal amount
when paid. P. 311 U. S. 119. of the bond representing capital investment. The other is
the right to demand and receive interim payments of
3. The tax laid by the 1934 Revenue Act upon income interest on the investment in the amounts and on the
"derived from . . . wages or compensation for personal dates specified by the coupons. Together, they are an
service, of whatever kind and in whatever form paid . . . ; obligation to pay principal and interest given in
also from interest . . . " cannot fairly be interpreted as not exchange for money or property which was presumably
applying to income derived from interest or the consideration for the obligation of the bond. Here
compensation when he who is entitled to receive it respondent, as owner of the bonds, had acquired the
makes use of his power to dispose of it in procuring legal right to demand payment at maturity of the interest
satisfactions which he would otherwise procure only by specified by the coupons and the power to command its
the use of the money when received. P. 311 U. S. 119. payment to others which constituted an economic gain
to him.
4. This case distinguished from Blair v. Commissioner, 300
U. S. 5, and compared with Lucas v. Earl, 281 U. S. 111, Admittedly not all economic gain of the taxpayer is
and Burnet v. Leininger, 285 U. S. 136. Pp. 311 U. S. 118-120. taxable income. From the beginning, the revenue laws
have been interpreted as defining "realization" of income
107 F.2d 906, reversed. as the taxable event, rather than the acquisition of the
right to receive it. And "realization" is not deemed to
occur until the income is paid. But the decisions and
Certiorari, 309 U.S. 650, to review the reversal of an order regulations have consistently recognized that receipt in
of the Board of Tax Appeals, 39 B.T.A. 757, sustaining a cash or property is not the only characteristic of
determination of a deficiency in income tax. realization of income to a taxpayer on the cash receipts
basis. Where the taxpayer does not receive payment of
MR. JUSTICE STONE delivered the opinion of the Court. income in money or property, realization may occur
when the last step is taken by which he obtains the
The sole question for decision is whether the gift, during fruition of the economic gain which has already accrued
the donor's taxable year, of interest coupons detached to him. Old Colony Trust Co. v. Commissioner, 279 U. S.
from the bonds, delivered to the donee and later in the 716; Corliss v. Bowers, 281 U. S. 376, 281 U. S. 378. Cf.
year paid at maturity, is the realization of income taxable Burnet v. Wells, 289 U. S. 670.
to the donor.
In the ordinary case the taxpayer who acquires the right
In 1934 and 1935, respondent, the owner of negotiable to receive income is taxed when he receives it, regardless
bonds, detached from them negotiable interest coupons of the time when his right to receive payment accrued.
shortly before their due date and delivered them as a gift But the rule that income is not taxable until realized has
to his son, who, in the same year, collected them at never been taken to mean that the taxpayer, even on
maturity. The Commissioner ruled that, under the the cash receipts basis, who has fully enjoyed the benefit
applicable § 22 of the Revenue Act of 1934, 48 Stat. 680, of the economic gain represented by his right to receive
686, the interest payments were taxable, in the years income can escape taxation because he has not himself
when paid, to the respondent donor, who reported his received payment of it from his obligor. The rule, founded
income on the cash receipts basis. The circuit court of on administrative convenience, is only one of
appeals reversed the order of the Board of Tax Appeals postponement of the tax to the final event of enjoyment
sustaining the tax. 107 F.2d 906; 39 B.T.A. 757. We granted of the income, usually the receipt of it by the taxpayer,
and not one of exemption from taxation where the the fruits of his investment or labor because he has
enjoyment is consummated by some event other than assigned them instead of collecting them himself and
the taxpayer's personal receipt of money or property. Cf. then paying them over to the donee is to affront
Aluminum Castings Co. v. Routzahn, 282 U. S. 92,282 U. S. common understanding and to deny the facts of
98. This may occur when he has made such use or common experience. Common understanding and
disposition of his power to receive or control the income experience are the touchstones for the interpretation of
as to procure in its place other satisfactions which are of the revenue laws.
economic worth. The question here is whether, because
one who in fact receives payment for services or interest The power to dispose of income is the equivalent of
payments is taxable only on his receipt of the payments, ownership of it. The exercise of that power to procure the
he can escape all tax by giving away his right to income payment of income to another is the enjoyment, and
in advance of payment. If the taxpayer procures hence the realization, of the income by him who
payment directly to his creditors of the items of interest or exercises it. We have had no difficulty in applying that
earnings due him, see Old Colony Trust Co. v. proposition where the assignment preceded the rendition
Commissioner, supra; Bowers v. Kerbaugh-Empire Co.,271 of the services, Lucas v. Earl, supra; Burnet v. Leininger,
U. S. 170; United States v. Kirby Lumber Co., 284 U. S. 1, or if supra, for it was recognized in the Leininger case that, in
he sets up a revocable trust with income payable to the such a case, the rendition of the service by the assignor
objects of his bounty, §§ 166, 167, Corliss v. Bowers, supra; was the means by which the income was controlled by
cf. Dickey v. Burnet, 56 F.2d 917, 921, he does not escape the donor, and of making his assignment effective. But it is
taxation because he did not actually receive the the assignment by which the disposition of income is
money. Cf. Douglas v. Willcuts, 296 U. S. 1; Helvering v. controlled when the service precedes the assignment,
Clifford, 309 U. S. 331. and, in both cases, it is the exercise of the power of
disposition of the interest or compensation, with the
Underlying the reasoning in these cases is the thought resulting payment to the donee, which is the enjoyment
that income is "realized" by the assignor because he, who by the donor of income derived from them.
owns or controls the source of the income, also controls
the disposition of that which he could have received This was emphasized in Blair v. Commissioner, 300 U. S. 5,
himself and diverts the payment from himself to others as on which respondent relies, where the distinction was
the means of procuring the satisfaction of his wants. The taken between a gift of income derived from an
taxpayer has equally enjoyed the fruits of his labor or obligation to pay compensation and a gift of income-
investment and obtained the satisfaction of his desires producing property. In the circumstances of that case,
whether he collects and uses the income to procure the right to income from the trust property was thought to
those satisfactions or whether he disposes of his right to be so identified with the equitable ownership of the
collect it as the means of procuring them. Cf. Burnet v. property from which alone the beneficiary derived his
Wells, supra. right to receive the income and his power to command
disposition of it that a gift of the income by the
Although the donor here, by the transfer of the coupons, beneficiary became effective only as a gift of his
has precluded any possibility of his collecting them ownership of the property producing it. Since the gift was
himself, he has nevertheless, by his act, procured deemed to be a gift of the property, the income from it
payment of the interest, as a valuable gift to a member was held to be the income of the owner of the property,
of his family. Such a use of his economic gain, the right to who was the donee, not the donor, a refinement which
receive income, to procure a satisfaction which can be was unnecessary if respondent's contention here is right,
obtained only by the expenditure of money or property but one clearly inapplicable to gifts of interest or wages.
would seem to be the enjoyment of the income whether Unlike income thus derived from an obligation to pay
the satisfaction is the purchase of goods at the corner interest or compensation, the income of the trust was
grocery, the payment of his debt there, or such regarded as no more the income of the donor than
nonmaterial satisfactions as may result from the payment would be the rent from a lease or a crop raised on a farm
of a campaign or community chest contribution, or a gift after the leasehold or the farm had been given
to his favorite son. Even though he never receives the away. Blair v. Commissioner, supra, 300 U. S. 12-13, and
money, he derives money's worth from the disposition of cases cited. See also Reinecke v. Smith, 289 U. S. 172, 289
the coupons which he has used as money or money's U. S. 177. We have held without deviation that, where the
worth in the procuring of a satisfaction which is donor retains control of the trust property, the income is
procurable only by the expenditure of money or money's taxable to him although paid to the donee. Corliss v.
worth. The enjoyment of the economic benefit accruing Bowers, supra. Cf. Helvering v. Clifford, supra.
to him by virtue of his acquisition of the coupons is
realized as completely as it would have been if he had The dominant purpose of the revenue laws is the taxation
collected the interest in dollars and expended them for of income to those who earn or otherwise create the right
any of the purposes named. Burnet v. Wells, supra. to receive it and enjoy the benefit of it when paid. See
Corliss v. Bowers, supra, 281 U. S. 378; Burnet v.
In a real sense, he has enjoyed compensation for money Guggenheim, 288 U. S. 280, 288 U. S. 283. The tax laid by
loaned or services rendered, and not any the less so the 1934 Revenue Act upon income "derived from . . .
because it is his only reward for them. To say that one wages, or compensation for personal service, of
who has made a gift thus derived from interest or whatever kind and in whatever form paid . . . ; also from
earnings paid to his donee has never enjoyed or realized interest . . ." therefore cannot fairly be interpreted as not
applying to income derived from interest or Commissioner, holding that the amounts collected on the
compensation when he who is entitled to receive it coupons were taxable as income to the petitioner."
makes use of his power to dispose of it in procuring
satisfactions which he would otherwise procure only by The decision of the Board of Tax Appeals was reversed,
the use of the money when received. and properly so, I think.

It is the statute which taxes the income to the donor The unmatured coupons given to the son were
although paid to his donee. Lucas v. Earl, supra; Burnet v. independent negotiable instruments, complete in
Leininger, supra. True, in those cases, the service which themselves. Through the gift, they became at once the
created the right to income followed the assignment, absolute property of the donee, free from the donor's
and it was arguable that, in point of legal theory, the right control and in no way dependent upon ownership of the
to the compensation vested instantaneously in the bonds. No question of actual fraud or purpose to defraud
assignor when paid, although he never received it, while the revenue is presented.
here, the right of the assignor to receive the income
antedated the assignment which transferred the right,
Neither Lucas v. Earl, 281 U. S. 111, nor Burnet v.
and thus precluded such an instantaneous vesting. But
Leininger, 285 U. S. 136, supports petitioner's view. Blair v.
the statute affords no basis for such "attenuated
Commissioner,300 U. S. 5, 300 U. S. 11-12, shows that
subtleties." The distinction was explicitly rejected as the
neither involved an unrestricted completed transfer of
basis of decision in Lucas v. Earl. It should be rejected
here, for no more than in the Earl case can the purpose
of the statute to tax the income to him who earns or
creates and enjoys it be escaped by "anticipatory Helvering v. Clifford, 309 U. S. 331, 309 U. S. 335-336,
arrangements . . . however skilfully devised" to prevent decided after the opinion below, is much relied upon by
the income from vesting even for a second in the donor. petitioner, but involved facts very different from those
now before us. There, no separate thing was absolutely
transferred and put beyond possible control by the
Nor is it perceived that there is any adequate basis for
transferor. The court affirmed that Clifford, both conveyor
distinguishing between the gift of interest coupons here
and trustee,
and a gift of salary or commissions. The owner of a
negotiable bond and of the investment which it
represents, if not the lender, stands in the place of the "retained the substance of full enjoyment of all the rights
lender. When, by the gift of the coupons, he has which previously he had in the property. . . . In substance,
separated his right to interest payments from his his control over the corpus was in all essential respects the
investment and procured the payment of the interest to same after the trust was created, as before. . . . With that
his donee, he has enjoyed the economic benefits of the control in his hands, he would keep direct command over
income in the same manner and to the same extent as all that he needed to remain in substantially the same
though the transfer were of earnings, and, in both cases, financial situation as before."
the import of the statute is that the fruit is not to be
attributed to a different tree from that on which it The general principles approved in Blair v.
grew. See Lucas v. Earl, supra, 281 U. S. 115. Commissioner, 300 U. S. 5, are applicable and controlling.
The challenged judgment should be affirmed.

The separate opinion of MR. JUSTICE McREYNOLDS.

The facts were stipulated. In the opinion of the court

below (107 F.2d 907), the issues are thus adequately

"The petitioner owned a number of coupon bonds. The

coupons represented the interest on the bonds and were
payable to bearer. In 1934, he detached unmatured
coupons of face value of $25,182.50 and transferred
them by manual delivery to his son as a gift. The coupons
matured later on in the same year, and the son collected
the face amount, $25,182.50, as his own property. There
was a similar transaction in 1935. The petitioner kept his
books on a cash basis. He did not include any part of the
moneys collected on the coupons in his income tax
returns for these two years. The son included them in his
returns. The Commissioner added the moneys collected
on the coupons to the petitioner's taxable income and
determined a tax deficiency for each year. The Board of
Tax Appeals, three members dissenting, sustained the
REVENUE, Stockhol Number and Number Number and
Petitioner, der Percentage of of Percentage of
Shares Held Addition Shares Held
Prior to the al Shares After the
Exchange Issued Exchange

-versus- FDC 2,537,358,000 67 42,217,0 2,579,575,000 61

.42% 00 .03%

FAI 00 420,877, 420,877,000 9.96

000 %
CORPORATION, OTHERS 1,226,177,000 32 0 1,226,177,000 29
Respondent. .58% .01%

----------------- ----- ------------- ---------------

x-------------------------------------x G. R. No. 167689 ------ -

COMMISSIONER OF INTERNAL 3,763,535,000 10 463,094, 4,226,629,000 (1

REVENUE, 0% 301 00%)

On 13 January 1997, FLI requested a ruling from the

Bureau of Internal Revenue (BIR) to the effect that no
gain or loss should be recognized in the aforesaid transfer
-versus- of real properties. Acting on the request, the BIR issued
Ruling No. S-34-046-97 dated 3 February 1997, finding that
the exchange is among those contemplated under
Section 34 (c) (2) of the old National Internal Revenue
FILINVEST DEVELOPMENT Code (NIRC)[4] which provides that (n)o gain or loss shall
CORPORATION, be recognized if property is transferred to a corporation
Respondent. by a person in exchange for a stock in such corporation
of which as a result of such exchange said person, alone
x---------------------------------------------------------------------------------- or together with others, not exceeding four (4) persons,
------------- x gains control of said corporation."[5] With the BIRs
reiteration of the foregoing ruling upon the 10 February
DECISION 1997 request for clarification filed by FLI,[6] the latter,
together with FDC and FAI, complied with all the
Assailed in these twin petitions for review on certiorari filed requirements imposed in the ruling.[7]
pursuant to Rule 45 of the 1997 Rules of Civil
Procedure are the decisions rendered by the Court of On various dates during the years 1996 and 1997, in the
Appeals (CA) in the following cases: (a) Decision dated meantime, FDC also extended advances in favor of its
16 December 2003 of the then Special Fifth Division in CA- affiliates, namely, FAI, FLI, Davao Sugar Central
G.R. SP No. 72992;[1] and, (b) Decision dated 26 January Corporation (DSCC) and Filinvest Capital, Inc.
2005 of the then Fourteenth Division in CA-G.R. SP No. (FCI).[8] Duly evidenced by instructional letters as well as
74510.[2] cash and journal vouchers, said cash advances
amounted to P2,557,213,942.60 in
1996[9] and P3,360,889,677.48 in 1997.[10] On 15 November
The Facts 1996, FDC also entered into a Shareholders Agreement
with Reco Herrera PTE Ltd. (RHPL) for the formation of a
The owner of 80% of the outstanding shares of respondent Singapore-based joint venture company called Filinvest
Filinvest Alabang, Inc. (FAI), respondent Filinvest Asia Corporation (FAC), tasked to develop and manage
Development Corporation (FDC) is a holding company FDCs 50% ownership of its PBCom Office Tower Project
which also owned 67.42% of the outstanding shares of (the Project). With their equity participation in FAC
Filinvest Land, Inc. (FLI). On 29 November 1996, FDC and respectively pegged at 60% and 40% in the Shareholders
FAI entered into a Deed of Exchange with FLI whereby Agreement, FDC subscribed to P500.7 million worth of
the former both transferred in favor of the latter parcels of shares in said joint venture company to RHPLs subscription
land appraised at P4,306,777,000.00. In exchange for said worth P433.8 million. Having paid its subscription by
parcels which were intended to facilitate development executing a Deed of Assignment transferring to FAC a
of medium-rise residential and commercial buildings, portion of its rights and interest in the Project worth P500.7
463,094,301 shares of stock of FLI were issued to FDC and million, FDC eventually reported a net loss
FAI.[3] As a result of the exchange, FLIs ownership structure of P190,695,061.00 in its Annual Income Tax Return for the
was changed to the extent reflected in the following taxable year 1996.[11]
tabular prcis, viz.:
On 3 January 2000, FDC received from the BIR a Formal FAC. As a consequence, FDC and FAC both prayed that
Notice of Demand to pay deficiency income and the subject assessments for deficiency income and
documentary stamp taxes, plus interests and compromise documentary stamp taxes for the years 1996 and 1997 be
penalties,[12] covered by the following Assessment cancelled and annulled.[20]
Notices, viz.: (a) Assessment Notice No. SP-INC-96-00018- On 4 December 2000, the CIR filed its answer, claiming
2000 for deficiency income taxes in the sum that the transfer of property in question should not be
of P150,074,066.27 for 1996; (b) Assessment Notice No. SP- considered tax free since, with the resultant diminution of
DST-96-00020-2000 for deficiency documentary stamp its shares in FLI, FDC did not gain further control of said
taxes in the sum of P10,425,487.06 for 1996; (c) Assessment corporation. Likewise calling attention to the fact that the
Notice No. SP-INC-97-00019-2000 for deficiency income cash advances FDC extended to its affiliates were
taxes in the sum of P5,716,927.03 for 1997; and (d) interest free despite the interest bearing loans it obtained
Assessment Notice No. SP-DST-97-00021-2000 for from banking institutions, the CIR invoked Section 43 of
deficiency documentary stamp taxes in the sum the old NIRC which, as implemented by Revenue
of P5,796,699.40 for 1997.[13] The foregoing deficiency Regulations No. 2, Section 179 (b) and (c), gave him "the
taxes were assessed on the taxable gain supposedly power to allocate, distribute or apportion income or
realized by FDC from the Deed of Exchange it executed deductions between or among such organizations,
with FAI and FLI, on the dilution resulting from the trades or business in order to prevent evasion of
Shareholders Agreement FDC executed with RHPL as well taxes." The CIR justified the imposition of documentary
as the arms-length interest rate and documentary stamp stamp taxes on the instructional letters as well as cash
taxes imposable on the advances FDC extended to its and journal vouchers for said cash advances on the
affiliates.[14] strength of Section 180 of the NIRC and Revenue
Regulations No. 9-94 which provide that loan transactions
On 3 January 2000, FAI similarly received from the BIR a are subject to said tax irrespective of whether or not they
Formal Letter of Demand for deficiency income taxes in are evidenced by a formal agreement or by mere office
the sum of P1,477,494,638.23 for the year memo. The CIR also argued that FDC realized taxable
1997.[15] Covered by Assessment Notice No. SP-INC-97- gain arising from the dilution of its shares in FAC as a result
0027-2000,[16] said deficiency tax was also assessed on the of its Shareholders' Agreement with RHPL.[21]
taxable gain purportedly realized by FAI from the Deed of
Exchange it executed with FDC and FLI.[17] On 26 January At the pre-trial conference, the parties filed a Stipulation
2000 or within the reglementary period of thirty (30) days of Facts, Documents and Issues[22] which was admitted in
from notice of the assessment, both FDC and FAI filed the 16 February 2001 resolution issued by the CTA. With
their respective requests for reconsideration/protest, on the further admission of the Formal Offer of Documentary
the ground that the deficiency income and Evidence subsequently filed by FDC and FAI [23] and the
documentary stamp taxes assessed by the BIR were conclusion of the testimony of Susana Macabelda anent
bereft of factual and legal basis.[18]Having submitted the the cash advances FDC extended in favor of its
relevant supporting documents pursuant to the 31 affiliates,[24] the CTA went on to render the Decision
January 2000 directive from the BIR Appellate Division, dated 10 September 2002 which, with the exception of
FDC and FAI filed on 11 September 2000 a letter the deficiency income tax on the interest income FDC
requesting an early resolution of their request for supposedly realized from the advances it extended in
reconsideration/protest on the ground that the 180 days favor of its affiliates, cancelled the rest of deficiency
prescribed for the resolution thereof under Section 228 of income and documentary stamp taxes assessed against
the NIRC was going to expire on 20 September 2000.[19] FDC and FAI for the years 1996 and 1997,[25] thus:

In view of the failure of petitioner Commissioner of Internal WHEREFORE, in view of all the
Revenue (CIR) to resolve their request for foregoing, the court finds the instant
reconsideration/protest within the aforesaid period, FDC petition partly meritorious. Accordingly,
and FAI filed on 17 October 2000 a petition for review Assessment Notice No. SP-INC-96-00018-
with the Court of Tax Appeals (CTA) pursuant to Section 2000 imposing deficiency income tax on
228 of the 1997 NIRC. Docketed before said court as CTA FDC for taxable year 1996, Assessment
Case No. 6182, the petition alleged, among other Notice No. SP-DST-96-00020-2000 and SP-
matters, that as previously opined in BIR Ruling No. S-34- DST-97-00021-2000 imposing deficiency
046-97, no taxable gain should have been assessed from documentary stamp tax on FDC for
the subject Deed of Exchange since FDC and FAI taxable years 1996 and 1997,
collectively gained further control of FLI as a respectively and Assessment Notice No.
consequence of the exchange; that correlative to the SP-INC-97-0027-2000 imposing deficiency
CIR's lack of authority to impute theoretical interests on income tax on FAI for the taxable year
the cash advances FDC extended in favor of its affiliates, 1997 are hereby CANCELLED and SET
the rule is settled that interests cannot be demanded in ASIDE.However, [FDC] is hereby ORDERED
the absence of a stipulation to the effect; that not being to PAY the amount of P5,691,972.03 as
promissory notes or certificates of obligations, the deficiency income tax for taxable year
instructional letters as well as the cash and journal 1997. In addition, petitioner is
vouchers evidencing said cash advances were not also ORDERED to PAY 20% delinquency
subject to documentary stamp taxes; and, that no interest computed from February 16,
income tax may be imposed on the prospective gain 2000 until full payment thereof pursuant
from the supposed appreciation of FDC's shareholdings in to Section 249 (c) (3) of the Tax Code.[26]
income taxes on the exchange of property between
FDC, FAI and FLI; (b) for deficiency documentary stamp
Finding that the collective increase of the equity taxes on the documents evidencing FDC's cash
participation of FDC and FAI in FLI rendered the gain advances to its affiliates; and (c) for deficiency income
derived from the exchange tax-free, the CTA also ruled tax on the gain FDC purportedly realized from the
that the increase in the value of FDC's shares in FAC did increase of the value of its shareholdings in FAC. [32] The
not result in economic advantage in the absence of foregoing petition was, however, denied due course and
actual sale or conversion thereof. While likewise finding dismissed for lack of merit in the herein assailed decision
that the documents evidencing the cash advances FDC dated 26 January 2005[33] rendered by the CA's then
extended to its affiliates cannot be considered as loan Fourteenth Division, upon the following findings and
agreements that are subject to documentary stamp tax, conclusions, to wit:
the CTA enunciated, however, that the CIR was justified
in assessing undeclared interests on the same cash 1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-
advances pursuant to his authority under Section 43 of 046-97, the 29 November 1996 Deed of Exchange
the NIRC in order to forestall tax evasion. For persuasive resulted in the combined control by FDC and FAI of
effect, the CTA referred to the equivalent provision in the more than 51% of the outstanding shares of FLI, hence,
Internal Revenue Code of the United States (IRC-US), i.e., no taxable gain can be recognized from the transaction
Sec. 482, as implemented by Section 1.482-2 of 1965-1969 under Section 34 (c) (2) of the old NIRC;
Regulations of the Law of Federal Income Taxation.[27]
2. The instructional letters as well as the cash and journal
Dissatisfied with the foregoing decision, FDC filed on 5 vouchers evidencing the advances FDC extended to its
November 2002 the petition for review docketed before affiliates are not subject to documentary stamp taxes
the CA as CA-G.R. No. 72992, pursuant to Rule 43 of pursuant to BIR Ruling No. 116-98, dated 30 July 1998,
the 1997 Rules of Civil Procedure. Calling attention to the since they do not partake the nature of loan
fact that the cash advances it extended to its affiliates agreements;
were interest-free in the absence of the express
stipulation on interest required under Article 1956 of 3. Although BIR Ruling No. 116-98 had been subsequently
the Civil Code, FDC questioned the imposition of an modified by BIR Ruling No. 108-99, dated 15 July 1999, to
arm's-length interest rate thereon on the ground, among the effect that documentary stamp taxes are imposable
others, that the CIR's authority under Section 43 of the on inter-office memos evidencing cash advances similar
NIRC: (a) does not include the power to impute to those extended by FDC, said latter ruling cannot be
imaginary interest on said transactions; (b) is directed only given retroactive application if to do so would be
against controlled taxpayers and not against mother or prejudicial to the taxpayer;
holding corporations; and, (c) can only be invoked in
cases of understatement of taxable net income or 4. FDC's alleged gain from the increase of its
evident tax evasion.[28] Upholding FDC's position, the CA's shareholdings in FAC as a consequence of the
then Special Fifth Division rendered the herein assailed Shareholders' Agreement it executed with RHPL cannot
decision dated 16 December 2003,[29] the decretal be considered taxable income since, until actually
portion of which states: converted thru sale or disposition of said shares, they
merely represent unrealized increase in capital.[34]
WHEREFORE, premises considered, the
instant petition is hereby GRANTED. The Respectively docketed before this Court as G.R. Nos.
assailed Decision dated September 10, 163653 and 167689, the CIR's petitions for review
2002 rendered by the Court of Tax on certiorari assailing the 16 December 2003 decision in
Appeals in CTA Case No. 6182 directing CA-G.R. No. 72992 and the 26 January 2005 decision in
petitioner Filinvest Development CA-G.R. SP No. 74510 were consolidated pursuant to the
Corporation to pay the amount 1 March 2006 resolution issued by this Courts Third Division.
of P5,691,972.03 representing deficiency
income tax on allegedly undeclared The Issues
interest income for the taxable year
1997, plus 20% delinquency interest
computed from February 16, 2000 until In G.R. No. 163653, the CIR urges the grant of its petition
full payment thereof is REVERSED and SET on the following ground:
ASIDE and, a new one entered annulling
Assessment Notice No. SP-INC-97-00019- THE COURT OF APPEALS ERRED IN
2000 imposing deficiency income tax on REVERSING THE DECISION OF THE COURT
petitioner for taxable year 1997. No OF TAX APPEALS AND IN HOLDING THAT
pronouncement as to costs.[30] THE ADVANCES EXTENDED BY
With the denial of its partial motion for SUBJECT TO INCOME TAX.[35]
reconsideration of the same 11 December 2002 resolution
issued by the CTA,[31] the CIR also filed the petition for
review docketed before the CA as CA-G.R. No. 74510. In
essence, the CIR argued that the CTA reversibly erred in
cancelling the assessment notices: (a) for deficiency
In G.R. No. 167689, on the other hand, petitioner proffers organizations, trades or businesses (whether or not
the following issues for resolution: incorporated and whether or not organized in the
Philippines) owned or controlled directly or indirectly by
I the same interests, the Commissioner of Internal Revenue
is authorized to distribute, apportion or allocate gross
THE HONORABLE COURT OF APPEALS COMMITTED income or deductions between or among such
GRAVE ABUSE OF DISCRETION IN HOLDING THAT organization, trade or business, if he determines that such
THE EXCHANGE OF SHARES OF STOCK FOR distribution, apportionment or allocation is necessary in
PROPERTY AMONG FILINVEST DEVELOPMENT order to prevent evasion of taxes or clearly to reflect the
CORPORATION (FDC), FILINVEST ALABANG, income of any such organization, trade or business. In
INCORPORATED (FAI) AND FILINVEST LAND amplification of the equivalent provision[39] under
INCORPORATED (FLI) MET ALL THE REQUIREMENTS Commonwealth Act No. 466,[40] Sec. 179(b) of Revenue
FOR THE NON-RECOGNITION OF TAXABLE GAIN Regulation No. 2 states as follows:
INTERNAL REVENUE CODE (NIRC) (NOW SECTION Determination of the taxable net income of
40 (C) (2) (c) OF THE NIRC. controlled taxpayer.

II (A) DEFINITIONS. When used in this section

THE HONORABLE COURT OF APPEALS COMMITTED (1) The term organization includes any kind,
REVERSIBLE ERROR IN HOLDING THAT THE LETTERS whether it be a sole proprietorship, a partnership, a trust,
OF INSTRUCTION OR CASH VOUCHERS EXTENDED an estate, or a corporation or association, irrespective of
BY FDC TO ITS AFFILIATES ARE NOT DEEMED LOAN the place where organized, where operated, or where
AGREEMENTS SUBJECT TO DOCUMENTARY STAMP its trade or business is conducted, and regardless of
TAXES UNDER SECTION 180 OF THE NIRC. whether domestic or foreign, whether exempt or
taxable, or whether affiliated or not.
(2) The terms trade or business include any trade
THE HONORABLE COURT OF APPEALS GRAVELY or business activity of any kind, regardless of whether or
ERRED IN HOLDING THAT GAIN ON DILUTION AS A where organized, whether owned individually or
RESULT OF THE INCREASE IN THE VALUE OF FDCS otherwise, and regardless of the place where carried on.
(3) The term controlled includes any kind of
The Courts Ruling control, direct or indirect, whether legally enforceable,
and however exercisable or exercised. It is the reality of
While the petition in G.R. No. 163653 is bereft of merit, we the control which is decisive, not its form or mode of
find the CIRs petition in G.R. No. 167689 impressed with exercise. A presumption of control arises if income or
partial merit. deductions have been arbitrarily shifted.

In G.R. No. 163653, the CIR argues that the CA erred in (4) The term controlled taxpayer means any one
reversing the CTAs finding that theoretical interests can of two or more organizations, trades, or businesses
be imputed on the advances FDC extended to its owned or controlled directly or indirectly by the same
affiliates in 1996 and 1997 considering that, for said interests.
purpose, FDC resorted to interest-bearing fund borrowings
from commercial banks. Since considerable interest (5) The term group and group of controlled
expenses were deducted by FDC when said funds were taxpayers means the organizations, trades or businesses
borrowed, the CIR theorizes that interest income should owned or controlled by the same interests.
likewise be declared when the same funds were sourced
for the advances FDC extended to its affiliates. Invoking (6) The term true net income means, in the case
Section 43 of the 1993 NIRC in relation to Section 179(b) of of a controlled taxpayer, the net income (or as the case
Revenue Regulation No. 2, the CIR maintains that it is may be, any item or element affecting net income)
vested with the power to allocate, distribute or apportion which would have resulted to the controlled taxpayer,
income or deductions between or among controlled had it in the conduct of its affairs (or, as the case may
organizations, trades or businesses even in the absence of be, any item or element affecting net income) which
fraud, since said power is intended to prevent evasion of would have resulted to the controlled taxpayer, had it in
taxes or clearly to reflect the income of any such the conduct of its affairs (or, as the case may be, in the
organizations, trades or businesses. In addition, the CIR particular contract, transaction, arrangement or other
asseverates that the CA should have accorded weight act) dealt with the other members or members of the
and respect to the findings of the CTA which, as the group at arms length. It does not mean the income, the
specialized court dedicated to the study and deductions, or the item or element of either, resulting to
consideration of tax matters, can take judicial notice of the controlled taxpayer by reason of the particular
US income tax laws and regulations.[37] contract, transaction, or arrangement, the controlled
taxpayer, or the interest controlling it, chose to make
Admittedly, Section 43 of the 1993 (even though such contract, transaction, or
NIRC[38] provides that, (i)n any case of two or more
arrangement be legally binding upon the parties taxpayer's taxable income is not reflective of that which it
thereto). would have realized had it been dealing at arm's length
with an uncontrolled taxpayer, the CIR can make the
(B) SCOPE AND PURPOSE. - The purpose of Section 44 of necessary rectifications in order to prevent evasion of
the Tax Code is to place a controlled taxpayer on a tax taxes.
parity with an uncontrolled taxpayer, by determining,
according to the standard of an uncontrolled taxpayer, Despite the broad parameters provided,
the true net income from the property and business of a however, we find that the CIR's powers of distribution,
controlled taxpayer. The interests controlling a group of apportionment or allocation of gross income and
controlled taxpayer are assumed to have complete deductions under Section 43 of the 1993 NIRC and
power to cause each controlled taxpayer so to conduct Section 179 of Revenue Regulation No. 2 does not
its affairs that its transactions and accounting records include the power to impute "theoretical interests" to the
truly reflect the net income from the property and controlled taxpayer's transactions. Pursuant to Section 28
business of each of the controlled taxpayers. If, however, of the 1993 NIRC,[42] after all, the term gross income is
this has not been done and the taxable net income are understood to mean all income from whatever
thereby understated, the statute contemplates that the source derived, including, but not limited to the following
Commissioner of Internal Revenue shall intervene, and, items: compensation for services, including fees,
by making such distributions, apportionments, or commissions, and similar items; gross income derived from
allocations as he may deem necessary of gross income business; gains derived from dealings in property; interest;
or deductions, or of any item or element affecting net rents; royalties; dividends; annuities; prizes and winnings;
income, between or among the controlled taxpayers pensions; and partners distributive share of the gross
constituting the group, shall determine the true net income of general professional partnership.[43] While it has
income of each controlled taxpayer. The standard to be been held that the phrase "from whatever source
applied in every case is that of an uncontrolled derived" indicates a legislative policy to include all
taxpayer. Section 44 grants no right to a controlled income not expressly exempted within the class of
taxpayer to apply its provisions at will, nor does it grant taxable income under our laws, the term "income" has
any right to compel the Commissioner of Internal been variously interpreted to mean "cash received or its
Revenue to apply its provisions. equivalent", "the amount of money coming to a person
within a specific time" or "something distinct from principal
(C) APPLICATION Transactions between controlled or capital."[44] Otherwise stated, there must be proof of
taxpayer and another will be subjected to special the actual or, at the very least, probable receipt or
scrutiny to ascertain whether the common control is realization by the controlled taxpayer of the item of gross
being used to reduce, avoid or escape taxes. In income sought to be distributed, apportioned or
determining the true net income of a controlled allocated by the CIR.
taxpayer, the Commissioner of Internal Revenue is not
restricted to the case of improper accounting, to the Our circumspect perusal of the record yielded no
case of a fraudulent, colorable, or sham transaction, or evidence of actual or possible showing that the
to the case of a device designed to reduce or avoid tax advances FDC extended to its affiliates had resulted to
by shifting or distorting income the interests subsequently assessed by the CIR. For all its
or deductions. The authority to determine true net harping upon the supposed fact that FDC had resorted
income extends to any case in which either by to borrowings from commercial banks, the CIR had
inadvertence or design the taxable net income in whole adduced no concrete proof that said funds were,
or in part, of a controlled taxpayer, is other than it would indeed, the source of the advances the former provided
have been had the taxpayer in the conduct of his affairs its affiliates. While admitting that FDC obtained interest-
been an uncontrolled taxpayer dealing at arms length bearing loans from commercial banks,[45] Susan
with another uncontrolled taxpayer.[41] Macabelda - FDC's Funds Management Department
Manager who was the sole witness presented before the
As may be gleaned from the definitions of the CTA - clarified that the subject advances were sourced
terms controlled and "controlled taxpayer" under from the corporation's rights offering in 1995 as well as the
paragraphs (a) (3) and (4) of the foregoing provision, it sale of its investment in Bonifacio Land in 1997.[46] More
would appear that FDC and its affiliates come within the significantly, said witness testified that said advances: (a)
purview of Section 43 of the 1993 NIRC. Aside from were extended to give FLI, FAI, DSCC and FCI financial
owning significant portions of the shares of stock of FLI, assistance for their operational and capital expenditures;
FAI, DSCC and FCI, the fact that FDC extended and, (b) were all temporarily in nature since they were
substantial sums of money as cash advances to its said repaid within the duration of one week to three months
affiliates for the purpose of providing them financial and were evidenced by mere journal entries, cash
assistance for their operational and capital expenditures vouchers and instructional letters.[47]
seemingly indicate that the situation sought to be
addressed by the subject provision exists. From the tenor Even if we were, therefore, to accord precipitate
of paragraph (c) of Section 179 of Revenue Regulation credulity to the CIR's bare assertion that FDC had
No. 2, it may also be seen that the CIR's power to deducted substantial interest expense from its gross
distribute, apportion or allocate gross income or income, there would still be no factual basis for the
deductions between or among controlled taxpayers may imputation of theoretical interests on the subject
be likewise exercised whether or not fraud inheres in the advances and assess deficiency income taxes
transaction/s under scrutiny. For as long as the controlled thereon. More so, when it is borne in mind that, pursuant
to Article 1956 of the Civil Code of the Philippines, no Then as now, the CIR argues that taxable gain should be
interest shall be due unless it has been expressly stipulated recognized for the exchange considering that FDC's
in writing. Considering that taxes, being burdens, are not controlling interest in FLI was actually decreased as a
to be presumed beyond what the applicable statute result thereof.For said purpose, the CIR calls attention to
expressly and clearly declares,[48] the rule is likewise the fact that, prior to the exchange, FDC owned
settled that tax statutes must be construed strictly against 2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding
the government and liberally in favor of the capital stock. Upon the issuance of 443,094,000 additional
taxpayer.[49] Accordingly, the general rule of requiring FLI shares as a consequence of the exchange and with
adherence to the letter in construing statutes applies with only 42,217,000 thereof accruing in favor of FDC for a
peculiar strictness to tax laws and the provisions of a total of 2,579,575,000 shares, said corporations controlling
taxing act are not to be extended by interest was supposedly reduced to 61%.03 when
implication.[50] While it is true that taxes are the lifeblood reckoned from the transferee's aggregate 4,226,629,000
of the government, it has been held that their assessment outstanding shares. Without owning a share from FLI's
and collection should be in accordance with law as any initial 3,763,535,000 outstanding shares, on the other
arbitrariness will negate the very reason for government hand, FAI's acquisition of 420,877,000 FLI shares as a result
itself.[51] of the exchange purportedly resulted in its control of only
9.96% of said transferee corporation's 4,226,629,000
In G.R. No. 167689, we also find a dearth of merit outstanding shares. On the principle that the transaction
in the CIR's insistence on the imposition of deficiency did not qualify as a tax-free exchange under Section 34
income taxes on the transfer FDC and FAI effected in (c) (2) of the 1993 NIRC, the CIR asseverates that taxable
exchange for the shares of stock of FLI. With respect to gain in the sum of P263,386,921.00 should be recognized
the Deed of Exchange executed between FDC, FAI and on the part of FDC and in the sum of P3,088,711,367.00 on
FLI, Section 34 (c) (2) of the 1993 NIRC pertinently provides the part of FAI.[57]
as follows:
The paucity of merit in the CIR's position is, however,
Sec. 34. Determination of amount of and evident from the categorical language of Section 34 (c)
recognition of gain or loss.- (2) of the 1993 NIRC which provides that gain or loss will
xxxx not be recognized in case the exchange of property for
stocks results in the control of the transferee by the
(c) Exception x x x x transferor, alone or with other transferors not exceeding
four persons. Rather than isolating the same as proposed
No gain or loss shall also be recognized if by the CIR, FDC's 2,579,575,000 shares or 61.03% control of
property is transferred to a corporation by a FLI's 4,226,629,000 outstanding shares should, therefore,
person in exchange for shares of stock in such be appreciated in combination with the 420,877,000 new
corporation of which as a result of such shares issued to FAI which represents 9.96% control of said
exchange said person, alone or together with transferee corporation. Together FDC's 2,579,575,000
others, not exceeding four persons, gains control shares (61.03%) and FAI's 420,877,000 shares (9.96%)
of said corporation; Provided, That stocks issued clearly add up to 3,000,452,000 shares or 70.99% of FLI's
for services shall not be considered as issued in 4,226,629,000 shares. Since the term "control" is clearly
return of property. defined as "ownership of stocks in a corporation
possessing at least fifty-one percent of the total voting
power of classes of stocks entitled to one vote" under
As even admitted in the 14 February 2001 Section 34 (c) (6) [c] of the 1993 NIRC, the exchange of
Stipulation of Facts submitted by the parties,[52] the property for stocks between FDC FAI and FLI clearly
requisites for the non-recognition of gain or loss under the qualify as a tax-free transaction under paragraph 34 (c)
foregoing provision are as follows: (a) the transferee is a (2) of the same provision.
corporation; (b) the transferee exchanges its shares of
stock for property/ies of the transferor; (c) the transfer is Against the clear tenor of Section 34(c) (2) of the 1993
made by a person, acting alone or together with others, NIRC, the CIR cites then Supreme Court Justice Jose Vitug
not exceeding four persons; and, (d) as a result of the and CTA Justice Ernesto D. Acosta who, in their book Tax
exchange the transferor, alone or together with others, Law and Jurisprudence, opined that said provision could
not exceeding four, gains control of the be inapplicable if control is already vested in the
transferee.[53] Acting on the 13 January 1997 request filed exchangor prior to exchange.[58] Aside from the fact that
by FLI, the BIR had, in fact, acknowledged the that the 10 September 2002 Decision in CTA Case No.
concurrence of the foregoing requisites in the Deed of 6182 upholding the tax-exempt status of the exchange
Exchange the former executed with FDC and FAI by between FDC, FAI and FLI was penned by no less than
issuing BIR Ruling No. S-34-046-97.[54] With the BIR's Justice Acosta himself,[59] FDC and FAI significantly point
reiteration of said ruling upon the request for clarification out that said authors have acknowledged that the
filed by FLI,[55] there is also no dispute that said transferee position taken by the BIR is to the effect that "the law
and transferors subsequently complied with the would apply even when the exchangor already has
requirements provided for the non-recognition of gain or control of the corporation at the time of the
loss from the exchange of property for tax, as provided exchange."[60] This was confirmed when, apprised in FLI's
under Section 34 (c) (2) of the 1993 NIRC.[56] request for clarification about the change of percentage
of ownership of its outstanding capital stock, the BIR
opined as follows:
thousand pesos (P250,000.00) executed by an individual
Please be informed that regardless of the foregoing, the for his purchase on installment for his personal use or that
transferors, Filinvest Development Corp. and Filinvest of his family and not for business, resale, barter or hire of
Alabang, Inc. still gained control of Filinvest Land, a house, lot, motor vehicle, appliance or furniture shall
Inc. The term 'control' shall mean ownership of stocks in a be exempt from the payment of documentary stamp
corporation by possessing at least 51% of the total voting tax provided under this Section.
power of all classes of stocks entitled to vote. Control is
determined by the amount of stocks received, i.e., total When read in conjunction with Section 173 of the 1993
subscribed, whether for property or for services by the NIRC,[63] the foregoing provision concededly applies to
transferor or transferors. In determining the 51% stock "(a)ll loan agreements, whether made or signed in the
ownership, only those persons who transferred property Philippines, or abroad when the obligation or right arises
for stocks in the same transaction may be counted up to from Philippine sources or the property or object of the
the maximum of five (BIR Ruling No. 547-93 dated contract is located or used in the
December 29, 1993.[61] Philippines." Correlatively, Section 3 (b) and Section 6 of
Revenue Regulations No. 9-94 provide as follows:
At any rate, it also appears that the supposed reduction
of FDC's shares in FLI posited by the CIR is more apparent Section 3. Definition of Terms. For purposes of these
than real. As the uncontested owner of 80% of the Regulations, the following term shall mean:
outstanding shares of FAI, it cannot be gainsaid that FDC
ideally controls the same percentage of the 420,877,000 (b) 'Loan agreement' refers to a contract in writing
shares issued to its said co-transferor which, by itself, where one of the parties delivers to another money or
represents 7.968% of the outstanding shares of other consumable thing, upon the condition that the
FLI. Considered alongside FDC's 61.03% control of FLI as a same amount of the same kind and quality shall be
consequence of the 29 November 1996 Deed of Transfer, paid. The term shall include credit facilities, which may
said 7.968% add up to an aggregate of 68.998% of said be evidenced by credit memo, advice or drawings.
transferee corporation's outstanding shares of stock
which is evidently still greater than the 67.42% FDC initially The terms 'Loan Agreement" under Section 180 and
held prior to the exchange. This much was admitted by "Mortgage' under Section 195, both of the Tax Code, as
the parties in the 14 February 2001 Stipulation of Facts, amended, generally refer to distinct and separate
Documents and Issues they submitted to the instruments. A loan agreement shall be taxed under
CTA.[62] Inasmuch as the combined ownership of FDC Section 180, while a deed of mortgage shall be taxed
and FAI of FLI's outstanding capital stock adds up to a under Section 195."
total of 70.99%, it stands to reason that neither of said
transferors can be held liable for deficiency income taxes "Section 6. Stamp on all Loan Agreements. All loan
the CIR assessed on the supposed gain which resulted agreements whether made or signed in the Philippines,
from the subject transfer. or abroad when the obligation or right arises from
Philippine sources or the property or object of the
On the other hand, insofar as documentary stamp taxes contract is located in the Philippines shall be subject to
on loan agreements and promissory notes are the documentary stamp tax of thirty centavos (P0.30) on
concerned, Section 180 of the NIRC provides follows: each two hundred pesos, or fractional part thereof, of
the face value of any such agreements, pursuant to
Sec. 180. Stamp tax on all loan agreements, promissory Section 180 in relation to Section 173 of the Tax Code.
notes, bills of exchange, drafts, instruments and
securities issued by the government or any of its In cases where no formal agreements or promissory
instrumentalities, certificates of deposit bearing interest notes have been executed to cover credit facilities, the
and others not payable on sight or demand. On all loan documentary stamp tax shall be based on the amount
agreements signed abroad wherein the object of the of drawings or availment of the facilities, which may be
contract is located or used in the Philippines; bill of evidenced by credit/debit memo, advice or drawings
exchange (between points within the Philippines), drafts, by any form of check or withdrawal slip, under Section
instruments and securities issued by the Government or 180 of the Tax Code.
any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of Applying the aforesaid provisions to the case at
money otherwise than at sight or on demand, or on all bench, we find that the instructional letters as well as the
promissory notes, whether negotiable or non-negotiable, journal and cash vouchers evidencing the advances FDC
except bank notes issued for circulation, and on each extended to its affiliates in 1996 and 1997 qualified as
renewal of any such note, there shall be collected a loan agreements upon which documentary stamp taxes
documentary stamp tax of Thirty centavos (P0.30) on may be imposed. In keeping with the caveat attendant
each two hundred pesos, or fractional part thereof, of to every BIR Ruling to the effect that it is valid only if the
the face value of any such agreement, bill of exchange, facts claimed by the taxpayer are correct, we find that
draft, certificate of deposit or note: Provided, That only the CA reversibly erred in utilizing BIR Ruling No. 116-
one documentary stamp tax shall be imposed on either 98, dated 30 July 1998 which, strictly speaking, could be
loan agreement, or promissory notes issued to secure invoked only by ASB Development Corporation, the
such loan, whichever will yield a higher tax: Provided taxpayer who sought the same. In said ruling, the CIR
however, That loan agreements or promissory notes the opined that documents like those evidencing the
aggregate of which does not exceed Two hundred fifty
advances FDC extended to its affiliates are not subject to penalty is, in turn, warranted under Sec. 250 [69] of the
documentary stamp tax, to wit: NIRC which prescribes the imposition thereof in case of
each failure to file an information or return, statement or
On the matter of whether or not the inter-office memo list, or keep any record or supply any information required
covering the advances granted by an affiliate company on the date prescribed therefor.
is subject to documentary stamp tax, it is informed that
nothing in Regulations No. 26 (Documentary Stamp Tax To our mind, no reversible error can, finally, be imputed
Regulations) and Revenue Regulations No. 9-94 states against both the CTA and the CA for invalidating the
that the same is subject to documentary stamp tax. Assessment Notice issued by the CIR for the deficiency
Such being the case, said inter-office memo evidencing income taxes FDC is supposed to have incurred as a
the lendings or borrowings which is neither a form of consequence of the dilution of its shares in FAC. Anent
promissory note nor a certificate of indebtedness issued FDCs Shareholders Agreement with RHPL, the record
by the corporation-affiliate or a certificate of obligation, shows that the parties were in agreement about the
which are, more or less, categorized as 'securities', is not following factual antecedents narrated in the 14 February
subject to documentary stamp tax imposed under 2001 Stipulation of Facts, Documents and Issues they
Section 180, 174 and 175 of the Tax Code of 1997, submitted before the CTA,[70] viz.:
respectively. Rather, the inter-office memo is being
prepared for accounting purposes only in order to avoid 1.11. On November 15, 1996, FDC entered into a
the co-mingling of funds of the corporate affiliates. Shareholders Agreement (SA) with Reco Herrera Pte. Ltd.
(RHPL) for the formation of a joint venture company
named Filinvest Asia Corporation (FAC) which is based
In its appeal before the CA, the CIR argued that the in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7,
foregoing ruling was later modified in BIR Ruling No. 108- Answer).
99 dated 15 July 1999, which opined that inter-office
memos evidencing lendings or borrowings extended by a 1.12. FAC, the joint venture company formed by FDC
corporation to its affiliates are akin to promissory notes, and RHPL, is tasked to develop and manage the 50%
hence, subject to documentary stamp taxes. [64] In ownership interest of FDC in its PBCom Office Tower
brushing aside the foregoing argument, however, the CA Project (Project) with the Philippine Bank of
applied Section 246 of the 1993 NIRC[65] from which Communications (par. 6.12, Petition; par. 7, Answer).
proceeds the settled principle that rulings, circulars, rules
and regulations promulgated by the BIR have no 1.13. Pursuant to the SA between FDC and RHPL, the
retroactive application if to so apply them would be equity participation of FDC and RHPL in FAC was 60%
prejudicial to the taxpayers.[66] Admittedly, this rule does and 40% respectively.
not apply: (a) where the taxpayer deliberately misstates
or omits material facts from his return or in any document 1.14. In accordance with the terms of the SA, FDC
required of him by the Bureau of Internal Revenue; (b) subscribed to P500.7 million worth of shares of stock
where the facts subsequently gathered by the Bureau of representing a 60% equity participation in FAC. In turn,
Internal Revenue are materially different from the facts on RHPL subscribed to P433.8 million worth of shares of stock
which the ruling is based; or (c) where the taxpayer of FAC representing a 40% equity participation in FAC.
acted in bad faith.[67] Not being the taxpayer who, in the
first instance, sought a ruling from the CIR, however, FDC 1.15. In payment of its subscription in FAC, FDC executed
cannot invoke the foregoing principle on non- a Deed of Assignment transferring to FAC a portion of
retroactivity of BIR rulings. FDCs right and interests in the Project to the extent
of P500.7 million.
Viewed in the light of the foregoing considerations, we
find that both the CTA and the CA erred in invalidating 1.16. FDC reported a net loss of P190,695,061.00 in its
the assessments issued by the CIR for the deficiency Annual Income Tax Return for the taxable year 1996. [71]
documentary stamp taxes due on the instructional letters
as well as the journal and cash vouchers evidencing the
advances FDC extended to its affiliates in 1996 and Alongside the principle that tax revenues are not
1997. In Assessment Notice No. SP-DST-96-00020-2000, the intended to be liberally construed,[72] the rule is settled
CIR correctly assessed the sum of P6,400,693.62 for that the findings and conclusions of the CTA are
documentary stamp tax, P3,999,793.44 in interests accorded great respect and are generally upheld by this
and P25,000.00 as compromise penalty, for a total Court, unless there is a clear showing of a reversible error
of P10,425,487.06. Alongside the sum of P4,050,599.62 for or an improvident exercise of authority.[73] Absent
documentary stamp tax, the CIR similarly showing of such error here, we find no strong and cogent
assessed P1,721,099.78 in interests and P25,000.00 as reasons to depart from said rule with respect to the CTA's
compromise penalty in Assessment Notice No. SP-DST-97- finding that no deficiency income tax can be assessed
00021-2000 or a total of P5,796,699.40. The imposition of on the gain on the supposed dilution and/or increase in
deficiency interest is justified under Sec. 249 (a) and (b) of the value of FDC's shareholdings in FAC which the CIR, at
the NIRC which authorizes the assessment of the same at any rate, failed to establish. Bearing in mind the meaning
the rate of twenty percent (20%), or such higher rate as of "gross income" as above discussed, it cannot be
may be prescribed by regulations, from the date gainsaid, even then, that a mere increase or
prescribed for the payment of the unpaid amount of tax appreciation in the value of said shares cannot be
until full payment.[68] The imposition of the compromise considered income for taxation purposes. Since a mere
advance in the value of the property of a person or (1) The BIR’s disallowance of ICC’s claimed expense
corporation in no sense constitute the income specified in deductions for professional and security services billed to
the revenue law, it has been held in the early case and paid by ICC in 1986, to wit:
of Fisher vs. Trinidad,[74] that it constitutes and can be
treated merely as an increase of capital. Hence, the CIR (a) Expenses for the auditing services of SGV & Co., 3 for
has no factual and legal basis in assessing income tax on the year ending December 31, 1985;4
the increase in the value of FDC's shareholdings in FAC
until the same is actually sold at a profit.
(b) Expenses for the legal services [inclusive of retainer
fees] of the law firm Bengzon Zarraga Narciso Cudala
WHEREFORE, premises considered, the CIR's petition for
Pecson Azcuna & Bengson for the years 1984 and 1985.5
review on certiorari in G.R. No. 163653 is DENIED for lack of
merit and the CAs 16 December 2003 Decision in G.R. No.
72992 is AFFIRMED in toto. The CIRs petition in G.R. No. (c) Expense for security services of El Tigre Security &
167689 is PARTIALLY GRANTED and the CAs 26 January Investigation Agency for the months of April and May
2005 Decision in CA-G.R. SP No. 74510 isMODIFIED. 1986.6

Accordingly, Assessment Notices Nos. SP-DST-96- (2) The alleged understatement of ICC’s interest income
00020-2000 and SP-DST-97-00021-2000 issued for on the three promissory notes due from Realty
deficiency documentary stamp taxes due on the Investment, Inc.
instructional letters as well as journal and cash vouchers
evidencing the advances FDC extended to its affiliates The deficiency expanded withholding tax
are declared valid. of P4,897.79 (inclusive of interest and surcharge) was
allegedly due to the failure of ICC to withhold 1%
The cancellation of Assessment Notices Nos. SP- expanded withholding tax on its claimed P244,890.00
INC-96-00018-2000, SP-INC-97-00019-2000 and SP-INC-97- deduction for security services.7
0027-2000 issued for deficiency income assessed on (a)
the arms-length interest from said advances; (b) the gain
from FDCs Deed of Exchange with FAI and FLI; and (c) On March 23, 1990, ICC sought a reconsideration of the
income from the dilution resulting from FDCs Shareholders subject assessments. On February 9, 1995, however, it
Agreement with RHPL is, however, upheld. received a final notice before seizure demanding
SO ORDERED. 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
G.R. No. 172231 February 12, 2007 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
COMMISSIONER OF INTERNAL REVENUE, Petitioner, reiterating the payment of deficiency tax, amounts to a
vs. final decision on the protested assessment and may
ISABELA CULTURAL CORPORATION, Respondent. therefore be questioned before the CTA. This conclusion
was sustained by this Court on July 1, 2001, in G.R. No.
DECISION 135210.8 The case was thus remanded to the CTA for
further proceedings.
On February 26, 2003, the CTA rendered a decision
Petitioner Commissioner of Internal Revenue (CIR) assails canceling and setting aside the assessment notices
the September 30, 2005 Decision1 of the Court of Appeals issued against ICC. It held that the claimed deductions
in CA-G.R. SP No. 78426 affirming the February 26, 2003 for professional and security services were properly
Decision2 of the Court of Tax Appeals (CTA) in CTA Case claimed by ICC in 1986 because it was only in the said
No. 5211, which cancelled and set aside the Assessment year when the bills demanding payment were sent to
Notices for deficiency income tax and expanded ICC. Hence, even if some of these professional services
withholding tax issued by the Bureau of Internal Revenue were rendered to ICC in 1984 or 1985, it could not
(BIR) against respondent Isabela Cultural Corporation declare the same as deduction for the said years as the
(ICC). amount thereof could not be determined at that time.

The facts show that on February 23, 1990, ICC, a domestic The CTA also held that ICC did not understate its interest
corporation, received from the BIR Assessment Notice No. income on the subject promissory notes. It found that it
FAS-1-86-90-000680 for deficiency income tax in the was the BIR which made an overstatement of said
amount of P333,196.86, and Assessment Notice No. FAS-1- income when it compounded the interest income
86-90-000681 for deficiency expanded withholding tax in receivable by ICC from the promissory notes of Realty
the amount of P4,897.79, inclusive of surcharges and Investment, Inc., despite the absence of a stipulation in
interest, both for the taxable year 1986. 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
The deficiency income tax of P333,196.86, arose from:
compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% be taken for the taxable year in which ‘paid or accrued’
expanded withholding tax on its claimed deduction for or ‘paid or incurred’, dependent upon the method of
security services as shown by the various payment orders accounting upon the basis of which the net income is
and confirmation receipts it presented as evidence. The computed x x x".
dispositive portion of the CTA’s Decision, reads:
Accounting methods for tax purposes comprise a set of
WHEREFORE, in view of all the foregoing, Assessment rules for determining when and how to report income
Notice No. FAS-1-86-90-000680 for deficiency income tax and deductions.12 In the instant case, the accounting
in the amount of P333,196.86, and Assessment Notice No. method used by ICC is the accrual method.
FAS-1-86-90-000681 for deficiency expanded withholding
tax in the amount of P4,897.79, inclusive of surcharges Revenue Audit Memorandum Order No. 1-2000, provides
and interest, both for the taxable year 1986, are hereby that under the accrual method of accounting, expenses
CANCELLED and SET ASIDE. not being claimed as deductions by a taxpayer in the
current year when they are incurred cannot be claimed
SO ORDERED.9 as deduction from income for the succeeding year. Thus,
a taxpayer who is authorized to deduct certain expenses
Petitioner filed a petition for review with the Court of and other allowable deductions for the current year but
Appeals, which affirmed the CTA decision,10 holding that failed to do so cannot deduct the same for the next
although the professional services (legal and auditing year.13
services) were rendered to ICC in 1984 and 1985, the cost
of the services was not yet determinable at that time, The accrual method relies upon the taxpayer’s right to
hence, it could be considered as deductible expenses receive amounts or its obligation to pay them, in
only in 1986 when ICC received the billing statements for opposition to actual receipt or payment, which
said services. It further ruled that ICC did not understate characterizes the cash method of accounting. Amounts
its interest income from the promissory notes of Realty of income accrue where the right to receive them
Investment, Inc., and that ICC properly withheld and become fixed, where there is created an enforceable
remitted taxes on the payments for security services for liability. Similarly, liabilities are accrued when fixed and
the taxable year 1986. determinable in amount, without regard to
indeterminacy merely of time of payment.14
Hence, petitioner, through the Office of the Solicitor
General, filed the instant petition contending that since For a taxpayer using the accrual method, the
ICC is using the accrual method of accounting, the determinative question is, when do the facts present
expenses for the professional services that accrued in themselves in such a manner that the taxpayer must
1984 and 1985, should have been declared as recognize income or expense? The accrual of income
deductions from income during the said years and the and expense is permitted when the all-events test has
failure of ICC to do so bars it from claiming said expenses been met. This test requires: (1) fixing of a right to income
as deduction for the taxable year 1986. As to the alleged or liability to pay; and (2) the availability of the
deficiency interest income and failure to withhold reasonable accurate determination of such income or
expanded withholding tax assessment, petitioner invoked liability.
the presumption that the assessment notices issued by
the BIR are valid. The all-events test requires the right to income or liability
be fixed, and the amount of such income or liability be
The issue for resolution is whether the Court of Appeals determined with reasonable accuracy. However, the test
correctly: (1) sustained the deduction of the expenses for does not demand that the amount of income or liability
professional and security services from ICC’s gross be known absolutely, only that a taxpayer has at his
income; and (2) held that ICC did not understate its disposal the information necessary to compute the
interest income from the promissory notes of Realty amount with reasonable accuracy. The all-events test is
Investment, Inc; and that ICC withheld the required 1% satisfied where computation remains uncertain, if its basis
withholding tax from the deductions for security services. is unchangeable; the test is satisfied where a
computation may be unknown, but is not as much as
The requisites for the deductibility of ordinary and unknowable, within the taxable year. The amount of
necessary trade, business, or professional expenses, like liability does not have to be determined exactly; it must
expenses paid for legal and auditing services, are: (a) the be determined with "reasonable accuracy." Accordingly,
expense must be ordinary and necessary; (b) it must have the term "reasonable accuracy" implies something less
been paid or incurred during the taxable year; (c) it must than an exact or completely accurate amount.[15]
have been paid or incurred in carrying on the trade or
business of the taxpayer; and (d) it must be supported by The propriety of an accrual must be judged by the facts
receipts, records or other pertinent papers.11 that a taxpayer knew, or could reasonably be expected
to have known, at the closing of its books for the taxable
The requisite that it must have been paid or incurred year.[16] Accrual method of accounting presents largely
during the taxable year is further qualified by Section 45 a question of fact; such that the taxpayer bears the
of the National Internal Revenue Code (NIRC) which burden of proof of establishing the accrual of an item of
states that: "[t]he deduction provided for in this Title shall income or deduction.17
Corollarily, it is a governing principle in taxation that tax 1986. Hence, per Revenue Audit Memorandum Order No.
exemptions must be construed in strictissimi juris against 1-2000, they cannot be validly deducted from its gross
the taxpayer and liberally in favor of the taxing authority; income for the said year and were therefore properly
and one who claims an exemption must be able to justify disallowed by the BIR.
the same by the clearest grant of organic or statute law.
An exemption from the common burden cannot be As to the expenses for security services, the records show
permitted to exist upon vague implications. And since a that these expenses were incurred by ICC in 1986 20and
deduction for income tax purposes partakes of the could therefore be properly claimed as deductions for
nature of a tax exemption, then it must also be strictly the said year.
Anent the purported understatement of interest income
In the instant case, the expenses for professional fees from the promissory notes of Realty Investment, Inc., we
consist of expenses for legal and auditing services. The sustain the findings of the CTA and the Court of Appeals
expenses for legal services pertain to the 1984 and 1985 that no such understatement exists and that only simple
legal and retainer fees of the law firm Bengzon Zarraga interest computation and not a compounded one should
Narciso Cudala Pecson Azcuna & Bengson, and for have been applied by the BIR. There is indeed no
reimbursement of the expenses of said firm in connection stipulation between the latter and ICC on the application
with ICC’s tax problems for the year 1984. As testified by of compounded interest.21 Under Article 1959 of the Civil
the Treasurer of ICC, the firm has been its counsel since Code, unless there is a stipulation to the contrary, interest
the 1960’s.19 From the nature of the claimed deductions due should not further earn interest.
and the span of time during which the firm was retained,
ICC can be expected to have reasonably known the
Likewise, the findings of the CTA and the Court of
retainer fees charged by the firm as well as the
Appeals that ICC truly withheld the required withholding
compensation for its legal services. The failure to
tax from its claimed deductions for security services and
determine the exact amount of the expense during the
remitted the same to the BIR is supported by payment
taxable year when they could have been claimed as
order and confirmation receipts.22 Hence, the Assessment
deductions cannot thus be attributed solely to the
Notice for deficiency expanded withholding tax was
delayed billing of these liabilities by the firm. For one, ICC,
properly cancelled and set aside.
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 In sum, Assessment Notice No. FAS-1-86-90-000680 in the
another, it could have reasonably determined the amount of P333,196.86 for deficiency income tax should
amount of legal and retainer fees owing to its familiarity be cancelled and set aside but only insofar as the
with the rates charged by their long time legal consultant. claimed deductions of ICC for security services. Said
Assessment is valid as to the BIR’s disallowance of ICC’s
expenses for professional services. The Court of Appeal’s
As previously stated, the accrual method presents largely
cancellation of Assessment Notice No. FAS-1-86-90-000681
a question of fact and that the taxpayer bears the
in the amount of P4,897.79 for deficiency expanded
burden of establishing the accrual of an expense or
withholding tax, is sustained.
income. However, ICC failed to discharge this burden. As
to when the firm’s performance of its services in
connection with the 1984 tax problems were completed, WHEREFORE, the petition is PARTIALLY GRANTED. The
or whether ICC exercised reasonable diligence to inquire September 30, 2005 Decision of the Court of Appeals in
about the amount of its liability, or whether it does or CA-G.R. SP No. 78426, is AFFIRMED with the
does not possess the information necessary to compute MODIFICATION that Assessment Notice No. FAS-1-86-90-
the amount of said liability with reasonable accuracy, are 000680, which disallowed the expense deduction of
questions of fact which ICC never established. It simply Isabela Cultural Corporation for professional and security
relied on the defense of delayed billing by the firm and services, is declared valid only insofar as the expenses for
the company, which under the circumstances, is not the professional fees of SGV & Co. and of the law firm,
sufficient to exempt it from being charged with Bengzon Zarraga Narciso Cudala Pecson Azcuna &
knowledge of the reasonable amount of the expenses for Bengson, are concerned. The decision is affirmed in all
legal and auditing services. other respects.

In the same vein, the professional fees of SGV & Co. for The case is remanded to the BIR for the computation of
auditing the financial statements of ICC for the year 1985 Isabela Cultural Corporation’s liability under Assessment
cannot be validly claimed as expense deductions in Notice No. FAS-1-86-90-000680.
1986. This is so because ICC failed to present evidence
showing that even with only "reasonable accuracy," as SO ORDERED.
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 BANK OF COMMERCE, respondent.
the claimed expense deductions for the professional
services were allowable deductions for the taxable year
DECISION receipts must be an allowable exclusion under the Tax
Code and its pertinent implementing Rules and
CALLEJO, SR., J.: Regulations. Moreover, it must be supported by
This is a petition for review on certiorari of the
Decision[1] of the Court of Appeals (CA) in CA-G.R. SP No. 7. Petitioner must likewise prove that the alleged
52706, affirming the ruling of the Court of Tax Appeals refundable/creditable gross receipt taxes were neither
(CTA)[2] in CTA Case No. 5415. automatically applied as tax credit against its tax liability
The facts of the case are undisputed. for the succeeding quarter/s of the succeeding year nor
included as creditable taxes declared and applied to the
In 1994 and 1995, the respondent Bank of succeeding taxable year/s;
Commerce derived passive income in the form of
interests or discounts from its investments in government 8. Claims for tax refund/credit are construed in strictissimi
securities and private commercial papers. On several juris against the taxpayer as it partakes the nature of an
occasions during the said period, it paid 5% gross receipts exemption from tax and it is incumbent upon the
tax on its income, as reflected in its quarterly percentage petitioner to prove that it is entitled thereto under the law.
tax returns. Included therein were the respondent banks Failure on the part of the petitioner to prove the same is
passive income from the said investments amounting fatal to its claim for tax refund/credit;
to P85,384,254.51, which had already been subjected to
a final tax of 20%.
9. Furthermore, petitioner must prove that it has complied
Meanwhile, on January 30, 1996, the CTA rendered with the provision of Section 230 (now Section 229) of the
judgment in Asia Bank Corporation v. Commissioner of Tax Code, as amended.[3]
Internal Revenue, CTA Case No. 4720, holding that the
20% final withholding tax on interest income from banks The CTA summarized the issues to be resolved as
does not form part of taxable gross receipts for Gross follows: whether or not the final income tax withheld
Receipts Tax (GRT) purposes. The CTA relied on Section should form part of the gross receipts[4] of the taxpayer for
4(e) of Revenue Regulations (Rev. Reg.) No. 12-80. GRT purposes; and whether or not the respondent bank
was entitled to a refund of P853,842.54.[5]
Relying on the said decision, the respondent bank
filed an administrative claim for refund with the The respondent bank averred that for purposes of
Commissioner of Internal Revenue on July 19, 1996. It computing the 5% gross receipts tax, the final withholding
claimed that it had overpaid its gross receipts tax for 1994 tax does not form part of gross receipts.[6] On the other
to 1995 by P853,842.54, computed as follows: hand, while the Commissioner conceded that the Court
defined gross receipts as all receipts of taxpayers
Gross receipts subjected to excluding those which have been especially earmarked
Final Tax Derived from Passive by law or regulation for the government or some person
Investment P85,384,254.51 other than the taxpayer in CIR v. Manila Jockey Club,
x 20% Inc.,[7] he claimed that such definition was applicable
20% Final Tax Withheld 17,076,850.90 only to a proprietor of an amusement place, not a
at Source x 5% banking institution which is an entirely different entity
P 853,842.54 altogether. As such, according to the Commissioner, the
ruling of the Court in Manila Jockey Club was
Before the Commissioner could resolve the claim, inapplicable.
the respondent bank filed a petition for review with the In its Decision dated April 27, 1999, the CTA by a
CTA, lest it be barred by the mandatory two-year majority decision[8] partially granted the petition and
prescriptive period under Section 230 of the Tax Code ordered that the amount of P355,258.99 be refunded to
(now Section 229 of the Tax Reform Act of 1997). the respondent bank. Thefallo of the decision reads:
In his answer to the petition, the Commissioner
interposed the following special and affirmative defenses: WHEREFORE, in view of all the foregoing, respondent is
hereby ORDERED to REFUND in favor of petitioner Bank of
5. The alleged refundable/creditable gross receipts taxes Commerce the amount of P355,258.99 representing
were collected and paid pursuant to law and pertinent validly proven erroneously withheld taxes from interest
BIR implementing rules and regulations; hence, the same income derived from its investments in government
are not refundable. Petitioner must prove that the income securities for the years 1994 and 1995.[9]
from which the refundable/creditable taxes were paid
from, were declared and included in its gross income In ruling for respondent bank, the CTA relied on the
during the taxable year under review; ruling of the Court in Manila Jockey Club, and held that
the term gross receipts excluded those which had been
6. Petitioners allegation that it erroneously and excessively especially earmarked by law or regulation for the
paid its gross receipt tax during the year under review government or persons other than the taxpayer. The CTA
does not ipso facto warrant the refund/credit. Petitioner also cited its rulings in China Banking Corporation
must prove that the exclusions claimed by it from its gross v. CIR[10] and Equitable Banking Corporation v. CIR.[11]
The CTA ratiocinated that the aforesaid amount The Commissioner now assails the said decision
of P355,258.99 represented the claim of the respondent before this Court, contending that:
bank, which was filed within the two-year mandatory
prescriptive period and was substantiated by material THE COURT OF APPEALS ERRED IN HOLDING THAT THE 20%
and relevant evidence. The CTA applied Section 204(3) FINAL WITHHOLDING TAX ON BANKS INTEREST INCOME
of the National Internal Revenue Code (NIRC).[12] DOES NOT FORM PART OF THE TAXABLE GROSS RECEIPTS
The Commissioner then filed a petition for review IN COMPUTING THE 5% GROSS RECEIPTS TAX (GRT, for
under Rule 43 of the Rules of Court before the CA, brevity).[17]
alleging that:
The petitioner avers that the reliance by the CTA
(1) There is no provision of law which excludes the and the CA on Section 4(e) of Rev. Reg. No. 12-80 is
20% final income tax withheld under Section misplaced; the said provision merely authorizes the
50(a) of the Tax Code in the computation of determination of the amount of gross receipts based on
the 5% gross receipts tax. the taxpayers method of accounting under then Section
37 (now Section 43) of the Tax Code. The petitioner
asserts that the said provision ceased to exist as of
(2) The Tax Court erred in applying the ruling in October 15, 1984, when Rev. Reg. No. 17-84 took effect.
Collector of Internal Revenue vs. Manila Jockey The petitioner further points out that under paragraphs
Club (108 Phil. 821) in the resolution of the legal 7(a) and (c) of Rev. Reg. No. 17-84, interest income of
issues involved in the instant case.[13] financial institutions (including banks) subject to
withholding tax are included as part of the gross receipts
The Commissioner reiterated his stand that the ruling upon which the gross receipts tax is to be imposed. Citing
of this Court in Manila Jockey Club, which was affirmed the ruling of the CA in Commissioner of Internal Revenue
in Visayan Cebu Terminal Co., Inc. v. Commissioner of v. Asianbank Corporation[18] (which likewise cited Bank of
Internal Revenue,[14] is not decisive. He averred that the America NT & SA v. Court of Appeals, [19]) the petitioner
factual milieu in the said case is different, involving as it posits that in computing the 5% gross receipts tax, the
did the wager fund. The Commissioner further pointed out income need not be actually received. For income to
that in Manila Jockey Club, the Court ruled that the race form part of the taxable gross receipts, constructive
tracks commission did not form part of the gross receipts, receipt is enough. The petitioner is, likewise, adamant in
and as such were not subjected to the 20% amusement his claim that the final withholding tax from the
tax. On the other hand, the issue in Visayan Cebu respondent banks income forms part of the taxable gross
Terminal was whether or not the gross receipts receipts for purposes of computing the 5% of gross
corresponding to 28% of the total gross income of the receipts tax. The petitioner posits that the ruling of this
service contractor delivered to the Bureau of Customs Court in Manila Jockey Club is not decisive of the issue in
formed part of the gross receipts was subject to 3% of this case.
contractors tax under Section 191 of the Tax Code. It was
further pointed out that the respondent bank, on the The petition is meritorious.
other hand, was a banking institution and not a The issues in this case had been raised and resolved
contractor. The petitioner insisted that the term gross by this Court in China Banking Corporation v. Court of
receipts is self-evident; it includes all items of income of Appeals,[20] and CIR v. Solidbank Corporation.[21]
the respondent bank regardless of whether or not the
same were allocated or earmarked for a specific Section 27(D)(1) of the Tax Code reads:
purpose, to distinguish it from net receipts.

On August 14, 2001, the CA rendered judgment (D) Rates of Tax on Certain Passive Incomes.
dismissing the petition. Citing Sections 51 and 58(A) of the
NIRC, Section 4(e) of Rev. Reg. No. 12-80[15] and the ruling (1) Interest from Deposits and Yield or any other Monetary
of this Court inManila Jockey Club, the CA held that Benefit from Deposit Substitutes and from Trust Funds and
the P17,076,850.90 representing the final withholding tax Similar Arrangements, and Royalties. A final tax at the
derived from passive investments subjected to final tax rate of twenty percent (20%) is hereby imposed upon the
should not be construed as forming part of the gross amount of interest on currency bank deposit and yield or
receipts of the respondent bank upon which the 5% gross any other monetary benefit from deposit substitutes and
receipts tax should be imposed. The CA declared that from trust funds and similar arrangements received by
the final withholding tax in the amount of P17,768,509.00 domestic corporations, and royalties, derived from
was a trust fund for the government; hence, does not sources within the Philippines: Provided, however, That
form part of the respondents gross receipts. The legal interest income derived by a domestic corporation from
ownership of the amount had already been vested in the a depository bank under the expanded foreign currency
government. Moreover, the CA declared, the respondent deposit system shall be subject to a final income tax at
did not reap any benefit from the said amount. As such, the rate of seven and one-half percent (7%) of such
subjecting the said amount to the 5% gross receipts tax interest income.
would result in double taxation. The appellate court
further cited CIR v. Tours Specialists, Inc.,[16] and declared On the other hand, Section 57(A)(B) of the Tax Code
that the ruling of the Court in Manila Jockey Club was authorizes the withholding of final tax on certain income
decisive of the issue. creditable at source:
SEC. 57. Withholding of Tax at Source. Provided, however, That in case the maturity period
referred to in paragraph (a) is shortened thru pre-
(A) Withholding of Final Tax on Certain Incomes. Subject termination, then the maturity period shall be reckoned
to rules and regulations, the Secretary of Finance may to end as of the date of pre-termination for purposes of
promulgate, upon the recommendation of the classifying the transaction as short, medium or long-term
Commissioner, requiring the filing of income tax return by and the correct rate of tax shall be applied accordingly.
certain income payees, the tax imposed or prescribed by
Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), Nothing in this Code shall preclude the Commissioner
25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1), 27(D)(2), from imposing the same tax herein provided on persons
27(D)(3), 27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), performing similar banking activities.
28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3),
28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 The Tax Code does not define gross receipts. Absent
of this Code on specified items of income shall be any statutory definition, the Bureau of Internal Revenue
withheld by payor-corporation and/or person and paid in has applied the term in its plain and ordinary meaning.[23]
the same manner and subject to the same conditions as
provided in Section 58 of this Code. In National City Bank v. CIR,[24] the CTA held that
gross receipts should be interpreted as the whole amount
(B) Withholding of Creditable Tax at Source. The Secretary received as interest, without deductions; otherwise, if
of Finance may, upon the recommendation of the deductions were to be made from gross receipts, it would
Commissioner, require the withholding of a tax on the be considered as net receipts. The CTA changed course,
items of income payable to natural or juridical persons, however, when it promulgated its decision in Asia Bank; it
residing in the Philippines, by payor-corporation/persons applied Section 4(e) of Rev. Reg. No. 12-80 and the ruling
as provided for by law, at the rate of not less than one of this Court in Manila Jockey Club, holding that the 20%
percent (1%) but not more than thirty-two percent (32%) final withholding tax on the petitioner banks interest
thereof, which shall be credited against the income tax income should not form part of its taxable gross receipts,
liability of the taxpayer for the taxable year. since the final tax was not actually received by the
petitioner bank but went to the coffers of the
The tax deducted and withheld by withholding
agents under the said provision shall be held as a special The Court agrees with the contention of the
fund in trust for the government until paid to the petitioner that the appellate courts reliance on Rev. Reg.
collecting officer.[22] No. 12-80, the rulings of the CTA in Asia Bank, and of this
Court in Manila Jockey Club has no legal and factual
Section 121 (formerly Section 119) of the Tax Code bases. Indeed, the Court ruled in China Banking
provides that a tax on gross receipts derived from sources Corporation v. Court of Appeals[25] that:
within the Philippines by all banks and non-bank financial
intermediaries shall be computed in accordance with the
schedules therein: In Far East Bank & Trust Co. v. Commissioner and Standard
Chartered Bank v. Commissioner, both promulgated on
16 November 2001, the tax court ruled that the final
(a) On interest, commissions and discounts from lending withholding tax forms part of the banks gross receipts in
activities as well as income from financial leasing, on the computing the gross receipts tax. The tax court held that
basis of remaining maturities of instruments from which Section 4(e) of Revenue Regulations No. 12-80 did not
such receipts are derived: prescribe the computation of the amount of gross
receipts but merely authorized the determination of the
Short-term maturity (not in excess of two (2) years) 5% amount of gross receipts on the basis of the method of
accounting being used by the taxpayer.
Medium-term maturity (over two (2) years but
not exceeding four (4) years) 3% The word gross must be used in its plain and ordinary
meaning. It is defined as whole, entire, total, without
Long-term maturity deduction. A common definition is without
deduction.[26] Gross is also defined as taking in the whole;
having no deduction or abatement; whole, total as
(1) Over four (4) years but not exceeding
opposed to a sum consisting of separate or specified
seven (7) years 1%
parts.[27] Gross is the antithesis of net.[28] Indeed, in China
Banking Corporation v. Court of Appeals, [29] the Court
(2) Over seven (7) years 0% defined the term in this wise:

(b) On dividends 0% As commonly understood, the term gross receipts means

the entire receipts without any deduction. Deducting any
(c) On royalties, rentals of property, real or personal, amount from the gross receipts changes the result, and
profits from exchange and all other items the meaning, to net receipts. Any deduction from gross
treated receipts is inconsistent with a law that mandates a tax on
as gross income under Section 32 of this Code 5% gross receipts, unless the law itself makes an exception.
As explained by the Supreme Court of Pennsylvania
in Commonwealth of Pennsylvania v. Koppers Company, gross receipts, failing which, the claim of deduction has
Inc., - no leg to stand on. Moreover, where such an exception is
claimed, the statute is construed strictly in favor of the
Highly refined and technical tax concepts have been taxing authority. The exemption must be clearly and
developed by the accountant and legal technician unambiguously expressed in the statute, and must be
primarily because of the impact of federal income tax clearly established by the taxpayer claiming the right
legislation. However, this in no way should affect or thereto. Thus, taxation is the rule and the claimant must
control the normal usage of words in the construction of show that his demand is within the letter as well as the
our statutes; and we see nothing that would require us spirit of the law.[30]
not to include the proceeds here in question in the gross In this case, there is no law which allows the
receipts allocation unless statutorily such inclusion is deduction of 20% final tax from the respondent banks
prohibited. Under the ordinary basic methods of handling interest income for the computation of the 5% gross
accounts, the term gross receipts, in the absence of any receipts tax. On the other hand, Section 8(a)(c), Rev.
statutory definition of the term, must be taken to include Reg. No. 17-84 provides that interest earned on Philippine
the whole total gross receipts without any deductions, x x bank deposits and yield from deposit substitutes are
x. [Citations omitted] (Emphasis supplied) included as part of the tax base upon which the gross
receipts tax is imposed. Such earned interest refers to the
Likewise, in Laclede Gas Co. v. City of St. Louis, the gross interest without deduction since the regulations do
Supreme Court of Missouri held: not provide for any such deduction. The gross interest,
without deduction, is the amount the borrower pays, and
The word gross appearing in the term gross receipts, as the income the lender earns, for the use by the borrower
used in the ordinance, must have been and was there of the lenders money. The amount of the final tax plainly
used as the direct antithesis of the word net. In its usual covers for the interest earned and is consequently part of
and ordinary meaning gross receipts of a business is the the taxable gross receipt of the lender.[31]
whole and entire amount of the receipts without
The bare fact that the final withholding tax is a
deduction, x x x. On the contrary, net receipts usually are
special trust fund belonging to the government and that
the receipts which remain after deductions are made
the respondent bank did not benefit from it while in
from the gross amount thereof of the expenses and cost
custody of the borrower does not justify its exclusion from
of doing business, including fixed charges and
the computation of interest income. Such final
depreciation. Gross receipts become net receipts after
withholding tax covers for the respondent banks income
certain proper deductions are made from the gross. And
and is the amount to be used to pay its tax liability to the
in the use of the words gross receipts, the instant
government. This tax, along with the creditable
ordinance, of course, precluded plaintiff from first
withholding tax, constitutes payment which would
deducting its costs and expenses of doing business, etc.,
extinguish the respondent banks obligation to the
in arriving at the higher base figure upon which it must
government. The bank can only pay the money it owns,
pay the 5% tax under this ordinance. (Emphasis supplied)
or the money it is authorized to pay.[32]

Absent a statutory definition, the term gross receipts is In the same vein, the respondent banks reliance on
understood in its plain and ordinary meaning. Words in a Section 4(e) of Rev. Reg. No. 12-80 and the ruling of the
statute are taken in their usual and familiar signification, CTA in Asia Bank is misplaced. The Courts discussion
with due regard to their general and popular use. The in China Banking Corporation[33] is instructive on this
Supreme Court of Hawaii held in Bishop Trust Company v. score:
Burns that -
CBC also relies on the Tax Courts ruling in Asia Bank that
xxx It is fundamental that in construing or interpreting a Section 4(e) of Revenue Regulations No. 12-80 authorizes
statute, in order to ascertain the intent of the legislature, the exclusion of the final tax from the banks taxable gross
the language used therein is to be taken in the generally receipts. Section 4(e) provides that:
accepted and usual sense. Courts will presume that the
words in a statute were used to express their meaning in Sec. 4. x x x
common usage. This principle is equally applicable to a
tax statute. [Citations omitted] (Emphasis supplied)
(e) Gross receipts tax on banks, non-bank financial
intermediaries, financing companies, and other non-bank
The Court, likewise, declared that Section 121 of the financial intermediaries not performing quasi-banking
Tax Code expressly subjects interest income of banks to functions. - The rates of taxes to be imposed on the gross
the gross receipts tax. Such express inclusion of interest receipts of such financial institutions shall be based on all
income in taxable gross receipts creates items of income actually received. Mere accrual shall not
a presumption that the entire amount of the interest be considered, but once payment is received on such
income, without any deduction, is subject to the gross accrual or in cases of prepayment, then the amount
receipts tax. Indeed, there is a presumption that receipts actually received shall be included in the tax base of
of a person engaging in business are subject to the gross such financial institutions, as provided hereunder: x x x.
receipts tax. Such presumption may only be overcome by (Emphasis supplied by Tax Court)
pointing to a specific provision of law allowing such
deduction of the final withholding tax from the taxable
Section 4(e) states that the gross receipts shall be based Act No. 309 and Executive Order No. 320 apportioned
on all items of income actually received. The tax court the total amount of the bets in horse races as follows:
in Asia Bank concluded that it is but logical to infer that
the final tax, not having been received by petitioner but 87 % as dividends to holders of winning tickets, 12 % as
instead went to the coffers of the government, should no commission of the Manila Jockey Club, of which % was
longer form part of its gross receipts for the purpose of assigned to the Board of Races and 5% was distributed as
computing the GRT. prizes for owners of winning horses and authorized
bonuses for jockeys.
The Tax Court erred glaringly in interpreting Section 4(e) of
Revenue Regulations No. 12-80. Income may be taxable A subsequent law, Republic Act No. 1933 (RA No. 1933),
either at the time of its actual receipt or its accrual, amended the sharing by ordering the distribution of the
depending on the accounting method of the taxpayer. bets as follows:
Section 4(e) merely provides for an exception to the rule,
making interest income taxable for gross receipts tax
Sec. 19. Distribution of receipts. The total wager funds or
purposes only upon actual receipt. Interest is accrued,
gross receipts from the sale of pari-mutuel tickets shall
and not actually received, when the interest is due and
be apportioned as follows: eighty-seven and one-half per
demandable but the borrower has not actually paid and
centum shall be distributed in the form of dividends
remitted the interest, whether physically or constructively.
among the holders of win, place and show horses, as the
Section 4(e) does not exclude accrued interest income
case may be, in the regular races; six and one-half per
from gross receipts but merely postpones its inclusion until
centum shall be set aside as the commission of the
actual payment of the interest to the lending bank. This is
person, racetrack, racing club, or any other entity
clear when Section 4(e) states that [m]ere accrual shall
conducting the races; five and one-half per centum shall
not be considered, but once payment is received on
be set aside for the payment of stakes or prizes for win,
such accrual or in case of prepayment, then the amount
place and show horses and authorized bonuses for
actually received shall be included in the tax base of
jockeys; and one-half per centum shall be paid to a
such financial institutions x x x.
special fund to be used by the Games and Amusements
Board to cover its expenses and such other purposes
Actual receipt of interest income is not limited to physical authorized under this Act. xxx. (Emphasis supplied)
receipt. Actual receipt may either be physical receipt or
constructive receipt. When the depository bank withholds
Under the distribution of receipts expressly mandated in
the final tax to pay the tax liability of the lending bank,
Section 19 of RA No. 1933, the gross receipts apportioned
there is prior to the withholding a constructive receipt by
to Manila Jockey Club referred only to its own 6 %
the lending bank of the amount withheld. From the
commission. There is no dispute that the 5 % share of the
amount constructively received by the lending bank, the
horse-owners and jockeys, and the % share of the Games
depository bank deducts the final withholding tax and
and Amusements Board, do not form part of Manila
remits it to the government for the account of the lending
Jockey Clubs gross receipts. RA No. 1933 took effect on
bank. Thus, the interest income actually received by the
22 June 1957, three years before the Court
lending bank, both physically and constructively, is the
decided Manila Jockey Club on 30 June 1960.
net interest plus the amount withheld as final tax.

Even under the earlier law, Manila Jockey Club did not
The concept of a withholding tax on income obviously
own the entire 12 % commission. Manila Jockey Club
and necessarily implies that the amount of the tax
owned, and could keep and use, only 7% of the total
withheld comes from the income earned by the
bets. Manila Jockey Club merely held in trust the balance
taxpayer. Since the amount of the tax withheld
of 5 % for the benefit of the Board of Races and the
constitutes income earned by the taxpayer, then that
winning horse-owners and jockeys, the real owners of the
amount manifestly forms part of the taxpayers gross
5 1/2 % share.
receipts. Because the amount withheld belongs to the
taxpayer, he can transfer its ownership to the
government in payment of his tax liability. The amount The Court in Manila Jockey Club quoted with approval
withheld indubitably comes from income of the taxpayer, the following Opinion of the Secretary of Justice
and thus forms part of his gross receipts. made prior to RA No. 1933:

The Court went on to explain in that case that far There is no question that the Manila Jockey Club, Inc.
from supporting the petitioners contention, its ruling owns only 7-1/2% [sic] of the bets registered by the
in Manila Jockey Club, in fact even buttressed the Totalizer. This portion represents its share or commission in
contention of the Commissioner. Thus: 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% [sic] does not belong
CBC cites Collector of Internal Revenue v. Manila Jockey
to the club. It is merely held in trust for distribution as prizes
Club as authority that the final withholding tax on interest
to the owners of winning horses. It is destined for no other
income does not form part of a banks gross receipts
object than the payment of prizes and the club cannot
because the final tax is earmarked by regulation for the
otherwise appropriate this portion without incurring
government. CBCs reliance on the Manila Jockey Club is
liability to the owners of winning horses. It can not be
misplaced. In this case, the Court stated that Republic
considered as an item of expense because the sum used
for the payment of prizes is not taken from the funds of the national government under the Tax Code and
the club but from a certain portion of the total bets operate within the same Philippine jurisdiction for the
especially earmarked for that purpose. (Emphasis same purpose of raising revenues, the taxing periods they
supplied) affect are different. The FWT is deducted and withheld as
soon as the income is earned, and is paid after
Consequently, the Court ruled that the 5 % balance of every calendar quarter in which it is earned. On the other
the commission, not being owned by Manila Jockey hand, the GRT is neither deducted nor withheld, but is
Club, did not form part of its gross receipts for purposes of paid only after every taxable quarter in which it is earned.
the amusement tax. Manila Jockey Club correctly paid
the amusement tax based only on its own 7% commission Third, these two taxes are of different kinds or characters.
under RA No. 309 and Executive Order No. 320. The FWT is an income tax subject to withholding, while the
GRT is a percentage tax not subject to withholding.
Manila Jockey Club does not support CBCs contention
but rather the Commissioners position. The Court ruled In short, there is no double taxation, because there is no
in Manila Jockey Club that receipts not owned by the taxing twice, by the same taxing authority, within the
Manila Jockey Club but merely held by it in trust did not same jurisdiction, for the same purpose, in different taxing
form part of Manila Jockey Clubs gross receipts. periods, some of the property in the territory. Subjecting
Conversely, receipts owned by the Manila Jockey Club interest income to a 20% FWT and including it in the
would form part of its gross receipts.[34] computation of the 5% GRT is clearly not double taxation.

We reverse the ruling of the CA that subjecting the IN LIGHT OF THE FOREGOING, the petition is
Final Withholding Tax (FWT) to the 5% of gross receipts tax GRANTED. The decision of the Court of Appeals in CA-
would result in double taxation. In CIR v. Solidbank G.R. SP No. 52706 and that of the Court of Tax Appeals in
Corporation,[35] we ruled, thus: CTA Case No. 5415 are SET ASIDE and REVERSED. The CTA
is hereby ORDERED to DISMISS the petition of respondent
We have repeatedly said that the two taxes, subject of Bank of Commerce. No costs.
this litigation, are different from each other. The basis of SO ORDERED.
their imposition may be the same, but their natures are
different, thus leading us to a final point. Is there double

The Court finds none.

Double taxation means taxing the same property twice

when it should be taxed only once; that is, xxx taxing the
same person twice by the same jurisdiction for the same
thing. It is obnoxious when the taxpayer is taxed twice,
when it should be but once. Otherwise described as
direct duplicate taxation, the two taxes must be imposed
on the same subject matter, for the same purpose, by the
same taxing authority, within the same jurisdiction, during
the same taxing period; and they must be of the same
kind or character.

First, the taxes herein are imposed on two different

subject matters. The subject matter of the FWT is the
passive income generated in the form of interest on
deposits and yield on deposit substitutes, while the
subject matter of the GRT is the privilege of engaging in
the business of banking.

A tax based on receipts is a tax on business rather than

on the property; hence, it is an excise rather than a
property tax. It is not an income tax, unlike the FWT. In
fact, we have already held that one can be taxed for
engaging in business and further taxed differently for the
income derived therefrom. Akin to our ruling in Velilla v.
Posadas, these two taxes are entirely distinct and are
assessed under different provisions.

Second, although both taxes are national in scope

because they are imposed by the same taxing authority
G.R. No. L-21570 July 26, 1966
Net income per audited return P 3,287.81

LIMPAN INVESTMENT CORPORATION, petitioner, Add: Unallowable deductions:

AL., respondents.
(Sched. A) . . . . . . . . . . . . . . . . . . . .
Vicente L. San Luis for petitioner.
Office of the Solicitor General A. A. Alafriz, Assistant Excess Depreciation (Sched. B) . . . .
Solicitor General F. B. Rosete, Solicitor A. B. Afurong and P24,459.00
. . . . . . . . . . . . . 4,260.00
Atty. V. G. Saldajeno for respondents.
Net income per investigation P27,746.00
REYES, J.B.L., J.:
Tax due thereon P5,549.00

Appeal interposed by petitioner Limpan Investment Less: Amount already assessed 657.00
Corporation against a decision of the Court of Tax
Appeals, in its CTA Case No. 699, holding and ordering it Balance P4,892.00
(petitioner) to pay respondent Commissioner of Internal
Revenue the sums of P7,338.00 and P30,502.50, Add: 50% Surcharge 2,446.00
representing deficiency income taxes, plus 50% surcharge
and 1% monthly interest from June 30, 1959 to the date of
payment, with cost. 90-AR-C-1196-58/57

The facts of this case are: Net income per audited return P11,098.00

Add: Unallowable deductions:

Petitioner, a domestic corporation duly registered since
June 21, 1955, is engaged in the business of leasing real Undeclared Rental Receipt (Sched.
properties. It commenced actual business operations on A) . . . . . . . . P81,690.00
July 1, 1955. Its principal stockholders are the spouses
Isabelo P. Lim and Purificacion Ceñiza de Lim, who own Excess Depreciation (Sched. B) . . . .
and control ninety-nine per cent (99%) of its total paid-up . . . . . . . . . . . 16,338.00
capital. Its president and chairman of the board is the
same Isabelo P. Lim.1äwphï1.ñët Net income per investigation P109,126.00

Tax due thereon P22,555.00

Its real properties consist of several lots and buildings,
mostly situated in Manila and in Pasay City, all of which Less: Amount already assessed 2,220.00
were acquired from said Isabelo P. Lim and his mother,
Vicente Pantangco Vda. de Lim. Balance 20,335.00

Add: 50% Surcharge 10,167.50

Petitioner corporation duly filed its 1956 and 1957 income
tax returns, reporting therein net incomes of P3,287.81 DEFICIENCY TAX DUE P30,502.50
and P11,098.36, respectively, for which it paid the
corresponding taxes therefor in the sums of P657.00 and
P2,220.00. Petitioner corporation requested respondent
Commissioner of Internal Revenue to reconsider the
Sometime in 1958 and 1959, the examiners of the Bureau above assessment but the latter denied said request and
of Internal Revenue conducted an investigation of reiterated its original assessment and demand, plus 5%
petitioner's 1956 and 1957 income tax returns and, in the surcharge and the 1% monthly interest from June 30, 1959
course thereof, they discovered and ascertained that to the date of payment; hence, the corporation filed its
petitioner had underdeclared its rental incomes by petition for review before the Tax Appeals court,
P20,199.00 and P81,690.00 during these taxable years and questioning the correctness and validity of the above
had claimed excessive depreciation of its buildings in the assessment of respondent Commissioner of Internal
sums of P4,260.00 and P16,336.00 covering the same Revenue. It disclaimed having received or collected the
period. On the basis of these findings, respondent amount of P20,199.00, as unreported rental income for
Commissioner of Internal Revenue issued its letter- 1956, or any part thereof, reasoning out that 'the previous
assessment and demand for payment of deficiency owners of the leased building has (have) to collect part
income tax and surcharge against petitioner corporation, of the total rentals in 1956 to apply to their payment of
computed as follows: rental in the land in the amount of P21,630.00" (par. 11,
petition). It also denied having received or collected the
amount of P81,690.00, as unreported rental income for
90-AR-C-348-58/56 1957, or any part thereof, explaining that part of said
amount totalling P31,380.00 was not declared as income
in its 1957 tax return because its president, Isabelo P. Lim, personally interviewed the tenants of petitioner and
who collected and received P13,500.00 from certain found that these tenants had been regularly paying their
tenants, did not turn the same over to petitioner rentals to the collectors of either petitioner or its president,
corporation in said year but did so only in 1959; that a Isabelo P. Lim, but these payments were not declared in
certain tenant (Go Tong) deposited in court his rentals the corresponding returns; and that in applying rates of
amounting to P10,800.00, over which the corporation had depreciation to petitioner's buildings, he adopted Bulletin
no actual or constructive control; and that a sub-tenant "F" of the U.S. Federal Internal Revenue Service.
paid P4,200.00 which ought not be declared as rental
income. On the basis of the evidence, the Tax Court upheld
respondent Commissioner's assessment and demand for
Petitioner likewise alleged in its petition that the rates of deficiency income tax which, as above stated in the
depreciation applied by respondent Commissioner of its beginning of this opinion, petitioner has appealed to this
buildings in the above assessment are unfair and Court.
Petitioner corporation pursues, the same theory
Sole witness for petitioner corporation in the Tax Court advocated in the court below and assigns the following
was its Secretary-Treasurer, Vicente G. Solis, who alleged errors of the trial court in its brief, to wit:
admitted that it had omitted to report the sum of
P12,100.00 as rental income in its 1956 tax return and also I. The respondent Court erred in holding that the
the sum of P29,350.00 as rental income in its 1957 tax petitioner had an unreported rental income of
return. However, with respect to the difference between P20,199.00 for the year 1956.
this omitted income (P12,100.00) and the sum (P20,199.00)
found by respondent Commissioner as undeclared in
II. The respondent Court erred in holding that the
1956, petitioner corporation, through the same witness
petitioner had an unreported rental income of
(Solis), tried to establish that it did not collect or receive
P81,690.00 for the year 1957.
the same because, in view of the refusal of some tenants
to recognize the new owner, Isabelo P. Lim and Vicenta
Pantangco Vda. de Lim, the former owners, on one III. The respondent Court erred in holding that the
hand, and the same Isabelo P. Lim, as president of depreciation in the amount of P20,598.00
petitioner corporation, on the other, had verbally agreed claimed by petitioner for the years 1956 and 1957
in 1956 to turn over to petitioner corporation six per cent was excessive.
(6%) of the value of all its properties, computed at
P21,630.00, in exchange for whatever rentals the Lims and prays that the appealed decision be reversed.
may collect from the tenants. And, with respect to the
difference between the admittedly undeclared sum of This appeal is manifestly unmeritorious. Petitioner having
P29,350.00 and that found by respondent Commissioner admitted, through its own witness (Vicente G. Solis), that it
as unreported rental income, (P81,690.00) in 1957, the had undeclared more than one-half (1/2) of the amount
same witness Solis also tried to establish that petitioner (P12,100.00 out of P20,199.00) found by the BIR examiners
corporation did not receive or collect the same but that as unreported rental income for the year 1956 and more
its president, Isabelo P. Lim, collected part thereof and than one-third (1/3) of the amount (P29,350.00 out of
may have reported the same in his own personal income P81,690.00) ascertained by the same examiners as
tax return; that same Isabelo P. Lim collected P13,500.00, unreported rental income for the year 1957, contrary to its
which he turned over to petitioner in 1959 only; that a original claim to the revenue authorities, it was incumbent
certain tenant (Go Tong deposited in court his rentals upon it to establish the remainder of its pretensions by
(P10,800.00), over which the corporation had no actual or clear and convincing evidence, that in the case is
constructive control and which were withdrawn only in lacking.
1958; and that a sub-tenant paid P4,200.00 which ought
not be declared as rental income in 1957.
With respect to the balance, which petitioner denied
having unreported in the disputed tax returns, the excuse
With regard to the depreciation which respondent that Isabelo P. Lim and Vicenta Pantangco Vda. de Lim
disallowed and deducted from the returns filed by retained ownership of the lands and only later transferred
petitioner, the same witness tried to establish that some of or disposed of the ownership of the buildings existing
its buildings are old and out of style; hence, they are thereon to petitioner corporation, so as to justify the
entitled to higher rates of depreciation than those alleged verbal agreement whereby they would turn over
adopted by respondent in his assessment. to petitioner corporation six percent (6%) of the value of
its properties to be applied to the rentals of the land and
Isabelo P. Lim was not presented as witness to in exchange for whatever rentals they may collect from
corroborate the above testimony of Vicente G. Solis. the tenants who refused to recognize the new owner or
vendee of the buildings, is not only unusual but
On the other hand, Plaridel M. Mingoa, one of the BIR uncorroborated by the alleged transferors, or by any
examiners who personally conducted the investigation of document or unbiased evidence. Hence, the first
the 1956 and 1957 income tax returns of petitioner assigned error is without merit.
corporation, testified for the respondent that he
As to the second assigned error, petitioner's denial and
explanation of the non-receipt of the remaining
unreported income for 1957 is not substantiated by
satisfactory corroboration. As above noted, Isabelo P. Lim
was not presented as witness to confirm accountant Solis
nor was his 1957 personal income tax return submitted in
court to establish that the rental income which he
allegedly collected and received in 1957 were reported

The withdrawal in 1958 of the deposits in court pertaining

to the 1957 rental income is no sufficient justification for
the non-declaration of said income in 1957, since the
deposit was resorted to due to the refusal of petitioner to
accept the same, and was not the fault of its tenants;
hence, petitioner is deemed to have constructively
received such rentals in 1957. The payment by the sub-
tenant in 1957 should have been reported as rental
income in said year, since it is income just the same
regardless of its source.

On the third assigned error, suffice it to state that this

Court has already held that "depreciation is a question of
fact and is not measured by theoretical yardstick, but
should be determined by a consideration of actual facts",
and the findings of the Tax Court in this respect should not
be disturbed when not shown to be arbitrary or in abuse
of discretion (Commissioner of Internal Revenue vs. Priscila
Estate, Inc., et al., L-18282, May 29, 1964), and petitioner
has not shown any arbitrariness or abuse of discretion in
the part of the Tax Court in finding that petitioner claimed
excessive depreciation in its returns. It appearing that the
Tax Court applied rates of depreciation in accordance
with Bulletin "F" of the U.S. Federal Internal Revenue
Service, which this Court pronounced as having strong
persuasive effect in this jurisdiction, for having been the
result of scientific studies and observation for a long
period in the United States, after whose Income Tax Law
ours is patterned (M. Zamora vs. Collector of internal
Revenue & Collector of Internal Revenue vs. M. Zamora;
E. Zamora vs. Collector of Internal Revenue and Collector
of Internal Revenue vs. E. Zamora, Nos. L-15280, L-15290, L-
15289 and L-15281, May 31, 1963), the foregoing error is
devoid of merit.

Wherefore, the appealed decision should be, as it is

hereby, affirmed. With costs against petitioner-appellant,
Limpan Investment Corporation.