G.R. No.

L-19727 May 20, 1965

THE COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
PHOENIX ASSURANCE CO., LTD., respondent.

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

G.R. No. L-19903 May 20, 1965

PHOENIX ASSURANCE, CO., LTD., petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.

Office of the Solicitor General for petitioner-respondent Commissioner of Internal Revenue.

Sycip, Salazar, Luna & Associates and A. S. Monzon, B. V. Abela & J. M. Castillo for respondent-
petitioner Phoenix Assurance Co., Ltd.

BENGZON, J.P., J.:

From a judgment of the Court of Tax Appeals in C.T.A. Cases Nos. 305 and 543, consolidated
and jointly heard therein, these two appeals were taken. Since they involve the same facts and
interrelated issues, the appeals are herein decided together.

Phoenix Assurance Co., Ltd., a foreign insurance corporation organized under the laws of Great
Britain, is licensed to do business in the Philippines with head office in London. Through its head
office, it entered in London into worldwide reinsurance treaties with various foreign insurance
companies. It agree to cede a portion of premiums received on original insurances
underwritten by its head office, subsidiaries, and branch offices throughout the world, in
consideration for assumption by the foreign insurance companies of an equivalent portion of
the liability from such original insurances.1äwphï1.ñët

Pursuant to such reinsurance treaties, Phoenix Assurance Co., Ltd., ceded portions of the
premiums it earned from its underwriting business in the Philippines, as follows:

Year Amount Ceded

1952 P316,526.75

1953 P246,082.04

1954 P203,384.69

upon which the Commissioner of Internal Revenue, by letter of May 6, 1958, assessed the
following withholding tax:
 Year Withholding Tax

1952 P 75,966.42

1953 59,059.68

1954 48,812.32

Total P183,838.42
=============

On April 1, 1951, Phoenix Assurance Co., Ltd. filed its Philippine income tax return for 1950,
claiming therein, among others, a deduction of P37,147.04 as net addition to marine insurance
reserve equivalent to 40% of the gross marine insurance premiums received during the year.
The Commissioner of Internal Revenue disallowed P11,772.57 of such claim for deduction and
subsequently assessed against Phoenix Assurance Co., Ltd. the sum of P1,884.00 as deficiency
income tax. The disallowance resulted from the fixing by the Commissioner of the net addition
to the marine insurance reserve at 100% of the marine insurance premiums received during the
last three months of the year. The Commissioner assumed that "ninety and third, days are
approximately the length of time required before shipments reach their destination or before
claims are received by the insurance companies."

On April 1, 1953, Phoenix Assurance Co., Ltd. filed its Philippine income tax return for 1952,
declaring therein a deduction from gross income of P35,912.25 as part of the head office
expenses incurred for its Philippine business, computed at 5% on its gross Philippine income.

On August 30, 1955 it amended its income tax return for 1952 by excluding from its gross
income the amount of P316,526.75 representing reinsurance premiums ceded to foreign
reinsurers and further eliminating deductions corresponding to the coded premiums. The
amended return showed an income tax due in the amount of P2,502.00. The Commissioner of
Internal Revenue disallowed P15,826.35 of the claimed deduction for head office expenses and
assessed a deficiency tax of P5,667.00 on July 24, 1958.

On April 30, 1954, Phoenix Assurance Co., Ltd. filed its Philippine income tax return for 1953
and claimed therein a deduction from gross income of P33,070.88 as head office expenses
allocable to its Philippine business, equivalent to 5%, of its gross Philippine income. On August
30, 1955 it amended its 1953 income tax return to exclude from its gross income the amount of
P246,082.04 representing reinsurance premiums ceded to foreign reinsurers. At the same time,
it requested the refund of P23,409.00 as overpaid income tax for 1953. To avoid the
prescriptive period provided for in Section 306 of the Tax Code, it filed a petition for review on
April 11, 1956 in the Court of Tax Appeals praying for such refund. After verification of the
amended income tax return the Commissioner of Internal Revenue disallowed P12,304.10 of
the deduction representing head office expenses allocable to Philippine business thereby
reducing the refundable amount to P20,180.00.
On April 29, 1955, Phoenix Assurance Co., Ltd. filed its Philippine income tax return for 1954
claiming therein, among others, a deduction from gross income of P99,624.75 as head office
expenses allocable to its Philippine business, computed at 5% of its gross Philippine income. It
also excluded from its gross income the amount of P203,384.69 representing reinsurance
premiums ceded to foreign reinsurers not doing business in the Philippines.

On August 1, 1958 the Bureau of Internal Revenue released the following assessment for
deficiency income tax for the years 1952 and 1954 against Phoenix Assurance Co., Ltd.:

1952

Net income per audited return P 12,511.61

Unallowable deduction & additional income:

Overclaimed Head Office expenses:

Amount claimed . . . . . . . . .
P 35,912.25
...

Amount allowed . . . . . . . . .
20,085.90 P 15,826.35
...

Net income per investigation P 28,337.96

Tax due thereon P 5,667.00

===========

1954

Net income per audited P160,320.21

Unallowable deduction & additional income:

Overclaimed Head Office expenses:

Amount claimed . . . . . . . . .
P29,624.73
...

Amount allowed . . . . . . . . .
19,455.50 10,16.23
...

Net income per investigation P170,489.41

 Tax due thereon P 39,737.00

Less: amount already assessed 36,890.00

DEFICIENCY TAX DUE P 2,847.00

===========

The above assessment resulted from the disallowance of a portion of the deduction claimed by
Phoenix Assurance Co., Ltd. as head office expenses allocable to its business in the Philippines
fixed by the Commissioner at 5% of the net Philippine income instead of 5% of the gross
Philippine income as claimed in the returns.

Phoenix Assurance Co., Ltd. protested against the aforesaid assessments for withholding tax
and deficiency income tax. However, the Commissioner of Internal Revenue denied such
protest. Subsequently, Phoenix Assurance Co., Ltd. appealed to the Court of Tax Appeals. In a
decision dated February 14, 1962, the Court of Tax Appeals allowed in full the decision claimed
by Phoenix Assurance Co., Ltd. for 1950 as net addition to marine insurance reserve;
determined the allowable head office expenses allocable to Philippine business to be 5% of the
net income in the Philippines; declared the right of the Commissioner of Internal Revenue to
assess deficiency income tax for 1952 to have prescribed; absolved Phoenix Assurance Co., Ltd.
from payment of the statutory penalties for non-filing of withholding tax return; and, rendered
the following judgment:

WHEREFORE, petitioner Phoenix Assurance Company, Ltd. is hereby ordered to pay the
Commissioner of Internal Revenue the respective amounts of P75,966.42, P59,059.68
and P48,812.32, as withholding tax for the years 1952, 1953 and 1954, and P2,847.00 as
income tax for 1954, or the total sum of P186,685.42 within thirty (30) days from the
date this decision becomes final. Upon the other hand, the respondent Commissioner is
ordered to refund to petitioner the sum of P20,180.00 as overpaid income tax for 1953,
which sum is to be deducted from the total sum of P186,685.42 due as taxes.

If any amount of the tax is not paid within the time prescribed above, there shall be
collected a surcharge of 5% of the tax unpaid, plus interest at the rate of 1% a month
from the date of delinquency to the date of payment, provided that the maximum
amount that may be collected as interest shall not exceed the amount corresponding to
a period of three (3) years. Without pronouncement as to costs.

Phoenix Assurance Co., Ltd. and the Commissioner of Internal Revenue have appealed to this
Court raising the following issues: (1) Whether or not reinsurance premiums ceded to foreign
reinsurers not doing business in the Philippines pursuant to reinsurance contracts executed
abroad are subject to withholding tax; (2) Whether or not the right of the Commissioner of
Internal Revenue to assess deficiency income tax for the year 1952 against Phoenix Assurance
Co., Ltd., has prescribed; (3) Whether or not the deduction of claimed by the Phoenix Assurance
Co., Ltd.as net addition to reserve for the year 1950 is excessive; (4) Whether or not the
deductions claimed by Phoenix Assurance Co., Ltd. for head office expenses allocable to
Philippine business for the years 1952, 1953 and 1954 are excessive.

The question of whether or not reinsurance premiums ceded to foreign reinsurers not doing
business in the Philippines pursuant to contracts executed abroad are income from sources
within the Philippines subject to withholding tax under Sections 53 and 54 of the Tax Code has
already been resolved in the affirmative in British Traders' Insurance Co., Ltd.v. Commisioner of
Internal Revenue, L-20501, April 30, 1965. 1

We come to the issue of prescription. Phoenix Assurance Co., Ltd. filed its income tax return for
1952 on April 1, 1953 showing a loss of P199,583.93. It amended said return on August 30, 1955
reporting a tax liability of P2,502.00. On July 24, 1958, after examination of the amended
return, the Commissioner of Internal Revenue assessed deficiency income tax in the sum of
P5,667.00. The Court of Tax Appeals found the right of the Commissioner of Internal Revenue
barred by prescription, the same having been exercised more than five years from the date the
original return was filed. On the other hand, the Commissioner of Internal Revenue insists that
his right to issue the assessment has not prescribed inasmuch as the same was availed of
before the 5-year period provided for in Section 331 of the Tax Code expired, counting the
running of the period from August 30, 1955, the date when the amended return was filed.

Section 331 of the Tax Code, which limits the right of the Commissioner of Internal Revenue to
assess income tax within five years from the Filipino of the income tax return, states:

SEC. 331. Period of limitation upon assessment and collection. — Except as provided in
the succeeding section internal revenue taxes shall be assessed within five years after
the return was filed, and no proceeding in court without assessment for the collection
of such taxes shall be begun after the expiration of such period. For the purposes of this
section, a return filed before the last day prescribed by law for the filing thereof shall be
considered as filed on such last day: Provided, That this limitation shall not apply to
cases already investigated prior to the approval of this Code.

The question is: Should the running of the prescriptive period commence from the filing of the
original or amended return?

The Court of Tax Appears that the original return was a complete return containing
"information on various items of income and deduction from which respondent may
intelligently compute and determine the tax liability of petitioner, hence, the prescriptive
period should be counted from the filing of said original return. On the other hand, the
Commissioner of Internal Revenue maintains that:

"... the deficiency income tax in question could not possibly be determined, or assessed,
on the basis of the original return filed on April 1, 1953, for considering that the
declared loss amounted to P199,583.93, the mere disallowance of part of the head
office expenses could not probably result in said loss being completely wiped out and
 Phoenix being liable to deficiency tax. Not until the amended return was filed on August
30, 1955 could the Commissioner assess the deficiency income tax in question."

Accordingly, he would wish to press for the counting of the prescriptive period from the filing of
the amended return.

To our mind, the Commissioner's view should be sustained. The changes and alterations
embodied in the amended income tax return consisted of the exclusion of reinsurance
premiums received from domestic insurance companies by Phoenix Assurance Co., Ltd.'s
London head office, reinsurance premiums ceded to foreign reinsurers not doing business in
the Philippines and various items of deduction attributable to such excluded reinsurance
premiums thereby substantially modifying the original return. Furthermore, although the
deduction for head office expenses allocable to Philippine business, whose disallowance gave
rise to the deficiency tax, was claimed also in the original return, the Commissioner could not
have possibly determined a deficiency tax thereunder because Phoenix Assurance Co., Ltd.
declared a loss of P199,583.93 therein which would have more than offset such disallowance of
P15,826.35. Considering that the deficiency assessment was based on the amended return
which, as aforestated, is substantially different from the original return, the period of limitation
of the right to issue the same should be counted from the filing of the amended income tax
return. From August 30, 1955, when the amended return was filed, to July 24, 1958, when the
deficiency assessment was issued, less than five years elapsed. The right of the Commissioner
to assess the deficiency tax on such amended return has not prescribed.

To strengthen our opinion, we believe that to hold otherwise, we would be paving the way for
taxpayers to evade the payment of taxes by simply reporting in their original return heavy
losses and amending the same more than five years later when the Commissioner of Internal
Revenue has lost his authority to assess the proper tax thereunder. The object of the Tax Code
is to impose taxes for the needs of the Government, not to enhance tax avoidance to its
prejudice.

We next consider Phoenix Assurance Co., Ltd.'s claim for deduction of P37,147.04 for 1950
representing net addition to reserve computed at 40% of the marine insurance premiums
received during the year. Treating said said deduction to be excessive, the Commissioner of
Internal Revenue reduced the same to P25,374.47 which is equivalent to 100% of all marine
insurance premiums received during the last months of the year.

Paragraph (a) of Section 32 of the Tax Code states:

SEC. 32. Special provisions regarding income and deductions of insurance companies,
whether domestic or foreign. — (a) Special deductions allowed to insurance companies.
— In the case of insurance companies, except domestic life insurance companies and
foreign life insurance companies doing business in the Philippines, the net additions, if
any, required by law to be made within the year to reserve funds and the sums other
than dividends paid within the year on policy and annuity contracts may be deducted
 from their gross income: Provided, however, That the released reserve be treated as
income for the year of release.

Section 186 of the Insurance Law requires the setting up of reserves for liability on marine
insurance:

SEC. 186. ... Provided, That for marine risks the insuring company shall be required to
charge as the liability for reinsurance fifty per centum of the premiums written in the
policies upon yearly risks, and the full premiums written in the policies upon all other
marine risks not terminated (Emphasis supplied.)

The reserve required for marine insurance is determined on two bases: 50% of premiums under
policies on yearly risks and 100% of premiums under policies of marine risks not terminated
during the year. Section 32 (a) of the Tax Code quoted above allows the full amount of such
reserve to be deducted from gross income.

It may be noteworthy to observe that the formulas for determining the marine reserve
employed by Phoenix Assurance Co., Ltd. and the Commissioner of Internal Revenue — 40% of
premiums received during the year and 100% of premiums received during the last three
months of the year, respectively — do not comply with Section 186. Said determination runs
short of the requirement. For purposes of the Insurance Law, this Court therefore cannot
countenance the same. The reserve called for in Section 186 is a safeguard to the general public
and should be strictly followed not only because it is an express provision but also as a matter
of public policy. However, for income tax purposes a taxpayer is free to deduct from its gross
income a lesser amount, or not to claim any deduction at all. What is prohibited by the income
tax law is to claim a deduction beyond the amount authorized therein.

Phoenix Assurance Co., Ltd.'s claim for deduction of P37,147.04 being less than the amount
required in Section 186 of the Insurance Law, the same cannot be and is not excessive, and
should therefore be fully allowed. *

We come now to the controversy on the taxpayer's claim for deduction on head office expenses
incurred during 1952, 1953, and 1954 allocable to its Philippine business computed at 5% of
its gross income in the Philippines The Commissioner of Internal Revenue redetermined such
deduction at 5% on Phoenix Assurance Co., Ltd's net incomethereby partially disallowing the
latter's claim. The parties are agreed as to the percentage — 5% — but differ as to the basis of
computation. Phoenix Assurance Co. Lt. insists that the 5% head office expenses be determined
from the gross income, while the Commissioner wants the computation to be made on the net
income. What, therefore, needs to be resolved is: Should the 5% be computed on the gross or
net income?

The record shows that the gross income of Phoenix Assurance Co., Ltd. consists of income from
its Philippine business as well as reinsurance premiums received for its head office in London
and reinsurance premiums ceded to foreign reinsurance. Since the items of income not
belonging to its Philippine business are not taxable to its Philippine branch, they should be
excluded in determining the head office expenses allowable to said Philippine branch. This
conclusion finds support in paragraph 2, subsection (a), Section 30 of the Tax Code, quoted
hereunder:

(2) Expenses allowable to non-resident alien individuals and foreign corporations. In the
case of a non-resident alien individual or a foreign corporation, the expenses deductible
are the, necessary expenses paid or incurred in carrying on any business or trade
conducted within the Philippines exclusively. (Emphasis supplied.)

Consequently, the deficiency assessments for 1952, 1953 and 1954, resulting from partial
disallowance of deduction representing head office expenses, are sustained.

Finally, the Commissioner of Internal Revenue assails the dispositive portion of the Tax Court's
decision limiting the maximum amount of interest collectible for deliquency of an amount
corresponding to a period of three years. He contends that since such limitation was
incorporated into Section 51 of the Tax Code by Republic Act 2343 which took effect only on
June 20, 1959, it must not be applied retroactively on withholding tax for the years 1952, 1953
and 1954.

The imposition of interest on unpaid taxes is one of the statutory penalties for tax delinquency,
from the payments of which the Court of Tax Appeals absolved the Phoenix Assurance Co., Ltd.
on the equitable ground that the latter's failure to pay the withholding tax was due to the
Commissioner's opinion that no withholding tax was due. Consequently, the taxpayer could be
held liable for the payment of statutory penalties only upon its failure to comply with the Tax
Court's judgment rendered on February 14. 1962, after Republic Act 2343 took effect. This part
of the ruling of the lower court ought not to be disturbed.

WHEREFORE, the decision appealed from is modified, Phoenix Assurance Co., Ltd. is hereby
ordered to pay the Commissioner, of Internal Revenue the amount of P75,966.42, P59,059.68
and P48,812.32 as withholding tax for the years 1952, 1953 and 1954, respectively, and the
sums of P5,667.00 and P2,847.00 as income tax for 1952 and 1954 or a total of P192,352.42.
The Commissioner of Internal Revenue is ordered to refund to Phoenix Assurance Co., Ltd. the
amount of P20,180.00 as overpaid income tax for 1953, which should be deducted from the
amount of P192,352.42.

If the amount of P192,352.42 or a portion thereof is not paid within thirty (30) days from the
date this judgment becomes final, there should be collected a surcharge and interest as
provided for in Section 51(c) (2) of the Tax Code. No costs. It is so ordered.
G.R. Nos. 106949-50 December 1, 1995

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner,

vs.
COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS, respondents.

G.R. Nos. 106984-85 December 1, 1995

COMMISSIONER INTERNAL REVENUE, petitioner,

vs.
PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE
COURT OF TAX APPEALS, respondents.

FELICIANO, J.:

The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R. Nos.
106949-50 and private respondent in G.R. Nos. 106984-85, is a Philippine corporation
registered with the Board of Investments ("BOI") as a preferred pioneer enterprise with respect
to its integrated pulp and paper mill, and as a preferred non-pioneerenterprise with respect to
its integrated plywood and veneer mills.

On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2)
letters of assessment and demand both dated 31 March 1983: (a) one for deficiency transaction
tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for
1977, for an aggregate amount of P88,763,255.00. These assessments were computed as
follows:

Transaction Tax

Interest payments on

money market

borrowings P 45,771,849.00
———————

35% Transaction tax due

thereon 16,020,147.00

Add: 25% surcharge 4,005,036.75

——————

T o t a l P 20,025,183.75

Add:

14% int. fr.

1-20-78 to

7-31-80 P 7,093,302.57

20% int, fr.

8-1-80 to

3-31-83 10,675,523.58

——————

17,768,826.15

——————

P 37,794,009.90

Documentary and Science Stamps Tax

Total face value of

debentures P100,000,000.00

Documentary Stamps

Tax Due

(P0.30 x P100,000.000 )

( P200 ) P 150,000.00

Science Stamps Tax Due

(P0.30 x P100,000,000 )

( P200 ) P 150,000.00
——————

T o t a l P 300,000.00

Add: Compromise for

non-affixture 300.00

——————

300,300.00

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90

===========

Deficiency Income Tax for 1977

Net income per return P 258,166.00

Add: Unallowable deductions

1) Disallowed deductions

availed of under

R.A. No. 5186 P 44,332,980.00

2) Capitalized interest

expenses on funds

used for acquisition

of machinery & other

equipment 42,840,131.00

3) Unexplained financial

guarantee expense 1,237,421.00

4) Understatement
of sales 2,391,644.00

5) Overstatement of

cost of sales 604,018.00

——————

P91,406,194.00

Net income per investigation P91,664,360.00

Income tax due thereon 34,734,559.00

Less: Tax already assessed per return 80,358.00

——————

Deficiency P34,654,201.00

Add:

14% int. fr.

4-15-78 to

7-31-81 P 11,128,503.56

20% int. fr.

8-1-80 to

4-15-81 4,886,242.34

——————

P16,014,745.90

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1

===========
On 26 April 1983, Picop protested the assessment of deficiency transaction tax and
documentary and science stamp taxes. Picop also protested on 21 May 1983 the deficiency
income tax assessment for 1977. These protests were not formally acted upon by respondent
CIR. On 26 September 1984, the CIR issued a warrant of distraint on personal property and a
warrant of levy on real property against Picop, to enforce collection of the contested
assessments; in effect, the CIR denied Picop's protests.

Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing the assessments.
After trial, the CTA rendered a decision dated 15 August 1989, modifying the findings of the CIR
and holding Picop liable for the reduced aggregate amount of P20,133,762.33, which was
itemized in the dispositive portion of the decision as follows:

35% Transaction Tax P 16,020,113.20

Documentary & Science

Stamp Tax 300,300.00

Deficiency Income Tax Due 3,813,349.33

——————

TOTAL AMOUNT DUE AND PAYABLE P 20,133,762.53 2

===========

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the
above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990,
respectively, the Court referred the two (2) Petitions to the Court of Appeals. The Court of
Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which
further reduced the liability of Picop to P6,338,354.70. The dispositive portion of the Court of
Appeals decision reads as follows:

WHEREFORE, the appeal of the Commissioner of Internal Revenue is denied for

lack of merit. The judgment against PICOP is modified, as follows:

1. PICOP is declared liable for the 35% transaction tax in the amount of
P3,578,543.51;

2. PICOP is absolved from the payment of documentary and science stamp tax of
P300,000.00 and the compromise penalty of P300.00;

3. PICOP shall pay 20% interest per annum on the deficiency income tax of
P1,481,579.15, for a period of three (3) years from 21 May 1983, or in the total
 amount of P888,947.49, and a surcharge of 10% on the latter amount, or
P88,984.75.

No pronouncement as to costs.

SO ORDERED.

Picop and the CIR once more filed separate Petitions for Review before the Supreme Court.
These cases were consolidated and, on 23 August 1993, the Court resolved to give due course
to both Petitions in G.R. Nos. 106949-50 and 106984-85 and required the parties to file their
Memoranda.

Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof.
It assails the propriety of the thirty-five percent (35%) deficiency transaction tax which the
Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions the
imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting
from disallowance of certain claimed financial guarantee expenses and claimed year-end
adjustments of sales and cost of sales figures by Picop's external auditors. 3

The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable
for surcharge and interest on unpaid transaction tax and for documentary and science stamp
taxes and in allowing Picop to claim as deductible expenses:

(a) the net operating losses of another corporation (i.e., Rustan Pulp and Paper
Mills, Inc.); and

(b) interest payments on loans for the purchase of machinery and equipment.

The CIR also claims that Picop should be held liable for interest at fourteen percent
(14%) per annum from 15 April 1978 for three (3) years, and interest at twenty percent
(20%) per annum for a maximum of three (3) years; and for a surcharge of ten percent
(10%), on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for
the corporate development tax equivalent to five percent (5%) of its correct 1977 net
income.

The issues which we must here address may be sorted out and grouped in the following
manner:

I. Whether Picop is liable for:

(1) the thirty-five percent (35%) transaction tax;

(2) interest and surcharge on unpaid transaction tax; and

 (3) documentary and science stamp taxes;

II. Whether Picop is entitled to deductions against income of:

(1) interest payments on loans for the purchase of

machinery and equipment;

(2) net operating losses incurred by the Rustan

Pulp and Paper Mills, Inc.; and

(3) certain claimed financial guarantee expenses; and

III. (1) Whether Picop had understated its sales and overstated its
cost of sales for 1977; and

(2) Whether Picop is liable for the corporate

development tax of five percent (5%) of its net
income for 1977.

We will consider these issues in the foregoing sequence.

I.

(1) Whether Picop is liable

for the thirty-five percent
(35%) transaction tax.

With the authorization of the Securities and Exchange Commission, Picop issued commercial
paper consisting of serially numbered promissory notes with the total face value of
P229,864,000.00 and a maturity period of one (1) year, i.e., from 24 December 1977 to 23
December 1978. These promissory notes were purchased by various commercial banks and
financial institutions. On these promissory notes, Picop paid interest in the aggregate amount
of P45,771,849.00. In respect of these interest payments, the CIR required Picop to pay the
thirty-five percent (35%) transaction tax.

The CIR based this assessment on Presidential Decree No. 1154 dated 3 June 1977, which reads
in part as follows:

Sec. 1. The National Internal Revenue Code, as amended, is hereby further

amended by adding a new section thereto to read as follows:

Sec. 195-C. Tax on certain interest. — There shall be levied, assessed, collected
and paid on every commercial paper issued in the primary market as principal
instrument, a transaction tax equivalent to thirty-five percent (35%) based on
the gross amount of interest thereto as defined hereunder, which shall be paid
by the borrower/issuer: Provided, however, that in the case of a long-term
commercial paper whose maturity exceeds more than one year, the borrower
shall pay the tax based on the amount of interest corresponding to one year, and
thereafter shall pay the tax upon accrual or actual payment (whichever is earlier)
of the untaxed portion of the interest which corresponds to a period not
exceeding one year.

The transaction tax imposed in this section shall be a final tax to be paid by the
borrower and shall be allowed as a deductible item for purposes of computing
the borrower's taxable income.

For purposes of this tax —

(a) "Commercial paper" shall be defined as an instrument evidencing

indebtedness of any person or entity, including banks and non-banks performing
quasi-banking functions, which is issued, endorsed, sold, transferred or in any
manner conveyed to another person or entity, either with or without recourse
and irrespective of maturity. Principally, commercial papers are promissory
notes and/or similar instruments issued in the primary market and shall not
include repurchase agreements, certificates of assignments, certificates of
participations, and such other debt instruments issued in the secondary market.

(b) The term "interest" shall mean the difference between what the principal
borrower received and the amount it paid upon maturity of the commercial
paper which shall, in no case, be lower than the interest rate prevailing at the
time of the issuance or renewal of the commercial paper. Interest shall be
deemed synonymous with discount and shall include all fees, commissions,
premiums and other payments which form integral parts of the charges imposed
as a consequence of the use of money.

In all cases, where no interest rate is stated or if the rate stated is lower than the
prevailing interest rate at the time of the issuance or renewal of commercial
paper, the Commissioner of Internal Revenue, upon consultation with the
Monetary Board of the Central Bank of the Philippines, shall adjust the interest
rate in accordance herewith, and assess the tax on the basis thereof.

The tax herein imposed shall be remitted by the borrower to the Commissioner of
Internal Revenue or his Collection Agent in the municipality where such borrower
has its principal place of business within five (5) working days from the issuance
of the commercial paper. In the case of long term commercial paper, the tax
upon the untaxed portion of the interest which corresponds to a period not
exceeding one year shall be paid upon accrual payment, whichever is earlier.
(Emphasis supplied)
 Both the CTA and the Court of Appeals sustained the assessment of transaction tax.

In the instant Petition, Picop reiterates its claim that it is exempt from the payment of the
transaction tax by virtue of its tax exemption under R.A. No. 5186, as amended, known as the
Investment Incentives Act, which in the form it existed in 1977-1978, read in relevant part as
follows:

Sec. 8. Incentives to a Pioneer Enterprise. In addition to the incentives provided

in the preceding section, pioneer enterprises shall be granted the following
incentive benefits:

(a) Tax Exemption. Exemption from all taxes under the National Internal Revenue
Code, except income tax, from the date the area of investment is included in the
Investment Priorities Plan to the following extent:

(1) One hundred per cent (100%) for the first five years;

(2) Seventy-five per cent (75%) for the sixth through the eighth years;

(3) Fifty per cent (50%) for the ninth and tenth years;

(4) Twenty per cent (20%) for the eleventh and twelfth years; and

(5) Ten per cent (10%) for the thirteenth through the fifteenth year.

xxx xxx xxx 4

We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No.
5186, as amended, does not include exemption from the thirty-five percent (35%) transaction
tax. In the first place, the thirty-five percent (35%) transaction tax 5 is an income tax, that is, it is
a tax on the interest income of the lenders or creditors. In Western Minolco
Corporation v. Commissioner of Internal Revenue, 6 the petitioner corporation borrowed funds
from several financial institutions from June 1977 to October 1977 and paid the corresponding
thirty-five (35%) transaction tax thereon in the amount of P1,317,801.03, pursuant to Section
210 (b) of the 1977 Tax Code. Western Minolco applied for refund of that amount alleging it
was exempt from the thirty-five (35%) transaction tax by reason of Section 79-A of C.A. No. 137,
as amended, which granted new mines and old mines resuming operation "five (5) years
complete tax exemptions, except income tax, from the time of its actual bonafide orders for
equipment for commercial production." In denying the claim for refund, this Court held:

The petitioner's contentions deserve scant consideration. The 35% transaction

tax is imposed on interest income from commercial papers issued in the primary
money market. Being a tax on interest, it is a tax on income.
 As correctly ruled by the respondent Court of Tax Appeals:

Accordingly, we need not and do not think it necessary to discuss

further the nature of the transaction tax more than to say that the
incipient scheme in the issuance of Letter of Instructions No. 340
on November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve
operational simplicity and effective administration in capturing
the interest-income "windfall" from money market operations as
a new source of revenue, has lost none of its animating principle
in parturition of amendatory Presidential Decree No. 1154, now
Section 210 (b) of the Tax Code. The tax thus imposed is actually a
tax on interest earnings of the lenders or placers who are actually
the taxpayers in whose income is imposed. Thus "the borrower
withholds the tax of 35% from the interest he would have to pay
the lender so that he (borrower) can pay the 35% of the interest
to the Government." (Citation omitted) . . . . Suffice it to state that
the broad consensus of fiscal and monetary authorities is that
"even if nominally, the borrower is made to pay the tax, actually,
the tax is on the interest earning of the immediate and all prior
lenders/placers of the money. . . ." (Rollo, pp. 36-37)

The 35% transaction tax is an income tax on interest earnings to the lenders or
placers. The latter are actually the taxpayers. Therefore, the tax cannot be a tax
imposed upon the petitioner. In other words, the petitioner who borrowed funds
from several financial institutions by issuing commercial papers merely withheld
the 35% transaction tax before paying to the financial institutions the interests
earned by them and later remitted the same to the respondent Commissioner of
Internal Revenue. The tax could have been collected by a different procedure but
the statute chose this method. Whatever collecting procedure is adopted does
not change the nature of the tax.

xxx xxx xxx 7

(Emphasis supplied)

Much the same issue was passed upon in Marinduque Mining Industrial Corporation
v. Commissioner of Internal Revenue 8 and resolved in the same way:

It is very obvious that the transaction tax, which is a tax on interest derived from
commercial paper issued in the money market, is not a tax contemplated in the
above-quoted legal provisions. The petitioner admits that it is subject to income
tax. Its tax exemption should be strictly construed.
 We hold that petitioner's claim for refund was justifiably denied. The transaction
tax, although nominally categorized as a business tax, is in reality a withholding
tax as positively stated in LOI No. 340. The petitioner could have shifted the tax
to the lenders or recipients of the interest. It did not choose to do so. It cannot
be heard now to complain about the tax. LOI No. 340 is an extraneous or
extrinsic aid to the construction of section 210 (b).

xxx xxx xxx 9

(Emphasis supplied)

It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside
the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of R.A.
No. 5186, as amended. Picop was the withholding agent, obliged to withhold thirty-five percent
(35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau
of Internal Revenue ("BIR"). As a withholding agent, Picop is made personally liable for the
thirty-five percent (35%) transaction tax 10 and if it did not actually withhold thirty-five percent
(35%) of the interest monies it had paid to its lenders, Picop had only itself to blame.

Picop claims that it had relied on a ruling, dated 6 October 1977, issued by the CIR, which held
that Picop was not liable for the thirty-five (35%) transaction tax in respect of debenture bonds
issued by Picop. Prior to the issuance of the promissory notes involved in the instant case, Picop
had also issued debenture bonds P100,000,000.00 in aggregate face value. The managing
underwriter of this debenture bond issue, Bancom Development Corporation, requested a
formal ruling from the Bureau of Internal Revenue on the liability of Picop for the thirty-five
percent (35%) transaction tax in respect of such bonds. The ruling rendered by the then Acting
Commissioner of Internal Revenue, Efren I. Plana, stated in relevant part:

It is represented that PICOP will be offering to the public primary bonds in the
aggregate principal sum of one hundred million pesos (P100,000,000.00); that
the bonds will be issued as debentures in denominations of one thousand pesos
(P1,000.00) or multiples, to mature in ten (10) years at 14% interest per
annum payable semi-annually; that the bonds are convertible into common stock
of the issuer at the option of the bond holder at an agreed conversion price;
that the issue will be covered by a "Trust Indenture" with a duly authorized trust
corporation as required by the Securities and Exchange Commission, which
trustee will act for and in behalf of the debenture bond holders as beneficiaries;
that once issued, the bonds cannot be preterminated by the holder and cannot
be redeemed by the issuer until after eight (8) years from date of issue; that the
debenture bonds will be subordinated to present and future debts of PICOP; and
that said bonds are intended to be listed in the stock exchanges, which will place
them alongside listed equity issues.
 In reply, I have the honor to inform you that although the bonds hereinabove
described are commercial papers which will be issued in the primary market,
however, it is clear from the abovestated facts that said bonds will not be issued
as money market instruments. Such being the case, and considering that the
purposes of Presidential Decree No. 1154, as can be gleaned from Letter of
Instruction No. 340, dated November 21, 1975, are (a) to regulate money market
transactions and (b) to ensure the collection of the tax on interest derived from
money market transactions by imposing a withholding tax thereon, said bonds
do not come within the purview of the "commercial papers" intended to be
subjected to the 35% transaction tax prescribed in Presidential Decree No. 1154,
as implemented by Revenue Regulations No. 7-77. (See Section 2 of said
Regulation) Accordingly, PICOP is not subject to 35% transaction tax on its issues
of the aforesaid bonds. However, those investing in said bonds should be made
aware of the fact that the transaction tax is not being imposed on the issuer of
said bonds by printing or stamping thereon, in bold letters, the following
statement: "ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154.
BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR INCOME
TAX." 11 (Emphases supplied)

In the above quoted ruling, the CIR basically held that Picop's debenture bonds did not
constitute "commercial papers" within the meaning of P.D. No. 1154, and that, as such, those
bonds were not subject to the thirty-five percent (35%) transaction tax imposed by P.D. No.
1154.

The above ruling, however, is not applicable in respect of the promissory notes which are the
subject matter of the instant case. It must be noted that the debenture bonds which were the
subject matter of Commissioner Plana's ruling were long-term bonds maturing in ten (10) years
and which could not be pre-terminated and could not be redeemed by Picop until after eight (8)
years from date of issue; the bonds were moreover subordinated to present and future debts
of Picop and convertible into common stock of Picop at the option of the bondholder. In
contrast, the promissory notes involved in the instant case are short-term instruments bearing
a one-year maturity period. These promissory notes constitute the very archtype of money
market instruments. For money market instruments are precisely, by custom and usage of the
financial markets, short-term instruments with a tenor of one (1) year or less. 12 Assuming,
therefore, (without passing upon) the correctness of the 6 October 1977 BIR ruling, Picop's
short-term promissory notes must be distinguished, and treated differently, from Picop's long-
term debenture bonds.

We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction
tax due in respect of interest payments on its money market borrowings.

At the same time, we agree with the Court of Appeals that the transaction tax may be levied
only in respect of the interest earnings of Picop's money market lenders accruing after P.D. No.
1154 went into effect, and not in respect of all the 1977 interest earnings of such lenders. The
Court of Appeals pointed out that:

PICOP, however contends that even if the tax has to be paid, it should be
imposed only for the interests earned after 20 September 1977 when PD 1154
creating the tax became effective. We find merit in this contention. It appears
that the tax was levied on interest earnings from January to October, 1977.
However, as found by the lower court, PD 1154 was published in the Official
Gazette only on 5 September 1977, and became effective only fifteen (15) days
after the publication, or on 20 September 1977, no other effectivity date having
been provided by the PD. Based on the Worksheet prepared by the
Commissioner's office, the interests earned from 20 September to October 1977
was P10,224,410.03. Thirty-five (35%) per cent of this is P3,578,543.51 which is
all PICOP should pay as transaction tax. 13 (Emphasis supplied)

P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirty-five
percent (35%) transaction tax in respect of interest earnings which accrued before the
effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the
legislative authority intended to bring about such retroactive imposition of the tax.

(2) Whether Picop is liable

for interest and surcharge
on unpaid transaction tax.

With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five
percent (25%) surcharge and for interest at the rate of fourteen percent (14%) per annum from
the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of Revenue
Regulation 7-77 dated 3 June 1977, 14 issued by the Secretary of Finance. This Section reads:

Sec. 10. Penalties. — Where the amount shown by the taxpayer to be due on its
return or part of such payment is not paid on or before the date prescribed for
its payment, the amount of the tax shall be increased by twenty-five (25%) per
centum, the increment to be a part of the tax and the entire amount shall be
subject to interest at the rate of fourteen (14%) per centum per annum from the
date prescribed for its payment.

In the case of willful neglect to file the return within the period prescribed herein
or in case a false or fraudulent return is willfully made, there shall be added to
the tax or to the deficiency tax in case any payment has been made on the basis
of such return before the discovery of the falsity or fraud, a surcharge of fifty
(50%) per centum of its amount. The amount so added to any tax shall be
collected at the same time and in the same manner and as part of the tax unless
the tax has been paid before the discovery of the falsity or fraud, in which case
the amount so added shall be collected in the same manner as the tax.
 In addition to the above administrative penalties, the criminal and civil
penalties as provided for under Section 337 of the Tax Code of 1977 shall be
imposed for violation of any provision of Presidential Decree No.
1154. 15 (Emphases supplied)

The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code,
invoked by the Secretary of Finance in issuing Revenue Regulation 7-77, set out, in
comprehensive terms, the rule-making authority of the Secretary of Finance:

Sec. 326. Authority of Secretary of Finance to Promulgate Rules and Regulations.

— The Secretary of Finance, upon recommendation of the Commissioner of
Internal Revenue, shall promulgate all needful rules and regulations for the
effective enforcement of the provisions of this Code. (Emphasis supplied)

Section 4 of the same Code contains a list of subjects or areas to be dealt with by the
Secretary of Finance through the medium of an exercise of his quasi-legislative or rule-
making authority. This list, however, while it purports to be open-ended,
does not include the imposition of administrative or civil penalties such as the payment
of amounts additional to the tax due. Thus, in order that it may be held to be legally
effective in respect of Picop in the present case, Section 10 of Revenue Regulation 7-77
must embody or rest upon some provision in the Tax Code itself which imposes
surcharge and penalty interest for failure to make a transaction tax payment when due.

P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge
and penalty interest in case of failure to pay the thirty-five percent (35%) transaction tax when
due. Neither did Section 210 (b) of the 1977 Tax Code which re-enacted Section 195-C inserted
into the Tax Code by P.D. No. 1154.

The CIR, both in its petition before the Court of Appeals and its Petition in the instant case,
points to Section 51 (e) of the 1977 Tax Code as its source of authority for assessing a surcharge
and penalty interest in respect of the thirty-five percent (35%) transaction tax due from Picop.
This Section needs to be quoted in extenso:

Sec. 51. Payment and Assessment of Income Tax. —

(c) Definition of deficiency. — As used in this Chapter in respect of a tax imposed

by this Title, the term "deficiency" means:

(1) The amount by which the tax imposed by this Title exceeds the amount
shown as the tax by the taxpayer upon his return; but the amount so shown on
the return shall first be increased by the amounts previously assessed (or
collected without assessment) as a deficiency, and decreased by the amount
previously abated, credited, returned, or otherwise in respect of such tax; . . .
 xxx xxx xxx

(e) Additions to the tax in case of non-payment. —

(1) Tax shown on the return. — Where the amount determined by the taxpayer
as the tax imposed by this Title or any installment thereof, or any part of such
amount or installment is not paid on or before the date prescribed for its
payment, there shall be collected as a part of the tax, interest upon such unpaid
amount at the rate of fourteen per centum per annum from the date prescribed
for its payment until it is paid: Provided, That the maximum amount that may be
collected as interest on deficiency shall in no case exceed the amount
corresponding to a period of three years, the present provisions regarding
prescription to the contrary notwithstanding.

(2) Deficiency. — Where a deficiency, or any interest assessed in connection

therewith under paragraph (d) of this section, or any addition to the taxes
provided for in Section seventy-two of this Code is not paid in full within thirty
days from the date of notice and demand from the Commissioner of Internal
Revenue, there shall be collected upon the unpaid amount as part of the tax,
interest at the rate of fourteen per centum per annum from the date of such
notice and demand until it is paid: Provided, That the maximum amount that
may be collected as interest on deficiency shall in no case exceed the amount
corresponding to a period of three years, the present provisions regarding
prescription to the contrary notwithstanding.

(3) Surcharge. — If any amount of tax included in the notice and demand from
the Commissioner of Internal Revenue is not paid in full within thirty days after
such notice and demand, there shall be collected in addition to the interest
prescribed herein and in paragraph (d) above and as part of the tax a surcharge
of five per centum of the amount of tax unpaid. (Emphases supplied)

Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2) above, provides:

Sec. 72. Surcharges for failure to render returns and for rendering false and
fraudulent returns. — In case of willful neglect to file the return or list required by
this Title within the time prescribed by law, or in case a false or fraudulent return
or list is wilfully made, the Commissioner of Internal Revenue shall add to the tax
or to the deficiency tax, in case any payment has been made on the basis of such
return before the discovery of the falsity or fraud, as surcharge of fifty per
centum of the amount of such tax or deficiency tax. In case of any failure to make
and file a return or list within the time prescribed by law or by the Commissioner
or other Internal Revenue Officer, not due to willful neglect, the Commissioner of
Internal Revenue shall add to the tax twenty-five per centum of its amount,
except that, when a return is voluntarily and without notice from the
 Commissioner or other officer filed after such time, and it is shown that the
failure to file it was due to a reasonable cause, no such addition shall be made to
the tax. The amount so added to any tax shall be collected at the same time, in
the same manner and as part of the tax unless the tax has been paid before the
discovery of the neglect, falsity, or fraud, in which case the amount so added
shall be collected in the same manner as the tax. (Emphases supplied)

It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977 Tax Code, authorize the
imposition of surcharge and interest only in respect of a "tax imposed by this Title," that is to
say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes a
surcharge only in case of failure to file a return or list "required by this Title," that is, Title II
on "Income Tax." The thirty-five percent (35%) transaction tax is, however, imposed in the 1977
Tax Code by Section 210 (b) thereof which Section is embraced in Title V on "Taxes on Business"
of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax
imposed on interest income earned by lenders or creditors purchasing commercial paper on the
money market, the relevant provisions, i.e., Section 210 (b), were not inserted in Title II of the
1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of
the taxes in respect of which Section 51 (e) authorized the imposition of surcharge and interest
and Section 72 the imposition of a fraud surcharge.

It is not without reluctance that we reach the above conclusion on the basis of what may well
have been an inadvertent error in legislative draftsmanship, a type of error common enough
during the period of Martial Law in our country. Nevertheless, we are compelled to adopt this
conclusion. We consider that the authority to impose what the present Tax Code calls (in
Section 248) civil penalties consisting of additions to the tax due, must be expressly given in the
enabling statute, in language too clear to be mistaken. The grant of that authority is not lightly
to be assumed to have been made to administrative officials, even to one as highly placed as
the Secretary of Finance.

The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the
1977 Tax Code did not authorize the imposition of a surcharge and penalty interest for failure
to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b) of the same
Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay
all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions
imposing particular taxes are textually located. Section 247 (a) of the NIRC, as amended, reads:

Title X

Statutory Offenses and Penalties

Chapter I

Additions to the Tax

 Sec. 247. General Provisions. — (a) The additions to the tax or deficiency tax
prescribed in this Chapter shall apply to all taxes, fees and charges imposed in
this Code. The amount so added to the tax shall be collected at the same time, in
the same manner and as part of the tax. . . .

Sec. 248. Civil Penalties. — (a) There shall be imposed, in addition to the tax
required to be paid, penalty equivalent to twenty-five percent (25%) of the
amount due, in the following cases:

xxx xxx xxx

(3) failure to pay the tax within the time prescribed for its
payment; or

xxx xxx xxx

(c) the penalties imposed hereunder shall form part of the tax and the entire
amount shall be subject to the interest prescribed in Section 249.

Sec. 249. Interest. — (a) In General. — There shall be assessed and collected on
any unpaid amount of tax, interest at the rate of twenty percent (20%) per
annum or such higher rate as may be prescribed by regulations, from the date
prescribed for payment until the amount is fully paid. . . . (Emphases supplied)

In other words, Section 247 (a) of the current NIRC supplies what did not exist back in
1977 when Picop's liability for the thirty-five percent (35%) transaction tax became
fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is
nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in
1985, was intended to be given retroactive application by the legislative authority. 16

(3) Whether Picop is Liable

for Documentary and
Science Stamp Taxes.

As noted earlier, Picop issued sometime in 1977 long-term subordinated convertible debenture
bonds with an aggregate face value of P100,000,000.00. Picop stated, and this was not disputed
by the CIR, that the proceeds of the debenture bonds were in fact utilized to finance the BOI-
registered operations of Picop. The CIR assessed documentary and science stamp taxes,
amounting to P300,000.00, on the issuance of Picop's debenture bonds. It is claimed by Picop
that its tax exemption — "exemption from all taxes under the National Internal Revenue Code,
except income tax" on a declining basis over a certain period of time — includes exemption
from the documentary and science stamp taxes imposed under the NIRC.
The CIR, upon the other hand, stresses that the tax exemption under the Investment Incentives
Act may be granted or recognized only to the extent that the claimant Picop was engaged in
registered operations, i.e., operations forming part of its integrated pulp and paper
project. 17 The borrowing of funds from the public, in the submission of the CIR, was not an
activity included in Picop's registered operations. The CTA adopted the view of the CIR and held
that "the issuance of convertible debenture bonds [was] not synonymous [with] the
manufactur[ing] operations of an integrated pulp and paper mill." 18

The Court of Appeals took a less rigid view of the ambit of the tax exemption granted to
registered pioneer enterprises. Said the Court of Appeals:

. . . PICOP's explanation that the debenture bonds were issued to finance its
registered operation is logical and is unrebutted. We are aware that tax
exemptions must be applied strictly against the beneficiary in order to deter
their abuse. It would indeed be altogether a different matter if there is a showing
that the issuance of the debenture bonds had no bearing whatsoever on the
registered operations PICOP and that they were issued in connection with a
totally different business undertaking of PICOP other than its registered
operation. There is, however, a dearth of evidence in this regard. It cannot be
denied that PICOP needed funds for its operations. One of the means it used to
raise said funds was to issue debenture bonds. Since the money raised thereby
was to be used in its registered operation, PICOP should enjoy the incentives
granted to it by R.A. 5186, one of which is the exemption from payment of all
taxes under the National Internal Revenue Code, except income taxes, otherwise
the purpose of the incentives would be defeated. Documentary and science
stamp taxes on debenture bonds are certainly not income taxes. 19 (Emphasis
supplied)

Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended
beyond the ordinary and reasonable intendment of the language actually used by the legislative
authority in granting the exemption. The issuance of debenture bonds is certainly conceptually
distinct from pulping and paper manufacturing operations. But no one contends that issuance
of bonds was a principal or regular business activity of Picop; only banks or other financial
institutions are in the regular business of raising money by issuing bonds or other instruments
to the general public. We consider that the actual dedication of the proceeds of the bonds to
the carrying out of Picop's registered operations constituted a sufficient nexus with such
registered operations so as to exempt Picop from stamp taxes ordinarily imposed upon or in
connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this
matter that the CTA and the CIR had erred in rejecting Picop's claim for exemption from stamp
taxes.

It remains only to note that after commencement of the present litigation before the CTA, the
BIR took the position that the tax exemption granted by R.A. No. 5186, as
amended, does include exemption from documentary stamp taxes on transactions entered into
by BOI-registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a
registered preferred pioneer enterprise engaged in the manufacture of integrated circuits,
magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary
stamp taxes. The Commissioner said:

You now request a ruling that as a preferred pioneer enterprise, you are exempt
from the payment of Documentary Stamp Tax (DST).

In reply, please be informed that your request is hereby granted. Pursuant to

Section 46 (a) of Presidential Decree No. 1789, pioneer enterprises registered
with the BOI are exempt from all taxes under the National Internal Revenue
Code, except from all taxes under the National Internal Revenue Code, except
income tax, from the date the area of investment is included in the Investment
Priorities Plan to the following extent:

xxx xxx xxx

Accordingly, your company is exempt from the payment of documentary stamp

tax to the extent of the percentage aforestated on transactions connected with
the registered business activity. (BIR Ruling No. 111-81) However, if said
transactions conducted by you require the execution of a taxable document with
other parties, said parties who are not exempt shall be the one directly liable for
the tax. (Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other words,
said parties shall be liable to the same percentage corresponding to your tax
exemption. (Emphasis supplied)

Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a
registered pioneer enterprise producing polyester filament yarn was entitled to
exemption "from the documentary stamp tax on [its] sale of real property in Makati up
to December 31, 1989." It appears clear to the Court that the CIR, administratively at
least, no longer insists on the position it originally took in the instant case before the
CTA.

II

(1) Whether Picop is entitled

to deduct against current
income interest payments
on loans for the purchase
of machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the
purchase of machinery and equipment needed for its operations. In its 1977 Income Tax
Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these
loans as a deduction from its 1977 gross income.

The CIR disallowed this deduction upon the ground that, because the loans had been incurred
for the purchase of machinery and equipment, the interest payments on those loans should
have been capitalized instead and claimed as a depreciation deduction taking into account the
adjusted basis of the machinery and equipment (original acquisition cost plus interest charges)
over the useful life of such assets.

Both the CTA and the Court of Appeals sustained the position of Picop and held that the
interest deduction claimed by Picop was proper and allowable. In the instant Petition, the CIR
insists on its original position.

We begin by noting that interest payments on loans incurred by a taxpayer (whether BOI-
registered or not) are allowed by the NIRC as deductions against the taxpayer's gross income.
Section 30 of the 1977 Tax Code provided as follows:

Sec. 30. Deduction from Gross Income. — The following may be deducted from
gross income:

(a) Expenses:

xxx xxx xxx

(b) Interest:

(1) In general. — The amount of interest paid within the taxable

year on indebtedness, except on indebtedness incurred or
continued to purchase or carry obligations the interest upon
which is exempt from taxation as income under this Title: . . .
(Emphasis supplied)

Thus, the general rule is that interest expenses are deductible against gross income and
this certainly includes interest paid under loans incurred in connection with the carrying
on of the business of the taxpayer. 20 In the instant case, the CIR does not dispute that
the interest payments were made by Picop on loans incurred in connection with the
carrying on of the registered operations of Picop, i.e., the financing of the purchase of
machinery and equipment actually used in the registered operations of Picop. Neither
does the CIR deny that such interest payments were legally due and demandable under
the terms of such loans, and in fact paid by Picop during the tax year 1977.

The CIR has been unable to point to any provision of the 1977 Tax Code or any other Statute
that requires the disallowance of the interest payments made by Picop. The CIR invokes Section
79 of Revenue Regulations No. 2 as amended which reads as follows:
 Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other
purposes on account of capital or surplus invested in the business, which does
not represent a charge arising under an interest-bearing obligation,
is not allowable deduction from gross income. (Emphases supplied)

We read the above provision of Revenue Regulations No. 2 as referring to so called

"theoretical interest," that is to say, interest "calculated" or computed (and
not incurred or paid) for the purpose of determining the "opportunity cost" of investing
funds in a given business. Such "theoretical" or imputed interest does not arise from a
legally demandable interest-bearing obligation incurred by the taxpayer who however
wishes to find out, e.g., whether he would have been better off by lending out his funds
and earning interest rather than investing such funds in his business. One thing that
Section 79 quoted above makes clear is that interest which does constitute a charge
arising under an interest-bearing obligation is an allowable deduction from gross
income.

It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after"
paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges Chargeable to Capital Account and
Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph reads as follows:

(B) Taxes and Carrying Charges. — The items thus chargeable to capital accounts
are —

(11) In the case of real property, whether improved or unimproved and whether
productive or nonproductive.

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own
funds). 21

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be related
to the relevant provisions of the U.S. Internal Revenue Code, which provisions deal with the
general topic of adjusted basis for determining allowable gain or loss on sales or exchanges of
property and allowable depreciation and depletion of capital assets of the taxpayer:

Present Rule. The Internal Revenue Code, and the Regulations promulgated
thereunder provide that "No deduction shall be allowed for amounts paid or
accrued for such taxes and carrying charges as, under regulations prescribed by
the Secretary or his delegate, are chargeable to capital account with respect to
property, if the taxpayer elects, in accordance with such regulations, to treat
such taxes or charges as so chargeable."

At the same time, under the adjustment of basis provisions which have just been
discussed, it is provided that adjustment shall be made for all "expenditures,
receipts, losses, or other items" properly chargeable to a capital account, thus
 including taxes and carrying charges; however, an exception exists, in which
event such adjustment to the capital account is not made, with respect to taxes
and carrying charges which the taxpayer has not elected to capitalize but for
which a deduction instead has been taken. 22 (Emphasis supplied)

The "carrying charges" which may be capitalized under the above quoted provisions of
the U.S. Internal Revenue Code include, as the CIR has pointed out, interest on a loan
"(but not theoretical interest of a taxpayer using his own funds)." What the CIR failed to
point out is that such "carrying charges" may, at the election of the taxpayer, either be
(a) capitalized in which case the cost basis of the capital assets, e.g., machinery and
equipment, will be adjusted by adding the amount of such interest
payments or alternatively, be (b) deducted from gross income of the taxpayer. Should
the taxpayer elect to deduct the interest payments against its gross income, the
taxpayer cannot at the same time capitalize the interest payments. In other words, the
taxpayer is not entitled to both the deduction from gross income and the adjusted
(increased) basis for determining gain or loss and the allowable depreciation charge. The
U.S. Internal Revenue Code does not prohibit the deduction of interest on a
loan obtained for purchasing machinery and equipment against gross income, unless the
taxpayer has also or previously capitalized the same interest payments and thereby
adjusted the cost basis of such assets.

We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a loan
incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel the
capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a
taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly,
the general rule that interest payments on a legally demandable loan are deductible from gross
income must be applied.

The CIR argues finally that to allow Picop to deduct its interest payments against its gross
income would be to encourage fraudulent claims to double deductions from gross income:

[t]o allow a deduction of incidental expense/cost incurred in the purchase of

fixed asset in the year it was incurred would invite tax
evasion through fraudulent application of double deductions from gross
income. 23 (Emphases supplied)

The Court is not persuaded. So far as the records of the instant cases show, Picop has
not claimed to be entitled to double deduction of its 1977 interest payments. The CIR
has neither alleged nor proved that Picop had previously adjusted its cost basis for the
machinery and equipment purchased with the loan proceeds by capitalizing the interest
payments here involved. The Court will not assume that the CIR would be unable or
unwilling to disallow "a double deduction" should Picop, having deducted its interest
cost from its gross income, also attempt subsequently to adjust upward the cost basis of
 the machinery and equipment purchased and claim, e.g., increased deductions for
depreciation.

We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of
Picop's 1977 interest payments on its loans for capital equipment against its gross income for
1977.

(2) Whether Picop is entitled

to deduct against current
income net operating losses
incurred by Rustan Pulp
and Paper Mills, Inc.

On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper
Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the
rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred,
assigned and conveyed to Picop as the surviving corporation. The entire subscribed and
outstanding capital stock of RPPM and RMC would be exchanged for 2,891,476 fully paid up
Class "A" common stock of Picop (with a par value of P10.00) and 149,848 shares of preferred
stock of Picop (with a par value of P10.00), to be issued by Picop, the result being that Picop
would wholly own both RPPM and RMC while the stockholders of RPPM and RMC would join
the ranks of Picop's shareholders. In addition, Picop paid off the obligations of RPPM to the
Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing
6,824,034 shares of preferred stock (with a par value of P10.00) to the DBP. The merger
agreement was approved in 1977 by the creditors and stockholders of Picop, RPPM and RMC
and by the Securities and Exchange Commission. Thereupon, on 30 November 1977, apparently
the effective date of merger, RPPM and RMC were dissolved. The Board of Investments
approved the merger agreement on 12 January 1978.

It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before
merger effective date, RPPM had over preceding years accumulated losses in the total amount
of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00 of RPPM's
accumulated losses as a deduction against Picop's 1977 gross income. 24

Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold
all the outstanding shares of RMC stock to San Miguel Corporation for the sum of
P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. 25

In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186 which provides as
follows:

Sec. 7. Incentives to Registered Enterprise. — A registered enterprise, to the

extent engaged in a preferred area of investment, shall be granted the following
incentive benefits:
 xxx xxx xxx

(c) Net Operating Loss Carry-over. — A net operating loss incurred in any of the
first ten years of operations may be carried over as a deduction from taxable
income for the six years immediately following the year of such loss. The entire
amount of the loss shall be carried over to the first of the six taxable years
following the loss, and any portion of such loss which exceeds the taxable
income of such first year shall be deducted in like manner from the taxable
income of the next remaining five years. The net operating loss shall be
computed in accordance with the provisions of the National Internal Revenue
Code, any provision of this Act to the contrary notwithstanding, except that
income not taxable either in whole or in part under this or other laws shall be
included in gross income. (Emphasis supplied)

Picop had secured a letter-opinion from the BOI dated 21 February 1977 — that is, after
the date of the agreement of merger but before the merger became effective — relating
to the deductibility of the previous losses of RPPM under Section 7 (c) of R.A. No. 5186
as amended. The pertinent portions of this BOI opinion, signed by BOI Governor Cesar
Lanuza, read as follows:

2) PICOP will not be allowed to carry over the losses of Rustan prior to the legal
dissolution of the latter because at that time the two (2) companies still had
separate legal personalities;

3) After BOI approval of the merger, PICOP can no longer apply for the
registration of the registered capacity of Rustan because with the approved
merger, such registered capacity of Rustan transferred to PICOP will have the
same registration date as that of Rustan. In this case, the previous losses of
Rustan may be carried over by PICOP, because with the merger, PICOP assumes
all the rights and obligations of Rustan subject, however, to the period prescribed
for carrying over of such
losses. 26 (Emphasis supplied)

Curiously enough, Picop did not also seek a ruling on this matter, clearly a matter of tax
law, from the Bureau of Internal Revenue. Picop chose to rely solely on the BOI letter-
opinion.

The CIR disallowed all the deductions claimed on the basis of RPPM's losses, apparently on two
(2) grounds. Firstly, the previous losses were incurred by "another taxpayer," RPPM, and not by
Picop in connection with Picop's own registered operations. The CIR took the view that Picop,
RPPM and RMC were merged into one (1) corporate personality only on 12 January 1978, upon
approval of the merger agreement by the BOI. Thus, during the taxable year 1977, Picop on the
one hand and RPPM and RMC on the other, still had their separate juridical personalities.
Secondly, the CIR alleged that these losses had been incurred by RPPM "from the borrowing of
funds" and not from carrying out of RPPM's registered operations. We focus on the first
ground. 27

The CTA upheld the deduction claimed by Picop; its reasoning, however, is less than crystal
clear, especially in respect of its view of what the U.S. tax law was on this matter. In any event,
the CTA apparently fell back on the BOI opinion of 21 February 1977 referred to above. The CTA
said:

Respondent further averred that the incentives granted under Section 7 of R.A.
No. 5186 shall be available only to the extent in which they are engaged in
registered operations, citing Section 1 of Rule IX of the Basic Rules and
Regulations to Implement the Intent and Provisions of the Investment Incentives
Act, R.A. No. 5186.

We disagree with respondent. The purpose of the merger was to rationalize the
container board industry and not to take advantage of the net losses incurred by
RPPMI prior to the stock swap. Thus, when stock of a corporation is purchased in
order to take advantage of the corporation's net operating loss incurred in years
prior to the purchase, the corporation thereafter entering into a trade or
business different from that in which it was previously engaged, the net
operating loss carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5,
Mertens, Law of Federal Income Taxation, Chap. 29.11a, p. 103]. 28 Furthermore,
once the BOI approved the merger agreement, the registered capacity of Rustan
shall be transferred to PICOP, and the previous losses of Rustan may be carried
over by PICOP by operation of law. [BOI ruling dated February 21, 1977 (Exh. J-
1)] It is clear therefrom, that the deduction availed of under Section 7(c) of R.A.
No. 5186 was only proper." (pp. 38-43, Rollo of SP No. 20070) 29 (Emphasis
supplied)

In respect of the above underscored portion of the CTA decision, we must note that the
CTA in fact overlooked the statement made by petitioner's counsel before the CTA that:

Among the attractions of the merger to Picop was the accumulated net operating
loss carry-over of RMC that it might possibly use to relieve it (Picop) from its
income taxes, under Section 7 (c) of R.A.5186. Said section provides:

xxx xxx xxx

With this benefit in mind, Picop addressed three (3) questions to the BOI in a
letter dated November 25, 1976. The BOI replied on February 21, 1977 directly
answering the three (3) queries. 30 (Emphasis supplied)

The size of RPPM's accumulated losses as of the date of the merger — more than
P81,000,000.00 — must have constituted a powerful attraction indeed for Picop.
The Court of Appeals followed the result reached by the CTA. The Court of Appeals, much like
the CTA, concluded that since RPPM was dissolved on 30 November 1977, its accumulated
losses were appropriately carried over by Picop in the latter's 1977 Income Tax Return "because
by that time RPPMI and Picop were no longer separate and different taxpayers." 31

After prolonged consideration and analysis of this matter, the Court is unable to agree with the
CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's
1977 gross income.

It is important to note at the outset that in our jurisdiction, the ordinary rule — that is, the rule
applicable in respect of corporations not registered with the BOI as a preferred pioneer
enterprise — is that net operating losses cannot be carried over. Under our Tax Code, both in
1977 and at present, losses may be deducted from gross income only if such losses were
actually sustained in the same year that they are deducted or charged off. Section 30 of the
1977 Tax Code provides:

Sec. 30. Deductions from Gross Income. — In computing net income, there shall
be allowed as deduction —

xxx xxx xxx

(d) Losses:

(1) By Individuals. — In the case of an individual, losses actually sustained during

the taxable year and not compensated for by an insurance or otherwise —

(A) If incurred in trade or business;

xxx xxx xxx

(2) By Corporations. — In a case of a corporation, all losses actually sustained

and charged off within the taxable year and not compensated for by insurance or
otherwise.

(3) By Non-resident Aliens or Foreign Corporations. — In the case of a non-

resident alien individual or a foreign corporation, the losses deductible are
those actually sustained during the year incurred in business or trade
conducted within the Philippines, . . . 32 (Emphasis supplied)

Section 76 of the Philippine Income Tax Regulations (Revenue Regulation No. 2, as

amended) is even more explicit and detailed:

Sec. 76. When charges are deductible. — Each year's return, so far as practicable,
both as to gross income and deductions therefrom should be complete in itself,
 and taxpayers are expected to make every reasonable effort to ascertain the
facts necessary to make a correct return. The expenses, liabilities, or deficit of
one year cannot be used to reduce the income of a subsequent year. A taxpayer
has the right to deduct all authorized allowances and it follows that if he does
not within any year deduct certain of his expenses, losses, interests, taxes, or
other charges,
he can not deduct them from the income of the next or any succeeding year. . . .

xxx xxx xxx

. . . . If subsequent to its occurrence, however, a taxpayer first ascertains the

amount of a loss sustained during a prior taxable year which has not been
deducted from gross income, he may render an amended return for such
preceding taxable year including such amount of loss in the deduction from gross
income and may in proper cases file a claim for refund of the excess paid by
reason of the failure to deduct such loss in the original return. A loss from theft
or embezzlement occurring in one year and discovered in another is ordinarily
deductible for the year in which sustained. (Emphases supplied)

It is thus clear that under our law, and outside the special realm of BOI-registered
enterprises, there is no such thing as a carry-over of net operating loss. To the
contrary, losses must be deducted against current income in the taxable year when such
losses were incurred. Moreover, such losses may be charged off only against income
earned in the same taxable year when the losses were incurred.

Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special
incentive to be granted only to registered pioneer enterprises and only with respect to their
registered operations. The statutory purpose here may be seen to be the encouragement of the
establishment and continued operation of pioneer industries by allowing the registered
enterprise to accumulate its operating losses which may be expected during the early years of
the enterprise and to permit the enterprise to offset such losses against income earned by it in
later years after successful establishment and regular operations. To promote its economic
development goals, the Republic foregoes or defers taxing the income of the pioneer enterprise
until after that enterprise has recovered or offset its earlier losses. We consider that the
statutory purpose can be served only if the accumulated operating losses are carried over and
charged off against income subsequently earned and accumulated by the same enterprise
engaged in the same registered operations.

In the instant case, to allow the deduction claimed by Picop would be to permit one corporation
or enterprise, Picop, to benefit from the operating losses accumulated by another corporation
or enterprise, RPPM. RPPM far from benefiting from the tax incentive granted by the BOI
statute, in fact gave up the struggle and went out of existence and its former stockholders
joined the much larger group of Picop's stockholders. To grant Picop's claimed deduction would
be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from
the very beginning) which had not been earned by the registered enterprise which had suffered
the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop
to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the
CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its
income from taxation thereof although Picop had not run the risks and incurred the losses
which had been encountered and suffered by RPPM. Conversely, the income that would be
shielded from taxation is not income that was, after much effort, eventually generated by the
same registered operations which earlier had sustained losses. We consider and so hold that
there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result.
Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be
projected by Section 7 (c), R.A. No. 5186.

The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating
losses against Picop's 1977 gross income, basically because towards the end of the taxable year
1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop,
remained. The losses suffered by RPPM's registered operations and the gross income generated
by Picop's own registered operations now came under one and the same corporate roof. We
consider that this circumstance relates much more to form than to substance. We do not
believe that that single purely technical factor is enough to authorize and justify the deduction
claimed by Picop. Picop's claim for deduction is not only bereft of statutory basis; it does
violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of
R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss
carry-over to BOI-registered pioneer enterprises, the legislature could not have intended to
require the Republic to forego tax revenues in order to benefit a corporation which had run no
risks and suffered no losses, but had merely purchased another's losses.

Both the CTA and the Court of Appeals appeared much impressed not only with corporate
technicalities but also with the U.S. tax law on this matter. It should suffice, however, simply to
note that in U.S. tax law, the availability to companies generally of operating loss carry-overs
and of operating loss carry-backs is expressly provided and regulated in great detail by
statute. 33 In our jurisdiction, save for Section 7 (c) of R.A. No. 5186, no statute recognizes or
permits loss carry-overs and loss carry-backs. Indeed, as already noted, our tax law expressly
rejects the very notion of loss carry-overs and carry-backs.

We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977
Income Tax Return must be disallowed.

(3) Whether Picop is entitled

to deduct against current
income certain claimed
financial guarantee expenses.

In its Income Tax Return for 1977, Picop also claimed a deduction in the amount of
P1,237,421.00 as financial guarantee expenses.
This deduction is said to relate to chattel and real estate mortgages required from Picop by the
Philippine National Bank ("PNB") and DBP as guarantors of loans incurred by Picop from foreign
creditors. According to Picop, the claimed deduction represents registration fees and other
expenses incidental to registration of mortgages in favor of DBP and PNB.

In support of this claimed deduction, Picop allegedly showed its own vouchers to BIR Examiners
to prove disbursements to the Register of Deeds of Tandag, Surigao del Sur, of particular
amounts. In the proceedings before the CTA, however, Picop did not submit in evidence such
vouchers and instead presented one of its employees to testify that the amount claimed had
been disbursed for the registration of chattel and real estate mortgages.

The CIR disallowed this claimed deduction upon the ground of insufficiency of evidence. This
disallowance was sustained by the CTA and the Court of Appeals. The CTA said:

No records are available to support the abovementioned expenses. The vouchers

merely showed that the amounts were paid to the Register of Deeds and simply
cash account. Without the supporting papers such as the invoices or official
receipts of the Register of Deeds, these vouchers standing alone cannot prove
that the payments made were for the accrued expenses in question. The best
evidence of payment is the official receipts issued by the Register of Deeds. The
testimony of petitioner's witness that the official receipts and cash vouchers
were shown to the Bureau of Internal Revenue will not suffice if no records could
be presented in court for proper marking and identification. 34 Emphasis
supplied)

The Court of Appeals added:

The mere testimony of a witness for PICOP and the cash vouchers do not suffice
to establish its claim that registration fees were paid to the Register of Deeds for
the registration of real estate and chattel mortgages in favor of Development
Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's
loans. The witness could very well have been merely repeating what he was
instructed to say regardless of the truth, while the cash vouchers, which we do
not find on file, are not said to provide the necessary details regarding the
nature and purpose of the expenses reflected therein. PICOP should have
presented, through the guarantors, its owner's copy of the registered titles with
the lien inscribed thereon as well as an official receipt from the Register of Deeds
evidencing payment of the registration fee. 35 (Emphasis supplied)

We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has
the burden of proving entitlement to a claimed deduction. 36 In the instant case, even Picop's
own vouchers were not submitted in evidence and the BIR Examiners denied that such
vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only
confirm the fact of disbursement but not necessarily the purpose thereof. 37 The best evidence
that Picop should have presented to support its claimed deduction were the invoices and
official receipts issued by the Register of Deeds. Picop not only failed to present such
documents; it also failed to explain the loss thereof, assuming they had existed before. 38 Under
the best evidence rule, 39 therefore, the testimony of Picop's employee was inadmissible and
was in any case entitled to very little, if any, credence.

We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not

adequately shown and that such deduction must be disallowed.

III

(1) Whether Picop had understated

its sales and overstated its
cost of sales for 1977.

In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had
understated its sales by P2,391,644.00 and, upon the other hand, overstated its cost of sales by
P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its
own return.

The 1977 Income Tax Return of Picop set forth the following figures:

Sales (per Picop's Income Tax Return):

Paper P 537,656,719.00

Timber P 263,158,132.00

———————

Total Sales P 800,814,851.00

============

Upon the other hand, Picop's Books of Accounts reflected higher sales figures:

Sales (per Picop's Books of Accounts):

Paper P 537,656,719.00

Timber P 265,549,776.00

———————
 Total Sales P 803,206,495.00

============

The above figures thus show a discrepancy between the sales figures reflected in Picop's
Books of Accounts and the sales figures reported in its 1977 Income Tax Return,
amounting to: P2,391,644.00.

The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when
compared with the cost figures in its Books of Accounts, was overstated:

Cost of Sales
(per Income Tax Return) P607,246,084.00
Cost of Sales
(per Books of Accounts) P606,642,066.00

———————

Discrepancy P 604,018.00
============

Picop did not deny the existence of the above noted discrepancies. In the proceedings before
the CTA, Picop presented one of its officials to explain the foregoing discrepancies. That
explanation is perhaps best presented in Picop's own words as set forth in its Memorandum
before this Court:

. . . that the adjustment discussed in the testimony of the witness, represent the
best and most objective method of determining in pesos the amount of the
correct and actual export sales during the year. It was this correct and actual
export sales and costs of sales that were reflected in the income tax return and
in the audited financial statements. These corrections did not result in realization
of income and should not give rise to any deficiency tax.

xxx xxx xxx

What are the facts of this case on this matter? Why were adjustments necessary
at the year-end?

Because of PICOP's procedure of recording its export sales (reckoned in U.S.

dollars) on the basis of a fixed rate, day to day and month to month, regardless
of the actual exchange rate and without waiting when the actual proceeds are
received. In other words, PICOP recorded its export sales at a pre-determined
fixed exchange rate. That pre-determined rate was decided upon at the
beginning of the year and continued to be used throughout the year.
 At the end of the year, the external auditors made an examination. In that
examination, the auditors determined with accuracy the actual dollar proceeds
of the export sales received. What exchange rate was used by the auditors to
convert these actual dollar proceeds into Philippine pesos? They used the
average of the differences between (a) the recorded fixed exchange rate and (b)
the exchange rate at the time the proceeds were actually received. It was this
rate at time of receipt of the proceeds that determined the amount of pesos
credited by the Central Bank (through the agent banks) in favor of PICOP. These
accumulated differences were averaged by the external auditors and this was
what was used at the year-end for income tax and other government-report
purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40

The above explanation, unfortunately, at least to the mind of the Court, raises more questions
than it resolves. Firstly, the explanation assumes that all of Picop's sales were export sales for
which U.S. dollars (or other foreign exchange) were received. It also assumes that the expenses
summed up as "cost of sales" were all dollar expenses and that no peso expenses had been
incurred. Picop's explanation further assumes that a substantial part of Picop's dollar proceeds
for its export sales were not actually surrendered to the domestic banking system and
seasonably converted into pesos; had all such dollar proceeds been converted into pesos, then
the peso figures could have been simply added up to reflect the actual peso value of Picop's
export sales. Picop offered no evidence in respect of these assumptions, no explanation why
and how a "pre-determined fixed exchange rate" was chosen at the beginning of the year and
maintained throughout. Perhaps more importantly, Picop was unable to explain why its Books
of Accounts did not pick up the same adjustments that Picop's External Auditors were alleged
to have made for purposes of Picop's Income Tax Return. Picop attempted to explain away the
failure of its Books of Accounts to reflect the same adjustments (no correcting entries,
apparently) simply by quoting a passage from a case where this Court refused to ascribe much
probative value to the Books of Accounts of a corporate taxpayer in a tax case. 41What appears
to have eluded Picop, however, is that its Books of Accounts, which are kept by its own
employees and are prepared under its control and supervision, reflect what may be deemed to
be admissions against interest in the instant case. For Picop's Books of Accounts precisely
show higher sales figures and lower cost of sales figures than Picop's Income Tax Return.

It is insisted by Picop that its Auditors' adjustments simply present the "best and most
objective" method of reflecting in pesos the "correct and ACTUAL export sales" 42 and that the
adjustments or "corrections" "did not result in realization of [additional] income and should not
give rise to any deficiency tax." The correctness of this contention is not self-evident. So far as
the record of this case shows, Picop did not submit in evidence the aggregate amount of its U.S.
dollar proceeds of its export sales; neither did it show the Philippine pesos it had actually
received or been credited for such U.S. dollar proceeds. It is clear to this Court that the
testimonial evidence submitted by Picop fell far short of demonstrating the correctness of its
explanation.
Upon the other hand, the CIR has made out at least a prima facie case that Picop had
understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the
CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as
already noted, they embody what must appear to be admissions against Picop's own interest.

Accordingly, we must affirm the findings of the Court of Appeals and the CTA.

(2) Whether Picop is liable for

the corporate development
tax of five percent (5%)
of its income for 1977.

The five percent (5%) corporate development tax is an additional corporate income tax
imposed in Section 24 (e) of the 1977 Tax Code which reads in relevant part as follows:

(e) Corporate development tax. — In addition to the tax imposed in subsection

(a) of this section, an additional tax in an amount equivalent to 5 per cent of the
same taxable net income shall be paid by a domestic or a resident foreign
corporation; Provided, That this additional tax shall be imposed only if the net
income exceeds 10 per cent of the net worth, in case of a domestic corporation,
or net assets in the Philippines in case of a resident foreign corporation: . . . .

The additional corporate income tax imposed in this subsection shall be

collected and paid at the same time and in the same manner as the tax imposed
in subsection (a) of this section.

Since this five percent (5%) corporate development tax is an income tax, Picop is not
exempted from it under the provisions of Section 8 (a) of R.A. No. 5186.

For purposes of determining whether the net income of a corporation exceeds ten percent
(10%) of its net worth, the term "net worth" means the stockholders' equity represented by the
excess of the total assets over liabilities as reflected in the corporation's balance sheet provided
such balance sheet has been prepared in accordance with generally accepted accounting
principles employed in keeping the books of the corporation. 43

The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net
worth figure or total stockholders' equity as reflected in its Audited Financial Statements for
1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent
(10%) of its net worth, Picop must be held liable for the five percent (5%) corporate
development tax in the amount of P2,434,367.75.

Recapitulating, we hold:
(1) Picop is liable for the thirty-five percent (35%) transaction tax in the amount of
P3,578,543.51.

(2) Picop is not liable for interest and surcharge on unpaid transaction tax.

(3) Picop is exempt from payment of documentary and science stamp taxes in the amount of
P300,000.00 and the compromise penalty of P300.00.

(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans
for, among other things, the purchase of machinery and equipment.

(5) Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses
previously incurred by RPPM, is disallowed for lack of merit.

(6) Picop's claimed deduction for certain financial guarantee expenses in the amount
P1,237,421.00 is disallowed for failure adequately to prove such expenses.

(7) Picop has understated its sales by P2,391,644.00 and overstated its cost of sales by
P604,018.00, for 1977.

(8) Picop is liable for the corporate development tax of five percent (5%) of its adjusted net
income for 1977 in the amount of P2,434,367.75.

Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for
deficiency income tax for the year 1977 computed as follows:

Deficiency Income Tax

Net Income Per Return P 258,166.00

Add:

Unallowable Deductions

(1) Deduction of net

operating losses
incurred by RPPM P 44,196,106.00

(2) Unexplained financial

guarantee expenses P 1,237,421.00

(3) Understatement of
Sales P 2,391,644.00
 (4) Overstatement of
Cost of Sales P 604,018.00

——————

Total P 48,429,189.00

——————

Net Income as Adjusted P 48,687,355.00

===========

Income Tax Due Thereon 44 P 17,030,574.00

Less:

Tax Already Assessed per

Return 80,358.00

——————

Deficiency Income Tax P 16,560,216.00

Add:

Five percent (5%) Corporate

Development Tax P 2,434,367.00

Total Deficiency Income Tax P 18,994,583.00

===========

Add:

Five percent (5%) surcharge 45 P 949,729.15

——————

Total Deficiency Income Tax

with surcharge P 19,944,312.15

Add:
 Fourteen percent (14%)

interest from 15 April

1978 to 14 April 1981 46 P 8,376,610.80

Fourteen percent (14%)

interest from 21 April

1983 to 20 April 1986 47 P 11,894,787.00

——————

Total Deficiency Income Tax

Due and Payable P 40,215,709.00

===========

WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and
Picop is hereby ORDERED to pay the CIR the aggregate amount of P43,794,252.51 itemized as
follows:

(1) Thirty-five percent (35%)

transaction tax P 3,578,543.51

(2) Total Deficiency Income

Tax Due 40,215,709.00

———————

Aggregate Amount Due and Payable P 43,794,252.51

============

No pronouncement as to costs.

SO ORDERED.
G.R. No. 148187 April 16, 2008
PHILEX MINING CORPORATION, petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
DECISION
YNARES-SANTIAGO, J.:
This is a petition for review on certiorari of the June 30, 2000 Decision 1 of the Court of Appeals
in CA-G.R. SP No. 49385, which affirmed the Decision2 of the Court of Tax Appeals in C.T.A. Case
No. 5200. Also assailed is the April 3, 2001 Resolution3 denying the motion for reconsideration.
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an
agreement4 with Baguio Gold Mining Company ("Baguio Gold") for the former to manage and
operate the latter’s mining claim, known as the Sto. Nino mine, located in Atok and Tublay,
Benguet Province. The parties’ agreement was denominated as "Power of Attorney" and
provided for the following terms:
4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make
available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS
(P11,000,000.00), in such amounts as from time to time may be required by the
MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO.
NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be deemed, for
internal audit purposes, as the owner’s account in the Sto. Nino PROJECT. Any part of
any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino
PROJECT, shall be added to such owner’s account.
5. Whenever the MANAGERS shall deem it necessary and convenient in connection with
the MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or
property to the Sto. Nino PROJECT, in accordance with the following arrangements:
(a) The properties shall be appraised and, together with the cash, shall be carried
by the Sto. Nino PROJECT as a special fund to be known as the MANAGERS’
account.
(b) The total of the MANAGERS’ account shall not exceed P11,000,000.00, except
with prior approval of the PRINCIPAL; provided, however, that if the
compensation of the MANAGERS as herein provided cannot be paid in cash from
the Sto. Nino PROJECT, the amount not so paid in cash shall be added to the
MANAGERS’ account.
(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino
PROJECT until termination of this Agency.
(d) The MANAGERS’ account shall not accrue interest. Since it is the desire of the
PRINCIPAL to extend to the MANAGERS the benefit of subsequent appreciation
of property, upon a projected termination of this Agency, the ratio which the
MANAGERS’ account has to the owner’s account will be determined, and the
 corresponding proportion of the entire assets of the STO. NINO MINE, excluding
the claims, shall be transferred to the MANAGERS, except that such transferred
assets shall not include mine development, roads, buildings, and similar property
which will be valueless, or of slight value, to the MANAGERS. The MANAGERS
can, on the other hand, require at their option that property originally
transferred by them to the Sto. Nino PROJECT be re-transferred to them. Until
such assets are transferred to the MANAGERS, this Agency shall remain
subsisting.
xxxx
12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of
the Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay
income tax on their compensation, while the PRINCIPAL shall pay income tax on the net
profit of the Sto. Nino PROJECT after deduction therefrom of the MANAGERS’
compensation.
xxxx
16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in
the future, may incur other obligations in favor of the MANAGERS. This Power of
Attorney has been executed as security for the payment and satisfaction of all such
obligations of the PRINCIPAL in favor of the MANAGERS and as a means to fulfill the
same. Therefore, this Agency shall be irrevocable while any obligation of the PRINCIPAL
in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account. After all
obligations of the PRINCIPAL in favor of the MANAGERS have been paid and satisfied in
full, this Agency shall be revocable by the PRINCIPAL upon 36-month notice to the
MANAGERS.
17. Notwithstanding any agreement or understanding between the PRINCIPAL and the
MANAGERS to the contrary, the MANAGERS may withdraw from this Agency by giving 6-
month notice to the PRINCIPAL. The MANAGERS shall not in any manner be held liable
to the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d) hereof shall be
operative in case of the MANAGERS’ withdrawal.
x x x x5
In the course of managing and operating the project, Philex Mining made advances of cash and
property in accordance with paragraph 5 of the agreement. However, the mine suffered
continuing losses over the years which resulted to petitioner’s withdrawal as manager of the
mine on January 28, 1982 and in the eventual cessation of mine operations on February 20,
1982.6
Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in
Payment"7 wherein Baguio Gold admitted an indebtedness to petitioner in the amount of
P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold’s
tangible assets to petitioner, transferring to the latter Baguio Gold’s equitable title in its
Philodrill assets and finally settling the remaining liability through properties that Baguio Gold
may acquire in the future.
On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in
Payment"8 where the parties determined that Baguio Gold’s indebtedness to petitioner actually
amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors
that petitioner had assumed as guarantor. These liabilities pertained to long-term loans
amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA
and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by first
assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its
Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a
remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.
Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding
indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that
were set up in 1981 and P2,860,768.00 to the 1982 operations.
In its 1982 annual income tax return, petitioner deducted from its gross income the amount of
P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and
allowances."9 However, the Bureau of Internal Revenue (BIR) disallowed the amount as
deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must be allowed since all
requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing
debt; (b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable
year when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid management contract it entered into
with Baguio Gold. The bad debt deduction represented advances made by petitioner which,
pursuant to the management contract, formed part of Baguio Gold’s "pecuniary obligations" to
petitioner. It also included payments made by petitioner as guarantor of Baguio Gold’s long-
term loans which legally entitled petitioner to be subrogated to the rights of the original
creditor.
Petitioner also asserted that due to Baguio Gold’s irreversible losses, it became evident that it
would not be able to recover the advances and payments it had made in behalf of Baguio Gold.
For a debt to be considered worthless, petitioner claimed that it was neither required to
institute a judicial action for collection against the debtor nor to sell or dispose of collateral
assets in satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce
collection and exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioner’s protest for lack of legal and factual basis. It
held that the alleged debt was not ascertained to be worthless since Baguio Gold remained
existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a
valid and subsisting debt considering that, under the management contract, petitioner was to
be paid fifty percent (50%) of the project’s net profit.10
Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as
follows:
 WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED
for lack of merit. The assessment in question, viz: FAS-1-82-88-003067 for deficiency
income tax in the amount of P62,811,161.39 is hereby AFFIRMED.
ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY
respondent Commissioner of Internal Revenue the amount of P62,811,161.39, plus, 20%
delinquency interest due computed from February 10, 1995, which is the date after the
20-day grace period given by the respondent within which petitioner has to pay the
deficiency amount x x x up to actual date of payment.
SO ORDERED.11
The CTA rejected petitioner’s assertion that the advances it made for the Sto. Nino mine were
in the nature of a loan. It instead characterized the advances as petitioner’s investment in a
partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. The
CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a
partnership agreement. Since the advanced amount partook of the nature of an investment, it
could not be deducted as a bad debt from petitioner’s gross income.
The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of
Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were
made, Baguio Gold was not in default since its loans were not yet due and demandable. What
petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America
showing that it was merely demanding payment of the installment and interests due.
Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-payment.
The Court of Appeals affirmed the decision of the CTA.12 Hence, upon denial of its motion for
reconsideration,13petitioner took this recourse under Rule 45 of the Rules of Court, alleging
that:
I.
The Court of Appeals erred in construing that the advances made by Philex in the
management of the Sto. Nino Mine pursuant to the Power of Attorney partook of the
nature of an investment rather than a loan.
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the
Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the development of
the Sto. Nino Mine notwithstanding the clear absence of any intent on the part of Philex
and Baguio Gold to form a partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney and in completely
disregarding the Compromise Agreement and the Amended Compromise Agreement
when it construed the nature of the advances made by Philex.
IV.
 The Court of Appeals erred in refusing to delve upon the issue of the propriety of the
bad debts write-off.14
Petitioner insists that in determining the nature of its business relationship with Baguio Gold,
we should not only rely on the "Power of Attorney", but also on the subsequent "Compromise
with Dation in Payment" and "Amended Compromise with Dation in Payment" that the parties
executed in 1982. These documents, allegedly evinced the parties’ intent to treat the advances
and payments as a loan and establish a creditor-debtor relationship between them.
The petition lacks merit.
The lower courts correctly held that the "Power of Attorney" is the instrument that is material
in determining the true nature of the business relationship between petitioner and Baguio
Gold. Before resort may be had to the two compromise agreements, the parties’ contractual
intent must first be discovered from the expressed language of the primary contract under
which the parties’ business relations were founded. It should be noted that the compromise
agreements were mere collateral documents executed by the parties pursuant to the
termination of their business relationship created under the "Power of Attorney". On the other
hand, it is the latter which established the juridical relation of the parties and defined the
parameters of their dealings with one another.
The execution of the two compromise agreements can hardly be considered as a subsequent or
contemporaneous act that is reflective of the parties’ true intent. The compromise agreements
were executed eleven years after the "Power of Attorney" and merely laid out a plan or
procedure by which petitioner could recover the advances and payments it made under the
"Power of Attorney". The parties entered into the compromise agreements as a consequence of
the dissolution of their business relationship. It did not define that relationship or indicate its
real character.
An examination of the "Power of Attorney" reveals that a partnership or joint venture was
indeed intended by the parties. Under a contract of partnership, two or more persons bind
themselves to contribute money, property, or industry to a common fund, with the intention of
dividing the profits among themselves.15 While a corporation, like petitioner, cannot generally
enter into a contract of partnership unless authorized by law or its charter, it has been held that
it may enter into a joint venture which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has no precise legal
definition, but it has been generally understood to mean an organization formed for
some temporary purpose. x x x It is in fact hardly distinguishable from the partnership,
since their elements are similar – community of interest in the business, sharing of
profits and losses, and a mutual right of control. x x x The main distinction cited by most
opinions in common law jurisdictions is that the partnership contemplates a general
business with some degree of continuity, while the joint venture is formed for the
execution of a single transaction, and is thus of a temporary nature. x x x This
observation is not entirely accurate in this jurisdiction, since under the Civil Code, a
partnership may be particular or universal, and a particular partnership may have for its
object a specific undertaking. x x x It would seem therefore that under Philippine law, a
joint venture is a form of partnership and should be governed by the law of
 partnerships. The Supreme Court has however recognized a distinction between these
two business forms, and has held that although a corporation cannot enter into a
partnership contract, it may however engage in a joint venture with others. x x x
(Citations omitted) 16
Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties
had intended to create a partnership and establish a common fund for the purpose. They also
had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of
the mine.
Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money,
property and industry to the common fund known as the Sto. Niño mine. 17 In this regard, we
note that there is a substantive equivalence in the respective contributions of the parties to the
development and operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement,
petitioner and Baguio Gold were to contribute equally to the joint venture assets under their
respective accounts. Baguio Gold would contribute P11M under its owner’s account plus any of
its income that is left in the project, in addition to its actual mining claim. Meanwhile,
petitioner’s contribution would consist of its expertise in the management and operation of
mines, as well as the manager’s account which is comprised of P11M in funds and property and
petitioner’s "compensation" as manager that cannot be paid in cash.
However, petitioner asserts that it could not have entered into a partnership agreement with
Baguio Gold because it did not "bind" itself to contribute money or property to the project; that
under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or
property to the Sto. Niño project "(w)henever the MANAGERS shall deem it necessary and
convenient in connection with the MANAGEMENT of the STO. NIÑO MINE."18
The wording of the parties’ agreement as to petitioner’s contribution to the common fund does
not detract from the fact that petitioner transferred its funds and property to the project as
specified in paragraph 5, thus rendering effective the other stipulations of the contract,
particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until
termination of the parties’ business relations. As can be seen, petitioner became bound by its
contributions once the transfers were made. The contributions acquired an obligatory nature as
soon as petitioner had chosen to exercise its option under paragraph 5.
There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal
of advances should not be taken as an indication that it had entered into a partnership with
Baguio Gold; that the stipulation only showed that what the parties entered into was actually a
contract of agency coupled with an interest which is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the
principal due to an interest of a third party that depends upon it, or the mutual interest of both
principal and agent.19 In this case, the non-revocation or non-withdrawal under paragraph 5(c)
applies to the advances made by petitioner who is supposedly the agent and not the principal
under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation
under the agreement is one of agency coupled with an interest and not a partnership.
Neither can paragraph 16 of the agreement be taken as an indication that the relationship of
the parties was one of agency and not a partnership. Although the said provision states that
"this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the
MANAGERS is outstanding, inclusive of the MANAGERS’ account," it does not necessarily follow
that the parties entered into an agency contract coupled with an interest that cannot be
withdrawn by Baguio Gold.
It should be stressed that the main object of the "Power of Attorney" was not to confer a power
in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a
business relationship between petitioner and Baguio Gold, in which the former was to manage
and operate the latter’s mine through the parties’ mutual contribution of material resources
and industry. The essence of an agency, even one that is coupled with interest, is the agent’s
ability to represent his principal and bring about business relations between the latter and third
persons.20 Where representation for and in behalf of the principal is merely incidental or
necessary for the proper discharge of one’s paramount undertaking under a contract, the latter
may not necessarily be a contract of agency, but some other agreement depending on the
ultimate undertaking of the parties.21
In this case, the totality of the circumstances and the stipulations in the parties’ agreement
indubitably lead to the conclusion that a partnership was formed between petitioner and
Baguio Gold.
First, it does not appear that Baguio Gold was unconditionally obligated to return the advances
made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon
termination of the parties’ business relations, "the ratio which the MANAGER’S account has to
the owner’s account will be determined, and the corresponding proportion of the entire assets
of the STO. NINO MINE, excluding the claims" shall be transferred to petitioner. 22 As pointed
out by the Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the
mine’s assets upon dissolution of the parties’ business relations. There was nothing in the
agreement that would require Baguio Gold to make payments of the advances to petitioner as
would be recognized as an item of obligation or "accounts payable" for Baguio Gold.
Thus, the tax court correctly concluded that the agreement provided for a distribution of assets
of the Sto. Niño mine upon termination, a provision that is more consistent with a partnership
than a creditor-debtor relationship. It should be pointed out that in a contract of loan, a person
who receives a loan or money or any fungible thing acquires ownership thereof and is bound to
pay the creditor an equal amount of the same kind and quality.23 In this case, however, there
was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it had
advanced, but only the return of an amount pegged at a ratio which the manager’s account had
to the owner’s account.
In this connection, we find no contractual basis for the execution of the two compromise
agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly
arose from the termination of their business relations over the Sto. Nino mine. The "Power of
Attorney" clearly provides that petitioner would only be entitled to the return of a
proportionate share of the mine assets to be computed at a ratio that the manager’s account
had to the owner’s account. Except to provide a basis for claiming the advances as a bad debt
deduction, there is no reason for Baguio Gold to hold itself liable to petitioner under the
compromise agreements, for any amount over and above the proportion agreed upon in the
"Power of Attorney".
Next, the tax court correctly observed that it was unlikely for a business corporation to lend
hundreds of millions of pesos to another corporation with neither security, or collateral, nor a
specific deed evidencing the terms and conditions of such loans. The parties also did not
provide a specific maturity date for the advances to become due and demandable, and the
manner of payment was unclear. All these point to the inevitable conclusion that the advances
were not loans but capital contributions to a partnership.
The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it
would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement.
The entirety of the parties’ contractual stipulations simply leads to no other conclusion than
that petitioner’s "compensation" is actually its share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in
the profits of a business is prima facie evidence that he is a partner in the business." Petitioner
asserts, however, that no such inference can be drawn against it since its share in the profits of
the Sto Niño project was in the nature of compensation or "wages of an employee", under the
exception provided in Article 1769 (4) (b).24
On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold
who will be paid "wages" pursuant to an employer-employee relationship. To begin with,
petitioner was the manager of the project and had put substantial sums into the venture in
order to ensure its viability and profitability. By pegging its compensation to profits, petitioner
also stood not to be remunerated in case the mine had no income. It is hard to believe that
petitioner would take the risk of not being paid at all for its services, if it were truly just an
ordinary employee.
Consequently, we find that petitioner’s "compensation" under paragraph 12 of the agreement
actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not
be entitled to an equal share in the income of the mine if it were just an employee of Baguio
Gold.25 It is not surprising that petitioner was to receive a 50% share in the net profits,
considering that the "Power of Attorney" also provided for an almost equal contribution of the
parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the
notion that the parties’ relations were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioner’s advances as investments in a
partnership known as the Sto. Nino mine. The advances were not "debts" of Baguio Gold to
petitioner inasmuch as the latter was under no unconditional obligation to return the same to
the former under the "Power of Attorney". As for the amounts that petitioner paid as guarantor
to Baguio Gold’s creditors, we find no reason to depart from the tax court’s factual finding that
Baguio Gold’s debts were not yet due and demandable at the time that petitioner paid the
same. Verily, petitioner pre-paid Baguio Gold’s outstanding loans to its bank creditors and this
conclusion is supported by the evidence on record.26
In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income.
Deductions for income tax purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing evidence that he is entitled to
the deduction claimed.27 In this case, petitioner failed to substantiate its assertion that the
advances were subsisting debts of Baguio Gold that could be deducted from its gross income.
Consequently, it could not claim the advances as a valid bad debt deduction.
WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No.
49385 dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in C.T.A.
Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the
deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency
interest computed from February 10, 1995, which is the due date given for the payment of the
deficiency income tax, up to the actual date of payment.
SO ORDERED.
 [G.R. No. 108576. January 20, 1999]

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS, COURT OF

TAX APPEALS and A. SORIANO CORP., respondents.

DECISION
MARTINEZ, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the
Court of Appeals (CA)[1]which affirmed the ruling of the Court of Tax Appeals (CTA)[2] that
private respondent A. Soriano Corporations (hereinafter ANSCOR) redemption and exchange of
the stocks of its foreign stockholders cannot be considered as essentially equivalent to a
distribution of taxable dividends under Section 83(b) of the 1939 Internal Revenue Act [3]
The undisputed facts are as follows:
Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States,
formed the corporation A. Soriano Y Cia, predecessor of ANSCOR, with a P1,000,000.00
capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is
wholly owned and controlled by the family of Don Andres, who are all non-resident aliens.[4] In
1937, Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued.[5]
On September 12, 1945, ANSCORs authorized capital stock was increased to P2,500,000.00
divided into 25,000 common shares with the same par value. Of the additional 15,000 shares,
only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders
waived in favor of the former their pre-emptive rights to subscribe to the new issues.[6] This
increased his subscription to 14,963 common shares.[7] A month later,[8] Don Andres transferred
1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in
ANSCOR.[9] Both sons are foreigners.[10]
By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made
between 1949 and December 20, 1963.[11] On December 30, 1964 Don Andres died. As of that
date, the records revealed that he has a total shareholdings of 185,154 shares[12] - 50,495 of
which are original issues and the balance of 134,659 shares as stock dividend
declarations.[13] Correspondingly, one-half of that shareholdings or 92,577[14] shares were
transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part
of his estate.[15]
A day after Don Andres died, ANSCOR increased its capital stock to P20M[16] and in 1966
further increased it to P30M.[17] In the same year (December 1966), stock dividends worth
46,290 and 46,287 shares were respectively received by the Don Andres estate[18] and Doa
Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and
138,864[19] common shares each.[20]
 On December 28, 1967, Doa Carmen requested a ruling from the United States Internal
Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be
considered as a tax avoidance scheme[21] under Section 367 of the 1954 U.S. Revenue Act.[22] By
January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common
and 150,000 preferred shares.[23]
In a letter-reply dated February 1968, the IRS opined that the exchange is only a
recapitalization scheme and not tax avoidance.[24] Consequently,[25] on March 31, 1968 Doa
Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified
preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares for
the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to
127,727.[26]
On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common
shares from the Don Andres estate. By November 1968, the Board further increased ANSCORs
capital stock to P75M divided into 150,000 preferred shares and 600,000 common
shares.[27] About a year later, ANSCOR again redeemed 80,000 common shares from the Don
Andres estate,[28] further reducing the latters common shareholdings to 19,727. As stated in the
board Resolutions, ANSCORs business purpose for both redemptions of stocks is to partially
retire said stocks as treasury shares in order to reduce the companys foreign exchange
remittances in case cash dividends are declared.[29]
In 1973, after examining ANSCORs books of account and records, Revenue examiners
issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source,
pursuant to Sections 53 and 54 of the 1939 Revenue Code, [30] for the year 1968 and the second
quarter of 1969 based on the transactions of exchange and redemption of stocks. [31]The Bureau
of Internal Revenue (BIR) made the corresponding assessments despite the claim of ANSCOR
that it availed of the tax amnesty under Presidential Decree (P.D.) 23[32] which were amended
by P.D.s 67 and 157.[33] However, petitioner ruled that the invoked decrees do not cover
Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR
was assessed.[34] ANSCORs subsequent protest on the assessments was denied in 1983 by
petitioner.[35]
Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax
assessments on the redemptions and exchange of stocks. In its decision, the Tax Court reversed
petitioners ruling, after finding sufficient evidence to overcome the prima facie correctness of
the questioned assessments.[36] In a petition for review, the CA, as mentioned, affirmed the
ruling of the CTA.[37] Hence, this petition.
The bone of contention is the interpretation and application of Section 83(b) of the 1939
Revenue Act[38] which provides:
Sec. 83. Distribution of dividends or assets by corporations.

(b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall
not be subject to tax. However, if a corporation cancels or redeems stock issued as a
dividend at such time and in such manner as to make the distribution and cancellation or
redemption, in whole or in part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent it represents a distribution of earnings or
profits accumulated after March first, nineteen hundred and thirteen.(Italics supplied).
Specifically, the issue is whether ANSCORs redemption of stocks from its stockholder as well as
the exchange of common with preferred shares can be considered as essentially equivalent to
the distribution of taxable dividend, making the proceeds thereof taxable under the provisions
of the above-quoted law.
Petitioner contends that the exchange transaction is tantamount to cancellation under
Section 83(b) making the proceeds thereof taxable. It also argues that the said Section applies
to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims
that under the net effect test, the estate of Don Andres gained from the redemption.
Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two
transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act.[39]
ANSCOR, however, avers that it has no duty to withhold any tax either from the Don
Andres estate or from Doa Carmen based on the two transactions, because the same were
done for legitimate business purposes which are (a) to reduce its foreign exchange remittances
in the event the company would declare cash dividends,[40] and to (b) subsequently filipinized
ownership of ANSCOR, as allegedly envisioned by Don Andres.[41] It likewise invoked the
amnesty provisions of P.D. 67.
We must emphasize that the application of Sec. 83(b) depends on the special factual
circumstances of each case.[42]The findings of facts of a special court (CTA) exercising particular
expertise on the subject of tax, generally binds this Court,[43] considering that it is substantially
similar to the findings of the CA which is the final arbiter of questions of facts. [44] The issue in
this case does not only deal with facts but whether the law applies to a particular set of facts.
Moreover, this Court is not necessarily bound by the lower courts conclusions of law drawn
from such facts.[45]
AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D. 67[46] provides:
I. In all cases of voluntary disclosures of previously untaxed income and/or wealth such
as earnings, receipts, gifts, bequests or any other acquisitions from any source
whatsoever which are taxable under the National Internal Revenue Code, as amended,
realized here or abroad by any taxpayer, natural or juridical; the collection of all internal
revenue taxes including the increments or penalties or account of non-payment as well
as all civil, criminal or administrative liabilities arising from or incident to such
disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-
Graft and Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws
and regulations, laws and regulations on Immigration and Deportation, or any other
applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax of ten
 (10%) per centum on such previously untaxed income or wealth is hereby imposed,
subject to the following conditions: (conditions omitted) [Emphasis supplied].
The decree condones the collection of all internal revenue taxes including the increments or
penalties or account of non-payment as well as all civil, criminal or administrative liabilities
arising from or incident to (voluntary) disclosures under the NIRC of previously untaxed income
and/or wealth realized here or abroad by any taxpayer, natural or juridical.
May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the
amnesty? An income taxpayer covers all persons who derive taxable income. [47] ANSCOR was
assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code.
As such, it is being held liable in its capacity as a withholding agent and not in its personality as
a taxpayer.
In the operation of the withholding tax system, the withholding agent is the payor, a
separate entity acting no more than an agent of the government for the collection of the
tax[48] in order to ensure its payments;[49] the payer is the taxpayer he is the person subject to
tax impose by law;[50] and the payee is the taxing authority.[51] In other words, the withholding
agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the
agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent
from the taxpayer,[52] because the income tax is still impose on and due from the latter. The
agent is not liable for the tax as no wealth flowed into him he earned no income. The Tax Code
only makes the agent personally liable for the tax[53] (c) 1939 Tax Code, as amended by R.A. No.
2343 which provides in part that xxx Every such person is made personally liable for such tax
xxx.53 arising from the breach of its legal duty to withhold as distinguish from its duty to pay
tax since:
the governments cause of action against the withholding agent is not for the collection
of income tax, but for the enforcement of the withholding provision of Section 53 of
the Tax Code, compliance with which is imposed on the withholding agent
and not upon the taxpayer.[54]
Not being a taxpayer, a withholding agent, like ANSCOR in this transaction, is not protected by
the amnesty under the decree.
Codal provisions on withholding tax are mandatory and must be complied with by the
withholding agent.[55] The taxpayer should not answer for the non-performance by the
withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former
could not be deemed to have evaded the tax had the withholding agent performed its duty.
This could be the situation for which the amnesty decree was intended. Thus, to curtail tax
evasion and give tax evaders a chance to reform,[56] it was deemed administratively feasible to
grant tax amnesty in certain instances. In addition, a tax amnesty, much like a tax exemption, is
never favored nor presumed in law and if granted by a statute, the terms of the amnesty like
that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of
the taxing authority.[57] The rule on strictissimi juris equally applies.[58] So that, any doubt in the
application of an amnesty law/decree should be resolved in favor of the taxing authority.
 Furthermore, ANSCORs claim of amnesty cannot prosper. The implementing rules of P.D.
370 which expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to
wit:
Section 4. Cases not covered by amnesty. The following cases are not covered by the amnesty
subject of these regulations:
xxx xxx xxx
(2) Tax liabilities with or without assessments, on withholding tax at source provided under
Sections 53 and 54 of the National Internal Revenue Code, as amended;[59]
ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific
provision of law, it is not covered by the amnesty.

TAX ON STOCK DIVIDENDS

General Rule

Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code
of 1928.[60] It laid down the general rule known as the proportionate test[61] wherein stock
dividends once issued form part of the capital and, thus, subject to income tax. [62] Specifically,
the general rule states that:
A stock dividend representing the transfer of surplus to capital account shall not be subject to
tax.
Having been derived from a foreign law, resort to the jurisprudence of its origin may shed
light. Under the US Revenue Code, this provision originally referred to stock dividends only,
without any exception. Stock dividends, strictly speaking, represent capital and do not
constitute income to its recipient.[63] So that the mere issuance thereof is not yet subject to
income tax[64] as they are nothing but an enrichment through increase in value of capital
investment.[65] As capital, the stock dividends postpone the realization of profits because the
fund represented by the new stock has been transferred from surplus to capital and no longer
available for actual distribution.[66] Income in tax law is an amount of money coming to a person
within a specified time, whether as payment for services, interest, or profit from
investment.[67]It means cash or its equivalent.[68] It is gain derived and severed from
capital,[69] from labor or from both combined[70] - so that to tax a stock dividend would be to tax
a capital increase rather than the income.[71] In a loose sense, stock dividends issued by the
corporation, are considered unrealized gain, and cannot be subjected to income tax until that
gain has been realized. Before the realization, stock dividends are nothing but a representation
of an interest in the corporate properties.[72] As capital, it is not yet subject to income tax. It
should be noted that capital and income are different. Capital is wealth or fund; whereas
income is profit or gain or the flow of wealth.[73] The determining factor for the imposition of
income tax is whether any gain or profit was derived from a transaction.[74]
 The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such time and in such
manner as to make the distribution and cancellation or redemption, in whole or in
part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed
in redemption or cancellation of the stock shall be considered as taxable income to the extent it
represents a distribution of earnings or profits accumulated after March first, nineteen hundred
and thirteen. (Emphasis supplied).

In a response to the ruling of the American Supreme Court in the case of Eisner v.
Macomber[75] (that pro rata stock dividends are not taxable income), the exempting clause
above quoted was added because corporations found a loophole in the original provision. They
resorted to devious means to circumvent the law and evade the tax. Corporate earnings would
be distributed under the guise of its initial capitalization by declaring the stock dividends
previously issued and later redeem said dividends by paying cash to the stockholder. This
process of issuance-redemption amounts to a distribution of taxable cash dividends which was
just delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the
effects of taxation.

Thus, to plug the loophole the exempting clause was added. It provides that the redemption or
cancellation of stock dividends, depending on the time and manner it was made is essentially
equivalent to a distribution of taxable dividends, making the proceeds thereof taxable income
to the extent it represents profits. The exception was designed to prevent the issuance and
cancellation or redemption of stock dividends, which is fundamentally not taxable, from being
made use of as a device for the actual distribution of cash dividends, which is taxable.[76] Thus,
the provision had the obvious purpose of preventing a corporation from avoiding
dividend tax treatment by distributing earnings to its shareholders in two transactions a
pro rata stock dividend followed by a pro rata redemption that would have the same
economic consequences as a simple dividend.[77]
Although redemption and cancellation are generally considered capital transactions, as such,
they are not subject to tax. However, it does not necessarily mean that a shareholder may not
realize a taxable gain from such transactions.[78] Simply put, depending on the circumstances,
the proceeds of redemption of stock dividends are essentially distribution of cash dividends,
which when paid becomes the absolute property of the stockholder. Thereafter, the latter
becomes the exclusive owner thereof and can exercise the freedom of choice [79] Having realized
gain from that redemption, the income earner cannot escape income tax.[80]
As qualified by the phrase such time and in such manner, the exception was not intended
to characterize as taxable dividend every distribution of earnings arising from the redemption
of stock dividends.[81] So that, whether the amount distributed in the redemption should be
treated as the equivalent of a taxable dividend is a question of fact,[82] which is determinable on
the basis of the particular facts of the transaction in question.[83] No decisive test can be used to
determine the application of the exemption under Section 83(b) The use of the words such
manner and essentially equivalent negative any idea that a weighted formula can resolve a
crucial issue Should the distribution be treated as taxable dividend.[84] On this aspect, American
courts developed certain recognized criteria, which includes the following:[85]
1) the presence or absence of real business purpose,
2) the amount of earnings and profits available for the declaration of a regular dividend
and the corporations past record with respect to the declaration of dividends,
3) the effect of the distribution as compared with the declaration of regular dividend,
4) the lapse of time between issuance and redemption,[86]
5) the presence of a substantial surplus[87] and a generous supply of cash which invites
suspicion as does a meager policy in relation both to current earnings and
accumulated surplus.[88]

REDEMPTION AND CANCELLATION

For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is
redemption or cancellation; (b) the transaction involves stock dividends and (c) the time and
manner of the transaction makes it essentially equivalent to a distribution of taxable dividends.
Of these, the most important is the third.
Redemption is repurchase, a reacquisition of stock by a corporation which issued the
stock[89] in exchange for property, whether or not the acquired stock is cancelled, retired or
held in the treasury.[90] Essentially, the corporation gets back some of its stock, distributes cash
or property to the shareholder in payment for the stock, and continues in business as before.
The redemption of stock dividends previously issued is used as a veil for the constructive
distribution of cash dividends. In the instant case, there is no dispute that
ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000
common shares). But where did the shares redeemed come from? If its source is the original
capital subscriptions upon establishment of the corporation or from initial capital investment in
an existing enterprise, its redemption to the concurrent value of acquisition may not invite the
application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of
capital. On the contrary, if the redeemed shares are from stock dividend declarations other
than as initial capital investment, the proceeds of the redemption is additional wealth, for it is
not merely a return of capital but a gain thereon.
It is not the stock dividends but the proceeds of its redemption that may be deemed as
taxable dividends. Here, it is undisputed that at the time of the last redemption, the original
common shares owned by the estate were only 25,247.5.[91]This means that from the total of
108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5)
must have come from stock dividends. Besides, in the absence of evidence to the contrary, the
Tax Code presumes that every distribution of corporate property, in whole or in part, is made
out of corporate profits,[92] such as stock dividends. The capital cannot be distributed in the
form of redemption of stock dividends without violating the trust fund doctrine wherein the
capital stock, property and other assets of the corporation are regarded as equity in trust for
the payment of the corporate creditors.[93] Once capital, it is always capital.[94] That doctrine
was intended for the protection of corporate creditors.[95]
With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3
years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient
indicator to determine taxability. It is a must to consider the factual circumstances as to the
manner of both the issuance and the redemption. The time element is a factor to show a device
to evade tax and the scheme of cancelling or redeeming the same shares is a method usually
adopted to accomplish the end sought.[96] Was this transaction used as a continuing plan,
device or artifice to evade payment of tax? It is necessary to determine the net effect of the
transaction between the shareholder-income taxpayer and the acquiring (redeeming)
corporation.[97] The net effect test is not evidence or testimony to be considered; it is rather an
inference to be drawn or a conclusion to be reached.[98] It is also important to know whether
the issuance of stock dividends was dictated by legitimate business reasons, the presence of
which might negate a tax evasion plan.[99]
The issuance of stock dividends and its subsequent redemption must be separate, distinct,
and not related, for the redemption to be considered a legitimate tax scheme.[100] Redemption
cannot be used as a cloak to distribute corporate earnings.[101] Otherwise, the apparent
intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has
been ruled that:
[A]n operation with no business or corporate purpose is a mere devise which put on the form of
a corporate reorganization as a disguise for concealing its real character, and the sole object
and accomplishment of which was the consummation of a preconceived plan, not to reorganize
a business or any part of a business, but to transfer a parcel of corporate shares to a
stockholder.[102]

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be
applicable if the redeemed shares were issued with bona fide business purpose,[103] which is
judged after each and every step of the transaction have been considered and the whole
transaction does not amount to a tax evasion scheme.
ANSCOR invoked two reasons to justify the redemptions (1) the alleged filipinization
program and (2) the reduction of foreign exchange remittances in case cash dividends are
declared. The Court is not concerned with the wisdom of these purposes but on their relevance
to the whole transaction which can be inferred from the outcome thereof. Again, it is the net
effect rather than the motives and plans of the taxpayer or his corporation [104] that is the
fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result.[105] It
also applies even if at the time of the issuance of the stock dividend, there was no intention to
redeem it as a means of distributing profit or avoiding tax on dividends.[106]The existence of
legitimate business purposes in support of the redemption of stock dividends is immaterial in
incometaxation. It has no relevance in determining dividend equivalence.[107] Such purposes
may be material only upon the issuance of the stock dividends. The test of taxability under the
exempting clause, when it provides such time and manner as would make the redemption
essentially equivalent to the distribution of a taxable dividend, is whether the
redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there
may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income
is not deemed realize until the fruit has fallen or been plucked from the tree.
The three elements in the imposition of income tax are: (1) there must be gain or profit, (2)
that the gain or profit is realized or received, actually or constructively, [108] and (3) it is not
exempted by law or treaty from income tax. Any business purpose as to why or how the income
was earned by the taxpayer is not a requirement. Income tax is assessed on income received
from any property, activity or service that produces the income because the Tax Code stands as
an indifferent neutral party on the matter of where income comes from.[109]
As stated above, the test of taxability under the exempting clause of Section 83(b) is,
whether income was realized through the redemption of stock dividends. The redemption
converts into money the stock dividends which become a realized profit or gain and
consequently, the stockholders separate property.[110] Profits derived from the capital invested
cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends
can be reached by income taxation regardless of the existence of any business purpose for the
redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the
redemption is supported by legitimate business reasons would defeat the very purpose of
imposing tax on income. Such argument would open the door for income earners not to pay tax
so long as the person from whom the income was derived has legitimate business reasons. In
other words, the payment of tax under the exempting clause of Section 83(b) would be made to
depend not on the income of the taxpayer but on the business purposes of a third party (the
corporation herein) from whom the income was earned. This is absurd, illogical and impractical
considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in
determining the legitimacy of business reasons that every income earner may interposed. It is
not administratively feasible and cannot therefore be allowed.
The ruling in the American cases cited and relied upon by ANSCOR that the redeemed
shares are the equivalent of dividend only if the shares were not issued for genuine business
purposes[111] or the redeemed shares have been issued by a corporation bona fide[112] bears no
relevance in determining the non-taxability of the proceeds of redemption. ANSCOR, relying
heavily and applying said cases, argued that so long as the redemption is supported by valid
corporate purposes the proceeds are not subject to tax.[113] The adoption by the courts
below [114] of such argument is misleading if not misplaced. A review of the cited American
cases shows that the presence or absence of genuine business purposes may be material with
respect to the issuance or declaration of stock dividends but not on its subsequent redemption.
The issuance and the redemption of stocks are two different transactions. Although the
existence of legitimate corporate purposes may justify a corporations acquisition of its own
shares under Section 41 of the Corporation Code,[115] such purposes cannot excuse the
stockholder from the effects of taxation arising from the redemption. If the issuance of stock
dividends is part of a tax evasion plan and thus, without legitimate business reasons the
redemption becomes suspicious which may call for the application of the exempting clause. The
substance of the whole transaction, not its form, usually controls the tax consequences.[116]
 The two purposes invoked by ANSCOR under the facts of this case are no excuse for its tax
liability. First, the alleged filipinization plan cannot be considered legitimate as it was not
implemented until the BIR started making assessments on the proceeds of the redemption.
Such corporate plan was not stated in nor supported by any Board Resolution but a mere
afterthought interposed by the counsel of ANSCOR. Being a separate entity, the corporation
can act only through its Board of Directors.[117] The Board Resolutions authorizing the
redemptions state only one purpose reduction of foreign exchange remittances in case cash
dividends are declared. Not even this purpose can be given credence. Records show that
despite the existence of enormous corporate profits no cash dividend was ever declared by
ANSCOR from 1945 until the BIR started making assessments in the early 1970s. Although a
corporation under certain exceptions, has the prerogative when to issue dividends, yet when
no cash dividends was issued for about three decades, this circumstance negates the legitimacy
of ANSCORs alleged purposes. Moreover, to issue stock dividends is to increase the
shareholdings of ANSCORs foreign stockholders contrary to its filipinization plan. This would
also increase rather than reduce their need for foreign exchange remittances in case of cash
dividend declaration, considering that ANSCOR is a family corporation where the majority
shares at the time of redemptions were held by Don Andres foreign heirs.
Secondly, assuming arguendo, that those business purposes are legitimate, the same
cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayers liability to pay
income tax would be made to depend upon a third person who did not earn the income being
taxed. Furthermore, even if the said purposes support the redemption and justify the issuance
of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein
assessed because the proceeds of the redemption are deemed taxable dividends since it was
shown that income was generated therefrom.
Thirdly, ANSCOR argued that to treat as taxable dividend the proceeds of the redeemed
stock dividends would be to impose on such stock an undisclosed lien and would be extremely
unfair to intervening purchasers, i.e. those who buys the stock dividends after their
issuance.[118] Such argument, however, bears no relevance in this case as no intervening buyer
is involved. And even if there is an intervening buyer, it is necessary to look into the factual
milieu of the case if income was realized from the transaction. Again, we reiterate that the
dividend equivalence test depends on such time and manner of the transaction and its net
effect. The undisclosed lien[119] may be unfair to a subsequent stock buyer who has no capital
interest in the company. But the unfairness may not be true to an original subscriber like Don
Andres, who holds stock dividends as gains from his investments. The subsequent buyer who
buys stock dividends is investing capital. It just so happen that what he bought is stock
dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely
to return his capital subscription, which is income if redeemed from the original subscriber.
After considering the manner and the circumstances by which the issuance and
redemption of stock dividends were made, there is no other conclusion but that the proceeds
thereof are essentially considered equivalent to a distribution of taxable dividends. As taxable
dividend under Section 83(b), it is part of the entire income subject to tax under Section 22 in
relation to Section 21[120] of the 1939 Code. Moreover, under Section 29(a) of said Code,
dividends are included in gross income. As income, it is subject to income tax which is required
to be withheld at source. The 1997 Tax Code may have altered the situation but it does not
change this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES[121]

Exchange is an act of taking or giving one thing for another[122] involving reciprocal
transfer[123] and is generally considered as a taxable transaction. The exchange of common
stocks with preferred stocks, or preferred for common or a combination of either for both, may
not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not
applicable. This is true in a trade between two (2) persons as well as a trade between a
stockholder and a corporation. In general, this trade must be parts of merger, transfer to
controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or
loss may be recognized on exchange of property, stock or securities related to
reorganizations.[124]
Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into
common and preferred, and that parts of the common shares of the Don Andres estate and all
of Doa Carmens shares were exchanged for the whole 150, 000 preferred shares. Thereafter,
both the Don Andres estate and Doa Carmen remained as corporate subscribers except that
their subscriptions now include preferred shares. There was no change in their proportional
interest after the exchange. There was no cash flow. Both stocks had the same par value. Under
the facts herein, any difference in their market value would be immaterial at the time of
exchange because no income is yet realized it was a mere corporate paper transaction. It would
have been different, if the exchange transaction resulted into a flow of wealth, in which case
income tax may be imposed.[125]
Reclassification of shares does not always bring any substantial alteration in the subscribers
proportional interest. But the exchange is different there would be a shifting of the balance of
stock features, like priority in dividend declarations or absence of voting rights. Yet neither the
reclassification nor exchange per se, yields realize income for tax purposes. A common stock
represents the residual ownership interest in the corporation. It is a basic class of stock
ordinarily and usually issued without extraordinary rights or privileges and entitles the
shareholder to a pro rata division of profits.[126]Preferred stocks are those which entitle the
shareholder to some priority on dividends and asset distribution.[127]
Both shares are part of the corporations capital stock. Both stockholders are no different
from ordinary investors who take on the same investment risks. Preferred and common
shareholders participate in the same venture, willing to share in the profits and losses of the
enterprise.[128] Moreover, under the doctrine of equality of shares all stocks issued by the
corporation are presumed equal with the same privileges and liabilities, provided that the
Articles of Incorporation is silent on such differences.[129] In this case, the exchange of shares,
without more, produces no realized income to the subscriber. There is only a modification of
the subscribers rights and privileges - which is not a flow of wealth for tax purposes. The issue
of taxable dividend may arise only once a subscriber disposes of his entire interest and not
when there is still maintenance of proprietary interest.[130]
WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in
that ANSCORs redemption of 82,752.5 stock dividends is herein considered as essentially
equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-
at-source. The decision is AFFIRMED in all other respects.
SO ORDERED.