G.R. No.

160756 March 9, 2010

CHAMBER OF REAL ESTATE AND BUILDERS' ASSOCIATIONS, INC., Petitioner,

vs.
THE HON. EXECUTIVE SECRETARY ALBERTO ROMULO, THE HON. ACTING
SECRETARY OF FINANCE JUANITA D. AMATONG, and THE HON.
COMMISSIONER OF INTERNAL REVENUE GUILLERMO PARAYNO,
JR., Respondents.

DECISION

CORONA, J.:

In this original petition for certiorari and mandamus,1 petitioner Chamber of Real Estate
and Builders’ Associations, Inc. is questioning the constitutionality of Section 27 (E) of
Republic Act (RA) 84242 and the revenue regulations (RRs) issued by the Bureau of
Internal Revenue (BIR) to implement said provision and those involving creditable
withholding taxes.3

Petitioner is an association of real estate developers and builders in the Philippines. It

impleaded former Executive Secretary Alberto Romulo, then acting Secretary of
Finance Juanita D. Amatong and then Commissioner of Internal Revenue Guillermo
Parayno, Jr. as respondents.

Petitioner assails the validity of the imposition of minimum corporate income tax (MCIT)
on corporations and creditable withholding tax (CWT) on sales of real properties
classified as ordinary assets.

Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is

implemented by RR 9-98. Petitioner argues that the MCIT violates the due process
clause because it levies income tax even if there is no realized gain.

Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and
2.58.2 of RR 2-98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe
the rules and procedures for the collection of CWT on the sale of real properties
categorized as ordinary assets. Petitioner contends that these revenue regulations are
contrary to law for two reasons: first, they ignore the different treatment by RA 8424 of
ordinary assets and capital assets and second, respondent Secretary of Finance has no
authority to collect CWT, much less, to base the CWT on the gross selling price or fair
market value of the real properties classified as ordinary assets.

Petitioner also asserts that the enumerated provisions of the subject revenue
regulations violate the due process clause because, like the MCIT, the government
collects income tax even when the net income has not yet been determined. They
contravene the equal protection clause as well because the CWT is being levied upon
real estate enterprises but not on other business enterprises, more particularly those in
the manufacturing sector.

The issues to be resolved are as follows:

(1) whether or not this Court should take cognizance of the present case;

(2) whether or not the imposition of the MCIT on domestic corporations is

unconstitutional and

(3) whether or not the imposition of CWT on income from sales of real properties
classified as ordinary assets under RRs 2-98, 6-2001 and 7-2003, is
unconstitutional.

Overview of the Assailed Provisions

Under the MCIT scheme, a corporation, beginning on its fourth year of operation, is
assessed an MCIT of 2% of its gross income when such MCIT is greater than the
normal corporate income tax imposed under Section 27(A).4 If the regular income tax is
higher than the MCIT, the corporation does not pay the MCIT. Any excess of the MCIT
over the normal tax shall be carried forward and credited against the normal income tax
for the three immediately succeeding taxable years. Section 27(E) of RA 8424 provides:

Section 27 (E). [MCIT] on Domestic Corporations. -

(1) Imposition of Tax. – A [MCIT] of two percent (2%) of the gross income as of
the end of the taxable year, as defined herein, is hereby imposed on a
corporation taxable under this Title, beginning on the fourth taxable year
immediately following the year in which such corporation commenced its
business operations, when the minimum income tax is greater than the tax
computed under Subsection (A) of this Section for the taxable year.

(2) Carry Forward of Excess Minimum Tax. – Any excess of the [MCIT] over the
normal income tax as computed under Subsection (A) of this Section shall be
carried forward and credited against the normal income tax for the three (3)
immediately succeeding taxable years.

(3) Relief from the [MCIT] under certain conditions. – The Secretary of Finance is
hereby authorized to suspend the imposition of the [MCIT] on any corporation
which suffers losses on account of prolonged labor dispute, or because of force
majeure, or because of legitimate business reverses.

The Secretary of Finance is hereby authorized to promulgate, upon

recommendation of the Commissioner, the necessary rules and regulations that
shall define the terms and conditions under which he may suspend the imposition
of the [MCIT] in a meritorious case.
 (4) Gross Income Defined. – For purposes of applying the [MCIT] provided under
Subsection (E) hereof, the term ‘gross income’ shall mean gross sales less sales
returns, discounts and allowances and cost of goods sold. "Cost of goods sold"
shall include all business expenses directly incurred to produce the merchandise
to bring them to their present location and use.

For trading or merchandising concern, "cost of goods sold" shall include the invoice cost
of the goods sold, plus import duties, freight in transporting the goods to the place
where the goods are actually sold including insurance while the goods are in transit.

For a manufacturing concern, "cost of goods manufactured and sold" shall include all
costs of production of finished goods, such as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance premiums and other costs incurred to
bring the raw materials to the factory or warehouse.

In the case of taxpayers engaged in the sale of service, "gross income" means gross
receipts less sales returns, allowances, discounts and cost of services. "Cost of
services" shall mean all direct costs and expenses necessarily incurred to provide the
services required by the customers and clients including (A) salaries and employee
benefits of personnel, consultants and specialists directly rendering the service and (B)
cost of facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies: Provided, however, that in the case of banks,
"cost of services" shall include interest expense.

On August 25, 1998, respondent Secretary of Finance (Secretary), on the

recommendation of the Commissioner of Internal Revenue (CIR), promulgated RR 9-98
implementing Section 27(E).5 The pertinent portions thereof read:

Sec. 2.27(E) [MCIT] on Domestic Corporations. –

(1) Imposition of the Tax. – A [MCIT] of two percent (2%) of the gross income as of the
end of the taxable year (whether calendar or fiscal year, depending on the accounting
period employed) is hereby imposed upon any domestic corporation beginning the
fourth (4th) taxable year immediately following the taxable year in which such
corporation commenced its business operations. The MCIT shall be imposed whenever
such corporation has zero or negative taxable income or whenever the amount of
minimum corporate income tax is greater than the normal income tax due from such
corporation.

For purposes of these Regulations, the term, "normal income tax" means the income
tax rates prescribed under Sec. 27(A) and Sec. 28(A)(1) of the Code xxx at 32%
effective January 1, 2000 and thereafter.

xxx xxx xxx

(2) Carry forward of excess [MCIT]. – Any excess of the [MCIT] over the normal income
tax as computed under Sec. 27(A) of the Code shall be carried forward on an annual
basis and credited against the normal income tax for the three (3) immediately
succeeding taxable years.

xxx xxx xxx

Meanwhile, on April 17, 1998, respondent Secretary, upon recommendation of

respondent CIR, promulgated RR 2-98 implementing certain provisions of RA 8424
involving the withholding of taxes.6 Under Section 2.57.2(J) of RR No. 2-98, income
payments from the sale, exchange or transfer of real property, other than capital assets,
by persons residing in the Philippines and habitually engaged in the real estate
business were subjected to CWT:

Sec. 2.57.2. Income payment subject to [CWT] and rates prescribed thereon:

xxx xxx xxx

(J) Gross selling price or total amount of consideration or its equivalent paid to the
seller/owner for the sale, exchange or transfer of. – Real property, other than capital
assets, sold by an individual, corporation, estate, trust, trust fund or pension fund and
the seller/transferor is habitually engaged in the real estate business in accordance with
the following schedule –

Those which are exempt from a Exempt

withholding tax at source as
prescribed in Sec. 2.57.5 of
these regulations.

With a selling price of five 1.5%

hundred thousand pesos
(₱500,000.00) or less.

With a selling price of more than 3.0%

five hundred thousand pesos
(₱500,000.00) but not more
than two million pesos
(₱2,000,000.00).

With selling price of more than 5.0%

two million pesos
(₱2,000,000.00)

xxx xxx xxx

Gross selling price shall mean the consideration stated in the sales document or the fair
market value determined in accordance with Section 6 (E) of the Code, as amended,
whichever is higher. In an exchange, the fair market value of the property received in
exchange, as determined in the Income Tax Regulations shall be used.

Where the consideration or part thereof is payable on installment, no withholding tax is

required to be made on the periodic installment payments where the buyer is an
individual not engaged in trade or business. In such a case, the applicable rate of tax
based on the entire consideration shall be withheld on the last installment or
installments to be paid to the seller.

However, if the buyer is engaged in trade or business, whether a corporation or

otherwise, the tax shall be deducted and withheld by the buyer on every installment.

This provision was amended by RR 6-2001 on July 31, 2001:

Sec. 2.57.2. Income payment subject to [CWT] and rates prescribed thereon:

xxx xxx xxx

(J) Gross selling price or total amount of consideration or its equivalent paid to the
seller/owner for the sale, exchange or transfer of real property classified as ordinary
asset. - A [CWT] based on the gross selling price/total amount of consideration or the
fair market value determined in accordance with Section 6(E) of the Code, whichever is
higher, paid to the seller/owner for the sale, transfer or exchange of real property, other
than capital asset, shall be imposed upon the withholding agent,/buyer, in accordance
with the following schedule:

Where the seller/transferor is exempt from [CWT] in Exempt

accordance with Sec. 2.57.5 of these regulations.
Upon the following values of real property, where
the seller/transferor is habitually engaged in the real
estate business.
With a selling price of Five Hundred Thousand 1.5%
Pesos (₱500,000.00) or less.
With a selling price of more than Five Hundred 3.0%
Thousand Pesos (₱500,000.00) but not more than
Two Million Pesos (₱2,000,000.00).
With a selling price of more than two Million Pesos 5.0%
(₱2,000,000.00).

xxx xxx xxx

Gross selling price shall remain the consideration stated in the sales document or the
fair market value determined in accordance with Section 6 (E) of the Code, as
amended, whichever is higher. In an exchange, the fair market value of the property
received in exchange shall be considered as the consideration.

xxx xxx xxx

However, if the buyer is engaged in trade or business, whether a corporation or

otherwise, these rules shall apply:

(i) If the sale is a sale of property on the installment plan (that is, payments in the year
of sale do not exceed 25% of the selling price), the tax shall be deducted and withheld
by the buyer on every installment.

(ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale not
on the installment plan" (that is, payments in the year of sale exceed 25% of the selling
price), the buyer shall withhold the tax based on the gross selling price or fair market
value of the property, whichever is higher, on the first installment.

In any case, no Certificate Authorizing Registration (CAR) shall be issued to the buyer
unless the [CWT] due on the sale, transfer or exchange of real property other than
capital asset has been fully paid. (Underlined amendments in the original)

Section 2.58.2 of RR 2-98 implementing Section 58(E) of RA 8424 provides that any
sale, barter or exchange subject to the CWT will not be recorded by the Registry of
Deeds until the CIR has certified that such transfers and conveyances have been
reported and the taxes thereof have been duly paid:7

Sec. 2.58.2. Registration with the Register of Deeds. – Deeds of conveyances of land or
land and building/improvement thereon arising from sales, barters, or exchanges
subject to the creditable expanded withholding tax shall not be recorded by the Register
of Deeds unless the [CIR] or his duly authorized representative has certified that such
transfers and conveyances have been reported and the expanded withholding tax,
inclusive of the documentary stamp tax, due thereon have been fully paid xxxx.

On February 11, 2003, RR No. 7-20038 was promulgated, providing for the guidelines in
determining whether a particular real property is a capital or an ordinary asset for
purposes of imposing the MCIT, among others. The pertinent portions thereof state:

Section 4. Applicable taxes on sale, exchange or other disposition of real property. -

Gains/Income derived from sale, exchange, or other disposition of real properties shall,
unless otherwise exempt, be subject to applicable taxes imposed under the Code,
depending on whether the subject properties are classified as capital assets or ordinary
assets;

a. In the case of individual citizen (including estates and trusts), resident aliens, and
non-resident aliens engaged in trade or business in the Philippines;
 xxx xxx xxx

(ii) The sale of real property located in the Philippines, classified as ordinary assets,
shall be subject to the [CWT] (expanded) under Sec. 2.57..2(J) of [RR 2-98], as
amended, based on the gross selling price or current fair market value as determined in
accordance with Section 6(E) of the Code, whichever is higher, and consequently, to
the ordinary income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the
case may be, based on net taxable income.

xxx xxx xxx

c. In the case of domestic corporations. –

xxx xxx xxx

(ii) The sale of land and/or building classified as ordinary asset and other real property
(other than land and/or building treated as capital asset), regardless of the classification
thereof, all of which are located in the Philippines, shall be subject to the [CWT]
(expanded) under Sec. 2.57.2(J) of [RR 2-98], as amended, and consequently, to the
ordinary income tax under Sec. 27(A) of the Code. In lieu of the ordinary income tax,
however, domestic corporations may become subject to the [MCIT] under Sec. 27(E) of
the Code, whichever is applicable.

xxx xxx xxx

We shall now tackle the issues raised.

Existence of a Justiciable Controversy

Courts will not assume jurisdiction over a constitutional question unless the following
requisites are satisfied: (1) there must be an actual case calling for the exercise of
judicial review; (2) the question before the court must be ripe for adjudication; (3) the
person challenging the validity of the act must have standing to do so; (4) the question
of constitutionality must have been raised at the earliest opportunity and (5) the issue of
constitutionality must be the very lis mota of the case.9

Respondents aver that the first three requisites are absent in this case. According to
them, there is no actual case calling for the exercise of judicial power and it is not yet
ripe for adjudication because

[petitioner] did not allege that CREBA, as a corporate entity, or any of its members, has
been assessed by the BIR for the payment of [MCIT] or [CWT] on sales of real property.
Neither did petitioner allege that its members have shut down their businesses as a
result of the payment of the MCIT or CWT. Petitioner has raised concerns in mere
abstract and hypothetical form without any actual, specific and concrete instances cited
that the assailed law and revenue regulations have actually and adversely affected it.
Lacking empirical data on which to base any conclusion, any discussion on the
constitutionality of the MCIT or CWT on sales of real property is essentially an academic
exercise.

Perceived or alleged hardship to taxpayers alone is not an adequate justification for

adjudicating abstract issues. Otherwise, adjudication would be no different from the
giving of advisory opinion that does not really settle legal issues.10

An actual case or controversy involves a conflict of legal rights or an assertion of

opposite legal claims which is susceptible of judicial resolution as distinguished from a
hypothetical or abstract difference or dispute.11 On the other hand, a question is
considered ripe for adjudication when the act being challenged has a direct adverse
effect on the individual challenging it.12

Contrary to respondents’ assertion, we do not have to wait until petitioner’s members

have shut down their operations as a result of the MCIT or CWT. The assailed
provisions are already being implemented. As we stated in Didipio Earth-Savers’ Multi-
Purpose Association, Incorporated (DESAMA) v. Gozun:13

By the mere enactment of the questioned law or the approval of the challenged act, the
dispute is said to have ripened into a judicial controversy even without any other overt
act. Indeed, even a singular violation of the Constitution and/or the law is enough to
awaken judicial duty.14

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

Respondents next argue that petitioner has no legal standing to sue:

Petitioner is an association of some of the real estate developers and builders in the
Philippines. Petitioners did not allege that [it] itself is in the real estate business. It did
not allege any material interest or any wrong that it may suffer from the enforcement of
[the assailed provisions].15

Legal standing or locus standi is a party’s personal and substantial interest in a case
such that it has sustained or will sustain direct injury as a result of the governmental act
being challenged.16 In Holy Spirit Homeowners Association, Inc. v. Defensor,17 we held
that the association had legal standing because its members stood to be injured by the
enforcement of the assailed provisions:

Petitioner association has the legal standing to institute the instant petition xxx. There is
no dispute that the individual members of petitioner association are residents of the
NGC. As such they are covered and stand to be either benefited or injured by the
enforcement of the IRR, particularly as regards the selection process of beneficiaries
and lot allocation to qualified beneficiaries. Thus, petitioner association may assail those
provisions in the IRR which it believes to be unfavorable to the rights of its members.
xxx Certainly, petitioner and its members have sustained direct injury arising from the
enforcement of the IRR in that they have been disqualified and eliminated from the
selection process.18

In any event, this Court has the discretion to take cognizance of a suit which does not
satisfy the requirements of an actual case, ripeness or legal standing when paramount
public interest is involved.19 The questioned MCIT and CWT affect not only petitioners
but practically all domestic corporate taxpayers in our country. The transcendental
importance of the issues raised and their overreaching significance to society make it
proper for us to take cognizance of this petition.20

Concept and Rationale of the MCIT

The MCIT on domestic corporations is a new concept introduced by RA 8424 to the

Philippine taxation system. It came about as a result of the perceived inadequacy of the
self-assessment system in capturing the true income of corporations.21 It was devised
as a relatively simple and effective revenue-raising instrument compared to the normal
income tax which is more difficult to control and enforce. It is a means to ensure that
everyone will make some minimum contribution to the support of the public sector. The
congressional deliberations on this are illuminating:

Senator Enrile. Mr. President, we are not unmindful of the practice of certain
corporations of reporting constantly a loss in their operations to avoid the payment of
taxes, and thus avoid sharing in the cost of government. In this regard, the Tax Reform
Act introduces for the first time a new concept called the [MCIT] so as to minimize tax
evasion, tax avoidance, tax manipulation in the country and for administrative
convenience. … This will go a long way in ensuring that corporations will pay their just
share in supporting our public life and our economic advancement. 22

Domestic corporations owe their corporate existence and their privilege to do business
to the government. They also benefit from the efforts of the government to improve the
financial market and to ensure a favorable business climate. It is therefore fair for the
government to require them to make a reasonable contribution to the public expenses.

Congress intended to put a stop to the practice of corporations which, while having
large turn-overs, report minimal or negative net income resulting in minimal or zero
income taxes year in and year out, through under-declaration of income or over-
deduction of expenses otherwise called tax shelters.23

Mr. Javier (E.) … [This] is what the Finance Dept. is trying to remedy, that is why they
have proposed the [MCIT]. Because from experience too, you have corporations which
have been losing year in and year out and paid no tax. So, if the corporation has been
losing for the past five years to ten years, then that corporation has no business to be in
business. It is dead. Why continue if you are losing year in and year out? So, we have
this provision to avoid this type of tax shelters, Your Honor.24
The primary purpose of any legitimate business is to earn a profit. Continued and
repeated losses after operations of a corporation or consistent reports of minimal net
income render its financial statements and its tax payments suspect. For sure, certain
tax avoidance schemes resorted to by corporations are allowed in our jurisdiction. The
MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax
evasion and minimizes tax avoidance schemes achieved through sophisticated and
artful manipulations of deductions and other stratagems. Since the tax base was
broader, the tax rate was lowered.

To further emphasize the corrective nature of the MCIT, the following safeguards were
incorporated into the law:

First, recognizing the birth pangs of businesses and the reality of the need to recoup
initial major capital expenditures, the imposition of the MCIT commences only on the
fourth taxable year immediately following the year in which the corporation commenced
its operations.25 This grace period allows a new business to stabilize first and make its
ventures viable before it is subjected to the MCIT.26

Second, the law allows the carrying forward of any excess of the MCIT paid over the
normal income tax which shall be credited against the normal income tax for the three
immediately succeeding years.27

Third, since certain businesses may be incurring genuine repeated losses, the law
authorizes the Secretary of Finance to suspend the imposition of MCIT if a corporation
suffers losses due to prolonged labor dispute, force majeure and legitimate business
reverses.28

Even before the legislature introduced the MCIT to the Philippine taxation system,
several other countries already had their own system of minimum corporate income
taxation. Our lawmakers noted that most developing countries, particularly Latin
American and Asian countries, have the same form of safeguards as we do. As pointed
out during the committee hearings:

[Mr. Medalla:] Note that most developing countries where you have of course quite a bit
of room for underdeclaration of gross receipts have this same form of safeguards.

In the case of Thailand, half a percent (0.5%), there’s a minimum of income tax of half a
percent (0.5%) of gross assessable income. In Korea a 25% of taxable income before
deductions and exemptions. Of course the different countries have different basis for
that minimum income tax.

The other thing you’ll notice is the preponderance of Latin American countries that
employed this method. Okay, those are additional Latin American countries. 29

At present, the United States of America, Mexico, Argentina, Tunisia, Panama and
Hungary have their own versions of the MCIT.30
MCIT Is Not Violative of Due Process

Petitioner claims that the MCIT under Section 27(E) of RA 8424 is unconstitutional
because it is highly oppressive, arbitrary and confiscatory which amounts to deprivation
of property without due process of law. It explains that gross income as defined under
said provision only considers the cost of goods sold and other direct expenses; other
major expenditures, such as administrative and interest expenses which are equally
necessary to produce gross income, were not taken into account. 31 Thus, pegging the
tax base of the MCIT to a corporation’s gross income is tantamount to a confiscation of
capital because gross income, unlike net income, is not "realized gain." 32

We disagree.

Taxes are the lifeblood of the government. Without taxes, the government can neither
exist nor endure. The exercise of taxing power derives its source from the very
existence of the State whose social contract with its citizens obliges it to promote public
interest and the common good.33

Taxation is an inherent attribute of sovereignty.34 It is a power that is purely

legislative.35 Essentially, this means that in the legislature primarily lies the discretion to
determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and
situs (place) of taxation.36 It has the authority to prescribe a certain tax at a specific rate
for a particular public purpose on persons or things within its jurisdiction. In other words,
the legislature wields the power to define what tax shall be imposed, why it should be
imposed, how much tax shall be imposed, against whom (or what) it shall be imposed
and where it shall be imposed.

As a general rule, the power to tax is plenary and unlimited in its range, acknowledging
in its very nature no limits, so that the principal check against its abuse is to be found
only in the responsibility of the legislature (which imposes the tax) to its constituency
who are to pay it.37 Nevertheless, it is circumscribed by constitutional limitations. At the
same time, like any other statute, tax legislation carries a presumption of
constitutionality.

The constitutional safeguard of due process is embodied in the fiat "[no] person shall be
deprived of life, liberty or property without due process of law." In Sison, Jr. v. Ancheta,
et al.,38 we held that the due process clause may properly be invoked to invalidate, in
appropriate cases, a revenue measure39 when it amounts to a confiscation of
property.40 But in the same case, we also explained that we will not strike down a
revenue measure as unconstitutional (for being violative of the due process clause) on
the mere allegation of arbitrariness by the taxpayer.41 There must be a factual
foundation to such an unconstitutional taint.42 This merely adheres to the authoritative
doctrine that, where the due process clause is invoked, considering that it is not a fixed
rule but rather a broad standard, there is a need for proof of such persuasive
character.43
Petitioner is correct in saying that income is distinct from capital.44 Income means all the
wealth which flows into the taxpayer other than a mere return on capital. Capital is a
fund or property existing at one distinct point in time while income denotes a flow of
wealth during a definite period of time.45 Income is gain derived and severed from
capital.46 For income to be taxable, the following requisites must exist:

(1) there must be gain;

(2) the gain must be realized or received and

(3) the gain must not be excluded by law or treaty from taxation. 47

Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is
not income. In other words, it is income, not capital, which is subject to income tax.
However, the MCIT is not a tax on capital.

The MCIT is imposed on gross income which is arrived at by deducting the capital spent
by a corporation in the sale of its goods, i.e., the cost of goods48 and other direct
expenses from gross sales. Clearly, the capital is not being taxed.

Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the
normal net income tax, and only if the normal income tax is suspiciously low. The MCIT
merely approximates the amount of net income tax due from a corporation, pegging the
rate at a very much reduced 2% and uses as the base the corporation’s gross income.

Besides, there is no legal objection to a broader tax base or taxable income by

eliminating all deductible items and at the same time reducing the applicable tax rate.49

Statutes taxing the gross "receipts," "earnings," or "income" of particular

corporations are found in many jurisdictions. Tax thereon is generally held to be within
the power of a state to impose; or constitutional, unless it interferes with interstate
commerce or violates the requirement as to uniformity of taxation.50

The United States has a similar alternative minimum tax (AMT) system which is
generally characterized by a lower tax rate but a broader tax base. 51 Since our income
tax laws are of American origin, interpretations by American courts of our parallel tax
laws have persuasive effect on the interpretation of these laws.52 Although our MCIT is
not exactly the same as the AMT, the policy behind them and the procedure of their
implementation are comparable. On the question of the AMT’s constitutionality, the
United States Court of Appeals for the Ninth Circuit stated in Okin v. Commissioner:53

In enacting the minimum tax, Congress attempted to remedy general taxpayer distrust
of the system growing from large numbers of taxpayers with large incomes who were
yet paying no taxes.

xxx xxx xxx

We thus join a number of other courts in upholding the constitutionality of the [AMT]. xxx
[It] is a rational means of obtaining a broad-based tax, and therefore is constitutional.54

The U.S. Court declared that the congressional intent to ensure that corporate
taxpayers would contribute a minimum amount of taxes was a legitimate governmental
end to which the AMT bore a reasonable relation.55

American courts have also emphasized that Congress has the power to condition, limit
or deny deductions from gross income in order to arrive at the net that it chooses to
tax.56 This is because deductions are a matter of legislative grace.57

Absent any other valid objection, the assignment of gross income, instead of net
income, as the tax base of the MCIT, taken with the reduction of the tax rate from 32%
to 2%, is not constitutionally objectionable.

Moreover, petitioner does not cite any actual, specific and concrete negative
experiences of its members nor does it present empirical data to show that the
implementation of the MCIT resulted in the confiscation of their property.

In sum, petitioner failed to support, by any factual or legal basis, its allegation that the
MCIT is arbitrary and confiscatory. The Court cannot strike down a law as
unconstitutional simply because of its yokes.58 Taxation is necessarily burdensome
because, by its nature, it adversely affects property rights.59 The party alleging the law’s
unconstitutionality has the burden to demonstrate the supposed violations in
understandable terms.60

RR 9-98 Merely Clarifies Section 27(E) of RA 8424

Petitioner alleges that RR 9-98 is a deprivation of property without due process of law
because the MCIT is being imposed and collected even when there is actually a loss, or
a zero or negative taxable income:

Sec. 2.27(E) [MCIT] on Domestic Corporations. —

(1) Imposition of the Tax. — xxx The MCIT shall be imposed whenever such corporation
has zero or negative taxable income or whenever the amount of [MCIT] is greater
than the normal income tax due from such corporation. (Emphasis supplied)

RR 9-98, in declaring that MCIT should be imposed whenever such corporation has
zero or negative taxable income, merely defines the coverage of Section 27(E). This
means that even if a corporation incurs a net loss in its business operations or reports
zero income after deducting its expenses, it is still subject to an MCIT of 2% of its gross
income. This is consistent with the law which imposes the MCIT on gross income
notwithstanding the amount of the net income. But the law also states that the MCIT is
to be paid only if it is greater than the normal net income. Obviously, it may well be the
case that the MCIT would be less than the net income of the corporation which posts a
zero or negative taxable income.

We now proceed to the issues involving the CWT.

The withholding tax system is a procedure through which taxes (including income taxes)
are collected.61 Under Section 57 of RA 8424, the types of income subject to
withholding tax are divided into three categories: (a) withholding of final tax on certain
incomes; (b) withholding of creditable tax at source and (c) tax-free covenant bonds.
Petitioner is concerned with the second category (CWT) and maintains that the revenue
regulations on the collection of CWT on sale of real estate categorized as ordinary
assets are unconstitutional.

Petitioner, after enumerating the distinctions between capital and ordinary assets under
RA 8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and Sections 4(a)(ii)
and (c)(ii) of RR 7-2003 were promulgated "with grave abuse of discretion amounting to
lack of jurisdiction" and "patently in contravention of law"62 because they ignore such
distinctions. Petitioner’s conclusion is based on the following premises: (a) the revenue
regulations use gross selling price (GSP) or fair market value (FMV) of the real estate
as basis for determining the income tax for the sale of real estate classified as ordinary
assets and (b) they mandate the collection of income tax on a per transaction basis, i.e.,
upon consummation of the sale via the CWT, contrary to RA 8424 which calls for the
payment of the net income at the end of the taxable period.63

Petitioner theorizes that since RA 8424 treats capital assets and ordinary assets
differently, respondents cannot disregard the distinctions set by the legislators as
regards the tax base, modes of collection and payment of taxes on income from the
sale of capital and ordinary assets.

Petitioner’s arguments have no merit.

Authority of the Secretary of Finance to Order the Collection of CWT on Sales of

Real Property Considered as Ordinary Assets

The Secretary of Finance is granted, under Section 244 of RA 8424, the authority to
promulgate the necessary rules and regulations for the effective enforcement of the
provisions of the law. Such authority is subject to the limitation that the rules and
regulations must not override, but must remain consistent and in harmony with, the law
they seek to apply and implement.64 It is well-settled that an administrative agency
cannot amend an act of Congress.65

We have long recognized that the method of withholding tax at source is a procedure of
collecting income tax which is sanctioned by our tax laws.66 The withholding tax system
was devised for three primary reasons: first, to provide the taxpayer a convenient
manner to meet his probable income tax liability; second, to ensure the collection of
income tax which can otherwise be lost or substantially reduced through failure to file
the corresponding returns and third, to improve the government’s cash flow. 67 This
results in administrative savings, prompt and efficient collection of taxes, prevention of
delinquencies and reduction of governmental effort to collect taxes through more
complicated means and remedies.68

Respondent Secretary has the authority to require the withholding of a tax on items of
income payable to any person, national or juridical, residing in the Philippines. Such
authority is derived from Section 57(B) of RA 8424 which provides:

SEC. 57. Withholding of Tax at Source. –

xxx xxx xxx

(B) Withholding of Creditable Tax at Source. The [Secretary] may, upon the
recommendation of the [CIR], require the withholding of a tax on the items of income
payable to natural or juridical persons, residing in the Philippines, by payor-
corporation/persons as provided for by law, at the rate of not less than one percent (1%)
but not more than thirty-two percent (32%) thereof, which shall be credited against the
income tax liability of the taxpayer for the taxable year.

The questioned provisions of RR 2-98, as amended, are well within the authority given
by Section 57(B) to the Secretary, i.e., the graduated rate of 1.5%-5% is between the
1%-32% range; the withholding tax is imposed on the income payable and the tax is
creditable against the income tax liability of the taxpayer for the taxable year.

Effect of RRs on the Tax Base for the Income Tax of Individuals or Corporations
Engaged in the Real Estate Business

Petitioner maintains that RR 2-98, as amended, arbitrarily shifted the tax base of a real
estate business’ income tax from net income to GSP or FMV of the property sold.

Petitioner is wrong.

The taxes withheld are in the nature of advance tax payments by a taxpayer in order to
extinguish its possible tax obligation. 69 They are installments on the annual tax which
may be due at the end of the taxable year.70

Under RR 2-98, the tax base of the income tax from the sale of real property classified
as ordinary assets remains to be the entity’s net income imposed under Section 24
(resident individuals) or Section 27 (domestic corporations) in relation to Section 31 of
RA 8424, i.e. gross income less allowable deductions. The CWT is to be deducted from
the net income tax payable by the taxpayer at the end of the taxable year. 71 Precisely,
Section 4(a)(ii) and (c)(ii) of RR 7-2003 reiterate that the tax base for the sale of real
property classified as ordinary assets remains to be the net taxable income:
Section 4. – Applicable taxes on sale, exchange or other disposition of real property. -
Gains/Income derived from sale, exchange, or other disposition of real properties shall
unless otherwise exempt, be subject to applicable taxes imposed under the Code,
depending on whether the subject properties are classified as capital assets or ordinary
assets;

xxx xxx xxx

a. In the case of individual citizens (including estates and trusts), resident aliens, and
non-resident aliens engaged in trade or business in the Philippines;

xxx xxx xxx

(ii) The sale of real property located in the Philippines, classified as ordinary assets,
shall be subject to the [CWT] (expanded) under Sec. 2.57.2(j) of [RR 2-98], as
amended, based on the [GSP] or current [FMV] as determined in accordance with
Section 6(E) of the Code, whichever is higher, and consequently, to the ordinary
income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the case
may be, based on net taxable income.

xxx xxx xxx

c. In the case of domestic corporations.

The sale of land and/or building classified as ordinary asset and other real property
(other than land and/or building treated as capital asset), regardless of the classification
thereof, all of which are located in the Philippines, shall be subject to the [CWT]
(expanded) under Sec. 2.57.2(J) of [RR 2-98], as amended, and consequently,
to theordinary income tax under Sec. 27(A) of the Code. In lieu of the ordinary
income tax, however, domestic corporations may become subject to the [MCIT] under
Sec. 27(E) of the same Code, whichever is applicable. (Emphasis supplied)

Accordingly, at the end of the year, the taxpayer/seller shall file its income tax return
and credit the taxes withheld (by the withholding agent/buyer) against its tax due. If the
tax due is greater than the tax withheld, then the taxpayer shall pay the difference. If, on
the other hand, the tax due is less than the tax withheld, the taxpayer will be entitled to
a refund or tax credit. Undoubtedly, the taxpayer is taxed on its net income.

The use of the GSP/FMV as basis to determine the withholding taxes is evidently for
purposes of practicality and convenience. Obviously, the withholding agent/buyer who is
obligated to withhold the tax does not know, nor is he privy to, how much the
taxpayer/seller will have as its net income at the end of the taxable year. Instead, said
withholding agent’s knowledge and privity are limited only to the particular transaction in
which he is a party. In such a case, his basis can only be the GSP or FMV as these are
the only factors reasonably known or knowable by him in connection with the
performance of his duties as a withholding agent.
No Blurring of Distinctions Between Ordinary Assets and Capital Assets

RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real
property categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA
8424 imposes a final tax and flat rate of 6% on the gain presumed to be realized from
the sale of a capital asset based on its GSP or FMV. This final tax is also withheld at
source.72

The differences between the two forms of withholding tax, i.e., creditable and final, show
that ordinary assets are not treated in the same manner as capital assets. Final
withholding tax (FWT) and CWT are distinguished as follows:

FWT CWT

a) The amount of income tax a) Taxes withheld on certain income

withheld by the withholding agent is payments are intended to equal or
constituted as a full and final at least approximate the tax due of
payment of the income tax due from the payee on said income.
the payee on the said income.

b)The liability for payment of the tax b) Payee of income is required to

rests primarily on the payor as a
withholding agent.
report the income and/or pay the
difference between the tax withheld
and the tax due on the income. The
payee also has the right to ask for a
refund if the tax withheld is more
than the tax due.

c) The payee is not required to file c) The income recipient is still

an income tax return for the required to file an income tax return,
particular income.73 as prescribed in Sec. 51 and Sec.
52 of the NIRC, as amended.74

As previously stated, FWT is imposed on the sale of capital assets. On the other hand,
CWT is imposed on the sale of ordinary assets. The inherent and substantial
differences between FWT and CWT disprove petitioner’s contention that ordinary assets
are being lumped together with, and treated similarly as, capital assets in contravention
of the pertinent provisions of RA 8424.
Petitioner insists that the levy, collection and payment of CWT at the time of transaction
are contrary to the provisions of RA 8424 on the manner and time of filing of the return,
payment and assessment of income tax involving ordinary assets. 75

The fact that the tax is withheld at source does not automatically mean that it is treated
exactly the same way as capital gains. As aforementioned, the mechanics of the FWT
are distinct from those of the CWT. The withholding agent/buyer’s act of collecting the
tax at the time of the transaction by withholding the tax due from the income payable is
the essence of the withholding tax method of tax collection.

No Rule that Only Passive

Incomes Can Be Subject to CWT

Petitioner submits that only passive income can be subjected to withholding tax,
whether final or creditable. According to petitioner, the whole of Section 57 governs the
withholding of income tax on passive income. The enumeration in Section 57(A) refers
to passive income being subjected to FWT. It follows that Section 57(B) on CWT should
also be limited to passive income:

SEC. 57. Withholding of Tax at Source. —

(A) Withholding of Final Tax on Certain Incomes. — Subject to rules and

regulations, the [Secretary] may promulgate, upon the recommendation of the
[CIR], requiring the filing of income tax return by certain income payees, the tax
imposed or prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1);
25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1), 27(D)(2), 27(D)(3),
27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c), 28(B)(1),
28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282
of this Code on specified items of income shall be withheld by payor-
corporation and/or person and paid in the same manner and subject to the same
conditions as provided in Section 58 of this Code.

(B) Withholding of Creditable Tax at Source. — The [Secretary] may, upon the
recommendation of the [CIR], require the withholding of a tax on the items of
income payable to natural or juridical persons, residing in the Philippines,
by payor-corporation/persons as provided for by law, at the rate of not less than
one percent (1%) but not more than thirty-two percent (32%) thereof, which shall
be credited against the income tax liability of the taxpayer for the taxable year.
(Emphasis supplied)

This line of reasoning is non sequitur.

Section 57(A) expressly states that final tax can be imposed on certain kinds of income
and enumerates these as passive income. The BIR defines passive income by stating
what it is not:
…if the income is generated in the active pursuit and performance of the corporation’s
primary purposes, the same is not passive income…76

It is income generated by the taxpayer’s assets. These assets can be in the form of real
properties that return rental income, shares of stock in a corporation that earn dividends
or interest income received from savings.

On the other hand, Section 57(B) provides that the Secretary can require a CWT on
"income payable to natural or juridical persons, residing in the Philippines." There is no
requirement that this income be passive income. If that were the intent of Congress, it
could have easily said so.

Indeed, Section 57(A) and (B) are distinct. Section 57(A) refers to FWT while Section
57(B) pertains to CWT. The former covers the kinds of passive income enumerated
therein and the latter encompasses any income other than those listed in 57(A). Since
the law itself makes distinctions, it is wrong to regard 57(A) and 57(B) in the same way.

To repeat, the assailed provisions of RR 2-98, as amended, do not modify or deviate

from the text of Section 57(B). RR 2-98 merely implements the law by specifying what
income is subject to CWT. It has been held that, where a statute does not require any
particular procedure to be followed by an administrative agency, the agency may adopt
any reasonable method to carry out its functions.77 Similarly, considering that the law
uses the general term "income," the Secretary and CIR may specify the kinds of income
the rules will apply to based on what is feasible. In addition, administrative rules and
regulations ordinarily deserve to be given weight and respect by the courts 78 in view of
the rule-making authority given to those who formulate them and their specific expertise
in their respective fields.

No Deprivation of Property Without Due Process

Petitioner avers that the imposition of CWT on GSP/FMV of real estate classified as
ordinary assets deprives its members of their property without due process of law
because, in their line of business, gain is never assured by mere receipt of the selling
price. As a result, the government is collecting tax from net income not yet gained or
earned.

Again, it is stressed that the CWT is creditable against the tax due from the seller of the
property at the end of the taxable year. The seller will be able to claim a tax refund if its
net income is less than the taxes withheld. Nothing is taken that is not due so there is
no confiscation of property repugnant to the constitutional guarantee of due process.
More importantly, the due process requirement applies to the power to tax. 79 The CWT
does not impose new taxes nor does it increase taxes.80 It relates entirely to the method
and time of payment.

Petitioner protests that the refund remedy does not make the CWT less burdensome
because taxpayers have to wait years and may even resort to litigation before they are
granted a refund.81 This argument is misleading. The practical problems encountered in
claiming a tax refund do not affect the constitutionality and validity of the CWT as a
method of collecting the tax.1avvphi1

Petitioner complains that the amount withheld would have otherwise been used by the
enterprise to pay labor wages, materials, cost of money and other expenses which can
then save the entity from having to obtain loans entailing considerable interest expense.
Petitioner also lists the expenses and pitfalls of the trade which add to the burden of the
realty industry: huge investments and borrowings; long gestation period; sudden and
unpredictable interest rate surges; continually spiraling development/construction costs;
heavy taxes and prohibitive "up-front" regulatory fees from at least 20 government
agencies.82

Petitioner’s lamentations will not support its attack on the constitutionality of the CWT.
Petitioner’s complaints are essentially matters of policy best addressed to the executive
and legislative branches of the government. Besides, the CWT is applied only on the
amounts actually received or receivable by the real estate entity. Sales on installment
are taxed on a per-installment basis.83 Petitioner’s desire to utilize for its operational and
capital expenses money earmarked for the payment of taxes may be a practical
business option but it is not a fundamental right which can be demanded from the court
or from the government.

No Violation of Equal Protection

Petitioner claims that the revenue regulations are violative of the equal protection clause
because the CWT is being levied only on real estate enterprises. Specifically, petitioner
points out that manufacturing enterprises are not similarly imposed a CWT on their
sales, even if their manner of doing business is not much different from that of a real
estate enterprise. Like a manufacturing concern, a real estate business is involved in a
continuous process of production and it incurs costs and expenditures on a regular
basis. The only difference is that "goods" produced by the real estate business are
house and lot units.84

Again, we disagree.

The equal protection clause under the Constitution means that "no person or class of
persons shall be deprived of the same protection of laws which is enjoyed by other
persons or other classes in the same place and in like circumstances." 85 Stated
differently, all persons belonging to the same class shall be taxed alike. It follows that
the guaranty of the equal protection of the laws is not violated by legislation based on a
reasonable classification. Classification, to be valid, must (1) rest on substantial
distinctions; (2) be germane to the purpose of the law; (3) not be limited to existing
conditions only and (4) apply equally to all members of the same class. 86

The taxing power has the authority to make reasonable classifications for purposes of
taxation.87 Inequalities which result from a singling out of one particular class for
taxation, or exemption, infringe no constitutional limitation. 88 The real estate industry is,
by itself, a class and can be validly treated differently from other business enterprises.

Petitioner, in insisting that its industry should be treated similarly as manufacturing

enterprises, fails to realize that what distinguishes the real estate business from other
manufacturing enterprises, for purposes of the imposition of the CWT, is not their
production processes but the prices of their goods sold and the number of transactions
involved. The income from the sale of a real property is bigger and its frequency of
transaction limited, making it less cumbersome for the parties to comply with the
withholding tax scheme.

On the other hand, each manufacturing enterprise may have tens of thousands of
transactions with several thousand customers every month involving both minimal and
substantial amounts. To require the customers of manufacturing enterprises, at present,
to withhold the taxes on each of their transactions with their tens or hundreds of
suppliers may result in an inefficient and unmanageable system of taxation and may
well defeat the purpose of the withholding tax system.

Petitioner counters that there are other businesses wherein expensive items are also
sold infrequently, e.g. heavy equipment, jewelry, furniture, appliance and other capital
goods yet these are not similarly subjected to the CWT.89As already discussed, the
Secretary may adopt any reasonable method to carry out its functions. 90 Under Section
57(B), it may choose what to subject to CWT.

A reading of Section 2.57.2 (M) of RR 2-98 will also show that petitioner’s argument is
not accurate. The sales of manufacturers who have clients within the top 5,000
corporations, as specified by the BIR, are also subject to CWT for their transactions with
said 5,000 corporations.91

Section 2.58.2 of RR No. 2-98 Merely Implements Section 58 of RA 8424

Lastly, petitioner assails Section 2.58.2 of RR 2-98, which provides that the Registry of
Deeds should not effect the regisration of any document transferring real property
unless a certification is issued by the CIR that the withholding tax has been paid.
Petitioner proffers hardly any reason to strike down this rule except to rely on its
contention that the CWT is unconstitutional. We have ruled that it is not. Furthermore,
this provision uses almost exactly the same wording as Section 58(E) of RA 8424 and is
unquestionably in accordance with it:

Sec. 58. Returns and Payment of Taxes Withheld at Source. –

(E) Registration with Register of Deeds. - No registration of any document

transferring real property shall be effected by the Register of Deeds unless the
[CIR] or his duly authorized representative has certified that such transfer has
been reported, and the capital gains or [CWT], if any, has been paid: xxxx any
violation of this provision by the Register of Deeds shall be subject to the penalties
imposed under Section 269 of this Code. (Emphasis supplied)

Conclusion

The renowned genius Albert Einstein was once quoted as saying "[the] hardest thing in
the world to understand is the income tax."92 When a party questions the
constitutionality of an income tax measure, it has to contend not only with Einstein’s
observation but also with the vast and well-established jurisprudence in support of the
plenary powers of Congress to impose taxes. Petitioner has miserably failed to
discharge its burden of convincing the Court that the imposition of MCIT and CWT is
unconstitutional.

WHEREFORE, the petition is hereby DISMISSED.

Costs against petitioner.

SO ORDERED.

RENATO C. CORONA
Associate Justice

WE CONCUR:

G.R. No. 198756 January 13, 2015

BANCO DE ORO, BANK OF COMMERCE, CHINA BANKING CORPORATION,

METROPOLITAN BANK & TRUST COMPANY, PHILIPPINE BANK OF
COMMUNICATIONS, PHILIPPINE NATIONAL BANK, PHILIPPINE VETERANS
BANK AND PLANTERS DEVELOPMENT BANK, Petitioners,

RIZAL COMMERCIAL BANKING CORPORATION AND RCBC CAPITAL

CORPORATION, Petitioners-Intervenors,

CAUCUS OF DEVELOPMENT NGO NETWORKS, Petitioner-Intervenor,

vs.
REPUBLIC OF THE PHILIPPINES, THE COMMISSIONER OF INTERNAL REVENUE,
BUREAU OF INTERNAL REVENUE, SECRETARY OF FINANCE, DEPARTMENT OF
FINANCE, THE NATIONAL TREASURER AND BUREAU OF
TREASURY, Respondent.

DECISION

LEONEN, J.:

The case involves the proper tax treatment of the discount or interest income arising
from the ₱35 billion worth of 10-year zero-coupon treasury bonds issued by the Bureau
of Treasury on October 18, 2001 (denominated as the Poverty Eradication and
Alleviation Certificates or the PEA Ce Bonds by the Caucus of Development NGO
Networks).

On October 7, 2011, the Commissioner of Internal Revenue issued BIR Ruling No. 370-
20111 (2011 BIR Ruling), declaring that the PEACe Bonds being deposit substitutes are
subject to the 20% final withholding tax. Pursuant to this ruling, the Secretary of Finance
directed the Bureau of Treasury to withhold a 20% final tax from the face value of the
PEACe Bonds upon their payment at maturity on October 18, 2011.

This is a petition for certiorari, prohibition and/or mandamus2 filed by petitioners under
Rule 65 of the Rules of Court seeking to:

a. ANNUL Respondent BIR's Ruling No. 370-2011 dated 7 October 2011 [and]
other related rulings issued by BIR of similar tenor and import, for being
unconstitutional and for having been issued without jurisdiction or with grave
abuse of discretion amounting to lack or· excess of jurisdiction ... ;

b. PROHIBIT Respondents, particularly the BTr; from withholding or collecting

the 20% FWT from the payment of the face value of the Government Bonds upon
their maturity;

c. COMMAND Respondents, particularly the BTr, to pay the full amount of the
face value of the Government Bonds upon maturity ... ; and

d. SECURE a temporary restraining order (TRO), and subsequently a writ of

preliminary injunction, enjoining Respondents, particularly the BIR and the BTr,
from withholding or collecting 20% FWT on the Government Bonds and the
respondent BIR from enforcing the assailed 2011 BIR Ruling, as well asother
related rulings issued by the BIR of similar tenor and import, pending the
resolution by [the court] of the merits of [the] Petition.3

Factual background
By letter4 dated March 23, 2001, the Caucus of Development NGO Networks (CODE-
NGO) "with the assistance of its financial advisors, Rizal Commercial Banking Corp.
("RCBC"), RCBC Capital Corp. ("RCBC Capital"), CAPEX Finance and Investment
Corp. ("CAPEX") and SEED Capital Ventures, Inc. (SEED)," 5 requested an approval
from the Department of Finance for the issuance by the Bureau of Treasury of 10-year
zerocoupon Treasury Certificates (T-notes).6 The T-notes would initially be purchased
by a special purpose vehicle on behalf of CODE-NGO, repackaged and sold at a
premium to investors as the PEACe Bonds.7 The net proceeds from the sale of the
Bonds"will be used to endow a permanent fund (Hanapbuhay® Fund) to finance
meritorious activities and projects of accredited non-government organizations (NGOs)
throughout the country."8

Prior to and around the time of the proposal of CODE-NGO, other proposals for the
issuance of zero-coupon bonds were also presented by banks and financial institutions,
such as First Metro Investment Corporation (proposal dated March 1,
2001),9 International Exchange Bank (proposal dated July 27, 2000), 10 Security Bank
Corporation and SB Capital Investment Corporation (proposal dated July 25,
2001),11 and ATR-Kim Eng Fixed Income, Inc. (proposal dated August 25,
1999).12 "[B]oth the proposals of First Metro Investment Corp. and ATR-Kim Eng Fixed
Income indicate that the interest income or discount earned on the proposed
zerocoupon bonds would be subject to the prevailing withholding tax." 13

A zero-coupon bondis a bond bought at a price substantially lower than its face value
(or at a deep discount), with the face value repaid at the time of maturity. 14 It does not
make periodic interest payments, or have socalled "coupons," hence the term zero-
coupon bond.15 However, the discount to face value constitutes the return to the
bondholder.16

On May 31, 2001, the Bureau of Internal Revenue, in reply to CODENGO’s letters dated
May 10, 15, and 25, 2001, issued BIR Ruling No. 020-200117 on the tax treatment of the
proposed PEACe Bonds. BIR Ruling No. 020-2001, signed by then Commissioner
ofInternal Revenue René G. Bañez confirmed that the PEACe Bonds would not be
classified as deposit substitutes and would not be subject to the corresponding
withholding tax:

Thus, to be classified as "deposit substitutes", the borrowing of funds must be obtained

from twenty (20) or more individuals or corporate lenders at any one time. In the light of
your representation that the PEACe Bonds will be issued only to one entity, i.e., Code
NGO, the same shall not be considered as "deposit substitutes" falling within the
purview of the above definition. Hence, the withholding tax on deposit substitutes will
not apply.18 (Emphasis supplied)

The tax treatment of the proposed PEACe Bonds in BIR Ruling No. 020-2001 was
subsequently reiterated in BIR Ruling No. 035-200119 dated August 16, 2001 and BIR
Ruling No. DA-175-0120 dated September 29, 2001 (collectively, the 2001 Rulings). In
sum, these rulings pronounced that to be able to determine whether the financial
assets, i.e., debt instruments and securities are deposit substitutes, the "20 or more
individual or corporate lenders" rule must apply. Moreover, the determination of the
phrase "at any one time" for purposes of determining the "20 or more lenders" is to be
determined at the time of the original issuance. Such being the case, the PEACe Bonds
were not to be treated as deposit substitutes.

Meanwhile, in the memorandum21 dated July 4, 2001, Former Treasurer Eduardo

Sergio G. Edeza (Former Treasurer Edeza) questioned the propriety of issuing the
bonds directly to a special purpose vehicle considering that the latter was not a
Government Securities Eligible Dealer (GSED).22 Former Treasurer Edeza
recommended that the issuance of the Bonds "be done through the ADAPS" 23 and that
CODE-NGO "should get a GSED to bid in [sic] its behalf."24

Subsequently, in the notice to all GSEDs entitled Public Offering of Treasury

Bonds25 (Public Offering) dated October 9, 2001, the Bureau of Treasury announced
that "₱30.0B worth of 10-year Zero[-] Coupon Bonds [would] be auctioned on October
16, 2001[.]"26 The notice stated that the Bonds "shall be issued to not morethan 19
buyers/lenders hence, the necessity of a manual auction for this maiden issue."27 It also
required the GSEDs to submit their bids not later than 12 noon on auction date and to
disclose in their bid submissions the names of the institutions bidding through them to
ensure strict compliance with the 19 lender limit.28 Lastly, it stated that "the issue being
limitedto 19 lenders and while taxable shall not be subject to the 20% final withholding
[tax]."29

On October 12, 2001, the Bureau of Treasury released a memo 30 on the "Formula for
the Zero-Coupon Bond." The memo stated inpart that the formula (in determining the
purchase price and settlement amount) "is only applicable to the zeroes that are not
subject to the 20% final withholding due to the 19 buyer/lender limit."31

A day before the auction date or on October 15, 2001, the Bureau of Treasury issued
the "Auction Guidelines for the 10-year Zero-Coupon Treasury Bond to be Issued on
October 16, 2001" (Auction Guidelines).32 The Auction Guidelines reiterated that the
Bonds to be auctioned are "[n]ot subject to 20% withholding tax as the issue will be
limited to a maximum of 19 lenders in the primary market (pursuant to BIR Revenue
Regulation No. 020 2001)."33The Auction Guidelines, for the first time, also stated that
the Bonds are "[e]ligible as liquidity reserves (pursuant to MB Resolution No. 1545
dated 27 September 2001)[.]"34

On October 16, 2001, the Bureau of Treasury held an auction for the 10-year zero-
coupon bonds.35 Also on the same date, the Bureau of Treasury issued another
memorandum36 quoting excerpts of the ruling issued by the Bureau of Internal Revenue
concerning the Bonds’ exemption from 20% final withholding tax and the opinion of the
Monetary Board on reserve eligibility.37
During the auction, there were 45 bids from 15 GSEDs.38 The bidding range was very
wide, from as low as 12.248% to as high as 18.000%.39 Nonetheless, the Bureau of
Treasury accepted the auction results.40 The cut-off was at 12.75%.41

After the auction, RCBC which participated on behalf of CODE-NGO was declared as
the winning bidder having tendered the lowest bids.42 Accordingly, on October 18, 2001,
the Bureau of Treasury issued ₱35 billion worth of Bonds at yield-to-maturity of 12.75%
to RCBC for approximately ₱10.17 billion,43 resulting in a discount of approximately
₱24.83 billion.

Also on October 16, 2001, RCBC Capital entered into an underwriting Agreement44 with
CODE-NGO, whereby RCBC Capital was appointed as the Issue Manager and Lead
Underwriter for the offering of the PEACe Bonds.45RCBC Capital agreed to
underwrite46 on a firm basis the offering, distribution and sale of the 35 billion Bonds at
the price of ₱11,995,513,716.51.47 In Section 7(r) of the underwriting agreement,
CODE-NGO represented that "[a]ll income derived from the Bonds, inclusive of
premium on redemption and gains on the trading of the same, are exempt from all forms
of taxation as confirmed by Bureau of Internal Revenue (BIR) letter rulings dated 31
May 2001 and 16 August 2001, respectively."48

RCBC Capital sold the Government Bonds in the secondary market for an issue price of
₱11,995,513,716.51. Petitioners purchased the PEACe Bonds on different dates.49

BIR rulings

On October 7, 2011, "the BIR issued the assailed 2011 BIR Ruling imposing a 20%
FWT on the Government Bonds and directing the BTr to withhold said final tax at the
maturity thereof, [allegedly without] consultation with Petitioners as bond holders, and
without conducting any hearing."50

"It appears that the assailed 2011 BIR Ruling was issued in response to a query of the
Secretary of Finance on the proper tax treatment of the discount or interest income
derived from the Government Bonds."51 The Bureau of Internal Revenue, citing three (3)
of its rulings rendered in 2004 and 2005, namely: BIR Ruling No. 007-0452 dated July
16, 2004; BIR Ruling No. DA-491-0453 dated September 13, 2004; and BIR Ruling No.
008-0554 dated July 28, 2005, declared the following:

The Php 24.3 billion discount on the issuance of the PEACe Bonds should be subject to
20% Final Tax on interest income from deposit substitutes. It is now settled that all
treasury bonds (including PEACe Bonds), regardless of the number of
purchasers/lenders at the time of origination/issuance are considered deposit
substitutes. In the case of zero-coupon bonds, the discount (i.e. difference between face
value and purchase price/discounted value of the bond) is treated as interest income of
the purchaser/holder. Thus, the Php 24.3 interest income should have been properly
subject to the 20% Final Tax as provided in Section 27(D)(1) of the Tax Code of 1997. .
..
 ....

However, at the time of the issuance of the PEACe Bonds in 2001, the BTr was not able
tocollect the final tax on the discount/interest income realized by RCBC as a result of
the 2001 Rulings. Subsequently, the issuance of BIR Ruling No. 007-04 dated July 16,
2004 effectively modifies and supersedes the 2001 Rulings by stating that the [1997]
Tax Code is clear that the "term public means borrowing from twenty (20) or more
individual or corporate lenders at any one time." The word "any" plainly indicates that
the period contemplated is the entire term of the bond, and not merely the point of
origination or issuance. . . . Thus, by taking the PEACe bonds out of the ambit of
deposits [sic] substitutes and exempting it from the 20% Final Tax, an exemption in
favour of the PEACe Bonds was created when no such exemption is found in the law. 55

On October 11, 2011, a "Memo for Trading Participants No. 58-2011 was issued by the
Philippine Dealing System Holdings Corporation and Subsidiaries ("PDS Group"). The
Memo provides that in view of the pronouncement of the DOF and the BIR on the
applicability of the 20% FWT on the Government Bonds, no transferof the same shall be
allowed to be recorded in the Registry of Scripless Securities ("ROSS") from 12 October
2011 until the redemption payment date on 18 October 2011. Thus, the bondholders of
record appearing on the ROSS as of 18 October 2011, which include the Petitioners,
shall be treated by the BTr asthe beneficial owners of such securities for the relevant
[tax] payments to be imposed thereon."56

On October 17, 2011, replying to anurgent query from the Bureau of Treasury, the
Bureau of Internal Revenue issued BIR Ruling No. DA 378-201157 clarifying that the
final withholding tax due on the discount or interest earned on the PEACe Bonds should
"be imposed and withheld not only on RCBC/CODE NGO but also [on] ‘all subsequent
holders of the Bonds.’"58

On October 17, 2011, petitioners filed a petition for certiorari, prohibition, and/or
mandamus (with urgent application for a temporary restraining order and/or writ of
preliminary injunction)59 before this court.

On October 18, 2011, this court issued a temporary restraining order (TRO)60 "enjoining
the implementation of BIR Ruling No. 370-2011 against the [PEACe Bonds,] . . . subject
to the condition that the 20% final withholding tax on interest income there from shall be
withheld by the petitioner banks and placed in escrow pending resolution of [the]
petition."61

On October 28, 2011, RCBC and RCBC Capital filed a motion for leave of court to
intervene and to admit petition-in-intervention62 dated October 27, 2011, which was
granted by this court on November 15, 2011.63

Meanwhile, on November 9, 2011, petitioners filed their "Manifestation with Urgent Ex

Parte Motion to Direct Respondents to Comply with the TRO."64 They alleged that on
the same day that the temporary restraining order was issued, the Bureau of Treasury
paid to petitioners and other bondholders the amounts representing the face value of
the Bonds, net however of the amounts corresponding to the 20% final withholding tax
on interest income, and that the Bureau of Treasury refused to release the amounts
corresponding to the 20% final withholding tax.65On November 15, 2011, this court
directed respondents to: "(1) SHOW CAUSE why they failed to comply with the October
18, 2011 resolution; and (2) COMPLY with the Court’s resolution in order that
petitioners may place the corresponding funds in escrow pending resolution of the
petition."66

On the same day, CODE-NGO filed a motion for leave to intervene (and to admit
attached petition-in-intervention with comment on the petitionin-intervention of RCBC
and RCBC Capital).67 The motion was granted by this court on November 22, 2011. 68

On December 1, 2011, public respondents filed their compliance.69 They explained that:
1) "the implementation of [BIR Ruling No. 370-2011], which has already been performed
on October 18, 2011 with the withholding of the 20% final withholding tax on the face
value of the PEACe bonds, is already fait accompli . . . when the Resolution and TRO
were served to and received by respondents BTr and National Treasurer [on October
19, 2011]";70 and 2) the withheld amount has ipso facto become public funds and
cannot be disbursed or released to petitioners without congressional
appropriation.71 Respondents further aver that"[i]nasmuch as the . . . TRO has already
become moot . . . the condition attached to it, i.e., ‘that the 20% final withholding tax on
interest income therefrom shall be withheld by the banks and placed in escrow . . .’has
also been rendered moot[.]"72

On December 6, 2011, this court noted respondents' compliance.73

On February 22, 2012, respondents filed their consolidated comment 74 on the petitions-
in-intervention filed by RCBC and RCBC Capital and On November 27, 2012,
petitioners filed their "Manifestation with Urgent Reiterative Motion (To Direct
Respondents to Comply with the Temporary Restraining Order)."75

On December 4, 2012, this court: (a) noted petitioners’ manifestation with urgent
reiterative motion (to direct respondents to comply with the temporary restraining order);
and (b) required respondents to comment thereon.76

Respondents’ comment77 was filed on April 15,2013, and petitioners filed their
reply78 on June 5, 2013.

Issues

The main issues to be resolved are:

I. Whether the PEACe Bonds are "deposit substitutes" and thus subject to 20%
final withholding tax under the 1997 National Internal Revenue Code. Related to
this question is the interpretation of the phrase "borrowing from twenty (20) or
 more individual or corporate lenders at any one time" under Section 22(Y) of the
1997 National Internal Revenue Code, particularly on whether the reckoning of
the 20 lenders includes trading of the bonds in the secondary market; and

II. If the PEACe Bonds are considered "deposit substitutes," whether the
government or the Bureau of Internal Revenue is estopped from imposing and/or
collecting the 20% final withholding tax from the face value of these Bonds

a. Will the imposition of the 20% final withholding tax violate the non-
impairment clause of the Constitution?

b. Will it constitute a deprivation of property without due process of law?

c. Will it violate Section 245 of the 1997 National Internal Revenue Code
on non-retroactivity of rulings?

Arguments of petitioners, RCBC and RCBC

Capital, and CODE-NGO

Petitioners argue that "[a]s the issuer of the Government Bonds acting through the BTr,
the Government is obligated . . . to pay the face value amount of Ph₱35 Billion upon
maturity without any deduction whatsoever."79 They add that "the Government cannot
impair the efficacy of the [Bonds] by arbitrarily, oppressively and unreasonably imposing
the withholding of 20% FWT upon the [Bonds] a mere eleven (11) days before maturity
and after several, consistent categorical declarations that such bonds are exempt from
the 20% FWT, without violating due process"80 and the constitutional principle on non-
impairment of contracts.81 Petitioners aver that at the time they purchased the Bonds,
they had the right to expect that they would receive the full face value of the Bonds
upon maturity, in view of the 2001 BIR Rulings.82 "[R]egardless of whether or not the
2001 BIR Rulings are correct, the fact remains that [they] relied [on] good faith
thereon."83

At any rate, petitioners insist that the PEACe Bonds are not deposit substitutes as
defined under Section 22(Y) of the 1997 National Internal Revenue Code because there
was only one lender (RCBC) to whom the Bureau of Treasury issued the Bonds. 84 They
allege that the 2004, 2005, and 2011 BIR Rulings "erroneously interpreted that the
number of investors that participate in the ‘secondary market’ is the determining factor
in reckoning the existence or non-existence of twenty (20) or more individual or
corporate lenders."85 Furthermore, they contend that the Bureau of Internal Revenue
unduly expanded the definition of deposit substitutes under Section 22 of the 1997
National Internal Revenue Code in concluding that "the mere issuance of government
debt instruments and securities is deemed as falling within the coverage of ‘deposit
substitutes[.]’"86 Thus, "[t]he 2011 BIR Ruling clearly amount[ed] to an unauthorized act
of administrative legislation[.]"87
Petitioners further argue that their income from the Bonds is a "trading gain," which is
exempt from income tax.88They insist that "[t]hey are not lenders whose income is
considered as ‘interest income or yield’ subject to the 20% FWT under Section 27 (D)(1)
of the [1997 National Internal Revenue Code]"89 because they "acquired the
Government Bonds in the secondary or tertiary market." 90

Even assuming without admitting that the Government Bonds are deposit substitutes,
petitioners argue that the collection of the final tax was barred by prescription. 91 They
point out that under Section 7 of DOF Department Order No. 141-95,92 the final
withholding tax "should have been withheld at the time of their issuance[.]" 93 Also, under
Section 203 of the 1997 National Internal Revenue Code, "internal revenuetaxes, such
as the final tax, [should] be assessed within three (3) years after the last day prescribed
by law for the filing of the return."94

Moreover, petitioners contend that the retroactive application of the 2011 BIR Ruling
without prior notice to them was in violation of their property rights,95 their constitutional
right to due process96 as well as Section 246 of the 1997 National Internal Revenue
Code on non-retroactivity of rulings.97 Allegedly, it would also have "an adverse effect of
colossal magnitude on the investors, both localand foreign, the Philippine capital
market, and most importantly, the country’s standing in the international commercial
community."98 Petitioners explained that "unless enjoined, the government’s threatened
refusal to pay the full value of the Government Bonds will negatively impact on the
image of the country in terms of protection for property rights (including financial
assets), degree of legal protection for lender’s rights, and strength of investor
protection."99 They cited the country’s ranking in the World Economic Forum: 75th in the
world in its 2011–2012 Global Competitiveness Index, 111th out of 142 countries
worldwide and 2nd to the last among ASEAN countries in terms of Strength of Investor
Protection, and 105th worldwide and last among ASEAN countries in terms of Property
Rights Index and Legal Rights Index.100 It would also allegedly "send a reverberating
message to the whole world that there is no certainty, predictability, and stability of
financial transactions in the capital markets[.]"101 "[T]he integrity of Government-issued
bonds and notes will be greatly shattered and the credit of the Philippine Government
will suffer"102 if the sudden turnaround of the government will be allowed, 103 and it will
reinforce "investors’ perception that the level of regulatory risk for contracts entered into
by the Philippine Government is high,"104 thus resulting in higher interestrate for
government-issued debt instruments and lowered credit rating.105

Petitioners-intervenors RCBC and RCBC Capital contend that respondent

Commissioner of Internal Revenue "gravely and seriously abused her discretion in the
exercise of her rule-making power"106 when she issued the assailed 2011 BIR Ruling
which ruled that "all treasury bonds are ‘deposit substitutes’ regardless of the number of
lenders, in clear disregard of the requirement of twenty (20)or more lenders mandated
under the NIRC."107 They argue that "[b]y her blanket and arbitrary classification of
treasury bonds as deposit substitutes, respondent CIR not only amended and expanded
the NIRC, but effectively imposed a new tax on privately-placed treasury
bonds."108Petitioners-intervenors RCBC and RCBC Capital further argue that the 2011
BIR Ruling will cause substantial impairment of their vested rights 109 under the Bonds
since the ruling imposes new conditions by "subjecting the PEACe Bonds to the twenty
percent (20%) final withholding tax notwithstanding the fact that the terms and
conditions thereof as previously represented by the Government, through respondents
BTr and BIR, expressly state that it is not subject to final withholding tax upon their
maturity."110 They added that "[t]he exemption from the twenty percent (20%) final
withholding tax [was] the primary inducement and principal consideration for [their]
participat[ion] in the auction and underwriting of the PEACe Bonds." 111

Like petitioners, petitioners-intervenors RCBC and RCBC Capital also contend that
respondent Commissioner of Internal Revenue violated their rights to due process when
she arbitrarily issued the 2011 BIR Ruling without prior notice and hearing, and the
oppressive timing of such ruling deprived them of the opportunity to challenge the
same.112

Assuming the 20% final withholding tax was due on the PEACe Bonds, petitioners-
intervenors RCBC and RCBC Capital claim that respondents Bureau of Treasury and
CODE-NGO should be held liable "as [these] parties explicitly represented . . . that the
said bonds are exempt from the final withholding tax." 113

Finally, petitioners-intervenors RCBC and RCBC Capital argue that "the implementation
of the [2011 assailed BIR Ruling and BIR Ruling No. DA 378-2011] will have pernicious
effects on the integrity of existing securities, which is contrary to the State policies of
stabilizing the financial system and of developing capital markets." 114

For its part, CODE-NGO argues that: (a) the 2011 BIR Ruling and BIR Ruling No. DA
378-2011 are "invalid because they contravene Section 22(Y) of the 1997 [NIRC] when
the said rulings disregarded the applicability of the ‘20 or more lender’ rule to
government debt instruments"[;]115 (b) "when [it] sold the PEACe Bonds in the
secondary market instead of holding them until maturity, [it] derived . . . long-term
trading gain[s], not interest income, which [are] exempt . . . under Section 32(B)(7)(g) of
the 1997 NIRC"[;]116 (c) "the tax exemption privilege relating to the issuance of the
PEACe Bonds . . . partakes of a contractual commitment granted by the Government in
exchange for a valid and material consideration [i.e., the issue price paid and savings in
borrowing cost derived by the Government,] thus protected by the non-impairment
clause of the 1987 Constitution"[;]117 and (d) the 2004, 2005, and 2011 BIR Rulings "did
not validly revoke the 2001 BIR Rulings since no notice of revocation was issued to [it],
RCBC and [RCBC Capital] and petitioners[-bondholders], nor was there any BIR
administrative guidance issued and published[.]"118CODE-NGO additionally argues that
impleading it in a Rule 65 petition was improper because: (a) it involves determination of
a factual question;119 and (b) it is premature and states no cause of action as it amounts
to an anticipatory third-party claim.120

Arguments of respondents
Respondents argue that petitioners’ direct resort to this court to challenge the 2011 BIR
Ruling violates the doctrines of exhaustion of administrative remedies and hierarchy
ofcourts, resulting in a lack of cause of action that justifies the dismissal of the
petition.121 According to them, "the jurisdiction to review the rulings of the
[Commissioner of Internal Revenue], after the aggrieved party exhausted the
administrative remedies, pertains to the Court of Tax Appeals." 122 They point out that "a
case similar to the present Petition was [in fact] filed with the CTA on October 13,
2011[,] [docketed as] CTA Case No. 8351 [and] entitled, ‘Rizal Commercial Banking
Corporation and RCBC Capital Corporation vs. Commissioner of Internal Revenue, et
al.’"123

Respondents further take issue on the timeliness of the filing of the petition and
petitions-in-intervention.124 They argue that under the guise of mainly assailing the 2011
BIR Ruling, petitioners are indirectly attacking the 2004 and 2005 BIR Rulings, of which
the attack is legally prohibited, and the petition insofar as it seeks to nullify the 2004 and
2005 BIR Rulings was filed way out of time pursuant to Rule 65, Section 4. 125

Respondents contend that the discount/interest income derived from the PEACe Bonds
is not a trading gain but interest income subject to income tax.126 They explain that
"[w]ith the payment of the Ph₱35 Billion proceeds on maturity of the PEACe Bonds,
Petitioners receive an amount of money equivalent to about Ph₱24.8 Billion as payment
for interest. Such interest is clearly an income of the Petitioners considering that the
same is a flow of wealth and not merely a return of capital – the capital initially invested
in the Bonds being approximately Ph₱10.2 Billion[.]" 127

Maintaining that the imposition of the 20% final withholding tax on the PEACe Bonds
does not constitute an impairment of the obligations of contract, respondents aver that:
"The BTr has no power to contractually grant a tax exemption in favour of Petitioners
thus the 2001 BIR Rulings cannot be considered a material term of the
Bonds"[;]128 "[t]here has been no change in the laws governing the taxability of interest
income from deposit substitutes and said laws are read into every contract"[;]129 "[t]he
assailed BIR Rulings merely interpret the term "deposit substitute" in accordance with
the letter and spirit of the Tax Code"[;]130 "[t]he withholding of the 20% FWT does not
result in a default by the Government as the latter performed its obligations to the
bondholders in full"[;]131 and "[i]f there was a breach of contract or a misrepresentation it
was between RCBC/CODE-NGO/RCBC Cap and the succeeding purchasers of the
PEACe Bonds."132

Similarly, respondents counter that the withholding of "[t]he 20% final withholding tax on
the PEACe Bonds does not amount to a deprivation of property without due process of
law."133 Their imposition of the 20% final withholding tax is not arbitrary because they
were only performing a duty imposed by law;134 "[t]he 2011 BIR Ruling is
aninterpretative rule which merely interprets the meaning of deposit substitutes [and
upheld] the earlier construction given to the termby the 2004 and 2005 BIR
Rulings."135 Hence, respondents argue that "there was no need to observe the
requirements of notice, hearing, and publication[.]" 136
Nonetheless, respondents add that "there is every reason to believe that Petitioners —
all major financial institutions equipped with both internal and external accounting and
compliance departments as wellas access to both internal and external legal counsel;
actively involved in industry organizations such as the Bankers Association of the
Philippines and the Capital Market Development Council; all actively taking part in the
regular and special debt issuances of the BTr and indeed regularly proposing products
for issue by BTr — had actual notice of the 2004 and 2005 BIR Rulings."137 Allegedly,
"the sudden and drastic drop — including virtually zero trading for extended periods of
six months to almost a year — in the trading volume of the PEACe Bonds after the
release of BIR Ruling No. 007-04 on July 16, 2004 tend to indicate that market
participants, including the Petitioners herein, were aware of the ruling and its
consequences for the PEACe Bonds."138

Moreover, they contend that the assailed 2011 BIR Ruling is a valid exercise of the
Commissioner of Internal Revenue’s rule-making power;139 that it and the 2004 and
2005 BIR Rulings did not unduly expand the definition of deposit substitutes by creating
an unwarranted exception to the requirement of having 20 or more
lenders/purchasers;140 and the word "any" in Section 22(Y) of the National Internal
Revenue Code plainly indicates that the period contemplated is the entire term of the
bond and not merely the point of origination or issuance.141

Respondents further argue that a retroactive application of the 2011 BIR Ruling will not
unjustifiably prejudice petitioners.142 "[W]ith or without the 2011 BIR Ruling, Petitioners
would be liable topay a 20% final withholding tax just the same because the PEACe
Bonds in their possession are legally in the nature of deposit substitutes subject to a
20% final withholding tax under the NIRC."143 Section 7 of DOF Department Order No.
141-95 also provides that incomederived from Treasury bonds is subject to the 20%
final withholding tax.144 "[W]hile revenue regulations as a general rule have no
retroactive effect, if the revocation is due to the fact that the regulation is erroneous or
contrary to law, such revocation shall have retroactive operation as to affect past
transactions, because a wrong construction of the law cannot give rise to a vested right
that can be invoked by a taxpayer."145

Finally, respondents submit that "there are a number of variables and factors affecting a
capital market."146 "[C]apital market itself is inherently unstable."147 Thus, "[p]etitioners’
argument that the 20% final withholding tax . . . will wreak havoc on the financial stability
of the country is a mere supposition that is not a justiciable issue." 148

On the prayer for the temporary restraining order, respondents argue that this order
"could no longer be implemented [because] the acts sought to be enjoined are already
fait accompli."149 They add that "to disburse the funds withheld to the Petitioners at this
time would violate Section 29[,] Article VI of the Constitution prohibiting ‘money being
paid out of the Treasury except in pursuance of an appropriation made by
law[.]’"150 "The remedy of petitioners is to claim a tax refund under Section 204(c) of the
Tax Code should their position be upheld by the Honorable Court."151
Respondents also argue that "the implementation of the TRO would violate Section 218
of the Tax Code in relation to Section 11 of Republic Act No. 1125 (as amended by
Section 9 of Republic Act No. 9282) which prohibits courts, except the Court of Tax
Appeals, from issuing injunctions to restrain the collection of any national internal
revenue tax imposed by the Tax Code."152

Summary of arguments

In sum, petitioners and petitioners-intervenors, namely, RCBC, RCBC Capital, and

CODE-NGO argue that:

1. The 2011 BIR Ruling is ultra vires because it is contrary to the 1997 National
Internal Revenue Code when it declared that all government debt instruments
are deposit substitutes regardless of the 20-lender rule; and

2. The 2011 BIR Ruling cannot be applied retroactively because:

a) It will violate the contract clause;

● It constitutes a unilateral amendment of a material term (tax exempt

status) in the Bonds, represented by the government as an inducement
and important consideration for the purchase of the Bonds;

b) It constitutes deprivation ofproperty without due process because there

was no prior notice to bondholders and hearing and publication;

c) It violates the rule on non-retroactivity under the 1997 National Internal

Revenue Code;

d) It violates the constitutional provision on supporting activities of non-

government organizations and development of the capital market; and

e) The assessment had already prescribed.

Respondents counter that:

1) Respondent Commissioner of Internal Revenue did not act with grave abuse of
discretion in issuing the challenged 2011 BIR Ruling:

a. The 2011 BIR Ruling, being an interpretative rule, was issued by virtue of the
Commissioner of Internal Revenue’s power to interpret the provisions of the 1997
National Internal Revenue Code and other tax laws;

b. Commissioner of Internal Revenue merely restates and confirms the

interpretations contained in previously issued BIR Ruling Nos. 007-2004, DA-
 491-04,and 008-05, which have already effectively abandoned or revoked the
2001 BIR Rulings;

c. Commissioner of Internal Revenue is not bound by his or her predecessor’s

rulings especially when the latter’s rulings are not in harmony with the law; and

d. The wrong construction of the law that the 2001 BIR Rulings have perpetrated
cannot give rise to a vested right. Therefore, the 2011 BIR Ruling can be given
retroactive effect.

2) Rule 65 can be resorted to only if there is no appeal or any plain, speedy, and
adequate remedy in the ordinary course of law:

a. Petitioners had the basic remedy offiling a claim for refund of the 20% final
withholding tax they allege to have been wrongfully collected; and

b. Non-observance of the doctrine of exhaustion of administrative remedies and of

hierarchy of courts.

Court’s ruling

Procedural Issues
Non-exhaustion of
administrative remedies proper

Under Section 4 of the 1997 National Internal Revenue Code, interpretative rulings are
reviewable by the Secretary of Finance.

SEC. 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax Cases. -
The power to interpret the provisions of this Code and other tax laws shall be under the
exclusive and original jurisdiction of the Commissioner, subject to review by the
Secretary of Finance. (Emphasis supplied)

Thus, it was held that "[i]f superior administrative officers [can] grant the relief prayed
for, [then] special civil actions are generally not entertained." 153 The remedy within the
administrative machinery must be resorted to first and pursued to its appropriate
conclusion before the court’s judicial power can be sought.154

Nonetheless, jurisprudence allows certain exceptions to the rule on exhaustion of

administrative remedies:

[The doctrine of exhaustion of administrative remedies] is a relative one and its flexibility
is called upon by the peculiarity and uniqueness of the factual and circumstantial
settings of a case. Hence, it is disregarded (1) when there is a violation of due process,
(2) when the issue involved is purely a legal question,155 (3) when the administrative
action is patently illegal amounting to lack or excess of jurisdiction,(4) when there is
estoppel on the part of the administrative agency concerned,(5) when there is
irreparable injury, (6) when the respondent is a department secretary whose acts as an
alter ego of the President bears the implied and assumed approval of the latter, (7)
when to require exhaustion of administrative remedies would be unreasonable, (8)
when it would amount to a nullification of a claim, (9) when the subject matter is a
private land in land case proceedings, (10) when the rule does not provide a plain,
speedy and adequate remedy, (11) when there are circumstances indicating the
urgency of judicial intervention.156 (Emphasis supplied, citations omitted)

The exceptions under (2) and (11)are present in this case. The question involved is
purely legal, namely: (a) the interpretation of the 20-lender rule in the definition of the
terms public and deposit substitutes under the 1997 National Internal Revenue Code;
and (b) whether the imposition of the 20% final withholding tax on the PEACe Bonds
upon maturity violates the constitutional provisions on non-impairment of contracts and
due process. Judicial intervention is likewise urgent with the impending maturity of the
PEACe Bonds on October 18, 2011.

The rule on exhaustion of administrative remedies also finds no application when the
exhaustion will result in an exercise in futility.157

In this case, an appeal to the Secretary of Finance from the questioned 2011 BIR Ruling
would be a futile exercise because it was upon the request of the Secretary of Finance
that the 2011 BIR Ruling was issued by the Bureau of Internal Revenue. It appears that
the Secretary of Finance adopted the Commissioner of Internal Revenue’s opinions as
his own.158 This position was in fact confirmed in the letter159 dated October 10, 2011
where he ordered the Bureau of Treasury to withhold the amount corresponding to the
20% final withholding tax on the interest or discounts allegedly due from the
bondholders on the strength of the 2011 BIR Ruling. Doctrine on hierarchy of courts

We agree with respondents that the jurisdiction to review the rulings of the
Commissioner of Internal Revenue pertains to the Court of Tax Appeals. The
questioned BIR Ruling Nos. 370-2011 and DA 378-2011 were issued in connection with
the implementation of the 1997 National Internal Revenue Code on the taxability of the
interest income from zero-coupon bonds issued by the government.

Under Republic Act No. 1125 (An Act Creating the Court of Tax Appeals), as amended
by Republic Act No. 9282,160such rulings of the Commissioner of Internal Revenue are
appealable to that court, thus:

SEC. 7.Jurisdiction.- The CTA shall exercise:

a. Exclusive appellate jurisdiction to review by appeal, as herein provided:

1. Decisions of the Commissioner of Internal Revenue in cases involving disputed

assessments, refunds of internal revenue taxes, fees or other charges, penalties in
relation thereto, or other matters arising under the National Internal Revenue or other
laws administered by the Bureau of Internal Revenue;

....

SEC. 11. Who May Appeal; Mode of Appeal; Effect of Appeal. - Any party adversely
affected by a decision, ruling or inaction of the Commissioner of Internal Revenue, the
Commissioner of Customs, the Secretary of Finance, the Secretary of Trade and
Industry or the Secretary of Agriculture or the Central Board of Assessment Appeals or
the Regional Trial Courts may file an appeal with the CTA within thirty (30) days after
the receipt of such decision or rulingor after the expiration of the period fixed by law for
action as referred toin Section 7(a)(2) herein.

....

SEC. 18. Appeal to the Court of Tax Appeals En Banc. - No civil proceeding involving
matters arising under the National Internal Revenue Code, the Tariff and Customs Code
or the Local Government Code shall be maintained, except as herein provided, until and
unless an appeal has been previously filed with the CTA and disposed of in accordance
with the provisions of this Act.

In Commissioner of Internal Revenue v. Leal,161 citing Rodriguez v. Blaquera,162 this

court emphasized the jurisdiction of the Court of Tax Appeals over rulings of the Bureau
of Internal Revenue, thus:

While the Court of Appeals correctly took cognizance of the petition for certiorari,
however, let it be stressed that the jurisdiction to review the rulings of the Commissioner
of Internal Revenue pertains to the Court of Tax Appeals, not to the RTC.

The questioned RMO No. 15-91 and RMC No. 43-91 are actually rulings or opinions of
the Commissioner implementing the Tax Code on the taxability of pawnshops.. . .

....

Such revenue orders were issued pursuant to petitioner's powers under Section 245 of
the Tax Code, which states:

"SEC. 245. Authority of the Secretary of Finance to promulgate rules and regulations. —
The Secretary of Finance, upon recommendation of the Commissioner, shall
promulgate all needful rules and regulations for the effective enforcement of the
provisions of this Code.

The authority of the Secretary of Finance to determine articles similar or analogous to

those subject to a rate of sales tax under certain category enumerated in Section 163
and 165 of this Code shall be without prejudice to the power of the Commissioner of
Internal Revenue to make rulings or opinions in connection with the implementation of
the provisionsof internal revenue laws, including ruling on the classification of articles of
sales and similar purposes." (Emphasis in the original)

....

The Court, in Rodriguez, etc. vs. Blaquera, etc., ruled:

"Plaintiff maintains that this is not an appeal from a ruling of the Collector of Internal
Revenue, but merely an attempt to nullify General Circular No. V-148, which does not
adjudicate or settle any controversy, and that, accordingly, this case is not within the
jurisdiction of the Court of Tax Appeals.

We find no merit in this pretense. General Circular No. V-148 directs the officers
charged with the collection of taxes and license fees to adhere strictly to the
interpretation given by the defendant tothe statutory provisions abovementioned, as set
forth in the Circular. The same incorporates, therefore, a decision of the Collector of
Internal Revenue (now Commissioner of Internal Revenue) on the manner of
enforcement of the said statute, the administration of which is entrusted by law to the
Bureau of Internal Revenue. As such, it comes within the purview of Republic Act No.
1125, Section 7 of which provides that the Court of Tax Appeals ‘shall exercise
exclusive appellate jurisdiction to review by appeal . . . decisions of the Collector of
Internal Revenue in . . . matters arising under the National Internal Revenue Code or
other law or part of the law administered by the Bureau of Internal Revenue.’" 163

In exceptional cases, however, this court entertained direct recourse to it when "dictated
by public welfare and the advancement of public policy, or demanded by the broader
interest of justice, or the orders complained of were found to be patent nullities, or the
appeal was considered as clearly an inappropriate remedy." 164

In Philippine Rural Electric Cooperatives Association, Inc. (PHILRECA) v. The

Secretary, Department of Interior and Local Government,165 this court noted that the
petition for prohibition was filed directly before it "in disregard of the rule on hierarchy of
courts. However, [this court] opt[ed] to take primary jurisdiction over the . . . petition and
decide the same on its merits in viewof the significant constitutional issues raised by the
parties dealing with the tax treatment of cooperatives under existing laws and in the
interest of speedy justice and prompt disposition of the matter."166

Here, the nature and importance of the issues raised167 to the investment and banking
industry with regard to a definitive declaration of whether government debt instruments
are deposit substitutes under existing laws, and the novelty thereof, constitute
exceptional and compelling circumstances to justify resort to this court in the first
instance.

The tax provision on deposit substitutes affects not only the PEACe Bonds but also any
other financial instrument or product that may be issued and traded in the market. Due
to the changing positions of the Bureau of Internal Revenue on this issue, there isa
need for a final ruling from this court to stabilize the expectations in the financial market.

Finally, non-compliance with the rules on exhaustion of administrative remedies and

hierarchy of courts had been rendered moot by this court’s issuance of the temporary
restraining order enjoining the implementation of the 2011 BIR Ruling. The temporary
restraining order effectively recognized the urgency and necessity of direct resort to this
court.

Substantive issues

Tax treatment of deposit

substitutes

Under Sections 24(B)(1), 27(D)(1),and 28(A)(7) of the 1997 National Internal Revenue
Code, a final withholdingtax at the rate of 20% is imposed on interest on any currency
bank deposit and yield or any other monetary benefit from deposit substitutes and from
trust funds and similar arrangements. These provisions read:

SEC. 24. Income Tax Rates.

....

(B) Rate of Tax on Certain Passive Income.

(1) Interests, Royalties, Prizes, and Other Winnings. - A final tax at the rate of twenty
percent (20%) is hereby imposed upon the amount of interest fromany currency bank
deposit and yield or any other monetary benefit from deposit substitutes and from trust
funds and similar arrangements; . . . Provided, further, That interest income from long-
term deposit or investment in the form of savings, common or individual trust funds,
deposit substitutes, investment management accounts and other investments
evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas
(BSP) shall be exempt from the tax imposed under this Subsection: Provided, finally,
That should the holder of the certificate pre-terminate the deposit or investment before
the fifth (5th) year, a final tax shall be imposed on the entire income and shall be
deducted and withheld by the depository bank from the proceeds of the long-term
deposit or investment certificate based on the remaining maturity thereof:

Four (4) years to less than five (5) years - 5%;

Three (3) years to less than four (4) years - 12%; and

Less than three (3) years - 20%. (Emphasis supplied)

SEC. 27. Rates of Income Tax on Domestic Corporations. -

....

(D) Rates of Tax on Certain Passive Incomes. -

(1) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes and from Trust Funds and Similar Arrangements, and Royalties. - A final tax
at the rate of twenty percent (20%) is hereby imposed upon the amount of interest on
currency bank deposit and yield or any other monetary benefit from deposit substitutes
and from trust funds and similar arrangements received by domestic corporations, and
royalties, derived from sources within the Philippines: Provided, however, That interest
income derived by a domestic corporation from a depository bank under the expanded
foreign currency deposit system shall be subject to a final income tax at the rate of
seven and one-half percent (7 1/2%) of such interest income. (Emphasis supplied)

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

....

(7) Tax on Certain Incomes Received by a Resident Foreign Corporation. -

(a) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes, Trust Funds and Similar Arrangements and Royalties. - Interest from any
currency bank deposit and yield or any other monetary benefit from deposit substitutes
and from trust funds and similar arrangements and royalties derived from sources within
the Philippines shall be subject to a final income tax at the rate of twenty percent (20%)
of such interest: Provided, however, That interest income derived by a resident foreign
corporation from a depository bank under the expanded foreign currency deposit
system shall be subject to a final income tax at the rate of seven and one-half percent (7
1/2%) of such interest income. (Emphasis supplied)

This tax treatment of interest from bank deposits and yield from deposit substitutes was
first introduced in the 1977 National Internal Revenue Code through Presidential Decree
No. 1739168 issued in 1980. Later, Presidential Decree No. 1959, effective on October
15, 1984, formally added the definition of deposit substitutes, viz:

(y) ‘Deposit substitutes’ shall mean an alternative form of obtaining funds from the
public, other than deposits, through the issuance, endorsement, or acceptance of debt
instruments for the borrower's own account, for the purpose of relending or purchasing
of receivables and other obligations, or financing their own needs or the needs of their
agent or dealer.These promissory notes, repurchase agreements, certificates of
assignment or participation and similar instrument with recourse as may be authorized
by the Central Bank of the Philippines, for banks and non-bank financial intermediaries
or by the Securities and Exchange Commission of the Philippines for commercial,
industrial, finance companies and either non-financial companies: Provided, however,
that only debt instruments issued for inter-bank call loans to cover deficiency in reserves
against deposit liabilities including those between or among banks and quasi-banks
shall not be considered as deposit substitute debt instruments. (Emphasis supplied)

Revenue Regulations No. 17-84, issued to implement Presidential Decree No. 1959,
adopted verbatim the same definition and specifically identified the following borrowings
as "deposit substitutes":

SECTION 2. Definitions of Terms. . . .

(h) "Deposit substitutes" shall mean –

....

(a) All interbank borrowings by or among banks and non-bank financial

institutions authorized to engage in quasi-banking functions evidenced by deposit
substitutes instruments, except interbank call loans to cover deficiency in
reserves against deposit liabilities as evidenced by interbank loan advice or
repayment transfer tickets.

(b) All borrowings of the national and local government and its instrumentalities
including the Central Bank of the Philippines, evidenced by debt instruments
denoted as treasury bonds, bills, notes, certificates of indebtedness and similar
instruments.

(c) All borrowings of banks, non-bank financial intermediaries, finance

companies, investment companies, trust companies, including the trust
department of banks and investment houses, evidenced by deposit substitutes
instruments. (Emphasis supplied)

The definition of deposit substitutes was amended under the 1997 National Internal
Revenue Code with the addition of the qualifying phrase for public – borrowing from 20
or more individual or corporate lenders at any one time. Under Section 22(Y), deposit
substitute is defined thus: SEC. 22. Definitions- When used in this Title:

....

(Y) The term ‘deposit substitutes’ shall mean an alternative form of obtaining funds from
the public(the term 'public' means borrowing from twenty (20) or more individual or
corporate lenders at any one time) other than deposits, through the issuance,
endorsement, or acceptance of debt instruments for the borrower’s own account, for the
purpose of relending or purchasing of receivables and other obligations, or financing
their own needs or the needs of their agent or dealer. These instruments may include,
but need not be limited to, bankers’ acceptances, promissory notes, repurchase
agreements, including reverse repurchase agreements entered into by and between the
Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of
assignment or participation and similar instruments with recourse: Provided, however,
That debt instruments issued for interbank call loans with maturity of not more than five
(5) days to cover deficiency in reserves against deposit liabilities, including those
between or among banks and quasi-banks, shall not be considered as deposit
substitute debt instruments. (Emphasis supplied)

Under the 1997 National Internal Revenue Code, Congress specifically defined "public"
to mean "twenty (20) or more individual or corporate lenders at any one time." Hence,
the number of lenders is determinative of whether a debt instrument should be
considered a deposit substitute and consequently subject to the 20% final withholding
tax.

20-lender rule

Petitioners contend that "there [is]only one (1) lender (i.e. RCBC) to whom the BTr
issued the Government Bonds."169 On the other hand, respondents theorize that the
word "any" "indicates that the period contemplated is the entire term of the bond and not
merely the point of origination or issuance[,]"170 such that if the debt instruments "were
subsequently sold in secondary markets and so on, insuch a way that twenty (20) or
more buyers eventually own the instruments, then it becomes indubitable that funds
would be obtained from the "public" as defined in Section 22(Y) of the NIRC." 171 Indeed,
in the context of the financial market, the words "at any one time" create an ambiguity.

Financial markets

Financial markets provide the channel through which funds from the surplus units
(households and business firms that have savings or excess funds) flow to the deficit
units (mainly business firms and government that need funds to finance their operations
or growth). They bring suppliers and users of funds together and provide the means by
which the lenders transform their funds into financial assets, and the borrowers receive
these funds now considered as their financial liabilities. The transfer of funds is
represented by a security, such as stocks and bonds. Fund suppliers earn a return on
their investment; the return is necessary to ensure that funds are supplied to the
financial markets.172

"The financial markets that facilitate the transfer of debt securities are commonly
classified by the maturity of the securities[,]"173 namely: (1) the money market, which
facilitates the flow of short-term funds (with maturities of one year or less); and (2) the
capital market, which facilitates the flow of long-term funds (with maturities of more than
one year).174

Whether referring to money marketsecurities or capital market securities, transactions

occur either in the primary market or in the secondary market.175 "Primary markets
facilitate the issuance of new securities. Secondary markets facilitate the trading of
existing securities, which allows for a change in the ownership of the securities."176 The
transactions in primary markets exist between issuers and investors, while secondary
market transactions exist among investors.177

"Over time, the system of financial markets has evolved from simple to more complex
ways of carrying out financial transactions."178 Still, all systems perform one basic
function: the quick mobilization of money from the lenders/investors to the borrowers. 179

Fund transfers are accomplished in three ways: (1) direct finance; (2) semidirect
finance; and (3) indirect finance.180

With direct financing, the "borrower and lender meet each other and exchange funds in
returnfor financial assets"181(e.g., purchasing bonds directly from the company issuing
them). This method provides certain limitations such as: (a) "both borrower and lender
must desire to exchange the same amount of funds at the same time"[;]182 and (b) "both
lender and borrower must frequently incur substantial information costs simply to find
each other."183

In semidirect financing, a securities broker or dealer brings surplus and deficit units
together, thereby reducing information costs.184 A Broker185 is "an individual or financial
institution who provides information concerning possible purchases and sales of
securities. Either a buyer or a seller of securities may contact a broker, whose job is
simply to bring buyers and sellers together."186 A dealer187 "also serves as a middleman
between buyers and sellers, but the dealer actually acquires the seller’s securities in the
hope of selling them at a later time at a more favorable price."188 Frequently, "a dealer
will split up a large issue of primary securities into smaller units affordable by . . . buyers
. . . and thereby expand the flow of savings into investment."189 In semi direct financing,
"[t]he ultimate lender still winds up holding the borrower’s securities, and therefore the
lender must be willing to accept the risk, liquidity, and maturity characteristics of the
borrower’s [debt security]. There still must be a fundamental coincidence of wants and
needs between [lenders and borrowers] for semidirect financial transactions to take
place."190

"The limitations of both direct and semidirect finance stimulated the development of
indirect financial transactions, carried out with the help of financial intermediaries" 191 or
financial institutions, like banks, investment banks, finance companies, insurance
companies, and mutual funds.192 Financial intermediaries accept funds from surplus
units and channel the funds to deficit units.193 "Depository institutions [such as banks]
accept deposits from surplus units and provide credit to deficit units through loans and
purchase of [debt] securities."194 Nondepository institutions, like mutual funds, issue
securities of their own (usually in smaller and affordable denominations) to surplus units
and at the same time purchase debt securities of deficit units.195 "By pooling the
resources of[small savers, a financial intermediary] can service the credit needs of large
firms simultaneously."196
The financial market, therefore, is an agglomeration of financial transactions in
securities performed by market participants that works to transfer the funds from the
surplus units (or investors/lenders) to those who need them (deficit units or borrowers).

Meaning of "at any one time"

Thus, from the point of view of the financial market, the phrase "at any one time" for
purposes of determining the "20 or more lenders" would mean every transaction
executed in the primary or secondary market in connection with the purchase or sale of
securities.

For example, where the financial assets involved are government securities like bonds,
the reckoning of "20 or more lenders/investors" is made at any transaction in connection
with the purchase or sale of the Government Bonds, such as:

1. Issuance by the Bureau of Treasury of the bonds to GSEDs in the primary

market;

2. Sale and distribution by GSEDs to various lenders/investors in the secondary

market;

3. Subsequent sale or trading by a bondholder to another lender/investor in the

secondary market usually through a broker or dealer; or

4. Sale by a financial intermediary-bondholder of its participation interests in the

bonds to individual or corporate lenders in the secondary market.

When, through any of the foregoing transactions, funds are simultaneously obtained
from 20 or morelenders/investors, there is deemed to be a public borrowing and the
bonds at that point intime are deemed deposit substitutes. Consequently, the seller is
required to withhold the 20% final withholding tax on the imputed interest income from
the bonds.

For debt instruments that are

not deposit substitutes, regular
income tax applies

It must be emphasized, however, that debt instruments that do not qualify as deposit
substitutes under the 1997 National Internal Revenue Code are subject to the regular
income tax.

The phrase "all income derived from whatever source" in Chapter VI, Computation of
Gross Income, Section 32(A) of the 1997 National Internal Revenue Code discloses a
legislative policy to include all income not expressly exempted as within the class of
taxable income under our laws.
"The definition of gross income isbroad enough to include all passive incomes subject to
specific tax rates or final taxes."197 Hence, interest income from deposit substitutes are
necessarily part of taxable income. "However, since these passive incomes are already
subject to different rates and taxed finally at source, they are no longer included in the
computation of gross income, which determines taxable income." 198 "Stated otherwise .
. . if there were no withholding tax system in place in this country, this 20 percent portion
of the ‘passive’ income of [creditors/lenders] would actually be paid to the
[creditors/lenders] and then remitted by them to the government in payment of their
income tax."199

This court, in Chamber of Real Estate and Builders’ Associations, Inc. v.

Romulo,200 explained the rationale behind the withholding tax system:

The withholding [of tax at source] was devised for three primary reasons: first, to
provide the taxpayer a convenient manner to meet his probable income tax liability;
second, to ensure the collection of income tax which can otherwise be lost or
substantially reduced through failure to file the corresponding returns[;] and third, to
improve the government’s cash flow. This results in administrative savings, prompt and
efficient collection of taxes, prevention of delinquencies and reduction of governmental
effort to collect taxes through more complicated means and remedies. 201 (Citations
omitted)

"The application of the withholdings system to interest on bank deposits or yield from
deposit substitutes is essentially to maximize and expedite the collection of income
taxes by requiring its payment at the source."202

Hence, when there are 20 or more lenders/investors in a transaction for a specific bond
issue, the seller isrequired to withhold the 20% final income tax on the imputed interest
income from the bonds.

Interest income v. gains from sale or redemption

The interest income earned from bonds is not synonymous with the "gains"
contemplated under Section 32(B)(7)(g)203 of the 1997 National Internal Revenue Code,
which exempts gains derived from trading, redemption, or retirement of long-term
securities from ordinary income tax.

The term "gain" as used in Section 32(B)(7)(g) does not include interest, which
represents forbearance for the use of money. Gains from sale or exchange or
retirement of bonds orother certificate of indebtedness fall within the general category of
"gainsderived from dealings in property" under Section 32(A)(3), while interest from
bonds or other certificate of indebtedness falls within the category of "interests" under
Section 32(A)(4).204 The use of the term "gains from sale" in Section 32(B)(7)(g) shows
the intent of Congress not toinclude interest as referred under Sections 24, 25, 27, and
28 in the exemption.205
Hence, the "gains" contemplated in Section 32(B)(7)(g) refers to: (1) gain realized from
the trading of the bonds before their maturity date, which is the difference between the
selling price of the bonds in the secondary market and the price at which the bonds
were purchased by the seller; and (2) gain realized by the last holder of the bonds when
the bonds are redeemed at maturity, which is the difference between the proceeds from
the retirement of the bonds and the price atwhich such last holder acquired the bonds.
For discounted instruments,like the zero-coupon bonds, the trading gain shall be the
excess of the selling price over the book value or accreted value (original issue price
plus accumulated discount from the time of purchase up to the time of sale) of the
instruments.206

The Bureau of Internal

Revenue rulings

The Bureau of Internal Revenue’s interpretation as expressed in the three 2001 BIR
Rulings is not consistent with law.207 Its interpretation of "at any one time" to mean at
the point of origination alone is unduly restrictive.

BIR Ruling No. 370-2011 is likewise erroneous insofar as it stated (relying on the 2004
and 2005 BIR Rulings) that "all treasury bonds . . . regardlessof the number of
purchasers/lenders at the time of origination/issuance are considered deposit
substitutes."208 Being the subject of this petition, it is, thus, declared void because it
completely disregarded the 20 or more lender rule added by Congress in the 1997
National Internal Revenue Code. It also created a distinction for government debt
instruments as against those issued by private corporations when there was none in the
law.

Tax statutes must be reasonably construed as to give effect to the whole act. Their
constituent provisions must be read together, endeavoring to make every part effective,
harmonious, and sensible.209 That construction which will leave every word operative
will be favored over one that leaves some word, clause, or sentence meaningless and
insignificant.210

It may be granted that the interpretation of the Commissioner of Internal Revenue in

charge of executing the 1997 National Internal Revenue Code is an authoritative
construction ofgreat weight, but the principle is not absolute and may be overcome by
strong reasons to the contrary. If through a misapprehension of law an officer has
issued an erroneous interpretation, the error must be corrected when the true
construction is ascertained.

In Philippine Bank of Communications v. Commissioner of Internal Revenue,211 this

court upheld the nullification of Revenue Memorandum Circular (RMC) No. 7-85 issued
by the Acting Commissioner of Internal Revenue because it was contrary to the express
provision of Section 230 of the 1977 National Internal Revenue Codeand, hence,
"[cannot] be given weight for to do so would, in effect, amend the statute." 212 Thus:
When the Acting Commissioner of Internal Revenue issued RMC 7-85, changing the
prescriptive period of two years to ten years on claims of excess quarterly income tax
payments, such circular created a clear inconsistency with the provision of Sec. 230 of
1977 NIRC. In so doing, the BIR did not simply interpret the law; rather it legislated
guidelines contrary to the statute passed by Congress.

It bears repeating that Revenue memorandum-circulars are considered administrative

rulings (in the sense of more specific and less general interpretations of tax laws) which
are issued from time to time by the Commissioner of Internal Revenue. It is widely
accepted that the interpretation placed upon a statute by the executive officers, whose
duty is to enforce it, is entitled to great respect by the courts. Nevertheless, such
interpretation is not conclusive and will be ignored if judicially found to be erroneous.
Thus, courts will not countenance administrative issuances that override, instead of
remaining consistent and in harmony with, the law they seek to apply and
implement.213(Citations omitted)

This court further held that "[a] memorandum-circular of a bureau head could not
operate to vest a taxpayer with a shield against judicial action [because] there are no
vested rights to speak of respecting a wrong construction of the law by the
administrative officials and such wrong interpretation could not place the Government in
estoppel to correct or overrule the same."214 In Commissioner of Internal Revenue v.
Michel J. Lhuillier Pawnshop, Inc.,215 this court nullified Revenue Memorandum Order
(RMO) No. 15-91 and RMC No. 43-91, which imposed a 5% lending investor's tax on
pawnshops.216 It was held that "the [Commissioner] cannot, in the exercise of [its
interpretative] power, issue administrative rulings or circulars not consistent with the law
sought to be applied. Indeed, administrative issuances must not override, supplant or
modify the law, but must remain consistent with the law they intend to carry out. Only
Congress can repeal or amend the law."217

In Misamis Oriental Association of Coco Traders, Inc. v. Department of Finance

Secretary,218 this court stated that the Commissioner of Internal Revenue is not bound
by the ruling of his predecessors,219 but, to the contrary, the overruling of decisions is
inherent in the interpretation of laws:

[I]n considering a legislative rule a court is free to make three inquiries: (i) whether the
rule is within the delegated authority of the administrative agency; (ii) whether itis
reasonable; and (iii) whether it was issued pursuant to proper procedure. But the court
is not free to substitute its judgment as to the desirability or wisdom of the rule for the
legislative body, by its delegation of administrative judgment, has committed those
questions to administrative judgments and not to judicial judgments. In the case of an
interpretative rule, the inquiry is not into the validity but into the correctness or propriety
of the rule. As a matter of power a court, when confronted with an interpretative rule, is
free to (i) give the force of law to the rule; (ii) go to the opposite extreme and substitute
its judgment; or (iii) give some intermediate degree of authoritative weight to the
interpretative rule.
In the case at bar, we find no reason for holding that respondent Commissioner erred in
not considering copra as an "agricultural food product" within the meaning of § 103(b) of
the NIRC. As the Solicitor General contends, "copra per se is not food, that is, it is not
intended for human consumption. Simply stated, nobody eats copra for food." That
previous Commissioners considered it so, is not reason for holding that the present
interpretation is wrong. The Commissioner of Internal Revenue is not bound by the
ruling of his predecessors. To the contrary, the overruling of decisions is inherent in the
interpretation of laws.220 (Emphasis supplied, citations omitted)

Tax treatment of income

derived from the PEACe Bonds

The transactions executed for the sale of the PEACe Bonds are:

1. The issuance of the 35 billion Bonds by the Bureau of Treasury to

RCBC/CODE-NGO at 10.2 billion; and

2. The sale and distribution by RCBC Capital (underwriter) on behalf of CODE-

NGO of the PEACe Bonds to undisclosed investors at ₱11.996 billion.

It may seem that there was only one lender — RCBC on behalf of CODE-NGO — to
whom the PEACe Bonds were issued at the time of origination. However, a reading of
the underwriting agreement221 and RCBC term sheet222reveals that the settlement dates
for the sale and distribution by RCBC Capital (as underwriter for CODE-NGO) of the
PEACe Bonds to various undisclosed investors at a purchase price of approximately
₱11.996 would fall on the same day, October 18, 2001, when the PEACe Bonds were
supposedly issued to CODE-NGO/RCBC. In reality, therefore, the entire ₱10.2 billion
borrowing received by the Bureau of Treasury in exchange for the ₱35 billion worth of
PEACe Bonds was sourced directly from the undisclosed number of investors to whom
RCBC Capital/CODE-NGO distributed the PEACe Bonds — all at the time of origination
or issuance. At this point, however, we do not know as to how many investors the
PEACe Bonds were sold to by RCBC Capital.

Should there have been a simultaneous sale to 20 or more lenders/investors, the

PEACe Bonds are deemed deposit substitutes within the meaning of Section 22(Y) of
the 1997 National Internal Revenue Code and RCBC Capital/CODE-NGO would have
been obliged to pay the 20% final withholding tax on the interest or discount from the
PEACe Bonds. Further, the obligation to withhold the 20% final tax on the
corresponding interest from the PEACe Bonds would likewise be required of any
lender/investor had the latter turnedaround and sold said PEACe Bonds, whether in
whole or part, simultaneously to 20 or more lenders or investors.

We note, however, that under Section 24223 of the 1997 National Internal Revenue
Code, interest income received by individuals from longterm deposits or investments
with a holding period of not less than five (5) years is exempt from the final tax.
Thus, should the PEACe Bonds be found to be within the coverage of deposit
substitutes, the proper procedure was for the Bureau of Treasury to pay the face value
of the PEACe Bonds to the bondholders and for the Bureau of Internal Revenue to
collect the unpaid final withholding tax directly from RCBC Capital/CODE-NGO, orany
lender or investor if such be the case, as the withholding agents.

The collection of tax is not

barred by prescription

The three (3)-year prescriptive period under Section 203 of the 1997 National Internal
Revenue Code to assess and collect internal revenue taxes is extended to 10 years in
cases of (1) fraudulent returns; (2) false returns with intent to evade tax; and (3) failureto
file a return, to be computed from the time of discovery of the falsity, fraud, or omission.
Section 203 states:

SEC. 203. Period of Limitation Upon Assessment and Collection. - Except as provided
in Section 222, internal revenue taxes shall be assessed within three (3) years after the
last day prescribed by law for the filing of the return, and no proceeding in court without
assessment for the collection of such taxes shall be begun after the expiration of such
period: Provided, That in a case where a return is filed beyond the period prescribed by
law, the three (3)-year period shall be counted from the day the return was filed. For
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. (Emphasis supplied)

....

SEC. 222. Exceptions as to Period of Limitation of Assessment and Collection of Taxes.

(a) In the case of a false or fraudulent return with intent to evade tax or of failure to file a
return, the tax may be assessed, or a proceeding in court for the collection of such tax
may be filed without assessment, at any time within ten (10) years after the discovery of
the falsity, fraud or omission: Provided, That in a fraud assessment which has become
final and executory, the fact of fraud shall be judicially taken cognizance of in the civil or
criminal action for the collection thereof.

Thus, should it be found that RCBC Capital/CODE-NGO sold the PEACe Bonds to 20
or more lenders/investors, the Bureau of Internal Revenue may still collect the unpaid
tax from RCBC Capital/CODE-NGO within 10 years after the discovery of the omission.

In view of the foregoing, there is no need to pass upon the other issues raised by
petitioners and petitioners-intervenors.

Reiterative motion on the temporary restraining order

Respondents’ withholding of the
20% final withholding tax on
October 18, 2011 was justified

Under the Rules of Court, court orders are required to be "served upon the parties
affected."224 Moreover, service may be made personally or by mail.225 And, "[p]ersonal
service is complete upon actual delivery [of the order.]" 226This court’s temporary
restraining order was received only on October 19, 2011, or a day after the PEACe
Bonds had matured and the 20% final withholding tax on the interest income from the
same was withheld.

Publication of news reports in the print and broadcast media, as well as on the internet,
is not a recognized mode of service of pleadings, court orders, or processes. Moreover,
the news reports227 cited by petitioners were posted minutes before the close of office
hours or late in the evening of October 18, 2011, and they did not givethe exact
contents of the temporary restraining order.

"[O]ne cannot be punished for violating an injunction or an order for an injunction unless
it is shown that suchinjunction or order was served on him personally or that he had
notice of the issuance or making of such injunction or order." 228

At any rate, "[i]n case of doubt, a withholding agent may always protect himself or
herself by withholding the tax due"229 and return the amount of the tax withheld should it
be finally determined that the income paid is not subject to withholding. 230 Hence,
respondent Bureau of Treasury was justified in withholding the amount corresponding to
the 20% final withholding tax from the proceeds of the PEACe Bonds, as it received this
court’s temporary restraining order only on October 19, 2011, or the day after this tax
had been withheld.

Respondents’ retention of the

amounts withheld is a defiance
of the temporary restraining
order

Nonetheless, respondents’ continued failure to release to petitioners the amount

corresponding to the 20% final withholding tax in order that it may be placed in escrow
as directed by this court constitutes a defiance of this court’s temporary restraining
order.231

The temporary restraining order is not moot. The acts sought to be enjoined are not fait
accompli. For an act to be considered fait accompli, the act must have already been
fully accomplished and consummated.232 It must be irreversible, e.g., demolition of
properties,233 service of the penalty of imprisonment,234 and hearings on cases.235When
the act sought to be enjoined has not yet been fully satisfied, and/or is still continuing in
nature,236 the defense of fait accomplicannot prosper.
The temporary restraining order enjoins the entire implementation of the 2011 BIR
Ruling that constitutes both the withholding and remittance of the 20% final withholding
tax to the Bureau of Internal Revenue. Even though the Bureau of Treasury had already
withheld the 20% final withholding tax237 when it received the temporary restraining
order, it had yet to remit the monies it withheld to the Bureau of Internal Revenue, a
remittance which was due only on November 10, 2011.238 The act enjoined by the
temporary restraining order had not yet been fully satisfied and was still continuing.

Under DOF-DBM Joint Circular No. 1-2000A239 dated July 31, 2001 which prescribes to
national government agencies such as the Bureau of Treasury the procedure for the
remittance of all taxes it withheld to the Bureau of Internal Revenue, a national agency
shall file before the Bureau of Internal Revenue a Tax Remittance Advice (TRA)
supported by withholding tax returns on or before the 10th day of the following month
after the said taxes had been withheld.240 The Bureau of Internal Revenue shall transmit
an original copy of the TRA to the Bureau of Treasury,241which shall be the basis for
recording the remittance of the tax collection.242 The Bureau of Internal Revenue will
then record the amount of taxes reflected in the TRA as tax collection in the Journal
ofTax Remittance by government agencies based on its copies of the
TRA.243 Respondents did not submit any withholding tax return or TRA to provethat the
20% final withholding tax was indeed remitted by the Bureau of Treasury to the Bureau
of Internal Revenue on October 18, 2011.

Respondent Bureau of Treasury’s Journal Entry Voucher No. 11-10-10395244 dated

October 18, 2011 submitted to this court shows:

Account Debit Amount Credit

Code Amount
Bonds Payable-L/T, Dom-Zero 442-360 35,000,000,000.00
Coupon T/Bonds
(Peace Bonds) – 10 yr
Sinking Fund-Cash (BSF) 198-001 30,033,792,203.59
Due to BIR 412-002 4,966,207,796.41
To record redemption of 10yr Zero
coupon (Peace Bond) net of the 20%
final
withholding tax pursuant to BIR
Ruling No.
378-2011, value date, October 18,
2011 per
BTr letter authority and BSP Bank
Statements.
The foregoing journal entry, however, does not prove that the amount of
₱4,966,207,796.41, representing the 20% final withholding tax on the PEACe Bonds,
was disbursed by it and remitted to the Bureau of Internal Revenue on October 18,
2011. The entries merely show that the monies corresponding to 20% final withholding
tax was set aside for remittance to the Bureau of Internal Revenue.

We recall the November 15, 2011 resolution issued by this court directing respondents
to "show cause why they failed to comply with the [TRO]; and [to] comply with the [TRO]
in order that petitioners may place the corresponding funds in escrow pending
resolution of the petition."245 The 20% final withholding tax was effectively placed in
custodia legiswhen this court ordered the deposit of the amount in escrow. The Bureau
of Treasury could still release the money withheld to petitioners for the latter to place in
escrow pursuant to this court’s directive. There was no legal obstacle to the release of
the 20% final withholding tax to petitioners. Congressional appropriation is not required
for the servicing of public debts in view of the automatic appropriations clause embodied
in Presidential Decree Nos. 1177 and 1967.

Section 31 of Presidential Decree No. 1177 provides:

Section 31. Automatic Appropriations. All expenditures for (a) personnel retirement
premiums, government service insurance, and other similar fixed expenditures, (b)
principal and interest on public debt, (c) national government guarantees of obligations
which are drawn upon, are automatically appropriated: provided, that no obligations
shall be incurred or payments made from funds thus automatically appropriated except
as issued in the form of regular budgetary allotments.

Section 1 of Presidential Decree No. 1967 states:

Section 1. There is hereby appropriated, out of any funds in the National Treasury not
otherwise appropriated, such amounts as may be necessary to effect payments on
foreign or domestic loans, or foreign or domestic loans whereon creditors make a call
on the direct and indirect guarantee of the Republic of the Philippines, obtained by:

a. the Republic of the Philippines the proceeds of which were relent to

government-owned or controlled corporations and/or government financial
institutions;

b. government-owned or controlled corporations and/or government financial

institutions the proceeds of which were relent to public or private institutions;

c. government-owned or controlled corporations and/or financial institutions and

guaranteed by the Republic of the Philippines;

d. other public or private institutions and guaranteed by government owned or

controlled corporations and/or government financial institutions.
The amount of ₱35 billion that includes the monies corresponding to 20% final
withholding tax is a lawfuland valid obligation of the Republic under the Government
Bonds. Since said obligation represents a public debt, the release of the monies
requires no legislative appropriation.

Section 2 of Republic Act No. 245 likewise provides that the money to be used for the
payment of Government Bonds may be lawfully taken from the continuing appropriation
out of any monies in the National Treasury and is not required to be the subject of
another appropriation legislation: SEC. 2. The Secretary of Finance shall cause to be
paid out of any moneys in the National Treasury not otherwise appropriated, or from any
sinking funds provided for the purpose by law, any interest falling due, or accruing, on
any portion of the public debt authorized by law. He shall also cause to be paid out of
any such money, or from any such sinking funds the principal amount of any obligations
which have matured, or which have been called for redemption or for which redemption
has been demanded in accordance with terms prescribed by him prior to date of issue. .
. In the case of interest-bearing obligations, he shall pay not less than their face value;
in the case of obligations issued at a discount he shall pay the face value at maturity; or
if redeemed prior to maturity, such portion of the face value as is prescribed by the
terms and conditions under which such obligations were originally issued. There are
hereby appropriated as a continuing appropriation out of any moneys in the National
Treasury not otherwise appropriated, such sums as may be necessary from time to time
to carry out the provisions of this section. The Secretary of Finance shall transmit to
Congress during the first month of each regular session a detailed statement of all
expenditures made under this section during the calendar year immediately preceding.

Thus, DOF Department Order No. 141-95, as amended, states that payment for
Treasury bills and bonds shall be made through the National Treasury’s account with
the Bangko Sentral ng Pilipinas, to wit:

Section 38. Demand Deposit Account.– The Treasurer of the Philippines maintains a
Demand Deposit Account with the Bangko Sentral ng Pilipinas to which all proceeds
from the sale of Treasury Bills and Bonds under R.A. No. 245, as amended, shall be
credited and all payments for redemption of Treasury Bills and Bonds shall be
charged.1âwphi1

Regarding these legislative enactments ordaining an automatic appropriations provision

for debt servicing, this court has held:

Congress . . . deliberates or acts on the budget proposals of the President, and

Congress in the exercise of its own judgment and wisdom formulates an appropriation
act precisely following the process established by the Constitution, which specifies that
no money may be paid from the Treasury except in accordance with an appropriation
made by law.

Debt service is not included inthe General Appropriation Act, since authorization
therefor already exists under RA Nos. 4860 and 245, as amended, and PD 1967.
Precisely in the light of this subsisting authorization as embodied in said Republic Acts
and PD for debt service, Congress does not concern itself with details for
implementation by the Executive, butlargely with annual levels and approval thereof
upon due deliberations as part of the whole obligation program for the year. Upon such
approval, Congress has spoken and cannot be said to havedelegated its wisdom to the
Executive, on whose part lies the implementation or execution of the legislative
wisdom.246 (Citation omitted)

Respondent Bureau of Treasury had the duty to obey the temporary restraining order
issued by this court, which remained in full force and effect, until set aside, vacated, or
modified. Its conduct finds no justification and is reprehensible.247

WHEREFORE, the petition for review and petitions-in-intervention are GRANTED. BIR
Ruling Nos. 370-2011 and DA 378-2011 are NULLIFIED.

Furthermore, respondent Bureau of Treasury is REPRIMANDED for its continued

retention of the amount corresponding to the 20% final withholding tax despite this
court's directive in the temporary restraining order and in the resolution dated November
15, 2011 to deliver the amounts to the banks to be placed in escrow pending resolution
of this case.

Respondent Bureau of Treasury is hereby ORDERED to immediately ·release and pay

to the bondholders the amount corresponding-to the 20% final withholding tax that it
withheld on October 18, 2011.

MARVIC M.V.F. LEONEN

Associate Justice

WE CONCUR:
G.R. No. 175410 November 12, 2014

SMI-ED PHILIPPINES TECHNOLOGY, INC., Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

DECISION

LEONEN, J.:

In an action for the refund of taxes allegedly erroneously paid, the Court of Tax Appeals
may determine whether there are taxes that should have been paid in lieu of the taxes
paid. Determining the proper category of tax that should have been paid is not an
assessment. It is incidental to determining whether there should be a refund.

A Philippine Economic Zone Authority (PEZA)-registered corporation that has never

commenced operations may not avail the tax incentives and preferential rates given to
PEZA-registered enterprises. Such corporation is subject to ordinary tax rates under the
National Internal Revenue Code of 1997.

This is a petition for review1 on certiorari of the November 3, 2006 Court of Tax Appeals
En Banc decision.2 It affirmed the Court of Tax Appeals Second Division’s decision 3 and
resolution4 denying petitioner SMI-Ed Philippines Technology, Inc.’s (SMI-Ed
Philippines) claim for tax refund.5

SMI-Ed Philippines is a PEZA-registered corporation authorized "to engage in the

business of manufacturing ultra high-density microprocessor unit package."6

After its registration on June 29, 1998, SMI-Ed Philippines constructed buildings and
purchased machineries and equipment.7 As of December 31, 1999, the total cost of the
properties amounted to ₱3,150,925,917.00.8

SMI-Ed Philippines "failed to commence operations."9 Its factory was temporarily

closed, effective October 15, 1999. On August 1, 2000, it sold its buildings and some of
its installed machineries and equipment to Ibiden Philippines, Inc., another PEZA-
registered enterprise, for ¥2,100,000,000.00 (₱893,550,000.00). SMI-Ed Philippines
was dissolved on November 30, 2000.10

In its quarterly income tax return for year 2000, SMI-Ed Philippines subjected the entire
gross sales of itsproperties to 5% final tax on PEZA registered corporations. SMI-Ed
Philippines paid taxes amounting to ₱44,677,500.00. 11
On February 2, 2001, after requesting the cancellation of its PEZA registration and
amending its articles of incorporation to shorten its corporate term, SMI-Ed Philippines
filed an administrative claim for the refund of ₱44,677,500.00 with the Bureauof Internal
Revenue (BIR). SMIEd Philippines alleged that the amountwas erroneously paid. It also
indicated the refundable amount in its final income tax return filed on March 1, 2001. It
also alleged that it incurred a net loss of ₱2,233,464,538.00.12

The BIR did not act on SMI-Ed Philippines’ claim, which prompted the latter to file a
petition for reviewbefore the Court of Tax Appeals on September 9, 2002. 13

The Court of Tax Appeals Second Division denied SMI-Ed Philippines’ claim for refund
in the decision dated December 29, 2004.14

The Court of Tax Appeals Second Division found that SMI-Ed Philippines’ administrative
claim for refund and the petition for review with the Court of Tax Appeals were filed
within the two-year prescriptive period.15 However, fiscal incentives given to PEZA-
registered enterprises may be availed only by PEZA-registered enterprises that had
already commenced operations.16 Since SMI-Ed Philippines had not commenced
operations, it was not entitled to the incentives of either the income tax holiday or the
5% preferential tax rate.17 Payment of the 5% preferential tax amounting to
₱44,677,500.00 was erroneous.18

After finding that SMI-Ed Philippines sold properties that were capital assets under
Section 39(A)(1) of the National Internal Revenue Code of 1997, the Court of Tax
Appeals Second Division subjected the sale of SMIEd Philippines’ assets to 6% capital
gains tax under Section 27(D)(5) of the same Code and Section 2 of Revenue
Regulations No. 8-98.19 It was found liable for capital gains tax amounting to
₱53,613,000.00.20 Therefore, SMIEd Philippines must still pay the balance of
₱8,935,500.00 as deficiency tax,21 "which respondent should perhaps look into."22 The
dispositive portion of the Court of Tax Appeals Second Division’s decision reads:

WHEREFORE, premises considered, the instant petition is hereby DENIED.

SO ORDERED.23

The Court of Tax Appeals denied SMI-Ed Philippines’ motion for reconsideration in its
June 15, 2005 resolution.24

On July 17, 2005, SMI-Ed Philippines filed a petition for review before the Court of Tax
Appeals En Banc.25 It argued that the Court of Tax Appeals Second Division
erroneously assessed the 6% capital gains tax on the sale of SMI-Ed Philippines’
equipment, machineries, and buildings.26 It also argued that the Court of Tax Appeals
Second Division cannot make an assessment at the first instance. 27 Even if the Court of
Tax Appeals Second Division has such power, the period to make an assessment had
already prescribed.28
In the decision promulgated on November 3, 2006, the Court of Tax Appeals En Banc
dismissed SMI-Ed Philippines’ petition and affirmed the Court of Tax Appeals Second
Division’s decision and resolution.29 The dispositive portion of the Court of Tax Appeals
En Banc’s decision reads:

WHEREFORE, finding no reversible error to reverse the assailed Decision promulgated

on December 29, 2004 and the Resolution dated June 15, 2005, the instant petition for
review is hereby DISMISSED. Accordingly, the assailed Decision and Resolution are
hereby AFFIRMED. SO ORDERED.30

SMI-Ed Philippines filed a petition for review before this court on December 27,
2006,31 praying for the grant of its claim for refund and the reversal of the Court of Tax
Appeals En Banc’s decision.32

SMI-Ed Philippines assigned the following errors:

A. The honorable CTA En Banc grievously erred and acted beyond its jurisdiction
when it assessed for deficiency tax in the first instance.

B. Even assuming that the honorable CTA En Banc has the right to make an
assessment against the petitioner-appellant, it grievously erred in finding that the
machineries and equipment sold by the petitioner-appellant is subject to the six
percent (6%) capital gains tax under Section 27(D)(5) of the Tax Code. 33

Petitioner argued that the Court of Tax Appeals has no jurisdiction to make an
assessment since its jurisdiction, with respect to the decisions of respondent, is merely
appellate.34 Moreover, the power to make assessment had already prescribed under
Section 203 of the National Internal Revenue Code of 1997 since the return for the
erroneous payment was filed on September 13, 2000. This is more than three (3) years
from the last day prescribed by law for the filing of the return.35

Petitioner also argued that the Court of Tax Appeals En Banc erroneously subjected
petitioner’s machineries to 6% capital gains tax.36 Section 27(D)(5) of the National
Internal Revenue Code of 1997 is clear that the 6% capital gains tax on domestic
corporations applies only on the sale of lands and buildings and not tomachineries and
equipment.37 Since ¥1,700,000,000.00 of the ¥2,100,000,000.00 constituted the
consideration for the sale of petitioner’s machineries, only ¥400,000,000.00 or
₱170,200,000.00 should be subjected to the 6% capital gains tax. 38 Petitioner should be
liable only for ₱10,212,000.00.39 It should be entitled to a refund of ₱34,464,500.00 after
deducting ₱10,212,000.00 from the erroneously paid final tax of ₱44,677,500.00.40

In its comment, respondent argued that the Court of Tax Appeals’ determination of
petitioner’s liability for capital gains tax was not an assessment. Such determination was
necessary to settle the question regarding the tax consequence of the sale of the
properties.41 This is clearly within the Court of Tax Appeals’ jurisdiction under Section 7
of Republic Act No. 9282.42 Respondent also argued that "petitioner failed to justify its
claim for refund."43

The petition is meritorious.

Jurisdiction of the Court of Tax Appeals

The term "assessment" refers to the determination of amounts due from a person
obligated to make payments. In the context of national internal revenue collection, it
refers the determination of the taxes due from a taxpayer under the National Internal
Revenue Code of 1997.

The power and duty to assess national internal revenue taxes are lodged with the
BIR.44 Section 2 of the National Internal Revenue Code of 1997 provides:

SEC. 2. Powers and Duties of the Bureau of Internal Revenue. - The Bureau of Internal
Revenue shall be under the supervision and control of the Department of Finance and
its powers and duties shall comprehend the assessment and collection ofall national
internal revenue taxes, fees, and charges, and the enforcement of all forfeitures,
penalties, and fines connected therewith, including the execution of judgments in all
cases decided in its favor by the Court of Tax Appeals and the ordinary courts. The
Bureau shall give effect to and administer the supervisory and police powers conferred
to it by this Code or other laws. (Emphasis supplied) The BIR is not mandated to make
an assessment relative to every return filed with it. Tax returns filed with the BIR enjoy
the presumption that these are in accordance with the law.45 Tax returns are also
presumed correct since these are filed under the penalty of perjury. 46Generally,
however, the BIR assesses taxes when it appears, after a return had been filed, that the
taxes paid were incorrect,47 false,48 or fraudulent.49 The BIR also assesses taxes when
taxes are due but no return is filed.50 Thus:

SEC. 6. Power of the Commissioner to Make assessments and Prescribe additional

Requirements for Tax Administration and Enforcement.–

(A) Examination of Returns and Determination of Tax Due. - After a return has been
filed as required under the provisions of this Code, the Commissioner or his duly
authorized representative may authorize the examination of any taxpayer and the
assessment of the correct amount of tax: Provided, however; That failure to file a return
shall not prevent the Commissioner from authorizing the examination of any
taxpayer.The tax or any deficiency tax so assessed shall be paid upon notice and
demand from the Commissioner or from his duly authorized representative.

....

SEC. 222. Exceptions as to Period of Limitation of Assessment and Collection of Taxes.

(a) In the case of a false or fraudulent return with intent to evade tax or of failure to file a
return, the tax may be assessed, or a preceeding in court for the collection of such tax
may be filed without assessment, at any time within ten (10) years after the discovery of
the falsity, fraud or omission: Provided, That in a fraud assessment which has become
final and executory, the fact of fraud shall be judicially taken cognizance of in the civil or
criminal action for the collection thereof. (Emphasis supplied)

The Court of Tax Appeals has no powerto make an assessment at the first instance. On
matters such as tax collection, tax refund, and others related to the national internal
revenue taxes, the Court of Tax Appeals’ jurisdiction is appellate in nature.

Section 7(a)(1) and Section 7(a)(2) of Republic Act No. 1125,51 as amended by
Republic Act No. 9282,52 provide that the Court of Tax Appeals reviews decisions and
inactions of the Commissioner of Internal Revenue in disputed assessments and claims
for tax refunds. Thus: SEC. 7. Jurisdiction.- The CTA shall exercise:

a. Exclusive appellate jurisdiction toreview by appeal, as herein provided:

1. Decisions of the Commissioner of Internal Revenue in cases involving

disputed assessments, refunds of internal revenue taxes, fees or other charges,
penalties in relation thereto, or other matters arising under the National Internal
Revenue or other laws administered by the Bureau of Internal Revenue;

2. Inaction by the Commissioner of Internal Revenue in cases involving disputed

assessments, refunds of internal revenue taxes, fees or other charges, penalties
in relations thereto, or other matters arising under the National Internal Revenue
Code or other laws administered by the Bureau of Internal Revenue, where the
National Internal Revenue Code provides a specific period of action, in which
case the inaction shall be deemed a denial[.] (Emphasis supplied) Based on
these provisions, the following must be present for the Court of Tax Appeals to
have jurisdiction over a case involving the BIR’s decisions or inactions:

a) A case involving any of the following:

i. Disputed assessments;

ii. Refunds of internal revenue taxes, fees, or other charges,

penalties in relation thereto; and

iii. Other matters arising under the National Internal Revenue Code
of 1997.

b) Commissioner of Internal Revenue’s decision or inaction in a case

submitted to him or her
Thus, the BIR first has to make an assessment of the taxpayer’s liabilities. When the
BIR makes the assessment, the taxpayer is allowed to dispute that assessment before
the BIR. If the BIR issues a decision that is unfavorable to the taxpayer or if the BIR fails
to act on a dispute brought by the taxpayer, the BIR’s decision or inaction may be
brought on appeal to the Court of Tax Appeals. The Court of Tax Appeals then acquires
jurisdiction over the case.

When the BIR’s unfavorable decision is brought on appeal to the Court of Tax Appeals,
the Court of Tax Appeals reviews the correctness of the BIR’s assessment and
decision. In reviewing the BIR’s assessment and decision, the Court of Tax Appeals had
to make its own determination of the taxpayer’s tax liabilities. The Court of Tax Appeals
may not make such determination before the BIR makes its assessment and before a
dispute involving such assessment is brought to the Court of Tax Appeals on appeal.

The Court of Tax Appeals’ jurisdiction is not limited to cases when the BIR makes an
assessment or a decision unfavorable to the taxpayer. Because Republic Act No.
112553 also vests the Court of Tax Appeals with jurisdiction over the BIR’s inaction on a
taxpayer’s refund claim, there may be instances when the Court of Tax Appeals has to
take cognizance of cases that have nothing to do with the BIR’s assessments or
decisions. When the BIR fails to act on a claim for refund of voluntarily but mistakenly
paid taxes, for example, there is no decision or assessment involved.

Taxes are generally self-assessed. They are initially computed and voluntarily paid by
the taxpayer. The government does not have to demand it. If the tax payments are
correct, the BIR need not make an assessment.

The self-assessing and voluntarily paying taxpayer, however, may later find that he or
she has erroneously paid taxes. Erroneously paid taxes may come in the form of
amounts thatshould not have been paid. Thus, a taxpayer may find that he or she has
paid more than the amount that should have been paid under the law. Erroneously paid
taxes may also come in the form of tax payments for the wrong category of tax. Thus, a
taxpayer may find that he or she has paid a certain kindof tax that he or she is not
subject to.

In these instances, the taxpayer may ask for a refund. If the BIR fails to act on the
request for refund, the taxpayer may bring the matter to the Court of Tax Appeals.

From the taxpayer’s self-assessment and tax payment up to his or her request for
refund and the BIR’s inaction,the BIR’s participation is limited to the receipt of the
taxpayer’s payment. The BIR does not make an assessment; the BIR issues no
decision; and there is no dispute yet involved. Since there is no BIR assessment yet,
the Court of Tax Appeals may not determine the amount of taxes due from the taxpayer.
There is also no decision yet to review. However, there was inaction on the part of the
BIR. That inaction is within the Court of Tax Appeals’ jurisdiction.
In other words, the Court of Tax Appeals may acquire jurisdiction over cases even if
they do not involve BIR assessments or decisions.

In this case, the Court of Tax Appeals’ jurisdiction was acquired because petitioner
brought the case on appeal before the Court of Tax Appeals after the BIR had failed to
act on petitioner’s claim for refund of erroneously paid taxes. The Court of Tax Appeals
did not acquire jurisdiction as a result of a disputed assessment of a BIR decision.

Petitioner argued that the Court of Tax Appeals had no jurisdiction to subject it to 6%
capital gains tax or other taxes at the first instance. The Court of Tax Appeals has no
power to make an assessment.

As earlier established, the Court of Tax Appeals has no assessment powers. In stating
that petitioner’s transactions are subject to capital gains tax, however, the Court of Tax
Appeals was not making an assessment. It was merely determining the proper category
of tax that petitioner should have paid, in view of its claim that it erroneously imposed
upon itself and paid the 5% final tax imposed upon PEZA-registered enterprises.

The determination of the proper category of tax that petitioner should have paid is an
incidental matter necessary for the resolution of the principal issue, which is whether
petitioner was entitled to a refund.54

The issue of petitioner’s claim for tax refund is intertwined with the issue of the proper
taxes that are due from petitioner. A claim for tax refund carries the assumption that the
tax returns filed were correct.55 If the tax return filed was not proper, the correctness of
the amount paid and, therefore, the claim for refund become questionable. In that case,
the court must determine if a taxpayer claiming refund of erroneously paid taxes is more
properly liable for taxes other than that paid.

In South African Airways v. Commissioner of Internal Revenue,56 South African Airways

claimed for refund of its erroneously paid 2½% taxes on its gross Philippine billings.
This court did not immediately grant South African’s claim for refund. This is because
although this court found that South African Airways was not subject to the 2½% tax on
its gross Philippine billings, this court also found that it was subject to 32% tax on its
taxable income.57

In this case, petitioner’s claim that it erroneously paid the 5% final tax is an admission
that the quarterly tax return it filed in 2000 was improper. Hence, to determine if
petitioner was entitled to the refund being claimed, the Court of Tax Appeals has the
duty to determine if petitioner was indeed not liable for the 5% final tax and, instead,
liable for taxes other than the 5% final tax. As in South African Airways, petitioner’s
request for refund can neither be granted nor denied outright without such
determination.58
If the taxpayer is found liable for taxes other than the erroneously paid 5% final tax, the
amount of the taxpayer’s liability should be computed and deducted from the refundable
amount.

Any liability in excess of the refundable amount, however, may not be collected in a
case involving solely the issue of the taxpayer’s entitlement to refund. The question of
tax deficiencyis distinct and unrelated to the question of petitioner’s entitlement to
refund. Tax deficiencies should be subject to assessment procedures and the rules of
prescription. The court cannot be expected to perform the BIR’s duties whenever it fails
to do so either through neglect or oversight. Neither can court processes be used as a
tool to circumvent laws protecting the rights of taxpayers.

II

Petitioner’s entitlement to benefits given to PEZA-registered enterprises

Petitioner is not entitled to benefits given to PEZA-registered enterprises, including the

5% preferential tax rate under Republic Act No. 7916 or the Special Economic Zone Act
of 1995. This is because it never began its operation.

Essentially, the purpose of Republic Act No. 7916 is to promote development and
encourage investments and business activities that will generate employment. 59 Giving
fiscal incentives to businesses is one of the means devised to achieve this purpose. It
comes with the expectation that persons who will avail these incentives will contribute to
the purpose’s achievement. Hence, to avail the fiscal incentives under Republic Act No.
7916, the law did not say that mere PEZA registration is sufficient.

Republic Act No. 7916 or The Special Economic Zone Act of 1995 provides:

SEC. 23. Fiscal Incentives.— Business establishments operating within the

ECOZONES shall be entitled to the fiscal incentives as provided for under Presidential
Decree No. 66, the law creating the Export Processing Zone Authority, or those
provided under Book VI of Executive Order No. 226, otherwise known as the Omnibus
Investment Code of 1987.

Furthermore, tax credits for exporters using local materials as inputs shall enjoy the
same benefits provided for in the Export Development Act of 1994.

SEC. 24. Exemption from Taxes Under the National Internal Revenue Code. — Any
provision of existing laws, rules and regulations to the contrary notwithstanding, no
taxes, local and national, shall be imposed on business establishments operating within
the ECOZONE. In lieu of paying taxes, five percent (5%) of the gross income earned by
all businesses and enterprises within the ECOZONE shall be remitted tothe national
government. This five percent (5%) shall be shared and distributed as follows:

a. Three percent (3%) to the national government;

 b. One percent (1%) to the localgovernment units affected by the declaration of
the ECOZONE inproportion to their population, land area, and equal sharing
factors; and

c. One percent (1%) for the establishment of a development fund to be utilized

for the development of municipalities outside and contiguous to each ECOZONE:
Provided, however, That the respective share of the affected local government
units shall be determined on the basis of the following formula:

1. Population - fifty percent (50%);

2. Land area - twenty-five percent (25%); and

3. Equal sharing - twenty-five percent (25%). (Emphasis supplied)

Based on these provisions, the fiscal incentives and the 5% preferential tax rate are
available only to businesses operating within the Ecozone.60 A business is considered in
operation when it starts entering into commercial transactions that are not merely
incidental to but are related to the purposes of the business. It is similar to the definition
of "doing business," as applied in actions involvingthe right of foreign corporations to
maintain court actions. In Mentholatum Co. Inc., et al. v. Mangaliman, et al., 61 this court
said that the terms "doing" or "engaging in" or "transacting" business":

. . . impl[y] a continuity of commercial dealings and arrangements, and contemplates, to

that extent, the performance of acts or works or the exercise of some of the functions
normally incident to, and in progressive prosecution of, the purpose and object of its
organization.62 Petitioner never started its operations since its registration on June 29,
199863 because of the Asian financial crisis.64 Petitioner admitted this.65 Therefore, it
cannot avail the incentives provided under Republic Act No. 7916. It is not entitled to the
preferential tax rate of 5% on gross income in lieu of all taxes. Because petitioner is not
entitled to a preferential rate, it is subject to ordinary tax rates under the National
Internal Revenue Code of 1997.

III

Imposition of capital gains tax

The Court of Tax Appeals found that petitioner’s sale of its properties is subject to
capital gains tax.

For petitioner’s properties to be subjected to capital gains tax, the properties must form
part ofpetitioner’s capital assets.

Section 39(A)(1) of the National Internal Revenue Code of 1997 defines "capital
assets":
SEC. 39. Capital Gains and Losses. -

(A) Definitions.- As used in this Title -

(1) Capital Assets.- the term ‘capital assets’ means property held by the taxpayer
(whether or not connected with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of the taxable year, or property held by
the taxpayer primarily for sale to customers in the ordinary course of his trade
orbusiness, or property used in the trade or business, of a character which is subject to
the allowance for depreciation provided in Subsection (F) of Section 34; or real property
used in trade or business of the taxpayer. (Emphasis supplied) Thus, "capital assets"
refers to taxpayer’s property that is NOT any of the following:

1. Stock in trade;

2. Property that should be included inthe taxpayer’s inventory at the close of the
taxable year;

3. Property held for sale in the ordinary course of the taxpayer’s business;

4. Depreciable property used in the trade or business; and

5. Real property used in the trade or business.

The properties involved in this case include petitioner’s buildings, equipment, and
machineries. They are not among the exclusions enumerated in Section 39(A)(1) of the
National Internal Revenue Code of 1997. None of the properties were used in
petitioner’s trade or ordinary course of business because petitioner never commenced
operations. They were not part of the inventory. None of themwere stocks in trade.
Based on the definition of capital assets under Section 39 of the National Internal
Revenue Code of 1997, they are capital assets.

Respondent insists that since petitioner’s machineries and equipment are classified as
capital assets, their sales should be subject to capital gains tax. Respondent is
mistaken.

In Commissioner of Internal Revenue v. Fortune Tobacco Corporation,66 this court said:

The rule in the interpretation of tax laws is that a statute will not be construed as
imposing a tax unless it does so clearly, expressly, and unambiguously. A tax cannot be
imposed without clear and express words for that purpose. Accordingly, the general rule
of requiring adherence to the letter in construing statutes applies with peculiar strictness
to tax laws and the provisions of a taxing act are not to be extended by implication. In
answering the question of who is subject to tax statutes, it is basic that in case of doubt,
such statutes are to be construed most strongly against the government and in favor of
the subjects or citizens because burdens are not to be imposed nor presumed to be
imposed beyond what statutes expressly and clearly import. As burdens, taxes should
not be unduly exacted nor assumed beyond the plain meaning of the tax
laws.67 (Citations omitted)

Capital gains of individuals and corporations from the sale of real properties are taxed
differently. Individuals are taxed on capital gains from sale of all real properties located
in the Philippines and classified as capital assets. Thus:

SEC. 24. Income Tax Rates.

....

(D) Capital Gains from Sale of Real Property. –

(1) In General. - The provisions of Section 39(B) notwithstanding, a final tax of six
percent (6%) based on the gross selling price or current fair market value as determined
in accordance with Section 6(E) of this Code, whichever is higher, is hereby imposed
upon capital gains presumed to have been realized from the sale, exchange, or other
disposition of real property located in the Philippines, classified as capital assets,
including pacto de retro sales and other forms of conditional sales, by individuals,
including estates and trusts: Provided, That the tax liability, if any, on gains from sales
or other dispositions of real property to the government or any of its political
subdivisions or agencies or to government-owned or controlled corporations shall be
determined either under Section 24 (A) or under this Subsection, at the option of the
taxpayer.68 (Emphasis supplied)

For corporations, the National Internal Revenue Code of 1997 treats the sale of land
and buildings, and the sale of machineries and equipment, differently. Domestic
corporations are imposed a 6% capital gains tax only on the presumed gain realized
from the sale of lands and/or buildings. The National Internal Revenue Code of 1997
does not impose the 6% capital gains tax on the gains realized from the sale of
machineries and equipment. Section 27(D)(5) of the National Internal Revenue Code of
1997 provides:

SEC. 27. Rates of Income tax on Domestic Corporations. -

....

(D) Rates of Tax on Certain Passive Incomes. -

....

(5) Capital Gains Realized from the Sale, Exchange or Disposition of Lands and/or
Buildings. - A final tax of six percent (6%) is hereby imposed on the gain presumed to
have been realized on the sale, exchange or disposition of lands and/or buildings which
are not actually used in the business of a corporation and are treated as capital assets,
based on the gross selling price of fair market value as determined in accordance with
Section 6(E) of this Code, whichever is higher, of such lands and/or buildings.
(Emphasis supplied)

Therefore, only the presumed gain from the sale of petitioner’s land and/or building may
be subjected to the 6% capital gains tax. The income from the sale of petitioner’s
machineries and equipment is subject to the provisions on normal corporate income tax.

To determine, therefore, if petitioner is entitled to refund, the amount of capital gains tax
for the sold land and/or building of petitioner and the amount of corporate income tax for
the sale of petitioner’s machineries and equipment should be deducted from the total
final tax paid. Petitioner indicated, however, in its March 1, 2001 income tax return for
the 11-month period ending on November 30, 2000 that it suffered a net loss of
₱2,233,464,538.00.69 This declaration was made under the pain of perjury. Section 267
of the National Internal Revenue Code of 1997 provides:

SEC. 267. Declaration under Penalties of Perjury. - Any declaration, return and other
statement required under this Code, shall, in lieu of an oath, contain a written statement
that they are made under the penalties of perjury. Any person who willfully files a
declaration, return or statement containing information which is not true and correct as
to every material matter shall, upon conviction, be subject to the penalties prescribed for
perjury under the Revised Penal Code. Moreover, Rule 131, Section 3(ff) of the Rules of
Court provides for the presumption that the law has been obeyed unless contradicted or
overcome by other evidence, thus:

SEC. 3. Disputable presumptions.— The following presumptions are satisfactory if

uncontradicted, but may be contradicted and overcome by other evidence:

....

(ff) That the law has been obeyed;

The BIR did not make a deficiency assessment for this declaration. Neither did the BIR
dispute this statement in its pleadings filed before this court. There is, therefore, no
reason todoubt the truth that petitioner indeed suffered a net loss in 2000.

Since petitioner had not started its operations, it was also not subject to the minimum
corporate income tax of 2% on gross income.70 Therefore, petitioner is not liable for any
income tax.

IV

Prescription
Section 203 of the National Internal Revenue Code of 1997 provides that as a general
rule, the BIR has three (3) years from the last day prescribed by law for the filing of a
return to make an assessment. If the return is filed beyond the last day prescribed by
law for filing, the three-year period shall run from the actual date of filing. Thus:

SEC. 203. Period of Limitation Upon Assessment and Collection. - Except as provided
in Section 222, internal revenue taxes shall be assessed within three (3) years after the
last day prescribed by law for the filing of the return, and no proceeding in court without
assessment for the collection of such taxes shall be begun after the expiration of such
period: Provided, That in a case where a return is filed beyond the period prescribed by
law, the three (3)-year period shall be counted from the day the return was filed. For
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.

This court said that the prescriptive period to make an assessment of internal revenue
taxes is provided "primarily to safeguard the interests of taxpayers from unreasonable
investigation."71 This court explained in Commissioner of Internal Revenue v. FMF
Development Corporation72 the reason behind the provisions on prescriptive periods for
tax assessments: Accordingly, the government must assess internal revenue taxes on
time so as not to extend indefinitely the period of assessment and deprive the taxpayer
of the assurance that it will no longer be subjected to further investigation for taxes after
the expiration of reasonable period of time.73

Rules derogating taxpayers’ right against prolonged and unscrupulous investigations

are strictly construed against the government.74

[T]he law on prescription should beinterpreted in a way conducive to bringing about the
beneficent purpose of affording protection to the taxpayer within the contemplation of
the Commission which recommended the approval of the law. To the Government, its
tax officers are obliged to act promptlyin the making of assessment so that taxpayers,
after the lapse of the period of prescription, would have a feeling of security against
unscrupulous tax agents who will always try to find an excuse to inspect the books of
taxpayers, not to determine the latter’s real liability, but to take advantage of a possible
opportunity to harass even law-abiding businessmen. Without such legal defense,
taxpayers would be open season to harassment by unscrupulous tax agents. 75

Moreover, in Commissioner of Internal Revenue v. BF Goodrich Phils.: 76

For the purpose of safeguarding taxpayers from any unreasonable examination,

investigation or assessment, our tax law provides a statute of limitations in the collection
of taxes. Thus, the law on prescription, being a remedial measure, should be liberally
construed in order to afford such protection. As a corollary, the exceptions to the law on
prescription should perforce be strictly construed[.]

....
. . . . Such instances of negligence or oversight on the part of the BIR cannot prejudice
taxpayers, considering that the prescriptive period was precisely intended to give them
peace of mind.77 (Citation omitted)

The BIR had three years from the filing of petitioner’s final tax return in 2000 to assess
petitioner’s taxes. Nothing stopped the BIR from making the correct assessment. The
elevation of the refund claim with the Court of Tax Appeals was not a bar against the
BIR’s exercise of its assessment powers.

The BIR, however, did not initiate any assessment for deficiency capital gains
tax.78 Since more than a decade have lapsed from the filing of petitioner's return, the
BIR can no longer assess petitioner for deficiency capital gains taxes, if petitioner is
later found to have capital gains tax liabilities in excess of the amount claimed for
refund.

The Court of Tax Appeals should not be expected to perform the BIR's duties of
assessing and collecting taxes whenever the BIR, through neglect or oversight, fails to
do so within the prescriptive period allowed by law.

WHEREFORE, the Court of Tax Appeals' November 3, 2006 decision is SET ASIDE.
The Bureau of Internal Revenue is ordered to refund petitioner SMI-Ed Philippines
Technology, Inc. the amount of 5% final tax paid to the BIR, less the 6% capital gains
tax on the sale of petitioner SMI-Ed Philippines Technology, Inc. 's land and building. In
view of the lapse of the prescriptive period for assessment, any capital gains tax
accrued from the sale of its land and building that is in excess of the 5% final tax paid to
the Bureau of Internal Revenue may no longer be recovered from petitioner SMI-Ed
Philippines Technology, Inc.

SO ORDERED.

MARVIC M.V.F. LEONEN

Associate Justice

WE CONCUR:
G.R. No. 108067 January 20, 2000

CYANAMID PHILIPPINES, INC., petitioner,

vs.
THE COURT OF APPEALS, THE COURT OF TAX APPEALS and COMMISSIONER
OF INTERNAL REVENUE,respondent.

QUISUMBING, J.:

Petitioner disputes the decision1 of the Court of Appeals which affirmed the decision2 of
the Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of
Internal Revenue the amount of three million, seven hundred seventy-four thousand,
eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as 25% surtax on
improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest
from January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal
Revenue Code.1âwphi1.nêt

The Court of Tax Appeals made the following factual findings:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is

a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is
engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of
imported finished goods, and an importer/indentor.

On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the
payment of deficiency income tax of one hundred nineteen thousand eight hundred
seventeen (P119,817.00) pesos for taxable year 1981, as follows:
 Net income disclosed by the return as audited 14,575,210.00
Add: Discrepancies:
Professional fees/yr. 17018 261,877.00
per investigation 110,399.37
Total Adjustment 152,477.00
Net income per Investigation 14,727,687.00
Less: Personal and additional exemptions
Amount subject to tax 14,727,687.00
Income tax due thereon . . . 25% Surtax 2,385,231.50 3,237,495.00
Less: Amount already assessed 5,161,788.00
BALANCE 75,709.00
monthly interest from 1,389,639.00 44,108.00

Compromise penalties

TOTAL AMOUNT DUE 3,774,867.50 119,817.003

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax
Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of
P119,817.00; and 1981 Deficiency Percentage Assessment of P8,846.72. 4 Petitioner,
through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others,
that the surtax for the undue accumulation of earnings was not proper because the said
profits were retained to increase petitioner's working capital and it would be used for
reasonable business needs of the company. Petitioner contended that it availed of the
tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil and
criminal prosecution granted by the law.

On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the
cancellation of the assessment notices and rendered its resolution, as follows:

It appears that your client availed of Executive Order No. 41 under File No. 32A-
F-000455-41B as certified and confirmed by our Tax Amnesty Implementation
Office on October 6, 1987.

In reply thereto, I have the honor to inform you that the availment of the tax
amnesty under Executive Order No. 41, as amended is sufficient basis, in
appropriate cases, for the cancellation of the assessment issued after August 21,
 1986. (Revenue Memorandum Order No. 4-87) Said availment does not,
therefore, result in cancellation of assessments issued before August 21, 1986.
as in the instant case. In other words, the assessments in this case issued on
January 30, 1985 despite your client's availment of the tax amnesty under
Executive Order No. 41, as amended still subsist.

Such being the case, you are therefore, requested to urge your client to pay this
Office the aforementioned deficiency income tax and surtax on undue
accumulation of surplus in the respective amounts of P119,817.00 and
P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30)
days from receipt hereof, otherwise this office will be constrained to enforce
collection thereof thru summary remedies prescribed by law.

This constitutes the final decision of this Office on this matter.5

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case,
however, both parties agreed to compromise the 1981 deficiency income tax
assessment of P119,817.00. Petitioner paid a reduced amount — twenty-six thousand,
five hundred seventy-seven pesos (P26,577.00) — as compromise settlement.
However, the surtax on improperly accumulated profits remained unresolved.

Petitioner claimed that CIR's assessment representing the 25% surtax on its
accumulated earnings for the year 1981 had no legal basis for the following reasons: (a)
petitioner accumulated its earnings and profits for reasonable business requirements to
meet working capital needs and retirement of indebtedness; (b) petitioner is a wholly
owned subsidiary of American Cyanamid Company, a corporation organized under the
laws of the State of Maine, in the United States of America, whose shares of stock are
listed and traded in New York Stock Exchange. This being the case, no individual
shareholder income taxes by petitioner's accumulation of earnings and profits, instead
of distribution of the same.

In denying the petition, the Court of Tax Appeals made the following pronouncements:

Petitioner contends that it did not declare dividends for the year 1981 in order to
use the accumulated earnings as working capital reserve to meet its "reasonable
business needs". The law permits a stock corporation to set aside a portion of its
retained earnings for specified purposes (citing Section 43, paragraph 2 of the
Corporation Code of the Philippines). In the case at bar, however, petitioner's
purpose for accumulating its earnings does not fall within the ambit of any of
these specified purposes.

More compelling is the finding that there was no need for petitioner to set aside a
portion of its retained earnings as working capital reserve as it claims since it had
considerable liquid funds. A thorough review of petitioner's financial statement
(particularly the Balance Sheet, p. 127, BIR Records) reveals that the corporation
had considerable liquid funds consisting of cash accounts receivable, inventory
and even its sales for the period is adequate to meet the normal needs of the
business. This can be determined by computing the current asset to liability ratio
of the company:

current ratio = current assets/ current liabilities

= P 47,052,535.00 / P21,275,544.00

= 2.21: 1
========

The significance of this ratio is to serve as a primary test of a company's

solvency to meet current obligations from current assets as a going concern or a
measure of adequacy of working capital.

xxx xxx xxx

We further reject petitioner's argument that "the accumulated earnings tax does
not apply to a publicly-held corporation" citing American jurisprudence to support
its position. The reference finds no application in the case at bar because under
Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated
September 17, 1980), the exceptions to the accumulated earnings tax are
expressly enumerated, to wit: Bank, non-bank financial intermediaries,
corporations organized primarily, and authorized by the Central Bank of the
Philippines to hold shares of stock of banks, insurance companies, or personal
holding companies, whether domestic or foreign. The law on the matter is clear
and specific. Hence, there is no need to resort to applicable cases decided by the
American Federal Courts for guidance and enlightenment as to whether the
provision of Section 25 of the NIRC should apply to petitioner.

Equally clear and specific are the provisions of E.O. 41 particularly with respect
to its effectivity and coverage . . .

. . . Said availment does not result in cancellation of assessments issued before

August 21, 1986 as petitioner seeks to do in the case at bar. Therefore, the
assessments in this case, issued on January 30, 1985 despite petitioner's
availment of the tax amnesty under E.O. 41 as amended, still subsist.

xxx xxx xxx

WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay

respondent Commissioner of Internal Revenue the sum of P3,774,867.50
representing 25% surtax on improper accumulation of profits for 1981, plus 10%
surcharge and 20% annual interest from January 30, 1985 to January 30, 1987. 6
Petitioner appealed the Court of Tax Appeal's decision to the Court of Appeals.
Affirming the CTA decision, the appellate court said:

In reviewing the instant petition and the arguments raised herein, We find no
compelling reason to reverse the findings of the respondent Court. The
respondent Court's decision is supported by evidence, such as petitioner
corporation's financial statement and balance sheets (p. 127, BIR Records). On
the other hand the petitioner corporation could only come up with an alternative
formula lifted from a decision rendered by a foreign court (Bardahl Mfg. Corp. vs.
Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its particular
financial position, the petitioner corporation attempts to justify its accumulated
surplus earnings. To Our mind, the petitioner corporation's alternative formula
cannot overturn the persuasive findings and conclusion of the respondent Court
based, as it is, on the applicable laws and jurisprudence, as well as standards in
the computation of taxes and penalties practiced in this jurisdiction.

WHEREFORE, in view of the foregoing, the instant petition is hereby

DISMISSED and the decision of the Court of Tax Appeals dated August 6, 1992
in C.T.A. Case No. 4250 is AFFIRMED in toto.7

Hence, petitioner now comes before us and assigns as sole issue:

WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE

PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR THE
YEAR 1981.8

Sec. 259 of the old National Internal Revenue Code of 1977 states:

Sec. 25. Additional tax on corporation improperly accumulating profits or

surplus —

(a) Imposition of tax. — If any corporation is formed or availed of for the purpose
of preventing the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of
permitting its gains and profits to accumulate instead of being divided or
distributed, there is levied and assessed against such corporation, for each
taxable year, a tax equal to twenty-five per-centum of the undistributed portion of
its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four, and shall be computed, collected and paid in the same
manner and subject to the same provisions of law, including penalties, as that
tax.

(b) Prima facie evidence. — The fact that any corporation is mere holding
company shall be prima facieevidence of a purpose to avoid the tax upon its
shareholders or members. Similar presumption will lie in the case of an
investment company where at any time during the taxable year more than
 fifty per centum in value of its outstanding stock is owned, directly or indirectly, by
one person.

(c) Evidence determinative of purpose. — The fact that the earnings or profits of
a corporation are permitted to accumulate beyond the reasonable needs of the
business shall be determinative of the purpose to avoid the tax upon its
shareholders or members unless the corporation, by clear preponderance of
evidence, shall prove the contrary.

(d) Exception. — The provisions of this sections shall not apply to banks, non-
bank financial intermediaries, corporation organized primarily, and authorized by
the Central Bank of the Philippines to hold shares of stock of banks, insurance
companies, whether domestic or foreign.

The provision discouraged tax avoidance through corporate surplus accumulation.

When corporations do not declare dividends, income taxes are not paid on the
undeclared dividends received by the shareholders. The tax on improper accumulation
of surplus is essentially a penalty tax designed to compel corporations to distribute
earnings so that the said earnings by shareholders could, in turn, be taxed.

Relying on decisions of the American Federal Courts, petitioner stresses that the
accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a
publicly owned company.10 Specifically, petitioner cites Golconda Mining
Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals
had taken the position that the accumulated earnings tax could only apply to a closely
held corporation.

A review of American taxation history on accumulated earnings tax will show that the
application of the accumulated earnings tax to publicly held corporations has been
problematic. Initially, the Tax Court and the Court of Claims held that the accumulated
earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of
Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely
held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax
could be imposed on widely held corporations including those not controlled by a few
shareholders or groups of shareholders. The Service indicated it would not follow the
Ninth Circuit regarding publicly held corporations.11 In 1984, American legislation
nullified the Ninth Circuit's Golconda ruling and made it clear that the accumulated
earnings tax is not limited to closely held corporations.12 Clearly, Golconda is no longer
a reliable precedent.

The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739,
enumerated the corporations exempt from the imposition of improperly accumulated tax:
(a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d)
corporations organized primarily and authorized by the Central Bank of the Philippines
to hold shares of stocks of banks. Petitioner does not fall among those exempt classes.
Besides, the rule on enumeration is that the express mention of one person, thing, act,
or consequence is construed to exclude all others.13 Laws granting exemption from tax
are construed strictissimi juris against the taxpayer and liberally in favor of the taxing
power.14 Taxation is the rule and exemption is the exception.15 The burden of proof rests
upon the party claiming exemption to prove that it is, in fact, covered by the exemption
so claimed,16 a burden which petitioner here has failed to discharge.

Another point raised by the petitioner in objecting to the assessment, is that increase of
working capital by a corporation justifies accumulating income. Petitioner asserts that
respondent court erred in concluding that Cyanamid need not infuse additional working
capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of
current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula,
which allowed retention, as working capital reserve, sufficient amounts of liquid assets
to carry the company through one operating cycle. The "Bardahl" 17 formula was
developed to measure corporate liquidity. The formula requires an examination of
whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and
any extraordinary expenses reasonably anticipated, plus enough to operate the
business during one operating cycle. Operating cycle is the period of time it takes to
convert cash into raw materials, raw materials into inventory, and inventory into sales,
including the time it takes to collect payment for the
sales.18

Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00

pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus,
petitioner asserts that Cyanamid had a working capital deficit of
P7,986,633.00.19 Therefore, the P9,540,926.00 accumulated income as of 1981 may be
validly accumulated to increase the petitioner's working capital for the succeeding year.

We note, however, that the companies where the "Bardahl" formula was applied, had
operating cycles much shorter than that of petitioner. In Atlas Tool
Co., Inc, vs. CIR,20 the company's operating cycle was only 3.33 months or 27.75% of
the year. In Cataphote Corp. of Mississippi vs. United States,21 the corporation's
operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid,
the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will
need sufficient liquid funds, of at least three quarters of the year, to cover the operating
costs of the business. There are variations in the application of the "Bardahl" formula,
such as average operating cycle or peak operating cycle. In times when there is no
recurrence of a business cycle, the working capital needs cannot be predicted with
accuracy. As stressed by American authorities, although the "Bardahl" formula is well-
established and routinely applied by the courts, it is not a precise rule. It is used only for
administrative convenience.22 Petitioner's application of the "Bardahl" formula merely
creates a false illusion of exactitude.

Other formulas are also used, e.g. the ratio of current assets to current liabilities and the
adoption of the industry standard.23 The ratio of current assets to current liabilities is
used to determine the sufficiency of working capital. Ideally, the working capital should
equal the current liabilities and there must be 2 units of current assets for every unit of
current liability, hence the so-called "2 to 1" rule.24

As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its
current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in
working capital. Said working capital was expected to increase further when more funds
were generated from the succeeding year's sales. Available income covered expenses
or indebtedness for that year, and there appeared no reason to expect an impending
"working capital deficit" which could have necessitated an increase in working capital,
as rationalized by petitioner.

In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,25 we held that:

. . . [T]here is no need to have such a large amount at the beginning of the

following year because during the year, current assets are converted into cash
and with the income realized from the business as the year goes, these
expenses may well be taken care of. [citation omitted]. Thus, it is erroneous to
say that the taxpayer is entitled to retain enough liquid net assets in amounts
approximately equal to current operating needs for the year to cover "cost of
goods sold and operating expenses:" for "it excludes proper consideration of
funds generated by the collection of notes receivable as trade accounts during
the course of the year."26

If the CIR determined that the corporation avoided the tax on shareholders by permitting
earnings or profits to accumulate, and the taxpayer contested such a determination, the
burden of proving the determination wrong, together with the corresponding burden of
first going forward with evidence, is on the taxpayer. This applies even if the corporation
is not a mere holding or investment company and does not have an unreasonable
accumulation of earnings or profits.27

In order to determine whether profits are accumulated for the reasonable needs to avoid
the surtax upon shareholders, it must be shown that the controlling intention of the
taxpayer is manifest at the time of accumulation, not intentions declared subsequently,
which are mere afterthoughts.28 Furthermore, the accumulated profits must be used
within a reasonable time after the close of the taxable year. In the instant case,
petitioner did not establish, by clear and convincing evidence, that such accumulation of
profit was for the immediate needs of the business.

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,29 we ruled:

To determine the "reasonable needs" of the business in order to justify an

accumulation of earnings, the Courts of the United States have invented the so-
called "Immediacy Test" which construed the words "reasonable needs of the
business" to mean the immediate needs of the business, and it was generally
held that if the corporation did not prove an immediate need for the accumulation
of the earnings and profits, the accumulation was not for the reasonable needs of
 the business, and the penalty tax would apply. (Mertens. Law of Federal Income
Taxation, Vol. 7, Chapter 39, p, 103).30

In the present case, the Tax Court opted to determine the working capital sufficiency by
using the ratio between current assets to current liabilities. The working capital needs of
a business depend upon nature of the business, its credit policies, the amount of
inventories, the rate of the turnover, the amount of accounts receivable, the collection
rate, the availability of credit to the business, and similar factors. Petitioner, by adhering
to the "Bardahl" formula, failed to impress the tax court with the required definiteness
envisioned by the statute. We agree with the tax court that the burden of proof to
establish that the profits accumulated were not beyond the reasonable needs of the
company, remained on the taxpayer. This Court will not set aside lightly the conclusion
reached by the Court of Tax Appeals which, by the very nature of its function, is
dedicated exclusively to the consideration of tax problems and has necessarily
developed an expertise on the subject, unless there has been an abuse or improvident
exercise of authority.31 Unless rebutted, all presumptions generally are indulged in favor
of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure
to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold
the correctness of tax court's ruling as affirmed by the Court of Appeals.

WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals,
sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against
petitioner.1âwphi1.nêt

SO ORDERED.

Bellosillo, Mendoza, Buena and De Leon, Jr., JJ., concur.

212 Phil. 444

GUERRERO, J.:
In this Petition for Review on Certiorari, petitioner, the Manila Wine Merchants, Inc.,
disputes the decision of the Court of Tax Appeals ordering it (petitioner) to pay
respondent, the Commissioner of Internal Revenue, the amount of P86,804.38 as 25%
surtax plus interest which represents the additional tax due petitioner for improperly
accumulating profits or surplus in the taxable year 1957 under Sec. 25 of the National
Internal Revenue Code.
The Court of Tax Appeals made the following finding of facts, to wit:
"Petitioner, a domestic corporation organized in 1937, is principally engaged in the
importation and sale of whisky, wines, liquors and distilled spirits. Its original
subscribed and paid capital was P500,000.00. Its capital of P500,000.00 was reduced
to P250,000.00 in 1950 with the approval of the Securities and Exchange Commission
but the reduction of the capital was never implemented. On June 21, 1958, petitioner's
capital was increased to P1,000,000.00 with the approval of the said Commission.
On December 31, 1957, herein respondent caused the examination of herein petitioner's
book of account and found the latter of having unreasonably accumulated surplus of
P428,934.32 for the calendar year 1947 to 1957, in excess of the reasonable needs of the
business subject to the 25% surtax imposed by Section 25 of the Tax Code.
On February 26, 1963, the Commissioner of Internal Revenue demanded upon the
Manila Wine Merchants, Inc. payment of P126,536.12 as 25% surtax and interest on the
latter's unreasonable accumulation of profits and surplus for the year 1957, computed as
follows:

Unreasonable accumulation of surtax P428,934.42

25% surtax due thereon P107,234.00
Add: 1/2% monthly interest from June 20, 1959 to
19,302.12
June 20, 1962.
TOTAL AMOUNT DUE AND COLLECTIBLE P126,536.12
Respondent contends that petitioner has accumulated earnings beyond the reasonable
needs of its business because the average ratio of the cash dividends declared and paid
by petitioner from 1947 to 1957 was 40.33% of the total surplus available for distribution
at the end of each calendar year. On the other hand, petitioner contends that in 1957, it
distributed 100% of its net earnings after income tax and part of the surplus for prior
years. Respondent further submits that the accumulated earnings tax should be based
on 25% of the total surplus available at the end of each calendar year while petitioner
maintains that the 25% surtax is imposed on the total surplus or net income for the year
after deducting therefrom the income tax due.
The records show the following analysis of petitioner's net income, cash dividends and
earned surplus for the years 1946 to 1957:[1]
Percentage of Dividens to Balance of
Net Income After
Year Total Cash Net Income After Net Earned
Income Tax
Income Surplus
 1946 P613,790.00 P200,000. 32.58% P234,104.81
1947 425,719.87 360,000. 84.56% 195,167.10
1948 415,591.83 375,000. 90.23% 272,991.38
1949 335,058.06 200,000. 59.69% 893,113.42
1950 399,698.09 600,000. 150.11% 234,987.07
1951 346,257.26 300,000. 86.64% 281,244.33
1952 196,161.97 200,000. 101.96% 277,406.30
1953 169,714.04 200,000. 117.85% 301,138.84
1954 238,124.85 250,000. 104.99% 289,262.69
1955 312,284.74 200,000. 64.04% 401,548.43
1956 374,240.28 300,000. 80.16% 475,788.71
1957 353,145.71 400,000. 113.27% 428,934.42
P4,179,787.36 P3,585,000. 85.77% P3,785,688.50
Another basis of respondent in assessing petitioner for accumulated earnings tax is its
substantial investment of surplus or profits in unrelated business. These investments
are itemized as follows:
1. Acme Commercial Co., Inc. P 27,501.00
2. Union Insurance Society of Canton 1,145.76
3. U.S.A. Treasury Bond 347,217.50
4. Wack Wack Gold & Country Club 1.00
P375,865.26
As to the investment of P27,501.00 made by petitioner in the Acme Commercial Co.,
Inc., Mr. N.R.E. Hawkins, president of the petitioner corporation[2] explained as follows:
'The first item consists of shares of Acme Commercial Co., Inc. which the Company
acquired in 1947 and 1949. In the said years, we thought it prudent to invest in a
business which patronizes us. As a supermarket, Acme Commercial Co., Inc. is one of
our best customers. The investment has proven to be beneficial to the stockholders of
this Company. As an example, the Company received cash dividends in 1961 totalling
P16,875.00 which was included in its income tax return for the said year.'
As to the investments of petitioner in Union Insurance Society of Canton and Wack
Wack Golf Club in the sums of P1,145.76 and P1.00, respectively, the same official of the
petitioner-corporation stated that:[3]
'The second and fourth items are small amounts which we believe would not affect this
case substantially. As regards the Union Insurance Society of Canton shares, this was a
pre-war investment, when Wise & Co., Inc., Manila Wine Merchants and the said
insurance firm were common stockholders of the Wise Bldg. Co., Inc. and the three
companies were all housed in the same building. Union Insurance invested in Wise
Bldg, Co., Inc. but invited Manila Wine Merchants, Inc. to buy a few of its shares.'
As to the U.S.A. Treasury Bonds amounting to P347,217.50, Mr. Hawkins explained as
follows:[4]
'With regards to the U.S.A. Treasury Bills in the amount of P347,217.50, in 1950, our
balance sheet for the said year shows the Company had deposited in current account in
various banks P629,403.64 which was not earning any interest. We decided to utilize
part of this money as reserve to finance our importations and to take care of future
expansion including acquisition of a lot and the construction of our own office building
and bottling plant.
At that time, we believed that a dollar reserve abroad would be useful to the Company in
meeting immediate urgent orders of its local customers. In order that the money may
earn interest, the Company, on May 31, 1951 purchased US Treasury bills with 90-day
maturity and earning approximately 1% interest with the face value of US$175,000.00.
US Treasury Bills are easily convertible into cash and for the said reason they may be
better classified as cash rather than investments.
The Treasury Bills in question were held as such for many years in view of our
expectation that the Central Bank inspite of the controls would allow no-dollar licenses
importations. However, since the Central Bank did not relax its policy with respect
thereto, we decided sometime in 1957 to hold the bills for a few more years in view of
our plan to buy a lot and construct a building of our own. According to the lease
agreement over the building formerly occupied by us in Dasmariñas St., the lease was to
expire sometime in 1957. At that time, the Company was not yet qualified to own real
property in the Philippines. We therefore waited until 60% of the stocks of the Company
would be owned by Filipino citizens before making definite plans. Then in 1959 when
the Company was already more than 60% Filipino owned, we commenced looking for a
suitable location and then finally in 1961, we bought the main lot with an old building on
Otis St., Paco, our present site, for P665,000.00. Adjoining smaller lots were bought
later. After the purchase of the main property, we proceeded with the remodelling of the
old building and the construction of additions, which were completed at a cost of
P143,896.00 in April, 1962.
In view of the needs of the business of this Company and the purchase of the Otis lots
and the construction of the improvements thereon, most of its available funds including
the Treasury Bills had been utilized, but inspite of the said expenses the Company
consistently declared dividends to its stockholders. The Treasury Bills were liquidated
on February 15,1962.'
Respondent found that the accumulated surplus in question were invested to 'unrelated
business' which were not considered in the 'immediate needs' of the Company such that
the 25% surtax be imposed therefrom."
Petitioner appealed to the Court of Tax Appeals.
On the basis of the tabulated figures, supra, the Court of Tax Appeals found that the
average percentage of cash dividends distributed was 85.77% for a period of 11 years
from 1946 to 1957 and not only 40.33% of the total surplus available for distribution at
the end of each calendar year actually distributed by the petitioner to its stockholders,
which is indicative of the view that the Manila Wine Merchants, Inc. was not formed for
the purpose of preventing the imposition of income tax upon its shareholders.[5]
With regards to the alleged substantial investment of surplus or profits in unrelated
business, the Court of Tax Appeals held that the investment of petitioner with Acme,
Commercial Co., Inc., Union Insurance Society of Canton and with the Wack Wack Golf
and Country Club are harmless accumulation of surplus and, therefore, not subject to
the 25% surtax provided in Section 25 of the Tax Code.[6]
As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals
ruled that its purchase was in no way related to petitioner's business of importing and
selling wines, whisky, liquors and distilled spirits. Respondent Court was convinced that
the surplus of P347,217.50 which was invested in the U.S.A. Treasury Bonds was availed
of by petitioner for the purpose of preventing the imposition of the surtax upon
petitioner's shareholders by permitting its earnings and profits to accumulate beyond
the reasonable needs of business. Hence, the Court of Tax Appeals modified
respondent's decision by imposing upon petitioner the 25% surtax for 1957 only in the
amount of P86,804.38 computed as follows:
Unreasonable accumulation of surplus P347,217.50
25% surtax due thereon P 86,804.38[7]
On May 30, 1966, the Court of Tax Appeals denied the motion for reconsideration filed
by petitioner on March 30, 1966. Hence, this petition.
Petitioner assigns the following errors:
I
The Court of Tax Appeals erred in holding that petitioner was availed of for the purpose
of preventing the imposition of a surtax on its shareholders.
II
The Court of Tax Appeals erred in holding that petitioner's purchase of U.S.A. Treasury
Bills in 1951 was an investment in unrelated business subject to the 25% surtax in 1957
as surplus profits improperly accumulated in the latter year.
III
The Court of Tax Appeals erred in not finding that petitioner did not accumulate its
surplus profits improperly in 1957, and in not holding that such surplus profits,
including the so-called unrelated investments, were necessary for its reasonable
business needs.
IV
The Court of Tax Appeals erred in not holding that petitioner had overcome the prima
facie presumption provided for in Section 25(c) of the Revenue Code.
V
The Court of Tax Appeals erred in finding petitioner liable for the payment of the surtax
of P86,804.38 and in denying petitioner's Motion for Reconsideration and/or New
Trial.
The issues in this case can be summarized as follows: (1) whether the purchase of the
U.S.A. Treasury bonds by petitioner in 1951 can be construed as an investment to an
unrelated business and hence, such was availed of by petitioner for the purpose of
preventing the imposition of the surtax upon petitioner's shareholders by permitting its
earnings and profits to accumulate beyond the reasonable needs of the business, and if
so, (2) whether the penalty tax of twenty-five percent (25%) can be imposed on such
improper accumulation in 1957 despite the fact that the accumulation occurred in 1951.
The pertinent provision of the National Internal Revenue Code reads as follows:
"Sec. 25. Additional tax on corporations improperly accumulating profits or surplus. -
(a) Imposition of Tax. - If any corporation, except banks, insurance companies, or
personal holding companies whether domestic or foreign, is formed or availed of for the
purpose of preventing the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of permitting its
gains and profits to accumulate instead of being divided or distributed, there is levied
and assessed against such corporation, for each taxable year, a tax equal to twenty-five
per centum of the undistributed portion of its accumulated profits or surplus which shall
be in addition to the tax imposed by section twenty-four and shall be computed,
collected and paid in the same manner and subject to the same provisions of law,
including penalties, as that tax: Provided, that no such tax shall be levied upon any
accumulated profits or surplus, if they are invested in any dollar-producing or dollar-
saving industry or in the purchase of bonds issued by the Central Bank of the
Philippines.
xxx xxx xxx xxx
(c) Evidence determinative of purpose. - The fact that earnings of profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business
shall be determinative of the purpose to avoid the tax upon its shareholders or members
unless the corporation, by clear preponderance of evidence, shall prove the contrary."
(As amended by Republic Act No. 1823).
As correctly pointed out by the Court of Tax Appeals, inasmuch as the provisions of
Section 25 of the National Internal Revenue Code were bodily lifted from Section 102 of
the U.S. Internal Revenue Code of 1939, including the regulations issued in connection
therewith, it would be proper to resort to applicable cases decided by the American
Federal Courts for guidance and enlightenment.
A prerequisite to the imposition of the tax has been that the corporation be formed or
availed of for the purpose of avoiding the income tax (or surtax) on its shareholders, or
on the shareholders of any other corporation by permitting the earnings and profits of
the corporation to accumulate instead of dividing them among or distributing them to
the shareholders. If the earnings and profits were distributed, the shareholders would be
required to pay an income tax thereon whereas, if the distribution were not made to
them, they would incur no tax in respect to the undistributed earnings and profits of the
corporation.[8] The touchstone of liability is the purpose behind the accumulation of the
income and not the consequences of the accumulation.[9] Thus, if the failure to pay
dividends is due to some other cause, such as the use of undistributed earnings and
profits for the reasonable needs of the business, such purpose does not fall within the
interdiction of the statute.[10]
An accumulation of earnings or profits (including undistributed earnings or profits of
prior years) is unreasonable if it is not required for the purpose of the business,
considering all the circumstances of the case.[11]
In purchasing the U.S.A. Treasury Bonds, in 1951, petitioner argues that these bonds
were so purchased (1) in order to finance their importation; and that a dollar reserve
abroad would be useful to the Company in meeting urgent orders of its local customers
and (2) to take care of future expansion including the acquisition of a lot and the
construction of their office building and bottling plant.
We find no merit in the petition.
To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase
of the U.S.A. Treasury Bonds in 1951 with a face value of $175,000.00 was an
investment within the reasonable needs of the Corporation.
To determine the "reasonable needs" of the business in order to justify an accumulation
of earnings, the Courts of the United States have invented the so-called "Immediacy
Test" which construed the words "reasonable needs of the business" to mean the
immediate needs of the business, and it was generally held that if the corporation did
not prove an immediate need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and the penalty tax
would apply.[12] American cases likewise hold that investment of the earnings and profits
of the corporation in stock or securities of an unrelated business usually indicates an
accumulation beyond the reasonable needs of the business.[13]
The finding of the Court of Tax Appeals that the purchase of the U.S.A. Treasury bonds
were in no way related to petitioner's business of importing and selling wines whisky,
liquors and distilled spirits, and thus construed as an investment beyond the reasonable
needs of the business[14] is binding on Us, the same being factual.[15] Furthermore, the
wisdom behind this finding cannot be doubted. The case of J.M. Perry & Co. vs.
Commissioner of Internal Revenue[16] supports the same. In that case, the U.S. Court
said the following:
"It appears that the taxpayer corporation was engaged in the business of cold storage
and warehousing in Yahima, Washington. It maintained a cold storage plant, divided
into four units, having a total capacity of 490,000 boxes of fruits. It presented evidence
to the effect that various alterations and repairs to its plant were contemplated in the tax
years, x x x
It also appeared that in spite of the fact that the taxpayer contended that it needed to
maintain this large cash reserve on hand, it proceeded to make various investments
which had no relation to its storage business. In 1934, it purchased mining stock which
it sold in 1935 at a profit of US $47,995.29. x x x
All these things may reasonably have appealed to the Board as incompatible with a
purpose to strengthen the financial position of the taxpayer and to provide for needed
alteration."
The records further reveal that from May 1951 when petitioner purchased the U.S.A.
Treasury shares, until 1962 when it finally liquidated the same, it (petitioner) never had
the occasion to use the said shares in aiding or financing its importation. This militates
against the purpose enunciated earlier by petitioner that the shares were purchased to
finance its importation business. To justify an accumulation of earnings and profits for
the reasonably anticipated future needs, such accumulation must be used within a
reasonable time after the close of the taxable year.[17]
Petitioner advanced the argument that the U.S.A. Treasury shares were held for a few
more years from 1957, in view of a plan to buy a lot and construct a building of their
own; that at that time (1957), the Company was not yet qualified to own real property in
the Philippines, hence it (petitioner) had to wait until sixty percent (60%) of the stocks
of the Company would be owned by Filipino citizens before making definite plans.[18]
These arguments of petitioner indicate that it considers the U.S.A. Treasury shares not
only for the purpose of aiding or financing its importation but likewise for the purpose
of buying a lot and constructing a building thereon in the near future, but conditioned
upon the completion of the 60% citizenship requirement of stock ownership of the
Company in order to qualify it to purchase and own a lot. The time when the company
would be able to establish itself to meet the said requirement and the decision to pursue
the same are dependent upon various future contingencies. Whether these
contingencies would unfold favorably to the Company and if so, whether the Company
would decide later to utilize the U.S.A. Treasury shares according to its plan, remains to
be seen. From these assertions of petitioner, We cannot gather anything definite or
certain. This, We cannot approve.
In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the surtax upon shareholders, the controlling intention of the
taxpayer is that which is manifested at the time of accumulation not subsequently
declared intentions which are merely the product of afterthought.[19] A speculative and
indefinite purpose will not suffice. The mere recognition of a future problem and the
discussion of possible and alternative solutions is not sufficient. Definiteness of plan
coupled with action taken towards its consummation are essential.[20]
The Court of Tax Appeals correctly made the following ruling:[21]
"As to the statement of Mr. Hawkins in Exh. "B" regarding the expansion program of the
petitioner by purchasing a lot and building of its own, we find no justifiable reason for
the retention in 1957 or thereafter of the US Treasury Bonds which were purchased in
1951.
xxx xxx xxx xxx
"Moreover, if there was any thought for the purchase of a lot and building for the needs
of petitioner's business, the corporation may not with impunity permit its earnings to
pile up merely because at some future time certain outlays would have to be made.
Profits may only be accumulated for the reasonable needs of the business, and implicit
in this is further requirement of a reasonable time."
Viewed on the foregoing analysis and tested under the "immediacy doctrine," We are
convinced that the Court of Tax Appeals is correct in finding that the investment made
by petitioner in the U.S.A. Treasury shares in 1951 was an accumulation of profits in
excess of the reasonable needs of petitioner's business.
Finally, petitioner asserts that the surplus profits allegedly accumulated in the form of
U.S.A. Treasury shares in 1951 by it (petitioner) should not be subject to the surtax in
1957. In other words, petitioner claims that the surtax of 25% should be based on the
surplus accumulated in 1951 and not in 1957.
This is devoid of merit.
The rule is now settled in Our jurisprudence that undistributed earnings or profits of
prior years are taken into consideration in determining unreasonable accumulation for
purposes of the 25% surtax.[22] The case of Basilan Estates, Inc. vs. Commissioner of
Internal Revenue[23] further strengthens this rule, and We quote:
"Petitioner questions why the examiner covered the period from 1948-1953 when the
taxable year on review was 1953. The surplus of P347,507.01 was taken by the examiner
from the balance sheet of the petitioner for 1953. To check the figure arrived at, the
examiner traced the accumulation process from 1947 until 1953, and petitioner's figure
stood out to be correct. There was no error in the process applied, for previous
accumulations should be considered in determining unreasonable accumulation for the
year concerned. 'In determining whether accumulations of earnings or profits in a
particular year are within the reasonable needs of a corporation, it is necessary to take
into account prior accumulations, since accumulations prior to the year involved may
have been sufficient to cover the business needs and additional accumulations during
the year involved would not reasonably be necessary.'"
WHEREFORE, IN VIEW OF THE FOREGOING, the decision of the Court of Tax
Appeals is AFFIRMED in toto, with costs against petitioner. SO ORDERED.
Makasiar (Chairman), Aquino, Concepcion, Jr., Abad Santos, De Castro, and Escolin,
JJ., concur.

G.R. No. 195909 September 26, 2012

COMMISSIONER OF INTERNAL REVENUE, PETITIONER,

vs.
ST. LUKE'S MEDICAL CENTER, INC., RESPONDENT.

x-----------------------x

G.R. No. 195960

ST. LUKE'S MEDICAL CENTER, INC., PETITIONER,

vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DECISION
CARPIO, J.:

The Case

These are consolidated 1 petitions for review on certiorari under Rule 45 of the Rules of
Court assailing the Decision of 19 November 2010 of the Court of Tax Appeals (CTA)
En Banc and its Resolution 2 of 1 March 2011 in CTA Case No. 6746. This Court
resolves this case on a pure question of law, which involves the interpretation of Section
27(B) vis-à-vis Section 30(E) and (G) of the National Internal Revenue Code of the
Philippines (NIRC), on the income tax treatment of proprietary non-profit hospitals.

The Facts

St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as a non-stock and
non-profit corporation. Under its articles of incorporation, among its corporate purposes
are:

(a) To establish, equip, operate and maintain a non-stock, non-profit Christian,

benevolent, charitable and scientific hospital which shall give curative,
rehabilitative and spiritual care to the sick, diseased and disabled persons;
provided that purely medical and surgical services shall be performed by duly
licensed physicians and surgeons who may be freely and individually contracted
by patients;

(b) To provide a career of health science education and provide medical services
to the community through organized clinics in such specialties as the facilities
and resources of the corporation make possible;

(c) To carry on educational activities related to the maintenance and promotion of

health as well as provide facilities for scientific and medical researches which, in
the opinion of the Board of Trustees, may be justified by the facilities, personnel,
funds, or other requirements that are available;

(d) To cooperate with organized medical societies, agencies of both government

and private sector; establish rules and regulations consistent with the highest
professional ethics;

xxxx3

On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke's
deficiency taxes amounting to ₱76,063,116.06 for 1998, comprised of deficiency income
tax, value-added tax, withholding tax on compensation and expanded withholding tax.
The BIR reduced the amount to ₱63,935,351.57 during trial in the First Division of the
CTA. 4
On 14 January 2003, St. Luke's filed an administrative protest with the BIR against the
deficiency tax assessments. The BIR did not act on the protest within the 180-day
period under Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.

The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals, should be
applicable to St. Luke's. According to the BIR, Section 27(B), introduced in 1997, "is a
new provision intended to amend the exemption on non-profit hospitals that were
previously categorized as non-stock, non-profit corporations under Section 26 of the
1997 Tax Code x x x." 5 It is a specific provision which prevails over the general
exemption on income tax granted under Section 30(E) and (G) for non-stock, non-profit
charitable institutions and civic organizations promoting social welfare. 6

The BIR claimed that St. Luke's was actually operating for profit in 1998 because only
13% of its revenues came from charitable purposes. Moreover, the hospital's board of
trustees, officers and employees directly benefit from its profits and assets. St. Luke's
had total revenues of ₱1,730,367,965 or approximately ₱1.73 billion from patient
services in 1998. 7

St. Luke's contended that the BIR should not consider its total revenues, because its
free services to patients was ₱218,187,498 or 65.20% of its 1998 operating income
(i.e., total revenues less operating expenses) of ₱334,642,615. 8 St. Luke's also claimed
that its income does not inure to the benefit of any individual.

St. Luke's maintained that it is a non-stock and non-profit institution for charitable and
social welfare purposes under Section 30(E) and (G) of the NIRC. It argued that the
making of profit per se does not destroy its income tax exemption.

The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments
before the CTA that Section 27(B) applies to St. Luke's. The petition raises the sole
issue of whether the enactment of Section 27(B) takes proprietary non-profit hospitals
out of the income tax exemption under Section 30 of the NIRC and instead, imposes a
preferential rate of 10% on their taxable income. The BIR prays that St. Luke's be
ordered to pay ₱57,659,981.19 as deficiency income and expanded withholding tax for
1998 with surcharges and interest for late payment.

The petition of St. Luke's in G.R. No. 195960 raises factual matters on the treatment
and withholding of a part of its income, 9 as well as the payment of surcharge and
delinquency interest. There is no ground for this Court to undertake such a factual
review. Under the Constitution 10 and the Rules of Court, 11 this Court's review power is
generally limited to "cases in which only an error or question of law is involved." 12 This
Court cannot depart from this limitation if a party fails to invoke a recognized exception.

The Ruling of the Court of Tax Appeals

The CTA En Banc Decision on 19 November 2010 affirmed in toto the CTA First
Division Decision dated 23 February 2009 which held:

WHEREFORE, the Amended Petition for Review [by St. Luke's] is hereby PARTIALLY
GRANTED. Accordingly, the 1998 deficiency VAT assessment issued by respondent
against petitioner in the amount of ₱110,000.00 is hereby CANCELLED and
WITHDRAWN. However, petitioner is hereby ORDERED to PAY deficiency income tax
and deficiency expanded withholding tax for the taxable year 1998 in the respective
amounts of ₱5,496,963.54 and ₱778,406.84 or in the sum of ₱6,275,370.38, x x x.

xxxx

In addition, petitioner is hereby ORDERED to PAY twenty percent (20%) delinquency

interest on the total amount of ₱6,275,370.38 counted from October 15, 2003 until full
payment thereof, pursuant to Section 249(C)(3) of the NIRC of 1997.

SO ORDERED. 13

The deficiency income tax of ₱5,496,963.54, ordered by the CTA En Banc to be paid,
arose from the failure of St. Luke's to prove that part of its income in 1998 (declared as
"Other Income-Net") 14 came from charitable activities. The CTA cancelled the
remainder of the ₱63,113,952.79 deficiency assessed by the BIR based on the 10% tax
rate under Section 27(B) of the NIRC, which the CTA En Banc held was not applicable
to St. Luke's. 15

The CTA ruled that St. Luke's is a non-stock and non-profit charitable institution covered
by Section 30(E) and (G) of the NIRC. This ruling would exempt all income derived by
St. Luke's from services to its patients, whether paying or non-paying. The CTA
reiterated its earlier decision in St. Luke's Medical Center, Inc. v. Commissioner of
Internal Revenue, 16 which examined the primary purposes of St. Luke's under its
articles of incorporation and various documents 17 identifying St. Luke's as a charitable
institution.

The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City, 18 which
states that "a charitable institution does not lose its charitable character and its
consequent exemption from taxation merely because recipients of its benefits who are
able to pay are required to do so, where funds derived in this manner are devoted to the
charitable purposes of the institution x x x." 19 The generation of income from paying
patients does not per se destroy the charitable nature of St. Luke's.

Hospital de San Juan cited Jesus Sacred Heart College v. Collector of Internal
Revenue, 20 which ruled that the old NIRC (Commonwealth Act No. 466, as
amended) 21 "positively exempts from taxation those corporations or associations which,
otherwise, would be subject thereto, because of the existence of x x x net
income." 22 The NIRC of 1997 substantially reproduces the provision on charitable
institutions of the old NIRC. Thus, in rejecting the argument that tax exemption is lost
whenever there is net income, the Court in Jesus Sacred Heart College declared:
"[E]very responsible organization must be run to at least insure its existence, by
operating within the limits of its own resources, especially its regular income. In other
words, it should always strive, whenever possible, to have a surplus." 23

The CTA held that Section 27(B) of the present NIRC does not apply to St.
Luke's. 24 The CTA explained that to apply the 10% preferential rate, Section 27(B)
requires a hospital to be "non-profit." On the other hand, Congress specifically used the
word "non-stock" to qualify a charitable "corporation or association" in Section 30(E) of
the NIRC. According to the CTA, this is unique in the present tax code, indicating an
intent to exempt this type of charitable organization from income tax. Section 27(B)
does not require that the hospital be "non-stock." The CTA stated, "it is clear that non-
stock, non-profit hospitals operated exclusively for charitable purpose are exempt from
income tax on income received by them as such, applying the provision of Section
30(E) of the NIRC of 1997, as amended." 25

The Issue

The sole issue is whether St. Luke's is liable for deficiency income tax in 1998 under
Section 27(B) of the NIRC, which imposes a preferential tax rate of 10% on the income
of proprietary non-profit hospitals.

The Ruling of the Court

St. Luke's Petition in G.R. No. 195960

As a preliminary matter, this Court denies the petition of St. Luke's in G.R. No. 195960
because the petition raises factual issues. Under Section 1, Rule 45 of the Rules of
Court, "[t]he petition shall raise only questions of law which must be distinctly set forth."
St. Luke's cites Martinez v. Court of Appeals 26 which permits factual review "when the
Court of Appeals [in this case, the CTA] manifestly overlooked certain relevant facts not
disputed by the parties and which, if properly considered, would justify a different
conclusion." 27

This Court does not see how the CTA overlooked relevant facts. St. Luke's itself stated
that the CTA "disregarded the testimony of [its] witness, Romeo B. Mary, being
allegedly self-serving, to show the nature of the 'Other Income-Net' x x x." 28 This is not
a case of overlooking or failing to consider relevant evidence. The CTA obviously
considered the evidence and concluded that it is self-serving. The CTA declared that it
has "gone through the records of this case and found no other evidence aside from the
self-serving affidavit executed by [the] witnesses [of St. Luke's] x x x." 29

The deficiency tax on "Other Income-Net" stands. Thus, St. Luke's is liable to pay the
25% surcharge under Section 248(A)(3) of the NIRC. There is "[f]ailure to pay the
deficiency tax within the time prescribed for its payment in the notice of
assessment[.]" 30 St. Luke's is also liable to pay 20% delinquency interest under Section
249(C)(3) of the NIRC. 31 As explained by the CTA En Banc, the amount of
₱6,275,370.38 in the dispositive portion of the CTA First Division Decision includes only
deficiency interest under Section 249(A) and (B) of the NIRC and not delinquency
interest. 32

The Main Issue

The issue raised by the BIR is a purely legal one. It involves the effect of the
introduction of Section 27(B) in the NIRC of 1997 vis-à-vis Section 30(E) and (G) on the
income tax exemption of charitable and social welfare institutions. The 10% income tax
rate under Section 27(B) specifically pertains to proprietary educational institutions and
proprietary non-profit hospitals. The BIR argues that Congress intended to remove the
exemption that non-profit hospitals previously enjoyed under Section 27(E) of the NIRC
of 1977, which is now substantially reproduced in Section 30(E) of the NIRC of
1997. 33 Section 27(B) of the present NIRC provides:

SEC. 27. Rates of Income Tax on Domestic Corporations. -

xxxx

(B) Proprietary Educational Institutions and Hospitals. - Proprietary educational

institutions and hospitals which are non-profit shall pay a tax of ten percent (10%) on
their taxable income except those covered by Subsection (D) hereof: Provided, That if
the gross income from unrelated trade, business or other activity exceeds fifty percent
(50%) of the total gross income derived by such educational institutions or hospitals
from all sources, the tax prescribed in Subsection (A) hereof shall be imposed on the
entire taxable income. For purposes of this Subsection, the term 'unrelated trade,
business or other activity' means any trade, business or other activity, the conduct of
which is not substantially related to the exercise or performance by such educational
institution or hospital of its primary purpose or function. A 'proprietary educational
institution' is any private school maintained and administered by private individuals or
groups with an issued permit to operate from the Department of Education, Culture and
Sports (DECS), or the Commission on Higher Education (CHED), or the Technical
Education and Skills Development Authority (TESDA), as the case may be, in
accordance with existing laws and regulations. (Emphasis supplied)

St. Luke's claims tax exemption under Section 30(E) and (G) of the NIRC. It contends
that it is a charitable institution and an organization promoting social welfare. The
arguments of St. Luke's focus on the wording of Section 30(E) exempting from income
tax non-stock, non-profit charitable institutions. 34 St. Luke's asserts that the legislative
intent of introducing Section 27(B) was only to remove the exemption for "proprietary
non-profit" hospitals. 35 The relevant provisions of Section 30 state:

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not
be taxed under this Title in respect to income received by them as such:
 xxxx

(E) Nonstock corporation or association organized and operated exclusively for

religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of
veterans, no part of its net income or asset shall belong to or inure to the benefit of any
member, organizer, officer or any specific person;

xxxx

(G) Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;

xxxx

Notwithstanding the provisions in the preceding paragraphs, the income of whatever

kind and character of the foregoing organizations from any of their properties, real or
personal, or from any of their activities conducted for profit regardless of the disposition
made of such income, shall be subject to tax imposed under this Code. (Emphasis
supplied)

The Court partly grants the petition of the BIR but on a different ground. We hold that
Section 27(B) of the NIRC does not remove the income tax exemption of proprietary
non-profit hospitals under Section 30(E) and (G). Section 27(B) on one hand, and
Section 30(E) and (G) on the other hand, can be construed together without the removal
of such tax exemption. The effect of the introduction of Section 27(B) is to subject the
taxable income of two specific institutions, namely, proprietary non-profit educational
institutions 36 and proprietary non-profit hospitals, among the institutions covered by
Section 30, to the 10% preferential rate under Section 27(B) instead of the ordinary 30%
corporate rate under the last paragraph of Section 30 in relation to Section 27(A)(1).

Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1)
proprietary non-profit educational institutions and (2) proprietary non-profit hospitals.
The only qualifications for hospitals are that they must be proprietary and non-profit.
"Proprietary" means private, following the definition of a "proprietary educational
institution" as "any private school maintained and administered by private individuals or
groups" with a government permit. "Non-profit" means no net income or asset accrues
to or benefits any member or specific person, with all the net income or asset devoted to
the institution's purposes and all its activities conducted not for profit.

"Non-profit" does not necessarily mean "charitable." In Collector of Internal Revenue v.

Club Filipino Inc. de Cebu, 37this Court considered as non-profit a sports club organized
for recreation and entertainment of its stockholders and members. The club was
primarily funded by membership fees and dues. If it had profits, they were used for
overhead expenses and improving its golf course. 38 The club was non-profit because of
its purpose and there was no evidence that it was engaged in a profit-making
enterprise. 39
The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not
charitable. The Court defined "charity" in Lung Center of the Philippines v. Quezon
City 40 as "a gift, to be applied consistently with existing laws, for the benefit of an
indefinite number of persons, either by bringing their minds and hearts under the
influence of education or religion, by assisting them to establish themselves in life or
[by] otherwise lessening the burden of government." 41A non-profit club for the benefit of
its members fails this test. An organization may be considered as non-profit if it does not
distribute any part of its income to stockholders or members. However, despite its being
a tax exempt institution, any income such institution earns from activities conducted for
profit is taxable, as expressly provided in the last paragraph of Section 30.

To be a charitable institution, however, an organization must meet the substantive test

of charity in Lung Center. The issue in Lung Center concerns exemption from real
property tax and not income tax. However, it provides for the test of charity in our
jurisdiction. Charity is essentially a gift to an indefinite number of persons which lessens
the burden of government. In other words, charitable institutions provide for free goods
and services to the public which would otherwise fall on the shoulders of government.
Thus, as a matter of efficiency, the government forgoes taxes which should have been
spent to address public needs, because certain private entities already assume a part of
the burden. This is the rationale for the tax exemption of charitable institutions. The loss
of taxes by the government is compensated by its relief from doing public works which
would have been funded by appropriations from the Treasury. 42

Charitable institutions, however, are not ipso facto entitled to a tax exemption. The
requirements for a tax exemption are specified by the law granting it. The power of
Congress to tax implies the power to exempt from tax. Congress can create tax
exemptions, subject to the constitutional provision that "[n]o law granting any tax
exemption shall be passed without the concurrence of a majority of all the Members of
Congress." 43 The requirements for a tax exemption are strictly construed against the
taxpayer 44 because an exemption restricts the collection of taxes necessary for the
existence of the government.

The Court in Lung Center declared that the Lung Center of the Philippines is a
charitable institution for the purpose of exemption from real property taxes. This ruling
uses the same premise as Hospital de San Juan 45 and Jesus Sacred Heart
College 46 which says that receiving income from paying patients does not destroy the
charitable nature of a hospital.

As a general principle, a charitable institution does not lose its character as such and its
exemption from taxes simply because it derives income from paying patients, whether
out-patient, or confined in the hospital, or receives subsidies from the government, so
long as the money received is devoted or used altogether to the charitable object which
it is intended to achieve; and no money inures to the private benefit of the persons
managing or operating the institution. 47
For real property taxes, the incidental generation of income is permissible because the
test of exemption is the use of the property. The Constitution provides that "[c]haritable
institutions, churches and personages or convents appurtenant thereto, mosques, non-
profit cemeteries, and all lands, buildings, and improvements, actually, directly, and
exclusively used for religious, charitable, or educational purposes shall be exempt from
taxation." 48 The test of exemption is not strictly a requirement on the intrinsic nature or
character of the institution. The test requires that the institution use the property in a
certain way, i.e. for a charitable purpose. Thus, the Court held that the Lung Center of
the Philippines did not lose its charitable character when it used a portion of its lot for
commercial purposes. The effect of failing to meet the use requirement is simply to
remove from the tax exemption that portion of the property not devoted to charity.

The Constitution exempts charitable institutions only from real property taxes. In the
NIRC, Congress decided to extend the exemption to income taxes. However, the way
Congress crafted Section 30(E) of the NIRC is materially different from Section 28(3),
Article VI of the Constitution. Section 30(E) of the NIRC defines the corporation or
association that is exempt from income tax. On the other hand, Section 28(3), Article VI
of the Constitution does not define a charitable institution, but requires that the
institution "actually, directly and exclusively" use the property for a charitable purpose.

Section 30(E) of the NIRC provides that a charitable institution must be:

(1) A non-stock corporation or association;

(2) Organized exclusively for charitable purposes;

(3) Operated exclusively for charitable purposes; and

(4) No part of its net income or asset shall belong to or inure to the benefit of any
member, organizer, officer or any specific person.

Thus, both the organization and operations of the charitable institution must be devoted
"exclusively" for charitable purposes. The organization of the institution refers to its
corporate form, as shown by its articles of incorporation, by-laws and other constitutive
documents. Section 30(E) of the NIRC specifically requires that the corporation or
association be non-stock, which is defined by the Corporation Code as "one where no
part of its income is distributable as dividends to its members, trustees, or
officers" 49 and that any profit "obtain[ed] as an incident to its operations shall, whenever
necessary or proper, be used for the furtherance of the purpose or purposes for which
the corporation was organized." 50 However, under Lung Center, any profit by a
charitable institution must not only be plowed back "whenever necessary or proper," but
must be "devoted or used altogether to the charitable object which it is intended to
achieve." 51

The operations of the charitable institution generally refer to its regular activities.
Section 30(E) of the NIRC requires that these operations be exclusive to charity. There
is also a specific requirement that "no part of [the] net income or asset shall belong to or
inure to the benefit of any member, organizer, officer or any specific person." The use of
lands, buildings and improvements of the institution is but a part of its operations.

There is no dispute that St. Luke's is organized as a non-stock and non-profit charitable
institution. However, this does not automatically exempt St. Luke's from paying taxes.
This only refers to the organization of St. Luke's. Even if St. Luke's meets the test of
charity, a charitable institution is not ipso facto tax exempt. To be exempt from real
property taxes, Section 28(3), Article VI of the Constitution requires that a charitable
institution use the property "actually, directly and exclusively" for charitable purposes.
To be exempt from income taxes, Section 30(E) of the NIRC requires that a charitable
institution must be "organized and operated exclusively" for charitable purposes.
Likewise, to be exempt from income taxes, Section 30(G) of the NIRC requires that the
institution be "operated exclusively" for social welfare.

However, the last paragraph of Section 30 of the NIRC qualifies the words "organized
and operated exclusively" by providing that:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever

kind and character of the foregoing organizations from any of their properties, real or
personal, or from any of their activities conducted for profit regardless of the disposition
made of such income, shall be subject to tax imposed under this Code. (Emphasis
supplied)

In short, the last paragraph of Section 30 provides that if a tax exempt charitable
institution conducts "any" activity for profit, such activity is not tax exempt even as its
not-for-profit activities remain tax exempt. This paragraph qualifies the requirements in
Section 30(E) that the "[n]on-stock corporation or association [must be] organized and
operated exclusively for x x x charitable x x x purposes x x x." It likewise qualifies the
requirement in Section 30(G) that the civic organization must be "operated exclusively"
for the promotion of social welfare.

Thus, even if the charitable institution must be "organized and operated exclusively" for
charitable purposes, it is nevertheless allowed to engage in "activities conducted for
profit" without losing its tax exempt status for its not-for-profit activities. The only
consequence is that the "income of whatever kind and character" of a charitable
institution "from any of its activities conducted for profit, regardless of the disposition
made of such income, shall be subject to tax." Prior to the introduction of Section 27(B),
the tax rate on such income from for-profit activities was the ordinary corporate rate
under Section 27(A). With the introduction of Section 27(B), the tax rate is now 10%.

In 1998, St. Luke's had total revenues of ₱1,730,367,965 from services to paying
patients. It cannot be disputed that a hospital which receives approximately ₱1.73 billion
from paying patients is not an institution "operated exclusively" for charitable purposes.
Clearly, revenues from paying patients are income received from "activities conducted
for profit." 52 Indeed, St. Luke's admits that it derived profits from its paying patients. St.
Luke's declared ₱1,730,367,965 as "Revenues from Services to Patients" in contrast to
its "Free Services" expenditure of ₱218,187,498. In its Comment in G.R. No. 195909,
St. Luke's showed the following "calculation" to support its claim that 65.20% of its
"income after expenses was allocated to free or charitable services" in 1998. 53

REVENUES FROM SERVICES TO PATIENTS ₱1,730,367,965.00

OPERATING EXPENSES
Professional care of patients ₱1,016,608,394.00
Administrative 287,319,334.00
Household and Property 91,797,622.00
₱1,395,725,350.00

INCOME FROM OPERATIONS ₱334,642,615.00 100%

Free Services -218,187,498.00 -
65.20%
INCOME FROM OPERATIONS, Net of FREE ₱116,455,117.00 34.80%
SERVICES

OTHER INCOME 17,482,304.00

EXCESS OF REVENUES OVER EXPENSES ₱133,937,421.00

In Lung Center, this Court declared:

"[e]xclusive" is defined as possessed and enjoyed to the exclusion of others; debarred

from participation or enjoyment; and "exclusively" is defined, "in a manner to exclude; as
enjoying a privilege exclusively." x x x The words "dominant use" or "principal use"
cannot be substituted for the words "used exclusively" without doing violence to the
Constitution and the law. Solely is synonymous with exclusively. 54

The Court cannot expand the meaning of the words "operated exclusively" without
violating the NIRC. Services to paying patients are activities conducted for profit. They
cannot be considered any other way. There is a "purpose to make profit over and above
the cost" of services. 55 The ₱1.73 billion total revenues from paying patients is not even
incidental to St. Luke's charity expenditure of ₱218,187,498 for non-paying patients.
St. Luke's claims that its charity expenditure of ₱218,187,498 is 65.20% of its operating
income in 1998. However, if a part of the remaining 34.80% of the operating income is
reinvested in property, equipment or facilities used for services to paying and non-
paying patients, then it cannot be said that the income is "devoted or used altogether to
the charitable object which it is intended to achieve." 56 The income is plowed back to
the corporation not entirely for charitable purposes, but for profit as well. In any case,
the last paragraph of Section 30 of the NIRC expressly qualifies that income from
activities for profit is taxable "regardless of the disposition made of such income."

Jesus Sacred Heart College declared that there is no official legislative record
explaining the phrase "any activity conducted for profit." However, it quoted a deposition
of Senator Mariano Jesus Cuenco, who was a member of the Committee of Conference
for the Senate, which introduced the phrase "or from any activity conducted for profit."

P. Cuando ha hablado de la Universidad de Santo Tomás que tiene un hospital, no cree

Vd. que es una actividad esencial dicho hospital para el funcionamiento del colegio de
medicina de dicha universidad?

xxxx

R. Si el hospital se limita a recibir enformos pobres, mi contestación seria afirmativa;

pero considerando que el hospital tiene cuartos de pago, y a los mismos generalmente
van enfermos de buena posición social económica, lo que se paga por estos enfermos
debe estar sujeto a 'income tax', y es una de las razones que hemos tenido para
insertar las palabras o frase 'or from any activity conducted for profit.' 57

The question was whether having a hospital is essential to an educational institution like
the College of Medicine of the University of Santo Tomas. Senator Cuenco answered
that if the hospital has paid rooms generally occupied by people of good economic
standing, then it should be subject to income tax. He said that this was one of the
reasons Congress inserted the phrase "or any activity conducted for profit."

The question in Jesus Sacred Heart College involves an educational

institution. 58 However, it is applicable to charitable institutions because Senator
Cuenco's response shows an intent to focus on the activities of charitable institutions.
Activities for profit should not escape the reach of taxation. Being a non-stock and non-
profit corporation does not, by this reason alone, completely exempt an institution from
tax. An institution cannot use its corporate form to prevent its profitable activities from
being taxed.

The Court finds that St. Luke's is a corporation that is not "operated exclusively" for
charitable or social welfare purposes insofar as its revenues from paying patients are
concerned. This ruling is based not only on a strict interpretation of a provision granting
tax exemption, but also on the clear and plain text of Section 30(E) and (G). Section
30(E) and (G) of the NIRC requires that an institution be "operated exclusively" for
charitable or social welfare purposes to be completely exempt from income tax. An
institution under Section 30(E) or (G) does not lose its tax exemption if it earns income
from its for-profit activities. Such income from for-profit activities, under the last
paragraph of Section 30, is merely subject to income tax, previously at the ordinary
corporate rate but now at the preferential 10% rate pursuant to Section 27(B).

A tax exemption is effectively a social subsidy granted by the State because an exempt
institution is spared from sharing in the expenses of government and yet benefits from
them. Tax exemptions for charitable institutions should therefore be limited to
institutions beneficial to the public and those which improve social welfare. A profit-
making entity should not be allowed to exploit this subsidy to the detriment of the
government and other taxpayers.1âwphi1

St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to be
completely tax exempt from all its income. However, it remains a proprietary non-profit
hospital under Section 27(B) of the NIRC as long as it does not distribute any of its
profits to its members and such profits are reinvested pursuant to its corporate
purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to the preferential
tax rate of 10% on its net income from its for-profit activities.

St. Luke's is therefore liable for deficiency income tax in 1998 under Section 27(B) of
the NIRC. However, St. Luke's has good reasons to rely on the letter dated 6 June 1990
by the BIR, which opined that St. Luke's is "a corporation for purely charitable and social
welfare purposes"59 and thus exempt from income tax. 60 In Michael J. Lhuillier, Inc. v.
Commissioner of Internal Revenue, 61 the Court said that "good faith and honest belief
that one is not subject to tax on the basis of previous interpretation of government
agencies tasked to implement the tax law, are sufficient justification to delete the
imposition of surcharges and interest." 62

WHEREFORE, the petition of the Commissioner of Internal Revenue in G.R. No.

195909 is PARTLY GRANTED. The Decision of the Court of Tax Appeals En Banc
dated 19 November 2010 and its Resolution dated 1 March 2011 in CTA Case No. 6746
are MODIFIED. St. Luke's Medical Center, Inc. is ORDERED TO PAY the deficiency
income tax in 1998 based on the 10% preferential income tax rate under Section 27(B)
of the National Internal Revenue Code. However, it is not liable for surcharges and
interest on such deficiency income tax under Sections 248 and 249 of the National
Internal Revenue Code. All other parts of the Decision and Resolution of the Court of
Tax Appeals are AFFIRMED.

The petition of St. Luke's Medical Center, Inc. in G.R. No. 195960 is DENIED for
violating Section 1, Rule 45 of the Rules of Court.

SO ORDERED.

Leonardo-De Castro*, Brion, Perez, and Perlas-Bernabe, JJ., concur.

G.R. No. 124043 October 14, 1998
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
COURT OF APPEALS, COURT OF TAX APPEALS and YOUNG MEN'S CHRISTIAN
ASSOCIATION OF THE PHILIPPINES, INC., respondents.

PANGANIBAN, J.:

Is the income derived from rentals of real property owned by the Young Men's Christian
Association of the Philippines, Inc. (YMCA) — established as "a welfare, educational
and charitable non-profit corporation" — subject to income tax under the National
Internal Revenue Code (NIRC) and the Constitution?

The Case

This is the main question raised before us in this petition for review
on certiorari challenging two Resolutions issued by the Court of Appeals1 on
September 28, 19952 and February 29, 19963 in CA-GR SP No. 32007. Both
Resolutions affirmed the Decision of the Court of Tax Appeals (CTA) allowing the
YMCA to claim tax exemption on the latter's income from the lease of its real
property.

The Facts

The facts are undisputed.4 Private Respondent YMCA is a non-stock, non-profit

institution, which conducts various programs and activities that are beneficial to
the public, especially the young people, pursuant to its religious, educational and
charitable objectives.

In 1980, private respondent earned, among others, an income of P676,829.80 from

leasing out a portion of its premises to small shop owners, like restaurants and
canteen operators, and P44,259.00 from parking fees collected from non-
members. On July 2, 1984, the commissioner of internal revenue (CIR) issued an
assessment to private respondent, in the total amount of P415,615.01 including
surcharge and interest, for deficiency income tax, deficiency expanded
withholding taxes on rentals and professional fees and deficiency withholding tax
on wages. Private respondent formally protested the assessment and, as a
supplement to its basic protest, filed a letter dated October 8, 1985. In reply, the
CIR denied the claims of YMCA.

Contesting the denial of its protest, the YMCA filed a petition for review at the
Court of Tax Appeals (CTA) on March 14, 1989. In due course, the CTA issued this
ruling in favor of the YMCA:
. . . [T]he leasing of [private respondent's] facilities to small shop
owners, to restaurant and canteen operators and the operation of the
parking lot are reasonably incidental to and reasonably necessary
for the accomplishment of the objectives of the [private
respondents]. It appears from the testimonies of the witnesses for
the [private respondent] particularly Mr. James C. Delote, former
accountant of YMCA, that these facilities were leased to members
and that they have to service the needs of its members and their
guests. The rentals were minimal as for example, the barbershop
was only charged P300 per month. He also testified that there was
actually no lot devoted for parking space but the parking was done at
the sides of the building. The parking was primarily for members
with stickers on the windshields of their cars and they charged P.50
for non-members. The rentals and parking fees were just enough to
cover the costs of operation and maintenance only. The earning[s]
from these rentals and parking charges including those from lodging
and other charges for the use of the recreational facilities constitute
[the] bulk of its income which [is] channeled to support its many
activities and attainment of its objectives. As pointed out earlier, the
membership dues are very insufficient to support its program. We
find it reasonably necessary therefore for [private respondent] to
make [the] most out [of] its existing facilities to earn some income. It
would have been different if under the circumstances, [private
respondent] will purchase a lot and convert it to a parking lot to cater
to the needs of the general public for a fee, or construct a building
and lease it out to the highest bidder or at the market rate for
commercial purposes, or should it invest its funds in the buy and sell
of properties, real or personal. Under these circumstances, we could
conclude that the activities are already profit oriented, not incidental
and reasonably necessary to the pursuit of the objectives of the
association and therefore, will fall under the last paragraph of
Section 27 of the Tax Code and any income derived therefrom shall
be taxable.

Considering our findings that [private respondent] was not engaged

in the business of operating or contracting [a] parking lot, we find no
legal basis also for the imposition of [a] deficiency fixed tax and [a]
contractor's tax in the amount[s] of P353.15 and P3,129.73,
respectively.

xxx xxx xxx

WHEREFORE, in view of all the foregoing, the following assessments

are hereby dismissed for lack of merit:

1980 Deficiency Fixed Tax — P353,15;

 1980 Deficiency Contractor's Tax — P3,129.23;

1980 Deficiency Income Tax — P372,578.20.

While the following assessments are hereby sustained:

1980 Deficiency Expanded Withholding Tax — P1,798.93;

1980 Deficiency Withholding Tax on Wages — P33,058.82

plus 10% surcharge and 20% interest per annum from July 2, 1984
until fully paid but not to exceed three (3) years pursuant to Section
51(e)(2) & (3) of the National Internal Revenue Code effective as of
1984. 5

Dissatisfied with the CTA ruling, the CIR elevated the case to the Court of
Appeals (CA). In its Decision of February 16, 1994, the CA6 initially decided in
favor of the CIR and disposed of the appeal in the following manner:

Following the ruling in the afore-cited cases of Province of Abra vs.

Hernando and Abra Valley College Inc. vs. Aquino, the ruling of the
respondent Court of Tax Appeals that "the leasing of petitioner's
(herein respondent's) facilities to small shop owners, to restaurant
and canteen operators and the operation of the parking lot are
reasonably incidental to and reasonably necessary for the
accomplishment of the objectives of the petitioners, and the income
derived therefrom are tax exempt, must be reversed.

WHEREFORE, the appealed decision is hereby REVERSED in so far

as it dismissed the assessment for:

1980 Deficiency Income Tax P 353.15

1980 Deficiency Contractor's Tax P 3,129.23, &

1980 Deficiency Income Tax P 372,578.20

but the same is AFFIRMED in all other respect. 7

Aggrieved, the YMCA asked for reconsideration based on the following grounds:

The findings of facts of the Public Respondent Court of Tax Appeals

being supported by substantial evidence [are] final and conclusive.
 II

The conclusions of law of [p]ublic [r]espondent exempting [p]rivate

[r]espondent from the income on rentals of small shops and parking
fees [are] in accord with the applicable law and jurisprudence. 8

Finding merit in the Motion for Reconsideration filed by the YMCA, the CA
reversed itself and promulgated on September 28, 1995 its first assailed
Resolution which, in part, reads:

The Court cannot depart from the CTA's findings of fact, as they are
supported by evidence beyond what is considered as substantial.

xxx xxx xxx

The second ground raised is that the respondent CTA did not err in
saying that the rental from small shops and parking fees do not
result in the loss of the exemption. Not even the petitioner would
hazard the suggestion that YMCA is designed for profit.
Consequently, the little income from small shops and parking fees
help[s] to keep its head above the water, so to speak, and allow it to
continue with its laudable work.

The Court, therefore, finds the second ground of the motion to be

meritorious and in accord with law and jurisprudence.

WHEREFORE, the motion for reconsideration is GRANTED; the

respondent CTA's decision is AFFIRMED in toto.9

The internal revenue commissioner's own Motion for Reconsideration was denied
by Respondent Court in its second assailed Resolution of February 29, 1996.
Hence, this petition for review under Rule 45 of the Rules of Court. 10

The Issues

Before us, petitioner imputes to the Court of Appeals the following errors:

In holding that it had departed from the findings of fact of

Respondent Court of Tax Appeals when it rendered its Decision
dated February 16, 1994; and

II
 In affirming the conclusion of Respondent Court of Tax Appeals that
the income of private respondent from rentals of small shops and
parking fees [is] exempt from taxation. 11

This Court's Ruling

The petition is meritorious.

First Issue:
Factual Findings of the CTA

Private respondent contends that the February 16, 1994 CA Decision reversed the
factual findings of the CTA. On the other hand, petitioner argues that the CA
merely reversed the "ruling of the CTA that the leasing of private respondent's
facilities to small shop owners, to restaurant and canteen operators and the
operation of parking lots are reasonably incidental to and reasonably necessary
for the accomplishment of the objectives of the private respondent and that the
income derived therefrom are tax exempt." 12 Petitioner insists that what the
appellate court reversed was the legal conclusion, not the factual finding, of the
CTA. 13The commissioner has a point.

Indeed, it is a basic rule in taxation that the factual findings of the CTA, when
supported by substantial evidence, will be disturbed on appeal unless it is shown
that the said court committed gross error in the appreciation of facts. 14 In the
present case, this Court finds that the February 16, 1994 Decision of the CA did
not deviate from this rule. The latter merely applied the law to the facts as found
by the CTA and ruled on the issue raised by the CIR: "Whether or not the
collection or earnings of rental income from the lease of certain premises and
income earned from parking fees shall fall under the last paragraph of Section 27
of the National Internal Revenue Code of 1977, as amended." 15

Clearly, the CA did not alter any fact or evidence. It merely resolved the
aforementioned issue, as indeed it was expected to. That it did so in a manner
different from that of the CTA did not necessarily imply a reversal of factual
findings.

The distinction between a question of law and a question of fact is clear-cut. It

has been held that "[t]here is a question of law in a given case when the doubt or
difference arises as to what the law is on a certain state of facts; there is a
question of fact when the doubt or difference arises as to the truth or falsehood
of alleged facts." 16 In the present case, the CA did not doubt, much less change,
the facts narrated by the CTA. It merely applied the law to the facts. That its
interpretation or conclusion is different from that of the CTA is not irregular or
abnormal.
 Second Issue:
Is the Rental Income of the YMCA Taxable?

We now come to the crucial issue: Is the rental income of the YMCA from its real
estate subject to tax? At the outset, we set forth the relevant provision of the
NIRC:

Sec. 27. Exemptions from tax on corporations. — The following

organizations shall not be taxed under this Title in respect to income
received by them as such —

xxx xxx xxx

(g) Civic league or organization not organized for profit but operated
exclusively for the promotion of social welfare;

(h) Club organized and operated exclusively for pleasure, recreation,

and other non-profitable purposes, no part of the net income of
which inures to the benefit of any private stockholder or member;

xxx xxx xxx

Notwithstanding the provisions in the preceding paragraphs, the

income of whatever kind and character of the foregoing
organizations from any of their properties, real or personal, or from
any of their activities conducted for profit, regardless of the
disposition made of such income, shall be subject to the tax
imposed under this Code. (as amended by Pres. Decree No. 1457)

Petitioner argues that while the income received by the organizations enumerated
in Section 27 (now Section 26) of the NIRC is, as a rule, exempted from the
payment of tax "in respect to income received by them as such," the exemption
does not apply to income derived ". . . from any of their properties, real or
personal, or from any of their activities conducted for profit, regardless of the
disposition made of such income . . . ."

Petitioner adds that "rental income derived by a tax-exempt organization from the
lease of its properties, real or personal, [is] not, therefore, exempt from income
taxation, even if such income [is] exclusively used for the accomplishment of its
objectives." 17 We agree with the commissioner.

Because taxes are the lifeblood of the nation, the Court has always applied the
doctrine of strict in interpretation in construing tax exemptions. 18 Furthermore, a
claim of statutory exemption from taxation should be manifest. and unmistakable
from the language of the law on which it is based. Thus, the claimed exemption
"must expressly be granted in a statute stated in a language too clear to be
mistaken." 19

In the instant case, the exemption claimed by the YMCA is expressly disallowed
by the very wording of the last paragraph of then Section 27 of the NIRC which
mandates that the income of exempt organizations (such as the YMCA) from any
of their properties, real or personal, be subject to the tax imposed by the same
Code. Because the last paragraph of said section unequivocally subjects to tax
the rent income of the YMCA from its real property, 20 the Court is duty-bound to
abide strictly by its literal meaning and to refrain from resorting to any
convoluted attempt at construction.

It is axiomatic that where the language of the law is clear and unambiguous, its
express terms must be applied. 21 Parenthetically, a consideration of the question
of construction must not even begin, particularly when such question is on
whether to apply a strict construction or a liberal one on statutes that grant tax
exemptions to "religious, charitable and educational propert[ies] or
institutions." 22

The last paragraph of Section 27, the YMCA argues, should be "subject to the
qualification that the income from the properties must arise from activities
'conducted for profit' before it may be considered taxable." 23This argument is
erroneous. As previously stated, a reading of said paragraph ineludibly shows
that the income from any property of exempt organizations, as well as that arising
from any activity it conducts for profit, is taxable. The phrase "any of their
activities conducted for profit" does not qualify the word "properties." This
makes from the property of the organization taxable, regardless of how that
income is used — whether for profit or for lofty non-profit purposes.

Verba legis non est recedendum. Hence, Respondent Court of Appeals committed
reversible error when it allowed, on reconsideration, the tax exemption claimed
by YMCA on income it derived from renting out its real property, on the solitary
but unconvincing ground that the said income is not collected for profit but is
merely incidental to its operation. The law does not make a distinction. The rental
income is taxable regardless of whence such income is derived and how it is
used or disposed of. Where the law does not distinguish, neither should we.

Constitutional Provisions

On Taxation

Invoking not only the NIRC but also the fundamental law, private respondent
submits that Article VI, Section 28 of par. 3 of the 1987 Constitution, 24 exempts
"charitable institutions" from the payment not only of property taxes but also of
income tax from any source. 25 In support of its novel theory, it compares the use
of the words "charitable institutions," "actually" and "directly" in the 1973 and the
1987 Constitutions, on the one hand; and in Article VI, Section 22, par. 3 of the
1935 Constitution, on the other hand. 26

Private respondent enunciates three points. First, the present provision is

divisible into two categories: (1) "[c]haritable institutions, churches and
parsonages or convents appurtenant thereto, mosques and non-profit
cemeteries," the incomes of which are, from whatever source, all tax-
exempt; 27 and (2) "[a]ll lands, buildings and improvements actually and directly
used for religious, charitable or educational purposes," which are exempt only
from property taxes. 28 Second, Lladoc v. Commissioner of Internal
Revenue, 29which limited the exemption only to the payment of property taxes,
referred to the provision of the 1935 Constitution and not to its counterparts in
the 1973 and the 1987 Constitutions. 30 Third, the phrase "actually, directly and
exclusively used for religious, charitable or educational purposes" refers not only
to "all lands, buildings and improvements," but also to the above-quoted first
category which includes charitable institutions like the private respondent. 31

The Court is not persuaded. The debates, interpellations and expressions of

opinion of the framers of the Constitution reveal their intent which, in turn, may
have guided the people in ratifying the Charter. 32 Such intent must be
effectuated.

Accordingly, Justice Hilario G. Davide, Jr., a former constitutional commissioner,

who is now a member of this Court, stressed during the Concom debates that ". .
. what is exempted is not the institution itself . . .; those exempted from real estate
taxes are lands, buildings and improvements actually, directly and exclusively
used for religious, charitable or educational
purposes." 33 Father Joaquin G. Bernas, an eminent authority on the Constitution
and also a member of the Concom, adhered to the same view that the exemption
created by said provision pertained only to property taxes. 34

In his treatise on taxation, Mr. Justice Jose C. Vitug concurs, stating that "[t]he
tax exemption coversproperty taxes only." 35 Indeed, the income tax exemption
claimed by private respondent finds no basis in Article VI, Section 26, par. 3 of
the Constitution.

Private respondent also invokes Article XIV, Section 4, par. 3 of the

Character, 36 claiming that the YMCA "is a non-stock, non-profit educational
institution whose revenues and assets are used actually, directly and exclusively
for educational purposes so it is exempt from taxes on its properties and
income." 37 We reiterate that private respondent is exempt from the payment of
property tax, but not income tax on the rentals from its property. The bare
allegation alone that it is a non-stock, non-profit educational institution is
insufficient to justify its exemption from the payment of income tax.
As previously discussed, laws allowing tax exemption are construed strictissimi
juris. Hence, for the YMCA to be granted the exemption it claims under the
aforecited provision, it must prove with substantial evidence that (1) it falls under
the classification non-stock, non-profit educational institution; and (2) the income
it seeks to be exempted from taxation is used actually, directly, and exclusively
for educational purposes. However, the Court notes that not a scintilla of
evidence was submitted by private respondent to prove that it met the said
requisites.

Is the YMCA an educational institution within the purview of Article XIV, Section
4, par. 3 of the Constitution? We rule that it is not. The term "educational
institution" or "institution of learning" has acquired a well-known technical
meaning, of which the members of the Constitutional Commission are deemed
cognizant. 38 Under the Education Act of 1982, such term refers to schools. 39 The
school system is synonymous with formal education, 40 which "refers to the
hierarchically structured and chronologically graded learnings organized and
provided by the formal school system and for which certification is required in
order for the learner to progress through the grades or move to the higher
levels." 41 The Court has examined the "Amended Articles of Incorporation" and
"By-Laws"43 of the YMCA, but found nothing in them that even hints that it is a
school or an educational institution. 44

Furthermore, under the Education Act of 1982, even non-formal education is

understood to be school-based and "private auspices such as foundations and
civic-spirited organizations" are ruled out. 45 It is settled that the term
"educational institution," when used in laws granting tax exemptions, refers to a
". . . school seminary, college or educational establishment . . . ." 46 Therefore, the
private respondent cannot be deemed one of the educational institutions covered
by the constitutional provision under consideration.

. . . Words used in the Constitution are to be taken in their ordinary

acceptation. While in its broadest and best sense education
embraces all forms and phases of instruction, improvement and
development of mind and body, and as well of religious and moral
sentiments, yet in the common understanding and application it
means a place where systematic instruction in any or all of the useful
branches of learning is given by methods common to schools and
institutions of learning. That we conceive to be the true intent and
scope of the term [educational institutions,] as used in the
Constitution. 47

Moreover, without conceding that Private Respondent YMCA is an educational

institution, the Court also notes that the former did not submit proof of the
proportionate amount of the subject income that was actually, directly and
exclusively used for educational purposes. Article XIII, Section 5 of the YMCA by-
laws, which formed part of the evidence submitted, is patently insufficient, since
the same merely signified that "[t]he net income derived from the rentals of the
commercial buildings shall be apportioned to the Federation and Member
Associations as the National Board may decide." 48 In sum, we find no basis for
granting the YMCA exemption from income tax under the constitutional provision
invoked.

Cases Cited by Private

Respondent Inapplicable

The cases 49 relied on by private respondent do not support its cause. YMCA of
Manila v. Collector of Internal Revenue 50 and Abra Valley College, Inc. v.
Aquino 51 are not applicable, because the controversy in both cases involved
exemption from the payment of property tax, not income tax. Hospital de San
Juan de Dios, Inc. v. Pasay City 52 is not in point either, because it involves a
claim for exemption from the payment of regulatory fees, specifically electrical
inspection fees, imposed by an ordinance of Pasay City — an issue not at all
related to that involved in a claimed exemption from the payment of income taxes
imposed on property leases. In Jesus Sacred Heart College v. Com. of Internal
Revenue, 53 the party therein, which claimed an exemption from the payment of
income tax, was an educational institution which submitted substantial evidence
that the income subject of the controversy had been devoted or used solely for
educational purposes. On the other hand, the private respondent in the present
case has not given any proof that it is an educational institution, or that part of its
rent income is actually, directly and exclusively used for educational purposes.

Epilogue

In deliberating on this petition, the Court expresses its sympathy with private
respondent. It appreciates the nobility of its cause. However, the Court's power
and function are limited merely to applying the law fairly and objectively. It cannot
change the law or bend it to suit its sympathies and appreciations. Otherwise, it
would be overspilling its role and invading the realm of legislation.

We concede that private respondent deserves the help and the encouragement of
the government. It needs laws that can facilitate, and not frustrate, its
humanitarian tasks. But the Court regrets that, given its limited constitutional
authority, it cannot rule on the wisdom or propriety of legislation. That
prerogative belongs to the political departments of government. Indeed, some of
the members of the Court may even believe in the wisdom and prudence of
granting more tax exemptions to private respondent. But such belief, however
well-meaning and sincere, cannot bestow upon the Court the power to change or
amend the law.

WHEREFORE, the petition is GRANTED. The Resolutions of the Court of Appeals

dated September 28, 1995 and February 29, 1996 are hereby REVERSED and SET
ASIDE. The Decision of the Court of Appeals dated February 16, 1995 is
REINSTATED, insofar as it ruled that the income derived by petitioner from
rentals of its real property is subject to income tax. No pronouncement as to
costs.

SO ORDERED.

Davide, Jr., Vitug and Quisumbing, JJ., concur.

Bellosillo, J., Please see Dissenting Opinion.

 November 9, 2016

G.R. No. 196596

COMMISSIONER OF INTERNAL REVENUE, Petitioner

vs.
DE LA SALLE UNIVERSITY, INC., Respondent

x-----------------------x

G.R. No. 198841

DE LA SALLE UNIVERSITY INC., Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

x-----------------------x

G.R. No. 198941

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
DE LA SALLE UNIVERSITY, INC., Respondent.

DECISION

BRION, J.:

Before the Court are consolidated petitions for review on certiorari:1

1. G.R. No. 196596 filed by the Commissioner of Internal Revenue (Commissioner) to

assail the December 10, 2010 decision and March 29, 2011 resolution of the Court of
Tax Appeals (CTA) in En Banc Case No. 622;2

2. G.R. No. 198841 filed by De La Salle University, Inc. (DLSU) to assail the June 8,
2011 decision and October 4, 2011 resolution in CTA En Banc Case No. 671;3 and

3. G.R. No. 198941 filed by the Commissioner to assail the June 8, 2011 decision and
October 4, 2011 resolution in CTA En Banc Case No. 671.4

G.R. Nos. 196596, 198841 and 198941 all originated from CTA Special First
Division (CTA Division) Case No. 7303. G.R. No. 196596 stemmed from CTA En
Banc Case No. 622 filed by the Commissioner to challenge CTA Case No. 7303. G.R.
No. 198841 and 198941 both stemmed from CTA En Banc Case No. 671 filed by
DLSU to also challenge CTA Case No. 7303.
 The Factual Antecedents

Sometime in 2004, the Bureau of Internal Revenue (BIR) issued to DLSU Letter of
Authority (LOA) No. 2794 authorizing its revenue officers to examine the latter's books
of accounts and other accounting records for all internal revenue taxes for the
period Fiscal Year Ending 2003 and Unverified Prior Years.5

On May 19, 2004, BIR issued a Preliminary Assessment Notice to DLSU.6

Subsequently on August 18, 2004, the BIR through a Formal Letter of

Demand assessed DLSU the following deficiency taxes: (1) income tax on rental
earnings from restaurants/canteens and bookstores operating within the campus;
(2) value-added tax (VAI) on business income; and (3) documentary stamp tax (DSI) on
loans and lease contracts. The BIR demanded the payment of ₱17,303,001.12,
inclusive of surcharge, interest and penalty for taxable years 2001, 2002 and 2003.7

DLSU protested the assessment. The Commissioner failed to act on the protest; thus,
DLSU filed on August 3, 2005 a petition for review with the CTA Division.8

DLSU, a non-stock, non-profit educational institution, principally anchored its petition

on Article XIV, Section 4 (3)of the Constitution, which reads:

(3) All revenues and assets of non-stock, non-profit educational institutions used
actually, directly, and exclusively for educational purposes shall be exempt from taxes
and duties. xxx.

On January 5, 2010, the CTA Division partially granted DLSU's petition for review. The
dispositive portion of the decision reads:

WHEREFORE, the Petition for Review is PARTIALLY GRANTED. The DST

assessment on the loan transactions of [DLSU] in the amount of ₱1,1681,774.00 is
hereby CANCELLED. However, [DLSU] is ORDERED TO PAY deficiency income tax,
VAT and DST on its lease contracts, plus 25% surcharge for the fiscal years 2001, 2002
and 2003 in the total amount of ₱18,421,363.53 ... xxx.

In addition, [DLSU] is hereby held liable to pay 20% delinquency interest on the total
amount due computed from September 30, 2004 until full payment thereof pursuant to
Section 249(C)(3) of the [National Internal Revenue Code]. Further, the compromise
penalties imposed by [the Commissioner] were excluded, there being no compromise
agreement between the parties.

SO ORDERED.9

Both the Commissioner and DLSU moved for the reconsideration of the January 5,
2010 decision.10 On April 6, 2010, the CTA Division denied the Commissioner's motion
for reconsideration while it held in abeyance the resolution on DLSU's motion for
reconsideration.11

On May 13, 2010, the Commissioner appealed to the CTA En Banc (CTA En
Banc Case No. 622) arguing that DLSU's use of its revenues and assets for non-
educational or commercial purposes removed these items from the exemption coverage
under the Constitution.12

On May 18, 2010, DLSU formally offered to the CTA Division supplemental pieces of
documentary evidence to prove that its rental income was used actually, directly and
exclusively for educational purposes.13 The Commissioner did not promptly object to the
formal offer of supplemental evidence despite notice.14

On July 29, 2010, the CTA Division, in view of the supplemental evidence submitted,
reduced the amount of DLSU's tax deficiencies. The dispositive portion of the amended
decision reads:

WHEREFORE, [DLSU]'s Motion for Partial Reconsideration is hereby PARTIALLY

GRANTED. [DLSU] is hereby ORDERED TO PAY for deficiency income tax, VAT and
DST plus 25% surcharge for the fiscal years 2001, 2002 and 2003 in the total adjusted
amount of ₱5,506,456.71 ... xxx.

In addition, [DLSU] is hereby held liable to pay 20% per annum deficiency interest on
the ... basic deficiency taxes ... until full payment thereof pursuant to Section 249(B) of
the [National Internal Revenue Code] ... xxx.

Further, [DLSU] is hereby held liable to pay 20% per annum delinquency interest on the
deficiency taxes, surcharge and deficiency interest which have accrued ... from
September 30, 2004 until fully paid.15

Consequently, the Commissioner supplemented its petition with the CTA En Banc and
argued that the CTA Division erred in admitting DLSU's additional evidence. 16

Dissatisfied with the partial reduction of its tax liabilities, DLSU filed a separate petition
for review with the CTA En Banc (CTA En Banc Case No. 671) on the following
grounds: (1) the entire assessment should have been cancelled because it was based
on an invalid LOA; (2) assuming the LOA was valid, the CTA Division should still have
cancelled the entire assessment because DLSU submitted evidence similar to those
submitted by Ateneo De Manila University (Ateneo) in a separate case where the CTA
cancelled Ateneo's tax assessment;17 and (3) the CTA Division erred in finding that
a portion of DLSU's rental income was not proved to have been used actually, directly
and exclusively for educational purposes.18

The CTA En Banc Rulings

CTA En Banc Case No. 622

The CTA En Banc dismissed the Commissioner's petition for review and sustained the
findings of the CTA Division.19

Tax on rental income

Relying on the findings of the court-commissioned Independent Certified Public

Accountant (Independent CPA), the CTA En Banc found that DLSU was able to prove
that a portion of the assessed rental income was used actually, directly and exclusively
for educational purposes; hence, exempt from tax.20 The CTA En Banc was satisfied
with DLSU's supporting evidence confirming that part of its rental income had indeed
been used to pay the loan it obtained to build the university's Physical Education –
Sports Complex.21

Parenthetically, DLSU's unsubstantiated claim for exemption, i.e., the part of its income
that was not shown by supporting documents to have been actually, directly and
exclusively used for educational purposes, must be subjected to income tax and VAT.22

DST on loan and mortgage transactions

Contrary to the Commissioner's contention, DLSU froved its remittance of the DST due
on its loan and mortgage documents.23 The CTA En Banc found that DLSU's DST
payments had been remitted to the BIR, evidenced by the stamp on the documents
made by a DST imprinting machine, which is allowed under Section 200 (D) of the
National Internal Revenue Code (Tax Code)24 and Section 2 of Revenue Regulations
(RR) No. 15-2001.25

Admissibility of DLSU's supplemental evidence

The CTA En Banc held that the supplemental pieces of documentary evidence were
admissible even if DLSU formally offered them only when it moved for reconsideration
of the CTA Division's original decision. Notably, the law creating the CTA provides that
proceedings before it shall not be governed strictly by the technical rules of evidence.26

The Commissioner moved but failed to obtain a reconsideration of the CTA En

Banc's December 10, 2010 decision.27 Thus, she came to this court for relief through a
petition for review on certiorari (G.R. No. 196596).

CTA En Banc Case No. 671

The CTA En Banc partially granted DLSU's petition for review and further reduced its
tax liabilities to ₱2,554,825.47inclusive of surcharge.28

On the validity of the Letter of Authority

The issue of the LOA' s validity was raised during trial;29 hence, the issue was deemed
properly submitted for decision and reviewable on appeal.
Citing jurisprudence, the CTA En Banc held that a LOA should cover only one taxable
period and that the practice of issuing a LOA covering audit of unverified prior years is
prohibited.30 The prohibition is consistent with Revenue Memorandum Order (RMO) No.
43-90, which provides that if the audit includes more than one taxable period, the other
periods or years shall be specifically indicated in the LOA.31

In the present case, the LOA issued to DLSU is for Fiscal Year Ending 2003 and
Unverified Prior Years. Hence, the assessments for deficiency income tax, VAT and
DST for taxable years 2001 and 2002 are void, but the assessment for taxable
year 2003 is valid.32

On the applicability of the Ateneo case

The CTA En Banc held that the Ateneo case is not a valid precedent because it
involved different parties, factual settings, bases of assessments, sets of evidence, and
defenses.33

On the CTA Division's appreciation of the evidence

The CTA En Banc affirmed the CTA Division's appreciation of DLSU' s evidence. It held
that while DLSU successfully proved that a portion of its rental income was transmitted
and used to pay the loan obtained to fund the construction of the Sports Complex, the
rental income from other sources were not shown to have been actually, directly and
exclusively used for educational purposes.34

Not pleased with the CTA En Banc's ruling, both DLSU (G.R. No. 198841) and the
Commissioner (G.R. No. 198941) came to this Court for relief.

The Consolidated Petitions

G.R. No. 196596

The Commissioner submits the following arguments:

First, DLSU's rental income is taxable regardless of how such income is derived, used
or disposed of.35 DLSU's operations of canteens and bookstores within its campus even
though exclusively serving the university community do not negate income tax liability. 36

The Commissioner contends that Article XIV, Section 4 (3) of the Constitution must be
harmonized with Section 30 (H) of the Tax Code, which states among others, that the
income of whatever kind and character of [a non-stock and non-profit educational
institution] from any of [its] properties, real or personal, or from any of [its] activities
conducted for profit regardless of the disposition made of such income, shall be subject
to tax imposed by this Code.37
The Commissioner argues that the CTA En Banc misread and misapplied the case
of Commissioner of Internal Revenue v. YMCA38 to support its conclusion that
revenues however generated are covered by the constitutional exemption, provided
that, the revenues will be used for educational purposes or will be held in reserve for
such purposes.39

On the contrary, the Commissioner posits that a tax-exempt organization like DLSU is
exempt only from property tax but not from income tax on the rentals earned from
property.40 Thus, DLSU's income from the leases of its real properties is not exempt
from taxation even if the income would be used for educational purposes. 41

Second, the Commissioner insists that DLSU did not prove the fact of DST
payment42 and that it is not qualified to use the On-Line Electronic DST Imprinting
Machine, which is available only to certain classes of taxpayers under RR No. 9-2000.43

Finally, the Commissioner objects to the admission of DLSU's supplemental offer of

evidence. The belated submission of supplemental evidence reopened the case for trial,
and worse, DLSU offered the supplemental evidence only after it received the
unfavorable CTA Division's original decision.44 In any case, DLSU's submission of
supplemental documentary evidence was unnecessary since its rental income was
taxable regardless of its disposition.45

G.R. No. 198841

DLSU argues as that:

First, RMO No. 43-90 prohibits the practice of issuing a LOA with any indication
of unverified prior years. A LOA issued contrary to RMO No. 43-90 is void, thus, an
assessment issued based on such defective LOA must also be void.46

DLSU points out that the LOA issued to it covered the Fiscal Year Ending 2003 and
Unverified Prior Years. On the basis of this defective LOA, the Commissioner assessed
DLSU for deficiency income tax, VAT and DST for taxable years 2001, 2002 and
2003.47 DLSU objects to the CTA En Banc's conclusion that the LOA is valid for taxable
year 2003. According to DLSU, when RMO No. 43-90 provides that:

The practice of issuing [LOAs] covering audit of 'unverified prior years' is hereby
prohibited.

it refers to the LOA which has the format "Base Year + Unverified Prior Years." Since
the LOA issued to DLSU follows this format, then any assessment arising from it must
be entirely voided.48

Second, DLSU invokes the principle of uniformity in taxation, which mandates that for
similarly situated parties, the same set of evidence should be appreciated and weighed
in the same manner.49 The CTA En Banc erred when it did not similarly appreciate
DLSU' s evidence as it did to the pieces of evidence submitted by Ateneo, also a non-
stock, non-profit educational institution.50

G.R. No. 198941

The issues and arguments raised by the Commissioner in G.R. No. 198941 petition
are exactly the same as those she raised in her: (1) petition docketed as G.R. No.
196596 and (2) comment on DLSU's petition docketed as G.R. No. 198841. 51

Counter-arguments

DLSU's Comment on G.R. No. 196596

First, DLSU questions the defective verification attached to the petition.52

Second, DLSU stresses that Article XIV, Section 4 (3) of the Constitution is clear that all
assets and revenues of non-stock, non-profit educational institutions used actually,
directly and exclusively for educational purposes are exempt from taxes and duties. 53

On this point, DLSU explains that: (1) the tax exemption of non-stock, non-profit
educational institutions is novel to the 1987 Constitution and that Section 30 (H) of
the 1997 Tax Code cannot amend the 1987 Constitution;54 (2) Section 30 of the 1997
Tax Code is almost an exact replica of Section 26 of the 1977 Tax Code -with the
addition of non-stock, non-profit educational institutions to the list of tax-exempt entities;
and (3) that the 1977 Tax Code was promulgated when the 1973 Constitution was still
in place.

DLSU elaborates that the tax exemption granted to a private educational institution
under the 1973 Constitution was only for real property tax. Back then, the special tax
treatment on income of private educational institutions only emanates from
statute, i.e., the 1977 Tax Code. Only under the 1987 Constitution that exemption from
tax of all the assets and revenues of non-stock, non-profit educational institutions used
actually, directly and exclusively for educational purposes, was expressly and
categorically enshrined.55

DLSU thus invokes the doctrine of constitutional supremacy, which renders any
subsequent law that is contrary to the Constitution void and without any force and
effect.56 Section 30 (H) of the 1997 Tax Code insofar as it subjects to tax the income of
whatever kind and character of a non-stock and non-profit educational institution from
any of its properties, real or personal, or from any of its activities conducted for
profit regardless of the disposition made of such income, should be declared without
force and effect in view of the constitutionally granted tax exemption on "all revenues
and assets of non-stock, non-profit educational institutions used actually, directly, and
exclusively for educational purposes."57
DLSU further submits that it complies with the requirements enunciated in
the YMCA case, that for an exemption to be granted under Article XIV, Section 4 (3) of
the Constitution, the taxpayer must prove that: (1) it falls under the classification non-
stock, non-profit educational institution; and (2) the income it seeks to be exempted
from taxation is used actually, directly and exclusively for educational purposes.58 Unlike
YMCA, which is not an educational institution, DLSU is undisputedly a non-stock, non-
profit educational institution. It had also submitted evidence to prove that it actually,
directly and exclusively used its income for educational purposes.59

DLSU also cites the deliberations of the 1986 Constitutional Commission where they
recognized that the tax exemption was granted "to incentivize private educational
institutions to share with the State the responsibility of educating the youth." 60

Third, DLSU highlights that both the CTA En Banc and Division found that the bank that
handled DLSU' s loan and mortgage transactions had remitted to the BIR the DST
through an imprinting machine, a method allowed under RR No. 15-2001.61 In any case,
DLSU argues that it cannot be held liable for DST owing to the exemption granted under
the Constitution.62

Finally, DLSU underscores that the Commissioner, despite notice, did not oppose the
formal offer of supplemental evidence. Because of the Commissioner's failure to timely
object, she became bound by the results of the submission of such supplemental
evidence.63

The CIR's Comment on G.R. No. 198841

The Commissioner submits that DLSU is estopped from questioning the LOA's validity
because it failed to raise this issue in both the administrative and judicial
proceedings.64 That it was asked on cross-examination during the trial does not make it
an issue that the CTA could resolve.65 The Commissioner also maintains that DLSU's
rental income is not tax-exempt because an educational institution is only exempt from
property tax but not from tax on the income earned from the property.66

DLSU's Comment on G.R. No. 198941

DLSU puts forward the same counter-arguments discussed above.67 In addition, DLSU
prays that the Court award attorney's fees in its favor because it was constrained to
unnecessarily retain the services of counsel in this separate petition.68

Issues

Although the parties raised a number of issues, the Court shall decide only the pivotal
issues, which we summarize as follows:
 I. Whether DLSU' s income and revenues proved to have been used actually,
directly and exclusively for educational purposes are exempt from duties and
taxes;

II. Whether the entire assessment should be voided because of the defective
LOA;

III. Whether the CTA correctly admitted DLSU's supplemental pieces of evidence;
and

IV. Whether the CTA's appreciation of the sufficiency of DLSU's evidence may be
disturbed by the Court.

Our Ruling

As we explain in full below, we rule that:

I. The income, revenues and assets of non-stock, non-profit educational

institutions proved to have been used actually, directly and exclusively for
educational purposes are exempt from duties and taxes.

II. The LOA issued to DLSU is not entirely void. The assessment for taxable year
2003 is valid.

III. The CTA correctly admitted DLSU's formal offer of supplemental evidence;
and

IV. The CTA's appreciation of evidence is conclusive unless the CTA is shown to
have manifestly overlooked certain relevant facts not disputed by the parties and
which, if properly considered, would justify a different conclusion.

The parties failed to convince the Court that the CTA overlooked or failed to consider
relevant facts. We thus sustain the CTA En Banc's findings that:

a. DLSU proved that a portion of its rental income was used actually, directly and
exclusively for educational purposes; and

b. DLSU proved the payment of the DST through its bank's on-line imprinting
machine.

I. The revenues and assets of non-stock,

non-profit educational institutions
proved to have been used actually,
directly, and exclusively for educational
purposes are exempt from duties and
taxes.
DLSU rests it case on Article XIV, Section 4 (3) of the 1987 Constitution, which reads:

(3) All revenues and assets of non-stock, non-profit educational institutions used
actually, directly, and exclusively for educational purposes shall
be exempt from taxes and duties. Upon the dissolution or cessation of the corporate
existence of such institutions, their assets shall be disposed of in the manner provided
by law.

Proprietary educational institutions, including those cooperatively owned, may

likewise be entitled to such exemptions subject to
the limitations provided by law including restrictions on dividends and provisions for
reinvestment. [underscoring and emphasis supplied]

Before fully discussing the merits of the case, we observe that:

First, the constitutional provision refers to two kinds of educational institutions: (1) non-
stock, non-profit educational institutions and (2) proprietary educational institutions.69

Second, DLSU falls under the first category. Even the Commissioner admits the status
of DLSU as a non-stock, non-profit educational institution.70

Third, while DLSU's claim for tax exemption arises from and is based on the
Constitution, the Constitution, in the same provision, also imposes certain conditions to
avail of the exemption. We discuss below the import of the constitutional text vis-a-
vis the Commissioner's counter-arguments.

Fourth, there is a marked distinction between the treatment of non-stock, non-profit

educational institutions and proprietary educational institutions. The tax exemption
granted to non-stock, non-profit educational institutions is conditioned only on the
actual, direct and exclusive use of their revenues and assets for educational purposes.
While tax exemptions may also be granted to proprietary educational institutions, these
exemptions may be subject to limitations imposed by Congress.

As we explain below, the marked distinction between a non-stock, non-profit and a

proprietary educational institution is crucial in determining the nature and extent of the
tax exemption granted to non-stock, non-profit educational institutions.

The Commissioner opposes DLSU's claim for tax exemption on the basis of Section 30
(H) of the Tax Code. The relevant text reads:

The following organizations shall not be taxed under this Title [Tax on

Income] in respect to income received by them as such:

xxxx
(H) A non-stock and non-profit educational institution

xxxx

Notwithstanding the provisions in the preceding paragraphs, the income of whatever

kind and character of the foregoing organizations from any of their properties, real
or personal, or from any of their activities conducted for
profit regardless of the disposition made of such income shall be subject to tax
imposed under this Code. [underscoring and emphasis supplied]

The Commissioner posits that the 1997 Tax Code qualified the tax exemption granted to
non-stock, non-profit educational institutions such that the revenues and income they
derived from their assets, or from any of their activities conducted for profit, are
taxable even if these revenues and income are used for educational purposes.

Did the 1997 Tax Code qualify the tax exemption constitutionally-granted to non-stock,
non-profit educational institutions?

We answer in the negative.

While the present petition appears to be a case of first impression,71 the Court in
the YMCA case had in fact already analyzed and explained the meaning of Article XIV,
Section 4 (3) of the Constitution. The Court in that case made doctrinal pronouncements
that are relevant to the present case.

The issue in YMCA was whether the income derived from rentals of real property owned
by the YMCA, established as a "welfare, educational and charitable non-profit
corporation," was subject to income tax under the Tax Code and the Constitution. 72

The Court denied YMCA's claim for exemption on the ground that as a charitable
institution falling under Article VI, Section 28 (3) of the Constitution,73 the YMCA is not
tax-exempt per se; " what is exempted is not the institution itself... those exempted from
real estate taxes are lands, buildings and improvements actually, directly and
exclusively used for religious, charitable or educational purposes." 74

The Court held that the exemption claimed by the YMCA is expressly disallowed by
the last paragraph of then Section 27 (now Section 30) of the Tax Code, which
mandates that the income of exempt organizations from any of their properties, real or
personal, are subject to the same tax imposed by the Tax Code, regardless of how that
income is used. The Court ruled that the last paragraph of Section 27 unequivocally
subjects to tax the rent income of the YMCA from its property.75

In short, the YMCA is exempt only from property tax but not from income tax.

As a last ditch effort to avoid paying the taxes on its rental income, the YMCA invoked
the tax privilege granted under Article XIV, Section 4 (3) of the Constitution.
The Court denied YMCA's claim that it falls under Article XIV, Section 4 (3) of the
Constitution holding that the term educational institution, when used in laws granting tax
exemptions, refers to the school system (synonymous with formal education); it includes
a college or an educational establishment; it refers to the hierarchically structured and
chronologically graded learnings organized and provided by the formal school system.76

The Court then significantly laid down the requisites for availing the tax exemption under
Article XIV, Section 4 (3), namely: (1) the taxpayer falls under the classification non-
stock, non-profit educational institution; and (2) the income it seeks to be exempted
from taxation is used actually, directly and exclusively for educational purposes.77

We now adopt YMCA as precedent and hold that:

1. The last paragraph of Section 30 of the Tax Code is without force and effect with
respect to non-stock, non-profit educational institutions, provided, that the non-stock,
non-profit educational institutions prove that its assets and revenues are used actually,
directly and exclusively for educational purposes.

2. The tax-exemption constitutionally-granted to non-stock, non-profit educational

institutions, is not subject to limitations imposed by law.

The tax exemption granted by the

Constitution to non-stock, non-profit
educational institutions is conditioned only
on the actual, direct and exclusive use of
their assets, revenues and income78 for
educational purposes.

We find that unlike Article VI, Section 28 (3) of the Constitution (pertaining to charitable
institutions, churches, parsonages or convents, mosques, and non-profit cemeteries),
which exempts from tax only the assets,
i.e., "all lands, buildings, and improvements, actually, directly, and exclusively used
for religious, charitable, or educational purposes ... ," Article XIV, Section 4
(3) categorically states that "[a]ll revenues and assets ... used actually, directly, and
exclusively for educational purposes shall be exempt from taxes and duties."

The addition and express use of the word revenues in Article XIV, Section 4 (3) of the
Constitution is not without significance.

We find that the text demonstrates the policy of the 1987 Constitution, discernible from
the records of the 1986 Constitutional Commission79 to provide broader tax privilege to
non-stock, non-profit educational institutions as recognition of their role in assisting the
State provide a public good. The tax exemption was seen as beneficial to students who
may otherwise be charged unreasonable tuition fees if not for the tax exemption
extended to all revenues and assets of non-stock, non-profit educational institutions.80
Further, a plain reading of the Constitution would show that Article XIV, Section 4 (3)
does not require that the revenues and income must have also been sourced from
educational activities or activities related to the purposes of an educational institution.
The phrase all revenues is unqualified by any reference to the source of revenues.
Thus, so long as the revenues and income are used actually, directly and exclusively for
educational purposes, then said revenues and income shall be exempt from taxes and
duties.81

We find it helpful to discuss at this point the taxation of revenues versus the taxation
of assets.

Revenues consist of the amounts earned by a person or entity from the conduct of
business operations.82 It may refer to the sale of goods, rendition of services, or the
return of an investment. Revenue is a component of the tax base in income
tax,83 VAT,84 and local business tax (LBT).85

Assets, on the other hand, are the tangible and intangible properties owned by a person
or entity.86 It may refer to real estate, cash deposit in a bank, investment in the stocks of
a corporation, inventory of goods, or any property from which the person or entity may
derive income or use to generate the same. In Philippine taxation, the fair market value
of real property is a component of the tax base in real property tax (RPT).87 Also, the
landed cost of imported goods is a component of the tax base in VAT on
importation88 and tariff duties.89

Thus, when a non-stock, non-profit educational institution proves that it uses

its revenues actually, directly, and exclusively for educational purposes, it shall be
exempted from income tax, VAT, and LBT. On the other hand, when it also shows that it
uses its assets in the form of real property for educational purposes, it shall be
exempted from RPT.

To be clear, proving the actual use of the taxable item will result in an exemption, but
the specific tax from which the entity shall be exempted from shall depend on whether
the item is an item of revenue or asset.

To illustrate, if a university leases a portion of its school building to a bookstore or

cafeteria, the leased portion is not actually, directly and exclusively used for educational
purposes, even if the bookstore or canteen caters only to university students, faculty
and staff.

The leased portion of the building may be subject to real property tax, as held in Abra
Valley College, Inc. v. Aquino.90 We ruled in that case that the test of exemption from
taxation is the use of the property for purposes mentioned in the Constitution. We also
held that the exemption extends to facilities which are incidental to and reasonably
necessary for the accomplishment of the main purposes.
In concrete terms, the lease of a portion of a school building for commercial purposes,
removes such asset from the property tax exemption granted under the
Constitution.91 There is no exemption because the asset is not used actually, directly
and exclusively for educational purposes. The commercial use of the property is
also not incidental to and reasonably necessary for the accomplishment of the main
purpose of a university, which is to educate its students.

However, if the university actually, directly and exclusively uses for educational
purposes the revenues earned from the lease of its school building, such revenues shall
be exempt from taxes and duties. The tax exemption no longer hinges on the use of the
asset from which the revenues were earned, but on the actual, direct and exclusive use
of the revenues for educational purposes.

Parenthetically, income and revenues of non-stock, non-profit educational

institution not used actually, directly and exclusively for educational purposes are not
exempt from duties and taxes. To avail of the exemption, the taxpayer must factually
prove that it used actually, directly and exclusively for educational purposes the
revenues or income sought to be exempted.

The crucial point of inquiry then is on the use of the assets or on the use of the
revenues. These are two things that must be viewed and treated separately. But so
long as the assets or revenues are used actually, directly and exclusively for
educational purposes, they are exempt from duties and taxes.

The tax exemption granted by the

Constitution to non-stock, non-profit
educational institutions, unlike the exemption
that may be availed of by proprietary
educational institutions, is not subject to
limitations imposed by law.

That the Constitution treats non-stock, non-profit educational institutions differently from
proprietary educational institutions cannot be doubted. As discussed, the privilege
granted to the former is conditioned only on the actual, direct and exclusive use of their
revenues and assets for educational purposes. In clear contrast, the tax privilege
granted to the latter may be subject to limitations imposed by law.

We spell out below the difference in treatment if only to highlight the privileged status of
non-stock, non-profit educational institutions compared with their proprietary
counterparts.

While a non-stock, non-profit educational institution is classified as a tax-exempt entity

under Section 30 (Exemptions from Tax on Corporations) of the Tax Code, a proprietary
educational institution is covered by Section 27 (Rates of Income Tax on Domestic
Corporations).
To be specific, Section 30 provides that exempt organizations like non-stock, non-profit
educational institutions shall not be taxed on income received by them as such.

Section 27 (B), on the other hand, states that "[p]roprietary educational institutions ...
which are nonprofit shall pay a tax of ten percent (10%) on their taxable income .. .
Provided, that if the gross income from unrelated trade, business or other activity
exceeds fifty percent (50%) of the total gross income derived by such educational
institutions ... [the regular corporate income tax of 30%] shall be imposed on the entire
taxable income ... "92

By the Tax Code's clear terms, a proprietary educational institution is entitled only to the
reduced rate of 10% corporate income tax. The reduced rate is applicable only if: (1) the
proprietary educational institution is nonprofit and (2) its gross income from unrelated
trade, business or activity does not exceed 50% of its total gross income.

Consistent with Article XIV, Section 4 (3) of the Constitution, these limitations do not
apply to non-stock, non-profit educational institutions.

Thus, we declare the last paragraph of Section 30 of the Tax Code without force and
effect for being contrary to the Constitution insofar as it subjects to tax the income and
revenues of non-stock, non-profit educational institutions used actually, directly and
exclusively for educational purpose. We make this declaration in the exercise of and
consistent with our duty93 to uphold the primacy of the Constitution.94

Finally, we stress that our holding here pertains only to non-stock, non-profit educational
institutions and does not cover the other exempt organizations under Section 30 of the
Tax Code.

For all these reasons, we hold that the income and revenues of DLSU proven to have
been used actually, directly and exclusively for educational purposes are exempt from
duties and taxes.

II. The LOA issued to DLSU is

not entirely void. The
assessment for taxable year
2003 is valid.

DLSU objects to the CTA En Banc 's conclusion that the LOA is valid for taxable year
2003 and insists that the entire LOA should be voided for being contrary to RMO No.
43-90, which provides that if tax audit includes more than one taxable period, the other
periods or years shall be specifically indicated in the LOA.

A LOA is the authority given to the appropriate revenue officer to examine the books of
account and other accounting records of the taxpayer in order to determine the
taxpayer's correct internal revenue liabilities95 and for the purpose of collecting the
correct amount of tax,96 in accordance with Section 5 of the Tax Code, which gives the
CIR the power to obtain information, to summon/examine, and take testimony of
persons. The LOA commences the audit process97 and informs the taxpayer that it is
under audit for possible deficiency tax assessment.

Given the purposes of a LOA, is there basis to completely nullify the LOA issued to
DLSU, and consequently, disregard the BIR and the CTA's findings of tax deficiency for
taxable year 2003?

We answer in the negative.

The relevant provision is Section C of RMO No. 43-90, the pertinent portion of which
reads:

3. A Letter of Authority [LOA] should cover a taxable period not exceeding one taxable
year. The practice of issuing [LO As] covering audit of unverified prior years is hereby
prohibited. If the audit of a taxpayer shall include more than one taxable period, the
other periods or years shall be specifically indicated in the [LOA]. 98

What this provision clearly prohibits is the practice of issuing LOAs covering audit
of unverified prior years. RMO 43-90 does not say that a LOA which contains unverified
prior years is void. It merely prescribes that if the audit includes more than one taxable
period, the other periods or years must be specified. The provision read as a whole
requires that if a taxpayer is audited for more than one taxable year, the BIR must
specify each taxable year or taxable period on separate LOAs.

Read in this light, the requirement to specify the taxable period covered by the LOA is
simply to inform the taxpayer of the extent of the audit and the scope of the revenue
officer's authority. Without this rule, a revenue officer can unduly burden the taxpayer by
demanding random accounting records from random unverified years, which may
include documents from as far back as ten years in cases of fraud audit.99

In the present case, the LOA issued to DLSU is for Fiscal Year Ending 2003 and
Unverified Prior Years. The LOA does not strictly comply with RMO 43-90 because it
includes unverified prior years. This does not mean, however, that the entire LOA is
void.

As the CTA correctly held, the assessment for taxable year 2003 is valid because this
taxable period is specified in the LOA. DLSU was fully apprised that it was being
audited for taxable year 2003. Corollarily, the assessments for taxable years 2001 and
2002 are void for having been unspecified on separate LOAs as required under RMO
No. 43-90.

Lastly, the Commissioner's claim that DLSU failed to raise the issue of the LOA' s
validity at the CTA Division, and thus, should not have been entertained on appeal, is
not accurate.
On the contrary, the CTA En Banc found that the issue of the LOA's validity came up
during the trial.100 DLSU then raised the issue in its memorandum and motion for partial
reconsideration with the CTA Division. DLSU raised it again on appeal to the CTA En
Banc. Thus, the CTA En Banc could, as it did, pass upon the validity of the
LOA.101Besides, the Commissioner had the opportunity to argue for the validity of the
LOA at the CTA En Banc but she chose not to file her comment and memorandum
despite notice.102

III.The CTA correctly admitted

the supplemental evidence
formally offered by DLSU.

The Commissioner objects to the CTA Division's admission of DLSU's supplemental

pieces of documentary evidence.

To recall, DLSU formally offered its supplemental evidence upon filing its motion for
reconsideration with the CTA Division.103 The CTA Division admitted the supplemental
evidence, which proved that a portion of DLSU's rental income was used actually,
directly and exclusively for educational purposes. Consequently, the CTA Division
reduced DLSU's tax liabilities.

We uphold the CTA Division's admission of the supplemental evidence on distinct but
mutually reinforcing grounds, to wit: (1) the Commissioner failed to timely object to the
formal offer of supplemental evidence; and (2) the CTA is not governed strictly by the
technical rules of evidence.

First, the failure to object to the offered evidence renders it admissible, and the court
cannot, on its own, disregard such evidence.104

The Court has held that if a party desires the court to reject the evidence offered, it must
so state in the form of a timely objection and it cannot raise the objection to the
evidence for the first time on appeal.105 Because of a party's failure to timely object, the
evidence offered becomes part of the evidence in the case. As a consequence, all the
parties are considered bound by any outcome arising from the offer of evidence
properly presented.106

As disclosed by DLSU, the Commissioner did not oppose the supplemental formal offer
of evidence despite notice.107 The Commissioner objected to the admission of the
supplemental evidence only when the case was on appeal to the CTA En Banc. By the
time the Commissioner raised her objection, it was too late; the formal offer,
admission and evaluation of the supplemental evidence were all fait accompli.

We clarify that while the Commissioner's failure to promptly object had no bearing on
the materiality or sufficiency of the supplemental evidence admitted, she was bound by
the outcome of the CTA Division's assessment of the evidence.108
Second, the CTA is not governed strictly by the technical rules of evidence. The CTA
Division's admission of the formal offer of supplemental evidence, without prompt
objection from the Commissioner, was thus justified.

Notably, this Court had in the past admitted and considered evidence attached to the
taxpayers' motion for reconsideration.1âwphi1

In the case of BPI-Family Savings Bank v. Court of Appeals,109 the tax refund claimant
attached to its motion for reconsideration with the CT A its Final Adjustment Return. The
Commissioner, as in the present case, did not oppose the taxpayer's motion for
reconsideration and the admission of the Final Adjustment Return.110 We thus admitted
and gave weight to the Final Adjustment Return although it was only submitted upon
motion for reconsideration.

We held that while it is true that strict procedural rules generally frown upon the
submission of documents after the trial, the law creating the CTA specifically provides
that proceedings before it shall not be governed strictly by the technical rules of
evidence111 and that the paramount consideration remains the ascertainment of truth.
We ruled that procedural rules should not bar courts from considering undisputed
facts to arrive at a just determination of a controversy.112

We applied the same reasoning in the subsequent cases of Filinvest Development

Corporation v. Commissioner of Internal Revenue113 and Commissioner of Internal
Revenue v. PERF Realty Corporation,114 where the taxpayers also submitted the
supplemental supporting document only upon filing their motions for reconsideration.

Although the cited cases involved claims for tax refunds, we also dispense with the strict
application of the technical rules of evidence in the present tax assessment case. If
anything, the liberal application of the rules assumes greater force and significance in
the case of a taxpayer who claims a constitutionally granted tax exemption. While the
taxpayers in the cited cases claimed refund of excess tax payments based on the Tax
Code,115 DLSU is claiming tax exemption based on the Constitution. If liberality is
afforded to taxpayers who paid more than they should have under a statute, then with
more reason that we should allow a taxpayer to prove its exemption from tax based on
the Constitution.

Hence, we sustain the CTA's admission of DLSU's supplemental offer of evidence not
only because the Commissioner failed to promptly object, but more so because the
strict application of the technical rules of evidence may defeat the intent of the
Constitution.

IV. The CTA's appreciation of

evidence is generally binding on
the Court unless compelling
reasons justify otherwise.
It is doctrinal that the Court will not lightly set aside the conclusions reached by the CTA
which, by the very nature of its function of being dedicated exclusively to the resolution
of tax problems, has developed an expertise on the subject, unless there has been an
abuse or improvident exercise of authority.116 We thus accord the findings of fact by the
CTA with the highest respect. These findings of facts can only be disturbed on appeal if
they are not supported by substantial evidence or there is a showing of gross error or
abuse on the part of the CTA. In the absence of any clear and convincing proof to the
contrary, this Court must presume that the CTA rendered a decision which is valid in
every respect.117

We sustain the factual findings of the CTA.

The parties failed to raise credible basis for us to disturb the CTA's findings that DLSU
had used actually, directly and exclusively for educational purposes a portion of its
assessed income and that it had remitted the DST payments though an online
imprinting machine.

a. DLSU used actually, directly, and exclusively for educational purposes a portion of its
assessed income.

To see how the CTA arrived at its factual findings, we review the process undertaken,
from which it deduced that DLSU successfully proved that it used actually, directly and
exclusively for educational purposes a portion of its rental income.

The CTA reduced DLSU' s deficiency income tax and VAT liabilities in view of the
submission of the supplemental evidence, which consisted of statement of receipts,
statement of disbursement and fund balance and statement of fund changes.118

These documents showed that DLSU borrowed ₱93.86 Million, 119 which was used to
build the university's Sports Complex. Based on these pieces of evidence, the CTA
found that DLSU' s rental income from its concessionaires were indeed transmitted and
used for the payment of this loan. The CTA held that the degree of preponderance of
evidence was sufficiently met to prove actual, direct and exclusive use for educational
purposes.

The CTA also found that DLSU's rental income from other concessionaires, which were
allegedly deposited to a fund (CF-CPA Account),120 intended for the university's capital
projects, was not proved to have been used actually, directly and exclusively for
educational purposes. The CTA observed that "[DLSU] ... failed to fully account for
and substantiate all the disbursements from the [fund]." Thus, the CTA "cannot
ascertain whether rental income from the [other] concessionaires was indeed used for
educational purposes."121

To stress, the CTA's factual findings were based on and supported by the report of the
Independent CPA who reviewed, audited and examined the voluminous documents
submitted by DLSU.
Under the CTA Revised Rules, an Independent CPA's functions include: (a)
examination and verification of receipts, invoices, vouchers and other long accounts; (b)
reproduction of, and comparison of such reproduction with, and certification that the
same are faithful copies of original documents, and pre-marking of documentary
exhibits consisting of voluminous documents; (c) preparation of schedules or
summaries containing a chronological listing of the numbers, dates and amounts
covered by receipts or invoices or other relevant documents and the amount(s) of taxes
paid; (d) making findings as to compliance with substantiation requirements
under pertinent tax laws, regulations and jurisprudence; (e) submission of a formal
report with certification of authenticity and veracity of findings and conclusions in the
performance of the audit; (f) testifying on such formal report; and (g) performing such
other functions as the CTA may direct.122

Based on the Independent CPA's report and on its own appreciation of the evidence,
the CTA held that only the portion of the rental income pertaining to the substantiated
disbursements (i.e., proved by receipts, vouchers, etc.) from the CF-CPA Account was
considered as used actually, directly and exclusively for educational purposes.
Consequently, the unaccounted and unsubstantiated disbursements must be subjected
to income tax and VAT.123

The CTA then further reduced DLSU's tax liabilities by cancelling the assessments for
taxable years 2001 and 2002 due to the defective LOA.124

The Court finds that the above fact-finding process undertaken by the CTA shows that it
based its ruling on the evidence on record, which we reiterate, were examined and
verified by the Independent CPA. Thus, we see no persuasive reason to deviate from
these factual findings.

However, while we generally respect the factual findings of the CTA, it does not mean
that we are bound by its conclusions. In the present case, we do not agree with
the method used by the CTA to arrive at DLSU' s unsubstantiated rental
income (i.e., income not proved to have been actually, directly and exclusively used for
educational purposes).

To recall, the CTA found that DLSU earned a rental income of ₱l0,610,379.00 in taxable
year 2003.125 DLSU earned this income from leasing a portion of its premises to:
1) MTG-Sports Complex, 2) La Casita, 3) Alarey, Inc., 4) Zaide Food Corp., 5) Capri
International, and 6) MTO Bookstore.126

To prove that its rental income was used for educational purposes, DLSU identified the
transactions where the rental income was expended, viz.: 1) ₱4,007,724.00127 used to
pay the loan obtained by DLSU to build the Sports Complex; and
2) ₱6,602,655.00 transferred to the CF-CPA Account.128

DLSU also submitted documents to the Independent CPA to prove that the
₱6,602,655.00 transferred to the CF-CPA Account was used actually, directly and
exclusively for educational purposes. According to the Independent CPA' findings,
DLSU was able to substantiate disbursements from the CF-CPA Account amounting
to ₱6,259,078.30.

Contradicting the findings of the Independent CPA, the CTA concluded that out of
the ₱l0,610,379.00 rental income, ₱4,841,066.65 was unsubstantiated, and thus,
subject to income tax and VAT.129

The CTA then concluded that the ratio of substantiated disbursements to the total
disbursements from the CF-CPA Account for taxable year 2003 is only 26.68%.130 The
CTA held as follows:

However, as regards petitioner's rental income from Alarey, Inc., Zaide Food Corp.,
Capri International and MTO Bookstore, which were transmitted to the CF-CPA
Account, petitioner again failed to fully account for and substantiate all the
disbursements from the CF-CPA Account; thus failing to prove that the rental income
derived therein were actually, directly and exclusively used for educational purposes.
Likewise, the findings of the Court-Commissioned Independent CPA show that the
disbursements from the CF-CPA Account for fiscal year 2003 amounts to
₱6,259,078.30 only. Hence, this portion of the rental income, being the substantiated
disbursements of the CF-CPA Account, was considered by the Special First Division as
used actually, directly and exclusively for educational purposes. Since for fiscal year
2003, the total disbursements per voucher is ₱6,259,078.3 (Exhibit "LL-25-C"), and the
total disbursements per subsidiary ledger amounts to ₱23,463,543.02 (Exhibit "LL-29-
C"), the ratio of substantiated disbursements for fiscal year 2003 is 26.68%
(₱6,259,078.30/₱23,463,543.02). Thus, the substantiated portion of CF-CPA
Disbursements for fiscal year 2003, arrived at by multiplying the ratio of 26.68% with the
total rent income added to and used in the CF-CPA Account in the amount of
₱6,602,655.00 is ₱1,761,588.35.131 (emphasis supplied)

For better understanding, we summarize the CTA's computation as follows:

1. The CTA subtracted the rent income used in the construction of the Sports Complex
(₱4,007,724.00) from the rental income (₱10,610,379.00) earned from the
abovementioned concessionaries. The difference (₱6,602,655.00) was the portion
claimed to have been deposited to the CF-CPA Account.

2. The CTA then subtracted the supposed substantiated portion of CF-CPA

disbursements (₱1,761,308.37) from the ₱6,602,655.00 to arrive at the supposed
unsubstantiated portion of the rental income (₱4,841,066.65).132

3. The substantiated portion of CF-CPA disbursements (₱l,761,308.37)133 was derived

by multiplying the rental income claimed to have been added to the CF-CPA Account
(₱6,602,655.00) by 26.68% or the ratio of substantiated disbursements to total
disbursements (₱23,463,543.02).
4. The 26.68% ratio134 was the result of dividing the substantiated disbursements from
the CF-CPA Account as found by the Independent CPA (₱6,259,078.30) by the total
disbursements (₱23,463,543.02) from the same account.

We find that this system of calculation is incorrect and does not truly give effect to the
constitutional grant of tax exemption to non-stock, non-profit educational institutions.
The CTA's reasoning is flawed because it required DLSU to substantiate an amount that
is greater than the rental income deposited in the CF-CPA Account in 2003.

To reiterate, to be exempt from tax, DLSU has the burden of proving that the proceeds
of its rental income (which amounted to a total of ₱10.61 million)135 were used for
educational purposes. This amount was divided into two parts: (a) the ₱4.0l million,
which was used to pay the loan obtained for the construction of the Sports Complex;
and (b) the ₱6.60 million,136 which was transferred to the CF-CPA account.

For year 2003, the total disbursement from the CF-CPA account amounted to ₱23 .46
million.137 These figures, read in light of the constitutional exemption, raises the
question: does DLSU claim that the whole total CF-CPA disbursement of ₱23.46
million is tax-exempt so that it is required to prove that all these disbursements
had been made for educational purposes?

We answer in the negative.

The records show that DLSU never claimed that the total CF-CPA disbursements of
₱23.46 million had been for educational purposes and should thus be tax-exempt;
DLSU only claimed ₱10.61 million for tax-exemption and should thus be required to
prove that this amount had been used as claimed.

Of this amount, ₱4.01 had been proven to have been used for educational purposes, as
confirmed by the Independent CPA. The amount in issue is therefore the balance of
₱6.60 million which was transferred to the CF-CPA which in turn made disbursements
of ₱23.46 million for various general purposes, among them the ₱6.60 million
transferred by DLSU.

Significantly, the Independent CPA confirmed that the CF-CPA made disbursements for
educational purposes in year 2003 in the amount ₱6.26 million. Based on these given
figures, the CT A concluded that the expenses for educational purposes that had been
coursed through the CF-CPA should be prorated so that only the portion that ₱6.26
million bears to the total CF-CPA disbursements should be credited to DLSU for tax
exemption.

This approach, in our view, is flawed given the constitutional requirement that
revenues actually and directly used for educational purposes should be tax-exempt. As
already mentioned above, DLSU is not claiming that the whole ₱23.46 million CF-CPA
disbursement had been used for educational purposes; it only claims that ₱6.60 million
transferred to CF-CPA had been used for educational purposes. This was what DLSU
needed to prove to have actually and directly used for educational purposes.

That this fund had been first deposited into a separate fund (the CF -CPA established to
fund capital projects) lends peculiarity to the facts of this case, but does not detract from
the fact that the deposited funds were DLSU revenue funds that had been confirmed
and proven to have been actually and directly used for educational purposes via the CF-
CPA. That the CF-CPA might have had other sources of funding is irrelevant because
the assessment in the present case pertains only to the rental income which DLSU
indisputably earned as revenue in 2003. That the proven CF-CPA funds used for
educational purposes should not be prorated as part of its total CF-CPA disbursements
for purposes of crediting to DLSU is also logical because no claim whatsoever had been
made that the totality of the CF-CPA disbursements had been for educational purposes.
No prorating is necessary; to state the obvious, exemption is based on actual and direct
use and this DLSU has indisputably proven.

Based on these considerations, DLSU should therefore be liable only for the difference
between what it claimed and what it has proven. In more concrete terms,
DLSU only had to prove that its rental income for taxable year 2003 (₱10,610,379.00)
was used for educational purposes. Hence, while the total disbursements from the CF-
CPA Account amounted to ₱23,463,543.02, DLSU only had to substantiate its Pl0.6
million rental income, part of which was the ₱6,602,655.00 transferred to the CF-CPA
account. Of this latter amount, ₱6.259 million was substantiated to have been used for
educational purposes.

To summarize, we thus revise the tax base for deficiency income tax and VAT for
taxable year 2003 as follows:

CTA
Decision138 Revised
Rental income 10,610,379.00 10,610,379.00
Less: Rent income used in construction of the 4,007,724.00 4,007,724.00
Sports Complex

Rental income deposited to the CF-CPA

6,602,655.00 6,602,655.00
Account

Less: Substantiated portion of CF-CPA 1,761,588.35 6,259,078.30

disbursements

Tax base for deficiency income tax and

4,841,066.65 343.576.70
VAT
On DLSU' s argument that the CTA should have appreciated its evidence in the same
way as it did with the evidence submitted by Ateneo in another separate case, the CTA
explained that the issue in the Ateneo case was not the same as the issue in the
present case.

The issue in the Ateneo case was whether or not Ateneo could be held liable to pay
income taxes and VAT under certain BIR and Department of Finance issuances139 that
required the educational institution to own and operate the canteens, or other
commercial enterprises within its campus, as condition for tax exemption. The CTA held
that the Constitution does not require the educational institution to own or operate these
commercial establishments to avail of the exemption.140

Given the lack of complete identity of the issues involved, the CTA held that it had to
evaluate the separate sets of evidence differently. The CTA likewise stressed that
DLSU and Ateneo gave distinct defenses and that its wisdom "cannot be equated on its
decision on two different cases with two different issues."141

DLSU disagrees with the CTA and argues that the entire assessment must be cancelled
because it submitted similar, if not stronger sets of evidence, as Ateneo. We reject
DLSU's argument for being non sequitur. Its reliance on the concept of uniformity of
taxation is also incorrect.

First, even granting that Ateneo and DLSU submitted similar evidence, the sufficiency
and materiality of the evidence supporting their respective claims for tax exemption
would necessarily differ because their attendant issues and facts differ.

To state the obvious, the amount of income received by DLSU and by Ateneo during the
taxable years they were assessed varied. The amount of tax assessment
also varied. The amount of income proven to have been used for educational purposes
also varied because the amount substantiated varied.142 Thus, the amount of tax
assessment cancelled by the CTA varied.

On the one hand, the BIR assessed DLSU a total tax deficiency of ₱17,303,001.12 for
taxable years 2001, 2002 and 2003. On the other hand, the BIR assessed Ateneo a
total deficiency tax of ₱8,864,042.35 for the same period. Notably, DLSU was assessed
deficiency DST, while Ateneo was not.143

Thus, although both Ateneo and DLSU claimed that they used their rental income
actually, directly and exclusively for educational purposes by submitting similar
evidence, e.g., the testimony of their employees on the use of university revenues, the
report of the Independent CPA, their income summaries, financial statements,
vouchers, etc., the fact remains that DLSU failed to prove that a portion of its income
and revenues had indeed been used for educational purposes.

The CTA significantly found that some documents that could have fully supported
DLSU's claim were not produced in court. Indeed, the Independent CPA testified that
some disbursements had not been proven to have been used actually, directly and
exclusively for educational purposes.144

The final nail on the question of evidence is DLSU's own admission that the original of
these documents had not in fact been produced before the CTA although it claimed that
there was no bad faith on its part.145 To our mind, this admission is a good indicator of
how the Ateneo and the DLSU cases varied, resulting in DLSU's failure to substantiate
a portion of its claimed exemption.

Further, DLSU's invocation of Section 5, Rule 130 of the Revised

Rules on Evidence, that the contents of the missing supporting documents were proven
by its recital in some other authentic documents on record,146 can no longer be
entertained at this late stage of the proceeding. The CTA did not rule on this particular
claim. The CTA also made no finding on DLSU' s assertion of lack of bad faith. Besides,
it is not our duty to go over these documents to test the truthfulness of their contents,
this Court not being a trier of facts.

Second, DLSU misunderstands the concept of uniformity of taxation.

Equality and uniformity of taxation means that all taxable articles or kinds of property of
the same class shall be taxed at the same rate.147 A tax is uniform when it operates with
the same force and effect in every place where the subject of it is found. 148 The concept
requires that all subjects of taxation similarly situated should be treated alike and placed
in equal footing.149

In our view, the CTA placed Ateneo and DLSU in equal footing. The CTA treated them
alike because their income proved to have been used actually, directly and exclusively
for educational purposes were exempted from taxes. The CTA equally applied the
requirements in the YMCA case to test if they indeed used their revenues for
educational purposes.

DLSU can only assert that the CTA violated the rule on uniformity if it can show that,
despite proving that it used actually, directly and exclusively for educational purposes its
income and revenues, the CTA still affirmed the imposition of taxes. That the DLSU
secured a different result happened because it failed to fully prove that it used actually,
directly and exclusively for educational purposes its revenues and income.

On this point, we remind DLSU that the rule on uniformity of taxation does not mean
that subjects of taxation similarly situated are treated in literally the same way in all and
every occasion. The fact that the Ateneo and DLSU are both non-stock, non-profit
educational institutions, does not mean that the CTA or this Court would similarly decide
every case for (or against) both universities. Success in tax litigation, like in any other
litigation, depends to a large extent on the sufficiency of evidence. DLSU's evidence
was wanting, thus, the CTA was correct in not fully cancelling its tax liabilities.
b. DLSU proved its payment of the DST

The CTA affirmed DLSU's claim that the DST due on its mortgage and loan transactions
were paid and remitted through its bank's On-Line Electronic DST Imprinting
Machine. The Commissioner argues that DLSU is not allowed to use this method of
payment because an educational institution is excluded from the class of taxpayers who
can use the On-Line Electronic DST Imprinting Machine.

We sustain the findings of the CTA. The Commissioner's argument lacks basis in both
the Tax Code and the relevant revenue regulations.

DST on documents, loan agreements, and papers shall be levied, collected and paid for
by the person making, signing, issuing, accepting, or transferring the same.150 The Tax
Code provides that whenever one party to the document enjoys exemption from DST,
the other party not exempt from DST shall be directly liable for the tax. Thus, it is clear
that DST shall be payable by any party to the document, such that the payment and
compliance by one shall mean the full settlement of the DST due on the document.

In the present case, DLSU entered into mortgage and loan agreements with banks.
These agreements are subject to DST.151 For the purpose of showing that the DST on
the loan agreement has been paid, DLSU presented its agreements bearing the imprint
showing that DST on the document has been paid by the bank, its counterparty. The
imprint should be sufficient proof that DST has been paid. Thus, DLSU cannot be
further assessed for deficiency DST on the said documents.

Finally, it is true that educational institutions are not included in the class of taxpayers
who can pay and remit DST through the On-Line Electronic DST Imprinting
Machine under RR No. 9-2000. As correctly held by the CTA, this is irrelevant because
it was not DLSU who used the On-Line Electronic DST Imprinting Machine but the bank
that handled its mortgage and loan transactions. RR No. 9-2000 expressly includes
banks in the class of taxpayers that can use the On-Line Electronic DST Imprinting
Machine.

Thus, the Court sustains the finding of the CTA that DLSU proved the

payment of the assessed DST deficiency, except for the unpaid balance of

₱13,265.48.152

WHEREFORE, premises considered, we DENY the petition of the Commissioner of

Internal Revenue in G.R. No. 196596 and AFFIRM the December 10, 2010 decision
and March 29, 2011 resolution of the Court of Tax Appeals En Banc in CTA En
Banc Case No. 622, except for the total amount of deficiency tax liabilities of De La
Salle University, Inc., which had been reduced.
We also DENY both the petition of De La Salle University, Inc. in G.R. No. 198841 and
the petition of the Commissioner of Internal Revenue in G.R. No. 198941 and
thus AFFIRM the June 8, 2011 decision and October 4, 2011 resolution of the Court of
Tax Appeals En Banc in CTA En Banc Case No. 671, with the MODIFICATION that the
base for the deficiency income tax and VAT for taxable year 2003 is ₱343,576.70.

SO ORDERED.

ARTURO D. BRION
Associate Justice

WE CONCUR:

G.R. No. 180356 February 16, 2010

SOUTH AFRICAN AIRWAYS, Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

DECISION

VELASCO, JR., J.:

The Case

This Petition for Review on Certiorari under Rule 45 seeks the reversal of the July 19,
2007 Decision1 and October 30, 2007 Resolution2 of the Court of Tax Appeals (CTA) En
Banc in CTA E.B. Case No. 210, entitled South African Airways v. Commissioner of
Internal Revenue. The assailed decision affirmed the Decision dated May 10, 20063and
Resolution dated August 11, 20064 rendered by the CTA First Division.

The Facts

Petitioner South African Airways is a foreign corporation organized and existing under
and by virtue of the laws of the Republic of South Africa. Its principal office is located at
Airways Park, Jones Road, Johannesburg International Airport, South Africa. In the
Philippines, it is an internal air carrier having no landing rights in the country. Petitioner
has a general sales agent in the Philippines, Aerotel Limited Corporation (Aerotel).
Aerotel sells passage documents for compensation or commission for petitioner’s off-
line flights for the carriage of passengers and cargo between ports or points outside the
territorial jurisdiction of the Philippines. Petitioner is not registered with the Securities
and Exchange Commission as a corporation, branch office, or partnership. It is not
licensed to do business in the Philippines.

For the taxable year 2000, petitioner filed separate quarterly and annual income tax
returns for its off-line flights, summarized as follows:

2.5% Gross
Period Date Filed
Phil. Billings
1st Quarter May 30, 2000 222,531.25
2nd Quarter August 29, 2000 424,046.95
For Passenger PhP
3rd Quarter November 29, 2000 422,466.00
4th Quarter April 16, 2000 453,182.91
Sub-total PhP 1,522,227.11
1st Quarter May 30, 2000 81,531.00
2nd Quarter August 29, 2000 50,169.65
For Cargo PhP
3rd Quarter November 29, 2000 36,383.74
4th Quarter April 16, 2000 37,454.88
Sub-total PhP 205,539.27
TOTAL 1,727,766.38

Thereafter, on February 5, 2003, petitioner filed with the Bureau of Internal Revenue,
Revenue District Office No. 47, a claim for the refund of the amount of PhP
1,727,766.38 as erroneously paid tax on Gross Philippine Billings (GPB) for the taxable
year 2000. Such claim was unheeded. Thus, on April 14, 2003, petitioner filed a Petition
for Review with the CTA for the refund of the abovementioned amount. The case was
docketed as CTA Case No. 6656.

On May 10, 2006, the CTA First Division issued a Decision denying the petition for lack
of merit. The CTA ruled that petitioner is a resident foreign corporation engaged in trade
or business in the Philippines. It further ruled that petitioner was not liable to pay tax on
its GPB under Section 28(A)(3)(a) of the National Internal Revenue Code (NIRC) of
1997. The CTA, however, stated that petitioner is liable to pay a tax of 32% on its
income derived from the sales of passage documents in the Philippines. On this ground,
the CTA denied petitioner’s claim for a refund.

Petitioner’s Motion for Reconsideration of the above decision was denied by the CTA
First Division in a Resolution dated August 11, 2006.

Thus, petitioner filed a Petition for Review before the CTA En Banc, reiterating its claim
for a refund of its tax payment on its GPB. This was denied by the CTA in its assailed
decision. A subsequent Motion for Reconsideration by petitioner was also denied in the
assailed resolution of the CTA En Banc.

Hence, petitioner went to us.

The Issues

Whether or not petitioner, as an off-line international carrier selling passage documents

through an independent sales agent in the Philippines, is engaged in trade or business
in the Philippines subject to the 32% income tax imposed by Section 28 (A)(1) of the
1997 NIRC.

Whether or not the income derived by petitioner from the sale of passage documents
covering petitioner’s off-line flights is Philippine-source income subject to Philippine
income tax.

Whether or not petitioner is entitled to a refund or a tax credit of erroneously paid tax on
Gross Philippine Billings for the taxable year 2000 in the amount of P1,727,766.38. 5

The Court’s Ruling

This petition must be denied.

Petitioner Is Subject to Income Tax at the Rate of 32% of Its Taxable Income

Preliminarily, we emphasize that petitioner is claiming that it is exempted from being

taxed for its sale of passage documents in the Philippines. Petitioner, however, failed to
sufficiently prove such contention.

In Commissioner of Internal Revenue v. Acesite (Philippines) Hotel Corporation, 6 we

held, "Since an action for a tax refund partakes of the nature of an exemption, which
cannot be allowed unless granted in the most explicit and categorical language, it is
strictly construed against the claimant who must discharge such burden convincingly."

Petitioner has failed to overcome such burden.

In essence, petitioner calls upon this Court to determine the legal implication of the
amendment to Sec. 28(A)(3)(a) of the 1997 NIRC defining GPB. It is petitioner’s
contention that, with the new definition of GPB, it is no longer liable under Sec.
28(A)(3)(a). Further, petitioner argues that because the 2 1/2% tax on GPB is
inapplicable to it, it is thereby excluded from the imposition of any income tax.

Sec. 28(b)(2) of the 1939 NIRC provided:

(2) Resident Corporations. – A corporation organized, authorized, or existing under the

laws of a foreign country, engaged in trade or business within the Philippines, shall be
taxable as provided in subsection (a) of this section upon the total net income received
in the preceding taxable year from all sources within the Philippines: Provided, however,
that international carriers shall pay a tax of two and one-half percent on their gross
Philippine billings.

This provision was later amended by Sec. 24(B)(2) of the 1977 NIRC, which defined
GPB as follows:

"Gross Philippine billings" include gross revenue realized from uplifts anywhere in the
world by any international carrier doing business in the Philippines of passage
documents sold therein, whether for passenger, excess baggage or mail, provided the
cargo or mail originates from the Philippines.

In the 1986 and 1993 NIRCs, the definition of GPB was further changed to read:

"Gross Philippine Billings" means gross revenue realized from uplifts of passengers
anywhere in the world and excess baggage, cargo and mail originating from the
Philippines, covered by passage documents sold in the Philippines.

Essentially, prior to the 1997 NIRC, GPB referred to revenues from uplifts anywhere in
the world, provided that the passage documents were sold in the Philippines.
Legislature departed from such concept in the 1997 NIRC where GPB is now defined
under Sec. 28(A)(3)(a):

"Gross Philippine Billings" refers to the amount of gross revenue derived from carriage
of persons, excess baggage, cargo and mail originating from the Philippines in a
continuous and uninterrupted flight, irrespective of the place of sale or issue and the
place of payment of the ticket or passage document.

Now, it is the place of sale that is irrelevant; as long as the uplifts of passengers and
cargo occur to or from the Philippines, income is included in GPB.

As correctly pointed out by petitioner, inasmuch as it does not maintain flights to or from
the Philippines, it is not taxable under Sec. 28(A)(3)(a) of the 1997 NIRC. This much
was also found by the CTA. But petitioner further posits the view that due to the non-
applicability of Sec. 28(A)(3)(a) to it, it is precluded from paying any other income tax for
its sale of passage documents in the Philippines.

Such position is untenable.

In Commissioner of Internal Revenue v. British Overseas Airways Corporation (British

Overseas Airways),7 which was decided under similar factual circumstances, this Court
ruled that off-line air carriers having general sales agents in the Philippines are engaged
in or doing business in the Philippines and that their income from sales of passage
documents here is income from within the Philippines. Thus, in that case, we held the
off-line air carrier liable for the 32% tax on its taxable income.

Petitioner argues, however, that because British Overseas Airways was decided under
the 1939 NIRC, it does not apply to the instant case, which must be decided under the
1997 NIRC. Petitioner alleges that the 1939 NIRC taxes resident foreign corporations,
such as itself, on all income from sources within the Philippines. Petitioner’s
interpretation of Sec. 28(A)(3)(a) of the 1997 NIRC is that, since it is an international
carrier that does not maintain flights to or from the Philippines, thereby having no GPB
as defined, it is exempt from paying any income tax at all. In other words, the existence
of Sec. 28(A)(3)(a) according to petitioner precludes the application of Sec. 28(A)(1) to
it.

Its argument has no merit.

First, the difference cited by petitioner between the 1939 and 1997 NIRCs with regard to
the taxation of off-line air carriers is more apparent than real.

We point out that Sec. 28(A)(3)(a) of the 1997 NIRC does not, in any categorical term,
exempt all international air carriers from the coverage of Sec. 28(A)(1) of the 1997
NIRC. Certainly, had legislature’s intentions been to completely exclude all international
air carriers from the application of the general rule under Sec. 28(A)(1), it would have
used the appropriate language to do so; but the legislature did not. Thus, the logical
interpretation of such provisions is that, if Sec. 28(A)(3)(a) is applicable to a taxpayer,
then the general rule under Sec. 28(A)(1) would not apply. If, however, Sec. 28(A)(3)(a)
does not apply, a resident foreign corporation, whether an international air carrier or not,
would be liable for the tax under Sec. 28(A)(1).

Clearly, no difference exists between British Overseas Airways and the instant case,
wherein petitioner claims that the former case does not apply. Thus, British Overseas
Airways applies to the instant case. The findings therein that an off-line air carrier is
doing business in the Philippines and that income from the sale of passage documents
here is Philippine-source income must be upheld.

Petitioner further reiterates its argument that the intention of Congress in amending the
definition of GPB is to exempt off-line air carriers from income tax by citing the
pronouncements made by Senator Juan Ponce Enrile during the deliberations on the
provisions of the 1997 NIRC. Such pronouncements, however, are not controlling on
this Court. We said in Espino v. Cleofe:8

A cardinal rule in the interpretation of statutes is that the meaning and intention of the
law-making body must be sought, first of all, in the words of the statute itself, read and
considered in their natural, ordinary, commonly-accepted and most obvious
significations, according to good and approved usage and without resorting to forced or
subtle construction. Courts, therefore, as a rule, cannot presume that the law-making
body does not know the meaning of words and rules of grammar. Consequently, the
grammatical reading of a statute must be presumed to yield its correct sense. x x x It is
also a well-settled doctrine in this jurisdiction that statements made by individual
members of Congress in the consideration of a bill do not necessarily reflect the sense
of that body and are, consequently, not controlling in the interpretation of law.
(Emphasis supplied.)

Moreover, an examination of the subject provisions of the law would show that
petitioner’s interpretation of those provisions is erroneous.

Sec. 28(A)(1) and (A)(3)(a) provides:

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

(1) In General. - Except as otherwise provided in this Code, a corporation

organized, authorized, or existing under the laws of any foreign country, engaged
in trade or business within the Philippines, shall be subject to an income tax
equivalent to thirty-five percent (35%) of the taxable income derived in the
preceding taxable year from all sources within the Philippines: provided, That
effective January 1, 1998, the rate of income tax shall be thirty-four percent
(34%); effective January 1, 1999, the rate shall be thirty-three percent (33%), and
effective January 1, 2000 and thereafter, the rate shall be thirty-two percent
(32%).

xxxx

(3) International Carrier. - An international carrier doing business in the

Philippines shall pay a tax of two and one-half percent (2 1/2%) on its ‘Gross
Philippine Billings’ as defined hereunder:

(a) International Air Carrier. – ‘Gross Philippine Billings’ refers to the amount of
gross revenue derived from carriage of persons, excess baggage, cargo and mail
originating from the Philippines in a continuous and uninterrupted flight,
irrespective of the place of sale or issue and the place of payment of the ticket or
passage document: Provided, That tickets revalidated, exchanged and/or
indorsed to another international airline form part of the Gross Philippine Billings
 if the passenger boards a plane in a port or point in the Philippines: Provided,
further, That for a flight which originates from the Philippines, but transshipment
of passenger takes place at any port outside the Philippines on another airline,
only the aliquot portion of the cost of the ticket corresponding to the leg flown
from the Philippines to the point of transshipment shall form part of Gross
Philippine Billings.

Sec. 28(A)(1) of the 1997 NIRC is a general rule that resident foreign corporations are
liable for 32% tax on all income from sources within the Philippines. Sec. 28(A)(3) is an
exception to this general rule.

An exception is defined as "that which would otherwise be included in the provision from
which it is excepted. It is a clause which exempts something from the operation of a
statue by express words."9 Further, "an exception need not be introduced by the words
‘except’ or ‘unless.’ An exception will be construed as such if it removes something from
the operation of a provision of law."10

In the instant case, the general rule is that resident foreign corporations shall be liable
for a 32% income tax on their income from within the Philippines, except for resident
foreign corporations that are international carriers that derive income "from carriage of
persons, excess baggage, cargo and mail originating from the Philippines" which shall
be taxed at 2 1/2% of their Gross Philippine Billings. Petitioner, being an international
carrier with no flights originating from the Philippines, does not fall under the exception.
As such, petitioner must fall under the general rule. This principle is embodied in the
Latin maxim, exception firmat regulam in casibus non exceptis, which means, a thing
not being excepted must be regarded as coming within the purview of the general rule. 11

To reiterate, the correct interpretation of the above provisions is that, if an international

air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2
1/2% of its Gross Philippine Billings, while international air carriers that do not have
flights to and from the Philippines but nonetheless earn income from other activities in
the country will be taxed at the rate of 32% of such income.

As to the denial of petitioner’s claim for refund, the CTA denied the claim on the basis
that petitioner is liable for income tax under Sec. 28(A)(1) of the 1997 NIRC. Thus,
petitioner raises the issue of whether the existence of such liability would preclude their
claim for a refund of tax paid on the basis of Sec. 28(A)(3)(a). In answer to petitioner’s
motion for reconsideration, the CTA First Division ruled in its Resolution dated August
11, 2006, thus:

On the fourth argument, petitioner avers that a deficiency tax assessment does not, in
any way, disqualify a taxpayer from claiming a tax refund since a refund claim can
proceed independently of a tax assessment and that the assessment cannot be offset
by its claim for refund.
Petitioner’s argument is erroneous. Petitioner premises its argument on the existence of
an assessment. In the assailed Decision, this Court did not, in any way, assess
petitioner of any deficiency corporate income tax. The power to make assessments
against taxpayers is lodged with the respondent. For an assessment to be made,
respondent must observe the formalities provided in Revenue Regulations No. 12-99.
This Court merely pointed out that petitioner is liable for the regular corporate income
tax by virtue of Section 28(A)(3) of the Tax Code. Thus, there is no assessment to
speak of.12

Precisely, petitioner questions the offsetting of its payment of the tax under Sec.
28(A)(3)(a) with their liability under Sec. 28(A)(1), considering that there has not yet
been any assessment of their obligation under the latter provision. Petitioner argues that
such offsetting is in the nature of legal compensation, which cannot be applied under
the circumstances present in this case.

Article 1279 of the Civil Code contains the elements of legal compensation, to wit:

Art. 1279. In order that compensation may be proper, it is necessary:

(1) That each one of the obligors be bound principally, and that he be at the
same time a principal creditor of the other;

(2) That both debts consist in a sum of money, or if the things due are
consumable, they be of the same kind, and also of the same quality if the latter
has been stated;

(3) That the two debts be due;

(4) That they be liquidated and demandable;

(5) That over neither of them there be any retention or controversy, commenced
by third persons and communicated in due time to the debtor.

And we ruled in Philex Mining Corporation v. Commissioner of Internal Revenue, 13 thus:

In several instances prior to the instant case, we have already made the
pronouncement that taxes cannot be subject to compensation for the simple reason that
the government and the taxpayer are not creditors and debtors of each other. There is a
material distinction between a tax and debt. Debts are due to the Government in its
corporate capacity, while taxes are due to the Government in its sovereign capacity. We
find no cogent reason to deviate from the aforementioned distinction.

Prescinding from this premise, in Francia v. Intermediate Appellate Court, we

categorically held that taxes cannot be subject to set-off or compensation, thus:
We have consistently ruled that there can be no off-setting of taxes against the claims
that the taxpayer may have against the government. A person cannot refuse to pay a
tax on the ground that the government owes him an amount equal to or greater than the
tax being collected. The collection of a tax cannot await the results of a lawsuit against
the government.

The ruling in Francia has been applied to the subsequent case of Caltex Philippines,
Inc. v. Commission on Audit, which reiterated that:

. . . a taxpayer may not offset taxes due from the claims that he may have against the
government. Taxes cannot be the subject of compensation because the government
and taxpayer are not mutually creditors and debtors of each other and a claim for taxes
is not such a debt, demand, contract or judgment as is allowed to be set-off.

Verily, petitioner’s argument is correct that the offsetting of its tax refund with its alleged
tax deficiency is unavailing under Art. 1279 of the Civil Code.

Commissioner of Internal Revenue v. Court of Tax Appeals,14 however, granted the

offsetting of a tax refund with a tax deficiency in this wise:

Further, it is also worth noting that the Court of Tax Appeals erred in denying petitioner’s
supplemental motion for reconsideration alleging bringing to said court’s attention the
existence of the deficiency income and business tax assessment against Citytrust. The
fact of such deficiency assessment is intimately related to and inextricably intertwined
with the right of respondent bank to claim for a tax refund for the same year. To award
such refund despite the existence of that deficiency assessment is an absurdity and a
polarity in conceptual effects. Herein private respondent cannot be entitled to refund
and at the same time be liable for a tax deficiency assessment for the same year.

The grant of a refund is founded on the assumption that the tax return is valid, that is,
the facts stated therein are true and correct. The deficiency assessment, although not
yet final, created a doubt as to and constitutes a challenge against the truth and
accuracy of the facts stated in said return which, by itself and without unquestionable
evidence, cannot be the basis for the grant of the refund.

Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the
applicable law when the claim of Citytrust was filed, provides that "(w)hen an
assessment is made in case of any list, statement, or return, which in the opinion of the
Commissioner of Internal Revenue was false or fraudulent or contained any
understatement or undervaluation, no tax collected under such assessment shall be
recovered by any suits unless it is proved that the said list, statement, or return was not
false nor fraudulent and did not contain any understatement or undervaluation; but this
provision shall not apply to statements or returns made or to be made in good faith
regarding annual depreciation of oil or gas wells and mines."
Moreover, to grant the refund without determination of the proper assessment and the
tax due would inevitably result in multiplicity of proceedings or suits. If the deficiency
assessment should subsequently be upheld, the Government will be forced to institute
anew a proceeding for the recovery of erroneously refunded taxes which recourse must
be filed within the prescriptive period of ten years after discovery of the falsity, fraud or
omission in the false or fraudulent return involved.This would necessarily require and
entail additional efforts and expenses on the part of the Government, impose a burden
on and a drain of government funds, and impede or delay the collection of much-
needed revenue for governmental operations.1avvphi1

Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both

logically necessary and legally appropriate that the issue of the deficiency tax
assessment against Citytrust be resolved jointly with its claim for tax refund, to
determine once and for all in a single proceeding the true and correct amount of tax due
or refundable.

In fact, as the Court of Tax Appeals itself has heretofore conceded,it would be only just
and fair that the taxpayer and the Government alike be given equal opportunities to
avail of remedies under the law to defeat each other’s claim and to determine all
matters of dispute between them in one single case. It is important to note that in
determining whether or not petitioner is entitled to the refund of the amount paid, it
would [be] necessary to determine how much the Government is entitled to collect as
taxes. This would necessarily include the determination of the correct liability of the
taxpayer and, certainly, a determination of this case would constitute res judicata on
both parties as to all the matters subject thereof or necessarily involved therein.
(Emphasis supplied.)

Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997
NIRC. The above pronouncements are, therefore, still applicable today.

Here, petitioner’s similar tax refund claim assumes that the tax return that it filed was
correct. Given, however, the finding of the CTA that petitioner, although not liable under
Sec. 28(A)(3)(a) of the 1997 NIRC, is liable under Sec. 28(A)(1), the correctness of the
return filed by petitioner is now put in doubt. As such, we cannot grant the prayer for a
refund.

Be that as it may, this Court is unable to affirm the assailed decision and resolution of
the CTA En Banc on the outright denial of petitioner’s claim for a refund. Even though
petitioner is not entitled to a refund due to the question on the propriety of petitioner’s
tax return subject of the instant controversy, it would not be proper to deny such claim
without making a determination of petitioner’s liability under Sec. 28(A)(1).

It must be remembered that the tax under Sec. 28(A)(3)(a) is based on GPB, while Sec.
28(A)(1) is based on taxable income, that is, gross income less deductions and
exemptions, if any. It cannot be assumed that petitioner’s liabilities under the two
provisions would be the same. There is a need to make a determination of petitioner’s
liability under Sec. 28(A)(1) to establish whether a tax refund is forthcoming or that a tax
deficiency exists. The assailed decision fails to mention having computed for the tax
due under Sec. 28(A)(1) and the records are bereft of any evidence sufficient to
establish petitioner’s taxable income. There is a necessity to receive evidence to
establish such amount vis-à-vis the claim for refund. It is only after such amount is
established that a tax refund or deficiency may be correctly pronounced.

WHEREFORE, the assailed July 19, 2007 Decision and October 30, 2007 Resolution of
the CTA En Banc in CTA E.B. Case No. 210 are SET ASIDE. The instant case is
REMANDED to the CTA En Banc for further proceedings and appropriate action, more
particularly, the reception of evidence for both parties and the corresponding disposition
of CTA E.B. Case No. 210 not otherwise inconsistent with our judgment in this Decision.

SO ORDERED.

PRESBITERO J. VELASCO, JR.

Associate Justice

WE CONCUR: