CIR V.

BOAC
NATURE OF THE CASE: REVIEW ON CERTIORARI

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the joint Decision of
the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, which set aside
petitioner's assessment of deficiency income taxes against respondent British Overseas Airways
Corporation (BOAC) for the fiscal years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its
Resolution of 18 November, 1983 denying reconsideration.

FACTS:

BOAC is a 100% British Government-owned corporation engaged in the international airline business.

As such it operates air transportation service and sells transportation tickets over the routes of the other
airline members.

It is admitted that BOAC had no landing rights for traffic purposes in the Philippines.

It maintained a general sales agent in the Philippines — Wamer Barnes and Company, Ltd., and later
Qantas Airways — which was responsible for selling BOAC tickets covering passengers and cargoes.

(CIR) assessed BOAC for deficiency income taxes. This was protested by BOAC. CIR denied the claim for
refund of BOAC. BOAC filed a petition for review with Tax Court praying that it be absolved of liability for
deficiency income tax.

Tax court decision

The Tax Court held that the proceeds of sales of BOAC passage tickets in the Philippines do not
constitute BOAC income from Philippine sources "since no service of carriage of passengers or freight
was performed by BOAC within the Philippines" and, therefore, said income is not subject to Philippine
income tax. The CTA position was that income from transportation is income from services so that the
place where services are rendered determines the source.

Hence, this Petition for Review on certiorari of the Decision of the Tax Court.

ISSUE:

Whether or not the revenue derived by British Overseas Airways Corporation (BOAC) from sales of
tickets in the Philippines for air transportation constitute income of BOAC from Philippine sources and
taxable.

HELD:

YES, the revenue derived by BOAC from sales of tickets in the Philippines for air transportation
constitute income from Philippine sources and taxable. It is our considered opinion that BOAC is a
resident foreign corporation.

Under the law, a resident foreign corporation is subject to tax upon its total net income received in the
preceding taxable year from all sources within the Philippines.
Here, the regular sale of tickets, its main activity, is the very lifeblood of the airline business, the
generation of sales being the paramount objective. There should be no doubt then that BOAC was
"engaged in" business in the Philippines through a local agent during the period covered by the
assessments. Accordingly, it is a resident foreign corporation subject to tax upon its total net income
received in the preceding taxable year from all sources within the Philippines.

The Tax Code defines "gross income" thus:

Take note!!! definition of income, taxable income!!!

"Gross income" includes gains, profits, and income derived from salaries, wages or compensation for
personal service of whatever kind and in whatever form paid, or from profession, vocations, trades,
business, commerce, sales, or dealings in property, whether real or personal, growing out of the
ownership or use of or interest in such property; also from interests, rents, dividends, securities, or the
transactions of any business carried on for gain or profile, or gains, profits, and income derived from any
source whatever (Sec. 29[3]; Emphasis supplied)

The definition is broad and comprehensive to include proceeds from sales of transport documents. "The
words 'income from any source whatever' disclose a legislative policy to include all income not expressly
exempted within the class of taxable income under our laws." Income means "cash received or its
equivalent"; it is the amount of money coming to a person within a specific time ...; it means something
distinct from principal or capital. For, while capital is a fund, income is a flow. As used in our income tax
law, "income" refers to the flow of wealth. 6

Madrigal v. Rafferty (CIR)

Nature of the case:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to
the Civil Code, a law of Spanish origin.

Facts:

Vicente Madrigal filed sworn declaration with the Collector of Internal Revenue with the claim that it
was in fact the income of the conjugal partnership existing between himself and his wife Susana
Paterno, and that in computing and assessing the additional income tax provided by the Act of Congress
the income declared by Vicente Madrigal should be divided into two equal parts, one-half to be
considered the income of Vicente Madrigal and the other half of Susana Paterno.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in the
Income Tax Law.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income tax, is that is
should be divided into two equal parts, because of the conjugal partnership existing between them. The
learned argument of counsel is mostly based upon the provisions of the Civil Code establishing the
sociedad de gananciales. The counter contentions of appellees are that the taxes imposed by the
Income Tax Law are as the name implies taxes upon income tax and not upon capital and property; that
the fact that Madrigal was a married man, and his marriage contracted under the provisions governing
the conjugal partnership, has no bearing on income considered as income, and that the distinction must
be drawn between the ordinary form of commercial partnership and the conjugal partnership of
spouses resulting from the relation of marriage.

Held:

, this court in speaking of the conjugal partnership, decided that "prior to the liquidation the interest of
the wife and in case of her death, of her heirs, is an interest inchoate, a mere expectancy, which
constitutes neither a legal nor an equitable estate, and does not ripen into title until there appears that
there are assets in the community as a result of the liquidation and settlement." (Nable Jose vs. Nable
Jose [1916], 15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband Vicente
Madrigal during the life of the conjugal partnership. She has an interest in the ultimate property rights
and in the ultimate ownership of property acquired as income after such income has become capital.
Susana Paterno has no absolute right to one-half the income of the conjugal partnership. Not being
seized of a separate estate, Susana Paterno cannot make a separate return in order to receive the
benefit of the exemption which would arise by reason of the additional tax. As she has no estate and
income, actually and legally vested in her and entirely distinct from her husband's property, the income
cannot properly be considered the separate income of the wife for the purposes of the additional tax.
Moreover, the Income Tax Law does not look on the spouses as individual partners in an ordinary
partnership. The husband and wife are only entitled to the exemption of P8,000 specifically granted by
the law. The higher schedules of the additional tax directed at the incomes of the wealthy may not be
partially defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership and
having no application to the Income Tax Law. The aims and purposes of the Income Tax Law must be
given effect.
Take note!!! definition of income, taxable income!!!

Income as contrasted with capital or property is to be the test. The essential difference between capital
and income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is
called capital. A flow of services rendered by that capital by the payment of money from it or any other
benefit rendered by a fund of capital in relation to such fund through a period of time is called an
income. Capital is wealth, while income is the service of wealth. (See Fisher, "The Nature of Capital and
Income.") The Supreme Court of Georgia expresses the thought in the following figurative language:
"The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree,
income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on
property. "Income," as here used, can be defined as "profits or gains." (London County Council vs.
Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax
Cas., 265. See further Foster's Income Tax, second edition [1915], Chapter IV; Black on Income Taxes,

Limpan Investment Corp. v. CIR

FACTS:

• BIR assessed deficiency taxes on Limpan Corp, a company that leases real property, for under-
declaring its rental income for years 1956-57 by around P20K and P81K respectively.
• Petitioner appeals on the ground that portions of these underdeclared rents are yet to be collected by
the previous owners and turned over or received by the corporation.
• Petitioner cited that some rents were deposited with the court, such that the corporation does not
have actual nor constructive control over them.
• The sole witness for the petitioner, Solis (Corporate Secretary- Treasurer) admitted to some
undeclared rents in 1956 and1957, and that some balances were not collected by the corporation in
1956 because the lessees refused to recognize and pay rent to the new owners and that the corp’s
president Isabelo Lim collected some rent and reported it in his personal income statement, but did not
turn over the rent to the corporation.

• He also cites lack of actual or constructive control over rents deposited with the court.

ISSUE:

Whether or not the BIR was correct in assessing deficiency taxes against Limpan Corp. for undeclared
rental income

HELD:
Yes. Petitioner admitted that it indeed had undeclared income (although only a part and not the full
amount assessed by BIR). Thus, it has become incumbent upon them to prove their excuses by clear and
convincing evidence, which it has failed to do. When is there constructive receipt of rent? With regard to
1957 rents deposited with the court, and withdrawn only in 1958, the court viewed the corporation as
having constructively received said rents. The non-collection was the petitioner’s fault since it refused to
refused to accept the rent, and not due to nonpayment of lessees. Hence, although the corporation did
not actually receive the rent, it is deemed to have constructively received them.

Take note!!! definition of income, taxable income!!!

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

Republic v. Dela Rama

Nature of the case: This is an appeal from the decision of the Court of First Instance of Manila, dated
December 23, 1961, in its Civil Case No. 46494, dismissing the complaint of the Republic of the
Philippines against the heirs of the late Esteban de la Rama from the collection of P56,032.50 as
deficiency income tax, inclusive of 50% surcharge, for the year 1950

Facts of the case:

The executor of the estate of the late Esteban de la Rama files an income tax return of the estate.

The BIR found out that there had been received by the estate from the De la Rama Steamship Company,
dividends which was not declared in the income tax return of the estate.

The Bureau of Internal Revenue then made an assessment as deficiency income tax against the estate.
The deficiency income tax not having been paid, the Republic of the Philippines filed with the Court of
First Instance a complaint against the heirs of Esteban de la Rama, seeking to collect from each heir
his/her proportionate share in the income tax liability of the estate.

The defendants-appellees, thru counsel, filed their answers

(1) that no cash dividends of P86,800.00 had been paid to the estate;

(2) that the administration of the estate had been extended by the probate court precisely for the
purpose of collecting said dividends;

(3) that the collection of the alleged deficiency income tax had prescribed.

the lower court found that the dividends declared by the De la Rama Steamship Co. in favor of the late
Esteban de la Rama were applied to the obligation of the estate to the company declaring the dividends;

that the administration of the estate was extended for the purpose of recovering for the estate said
dividends from the De la Rama Steamship Co., Inc.;

After trial, the lower court rendered its decision, dated December 23, 1961, dismissing the complaint.

The plaintiff-appellant maintains that this crediting of accounts in the books of the company constituted
a constructive receipt by the estate or the heirs of Esteban de la Rama of the dividends, and this
dividend was an income of the estate and was, therefore, taxable.

Issues:

The question to be resolved is whether or not the said application of the dividends to the personal
accounts of the deceased Esteban de la Rama constituted constructive payment to, and hence,
constructively received by, the estate or the heirs. If the debts to which the dividends were applied
really existed, and were legally demandable and chargeable against the deceased, there was
constructive receipt of the dividends; if there were no such debts, then there was no constructive
receipt.

It is not disputed that the dividends in question were not actually paid either to the estate, or to the
heirs, of the late Esteban de la Rama.

Hence, if income has not been received, no income tax can be assessed thereon. Inasmuch as, the
income was not received either by the estate, or by the heirs, neither the estate nor the heir can be
liable for the payment of income tax therefor.

Take note!!! definition of income, taxable income!!!

Under the National Internal Revenue Code, income tax is assessed on income that has been received.
Thus, Section 21 of the Code requires that the income must be received by an individual before a tax can
be levied thereon.
CIR v. Japan Airlines
JAL is also a foreign corporation likewise engaged in the business of International air carriage. 

Now if British Overseas Airways Corp. (BOAC) merely used ticket sales agent and stayed at bay. The Japs
did it differently JAL maintained an office at the Filipinas Hotel, Roxas Boulevard Manila since mid-July of
1957.  

The said office did not sell tickets but was merely for the promotion of the company.  

But that's what they think.  On July 17 1957, JAL constituted Philippine Airlines (PAL) as its ticket agent in
the Philippines. PAL therefore sold tickets for and in behalf of JAL. Same as BOAC there was absence of
flight operations to and from the Philippines in this case. Meaning JAL likewise had no landing rights.
And so like BOAC what were talking about here are connecting flights.

So obviously this didn't escape the long 'nose'.. I mean claws of the BIR. On June 1972, JAL received
deficiency income tax assessments notices and a demand letter from petitioner CIR for years 1959
through 1963. 

Of course JAL protested as BOAC did, against said assessments alleging that as a non-resident foreign
corporation, it is taxable only on income from Philippines sources as determined by section 37 of the Tax
Code, there being no income on said years, JAL is not liable for taxes.

ISSUE:

Whether or not the proceeds from sales of JAL tickets sold in the Philippines by Philippine Airlines (PAL)
are taxable as income from sources within the Philippines.

HELD:

YES.  Court said the ticket sales are taxable.

Take note!!! Source of income, taxable income!!!

Citing the case of CIR v BOAC, the court reiterated that the source of an income is the property,
activity or service that produced the income. For the source of income to be considered as coming from
the Philippines, it is sufficient that the income is derived from activity within the Philippines. 

The absence of flight operations to and from the Philippines is not determinative of the source of
income or the situs of income taxation. 

The test of taxability is the source, and the source of the income is that activity which produced the
income. In this case, as JAL constituted PAL as its agent, the sales of JAL tickets made by PAL is taxable

JAL likewise lost this case.

Western Minolco Corp. v. CIR & CTA

Petitioner is a domestic corporation engaged in mining.

The petitioner was granted Certificate of Qualification for Tax Exemption.

The petitioner was also granted by the Securities and Exchange Commission the authority to borrow
money and issue commercial papers.

Pursuant to this authority, the petitioner borrowed funds from several financial institutions and paid the
corresponding 35% transaction tax due

The petitioner applied for the refund alleging that it was not liable to pay the 35% transaction tax under
its Certificate of Qualification for Tax Exemption.

Commissioner of internal Revenue denied the petitioner's claim for refund. The CIR contends that

a) The 35% transaction tax is actually a tax on the interest earnings of the lender who is actually
the taxpayer on whose income, the tax is imposed;

b) Petitioner's exemption from taxes granted relates to importations of machineries, tools and
equipment to be used in the mining operations and taxes on mining claims, improvement
thereon and mineral products, whereas the 35% transaction tax is levied on transactions
pertaining to commercial papers issued in the primary money market as principal instruments;
in other words, the tax exemption do not apply to this case of petitioner.

The petitioner filed a petition for review with the respondent Court of Tax Appeals.

Issue:

Whether or not the tax exemption granted to the petitioner also covers the 35% transaction tax levied
on transactions pertaining to commercial papers.

Held:

No, the exemption granted to petitioner does not exempt him to pay the 35% transaction tax levied on
transactions pertaining to commercial papers.

Under the law,

Section 1 of Presidential Decree No. 237 on Compensating Tax, Section I of P.D. No. 238 on Conditionally
Free Importations, and Section 53 of P.D. No. 463 all refer to tax exemptions for importations of
machineries, tools for production, plants to convert mineral ores into saleable form, spare parts,
supplies, materials, accessories, explosives, chemicals and transportation and communication facilities,
to be used in mining operations. Section 53 of P.D. No. 463 likewise refers to tax exemptions for mining
claims and improvements thereon, and mineral products, except income tax.

The petitioner's Certificate of Qualification for Tax Exemption No. 34 exempts "... from payment of all
taxes except income tax, payable by him in the conduct of his business and in the importation of
machineries, spare parts and or equipment…
Here in this case, the transaction tax of P1,317,801.03 paid by the petitioner was not actually imposed
upon it in the conduct of its mining business or in the importation of machinery, spare parts and or
equipment.

Petitioner Western Minolco Corporation has failed to justify its claimed exemption from the 35,7c,
transaction tax. The decision of the Commissioner of Internal Revenue denying the petitioner's claim for
refund is affirmed.

Petitioner submits that inasmuch as taxes in general constitute allowable deductions from gross income
in the determination of taxable net income, the 35% transaction tax is a business tax and not an income
tax because the Revenue Code itself classifies it as "Business Tax" under Title V, and that P. D. No. 1154
expressly states that the transaction tax shall be allowed as a deductible item for purposes of
determining the borrower's taxable income.

The petitioner's contentions deserve scant consideration, The 35%, transaction tax is imposed on
interest income from commercial papers issued in the primary money market. Being a tax on interest, it
is a tax on income.

As correctly ruled by the respondent Court of Tax Appeals:

Accordingly, we need not and do not think it necessary to discuss further the nature of the transaction
tax more than to say that the incipient scheme in the issuance of Letter of Instructions No. 340 on
November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational simplicity and effective
administration in capturing the interest-income 'windfall' from money market operations as a new
source of revenue has lost none of its animating principle in parturition of amendatory Presidential
decree No. 1154, now Section 210(b) of the Tax Code. The tax thus imposed is actually a tax on interest
earrings of the lenders or placers who are actually the taxpayer,, in whose income is imposed. Thus, "the
borrower withholds the tax of 35% from the interest he would have to pay the lender so that he
(borrower) can pay the 35% of the interest to the Government." (President Marcos, Times Journal, June
17, 1977 cited in Respondent's Memorandum p. 6) ... Suffice it to state that the broad concensus of
fiscal and monetary authorities is that "even if nominally, the borrower is made to pay the tax, actually
the tax is on the interest earning of the immediate and an prior lenders/placers of the money ... (Rollo,
pp. 36-37)

CIR v. Henderson

Rental allowances and travel allowances by a company are not part of taxable income.
FACTS:

• Sps. Arthur Henderson and Marie Henderson filed their annual income tax with the
BIR. Arthur is president of American International Underwriters for the Philippines, Inc.,
which is a domestic corporation engaged in the business of general non-life insurance,
and represents a group of American insurance companies engaged in the business of
general non-life insurance.

• The BIR demanded payment for alleged deficiency taxes. In their computation, the BIR
included as part of taxable income: 1) Arthur’s allowances for rental, residential
expenses, subsistence, water, electricity and telephone expenses 2) entrance fee to the
Marikina Gun and Country Club which was paid by his employer for his account and 3)
travelling allowance of his wife

• The taxpayers justifications are as follows:

1) as to allowances for rental and utilities, Arthur did not receive money for the
allowances. Instead, the apartment is furnished and paid for by his employer-
corporation (the mother company of American International), for the employer
corporation’s purposes. The spouses had no choice but to live in the expensive
apartment, since the company used it to entertain guests, to accommodate officials, and
to entertain customers. According to taxpayers, only P 4,800 per year is the reasonable
amount that the spouses would be spending on rental if they were not required to live in
those apartments. Thus, it is the amount they deem is subject to tax. The excess is to
be treated as expense of the company.

2) The entrance fee should not be considered income since it is an expense of his
employer, and membership therein is merely incidental to his duties of increasing and
sustaining the business of his employer.

3) His wife merely accompanied him to New York on a business trip as his secretary,
and at the employer-corporation’s request, for the wife to look at details of the plans of a
building that his employer intended to construct. Such must not be considered taxable
income.
 

• The Collector of Internal Revenue merely allowed the entrance fee as nontaxable. The
rent expense and travel expenses were still held to be taxable. The Court of Tax
Appeals ruled in favor of the taxpayers, that such expenses must not be considered part
of taxable income. Letters of the wife while in New York concerning the proposed
building were presented as evidence.

ISSUE: Whether or not the rental allowances and travel allowances

furnished and given by the employer-corporation are part of taxable
income?

HELD: NO. Such claims are substantially supported by evidence.

These claims are therefore NOT part of taxable income. No part of the allowances in
question redounded to their personal benefit, nor were such amounts retained by them.
These bills were paid directly by the employer-corporation to the creditors. The rental
expenses and subsistence allowances are to be considered not subject to income tax.
Arthur’s high executive position and social standing, demanded and compelled the
couple to live in a more spacious and expensive quarters. Such ‘subsistence allowance’
was a SEPARATE account from the account for salaries and wages of employees. The
company did not charge rentals as deductible from the salaries of the employees.
These expenses are COMPANY EXPENSES, not income by employees which are
subject to tax.

Rodriguez v. CIR
Nature of the case:

This is a petition for review of the decision of the Court of Tax Appeals in its CTA Case No. 849, affirming
the decision of the respondent Collector (now Commissioner) of Internal Revenue holding petitioner E.
Rodriguez, Inc. liable for deficiency income tax in the sum of P63,880.00 for the year 1950.

Facts:

The land owned by the petitioner was expropriated.

Then petitioner filed its income tax return showing on the face thereof a loss. In said return, petitioner
did not include the sum received by it from the government in the form of bonds in payment of its
expropriated properties, in the belief that the said amount was free or exempt from taxation. When this
return was later examined by an agent of the Bureau of Internal Revenue, the Collector of said bureau
assessed against petitioner a deficiency income tax.

Then petitioner offered by way of compromise to pay in full settlement of its disputed deficiency income
tax liability for 1950. This offer was rejected by the Collector of Internal Revenue; whereupon, under
date of June 24, 1960, petitioner filed a petition for review of the assessment in question before the
respondent Court of Tax Appeals which, after trial on the merits, rendered its decision affirming the
assessment in question. Hence, this appeal by petitioner thru the instant petition for review of the said
decision of respondent of Court of Tax Appeals.

Issue:

whether or not in determining the profit realized from the payment of the purchase price of its
(petitioner's) expropriated property, for income tax purposes portion of the purchase price paid in the
form of tax-exempt bonds issued under Republic Act No. 333 should be included.

Held:

There can be no question that petitioner is taxable on its income derived from the sale of its property to
the Government. The fact that a portion of the purchase price of the property was paid by the
Government in the form of tax exempt bonds does not operate to exempt said income from income tax.
The income from the sale of the land in question and the bond are two different and distinct taxable
items so that the exemption of one does not operate to exempt the other, unless the law expressly so
provides.

The above rules should be applied to the case at bar where the law invoked (Section 9 of Republic Act
No. 333) does not make any reference whatsoever to exemption of income derived from sale of
expropriated property thereunder unlike under Republic Act No. 1400 where relative to the price paid
by the Government for any agricultural land acquired for resale to tenants there is an express
declaration that the same "shall not be considered as income of the landowner concerned for purposes
of the income tax." Nor are We convinced by the argument that the particular provision of Republic Act
No. 333 relied upon which grants exemption on bonds issued thereunder for purposes of inducement to
private landowners within the new capital site to part away with their properties in favor of the
Government other than for cash should be taken to mean that said property owners need not pay
income tax on their income derived from the sale of such properties. The pertinent Congressional
Record of the proceedings held during the consideration of the bill which later became Republic Act No.
333, 8 does not show that Congress had intended to exempt said property owners from the payment of
income tax on the proceeds of the sale of their properties when the same is paid in government bonds
issued under the said law. Likewise even were We to assume for the sake of argument, that the Capital
City Planning Commission and other officials of the government did make some assurance or promise to
herein petitioner that the portion of the price of its expropriated property paid in tax-exempt
government bonds would not be made subject to income tax payment, such assurance or promise,
made without statutory sanction, cannot bind the Government. The same amounts to a surrender of the
State's power to require payment of income tax, which in this case is not explicitly granted by Republic
Act No. 333. It is a well-known rule that erroneous application and enforcement of the law by public
officers do not block subsequent correct application of the statute, 9 and that the Government is never
estopped by mistake or error on the part of its agents. 10 In the present circumstances, the Collector of
Internal Revenue is right in assessing against petitioner the deficiency income tax in question, consonant
with the proposition that income from expropriation proceedings is income from sales or exchange and
therefore taxable. 11

CIR v. Manning, Simmons & CTA

Nature of the case:

This is a petition for review of the decision of the Court of Tax Appeals, in CTA case 1626, which set aside
the income tax assessments issued by the Commissioner of Internal Revenue against John L. Manning,
W.D. McDonald and E.E. Simmons (hereinafter referred to as the respondents), for alleged undeclared
stock dividends received in 1958 from the Manila Trading and Supply Co. (hereinafter referred to as the
MANTRASCO) valued at P7,973,660.

Facts:

The Bureau of Internal Revenue concluded that the distribution of the 24,700 shares of Reese as stock
dividends was in effect a distribution of the "assets or property of the corporation." It therefore
assessed respondents for deficiency income taxes as well as for fraud penalty and interest charges. The
Court of Tax Appeals absolved respondent from any liability for receiving the questioned stock dividends
on the ground that their respective one-third interest in the Company remained the same before and
after the declaration of the stock dividends and only the number of shares held by each of them had
changed.

On a petition for review, the Supreme Court held that the newly acquired shares were not treasury
shares; their declaration as treasury stock dividends was a complete nullity and that the assessment by
the Commissioner of fraud penalty and the imposition of interest charges pursuant to the provision of
the Tax Code were made in accordance with law.

2. ID.; ID.; ID.; DECLARATION OF QUESTIONED SHARES AS TREASURY STOCK DIVIDENDS, A NULLITY. —
Where the manifest intention of the parties to the trust agreement was, in sum and substance, to treat
the shares of a deceased stockholder as absolutely outstanding shares of said stockholder’s estate until
they were fully paid. the declaration of said shares as treasury stock dividend was a complete nullity and
plainly violative of public policy.

3. ID.; ID.; STOCK DIVIDEND PAYABLE ONLY FROM RETAINED EARNINGS. — A stock dividend, being one
payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained
earnings.

4. ID.; ID.; PURCHASE OF HOLDING RESULTING IN DISTRIBUTION OF EARNINGS TAXABLE. — Where by

the use of a trust instrument as a convenient technical device, respondents bestowed unto themselves
the full worth and value of a deceased stockholder’s corporate holding acquired with the very earnings
of the companies, such package device which obviously is not designed to carry out the usual stock
dividend purpose of corporate expansion reinvestment, e.g., the acquisition of additional facilities and
other capital budget items, but exclusively for expanding the capital base of the surviving stockholders in
the company, cannot be allowed to deflect the latter’s responsibilities toward our income tax laws. The
conclusion is ineluctable that whenever the company parted with a portion of its earnings "to buy" the
corporate holdings of the deceased stockholders, it was in ultimate effect and result making a
distribution of such earnings to the surviving stockholders. All these amounts are consequently subject
to income tax as being, in truth and in fact, a flow of cash benefits to the surviving stockholders.

Take note!!!

A. National Internal Revenue Code

"SEC. 83. Distribution of dividends or assets by corporations — (a) Definition of Dividends — The term
‘dividends’ when used in this Title means any distribution made by a corporation to its shareholders out
of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its
shareholders, whether in money or in other property.

"Where a corporation distributes all of its assets in complete liquidation or dissolution the gain realized
or loss sustained by the stockholder, whether individual or corporate, is a taxable income or deductible
loss, as the case may be.

"(b) Stock dividend. — A stock dividend representing the transfer of surplus to capital account shall not
be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time
and in such manner as to make the distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption
or cancellation of the stock shall be considered as taxable income to the extent that it represents a
distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen."cralaw
virtua1aw library

Of pointed relevance is this useful discussion of the nature of a stock dividend: 8

"‘A stock dividend always involves a transfer of surplus (or profit) to capital stock.’ Graham and Katz,
Accounting in Law Practice, 2d ed. 1938, No. 70. As the court said in United States v. Siegel, 8 Cir., 1931,
52 F 2d 63, 65, 78 ALR 672: ‘A stock dividend is a conversion of surplus or undivided profits into capital
stock, which is distributed to stockholders in lieu of a cash dividend.’ Congress itself has defined the
term ‘dividend’ in No. 115(a) of the Act as meaning any distribution made by a corporation to its
shareholders, whether in money or in other property, out of its earnings or profits. In Eisner v.
Macomber, 1920, 252 US 189, 40 S Ct 189, 64 L Ed 521, 9 ALR 1570, both the prevailing and the
dissenting opinions recognized that within the meaning of the revenue acts the essence of a stock
dividend was the segregation out of surplus account of a definite portion of the corporate earnings as
part of the permanent capital resources of the corporation by the device of capitalizing the same, and
the issuance to the stockholders of additional shares of stock representing the profits so
capitalized."cralaw virtua1aw library

The conclusion is thus ineluctable that whenever the companies involved herein parted with a portion of
their earnings "to buy" the corporate holdings of Reese, they were in ultimate effect and result making a
distribution of such earnings to the respondents. All these amounts are consequently subject to income
tax as being, in truth and in fact, a flow of cash benefits to the respondents.

We are of the opinion, however, that the Commissioner erred in assessing the respondents the total
acquisition cost (P7,973,660) of the alleged treasury stock dividends in one lump sum. The record shows
that the earnings of MANTRASCO over a period of years were used to gradually wipe out the holdings
therein of Reese. Consequently, those earnings, which we hold, under the facts disclosed in the case at
bar, as in effect having been distributed to the respondents, should be taxed for each of the
corresponding years when payments were made to Reese’s estate on account of his 24,700 shares. With
regard to payments made with MANTRASCO earnings in 1958 and the years before, while indeed those
earnings were utilized in those years to gradually pay off the value of Reese’s holdings in MANTRASCO,
there is no evidence from which it can be inferred that prior to the passage of the stockholders’
resolution of December 22, 1958 the contributed equity of each of the respondents rose
correspondingly. It was only by virtue of the authority contained in the said resolution that the
respondents actually, albeit illegally, appropriated and partitioned among themselves the stockholders’
equity representing Reese’s interests in MANTRASCO. As those payments accrued in favor of the
respondents in 1958 they are and should be liable, for income tax purposes, to the extent of the
aggregate amount paid, from 1955 to 1958, by MANTRASCO to buy off Reese’s shares.

The fact that the resolution authorizing the distribution of the said earnings is null and void is of no
moment. Under the National Internal Revenue Code, income tax is assessed on income received from
any property, activity or service that produces income. 9 The Tax Code stands as an indifferent, neutral
party on the matter of where the income comes from. 10

CIR v. Javier

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

There was a mistaken remittance received by Javier and when he filed his income tax return he states as
a footnote that a sum of money that he erroneously received and already spent is the subject of a
pending litigation and there did not declare it as income.

Held:

No he is not liable for the fraud penalty of 50% as the failure to declare the "mistaken remittance" is not
fraudulent.

A "fraudulent return" is always an attempt to evade a tax, but a merely "false return" may not be, Rick v.
U.S., App. D.C., 161 F. 2d 897, 898.16

In the case at bar, there was no actual and intentional fraud through willful and deliberate misleading of
the government agency concerned, the Bureau of Internal Revenue, headed by the herein petitioner.
The government was not induced to give up some legal right and place itself at a disadvantage so as to
prevent its lawful agents from proper assessment of tax liabilities because Javier did not conceal
anything. Error or mistake of law is not fraud. The petitioner's zealousness to collect taxes from the
unearned windfall to Javier is highly commendable.1âwphi1 Unfortunately, the imposition of the fraud
penalty in this case is not justified by the extant facts. Javier may be guilty of swindling charges, perhaps
even for greed by spending most of the money he received, but the records lack a clear showing of fraud
committed because he did not conceal the fact that he had received an amount of money although it
was a "subject of litigation." As ruled by respondent Court of Tax Appeals, the 50% surcharge imposed as
fraud penalty by the petitioner against the private respondent in the deficiency assessment should be
deleted.