Income Tax - cases

Hermilando I. Mandanas v. The Executive Secretary, G.R. No. 199802, July 3,

2018

Antecedents

One of the key features of the 1987 Constitution is its push towards
decentralization of government and local autonomy. Local autonomy has two
facets, the administrative and the fiscal. Fiscal autonomy means that local
governments have the power to create their own sources of revenue in addition to
their equitable share in the national taxes released by the National Government, as
well as the power to allocate their resources in accordance with their own
priorities.1   Such autonomy is as indispensable to the viability of the policy of
decentralization as the other.

Implementing the constitutional mandate for decentralization and local autonomy,

Congress enacted Republic Act No. 7160, otherwise known as the   Local
Government Code (LGC), in order to guarantee the fiscal autonomy of the LGUs
by specifically providing that:

SECTION 284. Allotment of Internal Revenue Taxes. - Local government units

shall have a share in the national internal revenue taxes based on the collection of
the third fiscal year preceding the current fiscal year as follows:

(a) On the first year of the effectivity of this Code, thirty percent (30%); (b) On the
second year, thirty-five percent (35%); and

(c) On the third year and thereafter, forty percent (40%).

Provided, That in the event that the National Government incurs an unmanageable
public sector deficit, the President of the Philippines is hereby authorized, upon the
recommendation of Secretary of Finance, Secretary of Interior and Local
Government, and Secretary of Budget and Management, and subject to
consultation with the presiding officers of both Houses of Congress and the
presidents of the "liga", to make the necessary adjustments in the internal revenue
allotment of local government units but in no case shall the allotment be less than
thirty percent (30%) of the collection of national internal revenue taxes of the third
fiscal year preceding the current fiscal year: Provided, further, That in the first year
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of the effectivity of this Code, the local government units shall, in addition to the
thirty percent (30%) internal revenue allotment which shall include the cost of
devolved functions for essential public services, be entitled to receive the amount
equivalent to the cost of devolved personal services.

The share of the LGUs, heretofore known as the Internal Revenue Allotment
(IRA), has been regularly released to the LGUs. According to the implementing
rules and regulations of the LGC, the IRA is determined on the basis of the actual
collections of the National Internal Revenue Taxes (NIRTs) as certified by the
Bureau of Internal Revenue (BIR).2

G.R. No. 199802 (Mandanas,   et al.)   is a special civil action

for   certiorari,   prohibition and   mandamus   assailing the manner the General
Appropriations Act (GAA) for FY 2012 computed the IRA for the LGUs.

Mandanas, et al. allege herein that certain collections of NIR Ts by the Bureau of

Customs (BOC) - specifically: excise taxes, value added taxes (VATs) and
documentary stamp taxes (DSTs) - have not been included in the base amounts for
the computation of the IRA; that such taxes, albeit collected by the BOC, should
form part of the base from which the IRA should be computed because they
constituted NIRTs; that, consequently, the release of the additional amount of
₱60,750,000,000.00 to the LGUs as their IRA for FY 2012 should be ordered; and
that for the same reason the LGUs should also be released their unpaid IRA for FY
1992 to FY 2011, inclusive, totaling ₱438,103,906,675.73.

In G.R. No. 208488, Congressman Enrique Garcia, Jr., the lone petitioner, seeks
the writ of   mandamus   to compel the respondents thereat to compute the   just
share of the LGUs on the basis of all national taxes. His petition insists on a literal
reading of Section 6, Article X of the 1987 Constitution. He avers that the insertion
by Congress of the words internal revenue in the phrase national taxes found in
Section 284 of the LGC caused the diminution of the base for determining the just
share of the LGUs, and should be declared unconstitutional; that, moreover, the
exclusion of certain taxes and accounts pursuant to or in accordance with special
laws was similarly constitutionally untenable; that the VA Ts and excise taxes
collected by the BOC should be included in the computation of the IRA; and that
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the respondents should compute the IRA on the basis of all national tax collections,
and thereafter distribute any shortfall to the LGUs.

It is noted that named as common respondents were the then incumbent Executive
Secretary, Secretary of Finance, the Secretary of the Department of Budget and
Management (DBM), and the Commissioner of Internal Revenue. In addition,
Mandanas,   et al.   impleaded the National Treasurer, while Garcia added the
Commissioner of Customs.

The cases were consolidated on October 22, 2013.   3   In the meanwhile,

Congressman Garcia, Jr. passed away. Jose Enrique Garcia III, who was
subsequently elected to the same congressional post, was substituted for
Congressman Garcia, Jr. as the petitioner in G.R. No. 208488 under the resolution
promulgated on August 23, 2016.4

In response to the petitions, the several respondents, represented by the Office of

the Solicitor General (OSG), urged the dismissal of the petitions upon procedural
and substantive considerations.

Anent the procedural considerations, the OSG argues that the petitions are
procedurally defective because, firstly, mandamus does not lie in order to achieve
the reliefs sought because Congress may not be compelled to appropriate the sums
allegedly illegally withheld for to do so will violate the doctrine of separation of
powers; and, secondly, mandamus does not also lie to compel the DBM to release
the amounts to the LGUs because such disbursements will be contrary to the
purposes specified in the GAA; that Garcia has no clear legal right to sustain his
suit for mandamus; that the filing of Garcia's suit violates the doctrine of hierarchy
of courts; and that Garcia's petition seeks declaratory relief but the Court cannot
grant such relief in the exercise of its original jurisdiction.

On the substantive considerations, the OSG avers that Article 284 of the LGC is
consistent with the mandate of Section 6, Article X of the 1987 Constitution to the
effect that the LGUs shall have a   just share   in the national taxes; that the
determination of the   just share   is within the discretion of Congress; that the
limitation under the LGC of the basis for the just share in the NIRTs was within the
powers granted to Congress by the 1987 Constitution; that the LGUs have been
receiving their just share in the national taxes based on the correct base amount;
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that Congress has the authority to exclude certain taxes from the base amount in
computing the IRA; that there is a distinction between the VA Ts, excise taxes and
DSTs collected by the BIR, on one hand, and the VA Ts, excise taxes and DSTs
collected by the BOC, on the other, thereby warranting their different treatment;
and that Development Budget Coordination Committee (DBCC) Resolution No.
2003-02 dated September 4, 2003 has limited the base amount for the computation
of the IRA to the "cash collections based on the BIR data as reconciled with the
Bureau of Treasury;" and that the collection of such national taxes by the BOC
should be excluded.

Issues

The issues for resolution are limited to the following, namely:

I.

Whether or not Mandamus is the proper vehicle to assail the constitutionality of the
relevant provisions of the GAA and the LGC;

II.

Whether or not Section 284 of the LGC is unconstitutional for being repugnant to
Section 6, Article X of the 1987 Constitution;

III.

Whether or not the existing shares given to the LGUs by virtue of the GAA is
consistent with the constitutional mandate to give LGUs a 'just share" to national
taxes following Article X, Section 6 of the 1987 Constitution;

IV.

Whether or not the petitioners are entitled to the reliefs prayed for.

Simply stated, the petitioners raise the novel question of whether or not the
exclusion of certain national taxes from the base amount for the computation of
the just share of the LGUs in the national taxes is constitutional.
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Ruling of the Court

The petitions are partly meritorious.

I

Mandamus is an improper remedy

Mandanas, et al. seek the writs of certiorari, prohibition and mandamus, while

Garcia prays for the writ of mandamus. Both groups of petitioners impugn the
validity of Section 284 of the LGC.

The remedy of   mandamus   is defined in Section 3, Rule 65 of the   Rules of

Court, which provides:

Section 3. Petition for mandamus. - When any tribunal, corporation, board, officer
or person unlawfully neglects the performance of an act which the law specifically
enjoins as a duty resulting from an office, trust, or station, or unlawfully excludes
another from the use and enjoyment of a right or office to which such other is
entitled, and there is no other plain, speedy and adequate remedy in the ordinary
course of law, the person aggrieved thereby may file a verified petition in the
proper court, alleging the facts with certainty and praying that judgment be
rendered commanding the respondent, immediately or at some other time to be
specified by the court, to do the act required to be done to protect the rights of the
petitioner, and to pay the damages sustained by the petitioner by reason of the
wrongful acts of the respondent.

The petition shall also contain a sworn certification of non-forum shopping as

provided in the third paragraph of section 3, Rule 46.

For the writ of mandamus to issue, the petitioner must show that the act sought to
be performed or compelled is ministerial on the part of the respondent. An act is
ministerial when it does not require the exercise of judgment and the act is
performed pursuant to a legal mandate. The burden of proof is on
the mandamus petitioner to show that he is entitled to the performance of a legal
right, and that the respondent has a corresponding duty to perform the act. The writ
of mandamus may not issue to compel an official to do anything that is not his duty
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to do, or that is his duty not to do, or to obtain for the petitioner anything to which
he is not entitled by law. 5

Considering that its determination of what constitutes the just share of the LGUs in
the national taxes under the 1987 Constitution is an entirely discretionary power,
Congress cannot be compelled by writ of   mandamus   to act either way. The
discretion of Congress thereon, being exclusive, is not subject to external direction;
otherwise, the delicate balance underlying our system of government may be
unduly disturbed. This conclusion should at once then demand the dismissal of the
Garcia petition in G.R. No. 208488, but we do not dismiss it. Garcia has attributed
the non-release of some portions of their IRA balances to an alleged congressional
indiscretion - the diminution of the base amount for computing the LGU's just
share. He has asserted that Congress altered the constitutional base not only by
limiting the base to the NIRTs instead of including therein all national taxes, but
also by excluding some national taxes and revenues that only benefitted a few
LGUs to the detriment of the rest of the LGUs.

Garcia's petition, while dubbed as a petition for   mandamus,   is also a petition

for certiorari because it alleges that Congress thereby committed grave abuse of
discretion amounting to lack or excess of jurisdiction. It is worth reminding that
the actual nature of every action is determined by the allegations in the body of the
pleading or the complaint itself, not by the nomenclature used to designate the
same.  6  Moreover, neither should the prayer for relief be controlling; hence, the
courts may still grant the proper relief as the facts alleged in the pleadings and the
evidence introduced may warrant even without a prayer for specific remedy.7

In this regard, Garcia's allegation of the unconstitutionality of the insertion by

Congress of the words   internal revenue   in the phrase   national taxes   justifies
treating his petition as one for certiorari. It becomes our duty, then, to assume
jurisdiction over his petition. In Araullo v. Aquino III,8 the Court has emphatically
opined that the Court's certiorari jurisdiction under the expanded judicial power as
stated in the second paragraph of Section 1, Article VIII of the Constitution can be
asserted:

xxxx to set right and undo any act of grave abuse of discretion amounting to lack
or excess of jurisdiction by any branch or instrumentality of the Government, the
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Court is not at all precluded from making the inquiry provided the challenge was
properly brought by interested or affected parties. The Court has been thereby
entrusted expressly or by necessary implication with both the duty and the
obligation of determining, in appropriate cases, the validity of any assailed
legislative or executive action. This entrustment is consistent with the republican
system of checks and balances. 9

Further, observing that one of the reliefs being sought by Garcia is identical to the
main relief sought by Mandanas,   et al.,   the Court should rightly dwell on the
substantive arguments posited by Garcia to the extent that they are relevant to the
ultimate resolution of these consolidated suits.

II.

Municipal corporations and their relationship with Congress

The correct resolution and fair disposition of the issues interposed for our
consideration require a review of the basic principles underlying our system of
local governments, and of the extent of the autonomy granted to the LGUs by the
1987 Constitution.

Municipal corporations are now commonly known as local governments. They are
the bodies politic established by law partly as agencies of the State to assist in the
civil governance of the country. Their chief purpose has been to regulate and
administer the local and internal affairs of the cities, municipalities or districts.
They are legal institutions formed by charters from the sovereign power, whereby
the populations within communities living within prescribed areas have formed
themselves into bodies politic and corporate, and assumed their corporate names
with the right of continuous succession and for the purposes and with the authority
of subordinate self-government and improvement and the local administration of
the affairs of the State. 10

Municipal corporations, being the mere creatures of the State, are subject to the
will of Congress, their creator. Their continued existence and the grant of their
powers are dependent on the discretion of Congress. On this matter, Judge John F.
Dillon of the State of Iowa in the United States of America enunciated in Merriam
v. Moody's Executors11   the rule of statutory construction that came to be oft-
mentioned as Dillon's Rule, to wit:
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[A] municipal corporation possesses and can exercise the following powers and no
others: First, those granted in express words; second, those necessarily implied or
necessarily incident to the powers expressly granted; third, those absolutely
essential to the declared objects and purposes of the corporation-not simply
convenient but indispensible; fourth, any fair doubt as to the existence of a power
is resolved by the courts against the corporation-against the existence of the
powers. 12

The formulation of Dillon's Rule has since undergone slight modifications. Judge
Dillon himself introduced some of the modifications through his   post-
Merriam   writings with the objective of alleviating the original formulation's
harshness. The word   fairly   was added to the second   proviso; the
word   absolutely   was deleted from the third   proviso; and the
words reasonable and substantial were added to the fourth proviso, thusly:

x x x second, those necessarily or   fairly   implied in or incident to the powers

expressly granted; third, those essential to x x x. Any fair, reasonable, doubt. 13

The modified Dillon's Rule has been followed in this jurisdiction, and has remained
despite both the 1973 Constitution and the 1987 Constitution mandating autonomy
for local governments. This has been made evident in several rulings of the Court,
one of which was that handed down in Magtajas v. Pryce Properties Corporation,
lnc.: 14

In light of all the above considerations, we see no way of arriving at the conclusion
urged on us by the petitioners that the ordinances in question are valid. On the
contrary, we find that the ordinances violate P.D. 1869, which has the character and
force of a statute, as well as the public policy expressed in the decree allowing the
playing of certain games of chance despite the prohibition of gambling in general.

The rationale of the requirement that the ordinances should not contravene a statute
is obvious. Municipal governments are only agents of the national government.
Local councils exercise only delegated legislative powers conferred on them by
Congress as the national lawmaking body. The delegate cannot be superior to
the principal or exercise powers higher than those of the latter. It is a heresy to
suggest that the local government units can undo the acts of Congress, from
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which they have derived their power in the first place, and negate by mere
ordinance the mandate of the statute.

Municipal corporations owe their origin to, and derive their powers and rights
wholly from the legislature. It breathes into them the breath of life, without
which they cannot exist. As it creates, so it may destroy. As it may destroy, it
may abridge and control. Unless there is some constitutional limitation on the
right, the legislature might, by a single act, and if we can suppose it capable of
so great a folly and so great a wrong, sweep from existence all of the municipal
corporations in the State, and the corporation could not prevent it. We know
of no limitation on the right so far as to the corporation themselves are
concerned. They are, so to phrase it, the mere tenants at will of the legislature.

This basic relationship between the national legislature and the local
government units has not been enfeebled by the new provisions in the
Constitution strengthening the policy of local autonomy. Without meaning to
detract from that policy, we here confirm that Congress retains control of the
local government units although in significantly reduced degree now than
under our previous Constitutions. The power to create still includes the power
to destroy. The power to grant still includes the power to withhold or recall.

True, there are certain notable innovations in the Constitution, like the direct
conferment on the local government units of the power to tax, which cannot
now be withdrawn by mere statute. By and large, however, the national
legislature is still the principal of the local government units, which cannot
defy its will or modify or violate it. [Bold underscoring supplied for emphasis]

Also, in the earlier ruling in Ganzon v. Court of Appeals,  15  the Court has pointed
out that the 1987 Constitution, in mandating autonomy for the LGUs, did not
intend to deprive Congress of its authority and prerogatives over the LGUs.

Nonetheless, the LGC has tempered the application of Dillon's Rule in the
Philippines by providing a norm of interpretation in favor of the LGUs in its
Section 5(a), to wit:

xxxx
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(a) Any provision on a power of a local government unit shall be liberally

interpreted in its favor, and in case of doubt, any question thereon shall be resolved
in favor of devolution of powers and of the local government unit. Any fair and
reasonable doubt as to the existence of the power shall be interpreted in favor
of the local government unit concerned; [Bold underscoring supplied for
emphasis]

xxxx

III.

The extent of local autonomy in the Philippines

Regardless, there remains no question that Congress possesses and wields plenary
power to control and direct the destiny of the LGUs, subject only to the
Constitution itself, for Congress, just like any branch of the Government, should
bow down to the majesty of the Constitution, which is always supreme.

The 1987 Constitution limits Congress' control over the LGUs by ordaining in
Section 25 of its Article II that: "The State shall ensure the autonomy of local
governments."   The autonomy of the LGUs as thereby ensured does not
contemplate the fragmentation of the Philippines into a collection of mini-
states,  16  or the creation of imperium in imperio.  17  The grant of autonomy simply
means that Congress will allow the LGUs to perform certain functions and exercise
certain powers in order not for them to be overly dependent on the National
Government subject to the limitations that the 1987 Constitution or Congress may
impose.  18  Local autonomy recognizes the wholeness of the Philippine society in
its ethnolinguistic, cultural, and even religious diversities.19

The constitutional mandate to ensure local autonomy refers to decentralization.20 In

its broad or general sense, decentralization has two forms in the Philippine setting,
namely: the decentralization of power and the decentralization of administration.
The decentralization of power involves the abdication of political power in favor of
the autonomous LGUs as to grant them the freedom to chart their own destinies
and to shape their futures with minimum intervention from the central government.
This amounts to self-immolation because the autonomous LGUs thereby become
accountable not to the central authorities but to their constituencies. On the other
hand, the decentralization of administration occurs when the central government
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delegates administrative powers to the LGUs as the means of broadening the base
of governmental powers and of making the LGUs more responsive and
accountable in the process, and thereby ensure their fullest development as self-
reliant communities and more effective partners in the pursuit of the goals of
national development and social progress. This form of decentralization further
relieves the central government of the burden of managing local affairs so that it
can concentrate on national concerns.21

Two groups of LGUs enjoy decentralization in distinct ways. The decentralization

of power has been given to the regional units (namely, the Autonomous Region for
Muslim Mindanao [ARMM] and the constitutionally-mandated Cordillera
Autonomous Region [CAR]). The other group of LGUs   (i.e.,   provinces, cities,
municipalities and barangays) enjoy the decentralization of administration.22  The
distinction can be reasonably understood. The provinces, cities, municipalities and
barangays are given decentralized administration to make governance at the local
levels more directly responsive and effective. In turn, the economic, political and
social developments of the smaller political units are expected to propel social and
economic growth and development.  23  In contrast, the regional autonomy of the
ARMM and the CAR aims to permit determinate groups with common traditions
and shared social-cultural characteristics to freely develop their ways of life and
heritage, to exercise their rights, and to be in charge of their own affairs through
the establishment of a special governance regime for certain member communities
who choose their own authorities from within themselves, and exercise the
jurisdictional authority legally accorded to them to decide their internal community
affairs. 24

It is to be underscored, however, that the decentralization of power in favor of the

regional units is not unlimited but involves only the powers enumerated by Section
20, Article X of the 1987 Constitution and by the acts of Congress. For, with
various powers being devolved to the regional units, the grant and exercise of such
powers should always be consistent with and limited by the 1987 Constitution and
the national laws.   25   In other words, the powers are guardedly, not absolutely,
abdicated by the National Government.

Illustrative of the limitation is what transpired in   Serna v. Commission on

Elections,26  where the Court struck down Section 19, Article VI of Republic Act
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No. 9054 (An Act to Strengthen and Expand the Organic Act for the Autonomous
Region in Muslim Mindanao, Amending for the Purpose Republic Act No. 6734,
entitled "An Act Providing for the Autonomous Region in Muslim Mindanao," as
Amended)   insofar as the provision granted to the ARMM the power to create
provinces and cities, and consequently declared as void Muslim Mindanao
Autonomy Act No. 201 creating the Province of Shariff Kabunsuan for being
contrary to Section 5, Article VI and Section 20, Article X of the 1987
Constitution, as well as Section 3 of the Ordinance appended to the 1987
Constitution. The Court clarified therein that only Congress could create provinces
and cities. This was because the creation of provinces and cities necessarily
entailed the creation of legislative districts, a power that only Congress could
exercise pursuant to Section 5, Article VI of the 1987 Constitution and Section 3 of
the Ordinance appended to the Constitution; as such, the ARMM would be thereby
usurping the power of Congress to create legislative districts and national offices.27

The 1987 Constitution has surely encouraged decentralization by mandating that a

system of decentralization be instituted through the LGC in order to enable a more
responsive and accountable local government structure.28  It has also delegated the
power to tax to the LGUs by authorizing them to create their own sources of
income that would make them self-reliant.29  It further ensures that each and every
LGU will have a just share in national taxes as well in the development of the
national wealth.30

The LGC has further delineated in its Section 3 the different operative principles of
decentralization to be adhered to consistently with the constitutional policy on
local autonomy, viz.:

Sec. 3. Operative Principles of Decentralization-

The formulation and implementation of policies and measures on local autonomy

shall be guided by the following operative principles:

(a) There shall be an effective allocation among the different local government
units of their respective powers, functions, responsibilities, and resources;
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(b) There shall be established in every local government unit an accountable,

efficient, and dynamic organizational structure and operating mechanism that will
meet the priority needs and service requirements of its communities;

(c) Subject to civil service law, rules and regulations, local officials and employees
paid wholly or mainly from local funds shall be appointed or removed, according
to merit and fitness, by the appropriate appointing authority;

(d) The vesting of duty, responsibility, and accountability in local government units
shall be accompanied with provision for reasonably adequate resources to
discharge their powers and effectively carry out their functions: hence, they shall
have the power to create and broaden their own sources of revenue and the right to
a just share in national taxes and an equitable share in the proceeds of the
utilization and development of the national wealth within their respective areas;

(e) Provinces with respect to component cities and municipalities, and cities and
municipalities with respect to component barangays, shall ensure that the acts of
their component units are within the scope of their prescribed powers and
functions;

(f) Local government units may group themselves, consolidate or coordinate their
efforts, services, and resources commonly beneficial to them;

(g) The capabilities of local government units, especially the municipalities and
barangays, shall be enhanced by providing them with opportunities to participate
actively in the implementation of national programs and projects;

(h) There shall be a continuing mechanism to enhance local autonomy not only by
legislative enabling acts but also by administrative and organizational reforms;

(i) Local government units shall share with the national government the
responsibility in the management and maintenance of ecological balance within
their territorial jurisdiction, subject to the provisions of this Code and national
policies;
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(j) Effective mechanisms for ensuring the accountability of local government units
to their respective constituents shall be strengthened in order to upgrade
continually the quality of local leadership;

(k) The realization of local autonomy shall be facilitated through improved

coordination of national government policies and programs an extension of
adequate technical and material assistance to less developed and deserving local
government units;

(l) The participation of the private sector in local governance, particularly in the
delivery of basic services, shall be encouraged to ensure the viability of local
autonomy as an alternative strategy for sustainable development; and

(m) The national government shall ensure that decentralization contributes to the
continuing improvement of the performance of local government units and the
quality of community life.

Based on the foregoing delineation, decentralization can be considered as the

decision by the central government to empower its subordinates, whether
geographically or functionally constituted, to exercise authority in certain areas. It
involves decision-making by subnational units, and is typically a delegated power,
whereby a larger government chooses to delegate authority to more local
governments.31   It is also a process, being the set of policies, electoral or
constitutional reforms that transfer responsibilities, resources or authority from the
higher to the lower levels of government.32 It is often viewed as a shift of authority
towards local governments and away from the central government, with total
government authority over society and economy imagined as fixed.33

As a system of transferring authority and power from the National Government to

the LGUs, decentralization in the Philippines may be categorized into four,
namely: (1) political decentralization or devolution; (2) administrative
decentralization or deconcentration; (3) fiscal decentralization; and (4) policy or
decision-making decentralization.

Political decentralization or devolution occurs when there is a transfer of powers,

responsibilities, and resources from the central government to the LOU s for the
performance of certain functions. It is a more liberal form of decentralization
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because there is an actual transfer of powers and responsibilities. It aims to grant

greater autonomy to the LGUs in cognizance of their right to self-government, to
make them self-reliant, and to improve their administrative and technical
capabilities.34  It is an act by which the National Government confers power and
authority upon the various LGUs to perform specific functions and responsibilities.
35   It encompasses reforms to open sub-national representation and policies to

"devolve political authority or electoral capacities to sub-national actors.

"36  Section 16 to Section 19 of the LGC characterize political decentralization in
the LGC as different LGUs empowered to address the different needs of their
constituents. In contrast, devolution in favor of the regional units is more
expansive because they are given the authority to regulate a wider array of
subjects, including personal, family and property relations.

Administrative decentralization or deconcentration involves the transfer of

functions or the delegation of authority and responsibility from the national office
to the regional and local offices.  37  Consistent with this concept, the LGC has
created the Local School Boards,38   the Local Health Boards39   and the Local
Development Councils,40   and has transferred some of the authority from the
agencies of the National Government, like the Department of Education and the
Department of Health, to such bodies to better cope up with the needs of particular
localities.

Fiscal decentralization means that the LGUs have the power to create their own
sources of revenue in addition to their just share in the national taxes released by
the National Government. It includes the power to allocate their resources in
accordance with their own priorities. It thus extends to the preparation of their
budgets, so that the local officials have to work within the constraints of their
budgets. The budgets are not formulated at the national level and imposed on local
governments, without regard as to whether or not they are relevant to local needs
and resources. Hence, the necessity of a balancing of viewpoints and the
harmonization of proposals from both local and national officials, who in any case
are partners in the attainment of national goals, is recognized and addressed.41

Fiscal decentralization emanates from a specific constitutional mandate that is

expressed in several provisions of Article X   (Local Government)   of the 1987
Constitution, specifically: Section 5;42 Section 6;43 and Section 7.44
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The constitutional authority extended to each and every LGU to create its own
sources of income and revenue has been formalized from Section 128 to Section
133 of the LGC. To implement the LGUs' entitlement to the just share in the
national taxes, Congress has enacted Section 284 to Section 288 of the LGC.
Congress has further enacted Section 289 to Section 294 of the LGC to define the
share of the LGUs in the national wealth. Indeed, the requirement for the automatic
release to the LGUs of their just share in the national taxes is but the consequence
of the constitutional mandate for fiscal decentralization. 45

For sure, fiscal decentralization does not signify the absolute freedom of the LGUs
to create their own sources of revenue and to spend their revenues unrestrictedly or
upon their individual whims and caprices. Congress has subjected the LGUs'
power to tax to the guidelines set in Section 130 of the LGC and to the limitations
stated in Section 133 of the LGC. The concept of local fiscal autonomy does not
exclude any manner of intervention by the National Government in the form of
supervision if only to ensure that the local programs, fiscal and otherwise, are
consistent with the national goals.46

Lastly, policy- or decision-making decentralization exists if at least one sub-

national tier of government has exclusive authority to make decisions on at least
one policy issue.47

In fine, certain limitations are and can be imposed by Congress in all the forms of
decentralization, for local autonomy, whether as to power or as to administration, is
not absolute. The LGUs remain to be the tenants of the will of Congress subject to
the guarantees that the Constitution itself imposes.

IV.

Section 284 of the LGC deviates from the plain language

of Section 6 of Article X of the 1987 Constitution

Section 6, Article X the 1987 Constitution textually commands the allocation to the
LGUs of a just share in the national taxes, viz.:

Section 6. Local government units shall have a just share, as determined by law, in
the national taxes which shall be automatically released to them.
Income Tax - cases

Section 6, when parsed, embodies three mandates, namely: (1) the LGUs shall
have a just share in the national taxes; (2) the just share shall be determined by
law; and (3) the just share shall be automatically released to the LGUs.48

Congress has sought to carry out the second mandate of Section 6 by enacting
Section 284, Title III   (Shares of Local Government Units in the Proceeds of
National Taxes), of the LGC, which is again quoted for ready reference:

Section 284. Allotment of Internal Revenue Taxes. - Local government units shall

have a share in the national internal revenue taxes based on the collection of the
third fiscal year preceding the current fiscal year as follows:

(a) On the first year of the effectivity of this Code, thirty percent (30%);

(b) On the second year, thirty-five percent (35%); and

(c) On the third year and thereafter, forty percent (40%).

Provided, That in the event that the national government incurs an unmanageable
public sector deficit, the President of the Philippines is hereby authorized, upon the
recommendation of Secretary of Finance, Secretary of Interior and Local
Government and Secretary of Budget and Management, and subject to consultation
with the presiding officers of both Houses of Congress and the presidents of the
"liga", to make the necessary adjustments in the internal. revenue allotment of local
government units but in no case shall the allotment be less than thirty percent
(30%) of the collection of national internal revenue taxes of the third fiscal year
preceding the current fiscal year: Provided, further, That in the first year of the
effectivity of this Code, the local government units shall, in addition to the thirty
percent (30%) internal revenue allotment which shall include the cost of devolved
functions for essential public services, be entitled to receive the amount equivalent
to the cost of devolved personal services.

There is no issue as to what constitutes the LGUs'   just share   expressed in

percentages of the national taxes   (i.e.,   30%, 35% and 40% stipulated in
subparagraphs (a), (b), and (c) of Section 284 ). Yet, Section
6, supra, mentions national taxes as the source of the just share of the LGUs while
Income Tax - cases

Section 284 ordains that the share of the LG Us be taken from national internal

revenue taxes instead.

Has not Congress thereby infringed the constitutional provision?

Garcia contends that Congress has exceeded its constitutional boundary by limiting
to the NIRTs the base from which to compute the just share of the LGUs.

We agree with Garcia's contention.

Although the power of Congress to make laws is plenary in nature, congressional

lawmaking remains subject to the limitations stated in the 1987 Constitution.49 The
phrase national internal revenue taxes engrafted in Section 284 is undoubtedly
more restrictive than the term   national taxes   written in Section 6. As such,
Congress has actually departed from the letter of the 1987 Constitution stating
that national taxes should be the base from which the just share of the LGU comes.
Such departure is impermissible. Verba legis non est recedendum (from the words
of a statute there should be no departure).   50   Equally impermissible is that
Congress has also thereby curtailed the guarantee of fiscal autonomy in favor of the
LGUs under the 1987 Constitution.

Taxes are the enforced proportional contributions exacted by the State from
persons and properties pursuant to its sovereignty in order to support the
Gove1nment and to defray all the public needs. Every tax has three elements,
namely: (a) it is an enforced proportional contribution from persons and properties;
(b) it is imposed by the State by virtue of its sovereignty; and (c) it is levied for the
support of the Government.51 Taxes are classified into national and local. National
taxes are those levied by the National Government, while local taxes are those
levied by the LGUs.52

What the phrase national internal revenue taxes as used in Section 284 included
are all the taxes enumerated in Section 21 of the National Internal Revenue Code
(NIRC), as amended by R.A. No. 8424, viz.:

Section 21.   Sources of Revenue.   - The following taxes, fees and charges are
deemed to be national internal revenue taxes:
Income Tax - cases

(a) Income tax;

(b) Estate and donor's taxes;

(c) Value-added tax;

(d) Other percentage taxes;

(e) Excise taxes;

(f) Documentary stan1p taxes; and

(g) Such other taxes as arc or hereafter may be imposed and collected by the
Bureau of Internal Revenue.

In view of the foregoing enumeration of what are the national internal revenue
taxes, Section 284 has effectively deprived the LGUs from deriving their   just
share from other national taxes, like the customs duties.

Strictly speaking, customs duties are also taxes because they are exactions whose
proceeds become public funds. According to   Garcia v. Executive Secretary,
53  customs duties is the nomenclature given to taxes imposed on the importation

and exportation of commodities and merchandise to or from a foreign country.

Although customs duties have either or both the generation of revenue and the
regulation of economic or social activity as their moving purposes, it is often
difficult to say which of the two is the principal objective in a particular instance,
for, verily, customs duties, much like internal revenue taxes, are rarely designed to
achieve only one policy objective.54  We further note that Section 102(00) of R.A.
No. 10863 (Customs Modernization and Tariff Act) expressly includes all fees and
charges imposed under the Act under the blanket term of taxes.

It is clear from the foregoing clarification that the exclusion of other national taxes
like customs duties from the base for determining the just share of the LG Us
contravened the express constitutional edict in Section 6, Article X the 1987
Constitution.

Still, the OSG posits that Congress can manipulate, by law, the base of the
allocation of the just share in the national taxes of the LGUs.
Income Tax - cases

The position of the OSG cannot be sustained. Although it has the primary
discretion to determine and fix the   just share   of the LGUs in the national
taxes (e.g., Section 284 of the LGC), Congress cannot disobey the express mandate
of Section 6, Article X of the 1987 Constitution for the just share of the LGUs to
be derived from the national taxes. The phrase as determined by law in Section 6
follows and qualifies the phrase just share, and cannot be construed as qualifying
the succeeding phrase in the national taxes. The intent of the people in respect of
Section 6 is really that the base for reckoning the just share of the LGUs should
includes all national taxes. To read Section 6 differently as requiring that the just
share of LGUs in the national taxes shall be determined by law is tantamount to
the unauthorized revision of the 1987 Constitution.

V.

Congress can validly exclude taxes that will constitute the base amount for

the computation of the IRA only if a Constitutional provision allows such
exclusion

Garcia submits that even assuming that the present version of Section 284 of the
LGC is constitutionally valid, the implementation thereof has been erroneous
because Section 284 does not authorize any exclusion or deduction from the
collections of the NIRTs for purposes of the computation of the allocations to the
LGUs. He further submits that the exclusion of certain NIRTs diminishes the fiscal
autonomy granted to the LGUs. He claims that the following NIRTs have been
illegally excluded from the base for determining the fair share of the LGUs in the
IRA, to wit:

(1) NIRTs collected by the cities and provinces and divided exclusively among the
LGUs of the Autonomous Region for Muslim Mindanao (ARMM), the regional
government and the central government, pursuant to Section 1555  in relation to
Section 9,56  Article IX of R.A. No. 9054 (An Act to Strengthen and Expand the
Organic Act for the Autonomous Region in Muslim Mindanao, amending for the
purpose Republic Act No. 6734, entitled An Act providing for an Organic Act for
the Autonomous Region in Muslim Mindanao);

(2) The shares in the excise taxes on mineral products of the different LG Us, as
provided in Section 287 of the NIRC57 in relation to Section 290 of the LGC;58
Income Tax - cases

(3) The shares of the relevant LGUs in the franchise taxes paid by Manila Jockey
Club, Inc.59 and Philippine Racing Club, Inc.;60

(4) The shares of various municipalities in VAT collections under R.A. No.
7643 (An Act to Empower the Commissioner of Internal Revenue to Require the
Payment of the Value Added Tax Every Month and to Allow Local Government
Units to Share in VAT Revenue, Amending for this Purpose Certain Sections of the
National Internal Revenue Code) as embodied in Section 283 of the NIRC;61

(5) The shares of relevant LGUs in the proceeds of the sale and conversion of
former military bases in accordance with R.A. No. 7227 (Bases Conversion and
Development Act of 1992);62

(6) The shares of different LGUs in the excise taxes imposed on locally
manufactured Virginia tobacco products as provided in Section 3 of R.A. No.
7171 (An Act to Promote the Development of the Farmers in the Virginia Tobacco
Producing Provinces), and as now provided in Section 289 of the NIRC;63

(7) The shares of different LGUs in the incremental revenues from Burley and
native tobacco products under Section 8 of R.A. No. 8240   (An Act Amending
Sections 138, 140 and 142 of the National Internal Revenue Code as Amended and
for Other Purposes) and as now provided in Section 288 of the NIRC;64 and

(8) The share of the Commission of Audit (COA) in the NIRTs as provided in
Section 24p) of P.D. No. 1445 (Government Auditing Code of the Philippines) 65 in
relation to Section 284 of the NIRC.66

Garcia insists that the foregoing taxes and revenues should have been included by
Congress and, by extension, the BIR in the base for computing the IRA on the
strength of the cited provisions; that the LGC did not authorize such exclusion; and
that the continued exclusion has undermined the fiscal autonomy guaranteed by the
1987 Constitution.

The insistence of Garcia is valid to an extent.

Income Tax - cases

An examination of the above-enumerated laws confirms that the following have

been excluded from the base for reckoning the just share of the LGUs as required
by Section 6, Article X of the 1987 Constitution, namely:

(a) The share of the affected LGUs in the proceeds of the sale and conversion of
former military bases in accordance with R.A. No. 7227;

(b) The share of the different LGUs in the excise taxes imposed on locally
manufactured Virginia tobacco products as provided for in Section 3, R.A. No.
7171, and as now provided in Section 289 of the NIRC;

(c) The share of the different LGU s in incremental revenues from Burley and
native tobacco products under Section 8 of R.A. No. 8240, and as now provided
for in Section 288 of the NIRC;

(d) The share of the COA in the NIRTs as provided in Section 24(3) of P.D. No.
144567 in relation to Section 284 of the NIRC;

(e) The shares of the different LGUs in the excise taxes on mineral products, as
provided in Section 287 of the NIRC in relation to Section 290 of the LGC;

(f) The NIRTs collected by the cities and provinces and divided exclusively among
the LGUs of the ARMM, the regional government and the central government,
pursuant to Section 1568  in relation to Section 9,69  Article IX of R. A. No. 9054;
and

(g) The shares of the relevant LG Us in the franchise taxes paid by Manila Jockey
Club, Inc., and the Philippine Racing Club, Inc.

Anent the share of the affected LG Us in the proceeds of the sale and conversion of
the former military bases pursuant to R.A. No. 7227, the exclusion is warranted for
the reason that such proceeds do not come from a tax, fee or exaction imposed on
the sale and conversion.

As to the share of the affected LGUs in the excise taxes imposed on locally
manufactured Virginia tobacco products under R.A. No. 7171 (now Section 289 of
the NIRC); the share of the affected LGUs in incremental revenues from Burley
Income Tax - cases

and native tobacco products under Section 8, R.A. No. 8240 (now Section 288 of
the NIRC); the share of the COA in the NIRTs pursuant to Section 24(3) of P.D.
No. 1445 in relation to Section 284 of the NIRC; and the share of the host LGUs in
the franchise taxes paid by the Manila Jockey Club, Inc., and Philippine Racing
Club, Inc., under Section 6 of R.A. No. 6631 and Section 8 of R:A. No. 6632,
respectively, the exclusion is also justified. Although such shares involved national
taxes as defined under the NIRC, Congress had the authority to exclude them by
virtue of their being taxes imposed for special purposes. A reading of Section 288
and Section 289 of the NIRC and Section 24(3) of P.D. No. 1445 in relation to
Section 284 of the NIRC reveals that all such taxes are levied and collected for a
special purpose. 70 The same is true for the franchise taxes paid under Section 6 of
R.A. No. 6631 and Section 8 of R.A. No. 6632, inasmuch as certain percentages of
the franchise taxes go to different beneficiaries. The exclusion conforms to Section
29(3), Article VI of the 1987 Constitution, which states:

Section 29. x x x

xxxx

(3) All money collected on any tax levied for a special purpose shall be treated
as a special fund and paid out for such purpose only. If the purpose for which a
special fund was created has been fulfilled or abandoned, the balance, if any, shall
be transferred to the general funds of the Government. [Bold emphasis supplied]

The exclusion of the share of the different LGUs in the excise taxes imposed on
mineral products pursuant to Section 287 of the NIRC in relation to Section 290 of
the LGC is premised on a different constitutional provision. Section 7, Article X of
the 1987 Constitution allows affected LGUs to have an equitable share in the
proceeds of the utilization of the nation's national wealth "within their respective
areas," to wit:

Section 7. Local governments shall be entitled to an equitable share in the proceeds

of the utilization and development of the national wealth within their respective
areas, in the manner provided by law, including sharing the same with the
inhabitants by way of direct benefits.
Income Tax - cases

This constitutional provision is implemented by Section 287 of the NIRC and

Section 290 of the LGC thusly:

SEC. 287.   Shares of Local Government Units in the Proceeds from the
Development and Utilization of the National Wealth. - Local Government units
shall have an equitable share in the proceeds derived from the utilization and
development of the national wealth, within their respective areas, including sharing
the same with the inhabitants by way of direct benefits.

(A) Amount of Share of Local Government Units. - Local government units shall,
in addition to the internal revenue allotment, have a share of forty percent (40'Yo)
of the gross collection derived by the national government from the preceding
fiscal year from excise taxes on mineral products, royalties, and such other taxes,
fees or charges, including related surcharges, interests or fines, and from its share
in any co-production, joint venture or production sharing agreement in the
utilization and development of the national wealth within their territorial
jurisdiction.

(B) Share of the Local Governments from Any Government Agency or

Government-owned or - Controlled Corporation. - Local Government Units shall
have a share, based on the preceding fiscal year, from the proceeds derived by any
government agency or government-owned or controlled corporation engaged in the
utilization and development of the national wealth based on the following formula,
whichever will produce a higher share for the local government unit:

(1) One percent (l %) of the gross sales or receipts of the preceding calendar year,
or

(2) Forty percent (40%) of the excise taxes on mineral products, royalties, and such
other taxes, fees or charges, including related surcharges, interests or fines the
government agency or government-owned or -controlled corporations would have
paid if it were not otherwise exempt. [Bold emphasis supplied]

SEC. 290. Amount of Share of Local Government Units. - Local government units

shall, in addition to the internal revenue allotment, have a share of forty percent
( 40%) of the gross collection derived by the national government from the
preceding fiscal year from mining taxes, royalties, forestry and fishery charges, and
Income Tax - cases

such other taxes, fees, or charges, including related surcharges, interests, or fines,
and from its share in any co-production, joint venture or production sharing
agreement in the utilization and development of the national wealth within their
territorial jurisdiction. [Bold emphasis supplied]

Lastly, the NIRTs collected by the provinces and cities within the ARMM whose
portions are distributed to the ARMM's provincial, city and regional governments
are also properly excluded for such taxes are intended to truly enable a sustainable
and feasible autonomous region as guaranteed by the 1987 Constitution. The
mandate under Section 15 to Section 21, Article X of the 1987 Constitution is to
allow the separate development of peoples with distinctive cultures and traditions
in the autonomous areas.71   The grant of autonomy to the autonomous regions
includes the right of self-determination-which in turn ensures the right of the
peoples residing therein to the necessary level of autonomy that will guarantee the
support of their own cultural identities, the establishment of priorities by their
respective communities' internal decision-making processes and the management
of collective matters by themselves.72   As such, the NIRTs collected by the
provinces and cities within the ARMM will ensure local autonomy and their very
existence with a continuous supply of funding sourced from their very own areas.
The ARMM will become self-reliant and dynamic consistent with the dictates of
the 1987 Constitution.

The shares of the municipalities in the VATs collected pursuant to R.A. No. 7643
should be included in determining the base for computing the just share because
such VATs are national taxes, and nothing can validly justify their exclusion.

In recapitulation, the national taxes to be included in the base for computing the
just share the LGUs shall henceforth be, but shall not be limited to, the following:

1. The NIRTs enumerated in Section 21 of the NIRC, as amended, to be inclusive

of the VA Ts, excise taxes, and DSTs collected by the BIR and the BOC, and their
deputized agents;

2. Tariff and customs duties collected by the BOC;

3. 50% of the VATs collected in the ARMM, and 30% of all other national taxes
collected in the ARMM; the remaining 50% of the VA Ts and 70% of the
Income Tax - cases

collections of the other national taxes in the ARMM shall be the exclusive share of
the ARMM pursuant to Section 9 and Section 15 of R.A. No. 9054;

4. 60% of the national taxes collected from the exploitation and development of the
national wealth; the remaining 40% will exclusively accrue to the host LGUs
pursuant to Section 290 of the LGC;

5. 85% of the excise taxes collected from locally manufactured Virginia and other
tobacco products; the remaining 15% shall accrue to the special purpose funds
pursuant created in R.A. No. 7171 and R.A. No. 7227;

6. The entire 50% of the national taxes collected under Section 106, Section 108
and Section 116 of the NIRC in excess of the increase in collections for the
immediately preceding year; and

7. 5% of the franchise taxes in favor of the national government paid by franchise

holders in accordance with Section 6 of R.A. No. 6631 and Section 8 of R.A. No.
6632.

VI.

Entitlement to the reliefs sought

The petitioners' prayer for the payment of the arrears of the LGUs' just share on the
theory that the computation of the base amount had been unconstitutional all along
cannot be granted.

It is true that with our declaration today that the IRA is not in accordance with the
constitutional determination of the just share of the LGUs in the national taxes,
logic demands that the LGUs should receive the difference between the   just
share they should have received had the LGC properly reckoned such just share
from all national taxes, on the one hand, and the share - represented by the IRA-
the LGUs have actually received since the effectivity of the IRA under the LGC,
on the other. This puts the National Government in arrears as to the just share of
the LGUs. A legislative or executive act declared void for being unconstitutional
cannot give rise to any right or obligation. 73

Yet, the Court has conceded in Arau/lo v. Aquino III74that:

Income Tax - cases

x x x the generality of the rule makes us ponder whether rigidly applying the
rule may at times be impracticable or wasteful. Should we not recognize the
need to except from the rigid application of the rule the instances in which the
void law or executive act produced an almost irreversible result?

The need is answered by the doctrine of operative fact. The doctrine, definitely not
a novel one, has been exhaustively explained in   De Agbayani v. Philippine
National Bank:

The decision now on appeal reflects the orthodox view that an unconstitutional act,
for that matter an executive order or a municipal ordinance likewise suffering from
that infirmity, cannot be the source of any legal rights or duties. Nor can it justify
any official act taken under it. Its repugnancy to the fundamental law once
judicially declared results in its being to all intents and purposes a mere scrap of
paper. As the new Civil Code puts it: 'When the courts declare a law to be
inconsistent with the Constitution, the former shall be void and the latter shall
govern.' Administrative or executive acts, orders and regulations shall be valid only
when they are not contrary to the laws of the Constitution. It is understandable why
it should be so, the Constitution being supreme and paramount. Any legislative or
executive act contrary to its terms cannot survive.

Such a view has support in logic and possesses the merit of simplicity. It may
not however be sufficiently realistic. It does not admit of doubt that prior to
the declaration of nullity such challenged legislative or executive act must
have been in force and had to be complied with. This is so as until after the
judiciary, in an appropriate case, declares its invalidity, it is entitled to
obedience and respect. Parties may have acted under it and may have changed
their positions. What could be more fitting than that in a subsequent litigation
regard be had to what has been done while such legislative or executive act
was in operation and presumed to be valid in all respects. It is now accepted as
a doctrine that prior to its being nullified, its existence as a fact must be
reckoned with. This is merely to reflect awareness that precisely because the
judiciary is the governmental organ which has the final say on whether or not
a legislative or executive measure is valid, a period of time may have elapsed
before it can exercise the power of judicial review that may lead to a
declaration of nullity. It would be to deprive the law of its quality of fairness
Income Tax - cases

and justice then, if there be no recognition of what had transpired prior to

such adjudication.

In the language of an American Supreme Court decision: ‘The actual existence of a

statute, prior to such a determination [of unconstitutionality], is an operative fact
and may have consequences which cannot justly be ignored. The past cannot
always be erased by a new judicial declaration. The effect of the subsequent ruling
as to invalidity may have to be considered in various aspects, with respect to
particular relations, individual and corporate, and particular conduct, private and
official.'

The doctrine of operative fact recognizes the existence of the law or executive act
prior to the determination of its unconstitutionality as an operative fact that
produced consequences that cannot always be erased, ignored or disregarded. In
short, it nullifies the void law or executive act but sustains its effects. It provides an
exception to the general rule that a void or unconstitutional law produces no effect.
75 But its use must be subjected to great scrutiny and circumspection, and it cannot

be invoked to validate an unconstitutional law or executive act, but is resorted to

only as a matter of equity and fair play.   76   It applies only to cases where
extraordinary circumstances exist, and only when the extraordinary circumstances
have met the stringent conditions that will permit its application.

Conformably with the foregoing pronouncements in   Araullo   v.   Aquino III,   the

effect of our declaration through this decision of the unconstitutionality of Section
284 of the LGC and its related laws as far as they limited the source of the just
share of the LGUs to the NIRTs is prospective. It cannot be otherwise.

VII.

Automatic release of the LGUs' just share in the National Taxes

Section 6, Article X of the 1987 Constitution commands that the just share of the
LGUs in national taxes shall be   automatically released   to them. The
term automatic connotes something mechanical, spontaneous and perfunctory; and,
in the context of this case, the LGUs are not required to perform any act or thing in
order to receive their just share in the national taxes.77
Income Tax - cases

Before anything, we must highlight that the 1987 Constitution includes several
provisions that actually deal with and authorize the automatic release of funds by
the National Government.

To begin with, Section 3 of Article VIII favors the Judiciary with the automatic and
regular release of its appropriations:

Section 3. The Judiciary shall enjoy fiscal autonomy. Appropriations for the
Judiciary may not be reduced by the legislature below the amount appropriated for
the previous year and, after approval, shall be automatically and regularly released.

Then there is Section 5 of Article IX(A), which contains the common provision in
favor of the Constitutional Commissions:

Section 5. The Commission shall enjoy fiscal autonomy. Their approved annual
appropriations shall be automatically and regularly released.

Section 14 of Article XI extends to the Office of the Ombudsman a similar

privilege:

Section 14. The Office of the Ombudsman shall enjoy fiscal autonomy. Its
approved annual appropriations shall be automatically and regularly released.

Section 17(4) of Article XIII replicates the privilege in favour of the Commission
on Human Rights:

Section 17(4) The approved annual appropriations of the Commission shall be

automatically and regularly released.

The foregoing constitutional provisions share two aspects. The first relates to the
grant of   fiscal autonomy,   and the second concerns the   automatic release of
funds.  78  The common denominator of the provisions is that the automatic release
of the appropriated amounts is predicated on the approval of the annual
appropriations of the offices or agencies concerned.

Directly contrasting with the foregoing provisions is Section 6, Article X of the

1987 Constitution because the latter provision forthrightly ordains that the "(l)ocal
government units shall have a just share, as determined by law, in the national
Income Tax - cases

taxes   which shall be automatically released to them."   Section 6 does not

mention of appropriation as a condition for the automatic release of the just share
to the LGUs. This is because Congress not only already determined the   just
share through the LGC's fixing the percentage of the collections of the NIRTs to
constitute such fair share subject to the power of the President to adjust the same
in order to manage public sector deficits subject to limitations on the adjustments,
but also explicitly authorized such just share to be "automatically released" to the
LGUs in the proportions and regularity set under Section 28579 of the LGC without
need of annual appropriation. To operationalize the automatic release without need
of appropriation, Section 286 of the LGC clearly provides that the automatic
release of the   just share   directly to the provincial, city, municipal or barangay
treasurer, as the case may be, shall be "without need of any further action," viz.:

Section 286.   Automatic Release of Shares.   - (a) The share of each local
government unit shall be released, without need of any further action; directly
to the provincial, city, municipal or barangay treasurer, as the case may be, on
a quarterly basis within five (5) days after the end of each quarter, and which
shall not be subject to any lien or holdback that may be imposed by the
National Government for whatever purpose. x x x (Bold emphasis supplied)

The 1987 Constitution is forthright and unequivocal in ordering that the   just
share of the LGUs in the national taxes shall be automatically released to them.
With Congress having established the just share through the LGC, it seems to be
beyond debate that the inclusion of the just share of the LGUs in the annual GAAs
is unnecessary, if not superfluous. Hence, the just share of the LGUs in the national
taxes shall be released to them without need of yearly appropriation.

1. DECLARES   the phrase "internal revenue" appearing in Section 284 of

Republic Act No. 7160   (Local Government Code)   UNCONSTITUTIONAL,
and DELETES the phrase from Section 284.

Section 284, as hereby modified, shall henceforth read as follows:

Section 284. Allotment of Taxes. - Local government units shall have a share in the
national taxes based on the collection of the third fiscal year preceding the current
fiscal year as follows:
Income Tax - cases

(a) On the first year of the effectivity of this Code, thirty percent (30%);

(b) On the second year, thirty-five percent (35%); and

(c) On the third year and thereafter, forty percent (40%).

Provided, That in the event that the national government incurs an unmanageable
public sector deficit, the President of the Philippines is hereby authorized, upon the
recommendation of Secretary of Finance, Secretary of Interior and Local
Government and Secretary of Budget and Management, and subject to consultation
with the presiding officers of both Houses of Congress and the presidents of the
"liga", to make the necessary adjustments in the allotment of local government
units but in no case shall the allotment be less than thirty percent (30%) of the
collection of national taxes of the third fiscal year preceding the current fiscal year;
Provided, further, That in the first year of the effectivity of this Code, the local
government units shall, in addition to the thirty percent (30%) allotment which
shall include the cost of devolved functions for essential public services, be entitled
to receive the amount equivalent to the cost of devolved personal services.

The phrase "internal revenue" is likewise hereby   DELETED   from the related
sections of Republic Act No. 7160 (Local Government Code), specifically Section
285, Section 287, and Section 290, which provisions shall henceforth read as
follows:

Section 285.   Allocation to Local Government Units.   - The share of local

government units in the allotment shall be collected in the following manner:

(a) Provinces - Twenty-three percent (23%);

(b) Cities - Twenty-three percent (23%);

(c) Municipalities - Thirty-four percent (34%); and

(d) Barangays - Twenty percent (20%)

Provided, however, That the share of each province, city, and municipality shall be
determined on the basis of the following formula:
Income Tax - cases

(a) Population -- Fifty percent (50%);

(b) Land Area-· Twenty-five percent (25%); and

(c) Equal sharing--Twenty-five percent (25%)

Provided, further. That the share of each barangay with a population of not less
than one hundred (100) inhabitants shall not be less than Eighty thousand
(₱80,000.00) per annum chargeable against the twenty percent (20%) share of the
barangay from the allotment, and the balance to be allocated on the basis of the
following formula:

(a) On the first year of the effoctivity of this Code:

(1) Population - Forty percent (40%); and

(2) Equal sharing - Sixty percent (50%)

(b) On the second year:

(1) Population - Fifty percent (50%); and

(2) Equal sharing - Fifty percent (50%)

(c) On the third year and thereafter.

(1) Population - Sixty percent (60%); and

(2) Equal sharing - Forty percent (40%).

Provided, finally, That the financial requirements of barangays created by local

government units after the effectivity of this Code shall be the responsibility of the
local government unit concerned.

xxxx

Sectfon 287.   Local Development Projects.   - Each local government unit shall
appropriate in its annual budget no less than twenty percent (20%) of its annual
allotment for development projects. Copies of the development plans of local
Income Tax - cases

government units shall be furnished the Department of Interior and Local

Government.

xxxx

Section 290. Amount of Share of Local Government Units. - Local government

units shall, in addition to the allotment, have a share of forty percent (40%) of the
gross collection derived by the national government from the preceding fiscal year
from mining taxes, royalties, forestry and fishery charges, and such other taxes,
fees, or charges, including related surcharges, interests, or fines, and from its share
in any co-production, joint venture or production sharing agreement in the
utilization and development of the national wealth within their territorial
jurisdiction.

Article 378, Article 379, Article 380, Article 382, Article 409, Article 461, and
related provisions of the Implementing Rules and Regulations of R.A. No. 7160
are hereby MODIFIED to reflect the deletion of the phrase "internal revenue" as
directed herein.

Henceforth, any mention of "Internal Revenue Allotment" or "IRA" in Republic

Act No. 7160   (Local Government Code)   and its Implementing Rules and
Regulations shall be understood as pertaining to the allotment of the Local
Government Units derived from the national taxes;

2. ORDERS the SECRETARY OF THE DEPARTMENT OF FINANCE; the

SECRETARY OF THE DEPARTMENT OF BUDGET AND
MANAGEMENT; the COMMISSIONER OF INTERNAL REVENUE; the
COMMISSIONER OF CUSTOMS; and the NATIONAL TREASURER   to
include ALL COLLECTIONS OF NATIONAL TAXES in the computation of
the base of the just share of the Local Government Units according to the ratio
provided in the now-modified Section 284 of Republic Act No. 7160   (Local
Government Code)   except those accruing to special purpose funds and special
allotments for the utilization and development of the national wealth.

For this purpose, the collections of national taxes for inclusion in the base of the
just share the Local Government Units shall include, but shall not be limited to, the
following:
Income Tax - cases

(a) The national internal revenue taxes enumerated in Section 21 of the National

Internal Revenue Code, as amended, collected by the Bureau of Internal Revenue
and the Bureau of Customs;

(b) Tariff and customs duties collected by the Bureau of Customs;

(c) 50% of the value-added taxes collected in the Autonomous Region in Muslim
Mindanao, and 30% of all other national tax collected in the Autonomous Region
in Muslim Mindanao.

The remaining 50% of the collections of value-added taxes and 70% of the
collections of the other national taxes in the Autonomous Region in Muslim
Mindanao shall be the exclusive share of the Autonomous Region in Muslim
Mindanao pursuant to Section 9 and Section 15 of Republic Act No. 9054.

(d) 60% of the national taxes collected from the exploitation and development of
the national wealth.

The remaining 401% of the national taxes collected from the exploitation and
development of the national wealth shall exclusively accrue to the host Local
Government Units pursuant to Section 290 of Republic Act No. 7160   (Local
Government Code);

(e) 85% of the excise taxes collected from locally manufactured Virginia and other
tobacco products.

The remaining 15% shall accrue to the special purpose funds created by Republic
Act No. 7171 and Republic Act No. 7227;

(f) The entire 50% of the national taxes collected under Sections 106, 108 and 116
of the NIRC as provided under Section 283 of the NIRC; and

(g) 5% of the 25% franchise taxes given to the National Government under Section
6 of Republic Act No. 6631 and Section 8 of Republic Act No. 6632.

3. DECLARES that:
Income Tax - cases

(a) The apportionment of the 25% of the franchise taxes collected from the Manila
Jockey Club and Philippine Racing Club, Inc. - that is, five percent (5%) to the
National Government; five percent (5%) to the host municipality or city; seven
percent (7%) to the Philippine Charity Sweepstakes Office; six percent (6%) to the
Anti-Tuberculosis Society; and two percent (2%) to the White Cross pursuant to
Section 6 of Republic Act No. 6631 and Section 8 of Republic Act No. 6632 -
is VALID;

(b) Section 8 and Section 12 of Republic Act No. 7227

are   VALID;   and,   ACCORDINGLY,   the proceeds from the sale of the former
military bases converted to alienable lands thereunder are EXCLUDED from the
computation of the national tax allocations of the Local Government Units; and

(c) Section 24(3) of Presidential Decree No. 1445, in relation to Section 284 of the
National Internal Revenue Code, apportioning one-half of one percent (1/2of1%)
of national tax collections as the auditing fee of the Commission on Audit
is VALID;

4. DIRECTS the Bureau of Internal Revenue and the Bureau of Customs and their
deputized collecting agents to certify all national tax collections, pursuant to
Article 3 78 of the Implementing Rules and Regulations of R.A. No. 7160;

5. DISMISSES the claims of the Local Government Units for the settlement by the
National Government of arrears in the just share on the ground that this decision
shall have PROSPECTIVE APPLICATION; and

6.   COMMANDS   the   AUTOMATIC RELEASE WITHOUT NEED OF

FURTHER ACTION of the just shares of the Local Government Units in the
national taxes, through their respective provincial, city, municipal, or barangay
treasurers, as the case may be, on a quarterly basis but not beyond five (5) days
from the end of each quarter, as directed in Section 6, Article X of the 1987
Constitution and Section 286 of Republic Act No. 7160   (Local Government
Code),   and operationalized by Article 383 of the Implementing Rules and
Regulations of RA 7160.
Income Tax - cases

Let a copy of this decision be furnished to the President of the Republic of the
Philippines, the President of the Senate, and the Speaker of the House of
Representatives for their information and guidance.

SO ORDERED.

Rufino R. Tan v. Ramon R. Del Rosario, Jr., G.R No. 109289, October 3, 1994

These two consolidated special civil actions for prohibition challenge, in G.R. No.
109289, the constitutionality of Republic Act No. 7496, also commonly known as
the Simplified Net Income Taxation Scheme ("SNIT"), amending certain
provisions of the National Internal Revenue Code and, in

G.R. No. 109446, the validity of Section 6, Revenue Regulations No. 2-93,
promulgated by public respondents pursuant to said law.

Petitioners claim to be taxpayers adversely affected by the continued

implementation of the amendatory legislation.

In G.R. No. 109289, it is asserted that the enactment of Republic Act


No. 7496 violates the following provisions of the Constitution:

Article VI, Section 26(1) — Every bill passed by the Congress shall embrace only
one subject which shall be expressed in the title thereof.

Article VI, Section 28(1) — The rule of taxation shall be uniform and equitable.
The Congress shall evolve a progressive system of taxation.

Article III, Section 1 — No person shall be deprived of . . . property without due

process of law, nor shall any person be denied the equal protection of the laws.

In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No.

2-93, argue that public respondents have exceeded their rule-making authority in
applying SNIT to general professional partnerships.

The Solicitor General espouses the position taken by public respondents.

Income Tax - cases

The Court has given due course to both petitions. The parties, in compliance with
the Court's directive, have filed their respective memoranda.

G.R. No. 109289

Petitioner contends that the title of House Bill No. 34314, progenitor of Republic
Act No. 7496, is a misnomer or, at least, deficient for being merely entitled,
"Simplified Net Income Taxation Scheme for the Self-Employed

and Professionals Engaged in the Practice of their Profession" (Petition in G.R. No.
109289).

The full text of the title actually reads:

An Act Adopting the Simplified Net Income Taxation Scheme For The Self-
Employed and Professionals Engaged In The Practice of Their Profession,
Amending Sections 21 and 29 of the National Internal Revenue Code, as
Amended.

The pertinent provisions of Sections 21 and 29, so referred to, of the National
Internal Revenue Code, as now amended, provide:

Sec. 21. Tax on citizens or residents. —

xxx xxx xxx

(f) Simplified Net Income Tax for the Self-Employed and/or Professionals Engaged
in the Practice of Profession. — A tax is hereby imposed upon the taxable net
income as determined in Section 27 received during each taxable year from all
sources, other than income covered by paragraphs (b), (c), (d) and (e) of this
section by every individual whether

a citizen of the Philippines or an alien residing in the Philippines who is self-
employed or practices his profession herein, determined in accordance with the
following schedule:

Not over P10,000 3%

Over P10,000 P300 + 9%


but not over P30,000 of excess over P10,000
Income Tax - cases

Over P30,000 P2,100 + 15%


but not over P120,00 of excess over P30,000

Over P120,000 P15,600 + 20%


but not over P350,000 of excess over P120,000

Over P350,000 P61,600 + 30%


of excess over P350,000

Sec. 29. Deductions from gross income. — In computing taxable income subject to

tax under Sections 21(a), 24(a), (b) and (c); and 25 (a)(1), there shall be allowed as
deductions the items specified in paragraphs (a) to (i) of this
section: Provided, however, That in computing taxable income subject to tax under
Section 21 (f) in the case of individuals engaged in business or practice of
profession, only the following direct costs shall be allowed as deductions:

(a) Raw materials, supplies and direct labor;

(b) Salaries of employees directly engaged in activities in the course of or pursuant

to the business or practice of their profession;

(c) Telecommunications, electricity, fuel, light and water;

(d) Business rentals;

(e) Depreciation;

(f) Contributions made to the Government and accredited relief organizations for
the rehabilitation of calamity stricken areas declared by the President; and

(g) Interest paid or accrued within a taxable year on loans contracted from
accredited financial institutions which must be proven to have been incurred in
connection with the conduct of a taxpayer's profession, trade or business.

For individuals whose cost of goods sold and direct costs are difficult to determine,
a maximum of forty per cent (40%) of their gross receipts shall be allowed as
deductions to answer for business or professional expenses as the case may be.
Income Tax - cases

On the basis of the above language of the law, it would be difficult to accept
petitioner's view that the amendatory law should be considered as having now
adopted a gross income, instead of as having still retained the net income, taxation
scheme. The allowance for deductible items, it is true, may have significantly been
reduced by the questioned law in comparison with that which has prevailed prior to
the amendment; limiting, however, allowable deductions from gross income is
neither discordant with, nor opposed to, the net income tax concept. The fact of the
matter is still that various deductions, which are by no means inconsequential,
continue to be well provided under the new law.

Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to
prevent log-rolling legislation intended to unite the members of the legislature who
favor any one of unrelated subjects in support of the whole act, (b) to avoid
surprises or even fraud upon the legislature, and (c) to fairly apprise the people,
through such publications of its proceedings as are usually made, of the subjects of
legislation.1 The above objectives of the fundamental law appear to us to have been
sufficiently met. Anything else would be to require a virtual compendium of the
law which could not have been the intendment of the constitutional mandate.

Petitioner intimates that Republic Act No. 7496 desecrates the constitutional
requirement that taxation "shall be uniform and equitable" in that the law would
now attempt to tax single proprietorships and professionals differently from the
manner it imposes the tax on corporations and partnerships. The contention clearly
forgets, however, that such a system of income taxation has long been the
prevailing rule even prior to Republic Act No. 7496.

Uniformity of taxation, like the kindred concept of equal protection, merely

requires that all subjects or objects of taxation, similarly situated, are to be treated
alike both in privileges and liabilities (Juan Luna Subdivision vs. Sarmiento, 91
Phil. 371). Uniformity does not forfend classification as long as: (1) the standards
that are used therefor are substantial and not arbitrary, (2) the categorization is
germane to achieve the legislative purpose, (3) the law applies, all things being
equal, to both present and future conditions, and (4) the classification applies
equally well to all those belonging to the same class (Pepsi Cola vs. City of
Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 52).
Income Tax - cases

What may instead be perceived to be apparent from the amendatory law is the
legislative intent to increasingly shift the income tax system towards the schedular
approach2  in the income taxation of individual taxpayers and to maintain, by and
large, the present global treatment3  on taxable corporations. We certainly do not
view this classification to be arbitrary and inappropriate.

Petitioner gives a fairly extensive discussion on the merits of the law, illustrating,
in the process, what he believes to be an imbalance between the tax liabilities of
those covered by the amendatory law and those who are not. With the legislature
primarily lies the discretion to determine the nature (kind), object (purpose), extent
(rate), coverage (subjects) and situs (place) of taxation. This court cannot freely
delve into those matters which, by constitutional fiat, rightly rest on legislative
judgment. Of course, where a tax measure becomes so unconscionable and unjust
as to amount to confiscation of property, courts will not hesitate to strike it down,
for, despite all its plenitude, the power to tax cannot override constitutional
proscriptions. This stage, however, has not been demonstrated to have been
reached within any appreciable distance in this controversy before us.

Having arrived at this conclusion, the plea of petitioner to have the law declared
unconstitutional for being violative of due process must perforce fail. The due
process clause may correctly be invoked only when there is a clear contravention
of inherent or constitutional limitations in the exercise of the tax power. No such
transgression is so evident to us.

G.R. No. 109446

The several propositions advanced by petitioners revolve around the question of

whether or not public respondents have exceeded their authority in promulgating
Section 6, Revenue Regulations No. 2-93, to carry out Republic Act No. 7496.

The questioned regulation reads:

Sec. 6. General Professional Partnership — The general professional partnership

(GPP) and the partners comprising the GPP are covered by R. A. No. 7496. Thus,
in determining the net profit of the partnership, only the direct costs mentioned in
said law are to be deducted from partnership income. Also, the expenses paid or
incurred by partners in their individual capacities in the practice of their profession
Income Tax - cases

which are not reimbursed or paid by the partnership but are not considered as
direct cost, are not deductible from his gross income.

The real objection of petitioners is focused on the administrative interpretation of

public respondents that would apply SNIT to partners in general professional
partnerships. Petitioners cite the pertinent deliberations in Congress during its
enactment of Republic Act No. 7496, also quoted by the Honorable Hernando B.
Perez, minority floor leader of the House of Representatives, in the latter's
privilege speech by way of commenting on the questioned implementing
regulation of public respondents following the effectivity of the law, thusly:

MR. ALBANO, Now Mr. Speaker, I would like to get the correct impression of
this bill. Do we speak here of individuals who are earning, I mean, who earn
through business enterprises and therefore, should file an income tax return?

MR. PEREZ. That is correct, Mr. Speaker. This does not apply to corporations. It
applies only to individuals.

(See Deliberations on H. B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis

ours).

Other deliberations support this position, to wit:

MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from Batangas say
that this bill is intended to increase collections as far as individuals are concerned
and to make collection of taxes equitable?

MR. PEREZ. That is correct, Mr. Speaker.

(Id. at 6:40 P.M.; Emphasis ours).

In fact, in the sponsorship speech of Senator Mamintal Tamano on the Senate

version of the SNITS, it is categorically stated, thus:

This bill, Mr. President, is not applicable to business corporations or to

partnerships; it is only with respect to individuals and professionals. (Emphasis
ours)
Income Tax - cases

The Court, first of all, should like to correct the apparent misconception that
general professional partnerships are subject to the payment of income tax or that
there is a difference in the tax treatment between individuals engaged in business
or in the practice of their respective professions and partners in general
professional partnerships. The fact of the matter is that a general professional
partnership, unlike an ordinary business partnership (which is treated as a
corporation for income tax purposes and so subject to the corporate income tax), is
not itself an income taxpayer. The income tax is imposed not on the professional
partnership, which is tax exempt, but on the partners themselves in their individual
capacity computed on their distributive shares of partnership profits. Section 23 of
the Tax Code, which has not been amended at all by Republic Act 7496, is explicit:

Sec. 23. Tax liability of members of general professional partnerships. — (a)

Persons exercising a common profession in general partnership shall be liable for
income tax only in their individual capacity, and the share in the net profits of the
general professional partnership to which any taxable partner would be entitled
whether distributed or otherwise, shall be returned for taxation and the tax paid in
accordance with the provisions of this Title.

(b) In determining his distributive share in the net income of the partnership, each
partner —

(1) Shall take into account separately his distributive share of the partnership's
income, gain, loss, deduction, or credit to the extent provided by the pertinent
provisions of this Code, and

(2) Shall be deemed to have elected the itemized deductions, unless he declares his
distributive share of the gross income undiminished by his share of the deductions.

There is, then and now, no distinction in income tax liability between a person who
practices his profession alone or individually and one who does it through
partnership (whether registered or not) with others in the exercise of a common
profession. Indeed, outside of the gross compensation income tax and the final tax
on passive investment income, under the present income tax system all individuals
deriving income from any source whatsoever are treated in almost invariably the
same manner and under a common set of rules.
Income Tax - cases

We can well appreciate the concern taken by petitioners if perhaps we were to

consider Republic Act No. 7496 as an entirely independent, not merely as an
amendatory, piece of legislation. The view can easily become myopic, however,
when the law is understood, as it should be, as only forming part of, and subject to,
the whole income tax concept and precepts long obtaining under the National
Internal Revenue Code. To elaborate a little, the phrase "income taxpayers" is an
all embracing term used in the Tax Code, and it practically covers all persons who
derive taxable income. The law, in levying the tax, adopts the most comprehensive
tax   situs   of nationality and residence of the taxpayer (that renders citizens,
regardless of residence, and resident aliens subject to income tax liability on their
income from all sources) and of the generally accepted and internationally
recognized income taxable base (that can subject non-resident aliens and foreign
corporations to income tax on their income from Philippine sources). In the
process, the Code classifies taxpayers into four main groups, namely: (1)
Individuals, (2) Corporations, (3) Estates under Judicial Settlement and (4)
Irrevocable Trusts (irrevocable both as to corpus and as to income).

Partnerships are, under the Code, either "taxable partnerships" or "exempt

partnerships." Ordinarily, partnerships, no matter how created or organized, are
subject to income tax (and thus alluded to as "taxable partnerships") which, for
purposes of the above categorization,   are by law assimilated to be within the
context of, and so legally contemplated as, corporations. Except for few variances,
such as in the application of the "constructive receipt rule" in the derivation of
income, the income tax approach is alike to both juridical persons. Obviously,
SNIT is not intended or envisioned, as so correctly pointed out in the discussions in
Congress during its deliberations on Republic Act 7496, aforequoted, to cover
corporations and partnerships which are independently subject to the payment of
income tax.

"Exempt partnerships," upon the other hand, are not similarly identified as
corporations nor even considered as independent taxable entities for income tax
purposes. A general   professional   partnership is such an example.4   Here, the
partners themselves, not the partnership (although it is still obligated to file an
income tax return [mainly for administration and data]), are liable for the payment
of income tax in their   individual   capacity computed on their respective and
distributive shares of profits. In the determination of the tax liability, a partner does
Income Tax - cases

so as an individual, and there is no choice on the matter. In fine, under the Tax
Code on income taxation, the general professional partnership is deemed to be no
more than a mere mechanism or a flow-through entity in the generation of income
by, and the ultimate distribution of such income to, respectively, each of the
individual partners.

Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the
above standing rule as now so modified by Republic Act

No. 7496 on basically the extent of allowable deductions applicable
to all individual income taxpayers on their non-compensation income. There is no
evident intention of the law, either before or after the amendatory legislation, to
place in an unequal footing or in significant variance the income tax treatment of
professionals who practice their respective professions individually and of those
who do it through a general professional partnership.

WHEREFORE, the petitions are DISMISSED. No special pronouncement on

costs.

SO ORDERED.

Commissioner of Internal Revenue v. Solidbank Corporation, G.R. No. 148191,

November 25, 2003

Under the Tax Code, the earnings of banks from "passive" income are subject to a
twenty percent final withholding tax (20% FWT). This tax is withheld at source
and is thus not actually and physically received by the banks, because it is paid
directly to the government by the entities from which the banks derived the
income. Apart from the 20% FWT, banks are also subject to a five percent gross
receipts tax (5% GRT) which is imposed by the Tax Code on their gross receipts,
including the "passive" income.

Since the 20% FWT is constructively received by the banks and forms part of their
gross receipts or earnings, it follows that it is subject to the 5% GRT. After all, the
amount withheld is paid to the government on their behalf, in satisfaction of their
withholding taxes. That they do not actually receive the amount does not alter the
fact that it is remitted for their benefit in satisfaction of their tax obligations.
Income Tax - cases

Stated otherwise, the fact is that if there were no withholding tax system in place in
this country, this 20 percent portion of the "passive" income of banks would
actually be paid to the banks and then remitted by them to the government in
payment of their income tax. The institution of the withholding tax system does not
alter the fact that the 20 percent portion of their "passive" income constitutes part
of their actual earnings, except that it is paid directly to the government on their
behalf in satisfaction of the 20 percent final income tax due on their "passive"
incomes.

The Case

Before us is a Petition for Review1 under Rule 45 of the Rules of Court, seeking to

annul the July 18, 2000 Decision2 and the May 8, 2001 Resolution3 of the Court of
Appeals4   (CA) in CA-GR SP No. 54599. The decretal portion of the assailed
Decision reads as follows:

"WHEREFORE, we AFFIRM in toto the assailed decision and resolution of the

Court of Tax Appeals."5

The challenged Resolution denied petitioner’s Motion for Reconsideration.

The Facts

Quoting petitioner, the CA6 summarized the facts of this case as follows:

"For the calendar year 1995, [respondent] seasonably filed its Quarterly Percentage
Tax Returns reflecting gross receipts (pertaining to 5% [Gross Receipts Tax] rate)
in the total amount of ₱1,474,691,693.44 with corresponding gross receipts tax
payments in the sum of ₱73,734,584.60, broken down as follows:

Period Covered Gross Receipts Gross Receipts Tax

January to March 1994 ₱188,406,061.95 ₱9,420,303.10
April to June 1994 370,913,832.70 18,545,691.63
July to September 1994 481,501,838.98 24,075,091.95
October to December 1994 433,869,959.81 21,693,497.98
Income Tax - cases

Total ₱1,474,691,693.44 ₱73,734,584.60

"[Respondent] alleges that the total gross receipts in the amount of

₱1,474,691,693.44 included the sum of ₱350,807,875.15 representing gross
receipts from passive income which was already subjected to 20% final
withholding tax.

"On January 30, 1996, [the Court of Tax Appeals] rendered a decision in CTA Case
No. 4720 entitled Asian Bank Corporation vs. Commissioner of Internal
Revenue[,] wherein it was held that the 20% final withholding tax on [a] bank’s
interest income should not form part of its taxable gross receipts for purposes of
computing the gross receipts tax.

"On June 19, 1997, on the strength of the aforementioned decision, [respondent]
filed with the Bureau of Internal Revenue [BIR] a letter-request for the refund or
issuance of [a] tax credit certificate in the aggregate amount of ₱3,508,078.75,
representing allegedly overpaid gross receipts tax for the year 1995, computed as
follows:

Gross Receipts Subjected to the Final Tax

Derived from Passive [Income] ₱350,807,875.15
Multiply by Final Tax rate 20%
20% Final Tax Withheld at Source ₱70,161,575.03
Multiply by [Gross Receipts Tax] rate 5%
Overpaid [Gross Receipts Tax] ₱3,508,078.75

"Without waiting for an action from the [petitioner], [respondent] on the same day
filed [a] petition for review [with the Court of Tax Appeals] in order to toll the
running of the two-year prescriptive period to judicially claim for the refund of
[any] overpaid internal revenue tax[,] pursuant to Section 230 [now 229] of the Tax
Code [also ‘National Internal Revenue Code’] x x x.

x x x           x x x          x x x
Income Tax - cases

"After trial on the merits, the [Court of Tax Appeals], on August 6, 1999, rendered
its decision ordering x x x petitioner to refund in favor of x x x respondent the
reduced amount of ₱1,555,749.65 as overpaid [gross receipts tax] for the year
1995. The legal issue x x x was resolved by the [Court of Tax Appeals], with Hon.
Amancio Q. Saga dissenting, on the strength of its earlier pronouncement in x x x
Asian Bank Corporation vs. Commissioner of Internal Revenue x x x, wherein it
was held that the 20% [final withholding tax] on [a] bank’s interest income should
not form part of its taxable gross receipts for purposes of computing the [gross
receipts tax]."7

Ruling of the CA

The CA held that the 20% FWT on a bank’s interest income did not form part of
the taxable gross receipts in computing the 5% GRT, because the FWT was not
actually received by the bank but was directly remitted to the government. The
appellate court curtly said that while the Tax Code "does not specifically state any
exemption, x x x the statute must receive a sensible construction such as will give
effect to the legislative intention, and so as to avoid an unjust or absurd
conclusion."8

Hence, this appeal.9

Issue

Petitioner raises this lone issue for our consideration:

"Whether or not the 20% final withholding tax on [a] bank’s interest income forms
part of the taxable gross receipts in computing the 5% gross receipts tax."10

The Court’s Ruling

The Petition is meritorious.

Sole Issue:

Whether the 20% FWT Forms Part


of the Taxable Gross Receipts
Income Tax - cases

Petitioner claims that although the 20% FWT on respondent’s interest income was
not actually received by respondent because it was remitted directly to the
government, the fact that the amount redounded to the bank’s benefit makes it part
of the taxable gross receipts in computing the 5% GRT. Respondent, on the other
hand, maintains that the CA correctly ruled otherwise.

We agree with petitioner. In fact, the same issue has been raised recently in China
Banking Corporation v. CA,11  where this Court held that the amount of interest
income withheld in payment of the 20% FWT forms part of gross receipts in
computing for the GRT on banks.

The FWT and the GRT:

Two Different Taxes

The 5% GRT is imposed by Section 11912 of the Tax Code,13 which provides:

"SEC. 119. Tax on banks and non-bank financial intermediaries. – There shall be
collected a tax on gross receipts derived from sources within the Philippines by all
banks and non-bank financial intermediaries in accordance with the following
schedule:

"(a) On interest, commissions and discounts from lending activities as well as

income from financial leasing, on the basis of remaining maturities of instruments
from which such receipts are derived.

Short-term maturity not in excess of two (2) years……………………5%

Medium-term maturity – over two (2) years

but not exceeding four (4) years………………………………….…...3%

Long-term maturity:

(i) Over four (4) years but not exceeding

seven (7) years……………………………………………1%

Income Tax - cases

(ii) Over seven (7) years………………………………….….0%

"(b) On dividends……………………………….……..0%

"(c) On royalties, rentals of property, real or personal, profits from exchange and
all other items treated as gross income under Section 2814   of this
Code………....................................................................5%

Provided, however, That in case the maturity period referred to in paragraph (a) is
shortened thru pretermination, then the maturity period shall be reckoned to end as
of the date of pretermination for purposes of classifying the transaction as short,
medium or long term and the correct rate of tax shall be applied accordingly.

"Nothing in this Code shall preclude the Commissioner from imposing the same
tax herein provided on persons performing similar banking activities."

The 5% GRT15 is included under "Title V. Other Percentage Taxes" of the Tax Code
and is not subject to withholding. The banks and non-bank financial intermediaries
liable therefor shall, under Section 125(a)(1),16 file quarterly returns on the amount
of gross receipts and pay the taxes due thereon within twenty (20)17 days after the
end of each taxable quarter.

The 20% FWT,18 on the other hand, falls under Section 24(e)(1)19 of "Title II. Tax
on Income." It is a tax on passive income, deducted and withheld at source by the
payor-corporation and/or person as withholding agent pursuant to Section 50,20 and
paid in the same manner and subject to the same conditions as provided for in
Section 51.21

A perusal of these provisions clearly shows that two types of taxes are involved in
the present controversy: (1) the GRT, which is a percentage tax; and (2) the FWT,
which is an income tax. As a bank, petitioner is covered by both taxes.

A percentage tax is a national tax measured by a certain percentage of the gross

selling price or gross value in money of goods sold, bartered or imported; or of the
gross receipts or earnings derived by any person engaged in the sale of services.
22 It is not subject to withholding.
Income Tax - cases

An income tax, on the other hand, is a national tax imposed on the net or the gross
income realized in a taxable year.23 It is subject to withholding.

In a withholding tax system, the payee is the taxpayer, the person on whom the tax
is imposed; the payor, a separate entity, acts as no more than an agent of the
government for the collection of the tax in order to ensure its payment. Obviously,
this amount that is used to settle the tax liability is deemed sourced from the
proceeds constitutive of the tax base.24   These proceeds are either actual or
constructive. Both parties herein agree that there is no actual receipt by the bank of
the amount withheld. What needs to be determined is if there is constructive receipt
thereof. Since the payee -- not the payor -- is the real taxpayer, the rule on
constructive receipt can be easily rationalized, if not made clearly manifest.25

Constructive Receipt

Versus Actual Receipt

Applying Section 7 of Revenue Regulations (RR) No. 17-84,26 petitioner contends

that there is constructive receipt of the interest on deposits and yield on deposit
substitutes.27 Respondent, however, claims that even if there is, it is Section 4(e) of
RR 12-8028 that nevertheless governs the situation.

Section 7 of RR 17-84 states:

"SEC. 7. Nature and Treatment of Interest on Deposits and Yield on Deposit

Substitutes. –

‘(a) The interest earned on Philippine Currency bank deposits and yield from
deposit substitutes subjected to the withholding taxes in accordance with these
regulations need not be included in the gross income in computing the depositor’s/
investor’s income tax liability in accordance with the provision of Section 29(b),
29 (c)30 and (d) of the National Internal Revenue Code, as amended.

‘(b) Only interest paid or accrued on bank deposits, or yield from deposit
substitutes declared for purposes of imposing the withholding taxes in accordance
with these regulations shall be allowed as interest expense deductible for purposes
of computing taxable net income of the payor.
Income Tax - cases

‘(c) If the recipient of the above-mentioned items of income are financial

institutions, the same shall be included as part of the tax base upon which the gross
receipt[s] tax is imposed.’"

Section 4(e) of RR 12-80, on the other hand, states that the tax rates to be imposed
on the gross receipts of banks, non-bank financial intermediaries, financing
companies, and other non-bank financial intermediaries not performing quasi-
banking activities shall be based on all items of income actually received. This
provision reads:

"SEC. 4. x x x x x x x x x

"(e) Gross receipts tax on banks, non-bank financial intermediaries, financing

companies, and other non-bank financial intermediaries not performing quasi-
banking activities. – The rates of tax to be imposed on the gross receipts of such
financial institutions shall be based on all items of income actually received. Mere
accrual shall not be considered, but once payment is received on such accrual or in
cases of prepayment, then the amount actually received shall be included in the tax
base of such financial institutions, as provided hereunder x x x."

Respondent argues that the above-quoted provision is plain and clear: since there is
no actual receipt, the FWT is not to be included in the tax base for computing the
GRT. There is supposedly no pecuniary benefit or advantage accruing to the bank
from the FWT, because the income is subjected to a tax burden immediately upon
receipt through the withholding process. Moreover, the earlier RR 12-80 covered
matters not falling under the later RR 17-84.31

We are not persuaded.

By analogy, we apply to the receipt of income the rules on actual and constructive
possession provided in Articles 531 and 532 of our Civil Code.

Under Article 531:32

"Possession is acquired by the material occupation of a thing or the exercise of a

right, or by the fact that it is subject to the action of our will, or by the proper acts
and legal formalities established for acquiring such right."
Income Tax - cases

Article 532 states:

"Possession may be acquired by the same person who is to enjoy it, by his legal
representative, by his agent, or by any person without any power whatever; but in
the last case, the possession shall not be considered as acquired until the person in
whose name the act of possession was executed has ratified the same, without
prejudice to the juridical consequences of negotiorum gestio in a proper case."33

The last means of acquiring possession under Article 531 refers to juridical acts --
the acquisition of possession by sufficient title – to which the law gives the force of
acts of possession.34 Respondent argues that only items of income actually received
should be included in its gross receipts. It claims that since the amount had already
been withheld at source, it did not have actual receipt thereof.

We clarify. Article 531 of the Civil Code clearly provides that the acquisition of the
right of possession is through the proper acts and legal formalities established
therefor. The withholding process is one such act. There may not be actual receipt
of the income withheld; however, as provided for in Article 532, possession by any
person without any power whatsoever shall be considered as acquired when ratified
by the person in whose name the act of possession is executed.

In our withholding tax system, possession is acquired by the payor as the

withholding agent of the government, because the taxpayer ratifies the very act of
possession for the government. There is thus constructive receipt. The processes of
bookkeeping and accounting for interest on deposits and yield on deposit
substitutes that are subjected to FWT are indeed -- for legal purposes -- tantamount
to delivery, receipt or remittance.35 Besides, respondent itself admits that its income
is subjected to a tax burden immediately upon "receipt," although it claims that it
derives no pecuniary benefit or advantage through the withholding process. There
being constructive receipt of such income -- part of which is withheld -- RR 17-84
applies, and that income is included as part of the tax base upon which the GRT is
imposed.

RR 12-80 Superseded by RR 17-84

We now come to the effect of the revenue regulations on interest income

constructively received.
Income Tax - cases

In general, rules and regulations issued by administrative or executive officers

pursuant to the procedure or authority conferred by law upon the administrative
agency have the force and effect, or partake of the nature, of a statute.36 The reason
is that statutes express the policies, purposes, objectives, remedies and sanctions
intended by the legislature in general terms. The details and manner of carrying
them out are oftentimes left to the administrative agency entrusted with their
enforcement.

In the present case, it is the finance secretary who promulgates the revenue
regulations, upon recommendation of the BIR commissioner. These regulations are
the consequences of a delegated power to issue legal provisions that have the effect
of law.37

A revenue regulation is binding on the courts as long as the procedure fixed for its
promulgation is followed. Even if the courts may not be in agreement with its
stated policy or innate wisdom, it is nonetheless valid, provided that its scope is
within the statutory authority or standard granted by the legislature.38 Specifically,
the regulation must (1) be germane to the object and purpose of the law;39 (2) not
contradict, but conform to, the standards the law prescribes;40 and (3) be issued for
the sole purpose of carrying into effect the general provisions of our tax laws.41

In the present case, there is no question about the regularity in the performance of
official duty. What needs to be determined is whether RR 12-80 has been repealed
by RR 17-84.

A repeal may be express or implied. It is express when there is a declaration in a

regulation -- usually in its repealing clause -- that another regulation, identified by
its number or title, is repealed. All others are implied repeals.42 An example of the
latter is a general provision that predicates the intended repeal on a substantial
conflict between the existing and the prior regulations.43

As stated in Section 11 of RR 17-84, all regulations, rules, orders or portions

thereof that are inconsistent with the provisions of the said RR are thereby
repealed. This declaration proceeds on the premise that RR 17-84 clearly reveals
such an intention on the part of the Department of Finance. Otherwise, later RRs
are to be construed as a continuation of, and not a substitute for, earlier RRs; and
Income Tax - cases

will continue to speak, so far as the subject matter is the same, from the time of the
first promulgation.44

There are two well-settled categories of implied repeals: (1) in case the provisions
are in irreconcilable conflict, the later regulation, to the extent of the conflict,
constitutes an implied repeal of an earlier one; and (2) if the later regulation covers
the whole subject of an earlier one and is clearly intended as a substitute, it will
similarly operate as a repeal of the earlier one.45 There is no implied repeal of an
earlier RR by the mere fact that its subject matter is related to a later RR, which
may simply be a cumulation or continuation of the earlier one.46

Where a part of an earlier regulation embracing the same subject as a later one may
not be enforced without nullifying the pertinent provision of the latter, the earlier
regulation is deemed impliedly amended or modified to the extent of the
repugnancy.47 The unaffected provisions or portions of the earlier regulation remain
in force, while its omitted portions are deemed repealed.48  An exception therein
that is amended by its subsequent elimination shall now cease to be so and instead
be included within the scope of the general rule.49

Section 4(e) of the earlier RR 12-80 provides that only items of income actually
received shall be included in the tax base for computing the GRT, but Section 7(c)
of the later RR 17-84 makes no such distinction and provides that all interests
earned shall be included. The exception having been eliminated, the clear intent is
that the later RR 17-84 includes the exception within the scope of the general rule.

Repeals by implication are not favored and will not be indulged, unless it is
manifest that the administrative agency intended them. As a regulation is presumed
to have been made with deliberation and full knowledge of all existing rules on the
subject, it may reasonably be concluded that its promulgation was not intended to
interfere with or abrogate any earlier rule relating to the same subject, unless it is
either repugnant to or fully inclusive of the subject matter of an earlier one, or
unless the reason for the earlier one is "beyond peradventure removed."50  Every
effort must be exerted to make all regulations stand -- and a later rule will not
operate as a repeal of an earlier one, if by any reasonable construction, the two can
be reconciled.51
Income Tax - cases

RR 12-80 imposes the GRT only on all items of income actually received, as
opposed to their mere accrual, while RR 17-84 includes all interest income in
computing the GRT. RR 12-80 is superseded by the later rule, because Section 4(e)
thereof is not restated in RR 17-84. Clearly therefore, as petitioner correctly states,
this particular provision was impliedly repealed when the later regulations took
effect.52

Reconciling the Two Regulations

Granting that the two regulations can be reconciled, respondent’s reliance on

Section 4(e) of RR 12-80 is misplaced and deceptive. The "accrual" referred to
therein should not be equated with the determination of the amount to be used as
tax base in computing the GRT. Such accrual merely refers to an accounting
method that recognizes income as earned although not received, and expenses as
incurred although not yet paid.

Accrual should not be confused with the concept of constructive possession or

receipt as earlier discussed. Petitioner correctly points out that income that is
merely accrued -- earned, but not yet received -- does not form part of the taxable
gross receipts; income that has been received, albeit constructively, does.53

The word "actually," used confusingly in Section 4(e), will be clearer if removed
entirely. Besides, if actually is that important, accrual should have been eliminated
for being a mere surplusage. The inclusion of accrual stresses the fact that Section
4(e) does not distinguish between actual and constructive receipt. It merely focuses
on the method of accounting known as the accrual system.

Under this system, income is accrued or earned in the year in which the taxpayer’s
right thereto becomes fixed and definite, even though it may not be actually
received until a later year; while a deduction for a liability is to be accrued or
incurred and taken when the liability becomes fixed and certain, even though it
may not be actually paid until later.54

Under any system of accounting, no duty or liability to pay an income tax upon a
transaction arises until the taxable year in which the event constituting the
condition precedent occurs.55 The liability to pay a tax may thus arise at a certain
time and the tax paid within another given time.56
Income Tax - cases

In reconciling these two regulations, the earlier one includes in the tax base for
GRT all income, whether actually or constructively received, while the later one
includes specifically interest income. In computing the income tax liability, the
only exception cited in the later regulations is the exclusion from gross income of
interest income, which is already subjected to withholding. This exception,
however, refers to a different tax altogether. To extend mischievously such
exception to the GRT will certainly lead to results not contemplated by the
legislators and the administrative body promulgating the regulations.

Manila Jockey Club


Inapplicable

In Commissioner of Internal Revenue v. Manila Jockey Club,57  we held that the

term "gross receipts" shall not include money which, although delivered, has been
especially earmarked by law or regulation for some person other than the taxpayer.
58

To begin, we have to nuance the definition of gross receipts59 to determine what it

is exactly. In this regard, we note that US cases have persuasive effect in our
jurisdiction, because Philippine income tax law is patterned after its US
counterpart.60

"‘[G]ross receipts’ with respect to any period means the sum of: (a) The total
amount received or accrued during such period from the sale, exchange, or other
disposition of x x x 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 its
trade or business, and (b) The gross income, attributable to a trade or business,
regularly carried on by the taxpayer, received or accrued during such period x x
x."61

"x x x [B]y gross earnings from operations x x x was intended all operations xxx
including incidental, subordinate, and subsidiary operations, as well as principal
operations."62
Income Tax - cases

"When we speak of the ‘gross earnings’ of a person or corporation, we mean the

entire earnings or receipts of such person or corporation from the business or
operations to which we refer."63

From these cases, "gross receipts"64   refer to the total, as opposed to the net,
income.65   These are therefore the total receipts before any deduction66   for the
expenses of management.67 Webster’s New International Dictionary, in fact, defines
gross as "whole or entire."

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

corporations are found in many jurisdictions.68 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.69

Moreover, we have emphasized that the BIR has consistently ruled that "gross
receipts" does not admit of any deduction.70 Following the principle of legislative
approval by reenactment,71  this interpretation has been adopted by the legislature
throughout the various reenactments of then Section 119 of the Tax Code.72

Given that a tax is imposed upon total receipts and not upon net earnings,73  shall
the income withheld be included in the tax base upon which such tax is imposed?
In other words, shall interest income constructively received still be included in the
tax base for computing the GRT?

We rule in the affirmative.

Manila Jockey Club does not apply to this case. Earmarking is not the same as
withholding. Amounts earmarked do not form part of gross receipts, because,
although delivered or received, these are by law or regulation reserved for some
person other than the taxpayer. On the contrary, amounts withheld form part of
gross receipts, because these are in constructive possession and not subject to any
reservation, the withholding agent being merely a conduit in the collection process.

The Manila Jockey Club had to deliver to the Board on Races, horse owners and
jockeys amounts that never became the property of the race track.74  Unlike these
amounts, the interest income that had been withheld for the government became
property of the financial institutions upon constructive possession thereof.
Income Tax - cases

Possession was indeed acquired, since it was ratified by the financial institutions in
whose name the act of possession had been executed. The money indeed belonged
to the taxpayers; merely holding it in trust was not enough.75

The government subsequently becomes the owner of the money when the financial
institutions pay the FWT to extinguish their obligation to the government. As this
Court has held before, this is the consideration for the transfer of ownership of the
FWT from these institutions to the government.76  It is ownership that determines
whether interest income forms part of taxable gross receipts.77  Being originally
owned by these financial institutions as part of their interest income, the FWT
should form part of their taxable gross receipts.

Besides, these amounts withheld are in payment of an income tax liability, which is
different from a percentage tax liability. Commissioner of Internal Revenue v.
Tours Specialists, Inc. aptly held thus:78

"x x x [G]ross receipts subject to tax under the Tax Code do not include monies or
receipts entrusted to the taxpayer which do not belong to them and do not redound
to the taxpayer’s benefit; and it is not necessary that there must be a law or
regulation which would exempt such monies and receipts within the meaning of
gross receipts under the Tax Code."79

In the construction and interpretation of tax statutes and of statutes in general, the
primary consideration is to ascertain and give effect to the intention of the
legislature.80  We ought to impute to the lawmaking body the intent to obey the
constitutional mandate, as long as its enactments fairly admit of such construction.
81  In fact, "x x x no tax can be levied without express authority of law, but the

statutes are to receive a reasonable construction with a view to carrying out their
purpose and intent."82

Looking again into Sections 24(e)(1) and 119 of the Tax Code, we find that the first
imposes an income tax; the second, a percentage tax. The legislature clearly
intended two different taxes. The FWT is a tax on passive income, while the GRT
is on business.83  The withholding of one is not equivalent to the payment of the
other.

Non-Exemption of FWT from GRT:

Income Tax - cases

Neither Unjust nor Absurd

Taxing the people and their property is essential to the very existence of
government. Certainly, one of the highest attributes of sovereignty is the power of
taxation,84   which may legitimately be exercised on the objects to which it is
applicable to the utmost extent as the government may choose.85 Being an incident
of sovereignty, such power is coextensive with that to which it is an incident.86 The
interest on deposits and yield on deposit substitutes of financial institutions, on the
one hand, and their business as such, on the other, are the two objects over which
the State has chosen to extend its sovereign power. Those not so chosen are, upon
the soundest principles, exempt from taxation.87

While courts will not enlarge by construction the government’s power of taxation,
88   neither will they place upon tax laws so loose a construction as to permit

evasions, merely on the basis of fanciful and insubstantial distinctions.89 When the

legislature imposes a tax on income and another on business, the imposition must
be respected. The Tax Code should be so construed, if need be, as to avoid empty
declarations or possibilities of crafty tax evasion schemes. We have consistently
ruled thus:

"x x x [I]t is upon taxation that the [g]overnment chiefly relies to obtain the means
to carry on its operations, and it is of the utmost importance that the modes adopted
to enforce the collection of the taxes levied should be summary and interfered with
as little as possible. x x x."90

"Any delay in the proceedings of the officers, upon whom the duty is devolved of
collecting the taxes, may derange the operations of government, and thereby cause
serious detriment to the public."91

"No government could exist if all litigants were permitted to delay the collection of
its taxes."92

A taxing act will be construed, and the intent and meaning of the legislature
ascertained, from its language.93 Its clarity and implied intent must exist to uphold
the taxes as against a taxpayer in whose favor doubts will be resolved.94 No such
doubts exist with respect to the Tax Code, because the income and percentage taxes
Income Tax - cases

we have cited earlier have been imposed in clear and express language for that
purpose.95

This Court has steadfastly adhered to the doctrine that its first and fundamental
duty is the application of the law according to its express terms -- construction and
interpretation being called for only when such literal application is impossible or
inadequate without them.96  In Quijano v. Development Bank of the Philippines,
97 we stressed as follows:

"No process of interpretation or construction need be resorted to where a provision

of law peremptorily calls for application." 98

A literal application of any part of a statute is to be rejected if it will operate

unjustly, lead to absurd results, or contradict the evident meaning of the statute
taken as a whole.99   Unlike the CA, we find that the literal application of the
aforesaid sections of the Tax Code and its implementing regulations does not
operate unjustly or contradict the evident meaning of the statute taken as a whole.
Neither does it lead to absurd results. Indeed, our courts are not to give words
meanings that would lead to absurd or unreasonable consequences.100   We have
repeatedly held thus:

"x x x [S]tatutes should receive a sensible construction, such as will give effect to
the legislative intention and so as to avoid an unjust or an absurd conclusion."101

"While it is true that the contemporaneous construction placed upon a statute by

executive officers whose duty is to enforce it should be given great weight by the
courts, still if such construction is so erroneous, x x x the same must be declared as
null and void."102

It does not even matter that the CTA, like in China Banking Corporation,103 relied
erroneously on Manila Jockey Club. Under our tax system, the CTA acts as a
highly specialized body specifically created for the purpose of reviewing tax cases.
104  Because of its recognized expertise, its findings of fact will ordinarily not be

reviewed, absent any showing of gross error or abuse on its part.105 Such findings
are binding on the Court and, absent strong reasons for us to delve into facts, only
questions of law are open for determination.106
Income Tax - cases

Respondent claims that it is entitled to a refund on the basis of excess GRT

payments. We disagree.

Tax refunds are in the nature of tax exemptions.107  Such exemptions are strictly
construed against the taxpayer, being highly disfavored108  and almost said "to be
odious to the law." Hence, those who claim to be exempt from the payment of a
particular tax must do so under clear and unmistakable terms found in the statute.
They must be able to point to some positive provision, not merely a vague
implication,109 of the law creating that right.110

The right of taxation will not be surrendered, except in words too plain to be
mistaken.1âwphi1 The reason is that the State cannot strip itself of this highest
attribute of sovereignty -- its most essential power of taxation -- by vague or
ambiguous language. Since tax refunds are in the nature of tax exemptions, these
are deemed to be "in derogation of sovereign authority and to be construed
strictissimi juris against the person or entity claiming the exemption."111

No less than our 1987 Constitution provides for the mechanism for granting tax
exemptions.112   They certainly cannot be granted by implication or mere
administrative regulation. Thus, when an exemption is claimed, it must indubitably
be shown to exist, for every presumption is against it,113 and a well-founded doubt
is fatal to the claim.114   In the instant case, respondent has not been able to
satisfactorily show that its FWT on interest income is exempt from the GRT. Like
China Banking Corporation, its argument creates a tax exemption where none
exists.115

No exemptions are normally allowed when a GRT is imposed. It is precisely

designed to maintain simplicity in the tax collection effort of the government and
to assure its steady source of revenue even during an economic slump.116

No Double Taxation

We have repeatedly said that the two taxes, subject of this litigation, are different
from each other. The basis of their imposition may be the same, but their natures
are different, thus leading us to a final point. Is there double taxation?

The Court finds none.

Income Tax - cases

Double taxation means taxing the same property twice when it should be taxed
only once; that is, "x x x taxing the same person twice by the same jurisdiction for
the same thing."117 It is obnoxious when the taxpayer is taxed twice, when it should
be but once.118 Otherwise described as "direct duplicate taxation,"119 the two taxes
must be imposed on the same subject matter, for the same purpose, by the same
taxing authority, within the same jurisdiction, during the same taxing period; and
they must be of the same kind or character.120

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

A tax based on receipts is a tax on business rather than on the property; hence, it is
an excise121 rather than a property tax.122 It is not an income tax, unlike the FWT. In
fact, we have already held that one can be taxed for engaging in business and
further taxed differently for the income derived therefrom.123 Akin to our ruling in
Velilla v. Posadas,124  these two taxes are entirely distinct and are assessed under
different provisions.

Second, although both taxes are national in scope because they are imposed by the
same taxing authority -- the national government under the Tax Code -- and
operate within the same Philippine jurisdiction for the same purpose of raising
revenues, the taxing periods they affect are different. The FWT is deducted and
withheld as soon as the income is earned, and is paid after every calendar quarter
in which it is earned. On the other hand, the GRT is neither deducted nor withheld,
but is paid only after every taxable quarter in which it is earned.

Third, these two taxes are of different kinds or characters. The FWT is an income
tax subject to withholding, while the GRT is a percentage tax not subject to
withholding.

In short, there is no double taxation, because there is no taxing twice, by the same
taxing authority, within the same jurisdiction, for the same purpose, in different
taxing periods, some of the property in the territory.125 Subjecting interest income
to a 20% FWT and including it in the computation of the 5% GRT is clearly not
double taxation.
Income Tax - cases

WHEREFORE, the Petition is GRANTED. The assailed Decision and Resolution

of the Court of Appeals are hereby REVERSED and SET ASIDE. No costs.

SO ORDERED.

Vicente Madrigal v. James Rafferty, G.R. No. L-12287, August 7, 1918

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

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1,
1914. The marriage was contracted under the provisions of law concerning
conjugal partnerships (sociedad de gananciales). On February 25, 1915, Vicente
Madrigal filed sworn declaration on the prescribed form with the Collector of
Internal Revenue, showing, as his total net income for the year 1914, the sum of
P296,302.73. Subsequently Madrigal submitted the claim that the said P296,302.73
did not represent his income for the year 1914, but was in fact the income of the
conjugal partnership existing between himself and his wife Susana Paterno, and
that in computing and assessing the additional income tax provided by the Act of
Congress of October 3, 1913, the income declared by Vicente Madrigal should be
divided into two equal parts, one-half to be considered the income of Vicente
Madrigal and the other half of Susana Paterno. The general question had in the
meantime been submitted to the Attorney-General of the Philippine Islands who in
an opinion dated March 17, 1915, held with the petitioner Madrigal. The revenue
officers being still unsatisfied, the correspondence together with this opinion was
forwarded to Washington for a decision by the United States Treasury Department.
The United States Commissioner of Internal Revenue reversed the opinion of the
Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided
adversely by the Collector of Internal Revenue, action was begun by Vicente
Madrigal and his wife Susana Paterno in the Court of First Instance of the city of
Manila against Collector of Internal Revenue and the Deputy Collector of Internal
Income Tax - cases

Revenue for the recovery of the sum of P3,786.08, alleged to have been wrongfully
and illegally collected by the defendants from the plaintiff, Vicente Madrigal,
under the provisions of the Act of Congress known as the Income Tax Law. The
burden of the complaint was that if the income tax for the year 1914 had been
correctly and lawfully computed there would have been due payable by each of the
plaintiffs the sum of P2,921.09, which taken together amounts of a total of
P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the
plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid as
income tax for the year 1914, P3,786.08, in excess of the sum lawfully due and
payable.

The answer of the defendants, together with an analysis of the tax declaration, the
pleadings, and the stipulation, sets forth the basis of defendants' stand in the
following way: The income of Vicente Madrigal and his wife Susana Paterno of the
year 1914 was made up of three items: (1) P362,407.67, the profits made by
Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits made
by Susana Paterno in her embroidery business; (3) P16,687.80, the profits made by
Vicente Madrigal in a pawnshop company. The sum of these three items is
P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the
year 1914. General deductions were claimed and allowed in the sum of
P86,879.24. The resulting net income was P296,302.73. For the purpose of
assessing the normal tax of one per cent on the net income there were allowed as
specific deductions the following: (1) P16,687.80, the tax upon which was to be
paid at source, and (2) P8,000, the specific exemption granted to Vicente Madrigal
and Susana Paterno, husband and wife. The remainder, P271,614.93 was the sum
upon which the normal tax of one per cent was assessed. The normal tax thus
arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax
provided for in the Income Tax Law. The trial court in an exhausted decision found
in favor of defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional
income tax, is that is should be divided into two equal parts, because of the
Income Tax - cases

conjugal partnership existing between them. The learned argument of counsel is

mostly based upon the provisions of the Civil Code establishing the sociedad de
gananciales. The counter contentions of appellees are that the taxes imposed by the
Income Tax Law are as the name implies taxes upon income tax and not upon
capital and property; that the fact that Madrigal was a married man, and his
marriage contracted under the provisions governing the conjugal partnership, has
no bearing on income considered as income, and that the distinction must be drawn
between the ordinary form of commercial partnership and the conjugal partnership
of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have
been given the course of history. The final stage has been the selection of income
as the norm of taxation. (See   Seligman, "The Income Tax," Introduction.) The
Income Tax Law of the United States, extended to the Philippine Islands, is the
result of an effect on the part of the legislators to put into statutory form this canon
of taxation and of social reform. The aim has been to mitigate the evils arising
from inequalities of wealth by a progressive scheme of taxation, which places the
burden on those best able to pay. To carry out this idea, public considerations have
demanded an exemption roughly equivalent to the minimum of subsistence. With
these exceptions, the income tax is supposed to reach the earnings of the entire
non-governmental property of the country. Such is the background of the Income
Tax Law.

Income as contrasted with capital or property is to be the test. The essential

difference between capital and income is that capital is a fund; income is a flow. A
fund of property existing at an instant of time is called capital. A flow of services
rendered by that capital by the payment of money from it or any other benefit
rendered by a fund of capital in relation to such fund through a period of time is
called an income. Capital is wealth, while income is the service of wealth.
(See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia
expresses the thought in the following figurative language: "The fact is that
property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a
tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on
income is not a tax on property. "Income," as here used, can be defined as "profits
Income Tax - cases

or gains." (London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J.

K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See
further Foster's Income Tax, second edition [1915], Chapter IV; Black on Income
Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U.S.,
549; and Towne vs. Eisner, decided by the United States Supreme Court, January 7,
1918.)

A regulation of the United States Treasury Department relative to returns by the

husband and wife not living apart, contains the following:

The husband, as the head and legal representative of the household and general
custodian of its income, should make and render the return of the aggregate income
of himself and wife, and for the purpose of levying the income tax it is assumed
that he can ascertain the total amount of said income. If a wife has a separate estate
managed by herself as her own separate property, and receives an income of more
than $3,000, she may make return of her own income, and if the husband has other
net income, making the aggregate of both incomes more than $4,000, the wife's
return should be attached to the return of her husband, or his income should be
included in her return, in order that a deduction of $4,000 may be made from the
aggregate of both incomes. The tax in such case, however, will be imposed only
upon so much of the aggregate income of both shall exceed $4,000. If either
husband or wife separately has an income equal to or in excess of $3,000, a return
of annual net income is required under the law, and such return must include the
income of both, and in such case the return must be made even though the
combined income of both be less than $4,000. If the aggregate net income of both
exceeds $4,000, an annual return of their combined incomes must be made in the
manner stated, although neither one separately has an income of $3,000 per annum.
They are jointly and separately liable for such return and for the payment of the
tax. The single or married status of the person claiming the specific exemption
shall be determined as one of the time of claiming such exemption which return is
made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the
Philippine Islands, we turn for a moment to consider the provisions of the Civil
Code dealing with the conjugal partnership. Recently in two elaborate decisions in
which a long line of Spanish authorities were cited, this court in speaking of the
Income Tax - cases

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.

The point we are discussing has heretofore been considered by the Attorney-
General of the Philippine Islands and the United States Treasury Department. The
decision of the latter overruling the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,

Chief, Bureau of Insular Affairs, War Department,

Washington, D. C.
Income Tax - cases

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of
submission of income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau,
advises that the Insular Auditor has been authorized to suspend action on the
warrants in question until an authoritative decision on the points raised can be
secured from the Treasury Department."

From the correspondence it appears that Gregorio Araneta, married and living with
his wife, had an income of an amount sufficient to require the imposition of the net
income was properly computed and then both income and deductions and the
specific exemption were divided in half and two returns made, one return for each
half in the names respectively of the husband and wife, so that under the returns as
filed there would be an escape from the additional tax; that Araneta claims the
returns are correct on the ground under the Philippine law his wife is entitled to
half of his earnings; that Araneta has dominion over the income and under the
Philippine law, the right to determine its use and disposition; that in this case the
wife has no "separate estate" within the contemplation of the Act of October 3,
1913, levying an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax
was assessed against the entire net income against Gregorio Araneta; that the tax
was paid and an application for refund made, and that the application for refund
was rejected, whereupon the matter was submitted to the Attorney-General of the
Islands who holds that the returns were correctly rendered, and that the refund
should be allowed; and thereupon the question at issue is submitted through the
Governor-General of the Islands and Bureau of Insular Affairs for the advisory
opinion of this office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands,
to be administered as in the United States but by the appropriate internal-revenue
officers of the Philippine Government. You are therefore advised that upon the
facts as stated, this office holds that for the Federal Income Tax (Act of October 3,
1913), the entire net income in this case was taxable to Gregorio Araneta, both for
Income Tax - cases

the normal and additional tax, and that the application for refund was properly
rejected.

The separate estate of a married woman within the contemplation of the Income
Tax Law is that which belongs to her solely and separate and apart from her
husband, and over which her husband has no right in equity. It may consist of lands
or chattels.

The statute and the regulations promulgated in accordance therewith provide that
each person of lawful age (not excused from so doing) having a net income of
$3,000 or over for the taxable year shall make a return showing the facts; that from
the net income so shown there shall be deducted $3,000 where the person making
the return is a single person, or married and not living with consort, and $1,000
additional where the person making the return is married and living with consort;
but that where the husband and wife both make returns (they living together), the
amount of deduction from the aggregate of their several incomes shall not exceed
$4,000.

The only occasion for a wife making a return is where she has income from a sole
and separate estate in excess of $3,000, but together they have an income in excess
of $4,000, in which the latter event either the husband or wife may make the return
but not both. In all instances the income of husband and wife whether from
separate estates or not, is taken as a whole for the purpose of the normal tax. Where
the wife has income from a separate estate makes return made by her husband,
while the incomes are added together for the purpose of the normal tax they are
taken separately for the purpose of the additional tax. In this case, however, the
wife has no separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.

Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas.
The Income Tax Law was drafted by the Congress of the United States and has
been by the Congress extended to the Philippine Islands. Being thus a law of
Income Tax - cases

American origin and being peculiarly intricate in its provisions, the authoritative
decision of the official who is charged with enforcing it has peculiar force for the
Philippines. It has come to be a well-settled rule that great weight should be given
to the construction placed upon a revenue law, whose meaning is doubtful, by the
department charged with its execution. (U.S. vs. Cerecedo Hermanos y Cia. [1907],
209 U.S., 338; In re Allen [1903], 2 Phil., 630; Government of the Philippine
Islands   vs.   Municipality of Binalonan, and Roman Catholic Bishop of Nueva
Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is
hereby affirmed with costs against appellants. So ordered.

Association of Non-Profit Clubs, Inc. (ANPC) v. Bureau of Internal Revenue, G.R.

No. 228539, June 26, 2019

Assailed in this petition for review on certiorari1  are the Decision2  dated July 1,
2016 and the Order3   dated November 7, 2016 of the Regional Trial Court of
Makati City, Branch 134 (RTC), in Special Civil Case No. 14- 985, which denied
petitioner Association of Non-Profit Clubs, Inc. (ANPC)'s petition4 for declaratory
relief, thereby upholding in full the validity of Revenue Memorandum Circular
(RMC) No. 35-2012.5




The Facts

On August 3, 2012, respondent the Bureau of Internal Revenue (BIR) issued RMC
No. 35-2012, entitled "Clarifying the Taxability of Clubs Organized and Operated
Exclusively for Pleasure, Recreation, and Other Non-Profit Purposes,"6 which was
addressed to all revenue officials, employees, and others concerned for their
guidance regarding the income tax and Valued Added Tax (VAT) liability of the
said recreational clubs.7

On the income tax component, RMC No. 35-2012 states that "[c]lubs which are
organized and operated exclusively for pleasure, recreation, and other non-
profit purposes are subject to income tax under the National Internal Revenue
Code [(NIRC)] of 1997,8  as amended [(1997 NIRC)]."9  The BIR justified the
foregoing interpretation based on the following reasons:
Income Tax - cases

According to the doctrine of casus omissus pro omisso habendus est, a person,
object, or thing omitted from an enumeration must be held to have been omitted
intentionally. The provision in the (1977 Tax Code] which granted income tax
exemption to such recreational clubs was omitted in the current list of tax exempt
corporations under [the 1997 NIRC], as amended.   Hence, the income of
recreational clubs from whatever source, including but not limited to
membership fees, assessment dues, rental income, and service fees are subject
to income tax.10 (Emphasis and underscoring supplied)
Likewise, on the VAT component, RMC No. 35-2012 provides that "the gross
receipts of recreational clubs including but not limited to membership fees,
assessment dues, rental income, and service fees are   subject to VAT."11   As
basis, the BIR relied on Section 105,12 Chapter I, Title IV of the 1997 NIRC, which
states that even a nonstock, nonprofit private organization or government entity is
liable to pay VAT on the sale of goods or services.13

On October 25, 2012, ANPC, along with the representatives of its member clubs,
invited Atty. Elenita Quimosing (Atty. Quimosing), Chief of Staff, Operations
Group of the BIR, to discuss "specifically the effects of the said [C]ircular and to
seek clarification and advice from the BIR on how it will affect the operational
requirements of each club and their members/stakeholders."14   During their
meeting, Atty. Quimosing discussed the basis and effects of RMC No. 35-2012,
and further suggested that the attendees submit a position paper to the BIR
expressing their concerns.15

Consequently, ANPC submitted its position paper,16   requesting "the non-

application of RMC [No.] 35-2012 for income tax and VAT liability on
membership fees, association dues, and fees of similar nature collected by [the]
exclusive membership clubs from [their] members which are used to defray the
expenses of the said clubs."17 However, despite the lapse of two (2) years, the BIR
has not acted upon the request, and all the member clubs of ANPC were subjected
to income tax and VAT on all membership fees, assessment dues, and service fees.
18

Aggrieved, ANPC, on behalf of its club members, filed a petition19 for declaratory

relief before the RTC on September 17, 2014, seeking to declare RMC No.
Income Tax - cases

35-2012 invalid, unjust, oppressive, confiscatory, and in violation of the due

process clause of the Constitution.20   ANPC argued that in issuing RMC No.
35-2012, the BIR acted beyond its rule-making authority in interpreting that
payments of membership fees, assessment dues, and service v fees are considered
as income subject to income tax, as well as a sale of service that is subject to VAT.
21

For its part, the Office of the Solicitor General (OSG), on behalf of the BIR, sought
the dismissal of the petition for ANPC's failure to exhaust all the available
administrative remedies. It also argued that RMC No. 35- 2012 is a mere
amplification of the existing law and the rules and regulations of the BIR on the
matter, positing that the said Circular merely explained that by removing
recreational clubs from the list of tax exempt entities or corporations, Congress
intended to subject them to income tax and VAT under the 1997 NIRC.22

The RTC Ruling

In a Decision23  dated July 1, 2016, the RTC denied the petition for declaratory
relief24  and upheld the validity and constitutionality of RMC No. 35-2012.25   On
the procedural issue, the RTC found that there was no violation of the doctrine of
exhaustion of administrative remedies, since judicial intervention was urgent in
light of the impending imposition of taxes on the membership fees and assessment
dues paid by the members of the exclusive clubs.26 As to the substantive issue, the
RTC found that given the apparent intent of Congress to subject recreational clubs
to taxes, the BIR, being the administrative agency concerned with the
implementation of the law, has the power to make such an interpretation through
the issuance of RMC No. 35-2012. As an interpretative rule issued well within the
powers of the BIR, the same need not be published and neither is a hearing
required for its validity.27

Undaunted, ANPC sought reconsideration,28   which the RTC denied in an

Order29  dated November 7, 2016. Raising pure questions of law, ANPC, herein
represented by its authorized representative, Ms. Felicidad M. Del Rosario, filed
the instant petition for review on certiorari directly before the Court.
Income Tax - cases

The Issue Before the Court

The essential issue for the Court's resolution is whether or not the RTC erred in
upholding in full the validity of RMC No. 35-2012.

The Court's Ruling

The petition is partly meritorious.

I.

The Court first resolves the procedural issues.

In its Comment,30  the BIR, through the OSG, seeks the dismissal of the present
petition on the ground that ANPC violated the doctrine of hierarchy of courts due
to its direct resort before the Court.31  Moreover, it asserts that ANPC violated the
doctrine of exhaustion of available administrative remedies, pointing out that
ANPC should have first elevated the matter to the Secretary of Finance for review
pursuant to Section 4,32  Title I of the 1997 NIRC.33

The contentions are untenable.

First, the Court holds that there was no violation of the doctrine of hierarchy of
courts because the present petition for review on   certiorari, filed pursuant to
Section 2 (c), Rule 41 in relation to Rule 45 of the Rules of Court, is the sole
remedy to appeal a decision of the RTC in cases involving pure questions of law.
The doctrine of hierarchy of courts is violated only when relief may be had through
multiple fora having concurrent jurisdiction over the case, such as in petitions
for certiorari, mandamus, and prohibition which are concurrently cognizable either
by the Regional Trial Courts, the Court of Appeals, or the Supreme Court. In Uy v.
Contreras:34
[W]hile it is true that this Court, the Court of Appeals, and the Regional Trial
Courts have concurrent original jurisdiction to issue writs of   certiorari,
prohibition, mandamus, quo warranto, and habeas corpus, such concurrence does
not accord litigants unrestrained freedom of choice of the court to which
Income Tax - cases

application therefor may be directed.   There is a   hierarchy of

courts   determinative of the venue of appeals which should also serve as a
general determinant of the proper forum for the application for the
extraordinary writs. A becoming regard for this judicial hierarchy by the
petitioner and her lawyers ought to have led them to file the petition with the
proper Regional Trial Court.35 (Emphasis and underscoring supplied)
Clearly, the correctness of the BIR's interpretation of the 1997 NIRC under the
assailed RMC is a pure question of law,36  because the same does not involve an
examination of the probative value of the evidence presented by the litigants or any
of them.37  Thus, being the only remedy to appeal the RTC's ruling upholding the
Circular's validity on a purely legal question, direct resort to this Court, through a
Rule 45 petition, was correctly availed by ANPC.

Anent the issue of exhaustion of administrative remedies, the Court likewise holds
that the said doctrine was not transgressed.

At the onset, it is apt to point out that RMC No. 35-2012 only clarified the
taxability (particularly, income tax and VAT liability) of clubs organized and
operated exclusively for pleasure, recreation, and other non-profit purposes based
on the BIR's own interpretation of the NIRC provisions on income tax and VAT.
Evidently, it was not designed "to implement a primary legislation by providing the
details thereof' as in a legislative rule; but rather, was intended only to "provide
guidelines to the law which the administrative agency is in charge of
enforcing,"38   as the said Circular was, in fact, addressed to "[a]ll [r]evenue
[o]fficials, [e]mployees[,] and [o]thers [c]oncerned"39   to guide them in the
enforcement of income tax and VAT laws against fees collected by the said clubs.

Given its nature, RMC No. 35-2012 is therefore subject to the administrative
review of the Secretary of Finance pursuant to Section 4, Title I of the 1997 NIRC,
which provides:
Section 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.
Income Tax - cases

x x x x (Emphases supplied)
Thus, as dictated by the rule on exhaustion of administrative remedies,40   the
validity of RMC No. 35-2012 should have been first subjected to the review of the
Secretary of Finance before ANPC sought judicial recourse with the RTC.

However, as exceptions to this rule, when the issue involved is purely a legal
question (as above-explained), or when there are circumstances indicating the
urgency of judicial intervention41   - as in this case where membership fees,
assessment dues, and the like of all recreational clubs would be imminently
subjected to income tax and VAT - then the doctrine of exhaustion of
administrative remedies may be relaxed.

Accordingly, ANPC's recourse to the RTC and now, before this Court are
permissible and hence, are not grounds to dismiss this case. That being said, the
Court now proceeds to resolve the substantive issue on whether or not RMC No.
35-2012 is valid.

II.

To recount, RMC No. 35-2012 is an interpretative rule issued by the BIR to guide
all revenue officials, employees, and others concerned in the enforcement of
income tax and VAT laws against clubs organized and operated exclusively for
pleasure, recreation, and other non-profit purposes ("recreational clubs" for
brevity).

As to its income tax component, RMC No. 35-2012 provides the interpretation that
since the old tax exemption previously accorded under Section 21 (h),42  Chapter
III, Title II of Presidential Decree No. 1158, otherwise known as the "National
Internal Revenue Code of 1977"43   (1977 Tax Code), to recreational clubs was
deleted in the 1997 NIRC, then the income of recreational clubs from whatever
source, including but not limited to membership fees, assessment dues, rental
income, and service fees, is subject to income tax.

The interpretation is partly correct.

Income Tax - cases

Indeed, applying the doctrine of casus omissus pro omisso habendus est (meaning,
a person, object or thing omitted from an enumeration must be held to have been
omitted intentionally44) , the fact that the 1997 NIRC omitted recreational clubs
from the list of exempt organizations under the 1977 Tax Code evinces the
deliberate intent of Congress to remove the tax income exemption previously
accorded to these clubs. As such, the income that recreational clubs derive "from
whatever source"45  is now subject to income tax under the provisions of the 1997
NIRC.

However, notwithstanding the correctness of the above-interpretation, RMC No.

35-2012 erroneously foisted a sweeping interpretation that membership fees
and assessment dues are sources of income of recreational clubs from which
income tax liability may accrue, viz.:
The provision in the [1977 Tax Code] which granted income tax exemption to such
recreational clubs was omitted in the current list of tax exempt corporations under
the [1997 NIRC], as amended. Hence, the income of recreational clubs from
whatever source, including but not limited to membership fees, assessment
dues, rental income, and service fees [is] subject to income tax.46 (Emphases and
underscoring supplied)
The distinction between "capital" and "income" is well-settled in our
jurisprudence. As held in the early case of Madrigal v. Rafferty,47  "capital" has
been delineated as a "fund" or "wealth," as opposed to "income" being "the flow of
services rendered by capital" or the "service of wealth":
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 income. Capital is wealth, while income is the service of wealth.
(See Fisher, "The Nature of Capital and Income.") The Supreme Court of
Georgi;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.,
Income Tax - cases

26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas.,
265. See further Foster's Income Tax, second edition [1915], Chapter IV; Black on
Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890],
136 U.S., 549; and Towne vs. Eisner, decided by the United States Supreme Court,
January 7, 1918.)48 (Emphases and underscoring supplied)
In Conwi v. Court of Tax Appeals,49  the Court elucidated that "income may be
defined as an amount of money coming to a person or corporation within a
specified time, whether as   payment for services, interest or profit from
investment. Unless otherwise specified, it means cash or its equivalent. Income
can also be thought of as a flow of the fruits of one's labor."50

As correctly argued by ANPC, membership fees, assessment dues, and other fees
of similar nature only constitute contributions to and/or replenishment of the
funds for the maintenance and operations of the facilities offered by
recreational clubs to their exclusive members.51  They represent funds "held in
trust" by these clubs to defray their operating and general costs and hence,
only constitute infusion of capital. 52

Case law provides that in order to constitute "income," there must be realized
"gain."53 Clearly, because of the nature of membership fees and assessment dues as
funds inherently dedicated for the maintenance, preservation, and upkeep of the
clubs' general operations and facilities, nothing is to be gained from their
collection. This stands in contrast to the fees received by recreational clubs coming
from their income-generating facilities, such as bars, restaurants, and food
concessionaires, or from income-generating activities, like the renting out of sports
equipment, services, and other accommodations: In these latter examples,
regardless of the purpose of the fees' eventual use, gain is already realized from the
moment they are collected because capital maintenance, preservation, or upkeep is
not their pre-determined purpose. As such, recreational clubs are generally free to
use these fees for whatever purpose they desire and thus, considered as
unencumbered "fruits" coming from a business transaction.

Further, given these recreational clubs' non-profit nature, membership fees and
assessment dues cannot be considered as funds that would represent these clubs'
interest or profit from any investment. In fact, these fees are paid by the clubs'
Income Tax - cases

members without any expectation of any yield or gain (unlike in stock

subscriptions), but only for the above-stated purposes and in order to retain their
membership therein.

In fine, for as long as these membership fees, assessment dues, and the like are
treated as collections by recreational clubs from their members as an inherent
consequence of their membership, and are, by nature, intended for the
maintenance, preservation, and upkeep of the clubs' general operations and
facilities, then these fees cannot be classified as "the income of recreational
clubs from whatever source" that are "subject to income tax."54 Instead, they
only form part of capital from which no income tax may be collected or
imposed.

It is a well-enshrined principle in our jurisdiction that the State cannot impose a tax
on capital as it constitutes an unconstitutional confiscation of property. As the
Court held in Chamber of Real Estate and Builders' Associations, Inc. v. Romulo:55
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. 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 [215 Phil. 582 (1984)], we held that the due process clause may
properly be invoked to invalidate, in appropriate cases, a revenue measure
when it amounts to a confiscation of property. 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. There must be a factual foundation to such an unconstitutional taint.
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.
Income Tax - cases

xxxx

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. x x x.56 (Emphases supplied)
In Misamis Oriental Association of Coco Traders, Inc. v. Department of Finance
Secretary,57 the Court held that "[a]s a matter of power[,] a court, when confronted
with an interpretative rule, [such as RMC No. 35-2012,] 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."58  Thus, by sweepingly including in RMC No. 35-2012 all membership fees
and assessment dues in its classification of "income of recreational clubs from
whatever source'' that are "subject to income tax,"59  the BIR exceeded its rule-
making authority. Case law holds that:
[T]he rule-making power of administrative agencies cannot be extended to amend
or expand statutory requirements or to embrace matters not originally encompassed
by the law. Administrative regulations should always be in accord with the
provisions of the statute they seek to carry into effect, and any resulting
inconsistency shall be resolved in favor of the basic law.60
Accordingly, the Court hereby declares the said interpretation to be invalid, and in
consequence, sets aside the ruling of the RTC.

In the same way, the Court declares as invalid the BIR's interpretation in RMC No.
35-2012 that membership fees, assessment dues, and the like are part of "the gross
receipts of recreational clubs" that are "subject to VAT."61

It is a basic principle that before a transaction is imposed VAT, a sale, barter or

exchange of goods or properties, or sale of a service is reguired.62  This is true
even if such sale is on a cost-reimbursement basis.63  Section 105, Chapter I, Title
IV of the 1997 NIRC reads:
Section 105.   Persons Liable.- Any person who, in the course of trade or
business, sells, barters, exchanges, leases goods or properties, renders services,
and any person who imports goods shall be   subject to the value-added tax
(VAT) imposed in Sections 106 to 108 of this Code.
Income Tax - cases

The value-added tax is an indirect tax and the amount of tax may be shifted or
passed on to the buyer, transferee or lessee of the goods, properties or services.
This rule shall likewise apply to existing contracts of   sale or lease of goods,
properties or services at the time of the effectivity of Republic Act No. 7716.

The phrase "in the course of trade or business" means the regular conduct or
pursuit of a commercial or an economic activity, including transactions incidental
thereto, by any person regardless of whether or not the person engaged therein is a
nonstock, nonprofit private organization (irrespective of the disposition of its net
income and whether or not it sells exclusively to members or their guests), or
government entity.

The rule of regularity, to the contrary notwithstanding, services as defined in this

Code rendered in the Philippines by nonresident foreign persons shall be
considered as being rendered in the course of trade or business. (Emphases
supplied)
As ANPC aptly pointed out, membership fees, assessment dues, and the like are
not subject to VAT because in collecting such fees, the club is not selling its service
to the members. Conversely, the members are not buying services from the club
when dues are paid; hence, there is no economic or commercial activity to speak of
as these dues are devoted for the operations/maintenance of the facilities of the
organization.64As such, there could be no "sale, barter or exchange of goods or
properties, or sale of a service" to speak of, which would then be subject to
VAT under the 1997 NIRC.

WHEREFORE, the petition is GRANTED. The Decision dated July 1, 2016 and
the Order dated November 7, 2016 of the Regional Trial Court of Makati City,
Branch 134, in Special Civil Case No. 14-985, are hereby   SET ASIDE. The
Court DECLARES that membership fees, assessment dues, and fees of similar
nature collected by clubs which are organized and operated exclusively for
pleasure, recreation, and other nonprofit purposes do not constitute as: (a) "the
income of recreational clubs from whatever source" that are "subject to income
tax"; and (b) part of the "gross receipts of recreational clubs" that are "subject to
[Value Added Tax]." Accordingly, Revenue Memorandum Circular No. 35-2012
should be interpreted in accordance with this Decision.
Income Tax - cases

SO ORDERED.

Commissioner of Internal Revenue v. Tours Specialists, Inc., G.R. No. L-66416,

March 21, 1990

This is a petition to review on certiorari the decision of the Court of Tax Appeals

which ruled that the money entrusted to private respondent Tours Specialists, Inc.,
earmarked and paid for hotel room charges of tourists, travelers and/or foreign
travel agencies does not form part of its gross receipts subject to the 3%
independent contractor's tax under the National Internal Revenue Code of 1977.

We adopt the findings of facts of the Court of Tax Appeals as follows:

For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived income
from its activities as a travel agency by servicing the needs of foreign tourists and
travelers and Filipino "Balikbayans" during their stay in this country. Some of the
services extended to the tourists consist of booking said tourists and travelers in
local hotels for their lodging and board needs; transporting these foreign tourists
from the airport to their respective hotels, and from the latter to the airport upon
their departure from the Philippines, transporting them from their hotels to various
embarkation points for local tours, visits and excursions; securing permits for them
to visit places of interest; and arranging their cultural entertainment, shopping and
recreational activities.

In order to ably supply these services to the foreign tourists, petitioner and its
correspondent counterpart tourist agencies abroad have agreed to offer a package
fee for the tourists. Although the fee to be paid by said tourists is quoted by the
petitioner, the payments of the hotel room accommodations, food and other
personal expenses of said tourists, as a rule, are paid directly either by tourists
themselves, or by their foreign travel agencies to the local hotels (pp. 77, t.s.n.,
February 2, 1981; Exhs. O & O-1, p. 29, CTA rec.; pp. 2425, t.s.n., ibid) and
restaurants or shops, as the case may be.

It is also the case that some tour agencies abroad request the local tour agencies,
such as the petitioner in the case, that the hotel room charges, in some specific
Income Tax - cases

cases, be paid through them. (Exh. Q, Q-1, p. 29 CTA rec., p. 25, T.s.n., ibid, pp.
5-6, 17-18, t.s.n., Aug. 20, 1981.; See also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981,
pp. 3-4, 11., t.s.n., Aug. 10, 1982). By this arrangement, the foreign tour agency
entrusts to the petitioner Tours Specialists, Inc., the fund for hotel room
accommodation, which in turn is paid by petitioner tour agency to the local hotel
when billed. The procedure observed is that the billing hotel sends the bill to the
petitioner. The local hotel identifies the individual tourist, or the particular groups
of tourists by code name or group designation and also the duration of their stay for
purposes of payment. Upon receipt of the bill, the petitioner then pays the local
hotel with the funds entrusted to it by the foreign tour correspondent agency.

Despite this arrangement, respondent Commissioner of Internal Revenue assessed

petitioner for deficiency 3% contractor's tax as independent contractor by including
the entrusted hotel room charges in its gross receipts from services for the years
1974 to 1976. Consequently, on December 6, 1979, petitioner received from
respondent the 3% deficiency independent contractor's tax assessment in the
amount of P122,946.93 for the years 1974 to 1976, inclusive, computed as follows:

1974 deficiency percentage tax

per investigation P 3,995.63

15% surcharge for late payment 998.91

—————

P 4,994.54

14% interest computed by quarters

up to 12-28-79 3,953.18 P 8,847.72

1975 deficiency percentage tax

per investigation P 8,427.39

25% surcharge for late payment 2,106.85

Income Tax - cases

—————

P 10,534.24

14% interest computed by quarters

up to 12-28-79 6,808.47 P 17,342.71

1976 deficiency percentage

per investigation P 54,276.42

25% surcharge for late payment 13,569.11

—————

P 67,845.53

14% interest computed by quarters

up to 12-28-79 28,910.97 P 96,756.50

————— —————

Total amount due P 122,946.93


=========

In addition to the deficiency contractor's tax of P122,946.93, petitioner was

assessed to pay a compromise penalty of P500.00.

Subsequently on December 11, 1979, petitioner formally protested the assessment

made by respondent on the ground that the money received and entrusted to it by
the tourists, earmarked to pay hotel room charges, were not considered and have
never been considered by it as part of its taxable gross receipts for purposes of
computing and paying its constractor's tax.

During one of the hearings in this case, a witness, Serafina Sazon, Certified Public
Accountant and in charge of the Accounting Department of petitioner, had testified,
her credibility not having been destroyed on cross examination, categorically stated
Income Tax - cases

that the amounts entrusted to it by the foreign tourist agencies intended for
payment of hotel room charges, were paid entirely to the hotel concerned, without
any portion thereof being diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25;
t.s.n.,   Aug.   20, 1981, pp. 5-9, 17-18). The testimony of Serafina Sazon was
corroborated by Gerardo Isada, General Manager of petitioner, declaring to the
effect that payments of hotel accommodation are made through petitioner without
any increase in the room charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the
reason why tourists pay their room charge, or through their foreign tourists
agencies, is the fact that the room charge is exempt from hotel room tax under P.D.
31. (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-examination, that if their
payment is made, thru petitioner's tour agency, the hotel cost or charges "is only an
act of accomodation on our (its) part" or that the "agent abroad instead of sending
several telexes and saving on bank charges they take the option to send money to
us to be held in trust to be endorsed to the hotel." (pp. 3-4, t.s.n. Aug. 10, 1982.)

Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written

protest, caused the issuance of a warrant of distraint and levy. (p. 51, BIR Rec.)
And later, respondent had petitioner's bank deposits garnished. (pp. 49-50, BIR
Rec.)

Taking this action of respondent as the adverse and final decision on the disputed
assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)

The petitioner raises the lone issue in this petition as follows:

WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL

AGENCY INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN
TOUR AGENCIES, INTENDED OR EARMARKED FOR HOTEL
ACCOMMODATIONS FORM PART OF GROSS RECEIPTS SUBJECT TO 3%
CONTRACTOR'S TAX. (Rollo, p. 23)

The petitioner premises the issue raised on the following assumptions:

Firstly, the ruling overlooks the fact that the amounts received, intended for hotel
room accommodations, were received as part of the package fee and, therefore,
form part of "gross receipts" as defined by law.
Income Tax - cases

Secondly,   there is no showing and is not established by the evidence. that the
amounts received and "earmarked" are actually what had been paid out as hotel
room charges. The mere possibility that the amounts actually paid could be less
than the amounts received is sufficient to destroy the validity of the ruling. (Rollo,
pp. 26-27)

In effect, the petitioner's lone issue is based on alleged error in the findings of facts
of the respondent court.

The well-settled doctrine is that the findings of facts of the Court of Tax Appeals
are binding on this Court and absent strong reasons for this Court to delve into
facts, only questions of law are open for determination. (Nilsen v. Commissioner of
Customs, 89 SCRA 43 [1979]; Balbas v. Domingo, 21 SCRA 444 [1967];
Raymundo v. De Joya, 101 SCRA 495 [1980]). In the recent case of Sy Po v. Court
of Appeals, (164 SCRA 524 [1988]), we ruled that the factual findings of the Court
of Tax Appeals are binding upon this court and can only be disturbed on appeal if
not supported by substantial evidence.

In the instant case, we find no reason to disregard and deviate from the findings of
facts of the Court of Tax Appeals.

As quoted earlier, the Court of Tax Appeals sufficiently explained the services of a
local travel agency, like the herein private respondent, rendered to foreign
customers. The respondent differentiated between the package fee — offered by
both the local travel agency and its correspondent counterpart tourist agencies
abroad and the requests made by some tour agencies abroad to local tour agencies
wherein the hotel room charges in some specific cases, would be paid to the local
hotels through them. In the latter case, the correspondent court found as a fact ". . .
that the foreign tour agency entrusts to the petitioner Tours Specialists, Inc. the
fund for hotel room accommodation, which in turn is paid by petitioner tour
agency to the local hotel when billed." (Rollo, p. 42) The following procedure is
followed: The billing hotel sends the bill to the respondent; the local hotel then
identifies the individual tourist, or the particular group of tourist by code name or
group designation plus the duration of their stay for purposes of payment; upon
receipt of the bill the private respondent pays the local hotel with the funds
entrusted to it by the foreign tour correspondent agency.
Income Tax - cases

Moreover, evidence presented by the private respondent shows that the amounts
entrusted to it by the foreign tourist agencies to pay the room charges of foreign
tourists in local hotels were not diverted to its funds; this arrangement was only an
act of accommodation on the part of the private respondent. This evidence was not
refuted.

In essence, the petitioner's assertion that the hotel room charges entrusted to the
private respondent were part of the package fee paid by foreign tourists to the
respondent is not correct. The evidence is clear to the effect that the amounts
entrusted to the private respondent were exclusively for payment of hotel room
charges of foreign tourists entrusted to it by foreign travel agencies.

As regards the petitioner's second assumption, the respondent court stated:

. . . [C]ontrary to the contention of respondent, the records show, firstly, in the

Examiners' Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December 1976
alone, the following sums made up the hotel room accommodations:

July 1976 P 102,702.97

Aug. 1976 121,167.19

Sept. 1976 53,209.61

—————

P 282,079.77

=========

Oct. 1976 P 71,134.80

Nov. 1976 409,019.17

Dec. 1976 142,761.55

—————

622,915.51
Income Tax - cases

—————

Grand Total P 904,995.29

=========

It is not true therefore, as stated by respondent, that there is no evidence proving

the amounts earmarked for hotel room charges. Since the BIR examiners could not
have manufactured the above figures representing "advances for hotel room
accommodations," these payments must have certainly been taken from the records
of petitioner, such as the invoices, hotel bills, official receipts and other pertinent
documents. (Rollo, pp. 48-49)

The factual findings of the respondent court are supported by substantial evidence,
hence binding upon this Court.

With these clarifications, the issue to be threshed out is as stated by the respondent
court, to wit:

. . . [W]hether or not the hotel room charges held in trust for foreign tourists and
travelers and/or correspondent foreign travel agencies and paid to local host hotels
form part of the taxable gross receipts for purposes of the 3% contractor's tax.
(Rollo, p. 45)

The petitioner opines that the gross receipts which are subject to the 3%
contractor's tax pursuant to Section 191 (Section 205 of the National Internal
Revenue Code of 1977) of the Tax Code include the entire gross receipts of a
taxpayer undiminished by any amount. According to the petitioner, this
interpretation is in consonance with B.I.R. Ruling No. 68-027, dated 23 October,
1968 (implementing Section 191 of the Tax Code) which states that the 3%
contractor's tax prescribed by Section 191 of the Tax Code is imposed of the gross
receipts of the contractor, "no deduction whatever being allowed by said law." The
petitioner contends that the only exception to this rule is when there is a law or
regulation which would exempt such gross receipts from being subjected to the 3%
contractor's tax citing the case of Commissioner of Internal Revenue v. Manila
Jockey Club, Inc. (108 Phil. 821 [1960]). Thus, the petitioner argues that since
there is no law or regulation that money entrusted, earmarked and paid for hotel
Income Tax - cases

room charges should not form part of the gross receipts, then the said hotel room
charges are included in the private respondent's gross receipts for purposes of the
3% contractor's tax.

In the case of   Commissioner of Internal Revenue v.   Manila Jockey Club, Inc.

(supra), the Commissioner appealed two decisions of the Court of Tax Appeals
disapproving his levy of amusement taxes upon the Manila Jockey Club, a duly
constituted corporation authorized to hold horse races in Manila. The facts of the
case show that the monies sought to be taxed never really belonged to the club. The
decision shows that during the period November 1946 to 1950, the Manila Jockey
Club paid amusement tax on its commission but without including the 5-1/2%
which pursuant to Executive Order 320 and Republic Act 309 went to the Board of
Races, the owner of horses and jockeys. Section 260 of the Internal Revenue Code
provides that the amusement tax was payable by the operator on its "gross
receipts". The Manila Jockey Club, however, did not consider as part of its "gross
receipts" subject to amusement tax the amounts which it had to deliver to the
Board on Races, the horse owners and the jockeys. This view was fully sustained
by three opinions of the Secretary of Justice, to wit:

There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the total
bets registered by the Totalizer. This portion represents its share or commission in
the total amount of money it handles and goes to the funds thereof as its own
property which it may legally disburse for its own purposes. The 5% does not
belong to the club. It is merely held in trust for distribution as prizes to the owners
of winning horses. It is destined for no other object than the payment of prizes and
the club cannot otherwise appropriate this portion without incurring liability to the
owners of winning horses. It cannot be considered as an item of expense because
the sum used for the payment of prizes is not taken from the funds of the club but
from a certain portion of the total bets especially earmarked for that purpose.

In view of all the foregoing, I am of the opinion that in the submission of the
returns for the amusement tax of 10% (now it is 20% of the "gross receipts",
provided for in Section 260 of the National Internal Revenue Code), the 5% of the
total bets that is set aside for prizes to owners of winning horses should not be
included by the Manila Jockey Club, Inc.
Income Tax - cases

The Collector of the Internal Revenue, however had a different opinion on the
matter and demanded payment of amusement taxes. The Court of Tax Appeals
reversed the Collector.

We affirmed the decision of the Court of Tax Appeals and stated:

The Secretary's opinion was correct. The Government could not have meant to tax
as gross receipt of the Manila Jockey Club the 1/2% which it directs same Club to
turn over to the Board on Races. The latter being a Government institution, there
would be double taxation, which should be avoided unless the statute admits of no
other interpretation. In the same manner, the Government could not have intended
to consider as gross receipt the portion of the funds which it directed the Club to
give, or knew the Club would give, to winning horses and jockeys — admittedly
5%. It is true that the law says that out of the total wager funds 12-1/2% shall be
set aside as the "commission" of the race track owner, but the law itself takes
official notice, and actually approves or directs payment of the portion that goes to
owners of horses as prizes and bonuses of jockeys, which portion is admittedly 5%
out of that 12-1/2% commission. As it did not at that time contemplate the
application of "gross receipts" revenue principle, the law in making a distribution
of the total wager funds, took no trouble of separating one item from the other; and
for convenience, grouped three items under one common denomination.

Needless to say, gross receipts of the proprietor of the amusement place should not
include any money which although delivered to the amusement place has been
especially earmarked by law or regulation for some person other than the
proprietor. (The situation thus differs from one in which the owner of the
amusement place, by a private contract, with its employees or partners, agrees to
reserve for them a portion of the proceeds of the establishment. (See Wong & Lee
v. Coll. 104 Phil. 469; 55 Off. Gaz. [51] 10539; Sy Chuico v. Coll., 107 Phil., 428;
59 Off. Gaz., [6] 896).

In the second case, the facts of the case are:

The Manila Jockey Club holds once a year a so called "special Novato race",
wherein only "novato" horses, (i.e. horses which are running for the first time in an
official [of the club] race), may take part. Owners of these horses must pay to the
Club an inscription fee of P1.00, and a declaration fee of P1.00 per horse. In
Income Tax - cases

addition, each of them must contribute to a common fund (P10.00 per horse). The
Club contributes an equal amount P10.00 per horse) to such common fund, the
total amount of which is added to the 5% participation of horse owners already
described herein-above in the first case.

Since the institution of this yearly special novato race in 1950, the Manila Jockey
Club never paid amusement tax on the moneys thus contributed by horse owners
(P10.00 each) because it entertained the belief that in accordance with the three
opinions of the Secretary of Justice herein-above described, such contributions
never formed part of its gross receipts. On the inscription fee of the P1.00 per
horse, it paid the tax. It did not on the declaration fee of P1.00 because it was
imposed by the Municipal Ordinance of Manila and was turned over to the City
officers.

The Collector of Internal Revenue required the Manila Jockey Club to pay
amusement tax on such contributed fund P10.00 per horse in the special novato
race, holding they were part of its gross receipts. The Manila Jockey Club
protested and resorted to the Court of Tax Appeals, where it obtained favorable
judgment on the same grounds sustained by said Court in connection with the 5%
of the total wager funds in the herein-mentioned first case; they were not receipts
of the Club.

We resolved the issue in the following manner:

We think the reasons for upholding the Tax Court's decision in the first case apply
to this one. The ten-peso contribution never belonged to the Club. It was held by it
as a trust fund. And then, after all, when it received the ten-peso contribution, it at
the same time contributed ten pesos out of its own pocket, and thereafter
distributed both amounts as prizes to horse owners. It would seem unreasonable to
regard the ten-peso contribution of the horse owners as taxable receipt of the Club,
since the latter, at the same moment it received the contribution necessarily lost ten
pesos too.

As demonstrated in the above-mentioned case, gross receipts subject to tax under

the Tax Code do not include monies or receipts entrusted to the taxpayer which do
not belong to them and do not redound to the taxpayer's benefit; and it is not
Income Tax - cases

necessary that there must be a law or regulation which would exempt such monies
and receipts within the meaning of gross receipts under the Tax Code.

Parenthetically, the room charges entrusted by the foreign travel agencies to the
private respondent do not form part of its gross receipts within the definition of the
Tax Code. The said receipts never belonged to the private respondent. The private
respondent never benefited from their payment to the local hotels. As stated earlier,
this arrangement was only to accommodate the foreign travel agencies.

Another objection raised by the petitioner is to the respondent court's application of

Presidential Decree 31 which exempts foreign tourists from payment of hotel room
tax. Section 1 thereof provides:

Sec. 1. — Foreign tourists and travelers shall be exempt from payment of any and
all hotel room tax for the entire period of their stay in the country.

The petitioner now alleges that P.D. 31 has no relevance to the case. He contends
that the tax under Section 191 of the Tax Code is in the nature of an excise tax; that
it is a tax on the exercise of the privilege to engage in business as a contractor and
that it is imposed on, and collectible from the person exercising the privilege. He
sums his arguments by stating that "while the burden may be shifted to the person
for whom the services are rendered by the contractor, the latter is not relieved from
payment of the tax." (Rollo, p. 28)

The same arguments were submitted by the Commissioner of Internal Revenue in

the case of Commissioner of Internal Revenue v. John Gotamco & Son., Inc. (148
SCRA 36 [1987]), to justify his imposition of the 3% contractor's tax under Section
191 of the National Internal Revenue Code on the gross receipts John Gotamco &
Sons, Inc., realized from the construction of the World Health Organization
(WHO) office building in Manila. We rejected the petitioner's arguments and ruled:

We agree with the Court of Tax Appeals in rejecting this contention of the
petitioner. Said the respondent court:

"In context, direct taxes are those that are demanded from the very person who, it
is intended or desired, should pay them; while indirect taxes are those that are
demanded in the first instance from one person in the expectation and intention that
Income Tax - cases

he can shift the burden to someone else. (Pollock v. Farmers, L & T Co., 1957 US
429, 15 S. Ct. 673, 39 Law. ed. 759). The contractor's tax is of course payable by
the contractor but in the last analysis it is the owner of the building that shoulders
the burden of the tax because the same is shifted by the contractor to the owner as a
matter of self-preservation. Thus, it is an indirect tax. And it is an indirect tax on
the WHO because, although it is payable by the petitioner, the latter can shift its
burden on the WHO. In the last analysis it is the WHO that will pay the tax
indirectly through the contractor and it certainly cannot be said that 'this tax has no
bearing upon the World Health Organization.'"

Petitioner claims that under the authority of the Philippine Acetylene Company
versus Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3%
contractor's tax falls directly on Gotamco and cannot be shifted to the WHO. The
Court of Tax Appeals, however, held that the said case is not controlling in this
case, since the Host Agreement specifically exempts the WHO from "indirect
taxes." We agree. The Philippine Acetylene case involved a tax on sales of goods
which under the law had to be paid by the manufacturer or producer; the fact that
the manufacturer or producer might have added the amount of the tax to the price
of the goods did not make the sales tax "a tax on the purchaser." The Court held
that the sales tax must be paid by the manufacturer or producer even if the sale is
made to tax-exempt entities like the National Power Corporation, an agency of the
Philippine Government, and to the Voice of America, an agency of the United
States Government.

The Host Agreement, in specifically exempting the WHO from "indirect taxes,"
contemplates taxes which, although not imposed upon or paid by the Organization
directly, form part of the price paid or to be paid by it.

Accordingly, the significance of P.D. 31 is clearly established in determining

whether or not hotel room charges of foreign tourists in local hotels are subject to
the 3% contractor's tax. As the respondent court aptly stated:

. . . If the hotel room charges entrusted to petitioner will be subjected to 3%

contractor's tax as what respondent would want to do in this case, that would in
effect do indirectly what P.D. 31 would not like hotel room charges of foreign
tourists to be subjected to hotel room tax. Although, respondent may claim that the
Income Tax - cases

3% contractor's tax is imposed upon a different incidence i.e. the gross receipts of

petitioner tourist agency which he asserts includes the hotel room charges entrusted
to it, the effect would be to impose a tax, and though different, it nonetheless
imposes a tax actually on room charges. One way or the other, it would not have
the effect of promoting tourism in the Philippines as that would increase the costs
or expenses by the addition of a hotel room tax in the overall expenses of said
tourists. (Rollo, pp. 51-52)

WHEREFORE, the instant petition is DENIED. The decision of the Court of Tax
Appeals is AFFIRMED. No pronouncement as to costs.

SO ORDERED.

Limpan Investment Corporation v. Commissioner of Internal Revenue, G.R. No.

L-21570, July 26, 1966

1. TAXATION; INCOME TAXES; EFFECT OF ADMISSION BY TAXPAYER

OF UNDECLARED INCOME; CASE AT BAR. — Petitioner, having admitted,
through its own witness, that it had not declared more than one-half of the amount
found by the BIR examiners as unreported rental income for the year 1956 and
more than one-third of the amount ascertained by the examiners as unreported
rental income for the year 1957, contrary to its original claim to the revenue
authorities, it was incumbent upon it to establish the remainder of its pretensions
by clear and convincing evidence.

2. ID.; ID.; CONSTRUCTIVE RECEIPT OF INCOME; CASE AT BAR. — The

withdrawal in 1958 of the deposits in court pertaining to the 1957 rental income is
not sufficient justification for the nondeclaration of said income in 1957, since the
deposit was resorted to due to the refusal of petitioner to accept the same, and was
not the fault of its tenants; hence, petitioner is deemed to have constructively
received such rentals in 1957. The payment by the subtenant in 1957 should have
been reported as rental income in said year, since it is income just the same
regardless of its source.

3. ID.; ID.; DEPRECIATION A QUESTION OF FACT. — This Court has already

held that "depreciation is a question of fact and is not measured by theoretical
Income Tax - cases

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 v. Priscila
Estate, Inc., Et Al., G.R. No. L-18282, May 29, 1964). The rates of depreciation on
Bulletin "F" of the Federal Internal Revenue Service has some persuasive effect
(Zamora v. Collector of Internal Revenue, L-15280, May 31, 1963).

DECISION

REYES, J.B.L., J.:

Appeal interposed by petitioner Limpan Investment Corporation against a decision

of the Court of Tax Appeals, in its CTA Case No. 699, holding and ordering it
(petitioner) to pay respondent Commissioner of Internal Revenue the sums of
P7,338.00 and P30,502.50, representing deficiency income taxes, plus 50%
surcharge for the years 1956, and 1957, respectively, plus 5% surcharge and 1%
monthly interest from June 30, 1959 to the date of payment, with costs.

The facts of this case are:chanrob1es virtual 1aw library

Petitioner, a domestic corporation duly registered since June 21, 1955, is engaged
in the business of leasing real properties. It commenced actual business operations
on July 1, 1955. Its principal stockholders are the spouses Isabelo P. Lim and
Purificacion Ceñiza de Lim, who own and control ninety-nine per cent (99%) of its
total paid-up capital. Its president and chairman of the board is the same Isabelo P.
Lim.

Its real properties consist of several lots and buildings, mostly situated in Manila
and in Pasay City, all of which were acquired from said Isabelo P. Lim and his
mother, Vicenta Pantangco Vda. de Lim.
Income Tax - cases

Petitioner corporation duly filed its 1956 and 1957 income tax returns, reporting
therein net incomes of P3,287.81 and P11,098.36 respectively, for which it paid the
corresponding taxes therefor in the sums of P657.00 and P2,220.00

Sometime in 1958 and 1959, the examiners of the Bureau of Internal Revenue
conducted an investigation of petitioner’s 1956 and 1957 income tax returns and,
in the course thereof, they discovered and ascertained that petitioner had
undeclared its rental incomes by P20,199.00 and P81,690.00 during these taxable
years and had claimed excessive depreciation of its buildings in the sums of P4,260
and P16,338.00 covering the same period. On the basis of these findings,
respondent Commissioner of Internal Revenue issued its letter- assessment and
demand for payment of deficiency income tax and surcharge against petitioner
corporation, computed as follows:chanrob1es virtual 1aw library

90-AR-C-348-58/56

Net income per audited return P3,287.81

Add: Unallowable deductions:chanrob1es virtual 1aw library

Undeclared Rental Receipt

(Schedule A) P20,199.00

Excess Depreciation (Sched. B) 4,260.00 P24,459.00

Net income per investigation 27,746.00

Tax due thereon 5,549.00

Less: Amount already assessed 657.00

Balance 4,892.00

Add: 50% Surcharge 2,446.00

Income Tax - cases

DEFICIENCY TAX DUE 7,338.00

90-AR-C-1196-58/57

Net income per audited return P11,098.00

Add: Unallowable deductions:chanrob1es virtual 1aw library

Undeclared Rental Receipt (Schedule A) P81,690.00

Excess Depreciation (Sched. B) 16,338.00 P98,028.00

Net income per investigation 109,126.00

Tax due thereon 22,555.00

Less: Amount already assessed 2,220.00

Balance 20,335.00

Add: 50% Surcharge 10,167.50

DEFICIENCY TAX DUE P30,502.50

Petitioner corporation requested respondent Commissioner of Internal Revenue to

reconsider the above assessment but the latter denied said request and reiterated its
original assessment and demand, plus 5% surcharge and the 1% monthly interest
from June 30, 1959 to the date of payment; hence, the corporation filed its petition
for review before the Tax Appeals Court, questioning the correctness and validity
of the above assessment of respondent Commissioner of Internal Revenue. It
disclaimed having received or collected the amount of P20,199.00, as unreported
rental income for 1956, or any part thereof, reasoning out that "the previous owners
of the leased buildings has (have) to collect part of the total rentals in 1956 to
apply to their payment of rental in the land in the amount of P21,630.00" (par. 11,
petition). It also denied having received or collected the amount of P81,690.00, as
unreported rental income for 1957, or any part thereof, explaining that part of said
Income Tax - cases

amount totalling P31,380.00 was not declared as income in its 1957 tax return
because its president, Isabelo P. Lim, who collected and received P13,500.00 from
certain tenants, did not turn the same over to petitioner corporation in said year but
did so only in 1959; that a certain tenant (Go Tong) deposited in court his rentals
amounting to P10,800.00, over which the corporation had no actual or constructive
control; and that a sub-tenant paid P4,200.00 which ought not be declared as rental
income.

Petitioner likewise alleged in its petition that the rates of depreciation applied by
respondent Commissioner to its buildings in the above assessment are unfair and
inaccurate.

Sole witness for petitioner corporation in the Tax Court was its Secretary-
Treasurer, Vicente G. Solis, who admitted that it had omitted to report the sum of
P12,100.00 as rental income in its 1956 tax return and also the sum of P29,350.00
as rental income in its 1957 tax return. However, with respect to the difference
between this omitted income (P12,100.00) and the sum (P20,199.00) found by
respondent Commissioner as undeclared in 1956, petitioner corporation through
the same witness (Solis), tried to establish that it did not collect or receive the same
because, in view of the refusal of some tenant to recognize the new owner, Isabelo
P. Lim and Vicenta Pantangco Vda. de Lim, the former owners, on one hand, and
the same Isabelo P. Lim, as president of petitioner corporation, on the other hand,
had verbally agreed in 1956 to turn over to petitioner corporation six per cent (6%)
of the value of all its properties, computed at P21,630.00, in exchange for whatever
rentals the Lims may collect from the tenants. And, with respect to the difference
between the admittedly undeclared sum of P29,350.00 and that found by
respondent Commissioner as unreported rental income (P81,690.00) in 1957, the
same witness Solis also tried to establish that petitioner corporation did not receive
or collect the same but that its president, Isabelo P. Lim, collected part thereof and
may have reported the same in his own personal income tax return; that same
Isabelo P. Lim collected P13,500.00, which he turned over to petitioner in 1959
only; that a certain tenant (Go Tong) deposited in court his rentals (P10,800.00),
over which the corporation had no actual or constructive control and which were
withdrawn only in 1958; and that a sub-tenant paid P4,200.00 which ought not be
declared as rental income in 1957.
Income Tax - cases

With regard to the depreciation which respondent disallowed and deducted from
the returns filed by petitioner, the same witness tried to establish that some of its
buildings are old and out of style; hence, they are entitled to higher rates of
depreciation than those adopted by respondent in his assessment.

Isabelo P. Lim was not presented as witness to corroborate the above testimony of
Vicente G. Solis.

On the other hand, Plaridel M. Mingoa, one of the BIR examiners who personally
conducted the investigation of the 1956, and 1957 income tax returns of petitioner
corporation, testified for the respondent that he personally interviewed the tenants
of petitioner and found that these tenants had been regularly paying their rentals to
the collectors of either petitioner or its president, Isabelo P. Lim, but these
payments were not declared in the corresponding returns; and that in applying rates
of depreciation to petitioner’s buildings, he adopted Bulletin "F", of the U.S.
Federal Internal Revenue Service.

On the basis of the evidence, the Tax Court upheld respondent Commissioner’s
assessment and demand for deficiency income tax which, as above stated in the
beginning of this opinion, petitioner has appealed to this Court.

Petitioner corporation pursues the same theory advocated in the court below and
assigns the following alleged errors of the trial court in its brief, to
wit:jgc:chanrobles.com.ph

"I. The respondent Court erred in holding that the petitioner had an unreported
rental income of P20,199.00 for the year 1956.

"II. The respondent Court erred in holding that the petitioner had an unreported
rental income of P81,690.00 for the year 1957.

"III. The respondent Court erred in holding that the depreciation in the amount of
P20,598.00 claimed by petitioner for the years 1956 and 1957 as excessive."cralaw
virtua1aw library

and prays that the appealed decision be reversed.

Income Tax - cases

This appeal is manifestly unmeritorious. Petitioner having admitted, through its

own witness (Vicente G. Solis), that it had undeclared more than one-half (1/2) of
the amount (P12,100.00 out of P20,199.00) found by the BIR examiners as
unreported rental income for the year 1956 and more than one-third (1/3) of the
amount (P29,350.00 out of P81,690.00) ascertained by the same examiners as
unreported rental income for the year 1957, contrary to its original claim to the
revenue authorities, it was incumbent upon it to establish the remainder of its
pretensions by clear and convincing evidence, that in the case is lacking.

With respect to the balance, which petitioner denied having unreported in the
disputed tax return, the excuse that Isabelo P. Lim and Vicenta Pantangco Vda. de
Lim retained ownership of the lands and only later transferred or disposed of the
ownership of the buildings existing thereon to petitioner corporation, so as to
justify the alleged verbal agreement whereby they would turn over to petitioner
corporation six percent (6%) of the value of its properties to be applied to the
rentals of the land and in exchange for whatever rentals they may collect from the
tenants who refused to recognize the new owner or vendee of the buildings, is not
only unusual but uncorroborated by the alleged transferors, or by any document or
unbiased evidence. Hence, the first assigned error is without merit.

As to the second assigned error, petitioner’s denial and explanation of the non-
receipt of the remaining unreported income for 1957 is not substantiated by
satisfactory corroboration. As above noted, Isabelo P. Lim was not presented as a
witness to confirm accountant Solis nor was his 1957 personal income tax return
submitted in court to establish that the rental income which he allegedly collected
and received in 1957 were reported therein.

The withdrawal in 1958 of the deposits in court pertaining to the 1957 rental
income is no sufficient justification for the non-declaration of said income in 1957,
since the deposit was resorted to due to the refusal of petitioner to accept the same,
and was not the fault of its tenants; hence, petitioner is deemed to have
constructively received such rentals in 1957. The payment by the sub-tenant in
1957 should have been reported as rental income in said year, since it is income
just the same regardless of its source.
Income Tax - cases

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 v. Priscila Estate, Inc.
Et. Al., L-18282, May 29, 1964) and petitioner has not shown any arbitrariness or
abuse of discretion on 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 v. Collector of Internal Revenue & Collector of Internal
Revenue v. M. Zamora; E. Zamora v. Collector of Internal Revenue & Collector of
Internal Revenue v. E. Zamora, Nos. L-15280, L-15290, L-15289 & L-15281, May
31, 1963), the foregoing error is devoid of merit.

WHEREFORE, the appealed decision should be, as it is hereby, affirmed. With

costs against petitioner-appellant, Limpan Investment Corporation.

Commissioner of Internal Revenue v. Isabela Cultural Corporation, G.R. No.

172231, February 12, 2007

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005
Decision1   of the Court of Appeals in CA-G.R. SP No. 78426 affirming the
February 26, 2003 Decision2 of the Court of Tax Appeals (CTA) in CTA Case No.
5211, which cancelled and set aside the Assessment Notices for deficiency income
tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR)
against respondent Isabela Cultural Corporation (ICC).

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

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

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

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

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm
Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984
and 1985.5

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

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

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and

surcharge) was allegedly due to the failure of ICC to withhold 1% expanded
withholding tax on its claimed P244,890.00 deduction for security services.7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On

February 9, 1995, however, it received a final notice before seizure demanding
payment of the amounts stated in the said notices. Hence, it brought the case to the
CTA which held that the petition is premature because the final notice of
assessment cannot be considered as a final decision appealable to the tax court.
This was reversed by the Court of Appeals holding that a demand letter of the BIR
reiterating the payment of deficiency tax, amounts to a final decision on the
protested assessment and may therefore be questioned before the CTA. This
conclusion was sustained by this Court on July 1, 2001, in G.R. No. 135210.8 The
case was thus remanded to the CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the
assessment notices issued against ICC. It held that the claimed deductions for
professional and security services were properly claimed by ICC in 1986 because it
was only in the said year when the bills demanding payment were sent to ICC.
Income Tax - cases

Hence, even if some of these professional services were rendered to ICC in 1984 or
1985, it could not declare the same as deduction for the said years as the amount
thereof could not be determined at that time.

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

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

WHEREFORE, in view of all the foregoing, Assessment Notice No.

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

SO ORDERED.9

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

Hence, petitioner, through the Office of the Solicitor General, filed the instant
petition contending that since ICC is using the accrual method of accounting, the
expenses for the professional services that accrued in 1984 and 1985, should have
Income Tax - cases

been declared as deductions from income during the said years and the failure of
ICC to do so bars it from claiming said expenses as deduction for the taxable year
1986. As to the alleged deficiency interest income and failure to withhold expanded
withholding tax assessment, petitioner invoked the presumption that the
assessment notices issued by the BIR are valid.

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

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

The requisite that it must have been paid or incurred during the taxable year is
further qualified by Section 45 of the National Internal Revenue Code (NIRC)
which states that: "[t]he deduction provided for in this Title shall be taken for the
taxable year in which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the
method of accounting upon the basis of which the net income is computed x x x".

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

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

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

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

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

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

Corollarily, it is a governing principle in taxation that tax exemptions must be

construed in strictissimi juris against the taxpayer and liberally in favor of the
taxing authority; and one who claims an exemption must be able to justify the
same by the clearest grant of organic or statute law. An exemption from the
Income Tax - cases

common burden cannot be permitted to exist upon vague implications. And since a
deduction for income tax purposes partakes of the nature of a tax exemption, then
it must also be strictly construed.18

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

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

In the same vein, the professional fees of SGV & Co. for auditing the financial
statements of ICC for the year 1985 cannot be validly claimed as expense
deductions in 1986. This is so because ICC failed to present evidence showing that
Income Tax - cases

even with only "reasonable accuracy," as the standard to ascertain its liability to
SGV & Co. in the year 1985, it cannot determine the professional fees which said
company would charge for its services.

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

As to the expenses for security services, the records show that these expenses were
incurred by ICC in 198620  and could therefore be properly claimed as deductions
for the said year.

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

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

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of

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

WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005

Decision of the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with
Income Tax - cases

the MODIFICATION that Assessment Notice No. FAS-1-86-90-000680, which

disallowed the expense deduction of Isabela Cultural Corporation for professional
and security services, is declared valid only insofar as the expenses for the
professional fees of SGV & Co. and of the law firm, Bengzon Zarraga Narciso
Cudala Pecson Azcuna & Bengson, are concerned. The decision is affirmed in all
other respects.

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

SO ORDERED.

National Development Corporation v. Commissioner of Internal Revenue, G.R.

No. L53961, June 30, 1987

We are asked to reverse the decision of the Court of Tax Appeals on the ground
that it is erroneous, We have carefully studied it and find it is not; on the contrary, it
is supported by law and doctrine. So finding, we affirm.

Reduced to simplest terms, the background facts are as follows.

The National Development Company entered into contracts in Tokyo with several
Japanese shipbuilding companies for the construction of twelve ocean-going
vessels. 1 The purchase price was to come from the proceeds of bonds issued by
the Central Bank. 2 Initial payments were made in cash and through irrevocable
letters of credit. 3 Fourteen promissory notes were signed for the balance by the
NDC and, as required by the shipbuilders, guaranteed by the Republic of the
Philippines. 4 Pursuant thereto, the remaining payments and the interests thereon
were remitted in due time by the NDC to Tokyo. The vessels were eventually
completed and delivered to the NDC in Tokyo. 5

The NDC remitted to the shipbuilders in Tokyo the total amount of

US$4,066,580.70 as interest on the balance of the purchase price. No tax was
withheld. The Commissioner then held the NDC liable on such tax in the total sum
of P5,115,234.74. Negotiations followed but failed. The BIR thereupon served on
Income Tax - cases

the NDC a warrant of distraint and levy to enforce collection of the claimed
amount. 6 The NDC went to the Court of Tax Appeals.

The BIR was sustained by the CTA except for a slight reduction of the tax
deficiency in the sum of P900.00, representing the compromise penalty. 7 The
NDC then came to this Court in a petition for certiorari.

The petition must fail for the following reasons.

The Japanese shipbuilders were liable to tax on the interest remitted to them under
Section 37 of the Tax Code, thus:jgc:chanrobles.com.ph

"SEC. 37. Income from sources within the Philippines. — (a) Gross income from
sources within the Philippines. — The following items of gross income shall be
treated as gross income from sources within the Philippines:chanrob1es virtual
1aw library

(1) Interest. — Interest derived from sources within the Philippines, and interest on
bonds, notes, or other interest-bearing obligations of residents, corporate or
otherwise;

x       x       x

The petitioner argues that the Japanese shipbuilders were not subject to tax under
the above provision because all the related activities — the signing of the contract,
the construction of the vessels, the payment of the stipulated price, and their
delivery to the NDC — were done in Tokyo. 8 The law, however, does not speak of
activity but of "source," which in this case is the NDC. This is a domestic and
resident corporation with principal offices in Manila.

As the Tax Court put

"It is quite apparent, under the terms of the law, that the Government’s right to levy
and collect income tax on interest received by foreign corporations not engaged in
trade or business within the Philippines is not planted upon the condition that ‘the
Income Tax - cases

activity or labor — and the sale from which the (interest) income flowed had its
situs’ in the Philippines. The law specifies: `Interest derived from sources within
the Philippines, and interest on bonds, notes, or other interest-bearing obligations
of residents, corporate or otherwise.’ Nothing there speaks of the `act or activity’ of
non-resident corporations in the Philippines, or place where the contract is signed.
The residence of the obligor who pays the interest rather than the physical location
of the securities, bonds or notes or the place of payment, is the determining factor
of the source of interest income. (Mertens, Law of Federal Income Taxation, Vol. 8,
p. 128, citing A.C. Monk 8: Co. Inc. 10 T.C. 77; Sumitomo Bank, Ltd., 19 BTA
480; Estate of L.E. Mckinnon, 6 BTA 412; Standard Marine Ins. Co., Ltd., 4 BTA
853; Marine Ins. Co., Ltd., 4 BTA 867. Accordingly, if the obligor is a resident of
the Philippines the interest payment paid by him can have no other source than
within the Philippines. The interest is paid not by the bond, note or other interest-
bearing obligations, but by the obligor. (See Mertens, Id., Vol. 8, p. 124.)

"Here in the case at bar, petitioner National Development Company, a corporation

duly organized and existing under the laws of the Republic of the Philippines, with
address and principal office at Calle Pureza, Sta. Mesa, Manila, Philippines
unconditionally promised to pay the Japanese shipbuilders, as obligor in fourteen
(14) promissory notes for each vessel, the balance of the contract price of the
twelve (12) ocean-going vessels purchased and acquired by it from the Japanese
corporations, including the interest on the principal sum at the rate of five per cent
(5%) per annum. (See Exhs. "D", D-1" to "D-13", pp. 100-113, CTA Records; par.
11, Partial Stipulation of Facts.) And pursuant to the terms and conditions of these
promissory notes, which are duly signed by its Vice Chairman and General
Manager, petitioner remitted to the Japanese shipbuilders in Japan during the years
1960, 1961, and 1962 the sum of $830,613.17, $1,654,936.52 and $1,541.031.00,
respectively, as interest on the unpaid balance of the purchase price of the aforesaid
vessels. (pars. 13, 14, & 15, Partial Stipulation of Facts.).

"The law is clear. Our plain duty is to apply it as written. The residence of the
obligor which paid the interest under consideration, petitioner herein, is Calle
Pureza, Sta. Mesa, Manila, Philippines; and as a corporation duly organized and
existing under the laws of the Philippines, it is a domestic corporation, resident of
the Philippines. (Sec. 84(c), National Internal Revenue Code.) The interest paid by
petitioner, which is admittedly a resident of the Philippines, is on the promissory
Income Tax - cases

notes issued by it. Clearly, therefore, the interest remitted to the Japanese
shipbuilders in Japan in 1960, 1961 and 1962 on the unpaid balance of the
purchase price of the vessels acquired by petitioner is interest derived from sources
within the Philippines subject to income tax under the then Section 24(b)(1) of the
National Internal Revenue Code." 9

There is no basis for saying that the interest payments were obligations of the
Republic of the Philippines and that the promissory notes of the NDC were
government securities exempt from taxation under Section 29(b)[4] of the Tax
Code, reading as follows:jgc:chanrobles.com.ph

"SEC. 29. Gross Income. — . . .

(b) Exclusions from gross income. — The following items shall not be included in
gross income and shall be exempt from taxation under this Title:chanrob1es virtual
1aw library

x       x       x

(4) Interest on Government Securities. — Interest upon the obligations of the

Government of the Republic of the Philippines or any political subdivision thereof,
but in the case of such obligations issued after approval of this Code, only to the
extent provided in the act authorizing the issue thereof. (As amended by Section 6,
R.A. No. 82; Emphasis supplied).

The law invoked by the petitioner as authorizing the issuance of securities is R.A.
No. 1407, which in fact is silent on this matter. C.A. No. 182 as amended by C.A.
No. 311 does carry such authorization but, like R.A. No. 1407, does not exempt
from taxes the interests on such securities.chanrobles law library : red

It is also incorrect to suggest that the Republic of the Philippines could not collect
taxes on the interest remitted because of the undertaking signed by the Secretary of
Finance in each of the promissory notes that:jgc:chanrobles.com.ph
Income Tax - cases

"Upon authority of the President of the Republic of the Philippines, the

undersigned, for value received, hereby absolutely and unconditionally guarantee
(sic), on behalf of the Republic of the Philippines, the due and punctual payment of
both principal and interest of the above note." 10

There is nothing in the above undertaking exempting the interests from taxes.
Petitioner has not established a clear waiver therein of the right to tax interests. Tax
exemptions cannot be merely implied but must be categorically and unmistakably
expressed. 11 Any doubt concerning this question must be resolved in favor of the
taxing power. 12

Nowhere in the said undertaking do we find any inhibition against the collection of
the disputed taxes. In fact, such undertaking was made by the government in
consonance with and certainly not against the following provisions of the Tax
Code:jgc:chanrobles.com.ph

"Sec. 53(b). Nonresident aliens. — All persons, corporations and general co-
partnerships (companies colectivas), in whatever capacity acting, including lessees
or mortgagors of real or personal capacity, executors, administrators, receivers,
conservators, fiduciaries, employers, and all officers and employees of the
Government of the Philippines having control, receipt, custody; disposal or
payment of interest, dividends, rents, salaries, wages, premiums, annuities,
compensations, remunerations, emoluments, or other fixed or determinable annual
or categorical gains, profits and income of any nonresident alien individual, not
engaged in trade or business within the Philippines and not having any office or
place of business therein, shall (except in the cases provided for in subsection (a)
of this section deduct and withhold from such annual or periodical gains, profits
and income a tax equal to twenty (now 30%) per centum thereof: . . . ."cralaw
virtua1aw library

"Sec. 54. Payment of corporation income tax at source. — In the case of foreign
corporations subject to taxation under this Title not engaged in trade or business
within the Philippines and not having any office or place of business therein, there
shall be deducted and withheld at the source in the same manner and upon the
same items as is provided in section fifty-three a tax equal to thirty (now 35%) per
centum thereof, and such tax shall be returned and paid in the same manner and
Income Tax - cases

subject to the same conditions as provided in that section: . . . ."cralaw virtua1aw

library

Manifestly, the said undertaking of the Republic of the Philippines merely

guaranteed the obligations of the NDC but without diminution of its taxing power
under existing laws.

In suggesting that the NDC is merely an administrator of the funds of the Republic
of the Philippines, the petitioner closes its eyes to the nature of this entity as a
corporation. As such, it is governed in its proprietary activities not only by its
charter but also by the Corporation Code and other pertinent laws.

The petitioner also forgets that it is not the NDC that is being taxed. The tax was
due on the interests earned by the Japanese shipbuilders. It was the income of these
companies and not the Republic of the Philippines that was subject to the tax the
NDC did not withhold.

In effect, therefore, the imposition of the deficiency taxes on the NDC is a penalty
for its failure to withhold the same from the Japanese shipbuilders. Such liability is
imposed by Section 53(c) of the Tax Code, thus:jgc:chanrobles.com.ph

"Section 53(c). Return and Payment. — Every person required to deduct and
withhold any tax under this section shall make return thereof, in duplicate, on or
before the fifteenth day of April of each year, and, on of before the time fixed by
law for the payment of the tax, shall pay the amount withheld to the officer of the
Government of the Philippines authorized to receive it. Every such person is made
personally liable for such tax, and is indemnified against the claims and demands
of any person for the amount of any payments made in accordance with the
provisions of this section. (As amended by Section 9, R.A. No. 2343.)"

In Philippine Guaranty Co. v. The Commissioner of Internal Revenue and the

Court of Tax Appeals, 13 the Court quoted with approval the following regulation
of the BIR on the responsibilities of withholding agents:jgc:chanrobles.com.ph

"In case of doubt, a withholding agent may always protect himself by withholding
the tax due, and promptly causing a query to be addressed to the Commissioner of
Income Tax - cases

Internal Revenue for the determination whether or not the income paid to an
individual is not subject to withholding. In case the Commissioner of Internal
Revenue decides that the income paid to an individual is not subject to
withholding, the withholding agent may thereupon remmit the amount of tax
withheld." (2nd par., Sec. 200, Income Tax Regulations).

"Strict observance of said steps is required of a withholding agent before he could

be released from liability," so said Justice Jose P. Bengson, who wrote the decision.
"Generally, the law frowns upon exemption from taxation; hence, an exempting
provision should be construed strictissimi juris." 14

The petitioner was remiss in the discharge of its obligation as the withholding
agent of the government and so should be held liable for its omission.

WHEREFORE, the appealed decision is AFFIRMED, without any pronouncement

as to costs. It is so ordered.

Commissioner of Internal Revenue vs. Juliane Baier-Nickel, As represented by

Marina Q. Guzman (Attorney-in-fact), G.R. No. 153793, August 29, 2006

Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18,
2002 Decision1 of the Court of Appeals in CA-G.R. SP No. 59794, which granted
the tax refund of respondent Juliane Baier-Nickel and reversed the June 28, 2000
Decision2  of the Court of Tax Appeals (CTA) in C.T.A. Case No. 5633. Petitioner
also assails the May 8, 2002 Resolution3   of the Court of Appeals denying its
motion for reconsideration.

The facts show that respondent Juliane Baier-Nickel, a non-resident German

citizen, is the President of JUBANITEX, Inc., a domestic corporation engaged in
"[m]anufacturing, marketing on wholesale only, buying or otherwise acquiring,
holding, importing and exporting, selling and disposing embroidered textile
products."4   Through JUBANITEX’s General Manager, Marina Q. Guzman, the
corporation appointed and engaged the services of respondent as commission
agent. It was agreed that respondent will receive 10% sales commission on all sales
actually concluded and collected through her efforts.5
Income Tax - cases

In 1995, respondent received the amount of P1,707,772.64, representing her sales

commission income from which JUBANITEX withheld the corresponding 10%
withholding tax amounting to P170,777.26, and remitted the same to the Bureau of
Internal Revenue (BIR). On October 17, 1997, respondent filed her 1995 income
tax return reporting a taxable income of P1,707,772.64 and a tax due of
P170,777.26.6

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26
alleged to have been mistakenly withheld and remitted by JUBANITEX to the
BIR. Respondent contended that her sales commission income is not taxable in the
Philippines because the same was a compensation for her services rendered in
Germany and therefore considered as income from sources outside the Philippines.

The next day, April 15, 1998, she filed a petition for review with the CTA
contending that no action was taken by the BIR on her claim for refund.7 On June
28, 2000, the CTA rendered a decision denying her claim. It held that the
commissions received by respondent were actually her remuneration in the
performance of her duties as President of JUBANITEX and not as a mere sales
agent thereof. The income derived by respondent is therefore an income taxable in
the Philippines because JUBANITEX is a domestic corporation.

On petition with the Court of Appeals, the latter reversed the Decision of the CTA,
holding that respondent received the commissions as sales agent of JUBANITEX
and not as President thereof. And since the "source" of income means the activity
or service that produce the income, the sales commission received by respondent is
not taxable in the Philippines because it arose from the marketing activities
performed by respondent in Germany. The dispositive portion of the appellate
court’s Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of Tax

Appeals dated June 28, 2000 is hereby REVERSED and SET ASIDE and the
respondent court is hereby directed to grant petitioner a tax refund in the amount of
Php 170,777.26.

SO ORDERED.8
Income Tax - cases

Petitioner filed a motion for reconsideration but was denied.9  Hence, the instant
recourse.

Petitioner maintains that the income earned by respondent is taxable in the

Philippines because the source thereof is JUBANITEX, a domestic corporation
located in the City of Makati. It thus implied that source of income means the
physical source where the income came from. It further argued that since
respondent is the President of JUBANITEX, any remuneration she received from
said corporation should be construed as payment of her overall managerial services
to the company and should not be interpreted as a compensation for a distinct and
separate service as a sales commission agent.

Respondent, on the other hand, claims that the income she received was payment
for her marketing services. She contended that income of nonresident aliens like
her is subject to tax only if the source of the income is within the Philippines.
Source, according to respondent is the situs of the activity which produced the
income. And since the source of her income were her marketing activities in
Germany, the income she derived from said activities is not subject to Philippine
income taxation.

The issue here is whether respondent’s sales commission income is taxable in the
Philippines.

Pertinent portion of the National Internal Revenue Code (NIRC), states:

SEC. 25. Tax on Nonresident Alien Individual. –

(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. –

(1) In General. – A nonresident alien individual engaged in trade or business in the

Philippines shall be subject to an income tax in the same manner as an individual
citizen and a resident alien individual, on taxable income received from all sources
within the Philippines. A nonresident alien individual who shall come to the
Philippines and stay therein for an aggregate period of more than one hundred
eighty (180) days during any calendar year shall be deemed a ‘nonresident alien
doing business in the Philippines,’ Section 22(G) of this Code notwithstanding.
Income Tax - cases

xxxx

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the
Philippines. – There shall be levied, collected and paid for each taxable year upon
the entire income received from all sources within the Philippines by every
nonresident alien individual not engaged in trade or business within the Philippines
x x x a tax equal to twenty-five percent (25%) of such income. x x x

Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or

not engaged in trade or business, are subject to Philippine income taxation on their
income received from all sources within the Philippines. Thus, the keyword in
determining the taxability of non-resident aliens is the income’s "source." In
construing the meaning of "source" in Section 25 of the NIRC, resort must be had
on the origin of the provision.

The first Philippine income tax law enacted by the Philippine Legislature was Act
No. 2833,10   which took effect on January 1, 1920.11   Under Section 1 thereof,
nonresident aliens are likewise subject to tax on income "from all sources within
the Philippine Islands," thus –

SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon
the entire net income received in the preceding calendar year from all sources by
every individual, a citizen or resident of the Philippine Islands, a tax of two per
centum upon such income; and a like tax shall be levied, assessed, collected, and
paid annually upon the entire net income received in the preceding calendar year
from all sources within the Philippine Islands by every individual, a nonresident
alien, including interest on bonds, notes, or other interest-bearing obligations of
residents, corporate or otherwise.

Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of
1916 as amended by U.S. Revenue Law of 1917.12 Being a law of American origin,
the authoritative decisions of the official charged with enforcing it in the U.S. have
peculiar persuasive force in the Philippines.13

The Internal Revenue Code of the U.S. enumerates specific types of income to be
treated as from sources within the U.S. and specifies when similar types of income
are to be treated as from sources outside the U.S.14   Under the said Code,
Income Tax - cases

compensation for labor and personal services performed in the U.S., is generally
treated as income from U.S. sources; while compensation for said services
performed outside the U.S., is treated as income from sources outside the U.S.15 A
similar provision is found in Section 42 of our NIRC, thus:

SEC. 42. x x x

(A) Gross Income From Sources Within the Philippines. x x x

xxxx

(3) Services. – Compensation for labor or personal services performed in the

Philippines;

xxxx

(C) Gross Income From Sources Without the Philippines. x x x

xxxx

(3) Compensation for labor or personal services performed without the Philippines;

The following discussions on sourcing of income under the Internal Revenue Code
of the U.S., are instructive:

The Supreme Court has said, in a definition much quoted but often debated, that
income may be derived from three possible sources only: (1) capital and/or (2)
labor; and/or (3) the sale of capital assets. While the three elements of this attempt
at definition need not be accepted as all-inclusive, they serve as useful guides in
any inquiry into whether a particular item is from "sources within the United
States" and suggest an investigation into the nature and location of the activities or
property which produce the income.

If the income is from labor the place where the labor is done should be decisive; if
it is done in this country, the income should be from "sources within the United
States." If the income is from capital, the place where the capital is employed
should be decisive; if it is employed in this country, the income should be from
Income Tax - cases

"sources within the United States." If the income is from the sale of capital assets,
the place where the sale is made should be likewise decisive.

Much confusion will be avoided by regarding the term "source" in this

fundamental light. It is not a place, it is an activity or property. As such, it has a
situs or location, and if that situs or location is within the United States the
resulting income is taxable to nonresident aliens and foreign corporations.

The intention of Congress in the 1916 and subsequent statutes was to discard the
1909 and 1913 basis of taxing nonresident aliens and foreign corporations and to
make the test of taxability the "source," or situs of the activities or property which
produce the income. The result is that, on the one hand, nonresident aliens and
nonresident foreign corporations are prevented from deriving income from the
United States free from tax, and, on the other hand, there is no undue imposition of
a tax when the activities do not take place in, and the property producing income is
not employed in, this country. Thus, if income is to be taxed, the recipient thereof
must be resident within the jurisdiction, or the property or activities out of which
the income issues or is derived must be situated within the jurisdiction so that the
source of the income may be said to have a situs in this country.

The underlying theory is that the consideration for taxation is protection of life and
property and that the income rightly to be levied upon to defray the burdens of the
United States Government is that income which is created by activities and
property protected by this Government or obtained by persons enjoying that
protection. 16

The important factor therefore which determines the source of income of personal
services is not the residence of the payor, or the place where the contract for
service is entered into, or the place of payment, but the place where the services
were actually rendered.17

In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue,18  the Court
addressed the issue on the applicable source rule relating to reinsurance premiums
paid by a local insurance company to a foreign insurance company in respect of
risks located in the Philippines. It was held therein that the undertaking of the
foreign insurance company to indemnify the local insurance company is the
activity that produced the income. Since the activity took place in the Philippines,
Income Tax - cases

the income derived therefrom is taxable in our jurisdiction. Citing Mertens, The

Law of Federal Income Taxation, the Court emphasized that the technical meaning
of source of income is the property, activity or service that produced the same.
Thus:

The source of an income is the property, activity or service that produced the
income. The reinsurance premiums remitted to appellants by virtue of the
reinsurance contracts, accordingly, had for their source the undertaking to
indemnify Commonwealth Insurance Co. against liability. Said undertaking is the
activity that produced the reinsurance premiums, and the same took place in the
Philippines. x x x the reinsured, the liabilities insured and the risk originally
underwritten by Commonwealth Insurance Co., upon which the reinsurance
premiums and indemnity were based, were all situated in the Philippines. x x x19

In   Commissioner of Internal Revenue v. British Overseas Airways

Corporation (BOAC),20  the issue was whether BOAC, a foreign airline company
which does not maintain any flight to and from the Philippines is liable for
Philippine income taxation in respect of sales of air tickets in the Philippines,
through a general sales agent relating to the carriage of passengers and cargo
between two points both outside the Philippines. Ruling in the affirmative, the
Court applied the case of Alexander Howden & Co., Ltd. v. Collector of Internal
Revenue, and reiterated the rule that the source of income is that "activity" which
produced the income. It was held that the "sale of tickets" in the Philippines is the
"activity" that produced the income and therefore BOAC should pay income tax in
the Philippines because it undertook an income producing activity in the country.

Both the petitioner and respondent cited the case of   Commissioner of Internal
Revenue v. British Overseas Airways Corporation in support of their arguments,
but the correct interpretation of the said case favors the theory of respondent that it
is the situs of the activity that determines whether such income is taxable in the
Philippines. The conflict between the majority and the dissenting opinion in the
said case has nothing to do with the underlying principle of the law on sourcing of
income. In fact, both applied the case of Alexander Howden & Co., Ltd. v.
Collector of Internal Revenue. The divergence in opinion centered on whether the
sale of tickets in the Philippines is to be construed as the "activity" that produced
the income, as viewed by the majority, or merely the physical source of the
Income Tax - cases

income, as ratiocinated by Justice Florentino P. Feliciano in his dissent. The

majority, through Justice Ameurfina Melencio-Herrera, as ponente, interpreted the
sale of tickets as a business activity that gave rise to the income of BOAC.
Petitioner cannot therefore invoke said case to support its view that source of
income is the physical source of the money earned. If such was the interpretation
of the majority, the Court would have simply stated that source of income is not the
business activity of BOAC but the place where the person or entity disbursing the
income is located or where BOAC physically received the same. But such was not
the import of the ruling of the Court. It even explained in detail the   business
activity undertaken by BOAC in the Philippines to pinpoint the taxable activity
and to justify its conclusion that BOAC is subject to Philippine income taxation.
Thus –

BOAC, during the periods covered by the subject assessments, maintained a

general sales agent in the Philippines. That general sales agent, from 1959 to 1971,
"was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip
into series of trips — each trip in the series corresponding to a different airline
company; (3) receiving the fare from the whole trip; and (4) consequently
allocating to the various airline companies on the basis of their participation in the
services rendered through the mode of interline settlement as prescribed by Article
VI of the Resolution No. 850 of the IATA Agreement." Those activities were in
exercise of the functions which are normally incident to, and are in progressive
pursuit of, the purpose and object of its organization as an international air carrier.
In fact, 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. x x x21

xxxx

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. In
BOAC's case, the sale of tickets in the Philippines is the activity that produces the
income. The tickets exchanged hands here and payments for fares were also made
here in Philippine currency. The situs of the source of payments is the Philippines.
Income Tax - cases

The flow of wealth proceeded from, and occurred within, Philippine territory,
enjoying the protection accorded by the Philippine government. In consideration of
such protection, the flow of wealth should share the burden of supporting the
government.

A transportation ticket is not a mere piece of paper. When issued by a common

carrier, it constitutes the contract between the ticket-holder and the carrier. It gives
rise to the obligation of the purchaser of the ticket to pay the fare and the
corresponding obligation of the carrier to transport the passenger upon the terms
and conditions set forth thereon. The ordinary ticket issued to members of the
traveling public in general embraces within its terms all the elements to constitute
it a valid contract, binding upon the parties entering into the relationship.22

The Court reiterates the rule that "source of income" relates to the property, activity
or service that produced the income. With respect to rendition of labor or personal
service, as in the instant case, it is the place where the labor or service was
performed that determines the source of the income. There is therefore no merit in
petitioner’s interpretation which equates source of income in labor or personal
service with the residence of the payor or the place of payment of the income.

Having disposed of the doctrine applicable in this case, we will now determine
whether respondent was able to establish the factual circumstances showing that
her income is exempt from Philippine income taxation.

The decisive factual consideration here is not the capacity in which respondent
received the income, but the sufficiency of evidence to prove that the services she
rendered were performed in Germany. Though not raised as an issue, the Court is
clothed with authority to address the same because the resolution thereof will settle
the vital question posed in this controversy.23

The settled rule is that tax refunds are in the nature of tax exemptions and are to be
construed strictissimi juris against the taxpayer.24  To those therefore, who claim a
refund rest the burden of proving that the transaction subjected to tax is actually
exempt from taxation.

In the instant case, the appointment letter of respondent as agent of JUBANITEX

stipulated that the activity or the service which would entitle her to 10%
Income Tax - cases

commission income, are "sales actually concluded and collected through [her]
efforts."25  What she presented as evidence to prove that she performed income
producing activities abroad, were copies of documents she allegedly faxed to
JUBANITEX and bearing instructions as to the sizes of, or designs and fabrics to
be used in the finished products as well as samples of sales orders purportedly
relayed to her by clients. However, these documents do not show whether the
instructions or orders faxed ripened into concluded or collected sales in Germany.
At the very least, these pieces of evidence show that while respondent was in
Germany, she sent instructions/orders to JUBANITEX. As to whether these
instructions/orders gave rise to consummated sales and whether these sales were
truly concluded in Germany, respondent presented no such evidence. Neither did
she establish reasonable connection between the orders/instructions faxed and the
reported monthly sales purported to have transpired in Germany.

The paucity of respondent’s evidence was even noted by Atty. Minerva Pacheco,
petitioner’s counsel at the hearing before the Court of Tax Appeals. She pointed out
that respondent presented no contracts or orders signed by the customers in
Germany to prove the sale transactions therein.26 Likewise, in her Comment to the
Formal Offer of respondent’s evidence, she objected to the admission of the faxed
documents bearing instruction/orders marked as Exhibits "R,"27   "V," "W", and
"X,"28 for being self serving.29 The concern raised by petitioner’s counsel as to the
absence of substantial evidence that would constitute proof that the sale
transactions for which respondent was paid commission actually transpired outside
the Philippines, is relevant because respondent stayed in the Philippines for 89
days in 1995. Except for the months of July and September 1995, respondent was
in the Philippines in the months of March, May, June, and August 1995,30 the same
months when she earned commission income for services allegedly performed
abroad. Furthermore, respondent presented no evidence to prove that JUBANITEX
does not sell embroidered products in the Philippines and that her appointment as
commission agent is exclusively for Germany and other European markets.

In sum, we find that the faxed documents presented by respondent did not
constitute substantial evidence, or that relevant evidence that a reasonable mind
might accept as adequate to support the conclusion31 that it was in Germany where
she performed the income producing service which gave rise to the reported
monthly sales in the months of March and May to September of 1995. She thus
Income Tax - cases

failed to discharge the burden of proving that her income was from sources outside
the Philippines and exempt from the application of our income tax law. Hence, the
claim for tax refund should be denied.

The Court notes that in   Commissioner of Internal Revenue v. Baier-Nickel,32   a

previous case for refund of income withheld from respondent’s remunerations for
services rendered abroad, the Court in a Minute Resolution dated February 17,
2003,33  sustained the ruling of the Court of Appeals that respondent is entitled to
refund the sum withheld from her sales commission income for the year 1994. This
ruling has no bearing in the instant controversy because the subject matter thereof
is the income of respondent for the year 1994 while, the instant case deals with her
income in   1995. Otherwise, stated,   res judicata   has no application here. Its
elements are: (1) there must be a final judgment or order; (2) the court that
rendered the judgment must have jurisdiction over the subject matter and the
parties; (3) it must be a judgment on the merits; (4) there must be between the two
cases identity of parties, of subject matter, and of causes of action.  34  The instant
case, however, did not satisfy the fourth requisite because there is no identity as to
the subject matter of the previous and present case of respondent which deals with
income earned and activities performed for different taxable years.

WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision

and May 8, 2002 Resolution of the Court of Appeals in CA-G.R. SP No. 59794,
are REVERSED and SET ASIDE. The June 28, 2000 Decision of the Court of
Tax Appeals in C.T.A. Case No. 5633, which denied respondent’s claim for refund
of income tax paid for the year 1995 is REINSTATED.

SO ORDERED.

Commissioner of Internal Revenue v. British Overseas Airways Corporation, 149

SCRA 395, April 30, 1987

British Overseas Airways Corp. (BOAC) is a British government owned

corporation. It's an international airline business. 

This is the British Airways nowadays. I think about around 1970s (yup, you got
that right, the setting of Conjuring2, London 1972) when a British parliament act
Income Tax - cases

merged BOAC with another state-owned airline, the British European Airways
(BEA) and formed what is now known as the British Airways...

Although I'm not sure if British Airways today have landing rights for traffic
purposes in the Philippines co'z BOAC from 1959 to 1972 had no landing rights
and thus did not carry passengers and/or cargo to or from the Philippines... 

Meaning no direct flights. Well since the dates had been stated exclusionary then I
infer that British Airways have landing rights in Manila these days. Well correct
me if I'm wrong airport people, I'm afraid I'm not much of a traveler, and
unfortunately not even one of those wonderful cosmopolitan souls. Although I
doubt if there are direct flights from Manila to London. And I'm too lazy to call
some travel agencies to verify my claim..

Moving right along, the thing with BOAC was it was a bonafide member of the
Interline Air Transport Association (IATA) and as such mean it can operate air
transportation service and sell transportation tickets over the routes of other airline
members.

What happened was using its IATA privilege it maintained a general sales agent in
the Philippines through Warner Barnes & Co. Ltd., and later, Qantas Airways.
 These sales agents were selling for BOAC airline tickets covering passengers and
cargoes.

So simply put.. that is income being generated within Philippine territory where the
BIR naturally had to come in... 

And so the Commissioner of Internal Revenue (CIR) assessed deficiency income

taxes against BOAC.

Thereby BOAC protested.

ISSUE:
Income Tax - cases

Whether the revenue derived by BOAC from ticket sales in the Philippines for air
transportation, while having no landing rights in the Philippines, constitute income
of BOAC from Philippine sources, and accordingly, taxable.

RULING:

Court said..

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.

In this case, the sale of tickets in the Philippines is the activity that produced the
income. The tickets exchanged hands here and payments for fares were also made
here in Philippine currency. The SITUS of the source of payments is the
Philippines. The flow of wealth proceeded from, and occurred within, Philippine
territory, enjoying the protection accorded by the Philippine Government.

So court said, in consideration of such protection, the flow of wealth should share
the burden of supporting the government.

(PD 68, in relation to PD 1355, ensures that international airlines are taxed on their
income from Philippine sources. The 2 1/2 %tax on gross billings is an income tax.
If it had been intended as an excise or percentage tax, it would have been placed
under Title V of the Tax Code covering taxes on business.)

BOAC lost this case.

Aurbach, et al. v. Sanitary Wares Manufacturing Corporation, 180 SCRA 130,

December 15, 1989

These consolidated petitions seek the review of the amended decision of the Court
of Appeals in CA-G.R. SP Nos. 05604 and 05617 which set aside the earlier
decision dated June 5, 1986, of the then Intermediate Appellate Court and directed
that in all subsequent elections for directors of Sanitary Wares Manufacturing
Income Tax - cases

Corporation (Saniwares), American Standard Inc. (ASI) cannot nominate more

than three (3) directors; that the Filipino stockholders shall not interfere in ASI's
choice of its three (3) nominees; that, on the other hand, the Filipino stockholders
can nominate only six (6) candidates and in the event they cannot agree on the six
(6) nominees, they shall vote only among themselves to determine who the six (6)
nominees will be, with cumulative voting to be allowed but without interference
from ASI.

The antecedent facts can be summarized as follows:

In 1961, Saniwares, a domestic corporation was incorporated for the primary

purpose of manufacturing and marketing sanitary wares. One of the incorporators,
Mr. Baldwin Young went abroad to look for foreign partners, European or
American who could help in its expansion plans. On August 15, 1962, ASI, a
foreign corporation domiciled in Delaware, United States entered into an
Agreement with Saniwares and some Filipino investors whereby ASI and the
Filipino investors agreed to participate in the ownership of an enterprise which
would engage primarily in the business of manufacturing in the Philippines and
selling here and abroad vitreous china and sanitary wares. The parties agreed that
the business operations in the Philippines shall be carried on by an incorporated
enterprise and that the name of the corporation shall initially be "Sanitary Wares
Manufacturing Corporation."

The Agreement has the following provisions relevant to the issues in these cases on
the nomination and election of the directors of the corporation:

3. Articles of Incorporation

(a) The Articles of Incorporation of the Corporation shall be substantially in the

form annexed hereto as Exhibit A and, insofar as permitted under Philippine law,
shall specifically provide for

(1) Cumulative voting for directors:

xxx xxx xxx

5. Management
Income Tax - cases

(a) The management of the Corporation shall be vested in a Board of Directors,

which shall consist of nine individuals. As long as American-Standard shall own at
least 30% of the outstanding stock of the Corporation, three of the nine directors
shall be designated by American-Standard, and the other six shall be designated by
the other stockholders of the Corporation. (pp. 51 & 53, Rollo of 75875)

At the request of ASI, the agreement contained provisions designed to protect it as

a minority group, including the grant of veto powers over a number of corporate
acts and the right to designate certain officers, such as a member of the Executive
Committee whose vote was required for important corporate transactions.

Later, the 30% capital stock of ASI was increased to 40%. The corporation was
also registered with the Board of Investments for availment of incentives with the
condition that at least 60% of the capital stock of the corporation shall be owned by
Philippine nationals.

The joint enterprise thus entered into by the Filipino investors and the American
corporation prospered. Unfortunately, with the business successes, there came a
deterioration of the initially harmonious relations between the two groups.
According to the Filipino group, a basic disagreement was due to their desire to
expand the export operations of the company to which ASI objected as it
apparently had other subsidiaries of joint joint venture groups in the countries
where Philippine exports were contemplated. On March 8, 1983, the annual
stockholders' meeting was held. The meeting was presided by Baldwin Young. The
minutes were taken by the Secretary, Avelino Cruz. After disposing of the
preliminary items in the agenda, the stockholders then proceeded to the election of
the members of the board of directors. The ASI group nominated three persons
namely; Wolfgang Aurbach, John Griffin and David P. Whittingham. The
Philippine investors nominated six, namely; Ernesto Lagdameo, Sr., Raul A.
Boncan, Ernesto R. Lagdameo, Jr., George F. Lee, and Baldwin Young. Mr.
Eduardo R, Ceniza then nominated Mr. Luciano E. Salazar, who in turn nominated
Mr. Charles Chamsay. The chairman, Baldwin Young ruled the last two
nominations out of order on the basis of section 5 (a) of the Agreement, the
consistent practice of the parties during the past annual stockholders' meetings to
nominate only nine persons as nominees for the nine-member board of directors,
Income Tax - cases

and the legal advice of Saniwares' legal counsel. The following events then,
transpired:

... There were protests against the action of the Chairman and heated arguments
ensued. An appeal was made by the ASI representative to the body of stockholders
present that a vote be taken on the ruling of the Chairman. The Chairman, Baldwin
Young, declared the appeal out of order and no vote on the ruling was taken. The
Chairman then instructed the Corporate Secretary to cast all the votes present and
represented by proxy equally for the 6 nominees of the Philippine Investors and the
3 nominees of ASI, thus effectively excluding the 2 additional persons nominated,
namely, Luciano E. Salazar and Charles Chamsay. The ASI representative, Mr.
Jaqua protested the decision of the Chairman and announced that all votes accruing
to ASI shares, a total of 1,329,695 (p. 27, Rollo, AC-G.R. SP No. 05617) were
being cumulatively voted for the three ASI nominees and Charles Chamsay, and
instructed the Secretary to so vote. Luciano E. Salazar and other proxy holders
announced that all the votes owned by and or represented by them 467,197 shares
(p. 27, Rollo, AC-G.R. SP No. 05617) were being voted cumulatively in favor of
Luciano E. Salazar. The Chairman, Baldwin Young, nevertheless instructed the
Secretary to cast all votes equally in favor of the three ASI nominees, namely,
Wolfgang Aurbach, John Griffin and David Whittingham and the six originally
nominated by Rogelio Vinluan, namely, Ernesto Lagdameo, Sr., Raul Boncan,
Ernesto Lagdameo, Jr., Enrique Lagdameo, George F. Lee, and Baldwin Young.
The Secretary then certified for the election of the following Wolfgang Aurbach,
John Griffin, David Whittingham Ernesto Lagdameo, Sr., Ernesto Lagdameo, Jr.,
Enrique Lagdameo, George F. Lee, Raul A. Boncan, Baldwin Young. The
representative of ASI then moved to recess the meeting which was duly seconded.
There was also a motion to adjourn (p. 28, Rollo, AC-G.R. SP No. 05617). This
motion to adjourn was accepted by the Chairman, Baldwin Young, who announced
that the motion was carried and declared the meeting adjourned. Protests against
the adjournment were registered and having been ignored, Mr. Jaqua the ASI
representative, stated that the meeting was not adjourned but only recessed and that
the meeting would be reconvened in the next room. The Chairman then threatened
to have the stockholders who did not agree to the decision of the Chairman on the
casting of votes bodily thrown out. The ASI Group, Luciano E. Salazar and other
stockholders, allegedly representing 53 or 54% of the shares of Saniwares, decided
to continue the meeting at the elevator lobby of the American Standard Building.
Income Tax - cases

The continued meeting was presided by Luciano E. Salazar, while Andres

Gatmaitan acted as Secretary. On the basis of the cumulative votes cast earlier in
the meeting, the ASI Group nominated its four nominees; Wolfgang Aurbach, John
Griffin, David Whittingham and Charles Chamsay. Luciano E. Salazar voted for
himself, thus the said five directors were certified as elected directors by the Acting
Secretary, Andres Gatmaitan, with the explanation that there was a tie among the
other six (6) nominees for the four (4) remaining positions of directors and that the
body decided not to break the tie. (pp. 37-39, Rollo of 75975-76)

These incidents triggered off the filing of separate petitions by the parties with the
Securities and Exchange Commission (SEC). The first petition filed was for
preliminary injunction by Saniwares, Emesto V. Lagdameo, Baldwin Young, Raul
A. Bonean Ernesto R. Lagdameo, Jr., Enrique Lagdameo and George F. Lee
against Luciano Salazar and Charles Chamsay. The case was denominated as SEC
Case No. 2417. The second petition was for quo warranto and application for
receivership by Wolfgang Aurbach, John Griffin, David Whittingham, Luciano E.
Salazar and Charles Chamsay against the group of Young and Lagdameo
(petitioners in SEC Case No. 2417) and Avelino F. Cruz. The case was docketed as
SEC Case No. 2718. Both sets of parties except for Avelino Cruz claimed to be the
legitimate directors of the corporation.

The two petitions were consolidated and tried jointly by a hearing officer who
rendered a decision upholding the election of the Lagdameo Group and dismissing
the quo warranto petition of Salazar and Chamsay. The ASI Group and Salazar
appealed the decision to the SEC en banc which affirmed the hearing officer's
decision.

The SEC decision led to the filing of two separate appeals with the Intermediate
Appellate Court by Wolfgang Aurbach, John Griffin, David Whittingham and
Charles Chamsay (docketed as AC-G.R. SP No. 05604) and by Luciano E. Salazar
(docketed as AC-G.R. SP No. 05617). The petitions were consolidated and the
appellate court in its decision ordered the remand of the case to the Securities and
Exchange Commission with the directive that a new stockholders' meeting of
Saniwares be ordered convoked as soon as possible, under the supervision of the
Commission.
Income Tax - cases

Upon a motion for reconsideration filed by the appellees Lagdameo Group) the
appellate court (Court of Appeals) rendered the questioned amended decision.
Petitioners Wolfgang Aurbach, John Griffin, David P. Whittingham and Charles
Chamsay in G.R. No. 75875 assign the following errors:

I. THE COURT OF APPEALS, IN EFFECT, UPHELD THE ALLEGED

ELECTION OF PRIVATE RESPONDENTS AS MEMBERS OF THE BOARD
OF DIRECTORS OF SANIWARES WHEN IN FACT THERE WAS NO
ELECTION AT ALL.

II. THE COURT OF APPEALS PROHIBITS THE STOCKHOLDERS FROM

EXERCISING THEIR FULL VOTING RIGHTS REPRESENTED BY THE
NUMBER OF SHARES IN SANIWARES, THUS DEPRIVING PETITIONERS
AND THE CORPORATION THEY REPRESENT OF THEIR PROPERTY
RIGHTS WITHOUT DUE PROCESS OF LAW.

III. THE COURT OF APPEALS IMPOSES CONDITIONS AND READS

PROVISIONS INTO THE AGREEMENT OF THE PARTIES WHICH WERE
NOT THERE, WHICH ACTION IT CANNOT LEGALLY DO. (p. 17,
Rollo-75875)

Petitioner Luciano E. Salazar in G.R. Nos. 75975-76 assails the amended decision
on the following grounds:

11.1. ThatAmendedDecisionwouldsanctiontheCA'sdisregard of binding contractual

agreements entered into by stockholders and the replacement of the conditions of
such agreements with terms never contemplated by the stockholders but merely
dictated by the CA .

11.2. The Amended decision would likewise sanction the deprivation of the
property rights of stockholders without due process of law in order that a favored
group of stockholders may be illegally benefitted and guaranteed a continuing
monopoly of the control of a corporation. (pp. 14-15, Rollo-75975-76)

On the other hand, the petitioners in G.R. No. 75951 contend that:

I
Income Tax - cases

THE AMENDED DECISION OF THE RESPONDENT COURT, WHILE

RECOGNIZING THAT THE STOCKHOLDERS OF SANIWARES ARE
DIVIDED INTO TWO BLOCKS, FAILS TO FULLY ENFORCE THE BASIC
INTENT OF THE AGREEMENT AND THE LAW.

II

THE AMENDED DECISION DOES NOT CATEGORICALLY RULE THAT

PRIVATE PETITIONERS HEREIN WERE THE DULY ELECTED DIRECTORS
DURING THE 8 MARCH 1983 ANNUAL STOCKHOLDERS MEETING OF
SANTWARES. (P. 24, Rollo-75951)

The issues raised in the petitions are interrelated, hence, they are discussed jointly.

The main issue hinges on who were the duly elected directors of Saniwares for the
year 1983 during its annual stockholders' meeting held on March 8, 1983. To
answer this question the following factors should be determined: (1) the nature of
the business established by the parties whether it was a joint venture or a
corporation and (2) whether or not the ASI Group may vote their additional 10%
equity during elections of Saniwares' board of directors.

The rule is that whether the parties to a particular contract have thereby established
among themselves a joint venture or some other relation depends upon their actual
intention which is determined in accordance with the rules governing the
interpretation and construction of contracts. (Terminal Shares, Inc. v. Chicago, B.
and Q.R. Co. (DC MO) 65 F Supp 678; Universal Sales Corp. v. California Press
Mfg. Co. 20 Cal. 2nd 751, 128 P 2nd 668)

The ASI Group and petitioner Salazar (G.R. Nos. 75975-76) contend that the actual
intention of the parties should be viewed strictly on the "Agreement" dated August
15,1962 wherein it is clearly stated that the parties' intention was to form a
corporation and not a joint venture.

They specifically mention number 16 under   Miscellaneous Provisions   which

states:

xxx xxx xxx

Income Tax - cases

c) nothing herein contained shall be construed to constitute any of the parties

hereto partners or joint venturers in respect of any transaction hereunder. (At P. 66,
Rollo-GR No. 75875)

They object to the admission of other evidence which tends to show that the
parties' agreement was to establish a joint venture presented by the Lagdameo and
Young Group on the ground that it contravenes the parol evidence rule under
section 7, Rule 130 of the Revised Rules of Court. According to them, the
Lagdameo and Young Group never pleaded in their pleading that the "Agreement"
failed to express the true intent of the parties.

The parol evidence Rule under Rule 130 provides:

Evidence of written agreements-When the terms of an agreement have been

reduced to writing, it is to be considered as containing all such terms, and
therefore, there can be, between the parties and their successors in interest, no
evidence of the terms of the agreement other than the contents of the writing,
except in the following cases:

(a) Where a mistake or imperfection of the writing, or its failure to express the true
intent and agreement of the parties or the validity of the agreement is put in issue
by the pleadings.

(b) When there is an intrinsic ambiguity in the writing.

Contrary to ASI Group's stand, the Lagdameo and Young Group pleaded in their
Reply and Answer to Counterclaim in SEC Case No. 2417 that the Agreement
failed to express the true intent of the parties, to wit:

xxx xxx xxx

4. While certain provisions of the Agreement would make it appear that the parties
thereto disclaim being partners or joint venturers such disclaimer is directed at
third parties and is not inconsistent with, and does not preclude, the existence of
two distinct groups of stockholders in Saniwares one of which (the Philippine
Investors) shall constitute the majority, and the other ASI shall constitute the
minority stockholder. In any event, the evident intention of the Philippine Investors
Income Tax - cases

and ASI in entering into the Agreement is to enter into ajoint venture enterprise,
and if some words in the Agreement appear to be contrary to the evident intention
of the parties, the latter shall prevail over the former (Art. 1370, New Civil Code).
The various stipulations of a contract shall be interpreted together attributing to the
doubtful ones that sense which may result from all of them taken jointly (Art.
1374, New Civil Code). Moreover, in order to judge the intention of the
contracting parties, their contemporaneous and subsequent acts shall be principally
considered. (Art. 1371, New Civil Code). (Part I, Original Records, SEC Case No.
2417)

It has been ruled:

In an action at law, where there is evidence tending to prove that the parties joined
their efforts in furtherance of an enterprise for their joint profit, the question
whether they intended by their agreement to create a joint adventure, or to assume
some other relation is a question of fact for the jury. (Binder v. Kessler v 200 App.
Div. 40,192 N Y S 653; Pyroa v. Brownfield (Tex. Civ. A.) 238 SW 725; Hoge v.
George, 27 Wyo, 423, 200 P 96 33 C.J. p. 871)

In the instant cases, our examination of important provisions of the Agreement as

well as the testimonial evidence presented by the Lagdameo and Young Group
shows that the parties agreed to establish a joint venture and not a corporation. The
history of the organization of Saniwares and the unusual arrangements which
govern its policy making body are all consistent with a joint venture and not with
an ordinary corporation. As stated by the SEC:

According to the unrebutted testimony of Mr. Baldwin Young, he negotiated the

Agreement with ASI in behalf of the Philippine nationals. He testified that ASI
agreed to accept the role of minority vis-a-vis the Philippine National group of
investors, on the condition that the Agreement should contain provisions to protect
ASI as the minority.

An examination of the Agreement shows that certain provisions were included to

protect the interests of ASI as the minority. For example, the vote of 7 out of 9
directors is required in certain enumerated corporate acts [Sec. 3 (b) (ii) (a) of the
Agreement]. ASI is contractually entitled to designate a member of the Executive
Income Tax - cases

Committee and the vote of this member is required for certain transactions [Sec. 3
(b) (i)].

The Agreement also requires a 75% super-majority vote for the amendment of the
articles and by-laws of Saniwares [Sec. 3 (a) (iv) and (b) (iii)]. ASI is also given
the right to designate the president and plant manager [Sec. 5 (6)]. The Agreement
further provides that the sales policy of Saniwares shall be that which is normally
followed by ASI [Sec. 13 (a)] and that Saniwares should not export "Standard"
products otherwise than through ASI's Export Marketing Services [Sec. 13 (6)].
Under the Agreement, ASI agreed to provide technology and know-how to
Saniwares and the latter paid royalties for the same. (At p. 2).

xxx xxx xxx

It is pertinent to note that the provisions of the Agreement requiring a 7 out of 9

votes of the board of directors for certain actions, in effect gave ASI (which
designates 3 directors under the Agreement) an effective veto power. Furthermore,
the grant to ASI of the right to designate certain officers of the corporation; the
super-majority voting requirements for amendments of the articles and by-laws;
and most significantly to the issues of tms case, the provision that ASI shall
designate 3 out of the 9 directors and the other stockholders shall designate the
other 6, clearly indicate that there are two distinct groups in Saniwares, namely
ASI, which owns 40% of the capital stock and the Philippine National stockholders
who own the balance of 60%, and that 2) ASI is given certain protections as the
minority stockholder.

Premises considered, we believe that under the Agreement there are two groups of
stockholders who established a corporation with provisions for a special
contractual relationship between the parties, i.e., ASI and the other stockholders.
(pp. 4-5)

Section 5 (a) of the agreement uses the word "designated" and not "nominated" or
"elected" in the selection of the nine directors on a six to three ratio. Each group is
assured of a fixed number of directors in the board.

Moreover, ASI in its communications referred to the enterprise as joint venture.

Baldwin Young also testified that Section 16(c) of the Agreement that "Nothing
Income Tax - cases

herein contained shall be construed to constitute any of the parties hereto partners
or joint venturers in respect of any transaction hereunder" was merely to obviate
the possibility of the enterprise being treated as partnership for tax purposes and
liabilities to third parties.

Quite often, Filipino entrepreneurs in their desire to develop the industrial and
manufacturing capacities of a local firm are constrained to seek the technology and
marketing assistance of huge multinational corporations of the developed world.
Arrangements are formalized where a foreign group becomes a minority owner of
a firm in exchange for its manufacturing expertise, use of its brand names, and
other such assistance. However, there is always a danger from such arrangements.
The foreign group may, from the start, intend to establish its own sole or
monopolistic operations and merely uses the joint venture arrangement to gain a
foothold or test the Philippine waters, so to speak. Or the covetousness may come
later. As the Philippine firm enlarges its operations and becomes profitable, the
foreign group undermines the local majority ownership and actively tries to
completely or predominantly take over the entire company. This undermining of
joint ventures is not consistent with fair dealing to say the least. To the extent that
such subversive actions can be lawfully prevented, the courts should extend
protection especially in industries where constitutional and legal requirements
reserve controlling ownership to Filipino citizens.

The Lagdameo Group stated in their appellees' brief in the Court of Appeal

In fact, the Philippine Corporation Code itself recognizes the right of stockholders
to enter into agreements regarding the exercise of their voting rights.

Sec. 100. Agreements by stockholders.-

xxx xxx xxx

2. An agreement between two or more stockholders, if in writing and signed by the

parties thereto, may provide that in exercising any voting rights, the shares held by
them shall be voted as therein provided, or as they may agree, or as determined in
accordance with a procedure agreed upon by them.
Income Tax - cases

Appellants contend that the above provision is included in the Corporation Code's
chapter on close corporations and Saniwares cannot be a close corporation because
it has 95 stockholders. Firstly, although Saniwares had 95 stockholders at the time
of the disputed stockholders meeting, these 95 stockholders are not separate from
each other but are divisible into groups representing a single Identifiable interest.
For example, ASI, its nominees and lawyers count for 13 of the 95 stockholders.
The YoungYutivo family count for another 13 stockholders, the Chamsay family
for 8 stockholders, the Santos family for 9 stockholders, the Dy family for 7
stockholders, etc. If the members of one family and/or business or interest group
are considered as one (which, it is respectfully submitted, they should be for
purposes of determining how closely held Saniwares is there were as of 8 March
1983, practically only 17 stockholders of Saniwares. (Please refer to discussion in
pp. 5 to 6 of appellees' Rejoinder Memorandum dated 11 December 1984 and
Annex "A" thereof).

Secondly, even assuming that Saniwares is technically not a close corporation

because it has more than 20 stockholders, the undeniable fact is that it is a close-
held   corporation. Surely, appellants cannot honestly claim that Saniwares is a
public issue or a widely held corporation.

In the United States, many courts have taken a realistic approach to joint venture
corporations and have not rigidly applied principles of corporation law designed
primarily for public issue corporations. These courts have indicated that express
arrangements between corporate joint ventures should be construed with less
emphasis on the ordinary rules of law usually applied to corporate entities and with
more consideration given to the nature of the agreement between the joint
venturers (Please see Wabash Ry v. American Refrigerator Transit Co., 7 F 2d 335;
Chicago, M & St. P. Ry v. Des Moines Union Ry; 254 Ass'n. 247 US. 490';
Seaboard Airline Ry v. Atlantic Coast Line Ry; 240 N.C. 495,.82 S.E. 2d 771;
Deboy v. Harris, 207 Md., 212,113 A 2d 903; Hathway v. Porter Royalty Pool, Inc.,
296 Mich. 90, 90, 295 N.W. 571; Beardsley v. Beardsley, 138 U.S. 262; "The Legal
Status of Joint Venture Corporations", 11 Vand Law Rev. p. 680,1958). These
American cases dealt with legal questions as to the extent to which the
requirements arising from the corporate form of joint venture corporations should
control, and the courts ruled that substantial justice lay with those litigants who
Income Tax - cases

relied on the joint venture agreement rather than the litigants who relied on the
orthodox principles of corporation law.

As correctly held by the SEC Hearing Officer:

It is said that participants in a joint venture, in organizing the joint venture deviate
from the traditional pattern of corporation management. A noted authority has
pointed out that just as in close corporations, shareholders' agreements in joint
venture corporations often contain provisions which do one or more of the
following: (1) require greater than majority vote for shareholder and director
action; (2) give certain shareholders or groups of shareholders power to select a
specified number of directors; (3) give to the shareholders control over the
selection and retention of employees; and (4) set up a procedure for the settlement
of disputes by arbitration (See I O' Neal, Close Corporations, 1971 ed., Section
1.06a, pp. 15-16) (Decision of SEC Hearing Officer, P. 16)

Thirdly paragraph 2 of Sec. 100 of the Corporation Code does not necessarily
imply that agreements regarding the exercise of voting rights are allowed only in
close corporations. As Campos and Lopez-Campos explain:

Paragraph 2 refers to pooling and voting agreements in particular. Does this

provision necessarily imply that these agreements can be valid only in close
corporations as defined by the Code? Suppose that a corporation has twenty five
stockholders, and therefore cannot qualify as a close corporation under section 96,
can some of them enter into an agreement to vote as a unit in the election of
directors? It is submitted that there is no reason for denying stockholders of
corporations other than close ones the right to enter into not voting or pooling
agreements to protect their interests, as long as they do not intend to commit any
wrong, or fraud on the other stockholders not parties to the agreement. Of course,
voting or pooling agreements are perhaps more useful and more often resorted to in
close corporations. But they may also be found necessary even in widely held
corporations. Moreover, since the Code limits the legal meaning of close
corporations to those which comply with the requisites laid down by section 96, it
is entirely possible that a corporation which is in fact a close corporation will not
come within the definition. In such case, its stockholders should not be precluded
Income Tax - cases

from entering into contracts like voting agreements if these are otherwise valid.
(Campos & Lopez-Campos, op cit, p. 405)

In short, even assuming that sec. 5(a) of the Agreement relating to the designation
or nomination of directors restricts the right of the Agreement's signatories to vote
for directors, such contractual provision, as correctly held by the SEC, is valid and
binding upon the signatories thereto, which include appellants. (Rollo No. 75951,
pp. 90-94)

In regard to the question as to whether or not the ASI group may vote their
additional equity during elections of Saniwares' board of directors, the Court of
Appeals correctly stated:

As in other joint venture companies, the extent of ASI's participation in the

management of the corporation is spelled out in the Agreement. Section 5(a) hereof
says that three of the nine directors shall be designated by ASI and the remaining
six by the other stockholders, i.e., the Filipino stockholders. This allocation of
board seats is obviously in consonance with the minority position of ASI.

Having entered into a well-defined contractual relationship, it is imperative that the

parties should honor and adhere to their respective rights and obligations
thereunder. Appellants seem to contend that any allocation of board seats, even in
joint venture corporations, are null and void to the extent that such may interfere
with the stockholder's rights to cumulative voting as provided in Section 24 of the
Corporation Code. This Court should not be prepared to hold that any agreement
which curtails in any way cumulative voting should be struck down, even if such
agreement has been freely entered into by experienced businessmen and do not
prejudice those who are not parties thereto. It may well be that it would be more
cogent to hold, as the Securities and Exchange Commission has held in the
decision appealed from, that cumulative voting rights may be voluntarily waived
by stockholders who enter into special relationships with each other to pursue and
implement specific purposes, as in joint venture relationships between foreign and
local stockholders, so long as such agreements do not adversely affect third parties.

In any event, it is believed that we are not here called upon to make a general rule
on this question. Rather, all that needs to be done is to give life and effect to the
Income Tax - cases

particular contractual rights and obligations which the parties have assumed for
themselves.

On the one hand, the clearly established minority position of ASI and the
contractual allocation of board seats Cannot be disregarded. On the other hand, the
rights of the stockholders to cumulative voting should also be protected.

In our decision sought to be reconsidered, we opted to uphold the second over the
first. Upon further reflection, we feel that the proper and just solution to give due
consideration to both factors suggests itself quite clearly. This Court should
recognize and uphold the division of the stockholders into two groups, and at the
same time uphold the right of the stockholders within each group to cumulative
voting in the process of determining who the group's nominees would be. In
practical terms, as suggested by appellant Luciano E. Salazar himself, this means
that if the Filipino stockholders cannot agree who their six nominees will be, a vote
would have to be taken among the Filipino stockholders only. During this voting,
each Filipino stockholder can cumulate his votes. ASI, however, should not be
allowed to interfere in the voting within the Filipino group. Otherwise, ASI would
be able to designate more than the three directors it is allowed to designate under
the Agreement, and may even be able to get a majority of the board seats, a result
which is clearly contrary to the contractual intent of the parties.

Such a ruling will give effect to both the allocation of the board seats and the
stockholder's right to cumulative voting. Moreover, this ruling will also give due
consideration to the issue raised by the appellees on possible violation or
circumvention of the Anti-Dummy Law (Com. Act No. 108, as amended) and the
nationalization requirements of the Constitution and the laws if ASI is allowed to
nominate more than three directors. (Rollo-75875, pp. 38-39)

The ASI Group and petitioner Salazar, now reiterate their theory that the ASI
Group has the right to vote their additional equity pursuant to Section 24 of the
Corporation Code which gives the stockholders of a corporation the right to
cumulate their votes in electing directors. Petitioner Salazar adds that this right if
granted to the ASI Group would not necessarily mean a violation of the Anti-
Dummy Act (Commonwealth Act 108, as amended). He cites section 2-a thereof
which provides:
Income Tax - cases

And provided finally that the election of aliens as members of the board of
directors or governing body of corporations or associations engaging in partially
nationalized activities shall be allowed in proportion to their allowable
participation or share in the capital of such entities. (amendments introduced by
Presidential Decree 715, section 1, promulgated May 28, 1975)

The ASI Group's argument is correct within the context of Section 24 of the
Corporation Code. The point of query, however, is whether or not that provision is
applicable to a joint venture with clearly defined agreements:

The legal concept of ajoint venture is of common law origin. It has no precise legal
definition but it has been generally understood to mean an organization formed for
some temporary purpose. (Gates v. Megargel, 266 Fed. 811 [1920]) It is in fact
hardly distinguishable from the partnership, since their elements are similar
community of interest in the business, sharing of profits and losses, and a mutual
right of control. Blackner v. Mc Dermott, 176 F. 2d. 498, [1949]; Carboneau v.
Peterson, 95 P. 2d., 1043 [1939]; Buckley v. Chadwick, 45 Cal. 2d. 183, 288 P. 2d.
12 289 P. 2d. 242 [1955]). The main distinction cited by most opinions in common
law jurisdictions is that the partnership contemplates a general business with some
degree of continuity, while the joint venture is formed for the execution of a single
transaction, and is thus of a temporary nature. (Tufts v. Mann 116 Cal. App. 170, 2
P. 2d. 500 [1931]; Harmon v. Martin, 395 111. 595, 71 NE 2d. 74 [1947]; Gates v.
Megargel 266 Fed. 811 [1920]). This observation is not entirely accurate in this
jurisdiction, since under the Civil Code, a partnership may be particular or
universal, and a particular partnership may have for its object a specific
undertaking. (Art. 1783, Civil Code). It would seem therefore that under Philippine
law, a joint venture is a form of partnership and should thus be governed by the law
of partnerships. The Supreme Court has however recognized a distinction between
these two business forms, and has held that although a corporation cannot enter
into a partnership contract, it may however engage in a joint venture with others.
(At p. 12, Tuazon v. Bolanos, 95 Phil. 906 [1954]) (Campos and Lopez-Campos
Comments, Notes and Selected Cases, Corporation Code 1981)

Moreover, the usual rules as regards the construction and operations of contracts
generally apply to a contract of joint venture. (O' Hara v. Harman 14 App. Dev.
(167) 43 NYS 556).
Income Tax - cases

Bearing these principles in mind, the correct view would be that the resolution of
the question of whether or not the ASI Group may vote their additional equity lies
in the agreement of the parties.

Necessarily, the appellate court was correct in upholding the agreement of the
parties as regards the allocation of director seats under Section 5 (a) of the
"Agreement," and the right of each group of stockholders to cumulative voting in
the process of determining who the group's nominees would be under Section 3 (a)
(1) of the "Agreement." As pointed out by SEC, Section 5 (a) of the Agreement
relates to the manner of nominating the members of the board of directors while
Section 3 (a) (1) relates to the manner of voting for these nominees.

This is the proper interpretation of the Agreement of the parties as regards the
election of members of the board of directors.

To allow the ASI Group to vote their additional equity to help elect even a Filipino
director who would be beholden to them would obliterate their minority status as
agreed upon by the parties. As aptly stated by the appellate court:

... ASI, however, should not be allowed to interfere in the voting within the Filipino
group. Otherwise, ASI would be able to designate more than the three directors it is
allowed to designate under the Agreement, and may even be able to get a majority
of the board seats, a result which is clearly contrary to the contractual intent of the
parties.

Such a ruling will give effect to both the allocation of the board seats and the
stockholder's right to cumulative voting. Moreover, this ruling will also give due
consideration to the issue raised by the appellees on possible violation or
circumvention of the Anti-Dummy Law (Com. Act No. 108, as amended) and the
nationalization requirements of the Constitution and the laws if ASI is allowed to
nominate more than three directors. (At p. 39, Rollo, 75875)

Equally important as the consideration of the contractual intent of the parties is the
consideration as regards the possible domination by the foreign investors of the
enterprise in violation of the nationalization requirements enshrined in the
Constitution and circumvention of the Anti-Dummy Act. In this regard, petitioner
Salazar's position is that the Anti-Dummy Act allows the ASI group to elect board
Income Tax - cases

directors in proportion to their share in the capital of the entity. It is to be noted,

however, that the same law also limits the election of aliens as members of the
board of directors in proportion to their allowance participation of said entity. In
the instant case, the foreign Group ASI was limited to designate three directors.
This is the allowable participation of the ASI Group. Hence, in future dealings, this
limitation of six to three board seats should always be maintained as long as the
joint venture agreement exists considering that in limiting 3 board seats in the 9-
man board of directors there are provisions already agreed upon and embodied in
the parties' Agreement to protect the interests arising from the minority status of
the foreign investors.

With these findings, we the decisions of the SEC Hearing Officer and SEC which
were impliedly affirmed by the appellate court declaring Messrs. Wolfgang
Aurbach, John Griffin, David P Whittingham, Emesto V. Lagdameo, Baldwin
young, Raul A. Boncan, Emesto V. Lagdameo, Jr., Enrique Lagdameo, and George
F. Lee as the duly elected directors of Saniwares at the March 8,1983 annual
stockholders' meeting.

On the other hand, the Lagdameo and Young Group (petitioners in G.R. No.
75951) object to a cumulative voting during the election of the board of directors
of the enterprise as ruled by the appellate court and submits that the six (6)
directors allotted the Filipino stockholders should be selected by consensus
pursuant to section 5 (a) of the Agreement which uses the word "designate"
meaning "nominate, delegate or appoint."

They also stress the possibility that the ASI Group might take control of the
enterprise if the Filipino stockholders are allowed to select their nominees
separately and not as a common slot determined by the majority of their group.

Section 5 (a) of the Agreement which uses the word designates in the allocation of
board directors should not be interpreted in isolation. This should be construed in
relation to section 3 (a) (1) of the Agreement. As we stated earlier, section 3(a) (1)
relates to the   manner of voting   for these nominees which is   cumulative
voting while section 5(a) relates to the manner of nominating the members of the
board of directors. The petitioners in G.R. No. 75951 agreed to this procedure,
hence, they cannot now impugn its legality.
Income Tax - cases

The insinuation that the ASI Group may be able to control the enterprise under the
cumulative voting procedure cannot, however, be ignored. The validity of the
cumulative voting procedure is dependent on the directors thus elected being
genuine members of the Filipino group, not voters whose interest is to increase the
ASI share in the management of Saniwares. The joint venture character of the
enterprise must always be taken into account, so long as the company exists under
its original agreement. Cumulative voting may not be used as a device to enable
ASI to achieve stealthily or indirectly what they cannot accomplish openly. There
are substantial safeguards in the Agreement which are intended to preserve the
majority status of the Filipino investors as well as to maintain the minority status
of the foreign investors group as earlier discussed. They should be maintained.

WHEREFORE, the petitions in G.R. Nos. 75975-76 and G.R. No. 75875 are
DISMISSED and the petition in G.R. No. 75951 is partly GRANTED. The
amended decision of the Court of Appeals is MODIFIED in that Messrs. Wolfgang
Aurbach John Griffin, David Whittingham Emesto V. Lagdameo, Baldwin Young,
Raul A. Boncan, Ernesto R. Lagdameo, Jr., Enrique Lagdameo, and George F. Lee
are declared as the duly elected directors of Saniwares at the March 8,1983 annual
stockholders' meeting. In all other respects, the questioned decision is AFFIRMED.
Costs against the petitioners in G.R. Nos. 75975-76 and G.R. No. 75875.

SO ORDERED.