Paper Industries Corp of the Philippines v.

CA
G.R. No. 106949-50
December 1, 1995
Feliciano, J.

Petitioner: Paper Industries Corp of the Philippines (PICOP)

Respondent: CA, CIR and CTA

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

Facts:
PICOP is a Philippine corporation registered with the Board of Investments (BOI) as a preferred
pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferred non-pioneer
enterprise with respect to its integrated plywood and veneer mills.

On April 21, 1983, PICOP received 2 letters of assessment and demand from the CIR, each
demanding (1) deficiency transaction tax and for documentary and science stamp tax
(P38,094,309.90) and (2) deficiency income tax for 1977(P50,668,946.90), for an aggregate amount
of P88,763,255.00.

On April 26, 1983, PICOP protested the assessments of deficiency transaction tax and documentary
and science stamp taxes. On May 21, 1983, PICOP protested on the deficiency income tax
assessment. These protests were not acted upon by the CIR. On Sept 26, 1984, the Cir issued a
warrant of distraint on personal property and a warrant of levy on real property against Picop to
enforce collection of the contested assessments, which meant the CIR denied their protests.

PICOP went before the CTA appealing the assessments. After trial, CTA rendered a decision reducing
the aggregate amount of P20,133,762.33 - 35% transaction tax (P16,020,113.20) + Documentary &
Science Stamp Tax (P300,300) + Deficiency Income Tax Due (P3,813,349.33).

PICOP and CIR both went to the SC on separate Petitions for Review of the CTA decision. SC
referred then back to the CA. The CA consolidated both petitions and further reduced the liability of
PICOP to P6,338,354.70 33 - 35% transaction tax (P3,578,543.51) + Documentary & Science Stamp
Tax (P300) + Deficiency Income Tax Due (P1,481,579.15).

PICOP and CIR filed another separate Petitions for Review before the SC. These were consolidated to
properly give due course to both petitions.

PICOP now maintains that it is not liable to pay any of the assessments at all. It assailed the propriety
of the 35% deficiency transaction tax (P3,578,543.51). PICOP also questioned the imposition of the
actual deficiency income tax, resulting from the disallowance of the claimed financial guarantee
expenses and claimed year-end adjustments of sales and cost of sale figures by PICOP's external
auditors
CIR insists that the CA erred in finding PICOP not liable and allowing them to claim the net operating
losses of another corporation (Rustan Pulp and Mills, Inc.) and interest payment on loans for the
machinery and equipment. CIR also claims that PICOP should be held liable for interest (14% pa)
from 1978 for 3 years, 20%and corporate development tax (5%) on the 1977 net income.

Issue
(1)W/N PICOP is liable for the following:
35% transactions; (YES)
Interest and surcharge on unpaid transaction tax; and
Documentary and science stamp taxes.

(2)W/N PICOP is entitled to deductions against the income of:

Interest payments of loans for the purchase of machinery and equipment;
Net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and
Certain claimed financial guarantee expenses;

(3)W/N W/N PICOP has understated its sales and overstates its cost of sales for 1977; and

(4)W/N PICOP is liable for the corporate development tax (5%) of its net income of 1977

Held:
(1) TRANSACTION TAX
With the authorization of the Securities and Exchange Commission, PICOP issued commercial paper
consisting of serially numbered promissory notes with the total face value of P229,864,000.00 and a
maturity period of one (1) year, i.e., from 24 December 1977 to 23 December 1978. These promissory
notes were purchased by various commercial banks and financial institutions. On these promissory
notes, PICOP paid interest in the aggregate amount of P45,771,849.00. In respect of these interest
payments, the CIR required PICOP to pay the 35% transaction tax, based on P.D. No. 1154 (which
amends Sec 195-C of the NIRC – tax on certain interest).

Both CTA and CA sustained the assessment of the transaction tax.

PICOP reiterates that it is exempt from payment of the transaction tax by virtue of its tax exemption
under RA 5186 (Investment Incentives Act), which existed in 1977-1978.

Sc agrees with the CTA and CA that PICOP’s exemption does not include exemption from the 35%
transaction tax. In the first place, it is an income tax on the interest income of the lenders or creditors.
Jurisprudence has provided for other cases in which companies are required to pay for the 35%
transaction tax on the interest income from commercial papers issued in the primary money market.
Transaction tax is an income tax and as such falls outside the tax exemption granted to registered
pioneer enterprises by section 8 of RA 5186. PICOP was the withholding agent, obliged to withhold
35% of the interest payable to its lenders and to remit said amount to the BIR.

The ruling dated Oct 6, 1977 issued by the CIR does not apply to the current issue at hand. The CIR
ruling held that PICOP’s debenture bonds (long-term) did not constitute "commercial papers" within
the meaning of P.D. No. 1154, and that, as such, those bonds were not subject to the 35% transaction
tax but the issue at hand is about the promissory notes (short-term).

PICOP was correctly held liable for the 35% transaction tax. However, the transaction tax must only
be imposed on the interest earnings of Picop's money market lenders accruing after P.D. No. 1154
went into effect, and not in respect of all the 1977 interest earnings of such lenders.

INTEREST AND SURCHARGE

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

The CIR, both in its petition before the Court of Appeals and its Petition in the instant case, points to
Section 51 (e) of the 1977 Tax Code as its source of authority for assessing a surcharge and penalty
interest in respect of the 35% transaction tax due from PICOP.

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

Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge and
penalty interest for failure to pay the 35% transaction tax imposed under Section 210 (b) of the same
Code. This was corrected by amendments inserted in 1985, which were not given retroactive effect.

DOCUMENTARY AND SCIENCE STAMP

Although tax exemptions are strictly construed against the tax payer. The SC considered the actual
dedication of the proceeds of the bonds to the carrying out of PICOP’s registered operations
constituted a sufficient nexus with such registered operations so as to exempt PICOP from taxes
ordinarily imposed upon or in connection with issuance of such bonds. We agree, therefore, with the
Court of Appeals on this matter that the CTA and the CIR had erred in rejecting PICOP’s claim for
exemption from stamp taxes.

(2) Interest payments of loans for the purchase of machinery and equipment (YES)

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

General Rule: Interest expenses are deductible against gross income and this certainly includes
interest paid under loans incurred in connection with the carrying on of the business of the taxpayer.

Section 79 of the 1977 Tax Code states that interest which does constitute a charge arising under an
interest-bearing obligation is an allowable deduction from gross income. In this case the general rule
must be applied. Such application wil not encourage fraudulent claims, unlike what the CIR is
claiming.

Net operating losses incurred by the Rustan Pulp and Paper Mills, Inc. (NO)

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

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

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

In claiming such deduction PICOP relied on Section 7 (c) of R.A. No. 5186. However, PICOP
secured a letter-opinion from the BOI (after the agreement of the merger but before it became
effective) relating to the deductibility of the NOLCO of RPPM under Section 7 (c). It states that
PICOL will not be allowed to carry over the losses of Rustan prior to the legal dissolution of the latter
because at that time the 2 companies still had separate legal personalities. With an approved merger,
the previous losses of Rustan may be carried over by PICOP, because with the merger, PICOP
assumes all the rights and obligations of Rustan subject, however, to the period prescribed for
carrying over such losses.

PICOP did not seek for an opinion from the BIR but merely relied on the BOI letter-opinion.

CIR disallowed the deductions because (1) they were incurred by another tax payer – RPPM (PICOP,
RPPM and RMC were merged into one corporation on Jan 12, 1978, upon approval of the merger
agreement by the BOI thus they still has separate judicial personalities before then.), (2) CIR alleged
that these losses had been incurred by RPPM from borrowing funds and not operations. (FOCUS ON
THE FIRST GROUND)

The size of RPPM's accumulated losses as of the date of the merger more than P81,000,000.00 must
have constituted a powerful attraction indeed for PICOP.

The SC is unable to agree with the CTA and CA on allowing the accumulated losses to be carried
over to PICOP’s 1977 gross income.

It is important to note at the outset that in our jurisdiction, the ordinary rule that is, the rule applicable
in respect of corporations not registered with the BOI as a preferred pioneer enterprise is that net
operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may
be deducted from gross income only if such losses were actually sustained in the same year that they
are deducted or charged off. It is thus clear that under our law, and outside the special realm of BOI-
registered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary,
losses must be deducted against current income in the taxable year when such losses were incurred.
Moreover, such losses may be charged off only against income earned in the same taxable year when
the losses were incurred.
R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be
granted only to registered pioneer enterprises and only with respect to their registered operations. The
statutory purpose here may be seen to be the encouragement of the establishment and continued
operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses
which may be expected during the early years of the enterprise and to permit the enterprise to offset
such losses against income earned by it in later years after successful establishment and regular
operations. To promote its economic development goals, the Republic foregoes or defers taxing the
income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We
consider that the statutory purpose can be served only if the accumulated operating losses are carried
over and charged off against income subsequently earned and accumulated by the same enterprise
engaged in the same registered operations.

To allow the deduction claimed by PICOP would be to permit one corporation or enterprise, PICOP,
to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. RPPM
far from benefitting from the tax incentive granted by the BOI statute, in fact gave up the struggle and
went out of existence and its former stockholders joined the much larger group of PICOP’s
stockholders. To grant PICOP’s claimed deduction would be to permit PICOP to shelter its otherwise
taxable income (an objective which PICOP had from the very beginning) which had not been earned
by the registered enterprise which had suffered the accumulated losses. In effect, to grant PICOP’s
claimed deduction would be to permit PICOP to purchase a tax deduction and RPPM to peddle its
accumulated operating losses.

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

Certain claimed financial guarantee expenses (NO)

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

(3)

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

It seems that there is a discrepancy between the sales figure reflected in PICOP’s book of accounts
and the sales figure report which PICOP did not deny. PICOP gave an explanation as to the
discrepancies which raised more questions for the SC. The explanation assumes that all of PICOP’s
sales were export sales for which U.S. dollars (or other foreign exchange) were received. It also
assumes that the expenses summed up as "cost of sales" were all dollar expenses and that no peso
expenses had been incurred. Picop's explanation further assumes that a substantial part of Picop's
dollar proceeds for its export sales were not actually surrendered to the domestic banking system and
seasonably converted into pesos; had all such dollar proceeds been converted into pesos then the peso
figures could have been simply added up to reflect the actual peso value of Picop's export sales. There
were no other evidence as to why there was a pre-determined exchange rate. Picop was unable to
explain why its Books of Accounts did not pick up the same adjustments that Picop's External
Auditors were alleged to have made for purposes of Picop's Income Tax Return.
PICOP’s attempt to explain the discrepancies in its book of accounts, which it has kept and prepared
under its own employees and which may be an admission against interest, SC is still not convinced.

Affirm the findings of CTA and CA

(4)

The 5% corporate development tax is an additional corporate income tax imposed in Section 24 (e) of
the 1977 Tax Code. Since this 5% corporate development tax is an income tax, PICOP is not
exempted from it under the provisions of Section 8 (a) of R.A. No. 5186.

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

SUMMARY:

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

PICOP is not liable for interest and surcharge on unpaid transaction tax.

PICOP is exempt from payment of documentary and science stamp taxes in the amount of P300,000
and the compromise penalty of P300.00

PICOP is entitled to its claimed deduction of P42,840,131 for interest payments on loands the
purchase of machinery and equipment.

PICOP’s claimed deduction in the amount of P44,196,106.00 for the operating losses previously
incurred by RPPM, is disallowed for lack of merit.

PICOP’s claimed deduction for certain 􏰀nancial guarantee expenses in the amount P1,237,421.00 is
disallowed for failure adequately to prove such expenses.

PICOP has understated its sales by P2,391,644.00 and overstated its cost of sales by P604,018.00, for
1977.

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

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

(1) 35% transaction tax P3,578,543.51

(2) Total Deficiency Income Tax Due P40,215,709.00

Aggregate Amount Due and Payable P43,794,252.51

SEPARATE OPINION
Vitug, J. – concurring

While I share, in most part, the conclusions expressed in the opinion, I regrettably find it difficult,
nevertheless, not to propose a reexamination of the Court's holding in Western Minolco Corporation
vs. Commissioner of Internal Revenue (124 SCRA 121), reiterated in Marinduque Mining and
Industrial Corporation vs. Commissioner of Internal Revenue (137 SCRA 88), that has taken the 35%
transaction tax on commercial papers issued in the primary market under the 1977 Revenue Code, in
relation to R.A.5186, to be an income tax. The income tax, referred to, in my view, is that imposed in
Title II, entitled "Income Tax," of the Revenue Code. Nowhere under that title is there a 35%
transaction tax.

There was a 35% transaction tax still in effect in 1977 but it was a tax not on the investor- lender in
whose favor the interest income on the commercial paper accrues. The tax was, instead, levied on the
borrower-issuer of commercial papers transacted in the primary market. Being the principal taxpayer,
the borrower-issuer could not have been likewise contemplated to be a mere tax withholding agent.
The tax was conceived as a tax on business transaction, and so it was rightly incorporated in Title V,
entitled "Privilege Taxes on Business and Occupation" of the Tax Code.

The fact that a taxpayer on whom the tax is imposed can shift, characteristic of indirect taxes, the
burden thereof to another does not make the latter the taxpayer and the former the withholding agent.
Indeed, the facility of shifting the burden of the tax is opposed to the idea of a direct tax to which
class the income tax actually belongs.

Accordingly, I vote to so reduce the tax liability of petitioners as adjudged by the amount
corresponding to the 35% transaction tax. In all other respects, I concur with the majority in the
judgment.