CIR v.

SC Johnson & Sons, 309 SCRA 87 (1999)

Facts

S.C. Johnson and Son, Inc., the respondent in this case, is a domestic corporation that entered
into a licensing agreement with SC Johnson and Son, USA, a foreign corporation not residing in
the same country. Under this agreement, the respondent was granted permission to use the
trademarks, patents, and technology owned by the latter company.

The respondent had an obligation to pay royalties to SC Johnson and Son, USA, based on a
percentage of their net sales. Additionally, the respondent was required to withhold 25% of the
royalty payments as withholding tax, which they duly paid. Subsequently, the respondent
submitted a request for a refund of the excessive withholding tax on royalties to the International
Tax Affairs Division (ITAD) of the Bureau of Internal Revenue. Their claim was based on the
argument that they should be eligible for a preferential tax rate of 10%.

However, the Commissioner did not take any action on the refund request. Consequently, the
private respondent initiated a petition for review before the Court of Tax Appeals (CTA). The
CTA ruled in favor of the private respondent and directed the Commissioner to issue a tax credit
certificate in favor of the respondent.

Following this, the Commissioner filed a petition for review with the Court of Appeals, and the
Court of Appeals affirmed the CTA's ruling in its entirety.

Issue

The question at hand is whether respondent SC Johnson and Son, Inc. is eligible for the 10%
royalty rate under the most favored nation clause, as stipulated in the RP-US Tax Treaty, with
regard to the RP-West Germany Tax Treaty.

Ruling

No. The purpose of the most favored nation clause is to establish the principle of equal
treatment in international relations. It allows citizens or subjects of the contracting nations to
enjoy the same privileges as those granted to the most favored nation. The key condition for
benefiting from this treatment is the similarity in the circumstances of tax payments, highlighting
the importance of equality.

Both the RP-US Tax Treaty and the RP-West Germany Tax Treaty involve taxation on royalties
related to the use of trademarks, patents, and technology.

The RP-US Tax Treaty is just one of several bilateral agreements that the Philippines has
entered into to prevent double taxation. These tax conventions are designed to eliminate the
situation where a person is subjected to comparable taxes by two or more states for the same
subject matter and during the same time period, known as international juridical double taxation.

Double taxation typically occurs when an individual is a resident of one contracting state and
earns income from, or holds capital in, another contracting state, and both states impose taxes
on that income or capital.

In this case, the Philippines is the state of source because the royalties are paid for the right to
use property or rights, such as trademarks, patents, and technology, located within the
Philippines. The United States is the state of residence because the taxpayer, S. C. Johnson
and Son, U.S.A., is headquartered there. According to the RP-US Tax Treaty, both the state of
residence and the state of source are allowed to tax the royalties, with restrictions on the tax
imposed by the state of source. Additionally, the relief from double taxation is provided through a
tax credit to citizens or residents of the United States, based on the taxes paid or accrued to the
Philippines. However, this amount cannot exceed the limitations set by United States law for the
taxable year.

Article 24 of the RP-Germany Tax Treaty permits crediting 20% of the gross amount of royalties
paid under Philippine law against German income and corporation tax. Conversely, Article 23 of
the RP-US Tax Treaty does not offer a similar tax credit. As the RP-US Tax Treaty does not
provide a matching tax credit of 20% for taxes paid to the Philippines on royalties, as allowed
under the RP-West Germany Tax Treaty, the private respondent cannot be considered eligible
for the 10% rate provided by the latter treaty. This is due to the absence of tax payments on
royalties under similar circumstances as required by the most favored nation clause.

Doctrine

Double taxation typically occurs when an individual is a resident of one contracting state and
earns income from, or holds capital in, another contracting state, and both states impose taxes
on that income or capital.
CIR v. Benigno Toda, 438 SCRA 290 (2004)

Facts

On March 2, 1989, CIC authorized Benigno P. Toda, Jr., who was the President and owner of
99.991% of its outstanding capital stock, to sell the Cibeles Building. Subsequently, on August
30, 1989, Toda purportedly sold the property for P100 million to Rafael A. Altonaga, who, on the
same day, sold the same property to Royal Match Inc. (RMI) for P200 million. Approximately
three and a half years later, Toda passed away.

On March 29, 1994, the Bureau of Internal Revenue (BIR) sent an assessment notice and
demand letter to CIC for a deficiency income tax related to the year 1989. On January 27, 1995,
the Estate of Benigno P. Toda, Jr., represented by special co-administrators Lorna Kapunan and
Mario Luza Bautista, received a Notice of Assessment from the Commissioner of Internal
Revenue (CIR) for a deficiency income tax for the year 1989. The Estate subsequently filed a
letter of protest, but the Commissioner dismissed the protest.

On February 15, 1996, the Estate filed a petition for review with the Court of Tax Appeals (CTA).
In its decision, the CTA determined that the Commissioner had failed to demonstrate that CIC
had engaged in fraud to deprive the government of the taxes owed. The CTA concluded that
even if a preconceived scheme was employed by CIC, it constituted tax avoidance rather than
tax evasion. Consequently, the CTA ruled that the Estate was not liable for the deficiency
income tax. The Commissioner then filed a petition for review with the Court of Appeals, which
upheld the CTA's decision. Hence, this is the appeal to the higher court.

Issue

Whether or not this is a case of tax evasion or tax avoidance.

Ruling

CIC indeed engaged in tax evasion.

Tax avoidance and tax evasion represent two common approaches employed by taxpayers to
mitigate their tax obligations. Tax avoidance involves the legitimate use of tax-saving strategies
permitted by law. Taxpayers should employ this method in good faith and within the boundaries
set by legal regulations. Conversely, tax evasion entails employing schemes that fall outside the
bounds of lawful means. When taxpayers engage in tax evasion, they typically expose
themselves to potential civil or criminal liabilities.

Tax evasion encompasses three key elements:

 1. The intent to achieve a specific outcome, such as paying less tax than the taxpayer
knows to be legally owed or not paying taxes when a tax liability exists.
2. An accompanying state of mind characterized as "evil," "bad faith," "willful," or
"deliberate and not accidental."
3. A course of action or omission that violates the law.

All these elements are present in the current case. The scheme employed by CIC, where it
appeared that there were two separate sales of the subject properties (first from CIC to
Altonaga and then from Altonaga to RMI), cannot be considered a legitimate tax planning
strategy. This scheme is tainted with fraudulent intent.

Altonaga's primary motive in acquiring and immediately transferring the title of the subject
properties on the same day was to create a tax shelter. The sale to him was essentially a tax
maneuver, a deceptive tactic without a genuine business purpose or economic substance.
Undoubtedly, the execution of these two sales was a deliberate effort to mislead the Bureau of
Internal Revenue (BIR) with the ultimate goal of reducing the resulting income tax liability.
Philex Mining v. CIR, G.R. No. L-125704, 28 Aug 1998

Facts

The Bureau of Internal Revenue (BIR) sent a letter to Philex Mining Corporation, requesting the
settlement of its excise tax liabilities, totaling P124 million. Philex responded by protesting the
payment demand, explaining that it had pending claims for input VAT credit/refund amounting to
P120 million. Philex argued that these tax credit/refund claims should be offset against the tax
liabilities.

In response, the BIR disagreed with Philex's position. They argued that since the pending
claims had not been conclusively established or determined, there could be no legal
compensation. Consequently, the BIR reiterated its demand for Philex to settle the outstanding
amount, along with interest, within 30 days from the receipt of their letter.

Upon appealing the case, the Court of Tax Appeals (CTA) ruled in favor of the BIR. Philex's
subsequent motion for reconsideration was also denied.

However, shortly after the denial of its motion for reconsideration, Philex managed to obtain its
VAT input credit/refund. In light of this grant, Philex now contends that it should automatically
offset this refund against its excise tax liabilities since both amounts had become due and
demandable, and were fully liquidated. Philex asserts that legal compensation should be
allowed to occur.

Issue

Whether legal compensation can properly take place between the VAT input credit/refund and
the excise tax liabilities of Philex.

Ruling

No. Taxes cannot be subject to compensation against any claims the taxpayer may have
against the government. This is because the government and the taxpayer do not have a
creditor-debtor relationship with each other. There is a fundamental distinction between taxes
and debts. Debts are obligations owed to the government in its corporate capacity, while taxes
are obligations owed to the government in its sovereign capacity.

As a result, a person cannot refuse to pay a tax by arguing that the government owes them an
amount equal to or greater than the tax being collected. The collection of taxes cannot be
delayed pending the outcome of a lawsuit against the government.

Philex's reliance on a previous court ruling in Commissioner of Internal Revenue v.

Itogon-Suyoc Mines, Inc., where it was held that a pending refund could offset an existing tax
liability even if the refund had not yet been approved by the Commissioner, is not valid. This
stance lacks support in current statutory law. When the National Internal Revenue Code of 1977
was enacted, the provision on which the Itogon-Suyoc decision was based was removed. The
ruling contradicts the fundamental principle in tax law that taxes are essential revenue for the
government and should be collected without unnecessary obstacles. A key feature of taxes is
that they are mandatory and not subject to the taxpayer's consent.
CIR v. BOAC, 149 SCRA 395 (1987)

Facts

The petitioner, Commissioner of Internal Revenue (CIR), is seeking a review of the decision by
the Court of Tax Appeals, which set aside the petitioner's assessment of deficiency income
taxes against the respondent, British Overseas Airways Corporation (BOAC), for the fiscal years
1959 to 1971.

BOAC is a 100% British Government-owned corporation that operates under the laws of the
United Kingdom and is engaged in the international airline business. During the periods covered
by the disputed assessments, BOAC did not have landing rights for traffic purposes in the
Philippines. Consequently, it did not transport passengers or cargo to or from the Philippines.
However, BOAC did maintain a general sales agent in the Philippines—first Wamer Barnes and
Company, Ltd., and later Qantas Airways—which was responsible for selling BOAC tickets
covering passengers and cargo.

On October 7, 1970, BOAC filed a claim for a refund of P858,307.79, which was subsequently
denied by the CIR on February 16, 1972. Before this denial, BOAC had already filed a petition
for review with the Tax Court on January 27, 1972, challenging the assessment and requesting
a refund of the amount paid.

The Court of Tax Appeals ruled in favor of BOAC, asserting that the proceeds from the sale of
BOAC tickets did not constitute BOAC income from Philippine sources. This was because
BOAC had not provided any carriage services for passengers or freight within the Philippines.
Consequently, the income was not subject to Philippine income tax. The CTA's position was that
income from transportation is considered income from services, and the source of such income
is determined by the location where the services are rendered.

Issue

Whether the income received by BOAC from the sale of air transportation tickets, despite not
having landing rights in the Philippines, should be categorized as income originating from
Philippine sources, and consequently, be subject to taxation.

Ruling

Yes. The source of income is the property, activity, or service responsible for generating that
income. To qualify as income originating from the Philippines, it is sufficient that the income is a
result of activity within the Philippines. In the case of BOAC, the sale of tickets in the Philippines
is the activity that generates income. These tickets were exchanged and payments were made
in Philippine currency. The point of payment is considered the source of income, which is within
the Philippines. The flow of wealth transpired within Philippine territory and benefited from the
protection of the Philippine government. Given this protection, the flow of wealth should
contribute to supporting the government.

It's essential to note that a transportation ticket is not merely a piece of paper; it represents a
contractual agreement between the ticket-holder and the carrier. It establishes the obligation of
the ticket purchaser to pay the fare and the corresponding obligation of the carrier to transport
the passenger under the terms and conditions specified on the ticket. Such tickets, issued to the
general traveling public, encompass all the elements of a valid contract, binding both parties
involved.

While Section 37(a) of the Tax Code enumerates types of gross income from sources within the
Philippines, such as interest, dividends, service, rentals and royalties, sale of real property, and
sale of personal property, it does not explicitly mention income from the sale of tickets for
international transportation. However, this omission does not exclude it from being considered
income from sources within the Philippines. Section 37 does not intend for its list to be
exhaustive. It simply designates the specified types of income as being from Philippine sources.
The section does not claim exclusivity, and other forms of income can be regarded as such.

The absence of flight operations to and from the Philippines does not determine the source of
income or the location of income taxation. Although BOAC was categorized as an off-line
international airline during the relevant period, the key criterion for taxability is the "source" of
income. The source of income is the activity that produced it. Incontestably, the sales of travel
documents, in these cases, took place in the Philippines, and the revenue generated stemmed
from an activity consistently conducted within the Philippines. Even if the BOAC tickets covered
the "transport of passengers and cargo to and from foreign cities," this does not alter the fact
that income from ticket sales originated in the Philippines. The term "source" essentially denotes
origin, and the origin of the income in this context is unequivocally the Philippines.
Madrigal v. Rafferty, G.R. No. 12287, 7 Aug 1918

Facts

Vicente Madrigal and Susana Paterno were lawfully married, and their marriage was conducted
according to the legal provisions governing conjugal partnerships (sociedad de gananciales).
On February 25, 1915, Vicente Madrigal submitted a sworn declaration to the Collector of
Internal Revenue, indicating that his total net income for the year 1914 amounted to
P296,302.73.

Subsequently, Madrigal asserted that the P296,302.73 did not represent his individual income
for the year 1914. Instead, he claimed that it constituted the income of the conjugal partnership
existing between himself and his wife, Susana Paterno. He argued that when calculating and
assessing the additional income tax mandated by the Act of Congress of October 3, 1913, the
income declared by Vicente Madrigal should be divided equally into two parts: one-half
attributed to Vicente Madrigal and the other half to Susana Paterno.

However, the revenue officer was not satisfied with Madrigal's explanation, and ultimately, the
United States Commissioner of Internal Revenue ruled against Madrigal's claim. Under protest,
Madrigal paid the assessed amount, which totaled P3,786.08. Subsequently, the couple sought
to recover this sum, alleging that it had been wrongfully and unlawfully assessed and collected
by the Commissioner of Internal Revenue.

Issue

Whether or not the income reported by Madrigal on February 25, 1915 should be divided
into 2 in computing for the additional income tax because of the conjugal partnership.

Ruling

No. The fundamental distinction between capital and income lies in their nature: capital is a
fund; income is a flow. In simpler terms, capital is akin to wealth, while income refers to the
utilization or service of that wealth.

In the context of the case, Mrs. Paterno holds an inchoate right to her husband Mr. Madrigal's
property during the existence of their conjugal partnership. Her interest is related to the ultimate
property rights and ownership of assets acquired as income, but only after that income has
transformed into capital. Mrs. Paterno does not possess an absolute entitlement to half of the
conjugal partnership's income. Since she does not have a distinct estate separate from her
husband, she cannot file a separate tax return to benefit from any exemptions associated with
the additional tax.

It is essential to note that the Income Tax Law does not treat spouses as individual partners in a
regular business partnership. Instead, it grants them a specific exemption of P8,000 as provided
by law. Attempting to circumvent the higher tax brackets intended for wealthier individuals by
relying on provisions from the Civil Code governing conjugal partnerships, which do not apply to
the Income Tax Law, would partially undermine the purpose of those tax schedules.

Furthermore, the Income Tax Law was originally drafted by the United States Congress and
subsequently extended to the Philippines by the same body. Given its American origin and its
intricate provisions, considerable weight should be given to the interpretation of this law by the
relevant government officials charged with its enforcement. It has become an established
principle that the interpretation provided by the government department responsible for
implementing a revenue law, especially in cases of ambiguity, holds significant authority within
the Philippines.