VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy Collector of Internal
Revenue, defendants-appellees.
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 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 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 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 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 AttorneyGeneral is as follows:
TREASURY DEPARTMENT, Washington.
Income Tax.
FRANK
Chief,
Bureau
Washington, D. C.

of

Insular

Affairs,

War

MCINTYRE,
Department,

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 GovernorGeneral 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 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.
Acting Commissioner.

GATES.

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 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.

FREDERICK
C.
vs.
WENCESLAO TRINIDAD, Collector of Internal Revenue, defendant-appellee.
Fisher
and
De
Witt
and
Acting Attorney-General Tuason for appellee.

Antonio

M.

FISHER, plaintiff-appellant,

Opisso

for

appellants.

JOHNSON, J.:
The only question presented by this appeal is: Are the "stock dividends" in the present case "income" and taxable
as such under the provisions of section 25 of Act No. 2833? While the appellant presents other important
questions, under the view which we have taken of the facts and the law applicable to the present case, we
deem it unnecessary to discuss them now.
The defendant demurred to the petition in the lower court. The facts are therefore admitted. They are simple and
may be stated as follows:
That during the year 1919 the Philippine American Drug Company was a corporation duly organized and existing
under the laws of the Philippine Islands, doing business in the City of Manila; that he appellant was a stockholder
in said corporation; that said corporation, as result of the business for that year, declared a "stock dividend"; that
the proportionate share of said stock divided of the appellant was P24,800; that the stock dividend for that
amount was issued to the appellant; that thereafter, in the month of March, 1920, the appellant, upon demand
of the appellee, paid under protest, and voluntarily, unto the appellee the sum of P889.91 as income tax on said

stock dividend. For the recovery of that sum (P889.91) the present action was instituted. The defendant demurred
to the petition upon the ground that it did not state facts sufficient to constitute cause of action. The demurrer
was sustained and the plaintiff appealed.
To sustain his appeal the appellant cites and relies on some decisions of the Supreme Court of the United States
as will as the decisions of the supreme court of some of the states of the Union, in which the questions before us,
based upon similar statutes, was discussed. Among the most important decisions may be mentioned the
following: Towne vs. Eisner, 245 U.S., 418; Doyle vs. Mitchell Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S.,
189; Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. Charlottesville Woolen Mills, 93 Va., 673.
In each of said cases an effort was made to collect an "income tax" upon "stock dividends" and in each case it
was held that "stock dividends" were capital and not an "income" and therefore not subject to the "income tax"
law.
The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U.S., 189) that a "stock
dividend" is not "income" but argues that said Act No. 2833, in imposing the tax on the stock dividend, does not
violate the provisions of the Jones Law. The appellee further argues that the statute of the United States providing
for tax upon stock dividends is different from the statute of the Philippine Islands, and therefore the decision of the
Supreme Court of the United States should not be followed in interpreting the statute in force here.
For the purpose of ascertaining the difference in the said statutes ( (United States and Philippine Islands),
providing for an income tax in the United States as well as that in the Philippine Islands, the two statutes are here
quoted for the purpose of determining the difference, if any, in the language of the two statutes.
Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the collection of an "income
tax." Section 2 of said Act attempts to define what is an income. The definition follows:
That the term "dividends" as used in this title shall be held to mean any distribution made or ordered to
made by a corporation, . . . which stock dividend shall be considered income, to the amount of its cash
value.
Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax." Section 25 of said Act attempts to
define the application of the income tax. The definition follows:
The term "dividends" as used in this Law shall be held to mean any distribution made or ordered to be
made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and
thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, . . . . Stock
dividend shall be considered income, to the amount of the earnings or profits distributed.
It will be noted from a reading of the provisions of the two laws above quoted that the writer of the law of the
Philippine Islands must have had before him the statute of the United States. No important argument can be
based upon the slight different in the wording of the two sections.
It is further argued by the appellee that there are no constitutional limitations upon the power of the Philippine
Legislature such as exist in the United States, and in support of that contention, he cites a number of decisions.
There is no question that the Philippine Legislature may provide for the payment of an income tax, but it cannot,
under the guise of an income tax, collect a tax on property which is not an "income." The Philippine Legislature
can not impose a tax upon "property" under a law which provides for a tax upon "income" only. The Philippine
Legislature has no power to provide a tax upon "automobiles" only, and under that law collect a tax upon
acarreton or bull cart. Constitutional limitations, that is to say, a statute expressly adopted for one purpose
cannot, without amendment, be applied to another purpose which is entirely distinct and different. A statute
providing for an income tax cannot be construed to cover property which is not, in fact income. The Legislature
cannot, by a statutory declaration, change the real nature of a tax which it imposes. A law which imposes an
important tax on rice only cannot be construed to an impose an importation tax on corn.
It is true that the statute in question provides for an income tax and contains a further provision that "stock
dividends" shall be considered income and are therefore subject to income tax provided for in said law. If "stock

dividends" are not "income" then the law permits a tax upon something not within the purpose and intent of the
law.
It becomes necessary in this connection to ascertain what is an "income in order that we may be able to
determine whether "stock dividends" are "income" in the sense that the word is used in the statute. Perhaps it
would be more logical to determine first what are "stock dividends" in order that we may more clearly understand
their relation to "income." Generally speaking, stock dividends represent undistributed increase in the capital of
corporations or firms, joint stock companies, etc., etc., for a particular period. They are used to show the
increased interest or proportional shares in the capital of each stockholder. In other words, the inventory of the
property of the corporation, etc., for particular period shows an increase in its capital, so that the stock
theretofore issued does not show the real value of the stockholder's interest, and additional stock is issued
showing the increase in the actual capital, or property, or assets of the corporation, etc.
To illustrate: A and B form a corporation with an authorized capital of P10,000 for the purpose of opening and
conducting a drug store, with assets of the value of P2,000, and each contributes P1,000. Their entire assets are
invested in drugs and put upon the shelves in their place of business. They commence business without a cent in
the treasury. Every dollar contributed is invested. Shares of stock to the amount of P1,000 are issued to each of
the incorporators, which represent the actual investment and entire assets of the corporation. Business for the first
year is good. Merchandise is sold, and purchased, to meet the demands of the growing trade. At the end of the
first year an inventory of the assets of the corporation is made, and it is then ascertained that the assets or capital
of the corporation on hand amount to P4,000, with no debts, and still not a cent in the treasury. All of the receipts
during the year have been reinvested in the business. Neither of the stockholders have withdrawn a penny from
the business during the year. Every peso received for the sale of merchandise was immediately used in the
purchase of new stock new supplies. At the close of the year there is not a centavo in the treasury, with which
either A or B could buy a cup of coffee or a pair of shoes for his family. At the beginning of the year they were
P2,000, and at the end of the year they were P4,000, and neither of the stockholders have received a centavo
from the business during the year. At the close of the year, when it is discovered that the assets are P4,000 and
not P2,000, instead of selling the extra merchandise on hand and thereby reducing the business to its original
capital, they agree among themselves to increase the capital they agree among themselves to increase the
capital issued and for that purpose issue additional stock in the form of "stock dividends" or additional stock of
P1,000 each, which represents the actual increase of the shares of interest in the business. At the beginning of the
year each stockholder held one-half interest in the capital. At the close of the year, and after the issue of the said
stock dividends, they each still have one-half interest in the business. The capital of the corporation increased
during the year, but has either of them received an income? It is not denied, for the purpose of ordinary taxation,
that the taxable property of the corporation at the beginning of the year was P2,000, that at the close of the
year it was P4,000, and that the tax rolls should be changed in accordance with the changed conditions in the
business. In other words, the ordinary tax should be increased by P2,000.
Another illustration: C and D organized a corporation for agricultural purposes with an authorized capital stock of
P20,000 each contributing P5,000. With that capital they purchased a farm and, with it, one hundred head of
cattle. Every peso contributed is invested. There is no money in the treasury. Much time and labor was expanded
during the year by the stockholders on the farm in the way of improvements. Neither received a centavo during
the year from the farm or the cattle. At the beginning of the year the assets of the corporation, including the
farm and the cattle, were P10,000, and at the close of the year and inventory of the property of the corporation
is made and it is then found that they have the same farm with its improvements and two hundred head of cattle
by natural increase. At the end of the year it is also discovered that, by reason of business changes, the farm and
the cattle both have increased in value, and that the value of the corporate property is now P20,000 instead of
P10,000 as it was at the beginning of the year. The incorporators instead of reducing the property to its original
capital, by selling off a part of its, issue to themselves "stock dividends" to represent the proportional value or
interest of each of the stockholders in the increased capital at the close of the year. There is still not a centavo in
the treasury and neither has withdrawn a peso from the business during the year. No part of the farm or cattle
has been sold and not a single peso was received out of the rents or profits of the capital of the corporation by
the stockholders.
Another illustration: A, an individual farmer, buys a farm with one hundred head of cattle for the sum of P10,000.
At the end of the first year, by reason of business conditions and the increase of the value of both real estate and
personal property, it is discovered that the value of the farm and the cattle is P20,000. A, during the year, has
received nothing from the farm or the cattle. His books at the beginning of the year show that he had property of
the value of P10,000. His books at the close of the year show that he has property of the value of P20,000. A is not

a corporation. The assets of his business are not shown therefore by certificates of stock. His books, however, show
that the value of his property has increased during the year by P10,000, under any theory of business or law, be
regarded as an "income" upon which the farmer can be required to pay an income tax? Is there any difference
in law in the condition of A in this illustration and the condition of A and B in the immediately preceding
illustration? Can the increase of the value of the property in either case be regarded as an "income" and be
subjected to the payment of the income tax under the law?
Each of the foregoing illustrations, it is asserted, is analogous to the case before us and, in view of that fact, let us
ascertain how lexicographers and the courts have defined an "income." The New Standard Dictionary, edition of
1915, defines an income as "the amount of money coming to a person or corporation within a specified time
whether as payment or corporation within a specified time whether as payment for services, interest, or profit
from investment." Webster's International Dictionary defines an income as "the receipt, salary; especially, the
annual receipts of a private person or a corporation from property." Bouvier, in his law dictionary, says that an
"income" in the federal constitution and income tax act, is used in its common or ordinary meaning and not in its
technical, or economic sense. (146 Northwestern Reporter, 812) Mr. Black, in his law dictionary, says "An income is
the returnin money from one's business, labor, or capital invested; gains, profit or private revenue." "An income
tax is a tax on the yearly profits arising from property , professions, trades, and offices."
The Supreme Court of the United States, in the case o Gray vs. Darlington (82 U.S., 653), said in speaking of
income that mere advance in value in no sense constitutes the "income" specified in the revenue law as
"income" of the owner for the year in which the sale of the property was made. Such advance constitutes and
can be treated merely as an increase of capital. (In re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 Pa.,
414.)
Mr. Justice Hughes, later Associate Justice of the Supreme Court of the United States and now Secretary of State
of the United States, in his argument before the Supreme Court of the United States in the case of Towne vs.
Eisner, supra, defined an "income" in an income tax law, unless it is otherwise specified, to mean cash or its
equivalent. It does not mean choses in action or unrealized increments in the value of the property, and cites in
support of the definition, the definition given by the Supreme Court in the case of Gray vs. Darlington, supra.
In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for the court, said: "Notwithstanding the
thoughtful discussion that the case received below, we cannot doubt that the dividend was capital as well for
the purposes of the Income Tax Law. . . . 'A stock dividend really takes nothing from the property of the
corporation, and adds nothing to the interests of the shareholders. Its property is not diminished and their interest
are not increased. . . . The proportional interest of each shareholder remains the same. . . .' In short, the
corporation is no poorer and the stockholder is no richer then they were before." (Gibbons vs. Mahon, 136 U.S.,
549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).
In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice Pitney, speaking for the court, said that the act
employs the term "income" in its natural and obvious sense, as importing something distinct from principal or
capital and conveying the idea of gain or increase arising from corporate activity.
Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speaking for the court said: "An
income may be defined as the gain derived from capital, from labor, or from both combined, provided it be
understood to include profit gained through a sale or conversion of capital assets."
For bookkeeping purposes, when stock dividends are declared, the corporation or company acknowledges a
liability, in form, to the stockholders, equivalent to the aggregate par value of their stock, evidenced by a
"capital stock account." If profits have been made by the corporation during a particular period and not divided,
they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus
account," etc., or the like. None of these, however, gives to the stockholders as a body, much less to any one of
them, either a claim against the going concern or corporation, for any particular sum of money, or a right to any
particular portion of the asset, or any shares sells or until the directors conclude that dividends shall be made a
part of the company's assets segregated from the common fund for that purpose. The dividend normally is
payable in money and when so paid, then only does the stockholder realize a profit or gain, which becomes his
separate property, and thus derive an income from the capital that he has invested. Until that, is done
theincreased assets belong to the corporation and not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated profits have
been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution, in
money or in kind, should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather
to postpone said realization, in that the fund represented by the new stock has been transferred from surplus to
assets, and no longer is available for actual distribution. The essential and controlling fact is that the stockholder
has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar
of his original investment, together with whatever accretions and accumulations resulting from employment of his
money and that of the other stockholders in the business of the company, still remains the property of the
company, and subject to business risks which may result in wiping out of the entire investment. Having regard to
the very truth of the matter, to substance and not to form, the stockholder by virtue of the stock dividend has in
fact received nothing that answers the definition of an "income." (Eisner vs. Macomber, 252 U.S., 189, 209, 211.)
The stockholder who receives a stock dividend has received nothing but a representation of his increased
interest in the capital of the corporation. There has been no separation or segregation of his interest. All the
property or capital of the corporation still belongs to the corporation. There has been no separation of the
interest of the stockholder from the general capital of the corporation. The stockholder, by virtue of the stock
dividend, has no separate or individual control over the interest represented thereby, further than he had before
the stock dividend was issued. He cannot use it for the reason that it is still the property of the corporation and not
the property of the individual holder of stock dividend. A certificate of stock represented by the stock dividend is
simply a statement of his proportional interest or participation in the capital of the corporation. For bookkeeping
purposes, a corporation, by issuing stock dividend, acknowledges a liability in form to the stockholders,
evidenced by a capital stock account. The receipt of a stock dividend in no way increases the money received
of a stockholder nor his cash account at the close of the year. It simply shows that there has been an increase in
the amount of the capital of the corporation during the particular period, which may be due to an increased
business or to a natural increase of the value of the capital due to business, economic, or other reasons. We
believe that the Legislature, when it provided for an "income tax," intended to tax only the "income" of
corporations, firms or individuals, as that term is generally used in its common acceptation; that is that the income
means money received, coming to a person or corporation for services, interest, or profit from investments. We
do not believe that the Legislature intended that a mere increase in the value of the capital or assets of a
corporation, firm, or individual, should be taxed as "income." Such property can be reached under the ordinary
from of taxation.
Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in discussing the difference between
"capital" and "income": "That the fundamental relation of 'capital' to 'income' has been much discussed by
economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former
depicted as a reservoir supplied from springs; the latter as the outlet stream, to be measured by its flow during a
period of time." It may be argued that a stockholder might sell the stock dividend which he had acquired. If he
does, then he has received, in fact, an income and such income, like any other profit which he realizes from the
business, is an income and he may be taxed thereon.
There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock
dividends declared, as in the present case. The one is a disbursement to the stockholder of accumulated
earnings, and the corporation at once parts irrevocably with all interest thereon. The other involves no
disbursement by the corporation. It parts with nothing to the stockholder. The latter receives, not an actual
dividend, but certificate of stock which simply evidences his interest in the entire capital, including such as by
investment of accumulated profits has been added to the original capital. They are not income to him, but
represent additions to the source of his income, namely, his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63
L.R.A. 587). Such a person is in the same position, so far as his income is concerned, as the owner of young
domestic animal, one year old at the beginning of the year, which is worth P50 and, which, at the end of the
year, and by reason of its growth, is worth P100. The value of his property has increased, but has had an income
during the year? It is true that he had taxable property at the beginning of the year of the value of P50, and the
same taxable property at another period, of the value of P100, but he has had no income in the common
acceptation of that word. The increase in the value of the property should be taken account of on the tax
duplicate for the purposes of ordinary taxation, but not as income for he has had none.
The question whether stock dividends are income, or capital, or assets has frequently come before the courts in
another form in cases of inheritance. A is a stockholder in a large corporation. He dies leaving a will by the
terms of which he give to B during his lifetime the "income" from said stock, with a further provision that C shall, at
B's death, become the owner of his share in the corporation. During B's life the corporation issues a stock

dividend. Does the stock dividend belong to B as an income, or does it finally belong to C as a part of his share in
the capital or assets of the corporation, which had been left to him as a remainder by A? While there has been
some difference of opinion on that question, we believe that a great weight of authorities hold that the stock
dividend is capital or assets belonging to C and not an income belonging to B. In the case of D'Ooge vs. Leeds
(176 Mass., 558, 560) it was held that stock dividends in such cases were regarded as capital and not
as income(Gibbons vs. Mahon, 136 U.S., 549.)
In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The distinction between the title of a corporation,
and the interest of its members or stockholders in the property of the corporation, is familiar and well settled. The
ownership of that property is in the corporation, and not in the holders of shares of its stock. The interest of each
stockholder consists in the right to a proportionate part of the profits whenever dividends are declared by the
corporation, during its existence, under its charter, and to a like proportion of the property remaining, upon the
termination or dissolution of the corporation, after payment of its debts." (Minot vs. Paine, 99 Mass., 101; Greeff vs.
Equitable Life Assurance Society, 160 N. Y., 19.) In the case of Dekoven vs. Alsop (205 Ill ,309, 63 L. R. A. 587) Mr.
Justice Wilkin said: "A dividend is defined as a corporate profit set aside, declared, and ordered by the directors
to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, these corporate
profits belong to the corporation, not to the stockholders, and are liable for corporate indebtedness.
There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock
dividends declared. The one is a disbursement to the stockholders of accumulated earning, and the corporation
at once parts irrevocably with all interest thereon. The other involves no disbursement by the corporation. It parts
with nothing to the stockholders. The latter receives, not an actual dividend, but certificates of stock which
evidence in a new proportion his interest in the entire capital. When a cash becomes the absolute property of
the stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A stock
dividend however, still being the property of the corporation and not the stockholder, it may be reached by an
execution against the corporation, and sold as a part of the property of the corporation. In such a case, if all the
property of the corporation is sold, then the stockholder certainly could not be charged with having received an
income by virtue of the issuance of the stock dividend. Until the dividend is declared and paid, the corporate
profits still belong to the corporation, not to the stockholders, and are liable for corporate indebtedness. The rule
is well established that cash dividend, whether large or small, are regarded as "income" and all stock dividends,
as capital or assets (Cook on Corporation, Chapter 32, secs. 534, 536; Davis vs. Jackson, 152 Mass., 58; Mills vs.
Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of Law, 2d ed., p. 738.)
If the ownership of the property represented by a stock dividend is still in the corporation and to in the holder of
such stock, then it is difficult to understand how it can be regarded as income to the stockholder and not as a
part of the capital or assets of the corporation. (Gibbsons vs. Mahon, supra.) the stockholder has received
nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may
never receive anything, depending upon the final outcome of the business of the corporation. The entire assets
of the corporation may be consumed by mismanagement, or eaten up by debts and obligations, in which case
the holder of the stock dividend will never have received an income from his investment in the corporation. A
corporation may be solvent and prosperous today and issue stock dividends in representation of its increased
assets, and tomorrow be absolutely insolvent by reason of changes in business conditions, and in such a case the
stockholder would have received nothing from his investment. In such a case, if the holder of the stock dividend
is required to pay an income tax on the same, the result would be that he has paid a tax upon an income which
he never received. Such a conclusion is absolutely contradictory to the idea of an income. An income subject to
taxation under the law must be an actual income and not a promised or prospective income.
The appelle argues that there is nothing in section 25 of Act No 2833 which contravenes the provisions of the
Jones Law. That may be admitted. He further argues that the Act of Congress (U.S. Revenue Act of 1918)
expressly authorized the Philippine Legislatures to provide for an income tax. That fact may also be admitted. But
a careful reading of that Act will show that, while it permitted a tax upon income, the same provided that
income shall include gains, profits, and income derived from salaries, wages, or compensation for personal
services, as well as from interest, rent, dividends, securities, etc. The appellee emphasizes the "income from
dividends." Of course, income received as dividends is taxable as an income but an income from "dividends" is a
very different thing from receipt of a "stock dividend." One is an actual receipt of profits; the other is a receipt of
a representation of the increased value of the assets of corporation.
In all of the foregoing argument we have not overlooked the decisions of a few of the courts in different parts of
the world, which have reached a different conclusion from the one which we have arrived at in the present

case. Inasmuch, however, as appeals may be taken from this court to the Supreme Court of the United States,
we feel bound to follow the same doctrine announced by that court.
Having reached the conclusion, supported by the great weight of the authority, that "stock dividends" are not
"income," the same cannot be taxes under that provision of Act No. 2833 which provides for a tax upon income.
Under the guise of an income tax, property which is not an income cannot be taxed. When the assets of a
corporation have increased so as to justify the issuance of a stock dividend, the increase of the assets should be
taken account of the Government in the ordinary tax duplicates for the purposes of assessment and collection of
an additional tax. For all of the foregoing reasons, we are of the opinion, and so decide, that the judgment of the
lower court should be revoked, and without any finding as to costs, it is so ordered.
G.R. No. L-21570

July 26, 1966

LIMPAN
INVESTMENT
vs.
COMMISSIONER OF INTERNAL REVENUE, ET AL., respondents.

CORPORATION, petitioner,

Vicente
L.
San
Luis
for
petitioner.
Office of the Solicitor General A. A. Alafriz, Assistant Solicitor General F. B. Rosete, Solicitor A. B. Afurong and Atty.
V. G. Saldajeno for respondents.
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 and 1% monthly
interest from June 30, 1959 to the date of payment, with cost.
The facts of this case are:
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 Ceiza 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.1wph1.t
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, Vicente Pantangco Vda. de Lim.
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 underdeclared 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 P4,260.00 and P16,336.00 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:
90-AR-C-348-58/56
Net income per audited return
Add: Unallowable deductions:
Undeclared Rental Receipt

P 3,287.81

(Sched. A) . . . . . . . . . . . . . . . . . . . . P20,199.00
Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . . . 4,260.00 P24,459.00
Net income per investigation

P27,746.00

Tax due thereon

P5,549.00

Less: Amount already assessed

657.00

Balance

P4,892.00

Add: 50% Surcharge

2,446.00

DEFICIENCY TAX DUE

P7,338.00

90-AR-C-1196-58/57
Net income per audited return

P11,098.00

Add: Unallowable deductions:

Undeclared Rental Receipt (Sched. A) . . . . . . . . P81,690.00
Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . 16,338.00

P98,028.00

Net income per investigation

P109,126.00

Tax due thereon

P22,555.00

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 building 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
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 subtenant 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 of 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 tenants 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, 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.
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:
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 was excessive.
and prays that the appealed decision be reversed.
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 returns, 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 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.
On the third assigned error, suffice it to state that this Court has already held that "depreciation is a question of
fact and is not measured by theoretical yardstick, but should be determined by a consideration of actual facts",
and the findings of the Tax Court in this respect should not be disturbed when not shown to be arbitrary or in
abuse of discretion (Commissioner of Internal Revenue vs. Priscila Estate, Inc., et al., L-18282, May 29, 1964), and
petitioner has not shown any arbitrariness or abuse of discretion in the part of the Tax Court in finding that
petitioner claimed excessive depreciation in its returns. It appearing that the Tax Court applied rates of
depreciation in accordance with Bulletin "F" of the U.S. Federal Internal Revenue Service, which this Court
pronounced as having strong persuasive effect in this jurisdiction, for having been the result of scientific studies
and observation for a long period in the United States, after whose Income Tax Law ours is patterned (M. Zamora
vs. Collector of internal Revenue & Collector of Internal Revenue vs. M. Zamora; E. Zamora vs. Collector of
Internal Revenue and Collector of Internal Revenue vs. E. Zamora, Nos. L-15280, L-15290, L-15289 and L-15281,
May 31, 1963), the foregoing error is devoid of merit.
Wherefore, the appealed decision should be, as it is hereby, affirmed. With costs against petitioner-appellant,
Limpan Investment Corporation.
CONWI vs. CTA
Petitioners pray that his Court reverse the Decision of the public respondent Court of Tax Appeals, promulgated
September 26, 1977 1 denying petitioners' claim for tax refunds, and order the Commissioner of Internal Revenue
to refund to them their income taxes which they claim to have been erroneously or illegally paid or collected.
As summarized by the Solicitor General, the facts of the cases are as follows:
Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine Manufacturing
Corporation, with offices at Sarmiento Building, Ayala Avenue, Makati, Rizal. Said corporation is a
subsidiary of Procter & Gamble, a foreign corporation based in Cincinnati, Ohio, U.S.A. During the
years 1970 and 1971 petitioners were assigned, for certain periods, to other subsidiaries of Procter
& Gamble, outside of the Philippines, during which petitioners were paid U.S. dollars as
compensation for services in their foreign assignments. (Paragraphs III, Petitions for Review, C.T.A.
Cases Nos. 2511 and 2594, Exhs. D, D-1 to D-19). When petitioners in C.T.A. Case No. 2511 filed their
income tax returns for the year 1970, they computed the tax due by applying the dollar-to-peso
conversion on the basis of the floating rate ordained under B.I.R. Ruling No. 70-027 dated May 14,
1970, as follows:
From January 1 to February 20, 1970 at the conversion rate of P3.90 to U.S. $1.00;
From February 21 to December 31, 1970 at the conversion rate of P6.25 to U.S. $1.00
Petitioners in C.T.A. Case No. 2594 likewise used the above conversion rate in converting their
dollar income for 1971 to Philippine peso. However, on February 8, 1973 and October 8, 1973,
petitioners in said cases filed with the office of the respondent Commissioner, amended income
tax returns for the above-mentioned years, this time using the par value of the peso as prescribed
in Section 48 of Republic Act No. 265 in relation to Section 6 of Commonwealth Act No. 265 in
relation to Section 6 of Commonwealth Act No. 699 as the basis for converting their respective
dollar income into Philippine pesos for purposes of computing and paying the corresponding

income tax due from them. The aforesaid computation as shown in the amended income tax
returns resulted in the alleged overpayments, refund and/or tax credit. Accordingly, claims for
refund of said over-payments were filed with respondent Commissioner. Without awaiting the
resolution of the Commissioner of the Internal Revenue on their claims, petitioners filed their
petitioner for review in the above-mentioned cases.
Respondent Commissioner filed his Answer to petitioners' petition for review in C.T.A. Case No. 2511
on July 31, 1973, while his Answer in C.T.A. Case No. 2594 was filed on August 7, 1974.
Upon joint motion of the parties on the ground that these two cases involve common question of
law and facts, that respondent Court of Tax Appeals heard the cases jointly. In its decision dated
September 26, 1977, the respondent Court of Tax Appeals held that the proper conversion rate for
the purpose of reporting and paying the Philippine income tax on the dollar earnings of petitioners
are the rates prescribed under Revenue Memorandum Circulars Nos. 7-71 and 41-71. Accordingly,
the claim for refund and/or tax credit of petitioners in the above-entitled cases was denied and
the petitions for review dismissed, with costs against petitioners. Hence, this petition for review
oncertiorari. 2
Petitioners claim that public respondent Court of Tax Appeals erred in holding:
1. That petitioners' dollar earnings are receipts derived from foreign exchange transactions.
2. That the proper rate of conversion of petitioners' dollar earnings for tax purposes in the prevailing free market
rate of exchange and not the par value of the peso; and
3. That the use of the par value of the peso to convert petitioners' dollar earnings for tax purposes into Philippine
pesos is "unrealistic" and, therefore, the prevailing free market rate should be the rate used.
Respondent Commissioner of Internal Revenue, on the other hand, refutes petitioners' claims as follows:
At the outset, it is submitted that the subject matter of these two cases are Philippine income tax
for the calendar years 1970 (CTA Case No. 2511) and 1971 (CTA Case No. 2594) and, therefore,
should be governed by the provisions of the National Internal Revenue Code and its implementing
rules and regulations, and not by the provisions of Central Bank Circular No. 42 dated May 21,
1953, as contended by petitioners.
Section 21 of the National Internal Revenue Code, before its amendment by Presidential Decrees
Nos. 69 and 323 which took effect on January 1, 1973 and January 1, 1974, respectively, imposed
a tax upon the taxable net income received during each taxable year from all sources by a
citizen of the Philippines, whether residing here or abroad.
Petitioners are citizens of the Philippines temporarily residing abroad by virtue of their employment.
Thus, in their tax returns for the period involved herein, they gave their legal residence/address as
c/o Procter & Gamble PMC, Ayala Ave., Makati, Rizal (Annexes "A" to "A-8" and Annexes "C" to "C8", Petition for Review, CTA Nos. 2511 and 2594).
Petitioners being subject to Philippine income tax, their dollar earnings should be converted into
Philippine pesos in computing the income tax due therefrom, in accordance with the provisions of
Revenue Memorandum Circular No. 7-71 dated February 11, 1971 for 1970 income and Revenue
Memorandum Circular No. 41-71 dated December 21, 1971 for 1971 income, which reiterated BIR
Ruling No. 70-027 dated May 4, 1970, to wit:
For internal revenue tax purposes, the free marker rate of conversion (Revenue
Circulars Nos. 7-71 and 41-71) should be applied in order to determine the true and
correct value in Philippine pesos of the income of petitioners. 3

After a careful examination of the records, the laws involved and the jurisprudence on the matter, We are
inclined to agree with respondents Court of Tax Appeals and Commissioner of Internal Revenue and thus vote to
deny the petition.
This basically an income tax case. For the proper resolution of these cases 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. 4 Income can also be though of
as flow of the fruits of one's labor. 5
Petitioners are correct as to their claim that their dollar earnings are not receipts derived from foreign exchange
transactions. For a foreign exchange transaction is simply that a transaction in foreign exchange, foreign
exchange being "the conversion of an amount of money or currency of one country into an equivalent amount
of money or currency of another." 6 When petitioners were assigned to the foreign subsidiaries of Procter &
Gamble, they were earning in their assigned nation's currency and were ALSO spending in said currency. There
was no conversion, therefore, from one currency to another.
Public respondent Court of Tax Appeals did err when it concluded that the dollar incomes of petitioner fell under
Section 2(f)(g) and (m) of C.B. Circular No. 42. 7
The issue now is, what exchange rate should be used to determine the peso equivalent of the foreign earnings of
petitioners for income tax purposes. Petitioners claim that since the dollar earnings do not fall within the
classification of foreign exchange transactions, there occurred no actual inward remittances, and, therefore,
they are not included in the coverage of Central Bank Circular No. 289 which provides for the specific instances
when the par value of the peso shall not be the conversion rate used. They conclude that their earnings should
be converted for income tax purposes using the par value of the Philippine peso.
Respondent Commissioner argues that CB Circular No. 289 speaks of receipts for export products, receipts of sale
of foreign exchange or foreign borrowings and investments but not income tax. He also claims that he had to use
the prevailing free market rate of exchange in these cases because of the need to ascertain the true and
correct amount of income in Philippine peso of dollar earners for Philippine income tax purposes.
A careful reading of said CB Circular No. 289 8 shows that the subject matters involved therein are export
products, invisibles, receipts of foreign exchange, foreign exchange payments, new foreign borrowing and
investments nothing by way of income tax payments. Thus, petitioners are in error by concluding that since
C.B. Circular No. 289 does not apply to them, the par value of the peso should be the guiding rate used for
income tax purposes.
The dollar earnings of petitioners are the fruits of their labors in the foreign subsidiaries of Procter & Gamble. It was
a definite amount of money which came to them within a specified period of time of two yeas as payment for
their services.
Section 21 of the National Internal Revenue Code, amended up to August 4, 1969, states as follows:
Sec. 21. Rates of tax on citizens or residents. A tax is hereby imposed upon the taxable net
income received during each taxable year from all sources by every individual, whether a citizen
of the Philippines residing therein or abroad or an alien residing in the Philippines, determined in
accordance with the following schedule:
xxx xxx xxx
And in the implementation for the proper enforcement of the National Internal Revenue Code, Section 338
thereof empowers the Secretary of Finance to "promulgate all needful rules and regulations" to effectively
enforce its provisions. 9
Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71 10 and 41-71 11 were issued to prescribed a
uniform rate of exchange from US dollars to Philippine pesos for INTERNAL REVENUE TAX PURPOSES for the years
1970 and 1971, respectively. Said revenue circulars were a valid exercise of the authority given to the Secretary

of Finance by the Legislature which enacted the Internal Revenue Code. And these are presumed to be a valid
interpretation of said code until revoked by the Secretary of Finance himself. 12
Petitioners argue that since there were no remittances and acceptances of their salaries and wages in US dollars
into the Philippines, they are exempt from the coverage of such circulars. Petitioners forget that they are citizens
of the Philippines, and their income, within or without, and in these cases wholly without, are subject to income
tax. Sec. 21, NIRC, as amended, does not brook any exemption.
Since petitioners have already paid their 1970 and 1971 income taxes under the uniform rate of exchange
prescribed under the aforestated Revenue Memorandum Circulars, there is no reason for respondent
Commissioner to refund any taxes to petitioner as said Revenue Memorandum Circulars, being of long standing
and not contrary to law, are valid. 13
Although it has become a worn-out cliche, the fact still remains that "taxes are the lifeblood of the government"
and one of the duties of a Filipino citizen is to pay his income tax.
WHEREFORE, the petitioners are denied for lack of merit. The dismissal by the respondent Court of Tax Appeals of
petitioners' claims for tax refunds for the income tax period for 1970 and 1971 is AFFIRMED. Costs against
petitioners.
SO ORDERED.
Brief Fact Summary. The Supreme Court consolidated two cases with a similar issue. In both cases, the taxpayers
did
not
report
money
received
as
punitive
damages
as
income.
Synopsis of Rule of Law. Gross income includes gains or profits and income derived from any source whatsoever.
Facts. Glenshaw Glass manufactures glass bottles and containers and was in litigation with the Hartford-Empire
Company, which manufactures machinery used by Glenshaw. Glenshaw made demands for exemplary
damages for fraud and treble damages for injury to its business for Hartfords violations of antitrust laws. The
parties settled and Glenshaw received $800,000. Of that, $324,529.94 represented punitive damages. Glenshaw
did
not
report
that
amount
as
income.
In Commissioner v. William Goldman Theatres, Inc., William Goldman sued Loews Inc. for violations of antitrust
law and sought treble damages. William Goldman received $375,000 in treble damages but claimed $250,000 of
that represented punitive damages and did not report it as income.
Issue. Whether money received as exemplary damages for fraud or as punitive damages of an antitrust recovery
must be considered gross income?
Held. Chief Justice Warren issued the opinion for the Supreme Court of the United States in holding that the
amounts should be considered gross income.
Marrita MURPHY and Daniel J. Leveille, Appellants v. INTERNAL REVENUE SERVICE and United States of America,
Appellees.
No. 05-5139.
Decided: July 3, 2007
Before: GINSBURG, Chief Judge, and ROGERS and BROWN, Circuit Judges. David K. Colapinto argued the cause
for appellants. With him on the briefs were Stephen M. Kohn and Michael D. Kohn. Richard R. Renner was on the
brief for amici curiae No FEAR Coalition, et al. in support of appellants. Gilbert S. Rothenberg, Attorney, U.S.
Department of Justice, argued the cause for appellees.
With him on the brief were Jeffrey A. Taylor, U.S.
Attorney, Richard T. Morrison, Deputy Assistant Attorney General, and Kenneth L. Greene and Francesca U.
Tamami, Attorneys. Bridget M. Rowan, Attorney, entered an appearance.
On Rehearing

Marrita Murphy brought this suit to recover income taxes she paid on the compensatory damages for emotional
distress and loss of reputation she was awarded in an administrative action she brought against her former
employer. Murphy contends that under 104(a)(2) of the Internal Revenue Code (IRC), 26 U.S.C. 104(a)(2),
her award should have been excluded from her gross income because it was compensation received on
account of personal physical injuries or physical sickness. She also maintains that, in any event, her award is not
part of her gross income as defined by 61 of the IRC, 26 U.S.C. 61. Finally, she argues that taxing her award
subjects her to an unapportioned direct tax in violation of Article I, Section 9 of the Constitution of the United
States.
We reject Murphy's argument in all aspects.

We hold, first, that Murphy's compensation was not received on

account of personal physical injuries excludable from gross income under 104(a)(2). Second, we conclude
gross income as defined by 61 includes compensatory damages for non-physical injuries. Third, we hold that
a tax upon such damages is within the Congress's power to tax.
I. Background
In 1994 Marrita Leveille (now Murphy) filed a complaint with the Department of Labor alleging that her former
employer, the New York Air National Guard (NYANG), in violation of various whistle-blower statutes, had
blacklisted her and provided unfavorable references to potential employers after she had complained to state
authorities of environmental hazards on a NYANG airbase. The Secretary of Labor determined the NYANG had
unlawfully discriminated and retaliated against Murphy, ordered that any adverse references to the taxpayer in
the files of the Office of Personnel Management be withdrawn, and remanded her case to an Administrative Law
Judge for findings on compensatory damages.
On remand Murphy submitted evidence that she had suffered both mental and physical injuries as a result of the
NYANG's blacklisting her. A psychologist testified that Murphy had sustained both somatic and emotional
injuries, basing his conclusion in part upon medical and dental records showing Murphy had bruxism, or teeth
grinding often associated with stress, which may cause permanent tooth damage. Noting that Murphy also
suffered from other physical manifestations of stress including anxiety attacks, shortness of breath, and
dizziness, and that Murphy testified she could not concentrate, stopped talking to friends, and no longer
enjoyed anything in life, the ALJ recommended compensatory damages totaling $70,000, of which $45,000
was for past and future emotional distress, and $25,000 was for injury to [Murphy's] vocational reputation from
having been blacklisted. None of the award was for lost wages or diminished earning capacity.
In 1999 the Department of Labor Administrative Review Board affirmed the ALJ's findings and recommendations.
See Leveille v. N.Y. Air Nat'l Guard, 1999 WL 966951, at *2-*4 (Oct. 25, 1999). On her tax return for 2000, Murphy
included the $70,000 award in her gross income pursuant to 61 of the IRC. See 26 U.S.C. 61(a) ([G]ross
income means all income from whatever source derived). As a result, she paid $20,665 in taxes on the award.
Murphy later filed an amended return in which she sought a refund of the $20,665 based upon 104(a)(2) of the
IRC, which provides that gross income does not include damages received on account of personal
physical injuries or physical sickness. In support of her amended return, Murphy submitted copies of her dental
and medical records. Upon deciding Murphy had failed to demonstrate the compensatory damages were
attributable to physical injury or physical sickness, the Internal Revenue Service denied her request for a
refund. Murphy thereafter sued the IRS and the United States in the district court.
In her complaint Murphy sought a refund of the $20,665, plus applicable interest, pursuant to the Sixteenth
Amendment to the Constitution of the United States, along with declaratory and injunctive relief against the IRS
pursuant to the Administrative Procedure Act and the Due Process Clause of the Fifth Amendment. She argued
her compensatory award was in fact for physical personal injuries and therefore excluded from gross income
under 104(a)(2).
In the alternative Murphy asserted taxing her award was unconstitutional because the
award was not income within the meaning of the Sixteenth Amendment. The Government moved to dismiss
Murphy's suit as to the IRS, contending the Service was not a proper defendant, and for summary judgment on all
claims.

The district court denied the Government's motion to dismiss, holding that Murphy had the right to bring an
action[] for declaratory judgments or [a] mandatory injunction against an agency by its official title,
pursuant to 703 of the APA, 5 U.S.C. 703. Murphy v. IRS, 362 F.Supp.2d 206, 211-12, 218 (2005). The court
then rejected all of Murphy's claims on the merits and granted summary judgment for the Government and the
IRS. Id.
Murphy appealed the judgment of the district court with respect to her claims under 104(a)(2) and the
Sixteenth Amendment. In Murphy v. IRS, 460 F.3d 79 (2006), we concluded Murphy's award was not exempt
from taxation pursuant to 104(a)(2), id. at 84, but also was not income within the meaning of the Sixteenth
Amendment, id. at 92, and therefore reversed the decision of the district court. The Government petitioned for
rehearing en banc, arguing for the first time that, even if Murphy's award is not income, there is no constitutional
impediment to taxing it because a tax on the award is not a direct tax and is imposed uniformly. In view of the
importance of the issue thus belatedly raised, the panel sua sponte vacated its judgment and reheard the case.
See Consumers Union of U.S., Inc. v. Fed. Power Comm'n, 510 F.2d 656, 662 (D.C.Cir.1975) ([R]egarding the
contents of briefs on appeal, we may also consider points not raised in the briefs or in oral argument. Our
willingness to do so rests on a balancing of considerations of judicial orderliness and efficiency against the need
for the greatest possible accuracy in judicial decisionmaking. The latter factor is of particular weight when the
decision affects the broad public interest.) (footnotes omitted); see also Eli Lilly & Co. v. Home Ins. Co., 794 F.2d
710, 717 (D.C.Cir.1986) (The rule in this circuit is that litigants must raise their claims on their initial appeal and not
in subsequent hearings following a remand. This is a specific application of the general waiver rule, which bends
only in exceptional circumstances, where injustice might otherwise result.) (quoting Dist. of Columbia v. Air
Florida, Inc., 750 F.2d 1077, 1085 (D.C.Cir.1984)) (citation omitted).
In the present opinion, we affirm the
judgment of the district court based upon the newly argued ground that Murphy's award, even if it is not income
within the meaning of the Sixteenth Amendment, is within the reach of the congressional power to tax under
Article I, Section 8 of the Constitution.
II.

Analysis

We review the district court's grant of summary judgment de novo, Flynn v. R.C. Tile, 353 F.3d 953, 957
(D.C.Cir.2004), bearing in mind that summary judgment is appropriate only if there is no genuine issue as to any
material fact and if the moving party is entitled to judgment as a matter of law, Anderson v. Liberty Lobby, Inc.,
477 U.S. 242, 250, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).
Before addressing Murphy's claims on their merits,
however, we must determine whether the district court erred in holding the IRS was a proper defendant.
A.

The IRS as a Defendant

The Government contends the courts lack jurisdiction over Murphy's claims against the IRS because the
Congress has not waived that agency's immunity from declaratory and injunctive actions pursuant to 28 U.S.C.
2201(a) (courts may grant declaratory relief except with respect to Federal taxes) and 26 U.S.C. 7421(a) (no
suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any
person); and insofar as the Congress in 28 U.S.C. 1346(a)(1) has waived immunity from civil actions seeking tax
refunds, that provision on its face applies to civil action[s] against the United States, not against the IRS. In reply
Murphy argues only that the Government forfeited the issue of sovereign immunity because it did not crossappeal the district court's denial of its motion to dismiss. See Fed. R.App. P. 4(a)(3). Notwithstanding the
Government's failure to cross-appeal, however, the court must address a question concerning its jurisdiction.
See Occidental Petroleum Corp. v. SEC, 873 F.2d 325, 328 (D.C.Cir.1989) (As a preliminary matter we must
address the question of our jurisdiction to hear this appeal).
Murphy and the district court are correct that 703 of the APA does create a right of action for equitable relief
against a federal agency but, as the Government correctly points out, the Congress has preserved the immunity
of the United States from declaratory and injunctive relief with respect to all tax controversies except those
pertaining to the classification of organizations under 501(c) of the IRC. See 28 U.S.C. 2201(a); 26 U.S.C.
7421(a). As an agency of the Government, of course, the IRS shares that immunity. See Settles v. U.S. Parole
Comm'n, 429 F.3d 1098, 1106 (D.C.Cir.2005) (agency retains the immunity it is due as an arm of the federal

sovereign). Insofar as the Congress in 28 U.S.C. 1346(a)(1) has waived sovereign immunity with respect to
suits for tax refunds, that provision specifically contemplates only actions against the United States. Therefore,
we hold the IRS, unlike the United States, may not be sued eo nomine in this case.
B.

Section 104(a)(2) of the IRC

Section 104(a) (Compensation for injuries or sickness) provides that gross income [under 61 of the IRC]
does not include the amount of any damages (other than punitive damages) received on account of personal
physical injuries or physical sickness. 26 U.S.C. 104(a)(2). Since 1996 it has further provided that, for purposes
of this exclusion, emotional distress shall not be treated as a physical injury or physical sickness. Id. 104(a).
The version of 104(a)(2) in effect prior to 1996 had excluded from gross income monies received in
compensation for personal injuries or sickness, which included both physical and nonphysical injuries such as
emotional distress. Id. 104(a)(2) (1995); see United States v. Burke, 504 U.S. 229, 235 n. 6, 112 S.Ct. 1867, 119
L.Ed.2d 34 (1992) ( [section] 104(a)(2) in fact encompasses a broad range of physical and nonphysical injuries to
personal interests). In Commissioner v. Schleier, 515 U.S. 323, 115 S.Ct. 2159, 132 L.Ed.2d 294 (1995), the Supreme
Court held that before a taxpayer may exclude compensatory damages from gross income pursuant to
104(a)(2), he must first demonstrate that the underlying cause of action giving rise to the recovery [was] based
upon tort or tort type rights. Id. at 337, 115 S.Ct. 2159. The taxpayer has the same burden under the statute
as amended. See, e.g., Chamberlain v. United States, 401 F.3d 335, 341 (5th Cir.2005).
Murphy contends 104(a)(2), even as amended, excludes her particular award from gross income. First, she
asserts her award was based upon tort type rights in the whistle-blower statutes the NYANG violated-a
position the Government does not challenge.
which claim the Government does dispute.

Second, she claims she was compensated for physical injuries,

Murphy points both to her psychologist's testimony that she had experienced somatic and body injuries as a
result of NYANG's blacklisting [her], and to the American Heritage Dictionary, which defines somatic as
relating to, or affecting the body, especially as distinguished from a body part, the mind, or the environment.
Murphy further argues the dental records she submitted to the IRS proved she has suffered permanent damage
to her teeth. Citing Walters v. Mintec/International, 758 F.2d 73, 78 (3d Cir.1985), and Payne v. Gen. Motors
Corp., 731 F.Supp. 1465, 1474-75 (D.Kan.1990), Murphy contends that substantial physical problems caused by
emotional distress are considered physical injuries or physical sickness.
Murphy further contends that neither 104 of the IRC nor the regulation issued thereunder limits the physical
disability exclusion to a physical stimulus.
In fact, as Murphy points out, the applicable regulation, which
provides that 104(a)(2) excludes from gross income the amount of any damages received (whether by suit or
agreement) on account of personal injuries or sickness, 26 C.F.R. 1.104-1(c), does not distinguish between
physical injuries stemming from physical stimuli and those arising from emotional trauma; rather, it tracks the pre1996 text of 104(a)(2), which the IRS agrees excluded from gross income compensation both for physical and
for nonphysical injuries.
For its part, the Government argues Murphy's focus upon the word physical in 104(a)(2) is misplaced; more
important is the phrase on account of. In O'Gilvie v. United States, 519 U.S. 79, 117 S.Ct. 452, 136 L.Ed.2d 454
(1996), the Supreme Court read that phrase to require a strong[] causal connection, thereby making
104(a)(2) applicable only to those personal injury lawsuit damages that were awarded by reason of, or because
of, the personal injuries. Id. at 83, 117 S.Ct. 452. The Court specifically rejected a but-for formulation in favor
of a stronger causal connection. Id. at 82-83, 117 S.Ct. 452. The Government therefore concludes Murphy
must demonstrate she was awarded damages because of her physical injuries, which the Government claims
she has failed to do.
Indeed, as the Government points out, the ALJ expressly recommended, and the Board expressly awarded,
compensatory damages because of Murphy's nonphysical injuries.
The Board analyzed the ALJ's
recommendation under the headings Compensatory damage for emotional distress or mental anguish and
Compensatory damage award for injury to professional reputation, and noted such damages compensate

not only for direct pecuniary loss, but also for such harms as impairment of reputation, personal humiliation, and
mental anguish and suffering. Leveille, 1999 WL 966951 at *2. In describing the ALJ's proposed award as
reasonable, the Board stated Murphy was to receive $45,000 for mental pain and anguish and $25,000 for
injury to professional reputation. Although Murphy may have suffered from bruxism or other physical symptoms
of stress, the Board focused upon Murphy's testimony that she experienced severe anxiety attacks, inability to
concentrate, a feeling that she no longer enjoyed anything in life, and marital conflict and upon her
psychologist's testimony about the substantial effect the negative references had on [Murphy]. Id. at *3. The
Board made no reference to her bruxism, and acknowledged that [a]ny attempt to set a monetary value on
intangible damages such as mental pain and anguish involves a subjective judgment, id. at *4, before
concluding the ALJ's recommendation was reasonable. The Government therefore argues there was no direct
causal link between the damages award at issue and [Murphy's] bruxism.
Murphy responds that it is undisputed she suffered both somatic and emotional injuries, and the ALJ and
Board expressly cited to the portion of her psychologist's testimony establishing that fact. She contends the
Board therefore relied upon her physical injuries in determining her damages, making those injuries a direct cause
of her award in spite of the Board's labeling the award as one for emotional distress.
Although the pre-1996 version of 104(a)(2) was at issue in O'Gilvie, the Court's analysis of the phrase on
account of, which phrase was unchanged by the 1996 Amendments, remains controlling here. Murphy no
doubt suffered from certain physical manifestations of emotional distress, but the record clearly indicates the
Board awarded her compensation only for mental pain and anguish and for injury to professional reputation.
Id. at *5. Although the Board cited her psychologist, who had mentioned her physical aliments, in support of
Murphy's description of her mental anguish, we cannot say the Board, notwithstanding its clear statements to
the contrary, actually awarded damages because of Murphy's bruxism and other physical manifestations of
stress. Id. at *3. At best-and this is doubtful-at best the Board and the ALJ may have considered her physical
injuries indicative of the severity of the emotional distress for which the damages were awarded, but her physical
injuries themselves were not the reason for the award. The Board thus having left no room for doubt about the
grounds for her award, we conclude Murphy's damages were not awarded by reason of, or because of,
[physical] personal injuries, O'Gilvie, 519 U.S. at 83, 117 S.Ct. 452.
to exclude her award from gross income.*
C.

Therefore, 104(a)(2) does not permit Murphy

Section 61 of the IRC

Murphy and the Government agree that for Murphy's award to be taxable, it must be part of her gross
income as defined by 61(a) of the IRC, which states in relevant part: gross income means all income from
whatever source derived. The Supreme Court has interpreted the section broadly to extend to all economic
gains not otherwise exempted. Comm'r v. Banks, 543 U.S. 426, 433, 125 S.Ct. 826, 160 L.Ed.2d 859 (2005); see
also, e.g., James v. United States, 366 U.S. 213, 219, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961) ( Section 61 encompasses
all accessions to wealth) (internal quotation mark omitted); Comm'r v. Glenshaw Glass Co., 348 U.S. 426, 430,
75 S.Ct. 473, 99 L.Ed. 483 (the Court has given a liberal construction to [gross income] in recognition of the
intention of Congress to tax all gains except those specifically exempted). Gross income in 61(a) is at least
as broad as the meaning of incomes in the Sixteenth Amendment.* See Glenshaw Glass, 348 U.S. at 429, 432 n.
11, 75 S.Ct. 473 (quoting H.R.Rep. No. 83-1337, at A18 (1954), reprinted in 1954 U.S.C.C.A.N. 4017, 4155); Helvering
v. Bruun, 309 U.S. 461, 468, 60 S.Ct. 631, 84 L.Ed. 864 (1940).
Murphy argues her award is not a gain or an accession to wealth and therefore not part of gross income.
Noting the Supreme Court has long recognized the principle that a restoration of capital [i]s not income; hence
it [falls] outside the definition of income upon which the law impose[s] a tax, O'Gilvie, 519 U.S. at 84, 117 S.Ct.
452; see, e.g., Doyle v. Mitchell Bros. Co., 247 U.S. 179, 187-88, 38 S.Ct. 467, 62 L.Ed. 1054 (1918); S. Pac. Co. v.
Lowe, 247 U.S. 330, 335, 38 S.Ct. 540, 62 L.Ed. 1142 (1918), Murphy contends a damage award for personal injuriesincluding nonphysical injuries-should be viewed as a return of a particular form of capital-human capital, as it
were. See Gary S. Becker, Human Capital (1st ed.1964); Gary S. Becker, The Economic Way of Looking at Life,
Nobel Lecture (Dec. 9, 1992), in Nobel Lectures in Economic Sciences 1991-1995, at 43-45 (Torsten Persson ed.,

1997). In her view, the Supreme Court in Glenshaw Glass acknowledged the relevance of the human capital
concept for tax purposes. There, in holding that punitive damages for personal injury were gross income
under the predecessor to 61, the Court stated:
The long history of holding personal injury recoveries nontaxable on the theory that they roughly correspond to
a return of capital cannot support exemption of punitive damages following injury to property Damages for
personal injury are by definition compensatory only.
considered a restoration of capital for taxation purposes.

Punitive damages, on the other hand, cannot be

348 U.S. at 432 n. 8, 75 S.Ct. 473. By implication, Murphy argues, damages for personal injury are a restoration of
capital.
As further support, Murphy cites various administrative rulings issued shortly after passage of the Sixteenth
Amendment that concluded recoveries from personal injuries were not income, such as this 1918 Opinion of the
Attorney General:
Without affirming that the human body is in a technical sense the capital invested in an accident policy, in a
broad, natural sense the proceeds of the policy do but substitute, so far as they go, capital which is the source of
future periodical income. They merely take the place of capital in human ability which was destroyed by the
accident. They are therefore capital as distinguished from income receipts.
31 Op. Att'y Gen. 304, 308; see T.D. 2747, 20 Treas. Dec. Int. Rev. 457 (1918); Sol. Op. 132, I-1 C.B. 92, 93-94 (1922)
([M]oney received on account of defamation of personal character does not constitute income within the
meaning of the sixteenth amendment and the statutes enacted thereunder). She also cites a House Report on
the bill that became the Revenue Act of 1918. H.R.Rep. No. 65-767, at 9-10 (1918) (Under the present law it is
doubtful whether amounts received as compensation for personal injury are required to be included in gross
income); see also Dotson v. United States, 87 F.3d 682, 685 (5th Cir.1996) (concluding on basis of House Report
that the Congress first enacted the personal injury compensation exclusion when such payments were
considered the return of human capital, and thus not constitutionally taxable income under the 16th
amendment).
Finally, Murphy argues her interpretation of 61 is reflected in the common law of tort and the provisions in
various environmental statutes and Title VII of the Civil Rights Act of 1964, all of which provide for make whole
relief. See, e.g., 42 U.S.C. 1981a; 15 U.S.C. 2622. If a recovery of damages designed to make whole the
plaintiff is taxable, she reasons, then one who receives the award has not been made whole after tax. Section
61 should not be read to create a conflict between the tax code and the make whole purpose of the various
statutes.
The Government disputes Murphy's interpretation on all fronts. First, noting the definition [of gross income in the
IRC] extends broadly to all economic gains, Banks, 543 U.S. at 433, 125 S.Ct. 826, the Government asserts Murphy
undeniably had economic gain because she was better off financially after receiving the damages award than
she was prior to receiving it. Second, the Government argues that the case law Murphy cites does not support
the proposition that the Congress lacks the power to tax as income recoveries for personal injuries. In its view, to
the extent the Supreme Court has addressed at all the taxability of compensatory damages, see, e.g., O'Gilvie,
519 U.S. at 86, 117 S.Ct. 452; Glenshaw Glass, 348 U.S. at 432 n. 8, 75 S.Ct. 473, it was merely articulating the
Congress's rationale at the time for not taxing such damages, not the Court's own view whether such damages
could constitutionally be taxed.
Third, the Government challenges the relevance of the administrative rulings Murphy cites from around the time
the Sixteenth Amendment was ratified; Treasury decisions dating from even closer to the time of ratification
treated damages received on account of personal injury as income. See T.D. 2135, 17 Treas. Dec. Int. Rev. 39,
42 (1915); T.D. 2690, Reg. No. 33 (Rev.), art. 4, 20 Treas. Dec. Int. Rev. 126, 130 (1918). Furthermore, administrative
rulings from the time suggest that, even if recoveries for physical personal injuries were not considered part of
income, recoveries for nonphysical personal injuries were. See Sol. Mem. 957, 1 C.B. 65 (1919) (damages for libel

subject to income tax); Sol. Mem. 1384, 2 C.B. 71 (1920) (recovery of damages from alienation of wife's affections
not regarded as return of capital, hence taxable). Although the Treasury changed its position in 1922, see Sol.
Op. 132, I-1 C.B. at 93-94, it did so only after the Supreme Court's decision in Eisner v. Macomber, 252 U.S. 189, 40
S.Ct. 189, 64 L.Ed. 521 (1920), which the Court later viewed as having established a definition of income that
served a useful purpose [but] was not meant to provide a touchstone to all future gross income questions.
Glenshaw Glass, 348 U.S. at 430-31, 75 S.Ct. 473. As for Murphy's contention that reading 61 to include her
damages would be in tension with the common law and various statutes providing for make whole relief, the
Government denies there is any tension and suggests Murphy is trying to turn a disagreement over tax policy into
a constitutional issue.
Finally, the Government argues that even if the concept of human capital is built into 61, Murphy's award is
nonetheless taxable because Murphy has no tax basis in her human capital. Under the IRC, a taxpayer's gain
upon the disposition of property is the difference between the amount realized from the disposition and his
basis in the property, 26 U.S.C. 1001, defined as the cost of such property, id. 1012, adjusted for
expenditures, receipts, losses, or other items, properly chargeable to [a] capital account, id. 1016(a)(1). The
Government asserts, The Code does not allow individuals to claim a basis in their human capital; accordingly,
Murphy's gain is the full value of the award. See Roemer v. Comm'r, 716 F.2d 693, 696 n. 2 (9th Cir.1983) (Since
there is no tax basis in a person's health and other personal interests, money received as compensation for an
injury to those interests might be considered a realized accession to wealth) (dictum).
Although Murphy and the Government focus primarily upon whether Murphy's award falls within the definition of
income first used in Glenshaw Glass,* coming within that definition is not the only way in which 61(a) could be
held to encompass her award.
Principles of statutory interpretation could show 61(a) includes Murphy's
award in her gross income regardless whether it was an accession to wealth, as Glenshaw Glass requires. For
example, if 61(a) were amended specifically to include in gross income $100,000 in addition to all other gross
income, then that additional sum would be a part of gross income under 61 even though no actual gain was
associated with it. In other words, although the Congress cannot make a thing income which is not so in fact,
Burk-Waggoner Oil Ass'n v. Hopkins, 269 U.S. 110, 114, 46 S.Ct. 48, 70 L.Ed. 183 (1925), it can label a thing income
and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment
but also Article I, Sections 8 and 9. See Penn Mut. Indem. Co. v. Comm'r, 277 F.2d 16, 20 (3d Cir.1960) (Congress
has the power to impose taxes generally, and if the particular imposition does not run afoul of any constitutional
restrictions then the tax is lawful, call it what you will) (footnote omitted). Accordingly, rather than ask whether
Murphy's award was an accession to her wealth, we go to the heart of the matter, which is whether her award is
properly included within the definition of gross income in 61(a), to wit, all income from whatever source
derived.
Looking at 61(a) by itself, one sees no indication that it covers Murphy's award unless the award is income
as defined by Glenshaw Glass and later cases. Damages received for emotional distress are not listed among
the examples of income in 61 and, as Murphy points out, an ambiguity in the meaning of a revenue-raising
statute should be resolved in favor of the taxpayer. See, e.g., Hassett v. Welch, 303 U.S. 303, 314, 58 S.Ct. 559, 82
L.Ed. 858 (1938); Gould v. Gould, 245 U.S. 151, 153, 38 S.Ct. 53, 62 L.Ed. 211 (1917); see also United Dominion
Indus., Inc. v. United States, 532 U.S. 822, 839, 121 S.Ct. 1934, 150 L.Ed.2d 45 (2001) (Thomas, J., concurring); id. at
839 n. 1, 121 S.Ct. 1934 (Stevens, J., dissenting); 3A Norman J. Singer, Sutherland Statutes & Statutory Construction
66:1 (6th ed.2003). A statute is to be read as a whole, however, see, e.g., Alaska Dep't of Envtl. Conservation
v. EPA, 540 U.S. 461, 489 n. 13, 124 S.Ct. 983, 157 L.Ed.2d 967 (2004), and reading 61 in combination with
104(a)(2) of the Internal Revenue Code presents a very different picture-a picture so clear that we have no
occasion to apply the canon favoring the interpretation of ambiguous revenue-raising statutes in favor of the
taxpayer.
As noted above, in 1996 the Congress amended 104(a) to narrow the exclusion to amounts received on
account of personal physical injuries or physical sickness from personal injuries or sickness, and explicitly to
provide that emotional distress shall not be treated as a physical injury or physical sickness, thus making clear
that an award received on account of emotional distress is not excluded from gross income under 104(a)(2).

Small Business Job Protection Act of 1996, Pub.L. 104-188, 1605, 110 Stat. 1755, 1838. As this amendment,
which narrows the exclusion, would have no effect whatsoever if such damages were not included within the
ambit of 61, and as we must presume that [w]hen Congress acts to amend a statute, it intends its
amendment to have real and substantial effect, Stone v. INS, 514 U.S. 386, 397, 115 S.Ct. 1537, 131 L.Ed.2d 465
(1995), the 1996 amendment of 104(a) strongly suggests 61 should be read to include an award for damages
from nonphysical harms.* Although it is unclear whether 61 covered such an award before 1996, we need not
address that question here; even if the provision did not do so prior to 1996, the presumption indicates the
Congress implicitly amended 61 to cover such an award when it amended 104(a).
We realize, of course, that amendments by implication, like repeals by implication, are disfavored. United States
v. Welden, 377 U.S. 95, 103 n. 12, 84 S.Ct. 1082, 12 L.Ed.2d 152 (1964); Cheney R.R. Co. v. R.R. Ret. Bd., 50 F.3d
1071, 1078 (D.C.Cir.1995).
The Supreme Court has also noted, however, that the classic judicial task of
reconciling many laws enacted over time, and getting them to make sense in combination, necessarily
assumes that the implications of a statute may be altered by the implications of a later statute. United States v.
Fausto, 484 U.S. 439, 453, 108 S.Ct. 668, 98 L.Ed.2d 830 (1988); see also FDA v. Brown & Williamson Tobacco Corp.,
529 U.S. 120, 133, 120 S.Ct. 1291, 146 L.Ed.2d 121 (2000) ([T]he meaning of one statute may be affected by other
Acts, particularly where Congress has spoken subsequently and more specifically to the topic at hand);
Almendarez-Torres v. United States, 523 U.S. 224, 237, 118 S.Ct. 1219, 140 L.Ed.2d 350 (1998) (suggesting later
enacted laws depend[ing] for their effectiveness upon clarification, or a change in the meaning of an earlier
statute provide a forward looking legislative mandate, guidance, or direct suggestion about how courts should
interpret the earlier provisions); cf. Franklin v. Gwinnett County Pub. Sch., 503 U.S. 60, 72-73, 112 S.Ct. 1028, 117
L.Ed.2d 208 (1992) (amendment of Title IX abrogating States' Eleventh Amendment immunity validated Court's
prior holding that Title IX created implied right of action); id. at 78, 112 S.Ct. 1028 (Scalia, J., concurring in
judgment) (amendment to Title IX was an implicit acknowledgment that damages are available).
This classic judicial task is before us now. For the 1996 amendment of 104(a) to make sense, gross income
in 61(a) must, and we therefore hold it does, include an award for nonphysical damages such as Murphy
received, regardless whether the award is an accession to wealth. Cf. Vermont Agency of Natural Res. v.
United States ex rel. Stevens, 529 U.S. 765, 786 & n. 17, 120 S.Ct. 1858, 146 L.Ed.2d 836 (2000) (determining meaning
of person in False Claims Act, which was originally enacted in 1863, based in part upon definition of person in
Program Fraud Civil Remedies Act of 1986, which was designed to operate in tandem with the [earlier Act]).
D.

The Congress's Power to Tax

The taxing power of the Congress is established by Article I, Section 8 of the Constitution: The Congress shall
have power to lay and collect taxes, duties, imposts and excises. There are two limitations on this power. First,
as the same section goes on to provide, all duties, imposts and excises shall be uniform throughout the United
States. Second, as provided in Section 9 of that same Article, No capitation, or other direct, tax shall be laid,
unless in proportion to the census or enumeration herein before directed to be taken. See also U.S. Const. art. I,
2, cl. 3 (direct taxes shall be apportioned among the several states which may be included within this union,
according to their respective numbers).* We now consider whether the tax laid upon Murphy's award violates
either of these two constraints.
1.

A Direct Tax?

Over the years, courts have considered numerous claims that one or another nonapportioned tax is a direct tax
and therefore unconstitutional. Although these cases have not definitively marked the boundary between
taxes that must be apportioned and taxes that need not be, see Bromley v. McCaughn, 280 U.S. 124, 136, 50 S.Ct.
46, 74 L.Ed. 226 (1929); Spreckels Sugar Ref. Co. v. McClain, 192 U.S. 397, 413, 24 S.Ct. 376, 48 L.Ed. 496 (1904)
(dividing line between taxes that are direct and those which are to be regarded simply as excises is often very
difficult to be expressed in words), some characteristics of each may be discerned.
Only three taxes are definitely known to be direct: (1) a capitation, U.S. Const. art. I, 9, (2) a tax upon real
property, and (3) a tax upon personal property. See Fernandez v. Wiener, 326 U.S. 340, 352, 66 S.Ct. 178, 90 L.Ed.

116 (1945) (Congress may tax real estate or chattels if the tax is apportioned); Pollock v. Farmers' Loan & Trust
Co., 158 U.S. 601, 637, 15 S.Ct. 912, 39 L.Ed. 1108 (1895) (Pollock II).** Such direct taxes are laid upon one's
general ownership of property, Bromley, 280 U.S. at 136, 50 S.Ct. 46; see also Flint v. Stone Tracy Co., 220 U.S.
107, 149, 31 S.Ct. 342, 55 L.Ed. 389 (1911), as contrasted with excise taxes laid upon a particular use or enjoyment
of property or the shifting from one to another of any power or privilege incidental to the ownership or enjoyment
of property. Fernandez, 326 U.S. at 352, 66 S.Ct. 178; see also Thomas v. United States, 192 U.S. 363, 370, 24 S.Ct.
305, 48 L.Ed. 481 (1904) (excises cover duties imposed on importation, consumption, manufacture and sale of
certain commodities, privileges, particular business transactions, vocations, occupations and the like). More
specifically, excise taxes include, in addition to taxes upon consumable items, see Patton v. Brady, 184 U.S. 608,
617-18, 22 S.Ct. 493, 46 L.Ed. 713 (1902), taxes upon the sale of grain on an exchange, Nicol v. Ames, 173 U.S. 509,
519, 19 S.Ct. 522, 43 L.Ed. 786 (1899), the sale of corporate stock, Thomas, 192 U.S. at 371, 24 S.Ct. 305, doing
business in corporate form, Flint, 220 U.S. at 151, 31 S.Ct. 342, gross receipts from the business of refining sugar,
Spreckels, 192 U.S. at 411, 24 S.Ct. 376, the transfer of property at death, Knowlton v. Moore, 178 U.S. 41, 81-82, 20
S.Ct. 747, 44 L.Ed. 969 (1900), gifts, Bromley, 280 U.S. at 138, 50 S.Ct. 46, and income from employment, see Pollock
v. Farmers' Loan & Trust Co., 157 U.S. 429, 579, 15 S.Ct. 673, 39 L.Ed. 759 (1895) ( Pollock I) (citing Springer v. United
States, 102 U.S. 586, 26 L.Ed. 253 (1881)).
Murphy and the amici supporting her argue the dividing line between direct and indirect taxes is based upon
the ultimate incidence of the tax; if the tax cannot be shifted to someone else, as a capitation cannot, then it is
a direct tax; but if the burden can be passed along through a higher price, as a sales tax upon a consumable
good can be, then the tax is indirect. This, she argues, was the distinction drawn when the Constitution was
ratified. See Albert Gallatin, A Sketch of the Finances of the United States (1796), reprinted in 3 The Writings of
Albert Gallatin 74-75 (Henry Adams ed., Philadelphia, J.P. Lippincott & Co. 1879) (The most generally received
opinion is, that by direct taxes those are meant which are raised on the capital or revenue of the people; by
indirect, such as are raised on their expense); The Federalist No. 36, at 225 (Alexander Hamilton) (Jacob E.
Cooke ed., 1961) (internal taxes[] may be subdivided into those of the direct and those of the indirect kind by
which must be understood duties and excises on articles of consumption).
But see Gallatin, supra, at 74
([Direct tax] is used, by different writers, and even by the same writers, in different parts of their writings, in a
variety of senses, according to that view of the subject they were taking); Edwin R.A. Seligman, The Income Tax
540 (photo. reprint 1970) (2d ed.1914) (there are almost as many classifications of direct and indirect taxes are
there are authors).
Moreover, the amici argue, this understanding of the distinction explains the different
restrictions imposed respectively upon the power of the Congress to tax directly (apportionment) and via excise
(uniformity). Duties, imposts, and excise taxes, which were expected to constitute the bulk of the new federal
government's revenue, see Erik M. Jensen, The Apportionment of Direct Taxes: Are Consumption Taxes
Constitutional?, 97 Colum. L.Rev. 2334, 2382 (1997), have a built-in safeguard against oppressively high rates:
Higher taxes result in higher prices and therefore fewer sales and ultimately lower tax revenues.
See The
Federalist No. 21, supra, at 134-35 (Alexander Hamilton). Taxes that cannot be shifted, in contrast, lack this selfregulating feature, and were therefore constrained by the more stringent requirement of apportionment. See
id. at 135 (In a branch of taxation where no limits to the discretion of the government are to be found in the
nature of things, the establishment of a fixed rule may be attended with fewer inconveniences than to leave
that discretion altogether at large); see also Jensen, supra, at 2382-84.
Finally, the amici contend their understanding of a direct tax was confirmed in Pollock II, where the Supreme
Court noted that the words duties, imposts, and excises' are put in antithesis to direct taxes, 158 U.S. at 622, 15
S.Ct. 912, for which it cited The Federalist No. 36 (Hamilton). Pollock II, 158 U.S. at 624-25, 15 S.Ct. 912. As it is
clear that Murphy cannot shift her tax burden to anyone else, per Murphy and the amici, it must be a direct tax.
The Government, unsurprisingly, backs a different approach; by its lights, only taxes that are capable of
apportionment in the first instance, specifically, capitation taxes and taxes on land, are direct taxes. The
Government maintains that this is how the term was generally understood at the time. See Calvin H. Johnson,
Fixing the Constitutional Absurdity of the Apportionment of Direct Tax, 21 Const. Comm. 295, 314 (2004).
Moreover, it suggests, this understanding is more in line with the underlying purpose of the tax and the

apportionment clauses, which were drafted in the intense light of experience under the Articles of
Confederation.
The Articles did not grant the Continental Congress the power to raise revenue directly; it could only requisition
funds from the States.
See Articles of Confederation art. VIII (1781); Bruce Ackerman, Taxation and the
Constitution, 99 Colum. L.Rev. 1, 6-7 (1999). This led to problems when the States, as they often did, refused to
remit funds. See Calvin H. Johnson, The Constitutional Meaning of Apportionment of Direct Taxes, 80 Tax Notes
591, 593-94 (1998). The Constitution redressed this problem by giving the new national government plenary
taxing power. See Ackerman, supra, at 7. In the Government's view, it therefore makes no sense to treat direct
taxes as encompassing taxes for which apportionment is effectively impossible, because the Framers could not
have intended to give Congress plenary taxing power, on the one hand, and then so limit that power by
requiring apportionment for a broad category of taxes, on the other.
This view is, according to the
Government, buttressed by evidence that the purpose of the apportionment clauses was not in fact to constrain
the power to tax, but rather to placate opponents of the compromise over representation of the slave states in
the House, as embodied in the Three-fifths Clause.* See Ackerman, supra, at 10-11. See generally Seligman,
supra, at 548-55. As the Government interprets the historical record, the apportionment limitation was more
symbolic than anything else: it appeased the anti-slavery sentiment of the North and offered a practical
advantage to the South as long as the scope of direct taxes was limited. See Ackerman, supra, at 10. But see
Erik M. Jensen, Taxation and the Constitution: How to Read the Direct Tax Clauses, 15 J.L. & Pol. 687, 704 (1999)
(One of the reasons [the direct tax restriction] worked as a compromise was that it had teeth-it made direct
taxes difficult to impose-and it had teeth however slaves were counted).
The Government's view of the clauses is further supported by the near contemporaneous decision of the
Supreme Court in Hylton v. United States, 3 U.S. (3 Dall.) 171, 1 L.Ed. 556 (1796), holding that a national tax upon
carriages was not a direct tax, and thus not subject to apportionment. Justices Chase and Iredell opined that a
direct tax was one that, unlike the carriage tax, as a practical matter could be apportioned among the States,
id. at 174 (Chase, J.); id. at 181 (Iredell, J.), while Justice Paterson, noting the connection between
apportionment and slavery, condemned apportionment as radically wrong and not to be extended by
construction, id. at 177-78.* As for Murphy's reliance upon Pollock II, the Government contends that although it
has never been overruled, every aspect of its reasoning has been eroded, see, e.g., Stanton v. Baltic Mining
Co., 240 U.S. 103, 112-13, 36 S.Ct. 278, 60 L.Ed. 546 (1916), and notes that in Pollock II itself the Court
acknowledged that taxation on business, privileges, or employments has assumed the guise of an excise tax,
158 U.S. at 635, 15 S.Ct. 912. Pollock II, in the Government's view, is therefore too weak a reed to support
Murphy's broad definition of direct tax and certainly does not make a tax on the conversion of human capital
into money problematic.
Murphy replies that the Government's historical analysis does not respond to the contemporaneous sources she
and the amici identified showing that taxes imposed upon individuals are direct taxes. As for Hylton, Murphy
argues nothing in that decision precludes her position; the Justices viewed the carriage tax there at issue as a tax
upon an expense, see 3 U.S. (3 Dall.) at 175 (Chase, J.); see also id. at 180-81 (Paterson, J.), which she agrees is
not a direct tax. See Pollock II, 158 U.S. at 626-27, 15 S.Ct. 912. To the extent Hylton is inconsistent with her
position, however, Murphy contends her references to the Federalist are more authoritative evidence of the
Framers' understanding of the term.
Murphy makes no attempt to reconcile her definition with the long line of cases identifying various taxes as excise
taxes, although several of them seem to refute her position directly. In particular, we do not see how a known
excise, such as the estate tax, see, e.g., New York Trust Co. v. Eisner, 256 U.S. 345, 349, 41 S.Ct. 506, 65 L.Ed. 963
(1921); Knowlton, 178 U.S. at 81-83, 20 S.Ct. 747, or a tax upon income from employment, see Pollock II, 158 U.S. at
635, 15 S.Ct. 912; Pollock I, 157 U.S. at 579, 15 S.Ct. 673; cf. Steward Mach. Co. v. Davis, 301 U.S. 548, 580-81, 57
S.Ct. 883, 81 L.Ed. 1279 (1937) (tax upon employers based upon wages paid to employees is an excise), can be
shifted to another person, absent which they seem to be in irreconcilable conflict with her position that a tax that
cannot be shifted to someone else is a direct tax. Though it could be argued that the incidence of an estate
tax is inevitably shifted to the beneficiaries, we see at work none of the restraint upon excessive taxation that

Murphy claims such shifting is supposed to provide; the tax is triggered by an event, death, that cannot be
shifted or avoided. In any event, Knowlton addressed the argument that Pollock I and II made ability to shift the
hallmark of a direct tax, and rejected it. 178 U.S. at 81-82, 20 S.Ct. 747.
Regardless what the original
understanding may have been, therefore, we are bound to follow the Supreme Court, which has strongly
intimated that Murphy's position is not the law.
That said, neither need we adopt the Government's position that direct taxes are only those capable of satisfying
the constraint of apportionment. In the abstract, such a constraint is no constraint at all; virtually any tax may
be apportioned by establishing different rates in different states. See Pollock II, 158 U.S. at 632-33, 15 S.Ct. 912.
If the Government's position is instead that by capable of apportionment it means capable of apportionment
in a manner that does not unfairly tax some individuals more than others, then it is difficult to see how a land tax,
which is widely understood to be a direct tax, could be apportioned by population without similarly imposing
significantly non-uniform rates.
See Hylton, 3 U.S. (3 Dall.) at 178-79 (Paterson, J.); Johnson, Constitutional
Absurdity, supra, at 328. But see, e.g., Hylton, 3 U.S. (3 Dall.) at 183 (Iredell, J.) (contending land tax is capable of
apportionment).
We find it more appropriate to analyze this case based upon the precedents and therefore to ask whether the
tax laid upon Murphy's award is more akin, on the one hand, to a capitation or a tax upon one's ownership of
property, or, on the other hand, more like a tax upon a use of property, a privilege, an activity, or a transaction,
see Thomas, 192 U.S. at 370, 24 S.Ct. 305. Even if we assume one's human capital should be treated as personal
property, it does not appear that this tax is upon ownership; rather, as the Government points out, Murphy is
taxed only after she receives a compensatory award, which makes the tax seem to be laid upon a transaction.
See Tyler v. United States, 281 U.S. 497, 502, 50 S.Ct. 356, 74 L.Ed. 991 (1930) (A tax laid upon the happening of an
event, as distinguished from its tangible fruits, is an indirect tax which Congress, in respect of some events
undoubtedly may impose); Simmons v. United States, 308 F.2d 160, 166 (4th Cir.1962) (tax upon receipt of
money is not a direct tax); cf. Penn Mut., 277 F.2d at 20.
Murphy's situation seems akin to an involuntary
conversion of assets; she was forced to surrender some part of her mental health and reputation in return for
monetary damages. Cf. 26 U.S.C. 1033 (property involuntarily converted into money is taxed to extent of gain
recognized).
At oral argument Murphy resisted this formulation on the ground that the receipt of an award in lieu of lost mental
health or reputation is not a transaction. This view is tenable, however, only if one decouples Murphy's injury
(emotional distress and lost reputation) from her monetary award, but that is not beneficial to Murphy's cause, for
then Murphy has nothing to offset the obvious accession to her wealth, which is taxable as income. Murphy also
suggested at oral argument that there was no transaction because she did not profit. Whether she profited is
irrelevant, however, to whether a tax upon an award of damages is a direct tax requiring apportionment; profit is
relevant only to whether, if it is a direct tax, it nevertheless need not be apportioned because the object of the
tax is income within the meaning of the Sixteenth Amendment. Cf. Spreckels, 192 U.S. at 412-13, 24 S.Ct. 376 (tax
upon gross receipts associated with business of refining sugar not a direct tax); Penn Mut., 277 F.2d at 20 (tax
upon gross receipts deemed valid indirect tax despite taxpayer's net loss).
So we return to the question: Is a tax upon this particular kind of transaction equivalent to a tax upon a person or
his property? Cf. Bromley, 280 U.S. at 138, 50 S.Ct. 46 (assuming without deciding that a tax levied upon all the
uses to which property may be put, or upon the exercise of a single power indispensable to the enjoyment of all
others over it, would be in effect a tax upon property). Murphy did not receive her damages pursuant to a
business activity, cf. Flint, 220 U.S. at 151, 31 S.Ct. 342; Spreckels, 192 U.S. at 411, 24 S.Ct. 376, and we therefore do
not view this tax as an excise under that theory. See Stratton's Independence, Ltd. v. Howbert, 231 U.S. 399, 41415, 34 S.Ct. 136, 58 L.Ed. 285 (1913) (The sale outright of a mining property might be fairly described as a mere
conversion of the capital from land into money). On the other hand, as noted above, the Supreme Court
several times has held a tax not related to business activity is nonetheless an excise. And the tax at issue here is
similar to those.

Bromley, in which a gift tax was deemed an excise, is particularly instructive: The Court noted it was a tax laid
only upon the exercise of a single one of those powers incident to ownership, 280 U.S. at 136, 50 S.Ct. 46, which
distinguished it from a tax which falls upon the owner merely because he is owner, regardless of the use or
disposition made of his property, id. at 137, 50 S.Ct. 46. A gift is the functional equivalent of a below-market
sale; it therefore stands to reason that if, as Bromley holds, a gift tax, or a tax upon a below-market sale, is a tax
laid not upon ownership but upon the exercise of a power incident to ownership, then a tax upon the sale of
property at fair market value is similarly laid upon an incidental power and not upon ownership, and hence is an
excise. Therefore, even if we were to accept Murphy's argument that the human capital concept is reflected in
the Sixteenth Amendment, a tax upon the involuntary conversion of that capital would still be an excise and not
subject to the requirement of apportionment. But see Nicol, 173 U.S. at 521, 19 S.Ct. 522 (indicating pre-Bromley
that tax upon every sale made in any place is really and practically upon property).
In any event, even if a tax upon the sale of property is a direct tax upon the property itself, we do not believe
Murphy's situation involves a tax upon the sale itself, considered separate and apart from the place and the
circumstances of the sale. Id. at 520, 19 S.Ct. 522. Instead, as in Nicol, this tax is more akin to a duty upon the
facilities made use of and actually employed in the transaction. Id. at 519, 19 S.Ct. 522. To be sure, the facility
used in Nicol was a commodities exchange whereas the facility used by Murphy was the legal system, but that
hardly seems a significant distinction. The tax may be laid upon the proceeds received when one vindicates a
statutory right, but the right is nonetheless a creature of law, which Knowlton identifies as a privilege taxable
by excise. 178 U.S. at 55, 20 S.Ct. 747 (right to take property by inheritance is granted by law and therefore
taxable as upon a privilege);* cf. Steward, 301 U.S. at 580-81, 57 S.Ct. 883 ([N]atural rights, so called, are as
much subject to taxation as rights of less importance. An excise is not limited to vocations or activities that may
be prohibited altogether It extends to vocations or activities pursued as of common right.) (footnote omitted).
2.

Uniformity

The Congress may not implement an excise tax that is not uniform throughout the United States. U.S. Const. art.
I, 8, cl. 1. A tax is uniform when it operates with the same force and effect in every place where the subject of
it is found. United States v. Ptasynski, 462 U.S. 74, 82, 103 S.Ct. 2239, 76 L.Ed.2d 427 (1983) (internal quotation
marks omitted); see also Knowlton, 178 U.S. at 84-86, 106, 20 S.Ct. 747. The tax laid upon an award of damages
for a nonphysical personal injury operates with the same force and effect throughout the United States and
therefore satisfies the requirement of uniformity.
III. Conclusion
For the foregoing reasons, we conclude (1) Murphy's compensatory award was not received on account of
personal physical injuries, and therefore is not exempt from taxation pursuant to 104(a)(2) of the IRC; (2) the
award is part of her gross income, as defined by 61 of the IRC; and (3) the tax upon the award is an excise
and not a direct tax subject to the apportionment requirement of Article I, Section 9 of the Constitution. The tax
is uniform throughout the United States and therefore passes constitutional muster. The judgment of the district
court is accordingly
Affirmed.
Old Colony Trust vs. CIR
Brief Fact Summary. Wood was president of the American Woolen Company. The company adopted a resolution
wherein
they
would
pay
the
tax
obligations
of
Wood
and
other
officers.
Synopsis of Rule of Law. The discharge of a taxpayers obligation by a third party is equivalent to direct receipt by
the taxpayer.
Facts. William Wood was president of the American Woolen Company for the years 1918 through 1920. The
company instated a policy for 1919 and 1920 wherein the company would pay the taxes of the president and

other company officers. The company paid $681,169.88 for 1918 and $351,179.27 for 1919 on behalf of Wood. The
Board
of
Tax
Appeals
held
that
these
amounts
paid
were
income
of
Wood.
Issue. Were the taxes paid by the company additional income of Wood?
Held. Chief Justice Taft issued the opinion for the Supreme Court of the United States affirming the lower court
and holding that the taxes paid were income to Wood.
Discussion. The Supreme Court notes that Wood and other employees received a direct benefit when their tax
obligation was discharged by the company. Wood received a benefit in exchange for his services to the
company. This was clearly a taxable gain.
Helvering v. Bruun
309 U.S. 461 (1940)
Bruun was a landlord. He leased some property to a tenant. When the lease expired, the tenant left and Bruun
took the property back.
While the tenant was in possession of the property, they knocked down an old building and built a new building
on the property. When they left, Bruun got to keep the new building.
The new building was assessed to be worth $51k more than the old one.
The IRS stepped in and said that Bruun's gain of a new building was a capital gain.
Bruun argued that no income had been realized yet because his interest was represented by a deed, and when
the tenant left, he had the exact same deed he had when the tenant arrived. So he hadn't gained anything.
Bruun suggested that the IRS would have to wait until the property was sold (aka the value was realized).
Basically, the construction of the new building increased the value of the land, but there were other ways the
value could change. But until the land was sold, Bruun hadn't received anything.
See Eisner v. Macomber (252 U.S. 189 (1920)), which says that in general, you don't have to report a gain until you
sell the property (aka "severance is a prerequisite to realization").
The IRS argued that until the day the tenant left, Bruun didn't own a new building, as soon as the lease ended,
Bruun did own a new building. He had received a gain and needed to pay taxes on it immediately.
The US Supreme Court found for the IRS.
The US Supreme Court found that upon when a lease ended, the landlord repossessed the real estate and
improvements and increase in value attributable to the improvements was taxable.
The real estate industry felt that this was very unfair to landlords. If the new building was expensive, the landlord
might be forced to sell the land just to be able to afford the tax. They lobbied Congress, who passed 26 U.S. C.
109 was to provide relief for exactly landlord's in Bruun's situation.
Now, under 109, gross income generally does not include improvements made by a tenant.
However, it does not include "improvements other than rent." That clause was added so the landlord and tenant
couldn't conspire to improve the property instead of paying rent.
So you can't say to a tenant, "instead of paying me rent, just build a fancy new building that I can keep after you
leave."
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS, COURT OF TAX APPEALS and A.
SORIANO CORP., respondents.

DECISION
MARTINEZ, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of Appeals
(CA)[1] which affirmed the ruling of the Court of Tax Appeals (CTA) [2] that private respondent A. Soriano
Corporations (hereinafter ANSCOR) redemption and exchange of the stocks of its foreign stockholders cannot be
considered as essentially equivalent to a distribution of taxable dividends under Section 83(b) of the 1939 Internal
Revenue Act[3]
The undisputed facts are as follows:
Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the
corporation A. Soriano Y Cia, predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000
common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don
Andres, who are all non-resident aliens.[4] In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares
originally issued.[5]
On September 12, 1945, ANSCORs authorized capital stock was increased to P2,500,000.00 divided into
25,000 common shares with the same par value. Of the additional 15,000 shares, only 10,000 was issued which
were all subscribed by Don Andres, after the other stockholders waived in favor of the former their pre-emptive
rights to subscribe to the new issues.[6] This increased his subscription to 14,963 common shares.[7] A month
later,[8] Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in
ANSCOR.[9] Both sons are foreigners.[10]
By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949
and December 20, 1963.[11] On December 30, 1964 Don Andres died. As of that date, the records revealed that
he has a total shareholdings of 185,154 shares[12] - 50,495 of which are original issues and the balance of 134,659
shares as stock dividend declarations.[13] Correspondingly, one-half of that shareholdings or 92,577[14] shares were
transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate.[15]
A day after Don Andres died, ANSCOR increased its capital stock to P20M[16] and in 1966 further increased it
to P30M.[17] In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were respectively
received by the Don Andres estate[18] and Doa Carmen from ANSCOR. Hence, increasing their accumulated
shareholdings to 138,867 and 138,864[19] common shares each.[20]
On December 28, 1967, Doa Carmen requested a ruling from the United States Internal Revenue Service
(IRS), inquiring if an exchange of common with preferred shares may be considered as a tax avoidance
scheme[21] under Section 367 of the 1954 U.S. Revenue Act.[22] By January 2, 1968, ANSCOR reclassified its existing
300,000 common shares into 150,000 common and 150,000 preferred shares.[23]
In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme
and not tax avoidance.[24] Consequently,[25] on March 31, 1968 Doa Carmen exchanged her whole 138,864
common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn,
exchanged 11,140 of its common shares for the remaining 11,140 preferred shares, thus reducing its (the estate)
common shares to 127,727.[26]
On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don
Andres estate. By November 1968, the Board further increased ANSCORs capital stock toP75M divided into
150,000 preferred shares and 600,000 common shares.[27] About a year later, ANSCOR again redeemed 80,000
common shares from the Don Andres estate,[28] further reducing the latters common shareholdings to 19,727. As
stated in the board Resolutions, ANSCORs business purpose for both redemptions of stocks is to partially retire said
stocks as treasury shares in order to reduce the companys foreign exchange remittances in case cash dividends
are declared.[29]
In 1973, after examining ANSCORs books of account and records, Revenue examiners issued a report
proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of
the 1939 Revenue Code,[30] for the year 1968 and the second quarter of 1969 based on the transactions of
exchange and redemption of stocks.[31] The Bureau of Internal Revenue (BIR) made the corresponding
assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree (P.D.)
23[32] which were amended by P.D.s 67 and 157.[33] However, petitioner ruled that the invoked decrees do not
cover Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was
assessed.[34] ANSCORs subsequent protest on the assessments was denied in 1983 by petitioner.[35]

Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the
redemptions and exchange of stocks. In its decision, the Tax Court reversed petitioners ruling, after finding
sufficient evidence to overcome the prima facie correctness of the questioned assessments.[36] In a petition for
review, the CA, as mentioned, affirmed the ruling of the CTA.[37] Hence, this petition.
The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue
Act[38] which provides:
Sec. 83. Distribution of dividends or assets by corporations.
(b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to
tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as
to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the
distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after
March first, nineteen hundred and thirteen. (Italics supplied).
Specifically, the issue is whether ANSCORs redemption of stocks from its stockholder as well as the exchange of
common with preferred shares can be considered as essentially equivalent to the distribution of taxable
dividend, making the proceeds thereof taxable under the provisions of the above-quoted law.
Petitioner contends that the exchange transaction is tantamount to cancellation under Section 83(b)
making the proceeds thereof taxable. It also argues that the said Section applies to stock dividendswhich is the
bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under the net effect test, the estate of Don
Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source
arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act. [39]
ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from
Doa Carmen based on the two transactions, because the same were done for legitimate business purposes
which are (a) to reduce its foreign exchange remittances in the event the company would declare cash
dividends,[40] and to (b) subsequently filipinized ownership of ANSCOR, as allegedly envisioned by Don
Andres.[41] It likewise invoked the amnesty provisions of P.D. 67.
We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances of
each case.[42] The findings of facts of a special court (CTA) exercising particular expertise on the subject of tax,
generally binds this Court,[43] considering that it is substantially similar to the findings of the CA which is the final
arbiter of questions of facts.[44] The issue in this case does not only deal with facts but whether the law applies to a
particular set of facts. Moreover, this Court is not necessarily bound by the lower courts conclusions of law drawn
from such facts.[45]
AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D. 67[46] provides:
I. In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings,
receipts, gifts, bequests or any other acquisitions from any source whatsoever which are taxable under
the National Internal Revenue Code, as amended, realized here or abroad by any taxpayer, natural or
juridical; the collection of all internal revenue taxes including the increments or penalties or account of
non-payment as well as all civil, criminal or administrative liabilities arising from or incident to such
disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-Graft and
Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and
regulations on Immigration and Deportation, or any other applicable law or proclamation, are hereby
condoned and, in lieu thereof, a tax of ten (10%) per centum on such previously untaxed income or
wealth is hereby imposed, subject to the following conditions: (conditions omitted) [Emphasis supplied].
The decree condones the collection of all internal revenue taxes including the increments or penalties or
account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to
(voluntary) disclosures under the NIRC of previously untaxed income and/or wealth realized here or abroad by
any taxpayer, natural or juridical.
May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An
income taxpayer covers all persons who derive taxable income.[47] ANSCOR was assessed by petitioner for

deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such, it is being held liable in its
capacity as a withholding agent and not in its personality as a taxpayer.
In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting
no more than an agent of the government for the collection of the tax [48] in order to ensure its payments;[49] the
payer is the taxpayer he is the person subject to tax impose by law; [50] and the payee is the taxing authority.[51] In
other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system,
however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from
the taxpayer,[52] because the income tax is still impose on and due from the latter. The agent is not liable for the
tax as no wealth flowed into him he earned no income. The Tax Code only makes the agent personally liable for
the tax[53] (c) 1939 Tax Code, as amended by R.A. No. 2343 which provides in part that xxx Every such person is
made personally liable for such tax xxx.53 arising from the breach of its legal duty to withhold as distinguish from
its duty to pay tax since:
the governments cause of action against the withholding agent is not for the collection of income tax,
but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with
which is imposed on the withholding agent and not upon the taxpayer.[54]
Not being a taxpayer, a withholding agent, like ANSCOR in this transaction, is not protected by the amnesty
under the decree.
Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent. [55] The
taxpayer should not answer for the non-performance by the withholding agent of its legal duty to withhold unless
there is collusion or bad faith. The former could not be deemed to have evaded the tax had the withholding
agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail
tax evasion and give tax evaders a chance to reform,[56] it was deemed administratively feasible to grant tax
amnesty in certain instances. In addition, a tax amnesty, much like a tax exemption, is never favored nor
presumed in law and if granted by a statute, the terms of the amnesty like that of a tax exemption must be
construed strictly against the taxpayer and liberally in favor of the taxing authority.[57] The rule on strictissimi
juris equally applies.[58] So that, any doubt in the application of an amnesty law/decree should be resolved in
favor of the taxing authority.
Furthermore, ANSCORs claim of amnesty cannot prosper. The implementing rules of P.D. 370 which
expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to wit:
Section 4. Cases not covered by amnesty. The following cases are not covered by the amnesty subject of these
regulations:
xxx xxx xxx
(2) Tax liabilities with or without assessments, on withholding tax at source provided under Sections 53 and 54 of
the National Internal Revenue Code, as amended;[59]
ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not
covered by the amnesty.

TAX ON STOCK DIVIDENDS

General Rule

Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928. [60] It laid
down the general rule known as the proportionate test [61] wherein stock dividends once issued form part of the
capital and, thus, subject to income tax.[62] Specifically, the general rule states that:
A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.
Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US
Revenue Code, this provision originally referred to stock dividends only, without any exception. Stock dividends,
strictly speaking, represent capital and do not constitute income to its recipient. [63] So that the mere issuance

thereof is not yet subject to income tax[64] as they are nothing but an enrichment through increase in value of
capital investment.[65] As capital, the stock dividends postpone the realization of profits because the fund
represented by the new stock has been transferred from surplus to capital and no longer available for actual
distribution.[66] Income in tax law is an amount of money coming to a person within a specified time, whether as
payment for services, interest, or profit from investment.[67] It means cash or its equivalent.[68] It is gain derived and
severed from capital,[69] from labor or from both combined[70] - so that to tax a stock dividend would be to tax a
capital increase rather than the income.[71] In a loose sense, stock dividends issued by the corporation, are
considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the
realization, stock dividends are nothing but a representation of an interest in the corporate properties. [72] As
capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is
wealth or fund; whereas income is profit or gain or the flow of wealth.[73] The determining factor for the imposition
of income tax is whether any gain or profit was derived from a transaction.[74]

The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to
make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution
of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered
as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first,
nineteen hundred and thirteen. (Emphasis supplied).
In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber[75] (that pro rata
stock dividends are not taxable income), the exempting clause above quoted was added because
corporations found a loophole in the original provision. They resorted to devious means to circumvent the law
and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by
declaring the stock dividends previously issued and later redeem said dividends by paying cash to the
stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was
just delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the effects of taxation.
Thus, to plug the loophole the exempting clause was added. It provides that the redemption or cancellation of
stock dividends, depending on the time and manner it was made is essentially equivalent to a distribution of
taxable dividends, making the proceeds thereof taxable income to the extent it represents profits. The exception
was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally
not taxable, from being made use of as a device for the actual distribution of cash dividends, which is
taxable.[76] Thus,
the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment
by distributing earnings to its shareholders in two transactions a pro rata stock dividend followed by a pro
rata redemption that would have the same economic consequences as a simple dividend. [77]
Although redemption and cancellation are generally considered capital transactions, as such, they are not
subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from
such transactions.[78] Simply put, depending on the circumstances, the proceeds of redemption of stock
dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the
stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of
choice[79] Having realized gain from that redemption, the income earner cannot escape income tax.[80]
As qualified by the phrase such time and in such manner, the exception was not intended to characterize as
taxable dividend every distribution of earnings arising from the redemption of stock dividends. [81] So that, whether
the amount distributed in the redemption should be treated as the equivalent of a taxable dividend is a question
of fact,[82] which is determinable on the basis of the particular facts of the transaction in question. [83] No decisive
test can be used to determine the application of the exemption under Section 83(b) The use of the words such
manner and essentially equivalent negative any idea that a weighted formula can resolve a crucial issue Should
the distribution be treated as taxable dividend.[84] On this aspect, American courts developed certain recognized
criteria, which includes the following:[85]
1) the presence or absence of real business purpose,

2) the amount of earnings and profits available for the declaration of a regular dividend and the
corporations past record with respect to the declaration of dividends,
3) the effect of the distribution as compared with the declaration of regular dividend,
4) the lapse of time between issuance and redemption,[86]
5) the presence of a substantial surplus[87] and a generous supply of cash which invites suspicion as does
a meager policy in relation both to current earnings and accumulated surplus.[88]

REDEMPTION AND CANCELLATION

For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is redemption or
cancellation; (b) the transaction involves stock dividends and (c) the time and manner of the transaction makes
it essentially equivalent to a distribution of taxable dividends. Of these, the most important is the third.
Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock [89] in exchange
for property, whether or not the acquired stock is cancelled, retired or held in the treasury. [90]Essentially, the
corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock,
and continues in business as before. The redemption of stock dividends previously issued is used as a veil for the
constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares
of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares
redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or
from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may
not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of capital.
On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital
investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain
thereon.
It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends.
Here, it is undisputed that at the time of the last redemption, the original common shares owned by the estate
were only 25,247.5.[91] This means that from the total of 108,000 shares redeemed from the estate, the balance of
82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the
contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of
corporate profits,[92] such as stock dividends. The capital cannot be distributed in the form of redemption of stock
dividends without violating the trust fund doctrine wherein the capital stock, property and other assets of the
corporation are regarded as equity in trust for the payment of the corporate creditors.[93] Once capital, it is
always capital.[94] That doctrine was intended for the protection of corporate creditors.[95]
With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time
alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a
must to consider the factual circumstances as to the manner of both the issuance and the redemption. The time
element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares
is a method usually adopted to accomplish the end sought.[96] Was this transaction used as a continuing plan,
device or artifice to evade payment of tax? It is necessary to determine the net effect of the transaction
between the shareholder-income taxpayer and the acquiring (redeeming) corporation.[97] The net effect test is
not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be
reached.[98] It is also important to know whether the issuance of stock dividends was dictated by legitimate
business reasons, the presence of which might negate a tax evasion plan.[99]
The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related,
for the redemption to be considered a legitimate tax scheme.[100] Redemption cannot be used as a cloak to
distribute corporate earnings.[101] Otherwise, the apparent intention to avoid tax becomes doubtful as the
intention to evade becomes manifest. It has been ruled that:
[A]n operation with no business or corporate purpose is a mere devise which put on the form of a corporate
reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which
was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to
transfer a parcel of corporate shares to a stockholder.[102]

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be applicable if the
redeemed shares were issued with bona fide business purpose,[103] which is judged after each and every step of
the transaction have been considered and the whole transaction does not amount to a tax evasion scheme.
ANSCOR invoked two reasons to justify the redemptions (1) the alleged filipinization program and (2) the
reduction of foreign exchange remittances in case cash dividends are declared. The Court is not concerned with
the wisdom of these purposes but on their relevance to the whole transaction which can be inferred from the
outcome thereof. Again, it is the net effect rather than the motives and plans of the taxpayer or his
corporation[104] that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the
result.[105] It also applies even if at the time of the issuance of the stock dividend, there was no intention to
redeem it as a means of distributing profit or avoiding tax on dividends.[106] The existence of legitimate
business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no
relevance in determining dividend equivalence.[107] Such purposes may be material only upon the issuance of
the stock dividends. The test of taxability under the exempting clause, when it provides such time and manner as
would make the redemption essentially equivalent to the distribution of a taxable dividend, is whether the
redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a
dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not deemed realize until the
fruit has fallen or been plucked from the tree.
The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that the gain or
profit is realized or received, actually or constructively,[108] and (3) it is not exempted by law or treaty from income
tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement.
Income tax is assessed on income received from any property, activity or service that produces the income
because the Tax Code stands as an indifferent neutral party on the matter of where income comes from.[109]
As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was
realized through the redemption of stock dividends. The redemption converts into money the stock dividends
which become a realized profit or gain and consequently, the stockholders separate property. [110] Profits derived
from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock
dividends can be reached by income taxation regardless of the existence of any business purpose for the
redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is
supported by legitimate business reasons would defeat the very purpose of imposing tax on income. Such
argument would open the door for income earners not to pay tax so long as the person from whom the income
was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of
Section 83(b) would be made to depend not on the income of the taxpayer but on the business purposes of a
third party (the corporation herein) from whom the income was earned. This is absurd, illogical and impractical
considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the
legitimacy of business reasons that every income earner may interposed. It is not administratively feasible and
cannot therefore be allowed.
The ruling in the American cases cited and relied upon by ANSCOR that the redeemed shares are the
equivalent of dividend only if the shares were not issued for genuine business purposes[111] or the redeemed
shares have been issued by a corporation bona fide[112] bears no relevance in determining the non-taxability of
the proceeds of redemption. ANSCOR, relying heavily and applying said cases, argued that so long as
the redemption is supported by valid corporate purposes the proceeds are not subject to tax.[113] The adoption
by the courts below [114] of such argument is misleading if not misplaced. A review of the cited American cases
shows that the presence or absence of genuine business purposes may be material with respect to
the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the
redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes
may justify a corporations acquisition of its own shares under Section 41 of the Corporation Code, [115] such
purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance
of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons the redemption
becomes suspicious which may call for the application of the exempting clause. The substance of the whole
transaction, not its form, usually controls the tax consequences.[116]
The two purposes invoked by ANSCOR under the facts of this case are no excuse for its tax liability. First, the
alleged filipinization plan cannot be considered legitimate as it was not implemented until the BIR started making
assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by
any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a separate entity, the
corporation can act only through its Board of Directors.[117] The Board Resolutions authorizing the redemptions
state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Not

even this purpose can be given credence. Records show that despite the existence of enormous corporate
profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the
early 1970s. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet
when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of
ANSCORs alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCORs
foreign stockholders contrary to its filipinization plan. This would also increase rather than reduce their need for
foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family
corporation where the majority shares at the time of redemptions were held by Don Andres foreign heirs.
Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid
excuse for the imposition of tax. Otherwise, the taxpayers liability to pay income tax would be made to depend
upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support
the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the
imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends
since it was shown that income was generated therefrom.
Thirdly, ANSCOR argued that to treat as taxable dividend the proceeds of the redeemed stock dividends
would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening purchasers,
i.e. those who buys the stock dividends after their issuance.[118] Such argument, however, bears no relevance in
this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into
the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend
equivalence test depends on such time and manner of the transaction and its net effect. The undisclosed
lien[119] may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness
may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his
investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he
bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to
return his capital subscription, which is income if redeemed from the original subscriber.
After considering the manner and the circumstances by which the issuance and redemption of stock
dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered
equivalent to a distribution of taxable dividends. As taxable dividend under Section 83(b), it is part of the entire
income subject to tax under Section 22 in relation to Section 21 [120] of the 1939 Code. Moreover, under Section
29(a) of said Code, dividends are included in gross income. As income, it is subject to income tax which is
required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this
disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES[121]

Exchange is an act of taking or giving one thing for another[122] involving reciprocal transfer[123] and is
generally considered as a taxable transaction. The exchange of common stocks with preferred stocks, or
preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as
the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade
between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled
corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on
exchange of property, stock or securities related to reorganizations.[124]
Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and
preferred, and that parts of the common shares of the Don Andres estate and all of Doa Carmens shares
were exchanged for the whole 150, 000 preferred shares. Thereafter, both the Don Andres estate and Doa
Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There
was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the
same par value. Under the facts herein, any difference in their market value would be immaterial at the time of
exchange because no income is yet realized it was a mere corporate paper transaction. It would have been
different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be
imposed.[125]
Reclassification of shares does not always bring any substantial alteration in the subscribers proportional
interest. But the exchange is different there would be a shifting of the balance of stock features, like priority in
dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields
realize income for tax purposes. A common stock represents the residual ownership interest in the corporation. It is

a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the
shareholder to a pro rata division of profits.[126] Preferred stocks are those which entitle the shareholder to some
priority on dividends and asset distribution.[127]
Both shares are part of the corporations capital stock. Both stockholders are no different from ordinary
investors who take on the same investment risks. Preferred and common shareholders participate in the same
venture, willing to share in the profits and losses of the enterprise. [128] Moreover, under the doctrine of equality of
shares all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided
that the Articles of Incorporation is silent on such differences.[129] In this case, the exchange of shares, without
more, produces no realized income to the subscriber. There is only a modification of the subscribers rights and
privileges - which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a
subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest. [130]
WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCORs
redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable
dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects.
SO ORDERED.
WISE
&
CO.,
INC.,
vs.
BIBIANO L. MEER, Collector of Internal Revenue, defendant-appellee.
Ross,
Selph,
Carrascoso
Office of the Solicitor General for appellee.

and

ET

Janda

AL., plaintiffs-appellants,

for

appellants.

HILADO, J.:
This is an appeal by Wise & Co., Inc. and its co-plaintiff from the judgment of the Court of First Instance of Manila
in civil case No. 56200 of said court, absolving the defendant Collector of Internal Revenue from the complaint
without costs. The complaint was for recovery of certain amounts therein specified, which had been paid by said
plaintiffs under written protest to said defendant, who had previously assessed said amounts against the
respective plaintiffs by way of deficiency income taxes for the year 1937, as detailed under paragraph 6 of
defendant's special defense (Record of Appeal, pp. 7-10). Appellants made eight assignments of error, to wit:
The trial court erred in finding:
I. That the Manila Wine Merchants, Ltd., a Hongkong corporation, was in liquidation beginning June 1,
1937, and that all dividends declared and paid thereafter were distributions of all its assets in complete
liquidation.
II. That all distributions made by the Hongkong corporation after June 1, 1937, were subject to both
normal tax and surtax.
III. That income received by one corporation from another was taxable under the Income Tax Law, and
that Wise & Co., Inc., was taxable on the distribution of its share of the same net profits on which the
Hongkong Company had already paid Philippine tax, despite the clear provisions of section 10 of the
Income Tax Law then in effect.
IV. That the non-resident individual stockholder appellants were subject to both normal and additional tax
on the distributions received despite the clear provisions of section 5 (b) of the Income Tax Law then in
effect.
V. That section 25 (a) of the Income Tax Law makes distributions in liquidation of a foreign corporation,
dissolution proceedings of which were conducted in a foreign country, taxable income to a non-resident
individual stockholder.

VI. That section 199 of the Income Tax regulations, providing that in a distribution by a corporation in
complete liquidation of its assets the gain realized by a stockholder, whether individual or corporate, is
taxable as a dividend, is ineffective.
VII. That the deficiency assessment was properly collected.
VIII. That the refunds claimed by plaintiffs were not in order, and in rendering judgment absolving the
Collector of Internal Revenue from making such refunds.
The facts have been stipulated in writing, as quoted verbatim in the decision of the trial court thus:
I
That the allegations of paragraphs I and II of the complaint are true and correct.
II
That during the year 1937, plaintiffs, except Mr. E.M.G. Strickland (who, as husband of the plaintiff Mrs.
E.M.G. Strickland, is only a nominal party herein), were stockholders of Manila Wine Merchants, Ltd., a
foreign corporation duly authorized to do business in the Philippines.
III
That on May 27, 1937, the Board of Directors of Manila Wine Merchants, Ltd., (hereinafter referred to as
the Hongkong Company), recommended to the stockholders of the company that they adopt the
resolutions necessary to enable the company to sell its business and assets to Manila Wine Merchants,
Inc., a Philippine corporation formed on May 27, 1937, (hereinafter referred to as the Manila Company),
for the sum of P400,000 Philippine currency; that this sale was duly authorized by the stockholders of the
Hongkong Company at a meeting held on July 22, 1937; that the contract of sale between the two
companies was executed on the same date, a copy of the contract being attached hereto as Schedule
"A"; and that the final resolutions completing the said sale and transferring the business and assets of the
Hongkong Company to the Manila Company were adopted on August 3, 1937, on which date the
Manila Company were adopted on August 3, 1937, on which date the Manila Company paid the
Hongkong company the P400,000 purchase price.
IV
That pursuant to a resolution by its Board of Directors purporting to declare a dividend, the Hongkong
Company made a distribution from its earnings for the year 1937 to its stockholders, plaintiffs receiving the
following:
Declared
June 8, 1937

and

paid

Wise & Co., Inc.

P7,677.82

Mr. J.F. MacGregor

2,554.86

Mr.
MacGregor

2,369.48

N.C.

Mr. C.J. Lafrentz

529.51

Mrs.
Strickland

2,369.48

E.M.G.

Mrs. M.J.G. Mullins

2,369.48

P17,870.63
That the Hongkong Company has paid Philippine income tax on the entire earnings from which the said
distributions were paid.
V
That after deducting the said dividend of June 8, 1937, the surplus of the Hongkong Company resulting
from the active conduct of its business was P74,182.12. That as a result of the sale of its business and assets
to the Manila Company, the surplus of the Hongkong Company was increased to a total of P270,116.59.
That pursuant to resolutions of its Board of Directors, and of its shareholders, purporting to declare
dividends, copies of which are attached hereto as Schedules "B" and "B-1", the Hongkong Company
distributed this surplus to its stockholders, plaintiffs receiving the following sums on the following dates:
Declared
July 22, 1937
Paid
August
4,
1937

Declared
July 22, 1937
Paid
October 28,
1937

Wise & Co., Inc.

P113,851.85

P 2,198.24

Mr. J.F. MacGregor

37,885.20

731.48

Mr. N.C. MacGregor

35,137.03

678.42

Mr. C.J. Lafrentz

7,851.86

151.61

Mrs. E.M.G. Strickland

35,137.03

678.42

Mrs. M.J.G. Mullins

35,137.03

678.42

P265,000.00

P 5,116.59

That Philippine income tax had been paid by the Hongkong Company on the said surplus from which the
said distributions were made.
VI
That on August 19, 1937, at a special general meeting of the shareholders of the Hongkong Company,
the stockholders by proper resolution directed that the company be voluntarily liquidated and its capital
distributed among the stockholders; that the stockholders at such meeting appointed a liquidator duly
paid off the remaining debts of the Hongkong Company and distributed its capital among the
stockholders including plaintiffs; that the liquidator duly filed his accounting on January 12, 1938, and in
accordance with the provisions of Hongkong Law, the Hongkong Company was duly dissolved at the
expiration of three moths from that date.
VII
That plaintiffs duly filed Philippine income tax returns. That defendant subsequently made the following
deficiency assessments against plaintiffs:
WISE & COMPANY, INC.
Net income as per return

P87,649.67

Add: Deductions disallowed Loss on

shares
of
pstock in the Manila Wine
Merchants,
Ltd.
presulting from the liquidation of
said firm

44,515.00

Income

not
Return
Share of surplus

of

declared:
capital P51,185.00
123,727.88

Total liquidating dividends received P174,912.88

Less value of shares as per books
95,700.00
Profits realized on shares of stock in
the
Manila Wine Merchants Ltd.
resulting
from the liquidation of the said
firm

P79,212.88

Accrued income tax as per return

5,258.98

Total

P216,636.53

Deduct accrued income tax

12,262.45

Net income as per investigation

204,374.08

6 per cent Normal tax

12,262.45

Less amount already paid

6,307.92

Balance still due and collectible

7,003.47

J. F. MACGREGOR
Net income as per return

P47,479.44

Deduct: Ordinary dividends

6,307.92

Net income as per investigation subject

to
normal
tax:
Return
of
capital P17,032,25
Share of surplus
41,171.52
Total liquidating dividends received P58,203.77
Less cost of shares

17,032.25

Profit realized on shares of stock

in the Manila Wine Merchants.,
Ltd.
Resulting from the liquidation of
said firm

P41,171.52

Normal tax at 3 per cent

1,235.15

Additional tax due

549.59

Total normal and additional taxes

1,784.74

Less: Amount already paid

549.59

Balance still due and collectible

1,235.15

N. C. MACGREGOR
Net income as per return

P44,177.06

Deduct: Ordinary dividends

5,992.11

Net income as per investigation subject

to
normal tax:
Return
Share of surplus

of

capital P15,796.75
38,184.95

Total liquidating dividends received. P53,981.70

Less cost of shares
15,796.75
Profit realized on shares of stock in
the
Manila Wine Merchants, Ltd.
Resulting

P38,184.95

from the liquidation of the said

firm
Normal tax at 3 per cent

1,145.55

Additional tax due

483.54

Total normal and additional taxes

1,629.09

Less amount already paid

483.55

Balance still due and collectible

1,145.54

C. J. LAFRENTZ
Net income as per return

P9,778.18

Deduct: Ordinary dividends

1,245.20

Net income as per investigation subject

to
normal tax:
Return
Share of surplus

of

capital P3,530.00
8,532.98

Total liquidating dividends received P12,062.98

Less cost of shares
3,530.00
Profit realized on shares of stock in
the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

P8,532.98

3 per cent
collectible

normal

tax

due

and
255.99

MRS. E. M. G. STRICKLAND
Net income as per return

P44,057.06

Deduct: Ordinary dividends

5,872.11

Net income as per investigation subject

to
normal tax:
Return
Share of surplus

of

capital P15,796.75
38,184.95

Total liquidating dividends received

Less cost of shares
P53,981.7015,796.75
Profit realized on shares of stock in
the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

P38,184.95

Normal tax at 3 per cent

1,145.55

Additional tax due

481.14

Total normal and additional taxes

1,626.69

Balance still due and collectible

1,145.54

MRS. M. J. G. MULLINS
Net income per return

P44,057.06

Deduct: Ordinary dividends

5,872.11

Net income as per investigation subject

to
normal tax:
Return

of

capital P15,796.75

Share of surplus

38,184.95

Total liquidating dividends received P53,981.70

Less cost of shares
15,796.75
Profit realized on shares of stock in
the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

P38,184.95

Normal tax at 3 per cent

1,145.55

Additional tax due

Total normal and additional taxes
Less amount already paid
Balance still due and collectible

481.14
1,626.69
481.15
P1,145.54

VIII
That said plaintiffs duly paid the said amounts demanded by defendant under written protest, which was
overruled in due course; that the plaintiffs have since July 1, 1939 requested from defendant a refund of
the said amounts which defendant has refused and still refuses to refund.
IX
That this stipulation is equally the work of both parties and shall be fairly interpreted to give effect to their
intention that this case shall be decided solely upon points of law.
X
The parties incorporate the Corporation Law and Companies Act of Hongkong and the applicable
decisions made thereunder, into this stipulation by reference, and either party may at any stage in the
proceedings in this case cite applicable sections of the law and the authorities decided thereunder as
though the same had been duly proved in evidence.
XI
That the parties hereto reserve the right to submit other and further evidence at the trial of this case.
(Record on Appeal, pp. 19-26.)
1. The first assignment of error. Appellants maintain that the amounts received by them and on which the taxes
in question were assessed and collected were ordinary dividends; while upon the other hand, appellee contends
that they were liquidating dividends. If the first proposition is correct, this assignment would be well-taken,
otherwise, the decision of the court upon the point must be upheld.
It appears that on May 27, 1937, the Board of Directors of the Manila Wine Merchants, Ltd. (hereafter called the
Hongkong Co.), recommended to the stockholders of said company "that the Company should be wound up
voluntarily by the members and the business sold as a going concern to a new company incorporated under the
laws of the Philippine Islands under the style of "The Manila Wine Merchants, Inc." (Annex A defendant's answer,
Record on Appeal, p. 12), and that they adopt the resolutions necessary to enable the company to sell its
business and assets to said new company (hereafter called the Manila Company), organized on that same date,
for the price of P400,000, Philippine currency; that the sale was duly authorized by the stockholders of the
Hongkong Co. at a meeting held on July 22, 1937; and that the contract of sale between the two companies
was executed on the same day, as appears from the copy of the contract, Schedule A of the Stipulation of Facts
(par. III, Stipulation of Facts, Record on Appeal, pp. 19-20). It will be noted that the Board of Directors of the
Hongkong Co., in recommending the sale, specifically mentioned "a new Company incorporated under the laws
of the Philippine Islands under the style of "The Manila Wine Merchants, Inc." as the purchaser, which fact shows
that at the time of the recommendation the Manila Company had already been formed, although on the very

same day; and this and the further fact that it was really the latter corporation that became the purchaser
should clearly point to the conclusion that the Manila Company was organized for the express purpose of
succeeding the Hongkong Co. The stipulated facts would admit of no saner interpretation.
While it is true that the contract of sale was signed on July 22, 1937, it contains in its paragraph 4 of the express
provision that the transfer "will take effect as on and from the first day of June, One thousand nine hundred and
thirty-seven, and until completion thereof, the Company shall stand possessed of the property hereby agreed to
be transferred and shall carry on its business in trust for the Corporation" (Schedule A of Stipulation of Facts,
Record on Appeal, p. 15). "The Company" was the Hongkong Company and "the Corporation" was the Manila
Company. For "the Company" to carry on business in trust for the "Corporation," it was necessary for the latter to
be the owner of the business. It is plain that the parties considered the sale as made as on and from June 1, 1937
for the purposes of said sale and transfer, both parties agreed that the deed of July 22, 1937, was to retroact to
the first day of the preceding month.
The cited provision could not have served any other purpose than to consider the sale as made as of June 1,
1937. If it had not been for this purpose, if the intention had been that the sale was to be effective upon the date
of the written contract or subsequently, said provision would certainly never have been written, for how could the
transfer or sale take effect as of June 1, 1937, if it were to be considered as made at a later date?
The first distribution made after June 1, 1937, of what plaintiffs call ordinary dividends but what defendant
denominates liquidating dividends was declared and paid on June 8, 1937 (Stipulation, Paragraph IV, Record on
Appeal, p. 20). It will be recalled that the recommendation of the Board of Directors of the Hongkong Company,
at their meeting on May 27, 1937, was first of all "that the company should be wound up voluntarily by the
members"(Record on Appeal, p.12), and in pursuance of that purpose, it was further recommended that the
Company's business be sold as a going concern to the Manila Company (ibid). Complying with the Companies
Ordinance 1932 for companies registered in Hongkong for the voluntary winding up by members, a Declaration
of Solvency was drawn up duly signed before the British Consul-General in Manila by the same directors, and said
declaration was returned to Hongkong for filing with the Registrar of Companies (ibid.) Both recommendations
were in due course approved and ratified. The later execution of the formal deed of sale and the successive
distributions of the amounts in question among the stockholders of the Hongkong Company were obviously other
steps in its complete liquidation. And they leave no room for doubt in the mind of the court that said distributions
were not in the ordinary course of business and with intent to maintain the corporation as a going concern in
which case they would have been distributions of ordinary dividends but after the liquidation of the business
had been decided upon, which makes them payments for the surrender and relinquishment of the stockholders'
interest in the corporation, or so-called liquidating dividends.
More than with the distribution of June 8, 1937, is this true with those declared on July 22, 1937, and paid on
August 4 and October 28, 1937, respectively (Stipulation of Facts, par. 5, Record on Appeal, p. 21). The
distributions thus declared on July 22, 1937, and paid on August 4 and October 28, 1937, were from the surplus of
the Hongkong Company resulting from the active conduct of its business and amounting to P74,182.12, which
surplus was augmented to a total of P270,116.59 as a result of the sale of its business and assets to the Manila
Company (ibid.). In both Schedules B and B-1 of the Stipulation of Facts (Record on appeal, pp. 16-18), being
minutes of directors' meetings of the Hongkong Co., where authorization and instruction were given to declare
and pay in the form of "dividends" to the shareholders the amounts in question, it was specifically provided that
the surplus to be so distributed be that resulting after providing for return of capital and necessary or various
expenses, as shown in the balance sheet prepared as of June 1, 1937, and in the reconstructed balance sheet of
the same date presented by the company's auditors, it having been resolved in Schedule B-1 that
"any balanceremaining to be distributed when final liquidator's account has been rendered and paid" (Record
on Appeal, p. 18; emphasis supplied). It thus becomes more evident that those distributions were to be made in
the course or as a result of the Hongkong Company's liquidation and that said liquidation was to
be complete and final. And although the various resolutions above-mentioned speak of distributions of dividends
when referring to those already alluded to, "a distribution does not necessarily become a dividend by reason of
the fact that it is called a dividend by the distributing corporation." (Holmes Federal Taxes, 6th edition, 774.)
The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its
stockholders upon dissolution. (Klein, Federal Income Taxation, 253-254.)
But it is contended by plaintiffs that as of August 4, 1937, the Hongkong Company "had taken no steps toward
dissolution or liquidation and still retained on hand liquid assets in excess of its capitalization." They also assert that

it was only on August 19, 1937, that said company took the first corporate steps toward liquidation (Appellant's
Brief, pp. 9-10). The fact, however, is that since July 22, 1937, when the formal deed of sale of all the properties,
assets, and business of the Hongkong Company to the Manila Company was made, it was expressly stipulated
that the sale or transfer shall take effect as of June 1, 1937. As already indicated, the transfer of what was sold,
like the sale itself, was, by the mutual agreement of the parties, considered as made on and from that date, and
that, if thereafter and until final completion of the transfer, the Hongkong Company continued to run the
business, it did so in trust for the new owner, the Manila Company. In the case of Canal-Commercial T. & S.
Bk.vs. Comm'r (63 Fed. [2d], 619, 620) it was held that:
. . . The determining element therefore is whether the distribution was in the ordinary course of business
and with intent to maintain the corporation as a going concern, or after deciding to quit with intent to
liquidate the business. Proceedings actually begun to dissolve the corporation or formal action taken to
liquidate it are but evidentiary and not indispensable. Tootle vs. Commissioner (C.C.A. 58 F. [2d, 576.) The
fact that the distribution is wholly from surplus and not from capital, and therefore lawful as a dividend is
only evidence. In Hellmich vs. Hellman, and Tootle vs. Commissioner, supra, the distribution was wholly
from profits yet held to be one in liquidation . . . (Emphasis Supplied.)
In the case at bar, when in the deed of July 22, 1937, by authority of its stockholders, the Hongkong Company
thru its authorized representative declared and agreed that the aforesaid sale and transfer shall take effect as of
June 1, 1937, and distribution from its assets to those same stockholders made after June 1, 1937, altho before July
22, 1937, must have been considered by them as liquidating dividends; for how could they consistently deem all
the business and assets of the corporation sold as of June 1, 1937, and still say that said corporation, as a going
concern, distributed ordinary dividends to them thereafter?
In Holmby Corporation vs. Comm'r (83 Fed. [2d], 548-550), the court said:
. . . the fact that the distributions were called "dividends" and were made, in part, from earnings and
profits, and that some of them were made before liquidation or dissolution proceedings were
commenced, is not controlling. . . . The determining element is whether the distributions were in the
ordinary course of business and with intent to maintain the corporation as a going concern, or after
deciding to quit and with intent to liquidate the business . . .. (Emphasis supplied.)
The directors or representatives of the Hongkong Company or the Manila Company, or both, could of course not
convert into ordinary dividends what in law and in reality were not such. As aptly stated by Chief Justice Shaw in
Comm. vs. Hunt (38 Am. Dec., 354-355),
The law is not to be hoodwinked by colorable pretenses. It looks at truth and reality through whatever
disguise they may assume.
The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock in fact,
they surrendered and relinquished their stock in return for said distributions, thus ceasing to be stockholders of the
Hongkong Company, which in turn ceased to exist in its own right as a going concern during its more or less brief
administration of the business as trustee for the Manila Company, and finally disappeared even as such trustee.
The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each
case depending on the particular circumstances of the case and the intent of the parties. If the
distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the
corporation is reallywinding up its business or recapitalizing and narrowing its activities, the distribution
may properly be treated as in complete or partial liquidation and as payment by the corporation to the
stockholder for his stock. The corporation is, in the latter instances, wiping out all parts of the stockholders'
interest in the company . . .. (Montgomery, Federal Income Tax Handbook [1938-1939], 258; emphasis
supplied.)
It is our considered opinion that we are not dealing here with "the legal right of a taxpayer to decrease the
amount of what otherwise will be his taxes, or altogether avoid them, by means which the law permits" (St. Louis
Union Co. vs. U.S., 82 Fed. [2d], 61), but with a situation where we have to apply in favor of the government the
principle that the "liability for taxes cannot be evaded by a transaction constituting a colorable subterfuge" (61

C.J., 173), it being clear that the distributions under consideration were not ordinary dividends and were taxable
in the manner, form and amounts decreed by the court below.
2. The second assignment of error. In disposing of the first assignment of error, we held that the distributions in
the instant case were not ordinary dividends but payments for surrendered or relinquished stock in a corporation
in complete liquidation, sometimes called liquidating dividends. The question is whether such amounts were
taxable income. The Income Tax Law, Act No. 2833 section 25 (a), as amended by section 4 of Act. No. 3761,inter
alia stipulated:
Where a corporation, partnership, association, joint-account, or insurance company distributes all of its
assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether
individual or corporation, is a taxable income or a deductible loss as the case may be. (Emphasis
supplied.)
Partial source of the foregoing provision was section 201 (c) of the U.S. Revenue Act of 1918, approved February
24, 1919, providing:
Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for the
stock or share, and any gain or profit realized thereby shall be taxed to the distributee as other gains or
profits.
It is a familiar rule of statutory construction that the judicial construction attached to the sources of statutes
adopted in a jurisdiction are of authoritative value in the interpretation of such local laws. The Supreme Court of
the United States has had occasion to construe certain pertinent parts of the Federal Revenue Act abovementioned on February 20, 1928, when it decided the case of Hellmich vs. Hellman (276 U.S., 233; 72 Law. ed.,
544). The case involved the recovery of additional income taxes assessed against the plaintiffs under protest. And
its determination hinged around the construction of parts of said act after which those of our own law now under
discussion were patterned. Justice Sanford said:
The question here is whether the gains realized by stockholders from the amounts distributed in the
liquidation of the assets of a dissolved corporation, out of its earnings or profits accumulated since
February 28, 1913, were taxable to them as other "gains or profits", or whether the amounts so distributed
were "dividends" exempt from the normal tax.
Section 201 (a) of the act defined the term "dividend" as "any distribution made by a corporation . . . to its
shareholders . . . whether in cash or in other property .. out of its earnings or profits accumulated since
February 28, 1913 . . .." Section 201 (c) provided that "amounts distributed in the liquidation of a
corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized
thereby shall be taxed to the distributee as other gains or profits."
Our law at the time of the transactions in question, in providing that where a corporation, etc. distributes all its
assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder is a taxable
income or a deductible loss as the case may be, in effect treated such distributions as payments in exchange for
the stock or share. Thus, in making the deficiency assessments under consideration, the Collector, among other
items, made proper deduction of the "value of shares" or "cost of shares" in the case of each individual plaintiff,
assessing the tax only on the resulting "profit realized" (Stipulation, par. VII, Record on Appeal, pp. 22-25); and of
course in case the value or cost of the shares should exceed the distribution received by the stockholder, the
resulting difference will be treated as a "deductible loss."
In the same case the Supreme Court of the United States made the following quotation, which is here relevant,
from Treasury Regulations 45, article 1548:
. . . So-called liquidation or dissolution dividends are not dividends within the meaning of the statute, and
amounts so distributed, whether or not including any surplus earned since February 28, 1913, are to be
regarded as payments for the stock of the dissolved corporation. Any excess so received over the cost of
his stock to the stockholder, or over its fair market value as of March 1, 1913, if acquired prior thereto, is a
taxable profit. A distribution in liquidation of the assets and business of a corporation, which is a return to
the stockholders of the value of his stock upon a surrender of his interest in the corporation, is

distinguishable from a dividend paid by a going corporation out of current earnings or accumulated
surplus when declared by the directors in their discretion, which is in the nature of a recurrent return upon
the stock. (72 Law. ed., 546.)
The Income Tax Law of the Philippines in force at the time defined the term "dividend" in section 25 (a), as
amended, as "any distribution made by a corporation . . . out of its earnings or profits accumulated since March
1, 1913, and payable to its shareholders whether in cash or other property." This definition is substantially the same
as that given to the same term by the U.S. Revenue Act of 1918 quoted by Justice Sanford in the passage above
inserted.
Plaintiffs contend that defendant's position would result in double taxation. A similar contention has been
adversely disposed of against the taxpayer in the Hellmich case in these words:
The gains realized by the stockholders from the distribution of the assets in liquidation were subject to the
normal tax in like manner as if they had sold their stock to third persons. The objection that this results in
double taxation of the accumulated earnings and profits is no more available in the one case than it
would have been in the other. See Merchants' Loan & T. Co. vs. Smietanki, 255 U.S., 509; 65 Law. ed., 751;
15 A.L.R., 1305; 41 Sup. Ct. Rep., 386; Goodrich vs. Edwards, 255 U.S. 527; 65 Law. ed., 758; 41 Sup. Ct. Rep.,
390. When, as here, Congress clearly expressed its intention, the statute must be sustained even though
double taxation results. See Patton vs. Brady , 184 U.S., 608; 46 Law ed., 713; 22 Sup. Ct. Rep., 493; Cream
of Wheat Co. vs. Grand Forks County, 253 U.S., 325, 330; 64 Law. ed., 931, 934; 40 Sup. Ct. Rep., 558.
(Hellmich vs. Hellman, supra; 72 Law. ed., 547.)
It should be borne in mind that plaintiffs received the distributions in question in exchange for the surrender and
relinquishment by them of their stock in the Hongkong Company which was dissolved and in process of complete
liquidation. That money in the hands of the corporation formed a part of its income and was properly taxable to
it under the then existing Income Tax Law. When the corporation was dissolved and in process of complete
liquidation and its shareholders surrendered their stock to it and it paid the sums in question to them in exchange,
a transaction took place, which was no different in its essence from a sale of the same stock to a third party who
paid therefor. In either case the shareholder who received the consideration for the stock earned that much
money as income of his own, which again was properly taxable to him under the same Income Tax Law. In the
case of the sale to a third person, it is not perceived how the objection of double taxation could have been
successfully raised. Neither can we conceive how it could be available where, as in this case, the stock was
transferred back to the dissolved corporation.
3. The third assignment of error. In view of what has been said in our consideration of the second assignment of
error, the third can be briefly disposed of. Having held that the distributions involved herein were not ordinary
dividends but payments for stock surrendered and relinquished by the shareholders to the dissolved corporation,
or so-called liquidating dividends, we have the road clear to declaring that under section 25 (a) of the former
Income Tax Law, as amended, said distributions were taxable alike to Wise and Co., Inc. and to the other
plaintiffs. We hold that both the proviso of section 10 (a) of said Income Tax Law and section 198 of Regulations
No. 81 refer to ordinary dividends, not to distributions made in complete liquidation or dissolution of a corporation
which result in the realization of a gain as specifically contemplated in section 25 (a) of the same law, as
amended, which as aforesaid expressly provides for the taxability of such gain as income, whether the
stockholder happens to be an individual or a corporation. By analogy, we can cite the following additional
passages from the Hellmich case:
The controlling question is whether the amounts distributed to the stockholders out of the earnings and
profits accumulated by the corporation since February 28, 1913, were to be treated under section 201 (a)
as "dividends," which were exempt from the normal tax; or under section 201 (c) as payments made by
the corporation in exchange for its stock, which were taxable "as other gains or profits.
It is true that if section 201 (a) stood alone its broad definition of the term "dividend" would apparently include
distributions made to stockholders in the liquidation of a corporation although this term, as generally
understood and used, refers to the recurrent return upon stock paid to stockholders by a going corporation in the
ordinary course of business, which does not reduce their stockholdings and leaves them in a position to enjoy
future returns upon the same stock. (See Lynch vs. Hornby, 247 U.S., 339, 344-346; and Langstaff vs. Lucas [D. C.], 9
Fed. [2d], 691, 694.)

However, when section 201 (a) and section 201 (c) are read together, under the long-established rule
that the intention of the lawmakers is to be deduced from a view of every material part of the statute
(Kohlsaatvs. Murphy, 96 U.S., 153, 159; 24 Law. ed., 846), we think it clear that the general definition of a
dividend in section 201 (a) was not intended to apply to distributions made to stockholders in the
liquidation of a corporation, but that it was intended that such distributions should be governed by
section 201 (c), which, dealing specifically with such liquidation, provided that the amounts distributed
should "be treated as payments in exchange for stock," and that any gain realized thereby should be
taxed to the stockholders "as other gains or profits." This brings the two sections into entire harmony and
gives to each its natural meaning and due effect. . . . (Hellmich vs. Hellman, supra; emphasis supplied.)
4. The fourth assignment of error. Under this assignment it is contended by the non-resident individual
stockholder appellants that they were not subject to the normal tax as regards the distributions received by them
and involved in the instant case. They "reported these distributions as dividends from profits on which Philippine
income tax had been paid . . .." (Appellants' brief, p. 21.) They assert that the distributions were subject only to the
additional tax; whereas the Collector contends that they were subject to both the normal and the additional tax.
After what has been said above, it hardly needs stating that the manner and form of reporting these distributions
employed by said appellants could not, under the Law, change their real nature as payments for surrendered
stock, or so-called liquidating dividends, provided for in section 25 (a) of the then Income Tax Law. Such
distributions under the law were subject to both the normal and the additional tax provided for.
. . . Loosely speaking, the distribution to the stockholders of a corporation's assets, upon liquidation, might
be termed a dividend; but this is not what is generally meant and understood by that word. As generally
understood and used, a dividend is a return upon the stock of its stockholders, paid to them by a going
corporation without reducing their stockholdings, leaving them in a position to enjoy future returns upon
the same stock . . .. In other words, it is earnings paid to him by the corporation upon his invested capital
therein, without wiping out his capital. On the other hand, when a solvent corporation dissolves and
liquidates, it distributes to its stockholders not only any earnings it may have on hand, but it also pays to
them their invested capital, namely, the amount which they had paid in for their stocks, thus wiping out
their interest in the company . . .. (Langstaff vs. Lucas, 9 Fed. [2d], 691, 694.)
5. The fifth assignment of error. This assignment is made in behalf of those appellants who were non-resident
alien individuals, and for them it is in effect said that if the distributions received by them were to be considered
as a sale of their stock to the Hongkong Company, the profit realized by them does not constitute income from
Philippine sources and is not subject to Philippine taxes, "since all steps in the carrying out of this so-called sale
took place outside the Philippines." (Appellants' brief, p. 26.) We do not think this contention is tenable under the
facts and circumstances of record. The Hongkong Company was at the time of the sale of its business in the
Philippines, and the Manila Company was a domestic corporation domiciled and doing business also in the
Philippines. Schedule A of the Stipulation of Facts (Record on Appeal, p. 13) declares, among other things, that
the Hongkong Company was incorporated for the purpose of carrying on in the Philippine Islands the business of
wine, beer, and spirit merchants and the other objects set out in its memorandum of association. Hence, its
earnings, profits, and assets, including those from whose proceeds the distributions in question were made, the
major part of which consisted in the purchase price of the business, had been earned and acquired in the
Philippines. From aught that appears in the record it is clear that said distributions were income "from Philippine
sources."
6. The sixth assignment of error. Section 199 of Regulations No. 81, deleting immaterial parts, reads:
SEC. 199. Distributions in liquidation. In all cases where a corporation . . . distributes all of its property or
assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder . . .
is taxable as a dividend to the extent that it is paid out of earnings or profits of the corporation . . .. If the
amount received by the stockholder in liquidation is less than the cost or other basis of the stock, a
deductible loss is sustained.
This regulation would seem to support the contention that the distributions in question, at least those proceeding
from sources other than the earnings or profits of the dissolved corporation, were not taxable. Placing the abovequoted section of Regulations No. 81 side by side with section 25 (a) of the amended Income Tax Law then in
force, we notice that while the regulation limits the taxability of the gain realized by the stockholder "to the extent
that it is paid out of earnings or profits of the corporation, "section 25 (a) of the law, far from so limiting its
taxability, provides that the gain thus realized, is a "taxable income" under the law so long as a gain is realized,

it will be taxable income whether the distribution comes from the earnings or profits of the corporation or from the
sale of all of its assets in general, so long as the distribution is made "in complete liquidation or dissolution". The
regulation makes the gain taxable as a dividend, while the law makes it a taxable income. An inevitable conflict
between the two provisions seems to exist, and in such a case, of course, the law prevails.
Treasury Department cannot impose or exempt from income taxes, and regulations purporting to exempt
from taxation income specifically taxes would be void.
xxx

xxx

xxx

Any erroneous interpretation of revenue act by regulation of Treasury Department would not estop
government from asserting tax on income, though taxpayer had been misled by such interpretation, and
by it induced to expose property to taxation. (Langstaff vs. Lucas, 9 Fed. [2d], 691.)
7 and 8. The seventh and eight assignments of error. In view of what has been said above, these two
assignments need no separate treatment.
For the foregoing consideration, the judgment appealed from will be affirmed with the costs of both instances
against the appellants. So ordered.
Moran, C.J., Paras, Feria, Pablo, Perfecto, Bengzon, Briones, Hontiveros, Padilla, and Tuason, JJ., concur.

RESOLUTION ON MOTION FOR RECONSIDERATION

J
u
l
y

2
8
,

1
9
4
7
HILADO, J.:
Plaintiffs and appellants have filed a motion for reconsideration dated July 10, 1947. After carefully considering
said motion, which makes particular reference to appellants' fifth assignment of error, the Court does not
consider the arguments therein adduced tenable. Stripped to their bare essentials, the movants' contentions are
summarized in the following propositions found on pages 3-4 of their motto, to wit:
Since appellants J.F. MacGregor, N.C. MacGregor, C.J. Lafrentz, E.M.G. Strickland, and Mrs. M.J.G. Mullins
were all non-resident aliens and since the court has held that the transaction in this case amounted to a
sale or exchange of their shares in a foreign corporation, which sale or exchange took place entirely
outside of the Philippine Islands, it follows that they have not derived income from the Philippine sources
and are not subject to the taxes which have been collected from them by defendant.
xxx

xxx

xxx

. . . On the other hand if the income results from the sale or exchange of the shares in question then the
non-resident alien stockholders who converted their shares abroad have received no income from
Philippine sources and are not subject to any tax whatsoever on their profits from the transaction.

Leaving aside the other portions of the above-quoted propositions as sufficiently covered in the court's decision,
let us direct attention to those parts thereof wherein it is pretended that the transaction took place "entirely
outside the Philippine Islands" or "abroad."
In the minutes, Schedule B of the stipulation of facts (Rec. on Appeal, pp. 16-17), it appears that on July 22, 1937,
an extraordinary meeting of shareholders of the Manila Wine Merchants, Ltd. was held and in said meeting,
among other things, it was resolved that the Directors of said company "be authorized and instructed to declare
and pay in the form of dividend to the shareholders the amount of any surplus existing after the above-referred
to sale has been consummated. This surplus, after providing for return of capital and necessary expense, as
shown in the Balance Sheet prepared as of June 1, 1937, after giving effect to the sale transaction abovereferred to, amounts to approximately P270,000." While Schedule B does not state the place where the meeting
was held, Schedule B-1 of the same stipulation of facts (Record on Appeal, pp. 17-18) furnishes us the information
that it was held in Manila. Schedule B-1 in this connection says:
Sale of Company: In accordance with resolution passed at an Extraordinary Meeting of Shareholders
heldin Manila (underscoring supplied) on July 22, 1937, at 3 o'clock, the Directors of the Manila Wine
Merchants Ltd., were authorized to sell the Company as a going concern in accordance with sale
agreement presented at the Meeting.
Later in the same Schedule B-1 we find that the declaration of dividends authorized in the previous meeting, as
stated in the minutes Schedule B, was made by the Board of Directors of the same Manila Wine Merchants, Ltd.,
of whose meeting on that same date, July 22, 1937, Schedule B-1 constitutes the minutes. The pertinent parts to
the minutes of said meeting read as follows:
Dividend: The second matter before the Meeting was the question of declaring a dividend to enable a
distribution in cash to be made, the dividend to be the entire amount standing at surplus after providing
for return of capital and various expenses in accordance with reconstructed balance sheet as at June 1,
1937 presented by our auditors.
xxx

xxx

xxx

Resolved that as after the Manila Wine Merchants Ltd. has been sold for the stipulated sum of P400,000
and money received, there will be after providing for return of capital, payment of income tax and other
charges, a sum of approximately P270,000 standing at surplus account, a dividend is now hereby
declared in amount covering the entire balance remaining at surplus account after the concern has
been wound up, and we hereby authorize the distribution of P265,000 as and when funds are available,
any balance remaining to be distributed when final Liquidator's account has been rendered and paid."
Again, while the minutes Schedule B-1 do not reveal the place where that board meeting was held, the fact
stated therein that it was held on July 22,1937, the self-same date of the extraordinary meeting of shareholders
referred to in the minutes Schedule B, at 3 o'clock (presumably p.m.), as recorded in Schedule B-1, clearly shows
that the said board meeting was held also in Manila, and not in Hongkong or elsewhere abroad, for J.F.
Macgregor and E. Heybrook, both of whom appear in both Schedules B and B-1 to have participated in both
meetings, could not, so far as the record discloses, very well be in Manila and Hongkong or elsewhere abroad on
that same date. There is no showing, nor is it even pretended that these two gentlemen after the meeting held in
Manila on July 22, 1937, at 3 o'clock, took an airplane or other mode of conveyance, as fast or faster, and hurried
to Hongkong or elsewhere abroad and attended the other meeting that very same day. Indeed, that both
meetings must have been held in Manila would seem to be the only natural and logical supposition from the fact
that the Manila Wine Merchants, Ltd., was admittedly conducting its business in said city and the Philippines in
general (Schedule A, Rec. on Appeal, p. 13). It seems clear, therefore, that the dividends in question were
declared in the Philippine Islands.
What was the legal effect of that declaration? Paragraph V of the stipulation of facts (Rec. on Appeal, pp. 20-21)
states that, pursuant to these resolutions, "the Hongkong Company (the same Manila Wine Merchants, Ltd.)
distributed this surplus to its stockholders, plaintiffs receiving (underscoring supplied) the following sums on the
following dates" (then follow plaintiffs' names with the respective amounts in Philippine pesos received by them
on the dates stated). It is not stated that they received their dividends in Hongkong or other foreign money. And
in their own brief (p. 25) they say that the payments or distributions thus received by them, as a result of the
liquidation and sale of said company, "were included as gross income in their Philippine income tax returns". This

fact further tends to show that those payments or distributions were received in the Philippine Islands, either by
plaintiffs personally or through their proxies or agents. Besides, in paragraph V of the stipulation of facts (Rec. on
Appeal, p. 21) it appears that the dividends or distributions pertaining to these individual plaintiffs as well as that
pertaining to their co-plaintiff Wise and Co., Inc., were paid on the same dates, namely, August 24, 1937, and
October 28, 1937; and it being undisputed that Wise and Co., Inc. was domiciled and had its principal office in
Manila (complaint, par. I, Rec. on Appeal, p.2), in which city it was presumably paid, it would seem obvious that
the concomitant payments thus made to the other plaintiffs were likewise effected in the same place, whether
the individual plaintiffs acted personally or through proxies or agents. It should also be remembered that while
the "registered office" of the Manila Wine Merchants, Ltd. was situated in the colony of Hongkong (Schedule A,
Rec. on Appeal, p. 13), the fact is that the only business for which it was incorporated was the wine, beer, and
spirit business, which had been and was being conducted exclusively within the Philippine Islands, and from the
record we deduce that it had also office in Manila where, so far as the record discloses, the payments were
made. Finally, the fact that payment was made in Philippine pesos would strongly corroborate the conclusion
that it was made in this country if it had been made in Hongkong or elsewhere abroad, the reasonable
assumption is that it would have been made in Hongkong dollars or in the currency of such other place abroad.
. . . However, where a corporation has not only declared a dividend but has specifically appropriated
and set apart from its other assets a fund out of which the dividend is to be paid, such action constitutes
the assets to set apart a trust fund in the hands of the corporation for the payment of the stockholders to
the exclusion of other creditors. . . . (18 C.J.S., p. 1115; emphasis supplied.)
As between successive owners of shares of stock in a corporation, the general rule is that dividends
belong to the persons who are the owners of the stock at the time they are declared, without regard to
the time during which the dividends were earned, and this is true although the dividends are made
payable at a future date. (18 C.J.S., 119, sec. 470 [a]; emphasis supplied.)
There is no controversy about the legal proposition that dividends declared belong to the owner of the
stock at the time the dividend is declared. (Livingstone County Bank vs. First State Bank, 136 Ky., 546, 554,
cited in footnote 36, p. 818, 14 C.J.; emphasis supplied.)
The moment the dividend is declared, it becomes then separate and distinct from the stock and the
dividend falls to him who is proprietor of the stock of which it was theretofore incident.
The doctrine is that a dividend is considered parcel of the mass of corporate property until declared and
therefore incident to and parcel of the stock up to the time it is declared; and before its declaration, will
pass with the sale or devise of the stock. Whosoever owns the stock prior to the declaration of a dividend,
owns the dividend also. (McLaren vs. Crescent Planning Mill Co., 117 Mo. A., 40, 47, cited in note 36, p.
818, 14 C.J.; emphasis supplied.)
In De Koven vs. Alsop (205 Ill., 309; 63 L.R.A., 587), the court said:
A dividend is defined as "a corporate profit set aside, declared, and ordered by the directors to be paid
to the stockholders on demand or at a fixed time. Until the dividend is declared, these corporate profits
belong to the corporation, not to the stockholders, and are liable for corporate indebtedness." (Emphasis
supplied.)
We are fully satisfied from the facts and data furnished here by the parties themselves that the dividends in
question were paid to plaintiffs, personally or thru their proxies or agents, in the Philippines. But aside from this,
from the moment they were declared and a definite fund specified for their payment (all surplus remaining "after
providing for return of capital and various expenses") and all of this was done in the Philippines to all legal
intents and purposes they earned those dividends in this country. From the record we deduce that the funds and
assets of the Manila Wine Merchants, Ltd., from which those dividends proceeded, were in the Philippines where
its business was located. So far as the record discloses, its liquidation was effected in terms of Philippine pesos,
indicating that it was made here. And this in turn would lead to the deduction that the funds and assets
liquidated were here.
Motion denied. So ordered.

James v. United States

366 U.S. 213 (1961)
James embezzled $738k from his employer. He was caught.
In addition to criminal penalties for embezzlement, the IRS stepped in and claimed that the $738k should be
counted in James' gross income. James disagreed.
James argued that since a person is legally obligated to repay money that they steal, they've received no
income in the same way as a person receives no income from taking out a loan. So there should be no tax
liability.
The US Supreme Court found for the IRS.
The US Supreme Court found that found that there was a material difference in the intention of the taxpayer to
repay the money. So the money should be considered to be gross income, even though there was an obligation
to repay.
The Court noted that nothing in the 16th Amendment prevented taxing illegal income.
DOJ wanted to go after criminals (like Al Capone), and the powers of the IRS can go beyond the powers of DOJ
(e.g. IRS makes you file taxes, but DOJ can't ask you to file a list of your felonies). So they wanted illegal income to
count as income so the IRS could go after them.
In this case, James avoided prison for embezzlement, but he was eventually sentenced to three years in prison for
tax evasion.
COMMISSIONER
OF
INTERNAL
REVENUE, petitioner,
vs.
THE HON. COURT OF APPEALS, THE COURT OF TAX APPEALS, GCL RETIREMENT PLAN, represented by its TrusteeDirector, respondents.

MELENCIO-HERRERA, J.:
This case is said to be precedent setting. While the amount involved is insignificant, the Solicitor General avers
that there are about 85 claims of the same nature pending in the Court of Tax Appeals and Bureau of Internal
Revenue totalling approximately P120M.
Petitioner, the Commissioner of Internal Revenue, seeks a reversal of the Decision of respondent Court of
Appeals, dated August 27, 1990, in CA-G.R. SP No. 20426, entitled "Commissioner of Internal Revenue vs. GCL
Retirement Plan, represented by its Trustee-Director and the Court of Tax Appeals," which affirmed the Decision of
the latter Court, dated 15 December 1986, in Case No. 3888, ordering a refund, in the sum of P11,302.19, to the
GCL Retirement Plan representing the withholding tax on income from money market placements and purchase
of treasury bills, imposed pursuant to Presidential Decree No. 1959.
There is no dispute with respect to the facts. Private Respondent, GCL Retirement Plan (GCL, for brevity) is an
employees' trust maintained by the employer, GCL Inc., to provide retirement, pension, disability and death
benefits to its employees. The Plan as submitted was approved and qualified as exempt from income tax by
Petitioner Commissioner of Internal Revenue in accordance with Rep. Act No. 4917. 1
In 1984, Respondent GCL made investsments and earned therefrom interest income from which was witheld the
fifteen per centum (15%) final witholding tax imposed by Pres. Decree No. 1959, 2 which took effect on 15
October 1984, to wit:
Date Kind of Investment Principal Income Earned 15% Tax

ACIC
12/05/84
10/22/84
11/19/84
11/23/84
12/05/84
COMBANK

P11,302.19

Market

Placement
P236,515.32
P8,751.96
234,632.75
9,815.89
225,886.51
10,629.22
344,448.64
17,313.33
324,633.81
15,077.44
Treasury
Bills

P1,312.66
1,472.38
1,594.38
2,597.00
2,261.52
2,064.15

On 15 January 1985, Respondent GCL filed with Petitioner a claim for refund in the amounts of P1,312.66 withheld
by Anscor Capital and Investment Corp., and P2,064.15 by Commercial Bank of Manila. On 12 February 1985, it
filed a second claim for refund of the amount of P7,925.00 withheld by Anscor, stating in both letters that it
disagreed with the collection of the 15% final withholding tax from the interest income as it is an entity fully
exempt from income tax as provided under Rep. Act No. 4917 in relation to Section 56 (b) 3 of the Tax Code.
The refund requested having been denied, Respondent GCL elevated the matter to respondent Court of Tax
Appeals (CTA). The latter ruled in favor of GCL, holding that employees' trusts are exempt from the 15% final
withholding tax on interest income and ordering a refund of the tax withheld. Upon appeal, originally to this
Court, but referred to respondent Court of Appeals, the latter upheld the CTA Decision. Before us now, Petitioner
assails that disposition.
It appears that under Rep. Act No. 1983, which took effect on 22 June 1957, amending Sec. 56 (b) of the National
Internal Revenue Code (Tax Code, for brevity), employees' trusts were exempt from income tax. That
lawprovided:
Sec. 56 Imposition of tax. (a) Application of tax. The taxes imposed by this Title upon
individuals shall apply to the income of estates or of any kind of property held in trust, including
xxx xxx xxx
(b) Exception. The tax imposed by this Title shall not apply to employees' trust which forms a part
of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or all of his
employees (1) if contributions are made to trust by such employer, or employees, or both, for the
purpose of distributing to such employees the earnings and principal of the fund accumulated by
the
trust
in
accordance
with
such
plan, . . .
On 3 June 1977, Pres. Decree No. 1156 provided, for the first time, for the withholding from the interest on bank
deposits at the source of a tax of fifteen per cent (15%) of said interest. However, it also allowed a specific
exemption in its Section 53, as follows:
Sec. 53. Withholding of tax at source.
xxx xxx xxx
(c) Withholding tax on interest on bank deposits. (1) Rate of withholding tax. Every bank or
banking institution shall deduct and withhold from the interest on bank deposits (except interest
paid or credited to non-resident alien individuals and foreign corporations), a tax equal to fifteen
per cent of the said interest: Provided, however, That no withholding of tax shall be made if the
aggregate amount of the interest on all deposit accounts maintained by a depositor alone or
together with another in any one bank at any time during the taxable period does not exceed
three hundred fifty pesos a year or eighty-seven pesos and fifty centavos per quarter. For this
purpose, interest on a deposit account maintained by two persons shall be deemed to be equally
owned by them.
(2) Treatment of bank deposit interest. The interest income shall be included in the gross income
in computing the depositor's income tax liability in according with existing law.

(3) Depositors enjoying tax exemption privileges or preferential tax treatment. In all cases where
the depositor is tax-exempt or is enjoying preferential income tax treatment under existing laws,
the withholding tax imposed in this paragraph shall be refunded or credited as the case may be
upon submission to the Commissioner of Internal Revenue of proof that the said depositor is a taxexempt entity or enjoys a preferential income tax treatment.
xxx xxx xxx
This exemption and preferential tax treatment were carried over in Pres. Decree No. 1739, effective on 17
September 1980, which law also subjected interest from bank deposits and yield from deposit substitutes to a final
tax of twenty per cent (20%). The pertinent provisions read:
Sec. 2. Section 21 of the same Code is hereby amended by adding a new paragraph to read as
follows:
Sec. 21. Rates of tax on citizens or residents.
xxx xxx xxx
Interest from Philippine Currency bank deposits and yield from deposit substitutes
whether received by citizens of the Philippines or by resident alien individuals, shall
be subject to the final tax as follows: (a) 15% of the interest on savings deposits, and
(b) 20% of the interest on time deposits and yield from deposit substitutes, which
shall be collected and paid as provided in Sections 53 and 54 of this
Code. Provided, That no tax shall be imposed if the aggregate amount of the
interest on all Philippine Currency deposit accounts maintained by a depositor
alone or together with another in any one bank at any time during the taxable
period does not exceed Eight Hundred Pesos (P800.00) a year or Two Hundred
Pesos (P200.00) per quarter. Provided, further, That if the recipient of such interest is
exempt from income taxation, no tax shall be imposed and that, if the recipient is
enjoying preferential income tax treatment, then the preferential tax rates so
provided shall be imposed (Emphasis supplied).
Sec. 3. Section 24 of the same Code is hereby amended by adding a new subsection (cc)
between subsections (c) and (d) to read as follows:
(cc) Rates of tax on interest from deposits and yield from deposit substitutes.
Interest on Philippine Currency bank deposits and yield from deposit substitutes
received by domestic or resident foreign corporations shall be subject to a final tax
on the total amount thereof as follows: (a) 15% of the interest on savings deposits;
and (b) 20% of the interest on time deposits and yield from deposit substitutes which
shall be collected and paid as provided in Sections 53 and 54 of this
Code. Provided, That if the recipient of such interest is exempt from income
taxation, no tax shall be imposed and that, if the recipient is enjoying preferential
income tax treatment, then the preferential tax rates so provided shall be
imposed (Emphasis supplied).
Sec. 9. Section 53(e) of the same Code is hereby amended to read as follows:
Se. 53(e) Withholding of final tax on interest on bank deposits and yield from
deposit substitutes.
(1) Withholding of final tax. Every bank or non-bank financial intermediary shall
deduct and withhold from the interest on bank deposits or yield from deposit
substitutes a final tax equal to fifteen (15%) per cent of the interest on savings
deposits and twenty (20%) per cent of the interest on time deposits or yield from
deposit substitutes:Provided, however, That no withholding tax shall be made if the
aggregate amount of the interest on all deposit accounts maintained by a

depositor alone or together with another in any one bank at any time during the
taxable period does not exceed Eight Hundred Pesos a year or Two Hundred Pesos
per quarter. For this purpose, interest on a deposit account maintained by two
persons shall be deemed to be equally owned by them.
(2) Depositors or placers/investors enjoying tax exemption privileges or preferential
tax treatment. In all cases where the depositor or placer/investor is tax exempt or
is enjoying preferential income tax treatment under existing laws, the withholding
tax imposed in this paragraph shall be refunded or credited as the case may be
upon submission to the Commissioner of Internal Revenue of proof that the said
depositor, or placer/investor is a tax exempt entity or enjoys a preferential income
tax treatment.
Subsequently, however, on 15 October 1984, Pres. Decree No. 1959 was issued, amending the aforestated
provisions to read:
Sec. 2. Section 21(d) of this Code, as amended, is hereby further amended to read as follows:
(d) On interest from bank deposits and yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements. Interest from
Philippine Currency Bank deposits and yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements whether received
by citizens of the Philippines, or by resident alien individuals, shall be subject to a
15% final tax to be collected and paid as provided in Sections 53 and 54 of this
Code.
Sec. 3. Section 24(cc) of this Code, as amended, is hereby further amended to read as follows:
(cc) Rates of tax on interest from deposits and yield or any other monetary benefit
from deposit substitutes and from trust fund and similar arrangements. Interest on
Philippine Currency Bank deposits and yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements received by
domestic or resident foreign corporations shall be subject to a 15% final tax to be
collected and paid as provided in Section 53 and 54 of this Code.
Sec. 4. Section 53 (d) (1) of this code is hereby amended to read as follows:
Sec. 53 (d) (1). Withholding of Final Tax. Every bank or non-bank financial
intermediary or commercial. industrial, finance companies, and other non-financial
companies authorized by the Securities and Exchange Commission to issue deposit
substitutes shall deduct and withhold from the interest on bank deposits or yield or
any other monetary benefit from deposit substitutes a final tax equal to fifteen per
centum(15%) of the interest on deposits or yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements.
It is to be noted that the exemption from withholding tax on interest on bank deposits previously extended by
Pres. Decree No. 1739 if the recipient (individual or corporation) of the interest income is exempt from income
taxation, and the imposition of the preferential tax rates if the recipient of the income is enjoying preferential
income tax treatment, were both abolished by Pres. Decree No. 1959. Petitioner thus submits that the deletion of
the exempting and preferential tax treatment provisions under the old law is a clear manifestation that the single
15% (now 20%) rate is impossible on all interest incomes from deposits, deposit substitutes, trust funds and similar
arrangements, regardless of the tax status or character of the recipients thereof. In short, petitioner's position is
that from 15 October 1984 when Pres. Decree No. 1959 was promulgated, employees' trusts ceased to be
exempt and thereafter became subject to the final withholding tax.
Upon the other hand, GCL contends that the tax exempt status of the employees' trusts applies to all kinds of
taxes, including the final withholding tax on interest income. That exemption, according to GCL, is derived from
Section 56(b) and not from Section 21 (d) or 24 (cc) of the Tax Code, as argued by Petitioner.

The sole issue for determination is whether or not the GCL Plan is exempt from the final withholding tax on interest
income from money placements and purchase of treasury bills required by Pres. Decree No. 1959.
We uphold the exemption.
To begin with, it is significant to note that the GCL Plan was qualified as exempt from income tax by the
Commissioner of Internal Revenue in accordance with Rep. Act No. 4917 approved on 17 June 1967. This law
specifically provided:
Sec. 1. Any provision of law to the contrary notwithstanding, the retirement benefits received by
officials and employees of private firms, whether individual or corporate, in accordance with a
reasonable private benefit plan maintained by the employer shall be exempt from all taxes and
shall not be liable to attachment, levy or seizure by or under any legal or equitable process
whatsoever except to pay a debt of the official or employee concerned to the private benefit
plan or that arising from liability imposed in a criminal action; . . . (emphasis ours).
In so far as employees' trusts are concerned, the foregoing provision should be taken in relation to then Section
56(b) (now 53[b]) of the Tax Code, as amended by Rep. Act No. 1983, supra, which took effect on 22 June 1957.
This provision specifically exempted employee's trusts from income tax and is repeated hereunder for emphasis:
Sec. 56. Imposition of Tax. (a) Application of tax. The taxes imposed by this Title upon
individuals shall apply to the income of estates or of any kind of property held in trust.
xxx xxx xxx
(b) Exception. The tax imposed by this Title shall not apply to employee's trust which forms part
of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or all of his
employees . . .
The tax-exemption privilege of employees' trusts, as distinguished from any other kind of property held in trust,
springs from the foregoing provision. It is unambiguous. Manifest therefrom is that the tax law has singled out
employees' trusts for tax exemption.
And rightly so, by virtue of the raison de'etre behind the creation of employees' trusts. Employees' trusts or benefit
plans normally provide economic assistance to employees upon the occurrence of certain contingencies,
particularly, old age retirement, death, sickness, or disability. It provides security against certain hazards to which
members of the Plan may be exposed. It is an independent and additional source of protection for the working
group. What is more, it is established for their exclusive benefit and for no other purpose.
The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in order to encourage the formation and
establishment of such private Plans for the benefit of laborers and employees outside of the Social Security Act.
Enlightening is a portion of the explanatory note to H.B. No. 6503, now R.A. 1983, reading:
Considering that under Section 17 of the social Security Act, all contributions collected and
payments of sickness, unemployment, retirement, disability and death benefits made
thereunder together with the income of the pension trust are exempt from any tax, assessment,
fee, or charge, it is proposed that a similar system providing for retirement, etc. benefits for
employees outside the Social Security Act be exempted from income taxes. (Congressional
Record, House of Representatives, Vol. IV, Part. 2, No. 57, p. 1859, May 3, 1957; cited in
Commissioner of Internal Revenue v. Visayan Electric Co., et al., G.R. No. L-22611, 27 May 1968, 23
SCRA 715); emphasis supplied.
It is evident that tax-exemption is likewise to be enjoyed by the income of the pension trust. Otherwise, taxation of
those earnings would result in a diminution accumulated income and reduce whatever the trust beneficiaries
would receive out of the trust fund. This would run afoul of the very intendment of the law.
The deletion in Pres. Decree No. 1959 of the provisos regarding tax exemption and preferential tax rates under
the old law, therefore, can not be deemed to extent to employees' trusts. Said Decree, being a general law, can

not repeal by implication a specific provision, Section 56(b) now 53 [b]) in relation to Rep. Act No. 4917 granting
exemption from income tax to employees' trusts. Rep. Act 1983, which excepted employees' trusts in its Section
56 (b) was effective on 22 June 1957 while Rep. Act No. 4917 was enacted on 17 June 1967, long before the
issuance of Pres. Decree No. 1959 on 15 October 1984. A subsequent statute, general in character as to its terms
and application, is not to be construed as repealing a special or specific enactment, unless the legislative
purpose to do so is manifested. This is so even if the provisions of the latter are sufficiently comprehensive to
include what was set forth in the special act (Villegas v. Subido, G.R. No. L-31711, 30 September 1971, 41 SCRA
190).
Notably, too, all the tax provisions herein treated of come under Title II of the Tax Code on "Income Tax." Section
21 (d), as amended by Rep. Act No. 1959, refers to the final tax on individuals and falls under Chapter II; Section
24 (cc) to the final tax on corporations under Chapter III; Section 53 on withholding of final tax to Returns and
Payment of Tax under Chapter VI; and Section 56 (b) to tax on Estates and Trusts covered by Chapter VII, Section
56 (b), taken in conjunction with Section 56 (a), supra, explicitly excepts employees' trusts from "the taxes
imposed by this Title." Since the final tax and the withholding thereof are embraced within the title on "Income
Tax," it follows that said trust must be deemed exempt therefrom. Otherwise, the exception becomes
meaningless.
There can be no denying either that the final withholding tax is collected from income in respect of which
employees' trusts are declared exempt (Sec. 56 [b], now 53 [b], Tax Code). The application of the withholdings
system to interest on bank deposits or yield from deposit substitutes is essentially to maximize and expedite the
collection of income taxes by requiring its payment at the source. If an employees' trust like the GCL enjoys a taxexempt status from income, we see no logic in withholding a certain percentage of that income which it is not
supposed to pay in the first place.
Petitioner also relies on Revenue Memorandum Circular 31-84, dated 30 October 1984, and Bureau of Internal
Revenue Ruling No. 027-e-000-00-005-85, dated 14 January 1985, as authorities for the argument that Pres.
Decree No. 1959 withdrew the exemption of employees' trusts from the withholding of the final tax on interest
income. Said Circular and Ruling pronounced that the deletion of the exempting and preferential tax treatment
provisions by Pres. Decree No. 1959 is a clear manifestation that the single 15% tax rate is imposable on all interest
income regardless of the tax status or character of the recipient thereof. But since we herein rule that Pres.
Decree No. 1959 did not have the effect of revoking the tax exemption enjoyed by employees' trusts, reliance on
those authorities is now misplaced.
WHEREFORE, the Writ of Certiorari prayed for is DENIED. The judgment of respondent Court of Appeals, affirming
that of the Court of Tax Appeals is UPHELD. No costs.
SO ORDERED.
COMMISSIONER
OF
INTERNAL
vs.
THE COURT OF APPEALS and EFREN P. CASTANEDA, respondents.

REVENUE, petitioner,

Leovigildo Monasterial for private respondent.

RESOLUTION

PADILLA, J.:p
The issue to be resolved in this petition for review on certiorari is whether or not terminal leave pay received by a
government official or employee on the occasion of his compulsory retirement from the government service is
subject to withholding (income) tax.
We resolve the issue in the negative.

Private respondent Efren P. Castaneda retired from the government service as Revenue Attache in the Philippine
Embassy in London, England, on 10 December 1982 under the provisions of Section 12 (c) of Commonwealth Act
186, as amended. Upon retirement, he received, among other benefits, terminal leave pay from which petitioner
Commissioner of Internal Revenue withheld P12,557.13 allegedly representing income tax thereon.
Castaneda filed a formal written claim with petitioner for a refund of the P12,557.13, contending that the cash
equivalent of his terminal leave is exempt from income tax. To comply with the two-year prescriptive period
within which claims for refund may be filed, Castaneda filed on 16 July 1984 with the Court of Tax Appeals a
Petition for Review, seeking the refund of income tax withheld from his terminal leave pay.
The Court of Tax Appeals found for private respondent Castaneda and ordered the Commissioner of Internal
Revenue to refund Castaneda the sum of P12,557.13 withheld as income tax. (,Annex "C", petition).
Petitioner appealed the above-mentioned Court of Tax Appeals decision to this Court, which was docketed as
G.R. No. 80320. In turn, we referred the case to the Court of Appeals for resolution. The case was docketed in the
Court of Appeals as CA-G.R. SP No. 20482.
On 26 September 1990, the Court of Appeals dismissed the petition for review and affirmed the decision of the
Court of Tax Appeals. Hence, the present recourse by the Commissioner of Internal Revenue.
The Solicitor General, acting on behalf of the Commissioner of Internal Revenue, contends that the terminal
leave pay is income derived from employer-employee relationship, citing in support of his stand Section 28 of the
National Internal Revenue Code; that as part of the compensation for services rendered, terminal leave pay is
actually part of gross income of the recipient. Thus
. . . It (terminal leave pay) cannot be viewed as salary for purposes which would reduce it. . . .
there can thus be no "commutation of salary" when a government retiree applies for terminal
leave because he is not receiving it as salary. What he applies for is a "commutation of leave
credits." It is an accumulation of credits intended for old age or separation from service. . . .
The Court has already ruled that the terminal leave pay received by a government official or employee is not
subject to withholding (income) tax. In the recent case of Jesus N. Borromeo vs. The Hon. Civil Service
Commission, et al., G.R. No. 96032, 31 July 1991, the Court explained the rationale behind the employee's
entitlement to an exemption from withholding (income) tax on his terminal leave pay as follows:
. . . commutation of leave credits, more commonly known as terminal leave, is applied for by an
officer or employee who retires, resigns or is separated from the service through no fault of his own.
(Manual on Leave Administration Course for Effectiveness published by the Civil Service
Commission, pages 16-17). In the exercise of sound personnel policy, the Government encourages
unused leaves to be accumulated. The Government recognizes that for most public servants,
retirement pay is always less than generous if not meager and scrimpy. A modest nest egg which
the senior citizen may look forward to is thus avoided. Terminal leave payments are given not only
at the same time but also for the same policy considerations governing retirement benefits.
In fine, not being part of the gross salary or income of a government official or employee but a retirement
benefit, terminal leave pay is not subject to income tax.
ACCORDINGLY, the petition for review is hereby DENIED.
SO ORDERED.
RE: REQUEST OF ATTY. BERNARDO ZIALCITA FOR RECONSIDERATION OF THE ACTION OF THE FINANCIAL AND BUDGET
OFFICE

RESOLUTION

GUTIERREZ, JR., J.:

On August 23, 1990, a resolution of the Court En Banc was issued regarding the amounts claimed by Atty.
Bernardo F. Zialcita on the occasion of his retirement. The resolution states, among others:
The terminal leave pay of Atty. Zialcita received by virtue of his compulsory retirement can never
be considered a part of his salary subject to the payment of income tax but falls under the phrase
"other similar benefits received by retiring employees and workers", within the meaning of Section
1 of PD No. 220 and is thus exempt from the payment of income tax. That the money value of his
accrued leave credits is not a part of his salary is further buttressed by Sec. 3 of PD No. 985,
otherwise known as The "Budgetary Reform Decree on Compensation and Position Classification
of 1976" particularly Sec. 3 (a) thereof, which makes it clear that the actual service is the period of
time for which pay has been received, excluding the period covered by terminal leave.
The dispositive portion provides:
Accordingly, the Court Resolved to (1) ORDER the Fiscal Management and Budget Office to
REFUND Atty. Zialcita the amount of P59,502.33 which was deducted from his terminal leave pay
as withholding tax; and (2) DECLARE that henceforth no withholding tax shall be deducted by any
Office of this Court from the terminal leave pay benefits of all retirees similarly situated including
those who have already retired and from whose retirement benefits such withholding taxes were
deducted. Sarmiento, J., is on leave.
On September 18, 1990, the Commissioner of Internal Revenue, as intervenor-movant and through the Solicitor
General, filed a motion for clarification and/or reconsideration with this Court.
After careful deliberation, the Court resolved to deny the motion for reconsideration and hereby holds that the
money value of the accumulated leave credits of Atty. Bernardo Zialcita are not taxable for the following
reasons:
1) Atty. Zialcita opted to retire under the provisions of Republic Act 660, which is incorporated in Commonwealth
Act No. 186. Section 12(c) of CA 186 states:
... Officials and employees retired under this Act shall be entitled to the commutation of the
unused vacation leave and sick leave, based on the highest rate received, which they may have
to their credit at the time of retirement.
Section 28(c) of the same Act, in turn, provides:
(c) Except as herein otherwise provided, the Government Service Insurance System, all benefits
granted under this Act, and all its forms and documents required of the members shall be exempt
from all types of taxes, documentary stamps, duties and contributions, fiscal or municipal, direct or
indirect, established or to be established; ... (Emphasis supplied)
Applying the two aforesaid provisions, it can be concluded that the amount received by Atty. Zialcita as
a result of the conversion of these unused leaves into cash is exempt from income tax.
2) The commutation of leave credits is commonly known as terminal leave. (Manual on Leave Administration
Course for Effectiveness, published by the Civil Service Commission, p. 17) Terminal leave is applied for by an
officer or employee who retires, resigns or is separated from the service through no fault of his own. (supra, p. 16)
Since terminal leave is applied for by an officer or employee who has already severed his connection with his
employer and who is no longer working, then it follows that the terminal leave pay, which is the cash value of his
accumulated leave credits, is no longer compensation for services rendered. It can not be viewed as salary.
3) Executive Order No. 1077, Section 1, provides:

Any officer or employee of the government who retires or voluntarily resigns or is separated from
the service through no fault of his own and whose leave benefits are not covered by special law,
shag be entitled to the commutation of all the accumulated vacation and/or sick leaves to his
credit, exclusive of Saturdays, Sundays and holidays, without litigation as to the number of days of
vacation and sick leaves that he may accumulate. (Emphasis supplied)
Meanwhile, Section 28(b) 7(b) of the National Internal Revenue Code (NIRC) states:
Sec. 28 (b) Exclusions from gross income. The following items shall not be included in gross
income and shall be exempt from taxation under this title:
xxx xxx xxx
(7) Retirement benefits, pensions, gratuities, etc.
xxx xxx xxx
(b) Any amount received by an official or employee or by his heirs from the employer as a
consequence of separation of such official or employee from the service of the employer due to
death, sickness or other physical disability or for any cause beyond the control of the said official
or employee. (Emphasis supplied)
In the case of Atty. Zialcita, he rendered government service from March 13, 1962 up to February 15, 1990. The
next day, or on February 16, 1990, he reached the compulsory retirement age of 65 years. Upon his compulsory
retirement, he is entitled to the commutation of his accumulated leave credits to its money value. Within the
purview of the above-mentioned provisions of the NLRC, compulsory retirement may be considered as a "cause
beyond the control of the said official or employee". Consequently, the amount that he received by way of
commutation of his accumulated leave credits as a result of his compulsory retirement, or his terminal leave pay,
fags within the enumerated exclusions from gross income and is therefore not subject to tax.
4. The terminal leave pay of Atty. Zialcita may likewise be viewed as a "retirement gratuity received by
government officials and employees" which is also another exclusion from gross income as provided for in Section
28(b), 7(f) of the NLRC. A gratuity is that paid to the beneficiary for past services rendered purely out of
generosity of the giver or grantor. (Peralta v. Auditor General, 100 Phil. 1051 [1957]) It is a mere bounty given by
the government in consideration or in recognition of meritorious services and springs from the appreciation and
graciousness of the government. (Pirovano v. De la Rama Steamship Co., 96 Phil. 335, 357 [1954]) When a
government employee chooses to go to work rather than absent himself and consume his leave credits, there is
no doubt that the government is thereby benefited by the employee's uninterrupted and continuous service. It is
in cognizance of this fact that laws were passed entitling retiring government employees, among others, to the
commutation of their accumulated leave credits. That which is given to him after retirement is out of the
Government's generosity and an appreciation for his having continued working when he could very well have
gone on vacation. Section 286 of Revised Administrative Code, as amended by RA 1081, provides that
"whenever any officer, employee or laborer of the Government of the Philippines shall voluntarily resign or be
separated from the service through no fault of his own, he shall be entitled to the commutation of all
accumulated vacation and/or sick leave to his credit: ..." (Emphasis supplied) Executive Order No. 1077,
mentioned above, later amended Section 286 by removing the limitation on the number of leave days that may
be accumulated and explicitly allowing retiring government employees to commute their accumulated leaves.
The commutation of accumulated leave credits may thus be considered a retirement gratuity, within the import
of Section 28(b), 7(f) of the NLRC, since it is given only upon retirement and in consideration of the retiree's
meritorious services.
It is clear that the law expresses the government's appreciation for many years of service already rendered and
the clear intention to reward faithful and often underpaid workers after the official relationship had been
terminated.
5) Section 284 of the Revised Administrative Code grants to a government employee 15 days vacation leave
and 15 days sick leave for every year of service. Hence, even if the government employee absents himself and
exhausts his leave credits, he is still deemed to have worked and to have rendered services. His leave benefits

are already imputed in, and form part of, his salary which in turn is subjected to withholding tax on income. He is
taxed on the entirety of his salaries without any deductions for any leaves not utilized. It follows then that the
money values corresponding to these leave benefits both the used and unused have already been taxed during
the year that they were earned. To tax them again when the retiring employee receives their money value as a
form of government concern and appreciation plainly constitutes an attempt to tax the employee a second
time. This is tantamount to double taxation.
The Commissioner of Internal Revenue seeks, in the alternative, to be clarified with respect to the following:
a. the applicability of the August 23, 1990 Resolution to other government officials and employees; and
b. to those who have already retired and from whose retirement benefits withholding taxes have been
deducted, whether or not the deducted taxes are refundable even without a written request for refund from the
taxpayer-retiree.
The case of Atty. Bernardo Zialcita (entitled Administrative Matter No. 90-6-015-SC) is merely an administrative
matter involving an employee of this Court who applied for retirement benefits and who questioned the
deductions on the benefits given to him. Hence, our resolution applies only to employees of the Judiciary. If we
extend the effects of the aforementioned resolution to all other government employees, in the absence of an
actual case and controversy, we would in principle be rendering an advisory opinion. We cannot foresee at this
time and for all cases all factors bearing upon the rights of government workers of varying categories from
diverse offices. The authorities concerned will have to determine and rule on each case as it arises. "Similarly
situated" is a most ambiguous and undefined term whose application cannot be fixed in advance.
With respect to the need for a written request for refund, we rule that Atty. Zialcita need no longer file a formal
request for refund since the August 23, 1990 Resolution, which principally deals with his case, already binds the
intervenor-movant Commissioner of Internal Revenue. However, with respect to other retirees allegedly similarly
situated and from whom withholding taxes on terminal leave pay have been deducted, we rule that these
retirees should file a written request for refund within two years from the date of promulgation of this resolution.
Fiscal considerations do not allow that this matter be left hanging for an indefinite period while retirees make up
their minds as to whether or hot they are entitled to refunds.
The Chief of the Finance Division of this Court likewise seeks clarification with respect to the applicability of our
August 23, 1990 Resolution to the following employees of this Court:
a) those who avail of optional retirement; and
b) those who resign or are separated from the service through no fault of their own.
The two groups mentioned above are also entitled to terminal leave pay in accordance with Section 286 of the
Revised Administrative Code, as amended by RA 1081. In the light of our ruling that to tax terminal leave pay
would result in the taxation of benefits given after and as direct consequences of retirement and would, in effect,
constitute double taxation, we rule that this resolution also applies to those who avail of optional retirement and
to those who resign or are separated from the service through no fault of their own.
The Court understands the urgent need of Government to tap all possible sources of revenue because of its
heavy expenditures and the failure of actual income to cover all disbursements. However, the solution is not the
levying of taxes on benefits and gratuities which by law are not supposed to be taxed. The remedy is to either
amend the retirement law subject, of course, to constitutional constraints or to institute vastly improved and
effective tax collection efforts.
All salaried workers and wage earners, whether in the public or the private sector, are taxed to the last centavo
of their incomes throughout the entirety of their working lives. The same cannot be said of factory workers,
leaders of industry, merchants, self-employed professionals, movie stars, fishing magnates, bus and jeepney
operators, vice lords, theatre owners, and real estate lessors, to name only a few. A middle or lower echelon
employee who retires after thirty or forty years of service helplessly sees his retirement pensions or benefits
unavoidably and rapidly decrease in value in only a few years even as his cost of living, age, health, and other
personal circumstances call for increased expenditures. We fail to see the logic in viewing with eager eyes for

purposes of tax revenues the fruits of a working lifetime of labor simply because fixed salaries and retirement
benefits are so visible and so convenient to levy upon. Retirees who are most deserving of compassion and who
can least carry the multifarious burdens of Government should not be so readily encumbered on a strained
interpretation of the law.
WHEREFORE, the Court Resolved to (1) DENY with FINALITY the motion for reconsideration of the intervenormovant and the Solicitor General; and (2) DECLARE (a) that the August 23, 1990 Resolution on A.M. No. 90-6-015SC specifically applies only to employees and officers of the Judiciary who retire, resign or are separated through
no fault of their own; and (b) that retirees and former employees of the Judiciary; except Atty. Zialcita, from
whose terminal leave pay withholding taxes have been deducted, must file a written claim for refund with the
Commissioner of Internal Revenue within two years from the date of promulgation of this resolution.
SO ORDERED.
INTERCONTINENTAL BROADCASTING CORPORATION (IBC), represented by ATTY. RENATOQ. BELLO, in his capacity
as
CEO
and
President, petitioner,
vs.
NOEMI B. AMARILLA, CORSINI R. LAGAHIT, ANATOLIO G. OTADOY, and CANDIDO C. QUIONES, JR.,respondents.

DECISION

CALLEJO, SR., J.:

Before us is a Petition for Review on Certiorari filed by petitioner Intercontinental Broadcasting Corporation (IBC)
assailing the Decision1 of the Court of Appeals in CA-G.R. SP No. 72414, which in turn affirmed the Decision 2 of the
National Labor Relations Commission (NLRC) in NLRC Case No. V-000660-2000.
On various dates, petitioner employed the following persons at its Cebu station: Candido C. Quiones, Jr.; on
February 1, 1975;3 Corsini R. Lagahit, as Studio Technician, also on February 1, 1975; 4 Anatolio G. Otadoy, as
Collector, on April 1, 1975;5 and Noemi Amarilla, as Traffic Clerk, on July 1, 1975.6 On March 1, 1986, the
government sequestered the station, including its properties, funds and other assets, and took over its
management and operations from its owner, Roberto Benedicto.7 However, in December 1986, the government
and Benedicto entered into a temporary agreement under which the latter would retain its management and
operation. On November 3, 1990, the Presidential Commission on Good Government (PCGG) and Benedicto
executed a Compromise Agreement,8 where Benedicto transferred and assigned all his rights, shares and
interests in petitioner station to the government. The PCGG submitted the Agreement to the Sandiganbayan in
Civil Case No. 0034 entitled "Republic of the Philippines v. Roberto S. Benedicto, et al."9
In the meantime, the four (4) employees retired from the company and received, on staggered basis, their
retirement benefits under the 1993 Collective Bargaining Agreement (CBA) between petitioner and the
bargaining unit of its employees.
Name of Employee
Candido C. Quiones, Jr.
Noemi B. Amarilla
Corsini R. Lagahit
Anatolio G. Otadoy

Date of Retirement
October 16, 1995
April 16, 1998
April 16, 1998
February 29, 1996

Retirement Benefit
P 766,532.97
P 1,134,239.47
P 1,298,879.50
P 751,914.30

In the meantime, a P1,500.00 salary increase was given to all employees of the company, current and retired,
effective July 1994. However, when the four retirees demanded theirs, petitioner refused and instead informed
them via a letter that their differentials would be used to offset the tax due on their retirement benefits in

accordance with the National Internal Revenue Code (NIRC). Amarilla was informed that the P71,480.00 of the
amount due to her would be used to offset her tax liability of P340,641.42.10 Otadoy was also informed in a letter
dated July 5, 1999, that his salary differential of P170,250.61 would be used to pay his tax liability which amounted
to P127,987.57. Since no tax liability was withheld from his retirement benefits, he even owed the
company P17,727.26 after the offsetting. Quiones was informed that he should have retired compulsorily in 1992
at age 55 as provided in the CBA, and that since he was already 58 when he retired, he was no longer entitled to
receive salary increases from 1992 to 1995. Consequently, he was overpaid by P137,932.22 for the "extension" of
his employment from 1992 to 1995, which amount he was obliged to return to the company. In any event, his
claim for salary differentials had expired pursuant to Article 291 of the Labor Code of the Philippines. 11 Lagahits
claim for salary differential of P73,165.23 was rejected by petitioner in a letter dated July 6, 1999, on the ground
that he had a tax liability of P396,619.03; since the amount would be used as partial payment for his tax liability,
he still owed the company P323,453.80.12
The four (4) retirees filed separate complaints13 against IBC TV-13 Cebu and Station Manager Louella F. Cabaero
for unfair labor practice and non-payment of backwages before the NLRC, Regional Arbitration Branch VII. As all
of the complainants had the same causes of action, their complaints were docketed as NLRC RAB-VII Case No.
10-1625-99.
The complainants averred that their retirement benefits are exempt from income tax under Article 32 of the NIRC.
Sections 28 and 72 of the NIRC, which petitioner relied upon in withholding their differentials, do not apply to
them since these provisions deal with the applicable income tax rates on foreign corporations and suits to
recover taxes based on false or fraudulent returns. They pointed out that, under Article VIII of the CBA, only those
employees who reached the age of 60 were considered retired, and those under 60 had the option to retire, like
Quiones and Otadoy who retired at ages 58 and 51, respectively. They prayed that they be paid their salary
differentials, as follows:
Otadoy
Quiones
Lagahit
Amarilla

P 170,250.61
P 170,250.61
P 73,165.23
P 71,480.0014

For its part, petitioner averred that under Section 21 of the NIRC, the retirement benefits received by employees
from their employers constitute taxable income. While retirement benefits are exempt from taxes under Section
28(b) of said Code, the law requires that such benefits received should be in accord with a reasonable
retirement plan duly registered with the Bureau of Internal Revenue (BIR) after compliance with the requirements
therein enumerated. Since its retirement plan in the 1993 CBA was not approved by the BIR, complainants were
liable for income tax on their retirement benefits. Petitioner claimed that it was mandated to withhold the income
tax due from the retirement benefits of said complainants. It was not estopped from correcting the mistakes of its
former officers. Under the law, complainants are obliged to return what had been mistakenly delivered to them. 15
In reply, complainants averred that the claims for the retirement salary differentials of Quiones and Otadoy had
not prescribed because the said CBA was implemented only in 1997. They pointed out that they filed their claims
with petitioner on April 3, 1999. They maintained that they availed of the optional retirement because of
petitioners inducement that there would be no tax deductions. Petitioner IBC did not commit any mistake in not
withholding the taxes due on their retirement benefits as shown by the fact that the PCCG, the Commission on
Audit (COA) and the Bureau of Internal Revenue (BIR) did not even require them to explain such mistake. They
pointed out that petitioner paid their retirement benefits on a staggered basis, and nonetheless failed to deduct
any amount as taxes.16
Petitioner countered that the retirement benefits received by the complainants were based on the CBA
between it and its bargaining units. Under Sections 72 and 73 of the NIRC, it is obliged to deduct and withhold
taxes determined in accordance with the rules and regulations to be prepared by the Secretary of Finance. It
was its duty to withhold the taxes on complainants retirement benefits, otherwise, it would be held civilly and
criminally liable under Sections 251, 254 and 255 of the NIRC.
On February 14, 2000, the Labor Arbiter rendered judgment in favor of the retirees. The fallo of the decision reads:

WHEREFORE, premises considered, judgment is hereby rendered ordering the respondent Intercontinental
Broadcasting Corporation (IBC TV-13 Cebu) to pay the complainants Noemi Amarilla and Corsini Lagahit
as follows:
1. Noemi E. Amarilla

P26,423.00

2. Corsino R. Lagahit

P26,423.00

Total

P52,846.00

The claim of complainants Anatolio Otadoy and Candido Quiones and the case against respondent
Louella F. Cabaero are dismissed for lack of merit.
SO ORDERED.17
The Labor Arbiter ruled that the claims of Quiones and Otadoy had prescribed. The retirement benefits of
complainants Lagahit and Amarilla, on the other hand, were exempt from income tax under Section 28(b) of the
NIRC. However, the differentials due to the two complainants were computed three years backwards due to the
law on prescription.
Petitioner appealed the decision of the Labor Arbiter to the NLRC, arguing that the retirement benefits of Amarilla
and Lagahit are not tax exempt. It insisted that the Labor Arbiter erred in declaring as unlawful the act of
withholding the employees salary differentials as payment for the latters tax liabilities.
Otadoy and Quiones no longer appealed the decision.
On May 21, 2002, the NLRC rendered its decision dismissing the appeal and affirming that of the Labor Arbiter.
The fallo of the decision reads:
WHEREFORE, the Decision of the Labor Arbiter dated February 14, 2000 is hereby AFFIRMED. Respondents
appeal is dismissed for lack of merit.
SO ORDERED.18
The NLRC held that the benefits of the retirement plan under the CBAs between petitioner and its union members
were subject to tax as the scheme was not approved by the BIR. However, it had also been the practice of
petitioner to give retiring employees their retirement pay without tax deductions and there was no justifiable
reason for the respondent to deviate from such practice. The NLRC concluded that petitioner was deemed to
have assumed the tax liabilities of the complainants on their retirement benefits, hence, had no right to deduct
taxes from their salary differentials. The NLRC thus ratiocinated:
The sole concern of the law is that tax shall be imposed on retirement benefits. The employer assuming
the payment of tax on behalf of the retiring employee to make the retirement attractive, does not
contravene the tax law, because it is not contrary to the law or public policy, morals and good customs. It
is significant to note that respondent did not refute the complainants allegations in their Position Papers,
to wit:
"Complainants Amarilla and Lagahit availed themselves of the offer of the respondent company
when they were induced and were made to believe that respondent companys employees who
avail of such early retirement can avail of that exemption on their retirement benefits. Were it not
for the offer of no tax liability, complainants would not have availed of such optional or early
retirement."
It is worthy to note that the retirement benefits of the complainants did not suffer any tax deductions
when they were given at the first instance. It is only after they claimed the salary differentials when the
respondent withheld the backwages for the payment of tax liabilities.

"From the facts it can be shown that the disbursement of retirement benefits of the complainants
were made on staggered basis, three (3) and four (4) times. So, if the company, as it claimed, is
really vent on deducting the alleged taxes due the complainants, they have three or four
opportunities to do so."
The respondents history reveals that it was paying retirement pays to its retiring employees without tax
deductions as a matter of practice. There is no justifiable reason for the respondent to deviate from that
practice now. It is deemed to have assumed the tax liabilities of the complainants.19
Aggrieved, petitioner elevated the decision before the CA on the following grounds:
1. THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION TANTAMOUNT TO LACK OF JURISDICTION WHEN
IT RULED THAT WHILE PETITIONER MAY NOT HAVE A RETIREMENT PLAN WHOSE BENEFITS THEREFROM ARE
EXEMPTED FROM TAXES UNDER SECTION 28 OF THE NIRC, BY VIRTUE OF ITS PREVIOUS PRACTICE THAT IT
ASSUMED THE PAYMENT OF TAX LIABILITES, IT IS DEEMED TO HAVE ANSWERED FOR THE TAX LIABILITES OF THE
COMPLAINANTS, WHICH ULTIMATE CONSEQUENCE, IF NOT RECTIFIED, SHALL CAUSE IRREPARABLE DAMAGE
AND INJURY TO THE PETITIONER CORPORATION.
2. THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION TANTAMOUNT TO LACK OR EXCESS OF
JURISDICTION IN AFFIRMING THE DECISION RENDERED BY THE LABOR ARBITER ON FEBRUARY 14, 2000 WHICH
GRANTED RETIREMENT DIFFERENTIAL TO RESPONDENTS AMARILLA AND LAGAHIT AS THESE ARE CONTRARY
TO THE FACTS AND RETIREMENT LAWS PARTICULARLY THE PROVISIONS EMBODIED IN SECTIONS 21, 27, 28 OF
THE NATIONAL INTERNAL REVENUE CODE AND R.A. 7641 IMPLEMENTING ARTICLE 287 OF THE LABOR CODE
AS WELL AS SECTION 6 OF THE IMPLEMENTING RULES OF RA 7641.
3. CONSEQUENT TO NLRCS RULING GRANTING RETIREMENT DIFFERENTIAL TO RESPONDENTS AMARILLA AND
LAGAHIT, THE HONORABLE NLRC GRAVELY ABUSED ITS DISCRETION TANTAMOUNT TO LACK OR EXCESS OF
JURISDICTION IN HOLDING THAT PETITIONERS ACT OF WITHHOLDING COMPLAINANTS BACKWAGES AS
PAYMENT OF THEIR TAX LIABILITIES IS ILLEGAL.20
On December 3, 2003, the CA rendered judgment dismissing the petition for lack of merit.
The appellate court declared that the salary differentials of the respondents are part of their taxable gross
income, considering that the CBA was not approved, much less submitted to the BIR. However, petitioner
could not withhold the corresponding tax liabilities of respondents due to the then existing CBA, providing
that such retirement benefits would not be subjected to any tax deduction, and that any such taxes
would be for its account. The appellate court relied on the allegations of respondents in their Position
Paper before the Labor Arbiter which petitioner failed to refute.
Petitioner filed a motion for reconsideration, which the appellate court denied. Hence, the present
petition, where petitioner avers that:
WITH ALL DUE RESPECT, THE COURT OF APPEALS COMMITTED REVERSIBLE ERROR WHEN IT RULED THAT SINCE
IT HAS BEEN THE PURPORTED PRACTICE OF PETITIONER IBC-13 NOT TO WITHHOLD TAXES DUE ON THE SALARY
DIFFERENTIAL AND THE RETIREMENT BENEFITS, PETITIONER IBC-13 NECESSARILY ASSUMED PAYMENT OF THE
TAXES AND COULD NOT THEREFORE WITHHOLD THE SAME NOTWITHSTANDING THE SUBSEQUENT DISCOVERY
THAT THE FAILURE TO WITHHOLD THE TAXES WAS DONE DUE TO THE OMISSION, MISTAKE, FRAUD OR
IRREGULARITY COMMITTED BY PREVIOUS MANAGEMENT.
WITH ALL DUE RESPECT, THE HONORABLE COURT OF APPEALS GLOSSED OVER THE FACT AND COMMITTED
REVERSIBLE ERROR WHEN IT AFFIRMED THE DECISION OF THE NATIONAL LABOR RELATIONS COMMISSION
DATED MAY 21, 2002 WHICH ORDERED PETITIONER IBC-13 TO PAY RETIREMENT DIFFERENTIAL TO
RESPONDENTS AMARILLA AND LAGAHIT AS THESE ARE CONTRARY TO THE FACTS AND RETIREMENT LAWS
PARTICULARLY THE PROVISIONS EMBODIED IN SECTIONS 21, 27, 28 OF THE NATIONAL INTERNAL REVENUE
CODE (AS AMENDED BY PRESIDENTIAL DECREE NO. 1994)21
Petitioner insists that respondents are liable for taxes on their retirement benefits because the retirement plan
under the CBA was not approved by the BIR. It insisted that it failed to comply with the requisites of Section 32 of

the NIRC and Rule II, Section 6 of the Rules Implementing the New Retirement Law which provides that retirement
pay shall be tax exempt upon compliance with the requirements under Section 2(b) of Revenue Regulation No.
12-86 dated August 1, 1986.
Petitioner maintains that respondents failed to present any document as proof that petitioner bound and obliged
itself to pay the withholding taxes on their retirement benefits. In fact, the Labor Arbiter did not make any finding
that petitioner had obliged itself to pay the withholding taxes on respondents retirement benefits. The NLRCs
reliance on the statements in its Position Paper that it undertook to pay for respondents withholding taxes is
misplaced.
While petitioner admits that its "previous directors" had paid the withholding taxes on the retirement benefits of
respondents, it explains that this practice was stopped when the new management took over. The new
management could not be expected to enforce and follow through the illegal policy of the old management
which is adverse to the interests of the petitioner; hence, the decisions of the NLRC and the CA affirming such
undertaking should be reversed. It points out that it is a government corporation, and as such, its officials and
employees may be held liable for violation of Section 3(a) of Republic Act Nos. 3019, and 6713. 22 Moreover, its
officers and employees are mandated to preserve the companys assets, and may, likewise be held liable for
failure to do so under Section 31 of the Corporation Code.
The issues are (1) whether the retirement benefits of respondents are part of their gross income; and (2) whether
petitioner is estopped from reneging on its agreement with respondent to pay for the taxes on said retirement
benefits.
We agree with petitioners contention that, under the CBA, it is not obliged to pay for the taxes on the
respondents retirement benefits. We have carefully reviewed the CBA and find no provision where petitioner
obliged itself to pay the taxes on the retirement benefits of its employees.
We also agree with petitioners contention that, under the NIRC, the retirement benefits of respondents are part
of their gross income subject to taxes. Section 28 (b) (7) (A) of the NIRC of 1986 23 provides:
Sec. 28. Gross Income.
xxxx
(b) Exclusions from gross income. - The following items shall not be included in gross income and shall be
exempt from taxation under this Title:
xxxx
(7) Retirement benefits, pensions, gratuities, etc. - (A) Retirement benefits received by officials and
employees of private firms whether individuals or corporate, in accordance with a reasonable private
benefit plan maintained by the employer: Provided, That the retiring official or employee has been in the
service of the same employer for at least ten (10) years and is not less than fifty years of age at the time of
his retirement: Provided, further, That the benefits granted under this subparagraph shall be availed of by
an official or employee only once. For purposes of this subsection, the term "reasonable private benefit
plan" means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the
benefit of some or all of his officials or employees, where contributions are made by such employer for
officials or employees, or both, for the purpose of distributing to such officials and employees the earnings
and principal of the fund thus accumulated, and wherein it is provided in said plan that at no time shall
any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for
the exclusive benefit of the said official and employees.
Revenue Regulation No. 12-86, the implementing rules of the foregoing provisions, provides:
(b) Pensions, retirements and separation pay. Pensions, retirement and separation pay constitute
compensation subject to withholding tax, except the following:

(1) Retirement benefit received by official and employees of private firms under a reasonable private
benefit plan maintained by the employer, if the following requirements are met:
(i) The retirement plan must be approved by the Bureau of Internal Revenue;
(ii) The retiring official or employees must have been in the service of the same employer for at
least ten (10) years and is not less than fifty (50) years of age at the time of retirement; and
(iii) The retiring official or employee shall not have previously availed of the privilege under the
retirement benefit plan of the same or another employer.
Thus, for the retirement benefits to be exempt from the withholding tax, the taxpayer is burdened to prove the
concurrence of the following elements: (1) a reasonable private benefit plan is maintained by the employer; (2)
the retiring official or employee has been in the service of the same employer for at least 10 years; (3) the retiring
official or employee is not less than 50 years of age at the time of his retirement; and (4) the benefit had been
availed of only once.
Article VIII of the 1993 CBA provides for two kinds of retirement plans - compulsory and optional. Thus:
ARTICLE
RETIREMENT

VIII

Section 1: Compulsory Retirement Any employee who has reached the age of Fifty Five (55) years shall be
retired from the COMPANY and shall be paid a retirement pay in accordance with the following schedule:
LENGTH OF SERVICE

RETIREMENT BENEFITS

1 year below 5 yrs.

15 days for every year of service

5 years 9 years

30 days for every year of service

10 years 14 years

50 days for every year of service

15 years 19 years

65 days for every year of service

20 years or more

80 days for every year of service

A supervisor who reached the age of Fifty (50) may at his/her option retire with the same retirement benefits
provided above.
Section 2: Optional Retirement Any covered employee, regardless of age, who has rendered at least five (5)
years of service to the COMPANY may voluntarily retire and the COMPANY agrees to pay Long Service Pay to
said covered employee in accordance with the following schedule:
LENGTH OF SERVICE

RETIREMENT BENEFITS

5 9 years

15 days for every year of service

10 14 years

30 days for every year of service

15 19 years

50 days for every year of service

20 years and above

60 days for every year of service

Section 3: Fraction of a Year In computing the retirement under Section 1 and 2 of this Article, a fraction of at
least six (6) months shall be considered as one whole year. Moreover, the COMPANY may exercise the option of
extending the employment of an employee.

Section 4: Severance of Employment Due to Illness When a supervisor suffers from disease and/or permanent
disability and her/his continued employment is prohibited by law or prejudicial to her/his health of the health of
his co-employees, the COMPANY shall not terminate the employment of the subject supervisor unless there is a
certification by a competent public health authority that the disease is of such a nature or at such stage that it
can not be cured within a period of six (6) months even with proper medical treatment. The supervisor may be
separated upon payment by the COMPANY of separation pay pursuant to law, unless the supervisor falls within
the purview of either Sections 1 or 2 hereof. In which case, the retirement benefits indicated therein shall apply,
whichever is higher.
Section 5: Loyalty Recognition The COMPANY shall recognize the services of the supervisor/director who have
reached the following number of years upon retirement by granting him/her a plaque of appreciation and any
lasting gift:
10 years but below 15 years

(P 3,000.00) worth

15 years but below 20 years

(P 7,000.00) worth

20 years and more

(P10,000.00) worth

Respondents were qualified to retire optionally from their employment with petitioner. However, there is no
evidence on record that the 1993 CBA had been approved or was ever presented to the BIR; hence, the
retirement benefits of respondents are taxable.
Under Section 80 of the NIRC, petitioner, as employer, was obliged to withhold the taxes on said benefits and
remit the same to the BIR.
Section 80. Liability for Tax.
(A) Employer. The employer shall be liable for the withholding and remittance of the correct amount of
tax required to be deducted and withheld under this Chapter. If the employer fails to withhold and remit
the correct amount of tax as required to be withheld under the provision of this Chapter, such tax shall be
collected from the employer together with the penalties or additions to the tax otherwise applicable in
respect to such failure to withhold and remit.
However, we agree with respondents contention that petitioner did not withhold the taxes due on their
retirement benefits because it had obliged itself to pay the taxes due thereon. This was done to induce
respondents to agree to avail of the optional retirement scheme. Thus, in its petition in this case, petitioner
averred that:
While it may indeed be conceded that the previous dispensation of petitioner IBC-13 footed the bill for
the withholding taxes, upon discovery by the new management, this was stopped altogether as this was
grossly prejudicial to the interest of the petitioner IBC-13. The policy of withholding the taxes due on the
differentials as a remedial measure was a matter of sound business judgment and dictates of good
governance aimed at protecting the interests of the government. Necessarily, the newly-appointed
board and officers of the petitioner, who learned about this grossly disadvantageous mistake committed
by the former management of petitioner IBC-13 cannot be expected to just follow suit blindly. An illegal
act simply cannot give rise to an obligation. Accordingly, the new officers were correct in not honoring
this highly suspect practice and it is now their duty to rectify this anomalous occurrence, otherwise, they
become remiss in the performance of their sworn responsibilities.
It need not be stressed that as board members and officers of the acquired asset of the government,
they are committed to preserve the assets thereof. Their concomitant obligations spring not only from their
fiduciary responsibility as corporate officers but as well as public officers.24
Respondents received their retirement benefits from the petitioner in three staggered installments without any tax
deduction for the simple reason that petitioner had remitted the same to the BIR with the use of its own funds
conformably with its agreement with the retirees. It was only when respondents demanded the payment of their
salary differentials that petitioner alleged, for the first time, that it had failed to present the 1993 CBA to the BIR for

approval, rendering such retirement benefits not exempt from taxes; consequently, they were obliged to refund
to it the amounts it had remitted to the BIR in payment of their taxes. Petitioner used this "failure" as an
afterthought, as an excuse for its refusal to remit to the respondents their salary differentials. Patently, petitioner is
estopped from doing so. It cannot renege on its commitment to pay the taxes on respondents retirement
benefits on the pretext that the "new management" had found the policy disadvantageous.
It must be stressed that the parties are free to enter into any contract stipulation provided it is not illegal or
contrary to public morals. When such agreement freely and voluntarily entered into turns out to be
advantageous to a party, the courts cannot "rescue" the other party without violating the constitutional right to
contract. Courts are not authorized to extricate the parties from the consequences of their acts. Thus, the fact
that the contract stipulations of the parties may turn out to be financially disadvantageous to them will not
relieve them of their obligation under the agreement.25
An agreement to pay the taxes on the retirement benefits as an incentive to prospective retirees and for them to
avail of the optional retirement scheme is not contrary to law or to public morals. Petitioner had agreed to
shoulder such taxes to entice them to voluntarily retire early, on its belief that this would prove advantageous to
it. Respondents agreed and relied on the commitment of petitioner. For petitioner to renege on its contract with
respondents simply because its new management had found the same disadvantageous would amount to a
breach of contract. There is even no evidence that any "new management" was ever installed by petitioner after
respondents retirement; nor is there evidence that the Board of Directors of petitioner resolved to renege on its
contract with respondents and demand the reimbursement for the amounts remitted by it to the BIR.
The well-entrenched rule is that estoppel may arise from a making of a promise if it was intended that the promise
should be relied upon and, in fact, was relied upon, and if a refusal to sanction the perpetration of fraud would
result to injustice. The mere omission by the promisor to do whatever he promises to do is sufficient forbearance to
give rise to a promissory estoppel.26
Petitioner cannot hide behind the fact that, under the compromise agreement between the PCGG and
Benedicto, the latter had assigned and conveyed to the Republic of the Philippines his shares, interests and rights
in petitioner. Respondents retired only after the Court affirmed the validity of the Compromise Agreement 27 and
the execution by petitioner and the union of their 1993 CBA while Civil Case No. 0034 was still pending in
theSandiganbayan. There is no showing that before respondents demanded the payment of their salary
differentials, petitioner had rejected its commitment to shoulder the taxes on respondents retirement benefits
and sought its nullification before the court; nor is there any showing that petitioners "new management" filed
any criminal or administrative charges against the former officers/board of directors comprising the "old
management" relative to the payment of the taxes on respondents retirement benefits.
IN VIEW OF ALL THE FOREGOING, the petition is DENIED for lack of merit. The Decision of the Court of Appeals in
CA-G.R. SP No. 72414 is AFFIRMED. Costs against the petitioner.
SO ORDERED.
COMMISSIONER
OF
INTERNAL
REVENUE, petitioner,
vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED MINING AND DEVELOPMENT CORPORATION and the
COURT OF TAX APPEALS, respondents.
G.R. No. 80041 January 22, 1990
COMMISSIONER
OF
INTERNAL
REVENUE, petitioner,
vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED MINING AND DEVELOPMENT CORPORATION and the
COURT OF TAX APPEALS, respondents.
Gadioma Law Offices for respondents.

REGALADO, J.:
These cases, involving the same issue being contested by the same parties and having originated from the same
factual antecedents generating the claims for tax credit of private respondents, the same were consolidated by
resolution of this Court dated May 31, 1989 and are jointly decided herein.
The records reflect that on April 17, 1970, Atlas Consolidated Mining and Development Corporation (hereinafter,
Atlas) entered into a Loan and Sales Contract with Mitsubishi Metal Corporation (Mitsubishi, for brevity), a
Japanese corporation licensed to engage in business in the Philippines, for purposes of the projected expansion
of the productive capacity of the former's mines in Toledo, Cebu. Under said contract, Mitsubishi agreed to
extend a loan to Atlas 'in the amount of $20,000,000.00, United States currency, for the installation of a new
concentrator for copper production. Atlas, in turn undertook to sell to Mitsubishi all the copper concentrates
produced from said machine for a period of fifteen (15) years. It was contemplated that $9,000,000.00 of said
loan was to be used for the purchase of the concentrator machinery from Japan. 1
Mitsubishi thereafter applied for a loan with the Export-Import Bank of Japan (Eximbank for short) obviously for
purposes of its obligation under said contract. Its loan application was approved on May 26, 1970 in the sum of
4,320,000,000.00, at about the same time as the approval of its loan for 2,880,000,000.00 from a consortium of
Japanese banks. The total amount of both loans is equivalent to $20,000,000.00 in United States currency at the
then prevailing exchange rate. The records in the Bureau of Internal Revenue show that the approval of the loan
by Eximbank to Mitsubishi was subject to the condition that Mitsubishi would use the amount as a loan to Atlas
and as a consideration for importing copper concentrates from Atlas, and that Mitsubishi had to pay back the
total amount of loan by September 30, 1981. 2
Pursuant to the contract between Atlas and Mitsubishi, interest payments were made by the former to the latter
totalling P13,143,966.79 for the years 1974 and 1975. The corresponding 15% tax thereon in the amount of
P1,971,595.01 was withheld pursuant to Section 24 (b) (1) and Section 53 (b) (2) of the National Internal Revenue
Code, as amended by Presidential Decree No. 131, and duly remitted to the Government. 3
On March 5, 1976, private respondents filed a claim for tax credit requesting that the sum of P1,971,595.01 be
applied against their existing and future tax liabilities. Parenthetically, it was later noted by respondent Court of
Tax Appeals in its decision that on August 27, 1976, Mitsubishi executed a waiver and disclaimer of its interest in
the
claim
for
tax
credit
in
favor
of
Atlas. 4
The petitioner not having acted on the claim for tax credit, on April 23, 1976 private respondents filed a petition
for review with respondent court, docketed therein as CTA Case No. 2801. 5 The petition was grounded on the
claim that Mitsubishi was a mere agent of Eximbank, which is a financing institution owned, controlled and
financed by the Japanese Government. Such governmental status of Eximbank, if it may be so called, is the basis
for private repondents' claim for exemption from paying the tax on the interest payments on the loan as earlier
stated. It was further claimed that the interest payments on the loan from the consortium of Japanese banks
were likewise exempt because said loan supposedly came from or were financed by Eximbank. The provision of
the National Internal Revenue Code relied upon is Section 29 (b) (7) (A), 6 which excludes from gross income:
(A) Income received from their investments in the Philippines in loans, stocks, bonds or other
domestic securities, or from interest on their deposits in banks in the Philippines by (1) foreign
governments, (2) financing institutions owned, controlled, or enjoying refinancing from them, and
(3) international or regional financing institutions established by governments.
Petitioner filed an answer on July 9, 1976. The case was set for hearing on April 6, 1977 but was later reset upon
manifestation of petitioner that the claim for tax credit of the alleged erroneous payment was still being reviewed
by the Appellate Division of the Bureau of Internal Revenue. The records show that on November 16, 1976, the
said division recommended to petitioner the approval of private respondent's claim. However, before action
could be taken thereon, respondent court scheduled the case for hearing on September 30, 1977, during which
trial private respondents presented their evidence while petitioner submitted his case on the basis of the records
of the Bureau of Internal Revenue and the pleadings. 7

On April 18, 1980, respondent court promulgated its decision ordering petitioner to grant a tax credit in favor of
Atlas in the amount of P1,971,595.01. Interestingly, the tax court held that petitioner admitted the material
averments of private respondents when he supposedly prayed "for judgment on the pleadings without off-spring
proof as to the truth of his allegations." 8 Furthermore, the court declared that all papers and documents
pertaining to the loan of 4,320,000,000.00 obtained by Mitsubishi from Eximbank show that this was the same
amount given to Atlas. It also observed that the money for the loans from the consortium of private Japanese
banks in the sum of 2,880,000,000.00 "originated" from Eximbank. From these, respondent court concluded that
the ultimate creditor of Atlas was Eximbank with Mitsubishi acting as a mere "arranger or conduit through which
the loans flowed from the creditor Export-Import Bank of Japan to the debtor Atlas Consolidated Mining &
Development Corporation." 9
A motion for reconsideration having been denied on August 20, 1980, petitioner interposed an appeal to this
Court, docketed herein as G.R. No. 54908.
While CTA Case No. 2801 was still pending before the tax court, the corresponding 15% tax on the amount of
P439,167.95 on the P2,927,789.06 interest payments for the years 1977 and 1978 was withheld and remitted to the
Government. Atlas again filed a claim for tax credit with the petitioner, repeating the same basis for exemption.
On June 25, 1979, Mitsubishi and Atlas filed a petition for review with the Court of Tax Appeals docketed as CTA
Case No. 3015. Petitioner filed his answer thereto on August 14, 1979, and, in a letter to private respondents dated
November 12, 1979, denied said claim for tax credit for lack of factual or legal basis. 10
On January 15, 1981, relying on its prior ruling in CTA Case No. 2801, respondent court rendered judgment
ordering the petitioner to credit Atlas the aforesaid amount of tax paid. A motion for reconsideration, filed on
March 10, 1981, was denied by respondent court in a resolution dated September 7, 1987. A notice of appeal
was filed on September 22, 1987 by petitioner with respondent court and a petition for review was filed with this
Court on December 19, 1987. Said later case is now before us as G.R. No. 80041 and is consolidated with G.R. No.
54908.
The principal issue in both petitions is whether or not the interest income from the loans extended to Atlas by
Mitsubishi is excludible from gross income taxation pursuant to Section 29 b) (7) (A) of the tax code and,
therefore, exempt from withholding tax. Apropos thereto, the focal question is whether or not Mitsubishi is a mere
conduit of Eximbank which will then be considered as the creditor whose investments in the Philippines on loans
are exempt from taxes under the code.
Prefatorily, it must be noted that respondent court erred in holding in CTA Case No. 2801 that petitioner should be
deemed to have admitted the allegations of the private respondents when it submitted the case on the basis of
the pleadings and records of the bureau. There is nothing to indicate such admission on the part of petitioner nor
can we accept respondent court's pronouncement that petitioner did not offer to prove the truth of its
allegations. The records of the Bureau of Internal Revenue relevant to the case were duly submitted and
admitted as petitioner's supporting evidence. Additionally, a hearing was conducted, with presentation of
evidence, and the findings of respondent court were based not only on the pleadings but on the evidence
adduced by the parties. There could, therefore, not have been a judgment on the pleadings, with the theorized
admissions imputed to petitioner, as mistakenly held by respondent court.
Time and again, we have ruled that findings of fact of the Court of Tax Appeals are entitled to the highest
respect and can only be disturbed on appeal if they are not supported by substantial evidence or if there is a
showing of gross error or abuse on the part of the tax court. 11 Thus, ordinarily, we could give due consideration to
the holding of respondent court that Mitsubishi is a mere agent of Eximbank. Compelling circumstances
obtaining and proven in these cases, however, warrant a departure from said general rule since we are
convinced that there is a misapprehension of facts on the part of the tax court to the extent that its conclusions
are speculative in nature.
The loan and sales contract between Mitsubishi and Atlas does not contain any direct or inferential reference to
Eximbank whatsoever. The agreement is strictly between Mitsubishi as creditor in the contract of loan and Atlas
as the seller of the copper concentrates. From the categorical language used in the document, one prestation
was in consideration of the other. The specific terms and the reciprocal nature of their obligations make it
implausible, if not vacuous to give credit to the cavalier assertion that Mitsubishi was a mere agent in said
transaction.

Surely, Eximbank had nothing to do with the sale of the copper concentrates since all that Mitsubishi stated in its
loan application with the former was that the amount being procured would be used as a loan to and in
consideration for importing copper concentrates from Atlas. 12 Such an innocuous statement of purpose could
not have been intended for, nor could it legally constitute, a contract of agency. If that had been the purpose
as respondent court believes, said corporations would have specifically so stated, especially considering their
experience and expertise in financial transactions, not to speak of the amount involved and its purchasing value
in 1970.
A thorough analysis of the factual and legal ambience of these cases impels us to give weight to the following
arguments of petitioner:
The nature of the above contract shows that the same is not just a simple contract of loan. It is not
a mere creditor-debtor relationship. It is more of a reciprocal obligation between ATLAS and
MITSUBISHI where the latter shall provide the funds in the installation of a new concentrator at the
former's Toledo mines in Cebu, while ATLAS in consideration of which, shall sell to MITSUBISHI, for a
term of 15 years, the entire copper concentrate that will be produced by the installed
concentrator.
Suffice it to say, the selling of the copper concentrate to MITSUBISHI within the specified term was
the consideration of the granting of the amount of $20 million to ATLAS. MITSUBISHI, in order to fulfill
its part of the contract, had to obtain funds. Hence, it had to secure a loan or loans from other
sources. And from what sources, it is immaterial as far as ATLAS in concerned. In this case,
MITSUBISHI obtained the $20 million from the EXIMBANK, of Japan and the consortium of Japanese
banks financed through the EXIMBANK, of Japan.
When MITSUBISHI therefore secured such loans, it was in its own independent capacity as a private
entity and not as a conduit of the consortium of Japanese banks or the EXIMBANK of Japan. While
the loans were secured by MITSUBISHI primarily "as a loan to and in consideration for importing
copper concentrates from ATLAS," the fact remains that it was a loan by EXIMBANK of Japan to
MITSUBISHI and not to ATLAS.
Thus, the transaction between MITSUBISHI and EXIMBANK of Japan was a distinct and separate
contract from that entered into by MITSUBISHI and ATLAS. Surely, in the latter contract, it is not
EXIMBANK, that was intended to be benefited. It is MITSUBISHI which stood to profit. Besides, the
Loan and Sales Contract cannot be any clearer. The only signatories to the same were MITSUBISHI
and ATLAS. Nowhere in the contract can it be inferred that MITSUBISHI acted for and in behalf of
EXIMBANK, of Japan nor of any entity, private or public, for that matter.
Corollary to this, it may well be stated that in this jurisdiction, well-settled is the rule that when a
contract of loan is completed, the money ceases to be the property of the former owner and
becomes the sole property of the obligor (Tolentino and Manio vs. Gonzales Sy, 50 Phil. 558).
In the case at bar, when MITSUBISHI obtained the loan of $20 million from EXIMBANK, of Japan,
said amount ceased to be the property of the bank and became the property of MITSUBISHI.
The conclusion is indubitable; MITSUBISHI, and NOT EXIMBANK, is the sole creditor of ATLAS, the
former being the owner of the $20 million upon completion of its loan contract with EXIMBANK of
Japan.
The interest income of the loan paid by ATLAS to MITSUBISHI is therefore entirely different from the
interest income paid by MITSUBISHI to EXIMBANK, of Japan. What was the subject of the 15%
withholding tax is not the interest income paid by MITSUBISHI to EXIMBANK, but the interest income
earned by MITSUBISHI from the loan to ATLAS. . . . 13
To repeat, the contract between Eximbank and Mitsubishi is entirely different. It is complete in itself, does not
appear to be suppletory or collateral to another contract and is, therefore, not to be distorted by other
considerations aliunde. The application for the loan was approved on May 20, 1970, or more than a month after
the contract between Mitsubishi and Atlas was entered into on April 17, 1970. It is true that under the contract of

loan with Eximbank, Mitsubishi agreed to use the amount as a loan to and in consideration for importing copper
concentrates from Atlas, but all that this proves is the justification for the loan as represented by Mitsubishi, a
standard banking practice for evaluating the prospects of due repayment. There is nothing wrong with such
stipulation as the parties in a contract are free to agree on such lawful terms and conditions as they see fit.
Limiting the disbursement of the amount borrowed to a certain person or to a certain purpose is not unusual,
especially in the case of Eximbank which, aside from protecting its financial exposure, must see to it that the
same are in line with the provisions and objectives of its charter.
Respondents postulate that Mitsubishi had to be a conduit because Eximbank's charter prevents it from making
loans except to Japanese individuals and corporations. We are not impressed. Not only is there a failure to
establish such submission by adequate evidence but it posits the unfair and unexplained imputation that, for
reasons subject only of surmise, said financing institution would deliberately circumvent its own charter to
accommodate an alien borrower through a manipulated subterfuge, but with it as a principal and the real
obligee.
The allegation that the interest paid by Atlas was remitted in full by Mitsubishi to Eximbank, assuming the truth
thereof, is too tenuous and conjectural to support the proposition that Mitsubishi is a mere conduit. Furthermore,
the remittance of the interest payments may also be logically viewed as an arrangement in paying Mitsubishi's
obligation to Eximbank. Whatever arrangement was agreed upon by Eximbank and Mitsubishi as to the manner
or procedure for the payment of the latter's obligation is their own concern. It should also be noted that
Eximbank's loan to Mitsubishi imposes interest at the rate of 75% per annum, while Mitsubishis contract with Atlas
merely states that the "interest on the amount of the loan shall be the actual cost beginning from and including
other dates of releases against loan." 14
It is too settled a rule in this jurisdiction, as to dispense with the need for citations, that laws granting exemption
from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power. Taxation is
the rule and exemption is the exception. The burden of proof rests upon the party claiming exemption to prove
that it is in fact covered by the exemption so claimed, which onus petitioners have failed to discharge.
Significantly, private respondents are not even among the entities which, under Section 29 (b) (7) (A) of the tax
code, are entitled to exemption and which should indispensably be the party in interest in this case.
Definitely, the taxability of a party cannot be blandly glossed over on the basis of a supposed "broad, pragmatic
analysis" alone without substantial supportive evidence, lest governmental operations suffer due to diminution of
much needed funds. Nor can we close this discussion without taking cognizance of petitioner's warning, of
pervasive relevance at this time, that while international comity is invoked in this case on the nebulous
representation that the funds involved in the loans are those of a foreign government, scrupulous care must be
taken to avoid opening the floodgates to the violation of our tax laws. Otherwise, the mere expedient of having
a Philippine corporation enter into a contract for loans or other domestic securities with private foreign entities,
which in turn will negotiate independently with their governments, could be availed of to take advantage of the
tax exemption law under discussion.
WHEREFORE, the decisions of the Court of Tax Appeals in CTA Cases Nos. 2801 and 3015, dated April 18, 1980 and
January 15, 1981, respectively, are hereby REVERSED and SET ASIDE.SO ORDERED.
G.R. No. L-54108 January 17, 1984
COMMISSIONER
OF
INTERNAL
REVENUE, petitioner,
vs.
COURT OF TAX APPEALS and SMITH KLINE & FRENCH OVERSEAS CO. (PHILIPPINE BRANCH),respondents.
The Solicitor General for petitioner.
Siguion Reyna, Montecillo & Ongsiako and J.C. Castaeda, Jr. and E.C. Alcantara for respondents.

AQUINO, J.:

This case is about the refund of a 1971 income tax amounting to P324,255. Smith Kline and French Overseas
Company, a multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the
Philippines. It is engaged in the importation, manufacture and sale of pharmaceuticals drugs and chemicals.
In its 1971 original income tax return, Smith Kline declared a net taxable income of P1,489,277 (Exh. A) and paid
P511,247 as tax due. Among the deductions claimed from gross income was P501,040 ($77,060) as its share of the
head office overhead expenses. However, in its amended return filed on March 1, 1973, there was an
overpayment of P324,255 "arising from underdeduction of home office overhead" (Exh. E). It made a formal claim
for the refund of the alleged overpayment.
It appears that sometime in October, 1972, Smith Kline received from its international independent auditors, Peat,
Marwick, Mitchell and Company, an authenticated certification to the effect that the Philippine share in the
unallocated overhead expenses of the main office for the year ended December 31, 1971 was actually $219,547
(P1,427,484). It further stated in the certification that the allocation was made on the basis of the percentage of
gross income in the Philippines to gross income of the corporation as a whole. By reason of the new adjustment,
Smith Kline's tax liability was greatly reduced from P511,247 to P186,992 resulting in an overpayment ofP324,255.
On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim Smith Kline filed
a petition for review with the Court of Tax Appeals.
In its decision of March 21, 1980, the Tax Court ordered the Commissioner to refund the overpayment or grant a
tax credit to Smith Kline. The Commissioner appealed to this Court.
The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No. 466,
which is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and which
reads:
SEC. 37. Income form sources within the Philippines.
xxx xxx xxx
(b) Net income from sources in the Philippines. From the items of gross income specified in
subsection (a) of this section there shall be deducted the expenses, losses, and other deductions
properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other
deductions which cannot definitely be allocated to some item or class of gross income. The
remainder, if any, shall be included in full as net income from sources within the Philippines.
xxx xxx xxx
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to
be made to determine the net income from Philippine sources:
SEC. 160. Apportionment of deductions. From the items specified in section 37(a), as being
derived specifically from sources within the Philippines there shall be deducted the expenses,
losses, and other deductions properly apportioned or allocated thereto and a ratable part of any
other expenses, losses or deductions which can not definitely be allocated to some item or class
of gross income. The remainder shall be included in full as net income from sources within the
Philippines. The ratable part is based upon the ratio of gross income from sources within the
Philippines to the total gross income.
Example: A non-resident alien individual whose taxable year is the calendar year, derived gross
income from all sources for 1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of a domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000

Gain from sale of real property located within the Philippines 11,000
Total P36,000
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of
the gross income was from sources without the Philippines, determined under section 37(c).
The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of
P8,000 is properly allocated to income from sources within the Philippines and the amount of
P40,000 is properly allocated to income from sources without the Philippines.
The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A
ratable part thereof, based upon the relation of gross income from sources within the Philippines to
the total gross income, shall be deducted in computing net income from sources within the
Philippines. Thus, these are deducted from the P36,000 of gross income from sources within the
Philippines expenses amounting to P14,000 [representing P8,000 properly apportioned to the
income from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses
which could not be allocated to any item or class of gross income.] The remainder, P22,000, is the
net income from sources within the Philippines.
From the foregoing provisions, it is manifest that where an expense is clearly related to the production of
Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building
in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without
resorting to apportionment.
The overhead expenses incurred by the parent company in connection with finance, administration, and
research and development, all of which direct benefit its branches all over the world, including the Philippines,
fall under a different category however. These are items which cannot be definitely allocated or Identified with
the operations of the Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under
section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible
share a ratable partof such expenses based upon the ratio of the local branch's gross income to the total gross
income, worldwide, of the multinational corporation.
In his petition for review, the Commissioner does not dispute the right of Smith Kline to avail itself of section 37(b)
of the Tax Code and section 160 of the regulations. But the Commissioner maintains that such right is not absolute
and that as there exists a contract (in this case a service agreement) which Smith Kline has entered into with its
home office, prescribing the amount that a branch can deduct as its share of the main office's overhead
expenses, that contract is binding.
The Commissioner contends that since the share of the Philippine branch has been fixed at $77,060, Smith Kline
itself cannot claim more than the said amount. To allow Smith Kline to deduct more than what was expressly
provided in the agreement would be to ignore its existence. It is a cardinal rule that a contract is the law
between the contracting parties and the stipulations therein must be respected unless these are proved to be
contrary to law, morals, good customs and public policy. There being allegedly no showing to the contrary, the
provisions thereof must be followed.
The Commissioner also argues that the Tax Court erred in relying on the certification of Peat, Marwick, Mitchell
and Company that Smith Kline is entitled to deduct P1,427,484 ($219,547) as its allotted share and that Smith Kline
has not presented any evidence to show that the home office expenses chargeable to Philippine operations
exceeded $77,060.
On the other hand, Smith Kline submits that the contract between itself and its home office cannot amend tax
laws and regulations. The matter of allocated expenses which are deductible under the law cannot be the
subject of an agreement between private parties nor can the Commissioner acquiesce in such an agreement.
Smith Kline had to amend its return because it is of common knowledge that audited financial statements are
generally completed three or four months after the close of the accounting period. There being no financial
statements yet when the certification of January 11, 1972 was made the treasurer could not have correctly

computed Smith Kline's share in the home office overhead expenses in accordance with the gross income
formula prescribed in section 160 of the Revenue Regulations. What the treasurer certified was a mere estimate.
Smith Kline likewise submits that it has presented ample evidence to support its claim for refund. To this end, it has
presented before the Tax Court the authenticated statement of Peat, Marwick, Mitchell and Company to show
that since the gross income of the Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit report
prepared by Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole was
$6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses was P1,427,484 ($219,547) (Exh. G
to G-2, BIR Records, 4-5).
Clearly, the weight of evidence bolsters its position that the amount of P1,427,484 represents the correct ratable
share, the same having been computed pursuant to section 37(b) and section 160.
In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share of the head office
overhead expenses in its income tax returns for the years 1973 to 1981, it deducted its ratable share of the total
overhead expenses of its head office for those years as computed by the independent auditors hired by the
parent company in Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to it.
We hold that Smith Kline's amended 1971 return is in conformity with the law and regulations. The Tax Court
correctly held that the refund or credit of the resulting overpayment is in order.
WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.
SO ORDERED
ALEXANDER
HOWDEN
&
CO.,
LTD.,
H.
G.
CHESTER
&
vs.
THE COLLECTOR (NOW COMMISSIONER) Of INTERNAL REVENUE, respondent.
Sycip,
Salazar,
Luna and Associates
Office of the Solicitor General for respondent.

and

Lichauco,

Picazo

OTHERS,

and

ET

Agcaoili

AL., petitioners,

for

petitioners.

BENGZON, J.P., J.:

In 1950 the Commonwealth Insurance Co., a domestic corporation, entered into reinsurance contracts with 32
British insurance companies not engaged in trade or business in the Philippines, whereby the former agreed to
cede to them a portion of the premiums on insurances on fire, marine and other risks it has underwritten in the
Philippines. Alexander Howden & Co., Ltd., also a British corporation not engaged in business in this country,
represented the aforesaid British insurance companies. The reinsurance contracts were prepared and signed by
the foreign reinsurers in England and sent to Manila where Commonwealth Insurance Co. signed them.
Pursuant to the aforesaid contracts, Commonwealth Insurance Co., in 1951, remitted P798,297.47 to Alexander
Howden & Co., Ltd., as reinsurance premiums. In behalf of Alexander Howden & Co., Ltd., Commonwealth
Insurance Co. filed in April 1952 an income tax return declaring the sum of P798,297.47, with accrued interest
thereon in the amount of P4,985.77, as Alexander Howden & Co., Ltd.'s gross income for calendar year 1951. It
also paid the Bureau of Internal Revenue P66,112.00 income tax thereon.
On May 12, 1954, within the two-year period provided for by law, Alexander Howden & Co., Ltd. filed with the
Bureau of Internal Revenue a claim for refund of the P66,112.00, later reduced to P65,115.00, because Alexander
Howden & Co., Ltd. agreed to the payment of P977.00 as income tax on the P4,985.77 accrued interest. A ruling
of the Commissioner of Internal Revenue, dated December 8, 1953, was invoked, stating that it exempted from
withholding tax reinsurance premiums received from domestic insurance companies by foreign insurance
companies not authorized to do business in the Philippines. Subsequently, Alexander Howden & Co., Ltd.
instituted an action in the Court of First Instance of Manila for the recovery of the aforesaid amount claimed.
Pursuant to Section 22 of Republic Act 1125 the case was certified to the Court of Tax Appeals. On November 24,
1961 the Tax Court denied the claim.

Plaintiffs have appealed, thereby squarely raising the following issues: (1) Are portions of premiums earned from
insurances locally underwritten by a domestic corporation, ceded to and received by non-resident foreign
reinsurance companies, thru a non-resident foreign insurance broker, pursuant to reinsurance contracts signed
by the reinsurers abroad but signed by the domestic corporation in the Philippines, subject to income tax or not?
(2) If subject thereto, may or may not the income tax on reinsurance premiums be withheld pursuant to Sections
53 and 54 of the National Internal Revenue Code?
Section 24 of the National Internal Revenue Code subjects to tax a non-resident foreign corporation's income
from sources within the Philippines. The first issue therefore hinges on whether or not the reinsurance premiums in
question came from sources within the Philippines.
Appellants would impress upon this Court that the reinsurance premiums came from sources outside the
Philippines, for these reasons: (1) The contracts of reinsurance, out of which the reinsurance premiums were
earned, were prepared and signed abroad, so that their situs lies outside the Philippines; (2) The reinsurers, not
being engaged in business in the Philippines, received the reinsurance premiums as income from their business
conducted in England and, as such, taxable in England; and, (3) Section 37 of the Tax Code, enumerating what
are income from sources within the Philippines, does not include reinsurance premiums.
The source of an income is the property, activity or service that produced the income. 1 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. In the first place, the reinsured,
the liabilities insured and the risks originally underwritten by Commonwealth Insurance Co., upon which the
reinsurance premiums and indemnity were based, were all situated in the Philippines. Secondly, contrary to
appellants' view, the reinsurance contracts were perfected in the Philippines, for Commonwealth Insurance Co.
signed them last in Manila. The American cases cited are inapplicable to this case because in all of them the
reinsurance contracts were signed outside the jurisdiction of the taxing State. And, thirdly, the parties to the
reinsurance contracts in question evidently intended Philippine law to govern. Article 11 thereof provided for
arbitration in Manila, according to the laws of the Philippines, of any dispute arising between the parties in regard
to the interpretation of said contracts or rights in respect of any transaction involved. Furthermore, the contracts
provided for the use of Philippine currency as the medium of exchange and for the payment of Philippine taxes.
Appellants should not confuse activity that creates income with business in the course of which an income is
realized. An activity may consist of a single act; while business implies continuity of transactions. 2 An income may
be earned by a corporation in the Philippines although such corporation conducts all its businesses abroad.
Precisely, Section 24 of the Tax Code does not require a foreign corporation to be engaged in business in the
Philippines in order for its income from sources within the Philippines to be taxable. It subjects foreign corporations
not doing business in the Philippines to tax for income from sources within the Philippines. If by source of income is
meant the business of the taxpayer, foreign corporations not engaged in business in the Philippines would be
exempt from taxation on their income from sources within the Philippines.
Furthermore, as used in our income tax law, "income" refers to the flow of wealth. 3 Such flow, in the instant case,
proceeded from the Philippines. Such income enjoyed the protection of the Philippine Government. As wealth
flowing from within the taxing jurisdiction of the Philippines and in consideration for protection accorded it by the
Philippines, said income should properly share the burden of maintaining the government.
Appellants further contend that reinsurance premiums not being among those mentioned in Section 37 of the Tax
Code as income from sources within the Philippines, the same should not be treated as such. Section 37,
however, is not an all-inclusive enumeration. It states that "the following items of gross income shall be treated as
gross income from sources within the Philippines." It does not state or imply that an income not listed therein is
necessarily from sources outside the Philippines.
As to appellants' contention that reinsurance premiums constitute "gross receipts" instead of "gross income", not
subject to income tax, suffice it to say that, as correctly observed by the Court of Tax Appeals, "gross receipts" of
amounts that do not constitute return of capital, such as reinsurance premiums, are part of the gross income of a
taxpayer. At any rate, the tax actually collected in this case was computed not on the basis of gross premium
receipts but on the net premium income, that is, after deducting general expenses, payment of policies and
taxes.

The reinsurance premiums in question being taxable, we turn to the issue whether or not they are subject to
withholding tax under Section 54 in relation to Section 53 of the Tax Code.
Subsection (b) of Section 53 subjects to withholding tax the following: interest, dividends, rents, salaries,
wages,premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual
or periodical gains, profits, and income of any non-resident alien individual not engaged in trade or business
within the Philippines and not having any office or place of business therein. Section 54, by reference, applies this
provision to foreign corporations not engaged in trade or business in the Philippines.
Appellants maintain that reinsurance premiums are not "premiums" at all as contemplated by Subsection (b) of
Section 53; that they are not within the scope of "other fixed or determinable annual or periodical gains, profits,
and income"; that, therefore, they are not items of income subject to withholding tax.
It is urged for the applicant that no opposition has been registered against his petition on the issues abovediscussed. Absence of opposition, however, does not preclude the scanning of the whole record by the
appellate court, with a view to preventing the conferment of citizenship to persons not fully qualified therefor
(Lee Ng Len vs. Republic, G.R. No. L-20151, March 31, 1965). The applicant's complaint of unfairness could have
some weight if the objections on appeal had been on points not previously passed upon. But the deficiencies
here in question are not new but well-known, having been ruled upon repeatedly by this Court, and we see no
excuse for failing to take them into account.1wph1.t
The argument of appellants is that "premiums", as used in Section 53 (b), is preceded by "rents, salaries, wages"
and followed by "annuities, compensations, remunerations" which connote periodical income payable to the
recipient on account of some investment or for personal services rendered. "Premiums" should, therefore, in
appellants' view, be given a meaning kindred to the other terms in the enumeration and be understood in its
broadest sense as "a reward or recompense for some act done; a bonus; compensation for the use of money; a
price for a loan; a sum in addition to interest."
We disagree with the foregoing proposition. Since Section 53 subjects to withholding tax various specified
income, among them, "premiums", the generic connotation of each and every word or phrase composing the
enumeration in Subsection (b) thereof is income. Perforce, the word "premiums", which is neither qualified nor
defined by the law itself, should mean income and should include all premiums constituting income, whether
they be insurance or reinsurance premiums.
Assuming that reinsurance premiums are not within the word "premiums" in Section 53, still they may be classified
as determinable and periodical income under the same provision of law. Section 199 of the Income Tax
Regulations defines fixed, determinable, annual and periodical income:
Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is
determinable whenever there is a basis of calculation by which the amount to be paid may be
ascertained.
The income need not be paid annually if it is paid periodically; that is to say, from time to time, whether or
not at regular intervals. That the length of time during which the payments are to be made may be
increased or diminished in accordance with someone's will or with the happening of an event does not
make the payments any the less determinable or periodical. ...
Reinsurance premiums, therefore, are determinable and periodical income: determinable, because they can be
calculated accurately on the basis of the reinsurance contracts; periodical, inasmuch as they were earned and
remitted from time to time.
Appellants' claim for refund, as stated, invoked a ruling of the Commissioner of Internal Revenue dated
December 8, 1953. Appellants' brief also cited rulings of the same official, dated October 13, 1953, February 7,
1955 and February 8, 1955, as well as the decision of the defunct Board of Tax Appeals in the case of Franklin
Baker Co., 4thereby attempting to show that the prevailing administrative interpretation of Sections 53 and 54 of
the Tax Code exempted from withholding tax reinsurance premiums ceded to non-resident foreign insurance
companies. It is asserted that since Sections 53 and 54 were "substantially re-enacted" by Republic Acts 1065
(approved June 12, 1954), 1291 (approved June 15, 1955), 1505 (approved June 16, 1956) and 2343 (approved

June 20, 1959) when the said administrative rulings prevailed, the rulings should be given the force of law under
the principle of legislative approval by re-enactment.
The principle of legislative approval by re-enactment may briefly be stated thus: Where a statute is susceptible of
the meaning placed upon it by a ruling of the government agency charged with its enforcement and the
Legislature thereafter re-enacts the provisions without substantial change, such action is to some extent
confirmatory that the ruling carries out the legislative purpose.5
The aforestated principle, however, is not applicable to this case. Firstly, Sections 53 and 54 were never
reenacted. Republic Acts 1065, 1291, 1505 and 2343 were merely amendments in respect to the rate of
taximposed in Sections 53 and 54. Secondly, the administrative rulings of the Commissioner of Internal Revenue
relied upon by the taxpayers were only contained in letters to taxpayers and never published, so that the
Legislature is not presumed to know said rulings. Thirdly, in the case on which appellants rely, Interprovincial
Autobus Co., Inc. vs. Collector of Internal Revenue, L-6741, January 31, 1956, what was declared to have
acquired the force or effect of law was a regulation promulgated to implement a law; whereas, in this case,
what appellants would seek to have the force of law are opinions on queries submitted.
It may not be amiss to note that in 1963, after the Tax Court rendered judgment in this case, Congress enacted
Republic Act 3825, as an amendment to Sections 24 and 54 of the Tax Code, exempting from income taxes and
withholding tax, reinsurance premiums received by foreign corporations not engaged in business in the
Philippines. Republic Act 3825 in effect took out from Sections 24 and 54 something which formed a part of the
subject matter therein,6 thereby affirming the taxability of reinsurance premiums prior to the aforestated
amendment.
Finally, appellant would argue that Judge Augusto M. Luciano, who penned the decision appealed from, was
disqualified to sit in this case since he had appeared as counsel for the Commissioner of Internal Revenue and, as
such, answered plaintiff's complaint before the Court of First Instance of Manila.
The Rules of Court provides that no judge shall sit in any case in which he has been counsel without the written
consent of all the parties in interest, signed by them and entered upon the record. The party objecting to the
judge's competency may file, in writing, with such judge his objection stating therein the grounds for it. The judge
shall thereupon proceed with the trial or withdraw therefrom, but his action shall be made in writing and made
part of the record.7
Appellants, instead of asking for Judge Luciano's disqualification by raising their objection in the Court of Tax
Appeals, are content to raise it for the first time before this Court. Such being the case they may not now be
heard to complain on this point, when Judge Luciano has given his opinion on the merits of the case. A litigant
cannot be permitted to speculate upon the action of the court and raise an objection of this nature after
decision has been rendered. 8
WHEREFORE, the judgment appealed from is hereby affirmed with costs against appellants. It is so ordered.
COMMISSIONER
OF
vs.
ISABELA CULTURAL CORPORATION, Respondent.

INTERNAL

REVENUE, Petitioner,

DECISION
YNARES-SANTIAGO, J.:
Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision 1 of the Court of
Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision 2 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.
The deficiency income tax of P333,196.86, arose from:
(1) The BIRs disallowance of ICCs 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 ICCs 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. 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 CTAs 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 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 ICCs 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
The accrual method relies upon the taxpayers 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 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 ICCs tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since
the 1960s.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 firms 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 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 1986 20and
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 BIRs disallowance of ICCs expenses for professional services. The Court of Appeals
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 CAG.R. SP No. 78426, is AFFIRMED with 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 Corporations liability under Assessment
Notice No. FAS-1-86-90-000680.
SO ORDERED.
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. GENERAL FOODS (PHILS.), INC., respondent.
DECISION
CORONA, J.:
Petitioner Commissioner of Internal Revenue (Commissioner) assails the resolution [1] of the Court of Appeals
reversing the decision[2] of the Court of Tax Appeals which in turn denied the protest filed by respondent General
Foods (Phils.), Inc., regarding the assessment made against the latter for deficiency taxes.
The records reveal that, on June 14, 1985, respondent corporation, which is engaged in the manufacture of
beverages such as Tang, Calumet and Kool-Aid, filed its income tax return for the fiscal year ending February 28,
1985. In said tax return, respondent corporation claimed as deduction, among other business expenses, the
amount of P9,461,246 for media advertising for Tang.
On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent
corporation. Consequently, respondent corporation was assessed deficiency income taxes in the amount
of P2,635, 141.42. The latter filed a motion for reconsideration but the same was denied.
On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the appeal was
dismissed:
With such a gargantuan expense for the advertisement of a singular product, which even excludes other
advertising and promotions expenses, we are not prepared to accept that such amount is reasonable to
stimulate the current sale of merchandise regardless of Petitioners explanation that such expense does not
connote unreasonableness considering the grave economic situation taking place after the Aquino assassination
characterized by capital fight, strong deterioration of the purchasing power of the Philippine peso and the
slacking demand for consumer products (Petitioners Memorandum, CTA Records, p. 273). We are not convinced
with such an explanation. The staggering expense led us to believe that such expenditure was incurred to create
or maintain some form of good will for the taxpayers trade or business or for the industry or profession of which the
taxpayer is a member. The term good will can hardly be said to have any precise signification; it is generally used
to denote the benefit arising from connection and reputation (Words and Phrases, Vol. 18, p. 556 citing Douhart
vs. Loagan, 86 III. App. 294). As held in the case of Welch vs. Helvering, efforts to establish reputation are akin to
acquisition of capital assets and, therefore, expenses related thereto are not business expenses but capital
expenditures. (Atlas Mining and Development Corp. vs. Commissioner of Internal Revenue, supra). For sure such
expenditure was meant not only to generate present sales but more for future and prospective benefits. Hence,
abnormally large expenditures for advertising are usually to be spread over the period of years during which the
benefits of the expenditures are received (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).
WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we hereby RESOLVE to DISMISS
the instant petition for lack of merit and ORDER the Petitioner to pay the respondent Commissioner the assessed
amount of P2,635,141.42 representing its deficiency income tax liability for the fiscal year ended February 28,
1985.[3]
Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which rendered a
decision reversing and setting aside the decision of the Court of Tax Appeals:
Since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same should
be allowed.

WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby GRANTED. Accordingly, the
Decision, dated 8 February 1994 of respondent Court of Tax Appeals is REVERSED and SET ASIDE and the letter,
dated 31 May 1988 of respondent Commissioner of Internal Revenue is CANCELLED.
SO ORDERED.[4]
Thus, the instant petition, wherein the Commissioner presents for the Courts consideration a lone issue:
whether or not the subject media advertising expense for Tang incurred by respondent corporation was an
ordinary and necessary expense fully deductible under the National Internal Revenue Code (NIRC).
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;[5] and he who claims an exemption must be able to justify
his claim by the clearest grant of organic or statute law. An exemption from the common burden cannot be
permitted to exist upon vague implications.[6]
Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax exemptions are
strictly construed, then deductions must also be strictly construed.
We then proceed to resolve the singular issue in the case at bar. Was the media advertising expense for
Tang paid or incurred by respondent corporation for the fiscal year ending February 28, 1985 necessary and
ordinary, hence, fully deductible under the NIRC? Or was it a capital expenditure, paid in order to create
goodwill and reputation for respondent corporation and/or its products, which should have been amortized over
a reasonable period?
Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:
(A) Expenses.(1) Ordinary and necessary trade, business or professional expenses.(a) In general.- There shall be allowed as deduction from gross income all ordinary and necessary
expenses paid or incurred during the taxable year in carrying on, or which are directly
attributable to, the development, management, operation and/or conduct of the trade,
business or exercise of a profession.
Simply put, to be deductible from gross income, the subject advertising expense must comply with the
following requisites: (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.[7]
The parties are in agreement that the subject advertising expense was paid or incurred within the
corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was necessary.
However, their views conflict as to whether or not it was ordinary. To be deductible, an advertising expense
should not only be necessary but also ordinary. These two requirements must be met.
The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it
failed the two conditions set by U.S. jurisprudence: first, reasonableness of the amount incurred and second, the
amount incurred must not be a capital outlay to create goodwill for the product and/or private respondents
business. Otherwise, the expense must be considered a capital expenditure to be spread out over a reasonable
time.
We agree.
There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising
expense. There being no hard and fast rule on the matter, the right to a deduction depends on a number of
factors such as but not limited to: the type and size of business in which the taxpayer is engaged; the volume and
amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the general
economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a
proper evaluation.
In the case at bar, the P9,461,246 claimed as media advertising expense for Tang alone was almost one-half
of its total claim for marketing expenses. Aside from that, respondent-corporation also claimed P2,678,328 as
other advertising and promotions expense and another P1,548,614, for consumer promotion.

Furthermore, the subject P9,461,246 media advertising expense for Tang was almost double the amount of
respondent corporations P4,640,636 general and administrative expenses.
We find the subject expense for the advertisement of a single product to be inordinately large. Therefore,
even if it is necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A)
of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of
services and (2) advertising designed to stimulate the future sale of merchandise or use of services. The second
type involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the
taxpayers trade or business or for the industry or profession of which the taxpayer is a member. If the expenditures
are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is
no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for
advertising of the second kind, then normally they should be spread out over a reasonable period of time.
We agree with the Court of Tax Appeals that the subject advertising expense was of the second kind. Not
only was the amount staggering; the respondent corporation itself also admitted, in its letter protest [8] to the
Commissioner of Internal Revenues assessment, that the subject media expense was incurred in order to protect
respondent corporations brand franchise, a critical point during the period under review.
The protection of brand franchise is analogous to the maintenance of goodwill or title to ones property. This is
a capital expenditure which should be spread out over a reasonable period of time.[9]
Respondent corporations venture to protect its brand franchise was tantamount to efforts to establish a
reputation. This was akin to the acquisition of capital assets and therefore expenses related thereto were not to
be considered as business expenses but as capital expenditures.[10]
True, it is the taxpayers prerogative to determine the amount of advertising expenses it will incur and where
to apply them.[11] Said prerogative, however, is subject to certain considerations. The first relates to the extent to
which the expenditures are actually capital outlays; this necessitates an inquiry into the nature or purpose of such
expenditures.[12] The second, which must be applied in harmony with the first, relates to whether the expenditures
are ordinary and necessary. Concomitantly, for an expense to be considered ordinary, it must be reasonable in
amount. The Court of Tax Appeals ruled that respondent corporation failed to meet the two foregoing limitations.
We find said ruling to be well founded. Respondent corporation incurred the subject advertising expense in
order to protect its brand franchise. We consider this as a capital outlay since it created goodwill for its business
and/or product. The P9,461,246 media advertising expense for the promotion of a single product, almost one-half
of petitioner corporations entire claim for marketing expenses for that year under review, inclusive of other
advertising and promotion expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly
unreasonable.
It has been a long standing policy and practice of the Court to respect the conclusions of quasi-judicial
agencies such as the Court of Tax Appeals, a highly specialized body specifically created for the purpose of
reviewing tax cases. The CTA, by the nature of its functions, is dedicated exclusively to the study and
consideration of tax problems. It has necessarily developed an expertise on the subject. We extend due
consideration to its opinion unless there is an abuse or improvident exercise of authority. [13] Since there is none in
the case at bar, the Court adheres to the findings of the CTA.
Accordingly, we find that the Court of Appeals committed reversible error when it declared the subject
media advertising expense to be deductible as an ordinary and necessary expense on the ground that it has not
been established that the item being claimed as deduction is excessive. It is not incumbent upon the taxing
authority to prove that the amount of items being claimed is unreasonable. The burden of proof to establish the
validity of claimed deductions is on the taxpayer.[14] In the present case, that burden was not discharged
satisfactorily.
WHEREFORE, premises considered, the instant petition is GRANTED. The assailed decision of the Court of
Appeals is hereby REVERSED and SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code, respondent
General Foods (Phils.), Inc. is hereby ordered to pay its deficiency income tax in the amount of P2,635,141.42, plus
25% surcharge for late payment and 20% annual interest computed from August 25, 1989, the date of the denial
of its protest, until the same is fully paid.
SO ORDERED.

THE
COMMISSIONER
vs.
CONSUELO L. VDA. DE PRIETO, respondent.

OF

INTERNAL

REVENUE, petitioner,

Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and Special Atty. B. Gatdula, Jr. for petitioner.
Formilleza and Latorre for respondent.
GUTIERREZ DAVID, J.:
This is an appeal from a decision of the Court of tax Appeals reversing the decision of the Commissioner of
Internal Revenue which held herein respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of
P21,410.38 as deficiency income tax, plus penalties and monthly interest.
The case was submitted for decision in the court below upon a stipulation of facts, which for brevity is
summarized as follows: On December 4, 1945, the respondent conveyed by way of gifts to her four children,
namely, Antonio, Benito, Carmen and Mauro, all surnamed Prieto, real property with a total assessed value of
P892,497.50. After the filing of the gift tax returns on or about February 1, 1954, the petitioner Commissioner of
Internal Revenue appraised the real property donated for gift tax purposes at P1,231,268.00, and assessed the
total sum of P117,706.50 as donor's gift tax, interest and compromises due thereon. Of the total sum of
P117,706.50 paid by respondent on April 29, 1954, the sum of P55,978.65 represents the total interest on account
of deliquency. This sum of P55,978.65 was claimed as deduction, among others, by respondent in her 1954
income tax return. Petitioner, however, disallowed the claim and as a consequence of such disallowance
assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid
P55,978.65, including interest up to March 31, 1957, surcharge and compromise for the late payment.
Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should
be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within
the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of
her donor's tax, and the same was paid within the year it is sought to be declared. The only question to be
determined, as stated by the parties, is whether or not such interest was paid upon an indebtedness within the
contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of which reads:
SEC. 30 Deductions from gross income. In computing net income there shall be allowed as deductions

xxx

xxx

xxx

(b) Interest:
(1) In general. The amount of interest paid within the taxable year on indebtedness, except on
indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt
from taxation as income under this Title.
The term "indebtedness" as used in the Tax Code of the United States containing similar provisions as in the
above-quoted section has been defined as an unconditional and legally enforceable obligation for the
payment of money.1awphl.nt (Federal Taxes Vol. 2, p. 13,019, Prentice-Hall, Inc.; Merten's Law of Federal
Income Taxation, Vol. 4, p. 542.) Within the meaning of that definition, it is apparent that a tax may be
considered an indebtedness. As stated by this Court in the case of Santiago Sambrano vs. Court of Tax Appeals
and Collector of Internal Revenue (101 Phil., 1; 53 Off. Gaz., 4839)
Although taxes already due have not, strictly speaking, the same concept as debts, they are, however,
obligations that may be considered as such.
The term "debt" is properly used in a comprehensive sense as embracing not merely money due by
contract but whatever one is bound to render to another, either for contract, or the requirement of the
law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584)

Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt.
(Idem).
A tax is a debt for which a creditor's bill may be brought in a proper case. (State vs. Georgia Co., 19 LRA
485).
It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her
gross income under section 30(b) of the Tax Code above quoted.
The above conclusion finds support in the established jurisprudence in the United States after whose laws our
Income Tax Law has been patterned. Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as
amended1 , which contains similarly worded provisions as sec. 30(b) of our Tax Code, the uniform ruling is that
interest on taxes is interest on indebtedness and is deductible. (U.S. vs. Jaffray, 306 U.S. 276. See also Lustig vs. U.S.,
138 F. Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34 AFTR 151; Penrose vs. U.S. 18 F.
Supp. 413, 18 AFTR 1289; Max Thomas Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax
Appeals Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States Reports, p. 255;
Armour vs.Commissioner of Internal Revenue, 6 Tax Court of the United States Reports, p. 359; The Koppers Coal
Co. vs.Commissioner of Internal Revenue, 7 Tax Court of United States Reports, p. 1209; Toy vs. Commissioner of
Internal Revenue; Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and Howard Fire Brick
Co. vs. Commissioner of Internal Revenue, 3 Tax Court of United States Reports, p. 62). The rule applies even
though the tax is nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec. 163, 13,022; see also Merten's Law of
Federal Income Taxation, Vol. 5, pp. 23-24.)
To sustain the proposition that the interest payment in question is not deductible for the purpose of computing
respondent's net income, petitioner relies heavily on section 80 of Revenue Regulation No. 2 (known as Income
Tax Regulation) promulgated by the Department of Finance, which provides that "the word `taxes' means taxes
proper and no deductions should be allowed for amounts representing interest, surcharge, or penalties incident
to delinquency." The court below, however, held section 80 as inapplicable to the instant case because while it
implements sections 30(c) of the Tax Code governing deduction of taxes, the respondent taxpayer seeks to
come under section 30(b) of the same Code providing for deduction of interest on indebtedness. We find the
lower court's ruling to be correct. Contrary to petitioner's belief, the portion of section 80 of Revenue Regulation
No. 2 under consideration has been part and parcel of the development to the law on deduction of taxes in the
United States. (See Capital Bldg. and Loan Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says:
"Penalties are to be distinguished from taxes and they are not deductible under the heading of taxs." . . . Interest
on state taxes is not deductible as taxes." (Vol. 5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing
cases.) This notwithstanding, courts in that jurisdiction, however, have invariably held that interest on deficiency
taxes are deductible, not as taxes, but as interest. (U.S. vs. Jaffray, et al., supra; see also Mertens, sec. 26.09, Vol.
4, p. 552, and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore, merely incorporated the
established application of the tax deduction statute in the United States, where deduction of "taxes" has always
been limited to taxes proper and has never included interest on delinquent taxes, penalties and surcharges.
To give to the quoted portion of section 80 of our Income Tax Regulations the meaning that the petitioner gives it
would run counter to the provision of section 30(b) of the Tax Code and the construction given to it by courts in
the United States. Such effect would thus make the regulation invalid for a "regulation which operates to create a
rule out of harmony with the statute, is a mere nullity." (Lynch vs. Tilden Produce Co., 265 U.S. 315; Miller vs.U.S., 294
U.S. 435.) As already stated, section 80 implements only section 30(c) of the Tax Code, or the provision allowing
deduction of taxes, while herein respondent seeks to be allowed deduction under section 30(b), which provides
for deduction of interest on indebtedness.
In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not
deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, the
taxpayer is not precluded thereby from claiming said interest payment as deduction under section 30(b) of the
same Code.
In view of the foregoing, the decision sought to be reviewed is affirmed, without pronouncement as to costs.
COMMISSIONER
OF
vs.
V.E. LEDNICKY and MARIA VALERO LEDNICKY, respondents.

INTERNAL

REVENUES, petitioner,

Office
of
the
Ozaeta, Gibbs and Ozaeta for respondents.

Solicitor

General

for

petitioner.

REYES, J.B.L., J.:

The above-captioned cases were elevated to this Court under separate petitions by the Commissioner for review
of the corresponding decisions of the Court of Tax Appeals. Since these cases involve the same parties and issues
akin to each case presented, they are herein decided jointly.
The respondents, V. E. Lednicky and Maria Valero Lednicky, are husband and wife, respectively, both American
citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years
in question.
In compliance with local law, the aforesaid respondents, on 27 March 1957, filed their income tax return for 1956,
reporting therein a gross income of P1,017,287. 65 and a net income of P733,809.44 on which the amount of
P317,395.4 was assessed after deducting P4,805.59 as withholding tax. Pursuant to the petitioner's assessment
notice, the respondents paid the total amount of P326,247.41, inclusive of the withheld taxes, on 15 April 1957.
On 17 March 1959, the respondents Lednickys filed an amended income tax return for 1956. The amendment
consists in a claimed deduction of P205,939.24 paid in 1956 to the United States government as federal income
tax for 1956. Simultaneously with the filing of the amended return, the respondents requested the refund of
P112,437.90.
When the petitioner Commissioner of Internal Revenue failed to answer the claim for refund, the respondents
filed their petition with the Tax Court on 11 April 1959 as CTA Case No. 646, which is now G. R. No. L-18286 in the
Supreme Court.
G. R. No. L-18169 (formerly CTA Case No. 570) is also a claim for refund in the amount of P150,269.00, as alleged
overpaid income tax for 1955, the facts of which are as follows:
On 28 February 1956, the same respondents-spouses filed their domestic income tax return for 1955, reporting a
gross income of P1,771,124.63 and a net income of P1,052,550.67. On 19 April 1956, they filed an amended
income tax return, the amendment upon the original being a lesser net income of P1,012,554.51, and, on the
basis of this amended return, they paid P570,252.00, inclusive of withholding taxes. After audit, the petitioner
determined a deficiency of P16,116.00, which amount, the respondents paid on 5 December 1956.
Back in 1955, however, the Lednickys filed with the U.S. Internal Revenue Agent in Manila their federal income tax
return for the years 1947, 1951, 1952, 1953, and 1954 on income from Philippine sources on a cash basis. Payment
of these federal income taxes, including penalties and delinquency interest in the amount of P264,588.82, were
made in 1955 to the U.S. Director of Internal Revenue, Baltimore, Maryland, through the National City Bank of
New York, Manila Branch. Exchange and bank charges in remitting payment totaled P4,143.91.
Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this
Honorable Court, without prejudice to the parties adducing other evidence to prove their case not covered by
this stipulation of facts. 1wph1.t
On 11 August 1958, the said respondents amended their Philippine income tax return for 1955 to include the
following deductions:
U.S. Federal income taxes

P471,867.32

Interest accrued up to May 15, 1955 40,333.92

Exchange and bank charges

4,143.91

Total

P516,345.15

and therewith filed a claim for refund of the sum of P166,384.00, which was later reduced to P150,269.00.
The respondents Lednicky brought suit in the Tax Court, which was docketed therein as CTA Case No. 570.
In G. R. No. 21434 (CTA Case No. 783), the facts are similar, but refer to respondents Lednickys' income tax return
for 1957, filed on 28 February 1958, and for which respondents paid a total sum of P196,799.65. In 1959, they filed
an amended return for 1957, claiming deduction of P190,755.80, representing taxes paid to the U.S. Government
on income derived wholly from Philippine sources. On the strength thereof, respondents seek refund of P90 520.75
as overpayment. The Tax Court again decided for respondents.
The common issue in all three cases, and one that is of first impression in this jurisdiction, is whether a citizen of the
United States residing in the Philippines, who derives income wholly from sources within the Republic of the
Philippines, may deduct from his gross income the income taxes he has paid to the United States government for
the taxable year on the strength of section 30 (C-1) of the Philippine Internal Revenue Code, reading as follows:
SEC. 30. Deduction from gross income. In computing net income there shall be allowed as deductions

(a) ...
(b) ...
(c) Taxes:
(1) In general. Taxes paid or accrued within the taxable year, except
(A) The income tax provided for under this Title;
(B) Income, war-profits, and excess profits taxes imposed by the authority of any
foreign country; but this deduction shall be allowed in the case of a taxpayer who
does not signify in his return his desire to have to any extent the benefits of
paragraph (3) of this subsection (relating to credit for foreign countries);
(C) Estate, inheritance and gift taxes; and
(D) Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed. (Emphasis supplied)
The Tax Court held that they may be deducted because of the undenied fact that the respondent
spouses did not "signify" in their income tax return a desire to avail themselves of the benefits of paragraph
3 (B) of the subsection, which reads:
Par. (c) (3) Credits against tax for taxes of foreign countries. If the taxpayer signifies in his return
his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with

(A) ...;
(B) Alien resident of the Philippines. In the case of an alien resident of the Philippines, the
amount of any such taxes paid or accrued during the taxable year to any foreign country,
if the foreign country of which such alien resident is a citizen or subject, in imposing such
taxes, allows a similar credit to citizens of the Philippines residing in such country;
It is well to note that the tax credit so authorized is limited under paragraph 4 (A and B) of the same
subsection, in the following terms:

Par. (c) (4) Limitation on credit. The amount of the credit taken under this section shall be
subject to each of the following limitations:
(A) The amount of the credit in respect to the tax paid or accrued to any country shall not
exceed the same proportion of the tax against which such credit is taken, which the
taxpayer's net income from sources within such country taxable under this Title bears to his
entire net income for the same taxable year; and
(B) The total amount of the credit shall not exceed the same proportion of the tax against
which such credit is taken, which the taxpayer's net income from sources without the
Philippines taxable under this Title bears to his entire net income for the same taxable year.
We agree with appellant Commissioner that the Construction and wording of Section 30 (c) (1) (B)
of the Internal Revenue Act shows the law's intent that the right to deduct income taxes paid to
foreign government from the taxpayer's gross income is given only as an alternative or substitute
to his right to claim a tax credit for such foreign income taxes under section 30 (c) (3) and (4); so
that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded
from deducting the foreign income taxes from his gross income. For it is obvious that in prescribing
that such deduction shall be allowed in the case of a taxpayer who does not signify in his return his
desire to have to any extent the benefits of paragraph (3) (relating to credits for taxes paid to
foreign countries), the statute assumes that the taxpayer in question also may signify his desire to
claim a tax credit and waive the deduction; otherwise, the foreign taxes would always be
deductible, and their mention in the list of non-deductible items in Section 30(c) might as well
have been omitted, or at least expressly limited to taxes on income from sources outside the
Philippine Islands.
Had the law intended that foreign income taxes could be deducted from gross income in any
event,regardless of the taxpayer's right to claim a tax credit, it is the latter right that should be
conditioned upon the taxpayer's waiving the deduction; in which Case the right to reduction
under subsection (c-1-B) would have been made absolute or unconditional (by omitting foreign
taxes from the enumeration of non-deductions), while the right to a tax credit under subsection (c3) would have been expressly conditioned upon the taxpayer's not claiming any deduction under
subsection (c-1). In other words, if the law had been intended to operate as contended by the
respondent taxpayers and by the Court of Tax Appeals section 30 (subsection (c-1) instead of
providing as at present:
SEC. 30. Deduction from gross income. In computing net income there shall be allowed as deductions

(a) ...
(b) ...
(c) Taxes:
(1) In general. Taxes paid or accrued within the taxable year, except
(A) The income tax provided for under this Title;
(B) Income, war-profits, and excess profits taxes imposed by the authority of any
foreign country; but this deduction shall be allowed in the case of a taxpayer who
does not signify in his return his desire to have to any extent the benefits of
paragraph (3) of this subsection (relating to credit for taxes of foreign countries);
(C) Estate, inheritance and gift taxes; and
(D) Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed.

would have merely provided:

SEC. 30. Decision from grow income. In computing net income there shall be allowed as deductions:
(a) ...
(b) ...
(c) Taxes paid or accrued within the taxable year, EXCEPT
(A) The income tax provided for in this Title;
(B) Omitted or else worded as follows:
Income, war profits and excess profits taxes imposed by authority of any foreign country
on income earned within the Philippines if the taxpayer does not claim the benefits under
paragraph 3 of this subsection;
(C) Estate, inheritance or gift taxes;
(D) Taxes assessed against local benefits of a kind tending to increase the value of the property
assessed.
while subsection (c-3) would have been made conditional in the following or equivalent terms:
(3) Credits against tax for taxes of foreign countries. If the taxpayer has not deducted such taxes from
his gross income but signifies in his return his desire to have the benefits of this paragraph, the tax imposed
by Title shall be credited with ... (etc.).
Petitioners admit in their brief that the purpose of the law is to prevent the taxpayer from claiming twice the
benefits of his payment of foreign taxes, by deduction from gross income (subs. c-1) and by tax credit (subs. c-3).
This danger of double credit certainly can not exist if the taxpayer can not claim benefit under either of these
headings at his option, so that he must be entitled to a tax credit (respondent taxpayers admittedly are not so
entitled because all their income is derived from Philippine sources), or the option to deduct from gross income
disappears altogether.
Much stress is laid on the thesis that if the respondent taxpayers are not allowed to deduct the income taxes they
are required to pay to the government of the United States in their return for Philippine income tax, they would be
subjected to double taxation. What respondents fail to observe is that double taxation becomes obnoxious only
where the taxpayer is taxed twice for the benefit of the same governmental entity (cf. Manila vs. Interisland Gas
Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the taxpayers
would have to pay two taxes on the same income, the Philippine government only receives the proceeds of one
tax. As between the Philippines, where the income was earned and where the taxpayer is domiciled, and the
United States, where that income was not earned and where the taxpayer did not reside, it is indisputable that
justice and equity demand that the tax on the income should accrue to the benefit of the Philippines. Any relief
from the alleged double taxation should come from the United States, and not from the Philippines, since the
former's right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production
of the wealth that is being taxed.
Aside from not conforming to the fundamental doctrine of income taxation that the right of a government to tax
income emanates from its partnership in the production of income, by providing the protection, resources,
incentive, and proper climate for such production, the interpretation given by the respondents to the revenue
law provision in question operates, in its application, to place a resident alien with only domestic sources of
income in an equal, if not in a better, position than one who has both domestic and foreign sources of income, a
situation which is manifestly unfair and short of logic.
Finally, to allow an alien resident to deduct from his gross income whatever taxes he pays to his own government
amounts to conferring on the latter the power to reduce the tax income of the Philippine government simply by

increasing the tax rates on the alien resident. Everytime the rate of taxation imposed upon an alien resident is
increased by his own government, his deduction from Philippine taxes would correspondingly increase, and the
proceeds for the Philippines diminished, thereby subordinating our own taxes to those levied by a foreign
government. Such a result is incompatible with the status of the Philippines as an independent and sovereign
state.
IN VIEW OF THE FOREGOING, the decisions of the Court of Tax Appeals are reversed, and, the disallowance of the
refunds claimed by the respondents Lednicky is affirmed, with costs against said respondents-appellees.
Hermanos vs. CIR
These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax
liability for the years 1950 to 1954 and for the year 1957. Both the taxpayer and the Commissioner of Internal
Revenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax Court's decisions,
insofar as their respective contentions on particular tax items were therein resolved against them. Since the issues
raised are interrelated, the Court resolves the four appeals in this joint decision.
Cases L-21551 and L-21557
The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of
engaging in business as an "investment company" with main office at Manila. Upon verification of the taxpayer's
income tax returns for the period in question, the Commissioner of Internal Revenue assessed against the
taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and P14,451.00 as alleged deficiency income
taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said assessments were the result of alleged
discrepancies found upon the examination and verification of the taxpayer's income tax returns for the said
years, summarized by the Tax Court in its decision of June 10, 1963 in CTA Case No. 787, as follows:
1. Losses
a. Losses in Mati Lumber Co. (1950)

P 8,050.00

b. Losses in or bad debts of Palawan Manganese Mines, Inc. (1951)

c. Losses in Balamban Coal Mines
1950

8,989.76

1951

27,732.66

d. Losses in Hacienda Dalupiri

1950

17,418.95

1951

29,125.82

1952

26,744.81

1953

21,932.62

1954

42,938.56

e. Losses in Hacienda Samal

1951

8,380.25

1952

7,621.73

2. Excessive depreciation of Houses

1950

P 8,180.40

353,134.25

1951

8,768.11

1952

18,002.16

1953

13,655.25

1954

29,314.98

3. Taxable increase in net worth

1950

P 30,050.00

1951

1,382.85

4. Gain realized from sale of real property in 1950

P 11,147.2611

The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2 of
the above summary, but overruled the Commissioner's disallowances of all the remaining items. It
therefore modified the deficiency assessments accordingly, found the total deficiency income taxes due
from the taxpayer for the years under review to amount to P123,436.00 instead of P166,063.00 as originally
assessed by the Commissioner, and rendered the following judgment:
RESUME
1950

P2,748.00

1951

108,724.00

1952

3,600.00

1953

2,501.00

1954

5,863.00

Total

P123,436.00

WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the sum of
P123,436.00 within 30 days from the date this decision becomes final. If the said amount, or any part
thereof, is not paid within said period, there shall be added to the unpaid amount as surcharge of 5%,
plus interest as provided in Section 51 of the National Internal Revenue Code, as amended. With costs
against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)
Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two
main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to the disputed
items of disallowances enumerated in the Tax Court's summary reproduced above, and second, whether or not
the government's right to collect the deficiency income taxes in question has already prescribed.
On the first issue, we will discuss the disputed items of disallowances seriatim.
1. Re allowances/disallowances of losses.
(a) Allowance of losses in Mati Lumber Co. (1950). The Commissioner of Internal Revenue questions the Tax
Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of P8,050.00
representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1, 1948, on the
ground that the worthlessness of said stock in the year 1950 had not been clearly established. The Commissioner
contends that although the said Company was no longer in operation in 1950, it still had its sawmill and
equipment which must be of considerable value. The Court, however, found that "the company ceased
operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where he subsequently
died. When the company eased to operate, it had no assets, in other words, completely insolvent. This
information as to the insolvency of the Company reached (the taxpayer) in 1950," when it properly claimed
the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of the National
Internal Revenue Code. 2

We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the stock
as worthless securities. Assuming that the Company would later somehow realize some proceeds from its sawmill
and equipment, which were still existing as claimed by the Commissioner, and that such proceeds would later be
distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer would then properly
be reportable as income of the taxpayer in the year it is received.
(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). The taxpayer appeals
from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which it
had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings on this item follow:
Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the
controlling stockholders of petitioner corporation, requested financial help from petitioner to enable it to
resume it mining operations in Coron, Palawan. The request for financial assistance was readily and
unanimously approved by the Board of Directors of petitioner, and thereafter a memorandum
agreement was executed on August 12, 1945, embodying the terms and conditions under which the
financial assistance was to be extended, the pertinent provisions of which are as follows:
"WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has agreed to
extend to the SECOND PARTY the requested financial help by way of accommodation advances
and for this purpose has authorized its President, Mr. Ramon J. Fernandez to cause the release of
funds to the SECOND PARTY.
"WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to extend to the
SECOND PARTY, the latter has agreed to pay to the former fifteen per centum (15%) of its net
profits.
"NOW THEREFORE, for and in consideration of the above premises, the parties hereto have agreed
and covenanted that in consideration of the financial help to be extended by the FIRST PARTY to
the SECOND PARTY to enable the latter to resume its mining operations in Coron, Palawan, the
SECOND PARTY has agreed and undertaken as it hereby agrees and undertakes to pay to the
FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)
Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly
advances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these
advances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By
1951, petitioner became convinced that those advances could no longer be recovered. While it continued to
give advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the
basis of the total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum of
P85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136-139, Id)." (Page 4,
Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950 and 1951 in the hope
that it might be able to recover the same, as in fact it continued to give advances up to 1952. From these facts,
and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advances
corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, was
the sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as
losses or bad debts?
It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid.
It is true that some testimonial evidence was presented to show that there was some agreement that the
advances would be repaid, but no documentary evidence was presented to this effect. The memorandum
agreement signed by the parties appears to be very clear that the consideration for the advances made by
petitioner was 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings
or profits, there was no obligation to repay those advances. It has been held that the voluntary advances made
without expectation of repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329, citing W. F.
Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC. 1593.
Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan
Manganese Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under the
memorandum agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner 15%
of its net profits, not the advances. No bad debt could arise where there is no valid and subsisting debt.

Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of
paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said
year, yet the debt is not deductible in 1951 as a worthless debt. It appears that the debtor was still in operation in
1951 and 1952, as petitioner continued to give advances in those years. It has been held that if the debtor
corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is not
considered worthless and therefore not deductible. 3
The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the
taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount
involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt." 4 We sustain the
government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese
Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record shows
that the board of directors of the two companies since August, 1945, were identical and that the only capital of
Palawan Manganese Mines, Inc. is the amount of P100,000.00 entered in the taxpayer's balance sheet as its
investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer made such large
advances to the subsidiary, despite the latter's admittedly poor financial condition.
The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that
under their memorandum agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no
earnings, there was no obligation to repay those advances, becomes immaterial, in the light of our resolution of
the question. The Tax Court correctly held that the subsidiary company was still in operation in 1951 and 1952 and
the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or investment could
not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. Furthermore, neither
under Section 30 (d) (2) of our Tax Code providing for deduction by corporations of losses actually sustained and
charged off during the taxable year nor under Section 30 (e) (1) thereof providing for deduction of bad debts
actually ascertained to be worthless and charged off within the taxable year, can there be a partial writing off of
a loss or bad debt, as was sought to be done here by the taxpayer. For such losses or bad debts must be
ascertained to be so and written off during the taxable year, are therefore deductible in full or not at all, in the
absence of any express provision in the Tax Code authorizing partial deductions.
The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the year
1951, as the subsidiary was still in operation in 1951 and 1952. The taxpayer, on the other hand, claims that its
advances were irretrievably lost because of the staggering losses suffered by its subsidiary in 1951 and that its
advances after 1949 were "only limited to the purpose of salvaging whatever ore was already available, and for
the purpose of paying the wages of the laborers who needed help." 7 The correctness of the Tax Court's ruling in
sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent
events shown in Cases L-24972 and L-24978 involving the taxpayer's 1957 income tax liability. (Infra, paragraph 6.)
It will there be seen that by 1956, the obligation of the taxpayer's subsidiary to it had been reduced from
P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January 1, 1956 that the subsidiary decided to
cease operations. 8
(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). The Court sustains the Tax Court's
disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban
coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns for said years.
The Tax Court correctly held that the losses "are deductible in 1952, when the mines were abandoned, and not in
1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions should be allowed
as losses for the corresponding years that they were incurred, because it made no sales of coal during said years,
since the promised road or outlet through which the coal could be transported from the mines to the provincial
road was not constructed, cannot be sustained. Some definite event must fix the time when the loss is sustained,
and here it was the event of actual abandonment of the mines in 1952. The Tax Court held that the losses,
totalling P36,722.42 were properly deductible in 1952, but the appealed judgment does not show that the
taxpayer was credited therefor in the determination of its tax liability for said year. This additional deduction of
P36,722.42 from the taxpayer's taxable income in 1952 would result in the elimination of the deficiency tax liability
for said year in the sum of P3,600.00 as determined by the Tax Court in the appealed judgment.
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). The Tax
Court overruled the Commissioner's disallowance of these items of losses thus:

Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950,
P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These deductions were
disallowed by respondent on the ground that the farm was operated solely for pleasure or as a hobby
and not for profit. This conclusion is based on the fact that the farm was operated continuously at a
loss.1awphl.nt
From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business
and not pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not
appear that the farm was used by petitioner for entertainment, social activities, or other non-business
purposes. Therefore, it is entitled to deduct expenses and losses in connection with the operation of said
farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, p.164)
Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes
farmers to determine their gross income on the basis of inventories. Said regulations provide:
"If gross income is ascertained by inventories, no deduction can be made for livestock or products
lost during the year, whether purchased for resale, produced on the farm, as such losses will be
reflected in the inventory by reducing the amount of livestock or products on hand at the close of
the year."
Evidently, petitioner determined its income or losses in the operation of said farm on the basis of
inventories. We quote from the memorandum of counsel for petitioner:
"The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive, the
corresponding yearly losses sustained in the operation of Hacienda Dalupiri, which losses represent
the excess of its yearly expenditures over the receipts; that is, the losses represent the difference
between the sales of livestock and the actual cash disbursements or expenses." (Pages 21-22,
Memorandum for Petitioner.)
As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its
operation, which losses were determined by means of inventories authorized under Section 100 of
Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said losses.
The same is true with respect to loss sustained in the operation of the Hacienda Samal for the years 1951
and 1952. 10
The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory
method of accounting. He concedes, however, "that the regulations referred to does not specify how the
inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the taxpayer ...
which merely consisted of an alleged physical count of the number of the livestock in Hacienda Dalupiri for the
years involved." 11 The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding
livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its
findings.
2. Disallowance of excessive depreciation of buildings (1950-1954). During the years 1950 to 1954, the taxpayer
claimed a depreciation allowance for its buildings at the annual rate of 10%. The Commissioner claimed that the
reasonable depreciation rate is only 3% per annum, and, hence, disallowed as excessive the amount claimed as
depreciation allowance in excess of 3% annually. We sustain the Tax Court's finding that the taxpayer did not
submit adequate proof of the correctness of the taxpayer's claim that the depreciable assets or buildings in
question had a useful life only of 10 years so as to justify its 10% depreciation per annum claim, such finding being
supported by the record. The taxpayer's contention that it has many zero or one-peso assets, 12representing very
old and fully depreciated assets serves but to support the Commissioner's position that a 10% annual
depreciation rate was excessive.
3. Taxable increase in net worth (1950-1951). The Tax Court set aside the Commissioner's treatment as taxable
income of certain increases in the taxpayer's net worth. It found that:

For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of
P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated by respondent as
taxable income of petitioner for said years.
It appears that petitioner had an account with the Manila Insurance Company, the records bearing on
which were lost. When its records were reconstituted the amount of P349,800.00 was set up as its liability to
the Manila Insurance Company. It was discovered later that the correct liability was only 319,750.00, or a
difference of P30,050.00, so that the records were adjusted so as to show the correct liability. The
correction or adjustment was made in 1950. Respondent contends that the reduction of petitioner's
liability to Manila Insurance Company resulted in the increase of petitioner's net worth to the extent of
P30,050.00 which is taxable. This is erroneous. The principle underlying the taxability of an increase in the
net worth of a taxpayer rests on the theory that such an increase in net worth, if unreported and not
explained by the taxpayer, comes from income derived from a taxable source. (See Perez v. Araneta,
G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, Nov. 25, 1958.) In this case, the
increase in the net worth of petitioner for 1950 to the extent of P30,050.00 was not the result of the receipt
by it of taxable income. It was merely the outcome of the correction of an error in the entry in its books
relating to its indebtedness to the Manila Insurance Company. The Income Tax Law imposes a tax on
income; it does not tax any or every increase in net worth whether or not derived from income. Surely, the
said sum of P30,050.00 was not income to petitioner, and it was error for respondent to assess a deficiency
income tax on said amount.
The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum of
P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in petitioner's books as outstanding
liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior years, so that
the necessary adjustments were made to correct the errors. If there was an increase in net worth of the
petitioner, the increase in net worth was not the result of receipt by petitioner of taxable income." 13 The
Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings. Certainly, these
increases in the taxpayer's net worth were not taxable increases in net worth, as they were not the result of the
receipt by it of unreported or unexplained taxable income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its indebtednesses to certain creditors, which had been
erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax Court's action must
be affirmed.
4. Gain realized from sale of real property (1950). We likewise sustain as being in accordance with the
evidence the Tax Court's reversal of the Commissioner's assessment on all alleged unreported gain in the sum of
P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As found by the Tax Court, the evidence
shows that this property was acquired in 1926 for P11,852.74, and was sold in 1950 for P60,000.00, apparently,
resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a discrepancy of
P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after acquiring the property, the taxpayer
had made improvements totalling P11,147.26, 16 accounting for the apparent discrepancy in the reported gain.
In other words, this figure added to the original acquisition cost of P11,852.74 results in a total cost of P23,000.00,
and the gain derived from the sale of the property for P60,000.00 was correctly reported by the taxpayer at
P37,000.00.
On the second issue of prescription, the taxpayer's contention that the Commissioner's action to recover its tax
liability should be deemed to have prescribed for failure on the part of the Commissioner to file a complaint for
collection against it in an appropriate civil action, as contradistinguished from the answer filed by the
Commissioner to its petition for review of the questioned assessments in the case a quo has long been rejected
by this Court. This Court has consistently held that "a judicial action for the collection of a tax is begun by the filing
of a complaint with the proper court of first instance, or where the assessment is appealed to the Court of Tax
Appeals, by filing an answer to the taxpayer's petition for review wherein payment of the tax is prayed for." 17 This
is but logical for where the taxpayer avails of the right to appeal the tax assessment to the Court of Tax Appeals,
the said Court is vested with the authority to pronounce judgment as to the taxpayer's liability to the exclusion of
any other court. In the present case, regardless of whether the assessments were made on February 24 and 27,
1956, as claimed by the Commissioner, or on December 27, 1955 as claimed by the taxpayer, the government's
right to collect the taxes due has clearly not prescribed, as the taxpayer's appeal or petition for review was filed
with the Tax Court on May 4, 1960, with the Commissioner filing on May 20, 1960 his Answer with a prayer for
payment of the taxes due, long before the expiration of the five-year period to effect collection by judicial
action counted from the date of assessment.

Cases L-24972 and L-24978

These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its corresponding
income tax return, the Commissioner assessed it for deficiency income tax in the amount of P38,918.76,
computed as follows:
Net income per return

P29,178.70

Add: Unallowable deductions:

(1) Net loss claimed on Ha. Dalupiri

89,547.33

(2) Amortization of Contractual right claimed as

an expense under Mines Operations
48,481.62
Net income per investigation

P167,297.65

Tax due thereon

38,818.00

Less: Amount already assessed

5,836.00

Balance

P32,982.00

Add:
6-20-62

1/2% monthly interest from 6-20-59 to

TOTAL AMOUNT DUE AND COLLECTIBLE

5,936.76
P38,918.76

18

The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its Hacienda
Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62, which allegedly
represented 1/5 of the cost of the "contractual right" over the mines of its subsidiary, Palawan Manganese Mines,
Inc. which the taxpayer had acquired. It found the taxpayer liable for deficiency income tax for the year 1957 in
the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the following judgment:
WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to pay to
respondent the amount of P9,696.00 as deficiency income tax for the year 1957, plus the corresponding
interest provided in Section 51 of the Revenue Code. If the deficiency tax is not paid in full within thirty (30)
days from the date this decision becomes final and executory, petitioner shall pay a surcharge of five per
cent (5%) of the unpaid amount, plus interest at the rate of one per cent (1%) a month, computed from
the date this decision becomes final until paid, provided that the maximum amount that may be
collected as interest shall not exceed the amount corresponding to a period of three (3) years. Without
pronouncement as to costs. 19
Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.
5. Allowance of losses in Hacienda Dalupiri (1957). The Tax Court cited its previous decision overruling the
Commissioner's disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it
was convinced that the hacienda was operated for business and not for pleasure. And in this appeal, the
Commissioner cites his arguments in his appellant's brief in Case No. L-21557. The Tax Court, in setting aside the
Commissioner's principal objections, which were directed to the accounting method used by the taxpayer found
that:
It is true that petitioner followed the cash basis method of reporting income and expenses in the
operation of the Hacienda Dalupiri and used the accrual method with respect to its mine operations. This
method of accounting, otherwise known as the hybrid method, followed by petitioner is not without
justification.
... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code provisions
permit, however, the use of a hybrid method of accounting, combining a cash and accrual
method, under circumstances and requirements to be set out in Regulations to be issued. Also, if a
taxpayer is engaged in more than one trade or business he may use a different method of

accounting for each trade or business. And a taxpayer may report income from a business on
accrual basis and his personal income on the cash basis.' (See Mertens, Law of Federal Income
Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p. 26.) 20
The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and
procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having failed to
show the contrary, we reiterate our ruling [supra, paragraph 1 (d) and (e)] that we find no compelling
reason to disturb its findings.
6. Disallowance of amortization of alleged "contractual rights." The reasons for sustaining this disallowance are
thus given by the Tax Court:
It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of Directors on
January 19, 1956, approved a resolution, the pertinent portions of which read as follows:
"RESOLVED, as it is hereby resolved, that the corporation's current assets composed of ores, fuel,
and oil, materials and supplies, spare parts and canteen supplies appearing in the inventory and
balance sheet of the Corporation as of December 31, 1955, with an aggregate value of
P97,636.98, contractual rights for the operation of various mining claims in Palawan with a value of
P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a total
value of P340,045.02 be, as they are hereby ceded and transferred to Fernandez Hermanos, Inc.,
as partial settlement of the indebtedness of the corporation to said Fernandez Hermanos Inc. in
the amount of P442,895.23." (Exh. E, p. 17, CTA rec.)
On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus:
"WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has decided to
cease operation on January 1, 1956 and in order to satisfy at least a part of its indebtedness to the
Corporation, it has proposed to transfer its current assets in the amount of NINETY SEVEN
THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100 (P97,636.98) as per its balance sheet as of
December 31, 1955, its contractual rights valued at ONE HUNDRED THOUSAND PESOS (P100,000.00)
and its title over various mining claims valued at ONE HUNDRED FORTY TWO THOUSAND FOUR
HUNDRED EIGHT PESOS & 10/100 (P142,408.10) or a total evaluation of THREE HUNDRED FORTY
THOUSAND FORTY FIVE PESOS & 08/100 (P340,045.08) which shall be applied in partial settlement of
its obligation to the Corporation in the amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT
HUNDRED EIGHTY FIVE PESOS & 23/100 (P442,885.23)," (Exh. E-1, p. 18, CTA rec.)
Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual rights
(P100,000.00) and the value of its mining claims (P142,408.10). Respondent disallowed the deduction on
the following grounds: (1) that the Palawan Manganese Mines, Inc. could not transfer P242,408.10 worth
of assets to petitioner because the balance sheet of the said corporation for 1955 shows that it had only
current as worth P97,636.96; and (2) that the alleged amortization of "contractual rights" is not allowed by
the Revenue Code.
The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act No.
2698, which provided in part:
"(g) Depletion of oil and gas wells and mines.:
"(1) In general. ... (B) in the case of mines, a reasonable allowance for depletion thereof not to
exceed the market value in the mine of the product thereof, which has been mined and sold
during the year for which the return and computation are made. The allowances shall be made
under rules and regulations to be prescribed by the Secretary of Finance: Provided, That when the
allowances shall equal the capital invested, ... no further allowance shall be made."
Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which it
actually transferred to the petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said amount

from its gross income for the year 1957 because such deduction in the form of depletion charge was not
sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.
xxx

xxx

xxx

The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the memorandum of
its mining engineer (Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves of the Busuange Mines
(Mines transferred by the Palawan Manganese Mines, Inc. to the petitioner) would be exhausted in five
(5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of the alleged cost of the mines corresponding
to the year 1957 and every year thereafter for a period of 5 years. The said memorandum merely showed
the estimated ore reserves of the mines and it probable selling price. No evidence whatsoever was
presented to show the produced mine and for how much they were sold during the year for which the
return and computation were made. This is necessary in order to determine the amount of depletion that
can be legally deducted from petitioner's gross income. The method employed by petitioner in making
an outright deduction of 1/5 of the cost of the mines is not authorized under Section 30(g) (1) (B) of the
Revenue Code. Respondent's disallowance of the alleged "contractual rights" amounting to P48,481.62
must therefore be sustained. 21
The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the
Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to mining
claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of this "capital investment" every year.
regardless of whether it had actually mined the product and sold the products. The very authorities cited in its
brief give the correct concept of depletion charges that they "allow for the exhaustion of the capital value of the
deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross income before
the net income can be determined, so the estimated cost of the reserve used up is allowed." 22 The alleged
"capital investment" method invoked by the taxpayer is not a method of depletion, but the Tax Code provision,
prior to its amendment by Section 1, of Republic Act No. 2698, which took effect on June 18, 1960, expressly
provided that "when the allowances shall equal the capital invested ... no further allowances shall be made;" in
other words, the "capital investment" was but the limitation of the amount of depletion that could be claimed.
The outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it were a "straight line" rate of
depreciation, was correctly held by the Tax Court not to be authorized by the Tax Code.
ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551 and L21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer for the
year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The judgment of the Court of Tax
Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in toto. No costs. So ordered.
BASILAN
ESTATES,
vs.
THE COMMISSIONER OF INTERNAL REVENUE and THE COURT OF TAX APPEALS, respondents.
Felix
A.
Gulfin
and
Office of the Solicitor General for respondents.

Antonio

S.

Alano

INC., petitioner,

for

petitioner.

BENGZON, J.P., J.:

A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc., with principal offices in Basilan
City, filed on March 24, 1954 its income tax returns for 1953 and paid an income tax of P8,028. On February 26,
1959, the Commissioner of Internal Revenue, per examiners' report of February 19, 1959, assessed Basilan Estates,
Inc., a deficiency income tax of P3,912 for 1953 and P86,876.85 as 25% surtax on unreasonably accumulated
profits as of 1953 pursuant to Section 25 of the Tax Code. On non-payment of the assessed amount, a warrant of
distraint and levy was issued but the same was not executed because Basilan Estates, Inc. succeeded in getting
the Deputy Commissioner of Internal Revenue to order the Director of the district in Zamboanga City to hold
execution and maintain constructive embargo instead. Because of its refusal to waive the period of prescription,
the corporation's request for reinvestigation was not given due course, and on December 2, 1960, notice was
served the corporation that the warrant of distraint and levy would be executed.

On December 20, 1960, Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for review of the
Commissioner's assessment, alleging prescription of the period for assessment and collection; error in disallowing
claimed depreciations, travelling and miscellaneous expenses; and error in finding the existence of unreasonably
accumulated profits and the imposition of 25% surtax thereon. On October 31, 1963, the Court of Tax Appeals
found that there was no prescription and affirmed the deficiency assessment in toto.
On February 21, 1964, the case was appealed to Us by the taxpayer, upon the following issues:
1. Has the Commissioner's right to collect deficiency income tax prescribed?
2. Was the disallowance of items claimed as deductible proper?
3. Have there been unreasonably accumulated profits? If so, should the 25% surtax be imposed on the balance
of the entire surplus from 1947-1953, or only for 1953?
4. Is the petitioner exempt from the penalty tax under Republic Act 1823 amending Section 25 of the Tax Code?
PRESCRIPTION
There is no dispute that the assessment of the deficiency tax was made on February 26, 1959; but the petitioner
claims that it never received notice of such assessment or if it did, it received the notice beyond the five-year
prescriptive period. To show prescription, the annotation on the notice (Exhibit 10, No. 52, ACR, p. 54-A of the BIR
records) "No accompanying letter 11/25/" is advanced as indicative of the fact that receipt of the notice was
after March 24, 1959, the last date of the five-year period within which to assess deficiency tax, since the original
returns were filed on March 24, 1954.
Although the evidence is not clear on this point, We cannot accept this interpretation of the petitioner,
considering the presence of circumstances that lead Us to presume regularity in the performance of official
functions. The notice of assessment shows the assessment to have been made on February 26, 1959, well within
the five-year period. On the right side of the notice is also stamped "Feb. 26, 1959" denoting the date of
release, according to Bureau of Internal Revenue practice. The Commissioner himself in his letter (Exh. H, p. 84 of
BIR records) answering petitioner's request to lift, the warrant of distraint and levy, asserts that notice had been
sent to petitioner. In the letter of the Regional Director forwarding the case to the Chief of the Investigation
Division which the latter received on March 10, 1959 (p. 71 of the BIR records), notice of assessment was said to
have been sent to petitioner. Subsequently, the Chief of the Investigation Division indorsed on March 18, 1959 (p.
24 of the BIR records) the case to the Chief of the Law Division. There it was alleged that notice was already sent
to petitioner on February 26, 1959. These circumstances pointing to official performance of duty must necessarily
prevail over petitioner's contrary interpretation. Besides, even granting that notice had been received by the
petitioner late, as alleged, under Section 331 of the Tax Code requiring five years within which to assessdeficiency
taxes, the assessment is deemed made when notice to this effect is released, mailed or sent by the Collector to
the taxpayer and it is not required that the notice be received by the taxpayer within the aforementioned fiveyear period.1
ASSESSMENT
The questioned assessment is as follows:
Net Income per return

P40,142.90

Add: Over-claimed depreciation

P10,500.49

Mis. expenses disallowed

6,759.17

Officer's
travelling
disallowed

2,300.40

expenses

19,560.06

Net Income per Investigation

P59,702.96

20% tax on P59,702.96

11,940.00

Less: Tax already assessed

8,028.00

Deficiency income tax

P3,912.00

Add: Additional tax of 25% on P347,507.01

86,876.75

Tax Due & Collectible

P90,788.75
=========

The Commissioner disallowed:

Over-claimed depreciation

P10,500.49

Miscellaneous expenses

6,759.17

Officer's travelling expenses

2,300.40

DEDUCTIONS
A. Depreciation. Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 on the
basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of said assets by increasing
it to conform with the increase in cost for their replacement. Accordingly, from 1950 to 1953 it deducted from
gross income the value of depreciation computed on the reappraised value.
In 1953, the year involved in this case, taxpayer claimed the following depreciation deduction:
Reappraised assets

P47,342.53

New assets consisting of hospital building and

equipment
3,910.45
Total depreciation
P51,252.98
Upon investigation and examination of taxpayer's books and papers, the Commissioner of Internal Revenue
found that the reappraised assets depreciated in 1953 were the same ones upon which depreciation was
claimed in 1952. And for the year 1952, the Commissioner had already determined, with taxpayer's concurrence,
the depreciation allowable on said assets to be P36,842.04, computed on their acquisition cost at rates fixed by
the taxpayer. Hence, the Commissioner pegged the deductible depreciation for 1953 on the same old assets at
P36,842.04 and disallowed the excess thereof in the amount of P10,500.49.
The question for resolution therefore is whether depreciation shall be determined on the acquisition cost or on the
reappraised value of the assets.
Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and
normal obsolescense. The term is also applied to amortization of the value of intangible assets, the use of which in
the trade or business is definitely limited in duration.2 Depreciation commences with the acquisition of the
property and its owner is not bound to see his property gradually waste, without making provision out of earnings
for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so
that at the end of any given term of years, the original investment remains as it was in the beginning. It is not only
the right of a company to make such a provision, but it is its duty to its bond and stockholders, and, in the case of
a public service corporation, at least, its plain duty to the public. 3 Accordingly, the law permits the taxpayer to
recover gradually his capital investment in wasting assets free from income tax. 4 Precisely, Section 30 (f) (1) which
states:
(1)In general. A reasonable allowance for deterioration of property arising out of its use or employment
in the business or trade, or out of its not being used: Provided, That when the allowance authorized under
this subsection shall equal the capital invested by the taxpayer . . . no further allowance shall be made. . .
.

allows a deduction from gross income for depreciation but limits the recovery to the capital invested in the asset
being depreciated.
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a
deduction over and above such cost cannot be claimed and allowed. The reason is that deductions from gross
income are privileges,5 not matters of right.6 They are not created by implication but upon clear expression in the
law.7
Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will
transgress the underlying purpose of a depreciation allowance. For then what the taxpayer would recover will
be, not only the acquisition cost, but also some profit. Recovery in due time thru depreciation of investment
made is the philosophy behind depreciation allowance; the idea of profit on the investment made has never
been the underlying reason for the allowance of a deduction for depreciation.
Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has no justification in
the law. The determination, therefore, of the Commissioner of Internal Revenue disallowing said amount, affirmed
by the Court of Tax Appeals, is sustained.
B. Expenses. The next item involves disallowed expenses incurred in 1953, broken as follows:
Miscellaneous expenses

P6,759.17

Officer's travelling expenses

2,300.40

Total

P9,059.57

These were disallowed on the ground that the nature of these expenses could not be satisfactorily explained nor
could the same be supported by appropriate papers.
Felix Gulfin, petitioner's accountant, explained the P6,759.17 was actual expenses credited to the account of the
president of the corporation incurred in the interest of the corporation during the president's trip to Manila (pp.
33-34 of TSN of Dec. 5, 1962); he stated that the P2,300.40 was the president's travelling expenses to and from
Manila as to the vouchers and receipts of these, he said the same were made but got burned during the Basilan
fire on March 30, 1962 (p. 40 of same TSN). Petitioner further argues that when it sent its records to Manila in
February, 1959, the papers in support of these miscellaneous and travelling expenses were not included for the
reason that by February 9, 1959, when the Bureau of Internal Revenue decided to investigate, petitioner had no
more obligation to keep the same since five years had lapsed from the time these expenses were incurred (p. 41
of same TSN). On this ground, the petitioner may be sustained, for under Section 337 of the Tax Code, receipts
and papers supporting such expenses need be kept by the taxpayer for a period of five years from the last entry.
At the time of the investigation, said five years had lapsed. Taxpayer's stand on this issue is therefore sustained.
UNREASONABLY ACCUMULATED PROFITS
Section 25 of the Tax Code which imposes a surtax on profits unreasonably accumulated, provides:
Sec. 25. Additional tax on corporations improperly accumulating profits or surplus (a) Imposition of tax.
If any corporation, except banks, insurance companies, or personal holding companies, whether
domestic or foreign, is formed or availed of for the purpose of preventing the imposition of the tax upon its
shareholders or members or the shareholders or members of another corporation, through the medium of
permitting its gains and profits to accumulate instead of being divided or distributed, there is levied and
assessed against such corporation, for each taxable year, a tax equal to twenty-five per centum of the
undistributed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four, and shall be computed, collected and paid in the same manner and subject to the
same provisions of law, including penalties, as that tax.1awphl.nt
The Commissioner found that in violation of the abovequoted section, petitioner had unreasonably accumulated
profits as of 1953 in the amount of P347,507.01, based on the following circumstances (Examiner's Report pp. 6268 of BIR records):

1. Strong financial position of the petitioner as of December 31, 1953. Assets were P388,617.00 while the
liabilities amounted to only P61,117.31 or a ratio of 6:1.
2. As of 1953, the corporation had considerable capital adequate to meet the reasonable needs of the
business amounting to P327,499.69 (assets less liabilities).
3. The P200,000 reserved for electrification of drier and mechanization and the P50,000 reserved for
malaria control were reverted to its surplus in 1953.
4. Withdrawal by shareholders, of large sums of money as personal loans.
5. Investment of undistributed earnings in assets having no proximate connection with the business as
hospital building and equipment worth P59,794.72.
6. In 1953, with an increase of surplus amounting to P677,232.01, the capital stock was increased to
P500,000 although there was no need for such increase.
Petitioner tried to show that in considering the surplus, the examiner did not take into account the possible
expenses for cultivation, labor, fertilitation, drainage, irrigation, repair, etc. (pp. 235-237 of TSN of Dec. 7, 1962). As
aptly answered by the examiner himself, however, they were already included as part of the working capital (pp.
237-238 of TSN of Dec. 7, 1962).
In the unreasonable accumulation of P347,507.01 are included P200,000 for electrification of driers and
mechanization and P50,000 for malaria control which were reserved way back in 1948 (p. 67 of the BIR records)
but reverted to the general fund only in 1953. If there were any plans for these amounts to be used in further
expansion through projects, it did not appear in the records as was properly indicated in 1948 when such
amounts were reserved. Thus, while in 1948 it was already clear that the money was intended to go to future
projects, in 1953 upon reversion to the general fund, no such intention was shown. Such reversion therefore gave
occasion for the Government to consider the same for tax purposes. The P250,000 reverted to the general fund
was sought to be explained as later used elsewhere: "part of it in the Hilano Industries, Inc. in building the factory
site and buildings to house technical men . . . part of it was spent in the facilities for the waterworks system and for
industrialization of the coconut industry" (p. 117 of TSN of Dec. 6, 1962). This is not sufficient explanation. Persuasive
jurisprudence on the matter such as those in the United States from where our tax law was derived, 8has it that: "In
order to determine whether profits were accumulated for the reasonable needs of the business or to avoid the
surtax upon shareholders, the controlling intention of the taxpayer is that which is manifested at the time of the
accumulation, not subsequently declared intentions which are merely the products of after-thought."9The
reversion here was made because the reserved amount was not enough for the projects intended, without any
intent to channel the same to some particular future projects in mind.
Petitioner argues that since it has P560,717.44 as its expenses for the year 1953, a surplus of P347,507.01 is not
unreasonably accumulated. As rightly contended by the Government, there is no need to have such a large
amount at the beginning of the following year because during the year, current assets are converted into cash
and with the income realized from the business as the year goes, these expenses may well be taken care of (pp.
238 of TSN of Dec. 7, 1962). Thus, it is erroneous to say that the taxpayer is entitled to retain enough liquid net
assets in amounts approximately equal to current operating needs for the year to cover "cost of goods sold and
operating expenses" for "it excludes proper consideration of funds generated by the collection of notes
receivable as trade accounts during the course of the year." 10 In fact, just because the fatal accumulations are
less than 70% of the annual operating expenses of the year, it does not mean that the accumulations are
reasonable as a matter of law."11
Petitioner tried to show that investments were made with Basilan Coconut Producers Cooperative Association
and Basilan Hospital (pp. 103-105 of TSN of Dec. 6, 1962) totalling P59,794.72 as of December 31, 1953. This shows
all the more the unreasonable accumulation. As of December 31, 1953 already P59,794.72 was spent yet as of
that date there was still a surplus of P347,507.01.
Petitioner questions why the examiner covered the period from 1948-1953 when the taxable year on review was
1953. The surplus of P347,507.01 was taken by the examiner from the balance sheet of petitioner for 1953. To
check the figure arrived at, the examiner traced the accumulation process from 1947 until 1953, and petitioner's

figure stood out to be correct. There was no error in the process applied, for previous accumulations should be
considered in determining unreasonable accumulations for the year concerned. "In determining whether
accumulations of earnings or profits in a particular year are within the reasonable needs of a corporation, it is
neccessary to take into account prior accumulations, since accumulations prior to the year involved may have
been sufficient to cover the business needs and additional accumulations during the year involved would not
reasonably be necessary."12
Another factor that stands out to show unreasonable accumulation is the fact that large amounts were
withdrawn by or advanced to the stockholders. For the year 1953 alone these totalled P197,229.26. Yet the surplus
of P347,507.01 was left as of December 31, 1953. We find unacceptable petitioner's explanation that these were
advances made in furtherance of the business purposes of the petitioner. As correctly held by the Court of Tax
Appeals, while certain expenses of the corporation were credited against these amounts, the unspent balance
was retained by the stockholders without refunding them to petitioner at the end of each year. These advances
were in fact indirect loans to the stockholders indicating the unreasonable accumulation of surplus beyond the
needs of the business.
ALLEGED EXEMPTION
Petitioner wishes to avail of the exempting proviso in Sec. 25 of the Internal Revenue Code as amended by R.A.
1823, approved June 22, 1957, whereby accumulated profits or surplus if invested in any dollar-producing or
dollar-earning industry or in the purchase of bonds issued by the Central Bank, may not be subject to the 25%
surtax. We have but to point out that the unreasonable accumulation was in 1953. The exemption was by virtue
of Republic Act 1823 which amended Sec. 25 only on June 22, 1957 more than three years after the period
covered by the assessment.
In resume, Basilan Estates, Inc. is liable for the payment of deficiency income tax and surtax for the year 1953 in
the amount of P88,977.42, computed as follows:
Net Income per return

P40,142.90

Add:
depreciation

10,500.49

Over-claimed

Net income per finding

P50,643.39

20% tax on P50,643.39

P10,128.67

Less:

8,028.00

Tax already assessed

Deficiency income tax

Add:
25%
P347,507.01

surtax

P2,100.67
on

Total tax due and collectible

86,876.75
P88,977.42
===========

WHEREFORE, the judgment appealed from is modified to the extent that petitioner is allowed its deductions for
travelling and miscellaneous expenses, but affirmed insofar as the petitioner is liable for P2,100.67 as deficiency
income tax for 1953 and P86,876.75 as 25% surtax on the unreasonably accumulated profit of P347,507.01. No
costs. So ordered.
Consolidated mines vs. cir
These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases
No. 565 and 578, both entitled "Consolidated Mines, Inc. vs. Commissioner of Internal Revenue," ordering the
Consolidated Mines, Inc., hereinafter referred to as the Company, to pay the Commissioner of Internal Revenue
the amounts of P79,812.93, P51,528.24 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and

1956, respectively, or the total sum of P202,733.99, plus 5% surcharge and 1% monthly interest from the date of
finality of the decision.
The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953
and 1956. In 1957 examiners of the Bureau of Internal Revenue investigated the income tax returns filed by the
Company because on August 10, 1954, its auditor, Felipe Ollada claimed the refund of the sum of P107,472.00
representing alleged overpayments of income taxes for the year 1951. After the investigation the examiners
reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share in the
company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax
purposes the Company had reported income and expenses on the accrual basis; (2) depletion and
depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and miscellaneous
expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956 (1) the Company
had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported
by evidence.
In view of said reports the Commissioner of Internal Revenue sent the Company a letter of demand requiring it to
pay certain deficiency income taxes for the years 1951 to 1954, inclusive, and for the year 1956. Deficiency
income tax assessment notices for said years were also sent to the Company. The Company requested a
reconsideration of the assessment, but the Commissioner refused to reconsider, hence the Company appealed
to the Court of Tax Appeals. The assessments for 1951 to 1954 were contested in CTA Case No. 565, while that for
1956 was contested in CTA Case No. 578. Upon agreement of the parties the two cases were heard and
decided jointly.
On May 6, 1961 the Tax Court rendered judgment ordering the Company to pay the amounts of P107,846.56,
P134,033.01 and P71,392.82 as deficiency income taxes for the years 1953, 1954 and 1956, respectively. The Tax
Court nullified the assessments for the years 1951 and 1952 on the ground that they were issued beyond the fiveyear period prescribed by Section 331 of the National Internal Revenue Code.
However, on August 7, 1961, upon motion of the Company, the Tax Court reconsidered its decision and further
reduced the deficiency income tax liabilities of the Company to P79,812.93, P51,528.24 and P71,382.82 for the
years 1953, 1954 and 1956, respectively. In this amended decision the Tax Court subscribed to the theory of the
Company that Benguet Consolidated Mining Company, hereafter referred to as Benguet, had no right to share
in "Accounts Receivable," hence one-half thereof may not be accrued as an expense of the Company for a
given year.
Both the Company and the Commissioner appealed to this Court. The Company questions the rate of mine
depletion adopted by the Court of Tax Appeals and the disallowance of depreciation charges and certain
miscellaneous
expenses
(G.R.
Nos.
L-18843 & L-18844). The Commissioner, on the other hand, questions what he characterizes as the "hybrid" or
"mixed" method of accounting utilized by the Company, and approved by the Tax Court, in treating the share of
Benguet in the net profits from the operation of the mines in connection with its income tax returns (G.R. Nos. L18853
&
L-18854).
With respect to methods of accounting, the Tax Code states:
Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual
accounting period (fiscal year or calendar year, as the case may be) in accordance with the
method of accounting regularly employed in keeping the books of such taxpayer but if no such
method of accounting has been so employed or if the method employed does not clearly reflect
the income the computation shall be made in accordance with such methods as in the opinion of
the Commissioner of Internal Revenue does clearly reflect the income ...
Sec. 39. Period in which items of gross income included. The amount of all items of gross income
shall be included in the gross income for the taxable year in which received by the taxpayer,
unless, under the methods of accounting permitted under section 38, any such amounts are to be
properly accounted for as of a different period ...

Sec. 40. Period for which deductions and credits taken. The deductions 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, unless in
order to clearly reflect the income the deductions should be taken as of a different period ...
It is said that accounting methods for tax purposes 1 comprise a set of rules for determining when and how to
report income and deductions. The U.S. Internal Revenue Code 2 allows each taxpayer to adopt the accounting
method most suitable to his business, and requires only that taxable income generally be based on the method
of accounting regularly employed in keeping the taxpayer's books, provided that the method clearly reflects
income. 3
The Company used the accrual method of accounting in computing its income. One of its expenses is the
amount-paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company
deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each
calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable."
However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem,
therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator)
on the "cash & carry" basis. The question is whether or not the accounting system used by the Company justifies
such a treatment of this item; and if not, whether said method used by the Company, and characterized by the
Commissioner as a "hybrid method," may be allowed under the aforequoted provisions of our tax code. 4
For a proper understanding of the situation the following facts are stated: The Company has certain mining
claims located in Masinloc, Zambales. Because it wanted to relieve itself of the work and expense necessary for
developing the claims, the Company, on July 9, 1934, entered into an agreement (Exhibit L) with Benguet, a
domestic anonymous partnership engaged in the production and marketing of chromite, whereby the latter
undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims.
The pertinent provisions of their agreement, as amended by the supplemental agreements of September 14,
1939 (Exhibit L-1) and October 2, 1941 (Exhibit L-2), are as follows:
IV. Benguet further agrees to provide such funds from its own resources as are in its judgment
necessary for the exploration and development of said claims and properties, for the purchase
and construction of said concentrator plant and for the installation of the proper transportation
facilities as provided in paragraphs I, II and III hereof until such time as the said properties are on a
profit producing basis and agrees thereafter to expand additional funds from its own resources, if
the income from the said claims is insufficient therefor, in the exploration and development of said
properties or in the enlargement or extension of said concentration and transportation facilities if
in its judgment good mining practice requires such additional expenditures. Such expenditures
from its own resources prior to the time the said properties are put on a profit producing basis shall
be reimbursed as provided in paragraph VIII hereof. Expenditures from its own resources thereafter
shall be charged against the subsequent gross income of the properties as provided in paragraph
X hereof.
VII. As soon as practicable after the close of each month Benguet shall furnish Consolidated with a
statement showing its expenditures made and ore settlements received under this agreement for
the preceding month which statement shall betaken as accepted by Consolidated unless
exception is taken thereto or to any item thereof within ten days in writing in which case the
dispute shall be settled by agreement or by arbitration as provided in paragraph XXII hereof.
VIII. While Benguet is being reimbursed for all its expenditures, advances and disbursements
hereunder as evidenced by said statements of accounts, the net profits resulting from the
operation of the aforesaid claims or properties shall be divided ninety per cent (90%) to Benguet
and ten per cent (10%) to Consolidated. Such division of net profits shall be based on the receipts,
and expenditures during each calendar year, and shall continue until such time as the ninety per
cent (90%) of the net profits pertaining to Benguet hereunder shall equal the amount of such
expenditures, advances and disbursements. The net profits shall be computed as provided in
Paragraph X hereof.

X. After Benguet has been fully reimbursed for its expenditures, advances and disbursements as
aforesaid the net profits from the operation shall be divided between Benguet and Consolidated
share and share alike, it being understood however, that the net profits as the term is used in this
agreement shall be computed by deducting from gross income all operating expenses and all
disbursements of any nature whatsoever as may be made in order to carry out the terms of this
agreement.
XIII. It is understood that Benguet shall receive no compensation for services rendered as manager
or technical consultants in connection with the carrying out of this agreement. It may, however,
charge against the operation actual additional expenses incurred in its Manila Office in
connection with the carrying out of the terms of this agreement including traveling expenses of
consulting staff to the mines. Such expenses, however, shall not exceed the sum of One Thousand
Pesos (P1,000.00) per month. Otherwise, the sole compensation of Benguet shall be its proportion
of the net profits of the operation as herein above set forth.
XIV. All payments due Consolidated by Benguet under the terms of this agreement with respect to
expenditures made and ore settlements received during the preceding calendar month, shall be
payable on or before the twentieth day of each month.
There is no question with respect to the 90%-10% sharing of profits while Benguet was being reimbursed the
expenses disbursed during the period it was trying to put the mines on a profit-producing basis. 5 It appears that
by 1953 Benguet had completely recouped said advances, because they were then dividing the profits share
and share alike. .
As heretofore stated the question is: Under the arrangement between the Company and Benguet, when did
Benguet's
50%
share
in
the
"Accounts
Receivable
accrue? 6
The following table (summary, Exhibit A, of examiner's report of January 28, 1967, Exh. 8) prepared for the
Commissioner graphically illustrates the effect of the inclusion of one-half of "Accounts Receivable" as expense in
the computation of the net income of the Company:
SUMMARY:

1951

1952

1953

1954

Original share
of Benguet

1,313,640.26

3,521,751,94

2,340,624.59

2,622,968.58

Additional
share
Rec'bles

383,829.87

677,504.76

577,394.66

282,724.76

Total share of
Benguet

1,697,470.13

4,199,256.70

2,918,009.25

2,905,693.34

Less: Receipts
due from prior
year operation

269,619.00

383,829.87

677,504.76

577,384.66

Share
Benguet
adjusted
(Acc'rd)

of
as

1,427,851.13

3,815,426.83

2,240,504.49

2,328,308.68

Less:
Participation of
Benguet
already
deducted

1,313,640.26

3,521,751.94

2,340,624.59

2,622,968.58

of

Additional
Expense
(Income)

114,210.87

293,674.89

(100,120.10)

(294,659.90)

In the aforesaid table "Additional share on Rec'bles" is one-half of "Total Rec'bles minus "Total Payables." It
indicates, from the Commissioner's viewpoint, that there were years when the Company had been overstating its
income (1951 and 1952) and there were years when it had been understating its income (1953 and 1954). 7 The
Commissioner is not interested in the taxes for 1951 and 1952 (which had prescribed anyway) when the
Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the
"Accounts Receivable" was less than that of the previous year, and the Company, therefore, appears to have
deducted, as expense, compensation to Benguet bigger (than what the Commissioner claims is due) by one-half
of the difference between the year's "Accounts Receivable" and the previous year's "Accounts Receivable," thus
apparently understating its income to that extent.
According to the agreement between the Company and Benguet the net profits "shall be computed by
deducting from gross income all operating expenses and all expenses of any nature whatsoever." Periodically,
Benguet was to furnish the Company with the statement of accounts for a given month "as soon as practicable
after the close" of that month. The Company had ten days from receipt of the statement to register its objections
thereto. Thereafter, the statement was considered binding on the Company. And all payments due the
Company "with respect to the expenditures made and ore settlements received during the calendar month shall
be payable on or before the twentieth of each month."
The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from
the terms of the agreement? The statement of accounts (par. VIII) and the payment part (XIV) that
Benguet 8must make are both with respect to "expenditures made and ore settlements received." "Expenditures"
are payments of money. 9 This is the meaning intended by the parties, considering the provision that Benguet
agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources"
were to be reimbursed first as provided in par. VIII, and later as provided in par. X. "Settlement" does not
necessarily mean payment or satisfaction, though it may mean that; it frequently means adjustment or
arrangement. 10 The term "settlement" may be used in the sense of "payment," or it may be used in the sense of
"adjustment" or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance
between contending parties," depending upon the circumstances under which, and the connection in which,
use of the term is made. 11 In the term "ore settlements received," the word "settlement" was not used in the
concept of "adjustment," "arrangement" or "ascertainment of a balance between contending parties," since all
these are "made," not "received." "Payment," then, is the more appropriate equivalent of, and interchangeable
with, the term "Settlement." Hence, "ore settlements received" means "ore payments received," which excludes
"Accounts Receivable." Thus, both par. VIII and par. XIV refer to "payment," either received or paid by Benguet.
According to par. X, the 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by
deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be
made in order to carry out the terms of the agreement." The term "gross profit" was not defined. In the accrual
method of accounting "gross income" would include both "cash receipts" and "Accounts Receivable." But the
term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be
defined in such a way as to ascertain the sense in which the parties have used it in contracting. 12 According to
par. VIII 13 the "division of net profits shall be based on the receipts and expenditures." The term "expenditures" we
have already analyzed. As used, receipts" means "money received." 14 The same par. VIII uses the term
"expenditures, advances and disbursements." "Disbursements" means "payment," 15 while the word "advances"
when used in a contract ordinarily means money furnished with an expectation that it shall be returned. 16 It is
thus clear from par. VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing
arrangement) only "cash payments" received and "cash disbursements" made by Benguet were to be
considered. On the presumption that the parties were consistent in the use of the term, the same meaning must
be given to "net profits" as used in par. X, and "gross income," accordingly, must be equated with "cash receipts."
The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual
receipts over disbursements, without considering "Accounts Receivable" and "Accounts Payable" as factors in the
computation. Benguet then did not have a right to share in "Accounts Receivable," and, correspondingly, the
Company did not have the liability to pay Benguet any part of that item. And a deduction cannot be accrued
until an actual liability is incurred, even if payment has not been made. 17

Here we have to distinguish between (1) the method of accounting used by the Company in determining its net
income for tax purposes; and (2) the method of computation agreed upon between the Company and
Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties,
being free to do so, had contracted that in the method of computing compensation the basis were "cash
receipts" and "cash payments." Once determined in accordance with the stipulated bases and procedure, then
the amount due Benguet for each month accrued at the end of that month, whether the Company had made
payment or not (see par. XIV of the agreement). To make the Company deduct as an expense one-half of the
"Accounts Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have under the
contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated
by them. 18
Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing
said one-half as a deduction. The Company was not using a hybrid method of accounting, but was consistent in
its use of the accrual method of accounting. The first issue raised by the Company is with respect to the rate of
mine depletion used by the Court of Tax Appeals. The Tax Code provides that in computing net income there
shall be allowed as deduction, in the case of mines, a reasonable allowance for depletion thereof not to exceed
the market value in the mine of the product thereof which has been mined and sold during the year for which
the return is made [Sec. 30(g) (1) (B)]. 19
The formula 20 for computing the rate of depletion is:
Cost
of
Mine
---------------------- = Rate of Depletion Per Unit Estimated ore Deposit of Product Mined and sold

Property

The Commissioner and the Company do not agree as to the figures corresponding to either factor that affects
the rate of depletion per unit. The figures according to the Commissioner are:
P2,646,878.44
(mine
------------------------=
4,471,892 tons (estimated ore deposit)
while
P4,238,974.57
------------------------4,156,888
ore deposit)

the
(mine
-

cost)

P0.59189
depletion

Company
cost)
=

insists
P1.0197
depletion
tons

(rate

of
ton)

they
(rate
per

are:
of
ton)
(estimated

per

They agree, however, that the "cost of the mine property" consists of (1) mine cost; and (2) expenses of
development before production. As to mine cost, the parties are practically in agreement the Commissioner
says it is P2,515,000 (the Company puts it at P2,500,000). As to expenses of development before production the
Commissioner and the Company widely differ. The Company claims it is P1,738,974.56, while the Commissioner
says it is only P131,878.44. The Company argues that the Commissioner's figure is "a patently insignificant and
inadequate figure when one considers the tens of millions of pesos of revenue and production that petitioner's
chromite mine fields have finally produced."
As an income tax concept, depletion is wholly a creation of the statute 21 "solely a matter of legislative
grace." 22Hence, the taxpayer has the burden of justifying the allowance of any deduction claimed. 23 As in
connection with all other tax controversies, the burden of proof to show that a disallowance of depletion by the
Commissioner is incorrect or that an allowance made is inadequate is upon the taxpayer, and this is true with
respect to the value of the property constituting the basis of the deduction. 24 This burden-of-proof rule has been
frequently applied and a value claimed has been disallowed for lack of evidence. 25
As proof that the amount spent for developing the mines was P1,738,974.56, the Company relies on the testimony
of Eligio S. Garcia and on Exhibits 1, 31 and 38.
Exhibit I is the Company's report to its stockholders for the year 1947. It contains the Company's balance sheet as
of December 31, 1946 (Exhibit I-1). Among the assets listed is "Mines, Improvement & Dev." in the amount of
P4,238,974.57, which, according to the Company, consisted of P2,500,000, purchase price of the mine, and

P1,738,974.56, cost of developing it. The Company also points to the statement therein that "Benguet invested
approximately P2,500,000 to put the property in operation, the greater part of such investment being devoted to
the construction of a 25-kilometer road and the installation of port facilities." This amount of P2,500,000 was only
an estimate. The Company has not explained in detail in what this amount or the lesser amount of P1,738,974.56
consisted. Nor has it explained how that bigger amount became P1,738,974.56 in the balance sheet for
December 31, 1946.
According to the Company the total sum of P4,238,974.57 as "Mines, Improvement & Dev." was taken from its prewar balance sheet of December 31, 1940. As proof of this it cites the sworn certification (Exhibit 38) executed on
October 25, 1946 by R.P. Flood, in his capacity as treasurer of the Company, and attached to other papers of the
Company filed with the Securities and Exchange Commission in compliance with the provisions of Republic Act
No. 62 (An Act to require the presentation of proof of ownership of securities and the reconstruction of corporate
and partnership records, and for other purposes). In said certification there are statements to the effect that "the
Statement of Assets & Liabilities of Consolidated Mines, Incorporated, submitted to the Securities & Exchange
Commission as a requirement for the reconstitution of the records of the said corporation, is as of September 4,
1946;" and that "the figure P4,238,974.57 representing the value of Mines, Improvements and Developments
appearing therein, was taken from the Balance Sheet as of December 31, 1940, which is the only available
source of information of the Corporation regarding the above and consequently the undersigned considers the
stated figure to be only an estimate of the value of those items at the present time. "This figure, the Company
claims, is based on entries made in the ordinary and regular course of its business dating as far back as before
the war. The Company places reliance on Sec. 39, Rule 130, Revised Rules of Court (formerly Sec. 34, Rule 123),
which provides that entries made at, or near the time of the transactions to which they refer, by a person
deceased, outside of the Philippines or unable to testify, who was in a position to know the facts therein stated,
may be received as prima facie evidence, if such person made the entries in his professional capacity or in the
performance of duty and in the ordinary or regular course of business or duty."
Note that Exhibit 38 is not the "entries," covered by the rule. The Company, however, urges, unreasonably, we
think, that it should be afforded the same probative value since it is based on such "entries" meaning the balance
sheet of December 31, 1940, which was not presented in evidence. Even with the presentation of said balance
sheet the Company would still have had to prove (1) that the person who made the entry did so in his
professional capacity or in the performance of a duty; (2) that the entry was made in the ordinary course of
business or duty; (3) that the entry was made at or near the time of the transaction to which it related; (4) that the
one who made it was in a position to know the facts stated in the entry; and (5) that he is dead, outside the
Philippines or unable to testify 26
A balance sheet may not be considered as "entries made in the ordinary course of business," which, according
to Moran:
means that the entries have been made regularly, as is usual, in the management of the trade or
business. It is essential, therefore, that there be regularity in the entries. The entry which is being
introduced in evidence should appear to be part of a group of regular entries. ... The regularity of
the entries maybe proved by the form in which they appear in the corresponding book. 27
A balance sheet, as that word is uniformly used by bookkeepers and businessmen, is a paper which shows "a
summation or general balance of all accounts," but not the particular items going to make up the several
accounts; and it is therefore essentially different from a paper embracing "a full and complete statement of all
the disbursements and receipts, showing from what sources such receipts were derived, and for what and to
whom such disbursements or payments were made, and for what object or purpose the same were made;" but
such matters may find an appropriate place in an itemized account. 28 Neither can it be said that a balance
sheet complies with the third requisite, since the entries therein were not made at or near the time of the
transactions to which they related.
In order to render admissible books of account it must appear that they are books of original entry,
that the entries were made in the ordinary course of business, contemporaneously with the facts
recorded, and by one who had knowledge of the facts. San Francisco Teaming Co v Gray (1909)
11 CA 314, 104 P 999. See Brown v Ball (1932) 123 CA 758, 12 P2d 28, to the effect that the books
must be kept in the regular course of business. 29

A "ledger" is a book of accounts in which are collected and arranged, each under its appropriate
head, the various transactions scattered throughout the journal or daybook, land is not a "book of
original entries," within the rule making such books competent evidence. First Nat. Building Co. v.
Vanderberg, 119 P 224, 227; 29 Okl. 583. 30
Code Iowa, No. 3658, providing that "books of account" are receivable in evidence, etc., means
a book containing charges, and showing a continuous dealing with persons generally. A book, to
be admissible, must be kept as an account book, and the charges made in the usual course of
business. Security Co. v. Graybeal, 52 NW 497, 85 Iowa 543, 39 Am St Rep 311. 31
Books of account may therefore be admissible under the rule. In tax cases, however, this Court appears not to
place too high a probative value on them, considering the statement in the case of Collector of Internal
Revenue v. Reyes 32 that "books of account do not prove per se that they are veracious; in fact they may be
more consistent than truthful." Indeed, books of account may be used to carry out a plan of tax evasion. 33
At most, therefore, the presentation of the balance sheet of December 31, 1940 would only prove that the figure
P4,238,974.57 appears therein as corresponding to mine cost. But the Company would still need to present proof
to justify its adoption of that figure. It had burden of establishing the components of the amount of P1,738,974.57:
what were the particular expenses made and the corresponding amount of each, so that it may be determined
whether the expenses were actually made and whether the items are properly part of cost of mine
development, or are actually depreciable items.
In this connection we take up Exhibit 31 of the Commissioner. This is the memorandum of BIR Examiner Cesar P.
Aguirre to the Chief of the Investigating Division of the Bureau of Internal Revenue. According to this report "the
counsel of the taxpayer alleges that the cost of Masinloc Mine properties and improvement is P4,238,974.56
instead of P2,646,879.44 as taken up in this report," and that the expenses as of 1941 were as follows:
Assets subject to:
1941
1. Depletion P2,646,878.44
2. 10 years depreciation 1,188,987.76
3. 3 years depreciation 78,283.75
4. 20 years depreciation 9,143.63
5. 10% amortization 171,985.00
Less: Cost Chromite Field P4,085,277.58
Expenses by operator 2,515,000.00 P1,570,277.58
The examiner concluded that "in the light of the figures listed above, the counsel for the taxpayer fairly stated the
amount disbursed by the operator until the mine property was put to production in 1939." The Company
capitalizes on this conclusion, completely disregarding the examiner's other statements, as follows:
The counsel, however, is not aware of the fact that the expenses made by the operator are those
which are depreciable and\or amortizable instead of depletable expenditures. The first post-war
Balance Sheet (12/31/46) of the taxpayer shows that its Mines, Improvement & Dev. is
P4,328,974.57. Considering the expenditures incurred by Benguet Consolidated as of 1941
(P1,570,277.58); the rehabilitation expenses in 1946 (P211,223.72); and the cost of the Masinloc
Chromite Field, the total cost would only be P4,296,501.30. Of the total expenditure of
P1,570,277.58 as of 1941, P1,438,389.124 were spent on depreciable and/or amortizable expenses
and P131,878.44 were made for the direct improvement of the mine property.

In as much as the expenditure of the operator as of 1941 and the cost of the mine property were
taken up in the account Mines, Improvement & Rehabilitation in 1946, all its assets that were
rightfully subject to depletion was P2,646,878.44.
Because of the above qualification a large part of the amount spent by the operator
purpose of depletion deduction, 35 depletion being different from depreciation. 36

34

may not be allowed for

The Company's balance sheet for December 31, 1947 lists the "mine cost" of P2,500,000 as "development cost"
and the amount of P1,738,974.37 as "suspense account (mining properties subject to war losses)." The Company
claims that its accountant, Mr. Calpo, made these errors, because he was then new at the job. Granting that
was what had happened, it does not affect the fact that the, evidence on hand is insufficient to prove the cost
of development alleged by the Company.
Nor can we rely on the statements of Eligio S. Garcia, who was the Company's treasurer and assistant secretary
at the time he testified on August 14, 1959. He admitted that he did not know how the figure P4,238,974.57 was
arrived at, explaining: "I only know that it is the figure appearing on the balance sheet as of December 31, 1946
as certified by the Company's auditors; and this we made as the basis of the valuation of the depletable value of
the mines." (p. 94, t.s.n.)
We, therefore, have to rely on the Commissioner's assertion that the "development cost" was P131,878.44, broken
down as follows: assessment, P34,092.12; development, P61,484.63; exploration, P13,966.62; and diamond drilling,
P22,335.07.
The question as to which figure should properly correspond to "mine cost" is one of fact. 37 The findings of fact of
the Tax Court, where reasonably supported by evidence, are conclusive upon the Supreme Court. 38
As regards the estimated ore deposit of the Company's mines, the Company's figure is "4,156,888 tons," while that
of the Commissioner is the larger figure "4,471,892 tons." The difference of 315,004 tons was due to the fact that
the Commissioner took into account all the ore that could probably be removed and marketed by the
Company, utilizing the total tonnage shipped before and after the war (933,180 tons) and the total reserve of
shipping material pegged at 3,583,712 tons. On the other hand the Company's estimate was arrived at by taking
into consideration only the quantity shipped from solid ore namely, 733,180 tons (deducting from the total
tonnage shipped before and after the war an estimated float of 200,000 tons), and then adding the total
recoverable ore which was assessed at 3,423,708 tons.
The above-stated figures were obtained from the report 39 of geologist Paul A. Schaeffer, who had been earlier
commissioned by the Company to conduct a study of the metallurgical possibilities of the Company's mines. In
order to have a fair understanding of how the contending parties arrived at their respective figures, We quote a
pertinent portion of the geologist's report:
Milling Data
Ore mined before the war ............... 336,850 tons
Ore mined after the war ............... 1,779,350 tons
Total ........................................... 2,116,200 tons
x Ore shipped before the war ......... 337,611 tons
xx Ore shipped after the war ............ 595,569 tons
Total ................................................ 933,180 tons
Less an estimated float of .................. 200,000 tons
Total shipped from solid ore .............. 733,180 tons

Proportion
-------mined 2,116,200

shipped
=

733,180
-----------

or approximately 35% of mine ore is shipped.

Dumps
Material on dumps now total 383,346 tons. Using the above tonnage for ore shipped from mining (excluding float)
there should have been a total of 1,383,020 tons of waste produced of which almost 1,000,00 tons has been
removed from the mining area of the hill. I believe that half still remains as alluviuma long the three principal
intermittent creeks which head in the mining area, and the remaining half million has washed into the river. Of
course this is pure speculation.
x much was float material, probably about one half, leaving about 170.000 tons mined from the hill.
xx some float included.
xxx xxx xxx
Ore Reserve
The A and B ore is considered sufficiently developed by drilling and tunnels to constitute the ore reserve. C ore
must be checked by drilling.
Tons
A
.
.
.
.
B
.
.
.
.
Total
.
.
.
C
.
.
.
.
Grand Total . . . . 11,722,300

.
.

.
.

.
.

.
.

.
.

.
.

.
.
.
.

.
.

.
.

.
.

7,729,800
1,780,500
9,510,300
2,212,00

Therefore, the total ore reserve may be considered to be 9,510,300 tons. Based on past experience 35% is
shipping ore.
With the present mill there is considerably more recovery. The ore is mined selectively (between dikes). The results
are about as follows:
Of 1,500 tons mined, 500 tons are sorted and shipped direct, the remaining 1,000 tons going to the mill from which
250 tons ore recovered for shipment. Thus 50% of the selectively mined ore is recovered.
Thus for the reserve tonnage:
Total
reserve
Less
20%
7,608,240
Less
10%
6,847,416
x
.50 =

.
.
dike

.
.
.
material

low

grade

.
.

ore

.
.
.

.
.

.
.

.
.

.
.

9,510,300
1,902,060

760,824

.
.

Total recoverable ore . . . . . . . . . . 3,423,708 tons

It is probable that 30% of the dump material could be recovered by milling. So adding to the
above 115,004 ore recoverable from the dumps, we get a total reserve of shipping material of

3,538,712 tons. With the sink float section added to the mill this should be increased by perhaps
20%.
On the basis of the above report the Company faults the Tax Court is sustaining the Commissioner's estimate of
the ore deposit. While the figures corresponding to the total gross tonnage shipped before and after the war
have not been assailed as erroneous, the Company maintains that the estimated float 40 of 200,000 tons as
reported in the geologist's study should have been deducted therefrom, such that the combined total of the ore
shipped should have been placed at a net of 733,180 tons instead of 933,180 tons. The other figure the Company
assails as having been improperly included by the Commissioner in his statement of ore reserve refers to the
"Recoverable ore from dump material 115,004 tons." The Company's argument in this regard runs thus:
... This apparently was included by respondent by virtue of the geologist's report that "it is probable
that 30% of the dump material should be recovered by milling." Actually, however, such recovery
from dump or waste material is problematical and is merely a contingency, and hence, the item
of 115,004 tons should not be included in the statement of the ore reserves. Taking out these two
items improperly and erroneously included in respondent Commissioner of Internal Revenue's
examiner's report, to wit, float or waste material of 200,060 tons and supposedly recoverable ore
from dump materials of 115,004 tons, totaling 315,004 tons, from the total figure of 4,471,892 tons
given by him, the figure of 4,156.888 tons results as the proper statement of the total estimated ore
as correctly used by petitioner in its statement of ore reserves for purposes of depletion. 41
We agree with the Company's observation on this point. The geological report appears clear enough: the
estimated float of 200,000 tons consisting of pieces of ore that had broken loose and become detached by
erosion from their original position could hardly be viewed as still forming part of the total estimated ore deposit.
Having already been broken up into numerous small pieces and practically rendered useless for mining purposes,
the same could not appreciably increase the ore potentials of the Company's mines. As to the 115,004 tons
which geologist Paul A. Schaeffer believed could still be recovered by milling from the material on dumps, there
are no sufficient data on which to affirm or deny the accuracy of the said figure. It may, however, be taken as
correct, considering that it came from the Company's own commissioned geologist and that by the Company's
own admission 42 by 1957 it had mined and sold much more than its original estimated ore deposit of 4,156,888
tons. We think that 4,271,892 tons 43 would be a fair estimate of the ore deposit in the Company's mines.
The
correct
P2,515,000.00
(mine
cost
4,271,892 (estimated ore deposit)

figures
proper)
+

therefore
P131,878.44
(development

are:
cost)

or
P2,646,878.44
4,271,892
deposit)

(mine
cost) =
(estimated

P0.6196
ore

(rate

of
per

depletion
ton)

In its second assigned error, the Company questions the disallowance by the Tax Court of the depreciation
charges claimed by the Company as deductions from its gross income 44 The items thus disallowed consist mainly
of depreciation expenses for the years 1953 and 1954 allegedly sustained as a result of the deterioration of some
of the Company's incomplete constructions.
The initial memorandum 45 of the BIR examiner assigned to verify the income tax liabilities of the Company
pursuant to the latter's claim of having overpaid its income taxes states the basic reason why the Company's
claimed depreciation should be disallowed or re-adjusted, thus: since "..., up to its completion (the incomplete
asset) has not been and is not capable of use in the operation, the depreciation claimed could not, in fairness to
the Government and the taxpayer, be considered as proper deduction for income tax purposes as the said asset
is still under construction." Vis-a-Vis the Commissioner's consistent position in this regard the company simply
repeatedly requested for time 46 in view of the alleged voluminous working sheets that had to be re-evaluated
and recomputed to justify its claimed depreciation items within which to submit a separate memorandum in
itemized form detailing the Company's objections to the items of depreciation adjustments or disallowances for
the years involved. Strangely enough, despite the period granted, the record is bare that the Company ever
submitted its itemized objection as proposed. Inasmuch as the taxpayer has the burden of justifying the
deductions claimed for depreciation, the Company's failure to discharge the burden prevents this Court, from

disturbing the Commissioner's computation. For taxation purposes the phrase "out of its not being used," with
reference to depreciation allowable on assets which are idle or the use of which is temporarily suspended, should
be understood to refer only to property that has once been used in the trade or business, not to property that has
never been actually devoted to the taxpayer's business, particularly incomplete assets that have yet to be used. .
The Company's third assigned error assails the Court of Tax Appeals in not allowing the deduction from its gross
income of certain miscellaneous business expenditures in the course of its operation for the years 1954 and 1956.
For 1954 the deduction claimed amounted to P38,081.20, of which the Court allowed P25,600.00 and disallowed
P13,481.20, 47 "for lack of any supporting paper or evidence." For the year 1956 the claim amounted to P20,050.00
of which the Court allowed P2,460.00, representing the one-month salary Christmas bonus given to some of the
employees, and upheld the disallowance of P17,590.00 on the ground that the Company "failed to prove
substantially that said expenses were actually incurred and are legally deductible expenses."
Regarding the disallowed amount of P13,481.20 the year 1954, the Company submits that it consisted of
expenses supported by "vouchers and cancelled checks evidencing payments of these amounts," and were
necessary and ordinary expenses of business for that year. On the disallowance by the Tax Court of the sum of
P17,590.00 out of a total deduction for miscellaneous expenses for 1956 among to P20,050.00, the Company
advances the same argument, namely, that the amount consisted of normal and regular expenses for that year
as evidenced by vouchers and cancelled checks.
These vouchers and cancelled checks of the Company, however, only show that the amounts claimed had
indeed been spent, and confirm the fact of disbursement, but do not necessarily prove that the expenses for
which they we're disbursed are deductible items. In the case of Collector of Internal Revenue vs. Goodrich
International Rubber Co. 48 this Court rejected the taxpayer's similar claim for deduction of alleged representation
expenses, based upon receipts issued not by the entities to which the alleged expenses but by the officers of
taxpayer corporation who allegedly paid them. It was there stated:
If the expenses had really been incurred, receipts or chits would have been issued by the entities
to which the payments have been made, and it would have been easy for Goodrich or its officers
to produce such receipts. These receipts issued by said officers merely attest to their claim that
they had incurred and paid said expenses. They do not establish payment of said alleged
expenses to the entities in which the same are said to have been incurred.
In the case before Us, except for the Company's own vouchers and cancelled checks, together with the
Company treasurer's lone and uncorroborated testimony regarding the purpose of said disbursements, there is no
other supporting evidence to show that the expenses were legally deductible items. We therefore affirm the Tax
Court's disallowance of the same.
In resume, this Court finds:
(1) that the Company was not using a "hybrid" method of accounting in the preparation of its income tax returns,
but was consistent in its use of the accrual method of accounting;
(2) that the rate of depletion per ton of the ore deposit mined and sold by the Company is P0.6196 per ton
P0.59189 as contended by the Commissioner nor P1.0197 as claimed by the Company;

49

not

(3) that the disallowance by the Tax Court of the depreciation charges claimed by the Company is correct in
view of the latter's failure to itemize and/or substantiate with definite proof that the Commissioner's own method
of determining depreciation is unreasonable or inaccurate;
(4) that for lack of supporting evidence to show that the Company's claimed expenses were legally deductible
items, the Tax Court's disallowance of the same is affirmed.
As recomputed then, the deficiency income taxes due from the Company are as follows:
1953

Net
income
as
per
audited
Unallowable deductions & additional income

return

_________________

P5,193,716.89

Depletion overcharged _________________________ P178,477.04 Depreciation adjustment ________________________

93,862.96
Total
adjustments
_____________________________
272,340.00
Net
income
as
per
investigation
___________________
5,466,056.89
Income
tax
due
thereon 50 _______________________
1,522,495.92
Less amount already assessed ____________________ 1,446,241.00 DEFICIENCY TAX DUE ______________________
76,254.92
1954
Net income as per audited return _________________ P3,320,307.68 Unallowable deductions & additional
income
Depletion overcharged _________________________ P147,895.72 Depreciation adjustment ________________________
11,878.12 Miscellaneous expenses ________________________ 13,481.20
Total
adjustments
_____________________________
173,255.04
Net
income
as
per
investigation
___________________
3,493,562.72
Income
tax
due
thereon
_________________________
970,197.56
Less amount already assessed ____________________ 921,686.00 DEFICIENCY TAX DUE ______________________
48,511.56
1956
Net income as per audited return _________________ P11,504,483.97 Unallowable deductions & additional
income
Depletion overcharged _________________________ P221,272.98 Miscellaneous expenses ________________________
17,590.00
Total
adjustments
_____________________________
238,862.98
Net
income
as
per
investigation
__________________
11,743,346.95
Income
tax
due
thereon
________________________
3,280,137.14
Less amount already assessed ___________________ 3,213,256.00 DEFICIENCY TAX DUE ______________________
66,881.14
TOTAL DEFICIENCY TAXES DUE _____________ 191,647.62
WHEREFORE, the appealed decision is hereby modified by ordering Consolidated Mines, Inc. to pay the
Commissioner of Internal Revenue the amounts of P76,254.92, P48,511.56 and P66,881.14 as deficiency income
taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P191,647.62 under the terms specified by
the Tax Court, without pronouncement as to costs.
3M
PHILIPPINES,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.

INC., petitioner,

Bito, Misa & Lozada for petitioner.

The Office of the Solicitor General for respondent.

GRIO-AQUINO, J.:
This is a petition for review of the decision of the Court of Tax Appeals which affirmed the assessment of
deficiency income tax on the petitioner's 1974 income tax return, for deductions of "business expenses" in the

form of royalty payments to its foreign licensor which the respondent Commissioner of Internal Revenue
disallowed. This case hinges on the propriety or impropriety of the deductions.
3M Philippines, Inc. is a subsidiary of the Minnesota Mining and Manufacturing Company (or "3M-St. Paul") a nonresident foreign corporation with principal office in St. Paul, Minnesota, U.S.A. It is the exclusive importer,
manufacturer, wholesaler, and distributor in the Philippines of all products of 3M-St. Paul. To enable it to
manufacture, package, promote, market, sell and install the highly specialized products of its parent company,
and render the necessary post-sales service and maintenance to its customers, petitioner entered into a "Service
Information and Technical Assistance Agreement" and a "Patent and Trademark License Agreement" with the
latter under which the petitioner agreed to pay to 3M-St. Paul a technical service fee of 3% and a royalty of 2% of
its net sales. Both agreements were submitted to, and approved by, the Central Bank of the Philippines.
In its income tax return for the fiscal year ended October 31, 1974, the petitioner claimed the following
deductions as business expenses:
(a) royalties and technical service fees of P 3,050,646.00; and
(b) pre-operational cost of tape coater of P97,485.08.
On the first item, the respondent Commissioner of Internal Revenue allowed a deduction of P797,046.09 only as
technical service fee and royalty for locally manufactured products, but disallowed the sum of P2,323,599.02
alleged to have been paid by the petitioner to 3M-St. Paul as technical service fee and royalty on
P46,471,998.00worth of finished products imported by the petitioner from the parent company, on the ground
that the fee and royalty should be based only on locally manufactured goods. The improper deduction was
treated by respondent as a disguised dividend or income.
On the second item, respondent allowed P19,544.77 or one-fifth (1/5) of petitioner's capital expenditure of
P97,046.09 for its tape coater which was installed in 1973 because such expenditure should be amortized for a
period of five (5) years, hence, payment of the disallowed balance of P77,740.38 should be spread over the next
four (4) years. Respondent ordered petitioner to pay P840,540 as deficiency income tax on its 1974 return, plus
P353,026.80 as 14% interest per annum from February 15, 1975 to February 15, 1976, or a total ofP1,193,566.80.
Petitioner protested the assessment in a letter dated March 7, 1980. The respondent Commissioner did not answer
the protest. Instead, he issued warrants of distraint and levy on October 1, 1984. On October 23, 1984, petitioner
appealed to the Court of Tax Appeals by petition for review with a prayer for the issuance of a writ of preliminary
injunction to stop the enforcement of the warrants of distraint and levy. The writ was issued upon petitioner
posting a P1,850,000 bond.
After the respondent had filed his answer to the petition for review and hearings were held, the Tax Court
rendered a decision on August 14, 1987 upholding the Commissioner's ruling. Petitioner's motion for
reconsideration of the decision was denied by the Tax Court on April 6, 1988. A copy of the resolution was
received by petitioner on April 21, 1988.
On April 25, 1988, petitioner sought a review in this Court of the Tax Court's decision.
The pertinent legal provisions in this case are Section 29(a)(1) of the Internal Revenue Code and Circular No. 393
of the Central Bank.
Because remittances to foreign licensors of technical service fees and royalties are made in foreign exchange,
CB Circular No. 393 (Regulations Governing Royalties/Rentals) dated December 7, 1973 was promulgated by the
Central Bank as an exchange control regulation to conserve foreign exchange and avoid unnecessary drain on
the country's international reserves (69 O.G. No. 51, pp. 11737-38). Section 3-C of the circular provides that
royalties shall be paid only on commodities manufactured by the licensee under the royalty agreement:
Section 3. Requirements for Approval and Registration. The requirements for approval and
registration as provided for in Section 2 above include, but are not limited to the following:
a. xxx xxx xxx

b. xxx xxx xxx

c. The royalty/rental contracts involving manufacturing' royalty, e.g., actual transfers of
technological services such as secret formula/processes, technical know how and the like shall not
exceed five (5) per cent of the wholesale price of the commodity/ties manufactured under the
royalty agreement. For contracts involving 'marketing' services such as the use of foreign brands or
trade names or trademarks, the royalty/rental rate shall not exceed two (2) per cent of the
wholesale price of the commodity/ties manufactured under the royalty agreement. The
producer's or foreign licensor's share in the proceeds from the distribution/exhibition of the films
shall not exceed sixty (60) per cent of the net proceeds (gross proceeds less local expenses) from
the exhibition/distribution of the films. ... (Emphasis supplied.) (p. 27, Rollo.)
Clearly, no royalty is payable on the wholesale price of finished products imported by the licensee from the
licensor. However, petitioner argues that the law applicable to its case is only Section 29(a)(1) of the Tax Code
which provides:
(a) Expenses. (1) Business expenses. (A) In general. All ordinary and necessary expenses
paid or incurred during the taxable year in carrying on any trade or business, including a
reasonable allowance for salaries or other compensation for personal services actually rendered;
travelling expenses while away from home in the pursuit of a trade, profession or business,
rentals or other payments required to be made as a condition to the continued use or possession,
for the purpose of the trade, profession or business, for property to which the taxpayer has not
taken or is not taking title or in which he has no equity.
Petitioner points out that the Central bank "has no say in the assessment and collection of internal revenue taxes
as such power is lodged in the Bureau of Internal Revenue," that the Tax Code "never mentions Circular 393 and
there is no law or regulation governing deduction of business expenses that refers to said circular." (p. 9, Petition.)
The argument is specious, for, although the Tax Code allows payments of royalty to be deducted from gross
income as business expenses, it is CB Circular No. 393 that defines what royalty payments are proper. Hence,
improper payments of royalty are not deductible as legitimate business expenses.
CB Circular No. 393 dated December 7,1983 was published in the Official Gazette issue of December 17,1973 (69
O.G. No. 51, p. 11737). Circulars issued by the Central Bank in the exercise of its authority under the Central Bank
Act, and which have been duly published in the Official Gazette, have the force and effect of law (People vs.
Que Po Lay, 94 Phil. 640; Lim Hoa Ting vs. Central Bank, 104 Phil. 573). They are binding on everybody, the
petitioner, as much as the public respondent.
WHEREFORE, finding no reversible error in the decision of the Court of Tax Appeals, the petition for review is
denied. Costs against the petitioner.
SO ORDERED.