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DONALVO_2016
INCOME TAXATION
IX. Income
a. Definition, Income vs. Capital
COMMISSIONER OF INTERNAL REVENUE vs. COURT OF
APPEALS
By: Alona Suzell B. Ruyeras
*Caveat: Long and Complicated Case. Several emphasis were
supplied to aid in understanding 
Facts:
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. ANSCOR is wholly owned and controlled
by the family of Don Andres, who are all non-resident aliens. In 1937,
Don Andres subscribed to 4,963 shares of the 5,000 shares originally
issued.
Several times, ANSOCOR declared stock dividends.
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 under Section 367 of the 1954 U.S. Revenue
Act. By January 2, 1968, ANSCOR reclassified its existing 300,000
common shares into 150,000 common and 150,000 preferred shares.
In a letter-reply dated February 1968, the IRS opined that the
exchange is only a recapitalization scheme and not tax avoidance.
Consequently, 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.
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 to P75M divided into 150,000 preferred shares and 600,000
common shares. About a year later, ANSCOR again redeemed
80,000 common shares from the Don Andres estate, 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 company‘s foreign exchange
remittances in case cash dividends are declared.
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, for the year 1968
and the second quarter of 1969 based on the transactions of
exchange and redemption of stocks.
The bone of contention is the interpretation and application of
Section 83(b) of the 1939 Revenue Act which provides:
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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).
*CIR’s Contention: 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 dividends which 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.
*ANSOCOR’s contention: 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, and to (b) subsequently filipinized ownership
of ANSCOR, as allegedly envisioned by Don Andres.
Issue:
W/N 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.
Ruling:
AS TO REDEMPTION – TAXABLE; AS TO EXCHANGE TO
PREFERRED STOCKS – NOT TAXABLE
TAX ON STOCK DIVIDENDS
*GENERAL RULE: A stock dividend representing the transfer of
surplus to capital account shall not be subject to tax.
Stock dividends, strictly speaking, represent capital and do
not constitute income to its recipient. So that the mere issuance
thereof is not yet subject to income tax as they are nothing but an
enrichment through increase in value of capital investment.
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
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corporate properties. 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. The determining factor for the imposition of income tax
is whether any gain or profit was derived from a transaction.
*EXCEPTION: 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.
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. 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. Having realized gain from
that redemption, the income earner cannot escape income tax.
No decisive test can be used to determine the application of the
exemption under Section 83(b). On this aspect, American courts
developed certain recognized criteria, which includes the following:
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,
5) The presence of a substantial surplus and a generous
supply of cash which invites suspicion as does a meager
policy in relation both to current earnings and accumulated
surplus.
*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.
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. 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
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transaction between the shareholder-income taxpayer and the
acquiring (redeeming) corporation. 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.
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 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. 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.
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, 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.
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.
*EXCHANGE OF COMMON WITH PREFERRED SHARES
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.
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.
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.
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C. When income is taxable
MADRIGAL vs. RAFFETY
By: Emmy Buniel
Facts:
Vicente Madrigal and Susana Paterno were legally married prior to
Januray 1, 1914. The marriage was contracted under the provisions
of law concerning conjugal partnership. In 1915, Madrigal filed a
declaration of his net income for year 1914, the sum of P296,302.73.
Vicente Madrigal was contending that the said declared income does
not represent his income for the year 1914 as it was the income of
his conjugal partnership with Paterno. He said that in computing for
his additional income tax, the amount declared should be divided by
2. The revenue officer was not satisfied with Madrigal‘s explanation
and ultimately, the United States Commissioner of Internal Revenue
decided against the claim of Madrigal.
Madrigal paid under protest, and the couple decided to recover the
sum of P3,786.08 alleged to have been wrongfully and illegally
assessed and collected by the CIR.
Issue:
Whether or not the income reported by Madrigal on 1915 should be
divided into 2 in computing for the additional income tax.
Ruling:
No! The point of view of the CIR is that the Income Tax Law, as the
name implies, taxes upon income and not upon capital and property.
The essential difference between capital and income is that capital is
a fund; income is a flow.
A fund of property existing at an instant of time is called capital. A
flow of services rendered by that capital by the payment of money
from it or any other benefit rendered by a fund of capital in relation to
such fund through a period of time is called income. Capital is wealth,
while income is the service of wealth.
Paterno has an inchoate right in the property of her husband
Madrigal during the lifetime of the conjugal property. She has an
interest in the ultimate ownership of property acquired as income of
the conjugal partnership. Not being seized of the separate estate,
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 or income, actually and legally vested in her
and entirely distinct from her husband property, the income cannot
properly be considered the separate income of the wife for the
purpose of the additional tax. The income tax law does not look on
the spouses as individual partners in an ordinary partnership.
As Paterno 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. To recapitulate, Vicente wants to
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half his declared income in computing for his tax since he is arguing
that he has a conjugal partnership with his wife. However, the court
ruled that the one that should be taxed is the income which is the
flow of the capital, thus it should not be divided into 2.
FISHER vs TRINIDAD (1922)
By: Kim Lorenzo Calatrava
Facts:
Frederick Fisher was a stockholder of Philippine American Drug
Company, a domestic corporation. For the year 1919 he declared a
―stock dividend‖ in the amount of P24,800 for which he was
subsequently taxed by the respondent Collector of Internal Revenue
for the sum of P889.91 as income tax. Fisher paid under protest and
brought action for recovery. Trinidad demurred which was sustained
hence this appeal.
Issue:
W/N stock dividends are income taxable under Sec. 25 of Act No.
2833 (The Income Tax Law)
HELD:
No. It is well-settled that stock dividends represent undistributed
increase in the capital of corporations or firms, joint stock companies,
etc., for a particular period. The inventory of the property of the
corporation 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.
In the case of Gray vs. Darlington (82 U.S., 653), the US Supreme
Court held that mere advance in value does not constitute 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 the case of Towne vs. Eisner, income was defined in an income
tax law to mean cash or its equivalent, unless it is otherwise specified.
It does not mean unrealized increments in the value of the property.
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 interests 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 than
they were before.
In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179), Mr.
Justice Pitney, said that the term "income" in its natural and obvious
sense, imports something distinct from principal or capital and
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conveying the idea of gain or increase arising from corporate
activity.
In the case of Eisner vs. Macomber (252 U.S., 189), income was
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.
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.
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. The stockholder by virtue of the stock dividend has in
fact received nothing that answers the definition of an "income."
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.
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."
A stock dividend, still being the property of the corporation and not
the stockholder, may be reached by an execution against the
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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.
If the ownership of the property represented by a stock dividend is
still in the corporation and not 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. 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.
As stock dividends are not "income," the same cannot be considered
taxes under that provision of Act No. 2833.
CONWI vs. COURT OF TAX APPEALS
By: Peter Vega
Ratio Decidendi
Income of Filipino citizens temporarily residing in a foreign country,
even if totally derived from outside the Philippines, is subject to tax
by virtue of Sec. 21, NIRC, viz: ―A tax is hereby imposed upon the
taxable net income received x x x from all sources by every individual,
whether a citizen of the Philippines residing therein or abroad x x x‖
(italics mine)
Facts:
Hernando Conwi et al. (Conwi et al.) are employees of Procter &
Gamble Philippine Manufacturing Corporation, a local subsidiary of
U.S.-based
Procter & Gamble.
Conwi et al. were temporarily assigned to subsidiaries of
Procter & Gamble outside of the Philippines, where they were
paid in U.S. dollars.
It is claimed that they earned and spent their money exclusively
abroad, and that they did not remit money back into the
Philippines during the time they were outside of the country earning
in dollars.
In the years 1970 and 1971, Conwi et al., since they were earning in
U.S. currency, in order to pay their income tax liabilities in Philippine
peso, used the prevailing free market rate of conversion
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prescribed under a Bureau of Internal Revenue ruling and two
Revenue Memorandum Circulars. However, in 1973, Conwi et al.
filed with the Commissioner of Internal Revenue (CIR) amended
income tax returns for the said years, this time using the par value
of the peso as conversion rate. The adjustment caused a
disparity between what was initially paid and what they were now
claiming to be their actual tax liabilities. Consequently, they asked
for a refund of the “overpayment.”
Even before the CIR could rule on the matter, Conwi et al. filed a
petition for review before the Court of Tax Appeals (CTA), which
eventually denied their claim for tax refund and/or tax credit.
Aggrieved, Conwi et al., via a petition for review, elevated the matter
to the Supreme Court.
Issues & Arguments
W/N the ruling and circulars above apply to Conwi et al.
(Note: Conti et al. argue that since there were no remittances and
acceptances of their salaries and wages in U.S. dollars into the
Philippines, they are exempt from the coverage of such ruling and
circulars.)
Held & Rationale
YES, the said ruling and circulars apply to Conwi et al.
―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. x x x ‗Income‘ can also
be thought of as a flow of the fruits of one‘s labor.‖ (See pages 87-88
of the case)
The dollar earnings of Conwi et al. are fruits of their labor in the
foreign subsidiaries of Procter & Gamble. They were given a definite
amount of money which came to them within a specified period of
time as payment for their services.
Sec. 21, NIRC, states: ―A tax is hereby imposed upon the taxable net
income received x x x from all sources by every individual,
whether a citizen of the Philippines residing therein or abroad x
x x‖
As such, their income is taxable even if there were no inward
remittances during the time they were earning in dollars abroad.
The ruling and the circulars are a valid exercise of power on the
part of the Secretary of Finance by virtue of Sec. 338, NIRC, which
empowers him “to promulgate all needful rules and regulations”
to effectively enforce its provisions.
Besides, they have already paid their taxes using the prescribed
rate of conversion. There is no need for the CIR to give them a
tax refund and/or credit.
Fallo
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Petition of Conwi et al. DENIED. The denial of their claim for tax
refund and/or credit by the CTA is AFFIRMED.
ii. Realization
2. Actual vs. Constructive Receipt
LIMPAN INVESTMENT CORPORATION vs. CIR
By: Kelvin John Du
Facts:
Limpan is a domestic corporation engaged in the business of leasing
real properties. Its principal stockholders are the spouses Isabelo P.
Lim and Purificacion Ceñiza de Lim, who own and control 99% of its
total paid-up capital.
Limpan duly filed its 1956 and 1957 income tax returns reporting
therein net incomes of P3,287.81 and P11,098.36, respectively. BIR
conducted an investigation and discovered and ascertained that
Limpan had underdeclared its rental incomes by P20,199.00 (1956)
and P81,690.00 (1957) and had claimed excessive depreciation of its
buildings. CIR issued its letter-assessment and demand for payment
of deficiency income tax and surcharge.
Limpan, through its Secretary-Treasurer, Vicente G. Solis, admitted
that it had omitted to report P12,100.00 as rental income in its 1956
tax return and P29,350.00 in 1957. However, with respect to the
difference between the admittedly undeclared sum of P29,350.00
and that found by CIR as unreported rental income (P81,690.00) in
1957, Solis also tried to establish that Limpan did not receive or
collect the same but that its president, Isabelo, collected part thereof
and may have reported the same in his own personal income tax
return; that Isabelo 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.
Issue:
WON Limpan is deemed to have constructively received rentals for
1957 and therefore should be liable for the unreported rental income
for 1957
Ruling:
Yes. Limpan's denial and explanation of the non-receipt of the
remaining unreported income for 1957 is not substantiated by
satisfactory corroboration. Isabelo 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
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said income in 1957, since the deposit was resorted to due to the
refusal of Limpan to accept the same, and was not the fault of its
tenants; hence, Limpan 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.
TAXATION 1 CASE DIGESTS_ATTY. DONALVO_2016
P53,613,000.00. Therefore, SMI-Ed Philippines must still pay the
balance of P8,935,500.00 as deficiency tax.
SMI-Ed Philippines filed a petition for review before the SC praying
for the grant of its claim for refund and the reversal of the Court of
Tax Appeals En Banc‘s decision.

c.Tax Treatment
Issue:
iii. Capital Gains Tax
2. Real Property (Domestic Corp.)
W/N the sale of SMI’s equipment and machineries is subject to a
SMI-ED PHILIPPINES vs CIR 6% capital gains tax? (NO)

By: Rea Romero

Facts: Ruling:
The CTA found that the properties of SMI were subject to capital
SMI-Ed Philippines is a PEZA-registered corporation authorized ―to gains tax. For petitioner‘s properties to be subjected to capital gains
engage in the business of manufacturing ultra high-density tax, the properties must form part of petitioner‘s capital assets.
microprocessor unit package. After its registration SMI-Ed Philippines
constructed buildings and purchased machineries and equipment. Section 39(A)(1) of the National Internal Revenue Code of 1997
SMI-Ed Philippines ―failed to commence operations.” Its factory defines ―capital assets‖:
was temporarily closed, it sold its buildings and some of its
installed machineries and equipment to Ibiden Philippines, Inc., SEC. 39. Capital Gains and Losses. -
another PEZA-registered enterprise. SMI was subsequently
dissolved. (A) Definitions. - As used in this Title -

In its quarterly income tax return for year 2000, SMI-Ed Philippines
subjected the entire gross sales of its properties to 5% final tax
on PEZA-registered corporations. SMI-Ed Philippines paid taxes
amounting to P44,677,500.00.
After requesting the cancellation of its PEZA registration and
amending its articles of incorporation to shorten its corporate term,
SMI-Ed Philippines filed an administrative claim for the refund of
P44,677,500.00 with the Bureau of Internal Revenue (BIR). SMI-Ed
Philippines alleged that the amount was erroneously paid. It also
alleged that it incurred a net loss of P2,233,464,538.00.
The BIR did not act on SMI-Ed Philippines‘ claim, which prompted
the latter to file a petition for review before the Court of Tax Appeals.
Court of Tax Appeals Second Division found that the fiscal incentives
given to PEZA-registered enterprises may be availed only by PEZA-
registered enterprises that had already commenced operations.
Since SMI-Ed Philippines had not commenced operations, it was not
entitled to the incentives of either the income tax holiday or the 5%
preferential tax rate. Payment of the 5% preferential tax amounting to
P44,677,500.00 was erroneous.
The Court of Tax Appeals Second Division subjected the sale of SMI-
Ed Philippines‘ assets to 6% capital gains tax under Section 27(D)(5)
of the same Code and Section 2 of Revenue Regulations No. 8-98. It
was found liable for capital gains tax amounting to
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(1) Capital Assets. - the term ‗capital assets‘ means
property held by the taxpayer (whether or not connected
with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which
would properly be included in the inventory of the taxpayer
if on hand at the close of the taxable year, or property held
by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business, or property used
in the trade or business, of a character which is subject to
the allowance for depreciation provided in Subsection (F)
of Section 34; or real property used in trade or business of
the taxpayer.
Thus, ―capital assets‖ refers to taxpayer‘s property that is NOT any of
the following:
1. Stock in trade;
2. Property that should be included in the taxpayer‘s inventory
at the close of the taxable year;
3. Property held for sale in the ordinary course of the
taxpayer‘s business;
4. Depreciable property used in the trade or business; and
5. Real property used in the trade or business.
The properties involved in this case include petitioner‘s buildings,
equipment, and machineries. They are not among the exclusions
enumerated in Section 39(A)(1) of the National Internal Revenue
6

Code of 1997. Based on the definition of capital assets under
Section 39 of the National Internal Revenue Code of 1997, they
are capital assets.
Respondent (CIR) insists that since petitioner‘s machineries and
equipment are classified as capital assets, their sales should be
subject to capital gains tax. Respondent is mistaken.
Capital gains of individuals and corporations from the sale of real
properties are taxed differently.Individuals are taxed on capital gains
from sale of all real properties located in the Philippines and
classified as capital assets. Thus:
SEC. 24. Income Tax Rates.
(D) Capital Gains from Sale of Real Property. –
(1) In General. - The provisions of Section 39(B)
notwithstanding, a final tax of six percent (6%) based on
the gross selling price or current fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, is hereby imposed upon capital gains
presumed to have been realized from the sale, exchange,
or other disposition of real property located in the
Philippines, classified as capital assets, including pacto de
retro sales and other forms of conditional sales, by
individuals, including estates and trusts: Provided, That the
tax liability, if any, on gains from sales or other dispositions
of real property to the government or any of its political
subdivisions or agencies or to government-owned or
controlled corporations shall be determined either under
Section 24 (A) or under this Subsection, at the option of the
taxpayer
For corporations, the National Internal Revenue Code of 1997 treats
the sale of land and buildings, and the sale of machineries and
equipment, differently. Domestic corporations are imposed a 6%
capital gains tax only on the presumed gain realized from the sale of
lands and/or buildings. The National Internal Revenue Code of 1997
does not impose the 6% capital gains tax on the gains realized from
the sale of machineries and equipment. Section 27(D)(5) of the
National Internal Revenue Code of 1997 provides:
SEC. 27. Rates of Income tax on Domestic
Corporations. - to Section 24 (b) (1) of the NIRC which states:
. . . .
(D) Rates of Tax on Certain Passive Incomes. -
. . . .
(5) Capital Gains Realized from the Sale, Exchange or
Disposition of Lands and/or Buildings. - A final tax of six
percent (6%) is hereby imposed on the gain presumed to
have been realized on the sale, exchange or disposition of
lands and/or buildings which are not actually used in the
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business of a corporation and are treated as capital assets,
based on the gross selling price of fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, of such lands and/or buildings.
(Emphasis supplied)
Therefore, only the presumed gain from the sale of petitioner’s
land and/or building may be subjected to the 6% capital gains
tax. The income from the sale of petitioner’s machineries and
equipment is subject to the provisions on normal corporate
income tax.
To determine, therefore, if petitioner is entitled to refund, the amount
of capital gains tax for the sold land and/or building of petitioner and
the amount of corporate income tax for the sale of petitioner‘s
machineries and equipment should be deducted from the total final
tax paid.
4. Interests
DUMAGUETE CATHEDRAL CREDIT COOPERATIVE [DCCCO],
Represented by Felicidad L. Ruiz vs. COMMISSIONER OF
INTERNAL REVENUE
By: Ray Gingco
Facts:
Dumaguete Cathedral Credit Cooperative (DCCCO) is a cooperative
duly registered with the the Cooperative Development Agency (CDA).
On 27 November 2001 the BIR issued Letters of Authority
authorizing BIR Officers Rambuyon and Cubillan to examine
DCCCO‘s books of accounts and other accounting recirds for internal
revenue taxes for the taxable years 1999 and 2000.
DCCCO received Preliminary Assessment Notices for deficiency
withholding taxes. The deficiency withholding taxes cover the
payments of the honorarium of the Board of Directors, security and
janitorial services, legal and professional fees, and interest on
savings and time deposits of its members. DCCCO contended that it
should not be made to pay the withholding taxes for the interest on
savings and time deposit as well as the delinquency interest pursuant
SECTION 24. Income Tax Rates. —
xxxx
(B) Rate of Tax on Certain Passive Income: —
(1) Interests, Royalties, Prizes, and Other Winnings. — A final
tax at the rate of twenty percent (20%) is hereby imposed
upon the amount of interest from any currency bank
7

deposit and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar
arrangements; x x x
This provision according to DCCCO applies only to banks and
not to cooperatives, since the phrase "similar arrangements" is
preceded by terms referring to banking transactions that have
deposit peculiarities. Petitioner thus posits that the savings and time
deposits of members of cooperatives are not included in the
enumeration, and thus not subject to the 20% final tax. To bolster its
position, petitioner cites BIR Ruling No. 551-888 and BIR Ruling DA-
591-2006 where the BIR ruled that interests from deposits
maintained by members of cooperative are not subject to withholding
tax under Section 24(B)(1) of the NIRC. Petitioner further contends
that pursuant to Article XII, Section 15 of the Constitution and Article
2 of Republic Act No. 6938 (RA 6938) or the Cooperative Code of the
Philippines, cooperatives enjoy a preferential tax treatment which
exempts their members from the application of Section 24(B)(1) of
the NIRC.
As counter-argument the CIR invoked the legal maxim ― Ubi lex non
distinguit nec nos distinguere debemos‖ (where the law does not
distinguish, the courts should not distinguish.) CIR maintains t hat
Section 24 (b) (1) of the NIRC applies to cooperatives as the phrase
―similar arrangements‖ is not limited to banks but includes
cooperatives that are depositaries of their members. Regarding this
exemption relied upon by DCCCO, the CIR avers to the rule that tax
exemptions are highly disfavored and construed strictissimi juris
against the taxpayer and liberally in favor of the taxing power.
Issue:
Whether or not DCCCO is liable for the payment of the withholding
taxes on the interest on savings and time deposits.
Ruling:
Yes. DCCCO is not liable for the payment of withholding taxes on the
interest on savings and time deposits.
The BIR through Commissioner Tan declared in BIR Ruling No. 551-
888 that:
―Based on the foregoing representations, you now request in
effect a ruling as to whether or not you are exempt from the
following:
1. Payment of sales tax
2. Filing and payment of income tax
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3. Withholding taxes from compensation of employees
and savings account and time deposits of members.”
The letter ruling further stated that:
―Since interest from any Philippine currency bank
deposit and yield or any other monetary benefit from
deposit substitutes are paid by banks, you are not
the party required to withhold the corresponding tax
on the aforesaid savings account and time deposits
of your members.‖
The CTA En Banc stated that the ruling does not hold true if the
savings and time deposits are being maintained in the cooperative,
for in this case, it is the cooperative which becomes the payor-
corporation, a separate entity acting no more than an agent of the
government for the collection of taxes, liable to withhold the
corresponding taxes on the interests earned.
The Supreme Court however held that there is nothing in the ruling to
suggest that it applies only when deposits are maintained in a bank.
Rather, the ruling clearly states, without any qualification, that since
interest from any Philippine currency bank deposit and yield or any
other monetary benefit from deposit substitutes are paid by banks,
cooperatives are not required to withhold the corresponding tax on
the interest from savings and time deposits of their members. This
interpretation was reiterated in BIR Ruling [DA-591-2006] dated
October 5, 2006, which was issued by Assistant Commissioner
James H. Roldan upon the request of the cooperatives for a
confirmatory ruling on several issues, among which is the alleged
exemption of interest income on members‘ deposit (over and above
the share capital holdings) from the 20% final withholding tax.
The National Internal Revenue Code states that a "final tax at the
rate of twenty percent (20%) is hereby imposed upon the amount of
interest on currency bank deposit and yield or any other monetary
benefit from the deposit substitutes and from trust funds and similar
arrangement x x x" for individuals under Section 24(B)(1) and for
domestic corporations under Section 27(D)(1). Considering the
members’ deposits with the cooperatives are not currency bank
deposits nor deposit substitutes, Section 24(B)(1) and Section
27(D)(1), therefore, do not apply to members of cooperatives
and to deposits of primaries with federations, respectively.
BIR Ruling No. 551-888 and BIR Ruling [DA-591-2006] are in perfect
harmony with the Constitution and the laws they seek to implement.
Accordingly, the interpretation in BIR Ruling No. 551-888 that
cooperatives are not required to withhold the corresponding tax on
the interest from savings and time deposits of their members, which
was reiterated in BIR Ruling [DA-591-2006], applies to the instant
case.
Members of cooperatives deserve a preferential tax treatment
pursuant to RA 6938, as amended by RA 9520. Given that petitioner
8

is a credit cooperative duly registered with the Cooperative
Development Authority (CDA), Section 24(B)(1) of the NIRC must be
read together with RA 6938, as amended by RA 9520.
7. Dividends
CIR vs. SORIANO
By: Katherina Gumboc
Facts:
ANSCOR, presently called "A. Soriano Y Cia", is a corporation wholly
owned and controlled by the family of Don Andres Soriano (US
citizen) who are all non-resident aliens. ANSCOR has P1M
capitalization divided into 10k common shares at a par value of
P100/share. In 1937, Don Andres subscribed to 4,963 shares of the
5k shares originally issued. Later on, ANSCOR‘s authorized capital
stock was increased to P2,500M divided into 25k common shares
with the same par value. When Don Andres died, he has a total
shareholdings of 185,154 shares – 50,495 of which are original
issues and the balance of 134,659 shares as stock dividend
declarations. Correspondingly, one-half of that shareholdings or
92,577 shares were transferred to his wife, Doña Carmen Soriano,
as her conjugal share. The other half formed part of his estate.
Throughout the year, ANSCOR increased its capital stock and its
accumulated shareholdings.
On January 2, 1968, ANSCOR reclassified its existing 300k common
shares into 150k common and 150k preferred shares. Upon inquiry
from the United States Internal Revenue Service (USIR) that an
exchange of common with preferred shares is only a recapitalization
scheme and not tax avoidance, Doña Carmen exchanged her whole
138,864 common shares for 138,860 of the newly reclassified
preferred shares.
Pursuant to a Board Resolution, ANSCOR started redeeming
common shares from Don Andres‘s estates. ANSCOR‘s business
purpose for both redemptions of stocks is to partially retire said
stocks as treasury shares in order to reduce the company‘s foreign
exchange remittances in case cash dividends are declared.
Basing from such, CIR assessed ANSCOR for deficiency withholding
tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue
Code, in relation to Section 83(b), based on the transactions of
exchange and redemption of stocks.
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
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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.
CIR contends that:
1. The exchange transaction is tantamount to
cancellation under Section 83(b) making the
proceeds thereof taxable;
2. It also argues that Section 83 applies to stock
dividends which is the bulk of stocks that ANSCOR
redeemed;
3. 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
ANSCOR countered that:
1. It has no duty to withhold any tax either from the Don
Andres estate or from Doña 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,
and
b. To subsequently "Filipinized" ownership of
ANSCOR, as allegedly, envisioned by Don
Andres.
Issue:
W/N ANSCOR‘s 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 Section 83.
Ruling:
YES. Section 83(b) of the 1939 NIRC was taken from Section
115(g)(1) of the U.S. Revenue Code of 1928 laid down the general
rule known as the proportionate test wherein stock dividends once
issued form part of the capital and, thus, subject to income tax.
GR: A stock dividend representing the transfer of surplus to capital
account shall not be subject to tax.
In a loose sense, stock dividends issued by the corporation, are
9

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. 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.
The determining factor for the imposition of income tax is whether
any gain or profit was derived from a transaction.
EXC: The exception is 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.
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.
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. 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. Having realized gain from that redemption, the income
earner cannot escape income tax.
CIR vs. MANNING
By: Lyzzaik L. Laguialam
Facts:
This is a petition for review of the decision of the Court of Tax
Appeals, in CTA case 1626, which set aside the income tax
assessments issued by the Commissioner of Internal Revenue
against John L. Manning, W.D. McDonald and E.E. Simmons
(hereinafter referred to as the respondents), for alleged undeclared
stock dividends received in 1958 from the Manila Trading and Supply
Co. (hereinafter referred to as the MANTRASCO) valued at
P7,973,660.
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In 1952 the MANTRASCO had an authorized capital stock of
P2,500,000 divided into 25,000 common shares; 24,700 of these
were owned by Julius S. Reese, and the rest, at 100 shares each, by
the three respondents.
On February 29, 1952, in view of Reese‘s desire that upon his death
MANTRASCO and its two subsidiaries, MANTRASCO (Guam), Inc.
and the Port Motors, Inc., would continue under the management of
the respondents, a trust agreement on his and the respondents‘
interests in MANTRASCO was executed by and among Reese
(therein referred to as OWNER), MANTRASCO (therein referred to
as COMPANY), the law firm of Ross, Selph, Carrascoso and Janda
(therein referred to as TRUSTEES), and the respondents (therein
referred to as MANAGERS).
On October 19, 1954 Reese died. The projected transfer of his
shares in the name of MANTRASCO could not, however, be
immediately effected for lack of sufficient funds to cover initial
payment on the shares.
On February 2, 1955, after MANTRASCO made a partial payment of
Reese‘s shares, the certificate for the 24,700 shares in Reese‘s
name was cancelled and a new certificate was issued in the name of
MANTRASCO. On the same date, and in the meantime that Reese‘s
interest had not been fully paid, the new certificate was endorsed to
the law firm of Ross, Selph, Carrascoso and Janda, as trustees for
and in behalf of MANTRASCO.
On December 22, 1958, at a special meeting of MANTRASCO
stockholders, the following resolution was passed:
"RESOLVED, that the 24,700 shares in the Treasury be reverted
back to the capital account of the company as a stock dividend to be
distributed to shareholders of record at the close of business on
December 22, 1958, in accordance with the action of the Board of
Directors at its meeting on December 19, 1958 which action is
hereby approved and confirmed."
On November 25, 1963 the entire purchase price of Reese‘s interest
in MANTRASCO was finally paid in full by the latter, On May 4, 1964
the trust agreement was terminated and the trustees delivered to
MANTRASCO all the shares which they were holding in trust.
Meanwhile, on September 14, 1962, an examination of
MANTRASCO‘s books was ordered by the Bureau of Internal
Revenue. The examination disclosed that (a) as of December 31,
1958 the 24,700 shares declared as dividends had been
proportionately distributed to the respondents, representing a total
book value or acquisition cost of P7,973,660; (b) the respondents
failed to declare the said stock dividends as part of their taxable
income.
On the basis of their examination, the BIR examiners concluded that
the distribution of Reese‘s shares as stock dividends was in effect a
10

distribution of the "asset or property of the corporation as may be
gleaned from the payment of cash for the redemption of said stock
and distributing the same as stock dividend."
The respondents unsuccessfully challenged the foregoing
assessments and, failing to secure a favorable reconsideration,
appealed to the Court of Tax Appeals.
On October 30, 1967 the CTA rendered judgment absolving the
respondents from any liability for receiving the questioned stock
dividends on the ground that their respective one-third interest in
MANTRASCO remained the same before and after the declaration of
stock dividends and only the number of shares held by each of them
had changed.
Issue: Whether or not the stock dividend is taxable.
Ruling:
Yes. The parties differ on the taxability of the "treasury" stock
dividends received by the respondents.
The respondents anchor their argument on the same basis as the
Court of Tax Appeals; whereas the Commissioner maintains that the
full value (P7,973,660) of the shares redeemed from Reese by
MANTRASCO which were subsequently distributed to the
respondents as stock dividends in 1958 should be taxed as income
of the respondents for that year, the said distribution being in effect a
distribution of cash. The respondents‘ interests in MANTRASCO, he
further argues, were only .4% prior to the declaration of the stock
dividends in 1958, but rose to 33 1/3% each after the said declaration.
In submitting their respective contentions, it is the assumption of both
parties that the 24,700 shares declared as stock dividends were
treasury shares. We are however convinced, after a careful study of
the trust agreement, that the said shares were not, on December 22,
1958 or at any time before or after that date, treasury shares. The
reasons are quite plain.
"‗A stock dividend always involves a transfer of surplus (or profit) to
capital stock.‘ Graham and Katz, Accounting in Law Practice, 2d ed.
1938, No. 70. As the court said in United States v. Siegel, 8 Cir.,
1931, 52 F 2d 63, 65, 78 ALR 672: ‗A stock dividend is a conversion
of surplus or undivided profits into capital stock, which is distributed
to stockholders in lieu of a cash dividend.‘ Congress itself has
defined the term ‗dividend‘ in No. 115(a) of the Act as meaning any
distribution made by a corporation to its shareholders, whether in
money or in other property, out of its earnings or profits. In Eisner v.
Macomber, 1920, 252 US 189, 40 S Ct 189, 64 L Ed 521, 9 ALR
1570, both the prevailing and the dissenting opinions recognized that
within the meaning of the revenue acts the essence of a stock
dividend was the segregation out of surplus account of a definite
portion of the corporate earnings as part of the permanent capital
resources of the corporation by the device of capitalizing the same,
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and the issuance to the stockholders of additional shares of stock
representing the profits so capitalized."
The declaration by the respondents and Reese‘s trustees of
MANTRASCO‘s alleged treasury stock dividends in favor of the
former, brings, however, into clear focus the ultimate purpose which
the parties to the trust instrument aimed to realize: to make the
respondents the sole owners of Reese‘s interest in MANTRASCO by
utilizing the periodic earnings of that company and its subsidiaries to
directly subsidize their purchase of the said interests, and by making
it appear outwardly, through the formal declaration of non-existent
stock dividends in the treasury, that they have not received any
income from those firms when, in fact, by that declaration they
secured to themselves the means to turn around as full owners of
Reese‘s shares. In other words, the respondents, using the trust
instrument as a convenient technical device, bestowed unto
themselves the full worth and value of Reese‘s corporate holdings
with the use of the very earnings of the companies. Such package
device, obviously not designed to carry out the usual stock dividend
purpose of corporate expansion reinvestment, e.g. the acquisition of
additional facilities and other capital budget items, but exclusively for
expanding the capital base of the respondents in MANTRASCO,
cannot be allowed to deflect the respondents‘ responsibilities toward
our income tax laws. The conclusion is thus ineluctable that
whenever the companies involved herein parted with a portion of
their earnings "to buy" the corporate holdings of Reese, they were in
ultimate effect and result making a distribution of such earnings to
the respondents. All these amounts are consequently subject to
income tax as being, in truth and in fact, a flow of cash benefits to the
respondents.
We are of the opinion, however, that the Commissioner erred in
assessing the respondents the total acquisition cost (P7,973,660) of
the alleged treasury stock dividends in one lump sum. The record
shows that the earnings of MANTRASCO over a period of years
were used to gradually wipe out the holdings therein of Reese.
Consequently, those earnings, which we hold, under the facts
disclosed in the case at bar, as in effect having been distributed to
the respondents, should be taxed for each of the corresponding
years when payments were made to Reese‘s estate on account of
his 24,700 shares. With regard to payments made with
MANTRASCO earnings in 1958 and the years before, while indeed
those earnings were utilized in those years to gradually pay off the
value of Reese‘s holdings in MANTRASCO, there is no evidence
from which it can be inferred that prior to the passage of the
stockholders‘ resolution of December 22, 1958 the contributed equity
of each of the respondents rose correspondingly. It was only by
virtue of the authority contained in the said resolution that the
respondents actually, albeit illegally, appropriated and partitioned
among themselves the stockholders‘ equity representing Reese‘s
interests in MANTRASCO. As those payments accrued in favor of
the respondents in 1958 they are and should be liable, for income tax
11

purposes, to the extent of the aggregate amount paid, from 1955 to
1958, by MANTRASCO to buy off Reese‘s shares.
WISE & CO., INC. vs. MEER
By: Marry Suan
Facts:
On June 1, 1937, Manila Wine Merchants, Ltd., a Hong Kong
company, was liquidated and its capital stock was distributed to its
stockholders, one of which is the petitioner, Wise & Co. Inc.
As part of its liquidation, the corporation was sold to Manila Wine
Merchants., Inc. for P400,000. The said earnings, declared as
dividends, were distributed to its stockholders. The Hong Kong
company then paid the income tax for the entire earnings.
As a result of the sale of its business and assets, a surplus was
realized by the Hong Kong company after deducting the dividends.
This surplus was also distributed to its stockholders. The Hong Kong
company also paid the income tax for the said surplus.
The petitioners then filed their respective income tax returns.
Commissioner Meer, then, made a deficiency assessment charging
the individual stockholders for taxes on the shares distributed to them
despite the fact that income tax was already paid by the Hong Kong
company. The petitioners paid the assessed amount in protest.
Petitioners 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, Commissioner Meer contends
that they were liquidating dividends.
Petitioners also contend that the earnings cannot be considered as
income from the Philippines because the sale was made outside the
2)
Philippines and is not subject to Philippine tax law
Issues:
1) WON the amount received by the petitioners were ordinary
dividends or liquidating dividends
2) WON such dividends were taxable
3) WON the profits realized by the non-resident alien
individual appellants constitute income from the Philippines
considering that the sale took place outside the Philippines
Ruling:
3)
1) The amount received were liquidating dividends.
Liquidating dividends involve the distribution of assets by a
corporation to its stockholders upon dissolution.
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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. 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.
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 really winding 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.
In the case at bar, it was stipulated in the deed of sale that
the sale and transfer of the corporation shall take effect on
June 1, 1937 while distribution took place on June 8. They
could not 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.
Yes. Petitioners received the said distributions in exchange
for the surrender and relinquishment by them of their stock
in the liquidated corporation. That money in the hands of
the corporation formed a part of its income and was
properly taxable to it under the Income Tax Law. When the
corporation was dissolved in the 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. The shareholder who received the
consideration for the stock earned received that money as
income of his own, which again was properly taxable to him
under the Income Tax Law.
Yes. At the time of the sale, the Hong Kong company was
engaged in its business in the Philippines. Its successor
was a domestic corporation and doing business also in the
Philippines. It must be taken into consideration that the
Hong Kong company was incorporated for the purpose of
carrying business in the Philippine Islands. Hence, its
12

earnings, profits and assets, including those from whose
proceeds the distribution was made, had been earned and
acquired in the Philippines. It is clear that the distributions
in questions were income ―from Philippine sources‖, hence,
taxable under Philippine law.
e. Exclusions
1. Retirement Benefits
RE: REQUEST OF ATTY. BERNARDO ZIALCITA
By: JM Banal
Facts:
The commutation of leave credits is commonly known as terminal
leave.
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. Atty. Zialcita
retired under the RA 660, which is incorporated in CA 186. Section
12(c) 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 GSIS, all
benefits granted under this Act, and all its forms and
documents required of the members shall be exempt from all
types of taxes, do ... xxx..
On August 23, 1990, the Court En Banc issued a resolution which
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.
Issue #1:
Whether terminal leave pay by virtue of compulsory retirement is
exempt from taxation?
Ruling:
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YES. 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. 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.
Section 28(b) 7(b) of the NIRC — Exclusions from gross income. —
The following items shall not be included in gross income and shall
be exempt from taxation under this title:
(7) Retirement benefits, pensions, gratuities, etc.
(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.
Within the purview of the 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.
ISSUE: RETIREMENT BENEFITS
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. 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.
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: ..." Executive Order No. 1077, removed 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.
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
13

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.
2. Income Derived by Government or Its Political Subdivisions
a. Withdrawal of Tax Exemption of PAGCOR
PAGCOR vs. BIR
By: Ana Grace Lapu
Facts:
The Philippine Amusement and Gaming Corporation (PAGCOR) was
created by P.D. No. 1067-A in 1977. Obviously, it is a government
owned and controlled corporation (GOCC).
In 1998, R.A. 8424 or the National Internal Revenue Code of 1997
(NIRC) became effective. Section 27 thereof provides that GOCC‘s
are NOT EXEMPT from paying income taxation but it exempted the
following GOCCs:
1. GSIS
2. SSS
3. PHILHEALTH
4. PCSO
5. PAGCOR
But in May 2005, R.A. 9337, a law amending certain provisions of
R.A. 8424, was passed. Section 1 thereof excluded PAGCOR from
the exempt GOCCs hence PAGCOR was subjected to pay income
taxation. In September 2005, the Bureau of Internal Revenue issued
the implementing rules and regulations (IRR) for R.A. 9337. In the
said IRR, it identified PAGCOR as subject to a 10% value added tax
(VAT) upon items covered by Section 108 of the NIRC (Sale of
Services and Use or Lease of Properties).
PAGCOR questions the constitutionality of Section 1 of R.A. 9337 as
well as the IRR. PAGCOR avers that the said provision violates the
equal protection clause. PAGCOR argues that it is similarly situated
with SSS, GSIS, PCSO, and PHILHEALTH, hence it should not be
excluded from the exemption.
Issue:
Whether or not PAGCOR should be subjected to income taxation.
Ruling: Yes.
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PAGCOR‘s contention that the law violated the constitution is not
tenable. The equal protection clause provides that all persons or
things similarly situated should be treated alike, both as to rights
conferred and responsibilities imposed.
The general rule is: ALL GOCC‘s are subject to income taxation.
However, certain classes of GOCC‘s may be exempt from income
taxation based on the following requisites for a valid classification
under the principle of equal protection:
1) It must be based on substantial distinctions.
2) It must be germane to the purposes of the law.
3) It must not be limited to existing conditions only.
4) It must apply equally to all members of the class.
The Supreme Court (SC) held that the omission of PAGCOR from
the list of tax-exempt GOCCs by RA 9337 does not violate the right
to equal protection of the laws under Section 1, Article III of the
Constitution, because PAGCOR‘s exemption from payment of
corporate income tax was not based on classification showing
substantial distinctions; rather, it was granted upon the corporation‘s
own request to be exempted from corporate income tax.
Legislative records likewise reveal that the legislative intention is to
require PAGCOR to pay corporate income tax.
With regard to the issue that the removal of PAGCOR from the
exempted list violates the non-impairment clause contained in
Section 10, Article III of the Constitution — which provides that no
law impairing the obligation of contracts shall be passed — the SC
explained that following its previous ruling in the case of Manila
Electric Company v. Province of Laguna 366 Phil. 428(1999), this
does not apply.
Franchises such as that granted to PAGCOR partake of the nature of
a grant, and is thus beyond the purview of the non-impairment clause
of the Constitution. As regards the liability of PAGCOR to VAT, the
SC finds (Section 4. 108-3) of Revenue Regulations No. (RR) 16-
2005, which subjects PAGCOR and its licensees and franchisees to
VAT, null and void for being contrary to the National Internal
Revenue Code (NIRC), as amended by RA 9337.
According to the SC, RA 9337 does not contain any provision that
subjects PAGCOR to VAT. Instead, the SC finds support to the
VAT exemption of PAGCOR under Section 109(k) of the Tax
Code, which provides that transactions exempt under
international agreements to which the Philippines is a signatory
or under special laws [except Presidential Decree No. (PD) 529]
are exempt from VAT. Considering that PAGCOR‘s charter, i.e.,
PD1869 — which grants PAGCOR exemption from taxes — is a
special law, it is exempt from payment of VAT. Accordingly, the SC
held that the BIR exceeded its authority in subjecting PAGCOR to
VAT, and thus declared RR 16-05 null and void — insofar as it
14

subjects PAGCOR to VAT — for being contrary to the NIRC, as
amended by RA 9337.
PAGCOR is subject to income tax but remains exempt from the
imposition of value-added tax.
With the amendment by R.A. No. 9337 of Section 27 (c) of the
National Internal Revenue Code of 1997 by omitting PAGCOR from
the list of government corporations exempt for income tax, the
legislative intent is to require PAGCOR to pay corporate income tax.
However, nowhere in R.A. No. 9337 is it provided that PAGCOR can
be subjected to VAT. Thus, the provision of RR No. 16-2005, which
the respondent BIR issued to implement the VAT law, subjecting
PAGCOR to 10% VAT is invalid for being contrary to R.A. No. 9337.
f. Income Tax Rates
2. Non-resident aliens engaged in trade or business
(Capital Gains-Real Property)
SMI-ED PHILIPPINES vs. CIR
By: Rea Romero
Facts:
SMI-Ed Philippines is a PEZA-registered corporation authorized ―to
engage in the business of manufacturing ultra high-density
microprocessor unit package. After its registration SMI-Ed Philippines
constructed buildings and purchased machineries and equipment.
SMI-Ed Philippines ―failed to commence operations.” Its factory
was temporarily closed, it sold its buildings and some of its
installed machineries and equipment to Ibiden Philippines, Inc.,
another PEZA-registered enterprise. SMI was subsequently
dissolved.
In its quarterly income tax return for year 2000, SMI-Ed Philippines
subjected the entire gross sales of its properties to 5% final tax
on PEZA-registered corporations. SMI-Ed Philippines paid taxes
amounting to P44,677,500.00.
After requesting the cancellation of its PEZA registration and
amending its articles of incorporation to shorten its corporate term,
SMI-Ed Philippines filed an administrative claim for the refund of
P44,677,500.00 with the Bureau of Internal Revenue (BIR). SMI-Ed
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Philippines alleged that the amount was erroneously paid. It also
alleged that it incurred a net loss of P2,233,464,538.00.
The BIR did not act on SMI-Ed Philippines‘ claim, which prompted
the latter to file a petition for review before the Court of Tax Appeals.
Court of Tax Appeals Second Division found that the fiscal incentives
given to PEZA-registered enterprises may be availed only by PEZA-
registered enterprises that had already commenced operations.
Since SMI-Ed Philippines had not commenced operations, it was not
entitled to the incentives of either the income tax holiday or the 5%
preferential tax rate. Payment of the 5% preferential tax amounting to
P44,677,500.00 was erroneous.
The Court of Tax Appeals Second Division subjected the sale of SMI-
Ed Philippines‘ assets to 6% capital gains tax under Section 27(D)(5)
of the same Code and Section 2 of Revenue Regulations No. 8-98. It
was found liable for capital gains tax amounting to
P53,613,000.00. Therefore, SMI-Ed Philippines must still pay the
balance of P8,935,500.00 as deficiency tax.
SMI-Ed Philippines filed a petition for review before the SC praying
for the grant of its claim for refund and the reversal of the Court of
Tax Appeals En Banc‘s decision.
Issue:
W/N the sale of SMI’s assets is subject to a 6% capital gains
tax? (YES, but only with respect to the land and buildings)
Ruling:
A Philippine Economic Zone Authority (PEZA)-registered corporation
that has never commenced operations may not avail the tax
incentives and preferential rates given to PEZA-registered
enterprises. Such corporation is subject to ordinary tax rates under
the National Internal Revenue Code of 1997. In this case, SMI never
commenced its operations.
The CTA found that the properties of SMI were subject to capital
gains tax. For petitioner‘s properties to be subjected to capital gains
tax, the properties must form part of petitioner‘s capital assets.
Section 39(A)(1) of the National Internal Revenue Code of 1997
defines ―capital assets‖:
SEC. 39. Capital Gains and Losses. -
(A) Definitions. - As used in this Title -
(1) Capital Assets. - the term ‗capital assets‘ means
property held by the taxpayer (whether or not connected
with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which would
15

properly be included in the inventory of the taxpayer if on
hand at the close of the taxable year, or property held by the
taxpayer primarily for sale to customers in the ordinary
course of his trade or business, or property used in the trade
or business, of a character which is subject to the allowance
for depreciation provided in Subsection (F) of Section 34; or
real property used in trade or business of the taxpayer.
Thus, ―capital assets‖ refers to taxpayer‘s property that is NOT any of
the following:
1. Stock in trade;
2. Property that should be included in the taxpayer‘s inventory
at the close of the taxable year;
3. Property held for sale in the ordinary course of the
taxpayer‘s business;
4. Depreciable property used in the trade or business; and
5. Real property used in the trade or business.
The properties involved in this case include petitioner‘s buildings,
equipment, and machineries. They are not among the exclusions
enumerated in Section 39(A)(1) of the National Internal Revenue
Code of 1997. Based on the definition of capital assets under
Section 39 of the National Internal Revenue Code of 1997, they
are capital assets.
Respondent (CIR) insists that since petitioner‘s machineries and
equipment are classified as capital assets, their sales should be
subject to capital gains tax. Respondent is mistaken.
Capital gains of individuals and corporations from the sale of real
properties are taxed differently.Individuals are taxed on capital gains
from sale of all real properties located in the Philippines and
classified as capital assets. Thus:
SEC. 24. Income Tax Rates.
(D) Capital Gains from Sale of Real Property. –
(1) In General. - The provisions of Section
39(B) notwithstanding, a final tax of six percent (6%) based
on the gross selling price or current fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, is hereby imposed upon capital gains
presumed to have been realized from the sale, exchange, or
other disposition of real property located in the Philippines,
classified as capital assets, including pacto de retro sales
and other forms of conditional sales, by individuals, including
estates and trusts: Provided, That the tax liability, if any, on
gains from sales or other dispositions of real property to the
government or any of its political subdivisions or agencies or
to government-owned or controlled corporations shall be
determined either under Section 24 (A) or under this
Subsection, at the option of the taxpayer
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For corporations, the National Internal Revenue Code of 1997 treats
the sale of land and buildings, and the sale of machineries and
equipment, differently. Domestic corporations are imposed a 6%
capital gains tax only on the presumed gain realized from the sale of
lands and/or buildings. The National Internal Revenue Code of 1997
does not impose the 6% capital gains tax on the gains realized from
the sale of machineries and equipment. Section 27(D)(5) of the
National Internal Revenue Code of 1997 provides:
SEC. 27. Rates of Income tax on Domestic Corporations.
-
. . . .
(D) Rates of Tax on Certain Passive Incomes. -
. . . .
(5) Capital Gains Realized from the Sale, Exchange or
Disposition of Lands and/or Buildings. - A final tax of six
percent (6%) is hereby imposed on the gain presumed to
have been realized on the sale, exchange or disposition of
lands and/or buildings which are not actually used in the
business of a corporation and are treated as capital assets,
based on the gross selling price of fair market value as
determined in accordance with Section 6(E) of this Code,
whichever is higher, of such lands and/or buildings.
(Emphasis supplied)
Therefore, only the presumed gain from the sale of petitioner‘s land
and/or building may be subjected to the 6% capital gains tax. The
income from the sale of petitioner‘s machineries and equipment is
subject to the provisions on normal corporate income tax.
To determine, therefore, if petitioner is entitled to refund, the amount
of capital gains tax for the sold land and/or building of petitioner and
the amount of corporate income tax for the sale of petitioner‘s
machineries and equipment should be deducted from the total final
tax paid.
iii. Corporations
1. Domestic Corporations (Special Domestic Corp. –
Proprietary Educational Institutions and Hospitals)
16

CIR vs. ST. LUKE'S
By: C.I. Jala
Facts:
(Re: Sec.30)
St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as
a non-stock and non-profit corporation.
On 16 December 2002, the Bureau of Internal Revenue (BIR)
assessed St. Luke's deficiency taxes amounting toP76,063,116.06
for 1998, comprised of deficiency income tax, value-added tax,
withholding tax on compensation and expanded withholding tax –
which was later on reduced to P63,935,351.57 during trial in the First
Division of the CTA.
On 14 January 2003, St. Luke's filed an administrative protest with
the BIR against the deficiency tax assessments.
BIR‘s contention: Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals,
should be applicable to St. Luke's. According to the BIR, Section
27(B), introduced in 1997, "is a new provision intended to amend the
exemption on non-profit hospitals that were previously categorized as
non-stock, non-profit corporations under Section 26 of the 1997 Tax
Code x x x." It is a specific provision which prevails over the general
exemption on income tax granted under Section 30(E) and (G) for
non-stock, non-profit charitable institutions and civic organizations
promoting social welfare.
The BIR claimed that St. Luke's was actually operating for profit in
1998 because only 13% of its revenues came from charitable
purposes. Moreover, the hospital's board of trustees, officers and
employees directly benefit from its profits and assets. St. Luke's had
total revenues of P1,730,367,965 or approximately P1.73 billion from
patient services in 1998.
BIR raised the effect of the introduction of Section 27(B) in the NIRC
of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption
of charitable and social welfare institutions. The 10% income tax rate
under Section 27(B) specifically pertains to proprietary educational
institutions and proprietary non-profit hospitals. The BIR argues that
Congress intended to remove the exemption that non-profit hospitals
previously enjoyed under Section 27(E) of the NIRC of 1977, which is
now substantially reproduced in Section 30(E) of the NIRC of
1997. Section 27(B) of the present NIRC provides:
SEC. 27. Rates of Income Tax on Domestic Corporations. -
xxxx
(B) Proprietary Educational Institutions and Hospitals. - Proprietary
educational institutions and hospitals which are non-profit shall pay a
tax of ten percent (10%) on their taxable income except those
covered by Subsection (D) hereof: Provided, That if the gross income
from unrelated trade, business or other activity exceeds fifty percent
(50%) of the total gross income derived by such educational
institutions or hospitals from all sources, the tax prescribed in
Subsection (A) hereof shall be imposed on the entire taxable income.
For purposes of this Subsection, the term 'unrelated trade, business
or other activity' means any trade, business or other activity, the
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conduct of which is not substantially related to the exercise or
performance by such educational institution or hospital of its primary
purpose or function. A 'proprietary educational institution' is any
private school maintained and administered by private individuals or
groups with an issued permit to operate from the Department of
Education, Culture and Sports (DECS), or the Commission on Higher
Education (CHED), or the Technical Education and Skills
Development Authority (TESDA), as the case may be, in accordance
with existing laws and regulations. (Emphasis supplied)
St. Luke's contention: BIR should not consider its total revenues,
because its free services to patients wasP218,187,498 or 65.20% of
its 1998 operating income (i.e., total revenues less operating
expenses) ofP334,642,615. St. Luke's also claimed that its income
does not inure to the benefit of any individual.
St. Luke's maintained that it is a non-stock and non-profit institution
for charitable and social welfare purposes under Section 30(E) and
(G) of the NIRC. It argued that the making of profit per se does not
destroy its income tax exemption.
St. Luke's claims tax exemption under Section 30(E) and (G) of the
NIRC. It contends that it is a charitable institution and an organization
promoting social welfare. The arguments of St. Luke's focus on the
wording of Section 30(E) exempting from income tax non-stock, non-
profit charitable institutions. 34 St. Luke's asserts that the legislative
intent of introducing Section 27(B) was only to remove the exemption
for "proprietary non-profit" hospitals. The relevant provisions of
Section 30 state:
SEC. 30. Exemptions from Tax on Corporations. - The following
organizations shall not be taxed under this Title in respect to income
received by them as such:
xxxx
(E) Nonstock corporation or association organized and operated
exclusively for religious, charitable, scientific, athletic, or cultural
purposes, or for the rehabilitation of veterans, no part of its net
income or asset shall belong to or inure to the benefit of any
member, organizer, officer or any specific person;
xxxx
(G) Civic league or organization not organized for profit but operated
exclusively for the promotion of social welfare;
xxxx
Notwithstanding the provisions in the preceding paragraphs, the
income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal, or from any of their
activities conducted for profit regardless of the disposition made of
such income, shall be subject to tax imposed under this Code.
(Emphasis supplied)
The CTA ruling: St. Luke's is a non-stock and non-profit charitable
institution covered by Section 30(E) and (G) of the NIRC. This ruling
would exempt all income derived by St. Luke's from services to its
patients, whether paying or non-paying. The CTA reiterated its earlier
decision in St. Luke's Medical Center, Inc. v. Commissioner of
Internal Revenue, which examined the primary purposes of St.
Luke's under its articles of incorporation and various
documents identifying St. Luke's as a charitable institution.
17

The CTA adopted the test in Hospital de San Juan de Dios, Inc. v.
Pasay City, which states that "a charitable institution does not lose
its charitable character and its consequent exemption from taxation
merely because recipients of its benefits who are able to pay are
required to do so, where funds derived in this manner are devoted to
the charitable purposes of the institution x x x." The generation of
income from paying patients does not per se destroy the charitable
nature of St. Luke's.
The CTA held that Section 27(B) of the present NIRC does not apply
to St. Luke's. The CTA explained that to apply the 10% preferential
rate, Section 27(B) requires a hospital to be "non-profit." On the other
hand, Congress specifically used the word "non-stock" to qualify a
charitable "corporation or association" in Section 30(E) of the NIRC.
Issue:
Whether St. Luke's is liable for deficiency income tax in 1998 under
Section 27(B) of the NIRC, which imposes a preferential tax rate of
10% on the income of proprietary non-profit hospitals.
Ruling: YES
Section 27(B) of the NIRC does not remove the income tax
exemption of proprietary non-profit hospitals under Section 30(E) and
(G). Section 27(B) on one hand, and Section 30(E) and (G) on the
other hand, can be construed together without the removal of such
tax exemption. The effect of the introduction of Section 27(B) is to
subject the taxable income of two specific institutions, namely,
proprietary non-profit educational institutions and proprietary non-
profit hospitals, among the institutions covered by Section 30, to the
10% preferential rate under Section 27(B) instead of the ordinary
30% corporate rate under the last paragraph of Section 30 in relation
to Section 27(A)(1).
Section 27(B) of the NIRC imposes a 10% preferential tax rate on the
income of (1) proprietary non-profit educational institutions and (2)
proprietary non-profit hospitals. The only qualifications for hospitals
are that they must be proprietary and non-profit. "Proprietary" means
private, following the definition of a "proprietary educational
institution" as "any private school maintained and administered by
private individuals or groups" with a government permit. "Non-profit"
means no net income or asset accrues to or benefits any member or
specific person, with all the net income or asset devoted to the
institution's purposes and all its activities conducted not for profit.
Thus, even if the charitable institution must be "organized and
operated exclusively" for charitable purposes, it is nevertheless
allowed to engage in "activities conducted for profit" without losing its
tax exempt status for its not-for-profit activities. The only
consequence is that the "income of whatever kind and character" of a
charitable institution "from any of its activities conducted for profit,
regardless of the disposition made of such income, shall be subject
to tax." Prior to the introduction of Section 27(B), the tax rate on such
income from for-profit activities was the ordinary corporate rate under
Section 27(A). With the introduction of Section 27(B), the tax rate is
now 10%.
St. Luke's fails to meet the requirements under Section 30(E) and (G)
of the NIRC to be completely tax exempt from all its income.
However, it remains a proprietary non-profit hospital under Section
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27(B) of the NIRC as long as it does not distribute any of its profits to
its members and such profits are reinvested pursuant to its corporate
purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to
the preferential tax rate of 10% on its net income from its for-profit
activities.
St. Luke's is therefore liable for deficiency income tax in 1998 under
Section 27(B) of the NIRC.
iii. Corporations
2. Domestic Corporations (Capital Gains)
SMI-ED PHILIPPINES vs CIR
Note! See same case under
c. Tax Treatment
iii. Capital Gains Tax
2. Real Property (Domestic Corp.)
iii. Corporations
3. Foreign Corporation
a. Resident Foreign Corp. (International
Carriers)
SOUTH AFRICAN AIRWAYS vs. CIR
By: Ellan Tingson
Facts:
Petitioner South African Airways is a foreign corporation organized
and existing under and by virtue of the laws of the Republic of South
Africa. Petitioner has a general sales agent in the Philippines, Aerotel
Limited Corporation (Aerotel). Aerotel sells passage documents for
compensation or commission for petitioners off-line flights for the
carriage of passengers and cargo between ports or points outside
the territorial jurisdiction of the Philippines. Petitioner is not registered
with the Securities and Exchange Commission as a corporation,
branch office, or partnership. It is not licensed to do business in the
Philippines.
For the taxable year 2000, petitioner filed separate quarterly and
annual income tax returns for its off-line flights.
On February 5, 2003, petitioner filed with the Bureau of Internal
Revenue, Revenue District Office No. 47, a claim for the refund of
the amount of PhP 1,727,766.38 as erroneously paid tax on Gross
Philippine Billings (GPB) for the taxable year 2000. Such claim was
unheeded. Thus, petitioner filed a Petition for Review with the CTA
for the refund of the abovementioned amount.
The CTA ruled that petitioner is a resident foreign corporation
engaged in trade or business in the Philippines. It further ruled that
petitioner was not liable to pay tax on its GPB under Section
28(A)(3)(a) of the National Internal Revenue Code (NIRC) of 1997.
18

The CTA, however, stated that petitioner is liable to pay a tax of 32%
on its income derived from the sales of passage documents in the
Philippines. On this ground, the CTA denied petitioners claim for a
refund.
Issue:
Whether or not petitioner, as an off-line international carrier selling
passage documents through an independent sales agent in the
Philippines, is engaged in trade or business in the Philippines subject
to the 32% income tax imposed by Section 28 (A)(1) of the 1997
NIRC.
Ruling:
Yes, the petitioner is liable for the 32% income tax.
Preliminarily, we emphasize that petitioner is claiming that it is
exempted from being taxed for its sale of passage documents in the
Philippines. Petitioner, however, failed to sufficiently prove such
contention.
Since an action for a tax refund partakes of the nature of an
exemption, which cannot be allowed unless granted in the most
explicit and categorical language, it is strictly construed against the
claimant who must discharge such burden convincingly.
It is petitioners contention that, with the new definition of GPB, it is no
longer liable under Sec. 28(A)(3)(a). Further, petitioner argues that
because the 2 1/2% tax on GPB is inapplicable to it, it is thereby
excluded from the imposition of any income tax.
The 1997 NIRC where Gross Philippine Billing is now defined under
Sec. 28(A)(3)(a):
Gross Philippine Billings refers to the amount of gross revenue
derived from carriage of persons, excess baggage, cargo and mail
originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of
payment of the ticket or passage document.
Now, it is the place of sale that is irrelevant; as long as the uplifts of
passengers and cargo occur to or from the Philippines, income is
included in GPB.
As correctly pointed out by petitioner, inasmuch as it does not
maintain flights to or from the Philippines, it is not taxable under Sec.
28(A)(3)(a) of the 1997 NIRC. But petitioner further posits the view
that due to the non-applicability of Sec. 28(A)(3)(a) to it, it is
precluded from paying any other income tax for its sale of passage
documents in the Philippines. Such position is untenable.
In Commissioner of Internal Revenue v. British Overseas Airways
Corporation (British Overseas Airways), which was decided under
similar factual circumstances, this Court ruled that off-line air carriers
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having general sales agents in the Philippines are engaged in or
doing business in the Philippines and that their income from sales of
passage documents here is income from within the Philippines. Thus,
in that case, we held the off-line air carrier liable for the 32% tax on
its taxable income.
Petitioners interpretation of Sec. 28(A)(3)(a) of the 1997 NIRC is that,
since it is an international carrier that does not maintain flights to or
from the Philippines, thereby having no GPB as defined, it is exempt
from paying any income tax at all. In other words, the existence of
Sec. 28(A)(3)(a) according to petitioner precludes the application of
Sec. 28(A)(1) to it.
We point out that Sec. 28(A)(3)(a) of the 1997 NIRC does not, in any
categorical term, exempt all international air carriers from the
coverage of Sec. 28(A)(1) of the 1997 NIRC. Certainly, had
legislatures intentions been to completely exclude all international air
carriers from the application of the general rule under Sec. 28(A)(1),
it would have used the appropriate language to do so; but the
legislature did not. Thus, the logical interpretation of such provisions
is that, if Sec. 28(A)(3)(a) is applicable to a taxpayer, then the
general rule under Sec. 28(A)(1) would not apply. If, however, Sec.
28(A)(3)(a) does not apply, a resident foreign corporation, whether
an international air carrier or not, would be liable for the tax under
Sec. 28(A)(1).
In the instant case, the general rule is that resident foreign
corporations shall be liable for a 32% income tax on their income
from within the Philippines, except for resident foreign corporations
that are international carriers that derive income from carriage of
persons, excess baggage, cargo and mail originating from the
Philippines which shall be taxed at 2 1/2% of their Gross Philippine
Billings. Petitioner, being an international carrier with no flights
originating from the Philippines, does not fall under the exception. As
such, petitioner must fall under the general rule.
To reiterate, the correct interpretation of the above provisions is that,
if an international air carrier maintains flights to and from the
Philippines, it shall be taxed at the rate of 2 1/2% of its Gross
Philippine Billings, while international air carriers that do not have
flights to and from the Philippines but nonetheless earn income from
other activities in the country will be taxed at the rate of 32% of such
income.
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CIR vs. BRITISH OVERSEAS
By: Maria Jessa G. Noble
Facts:
British Overseas Airways Corporation (BOAC) is a 100% British
Government-owned corporation organized and existing under the
laws of the United Kingdom. It is engaged in the international airline
business and is a member-signatory of the Interline Air Transport
Association (IATA). As such it operates air transportation service and
sells transportation tickets over the routes of the other airline
members. During the periods covered by the disputed assessments,
it is admitted that BOAC had no landing rights for traffic purposes in
the Philippines, and was not granted a Certificate of public
convenience and necessity to operate in the Philippines by the Civil
Aeronautics Board (CAB), except for a nine-month period, partly in
1961 and partly in 1962, when it was granted a temporary landing
permit by the CAB. Consequently, it did not carry passengers and/or
cargo to or from the Philippines, although during the period covered
by the assessments, it maintained a general sales agent in the
Philippines — Wamer Barnes and Company, Ltd., and later Qantas
Airways — which was responsible for selling BOAC tickets covering
passengers and cargoes.
The CIR assessed BOAC for deficiency taxes covering the years
1959 to 1967 and fiscal years 1968-1969 to 1970-1971.
BOAC contended that income derived from transportation is income
for services, with the result that the place where the services are
rendered determines the source. Since BOAC's service of
transportation is performed outside the Philippines, the income
derived is from sources without the Philippines and, therefore, not
taxable under our income tax laws.
Issues:
(1) Whether or not BOAC is a resident foreign corporation
(2) Whether or not the revenue from sales of tickets by BOAC in the
Philippines constitutes income from Philippine sources and,
accordingly, taxable under the Philippine income tax laws
Ruling:
(1) YES. Under Section 20 of the 1977 Tax Code:
(h) the term resident foreign corporation engaged in trade or
business within the Philippines or having an office or place of
business therein.
(i) The term "non-resident foreign corporation" applies to
a foreign corporation not engaged in trade or
business within the Philippines and not having any
office or place of business therein
BOAC is a resident foreign corporation. There is no specific criterion
as to what constitutes "doing" or "engaging in" or "transacting"
business. Each case must be judged in the light of its peculiar
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environmental circumstances. The term implies a continuity of
commercial dealings and arrangements, and contemplates, to that
extent, the performance of acts or works or the exercise of some of
the functions normally incident to, and in progressive prosecution of
commercial gain or for the purpose and object of the business
organization.
(2) YES. The source of an income is the property, activity or service
that produced the income. For the source of income to be
considered as coming from the Philippines, it is sufficient that the
income is derived from activity within the Philippines. In BOAC's case,
the sale of tickets in the Philippines is the activity that produces the
income. The tickets exchanged hands here and payments for fares
were also made here in Philippine currency. The site of the source of
payments is the Philippines. The flow of wealth proceeded from, and
occurred within, Philippine territory.
Unquestionably, the passage documentations in these cases were
sold in the Philippines and the revenue therefrom was derived from
an activity regularly pursued within the Philippines. And even if the
BOAC tickets sold covered the "transport of passengers and cargo to
and from foreign cities", it cannot alter the fact that income from the
sale of tickets was derived from the Philippines. The word "source"
conveys one essential idea, that of origin, and the origin of the
income herein is the Philippines.
The assessments upheld herein apply only to the fiscal years
covered by the questioned deficiency income tax assessments in
these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For,
pursuant to Presidential Decree No. 69, promulgated on 24
November, 1972, international carriers are now taxed as follows:
... Provided, however, That international carriers shall pay a
tax of 2-½ per cent on their cross Philippine billings. (Sec.
24[b] [21, Tax Code).
Presidential Decree No. 1355, promulgated on 21 April, 1978,
provided a statutory definition of the term "gross Philippine billings,"
thus:
... "Gross Philippine billings" includes gross revenue realized
from uplifts anywhere in the world by any international carrier
doing business in the Philippines of passage documents sold
therein, whether for passenger, excess baggage or mail
provided the cargo or mail originates from the Philippines. ...
The foregoing provision ensures that international airlines are taxed
on their income from Philippine sources. The 2-½ % tax on gross
Philippine billings is an income tax. If it had been intended as an
excise or percentage tax it would have been place under Title V of
the Tax Code covering Taxes on Business.
Note: The provision is now Section 28 (A) (3) of the NIRC which
states that:
SEC. 28. Rates of Income Tax on Foreign Corporations. –
(A) Tax on Resident Foreign Corporations. –
20

(3) International Carrier. - An international carrier doing
business in the Philippines shall pay a tax of two and one-half
percent (2 1/2%) on its "Gross Philippine Billings" as defined
hereunder:
(a) International Air Carrier. - "Gross Philippine
Billings" refers to the amount of gross revenue
derived from carriage of persons, excess baggage,
cargo and mail originating from the Philippines in a
continuous and uninterrupted flight, irrespective of
the place of sale or issue and the place of payment
of the ticket or passage document; Provided, That
tickets revalidated, exchanged and/or indorsed to
another international airline form part of the Gross
Philippine Billings if the passenger boards a plane in
a port or point in the Philippine; :Provided, further,
That for a flight which originates from the Philippines,
but transhipment of passenger takes place at any
port outside the Philippines on another airline, only
the aliquot portion of the cost of the ticket
corresponding to the leg flown from the Philippines
to the point of transhipment shall form part of Gross
Philippine Billings.
5. Exemptions from Tax on Corporations (Sec. 30)
CIR vs. ST. LUKE'S
By: C.I. Jala
Facts:
(copied from sec. 27 discussion)
St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as
a non-stock and non-profit corporation.
On 16 December 2002, the Bureau of Internal Revenue (BIR)
assessed St. Luke's deficiency taxes amounting toP76,063,116.06
for 1998, comprised of deficiency income tax, value-added tax,
withholding tax on compensation and expanded withholding tax –
which was later on reduced to P63,935,351.57 during trial in the First
Division of the CTA.
On 14 January 2003, St. Luke's filed an administrative protest with
the BIR against the deficiency tax assessments.
BIR‘s contention: Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals,
should be applicable to St. Luke's. According to the BIR, Section
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27(B), introduced in 1997, "is a new provision intended to amend the
exemption on non-profit hospitals that were previously categorized as
non-stock, non-profit corporations under Section 26 of the 1997 Tax
Code x x x." It is a specific provision which prevails over the general
exemption on income tax granted under Section 30(E) and (G) for
non-stock, non-profit charitable institutions and civic organizations
promoting social welfare.
The BIR claimed that St. Luke's was actually operating for profit in
1998 because only 13% of its revenues came from charitable
purposes. Moreover, the hospital's board of trustees, officers and
employees directly benefit from its profits and assets. St. Luke's had
total revenues of P1,730,367,965 or approximately P1.73 billion from
patient services in 1998.
BIR raised the effect of the introduction of Section 27(B) in the NIRC
of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption
of charitable and social welfare institutions. The 10% income tax rate
under Section 27(B) specifically pertains to proprietary educational
institutions and proprietary non-profit hospitals. The BIR argues that
Congress intended to remove the exemption that non-profit hospitals
previously enjoyed under Section 27(E) of the NIRC of 1977, which is
now substantially reproduced in Section 30(E) of the NIRC of 1997.
St. Luke's contention: BIR should not consider its total revenues,
because its free services to patients wasP218,187,498 or 65.20% of
its 1998 operating income (i.e., total revenues less operating
expenses) ofP334,642,615. St. Luke's also claimed that its income
does not inure to the benefit of any individual.
St. Luke's maintained that it is a non-stock and non-profit institution
for charitable and social welfare purposes under Section 30(E) and
(G) of the NIRC. It argued that the making of profit per se does not
destroy its income tax exemption.
St. Luke's claims tax exemption under Section 30(E) and (G) of the
NIRC. It contends that it is a charitable institution and an organization
promoting social welfare. The arguments of St. Luke's focus on the
wording of Section 30(E) exempting from income tax non-stock, non-
profit charitable institutions. St. Luke's asserts that the legislative
intent of introducing Section 27(B) was only to remove the exemption
for "proprietary non-profit" hospitals.
Issue:
Whether St. Luke's is tax exempt in all its income as provided under
Section 30(E) and (G) of the NIRC.
Ruling: NO
The Constitution exempts charitable institutions only from real
property taxes. In the NIRC, Congress decided to extend the
exemption to income taxes. However, the way Congress crafted
Section 30(E) of the NIRC is materially different from Section 28(3),
Article VI of the Constitution. Section 30(E) of the NIRC defines the
corporation or association that is exempt from income tax. On the
other hand, Section 28(3), Article VI of the Constitution does not
define a charitable institution, but requires that the institution "actually,
directly and exclusively" use the property for a charitable purpose.
Section 30(E) of the NIRC provides that a charitable institution must
be:
21

(1) A non-stock corporation or association;
(2) Organized exclusively for charitable purposes;
(3) Operated exclusively for charitable purposes; and
(4) No part of its net income or asset shall belong to or
inure to the benefit of any member, organizer, officer or any
specific person.
Thus, both the organization and operations of the charitable
institution must be devoted "exclusively" for charitable purposes. The
organization of the institution refers to its corporate form, as shown
by its articles of incorporation, by-laws and other constitutive
documents. Section 30(E) of the NIRC specifically requires that the
corporation or association be non-stock, which is defined by the
Corporation Code as "one where no part of its income is distributable
as dividends to its members, trustees, or officers" 49 and that any
profit "obtain[ed] as an incident to its operations shall, whenever
necessary or proper, be used for the furtherance of the purpose or
purposes for which the corporation was organized." 50 However,
under Lung Center, any profit by a charitable institution must not only
be plowed back "whenever necessary or proper," but must be
"devoted or used altogether to the charitable object which it is
intended to achieve."
The operations of the charitable institution generally refer to its
regular activities. Section 30(E) of the NIRC requires that these
operations be exclusive to charity. There is also a specific
requirement that "no part of [the] net income or asset shall belong to
or inure to the benefit of any member, organizer, officer or any
specific person." The use of lands, buildings and improvements of
the institution is but a part of its operations.
There is no dispute that St. Luke's is organized as a non-stock and
non-profit charitable institution. However, this does not automatically
exempt St. Luke's from paying taxes. This only refers to the
organization of St. Luke's. Even if St. Luke's meets the test of charity,
a charitable institution is not ipso facto tax exempt. To be exempt
from real property taxes, Section 28(3), Article VI of the Constitution
requires that a charitable institution use the property "actually,
directly and exclusively" for charitable purposes. To be exempt from
income taxes, Section 30(E) of the NIRC requires that a charitable
institution must be "organized and operated exclusively" for
charitable purposes. Likewise, to be exempt from income taxes,
Section 30(G) of the NIRC requires that the institution be "operated
exclusively" for social welfare.
However, the last paragraph of Section 30 of the NIRC qualifies the
words "organized and operated exclusively" by providing that:
Notwithstanding the provisions in the preceding paragraphs, the
income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal, or from any of their
activities conducted for profit regardless of the disposition made of
such income, shall be subject to tax imposed under this Code.
(Emphasis supplied)
In short, the last paragraph of Section 30 provides that if a tax
exempt charitable institution conducts "any" activity for profit, such
activity is not tax exempt even as its not-for-profit activities remain
tax exempt. This paragraph qualifies the requirements in Section
30(E) that the "[n]on-stock corporation or association [must be]
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organized and operated exclusively for x x x charitable x x x
purposes x x x." It likewise qualifies the requirement in Section 30(G)
that the civic organization must be "operated exclusively" for the
promotion of social welfare.
Thus, even if the charitable institution must be "organized and
operated exclusively" for charitable purposes, it is nevertheless
allowed to engage in "activities conducted for profit" without losing its
tax exempt status for its not-for-profit activities. The only
consequence is that the "income of whatever kind and character" of a
charitable institution "from any of its activities conducted for profit,
regardless of the disposition made of such income, shall be subject
to tax." Prior to the introduction of Section 27(B), the tax rate on such
income from for-profit activities was the ordinary corporate rate under
Section 27(A). With the introduction of Section 27(B), the tax rate is
now 10%.
The Court finds that St. Luke's is a corporation that is not "operated
exclusively" for charitable or social welfare purposes insofar as its
revenues from paying patients are concerned. This ruling is based
not only on a strict interpretation of a provision granting tax
exemption, but also on the clear and plain text of Section 30(E) and
(G). Section 30(E) and (G) of the NIRC requires that an institution be
"operated exclusively" for charitable or social welfare purposes to be
completely exempt from income tax. An institution under Section
30(E) or (G) does not lose its tax exemption if it earns income from
its for-profit activities. Such income from for-profit activities, under the
last paragraph of Section 30, is merely subject to income tax,
previously at the ordinary corporate rate but now at the preferential
10% rate pursuant to Section 27(B).
A tax exemption is effectively a social subsidy granted by the State
because an exempt institution is spared from sharing in the expenses
of government and yet benefits from them. Tax exemptions for
charitable institutions should therefore be limited to institutions
beneficial to the public and those which improve social welfare. A
profit-making entity should not be allowed to exploit this subsidy to
the detriment of the government and other taxpayers.
St. Luke's fails to meet the requirements under Section 30(E) and (G)
of the NIRC to be completely tax exempt from all its income.
However, it remains a proprietary non-profit hospital under Section
27(B) of the NIRC as long as it does not distribute any of its profits to
its members and such profits are reinvested pursuant to its corporate
purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to
the preferential tax rate of 10% on its net income from its for-profit
activities.
St. Luke's is therefore liable for deficiency income tax in 1998 under
Section 27(B) of the NIRC.
22

iv. Exclusions
7. Retirement Benefits, pensions, gratuities, separation
pay, etc.
COMMISSIONER OF INTERNAL REVENUE vs. THE HON. COURT
OF APPEALS, THE COURT OF TAX APPEALS, GCL
RETIREMENT PLAN
By: Mabelle Acosta
Facts:
GCL Retirement Plan 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 CIR in
accordance with Rep. Act No. 4917. In 1984, GCL made investments
and earned therefrom interest income from which was withheld the
fifteen per centum (15%) final withholding tax imposed by Pres.
Decree No. 1959, which took effect on 15 October 1984GCL filed
with CIR 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 P7,925.00withheld 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) of the Tax Code.
CIR – denied the refund, elevated the matter to CTA
CTA - 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.
CA - upheld the CTA Decision.
CIR‘s Contention - 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. CIR 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, CIR‘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.
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GCL contention - 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.
Issue: Whether GCL is exempted from Income Tax
Ruling:
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. 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, which took effect on 22 June 1957.
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.
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 deletion in Pres. Decree No. 1959 of the provisos
regarding tax exemption and preferential tax rates under the old law,
therefore, cannot be deemed to extent to employees' trusts. Said
Decree, being a general law, cannot 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. 1959on
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.
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 tax-exempt 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.
23
 TAXATION 1 CASE DIGESTS_ATTY. DONALVO_2016
SC ruled that Pres. Decree No. 1959 did not have the effect of citizen may look forward too is thus avoided. Terminal leave
revoking the tax exemption enjoyed by employees' trusts; reliance on payments are given not only at the same time but also for the same
those authorities is now misplaced. policy considering retirement benefits.‖

COMMISSIONER OF INTERNAL REVENUE vs. CA & EFREN RE: REQUEST OF ATTY. BERNARDO ZIALCITA
CASTANEDA
Note! See same case under:
By: Kathleen Rose Ching e. Exclusions
1. Retirement Benefits
Facts:

Respondent Castaneda retired from the government service as

Revenue Attache in the Philippine Embassy in London. Upon
retirement, he received, among other benefits, terminal leave pay
from which CIR withheld P12,557.13 allegedly representing income
tax thereon.

Castaneda filed a formal written claim with CIR for a refund of

P12,557.13, contending that the cash equivalent of his terminal leave
is exempt from income tax.

CTA ruled in favor of Castaneda and ordered CIR to refund the sum
of P12,557.13 withheld as income tax. CA affirmed.

CIR‘s contention: That the terminal leave pay is income derived from
employer-employee relationship; that as part of the compensation for
services rendered, terminal leave pay is actually part of gross income
of the recipient.

Issue:

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.

Ruling:

NO. SC ruled that the terminal leave pay received by a government

official or employee is not subject to withholding (income) tax. The
terminal leave pay is not part of the gross salary or income of a
government official or employee, but a retirement benefit, which is
not subject to income tax.

The rationale behind the employee‘s entitlement to an exemption

from withholding (income) tax on his terminal leave pay is 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. 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

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