2) The entrance fee should not be considered income since it is
COLLECTOR V. HENDERSON- Rental and Travel Allowance
are not Part of Taxable Income
FACTS:
• Sps. Arthur Henderson and Marie Henderson filed their annual
income tax with the BIR. Arthur is president of American
International Underwriters for the Philippines, Inc., which is a
domestic corporation engaged in the business of general non-life
insurance, and represents a group of American insurance
companies engaged in the business of general non-life
insurance.
• The BIR demanded payment for alleged deficiency taxes. In
their computation, the BIR included as part of taxable income: 1)
Arthur’s allowances for rental, residential expenses, subsistence,
water, electricity and telephone expenses 2) entrance fee to the
Marikina Gun and Country Club which was paid by his employer
for his account and 3) travelling allowance of his wife
• The taxpayers justifications are as follows:
1) as to allowances for rental and utilities, Arthur did not receive
money for the allowances. Instead, the apartment is furnished
and paid for by his employer-corporation (the mother company of
American International), for the employer corporation’s purposes.
The spouses had no choice but to live in the expensive
apartment, since the company used it to entertain guests, to
accommodate officials, and to entertain customers. According to
taxpayers, only P 4,800 per year is the reasonable amount that
the spouses would be spending on rental if they were not required
to live in those apartments. Thus, it is the amount they deem is
subject to tax. The excess is to be treated as expense of the
company.
an expense of his employer, and membership therein is merely
incidental to his duties of increasing and sustaining the business
of his employer.
3) His wife merely accompanied him to New York on a business
trip as his secretary, and at the employer-corporation’s request,
for the wife to look at details of the plans of a building that his
employer intended to construct. Such must not be considered
taxable income.
• The Collector of Internal Revenue merely allowed the entrance
fee as nontaxable. The rent expense and travel expenses were
still held to be taxable. The Court of Tax Appeals ruled in favor of
the taxpayers, that such expenses must not be considered part
of taxable income. Letters of the wife while in New York
concerning the proposed building were presented as evidence.
ISSUE: Whether or not the rental allowances and travel
allowances furnished and given by the employer-corporation are
part of taxable income?
HELD: NO. Such claims are substantially supported by evidence.
These claims are therefore NOT part of taxable income. No part
of the allowances in question redounded to their personal benefit,
nor were such amounts retained by them. These bills were paid
directly by the employer-corporation to the creditors. The rental
expenses and subsistence allowances are to be considered not
subject to income tax. Arthur’s high executive position and social
standing, demanded and compelled the couple to live in a more
spacious and expensive quarters. Such ‘subsistence allowance’
was a SEPARATE account from the account for salaries and
wages of employees. The company did not charge rentals as
deductible from the salaries of the employees. These expenses
are COMPANY EXPENSES, not income by employees which are
subject to tax.
G.R. No. L-12954 February 28, 1961
Less:Personal Exemption 2,500.00
COLLECTOR OF INTERNAL REVENUE, petitioner, ..............................
vs.
ARTHUR HENDERSON, respondent.
Amount subject to tax P27,073.79
x---------------------------------------------------------x .......................................
G.R. No. L-13049 February 28, 1961

ARTHUR HENDERSON, petitioner, 1949:

vs.
COLLECTOR OF INTERNAL REVENUE, respondent.
Net Income P31,817.66
Office of the Solicitor General for petitioner. .......................................................
Formilleza & Latorre for respondent.

PADILLA, J.: Less:Personal Exemption 2,500.00

..............................
These are petitioner filed by the Collector of Internal Revenue
(G.R. No. L-12954) and by Arthur Henderson (G.R. No. L-13049)
under the provisions of section 18, Republic Act No. 1125, for Amount subject to tax P29,317.66
review of a judgment dated 26 June 1957 and a resolution dated .......................................
28 September 1957 rendered and adopted by the Court of Tax
Appeals in Case No. 237.
1950:
The spouses Artuhur Henderson and Marie B. Henderson (later
referred to as the taxpayers) filed with the Bureau of Internal
Revenue returns of annual net income for the years 1948 to 1952,
Net Income P34,815.74
inclusive, where the following net incomes, personal exemptions
.......................................................
and amounts subject to tax appear:

1948: Less:Personal Exemption 3,000.00

..............................

Net Income P29,573.79

....................................................... Amount subject to tax P31,815.74
.......................................
 1951: 1948:

Net Income P32,605.83 14 May 1949, O.R. No. 52991, Exhibit B P2,068.12
........................................................ ....………..

Less:Personal Exemption 3,000.00 12 September 1950, O.R. No. 160473, 2,068.11

.............................. Exhibit B-1 .

Amount subject to tax P29,605.83 Total Paid P4,136.23

....................................... .........................................................

1952: 1949:

Net Income P36,780.11 13 May 1950, O.R. No. 232366, Exhibit G P2,314.95
....................................................... ...........…

Less:Personal Exemption 3,000.00 15 September 1950, O.R. No. 247918, 2,314.94

.............................. Exhibit G-1 .

Amount subject to tax P33,780.11 Total Paid P4,629.89

....................................... .........................................................

(Exhibits 1, 3, 5, 7, 9, A, F, J, N, R). In due time the taxpayers 1950:

received from the Bureau of Internal Revenue assessment
notices Nos. 15804-48, 25450-49, 15255-50, 25705-51 and
22527-52 and paid the amounts assessed as follows: 27 April 1951, O.R. No. 323173, Exhibit K P7,273.00
...……….
 On 28 November 1953, after investigation and verification, the
1951: Bureay of Internal Revenue reassessed the taxpayers'income for
the years 1948 to 1952, inclusive, as follows:

Amount withheld from salary and paid by P5,780.40

employer . 1948:

15 May 1952, O.R. No. 33250, Exhibit O 360.50 Net income per return
................. ..................................……………………… P29,573

15 August 1952, O.R. No. 383318, Exhibit 361.20 Add:

O-1 ..…..

Rent expense
Total Paid P6,502.10 .........................................................…….. 7,200.00
.........................................................

Additional bonus for 1947 received May 13, 1948 6,500.00

1952: .………

Amount withheld from salary and paid by P5,660.40 Other income:

employer .

Manager's residential expense (2/29/48 1,400.00

18 May 1953, O.R. No. 438026, Exhibit T 1,160.30 a/c/#4.51)
..…………

Manager's residential expense (refer to 1948 1,849.32

13 August 1953, O.R. No. 443483, Exhibit 1,160.30 P & L) ..
T-1 ...…..

Entrance fee — Marikina Gun & Country Club 200

Total Paid P7,981.00 ..……..
.........................................................
Net income per investigation P46,723.11 Capital loss (no capital gain)
.........................................………... ................... P3,248.84

Less: Personal exemption Undeclared bonus

...............................................………. 2,500.00 ...................………….. 3,857.75

Net taxable income Rental allowance from A.I.U.

..........................................................……… P44,223.11 ................... 1,800.00

Tax due thereon Subsistence allowance from

...............................................................……… P8,562.47 A.I.U. .…….. 6,051.30 14,958.09

Less: Amount of tax already paid per OR #52991 Net income per investigation P46,775.75
& 160473 .........................................………...
..……………………………………………………… 4,136.23

Less: Personal exemption 2,500.00

Deficiency tax still due & assessable ............................ P4,426.24 ...............................................………..

Amount of income subject to tax 43,275.75

..................................………….

1949:
Tax due thereon P8,292.21
...............................................................……….
Net income per return
..................................……………………… P31,817.66
Less: tax already assessed & paid per OR Nos. 4,629.89
232366 & 247918
Add: disallowances —
Deficiency tax due P3,662.23 Tax due thereon P10,296.00
............................................................………. ...............................................................……….

(Should be) 3,662.32 Less: tax already paid per OR No. #323173 7,273.00
......................................................................

Deficiency tax due & assessable P3,023.00

.................……………………..

1950:

Net income per return 1951:

..................................……………………… P34,815.74

Net income per return

Add: ..................................……………………… P32,605.83

Rent, electricity, water allowances Add: house rental allowance from AIU 5,782.91
.......................……….. 8,373.73

Net income per investigation

Net income per investigation P43,189.47 .........................................………... P83,388.74
.........................................………...

Less: Personal exemption

Less: Personal exemption 3,000.00 ...............................................……….. 3,000.00
...............................................………..

Amount of income subject to tax

Net taxable income P40,189.47 ..................................………….. P35,388.74
..........................................................………..
Tax due thereon Allowances for rent, telephone, water,
...............................................................………. P 8,560.00 electricity, etc. ..... 7,044.67

Less: tax already assessed and paid per O.R. Nos. Net income per investigation P47,672.18
A33250 .........................................………...
& 383318
.......................……………………………………… 6,502.00
Less: Personal exemption 3,000.00
...............................................………..
Deficiency tax due
.................………………………………………. P2,058.00
Net taxable income P44,672.18
..................................…………………………

Tax due thereon P12,089.00

1952: ...............................................................……….

Net income per return Less: Tax already withheld P5,660.40

..................................……………………… P36,780.11

Tax already paid per O.R. Nos. #438026,

Add: 443484 2,320.60 7,981.00

Withholding tax paid by company Deficiency tax still due & collectible P4,108.00
..................................... 600.00 ...............................…………

Travelling allowances (Exhibits 2, 4, 6, 8, 10) and demanded payment of thedeficiency

....................................................... 3,247.40 taxes on or before 28 February 1954 with respectto those due for
the years 1948, 1949, 1950 and 1952and on or before 15
February 1954 with respect to thatdue for the year 1951 (Exhibits
B-2, H, L, P, S).
In the foregoing assessments, the Bureau of InternalRevenue
considered as part of their taxable income thetaxpayer-husband's
allowances for rental, residential expenses,subsistence, water,
electricity and telephone; bonuspaid to him; withholding tax and
entrance fee to the Marikinagun and Country Bluc paid by his
employer for hisaccount; and travelling allowance of his wife. On
26 and27 January 1954 the taxpayers asked for
reconsiderationof the foregoing assessment (pp. 29, 31, BIR rec.)
andon 11 Februayr 1954 and 28 February 1955 stated
thegrounds and reasons in support of their request for
reconsideration (pp. 36-38, 62-66, BIR rec.). The claimthat as
regards the husband-taxpayer's allowances forrental and utilities
such as water, electricity and telephone,he did not receive the
money for said allowances, but thatthey lieved in the apartment
furnished and paid for byhis employer for its convenience; that
they had no choicebut live in the said apartment furnished by his
employer,otherwise they would have lived in a less expensive
one;that as regards his allowances for rental of P7,200
andresidential expenses of P1,400 and P1,849.32 in 1948,
rentalof P1,800 and subsistence of P6,051.50 (the latter
merelyconsisting of allowances for rent and utilities such as
light,water, telephone, etc.) in 1949 rental, electricity and waterof
P8,373.73 in 1950, rental of P5,782.91 in 1951 and
rental,telephone, water, electricity, etc. of P7,044.67 in 1952,
onlythe amount of P3,900 for each year, which is the amountthey
would have spent for rental of an apartment includingutilities,
should be taxed; that as regards the amount ofP200 representing
entrance fee to the Marikina Gun andCountry Club paid for him
by his employer in 1948, thesame should not be considered as
part of their income forit was an expense of his employer and his
membershiptherein was merely incidental to his duties of
increasingand sustaining the business of his employer; and that
asregards the wife-taxpayer's travelling allowance of P3,247.40
in 1952, it should not be considered as part of theirincome
because she merely accompanied him in his businesstrip to New
York as his secretary and, at the behestof her husband's
employer, to study and look into the detailsof the plans and
decorations of the building intendedto be constructed byn his
employer in its property at DeweyBoulevard. On 15 and 27
February 1954, the taxpayerspaid the deficiency taxes assessed
under Official ReceiptsNos. 451841, 451842, 451843, 451748
and 451844 (ExhibitsC, I, M, Q, and Y). After hearing conducted
by theConference Staff of the Bureau of Internal Revenue on5
October 1954 (pp. 74-85, BIR rec.), on 27 May 1955the Staff
recommended to the Collector of Internal Revenuethat the
assessments made on 28 November 1953 (Exhibits2, 4, 6, 8, 10)
be sustained except that the amountof P200 as entrance fee to
the Marikina Gun and CountryClub paid for the husband-
taxpayer's account by his employerin 1948 should not be
considered as part of thetaxpayers' taxable income for that year
(pp. 95-107, BIRrec.). On 14 July 1955, in line with the
recommendationof the Conference Staff, the Collector of Internal
Revenuedenied the taxpayers' request for reconsideration,
exceptas regards the assessment of their income tax due for
theyear 1948, which was modified as follows:
Net income per return P29,573.79
Add: Rent expense 7,200.00
Additional bonus for 1947
received on May 13, 1948 6,500.00
Manager's residential expense
(2/29/48 a/c #4.41) 1,400.00
Manager's residential expense
(1948 profit and loss) 1,849.32
Net income per investigation P46,523.11

Less: Personal exemption 2,500.00
Net taxable income P44,023.11
Tax due thereon P 8,506.47
Less; Amount already paid 4,136.23
Deficiency tax still due P 4,370.24
and demanded payment of the deficiency taxes of P4,370.24for
1948, P3,662.23 for 1949, P3,023 for 1950, P2,058 for1951 and
P4,108 for 1952, 5% surcharge and 1% monthlyinterest thereon
from 1 March 1954 to the date of paymentand P80 as
administrative penalty for late payment,to the City Treasurer of
Manila not later than 31 July1955 (Exhibit 14). On 30 January
1956 the taxpayersagain sought a reconsideration of the denial
of their requestfor reconsideration and offered to settle the case
ona more equitable basis by increasing the amount of thetaxable
portion of the husband-taxpayer's allowances forrental, etc. from
P3,000 yearly to P4,800 yearly, which "isthe value to the
employee of the benefits he derived therefrommeasured by what
he had saved on account thereof'in the ordinary course of his life
... for which hewould have spent in any case'". The taxpayers also
reiteratedtheir previous stand regarding the
transportationallowance of the wife-taxpayer of P3,247.40 in
1952 andrequested the refund of the amounts of P3,477.18,
P569.33,P1,294, P354 and P2,164, or a total of P7,858.51,
(Exhibit Z). On 10 February 1956 the taxpayers again
requestedthe Collector of Internal Revenue to refund to them
theamounts allegedly paid in excess as income taxes for
theyears 1948 to 1952, inclusive (Exhibit Z-1). The Collectorof
Internal Revenue did not take any action on the taxpayers'request
for refund.
On 15 February 1956 the taxpayers filed in the Courtof Tax
Appeals a petition to review the decision of theCollector of
Internal Revenue (C.T.A. Case No. 237). Afterhearing, on 26
June 1957 the Court rendered judgmentholding "that the inherent
nature of petitioner's(the husband-taxpayer) employment as
president of theAmerican International Underwriters as president
of theAmerican International Underwriters of the Philippines,Inc.
does not require him to occupy the apartments suppliedby his
employer-corporation;" that, however, onlythe amount of P4,800
annually, the ratable value to him ofthe quarters furnished
constitutes a part of taxable income;that since the taxpayers did
not receive any benefitout of the P3,247.40 traveling expense
allowance grantedin 1952 to the wife-taxpayer and that she
merely undertookthe trip abroad at the behest of her husband's
employer,the same could not be considered as income; andthat
even if it were considered as such, still it could not besubject to
tax because it was deductible as travel expense;and ordering the
Collector of Internal Revenue to refundto the taxpayers the
amount of P5,109.33 with interestfrom 27 February 1954, without
pronouncement as tocosts. The taxpayers filed a motion for
reconsiderationclaiming that the amount of P5,986.61 is the
amount refundableto them because the amounts of P1,400 and
P1,849.32 as manager's residential expenses in 1948 shouldnot
be included in their taxable net income for the reasonthat they are
of the same nature as the rentals for theapartment, they being
mainly expenses for utilities aslight, water and telephone in the
apartment furnished bythe husbant-taxpayer's employer. The
Collector of InternalRevenue filed an opposition to their motion
for reconsideration.He also filed a separate motion for
reconsiderationof the decision claiming that his assessmentunder
review was correct and should have been affirmed.The taxpayers
filed an opposition to this motion for reconsiderationof the
Collector of Internal Revenue; thelatter, a reply thereto. On 28
September 1957 the Courtdenied both motions for
reconsideration. On 7 October1957 the Collector of Internal
Revenue filed a notice ofappeal in the Court of Tax Appeals and
on 21 October1957, within the extension of time previously
granted bythis Court, a petition for review (G.R. No. L-12954).
On29 October 1957 the taxpayers filed a notice of appealin the
Court of Tax Appeals and a petition for review inthis Court (G.R.
No. L-13049).
The Collector of Internal Revenue had assigned the
followingerrors allegedly committed by the Court of TaxAppeals:
I. The Court of Tax Appeals erred in finding that theherein
respondent did not have any choice in the selection ofthe living
quarters occupied by him.
II. The Court of Tax Appeals erred in not consideringthe fact that
respondent is not a minor company official butthe President of his
employer-corporation, in the appreciationof respondent's alleged
lack of choice in the matter of the selectionof the quarters
occupied by him.
III. The Court of Tax Appeals erred in giving full weightand
credence to respondent's allegation, a self-serving and
unsupported declaration that the ratable value to him of the living
quarters and subsistence allowance was only P400.00 a month.
IV. The Court of Tax Appeals erred in holding that only the ratable
value of P4,800.00 per annum, or P400.00 a month constitutes
income to respondent.
V. The Court of Tax Appeals erred in arbitrarily fixing the amount
of P4,800.00 per annum, or P400.00 a month as the only amount
taxable aganst respondent during the five tax years in question.
VI. The Court of Tax Appeals erred in not finding that travelling
allowance in the amount of P3,247.40 constituted income to
respondent and, therefore, subject to the income tax.
VII. The Court of Tax Appeals erred in ordering the refund of the
sum of P5,109.33 with interest from February 17, 1954. (G.R. No.
L-12954.)
The taxpayers have assigned the following errors allegedly
committed by the Court of Tax Appeals:
I. The Court of Tax Appeals erred in its computation of the 1948
income tax and consequently in the amount that should be
refunded for that year.
II. The Court of Tax Appeals erred in denying our motion for
reconsideration as contained in its resolution dated September
28, 1957. (G.R. No. L-13049.)
The Government's appeal:
The Collector of Internal Revenue raises questions of fact. He
claims that the evidence is not sufficient to support the findings
and conclusion of the Court of Tax Appeals that the quarters
occupied by the taxpayers were not of their choice but that of the
husband-taxpayer's employer; that it did not take into
consideration the fact that the husband-taxpayer is not a mere
minor company official, but the highest executive of his employer-
corporation; and that the wife-taxpayer's trip abroad in 1952 was
not, as found by the Court, a business but a vacation trip. In
Collector of Internal Revenue vs. Aznar, 56, Off. Gaz. 2386, this
Court held that in petitions for review under section 18, Republic
Act No. 1125, it may review the findings of fact of the Court of Tax
Appeals.
The determination of the main issue in the case requires a review
of the evidence. Are the allowances for rental of the apartment
furnished by the husband-taxpayer's employer-corporation,
including utilities such as light, water, telephone, etc. and the
allowance for travel expenses given by his employer-corporation
to his wife in 1952 part of taxable income? Section 29,
Commonwealth Act No. 466, National Internal Revenue Code,
provides:
"Gross income" includes gains, profits, and income derived from
salaries, wages, or compensation for personal service of
whatever kind and in whatever form paid, or from professions,
vocations, trades, businesses, commerce, sales, or dealings in
property, whether real or personal, growing out of the ownership
or use of or interest in such property; also from interest, rents
dividend, securities, or the transaction of any business carried on
for gain or profit, or gains, profits, and income derived from any
source whatever. (Emphasis ours.)
The Court of Tax Appeals found that the husband-taxpayer "is the
president of the American International Underwriters for the
Philippines, Inc., a domestic corporation engaged in insurance
business;" that the taxpayers "entertained officials, guests and
customers of his employer-corporation, in apartments furnished
by the latter and successively occupied by him as president
thereof; that "In 1952, petitioner's wife, Mrs. Marie Henderson,
upon request o Mr. C. V. Starr, chairman of the parent corporation
of the American International Underwriters for the Philippines,
Inc., undertook a trip to New York in connection with the purchase
of a lot in Dewey Boulevardby petitioner's employer-corporatio,
the construction of a building thereon, the drawing of prospectus
and plans for said building, and other related matters."
Arthur H. Henderson testified that he is the President of American
International Underwriters for the Philippines, Inc., which
representa a group of American insurance companies engagad
in the business of general insurance except life insurance; that
he receives a basic annual salary of P30,000 and allowance for
house rental and utilities like light, water, telephone, etc.; that he
and his wife are childless and are the only two in the family; that
during the years 1948 to 1952, they lived in apartments chosen
by his employer; that from 1948 to the early part of 1950, they
lived at the Embassy Apartments on Dakota Street, Manila,
where they had a large sala, three bedrooms, dining room, two
bathrooms, kitchen and a large porch, and from the early part of
1950 to 1952, they lived at the Rosaria Apartments on the same
street where they had a kitchen, sala, dining room two bedrooms
and bathroom; that despite the fact that they were the only two in
the family, they had to live in apartments of the size beyond their
personal needs because as president of the corporation, he and
his wife had to entertain and put up houseguests; that during all
those years of 1948 to 1952, inclusive, they entertained and put
up houseguests of his company's officials, guests and customers
such as the president of C, V. Starr & Company, Inc., who spent
four weeks in his apartment, Thomas Cocklin, a lawyer from
Washington, D.C., and Manuel Elizalde, a stockholder of AIUPI;
that were he not required by his employer to live in those
apartments furnished to him, he and his wife would have chosen
an apartment only large enough for them and spend from P300
to P400 monthly for rental; that of the allowances granted to him,
only the amount of P4,800 annually, the maximum they would
have spent for rental, should be considered as taxable income
and the excess treated as expense of the company; and that the
trip to New York undertaken by his wife in 1952, for which she
was granted by his employer-corporation travelling expense
allowance of P3,247.40, was made at the behest of his employer
to assist its architect in the preparation of the plans for a proposed
building in Manila and procurement of supplies and materials for
its use, hence the said amount should not be considered as part
of taxable income. In support of his claim, letters written by his
wife while in New York concerning the proposed building,
inquiring about the progress made in the acquisition of the lot,
and informing him of the wishes of Mr. C. V. Starr, chairman of
the board of directors of the parent-corporation (Exhibits U-1, U-
1-A, V, V-1 and W) and a letter written by the witness to Mr. C. V.
Starr concerning the proposed building (Exhibits X, X-1) were
presented in evidence.
Mrs. Marie Henderson testified that for almost three years, she
and her husband gave parties every Friday night at their
apartment for about 18 to 20 people; that their guests were
officials of her husband's employer-corporation and other
corporations; that during those parties movies for the
entertainment of the guests were shown after dinner; that they
also entertained during luncheons and breakfasts; that these
involved and necessitated the services of additional servants;
and that in 1952 she was asked by Mr. C. V. Starr to come to New
York to take up problems concerning the proposed building and
entertainment because her husband could not make the trip
himself, and because "the woman of the family is closer to those
problems."
The evidence presented at the hearing of the case substantially
supports the findings of the Court of Tax Appeals. The taxpayers
are childless and are the only two in the family. The quarters,
therefore, that they occupied at the Embassy Apartments
consisting of a large sala, three bedrooms, dining room, two
bathrooms, kitchen and a large porch, and at the Rosaria
Apartments consisting of a kitchen, sala dining room, two
bedrooms and a bathroom, exceeded their personal needs. But
the exigencies of the husband-taxpayer's high executive position,
not to mention social standing, demanded and compelled them
to live in amore spacious and pretentious quarters like the ones
they had occupied. Although entertaining and putting up
houseguests and guests of the husbnad-taxpayer's employer-
corporation were not his predominand occupation as president,
yet he and his wife had to entertain and put up houseguests in
their apartments. That is why his employer-corporation had to
grant him allowances for rental and utilities in addition to his
annual basic salary to take care of those extra expenses for rental
and utilities in excess of their personal needs. Hence, the fact that
the taxpayers had to live or did not have to live in the apartments
chosen by the husband-taxpayer's employer-corporation is of no
moment, for no part of the allowances in question redounded to
their personal benefit or was retained by them. Their bills for
rental and utilities were paid directly by the employer-corporation
to the creditors (Exhibit AA to DDD, inclusive; pp. 104, 170-193,
t.s.n.). Neverthelss, as correctly held by the Court of Tax Appeals,
the taxpayers are entitled only to a ratable value of the
allowances in question, and only the amount of P4,800 annually,
the reasonable amount they would have spent for house rental
and utilities such as light, water, telephone, etc., should be the
amount subject to tax, and the excess considered as expenses
of the corporation.
Likewise, the findings of the Court of Tax Appeals that the wife-
taxpayer had to make the trip to New York at the behest of her
husband's employer-corporation to help in drawing up the plans
and specificatins of a proposed building, is also supported by the
evidence. The parts of the letters written by the wife-taxpayer to
her husband while in New York and the letter written by the
husband-taxpayer to Mr. C. V. Starr support the said findings
(Exhibits U-2, V-1, W-1, X). No part of the allowance for
travellking expenses redounded to the benefit of the taxpayers.
Neither was a part thereof retained by them. The fact that she had
herself operated on for tumors while in New York wsa but
incidental to her stay there and she must have merely taken
advantage of her presence in that city to undergo the operation.
The taxpayers' appeal:
The taxpayers claim that the Court of Tax Appeals erred in
considering the amounts of P1,400 and P1,849.32, or a total of
P3,249.32, for "manager's residential expense" in 1948 as
taxable income despite the fact "that they were of the same
nature as the rentals for the apartment, they being expenses for
utilities, such as light, water and telephone necessarily incidental
to the apartment furnished to him by his employer."
Mrs. Crescencia Perez Ramos, an examiner of the Bureau of
Internal Revenue who examined the books of accound of the
American International Underwriters for the Philippines, Inc.,
testified that he total amount of P3,249.32 was reflected in its
books as "living expenses of Mr. and Mrs. Arthur Henderson in
the quarters they occupied in 1948;" and that "the amount of
P1,400 was included as manager's residential expense while the
amount of P1,849.32 was entered as profit and loss account."
Buenaventura Loberiza, acting head of the accouting department
of the American International Underwriters for the Philippines,
Inc., testified that rentals, utilities, water, telephone and electric
bills of executives of the corporation were entered in the books of
account as "subsistence allowances and expenses;" that there
was a separate account for salaries and wages of employees and
officers; and that expenses for rentals and other utilities were not
charged to salary accounts.
The taxpayers' claim is supported by the evidence. The total
amount of P3,249.32 "for manager's residential expense" in 1948
should be treated as rentals for apartments and utilities and
should not form part of the ratable value subject to tax.
The computation made by the taxpayers is correct. Adding to the
amount of P29,573.79, their net income per return, the amount of
P6,500, the bonus received in 1948, and P4,800, the taxable
ratable value of the allowances, brings up their gross income to
P40,873.79. Deducting therefrom the amount of P2,500 for
personal exemption, the amount of P38,373.79 is the amount
subject to income tax. The income tax due on this amount is
P6,957.19 only. Deducting the amount of income tax due,
P6,957.19, from the amount already paid, P8,562.47 (Exhibits B,
B-1, C), the amount of P1,605.28 is the amount refundable to the
taxpayers. Add this amount to P563.33, P1,294.00, P354.00 and
P2,154.00, refundable to the taxpayers for 1949, 1950, 1951 and
1952 and the total is P5,986.61.
The judgment under review is modified as above indicated. The
Collector of Internal Revenue is ordered to refund to the
taxpayers the sum of P5,986.61, without pronouncement as to
costs.
GENERAL RULE: A stock dividend representing the transfer of
surplus to capital account shall not be subject to tax.
EXCEPTION: 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".
FACTS: -- reversal of the decision of the CA
• Don Andres Soriano, a citizen and resident of the United States,
formed the corporation "A. Soriano Y Cia", predecessor of
ANSCOR, with a P1,000,000.00 capitalization divided into 10,000
common shares at a par value of P100/share. ANSCOR is wholly
owned and controlled by the family of Don Andres, who are all
nonresident aliens.
• In 1937, Don Andres subscribed to 4,963 shares of the 5,000
shares originally issued. In 1945, ANSCOR's authorized capital
stock was increased to P2,500,000.00 divided into 25,000
common shares with the same par value. Don Andres' increased
his subscription to 14,963 common shares. A month later, Don
Andres transferred 1,250 shares each to his two sons, Jose and
Andres, Jr., as their initial investments in ANSCOR. Both sons
are foreigners.
• From 1947-1963, ANSCOR declared stock dividends. On
December 30, 1964 Don Andres died. As of that date, the records
revealed that he has a total shareholdings of 185,154 shares.
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.
• A day after Don Andres died, ANSCOR increased its capital
stock to P20M and in 1966 further increased it to P30M. Stock
dividends worth 46,290 and 46,287 shares were respectively
received by the Don Andres estate and Doña Carmen from
ANSCOR. Hence, increasing their accumulated shareholdings to
138,867 and 138,864 common shares each.
• 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 ANSCOR's
capital stock to P75M. About a year later, ANSCOR again
redeemed 80,000 common shares from the Don Andres' estate.
As stated in the Board Resolutions, 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.
• In 1973, after examining ANSCOR's 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.
ISSUE:
• Whether or not 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.
HELD:
• YES. The bone of contention is the interpretation and
application of Section 83(b) of the 1939 Revenue Act 38 which
provides:
• Sec. 83. Distribution of dividends or assets by corporations. —
(b) Stock dividends — A stock dividend representing the transfer
of surplus to capital account shall not be subject to tax. However,
if a corporation cancels or redeems stock issued as a dividend at
such time and in such manner as to make the distribution and
cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount so
distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent it represents a
distribution of earnings or profits accumulated after March first,
nineteen hundred and thirteen.
• Sec. 83(b) of the 1939 NIRC was taken from the Section
115(g)(1) of the U.S. Revenue Code of 1928. It 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. Specifically, the general rule states that: 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."
• The exception 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.
• 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. 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."
• Redemption is repurchase, a reacquisition of stock by a
corporation which issued the stock 89 in exchange for property,
whether or not the acquired stock is cancelled, retired or held in
the treasury. 90 Essentially, the corporation gets back some of its
stock, distributes cash or property to the shareholder in payment
for the stock, and continues in business as before. In the case,
ANSCOR redeemed shares twice. But where did the shares
redeemed come from? If its source is the original capital
subscriptions upon establishment of the corporation or from initial
capital investment in an existing enterprise, its redemption to the
concurrent value of acquisition may not invite the application of
Sec. 83(b) under the 1939 Tax Code, as it is not income but a
mere return of capital. On the contrary, if the redeemed shares
are from stock dividend declarations other than as initial capital
investment, the proceeds of the redemption is additional wealth,
for it is not merely a return of capital but a gain thereon.
• It is not the stock dividends but the proceeds of its redemption
that may be deemed as taxable dividends. At the time of the last
redemption, the original common shares owned by the estate
were only 25,247.5 91 This means that from the total of 108,000
shares redeemed from the estate, the balance of 82,752.5
(108,000 less 25,247.5) must have come from stock dividends.
In the absence of evidence to the contrary, the Tax Code
presumes that every distribution of corporate property, in whole
or in part, is made out of corporate profits such as stock
dividends. The capital cannot be distributed in the form of
redemption of stock dividends without violating the trust fund
doctrine.
• 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 issuance of stock dividends and its subsequent
redemption must be separate, distinct, and not related, for the
redemption to be considered a legitimate tax scheme.
Redemption cannot be used as a cloak to distribute corporate
earnings.
• ANSCOR invoked two reasons to justify the redemptions — (1)
the alleged "filipinization" program and (2) the reduction of foreign
exchange remittances in case cash dividends are declared. The
Court is not concerned with the wisdom of these purposes but on
their relevance to the whole transaction which can be inferred
from the outcome thereof. It is the "net effect rather than the
motives and plans of the taxpayer or his corporation". The test of
taxability under the exempting clause, when it provides "such
time and manner" as would make the redemption "essentially
equivalent to the distribution of a taxable dividend", is whether the
redemption resulted into a flow of wealth. If no wealth is realized
from the redemption, there may not be a dividend equivalence
treatment.
• The test of taxability under the exempting clause of Section
83(b) is, whether income was realized through the redemption of
stock dividends. The redemption converts into money the stock
dividends which become a realized profit or gain and
consequently, the stockholder's separate property. Profits
derived from the capital invested cannot escape income tax. As
realized income, the proceeds of the redeemed stock dividends
can be reached by income taxation regardless of the existence of
any business purpose for the redemption. Otherwise, to rule that
the said proceeds are exempt from income tax when the
redemption is supported by legitimate business reasons would
defeat the very purpose of imposing tax on income.

• The issuance and the redemption of stocks are two different

transactions. Although the existence of legitimate corporate
purposes may justify a corporation's acquisition of its own shares
under Section 41 of the Corporation Code, such purposes cannot
excuse the stockholder from the effects of taxation arising from
the redemption.

• Even if the said purposes support the redemption and justify the
issuance of stock dividends, the same has no bearing
whatsoever on the imposition of the tax herein assessed because
the proceeds of the redemption are deemed taxable dividends
since it was shown that income was generated therefrom.

• The proceeds thereof are essentially considered equivalent to a

distribution of taxable dividends. As "taxable dividend" under
Section 83(b), it is part of the "entire income" subject to tax under
Section 22 in relation to Section 21 120 of the 1939 Code.
Moreover, under Section 29(a) of said Code, dividends are
included in "gross income". As income, it is subject to income tax
which is required to be withheld at source.
G.R. No. 108576 January 20, 1999
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE COURT OF APPEALS, COURT OF TAX APPEALS and A.
SORIANO CORP., respondents.
MARTINEZ, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks the
reversal of the decision of the Court of Appeals (CA) 1 which
affirmed the ruling of the Court of Tax Appeals (CTA) 2 that
private respondent A. Soriano Corporation's (hereinafter
ANSCOR) redemption and exchange of the stocks of its foreign
stockholders cannot be considered as "essentially equivalent to
a distribution of taxable dividends" under, Section 83(b) of the
1939 Internal Revenue Act. 3
The undisputed facts are as follows:
Sometime in the 1930s, Don Andres Soriano, a citizen and
resident of the United States, formed the corporation "A. Soriano
Y Cia", predecessor of ANSCOR, with a P1,000,000.00
capitalization divided into 10,000 common shares at a par value
of P100/share. ANSCOR is wholly owned and controlled by the
family of Don Andres, who are all non-resident aliens. 4 In 1937,
Don Andres subscribed to 4,963 shares of the 5,000 shares
originally issued. 5
On September 12, 1945, ANSCOR's authorized capital stock was
increased to P2,500,000.00 divided into 25,000 common shares
with the same par value of the additional 15,000 shares, only
10,000 was issued which were all subscribed by Don Andres,
after the other stockholders waived in favor of the former their
pre-emptive rights to subscribe to the new issues. 6 This
increased his subscription to 14,963 common shares. 7 A month
later, 8 Don Andres transferred 1,250 shares each to his two
sons, Jose and Andres, Jr., as their initial investments in
ANSCOR. 9 Both sons are foreigners. 10
By 1947, ANSCOR declared stock dividends. Other stock
dividend declarations were made between 1949 and December
20, 1963. 11 On December 30, 1964 Don Andres died. As of that
date, the records revealed that he has a total shareholdings of
185,154 shares 12 — 50,495 of which are original issues and the
balance of 134.659 shares as stock dividend
13
declarations. Correspondingly, one-half of that shareholdings
or 92,577 14 shares were transferred to his wife, Doña Carmen
Soriano, as her conjugal share. The other half formed part of his
estate. 15
A day after Don Andres died, ANSCOR increased its capital stock
to P20M 16 and in 1966 further increased it to P30M. 17 In the
same year (December 1966), stock dividends worth 46,290 and
46,287 shares were respectively received by the Don Andres
estate 18 and Doña Carmen from ANSCOR. Hence, increasing
their accumulated shareholdings to 138,867 and
138,864 19 common shares each. 20
On December 28, 1967, Doña Carmen requested a ruling from
the United States Internal Revenue Service (IRS), inquiring if an
exchange of common with preferred shares may be considered
as a tax avoidance scheme 21 under Section 367 of the 1954 U.S.
Revenue Act. 22 By January 2, 1968, ANSCOR reclassified its
existing 300,000 common shares into 150,000 common and
150,000 preferred shares. 23
In a letter-reply dated February 1968, the IRS opined that the
exchange is only a recapitalization scheme and not tax
avoidance. 24 Consequently, 25 on March 31, 1968 Doña Carmen
exchanged her whole 138,864 common shares for 138,860 of the
newly reclassified preferred shares. The estate of Don Andres in
turn, exchanged 11,140 of its common shares, for the remaining
11,140 preferred shares, thus reducing its (the estate) common
shares to 127,727. 26
On June 30, 1968, pursuant to a Board Resolution, ANSCOR
redeemed 28,000 common shares from the Don Andres' estate.
By November 1968, the Board further increased ANSCOR's
capital stock to P75M divided into 150,000 preferred shares and
600,000 common shares. 27 About a year later, ANSCOR again
redeemed 80,000 common shares from the Don Andres'
estate, 28 further reducing the latter's common shareholdings to
19,727. As stated in the Board Resolutions, 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. 29
In 1973, after examining ANSCOR's books of account and
records, Revenue examiners issued a report proposing that
ANSCOR be assessed for deficiency withholding tax-at-source,
pursuant to Sections 53 and 54 of the 1939 Revenue Code, 30 for
the year 1968 and the second quarter of 1969 based on the
transactions of exchange 31 and redemption of stocks. 31 The
Bureau of Internal Revenue (BIR) made the corresponding
assessments despite the claim of ANSCOR that it availed of the
tax amnesty under Presidential Decree
32
(P.D.) 23 which were amended by P.D.'s 67 and
157. 33 However, petitioner ruled that the invoked decrees do not
cover Sections 53 and 54 in relation to Article 83(b) of the 1939
Revenue Act under which ANSCOR was
34
assessed. ANSCOR's subsequent protest on the assessments
was denied in 1983 by petitioner. 35
Subsequently, ANSCOR filed a petition for review with the CTA
assailing the tax assessments on the redemptions and exchange
of stocks. In its decision, the Tax Court reversed petitioner's
ruling, after finding sufficient evidence to overcome the prima
facie correctness of the questioned assessments. 36 In a petition
for review the CA as mentioned, affirmed the ruling of the
CTA. 37 Hence, this petition.
The bone of contention is the interpretation and application of
Section 83(b) of the 1939 Revenue Act 38 which provides:
Sec. 83. Distribution of dividends or assets by corporations. —
(b) Stock dividends — A stock dividend representing the transfer
of surplus to capital account shall not be subject to tax. However,
if a corporation cancels or redeems stock issued as a
dividend at such time and in such manner as to make the
distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the
amount so distributed in redemption or cancellation of the stock
shall be considered as taxable income to the extent it represents
a distribution of earnings or profits accumulated after March first,
nineteen hundred and thirteen. (Emphasis supplied)
Specifically, the issue is whether 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 the provisions of the above-
quoted law.
Petitioner contends that the exchange transaction a tantamount
to "cancellation" under Section 83(b) making the proceeds
thereof taxable. It also argues that the 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. 39
ANSCOR, however, avers that 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, 40 and to (b) subsequently "filipinized" ownership
of ANSCOR, as allegedly, envisioned by Don Andres. 41 It
likewise invoked the amnesty provisions of P.D. 67.
We must emphasize that the application of Sec. 83(b) depends
on the special factual circumstances of each case. 42 The findings
of facts of a special court (CTA) exercising particular expertise on
the subject of tax, generally binds this Court, 43 considering that
it is substantially similar to the findings of the CA which is the final
arbiter of questions of facts. 44 The issue in this case does not
only deal with facts but whether the law applies to a particular set
of facts. Moreover, this Court is not necessarily bound by the
lower courts' conclusions of law drawn from such facts. 45
AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D.
67 46 provides:
1. In all cases of voluntary disclosures of previously untaxed
income and/or wealth such as earnings, receipts, gifts, bequests
or any other acquisitions from any source whatsoever which are
taxable under the National Internal Revenue Code, as amended,
realized here or abroad by any taxpayer, natural or judicial; the
collection of all internal revenue taxes including the increments or
penalties or account of non-payment as well as all civil, criminal
or administrative liabilities arising from or incident to such
disclosures under the National Internal Revenue Code, the
Revised Penal Code, the Anti-Graft and Corrupt Practices Act,
the Revised Administrative Code, the Civil Service laws and
regulations, laws and regulations on Immigration and
Deportation, or any other applicable law or proclamation, are
hereby condoned and, in lieu thereof, a tax of ten (10%) per
centum on such previously untaxed income or wealth, is hereby
imposed, subject to the following conditions: (conditions omitted)
[Emphasis supplied].
The decree condones "the collection of all internal revenue taxes
including the increments or penalties or account of non-payment
as well as all civil, criminal or administrative liable arising from or
incident to" (voluntary) disclosures under the NIRC of previously
untaxed income and/or wealth "realized here or abroad by any
taxpayer, natural or juridical."
May the withholding agent, in such capacity, be deemed a
taxpayer for it to avail of the amnesty? An income taxpayer covers
all persons who derive taxable income. 47 ANSCOR was
assessed by petitioner for deficiency withholding tax under
Section 53 and 54 of the 1939 Code. As such, it is being held
liable in its capacity as a withholding agent and not its personality
as a taxpayer.
In the operation of the withholding tax system, the withholding
agent is the payor, a separate entity acting no more than an agent
of the government for the collection of the tax 48 in order to ensure
its payments; 49 the payer is the taxpayer — he is the person
subject to tax impose by law; 50 and the payee is the taxing
authority. 51 In other words, the withholding agent is merely a tax
collector, not a taxpayer. Under the withholding system, however,
the agent-payor becomes a payee by fiction of law. His (agent)
liability is direct and independent from the taxpayer, 52 because
the income tax is still impose on and due from the latter. The
agent is not liable for the tax as no wealth flowed into him — he
earned no income. The Tax Code only makes the agent
personally liable for the tax 53 arising from the breach of its legal
duty to withhold as distinguish from its duty to pay tax since:
the government's cause of action against the withholding is not
for the collection of income tax, but for the enforcement of the
withholding provision of Section 53 of the Tax Code, compliance
with which is imposed on the withholding agent and not upon the
taxpayer. 54
Not being a taxpayer, a withholding agent, like ANSCOR in this
transaction is not protected by the amnesty under the decree.
Codal provisions on withholding tax are mandatory and must be
complied with by the withholding agent. 55 The taxpayer should
not answer for the non-performance by the withholding agent of
its legal duty to withhold unless there is collusion or bad faith. The
former could not be deemed to have evaded the tax had the
withholding agent performed its duty. This could be the situation
for which the amnesty decree was intended. Thus, to curtail tax
evasion and give tax evaders a chance to reform, 56 it was
deemed administratively feasible to grant tax amnesty in certain
instances. In addition, a "tax amnesty, much like a tax exemption,
is never favored nor presumed in law and if granted by a statute,
the term of the amnesty like that of a tax exemption must be
construed strictly against the taxpayer and liberally in favor of the
taxing authority.57 The rule on strictissimi juris equally
58
applies. So that, any doubt in the application of an amnesty
law/decree should be resolved in favor of the taxing authority.
Furthermore, ANSCOR's claim of amnesty cannot prosper. The
implementing rules of P.D. 370 which expanded amnesty on
previously untaxed income under P.D. 23 is very explicit, to wit:
Sec. 4. Cases not covered by amnesty. — The following cases
are not covered by the amnesty subject of these regulations:
xxx xxx xxx
(2) Tax liabilities with or without assessments, on withholding tax
at source provided under Section 53 and 54 of the National
Internal Revenue Code, as amended; 59
ANSCOR was assessed under Sections 53 and 54 of the 1939
Tax Code. Thus, by specific provision of law, it is not covered by
the amnesty.
TAX ON STOCK DIVIDENDS
General Rule
Sec. 83(b) of the 1939 NIRC was taken from the Section
115(g)(1) of the U.S. Revenue Code of 1928. 60 It laid down the
general rule known as the proportionate test 61 wherein stock
dividends once issued form part of the capital and, thus, subject
to income tax.62 Specifically, the general rule states that:
A stock dividend representing the transfer of surplus to capital
account shall not be subject to tax.
Having been derived from a foreign law, resort to the
jurisprudence of its origin may shed light. Under the US Revenue
Code, this provision originally referred to "stock dividends" only,
without any exception. Stock dividends, strictly speaking,
represent capital and do not constitute income to its
recipient. 63 So that the mere issuance thereof is not yet subject
to income tax 64 as they are nothing but an "enrichment through
increase in value of capital
65
investment." As capital, the stock dividends postpone the
realization of profits because the "fund represented by the new
stock has been transferred from surplus to capital and no longer
available for actual distribution." 66 Income in tax law is "an
amount of money coming to a person within a specified time,
whether as payment for services, interest, or profit from
investment." 67 It means cash or its equivalent. 68 It is gain
derived and severed from capital, 69 from labor or from both
combined 70 — so that to tax a stock dividend would be to tax a
capital increase rather than the income. 71 In a loose sense, stock
dividends issued by the corporation, are considered unrealized
gain, and cannot be subjected to income tax until that gain has
been realized. Before the realization, stock dividends are nothing
but a representation of an interest in the corporate
properties. 72 As capital, it is not yet subject to income tax. It
should be noted that capital and income are different. Capital is
wealth or fund; whereas income is profit or gain or the flow of
wealth. 73 The determining factor for the imposition of income tax
is whether any gain or profit was derived from a transaction. 74
The Exception
However, if a corporation cancels or redeems stock issued as
a dividend at such time and in such manner as to make
the distribution and cancellation or redemption, in whole or in
part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation
of the stock shall be considered as taxable income to the extent
it represents a distribution of earnings or profits accumulated after
March first, nineteen hundred and thirteen. (Emphasis supplied).
In a response to the ruling of the American Supreme Court in the
case of Eisner v. Macomber 75 (that pro rata stock dividends are
not taxable income), the exempting clause above quoted was
added because provision corporation found a loophole in the
original provision. They resorted to devious means to circumvent
the law and evade the tax. Corporate earnings would be
distributed under the guise of its initial capitalization by declaring
the stock dividends previously issued and later redeem said
dividends by paying cash to the stockholder. This process of
issuance-redemption amounts to a distribution of taxable cash
dividends which was lust delayed so as to escape the tax. It
becomes a convenient technical strategy to avoid the effects of
taxation.
Thus, to plug the loophole — the exempting clause was added. It
provides that the redemption or cancellation of stock dividends,
depending on the "time" and "manner" it was made, is essentially
equivalent to a distribution of taxable dividends," making the
proceeds thereof "taxable income" "to the extent it represents
profits". The exception was designed to prevent the issuance and
cancellation or redemption of stock dividends, which is
fundamentally not taxable, from being made use of as a device
for the actual distribution of cash dividends, which is
taxable. 76 Thus,
the provision had the obvious purpose of preventing a corporation
from avoiding dividend tax treatment by distributing earnings to
its shareholders in two transactions — a pro rata stock dividend
followed by a pro rata redemption — that would have the same
economic consequences as a simple dividend. 77
Although redemption and cancellation are generally considered
capital transactions, as such. they are not subject to tax.
However, it does not necessarily mean that a shareholder may
not realize a taxable gain from such transactions. 78 Simply put,
depending on the circumstances, the proceeds of redemption of
stock dividends are essentially distribution of cash dividends,
which when paid becomes the absolute property of the
stockholder. Thereafter, the latter becomes the exclusive owner
thereof and can exercise the freedom of choice. 79 Having
realized gain from that redemption, the income earner cannot
escape income tax. 80
As qualified by the phrase "such time and in such manner," the
exception was not intended to characterize as taxable dividend
every distribution of earnings arising from the redemption of stock
dividend. 81 So that, whether the amount distributed in the
redemption should be treated as the equivalent of a "taxable
dividend" is a question of fact, 82 which is determinable on "the
basis of the particular facts of the transaction in question. 83 No
decisive test can be used to determine the application of the
exemption under Section 83(b). The use of the words "such
manner" and "essentially equivalent" negative any idea that a
weighted formula can resolve a crucial issue — Should the
distribution be treated as taxable dividend. 84 On this aspect,
American courts developed certain recognized criteria, which
includes the following: 85
1) the presence or absence of real business purpose,
2) the amount of earnings and profits available for the declaration
of a regular dividends and the corporation's past record with
respect to the declaration of dividends,
3) the effect of the distribution, as compared with the declaration
of regular dividend,
86
4) the lapse of time between issuance and redemption,
5) the presence of a substantial surplus 87 and a generous supply
of cash which invites suspicion as does a meager policy in
relation both to current earnings and accumulated surplus, 88
REDEMPTION AND CANCELLATION
For the exempting clause of Section, 83(b) to apply, it is
indispensable that: (a) there is redemption or cancellation; (b) the
transaction involves stock dividends and (c) the "time and
manner" of the transaction makes it "essentially equivalent to a
distribution of taxable dividends." Of these, the most important is
the third.
Redemption is repurchase, a reacquisition of stock by a
corporation which issued the stock 89 in exchange for property,
whether or not the acquired stock is cancelled, retired or held in
the treasury. 90 Essentially, the corporation gets back some of its
stock, distributes cash or property to the shareholder in payment
for the stock, and continues in business as before. The
redemption of stock dividends previously issued is used as a veil
for the constructive distribution of cash dividends. In the instant
case, there is no dispute that ANSCOR redeemed shares of
stocks from a stockholder (Don Andres) twice (28,000 and 80,000
common shares). But where did the shares redeemed come
from? If its source is the original capital subscriptions upon
establishment of the corporation or from initial capital investment
in an existing enterprise, its redemption to the concurrent value
of acquisition may not invite the application of Sec. 83(b) under
the 1939 Tax Code, as it is not income but a mere return of
capital. On the contrary, if the redeemed shares are from stock
dividend declarations other than as initial capital investment, the
proceeds of the redemption is additional wealth, for it is not
merely a return of capital but a gain thereon.
It is not the stock dividends but the proceeds of its redemption
that may be deemed as taxable dividends. Here, it is undisputed
that at the time of the last redemption, the original common
shares owned by the estate were only 25,247.5 91 This means
that from the total of 108,000 shares redeemed from the estate,
the balance of 82,752.5 (108,000 less 25,247.5) must have come
from stock dividends. Besides, in the absence of evidence to the
contrary, the Tax Code presumes that every distribution of
corporate property, in whole or in part, is made out of corporate
profits 92 such as stock dividends. The capital cannot be
distributed in the form of redemption of stock dividends without
violating the trust fund doctrine — wherein the capital stock,
property and other assets of the corporation are regarded as
equity in trust for the payment of the corporate creditors. 93 Once
capital, it is always capital. 94 That doctrine was intended for the
protection of corporate creditors. 95
With respect to the third requisite, ANSCOR redeemed stock
dividends issued just 2 to 3 years earlier. The time alone that
lapsed from the issuance to the redemption is not a sufficient
indicator to determine taxability. It is a must to consider the factual
circumstances as to the manner of both the issuance and the
redemption. The "time" element is a factor to show a device to
evade tax and the scheme of cancelling or redeeming the same
shares is a method usually adopted to accomplish the end
sought. 96 Was this transaction used as a "continuing plan,"
"device" or "artifice" to evade payment of tax? It is necessary to
determine the "net effect" of the transaction between the
shareholder-income taxpayer and the acquiring (redeeming)
corporation. 97 The "net effect" test is not evidence or testimony
to be considered; it is rather an inference to be drawn or a
conclusion to be reached. 98 It is also important to know whether
the issuance of stock dividends was dictated by legitimate
business reasons, the presence of which might negate a tax
evasion plan. 99
The issuance of stock dividends and its subsequent redemption
must be separate, distinct, and not related, for the redemption to
be considered a legitimate tax scheme. 100 Redemption cannot
be used as a cloak to distribute corporate
earnings. 101 Otherwise, the apparent intention to avoid tax
becomes doubtful as the intention to evade becomes manifest. It
has been ruled that:
[A]n operation with no business or corporate purpose — is a mere
devise which put on the form of a corporate reorganization as a
disguise for concealing its real character, and the sole object and
accomplishment of which was the consummation of a
preconceived plan, not to reorganize a business or any part of a
business, but to transfer a parcel of corporate shares to a
stockholder. 102
Depending on each case, the exempting provision of Sec. 83(b)
of the 1939 Code may not be applicable if the redeemed shares
were issued with bona fide business purpose, 103 which is judged
after each and every step of the transaction have been
considered and the whole transaction does not amount to a tax
evasion scheme.
ANSCOR invoked two reasons to justify the redemptions — (1)
the alleged "filipinization" program and (2) the reduction of foreign
exchange remittances in case cash dividends are declared. The
Court is not concerned with the wisdom of these purposes but on
their relevance to the whole transaction which can be inferred
from the outcome thereof. Again, it is the "net effect rather than
the motives and plans of the taxpayer or his corporation" 104 that
is the fundamental guide in administering Sec. 83(b). This tax
provision is aimed at the result. 105 It also applies even if at the
time of the issuance of the stock dividend, there was no intention
to redeem it as a means of distributing profit or avoiding tax on
dividends. 106 The existence of legitimate business purposes in
support of the redemption of stock dividends is immaterial in
income taxation. It has no relevance in determining "dividend
equivalence". 107 Such purposes may be material only upon the
issuance of the stock dividends. The test of taxability under the
exempting clause, when it provides "such time and manner" as
would make the redemption "essentially equivalent to the
distribution of a taxable dividend", is whether the redemption
resulted into a flow of wealth. If no wealth is realized from the
redemption, there may not be a dividend equivalence treatment.
In the metaphor of Eisner v. Macomber, income is not deemed
"realize" until the fruit has fallen or been plucked from the tree.
The three elements in the imposition of income tax are: (1) there
must be gain or and profit, (2) that the gain or profit is realized or
received, actually or constructively, 108 and (3) it is not exempted
by law or treaty from income tax. Any business purpose as to why
or how the income was earned by the taxpayer is not a
requirement. Income tax is assessed on income received from
any property, activity or service that produces the income
because the Tax Code stands as an indifferent neutral party on
the matter of where income comes
from. 109
As stated above, the test of taxability under the exempting clause
of Section 83(b) is, whether income was realized through the
redemption of stock dividends. The redemption converts into
money the stock dividends which become a realized profit or gain
and consequently, the stockholder's separate property. 110 Profits
derived from the capital invested cannot escape income tax. As
realized income, the proceeds of the redeemed stock dividends
can be reached by income taxation regardless of the existence of
any business purpose for the redemption. Otherwise, to rule that
the said proceeds are exempt from income tax when the
redemption is supported by legitimate business reasons would
defeat the very purpose of imposing tax on income. Such
argument would open the door for income earners not to pay tax
so long as the person from whom the income was derived has
legitimate business reasons. In other words, the payment of tax
under the exempting clause of Section 83(b) would be made to
depend not on the income of the taxpayer, but on the business
purposes of a third party (the corporation herein) from whom the
income was earned. This is absurd, illogical and impractical
considering that the Bureau of Internal Revenue (BIR) would be
pestered with instances in determining the legitimacy of business
reasons that every income earner may interposed. It is not
administratively feasible and cannot therefore be allowed.
The ruling in the American cases cited and relied upon by
ANSCOR that "the redeemed shares are the equivalent of
dividend only if the shares were not issued for genuine business
purposes", 111 or the "redeemed shares have been issued by a
corporation bona fide" 112 bears no relevance in determining the
non-taxability of the proceeds of redemption ANSCOR, relying
heavily and applying said cases, argued that so long as the
redemption is supported by valid corporate purposes the
proceeds are not subject to tax. 113 The adoption by the courts
below 114 of such argument is misleading if not misplaced. A
review of the cited American cases shows that the presence or
absence of "genuine business purposes" may be material with
respect to the issuance or declaration of stock dividends but not
on its subsequent redemption. The issuance and the redemption
of stocks are two different transactions. Although the existence of
legitimate corporate purposes may justify a corporation's
acquisition of its own shares under Section 41 of the Corporation
Code, 115 such purposes cannot excuse the stockholder from the
effects of taxation arising from the redemption. If the issuance of
stock dividends is part of a tax evasion plan and thus, without
legitimate business reasons, the redemption becomes suspicious
which exempting clause. The substance of the whole transaction,
not its form, usually controls the tax consequences. 116
The two purposes invoked by ANSCOR, under the facts of this
case are no excuse for its tax liability. First, the alleged
"filipinization" plan cannot be considered legitimate as it was not
implemented until the BIR started making assessments on the
proceeds of the redemption. Such corporate plan was not stated
in nor supported by any Board Resolution but a mere afterthought
interposed by the counsel of ANSCOR. Being a separate entity,
the corporation can act only through its Board of
Directors. 117 The Board Resolutions authorizing the redemptions
state only one purpose — reduction of foreign exchange
remittances in case cash dividends are declared. Not even this
purpose can be given credence. Records show that despite the
existence of enormous corporate profits no cash dividend was
ever declared by ANSCOR from 1945 until the BIR started
making assessments in the early 1970's. Although a corporation
under certain exceptions, has the prerogative when to issue
dividends, yet when no cash dividends was issued for about three
decades, this circumstance negates the legitimacy of ANSCOR's
alleged purposes. Moreover, to issue stock dividends is to
increase the shareholdings of ANSCOR's foreign stockholders
contrary to its "filipinization" plan. This would also increase rather
than reduce their need for foreign exchange remittances in case
of cash dividend declaration, considering that ANSCOR is a
family corporation where the majority shares at the time of
redemptions were held by Don Andres' foreign heirs.
Secondly, assuming arguendo, that those business purposes are
legitimate, the same cannot be a valid excuse for the imposition
of tax. Otherwise, the taxpayer's liability to pay income tax would
be made to depend upon a third person who did not earn the
income being taxed. Furthermore, even if the said purposes
support the redemption and justify the issuance of stock
dividends, the same has no bearing whatsoever on the imposition
of the tax herein assessed because the proceeds of the
redemption are deemed taxable dividends since it was shown
that income was generated therefrom.
Thirdly, ANSCOR argued that to treat as "taxable dividend" the
proceeds of the redeemed stock dividends would be to impose
on such stock an undisclosed lien and would be extremely unfair
to intervening purchase, i.e. those who buys the stock dividends
after their issuance. 118 Such argument, however, bears no
relevance in this case as no intervening buyer is involved. And
even if there is an intervening buyer, it is necessary to look into
the factual milieu of the case if income was realized from the
transaction. Again, we reiterate that the dividend equivalence test
depends on such "time and manner" of the transaction and its net
effect. The undisclosed lien 119 may be unfair to a subsequent
stock buyer who has no capital interest in the company. But the
unfairness may not be true to an original subscriber like Don
Andres, who holds stock dividends as gains from his investments.
The subsequent buyer who buys stock dividends is investing
capital. It just so happen that what he bought is stock dividends.
The effect of its (stock dividends) redemption from that
subsequent buyer is merely to return his capital subscription,
which is income if redeemed from the original subscriber.
After considering the manner and the circumstances by which the
issuance and redemption of stock dividends were made, there is
no other conclusion but that the proceeds thereof are essentially
considered equivalent to a distribution of taxable dividends. As
"taxable dividend" under Section 83(b), it is part of the "entire
income" subject to tax under Section 22 in relation to Section
21 120 of the 1939 Code. Moreover, under Section 29(a) of said
Code, dividends are included in "gross income". As income, it is
subject to income tax which is required to be withheld at source.
The 1997 Tax Code may have altered the situation but it does not
change this disposition.
EXCHANGE OF COMMON WITH PREFERRED SHARES 121
Exchange is an act of taking or giving one thing for another
involving 122 reciprocal transfer 123 and is generally considered as
a taxable transaction. The exchange of common stocks with
preferred stocks, or preferred for common or a combination of
either for both, may not produce a recognized gain or loss, so
long as the provisions of Section 83(b) is not applicable. This is
true in a trade between two (2) persons as well as a trade
between a stockholder and a corporation. In general, this trade
must be parts of merger, transfer to controlled corporation,
corporate acquisitions or corporate reorganizations. No taxable
gain or loss may be recognized on exchange of property, stock
or securities related to reorganizations. 124
Both the Tax Court and the Court of Appeals found that ANSCOR
reclassified its shares into common and preferred, and that parts
of the common shares of the Don Andres estate and all of Doña
Carmen's shares were exchanged for the whole 150.000
preferred shares. Thereafter, both the Don Andres estate and
Doña Carmen remained as corporate subscribers except that
their subscriptions now include preferred shares. There was no
change in their proportional interest after the exchange. There
was no cash flow. Both stocks had the same par value. Under the
facts herein, any difference in their market value would be
immaterial at the time of exchange because no income is yet
realized — it was a mere corporate paper transaction. It would
have been different, if the exchange transaction resulted into a
flow of wealth, in which case income tax may be imposed. 125
Reclassification of shares does not always bring any substantial
alteration in the subscriber's proportional interest. But the
exchange is different — there would be a shifting of the balance
of stock features, like priority in dividend declarations or absence
of voting rights. Yet neither the reclassification nor exchange per
se, yields realize income for tax purposes. A common stock
represents the residual ownership interest in the corporation. It is
a basic class of stock ordinarily and usually issued without
extraordinary rights or privileges and entitles the shareholder to
a pro rata division of profits. 126 Preferred stocks are those which
entitle the shareholder to some priority on dividends and asset
distribution. 127
Both shares are part of the corporation's capital stock. Both
stockholders are no different from ordinary investors who take on
the same investment risks. Preferred and common shareholders
participate in the same venture, willing to share in the profits and
losses of the enterprise. 128 Moreover, under the doctrine of
equality of shares — all stocks issued by the corporation are
presumed equal with the same privileges and liabilities, provided
that the Articles of Incorporation is silent on such differences. 129
In this case, the exchange of shares, without more, produces no
realized income to the subscriber. There is only a modification of
the subscriber's rights and privileges — which is not a flow of
wealth for tax purposes. The issue of taxable dividend may arise
only once a subscriber disposes of his entire interest and not
when there is still maintenance of proprietary interest. 130
WHEREFORE, premises considered, the decision of the Court of
Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5
stock dividends is herein considered as essentially equivalent to
a distribution of taxable dividends for which it is LIABLE for the
withholding tax-at-source. The decision is AFFIRMED in all other
respects.
[G.R. NO. 159610 : June 12, 2008]
COMMISSIONER OF INTERNAL
REVENUE, Petitioner, v. CENTRAL LUZON DRUG
CORPORATION, Respondent.
DECISION
CARPIO, J.:
The Case
This Petition for Review on Certiorari 1 assails the 13 August
2003 Decision2 of the Court of Appeals in CA-G.R. SP No. 70480.
The Court of Appeals dismissed the appeal filed by the
Commissioner of Internal Revenue (petitioner) questioning the 15
April 2002 Decision3 of the Court of Tax Appeals (CTA) in CTA
Case No. 6054 ordering petitioner to issue, in favor of Central
Luzon Drug Corporation (respondent), a tax credit certificate in
the amount of P2,376,805.63, arising from the alleged erroneous
interpretation of the term "tax credit" used in Section 4(a) of
Republic Act No. (RA) 7432.4
The Facts
Respondent is a domestic corporation engaged in the retail of
medicines and other pharmaceutical products. 5 In 1997, it
operated eight drugstores under the business name and style
"Mercury Drug."6
Pursuant to the provisions of RA 7432 and Revenue Regulations
No. (RR) 2-947 issued by the Bureau of Internal Revenue (BIR),
respondent granted 20% sales discount to qualified senior
citizens on their purchases of medicines covering the calendar
year 1997. The sales discount granted to senior citizens
totaled P2,798,508.00.
On 15 April 1998, respondent filed its 1997 Corporate Annual
Income Tax Return reflecting a nil income tax liability due to net
loss incurred from business operations
8
of P2,405,140.00. Respondent filed its 1997 Income Tax Return
under protest.9
On 19 March 1999, respondent filed with the petitioner a claim for
refund or credit of overpaid income tax for the taxable year 1997
in the amount of P2,660,829.00.10 Respondent alleged that the
overpaid tax was the result of the wrongful implementation of RA
7432. Respondent treated the 20% sales discount as a deduction
from gross sales in compliance with RR 2-94 instead of treating
it as a tax credit as provided under Section 4(a) of RA 7432.
On 6 April 2000, respondent filed a Petition for Review with the
CTA in order to toll the running of the two-year statutory period
within which to file a judicial claim. Respondent reasoned that RR
2-94, which is a mere implementing administrative regulation,
cannot modify, alter or amend the clear mandate of RA 7432.
Consequently, Section 2(i) of RR 2-94 is without force and effect
for being inconsistent with the law it seeks to implement.11
In his Answer, petitioner stated that the construction given to a
statute by a specialized administrative agency like the BIR is
entitled to great respect and should be accorded great weight.
When RA 7432 allowed senior citizens' discounts to be claimed
as tax credit, it was silent as to the mechanics of availing the
same. For clarification, the BIR issued RR 2-94 and defined the
term "tax credit" as a deduction from the establishment's gross
income and not from its tax liability in order to avoid an absurdity
that is not intended by the law.12
The Ruling of the Court of Tax Appeals
On 15 April 2002, the CTA rendered a Decision ordering
petitioner to issue a tax credit certificate in the amount
of P2,376,805.63 in favor of respondent.
The CTA stated that in a number of analogous cases, it has
consistently ruled that the 20% senior citizens' discount should
be treated as tax credit instead of a mere deduction from gross
income.13 In quoting its previous decisions, the CTA ruled that RR
2-94 engraved a new meaning to the phrase "tax credit" as
deductible from gross income which is a deviation from the plain
intendment of the law. An administrative regulation must not
contravene but should conform to the standards that the law
prescribes.14
The CTA also ruled that respondent has properly substantiated
its claim for tax credit by documentary evidence. However, based
on the examination conducted by the commissioned independent
certified public accountant (CPA), there were some material Total Income P 17,556,239.0
discrepancies due to missing cash slips, lack of senior citizen's
ID number, failure to include the cash slips in the summary report
and vice versa. Therefore, between the Summary Report Less: Operating expenses 16,913,699.00
presented by respondent and the audited amount presented by
the independent CPA, the CTA deemed it proper to consider the
lesser of two amounts. Net Income P 642,540.00

The re-computation of the overpaid income tax15 for the year

1997 is as follows: Less: Income subjected to final tax (Interest Income16 ) 249,172.00

Sales, Net P176,742,607.00

Net Taxable Income P 393,368.00

Add: 20% Sales Discount to Senior Citizens 2,798,508.00 Income Tax Due (35%) P 137,679.00

Sales, Gross P179,541,115.00

Less: Tax Credit (Cost of 20% discount as adjusted17 ) 2,514,484.63

Less: Cost of Sales Income Tax Payable (P 2,376,805.63

Merchandise inventory, beg. P 20,905,489.00 Income Tax Actually Paid : 0.00

Purchases 168,762,950.00 Income Tax Refundable (P 2,376,805.63

Merchandise inventory, end -27,281,439.00 162,387,000.00Aggrieved by the CTA's decision, petitioner elevated the case
before the Court of Appeals.

Gross Profit The Ruling of the Appellate Court

P 17,154,115.00

On 13 August 2003, the Court of Appeals affirmed the CTA's

Add: Miscellaneous income 402,124.00 decision in toto.
The Court of Appeals disagreed with petitioner's contention that
the CTA's decision applied a literal interpretation of the law. It
reasoned that under the verba legis rule, if the statute is clear,
plain, and free from ambiguity, it must be given its literal meaning
and applied without interpretation. This principle rests on the
presumption that the words used by the legislature in a statute
correctly express its intent and preclude the court from construing
it differently.18
The Court of Appeals distinguished "tax credit" as an amount
subtracted from a taxpayer's total tax liability to arrive at the tax
due while a "tax deduction" reduces the taxpayer's taxable
income upon which the tax liability is computed. "A credit differs
from deduction in that the former is subtracted from tax while the
latter is subtracted from income before the tax is computed."19
The Court of Appeals found no legal basis to support petitioner's
opinion that actual payment by the taxpayer or actual receipt by
the government of the tax sought to be credited or refunded is a
condition sine qua non for the availment of tax credit as
enunciated in Section 22920 of the Tax Code. The Court of
Appeals stressed that Section 229 of the Tax Code pertains to
illegally collected or erroneously paid taxes while RA 7432 is a
special law which uses the method of tax credit in the context of
just compensation. Further, RA 7432 does not require prior tax
payment as a condition for claiming the cost of the sales discount
as tax credit.
Hence, this petition.
The Issues
Petitioner raises two issues21 in this Petition:
1. Whether the appellate court erred in holding that respondent
may claim the 20% senior citizens' sales discount as a tax credit
deductible from future income tax liabilities instead of a mere
deduction from gross income or gross sales; andcralawlibrary
2. Whether the appellate court erred in holding that respondent is
entitled to a refund.
The Ruling of the Court
The petition lacks merit.
The issues presented are not novel. In two similar cases involving
the same parties where respondent lodged its claim for tax credit
on the senior citizens' discount granted in 199522 and 1996,23 this
Court has squarely ruled that the 20% senior citizens' discount
required by RA 7432 may be claimed as a tax credit and not
merely a tax deduction from gross sales or gross income. Under
RA 7432, Congress granted the tax credit benefit to all covered
establishments without conditions. The net loss incurred in a
taxable year does not preclude the grant of tax credit because by
its nature, the tax credit may still be deducted from a future, not a
present, tax liability. However, the senior citizens' discount
granted as a tax credit cannot be refunded.
RA 7432 expressly allows private establishments
to claim the amount of discounts they grant to senior citizens
as tax credit.
Section 4(a) of RA 7432 states:
SECTION 4. Privileges for the Senior Citizens. - The senior
citizens shall be entitled to the following:
a) the grant of twenty percent (20%) discount from all
establishments relative to the utilization of transportation
services, hotels and similar lodging establishments, restaurants
and recreation centers and purchase of medicines anywhere in
the country: Provided, That private establishments may claim the
cost as tax credit; (Emphasis supplied)cralawlibrary
However, RR 2-94 interpreted the tax credit provision of RA 7432
in this wise:
Sec. 2. DEFINITIONS. - For purposes of these regulations:
xxx
i. Tax Credit - refers to the amount representing 20% discount
granted to a qualified senior citizen by all establishments relative
to their utilization of transportation services, hotels and similar
lodging establishments, restaurants, drugstores, recreation
centers, theaters, cinema houses, concert halls, circuses,
carnivals and other similar places of culture, leisure and
amusement, which discount shall be deducted by the said
establishments from their gross income for income tax
purposes and from their gross sales for value-added tax or other
percentage tax purposes. (Emphasis supplied).
xxx
Sec. 4. Recording/Bookkeeping Requirement for Private
Establishments
xxx
The amount of 20% discount shall be deducted from the gross
income for income tax purposes and from gross sales of the
business enterprise concerned for purposes of the VAT and other
percentage taxes. (Emphasis supplied)cralawlibrary
Tax credit is defined as a peso-for-peso reduction from a
taxpayer's tax liability. It is a direct subtraction from the tax
payable to the government. On the other hand, RR 2-94 treated
the amount of senior citizens' discount as a tax deduction which
is only a subtraction from gross income resulting to a lower
taxable income. RR 2-94 treats the senior citizens' discount in the
same manner as the allowable deductions provided in Section
34, Chapter VII of the National Internal Revenue Code. RR 2-94
affords merely a fractional reduction in the taxes payable to the
government depending on the applicable tax rate.
In Commissioner of Internal Revenue v. Central Luzon Drug
Corporation,24 the Court ruled that petitioner's definition in RR 2-
94 of a tax credit is clearly erroneous. To deny the tax credit,
despite the plain mandate of the law, is indefensible.
In Commissioner of Internal Revenue v. Central Luzon Drug
Corporation, the Court declared, "When the law says that the cost
of the discount may be claimed as a tax credit, it means that the
amount - when claimed ― shall be treated as a reduction from
any tax liability, plain and simple." The Court further stated that
the law cannot be amended by a mere regulation because
"administrative agencies in issuing these regulations may not
enlarge, alter or restrict the provisions of the law it administers; it
cannot engraft additional requirements not contemplated by the
legislature." Hence, there being a dichotomy in the law and the
revenue regulation, the definition provided in Section 2(i) of RR
2-94 cannot be given effect.
The tax credit may still be deducted
from a future, not a present, tax liability.
In the petition filed before this Court, petitioner alleged that
respondent incurred a net loss from its business operations in
1997; hence, it did not pay any income tax. Since no tax payment
was made, it follows that no tax credit can also be claimed
because tax credits are usually applied against a tax liability.25
In Commissioner of Internal Revenue v. Central Luzon Drug
Corporation,26 the Court stressed that prior payment of tax liability
is not a pre-condition before a taxable entity can avail of the tax
credit. The Court declared, "Where there is no tax liability or
where a private establishment reports a net loss for the period,
the tax credit can be availed of and carried over to the next
taxable year."27 It is irrefutable that under RA 7432, Congress has
granted the tax credit benefit to all covered establishments
without conditions. Therefore, neither a tax liability nor a prior tax
payment is required for the existence or grant of a tax
credit.28 The applicable law on this point is clear and without any
qualifications.29
Hence, respondent is entitled to claim the amount
of P2,376,805.63 as tax credit despite incurring net loss from
business operations for the taxable year 1997.
The senior citizens' discount may be claimed
as a tax credit and not a refund.
Section 4(a) of RA 7432 expressly provides that private
establishments may claim the cost as a tax credit. A tax credit
can only be utilized as payment for future internal revenue tax
liabilities of the taxpayer while a tax refund, issued as a check or
a warrant, can be encashed. A tax refund can be availed of
immediately while a tax credit can only be utilized if the taxpayer
has existing or future tax liabilities.
If the words of the law are clear, plain, and free of ambiguity, it
must be given its literal meaning and applied without any
interpretation. Hence, the senior citizens' discount may be
claimed as a tax credit and not as a refund.30
RA 9257 now specifically provides that all covered
establishments
may claim the senior citizens' discount as tax deduction.
On 26 February 2004, RA 9257, otherwise known as the
"Expanded Senior Citizens Act of 2003," was signed into law and
became effective on 21 March 2004.31
RA 9257 has amended RA 7432. Section 4(a) of RA 9257 reads:
"Sec. 4. Privileges for the Senior Citizens. - The senior citizens
shall be entitled to the following:
(a) the grant of twenty percent (20%) discount from all
establishments relative to the utilization of services in hotels and
similar lodging establishments, restaurants and recreation
centers, and purchase of medicines in all establishments for the
exclusive use or enjoyment of senior citizens, including funeral
and burial services for the death of senior citizens;
xxx
The establishment may claim the discounts granted under (a), (f),
(g) and (h) as tax deduction based on the net cost of the goods
sold or services rendered: Provided, That the cost of the discount
shall be allowed as deduction from gross income for the same
taxable year that the discount is granted. Provided, further, That
the total amount of the claimed tax deduction net of value added
tax if applicable, shall be included in their gross sales receipts for
tax purposes and shall be subject to proper documentation and
to the provisions of the National Internal Revenue Code, as
amended." (Emphasis supplied)cralawlibrary
Contrary to the provision in RA 7432 where the senior citizens'
discount granted by all covered establishments can be claimed
as tax credit, RA 9257 now specifically provides that this discount
should be treated as tax deduction.
With the effectivity of RA 9257 on 21 March 2004, there is now a
new tax treatment for senior citizens' discount granted by all
covered establishments. This discount should be considered as
a deductible expense from gross income and no longer as tax
credit.32 The present case, however, covers the taxable year
1997 and is thus governed by the old law, RA 7432.
WHEREFORE, we DENY the petition. We AFFIRM the assailed
Decision of the Court of Appeals dated 13 August 2003 in CA-
G.R. SP No. 70480.
No pronouncement as to costs.
SO ORDERED.
Tax Case Digest: Commissioner of Internal Revenue vs Central Issue:
Luzon Drug Corporation GR No 159647 Whether or not respondent, despite incurring a net loss, may still
claim the 20% sales discount as a tax credit.
By PactaSuntServanda - July 08, 2014
Ruling:
Commissioner of Internal Revenue vs. Central Luzon Drug Yes, it is clear that Sec. 4a of RA 7432 grants to senior citizens
Corporation the privilege of obtaining a 20% discount on their purchase of
medicine from any private establishment in the country. The latter
G.R. No. 159647 April 15, 2005 may then claim the cost of the discount as a tax credit. Such credit
can be claimed even if the establishment operates at a loss.
Facts:
A tax credit generally refers to an amount that is “subtracted
Respondents operated six drugstores under the business name
directly from one’s total tax liability.” It is an “allowance against
Mercury Drug. From January to December 1996 respondent
the tax itself” or “a deduction from what is owed” by a taxpayer to
granted 20% sales discount to qualified senior citizens on their
the government.
purchases of medicines pursuant to RA 7432 for a total of ₱
A tax credit should be understood in relation to other tax
904,769.
concepts. One of these is tax deduction – which is subtraction
“from income for tax purposes,” or an amount that is “allowed by
On April 15, 1997, respondent filed its annual Income Tax Return
law to reduce income prior to the application of the tax rate to
for taxable year 1996 declaring therein net losses. On Jan. 16,
compute the amount of tax which is due.” In other words, whereas
1998 respondent filed with petitioner a claim for tax refund/credit
a tax credit reduces the tax due, tax deduction reduces the
of ₱ 904,769.00 allegedly arising from the 20% sales discount.
income subject to tax in order to arrive at the taxable income.
Unable to obtain affirmative response from petitioner, respondent
elevated its claim to the Court of Tax Appeals. The court
A tax credit is used to reduce directly the tax that is due, there
dismissed the same but upon reconsideration, the latter reversed
ought to be a tax liability before the tax credit can be
its earlier ruling and ordered petitioner to issue a Tax Credit
applied. Without that liability, any tax credit application will be
Certificate in favor of respondent citing CA GR SP No. 60057
useless. There will be no reason for deducting the latter when
(May 31, 2001, Central Luzon Drug Corp. vs. CIR) citing that Sec.
there is, to begin with, no existing obligation to the
229 of RA 7432 deals exclusively with illegally collected or
government. However, as will be presented shortly, the
erroneously paid taxes but that there are other situations which
existence of a tax credit or its grant by law is not the same as the
may warrant a tax credit/refund.
availment or use of such credit. While the grant is mandatory, the
availment or use is not. If a net loss is reported by, and no other
CA affirmed Court of Tax Appeal's decision reasoning that RA
taxes are currently due from, a business establishment, there will
7432 required neither a tax liability nor a payment of taxes by
obviously be no tax liability against which any tax credit can be
private establishments prior to the availment of a tax credit.
applied. For the establishment to choose the immediate
Moreover, such credit is not tantamount to an unintended benefit
availment of a tax credit will be premature and impracticable.
from the law, but rather a just compensation for the taking of
private property for public use.
Tax Case Digest: CIR V. Isabela Cultural Corp. (2007)
THIRD DIVISION
G.R. No. 172231 February 12, 2007
YNARES-SANTIAGO, J.
Lessons Applicable: Accrual method, burden of proof in accrual
method, deductibility of ordinary and necessary trade, business,
or professional expenses, all events test
Laws Applicable:
FACTS:
BIR disallowed Isabela Cultural Corp. deductible expenses for
services which were rendered in 1984 and 1985 but only billed,
paid and claimed as a deduction on 1986.
After CA sent its demand letters, Isabela protested.
CTA found it proper to be claimed in 1986 and affirmed by CA
ISSUE: W/N Isabela who uses accrual method can claim on 1986
only
HELD: case is remanded to the BIR for the computation of
Isabela Cultural Corporation’s liability under Assessment Notice
No. FAS-1-86-90-000680.
NO
The requisites for the deductibility of ordinary and necessary
trade, business, or professional expenses, like expenses paid for
legal and auditing services, are:
(a) the expense must be ordinary and necessary;
(b) it must have been paid or incurred during the taxable year; -
qualified by Section 45 of the National Internal Revenue Code
(NIRC) which states that: "[t]he deduction provided for in this Title
shall be taken for the taxable year in which ‘paid or accrued’ or
‘paid or incurred’, dependent upon the method of accounting
upon the basis of which the net income is computed
(c) it must have been paid or incurred in carrying on the trade or
business of the taxpayer; and
(d) it must be supported by receipts, records or other pertinent
papers.
Revenue Audit Memorandum Order No. 1-2000, provides that
under the accrual method of accounting, expenses not being
claimed as deductions by a taxpayer in the current year when
they are incurred cannot be claimed as deduction from income
for the succeeding year. Thus, a taxpayer who is authorized to
deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the
next year.
The accrual method relies upon the taxpayer’s right to receive
amounts or its obligation to pay them, in opposition to actual
receipt or payment, which characterizes the cash method of
accounting. Amounts of income accrue where the right to receive
them become fixed, where there is created an enforceable
liability. Similarly, liabilities are accrued when fixed and
determinable in amount, without regard to indeterminacy merely
of time of payment.
The accrual of income and expense is permitted when the all-
events test has been met. This test requires: (1) fixing of a right
to income or liability to pay; and (2) the availability of the
reasonable accurate determination of such income or liability.
The all-events test requires the right to income or liability be fixed,
and the amount of such income or liability be determined with
reasonable accuracy. However, the test does not demand that
the amount of income or liability be known absolutely, only that a
taxpayer has at his disposal the information necessary to
compute the amount with reasonable accuracy. The all-events
test is satisfied where computation remains uncertain, if its basis
is unchangeable; the test is satisfied where a computation may
be unknown, but is not as much as unknowable, within the
taxable year. The amount of liability does not have to be
determined exactly; it must be determined with "reasonable
accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate amount.

The propriety of an accrual must be judged by the facts that a

taxpayer knew, or could reasonably be expected to have known,
at the closing of its books for the taxable year.

Accrual method of accounting presents largely a question of fact;

such that the taxpayer bears the burden of proof of establishing
the accrual of an item of income or deduction.

In the instant case, the expenses for professional fees consist of

expenses for legal and auditing services. The expenses for legal
services pertain to the 1984 and 1985 legal and retainer fees of
the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson, and for reimbursement of the expenses of said firm in
connection with ICC’s tax problems for the year 1984. As testified
by the Treasurer of ICC, the firm has been its counsel since the
1960’s. - failed to prove the burden

Labels: 2007, Accrual method, all events test, burden of proof in

accrual method, Case Digest, CIR v. Isabela Cultural
Corp., expenses, February 12, G.R. No. 172231, tax case digest
CIR vs. Isabela Cultural Corporation
Isabela Cultural Corp.(ICC for brevity) , a domestic corporation
received from BIR assessment notice no. FAS-1-86-90000680
(680 for brevity) for deficiency income tax in the amount of PhP
333,196.86 and assessment notice no. FAS-1-86-90-000681
(681 for brevity) for deficiency expanded withholding tax in the
amount of PhP 4,897.79, inclusive of surcharge and interest both
for the taxable year 1986. The deficiency income tax of PhP
333,196 arose from BIR disallowance of ICC claimed expenses
deductions for professional and security services billed to and
paid by ICC in 1986.
The deficiency expanded withholding tax of PhP4,897.79 was
allegedly due to the failure of ICC to withhold 1% expanded
withholding tax on its claimed PhP244,890 deduction for security
services.
Court of Tax Appeal and Court of Appeal affirmed that the
professional services were rendered to ICC in 1984 and 1985,
the cost of the service was not yet determinable at that time,
hence, it could be considered as deductible expenses only in
1986 when ICC received the billing statement for said service. It
further ruled that ICC did not state its interest income from the
promissory notes of Realty Investment and that ICC properly
withheld the remitted taxes on the payment for security services
for the taxable year 1986.
Petitioner contend that since ICC is using the accrual method of
accounting, the expenses for the professional services that
accrued in 1984 and 9185 should have been declared as
deductions from income during the said years and the failure of
ICC to do so bars it from claiming said expenses as deduction for
the taxable year 1986.
ISSUE (1): WON CA is correct in sustaining the deduction of the
expenses for professionals and security services form ICC gross
income?
HELD: NO
Revenue Audit Memorandum Order No.1-2000 provides that
under the accrual method of accounting, expenses not being
claimed as deductions by a tax payer in the current year when
they are incurred cannot be claimed as deductions from the
income for the succeeding year.
ISSUE (2): WON CA correctly held that ICC did not understate its
interest income from the promissory notes of Realty Investment,
Inc; that ICC withheld the required 1% withholding tax from the
deduction for security services.
HELD:
Sustaining the finding of the CTA and CA that no such
understatement exist and that only simple interest computation
and not a compounded one should have been applied by the
BIR. There is no indeed no stipulation between the latter and ICC
on the application of compound interest.
Under Article 1959 of the Civil Code, unless there is a stipulation
to the contrary, interest due should not further earn interest.
CIR V GENERAL FOODS
14FEB
GR No. 143672| April 24, 2003 | J. Corona
Test of Reasonableness
Facts:
Respondent corporation General Foods (Phils), which is engaged
in the manufacture of “Tang”, “Calumet” and “Kool-Aid”, filed its
income tax return for the fiscal year ending February 1985 and
claimed as deduction, among other business expenses,
P9,461,246 for media advertising for “Tang”.
The Commissioner disallowed 50% of the deduction claimed and
assessed deficiency income taxes of P2,635,141.42 against
General Foods, prompting the latter to file an MR which was
denied.
General Foods later on filed a petition for review at CA, which
reversed and set aside an earlier decision by CTA dismissing the
company’s appeal.
Issue:
W/N the subject media advertising expense for “Tang” was
ordinary and necessary expense fully deductible under the NIRC
Held:
No. Tax exemptions must be construed in stricissimi juris against
the taxpayer and liberally in favor of the taxing authority, and he
who claims an exemption must be able to justify his claim by the
clearest grant of organic or statute law. Deductions for income
taxes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be
strictly construed.
To be deductible from gross income, the subject advertising
expense must comply with the following requisites: (a) the
expense must be ordinary and necessary; (b) it must have been
paid or incurred during the taxable year; (c) it must have been
paid or incurred in carrying on the trade or business of the
taxpayer; and (d) it must be supported by receipts, records or
other pertinent papers.
While the subject advertising expense was paid or incurred within
the corresponding taxable year and was incurred in carrying on a
trade or business, hence necessary, the parties’ views conflict
as to whether or not it was ordinary. To be deductible, an
advertising expense should not only be necessary but also
ordinary.
The Commissioner maintains that the subject advertising
expense was not ordinary on the ground that it failed the two
conditions set by U.S. jurisprudence: first, “reasonableness” of
the amount incurred and second, the amount incurred must not
be a capital outlay to create “goodwill” for the product and/or
private respondent’s business. Otherwise, the expense must be
considered a capital expenditure to be spread out over a
reasonable time.
There is yet to be a clear-cut criteria or fixed test for determining
the reasonableness of an advertising expense. There being no
hard and fast rule on the matter, the right to a deduction depends
on a number of factors such as but not limited to: the type and
size of business in which the taxpayer is engaged; the volume
and amount of its net earnings; the nature of the expenditure
itself; the intention of the taxpayer and the general economic
conditions. It is the interplay of these, among other factors and
properly weighed, that will yield a proper evaluation.
The Court finds the subject expense for the advertisement of a
single product to be inordinately large. Therefore, even if it is
necessary, it cannot be considered an ordinary expense
deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate

the current sale of merchandise or use of services and (2)
advertising designed to stimulate the future sale of merchandise
or use of services. The second type involves expenditures
incurred, in whole or in part, to create or maintain some form of
goodwill for the taxpayer’s trade or business or for the industry or
profession of which the taxpayer is a member. If the expenditures
are for the advertising of the first kind, then, except as to the
question of the reasonableness of amount, there is no doubt such
expenditures are deductible as business expenses. If, however,
the expenditures are for advertising of the second kind, then
normally they should be spread out over a reasonable period of
time.

The company’s media advertising expense for the promotion of a

single product is doubtlessly unreasonable considering it
comprises almost one-half of the company’s entire claim for
marketing expenses for that year under review. Petition
granted, judgment reversed and set aside.
G.R. No. L-24059 November 28, 1969
C. M. HOSKINS & CO., INC., petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.
Ross, Salcedo, Del Rosario, Bito and Misa for petitioner.
Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor
General Felicisimo R. Rosete and Special Attorney Michaelina R.
Balasbas for respondent.
TEEHANKEE, J.:
We uphold in this taxpayer's appeal the Tax Court's ruling that
payment by the taxpayer to its controlling stockholder of 50% of
its supervision fees or the amount of P99,977.91 is not a
deductible ordinary and necessary expense and should be
treated as a distribution of earnings and profits of the taxpayer.
Petitioner, a domestic corporation engaged in the real estate
business as brokers, managing agents and administrators, filed
its income tax return for its fiscal year ending September 30, 1957
showing a net income of P92,540.25 and a tax liability due
thereon of P18,508.00, which it paid in due course. Upon
verification of its return, respondent Commissioner of Internal
Revenue, disallowed four items of deduction in petitioner's tax
returns and assessed against it an income tax deficiency in the
amount of P28,054.00 plus interests. The Court of Tax Appeals
upon reviewing the assessment at the taxpayer's petition, upheld
respondent's disallowance of the principal item of petitioner's
having paid to Mr. C. M. Hoskins, its founder and controlling
stockholder the amount of P99,977.91 representing 50% of
supervision fees earned by it and set aside respondent's
disallowance of three other minor items. The Tax Court therefore
determined petitioner's tax deficiency to be in the amount of
P27,145.00 and on November 8, 1964 rendered judgment
against it, as follows:
WHEREFORE, premises considered, the decision of the
respondent is hereby modified. Petitioner is ordered to pay to the
latter or his representative the sum of P27,145.00, representing
deficiency income tax for the year 1957, plus interest at 1/2% per
month from June 20, 1959 to be computed in accordance with the
provisions of Section 51(d) of the National Internal Revenue
Code. If the deficiency tax is not paid within thirty (30) days from
the date this decision becomes final, petitioner is also ordered to
pay surcharge and interest as provided for in Section 51 (e) of the
Tax Code, without costs.
Petitioner questions in this appeal the Tax Court's findings that
the disallowed payment to Hoskins was an inordinately large one,
which bore a close relationship to the recipient's dominant
stockholdings and therefore amounted in law to a distribution of
its earnings and profits.
We find no merit in petitioner's appeal.
As found by the Tax Court, "petitioner was founded by Mr. C. M.
Hoskins in 1937, with a capital stock of 1,000 shares at a par
value of P1.00 each share; that of these 1,000 shares, Mr. C. M.
Hoskins owns 996 shares (the other 4 shares being held by the
other four officers of the corporation), which constitute exactly
99.6% of the total authorized capital stock (p. 92, t.s.n.); that
during the first four years of its existence, Mr. C. M. Hoskins was
the President, but during the taxable period in question, that is,
from October 1, 1956 to September 30, 1957, he was the
chairman of the Board of Directors and salesman-broker for the
company (p. 93, t.s.n.); that as chairman of the Board of
Directors, he received a salary of P3,750.00 a month, plus a
salary bonus of about P40,000.00 a year (p. 94, t.s.n.); that he
was also a stockholder and officer of the Paradise Farms, Inc.
and Realty Investments, Inc., from which petitioner derived a
large portion of its income in the form of supervision fees and
commissions earned on sales of lots (pp. 97-99, t.s.n.; Financial
Statements, attached to Exhibit '1', p. 11, BIR rec.); that as
chairman of the Board of Directors of petitioner, his duties were:
"To act as a salesman; as a director, preside over meetings and
to get all of the real estate business I could for the company by
negotiating sales, purchases, making appraisals, raising funds to
finance real estate operations where that was necessary' (p. 96,
t.s.n.); that he was familiar with the contract entered into by the
petitioner with the Paradise Farms, Inc. and the Realty
Investments, Inc. by the terms of which petitioner was 'to program
the development, arrange financing, plan the proposed
subdivision as outlined in the prospectus of Paradise Farms, Inc.,
arrange contract for road constructions, with the provision of
water supply to all of the lots and in general to serve as managing
agents for the Paradise Farms, Inc. and subsequently for the
Realty Investment, Inc." (pp. 96-97. t.s.n.)
Considering that in addition to being Chairman of the board of
directors of petitioner corporation, which bears his name,
Hoskins, who owned 99.6% of its total authorized capital stock
while the four other officers-stockholders of the firm owned a total
of four-tenths of 1%, or one-tenth of 1% each, with their
respective nominal shareholdings of one share each was also
salesman-broker for his company, receiving a 50% share of the
sales commissions earned by petitioner, besides his monthly
salary of P3,750.00 amounting to an annual compensation of
P45,000.00 and an annual salary bonus of P40,000.00, plus free
use of the company car and receipt of other similar allowances
and benefits, the Tax Court correctly ruled that the payment by
petitioner to Hoskins of the additional sum of P99,977.91 as his
equal or 50% share of the 8% supervision fees received by
petitioner as managing agents of the real estate, subdivision
projects of Paradise Farms, Inc. and Realty Investments, Inc. was
inordinately large and could not be accorded the treatment of
ordinary and necessary expenses allowed as deductible items
within the purview of Section 30 (a) (i) of the Tax Code.
If such payment of P99,977.91 were to be allowed as a deductible
item, then Hoskins would receive on these three items alone
(salary, bonus and supervision fee) a total of P184,977.91, which
would be double the petitioner's reported net income for the year
of P92,540.25. As correctly observed by respondent. If
independently, a one-time P100,000.00-fee to plan and lay down
the rules for supervision of a subdivision project were to be paid
to an experienced realtor such as Hoskins, its fairness and
deductibility by the taxpayer could be conceded; but here 50% of
the supervision fee of petitioner was being paid by it to Hoskins
every year since 1955 up to 1963 and for as long as its contract
with the subdivision owner subsisted, regardless of whether
services were actually rendered by Hoskins, since his services to
petitioner included such planning and supervision and were
already handsomely paid for by petitioner.
The fact that such payment was authorized by a standing
resolution of petitioner's board of directors, since "Hoskins had
personally conceived and planned the project" cannot change the
picture. There could be no question that as Chairman of the board
and practically an absolutely controlling stockholder of petitioner,
holding 99.6% of its stock, Hoskins wielded tremendous power
and influence in the formulation and making of the company's
policies and decisions. Even just as board chairman, going by
petitioner's own enumeration of the powers of the office, Hoskins,
could exercise great power and influence within the corporation,
such as directing the policy of the corporation, delegating powers
to the president and advising the corporation in determining
executive salaries, bonus plans and pensions, dividend policies,
etc.1
Petitioner's invoking of its policy since its incorporation of sharing
equally sales commissions with its salesmen, in accordance with
its board resolution of June 18, 1946, is equally untenable.
Petitioner's Sales Regulations provide:
Compensation of Salesmen
8. Schedule I — In the case of sales to prospects discovered and
worked by a salesman, even though the closing is done by or with
the help of the Sales Manager or other members of the staff, the
salesmen get one-half (1/2) of the total commission received by
the Company, but not exceeding five percent (5%). In the case of
subdivisions, when the office commission covers general
supervision, the 1/2-rule does not apply, the salesman's share
being stipulated in the case of each subdivision. In most cases
the salesman's share is 4%. (Exh. "N-1").2
It will be readily seen therefrom that when the petitioner's
commission covers general supervision, it is provided that the 1/2
rule of equal sharing of the sales commissions does not apply
and that the salesman's share is stipulated in the case of each
subdivision. Furthermore, what is involved here is not Hoskins'
salesman's share in the petitioner's 12% sales commission,
which he presumably collected also from petitioner without
respondent's questioning it, but a 50% share besides in
petitioner's planning and supervision fee of 8% of the gross sales,
as mentioned above. This is evident from petitioner's board's
resolution of July 14, 1953 (Exhibit 7), wherein it is recited that in
addition to petitioner's sales commission of 12% of gross sales,
the subdivision owners were paying to petitioner 8% of gross
sales as supervision fee, and a collection fee of 5% of gross
collections, or total fees of 25% of gross sales.
The case before us is similar to previous cases of disallowances
as deductible items of officers' extra fees, bonuses and
commissions, upheld by this Court as not being within the purview
of ordinary and necessary expenses and not passing the test of
reasonable compensation.3 In Kuenzle & Streiff, Inc. vs.
Commissioner of Internal Revenue decided by this Court on May
29, 1969,4 we reaffirmed the test of reasonableness, enunciated
in the earlier 1967 case involving the same parties, that: "It is a
general rule that 'Bonuses to employees made in good faith and
as additional compensation for the services actually rendered by
the employees are deductible, provided such payments, when
added to the stipulated salaries, do not exceed a reasonable
compensation for the services rendered' (4 Mertens Law of
Federal Income Taxation, Sec. 25.50, p. 410). The conditions
precedent to the deduction of bonuses to employees are: (1) the
payment of the bonuses is in fact compensation; (2) it must be for
personal services actually rendered; and (3) the bonuses, when
added to the salaries, are 'reasonable . . . when measured by the
amount and quality of the services performed with relation to the
business of the particular taxpayer' (Idem., Sec. 25, 44, p. 395).
"There is no fixed test for determining the reasonableness of a
given bonus as compensation. This depends upon many factors,
one of them being 'the amount and quality of the services
performed with relation to the business.' Other tests suggested
are: payment must be 'made in good faith'; 'the character of the
taxpayer's business, the volume and amount of its net earnings,
its locality, the type and extent of the services rendered, the
salary policy of the corporation'; 'the size of the particular
business'; 'the employees' qualifications and contributions to the
business venture'; and 'general economic conditions' (4 Mertens,
Law of Federal Income Taxation, Secs. 25.44, 25.49, 25.50,
25.51, pp. 407-412). However, 'in determining whether the
particular salary or compensation payment is reasonable, the
situation must be considered as whole. Ordinarily, no single
factor is decisive. . . . it is important to keep in mind that it seldom
happens that the application of one test can give satisfactory
answer, and that ordinarily it is the interplay of several factors,
properly weighted for the particular case, which must furnish the
final answer."
Petitioner's case fails to pass the test. On the right of the
employer as against respondent Commissioner to fix the
compensation of its officers and employees, we there held further
that while the employer's right may be conceded, the question of
the allowance or disallowance thereof as deductible expenses for
income tax purposes is subject to determination by respondent
Commissioner of Internal Revenue. Thus: "As far as petitioner's
contention that as employer it has the right to fix the
compensation of its officers and employees and that it was in the
exercise of such right that it deemed proper to pay the bonuses
in question, all that We need say is this: that right may be
conceded, but for income tax purposes the employer cannot
legally claim such bonuses as deductible expenses unless they
are shown to be reasonable. To hold otherwise would open the
gate of rampant tax evasion.
"Lastly, We must not lose sight of the fact that the question of
allowing or disallowing as deductible expenses the amounts paid
to corporate officers by way of bonus is determined by
respondent exclusively for income tax purposes. Concededly, he
has no authority to fix the amounts to be paid to corporate officers
by way of basic salary, bonus or additional remuneration — a
matter that lies more or less exclusively within the sound
discretion of the corporation itself. But this right of the corporation
is, of course, not absolute. It cannot exercise it for the purpose of
evading payment of taxes legitimately due to the State."

Finally, it should be noted that we have here a case practically of

a sole proprietorship of C. M. Hoskins, who however chose to
incorporate his business with himself holding virtually absolute
control thereof with 99.6% of its stock with four other nominal
shareholders holding one share each. Having chosen to use the
corporate form with its legal advantages of a separate corporate
personality as distinguished from his individual personality, the
corporation so created, i.e., petitioner, is bound to comport itself
in accordance with corporate norms and comply with its corporate
obligations. Specifically, it is bound to pay the income tax
imposed by law on corporations and may not legally be permitted,
by way of corporate resolutions authorizing payment of
inordinately large commissions and fees to its controlling
stockholder, to dilute and diminish its corresponding corporate
tax liability.

ACCORDINGLY, the decision appealed from is hereby affirmed,

with costs in both instances against petitioner.

Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar,

Sanchez, Castro, Fernando and Barredo, JJ., concur.
C. M. Hoskins & Co. Inc. v Commissioner of Internal Revenue · Payment of bonuses is in fact compensation

Facts: · Must be for personal services actually rendered

Hoskins, a domestic corporation engaged in the real estate
business as broker, managing agents and administrators, filed its
income tax return (ITR) showing a net income of P92,540.25 and
a tax liability of P18,508 which it paid.
· Bonuses when added to salaries are reasonable when
measured by the amount and quality of services performed with
relation to the business of the particular taxpayer.
There is no fixed test for determining the reasonableness of a
given bonus as compensation. This depends upon many factors.

CIR disallowed 4 items of deductions in the ITR. Court of Tax

Appeals upheld the disallowance of an item which was paid to
Mr. C. Hoskins representing 50% of supervision fees earned and
set aside the disallowance of the other 3 items.
Issue:
In the case, Hoskins fails to pass the test. CTA was correct in
holding that the payment of the company to Mr. Hoskins of the
sum P99,977.91 as 50% share of supervision fees received by
the company was inordinately large and could not be treated as
an ordinary and necessary expenses allowed for deduction.

Whether or not the disallowance of the 4 items were proper.

Held:

NOT deductible. It did not pass the test of reasonableness which

is:

General rule, bonuses to employees made in good faith and as

additional compensation for services actually rendered by the
employees are deductible, provided such payments, when added
to the salaries do not exceed the compensation for services
rendered.

The conditions precedent to the deduction of bonuses to

employees are:
G.R. No. L-13325 April 20, 1961
SANTIAGO GANCAYCO, petitioner,
vs.
THE COLLECTOR OF INTERNAL REVENUE, respondent.
Benjamin J. Molina for petitioner.
Office of the Solicitor General and Special Attorney Antonio A.
Garces for respondent.
CONCEPCION, J.:
Petitioner Santiago Gancayco seeks the review of a decision of
the Court of Tax Appeals, requiring him to pay P16,860.31, plus
surcharge and interest, by way of deficiency income tax for the
year 1949.
On May 10, 1950, Gancayco filed his income tax return for the
year 1949. Two (2) days later, respondent Collector of Internal
Revenue issued the corresponding notice advising him that his
income tax liability for that year amounted P9,793.62, which he
paid on May 15, 1950. A year later, on May 14, 1951, respondent
wrote the communication Exhibit C, notifying Gancayco, inter
alia, that, upon investigation, there was still due from him, a
efficiency income tax for the year 1949, the sum of P29,554.05.
Gancayco sought a reconsideration, which was part granted by
respondent, who in a letter dated April 8, 1953 (Exhibit D),
informed petitioner that his income tax defendant efficiency for
1949 amounted to P16,860.31. Gancayco urged another
reconsideration (Exhibit O), but no action taken on this request,
although he had sent several communications calling
respondent's attention thereto.
On April 15, 1956, respondent issued a warrant of distraint and
levy against the properties of Gancayco for the satisfaction of his
deficiency income tax liability, and accordingly, the municipal
treasurer of Catanauan, Quezon issued on May 29, 1956, a
notice of sale of said property at public auction on June 19, 1956.
Upon petition of Gancayco filed on June 16, 1956, the Court of
Tax Appeal issued a resolution ordering the cancellation of the
sale and directing that the same be readvertised at a future date,
in accordance with the procedure established by the National
Internal Revenue Code. Subsequently, or on June 22, 1956,
Gancayco filed an amended petition praying that said Court:
(a) Issue a writ of preliminary injunction, enjoining the
respondents from enforcing the collection of the alleged tax
liability due from the petitioner through summary proceeding
pending determination of the present case;
(b) After a review of the present case adjudge that the right of the
government to enforce collection of any liability due on this
account had already prescribed;
(c) That even assuming that prescription had not set in the
objections of petitioner to the disallowance of the entertainment,
representation and farming expenses be allowed;
xxx xxx xxx
In his answer respondent admitted some allegations the
amended petition, denied other allegations thereof an set up
some special defenses. Thereafter Gancayco received from the
municipal treasurer of Catanauan, Quezon, another notice of
auction sale of his properties, to take place on August 29, 1956.
On motion of Gancayco, the Court of Tax Appeals, by resolution
dated August 27, 1956, "cancelled" the aforementioned sale and
enjoined respondent and the municipal treasurer of Catanauan,
Quezon, from proceeding with the same. After appropriate
proceedings, the Court of Tax Appeals rendered, on November
14, 1957, the decision adverted to above.
Gancayco maintains that the right to collect the deficiency income
tax in question is barred by the statute of limitations. In this
connection, it should be noted, however, that there are two (2)
civil remedies for the collection of internal revenue taxes, namely:
(a) by distraint of personal property and levy upon real property;
and (b) by "judicial action" (Commonwealth Act 456, section 316).
The first may not be availed of except within three (3) years after
the "return is due or has been made ..." (Tax Code, section 51 [d]
). After the expiration of said Period, income taxes may not be
legally and validly collected by distraint and/or levy (Collector of
Internal Revenue v. Avelino, L-9202, November 19, 1956;
Collector of Internal Revenue v. Reyes, L-8685, January 31,
1957; Collector of Internal Revenue v. Zulueta, L-8840, February
8, 1957; Sambrano v. Court of Tax Appeals, L-8652, March 30,
1957). Gancayco's income tax return for 1949 was filed on May
10, 1950; so that the warrant of distraint and levy issued on May
15, 1956, long after the expiration of said three-year period, was
illegal and void, and so was the attempt to sell his properties in
pursuance of said warrant.
The "judicial action" mentioned in the Tax Code may be resorted
to within five (5) years from the date the return has been filed, if
there has been no assessment, or within five (5) years from the
date of the assessment made within the statutory period, or within
the period agreed upon, in writing, by the Collector of Internal
Revenue and the taxpayer. before the expiration of said five-year
period, or within such extension of said stipulated period as may
have been agreed upon, in writing, made before the expiration of
the period previously situated, except that in the case of a false
or fraudulent return with intent to evade tax or of a failure to file a
return, the judicial action may be begun at any time within ten (10)
years after the discovery of the falsity, fraud or omission (Sections
331 and 332 of the Tax Code). In the case at bar, respondent
made three (3) assessments: (a) the original assessment of
P9,793.62, made on May 12, 1950; (b) the first deficiency income
tax assessment of May 14, 1951, for P29,554.05; and (c) the
amended deficiency income tax assessment of April 8, 1953, for
P16,860.31.
Gancayco argues that the five-year period for the judicial action
should be counted from May 12, 1950, the date of the original
assessment, because the income tax for 1949, he says, could
have been collected from him since then. Said assessment was,
however, not for the deficiency income tax involved in this
proceedings, but for P9,793.62, which he paid forthwith. Hence,
there never had been any cause for a judicial action against him,
and, per force, no statute of limitations to speak of, in connection
with said sum of P9,793.62.
Neither could said statute have begun to run from May 14, 1951,
the date of the first deficiency income tax assessment or
P29,554.05, because the same was, upon Gancayco's request,
reconsidered or modified by the assessment made on April 8,
1953, for P16,860.31. Indeed, this last assessment is what
Gancayco contested in the amended petition filed by him with the
Court of Tax Appeals. The amount involved in such assessment
which Gancayco refused to pay and respondent tried to collect by
warrant of distraint and/or levy, is the one in issue between the
parties. Hence, the five-year period aforementioned should be
counted from April 8, 1953, so that the statute of limitations does
not bar the present proceedings, instituted on April 12, 1956, if
the same is a judicial action, as contemplated in section 316 of
the Tax Code, which petitioner denies, upon the ground that
a. "The Court of Tax Appeals does not have original jurisdiction
to entertain an action for the collection of the tax due;
b. "The proper party to commence the judicial action to collect the
tax due is the government, and
c. "The remedies provided by law for the collection of the tax are
exclusive."
Said Section 316 provides:
The civil remedies for the collection of internal revenue taxes,
fees, or charges, and any increment thereto resulting from
delinquency shall be (a) by distraint of goods, chattels, or effects,
and other personal property of whatever character, including
stocks and other securities, debts, credits, bank accounts, and
interest in and rights to personal property, and by levy upon real
property; and (b) by judicial action. Either of these remedies or
both simultaneously may be pursued in the discretion of the
authorities charged with the collection of such taxes.
No exemption shall be allowed against the internal revenue taxes
in any case.
Petitioner contends that the judicial action referred to in this
provision is commenced by filing, with a court of first instance, of
a complaint for the collection of taxes. This was true at the time
of the approval of Commonwealth Act No. 456, on June 15, 1939.
However, Republic Act No. 1125 has vested the Court of Tax
Appeals, not only with exclusive appellate jurisdiction to review
decisions of the Collector (now Commissioner) of Internal
Revenue in cases involving disputed assessments, like the one
at bar, but, also, with authority to decide "all cases involving
disputed assessments of Internal Revenue taxes or customs
duties pending determination before the court of first instance" at
the time of the approval of said Act, on June 16, 1954 (Section
22, Republic Act No. 1125). Moreover, this jurisdiction to decide
all cases involving disputed assessments of internal revenue
taxes and customs duties necessarily implies the power to
authorize and sanction the collection of the taxes and duties
involved in such assessments as may be upheld by the Court of
Tax Appeals. At any rate, the same now has the authority
formerly vested in courts of first instance to hear and decide
cases involving disputed assessments of internal revenue taxes
and customs duties. Inasmuch as those cases filed with courts of
first instance constituted judicial actions, such is, likewise, the
nature of the proceedings before the Court of Tax Appeals,
insofar as sections 316 and 332 of the Tax Code are concerned.
The question whether the sum of P16,860.31 is due from
Gancayco as deficiency income tax for 1949 hinges on the
validity of his claim for deduction of two (2) items, namely: (a) for
farming expenses, P27,459.00; and (b) for representation
expenses, P8,933.45.
Section 30 of the Tax Code partly reads:
(a) Expenses:
(1) In General — All the ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or
business, including a reasonable allowance for salaries or other
compensation for personal services actually rendered; traveling
expenses while away from home in the pursuit of a trade or
business; and rentals or other payments required to be made as
a condition to the continued use or possession, for the purposes
of the trade or business, of property to which the taxpayer has not
taken or is not taking title or in which he has no equity. (Emphasis
supplied.)
Referring to the item of P27,459, for farming expenses allegedly
incurred by Gancayco, the decision appealed from has the
following to say:
No evidence has been presented as to the nature of the said
"farming expenses" other than the bare statement of petitioner
that they were spent for the "development and cultivation of (his)
property". No specification has been made as to the actual
amount spent for purchase of tools, equipment or materials, or
the amount spent for improvement. Respondent claims that the
entire amount was spent exclusively for clearing and
developing the farm which were necessary to place it in a
productive state. It is not, therefore, an ordinary expense but a
capitol expenditure. Accordingly, it is not deductible but it may be
amortized, in accordance with section 75 of Revenue Regulations
No. 2, cited above. See also, section 31 of the Revenue Code
which provides that in computing net income, no deduction shall
in any case be allowed in respect of any amount paid out for new
buildings or for permanent improvements, or betterments made
to increase the value of any property or estate. (Emphasis
supplied.)
We concur in this view, which is a necessary consequence of
section 31 of the Tax Code, pursuant to which:
(a) General Rule — In computing net income no deduction shall
in any case be allowed in respect of —
(1) Personal, living, or family expenses;
(2) Any amount paid out for new buildings or for permanent
improvements, or betterments made to increase the value of any
property or estate;
(3) Any amount expended in restoring property or in making good
the exhaustion thereof for which an allowance is or has been
made; or
(4) Premiums paid on any life insurance policy covering the life of
any officer or employee, or any person financially interested in
any trade or business carried on by the taxpayer, individual or
corporate, when the taxpayer is directly or indirectly a beneficiary
under such policy. (Emphasis supplied.)
Said view is, likewise, in accord with the consensus of the
authorities on the subject.
Expenses incident to the acquisition of property follow the same
rule as applied to payments made as direct consideration for the
property. For example, commission paid in acquiring property are
considered as representing part of the cost of the property
acquired. The same treatment is to be accorded to amounts
expended for maps, abstracts, legal opinions on titles, recording
fees and surveys. Other non-deductible expenses include
amounts paid in connection with geological
explorations, development and subdividing of real
estate; clearing and grading; restoration of soil, drilling wells,
architects's fees and similar types of expenditures. (4 Merten's
Law of Federal Income Taxation, Sec. 25.20, pp. 348-349; see
also sec. 75 of the income Regulation of the B.I.R.; Emphasis
supplied.)
The cost of farm machinery, equipment and farm building
represents a capital investment and is not an allowable deduction
as an item of expense. Amounts expended in the development of
farms, orchards, and ranches prior to the time when the
productive state is reached may be regarded as investments of
capital. (Merten's Law of Federal Income Taxation, supra, sec.
25.108, p. 525.)
Expenses for clearing off and grading lots acquired is
a capital expenditure, representing part of the cost of the land
and was not deductible as an expense. (Liberty Banking Co. v.
Heiner 37 F [2d] 703 [8AFTR 100111] [CCA 3rd]; The B.L. Marble
Chair Company v. U.S., 15 AFTR 746).
An item of expenditure, in order to be deductible under this
section of the statute providing for the deduction
of ordinary and necessary business expenses, must
fall squarely within the language of the statutory provision. This
section is intended primarily, although not always necessarily, to
cover expenditures of a recurring nature where the benefit
derived from the payment is realized and exhausted within the
taxable year. Accordingly, if the result of the expenditure is
the acquisition of an asset which has an economically useful
life beyond the taxable year, no deduction of such payment may
be obtained under the provisions of the statute. In such cases, to
the extent that a deduction is allowable, it must be obtained under
the provisions of the statute which permit deductions for
amortization, depreciation, depletion or loss. (W.B. Harbeson Co.
24 BTA, 542; Clark Thread Co., 28 BTA 1128 aff'd 100 F [2d] 257
[CCA 3rd, 1938]; 4 Merten's Law of Federal Income Taxation,
Sec. 25.17, pp. 337-338.)
Gancayco's claim for representation expenses aggregated
P31,753.97, of which P22,820.52 was allowed, and P8,933.45
disallowed. Such disallowance is justified by the record, for, apart
from the absence of receipts, invoices or vouchers of the
expenditures in question, petitioner could not specify the items
constituting the same, or when or on whom or on what they were
incurred. The case of Cohan v. Commissioner, 39 F (2d) 540,
cited by petitioner is not in point, because in that case there was
evidence on the amounts spent and the persons entertained and
the necessity of entertaining them, although there were no
receipts an vouchers of the expenditures involved therein. Such
is not the case of petitioner herein.
Being in accordance with the facts and law, the decision of the
Court of Tax Appeals is hereby affirmed therefore, with costs
against petitioner Santiago Cancayco. It is so ordered.
Gancayco vs.Collector

Gancyaco files his income tax return for the year

1949. Respondent issued a warrant of distraint and levy against
the properties of Gancayco for the satisfaction of his deficiency
income tax liability, and accordingly, the municipal treasurer
issued a notice of sale of said property at public auction.
Gancayco filed a petition to cancel the sale and direct that the
same be re-advertised at a future date

ISSUE: Whether the sum of PhP 16,860.31 is due from Gancayco

as deficiency income tax for 1949 hinges on the validity of his
claim for deduction:
a) farming expense PhP 27,459
b) representation expenses PhP 8,933.45

HELD:
a)Farming Expenses - no evidence has been presnted as to the
nature of the said farming expenses other than the care
statement of petitioner that they were spent for the development
and cultivation of his property.

No specification has been made as to the actual amount spent

for purchase of tools, equipment or materials or the amount spent
for improvement.

b) Representation expense
PhP 22, 820 is allowed
PhP 8,993.45 is disallowed because of the absence of recipt,
invoices or vouchers of the expenditures in question, petitioner
could not sspecify the items constituting the same when or on
whom or on what they were incurred
G.R. No. L-25299 July 29, 1969
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
ITOGON-SUYOC MINES, INC., and THE COURT OF TAX
APPEALS, respondents.
Office of the Solicitor General Antonio P. Barredo, Assistant
Solicitor General Felicisimo R. Rosete and Special Attorney
Oscar S. de Castro for petitioner.
Ramon O. Reynoso, Jr. and Melchor R. Flores for respondents.
FERNANDO, J.:
The question presented for determination in this petition for the
review of a decision of the Court of Tax Appeals, one that is of
first impression, would not have arisen had respondent Itogon-
Suyoc Mines, Inc., the taxpayer involved, duly paid in full its
liability according to its income tax return for the fiscal year 1960-
61. Instead, it deducted right away the amount represented by
claim for refund filed eight (8) months back, for the previous year's
income tax, for which it was not liable at all, so it alleged, as it
suffered a loss instead, a claim subsequently favorably acted on
by petitioner Commissioner of Internal Revenue but after the date
of such payment of the 1960-1961 tax. Accordingly, an interest in
the amount of P1,512.83 was charged by petitioner
Commissioner of Internal Revenue on the sum withheld on the
ground that no deduction on such refund should be allowed
before its approval. When the matter was taken up before the
Court of Tax Appeals, the above assessment representing
interest was set aside in the decision of September 30, 1965.
That is the decision now an appeal by petitioner Commissioner
of Internal Revenue. We sustain the Court of Tax Appeals.
Respondent Itogon-Suyoc Mines, Inc., a mining corporation duly
organized and existing in accordance with the laws of the
Philippines, filed on January 13, 1961, its income tax return for
the fiscal year 1959-1960. It declared a taxable income of
P114,368.04 and a tax due thereon amounting to P26,310.41, for
which it paid on the same day, the amount of P13,155.20 as the
first installment of the income tax due. On May 17, 1961,
petitioner filed an amended income tax return, reporting therein a
net loss of P331,707.33. It thus sought a refund from the
Commissioner of Internal Revenue, now the
petitioner.1äwphï1.ñët
On February 14, 1962, respondent Itogon-Suyoc Mines, Inc. filed
its income tax return for the fiscal year 1960-1961, setting forth
its income tax liability to the tune of P97,345.00, but deducting
the amount of P13,155.20 representing alleged tax credit for
overpayment of the preceding fiscal year 1959-1960. 0n
December 18, 1962, petitioner Commissioner of Internal
Revenue assessed against the respondent the amount of
P1,512.83 as 1% monthly interest on the aforesaid amount of
P13,155.20 from January 16, 1962 to December 31, 1962. The
basis for such an assessment was the absence of legal right to
deduct said amount before the refund or tax credit thereof was
approved by petitioner Commissioner of Internal Revenue. 1
Such an assessment was contested by respondent before the
Court of Tax Appeals. As already noted, it prevailed. The decision
of September 30, 1965, now on appeal, explains why. Thus:
"Respondent assessed against the petitioner the amount of
P1,512.83 as 1% monthly interest on the sum of P13,155.20 from
January 16, 1962 to December 31, 1962 on the ground that
petitioner had no legal right to deduct the said amount from its
income tax liability for the fiscal year 1960-1961 until the refund
or tax credit thereof has been approved by respondent. As
aforestated, petitioner paid the amount of P13,155.20 as first
installment on its reported income tax liability for the fiscal year
1959-1960. But, it turned out that instead of deriving a net gain, it
sustained a net loss during the said fiscal year. Accordingly, it
filed an amended income tax return and a claim for the refund of
the sum of P13,155.20, which sum it subsequently, deducted
from its income tax liability for the succeeding fiscal year 1960-
1961. The overpayment for the fiscal year 1959-1960 and the
deduction of the overpaid amount from its 1960-1961 tax liability
are not denied by respondent. In this circumstance, we find it
unfair and unjust for the Commissioner to exact an interest on the
said sum of P13,155.20, which, after all, was paid to and received
by the government even before the incidence of the tax in
question." 2
That is the question before us in this petition for review by the
Commissioner of Internal Revenue. He argues that the Court of
Tax Appeals should not have absolved respondent corporation
"from liability to pay the sum of P1,512.83 as 1% monthly interest
for delinquency in the payment of income tax for the fiscal year
1960-1961." 3 As noted at the outset, we find such contention far
from persuasive.
It could not be error for the Court of Tax Appeals, considering the
admitted fact of overpayment, entitling respondent to refund, to
hold that petitioner should not repose an interest on the aforesaid
sum of P13,155.20 "which after all was paid to and received by
the government even before the incidence of the tax in question."
It would be, according to the Court of Tax Appeals, "unfair and
unjust" to do so. We agree but we go farther. The imposition of
such an interest by petitioner is not supported by law.
The National Internal Revenue Code provides that interest upon
the amount determined as a deficiency shall be assessed and
shall be paid upon notice and demand from the Commissioner of
Internal Revenue at the specified. 4 It is made clear, however, in
an earlier provision found in the same section that if in any
preceding year, the taxpayer was entitled to a refund of any
amount due as tax, such amount, if not yet refunded, may be
deducted from the tax to be paid. 5
There is no question respondent was entitled to a refund. Instead
of waiting for the sum involved to be delivered to it, it deducted
the said amount from the tax that it had to pay. That it had a right
to do according to the law. It is true a doubt could have arisen
due to the fact that as of the time such a deduction was made,
the Commissioner of Internal Revenue had not as yet approved
such a refund. It is an admitted fact though that respondent was
clearly entitled to it, and petitioner did not allege otherwise. Nor
could he do so. Under all the circumstances disclosed therefore,
the applicability of the legal provision allowing such a deduction
from the amount of the tax to be paid cannot be disputed.
This conclusion is in accordance with the principle announced
in Castro v. Collector of Internal Revenue. 6 While the case is not
directly in point, it yields an implication that makes even more
formidable the case for respondent taxpayer. As there held, the
imposition of the monthly interest was considered as not
constituting a penalty "but a just compensation to the state for the
delay in paying the tax, and for the concomitant use by the
taxpayer of funds that rightfully should be in the government's
hands ...."
What is therefore sought to be avoided is for the taxpayer to make
use of funds that should have been paid to the government. Here,
in view of the overpayment for the fiscal year 1959-1960, the sum
of P13,155.20 had already formed part of the public funds. It
cannot be said, therefore, that respondent taxpayer was guilty of
any delay enabling it to utilize a sum of money that should have
been in the government treasury.
How then, as a matter of pure law, even if we lay to one side the
demands of fairness and justice, which to the Court of Tax
Appeals seem to be uppermost, can its decision be overturned?
Accordingly, we find no valid ground for this appeal.
WHEREFORE, the decision of September 30, 1965 of the Court
of Tax Appeals is affirmed. Without pronouncement as to
costs.1äwphï1.ñët
Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar,
Sanchez, Castro, Capistrano and Teehankee, JJ., concur.
Barredo, J., took no part.
139 Phil. 142
FERNANDO, J.:
The question presented for determination in this petition for the
review of a decision of the Court of Tax Appeals, one that is of
first impression, would not have arisen had respondent Itogon-
Suyoc Mines, Inc., the taxpayer involved, duly paid in full its
liability according to its income tax return for the fiscal year 1960-
61. Instead, it deducted right away the amount represented by a
claim for refund filed eight (8) months back, for the previous year's
income tax, for which it was not liable at all, so it alleged, as it
suffered a loss instead, a claim subsequently favorably acted on
by petitioner Commissioner of Internal Revenue but after the date
of such payment of the 1960-1961 tax. Accordingly, an interest
in the amount of P1,512.83 was charged by petitioner
Commissioner of Internal Revenue on the sum withheld on the
ground that no deduction on such refund should be allowed
before its approval. When the matter was taken up before the
Court of Tax Appeals, the above assessment representing
interest was set aside in the decision of September 30,
1965. That is the decision now on appeal by petitioner
Commissioner of Internal Revenue. We sustain the Court of Tax
Appeals.
Respondent Itogon-Suyoc Mines, Inc., a mining corporation duly
organized and existing in accordance with the laws of the
Philippines, filed on January 13, 1961, its income tax return for
the fiscal year 1959-1960. It declared a taxable income of
P114,368.04 and a tax due thereon amounting to P26,310.41, for
which it paid on the same day, the amount of P13,155.20 as the
first installment of the income tax due. On May 17, 1961,
petitioner filed an amended income tax return, reporting therein a
net loss of P331,707.33. It thus sought a refund from the
Commissioner of Internal Revenue, now the petitioner.
On February 14, 1962, respondent Itogon-Suyoc Mines, Inc. filed
its income tax return for the fiscal year 1960-1961, setting forth
its income tax liability to the tune of P97,345.00, but deducting
the amount of P13,155.20 representing alleged tax credit for
overpayment of the preceding fiscal year 1959-1960. On
December 18, 1962, petitioner Commissioner of Internal
Revenue assessed against the respondent the amount of
P1,512.83 as 1% monthly interest on the aforesaid amount of
P13,155.20 from January 16, 1962 to December 31, 1962. The
basis for such an assessment was the absence of legal right to
deduct said amount before the refund or tax credit thereof was
approved by petitioner Commissioner of Internal Revenue.[1]
Such an assessment was contested by respondent before the
Court of Tax Appeals. As already noted, it prevailed. The
decision of September 30, 1965, now on appeal, explains
why. Thus: "Respondent assessed against the petitioner the
amount of P1,512.83 as 1% monthly interest on the sum of
P13,155.20 from January 16, 1962 to December 31, 1962 on the
ground that petitioner had no legal right to deduct the said amount
from its income tax liability for the fiscal year 1960-1961 until the
refund or tax credit thereof has been approved by
respondent. As aforestated, petitioner paid the amount of
P13,155.20 as first installment on its reported income tax liability
for the fiscal year 1959-1960. But, it turned out that instead of
deriving a net gain, it sustained a net loss during the said fiscal
year. Accordingly, it filed an amended income tax return and a
claim for the refund of the sum of P13,155.20, which sum it
subsequently deducted from its income tax liability for the
succeeding fiscal year 1960-1961. The overpayment for the
fiscal year 1959-1960 and the deduction of the overpaid amount
from its 1960-1961 tax liability are not denied by respondent. In
this circumstance, we find it unfair and unjust for the
Commissioner to exact an interest on the said sum of
P13,155.20, which, after all, was paid to and received by the
government even before the incidence of the tax in question."[2]
That is the question before us in this petition for review by the
Commissioner of Internal Revenue. He argues that the Court of
Tax Appeals should not have absolved respondent corporation
"from liability to pay the sum of P1,512.83 as 1% monthly interest
for delinquency in the payment of income tax for the fiscal year
1960-1961."[3] As noted at the outset, we find such contention far
from persuasive.
It could not be error for the Court of Tax Appeals, considering the
admitted fact of overpayment, entitling respondent to refund, to
hold that petitioner should not impose an interest on the aforesaid
sum of P13,155.20 "which after all was paid to and received by
the government even before the incidence of the tax in question."
It would be, according to the Court of Tax Appeals, "unfair and
unjust" to do so. We agree but we go farther. The imposition of
such an interest by petitioner is not supported by law.
formidable the case for respondent taxpayer. As there held, the
imposition of the monthly interest was considered as not
constituting a penalty "but a just compensation to the state for the
delay in paying the tax, and for the concomitant use by the
taxpayer of funds that rightfully should be in the government's
hands * * *."
What is therefore sought to be avoided is for the taxpayer to make
use of funds that should have been paid to the
government. Here, in view of the overpayment for the fiscal year
1959-1960, the sum of P13,155.20 had already formed part of the
public funds. It cannot be said, therefore, that respondent
taxpayer was guilty of any delay enabling it to utilize a sum of
money that should have been in the government treasury.

The National Internal Revenue Code provides that interest upon
the amount determined as a deficiency shall be assessed and
shall be paid upon notice and demand from the Commissioner of
Internal Revenue at the rate therein specified.[4] It is made clear,
however, in an earlier provision found in the same section that if
in any preceding year, the taxpayer was entitled to a refund of
any amount due as tax, such amount, if not yet refunded, may be
deducted from the tax to be paid.[5]
How then, as a matter of pure law, even if we lay to one side the
demands of fairness and justice, which to the Court of Tax
Appeals seem to be uppermost, can its decision be
overturned? Accordingly, we find no valid ground for this appeal.
WHEREFORE, the decision of September 30, 1965 of the Court
of Tax Appeals is affirmed. Without pronouncement as to costs.

There is no question respondent was entitled to a refund. Instead

of waiting for the sum involved to be delivered to it, it deducted
the said amount from the tax that it had to pay. That it had a right
to do according to the law. It is true a doubt could have arisen
due to the fact that as of the time such a deduction was made,
the Commissioner of Internal Revenue had not as yet approved
such a refund. It is an admitted fact though that respondent was
clearly entitled to it, and petitioner did not allege otherwise. Nor
could he do so. Under all the circumstances disclosed therefore,
the applicability of the legal provision allowing such a deduction
from the amount of the tax to be paid cannot be disputed.

This conclusion is in accordance with the principle announced in

Castro v. Collector of Internal Revenue.[6] While the case is not
directly in point, it yields an implication that makes even more