Taxation Latest for Prinitng

G.R. No. L-19392 April 14, 1965

ALEXANDER HOWDEN & CO., LTD., H. G. CHESTER & OTHERS, ET AL., petitioners,

vs.

THE COLLECTOR (NOW COMMISSIONER) Of INTERNAL REVENUE, respondent.

Sycip, Salazar, Luna and Associates and Lichauco, Picazo and Agcaoili for petitioners.

Office of the Solicitor General for respondent.

BENGZON, J.P., J.:

In 1950 the Commonwealth Insurance Co., a domestic corporation, entered into reinsurance contracts with 32 British insurance companies

not engaged in trade or business in the Philippines, whereby the former agreed to cede to them a portion of the premiums on insurances on

fire, marine and other risks it has underwritten in the Philippines. Alexander Howden & Co., Ltd., also a British corporation not engaged in

business in this country, represented the aforesaid British insurance companies. The reinsurance contracts were prepared and signed by the

foreign reinsurers in England and sent to Manila where Commonwealth Insurance Co. signed them.

Pursuant to the aforesaid contracts, Commonwealth Insurance Co., in 1951, remitted P798,297.47 to Alexander Howden & Co., Ltd., as

reinsurance premiums. In behalf of Alexander Howden & Co., Ltd., Commonwealth Insurance Co. filed in April 1952 an income tax return

declaring the sum of P798,297.47, with accrued interest thereon in the amount of P4,985.77, as Alexander Howden & Co., Ltd.'s gross

income for calendar year 1951. It also paid the Bureau of Internal Revenue P66,112.00 income tax thereon.

On May 12, 1954, within the two-year period provided for by law, Alexander Howden & Co., Ltd. filed with the Bureau of Internal

Revenue a claim for refund of the P66,112.00, later reduced to P65,115.00, because Alexander Howden & Co., Ltd. agreed to the payment

of P977.00 as income tax on the P4,985.77 accrued interest. A ruling of the Commissioner of Internal Revenue, dated December 8, 1953,

was invoked, stating that it exempted from withholding tax reinsurance premiums received from domestic insurance companies by foreign

insurance companies not authorized to do business in the Philippines. Subsequently, Alexander Howden & Co., Ltd. instituted an action in

the Court of First Instance of Manila for the recovery of the aforesaid amount claimed. Pursuant to Section 22 of Republic Act 1125 the

case was certified to the Court of Tax Appeals. On November 24, 1961 the Tax Court denied the claim.

Plaintiffs have appealed, thereby squarely raising the following issues: (1) Are portions of premiums earned from insurances locally

underwritten by a domestic corporation, ceded to and received by non-resident foreign reinsurance companies, thru a non-resident foreign

insurance broker, pursuant to reinsurance contracts signed by the reinsurers abroad but signed by the domestic corporation in the

Philippines, subject to income tax or not? (2) If subject thereto, may or may not the income tax on reinsurance premiums be withheld

pursuant to Sections 53 and 54 of the National Internal Revenue Code?

Section 24 of the National Internal Revenue Code subjects to tax a non-resident foreign corporation's income from sources within the

Philippines. The first issue therefore hinges on whether or not the reinsurance premiums in question came from sources within the

Philippines.

Appellants would impress upon this Court that the reinsurance premiums came from sources outside the Philippines, for these reasons: (1)

The contracts of reinsurance, out of which the reinsurance premiums were earned, were prepared and signed abroad, so that their situs lies

outside the Philippines; (2) The reinsurers, not being engaged in business in the Philippines, received the reinsurance premiums as income

from their business conducted in England and, as such, taxable in England; and, (3) Section 37 of the Tax Code, enumerating what are

income from sources within the Philippines, does not include reinsurance premiums.

The source of an income is the property, activity or service that produced the income. 1

The reinsurance premiums remitted to appellants by

virtue of the reinsurance contracts, accordingly, had for their source the undertaking to indemnify Commonwealth Insurance Co. against

liability. Said undertaking is the activity that produced the reinsurance premiums, and the same took place in the Philippines. In the first

place, the reinsured, the liabilities insured and the risks originally underwritten by Commonwealth Insurance Co., upon which the

reinsurance premiums and indemnity were based, were all situated in the Philippines. Secondly, contrary to appellants' view, the reinsurance

contracts were perfected in the Philippines, for Commonwealth Insurance Co. signed them last in Manila. The American cases cited are

inapplicable to this case because in all of them the reinsurance contracts were signed outside the jurisdiction of the taxing State. And,

thirdly, the parties to the reinsurance contracts in question evidently intended Philippine law to govern. Article 11 thereof provided for

arbitration in Manila, according to the laws of the Philippines, of any dispute arising between the parties in regard to the interpretation of

said contracts or rights in respect of any transaction involved. Furthermore, the contracts provided for the use of Philippine currency as the

medium of exchange and for the payment of Philippine taxes.

Appellants should not confuse activity that creates income with business in the course of which an income is realized. An activity may

consist of a single act; while business implies continuity of transactions. 2

An income may be earned by a corporation in the Philippines

although such corporation conducts all its businesses abroad. Precisely, Section 24 of the Tax Code does not require a foreign corporation to

be engaged in business in the Philippines in order for its income from sources within the Philippines to be taxable. It subjects foreign

corporations not doing business in the Philippines to tax for income from sources within the Philippines. If by source of income is meant the

business of the taxpayer, foreign corporations not engaged in business in the Philippines would be exempt from taxation on their income

from sources within the Philippines.

Furthermore, as used in our income tax law, "income" refers to the flow of wealth. 3

Such flow, in the instant case, proceeded from the

Philippines. Such income enjoyed the protection of the Philippine Government. As wealth flowing from within the taxing jurisdiction of the

Philippines and in consideration for protection accorded it by the Philippines, said income should properly share the burden of maintaining

the government.

Appellants further contend that reinsurance premiums not being among those mentioned in Section 37 of the Tax Code as income from

sources within the Philippines, the same should not be treated as such. Section 37, however, is not an all-inclusive enumeration. It states that

"the following items of gross income shall be treated as gross income from sources within the Philippines." It does not state or imply that an

income not listed therein is necessarily from sources outside the Philippines.

As to appellants' contention that reinsurance premiums constitute "gross receipts" instead of "gross income", not subject to income tax,

suffice it to say that, as correctly observed by the Court of Tax Appeals, "gross receipts" of amounts that do not constitute return of capital,

such as reinsurance premiums, are part of the gross income of a taxpayer. At any rate, the tax actually collected in this case was computed

not on the basis of gross premium receipts but on the net premium income, that is, after deducting general expenses, payment of policies

and taxes.

The reinsurance premiums in question being taxable, we turn to the issue whether or not they are subject to withholding tax under Section

54 in relation to Section 53 of the Tax Code.

Subsection (b) of Section 53 subjects to withholding tax the following: interest, dividends, rents, salaries, wages, premiums, annuities,

compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income of any non-

resident alien individual not engaged in trade or business within the Philippines and not having any office or place of business therein.

Section 54, by reference, applies this provision to foreign corporations not engaged in trade or business in the Philippines.

Appellants maintain that reinsurance premiums are not "premiums" at all as contemplated by Subsection (b) of Section 53; that they are not

within the scope of "other fixed or determinable annual or periodical gains, profits, and income"; that, therefore, they are not items of

income subject to withholding tax.

It is urged for the applicant that no opposition has been registered against his petition on the issues above-discussed. Absence of opposition,

however, does not preclude the scanning of the whole record by the appellate court, with a view to preventing the conferment of citizenship

to persons not fully qualified therefor (Lee Ng Len vs. Republic, G.R. No. L-20151, March 31, 1965). The applicant's complaint of

unfairness could have some weight if the objections on appeal had been on points not previously passed upon. But the deficiencies here in

question are not new but well-known, having been ruled upon repeatedly by this Court, and we see no excuse for failing to take them into

account.1äwphï1.ñët

The argument of appellants is that "premiums", as used in Section 53 (b), is preceded by "rents, salaries, wages" and followed by "annuities,

compensations, remunerations" which connote periodical income payable to the recipient on account of some investment or for personal

services rendered. "Premiums" should, therefore, in appellants' view, be given a meaning kindred to the other terms in the enumeration and

be understood in its broadest sense as "a reward or recompense for some act done; a bonus; compensation for the use of money; a price for a

loan; a sum in addition to interest."

We disagree with the foregoing proposition. Since Section 53 subjects to withholding tax various specified income, among them,

"premiums", the generic connotation of each and every word or phrase composing the enumeration in Subsection (b) thereof is income.

Perforce, the word "premiums", which is neither qualified nor defined by the law itself, should mean income and should include all

premiums constituting income, whether they be insurance or reinsurance premiums.

Assuming that reinsurance premiums are not within the word "premiums" in Section 53, still they may be classified as determinable and

periodical income under the same provision of law. Section 199 of the Income Tax Regulations defines fixed, determinable, annual and

periodical income:

Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is determinable whenever there is

a basis of calculation by which the amount to be paid may be ascertained.

The income need not be paid annually if it is paid periodically; that is to say, from time to time, whether or not at regular intervals.

That the length of time during which the payments are to be made may be increased or diminished in accordance with someone's

will or with the happening of an event does not make the payments any the less determinable or periodical. ...

Reinsurance premiums, therefore, are determinable and periodical income: determinable, because they can be calculated accurately on the

basis of the reinsurance contracts; periodical, inasmuch as they were earned and remitted from time to time.

Appellants' claim for refund, as stated, invoked a ruling of the Commissioner of Internal Revenue dated December 8, 1953. Appellants' brief

also cited rulings of the same official, dated October 13, 1953, February 7, 1955 and February 8, 1955, as well as the decision of the defunct

Board of Tax Appeals in the case of Franklin Baker Co., 4

thereby attempting to show that the prevailing administrative interpretation of

Sections 53 and 54 of the Tax Code exempted from withholding tax reinsurance premiums ceded to non-resident foreign insurance

companies. It is asserted that since Sections 53 and 54 were "substantially re-enacted" by Republic Acts 1065 (approved June 12, 1954),

1291 (approved June 15, 1955), 1505 (approved June 16, 1956) and 2343 (approved June 20, 1959) when the said administrative rulings

prevailed, the rulings should be given the force of law under the principle of legislative approval by re-enactment.

The principle of legislative approval by re-enactment may briefly be stated thus: Where a statute is susceptible of the meaning placed upon

it by a ruling of the government agency charged with its enforcement and the Legislature thereafter re-enacts the provisions without

substantial change, such action is to some extent confirmatory that the ruling carries out the legislative purpose.5

The aforestated principle, however, is not applicable to this case. Firstly, Sections 53 and 54 were never reenacted. Republic Acts 1065,

1291, 1505 and 2343 were merely amendments in respect to the rate of tax imposed in Sections 53 and 54. Secondly, the administrative

rulings of the Commissioner of Internal Revenue relied upon by the taxpayers were only contained in letters to taxpayers and never

published, so that the Legislature is not presumed to know said rulings. Thirdly, in the case on which appellants rely, Interprovincial

Autobus Co., Inc. vs. Collector of Internal Revenue, L-6741, January 31, 1956, what was declared to have acquired the force or effect of law

was a regulation promulgated to implement a law; whereas, in this case, what appellants would seek to have the force of law are opinions

on queries submitted.

It may not be amiss to note that in 1963, after the Tax Court rendered judgment in this case, Congress enacted Republic Act 3825, as an

amendment to Sections 24 and 54 of the Tax Code, exempting from income taxes and withholding tax, reinsurance premiums received by

foreign corporations not engaged in business in the Philippines. Republic Act 3825 in effect took out from Sections 24 and 54 something

which formed a part of the subject matter therein,6 thereby affirming the taxability of reinsurance premiums prior to the aforestated

amendment.

Finally, appellant would argue that Judge Augusto M. Luciano, who penned the decision appealed from, was disqualified to sit in this case

since he had appeared as counsel for the Commissioner of Internal Revenue and, as such, answered plaintiff's complaint before the Court of

First Instance of Manila.

The Rules of Court provides that no judge shall sit in any case in which he has been counsel without the written consent of all the parties in

interest, signed by them and entered upon the record. The party objecting to the judge's competency may file, in writing, with such judge his

objection stating therein the grounds for it. The judge shall thereupon proceed with the trial or withdraw therefrom, but his action shall be

made in writing and made part of the record.7

Appellants, instead of asking for Judge Luciano's disqualification by raising their objection in the Court of Tax Appeals, are content to raise

it for the first time before this Court. Such being the case they may not now be heard to complain on this point, when Judge Luciano has

given his opinion on the merits of the case. A litigant cannot be permitted to speculate upon the action of the court and raise an objection of

this nature after decision has been rendered. 8

WHEREFORE, the judgment appealed from is hereby affirmed with costs against appellants. It is so ordered.

G.R. No. 153793 August 29, 2006

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.

JULIANE BAIER-NICKEL, as represented by Marina Q. Guzman (Attorney-in-fact) Respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18, 2002 Decision1 of the Court of Appeals in CA-G.R. SP

No. 59794, which granted the tax refund of respondent Juliane Baier-Nickel and reversed the June 28, 2000 Decision2 of the Court of Tax

Appeals (CTA) in C.T.A. Case No. 5633. Petitioner also assails the May 8, 2002 Resolution3 of the Court of Appeals denying its motion for

reconsideration.

The facts show that respondent Juliane Baier-Nickel, a non-resident German citizen, is the President of JUBANITEX, Inc., a domestic

corporation engaged in "[m]anufacturing, marketing on wholesale only, buying or otherwise acquiring, holding, importing and exporting,

selling and disposing embroidered textile products."4 Through JUBANITEX‘s General Manager, Marina Q. Guzman, the corporation

appointed and engaged the services of respondent as commission agent. It was agreed that respondent will receive 10% sales commission on

all sales actually concluded and collected through her efforts.5

In 1995, respondent received the amount of P1,707,772.64, representing her sales commission income from which JUBANITEX withheld

the corresponding 10% withholding tax amounting to P170,777.26, and remitted the same to the Bureau of Internal Revenue (BIR). On

October 17, 1997, respondent filed her 1995 income tax return reporting a taxable income of P1,707,772.64 and a tax due of P170,777.26.6

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26 alleged to have been mistakenly withheld and remitted by

JUBANITEX to the BIR. Respondent contended that her sales commission income is not taxable in the Philippines because the same was a

compensation for her services rendered in Germany and therefore considered as income from sources outside the Philippines.

The next day, April 15, 1998, she filed a petition for review with the CTA contending that no action was taken by the BIR on her claim for

refund.7 On June 28, 2000, the CTA rendered a decision denying her claim. It held that the commissions received by respondent were

actually her remuneration in the performance of her duties as President of JUBANITEX and not as a mere sales agent thereof. The income

derived by respondent is therefore an income taxable in the Philippines because JUBANITEX is a domestic corporation.

On petition with the Court of Appeals, the latter reversed the Decision of the CTA, holding that respondent received the commissions as

sales agent of JUBANITEX and not as President thereof. And since the "source" of income means the activity or service that produce the

income, the sales commission received by respondent is not taxable in the Philippines because it arose from the marketing activities

performed by respondent in Germany. The dispositive portion of the appellate court‘s Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of Tax Appeals dated June 28, 2000 is hereby REVERSED and SET

ASIDE and the respondent court is hereby directed to grant petitioner a tax refund in the amount of Php 170,777.26.

SO ORDERED.8

Petitioner filed a motion for reconsideration but was denied.9 Hence, the instant recourse.

Petitioner maintains that the income earned by respondent is taxable in the Philippines because the source thereof is JUBANITEX, a

domestic corporation located in the City of Makati. It thus implied that source of income means the physical source where the income came

from. It further argued that since respondent is the President of JUBANITEX, any remuneration she received from said corporation should

be construed as payment of her overall managerial services to the company and should not be interpreted as a compensation for a distinct

and separate service as a sales commission agent.

Respondent, on the other hand, claims that the income she received was payment for her marketing services. She contended that income of

nonresident aliens like her is subject to tax only if the source of the income is within the Philippines. Source, according to respondent is the

situs of the activity which produced the income. And since the source of her income were her marketing activities in Germany, the income

she derived from said activities is not subject to Philippine income taxation.

The issue here is whether respondent‘s sales commission income is taxable in the Philippines.

Pertinent portion of the National Internal Revenue Code (NIRC), states:

SEC. 25. Tax on Nonresident Alien Individual. –

(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. –

(1) In General. – A nonresident alien individual engaged in trade or business in the Philippines shall be subject to an income tax in the same

manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. A

nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than one hundred eighty

(180) days during any calendar year shall be deemed a ‗nonresident alien doing business in the Philippines,‘ Section 22(G) of this Code

notwithstanding.

x x x x

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines. – There shall be levied, collected and paid for

each taxable year upon the entire income received from all sources within the Philippines by every nonresident alien individual not engaged

in trade or business within the Philippines x x x a tax equal to twenty-five percent (25%) of such income. x x x

Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or not engaged in trade or business, are subject to Philippine

income taxation on their income received from all sources within the Philippines. Thus, the keyword in determining the taxability of non-

resident aliens is the income‘s "source." In construing the meaning of "source" in Section 25 of the NIRC, resort must be had on the origin

of the provision.

The first Philippine income tax law enacted by the Philippine Legislature was Act No. 2833,10

which took effect on January 1, 1920.11

Under Section 1 thereof, nonresident aliens are likewise subject to tax on income "from all sources within the Philippine Islands," thus –

SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar

year from all sources by every individual, a citizen or resident of the Philippine Islands, a tax of two per centum upon such income; and a

like tax shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar year from all

sources within the Philippine Islands by every individual, a nonresident alien, including interest on bonds, notes, or other interest-bearing

obligations of residents, corporate or otherwise.

Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of 1916 as amended by U.S. Revenue Law of 1917.12

Being a

law of American origin, the authoritative decisions of the official charged with enforcing it in the U.S. have peculiar persuasive force in the

Philippines.13

The Internal Revenue Code of the U.S. enumerates specific types of income to be treated as from sources within the U.S. and specifies

when similar types of income are to be treated as from sources outside the U.S.14

Under the said Code, compensation for labor and personal

services performed in the U.S., is generally treated as income from U.S. sources; while compensation for said services performed outside

the U.S., is treated as income from sources outside the U.S.15

A similar provision is found in Section 42 of our NIRC, thus:

SEC. 42. x x x

(A) Gross Income From Sources Within the Philippines. x x x

x x x x

(3) Services. – Compensation for labor or personal services performed in the Philippines;

x x x x

(C) Gross Income From Sources Without the Philippines. x x x

x x x x

(3) Compensation for labor or personal services performed without the Philippines;

The following discussions on sourcing of income under the Internal Revenue Code of the U.S., are instructive:

The Supreme Court has said, in a definition much quoted but often debated, that income may be derived from three possible sources only:

(1) capital and/or (2) labor; and/or (3) the sale of capital assets. While the three elements of this attempt at definition need not be accepted

as all-inclusive, they serve as useful guides in any inquiry into whether a particular item is from "sources within the United States" and

suggest an investigation into the nature and location of the activities or property which produce the income.

If the income is from labor the place where the labor is done should be decisive; if it is done in this country, the income should be from

"sources within the United States." If the income is from capital, the place where the capital is employed should be decisive; if it is

employed in this country, the income should be from "sources within the United States." If the income is from the sale of capital assets, the

place where the sale is made should be likewise decisive.

Much confusion will be avoided by regarding the term "source" in this fundamental light. It is not a place, it is an activity or property. As

such, it has a situs or location, and if that situs or location is within the United States the resulting income is taxable to nonresident aliens

and foreign corporations.

The intention of Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913 basis of taxing nonresident aliens and

foreign corporations and to make the test of taxability the "source," or situs of the activities or property which produce the income. The

result is that, on the one hand, nonresident aliens and nonresident foreign corporations are prevented from deriving income from the United

States free from tax, and, on the other hand, there is no undue imposition of a tax when the activities do not take place in, and the property

producing income is not employed in, this country. Thus, if income is to be taxed, the recipient thereof must be resident within the

jurisdiction, or the property or activities out of which the income issues or is derived must be situated within the jurisdiction so that the

source of the income may be said to have a situs in this country.

The underlying theory is that the consideration for taxation is protection of life and property and that the income rightly to be levied upon to

defray the burdens of the United States Government is that income which is created by activities and property protected by this Government

or obtained by persons enjoying that protection. 16

The important factor therefore which determines the source of income of personal services is not the residence of the payor, or the place

where the contract for service is entered into, or the place of payment, but the place where the services were actually rendered.17

In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue,18

the Court addressed the issue on the applicable source rule relating to

reinsurance premiums paid by a local insurance company to a foreign insurance company in respect of risks located in the Philippines. It

was held therein that the undertaking of the foreign insurance company to indemnify the local insurance company is the activity that

produced the income. Since the activity took place in the Philippines, the income derived therefrom is taxable in our jurisdiction. Citing

Mertens, The Law of Federal Income Taxation, the Court emphasized that the technical meaning of source of income is the property,

activity or service that produced the same. Thus:

The source of an income is the property, activity or service that produced the income. The reinsurance premiums remitted to appellants by

virtue of the reinsurance contracts, accordingly, had for their source the undertaking to indemnify Commonwealth Insurance Co. against

liability. Said undertaking is the activity that produced the reinsurance premiums, and the same took place in the Philippines. x x x the

reinsured, the liabilities insured and the risk originally underwritten by Commonwealth Insurance Co., upon which the reinsurance

premiums and indemnity were based, were all situated in the Philippines. x x x19

In Commissioner of Internal Revenue v. British Overseas Airways Corporation (BOAC),20

the issue was whether BOAC, a foreign airline

company which does not maintain any flight to and from the Philippines is liable for Philippine income taxation in respect of sales of air

tickets in the Philippines, through a general sales agent relating to the carriage of passengers and cargo between two points both outside the

Philippines. Ruling in the affirmative, the Court applied the case of Alexander Howden & Co., Ltd. v. Collector of Internal Revenue, and

reiterated the rule that the source of income is that "activity" which produced the income. It was held that the "sale of tickets" in the

Philippines is the "activity" that produced the income and therefore BOAC should pay income tax in the Philippines because it undertook an

income producing activity in the country.

Both the petitioner and respondent cited the case of Commissioner of Internal Revenue v. British Overseas Airways Corporation in support

of their arguments, but the correct interpretation of the said case favors the theory of respondent that it is the situs of the activity that

determines whether such income is taxable in the Philippines. The conflict between the majority and the dissenting opinion in the said case

has nothing to do with the underlying principle of the law on sourcing of income. In fact, both applied the case of Alexander Howden &

Co., Ltd. v. Collector of Internal Revenue. The divergence in opinion centered on whether the sale of tickets in the Philippines is to be

construed as the "activity" that produced the income, as viewed by the majority, or merely the physical source of the income, as ratiocinated

by Justice Florentino P. Feliciano in his dissent. The majority, through Justice Ameurfina Melencio-Herrera, as ponente, interpreted the sale

of tickets as a business activity that gave rise to the income of BOAC. Petitioner cannot therefore invoke said case to support its view that

source of income is the physical source of the money earned. If such was the interpretation of the majority, the Court would have simply

stated that source of income is not the business activity of BOAC but the place where the person or entity disbursing the income is located

or where BOAC physically received the same. But such was not the import of the ruling of the Court. It even explained in detail the

business activity undertaken by BOAC in the Philippines to pinpoint the taxable activity and to justify its conclusion that BOAC is subject

to Philippine income taxation. Thus –

BOAC, during the periods covered by the subject assessments, maintained a general sales agent in the Philippines. That general sales agent,

from 1959 to 1971, "was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in the

series corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various

airline companies on the basis of their participation in the services rendered through the mode of interline settlement as prescribed by

Article VI of the Resolution No. 850 of the IATA Agreement." Those activities were in exercise of the functions which are normally

incident to, and are in progressive pursuit of, the purpose and object of its organization as an international air carrier. In fact, the regular sale

of tickets, its main activity, is the very lifeblood of the airline business, the generation of sales being the paramount objective. There should

be no doubt then that BOAC was "engaged in" business in the Philippines through a local agent during the period covered by the

assessments. x x x21

x x x x

The source of an income is the property, activity or service that produced the income. For the source of income to be considered as coming

from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the

Philippines is the activity that produces the income. The tickets exchanged hands here and payments for fares were also made here in

Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded from, and occurred within,

Philippine territory, enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow of wealth

should share the burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between the ticket-holder

and the carrier. It gives rise to the obligation of the purchaser of the ticket to pay the fare and the corresponding obligation of the carrier to

transport the passenger upon the terms and conditions set forth thereon. The ordinary ticket issued to members of the traveling public in

general embraces within its terms all the elements to constitute it a valid contract, binding upon the parties entering into the relationship.22

The Court reiterates the rule that "source of income" relates to the property, activity or service that produced the income. With respect to

rendition of labor or personal service, as in the instant case, it is the place where the labor or service was performed that determines the

source of the income. There is therefore no merit in petitioner‘s interpretation which equates source of income in labor or personal service

with the residence of the payor or the place of payment of the income.

Having disposed of the doctrine applicable in this case, we will now determine whether respondent was able to establish the factual

circumstances showing that her income is exempt from Philippine income taxation.

The decisive factual consideration here is not the capacity in which respondent received the income, but the sufficiency of evidence to prove

that the services she rendered were performed in Germany. Though not raised as an issue, the Court is clothed with authority to address the

same because the resolution thereof will settle the vital question posed in this controversy.23

The settled rule is that tax refunds are in the nature of tax exemptions and are to be construed strictissimi juris against the taxpayer.24

To

those therefore, who claim a refund rest the burden of proving that the transaction subjected to tax is actually exempt from taxation.

In the instant case, the appointment letter of respondent as agent of JUBANITEX stipulated that the activity or the service which would

entitle her to 10% commission income, are "sales actually concluded and collected through [her] efforts."25

What she presented as evidence

to prove that she performed income producing activities abroad, were copies of documents she allegedly faxed to JUBANITEX and bearing

instructions as to the sizes of, or designs and fabrics to be used in the finished products as well as samples of sales orders purportedly

relayed to her by clients. However, these documents do not show whether the instructions or orders faxed ripened into concluded or

collected sales in Germany. At the very least, these pieces of evidence show that while respondent was in Germany, she sent

instructions/orders to JUBANITEX. As to whether these instructions/orders gave rise to consummated sales and whether these sales were

truly concluded in Germany, respondent presented no such evidence. Neither did she establish reasonable connection between the

orders/instructions faxed and the reported monthly sales purported to have transpired in Germany.

The paucity of respondent‘s evidence was even noted by Atty. Minerva Pacheco, petitioner‘s counsel at the hearing before the Court of Tax

Appeals. She pointed out that respondent presented no contracts or orders signed by the customers in Germany to prove the sale transactions

therein.26

Likewise, in her Comment to the Formal Offer of respondent‘s evidence, she objected to the admission of the faxed documents

bearing instruction/orders marked as Exhibits "R,"27

"V," "W", and "X,"28

for being self serving.29

The concern raised by petitioner‘s

counsel as to the absence of substantial evidence that would constitute proof that the sale transactions for which respondent was paid

commission actually transpired outside the Philippines, is relevant because respondent stayed in the Philippines for 89 days in 1995. Except

for the months of July and September 1995, respondent was in the Philippines in the months of March, May, June, and August 1995,30

the

same months when she earned commission income for services allegedly performed abroad. Furthermore, respondent presented no evidence

to prove that JUBANITEX does not sell embroidered products in the Philippines and that her appointment as commission agent is

exclusively for Germany and other European markets.

In sum, we find that the faxed documents presented by respondent did not constitute substantial evidence, or that relevant evidence that a

reasonable mind might accept as adequate to support the conclusion31

that it was in Germany where she performed the income producing

service which gave rise to the reported monthly sales in the months of March and May to September of 1995. She thus failed to discharge

the burden of proving that her income was from sources outside the Philippines and exempt from the application of our income tax law.

Hence, the claim for tax refund should be denied.

The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel,32

a previous case for refund of income withheld from

respondent‘s remunerations for services rendered abroad, the Court in a Minute Resolution dated February 17, 2003,33

sustained the ruling

of the Court of Appeals that respondent is entitled to refund the sum withheld from her sales commission income for the year 1994. This

ruling has no bearing in the instant controversy because the subject matter thereof is the income of respondent for the year 1994 while, the

instant case deals with her income in 1995. Otherwise, stated, res judicata has no application here. Its elements are: (1) there must be a final

judgment or order; (2) the court that rendered the judgment must have jurisdiction over the subject matter and the parties; (3) it must be a

judgment on the merits; (4) there must be between the two cases identity of parties, of subject matter, and of causes of action. 34

The instant

case, however, did not satisfy the fourth requisite because there is no identity as to the subject matter of the previous and present case of

respondent which deals with income earned and activities performed for different taxable years.

WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision and May 8, 2002 Resolution of the Court of Appeals in CA-

G.R. SP No. 59794, are REVERSED and SET ASIDE. The June 28, 2000 Decision of the Court of Tax Appeals in C.T.A. Case No. 5633,

which denied respondent‘s claim for refund of income tax paid for the year 1995 is REINSTATED.

SO ORDERED.

G.R. No. L-5896 August 31, 1955

A. SORIANO Y CIA., petitioner-appellant,

vs.

COLLECTOR OF INTERNAL REVENUE, respondent-appellee.

Modesto Formilleza for petitioner.

Office of the Solicitor General Juan R. Liwag and Solicitor Jose P. Alejandro for respondent.

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

This is a petition for review of the decision of the Board of Tax Appeals affirming the decision of the respondent-appellee Collector of

Internal Revenue holding the petitioner A. Soriano y Cia. liable for the payment of P47,002.52 as sales tax and surcharge (as required by

Sec. 182 of the National Internal Revenue Code, as amended) on its gross sales to the United Africa Co., Ltd. of 57 tractors acquired from

the Foreign Liquidation Commission.

It appears that in the year 1947, petitioner was engaged in the business of selling surplus goods acquired from the Foreign Liquidation

Commission pursuant to an agreement with the United States Government whereby petitioner undertook to rehabilitate the Veterans

Administration Building (formerly Heacock Building) for and in consideration of over a million pesos worth of surplus goods. Part of the

surplus goods consisted of tractors which were then in the various U. S. military bases or depots in the Philippines. The petitioner had yards

known as "Sta. Mesa Yard" and "Pieco Yard" located in Manila, where some of the surplus goods were stored, and those which were

defective reconditioned.

In January, 1947, the United Africa Co., Ltd. sent its representative, Hugh Watson Gibson, to the Philippines to look into the availability of

tractors for sale in the Philippines. Gibson learned of the petitioner's business and contracted to buy tractors from the latter, to be delivered

f.a.s. (free alongside ship), Manila, in good working condition and capable of running off lighters under their own power. A tractor expert,

Mr. Tex Taylor, was employed by the foreign company to select, inspect and test the tractors before delivery.

Tex Taylor went to the different military bases, took the serial numbers of the tractors which he wanted, and gave the list thereof to the

petitioner, who then secured from the Foreign Liquidation Commission the purchase invoices and other documents for the immediate

release of the tractors. The tractors were then removed by petitioner to its Pieco Yard, where they were tested by Tex Taylor. Those found

to be in good condition were approved by Taylor, wherefore petitioner presented to him the sales invoices for his signature, stamping his

approval thereon. Twenty-four of the tractors were found defective and so were brought to petitioner's Sta. Mesa Yard for reconditioning.

Upon approval of each invoice, the same was presented by petitioner to the Philippine Refining Company, Inc., an affiliate of the foreign

buyer, for payment of the purchase price. The Philippine Refining Co. would in turn notify the National City Bank of New York and the

Hongkong and Shanghai Banking Corporation, Manila, where the United Africa Co. had dollar deposits, to make payment of petitioner's

invoices. The tractors were delivered by petitioner to the pier in Manila by means of barges as soon as notice was received from the

representative of its foreign buyer that a carrying vessel was ready. On June 24 and August 26, 1947, the Philippine Refining Co., Inc.

shipped the 57 tractors acquired from petitioner from the port of Manila to United Africa Co., Ltd. at Dares Salaem, East Africa. The total

value of the tractors was P757,000. However, due to certain defects of some of them upon reaching Africa, the sum of P4,959.19 was

reimbursed by petitioner to its foreign buyer by credit memo.

The question at issue is whether or not petitioner is liable for the payment of percentage or sales tax on its gross sales of the 57 tractors in

question to the United Africa Co., Ltd. under the provisions of Sec. 186 of the National Internal Revenue Code.

Section 186. Percentage tax on sales of other articles.—There is levied, assessed and collected once only on every original sale,

barter, exchange, and similar transaction intended to transfer ownership of, or title to, the articles not enumerated in sections 184

and 185, a tax equivalent to five per centum of the gross selling price or gross value in money of the articles so sold, bartered,

exchanged, or transferred, such tax to be paid by the manufacturer, producer, or importer; . . .. (Emphasis supplied)

Under the above provisions, petitioner's liability would thus depend on first, whether or not it was an importer of the 57 tractors in question,

and second, whether it made an original sale thereof in the Philippines.

The theory of the Bureau of Internal Revenue, affirmed by the defunct Board of Tax Appeals, is that petitioner imported the tractors from

the army bases; that they were subsequently sold to its foreign buyer within the Philippines; and that title passed upon delivery to the carrier

f.a.s. Manila.

In the cases of Go Chen Tee vs. Meer,1 L-2825 ( July 7, 1950) and Saura Import and Export Co. vs. Meer,

2 L-2927 (February 26, 1951), this

Court has already held that one who acquires title to surplus equipment found in U. S. army bases or installations within the Philippines by

purchase, and then brings them out of those bases or depots, is an importer, and sales made by him by such surplus goods to the general

public are taxable under sections 185 and 186 of the Tax Code.

Petitioner insists, however, that it did not import the 57 tractors in question for the Foreign Liquidation Commission because title to the

same passed to its foreign buyer while the goods were still at the foreign bases, and that they passed Philippine territory merely in transit to

pier, Manila, where they were delivered f.a.s.; hence its sale of the tractors was not domestic and therefore not liable for the payment of

sales tax.

Petitioner's theory is not supported by the records. It admits that delivery of the tractors was made by it to the carrier f.a.s. Manila (letter to

Secretary of Finance of August 18, 1950, I Records, p. 192; also letter of October 17, 1949, p. 132). The rule is that where the contract is to

deliver goods f.a.s, the property passes on delivery at the wharf or the dock (II Williston on Sales, pp. 120-121; 46 Am. Jur. 608-609).

Otherwise stated, delivery to the carrier is delivery to the buyer, (Behn, Meyer & Co., Ltd. vs. Yangco, 38 Phil., 602; 46 Am. Jur. 605). True

that this rule yields to evidence of a contrary intent between the parties, but there is here no proof to show that petitioner and its foreign

buyer intended otherwise, that is, that delivery and the passing of title to its buyer should take place right in the army bases where the

tractors were located. On the contrary, petitioner itself has admitted that Tex Taylor (who is no alleged to have accepted delivery of the

tractors in behalf of the United Africa Co., Ltd.) has no power or authority whatever to do so.

In its letter to the Collector of Internal Revenue on July 16, 1949 (Records, Vol. I, p. 119), petitioner stated:

(2) Prices and terms having been agreed upon, Mr. Gibson secured the services of a tractor expert from United States thru United

Africa Co. offices in New York. Tractor expert Mr. Tex Taylor came over to the Philippines to inspect and "accept" the tractors.

We wish to state here that the so-called acceptance by Mr. Taylor of these tractors was simply an acceptance as to condition and

did not constitute an acceptance of delivery. The tractors in question were U. S. Army and Navy Surplus equipment. They were

second hand and needed reconditioning. Mr. Tex Taylor saw to it that they were properly reconditioned. Neither Mr. Gibson nor

Mr. Taylor had authority to accept delivery of these tractors.

And in a subsequent letter addressed to the Secretary of Finance on October 17, 1949 (Records, p. 131), petitioner further stated:

(b) Mr. Tex Taylor, who is alleged to have inspected and accepted in the Philippines the tractors subject of this sale was a mere

technician, employee of the United Africa Co. with specific and limited functions consisting of examining and approving the

condition of the tractors for purchase and could not have been considered the general and legal representative of our purchaser for

he had no authority to enter into any sort of business transaction in the Philippines.

These letters show that Tex Taylor had not authority to accept delivery of the tractors for the buyer United Africa Co., Ltd., his duty being

merely to inspect and approve their condition. The designation by Taylor of the tractors he selected at the bases, therefore, was merely a

preliminary step for their removal from the bases to petitioner's service and storage yards in Manila, where Taylor actually inspected and

tested them, and those found defective (23 tractors) were brought to the Sta. Mesa Yard where they were reconditioned (t.s.n. pp. 14-15).

Then petitioner made delivery of the tractors at the pier in Manila whenever there was an available boat for transportation to Africa, and it

was so informed by the representatives of the United Africa Co. Hence, it was only at Manila that the goods were delivered, and title passed

to the buyer; and from their removal from the bases until their delivery at shipside, title to the tractors was in the seller.

Other undisputed facts in the record also force the conclusion that title to the tractors in question passed to petitioner's buyer not at the

bases, but only at pier, Manila. First, it was petitioner who paid for the delivery charges from the different bases to the pier, pursuant to the

tax in "fob" or "f.a.s." sales that "the seller pays all charges and is subject to risk until the goods are placed alongside the 'vessel' (Williston,

supra). Second, the tractors were described in petitioner's invoices (Vol. I, Records, pp. 65-70) as bearing certain numbers followed by the

phrase "Our Unit Sta. Mesa" or "Our Unit Pieco", showing that the tractors were first brought to petitioner's yards and numbered

accordingly, in the same way that all goods found and stored in these yards were numbered, and it was only after they had passed

petitioner's yards that they were delivered to the buyer. Third, two of petitioner's invoices (Records, I, pp. 70-71) stated that the tractors

were inspected and accepted at Pieco Yard and/or Sta. Mesa Yard, which disproves petitioner's contention that Tex Taylor tested and

approved of them right in the bases. Fourth, petitioner's own witness Epimaco Gonzales admitted that it was only at Pieco Yard that Taylor

inspected and tested that tractors (t.s.n. 9-10).

Petitioner argues that the goods in question did not acquire a taxable situs in the Philippines because they merely passed Philippine territory

in transit and that they were not intended for local use but for exportation to a foreign country. We find this argument irrelevant, since the

tax in dispute is one on transaction (sales) and not a tax on the property sold. The sale of the tractors was consummated in the Philippines,

for title was transferred to the foreign buyer at the pier in Manila; hence, the situs of the sale is Philippines and it is taxable in this country.

Finally, petitioner urges that the repeal of the consignment or "export tax" under Sec. 187 of the Internal Revenue Code shows the intention

of the legislature to exempt all exports from tax.

It should not be forgotten that the consignment tax formerly imposed on exports by section 187 of the Tax Code (now repealed by R. A. 41)

is different from the sales tax imposed by Art. 186, which has not been repealed. The distinction between the two kinds of tax was pointed

out by this Court in the case of Vegetable Oil Corp. vs. Trinidad, 45 Phil., 834-835, where we held:

That the consignment tax is not a sales tax is, however, too obvious for argument, the fact that it is provided for in the same section

as the sales tax does not necessarily make it so. There is all the difference in the word between a consignment and a sale. As stated

by counsel for the appellee, the tax on consignment is a privilege tax pure and simple; it is a tax on the business of consigning

commodities abroad from these Islands. . . . If the tax were one on sales we would readily agree that the sales, in order to be

taxable in the Philippines must be consummated there.

When the above case decided, the sales tax and the consignment tax were both provided for in section 1459 of the Administrative Code.

Later, obviously to avoid confusion, the legislature separated the two taxes, the sales tax having been provided under sections 184, 185 and

186 of the Internal Revenue Code, while the consignment tax was placed under Sec. 187. The latter section was subsequently repealed by

Republic Act No. 41, so that the consignment tax on exports no longer exists, while the sales tax remains.

Petitioner contends that to tax one who sells goods intended for export would be to nullify the legislative intent behind the repeal of the tax

on consignments abroad, which is to encourage exports. The argument is fallacious. The law subjects to the payment of the sales tax not to

the buyer who intends to export what he buys, but the seller, because such sale is domestic and therefore liable for the payment of sales tax

in this country.

Domestic and foreign sale distinguished.—The sales tax liability of a person consigning his timber abroad depends upon where the

title to the timber consigned passes from the seller to the buyer. If the title to the timber consigned abroad passes to the buyer

within the jurisdiction of the Philippines, the transaction is domestic and is subject to the sales tax; otherwise, the transaction will

be considered a foreign sale and is exempt from the sales tax prescribed in section 186 of the Tax Code. (Formilleza,

Commentaries on the N. I. R. C., Vol. II, pp. 729-730)

As for the legislative policy to exempt consignments abroad from tax in order to encourage exports, the Solicitor General has pointed out

that it is only the exportation of locally produced or manufactured products, and not every kind of exportation, that Congress wanted to

encourage and promote. Hence, section 189 of the Code exempts from percentage tax coconut oil and by-products of copra produced or

manufactured in the Philippines; section 190, idem, exempts from compensating tax imported articles to be used in the manufacture or

preparation of articles in this country for consignments abroad; section 3 of R. A. 601 exempts from the foreign exchange tax amounts used

for the payment of transportation charges on articles or containers imported into the Philippines intended for use in the manufacture or

preparation of local products for consignment abroad; and R. A. 822 exempts from the processing tax imposed by Sec. 189 of the Code

dessicated coconut manufactured in this country if removed for exportation. Clearly enough, the exportation of the tractors in question does

not come under the declared policy of the legislature to encourage exportation of products locally manufactured and produced. On the other

hand, as correctly observed by the Solicitor General, our country needed then, and still needs now, tractors for the development of our own

agriculture, so that the sale of such tractors to foreign buyers for a profit, thereby depriving our own countrymen of their use in the

development of our own agriculture and increase of our production, hardly justifies the tax exemption that petitioner claims.

Wherefore, the decision appealed from is affirmed, with costs against petitioner. So ordered.

Quill vs. North Dakota

The facts in Quill Corp. are as follows: North Dakota sent a notice to Quill Corp. that it owed use tax (a companion tax to the sales tax)

payments for purchases that North Dakota residents had made through Quill Corp.‘s catalogue. Quill responded that it did not have nexus in

North Dakota because it had no physical operations or employees and hence did not have to collect North Dakota use tax on sales made to

North Dakota customers.

The Supreme Court sided with Quill, ruling that a taxpayer must have a physical presence in a state in order to require collection of sales or

use tax for purchases made by in-state customers. Physical presence means offices, branches, warehouses, employees, etc. The existence of

customers alone (i.e. economic presence) did not create sufficient nexus under the Commerce Clause for North Dakota to impose a sales tax

collection burden on Quill Corp..

The Supreme Court‘s reasoning was at least partially based on the fact that, at the time the case was decided in 1992, there were over 6,000

separate sales and use tax jurisdictions in the United States (states, localities, special tax districts, etc.) and to impose a collection obligation

on a remote seller would impose a crushing burden that would severely restrict interstate commerce. Today, a movement is afoot to simplify

state sales tax systems in order to lobby Congress to overturn Quill and require remote sellers to collect sales and use tax.

Quill Corp. v. North Dakota, 504 U.S. 298 (1992)

Background:

Quill, an office supplies company, had no physical presence within the state of North Dakota. In 1987, the statute, which defined

―retailer‖ for tax purposes, was amended to include ―every person who engages in regular or systematic solicitation of a consumer

market in the state.‖ Thus, the Tax Commissioner of North Dakota sent notice to Quill stating that it owed a use tax for purchases

that North Dakota residents made through Quill‘s mail order catalog.

Holding:

Under the Commerce Clause of the Constitution, a state cannot require an out-of-state retailer to collect use tax unless the retailer

has a ―substantial nexus‖ with the taxing state.

The Supreme Court sided with Quill, ruling that a taxpayer must have a physical presence in a state in order to require collection of

sales or use tax for purchases made by in-state customers. Physical presence means offices, branches, warehouses, employees, etc.

Implications

If an online retailer has a physical presence in a particular state, such as an office, store or warehouse, it must collect sales tax from

customers in that state. Conversely, if a business has no physical presence in a state, it is not required to collect sales tax for sales

from that state.

At the time of Quill, the court noted that it was unreasonable to force Internet retailers to comply with over 7,500 tax jurisdictions,

and would put a strain on interstate commerce. Some estimates place this number even higher, with the number at 11,000. In

addition, many states make certain products, such as groceries, exempt from certain taxes. Without any sort of uniform sales tax,

requiring retailers to comply with every jurisdiction's tax may be unworkable.

In light of Quill, states responded with laws designed to collect sales and use tax, in a more direct manner.

Vodafone vs. Union of India

Background

The Supreme Court today delivered its verdict in the Vodafone case putting an end to the nearly five- year old controversy surrounding the

taxability in India of offshore transfer of shares of a Cayman Islands company by the Hutchison Group to the Vodafone Group. In a

landmark decision, the Supreme Court reversed the decision of the Bombay High Court and held that the Indian tax authorities did not

have territorial jurisdiction to tax the offshore transaction, and therefore, Vodafone was not liable to withhold Indian taxes.

The Transaction

In February 2007, Vodafone International Holdings B.V (Vodafone or VIH), a Dutch entity, had acquired 100 percent shares in CGP

(Holdings) Limited (CGP), a Cayman Islands company for USD 11.1 billion from Hutchinson Telecommunications International Limited

(HTIL). CGP, through various intermediate companies/ contractual arrangements controlled 67 percent of Hutchison Essar Limited (HEL),

an Indian company. The acquisition resulted in Vodafone acquiring control over CGP and its downstream subsidiaries including,

ultimately, HEL.HEL was a joint venture between the Hutchinsongroup and the Essar group. It had obtained telecom licences to provide

cellular telephony in different circles in India from November 1994.

The Controversy

In September 2007, the tax department issued a show cause notice to Vodafone to explain why tax was not withheld on payments made to

HTIL in relation to the above transaction. The tax department contended that the transaction of transfer of shares in CGP had the effect of

indirect transfer of assets situated in India.

•Vodafone filed a writ petition in the Bombay High Court, inter alia, challenging the jurisdiction of the tax authorities in the matter. By its

order dated 3 December 2008, the Bombay High Court held that the tax authorities had made out a prima faciecase that the transaction was

one of transfer of a capital asset situate in India, and accordingly, the Indian income-tax authorities had jurisdiction over the matter.

•Vodafone challenged the order of the Bombay High Court before the Supreme Court. In its ruling, dated 23 January 2009, the Supreme

Court directed the tax authorities to first determine the jurisdictional challenge raised by Vodafone. It also permitted Vodafone to challenge

the decision of the tax authorities on the preliminary issue of jurisdiction before the High Court.

•In May 2010, the tax authorities held that they had jurisdiction to proceed against Vodafone for their alleged failure to withhold tax from

payments made under Section 201 of the Income-tax Act, 1961 (the Act). This order of the tax authorities was challenged by Vodafone

before the Bombay High Court.

•By its order dated 8 September 2010, the Bombay High Court dismissed Vodafone‘s challenge to the order passed by the tax authorities.

Vodafone filed aSpecial Leave Petition (SLP) against the High Court order before the Supreme Court. On 26 November 2010, SLP was

admitted and the Supreme Court directed Vodafone to deposit a sum of INR 25000 million within three weeks and provide a bank guarantee

of INR 85000million within eight weeks from the date of its order.

Interpretation of Section 9(1)(i)of the Act

•At the heart of the controversy was the interpretation of Section 9(1)(i)of the Act. As per the said section, inter alia, income accruing or

arising directly or indirectly from the transfer of a capital asset situated in India is deemed to accrue/ arise in India in the hands of a

nonresident.

•In connection with the above, the Supreme Court observed that:

Charge to capital gains under Section 9(1)(i) of the Act arises on existence of three elements, viz, transfer, existence of a capital asset and

situation of such asset in India.The legislature has not used the words ‗indirect transfer‘ in Section 9(1)(i) of the Act. If the word ‗indirect‘

is read into Section 9(1)(i) of the Act, then the phrase ‗capital asset situate in India‘ would be rendered nugatorySection 9(1)(i) of the Act

does not have ‗look through‘ provisions, and it cannot be extended to cover indirect transfers of capital assets/ property situated in India.The

proposals contained in the Direct Taxes Code Bill, 2010, on taxation of offshore share transactions indicate that indirect transfers are not

covered by Section 9(1)(i) of the Act. A legal fiction has alimited scope and it cannot be expanded by giving purposive interpretation,

particularly if the result of such interpretation is to transform the concept of chargeability which is also there in Section 9(1)(i) of the Act.

•Accordingly, the Supreme Court concluded that the transfer of the share in CGP did not result in the transfer of a capital asset situated in

India, and gains from such transfer could not be subject to Indian tax.

Conclusion

For the reasons discussed above, the Supreme Court held that gains arising from the said transaction were not liable to tax in India, and that

therefore there was no obligation on Vodafone to deduct tax at source.

G.R. No. 172231 February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.

ISABELA CULTURAL CORPORATION, Respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision1 of the Court of Appeals in CA-G.R. SP No.

78426 affirming the February 26, 2003 Decision2 of the Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside

the Assessment Notices for deficiency income tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against

respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment Notice No. FAS-1-86-90-

000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded

withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986.

The deficiency income tax of P333,196.86, arose from:

(1) The BIR‘s disallowance of ICC‘s claimed expense deductions for professional and security services billed to and paid by ICC

in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co.,3 for the year ending December 31, 1985;

4

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso Cudala Pecson

Azcuna & Bengson for the years 1984 and 1985.5

(c) Expense for security services of El Tigre Security & Investigation Agency for the months of April and May 1986.6

(2) The alleged understatement of ICC‘s interest income on the three promissory notes due from Realty Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly due to the failure of ICC to

withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services.7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995, however, it received a final notice

before seizure demanding payment of the amounts stated in the said notices. Hence, it brought the case to the CTA which held that the

petition is premature because the final notice of assessment cannot be considered as a final decision appealable to the tax court. This was

reversed by the Court of Appeals holding that a demand letter of the BIR reiterating the payment of deficiency tax, amounts to a final

decision on the protested assessment and may therefore be questioned before the CTA. This conclusion was sustained by this Court on July

1, 2001, in G.R. No. 135210.8 The case was thus remanded to the CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices issued against ICC. It held that the

claimed deductions for professional and security services were properly claimed by ICC in 1986 because it was only in the said year when

the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it

could not declare the same as deduction for the said years as the amount thereof could not be determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory notes. It found that it was the BIR which made

an overstatement of said income when it compounded the interest income receivable by ICC from the promissory notes of Realty

Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded interest; nor of a circumstance, like delay

in payment or breach of contract, that would justify the application of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for security services as shown by

the various payment orders and confirmation receipts it presented as evidence. The dispositive portion of the CTA‘s Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of

P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79,

inclusive of surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET ASIDE.

SO ORDERED.9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision,10

holding that although the professional

services (legal and auditing services) were rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time,

hence, it could be considered as deductible expenses only in 1986 when ICC received the billing statements for said services. It further ruled

that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc., and that ICC properly withheld and

remitted taxes on the payments for security services for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that since ICC is using the accrual

method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have been declared as deductions

from income during the said years and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year

1986. As to the alleged deficiency interest income and failure to withhold expanded withholding tax assessment, petitioner invoked the

presumption that the assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for professional and security

services from ICC‘s gross income; and (2) held that ICC did not understate its interest income from the promissory notes of Realty

Investment, Inc; and that ICC withheld the required 1% withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and

auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it

must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or

other pertinent papers.11

The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the National Internal

Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the taxable year in which ‗paid or

accrued‘ or ‗paid or incurred‘, dependent upon the method of accounting upon the basis of which the net income is computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions.12

In the

instant case, the accounting method used by ICC is the accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as

deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year.

Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot

deduct the same for the next year.13

The accrual method relies upon the 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.14

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the

taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This

test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such

income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with

reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer

has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where

computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as

unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with

"reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate

amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at

the closing of its books for the taxable year.[16] Accrual method of accounting presents largely a question of fact; such that the taxpayer

bears the burden of proof of establishing the accrual of an item of income or deduction.17

Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and

liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same by the clearest grant of organic

or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And since a deduction for

income tax purposes partakes of the nature of a tax exemption, then it must also be strictly construed.18

In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services

pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for

reimbursement of the expenses of said firm in connection with 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.19

From the nature of the claimed deductions and the span of time during which the firm was

retained, ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal

services. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions

cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could

have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it

could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time

legal consultant.

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the burden of establishing the accrual

of an expense or income. However, ICC failed to discharge this burden. As to when the firm‘s performance of its services in connection

with the 1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire about the amount of its liability, or

whether it does or does not possess the information necessary to compute the amount of said liability with reasonable accuracy, are

questions of fact which ICC never established. It simply relied on the defense of delayed billing by the firm and the company, which under

the circumstances, is not sufficient to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal and

auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly

claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even with only "reasonable

accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said

company would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were allowable

deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its

gross income for the said year and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by ICC in 198620

and could therefore be

properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty Investment, Inc., we sustain the findings of the

CTA and the Court of Appeals that no such understatement exists and that only simple interest computation and not a compounded one

should have been applied by the BIR. There is indeed no stipulation between the latter and ICC on the application of compounded interest.21

Under Article 1959 of the Civil Code, unless there is a stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required withholding tax from its claimed

deductions for security services and remitted the same to the BIR is supported by payment order and confirmation receipts.22

Hence, the

Assessment Notice for deficiency expanded withholding tax was properly cancelled and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income tax should be cancelled and set

aside but only insofar as the claimed deductions of ICC for security services. Said Assessment is valid as to the BIR‘s disallowance of

ICC‘s expenses for professional services. The Court of Appeal‘s cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount

of P4,897.79 for deficiency expanded withholding tax, is sustained.

WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision of the Court of Appeals in CA-G.R. SP No.

78426, is AFFIRMED with the MODIFICATION that Assessment Notice No. FAS-1-86-90-000680, which disallowed the expense

deduction of Isabela Cultural Corporation for professional and security services, is declared valid only insofar as the expenses for the

professional fees of SGV & Co. and of the law firm, Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, are concerned. The

decision is affirmed in all other respects.

The case is remanded to the BIR for the computation of Isabela Cultural Corporation‘s liability under Assessment Notice No. FAS-1-86-90-

000680.SO ORDERED.

G.R. Nos. 141104 & 148763 June 8, 2007

ATLAS CONSOLIDATED MINING AND DEVELOPMENT CORPORATION, petitioner,

vs.

COMMISSIONER OF INTERNAL REVENUE, respondent.

D E C I S I O N

CHICO-NAZARIO, J.:

Before this Court are the consolidated cases involving the unsuccessful claims of herein petitioner Atlas Consolidated Mining and

Development Corporation (petitioner corporation) for the refund/credit of the input Value Added Tax (VAT) on its purchases of capital

goods and on its zero-rated sales in the taxable quarters of the years 1990 and 1992, the denial of which by the Court of Tax Appeals

(CTA), was affirmed by the Court of Appeals.

Petitioner corporation is engaged in the business of mining, production, and sale of various mineral products, such as gold, pyrite, and

copper concentrates. It is a VAT-registered taxpayer. It was initially issued VAT Registration No. 32-A-6-002224, dated 1 January 1988,

but it had to register anew with the appropriate revenue district office (RDO) of the Bureau of Internal Revenue (BIR) when it moved its

principal place of business, and it was re-issued VAT Registration No. 32-0-004622, dated 15 August 1990.1

G.R. No. 141104

Petitioner corporation filed with the BIR its VAT Return for the first quarter of 1992.2 It alleged that it likewise filed with the BIR the

corresponding application for the refund/credit of its input VAT on its purchases of capital goods and on its zero-rated sales in the amount

of P26,030,460.00.3 When its application for refund/credit remained unresolved by the BIR, petitioner corporation filed on 20 April 1994 its

Petition for Review with the CTA, docketed as CTA Case No. 5102. Asserting that it was a "zero-rated VAT person," it prayed that the

CTA order herein respondent Commissioner of Internal Revenue (respondent Commissioner) to refund/credit petitioner corporation with

the amount of P26,030,460.00, representing the input VAT it had paid for the first quarter of 1992. The respondent Commissioner opposed

and sought the dismissal of the petition for review of petitioner corporation for failure to state a cause of action. After due trial, the CTA

promulgated its Decision4 on 24 November 1997 with the following disposition –

WHEREFORE, in view of the foregoing, the instant claim for refund is hereby DENIED on the ground of prescription,

insufficiency of evidence and failure to comply with Section 230 of the Tax Code, as amended. Accordingly, the petition at bar is

hereby DISMISSED for lack of merit.

The CTA denied the motion for reconsideration of petitioner corporation in a Resolution5 dated 15 April 1998.

When the case was elevated to the Court of Appeals as CA-G.R. SP No. 47607, the appellate court, in its Decision,6 dated 6 July 1999,

dismissed the appeal of petitioner corporation, finding no reversible error in the CTA Decision, dated 24 November 1997. The subsequent

motion for reconsideration of petitioner corporation was also denied by the Court of Appeals in its Resolution,7 dated 14 December 1999.

Thus, petitioner corporation comes before this Court, via a Petition for Review on Certiorari under Rule 45 of the Revised Rules of Court,

assigning the following errors committed by the Court of Appeals –

I

THE COURT OF APPEALS ERRED IN AFFIRMING THE REQUIREMENT OF REVENUE REGULATIONS NO. 2-88 THAT

AT LEAST 70% OF THE SALES OF THE [BOARD OF INVESTMENTS (BOI)]-REGISTERED FIRM MUST CONSIST OF

EXPORTS FOR ZERO-RATING TO APPLY.

II

THE COURT OF APPEALS ERRED IN AFFIRMING THAT PETITIONER FAILED TO SUBMIT SUFFICIENT EVIDENCE

SINCE FAILURE TO SUBMIT PHOTOCOPIES OF VAT INVOICES AND RECEIPTS IS NOT A FATAL DEFECT.

III

THE COURT OF APPEALS ERRED IN RULING THAT THE JUDICIAL CLAIM WAS FILED BEYOND THE

PRESCRIPTIVE PERIOD SINCE THE JUDICIAL CLAIM WAS FILED WITHIN TWO (2) YEARS FROM THE FILING OF

THE VAT RETURN.

IV

THE COURT OF APPEALS ERRED IN NOT ORDERING CTA TO ALLOW THE RE-OPENING OF THE CASE FOR

PETITIONER TO PRESENT ADDITIONAL EVIDENCE.8

G.R. No. 148763

G.R. No. 148763 involves almost the same set of facts as in G.R. No. 141104 presented above, except that it relates to the claims of

petitioner corporation for refund/credit of input VAT on its purchases of capital goods and on its zero-rated sales made in the last three

taxable quarters of 1990.

Petitioner corporation filed with the BIR its VAT Returns for the second, third, and fourth quarters of 1990, on 20 July 1990, 18 October

1990, and 20 January 1991, respectively. It submitted separate applications to the BIR for the refund/credit of the input VAT paid on its

purchases of capital goods and on its zero-rated sales, the details of which are presented as follows –

Date of Application Period Covered Amount Applied For

21 August 1990 2nd

Quarter, 1990 P 54,014,722.04

21 November 1990 3rd

Quarter, 1990 75,304,774.77

19 February 1991 4th

Quarter, 1990 43,829,766.10

When the BIR failed to act on its applications for refund/credit, petitioner corporation filed with the CTA the following petitions for review

–

Date Filed Period Covered CTA Case No.

20 July 1992 2nd

Quarter, 1990 4831

9 October 1992 3rd

Quarter, 1990 4859

14 January 1993 4th

Quarter, 1990 4944

which were eventually consolidated. The respondent Commissioner contested the foregoing Petitions and prayed for the dismissal thereof.

The CTA ruled in favor of respondent Commissioner and in its Decision,9 dated 30 October 1997, dismissed the Petitions mainly on the

ground that the prescriptive periods for filing the same had expired. In a Resolution,10

dated 15 January 1998, the CTA denied the motion

for reconsideration of petitioner corporation since the latter presented no new matter not already discussed in the court's prior Decision. In

the same Resolution, the CTA also denied the alternative prayer of petitioner corporation for a new trial since it did not fall under any of the

grounds cited under Section 1, Rule 37 of the Revised Rules of Court, and it was not supported by affidavits of merits required by Section 2

of the same Rule.

Petitioner corporation appealed its case to the Court of Appeals, where it was docketed as CA-G.R. SP No. 46718. On 15 September 2000,

the Court of Appeals rendered its Decision,11

finding that although petitioner corporation timely filed its Petitions for Review with the CTA,

it still failed to substantiate its claims for the refund/credit of its input VAT for the last three quarters of 1990. In its Resolution,12

dated 27

June 2001, the appellate court denied the motion for reconsideration of petitioner corporation, finding no cogent reason to reverse its

previous Decision.

Aggrieved, petitioner corporation filed with this Court another Petition for Review on Certiorari under Rule 45 of the Revised Rules of

Court, docketed as G.R. No. 148763, raising the following issues –

A.

WHETHER OR NOT THE COURT OF APPEALS ERRED IN HOLDING THAT PETITIONER'S CLAIM IS BARRED

UNDER REVENUE REGULATIONS NOS. 2-88 AND 3-88 I.E., FOR FAILURE TO PTOVE [sic] THE 70% THRESHOLD

FOR ZERO-RATING TO APPLY AND FOR FAILURE TO ESTABLISH THE FACTUAL BASIS FOR THE INSTANT

CLAIM.

B.

WHETHER OR NOT THE COURT OF APPEALS ERRED IN FINDING THAT THERE IS NO BASIS TO GRANT

PETITIONER'S MOTION FOR NEW TRIAL.

There being similarity of parties, subject matter, and issues, G.R. Nos. 141104 and 148763 were consolidated pursuant to a Resolution,

dated 4 September 2006, issued by this Court. The ruling of this Court in these cases hinges on how it will resolve the following key issues:

(1) prescription of the claims of petitioner corporation for input VAT refund/credit; (2) validity and applicability of Revenue Regulations

No. 2-88 imposing upon petitioner corporation, as a requirement for the VAT zero-rating of its sales, the burden of proving that the buyer

companies were not just BOI-registered but also exporting 70% of their total annual production; (3) sufficiency of evidence presented by

petitioner corporation to establish that it is indeed entitled to input VAT refund/credit; and (4) legal ground for granting the motion of

petitioner corporation for re-opening of its cases or holding of new trial before the CTA so it could be given the opportunity to present the

required evidence.

Prescription

The prescriptive period for filing an application for tax refund/credit of input VAT on zero-rated sales made in 1990 and 1992 was governed

by Section 106(b) and (c) of the Tax Code of 1977, as amended, which provided that –

SEC. 106. Refunds or tax credits of input tax. – x x x.

(b) Zero-rated or effectively zero-rated sales. – Any person, except those covered by paragraph (a) above, whose sales are zero-

rated may, within two years after the close of the quarter when such sales were made, apply for the issuance of a tax credit

certificate or refund of the input taxes attributable to such sales to the extent that such input tax has not been applied against output

tax.

x x x x

(e) Period within which refund of input taxes may be made by the Commissioner. – The Commissioner shall refund input taxes

within 60 days from the date the application for refund was filed with him or his duly authorized representative. No refund of input

taxes shall be allowed unless the VAT-registered person files an application for refund within the period prescribed in paragraphs

(a), (b) and (c) as the case may be.

By a plain reading of the foregoing provision, the two-year prescriptive period for filing the application for refund/credit of input VAT on

zero-rated sales shall be determined from the close of the quarter when such sales were made.

Petitioner contends, however, that the said two-year prescriptive period should be counted, not from the close of the quarter when the zero-

rated sales were made, but from the date of filing of the quarterly VAT return and payment of the tax due 20 days thereafter, in accordance

with Section 110(b) of the Tax Code of 1977, as amended, quoted as follows –

SEC. 110. Return and payment of value-added tax. – x x x.

(b) Time for filing of return and payment of tax. – The return shall be filed and the tax paid within 20 days following the end of

each quarter specifically prescribed for a VAT-registered person under regulations to be promulgated by the Secretary of Finance:

Provided, however, That any person whose registration is cancelled in accordance with paragraph (e) of Section 107 shall file a

return within 20 days from the cancellation of such registration.

It is already well-settled that the two-year prescriptive period for instituting a suit or proceeding for recovery of corporate income tax

erroneously or illegally paid under Section 23013

of the Tax Code of 1977, as amended, was to be counted from the filing of the final

adjustment return. This Court already set out in ACCRA Investments Corporation v. Court of Appeals,14

the rationale for such a rule, thus –

Clearly, there is the need to file a return first before a claim for refund can prosper inasmuch as the respondent Commissioner by

his own rules and regulations mandates that the corporate taxpayer opting to ask for a refund must show in its final adjustment

return the income it received from all sources and the amount of withholding taxes remitted by its withholding agents to the Bureau

of Internal Revenue. The petitioner corporation filed its final adjustment return for its 1981 taxable year on April 15, 1982. In our

Resolution dated April 10, 1989 in the case of Commissioner of Internal Revenue v. Asia Australia Express, Ltd. (G.R. No. 85956),

we ruled that the two-year prescriptive period within which to claim a refund commences to run, at the earliest, on the date of the

filing of the adjusted final tax return. Hence, the petitioner corporation had until April 15, 1984 within which to file its claim for

refund.

Considering that ACCRAIN filed its claim for refund as early as December 29, 1983 with the respondent Commissioner who

failed to take any action thereon and considering further that the non-resolution of its claim for refund with the said Commissioner

prompted ACCRAIN to reiterate its claim before the Court of Tax Appeals through a petition for review on April 13, 1984, the

respondent appellate court manifestly committed a reversible error in affirming the holding of the tax court that ACCRAIN's claim

for refund was barred by prescription.

It bears emphasis at this point that the rationale in computing the two-year prescriptive period with respect to the petitioner

corporation's claim for refund from the time it filed its final adjustment return is the fact that it was only then that ACCRAIN could

ascertain whether it made profits or incurred losses in its business operations. The "date of payment", therefore, in ACCRAIN's

case was when its tax liability, if any, fell due upon its filing of its final adjustment return on April 15, 1982.

In another case, Commissioner of Internal Revenue v. TMX Sales, Inc.,15

this Court further expounded on the same matter –

A re-examination of the aforesaid minute resolution of the Court in the Pacific Procon case is warranted under the circumstances

to lay down a categorical pronouncement on the question as to when the two-year prescriptive period in cases of quarterly

corporate income tax commences to run. A full-blown decision in this regard is rendered more imperative in the light of the

reversal by the Court of Tax Appeals in the instant case of its previous ruling in the Pacific Procon case.

Section 292 (now Section 230) of the National Internal Revenue Code should be interpreted in relation to the other provisions of

the Tax Code in order to give effect the legislative intent and to avoid an application of the law which may lead to inconvenience

and absurdity. In the case of People vs. Rivera (59 Phil. 236 [1933]), this Court stated that statutes should receive a sensible

construction, such as will give effect to the legislative intention and so as to avoid an unjust or an absurd conclusion.

INTERPRETATIO TALIS IN AMBIGUIS SEMPER FRIENDA EST, UT EVITATUR INCONVENIENS ET ABSURDUM. Where

there is ambiguity, such interpretation as will avoid inconvenience and absurdity is to be adopted. Furthermore, courts must give

effect to the general legislative intent that can be discovered from or is unraveled by the four corners of the statute, and in order to

discover said intent, the whole statute, and not only a particular provision thereof, should be considered. (Manila Lodge No. 761, et

al. vs. Court of Appeals, et al. 73 SCRA 162 [1976) Every section, provision or clause of the statute must be expounded by

reference to each other in order to arrive at the effect contemplated by the legislature. The intention of the legislator must be

ascertained from the whole text of the law and every part of the act is to be taken into view. (Chartered Bank vs. Imperial, 48 Phil.

931 [1921]; Lopez vs. El Hoger Filipino, 47 Phil. 249, cited in Aboitiz Shipping Corporation vs. City of Cebu, 13 SCRA 449

[1965]).

Thus, in resolving the instant case, it is necessary that we consider not only Section 292 (now Section 230) of the National Internal

Revenue Code but also the other provisions of the Tax Code, particularly Sections 84, 85 (now both incorporated as Section 68),

Section 86 (now Section 70) and Section 87 (now Section 69) on Quarterly Corporate Income Tax Payment and Section 321 (now

Section 232) on keeping of books of accounts. All these provisions of the Tax Code should be harmonized with each other.

x x x x

Therefore, the filing of a quarterly income tax returns required in Section 85 (now Section 68) and implemented per BIR Form

1702-Q and payment of quarterly income tax should only be considered mere installments of the annual tax due. These quarterly

tax payments which are computed based on the cumulative figures of gross receipts and deductions in order to arrive at a net

taxable income, should be treated as advances or portions of the annual income tax due, to be adjusted at the end of the calendar or

fiscal year. This is reinforced by Section 87 (now Section 69) which provides for the filing of adjustment returns and final payment

of income tax. Consequently, the two-year prescriptive period provided in Section 292 (now Section 230) of the Tax Code should

be computed from the time of filing the Adjustment Return or Annual Income Tax Return and final payment of income tax.

In the case of Collector of Internal Revenue vs. Antonio Prieto (2 SCRA 1007 [1961]), this Court held that when a tax is paid in

installments, the prescriptive period of two years provided in Section 306 (Section 292) of the National Internal Revenue Code

should be counted from the date of the final payment. This ruling is reiterated in Commissioner of Internal Revenue vs. Carlos

Palanca (18 SCRA 496 [1966]), wherein this Court stated that where the tax account was paid on installment, the computation of

the two-year prescriptive period under Section 306 (Section 292) of the Tax Code, should be from the date of the last installment.

In the instant case, TMX Sales, Inc. filed a suit for a refund on March 14, 1984. Since the two-year prescriptive period should be

counted from the filing of the Adjustment Return on April 15,1982, TMX Sales, Inc. is not yet barred by prescription.

The very same reasons set forth in the afore-cited cases concerning the two-year prescriptive period for claims for refund of illegally or

erroneously collected income tax may also apply to the Petitions at bar involving the same prescriptive period for claims for refund/credit of

input VAT on zero-rated sales.

It is true that unlike corporate income tax, which is reported and paid on installment every quarter, but is eventually subjected to a final

adjustment at the end of the taxable year, VAT is computed and paid on a purely quarterly basis without need for a final adjustment at the

end of the taxable year. However, it is also equally true that until and unless the VAT-registered taxpayer prepares and submits to the BIR

its quarterly VAT return, there is no way of knowing with certainty just how much input VAT16

the taxpayer may apply against its output

VAT;17

how much output VAT it is due to pay for the quarter or how much excess input VAT it may carry-over to the following quarter; or

how much of its input VAT it may claim as refund/credit. It should be recalled that not only may a VAT-registered taxpayer directly apply

against his output VAT due the input VAT it had paid on its importation or local purchases of goods and services during the quarter; the

taxpayer is also given the option to either (1) carry over any excess input VAT to the succeeding quarters for application against its future

output VAT liabilities, or (2) file an application for refund or issuance of a tax credit certificate covering the amount of such input VAT.18

Hence, even in the absence of a final adjustment return, the determination of any output VAT payable necessarily requires that the VAT-

registered taxpayer make adjustments in its VAT return every quarter, taking into consideration the input VAT which are creditable for the

present quarter or had been carried over from the previous quarters.

Moreover, when claiming refund/credit, the VAT-registered taxpayer must be able to establish that it does have refundable or creditable

input VAT, and the same has not been applied against its output VAT liabilities – information which are supposed to be reflected in the

taxpayer's VAT returns. Thus, an application for refund/credit must be accompanied by copies of the taxpayer's VAT return/s for the taxable

quarter/s concerned.

Lastly, although the taxpayer's refundable or creditable input VAT may not be considered as illegally or erroneously collected, its

refund/credit is a privilege extended to qualified and registered taxpayers by the very VAT system adopted by the Legislature. Such input

VAT, the same as any illegally or erroneously collected national internal revenue tax, consists of monetary amounts which are currently in

the hands of the government but must rightfully be returned to the taxpayer. Therefore, whether claiming refund/credit of illegally or

erroneously collected national internal revenue tax, or input VAT, the taxpayer must be given equal opportunity for filing and pursuing its

claim.

For the foregoing reasons, it is more practical and reasonable to count the two-year prescriptive period for filing a claim for refund/credit of

input VAT on zero-rated sales from the date of filing of the return and payment of the tax due which, according to the law then existing,

should be made within 20 days from the end of each quarter. Having established thus, the relevant dates in the instant cases are summarized

and reproduced below –

Period Covered Date of Filing

(Return w/ BIR)

Date of Filing (Application

w/ BIR)

Date of Filing (Case

w/ CTA)

2nd

Quarter, 1990 20 July 1990 21 August 1990 20 July 1992

3rd

Quarter, 1990 18 October 1990 21 November 1990 9 October 1992

4th

Quarter, 1990 20 January 1991 19 February 1991 14 January 1993

1st Quarter, 1992 20 April 1992 -- 20 April 1994

The above table readily shows that the administrative and judicial claims of petitioner corporation for refund of its input VAT on its zero-

rated sales for the last three quarters of 1990 were all filed within the prescriptive period.

However, the same cannot be said for the claim of petitioner corporation for refund of its input VAT on its zero-rated sales for the first

quarter of 1992. Even though it may seem that petitioner corporation filed in time its judicial claim with the CTA, there is no showing that it

had previously filed an administrative claim with the BIR. Section 106(e) of the Tax Code of 1977, as amended, explicitly provided that no

refund of input VAT shall be allowed unless the VAT-registered taxpayer filed an application for refund with respondent Commissioner

within the two-year prescriptive period. The application of petitioner corporation for refund/credit of its input VAT for the first quarter of

1992 was not only unsigned by its supposed authorized representative, Ma. Paz R. Semilla, Manager-Finance and Treasury, but it was not

dated, stamped, and initialed by the BIR official who purportedly received the same. The CTA, in its Decision,19

dated 24 November 1997,

in CTA Case No. 5102, made the following observations –

This Court, likewise, rejects any probative value of the Application for Tax Credit/Refund of VAT Paid (BIR Form No. 2552)

[Exhibit "B'] formally offered in evidence by the petitioner on account of the fact that it does not bear the BIR stamp showing the

date when such application was filed together with the signature or initial of the receiving officer of respondent's Bureau. Worse

still, it does not show the date of application and the signature of a certain Ma. Paz R. Semilla indicated in the form who appears to

be petitioner's authorized filer.

A review of the records reveal that the original of the aforecited application was lost during the time petitioner transferred its office

(TSN, p. 6, Hearing of December 9, 1994). Attempt was made to prove that petitioner exerted efforts to recover the original copy,

but to no avail. Despite this, however, We observe that petitioner completely failed to establish the missing dates and signatures

abovementioned. On this score, said application has no probative value in demonstrating the fact of its filing within two years after

the [filing of the VAT return for the quarter] when petitioner's sales of goods were made as prescribed under Section 106(b) of the

Tax Code. We believe thus that petitioner failed to file an application for refund in due form and within the legal period set by law

at the administrative level. Hence, the case at bar has failed to satisfy the requirement on the prior filing of an application for

refund with the respondent before the commencement of a judicial claim for refund, as prescribed under Section 230 of the Tax

Code. This fact constitutes another one of the many reasons for not granting petitioner's judicial claim.

As pointed out by the CTA, in serious doubt is not only the fact of whether petitioner corporation timely filed its administrative claim for

refund of its input VAT for the first quarter of 1992, but also whether petitioner corporation actually filed such administrative claim in the

first place. For failing to prove that it had earlier filed with the BIR an application for refund/credit of its input VAT for the first quarter of

1992, within the period prescribed by law, then the case instituted by petitioner corporation with the CTA for the refund/credit of the very

same tax cannot prosper.

Revenue Regulations No. 2-88 and the 70% export requirement

Under Section 100(a) of the Tax Code of 1977, as amended, a 10% VAT was imposed on the gross selling price or gross value in money of

goods sold, bartered or exchanged. Yet, the same provision subjected the following sales made by VAT-registered persons to 0% VAT –

(1) Export sales; and

(2) Sales to persons or entities whose exemption under special laws or international agreements to which the Philippines is a

signatory effectively subjects such sales to zero-rate.

"Export Sales" means the sale and shipment or exportation of goods from the Philippines to a foreign country, irrespective of any

shipping arrangement that may be agreed upon which may influence or determine the transfer of ownership of the goods so

exported, or foreign currency denominated sales. "Foreign currency denominated sales", means sales to nonresidents of goods

assembled or manufactured in the Philippines, for delivery to residents in the Philippines and paid for in convertible foreign

currency remitted through the banking system in the Philippines.

These are termed zero-rated sales. A zero-rated sale is still considered a taxable transaction for VAT purposes, although the VAT rate

applied is 0%. A sale by a VAT-registered taxpayer of goods and/or services taxed at 0% shall not result in any output VAT, while the input

VAT on its purchases of goods or services related to such zero-rated sale shall be available as tax credit or refund.20

Petitioner corporation questions the validity of Revenue Regulations No. 2-88 averring that the said regulations imposed additional

requirements, not found in the law itself, for the zero-rating of its sales to Philippine Smelting and Refining Corporation (PASAR) and

Philippine Phosphate, Inc. (PHILPHOS), both of which are registered not only with the BOI, but also with the then Export Processing Zone

Authority (EPZA).21

The contentious provisions of Revenue Regulations No. 2-88 read –

SEC. 2. Zero-rating. – (a) Sales of raw materials to BOI-registered exporters. – Sales of raw materials to export-oriented BOI-

registered enterprises whose export sales, under rules and regulations of the Board of Investments, exceed seventy percent (70%)

of total annual production, shall be subject to zero-rate under the following conditions:

"(1) The seller shall file an application with the BIR, ATTN.: Division, applying for zero-rating for each and every

separate buyer, in accordance with Section 8(d) of Revenue Regulations No. 5-87. The application should be

accompanied with a favorable recommendation from the Board of Investments."

"(2) The raw materials sold are to be used exclusively by the buyer in the manufacture, processing or repacking of his

own registered export product;

"(3) The words "Zero-Rated Sales" shall be prominently indicated in the sales invoice. The exporter (buyer) can no longer

claim from the Bureau of Internal Revenue or any other government office tax credits on their zero-rated purchases;

(b) Sales of raw materials to foreign buyer. – Sales of raw materials to a nonresident foreign buyer for delivery to a resident local

export-oriented BOI-registered enterprise to be used in manufacturing, processing or repacking of the said buyer's goods and paid

for in foreign currency, inwardly remitted in accordance with Central Bank rules and regulations shall be subject to zero-rate.

It is the position of the respondent Commissioner, affirmed by the CTA and the Court of Appeals, that Section 2 of Revenue Regulations

No. 2-88 should be applied in the cases at bar; and to be entitled to the zero-rating of its sales to PASAR and PHILPHOS, petitioner

corporation, as a VAT-registered seller, must be able to prove not only that PASAR and PHILPHOS are BOI-registered corporations, but

also that more than 70% of the total annual production of these corporations are actually exported. Revenue Regulations No. 2-88 merely

echoed the requirement imposed by the BOI on export-oriented corporations registered with it.

While this Court is not prepared to strike down the validity of Revenue Regulations No. 2-88, it finds that its application must be limited

and placed in the proper context. Note that Section 2 of Revenue Regulations No. 2-88 referred only to the zero-rated sales of raw materials

to export-oriented BOI-registered enterprises whose export sales, under BOI rules and regulations, should exceed seventy percent (70%) of

their total annual production.

Section 2 of Revenue Regulations No. 2-88, should not have been applied to the zero-rating of the sales made by petitioner corporation to

PASAR and PHILPHOS. At the onset, it must be emphasized that PASAR and PHILPHOS, in addition to being registered with the BOI,

were also registered with the EPZA and located within an export-processing zone. Petitioner corporation does not claim that its sales to

PASAR and PHILPHOS are zero-rated on the basis that said sales were made to export-oriented BOI-registered corporations, but rather, on

the basis that the sales were made to EPZA-registered enterprises operating within export processing zones. Although sales to export-

oriented BOI-registered enterprises and sales to EPZA-registered enterprises located within export processing zones were both deemed

export sales, which, under Section 100(a) of the Tax Code of 1977, as amended, shall be subject to 0% VAT distinction must be made

between these two types of sales because each may have different substantiation requirements.

The Tax Code of 1977, as amended, gave a limited definition of export sales, to wit: "The sale and shipment or exportation of goods from

the Philippines to a foreign country, irrespective of any shipping arrangement that may be agreed upon which may influence or determine

the transfer of ownership of the goods so exported, or foreign currency denominated sales." Executive Order No. 226, otherwise known as

the Omnibus Investments Code of 1987 - which, in the years concerned (i.e., 1990 and 1992), governed enterprises registered with both the

BOI and EPZA, provided a more comprehensive definition of export sales, as quoted below:

"ART. 23. "Export sales" shall mean the Philippine port F.O.B. value, determined from invoices, bills of lading, inward letters of

credit, landing certificates, and other commercial documents, of export products exported directly by a registered export producer

or the net selling price of export product sold by a registered export producer or to an export trader that subsequently exports the

same: Provided, That sales of export products to another producer or to an export trader shall only be deemed export sales when

actually exported by the latter, as evidenced by landing certificates of similar commercial documents: Provided, further, That

without actual exportation the following shall be considered constructively exported for purposes of this provision: (1) sales to

bonded manufacturing warehouses of export-oriented manufacturers; (2) sales to export processing zones; (3) sales to registered

export traders operating bonded trading warehouses supplying raw materials used in the manufacture of export products under

guidelines to be set by the Board in consultation with the Bureau of Internal Revenue and the Bureau of Customs; (4) sales to

foreign military bases, diplomatic missions and other agencies and/or instrumentalities granted tax immunities, of locally

manufactured, assembled or repacked products whether paid for in foreign currency or not: Provided, further, That export sales of

registered export trader may include commission income; and Provided, finally, That exportation of goods on consignment shall

not be deemed export sales until the export products consigned are in fact sold by the consignee.

Sales of locally manufactured or assembled goods for household and personal use to Filipinos abroad and other non-residents of

the Philippines as well as returning Overseas Filipinos under the Internal Export Program of the government and paid for in

convertible foreign currency inwardly remitted through the Philippine banking systems shall also be considered export sales.

(Underscoring ours.)

The afore-cited provision of the Omnibus Investments Code of 1987 recognizes as export sales the sales of export products to another

producer or to an export trader, provided that the export products are actually exported. For purposes of VAT zero-rating, such producer or

export trader must be registered with the BOI and is required to actually export more than 70% of its annual production.

Without actual exportation, Article 23 of the Omnibus Investments Code of 1987 also considers constructive exportation as export sales.

Among other types of constructive exportation specifically identified by the said provision are sales to export processing zones. Sales to

export processing zones are subjected to special tax treatment. Article 77 of the same Code establishes the tax treatment of goods or

merchandise brought into the export processing zones. Of particular relevance herein is paragraph 2, which provides that "Merchandise

purchased by a registered zone enterprise from the customs territory and subsequently brought into the zone, shall be considered as export

sales and the exporter thereof shall be entitled to the benefits allowed by law for such transaction."

Such tax treatment of goods brought into the export processing zones are only consistent with the Destination Principle and Cross Border

Doctrine to which the Philippine VAT system adheres. According to the Destination Principle,22

goods and services are taxed only in the

country where these are consumed. In connection with the said principle, the Cross Border Doctrine23

mandates that no VAT shall be

imposed to form part of the cost of the goods destined for consumption outside the territorial border of the taxing authority. Hence, actual

export of goods and services from the Philippines to a foreign country must be free of VAT, while those destined for use or consumption

within the Philippines shall be imposed with 10% VAT.24

Export processing zones25

are to be managed as a separate customs territory from

the rest of the Philippines and, thus, for tax purposes, are effectively considered as foreign territory. For this reason, sales by persons from

the Philippine customs territory to those inside the export processing zones are already taxed as exports.

Plainly, sales to enterprises operating within the export processing zones are export sales, which, under the Tax Code of 1977, as amended,

were subject to 0% VAT. It is on this ground that petitioner corporation is claiming refund/credit of the input VAT on its zero-rated sales to

PASAR and PHILPHOS.

The distinction made by this Court in the preceding paragraphs between the zero-rated sales to export-oriented BOI-registered enterprises

and zero-rated sales to EPZA-registered enterprises operating within export processing zones is actually supported by subsequent

development in tax laws and regulations. In Revenue Regulations No. 7-95, the Consolidated VAT Regulations, as amended,26

the BIR

defined with more precision what are zero-rated export sales –

(1) The sale and actual shipment of goods from the Philippines to a foreign country, irrespective of any shipping arrangement that

may be agreed upon which may influence or determine the transfer of ownership of the goods so exported paid for in acceptable

foreign currency or its equivalent in goods or services, and accounted for in accordance with the rules and regulations of the

Bangko Sentral ng Pilipinas (BSP);

(2) The sale of raw materials or packaging materials to a non-resident buyer for delivery to a resident local export-oriented

enterprise to be used in manufacturing, processing, packing or repacking in the Philippines of the said buyer's goods and paid for in

acceptable foreign currency and accounted for in accordance with the rules and regulations of the Bangko Sentral ng Pilipinas

(BSP);

(3) The sale of raw materials or packaging materials to an export-oriented enterprise whose export sales exceed seventy percent

(70%) of total annual production;

Any enterprise whose export sales exceed 70% of the total annual production of the preceding taxable year shall be considered an

export-oriented enterprise upon accreditation as such under the provisions of the Export Development Act (R.A. 7844) and its

implementing rules and regulations;

(4) Sale of gold to the Bangko Sentral ng Pilipinas (BSP); and

(5) Those considered export sales under Articles 23 and 77 of Executive Order No. 226, otherwise known as the Omnibus

Investments Code of 1987, and other special laws, e.g. Republic Act No. 7227, otherwise known as the Bases Conversion and

Development Act of 1992.

The Tax Code of 1997, as amended,27

later adopted the foregoing definition of export sales, which are subject to 0% VAT.

This Court then reiterates its conclusion that Section 2 of Revenue Regulations No. 2-88, which applied to zero-rated export sales to export-

oriented BOI-registered enterprises, should not be applied to the applications for refund/credit of input VAT filed by petitioner corporation

since it based its applications on the zero-rating of export sales to enterprises registered with the EPZA and located within export processing

zones.

Sufficiency of evidence

There can be no dispute that the taxpayer-claimant has the burden of proving the legal and factual bases of its claim for tax credit or refund,

but once it has submitted all the required documents, it is the function of the BIR to assess these documents with purposeful dispatch.28

It

therefore falls upon herein petitioner corporation to first establish that its sales qualify for VAT zero-rating under the existing laws (legal

basis), and then to present sufficient evidence that said sales were actually made and resulted in refundable or creditable input VAT in the

amount being claimed (factual basis).

It would initially appear that the applications for refund/credit filed by petitioner corporation cover only input VAT on its purportedly zero-

rated sales to PASAR and PHILPHOS; however, a more thorough perusal of its applications, VAT returns, pleadings, and other records of

these cases would reveal that it is also claiming refund/credit of its input VAT on purchases of capital goods and sales of gold to the Central

Bank of the Philippines (CBP).

This Court finds that the claims for refund/credit of input VAT of petitioner corporation have sufficient legal bases.

As has been extensively discussed herein, Section 106(b)(2), in relation to Section 100(a)(2) of the Tax Code of 1977, as amended, allowed

the refund/credit of input VAT on export sales to enterprises operating within export processing zones and registered with the EPZA, since

such export sales were deemed to be effectively zero-rated sales.29

The fact that PASAR and PHILPHOS, to whom petitioner corporation

sold its products, were operating inside an export processing zone and duly registered with EPZA, was never raised as an issue herein.

Moreover, the same fact was already judicially recognized in the case Atlas Consolidated Mining & Development Corporation v.

Commissioner of Internal Revenue.30

Section 106(c) of the same Code likewise permitted a VAT-registered taxpayer to apply for

refund/credit of the input VAT paid on capital goods imported or locally purchased to the extent that such input VAT has not been applied

against its output VAT. Meanwhile, the effective zero-rating of sales of gold to the CBP from 1989 to 199131

was already affirmed by this

Court in Commissioner of Internal Revenue v. Benguet Corporation,32

wherein it ruled that –

At the time when the subject transactions were consummated, the prevailing BIR regulations relied upon by respondent ordained

that gold sales to the Central Bank were zero-rated. The BIR interpreted Sec. 100 of the NIRC in relation to Sec. 2 of E.O. No. 581

s. 1980 which prescribed that gold sold to the Central Bank shall be considered export and therefore shall be subject to the export

and premium duties. In coming out with this interpretation, the BIR also considered Sec. 169 of Central Bank Circular No. 960

which states that all sales of gold to the Central Bank are considered constructive exports. x x x.

This Court now comes to the question of whether petitioner corporation has sufficiently established the factual bases for its applications for

refund/credit of input VAT. It is in this regard that petitioner corporation has failed, both in the administrative and judicial level.

Applications for refund/credit of input VAT with the BIR must comply with the appropriate revenue regulations. As this Court has already

ruled, Revenue Regulations No. 2-88 is not relevant to the applications for refund/credit of input VAT filed by petitioner corporation;

nonetheless, the said applications must have been in accordance with Revenue Regulations No. 3-88, amending Section 16 of Revenue

Regulations No. 5-87, which provided as follows –

SECTION 16. Refunds or tax credits of input tax. –

x x x x

(c) Claims for tax credits/refunds. – Application for Tax Credit/Refund of Value-Added Tax Paid (BIR Form No. 2552) shall be

filed with the Revenue District Office of the city or municipality where the principal place of business of the applicant is located or

directly with the Commissioner, Attention: VAT Division.

A photocopy of the purchase invoice or receipt evidencing the value added tax paid shall be submitted together with the

application. The original copy of the said invoice/receipt, however, shall be presented for cancellation prior to the issuance of the

Tax Credit Certificate or refund. In addition, the following documents shall be attached whenever applicable:

x x x x

"3. Effectively zero-rated sale of goods and services.

"i) photo copy of approved application for zero-rate if filing for the first time.

"ii) sales invoice or receipt showing name of the person or entity to whom the sale of goods or services were

delivered, date of delivery, amount of consideration, and description of goods or services delivered.

"iii) evidence of actual receipt of goods or services.

"4. Purchase of capital goods.

"i) original copy of invoice or receipt showing the date of purchase, purchase price, amount of value-added tax

paid and description of the capital equipment locally purchased.

"ii) with respect to capital equipment imported, the photo copy of import entry document for internal revenue tax

purposes and the confirmation receipt issued by the Bureau of Customs for the payment of the value-added tax.

"5. In applicable cases,

where the applicant's zero-rated transactions are regulated by certain government agencies, a statement therefrom showing the

amount and description of sale of goods and services, name of persons or entities (except in case of exports) to whom the goods or

services were sold, and date of transaction shall also be submitted.

In all cases, the amount of refund or tax credit that may be granted shall be limited to the amount of the value-added tax (VAT)

paid directly and entirely attributable to the zero-rated transaction during the period covered by the application for credit or refund.

Where the applicant is engaged in zero-rated and other taxable and exempt sales of goods and services, and the VAT paid (inputs)

on purchases of goods and services cannot be directly attributed to any of the aforementioned transactions, the following formula

shall be used to determine the creditable or refundable input tax for zero-rated sale:

Amount of Zero-rated Sale

Total Sales

X

Total Amount of Input Taxes

=

Amount Creditable/Refundable

In case the application for refund/credit of input VAT was denied or remained unacted upon by the BIR, and before the lapse of the two-

year prescriptive period, the taxpayer-applicant may already file a Petition for Review before the CTA. If the taxpayer's claim is supported

by voluminous documents, such as receipts, invoices, vouchers or long accounts, their presentation before the CTA shall be governed by

CTA Circular No. 1-95, as amended, reproduced in full below –

In the interest of speedy administration of justice, the Court hereby promulgates the following rules governing the presentation of

voluminous documents and/or long accounts, such as receipts, invoices and vouchers, as evidence to establish certain facts

pursuant to Section 3(c), Rule 130 of the Rules of Court and the doctrine enunciated in Compania Maritima vs. Allied Free

Workers Union (77 SCRA 24), as well as Section 8 of Republic Act No. 1125:

1. The party who desires to introduce as evidence such voluminous documents must, after motion and approval by the Court,

present:

(a) a Summary containing, among others, a chronological listing of the numbers, dates and amounts covered by the

invoices or receipts and the amount/s of tax paid; and (b) a Certification of an independent Certified Public Accountant

attesting to the correctness of the contents of the summary after making an examination, evaluation and audit of the

voluminous receipts and invoices. The name of the accountant or partner of the firm in charge must be stated in the

motion so that he/she can be commissioned by the Court to conduct the audit and, thereafter, testify in Court relative to

such summary and certification pursuant to Rule 32 of the Rules of Court.

2. The method of individual presentation of each and every receipt, invoice or account for marking, identification and comparison

with the originals thereof need not be done before the Court or Clerk of Court anymore after the introduction of the summary and

CPA certification. It is enough that the receipts, invoices, vouchers or other documents covering the said accounts or payments to

be introduced in evidence must be pre-marked by the party concerned and submitted to the Court in order to be made accessible to

the adverse party who desires to check and verify the correctness of the summary and CPA certification. Likewise, the originals of

the voluminous receipts, invoices or accounts must be ready for verification and comparison in case doubt on the authenticity

thereof is raised during the hearing or resolution of the formal offer of evidence.

Since CTA Cases No. 4831, 4859, 4944,33

and 5102,34

were still pending before the CTA when the said Circular was issued, then petitioner

corporation must have complied therewith during the course of the trial of the said cases.

In Commissioner of Internal Revenue v. Manila Mining Corporation,35

this Court denied the claim of therein respondent, Manila Mining

Corporation, for refund of the input VAT on its supposed zero-rated sales of gold to the CBP because it was unable to substantiate its claim.

In the same case, this Court emphasized the importance of complying with the substantiation requirements for claiming refund/credit of

input VAT on zero-rated sales, to wit –

For a judicial claim for refund to prosper, however, respondent must not only prove that it is a VAT registered entity and that it

filed its claims within the prescriptive period. It must substantiate the input VAT paid by purchase invoices or official receipts.

This respondent failed to do.

Revenue Regulations No. 3-88 amending Revenue Regulations No. 5-87 provides the requirements in claiming tax credits/refunds.

x x x x

Under Section 8 of RA1125, the CTA is described as a court of record. As cases filed before it are litigated de novo, party litigants

should prove every minute aspect of their cases. No evidentiary value can be given the purchase invoices or receipts submitted to

the BIR as the rules on documentary evidence require that these documents must be formally offered before the CTA.

This Court thus notes with approval the following findings of the CTA:

x x x [S]ale of gold to the Central Bank should not be subject to the 10% VAT-output tax but this does not ipso fact mean

that [the seller] is entitled to the amount of refund sought as it is required by law to present evidence showing the input

taxes it paid during the year in question. What is being claimed in the instant petition is the refund of the input taxes paid

by the herein petitioner on its purchase of goods and services. Hence, it is necessary for the Petitioner to show proof that

it had indeed paid the input taxes during the year 1991. In the case at bar, Petitioner failed to discharge this duty. It did

not adduce in evidence the sales invoice, receipts or other documents showing the input value added tax on the purchase

of goods and services.

x x x

Section 8 of Republic Act 1125 (An Act Creating the Court of Tax Appeals) provides categorically that the Court of Tax Appeals

shall be a court of record and as such it is required to conduct a formal trial (trial de novo) where the parties must present their

evidence accordingly if they desire the Court to take such evidence into consideration. (Emphasis and italics supplied)

A "sales or commercial invoice" is a written account of goods sold or services rendered indicating the prices charged therefor or a

list by whatever name it is known which is used in the ordinary course of business evidencing sale and transfer or agreement to sell

or transfer goods and services.

A "receipt" on the other hand is a written acknowledgment of the fact of payment in money or other settlement between seller and

buyer of goods, debtor or creditor, or person rendering services and client or customer.

These sales invoices or receipts issued by the supplier are necessary to substantiate the actual amount or quantity of goods sold and

their selling price, and taken collectively are the best means to prove the input VAT payments.36

Although the foregoing decision focused only on the proof required for the applicant for refund/credit to establish the input VAT payments

it had made on its purchases from suppliers, Revenue Regulations No. 3-88 also required it to present evidence proving actual zero-rated

VAT sales to qualified buyers, such as (1) photocopy of the approved application for zero-rate if filing for the first time; (2) sales invoice or

receipt showing the name of the person or entity to whom the goods or services were delivered, date of delivery, amount of consideration,

and description of goods or services delivered; and (3) the evidence of actual receipt of goods or services.

Also worth noting in the same decision is the weight given by this Court to the certification by the independent certified public accountant

(CPA), thus –

Respondent contends, however, that the certification of the independent CPA attesting to the correctness of the contents of the

summary of suppliers' invoices or receipts which were examined, evaluated and audited by said CPA in accordance with CTA

Circular No. 1-95 as amended by CTA Circular No. 10-97 should substantiate its claims.

There is nothing, however, in CTA Circular No. 1-95, as amended by CTA Circular No. 10-97, which either expressly or impliedly

suggests that summaries and schedules of input VAT payments, even if certified by an independent CPA, suffice as evidence of

input VAT payments.

x x x x

The circular, in the interest of speedy administration of justice, was promulgated to avoid the time-consuming procedure of

presenting, identifying and marking of documents before the Court. It does not relieve respondent of its imperative task of pre-

marking photocopies of sales receipts and invoices and submitting the same to the court after the independent CPA shall have

examined and compared them with the originals. Without presenting these pre-marked documents as evidence – from which the

summary and schedules were based, the court cannot verify the authenticity and veracity of the independent auditor's conclusions.

There is, moreover, a need to subject these invoices or receipts to examination by the CTA in order to confirm whether they are

VAT invoices. Under Section 21 of Revenue Regulation, No. 5-87, all purchases covered by invoices other than a VAT invoice

shall not be entitled to a refund of input VAT.

x x x x

While the CTA is not governed strictly by technical rules of evidence, as rules of procedure are not ends in themselves but are

primarily intended as tools in the administration of justice, the presentation of the purchase receipts and/or invoices is not mere

procedural technicality which may be disregarded considering that it is the only means by which the CTA may ascertain and verify

the truth of the respondent's claims.

The records further show that respondent miserably failed to substantiate its claims for input VAT refund for the first semester of

1991. Except for the summary and schedules of input VAT payments prepared by respondent itself, no other evidence was adduced

in support of its claim.

As for respondent's claim for input VAT refund for the second semester of 1991, it employed the services of Joaquin Cunanan &

Co. on account of which it (Joaquin Cunanan & Co.) executed a certification that:

We have examined the information shown below concerning the input tax payments made by the Makati Office of Manila

Mining Corporation for the period from July 1 to December 31, 1991. Our examination included inspection of the

pertinent suppliers' invoices and official receipts and such other auditing procedures as we considered necessary in the

circumstances. x x x

As the certification merely stated that it used "auditing procedures considered necessary" and not auditing procedures which are in

accordance with generally accepted auditing principles and standards, and that the examination was made on "input tax payments

by the Manila Mining Corporation," without specifying that the said input tax payments are attributable to the sales of gold to the

Central Bank, this Court cannot rely thereon and regard it as sufficient proof of the respondent's input VAT payments for the

second semester.37

As for the Petition in G.R. No. 141104, involving the input VAT of petitioner corporation on its zero-rated sales in the first quarter of 1992,

this Court already found that the petitioner corporation failed to comply with Section 106(b) of the Tax Code of 1977, as amended,

imposing the two-year prescriptive period for the filing of the application for refund/credit thereof. This bars the grant of the application for

refund/credit, whether administratively or judicially, by express mandate of Section 106(e) of the same Code.

Granting arguendo that the application of petitioner corporation for the refund/credit of the input VAT on its zero-rated sales in the first

quarter of 1992 was actually and timely filed, petitioner corporation still failed to present together with its application the required

supporting documents, whether before the BIR or the CTA. As the Court of Appeals ruled –

In actions involving claims for refund of taxes assessed and collected, the burden of proof rests on the taxpayer. As clearly

discussed in the CTA's decision, petitioner failed to substantiate its claim for tax refunds. Thus:

"We note, however, that in the cases at bar, petitioner has relied totally on Revenue Regulations No. 2-88 in determining

compliance with the documentary requirements for a successful refund or issuance of tax credit. Unmentioned is the

applicable and specific amendment later introduced by Revenue Regulations No. 3-88 dated April 7, 1988 (issued barely

after two months from the promulgation of Revenue Regulations No. 2-88 on February 15, 1988), which amended Section

16 of Revenue Regulations No. 5-87 on refunds or tax credits of input tax. x x x.

x x x x

"A thorough examination of the evidence submitted by the petitioner before this court reveals outright the failure to

satisfy documentary requirements laid down under the above-cited regulations. Specifically, petitioner was not able to

present the following documents, to wit:

"a) sales invoices or receipts;

"b) purchase invoices or receipts;

"c) evidence of actual receipt of goods;

"d) BOI statement showing the amount and description of sale of goods, etc.

"e) original or attested copies of invoice or receipt on capital equipment locally purchased; and

"f) photocopy of import entry document and confirmation receipt on imported capital equipment.

"There is the need to examine the sales invoices or receipts in order to ascertain the actual amount or quantity of goods

sold and their selling price. Without them, this Court cannot verify the correctness of petitioner's claim inasmuch as the

regulations require that the input taxes being sought for refund should be limited to the portion that is directly and entirely

attributable to the particular zero-rated transaction. In this instance, the best evidence of such transaction are the said sales

invoices or receipts.

"Also, even if sales invoices are produced, there is the further need to submit evidence that such goods were actually

received by the buyer, in this case, by CBP, Philp[h]os and PASAR.

x x x x

"Lastly, this Court cannot determine whether there were actual local and imported purchase of capital goods as well as

domestic purchase of non-capital goods without the required purchase invoice or receipt, as the case may be, and

confirmation receipts.

"There is, thus, the imperative need to submit before this Court the original or attested photocopies of petitioner's invoices

or receipts, confirmation receipts and import entry documents in order that a full ascertainment of the claimed amount

may be achieved.

"Petitioner should have taken the foresight to introduce in evidence all of the missing documents abovementioned. Cases

filed before this Court are litigated de novo. This means that party litigants should endeavor to prove at the first instance

every minute aspect of their cases strictly in accordance with the Rules of Court, most especially on documentary

evidence." (pp. 37-42, Rollo)

Tax refunds are in the nature of tax exemptions. It is regarded as in derogation of the sovereign authority, and should be construed

in strictissimi juris against the person or entity claiming the exemption. The taxpayer who claims for exemption must justify his

claim by the clearest grant of organic or statute law and should not be permitted to stand on vague implications (Asiatic Petroleum

Co. v. Llanes, 49 Phil. 466; Northern Phil. Tobacco Corp. v. Mun. of Agoo, La Union, 31 SCRA 304; Reagan v. Commissioner, 30

SCRA 968; Asturias Sugar Central, Inc. v. Commissioner of Customs, 29 SCRA 617; Davao Light and Power Co., Inc. v.

Commissioner of Customs, 44 SCRA 122).

There is no cogent reason to fault the CTA's conclusion that the SGV's certificate is "self-destructive", as it finds comfort in the

very SGV's stand, as follows:

"It is our understanding that the above procedure are sufficient for the purpose of the Company. We make no presentation

regarding the sufficiency of these procedures for such purpose. We did not compare the total of the input tax claimed each

quarter against the pertinent VAT returns and books of accounts. The above procedures do not constitute an audit made in

accordance with generally accepted auditing standards. Accordingly, we do not express an opinion on the company's

claim for input VAT refund or credit. Had we performed additional procedures, or had we made an audit in accordance

with generally accepted auditing standards, other matters might have come to our attention that we would have

accordingly reported on."

The SGV's "disclaimer of opinion" carries much weight as it is petitioner's independent auditor. Indeed, SGV expressed that it "did

not compare the total of the input tax claimed each quarter against the VAT returns and books of accounts."38

Moving on to the Petition in G.R. No. 148763, concerning the input VAT of petitioner corporation on its zero-rated sales in the second,

third, and fourth quarters of 1990, the appellate court likewise found that petitioner corporation failed to sufficiently establish its claims.

Already disregarding the declarations made by the Court of Appeals on its erroneous application of Revenue Regulations No. 2-88, quoted

hereunder is the rest of the findings of the appellate court after evaluating the evidence submitted in accordance with the requirements under

Revenue Regulations No. 3-88 –

The Secretary of Finance validly adopted Revenue Regulations [No.] x x x 3-98 pursuant to Sec. 245 of the National Internal

Revenue Code, which recognized his power to "promulgate all needful rules and regulations for the effective enforcement of the

provisions of this Code." Thus, it is incumbent upon a taxpayer intending to file a claim for refund of input VATs or the issuance

of a tax credit certificate with the BIR x x x to prove sales to such buyers as required by Revenue Regulations No. 3-98. Logically,

the same evidence should be presented in support of an action to recover taxes which have been paid.

x x x Neither has [herein petitioner corporation] presented sales invoices or receipts showing sales of gold, copper concentrates,

and pyrite to the CBP, [PASAR], and [PHILPHOS], respectively, and the dates and amounts of the same, nor any evidence of

actual receipt by the said buyers of the mineral products. It merely presented receipts of purchases from suppliers on which input

VATs were allegedly paid. Thus, the Court of Tax Appeals correctly denied the claims for refund of input VATs or the issuance of

tax credit certificates of petitioner [corporation]. Significantly, in the resolution, dated 7 June 2000, this Court directed the parties

to file memoranda discussing, among others, the submission of proof for "its [petitioner's] sales of gold, copper concentrates, and

pyrite to buyers." Nevertheless, the parties, including the petitioner, failed to address this issue, thereby necessitating the

affirmance of the ruling of the Court of Tax Appeals on this point.39

This Court is, therefore, bound by the foregoing facts, as found by the appellate court, for well-settled is the general rule that the jurisdiction

of this Court in cases brought before it from the Court of Appeals, by way of a Petition for Review on Certiorari under Rule 45 of the

Revised Rules of Court, is limited to reviewing or revising errors of law; findings of fact of the latter are conclusive.40

This Court is not a

trier of facts. It is not its function to review, examine and evaluate or weigh the probative value of the evidence presented.41

The distinction between a question of law and a question of fact is clear-cut. It has been held that "[t]here is a question of law in a given

case when the doubt or difference arises as to what the law is on a certain state of facts; there is a question of fact when the doubt or

difference arises as to the truth or falsehood of alleged facts."42

Whether petitioner corporation actually made zero-rated sales; whether it paid input VAT on these sales in the amount it had declared in its

returns; whether all the input VAT subject of its applications for refund/credit can be attributed to its zero-rated sales; and whether it had not

previously applied the input VAT against its output VAT liabilities, are all questions of fact which could only be answered after reviewing,

examining, evaluating, or weighing the probative value of the evidence it presented, and which this Court does not have the jurisdiction to

do in the present Petitions for Review on Certiorari under Rule 45 of the revised Rules of Court.

Granting that there are exceptions to the general rule, when this Court looked into questions of fact under particular circumstances,43

none

of these exist in the instant cases. The Court of Appeals, in both cases, found a dearth of evidence to support the claims for refund/credit of

the input VAT of petitioner corporation, and the records bear out this finding. Petitioner corporation itself cannot dispute its non-compliance

with the requirements set forth in Revenue Regulations No. 3-88 and CTA Circular No. 1-95, as amended. It concentrated its arguments on

its assertion that the substantiation requirements under Revenue Regulations No. 2-88 should not have applied to it, while being

conspicuously silent on the evidentiary requirements mandated by other relevant regulations.

Re-opening of cases/holding of new trial before the CTA

This Court now faces the final issue of whether the prayer of petitioner corporation for the re-opening of its cases or holding of new trial

before the CTA for the reception of additional evidence, may be granted. Petitioner corporation prays that the Court exercise its discretion

on the matter in its favor, consistent with the policy that rules of procedure be liberally construed in pursuance of substantive justice.

This Court, however, cannot grant the prayer of petitioner corporation.

An aggrieved party may file a motion for new trial or reconsideration of a judgment already rendered in accordance with Section 1, Rule 37

of the revised Rules of Court, which provides –

SECTION 1. Grounds of and period for filing motion for new trial or reconsideration. – Within the period for taking an appeal, the

aggrieved party may move the trial court to set aside the judgment or final order and grant a new trial for one or more of the

following causes materially affecting the substantial rights of said party:

(a) Fraud, accident, mistake or excusable negligence which ordinary prudence could not have guarded against and by reason of

which such aggrieved party has probably been impaired in his rights; or

(b) Newly discovered evidence, which he could not, with reasonable diligence, have discovered and produced at the trial, and

which if presented would probably alter the result.

Within the same period, the aggrieved party may also move fore reconsideration upon the grounds that the damages awarded are

excessive, that the evidence is insufficient to justify the decision or final order, or that the decision or final order is contrary to law.

In G.R. No. 148763, petitioner corporation attempts to justify its motion for the re-opening of its cases and/or holding of new trial before the

CTA by contending that the "[f]ailure of its counsel to adduce the necessary evidence should be construed as excusable negligence or

mistake which should constitute basis for such re-opening of trial as for a new trial, as counsel was of the belief that such evidence was

rendered unnecessary by the presentation of unrebutted evidence indicating that respondent [Commissioner] has acknowledged the sale of

[sic] PASAR and [PHILPHOS] to be zero-rated." 44

The CTA denied such motion on the ground that it was not accompanied by an affidavit

of merit as required by Section 2, Rule 37 of the revised Rules of Court. The Court of Appeals affirmed the denial of the motion, but apart

from this technical defect, it also found that there was no justification to grant the same.

On the matter of the denial of the motion of the petitioner corporation for the re-opening of its cases and/or holding of new trial based on the

technicality that said motion was unaccompanied by an affidavit of merit, this Court rules in favor of the petitioner corporation. The facts

which should otherwise be set forth in a separate affidavit of merit may, with equal effect, be alleged and incorporated in the motion itself;

and this will be deemed a substantial compliance with the formal requirements of the law, provided, of course, that the movant, or other

individual with personal knowledge of the facts, take oath as to the truth thereof, in effect converting the entire motion for new trial into an

affidavit.45

The motion of petitioner corporation was prepared and verified by its counsel, and since the ground for the motion was premised

on said counsel's excusable negligence or mistake, then the obvious conclusion is that he had personal knowledge of the facts relating to

such negligence or mistake. Hence, it can be said that the motion of petitioner corporation for the re-opening of its cases and/or holding of

new trial was in substantial compliance with the formal requirements of the revised Rules of Court.

Even so, this Court finds no sufficient ground for granting the motion of petitioner corporation for the re-opening of its cases and/or holding

of new trial.

In G.R. No. 141104, petitioner corporation invokes the Resolution,46

dated 20 July 1998, by the CTA in another case, CTA Case No. 5296,

involving the claim of petitioner corporation for refund/credit of input VAT for the third quarter of 1993. The said Resolution allowed the

re-opening of CTA Case No. 5296, earlier dismissed by the CTA, to give the petitioner corporation the opportunity to present the missing

export documents.

The rule that the grant or denial of motions for new trial rests on the discretion of the trial court,47

may likewise be extended to the CTA.

When the denial of the motion rests upon the discretion of a lower court, this Court will not interfere with its exercise, unless there is proof

of grave abuse thereof.48

That the CTA granted the motion for re-opening of one case for the presentation of additional evidence and, yet, deny a similar motion in

another case filed by the same party, does not necessarily demonstrate grave abuse of discretion or arbitrariness on the part of the CTA.

Although the cases involve identical parties, the causes of action and the evidence to support the same can very well be different. As can be

gleaned from the Resolution, dated 20 July 1998, in CTA Case No. 5296, petitioner corporation was claiming refund/credit of the input

VAT on its zero-rated sales, consisting of actual export sales, to Mitsubishi Metal Corporation in Tokyo, Japan. The CTA took into account

the presentation by petitioner corporation of inward remittances of its export sales for the quarter involved, its Supply Contract with

Mitsubishi Metal Corporation, its 1993 Annual Report showing its sales to the said foreign corporation, and its application for refund. In

contrast, the present Petitions involve the claims of petitioner corporation for refund/credit of the input VAT on its purchases of capital

goods and on its effectively zero-rated sales to CBP and EPZA-registered enterprises PASAR and PHILPHOS for the second, third, and

fourth quarters of 1990 and first quarter of 1992. There being a difference as to the bases of the claims of petitioner corporation for

refund/credit of input VAT in CTA Case No. 5926 and in the Petitions at bar, then, there are resulting variances as to the evidence required

to support them.

Moreover, the very same Resolution, dated 20 July 1998, in CTA Case No. 5296, invoked by petitioner corporation, emphasizes that the

decision of the CTA to allow petitioner corporation to present evidence "is applicable pro hac vice or in this occasion only as it is the

finding of [the CTA] that petitioner [corporation] has established a few of the aforementioned material points regarding the possible

existence of the export documents together with the prior and succeeding returns for the quarters involved, x x x" [Emphasis supplied.]

Therefore, the CTA, in the present cases, cannot be bound by its ruling in CTA Case No. 5296, when these cases do not involve the exact

same circumstances that compelled it to grant the motion of petitioner corporation for re-opening of CTA Case No. 5296.

Finally, assuming for the sake of argument that the non-presentation of the required documents was due to the fault of the counsel of

petitioner corporation, this Court finds that it does not constitute excusable negligence or mistake which would warrant the re-opening of

the cases and/or holding of new trial.

Under Section 1, Rule 37 of the Revised Rules of Court, the "negligence" must be excusable and generally imputable to the party because if

it is imputable to the counsel, it is binding on the client. To follow a contrary rule and allow a party to disown his counsel's conduct would

render proceedings indefinite, tentative, and subject to re-opening by the mere subterfuge of replacing the counsel. What the aggrieved

litigant should do is seek administrative sanctions against the erring counsel and not ask for the reversal of the court's ruling.49

As elucidated by this Court in another case,50

the general rule is that the client is bound by the action of his counsel in the conduct of his

case and he cannot therefore complain that the result of the litigation might have been otherwise had his counsel proceeded differently. It

has been held time and again that blunders and mistakes made in the conduct of the proceedings in the trial court as a result of the

ignorance, inexperience or incompetence of counsel do not qualify as a ground for new trial. If such were to be admitted as valid reasons for

re-opening cases, there would never be an end to litigation so long as a new counsel could be employed to allege and show that the prior

counsel had not been sufficiently diligent, experienced or learned.

Moreover, negligence, to be "excusable," must be one which ordinary diligence and prudence could not have guarded against.51

Revenue

Regulations No. 3-88, which was issued on 15 February 1988, had been in effect more than two years prior to the filing by petitioner

corporation of its earliest application for refund/credit of input VAT involved herein on 21 August 1990. CTA Circular No. 1-95 was issued

only on 25 January 1995, after petitioner corporation had filed its Petitions before the CTA, but still during the pendency of the cases of

petitioner corporation before the tax court. The counsel of petitioner corporation does not allege ignorance of the foregoing administrative

regulation and tax court circular, only that he no longer deemed it necessary to present the documents required therein because of the

presentation of alleged unrebutted evidence of the zero-rated sales of petitioner corporation. It was a judgment call made by the counsel as

to which evidence to present in support of his client's cause, later proved to be unwise, but not necessarily negligent.

Neither is there any merit in the contention of petitioner corporation that the non-presentation of the required documentary evidence was

due to the excusable mistake of its counsel, a ground under Section 1, Rule 37 of the revised Rules of Court for the grant of a new trial.

"Mistake," as it is referred to in the said rule, must be a mistake of fact, not of law, which relates to the case.52

In the present case, the

supposed mistake made by the counsel of petitioner corporation is one of law, for it was grounded on his interpretation and evaluation that

Revenue Regulations No. 3-88 and CTA Circular No. 1-95, as amended, did not apply to his client's cases and that there was no need to

comply with the documentary requirements set forth therein. And although the counsel of petitioner corporation advocated an erroneous

legal position, the effects thereof, which did not amount to a deprivation of his client's right to be heard, must bind petitioner corporation.

The question is not whether petitioner corporation succeeded in establishing its interests, but whether it had the opportunity to present its

side.53

Besides, litigation is a not a "trial and error" proceeding. A party who moves for a new trial on the ground of mistake must show that

ordinary prudence could not have guarded against it. A new trial is not a refuge for the obstinate.54

Ordinary prudence in these cases would

have dictated the presentation of all available evidence that would have supported the claims for refund/credit of input VAT of petitioner

corporation. Without sound legal basis, counsel for petitioner corporation concluded that Revenue Regulations No. 3-88, and later on, CTA

Circular No. 1-95, as amended, did not apply to its client's claims. The obstinacy of petitioner corporation and its counsel is demonstrated in

their failure, nay, refusal, to comply with the appropriate administrative regulations and tax court circular in pursuing the claims for

refund/credit, now subject of G.R. Nos. 141104 and 148763, even though these were separately instituted in a span of more than two years.

It is also evident in the failure of petitioner corporation to address the issue and to present additional evidence despite being given the

opportunity to do so by the Court of Appeals. As pointed out by the appellate court, in its Decision, dated 15 September 2000, in CA-G.R.

SP No. 46718 –

x x x Significantly, in the resolution, dated 7 June 2000, this Court directed the parties to file memoranda discussing, among

others, the submission of proof for "its [petitioner's] sales of gold, copper concentrates, and pyrite to buyers." Nevertheless, the

parties, including the petitioner, failed to address this issue, thereby necessitating the affirmance of the ruling of the Court of Tax

Appeals on this point.55

Summary

Hence, although this Court agreed with the petitioner corporation that the two-year prescriptive period for the filing of claims for

refund/credit of input VAT must be counted from the date of filing of the quarterly VAT return, and that sales to EPZA-registered

enterprises operating within economic processing zones were effectively zero-rated and were not covered by Revenue Regulations No. 2-

88, it still denies the claims of petitioner corporation for refund of its input VAT on its purchases of capital goods and effectively zero-rated

sales during the second, third, and fourth quarters of 1990 and the first quarter of 1992, for not being established and substantiated by

appropriate and sufficient evidence. Petitioner corporation is also not entitled to the re-opening of its cases and/or holding of new trial since

the non-presentation of the required documentary evidence before the BIR and the CTA by its counsel does not constitute excusable

negligence or mistake as contemplated in Section 1, Rule 37 of the revised Rules of Court.

WHEREFORE, premises considered, the instant Petitions for Review are hereby DENIED, and the Decisions, dated 6 July 1999 and 15

September 2000, of the Court of Appeals in CA-G.R. SP Nos. 47607 and 46718, respectively, are hereby AFFIRMED. Costs against

petitioner.

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. GENERAL FOODS (PHILS.), INC., respondent.

D E C I S I O N

CORONA, J.:

Petitioner Commissioner of Internal Revenue (Commissioner) assails the resolution1[1] of the Court of Appeals reversing the decision2[2]

of the Court of Tax Appeals which in turn denied the protest filed by respondent General Foods (Phils.), Inc., regarding the assessment

made against the latter for deficiency taxes.

The records reveal that, on June 14, 1985, respondent corporation, which is engaged in the manufacture of beverages such as Tang, Calumet

and Kool-Aid, filed its income tax return for the fiscal year ending February 28, 1985. In said tax return, respondent corporation claimed as

deduction, among other business expenses, the amount of P9,461,246 for media advertising for Tang.

On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent corporation. Consequently,

respondent corporation was assessed deficiency income taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration

but the same was denied.

On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the appeal was dismissed:

With such a gargantuan expense for the advertisement of a singular product, which even excludes other advertising and promotions

expenses, we are not prepared to accept that such amount is reasonable to stimulate the current sale of merchandise regardless of Petitioners

explanation that such expense does not connote unreasonableness considering the grave economic situation taking place after the Aquino

assassination characterized by capital fight, strong deterioration of the purchasing power of the Philippine peso and the slacking demand for

consumer products (Petitioners Memorandum, CTA Records, p. 273). We are not convinced with such an explanation. The staggering

expense led us to believe that such expenditure was incurred to create or maintain some form of good will for the taxpayers trade or

business or for the industry or profession of which the taxpayer is a member. The term good will can hardly be said to have any precise

signification; it is generally used to denote the benefit arising from connection and reputation (Words and Phrases, Vol. 18, p. 556 citing

Douhart vs. Loagan, 86 III. App. 294). As held in the case of Welch vs. Helvering, efforts to establish reputation are akin to acquisition of

capital assets and, therefore, expenses related thereto are not business expenses but capital expenditures. (Atlas Mining and Development

Corp. vs. Commissioner of Internal Revenue, supra). For sure such expenditure was meant not only to generate present sales but more for

future and prospective benefits. Hence, abnormally large expenditures for advertising are usually to be spread over the period of years

during which the benefits of the expenditures are received (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we hereby RESOLVE to DISMISS the instant petition

for lack of merit and ORDER the Petitioner to pay the respondent Commissioner the assessed amount of P2,635,141.42 representing its

deficiency income tax liability for the fiscal year ended February 28, 1985.3[3]

Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which rendered a decision reversing and setting aside

the decision of the Court of Tax Appeals:

Since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same should be allowed.

WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby GRANTED. Accordingly, the Decision, dated 8

February 1994 of respondent Court of Tax Appeals is REVERSED and SET ASIDE and the letter, dated 31 May 1988 of respondent

Commissioner of Internal Revenue is CANCELLED.

SO ORDERED.4[4]

Thus, the instant petition, wherein the Commissioner presents for the Courts consideration a lone issue: whether or not the subject media

advertising expense for Tang incurred by respondent corporation was an ordinary and necessary expense fully deductible under the National

Internal Revenue Code (NIRC).

It is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of

the taxing authority;5[5] and he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute law. An

exemption from the common burden cannot be permitted to exist upon vague implications.6[6]

Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed, then deductions

must also be strictly construed.

We then proceed to resolve the singular issue in the case at bar. Was the media advertising expense for Tang paid or incurred by respondent

corporation for the fiscal year ending February 28, 1985 necessary and ordinary, hence, fully deductible under the NIRC? Or was it a capital

expenditure, paid in order to create goodwill and reputation for respondent corporation and/or its products, which should have been

amortized over a reasonable period?

Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:

(A) Expenses.-

(1) Ordinary and necessary trade, business or professional expenses.-

(a) In general.- There shall be allowed as deduction from gross income all ordinary and necessary expenses paid or

incurred during the taxable year in carrying on, or which are directly attributable to, the development,

management, operation and/or conduct of the trade, business or exercise of a profession.

Simply put, to be deductible from gross income, the subject advertising expense must comply with the following requisites: (a) the expense

must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in

carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers.7[7]

The parties are in agreement that the subject advertising expense was paid or incurred within the corresponding taxable year and was

incurred in carrying on a trade or business. Hence, it was necessary. However, their views conflict as to whether or not it was ordinary. To

be deductible, an advertising expense should not only be necessary but also ordinary. These two requirements must be met.

The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the two conditions set by

U.S. jurisprudence: first, reasonableness of the amount incurred and second, the amount incurred must not be a capital outlay to create

goodwill for the product and/or private respondents business. Otherwise, the expense must be considered a capital expenditure to be spread

out over a reasonable time.

We agree.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There being no hard and fast

rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: the type and size of business in which

the taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the

general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation.

In the case at bar, the P9,461,246 claimed as media advertising expense for Tang alone was almost one-half of its total claim for marketing

expenses. Aside from that, respondent-corporation also claimed P2,678,328 as other advertising and promotions expense and another

P1,548,614, for consumer promotion.

Furthermore, the subject P9,461,246 media advertising expense for Tang was almost double the amount of respondent corporations

P4,640,636 general and administrative expenses.

We find the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it is necessary, it cannot be

considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2) advertising

designed to stimulate the future sale of merchandise or use of services. The second type involves expenditures incurred, in whole or in part,

to create or maintain some form of goodwill for the taxpayers trade or business or for the industry or profession of which the taxpayer is a

member. If the expenditures are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is

no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then

normally they should be spread out over a reasonable period of time.

We agree with the Court of Tax Appeals that the subject advertising expense was of the second kind. Not only was the amount staggering;

the respondent corporation itself also admitted, in its letter protest8[8] to the Commissioner of Internal Revenues assessment, that the

subject media expense was incurred in order to protect respondent corporations brand franchise, a critical point during the period under

review.

The protection of brand franchise is analogous to the maintenance of goodwill or title to ones property. This is a capital expenditure which

should be spread out over a reasonable period of time.9[9]

Respondent corporations venture to protect its brand franchise was tantamount to efforts to establish a reputation. This was akin to the

acquisition of capital assets and therefore expenses related thereto were not to be considered as business expenses but as capital

expenditures.10[10]

True, it is the taxpayers prerogative to determine the amount of advertising expenses it will incur and where to apply them.11[11] Said

prerogative, however, is subject to certain considerations. The first relates to the extent to which the expenditures are actually capital

outlays; this necessitates an inquiry into the nature or purpose of such expenditures.12[12] The second, which must be applied in harmony

with the first, relates to whether the expenditures are ordinary and necessary. Concomitantly, for an expense to be considered ordinary, it

must be reasonable in amount. The Court of Tax Appeals ruled that respondent corporation failed to meet the two foregoing limitations.

We find said ruling to be well founded. Respondent corporation incurred the subject advertising expense in order to protect its brand

franchise. We consider this as a capital outlay since it created goodwill for its business and/or product. The P9,461,246 media advertising

expense for the promotion of a single product, almost one-half of petitioner corporations entire claim for marketing expenses for that year

under review, inclusive of other advertising and promotion expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly

unreasonable.

It has been a long standing policy and practice of the Court to respect the conclusions of quasi-judicial agencies such as the Court of Tax

Appeals, a highly specialized body specifically created for the purpose of reviewing tax cases. The CTA, by the nature of its functions, is

dedicated exclusively to the study and consideration of tax problems. It has necessarily developed an expertise on the subject. We extend

due consideration to its opinion unless there is an abuse or improvident exercise of authority.13[13] Since there is none in the case at bar,

the Court adheres to the findings of the CTA.

Accordingly, we find that the Court of Appeals committed reversible error when it declared the subject media advertising expense to be

deductible as an ordinary and necessary expense on the ground that it has not been established that the item being claimed as deduction is

excessive. It is not incumbent upon the taxing authority to prove that the amount of items being claimed is unreasonable. The burden of

proof to establish the validity of claimed deductions is on the taxpayer.14[14] In the present case, that burden was not discharged

satisfactorily.

WHEREFORE, premises considered, the instant petition is GRANTED. The assailed decision of the Court of Appeals is hereby

REVERSED and SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code, respondent General Foods (Phils.), Inc. is hereby ordered

to pay its deficiency income tax in the amount of P2,635,141.42, plus 25% surcharge for late payment and 20% annual interest computed

from August 25, 1989, the date of the denial of its protest, until the same is fully paid. SO ORDERED.

MARIANO ZAMORA, petitioner,

vs.

COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

In the above-entitled cases, a joint decision was rendered by the lower court because they involved practically the same issues. We do so,

likewise, for the same reason.

Cases Nos. L-15290 and L-15280

Mariano Zamora, owner of the Bay View Hotel and Farmacia Zamora, Manila, filed his income tax returns the years 1951 and 1952. The

Collector of Internal Revenue found that he failed to file his return of the capital gains derived from the sale of certain real properties and

claimed deductions which were not allowable. The collector required him to pay the sums of P43,758.50 and P7,625.00, as deficiency

income tax for the years 1951 and 1952, respectively (C.T.A. Case No. 234, now L-15290). On appeal by Zamora, the Court of Tax

Appeals on December 29, 1958, modified the decision appealed from and ordered him to pay the reduced total sum of P30,258.00

(P22,980.00 and P7,278.00, as deficiency income tax for the years 1951 and 1952, respectively), within thirty (30) days from the date the

decision becomes final, plus the corresponding surcharges and interest in case of delinquency, pursuant to section 51(e), Int. Revenue Code.

With costs against petitioner.

Having failed to obtain a reconsideration of the decision, Mariano Zamora appealed (L-15290), alleging that the Court of Tax Appeals erred

—

(1) In dissallowing P10,478.50, as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia

Zamora (which is ½ of P20,957.00, supposed business expenses):

(2) In disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel Building;

(3) In disregarding the price stated in the deed of sale, as the costs of a Manila property, for the purpose of determining alleged

capital gains; and

(4) In applying the Ballantyne scale of values in determining the cost of said property.

The Collector of Internal Revenue (L-15280) also appealed, claiming that the Court of Tax Appeals erred —

(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the said real property in question during

the Japanese occupation, partly in Philippine currency and partly in Japanese war notes, and

(2) In not holding that Mariano Zamora is liable for the payment of the sums of P43,758.00 and P7,625.00 as deficiency income

taxes, for the years 1951 and 1952, plus the 5% surcharge and 1% monthly interest, from the date said amounts became due to the

date of actual payment.

Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court,

without prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts. 1äwphï1.ñët

Cases Nos. L-15289 and L-15281

Mariano Zamora and his deceased sister Felicidad Zamora, bought a piece of land located in Manila on May 16, 1944, for P132,000.00 and

sold it for P75,000.00 on March 5, 1951. They also purchased a lot located in Quezon City for P68,959.00 on January 19, 1944, which they

sold for P94,000 on February 9, 1951. The CTA ordered the estate of the late Felicidad Zamora (represented by Esperanza A. Zamora, as

special administratrix of her estate), to pay the sum of P235.50, representing alleged deficiency income tax and surcharge due from said

estate. Esperanza A. Zamora appealed and alleged that the CTA erred: —

The Commissioner of Internal Revenue likewise appealed from the decision, claiming that the lower court erred: —

(1) In giving credence to the uncorroborated testimony of Mariano Zamora that he bought the real property involved during the

Japanese occupation, partly in genuine Philippine currency and partly in Japanese war notes; and

(2) In not holding that Esperanza A. Zamora, as administratrix, is liable for the payment of the sum of P613.00 as deficiency

income tax and 50% surcharge for 1951, plus 50% surcharge and 1% monthly interest from the date said amount became due, to

the date of actual payment.

It is alleged by Mariano Zamora that the CTA erred in disallowing P10,478.50 as promotion expenses incurred by his wife for the

promotion of the Bay View Hotel and Farmacia Zamora. He contends that the whole amount of P20,957.00 as promotion expenses in his

1951 income tax returns, should be allowed and not merely one-half of it or P10,478.50, on the ground that, while not all the itemized

expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. For, as

alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano), during her travel to Japan and the

United States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however,

found that for said trip Mrs. Zamora obtained only the sum of P5,000.00 from the Central Bank and that in her application for dollar

allocation, she stated that she was going abroad on a combined medical and business trip, which facts were not denied by Mariano Zamora.

No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00 given to his wife which she spent

abroad. No explanation had been made either that the statement contained in Mrs. Zamora's application for dollar allocation that she was

going abroad on a combined medical and business trip, was not correct. The alleged expenses were not supported by receipts. Mrs. Zamora

could not even remember how much money she had when she left abroad in 1951, and how the alleged amount of P20,957.00 was spent.

Section 30, of the Tax Code, provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary

expenses paid or incurred during the taxable year, in carrying on any trade or business (Vol. 4, Mertens, Law of Federal Income Taxation,

sec. 25.03, p. 307). Since promotion expenses constitute one of the deductions in conducting a business, same must testify these

requirements. Claim for the deduction of promotion expenses or entertainment expenses must also be substantiated or supported by record

showing in detail the amount and nature of the expenses incurred (N.H. Van Socklan, Jr. v. Comm. of Int. Rev.; 33 BTA 544). Considering,

as heretofore stated, that the application of Mrs. Zamora for dollar allocation shows that she went abroad on a combined medical and

business trip, not all of her expenses came under the category of ordinary and necessary expenses; part thereof constituted her personal

expenses. There having been no means by which to ascertain which expense was incurred by her in connection with the business of Mariano

Zamora and which was incurred for her personal benefit, the Collector and the CTA in their decisions, considered 50% of the said amount

of P20,957.00 as business expenses and the other 50%, as her personal expenses. We hold that said allocation is very fair to Mariano

Zamora, there having been no receipt whatsoever, submitted to explain the alleged business expenses, or proof of the connection which said

expenses had to the business or the reasonableness of the said amount of P20,957.00. While in situations like the present, absolute certainty

is usually no possible, the CTA should make as close an approximation as it can, bearing heavily, if it chooses, upon the taxpayer whose

inexactness is of his own making.

In the case of Visayan Cebu Terminal Co., Inc. v. Collector of Int. Rev., G.R. No. L-12798, May 30, 1960, it was declared that

representation expenses fall under the category of business expenses which are allowable deductions from gross income, if they meet the

conditions prescribed by law, particularly section 30 (a) [1], of the Tax Code; that to be deductible, said business expenses must be ordinary

and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of

reasonableness in amount; that when some of the representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but

others were without vouchers or chits, documents or supporting papers; that there is no more than oral proof to the effect that payments

have been made for representation expenses allegedly made by the taxpayer and about the general nature of such alleged expenses; that

accordingly, it is not possible to determine the actual amount covered by supporting papers and the amount without supporting papers, the

court should determine from all available data, the amount properly deductible as representation expenses.

In view hereof, We are of the opinion that the CTA, did not commit error in allowing as promotion expenses of Mrs. Zamora claimed in

Mariano Zamora's 1951 income tax returns, merely one-half or P10,478.50.

Petitioner Mariano Zamora alleges that the CTA erred in disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel

Building but only 2-½%. In justifying depreciation deduction of 3-½%, Mariano Zamora contends that (1) the Ermita District, where the

Bay View Hotel is located, is now becoming a commercial district; (2) the hotel has no room for improvement; and (3) the changing modes

in architecture, styles of furniture and decorative designs, "must meet the taste of a fickle public". It is a fact, however, that the CTA, in

estimating the reasonable rate of depreciation allowance for hotels made of concrete and steel at 2-½%, the three factors just mentioned had

been taken into account already. Said the CTA—

Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of the building for

business purposes depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the

rate of change in population, the shifting of land values, as well as the extent and maintenance and rehabilitation. It is allowed a

depreciation rate of 2-½% corresponding to a normal useful life of only 40 years (1955 PH Federal Taxes, Par 14 160-K).

Consequently, the stand of the petitioners can not be sustained.

As the lower court based its findings on Bulletin F, petitioner Zamora, argues that the same should have been first proved as a law, to be

subject to judicial notice. Bulletin F, is a publication of the US Federal Internal Revenue Service, which was made after a study of the lives

of the properties. In the words of the lower court: "It contains the list of depreciable assets, the estimated average useful lives thereof and

the rates of depreciation allowable for each kind of property. (See 1955 PH Federal Taxes, Par. 14, 160 to Par. 14, 163-0). It is true that

Bulletin F has no binding force, but it has a strong persuasive effect considering that the same has been the result of scientific studies and

observation for a long period in the United States after whose Income Tax Law ours is patterned." Verily, courts are permitted to look into

and investigate the antecedents or the legislative history of the statutes involved (Director of Lands v. Abaya, et al., 63 Phil. 559). Zamora

also contends that his basis for applying the 3-½% rate is the testimony of its witness Mariano Katipunan, who cited a book entitled "Hotel

Management — Principles and Practice" by Lucius Boomer, President, Hotel Waldorf Astoria Corporation. As well commented by the

Solicitor General, "while the petitioner would deny us the right to use Bulletin F, he would insist on using as authority, a book in Hotel

management written by a man who knew more about hotels than about taxation. All that the witness did (Katipunan) . . . is to read excerpts

from the said book (t.s.n. pp. 99-101), which admittedly were based on the decision of the U.S. Tax Courts, made in 1928 (t.s.n. p. 106)". In

view hereof, We hold that the 2-½% rate of depreciation of the Bay View Hotel building, is approximately correct.

The next items in dispute are the undeclared capital gains derived from the sales in 1951 of certain real properties in Malate, Manila and in

Quezon City, acquired during the Japanese occupation.

The Manila property (Esperanza Zamora v. Coll. of Int. Rev., Case No. L-15289). The CTA held in this case, that the cost basis of property

acquired in Japanese war notes is the equivalent of the war notes in genuine Philippine currency in accordance with the Ballantyne Scale of

values, and that the determination of the gain derived or loss sustained in the sale of such property is not affected by the decline at the time

of sale, in the purchasing power of the Philippine currency. It was found by the CTA that the purchase price of P132,000.00 was not entirely

paid in Japanese War notes but ½ thereof or P66,000.00 was in Philippine currency, and that during certain periods of the enemy

occupation, the value of the Japanese war notes was very much less than the value of the genuine Philippine currency. On this point, the

CTA declared —

Finally, it is alleged that the purchase price of P132,000.00 was not entirely paid in Japanese war notes, Mariano Zamora, co-

owner of the property in question, testified that P66,000.00 was paid in Philippine currency and the other P66,000.00 was paid in

Japanese war notes. No evidence was presented by respondent to rebut the testimony of Mariano Zamora; it is assailed merely as

being improbable. We have examined this question thoroughly and we are inclined to give credence to the allegation that a portion

of the purchase price of the property was paid in Philippine money. In the first place, it appears that the Zamoras owned the

Farmacia Zamora which continued to engage in business during the war years and that a considerable portion of its sales was paid

for in genuine Philippine currency. This circumstance enabled the Zamoras to accumulate Philippine money which they used in

acquiring the property in question and another property in Quezon City. In the second place, P132,000.00 in Japanese war notes in

May, 1944 is equivalent to only P11,000.00. The property in question had at the time an assessed value of P27,031.00 (in

Philippine currency). Considering the well known fact that the assessed value of real property is very much below the fair market

value, it is incredible that said property should have been sold by the owner thereof for less than one-half of its assessed value.

These facts have convinced us of the veracity of the allegation that of the purchase price of P132,000.00 the sum of P66,000.00

was paid in Philippine currency, so that only the sum of P66,000.00 was paid in Japanese War notes.

This being the case, the Ballantyne Scale of values, which was the result of an impartial scientific study, adopted and given judicial

recognition, should be applied. As the value of the Japanese war notes in May, 1944 when the Manila property was bought, was 1 ½ of the

genuine Philippine Peso (Ballantyne Scale), and since the gain derived or loss sustained in the disposition of this property is to reckoned in

terms of Philippine Peso, the value of the Japanese war notes used in the purchase of the property, must be reduced in terms of the genuine

Philippine Peso to determine the cost of acquisition. It, therefore, results that since the sum of P66,000.00 in Japanese war notes in May,

1944 is equivalent to P5,500.00 in Philippine currency (P66,000.00 divided by 12), the acquisition cost of the property in question is

P66,000.00 plus P5,500.00 or P71,500.00 and that as the property was sold for P75,000.00 in 1951, the owners thereof Mariano and

Felicidad Zamora derived a capital gain of P3,500.00 or P1,750.00 each.

The Quezon City Property (Mariano Zamora v. Coll. of Customs, Case No. 15290). The Zamoras alleged that the entire purchase price of

P68,959.00 was paid in Philippine currency. The collector, on the other hand, contends that the purchase price of P68,959.00 was paid in

Japanese war notes. The CTA, however, giving credence to Zamora's version, said —

. . . If , as contended by respondent, the purchase price of P68,959.00 was paid in Japanese war notes, the purchase price in

Philippine currency would be only P17,239.75 (P68,959.00 divided by 4, 34.00 in war notes being equivalent to P1.00 in

Philippine currency). The assessed value of said property in Philippine currency at the time of acquisition was P46,910.00. It is

quite incredible that real property with an assessed value of P46,910.00 should have been sold by the owner thereof in Japanese

war notes with an equivalent value in Philippine currency of only P17,239.75. We are more inclined to believe the allegation that it

was purchased for P68,959.00 in genuine Philippine currency. Since the property was sold for P94,000.00 on February 9, 1951,

the gain derived from the sale is P15,361.75, after deducting from the selling price the cost of acquisition in the sum of P68,959.00

and the expense of sale in the sum of P9,679.25.

The above appraisal is correct, and We have no plausible reason to disturb the same.

Consequently, the total undeclared income of petitioners derived from the sales of the Manila and Quezon City properties in 1951 is

P17,111.75 (P1,750.00 plus P15,361.75), 50% of which in the sum of P8,555.88 is taxable, the said properties being capital assets held for

more than one year.

IN VIEW HEREOF, the petition in each of the above-entitled cases is dismissed, and the decision appealed from is affirmed, without

special pronouncement as to costs.

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.

KUENZLE & STREIFF, INC., petitioner,

vs.

THE COMMISSIONER OF INTERNAL REVENUE, respondent.

Angel S. Gamboa for petitioner.

Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Jose P. Alejandro and Special Attorney Virgilio C. Saldajeno

for respondent.

DIZON, J.:

Petition filed by Kuenzle & Streiff Inc. for the review of the decision of the Court of Tax Appeals in C.T.A. Case No. 551 sustaining the

assessments of the respondent issued against it, for deficiency income taxes for the years 1953, 1954 and 1955 in the amounts of

P40,455.00, P11,248.00 and P16,228.00, respectively, arising from the disallowance, as deductible expenses, of the bonuses paid by

petitioner to its officers, upon the ground that they were not ordinary, nor necessary, nor reasonable expenses within the purview of Section

30(a) (1) of the National Internal Revenue Code.

Petitioner, a domestic corporation, filed its income tax returns for the taxable years 1953, 1954 and 1955, declaring net losses of P2,085.84,

P4,953.91 and P9,246.07 respectively. Upon a verification thereof, the respondent, on September 9, 1957, assessed against it the deficiency

income taxes in question, arrived at as follows:

For the year 1953, by disallowing as deductions all amounts paid that year by the petitioner as bonus to its officers and staff-members in the

aggregate sum of P175,140.00, this resulting in a net taxable income of petitioner amounting to P173,054.16; for the taxable years 1954 and

1955, the similar disallowance as deductions of a portion of the bonuses paid by petitioner in said years to its officers and staff-members in

the aggregate sums of P88,193.33 for 1954 and P90,385.00 for 1955, resulted likewise in a net taxable income for petitioner in the sum of

P83,239.42 for 1954 and P81,138.93 for 1955.

On July 9, 1958 petitioner filed with the Court of Tax Appeals a petition for review contesting the aforementioned assessments (C.T.A.

Case No. 551), and on April 28, 1961, said Court rendered judgment as follows:

"FOR THE FOREGOING CONSIDERATIONS, the decision appealed from is hereby affirmed with respect to deficiency assessment for

the years 1953 and 1955. As regards the deficiency assessment for the year 1954, the same is hereby modified in the sense that the amount

due from petitioner is P11,248.00, instead of P16,648.00. Accordingly, petitioner is ordered to pay within thirty days from the date this

decision becomes final the sums of P40,455.00 and P16,228.00, plus 5% surcharge and 1% monthly interest from October 1, 1957 until

paid. It is likewise ordered to pay the sum of P11,248.00 within the same period, and, if not so paid, there shall be added thereto 5%

surcharge and 1% monthly interest from the date of delinquency to the date of payment. With costs against petitioner."

Petitioner moved for a reconsideration of the abovequoted decision, and on August 21, 1961, the court amended the same to include the

following at the end thereof:

... In both cases, the maximum amount of interest shall not exceed the amount corresponding to a period of three years, pursuant to

Section 51(e) (2) of the National Internal Revenue Code, as amended by Section 8 of Republic Act No. 2343. With costs against

petitioner.

Having found that the bonuses in question were paid for services actually rendered by the recipients thereof, the tax court proceeded to

consider the question of "whether or not they are reasonable". In this connection it construed Section 30(a) (1) of the Revenue Code as

allowing the deduction from gross income of all the ordinary and necessary expenses incurred during the taxable year in carrying on the

trade or business of the taxpayer, including a reasonable allowance for salaries or other compensation for personal services actually

rendered. We agree with the view thus expressed, as well as with court's conclusion that the bonuses in question were not reasonable

considering all material and relevant factors.

Petitioner contends that the tax court, in arriving at its conclusion, acted "in a purely arbitrary manner", and erred in not considering

individually the total compensation paid to each of petitioner's officers and staff members in determining the reasonableness of the bonuses

in question, and that it erred likewise in holding that there was nothing in the record indicating that the actuation of the respondent was

unreasonable or unjust.

It is not true, as petitioner claims to support its view, that the respondent and the tax court based their ruling exclusively upon the fact that

petitioner had suffered net losses in its business operations during the years when the bonuses in question were paid. The truth appears to be

that, in arriving at such conclusion, the respondent and the tax court gave due consideration to all the material factors that led this Court to

decide an earlier case of petitioner itself involving the same issue and where the test for determining the reasonableness of bonuses and

additional compensation for services actually rendered were laid down by Us as follows:

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 condition precedents

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) 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). Here it is

admitted that the bonuses are in fact compensation and were paid for services actually rendered. The only question is whether the

payment of said bonuses is reasonable.

There plaintiff 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 a whole.lawphi1.ñet 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 a satisfactory answer, and that ordinarily it is the interplay of several factors, properly weighted for

the particular case, which must furnish the final answer (Idem)." Kuenzle & Streiff v. Coll. of Int. Rev., G. R. Nos. L-12010 & L-12113,

Oct. 20, 1959.)

Making a distinction between petitioner's previous case and the present, the tax court said that while it is true that in the former (C.T.A. No.

169, December 29, 1956, G.R. Nos. L-12010 and L-12113, October 20, 1959, involving taxable years 1950 to 1952 (We allowed — and

considered deductible — bonuses in amounts bigger than the ones allowed by respondent in the case at bar, that was due to the fact that

petitioner had earned huge profits during the years 1950-52. So much so that, the payment of such bonuses notwithstanding, petitioner still

had substantial net profits distributable as dividends among its stockholders. In the present case, on the other hand, it is clear that the

ultimate and inevitable result of the payment of the questioned bonuses would be net losses for petitioner during the taxable years in which

they were paid.

It seems clear from the record that, in arriving at its main conclusion, the tax court considered, inter alia, the following factors:

In the first place, for the years 1953, 1954 and 1955 the petitioner paid to its following top officers: A. P. Kuenzle, H. A. Streiff, A. Jung, G.

Gattaneo, A. Schatzmann, F. E. Rein, M. Klinger, A. Huber, S. Meili, M. Triaca, J. Ortiz, H. Vogt, W. Ramp, W. Strehler, H. R. Jung, K.

Schedler, P. C. Curtis, R. Oefeli, substantial amounts as salaries and bonuses ranging from P9,000.00 yearly as a minimum (except in the

case) and P50,000.00 as maximum. All these officials headed various departments of petitioner's business. While it must be assumed, on the

one hand, in the absence of evidence to the contrary, that they were competent, on the other the record discloses no evidence nor has

petitioner ever made the claim that all or some of them were gifted with some special talent, or had undergone some extraordinary training,

or had accomplished any particular task, that contributed materially to the success of petitioner's business during the taxable years in

question.

In the second place, working under the above-named officials and constituting what we might call the staff of petitioner's working

personnel, were a good number of other employees — mostly Filipinos (T.s.n., pp. 222-223) — all of whom, according to the record (Idem.

223), received no pay increase at all during the same years.

In the third place, the above salaries and bonuses were paid to petitioner's top officials mentioned heretofore, in spite of the fact that

according to its income tax returns for the relevant years, it had suffered net losses as follows: P2,085.84, P4,953.91, P9,246.07 for the years

1953, 1954 and 1955, respectively. In fact, petitioner's financial statements further show that its gross assets suffered a gradual decrease for

the same years (Exh. B-1, p. 58, B.I.R., records, Exh. D-1, p. 36 id., Exh. F-1, p. 14 id.), and that a similar downward trend took place in its

surplus and capital position during the same period of time.

That the charge of arbitrariness against respondent is without merit is further shown by the following considerations:

Petitioner admits that the amounts it paid to its top officers in 1953 as bonus or "additional remuneration" were taken either from operating

funds, that is, funds from the year's business operations, or from its general reserve. Normally, the amounts taken from the first source

should have constituted profits of the corporation distributable as dividends amongst its shareholders. Instead it would appear that they were

diverted from this purpose and used to pay the bonuses for the year 1953. In the case of the amounts taken from the general reserve it seems

clear that the company had to resort to the use of such reserve funds because the item of expense to be met could not be considered as

ordinary or necessary — and was therefore beyond the purview of the provisions of Section 30(a) (1) of the National Internal Revenue

Code. This being so, We cannot see our way clear to holding that the respondent acted arbitrarily in disallowing as deductible expenses the

amounts thus paid as bonus or "additional remuneration".

Neither does the total disallowance of the bonuses paid to some officers and the partial disallowance of those paid to others show that

respondent acted unjustly and unreasonably. The record sufficiently shows that the total disallowance was more or less due to the fact that

the affected officers had previously received substantial increases in their basic salaries.

Petitioner justifies payment of these bonuses to its top officials by saying that its general salary policy was to give a low salary but to grant

substantial bonuses at the end of each year, so that its officers may receive considerable lump sums with which to purchase whatever

expensive objects or items they might need. While We are not prepared to hold that such policy is unreasonable, still We believe that its

application should not result in producing a net loss for the employer at the end of the year, for if that were to be the case, the scheme may

be utilized to freely achieve some other purpose — evade payment of taxes.

The authority relied upon by petitioner (Mertens Law of Federal Income Taxation, Vol. IV, p. 418) does not apply to the present case,

because it refers to the salary paid to an employee, which may be claimed as a deductible amount. In the case before Us the respondent does

not question the basic salaries paid by petitioner to the officers and employees, but disallowed only the bonuses paid to petitioner's top

officers at the end of the taxable years in question.

In further support of its appeal petitioner claims that the amounts disallowed by the respondent should be considered as legitimate business

expenses as their payment was made in good faith. In bringing up this point, petitioner treads on dangerous ground. In the first place, good

faith cannot decide whether a business is reasonable or unreasonable for purposes of income tax deduction. In the second place, petitioner's

good faith in the matter at issue is not overly manifest, considering that the questioned bonuses were fixed and paid at the end the years in

question — at a time, therefore, when petitioner fully knew that it was going to suffer a net loss in its business operations.

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 bonus in question, all that We need say is this: that right maybe 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 to 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.

WHEREFORE, the appealed decision being in accordance with law, the same is hereby affirmed, with costs.

G.R. Nos. 106949-50 December 1, 1995

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner,

vs.

COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

G.R. Nos. 106984-85 December 1, 1995

COMMISSIONER INTERNAL REVENUE, petitioner,

vs.

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX

APPEALS, respondents.

FELICIANO, J.:

The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R. Nos. 106949-50 and private respondent in G.R.

Nos. 106984-85, is a Philippine corporation registered with the Board of Investments ("BOI") as a preferred pioneer enterprise with respect

to its integrated pulp and paper mill, and as a preferred non-pioneer enterprise with respect to its integrated plywood and veneer mills.

On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2) letters of assessment and demand both dated

31 March 1983: (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income

tax for 1977, for an aggregate amount of P88,763,255.00. These assessments were computed as follows:

Transaction Tax

Interest payments on

money market

borrowings P 45,771,849.00

———————

35% Transaction tax due

thereon 16,020,147.00

Add: 25% surcharge 4,005,036.75

——————

T o t a l P 20,025,183.75

Add:

14% int. fr.

1-20-78 to

7-31-80 P 7,093,302.57

20% int, fr.

8-1-80 to

3-31-83 10,675,523.58

——————

17,768,826.15

——————

P 37,794,009.90

Documentary and Science Stamps Tax

Total face value of

debentures P100,000,000.00

Documentary Stamps

Tax Due

(P0.30 x P100,000.000 )

( P200 ) P 150,000.00

Science Stamps Tax Due

(P0.30 x P100,000,000 )

( P200 ) P 150,000.00

——————

T o t a l P 300,000.00

Add: Compromise for

non-affixture 300.00

——————

300,300.00

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90

===========

Deficiency Income Tax for 1977

Net income per return P 258,166.00

Add: Unallowable deductions

1) Disallowed deductions

availed of under

R.A. No. 5186 P 44,332,980.00

2) Capitalized interest

expenses on funds

used for acquisition

of machinery & other

equipment 42,840,131.00

3) Unexplained financial

guarantee expense 1,237,421.00

4) Understatement

of sales 2,391,644.00

5) Overstatement of

cost of sales 604,018.00

——————

P91,406,194.00

Net income per investigation P91,664,360.00

Income tax due thereon 34,734,559.00

Less: Tax already assessed per return 80,358.00

——————

Deficiency P34,654,201.00

Add:

14% int. fr.

4-15-78 to

7-31-81 P 11,128,503.56

20% int. fr.

8-1-80 to

4-15-81 4,886,242.34

——————

P16,014,745.90

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1

===========

On 26 April 1983, Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. Picop also

protested on 21 May 1983 the deficiency income tax assessment for 1977. These protests were not formally acted upon by respondent CIR.

On 26 September 1984, the CIR issued a warrant of distraint on personal property and a warrant of levy on real property against Picop, to

enforce collection of the contested assessments; in effect, the CIR denied Picop's protests.

Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing the assessments. After trial, the CTA rendered a decision dated

15 August 1989, modifying the findings of the CIR and holding Picop liable for the reduced aggregate amount of P20,133,762.33, which

was itemized in the dispositive portion of the decision as follows:

35% Transaction Tax P 16,020,113.20

Documentary & Science

Stamp Tax 300,300.00

Deficiency Income Tax Due 3,813,349.33

——————

TOTAL AMOUNT DUE AND PAYABLE P 20,133,762.53 2

===========

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2)

Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. The

Court of Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which further reduced the liability of Picop

to P6,338,354.70. The dispositive portion of the Court of Appeals decision reads as follows:

WHEREFORE, the appeal of the Commissioner of Internal Revenue is denied for lack of merit. The judgment against

PICOP is modified, as follows:

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

2. PICOP is absolved from the payment of documentary and science stamp tax of P300,000.00 and the compromise

penalty of P300.00;

3. PICOP shall pay 20% interest per annum on the deficiency income tax of P1,481,579.15, for a period of three (3) years

from 21 May 1983, or in the total amount of P888,947.49, and a surcharge of 10% on the latter amount, or P88,984.75.

No pronouncement as to costs.

SO ORDERED.

Picop and the CIR once more filed separate Petitions for Review before the Supreme Court. These cases were consolidated and, on 23

August 1993, the Court resolved to give due course to both Petitions in G.R. Nos. 106949-50 and 106984-85 and required the parties to file

their Memoranda.

Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof. It assails the propriety of the thirty-five

percent (35%) deficiency transaction tax which the Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions

the imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting from disallowance of certain claimed

financial guarantee expenses and claimed year-end adjustments of sales and cost of sales figures by Picop's external auditors. 3

The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable for surcharge and interest on unpaid

transaction tax and for documentary and science stamp taxes and in allowing Picop to claim as deductible expenses:

(a) the net operating losses of another corporation (i.e., Rustan Pulp and Paper Mills, Inc.); and

(b) interest payments on loans for the purchase of machinery and equipment.

The CIR also claims that Picop should be held liable for interest at fourteen percent (14%) per annum from 15 April 1978 for three

(3) years, and interest at twenty percent (20%) per annum for a maximum of three (3) years; and for a surcharge of ten percent

(10%), on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for the corporate development tax

equivalent to five percent (5%) of its correct 1977 net income.

The issues which we must here address may be sorted out and grouped in the following manner:

I. Whether Picop is liable for:

(1) the thirty-five percent (35%) transaction tax;

(2) interest and surcharge on unpaid transaction tax; and

(3) documentary and science stamp taxes;

II. Whether Picop is entitled to deductions against income of:

(1) interest payments on loans for the purchase of machinery and equipment;

(2) net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and

(3) certain claimed financial guarantee expenses; and

III. (1) Whether Picop had understated its sales and overstated its cost of sales for 1977; and

(2) Whether Picop is liable for the corporate development tax of five percent (5%) of

its net income for 1977.

We will consider these issues in the foregoing sequence.

I.

(1) Whether Picop is liable

for the thirty-five percent

(35%) transaction tax.

With the authorization of the Securities and Exchange Commission, Picop issued commercial paper consisting of serially numbered

promissory notes with the total face value of P229,864,000.00 and a maturity period of one (1) year, i.e., from 24 December 1977 to 23

December 1978. These promissory notes were purchased by various commercial banks and financial institutions. On these promissory

notes, Picop paid interest in the aggregate amount of P45,771,849.00. In respect of these interest payments, the CIR required Picop to pay

the thirty-five percent (35%) transaction tax.

The CIR based this assessment on Presidential Decree No. 1154 dated 3 June 1977, which reads in part as follows:

Sec. 1. The National Internal Revenue Code, as amended, is hereby further amended by adding a new section thereto to

read as follows:

Sec. 195-C. Tax on certain interest. — There shall be levied, assessed, collected and paid on every commercial paper

issued in the primary market as principal instrument, a transaction tax equivalent to thirty-five percent (35%) based on the

gross amount of interest thereto as defined hereunder, which shall be paid by the borrower/issuer: Provided, however, that

in the case of a long-term commercial paper whose maturity exceeds more than one year, the borrower shall pay the tax

based on the amount of interest corresponding to one year, and thereafter shall pay the tax upon accrual or actual payment

(whichever is earlier) of the untaxed portion of the interest which corresponds to a period not exceeding one year.

The transaction tax imposed in this section shall be a final tax to be paid by the borrower and shall be allowed as a

deductible item for purposes of computing the borrower's taxable income.

For purposes of this tax —

(a) "Commercial paper" shall be defined as an instrument evidencing indebtedness of any person or entity, including

banks and non-banks performing quasi-banking functions, which is issued, endorsed, sold, transferred or in any manner

conveyed to another person or entity, either with or without recourse and irrespective of maturity. Principally, commercial

papers are promissory notes and/or similar instruments issued in the primary market and shall not include repurchase

agreements, certificates of assignments, certificates of participations, and such other debt instruments issued in the

secondary market.

(b) The term "interest" shall mean the difference between what the principal borrower received and the amount it paid

upon maturity of the commercial paper which shall, in no case, be lower than the interest rate prevailing at the time of the

issuance or renewal of the commercial paper. Interest shall be deemed synonymous with discount and shall include all

fees, commissions, premiums and other payments which form integral parts of the charges imposed as a consequence of

the use of money.

In all cases, where no interest rate is stated or if the rate stated is lower than the prevailing interest rate at the time of the

issuance or renewal of commercial paper, the Commissioner of Internal Revenue, upon consultation with the Monetary

Board of the Central Bank of the Philippines, shall adjust the interest rate in accordance herewith, and assess the tax on

the basis thereof.

The tax herein imposed shall be remitted by the borrower to the Commissioner of Internal Revenue or his Collection

Agent in the municipality where such borrower has its principal place of business within five (5) working days from the

issuance of the commercial paper. In the case of long term commercial paper, the tax upon the untaxed portion of the

interest which corresponds to a period not exceeding one year shall be paid upon accrual payment, whichever is earlier.

(Emphasis supplied)

Both the CTA and the Court of Appeals sustained the assessment of transaction tax.

In the instant Petition, Picop reiterates its claim that it is exempt from the payment of the transaction tax by virtue of its tax exemption under

R.A. No. 5186, as amended, known as the Investment Incentives Act, which in the form it existed in 1977-1978, read in relevant part as

follows:

Sec. 8. Incentives to a Pioneer Enterprise. In addition to the incentives provided in the preceding section, pioneer

enterprises shall be granted the following incentive benefits:

(a) Tax Exemption. Exemption from all taxes under the National Internal Revenue Code, except income tax, from the date

the area of investment is included in the Investment Priorities Plan to the following extent:

(1) One hundred per cent (100%) for the first five years;

(2) Seventy-five per cent (75%) for the sixth through the eighth years;

(3) Fifty per cent (50%) for the ninth and tenth years;

(4) Twenty per cent (20%) for the eleventh and twelfth years; and

(5) Ten per cent (10%) for the thirteenth through the fifteenth year.

xxx xxx xxx 4

We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No. 5186, as amended, does not include exemption

from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax 5 is an income tax, that is, it

is a tax on the interest income of the lenders or creditors. In Western Minolco Corporation v. Commissioner of Internal Revenue, 6 the

petitioner corporation borrowed funds from several financial institutions from June 1977 to October 1977 and paid the corresponding thirty-

five (35%) transaction tax thereon in the amount of P1,317,801.03, pursuant to Section 210 (b) of the 1977 Tax Code. Western Minolco

applied for refund of that amount alleging it was exempt from the thirty-five (35%) transaction tax by reason of Section 79-A of C.A. No.

137, as amended, which granted new mines and old mines resuming operation "five (5) years complete tax exemptions, except income tax,

from the time of its actual bonafide orders for equipment for commercial production." In denying the claim for refund, this Court held:

The petitioner's contentions deserve scant consideration. The 35% transaction tax is imposed on interest income from

commercial papers issued in the primary money market. Being a tax on interest, it is a tax on income.

As correctly ruled by the respondent Court of Tax Appeals:

Accordingly, we need not and do not think it necessary to discuss further the nature of the transaction

tax more than to say that the incipient scheme in the issuance of Letter of Instructions No. 340 on

November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational simplicity and effective

administration in capturing the interest-income "windfall" from money market operations as a new

source of revenue, has lost none of its animating principle in parturition of amendatory Presidential

Decree No. 1154, now Section 210 (b) of the Tax Code. The tax thus imposed is actually a tax on

interest earnings of the lenders or placers who are actually the taxpayers in whose income is imposed.

Thus "the borrower withholds the tax of 35% from the interest he would have to pay the lender so that

he (borrower) can pay the 35% of the interest to the Government." (Citation omitted) . . . . Suffice it to

state that the broad consensus of fiscal and monetary authorities is that "even if nominally, the borrower

is made to pay the tax, actually, the tax is on the interest earning of the immediate and all prior

lenders/placers of the money. . . ." (Rollo, pp. 36-37)

The 35% transaction tax is an income tax on interest earnings to the lenders or placers. The latter are actually the

taxpayers. Therefore, the tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed

funds from several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before

paying to the financial institutions the interests earned by them and later remitted the same to the respondent

Commissioner of Internal Revenue. The tax could have been collected by a different procedure but the statute chose this

method. Whatever collecting procedure is adopted does not change the nature of the tax.

xxx xxx xxx 7

(Emphasis supplied)

Much the same issue was passed upon in Marinduque Mining Industrial Corporation v. Commissioner of Internal Revenue 8 and

resolved in the same way:

It is very obvious that the transaction tax, which is a tax on interest derived from commercial paper issued in the money

market, is not a tax contemplated in the above-quoted legal provisions. The petitioner admits that it is subject to income

tax. Its tax exemption should be strictly construed.

We hold that petitioner's claim for refund was justifiably denied. The transaction tax, although nominally categorized as a

business tax, is in reality a withholding tax as positively stated in LOI No. 340. The petitioner could have shifted the tax

to the lenders or recipients of the interest. It did not choose to do so. It cannot be heard now to complain about the tax.

LOI No. 340 is an extraneous or extrinsic aid to the construction of section 210 (b).

xxx xxx xxx 9

(Emphasis supplied)

It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to

registered pioneer enterprises by Section 8 of R.A. No. 5186, as amended. Picop was the withholding agent, obliged to withhold thirty-five

percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau of Internal Revenue ("BIR"). As a

withholding agent, Picop is made personally liable for the thirty-five percent (35%) transaction tax 10

and if it did not actually withhold

thirty-five percent (35%) of the interest monies it had paid to its lenders, Picop had only itself to blame.

Picop claims that it had relied on a ruling, dated 6 October 1977, issued by the CIR, which held that Picop was not liable for the thirty-five

(35%) transaction tax in respect of debenture bonds issued by Picop. Prior to the issuance of the promissory notes involved in the instant

case, Picop had also issued debenture bonds P100,000,000.00 in aggregate face value. The managing underwriter of this debenture bond

issue, Bancom Development Corporation, requested a formal ruling from the Bureau of Internal Revenue on the liability of Picop for the

thirty-five percent (35%) transaction tax in respect of such bonds. The ruling rendered by the then Acting Commissioner of Internal

Revenue, Efren I. Plana, stated in relevant part:

It is represented that PICOP will be offering to the public primary bonds in the aggregate principal sum of one hundred

million pesos (P100,000,000.00); that the bonds will be issued as debentures in denominations of one thousand pesos

(P1,000.00) or multiples, to mature in ten (10) years at 14% interest per annum payable semi-annually; that the bonds are

convertible into common stock of the issuer at the option of the bond holder at an agreed conversion price; that the issue

will be covered by a "Trust Indenture" with a duly authorized trust corporation as required by the Securities and Exchange

Commission, which trustee will act for and in behalf of the debenture bond holders as beneficiaries; that once issued, the

bonds cannot be preterminated by the holder and cannot be redeemed by the issuer until after eight (8) years from date of

issue; that the debenture bonds will be subordinated to present and future debts of PICOP; and that said bonds are

intended to be listed in the stock exchanges, which will place them alongside listed equity issues.

In reply, I have the honor to inform you that although the bonds hereinabove described are commercial papers which will

be issued in the primary market, however, it is clear from the abovestated facts that said bonds will not be issued as

money market instruments. Such being the case, and considering that the purposes of Presidential Decree No. 1154, as can

be gleaned from Letter of Instruction No. 340, dated November 21, 1975, are (a) to regulate money market transactions

and (b) to ensure the collection of the tax on interest derived from money market transactions by imposing a withholding

tax thereon, said bonds do not come within the purview of the "commercial papers" intended to be subjected to the 35%

transaction tax prescribed in Presidential Decree No. 1154, as implemented by Revenue Regulations No. 7-77. (See

Section 2 of said Regulation) Accordingly, PICOP is not subject to 35% transaction tax on its issues of the aforesaid

bonds. However, those investing in said bonds should be made aware of the fact that the transaction tax is not being

imposed on the issuer of said bonds by printing or stamping thereon, in bold letters, the following statement: "ISSUER

NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154. BONDHOLDER SHOULD DECLARE INTEREST

EARNING FOR INCOME TAX." 11

(Emphases supplied)

In the above quoted ruling, the CIR basically held that Picop's debenture bonds did not constitute "commercial papers" within the meaning

of P.D. No. 1154, and that, as such, those bonds were not subject to the thirty-five percent (35%) transaction tax imposed by P.D. No. 1154.

The above ruling, however, is not applicable in respect of the promissory notes which are the subject matter of the instant case. It must be

noted that the debenture bonds which were the subject matter of Commissioner Plana's ruling were long-term bonds maturing in ten (10)

years and which could not be pre-terminated and could not be redeemed by Picop until after eight (8) years from date of issue; the bonds

were moreover subordinated to present and future debts of Picop and convertible into common stock of Picop at the option of the

bondholder. In contrast, the promissory notes involved in the instant case are short-term instruments bearing a one-year maturity period.

These promissory notes constitute the very archtype of money market instruments. For money market instruments are precisely, by custom

and usage of the financial markets, short-term instruments with a tenor of one (1) year or less. 12

Assuming, therefore, (without passing

upon) the correctness of the 6 October 1977 BIR ruling, Picop's short-term promissory notes must be distinguished, and treated differently,

from Picop's long-term debenture bonds.

We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction tax due in respect of interest payments on its

money market borrowings.

At the same time, we agree with the Court of Appeals that the transaction tax may be levied only in respect of the interest earnings of

Picop's money market lenders accruing after P.D. No. 1154 went into effect, and not in respect of all the 1977 interest earnings of such

lenders. The Court of Appeals pointed out that:

PICOP, however contends that even if the tax has to be paid, it should be imposed only for the interests earned after 20

September 1977 when PD 1154 creating the tax became effective. We find merit in this contention. It appears that the tax

was levied on interest earnings from January to October, 1977. However, as found by the lower court, PD 1154 was

published in the Official Gazette only on 5 September 1977, and became effective only fifteen (15) days after the

publication, or on 20 September 1977, no other effectivity date having been provided by the PD. Based on the Worksheet

prepared by the Commissioner's office, the interests earned from 20 September to October 1977 was P10,224,410.03.

Thirty-five (35%) per cent of this is P3,578,543.51 which is all PICOP should pay as transaction tax. 13

(Emphasis

supplied)

P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirty-five percent (35%) transaction tax in respect of

interest earnings which accrued before the effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the legislative

authority intended to bring about such retroactive imposition of the tax.

(2) Whether Picop is liable

for interest and surcharge

on unpaid transaction tax.

With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five percent (25%) surcharge and for interest at

the rate of fourteen percent (14%) per annum from the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of

Revenue Regulation 7-77 dated 3 June 1977, 14

issued by the Secretary of Finance. This Section reads:

Sec. 10. Penalties. — Where the amount shown by the taxpayer to be due on its return or part of such payment is not paid

on or before the date prescribed for its payment, the amount of the tax shall be increased by twenty-five (25%) per centum,

the increment to be a part of the tax and the entire amount shall be subject to interest at the rate of fourteen (14%) per

centum per annum from the date prescribed for its payment.

In the case of willful neglect to file the return within the period prescribed herein or in case a false or fraudulent return is

willfully made, there shall be added to the tax or to the deficiency tax in case any payment has been made on the basis of

such return before the discovery of the falsity or fraud, a surcharge of fifty (50%) per centum of its amount. The amount

so added to any tax shall be collected at the same time and in the same manner and as part of the tax unless the tax has

been paid before the discovery of the falsity or fraud, in which case the amount so added shall be collected in the same

manner as the tax.

In addition to the above administrative penalties, the criminal and civil penalties as provided for under Section 337 of the

Tax Code of 1977 shall be imposed for violation of any provision of Presidential Decree No. 1154. 15

(Emphases

supplied)

The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code, invoked by the Secretary of Finance in issuing

Revenue Regulation 7-77, set out, in comprehensive terms, the rule-making authority of the Secretary of Finance:

Sec. 326. Authority of Secretary of Finance to Promulgate Rules and Regulations. — The Secretary of Finance, upon

recommendation of the Commissioner of Internal Revenue, shall promulgate all needful rules and regulations for the

effective enforcement of the provisions of this Code. (Emphasis supplied)

Section 4 of the same Code contains a list of subjects or areas to be dealt with by the Secretary of Finance through the medium of

an exercise of his quasi-legislative or rule-making authority. This list, however, while it purports to be open-ended, does not

include the imposition of administrative or civil penalties such as the payment of amounts additional to the tax due. Thus, in order

that it may be held to be legally effective in respect of Picop in the present case, Section 10 of Revenue Regulation 7-77 must

embody or rest upon some provision in the Tax Code itself which imposes surcharge and penalty interest for failure to make a

transaction tax payment when due.

P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge and penalty interest in case of failure to

pay the thirty-five percent (35%) transaction tax when due. Neither did Section 210 (b) of the 1977 Tax Code which re-enacted Section 195-

C inserted into the Tax Code by P.D. No. 1154.

The CIR, both in its petition before the Court of Appeals and its Petition in the instant case, points to Section 51 (e) of the 1977 Tax Code as

its source of authority for assessing a surcharge and penalty interest in respect of the thirty-five percent (35%) transaction tax due from

Picop. This Section needs to be quoted in extenso:

Sec. 51. Payment and Assessment of Income Tax. —

(c) Definition of deficiency. — As used in this Chapter in respect of a tax imposed by this Title, the term "deficiency"

means:

(1) The amount by which the tax imposed by this Title exceeds the amount shown as the tax by the taxpayer upon his

return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected

without assessment) as a deficiency, and decreased by the amount previously abated, credited, returned, or otherwise in

respect of such tax; . . .

xxx xxx xxx

(e) Additions to the tax in case of non-payment. —

(1) Tax shown on the return. — Where the amount determined by the taxpayer as the tax imposed by this Title or any

installment thereof, or any part of such amount or installment is not paid on or before the date prescribed for its payment,

there shall be collected as a part of the tax, interest upon such unpaid amount at the rate of fourteen per centum per annum

from the date prescribed for its payment until it is paid: Provided, That the maximum amount that may be collected as

interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions

regarding prescription to the contrary notwithstanding.

(2) Deficiency. — Where a deficiency, or any interest assessed in connection therewith under paragraph (d) of this section,

or any addition to the taxes provided for in Section seventy-two of this Code is not paid in full within thirty days from the

date of notice and demand from the Commissioner of Internal Revenue, there shall be collected upon the unpaid amount

as part of the tax, interest at the rate of fourteen per centum per annum from the date of such notice and demand until it is

paid: Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the

amount corresponding to a period of three years, the present provisions regarding prescription to the contrary

notwithstanding.

(3) Surcharge. — If any amount of tax included in the notice and demand from the Commissioner of Internal Revenue is

not paid in full within thirty days after such notice and demand, there shall be collected in addition to the interest

prescribed herein and in paragraph (d) above and as part of the tax a surcharge of five per centum of the amount of tax

unpaid. (Emphases supplied)

Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2) above, provides:

Sec. 72. Surcharges for failure to render returns and for rendering false and fraudulent returns. — In case of willful

neglect to file the return or list required by this Title within the time prescribed by law, or in case a false or fraudulent

return or list is wilfully made, the Commissioner of Internal Revenue shall add to the tax or to the deficiency tax, in case

any payment has been made on the basis of such return before the discovery of the falsity or fraud, as surcharge of fifty

per centum of the amount of such tax or deficiency tax. In case of any failure to make and file a return or list within the

time prescribed by law or by the Commissioner or other Internal Revenue Officer, not due to willful neglect, the

Commissioner of Internal Revenue shall add to the tax twenty-five per centum of its amount, except that, when a return is

voluntarily and without notice from the Commissioner or other officer filed after such time, and it is shown that the failure

to file it was due to a reasonable cause, no such addition shall be made to the tax. The amount so added to any tax shall be

collected at the same time, in the same manner and as part of the tax unless the tax has been paid before the discovery of

the neglect, falsity, or fraud, in which case the amount so added shall be collected in the same manner as the tax.

(Emphases supplied)

It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977 Tax Code, authorize the imposition of surcharge and interest only in

respect of a "tax imposed by this Title," that is to say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code

imposes a surcharge only in case of failure to file a return or list "required by this Title," that is, Title II on "Income Tax." The thirty-five

percent (35%) transaction tax is, however, imposed in the 1977 Tax Code by Section 210 (b) thereof which Section is embraced in Title V

on "Taxes on Business" of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax imposed on interest income

earned by lenders or creditors purchasing commercial paper on the money market, the relevant provisions, i.e., Section 210 (b), were not

inserted in Title II of the 1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of the taxes in respect

of which Section 51 (e) authorized the imposition of surcharge and interest and Section 72 the imposition of a fraud surcharge.

It is not without reluctance that we reach the above conclusion on the basis of what may well have been an inadvertent error in legislative

draftsmanship, a type of error common enough during the period of Martial Law in our country. Nevertheless, we are compelled to adopt

this conclusion. We consider that the authority to impose what the present Tax Code calls (in Section 248) civil penalties consisting of

additions to the tax due, must be expressly given in the enabling statute, in language too clear to be mistaken. The grant of that authority is

not lightly to be assumed to have been made to administrative officials, even to one as highly placed as the Secretary of Finance.

The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the 1977 Tax Code did not authorize the

imposition of a surcharge and penalty interest for failure to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b)

of the same Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay all taxes imposed in the Tax

Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. Section 247 (a) of the

NIRC, as amended, reads:

Title X

Statutory Offenses and Penalties

Chapter I

Additions to the Tax

Sec. 247. General Provisions. — (a) The additions to the tax or deficiency tax prescribed in this Chapter shall apply to all

taxes, fees and charges imposed in this Code. The amount so added to the tax shall be collected at the same time, in the

same manner and as part of the tax. . . .

Sec. 248. Civil Penalties. — (a) There shall be imposed, in addition to the tax required to be paid, penalty equivalent to

twenty-five percent (25%) of the amount due, in the following cases:

xxx xxx xxx

(3) failure to pay the tax within the time prescribed for its payment; or

xxx xxx xxx

(c) the penalties imposed hereunder shall form part of the tax and the entire amount shall be subject to the interest

prescribed in Section 249.

Sec. 249. Interest. — (a) In General. — There shall be assessed and collected on any unpaid amount of tax, interest at the

rate of twenty percent (20%) per annum or such higher rate as may be prescribed by regulations, from the date prescribed

for payment until the amount is fully paid. . . . (Emphases supplied)

In other words, Section 247 (a) of the current NIRC supplies what did not exist back in 1977 when Picop's liability for the thirty-

five percent (35%) transaction tax became fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is

nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in 1985, was intended to be given retroactive

application by the legislative authority. 16

(3) Whether Picop is Liable

for Documentary and

Science Stamp Taxes.

As noted earlier, Picop issued sometime in 1977 long-term subordinated convertible debenture bonds with an aggregate face value of

P100,000,000.00. Picop stated, and this was not disputed by the CIR, that the proceeds of the debenture bonds were in fact utilized to

finance the BOI-registered operations of Picop. The CIR assessed documentary and science stamp taxes, amounting to P300,000.00, on the

issuance of Picop's debenture bonds. It is claimed by Picop that its tax exemption — "exemption from all taxes under the National Internal

Revenue Code, except income tax" on a declining basis over a certain period of time — includes exemption from the documentary and

science stamp taxes imposed under the NIRC.

The CIR, upon the other hand, stresses that the tax exemption under the Investment Incentives Act may be granted or recognized only to the

extent that the claimant Picop was engaged in registered operations, i.e., operations forming part of its integrated pulp and paper project. 17

The borrowing of funds from the public, in the submission of the CIR, was not an activity included in Picop's registered operations. The

CTA adopted the view of the CIR and held that "the issuance of convertible debenture bonds [was] not synonymous [with] the

manufactur[ing] operations of an integrated pulp and paper mill." 18

The Court of Appeals took a less rigid view of the ambit of the tax exemption granted to registered pioneer enterprises. Said the Court of

Appeals:

. . . PICOP's explanation that the debenture bonds were issued to finance its registered operation is logical and is

unrebutted. We are aware that tax exemptions must be applied strictly against the beneficiary in order to deter their abuse.

It would indeed be altogether a different matter if there is a showing that the issuance of the debenture bonds had no

bearing whatsoever on the registered operations PICOP and that they were issued in connection with a totally different

business undertaking of PICOP other than its registered operation. There is, however, a dearth of evidence in this regard.

It cannot be denied that PICOP needed funds for its operations. One of the means it used to raise said funds was to issue

debenture bonds. Since the money raised thereby was to be used in its registered operation, PICOP should enjoy the

incentives granted to it by R.A. 5186, one of which is the exemption from payment of all taxes under the National Internal

Revenue Code, except income taxes, otherwise the purpose of the incentives would be defeated. Documentary and science

stamp taxes on debenture bonds are certainly not income taxes. 19

(Emphasis supplied)

Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended beyond the ordinary and reasonable intendment

of the language actually used by the legislative authority in granting the exemption. The issuance of debenture bonds is certainly

conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or

regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or

other instruments to the general public. We consider that the actual dedication of the proceeds of the bonds to the carrying out of Picop's

registered operations constituted a sufficient nexus with such registered operations so as to exempt Picop from stamp taxes ordinarily

imposed upon or in connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this matter that the CTA and

the CIR had erred in rejecting Picop's claim for exemption from stamp taxes.

It remains only to note that after commencement of the present litigation before the CTA, the BIR took the position that the tax exemption

granted by R.A. No. 5186, as amended, does include exemption from documentary stamp taxes on transactions entered into by BOI-

registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a registered preferred pioneer enterprise engaged in

the manufacture of integrated circuits, magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary stamp taxes.

The Commissioner said:

You now request a ruling that as a preferred pioneer enterprise, you are exempt from the payment of Documentary Stamp

Tax (DST).

In reply, please be informed that your request is hereby granted. Pursuant to Section 46 (a) of Presidential Decree No.

1789, pioneer enterprises registered with the BOI are exempt from all taxes under the National Internal Revenue Code,

except from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment

is included in the Investment Priorities Plan to the following extent:

xxx xxx xxx

Accordingly, your company is exempt from the payment of documentary stamp tax to the extent of the percentage

aforestated on transactions connected with the registered business activity. (BIR Ruling No. 111-81) However, if said

transactions conducted by you require the execution of a taxable document with other parties, said parties who are not

exempt shall be the one directly liable for the tax. (Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other

words, said parties shall be liable to the same percentage corresponding to your tax exemption. (Emphasis supplied)

Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a registered pioneer enterprise producing

polyester filament yarn was entitled to exemption "from the documentary stamp tax on [its] sale of real property in Makati up to

December 31, 1989." It appears clear to the Court that the CIR, administratively at least, no longer insists on the position it

originally took in the instant case before the CTA.

II

(1) Whether Picop is entitled

to deduct against current

income interest payments

on loans for the purchase

of machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the purchase of machinery and equipment needed

for its operations. In its 1977 Income Tax Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these

loans as a deduction from its 1977 gross income.

The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the purchase of machinery and equipment,

the interest payments on those loans should have been capitalized instead and claimed as a depreciation deduction taking into account the

adjusted basis of the machinery and equipment (original acquisition cost plus interest charges) over the useful life of such assets.

Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed by Picop was proper

and allowable. In the instant Petition, the CIR insists on its original position.

We begin by noting that interest payments on loans incurred by a taxpayer (whether BOI-registered or not) are allowed by the NIRC as

deductions against the taxpayer's gross income. Section 30 of the 1977 Tax Code provided as follows:

Sec. 30. Deduction from Gross Income. — The following may be deducted from gross income:

(a) Expenses:

xxx xxx xxx

(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except on

indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt

from taxation as income under this Title: . . . (Emphasis supplied)

Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under

loans incurred in connection with the carrying on of the business of the taxpayer. 20

In the instant case, the CIR does not dispute

that the interest payments were made by Picop on loans incurred in connection with the carrying on of the registered operations of

Picop, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Picop. Neither

does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by

Picop during the tax year 1977.

The CIR has been unable to point to any provision of the 1977 Tax Code or any other Statute that requires the disallowance of the interest

payments made by Picop. The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows:

Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other purposes on account of capital or surplus

invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable

deduction from gross income. (Emphases supplied)

We read the above provision of Revenue Regulations No. 2 as referring to so called "theoretical interest," that is to say, interest

"calculated" or computed (and not incurred or paid) for the purpose of determining the "opportunity cost" of investing funds in a

given business. Such "theoretical" or imputed interest does not arise from a legally demandable interest-bearing obligation incurred

by the taxpayer who however wishes to find out, e.g., whether he would have been better off by lending out his funds and earning

interest rather than investing such funds in his business. One thing that Section 79 quoted above makes clear is that interest which

does constitute a charge arising under an interest-bearing obligation is an allowable deduction from gross income.

It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and

Carrying Charges Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph reads

as follows:

(B) Taxes and Carrying Charges. — The items thus chargeable to capital accounts are —

(11) In the case of real property, whether improved or unimproved and whether productive or nonproductive.

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds). 21

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be related to the relevant provisions of the U.S.

Internal Revenue Code, which provisions deal with the general topic of adjusted basis for determining allowable gain or loss on sales or

exchanges of property and allowable depreciation and depletion of capital assets of the taxpayer:

Present Rule. The Internal Revenue Code, and the Regulations promulgated thereunder provide that "No deduction shall

be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the

Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance

with such regulations, to treat such taxes or charges as so chargeable."

At the same time, under the adjustment of basis provisions which have just been discussed, it is provided that adjustment

shall be made for all "expenditures, receipts, losses, or other items" properly chargeable to a capital account, thus

including taxes and carrying charges; however, an exception exists, in which event such adjustment to the capital account

is not made, with respect to taxes and carrying charges which the taxpayer has not elected to capitalize but for which a

deduction instead has been taken. 22

(Emphasis supplied)

The "carrying charges" which may be capitalized under the above quoted provisions of the U.S. Internal Revenue Code include, as

the CIR has pointed out, interest on a loan "(but not theoretical interest of a taxpayer using his own funds)." What the CIR failed to

point out is that such "carrying charges" may, at the election of the taxpayer, either be (a) capitalized in which case the cost basis

of the capital assets, e.g., machinery and equipment, will be adjusted by adding the amount of such interest payments or

alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to deduct the interest payments against

its gross income, the taxpayer cannot at the same time capitalize the interest payments. In other words, the taxpayer is not entitled

to both the deduction from gross income and the adjusted (increased) basis for determining gain or loss and the allowable

depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction of interest on a loan obtained for purchasing

machinery and equipment against gross income, unless the taxpayer has also or previously capitalized the same interest payments

and thereby adjusted the cost basis of such assets.

We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and

equipment. Neither does our 1977 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent

on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on

a legally demandable loan are deductible from gross income must be applied.

The CIR argues finally that to allow Picop to deduct its interest payments against its gross income would be to encourage fraudulent claims

to double deductions from gross income:

[t]o allow a deduction of incidental expense/cost incurred in the purchase of fixed asset in the year it was incurred would

invite tax evasion through fraudulent application of double deductions from gross income. 23

(Emphases supplied)

The Court is not persuaded. So far as the records of the instant cases show, Picop has not claimed to be entitled to double

deduction of its 1977 interest payments. The CIR has neither alleged nor proved that Picop had previously adjusted its cost basis

for the machinery and equipment purchased with the loan proceeds by capitalizing the interest payments here involved. The Court

will not assume that the CIR would be unable or unwilling to disallow "a double deduction" should Picop, having deducted its

interest cost from its gross income, also attempt subsequently to adjust upward the cost basis of the machinery and equipment

purchased and claim, e.g., increased deductions for depreciation.

We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of Picop's 1977 interest payments on its loans for

capital equipment against its gross income for 1977.

(2) Whether Picop is entitled

to deduct against current

income net operating losses

incurred by Rustan Pulp

and Paper Mills, Inc.

On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan

Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC

were to be transferred, assigned and conveyed to Picop as the surviving corporation. The entire subscribed and outstanding capital stock of

RPPM and RMC would be exchanged for 2,891,476 fully paid up Class "A" common stock of Picop (with a par value of P10.00) and

149,848 shares of preferred stock of Picop (with a par value of P10.00), to be issued by Picop, the result being that Picop would wholly own

both RPPM and RMC while the stockholders of RPPM and RMC would join the ranks of Picop's shareholders. In addition, Picop paid off

the obligations of RPPM to the Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing 6,824,034

shares of preferred stock (with a par value of P10.00) to the DBP. The merger agreement was approved in 1977 by the creditors and

stockholders of Picop, RPPM and RMC and by the Securities and Exchange Commission. Thereupon, on 30 November 1977, apparently

the effective date of merger, RPPM and RMC were dissolved. The Board of Investments approved the merger agreement on 12 January

1978.

It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before merger effective date, RPPM had over

preceding years accumulated losses in the total amount of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00

of RPPM's accumulated losses as a deduction against Picop's 1977 gross income. 24

Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding shares of RMC stock to

San Miguel Corporation for the sum of P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. 25

In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186 which provides as follows:

Sec. 7. Incentives to Registered Enterprise. — A registered enterprise, to the extent engaged in a preferred area of

investment, shall be granted the following incentive benefits:

xxx xxx xxx

(c) Net Operating Loss Carry-over. — A net operating loss incurred in any of the first ten years of operations may be

carried over as a deduction from taxable income for the six years immediately following the year of such loss. The entire

amount of the loss shall be carried over to the first of the six taxable years following the loss, and any portion of such loss

which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next

remaining five years. The net operating loss shall be computed in accordance with the provisions of the National Internal

Revenue Code, any provision of this Act to the contrary notwithstanding, except that income not taxable either in whole or

in part under this or other laws shall be included in gross income. (Emphasis supplied)

Picop had secured a letter-opinion from the BOI dated 21 February 1977 — that is, after the date of the agreement of merger but

before the merger became effective — relating to the deductibility of the previous losses of RPPM under Section 7 (c) of R.A. No.

5186 as amended. The pertinent portions of this BOI opinion, signed by BOI Governor Cesar Lanuza, read as follows:

2) PICOP will not be allowed to carry over the losses of Rustan prior to the legal dissolution of the latter because at that

time the two (2) companies still had separate legal personalities;

3) After BOI approval of the merger, PICOP can no longer apply for the registration of the registered capacity of Rustan

because with the approved merger, such registered capacity of Rustan transferred to PICOP will have the same

registration date as that of Rustan. In this case, the previous losses of Rustan may be carried over by PICOP, because with

the merger, PICOP assumes all the rights and obligations of Rustan subject, however, to the period prescribed for

carrying over of such

losses. 26

(Emphasis supplied)

Curiously enough, Picop did not also seek a ruling on this matter, clearly a matter of tax law, from the Bureau of Internal Revenue.

Picop chose to rely solely on the BOI letter-opinion.

The CIR disallowed all the deductions claimed on the basis of RPPM's losses, apparently on two (2) grounds. Firstly, the previous losses

were incurred by "another taxpayer," RPPM, and not by Picop in connection with Picop's own registered operations. The CIR took the view

that Picop, RPPM and RMC were merged into one (1) corporate personality only on 12 January 1978, upon approval of the merger

agreement by the BOI. Thus, during the taxable year 1977, Picop on the one hand and RPPM and RMC on the other, still had their separate

juridical personalities. Secondly, the CIR alleged that these losses had been incurred by RPPM "from the borrowing of funds" and not from

carrying out of RPPM's registered operations. We focus on the first ground. 27

The CTA upheld the deduction claimed by Picop; its reasoning, however, is less than crystal clear, especially in respect of its view of what

the U.S. tax law was on this matter. In any event, the CTA apparently fell back on the BOI opinion of 21 February 1977 referred to above.

The CTA said:

Respondent further averred that the incentives granted under Section 7 of R.A. No. 5186 shall be available only to the

extent in which they are engaged in registered operations, citing Section 1 of Rule IX of the Basic Rules and Regulations

to Implement the Intent and Provisions of the Investment Incentives Act, R.A. No. 5186.

We disagree with respondent. The purpose of the merger was to rationalize the container board industry and not to take

advantage of the net losses incurred by RPPMI prior to the stock swap. Thus, when stock of a corporation is purchased in

order to take advantage of the corporation's net operating loss incurred in years prior to the purchase, the corporation

thereafter entering into a trade or business different from that in which it was previously engaged, the net operating loss

carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5, Mertens, Law of Federal Income Taxation, Chap.

29.11a, p. 103]. 28

Furthermore, once the BOI approved the merger agreement, the registered capacity of Rustan shall be

transferred to PICOP, and the previous losses of Rustan may be carried over by PICOP by operation of law. [BOI ruling

dated February 21, 1977 (Exh. J-1)] It is clear therefrom, that the deduction availed of under Section 7(c) of R.A. No.

5186 was only proper." (pp. 38-43, Rollo of SP No. 20070) 29

(Emphasis supplied)

In respect of the above underscored portion of the CTA decision, we must note that the CTA in fact overlooked the statement made

by petitioner's counsel before the CTA that:

Among the attractions of the merger to Picop was the accumulated net operating loss carry-over of RMC that it might

possibly use to relieve it (Picop) from its income taxes, under Section 7 (c) of R.A. 5186. Said section provides:

xxx xxx xxx

With this benefit in mind, Picop addressed three (3) questions to the BOI in a letter dated November 25, 1976. The BOI

replied on February 21, 1977 directly answering the three (3) queries. 30

(Emphasis supplied)

The size of RPPM's accumulated losses as of the date of the merger — more than P81,000,000.00 — must have constituted a

powerful attraction indeed for Picop.

The Court of Appeals followed the result reached by the CTA. The Court of Appeals, much like the CTA, concluded that since RPPM was

dissolved on 30 November 1977, its accumulated losses were appropriately carried over by Picop in the latter's 1977 Income Tax Return

"because by that time RPPMI and Picop were no longer separate and different taxpayers." 31

After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the

deductibility of RPPM's accumulated losses against Picop's 1977 gross income.

It is important to note at the outset that in our jurisdiction, the ordinary rule — that is, the rule applicable in respect of corporations not

registered with the BOI as a preferred pioneer enterprise — is that net operating losses cannot be carried over. Under our Tax Code, both in

1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are

deducted or charged off. Section 30 of the 1977 Tax Code provides:

Sec. 30. Deductions from Gross Income. — In computing net income, there shall be allowed as deduction —

xxx xxx xxx

(d) Losses:

(1) By Individuals. — In the case of an individual, losses actually sustained during the taxable year and not compensated

for by an insurance or otherwise —

(A) If incurred in trade or business;

xxx xxx xxx

(2) By Corporations. — In a case of a corporation, all losses actually sustained and charged off within the taxable year

and not compensated for by insurance or otherwise.

(3) By Non-resident Aliens or Foreign Corporations. — In the case of a non-resident alien individual or a foreign

corporation, the losses deductible are those actually sustained during the year incurred in business or trade conducted

within the Philippines, . . . 32

(Emphasis supplied)

Section 76 of the Philippine Income Tax Regulations (Revenue Regulation No. 2, as amended) is even more explicit and detailed:

Sec. 76. When charges are deductible. — Each year's return, so far as practicable, both as to gross income and deductions

therefrom should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts

necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of

a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within

any year deduct certain of his expenses, losses, interests, taxes, or other charges,

he can not deduct them from the income of the next or any succeeding year. . . .

xxx xxx xxx

. . . . If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior

taxable year which has not been deducted from gross income, he may render an amended return for such preceding

taxable year including such amount of loss in the deduction from gross income and may in proper cases file a claim for

refund of the excess paid by reason of the failure to deduct such loss in the original return. A loss from theft or

embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained.

(Emphases supplied)

It is thus clear that under our law, and outside the special realm of BOI-registered enterprises, there is no such thing as a carry-over

of net operating loss. To the contrary, losses must be deducted against current income in the taxable year when such losses were

incurred. Moreover, such losses may be charged off only against income earned in the same taxable year when the losses were

incurred.

Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered

pioneer enterprises and only with respect to their registered operations. The statutory purpose here may be seen to be the encouragement of

the establishment and continued operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses

which may be expected during the early years of the enterprise and to permit the enterprise to offset such losses against income earned by it

in later years after successful establishment and regular operations. To promote its economic development goals, the Republic foregoes or

defers taxing the income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We consider that the

statutory purpose can be served only if the accumulated operating losses are carried over and charged off against income subsequently

earned and accumulated by the same enterprise engaged in the same registered operations.

In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the

operating losses accumulated by another corporation or enterprise, RPPM. RPPM far from benefiting from the tax incentive granted by the

BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the much larger group of Picop's

stockholders. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which

Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In

effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated

operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from

taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM.

Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same

registered operations which earlier had sustained losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186

which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be

projected by Section 7 (c), R.A. No. 5186.

The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating losses against Picop's 1977 gross income,

basically because towards the end of the taxable year 1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop,

remained. The losses suffered by RPPM's registered operations and the gross income generated by Picop's own registered operations now

came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not

believe that that single purely technical factor is enough to authorize and justify the deduction claimed by Picop. Picop's claim for deduction

is not only bereft of statutory basis; it does violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of

R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss carry-over to BOI-registered pioneer enterprises,

the legislature could not have intended to require the Republic to forego tax revenues in order to benefit a corporation which had run no

risks and suffered no losses, but had merely purchased another's losses.

Both the CTA and the Court of Appeals appeared much impressed not only with corporate technicalities but also with the U.S. tax law on

this matter. It should suffice, however, simply to note that in U.S. tax law, the availability to companies generally of operating loss carry-

overs and of operating loss carry-backs is expressly provided and regulated in great detail by statute. 33

In our jurisdiction, save for Section

7 (c) of R.A. No. 5186, no statute recognizes or permits loss carry-overs and loss carry-backs. Indeed, as already noted, our tax law

expressly rejects the very notion of loss carry-overs and carry-backs.

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

(3) Whether Picop is entitled

to deduct against current

income certain claimed

financial guarantee expenses.

In its Income Tax Return for 1977, Picop also claimed a deduction in the amount of P1,237,421.00 as financial guarantee expenses.

This deduction is said to relate to chattel and real estate mortgages required from Picop by the Philippine National Bank ("PNB") and DBP

as guarantors of loans incurred by Picop from foreign creditors. According to Picop, the claimed deduction represents registration fees and

other expenses incidental to registration of mortgages in favor of DBP and PNB.

In support of this claimed deduction, Picop allegedly showed its own vouchers to BIR Examiners to prove disbursements to the Register of

Deeds of Tandag, Surigao del Sur, of particular amounts. In the proceedings before the CTA, however, Picop did not submit in evidence

such vouchers and instead presented one of its employees to testify that the amount claimed had been disbursed for the registration of

chattel and real estate mortgages.

The CIR disallowed this claimed deduction upon the ground of insufficiency of evidence. This disallowance was sustained by the CTA and

the Court of Appeals. The CTA said:

No records are available to support the abovementioned expenses. The vouchers merely showed that the amounts were

paid to the Register of Deeds and simply cash account. Without the supporting papers such as the invoices or official

receipts of the Register of Deeds, these vouchers standing alone cannot prove that the payments made were for the

accrued expenses in question. The best evidence of payment is the official receipts issued by the Register of Deeds. The

testimony of petitioner's witness that the official receipts and cash vouchers were shown to the Bureau of Internal

Revenue will not suffice if no records could be presented in court for proper marking and identification. 34

Emphasis

supplied)

The Court of Appeals added:

The mere testimony of a witness for PICOP and the cash vouchers do not suffice to establish its claim that registration

fees were paid to the Register of Deeds for the registration of real estate and chattel mortgages in favor of Development

Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The witness could very well

have been merely repeating what he was instructed to say regardless of the truth, while the cash vouchers, which we do

not find on file, are not said to provide the necessary details regarding the nature and purpose of the expenses reflected

therein. PICOP should have presented, through the guarantors, its owner's copy of the registered titles with the lien

inscribed thereon as well as an official receipt from the Register of Deeds evidencing payment of the registration fee. 35

(Emphasis supplied)

We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has the burden of proving entitlement to a

claimed deduction. 36

In the instant case, even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that

such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not

necessarily the purpose thereof. 37

The best evidence that Picop should have presented to support its claimed deduction were the invoices

and official receipts issued by the Register of Deeds. Picop not only failed to present such documents; it also failed to explain the loss

thereof, assuming they had existed before. 38

Under the best evidence rule, 39

therefore, the testimony of Picop's employee was inadmissible

and was in any case entitled to very little, if any, credence.

We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not adequately shown and that such deduction must be

disallowed.

III

(1) Whether Picop had understated

its sales and overstated its

cost of sales for 1977.

In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had understated its sales by P2,391,644.00 and, upon the

other hand, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its own

return.

The 1977 Income Tax Return of Picop set forth the following figures:

Sales (per Picop's Income Tax Return):

Paper P 537,656,719.00

Timber P 263,158,132.00

———————

Total Sales P 800,814,851.00

============

Upon the other hand, Picop's Books of Accounts reflected higher sales figures:

Sales (per Picop's Books of Accounts):

Paper P 537,656,719.00

Timber P 265,549,776.00

———————

Total Sales P 803,206,495.00

============

The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures

reported in its 1977 Income Tax Return, amounting to: P2,391,644.00.

The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when compared with the cost figures in its Books

of Accounts, was overstated:

Cost of Sales

(per Income Tax Return) P607,246,084.00

Cost of Sales

(per Books of Accounts) P606,642,066.00

———————

Discrepancy P 604,018.00

============

Picop did not deny the existence of the above noted discrepancies. In the proceedings before the CTA, Picop presented one of its officials to

explain the foregoing discrepancies. That explanation is perhaps best presented in Picop's own words as set forth in its Memorandum before

this Court:

. . . that the adjustment discussed in the testimony of the witness, represent the best and most objective method of

determining in pesos the amount of the correct and actual export sales during the year. It was this correct and actual export

sales and costs of sales that were reflected in the income tax return and in the audited financial statements. These

corrections did not result in realization of income and should not give rise to any deficiency tax.

xxx xxx xxx

What are the facts of this case on this matter? Why were adjustments necessary at the year-end?

Because of PICOP's procedure of recording its export sales (reckoned in U.S. dollars) on the basis of a fixed rate, day to

day and month to month, regardless of the actual exchange rate and without waiting when the actual proceeds are

received. In other words, PICOP recorded its export sales at a pre-determined fixed exchange rate. That pre-determined

rate was decided upon at the beginning of the year and continued to be used throughout the year.

At the end of the year, the external auditors made an examination. In that examination, the auditors determined with

accuracy the actual dollar proceeds of the export sales received. What exchange rate was used by the auditors to convert

these actual dollar proceeds into Philippine pesos? They used the average of the differences between (a) the recorded

fixed exchange rate and (b) the exchange rate at the time the proceeds were actually received. It was this rate at time of

receipt of the proceeds that determined the amount of pesos credited by the Central Bank (through the agent banks) in

favor of PICOP. These accumulated differences were averaged by the external auditors and this was what was used at the

year-end for income tax and other government-report purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40

The above explanation, unfortunately, at least to the mind of the Court, raises more questions than it resolves. Firstly, the explanation

assumes that all of Picop's sales were export sales for which U.S. dollars (or other foreign exchange) were received. It also assumes that the

expenses summed up as "cost of sales" were all dollar expenses and that no peso expenses had been incurred. Picop's explanation further

assumes that a substantial part of Picop's dollar proceeds for its export sales were not actually surrendered to the domestic banking system

and seasonably converted into pesos; had all such dollar proceeds been converted into pesos, then the peso figures could have been simply

added up to reflect the actual peso value of Picop's export sales. Picop offered no evidence in respect of these assumptions, no explanation

why and how a "pre-determined fixed exchange rate" was chosen at the beginning of the year and maintained throughout. Perhaps more

importantly, Picop was unable to explain why its Books of Accounts did not pick up the same adjustments that Picop's External Auditors

were alleged to have made for purposes of Picop's Income Tax Return. Picop attempted to explain away the failure of its Books of Accounts

to reflect the same adjustments (no correcting entries, apparently) simply by quoting a passage from a case where this Court refused to

ascribe much probative value to the Books of Accounts of a corporate taxpayer in a tax case. 41

What appears to have eluded Picop,

however, is that its Books of Accounts, which are kept by its own employees and are prepared under its control and supervision, reflect

what may be deemed to be admissions against interest in the instant case. For Picop's Books of Accounts precisely show higher sales

figures and lower cost of sales figures than Picop's Income Tax Return.

It is insisted by Picop that its Auditors' adjustments simply present the "best and most objective" method of reflecting in pesos the "correct

and ACTUAL export sales" 42

and that the adjustments or "corrections" "did not result in realization of [additional] income and should not

give rise to any deficiency tax." The correctness of this contention is not self-evident. So far as the record of this case shows, Picop did not

submit in evidence the aggregate amount of its U.S. dollar proceeds of its export sales; neither did it show the Philippine pesos it had

actually received or been credited for such U.S. dollar proceeds. It is clear to this Court that the testimonial evidence submitted by Picop fell

far short of demonstrating the correctness of its explanation.

Upon the other hand, the CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as

set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as

already noted, they embody what must appear to be admissions against Picop's own interest.

Accordingly, we must affirm the findings of the Court of Appeals and the CTA.

(2) Whether Picop is liable for

the corporate development

tax of five percent (5%)

of its income for 1977.

The five percent (5%) corporate development tax is an additional corporate income tax imposed in Section 24 (e) of the 1977 Tax Code

which reads in relevant part as follows:

(e) Corporate development tax. — In addition to the tax imposed in subsection (a) of this section, an additional tax in an

amount equivalent to 5 per cent of the same taxable net income shall be paid by a domestic or a resident foreign

corporation; Provided, That this additional tax shall be imposed only if the net income exceeds 10 per cent of the net

worth, in case of a domestic corporation, or net assets in the Philippines in case of a resident foreign corporation: . . . .

The additional corporate income tax imposed in this subsection shall be collected and paid at the same time and in the

same manner as the tax imposed in subsection (a) of this section.

Since this five percent (5%) corporate development tax is an income tax, Picop is not exempted from it under the provisions of

Section 8 (a) of R.A. No. 5186.

For purposes of determining whether the net income of a corporation exceeds ten percent (10%) of its net worth, the term "net worth" means

the stockholders' equity represented by the excess of the total assets over liabilities as reflected in the corporation's balance sheet provided

such balance sheet has been prepared in accordance with generally accepted accounting principles employed in keeping the books of the

corporation. 43

The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as

reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent

(10%) of its net worth, Picop must be held liable for the five percent (5%) corporate development tax in the amount of P2,434,367.75.

Recapitulating, we hold:

(1) Picop is liable for the thirty-five percent (35%) transaction tax in the amount of P3,578,543.51.

(2) Picop is not liable for interest and surcharge on unpaid transaction tax.

(3) Picop is exempt from payment of documentary and science stamp taxes in the amount of P300,000.00 and the compromise penalty of

P300.00.

(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans for, among other things, the purchase of

machinery and equipment.

(5) Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses previously incurred by RPPM, is disallowed for lack

of merit.

(6) Picop's claimed deduction for certain financial guarantee expenses in the amount P1,237,421.00 is disallowed for failure adequately to

prove such expenses.

(7) Picop has understated its sales by P2,391,644.00 and overstated its cost of sales by P604,018.00, for 1977.

(8) Picop is liable for the corporate development tax of five percent (5%) of its adjusted net income for 1977 in the amount of

P2,434,367.75.

Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for deficiency income tax for the year 1977

computed as follows:

Deficiency Income Tax

Net Income Per Return P 258,166.00

Add:

Unallowable Deductions

(1) Deduction of net

operating losses

incurred by RPPM P 44,196,106.00

(2) Unexplained financial

guarantee expenses P 1,237,421.00

(3) Understatement of

Sales P 2,391,644.00

(4) Overstatement of

Cost of Sales P 604,018.00

——————

Total P 48,429,189.00

——————

Net Income as Adjusted P 48,687,355.00

===========

Income Tax Due Thereon 44

P 17,030,574.00

Less:

Tax Already Assessed per

Return 80,358.00

——————

Deficiency Income Tax P 16,560,216.00

Add:

Five percent (5%) Corporate

Development Tax P 2,434,367.00

Total Deficiency Income Tax P 18,994,583.00

===========

Add:

Five percent (5%) surcharge 45

P 949,729.15

——————

Total Deficiency Income Tax

with surcharge P 19,944,312.15

Add:

Fourteen percent (14%)

interest from 15 April

1978 to 14 April 1981 46

P 8,376,610.80

Fourteen percent (14%)

interest from 21 April

1983 to 20 April 1986 47

P 11,894,787.00

——————

Total Deficiency Income Tax

Due and Payable P 40,215,709.00

===========

WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay the

CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1) Thirty-five percent (35%)

transaction tax P 3,578,543.51

(2) Total Deficiency Income

Tax Due 40,215,709.00

———————

Aggregate Amount Due and Payable P 43,794,252.51

============

No pronouncement as to costs.

SO ORDERED.

THE COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

CONSUELO L. VDA. DE PRIETO, respondent.

Office of the Solicitor General Edilberto Barot, Solicitor F.R. Rosete and Special Atty. B. Gatdula, Jr. for petitioner.

Formilleza and Latorre for respondent.

GUTIERREZ DAVID, J.:

This is an appeal from a decision of the Court of tax Appeals reversing the decision of the Commissioner of Internal Revenue which held

herein respondent Consuelo L. Vda. de Prieto liable for the payment of the sum of P21,410.38 as deficiency income tax, plus penalties and

monthly interest.

The case was submitted for decision in the court below upon a stipulation of facts, which for brevity is summarized as follows: On

December 4, 1945, the respondent conveyed by way of gifts to her four children, namely, Antonio, Benito, Carmen and Mauro, all

surnamed Prieto, real property with a total assessed value of P892,497.50. After the filing of the gift tax returns on or about February 1,

1954, the petitioner Commissioner of Internal Revenue appraised the real property donated for gift tax purposes at P1,231,268.00, and

assessed the total sum of P117,706.50 as donor's gift tax, interest and compromises due thereon. Of the total sum of P117,706.50 paid by

respondent on April 29, 1954, the sum of P55,978.65 represents the total interest on account of deliquency. This sum of P55,978.65 was

claimed as deduction, among others, by respondent in her 1954 income tax return. Petitioner, however, disallowed the claim and as a

consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid

P55,978.65, including interest up to March 31, 1957, surcharge and compromise for the late payment.

Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that

what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by

respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be declared. The

only question to be determined, as stated by the parties, is whether or not such interest was paid upon an indebtedness within the

contemplation of section 30 (b) (1) of the Tax Code, the pertinent part of which reads:

SEC. 30 Deductions from gross income. — In computing net income there shall be allowed as deductions —

x x x x x x x x x

(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or

continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title.

The term "indebtedness" as used in the Tax Code of the United States containing similar provisions as in the above-quoted section has been

defined as an unconditional and legally enforceable obligation for the payment of money.1awphîl.nèt (Federal Taxes Vol. 2, p. 13,019,

Prentice-Hall, Inc.; Merten's Law of Federal Income Taxation, Vol. 4, p. 542.) Within the meaning of that definition, it is apparent that a tax

may be considered an indebtedness. As stated by this Court in the case of Santiago Sambrano vs. Court of Tax Appeals and Collector of

Internal Revenue (101 Phil., 1; 53 Off. Gaz., 4839) —

Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be

considered as such.

The term "debt" is properly used in a comprehensive sense as embracing not merely money due by contract but whatever one is

bound to render to another, either for contract, or the requirement of the law. (Camben vs. Fink Coule and Coke Co. 61 LRA 584)

Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt. (Idem).

A tax is a debt for which a creditor's bill may be brought in a proper case. (State vs. Georgia Co., 19 LRA 485).

It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under

section 30(b) of the Tax Code above quoted.

The above conclusion finds support in the established jurisprudence in the United States after whose laws our Income Tax Law has been

patterned. Thus, under sec. 23(b) of the Internal Revenue Code of 1939, as amended 1

, which contains similarly worded provisions as sec.

30(b) of our Tax Code, the uniform ruling is that interest on taxes is interest on indebtedness and is deductible. (U.S. vs. Jaffray, 306 U.S.

276. See also Lustig vs. U.S., 138 F. Supp. 870; Commissioner of Internal Revenue vs. Bryer, 151 F. 2d 267, 34 AFTR 151; Penrose vs.

U.S. 18 F. Supp. 413, 18 AFTR 1289; Max Thomas Davis, et al. vs. Commissioner of Internal Revenue, 46 U.S. Boared of Tax Appeals

Reports, p. 663, citing U.S. vs. Jaffray, 6 Tax Court of United States Reports, p. 255; Armour vs. Commissioner of Internal Revenue, 6 Tax

Court of the United States Reports, p. 359; The Koppers Coal Co. vs. Commissioner of Internal Revenue, 7 Tax Court of United States

Reports, p. 1209; Toy vs. Commissioner of Internal Revenue; Lucas vs. Comm., 34 U.S. Board of Tax Appeals Reports, 877; Evens and

Howard Fire Brick Co. vs. Commissioner of Internal Revenue, 3 Tax Court of United States Reports, p. 62). The rule applies even though

the tax is nondeductible. (Federal Taxes, Vol. 2, Prentice Hall, sec. 163, 13,022; see also Merten's Law of Federal Income Taxation, Vol. 5,

pp. 23-24.)

To sustain the proposition that the interest payment in question is not deductible for the purpose of computing respondent's net income,

petitioner relies heavily on section 80 of Revenue Regulation No. 2 (known as Income Tax Regulation) promulgated by the Department of

Finance, which provides that "the word `taxes' means taxes proper and no deductions should be allowed for amounts representing interest,

surcharge, or penalties incident to delinquency." The court below, however, held section 80 as inapplicable to the instant case because while

it implements sections 30(c) of the Tax Code governing deduction of taxes, the respondent taxpayer seeks to come under section 30(b) of

the same Code providing for deduction of interest on indebtedness. We find the lower court's ruling to be correct. Contrary to petitioner's

belief, the portion of section 80 of Revenue Regulation No. 2 under consideration has been part and parcel of the development to the law on

deduction of taxes in the United States. (See Capital Bldg. and Loan Assn. vs. Comm., 23 BTA 848. Thus, Mertens in his treatise says:

"Penalties are to be distinguished from taxes and they are not deductible under the heading of taxs." . . . Interest on state taxes is not

deductible as taxes." (Vol. 5, Law on Federal Income Taxation, pp. 22-23, sec. 27.06, citing cases.) This notwithstanding, courts in that

jurisdiction, however, have invariably held that interest on deficiency taxes are deductible, not as taxes, but as interest. (U.S. vs. Jaffray, et

al., supra; see also Mertens, sec. 26.09, Vol. 4, p. 552, and cases cited therein.) Section 80 of Revenue Regulation No. 2, therefore, merely

incorporated the established application of the tax deduction statute in the United States, where deduction of "taxes" has always been

limited to taxes proper and has never included interest on delinquent taxes, penalties and surcharges.

To give to the quoted portion of section 80 of our Income Tax Regulations the meaning that the petitioner gives it would run counter to the

provision of section 30(b) of the Tax Code and the construction given to it by courts in the United States. Such effect would thus make the

regulation invalid for a "regulation which operates to create a rule out of harmony with the statute, is a mere nullity." (Lynch vs. Tilden

Produce Co., 265 U.S. 315; Miller vs. U.S., 294 U.S. 435.) As already stated, section 80 implements only section 30(c) of the Tax Code, or

the provision allowing deduction of taxes, while herein respondent seeks to be allowed deduction under section 30(b), which provides for

deduction of interest on indebtedness.

In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not deductible as tax under Section

30(c) of the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest

payment as deduction under section 30(b) of the same Code.

In view of the foregoing, the decision sought to be reviewed is affirmed, without pronouncement as to costs.

COMMISSIONER OF INTERNAL REVENUES, petitioner,

vs.

V.E. LEDNICKY and MARIA VALERO LEDNICKY, respondents.

Office of the Solicitor General for petitioner.

Ozaeta, Gibbs and Ozaeta for respondents.

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

The above-captioned cases were elevated to this Court under separate petitions by the Commissioner for review of the corresponding

decisions of the Court of Tax Appeals. Since these cases involve the same parties and issues akin to each case presented, they are herein

decided jointly.

The respondents, V. E. Lednicky and Maria Valero Lednicky, are husband and wife, respectively, both American citizens residing in the

Philippines, and have derived all their income from Philippine sources for the taxable years in question.

In compliance with local law, the aforesaid respondents, on 27 March 1957, filed their income tax return for 1956, reporting therein a gross

income of P1,017,287. 65 and a net income of P733,809.44 on which the amount of P317,395.4 was assessed after deducting P4,805.59 as

withholding tax. Pursuant to the petitioner's assessment notice, the respondents paid the total amount of P326,247.41, inclusive of the

withheld taxes, on 15 April 1957.

On 17 March 1959, the respondents Lednickys filed an amended income tax return for 1956. The amendment consists in a claimed

deduction of P205,939.24 paid in 1956 to the United States government as federal income tax for 1956. Simultaneously with the filing of

the amended return, the respondents requested the refund of P112,437.90.

When the petitioner Commissioner of Internal Revenue failed to answer the claim for refund, the respondents filed their petition with the

Tax Court on 11 April 1959 as CTA Case No. 646, which is now G. R. No. L-18286 in the Supreme Court.

G. R. No. L-18169 (formerly CTA Case No. 570) is also a claim for refund in the amount of P150,269.00, as alleged overpaid income tax

for 1955, the facts of which are as follows:

On 28 February 1956, the same respondents-spouses filed their domestic income tax return for 1955, reporting a gross income of

P1,771,124.63 and a net income of P1,052,550.67. On 19 April 1956, they filed an amended income tax return, the amendment upon the

original being a lesser net income of P1,012,554.51, and, on the basis of this amended return, they paid P570,252.00, inclusive of

withholding taxes. After audit, the petitioner determined a deficiency of P16,116.00, which amount, the respondents paid on 5 December

1956.

Back in 1955, however, the Lednickys filed with the U.S. Internal Revenue Agent in Manila their federal income tax return for the years

1947, 1951, 1952, 1953, and 1954 on income from Philippine sources on a cash basis. Payment of these federal income taxes, including

penalties and delinquency interest in the amount of P264,588.82, were made in 1955 to the U.S. Director of Internal Revenue, Baltimore,

Maryland, through the National City Bank of New York, Manila Branch. Exchange and bank charges in remitting payment totaled

P4,143.91.

Wherefore, the parties respectfully pray that the foregoing stipulation of facts be admitted and approved by this Honorable Court, without

prejudice to the parties adducing other evidence to prove their case not covered by this stipulation of facts. 1äwphï1.ñët

On 11 August 1958, the said respondents amended their Philippine income tax return for 1955 to include the following deductions:

U.S. Federal income taxes P471,867.32

Interest accrued up to May 15, 1955 40,333.92

Exchange and bank charges 4,143.91

T o t a l

P516,345.15

and therewith filed a claim for refund of the sum of P166,384.00, which was later reduced to P150,269.00.

The respondents Lednicky brought suit in the Tax Court, which was docketed therein as CTA Case No. 570.

In G. R. No. 21434 (CTA Case No. 783), the facts are similar, but refer to respondents Lednickys' income tax return for 1957, filed on 28

February 1958, and for which respondents paid a total sum of P196,799.65. In 1959, they filed an amended return for 1957, claiming

deduction of P190,755.80, representing taxes paid to the U.S. Government on income derived wholly from Philippine sources. On the

strength thereof, respondents seek refund of P90 520.75 as overpayment. The Tax Court again decided for respondents.

The common issue in all three cases, and one that is of first impression in this jurisdiction, is whether a citizen of the United States residing

in the Philippines, who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the

income taxes he has paid to the United States government for the taxable year on the strength of section 30 (C-1) of the Philippine Internal

Revenue Code, reading as follows:

SEC. 30. Deduction from gross income. — In computing net income there shall be allowed as deductions —

(a) ...

(b) ...

(c) Taxes:

(1) In general. — Taxes paid or accrued within the taxable year, except —

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but

this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to

have to any extent the benefits of paragraph (3) of this subsection (relating to credit for foreign

countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property

assessed. (Emphasis supplied)

The Tax Court held that they may be deducted because of the undenied fact that the respondent spouses did not "signify" in their

income tax return a desire to avail themselves of the benefits of paragraph 3 (B) of the subsection, which reads:

Par. (c) (3) Credits against tax for taxes of foreign countries. — If the taxpayer signifies in his return his desire to have

the benefits of this paragraph, the tax imposed by this Title shall be credited with —

(A) ...;

(B) Alien resident of the Philippines. — In the case of an alien resident of the Philippines, the amount of any

such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such

alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the Philippines

residing in such country;

It is well to note that the tax credit so authorized is limited under paragraph 4 (A and B) of the same subsection, in the following

terms:

Par. (c) (4) Limitation on credit. — The amount of the credit taken under this section shall be subject to each of the

following limitations:

(A) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same

proportion of the tax against which such credit is taken, which the taxpayer's net income from sources within

such country taxable under this Title bears to his entire net income for the same taxable year; and

(B) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is

taken, which the taxpayer's net income from sources without the Philippines taxable under this Title bears to his

entire net income for the same taxable year.

We agree with appellant Commissioner that the Construction and wording of Section 30 (c) (1) (B) of the Internal

Revenue Act shows the law's intent that the right to deduct income taxes paid to foreign government from the taxpayer's

gross income is given only as an alternative or substitute to his right to claim a tax credit for such foreign income taxes

under section 30 (c) (3) and (4); so that unless the alien resident has a right to claim such tax credit if he so chooses, he is

precluded from deducting the foreign income taxes from his gross income. For it is obvious that in prescribing that such

deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the

benefits of paragraph (3) (relating to credits for taxes paid to foreign countries), the statute assumes that the taxpayer in

question also may signify his desire to claim a tax credit and waive the deduction; otherwise, the foreign taxes would

always be deductible, and their mention in the list of non-deductible items in Section 30(c) might as well have been

omitted, or at least expressly limited to taxes on income from sources outside the Philippine Islands.

Had the law intended that foreign income taxes could be deducted from gross income in any event, regardless of the

taxpayer's right to claim a tax credit, it is the latter right that should be conditioned upon the taxpayer's waiving the

deduction; in which Case the right to reduction under subsection (c-1-B) would have been made absolute or unconditional

(by omitting foreign taxes from the enumeration of non-deductions), while the right to a tax credit under subsection (c-3)

would have been expressly conditioned upon the taxpayer's not claiming any deduction under subsection (c-1). In other

words, if the law had been intended to operate as contended by the respondent taxpayers and by the Court of Tax Appeals

section 30 (subsection (c-1) instead of providing as at present:

SEC. 30. Deduction from gross income. — In computing net income there shall be allowed as deductions —

(a) ...

(b) ...

(c) Taxes:

(1) In general. — Taxes paid or accrued within the taxable year, except —

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed by the authority of any foreign country; but

this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to

have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign

countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property

assessed.

would have merely provided:

SEC. 30. Decision from grow income. — In computing net income there shall be allowed as deductions:

(a) ...

(b) ...

(c) Taxes paid or accrued within the taxable year, EXCEPT —

(A) The income tax provided for in this Title;

(B) Omitted or else worded as follows:

Income, war profits and excess profits taxes imposed by authority of any foreign country on income earned within the

Philippines if the taxpayer does not claim the benefits under paragraph 3 of this subsection;

(C) Estate, inheritance or gift taxes;

(D) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

while subsection (c-3) would have been made conditional in the following or equivalent terms:

(3) Credits against tax for taxes of foreign countries. — If the taxpayer has not deducted such taxes from his gross income but

signifies in his return his desire to have the benefits of this paragraph, the tax imposed by Title shall be credited with ... (etc.).

Petitioners admit in their brief that the purpose of the law is to prevent the taxpayer from claiming twice the benefits of his payment of

foreign taxes, by deduction from gross income (subs. c-1) and by tax credit (subs. c-3). This danger of double credit certainly can not exist

if the taxpayer can not claim benefit under either of these headings at his option, so that he must be entitled to a tax credit (respondent

taxpayers admittedly are not so entitled because all their income is derived from Philippine sources), or the option to deduct from gross

income disappears altogether.

Much stress is laid on the thesis that if the respondent taxpayers are not allowed to deduct the income taxes they are required to pay to the

government of the United States in their return for Philippine income tax, they would be subjected to double taxation. What respondents fail

to observe is that double taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same governmental entity

(cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the

taxpayers would have to pay two taxes on the same income, the Philippine government only receives the proceeds of one tax. As between

the Philippines, where the income was earned and where the taxpayer is domiciled, and the United States, where that income was not earned

and where the taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income should accrue to the

benefit of the Philippines. Any relief from the alleged double taxation should come from the United States, and not from the Philippines,

since the former's right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production of the wealth

that is being taxed.

Aside from not conforming to the fundamental doctrine of income taxation that the right of a government to tax income emanates from its

partnership in the production of income, by providing the protection, resources, incentive, and proper climate for such production, the

interpretation given by the respondents to the revenue law provision in question operates, in its application, to place a resident alien with

only domestic sources of income in an equal, if not in a better, position than one who has both domestic and foreign sources of income, a

situation which is manifestly unfair and short of logic.

Finally, to allow an alien resident to deduct from his gross income whatever taxes he pays to his own government amounts to conferring on

the latter the power to reduce the tax income of the Philippine government simply by increasing the tax rates on the alien resident.

Everytime the rate of taxation imposed upon an alien resident is increased by his own government, his deduction from Philippine taxes

would correspondingly increase, and the proceeds for the Philippines diminished, thereby subordinating our own taxes to those levied by a

foreign government. Such a result is incompatible with the status of the Philippines as an independent and sovereign state.

IN VIEW OF THE FOREGOING, the decisions of the Court of Tax Appeals are reversed, and, the disallowance of the refunds claimed by

the respondents Lednicky is affirmed, with costs against said respondents-appellees.

PHILEX MINING CORPORATION, petitioner,

vs.

COMMISSIONER OF INTERNAL REVENUE, respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

This is a petition for review on certiorari of the June 30, 2000 Decision1 of the Court of Appeals in CA-G.R. SP No. 49385, which affirmed

the Decision2 of the Court of Tax Appeals in C.T.A. Case No. 5200. Also assailed is the April 3, 2001 Resolution

3 denying the motion for

reconsideration.

The facts of the case are as follows:

On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an agreement4 with Baguio Gold Mining Company

("Baguio Gold") for the former to manage and operate the latter‘s mining claim, known as the Sto. Nino mine, located in Atok and Tublay,

Benguet Province. The parties‘ agreement was denominated as "Power of Attorney" and provided for the following terms:

4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available to the MANAGERS (Philex

Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from time to time may be required by the

MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN

MILLION PESOS (P11,000,000.00) shall be deemed, for internal audit purposes, as the owner‘s account in the Sto. Nino

PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino PROJECT,

shall be added to such owner‘s account.

5. Whenever the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO. NINO

MINE, they may transfer their own funds or property to the Sto. Nino PROJECT, in accordance with the following arrangements:

(a) The properties shall be appraised and, together with the cash, shall be carried by the Sto. Nino PROJECT as a special

fund to be known as the MANAGERS‘ account.

(b) The total of the MANAGERS‘ account shall not exceed P11,000,000.00, except with prior approval of the

PRINCIPAL; provided, however, that if the compensation of the MANAGERS as herein provided cannot be paid in cash

from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to the MANAGERS‘ account.

(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino PROJECT until termination of this

Agency.

(d) The MANAGERS‘ account shall not accrue interest. Since it is the desire of the PRINCIPAL to extend to the

MANAGERS the benefit of subsequent appreciation of property, upon a projected termination of this Agency, the ratio

which the MANAGERS‘ account has to the owner‘s account will be determined, and the corresponding proportion of the

entire assets of the STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that such

transferred assets shall not include mine development, roads, buildings, and similar property which will be valueless, or of

slight value, to the MANAGERS. The MANAGERS can, on the other hand, require at their option that property originally

transferred by them to the Sto. Nino PROJECT be re-transferred to them. Until such assets are transferred to the

MANAGERS, this Agency shall remain subsisting.

x x x x

12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the Sto. Nino PROJECT before income

tax. It is understood that the MANAGERS shall pay income tax on their compensation, while the PRINCIPAL shall pay income

tax on the net profit of the Sto. Nino PROJECT after deduction therefrom of the MANAGERS‘ compensation.

x x x x

16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the future, may incur other obligations

in favor of the MANAGERS. This Power of Attorney has been executed as security for the payment and satisfaction of all such

obligations of the PRINCIPAL in favor of the MANAGERS and as a means to fulfill the same. Therefore, this Agency shall be

irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS‘

account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been paid and satisfied in full, this Agency

shall be revocable by the PRINCIPAL upon 36-month notice to the MANAGERS.

17. Notwithstanding any agreement or understanding between the PRINCIPAL and the MANAGERS to the contrary, the

MANAGERS may withdraw from this Agency by giving 6-month notice to the PRINCIPAL. The MANAGERS shall not in any

manner be held liable to the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d) hereof shall be operative in case of

the MANAGERS‘ withdrawal.

x x x x5

In the course of managing and operating the project, Philex Mining made advances of cash and property in accordance with paragraph 5 of

the agreement. However, the mine suffered continuing losses over the years which resulted to petitioner‘s withdrawal as manager of the

mine on January 28, 1982 and in the eventual cessation of mine operations on February 20, 1982.6

Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in Payment"7 wherein Baguio Gold admitted an

indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio Gold‘s

tangible assets to petitioner, transferring to the latter Baguio Gold‘s equitable title in its Philodrill assets and finally settling the remaining

liability through properties that Baguio Gold may acquire in the future.

On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in Payment"8 where the parties determined that

Baguio Gold‘s indebtedness to petitioner actually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other

creditors that petitioner had assumed as guarantor. These liabilities pertained to long-term loans amounting to US$11,000,000.00 contracted

by Baguio Gold from the Bank of America NT & SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two

segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its Philodrill assets for

P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding indebtedness to petitioner in the amount of

P114,996,768.00.

Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding indebtedness of Baguio Gold by charging

P112,136,000.00 to allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982 operations.

In its 1982 annual income tax return, petitioner deducted from its gross income the amount of P112,136,000.00 as "loss on settlement of

receivables from Baguio Gold against reserves and allowances."9 However, the Bureau of Internal Revenue (BIR) disallowed the amount as

deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.

Petitioner protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt deduction were satisfied, to

wit: (a) there was a valid and existing debt; (b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year

when it was determined to be worthless.

Petitioner emphasized that the debt arose out of a valid management contract it entered into with Baguio Gold. The bad debt deduction

represented advances made by petitioner which, pursuant to the management contract, formed part of Baguio Gold‘s "pecuniary

obligations" to petitioner. It also included payments made by petitioner as guarantor of Baguio Gold‘s long-term loans which legally

entitled petitioner to be subrogated to the rights of the original creditor.

Petitioner also asserted that due to Baguio Gold‘s irreversible losses, it became evident that it would not be able to recover the advances and

payments it had made in behalf of Baguio Gold. For a debt to be considered worthless, petitioner claimed that it was neither required to

institute a judicial action for collection against the debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough

that a taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable means to collect.

On October 28, 1994, the BIR denied petitioner‘s protest for lack of legal and factual basis. It held that the alleged debt was not ascertained

to be worthless since Baguio Gold remained existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a

valid and subsisting debt considering that, under the management contract, petitioner was to be paid fifty percent (50%) of the project‘s net

profit.10

Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as follows:

WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED for lack of merit. The assessment in

question, viz: FAS-1-82-88-003067 for deficiency income tax in the amount of P62,811,161.39 is hereby AFFIRMED.

ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY respondent Commissioner of Internal

Revenue the amount of P62,811,161.39, plus, 20% delinquency interest due computed from February 10, 1995, which is the date

after the 20-day grace period given by the respondent within which petitioner has to pay the deficiency amount x x x up to actual

date of payment.

SO ORDERED.11

The CTA rejected petitioner‘s assertion that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead

characterized the advances as petitioner‘s investment in a partnership with Baguio Gold for the development and exploitation of the Sto.

Nino mine. The CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a partnership agreement.

Since the advanced amount partook of the nature of an investment, it could not be deducted as a bad debt from petitioner‘s gross income.

The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of Baguio Gold could not be allowed as a bad

debt deduction. At the time the payments were made, Baguio Gold was not in default since its loans were not yet due and demandable.

What petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America showing that it was merely demanding

payment of the installment and interests due. Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-payment.

The Court of Appeals affirmed the decision of the CTA.12

Hence, upon denial of its motion for reconsideration,13

petitioner took this

recourse under Rule 45 of the Rules of Court, alleging that:

I.

The Court of Appeals erred in construing that the advances made by Philex in the management of the Sto. Nino Mine pursuant to

the Power of Attorney partook of the nature of an investment rather than a loan.

II.

The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino Mine indicates that Philex is a

partner of Baguio Gold in the development of the Sto. Nino Mine notwithstanding the clear absence of any intent on the part of

Philex and Baguio Gold to form a partnership.

III.

The Court of Appeals erred in relying only on the Power of Attorney and in completely disregarding the Compromise Agreement

and the Amended Compromise Agreement when it construed the nature of the advances made by Philex.

IV.

The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts write-off.14

Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we should not only rely on the "Power of

Attorney", but also on the subsequent "Compromise with Dation in Payment" and "Amended Compromise with Dation in Payment" that the

parties executed in 1982. These documents, allegedly evinced the parties‘ intent to treat the advances and payments as a loan and establish a

creditor-debtor relationship between them.

The petition lacks merit.

The lower courts correctly held that the "Power of Attorney" is the instrument that is material in determining the true nature of the business

relationship between petitioner and Baguio Gold. Before resort may be had to the two compromise agreements, the parties‘ contractual

intent must first be discovered from the expressed language of the primary contract under which the parties‘ business relations were

founded. It should be noted that the compromise agreements were mere collateral documents executed by the parties pursuant to the

termination of their business relationship created under the "Power of Attorney". On the other hand, it is the latter which established the

juridical relation of the parties and defined the parameters of their dealings with one another.

The execution of the two compromise agreements can hardly be considered as a subsequent or contemporaneous act that is reflective of the

parties‘ true intent. The compromise agreements were executed eleven years after the "Power of Attorney" and merely laid out a plan or

procedure by which petitioner could recover the advances and payments it made under the "Power of Attorney". The parties entered into the

compromise agreements as a consequence of the dissolution of their business relationship. It did not define that relationship or indicate its

real character.

An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed intended by the parties. Under a contract

of partnership, two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of

dividing the profits among themselves.15

While a corporation, like petitioner, cannot generally enter into a contract of partnership unless

authorized by law or its charter, it has been held that it may enter into a joint venture which is akin to a particular partnership:

The legal concept of a joint venture is of common law origin. It has no precise legal definition, but it has been generally understood

to mean an organization formed for some temporary purpose. x x x It is in fact hardly distinguishable from the partnership, since

their elements are similar – community of interest in the business, sharing of profits and losses, and a mutual right of control. x x x

The main distinction cited by most opinions in common law jurisdictions is that the partnership contemplates a general business

with some degree of continuity, while the joint venture is formed for the execution of a single transaction, and is thus of a

temporary nature. x x x This observation is not entirely accurate in this jurisdiction, since under the Civil Code, a partnership may

be particular or universal, and a particular partnership may have for its object a specific undertaking. x x x It would seem therefore

that under Philippine law, a joint venture is a form of partnership and should be governed by the law of partnerships. The Supreme

Court has however recognized a distinction between these two business forms, and has held that although a corporation cannot

enter into a partnership contract, it may however engage in a joint venture with others. x x x (Citations omitted) 16

Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had intended to create a partnership and

establish a common fund for the purpose. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the

income of the mine.

Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money, property and industry to the common fund

known as the Sto. Niño mine.17

In this regard, we note that there is a substantive equivalence in the respective contributions of the parties to

the development and operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute

equally to the joint venture assets under their respective accounts. Baguio Gold would contribute P11M under its owner‘s account plus any

of its income that is left in the project, in addition to its actual mining claim. Meanwhile, petitioner‘s contribution would consist of its

expertise in the management and operation of mines, as well as the manager‘s account which is comprised of P11M in funds and property

and petitioner‘s "compensation" as manager that cannot be paid in cash.

However, petitioner asserts that it could not have entered into a partnership agreement with Baguio Gold because it did not "bind" itself to

contribute money or property to the project; that under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or

property to the Sto. Niño project "(w)henever the MANAGERS shall deem it necessary and convenient in connection with the

MANAGEMENT of the STO. NIÑO MINE."18

The wording of the parties‘ agreement as to petitioner‘s contribution to the common fund does not detract from the fact that petitioner

transferred its funds and property to the project as specified in paragraph 5, thus rendering effective the other stipulations of the contract,

particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until termination of the parties‘ business relations. As

can be seen, petitioner became bound by its contributions once the transfers were made. The contributions acquired an obligatory nature as

soon as petitioner had chosen to exercise its option under paragraph 5.

There is no merit to petitioner‘s claim that the prohibition in paragraph 5(c) against withdrawal of advances should not be taken as an

indication that it had entered into a partnership with Baguio Gold; that the stipulation only showed that what the parties entered into was

actually a contract of agency coupled with an interest which is not revocable at will and not a partnership.

In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the principal due to an interest of a third party

that depends upon it, or the mutual interest of both principal and agent.19

In this case, the non-revocation or non-withdrawal under paragraph

5(c) applies to the advances made by petitioner who is supposedly the agent and not the principal under the contract. Thus, it cannot be

inferred from the stipulation that the parties‘ relation under the agreement is one of agency coupled with an interest and not a partnership.

Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one of agency and not a

partnership. Although the said provision states that "this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of

the MANAGERS is outstanding, inclusive of the MANAGERS‘ account," it does not necessarily follow that the parties entered into an

agency contract coupled with an interest that cannot be withdrawn by Baguio Gold.

It should be stressed that the main object of the "Power of Attorney" was not to confer a power in favor of petitioner to contract with third

persons on behalf of Baguio Gold but to create a business relationship between petitioner and Baguio Gold, in which the former was to

manage and operate the latter‘s mine through the parties‘ mutual contribution of material resources and industry. The essence of an agency,

even one that is coupled with interest, is the agent‘s ability to represent his principal and bring about business relations between the latter

and third persons.20

Where representation for and in behalf of the principal is merely incidental or necessary for the proper discharge of

one‘s paramount undertaking under a contract, the latter may not necessarily be a contract of agency, but some other agreement depending

on the ultimate undertaking of the parties.21

In this case, the totality of the circumstances and the stipulations in the parties‘ agreement indubitably lead to the conclusion that a

partnership was formed between petitioner and Baguio Gold.

First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by petitioner under the agreement.

Paragraph 5 (d) thereof provides that upon termination of the parties‘ business relations, "the ratio which the MANAGER‘S account has to

the owner‘s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the

claims" shall be transferred to petitioner.22

As pointed out by the Court of Tax Appeals, petitioner was merely entitled to a proportionate

return of the mine‘s assets upon dissolution of the parties‘ business relations. There was nothing in the agreement that would require Baguio

Gold to make payments of the advances to petitioner as would be recognized as an item of obligation or "accounts payable" for Baguio

Gold.

Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of the Sto. Niño mine upon termination, a

provision that is more consistent with a partnership than a creditor-debtor relationship. It should be pointed out that in a contract of loan, a

person who receives a loan or money or any fungible thing acquires ownership thereof and is bound to pay the creditor an equal amount of

the same kind and quality.23

In this case, however, there was no stipulation for Baguio Gold to actually repay petitioner the cash and

property that it had advanced, but only the return of an amount pegged at a ratio which the manager‘s account had to the owner‘s account.

In this connection, we find no contractual basis for the execution of the two compromise agreements in which Baguio Gold recognized a

debt in favor of petitioner, which supposedly arose from the termination of their business relations over the Sto. Nino mine. The "Power of

Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate share of the mine assets to be computed at a

ratio that the manager‘s account had to the owner‘s account. Except to provide a basis for claiming the advances as a bad debt deduction,

there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for any amount over and above the

proportion agreed upon in the "Power of Attorney".

Next, the tax court correctly observed that it was unlikely for a business corporation to lend hundreds of millions of pesos to another

corporation with neither security, or collateral, nor a specific deed evidencing the terms and conditions of such loans. The parties also did

not provide a specific maturity date for the advances to become due and demandable, and the manner of payment was unclear. All these

point to the inevitable conclusion that the advances were not loans but capital contributions to a partnership.

The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it would receive 50% of the net profits as

"compensation" under paragraph 12 of the agreement. The entirety of the parties‘ contractual stipulations simply leads to no other

conclusion than that petitioner‘s "compensation" is actually its share in the income of the joint venture.

Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in the profits of a business is prima facie

evidence that he is a partner in the business." Petitioner asserts, however, that no such inference can be drawn against it since its share in the

profits of the Sto Niño project was in the nature of compensation or "wages of an employee", under the exception provided in Article 1769

(4) (b).24

On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold who will be paid "wages" pursuant to an

employer-employee relationship. To begin with, petitioner was the manager of the project and had put substantial sums into the venture in

order to ensure its viability and profitability. By pegging its compensation to profits, petitioner also stood not to be remunerated in case the

mine had no income. It is hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an

ordinary employee.

Consequently, we find that petitioner‘s "compensation" under paragraph 12 of the agreement actually constitutes its share in the net profits

of the partnership. Indeed, petitioner would not be entitled to an equal share in the income of the mine if it were just an employee of Baguio

Gold.25

It is not surprising that petitioner was to receive a 50% share in the net profits, considering that the "Power of Attorney" also

provided for an almost equal contribution of the parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the

notion that the parties‘ relations were indeed of partners and not employer-employee.

All told, the lower courts did not err in treating petitioner‘s advances as investments in a partnership known as the Sto. Nino mine. The

advances were not "debts" of Baguio Gold to petitioner inasmuch as the latter was under no unconditional obligation to return the same to

the former under the "Power of Attorney". As for the amounts that petitioner paid as guarantor to Baguio Gold‘s creditors, we find no

reason to depart from the tax court‘s factual finding that Baguio Gold‘s debts were not yet due and demandable at the time that petitioner

paid the same. Verily, petitioner pre-paid Baguio Gold‘s outstanding loans to its bank creditors and this conclusion is supported by the

evidence on record.26

In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income. Deductions for income tax purposes partake of

the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to

the deduction claimed.27

In this case, petitioner failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold

that could be deducted from its gross income. Consequently, it could not claim the advances as a valid bad debt deduction.

WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No. 49385 dated June 30, 2000, which

affirmed the decision of the Court of Tax Appeals in C.T.A. Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is

ORDERED to PAY the deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency interest computed from

February 10, 1995, which is the due date given for the payment of the deficiency income tax, up to the actual date of payment.

SO ORDERED.

Hermanos vs CIR

These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax liability for the years 1950 to

1954 and for the year 1957. Both the taxpayer and the Commissioner of Internal Revenue, as petitioner and respondent in the cases a quo

respectively, appealed from the Tax Court's decisions, insofar as their respective contentions on particular tax items were therein resolved

against them. Since the issues raised are interrelated, the Court resolves the four appeals in this joint decision.

Cases L-21551 and L-21557

The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of engaging in business as an

"investment company" with main office at Manila. Upon verification of the taxpayer's income tax returns for the period in question, the

Commissioner of Internal Revenue assessed against the taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and

P14,451.00 as alleged deficiency income taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said assessments were the

result of alleged discrepancies found upon the examination and verification of the taxpayer's income tax returns for the said years,

summarized by the Tax Court in its decision of June 10, 1963 in CTA Case No. 787, as follows:

1. Losses —

a. Losses in Mati Lumber Co. (1950) P 8,050.00

b. Losses in or bad debts of Palawan Manganese Mines, Inc. (1951) 353,134.25

c. Losses in Balamban Coal Mines —

1950 8,989.76

1951 27,732.66

d. Losses in Hacienda Dalupiri —

1950 17,418.95

1951 29,125.82

1952 26,744.81

1953 21,932.62

1954 42,938.56

e. Losses in Hacienda Samal —

1951 8,380.25

1952 7,621.73

2. Excessive depreciation of Houses —

1950 P 8,180.40

1951 8,768.11

1952 18,002.16

1953 13,655.25

1954 29,314.98

3. Taxable increase in net worth —

1950 P 30,050.00

1951 1,382.85

4. Gain realized from sale of real property in 1950 P 11,147.2611

The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2 of the above summary, but

overruled the Commissioner's disallowances of all the remaining items. It therefore modified the deficiency assessments

accordingly, found the total deficiency income taxes due from the taxpayer for the years under review to amount to P123,436.00

instead of P166,063.00 as originally assessed by the Commissioner, and rendered the following judgment:

RESUME

1950 P2,748.00

1951 108,724.00

1952 3,600.00

1953 2,501.00

1954 5,863.00

Total

P123,436.00

WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the sum of P123,436.00 within 30

days from the date this decision becomes final. If the said amount, or any part thereof, is not paid within said period, there shall be

added to the unpaid amount as surcharge of 5%, plus interest as provided in Section 51 of the National Internal Revenue Code, as

amended. With costs against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)

Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two main issues are raised by the

parties: first, the correctness of the Tax Court's rulings with respect to the disputed items of disallowances enumerated in the Tax Court's

summary reproduced above, and second, whether or not the government's right to collect the deficiency income taxes in question has

already prescribed.

On the first issue, we will discuss the disputed items of disallowances seriatim.

1. Re allowances/disallowances of losses.

(a) Allowance of losses in Mati Lumber Co. (1950). — The Commissioner of Internal Revenue questions the Tax Court's allowance of the

taxpayer's writing off as worthless securities in its 1950 return the sum of P8,050.00 representing the cost of shares of stock of Mati Lumber

Co. acquired by the taxpayer on January 1, 1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly

established. The Commissioner contends that although the said Company was no longer in operation in 1950, it still had its sawmill and

equipment which must be of considerable value. The Court, however, found that "the company ceased operations in 1949 when its Manager

and owner, a certain Mr. Rocamora, left for Spain ,where he subsequently died. When the company eased to operate, it had no assets, in

other words, completely insolvent. This information as to the insolvency of the Company — reached (the taxpayer) in 1950," when it

properly claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of the National Internal

Revenue Code. 2

We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the stock as worthless securities.

Assuming that the Company would later somehow realize some proceeds from its sawmill and equipment, which were still existing as

claimed by the Commissioner, and that such proceeds would later be distributed to its stockholders such as the taxpayer, the amount so

received by the taxpayer would then properly be reportable as income of the taxpayer in the year it is received.

(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). — The taxpayer appeals from the Tax Court's

disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which it had advanced or loaned to Palawan

Manganese Mines, Inc. The Tax Court's findings on this item follow:

Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the controlling stockholders of

petitioner corporation, requested financial help from petitioner to enable it to resume it mining operations in Coron, Palawan. The

request for financial assistance was readily and unanimously approved by the Board of Directors of petitioner, and thereafter a

memorandum agreement was executed on August 12, 1945, embodying the terms and conditions under which the financial

assistance was to be extended, the pertinent provisions of which are as follows:

"WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has agreed to extend to the

SECOND PARTY the requested financial help by way of accommodation advances and for this purpose has authorized

its President, Mr. Ramon J. Fernandez to cause the release of funds to the SECOND PARTY.

"WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to extend to the SECOND PARTY,

the latter has agreed to pay to the former fifteen per centum (15%) of its net profits.

"NOW THEREFORE, for and in consideration of the above premises, the parties hereto have agreed and covenanted that

in consideration of the financial help to be extended by the FIRST PARTY to the SECOND PARTY to enable the latter to

resume its mining operations in Coron, Palawan, the SECOND PARTY has agreed and undertaken as it hereby agrees and

undertakes to pay to the FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)

Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly advances starting from 1945, which

advances amounted to P587,308.07 by the end of 1951. Despite these advances and the resumption of operations by Palawan Manganese

Mines, Inc., it continued to suffer losses. By 1951, petitioner became convinced that those advances could no longer be recovered. While it

continued to give advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the basis of the

total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum of P85,647.14 had to be deducted, the

latter sum representing its pre-war assets. (t.s.n., pp. 136-139, Id)." (Page 4, Memorandum for Petitioner.) Petitioner decided to maintain the

advances given in 1950 and 1951 in the hope that it might be able to recover the same, as in fact it continued to give advances up to 1952.

From these facts, and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advances

corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, was the sum of P353,134.25

properly claimed by petitioner as deduction in its income tax return for 1951, either as losses or bad debts?

It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid. It is true that some

testimonial evidence was presented to show that there was some agreement that the advances would be repaid, but no documentary evidence

was presented to this effect. The memorandum agreement signed by the parties appears to be very clear that the consideration for the

advances made by petitioner was 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or

profits, there was no obligation to repay those advances. It has been held that the voluntary advances made without expectation of

repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329, citing W. F. Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR

395; George B. Markle, 17 TC. 1593.

Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan Manganese Mines, Inc., without

expectation of repayment. Petitioner could not sue for recovery under the memorandum agreement because the obligation of Palawan

Manganese Mines, Inc. was to pay petitioner 15% of its net profits, not the advances. No bad debt could arise where there is no valid and

subsisting debt.

Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of paying the debt in 1951, when

petitioner wrote off the advances and deducted the amount in its return for said year, yet the debt is not deductible in 1951 as a worthless

debt. It appears that the debtor was still in operation in 1951 and 1952, as petitioner continued to give advances in those years. It has been

held that if the debtor corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is not

considered worthless and therefore not deductible. 3

The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the taxpayer has taken an

"ambiguous position " and "has not definitely taken a stand on whether the amount involved is claimed as losses or as bad debts but insists

that it is either a loss or a bad debt." 4

We sustain the government's position that the advances made by the taxpayer to its 100% subsidiary,

Palawan Manganese Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5

The evidence on record shows that

the board of directors of the two companies since August, 1945, were identical and that the only capital of Palawan Manganese Mines, Inc.

is the amount of P100,000.00 entered in the taxpayer's balance sheet as its investment in its subsidiary company. 6

This fact explains the

liberality with which the taxpayer made such large advances to the subsidiary, despite the latter's admittedly poor financial condition.

The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that under their memorandum

agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no earnings, there was no obligation to repay those advances,

becomes immaterial, in the light of our resolution of the question. The Tax Court correctly held that the subsidiary company was still in

operation in 1951 and 1952 and the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or investment

could not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. Furthermore, neither under Section 30 (d)

(2) of our Tax Code providing for deduction by corporations of losses actually sustained and charged off during the taxable year nor under

Section 30 (e) (1) thereof providing for deduction of bad debts actually ascertained to be worthless and charged off within the taxable year,

can there be a partial writing off of a loss or bad debt, as was sought to be done here by the taxpayer. For such losses or bad debts must be

ascertained to be so and written off during the taxable year, are therefore deductible in full or not at all, in the absence of any express

provision in the Tax Code authorizing partial deductions.

The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the year 1951, as the subsidiary was

still in operation in 1951 and 1952. The taxpayer, on the other hand, claims that its advances were irretrievably lost because of the

staggering losses suffered by its subsidiary in 1951 and that its advances after 1949 were "only limited to the purpose of salvaging whatever

ore was already available, and for the purpose of paying the wages of the laborers who needed help." 7

The correctness of the Tax Court's

ruling in sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent events shown in

Cases L-24972 and L-24978 involving the taxpayer's 1957 income tax liability. (Infra, paragraph 6.) It will there be seen that by 1956, the

obligation of the taxpayer's subsidiary to it had been reduced from P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on

January 1, 1956 that the subsidiary decided to cease operations. 8

(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The Court sustains the Tax Court's disallowance of the sums of

P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban coal mines in Cebu in 1950 and 1951, respectively, and

claimed as losses in the taxpayer's returns for said years. The Tax Court correctly held that the losses "are deductible in 1952, when the

mines were abandoned, and not in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions should be

allowed as losses for the corresponding years that they were incurred, because it made no sales of coal during said years, since the promised

road or outlet through which the coal could be transported from the mines to the provincial road was not constructed, cannot be sustained.

Some definite event must fix the time when the loss is sustained, and here it was the event of actual abandonment of the mines in 1952. The

Tax Court held that the losses, totalling P36,722.42 were properly deductible in 1952, but the appealed judgment does not show that the

taxpayer was credited therefor in the determination of its tax liability for said year. This additional deduction of P36,722.42 from the

taxpayer's taxable income in 1952 would result in the elimination of the deficiency tax liability for said year in the sum of P3,600.00 as

determined by the Tax Court in the appealed judgment.

(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). — The Tax Court overruled the

Commissioner's disallowance of these items of losses thus:

Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950, P29,125.82 in 1951,

P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These deductions were disallowed by respondent on the ground

that the farm was operated solely for pleasure or as a hobby and not for profit. This conclusion is based on the fact that the farm

was operated continuously at a loss.1awphîl.nèt

From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business and not pleasure. It was

mainly a cattle farm, although a few race horses were also raised. It does not appear that the farm was used by petitioner for

entertainment, social activities, or other non-business purposes. Therefore, it is entitled to deduct expenses and losses in connection

with the operation of said farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, p.164)

Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes farmers to determine their

gross income on the basis of inventories. Said regulations provide:

"If gross income is ascertained by inventories, no deduction can be made for livestock or products lost during the year,

whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the

amount of livestock or products on hand at the close of the year."

Evidently, petitioner determined its income or losses in the operation of said farm on the basis of inventories. We quote from the

memorandum of counsel for petitioner:

"The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive, the corresponding yearly

losses sustained in the operation of Hacienda Dalupiri, which losses represent the excess of its yearly expenditures over

the receipts; that is, the losses represent the difference between the sales of livestock and the actual cash disbursements or

expenses." (Pages 21-22, Memorandum for Petitioner.)

As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its operation, which losses were

determined by means of inventories authorized under Section 100 of Revenue Regulations No. 2, it was error for respondent to

have disallowed the deduction of said losses. The same is true with respect to loss sustained in the operation of the Hacienda Samal

for the years 1951 and 1952. 10

The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory method of accounting. He

concedes, however, "that the regulations referred to does not specify how the inventories are to be made. The Tax Court, however, felt

satisfied with the evidence presented by the taxpayer ... which merely consisted of an alleged physical count of the number of the livestock

in Hacienda Dalupiri for the years involved." 11

The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding

livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its findings.

2. Disallowance of excessive depreciation of buildings (1950-1954). — During the years 1950 to 1954, the taxpayer claimed a depreciation

allowance for its buildings at the annual rate of 10%. The Commissioner claimed that the reasonable depreciation rate is only 3% per

annum, and, hence, disallowed as excessive the amount claimed as depreciation allowance in excess of 3% annually. We sustain the Tax

Court's finding that the taxpayer did not submit adequate proof of the correctness of the taxpayer's claim that the depreciable assets or

buildings in question had a useful life only of 10 years so as to justify its 10% depreciation per annum claim, such finding being supported

by the record. The taxpayer's contention that it has many zero or one-peso assets, 12

representing very old and fully depreciated assets serves

but to support the Commissioner's position that a 10% annual depreciation rate was excessive.

3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the Commissioner's treatment as taxable income of certain

increases in the taxpayer's net worth. It found that:

For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of P30,050.00, and for the year

1951, the sum of P1,382.85. These amounts were treated by respondent as taxable income of petitioner for said years.

It appears that petitioner had an account with the Manila Insurance Company, the records bearing on which were lost. When its

records were reconstituted the amount of P349,800.00 was set up as its liability to the Manila Insurance Company. It was

discovered later that the correct liability was only 319,750.00, or a difference of P30,050.00, so that the records were adjusted so as

to show the correct liability. The correction or adjustment was made in 1950. Respondent contends that the reduction of petitioner's

liability to Manila Insurance Company resulted in the increase of petitioner's net worth to the extent of P30,050.00 which is

taxable. This is erroneous. The principle underlying the taxability of an increase in the net worth of a taxpayer rests on the theory

that such an increase in net worth, if unreported and not explained by the taxpayer, comes from income derived from a taxable

source. (See Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, Nov. 25, 1958.)

In this case, the increase in the net worth of petitioner for 1950 to the extent of P30,050.00 was not the result of the receipt by it of

taxable income. It was merely the outcome of the correction of an error in the entry in its books relating to its indebtedness to the

Manila Insurance Company. The Income Tax Law imposes a tax on income; it does not tax any or every increase in net worth

whether or not derived from income. Surely, the said sum of P30,050.00 was not income to petitioner, and it was error for

respondent to assess a deficiency income tax on said amount.

The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum of P1,382.85. It appears that

certain items (all amounting to P1,382.85) remained in petitioner's books as outstanding liabilities of trade creditors. These accounts were

discovered in 1951 as having been paid in prior years, so that the necessary adjustments were made to correct the errors. If there was an

increase in net worth of the petitioner, the increase in net worth was not the result of receipt by petitioner of taxable income." 13

The

Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings. Certainly, these increases in the taxpayer's net

worth were not taxable increases in net worth, as they were not the result of the receipt by it of unreported or unexplained taxable income,

but were shown to be merely the result of the correction of errors in its entries in its books relating to its indebtednesses to certain creditors,

which had been erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax Court's action must be

affirmed.

4. Gain realized from sale of real property (1950). — We likewise sustain as being in accordance with the evidence the Tax Court's reversal

of the Commissioner's assessment on all alleged unreported gain in the sum of P11,147.26 in the sale of a certain real property of the

taxpayer in 1950. As found by the Tax Court, the evidence shows that this property was acquired in 1926 for P11,852.74, and was sold in

1950 for P60,000.00, apparently, resulting in a gain of P48,147.26. 14

The taxpayer reported in its return a gain of P37,000.00, or a

discrepancy of P11,147.26. 15

It was sufficiently proved from the taxpayer's books that after acquiring the property, the taxpayer had made

improvements totalling P11,147.26, 16

accounting for the apparent discrepancy in the reported gain. In other words, this figure added to the

original acquisition cost of P11,852.74 results in a total cost of P23,000.00, and the gain derived from the sale of the property for

P60,000.00 was correctly reported by the taxpayer at P37,000.00.

On the second issue of prescription, the taxpayer's contention that the Commissioner's action to recover its tax liability should be deemed to

have prescribed for failure on the part of the Commissioner to file a complaint for collection against it in an appropriate civil action, as

contradistinguished from the answer filed by the Commissioner to its petition for review of the questioned assessments in the case a quo has

long been rejected by this Court. This Court has consistently held that "a judicial action for the collection of a tax is begun by the filing of a

complaint with the proper court of first instance, or where the assessment is appealed to the Court of Tax Appeals, by filing an answer to the

taxpayer's petition for review wherein payment of the tax is prayed for." 17

This is but logical for where the taxpayer avails of the right to

appeal the tax assessment to the Court of Tax Appeals, the said Court is vested with the authority to pronounce judgment as to the

taxpayer's liability to the exclusion of any other court. In the present case, regardless of whether the assessments were made on February 24

and 27, 1956, as claimed by the Commissioner, or on December 27, 1955 as claimed by the taxpayer, the government's right to collect the

taxes due has clearly not prescribed, as the taxpayer's appeal or petition for review was filed with the Tax Court on May 4, 1960, with the

Commissioner filing on May 20, 1960 his Answer with a prayer for payment of the taxes due, long before the expiration of the five-year

period to effect collection by judicial action counted from the date of assessment.

Cases L-24972 and L-24978

These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its corresponding income tax return, the

Commissioner assessed it for deficiency income tax in the amount of P38,918.76, computed as follows:

Net income per return P29,178.70

Add: Unallowable deductions:

(1) Net loss claimed on Ha. Dalupiri 89,547.33

(2) Amortization of Contractual right claimed as an expense

under Mines Operations 48,481.62

Net income per investigation

P167,297.65

Tax due thereon 38,818.00

Less: Amount already assessed

5,836.00 18

B a l a n c e P32,982.00

Add: 1/2% monthly interest from 6-20-59 to 6-20-62 5,936.76

TOTAL AMOUNT DUE AND COLLECTIBLE

P38,918.76

The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its Hacienda Dalupiri in the sum of

P89,547.33 but sustained the disallowance of the sum of P48,481.62, which allegedly represented 1/5 of the cost of the "contractual right"

over the mines of its subsidiary, Palawan Manganese Mines, Inc. which the taxpayer had acquired. It found the taxpayer liable for

deficiency income tax for the year 1957 in the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the

following judgment:

WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to pay to respondent the amount of

P9,696.00 as deficiency income tax for the year 1957, plus the corresponding interest provided in Section 51 of the Revenue Code.

If the deficiency tax is not paid in full within thirty (30) days from the date this decision becomes final and executory, petitioner

shall pay a surcharge of five per cent (5%) of the unpaid amount, plus interest at the rate of one per cent (1%) a month, computed

from the date this decision becomes final until paid, provided that the maximum amount that may be collected as interest shall not

exceed the amount corresponding to a period of three (3) years. Without pronouncement as to costs. 19

Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.

5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited its previous decision overruling the Commissioner's

disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it was convinced that the hacienda was

operated for business and not for pleasure. And in this appeal, the Commissioner cites his arguments in his appellant's brief in Case No. L-

21557. The Tax Court, in setting aside the Commissioner's principal objections, which were directed to the accounting method used by the

taxpayer found that:

It is true that petitioner followed the cash basis method of reporting income and expenses in the operation of the Hacienda Dalupiri

and used the accrual method with respect to its mine operations. This method of accounting, otherwise known as the hybrid

method, followed by petitioner is not without justification.

... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code provisions permit, however, the

use of a hybrid method of accounting, combining a cash and accrual method, under circumstances and requirements to be

set out in Regulations to be issued. Also, if a taxpayer is engaged in more than one trade or business he may use a

different method of accounting for each trade or business. And a taxpayer may report income from a business on accrual

basis and his personal income on the cash basis.' (See Mertens, Law of Federal Income Taxation, Zimet & Stanley

Revision, Vol. 2, Sec. 12.08, p. 26.) 20

The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and procedure as properly reflecting

the taxpayer's income or losses, and the Commissioner having failed to show the contrary, we reiterate our ruling [supra, paragraph

1 (d) and (e)] that we find no compelling reason to disturb its findings.

6. Disallowance of amortization of alleged "contractual rights." — The reasons for sustaining this disallowance are thus given by the Tax

Court:

It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of Directors on January 19, 1956,

approved a resolution, the pertinent portions of which read as follows:

"RESOLVED, as it is hereby resolved, that the corporation's current assets composed of ores, fuel, and oil, materials and

supplies, spare parts and canteen supplies appearing in the inventory and balance sheet of the Corporation as of December

31, 1955, with an aggregate value of P97,636.98, contractual rights for the operation of various mining claims in Palawan

with a value of P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a total value of

P340,045.02 be, as they are hereby ceded and transferred to Fernandez Hermanos, Inc., as partial settlement of the

indebtedness of the corporation to said Fernandez Hermanos Inc. in the amount of P442,895.23." (Exh. E, p. 17, CTA

rec.)

On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus:

"WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has decided to cease operation on

January 1, 1956 and in order to satisfy at least a part of its indebtedness to the Corporation, it has proposed to transfer its

current assets in the amount of NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100

(P97,636.98) as per its balance sheet as of December 31, 1955, its contractual rights valued at ONE HUNDRED

THOUSAND PESOS (P100,000.00) and its title over various mining claims valued at ONE HUNDRED FORTY TWO

THOUSAND FOUR HUNDRED EIGHT PESOS & 10/100 (P142,408.10) or a total evaluation of THREE HUNDRED

FORTY THOUSAND FORTY FIVE PESOS & 08/100 (P340,045.08) which shall be applied in partial settlement of its

obligation to the Corporation in the amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT HUNDRED

EIGHTY FIVE PESOS & 23/100 (P442,885.23)," (Exh. E-1, p. 18, CTA rec.)

Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual rights (P100,000.00) and the

value of its mining claims (P142,408.10). Respondent disallowed the deduction on the following grounds: (1) that the Palawan

Manganese Mines, Inc. could not transfer P242,408.10 worth of assets to petitioner because the balance sheet of the said

corporation for 1955 shows that it had only current as worth P97,636.96; and (2) that the alleged amortization of "contractual

rights" is not allowed by the Revenue Code.

The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act No. 2698, which provided in

part:

"(g) Depletion of oil and gas wells and mines.:

"(1) In general. — ... (B) in the case of mines, a reasonable allowance for depletion thereof not to exceed the market value

in the mine of the product thereof, which has been mined and sold during the year for which the return and computation

are made. The allowances shall be made under rules and regulations to be prescribed by the Secretary of Finance:

Provided, That when the allowances shall equal the capital invested, ... no further allowance shall be made."

Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which it actually transferred to the

petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said amount from its gross income for the year 1957 because such

deduction in the form of depletion charge was not sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.

x x x x x x x x x

The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the memorandum of its mining engineer

(Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves of the Busuange Mines (Mines transferred by the Palawan

Manganese Mines, Inc. to the petitioner) would be exhausted in five (5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of

the alleged cost of the mines corresponding to the year 1957 and every year thereafter for a period of 5 years. The said

memorandum merely showed the estimated ore reserves of the mines and it probable selling price. No evidence whatsoever was

presented to show the produced mine and for how much they were sold during the year for which the return and computation were

made. This is necessary in order to determine the amount of depletion that can be legally deducted from petitioner's gross income.

The method employed by petitioner in making an outright deduction of 1/5 of the cost of the mines is not authorized under Section

30(g) (1) (B) of the Revenue Code. Respondent's disallowance of the alleged "contractual rights" amounting to P48,481.62 must

therefore be sustained. 21

The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the Tax Code its "capital

investment," representing the alleged value of its contractual rights and titles to mining claims in the sum of P242,408.10 and thus deduct

outright one-fifth (1/5) of this "capital investment" every year. regardless of whether it had actually mined the product and sold the

products. The very authorities cited in its brief give the correct concept of depletion charges that they "allow for the exhaustion of the

capital value of the deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross income before the net

income can be determined, so the estimated cost of the reserve used up is allowed." 22

The alleged "capital investment" method invoked by

the taxpayer is not a method of depletion, but the Tax Code provision, prior to its amendment by Section 1, of Republic Act No. 2698,

which took effect on June 18, 1960, expressly provided that "when the allowances shall equal the capital invested ... no further allowances

shall be made;" in other words, the "capital investment" was but the limitation of the amount of depletion that could be claimed. The

outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it were a "straight line" rate of depreciation, was correctly held by

the Tax Court not to be authorized by the Tax Code.

ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551 and L-21557, as modified by

the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer for the year 1953 as directed in paragraph 1 (c) of this

decision, is hereby affirmed. The judgment of the Court of Tax Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in

toto. No costs. So ordered.

BASILAN ESTATES, INC., petitioner,

vs.

THE COMMISSIONER OF INTERNAL REVENUE and THE COURT OF TAX APPEALS, respondents.

Felix A. Gulfin and Antonio S. Alano for petitioner.

Office of the Solicitor General for respondents.

BENGZON, J.P., J.:

A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc., with principal offices in Basilan City, filed on March 24,

1954 its income tax returns for 1953 and paid an income tax of P8,028. On February 26, 1959, the Commissioner of Internal Revenue, per

examiners' report of February 19, 1959, assessed Basilan Estates, Inc., a deficiency income tax of P3,912 for 1953 and P86,876.85 as 25%

surtax on unreasonably accumulated profits as of 1953 pursuant to Section 25 of the Tax Code. On non-payment of the assessed amount, a

warrant of distraint and levy was issued but the same was not executed because Basilan Estates, Inc. succeeded in getting the Deputy

Commissioner of Internal Revenue to order the Director of the district in Zamboanga City to hold execution and maintain constructive

embargo instead. Because of its refusal to waive the period of prescription, the corporation's request for reinvestigation was not given due

course, and on December 2, 1960, notice was served the corporation that the warrant of distraint and levy would be executed.

On December 20, 1960, Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for review of the Commissioner's assessment,

alleging prescription of the period for assessment and collection; error in disallowing claimed depreciations, travelling and miscellaneous

expenses; and error in finding the existence of unreasonably accumulated profits and the imposition of 25% surtax thereon. On October 31,

1963, the Court of Tax Appeals found that there was no prescription and affirmed the deficiency assessment in toto.

On February 21, 1964, the case was appealed to Us by the taxpayer, upon the following issues:

1. Has the Commissioner's right to collect deficiency income tax prescribed?

2. Was the disallowance of items claimed as deductible proper?

3. Have there been unreasonably accumulated profits? If so, should the 25% surtax be imposed on the balance of the entire surplus from

1947-1953, or only for 1953?

4. Is the petitioner exempt from the penalty tax under Republic Act 1823 amending Section 25 of the Tax Code?

PRESCRIPTION

There is no dispute that the assessment of the deficiency tax was made on February 26, 1959; but the petitioner claims that it never received

notice of such assessment or if it did, it received the notice beyond the five-year prescriptive period. To show prescription, the annotation on

the notice (Exhibit 10, No. 52, ACR, p. 54-A of the BIR records) "No accompanying letter 11/25/" is advanced as indicative of the fact that

receipt of the notice was after March 24, 1959, the last date of the five-year period within which to assess deficiency tax, since the original

returns were filed on March 24, 1954.

Although the evidence is not clear on this point, We cannot accept this interpretation of the petitioner, considering the presence of

circumstances that lead Us to presume regularity in the performance of official functions. The notice of assessment shows the assessment to

have been made on February 26, 1959, well within the five-year period. On the right side of the notice is also stamped "Feb. 26, 1959" —

denoting the date of release, according to Bureau of Internal Revenue practice. The Commissioner himself in his letter (Exh. H, p. 84 of

BIR records) answering petitioner's request to lift, the warrant of distraint and levy, asserts that notice had been sent to petitioner. In the

letter of the Regional Director forwarding the case to the Chief of the Investigation Division which the latter received on March 10, 1959 (p.

71 of the BIR records), notice of assessment was said to have been sent to petitioner. Subsequently, the Chief of the Investigation Division

indorsed on March 18, 1959 (p. 24 of the BIR records) the case to the Chief of the Law Division. There it was alleged that notice was

already sent to petitioner on February 26, 1959. These circumstances pointing to official performance of duty must necessarily prevail over

petitioner's contrary interpretation. Besides, even granting that notice had been received by the petitioner late, as alleged, under Section 331

of the Tax Code requiring five years within which to assess deficiency taxes, the assessment is deemed made when notice to this effect is

released, mailed or sent by the Collector to the taxpayer and it is not required that the notice be received by the taxpayer within the

aforementioned five-year period.1

ASSESSMENT

The questioned assessment is as follows:

Net Income per return P40,142.90

Add: Over-claimed depreciation P10,500.49

Mis. expenses disallowed 6,759.17

Officer's travelling expenses disallowed

2,300.40

19,560.06

Net Income per Investigation P59,702.96

20% tax on P59,702.96 11,940.00

Less: Tax already assessed 8,028.00

Deficiency income tax P3,912.00

Add: Additional tax of 25% on P347,507.01 86,876.75

Tax Due & Collectible

P90,788.75

=========

The Commissioner disallowed:

Over-claimed depreciation P10,500.49

Miscellaneous expenses 6,759.17

Officer's travelling expenses 2,300.40

DEDUCTIONS

A. Depreciation. — Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 on the basis of their acquisition

cost. As of January 1, 1950 it changed the depreciable value of said assets by increasing it to conform with the increase in cost for their

replacement. Accordingly, from 1950 to 1953 it deducted from gross income the value of depreciation computed on the reappraised value.

In 1953, the year involved in this case, taxpayer claimed the following depreciation deduction:

Reappraised assets P47,342.53

New assets consisting of hospital building and equipment 3,910.45

Total depreciation P51,252.98

Upon investigation and examination of taxpayer's books and papers, the Commissioner of Internal Revenue found that the reappraised

assets depreciated in 1953 were the same ones upon which depreciation was claimed in 1952. And for the year 1952, the Commissioner had

already determined, with taxpayer's concurrence, the depreciation allowable on said assets to be P36,842.04, computed on their acquisition

cost at rates fixed by the taxpayer. Hence, the Commissioner pegged the deductible depreciation for 1953 on the same old assets at

P36,842.04 and disallowed the excess thereof in the amount of P10,500.49.

The question for resolution therefore is whether depreciation shall be determined on the acquisition cost or on the reappraised value of the

assets.

Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal obsolescense. The

term is also applied to amortization of the value of intangible assets, the use of which in the trade or business is definitely limited in

duration.2 Depreciation commences with the acquisition of the property and its owner is not bound to see his property gradually waste,

without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is

kept unimpaired, so that at the end of any given term of years, the original investment remains as it was in the beginning. It is not only the

right of a company to make such a provision, but it is its duty to its bond and stockholders, and, in the case of a public service corporation,

at least, its plain duty to the public.3 Accordingly, the law permits the taxpayer to recover gradually his capital investment in wasting assets

free from income tax.4 Precisely, Section 30 (f) (1) which states:

(1)In general. — A reasonable allowance for deterioration of property arising out of its use or employment in the business or trade,

or out of its not being used: Provided, That when the allowance authorized under this subsection shall equal the capital invested by

the taxpayer . . . no further allowance shall be made. . . .

allows a deduction from gross income for depreciation but limits the recovery to the capital invested in the asset being depreciated.

The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over and above such cost

cannot be claimed and allowed. The reason is that deductions from gross income are privileges,5 not matters of right.

6 They are not created

by implication but upon clear expression in the law.7

Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the underlying purpose

of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery

in due time thru depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit on the investment made

has never been the underlying reason for the allowance of a deduction for depreciation.

Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has no justification in the law. The

determination, therefore, of the Commissioner of Internal Revenue disallowing said amount, affirmed by the Court of Tax Appeals, is

sustained.

B. Expenses. — The next item involves disallowed expenses incurred in 1953, broken as follows:

Miscellaneous expenses P6,759.17

Officer's travelling expenses 2,300.40

Total P9,059.57

These were disallowed on the ground that the nature of these expenses could not be satisfactorily explained nor could the same be supported

by appropriate papers.

Felix Gulfin, petitioner's accountant, explained the P6,759.17 was actual expenses credited to the account of the president of the corporation

incurred in the interest of the corporation during the president's trip to Manila (pp. 33-34 of TSN of Dec. 5, 1962); he stated that the

P2,300.40 was the president's travelling expenses to and from Manila as to the vouchers and receipts of these, he said the same were made

but got burned during the Basilan fire on March 30, 1962 (p. 40 of same TSN). Petitioner further argues that when it sent its records to

Manila in February, 1959, the papers in support of these miscellaneous and travelling expenses were not included for the reason that by

February 9, 1959, when the Bureau of Internal Revenue decided to investigate, petitioner had no more obligation to keep the same since five

years had lapsed from the time these expenses were incurred (p. 41 of same TSN). On this ground, the petitioner may be sustained, for

under Section 337 of the Tax Code, receipts and papers supporting such expenses need be kept by the taxpayer for a period of five years

from the last entry. At the time of the investigation, said five years had lapsed. Taxpayer's stand on this issue is therefore sustained.

UNREASONABLY ACCUMULATED PROFITS

Section 25 of the Tax Code which imposes a surtax on profits unreasonably accumulated, provides:

Sec. 25. Additional tax on corporations improperly accumulating profits or surplus — (a) Imposition of tax. — If any corporation,

except banks, insurance companies, or personal holding companies, whether domestic or foreign, is formed or availed of for the

purpose of preventing the imposition of the tax upon its shareholders or members or the shareholders or members of another

corporation, through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there is

levied and assessed against such corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed

portion of its accumulated profits or surplus which shall be in addition to the tax imposed by section twenty-four, and shall be

computed, collected and paid in the same manner and subject to the same provisions of law, including penalties, as that

tax.1awphîl.nèt

The Commissioner found that in violation of the abovequoted section, petitioner had unreasonably accumulated profits as of 1953 in the

amount of P347,507.01, based on the following circumstances (Examiner's Report pp. 62-68 of BIR records):

1. Strong financial position of the petitioner as of December 31, 1953. Assets were P388,617.00 while the liabilities amounted to

only P61,117.31 or a ratio of 6:1.

2. As of 1953, the corporation had considerable capital adequate to meet the reasonable needs of the business amounting to

P327,499.69 (assets less liabilities).

3. The P200,000 reserved for electrification of drier and mechanization and the P50,000 reserved for malaria control were reverted

to its surplus in 1953.

4. Withdrawal by shareholders, of large sums of money as personal loans.

5. Investment of undistributed earnings in assets having no proximate connection with the business — as hospital building and

equipment worth P59,794.72.

6. In 1953, with an increase of surplus amounting to P677,232.01, the capital stock was increased to P500,000 although there was

no need for such increase.

Petitioner tried to show that in considering the surplus, the examiner did not take into account the possible expenses for cultivation, labor,

fertilitation, drainage, irrigation, repair, etc. (pp. 235-237 of TSN of Dec. 7, 1962). As aptly answered by the examiner himself, however,

they were already included as part of the working capital (pp. 237-238 of TSN of Dec. 7, 1962).

In the unreasonable accumulation of P347,507.01 are included P200,000 for electrification of driers and mechanization and P50,000 for

malaria control which were reserved way back in 1948 (p. 67 of the BIR records) but reverted to the general fund only in 1953. If there

were any plans for these amounts to be used in further expansion through projects, it did not appear in the records as was properly indicated

in 1948 when such amounts were reserved. Thus, while in 1948 it was already clear that the money was intended to go to future projects, in

1953 upon reversion to the general fund, no such intention was shown. Such reversion therefore gave occasion for the Government to

consider the same for tax purposes. The P250,000 reverted to the general fund was sought to be explained as later used elsewhere: "part of it

in the Hilano Industries, Inc. in building the factory site and buildings to house technical men . . . part of it was spent in the facilities for the

waterworks system and for industrialization of the coconut industry" (p. 117 of TSN of Dec. 6, 1962). This is not sufficient explanation.

Persuasive jurisprudence on the matter such as those in the United States from where our tax law was derived,8 has it that: "In order to

determine whether profits were accumulated for the reasonable needs of the business or to avoid the surtax upon shareholders, the

controlling intention of the taxpayer is that which is manifested at the time of the accumulation, not subsequently declared intentions which

are merely the products of after-thought."9 The reversion here was made because the reserved amount was not enough for the projects

intended, without any intent to channel the same to some particular future projects in mind.

Petitioner argues that since it has P560,717.44 as its expenses for the year 1953, a surplus of P347,507.01 is not unreasonably accumulated.

As rightly contended by the Government, there is no need to have such a large amount at the beginning of the following year because during

the year, current assets are converted into cash and with the income realized from the business as the year goes, these expenses may well be

taken care of (pp. 238 of TSN of Dec. 7, 1962). Thus, it is erroneous to say that the taxpayer is entitled to retain enough liquid net assets in

amounts approximately equal to current operating needs for the year to cover "cost of goods sold and operating expenses" for "it excludes

proper consideration of funds generated by the collection of notes receivable as trade accounts during the course of the year."10

In fact, just

because the fatal accumulations are less than 70% of the annual operating expenses of the year, it does not mean that the accumulations are

reasonable as a matter of law."11

Petitioner tried to show that investments were made with Basilan Coconut Producers Cooperative Association and Basilan Hospital (pp.

103-105 of TSN of Dec. 6, 1962) totalling P59,794.72 as of December 31, 1953. This shows all the more the unreasonable accumulation.

As of December 31, 1953 already P59,794.72 was spent — yet as of that date there was still a surplus of P347,507.01.

Petitioner questions why the examiner covered the period from 1948-1953 when the taxable year on review was 1953. The surplus of

P347,507.01 was taken by the examiner from the balance sheet of petitioner for 1953. To check the figure arrived at, the examiner traced

the accumulation process from 1947 until 1953, and petitioner's figure stood out to be correct. There was no error in the process applied, for

previous accumulations should be considered in determining unreasonable accumulations for the year concerned. "In determining whether

accumulations of earnings or profits in a particular year are within the reasonable needs of a corporation, it is neccessary to take into

account prior accumulations, since accumulations prior to the year involved may have been sufficient to cover the business needs and

additional accumulations during the year involved would not reasonably be necessary."12

Another factor that stands out to show unreasonable accumulation is the fact that large amounts were withdrawn by or advanced to the

stockholders. For the year 1953 alone these totalled P197,229.26. Yet the surplus of P347,507.01 was left as of December 31, 1953. We

find unacceptable petitioner's explanation that these were advances made in furtherance of the business purposes of the petitioner. As

correctly held by the Court of Tax Appeals, while certain expenses of the corporation were credited against these amounts, the unspent

balance was retained by the stockholders without refunding them to petitioner at the end of each year. These advances were in fact indirect

loans to the stockholders indicating the unreasonable accumulation of surplus beyond the needs of the business.

ALLEGED EXEMPTION

Petitioner wishes to avail of the exempting proviso in Sec. 25 of the Internal Revenue Code as amended by R.A. 1823, approved June 22,

1957, whereby accumulated profits or surplus if invested in any dollar-producing or dollar-earning industry or in the purchase of bonds

issued by the Central Bank, may not be subject to the 25% surtax. We have but to point out that the unreasonable accumulation was in 1953.

The exemption was by virtue of Republic Act 1823 which amended Sec. 25 only on June 22, 1957 — more than three years after the period

covered by the assessment.

In resume, Basilan Estates, Inc. is liable for the payment of deficiency income tax and surtax for the year 1953 in the amount of P88,977.42,

computed as follows:

Net Income per return P40,142.90

Add: Over-claimed depreciation 10,500.49

Net income per finding

P50,643.39

20% tax on P50,643.39 P10,128.67

Less: Tax already assessed 8,028.00

Deficiency income tax

P2,100.67

Add: 25% surtax on P347,507.01 86,876.75

Total tax due and collectible

P88,977.42

===========

WHEREFORE, the judgment appealed from is modified to the extent that petitioner is allowed its deductions for travelling and

miscellaneous expenses, but affirmed insofar as the petitioner is liable for P2,100.67 as deficiency income tax for 1953 and P86,876.75 as

25% surtax on the unreasonably accumulated profit of P347,507.01. No costs. So ordered.

LIMPAN INVESTMENT CORPORATION, petitioner,

vs.

COMMISSIONER OF INTERNAL REVENUE, ET AL., respondents.

Vicente L. San Luis for petitioner.

Office of the Solicitor General A. A. Alafriz, Assistant Solicitor General F. B. Rosete, Solicitor A. B. Afurong and Atty. V. G. Saldajeno for

respondents.

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

Appeal interposed by petitioner Limpan Investment Corporation against a decision of the Court of Tax Appeals, in its CTA Case No. 699,

holding and ordering it (petitioner) to pay respondent Commissioner of Internal Revenue the sums of P7,338.00 and P30,502.50,

representing deficiency income taxes, plus 50% surcharge and 1% monthly interest from June 30, 1959 to the date of payment, with cost.

The facts of this case are:

Petitioner, a domestic corporation duly registered since June 21, 1955, is engaged in the business of leasing real properties. It commenced

actual business operations on July 1, 1955. Its principal stockholders are the spouses Isabelo P. Lim and Purificacion Ceñiza de Lim, who

own and control ninety-nine per cent (99%) of its total paid-up capital. Its president and chairman of the board is the same Isabelo P.

Lim.1äwphï1.ñët

Its real properties consist of several lots and buildings, mostly situated in Manila and in Pasay City, all of which were acquired from said

Isabelo P. Lim and his mother, Vicente Pantangco Vda. de Lim.

Petitioner corporation duly filed its 1956 and 1957 income tax returns, reporting therein net incomes of P3,287.81 and P11,098.36,

respectively, for which it paid the corresponding taxes therefor in the sums of P657.00 and P2,220.00.

Sometime in 1958 and 1959, the examiners of the Bureau of Internal Revenue conducted an investigation of petitioner's 1956 and 1957

income tax returns and, in the course thereof, they discovered and ascertained that petitioner had underdeclared its rental incomes by

P20,199.00 and P81,690.00 during these taxable years and had claimed excessive depreciation of its buildings in the sums of P4,260.00 and

P16,336.00 covering the same period. On the basis of these findings, respondent Commissioner of Internal Revenue issued its letter-

assessment and demand for payment of deficiency income tax and surcharge against petitioner corporation, computed as follows:

90-AR-C-348-58/56

Net income per audited return P 3,287.81

Add: Unallowable deductions:

Undeclared Rental Receipt

(Sched. A) . . . . . . . . . . . . . . . . . . . . P20,199.00

Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . . . 4,260.00 P24,459.00

Net income per investigation P27,746.00

Tax due thereon P5,549.00

Less: Amount already assessed 657.00

Balance P4,892.00

Add: 50% Surcharge 2,446.00

DEFICIENCY TAX DUE P7,338.00

90-AR-C-1196-58/57

Net income per audited return P11,098.00

Add: Unallowable deductions:

Undeclared Rental Receipt (Sched. A) . . . . . . . . P81,690.00

Excess Depreciation (Sched. B) . . . . . . . . . . . . . . . 16,338.00 P98,028.00

Net income per investigation P109,126.00

Tax due thereon P22,555.00

Less: Amount already assessed 2,220.00

Balance 20,335.00

Add: 50% Surcharge 10,167.50

DEFICIENCY TAX DUE P30,502.50

Petitioner corporation requested respondent Commissioner of Internal Revenue to reconsider the above assessment but the latter denied said

request and reiterated its original assessment and demand, plus 5% surcharge and the 1% monthly interest from June 30, 1959 to the date of

payment; hence, the corporation filed its petition for review before the Tax Appeals court, questioning the correctness and validity of the

above assessment of respondent Commissioner of Internal Revenue. It disclaimed having received or collected the amount of P20,199.00,

as unreported rental income for 1956, or any part thereof, reasoning out that 'the previous owners of the leased building has (have) to collect

part of the total rentals in 1956 to apply to their payment of rental in the land in the amount of P21,630.00" (par. 11, petition). It also denied

having received or collected the amount of P81,690.00, as unreported rental income for 1957, or any part thereof, explaining that part of

said amount totalling P31,380.00 was not declared as income in its 1957 tax return because its president, Isabelo P. Lim, who collected and

received P13,500.00 from certain tenants, did not turn the same over to petitioner corporation in said year but did so only in 1959; that a

certain tenant (Go Tong) deposited in court his rentals amounting to P10,800.00, over which the corporation had no actual or constructive

control; and that a sub-tenant paid P4,200.00 which ought not be declared as rental income.

Petitioner likewise alleged in its petition that the rates of depreciation applied by respondent Commissioner of its buildings in the above

assessment are unfair and inaccurate.

Sole witness for petitioner corporation in the Tax Court was its Secretary-Treasurer, Vicente G. Solis, who admitted that it had omitted to

report the sum of P12,100.00 as rental income in its 1956 tax return and also the sum of P29,350.00 as rental income in its 1957 tax return.

However, with respect to the difference between this omitted income (P12,100.00) and the sum (P20,199.00) found by respondent

Commissioner as undeclared in 1956, petitioner corporation, through the same witness (Solis), tried to establish that it did not collect or

receive the same because, in view of the refusal of some tenants to recognize the new owner, Isabelo P. Lim and Vicenta Pantangco Vda. de

Lim, the former owners, on one hand, and the same Isabelo P. Lim, as president of petitioner corporation, on the other, had verbally agreed

in 1956 to turn over to petitioner corporation six per cent (6%) of the value of all its properties, computed at P21,630.00, in exchange for

whatever rentals the Lims may collect from the tenants. And, with respect to the difference between the admittedly undeclared sum of

P29,350.00 and that found by respondent Commissioner as unreported rental income, (P81,690.00) in 1957, the same witness Solis also

tried to establish that petitioner corporation did not receive or collect the same but that its president, Isabelo P. Lim, collected part thereof

and may have reported the same in his own personal income tax return; that same Isabelo P. Lim collected P13,500.00, which he turned

over to petitioner in 1959 only; that a certain tenant (Go Tong deposited in court his rentals (P10,800.00), over which the corporation had no

actual or constructive control and which were withdrawn only in 1958; and that a sub-tenant paid P4,200.00 which ought not be declared as

rental income in 1957.

With regard to the depreciation which respondent disallowed and deducted from the returns filed by petitioner, the same witness tried to

establish that some of its buildings are old and out of style; hence, they are entitled to higher rates of depreciation than those adopted by

respondent in his assessment.

Isabelo P. Lim was not presented as witness to corroborate the above testimony of Vicente G. Solis.

On the other hand, Plaridel M. Mingoa, one of the BIR examiners who personally conducted the investigation of the 1956 and 1957 income

tax returns of petitioner corporation, testified for the respondent that he personally interviewed the tenants of petitioner and found that these

tenants had been regularly paying their rentals to the collectors of either petitioner or its president, Isabelo P. Lim, but these payments were

not declared in the corresponding returns; and that in applying rates of depreciation to petitioner's buildings, he adopted Bulletin "F" of the

U.S. Federal Internal Revenue Service.

On the basis of the evidence, the Tax Court upheld respondent Commissioner's assessment and demand for deficiency income tax which, as

above stated in the beginning of this opinion, petitioner has appealed to this Court.

Petitioner corporation pursues, the same theory advocated in the court below and assigns the following alleged errors of the trial court in its

brief, to wit:

I. The respondent Court erred in holding that the petitioner had an unreported rental income of P20,199.00 for the year 1956.

II. The respondent Court erred in holding that the petitioner had an unreported rental income of P81,690.00 for the year 1957.

III. The respondent Court erred in holding that the depreciation in the amount of P20,598.00 claimed by petitioner for the years

1956 and 1957 was excessive.

and prays that the appealed decision be reversed.

This appeal is manifestly unmeritorious. Petitioner having admitted, through its own witness (Vicente G. Solis), that it had undeclared more

than one-half (1/2) of the amount (P12,100.00 out of P20,199.00) found by the BIR examiners as unreported rental income for the year

1956 and more than one-third (1/3) of the amount (P29,350.00 out of P81,690.00) ascertained by the same examiners as unreported rental

income for the year 1957, contrary to its original claim to the revenue authorities, it was incumbent upon it to establish the remainder of its

pretensions by clear and convincing evidence, that in the case is lacking.

With respect to the balance, which petitioner denied having unreported in the disputed tax returns, the excuse that Isabelo P. Lim and

Vicenta Pantangco Vda. de Lim retained ownership of the lands and only later transferred or disposed of the ownership of the buildings

existing thereon to petitioner corporation, so as to justify the alleged verbal agreement whereby they would turn over to petitioner

corporation six percent (6%) of the value of its properties to be applied to the rentals of the land and in exchange for whatever rentals they

may collect from the tenants who refused to recognize the new owner or vendee of the buildings, is not only unusual but uncorroborated by

the alleged transferors, or by any document or unbiased evidence. Hence, the first assigned error is without merit.

As to the second assigned error, petitioner's denial and explanation of the non-receipt of the remaining unreported income for 1957 is not

substantiated by satisfactory corroboration. As above noted, Isabelo P. Lim was not presented as witness to confirm accountant Solis nor

was his 1957 personal income tax return submitted in court to establish that the rental income which he allegedly collected and received in

1957 were reported therein.

The withdrawal in 1958 of the deposits in court pertaining to the 1957 rental income is no sufficient justification for the non-declaration of

said income in 1957, since the deposit was resorted to due to the refusal of petitioner to accept the same, and was not the fault of its tenants;

hence, petitioner is deemed to have constructively received such rentals in 1957. The payment by the sub-tenant in 1957 should have been

reported as rental income in said year, since it is income just the same regardless of its source.

On the third assigned error, suffice it to state that this Court has already held that "depreciation is a question of fact and is not measured by

theoretical yardstick, but should be determined by a consideration of actual facts", and the findings of the Tax Court in this respect should

not be disturbed when not shown to be arbitrary or in abuse of discretion (Commissioner of Internal Revenue vs. Priscila Estate, Inc., et al.,

L-18282, May 29, 1964), and petitioner has not shown any arbitrariness or abuse of discretion in the part of the Tax Court in finding that

petitioner claimed excessive depreciation in its returns. It appearing that the Tax Court applied rates of depreciation in accordance with

Bulletin "F" of the U.S. Federal Internal Revenue Service, which this Court pronounced as having strong persuasive effect in this

jurisdiction, for having been the result of scientific studies and observation for a long period in the United States, after whose Income Tax

Law ours is patterned (M. Zamora vs. Collector of internal Revenue & Collector of Internal Revenue vs. M. Zamora; E. Zamora vs.

Collector of Internal Revenue and Collector of Internal Revenue vs. E. Zamora, Nos. L-15280, L-15290, L-15289 and L-15281, May 31,

1963), the foregoing error is devoid of merit.

Wherefore, the appealed decision should be, as it is hereby, affirmed. With costs against petitioner-appellant, Limpan Investment

Corporation.

CONSOLIDATED MINES, INC., petitioner,

vs.

COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.

G.R. Nos. L-18853 & L-18854 August 29, 1974

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

CONSOLIDATED MINES, INC., respondent.

Office of the Solicitor General for Commissioner of Internal Revenue.

Tañada, Carreon & Tañada for Consolidated Mines, Inc.

MAKALINTAL, C.J.:p

These are appeals from the amended decision of the Court of Tax Appeals dated August 7, 1961, in CTA Cases No. 565 and 578, both

entitled "Consolidated Mines, Inc. vs. Commissioner of Internal Revenue," ordering the Consolidated Mines, Inc., hereinafter referred to as

the Company, to pay the Commissioner of Internal Revenue the amounts of P79,812.93, P51,528.24 and P71,392.82 as deficiency income

taxes for the years 1953, 1954 and 1956, respectively, or the total sum of P202,733.99, plus 5% surcharge and 1% monthly interest from the

date of finality of the decision.

The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953 and 1956. In 1957

examiners of the Bureau of Internal Revenue investigated the income tax returns filed by the Company because on August 10, 1954, its

auditor, Felipe Ollada claimed the refund of the sum of P107,472.00 representing alleged overpayments of income taxes for the year 1951.

After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share

in the company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax purposes the Company

had reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had been overcharged; and (3) the claims

for audit and legal fees and miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956

(1) the Company had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported by

evidence.

In view of said reports the Commissioner of Internal Revenue sent the Company a letter of demand requiring it to pay certain deficiency

income taxes for the years 1951 to 1954, inclusive, and for the year 1956. Deficiency income tax assessment notices for said years were also

sent to the Company. The Company requested a reconsideration of the assessment, but the Commissioner refused to reconsider, hence the

Company appealed to the Court of Tax Appeals. The assessments for 1951 to 1954 were contested in CTA Case No. 565, while that for

1956 was contested in CTA Case No. 578. Upon agreement of the parties the two cases were heard and decided jointly.

On May 6, 1961 the Tax Court rendered judgment ordering the Company to pay the amounts of P107,846.56, P134,033.01 and P71,392.82

as deficiency income taxes for the years 1953, 1954 and 1956, respectively. The Tax Court nullified the assessments for the years 1951 and

1952 on the ground that they were issued beyond the five-year period prescribed by Section 331 of the National Internal Revenue Code.

However, on August 7, 1961, upon motion of the Company, the Tax Court reconsidered its decision and further reduced the deficiency

income tax liabilities of the Company to P79,812.93, P51,528.24 and P71,382.82 for the years 1953, 1954 and 1956, respectively. In this

amended decision the Tax Court subscribed to the theory of the Company that Benguet Consolidated Mining Company, hereafter referred to

as Benguet, had no right to share in "Accounts Receivable," hence one-half thereof may not be accrued as an expense of the Company for a

given year.

Both the Company and the Commissioner appealed to this Court. The Company questions the rate of mine depletion adopted by the Court

of Tax Appeals and the disallowance of depreciation charges and certain miscellaneous expenses (G.R. Nos.

L-18843 & L-18844). The Commissioner, on the other hand, questions what he characterizes as the "hybrid" or "mixed" method of

accounting utilized by the Company, and approved by the Tax Court, in treating the share of Benguet in the net profits from the operation of

the mines in connection with its income tax returns (G.R. Nos. L-18853 &

L-18854).

With respect to methods of accounting, the Tax Code states:

Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's annual accounting period

(fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in

keeping the books of such taxpayer but if no such method of accounting has been so employed or if the method employed

does not clearly reflect the income the computation shall be made in accordance with such methods as in the opinion of

the Commissioner of Internal Revenue does clearly reflect the income ...

Sec. 39. Period in which items of gross income included. — The amount of all items of gross income shall be included in

the gross income for the taxable year in which received by the taxpayer, unless, under the methods of accounting

permitted under section 38, any such amounts are to be properly accounted for as of a different period ...

Sec. 40. Period for which deductions and credits taken. — The deductions provided for in this Title shall be taken for the

taxable year in which "paid or accrued" or "paid or incurred" dependent upon the method of accounting upon the basis of

which the net income is computed, unless in order to clearly reflect the income the deductions should be taken as of a

different period ...

It is said that accounting methods for tax purposes 1

comprise a set of rules for determining when and how to report income and deductions.

The U.S. Internal Revenue Code 2

allows each taxpayer to adopt the accounting method most suitable to his business, and requires only that

taxable income generally be based on the method of accounting regularly employed in keeping the taxpayer's books, provided that the

method clearly reflects income. 3

The Company used the accrual method of accounting in computing its income. One of its expenses is the amount-paid to Benguet as mine

operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus

disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the

"accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem, therefore,

that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis. The question

is whether or not the accounting system used by the Company justifies such a treatment of this item; and if not, whether said method used

by the Company, and characterized by the Commissioner as a "hybrid method," may be allowed under the aforequoted provisions of our tax

code. 4

For a proper understanding of the situation the following facts are stated: The Company has certain mining claims located in Masinloc,

Zambales. Because it wanted to relieve itself of the work and expense necessary for developing the claims, the Company, on July 9, 1934,

entered into an agreement (Exhibit L) with Benguet, a domestic anonymous partnership engaged in the production and marketing of

chromite, whereby the latter undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims.

The pertinent provisions of their agreement, as amended by the supplemental agreements of September 14, 1939 (Exhibit L-1) and October

2, 1941 (Exhibit L-2), are as follows:

IV. Benguet further agrees to provide such funds from its own resources as are in its judgment necessary for the

exploration and development of said claims and properties, for the purchase and construction of said concentrator plant

and for the installation of the proper transportation facilities as provided in paragraphs I, II and III hereof until such time

as the said properties are on a profit producing basis and agrees thereafter to expand additional funds from its own

resources, if the income from the said claims is insufficient therefor, in the exploration and development of said properties

or in the enlargement or extension of said concentration and transportation facilities if in its judgment good mining

practice requires such additional expenditures. Such expenditures from its own resources prior to the time the said

properties are put on a profit producing basis shall be reimbursed as provided in paragraph VIII hereof. Expenditures from

its own resources thereafter shall be charged against the subsequent gross income of the properties as provided in

paragraph X hereof.

VII. As soon as practicable after the close of each month Benguet shall furnish Consolidated with a statement showing its

expenditures made and ore settlements received under this agreement for the preceding month which statement shall

betaken as accepted by Consolidated unless exception is taken thereto or to any item thereof within ten days in writing in

which case the dispute shall be settled by agreement or by arbitration as provided in paragraph XXII hereof.

VIII. While Benguet is being reimbursed for all its expenditures, advances and disbursements hereunder as evidenced by

said statements of accounts, the net profits resulting from the operation of the aforesaid claims or properties shall be

divided ninety per cent (90%) to Benguet and ten per cent (10%) to Consolidated. Such division of net profits shall be

based on the receipts, and expenditures during each calendar year, and shall continue until such time as the ninety per cent

(90%) of the net profits pertaining to Benguet hereunder shall equal the amount of such expenditures, advances and

disbursements. The net profits shall be computed as provided in Paragraph X hereof.

X. After Benguet has been fully reimbursed for its expenditures, advances and disbursements as aforesaid the net profits

from the operation shall be divided between Benguet and Consolidated share and share alike, it being understood

however, that the net profits as the term is used in this agreement shall be computed by deducting from gross income all

operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of this

agreement.

XIII. It is understood that Benguet shall receive no compensation for services rendered as manager or technical

consultants in connection with the carrying out of this agreement. It may, however, charge against the operation actual

additional expenses incurred in its Manila Office in connection with the carrying out of the terms of this agreement

including traveling expenses of consulting staff to the mines. Such expenses, however, shall not exceed the sum of One

Thousand Pesos (P1,000.00) per month. Otherwise, the sole compensation of Benguet shall be its proportion of the net

profits of the operation as herein above set forth.

XIV. All payments due Consolidated by Benguet under the terms of this agreement with respect to expenditures made and

ore settlements received during the preceding calendar month, shall be payable on or before the twentieth day of each

month.

There is no question with respect to the 90%-10% sharing of profits while Benguet was being reimbursed the expenses disbursed during the

period it was trying to put the mines on a profit-producing basis. 5

It appears that by 1953 Benguet had completely recouped said advances,

because they were then dividing the profits share and share alike. .

As heretofore stated the question is: Under the arrangement between the Company and Benguet, when did Benguet's 50% share in the

"Accounts Receivable

accrue? 6

The following table (summary, Exhibit A, of examiner's report of January 28, 1967, Exh. 8) prepared for the Commissioner graphically

illustrates the effect of the inclusion of one-half of "Accounts Receivable" as expense in the computation of the net income of the Company:

SUMMARY: 1951 1952 1953 1954

Original share of

Benguet

1,313,640.26 3,521,751,94 2,340,624.59 2,622,968.58

Additional share

of Rec'bles

383,829.87 677,504.76 577,394.66 282,724.76

Total share of

Benguet

1,697,470.13 4,199,256.70 2,918,009.25 2,905,693.34

Less: Receipts due

from prior year

operation

269,619.00 383,829.87 677,504.76 577,384.66

Share of Benguet

as adjusted

(Acc'rd)

1,427,851.13 3,815,426.83 2,240,504.49 2,328,308.68

Less: Participation

of Benguet

already deducted

1,313,640.26 3,521,751.94 2,340,624.59 2,622,968.58

Additional

Expense (Income)

114,210.87 293,674.89 (100,120.10) (294,659.90)

In the aforesaid table "Additional share on Rec'bles" is one-half of "Total Rec'bles minus "Total Payables." It indicates, from the

Commissioner's viewpoint, that there were years when the Company had been overstating its income (1951 and 1952) and there were years

when it had been understating its income (1953 and 1954). 7

The Commissioner is not interested in the taxes for 1951 and 1952 (which had

prescribed anyway) when the Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the

"Accounts Receivable" was less than that of the previous year, and the Company, therefore, appears to have deducted, as expense,

compensation to Benguet bigger (than what the Commissioner claims is due) by one-half of the difference between the year's "Accounts

Receivable" and the previous year's "Accounts Receivable," thus apparently understating its income to that extent.

According to the agreement between the Company and Benguet the net profits "shall be computed by deducting from gross income all

operating expenses and all expenses of any nature whatsoever." Periodically, Benguet was to furnish the Company with the statement of

accounts for a given month "as soon as practicable after the close" of that month. The Company had ten days from receipt of the statement

to register its objections thereto. Thereafter, the statement was considered binding on the Company. And all payments due the Company

"with respect to the expenditures made and ore settlements received during the calendar month shall be payable on or before the twentieth

of each month."

The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from the terms of the agreement?

The statement of accounts (par. VIII) and the payment part (XIV) that Benguet 8 must make are both with respect to "expenditures made and

ore settlements received." "Expenditures" are payments of money. 9

This is the meaning intended by the parties, considering the provision

that Benguet agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources" were to be

reimbursed first as provided in par. VIII, and later as provided in par. X. "Settlement" does not necessarily mean payment or satisfaction,

though it may mean that; it frequently means adjustment or arrangement. 10

The term "settlement" may be used in the sense of "payment," or

it may be used in the sense of "adjustment" or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance

between contending parties," depending upon the circumstances under which, and the connection in which, use of the term is made. 11

In the

term "ore settlements received," the word "settlement" was not used in the concept of "adjustment," "arrangement" or "ascertainment of a

balance between contending parties," since all these are "made," not "received." "Payment," then, is the more appropriate equivalent of, and

interchangeable with, the term "Settlement." Hence, "ore settlements received" means "ore payments received," which excludes "Accounts

Receivable." Thus, both par. VIII and par. XIV refer to "payment," either received or paid by Benguet.

According to par. X, the 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by deducting from gross income all

operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of the agreement." The

term "gross profit" was not defined. In the accrual method of accounting "gross income" would include both "cash receipts" and "Accounts

Receivable." But the term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be defined in

such a way as to ascertain the sense in which the parties have used it in contracting. 12

According to par. VIII 13

the "division of net profits

shall be based on the receipts and expenditures." The term "expenditures" we have already analyzed. As used, receipts" means "money

received." 14

The same par. VIII uses the term "expenditures, advances and disbursements." "Disbursements" means "payment," 15

while the

word "advances" when used in a contract ordinarily means money furnished with an expectation that it shall be returned. 16

It is thus clear

from par. VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing arrangement) only "cash payments" received

and "cash disbursements" made by Benguet were to be considered. On the presumption that the parties were consistent in the use of the

term, the same meaning must be given to "net profits" as used in par. X, and "gross income," accordingly, must be equated with "cash

receipts." The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual receipts over

disbursements, without considering "Accounts Receivable" and "Accounts Payable" as factors in the computation. Benguet then did not

have a right to share in "Accounts Receivable," and, correspondingly, the Company did not have the liability to pay Benguet any part of that

item. And a deduction cannot be accrued until an actual liability is incurred, even if payment has not been made. 17

Here we have to distinguish between (1) the method of accounting used by the Company in determining its net income for tax purposes; and

(2) the method of computation agreed upon between the Company and Benguet in determining the amount of compensation that was to be

paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation the basis

were "cash receipts" and "cash payments." Once determined in accordance with the stipulated bases and procedure, then the amount due

Benguet for each month accrued at the end of that month, whether the Company had made payment or not (see par. XIV of the agreement).

To make the Company deduct as an expense one-half of the "Accounts Receivable" would, in effect, be equivalent to giving Benguet a right

which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated

by them. 18

Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing said one-half as a deduction.

The Company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting. The first

issue raised by the Company is with respect to the rate of mine depletion used by the Court of Tax Appeals. The Tax Code provides that in

computing net income there shall be allowed as deduction, in the case of mines, a reasonable allowance for depletion thereof not to exceed

the market value in the mine of the product thereof which has been mined and sold during the year for which the return is made [Sec. 30(g)

(1) (B)]. 19

The formula 20

for computing the rate of depletion is:

Cost of Mine Property

---------------------- = Rate of Depletion Per Unit Estimated ore Deposit of Product Mined and sold

The Commissioner and the Company do not agree as to the figures corresponding to either factor that affects the rate of depletion per unit.

The figures according to the Commissioner are:

P2,646,878.44 (mine cost) P0.59189 (rate of

------------------------- = depletion per ton)

4,471,892 tons (estimated ore deposit)

while the Company insists they are:

P4,238,974.57 (mine cost) P1.0197 (rate of

------------------------- - = depletion per ton)

4,156,888 tons (estimated

ore deposit)

They agree, however, that the "cost of the mine property" consists of (1) mine cost; and (2) expenses of development before production. As

to mine cost, the parties are practically in agreement — the Commissioner says it is P2,515,000 (the Company puts it at P2,500,000). As to

expenses of development before production the Commissioner and the Company widely differ. The Company claims it is P1,738,974.56,

while the Commissioner says it is only P131,878.44. The Company argues that the Commissioner's figure is "a patently insignificant and

inadequate figure when one considers the tens of millions of pesos of revenue and production that petitioner's chromite mine fields have

finally produced."

As an income tax concept, depletion is wholly a creation of the statute 21

— "solely a matter of legislative grace." 22

Hence, the taxpayer has

the burden of justifying the allowance of any deduction claimed. 23

As in connection with all other tax controversies, the burden of proof to

show that a disallowance of depletion by the Commissioner is incorrect or that an allowance made is inadequate is upon the taxpayer, and

this is true with respect to the value of the property constituting the basis of the deduction. 24

This burden-of-proof rule has been frequently

applied and a value claimed has been disallowed for lack of evidence. 25

As proof that the amount spent for developing the mines was P1,738,974.56, the Company relies on the testimony of Eligio S. Garcia and

on Exhibits 1, 31 and 38.

Exhibit I is the Company's report to its stockholders for the year 1947. It contains the Company's balance sheet as of December 31, 1946

(Exhibit I-1). Among the assets listed is "Mines, Improvement & Dev." in the amount of P4,238,974.57, which, according to the Company,

consisted of P2,500,000, purchase price of the mine, and P1,738,974.56, cost of developing it. The Company also points to the statement

therein that "Benguet invested approximately P2,500,000 to put the property in operation, the greater part of such investment being devoted

to the construction of a 25-kilometer road and the installation of port facilities." This amount of P2,500,000 was only an estimate. The

Company has not explained in detail in what this amount or the lesser amount of P1,738,974.56 consisted. Nor has it explained how that

bigger amount became P1,738,974.56 in the balance sheet for December 31, 1946.

According to the Company the total sum of P4,238,974.57 as "Mines, Improvement & Dev." was taken from its pre-war balance sheet of

December 31, 1940. As proof of this it cites the sworn certification (Exhibit 38) executed on October 25, 1946 by R.P. Flood, in his

capacity as treasurer of the Company, and attached to other papers of the Company filed with the Securities and Exchange Commission in

compliance with the provisions of Republic Act No. 62 (An Act to require the presentation of proof of ownership of securities and the

reconstruction of corporate and partnership records, and for other purposes). In said certification there are statements to the effect that "the

Statement of Assets & Liabilities of Consolidated Mines, Incorporated, submitted to the Securities & Exchange Commission as a

requirement for the reconstitution of the records of the said corporation, is as of September 4, 1946;" and that "the figure P4,238,974.57

representing the value of Mines, Improvements and Developments appearing therein, was taken from the Balance Sheet as of December 31,

1940, which is the only available source of information of the Corporation regarding the above and consequently the undersigned considers

the stated figure to be only an estimate of the value of those items at the present time. "This figure, the Company claims, is based on entries

made in the ordinary and regular course of its business dating as far back as before the war. The Company places reliance on Sec. 39, Rule

130, Revised Rules of Court (formerly Sec. 34, Rule 123), which provides that entries made at, or near the time of the transactions to which

they refer, by a person deceased, outside of the Philippines or unable to testify, who was in a position to know the facts therein stated, may

be received as prima facie evidence, if such person made the entries in his professional capacity or in the performance of duty and in the

ordinary or regular course of business or duty."

Note that Exhibit 38 is not the "entries," covered by the rule. The Company, however, urges, unreasonably, we think, that it should be

afforded the same probative value since it is based on such "entries" meaning the balance sheet of December 31, 1940, which was not

presented in evidence. Even with the presentation of said balance sheet the Company would still have had to prove (1) that the person who

made the entry did so in his professional capacity or in the performance of a duty; (2) that the entry was made in the ordinary course of

business or duty; (3) that the entry was made at or near the time of the transaction to which it related; (4) that the one who made it was in a

position to know the facts stated in the entry; and (5) that he is dead, outside the Philippines or unable to testify 26

A balance sheet may not be considered as "entries made in the ordinary course of business," which, according to Moran:

means that the entries have been made regularly, as is usual, in the management of the trade or business. It is essential,

therefore, that there be regularity in the entries. The entry which is being introduced in evidence should appear to be part

of a group of regular entries. ... The regularity of the entries maybe proved by the form in which they appear in the

corresponding book. 27

A balance sheet, as that word is uniformly used by bookkeepers and businessmen, is a paper which shows "a summation or general balance

of all accounts," but not the particular items going to make up the several accounts; and it is therefore essentially different from a paper

embracing "a full and complete statement of all the disbursements and receipts, showing from what sources such receipts were derived, and

for what and to whom such disbursements or payments were made, and for what object or purpose the same were made;" but such matters

may find an appropriate place in an itemized account. 28

Neither can it be said that a balance sheet complies with the third requisite, since

the entries therein were not made at or near the time of the transactions to which they related.

In order to render admissible books of account it must appear that they are books of original entry, that the entries were

made in the ordinary course of business, contemporaneously with the facts recorded, and by one who had knowledge of

the facts. San Francisco Teaming Co v Gray (1909) 11 CA 314, 104 P 999. See Brown v Ball (1932) 123 CA 758, 12 P2d

28, to the effect that the books must be kept in the regular course of business. 29

A "ledger" is a book of accounts in which are collected and arranged, each under its appropriate head, the various

transactions scattered throughout the journal or daybook, land is not a "book of original entries," within the rule making

such books competent evidence. First Nat. Building Co. v. Vanderberg, 119 P 224, 227; 29 Okl. 583. 30

Code Iowa, No. 3658, providing that "books of account" are receivable in evidence, etc., means a book containing

charges, and showing a continuous dealing with persons generally. A book, to be admissible, must be kept as an account

book, and the charges made in the usual course of business. Security Co. v. Graybeal, 52 NW 497, 85 Iowa 543, 39 Am St

Rep 311. 31

Books of account may therefore be admissible under the rule. In tax cases, however, this Court appears not to place too high a probative

value on them, considering the statement in the case of Collector of Internal Revenue v. Reyes 32

that "books of account do not prove per se

that they are veracious; in fact they may be more consistent than truthful." Indeed, books of account may be used to carry out a plan of tax

evasion. 33

At most, therefore, the presentation of the balance sheet of December 31, 1940 would only prove that the figure P4,238,974.57 appears

therein as corresponding to mine cost. But the Company would still need to present proof to justify its adoption of that figure. It had burden

of establishing the components of the amount of P1,738,974.57: what were the particular expenses made and the corresponding amount of

each, so that it may be determined whether the expenses were actually made and whether the items are properly part of cost of mine

development, or are actually depreciable items.

In this connection we take up Exhibit 31 of the Commissioner. This is the memorandum of BIR Examiner Cesar P. Aguirre to the Chief of

the Investigating Division of the Bureau of Internal Revenue. According to this report "the counsel of the taxpayer alleges that the cost of

Masinloc Mine properties and improvement is P4,238,974.56 instead of P2,646,879.44 as taken up in this report," and that the expenses as

of 1941 were as follows:

Assets subject to:

1941

1. Depletion P2,646,878.44

2. 10 years depreciation 1,188,987.76

3. 3 years depreciation 78,283.75

4. 20 years depreciation 9,143.63

5. 10% amortization 171,985.00

Less: Cost Chromite Field P4,085,277.58

Expenses by operator 2,515,000.00 P1,570,277.58

The examiner concluded that "in the light of the figures listed above, the counsel for the taxpayer fairly stated the amount disbursed by the

operator until the mine property was put to production in 1939." The Company capitalizes on this conclusion, completely disregarding the

examiner's other statements, as follows:

The counsel, however, is not aware of the fact that the expenses made by the operator are those which are depreciable

and\or amortizable instead of depletable expenditures. The first post-war Balance Sheet (12/31/46) of the taxpayer shows

that its Mines, Improvement & Dev. is P4,328,974.57. Considering the expenditures incurred by Benguet Consolidated as

of 1941 (P1,570,277.58); the rehabilitation expenses in 1946 (P211,223.72); and the cost of the Masinloc Chromite Field,

the total cost would only be P4,296,501.30. Of the total expenditure of P1,570,277.58 as of 1941, P1,438,389.124 were

spent on depreciable and/or amortizable expenses and P131,878.44 were made for the direct improvement of the mine

property.

In as much as the expenditure of the operator as of 1941 and the cost of the mine property were taken up in the account

Mines, Improvement & Rehabilitation in 1946, all its assets that were rightfully subject to depletion was P2,646,878.44.

Because of the above qualification a large part of the amount spent by the operator 34

may not be allowed for purpose of depletion

deduction, 35

depletion being different from depreciation. 36

The Company's balance sheet for December 31, 1947 lists the "mine cost" of P2,500,000 as "development cost" and the amount of

P1,738,974.37 as "suspense account (mining properties subject to war losses)." The Company claims that its accountant, Mr. Calpo, made

these errors, because he was then new at the job. Granting that was what had happened, it does not affect the fact that the, evidence on hand

is insufficient to prove the cost of development alleged by the Company.

Nor can we rely on the statements of Eligio S. Garcia, who was the Company's treasurer and assistant secretary at the time he testified on

August 14, 1959. He admitted that he did not know how the figure P4,238,974.57 was arrived at, explaining: "I only know that it is the

figure appearing on the balance sheet as of December 31, 1946 as certified by the Company's auditors; and this we made as the basis of the

valuation of the depletable value of the mines." (p. 94, t.s.n.)

We, therefore, have to rely on the Commissioner's assertion that the "development cost" was P131,878.44, broken down as follows:

assessment, P34,092.12; development, P61,484.63; exploration, P13,966.62; and diamond drilling, P22,335.07.

The question as to which figure should properly correspond to "mine cost" is one of fact. 37

The findings of fact of the Tax Court, where

reasonably supported by evidence, are conclusive upon the Supreme Court. 38

As regards the estimated ore deposit of the Company's mines, the Company's figure is "4,156,888 tons," while that of the Commissioner is

the larger figure "4,471,892 tons." The difference of 315,004 tons was due to the fact that the Commissioner took into account all the ore

that could probably be removed and marketed by the Company, utilizing the total tonnage shipped before and after the war (933,180 tons)

and the total reserve of shipping material pegged at 3,583,712 tons. On the other hand the Company's estimate was arrived at by taking into

consideration only the quantity shipped from solid ore namely, 733,180 tons (deducting from the total tonnage shipped before and after the

war an estimated float of 200,000 tons), and then adding the total recoverable ore which was assessed at 3,423,708 tons.

The above-stated figures were obtained from the report 39

of geologist Paul A. Schaeffer, who had been earlier commissioned by the

Company to conduct a study of the metallurgical possibilities of the Company's mines. In order to have a fair understanding of how the

contending parties arrived at their respective figures, We quote a pertinent portion of the geologist's report:

Milling Data

Ore mined before the war ............... 336,850 tons

Ore mined after the war ............... 1,779,350 tons

Total ........................................... 2,116,200 tons

x Ore shipped before the war ......... 337,611 tons

xx Ore shipped after the war ............ 595,569 tons

Total ................................................ 933,180 tons

Less an estimated float of .................. 200,000 tons

Total shipped from solid ore .............. 733,180 tons

Proportion shipped 733,180

-------- = -----------

mined 2,116,200

or approximately 35% of mine ore is shipped.

Dumps

Material on dumps now total 383,346 tons. Using the above tonnage for ore shipped from mining (excluding float) there should have been a

total of 1,383,020 tons of waste produced of which almost 1,000,00 tons has been removed from the mining area of the hill. I believe that

half still remains as alluviuma long the three principal intermittent creeks which head in the mining area, and the remaining half million has

washed into the river. Of course this is pure speculation.

x — much was float material, probably about one half, leaving about 170.000 tons mined from the hill.

xx — some float included.

xxx xxx xxx

Ore Reserve

The A and B ore is considered sufficiently developed by drilling and tunnels to constitute the ore reserve. C ore must be checked by drilling.

Tons

A . . . . . . . . . . . . . 7,729,800

B . . . . . . . . . . . . . 1,780,500

Total . . . . . . . . . . 9,510,300

C . . . . . . . . . . . . . 2,212,00

Grand Total . . . . 11,722,300

Therefore, the total ore reserve may be considered to be 9,510,300 tons. Based on past experience 35% is shipping ore.

With the present mill there is considerably more recovery. The ore is mined selectively (between dikes). The results are about as follows:

Of 1,500 tons mined, 500 tons are sorted and shipped direct, the remaining 1,000 tons going to the mill from which 250 tons ore recovered

for shipment. Thus 50% of the selectively mined ore is recovered.

Thus for the reserve tonnage:

Total reserve . . . . . . . . . . . . . . . 9,510,300

Less 20% dike material . . . . . . . 1,902,060

7,608,240

Less 10% low grade ore . . . . . . 760,824

6,847,416

x

.50 =

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

It is probable that 30% of the dump material could be recovered by milling. So adding to the above 115,004 ore

recoverable from the dumps, we get a total reserve of shipping material of 3,538,712 tons. With the sink float section

added to the mill this should be increased by perhaps 20%.

On the basis of the above report the Company faults the Tax Court is sustaining the Commissioner's estimate of the ore deposit. While the

figures corresponding to the total gross tonnage shipped before and after the war have not been assailed as erroneous, the Company

maintains that the estimated float 40 of 200,000 tons as reported in the geologist's study should have been deducted therefrom, such that the

combined total of the ore shipped should have been placed at a net of 733,180 tons instead of 933,180 tons. The other figure the Company

assails as having been improperly included by the Commissioner in his statement of ore reserve refers to the "Recoverable ore from dump

material — 115,004 tons." The Company's argument in this regard runs thus:

... This apparently was included by respondent by virtue of the geologist's report that "it is probable that 30% of the dump

material should be recovered by milling." Actually, however, such recovery from dump or waste material is problematical

and is merely a contingency, and hence, the item of 115,004 tons should not be included in the statement of the ore

reserves. Taking out these two items improperly and erroneously included in respondent Commissioner of Internal

Revenue's examiner's report, to wit, float or waste material of 200,060 tons and supposedly recoverable ore from dump

materials of 115,004 tons, totaling 315,004 tons, from the total figure of 4,471,892 tons given by him, the figure of

4,156.888 tons results as the proper statement of the total estimated ore as correctly used by petitioner in its statement of

ore reserves for purposes of depletion. 41

We agree with the Company's observation on this point. The geological report appears clear enough: the estimated float of 200,000 tons

consisting of pieces of ore that had broken loose and become detached by erosion from their original position could hardly be viewed as still

forming part of the total estimated ore deposit. Having already been broken up into numerous small pieces and practically rendered useless

for mining purposes, the same could not appreciably increase the ore potentials of the Company's mines. As to the 115,004 tons which

geologist Paul A. Schaeffer believed could still be recovered by milling from the material on dumps, there are no sufficient data on which to

affirm or deny the accuracy of the said figure. It may, however, be taken as correct, considering that it came from the Company's own

commissioned geologist and that by the Company's own admission 42

by 1957 it had mined and sold much more than its original estimated

ore deposit of 4,156,888 tons. We think that 4,271,892 tons 43

would be a fair estimate of the ore deposit in the Company's mines.

The correct figures therefore are:

P2,515,000.00 (mine cost proper) + P131,878.44 (development cost)

4,271,892 (estimated ore deposit)

or

P2,646,878.44 (mine cost) = P0.6196 (rate of depletion

4,271,892 (estimated ore per ton)

deposit)

In its second assigned error, the Company questions the disallowance by the Tax Court of the depreciation charges claimed by the Company

as deductions from its gross income 44

The items thus disallowed consist mainly of depreciation expenses for the years 1953 and 1954

allegedly sustained as a result of the deterioration of some of the Company's incomplete constructions.

The initial memorandum 45

of the BIR examiner assigned to verify the income tax liabilities of the Company pursuant to the latter's claim of

having overpaid its income taxes states the basic reason why the Company's claimed depreciation should be disallowed or re-adjusted, thus:

since "..., up to its completion (the incomplete asset) has not been and is not capable of use in the operation, the depreciation claimed could

not, in fairness to the Government and the taxpayer, be considered as proper deduction for income tax purposes as the said asset is still

under construction." Vis-a-Vis the Commissioner's consistent position in this regard the company simply repeatedly requested for time 46

—

in view of the alleged voluminous working sheets that had to be re-evaluated and recomputed to justify its claimed depreciation items

within which to submit a separate memorandum in itemized form detailing the Company's objections to the items of depreciation

adjustments or disallowances for the years involved. Strangely enough, despite the period granted, the record is bare that the Company ever

submitted its itemized objection as proposed. Inasmuch as the taxpayer has the burden of justifying the deductions claimed for depreciation,

the Company's failure to discharge the burden prevents this Court, from disturbing the Commissioner's computation. For taxation purposes

the phrase "out of its not being used," with reference to depreciation allowable on assets which are idle or the use of which is temporarily

suspended, should be understood to refer only to property that has once been used in the trade or business, not to property that has never

been actually devoted to the taxpayer's business, particularly incomplete assets that have yet to be used. .

The Company's third assigned error assails the Court of Tax Appeals in not allowing the deduction from its gross income of certain

miscellaneous business expenditures in the course of its operation for the years 1954 and 1956. For 1954 the deduction claimed amounted to

P38,081.20, of which the Court allowed P25,600.00 and disallowed P13,481.20, 47

"for lack of any supporting paper or evidence." For the

year 1956 the claim amounted to P20,050.00 of which the Court allowed P2,460.00, representing the one-month salary Christmas bonus

given to some of the employees, and upheld the disallowance of P17,590.00 on the ground that the Company "failed to prove substantially

that said expenses were actually incurred and are legally deductible expenses."

Regarding the disallowed amount of P13,481.20 the year 1954, the Company submits that it consisted of expenses supported by "vouchers

and cancelled checks evidencing payments of these amounts," and were necessary and ordinary expenses of business for that year. On the

disallowance by the Tax Court of the sum of P17,590.00 out of a total deduction for miscellaneous expenses for 1956 among to P20,050.00,

the Company advances the same argument, namely, that the amount consisted of normal and regular expenses for that year as evidenced by

vouchers and cancelled checks.

These vouchers and cancelled checks of the Company, however, only show that the amounts claimed had indeed been spent, and confirm

the fact of disbursement, but do not necessarily prove that the expenses for which they we're disbursed are deductible items. In the case of

Collector of Internal Revenue vs. Goodrich International Rubber Co. 48

this Court rejected the taxpayer's similar claim for deduction of

alleged representation expenses, based upon receipts issued not by the entities to which the alleged expenses but by the officers of taxpayer

corporation who allegedly paid them. It was there stated:

If the expenses had really been incurred, receipts or chits would have been issued by the entities to which the payments

have been made, and it would have been easy for Goodrich or its officers to produce such receipts. These receipts issued

by said officers merely attest to their claim that they had incurred and paid said expenses. They do not establish payment

of said alleged expenses to the entities in which the same are said to have been incurred.

In the case before Us, except for the Company's own vouchers and cancelled checks, together with the Company treasurer's lone and

uncorroborated testimony regarding the purpose of said disbursements, there is no other supporting evidence to show that the expenses were

legally deductible items. We therefore affirm the Tax Court's disallowance of the same.

In resume, this Court finds:

(1) that the Company was not using a "hybrid" method of accounting in the preparation of its income tax returns, but was consistent in its

use of the accrual method of accounting;

(2) that the rate of depletion per ton of the ore deposit mined and sold by the Company is P0.6196 per ton 49

not P0.59189 as contended by

the Commissioner nor P1.0197 as claimed by the Company;

(3) that the disallowance by the Tax Court of the depreciation charges claimed by the Company is correct in view of the latter's failure to

itemize and/or substantiate with definite proof that the Commissioner's own method of determining depreciation is unreasonable or

inaccurate;

(4) that for lack of supporting evidence to show that the Company's claimed expenses were legally deductible items, the Tax Court's

disallowance of the same is affirmed.

As recomputed then, the deficiency income taxes due from the Company are as follows:

1953

Net income as per audited return _________________ P5,193,716.89

Unallowable deductions & additional income

Depletion overcharged _________________________ P178,477.04 Depreciation adjustment ________________________ 93,862.96

Total adjustments _____________________________ 272,340.00

Net income as per investigation ___________________ 5,466,056.89

Income tax due thereon 50

_______________________ 1,522,495.92

Less amount already assessed ____________________ 1,446,241.00 DEFICIENCY TAX DUE ______________________ 76,254.92

1954

Net income as per audited return _________________ P3,320,307.68 Unallowable deductions & additional

income

Depletion overcharged _________________________ P147,895.72 Depreciation adjustment ________________________ 11,878.12

Miscellaneous expenses ________________________ 13,481.20

Total adjustments _____________________________ 173,255.04

Net income as per investigation ___________________ 3,493,562.72

Income tax due thereon _________________________ 970,197.56

Less amount already assessed ____________________ 921,686.00 DEFICIENCY TAX DUE ______________________ 48,511.56

1956

Net income as per audited return _________________ P11,504,483.97 Unallowable deductions & additional

income

Depletion overcharged _________________________ P221,272.98 Miscellaneous expenses ________________________ 17,590.00

Total adjustments _____________________________ 238,862.98

Net income as per investigation __________________ 11,743,346.95

Income tax due thereon ________________________ 3,280,137.14

Less amount already assessed ___________________ 3,213,256.00 DEFICIENCY TAX DUE ______________________ 66,881.14

TOTAL DEFICIENCY TAXES DUE _____________ 191,647.62

WHEREFORE, the appealed decision is hereby modified by ordering Consolidated Mines, Inc. to pay the Commissioner of Internal

Revenue the amounts of P76,254.92, P48,511.56 and P66,881.14 as deficiency income taxes for the years 1953, 1954 and 1956,

respectively, or the total sum of P191,647.62 under the terms specified by the Tax Court, without pronouncement as to costs.

3M PHILIPPINES, INC., petitioner,

vs.

COMMISSIONER OF INTERNAL REVENUE, respondent.

Bito, Misa & Lozada for petitioner.

The Office of the Solicitor General for respondent.

GRIÑO-AQUINO, J.:

This is a petition for review of the decision of the Court of Tax Appeals which affirmed the assessment of deficiency income tax on the

petitioner's 1974 income tax return, for deductions of "business expenses" in the form of royalty payments to its foreign licensor which the

respondent Commissioner of Internal Revenue disallowed. This case hinges on the propriety or impropriety of the deductions.

3M Philippines, Inc. is a subsidiary of the Minnesota Mining and Manufacturing Company (or "3M-St. Paul") a non-resident foreign

corporation with principal office in St. Paul, Minnesota, U.S.A. It is the exclusive importer, manufacturer, wholesaler, and distributor in the

Philippines of all products of 3M-St. Paul. To enable it to manufacture, package, promote, market, sell and install the highly specialized

products of its parent company, and render the necessary post-sales service and maintenance to its customers, petitioner entered into a

"Service Information and Technical Assistance Agreement" and a "Patent and Trademark License Agreement" with the latter under which

the petitioner agreed to pay to 3M-St. Paul a technical service fee of 3% and a royalty of 2% of its net sales. Both agreements were

submitted to, and approved by, the Central Bank of the Philippines.

In its income tax return for the fiscal year ended October 31, 1974, the petitioner claimed the following deductions as business expenses:

(a) royalties and technical service fees of P 3,050,646.00; and

(b) pre-operational cost of tape coater of P97,485.08.

On the first item, the respondent Commissioner of Internal Revenue allowed a deduction of P797,046.09 only as technical service fee and

royalty for locally manufactured products, but disallowed the sum of P2,323,599.02 alleged to have been paid by the petitioner to 3M-St.

Paul as technical service fee and royalty on P46,471,998.00 worth of finished products imported by the petitioner from the parent company,

on the ground that the fee and royalty should be based only on locally manufactured goods. The improper deduction was treated by

respondent as a disguised dividend or income.

On the second item, respondent allowed P19,544.77 or one-fifth (1/5) of petitioner's capital expenditure of P97,046.09 for its tape coater

which was installed in 1973 because such expenditure should be amortized for a period of five (5) years, hence, payment of the disallowed

balance of P77,740.38 should be spread over the next four (4) years. Respondent ordered petitioner to pay P840,540 as deficiency income

tax on its 1974 return, plus P353,026.80 as 14% interest per annum from February 15, 1975 to February 15, 1976, or a total of

P1,193,566.80.

Petitioner protested the assessment in a letter dated March 7, 1980. The respondent Commissioner did not answer the protest. Instead, he

issued warrants of distraint and levy on October 1, 1984. On October 23, 1984, petitioner appealed to the Court of Tax Appeals by petition

for review with a prayer for the issuance of a writ of preliminary injunction to stop the enforcement of the warrants of distraint and levy.

The writ was issued upon petitioner posting a P1,850,000 bond.

After the respondent had filed his answer to the petition for review and hearings were held, the Tax Court rendered a decision on August 14,

1987 upholding the Commissioner's ruling. Petitioner's motion for reconsideration of the decision was denied by the Tax Court on April 6,

1988. A copy of the resolution was received by petitioner on April 21, 1988.

On April 25, 1988, petitioner sought a review in this Court of the Tax Court's decision.

The pertinent legal provisions in this case are Section 29(a)(1) of the Internal Revenue Code and Circular No. 393 of the Central Bank.

Because remittances to foreign licensors of technical service fees and royalties are made in foreign exchange, CB Circular No. 393

(Regulations Governing Royalties/Rentals) dated December 7, 1973 was promulgated by the Central Bank as an exchange control

regulation to conserve foreign exchange and avoid unnecessary drain on the country's international reserves (69 O.G. No. 51, pp. 11737-38).

Section 3-C of the circular provides that royalties shall be paid only on commodities manufactured by the licensee under the royalty

agreement:

Section 3. Requirements for Approval and Registration. — The requirements for approval and registration as provided for

in Section 2 above include, but are not limited to the following:

a. xxx xxx xxx

b. xxx xxx xxx

c. The royalty/rental contracts involving manufacturing' royalty, e.g., actual transfers of technological services such as

secret formula/processes, technical know how and the like shall not exceed five (5) per cent of the wholesale price of the

commodity/ties manufactured under the royalty agreement. For contracts involving 'marketing' services such as the use of

foreign brands or trade names or trademarks, the royalty/rental rate shall not exceed two (2) per cent of the wholesale

price of the commodity/ties manufactured under the royalty agreement. The producer's or foreign licensor's share in the

proceeds from the distribution/exhibition of the films shall not exceed sixty (60) per cent of the net proceeds (gross

proceeds less local expenses) from the exhibition/distribution of the films. ... (Emphasis supplied.) (p. 27, Rollo.)

Clearly, no royalty is payable on the wholesale price of finished products imported by the licensee from the licensor. However, petitioner

argues that the law applicable to its case is only Section 29(a)(1) of the Tax Code which provides:

(a) Expenses. — (1) Business expenses. — (A) In general. — All ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other

compensation for personal services actually rendered; travelling expenses while away from home in the pursuit of a trade,

profession or business, rentals or other payments required to be made as a condition to the continued use or possession,

for the purpose of the trade, profession or business, for property to which the taxpayer has not taken or is not taking title

or in which he has no equity.

Petitioner points out that the Central bank "has no say in the assessment and collection of internal revenue taxes as such power is lodged in

the Bureau of Internal Revenue," that the Tax Code "never mentions Circular 393 and there is no law or regulation governing deduction of

business expenses that refers to said circular." (p. 9, Petition.)

The argument is specious, for, although the Tax Code allows payments of royalty to be deducted from gross income as business expenses, it

is CB Circular No. 393 that defines what royalty payments are proper. Hence, improper payments of royalty are not deductible as legitimate

business expenses.

CB Circular No. 393 dated December 7,1983 was published in the Official Gazette issue of December 17,1973 (69 O.G. No. 51, p. 11737).

Circulars issued by the Central Bank in the exercise of its authority under the Central Bank Act, and which have been duly published in the

Official Gazette, have the force and effect of law (People vs. Que Po Lay, 94 Phil. 640; Lim Hoa Ting vs. Central Bank, 104 Phil. 573).

They are binding on everybody, the petitioner, as much as the public respondent.

WHEREFORE, finding no reversible error in the decision of the Court of Tax Appeals, the petition for review is denied. Costs against the

petitioner.

SO ORDERED.

Supreme Transliner vs BPI

DECISION

VILLARAMA, JR., J.:

This case involves the question of the correct redemption price payable to a mortgagee bank as purchaser of the property in a

foreclosure sale.

On April 24, 1995, Supreme Transliner, Inc. represented by its Managing Director, Moises C. Alvarez, and Paulita S. Alvarez,

obtained a loan in the amount of P9,853,000.00 from BPI Family Savings Bank with a 714-square meter lot covered by Transfer Certificate

of Title No. T-79193 in the name of Moises C. Alvarez and Paulita S. Alvarez, as collateral.15[1]

For non-payment of the loan, the mortgage was extrajudicially foreclosed and the property was sold to the bank as the highest

bidder in the public auction conducted by the Office of the Provincial Sheriff of Lucena City. On August 7, 1996, a Certificate of Sale16[2]

was issued in favor of the bank and the same was registered on October 1, 1996.

Before the expiration of the one-year redemption period, the mortgagors notified the bank of their intention to redeem the property.

Accordingly, the following Statement of Account17[3] was prepared by the bank indicating the total amount due under the mortgage loan

agreement:

x x x x

Balance of Principal P 9,551,827.64

Add: Interest Due

Late Payment Charges

MRI

Fire Insurance

Foreclosure Expenses

1,417,761.24

155,546.25

0.00

0.00

155,817.23

Sub-total

Less: Unapplied Payment

P 11,280,952.36

908,241.01

Total Amount Due As Of 08/07/96 (Auction

Date)

10,372,711.35

Add: Attorneys Fees (15%) 1,555,906.70

Liquidated Damages (15%) 1,555,906.70

Interest on P 10,372,711.35 from

08/07/96 to 04/07/97 (243 days) at

17.25% p.a.

1,207,772.58

x x x x

Asset Acquired Expenses:

Documentary Stamps 155,595.00

Capital Gains Tax 518,635.57

Foreclosure Fee 207,534.23

Registration and Filing Fee 23,718.00

Addl. Registration & Filing Fee 660.00 906,142.79

Interest on P 906,142.79 from

08/07/96 to 04/07/97 (243 days)

at 17.25% p.a.

105,509.00

Cancellation Fee 300.00

Total Amount Due As Of 04/07/97 (Subject to

Audit)

P 15,704,249.12

x x x x

The mortgagors requested for the elimination of liquidated damages and reduction of attorneys fees and interest (1% per month)

but the bank refused. On May 21, 1997, the mortgagors redeemed the property by paying the sum of P15,704,249.12. A Certificate of

Redemption18[4] was issued by the bank on May 27, 1997.

On June 11, 1997, the mortgagors filed a complaint against the bank to recover the allegedly unlawful and excessive charges

totaling P5,331,237.77, with prayer for damages and attorneys fees, docketed as Civil Case No. 97-72 of the Regional Trial Court of Lucena

City, Branch 57.

In its Answer with Special and Affirmative Defenses and Counterclaim, the bank asserted that the redemption price reflecting the

stipulated interest, charges and/or expenses, is valid, legal and in accordance with documents duly signed by the mortgagors. The bank

further contended that the claims are deemed waived and the mortgagors are already estopped from questioning the terms and conditions of

their contract.

On September 30, 1997, the bank filed a motion to set the case for hearing on the special and affirmative defenses by way of

motion to dismiss. The trial court denied the motion on January 8, 1998 and also denied the banks motion for reconsideration. The bank

elevated the matter to the Court of Appeals (CA-G.R. SP No. 47588) which dismissed the petition for certiorari on February 26, 1999.

On February 14, 2002, the trial court rendered its decision19[5] dismissing the complaint and the banks counterclaims. The trial

court held that plaintiffs-mortgagors are bound by the terms of the mortgage loan documents which clearly provided for the payment of the

following interest, charges and expenses: 18% p.a. on the loan, 3% post-default penalty, 15% liquidated damages, 15% attorneys fees and

collection and legal costs. Plaintiffs-mortgagors claim that they paid the redemption price demanded by the defendant bank under extreme

pressure was rejected by the trial court since there was active negotiation for the final redemption price between the banks representatives

and plaintiffs-mortgagors who at the time had legal advice from their counsel, together with Orient Development Banking Corporation

which committed to finance the redemption.

According to the trial court, plaintiffs-mortgagors are estopped from questioning the correctness of the redemption price as they

had freely and voluntarily signed the letter-agreement prepared by the defendant bank, and along with Orient Bank expressed their

conformity to the terms and conditions therein, thus:

May 14, 1997

ORIENT DEVELOPMENT BANKING CORPORATION

7th

Floor Ever Gotesco Corporate Center

C.M. Recto Avenue corner Matapang Street

Manila

Attention: MS. AIDA C. DELA ROSA

Senior Vice-President

Gentlemen:

This refers to your undertaking to settle the account of SUPREME TRANS LINER, INC. and spouses MOISES

C. ALVAREZ and PAULITA S. ALVAREZ, covering the real estate property located in the Poblacion, City of Lucena

under TCT No. T-79193 which was foreclosed by BPI FAMILY SAVINGS BANK, INC.

With regard to the proposed refinancing of the account, we interpose no objection to the annotation of your

mortgage lien thereon subject to the following conditions:

1. That all expenses for the registration of the annotation of mortgage and other incidental registration and

cancellation expenses shall be borne by the borrower.

2. That you will recognize our mortgage liens as first and superior until the loan with us is fully paid.

3. That you will annotate your mortgage lien and pay us the full amount to close the loan within five (5)

working days from the receipt of the titles. If within this period, you have not registered the same and paid

us in full, you will immediately and unconditionally return the titles to us without need of demand, free from

liens/encumbrances other than our lien.

4. That in case of loss of titles, you will undertake and shoulder the cost of re-issuance of a new owners titles.

5. That we will issue the Certificate of Redemption after full payment of P15,704,249.12. representing the

outstanding balance of the loan as of May 15, 1997 including interest and other charges thereof within

a period of five (5) working days after clearance of the check payment.

6. That we will release the title and the Certificate of Redemption and other pertinent papers only to your

authorized representative with complete authorization and identification.

7. That all expenses related to the cancellation of your annotated mortgage lien should the Bank be not fully

paid on the period above indicated shall be charged to you.

If you find the foregoing conditions acceptable, please indicate your conformity on the space provided below and

return to us the duplicate copy.

Very truly yours,

BPI FAMILY BANK

BY:

(SGD.) LOLITA C. CARRIDO

Manager

C O N F O R M E :

ORIENT DEVELOPMENT BANKING CORPORATION

(SGD.) AIDA C. DELA ROSA

Senior Vice President

C O N F O R M E :

SUPREME TRANS LINER, INC.

(SGD.) MOISES C. ALVAREZ/PAULITA S. ALVAREZ

Mortgagors20[6]

(Underscoring in the original; emphasis supplied.)

As to plaintiffs-mortgagors contention that the amounts representing attorneys fees and liquidated damages were already included

in the P10,372,711.35 bid price, the trial court said this was belied by their own evidence, the Statement of Account showing the breakdown

of the redemption price as computed by the defendant bank.

The mortgagors appealed to the CA (CA-G.R. CV No. 74761) which, by Decision21[7] dated April 6, 2004 reversed the trial court

and decreed as follows:

WHEREFORE, foregoing considered, the appealed decision is hereby REVERSED and SET ASIDE. A new one

is hereby entered as follows:

1. Plaintiffs-appellants complaint for damages against defendant-appellee is hereby REINSTATED;

2. Defendant-appellee is hereby ORDERED to return to plaintiffs-appellees (sic) the invalidly collected

amount of P3,111,813.40 plus six (6) percent legal interest from May 21, 1997 until fully returned;

3. Defendant-appellee is hereby ORDERED to pay plaintiffs-appellees (sic) the amount of P100,000.00 as

moral damages, P100,000.00 as exemplary damages and P100,000.00 as attorneys fees;

4. Costs against defendant-appellee.

SO ORDERED.22[8]

The CA ruled that attorneys fees and liquidated damages were already included in the bid price of P10,372,711.35 as per the

recitals in the Certificate of Sale that said amount was paid to the foreclosing mortgagee to satisfy not only the principal loan but also

interest and penalty charges, cost of publication and expenses of the foreclosure proceedings. These penalty charges consist of 15%

attorneys fees and 15% liquidated damages which the bank imposes as penalty in cases of violation of the terms of the mortgage deed. The

total redemption price thus should only be P12,592,435.72 and the bank should return the amount of P3,111,813.40 representing attorneys

fees and liquidated damages. The appellate court further stated that the mortgagors cannot be deemed estopped to question the propriety of

the charges because from the very start they had repeatedly questioned the imposition of attorneys fees and liquidated damages and were

merely constrained to pay the demanded redemption price for fear that the redemption period will expire without them redeeming their

property.23[9]

By Resolution24[10] dated October 12, 2004, the CA denied the parties respective motions for reconsideration.

Hence, these petitions separately filed by the mortgagors and the bank.

In G.R. No. 165617, the petitioners-mortgagors raise the single issue of whether the foreclosing mortgagee should pay capital

gains tax upon execution of the certificate of sale, and if paid by the mortgagee, whether the same should be shouldered by the

redemptioner. They specifically prayed for the return of all asset-acquired expenses consisting of documentary stamps tax, capital gains tax,

foreclosure fee, registration and filing fee, and additional registration and filing fee totaling P906,142.79, with 6% interest thereon from

May 21, 1997.25[11]

On the other hand, the petitioner bank in G.R. No. 165837 assails the CA in holding that

1. the Certificate of Sale, the bid price of P10,372,711.35 includes penalty charges and as such for purposes of

computing the redemption price petitioner can no longer impose upon the private respondents the penalty charges in the

form of 15% attorneys fees and the 15% liquidated damages in the aggregate amount of P3,111,813.40, although the

evidence presented by the parties show otherwise.

2. private respondents cannot be considered to be under estoppel to question the propriety of the aforestated penalty

charges despite the fact that, as found by the Honorable Trial Court, there was very active negotiation between the parties

in the computation of the redemption price culminating into the signing freely and voluntarily by the petitioner, the

private respondents and Orient Bank, which financed the redemption of the foreclosed property, of Exhibit 3, wherein

they mutually agreed that the redemption price is in the sum of P15,704,249.12.

3. petitioner [to] pay private respondents damages in the aggregate amount of P300,000.00 on the ground that the

former acted in bad faith in the imposition upon them of the aforestated penalty charges, when in truth it is entitled thereto

as the law and the contract expressly provide and that private respondents agreed to pay the same.26[12]

On the correct computation of the redemption price, Section 78 of Republic Act No. 337, otherwise known as the General Banking

Act, governs in cases where the mortgagee is a bank.27[13] Said provision reads:

SEC. 78. x x x In the event of foreclosure, whether judicially or extrajudicially, of any mortgage on real estate

which is security for any loan granted before the passage of this Act or under the provisions of this Act, the mortgagor or

debtor whose real property has been sold at public auction, judicially or extrajudicially, for the full or partial payment of

an obligation to any bank, banking or credit institution, within the purview of this Act shall have the right, within one year

after the sale of the real estate as a result of the foreclosure of the respective mortgage, to redeem the property by paying

the amount fixed by the court in the order of execution, or the amount due under the mortgage deed, as the case may

be, with interest thereon at the rate specified in the mortgage, and all the costs, and judicial and other expenses

incurred by the bank or institution concerned by reason of the execution and sale and as a result of the custody of

said property less the income received from the property. x x x x (Emphasis supplied.)

Under the Mortgage Loan Agreement,28[14] petitioners-mortgagors undertook to pay the attorneys fees and the costs of

registration and foreclosure. The following contract terms would show that the said items are separate and distinct from the bid price which

represents only the outstanding loan balance with stipulated interest thereon.

23. Application of Proceeds of Foreclosure Sale. The proceeds of sale of the mortgaged property/ies shall be

applied as follows:

a) To the payment of the expenses and cost of foreclosure and sale, including the attorneys fees as herein

provided;

b) To the satisfaction of all interest and charges accruing upon the obligations herein and hereby secured.

c) To the satisfaction of the principal amount of the obligations herein and hereby secured.

d) To the satisfaction of all other obligations then owed by the Borrower/Mortgagor to the Bank or any of its

subsidiaries/affiliates such as, but not limited to BPI Credit Corporation; or to Bank of the Philippine Islands or any of its

subsidiaries/affiliates such as, but not limited to BPI Leasing Corporation, BPI Express Card Corporation, BPI Securities

Corporation and BPI Agricultural Development Bank; and

e) The balance, if any, to be due to the Borrower/Mortgagor.

x x x x

31. Attorneys Fees: In case the Bank should engage the services of counsel to enforce its rights under this

Agreement, the Borrower/Mortgagor shall pay an amount equivalent to fifteen (15%) percent of the total amount claimed

by the Bank, which in no case shall be less than P2,000.00, Philippine currency, plus costs, collection expenses and

disbursements allowed by law, all of which shall be secured by this mortgage.29[15]

Additionally, the Disclosure Statement on Loan/Credit Transaction30[16] also duly signed by the petitioners-mortgagors provides:

10. ADDITIONAL CHARGES IN CASE CERTAIN STIPULATIONS ARE NOT MET BY THE BORROWER

a. Post Default Penalty 3.00% per month

b. Attorneys Services 15% of sum due but not less than P2,000.00

c. Liquidated Damages 15% of sum due but not less than P10,000.00

d. Collection & Legal Cost As provided by the Rules of Court

e. Others (Specify)

As correctly found by the trial court, that attorneys fees and liquidated damages were not yet included in the bid price of

P10,372,711.35 is clearly shown by the Statement of Account as of April 4, 1997 prepared by the petitioner bank and given to petitioners-

mortgagors. On the other hand, par. 23 of the Mortgage Loan Agreement indicated that asset acquired expenses were to be added to the

redemption price as part of costs and other expenses incurred by the mortgagee bank in connection with the foreclosure sale.

Coming now to the issue of capital gains tax, we find merit in petitioners-mortgagors argument that there is no legal basis for the

inclusion of this charge in the redemption price. Under Revenue Regulations (RR) No. 13-85 (December 12, 1985), every sale or exchange

or other disposition of real property classified as capital asset under Section 34(a)31[17] of the Tax Code shall be subject to the final capital

gains tax. The term sale includes pacto de retro and other forms of conditional sale. Section 2.2 of Revenue Memorandum Order (RMO)

No. 29-86 (as amended by RMO No. 16-88 and as further amended by RMO Nos. 27-89 and 6-92) states that these conditional sales

necessarily include mortgage foreclosure sales (judicial and extrajudicial foreclosure sales). Further, for real property foreclosed by a bank

on or after September 3, 1986, the capital gains tax and documentary stamp tax must be paid before title to the property can be consolidated

in favor of the bank.32[18]

Under Section 63 of Presidential Decree No. 1529 otherwise known as the Property Registration Decree, if no right of redemption

exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser. But where the

right of redemption exists, the certificate of title of the mortgagor shall not be cancelled, but the certificate of sale and the order confirming

the sale shall be registered by brief memorandum thereof made by the Register of Deeds upon the certificate of title. In the event the

property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a brief memorandum thereof shall

be made by the Register of Deeds on the certificate of title.

It is therefore clear that in foreclosure sale, there is no actual transfer of the mortgaged real property until after the expiration of the

one-year redemption period as provided in Act No. 3135 and title thereto is consolidated in the name of the mortgagee in case of non-

redemption. In the interim, the mortgagor is given the option whether or not to redeem the real property. The issuance of the Certificate of

Sale does not by itself transfer ownership.33[19]

RR No. 4-99 issued on March 16, 1999, further amends RMO No. 6-92 relative to the payment of Capital Gains Tax and

Documentary Stamp Tax on extrajudicial foreclosure sale of capital assets initiated by banks, finance and insurance companies.

SEC. 3. CAPITAL GAINS TAX.

(1) In case the mortgagor exercises his right of redemption within one year from the issuance of the

certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and

no sale or transfer of real property was realized. x x x

(2) In case of non-redemption, the capital gains [tax] on the foreclosure sale imposed under Secs. 24(D)(1) and

27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the

expiration of the one-year period of redemption provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118,

and shall be paid within thirty (30) days from the expiration of the said one-year redemption period.

SEC. 4. DOCUMENTARY STAMP TAX.

(1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the P15.00

documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997 because no land or realty was sold or

transferred for a consideration.

(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and paid by the

person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed,

issued, accepted or transferred where the property is situated in the Philippines. x x x (Emphasis supplied.)

Although the subject foreclosure sale and redemption took place before the effectivity of RR No. 4-99, its provisions may be given

retroactive effect in this case.

Section 246 of the NIRC of 1997 states:

SEC. 246. Non-Retroactivity of Rulings. Any revocation, modification, or reversal of any of the rules and

regulations promulgated in accordance with the preceding Sections or any of the rulings or circulars promulgated by the

Commissioner shall not be given retroactive application if the revocation, modification, or reversal will be prejudicial

to the taxpayers, except in the following cases:

(a) where the taxpayer deliberately misstates or omits material facts from his return or in any document required

of him by the Bureau of Internal Revenue;

(b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially different from the

facts on which the ruling is based; or

(c) where the taxpayer acted in bad faith.

In this case, the retroactive application of RR No. 4-99 is more consistent with the policy of aiding the exercise of the right of

redemption. As the Court of Tax Appeals concluded in one case, RR No. 4-99 has curbed the inequity of imposing a capital gains tax even

before the expiration of the redemption period [since] there is yet no transfer of title and no profit or gain is realized by the mortgagor at the

time of foreclosure sale but only upon expiration of the redemption period.34[20] In his commentaries, De Leon expressed the view that

while revenue regulations as a general rule have no retroactive effect, if the revocation is due to the fact that the regulation is erroneous or

contrary to law, such revocation shall have retroactive operation as to affect past transactions, because a wrong construction of the law

cannot give rise to a vested right that can be invoked by a taxpayer.35[21]

Considering that herein petitioners-mortgagors exercised their right of redemption before the expiration of the statutory one-year

period, petitioner bank is not liable to pay the capital gains tax due on the extrajudicial foreclosure sale. There was no actual transfer of title

from the owners-mortgagors to the foreclosing bank. Hence, the inclusion of the said charge in the total redemption price was unwarranted

and the corresponding amount paid by the petitioners-mortgagors should be returned to them.

WHEREFORE, premises considered, both petitions are PARTLY GRANTED.

In G.R. No. 165617, BPI Family Savings Bank, Inc. is hereby ordered to RETURN the amounts representing capital gains and

documentary stamp taxes as reflected in the Statement of Account To Redeem as of April 7, 1997, to petitioners Supreme Transliner, Inc.,

Moises C. Alvarez and Paulita Alvarez, and to retain only the sum provided in RR No. 4-99 as documentary stamps tax due on the

foreclosure sale.

In G.R. No. 165837, petitioner BPI Family Savings Bank, Inc. is hereby declared entitled to the attorneys fees and liquidated

damages included in the total redemption price paid by Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez. The sums

awarded as moral and exemplary damages, attorneys fees and costs in favor of Supreme Transliner, Inc., Moises C. Alvarez and Paulita

Alvarez are DELETED.

The Decision dated April 6, 2004 of the Court of Appeals in CA-G.R. CV No. 74761 is accordingly MODIFIED.

SO ORDERED.

G.R. No. 160193 March 3, 2008

M.E. HOLDING CORPORATION, petitioner,

vs.

THE HON. COURT OF APPEALS, COURT OF TAX APPEALS, and THE COMMISSIONER OF INTERNAL REVENUE, respondents.

D E C I S I O N

VELASCO, JR., J.:

This case involves Republic Act No. (RA) 7432, otherwise known as An Act to Maximize the Contribution of Senior Citizens to Nation

Building, Grant Benefits and Special Privileges and for Other Purposes,passed onApril 23, 1992. It granted, among others, a 20% sales

discount on purchases of medicines by qualified senior citizens.

On April 15, 1996, petitioner M.E. Holding Corporation (M.E.) filed its 1995 Corporate Annual Income Tax Return, claiming the 20% sales

discount it granted to qualified senior citizens. M.E. treated the discount as deductions from its gross income purportedly in accordance with

Revenue Regulation No. (RR) 2-94, Section 2(i) of the Bureau of Internal Revenue (BIR) issued on August 23, 1993. Sec. 2(i) states:

Section 2. DEFINITIONS. – For purposes of these regulations:

x x x x

i. Tax Credit – refers to the amount representing the 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.)

The deductions M.E. claimed amounted to PhP 603,424. However, it filed the return under protest, arguing that the discount to senior

citizens should be treated as tax credit under Sec. 4(a) of RA 7432, and not as mere deductions from M.E.'s gross income as provided under

RR 2-94.

Sec. 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.)

Subsequently, on December 27, 1996, M.E. sent BIR a letter-claim dated December 6, 1996,1 stating that it overpaid its income tax owing

to the BIR's erroneous interpretation of Sec. 4(a) of RA 7432.

Due to the inaction of the BIR, and to toll the running of the two-year prescriptive period in filing a claim for refund, M.E. filed an appeal

before the Court of Tax Appeals (CTA), reiterating its position that the sales discount should be treated as tax credit, and that RR 2-94,

particularly Section 2(i), was without effect for being inconsistent with RA 7432.

On April 25, 2000, the CTA rendered a Decision2 in favor of M.E., the fallo of which reads:

WHEREFORE, in view of the foregoing, petitioner's claim for refund is hereby partially GRANTED. Respondent is hereby

ORDERED to REFUND in favor of petitioner the amount of P122,195.74, representing overpaid income tax [for] the year 1995.

SO ORDERED.

The CTA ruled that the 20% sales discount granted to qualified senior citizens should be treated as tax credit and not as item deduction from

the gross income or sales, pointing out that Sec. 4(a) of RA 7432 was unequivocal on this point. The CTA held that Sec. 2(i) of RR 2-94

contravenes the clear proviso of RA 7432 prescribing that the 20% sales discount should be claimed as tax credit. Further, it ruled that RA

7432 is a law that necessarily prevails over an administrative issuance such as RR 2-94.

Unfortunately, what appears to be the victory of M.E. before the CTA was watered down by the tax court's declaration that, while the

independent auditor M.E. hired found the amount PhP 603,923.46 as having been granted as sales discount to qualified senior citizens, M.E.

failed to properly support the claimed discount with corresponding cash slips. Thus, the CTA reduced M.E.'s claim for PhP 603,923.46 sales

discount to PhP 362,574.57 after the CTA disallowed PhP 241,348.89 unsupported claims, and consequently lowered the refundable

amount to PhP 122,195.74.

On May 24, 2000, M.E. filed a Motion for Reconsideration, therein attributing its failure to submit and offer certain documents, specifically

the cash slips, to the inadvertence of its independent auditor who failed to transmit the documents to M.E.'s counsel. It also argued that the

tax credit should be based on the actual discount and not on the acquisition cost of the medicines.

On July 11, 2000, the CTA denied M.E.'s motion for reconsideration which contained a prayer to present additional evidence consisting of

duplicate copies of the cash slips allegedly not submitted to M.E. by its independent auditor.3 In refuting M.E.'s contention that the tax

credit should be based on the actual discount and not on the acquisition cost of the medicines, the CTA applied the Court of Appeals (CA)

ruling in CIR v. Elmas Drug Corporation,4 where the term "cost of the discount" was interpreted to mean only the direct acquisition cost,

excluding administrative and other incremental costs.

Aggrieved, M.E. went to the CA on a petition for review docketed as CA-G.R. SP No. 60134. On July 1, 2003, the CA rendered its

Decision,5 dismissing the petition.

Even as it laid the entire blame on M.E. for its failure to present its additional evidence, the CA pointed out that forgotten evidence is not

newly discovered evidence which can be presented to the appellate tax court, even after it had already rendered its decision. Likewise, the

CA interpreted, as did the CTA, the term "cost" to mean only the direct acquisition cost, adding that to interpret the word "cost" to include

"all administrative and incremental costs to sales to senior citizens" would open the floodgates for drugstores to pad the costs of the sales

with such broad, undefined, and varied administrative and incremental costs such that the government would ultimately bear the escalated

costs of the sales. And citing Commissioner of Internal Revenue v. Tokyo Shipping Co., Ltd., the CA held that claims for refund, being in

the nature of a claim for exemption, should be construed in strictissimi juris against the taxpayer.6

The CA denied petitioner's Motion for Reconsideration on September 24, 2003.7

Hence, the instant petition for review, anchored essentially on the same issues raised before the CA, as follows:

I.

WHETHER OR NOT THE HONORABLE COURT OF APPEALS GRAVELY ERRED AND HAS DEVIATED FROM

APPLICABLE LAWS AND JURISPRUDENCE IN NOT APPRECIATING OTHER COMPETENT EVIDENCE PROVING

THE AMOUNT OF DISCOUNTS GRANTED TO SENIOR CITIZENS AND MERELY RELYING SOLELY ON THE CASH

SLIPS.

II.

WHETHER OR NOT THE HONORABLE COURT OF APPEALS GRAVELY ERRED AND HAS COMMITTED GRAVE

ABUSE OF DISCRETION AMOUNTING TO LACK OR IN EXCESS OF JURISDICTION IN AFFIRMING THE COURT OF

TAX APPEALS' DENIAL OF PETITIONER'S MOTION TO ORDER AND SUBMIT AS DOCUMENTARY [EVIDENCE]

THE CASH SLIPS WHICH THE INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT INADVERTENTLY DID NOT

TURN OVER TO THE PETITIONER'S COUNSEL.

III.

WHETHER OR NOT THE TERM "COST" UNDER PARAGRAPH (A) SECTION 4 OF REPUBLIC ACT 7432 IS

EQUIVALENT ONLY TO ACQUISITION COST.8

Our Ruling

The petition is partly meritorious.

The 20% sales discount to senior citizens may be claimed by an establishment owner as tax credit. RA 7432, the applicable law, is

unequivocal on this. The implementing RR 2-94 that considers such discount as mere deductions to the taxpayer's gross income or gross

sales clearly clashes with the clear language of RA 7432, the law sought to be implemented. We need not delve on the nullity of the

implementing rule all over again as we have already put this issue at rest in a string of cases.9

Now, we will discuss the remaining issues in seriatim.

On the first issue, M.E. faults the CA for merely relying on the cash slips as basis for determining the total 20% sales discount given to

senior citizens. To M.E., there are other competent pieces of evidence available to prove the same point, such as the Special Record Book

required by the Bureau of Food and Drugs10

and the Special Record Book required under RR 2-94. According to M.E., these special record

books containing, as it were, the same information embodied in the cash slips were submitted to the CTA during M.E.'s formal offer of

evidence. Moreover, M.E. avers that the CA ought to have considered the special record books since their authenticity and the veracity of

their contents were corroborated by the store supervisor, Amelita Gonzales, and Rene Amby Reyes, its independent auditor.

M.E. fails to persuade. The determination of the exact amount M.E. claims as the 20% sales discount it granted to the senior citizens calls

for an evaluation of factual matters. The unyielding rule is that the findings of fact of the trial court, particularly when affirmed by the CA,

are binding upon this Court,11

save when the lower courts had overlooked, misunderstood, or misinterpreted certain facts or circumstances

of weight, which, if properly considered, would affect the result of the case and warrant a reversal of the decision. The instant case does not

fall under the exception; hence, we do not find any justification to review all over again the evidence presented before the CTA, and the

factual conclusions deduced therefrom.

Lest it be overlooked, the Rules of Court is of suppletory application in quasi-judicial proceedings. Be this as it may, the CTA was correct

in disallowing and not considering the belatedly-submitted cash slips to be part of the 20% sales discount for M.E.'s taxable year 1995. This

is as it should be in the light of Sec. 34 of Rule 132 prescribing that no evidence shall be considered unless formally offered with a

statement of the purpose why it is being offered. In addition, the rule is that the best evidence under the circumstance must be adduced to

prove the allegations in a complaint, petition, or protest. Only when the best evidence cannot be submitted may secondary evidence be

considered. But, in the instant case, the disallowed cash slips, the best evidence at that time, were not part of M.E.'s offer of evidence. While

it may be true that the authenticated special record books yield the same data found in the cash slips, they cannot plausibly be considered by

the courts a quo and made to corroborate pieces of evidence that have, in the first place, been disallowed. Recall also that M.E. offered the

disallowed cash slips as evidence only after the CTA had rendered its assailed decision. Thus, we cannot accept the excuse of inadvertence

of the independent auditor as excusable negligence. As aptly put by the CA, the belatedly-submitted cash slips do not constitute newly-

found evidence that may be submitted as basis for a new trial or reconsideration of the decision.

We reiterate at this juncture that claims for tax refund/credit, as in the instant case, are in the nature of claims for exemption. Accordingly,

the law relied upon is not only construed in strictissimi juris against the taxpayer, but also the proofs presented entitling a taxpayer to an

exemption are strictissimi scrutinized.

On the second issue, M.E. strongly asserts that the CA gravely abused its discretion in denying M.E. the opportunity to submit the

disallowed cash slips despite the independent auditor's admission, via an Affidavit,12

of guilt for inadvertence. M.E.'s counsel explains that

he relied on the independent auditor's representation that all the cash slips were turned over. Besides, M.E. asserts that the independent

auditor, being an officer of the court, having been commissioned by the CTA, is presumed to have done his duty in a regular manner, and,

therefore, his negligence should not be taken against M.E.

We do not agree with M.E. Grave abuse of discretion connotes capricious, whimsical, arbitrary, or despotic exercise of jurisdiction. The CA

surely cannot be guilty of gravely abusing its discretion when it refused to consider, in lieu of the unsubmitted additional cash slips, the

special record books which are only secondary evidence. The cash slips were the best evidence. Also, the CA noted that the belatedly-

offered cash slips were presented only after the CTA had rendered its decision. All these factors argue against the notion that the CA had, in

sustaining the CTA, whimsically and capriciously exercised its discretion.

On the third and last issue, M.E. contends that it is entitled, as a matter of law, to claim as tax credit the full amount of the sales discount

granted to senior citizens.

M.E.'s contention is correct. In Bicolandia Drug Corporation (formerly Elmas Drug Corporation) v. Commissioner of Internal Revenue, we

interpreted the term "cost" found in Sec. 4(a) of RA 7432 as referring to the amount of the 20% discount extended by a private

establishment to senior citizens in their purchase of medicines.13

There we categorically said that it is the Government that should fully

shoulder the cost of the sales discount granted to senior citizens. Thus, we reversed and set aside the CA's Decision in CA-G.R. SP No.

49946, which construed the same word "cost" to mean the theoretical acquisition cost of the medicines purchased by qualified senior

citizens. Accordingly, M.E. is entitled to a tax credit equivalent to the actual 20% sales discount it granted to qualified senior citizens.

With the disallowance of PhP 241,348.89 for being unsupported, and the net amount of PhP 362,574.57 for the actual 20% sales discount

granted to qualified senior citizens properly allowed by the CTA and fully appreciated as tax credit, the amount due as tax credit in favor of

M.E. is PhP 151,201.71, computed as follows:

Net Sales PhP 94,724,284.00

Add: 20% Discount to Senior Citizens

(Per Petitioner's Summary) 603,923.46

Gross Sales PhP 95,328,207.46

Less: Cost of Sales

Merchandise Inventory, beg. PhP 9,519,210.00

Add Purchases 87,288,988.00

Total Goods available for Sale PhP 96,808,198.00

Less: Merchandise Inventory, End PhP 9,469.349.00 PhP 87,338,849.00

Gross Income

PhP 7,989,358.46

Less: Operating Expenses

17,006,032.00

Net Operating Income /(Loss)

(PhP 9,016,673.54)

Add: Miscellaneous Income

43,489,663.00

Net Income

PhP 34,472,989.46

Less: Interest Income Subject to

Final Tax

22,242,227.00

Net Taxable Income PhP 12,230,762.46

Tax Due (PhP 12,230,762.46 x 35%) PhP 4,280,766.86

Less: 1) Tax Credit (20% Discount with supporting

documents) PhP 362,574.57

2) Income Tax Payment for the Year 4,069,394.00

Total PhP 4,431,968.57

AMOUNT OF TAX CREDIT PhP 151,201.71

Parenthetically, we note that M.E. originally prayed for a tax refund for its tax overpayment for CY 1995. The CTA and the CA granted the

desired refund, albeit at a lower amount due to their interpretation, erroneous as it turned out to be, of the term "cost." However, we cannot

agree with the courts a quo on what M.E. is entitled to. RA 7432 expressly provides that the sales discount may be claimed as tax credit, not

as tax refund.

It ought to be noted, however, that on February 26, 2004, RA 9257, or The Expanded Senior Citizens Act of 2003, amending RA 7432, was

signed into law, ushering in, upon its effectivity on March 21, 2004, a new tax treatment for sales discount purchases of qualified senior

citizens of medicines. Sec. 4(a) of RA 9257 provides:

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, x x x;

x x x x

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.)

Conformably, starting taxable year 2004, the 20% sales discount granted by establishments to qualified senior citizens is to be treated as tax

deduction, no longer as tax credit.14

IN VIEW OF THE FOREGOING, this petition is PARTLY GRANTED. The CA's Decision dated July 1, 2003 and its Resolution of

September 24, 2003 in CA-G.R. SP No. 60134, affirming the Decision of the CTA dated April 25, 2000 in CTA Case No. 5604, are

AFFIRMED with MODIFICATIONS insofar as the amount and mode of payment of M.E.'s claim are concerned. As modified, the fallo

of the April 25, 2000 Decision of the CTA shall read:

WHEREFORE, in view of the foregoing, petitioner M.E.'s claim for refund is hereby PARTIALLY GRANTED in the form of a

tax credit. Respondent Commissioner of Internal Revenue is ORDERED to issue a tax credit certificate in favor of M.E. in

the amount of PhP 151,201.71.

No pronouncement as to costs.SO ORDERED.

G.R. No. 159991 November 16, 2006

CARMELINO F. PANSACOLA, Petitioner,

vs.

COMMISSIONER OF INTERNAL REVENUE, Respondent.

D E C I S I O N

QUISUMBING, J.:

For review on certiorari is the Decision1 dated June 5, 2003 of the Court of Appeals in CA-G.R. S.P. No. 60475. The appellate court denied

petitioner‘s availment of the increased amounts of personal and additional exemptions under Republic Act No. 8424, the National Internal

Revenue Code of 19972 (NIRC), which took effect on January 1, 1998. Also assailed is the appellate court‘s Resolution

3 dated September

11, 2003, denying the motion for reconsideration.

The facts are undisputed.

On April 13, 1998, petitioner Carmelino F. Pansacola filed his income tax return for the taxable year 1997 that reflected an overpayment of

P5,950. In it he claimed the increased amounts of personal and additional exemptions under Section 354 of the NIRC, although his

certificate of income tax withheld on compensation indicated the lesser allowed amounts5 on these exemptions. He claimed a refund of

P5,950 with the Bureau of Internal Revenue, which was denied. Later, the Court of Tax Appeals also denied his claim because according to

the tax court, "it would be absurd for the law to allow the deduction from a taxpayer‘s gross income earned on a certain year of exemptions

availing on a different taxable year…"6 Petitioner sought reconsideration, but the same was denied.

7

On appeal, the Court of Appeals denied his petition for lack of merit. The appellate court ruled that Umali v. Estanislao,8 relied upon by

petitioner, was inapplicable to his case. It further ruled that the NIRC took effect on January 1, 1998, thus the increased exemptions were

effective only to cover taxable year 1998 and cannot be applied retroactively.

Petitioner, before us, raises a single issue:

…[W]hether or not the increased personal and additional exemptions under [the NIRC] can be availed of by the [p]etitioner for purposes of

computing his income tax liability for the taxable year 1997 and thus be entitled to the refund.9

Simply stated, the issue is: Could the exemptions under Section 35 of the NIRC, which took effect on January 1, 1998, be availed of for the

taxable year 1997?

Petitioner argues that the personal and additional exemptions are of a fixed character based on Section 35 (A) and (B) of the NIRC10

and as

ruled by this Court in Umali, these personal and additional exemptions are fixed amounts to which an individual taxpayer is entitled. He

contends that unlike other allowable deductions, the availability of these exemptions does not depend on the taxpayer‘s profession, trade or

business for a particular taxable period. Relying again in Umali, petitioner alleges that the Court of Appeals erred in ruling that the

increased exemptions were meant to be applied beginning taxable year 1998 and were to be reflected in the taxpayers‘ returns to be filed on

or before April 15, 1999. Petitioner reasons that such ruling would postpone the availability of the increased exemptions and literally defer

the effectivity of the NIRC to January 1, 1999. Petitioner insists that the increased exemptions were already available on April 15, 1998, the

deadline for filing income tax returns for taxable year 1997, because the NIRC was already effective.

Respondent, through the Office of the Solicitor General, counters that the increased exemptions were not yet available for taxable year 1997

because all provisions of the NIRC took effect on January 1, 1998 only; that the fixed character of personal and additional exemptions does

not necessarily mean that these were not time bound; and petitioner‘s proposition was contrary to Section 35 (C)11

of the NIRC. It further

stated that petitioner‘s exemptions were determined as of December 31, 1997 and the effectivity of the NIRC during the period of January 1

to April 15, 1998 did not affect his tax liabilities within the taxable year 1997; and the inclusive period from January 1 to April 15, 1998, the

filing dates and deadline for administrative purposes, was outside of the taxable year 1997. Respondent also maintains that Umali is not

applicable to this case.

Prefatorily, personal and additional exemptions under Section 35 of the NIRC are fixed amounts to which certain individual taxpayers

(citizens, resident aliens)12

are entitled. Personal exemptions are the theoretical personal, living and family expenses of an individual

allowed to be deducted from the gross or net income of an individual taxpayer. These are arbitrary amounts which have been calculated by

our lawmakers to be roughly equivalent to the minimum of subsistence,13

taking into account the personal status and additional qualified

dependents of the taxpayer. They are fixed amounts in the sense that the amounts have been predetermined by our lawmakers as provided

under Section 35 (A) and (B). Unless and until our lawmakers make new adjustments on these personal exemptions, the amounts allowed to

be deducted by a taxpayer are fixed as predetermined by Congress.

A careful scrutiny of the provisions14

of the NIRC specifically shows that Section 79 (D)15

provides that the personal and additional

exemptions shall be determined in accordance with the main provisions in Title II of the NIRC. Its main provisions pertain to Section 35

(A) and (B) which state,

SEC. 35. Allowance of Personal Exemption for Individual Taxpayer. -

(A) In General.-For purposes of determining the tax provided in Section 24(A) of this Title,16

there shall be allowed a basic personal

exemption as follows:

x x x x

For each married individual – P32,000

x x x x

(B) Additional Exemption for Dependents.–There shall be allowed an additional exemption of Eight thousand pesos (P8,000) for each

dependent not exceeding four (4). (Emphasis ours.)

Section 35 (A) and (B) allow the basic personal and additional exemptions as deductions from gross or net income, as the case maybe, to

arrive at the correct taxable income of certain individual taxpayers. Section 24 (A) (1) (a) imposed income tax on a resident citizen‘s taxable

income derived for each taxable year. It provides as follows:

SEC. 24. Income Tax Rates. –

(A) Rates of Income Tax on Individual Citizen …

(1) An income tax is hereby imposed:

(a) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B),17

(C),18

and (D)19

of

this Section, derived for each taxable year from all sources within and without the Philippines by every individual citizen of the Philippines

residing therein; (Emphasis ours.)

Section 31 defines "taxable income" as the pertinent items of gross income specified in the NIRC, less the deductions and/or personal and

additional exemptions, if any, authorized for such types of income by the NIRC or other special laws. As defined in Section 22 (P),20

"taxable year" means the calendar year, upon the basis of which the net income is computed under Title II of the NIRC. Section 4321

also

supports the rule that the taxable income of an individual shall be computed on the basis of the calendar year. In addition, Section 4522

provides that the deductions provided for under Title II of the NIRC shall be taken for the taxable year in which they are "paid or accrued"

or "paid or incurred."

Moreover, Section 79 (H)23

requires the employer to determine, on or before the end of the calendar year but prior to the payment of the

compensation for the last payroll period, the tax due from each employee‘s taxable compensation income for the entire taxable year in

accordance with Section 24 (A). This is for the purpose of either withholding from the employee‘s December salary, or refunding to him not

later than January 25 of the succeeding year, the difference between the tax due and the tax withheld.

Therefore, as provided in Section 24 (A) (1) (a) in relation to Sections 31 and 22 (P) and Sections 43, 45 and 79 (H) of the NIRC, the

income subject to income tax is the taxpayer‘s income as derived and computed during the calendar year, his taxable year.

Clearly from the abovequoted provisions, what the law should consider for the purpose of determining the tax due from an individual

taxpayer is his status and qualified dependents at the close of the taxable year and not at the time the return is filed and the tax due thereon

is paid. Now comes Section 35 (C) of the NIRC which provides,

Sec. 35. Allowance of Personal Exemption for Individual Taxpayer. –

x x x x

(C) Change of Status. – If the taxpayer marries or should have additional dependent(s) as defined above during the taxable year, the

taxpayer may claim the corresponding additional exemption, as the case may be, in full for such year.

If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions for himself and his

dependent(s) as if he died at the close of such year.

If the spouse or any of the dependents dies or if any of such dependents marries, becomes twenty-one (21) years old or becomes gainfully

employed during the taxable year, the taxpayer may still claim the same exemptions as if the spouse or any of the dependents died, or as if

such dependents married, became twenty-one (21) years old or became gainfully employed at the close of such year.

Emphasis must be made that Section 35 (C) of the NIRC allows a taxpayer to still claim the corresponding full amount of exemption for a

taxable year, e.g. if he marries; have additional dependents; he, his spouse, or any of his dependents die; and if any of his dependents marry,

turn 21 years old; or become gainfully employed. It is as if the changes in his or his dependents‘ status took place at the close of the taxable

year.

Consequently, his correct taxable income and his corresponding allowable deductions e.g. personal and additional deductions, if any, had

already been determined as of the end of the calendar year.

In the case of petitioner, the availability of the aforementioned deductions if he is thus entitled, would be reflected on his tax return filed on

or before the 15th day of April 1999 as mandated by Section 51 (C) (1).24

Since the NIRC took effect on January 1, 1998, the increased

amounts of personal and additional exemptions under Section 35, can only be allowed as deductions from the individual taxpayer‘s gross or

net income, as the case maybe, for the taxable year 1998 to be filed in 1999. The NIRC made no reference that the personal and additional

exemptions shall apply on income earned before January 1, 1998.

Thus, petitioner‘s reliance in Umali is misplaced.

In Umali, we noted that despite being given authority by Section 29 (1) (4)25

of the National Internal Revenue Code of 1977 to adjust these

exemptions, no adjustments were made to cover 1989. Note that Rep. Act No. 7167 is entitled "An Act Adjusting the Basic Personal and

Additional Exemptions Allowable to Individuals for Income Tax Purposes to the Poverty Threshold Level, Amending for the Purpose

Section 29, Paragraph (L), Items (1) and (2) (A), of the National Internal Revenue Code, As Amended, and For Other Purposes." Thus, we

said in Umali, that the adjustment provided by Rep. Act No. 7167 effective 1992, should consider the poverty threshold level in 1991, the

time it was enacted. And we observed therein that since the exemptions would especially benefit lower and middle-income taxpayers, the

exemption should be made to cover the past year 1991. To such an extent, Rep. Act No. 7167 was a social legislation intended to remedy

the non-adjustment in 1989. And as cited in Umali, this legislative intent is also clear in the records of the House of Representatives‘

Journal.

This is not so in the case at bar. There is nothing in the NIRC that expresses any such intent. The policy declarations in its enactment do not

indicate it was a social legislation that adjusted personal and additional exemptions according to the poverty threshold level nor is there any

indication that its application should retroact. At the time petitioner filed his 1997 return and paid the tax due thereon in April 1998, the

increased amounts of personal and additional exemptions in Section 35 were not yet available. It has not yet accrued as of December 31,

1997, the last day of his taxable year. Petitioner‘s taxable income covers his income for the calendar year 1997. The law cannot be given

retroactive effect. It is established that tax laws are prospective in application, unless it is expressly provided to apply retroactively.26

In the

NIRC, we note, there is no specific mention that the increased amounts of personal and additional exemptions under Section 35 shall be

given retroactive effect. Conformably too, personal and additional exemptions are considered as deductions from gross income. Deductions

for income tax purposes partake of the nature of tax exemptions, hence strictly construed27

against the taxpayer28

and cannot be allowed

unless granted in the most explicit and categorical language29

too plain to be mistaken.30

They cannot be extended by mere implication or

inference.31

And, where a provision of law speaks categorically, the need for interpretation is obviated, no plausible pretense being

entertained to justify non-compliance. All that has to be done is to apply it in every case that falls within its terms.32

Accordingly, the Court of Appeals and the Court of Tax Appeals were correct in denying petitioner‘s claim for refund.1âwphi1

WHEREFORE, the petition is DENIED for lack of merit. The Decision dated June 5, 2003 and the Resolution dated September 11, 2003

of the Court of Appeals in CA-G.R. S.P. No. 60475 are hereby AFFIRMED.

SO ORDERED.

G.R. No. L-65773-74 April 30, 1987

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX APPEALS, respondents.

Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.

MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the joint Decision of the Court of Tax Appeals (CTA) in

CTA Cases Nos. 2373 and 2561, dated 26 January 1983, which set aside petitioner's assessment of deficiency income taxes against

respondent British Overseas Airways Corporation (BOAC) for the fiscal years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its

Resolution of 18 November, 1983 denying reconsideration.

BOAC is a 100% British Government-owned corporation organized and existing under the laws of the United Kingdom It is engaged in the

international airline business and is a member-signatory of the Interline Air Transport Association (IATA). As such it operates air

transportation service and sells transportation tickets over the routes of the other airline members. During the periods covered by the

disputed assessments, it is admitted that BOAC had no landing rights for traffic purposes in the Philippines, and was not granted a

Certificate of public convenience and necessity to operate in the Philippines by the Civil Aeronautics Board (CAB), except for a nine-month

period, partly in 1961 and partly in 1962, when it was granted a temporary landing permit by the CAB. Consequently, it did not carry

passengers and/or cargo to or from the Philippines, although during the period covered by the assessments, it maintained a general sales

agent in the Philippines — Wamer Barnes and Company, Ltd., and later Qantas Airways — which was responsible for selling BOAC

tickets covering passengers and cargoes. 1

G.R. No. 65773 (CTA Case No. 2373, the First Case)

On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed BOAC the aggregate amount of P2,498,358.56

for deficiency income taxes covering the years 1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in the

issuance of a new assessment, dated 16 January 1970 for the years 1959 to 1967 in the amount of P858,307.79. BOAC paid this new

assessment under protest.

On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which claim was denied by the CIR on 16 February

1972. But before said denial, BOAC had already filed a petition for review with the Tax Court on 27 January 1972, assailing the assessment

and praying for the refund of the amount paid.

G.R. No. 65774 (CTA Case No. 2561, the Second Case)

On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal years 1968-1969 to 1970-1971 in

the aggregate amount of P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 as compromise penalties for violation of

Section 46 (requiring the filing of corporation returns) penalized under Section 74 of the National Internal Revenue Code (NIRC).

On 25 November 1971, BOAC requested that the assessment be countermanded and set aside. In a letter, dated 16 February 1972, however,

the CIR not only denied the BOAC request for refund in the First Case but also re-issued in the Second Case the deficiency income tax

assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 as compromise penalty under Section 74 of the Tax Code.

BOAC's request for reconsideration was denied by the CIR on 24 August 1973. This prompted BOAC to file the Second Case before the

Tax Court praying that it be absolved of liability for deficiency income tax for the years 1969 to 1971.

This case was subsequently tried jointly with the First Case.

On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the CIR. The Tax Court held that the proceeds of sales of

BOAC passage tickets in the Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, during the period in question,

do not constitute BOAC income from Philippine sources "since no service of carriage of passengers or freight was performed by BOAC

within the Philippines" and, therefore, said income is not subject to Philippine income tax. The CTA position was that income from

transportation is income from services so that the place where services are rendered determines the source. Thus, in the dispositive portion

of its Decision, the Tax Court ordered petitioner to credit BOAC with the sum of P858,307.79, and to cancel the deficiency income tax

assessments against BOAC in the amount of P534,132.08 for the fiscal years 1968-69 to 1970-71.

Hence, this Petition for Review on certiorari of the Decision of the Tax Court.

The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:

1. Whether or not the revenue derived by private respondent British Overseas Airways Corporation (BOAC) from sales of

tickets in the Philippines for air transportation, while having no landing rights here, constitute income of BOAC from

Philippine sources, and, accordingly, taxable.

2. Whether or not during the fiscal years in question BOAC s a resident foreign corporation doing business in the

Philippines or has an office or place of business in the Philippines.

3. In the alternative that private respondent may not be considered a resident foreign corporation but a non-resident

foreign corporation, then it is liable to Philippine income tax at the rate of thirty-five per cent (35%) of its gross income

received from all sources within the Philippines.

Under Section 20 of the 1977 Tax Code:

(h) the term resident foreign corporation engaged in trade or business within the Philippines or having an office or place

of business therein.

(i) The term "non-resident foreign corporation" applies to a foreign corporation not engaged in trade or business within

the Philippines and not having any office or place of business therein

It is our considered opinion that BOAC is a resident foreign corporation. There is no specific criterion as to what constitutes "doing" or

"engaging in" or "transacting" business. Each case must be judged in the light of its peculiar environmental circumstances. The term implies

a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of

some of the functions normally incident to, and in progressive prosecution of commercial gain or for the purpose and object of the business

organization. 2 "In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct

and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. 3

BOAC, during the periods covered by the subject - assessments, maintained a general sales agent in the Philippines, That general sales

agent, from 1959 to 1971, "was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip

in the series corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the

various airline companies on the basis of their participation in the services rendered through the mode of interline settlement as prescribed

by Article VI of the Resolution No. 850 of the IATA Agreement." 4 Those activities were in exercise of the functions which are normally

incident to, and are in progressive pursuit of, the purpose and object of its organization as an international air carrier. In fact, the regular sale

of tickets, its main activity, is the very lifeblood of the airline business, the generation of sales being the paramount objective. There should

be no doubt then that BOAC was "engaged in" business in the Philippines through a local agent during the period covered by the

assessments. Accordingly, it is a resident foreign corporation subject to tax upon its total net income received in the preceding taxable year

from all sources within the Philippines. 5

Sec. 24. Rates of tax on corporations. — ...

(b) Tax on foreign corporations. — ...

(2) Resident corporations. — A corporation organized, authorized, or existing under the laws of any foreign country,

except a foreign fife insurance company, engaged in trade or business within the Philippines, shall be taxable as provided

in subsection (a) of this section upon the total net income received in the preceding taxable year from all sources within

the Philippines. (Emphasis supplied)

Next, we address ourselves to the issue of whether or not the revenue from sales of tickets by BOAC in the Philippines constitutes income

from Philippine sources and, accordingly, taxable under our income tax laws.

The Tax Code defines "gross income" thus:

"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 profession, vocations, trades, business, 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 interests,

rents, dividends, securities, or the transactions of any business carried on for gain or profile, or gains, profits, and income

derived from any source whatever (Sec. 29[3]; Emphasis supplied)

The definition is broad and comprehensive to include proceeds from sales of transport documents. "The words 'income from any source

whatever' disclose a legislative policy to include all income not expressly exempted within the class of taxable income under our laws."

Income means "cash received or its equivalent"; it is the amount of money coming to a person within a specific time ...; it means something

distinct from principal or capital. For, while capital is a fund, income is a flow. As used in our income tax law, "income" refers to the flow

of wealth. 6

The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to 1970-71 amounted to P10,428,368 .00. 7

Did such "flow of wealth" come from "sources within the Philippines",

The source of an income is the property, activity or service that produced the income. 8 For the source of income to be considered as coming

from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the

Philippines is the activity that produces the income. The tickets exchanged hands here and payments for fares were also made here in

Philippine currency. The site of the source of payments is the Philippines. The flow of wealth proceeded from, and occurred within,

Philippine territory, enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow of wealth

should share the burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between the ticket-holder

and the carrier. It gives rise to the obligation of the purchaser of the ticket to pay the fare and the corresponding obligation of the carrier to

transport the passenger upon the terms and conditions set forth thereon. The ordinary ticket issued to members of the traveling public in

general embraces within its terms all the elements to constitute it a valid contract, binding upon the parties entering into the relationship. 9

True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources within the Philippines, namely: (1) interest, (21)

dividends, (3) service, (4) rentals and royalties, (5) sale of real property, and (6) sale of personal property, does not mention income from

the sale of tickets for international transportation. However, that does not render it less an income from sources within the Philippines.

Section 37, by its language, does not intend the enumeration to be exclusive. It merely directs that the types of income listed therein be

treated as income from sources within the Philippines. A cursory reading of the section will show that it does not state that it is an all-

inclusive enumeration, and that no other kind of income may be so considered. " 10

BOAC, however, would impress upon this Court that income derived from transportation is income for services, with the result that the

place where the services are rendered determines the source; and since BOAC's service of transportation is performed outside the

Philippines, the income derived is from sources without the Philippines and, therefore, not taxable under our income tax laws. The Tax

Court upholds that stand in the joint Decision under review.

The absence of flight operations to and from the Philippines is not determinative of the source of income or the site of income taxation.

Admittedly, BOAC was an off-line international airline at the time pertinent to this case. The test of taxability is the "source"; and the

source of an income is that activity ... which produced the income. 11 Unquestionably, the passage documentations in these cases were sold

in the Philippines and the revenue therefrom was derived from a activity regularly pursued within the Philippines. business a And even if

the BOAC tickets sold covered the "transport of passengers and cargo to and from foreign cities", 12 it cannot alter the fact that income

from the sale of tickets was derived from the Philippines. The word "source" conveys one essential idea, that of origin, and the origin of the

income herein is the Philippines. 13

It should be pointed out, however, that the assessments upheld herein apply only to the fiscal years covered by the questioned deficiency

income tax assessments in these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For, pursuant to Presidential Decree No. 69,

promulgated on 24 November, 1972, international carriers are now taxed as follows:

... Provided, however, That international carriers shall pay a tax of 2-½ per cent on their cross Philippine billings. (Sec.

24[b] [21, Tax Code).

Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory definition of the term "gross Philippine billings," thus:

... "Gross Philippine billings" includes gross revenue realized from uplifts anywhere in the world by any international

carrier doing business in the Philippines of passage documents sold therein, whether for passenger, excess baggage or

mail provided the cargo or mail originates from the Philippines. ...

The foregoing provision ensures that international airlines are taxed on their income from Philippine sources. The 2-½ % tax on gross

Philippine billings is an income tax. If it had been intended as an excise or percentage tax it would have been place under Title V of the Tax

Code covering Taxes on Business.

Lastly, we find as untenable the BOAC argument that the dismissal for lack of merit by this Court of the appeal in JAL vs. Commissioner of

Internal Revenue (G.R. No. L-30041) on February 3, 1969, is res judicata to the present case. The ruling by the Tax Court in that case was

to the effect that the mere sale of tickets, unaccompanied by the physical act of carriage of transportation, does not render the taxpayer

therein subject to the common carrier's tax. As elucidated by the Tax Court, however, the common carrier's tax is an excise tax, being a tax

on the activity of transporting, conveying or removing passengers and cargo from one place to another. It purports to tax the business of

transportation. 14 Being an excise tax, the same can be levied by the State only when the acts, privileges or businesses are done or

performed within the jurisdiction of the Philippines. The subject matter of the case under consideration is income tax, a direct tax on the

income of persons and other entities "of whatever kind and in whatever form derived from any source." Since the two cases treat of a

different subject matter, the decision in one cannot be res judicata to the other.

WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET ASIDE. Private respondent, the British Overseas

Airways Corporation (BOAC), is hereby ordered to pay the amount of P534,132.08 as deficiency income tax for the fiscal years 1968-69 to

1970-71 plus 5% surcharge, and 1% monthly interest from April 16, 1972 for a period not to exceed three (3) years in accordance with the

Tax Code. The BOAC claim for refund in the amount of P858,307.79 is hereby denied. Without costs.

SO ORDERED.

United Airlines vs. CIR

VILLARAMA, JR., J.:

Before us is a petition for review on certiorari under Rule 45 of the 1997 Rules of Civil Procedure, as amended, of the

Decision36[1] dated July 5, 2007 of the Court of Tax Appeals En Banc (CTA En Banc) in C.T.A. EB No. 227 denying petitioners claim for

tax refund of P5.03 million.

The undisputed facts are as follows:

Petitioner United Airlines, Inc. is a foreign corporation organized and existing under the laws of the State of Delaware, U.S.A.,

engaged in the international airline business.

Petitioner used to be an online international carrier of passenger and cargo, i.e., it used to operate passenger and cargo flights

originating in the Philippines. Upon cessation of its passenger flights in and out of the Philippines beginning February 21, 1998, petitioner

appointed a sales agent in the Philippines -- Aerotel Ltd. Corp., an independent general sales agent acting as such for several international

airline companies.37[2] Petitioner continued operating cargo flights from the Philippines until January 31, 2001.38[3]

On April 12, 2002, petitioner filed with respondent Commissioner a claim for income tax refund, pursuant to Section

28(A)(3)(a)39[4] of the National Internal Revenue Code of 1997 (NIRC) in relation to Article 4(7)40[5] of the Convention between the

Government of the Republic of the Philippines and the Government of the United States of America with respect to Income Taxes (RP-US

Tax Treaty). Petitioner sought to refund the total amount of P15,916,680.69 pertaining to income taxes paid on gross passenger and cargo

revenues for the taxable years 1999 to 2001, which included the amount of P5,028,813.23 allegedly representing income taxes paid in 1999

on passenger revenue from tickets sold in the Philippines, the uplifts of which did not originate in the Philippines. Citing the change in

definition of Gross Philippine Billings (GPB) in the NIRC, petitioner argued that since it no longer operated passenger flights originating

from the Philippines beginning February 21, 1998, its passenger revenue for 1999, 2000 and 2001 cannot be considered as income from

sources within the Philippines, and hence should not be subject to Philippine income tax under Article 941[6] of the RP-US Tax

Treaty.42[7]

As no resolution on its claim for refund had yet been made by the respondent and in view of the two (2)-year prescriptive period

(from the time of filing the Final Adjustment Return for the taxable year 1999) which was about to expire on April 15, 2002, petitioner filed

on said date a petition for review with the Court of Tax Appeals (CTA).43[8]

Petitioner asserted that under the new definition of GPB under the 1997 NIRC and Article 4(7) of the RP-US Tax Treaty,

Philippine tax authorities have jurisdiction to tax only the gross revenue derived by US air and shipping carriers from outgoing traffic in the

Philippines. Since the Bureau of Internal Revenue (BIR) erroneously imposed and collected income tax in 1999 based on petitioners gross

passenger revenue, as beginning 1998 petitioner no longer flew passenger flights to and from the Philippines, petitioner is entitled to a

refund of such erroneously collected income tax in the amount of P5,028,813.23.44[9]

In its Decision45[10] dated May 18, 2006, the CTAs First Division46[11] ruled that no excess or erroneously paid tax may be

refunded to petitioner because the income tax on GPB under Section 28(A)(3)(a) of the NIRC applies as well to gross revenue from carriage of

cargoes originating from the Philippines. It agreed that petitioner cannot be taxed on its 1999 passenger revenue from flights originating outside

the Philippines. However, in reporting a cargo revenue of P740.33 million in 1999, it was found that petitioner deducted two (2) items from its

gross cargo revenue of P2.84 billion: P141.79 million as commission and P1.98 billion as other incentives of its agent. These deductions were

erroneous because the gross revenue referred to in Section 28(A)(3)(a) of the NIRC was total revenue before any deduction of commission and

incentives. Petitioners gross cargo revenue in 1999, being P2.84 billion, the GPB tax thereon was P42.54 million and not P11.1 million, the

amount petitioner paid for the reported net cargo revenue of P740.33 million. The CTA First Division further noted that petitioner even

underpaid its taxes on cargo revenue by P31.43 million, which amount was much higher than the P5.03 million it asked to be refunded.

A motion for reconsideration was filed by petitioner but the First Division denied the same. It held that petitioners claim for tax

refund was not offset with its tax liability; that petitioners tax deficiency was due to erroneous deductions from its gross cargo revenue; that

it did not make an assessment against petitioner; and that it merely determined if petitioner was entitled to a refund based on the undisputed

facts and whether petitioner had paid the correct amount of tax.47[12]

Petitioner elevated the case to the CTA En Banc which affirmed the decision of the First Division.

Hence, this petition anchored on the following grounds:

I. THE CTA EN BANC GROSSLY ERRED IN DENYING THE PETITIONERS CLAIM FOR REFUND OF

ERRONEOUSLY PAID INCOME TAX ON GROSS PHILIPPINE BILLINGS [GPB] BASED ON ITS FINDING

THAT PETITIONERS UNDERPAYMENT OF [P31.43 MILLION] GPB TAX ON CARGO REVENUES IS A

LOT HIGHER THAN THE GPB TAX OF [P5.03 MILLION] ON PASSENGER REVENUES, WHICH IS THE

SUBJECT OF THE INSTANT CLAIM FOR REFUND. THE DENIAL OF PETITIONERS CLAIM ON SUCH

GROUND CLEARLY AMOUNTS TO AN OFF-SETTING OF TAX LIABILITIES, CONTRARY TO WELL-

SETTLED JURISPRUDENCE.

II. THE DECISION OF THE CTA EN BANC VIOLATED PETITIONERS RIGHT TO DUE PROCESS.

III. THE CTA EN BANC ACTED IN EXCESS OF ITS JURISDICTION BY DENYING PETITIONERS CLAIM FOR

REFUND OF ERRONEOUSLY PAID INCOME TAX ON GROSS PHILIPPINE BILLINGS BASED ON ITS

FINDING THAT PETITIONER UNDERPAID GPB TAX ON CARGO REVENUES IN THE AMOUNT OF

[P31.43 MILLION] FOR THE TAXABLE YEAR 1999.

IV. THE CTA EN BANC HAS NO AUTHORITY UNDER THE LAW TO MAKE ANY ASSESSMENTS FOR

DEFICIENCY TAXES. THE AUTHORITY TO MAKE ASSESSMENTS FOR DEFICIENCY NATIONAL

INTERNAL REVENUE TAXES IS VESTED BY THE 1997 NIRC UPON RESPONDENT.

V. ANY ASSESSMENT AGAINST PETITIONER FOR DEFICIENCY INCOME TAX FOR THE TAXABLE YEAR

1999 IS ALREADY BARRED BY PRESCRIPTION.48[13]

The main issue to be resolved is whether the petitioner is entitled to a refund of the amount of P5,028,813.23 it paid as income tax

on its passenger revenues in 1999.

Petitioner argues that its claim for refund of erroneously paid GPB tax on off-line passenger revenues cannot be denied based on

the finding of the CTA that petitioner allegedly underpaid the GPB tax on cargo revenues by P31,431,171.09, which underpayment is

allegedly higher than the GPB tax of P5,028,813.23 on passenger revenues, the amount of the instant claim. The denial of petitioners claim

for refund on such ground is tantamount to an offsetting of petitioners claim for refund of erroneously paid GPB against its alleged tax

liability. Petitioner thus cites the well-entrenched rule in taxation cases that internal revenue taxes cannot be the subject of set-off or

compensation.49[14]

According to petitioner, the offsetting of the liabilities is very clear in the instant case because the amount of petitioners claim for

refund of erroneously paid GPB tax of P5,028,813.23 for the taxable year 1999 is being offset against petitioners alleged deficiency GPB

tax liability on cargo revenues for the same year, which was not even the subject of an investigation nor any valid assessment issued by

respondent against the petitioner. Under Section 22850[15] of the NIRC, the taxpayer shall be informed in writing of the law and the facts

on which the assessment is made; otherwise, the assessment shall be void. This administrative process of issuing an assessment is part of

procedural due process enshrined in the 1987 Constitution. Records do not show that petitioner has been assessed by the BIR for any

deficiency GBP tax for 1999, nor was there any finding or investigation being conducted by respondent of any liability of petitioner for

GPB tax for the said taxable period. Clearly, petitioners right to due process was violated.51[16]

Petitioner further argues that the CTA acted in excess of its jurisdiction because the exclusive appellate jurisdiction of the CTA

covers only decisions or inactions of the respondent in cases involving disputed assessments. The CTA has effectively assessed petitioner

with a P31.43 million tax deficiency when it concluded that petitioner underpaid its GPB tax on cargo revenue. Since respondent did not

issue an assessment for any deficiency tax, the alleged deficiency tax on its cargo revenue in 1999 cannot be considered a disputed

assessment that may be passed upon by the CTA. Petitioner stresses that the authority to issue an assessment for deficiency internal revenue

taxes is vested by law on respondent, not with the CTA.52[17]

Lastly, petitioner argues that any assessment against it for deficiency income tax for taxable year 1999 is barred by prescription.

Petitioner claims that the prescriptive period within which an assessment for deficiency income tax may be made has prescribed on April

17, 2003, three (3) years after it filed its 1999 tax return.53[18]

Respondent Commissioner maintains that the CTA acted within its jurisdiction in denying petitioners claim for tax refund. It points

out that the objective of the CTAs determination of whether petitioner correctly paid its GPB tax for the taxable year 1999 was to ascertain

the latters entitlement to the claimed refund and not for the purpose of imposing any deficiency tax. Hence, petitioners arguments regarding

the propriety of the CTAs determination of its deficiency tax on its GPB for gross cargo revenues for 1999 are clearly misplaced.54[19]

The petition has no merit.

As correctly pointed out by petitioner, inasmuch as it ceased operating passenger flights to or from the Philippines in 1998, it is not

taxable under Section 28(A)(3)(a) of the NIRC for gross passenger revenues. This much was also found by the CTA. In South African

Airways v. Commissioner of Internal Revenue,55[20] we ruled that the correct interpretation of the said provisions is that, if an international

air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2% of its GPB, while international air carriers that do

not have flights to and from the Philippines but nonetheless earn income from other activities in the country will be taxed at the rate of 32%

of such income.

Here, the subject of claim for tax refund is the tax paid on passenger revenue for taxable year 1999 at the time when petitioner was

still operating cargo flights originating from the Philippines although it had ceased passenger flight operations. The CTA found that

petitioner had underpaid its GPB tax for 1999 because petitioner had made deductions from its gross cargo revenues in the income tax

return it filed for the taxable year 1999, the amount of underpayment even greater than the refund sought for erroneously paid GPB tax on

passenger revenues for the same taxable period. Hence, the CTA ruled petitioner is not entitled to a tax refund.

Petitioners arguments regarding the propriety of such determination by the CTA are misplaced.

Under Section 72 of the NIRC, the CTA can make a valid finding that petitioner made erroneous deductions on its gross cargo

revenue; that because of the erroneous deductions, petitioner reported a lower cargo revenue and paid a lower income tax thereon; and that

petitioner's underpayment of the income tax on cargo revenue is even higher than the income tax it paid on passenger revenue subject of the

claim for refund, such that the refund cannot be granted.

Section 72 of the NIRC reads:

SEC. 72. Suit to Recover Tax Based on False or Fraudulent Returns. - When an assessment is made in case

of any list, statement or return, which in the opinion of the Commissioner was false or fraudulent or contained any

understatement or undervaluation, no tax collected under such assessment shall be recovered by any suit, unless it is

proved that the said list, statement or return was not false nor fraudulent and did not contain any understatement or

undervaluation; but this provision shall not apply to statements or returns made or to be made in good faith regarding

annual depreciation of oil or gas wells and mines.

In the afore-cited case of South African Airways, this Court rejected similar arguments on the denial of claim for tax refund, as

follows:

Precisely, petitioner questions the offsetting of its payment of the tax under Sec. 28(A)(3)(a) with their

liability under Sec. 28(A)(1), considering that there has not yet been any assessment of their obligation under the

latter provision. Petitioner argues that such offsetting is in the nature of legal compensation, which cannot be applied

under the circumstances present in this case.

Article 1279 of the Civil Code contains the elements of legal compensation, to wit:

Art. 1279. In order that compensation may be proper, it is necessary:

(1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor

of the other;

(2) That both debts consist in a sum of money, or if the things due are consumable, they be of the same

kind, and also of the same quality if the latter has been stated;

(3) That the two debts be due;

(4) That they be liquidated and demandable;

(5) That over neither of them there be any retention or controversy, commenced by third persons and

communicated in due time to the debtor.

And we ruled in Philex Mining Corporation v. Commissioner of Internal Revenue, thus:

In several instances prior to the instant case, we have already made the pronouncement that taxes cannot

be subject to compensation for the simple reason that the government and the taxpayer are not creditors and

debtors of each other. There is a material distinction between a tax and debt. Debts are due to the Government in

its corporate capacity, while taxes are due to the Government in its sovereign capacity. We find no cogent reason

to deviate from the aforementioned distinction.

Prescinding from this premise, in Francia v. Intermediate Appellate Court, we categorically held that

taxes cannot be subject to set-off or compensation, thus:

We have consistently ruled that there can be no off-setting of taxes against the claims that the

taxpayer may have against the government. A person cannot refuse to pay a tax on the ground that the

government owes him an amount equal to or greater than the tax being collected. The collection of a tax

cannot await the results of a lawsuit against the government.

The ruling in Francia has been applied to the subsequent case of Caltex Philippines, Inc. v. Commission

on Audit, which reiterated that:

. . . a taxpayer may not offset taxes due from the claims that he may have against the

government. Taxes cannot be the subject of compensation because the government and taxpayer are not

mutually creditors and debtors of each other and a claim for taxes is not such a debt, demand, contract

or judgment as is allowed to be set-off.

Verily, petitioners argument is correct that the offsetting of its tax refund with its alleged tax deficiency is

unavailing under Art. 1279 of the Civil Code.

Commissioner of Internal Revenue v. Court of Tax Appeals, however, granted the offsetting of a tax refund

with a tax deficiency in this wise:

Further, it is also worth noting that the Court of Tax Appeals erred in denying petitioners supplemental

motion for reconsideration alleging bringing to said courts attention the existence of the deficiency income and

business tax assessment against Citytrust. The fact of such deficiency assessment is intimately related to and

inextricably intertwined with the right of respondent bank to claim for a tax refund for the same year. To award

such refund despite the existence of that deficiency assessment is an absurdity and a polarity in conceptual

effects. Herein private respondent cannot be entitled to refund and at the same time be liable for a tax deficiency

assessment for the same year.

The grant of a refund is founded on the assumption that the tax return is valid, that is, the facts

stated therein are true and correct. The deficiency assessment, although not yet final, created a doubt as to

and constitutes a challenge against the truth and accuracy of the facts stated in said return which, by itself

and without unquestionable evidence, cannot be the basis for the grant of the refund.

Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the applicable

law when the claim of Citytrust was filed, provides that (w)hen an assessment is made in case of any list,

statement, or return, which in the opinion of the Commissioner of Internal Revenue was false or fraudulent or

contained any understatement or undervaluation, no tax collected under such assessment shall be recovered by

any suits unless it is proved that the said list, statement, or return was not false nor fraudulent and did not contain

any understatement or undervaluation; but this provision shall not apply to statements or returns made or to be

made in good faith regarding annual depreciation of oil or gas wells and mines.

Moreover, to grant the refund without determination of the proper assessment and the tax due

would inevitably result in multiplicity of proceedings or suits. If the deficiency assessment should

subsequently be upheld, the Government will be forced to institute anew a proceeding for the recovery of

erroneously refunded taxes which recourse must be filed within the prescriptive period of ten years after

discovery of the falsity, fraud or omission in the false or fraudulent return involved. This would necessarily

require and entail additional efforts and expenses on the part of the Government, impose a burden on and a drain

of government funds, and impede or delay the collection of much-needed revenue for governmental operations.

Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both logically

necessary and legally appropriate that the issue of the deficiency tax assessment against Citytrust be

resolved jointly with its claim for tax refund, to determine once and for all in a single proceeding the true

and correct amount of tax due or refundable.

In fact, as the Court of Tax Appeals itself has heretofore conceded, it would be only just and fair that the

taxpayer and the Government alike be given equal opportunities to avail of remedies under the law to defeat each

others claim and to determine all matters of dispute between them in one single case. It is important to note that

in determining whether or not petitioner is entitled to the refund of the amount paid, it would [be] necessary to

determine how much the Government is entitled to collect as taxes. This would necessarily include the

determination of the correct liability of the taxpayer and, certainly, a determination of this case would constitute

res judicata on both parties as to all the matters subject thereof or necessarily involved therein. (Emphasis

supplied.)

Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997 NIRC. The above

pronouncements are, therefore, still applicable today.

Here, petitioners similar tax refund claim assumes that the tax return that it filed was correct. Given,

however, the finding of the CTA that petitioner, although not liable under Sec. 28(A)(3)(a) of the 1997 NIRC, is

liable under Sec. 28(A)(1), the correctness of the return filed by petitioner is now put in doubt. As such, we cannot

grant the prayer for a refund.56[21] (Additional emphasis supplied.)

In the case at bar, the CTA explained that it merely determined whether petitioner is entitled to a refund based on the facts. On the

assumption that petitioner filed a correct return, it had the right to file a claim for refund of GPB tax on passenger revenues it paid in 1999

when it was not operating passenger flights to and from the Philippines. However, upon examination by the CTA, petitioners return was

found erroneous as it understated its gross cargo revenue for the same taxable year due to deductions of two (2) items consisting of

commission and other incentives of its agent. Having underpaid the GPB tax due on its cargo revenues for 1999, petitioner is not entitled to a

refund of its GPB tax on its passenger revenue, the amount of the former being even much higher (P31.43 million) than the tax refund sought

(P5.2 million). The CTA therefore correctly denied the claim for tax refund after determining the proper assessment and the tax due. Obviously,

the matter of prescription raised by petitioner is a non-issue. The prescriptive periods under Sections 20357[22] and 22258[23] of the NIRC

find no application in this case.

We must emphasize that tax refunds, like tax exemptions, are construed strictly against the taxpayer and liberally in favor of the

taxing authority.59[24] In any event, petitioner has not discharged its burden of proof in establishing the factual basis for its claim for a

refund and we find no reason to disturb the ruling of the CTA. It has been a long-standing policy and practice of the Court to respect the

conclusions of quasi-judicial agencies such as the CTA, a highly specialized body specifically created for the purpose of reviewing tax

cases.60[25]

WHEREFORE, we DENY the petition for lack of merit and AFFIRM the Decision dated July 5, 2007 of the Court of Tax

Appeals En Banc in C.T.A. EB No. 227.

With costs against the petitioner.

SO ORDERED.