G.R. No.

78133 October 18, 1988

MARIANO P. PASCUAL and RENATO P. DRAGON, petitioners,

vs.
THE COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS,
respondents.

De la Cuesta, De las Alas and Callanta Law Offices for petitioners.

The Solicitor General for respondents

GANCAYCO, J.:

The distinction between co-ownership and an unregistered partnership or joint venture

for income tax purposes is the issue in this petition.

On June 22, 1965, petitioners bought two (2) parcels of land from Santiago Bernardino,
et al. and on May 28, 1966, they bought another three (3) parcels of land from Juan
Roque. The first two parcels of land were sold by petitioners in 1968 toMarenir
Development Corporation, while the three parcels of land were sold by petitioners to
Erlinda Reyes and Maria Samson on March 19,1970. Petitioners realized a net profit in
the sale made in 1968 in the amount of P165,224.70, while they realized a net profit of
P60,000.00 in the sale made in 1970. The corresponding capital gains taxes were paid
by petitioners in 1973 and 1974 by availing of the tax amnesties granted in the said
years.

However, in a letter dated March 31, 1979 of then Acting BIR Commissioner Efren I.
Plana, petitioners were assessed and required to pay a total amount of P107,101.70 as
alleged deficiency corporate income taxes for the years 1968 and 1970.

Petitioners protested the said assessment in a letter of June 26, 1979 asserting that
they had availed of tax amnesties way back in 1974.

In a reply of August 22, 1979, respondent Commissioner informed petitioners that in the
years 1968 and 1970, petitioners as co-owners in the real estate transactions formed an
unregistered partnership or joint venture taxable as a corporation under Section 20(b)
and its income was subject to the taxes prescribed under Section 24, both of the
National Internal Revenue Code 1 that the unregistered partnership was subject to
corporate income tax as distinguished from profits derived from the partnership by them
which is subject to individual income tax; and that the availment of tax amnesty under
P.D. No. 23, as amended, by petitioners relieved petitioners of their individual income
tax liabilities but did not relieve them from the tax liability of the unregistered
partnership. Hence, the petitioners were required to pay the deficiency income tax
assessed.
Petitioners filed a petition for review with the respondent Court of Tax Appeals docketed
as CTA Case No. 3045. In due course, the respondent court by a majority decision of
March 30, 1987, 2 affirmed the decision and action taken by respondent commissioner
with costs against petitioners.

It ruled that on the basis of the principle enunciated in Evangelista 3 an unregistered

partnership was in fact formed by petitioners which like a corporation was subject to
corporate income tax distinct from that imposed on the partners.

In a separate dissenting opinion, Associate Judge Constante Roaquin stated that

considering the circumstances of this case, although there might in fact be a co-
ownership between the petitioners, there was no adequate basis for the conclusion that
they thereby formed an unregistered partnership which made "hem liable for corporate
income tax under the Tax Code.

Hence, this petition wherein petitioners invoke as basis thereof the following alleged
errors of the respondent court:

A. IN HOLDING AS PRESUMPTIVELY CORRECT THE DETERMINATION OF THE

RESPONDENT COMMISSIONER, TO THE EFFECT THAT PETITIONERS FORMED AN
UNREGISTERED PARTNERSHIP SUBJECT TO CORPORATE INCOME TAX, AND
THAT THE BURDEN OF OFFERING EVIDENCE IN OPPOSITION THERETO RESTS
UPON THE PETITIONERS.

B. IN MAKING A FINDING, SOLELY ON THE BASIS OF ISOLATED SALE

TRANSACTIONS, THAT AN UNREGISTERED PARTNERSHIP EXISTED THUS
IGNORING THE REQUIREMENTS LAID DOWN BY LAW THAT WOULD WARRANT
THE PRESUMPTION/CONCLUSION THAT A PARTNERSHIP EXISTS.

C. IN FINDING THAT THE INSTANT CASE IS SIMILAR TO THE EVANGELISTA CASE

AND THEREFORE SHOULD BE DECIDED ALONGSIDE THE EVANGELISTA CASE.

D. IN RULING THAT THE TAX AMNESTY DID NOT RELIEVE THE PETITIONERS
FROM PAYMENT OF OTHER TAXES FOR THE PERIOD COVERED BY SUCH
AMNESTY. (pp. 12-13, Rollo.)

The petition is meritorious.

The basis of the subject decision of the respondent court is the ruling of this Court in
Evangelista. 4

In the said case, petitioners borrowed a sum of money from their father which together
with their own personal funds they used in buying several real properties. They
appointed their brother to manage their properties with full power to lease, collect, rent,
issue receipts, etc. They had the real properties rented or leased to various tenants for
several years and they gained net profits from the rental income. Thus, the Collector of
Internal Revenue demanded the payment of income tax on a corporation, among
others, from them.
In resolving the issue, this Court held as follows:

The issue in this case is whether petitioners are subject to the tax on corporations
provided for in section 24 of Commonwealth Act No. 466, otherwise known as the
National Internal Revenue Code, as well as to the residence tax for corporations and the
real estate dealers' fixed tax. With respect to the tax on corporations, the issue hinges on
the meaning of the terms corporation and partnership as used in sections 24 and 84 of
said Code, the pertinent parts of which read:

Sec. 24. Rate of the tax on corporations.—There shall be levied, assessed, collected,
and paid annually upon the total net income received in the preceding taxable year from
all sources by every corporation organized in, or existing under the laws of the
Philippines, no matter how created or organized but not including duly registered general
co-partnerships (companies collectives), a tax upon such income equal to the sum of the
following: ...

Sec. 84(b). The term "corporation" includes partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participation), associations
or insurance companies, but does not include duly registered general co-partnerships
(companies colectivas).

Article 1767 of the Civil Code of the Philippines provides:

By the 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.

Pursuant to this article, the essential elements of a partnership are two, namely: (a) an
agreement to contribute money, property or industry to a common fund; and (b) intent to
divide the profits among the contracting parties. The first element is undoubtedly present
in the case at bar, for, admittedly, petitioners have agreed to, and did, contribute money
and property to a common fund. Hence, the issue narrows down to their intent in acting
as they did. Upon consideration of all the facts and circumstances surrounding the case,
we are fully satisfied that their purpose was to engage in real estate transactions for
monetary gain and then divide the same among themselves, because:

1. Said common fund was not something they found already in existence. It was not a
property inherited by them pro indiviso. They created it purposely. What is more they
jointly borrowed a substantial portion thereof in order to establish said common fund.

2. They invested the same, not merely in one transaction, but in a series of transactions.
On February 2, 1943, they bought a lot for P100,000.00. On April 3, 1944, they
purchased 21 lots for P18,000.00. This was soon followed, on April 23, 1944, by the
acquisition of another real estate for P108,825.00. Five (5) days later (April 28, 1944),
they got a fourth lot for P237,234.14. The number of lots (24) acquired and transcations
undertaken, as well as the brief interregnum between each, particularly the last three
purchases, is strongly indicative of a pattern or common design that was not limited to
the conservation and preservation of the aforementioned common fund or even of the
property acquired by petitioners in February, 1943. In other words, one cannot but
perceive a character of habituality peculiar to business transactions engaged in for
purposes of gain.

3. The aforesaid lots were not devoted to residential purposes or to other personal uses,
of petitioners herein. The properties were leased separately to several persons, who,
 from 1945 to 1948 inclusive, paid the total sum of P70,068.30 by way of rentals.
Seemingly, the lots are still being so let, for petitioners do not even suggest that there has
been any change in the utilization thereof.

4. Since August, 1945, the properties have been under the management of one person,
namely, Simeon Evangelists, with full power to lease, to collect rents, to issue receipts, to
bring suits, to sign letters and contracts, and to indorse and deposit notes and checks.
Thus, the affairs relative to said properties have been handled as if the same belonged to
a corporation or business enterprise operated for profit.

5. The foregoing conditions have existed for more than ten (10) years, or, to be exact,
over fifteen (15) years, since the first property was acquired, and over twelve (12) years,
since Simeon Evangelists became the manager.

6. Petitioners have not testified or introduced any evidence, either on their purpose in
creating the set up already adverted to, or on the causes for its continued existence. They
did not even try to offer an explanation therefor.

Although, taken singly, they might not suffice to establish the intent necessary to
constitute a partnership, the collective effect of these circumstances is such as to leave
no room for doubt on the existence of said intent in petitioners herein. Only one or two of
the aforementioned circumstances were present in the cases cited by petitioners herein,
and, hence, those cases are not in point. 5

In the present case, there is no evidence that petitioners entered into an agreement to
contribute money, property or industry to a common fund, and that they intended to
divide the profits among themselves. Respondent commissioner and/ or his
representative just assumed these conditions to be present on the basis of the fact that
petitioners purchased certain parcels of land and became co-owners thereof.

In Evangelists, there was a series of transactions where petitioners purchased twenty-

four (24) lots showing that the purpose was not limited to the conservation or
preservation of the common fund or even the properties acquired by them. The
character of habituality peculiar to business transactions engaged in for the purpose of
gain was present.

In the instant case, petitioners bought two (2) parcels of land in 1965. They did not sell
the same nor make any improvements thereon. In 1966, they bought another three (3)
parcels of land from one seller. It was only 1968 when they sold the two (2) parcels of
land after which they did not make any additional or new purchase. The remaining three
(3) parcels were sold by them in 1970. The transactions were isolated. The character of
habituality peculiar to business transactions for the purpose of gain was not present.

In Evangelista, the properties were leased out to tenants for several years. The
business was under the management of one of the partners. Such condition existed for
over fifteen (15) years. None of the circumstances are present in the case at bar. The
co-ownership started only in 1965 and ended in 1970.

Thus, in the concurring opinion of Mr. Justice Angelo Bautista in Evangelista he said:
I wish however to make the following observation Article 1769 of the new Civil Code lays
down the rule for determining when a transaction should be deemed a partnership or a
co-ownership. Said article paragraphs 2 and 3, provides;

(2) Co-ownership or co-possession does not itself establish a partnership, whether such
co-owners or co-possessors do or do not share any profits made by the use of the
property;

(3) The sharing of gross returns does not of itself establish a partnership, whether or not
the persons sharing them have a joint or common right or interest in any property from
which the returns are derived;

From the above it appears that the fact that those who agree to form a co- ownership
share or do not share any profits made by the use of the property held in common does
not convert their venture into a partnership. Or the sharing of the gross returns does not
of itself establish a partnership whether or not the persons sharing therein have a joint or
common right or interest in the property. This only means that, aside from the
circumstance of profit, the presence of other elements constituting partnership is
necessary, such as the clear intent to form a partnership, the existence of a juridical
personality different from that of the individual partners, and the freedom to transfer or
assign any interest in the property by one with the consent of the others (Padilla, Civil
Code of the Philippines Annotated, Vol. I, 1953 ed., pp. 635-636)

It is evident that an isolated transaction whereby two or more persons contribute funds to
buy certain real estate for profit in the absence of other circumstances showing a
contrary intention cannot be considered a partnership.

Persons who contribute property or funds for a common enterprise and agree to share
the gross returns of that enterprise in proportion to their contribution, but who severally
retain the title to their respective contribution, are not thereby rendered partners. They
have no common stock or capital, and no community of interest as principal proprietors in
the business itself which the proceeds derived. (Elements of the Law of Partnership by
Flord D. Mechem 2nd Ed., section 83, p. 74.)

A joint purchase of land, by two, does not constitute a co-partnership in respect thereto;
nor does an agreement to share the profits and losses on the sale of land create a
partnership; the parties are only tenants in common. (Clark vs. Sideway, 142 U.S. 682,12
Ct. 327, 35 L. Ed., 1157.)

Where plaintiff, his brother, and another agreed to become owners of a single tract of
realty, holding as tenants in common, and to divide the profits of disposing of it, the
brother and the other not being entitled to share in plaintiffs commission, no partnership
existed as between the three parties, whatever their relation may have been as to third
parties. (Magee vs. Magee 123 N.E. 673, 233 Mass. 341.)

In order to constitute a partnership inter sese there must be: (a) An intent to form the
same; (b) generally participating in both profits and losses; (c) and such a community of
interest, as far as third persons are concerned as enables each party to make contract,
manage the business, and dispose of the whole property.-Municipal Paving Co. vs.
Herring 150 P. 1067, 50 III 470.)

The common ownership of property does not itself create a partnership between the
owners, though they may use it for the purpose of making gains; and they may, without
becoming partners, agree among themselves as to the management, and use of such
 property and the application of the proceeds therefrom. (Spurlock vs. Wilson, 142 S.W.
363,160 No. App. 14.) 6

The sharing of returns does not in itself establish a partnership whether or not the
persons sharing therein have a joint or common right or interest in the property. There
must be a clear intent to form a partnership, the existence of a juridical personality
different from the individual partners, and the freedom of each party to transfer or assign
the whole property.

In the present case, there is clear evidence of co-ownership between the petitioners.
There is no adequate basis to support the proposition that they thereby formed an
unregistered partnership. The two isolated transactions whereby they purchased
properties and sold the same a few years thereafter did not thereby make them
partners. They shared in the gross profits as co- owners and paid their capital gains
taxes on their net profits and availed of the tax amnesty thereby. Under the
circumstances, they cannot be considered to have formed an unregistered partnership
which is thereby liable for corporate income tax, as the respondent commissioner
proposes.

And even assuming for the sake of argument that such unregistered partnership
appears to have been formed, since there is no such existing unregistered partnership
with a distinct personality nor with assets that can be held liable for said deficiency
corporate income tax, then petitioners can be held individually liable as partners for this
unpaid obligation of the partnership p. 7 However, as petitioners have availed of the
benefits of tax amnesty as individual taxpayers in these transactions, they are thereby
relieved of any further tax liability arising therefrom.

WHEREFROM, the petition is hereby GRANTED and the decision of the respondent
Court of Tax Appeals of March 30, 1987 is hereby REVERSED and SET ASIDE and
another decision is hereby rendered relieving petitioners of the corporate income tax
liability in this case, without pronouncement as to costs.

SO ORDERED.

Cruz, Griño-Aquino and Medialdea, JJ., concur.

Narvasa, J., took no part.

Doctrine:
The sharing of gross returns does not of itself establish a partnership,
whether or not the persons sharing them have a joint or common right or
interest in any property from which the returns are derived. There must be
an unmistakable intention to form a partnership or joint venture.
Facts:
For at least one year after their receipt of two parcels of land from
their father, petitioners resold said lots to the Walled City Securities
Corporation and Olga Cruz Canda, for which they earned a profit of
P134,341.88 or P33,584 for each of them. They treated the profit as a
capital gain and paid an income tax on one-half thereof or of P16,792.
One day before the expiration of the five-year prescriptive period, the
Commissioner of Internal Revenue, Commissioner acting on the theory that
the four petitioners had formed an unregistered partnership or joint
venture, required the four petitioners to pay corporate income tax on the
total profit of P134,336 in addition to individual income tax on their shares
thereof, a 50% fraud surcharge and a 42% accumulated interest. Further,
the Commissioner considered the share of the profits of each petitioner in
the sum of P33,584 as a " taxable in full (not a mere capital gain of which is
taxable) and required them to pay deficiency income taxes aggregating
P56,707.20 including the 50% fraud surcharge and the accumulated
interest.
The petitioners contested the assessments. Two Judges of the Tax
Court sustained the same. Judge Roaquin dissented. Hence, the instant
appeal.

Issue:
Whether or not petitioners have indeed formed a partnership or joint
venture and thus, liable for corporate income tax.

Held:
We hold that it is error to consider the petitioners as having formed a
partnership under article 1767 of the Civil Code simply because they
allegedly contributed P178,708.12 to buy the two lots, resold the same and
divided the profit among themselves.
To regard the petitioners as having formed a taxable unregistered
partnership would result in oppressive taxation and confirm the dictum that
the power to tax involves the power to destroy. That eventuality should be
obviated.
As testified by Jose Obillos, Jr., they had no such intention. They were
co-owners pure and simple. To consider them as partners would obliterate
the distinction between a co-ownership and a partnership. The petitioners
were not engaged in any joint venture by reason of that isolated transaction.
Article 1769(3) of the Civil Code provides that "the sharing of gross
returns does not of itself establish a partnership, whether or not the
persons sharing them have a joint or common right or interest in any
property from which the returns are derived". There must be an
unmistakable intention to form a partnership or joint venture.
WHEREFORE, the judgment of the Tax Court is reversed and set
aside. The assessments are cancelled. No costs.

AMPANG TAN, petitioner,

vs.
THE COMMISSIONER OF CUSTOMS AND COLLECTOR OF CUSTOMS FOR THE
PORT OF JOLO, respondents.

RAMON ROCES, INC., petitioner,

vs.
THE COMMISSIONER OF CUSTOMS and COLLECTOR FOR THE PORT OF
MANILA, respondents.

Clemente M. Soriano for petitioner.

Office of the Solicitor General Ambrosio Padilla and Solicitor Felicisimo R. Rosete for
respondents.

LABRADOR, J.:

Appeal from resolutions from Court of Tax Appeals, dismissing the above-entitled cases on
the ground that the appeals filed by petitioner against the decisions of the Commissioner of
Customs were not perfected within the time prescribed by law.

In the first case, Ampang Tan vs. Commissioner of Customs, G. R. No. L-10940, it appears
that in his decision dated February 23, 1953, the Commissioner of Customs sustained an order of
the Collector of Customs for the Port of Jolo, decreeing the forfeiture and seizure of sixty-nine
cases of "Camel" cigarettes. The decision of the Commissioner was appealed to the defunct
Board of Tax Appeals, which affirmed the decision of said Commissioner in toto. The case was
then appealed to the Supreme Court, but we dismissed the case without prejudice, pursuant to
our decision in the case of U.S.T. vs. Board of Tax Appeals, 93 Phil., 376; 49 Off. Gaz., [6] 2245.

April 19, 1954, petitioner Ampang Tan filed a petition for review of the decision of the
Commissioner of Customs, with the Court of First Instance of Manila, but no action was taken
thereon because petitioner failed to follow up the said notice of appeal by the payment of the
final fee in said court. Subsequently, on November 26, 1954, the petitioner filed a motion with
the Supreme Court for the reinstatement of the case and in order that the same could be decided
pursuant to Section 21 of Republic Act No. 1125, but this motion for reinstatement was denied
by the Supreme Court on February 11, 1955.

But the Court of Tax Appeals in its resolution dated March 2, 1955, reinstated the petition
for review filed on October 26, 1954, on condition that the petitioner pay the docketing fee on
his petition for review. The docketing fee was paid on March 8, 1955.
 The question at issue is: Did petitioner Ampang Tan perfect an appeal from the decision of
the Commissioner of Customs within the time prescribed? The Court of Tax Appeals held that it
is true that April 19, 1954, the petitioner filed a notice of appeal with the Court of First Instance
of Manila, but filing fee in said court was never paid until March 8, 1955. Under the above
circumstances, the Court of Tax Appeals held, the appeal was not perfected in time, and the
Court of First Instance never acquired jurisdiction over the case for failure of petitioner to pay
the full amount of docketing fee essential to perfect an appeal, citing the case of Lazaro vs.
Endencia, 57 Phil., 552.

In the Court of Tax Appeals attempt was made by petitioner herein to prove that offer of
payment of the docketing fee was made, but the Court of Tax Appeals found that the evidence
submitted to that effect can not be believed.

In the other case, Ramon Roces, Inc vs. Commissioner of Customs, G.R. No. L-10942,
parallel proceedings took place. The decision of the Collector of Customs of Jolo was affirmed
by the Commissioner of Customs on October 6, 1952. The case was appealed to the Board of Tax
Appeals, which affirmed the decision on October 23, 1952. Against this decision appeal was
made to the Supreme Court, but this Court dismissed the appeal without prejudice on April 29,
1954, relying on its rulings in the case of U.S.T. vs. Board of Tax Appeals, supra. After dismissal
of the appeal by the Supreme Court, the petitioner Ramon Roces, Inc. file a notice of appeal with
the Commissioner of Customs for a review of the latter's decision by the Court of the First
Instance, but as in the other case no payment of the docketing fee in the court was ever made. On
October 26, 1954, petition for review was filed before the Court of Tax Appeals, but this was
dismissed without prejudice to whatever action the Supreme Court may take on petitioner's
motion of November 26, 1954, to have this case decided by said Tribunal on its Merits. On
March 2, 1955, the Court of Tax Appeals issued a resolution reinstating the petition for review
provided the petitioner first pay the docketing fee. Subsequently, the Court of Tax Appeals
dismissed the petition for review. The decision cites the case of Ampang Tan vs. Commissioner
of Customs, wherein it was found that no payment of docket fee in the Court of First Instance
was made when the decision of the Commissioner was filed by the petitioner on April 19, 1954.

Both cases were presented jointly before the Court. In this Court no attempt was made to
insist that the payment of docketing fee was made with the Commission of Customs upon filing
of the notice of appeal therein. But it is argued that when the Court dismissed the cases without
prejudice, such dismissal should have no effect upon the pendency of the appeal prosecuted
before the Board of Tax Appeals, and that when this Board was declared non-existent the cases
should have been considered transferred to the Court of First Instance. This argument rests on the
theory that the board of Tax Appeals was validly constituted body, which it never was. But if we
follow appellant's argument that appeal to the Board of Tax Appeals was validly prosecuted, we
come face to face with the fact that in both of the cases the Board of Tax Appeals itself had
confirmed the decisions of the Commissioner of Customs in toto.

The fact that the petitioner (themselves) presented their notice of appeal with the
Commissioner of Customs for the review of the latter's decisions of the Court of First Instance.
This shows that they themselves considered the Board of Tax Appeals never to have existed, and
the steps necessary to perfect an appeal must again be made before the cases nay be reviewed by
the Court of First Instance. Sufficient time was given to them to perfect their appeals, by
presenting the required notice of the appeal to the Commissioner of Customs and paying the
docketing fee in the Court of First Instance. Having failed in respect to the latter, the appeals
have never been perfected, for which reason the Court of Tax Appeals correctly held that it is
without jurisdiction to consider the appeals.

We find no error in the dismissal of the appeals by the Court of Tax Appeals and we affirm
its resolutions to that effect, with costs against petitioners. So ordered.

Paras, C.J., Bengzon, Padilla, Montemayor, Bautista Angelo, Conception, Endencia and
Barrera, JJ., concur.1âwphïl.nêt

The Lawphil Project - Arellano Law Foundation OLLECTOR OF INTERNAL REVENUE,

petitioner,
vs.
BATANGAS TRANSPORTATION COMPANY and LAGUNA-TAYABAS BUS
COMPANY, respondents.

Office of the Solicitor General Ambrosio Padilla, Solicitor Conrado T. Limcaoco and Zoilo R.
Zandoval for petitioner.
Ozaeta, Lichauco and Picazo for respondents.

MONTEMAYOR, J.:

This is an appeal from the decision of the Court of Tax Appeals (C.T.A.), which reversed the
assessment and decision of petitioner Collector of Internal Revenue, later referred to as
Collector, assessing and demanding from the respondents Batangas Transportation Company,
later referred to as Batangas Transportation, and Laguna-Tayabas Bus Company, later referred to
as Laguna Bus, the amount of P54,143.54, supposed to represent the deficiency income tax and
compromise for the years 1946 to 1949, inclusive, which amount, pending appeal in the C.T.A.,
but before the Collector filed his answer in said court, was increased to P148,890.14.

The following facts are undisputed: Respondent companies are two distinct and separate
corporations engaged in the business of land transportation by means of motor buses, and
operating distinct and separate lines. Batangas Transportation was organized in 1918, while
Laguna Bus was organized in 1928. Each company now has a fully paid up capital of Pl,000,000.
Before the last war, each company maintained separate head offices, that of Batangas
Transportation in Batangas, Batangas, while the Laguna Bus had its head office in San Pablo
Laguna. Each company also kept and maintained separate books, fleets of buses, management,
personnel, maintenance and repair shops, and other facilities. Joseph Benedict managed the
Batangas Transportation, while Martin Olson was the manager of the Laguna Bus. To show the
connection and close relation between the two companies, it should be stated that Max Blouse
was the President of both corporations and owned about 30 per cent of the stock in each
company. During the war, the American officials of these two corporations were interned in
Santo Tomas, and said companies ceased operations. They also lost their respective properties
and equipment. After Liberation, sometime in April, 1945, the two companies were able to
acquire 56 auto buses from the United States Army, and the two companies diveded said
equipment equally between themselves,registering the same separately in their respective names.
In March, 1947, after the resignation of Martin Olson as Manager of the Laguna Bus, Joseph
Benedict, who was then managing the Batangas Transportation, was appointed Manager of both
companies by their respective Board of Directors. The head office of the Laguna Bus in San
Pablo City was made the main office of both corporations. The placing of the two companies
under one sole mangement was made by Max Blouse, President of both companies, by virtue of
the authority granted him by resolution of the Board of Directors of the Laguna Bus on August
10, 1945, and ratified by the Boards of the two companies in their respective resolutions of
October 27, 1947.

According to the testimony of joint Manager Joseph Benedict, the purpose of the joint
management, which was called, "Joint Emergency Operation", was to economize in overhead
expenses; that by means of said joint operation, both companies had been able to save the
salaries of one manager, one assistant manager, fifteen inspectors, special agents, and one set of
office of clerical force, the savings in one year amounting to about P200,000 or about P100,000
for each company. At the end of each calendar year, all gross receipts and expenses of both
companies were determined and the net profits were divided fifty-fifty, and transferred to the
book of accounts of each company, and each company "then prepared its own income tax return
from this fifty per centum of the gross receipts and expenditures, assets and liabilities thus
transferred to it from the `Joint Emergency Operation' and paid the corresponding income taxes
thereon separately".

Under the theory that the two companies had pooled their resources in the establishment of the
Joint Emergency Operation, thereby forming a joint venture, the Collector wrote the bus
companies that there was due from them the amount of P422,210.89 as deficiency income tax
and compromise for the years 1946 to 1949, inclusive. Since the Collector caused to be
restrained, seized, and advertized for sale all the rolling stock of the two corporations, respondent
companies had to file a surety bond in the same amount of P422,210.89 to guarantee the payment
of the income tax assessed by him.

After some exchange of communications between the parties, the Collector, on January 8, 1955,
informed the respondents "that after crediting the overpayment made by them of their alleged
income tax liabilities for the aforesaid years, pursuant to the doctrine of equitable recoupment,
the income tax due from the `Joint Emergency Operation' for the years 1946 to 1949, inclusive,
is in the total amount of P54,143.54." The respondent companies appealed from said assessment
of P54,143.54 to the Court of Tax Appeals, but before filing his answer, the Collector set aside
his original assessment of P54,143.54 and reassessed the alleged income tax liability of
respondents of P148,890.14, claiming that he had later discovered that said companies had been
"erroneously credited in the last assessment with 100 per cent of their income taxes paid when
they should in fact have been credited with only 75 per cent thereof, since under Section 24 of
the Tax Code dividends received by them from the Joint Operation as a domestic corporation are
returnable to the extent of 25 per cent". That corrected and increased reassessment was embodied
in the answer filed by the Collector with the Court of Tax Appeals.
The theory of the Collector is the Joint Emergency Operation was a corporation distinct from the
two respondent companies, as defined in section 84 (b), and so liable to income tax under section
24, both of the National Internal Revenue Code. After hearing, the C.T.A. found and held, citing
authorities, that the Joint Emergency Operation or joint management of the two companies "is
not a corporation within the contemplation of section 84 (b) of the National Internal Revenue
Code much less a partnership, association or insurance company", and therefore was not subject
to the income tax under the provisions of section 24 of the same Code, separately and
independently of respondent companies; so, it reversed the decision of the Collector assessing
and demanding from the two companies the payment of the amount of P54,143.54 and/or the
amount of P148,890.14. The Tax Court did not pass upon the question of whether or not in the
appeal taken to it by respondent companies, the Collector could change his original assessment
by increasing the same from P54,143.14 to P148,890.14, to correct an error committed by him in
having credited the Joint Emergency Operation, totally or 100 per cent of the income taxes paid
by the respondent companies for the years 1946 to 1949, inclusive, by reason of the principle of
equitable recoupment, instead of only 75 per cent.

The two main and most important questions involved in the present appeal are: (1) whether the
two transportation companies herein involved are liable to the payment of income tax as a
corporation on the theory that the Joint Emergency Operation organized and operated by them is
a corporation within the meaning of Section 84 of the Revised Internal Revenue Code, and (2)
whether the Collector of Internal Revenue, after the appeal from his decision has been perfected,
and after the Court of Tax Appeals has acquired jurisdiction over the same, but before said
Collector has filed his answer with that court, may still modify his assessment subject of the
appeal by increasing the same, on the ground that he had committed error in good faith in
making said appealed assessment.

The first question has already been passed upon and determined by this Tribunal in the case of
Eufemia Evangelista et al., vs. Collector of Internal Revenue et al.,* G.R. No. L-9996,
promulgated on October 15, 1957. Considering the views and rulings embodied in our decision
in that case penned by Mr. Justice Roberto Concepcion, we deem it unnecessary to extensively
discuss the point. Briefly, the facts in that case are as follows: The three Evangelista sisters
borrowed from their father about P59,000 and adding thereto their own personal funds, bought
real properties, such as a lot with improvements for the sum of P100,000 in 1943, parcels of land
with a total area of almost P4,000 square meters with improvements thereon for P18,000 in 1944,
another lot for P108,000 in the same year, and still another lot for P237,000 in the same year. The
relatively large amounts invested may be explained by the fact that purchases were made during
the Japanese occupation, apparently in Japanese military notes. In 1945, the sisters appointed
their brother to manage their properties, with full power to lease, to collect and receive rents, on
default of such payment, to bring suits against the defaulting tenants, to sign all letters and
contracts, etc. The properties therein involved were rented to various tenants, and the sisters,
through their brother as manager, realized a net rental income of P5,948 in 1945, P7,498 in 1946,
and P12,615 in 1948.

In 1954, the Collector of Internal Revenue demanded of them among other things, payment of
income tax on corporations from the year 1945 to 1949, in the total amount of P6,157, including
surcharge and compromise. Dissatisfied with the said assessment, the three sisters appealed to
the Court of Tax Appeals, which court decided in favor of the Collector of Internal Revenue. On
appeal to us, we affirmed the decision of the Tax Court. We found and held that considering all
the facts and circumstances sorrounding the case, the three sisters had the purpose to engage in
real estate transactions for monetary gain and then divide the same among themselves; that they
contributed to a common fund which they invested in a series of transactions; that the properties
bought with this common fund had been under the management of one person with full power to
lease, to collect rents, issue receipts, bring suits, sign letters and contracts, etc., in such a manner
that the affairs relative to said properties have been handled as if the same belonged to a
corporation or business enterprise operated for profit; and that the said sisters had the intention to
constitute a partnership within the meaning of the tax law. Said sisters in their appeal insisted
that they were mere co-owners, not co-partners, for the reason that their acts did not create a
personality independent of them, and that some of the characteristics of partnerships were absent,
but we held that when the Tax Code includes "partnerships" among the entities subject to the tax
on corporations, it must refer to organizations which are not necessarily partnerships in the
technical sense of the term, and that furthermore, said law defined the term "corporation" as
including partnerships no matter how created or organized, thereby indicating that "a joint
venture need not be undertaken in any of the standard forms, or in conformity with the usual
requirements of the law on partnerships, in order that one could be deemed constituted for
purposes of the tax on corporations"; that besides, said section 84 (b) provides that the term
"corporation" includes "joint accounts" (cuentas en participacion) and "associations", none of
which has a legal personality independent of that of its members. The decision cites 7A Merten's
Law of Federal Income Taxation.

In the present case, the two companies contributed money to a common fund to pay the sole
general manager, the accounts and office personnel attached to the office of said manager, as
well as for the maintenance and operation of a common maintenance and repair shop. Said
common fund was also used to buy spare parts, and equipment for both companies, including
tires. Said common fund was also used to pay all the salaries of the personnel of both companies,
such as drivers, conductors, helpers and mechanics, and at the end of each year, the gross income
or receipts of both companies were merged, and after deducting therefrom the gross expenses of
the two companies, also merged, the net income was determined and divided equally between
them, wholly and utterly disregarding the expenses incurred in the maintenance and operation of
each company and of the individual income of said companies.

From the standpoint of the income tax law, this procedure and practice of determining the net
income of each company was arbitrary and unwarranted, disregarding as it did the real facts in
the case. There can be no question that the receipts and gross expenses of two, distinct and
separate companies operating different lines and in some cases, different territories, and different
equipment and personnel at least in value and in the amount of salaries, can at the end of each
year be equal or even approach equality. Those familiar with the operation of the business of land
transportation can readily see that there are many factors that enter into said operation. Much
depends upon the number of lines operated and the length of each line, including the number of
trips made each day. Some lines are profitable, others break above even, while still others are
operated at a loss, at least for a time, depending, of course, upon the volume of traffic, both
passenger and freight. In some lines, the operator may enjoy a more or less exclusive exclusive
operation, while in others, the competition is intense, sometimes even what they call "cutthroat
competition". Sometimes, the operator is involved in litigation, not only as the result of money
claims based on physical injuries ar deaths occassioned by accidents or collisions, but litigations
before the Public Service Commission, initiated by the operator itself to acquire new lines or
additional service and equipment on the lines already existing, or litigations forced upon said
operator by its competitors. Said litigation causes expense to the operator. At other times,
operator is denounced by competitors before the Public Service Commission for violation of its
franchise or franchises, for making unauthorized trips, for temporary abandonement of said lines
or of scheduled trips, etc. In view of this, and considering that the Batangas Transportation and
the Laguna Bus operated different lines, sometimes in different provinces or territories, under
different franchises, with different equipment and personnel, it cannot possibly be true and
correct to say that the end of each year, the gross receipts and income in the gross expenses of
two companies are exactly the same for purposes of the payment of income tax. What was
actually done in this case was that, although no legal personality may have been created by the
Joint Emergency Operation, nevertheless, said Joint Emergency Operation joint venture, or joint
management operated the business affairs of the two companies as though they constituted a
single entity, company or partnership, thereby obtaining substantial economy and profits in the
operation.

For the foregoing reasons, and in the light of our ruling in the Evangelista vs. Collector of
Internal Revenue case, supra, we believe and hold that the Joint Emergency Operation or sole
management or joint venture in this case falls under the provisions of section 84 (b) of the
Internal Revenue Code, and consequently, it is liable to income tax provided for in section 24 of
the same code.

The second important question to determine is whether or not the Collector of Internal Revenue,
after appeal from his decision to the Court of Tax Appeals has been perfected, and after the Tax
Court Appeals has acquired jurisdiction over the appeal, but before the Collector has filed his
answer with the court, may still modify his assessment, subject of the appeal, by increasing the
same. This legal point, interesting and vital to the interests of both the Government and the
taxpayer, provoked considerable discussion among the members of this Tribunal, a minority of
which the writer of this opinion forms part, maintaining that for the information and guidance of
the taxpayer, there should be a definite and final assessment on which he can base his decision
whether or not to appeal; that when the assessment is appealed by the taxpayer to the Court of
Tax Appeals, the collector loses control and jurisdiction over the same, the jurisdiction being
transferred automatically to the Tax Court, which has exclusive appellate jurisdiction over the
same; that the jurisdiction of the Tax Court is not revisory but only appellate, and therefore, it
can act only upon the amount of assessment subject of the appeal to determine whether it is valid
and correct from the standpoint of the taxpayer-appellant; that the Tax Court may only correct
errors committed by the Collector against the taxpayer, but not those committed in his favor,
unless the Government itself is also an appellant; and that unless this be the rule, the Collector of
Internal Revenue and his agents may not exercise due care, prudence and pay too much attention
in making tax assessments, knowing that they can at any time correct any error committed by
them even when due to negligence, carelessness or gross mistake in the interpretation or
application of the tax law, by increasing the assessment, naturally to the prejudice of the taxpayer
who would not know when his tax liability has been completely and definitely met and complied
with, this knowledge being necessary for the wise and proper conduct and operation of his
business; and that lastly, while in the United States of America, on appeal from the decision of
the Commissioner of Internal Revenue to the Board or Court of Tax Appeals, the Commissioner
may still amend or modify his assessment, even increasing the same the law in that jurisdiction
expressly authorizes the Board or Court of Tax Appeals to redetermine and revise the assessment
appealed to it.

The majority, however, holds, not without valid arguments and reasons, that the Government is
not bound by the errors committed by its agents and tax collectors in making tax assessments,
specially when due to a misinterpretation or application of the tax laws, more so when done in
good faith; that the tax laws provide for a prescriptive period within which the tax collectors may
make assessments and reassessments in order to collect all the taxes due to the Government, and
that if the Collector of Internal Revenue is not allowed to amend his assessment before the Court
of Tax Appeals, and since he may make a subsequent reassessment to collect additional sums
within the same subject of his original assessment, provided it is done within the prescriptive
period, that would lead to multiplicity of suits which the law does not encourage; that since the
Collector of Internal Revenue, in modifying his assessment, may not only increase the same, but
may also reduce it, if he finds that he has committed an error against the taxpayer, and may even
make refunds of amounts erroneously and illegally collected, the taxpayer is not prejudiced; that
the hearing before the Court of Tax Appeals partakes of a trial de novo and the Tax Court is
authorized to receive evidence, summon witnesses, and give both parties, the Government and
the taxpayer, opportunity to present and argue their sides, so that the true and correct amount of
the tax to be collected, may be determined and decided, whether resulting in the increase or
reduction of the assessment appealed to it. The result is that the ruling and doctrine now being
laid by this Court is, that pending appeal before the Court of Tax Appeals, the Collector of
Internal Revenue may still amend his appealed assessment, as he has done in the present case.

There is a third question raised in the appeal before the Tax Court and before this Tribunal,
namely, the liability of the two respondent transportation companies for 25 per cent surcharge
due to their failure to file an income tax return for the Joint Emergency Operation, which we
hold to be a corporation within the meaning of the Tax Code. We understand that said 25 per cent
surcharge is included in the assessment of P148,890.14. The surcharge is being imposed by the
Collector under the provisions of Section 72 of the Tax Code, which read as follows:

The Collector of Internal Revenue shall assess all income taxes. In case of willful neglect
to file the return or list within the time prescribed by law, or in case a false or fraudulent
return or list is willfully made the collector 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, a 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 list within the time
prescribed by law or by the Collector or other internal revenue officer, not due to willful
neglect, the Collector, shall add to the tax twenty-five per centum of its amount, except
that, when the return is voluntarily and without notice from the Collector or other officer
filed after such time, it is shown that the failure 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.

We are satisfied that the failure to file an income tax return for the Joint Emergency Operation
was due to a reasonable cause, the honest belief of respondent companies that there was no such
corporation within the meaning of the Tax Code, and that their separate income tax return was
sufficient compliance with the law. That this belief was not entirely without foundation and that
it was entertained in good faith, is shown by the fact that the Court of Tax Appeals itself
subscribed to the idea that the Joint Emergency Operation was not a corporation, and so
sustained the contention of respondents. Furthermore, there are authorities to the effect that belief
in good faith, on advice of reputable tax accountants and attorneys, that a corporation was not a
personal holding company taxable as such constitutes "reasonable cause" for failure to file
holding company surtax returns, and that in such a case, the imposition of penalties for failure to
file holding company surtax returns, and that in such a case, the imposition of penalties for
failure to file return is not warranted1

In view of the foregoing, and with the reversal of the appealed decision of the Court of Tax
Appeals, judgment is hereby rendered, holding that the Joint Emergency Operation involved in
the present is a corporation within the meaning of section 84 (b) of the Internal Revenue Code,
and so is liable to incom tax under section 24 of the code; that pending appeal in the Court of Tax
Appeals of an assessment made by the Collector of Internal Revenue, the Collector, pending
hearing before said court, may amend his appealed assessment and include the amendment in his
answer before the court, and the latter may on the basis of the evidence presented before it,
redetermine the assessment; that where the failure to file an income tax return for and in behalf
of an entity which is later found to be a corporation within the meaning of section 84 (b) of the
Tax Code was due to a reasonable cause, such as an honest belief based on the advice of its
attorneys and accountants, a penalty in the form of a surcharge should not be imposed and
collected. The respondents are therefore ordered to pay the amount of the reassessment made by
the Collector of Internal Revenue before the Tax Court, minus the amount of 25 per cent
surcharge. No costs.

G.R. No. 112675 January 25, 1999

AFISCO INSURANCE CORPORATION; CCC INSURANCE CORPORATION;

CHARTER INSURANCE CO., INC.; CIBELES INSURANCE CORPORATION;
COMMONWEALTH INSURANCE COMPANY; CONSOLIDATED INSURANCE CO.,
INC.; DEVELOPMENT INSURANCE & SURETY CORPORATION DOMESTIC
INSURANCE COMPANY OF THE PHILIPPINE; EASTERN ASSURANCE COMPANY
& SURETY CORP; EMPIRE INSURANCE COMPANY; EQUITABLE INSURANCE
CORPORATION; FEDERAL INSURANCE CORPORATION INC.; FGU INSURANCE
CORPORATION; FIDELITY & SURETY COMPANY OF THE PHILS., INC.; FILIPINO
MERCHANTS' INSURANCE CO., INC.; GOVERNMENT SERVICE INSURANCE
SYSTEM; MALAYAN INSURANCE CO., INC.; MALAYAN ZURICH INSURANCE CO.;
INC.; MERCANTILE INSURANCE CO., INC.; METROPOLITAN INSURANCE
COMPANY; METRO-TAISHO INSURANCE CORPORATION; NEW ZEALAND
INSURANCE CO., LTD.; PAN-MALAYAN INSURANCE CORPORATION;
PARAMOUNT INSURANCE CORPORATION; PEOPLE'S TRANS-EAST ASIA
INSURANCE CORPORATION; PERLA COMPANIA DE SEGUROS, INC.; PHILIPPINE
BRITISH ASSURANCE CO., INC.; PHILIPPINE FIRST INSURANCE CO., INC.;
PIONEER INSURANCE & SURETY CORP.; PIONEER INTERCONTINENTAL
INSURANCE CORPORATION; PROVIDENT INSURANCE COMPANY OF THE
PHILIPPINES; PYRAMID INSURANCE CO., INC.; RELIANCE SURETY &
INSURANCE COMPANY; RIZAL SURETY & INSURANCE COMPANY; SANPIRO
INSURANCE CORPORATION; SEABOARD-EASTERN INSURANCE CO., INC.;
SOLID GUARANTY, INC.; SOUTH SEA SURETY & INSURANCE CO., INC.; STATE
BONDING & INSURANCE CO., INC.; SUMMA INSURANCE CORPORATION;
TABACALERA INSURANCE CO., INC. — all assessed as "POOL OF MACHINERY
INSURERS, petitioner,
vs.
COURT OF APPEALS, COURT OF TAX APPEALS and COMISSIONER OF
INTERNAL REVENUE, respondent.

PANGANIBAN, J.:

Pursuant to "reinsurance treaties," a number of local insurance firms formed themselves

into a "pool" in order to facilitate the handling of business contracted with a nonresident
foreign insurance company. May the "clearing house" or "insurance pool" so formed be
deemed a partnership or an association that is taxable as a corporation under the
National Internal Revenue Code (NIRC)? Should the pool's remittances to the member
companies and to the said foreign firm be taxable as dividends? Under the facts of this
case, has the goverment's right to assess and collect said tax prescribed?

The Case

These are the main questions raised in the Petition for Review on Certiorari before us,
assailing the October 11, 1993 Decision 1 of the Court of Appeals 2 in CA-GR SP 25902,
which dismissed petitioners' appeal of the October 19, 1992 Decision 3 of the Court of
Tax Appeals 4 (CTA) which had previously sustained petitioners' liability for deficiency
income tax, interest and withholding tax. The Court of Appeals ruled:

5
WHEREFORE, the petition is DISMISSED, with costs against petitioner

The petition also challenges the November 15, 1993 Court of Appeals (CA) Resolution 6
denying reconsideration.

The Facts

The antecedent facts, 7 as found by the Court of Appeals, are as follows:

The petitioners are 41 non-life insurance corporations, organized and existing under the
laws of the Philippines. Upon issuance by them of Erection, Machinery Breakdown, Boiler
Explosion and Contractors' All Risk insurance policies, the petitioners on August 1, 1965
entered into a Quota Share Reinsurance Treaty and a Surplus Reinsurance Treaty with
the Munchener Ruckversicherungs-Gesselschaft (hereafter called Munich), a non-
resident foreign insurance corporation. The reinsurance treaties required petitioners to
form a [p]ool. Accordingly, a pool composed of the petitioners was formed on the same
day.

On April 14, 1976, the pool of machinery insurers submitted a financial statement and
filed an "Information Return of Organization Exempt from Income Tax" for the year ending
in 1975, on the basis of which it was assessed by the Commissioner of Internal Revenue
deficiency corporate taxes in the amount of P1,843,273.60, and withholding taxes in the
amount of P1,768,799.39 and P89,438.68 on dividends paid to Munich and to the
petitioners, respectively. These assessments were protested by the petitioners through its
auditors Sycip, Gorres, Velayo and Co.

On January 27, 1986, the Commissioner of Internal Revenue denied the protest and
ordered the petitioners, assessed as "Pool of Machinery Insurers," to pay deficiency
income tax, interest, and with [h]olding tax, itemized as follows:

Net income per information return P3,737,370.00

===========

Income tax due thereon P1,298,080.00

Add: 14% Int. fr. 4/15/76

to 4/15/79 545,193.60

——————

TOTAL AMOUNT DUE & P1,843,273.60

COLLECTIBLE

Dividend paid to Munich

Reinsurance Company P3,728,412.00

——————

35% withholding tax at

source due thereon P1,304,944.20

Add: 25% surcharge 326,236.05

14% interest from

1/25/76 to 1/25/79 137,019.14

 Compromise penalty-

non-filing of return 300.00

late payment 300.00

——————

TOTAL AMOUNT DUE & P1,768,799.39

COLLECTIBLE ===========

Dividend paid to Pool Members P655,636.00

===========

10% withholding tax at

source due thereon P65,563.60

Add: 25% surcharge 16,390.90

14% interest from

1/25/76 to 1/25/79 6,884.18

Compromise penalty-

non-filing of return 300.00

late payment 300.00

——————

TOTAL AMOUNT DUE & P89,438.68

8
COLLECTIBLE ===========

The CA ruled in the main that the pool of machinery insurers was a partnership taxable
as a corporation, and that the latter's collection of premiums on behalf of its members,
the ceding companies, was taxable income. It added that prescription did not bar the
Bureau of Internal Revenue (BIR) from collecting the taxes due, because "the taxpayer
cannot be located at the address given in the information return filed." Hence, this
Petition for Review before us. 9

The Issues

Before this Court, petitioners raise the following issues:

 1. Whether or not the Clearing House, acting as a mere agent and performing strictly
administrative functions, and which did not insure or assume any risk in its own name,
was a partnership or association subject to tax as a corporation;

2. Whether or not the remittances to petitioners and MUNICHRE of their respective

shares of reinsurance premiums, pertaining to their individual and separate contracts of
reinsurance, were "dividends" subject to tax; and

3. Whether or not the respondent Commissioner's right to assess the Clearing House had
already prescribed. 10

The Court's Ruling

The petition is devoid of merit. We sustain the ruling of the Court of Appeals that the
pool is taxable as a corporation, and that the government's right to assess and collect
the taxes had not prescribed.

First Issue:

Pool Taxable as a Corporation

Petitioners contend that the Court of Appeals erred in finding that the pool of clearing
house was an informal partnership, which was taxable as a corporation under the NIRC.
They point out that the reinsurance policies were written by them "individually and
separately," and that their liability was limited to the extent of their allocated share in the
original risk thus reinsured. 11 Hence, the pool did not act or earn income as a reinsurer.
12
Its role was limited to its principal function of "allocating and distributing the risk(s)
arising from the original insurance among the signatories to the treaty or the members
of the pool based on their ability to absorb the risk(s) ceded[;] as well as the
performance of incidental functions, such as records, maintenance, collection and
custody of funds, etc." 13

Petitioners belie the existence of a partnership in this case, because (1) they, the
reinsurers, did not share the same risk or solidary liability, 14 (2) there was no common
fund; 15 (3) the executive board of the pool did not exercise control and management of
its funds, unlike the board of directors of a corporation; 16 and (4) the pool or clearing
house "was not and could not possibly have engaged in the business of reinsurance
from which it could have derived income for itself." 17

The Court is not persuaded. The opinion or ruling of the Commission of Internal
Revenue, the agency tasked with the enforcement of tax law, is accorded much weight
and even finality, when there is no showing. that it is patently wrong, 18 particularly in
this case where the findings and conclusions of the internal revenue commissioner were
subsequently affirmed by the CTA, a specialized body created for the exclusive purpose
of reviewing tax cases, and the Court of Appeals. 19 Indeed,
 [I]t has been the long standing policy and practice of this Court to respect the conclusions
of quasi-judicial agencies, such as the Court of Tax Appeals which, by the nature of its
functions, is dedicated exclusively to the study and consideration of tax problems and has
necessarily developed an expertise on the subject, unless there has been an abuse or
20
improvident exercise of its authority.

This Court rules that the Court of Appeals, in affirming the CTA which had previously
sustained the internal revenue commissioner, committed no reversible error. Section 24
of the NIRC, as worded in the year ending 1975, provides:

Sec. 24. Rate of tax on corporations. — (a) Tax on domestic corporations. — A tax is
hereby imposed upon the taxable net income received during each taxable year from all
sources by every corporation organized in, or existing under the laws of the Philippines,
no matter how created or organized, but not including duly registered general co-
partnership (compañias colectivas), general professional partnerships, private
educational institutions, and building and loan associations . . . .

Ineludibly, the Philippine legislature included in the concept of corporations those

entities that resembled them such as unregistered partnerships and associations.
Parenthetically, the NIRC's inclusion of such entities in the tax on corporations was
made even clearer by the tax Reform Act of 1997, 21 which amended the Tax Code.
Pertinent provisions of the new law read as follows:

Sec. 27. Rates of Income Tax on Domestic Corporations. —

(A) In General. — Except as otherwise provided in this Code, an income tax of thirty-five
percent (35%) is hereby imposed upon the taxable income derived during each taxable
year from all sources within and without the Philippines by every corporation, as defined
in Section 22 (B) of this Code, and taxable under this Title as a corporation . . . .

Sec. 22. — Definition. — When used in this Title:

xxx xxx xxx

(B) The term "corporation" shall include partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion), associations,
or insurance companies, but does not include general professional partnerships [or] a
joint venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an
operating or consortium agreement under a service contract without the Government.
"General professional partnerships" are partnerships formed by persons for the sole
purpose of exercising their common profession, no part of the income of which is derived
from engaging in any trade or business.

xxx xxx xxx

Thus, the Court in Evangelista v. Collector of Internal Revenue 22 held that Section 24
covered these unregistered partnerships and even associations or joint accounts, which
had no legal personalities apart from their individual members. 23 The Court of Appeals
astutely applied Evangelista. 24
 . . . Accordingly, a pool of individual real property owners dealing in real estate business
was considered a corporation for purposes of the tax in sec. 24 of the Tax Code in
Evangelista v. Collector of Internal Revenue, supra. The Supreme Court said:

The term "partnership" includes a syndicate, group, pool, joint venture or

other unincorporated organization, through or by means of which any
business, financial operation, or venture is carried on. *** (8 Merten's
Law of Federal Income Taxation, p. 562 Note 63)

Art. 1767 of the Civil Code recognizes the creation of a contract of partnership when
"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." 25 Its
requisites are: "(1) mutual contribution to a common stock, and (2) a joint interest in the
profits." 26 In other words, a partnership is formed when persons contract "to devote to a
common purpose either money, property, or labor with the intention of dividing the
profits between
themselves." 27 Meanwhile, an association implies associates who enter into a "joint
enterprise . . . for the transaction of business." 28

In the case before us, the ceding companies entered into a Pool Agreement 29 or an
association 30 that would handle all the insurance businesses covered under their quota-
share reinsurance treaty 31 and surplus reinsurance treaty 32 with Munich. The following
unmistakably indicates a partnership or an association covered by Section 24 of the
NIRC:

(1) The pool has a common fund, consisting of money and other valuables that are
deposited in the name and credit of the pool. 33 This common fund pays for the
administration and operation expenses of the pool. 24

(2) The pool functions through an executive board, which resembles the board of
directors of a corporation, composed of one representative for each of the ceding
companies. 35

(3) True, the pool itself is not a reinsurer and does not issue any insurance policy;
however, its work is indispensable, beneficial and economically useful to the business of
the ceding companies and Munich, because without it they would not have received
their premiums. The ceding companies share "in the business ceded to the pool" and in
the "expenses" according to a "Rules of Distribution" annexed to the Pool Agreement. 36
Profit motive or business is, therefore, the primordial reason for the pool's formation. As
aptly found by the CTA:

. . . The fact that the pool does not retain any profit or income does not obliterate an
antecedent fact, that of the pool being used in the transaction of business for profit. It is
apparent, and petitioners admit, that their association or coaction was indispensable [to]
the transaction of the business, . . . If together they have conducted business, profit must
have been the object as, indeed, profit was earned. Though the profit was apportioned
 among the members, this is only a matter of consequence, as it implies that profit actually
37
resulted.

The petitioners' reliance on Pascuals v. Commissioner 38 is misplaced, because the

facts obtaining therein are not on all fours with the present case. In Pascual, there was
no unregistered partnership, but merely a co-ownership which took up only two isolated
transactions. 39 The Court of Appeals did not err in applying Evangelista, which involved
a partnership that engaged in a series of transactions spanning more than ten years, as
in the case before us.

Second Issue:

Pool's Remittances are Taxable

Petitioners further contend that the remittances of the pool to the ceding companies and
Munich are not dividends subject to tax. They insist that such remittances contravene
Sections 24 (b) (I) and 263 of the 1977 NIRC and "would be tantamount to an illegal
double taxation as it would result in taxing the same taxpayer" 40 Moreover, petitioners
argue that since Munich was not a signatory to the Pool Agreement, the remittances it
received from the pool cannot be deemed dividends. 41 They add that even if such
remittances were treated as dividends, they would have been exempt under the
previously mentioned sections of the 1977 NIRC, 42 as well as Article 7 of paragraph 1 43
and Article 5 of paragraph 5 44 of the RP-West German Tax Treaty. 45

Petitioners are clutching at straws. Double taxation means taxing the same property
twice when it should be taxed only once. That is, ". . . taxing the same person twice by
the same jurisdiction for the same thing" 46 In the instant case, the pool is a taxable
entity distinct from the individual corporate entities of the ceding companies. The tax on
its income is obviously different from the tax on the dividends received by the said
companies. Clearly, there is no double taxation here.

The tax exemptions claimed by petitioners cannot be granted, since their entitlement
thereto remains unproven and unsubstantiated. It is axiomatic in the law of taxation that
taxes are the lifeblood of the nation. Hence, "exemptions therefrom are highly
disfavored in law and he who claims tax exemption must be able to justify his claim or
right." 47 Petitioners have failed to discharge this burden of proof. The sections of the
1977 NIRC which they cite are inapplicable, because these were not yet in effect when
the income was earned and when the subject information return for the year ending
1975 was filed.

Referring, to the 1975 version of the counterpart sections of the NIRC, the Court still
cannot justify the exemptions claimed. Section 255 provides that no tax shall ". . . be
paid upon reinsurance by any company that has already paid the tax . . ." This cannot
be applied to the present case because, as previously discussed, the pool is a taxable
entity distinct from the ceding companies; therefore, the latter cannot individually claim
the income tax paid by the former as their own.
On the other hand, Section 24 (b) (1) 48 pertains to tax on foreign corporations; hence, it
cannot be claimed by the ceding companies which are domestic corporations. Nor can
Munich, a foreign corporation, be granted exemption based solely on this provision of
the Tax Code, because the same subsection specifically taxes dividends, the type of
remittances forwarded to it by the pool. Although not a signatory to the Pool Agreement,
Munich is patently an associate of the ceding companies in the entity formed, pursuant
to their reinsurance treaties which required the creation of said pool.

Under its pool arrangement with the ceding companies; Munich shared in their income
and loss. This is manifest from a reading of Article 3 49 and 10 50 of the Quota-Share
Reinsurance treaty and Articles 3 51 and 10 52 of the Surplus Reinsurance Treaty. The
foregoing interpretation of Section 24 (b) (1) is in line with the doctrine that a tax
exemption must be construed strictissimi juris, and the statutory exemption claimed
must be expressed in a language too plain to be mistaken. 53

Finally the petitioners' claim that Munich is tax-exempt based on the RP- West German
Tax Treaty is likewise unpersuasive, because the internal revenue commissioner
assessed the pool for corporate taxes on the basis of the information return it had
submitted for the year ending 1975, a taxable year when said treaty was not yet in
effect. 54 Although petitioners omitted in their pleadings the date of effectivity of the
treaty, the Court takes judicial notice that it took effect only later, on December 14, 1984.
55

Third Issue:

Prescription

Petitioners also argue that the government's right to assess and collect the subject tax
had prescribed. They claim that the subject information return was filed by the pool on
April 14, 1976. On the basis of this return, the BIR telephoned petitioners on November
11, 1981, to give them notice of its letter of assessment dated March 27, 1981. Thus,
the petitioners contend that the five-year statute of limitations then provided in the NIRC
had already lapsed, and that the internal revenue commissioner was already barred by
prescription from making an assessment. 56

We cannot sustain the petitioners. The CA and the CTA categorically found that the
prescriptive period was tolled under then Section 333 of the NIRC, 57 because "the
taxpayer cannot be located at the address given in the information return filed and for
which reason there was delay in sending the assessment." 58 Indeed, whether the
government's right to collect and assess the tax has prescribed involves facts which
have been ruled upon by the lower courts. It is axiomatic that in the absence of a clear
showing of palpable error or grave abuse of discretion, as in this case, this Court must
not overturn the factual findings of the CA and the CTA.
Furthermore, petitioners admitted in their Motion for Reconsideration before the Court of
Appeals that the pool changed its address, for they stated that the pool's information
return filed in 1980 indicated therein its "present address." The Court finds that this falls
short of the requirement of Section 333 of the NIRC for the suspension of the
prescriptive period. The law clearly states that the said period will be suspended only "if
the taxpayer informs the Commissioner of Internal Revenue of any change in the
address."

WHEREFORE, the petition is DENIED. The Resolution of the Court of Appeals dated
October 11, 1993 and November 15, 1993 are hereby AFFIRMED. Cost against
petitioners.1âwphi1.nêt

SO ORDERED.

Romero, Vitug, Purisima, Gonzaga-Reyes, JJ., concur.

Footno Commissioner vs BOAC

149 SCRA 395

Facts:

British overseas airways corp. (BOAC) a wholly owned British Corporation, is engaged in
international airlines business. From 1959to 1972, it has no loading rights for traffic purposes in the
Philippines but maintained a general sales agent in the Philippines which was responsible for selling,
BOAC tickets covering passengers and cargoes the CIR assessed deficiency income taxes against.

Issue: Is BOAC liable to pay taxes?

Ruling:

Yes. The source of income is the property, activity of service that produces the income. For the
source of income to be considered coming from the Philippines, it is sufficient that the income is derived
from the activity coming from the Philippines. The tax code provides that for revenue to be taxable, it
must constitute income from Philippine sources. In this case, the sale of tickets is the source of income.
The situs of the s

COMMISSIONER OF INTERNAL REVENUE, petitioner,vs.

BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX APPEALS,

respondents.
Facts: 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 Warner Barnes and Company, Ltd., and later Qantas
Airways which was responsible for selling BOAC tickets covering passengers and cargoes.

(First Case)

Petitioner Commissioner of Internal Revenue assessed BOAC the 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, for the years 1959 to 1967. BOAC paid this new
assessment under protest. BOAC filed a claim for refund which was denied by the CIR.

(Second Case)

BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal years
1968-1969 to 1970-1971 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).
BOAC requested that the assessment be countermanded and set aside. 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 in the second case.

Case was then jointly tried. 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.
Issue/s: 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.

Held: 1. Yes. 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. "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.

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.
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.

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]).

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.

The source of an income is the property, activity or service that produced the income.
For the source of income to be considered as coming from the Philippines, it is sufficient that the
income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the
Philippines is the activity that produces the income. The tickets exchanged hands here and
payments for fares were also made here in Philippine currency. The site of the source of
payments is the Philippines. The flow of wealth proceeded from, and occurred within, Philippine
territory, 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.

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.

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. 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", 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.

ource of payments is the Philippines. Tes

MARUBENI CORPORATION (formerly Marubeni-Iida, Co., Ltd.), petitioner, vs.

COMMISSIONER OF INTERNAL REVENUE AND COURT OF TAX APPEALS

Facts: Marubeni Corporation of Japan has equity investments in AG&P of Manila. For the first
quarter of 1981 ending March 31, AG&P declared and paid cash dividends to petitioner in the
amount of P849,720 and withheld the corresponding 10% final dividend tax thereon. Similarly,
for the third quarter of 1981 ending September 30, AG&P declared and paid P849,720 as cash
dividends to petitioner and withheld the corresponding 10% final dividend tax thereon.

AG&P directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not
only of the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of
1981, but also of the withheld 15% profit remittance tax based on the remittable amount after
deducting the final withholding tax of 10%.

In a letter dated January 29, 1981, petitioner, through the accounting firm Sycip, Gorres, Velayo
and Company, sought a ruling from the Bureau of Internal Revenue on whether or not the
dividends petitioner received from AG&P are effectively connected with its conduct or business
in the Philippines as to be considered branch profits subject to the 15% profit remittance tax
imposed under Section 24 (b) (2) of the National Internal Revenue Code as amended by
Presidential Decrees Nos. 1705 and 1773.

In reply to petitioner's query, Acting Commissioner Ruben Ancheta ruled:

Pursuant to Section 24 (b) (2) of the Tax Code, as amended, only profits remitted abroad by a
branch office to its head office which are effectively connected with its trade or business in the
Philippines are subject to the 15% profit remittance tax. To be effectively connected it is not
necessary that the income be derived from the actual operation of taxpayer-corporation's trade
or business; it is sufficient that the income arises from the business activity in which the
corporation is engaged. For example, if a resident foreign corporation is engaged in the buying
and selling of machineries in the Philippines and invests in some shares of stock on which
dividends are subsequently received, the dividends thus earned are not considered 'effectively
connected' with its trade or business in this country. (Revenue Memorandum Circular No. 55-
80).

In the instant case, the dividends received by Marubeni from AG&P are not income arising from
the business activity in which Marubeni is engaged. Accordingly, said dividends if remitted
abroad are not considered branch profits for purposes of the 15% profit remittance tax imposed
by Section 24 (b) (2) of the Tax Code, as amended.

Petitioner claimed for the refund or issuance of a tax credit of P229,424.40 "representing profit
tax remittance erroneously paid on the dividends remitted by AG&P to head office in Tokyo. It
was denied. While it is true that said dividends remitted were not subject to the 15% profit
remittance tax as the same were not income earned by a Philippine Branch of Marubeni
Corporation of Japan; and neither is it subject to the 10% intercorporate dividend tax, the
recipient of the dividends, being a non-resident stockholder, nevertheless, said dividend income
is subject to the 25 % tax pursuant to Article 10 (2) (b) of the Tax Treaty dated February 13,
1980 between the Philippines and Japan. The Commissioner pointed that inasmuch as the cash
dividends remitted by AG&P to Marubeni Corporation, Japan is subject to 25 % tax, and that the
taxes withheld of 10 % as intercorporate dividend tax and 15 % as profit remittance tax totals 25
%, the amount refundable offsets the liability, hence, nothing is left to be refunded.

Petitioner appealed to the Court of Tax Appeals which affirmed the denial of the refund by the
Commissioner of Internal Revenue. CTA held that the said dividends were distributions made by
the Atlantic, Gulf and Pacific Company(AG &P) of Manila to its shareholder out of its profits on
the investments of the Marubeni Corporation of Japan, a non-resident foreign corporation. The
investments in the Atlantic Gulf & Pacific Company of the Marubeni Corporation of Japan were
directly made by it and the dividends on the investments were likewise directly remitted to and
received by the Marubeni Corporation of Japan. Petitioner Marubeni Corporation Philippine
Branch has no participation or intervention, directly or indirectly, in the investments and in the
receipt of the dividends. And it appears that the funds invested in the Atlantic Gulf & Pacific
Company did not come out of the funds infused by the Marubeni Corporation of Japan to the
Marubeni Corporation Philippine Branch. As a matter of fact, the Central Bank of the Philippines,
in authorizing the remittance of the foreign exchange equivalent of the dividends in question,
treated the Marubeni Corporation of Japan as a non-resident stockholder of the Atlantic Gulf &
Pacific Company based on the supporting documents submitted to it.

Subject to certain exceptions not pertinent hereto, income is taxable to the person who earned
it. Admittedly, the dividends under consideration were earned by the Marubeni Corporation of
Japan, and hence, taxable to the said corporation. While it is true that the Marubeni Corporation
Philippine Branch is duly licensed to engage in business under Philippine laws, such dividends
are not the income of the Philippine Branch and are not taxable to the said Philippine branch.
We see no significance thereto in the identity concept or principal-agent relationship theory of
petitioner because such dividends are the income of and taxable to the Japanese corporation in
Japan and not to the Philippine branch.

Hence the instant petition for review

Issue: Whether or not Marubeni is a resident or non-resident corporation

Held: It is a resident corporation. Under the Tax Code, a resident foreign corporation is one that
is "engaged in trade or business" within the Philippines. Petitioner contends that precisely
because it is engaged in business in the Philippines through its Philippine branch that it must be
considered as a resident foreign corporation. Petitioner reasons that since the Philippine branch
and the Tokyo head office are one and the same entity, whoever made the investment in AG&P,
Manila does not matter at all. A single corporate entity cannot be both a resident and a non-
resident corporation depending on the nature of the particular transaction involved. Accordingly,
whether the dividends are paid directly to the head office or coursed through its local branch is
of no moment for after all, the head office and the office branch constitute but one corporate
entity, the Marubeni Corporation, which, under both Philippine tax and corporate laws, is a
resident foreign corporation because it is transacting business in the Philippines.

In other words, the alleged overpaid taxes were incurred for the remittance of dividend income
to the head office in Japan which is a separate and distinct income taxpayer from the branch in
the Philippines. There can be no other logical conclusion considering the undisputed fact that
the investment (totalling 283.260 shares including that of nominee) was made for purposes
peculiarly germane to the conduct of the corporate affairs of Marubeni Japan, but certainly not
of the branch in the Philippines. It is thus clear that petitioner, having made this independent
investment attributable only to the head office, cannot now claim the increments as ordinary
consequences of its trade or business in the Philippines and avail itself of the lower tax rate of
10 %.
But while public respondents correctly concluded that the dividends in dispute were neither
subject to the 15 % profit remittance tax nor to the 10 % intercorporate dividend tax, the
recipient being a non-resident stockholder, they grossly erred in holding that no refund was
forthcoming to the petitioner because the taxes thus withheld totalled the 25 % rate imposed by
the Philippine-Japan Tax Convention pursuant to Article 10 (2) (b).

To simply add the two taxes to arrive at the 25 % tax rate is to disregard a basic rule in taxation
that each tax has a different tax basis. While the tax on dividends is directly levied on the
dividends received, "the tax base upon which the 15 % branch profit remittance tax is imposed
is the profit actually remitted abroad."

WHEREFORE, the questioned decision of respondent Court of Tax Appeals dated February 12,
1986 which affirmed the denial by respondent Commissioner of Internal Revenue of petitioner
Marubeni Corporation's claim for refund is hereby REVERSED. The Commissioner of Internal
Revenue is ordered to refund or grant as tax credit in favor of petitioner the amount of
P144,452.40 representing overpayment of taxes on dividends received. No costs.

Income

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.

Bengzon, C.J., Bautista Angelo, Concepcion, Reyes, J.B.L., Barrera, Makalintal and Zaldivar,
JJ., concur.
Paredes, Dizon and Regala, JJ., took no part.

Conwi v. CTA

FACTS:

Petitioners are Filipino citizens and employees of Procter and Gamble Philippines with
an office located at Ayala Ave. Makati. The corporation is a subsidiary of P&G based at Ohio
USA. For the year 1970 and 1971, petitioners were assigned outside the Phil with their
compensation paid in US dollars. When they filed their income tax returns for the year 1970,
they’ve computed the tax by applying the dollar-to-peso conversion based on the floating rate
provided by the BIR. However, on 1973, they filed an amended tax return using the par value of
the peso provided by Sec.40 of RA 265. They claim for a refund due to overpayment.

Petitioners argued that since the dollar earnings does not fall within the classification of
foreign exchange transaction; there occurred no actual inward remittances therefore NOT
included in Central Bank Circular No. 289. CB no. 289 provides for specific instances when the
par value of the peso shall not be the conversion rate. Therefore, they can base their conversion
using the par value of the peso.

The Commissioner of the BIR denied the claim of petitioners stating that the basis must
be the prevailing free market rate of exchange and not the par value. CB No. 289 speaks of
receipts for export products, receipts of sale of foreign exchange and investment but not income
tax. The CTA also held that petitioner’s dollar earnings are receipts derived from foreign
exchange transactions.

ISSUES:

1) WON petitioner’s dollar earnings are receipts derived from foreign exchange
transactions.

2) WON the proper rate of conversion is the prevailing free market rate of exchange.
3) WON petitioners are exempt to pay tax for such income since there were no remittance/
acceptance of their salaries in UD Dollars into the Philippines.

HELD:

1) No. Income may be defined as an amount of money coming to a person or corporation

within a specified time, whether as payment for services, interest or profit from investment.
Unless otherwise specified, it means cash or its equivalent. Income can also be though of as
flow of the fruits of one's labor. Petitioners are correct in claiming that their dollar earnings are
not receipts derived from foreign exchange transactions. For a foreign exchange transaction is
simply that-foreign exchange being “the conversion of an amount of money of one country into
an equivalent amount of money of another country. When petitioners were assigned to the
foreign subsidiaries of P&G, they were earning in their assigned nation’s currency and were also
spending in said currency. There was no conversion from one currency to another.

2) Yes. Central Bank Circular no. 289 does not contemplate income tax payments. It shows
that the subject matter involved therein are exports products, invisibles, receipts of foreign
exchange, foreign exchange payments, new foreign borrowing and investments-nothing by way
of income tax .Petitioners erred in concluding that CB Circ No. 289 does not apply to them.
Therefore, the conversion should be the prevailing free market rate of exchange.

3) No. Even if there was no remittance and acceptance of their salaries and wages in US
Dollars into the Philippines, they are still bound to pay the tax. Petitioners forgot that they are
citizens of the Philippines, and their income, within or without, and in this case wholly without or
outside the Philippines, are subject to income tax. The petitions were denied for lack of merit.

Manila

EN BANC

G.R. No. L-12287 August 7, 1918

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

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION,
Deputy Collector of Internal Revenue, defendants-appellees.

Gregorio Araneta for appellants.

Assistant Attorney Round for appellees.

MALCOLM, J.:
This appeal calls for consideration of the Income Tax Law, a law of American origin, with
reference to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The
marriage was contracted under the provisions of law concerning conjugal partnerships (sociedad
de gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on the
prescribed form with the Collector of Internal Revenue, showing, as his total net income for the
year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the claim that the said
P296,302.73 did not represent his income for the year 1914, but was in fact the income of the
conjugal partnership existing between himself and his wife Susana Paterno, and that in
computing and assessing the additional income tax provided by the Act of Congress of October
3, 1913, the income declared by Vicente Madrigal should be divided into two equal parts, one-
half to be considered the income of Vicente Madrigal and the other half of Susana Paterno. The
general question had in the meantime been submitted to the Attorney-General of the Philippine
Islands who in an opinion dated March 17, 1915, held with the petitioner Madrigal. The revenue
officers being still unsatisfied, the correspondence together with this opinion was forwarded to
Washington for a decision by the United States Treasury Department. The United States
Commissioner of Internal Revenue reversed the opinion of the Attorney-General, and thus
decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely by the
Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana
Paterno in the Court of First Instance of the city of Manila against Collector of Internal Revenue
and the Deputy Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged
to have been wrongfully and illegally collected by the defendants from the plaintiff, Vicente
Madrigal, under the provisions of the Act of Congress known as the Income Tax Law. The
burden of the complaint was that if the income tax for the year 1914 had been correctly and
lawfully computed there would have been due payable by each of the plaintiffs the sum of
P2,921.09, which taken together amounts of a total of P5,842.18 instead of P9,668.21,
erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with the result that
plaintiff Madrigal has paid as income tax for the year 1914, P3,786.08, in excess of the sum
lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and
the stipulation, sets forth the basis of defendants' stand in the following way: The income of
Vicente Madrigal and his wife Susana Paterno of the year 1914 was made up of three items: (1)
P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2)
P4,086.50, the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the
profits made by Vicente Madrigal in a pawnshop company. The sum of these three items is
P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the year 1914.
General deductions were claimed and allowed in the sum of P86,879.24. The resulting net
income was P296,302.73. For the purpose of assessing the normal tax of one per cent on the net
income there were allowed as specific deductions the following: (1) P16,687.80, the tax upon
which was to be paid at source, and (2) P8,000, the specific exemption granted to Vicente
Madrigal and Susana Paterno, husband and wife. The remainder, P271,614.93 was the sum upon
which the normal tax of one per cent was assessed. The normal tax thus arrived at was
P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for
in the Income Tax Law. The trial court in an exhausted decision found in favor of defendants,
without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income tax, is
that is should be divided into two equal parts, because of the conjugal partnership existing
between them. The learned argument of counsel is mostly based upon the provisions of the Civil
Code establishing the sociedad de gananciales. The counter contentions of appellees are that the
taxes imposed by the Income Tax Law are as the name implies taxes upon income tax and not
upon capital and property; that the fact that Madrigal was a married man, and his marriage
contracted under the provisions governing the conjugal partnership, has no bearing on income
considered as income, and that the distinction must be drawn between the ordinary form of
commercial partnership and the conjugal partnership of spouses resulting from the relation of
marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been given
the course of history. The final stage has been the selection of income as the norm of taxation.
(See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States,
extended to the Philippine Islands, is the result of an effect on the part of the legislators to put
into statutory form this canon of taxation and of social reform. The aim has been to mitigate the
evils arising from inequalities of wealth by a progressive scheme of taxation, which places the
burden on those best able to pay. To carry out this idea, public considerations have demanded an
exemption roughly equivalent to the minimum of subsistence. With these exceptions, the income
tax is supposed to reach the earnings of the entire non-governmental property of the country.
Such is the background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference between
capital and income is that capital is a fund; income is a flow. A fund of property existing at an
instant of time is called capital. A flow of services rendered by that capital by the payment of
money from it or any other benefit rendered by a fund of capital in relation to such fund through
a period of time is called an income. Capital is wealth, while income is the service of wealth.
(See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia expresses the
thought in the following figurative language: "The fact is that property is a tree, income is the
fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring vs. City of
Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on property. "Income," as here used,
can be defined as "profits or gains." (London County Council vs. Attorney-General [1901], A. C.,
26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further
Foster's Income Tax, second edition [1915], Chapter IV; Black on Income Taxes, second edition
[1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U.S., 549; and Towne vs. Eisner, decided
by the United States Supreme Court, January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband and
wife not living apart, contains the following:

The husband, as the head and legal representative of the household and general custodian of its
income, should make and render the return of the aggregate income of himself and wife, and for
the purpose of levying the income tax it is assumed that he can ascertain the total amount of said
income. If a wife has a separate estate managed by herself as her own separate property, and
receives an income of more than $3,000, she may make return of her own income, and if the
husband has other net income, making the aggregate of both incomes more than $4,000, the
wife's return should be attached to the return of her husband, or his income should be included in
her return, in order that a deduction of $4,000 may be made from the aggregate of both incomes.
The tax in such case, however, will be imposed only upon so much of the aggregate income of
both shall exceed $4,000. If either husband or wife separately has an income equal to or in
excess of $3,000, a return of annual net income is required under the law, and such return must
include the income of both, and in such case the return must be made even though the combined
income of both be less than $4,000. If the aggregate net income of both exceeds $4,000, an
annual return of their combined incomes must be made in the manner stated, although neither
one separately has an income of $3,000 per annum. They are jointly and separately liable for
such return and for the payment of the tax. The single or married status of the person claiming
the specific exemption shall be determined as one of the time of claiming such exemption which
return is made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine
Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the
conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the conjugal partnership, decided that "prior to
the liquidation the interest of the wife and in case of her death, of her heirs, is an interest
inchoate, a mere expectancy, which constitutes neither a legal nor an equitable estate, and does
not ripen into title until there appears that there are assets in the community as a result of the
liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and
Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband
Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate
property rights and in the ultimate ownership of property acquired as income after such income
has become capital. Susana Paterno has no absolute right to one-half the income of the conjugal
partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return
in order to receive the benefit of the exemption which would arise by reason of the additional
tax. As she has no estate and income, actually and legally vested in her and entirely distinct from
her husband's property, the income cannot properly be considered the separate income of the
wife for the purposes of the additional tax. Moreover, the Income Tax Law does not look on the
spouses as individual partners in an ordinary partnership. The husband and wife are only entitled
to the exemption of P8,000 specifically granted by the law. The higher schedules of the
additional tax directed at the incomes of the wealthy may not be partially defeated by reliance on
provisions in our Civil Code dealing with the conjugal partnership and having no application to
the Income Tax Law. The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter
overruling the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission of
income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau, advises
that the Insular Auditor has been authorized to suspend action on the warrants in question
until an authoritative decision on the points raised can be secured from the Treasury
Department."

From the correspondence it appears that Gregorio Araneta, married and living with his
wife, had an income of an amount sufficient to require the imposition of the net income
was properly computed and then both income and deductions and the specific exemption
were divided in half and two returns made, one return for each half in the names
respectively of the husband and wife, so that under the returns as filed there would be an
escape from the additional tax; that Araneta claims the returns are correct on the ground
under the Philippine law his wife is entitled to half of his earnings; that Araneta has
dominion over the income and under the Philippine law, the right to determine its use and
disposition; that in this case the wife has no "separate estate" within the contemplation of
the Act of October 3, 1913, levying an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax was
assessed against the entire net income against Gregorio Araneta; that the tax was paid and
an application for refund made, and that the application for refund was rejected,
whereupon the matter was submitted to the Attorney-General of the Islands who holds
that the returns were correctly rendered, and that the refund should be allowed; and
thereupon the question at issue is submitted through the Governor-General of the Islands
and Bureau of Insular Affairs for the advisory opinion of this office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be
administered as in the United States but by the appropriate internal-revenue officers of
 the Philippine Government. You are therefore advised that upon the facts as stated, this
office holds that for the Federal Income Tax (Act of October 3, 1913), the entire net
income in this case was taxable to Gregorio Araneta, both for the normal and additional
tax, and that the application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax Law
is that which belongs to her solely and separate and apart from her husband, and over
which her husband has no right in equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that each
person of lawful age (not excused from so doing) having a net income of $3,000 or over
for the taxable year shall make a return showing the facts; that from the net income so
shown there shall be deducted $3,000 where the person making the return is a single
person, or married and not living with consort, and $1,000 additional where the person
making the return is married and living with consort; but that where the husband and wife
both make returns (they living together), the amount of deduction from the aggregate of
their several incomes shall not exceed $4,000.

The only occasion for a wife making a return is where she has income from a sole and
separate estate in excess of $3,000, but together they have an income in excess of $4,000,
in which the latter event either the husband or wife may make the return but not both. In
all instances the income of husband and wife whether from separate estates or not, is
taken as a whole for the purpose of the normal tax. Where the wife has income from a
separate estate makes return made by her husband, while the incomes are added together
for the purpose of the normal tax they are taken separately for the purpose of the
additional tax. In this case, however, the wife has no separate income within the
contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.
Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income
Tax Law was drafted by the Congress of the United States and has been by the Congress
extended to the Philippine Islands. Being thus a law of American origin and being peculiarly
intricate in its provisions, the authoritative decision of the official who is charged with enforcing
it has peculiar force for the Philippines. It has come to be a well-settled rule that great weight
should be given to the construction placed upon a revenue law, whose meaning is doubtful, by
the department charged with its execution. (U.S. vs. Cerecedo Hermanos y Cia. [1907], 209 U.S.,
338; In re Allen [1903], 2 Phil., 630; Government of the Philippine Islands vs. Municipality of
Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.) We conclude
that the judgment should be as it is hereby affirmed with costs against appellants. So ordered.

G.R. No. L-66416 March 21, 1990

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
TOURS SPECIALISTS, INC., and THE COURT OF TAX APPEALS, respondents.

Gadioma Law Offices for private respondent.

GUTIERREZ, JR., J.:

This is a petition to review on certiorari the decision of the Court of Tax Appeals which
ruled that the money entrusted to private respondent Tours Specialists, Inc., earmarked
and paid for hotel room charges of tourists, travelers and/or foreign travel agencies
does not form part of its gross receipts subject to the 3% independent contractor's tax
under the National Internal Revenue Code of 1977.

We adopt the findings of facts of the Court of Tax Appeals as follows:

For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived income from
its activities as a travel agency by servicing the needs of foreign tourists and travelers
and Filipino "Balikbayans" during their stay in this country. Some of the services extended
to the tourists consist of booking said tourists and travelers in local hotels for their lodging
and board needs; transporting these foreign tourists from the airport to their respective
hotels, and from the latter to the airport upon their departure from the Philippines,
transporting them from their hotels to various embarkation points for local tours, visits and
excursions; securing permits for them to visit places of interest; and arranging their
cultural entertainment, shopping and recreational activities.

In order to ably supply these services to the foreign tourists, petitioner and its
correspondent counterpart tourist agencies abroad have agreed to offer a package fee for
the tourists. Although the fee to be paid by said tourists is quoted by the petitioner, the
payments of the hotel room accommodations, food and other personal expenses of said
tourists, as a rule, are paid directly either by tourists themselves, or by their foreign travel
agencies to the local hotels (pp. 77, t.s.n., February 2, 1981; Exhs. O & O-1, p. 29, CTA
rec.; pp. 2425, t.s.n., ibid) and restaurants or shops, as the case may be.

It is also the case that some tour agencies abroad request the local tour agencies, such
as the petitioner in the case, that the hotel room charges, in some specific cases, be paid
through them. (Exh. Q, Q-1, p. 29 CTA rec., p. 25, T.s.n., ibid, pp. 5-6, 17-18, t.s.n., Aug.
20, 1981.; See also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981, pp. 3-4, 11., t.s.n., Aug. 10,
1982). By this arrangement, the foreign tour agency entrusts to the petitioner Tours
Specialists, Inc., the fund for hotel room accommodation, which in turn is paid by
petitioner tour agency to the local hotel when billed. The procedure observed is that the
billing hotel sends the bill to the petitioner. The local hotel identifies the individual tourist,
or the particular groups of tourists by code name or group designation and also the
duration of their stay for purposes of payment. Upon receipt of the bill, the petitioner then
pays the local hotel with the funds entrusted to it by the foreign tour correspondent
agency.

Despite this arrangement, respondent Commissioner of Internal Revenue assessed

petitioner for deficiency 3% contractor's tax as independent contractor by including the
entrusted hotel room charges in its gross receipts from services for the years 1974 to
1976. Consequently, on December 6, 1979, petitioner received from respondent the 3%
deficiency independent contractor's tax assessment in the amount of P122,946.93 for the
years 1974 to 1976, inclusive, computed as follows:

1974 deficiency percentage tax

per investigation P 3,995.63

15% surcharge for late payment 998.91

—————

P 4,994.54

14% interest computed by quarters

up to 12-28-79 3,953.18 P 8,847.72

1975 deficiency percentage tax

per investigation P 8,427.39

25% surcharge for late payment 2,106.85

—————

P 10,534.24

14% interest computed by quarters

up to 12-28-79 6,808.47 P 17,342.71

1976 deficiency percentage

per investigation P 54,276.42

25% surcharge for late payment 13,569.11

—————

P 67,845.53

14% interest computed by quarters

up to 12-28-79 28,910.97 P 96,756.50

————— —————

Total amount due P 122,946.93

=========
 In addition to the deficiency contractor's tax of P122,946.93, petitioner was assessed to
pay a compromise penalty of P500.00.

Subsequently on December 11, 1979, petitioner formally protested the assessment made
by respondent on the ground that the money received and entrusted to it by the tourists,
earmarked to pay hotel room charges, were not considered and have never been
considered by it as part of its taxable gross receipts for purposes of computing and
paying its constractor's tax.

During one of the hearings in this case, a witness, Serafina Sazon, Certified Public
Accountant and in charge of the Accounting Department of petitioner, had testified, her
credibility not having been destroyed on cross examination, categorically stated that the
amounts entrusted to it by the foreign tourist agencies intended for payment of hotel room
charges, were paid entirely to the hotel concerned, without any portion thereof being
diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25; t.s.n., Aug. 20, 1981, pp. 5-9,
17-18). The testimony of Serafina Sazon was corroborated by Gerardo Isada, General
Manager of petitioner, declaring to the effect that payments of hotel accommodation are
made through petitioner without any increase in the room charged (t.s.n., Oct. 9, 1981,
pp. 21-25) and that the reason why tourists pay their room charge, or through their
foreign tourists agencies, is the fact that the room charge is exempt from hotel room tax
under P.D. 31. (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-examination, that if
their payment is made, thru petitioner's tour agency, the hotel cost or charges "is only an
act of accomodation on our (its) part" or that the "agent abroad instead of sending several
telexes and saving on bank charges they take the option to send money to us to be held
in trust to be endorsed to the hotel." (pp. 3-4, t.s.n. Aug. 10, 1982.)

Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written

protest, caused the issuance of a warrant of distraint and levy. (p. 51, BIR Rec.) And later,
respondent had petitioner's bank deposits garnished. (pp. 49-50, BIR Rec.)

Taking this action of respondent as the adverse and final decision on the disputed
assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)

The petitioner raises the lone issue in this petition as follows:

WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL AGENCY

INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN TOUR AGENCIES,
INTENDED OR EARMARKED FOR HOTEL ACCOMMODATIONS FORM PART OF
GROSS RECEIPTS SUBJECT TO 3% CONTRACTOR'S TAX. (Rollo, p. 23)

The petitioner premises the issue raised on the following assumptions:

Firstly, the ruling overlooks the fact that the amounts received, intended for hotel room
accommodations, were received as part of the package fee and, therefore, form part of
"gross receipts" as defined by law.

Secondly, there is no showing and is not established by the evidence. that the amounts
received and "earmarked" are actually what had been paid out as hotel room charges.
The mere possibility that the amounts actually paid could be less than the amounts
received is sufficient to destroy the validity of the ruling. (Rollo, pp. 26-27)

In effect, the petitioner's lone issue is based on alleged error in the findings of facts of
the respondent court.
The well-settled doctrine is that the findings of facts of the Court of Tax Appeals are
binding on this Court and absent strong reasons for this Court to delve into facts, only
questions of law are open for determination. (Nilsen v. Commissioner of Customs, 89
SCRA 43 [1979]; Balbas v. Domingo, 21 SCRA 444 [1967]; Raymundo v. De Joya, 101
SCRA 495 [1980]). In the recent case of Sy Po v. Court of Appeals, (164 SCRA 524
[1988]), we ruled that the factual findings of the Court of Tax Appeals are binding upon
this court and can only be disturbed on appeal if not supported by substantial evidence.

In the instant case, we find no reason to disregard and deviate from the findings of facts
of the Court of Tax Appeals.

As quoted earlier, the Court of Tax Appeals sufficiently explained the services of a local
travel agency, like the herein private respondent, rendered to foreign customers. The
respondent differentiated between the package fee — offered by both the local travel
agency and its correspondent counterpart tourist agencies abroad and the requests
made by some tour agencies abroad to local tour agencies wherein the hotel room
charges in some specific cases, would be paid to the local hotels through them. In the
latter case, the correspondent court found as a fact ". . . that the foreign tour agency
entrusts to the petitioner Tours Specialists, Inc. the fund for hotel room accommodation,
which in turn is paid by petitioner tour agency to the local hotel when billed." (Rollo, p.
42) The following procedure is followed: The billing hotel sends the bill to the
respondent; the local hotel then identifies the individual tourist, or the particular group of
tourist by code name or group designation plus the duration of their stay for purposes of
payment; upon receipt of the bill the private respondent pays the local hotel with the
funds entrusted to it by the foreign tour correspondent agency.

Moreover, evidence presented by the private respondent shows that the amounts
entrusted to it by the foreign tourist agencies to pay the room charges of foreign tourists
in local hotels were not diverted to its funds; this arrangement was only an act of
accommodation on the part of the private respondent. This evidence was not refuted.

In essence, the petitioner's assertion that the hotel room charges entrusted to the
private respondent were part of the package fee paid by foreign tourists to the
respondent is not correct. The evidence is clear to the effect that the amounts entrusted
to the private respondent were exclusively for payment of hotel room charges of foreign
tourists entrusted to it by foreign travel agencies.

As regards the petitioner's second assumption, the respondent court stated:

. . . [C]ontrary to the contention of respondent, the records show, firstly, in the Examiners'
Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December 1976 alone, the
following sums made up the hotel room accommodations:

July 1976 P 102,702.97

Aug. 1976 121,167.19

 Sept. 1976 53,209.61

—————

P 282,079.77

=========

Oct. 1976 P 71,134.80

Nov. 1976 409,019.17

Dec. 1976 142,761.55

—————

622,915.51

—————

Grand Total P 904,995.29

=========

It is not true therefore, as stated by respondent, that there is no evidence proving the
amounts earmarked for hotel room charges. Since the BIR examiners could not have
manufactured the above figures representing "advances for hotel room
accommodations," these payments must have certainly been taken from the records of
petitioner, such as the invoices, hotel bills, official receipts and other pertinent documents.
(Rollo, pp. 48-49)

The factual findings of the respondent court are supported by substantial evidence,
hence binding upon this Court.

With these clarifications, the issue to be threshed out is as stated by the respondent
court, to wit:

. . . [W]hether or not the hotel room charges held in trust for foreign tourists and travelers
and/or correspondent foreign travel agencies and paid to local host hotels form part of the
taxable gross receipts for purposes of the 3% contractor's tax. (Rollo, p. 45)

The petitioner opines that the gross receipts which are subject to the 3% contractor's tax
pursuant to Section 191 (Section 205 of the National Internal Revenue Code of 1977) of
the Tax Code include the entire gross receipts of a taxpayer undiminished by any
amount. According to the petitioner, this interpretation is in consonance with B.I.R.
Ruling No. 68-027, dated 23 October, 1968 (implementing Section 191 of the Tax Code)
which states that the 3% contractor's tax prescribed by Section 191 of the Tax Code is
imposed of the gross receipts of the contractor, "no deduction whatever being allowed
by said law." The petitioner contends that the only exception to this rule is when there is
a law or regulation which would exempt such gross receipts from being subjected to the
3% contractor's tax citing the case of Commissioner of Internal Revenue v. Manila
Jockey Club, Inc. (108 Phil. 821 [1960]). Thus, the petitioner argues that since there is
no law or regulation that money entrusted, earmarked and paid for hotel room charges
should not form part of the gross receipts, then the said hotel room charges are
included in the private respondent's gross receipts for purposes of the 3% contractor's
tax.

In the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (supra),
the Commissioner appealed two decisions of the Court of Tax Appeals disapproving his
levy of amusement taxes upon the Manila Jockey Club, a duly constituted corporation
authorized to hold horse races in Manila. The facts of the case show that the monies
sought to be taxed never really belonged to the club. The decision shows that during the
period November 1946 to 1950, the Manila Jockey Club paid amusement tax on its
commission but without including the 5-1/2% which pursuant to Executive Order 320
and Republic Act 309 went to the Board of Races, the owner of horses and jockeys.
Section 260 of the Internal Revenue Code provides that the amusement tax was
payable by the operator on its "gross receipts". The Manila Jockey Club, however, did
not consider as part of its "gross receipts" subject to amusement tax the amounts which
it had to deliver to the Board on Races, the horse owners and the jockeys. This view
was fully sustained by three opinions of the Secretary of Justice, to wit:

There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the total bets
registered by the Totalizer. This portion represents its share or commission in the total
amount of money it handles and goes to the funds thereof as its own property which it
may legally disburse for its own purposes. The 5% does not belong to the club. It is
merely held in trust for distribution as prizes to the owners of winning horses. It is
destined for no other object than the payment of prizes and the club cannot otherwise
appropriate this portion without incurring liability to the owners of winning horses. It
cannot be considered as an item of expense because the sum used for the payment of
prizes is not taken from the funds of the club but from a certain portion of the total bets
especially earmarked for that purpose.

In view of all the foregoing, I am of the opinion that in the submission of the returns for
the amusement tax of 10% (now it is 20% of the "gross receipts", provided for in Section
260 of the National Internal Revenue Code), the 5% of the total bets that is set aside for
prizes to owners of winning horses should not be included by the Manila Jockey Club,
Inc.

The Collector of the Internal Revenue, however had a different opinion on the matter
and demanded payment of amusement taxes. The Court of Tax Appeals reversed the
Collector.

We affirmed the decision of the Court of Tax Appeals and stated:

The Secretary's opinion was correct. The Government could not have meant to tax as
gross receipt of the Manila Jockey Club the 1/2% which it directs same Club to turn over
to the Board on Races. The latter being a Government institution, there would be double
taxation, which should be avoided unless the statute admits of no other interpretation. In
the same manner, the Government could not have intended to consider as gross receipt
the portion of the funds which it directed the Club to give, or knew the Club would give, to
 winning horses and jockeys — admittedly 5%. It is true that the law says that out of the
total wager funds 12-1/2% shall be set aside as the "commission" of the race track owner,
but the law itself takes official notice, and actually approves or directs payment of the
portion that goes to owners of horses as prizes and bonuses of jockeys, which portion is
admittedly 5% out of that 12-1/2% commission. As it did not at that time contemplate the
application of "gross receipts" revenue principle, the law in making a distribution of the
total wager funds, took no trouble of separating one item from the other; and for
convenience, grouped three items under one common denomination.

Needless to say, gross receipts of the proprietor of the amusement place should not
include any money which although delivered to the amusement place has been
especially earmarked by law or regulation for some person other than the proprietor. (The
situation thus differs from one in which the owner of the amusement place, by a private
contract, with its employees or partners, agrees to reserve for them a portion of the
proceeds of the establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55 Off. Gaz. [51]
10539; Sy Chuico v. Coll., 107 Phil., 428; 59 Off. Gaz., [6] 896).

In the second case, the facts of the case are:

The Manila Jockey Club holds once a year a so called "special Novato race", wherein
only "novato" horses, (i.e. horses which are running for the first time in an official [of the
club] race), may take part. Owners of these horses must pay to the Club an inscription
fee of P1.00, and a declaration fee of P1.00 per horse. In addition, each of them must
contribute to a common fund (P10.00 per horse). The Club contributes an equal amount
P10.00 per horse) to such common fund, the total amount of which is added to the 5%
participation of horse owners already described herein-above in the first case.

Since the institution of this yearly special novato race in 1950, the Manila Jockey Club
never paid amusement tax on the moneys thus contributed by horse owners (P10.00
each) because it entertained the belief that in accordance with the three opinions of the
Secretary of Justice herein-above described, such contributions never formed part of its
gross receipts. On the inscription fee of the P1.00 per horse, it paid the tax. It did not on
the declaration fee of P1.00 because it was imposed by the Municipal Ordinance of
Manila and was turned over to the City officers.

The Collector of Internal Revenue required the Manila Jockey Club to pay amusement
tax on such contributed fund P10.00 per horse in the special novato race, holding they
were part of its gross receipts. The Manila Jockey Club protested and resorted to the
Court of Tax Appeals, where it obtained favorable judgment on the same grounds
sustained by said Court in connection with the 5% of the total wager funds in the herein-
mentioned first case; they were not receipts of the Club.

We resolved the issue in the following manner:

We think the reasons for upholding the Tax Court's decision in the first case apply to this
one. The ten-peso contribution never belonged to the Club. It was held by it as a trust
fund. And then, after all, when it received the ten-peso contribution, it at the same time
contributed ten pesos out of its own pocket, and thereafter distributed both amounts as
prizes to horse owners. It would seem unreasonable to regard the ten-peso contribution
of the horse owners as taxable receipt of the Club, since the latter, at the same moment it
received the contribution necessarily lost ten pesos too.
As demonstrated in the above-mentioned case, gross receipts subject to tax under the
Tax Code do not include monies or receipts entrusted to the taxpayer which do not
belong to them and do not redound to the taxpayer's benefit; and it is not necessary that
there must be a law or regulation which would exempt such monies and receipts within
the meaning of gross receipts under the Tax Code.

Parenthetically, the room charges entrusted by the foreign travel agencies to the private
respondent do not form part of its gross receipts within the definition of the Tax Code.
The said receipts never belonged to the private respondent. The private respondent
never benefited from their payment to the local hotels. As stated earlier, this
arrangement was only to accommodate the foreign travel agencies.

Another objection raised by the petitioner is to the respondent court's application of

Presidential Decree 31 which exempts foreign tourists from payment of hotel room tax.
Section 1 thereof provides:

Sec. 1. — Foreign tourists and travelers shall be exempt from payment of any and all
hotel room tax for the entire period of their stay in the country.

The petitioner now alleges that P.D. 31 has no relevance to the case. He contends that
the tax under Section 191 of the Tax Code is in the nature of an excise tax; that it is a
tax on the exercise of the privilege to engage in business as a contractor and that it is
imposed on, and collectible from the person exercising the privilege. He sums his
arguments by stating that "while the burden may be shifted to the person for whom the
services are rendered by the contractor, the latter is not relieved from payment of the
tax." (Rollo, p. 28)

The same arguments were submitted by the Commissioner of Internal Revenue in the
case of Commissioner of Internal Revenue v. John Gotamco & Son., Inc. (148 SCRA 36
[1987]), to justify his imposition of the 3% contractor's tax under Section 191 of the
National Internal Revenue Code on the gross receipts John Gotamco & Sons, Inc.,
realized from the construction of the World Health Organization (WHO) office building in
Manila. We rejected the petitioner's arguments and ruled:

We agree with the Court of Tax Appeals in rejecting this contention of the petitioner. Said
the respondent court:

"In context, direct taxes are those that are demanded from the very
person who, it is intended or desired, should pay them; while indirect
taxes are those that are demanded in the first instance from one person
in the expectation and intention that he can shift the burden to someone
else. (Pollock v. Farmers, L & T Co., 1957 US 429, 15 S. Ct. 673, 39
Law. ed. 759). The contractor's tax is of course payable by the contractor
but in the last analysis it is the owner of the building that shoulders the
burden of the tax because the same is shifted by the contractor to the
owner as a matter of self-preservation. Thus, it is an indirect tax. And it is
an indirect tax on the WHO because, although it is payable by the
petitioner, the latter can shift its burden on the WHO. In the last analysis
it is the WHO that will pay the tax indirectly through the contractor and it
 certainly cannot be said that 'this tax has no bearing upon the World
Health Organization.'"

Petitioner claims that under the authority of the Philippine Acetylene Company versus
Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3% contractor's tax falls
directly on Gotamco and cannot be shifted to the WHO. The Court of Tax Appeals,
however, held that the said case is not controlling in this case, since the Host Agreement
specifically exempts the WHO from "indirect taxes." We agree. The Philippine Acetylene
case involved a tax on sales of goods which under the law had to be paid by the
manufacturer or producer; the fact that the manufacturer or producer might have added
the amount of the tax to the price of the goods did not make the sales tax "a tax on the
purchaser." The Court held that the sales tax must be paid by the manufacturer or
producer even if the sale is made to tax-exempt entities like the National Power
Corporation, an agency of the Philippine Government, and to the Voice of America, an
agency of the United States Government.

The Host Agreement, in specifically exempting the WHO from "indirect taxes,"
contemplates taxes which, although not imposed upon or paid by the Organization
directly, form part of the price paid or to be paid by it.

Accordingly, the significance of P.D. 31 is clearly established in determining whether or

not hotel room charges of foreign tourists in local hotels are subject to the 3%
contractor's tax. As the respondent court aptly stated:

. . . If the hotel room charges entrusted to petitioner will be subjected to 3% contractor's

tax as what respondent would want to do in this case, that would in effect do indirectly
what P.D. 31 would not like hotel room charges of foreign tourists to be subjected to hotel
room tax. Although, respondent may claim that the 3% contractor's tax is imposed upon a
different incidence i.e. the gross receipts of petitioner tourist agency which he asserts
includes the hotel room charges entrusted to it, the effect would be to impose a tax, and
though different, it nonetheless imposes a tax actually on room charges. One way or the
other, it would not have the effect of promoting tourism in the Philippines as that would
increase the costs or expenses by the addition of a hotel room tax in the overall
expenses of said tourists. (Rollo, pp. 51-52)

WHEREFORE, the instant petition is DENIED. The decision of the Court of Tax Appeals
is AFFIRMED. No pronouncement as to costs.

SO ORDERED.

EISNER v. MACOMBER , 252 U.S. 189 (1920)

252 U.S. 189

EISNER, Internal Revenue Collector,

v.
MACOMBER.
No. 318.
 Argued April 16, 1919

Restored to Docket for Reargument, May 19, 1919.

Reargued Oct. 17 and 20, 1919.

Decided March 8, 1920.

[252 U.S. 189, 190] Mr. Assistant Attorney General Frierson, for plaintiff in error.

Messrs. Charles E. Hughes and George Welwood Murray, both of New York
[252 U.S. 189, 194]
City, for defendant in error.

[252 U.S. 189, 199]

Mr. Justice PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the
power to tax, as income of the stockholder and without apportionment, a stock dividend made
lawfully and in good faith against profits accumulated by the corporation since March 1, 1913.

It arises under the Revenue Act of September 8, 1916 (39 Stat. 756 et seq., c. 463 [Comp. St.
6336a et seq.]), which, in our opinion ( notwithstanding a contention of the government that will
be [252 U.S. 189, 200] noticed), plainly evinces the purpose of Congress to tax stock dividends as
income. 1

The facts, in outline, are as follows:

On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of
an authorized capital stock of $100,000, 000, had shares of stock outstanding, par value $100
each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided
profits invested in plant, property, and business and required for the purposes of the corporation,
amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1,
1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of
directors decided to issue additional shares sufficient to constitute a stock dividend of 50 per
cent. of the outstanding stock, and to transfer from surplus account to capital stock account an
amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to
the par value of the proposed new stock was transferred accordingly, and the new stock duly
issued against it and divided among the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for
1,100 additional [252 U.S. 189, 201] shares, of which 18.07 per cent., or 198.77 shares, par value
$19,877, were treated as representing surplus earned between March 1, 1913, and January 1,
1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue
Act of 1916, based upon a supposed income of $ 19,877 because of the new shares; and an
appeal to the Commissioner of Internal Revenue having been disallowed, she brought action
against the Collector to recover the tax. In her complaint she alleged the above facts, and
contended that in imposing such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3, and
article 1, 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned
according to population, and that the stock dividend was not income within the meaning of the
Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of
Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254; and, defendant having
failed to plead further, final judgment went against him. To review it, the present writ of error is
prosecuted.

The case was argued at the last term, and reargued at the present term, both orally and by
additional briefs.

We are constrained to hold that the judgment of the District Court must be affirmed: First,
because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a re-
examination of the question with the additional light thrown upon it by elaborate arguments, has
confirmed the view that the underlying ground of that decision is sound, that it disposes of the
question here presented, and that other fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus
earned prior to January 1, 1913, was taxable against the stockholder under the Act of October 3,
1913 (38 Stat. 114, 166, c. 16 ), which provided (section B, p. 167) that net income should
include 'dividends,' and also 'gains or profits and income derived [252 U.S. 189, 202] from any
source whatever.' Suit having been brought by a stockholder to recover the tax assessed against
him by reason of the dividend, the District Court sustained a demurrer to the complaint. 242 Fed.
702. The court treated the construction of the act as inseparable from the interpretation of the
Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U.S.
601 , 15 Sup. Ct. 912, and quoted the Amendment, proceeded very properly to say (242 Fed.
704):

'It is manifest that the stock dividend in question cannot be reached by the Income Tax
Act and could not, even though Congress expressly declared it to be taxable as income,
unless it is in fact income.'

It declined, however, to accede to the contention that in Gibbons v. Mahon, 136 U.S. 549 , 10
Sup. Ct. 1057, 'stock dividends' had received a definition sufficiently clear to be controlling,
treated the language of this court in that case as obiter dictum in respect of the matter then before
it (242 Fed. 706), and examined the question as res nova, with the result stated. When the case
came here, after overruling a motion to dismiss made by the government upon the ground that
the only question involved was the construction of the statute and not its constitutionality, we
dealt upon the merits with the question of construction only, but disposed of it upon
consideration of the essential nature of a stock dividend disregarding the fact that the one in
question was based upon surplus earnings that accrued before the Sixteenth Amendment took
effect. Not only so, but we rejected the reasoning of the District Court, saying ( 245 U.S. 426 , 38
Sup. Ct. 159, L. R. A. 1918D, 254):
 'Notwithstanding the thoughtful discussion that the case received below we cannot doubt
that the dividend was capital as well for the purposes of the Income Tax Law as for
distribution between tenant for life and remainderman. What was said by this court upon
the latter question is equally true for the former. 'A stock dividend really takes nothing
from the property of the corporation, and adds nothing to the [252 U.S. 189, 203] interests
of the shareholders. Its property is not diminished, and their interests are not increased. ...
The proportional interest of each shareholder remains the same. The only change is in the
evidence which represents that interest, the new shares and the original shares together
representing the same proportional interest that the original shares represented before the
issue of the new ones.' Gibbons v. Mahon, 136 U.S. 549, 559 , 560 S. [10 Sup. Ct. 1057].
In short, the corporation is no poorer and the stockholder is no richer than they were
before. Logan County v. United States, 169 U.S. 255 , 261 [18 Sup. Ct. 361]. If the
plaintiff gained any small advantage by the change, it certainly was not an advantage of
$417,450, the sum upon which he was taxed. ... What has happened is that the plaintiff's
old certificates have been split up in effect and have diminished in value to the extent of
the value of the new.'

This language aptly answered not only the reasoning of the District Court but the argument of the
Solicitor General in this court, which discussed the essential nature of a stock dividend. And if,
for the reasons thus expressed, such a dividend is not to be regarded as 'income' or 'dividends'
within the meaning of the act of 1913, we are unable to see how it can be brought within the
meaning of 'incomes' in the Sixteenth Amendment; it being very clear that Congress intended in
that act to exert its power to the extent permitted by the amendment. In Towne v. Eisner it was
not contended that any construction of the statute could make it narrower than the constitutional
grant; rather the contrary.

The fact that the dividend was charged against profits earned before the act of 1913 took effect,
even before the amendment was adopted, was neither relied upon nor alluded to in our
consideration of the merits in that case. Not only so, but had we considered that a stock dividend
constituted income in any true sense, it would have been held taxable under the act of 1913
notwithstanding it was [252 U.S. 189, 204] based upon profits earned before the amendment. We
ruled at the same term, in Lynch v. Hornby, 247 U.S. 339 , 38 Sup. Ct. 543, that a cash dividend
extraordinary in amount, and in Peabody v. Eisner, 247 U.S. 347 , 38 Sup. Ct. 546, that a
dividend paid in stock of another company, were taxable as income although based upon
earnings that accrued before adoption of the amendment. In the former case, concerning
'corporate profits that accumulated before the act took effect,' we declared ( 247 U.S. 343, 344 ,
38 S. Sup. Ct. 543, 545 [62 L. Ed. 1149]):

'Just as we deem the legislative intent manifest to tax the stockholder with respect to such
accumulations only if and when, and to the extent that, his interest in them comes to
fruition as income, that is, in dividends declared, so we can perceive no constitutional
obstacle that stands in the way of carrying out this intent when dividends are declared out
of a pre-existing surplus. ... Congress was at liberty under the amendment to tax as
income, without apportionment, everything that became income, in the ordinary sense of
the word, after the adoption of the amendment, including dividends received in the
ordinary course by a stockholder from a corporation, even though they were
 extraordinary in amount and might appear upon analysis to be a mere realization in
possession of an inchoate and contingent interest that the stockholder had in a surplus of
corporate assets previously existing.'

In Peabody v. Eisner, 247 U.S. 349, 350 , 38 S. Sup. Ct. 546, 547 (62 L. Ed. 1152), we observed
that the decision of the District Court in Towne v. Eisner had been reversed 'only upon the
ground that it related to a stock dividend which in fact took nothing from the property of the
corporation and added nothing to the interest of the shareholder, but merely changed the
evidence which represented that interest,' and we distinguished the Peabody Case from the
Towne Case upon the ground that 'the dividend of Baltimore & Ohio shares was not a stock
dividend but a distribution in specie of a portion of the assets of the Union Pacific.'

Therefore Towne v. Eisner cannot be regarded as turning [252 U.S. 189, 205] upon the point that
the surplus accrued to the company before the act took effect and before adoption of the
amendment. And what we have quoted from the opinion in that case cannot be regarded as obiter
dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view
then expressed, and might rest the present case there, not because that case in terms decided the
constitutional question, for it did not, but because the conclusion there reached as to the essential
nature of a stock dividend necessarily prevents its being regarded as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue
Act of 1916 declared (39 Stat. 757 [Comp. St . 6336b]) that a 'stock dividend shall be considered
income, to the amount of its cash value,' we will deal at length with the constitutional question,
incidentally testing the soundness of our previous conclusion.

The Sixteenth Amendment must be construed in connection with the taxing clauses of the
original Constitution and the effect attributed to them before the amendment was adopted. In
Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601 , 15 Sup. Ct. 912, under the Act of August
27, 1894 (28 Stat. 509, 553, c. 349, 27), it was held that taxes upon rents and profits of real estate
and upon returns from investments of personal property were in effect direct taxes upon the
property from which such income arose, imposed by reason of ownership; and that Congress
could not impose such taxes without apportioning them among the states according to
population, as required by article 1, 2, cl. 3, and section 9, cl. 4, of the original Constitution.

Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress
thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object
to be accomplished:

'The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among [252 U.S. 189, 206] the several states, and
without regard to any census or enumeration.'

As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the
necessity which otherwise might exist for an apportionment among the states of taxes laid on
income. Brushaber v. Union Pacific R. R. Co., 240 U.S. 1 , 17-19, 36 Sup. Ct. 236, Ann. Cas.
1917B, 713, L. R. A. 1917D, 414; Stanton v. Baltic Mining Co., 240 U.S. 103 , 112 et seq., 36
Sup. Ct. 278; Peck & Co. v. Lowe, 247 U.S. 165, 172 , 173 S., 38 Sup. Ct. 432.

A proper regard for its genesis, as well as its very clear language, requires also that this
amendment shall not be extended by loose construction, so as to repeal or modify, except as
applied to income, those provisions of the Constitution that require an apportionment according
to population for direct taxes upon property, real and personal. This limitation still has an
appropriate and important function, and is not to be overridden by Congress or disregarded by
the courts.

In order, therefore, that the clauses cited from article 1 of the Constitution may have proper force
and effect, save only as modified by the amendment, and that the latter also may have proper
effect, it becomes essential to distinguish between what is and what is not 'income,' as the term is
there used, and to apply the distinction, as cases arise, according to truth and substance, without
regard to form. Congress cannot by any definition it may adopt conclude the matter, since it
cannot by legislation alter the Constitution, from which alone it derives its power to legislate,
and within whose limitations alone that power can be lawfully exercised.

The fundamental relation of 'capital' to 'income' has been much discussed by economists, the
former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted
as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow
during a period of time. For the present purpose we require only a clear definition of the term
'income,' [252 U.S. 189, 207] as used in common speech, in order to determine its meaning in the
amendment, and, having formed also a correct judgment as to the nature of a stock dividend, we
shall find it easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's Internat.
Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising
under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U.S. 399, 415 ,
34 S. Sup. Ct. 136, 140 [58 L. Ed. 285]; Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 , 38 S.
Sup. Ct. 467, 469 [62 L. Ed. 1054]), 'Income may be defined as the gain derived from capital,
from labor, or from both combined,' provided it be understood to include profit gained through a
sale or conversion of capital assets, to which it was applied in the Doyle Case, 247 U.S. 183, 185
, 38 S. Sup. Ct. 467, 469 (62 L. Ed. 1054).

Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a
correct solution of the present controversy. The government, although basing its argument upon
the definition as quoted, placed chief emphasis upon the word 'gain,' which was extended to
include a variety of meanings; while the significance of the next three words was either
overlooked or misconceived. 'Derived-from- capital'; 'the gain-derived-from-capital,' etc. Here
we have the essential matter: not a gain accruing to capital; not a growth or increment of value in
the investment; but a gain, a profit, something of exchangeable value, proceeding from the
property, severed from the capital, however invested or employed, and coming in, being
'derived'-that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit
and disposal- that is income derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment-'incomes,
from whatever source derived'-the essential thought being expressed [252 U.S. 189, 208] with a
conciseness and lucidity entirely in harmony with the form and style of the Constitution.

Can a stock dividend, considering its essential character, be brought within the definition? To
answer this, regard must be had to the nature of a corporation and the stockholder's relation to it.
We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and
having a capital stock divided into shares to which a nominal or par value is attributed.

Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but
the evidence of it. They state the number of shares to which he is entitled and indicate their par
value and how the stock may be transferred. They show that he or his assignors, immediate or
remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest
proportionate to the whole, entitled to have the property and business of the company devoted
during the corporate existence to attainment of the common objects, entitled to vote at
stockholders' meetings, to receive dividends out of the corporation's profits if and when declared,
and, in the event of liquidation, to receive a proportionate share of the net assets, if any,
remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right
to withdraw any part of either capital or profits from the common enterprise; on the contrary, his
interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and
affairs of the company. Nor is it the interest of an owner in the assets themselves, since the
corporation has full title, legal and equitable, to the whole. The stockholder has the right to have
the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder,
he has no right to withdraw, only the right to persist, subject to the risks of the enterprise, and
looking only to dividends for his return. If he desires to dissociate himself [252 U.S. 189, 209]
from the company he can do so only by disposing of his stock.

For bookeeping purposes, the company acknowledges a liability in form to the stockholders
equivalent to the aggregate par value of their stock, evidenced by a 'capital stock account.' If
profits have been made and not divided they create additional bookkeeping liabilities under the
head of 'profit and loss,' 'undivided profits,' 'surplus account,' or the like. None of these, however,
gives to the stockholders as a body, much less to any one of them, either a claim against the
going concern for any particular sum of money, or a right to any particular portion of the assets
or any share in them unless or until the directors conclude that dividends shall be made and a part
of the company's assets segregated from the common fund for the purpose. The dividend
normally is payable in money, under exceptional circumstances in some other divisible property;
and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or
winding-up of the company) does the stockholder realize a profit or gain which becomes his
separate property, and thus derive income from the capital that he or his predecessor has
invested.

In the present case, the corporation had surplus and undivided profits invested in plant, property,
and business, and required for the purposes of the corporation, amounting to about $45,000,000,
in addition to outstanding capital stock of $50,000,000. In this the case is not extraordinary. The
profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be
in the form of money on hand in excess of what is required to meet current liabilities and finance
current operations of the company. Often, especially in a growing business, only a part,
sometimes a small part, of the year's profits is in property capable of division; the remainder
having been absorbed in the acquisition of increased plant, [252 U.S. 189, 210] quipment, stock in
trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part is
available for dividends, the balance of the year's profits is carried to the credit of undivided
profits, or surplus, or some other account having like significance. If thereafter the company
finds itself in funds beyond current needs it may declare dividends out of such surplus or
undivided profits; otherwise it may go on for years conducting a successful business, but
requiring more and more working capital because of the extension of its operations, and
therefore unable to declare dividends approximating the amount of its profits. Thus the surplus
may increase until it equals or even exceeds the par value of the outstanding capital stock. This
may be adjusted upon the books in the mode adopted in the case at bar-by declaring a 'stock
dividend.' This, however, is no more than a book adjustment, in essence not a dividend but rather
the opposite; no part of the assets of the company is separated from the common fund, nothing
distributed except paper certificates that evidence an antecedent increase in the value of the
stockholder's capital interest resulting from an accumulation of profits by the company, but
profits so far absorbed in the business as to render it impracticable to separate them for
withdrawal and distribution. In order to make the adjustment, a charge is made against surplus
account with corresponding credit to capital stock account, equal to the proposed 'dividend'; the
new stock is issued against this and the certificates delivered to the existing stockholders in
proportion to their previous holdings. This, however, is merely bookkeeping that does not affect
the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not
the essence, of the 'liability' acknowledged by the corporation to its own shareholders, and this
through a readjustment of accounts on one side of the balance sheet only, increasing 'capital
stock' at the expense of [252 U.S. 189, 211] 'SURPLUS'; IT DOES NOT ALTER THE PRE-
EXisting proportionate interest of any stockholder or increase the intrinsic value of his holding or
of the aggregate holdings of the other stockholders as they stood before. The new certificates
simply increase the number of the shares, with consequent dilution of the value of each share.

A 'stock dividend' shows that the company's accumulated profits have been capitalized, instead
of distributed to the stockholders or retained as surplus available for distribution in money or in
kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends
rather to postpone such realization, in that the fund represented by the new stock has been
transferred from surplus to capital, and no longer is available for actual distribution.

The essential and controlling fact is that the stockholder has received nothing out of the
company's assets for his separate use and benefit; on the contrary, every dollar of his original
investment, together with whatever accretions and accumulations have resulted from
employment of his money and that of the other stockholders in the business of the company, still
remains the property of the company, and subject to business risks which may result in wiping
out the entire investment. Having regard to the very truth of the matter, to substance and not to
form, he has recived nothing that answers the definition of income within the meaning of the
Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when lawfully made,
we lay aside the question whether in a particular case a stock dividend may be authorized by the
local law governing the corporation, or whether the capitalization of profits may be the result of
correct judgment and proper business policy on the part of its management, and a due regard for
the interests of the stockholders. And we are considering the taxability of bona fide stock
dividends only. [252 U.S. 189, 212] We are clear that not only does a stock dividend really take
nothing from the property of the corporation and add nothing to that of the shareholder, but that
the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is
the richer because of an increase of his capital, at the same time shows he has not realized or
received any income in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he
may, if he can find a buyer. It is equally true that if he does sell, and in doing so realizes a profit,
such profit, like any other, is income, and so far as it may have arisen since the Sixteenth
Amendment is taxable by Congress without apportionment. The same would be true were he to
sell some of his original shares at a profit. But if a shareholder sells dividend stock he necessarily
disposes of a part of his capital interest, just as if he should sell a part of his old stock, either
before or after the dividend. What he retains no longer entitles him to the same proportion of
future dividends as before the sale. His part in the control of the company likewise is diminished.
Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should
receive in common with other stockholders a 50 per cent. stock dividend, and should sell his
part, he thereby would be reduced from a majority to a minority stockholder, having six-
fifteenths instead of six- tenths of the total stock outstanding. A corresponding and proportionate
decrease in capital interest and in voting power would befall a minority holder should he sell
dividend stock; it being in the nature of things impossible for one to dispose of any part of such
an issue without a proportionate disturbance of the distribution of the entire capital stock, and a
like diminution of the seller's comparative voting power-that 'right preservative of rights' in the
control of a corporation. [252 U.S. 189, 213] Yet, without selling, the shareholder, unless possessed
of other resources, has not the wherewithal to pay an income tax upon the dividend stock.
Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not
income, than this demonstration that in the nature of things it requires conversion of capital in
order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the fundamental error
already mentioned-a failure to appraise correctly the force of the term 'income' as used in the
Sixteenth Amendment, or at least to give practical effect to it. Thus the government contends that
the tax 'is levied on income derived from corporate earnings,' when in truth the stockholder has
'derived' nothing except paper certificates which, so far as they have any effect, deny him present
participation in such earnings. It contends that the tax may be laid when earnings 'are received by
the stockholder,' whereas he has received none; that the profits are 'distributed by means of a
stock dividend,' although a stock dividend distributes no profits; that under the act of 1916 'the
tax is on the stockholder's share in corporate earnings,' when in truth a stockholder has no such
share, and receives none in a stock dividend; that 'the profits are segregated from his former
capital, and he has a separate certificate representing his invested profits or gains,' whereas there
has been no segregation of profits, nor has he any separate certificate representing a personal
gain, since the certificates, new and old, are alike in what they represent-a capital interest in the
entire concerns of the corporation.
We have no doubt of the power or duty of a court to look through the form of the corporation and
determine the question of the stockholder's right, in order to ascertain whether he has received
income taxable by Congress without apportionment. But, looking through the form, [252 U.S. 189,
214] we cannot disregard the essential truth disclosed, ignore the substantial difference between
corporation and stockholder, treat the entire organization as unreal, look upon stockholders as
partners, when they are not such, treat them as having in equity a right to a partition of the
corporate assets, when they have none, and indulge the fiction that they have received and
realized a share of the profits of the company which in truth they have neither received nor
realized. We must treat the corporation as a substantial entity separate from the stockholder, not
only because such is the practical fact but because it is only by recognizing such separateness
that any dividend-even one paid in money or property-can be regarded as income of the
stockholder. Did we regard corporation and stockholders as altogether identical, there would be
no income except as the corporation acquired it; and while this would be taxable against the
corporation as income under appropriate provisions of law, the individual stockholders could not
be separately and additionally taxed with respect to their several shares even when divided, since
if there were entire identity between them and the company they could not be regarded as
receiving anything from it, any more than if one's money were to be removed from one pocket to
another.

Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the
government nevertheless contends extent to which the gains accumulated by the extend to which
the gains accumulated by the corporation have made him the richer. There are two insuperable
difficulties with this: In the first place, it would depend upon how long he had held the stock
whether the stock dividend indicated the extent to which he had been enriched by the operations
of the company; unless he had held it throughout such operations the measure would not hold
true. Secondly, and more important for present purposes, enrichment through increase in value
[252 U.S. 189, 215] of capital investment is not income in any proper meaning of the term.

The complaint contains averments respecting the market prices of stock such as plaintiff held,
based upon sales before and after the stock dividend, tending to show that the receipt of the
additional shares did not substantially change the market value of her entire holdings. This tends
to show that in this instance market quotations reflected intrinsic values-a thing they do not
always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry
such as the present, when the question must be, not what will the thing sell for, but what is it in
truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a case where
stockholders use money received as cash dividends to purchase additional stock
contemporaneously issued by the corporation. But an actual cash dividend, with a real option to
the stockholder either to keep the money for his own or to reinvest it in new shares, would be as
far removed as possible from a true stock dividend, such as the one we have under consideration,
where nothing of value is taken from the company's assets and transferred to the individual
ownership of the several stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the corporation's
own shares and one made by distributing shares owned by it in the stock of another company,
calls for no comment beyond the statement that the latter distributes assets of the company
among the shareholders while the former does not, and for no citation of authority except
Peabody v. Eisner, 247 U.S. 347, 349 , 350 S., 38 Sup. Ct. 546.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the
position of the government. [252 U.S. 189, 216] Swan Brewery Co., Ltd. v. Rex, [252 U.S. 189, 1914]
A. C. 231, arose under the Dividend Duties Act of Western Australia, which provided that
'dividend' should include 'every dividend, profit, advantage, or gain intended to be paid or
credited to or distributed among any members or directors of any company,' except, etc. There
was a stock dividend, the new shares being allotted among the shareholders pro rata; and the
question was whether this was a distribution of a dividend within the meaning of the act. The
Judicial Committee of the Privy Council sustained the dividend duty upon the ground that,
although 'in ordinary language the new shares would not be called a dividend, nor would the
allotment of them be a distribution of a dividend,' yet, within the meaning of the act, such new
shares were an 'advantage' to the recipients. There being no constitutional restriction upon the
action of the lawmaking body, the case presented merely a question of statutory construction, and
manifestly the decision is not a precedent for the guidance of this court when acting under a duty
to test an act of Congress by the limitations of a written Constitution having superior force.

In Tax Commissioner v. Putnam (1917) 227 Mass. 522, 116 N. E. 904, L. R. A. 1917F, 806, it
was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred
upon the Legislature full power to tax incomes, 'must be interpreted as including every item
which by any reasonable understanding can fairly be regarded as income' (227 Mass. 526, 531,
116 N. E. 904, 907 [L. R. A. 1917F, 806]), and that under it a stock dividend was taxable as
income; the court saying (227 Mass. 535, 116 N. E. 911, L. R. A. 1917F, 806):

'In essence the thing which has been done is to distribute a symbol representing an
accumulation of profits, which instead of being paid out in cash is invested in the
business, thus augmenting its durable assets. In this aspect of the case the substance of
the transaction is no different from what it would be if a cash dividend had been declared
with the privilege of subscription to an equivalent amount of new shares.' [252 U.S. 189,
217] We cannot accept this reasoning. Evidently, in order to give a sufficiently broad
sweep to the new taxing provision, it was deemed necessary to take the symbol for the
substance, accumulation for distribution, capital accretion for its opposite; while a case
where money is paid into the hand of the stockholder with an option to buy new shares
with it, followed by acceptance of the option, was regarded as identical in substance with
a case where the stockholder receives no money and has no option. The Massachusetts
court was not under an obligation, like the one which binds us, of applying a
constitutional amendment in the light of other constitutional provisions that stand in the
way of extending it by construction.

Upon the second argument, the government, recognizing the force of the decision in Towne v.
Eisner, supra, and virtually abandoning the contention that a stock dividend increases the interest
of the stockholder or otherwise enriches him, insisted as an alternative that by the true
construction of the act of 1916 the tax is imposed, not upon the stock dividend, but rather upon
the stockholder's share of the undivided profits previously accumulated by the corporation; the
tax being levied as a matter of convenience at the time such profits become manifest through the
stock dividend. If so construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the stock of
corporations is beyond question, and that such interests might be valued in view of the condition
of the company, including its accumulated and undivided profits, is equally clear. But that this
would be taxation of property because of ownership, and hence would require apportionment
under the provisions of the Constitution, is settled beyond peradventure by previous decisions of
this court.

The government relies upon Collector v. Hubbard (1870) [252 U.S. 189, 218] 12 Wall. 1, (20 L. Ed.
272), which arose under section 117 of the Act of June 30, 1864 (13 Stat. 223, 282, c. 173),
providing that--

'The gains and profits of all companies, whether incorporated or partnership, other than
the companies specified in that section, shall be included in estimating the annual gains,
profits, or income of any person, entitled to the same, whether divided or otherwise.'

The court held an individual taxable upon his proportion of the earnings of a corporation
although not declared as dividends and although invested in assets not in their nature divisible.
Conceding that the stockholder for certain purposes had no title prior to dividend declared, the
court nevertheless said (12 Wall. 18):

'Grant all that, still it is true that the owner of a share of stock in a corporation holds the
share with all its incidents, and that among those incidents is the right to receive all future
dividends, that is, his proportional share of all profits not then divided. Profits are
incident to the share to which the owner at once becomes entitled provided he remains a
member of the corporation until a dividend is made. Regarded as an incident to the
shares, undivided profits are property of the shareholder, and as such are the proper
subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw
material for the purpose of being manufactured are investments in which the stockholders
are interested, and when such profits are actually appropriated to the payment of the debts
of the corporation they serve to increase the market value of the shares, whether held by
the original subscribers or by assignees.'

In so far as this seems to uphold the right of Congress to tax without apportionment a
stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as
overruled by Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601, 627 , 628 S., 637, 15 Sup. Ct.
912. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it
sustained a direct tax upon property not apportioned [252 U.S. 189, 219] AMONG THE STATES,
THE GOVERNMENT NEVERTHEless insists that the sixteenth Amendment removed this
obstacle, so that now the Hubbard Case is authority for the power of Congress to levy a tax on
the stockholder's share in the accumulated profits of the corporation even before division by the
declaration of a dividend of any kind. Manifestly this argument must be rejected, since the
amendment applies to income only, and what is called the stockholder's share in the accumulated
profits of the company is capital, not income. As we have pointed out, a stockholder has no
individual share in accumulated profits, nor in any particular part of the assets of the corporation,
prior to dividend declared.

Thus, from every point of view we are brought irresistibly to the conclusion that neither under
the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true
stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income
of the stockholder. The Revenue Act of 1916, in so far as it imposes a tax upon the stockholder
because of such dividend, contravenes the provisions of article 1, 2, cl. 3, and article 1, 9, cl. 4,
of the Constitution, and to this extent is invalid, notwithstanding the Sixteenth Amendment.

Judgment affirmed.

Mr. Justice HOLMES, dissenting.

I think that Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254, was right in its
reasoning and result and that on sound principles the stock dividend was not income. But it was
clearly intimated in that case that the construction of the statute then before the Court might be
different from that of the Constitution. 245 U.S. 425 , 38 Sup. Ct. 158, L. R. A. 1918D, 254. I
think that the word 'incomes' in the Sixteenth Amendment should be read in [252 U.S. 189, 220] 'a
sense most obvious to the common understanding at the time of its adoption.' Bishop v. State,
149 Ind. 223, 230, 48 N. E. 1038, 1040, 39 L. R. A. 278, 63 Am. St. Rep. 270; State v. Butler, 70
Fla. 102, 133, 69 South. 771. For it was for public adoption that it was proposed. McCulloch v.
Maryland, 4 Wheat. 316, 407. The known purpose of this Amendment was to get rid of nice
questions as to what might be direct taxes, and I cannot doubt that most people not lawyers
would suppose when they voted for it that they put a question like the present to rest. I am of
opinion that the Amendment justifies the tax. See Tax Commissioner v. Putnam, 227 Mass. 522,
532, 533, 116 N. E. 904, L. R. A. 1917F, 806.

Mr. Justice DAY concurs in this opinion.

Mr. Justice BRANDEIS delivered the following [dissenting] opinion:

Financiers, with the aid of lawyers, devised long ago two different methods by which a
corporation can, without increasing its indebtedness, keep for corporate purposes accumulated
profits, and yet, in effect, distribute these profits among its stockholders. One method is a simple
one. The capital stock is increased; the new stock is paid up with the accumulated profits; and the
new shares of paid-up stock are then distributed among the stockholders pro rata as a dividend. If
the stockholder prefers ready money to increasing his holding of the stock in the company, he
sells the new stock received as a dividend. The other method is slightly more complicated.
.arrangements are made for an increase of stock to be offered to stockholders pro rata at par, and,
at the same time, for the payment of a cash dividend equal to the amount which the stockholder
will be required to pay to [252 U.S. 189, 221] the company, if he avails himself of the right to
subscribe for his pro rata of the new stock. If the stockholder takes the new stock, as is expected,
he may endorse the dividend check received to the corporation and thus pay for the new stock. In
order to ensure that all the new stock so offered will be taken, the price at which it is offered is
fixed far below what it is believed will be its market value. If the stockholder prefers ready
money to an increase of his holdings of stock, he may sell his right to take new stock pro rata,
which is evidenced by an assignable instrument. In that event the purchaser of the rights repays
to the corporation, as the subscription price of the new stock, an amount equal to that which it
had paid as a chsh dividend to the stockholder.

Both of these methods of retaining accumulated profits while in effect distributing them as a
dividend had been in common use in the United States for many years prior to the adoption of
the Sixteenth Amendment. They were recognized equivalents. Whether a particular corporation
employed one or the other method was determined sometimes by requirements of the law under
which the corporation was organized; sometimes it was determined by preferences of the
individual officials of the corporation; and sometimes by stock market conditions. Whichever
method was employed the resultant distribution of the new stock was commonly referred to as a
stock dividend. How these two methods have been employed may be illustrated by the action in
this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial
Chronicle) of some of the Standard Oil companies, since the disintegration pursuant to the
decision of this court in 1911. Standard Oil Co. v. United States, 221 U.S. 1 , 31 Sup. Ct. 502, 34
L. R. A. (N. S.) 834, Ann. Cas. 1912D, 734.

(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911,
$1,000,000 capital stock (all common), and a large surplus. On May 15, [252 U.S. 189, 222] 1912,
it increased its capital stock to $30,000,000, and paid a simple stock dividend of 2,900 per cent.
in stock. 2

(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911,
$600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it paid a
simple stock dividend of 33 1/3 per cent., increasing the outstanding capital to $800,000. During
the calendar year 1912 it paid cash dividends aggregating 20 per cent., but it earned considerably
more, and had at the close of the year again a substantial surplus. On June 20, 1913, it declared a
further stock dividend of 25 per cent., thus increasing the capital to $1,000,000.3

(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913,
$1,000,000 capital stock (all common) and $3,701, 710 surplus. Of this surplus $902,457 had
been earned during the calendar year 1913, the net profits of that year having been $1,002,457
and the dividends paid only $100,000 (10 per cent.). On December 22, 1913, a cash dividend of
$200 per share was declared payable on February 14, 1914, to stockholders of record January 31,
1914, and these stockholders were offered the right to subscribe for an equal amount of new
stock at par and to apply the cash dividend in payment therefor. The outstanding stock was thus
increased to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends
were paid on this stock at an annual rate of between 15 per cent. and 20 per cent., but the
company's surplus increased by $2,347,614, so that on December 31, 1916, it had a large surplus
over its $3,000,000 capital stock. On December 15, 1916, the company issued a circular to the
stockholders, saying:

'The company's business for this year has shown a [252 U.S. 189, 223] very good increase
in volume and a proportionate increase in profits, and it is estimated that by January 1,
1917, the company will have a surplus of over $4,000,000. The board feels justified in
 stating that if the proposition to increase the capital stock is acted on favorably, it will be
proper in the near future to declare a cash dividend of 100 per cent. and to allow the
stockholders the privilege pro rata according to their holdings, to purchase the new stock
at par, the plan being to allow the stockholders, if they desire, to use their cash dividend
to pay for the new stock.'

The increase of stock was voted. The company then paid a cash dividend of 100 per cent.,
payable May 1, 1917, again offering to such stockholders the right to subscribe for an equal
amount of new stock at par and to apply the cash dividend in payment therefor.

Moody's Manual, describing the transaction with exactness, says first that the stock was
increased from $3,000,000 to $6,000,000, 'a cash dividend of 100 per cent., payable May 1,
1917, being exchanged for one share of new stock, the equivalent of a 100 per cent. stock
dividend.' But later in the report giving, as customary in the Manual the dividend record of the
company, the Manual says: 'A stock dividend of 200 per cent. was paid February 14, 1914, and
one of 100 per cent. on May 1, 1197.' And in reporting specifically the income account of the
company for a series of years ending December 31, covering net profits, dividends paid and
surplus for the year, it gives, as the aggregate of dividends for the year 1917, $ 660,000 (which
was the aggregate paid on the quarterly cash dividend-5 per cent. January and April; 6 per cent.
July and October), and adds in a note: 'In addition a stock dividend of 100 per cent. was paid
during the year.' 4 The Wall Street Journal of [252 U.S. 189, 224] May 2, 1917, p. 2, quotes the
1917 'high' price for Standard Oil of Kentucky as '375 ex stock dividend.'

It thus appears that among financiers and investors the distribution of the stock, by whichever
method effected, is called a stock dividend; that the two methods by which accumulated profits
are legally retained for corporate purposes and at the same time distributed as dividends are
recognized by them to be equivalents; and that the financial results to the corporation and to the
stockholders of the two methods are substantially the same-unless a difference results from the
application of the federal Income Tax Law.

Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the
Standard Oil Company (of California), a corporation organized under the laws of California and
having its principal place of business in that state. During that year she received from the
company a stock dividend representing profits earned since March 1, 1913. The dividend was
paid by direct issue of the stock to her according to the simple method described above, pursued
also by the Indiana and Nebraska companies. In 1917 she was taxed under the federal law on the
stock dividend so received at its par value of $100 a share, as income received during the year
1916. Such a stock dividend is income, as distinguished from capital, both under the law of New
York and under the law of California, because in both states every dividend representing profits
is deemed to be income, whether paid in cash or in stock. It had been so held in New York, where
the question arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust
Co., 172 N. Y. 137, 64 N. E. 796; Matter of Osborne, 209 N. Y. 450, 103 N. E. 723, 823, 50 L. R.
A. ( N. S.) 510, Ann.Cas. 1915A, 298; and also, where the question arose in matters of taxation,
People v. Glynn, [252 U.S. 189, 225] 130 App. Div. 332, 114 N. Y. Supp. 460; Id. 198 N. Y. 605, 92
N. E. 1097. It has been so held in California, where the question appears to have arisen only in
controversies between life tenant and remainderman. Estate of Duffill, 183 Pac. 337.
It is conceded that if the stock dividend paid to Mrs. Macomber had been made by the more
complicated method pursued by the Standard Oil Company of Kentucky; that is, issuing rights to
take new stock pro rata and paying to each stockholder simultaneously a dividend in cash
sufficient in amount to enable him to pay for this pro rata of new stock to be purchased-the
dividend so paid to him would have been taxable as income, whether he retained the cash or
whether he returned it to the corporation in payment for his pro rata of new stock. But it is
contended that, because the simple method was adopted of having the new stock issued direct to
the stockholders as paid-up stock, the new stock is not to be deemed income, whether she
retained it or converted it into cash by sale. If such a different result can flow merely from the
difference in the method pursued, it must be because Congress is without power to tax as income
of the stockholder either the stock received under the latter method or the proceeds of its sale; for
Congress has, by the provisions in the Revenue Act of 1916, expressly declared its purpose to
make stock dividends, by whichever method paid, taxable as income.

The Sixteenth Amendment, proclaimed February 25, 1913, declares:

'The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among the several states, and without regard to
any census or enumeration.'

The Revenue Act of September 8, 1916, c. 463, 2a, 39 Stat. 756, 757, provided:

'That the term 'dividends' as used in this title shall [252 U.S. 189, 226] be held to mean any
distribution made or ordered to be made by a corporation, ... out of its earnings or profits
accrued since March first, nineteen hundred and thirteen, and payable to its shareholders,
whether in cash or in stock of the corporation, ... which stock dividend shall be
considered income, to the amount of its cash value.'

Hitherto powers conferred upon Congress by the Constitution have been liberally construed, and
have been held to extend to every means appropriate to attain the end sought. In determining the
scope of the power the substance of the transaction, not its form has been regarded. Martin v.
Hunter, 1 Wheat, 304, 326; McCulloch v. Maryland, 4 Wheat. 316, 407, 415; Brown v.
Maryland, 12 Wheat. 419, 446; Craig v. Missouri, 4 Pet. 410, 433; Jarrolt v. Moberly, 103 U.S.
580, 585 , 587 S.; Legal Tender Case, 110 U.S. 421, 444 , 4 S. Sup. Ct. 122; Lithograph Co. v.
Sarony, 111 U.S. 53, 58 , 4 S. Sup. Ct. 279; United States v. Realty Co., 163 U.S. 427, 440 , 441
S., 442, 16 Sup. Ct. 1120; South Carolina v. United States, 199 U.S. 437, 448 , 449 S., 26 Sup.
Ct. 110, 4 Ann. Cas. 737. Is there anything in the phraseology of the Sixteenth Amendment or in
the nature of corporate dividends which should lead to a departure from these rules of
construction and compel this court to hold, that Congress is powerless to prevent a result so
extraordinary as that here contended for by the stockholder?

First. The term 'income,' when applied to the investment of the stockholder in a corporation, had,
before the adoption of the Sixteenth Amendment, been commonly understood to mean the
returns from time to time received by the stockholder from gains or earnings of the corporation.
A dividend received by a stockholder from a corporation may be either in distribution of capital
assets or in distribution of profits. Whether it is the one or the other is in no way affected by the
medium in which it is paid, nor by the method or means through which the particular thing
distributed as a dividend was procured. If the [252 U.S. 189, 227] dividend is declared payable in
cash, the money with which to pay it is ordinarily taken from surplus cash in the treasury. But (if
there are profits legally available for distribution and the law under which the company was
incorporated so permits) the company may raise the money by discounting negotiable paper; or
by selling bonds, scrip or stock of another corporation then in the treasury; or by selling its own
bonds, scrip or stock then in the treasury; or by selling its own bonds, scrip or stock issued
expressly for that purpose. How the money shall be raised is wholly a matter of financial
management. The manner in which it is raised in no way affects the question whether the
dividend received by the stockholder is income or capital; nor can it conceivably affect the
question whether it is taxable as income.

Likewise whether a dividend declared payable from profits shall be paid in cash or in some other
medium is also wholly a matter of financial management. If some other medium is decided upon,
it is also wholly a question of financial management whether the distribution shall be, for
instance, in bonds, scrip or stock of another corporation or in issues of its own. And if the
dividend is paid in its own issues, why should there be a difference in result dependent upon
whether the distribution was made from such securities then in the treasury or from others to be
created and issued by the company expressly for that purpose? So far as the distribution may be
made from its own issues of bonds, or preferred stock created expressly for the purpose, it clearly
would make no difference in the decision of the question whether the dividend was a distribution
of profits, that the securities had to be created expressly for the purpose of distribution. If a
dividend paid in securities of that nature represents a distribution of profits Congress may, of
course, tax it as income of the stockholder. Is the result different where the security distributed is
common stock? [252 U.S. 189, 228] Suppose that a corporation having power to buy and sell its
own stock, purchases, in the interval between its regular dividend dates, with moneys derived
from current profits, some of its own common stock as a temporary investment, intending at the
time of purchase to sell it before the next dividend date and to use the proceeds in paying
dividends, but later, deeming it inadvisable either to sell this stock or to raise by borrowing the
money necessary to pay the regular dividend in cash, declares a dividend payable in this stock;
can any one doubt that in such a case the dividend in common stock would be income of the
stockholder and constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547, 65 Atl.
1056, 8 L. R. A. (N. S.) 1011, 118 Am. St. Rep. 156, 9 Ann. Cas. 287; Leland v. Hayden, 102
Mass. 542. And would it not likewise be income of the stockholder subject to taxation if the
purpose of the company in buying the stock so distributed had been from the beginning to take it
off the market and distribute it among the stockholders as a dividend, and the company actually
did so? And proceeding a short step further: Suppose that a corporation decided to capitalize
some of its accumulated profits by creating additional common stock and selling the same to
raise working capital, but after the stock has been issued and certificates therefor are delivered to
the bankers for sale, general financial conditions make it undesirable to market the stock and the
company concludes that it is wiser to husband, for working capital, the cash which it had
intended to use in paying stockholders a dividend, and, instead, to pay the dividend in the
common stock which it had planned to sell; would not the stock so distributed be a distribution
of profits-and hence, when received, be income of the stockholder and taxable as such? If this be
conceded, why should it not be equally income of the stockholder, and taxable as such, if the
common stock created by capitalizing profits, had been originally created for the express purpose
of being distributed [252 U.S. 189, 229] as a dividend to the stockholder who afterwards received
it?

Second. It has been said that a dividend payable in bonds or preferred stock created for the
purpose of distributing profits may be income and taxable as such, but that the case is different
where the distribution is in common stock created for that purpose. Various reasons are assigned
for making this distinction. One is that the proportion of the stockholder's ownership to the
aggregate number of the shares of the company is not changed by the distribution. But that is
equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore, neither
maintenance nor change in the proportionate ownership of a stockholder in a corporation has any
bearing upon the question here involved. Another reason assigned is that the value of the old
stock held is reduced approximately by the value of the new stock received, so that the
stockholder after receipt of the stock dividend has no more than he had before it was paid. That is
equally true whether the dividend be paid in cash or in other property, for instance, bonds, scrip
or preferred stock of the company. The payment from profits of a large cash dividend, and even a
small one, customarily lowers the then market value of stock because the undivided property
represented by each share has been correspondingly reduced. The argument which appears to be
most strongly urged for the stockholders is, that when a stock dividend is made, no portion of the
assets of the company is thereby segregated for the stockholder. But does the issue of new bonds
or of preferred stock created for use as a dividend result in any segregation of assets for the
stockholder? In each case he receives a piece of paper which entitles him to certain rights in the
undivided property. Clearly segregation of assets in a physical sense is not an essential of
income. The year's gains of a partner is taxable as income, although there, likewise, no [252 U.S.
189, 230] segregation of his share in the gains from that of his partners is had.

The objection that there has been no segregation is presented also in another form. It is argued
that until there is a segregation, the stockholder cannot know whether he has really received
gains; since the gains may be invested in plant or merchandise or other property and perhaps be
later lost. But is not this equally true of the share of a partner in the year's profits of the firm or,
indeed, of the profits of the individual who is engaged in business alone? And is it not true, also,
when dividends are paid in cash? The gains of a business, whether conducted by an individual,
by a firm or by a corporation, are ordinarily reinvested in large part. Many a cash dividend
honestly declared as a distribution of profits, proves later to have been paid out of capital,
because errors in forecast prevent correct ascertainment of values. Until a business adventure has
been completely liquidated, it can never be determined with certainty whether there have been
profits unless the returns at least exceeded the capital originally invested. Business men, dealing
with the problem practically, fix necessarily periods and rules for determining whether there have
been net profits-that is, income or gains. They protect themselves from being seriously misled by
adopting a system of depreciation charges and reserves. Then, they act upon their own
determination, whether profits have been made. Congress in legislating has wisely adopted their
practices as its own rules of action.

Third. The Government urges that it would have been within the power of Congress to have
taxed as income of the stockholder his pro rata share of undistributed profits earned, even if no
stock dividend representing it had been paid. Strong reasons may be assigned for such a view.
See The Collector v. Hubbard, 12 Wall. 1. The undivided share of a partner in the year's
undistributed profits of his firm [252 U.S. 189, 231] is taxable as income of the partner, although
the share in the gain is not evidenced by any action taken by the firm. Why may not the
stockholder's interest in the gains of the company? The law finds no difficulty in disregarding the
corporate fiction whenever that is deemed necessary to attain a just result. Linn Timber Co. v.
United States, 236 U.S. 574 , 35 Sup. Ct. 440. See Morawetz on Corporations (2d Ed.) 227- 231;
Cook on Corporations (7th Ed.) 663, 664. The stockholder's interest in the property of the
corporation differs, not fundamentally but in form only, from the interest of a partner in the
property of the firm. There is much authority for the proposition that, under our law, a
partnership or joint stock company is just as distinct and palpable an entity in the idea of the law,
as distinguished from the individuals composing it, as is a corporations. 5 No reason appears,
why Congress, in legislating under a grant of power so comprehensive as that authorizing the
levy of an income tax, should be limited by the particular view of the relation of the stockholder
to the corporation and its property which may, in the absence of legislation, have been taken by
this court. But we have no occasion to decide the question whether Congress might have taxed to
the stockholder his undivided share of the corporation's earnings. For Congress has in this act
limited the income tax to that share of the stockholder in the earnings which is, in effect,
distributed by means of the stock dividend paid. In other words to render the stockholder taxable
there must be both earnings made and a dividend paid. Neither earnings without dividend-nor a
dividend without earnings-subjects the [252 U.S. 189, 232] stockholder to taxation under the
Revenue Act of 1916.

Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in
stock, is so complete that serious question of the taxability of stock dividends would probably
never have been made, if Congress had undertaken to tax only those dividends which represented
profits earned during the year in which the dividend was paid or in the year preceding. But this
court, construing liberally, not only the constitutional grant of power, but also the revenue act of
1913, held that Congress might tax, and had taxed, to the stockholder dividends received during
the year, although earned by the company long before; and even prior to the adoption of the
Sixteenth Amendment. Lynch v. Hornby, 247 U.S. 339 , 38 Sup. Ct. 543.6 That rule, if
indiscriminatingly applied to all stock dividends representing profits earned, might, in view of
corporate practice, have worked considerable hardship, and have raised serious questions. Many
corporations, without legally capitalizing any part of their profits, had assigned definitely some
part or all of the annual balances remaining after paying the usual cash dividends, to the uses to
which permanent capital is ordinarily applied. Some of the corporations doing this, transferred
such balances on their books to 'surplus' account-distinguishing between such permanent
'surplus' and the 'undivided profits' account. Other corporations, without this formality, had
assumed that the annual accumulating balances carried as undistributed profits were to be treated
as capital permanently invested in the business. And still others, without definite assumption of
any kind, had [252 U.S. 189, 233] so used undivided profits for capital purposes. To have made the
revenue law apply retroactively so as to reach such accumulated profits, if and whenever it
should be deemed desirable to capitalize them legally by the issue of additional stock distributed
as a dividend to stockholders, would have worked great injustice. Congress endeavored in the
Revenue Act of 1916 to guard against any serious hardship which might otherwise have arisen
from making taxable stock dividends representing accumulated profits. It did not limit the
taxability to stock dividends representing profits earned within the tax year or in the year
preceding; but it did limit taxability to such dividends representing profits earned since March 1,
1913. Thereby stockholders were given notice that their share also in undistributed profits
accumulating thereafter was at some time to be taxed as income. And Congress sought by section
3 (Comp. St. 1918, Comp. St. Ann. Supp. 1919, 6336c) to discourage the postponement of
distribution for the illegitimate purpose of evading liability to surtaxes.

Fifth. The decision of this court, that earnings made before the adoption of the Sixteenth
Amendment, but paid out in cash dividend after its adoption, were taxable as income of the
stockholder, involved a very liberal construction of the amendment. To hold now that earnings
both made and paid out after the adoption of the Sixteenth Amendment cannot be taxed as
income of the stockholder, if paid in the form of a stock dividend, involves an exceedingly
narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland, 12
Wheat. 419, 446 (6 L. Ed. 678):

'To construe the power so as to impair its efficacy, would tend to defeat an object, in the
attainment of which the American public took, and justly took, that strong interest which
arose from a full conviction of its necessity.'

No decision heretofore rendered by this court requires us to hold that Congress, in providing for
the taxation of [252 U.S. 189, 234] stock dividends, exceeded the power conferred upon it by the
Sixteenth Amendment. The two cases mainly relied upon to show that this was beyond the power
of Congress are Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158 L. R. A. 1918D, 254, which
involved a question not of constitutional power but of statutory construction, and Gibbons v.
Mahon, 136 U.S. 549 , 10 Sup. Ct. 1057, which involved a question arising between life tenant
and remainderman. So far as concerns Towne v. Eisner we have only to bear in mind what was
there said ( 245 U.S. 425 , 38 Sup. Ct. 159, L. R. A. 1918D, 254): 'But it is not necessarily true
that income means the same thing in the Constitution and the [an] act.' 7 Gibbons v. Mahon is
even less an authority for a narrow construction of the power to tax incomes conferred by the
Sixteenth Amendment. In that case the court was required to determine how, in the
administration of an estate in the District of Columbia, a stock dividend, representing profits,
received after the decedent's death, should be disposed of as between life tenant and
remainderman. The question was in essence: What shall the intention of the testator be presumed
to have been? On this question there was great diversity of opinion and practice in the courts of
English-speaking countries. Three well-defined rules were then competing for acceptance; two of
these involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on
Corporations ( 7th Ed.) 552-558.

1. The so-called English rule, declared in 1799, by Brander v. Brander, 4 Ves. Jr. 800, that a
dividend representing [252 U.S. 189, 235] profits, whether in cash, stock or other property, belongs
to the life tenant if it was a regular or ordinary dividend, and belongs to the remainderman if it
was an extraordinary dividend.

2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, 96 Am.
Dec. 705, that a dividend representing profits, whether regular, ordinary or extrordinary, if in
cash belongs to the life tenant, and if in stock belongs to the remainderman.
3. The so-called Pennsylvania rule declared in 1857 by Earp's Appeal, 28 Pa. 368, that where a
stock dividend is paid, the court shall inquire into the circumstances under which the fund had
been earned and accumulated out of which the dividend, whether a regular, an ordinary or an
extraordinary one, was paid. If it finds that the stock dividend was paid out of profits earned
since the decedent's death, the stock dividend belongs to the life tenant; if the court finds that the
stock dividend was paid from capital or from profits earned before the decedent's death, the stock
dividend belongs to the remainderman.

This court adopted in Gibbons v. Mahon as the rule of administration for the District of
Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice
Gray. Since then the same question has come up for decision in many of the states. The so-called
Massachusetts rule, although approved by this court, has found favor in only a few states. The
so-called Pennsylvania rule, on the other hand, has been adopted since by so many of the states
(including New York and California), that it has come to be known as the 'American rule.'
Whether, in view of these facts and the practical results of the operation of the two rules as
shown by the experience of the 30 years which have elapsed since the decision in Gibbons v.
Mahon, it might be desirable for this court to reconsider the question there decided, as [252 U.S.
189, 236] some other courts have done (see 29 Harvard Law Review, 551), we have no occasion
to consider in this case. For, as this court there pointed out ( 136 U.S. 560 , 1059 [34 L. Ed.
525]), the question involved was one 'between the owners of successive interests in particular
shares,' and not, as in Bailey v. Railroad Co., 22 Wall. 604, a question 'between the corporation
and the government, and [which] depended upon the terms of a statute carefully framed to
prevent corporations from evading payment of the tax upon their earnings.'

We have, however, not merely argument; we have examples which should convince us that 'there
is no inherent, necessary and immutable reason why stock dividends should always be treated as
capital.' Tax Commissioner v. Putnam, 227 Mass. 522, 533, 116 N. E. 904, L. R. A. 1917F. 806.
The Supreme Judical Court of Massachusetts has steadfastly adhered, despite ever-renewed
protest, to the rule that every stock dividend is, as between life tenant and remainderman, capital
and not income. But in construing the Massachusetts Income Tax Amendment, which is
substantially identical with the federal amendment, that court held that the Legislature was
thereby empowered to levy an income tax upon stock dividends representing profits. The courts
of England have, with some relaxation, adhered to their rule that every extraordinary dividend is,
as between life tenant and remainderman, to be deemed capital. But in 1913 the Judicial
Committee of the Privy Council held that a stock dividend representing accumulated profits was
taxable like an ordinary cash dividend, Swan Brewery Company, Limited v. The King, L. R.
1914 A. C. 231. In dismissing the appeal these words of the Chief Justice of the Supreme Court
of Western Australia were quoted (page 236) which show that the facts involved were identical
with those in the case at bar:

'Had the company distributed the �101,450 among the shareholders and had the
shareholders repaid such sums to the company as the price of the 81,160 new SHARES,
THE DUTY ON THE �101,450 [252 U.S. 189, 237] WOULD CLEARLY HAVE BEEN
PAYable. is not this virtually the effect of what was actually done? I think it is.'
Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth
Amendment, the owners of the most successful businesses in America will, as the facts in this
case illustrate, be able to escape taxation on a large part of what is actually their income. So far
as their profits are represented by stock received as dividends they will pay these taxes not upon
their income but only upon the income of their income. That such a result was intended by the
people of the United States when adopting the Sixteenth Amendment is inconceivable. Our sole
duty is to ascertain their intent as therein expressed. 8 In terse, comprehensive language befitting
the Constitution, they empowered Congress 'to lay and collect taxes on incomes from whatever
source derived.' They intended to include thereby everything which by reasonable understanding
can fairly be regarded as income. That stock dividends representing profits are so regarded, not
only by the plain people, but by investors and financiers, and by most of the courts of the
country, is shown, beyond peradventure, by their acts and by their utterances. It seems to me
clear, therefore, that Congress possesses the power which it exercised to make dividends
representing profits, taxable as income, whether the medium in which the dividend is paid be
cash or stock, and that it may define, as it has done, what dividends representing [252 U.S. 189, 238]
profits shall be deemed income. It surely is not clear that the enactment exceeds the power
granted by the Sixteenth Amendment. And, as this court has so often said, the high prerogative of
declaring an act of Congress invalid, should never be exercised except in a clear case. 9

'It is but a decent respect due to the wisdom, the integrity and the patriotism of the
legislative body, by which any law is passed, to presume in favor of its validity, until its
violation of the Constitution is proved beyond all reasonable doubt.' Ogden v. Saunders,
12 Wheat. 213, 269.

Mr. Justice CLARKE concurs in this opinion.

G.R. No. L-17518 October 30, 1922

FREDERICK C. FISHER, plaintiff-appellant,

vs.
WENCESLAO TRINIDAD, Collector of Internal Revenue, defendant-appellee.

Fisher and De Witt and Antonio M. Opisso for appellants.

Acting Attorney-General Tuason for appellee.

JOHNSON, J.:

The only question presented by this appeal is: Are the "stock dividends" in the present case
"income" and taxable as such under the provisions of section 25 of Act No. 2833? While the
appellant presents other important questions, under the view which we have taken of the facts
and the law applicable to the present case, we deem it unnecessary to discuss them now.

The defendant demurred to the petition in the lower court. The facts are therefore admitted.
They are simple and may be stated as follows:
 That during the year 1919 the Philippine American Drug Company was a corporation duly
organized and existing under the laws of the Philippine Islands, doing business in the City of
Manila; that he appellant was a stockholder in said corporation; that said corporation, as result of
the business for that year, declared a "stock dividend"; that the proportionate share of said stock
divided of the appellant was P24,800; that the stock dividend for that amount was issued to the
appellant; that thereafter, in the month of March, 1920, the appellant, upon demand of the
appellee, paid under protest, and voluntarily, unto the appellee the sum of P889.91 as income tax
on said stock dividend. For the recovery of that sum (P889.91) the present action was instituted.
The defendant demurred to the petition upon the ground that it did not state facts sufficient to
constitute cause of action. The demurrer was sustained and the plaintiff appealed.

To sustain his appeal the appellant cites and relies on some decisions of the Supreme Court
of the United States as will as the decisions of the supreme court of some of the states of the
Union, in which the questions before us, based upon similar statutes, was discussed. Among the
most important decisions may be mentioned the following: Towne vs. Eisner, 245 U.S., 418;
Doyle vs. Mitchell Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S., 189; Dekoven vs
Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. Charlottesville Woolen Mills, 93 Va., 673.

In each of said cases an effort was made to collect an "income tax" upon "stock dividends"
and in each case it was held that "stock dividends" were capital and not an "income" and
therefore not subject to the "income tax" law.

The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U.S.,
189) that a "stock dividend" is not "income" but argues that said Act No. 2833, in imposing the
tax on the stock dividend, does not violate the provisions of the Jones Law. The appellee further
argues that the statute of the United States providing for tax upon stock dividends is different
from the statute of the Philippine Islands, and therefore the decision of the Supreme Court of the
United States should not be followed in interpreting the statute in force here.

For the purpose of ascertaining the difference in the said statutes ( (United States and
Philippine Islands), providing for an income tax in the United States as well as that in the
Philippine Islands, the two statutes are here quoted for the purpose of determining the difference,
if any, in the language of the two statutes.

Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the
collection of an "income tax." Section 2 of said Act attempts to define what is an income. The
definition follows:

That the term "dividends" as used in this title shall be held to mean any distribution
made or ordered to made by a corporation, . . . which stock dividend shall be considered
income, to the amount of its cash value.

Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax." Section
25 of said Act attempts to define the application of the income tax. The definition follows:
 The term "dividends" as used in this Law shall be held to mean any distribution
made or ordered to be made by a corporation, . . . out of its earnings or profits accrued
since March first, nineteen hundred and thirteen, and payable to its shareholders, whether
in cash or in stock of the corporation, . . . . Stock dividend shall be considered income, to
the amount of the earnings or profits distributed.

It will be noted from a reading of the provisions of the two laws above quoted that the
writer of the law of the Philippine Islands must have had before him the statute of the United
States. No important argument can be based upon the slight different in the wording of the two
sections.

It is further argued by the appellee that there are no constitutional limitations upon the
power of the Philippine Legislature such as exist in the United States, and in support of that
contention, he cites a number of decisions. There is no question that the Philippine Legislature
may provide for the payment of an income tax, but it cannot, under the guise of an income tax,
collect a tax on property which is not an "income." The Philippine Legislature can not impose a
tax upon "property" under a law which provides for a tax upon "income" only. The Philippine
Legislature has no power to provide a tax upon "automobiles" only, and under that law collect a
tax upon a carreton or bull cart. Constitutional limitations, that is to say, a statute expressly
adopted for one purpose cannot, without amendment, be applied to another purpose which is
entirely distinct and different. A statute providing for an income tax cannot be construed to cover
property which is not, in fact income. The Legislature cannot, by a statutory declaration, change
the real nature of a tax which it imposes. A law which imposes an important tax on rice only
cannot be construed to an impose an importation tax on corn.

It is true that the statute in question provides for an income tax and contains a further
provision that "stock dividends" shall be considered income and are therefore subject to income
tax provided for in said law. If "stock dividends" are not "income" then the law permits a tax
upon something not within the purpose and intent of the law.

It becomes necessary in this connection to ascertain what is an "income in order that we

may be able to determine whether "stock dividends" are "income" in the sense that the word is
used in the statute. Perhaps it would be more logical to determine first what are "stock dividends"
in order that we may more clearly understand their relation to "income." Generally speaking,
stock dividends represent undistributed increase in the capital of corporations or firms, joint
stock companies, etc., etc., for a particular period. They are used to show the increased interest or
proportional shares in the capital of each stockholder. In other words, the inventory of the
property of the corporation, etc., for particular period shows an increase in its capital, so that the
stock theretofore issued does not show the real value of the stockholder's interest, and additional
stock is issued showing the increase in the actual capital, or property, or assets of the
corporation, etc.

To illustrate: A and B form a corporation with an authorized capital of P10,000 for the
purpose of opening and conducting a drug store, with assets of the value of P2,000, and each
contributes P1,000. Their entire assets are invested in drugs and put upon the shelves in their
place of business. They commence business without a cent in the treasury. Every dollar
contributed is invested. Shares of stock to the amount of P1,000 are issued to each of the
incorporators, which represent the actual investment and entire assets of the corporation.
Business for the first year is good. Merchandise is sold, and purchased, to meet the demands of
the growing trade. At the end of the first year an inventory of the assets of the corporation is
made, and it is then ascertained that the assets or capital of the corporation on hand amount to
P4,000, with no debts, and still not a cent in the treasury. All of the receipts during the year have
been reinvested in the business. Neither of the stockholders have withdrawn a penny from the
business during the year. Every peso received for the sale of merchandise was immediately used
in the purchase of new stock — new supplies. At the close of the year there is not a centavo in
the treasury, with which either A or B could buy a cup of coffee or a pair of shoes for his family.
At the beginning of the year they were P2,000, and at the end of the year they were P4,000, and
neither of the stockholders have received a centavo from the business during the year. At the
close of the year, when it is discovered that the assets are P4,000 and not P2,000, instead of
selling the extra merchandise on hand and thereby reducing the business to its original capital,
they agree among themselves to increase the capital they agree among themselves to increase the
capital issued and for that purpose issue additional stock in the form of "stock dividends" or
additional stock of P1,000 each, which represents the actual increase of the shares of interest in
the business. At the beginning of the year each stockholder held one-half interest in the capital.
At the close of the year, and after the issue of the said stock dividends, they each still have one-
half interest in the business. The capital of the corporation increased during the year, but has
either of them received an income? It is not denied, for the purpose of ordinary taxation, that the
taxable property of the corporation at the beginning of the year was P2,000, that at the close of
the year it was P4,000, and that the tax rolls should be changed in accordance with the changed
conditions in the business. In other words, the ordinary tax should be increased by P2,000.

Another illustration: C and D organized a corporation for agricultural purposes with an

authorized capital stock of P20,000 each contributing P5,000. With that capital they purchased a
farm and, with it, one hundred head of cattle. Every peso contributed is invested. There is no
money in the treasury. Much time and labor was expanded during the year by the stockholders on
the farm in the way of improvements. Neither received a centavo during the year from the farm
or the cattle. At the beginning of the year the assets of the corporation, including the farm and the
cattle, were P10,000, and at the close of the year and inventory of the property of the corporation
is made and it is then found that they have the same farm with its improvements and two hundred
head of cattle by natural increase. At the end of the year it is also discovered that, by reason of
business changes, the farm and the cattle both have increased in value, and that the value of the
corporate property is now P20,000 instead of P10,000 as it was at the beginning of the year. The
incorporators instead of reducing the property to its original capital, by selling off a part of its,
issue to themselves "stock dividends" to represent the proportional value or interest of each of
the stockholders in the increased capital at the close of the year. There is still not a centavo in the
treasury and neither has withdrawn a peso from the business during the year. No part of the farm
or cattle has been sold and not a single peso was received out of the rents or profits of the capital
of the corporation by the stockholders.

Another illustration: A, an individual farmer, buys a farm with one hundred head of cattle
for the sum of P10,000. At the end of the first year, by reason of business conditions and the
increase of the value of both real estate and personal property, it is discovered that the value of
the farm and the cattle is P20,000. A, during the year, has received nothing from the farm or the
cattle. His books at the beginning of the year show that he had property of the value of P10,000.
His books at the close of the year show that he has property of the value of P20,000. A is not a
corporation. The assets of his business are not shown therefore by certificates of stock. His
books, however, show that the value of his property has increased during the year by P10,000,
under any theory of business or law, be regarded as an "income" upon which the farmer can be
required to pay an income tax? Is there any difference in law in the condition of A in this
illustration and the condition of A and B in the immediately preceding illustration? Can the
increase of the value of the property in either case be regarded as an "income" and be subjected
to the payment of the income tax under the law?

Each of the foregoing illustrations, it is asserted, is analogous to the case before us and, in
view of that fact, let us ascertain how lexicographers and the courts have defined an "income."
The New Standard Dictionary, edition of 1915, defines an income as "the amount of money
coming to a person or corporation within a specified time whether as payment or corporation
within a specified time whether as payment for services, interest, or profit from investment."
Webster's International Dictionary defines an income as "the receipt, salary; especially, the
annual receipts of a private person or a corporation from property." Bouvier, in his law
dictionary, says that an "income" in the federal constitution and income tax act, is used in its
common or ordinary meaning and not in its technical, or economic sense. (146 Northwestern
Reporter, 812) Mr. Black, in his law dictionary, says "An income is the return in money from
one's business, labor, or capital invested; gains, profit or private revenue." "An income tax is a
tax on the yearly profits arising from property , professions, trades, and offices."

The Supreme Court of the United States, in the case o Gray vs. Darlington (82 U.S., 653),
said in speaking of income that mere advance in value in no sense constitutes the "income"
specified in the revenue law as "income" of the owner for the year in which the sale of the
property was made. Such advance constitutes and can be treated merely as an increase of capital.
(In re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 Pa., 414.)

Mr. Justice Hughes, later Associate Justice of the Supreme Court of the United States and
now Secretary of State of the United States, in his argument before the Supreme Court of the
United States in the case of Towne vs. Eisner, supra, defined an "income" in an income tax law,
unless it is otherwise specified, to mean cash or its equivalent. It does not mean choses in action
or unrealized increments in the value of the property, and cites in support of the definition, the
definition given by the Supreme Court in the case of Gray vs. Darlington, supra.

In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for the court, said:
"Notwithstanding the thoughtful discussion that the case received below, we cannot doubt that
the dividend was capital as well for the purposes of the Income Tax Law. . . . 'A stock dividend
really takes nothing from the property of the corporation, and adds nothing to the interests of the
shareholders. Its property is not diminished and their interest are not increased. . . . The
proportional interest of each shareholder remains the same. . . .' In short, the corporation is no
poorer and the stockholder is no richer then they were before." (Gibbons vs. Mahon, 136 U.S.,
549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).
 In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice Pitney, speaking for
the court, said that the act employs the term "income" in its natural and obvious sense, as
importing something distinct from principal or capital and conveying the idea of gain or increase
arising from corporate activity.

Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speaking for
the court said: "An income may be defined as the gain derived from capital, from labor, or from
both combined, provided it be understood to include profit gained through a sale or conversion of
capital assets."

For bookkeeping purposes, when stock dividends are declared, the corporation or company
acknowledges a liability, in form, to the stockholders, equivalent to the aggregate par value of
their stock, evidenced by a "capital stock account." If profits have been made by the corporation
during a particular period and not divided, they create additional bookkeeping liabilities under
the head of "profit and loss," "undivided profits," "surplus account," etc., or the like. None of
these, however, gives to the stockholders as a body, much less to any one of them, either a claim
against the going concern or corporation, for any particular sum of money, or a right to any
particular portion of the asset, or any shares sells or until the directors conclude that dividends
shall be made a part of the company's assets segregated from the common fund for that purpose.
The dividend normally is payable in money and when so paid, then only does the stockholder
realize a profit or gain, which becomes his separate property, and thus derive an income from the
capital that he has invested. Until that, is done the increased assets belong to the corporation and
not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's
accumulated profits have been capitalized, instead of distributed to the stockholders or retained
as surplus available for distribution, in money or in kind, should opportunity offer. Far from
being a realization of profits of the stockholder, it tends rather to postpone said realization, in
that the fund represented by the new stock has been transferred from surplus to assets, and no
longer is available for actual distribution. The essential and controlling fact is that the
stockholder has received nothing out of the company's assets for his separate use and benefit; on
the contrary, every dollar of his original investment, together with whatever accretions and
accumulations resulting from employment of his money and that of the other stockholders in the
business of the company, still remains the property of the company, and subject to business risks
which may result in wiping out of the entire investment. Having regard to the very truth of the
matter, to substance and not to form, the stockholder by virtue of the stock dividend has in fact
received nothing that answers the definition of an "income." (Eisner vs. Macomber, 252 U.S.,
189, 209, 211.)

The stockholder who receives a stock dividend has received nothing but a representation of
his increased interest in the capital of the corporation. There has been no separation or
segregation of his interest. All the property or capital of the corporation still belongs to the
corporation. There has been no separation of the interest of the stockholder from the general
capital of the corporation. The stockholder, by virtue of the stock dividend, has no separate or
individual control over the interest represented thereby, further than he had before the stock
dividend was issued. He cannot use it for the reason that it is still the property of the corporation
and not the property of the individual holder of stock dividend. A certificate of stock represented
by the stock dividend is simply a statement of his proportional interest or participation in the
capital of the corporation. For bookkeeping purposes, a corporation, by issuing stock dividend,
acknowledges a liability in form to the stockholders, evidenced by a capital stock account. The
receipt of a stock dividend in no way increases the money received of a stockholder nor his cash
account at the close of the year. It simply shows that there has been an increase in the amount of
the capital of the corporation during the particular period, which may be due to an increased
business or to a natural increase of the value of the capital due to business, economic, or other
reasons. We believe that the Legislature, when it provided for an "income tax," intended to tax
only the "income" of corporations, firms or individuals, as that term is generally used in its
common acceptation; that is that the income means money received, coming to a person or
corporation for services, interest, or profit from investments. We do not believe that the
Legislature intended that a mere increase in the value of the capital or assets of a corporation,
firm, or individual, should be taxed as "income." Such property can be reached under the
ordinary from of taxation.

Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in discussing the
difference between "capital" and "income": "That the fundamental relation of 'capital' to 'income'
has been much discussed by economists, the former being likened to the tree or the land, the
latter to the fruit or the crop; the former depicted as a reservoir supplied from springs; the latter
as the outlet stream, to be measured by its flow during a period of time." It may be argued that a
stockholder might sell the stock dividend which he had acquired. If he does, then he has
received, in fact, an income and such income, like any other profit which he realizes from the
business, is an income and he may be taxed thereon.

There is a clear distinction between an extraordinary cash dividend, no matter when

earned, and stock dividends declared, as in the present case. The one is a disbursement to the
stockholder of accumulated earnings, and the corporation at once parts irrevocably with all
interest thereon. The other involves no disbursement by the corporation. It parts with nothing to
the stockholder. The latter receives, not an actual dividend, but certificate of stock which simply
evidences his interest in the entire capital, including such as by investment of accumulated
profits has been added to the original capital. They are not income to him, but represent additions
to the source of his income, namely, his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63
L.R.A. 587). Such a person is in the same position, so far as his income is concerned, as the
owner of young domestic animal, one year old at the beginning of the year, which is worth P50
and, which, at the end of the year, and by reason of its growth, is worth P100. The value of his
property has increased, but has had an income during the year? It is true that he had taxable
property at the beginning of the year of the value of P50, and the same taxable property at
another period, of the value of P100, but he has had no income in the common acceptation of that
word. The increase in the value of the property should be taken account of on the tax duplicate
for the purposes of ordinary taxation, but not as income for he has had none.

The question whether stock dividends are income, or capital, or assets has frequently come
before the courts in another form — in cases of inheritance. A is a stockholder in a large
corporation. He dies leaving a will by the terms of which he give to B during his lifetime the
"income" from said stock, with a further provision that C shall, at B's death, become the owner of
his share in the corporation. During B's life the corporation issues a stock dividend. Does the
stock dividend belong to B as an income, or does it finally belong to C as a part of his share in
the capital or assets of the corporation, which had been left to him as a remainder by A? While
there has been some difference of opinion on that question, we believe that a great weight of
authorities hold that the stock dividend is capital or assets belonging to C and not an income
belonging to B. In the case of D'Ooge vs. Leeds (176 Mass., 558, 560) it was held that stock
dividends in such cases were regarded as capital and not as income (Gibbons vs. Mahon, 136
U.S., 549.)

In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The distinction between
the title of a corporation, and the interest of its members or stockholders in the property of the
corporation, is familiar and well settled. The ownership of that property is in the corporation, and
not in the holders of shares of its stock. The interest of each stockholder consists in the right to a
proportionate part of the profits whenever dividends are declared by the corporation, during its
existence, under its charter, and to a like proportion of the property remaining, upon the
termination or dissolution of the corporation, after payment of its debts." (Minot vs. Paine, 99
Mass., 101; Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.) In the case of Dekoven
vs. Alsop (205 Ill ,309, 63 L. R. A. 587) Mr. Justice Wilkin said: "A dividend is defined as a
corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on
demand or at a fixed time. Until the dividend is declared, these corporate profits belong to the
corporation, not to the stockholders, and are liable for corporate indebtedness.

There is a clear distinction between an extraordinary cash dividend, no matter when

earned, and stock dividends declared. The one is a disbursement to the stockholders of
accumulated earning, and the corporation at once parts irrevocably with all interest thereon. The
other involves no disbursement by the corporation. It parts with nothing to the stockholders. The
latter receives, not an actual dividend, but certificates of stock which evidence in a new
proportion his interest in the entire capital. When a cash becomes the absolute property of the
stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A
stock dividend however, still being the property of the corporation and not the stockholder, it
may be reached by an execution against the corporation, and sold as a part of the property of the
corporation. In such a case, if all the property of the corporation is sold, then the stockholder
certainly could not be charged with having received an income by virtue of the issuance of the
stock dividend. Until the dividend is declared and paid, the corporate profits still belong to the
corporation, not to the stockholders, and are liable for corporate indebtedness. The rule is well
established that cash dividend, whether large or small, are regarded as "income" and all stock
dividends, as capital or assets (Cook on Corporation, Chapter 32, secs. 534, 536; Davis vs.
Jackson, 152 Mass., 58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of Law, 2d ed.,
p. 738.)

If the ownership of the property represented by a stock dividend is still in the corporation
and to in the holder of such stock, then it is difficult to understand how it can be regarded as
income to the stockholder and not as a part of the capital or assets of the corporation. (Gibbsons
vs. Mahon, supra.) the stockholder has received nothing but a representation of an interest in the
property of the corporation and, as a matter of fact, he may never receive anything, depending
upon the final outcome of the business of the corporation. The entire assets of the corporation
may be consumed by mismanagement, or eaten up by debts and obligations, in which case the
holder of the stock dividend will never have received an income from his investment in the
corporation. A corporation may be solvent and prosperous today and issue stock dividends in
representation of its increased assets, and tomorrow be absolutely insolvent by reason of changes
in business conditions, and in such a case the stockholder would have received nothing from his
investment. In such a case, if the holder of the stock dividend is required to pay an income tax on
the same, the result would be that he has paid a tax upon an income which he never received.
Such a conclusion is absolutely contradictory to the idea of an income. An income subject to
taxation under the law must be an actual income and not a promised or prospective income.

The appelle argues that there is nothing in section 25 of Act No 2833 which contravenes
the provisions of the Jones Law. That may be admitted. He further argues that the Act of
Congress (U.S. Revenue Act of 1918) expressly authorized the Philippine Legislatures to provide
for an income tax. That fact may also be admitted. But a careful reading of that Act will show
that, while it permitted a tax upon income, the same provided that income shall include gains,
profits, and income derived from salaries, wages, or compensation for personal services, as well
as from interest, rent, dividends, securities, etc. The appellee emphasizes the "income from
dividends." Of course, income received as dividends is taxable as an income but an income from
"dividends" is a very different thing from receipt of a "stock dividend." One is an actual receipt
of profits; the other is a receipt of a representation of the increased value of the assets of
corporation.

In all of the foregoing argument we have not overlooked the decisions of a few of the
courts in different parts of the world, which have reached a different conclusion from the one
which we have arrived at in the present case. Inasmuch, however, as appeals may be taken from
this court to the Supreme Court of the United States, we feel bound to follow the same doctrine
announced by that court.

Having reached the conclusion, supported by the great weight of the authority, that "stock
dividends" are not "income," the same cannot be taxes under that provision of Act No. 2833
which provides for a tax upon income. Under the guise of an income tax, property which is not
an income cannot be taxed. When the assets of a corporation have increased so as to justify the
issuance of a stock dividend, the increase of the assets should be taken account of the
Government in the ordinary tax duplicates for the purposes of assessment and collection of an
additional tax. For all of the foregoing reasons, we are of the opinion, and so decide, that the
judgment of the lower court should be revoked, and without any finding as to costs, it is so
ordered.

Araullo, C.J. Avanceña, Villamor and Romualdez, JJ., concur.

Separate Opinions

STREET, J., concurring:

I agree that the trial court erred in sustaining the demurrer, and the judgment must be
reversed. Instead of demurring the defendant should have answered and alleged, if such be the
case, that the stock dividend which was the subject of taxation represents the amount of earnings
or profits distributed by means of the issuance of said stock dividend; and the case should have
been tried on that question of fact.

In this connection it will be noted that section 25 (a) of Act No. 2833, of the Philippine
Legislature, under which this tax was imposed, does not levy a tax generally on stock dividends
to the extend of the part of the stock nor even to the extend of its value, but declares that stock
dividends shall be considered as income to the amount of the earnings or profits distributed.
Under provision, before the tax can be lawfully assessed and collected, it must appear that he
stock dividend represents earning or profits distributed; and the burden of proof is on the
Collector of Internal Revenue to show this.

The case of Eisner vs. Macomber (252 U.S., 189; 64 L. ed., 521), has been cited as
authority for the proposition that it is incompetent for the Legislature to tax as income any
property which by nature is really capital — as a stock dividend is there said to be. In that case
the Supreme Court of the United States held that a Congressional Act taxing stock dividends as
income was repugnant to that provision of the Constitution of the United States which required
that direct taxes upon property shall be apportioned for collection among the several states
according to population and that the Sixteenth Amendment, in authorizing the imposition by
Congress of taxes upon income, had not vested Congress with the power to levy direct taxes, on
property under the guise of income taxes. But the resolution embodied in that decision was
evidently reached because of the necessity of harmonizing two different provisions of the
Constitution of the United States, as amended. In this jurisdiction our Legislature has full
authority to levy both taxes on property and income taxes; and there is no organic provision here
in force similar to that which, under the Constitution of the United States, requires direct taxes on
property to be levied in a particular way.

It results, under the statute here in force, there being no constitutional restriction upon the
action of the law making body, that the case before us presents merely a question of statutory
construction. That the problem should be viewed in this light, in a case where there is no
restriction upon the legislative body, is pointed our in Eisner vs. Macomber, supra, where in the
course of his opinion Mr. Justice Pitney refers to the cases of the Swan Brewery Co. vs. Rex
([1914] A. C. 231), and Tax Commissioner vs. Putnam (227 Mass., 522), as being distinguished
from Eisner vs. Macomber by the very circumstance that in those cases the law making body, or
bodies were under no restriction as to the method of levying taxes. Such is the situation here.

OSTRAND, J., dissenting:

In its final analysis the opinion of the court rests principally, if not entirely on the decision
of the United States Supreme Court in the case of Eisner vs. Macomber (252 U.S., 189), a
decision which, for at least two reasons, is entirely inapplicable to the present case.

In the first place, there is a radical difference between the definition of a taxable stock
dividend given in the United States Income Tax Law of September 8, 1916, construed in the case
of Eisner vs. Macomber, and that given in Act No. 2833 of the Philippine Legislature, the Act
with which we are concerned in the present case. The former provides that "stock dividend shall
be considered income, to the amount of its cash value;" the Philippine Act provides that "Stock
dividend shall be considered income, to the amount of the earnings or profits distributed." The
United State statute made stock dividends based upon an advance in the value of the property or
investment taxable as income whether resulting from earning or not; our statute make stock
dividends taxable only to the amount of the earning and profits distributed, and stock dividends
based on the increment income and are not taxable. Though the difference would seem
sufficiently obvious, we will endeavor to make it still clearer by borrowing one of the
illustrations with which the opinion of the court is provided. The court says:

A, an individual farmer, buys a farm with one hundred head of cattle for the sum of
P10,000. At the end of the first year, by reason of business conditions and the increase of
the value of both real estate and personal property, it is discovered that the value of the
farm and the cattle is P20,000. A, during the year has received nothing from the farm or
the cattle. His books at the beginning of the year show that he had property of the value
of P10,000. His books at the close of the year show that he has property of the value of
P20,000. A is not a corporation. The assets of his business are not shown therefore by
certificate of stock. His books, however, show that the value of his property has increased
during the year by P10,000. Can the P10,000, under any theory of business or law, be
regarded as an "income" upon which the farmer can be required to pay an income tax? Is
there any difference in law in the conditions of A in this illustration and the conditions of
A and B in the immediately preceding illustration? Can the increase of the value of the
property in either case be regarded as an 'income' and be subjected to the payment of the
income tax under the law?

I answer no. And while the increment if in the form of a stock dividend would have been
regarded as income under the United States statute and taxes as such, it is not regarded as income
and cannot be so taxes under our statute because it is not based on earnings or profits. That is
precisely the difference between the two statutes and that is the reason the illustration is not in
point in this case, though it would have been entirely appropriate in the Eisner vs. Macomber
case. It is also one of the reasons why that case is inapplicable here and why most of the
arguments in the majority opinion are beside the mark.

But let us suppose that A had sold the products of the farm during the year for P10,000
over and above his expense, and had invested the money in buildings and improvements on the
farm, thus increasing its value to P20,000. Why would not the P10,000 earned during the year
and so invested in improvements still be income for the year? And why would not a tax on these
earnings be an income tax under the definition given in Black's Law Dictionary, and quoted with
approval in the decision of the court, that "An income tax is a tax on the yearly profits arising
from the property, professions, trades, and offices?" There can be but one answer. There is no
reason whatever why the gains derived from the sale of the products of the farm should not be
regarded as income whether reinvested in improvements upon the farm or not and there is no
reason way a tax levied thereon cannot be considered an income tax.

Moreover, to constitute income, profits, or earnings need not necessarily be converted into
cash. Black's Law Dictionary says — and I am again quoting from the decision of the court —
"An income is the return in money from one's business, labor, or capital invested; gains profits,
or private revenue." As will be seen in the secondary sense of the word, income need not consist
in money; upon this point there is no divergence of view among the lexicographers. If a farmer
stores the gain produced upon his farm without selling, it may none the less be regarded as
income.

In the Eisner vs. Macomber case, the United States supreme Court felt bound to give the
word "income" a strict interpretation. Under article 1, paragraph 2, clause 3, and paragraph 9,
clause 4 of the original Constitution of the United States, Congress could not impose direct taxes
without apportioning them among the States according to population. As it was thought desirable
to impose Federal taxes upon incomes and as a levy of such taxes by appointment among the
States in proportion to population would lead to an unequal distribution of the tax with reference
to the amount of taxable incomes, the Sixteenth Amendment was adopted and which provided
that "The Congress shall have power to lay and collect taxes on incomes, from whatever source
derived, without apportionment among the several states, and without regard to any census or
enumeration."

The United States Supreme Court therefore says in the Eisner vs. Macomber case:

A proper regard for its generis, as well as its very clear language, requires also that
this Amendment shall not be extended by loose construction, so as to repeal or modify,
except as applied to income, those provisions of the Constitution that require an
apportionment according to population for direct taxes upon property, real and personal.
This limitation still has an appropriate and important functions, and is not to be
overridden by Congress or disregarded by the courts.

In order, therefore, that the clauses cited from Article I of the constitution may have
proper force and effect, save only as modified by the Amendment, and that the latter also
may have proper effect, it becomes essential to distinguish between what is and what is
not "income," as the term is there used; and to apply the distinction as cases arise,
according to truth and substance, without regard to form. Congress cannot by any
definition it may adopt conclude the matter, since it cannot by legislation alter the
Constitution, from which alone it derives its power to legislate, and within whose
limitations alone that power can be lawfully exercised.

That, in the absence of the peculiar restrictions placed by the Constitution upon taxing
power of Congress, the decision of the court might have been different is clearly indicated by the
following language:

Two recent decisions, proceeding from courts of high jurisdiction, are cited in
support of the position of the Government.

Sean Brewery Co. vs. Rex ([1914] A. C., 231), arose under the Dividend Duties
Act of Western Australia, which provided that "dividend" should include "every dividend,
profit, advantage, or gain intended to be paid or credited to or distributed among any
members or director of any company," except etc. There was a stock dividend, the new
shares being alloted among the shareholders pro rata; and the question was whether this
 was a distribution of a dividend within the meaning of the act. The Judicial Committee of
the Privy Council sustained the dividend duty upon the ground that, although "in ordinary
language the new shares would not be distribution of a dividend," yet within the meaning
of the act, such new share were an "advantage" to the recipients. There being no
constitutional restriction upon the action of the lawmaking body, the case presented
merely a question of statutory construction, and manifestly the decision is not a
precedent for the guidance of this court when acting under a duty to test an act of
Congress by the limitations of a written Constitution having superior force.

In Tax Commissioner vs. Putnam (1917], 227 Mass., 522), it was held that the 44th
Amendment to the constitution of Massachusetts, which conferred upon the legislature
full power to tax incomes, "must be interpreted as including every item which by any
reasonable understanding can fairly be regarded as income" (pp. 526, 531); and that
under it a stock dividend was taxable as income. . . . Evidently, in order to give a
sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the
symbol for the substance, accumulation for distribution, capital accretion for its opposite;
while a case where money is paid into the hand of the stockholder with an option to buy
new shares with it, followed by acceptance of the option, was regarded as identical in
substance with a case where the stockholder receives no money and has no option. The
Massachusetts court was not under an obligation, like the one which binds us, of
applying a constitutional provisions that stand in the way of extending it by construction.

The Philippine Legislature has full power to levy taxes both on capital or property and on
income, subject only to the provisions of the Organic Act that "the rule of taxation shall be
uniform." In providing for the income tax the Legislature is therefore entirely free to employ the
term "income" in its widest sense and is in nowise limited or hampered by organic limitations
such as those imposed upon Congress by the Constitution of the United States. This is the second
reason why the rule laid down in Eisner vs. Macomber has no application here.

The majority opinion in discussing this question, says:

There is no question that the Philippine Legislature may provide for the payment of
an income tax, but it cannot, under the guise of an income tax, collect a tax on property
which is not an "income." The Philippine Legislature cannot impose a tax upon "income"
only . The Philippine Legislature has no power to provide a tax upon "automobiles," only,
and under that law collect a tax upon a carreton or bull cart. Constitutional limitations
upon the power of the Legislature are not stronger than statutory limitations, that is to
say, a statute expressly adopted for one purpose cannot, without amendment, be applied
to another purpose which is entirely distinct and different. A statute providing for an
income tax cannot be construed to cover property which is not, in fact, income. The
Legislature cannot, by a statutory declaration, change the real of a nature of a tax which it
imposes. A law which imposes an importation tax on rice only cannot be construed to
impose an importation tax on corn.

These assertions while in the main true are, perhaps, a little to broadly stated; much will
depend on the circumstances of each particular case. If the Legislature cannot do the things
enumerate it must be by reason of the limitation imposed by the Organic Act, "That no bill which
may be enacted into law shall embrace more than on subject, and that subject shall be expressed
in the title of the bill." Similar provisions are contained in most State Constitutions, their object
being to prevent "log-rolling" and the passing of undesirable measures without their being
brought properly to the attention of the legislators. Where the prevention of this mischief is not
involved, the courts have uniformly given such provisions a very liberal construction and there
are few, if any, cases where a statute has been declared unconstitutional for dealing with several
cognate subjects in the same Act and under the same title. (Lewis Sutherland on Statutory
Construction, 2d ed., pars 109 et seq.: Government of the Philippine Island vs. Municipality of
Binalonan and Roman Catholic Bishop of Nueva Segovia, 32, Phil., 634). Certainly no income
tax statute would be declared unconstitutional on that ground for treating dividends as income
and providing for their taxation as such.

Reverting to the question of the nature of income, it is argued that a stock certificate has no
intrinsic value and that, therefore, even it is based on earnings instead of increment in capital it
cannot be regarded as income. But neither has a bank check or a time deposit certificate any
intrinsic value, yet it may be negotiated, or sold, or assigned and it represents a cash value. So
also does a stock certificate. A lawyer might take his fee in stock certificates instead of in money.
Would it be seriously contended that he had received no fee and that his efforts had brought no
income?1awph!l.net

Some of the members of the court agree that stock dividends based on earnings or profits
may be taxed as income, but take the view that in an action against the Collector of the Internal
Revenue for recovering back taxes paid on non-taxable stock dividends, the plaintiff need not
allege that the stock dividends are not base on earnings or profits distributed, but that question of
the taxability or non-taxability of the stock dividends is a matter of defense and should be set up
by the defendant by way of answer.

I think this view is erroneous. If some stock dividends are taxable and others are not, an
allegation that stock dividends in general have been taxed is not sufficient and does not state a
cause of action. the presumption is that the tax has been legally collected and the burden is upon
the plaintiff both to allege and prove facts showing that the collection is unlawfully or irregular.
(Code of Civil Procedure, sec. 334, subsec. 14 and 31.)

Malcolm, J., concurs.

Republic of the Philippines

SUPREME COURT
Manila

EN BANC

G.R. Nos. L-9738 and L-9771 May 31, 1957

BLAS GUTIERREZ, and MARIA MORALES, petitioners,
vs.
HONORABLE COURT OF TAX APPEALS, and THE COLLECTOR OF
INTERNAL REVENUE, respondents.

COLLECTOR OF INTERNAL REVENUE, petitioner,

vs.
BLAS GUTIERREZ, MARIA MORALES, and COURT OF TAX APPEALS,
respondents.

Rafael Morales for petitioners.

Assistant Solicitor General Ramon L. Avanceña and Solicitor Jose P. Alejandro for
respondents.

FELIX, J.:

Maria Morales was the registered owner of an agricultural land designated as Lot No.
724-C of the cadastral survey of Mabalacat, Pampanga. The Republic of the
Philippines, at the request of the U.S. Government and pursuant to the terms of the
Military Bases Agreement of March 14, 1947, instituted condemnation proceedings in
the Court of the First Instance of Pampanga, docketed, as Civil Case No. 148, for the
purpose of expropriating the lands owned by Maria Morales and others needed for the
expansion of the Clark Field Air Base, which project is necessary for the mutual
protection and defense of the Philippines and the United States. Blas Gutierrez was also
made a party defendant in said Civil Case No. 148 for being the husband of the
landowner Maria Morales. At the commencement of the action, the Republic of the
Philippines, therein plaintiff deposited with the Clerk of the Court of First Instance of
Pampanga the sum of P156,960, which was provisionally fixed as the value of the lands
sought to be expropriated, in order that it could take immediate possession of the same.

On January 27, 1949, upon order of the Court, the sum of P34,580 (PNB Check
721520-Exh. R) was paid by the Provincial treasurer of Pampanga to Maria Morales out
of the original deposit of P156,960 made by therein plaintiff. After due hearing, the
Court of First Instance of Pampanga rendered decision dated November 29, 1949,
wherein it fixed as just compensation P2,500 per hectare for some of the lots and
P3,000 per hectare for the others, which values were based on the reports of the
Commission on Appraisal whose members were chosen by both parties and by the
Court, which took into consideration the different conditions affecting, the value of the
condemned properties in making their findings.

In virtue of said decision, defendant Maria Morales was to receive the amount of
P94,305.75 as compensation for Lot No. 724-C which was one of the expropriated
lands. But the Court disapproved defendants' claims for consequential damages
considering them amply compensated by the price awarded to their said properties. In
order to avoid further litigation expenses and delay inherent to an appeal, the parties
entered into a compromise agreement on January 7, 1950, modifying in part the
decision rendered by the Court in the sense of fixing the compensation for all the lands,
without distinction, at P2,500 per hectare, which compromise agreement was approved
by the Court on January 9, 1950. This reduction of the price to P2,500 per hectare did
not affect Lot No. 724-C of defendant Maria Morales. Sometime in 1950, the spouses
Blas Gutierrez and Maria Morales received the sum of P59.785.75 presenting the
balance remaining in their favor after deducting the amount of P34,580 already
withdrawn from the compensation to them.

In a notice of assessment dated January 28, 1953, the Collector of Internal Revenue
demanded of the petitioners the payment of P8,481 as alleged deficiency income tax for
the year 1950, inclusive of surcharges and penalties. On March 5, 1953, counsel for
petitioner sent a letter to the Collector of Internal Revenue requesting the letter to
withdraw and reconsider said assessment, contending among others, that the
compensation paid to the spouses by the Government for their property was not
"income derived from sale, dealing or disposition of property" referred to by section 29
of the Tax Code and therefore not taxable; that even granting that condemnation of
private properties is embraced within the meaning of the word "sale" or "dealing", the
compensation received by the taxpayers must be considered as income for 1948 and not
for 1950 since the amount deposited and paid in 1948 represented more than 25 per cent
of the total compensation awarded by the court; that the assessment was made after the
lapse of the 3-year prescriptive period provided for in section 51-(d) of the Tax Code;
that the compensation in question should be exempted from taxation by reason of the
provision of section 29 (b)-6 of the Tax Code; that the spouses Blas Gutierrez and
Maria Morales did not realize any profit in said transaction as there were improvements
on the land already made and that the purchasing value of the peso at the time of the
expropriation proceeding had depreciated if compared to the value of the pre-war peso;
and that penalties should not be imposed on said spouses because granting the
assessment was correct, the emission of the compensation awarded therein was due to
an honest mistake.

This request was denied by the Collector of Internal Revenue, in a letter dated April 26,
1954, refuting point by point the arguments advanced by the taxpayers. The record
further shows that a warrant of distraint and levy was issued by the Collector of Internal
Revenue on the properties of Mr. & Mrs. Blas Gutierrez found in Mabalacat,
Pampanga, and a notice of tax lien was duly registered with the Register of Deeds of
San Fernando, Pampanga, on the same date Counsel for the spouses then requested that
the matter be referred to the Conference Staff of the Bureau of Internal Revenue for
proper hearing to which the Collector answered in a letter dated December 24, 1954,
stating that the request would be granted upon compliance by the taxpayers with the
requirements of Department of Finance order No. 213, i.e., the filing of a verified
petition to that effect and that one half of the total assessment should be guaranteed by a
bond, provided that the taxpayers would agree in writing to the suspension of the
running of the period of prescription.
The taxpayers then served notice that the case would be brought on appeal to the Court
of Tax Appeals, which they did by filing a petition with said Court to review the
assessment made by the Collector, of Internal Revenue, docketed as C.T.A. Case No.
65. In that instance, it was prayed that the Court render judgment declaring that the
taking of petitioners' land by the Government was not a sale or dealing in property; that
the amount paid to, petitioners as just compensation for their property should not be
dismissed by, way of taxation; that said compensation was by law exempt from taxation
and that the period to collect the income taxes by summary methods had prescribed;
that respondent Collector of Internal Revenue be enjoined from carrying out further
steps to collect from petitioners methods the said taxes which they alleged to be
erroneously assessed and for remedies which would serve the ends of law and justice.

The Solicitor General, in representation of the respondent Collector of Internal

Revenue, filed an answer on February 11, 1955, admitting some of the allegations of
petitioners and denying some of them, and as special defenses, he advanced the
contention that Court had no jurisdiction to entertain the petition; profit realized by
petitioners from the sale of the land in question was subject to income tax, that the full
compensation received by petitioners should be included in the income received in
1950, same having been paid in 1950 by the Government; that under the Bases
Agreement only residents of the United states are exempt from the payment of income
tax in the Philippines in respects to profits derived under a contract with the U.S.
Government in connection with the construction, maintenance and operation of the
bases; that in the determination of the gain or loss from the sale of property acquired on
or after March 1, 1913, the cost of acquisition and the selling price shall be taken into
account without qualification as to the purchasing power of the currency; that the
imposition of the 50 per cent surcharge was in accordance with the Tax Code, that the
Collector of Internal Revenue was empowered to collect petitioners' deficiency income
tax; and prayed that the petition for review be dismissed; petitioners be ordered to pay
the amount of P8,481 plus the delinquency penalty of 5 per cent for late payment and
monthly interest at the rate of 1 per cent from April 1, 1953, up to the date of actual
payment and for such other relief that may be deemed just and equitable in the
premises.

After due hearing and after the parties filed their respective memoranda, the Court of
Tax Appeals rendered decision on August 31, 1955, holding that it had jurisdiction to
hear and determine the case; that the gain derived by the petitioners from the
expropriation of their property constituted taxable income and as such was capital gain;
and that said gain was taxable in 1950 when it realized. It was also found by said Court
that the evidence did not warrant the imposition of the 50 per cent surcharge because
the petitioners acted in good faith and without intent to defraud the Government when
they failed to include in their gross income the proceeds they received from the
expropriated property, and, therefore, modified the assessment made by respondent,
requiring petitioners to pay only the sum of P5,654. From this decision, both parties
appealed to this Court and in this instance, petitioners Blas Gutierrez and Maria
Morales, as appellants in G.R. No. L-9738, made the following assessments of error:

1. That the Court of Tax Appeals erred in holding that, for income tax purposes,
income from expropriation should be deemed as income from sale, any profit
derived therefrom is subject to income tax as capital gain pursuant to the
provisions of Section 37-(a)-(5) in relation to Section 29-(a) of the Tax Code;

2. That the Court of Tax Appeals erred in not holding that, under the particular
circumstances in which the property of the appellants was taken by the
Philippine Government, the amount paid to them as just compensation is exempt
from income tax pursuant to Section 29-(b)-(6) of the Tax Code;

3. That the Court of Tax Appeals erred in not holding that the respondent
Collector is definitely barred by the Statute of Limitations from collecting the
deficiency income tax in question, whether administratively thru summary
methods, or judicially thru the ordinary court procedures;

4. That the Court of Tax Appeals erred in not holding that the capital gain found
by the respondent Collector as have been derived by the petitioners-appellants
from the expropriation of their property is merely nominal not subject to income
tax, and in not holding that the pronouncement of the court in the expropriation
case in this respect is binding upon the respondent Collector of Internal
Revenue; and

5. That the Court of Tax Appeals erred in not pronouncing upon the pleadings of
the parties that the petitioners-appellants did not derive any capital gain from the
expropriation of their property.

The appeal of the respondent Collector of the Internal Revenue was docketed in this
Court as G.R. No. L-9771, and in this case the Solicitor General ascribed to the lower
court the commission of the following error:

That the Court of Tax Appeals erred in holding that respondents are not subject
to the payment of the 50 per cent surcharge in spite of the fact that the latter's
income tax return for the year 1950 is false and/or fraudulent.

The facts just narrated are not disputed and the controversy only arose from the
assertion by the Collector of Internal Revenue that petitioners-appellants failed to
include from their gross income, in filing their income tax return for 1950, the amount
of P94,305.75 which they had received as compensation for their land taken by the
Government by expropriation proceedings. It is the contention of respondent Collector
of Internal Revenue that such transfer of property, for taxation purposes, is "sale" and
that the income derived therefrom is taxable. The pertinent provisions of the National
Internal Revenue Code applicable to the instant cases are the following:
 SEC. 29. GROSS INCOME. — (a) General definition. — "Gross income"
includes gains, profits, and income derived from salaries, wages, or
compensation for personal service of whatever kind and in whatever form paid,
or from professions, vocations, trades, businesses, commerce, sales or dealings
in property, whether real or personal, growing out of 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 profit, or gains, profits, and
income derived from any source whatsoever.

SEC. 37. INCOME FROM SOURCES WITHIN THE PHILIPPINES. —

(a) Gross income from sources within the Philippines. — The following items
of gross income shall be treated as gross income from sources within the
Philippines:

xxx xxx xxx

(5) SALE OF REAL PROPERTY. — Gains, profits, and income from

the sale of real property located in the Philippines;

xxx xxx xxx

There is no question that the property expropriated being located in the Philippines,
compensation or income derived therefrom ordinarily has to be considered as income
from sources within the Philippines and subject to the taxing jurisdiction of the
Philippines. However, it is to be remembered that said property was acquired by the
Government through condemnation proceedings and appellants' stand is, therefore, that
same cannot be considered as sale as said acquisition was by force, there being
practically no meeting of the minds between the parties. Consequently, the taxpayers
contend, this kind of transfer of ownership must perforce be distinguished from sale, for
the purpose of Section 29-(a) of the Tax Code. But the authorities in the United States
on the matter sustain the view expressed by the Collector of Internal Revenue, for it is
held that:

The transfer of property through condemnation proceedings is a sale or

exchange within the meaning of section 117 (a) of the 1936 Revenue Act and
profit from the transaction constitutes capital gain" (1942. Com. Int. Revenue
vs. Kieselbach (CCA 3) 127 F. (24) 359). "The taking of property by
condemnation and the, payment of just compensation therefore is a "sale" or
"exchange" within the meaning of section 117 (a) of the Revenue Act of 1936,
and profits from that transaction is capital gain (David S. Brown vs. Comm.,
1942, 42 BTA 139).

The proposition that income from expropriation proceedings is income from sales or
exchange and therefore taxable has been likewise upheld in the case of Lapham vs. U.S.
(1949, 40 AFTR 1370) and in Kneipp vs. U.S. (1949, 85 F Suppl. 902). It appears then
that the acquisition by the Government of private properties through the exercise of the
power of eminent domain, said properties being JUSTLY compensated, is embraced
within the meaning of the term "sale" "disposition of property", and the proceeds from
said transaction clearly fall within the definition of gross income laid down by Section
29 of the Tax Code of the Philippines.

Petitioners-appellants also averred that granting that the compensation thus received is
"income", same is exempted under Section 29-(b)-6 of the Tax Code, which reads as
follows:

SEC. 29. GROSS INCOME. —

xxx xxx xxx

(b) EXCLUSIONS FROM GROSS INCOME. — The following items shall not
be included in gross income and shall exempt from taxation under this Title;

xxx xxx xxx

(6) Income exempt under treaty. — Income of any kind, to the extent required
by any treaty obligation binding upon government of the Philippines.

The taxpayers maintain that since, at the of the U.S. Government, the proceeding to
expropriate the land in question necessary for the expansion of the Clark Field Air Base
was instituted by the Philippine Government as part of its obligation under the Military
Bases Agreement, the compensation accruing therefrom must necessarily fall under the
exemption provided for by Section 29-(b)-6 of the Tax Code. We find this stand
untenable, for the same Military Bases Agreement cited by appellants contains the
following:

ARTICLE XXII
CONDEMNATION OR EXPROPRIATION

1. Whenever it is necessary to acquire by condemnation or expropriation

proceedings real property belonging to private persons, association, or
corporations located in bases named in Annex "A" and Annex "B" in order to
carry out the purposes of this agreement, the Philippines, will institute and
prosecute such condemnation proceeding in accordance with the laws of the
Philippines. The United States agrees to reimburse the Philippines for all the
reasonable expenses, damages, and costs thereby incurred, including title value
of the property as determined by the Court. In addition, subject to mutual
agreements of the two governments, the United States shall reimburse the
Philippines for the reasonable costs of transportation and removal of any
 occupants displaced or ejected by reason of the condemnation or expropriation.

ARTICLE XII
INTERNAL REVENUE EXEMPTION

(1) No member of the United States Armed Forces except Filipino citizens,
serving in the Philippines in connection with the bases and residing in the
Philippines by reason only of such service, or his dependents, shall be liable to
pay income tax in the Philippines except in respect of income derived from
Philippine sources.

(2) No National of the United States serving in the Philippines in connection

with the construction, maintenance, operation or defense of the bases and
residing in the Philippines by reason only of such employment, or his spouse
and minor children and dependent parents of either spouse, shall be liable to
pay income tax in the Philippines except in respect of income derived from
Philippine sources or sources other than the United States.

(3) No person referred to in paragraphs 1 and 2 of this said Article shall be liable
to pay the government or local authorities of the Philippines any poll or
residence tax, or any imports or exports duties, or any other tax on personal
property imported for his own use provided, that private owned vehicles shall be
subject to payment of the following only: when certified as being used for
military purposes by appropriate United States Authorities, the normal license
plate fee; otherwise, the normal license and registration fees.

(4) No national of the United States, or corporation organized under the laws of
the United States, shall be liable to pay income tax in the Philippines in respect
of any profits derived under a contract made in the United States with the
government of the United States in connection with the construction,
maintenance, operation and defense of the bases, or any tax in the nature of a
license in respect of any service of work for the United, States in connection
with the construction, maintenance, operation and defense of the bases.

xxx xxx xxx

The facts brought about by the aforementioned terms of the said treaty need no further
elucidation. It is unmistakable that although the condemnation or expropriation of
properties was provided for, the exemption from tax of the compensation to be paid for
the expropriation of privately owned lands located in the Philippines was not given any
attention, and the internal revenue exemptions specifically taken care of by said
Agreement applies only to members of the U.S. Armed Forces serving in the
Philippines and U.S. nationals working in these Islands in connection with the
construction, maintenance, operation and defense of said bases.
Anent appellant taxpayers' allegation that the respondent Collector of Internal Revenue
was barred from collecting the deficiency income tax assessment, it having been made
beyond the 3-year period prescribed by section 51-(d) of the Tax Code, We have this
much to say. Although it is true that by order of the Court of First Instance of
Pampanga, the amount of P34,580 out of the original deposit made by the Government
was withdrawn in favor of appellants on January 27, 1949, the same cannot be
considered as income for 1950 when the balance of P59,785.75 was actually received.
Before that date (1950), appellant taxpayers were still the owners of their whole
property that was subject of condemnation proceedings and said amount of P34,580
was not paid to, but merely deposited in court and withdrawn by them. Therefore, the
payment of the value of Maria Morales' Lot 724-C was actually made by the Republic
of the Philippines in 1950 and it has to be credited as income for 1950 for it was then
when title over said property passed to the Republic of the Philippines. Appellant
taxpayers cannot say that the title over the property expropriated already passed to the
Government when the latter was placed in possession thereof, for in condemnation
proceedings, title to the land does not pass to the plaintiff until the indemnity is paid
(Calvo vs. Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the
expropriator, title does not actually pass to him until payment of the amount adjudged
by the Court and the registration of the judgment with the Register of Deeds (See
Visayan Refining Company vs. Camus et al., 40 Phil. 550; Metropolitan Water District
vs. De los Angeles, 55 Phil. 783). Now, if said amount should have been reported as
income for 1950 in the return that must have been filed on or before March 1, 1951, the
assessment made by the Collector on January 28, 1953, is still within the 3-year
prescriptive period provided for by Section 51-d and could, therefore, be collected
either by the administrative methods of distraint and levy or by judicial action (See
Collector of Internal Revenue vs. A P. Reyes et al., 100 Phil., 872; Collector of Internal
Revenue vs. Zulueta et al., 100 Phil., 872; and Sambrano vs. Court of Tax Appeals et al.,
supra, p. 1).

As to appellant taxpayers' proposition that the profit, derived by them from the
expropriation of their property is merely nominal and not subject to income tax, We find
Section 35 of the Tax Code illuminating. Said section reads as follows:

SEC. 35. DETERMINATION OF GAIN OR LOSS FROM THE SALE OR

OTHER DISPOSITION OF PROPERTY. — The gain derived or loss sustained
from the sale or other disposition of property, real or personal, or mixed, shall be
determined in accordance with the following schedule:

(a) xxx xxx xxx

(b) In the case of property acquired on or after March first, nineteen hundred
and thirteen, the cost thereof if such property was acquired by purchase or the
fair market price or value as of the date of the acquisition if the same was
acquired by gratuitous title.
 xxx xxx xxx

The records show that the property in question was adjudicated to Maria Morales by
order of the Court of First Instance of Pampanga on March 23, 1929, and in accordance
with the aforequoted section of the National Internal Revenue Code, only the fair
market price or value of the property as of the date of the acquisition thereof should be
considered in determining the gain or loss sustained by the property owner when the
property was disposed, without taking into account the purchasing power of the
currency used in the transaction. The records placed the value of the said property at the
time of its acquisition by appellant Maria Morales P28,291.73 and it is a fact that same
was compensated with P94,305.75 when it was expropriated. The resulting difference is
surely a capital gain and should be correspondingly taxed.

As to the only question raised by appellant Collector of Internal Revenue in case L-

9771, assailing the lower Court's order exonerating petitioners from the 50 per cent
surcharge imposed on the latter, on the ground that the taxpayers' income tax return for
1950 is false and/or fraudulent, it should be noted that the Court of Tax Appeals found
that the evidence did not warrant the imposition of said surcharge because the
petitioners therein acted in good faith and without intent to defraud the Government.

The question of fraud is a question of fact which frequently requires a nicely

balanced judgement to answer. All the facts and circumstances surrounding the
conduct of the tax payer's business and all the facts incident to the preparation of
the alleged fraudulent return should be considered. (Mertens, Federal Income
Taxation, Chapter 55).

The question of fraud being a question of fact and the lower court having made the
finding that "the evidence of this case does not warrant the imposition of the 50 per cent
surcharge", We are constrained to refrain from giving any consideration to the question
raised by the Solicitor General, for it is already settled in this jurisdiction that in passing
upon petitions to review decisions of the Court of Tax Appeals, We have to confine
ourselves to questions of law.

WHEREFORE, the decision appealed from by both parties is hereby affirmed, without
pronouncement as to costs. It is so ordered.

Paras, C.J., Montemayor, Reyes, A., Bautista Angelo, Concepcion, Reyes, J.B.L. and
Endencia, JJ., concur.

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.

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED MINING AND
DEVELOPMENT CORPORATION and the COURT OF TAX APPEALS, respondents.
G.R. No. 80041 January 22, 1990
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MITSUBISHI METAL CORPORATION, ATLAS CONSOLIDATED MINING AND
DEVELOPMENT CORPORATION and the COURT OF TAX APPEALS, respondents.

FACTS:
The records reflect that on April 17, 1970, Atlas Consolidated Mining and Development
Corporation (hereinafter, Atlas) entered into a Loan and Sales Contract with Mitsubishi Metal
Corporation (Mitsubishi, for brevity), a Japanese corporation licensed to engage in business
in the Philippines, for purposes of the projected expansion of the productive capacity of the
former's mines in Toledo, Cebu. Under said contract, Mitsubishi agreed to extend a loan to
Atlas 'in the amount of $20,000,000.00, United States currency, for the installation of a new
concentrator for copper production. Atlas, in turn undertook to sell to Mitsubishi all the
copper concentrates produced from said machine for a period of fifteen (15) years. It was
contemplated that $9,000,000.00 of said loan was to be used for the purchase of the
concentrator machinery from Japan. 1
Mitsubishi thereafter applied for a loan with the Export-Import Bank of Japan (Eximbank for
short) obviously for purposes of its obligation under said contract. Its loan application was
approved on May 26, 1970 in the sum of ¥4,320,000,000.00, at about the same time as the
approval of its loan for ¥2,880,000,000.00 from a consortium of Japanese banks. The total
amount of both loans is equivalent to $20,000,000.00 in United States currency at the then
prevailing exchange rate. The records in the Bureau of Internal Revenue show that the
approval of the loan by Eximbank to Mitsubishi was subject to the condition that Mitsubishi
would use the amount as a loan to Atlas and as a consideration for importing copper
concentrates from Atlas, and that Mitsubishi had to pay back the total amount of loan by
September 30, 1981. 2
Pursuant to the contract between Atlas and Mitsubishi, interest payments were made by the
former to the latter totalling P13,143,966.79 for the years 1974 and 1975. The
corresponding 15% tax thereon in the amount of P1,971,595.01 was withheld pursuant to
Section 24 (b) (1) and Section 53 (b) (2) of the National Internal Revenue Code, as amended
by Presidential Decree No. 131, and duly remitted to the Government. 3
On March 5, 1976, private respondents filed a claim for tax credit requesting that the sum of
P1,971,595.01 be applied against their existing and future tax liabilities. Parenthetically, it
was later noted by respondent Court of Tax Appeals in its decision that on August 27, 1976,
Mitsubishi executed a waiver and disclaimer of its interest in the claim for tax credit in favor
of Atlas. 4
ISSUES:
1. whether or not the interest income from the loans extended to Atlas by Mitsubishi is
excludible from gross income taxation pursuant to Section 29 b) (7) (A) of the tax
code and, therefore, exempt from withholding tax.
2. whether or not Mitsubishi is a mere conduit of Eximbank which will then be
considered as the creditor whose investments in the Philippines on loans are exempt
from taxes under the code.
HELD:
The loan and sales contract between Mitsubishi and Atlas does not contain any direct or
inferential reference to Eximbank whatsoever. The agreement is strictly between Mitsubishi
as creditor in the contract of loan and Atlas as the seller of the copper concentrates. From
the categorical language used in the document, one prestation was in consideration of the
other. The specific terms and the reciprocal nature of their obligations make it implausible, if
not vacuous to give credit to the cavalier assertion that Mitsubishi was a mere agent in said
transaction.
The contract between Eximbank and Mitsubishi is entirely different. It is complete in itself,
does not appear to be suppletory or collateral to another contract and is, therefore, not to be
distorted by other considerations aliunde. The application for the loan was approved on May
20, 1970, or more than a month after the contract between Mitsubishi and Atlas was entered
into on April 17, 1970. It is true that under the contract of loan with Eximbank, Mitsubishi
agreed to use the amount as a loan to and in consideration for importing copper
concentrates from Atlas, but all that this proves is the justification for the loan as
represented by Mitsubishi, a standard banking practice for evaluating the prospects of due
repayment. There is nothing wrong with such stipulation as the parties in a contract are free
to agree on such lawful terms and conditions as they see fit. Limiting the disbursement of
the amount borrowed to a certain person or to a certain purpose is not unusual, especially in
the case of Eximbank which, aside from protecting its financial exposure, must see to it that
the same are in line with the provisions and objectives of its charter.
Respondents postulate that Mitsubishi had to be a conduit because Eximbank's charter
prevents it from making loans except to Japanese individuals and corporations. We are not
impressed.
The allegation that the interest paid by Atlas was remitted in full by Mitsubishi to Eximbank,
assuming the truth thereof, is too tenuous and conjectural to support the proposition that
Mitsubishi is a mere conduit. Furthermore, the remittance of the interest payments may also
be logically viewed as an arrangement in paying Mitsubishi's obligation to Eximbank.
Whatever arrangement was agreed upon by Eximbank and Mitsubishi as to the manner or
procedure for the payment of the latter's obligation is their own concern. It should also be
noted that Eximbank's loan to Mitsubishi imposes interest at the rate of 75% per annum,
while Mitsubishis contract with Atlas merely states that the "interest on the amount of the
loan shall be the actual cost beginning from and including other dates of releases against
loan." 14
It is too settled a rule in this jurisdiction, as to dispense with the need for citations, that laws
granting exemption from tax are construed strictissimi juris against the taxpayer and
liberally in favor of the taxing power. Taxation is the rule and exemption is the exception.
The burden of proof rests upon the party claiming exemption to prove that it is in fact
covered by the exemption so claimed, which onus petitioners have failed to discharge.
WHEREFORE, the decisions of the Court of Tax Appeals in CTA Cases Nos. 2801 and 3015,
dated April 18, 1980 and January 15, 1981, respectively, are hereby REVERSED and SET
ASIDE.

Manila

EN BANC

G.R. No. L-21258 October 31, 1967

FILIPINAS LIFE ASSURANCE COMPANY, Petitioner, vs. THE COURT OF TAX

APPEALS and THE COMMISSIONER OF INTERNAL REVENUE, Respondents.

CASTRO, J.: chanrobles virtual law library

The issue posed in this appeal is whether domestic and resident foreign life insurance companies
are entitled to return only 25 per cent of their income from dividends under the 1957 amendment
of section 24 of the National Internal Revenue Code, the pertinent provisions of which read as
follows:

Sec. 24. Rate of Tax on Corporations. - (A) In general there shall be levied, assessed,
collected, and paid annually upon the total net income received in the preceding taxable
year from all sources by every corporation organized in, or existing under the laws of the
Philippines, no matter how created or organized, but not including duly registered general
copartnerships (companias colectivas), domestic life insurance companies and foreign
life insurance companies doing business in the Philippines, a tax upon such income equal
to the sum of the following: chanrobles virtual law library

Twenty per centum upon the amount by which such total net income does not exceed one
hundred thousand pesos; and chanrobles virtual law library

Twenty-eight per centum upon the amount by which such total net income exceeds one
hundred thousand pesos; and a like tax shall be levied, assessed, collected and paid
annually upon the total net income received in the preceding taxable year from all sources
within the Philippines by every corporation organized, authorized or existing under the
laws of any foreign country: . . . And provided, further, That in the case of dividends
received by a domestic or resident foreign corporation from a domestic corporation liable
to tax under this Chapter or from a domestic corporation engaged in a new and necessary
industry, as defined under Republic Act Numbered Nine hundred and one, only twenty-
five per centum thereof shall be returnable for purposes of the tax imposed by this
section.chanroblesvirtualawlibrary chanrobles virtual law library

(B) Rate of Tax on Life Insurance Companies. - There shall be levied, assessed, collected
and paid annually from every insurance company organized in or existing under the laws
 of the Philippines, or foreign life insurance company authorized to carry on business in
the Philippines, but not including purely cooperative companies or associations as
defined in section two hundred and fifty-five of this Code, on the total investment income
received by such company during the preceding taxable year from interest, dividends and
rents from all sources whether from or within the Philippines, a tax of six and one-half
per centum upon such income: Provided, however, That foreign life insurance companies
not doing business in the Philippines shall, on any investment income received by them
from the Philippines, be subject to tax as any other foreign corporation. . . .

The Court of Tax Appeals ruled that life insurance companies should report in full their income
from dividends because, while they are treated in subsection (B), the proviso regarding dividend
exclusion is found in subsection (A) which treats of corporations in general. The petitioner
appealed to this Court, contending, on the basis of the history of the proviso, that the benefits of
dividend exclusion are available to all domestic and resident foreign corporations regardless of
the business in which they may be engaged. chanroblesvirtualawlibrary chanrobles virtual law library

We agree with the petitioner. chanroblesvirtualawlibrary chanrobles virtual law library

The petitioner is a domestic life insurance company. On March 18, 1959, it filed an income tax return for
1958 showing the following data:

GROSS INCOME

From interest P 5,186.44

From 57,105.29
dividends

TOTAL GROSS P62,202.36

INCOME

TOTAL 10,317.47
DEDUCTIONS

Net income P51,974.89

Tax assessable:

Life Insurance P 3,378.00

Companies

TOTAL TAX P 3,378.00

DUE

Later, however, it filed an amended return, as follows:

 GROSS INCOME

From interest P 5,186.44

From 15,242.55
dividends

TOTAL GROSS P20,186.44

INCOME

TOTAL 10,317.47
DEDUCTIONS

Net income P10,111.52

Tax assessable:

Life Insurance P657.00

Companies

TOTAL TAX P657.00

DUE

This was accompanied with a claim for the refund of P2,721 representing the difference between
P3,378, which the petitioner had paid as income tax under its original return, and P657, which it
now averred was the correct amount due from it. The difference is due to the fact that, whereas in
its original income tax return the petitioner reported in full its income from dividends amounting
to P57,105.29,1 in its amended return it reported only 25 per cent, or P15,242.55,2 of the
dividends from domestic corporations. chanroblesvirtualawlibrary chanrobles virtual law library

The claim for refund was filed with the respondent Commissioner of Internal Revenue but, as he
had not been heard from, the petitioner, to avoid prescription of its action, took the matter to the
Court of Tax Appeals. The Tax Court, with two members voting and another one reserving his
vote, upheld the propriety of the action against the claim of the respondent that it was filed
prematurely. It however denied the claim of the petitioner for refund on the ground that the
proviso allowing the return of only 25 per cent of the income from dividends is found in
subsection (A) of section 24 of the National Internal Revenue Code, while life insurance
companies are dealt with in another subsection, although of the same section. The Tax Court's
ratio decidendi reads:

As a general rule of statutory construction a proviso is deemed to apply only to the

immediately preceding clause or provision. Where, as in the case at bar, there is no clear
legislative intention to apply it to the subse-clause or provision (Section 24[B]), we are
constrained to interpret the proviso as affecting only the preceding clause or provision.
(See Collector, et al. vs. Servando de los Angeles, et al. G.R. No. L-9899, August 13,
1957). Consequently, we are of the opinion that the proviso relative to the returnability of
only 25% of such dividends applies only to corporations organized in or existing under
 the laws of the Philippines . . ., but not including duly registered copartnerships
(companias colectivas), domestic life insurance companies and foreign life insurance
companies doing business in the Philippines.

But a purely syntactical approach is hardly a safe guide to the meaning of a statute. The position
of a proviso, for instance, although possessed of considerable influence, is not necessarily
controlling. The proviso may apply to sections or portions thereof which follow it or even to the
entire statute.3 Position, after all, cannot override intention, in the ascertainment of which the
legislative history of a statute is extremely more important.4 chanrobles virtual law library

A resort to legislative history should prove particularly helpful in the case of section 24 of the
Code as this section has gone through a miscellany of amendments, with the result that its basic
outlines are now only vaguely discernible. From a one-paragraph section it has grown into a
multi-paragraph one, with lengthy sentences qualified at every turn by exceptions and provisos.
The readability expert,5 who once complained of a provision of the U.S. Internal Revenue Code
as a "nightmare" of a writing, would be at a loss for words to describe section 24 of our Code.
virtual law library
chanroblesvirtualawlibrary chanrobles

The following table shows the changes which section 24 has undergone at each of the eight
different stages of its amendment.

CORPORATE INCOME TAX: A COMPARATIVE TABLE OF AMENDMENTS6 chanrobles virtual law library

(1) As originally enacted on June 15, 1939: chanrobles virtual law library

Sec. 24. Rate of tax on corporations. - There shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources by
every corporation organized in, or existing under the laws of, the Philippines, no matter how
created or organized, but not including duly registered general copartnerships (compañias
colectivas), a tax of eight per centum upon such income; and a like tax shall be levied, assessed,
collected, and paid annually upon the total net income received in the preceding taxable year
from all sources within the Philippines by every corporation organized, authorized, or existing
under the laws of any foreign country: Provided, however, That in the case of dividends received
by a domestic or resident foreign corporation from a domestic corporation liable to tax under this
Chapter, only twenty-five per centum thereof shall be returnable for purposes of the tax imposed
by this section. chanroblesvirtualawlibrary chanrobles virtual law library

(2) As amended by Republic Act 82, 1 Laws & Res. 250 (1946):

Sec. 24. Rate of tax on corporation. - There shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources
by every corporation organized in, or existing under the laws of the Philippines, no matter
how created or organized, but not including duly registered general copartnerships
(compañias colectivas), a tax of TWELVE per centum upon such income; and a like tax
shall be levied, assessed, collected, and paid annually upon the total net income received
in the preceding taxable year from all sources within the Philippines by every corporation
organized, authorized, or existing under the laws of any foreign country: Provided,
 however, THAT BUILDING AND LOAN ASSOCIATIONS OPERATING AS SUCH IN
ACCORDANCE WITH SECTIONS ONE HUNDRED SEVENTY-ONE TO ONE
HUNDRED NINETY OF THE CORPORATION LAW, AS AMENDED, SHALL PAY A
TAX OF SIX PER CENTUM ON THEIR TOTAL NET INCOME: AND PROVIDED,
FURTHER, That in the case of dividends received by a domestic or resident foreign
corporation from a domestic corporation liable to tax under this Chapter, only twenty-five
per centum thereof shall be returnable for purposes of the tax imposed by this section.

(3) As amended by Republic Act 590, 5 Laws & Res. 687 (1950):

Sec. 24. Rate of tax on corporations. - There shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources
by every corporation organized in, or existing under the laws of the Philippines, no matter
how created or organized, but not including duly registered general copartnerships
(compañias colectivas), a tax [of] SIXTEEN per centum upon such income; and a like tax
shall be levied, assessed, collected, and paid annually upon the total net income received
in the preceding taxable year from all sources within the Philippines by every corporation
organized, authorized, or existing under the laws of any foreign country; Provided,
however, That Building and Loan Associations operating as such in accordance with
sections one hundred and seventy-one to one hundred and ninety of the Corporation Law,
as amended, shall pay a tax of NINE per centum on their total net income: And provided,
further, That in the case of dividends received by a domestic or resident foreign
corporation from a domestic corporation liable to tax under this Chapter, only twenty-five
per centum thereof shall be returnable for purposes of the tax imposed by this section.

(4) As amended by Republic Act 600, 6 Laws & Res. 27 (1951):

Sec. 24. Rate of tax on corporations.7 - There shall be levied, assessed, collected, and
paid annually upon the total net income received in the preceding taxable year from all
sources by every corporation organized in, or existing under the laws of the Philippines,
no matter how created or organized, but not including duly registered general
copartnerships (compañias colectivas), a tax UPON SUCH INCOME EQUAL TO THE
SUM OF THE FOLLOWING: chanrobles virtual law library

TWENTY PER CENTUM UPON THE AMOUNT BY WHICH SUCH TOTAL NET
INCOME DOES NOT EXCEED ONE HUNDRED THOUSAND PESOS; AND chanrobles virtual law library

TWENTY-EIGHT PER CENTUM UPON THE AMOUNT BY WHICH SUCH TOTAL

NET INCOME EXCEEDS ONE HUNDRED THOUSAND PESOS; and a like tax shall
be levied, assessed, collected, and paid annually upon the total net income received in the
preceding taxable year from all sources within the Philippines by every corporation
organized, authorized, or existing under the laws of any foreign country: Provided,
however, That Building and Loan Associations operating as such in accordance with
sections one hundred and seventy-one to one hundred and ninety of the Corporation Law,
AS WELL AS PRIVATE EDUCATIONAL INSTITUTIONS, shall pay a tax of TWELVE
per centum AND TEN PER CENTUM, RESPECTIVELY, on their total net income: And
 provided, further, That in the case of dividends received by a domestic or resident foreign
corporation from a domestic corporation liable to tax under this Chapter, only twenty-five
per centum thereof shall be returnable for purposes of the tax imposed by this section.

(5) As amended by Republic Act 1148, 9 Laws & Res. 275 (1954):

Sec. 24. Rate of tax on corporations. - There shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources
by every corporation organized in, or existing under the laws of the Philippines, no matter
how created or organized, but not including duly registered general copartnerships
(compañias colectivas), a tax upon such income equal to the sum of the following: chanrobles virtual law library

Twenty per centum upon the amount by which such total net income does not exceed one
hundred thousand pesos; and chanrobles virtual law library

Twenty-eight per centum upon the amount by which such total net income exceeds one
hundred thousand pesos; and a like tax shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources
within the Philippines by every corporation organized, authorized or existing under the
laws of any foreign country: Provided, That Building and Loan Associations operating as
such in accordance with sections one hundred and seventy-one to one hundred and ninety
of the Corporation Law, as amended, as well as private educational institutions, shall pay
a tax of twelve per centum and ten per centum respectively, on their total net income:
And provided, further, That in the case of dividends received by a domestic or resident
foreign corporation from a domestic corporation liable to tax under this Chapter or
FROM A DOMESTIC CORPORARION ENGAGED IN NEW AND NECESSARY
INDUSTRY AS DEFINED UNDER REPUBLIC ACT NUMBERED NINE HUNDRED
AND ONE, only twenty-five per centum thereof shall be returnable for purposes of the
tax imposed by this section.

(6) As amended by Republic Act 1855, 12 Laws & Res. 354 (1957):

Sec. 24. Rate of tax on Corporations. - (A)8 IN GENERAL there shall be levied,
[assessed,] collected, and paid annually upon the total net income received in the
preceding taxable year from all sources by every corporation organized in, or existing
under the laws of the Philippines, no matter how created or organized, but not including
duly registered general copartnerships (compañias colectivas), DOMESTIC LIFE
INSURANCE COMPANIES AND FOREIGN LIFE INSURANCE COMPANIES
DOING BUSINESS IN THE PHILIPPINES, a tax upon such income equal to the sum of
the following:chanrobles virtual law library

Twenty per centum upon the amount by which such total net income does not exceed one
hundred thousand pesos; and chanrobles virtual law library

Twenty-eight per centum upon the amount by which such total net income exceeds one
hundred thousand pesos; and a like tax shall be levied, [assessed,] collected and paid
annually upon the total net income received in the preceding taxable year from all sources
within the Philippines by every corporation organized, authorized or existing under the
laws of any foreign country: Provided, however, That Building and Loan Associations
operating as such in accordance with sections one hundred and seventy-one to one
hundred and ninety of the Corporation Law, as amended, as well as private educational
institutions, shall pay a tax of twelve per centum and ten per centum, respectively, on
their total net income: And provided, further, That in the case of dividends received by a
domestic or resident foreign corporation from a domestic corporation liable to tax under
this Chapter or from a domestic corporation engaged in a new and necessary industry, as
defined under Republic Act Numbered Nine hundred and one, only twenty-five per
centum thereof shall be returnable for purposes of the tax imposed by this section.9
chanrobles virtual law library

(B) RATE OF TAX ON LIFE INSURANCE COMPANIES. - THERE SHALL BE

LEVIED, ASSESSED, COLLECTED AND PAID ANNUALLY FROM EVERY
INSURANCE COMPANY ORGANIZED IN OR EXISTING UNDER THE LAWS OF
THE PHILIPPINES, OR FOREIGN LIFE INSURANCE COMPANY AUTHORIZED
TO CARRY ON BUSINESS IN THE PHILIPPINES, BUT NOT INCLUDING PURELY
COOPERATIVE COMPANIES OR ASSOCIATIONS AS DEFINED IN SECTION
TWO HUNDRED FIFTY-FIVE OF THIS CODE, ON THE TOTAL INVESTMENT
INCOME RECEIVED BY SUCH COMPANY DURING THE PRECEDING TAXABLE
YEAR FROM INTEREST, DIVIDENDS AND RENTS FROM ALL SOURCES
WHETHER FROM OR WITHOUT THE PHILIPPINES, A TAX OF SIX AND ONE-
HALF PER CENTUM UPON SUCH INCOME: PROVIDED, HOWEVER, THAT
FOREIGN LIFE INSURANCE COMPANIES NOT DOING BUSINESS IN THE
PHILIPPINES SHALL, ON ANY INVESTMENT INCOME RECEIVED BY THEM
FROM THE PHILIPPINES, BE SUBJECT TO TAX AS ANY OTHER FOREIGN
CORPORATION. chanroblesvirtualawlibrary chanrobles virtual law library

THE TOTAL NET INVESTMENT INCOME OF DOMESTIC LIFE INSURANCE

COMPANIES IS THE GROSS INVESTMENT INCOME RECEIVED DURING THE
TAXABLE YEAR FROM RENTS, DIVIDENDS, AND INTEREST LESS
DEDUCTIONS FOR REAL ESTATE EXPENSES, DEPRECIATION, INTEREST PAID
WITHIN THE TAXABLE YEAR ON ITS INDEBTEDNESS, EXCEPT ON
INDEBTEDNESS INCURRED TO PURCHASE OR CARRY OBLIGATION THE
INTEREST UPON WHICH IS WHOLLY EXEMPT FROM TAXATION UNDER
EXISTING LAWS, AND SUCH INVESTMENT EXPENSES PAID DURING THE
TAXABLE YEAR AS ARE ORDINARY AND NECESSARY IN THE CONDUCT OF
THE INVESTMENTS: AND THE TOTAL NET INVESTMENT INCOME OF
FOREIGN LIFE INSURANCE COMPANIES DOING BUSINESS IN THE
PHILIPPINES IS THAT PORTION OF THEIR CROSS WORLD INVESTMENT
INCOME WHICH BEARS THE SAME RATIO TO SUCH EXPENSES AS THEIR
TOTAL PHILIPPINE RESERVE BEARS TO THEIR TOTAL WORLD RESERVE
LESS THAT PORTION OF THEIR TOTAL WORLD INVESTMENT EXPENSES
WHICH BEARS THE SAME RATIO TO SUCH EXPENSES AS THEIR TOTAL
PHILIPPINE INVESTMENT INCOME BEARS TO THEIR TOTAL WORLD
INVESTMENT INCOME.
(7) As amended by Republic Act 2343, 14 Laws & Res. 423 (1959);

Sec. 24. Rate of tax on corporations. - (a) TAX ON DOMESTIC CORPORATIONS. - In

general there shall be levied, collected, and paid annually upon the total net income
received in the preceding taxable year from all sources by every corporation organized in,
or existing under the laws of the Philippines, no matter how created or organized, but not
including duly registered general copartnerships (compañias colectivas), domestic life
insurance companies and foreign life insurance companies doing business in the
Philippines, a tax upon such income equal to the sum of the following: chanrobles virtual law library

TWENTY-TWO per centum upon the amount by which such total net income does not
exceed one hundred thousand pesos; and chanrobles virtual law library

THIRTY per centum upon the amount by which such total net income exceeds one
hundred thousand pesos; and a like tax shall be levied, collected, and paid annually upon
the total net income received in the preceding taxable year from all sources within the
Philippines by every corporation organized, authorized, or existing under the laws of any
foreign country: Provided, however, That building and loan associations operating as
such in accordance with sections one hundred and seventy-one to one hundred and ninety
of the Corporation law, as amended, as well as private educational institutions, shall pay a
tax of twelve per centum and ten per centum, respectively, on their total net income: And
provided, further, That in the case of dividends received by a domestic or resident foreign
corporation from a domestic corporation liable to tax under this Chapter or from a
domestic corporation engaged in a new and necessary industry, as defined under Republic
Act Numbered Nine hundred and one, only twenty-five per centum thereof, shall be
returnable for purposes of the tax imposed by this section. chanroblesvirtualawlibrary chanrobles virtual law library

(b) TAX ON FOREIGN CORPORATIONS. - (1) NON-RESIDENT CORPORATIONS. -

THERE SHALL BE LEVIED, COLLECTED AND PAID FOR EACH TAXABLE
YEAR, IN LIEU OF THE TAX IMPOSED BY THE PRECEDING PARAGRAPH,
UPON THE AMOUNT RECEIVED BY EVERY FOREIGN CORPORATION NOT
ENGAGED IN TRADE OR BUSINESS WITHIN THE PHILIPPINES, FROM ALL
SOURCES WITHIN THE PHILIPPINES, AS INTEREST, DIVIDENDS, RENTS,
SALARIES, WAGES, PREMIUMS, ANNUITIES, COMPENSATIONS,
REMUNERATIONS, EMOLUMENTS, OR, OTHER FIXED OR DETERMINABLE
ANNUAL OR PERIODICAL GAINS, PROFITS, AND INCOME, A TAX EQUAL TO
THIRTY PER CENTUM OF SUCH AMOUNT. chanroblesvirtualawlibrary chanrobles virtual law library

(2) RESIDENT CORPORATIONS. - A FOREIGN CORPORATION ENGAGED IN

TRADE OR BUSINESS WITHIN THE PHILIPPINES (EXCEPT FOREIGN LIFE
INSURANCE COMPANIES) SHALL BE TAXABLE AS PROVIDED IN SECTION (a)
OF THIS SECTION. chanroblesvirtualawlibrary chanrobles virtual law library

(c) Rate of tax on life insurance companies. - There shall be levied, assessed,10 collected
and paid annually from every life insurance company organized in or existing under the
laws of the Philippines, or foreign life insurance company authorized to carry on business
 in the Philippines but not including purely cooperative companies or associations as
defined in section two hundred fifty-five of this Code, on the total investment income
received by such company during the preceding taxable year from interest, dividends, and
rents from all sources, whether from or without the Philippines, a tax of six and one-half
per centum upon such income: Provided, however, That foreign life insurance companies
not doing business in the Philippines shall, on any investment income received by them
from the Philippines, be subject to tax as any other foreign corporation. chanroblesvirtualawlibrary chanrobles virtual law library

The total net investment income of domestic life insurance companies is the gross
investment income received during the taxable year from rents, dividends, and interest
less deductions for real estate expenses, depreciation, interest paid within the taxable year
on its indebtedness, except on indebtedness incurred to purchase or carry obligation the
interest upon which is wholly exempt from taxation under existing laws, and such
investment expenses paid during the taxable year as are ordinary and necessary in the
conduct of the investments; and the total net investment income of foreign life insurance
companies doing business in the Philippines is that portion of their gross world
investment income which bears the same ratio to such income as their total Philippine
reserve bears to their total world reserve less that portion of their total world investment
expenses which bear the same ratio to such expenses as their total Philippine investment
income bears to their total world investment income.

(8) As amended by Republic Act 3825, 60 O.G. 780 (1963):

Sec. 24. Rate of tax on corporations. - (a) Tax on domestic corporations. - In general
there shall be levied, collected, and paid annually upon the total net income received in
the preceding taxable year from all sources by every corporation organized in, or existing
under the laws of the Philippines, no matter how created or organized, but not including
duly registered general copartnerships (compañias colectivas), domestic life insurance
companies and foreign life insurance companies doing business in the Philippines, a tax
upon such income equal to the sum of the following: chanrobles virtual law library

Twenty-two per centum upon the amount by which such total net income does not exceed
one hundred thousand pesos; and chanrobles virtual law library

Thirty per centum upon the amount by which such total net income exceeds one hundred
thousand pesos; and a like tax shall be levied, collected, and paid annually upon the total
net income received in the preceding taxable year from all sources within the Philippines
by every corporation organized, authorized, or existing under the laws of any foreign
country: Provided, however, That building and loan associations operating as such in
accordance with sections one hundred and seventy-one to one hundred and ninety of the
Corporation Law, as amended, as well as private educational institutions, shall pay a tax
of twelve per centum and ten per centum respectively, on their total net income: And
provided, further, That in the case of dividends received by a domestic or resident foreign
corporation from a domestic corporation liable to tax under this Charter or from a
domestic corporation engaged in a new and necessary industry, as defined under Republic
 Act Numbered Nine hundred and one, only twenty-five per centum thereof shall be
returnable for purposes of the tax imposed by this section. chanroblesvirtualawlibrary chanrobles virtual law library

(b) Tax on foreign corporations. - (1) Non-resident corporations. There shall be levied,
collected, and paid for each taxable year, in lieu of the tax imposed by the preceding
paragraph, upon the amount received by every foreign corporation not engaged in trade
or business within the Philippines from all sources within the Philippines, as interest,
dividends, rents, salaries, wages, premiums, annuities, compensating, remunerations,
emoluments, or other fixed or determinable annual or periodical gains, profits, and
income, a tax equal to thirty per centum of such amount: PROVIDED, HOWEVER,
THAT PREMIUMS SHALL NOT INCLUDE REINSURANCE PREMIUMS. chanroblesvirtualawlibrary chanrobles virtual law library

(2) Resident corporations. - A foreign corporation engaged in trade or business within the
Philippines (except foreign life insurance companies) shall be taxable as provided in
subsection (a) of this section.
chanroblesvirtualawlibrary chanrobles virtual law library

(c) Rate of tax on life insurance companies. - There shall be levied, assessed,11 collected
and paid annually from every life insurance company organized or existing under the
laws of the Philippines, or foreign life insurance company authorized to carry on business
in the Philippines but not including purely cooperative companies or associations as
defined in section two hundred fifty-five of this Code, on the total investment income
received by such company during the preceding taxable year from interest, dividends, and
rents from all sources, whether from or without the Philippines, a tax of six and one-half
per centum upon such income: Provided, however, That foreign life insurance companies
not doing business in the Philippines shall, on any investment income received by them
from the Philippines, but subject to tax as any other foreign corporation. chanroblesvirtualawlibrary chanrobles virtual law library

The total net investment income of domestic life insurance companies is the gross
investment income received during the taxable year from rents, dividends, and interest
less deductions for real estate expenses, depreciation, interest paid within the taxable year
on its indebtedness, except on indebtedness incurred to purchase or carry obligation the
interest upon which is wholly exempt from taxation under existing laws, and such
investment expenses paid during the taxable year as are ordinary and necessary in the
conduct of the investments; and the total net investment income of foreign life insurance
companies doing business in the Philippines is that portion of their gross world
investment income which bears the same ratio to such income as their total Philippine
reserve bears to their total world reserve less that portion of their total world investment
expenses which bear the same ratio to such expenses as their total Philippine investment
income bears to their total world investment income.

(9) As amended by Republic Act 3841, 60 O.G. 1095 (1963):

Sec. 24. Rate of tax on corporations. - (a) Tax on domestic corporations. - In general
there shall be levied, collected, and paid annually upon the total net income received in
the preceding taxable year from all sources by every corporation organized in, or existing
under the laws of the Philippines, no matter how created or organized, but not including
duly registered general copartnership (compañias colectivas), domestic life insurance
companies and foreign life insurance compaties doing business in the Philippines, a tax
upon such income equal to the sum of the following: chanrobles virtual law library

Twenty-two per centum upon the amount by which such total net income does not exceed
one hundred thousand pesos; and chanrobles virtual law library

Thirty per centum upon the amount by which such total net income exceeds one hundred
thousand pesos; and a like tax shall be levied, collected, and paid annually upon the total
net income received in the preceding taxable year from all sources within the Philippines
by every corporation organized, authorized or existing under the laws of any foreign
country: Provided, however, That building and loan associations operating as such in
accordance with sections one hundred and seventy-one to one hundred and ninety of the
Corporation Law, as amended, as well as private educational institutions, shall pay a tax
of twelve per centum and ten per centum, respectively, on their total net income: And,
provided, further, That in the case of dividends received by a domestic or resident foreign
corporation from domestic corporation liable to tax under this Chapter or from a domestic
corporation engaged in a new and necessary industry, as defined under Republic Act
Numbered Nine hundred and one,12 only twenty-five per centum thereof shall be
returnable for purposes of the tax imposed by this section. chanroblesvirtualawlibrary chanrobles virtual law library

(b) Tax on foreign corporations. - (1) Non-resident corporations. - There shall be levied,
collected and paid for each taxable year, in lieu of the tax imposed by the preceding
paragraph, upon the amount received by every foreign corporation not engaged in trade
or business within the Philippines, from all sources within the Philippines as interest,
dividends, rents, salaries, wages, premiums, annuities, compensatinig, remunerations,
emoluments, or other fixed or determinable annual or periodical OR CASUAL gains,
profits and income, AND CAPITAL GAINS, a tax equal to thirty per centum of such
amount: Provided, however, That premiums shall not include reinsurance premiums.13 chanrobles virtual law library

(2) Resident corporations. - A foreign corporation engaged in trade or business within the
Philippines (except foreign life insurance companies) shall be taxable as provided in sub-
section (a) of this section.
chanroblesvirtualawlibrary chanrobles virtual law library

(c) Rate of tax on life insurance companies. - There shall be levied, assessed, collected
and paid annually from every life insurance company organized in or existing under the
laws of the Philippines, or foreign life insurance company authorized to carry on business
in the Philippines but not including purely cooperative companies or associations as
defined in section two hundred fifty-five of this Code, on the total investment income
received by such company during the preceding taxable year from interest, dividends, and
rents from all sources whether from or without the Philippines, a tax of six and one-half
per centum upon such income: Provided, however, That foreign life insurance companies
not doing business in the Philippines shall, on any investment income received by them
from the Philippines, be subject to tax as any other foreign corporation. chanroblesvirtualawlibrary chanrobles virtual law library
 The total net investment income of domestic life insurance companies is the gross
investment income received during the taxable year from rents, dividends, and interest
less deductions for real estate expenses, depreciation, interest, paid within the taxable
year on its indebtedness, except on indebtedness incurred to purchase or carry obligation
the interest upon which is wholly exempt from taxation under existing laws, and such
investment expenses paid during the taxable year as are ordinary and necessary in the
conduct of the investments; and the total net investment income of foreign life insurance
companies doing business in the Philippines is that portion of their gross world
investment income which bears the same ratio to such income as their total Philippine
reserve bears to their total world reserve less that portion of their total world investment
expenses which bear the same ratio to such expenses as their total Philippine investment
income bears to their total world investment income.

It will thus be seen that dividend exclusion has always been a dominant feature of corporate
income tax. It is a device for reducing extra or double taxation of distributed earnings. Since a
corporation cannot deduct from its gross income the amount of dividends distributed to its
corporation-shareholders during the taxable year, any distributed earnings are necessarily taxed
twice; initially at the corporate level when they are included in the corporation's taxable income,
and again, at the corporation-shareholder level when they are received as dividend. Thus, without
exclusion the successive taxation of the dividend as it passes from corporation to corporation
would result in repeated taxation of the same income and would leave very little for the ultimate
individual shareholder. At the same time the decision to tax a part (e.g., 25 per cent of such
dividends reflects the policy of discouraging complicated corporate structures as well as
corporate divisions in the form of parent-subsidiary arrangements adopted to achieve a lower
effective corporate income tax rate.14 chanrobles virtual law library

Until 1957 there had been no question that the proviso on dividend exclusion applied to all
domestic and resident foreign life insurance companies. The question arose when, by virtue of
Republic Act 1855 (1957), the original provisions of section 24, with slight modifications, were
made sub-section (A) while a new sub-section (B), entitled "Rate of Tax on Life Insurance
Companies," was added. The result is that the proviso on dividend exclusion now appears to
qualify only a part of section 24, making it doubtful whether after 1957 the income from
dividends of domestic and resident foreign life insurance companies still enjoys exemption,
although, as noted in passing,15 the proviso continues to speak of "the tax imposed by this
section" (not sub-section). chanroblesvirtualawlibrary chanrobles virtual law library

However, a review of the circumstances, which prompted the amendment of section 24 in 1957
shows no intention to withdraw from life insurance companies the exemption which theretofore
had been enjoyed by them along with non-life insurance companies. To be sure, the 1957
amendment was intended for a two-fold purpose: first, to change the tax base from premium
income to investment income and, second, to lower the tax on life insurance companies, in order
to encourage their growth as well as their investment in the development of the national
economy. chanroblesvirtualawlibrary chanrobles virtual law library

Prior to 1957, life insurance companies were required, for income tax purposes, to include
premium, receipts in gross income. It became generally recognized, however, that the inclusion
of premium receipts in the gross taxable income of life insurance companies was unsound
because premium receipts do not constitute income in the sense of gain or profit. They are really
savings deposits of the individual policyholders, a large portion of which goes directly to reserve
funds required by law for the payment of their claims for death benefits, cash surrender values
and maturity values. Therefore, to tax an insurance company on account of these "deposits" or
"savings" is actually to tax the policyholder for being provident. What constitutes true income for
a life insurance company is rather its investment income from interest, dividends and rents.16 chanrobles virtual law library

Besides, the premiums which a life insurance company receives are already subject to a tax of 3
per cent under section 255 of the Code. To require their inclusion in gross income for purposes of
section 24 is to subject them to double taxation.17 chanrobles virtual law library

The rate of tax was lowered in recognition of the fact that a life insurance company derives profit
from its investment income only to the extent that such income exceeds the rate of interest at
which the reserve must be maintained.18 chanrobles virtual law library

In sum, as the then Congressman Ferdinand Marcos described the bill which became Republic
Act 1855, "It is a bill which places [life] insurance companies in the same class as other
companies. And the rate is lower than in ordinary companies because it is six and one half per
cent."19 chanrobles virtual law library

If the purpose of the 1957 amendment was to place life insurance companies at par with other
companies by taking them on their true income, then the legislature could not have intended to
withdraw from them a privilege which they had then been enjoying in common with non-life
insurance companies. Indeed, by no rule of logic can the decision to exclude premium receipts
from gross income be considered a decision to include all of dividend income in gross income.
chanrobles virtual law library
chanroblesvirtualawlibrary

Nor could it have been the intention of the legislature to discriminate against domestic life
insurance companies in favor of resident foreign corporations engaged in other business. And yet
this is just the implication of the interpretation urged on us by the respondents. For, indeed, to
require life insurance companies to report in full their income from dividends would be not only
to treat them differently from other companies, contrary to the first aim of the amendment, but
also to impose on them a tax burden heavier than that imposed on resident foreign companies not
engaged in life insurance. Thus, following the interpretation of the respondents, a resident
foreign corporation with an income of P100,000 from dividends would be required to return only
25 per cent of it, or P25,000 the tax on which would be P5,000 (20% under Republic Act 1855).
In contrast, a domestic life insurance company, required to report all its income from dividends,
would have to pay a tax of P6,500 (6-1/2%), or P1,500 more, despite the fact that the rate of tax
on it is much lower. It seems rather clear that these discriminatory and lopsided results could not
have been intended by Congress. chanroblesvirtualawlibrary chanrobles virtual law library

That Congress intended to accord preferential tax treatment to domestic and resident foreign life
insurance companies is abundantly clear not only from the history of the 1957 amendment but
also from the Comparative Table (supra) which shows that while the rate of tax on corporations
in general has been raised, that on domestic and resident foreign life insurance companies has
remained at 6-1/2 per cent - the lowest among those imposed on various types of corporations.
chanrobles virtual law library
chanroblesvirtualawlibrary
The truth is that section 24 has undergone amendments through a process which, in Cardozo's
phrase,20 is no more intellectual than the use of paste pot and scissors. Consequently, reliance
cannot be placed on its grammatical construction in order to arrive at its meaning. As the
Comparative Table shows, after the amendment of section 24 in 1957, sub-section (A) thereof
did not have a title, compared to sub-section (B), entitled "Rate of Tax on Life Insurance
Companies" which was added. It took another amendment in 1959 to correct the deficiency, only
to commit another error. Thus while the word "assessed" was deleted from sub-section (a) in
consequence of the adoption of the "pay-as-you-file" system, the same word has remained in
sub-section (c) even to this date. Again, within the same year, 1963, Section 24 was amended
twice but in the process more errors were committed. For while Republic Act 3841 was passed
ostensibly to add certain words overlooked in the amendment of the section by Republic Act
3825, the proviso on reinsurance premium (which was the reason for the enactment of Republic
Act 3825) was inadvertently omitted in the text of section 24 (b) (1). chanroblesvirtualawlibrary chanrobles virtual law library

The reference to domestic and resident foreign life insurance companies in the excepting clause
of sub-section (a) is even more awkward because the exception relates to the coverage of the
entire section 24 and not simply to a sub-section thereof. Thus, registered general copartnerships
are excepted from the coverage of section 24 because they are not subject to tax as an entity. By
express provision of section 26 of the Code persons doing business as a general copartnership
duly registered in the mercantile registry are subject to income tax "only in their individual
capacity." On the other hand, by including domestic and resident foreign life insurance
companies in the excepting clause it was never the intention to exempt them from the payment of
corporate income tax, which is the subject of section 24 as a whole. Furthermore, the exclusion
of registered general copartnerships from the coverage of section 24 is justified because by
statutory definition they are not anyway considered "corporations." On the other hand, life
insurance companies are deemed "corporations" for purposes of the Code.21 chanrobles virtual law library

Thus, the haphazard amendment of section 24 by several legislative acts - as a result of which the
proviso on dividend exclusion is now found in sub-section (a) - makes reliance on its
grammatical construction highly unsafe and unsound in arriving at its meaning.22 Since nothing
in the history of the 1957 amendment or in the rationale of dividend exclusion indicates the
contrary, we hold that domestic and resident foreign life insurance companies are entitled to the
benefits of dividend exclusion, the position of the proviso allowing it notwithstanding. chanroblesvirtualawlibrary chanrobles virtual law library

ACCORDINGLY, the decision appealed from is reversed, and the respondent Commissioner of
Internal Revenue is ordered to refund to the petitioner company the amount of P2,721 as excess
income tax for 1958. No pronouncement as to costs. chanroblesvirtualawlibrary chanrobles virtual law library

Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Bengzon, J.P., Zaldivar, Sanchez, Angeles
and Fernando, JJ., concur.

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION & THE
COURT OF TAX APPEALS, respondents.
PARAS, J.:

This is a petition for review on certiorari filed by the herein petitioner, Commissioner of
Internal Revenue, seeking the reversal of the decision of the Court of Tax Appeals dated
January 31, 1984 in CTA Case No. 2883 entitled "Procter and Gamble Philippine
Manufacturing Corporation vs. Bureau of Internal Revenue," which declared petitioner
therein, Procter and Gamble Philippine Manufacturing Corporation to be entitled to the
sought refund or tax credit in the amount of P4,832,989.00 representing the alleged
overpaid withholding tax at source and ordering payment thereof.

The antecedent facts that precipitated the instant petition are as follows:

Private respondent, Procter and Gamble Philippine Manufacturing Corporation

(hereinafter referred to as PMC-Phil.), a corporation duly organized and existing under
and by virtue of the Philippine laws, is engaged in business in the Philippines and is a
wholly owned subsidiary of Procter and Gamble, U.S.A. herein referred to as PMC-
USA), a non-resident foreign corporation in the Philippines, not engaged in trade and
business therein. As such PMC-U.S.A. is the sole shareholder or stockholder of PMC
Phil., as PMC-U.S.A. owns wholly or by 100% the voting stock of PMC Phil. and is
entitled to receive income from PMC-Phil. in the form of dividends, if not rents or
royalties. In addition, PMC-Phil has a legal personality separate and distinct from PMC-
U.S.A. (Rollo, pp. 122-123).

For the taxable year ending June 30, 1974 PMC-Phil. realized a taxable net income of
P56,500,332.00 and accordingly paid the corresponding income tax thereon equivalent
to P25%-35% or P19,765,116.00 as provided for under Section 24(a) of the Philippine
Tax Code, the pertinent portion of which reads:

SEC. 24. Rates of tax on corporation. — a) Tax on domestic corporations. — A tax is

hereby imposed upon the taxable net income received during each taxable year from all
sources by every corporation organized in, or geting under the laws of the Philippines,
and partnerships, no matter how created or organized, but not including general
professional partnerships, in accordance with the following:

Twenty-five per cent upon the amount by which the taxable net income does not exceed
one hundred thousand pesos; and

Thirty-five per cent upon the amount by which the taxable net income exceeds one
hundred thousand pesos.

After taxation its net profit was P36,735,216.00. Out of said amount it declared a
dividend in favor of its sole corporate stockholder and parent corporation PMC-U.S.A. in
the total sum of P17,707,460.00 which latter amount was subjected to Philippine
taxation of 35% or P6,197,611.23 as provided for in Section 24(b) of the Philippine Tax
Code which reads in full:
 SECTION 1. The first paragraph of subsection (b) of Section 24 of the National Bureau
Internal Revenue Code, as amended, is hereby further amended to read as follows:

(b) Tax on foreign corporations. — 41) Non-resident corporation. — A

foreign corporation not engaged in trade or business in the Philippines,
including a foreign life insurance company not engaged in the life
insurance business in the Philippines, shall pay a tax equal to 35% of the
gross income received during its taxable year from all sources within the
Philippines, as interest (except interest on foreign loans which shall be
subject to 15% tax), dividends, rents, royalties, salaries, wages,
premiums, annuities, compensations, remunerations for technical
services or otherwise, emoluments or other fixed or determinable,
annual, periodical or casual gains, profits, and income, and capital gains:
Provided, however, That premiums shall not include re-insurance
premium Provided, further, That cinematograpy film owners, lessors, or
distributors, shall pay a tax of 15% on their gross income from sources
within the Philippines: Provided, still further That on dividends received
from a domestic corporation hable to tax under this Chapter, the tax shall
be 15% of the dividends received, which shall be collected and paid as
provided in Section 53(d) of this Code, subject to the condition that the
country in which the non-resident foreign corporation is domiciled shall
allow a credit against the tax due from the non-resident foreign
corporation, taxes deemed to have been paid in the Philippines
equivalent to 20% which represents the difference between the regular
tax (35%) on corporations and the tax (15%) on dividends as provided in
this section: Provided, finally That regional or area headquarters
established in the Philippines by multinational corporations and which
headquarters do not earn or derive income from the Philippines and
which act as supervisory, communications and coordinating centers for
their affiliates, subsidiaries or branches in the Asia-Pacific Region shall
not be subject to tax.

For the taxable year ending June 30, 1975 PMC-Phil. realized a taxable net income of
P8,735,125.00 which was subjected to Philippine taxation at the rate of 25%-35% or
P2,952,159.00, thereafter leaving a net profit of P5,782,966.00. As in the 2nd quarter of
1975, PMC-Phil. again declared a dividend in favor of PMC-U.S.A. at the tax rate of
35% or P6,457,485.00.

In July, 1977 PMC-Phil., invoking the tax-sparing credit provision in Section 24(b) as aforequoted, as the
withholding agent of the Philippine government, with respect to the dividend taxes paid by PMC-U.S.A.,
filed a claim with the herein petitioner, Commissioner of Internal Revenue, for the refund of the 20
percentage-point portion of the 35 percentage-point whole tax paid, arising allegedly from the alleged
"overpaid withholding tax at source or overpaid withholding tax in the amount of P4,832,989.00,"
computed as follows:

Dividend Tax 15% tax Alleged of

Income withheld under

PMC- at source tax over

U.S.A. at sparing

35% proviso payment

P17,707,46 P6,196,61 P2,656,11 P3,541,49

 0 1 9 2

6,457,485 2,260,119 968,622 1,291,497

P24,164,94 P8,457,73 P3,624,94 P4,832,98

6 1 1 9

There being no immediate action by the BIR on PMC-Phils' letter-claim the latter sought
the intervention of the CTA when on July 13, 1977 it filed with herein respondent court a
petition for review docketed as CTA No. 2883 entitled "Procter and Gamble Philippine
Manufacturing Corporation vs. The Commissioner of Internal Revenue," praying that it
be declared entitled to the refund or tax credit claimed and ordering respondent therein
to refund to it the amount of P4,832,989.00, or to issue tax credit in its favor in lieu of tax
refund. (Rollo, p. 41)

On the other hand therein respondent, Commissioner of qqqInterlaal Revenue, in his

answer, prayed for the dismissal of said Petition and for the denial of the claim for
refund. (Rollo, p. 48)

On January 31, 1974 the Court of Tax Appeals in its decision (Rollo, p. 63) ruled in favor
of the herein petitioner, the dispositive portion of the same reading as follows:

Accordingly, petitioner is entitled to the sought refund or tax credit of the amount
representing the overpaid withholding tax at source and the payment therefor by the
respondent hereby ordered. No costs.

SO ORDERED.

Hence this petition.

The Second Division of the Court without giving due course to said petition resolved to
require the respondents to comment (Rollo, p. 74). Said comment was filed on
November 8, 1984 (Rollo, pp. 83-90). Thereupon this Court by resolution dated
December 17, 1984 resolved to give due course to the petition and to consider
respondents' comulent on the petition as Answer. (Rollo, p. 93)

Petitioner was required to file brief on January 21, 1985 (Rollo, p. 96). Petitioner filed his
brief on May 13, 1985 (Rollo, p. 107), while private respondent PMC Phil filed its brief
on August 22, 1985.

Petitioner raised the following assignments of errors:

THE COURT OF TAX APPEALS ERRED IN HOLDING WITHOUT ANY BASIS IN FACT
AND IN LAW, THAT THE HEREIN RESPONDENT PROCTER & GAMBLE PHILIPPINE
MANUFACTURING CORPORATION (PMC-PHIL. FOR SHORT)IS ENTITLED TO THE
SOUGHT REFUND OR TAX CREDIT OF P4,832,989.00, REPRESENTING
ALLEGEDLY THE DIVIDED TAX OVER WITHHELD BY PMC-PHIL. UPON
REMITTANCE OF DIVIDEND INCOME IN THE TOTAL SUM OF P24,164,946.00 TO
PROCTER & GAMBLE, USA (PMC-USA FOR SHORT).

II

THE COURT OF TAX APPEALS ERRED IN HOLDING, WITHOUT ANY BASIS IN

FACT AND IN LAW, THAT PMC-USA, A NON-RESIDENT FOREIGN CORPORATION
UNDER SECTION 24(b) (1) OF THE PHILIPPINE TAX CODE AND A DOMESTIC
CORPORATION DOMICILED IN THE UNITED STATES, IS ENTITLED UNDER THE
U.S. TAX CODE AGAINST ITS U.S. FEDERAL TAXES TO A UNITED STATES
FOREIGN TAX CREDIT EQUIVALENT TO AT LEAST THE 20 PERCENTAGE-POINT
PORTION (OF THE 35 PERCENT DIVIDEND TAX) SPARED OR WAIVED OR
OTHERWISE CONSIDERED OR DEEMED PAID BY THE PHILIPPINE
GOVERNMENT.

The sole issue in this case is whether or not private respondent is entitled to the
preferential 15% tax rate on dividends declared and remitted to its parent corporation.

From this issue two questions are posed by the petitioner Commissioner of Internal
Revenue, and they are (1) Whether or not PMC-Phil. is the proper party to claim the
refund and (2) Whether or not the U. S. allows as tax credit the "deemed paid" 20%
Philippine Tax on such dividends?

The petitioner maintains that it is the PMC-U.S.A., the tax payer and not PMC-Phil. the
remitter or payor of the dividend income, and a mere withholding agent for and in behalf
of the Philippine Government, which should be legally entitled to receive the refund if
any. (Rollo, p. 129)

It will be observed at the outset that petitioner raised this issue for the first time in the
Supreme Court. He did not raise it at the administrative level, nor at the Court of Tax
Appeals. As clearly ruled by Us "To allow a litigant to assume a different posture when
he comes before the court and challenges the position he had accepted at the
administrative level," would be to sanction a procedure whereby the Court-which is
supposed to review administrative determinations would not review, but determine and
decide for the first time, a question not raised at the administrative forum." Thus it is well
settled that under the same underlying principle of prior exhaustion of administrative
remedies, on the judicial level, issues not raised in the lower court cannot generally be
raised for the first time on appeal. (Pampanga Sugar Dev. Co., Inc. v. CIR, 114 SCRA
725 [1982]; Garcia v. C.A., 102 SCRA 597 [1981]; Matialonzo v. Servidad, 107 SCRA
726 [1981]),

Nonetheless it is axiomatic that the State can never be in estoppel, and this is
particularly true in matters involving taxation. The errors of certain administrative officers
should never be allowed to jeopardize the government's financial position.
The submission of the Commissioner of Internal Revenue that PMC-Phil. is but a
withholding agent of the government and therefore cannot claim reimbursement of the
alleged over paid taxes, is completely meritorious. The real party in interest being the
mother corporation in the United States, it follows that American entity is the real party
in interest, and should have been the claimant in this case.

Closely intertwined with the first assignment of error is the issue of whether or not PMC-
U.S.A. — a non-resident foreign corporation under Section 24(b)(1) of the Tax Code
(the subsidiary of an American) a domestic corporation domiciled in the United States, is
entitled under the U.S. Tax Code to a United States Foreign Tax Credit equivalent to at
least the 20 percentage paid portion (of the 35% dividend tax) spared or waived as
otherwise considered or deemed paid by the government. The law pertinent to the issue
is Section 902 of the U.S. Internal Revenue Code, as amended by Public Law 87-834,
the law governing tax credits granted to U.S. corporations on dividends received from
foreign corporations, which to the extent applicable reads:

SEC. 902 - CREDIT FOR CORPORATE STOCKHOLDERS IN FOREIGN

CORPORATION.

(a) Treatment of Taxes Paid by Foreign Corporation - For purposes of this subject, a
domestic corporation which owns at least 10 percent of the voting stock of a foreign
corporation from which it receives dividends in any taxable year shall-

(1) to the extent such dividends are paid by such foreign corporation out
of accumulated profits [as defined in subsection (c) (1) (a)] of a year for
which such foreign corporation is not a less developed country
corporation, be deemed to have paid the same proportion of any income,
war profits, or excess profits taxes paid or deemed to be paid by such
foreign corporation to any foreign country or to any possession of the
United States on or with respect to such accumulated profits, which the
amount of such dividends (determined without regard to Section 78)
bears to the amount of such accumulated profits in excess of such
income, war profits, and excess profits taxes (other than those deemed
paid); and

(2) to the extent such dividends are paid by such foreign corporation out
of accumulated profits [as defined in subsection (c) (1) (b)] of a year for
which such foreign corporation is a less-developed country corporation,
be deemed to have paid the same proportion of any income, war profits,
or excess profits taxes paid or deemed to be paid by such foreign
corporation to any foreign country or to any possession of the United
States on or with respect to such accumulated profits, which the amount
of such dividends bears to the amount of such accumulated profits.

xxx xxx xxx

(c) Applicable Rules

(1) Accumulated profits defined - For purpose of this section, the term 'accumulated
profits' means with respect to any foreign corporation.
 (A) for purposes of subsections (a) (1) and (b) (1), the amount of its
gains, profits, or income computed without reduction by the amount of
the income, war profits, and excess profits taxes imposed on or with
respect to such profits or income by any foreign country.... ; and

(B) for purposes of subsections (a) (2) and (b) (2), the amount of its
gains, profits, or income in excess of the income, was profits, and excess
profits taxes imposed on or with respect to such profits or income.

The Secretary or his delegate shall have full power to determine from the accumulated
profits of what year or years such dividends were paid, treating dividends paid in the first
20 days of any year as having been paid from the accumulated profits of the preceding
year or years (unless to his satisfaction shows otherwise), and in other respects treating
dividends as having been paid from the most recently accumulated gains, profits, or
earnings. .. (Rollo, pp. 55-56)

To Our mind there is nothing in the aforecited provision that would justify tax return of
the disputed 15% to the private respondent. Furthermore, as ably argued by the
petitioner, the private respondent failed to meet certain conditions necessary in order
that the dividends received by the non-resident parent company in the United States
may be subject to the preferential 15% tax instead of 35%. Among other things, the
private respondent failed: (1) to show the actual amount credited by the U.S.
government against the income tax due from PMC-U.S.A. on the dividends received
from private respondent; (2) to present the income tax return of its mother company for
1975 when the dividends were received; and (3) to submit any duly authenticated
document showing that the U.S. government credited the 20% tax deemed paid in the
Philippines.

PREMISES CONSIDERED, the petition is GRANTED and the decision appealed from,
is REVERSED and SET ASIDE.

SO ORDERED.

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
WANDER PHILIPPINES, INC. AND THE COURT OF TAX APPEALS, respondents.
FACTS:
This is a petition for review on certiorari of the January 19, 1984 Decision of the Court of Tax
Appeals * in C.T.A. Case No.2884, entitled Wander Philippines, Inc. vs. Commissioner of
Internal Revenue, holding that Wander Philippines, Inc. is entitled to the preferential rate of
15% withholding tax on the dividends remitted to its foreign parent company, the Glaro S.A.
Ltd. of Switzerland, a non-resident foreign corporation.
Herein private respondent, Wander Philippines, Inc. (Wander, for short), is a domestic
corporation organized under Philippine laws. It is wholly-owned subsidiary of the Glaro S.A.
Ltd. (Glaro for short), a Swiss corporation not engaged in trade or business in the Philippines.
On July 18, 1975, Wander filed its withholding tax return for the second quarter ending June
30, 1975 and remitted to its parent company, Glaro dividends in the amount of P222,000.00,
on which 35% withholding tax thereof in the amount of P77,700.00 was withheld and paid to
the Bureau of Internal Revenue.
Again, on July 14, 1976, Wander filed a withholding tax return for the second quarter ending
June 30, 1976 on the dividends it remitted to Glaro amounting to P355,200.00, on wich 35%
tax in the amount of P124,320.00 was withheld and paid to the Bureau of Internal Revenue.
On July 5, 1977, Wander filed with the Appellate Division of the Internal Revenue a claim for
refund and/or tax credit in the amount of P115,400.00, contending that it is liable only to
15% withholding tax in accordance with Section 24 (b) (1) of the Tax Code, as amended by
Presidential Decree Nos. 369 and 778, and not on the basis of 35% which was withheld and
paid to and collected by the government.
Petitioner herein, having failed to act on the above-said claim for refund, on July 15, 1977,
Wander filed a petition with respondent Court of Tax Appeals.
On October 6, 1977, petitioner file his Answer.
On January 19, 1984, respondent Court of Tax Appeals rendered a Decision, the decretal
portion of which reads:
WHEREFORE, respondent is hereby ordered to grant a refund and/or tax credit
to petitioner in the amount of P115,440.00 representing overpaid withholding
tax on dividends remitted by it to the Glaro S.A. Ltd. of Switzerland during the
second quarter of the years 1975 and 1976.
On March 7, 1984, petitioner filed a Motion for Reconsideration but the same was denied in a
Resolution dated August 13, 1984. Hence, the instant petition.
Issues:
1. whether or not private respondent Wander is entitled to the preferential rate of 15%
withholding tax on dividends declared and remitted to its parent corporation, Glaro.
2. Whether petitioners appeal is proper.
HELD:
Petitioner maintains and argues that it is Glaro the tax payer, and not Wander, the remitter
or payor of the dividend income and a mere withholding agent for and in behalf of the
Philippine Government, which should be legally entitled to receive the refund if any.
It will be noted, however, that Petitioner's above-entitled argument is being raised for the
first time in this Court. It was never raised at the administrative level, or at the Court of Tax
Appeals. Thus, it is well settled that under the same underlying principle of prior exhaustion
of administrative remedies, on the judicial level, issues not raised in the lower court cannot
be raised for the first time on appeal.
In any event, the submission of petitioner that Wander is but a withholding agent of the
government and therefore cannot claim reimbursement of the alleged overpaid taxes, is
untenable. It will be recalled, that said corporation is first and foremost a wholly owned
subsidiary of Glaro. The fact that it became a withholding agent of the government which
was not by choice but by compulsion under Section 53 (b) of the Tax Code, cannot by any
stretch of the imagination be considered as an abdication of its responsibility to its mother
company. Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that
"the obligation imposed thereunder upon the withholding agent is compulsory." It is a device
to insure the collection by the Philippine Government of taxes on incomes, derived from
sources in the Philippines, by aliens who are outside the taxing jurisdiction of this Court. In
fact, Wander may be assessed for deficiency withholding tax at source, plus penalties
consisting of surcharge and interest (Section 54, NLRC). Therefore, as the Philippine
counterpart, Wander is the proper entity who should for the refund or credit of overpaid
withholding tax on dividends paid or remitted by Glaro.
Closely intertwined with the first assignment of error is the issue of whether or not
Switzerland, the foreign country where Glaro is domiciled, grants to Glaro a tax credit
against the tax due it, equivalent to 20%, or the difference between the regular 35% rate of
the preferential 15% rate. The dispute in this issue lies on the fact that Switzerland does not
impose any income tax on dividends received by Swiss corporation from corporations
domiciled in foreign countries.
Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this
case, reads:
Sec. 1. The first paragraph of subsection (b) of Section 24 of the National
Internal Revenue Code, as amended, is hereby further amended to read as
follows:
(b) Tax on foreign corporations. — 1) Non-resident corporation. A
foreign corporation not engaged in trade or business in the
Philippines, including a foreign life insurance company not
engaged in the life insurance business in the Philippines, shall
pay a tax equal to 35% of the gross income received during its
taxable year from all sources within the Philippines, as interest
(except interest on foreign loans which shall be subject to 15%
tax), dividends, premiums, annuities, compensations,
remuneration for technical services or otherwise, emoluments or
other fixed or determinable, annual, periodical or casual gains,
profits, and income, and capital gains: ... Provided, still further
That on dividends received from a domestic corporation liable to
tax under this Chapter, the tax shall be 15% of the dividends
received, which shall be collected and paid as provided in
Section 53 (d) of this Code, subject to the condition that the
country in which the non-resident foreign corporation is
domiciled shall allow a credit against the tax due from the non-
resident foreign corporation taxes deemed to have been paid in
the Philippines equivalent to 20% which represents the
difference between the regular tax (35%) on corporations and
the tax (15%) dividends as provided in this section: ...
From the above-quoted provision, the dividends received from a domestic corporation liable
to tax, the tax shall be 15% of the dividends received, subject to the condition that the
country in which the non-resident foreign corporation is domiciled shall allow a credit against
the tax due from the non-resident foreign corporation taxes deemed to have been paid in
the Philippines equivalent to 20% which represents the difference between the regular tax
(35%) on corporations and the tax (15%) dividends.
In the instant case, Switzerland did not impose any tax on the dividends received by Glaro.
Accordingly, Wander claims that full credit is granted and not merely credit equivalent to
20%. Petitioner, on the other hand, avers the tax sparing credit is applicable only if the
country of the parent corporation allows a foreign tax credit not only for the 15 percentage-
point portion actually paid but also for the equivalent twenty percentage point portion
spared, waived or otherwise deemed as if paid in the Philippines; that private respondent
does not cite anywhere a Swiss law to the effect that in case where a foreign tax, such as
the Philippine 35% dividend tax, is spared waived or otherwise considered as if paid in whole
or in part by the foreign country, a Swiss foreign-tax credit would be allowed for the whole or
for the part, as the case may be, of the foreign tax so spared or waived or considered as if
paid by the foreign country.
While it may be true that claims for refund are construed strictly against the claimant,
nevertheless, the fact that Switzerland did not impose any tax or the dividends received by
Glaro from the Philippines should be considered as a full satisfaction of the given condition.
For, as aptly stated by respondent Court, to deny private respondent the privilege to
withhold only 15% tax provided for under Presidential Decree No. 369, amending Section 24
(b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and
definitely will adversely affect foreign corporations" interest here and discourage them from
investing capital in our country.
Besides, it is significant to note that the conclusion reached by respondent Court is but a
confirmation of the May 19, 1977 ruling of petitioner that "since the Swiss Government does
not impose any tax on the dividends to be received by the said parent corporation in the
Philippines, the condition imposed under the above-mentioned section is satisfied.
Accordingly, the withholding tax rate of 15% is hereby affirmed."
Moreover, as a matter of principle, this Court will not set aside the conclusion reached by an
agency such as the Court of Tax Appeals which is, by the very nature of its function,
dedicated exclusively to the study and consideration of tax problems and has necessarily
developed an expertise on the subject unless there has been an abuse or improvident
exercise of authority (Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, which is
not present in the instant case.
WHEREFORE, the petition filed is DISMISSED for lack of merit.

MARUBENI CORPORATION (formerly Marubeni — Iida, Co., Ltd.), petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE AND COURT OF TAX APPEALS,
respondents.

Melquiades C. Gutierrez for petitioner.

The Solicitor General for respondents.

FERNAN, C.J.:

Petitioner, Marubeni Corporation, representing itself as a foreign corporation duly

organized and existing under the laws of Japan and duly licensed to engage in business
under Philippine laws with branch office at the 4th Floor, FEEMI Building, Aduana
Street, Intramuros, Manila seeks the reversal of the decision of the Court of Tax Appeals
1
dated February 12, 1986 denying its claim for refund or tax credit in the amount of
P229,424.40 representing alleged overpayment of branch profit remittance tax withheld
from dividends by Atlantic Gulf and Pacific Co. of Manila (AG&P).

The following facts are undisputed: Marubeni Corporation of Japan has equity
investments in AG&P of Manila. For the first quarter of 1981 ending March 31, AG&P
declared and paid cash dividends to petitioner in the amount of P849,720 and withheld
the corresponding 10% final dividend tax thereon. Similarly, for the third quarter of 1981
ending September 30, AG&P declared and paid P849,720 as cash dividends to
petitioner and withheld the corresponding 10% final dividend tax thereon. 2

AG&P directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not
only of the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of
1981, but also of the withheld 15% profit remittance tax based on the remittable amount after
deducting the final withholding tax of 10%. A schedule of dividends declared and paid by AG&P
to its stockholder Marubeni Corporation of Japan, the 10% final intercorporate dividend tax and
the 15% branch profit remittance tax paid thereon, is shown below:

1981 FIRST THIRD TOTAL OF

QUARTER QUARTER FIRST and
(three months (three months THIRD quarters
ended 3.31.81) ended 9.30.81)
(In Pesos)

Cash Dividends Paid 849,720.44 849,720.00 1,699,440.00

10% Dividend Tax 84,972.00 84,972.00 169,944.00

Withheld

Cash Dividend net of 10% 764,748.00 764,748.00 1,529,496.00

Dividend Tax Withheld

15% Branch Profit 114,712.20 114,712.20 229,424.40 3

Remittance Tax Withheld

Net Amount Remitted to 650,035.80 650,035.80 1,300,071.60

Petitioner

The 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of
P114,712.20 for the first quarter of 1981 were paid to the Bureau of Internal Revenue by
AG&P on April 20, 1981 under Central Bank Receipt No. 6757880. Likewise, the 10%
final dividend tax of P84,972 and the 15% branch profit remittance tax of P114,712 for
the third quarter of 1981 were paid to the Bureau of Internal Revenue by AG&P on
August 4, 1981 under Central Bank Confirmation Receipt No. 7905930. 4

Thus, for the first and third quarters of 1981, AG&P as withholding agent paid 15%
branch profit remittance on cash dividends declared and remitted to petitioner at its
head office in Tokyo in the total amount of P229,424.40 on April 20 and August 4, 1981.
5

In a letter dated January 29, 1981, petitioner, through the accounting firm Sycip, Gorres,
Velayo and Company, sought a ruling from the Bureau of Internal Revenue on whether
or not the dividends petitioner received from AG&P are effectively connected with its
conduct or business in the Philippines as to be considered branch profits subject to the
15% profit remittance tax imposed under Section 24 (b) (2) of the National Internal
Revenue Code as amended by Presidential Decrees Nos. 1705 and 1773.

In reply to petitioner's query, Acting Commissioner Ruben Ancheta ruled:

Pursuant to Section 24 (b) (2) of the Tax Code, as amended, only profits remitted abroad
by a branch office to its head office which are effectively connected with its trade or
business in the Philippines are subject to the 15% profit remittance tax. To be effectively
connected it is not necessary that the income be derived from the actual operation of
taxpayer-corporation's trade or business; it is sufficient that the income arises from the
 business activity in which the corporation is engaged. For example, if a resident foreign
corporation is engaged in the buying and selling of machineries in the Philippines and
invests in some shares of stock on which dividends are subsequently received, the
dividends thus earned are not considered 'effectively connected' with its trade or business
in this country. (Revenue Memorandum Circular No. 55-80).

In the instant case, the dividends received by Marubeni from AG&P are not income
arising from the business activity in which Marubeni is engaged. Accordingly, said
dividends if remitted abroad are not considered branch profits for purposes of the 15%
profit remittance tax imposed by Section 24 (b) (2) of the Tax Code, as amended . . . 6

Consequently, in a letter dated September 21, 1981 and filed with the Commissioner of
Internal Revenue on September 24, 1981, petitioner claimed for the refund or issuance
of a tax credit of P229,424.40 "representing profit tax remittance erroneously paid on
the dividends remitted by Atlantic Gulf and Pacific Co. of Manila (AG&P) on April 20 and
August 4, 1981 to ... head office in Tokyo. 7

On June 14, 1982, respondent Commissioner of Internal Revenue denied petitioner's

claim for refund/credit of P229,424.40 on the following grounds:

While it is true that said dividends remitted were not subject to the 15% profit remittance
tax as the same were not income earned by a Philippine Branch of Marubeni Corporation
of Japan; and neither is it subject to the 10% intercorporate dividend tax, the recipient of
the dividends, being a non-resident stockholder, nevertheless, said dividend income is
subject to the 25 % tax pursuant to Article 10 (2) (b) of the Tax Treaty dated February 13,
1980 between the Philippines and Japan.

Inasmuch as the cash dividends remitted by AG&P to Marubeni Corporation, Japan is

subject to 25 % tax, and that the taxes withheld of 10 % as intercorporate dividend tax
and 15 % as profit remittance tax totals (sic) 25 %, the amount refundable offsets the
liability, hence, nothing is left to be refunded. 8

Petitioner appealed to the Court of Tax Appeals which affirmed the denial of the refund
by the Commissioner of Internal Revenue in its assailed judgment of February 12, 1986.
9

In support of its rejection of petitioner's claimed refund, respondent Tax Court explained:

Whatever the dialectics employed, no amount of sophistry can ignore the fact that the
dividends in question are income taxable to the Marubeni Corporation of Tokyo, Japan.
The said dividends were distributions made by the Atlantic, Gulf and Pacific Company of
Manila to its shareholder out of its profits on the investments of the Marubeni Corporation
of Japan, a non-resident foreign corporation. The investments in the Atlantic Gulf &
Pacific Company of the Marubeni Corporation of Japan were directly made by it and the
dividends on the investments were likewise directly remitted to and received by the
Marubeni Corporation of Japan. Petitioner Marubeni Corporation Philippine Branch has
no participation or intervention, directly or indirectly, in the investments and in the receipt
of the dividends. And it appears that the funds invested in the Atlantic Gulf & Pacific
Company did not come out of the funds infused by the Marubeni Corporation of Japan to
the Marubeni Corporation Philippine Branch. As a matter of fact, the Central Bank of the
Philippines, in authorizing the remittance of the foreign exchange equivalent of (sic) the
dividends in question, treated the Marubeni Corporation of Japan as a non-resident
 stockholder of the Atlantic Gulf & Pacific Company based on the supporting documents
submitted to it.

Subject to certain exceptions not pertinent hereto, income is taxable to the person who
earned it. Admittedly, the dividends under consideration were earned by the Marubeni
Corporation of Japan, and hence, taxable to the said corporation. While it is true that the
Marubeni Corporation Philippine Branch is duly licensed to engage in business under
Philippine laws, such dividends are not the income of the Philippine Branch and are not
taxable to the said Philippine branch. We see no significance thereto in the identity
concept or principal-agent relationship theory of petitioner because such dividends are
the income of and taxable to the Japanese corporation in Japan and not to the Philippine
branch. 10

Hence, the instant petition for review.

It is the argument of petitioner corporation that following the principal-agent relationship

theory, Marubeni Japan is likewise a resident foreign corporation subject only to the 10
% intercorporate final tax on dividends received from a domestic corporation in
accordance with Section 24(c) (1) of the Tax Code of 1977 which states:

Dividends received by a domestic or resident foreign corporation liable to tax under this
Code — (1) Shall be subject to a final tax of 10% on the total amount thereof, which shall
be collected and paid as provided in Sections 53 and 54 of this Code ....

Public respondents, however, are of the contrary view that Marubeni, Japan, being a
non-resident foreign corporation and not engaged in trade or business in the
Philippines, is subject to tax on income earned from Philippine sources at the rate of 35
% of its gross income under Section 24 (b) (1) of the same Code which reads:

(b) Tax on foreign corporations — (1) Non-resident corporations. — A foreign corporation

not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five per
cent of the gross income received during each taxable year from all sources within the
Philippines as ... dividends ....

but expressly made subject to the special rate of 25% under Article 10(2) (b) of the Tax
Treaty of 1980 concluded between the Philippines and Japan. 11 Thus:

Article 10 (1) Dividends paid by a company which is a resident of a Contracting State to a

resident of the other Contracting State may be taxed in that other Contracting State.

(2) However, such dividends may also be taxed in the Contracting State of which the
company paying the dividends is a resident, and according to the laws of that Contracting
State, but if the recipient is the beneficial owner of the dividends the tax so charged shall
not exceed;

(a) . . .

(b) 25 per cent of the gross amount of the dividends in all other cases.
Central to the issue of Marubeni Japan's tax liability on its dividend income from
Philippine sources is therefore the determination of whether it is a resident or a non-
resident foreign corporation under Philippine laws.

Under the Tax Code, a resident foreign corporation is one that is "engaged in trade or
business" within the Philippines. Petitioner contends that precisely because it is
engaged in business in the Philippines through its Philippine branch that it must be
considered as a resident foreign corporation. Petitioner reasons that since the Philippine
branch and the Tokyo head office are one and the same entity, whoever made the
investment in AG&P, Manila does not matter at all. A single corporate entity cannot be
both a resident and a non-resident corporation depending on the nature of the particular
transaction involved. Accordingly, whether the dividends are paid directly to the head
office or coursed through its local branch is of no moment for after all, the head office
and the office branch constitute but one corporate entity, the Marubeni Corporation,
which, under both Philippine tax and corporate laws, is a resident foreign corporation
because it is transacting business in the Philippines.

The Solicitor General has adequately refuted petitioner's arguments in this wise:

The general rule that a foreign corporation is the same juridical entity as its branch office
in the Philippines cannot apply here. This rule is based on the premise that the business
of the foreign corporation is conducted through its branch office, following the principal
agent relationship theory. It is understood that the branch becomes its agent here. So that
when the foreign corporation transacts business in the Philippines independently of its
branch, the principal-agent relationship is set aside. The transaction becomes one of the
foreign corporation, not of the branch. Consequently, the taxpayer is the foreign
corporation, not the branch or the resident foreign corporation.

Corollarily, if the business transaction is conducted through the branch office, the latter
becomes the taxpayer, and not the foreign corporation. 12

In other words, the alleged overpaid taxes were incurred for the remittance of dividend
income to the head office in Japan which is a separate and distinct income taxpayer
from the branch in the Philippines. There can be no other logical conclusion considering
the undisputed fact that the investment (totalling 283.260 shares including that of
nominee) was made for purposes peculiarly germane to the conduct of the corporate
affairs of Marubeni Japan, but certainly not of the branch in the Philippines. It is thus
clear that petitioner, having made this independent investment attributable only to the
head office, cannot now claim the increments as ordinary consequences of its trade or
business in the Philippines and avail itself of the lower tax rate of 10 %.

But while public respondents correctly concluded that the dividends in dispute were
neither subject to the 15 % profit remittance tax nor to the 10 % intercorporate dividend
tax, the recipient being a non-resident stockholder, they grossly erred in holding that no
refund was forthcoming to the petitioner because the taxes thus withheld totalled the 25
% rate imposed by the Philippine-Japan Tax Convention pursuant to Article 10 (2) (b).
To simply add the two taxes to arrive at the 25 % tax rate is to disregard a basic rule in
taxation that each tax has a different tax basis. While the tax on dividends is directly
levied on the dividends received, "the tax base upon which the 15 % branch profit
remittance tax is imposed is the profit actually remitted abroad." 13

Public respondents likewise erred in automatically imposing the 25 % rate under Article
10 (2) (b) of the Tax Treaty as if this were a flat rate. A closer look at the Treaty reveals
that the tax rates fixed by Article 10 are the maximum rates as reflected in the phrase
"shall not exceed." This means that any tax imposable by the contracting state
concerned should not exceed the 25 % limitation and that said rate would apply only if
the tax imposed by our laws exceeds the same. In other words, by reason of our
bilateral negotiations with Japan, we have agreed to have our right to tax limited to a
certain extent to attain the goals set forth in the Treaty.

Petitioner, being a non-resident foreign corporation with respect to the transaction in

question, the applicable provision of the Tax Code is Section 24 (b) (1) (iii) in
conjunction with the Philippine-Japan Treaty of 1980. Said section provides:

(b) Tax on foreign corporations. — (1) Non-resident corporations — ... (iii) On dividends
received from a domestic corporation liable to tax under this Chapter, the tax shall be
15% of the dividends received, which shall be collected and paid as provided in Section
53 (d) of this Code, subject to the condition that the country in which the non-resident
foreign corporation is domiciled shall allow a credit against the tax due from the non-
resident foreign corporation, taxes deemed to have been paid in the Philippines
equivalent to 20 % which represents the difference between the regular tax (35 %) on
corporations and the tax (15 %) on dividends as provided in this Section; ....

Proceeding to apply the above section to the case at bar, petitioner, being a non-
resident foreign corporation, as a general rule, is taxed 35 % of its gross income from all
sources within the Philippines. [Section 24 (b) (1)].

However, a discounted rate of 15% is given to petitioner on dividends received from a

domestic corporation (AG&P) on the condition that its domicile state (Japan) extends in
favor of petitioner, a tax credit of not less than 20 % of the dividends received. This 20
% represents the difference between the regular tax of 35 % on non-resident foreign
corporations which petitioner would have ordinarily paid, and the 15 % special rate on
dividends received from a domestic corporation.

Consequently, petitioner is entitled to a refund on the transaction in question to be

computed as follows:

Total cash dividend paid ................P1,699,440.00

less 15% under Sec. 24
(b) (1) (iii ) .........................................254,916.00
------------------

Cash dividend net of 15 % tax

due petitioner ...............................P1,444.524.00
less net amount
 actually remitted .............................1,300,071.60
-------------------

Amount to be refunded to petitioner

representing overpayment of
taxes on dividends remitted ..............P 144 452.40
===========

It is readily apparent that the 15 % tax rate imposed on the dividends received by a
foreign non-resident stockholder from a domestic corporation under Section 24 (b) (1)
(iii) is easily within the maximum ceiling of 25 % of the gross amount of the dividends as
decreed in Article 10 (2) (b) of the Tax Treaty.

There is one final point that must be settled. Respondent Commissioner of Internal
Revenue is laboring under the impression that the Court of Tax Appeals is covered by
Batas Pambansa Blg. 129, otherwise known as the Judiciary Reorganization Act of
1980. He alleges that the instant petition for review was not perfected in accordance
with Batas Pambansa Blg. 129 which provides that "the period of appeal from final
orders, resolutions, awards, judgments, or decisions of any court in all cases shall be
fifteen (15) days counted from the notice of the final order, resolution, award, judgment
or decision appealed from ....

This is completely untenable. The cited BP Blg. 129 does not include the Court of Tax
Appeals which has been created by virtue of a special law, Republic Act No. 1125.
Respondent court is not among those courts specifically mentioned in Section 2 of BP
Blg. 129 as falling within its scope.

Thus, under Section 18 of Republic Act No. 1125, a party adversely affected by an
order, ruling or decision of the Court of Tax Appeals is given thirty (30) days from notice
to appeal therefrom. Otherwise, said order, ruling, or decision shall become final.

Records show that petitioner received notice of the Court of Tax Appeals's decision
denying its claim for refund on April 15, 1986. On the 30th day, or on May 15, 1986 (the
last day for appeal), petitioner filed a motion for reconsideration which respondent court
subsequently denied on November 17, 1986, and notice of which was received by
petitioner on November 26, 1986. Two days later, or on November 28, 1986, petitioner
simultaneously filed a notice of appeal with the Court of Tax Appeals and a petition for
review with the Supreme Court. 14 From the foregoing, it is evident that the instant
appeal was perfected well within the 30-day period provided under R.A. No. 1125, the
whole 30-day period to appeal having begun to run again from notice of the denial of
petitioner's motion for reconsideration.

WHEREFORE, the questioned decision of respondent Court of Tax Appeals dated

February 12, 1986 which affirmed the denial by respondent Commissioner of Internal
Revenue of petitioner Marubeni Corporation's claim for refund is hereby REVERSED.
The Commissioner of Internal Revenue is ordered to refund or grant as tax credit in
favor of petitioner the amount of P144,452.40 representing overpayment of taxes on
dividends received. No costs.

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,

G. R. No. 113703
January 31, 1997
-versus-

A. SORIANO CORPORATION, COURT OF TAX APPEALS

and COURT OF APPEALS,
Respondents.

DECISION

FRANCISCO, J.:

The facts of this case are undisputed. On November 27, 1987, private respondent, A.
Soriano Corporation [hereinafter referred to as ANSCOR for brevity], filed with the
respondent, Court of Tax Appeals, a petition for refund of excess tax payments it made
to the Bureau of Internal Revenue [BIR] in the amount of P273,876.05 for the year 1985
and P1,126,065.40 for the year 1986 or a total amount of P1,399,941.45, arriving at the
foregoing amount as follows:
1985

Prior years' excess income tax payments P3,016,841.00 [Exh. A] Plus:

Taxes withheld on interest P255,864.00

Rentals, etc. 812,380.00 1,068,244 [Exh. A]
P4,085,085.00
Less:
Income Tax P2,620,347.00
1981 tax credit claimed in CTA Case No. 3964 1,190,861.95
3,811,208.95
Excess tax payment P273,876.05 [Exh. D]

1986

Taxes withheld by withholding agents 1,126,065.40 [Exh. C]

Total excess tax payments P1,399,941.45"[1]
During trial before the Court of Tax Appeals, ANSCOR presented evidence to
substantiate its claim, to which no objection was interposed by the petitioner,
Commissioner of Internal Revenue, except for the purposes for which they were offered.
When ANSCOR rested its case, the petitioner, instead of presenting evidence, submitted
the case for decision solely upon the evidence adduced by ANSCOR and the pleadings on
record.[2]

On August 7, 1991, the Court of Tax Appeals rendered a decision, the pertinent portion
of which reads:

In the light of the course respondent has chosen to prove his case, the approach
turns out short. In a very recent case [Citytrust Banking Corporation vs.
Commissioner of Internal Revenue, CTA Case No. 4099, May 28, 1991] we
conclude under similar circumstances:
Respondent did not object to the existence of statements and certificates
which were offered by petitioner as proof of the withholding taxes but took
exception to their contents and purposes. Despite said reservation, up
until the submission of this case for decision, respondent was not heard to
complain about the veracity of the contents of these documents or exhibits
nor has it shown any irregularity in the same which will taint their
reliability or sufficiency as proofs of the taxes withheld despite the fact that
it is well within their competence to do so. Respondent is thereby
considered to have admitted the truth of the contents of these exhibits.
Hence, those amounts of withheld taxes which are supported by
corresponding statements or certificates of withholding taxes admitted in
evidence shall be allowed as tax credits.
Nor does the failure of respondent affect only the subject of 1985 taxes
Against the claimed deductions by petitioner for 1986, which it supported
with tax returns as evidence, respondent could only give out the
perfunctory resistance such as that 'mere allegation of net loss does not
ipso facto merit a refund'. But respondent for his part, did not present any
evidence that would have dispute the correctness of the tax returns and
other material facts therein [Citytrust Banking Corporation vs.
Commissioner of Internal Revenue, supra].
xxx xxx xxx
WHEREFORE, the petition is hereby GRANTED. Respondent is ordered to issue
a tax credit memorandum to petitioner in the sum of P1,399,941.45 to be used as
payment for its internal revenue tax liabilities."[3]

On September 17, 1991, the petitioner filed a motion for reconsideration of the foregoing
decision. Seeking the admission in evidence of a report [4] submitted only on September
18, 1991 by the BIR Official who investigated ANSCOR's claim for refund, a
supplemental motion for reconsideration was filed by the petitioner on September 27,
1991. The Court of Tax Appeals, however, denied the petitioner's motion for
reconsideration and supplemental motion for reconsideration. In a resolution dated
December 9, 1992, it held, among others, that the petitioner cannot be allowed to
present the BIR report of September 18, 1991 because such report was in the personal
physical possession of a subordinate of the petitioner during the trial and is therefore
not in the nature of a newly discovered evidence but is merely "forgotten evidence." [5]
The petitioner appealed to the Court of Appeals which affirmed the assailed decision
and resolution of the Court of Tax Appeals. Hence, this Petition for Review on Certiorari
raising the singular issue of: "whether CTA. Case No. 4201 should be reopened in order
to allow petitioner to present in evidence the report of investigation of the BIR officer on
private respondent's claim for refund."[6]

It is evident that what the petitioner sought before the Court of Tax Appeals was actually
a new trial on the ground of newly discovered evidence. Thus, as correctly put by
ANSCOR in its Comment to the Petition, the resolution of the above stated issue hinges
on the determination of the nature of the BIR report either as newly discovered
evidence, warranting a trial de novo, or "forgotten evidence" which can no longer be
considered on appeal.[7]

Section 5, Rule 13 of the Rules of the Court of Tax Appeals provides that the provisions
of Rule 37 of the Rules of Court shall be applicable to motions for new trial before the
Court of Tax Appeals. Under Section 1, Rule 37 of the Rules of Court, the requisites for
newly discovered evidence as a ground for a new trial are: [a] the evidence was
discovered after the trial; [b] such evidence could not have been discovered and
produced at the trial with reasonable diligence; and [c] that it is material, not merely
cumulative, corroborative or impeaching, and is of such weight that, if admitted, will
probably change the judgment. [8] All three requisites must characterize the evidence
sought to be introduced at the new trial.

We agree with the ruling of the respondent Courts that the BIR report of September 18,
1991 does not qualify as newly discovered evidence. Aside from petitioner's bare
assertion that the said report was not yet in existence at the time of the trial, he
miserably failed to offer any evidence to prove that the same could not have been
discovered and produced at the trial despite reasonable diligence. Why such a report of
vital significance could not have been prepared and presented during the four [4] long
years that the case was pending before the Court of Tax Appeals is simply beyond our
comprehension. Worse, petitioner did not even endeavor to explain this circumstance.

Perhaps realizing that under the Rules the said report cannot be correctly admitted as
newly discovered evidence, the petitioner invokes a liberal application of the Rules. He
submits that Section 8 of the Rules of the Court of Tax Appeals declaring that the latter
shall not be governed strictly by technical rules of evidence mandates a relaxation of the
requirements of new trial on the basis of newly discovered evidence. This is a dangerous
proposition and one which we refuse to countenance. we cannot agree more with the
Court of Appeals when it stated thus:

To accept the contrary view of the petitioner would give rise to a dangerous
precedent in that there would be no end to a hearing before respondent court
because, every time a party is aggrieved by its decision, he can have it set aside by
asking to be allowed to present additional evidence without having to comply
with the requirements of a motion for a new trial based on newly discovered
 evidence. Rule 13, Section 5 of the Rules of the Court of Tax Appeals should not
be ignored at will and at random to the prejudice of the orderly presentation of
issues and their resolution. To do so would affect, to a considerable extent, the
principle of stability of judicial decision.[9]

We are left with no recourse but to conclude that this is a simple case of negligence on
the part of the petitioner. For this act of negligence, the petitioner cannot be allowed to
seek refuge in a liberal application of the Rules. For it should not be forgotten that the
first and fundamental concern of the rules of procedure is to secure a just determination
of every action. In the case at bench, a liberal application of the rules of procedure to
suit the petitioner's purpose would clearly pave the way for injustice as it would be
rewarding an act of negligence with undeserved tolerance.

WHEREFORE, the petition is hereby DENIED and the assailed decision of the Court of
Appeals dated January 31, 1994 is AFFIRMED in toto.

COMMISIONER OF INTERNAL REVENUE vs. S.C. JOHNSON AND SON, INC.,

July 11, 2009, 11:16 pm
Filed under: PUBLIC INTL'L LAW, Treaty

Facts:

S.C. JOHNSON AND SON, INC., a domestic corporation organized and operating under
the Philippine laws, entered into a license agreement with SC Johnson and Son, United States of
America (USA), a non-resident foreign corporation based in the U.S.A. pursuant to which the
[respondent] was granted the right to use the trademark, patents and technology owned by the
latter including the right to manufacture, package and distribute the products covered by the
Agreement and secure assistance in management, marketing and production from SC Johnson
and Son, U. S. A.

The said License Agreement was duly registered with the Technology Transfer Board of
the Bureau of Patents, Trade Marks and Technology Transfer under Certificate of Registration
No. 8064.For the use of the trademark or technology, [respondent] was obliged to pay SC
Johnson and Son, USA royalties based on a percentage of net sales and subjected the same to
25% withholding tax on royalty payments which [respondent] paid for the period covering July
1992 to May 1993 in the total amount of P1,603,443.00

On October 29, 1993, [respondent] filed with the International Tax Affairs Division
(ITAD) of the BIR a claim for refund of overpaid withholding tax on royalties arguing that, “the
antecedent facts attending [respondent's] case fall squarely within the same circumstances under
which said MacGeorge and Gillete rulings were issued. Since the agreement was approved by
the Technology Transfer Board, the preferential tax rate of 10% should apply to the [respondent].
We therefore submit that royalties paid by the [respondent] to SC Johnson and Son, USA is only
subject to 10% withholding tax pursuant to the most-favored nation clause of the RP-US Tax
Treaty [Article 13 Paragraph 2 (b) (iii)] in relation to the RP-West Germany Tax Treaty [Article
12 (2) (b)]” (Petition for Review [filed with the Court of Appeals]

The RP-US Tax Treaty states that:

1) Royalties derived by a resident of one of the Contracting States from sources within the other
Contracting State may be taxed by both Contracting States.

2) However, the tax imposed by that Contracting State shall not exceed.

a) In the case of the United States, 15 percent of the gross amount of the royalties, and

b) In the case of the Philippines, the least of:

(i) 25 percent of the gross amount of the royalties;

(ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation
registered with the Philippine Board of Investments and engaged in preferred areas of activities;
and

(iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid
under similar circumstances to a resident of a third State.

The RP-Germany Tax Treaty provides:

(2) However, such royalties may also be taxed in the Contracting State in which they arise, and
according to the law of that State, but the tax so charged shall not exceed:

b) 10 percent of the gross amount of royalties arising from the use of, or the right to use, any
patent, trademark, design or model, plan, secret formula or process, or from the use of or the
right to use, industrial, commercial, or scientific equipment, or for information concerning
industrial, commercial or scientific experience.

For as long as the transfer of technology, under Philippine law, is subject to approval, the
limitation of the tax rate mentioned under b) shall, in the case of royalties arising in the Republic
of the Philippines, only apply if the contract giving rise to such royalties has been approved by
the Philippine competent authorities.

The Commissioner did not act on said claim for refund. Private respondent S.C. Johnson &
Son, Inc. (S.C. Johnson) then filed a petition for review before the Court of Tax Appeals
(CTA).The Court of Tax Appeals rendered its decision in favor of S.C. Johnson and ordered the
Commissioner of Internal Revenue to issue a tax credit certificate in the amount of P963,266.00
representing overpaid withholding tax on royalty payments, beginning July, 1992 to May, 1993.2
 The Commissioner of Internal Revenue thus filed a petition for review with the Court of
Appeals which rendered the decision finding no merit in the petition and affirming in toto the
CTA ruling.

Thus, this petition.

Issue:

Whether the Court of Appeals erred in ruling that SC Johnson and Son, USA is entitled to
the “Most Favored Nation” Tax rate of 10% on Royalties as provide in the RP-US Tax Treaty in
relation to the RP-West Germany Tax Treaty?

Ruling:.

Under Article 24 of the RP-West Germany Tax Treaty, the Philippine tax paid on income
from sources within the Philippines is allowed as a credit against German income and
corporation tax on the same income. In the case of royalties for which the tax is reduced to 10 or
15 percent according to paragraph 2 of Article 12 of the RP-West Germany Tax Treaty, the credit
shall be 20% of the gross amount of such royalty. To illustrate, the royalty income of a German
resident from sources within the Philippines arising from the use of, or the right to use, any
patent, trade mark, design or model, plan, secret formula or process, is taxed at 10% of the gross
amount of said royalty under certain conditions. The rate of 10% is imposed if credit against the
German income and corporation tax on said royalty is allowed in favor of the German resident.
That means the rate of 10% is granted to the German taxpayer if he is similarly granted a credit
against the income and corporation tax of West Germany. The clear intent of the “matching
credit” is to soften the impact of double taxation by different jurisdictions.

The RP-US Tax Treaty contains no similar “matching credit” as that provided under the
RP-West Germany Tax Treaty. Hence, the tax on royalties under the RP-US Tax Treaty is not
paid under similar circumstances as those obtaining in the RP-West Germany Tax Treaty.
Therefore, the “most favored nation” clause in the RP-West Germany Tax Treaty cannot be
availed of in interpreting the provisions of the RP-US Tax Treaty.5

The rationale for the most favored nation clause, the concessional tax rate of 10 percent
provided for in the RP-Germany Tax Treaty should apply only if the taxes imposed upon
royalties in the RP-US Tax Treaty and in the RP-Germany Tax Treaty are paid under similar
circumstances. This would mean that private respondent must prove that the RP-US Tax Treaty
grants similar tax reliefs to residents of the United States in respect of the taxes imposable upon
royalties earned from sources within the Philippines as those allowed to their German
counterparts under the RP-Germany Tax Treaty.

The RP-US and the RP-West Germany Tax Treaties do not contain similar provisions on
tax crediting. Article 24 of the RP-Germany Tax Treaty expressly allows crediting against
German income and corporation tax of 20% of the gross amount of royalties paid under the law
of the Philippines. On the other hand, Article 23 of the RP-US Tax Treaty, which is the
counterpart provision with respect to relief for double taxation, does not provide for similar
crediting of 20% of the gross amount of royalties paid.

Since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes
paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private
respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the
reason that there is no payment of taxes on royalties under similar circumstances.

WISE & CO., INC., ET. AL., vs. MEER

FACTS: Wise & Co., Inc. et. al (Plaintiff-appellants) were stockholders of Manila Wine Merchants, Ltd., a
foreign corporation duly authorized to do business in the Philippines. The Board of Directors of Manila
Wine Merchants, Ltd., (HK Co.), recommended to the stockholders that they adopt resolutions necessary
to sell its business and assets to Manila Wine Merchants, Inc., a Philippine corporation, (PH Co.), for the
sum of P400,000. The HK Co. made a distribution from its earnings for the year 1937 to its stockholders.
As a result of the sale of its business and assets to PH Co., a surplus was realized and the HK Co.
distributed this surplus to the shareholders (Appellants included).
Philippine income tax had been paid by HK Co. on the said surplus from which the said distributions were
made. At a special general meeting of the shareholders of the HK Co., the stockholders by resolution
directed that the company be voluntarily liquidated and its capital distributed among the stockholders. The
Appellants duly filed Income Tax Returns, on which the defendant, Meer (CIR) made deficiency
assessments. Plantiffs paid under written protest and sought recovery. CFI ruled in favor of CIR hence the
appeal.

SC HELD: CFI judgment affirmed. (Subsequent Motion for Reconsideration by Wise, et. al. denied)

ISSUES and RULINGS:

1.) Appellants contend that the amounts received by them and on which the taxes in question were
assessed and collected were ordinary dividends; CIR contends that they were liquidating dividends.
SC: The distributions under consideration were not ordinary dividends. Therefore, they are taxable as
liquidating dividends. It was stipulated in the deed of sale that the sale and transfer of the HK Co. shall
take effect on June 1, 1937. Distribution took place on June 8. They could not consistently deem all the
business and assets of the corporation sold as of June 1, 1937, and still say that said corporation, as a
going concern, distributed ordinary dividends to them thereafter.

2.) Are such liquidating dividends taxable income?

SC: Income tax law states that “Where a corporation, partnership, association, joint-account, or insurance
company distributes all of its assets in complete liquidation or dissolution, the gain realized or loss
sustained by the stockholder, whether individual or corporation, is a taxable income or a deductible loss
as the case may be.”
Appellants received the distributions in question in exchange for the surrender and relinquishment by
them of their stock in the HK Co. which was dissolved and in process of complete liquidation. That money
in the hands of the corporation formed a part of its income and was properly taxable to it under the
Income Tax Law. When the corporation was dissolved and in process of complete liquidation and its
shareholders surrendered their stock to it and it paid the sums in question to them in exchange, a
transaction took place. The shareholder who received the consideration for the stock earned that much
money as income of his own, which again was properly taxable to him under the Income Tax Law.

3.) Non-resident alien individual appellants contend that if the distributions received by them were to be
considered as a sale of their stock to the HK Co., the profit realized by them does not constitute income
from Philippine sources and is not subject to Philippine taxes, "since all steps in the carrying out of this
so-called sale took place outside the Philippines."
SC: This contention is untenable. The HK Co. was at the time of the sale of its business in the
Philippines, and the PH Co. was a domestic corporation domiciled and doing business also in the
Philippines. The HK Co. was incorporated for the purpose of carrying on in the Philippine Islands the
business of wine, beer, and spirit merchants and the other objects set out in its memorandum of
association. Hence, its earnings, profits, and assets, including those from whose proceeds the
distributions in question were made, the major part of which consisted in the purchase price of the
business, had been earned and acquired in the Philippines. As such, it is clear that said distributions were
income "from Philippine sources."