E.

INCOME TAXATION INCOME DISTINGUISHED FROM CAPITAL

[G.R. No. 108576. January 20, 1999.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP.,respondents. M. L. Gadioma Law Office for private respondent. The Solicitor General for petitioner. SYNOPSIS Don Andres Soriano, a citizen and resident of the United States formed in the 1930's the corporation "A Soriano Y Cia," predecessor of ANSCOR. On December 30, 1964 Don Andres died. On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from Don Andres' estate. By November 1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About a year later ANSCOR again redeemed 80,000 common shares from Don Andres' estate, further reducing the latter's common shareholdings. ANSCOR's business purpose for both redemptions of stock is to partially retire said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared. In 1973, after examining ANSCOR's books of account and records Revenue Examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue Code for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks. Subsequently, ANSCOR filed a petition for review with the Court of Tax Appeals assailing the tax assessments on the redemptions and exchange of stocks. In its decision, the CTA reversed the BIR's ruling after finding sufficient evidence to overcome the prima facie correctness of the questioned assessments. In a petition for review, the Court of Appeals affirmed the ruling of the CTA. Hence, the present petition. The issue is whether ANSCOR's redemption of stocks from its stockholders as well as the exchange of common shares can be considered as equivalent to the distribution of taxable dividend making the proceeds thereof taxable under the provisions Section 83 (B) of the 1939 Revenue Act.
SHECcT

The Supreme Court modified the decision of the Court of Appeals in that ANSCOR'S

redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is liable for the withholding tax-at-source. While the Board Resolutions authorizing the redemptions state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Said purpose was not given credence by the court in case at bar. Records show that despite the existence of enormous corporate profits no cash dividends were ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends are issued for about three decades, this circumstance negate the legitimacy of ANSCOR's alleged purposes. With regard to the exchange of shares, the Court ruled that the exchange of common with preferred shares is not taxable because it produces no realized income to the subscriber but only a modification of the subscriber's rights and privileges which is not a flow of wealth for tax purposes.
IHcTDA

SYLLABUS 1.TAXATION; PRESIDENTIAL DECREE NO. 67; NOT BEING A TAXPAYER, A WITHHOLDING AGENT LIKE THE PRIVATE RESPONDENT IS NOT PROTECTED BY THE AMNESTY UNDER THE DECREE. An income taxpayer covers all persons who derive taxable income. ANSCOR was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such, it is being held liable in its capacity as a withholding agent and not in its personality as a taxpayer. In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax in order to ensure its payments; the payer is the taxpayer he is the person subject to tax impose by law; and the payee is the taxing authority. In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the agentpayor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer, because the income tax is still impose on and due from the latter. The agent is not liable for the tax as no wealth flowed into him he earned no income. The Tax Code only makes the agent personally liable for the tax arising from the breach of its legal duty to withhold as distinguish from its duty to pay tax since: "the government's cause of action against the withholding agent is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer." Not being a taxpayer, a withholding agent, like ANSCOR in this transaction is not protected by the amnesty under the decree. Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent. The taxpayer should not answer for the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be deemed to have evaded the

tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail tax evasion and give tax evaders a chance to reform, it was deemed administratively feasible to grant tax amnesty in certain instances. In addition, a "tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by a statute, the terms of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority." The rule on strictissimi juris equally applies. So that, any doubt in the application of an amnesty law/decree should be resolved in favor of the taxing authority. 2.ID.; NATIONAL INTERNAL REVENUE CODE OF 1939; TAX ON STOCK DIVIDENDS; REDEMPTION AND CANCELLATION; PURPOSES INVOKED BY PRIVATE RESPONDENT CORPORATION, UNDER THE FACTS OF THE PRESENT CASE ARE NO EXCUSE FOR ITS TAX LIABILITY; REASON. First, the alleged "filipinization" plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a separate entity, the corporation can act only through its Board of Directors. The Board Resolutions authorizing the redemptions state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstances negates the legitimacy of ANSCOR's alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR's foreign stockholders contrary to its "filipinization" plan. This would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres' foreign heirs. Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be valid excuse for the imposition of tax. Otherwise, the taxpayer's liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was shown that income was generated therefrom. Thirdly, ANSCOR argued that to treat as 'taxable dividend' the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening purchasers, i.e. those who buys the stock dividends after their issuance. Such argument, however, bears no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into the factual milieu of the case if income was realized from the

transaction. Again, we reiterate that the dividend equivalence test depends on such "time and manner" of the transaction and its net effect. The undisclosed lien may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber. After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As "taxable dividend" under Section 83(b), it is part of the "entire income" subject to tax under Section 22 in relation to Section 21 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in "gross income." As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition.

3.ID.; ID.; ID.; THE EXCHANGE OF COMMON WITH PREFERRED SHARES IN CASE AT BAR IS NOT TAXABLE; IT PRODUCES NO REALIZED INCOME TO THE SUBSCRIBER BUT ONLY A MODIFICATION OF THE SUBSCRIBER'S RIGHTS AND PRIVILEGES WHICH IS NOT A FLOW OF WEALTH FOR TAX PURPOSES. Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doa Carmen's shares were exchanged for the whole 150,000 preferred shares. Thereafter, both the Don Andres estate and Doa Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized it was a mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be imposed. Reclassification of shares does not always bring any substantial alteration in the subscriber's proportional interest. But the exchange is different there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to a pro rata division of profits. Preferred stocks are those which entitle the shareholder to some priority on dividends and asset distribution. Both shares are part of the corporation's capital stock. Both stockholders are

no different from ordinary investors who take on the same investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the enterprise. Moreover, under the doctrine of equality of shares all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided that the Articles of Incorporation is silent on such differences. In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscriber's rights and privileges which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest.
CHEIcS

DECISION

MARTINEZ, J :
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Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of Appeals (CA) 1 which affirmed the ruling of the Court of Tax Appeals (CTA) 2 that private respondent A. Soriano Corporation's (hereinafter ANSCOR) redemption and exchange of the stocks of its foreign stockholders cannot be considered as "essentially equivalent to a distribution of taxable dividends" under Section 83(b) of the 1939 Internal Revenue Act. 3 The undisputed facts are as follows:
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Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don Andres, who are all non-resident aliens. 4 In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued. 5 On September 12, 1945, ANSCOR's authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value. Of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders waived in favor of the former their pre-emptive rights to subscribe to the new issues. 6 This increased his subscription to 14,963 common shares. 7 A month later, 8 Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR. 9 Both sons are foreigners. 10 By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were

made between 1949 and December 20, 1963. 11 On December 30, 1964 Don Andres died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares 12 50,495 of which are original issues and the balance of 134,659 shares as stock dividend declarations. 13 Correspondingly, one-half of that shareholdings or 92,577 14 shares were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate. 15 A day after Don Andres died, ANSCOR increased its capital stock to P20M 16 and in 1966 further increased it to P30M. 17 In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate 18 and Doa Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864 19 common shares each. 20 On December 28, 1967, Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme 21 under Section 367 of the 1954 U.S. Revenue Act. 22 By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. 23 In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme and not tax avoidance. 24 Consequently, 25 on March 31, 1968 Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727. 26 On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November 1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. 27 About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres' estate, 28 further reducing the latter's common shareholdings to 19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared. 29 In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-atsource, pursuant to Sections 53 and 54 of the 1939 Revenue Code, 30 for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks. 31 The Bureau of Internal Revenue (BIR) made the corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree

(P.D.) 23 32 which were amended by P.D.'s 67 and 157. 33 However, petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was assessed. 34 ANSCOR's subsequent protest on the assessments was denied in 1983 by petitioner. 35 Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks. In its decision, the Tax Court reversed petitioner's ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned assessments. 36 In a petition for review, the CA, as mentioned, affirmed the ruling of the CTA. 37 Hence, this petition.
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The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act 38 which provides:
"Sec. 83.Distribution of dividends or assets by corporations. (b)Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered astaxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen." (Italics supplied).

Specifically, the issue is whether ANSCOR's redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as "essentially equivalent to the distribution of taxable dividend," making the proceeds thereof taxable under the provisions of the above-quoted law. Petitioner contends that the exchange transaction is tantamount to "cancellation'' under Section 83(b) making the proceeds thereof taxable. It also argues that the said Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under the "net effect test," the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act. 39 ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from Doa Carmen based on the two transactions, because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the event the company would declare cash dividends,40 and to (b) subsequently "filipinized" ownership of ANSCOR, as allegedly envisioned by Don

Andres. 41 It likewise invoked the amnesty provisions of P.D. 67.

We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances of each case. 42 The findings of facts of a special court (CTA) exercising particular expertise on the subject of tax, generally binds this Court, 43 considering that it is substantially similar to the findings of the CA which is the final arbiter of questions of facts. 44 The issue in this case does not only deal with facts but whether the law applies to a particular set of facts. Moreover, this Court is not necessarily bound by the lower courts' conclusions of law drawn from such facts. 45 AMNESTY: We will deal first with the issue of tax amnesty. Section 1 of P.D. 67 46 provides:
"1.In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests or any other acquisitions from any source whatsoever which are taxable under the National Internal Revenue Code, as amended, realized here or abroad by any taxpayer, natural or juridical; the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to such disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and regulations on Immigration and Deportation, or any other applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax of ten (10%) per centum on such previously untaxed income or wealth is hereby imposed, subject to the following conditions: (conditions omitted) [Emphasis supplied].

The decree condones "the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to" (voluntary) disclosures under the NIRC of previously untaxed income and/or wealth "realized here or abroad by any taxpayer, natural or juridical." May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An income taxpayer covers all persons who derive taxable income. 47 ANSCOR was assessed by petitioner for deficiency withholding tax under Sections 53 and 54 of the 1939 Code. As such, it is being held liable in its capacity as a withholding agent and not in its personality as a taxpayer.

In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax 48 in order to ensure its payments; 49 the payer is the taxpayer he is the person subject to tax imposed by law; 50 and the payee is the taxing authority. 51 In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer, 52 because the income tax is still imposed on and due from the latter. The agent is not liable for the tax as no wealth flowed into him he earned no income. The Tax Code only makes the agent personally liable for the tax 53 arising from the breach of its legal duty to withhold as distinguished from its duty to pay tax since:
"the government's cause of action against the withholding agent is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer." 54

Not being a taxpayer, a withholding agent, like ANSCOR in this transaction, is not protected by the amnesty under the decree. Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent. 55 The taxpayer should not answer for the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be deemed to have evaded the tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail tax evasion and give tax evaders a chance to reform, 56 it was deemed administratively feasible to grant tax amnesty in certain instances. In addition, a "tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by a statute, the terms of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority." 57 The rule on strictissimi juris equally applies. 58 So that, any doubt in the application of an amnesty law/decree should be resolved in favor of the taxing authority. Furthermore, ANSCOR's claim of amnesty cannot prosper. The implementing rules of P.D. 370 which expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to wit:
"Section 4.Cases not covered by amnesty. The following cases are not covered by the amnesty subject of these regulations: xxx xxx xxx (2)Tax liabilities with or without assessments, on withholding tax at source provided under Sections 53 and 54 of the National Internal Revenue Code, as

amended; 59

ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not covered by the amnesty. TAX ON STOCK DIVIDENDS General Rule Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928. 60 It laid down the general rule known as the 'proportionate test' 61 wherein stock dividends once issued form part of the capital and, thus, subject to income tax. 62 Specifically, the general rule states that:
"A stock dividend representing the transfer of surplus to capital account shall not be subject to tax."
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Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to "stock dividends" only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient. 63 So that the mere issuance thereof is not yet subject to income tax 64 as they are nothing but an "enrichment through increase in value of capital investment." 65 As capital, the stock dividends postpone the realization of profits because the "fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution." 66 Income in tax law is "an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment." 67 It means cash or its equivalent. 68 It is gain derived and severed from capital, 69 from labor or from both combined 70 so that to tax a stock dividend would be to tax a capital increase rather than the income. 71 In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. 72 As capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth. 73 The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction.74 The Exception
"However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered astaxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred

and thirteen." (Emphasis supplied).

In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber 75 (that pro rata stock dividends are not taxable income), the exempting clause above quoted was added because corporations found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was just delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the effects of taxation. Thus, to plug the loophole the exempting clause was added. It provides that the redemption or cancellation of stock dividends, depending on the "time" and "manner" it was made, is "essentially equivalent to a distribution of taxable dividends," making the proceeds thereof "taxable income" "to the extent it represents profits". The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable. 76 Thus,
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"the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment by distributing earnings to its shareholders in two transactions apro rata stock dividend followed by a pro rata redemption that would have the same economic consequences as a simple dividend." 77

Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. 78 Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice. 79 Having realized gain from that redemption, the income earner cannot escape income tax. 80 As qualified by the phrase "such time and in such manner," the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividends. 81 So that, whether the amount distributed in the redemption should be treated as the equivalent of a "taxable dividend" is aquestion of fact, 8 2 which is determinable on "the basis of the particular facts of the transaction in question." 83 No decisive test can be used to determine the application of the exemption under Section 83(b). The use of the words "such manner" and "essentially equivalent"

negative any idea that a weighted formula can resolve a crucial issue Should the distribution be treated as taxable dividend. 84 On this aspect, American courts developed certain recognized criteria, which includes the following: 85 1)the presence or absence of real business purpose, 2)the amount of earnings and profits available for the declaration of a regular dividend and the corporation's past record with respect to the declaration of dividends, 3)the effect of the distribution as compared with the declaration of regular dividend, 4)the lapse of time between issuance and redemption, 86 5)the presence of a substantial surplus 87 and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus, 88 REDEMPTION AND CANCELLATION For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and (c) the "time and manner" of the transaction makes it "essentially equivalent to a distribution of taxable dividends." Of these, the most important is the third.
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Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock 89 in exchange for property, whether or not the acquired stock is cancelled, retired or held in the treasury. 90 Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before. The redemption of stock dividends previously issued is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the time of the last redemption, the original common shares owned by the estate were only 25,247.5. 91 This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits, 92 such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. 93 Once capital, it is always capital. 94 That doctrine was intended for the protection of corporate creditors.95 With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the manner of both the issuance and the redemption. The "time" element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares is a method usually adopted to accomplish the end sought. 96 Was this transaction used as a "continuing plan," "device" or "artifice" to evade payment of tax? It is necessary to determine the "net effect" of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. 97 The "net effect" test is not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be reached. 98 It is also important to know whether the issuance of stock dividends was dictated by legitimate business reasons, the presence of which might negate a tax evasion plan. 99
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The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related, for the redemption to be considered a legitimate tax scheme. 100 Redemption cannot be used as a cloak to distribute corporate earnings. 101 Otherwise, the apparent intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has been ruled that:
"[A]n operation with no business or corporate purpose is a mere devise which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to a stockholder." 102

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be applicable if the redeemed shares were issued with bona fide business purpose, 103 which is judged after each and every step of the transaction have been

considered and the whole transaction does not amount to a tax evasion scheme. ANSCOR invoked two reasons to justify the redemptions (1) the alleged "filipinization" program and (2) the reduction of foreign exchange remittances in case cash dividends are declared. The Court is not concerned with the wisdom of these purposes but on their relevance to the whole transaction which can be inferred from the outcome thereof. Again, it is the "net effect rather than the motives and plans of the taxpayer or his corporation" 104 that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result. 105 It also applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or avoiding tax on dividends. 106 The existence of legitimate business purposes in support of theredemption of stock dividends is immaterial in income taxation. It has no relevance in determining "dividend equivalence". 107 Such purposes may be material only upon the issuance of the stock dividends. The test of taxability under the exempting clause, when it provides "such time and manner" as would make the redemption "essentially equivalent to the distribution of a taxable dividend", is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not deemed "realize" until the fruit has fallen or been plucked from the tree. The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that the gain or profit is realized or received, actually or constructively, 108 and (3) it is not exempted by law or treaty from income tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comes from. 109 As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholder's separate property. 110 Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is supported by legitimate business reasons would defeat the very purpose of imposing tax on income. Such argument would open the door for income earners not to pay tax so long as the person from whom the income was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of Section 83(b) would be made to depend not on the income of the taxpayer, but on the business purposes of a third party (the corporation herein) from

whom the income was earned. This is absurd, illogical and impractical considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the legitimacy of business reasons that every income earner may interpose. It is not administratively feasible and cannot therefore be allowed.
cdasia

The ruling in the American cases cited and relied upon by ANSCOR that "the redeemed shares are the equivalent of dividend only if the shares were not issued for genuine business purposes", 111 or the "redeemed shares have been issued by a corporation bona fide" 112 bears no relevance in determining the non-taxability of the proceeds of redemption. ANSCOR, relying heavily and applying said cases, argued that so long as the redemption is supported by valid corporate purposes the proceeds are not subject to tax. 113 The adoption by the courts below 114 of such argument is misleading if not misplaced. A review of the cited American cases shows that the presence or absence of "genuine business purposes" may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporation's acquisition of its own shares under Section 41 of the Corporation Code, 115 such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons, the redemption becomes suspicious which may call for the application of the exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences. 116 The two purposes invoked by ANSCOR, under the facts of this case are no excuse for its tax liability. First, the alleged "filipinization" plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a separate entity, the corporation can act only through its Board of Directors. 117 The Board Resolutions authorizing the redemptions state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCOR's alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR's foreign stockholders contrary to its "filipinization" plan. This would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres' foreign heirs.

Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayer's liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was shown that income was generated therefrom. Thirdly, ANSCOR argued that to treat as 'taxable dividend' the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening purchasers, i.e. those who buys the stock dividends after their issuance. 118 Such argument, however, bears no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend equivalence test depends on such "time and manner" of the transaction and its net effect. The undisclosed lien 119 may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber.
cdasia

After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As "taxable dividend" under Section 83(b), it is part of the "entire income" subject to tax under Section 22 in relation to Section 21 120 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in "gross income". As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition. EXCHANGE OF COMMON WITH PREFERRED SHARES 121 Exchange is an act of taking or giving one thing for another 122 involving reciprocal transfer 123 and is generally considered as a taxable transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to

reorganizations. 124 Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doa Carmen's shares were exchanged for the whole 150,000 preferred shares. Thereafter, both the Don Andres estate and Doa Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized it was a mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be imposed. 125 Reclassification of shares does not always bring any substantial alteration in the subscriber's proportional interest. But the exchange is different there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to a pro rata division of profits. 126 Preferred stocks are those which entitle the shareholder to some priority on dividends and asset distribution. 127 Both shares are part of the corporation's capital stock. Both stockholders are no different from ordinary investors who take on the same investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the enterprise. 128 Moreover, under the doctrine of equality of shares all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided that the Articles of Incorporation is silent on such differences. 129
cdasia

In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscriber's rights and privileges which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest. 130 WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects. SO ORDERED.

[G.R. No. 12287. August 7, 1918.] VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffsappellants, 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. SYLLABUS 1.TAXATION; INCOME TAX; PURPOSES. The Income Tax Law of the United States in force in the Philippine Islands has selected income as the test of faculty in taxation. The aim has been to mitigate the evils arising from the 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 Law is supposed to reach the earnings of the entire non-governmental property of the country. 2.ID.; ID.; INCOME CONTRACTED WITH CAPITAL AND PROPERTY. 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. Capital is wealth, while income is the service of wealth. "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.) 3.ID.; ID.; "INCOME:," DEFINED. Income means profits or gains. 4.ID.; ID.; CONJUGAL PARTNERSHIPS. The decisions of this court in Nable Jose vs. Nable Jose [1916], 16 Off. Gaz., 871, and Manuel and Laxamanavs. Losano [1918], 16 Off. Gaz., 1265, approved and followed. The provisions of the Civil Code concerning conjugal partnerships have no application to the Income Tax Law. 5.ID.; ID.; ID. M and P were legally married prior to January 1, 1914. The marriage was contracted under the provisions concerning conjugal partnerships. The claim is submitted that the income shown on the form presented for 1914 was in fact the income of the conjugal partnership existing between M and P, and that in

computing and assessing the additional income tax, the income declared by M should be divided into two equal parts, one-half to be considered the income of M and the other half the income of P. Held: That P, the wife of M, has an inchoate right in the property of her husband M during the life of the conjugal partnership, but that P has no absolute right to one-half of the income of the conjugal partnership. 6.ID.; ID.; ID. The higher schedules of the additional tax provided by the Income Tax Law 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. The aims and purposes of the Income Tax Law must be given effect. 7.ID.; ID.; ID. The Income Tax Law does not look on the spouses as individual partners in an ordinary partnership. 8.ID.; ID.; STATUTORY CONSTRUCTION. The Income Tax Law, being a law of American origin and being peculiarly intricate in its provisions, the authoritative decision of the official charged with enforcing it has peculiar force for the Philippines. Great weight should be given to the construction placed upon a revenue law, whose meaning is doubtful, by the department charged with its execution

DECISION

MALCOLM, J :
p

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 a 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 VicenteMadrigal should be divided into two equal parts, one-half to be considered the income of Vicente Madrigal and the other half the income 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 AttorneyGeneral, 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 the 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 assessed and 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 and payable by each of the plaintiffs the sum of P2,921.09, which taken together amounts to a total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with the result that plaintiffMadrigal 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 for 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 it 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 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 in 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 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 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. AttorneyGeneral [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 as 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 of the time of claiming such exemption if such claim be made within the year for 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 AttorneyGeneral 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 married persons.' "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 additional tax provided by the statute; that 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 that 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, or where the husband and wife neither separately have an income of $3,000, but together they have an income in excess of $4,000, in which 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 and makes return thereof, or where her income is separately shown in the 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

E.7 SYSTEM OF INCOME TAXATION SCHEDULAR SYSTEM

[G.R. No. 109289. October 3, 1994.] RUFINO R. TAN, petitioner, vs. RAMON R. DEL ROSARIO, JR., as SECRETARY OF FINANCE & JOSE U. ONG, as COMMISSIONER OF INTERNAL REVENUE, respondents. [G.R. No. 109446. October 3, 1994.] CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES, CARLO A. CARAG, MANUELITO O. CABALLES, ELPIDIO C. JAMORA, JR. and BENJAMIN A. SOMERA, JR., petitioners, vs. RAMON R. DEL ROSARIO, in his capacity as SECRETARY OF FINANCE and JOSE U. ONG, in his capacity as COMMISSIONER OF INTERNAL REVENUE, respondents.

DECISION

VITUG, J :
p

These two consolidated special civil actions for prohibition challenge, in G.R. No. 109289, the constitutionality of Republic Act No. 7496, also commonly

known as the Simplified Net Income Taxation Scheme ("SNIT"), amending certain provisions of the National Internal Revenue Regulations No. 2-93, promulgated by public respondents pursuant to said law. Petitioners claim to be taxpayers adversely affected by the continued implementation of the amendatory legislation. In G.R. No. 109289, it is asserted that the enactment of Republic Act No. 7496 violates the following provisions of the Constitution:
"Article VI, Section 26 (1) Every bill passed by the Congress shall embrace only one subject which shall be expressed in the title thereof." "Article VI, Section 28 (1) The rule of the taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation." "Article III, Section 1 No person shall be deprived of . . . property without due process of law, nor shall any person be denied the equal protection of the laws."

In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No. 2-93, argue that public respondents have exceeded their rulemaking authority in applying SNIT to general professional partnerships. The Solicitor General espouses the position taken by public respondents. The Court has given due course to both petitions. The parties, in compliance with the Court's directive, have filed their respective memoranda. G.R. No. 109289 Petitioner contends that the title of House Bill No. 34314, progenitor of Republic Act No. 7496, is a misnomer or, at least, deficient for being merely entitled, "Simplified Net Income Taxation Scheme for the Self-Employed and Professionals Engaged in the Practice of their Profession" (Petition in G.R. No. 109289). The full text of the title actually reads:
"An Act Adopting the Simplified Net Income Taxation Scheme For The Self-Employed and Professionals Engaged In The Practice of Their Profession, Amending Sections 21 and 29 of the National Internal Revenue Code, as Amended."

The pertinent provisions of Sections 21 and 29, so referred to, of the National Internal Revenue Code, as now amended, provide:
"Section 21.Tax on citizens or residents. xxx xxx xxx "(f)Simplified Net Income Tax for the Self-Employed and/or

Professionals Engaged in the Practice of Profession. A tax is hereby imposed upon the taxable net income as determined in Section 27 received during each taxable year from all sources, other than income covered by paragraphs (b), (c), (d) and (e) of this section by every individual whether a citizen of the Philippines or an alien residing in the Philippines who is self-employed or practices his profession herein, determined in accordance with the following schedule: "Not over P10,0003%
Over P10,000 but not overP30,000P300 + 9% of excess overP10,000 Over P30,000 but not overP120,000P2,100 + 15% of excess over P30,000 Over P120,000 but not overP350,000P15,600 + P20% of excess over P120,000 Over P350,000P61,600 + 30% of excess over P350,000"

"SECTION 29.Deductions from gross income. In computing taxable income subject to tax under Sections 21(a), 24(a), (b) and (c); and 25 (a) (1), there shall be allowed as deductions the items specified in paragraphs (a) to (i) of this section: Provided, however, That in computing taxable income subject to tax under Section 21 (f) in the case of individuals engaged in business or practice of profession, only the following direct costs shall be allowed as deductions: "(a)Raw materials, supplies and direct labor; "(b)Salaries of employees directly engaged in activities in the course of or pursuant to the business or practice of their profession; "(c)Telecommunications, electricity, fuel, light and water; "(d)Business rentals; "(e)Depreciation; "(f)Contributions made to the Government and accredited relief organizations for the rehabilitation of calamity stricken areas declared by the President; and "(g)Interest paid or accrued within a taxable year on loans contracted from accredited financial institutions which must be proven to have been incurred in connection with the conduct of a taxpayer's profession, trade or business. "For individuals whose cost of goods sold and direct costs are difficult to determine, a maximum of forty per cent (40%) of their gross receipts shall be allowed as deductions to answer for business or professional expenses as the case may be."

On the basis of the above language of the law, it would be difficult to accept petitioner's view that the amendatory law should be considered as having now adopted a gross income, instead of as having still retained the net income,

taxation scheme. The allowance for deductible items, it is true, may have significantly been reduced by the questioned law in comparison with that which has prevailed prior to the amendment; limiting, however, allowable deductions from gross income is neither discordant with, nor opposed to, the net income tax concept. The fact of the matter is still that various deductions, which are by no means inconsequential, continue to be well provided under the new law. Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-rolling legislation intended to unite the members of the legislature who favor any one of unrelated subjects in the support of the whole act, (b) to avoid surprises or even fruad upon the legislature , and (c) to fairly apprise the people, through such publications of its proceedings as are usually made, of the subjects of legislation. 1 The above objectives of the fundamental law appear to us to have been sufficiently met. Anything else would be to require a virtual compendium of the law which could not have been the intendment of the constitutional mandate. Petitioner intimates that Republic Act No. 7496 desecrates the constitutional requirement that taxation "shall be uniform and equitable" in that the law would now attempt to tax single proprietorships and professionals differently from the manner it imposes the tax on corporations and partnerships. The contention clearly forgets, however, that such a system of income taxation has long been the prevailing rule even prior to Republic Act No. 7496. Uniformity of taxation, like the kindred concept of equal protection, merely requires that all subjects or objects of taxation, similarly situated, are to be treated alike both in privileges and liabilities (Juan Luna Subdivision vs. Sarmiento, 91 Phil. 371). Uniformity does not forfend classification as long as: (1) the standards that are used therefor are substantial and not arbitrary, (2) the categorization is germane to achieve the legislative purpose, (3) the law applies, all things being equal, to both present and future conditions, and (4) the classification applies equally well to all those belonging to the same class (Pepsi Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 771). What may instead be perceived to be apparent from the amendatory law is the legislative intent to increasingly shift the income tax system towards the schedular approach 2 in the income taxation of individual taxpayers and to maintain, by and large, the present global treatment 3 on taxable corporations. We certainly do not view this classification to be arbitrary and inappropriate. Petitioner gives a fairly extensive discussion on the merits of the law, illustrating, in the process, what he believes to be an imbalance between the tax liabilities of those covered by the amendatory law and those who are not. With the legislature primarily lies the discretion to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation. This court cannot freely delve into those matters which, by constitutional fiat, rightly

rest on legislative judgment. Of course, where a tax measure becomes so unconscionable and unjust as to amount to confiscation of property, courts will not hesitate to strike it down, for, despite all its plenitude, the power to tax cannot override constitutional proscriptions. This stage, however, has not been demonstrated to have been reached within any appreciable distance in this controversy before us. Having arrived at this conclusion, the plea of petitioner to have the law declared unconstitutional for being violative of due process must perforce fail. The due process clause may correctly be invoked only when there is a clear contravention of inherent or constitutional limitations in the exercise of the tax power. No such transgression is so evident to us. G.R No 109446 The several propositions advanced by petitioners revolve around the question of whether or not public respondents have exceeded their authority in promulgating Section 6, Revenue Regulations No. 2-93, to carry out Republic Act No. 7496. The questioned regulation reads:
"Sec. 6 General Professional Partnership The general professional partnership (GPP) and the partners comprising the GPP are covered by R.A. No. 7496. Thus, in determining the net profit of the partnership, only the direct costs mentioned in said law are to be deducted from partnership income. Also, the expenses paid or incurred by partners in their individual capacities in the practice of their profession which are not reimbursed or paid by the partnership but are not considered as direct cost, are not deductible from his gross income."

The real objection of petitioners is focused on the administrative interpretation of public respondents that would apply SNIT to partners in general professional partnerships. Petitioners cite the pertinent deliberations in Congress during its enactment of Republic Act No. 7496, also quoted by the Honorable Hernando B. Perez, minority floor leader of the House of the Representatives, in the latter's privilege speech by way of commenting on the questioned implementing regulation of public respondents following the effectivity of the law, thusly:
"'MR. ALBANO, Now Mr. Speaker, I would like to get the correct impression on this bill. Do we speak here of individuals who are earning, I mean, who earn through business enterprises and therefore, should file an income tax return? 'MR. PEREZ. That is correct, Mr. Speaker. This does not apply to corporations. It applies only to individuals.'

"(See Deliberations on H.B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis ours) "'Other deliberations support this position, to wit: 'MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from Batangas say that this bill is intended to increase collections as far as individuals are concerned and to make collection of taxes equitable? 'MR. PEREZ. That is correct, Mr. Speaker.' "(Id. at 6:40 P.M.; Emphasis ours) "In fact, in the sponsorship speech of Senator Mamintal Tamano on the Senate version of the SNITS, it is categorically stated, thus: "'This bill, Mr. President, is not applicable to business corporations or to partnerships; it is only with respect to individuals and professionals.' (Emphasis ours)"

The Court, first of all, should like to correct the apparent misconception that general professional partnerships are subject to the payment of income tax or that there is a difference in the tax treatment between individuals engaged in business or in the practice of their respective professions and partners in general professional partnerships. The fact of the matter is that a general professional partnership, unlike an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on their distributive shares of partnership profits. Section 23 of the Tax Code, which has not been amended at all by Republic Act 7496, is explicit:
"SECTION 23.Tax liability of members of general professional partnerships. (a) Persons exercising a common profession in general partnership shall be liable for income tax only in their individual capacity, and the share in the net profits of the general professional partnership to which any taxable partner would be entitled whether distributed or otherwise, shall be returned for taxation and the tax paid in accordance with the provisions of this Title. "(b)In determining his distributive share in the net income of the partnership, each partner "(1)Shall take into account separately his distributive share of the partnership's income, gain, loss, deduction, or credit to the extend provided by the pertinent provisions of this Code, and "(2)Shall be deemed to have elected the itemized deductions, unless he declares his distributive share of the gross income undiminished by his share of the deductions."

There is, then and now, no distinction in income tax liability between a person who practices his profession alone or individually and one who does it through partnership (whether registered or not) with others in the exercise of a common profession. Indeed, outside of the gross compensation income tax and the final tax on passive investment income, under the present income tax system all individuals deriving income from any source whatsoever are treated in almost invariably the same manner and under a common set of rules. We can well appreciate the concern taken by petitioners if perhaps we were to consider Republic Act No. 7496 as an entirely independent, not merely as an amendatory, piece of legislation. The view can easily become myopic, however, when the law is understood, as it should be, as only forming part of, and subject to, the whole income tax concept and precepts long obtaining under the National Internal Revenue Code. To elaborate a little, the phrase "income taxpayers" is an all embracing term used in the Tax Code, and it practically covers all persons who derive taxable income. The law, in levying the tax, adopts the most comprehensive tax situs of nationality and residence of the taxpayer (that renders citizens, regardless of residence, and resident aliens subject to income tax liability on their income from all sources) and of the generally accepted and internationally recognized income taxable base (that can subject non-resident aliens and foreign corporations to income tax on their income from Philippine sources). In the process, the Code classifies taxpayers into four main groups, namely: (1) Individuals, (2) Corporations, (3) Estates under Judicial Settlement and (4) Irrevocable Trusts (irrevocable both as to corpusand as to income). Partnerships are, under the Code, either "taxable partnerships" or "exempt partnerships." Ordinarily, partnerships, no matter how created or organized, are subject to income tax (and thus alluded to as "taxable partnerships") which, for purposes of the above categorization, are by law assimilated to be within the context of, and so legally contemplated as, corporations. Except for few variances, such as in the application of the "constructive receipt rule" in the derivation of income, the income tax approach is alike to both juridical persons. Obviously, SNIT is not intended or envisioned, as so correctly pointed out in the discussions in Congress during its deliberations on Republic Act 7496, aforequoted, to cover corporations and partnerships which are independently subject to the payment of income tax. "Exempt partnerships," upon the other hand, are not similarly identified as corporations nor even considered as independent taxable entities for income tax purposes. A general professional partnership is such an example. 4 Here, the partners themselves, not the partnership (although it is still obligated to file an income tax return [mainly for administration and data]), are liable for the payment of income tax in their individual, capacity computed their respective

and distributive shares of profits. In the determination of the tax liability, a partner does so as an individual, and there is no choice on the matter. In fine, under the Tax Code on income taxation, the general professional partnership is deemed to be no more than a mere mechanism or a flow-through entity in the generation of income by, and the ultimate distribution of such income to, respectively, each of the individual partners. Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the above standing rule as now so modified by Republic Act No. 7496 on basically the extent of allowable deductions applicable to all individual income taxpayers on their non-compensation income. There is no evident intention of the law, either before or after the amendatory legislation, to place in an unequal footing or in significant variance the income tax treatment of professionals who practice their respective professions individually and of those who do it through a general professional partnership. WHEREFORE, the petitions are DISMISSED. No special pronouncement on costs. SO ORDERED.

G. CORPORATE TAXPAYERS CORPORATE TAXPAYER DEFINITION

[G.R. No. 45425. April 29, 1939.] JOSE GATCHALIAN, ET AL., plaintiffs-appellants, vs. THE COLLECTOR OF INTERNAL REVENUE, defendant-appellee. Guillermo B. Reyes for appellants. Solicitor-General Tuason for appellee. SYLLABUS 1.PARTNERSHIP OF A CIVIL NATURE; COMMUNITY OF PROPERTY; SWEEPSTAKES; INCOME TAX. According to the stipulated facts the plaintiffs organized a partnership of a civil nature because each of them put up money to buy a sweepstakes ticket for the sole purpose of dividing equally the prize which they may win, as they did in fact in the amount of P60,000 (article 166C, Civil Code). The

partnership was not only formed, but upon the organization thereon and the winning of the prize, J. G. personally appeared in the office of the Philippine Charity Sweepstakes, in his capacity as co-partner, as such collected the prize, the office issued the check for P60,000 in favor of J. G. and company, and the said partner, in the same capacity, collected the check. All these circumstances repel the idea that the plaintiffs organized and formed a community of property only. 2.ID.; ID.; ID.; ID. Having organized and constituted a partnership of a civil nature, the said entity is the one bound to pay the income tax which the defendant collected under the aforesaid section 10 (a) of Act No. 2833, as amended by section 2 of Act No. 3761. There is no merit in plaintiffs' contention that the tax should be prorated among them and paid individually, resulting in their exemption from the tax.

DECISION

IMPERIAL, J :
p

The plaintiff brought this action to recover from the defendant Collector of Internal Revenue the sum of P1,863.44, with legal interest thereon, which they paid under protest by way of income tax. They appealed from the decision rendered in the case on October 23, 1936 by the Court of First Instance of the City of Manila, which dismissed the action with the costs against them. The case was submitted for decision upon the following stipulation of facts:
"Come now the parties to the above-mentioned case, through their respective undersigned attorneys, and hereby agree to respectfully submit to this Honorable Court the case upon the following statement of facts: "1.That plaintiffs are all residents of the municipality of Pulilan, Bulacan, and that defendant is the Collector of Internal Revenue of the Philippines; "2.That prior to December 15, 1934 plaintiffs, in order to enable them to purchase one sweepstakes ticket valued at two pesos (P2), subscribed and paid therefor the amounts as follows:

1.Jose GatchalianP0.18 2.Gregoria Cristobal.18 3.Saturnina Silva.08

4.Guillermo Tapia.13 5.Jesus Legaspi.15 6.Jose Silva.07 7.Tomasa Mercado.08 8.Julio Gatchalian.18 9.Emiliana Santiago.18 10.Maria C. Legaspi.16 11.Francisco Cabral.13 12.Gonzalo Javier.14 13.Maria Santiago.17 14.Buenaventura Guzman.13 15.Mariano Santos.14 Total2.00

"3.That immediately thereafter but prior to December 16, 1934, plaintiffs purchased, in the ordinary course of business, from one of the duly authorized agents of the National Charity Sweepstakes Office one ticket bearing No. 178637 for the sum of two pesos (P2) and that the said ticket was registered in the name of Jose Gatchalian and Company; "4.That as a result of the drawing of the sweepstakes on December 15, 1934, the above-mentioned ticket bearing No. 178637 won one of the third prizes in the amount of P50,000 and that the corresponding check covering the above-mentioned prize of P50,000 was drawn by the National Charity Sweepstakes Office in favor of Jose Gatchalian & Company against the Philippine National Bank, which check was cashed during the latter part of December, 1934 by Jose Gatchalian & Company; "5That on December 29, 1934, Jose Gatchalian was required by income tax examiner Alfredo David to file the corresponding income tax return covering the prize won by Jose Gatchalian & Company and that on December 29, 1934, the said return was signed by Jose Gatchalian, a copy of which return is enclosed

as Exhibit A and made a part hereof; "6.That on January 8, 1935, the defendant made an assessment against Jose Gatchalian & Company requesting the payment of the sum of P1,499.94 to the deputy provincial treasurer of Pulilan, Bulacan, giving to said Jose Gatchalian & Company until January 20, 1935 within which to pay the said amount of P1,499.94, a copy of which letter marked Exhibit B is inclosed and made a part hereof; "7.That on January 20, 1935, the plaintiffs, through their attorney, sent to defendant a reply, a copy of which marked Exhibit C is attached and made a part hereof, requesting exemption from the payment of the income tax to which reply there were enclosed fifteen (15) separate individual income tax returns filed separately by each one of the plaintiffs, copies of which returns are attached and marked Exhibits D-1 to D-15, respectively, in order of their names listed in the caption of this case and made parts hereof; a statement of sale signed by Jose Gatchalian showing the amounts put up by each of the plaintiffs to cover up the cost price of P2 of said ticket, copy of which statement is attached and marked as Exhibit E and made a part hereof; and a copy of the affidavit signed by Jose Gatchalian dated December 29, 1934 is attached and marked Exhibit F and made part hereof; "8.That the defendant in his letter dated January 28, 1935, a copy of which marked Exhibit G is enclosed, denied plaintiffs' request of January 20, 1935, for exemption from the payment of tax and reiterated his demand for the payment of the sum of P1,499.94 as income tax and gave plaintiffs until February 10, 1935 within which to pay the said tax; "9.That in view of the failure of the plaintiffs to pay the amount of tax demanded by the defendant, notwithstanding subsequent demand made by defendant upon the plaintiffs through their attorney on March 23, 1935, a copy of which marked Exhibit H is enclosed, defendant on May 13, 1935 issued a warrant of distraint and levy against the property of the plaintiffs, a copy of which warrant marked Exhibit I is enclosed and made a part hereof; "10.That to avoid embarrassment arising from the embargo of the property of the plaintiffs, the said plaintiffs on June 15, 1935, through Gregoria Cristobal, Maria C. Legaspi and Jesus Legaspi, paid under protest the sum of P601.51 as part of the tax and penalties to the municipal treasurer of Pulilan, Bulacan, as evidenced by official receipt No. 7454879 which is attached and marked Exhibit J and made a part hereof, and requested defendant that plaintiffs be allowed to pay under protest the balance of the tax and penalties by monthly installments; "11.That plaintiffs' request to pay the balance of the tax and penalties was granted by defendant subject to the condition that plaintiffs file the usual bond secured by two solvent persons to guarantee prompt payment of each installments as it becomes due; "12.That on July 16, 1935, plaintiff filed a bond, a copy of which marked

Exhibit K is inclosed and made a part hereof, to guarantee the payment of the balance of the alleged tax liability by monthly installments at the rate of P118.70 a month, the first payment under protest to be effected on or before July 31, 1935; "13. That on July 16, 1935 the said plaintiffs formally protested against the payment of the sum of P602.51, a copy of which protest is attached and marked Exhibit L but that defendant in his letter dated August 1, 1936 overruled the protest and denied the request for refund of the plaintiffs; "14.That, in view of the failure of the plaintiffs to pay the monthly installments in accordance with the terms and conditions of the bond filed by them, the defendant in his letter dated July 23, 1935, copy of which is attached and marked Exhibit M, ordered the municipal treasurer of Pulilan, Bulacan to execute within five days the warrant of distraint and levy issued against the plaintiffs on March 13, 1935; "15.That in order to avoid annoyance and embarrassment arising from the levy of their property, the plaintiffs on August 28, 1936, through JoseGatchalian, Guillermo Tapia, Maria Santiago and Emiliano Santiago, paid under protest to the municipal treasurer of Pulilan, Bulacan. the sum of P1,260.93 representing the unpaid balance of the income tax and penalties demanded by defendant as evidenced by income tax receipt No. 35811 which is attached and marked Exhibit N and made a part hereof; and that on September 3, 1936, the plaintiffs formally protested to the defendant against the payment of said amount and requested the refund thereof, copy of which is attached and marked Exhibit O and made part hereof; but that on September 4, 1936, the defendant overruled the protest and denied the refund thereof; copy of which is attached and marked Exhibit P and made a part hereof; and "16.That plaintiffs demanded upon defendant the refund of the total sum of one thousand eight hundred and sixty-three pesos and forty-four centavos (P1,863.44) paid under protest by them but that defendant refused and still refuses to refund ,the said amount notwithstanding the plaintiffs' demands. "17.The parties hereto reserve the right to present other and additional evidence if necessary."

Exhibit E referred to in the stipulation is of the following tenor:

"To whom it my concern: "I, Jose Gatchalian, a resident of Pulilan, Bulacan, married, of age, hereby certify, that on the 11th day of August, 1934, I sold parts of my share on ticket No. 178637 to the persons and for the amount indicated below and the part of my share remaining is also shown to wit:

PurchaserAmountAddress

1.Mariano SantosP0.14Pulilan, Bulacan. 2.Buenaventura Guzman.13Do. 3.Maria Santiago.17Do. 4.Gonzalo Javier.14Do. 5.Francisco Cabral.13Do. 6.Maria C. Legaspi.16Do. 7.Emiliana Santiago.13Do. 8.Julio Gatchalian.13Do. 9.Jose Silva.07Do.

10.Tomasa Mercado.08Do. 11.Jesus Legaspi.16Do. 12.Guillermo Tapia.18Do. 13.Saturnina Silva.08Do. 14.Gregoria Cristobal.18Do. 15.Jose Gatchalian.18Do. 2.00Total cost of said ticket; and that, therefore, the persons named above are entitled to the parts of whatever prize that might be won by said ticket.

"Pulilan, Bulacan, P. I. (Sgd.) "JOSE GATCHALIAN"

And a summary of Exhibits D-1 to D-15 inserted in the bill of exceptions as follows:

"RECAPITULATIONS OF 15 INDIVIDUAL INCOME TAX RETURNS FOR 1934 ALL DATED JANUARY 19, 1935 SUBMITTED TO THE COLLECTOR OFINTERNAL REVENUE.

ExhibitPurchasePriceNet NameNo.PricewonExpensesprize

1.Jose GatchalianD-1P0.18P4,425P4803,945 2.Gregoria CristobalD-2.184,5752,0002,575 3.Saturnina Silva D-3.081,8753601,515 4.Guillermo TapiaD-4.133,3253602,965 5.Jesus Legaspi by Maria CristobalD-5.153,8257203,105 6.Jose SilvaD-6.081,8753601,615 7.Tomasa MercadoD-7.071,8753601,515 8.Julio Gatchalian by Bea triz GuzmanD-8.133,1502402,910 9.Emiliana SantiagoD-9.133,3253602,966 10.Maria C. LegaspiD-10.164,1009603,140 11.Francisco CabralD-11.133,3253602965 12.Gonzalo JavierD-12.143,3253602,965 13.Maria SantiagoD-13.174,3503603,990 14.Buenaventura GuzmanD-14.133,3253602,965 15.Mariano Santos D-15.143,3253602,965

 2.0050,000"

The legal questions raised in plaintiffs-appellants' five assigned errors may properly be reduced to the two following: (1) Whether the plaintiffs formed a partnership, or merely a community of property without a personality of its own; in the first case it is admitted that the partnership thus formed is liable for the payment of income tax, whereas if there was merely a community of property, they are exempt from such payment; and (2) whether they should pay the tax collectively or whether the latter should be prorated among them and paid individually. The Collector of Internal Revenue collected the tax under section 10 of Act No. 2833, as last amended by section 2 of Act No. 3761, reading as follows:
"SEC. 10.(a) There shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding calendar year from all sources by every corporation, joint-stock company, partnership, joint account (cuenta en participacion), association or insurance company, organized in the Philippine Islands, no matter how created or organized, but not including duly registered general co-partnerships (compaias colectivas), a tax of three 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 calendar year from all sources within the Philippine Islands by every corporation, joint-stock company, partnership, joint account (cuenta en participacion), association, or insurance company organized, authorized, or existing under the laws of any foreign country, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise: Provided, however, That nothing in this section shall be construed as permitting the taxation of the income derived from dividends or net profits on which the normal tax has been paid. "The gain derived or loss sustained from the sale or other disposition by a corporation, joint-stock company, partnership, joint account (cuenta en participacion), association, or insurance company, or property, real, personal, or mixed, shall be ascertained in accordance with subsections (c) and (d) of section two of Act Numbered Two thousand eight hundred and thirty-three, as amended by Act Numbered Twenty-nine hundred and twenty-six. "The foregoing tax rate shall apply to the net income received by every taxable corporation, joint-stock company, partnership, joint account (cuenta en participacion), associations or insurance company in the calendar year nineteen hundred and twenty and in each year thereafter."

There is no doubt that if the plaintiffs merely formed a community of property the latter is exempt from the payment of income tax under the law. But according to

the stipulated facts the plaintiffs organized a partnership of a civil nature because each of them put up money to buy a sweepstakes ticket for the sole purpose of dividing equally the prize which they may win, as they did in fact in the amount of P50,000 (article 1665, Civil Code). The partnership was not only formed, but upon the organization thereof and the winning of the prize, Jose Gatchalian personally appeared in the office of the Philippine Charity Sweepstakes, in his capacity as co-partner, as such collected the prize, the office issued the check for P50,000 in favor of Jose Gatchalian and company, and the said partner. in the same capacity, collected the said check. All these circumstances repel the idea that the plaintiffs organized and formed a community of property only. Having organized and constituted a partnership of a civil nature, the said entity is the one bound to pay the income tax which the defendant collected under the aforesaid section 10 (a) of Act No. 2833, as amended by section 2 of Act No. 3761. There is no merit in plaintiffs' contention that the tax should be prorated among them and paid individually, resulting in their exemption from the tax. In view of the foregoing, the appealed decision is affirmed, with the costs of this instance to the plaintiff. appellants. So ordered.
CORPORATE TAXES IMPORPERLY ACCUMULATED EARNINGS

[G.R. No. L-29485. November 21, 1980.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. AYALA SECURITIES CORPORATION and THE HONORABLE COURT OF TAX APPEALS, respondents.

DECISION

TEEHANKEE, J :
p

Before the court is petitioner Commissioner of Internal Revenue's motion for reconsideration of the Court's decision of April 8, 1976 wherein the Court affirmed in toto the appealed decision of respondent Court of Tax Appeals, the dispositive portion of which provides as follows:
prLL

"WHEREFORE, the decision of the respondent Commissioner of Internal Revenue assessing petitioner the amount of P758,687.04 as 25% surtax and interest is reversed. Accordingly, said assessment of respondent for 1955 is hereby cancelled and declared of no force and effect. Without pronouncement as to costs."

This Court's decision under reconsideration held that the assessment made on February 21, 1961 by petitioner against respondent corporation (and received by the latter on March 22, 1961) in the sum of P758,687.04 on its surplus of P2,758,442.37 for its fiscal year ending September 30, 1955 fell under the five-year prescriptive period provided in section 331 of the National Internal Revenue Code and that the assessment had, therefore, been made after the expiration of the said five-year prescriptive period and was of no binding force and effect. Petitioner has urged that
"A perusal of Sections 331 and 332(a) will reveal that they refer to a tax, the basis of which is required by law to be reported in a return such as for example, income tax or sales tax. However, the surtax imposed by Section 25 of the Tax Code is not one such tax. Accumulated surplus are never returned for tax purposes, as there is no law requiring that such surplus be reported in a return for purposes of the 25% surtax. In fact, taxpayers resort to all means and devices to cover up the fact that they have unreasonably accumulated surplus."

Petitioner, therefore, submits that

"As there is no law requiring taxpayers to file returns of their accumulated surplus, it is obvious that neither Section 331 nor Section 332(a) of the Tax Code applies in a case involving the 25% surtax imposed by Section 25 of the Tax Code . . . "

Petitioner cites the Court of Tax Appeals' ruling in the earlier case of United Equipment & Supply Company vs. Commissioner of Internal Revenue (CTA Case No. 1795, October 30, 1971) which was appealed by petitioner taxpayer to this Court in G. R. No. L-35653 bearing the same title, which appeal was denied by this Court en banc for lack of merit as per its Resolution of October 25, 1972. In said case, the tax court squarely ruled that the provisions of sections 331 and 332 of the National Internal Revenue Code for prescriptive periods of five (5) and ten (10) years after the filing of the return do not apply to the tax on the taxpayer's unreasonably accumulated surplus under section 25 of the Tax Code since no return is required to be filed by law or by regulation on such unduly accumulated surplus on earnings, reasoning as follows:
LLjur

"In resisting the assessment amounting to P10,864.26 as accumulated earnings tax for 1957, petitioner also invoked the defense of prescription against the right

of respondent to assess the said tax. It is contended that since its income tax return for 1957 was filed in 1958, and with the clarification by respondent in his letter dated May 14, 1963, that the amount sought to be collected was petitioner's surtax liability under Section 25 rather than deficiency corporate income tax under Section 24 of the National Internal Revenue Code, the assessment has already prescribed under Section 331 of the same Code. "Section 331 of the Revenue Code provides: "SEC. 331.Period of limitation upon assessment and collection. Except as provided in the succeeding section, internal revenue taxes shall be assessed within five years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period. For the purpose of this section a return filed before the last day prescribed by law for the filing thereof shall be considered as filed on such last day; Provided, That this limitation shall not apply to cases already investigated prior to the approval of this Code. "Obviously, Section 331 applies to assessment of National Internal Revenue Taxes which requires the filing of returns. A return the filing of which is necessary to start the running of the five-year period for making an assessment, must be one which is required for the particular tax. Consequently, it has been held that the filing of an income tax return does not start the running of the statute of limitation for assessment of the sales tax. (Butuan Sawmill, Inc. v. Court of Tax Appeals, G.R. No. L-20601, Feb. 28, 1966, 16 SCRA 277). "Although petitioner filed an income tax return, no return was filed covering its surplus profits which were improperly accumulated. In fact, no return could have been filed, and the law could not possibly require, for obvious reasons, the filing of a return covering unreasonable accumulation of corporate surplus profits. A tax imposed upon unreasonable accumulation of surplus is in the nature of a penalty. (Helvering v. National Grocery Co., 304 U.S. 282). It would not be proper for the law to compel a corporation to report improper accumulation of surplus. Accordingly, Section 331 limiting the right to assess internal revenue taxes within five years from the date the return was filed or was due does not apply. "Neither does Section 332 apply. Said Section provides: "SEC. 332.Exceptions as to period of limitation of assessment and collection of taxes. (a) In the case of a false or fraudulent return with intent to evade tax or of failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within ten years after the discovery of

the falsity, fraud, or omission. "(b)Where before the expiration of the time prescribed in the preceding section for the assessment of the tax, both the Commissioner of Internal Revenue and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon. "(c)Where the assessment of any internal revenue tax has been made within the period of limitation above prescribed such tax may be collected by distraint or levy by a proceeding in court, but only if begun (1) within five years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by the Commissioner of Internal Revenue and the taxpayer before the expiration of such five-year period. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon. "It will be noted that Section 332 has reference to national internal revenue taxes which require the filing of returns. This is Implied from the provision that the ten-year period for assessment specified therein treats of the filing of a false or fraudulent return or of a failure to file a return. There can be no failure or omission to file a return where no return is required to be filed by law or by regulations. It is, therefore, our opinion that the ten-year period for making an assessment under Section 332 does not apply to internal revenue taxes which do not require the filing of a return. "It is well settled limitations upon the right of the government to assess and collect taxes will not be presumed in the absence of clear legislation to the contrary. The existence of a time limit beyond which the government may recover unpaid taxes is purely dependent upon some express statutory provision, (51 Am. Jur. 867; 10 Mertens Law on Federal Income Taxation, par. 57. 02.). It follows that in the absence of express statutory provision, the right of the government to assess unpaid taxes is imprescriptible. Since there is no express statutory provision limiting the right of the Commissioner of Internal Revenue to assess the tax on unreasonable accumulation of surplus provided in Section 25 of the Revenue Code, said tax may be assessed at any time." (Emphasis copied)

Such ruling was in effect upheld by this Court en banc upon its dismissal of the taxpayer's appeal for lack of merit as above stated.
LLpr

The Court is persuaded by the fundamental principle invoked by petitioner that limitations upon the right of the government to assess and collect taxes will not be presumed in the

absence of clear legislation to the contrary and that where the government has not by express statutory provision provided a limitation upon its right to assess unpaid taxes, such right is imprescriptible. The Court, therefore, reconsiders its ruling in its decision' under reconsideration that the right to assess and collect the assessment in question had prescribed after five years, and instead rules that there is no such time limit on the right of the Commissioner of Internal Revenue to assess the 25% tax on unreasonably accumulated surplus provided in section 25 of the Tax Code, since there is no express statutory provision limiting such right or providing for its prescription. The underlying purpose of the additional tax in question on a corporation's improperly accumulated profits or surplus is as set forth in the text of section 25 of the Tax Code itself 1 to avoid the situation where a corporation unduly retains its surplus earnings instead of declaring and paying dividends to its shareholders or members who would then have to pay the income tax due on such dividends received by them. The record amply shows that respondent corporation is a mere holding company of its shareholders through its mother company, a registered co-partnership then set up by the individual shareholders belonging to the same family and that theprima facie evidence and presumption set up by the Tax Code, therefore, applied without having been adequately rebutted by the respondent corporation.
prcd

Thus, Mr. Lamberto J. Cabral, the accountant of the corporation, testified before the court as follows:
"Atty. Garces The investigation Your Honor, shows that for the year 1955, the Ayala Securities Corporation had 175,000 outstanding shares of stock and out of these shares of Ayala Securities Corporation, the Ayala and Company owned 174,996 shares of stock. "Q.Is that right, Mr. Cabral? "Atty. Ong Objection, Your Honor, on the materiality of the question. "Judge Alvarez What is the materiality of the question?

"Atty. Garces We want to prove to this Honorable Court that Ayala Securities Corporation is a holding or investment company, the parent company being Ayala and Company. "Judge Alvarez Witness may answer. "A.I think so; yes. "Q.And Ayala and Company is owned almost wholly by the Zobel Family and the Ayala Family? "Atty. Ong If Your Honor please, objection again on the materiality. What would counsel for the respondent prove on this point? "Atty. Garces Same purpose, Your Honor; to prove that Ayala Securities Corporation is a mere investment or holding company. "Atty. Ong What is the materiality of the case if it is a mere investment company. In fact, we are here in court to prove the reasonableness or unreasonableness of the accumulation of profit. I think counsel for the respondent is trying to harp on presumption; but actually we will not be delving on presumption but on actual facts proving the reasonableness of the accumulation based on actual evidence. "Judge Alvarez. In order to determine the reasonableness or unreasonableness, there must be a basis. Witness will have to answer the question. "A.Yes. xxx xxx xxx "Q.As of September 30, 1955 when the Ayala Securities Corporation filed its income tax return, were the officers of the Ayala Securities Corporation

and the Ayala and Company housed in the same building? "A.Yes, sir; they were. "Q.And also are the employees of the Ayala Securities Corporation and the Ayala and Company the same meaning that the employees of the Ayala Securities Corporation are also the employees of the Ayala and Company? "A.At the time, if I remember right, Ayala and Company was the operating company and the employees were the employees of the Ayala and Company; (t.s.n., pp. 32-37)

Another witness, Mr. Salvador J. Lorayes, the Secretary and head of the Legal Department of the corporation, also testified that:
Judge Alvarez questions "Q.May we know from you whether Ayala Securities Corporation is an affiliate of Ayala and Company? "A.Yes, Your Honor. "Q.Do we understand from you that Ayala and Company is the mother corporation of this affiliate? "A.That is correct. "Q.And that the policy of Ayala Securities Corporation is practically governed by the officers or partners of Ayala and Company? "A.They have a strong influence over the policy of Ayala Securities Corporation. "Q.So that whatever is decided by the partners of Ayala and Company for a certain investment or project would also be followed by Ayala Securities Corporation? "A.If the project is assigned to Ayala Securities Corporation, it will be followed by Ayala Securities Corporation; if to another affiliate, no (t.s.n., pp. 149-150). . . ."
LLjur

Respondent corporation was therefore fully shown to fall under Revenue Regulation No. 2 implementing the provisions of the income tax law which provides on holding and investment companies that

"SEC. 20.Holding and Investment Companies. A corporation having practically no activities except holding property, and collecting the income therefrom or investing therein shall be considered a holding company within the meaning of section 25."

Petitioner commissioner's plausible alternative contention is that even if the 25% surtax were to be deemed subject to prescription, computed from the filing of the income tax return in 1955, the intent to evade payment of the surtax is an inherent quality of the violation and the return filed must necessarily partake of a false and or fraudulent character which would make applicable the 10-year prescriptive period provided in section 332(a) of the Tax Code and since the assessment was made in 1961 (the sixth year), the assessment was clearly within the 10-year prescriptive period. The Court sees no necessity, however, for ruling on this point in view of its adherence to the ruling in the earlier case of United Equipment & Supply Co., supra, holding that the 25% surtax is not subject to any statutory prescriptive period. ACCORDINGLY, the Court's decision of April 8, 1976 is set aside and in lieu thereof, judgment is hereby rendered ordering respondent corporation to pay the assessment in the sum of P758,687.04 as 25% surtax on its unreasonably accumulated surplus, plus the 5% surcharge and 1% monthly interest thereon, pursuant to section 51 (e) of the National Internal Revenue Code, as amended by R. A. 2343. With Costs.
cdphil

[G.R. No. 108067. January 20, 2000.] CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents. Romulo Mabanta Buenaventura Sayoc & De Los Angeles for petitioner. The Solicitor General for respondents. SYNOPSIS On February 7, 1985, the Commissioner of Internal Revenue (CIR) sent an assessment letter to petitioner Cyanamid Philippines, Inc. for taxable year 1981. On March 4, 1985 petitioner protested the assessment particularly, (1) the 25% Surtax Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and (3) 1981 Deficiency Percentage Assessment of P8,846.72. Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the

undue accumulation of earnings was not proper because the said profits were retained to increase petitioner's working capital and it could be used for reasonable business needs of the company. Petitioner contended further that it availed of the tax amnesty under Executive Order No. 41, hence, it enjoyed amnesty from civil and criminal prosecution granted by law. In reply, the CIR refused to allow the cancellation of the assessment notices on the ground that the availment of the tax amnesty under Executive Order No. 41, as amended, is sufficient basis, in appropriate cases, for the cancellation of the assessment issued after August 21, 1986 only. Petitioner appealed to the Court of Tax Appeals (CTA). During the pendency of the case, however, both parties agreed to compromise the 1981 deficiency income tax assessment and the petitioner paid the reduced amount. With regards to the surtax on improperly accumulated profits, the CTA denied the petition by ruling that there was no need for petitioner to set aside a portion of its retained earnings as working capital reserve as it claims since it had considerable liquid funds. On appeal, the Court of Appeals affirmed the CTA decision. In this petition, the Court ruled that the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon the nature of the business, its credit policies, the amount of inventories, the rate of turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. The Court agreed with the tax court that the burden of proof to establish that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. The Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority. Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure to prove the CIR incorrect, clearly and conclusively, this Court was constrained to uphold the correctness of tax court's ruling, as affirmed by the Court of Appeals. SYLLABUS 1.TAXATION; TAX ON CORPORATIONS; TAX ON IMPROPER ACCUMULATION OF SURPLUS; A PENALTY TAX DESIGNED TO COMPEL CORPORATIONS TO DISTRIBUTE EARNINGS. Section 25 of the National Internal Revenue Code discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by

shareholders could, in turn, be taxed. 2.ID.; ID.; ACCUMULATED EARNINGS TAX; NOT LIMITED TO CLOSELY HELD CORPORATIONS. A review of American taxation history on accumulated earnings tax will show that the application of the accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be imposed on widely held corporations including those not controlled by a few shareholders or groups of shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held corporations. In 1984, American legislation nullified the Ninth Circuit's Golconda ruling and made it clear that the accumulated earnings tax is not limited to closely held corporations. Clearly, Golconda is no longer a reliable precedent. 3.POLITICAL LAW; STATUTORY CONSTRUCTION; LAWS GRANTING EXEMPTION FROM TAX ARE CONSTRUED STRICTISSIMI JURIS AGAINST THE TAXPAYER AND LIBERALLY IN FAVOR OF TAXING POWER. The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or consequence is construed to exclude all others. 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, a burden which petitioner here has failed to discharge. 4.TAXATION; TAX ON CORPORATIONS; SURTAX ON IMPROPER ACCUMULATED PROFITS; "BARDAHL" FORMULA; ELUCIDATED. The "Bardahl" formula was developed to measure corporate liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the business during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory into sales, including the time it takes to collect payment for the sales. 5.ID.; ID.; ID.; ID.; NOT A PRECISE RULE; USED FOR ADMINISTRATIVE CONVENIENCE ONLY. We note, however, that the companies where the "Bardahl"

formula was applied, had operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR, the company's operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States, the corporation's operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business. There are variations in the application of the "Bardahl" formula, such as average operating cycle or peak operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by American authorities, although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It is used only for administrative convenience. 6.ID.; ID.; ID.; "2 TO 1" RULE; USED TO DETERMINE SUFFICIENCY OF WORKING CAPITAL. Other formulas are also used, e.g. the ratio of currents assets to current liabilities and the adoption of the industry standard. The ratio of current assets to current liabilities is used to determine the sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of current asset for every unit of current liability, hence the so-called "2 to 1" rule. 7.ID.; ID.; ID.; ID.; APPLIED IN CASE AT BAR. As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected to increase further when more funds were generated from the succeeding year's sales. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending 'working capital deficit' which could have necessitated an increase in working capital, as rationalized by petitioner. 8.ID.; ID.; ID.; BURDEN OF PROOF TO ESTABLISH THAT PROFITS ACCUMULATED WERE NOT BEYOND THE REASONABLE NEED OF COMPANY, REMAINED ON THE TAXPAYER. If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits. 9.ID.; ID.; ID.; ID.; PETITIONER FAILED TO ESTABLISH THE REQUIRED PROOF. In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon the nature of the business, its credit policies, the amount of

inventories, the rate of turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer.

10.ID.; ID.; ID.; CONTROLLING INTENTION OF TAXPAYER MUST BE SHOWN AT TIME OF ACCUMULATION; ACCUMULATED PROFITS MUST BE USED WITHIN REASONABLE TIME; NOT ESTABLISHED IN CASE AT BAR. In order to determine whether profits are accumulated for the reasonable heeds of the business to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts. Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs of the business. 11.REMEDIAL LAW; CREDIBILITY; ALL PRESUMPTIONS GENERALLY ARE INDULGED IN FAVOR OF CORRECTNESS OF CIR's ASSESSMENT AGAINST THE TAXPAYER. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority. Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the correctness of the tax court's ruling as affirmed by the Court of Appeals.

DECISION

QUISUMBING, J :
p

Petitioner disputes the decision 1 of the Court of Appeals which affirmed the decision 2 of the Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of Internal Revenue the amount of three million, seven hundred seventy-four thousand, eight hundred sixty-seven pesos and fifty centavos (P3,774,867.50) as 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from

January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal Revenue Code.
cdphil

The Court of Tax Appeals made the following factual findings: Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an importer/indentor. On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment of deficiency income tax of one hundred nineteen thousand eight hundred seventeen (P119,817.00) pesos for taxable year 1981, as follows:
"Net income disclosed by the return as audited14,575,210.00 Add: Discrepancies: Professional fees/yr.17018262,877.00 per investigation110,399.37 Total Adjustment152,477.00 Net income per Investigation14,727,687.00 Less: Personal and additional exemptions Amount subject to tax14,727,687.00 Income tax due thereon25% Surtax 2,385,231.503,237,495.00 Less: Amount already assessed5,161,788.00 BALANCE75,709.00 monthly interest from1,389,636.0044,108.00 Compromise penalties TOTAL AMOUNT DUE3,774,867.50119,817.00" 3

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax

Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency Percentage Assessment of P8,846.72. 4 Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the undue accumulation of earnings was not proper because the said profits were retained to increase petitioner's working capital and it would be used for reasonable business needs of the company. Petitioner contended that it availed of the tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by the law. On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the assessment notices and rendered its resolution, as follows:
"It appears that your client availed of Executive Order No. 41 under File No. 32A-F-000455-41B as certified and confirmed by our Tax Amnesty Implementation Office on October 6, 1987. In reply thereto, I have the honor to inform you that the availment of the tax amnesty under Executive Order No. 41, as amended is sufficient basis, in appropriate cases, for the cancellation of the assessment issued after August 21, 1986. (Revenue Memorandum Order No. 4-87) Said availment does not, therefore, result in cancellation of assessments issued before August 21, 1986, as in the instant case. In other words, the assessments in this case issued on January 30, 1985 despite your client's availment of the tax amnesty under Executive Order No. 41, as amended still subsist. Such being the case, you are therefore, requested to urge your client to pay this Office the aforementioned deficiency income tax and surtax on undue accumulation of surplus in the respective amounts of P119,817.00 and P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30) days from receipt hereof, otherwise this office will be constrained to enforce collection thereof thru summary remedies prescribed by law. This constitutes the final decision of this Office on this matter." 5

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both parties agreed to compromise the 1981 deficiency income tax assessment of P119,817.00. Petitioner paid a reduced amount twenty-six thousand, five hundred seventy-seven pesos (P26,577.00) as compromise settlement. However, the surtax on improperly accumulated profits remained unresolved. Petitioner claimed that CIR's assessment representing the 25% surtax on its accumulated earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner accumulated its earnings and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness; (b) petitioner is a wholly owned

subsidiary of American Cyanamid Company, a corporation organized under the laws of the State of Maine, in the United States of America, whose shares of stock are listed and traded in New York Stock Exchange. This being the case, no individual shareholder of petitioner could have evaded or prevented the imposition of individual income taxes by petitioner's accumulation of earnings and profits, instead of distribution of the same. In denying the petition, the Court of Tax Appeals made the following pronouncements:
"Petitioner contends that it did not declare dividends for the year 1981 in order to use the accumulated earnings as working capital reserve to meet its "reasonable business needs." The law permits a stock corporation to set aside a portion of its retained earnings for specified purposes (citing Section 43, paragraph 2 of the Corporation Code of the Philippines). In the case at bar, however, petitioner's purpose for accumulating its earnings does not fall within the ambit of any of these specified purposes. More compelling is the finding that there was no need for petitioner to set aside a portion of its retained earnings as working capital reserve as it claims since it had considerable liquid funds. A thorough review of petitioner's financial statement (particularly the Balance Sheet, p. 127, BIR Records) reveals that the corporation had considerable liquid funds consisting of cash accounts receivable, inventory and even its sales for the period is adequate to meet the normal needs of the business. This can be determined by computing the current asset to liability ratio of the company:
cdll

current ratio= current assets/current liabilities = P47,052,535.00/P21,275,544.00 = 2.21:1 ======

The significance of this ratio is to serve as a primary test of a company's solvency to meet current obligations from current assets as a going concern or a measure of adequacy of working capital. xxx xxx xxx We further reject petitioner's argument that "the accumulated earnings tax does not apply to a publicly-held corporation" citing American jurisprudence to support its position. The reference finds no application in the case at bar because under Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated September 17, 1980), the exceptions to the accumulated earnings tax are expressly enumerated, to wit: Bank, non-bank financial intermediaries,

corporations organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, or personal holding companies, whether domestic or foreign. The law on the matter is clear and specific. Hence, there is no need to resort to applicable cases decided by the American Federal Courts for guidance and enlightenment as to whether the provision of Section 25 of the NIRC should apply to petitioner. Equally clear and specific are the provisions of E.O. 41 particularly with respect to its effectivity and coverage . . . . . . Said availment does not result in cancellation of assessments issued before August 21, 1986 as petitioner seeks to do in the case at bar. Therefore, the assessments in this case, issued on January 30, 1985 despite petitioner's availment of the tax amnesty under E.O. 41 as amended, still subsist." xxx xxx xxx WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay respondent Commissioner of Internal Revenue the sum of P3,774,867.50 representing 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987." 6

Petitioner appealed the Court of Tax Appeal's decision to the Court of Appeals. Affirming the CTA decision, the appellate court said:
"In reviewing the instant petition and the arguments raised herein, We find no compelling reason to reverse the findings of the respondent Court. The respondent Court's decision is supported by evidence, such as petitioner corporation's financial statement and balance sheets (p. 127, BIR Records). On the other hand the petitioner corporation could only come up with an alternative formula lifted from a decision rendered by a foreign court (Bardahl Mfg. Corp. vs. Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its particular financial position, the petitioner corporation attempts to justify its accumulated surplus earnings. To Our mind, the petitioner corporation's alternative formula cannot overturn the persuasive findings and conclusion of the respondent Court based, as it is, on the applicable laws and jurisprudence, as well as standards in the computation of taxes and penalties practiced in this jurisdiction.

WHEREFORE, in view of the foregoing, the instant petition is hereby DISMISSED and the decision of the Court of Tax Appeals dated August 6, 1992 in C.T.A. Case No. 4250 is AFFIRMED in toto." 7

Hence, petitioner now comes before us and assigns as sole issue:

WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981. 8

Section 25 9 of the old National Internal Revenue Code of 1977 states:

"Sec. 25. Additional tax on corporation improperly accumulating profits or surplus. "(a)Imposition of tax. If any corporation is formed or availed of for the purpose of preventing the imposition of the tax upon its shareholders or members or the shareholders or members of another corporation, through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there is levied and assessed against such corporation, for each taxable year, a tax equal to twenty-five per-centum of the undistributed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by section twenty-four, and shall be computed, collected and paid in the same manner and subject to the same provisions of law, including penalties, as that tax. "(b)Prima facie evidence. The fact that any corporation is mere holding company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Similar presumption will lie in the case of an investment company where at any time during the taxable year more than fifty per centum in value of its outstanding stock is owned, directly or indirectly, by one person. "(c)Evidence determinative of purpose. The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence, shall prove the contrary. "(d)Exception The provisions of this sections shall not apply to banks, nonbank financial intermediaries, corporation organized primarily, and authorized by the Central Bank of the Philippines to hold shares of stock of banks, insurance companies, whether domestic or foreign.
llcd

The provision discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed.

Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned company. 10 Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated earnings tax could only apply to a closely held corporation. A review of American taxation history on accumulated earnings tax will show that the application of the accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be imposed on widely held corporations including those not controlled by a few shareholders or groups of shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held corporations. 11 In 1984, American legislation nullified the Ninth Circuit's Golconda ruling and made it clear that the accumulated earnings tax is not limited to closely held corporations. 12 Clearly, Golconda is no longer a reliable precedent. The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or consequence is construed to exclude all others. 13 Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power. 14 Taxation is the rule and exemption is the exception. 15 The burden of proof rests upon the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed, 16 a burden which petitioner here has failed to discharge. Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by a corporation justifies accumulating income. Petitioner asserts that respondent court erred in concluding that Cyanamid need not infuse additional working capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The "Bardahl" 17 formula was developed to measure corporate liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the business

during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory into sales, including the time it takes to collect payment for the sales. 18 Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts that Cyanamid had a working capital deficit of P7,986,633.00. 19 Therefore, the P9,540,926.00 accumulated income as of 1981 may be validly accumulated to increase the petitioner's working capital for the succeeding year. We note, however, that the companies where the "Bardahl" formula was applied, had operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs.CIR, 20 the company's operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States, 21 the corporation's operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business. There are variations in the application of the "Bardahl" formula, such as average operating cycle or peak operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by American authorities, although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It is used only for administrative convenience. 22 Petitioner's application of the "Bardahl" formula merely creates a false illusion of exactitude. Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the industry standard. 23 The ratio of current assets to current liabilities is used to determine the sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of current assets for every unit of current liability, hence the so-called "2 to 1" rule. 24 As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected to increase further when more funds were generated from the succeeding year's sales. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending 'working capital deficit' which could have necessitated an increase in working capital, as rationalized by petitioner. In Basilan Estates, Inc. vs. Commissioner of Internal Revenue, 25 we held that:
". . . [T]here is no need to have such a large amount at the beginning of the

following year because during the year, current assets are converted into cash and with the income realized from the business as the year goes, these expenses may well be taken care of. [citation omitted]. Thus, it is erroneous to say that the taxpayer is entitled to retain enough liquid net assets in amounts approximately equal to current operating needs for the year to cover 'cost of goods sold and operating expenses'; for 'it excludes proper consideration of funds generated by the collection of notes receivable as trade accounts during the course of the year." 26

If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits. 27 In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts. 28 Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs of the business.
LibLex

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue, 29 we ruled:

"To determine the 'reasonable needs' of the business in order to justify an accumulation of earnings, the Courts of the United States have invented the socalled 'Immediacy Test' which construed the words 'reasonable needs of the business' to mean the immediate needs of the business, and it was generally held that if the corporation did not prove an immediate need for the accumulation of the earnings and profits, the accumulation was not for the reasonable needs of the business, and the penalty tax would apply. (Mertens, Law of Federal Income Taxation, Vol. 7, Chapter 39, p. 103). 30

In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon the nature of the business, its credit policies, the amount of inventories, the rate of turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish

that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority. 31 Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR's assessment against the taxpayer. With petitioner's failure to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the correctness of tax court's ruling as affirmed by the Court of Appeals. WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals, sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.
LexLib

SO ORDERED.

EXEMPTION ON TAX ON CORPORATION

[G.R. No. 124043. October 14, 1998.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. COURT OF APPEALS, COURT OF TAX APPEALS and YOUNG MEN'S CHRISTIAN ASSOCIATION OF THE PHILIPPINES, INC., respondents. SYLLABUS 1.TAXATION; COURT OF TAX APPEALS; FACTUAL FINDINGS, WHEN SUPPORTED BY SUBSTANTIAL EVIDENCE, WILL NOT BE DISTURBED ON APPEAL; CASE AT BAR. It is a basic rule in taxation that the factual findings of the CTA, when supported by substantial evidence, will not be disturbed on appeal unless it is shown that the said court committed gross error in the appreciation of facts. In the present case, this Court finds that the February 16, 1994 Decision of the CA did not deviate from this rule. The latter merely applied the law to the facts as found by the CTA and ruled on

the issue raised by the CIR: "Whether or not the collection or earnings of rental income from the lease of certain premises and income earned from parking fees shall fall under the last paragraph of Section 27 of the National Internal Revenue Code of 1977, as amended." Clearly, the CA did not alter any fact or evidence. It merely resolved the aforementioned issue, as indeed it was expected to. That it did so in a manner different from that of the CTA did not necessarily imply a reversal of factual findings.
cdasia

2.ID.; APPEAL; QUESTION OF LAW AND QUESTION OF FACT, DISTINGUISHED. The distinction between a question of law and a question of fact is clear-cut. It has been held that "[t]here is a question of law in a given case when the doubt or difference arises as to what the law is on a certain state of facts; there is a question of fact when the doubt or difference arises as to the truth or falsehood of alleged facts." In the present case, the CA did not doubt, much less change, the facts narrated by the CTA. It merely applied the law to the facts. That its interpretation or conclusion is different from that of the CTA is not irregular or abnormal. 3.ID.; TAX EXEMPTION; COURT HAS ALWAYS APPLIED THE DOCTRINE OF STRICT INTERPRETATION IN CONSTRUING THEREOF; APPLICATION IN CASE AT BAR. Because taxes are the lifeblood of the nation, the Court has always applied the doctrine of strict interpretation in construing tax exemptions. Furthermore, a claim of statutory exemption from taxation should be manifest and unmistakable from the language of the law on which it is based. Thus, the claimed exemption "must expressly be granted in a statute stated in a language too clear to be mistaken." In the instant case, the exemption claimed by the YMCA is expressly disallowed by the very wording of the last paragraph of then Section 27 of the NIRC which mandates that the income of exempt organizations (such as the YMCA) from any of their properties, real or personal, be subject to the tax imposed by the same Code. Because the last paragraph of said section unequivocally subjects to tax the rent income of the YMCA from its real property, the Court is duty-bound to abide strictly by its literal meaning and to refrain from resorting to any convoluted attempt at construction. It is axiomatic that where the language of the law is clear and unambiguous, its express terms must be applied. Parenthetically, a consideration of the question of construction must not even begin, particularly when such question is on whether to apply a strict construction or a liberal one on statutes that grant tax exemptions to "religious, charitable and educational propert[ies] or institutions." The phrase "any of their activities conducted for profit" does not qualify the word "properties." This makes income from the property of the organization taxable, regardless of how that income is used whether for profit or for lofty non-profit purposes. Verba legis non est recedendum. Hence, Respondent Court of Appeals committed reversible error when it allowed, on reconsideration, the tax exemption claimed by YMCA on income it derived from renting out its real property, on the solitary but unconvincing ground that the said income is not collected for profit but is merely incidental to its operation. The law does not make a distinction. The rental income is taxable regardless of whence such income is

derived and how it is used or disposed of. Where the law does not distinguished, neither should we. 4.ID.; ID.; WHEN GRANTED; REQUISITES. Private respondent is exempt from the payment of property tax, but not income tax on the rentals from its property. The bare allegation alone that it is a non-stock, non-profit educational institution is insufficient to justify its exemption from the payment of income tax. For the YMCA to be granted the exemption it claims under the aforecited provision, it must prove with substantial evidence that (1) it falls under the classification non-stock, non-profit educational institution; and (2) the income it seeks to be exempted from taxation is used actually, directly, and exclusively for educational purposes.However, the Court notes that not a scintilla of evidence was submitted by private respondent to prove that it met the said requisites. 5.ID.; ID.; EDUCATIONAL INSTITUTION, CONSTRUED; WHEN NOT APPLICABLE; CASE AT BAR. Is the YMCA and educational institution within the purview of Article XIV, Section 4, par. 3 of the Constitution? We rule that it is not. The term "educational institution" or "institution of learning" has acquired a well-known technical meaning, of which the members of the Constitutional Commission are deemed cognizant. Under the Education Act of 1982, such term refers to schools. The school system is synonymous with formal education, which "refers to the hierarchically structured and chronologically graded learnings organized and provided by the formal school system and for which certification is required in order for the learner to progress through the grades or move to the higher levels." The Court has examined the "Amended Articles of Incorporation" and "By-Laws" of the YMCA, but found nothing in them that even hints that it is a school or an educational institution. Furthermore, under the Education Act of 1982, even non-formal education is understood to be school-based and "private auspices such as foundations and civic-spirited organizations" are ruled out. It is settled that the term "educational institution," when used in laws granting tax exemptions, refers to a ". . . school seminary, college or educational establishment . . . ." Therefore, the private respondent cannot be deemed one of the educational institutions covered by the constitutional provision under consideration. ". . . Words used in the Constitution are to be taken in their ordinary acceptation. While in its broadest and best sense education embraces all forms and phases of instruction, improvement and development of mind and body, and as well of religious and moral sentiments, yet in the common understanding and application it means a place where systematic institution in any or all of the useful branches of learning is given by methods common to schools and instruction of learning. That we conceive to be the true intent and scope of the term [educational institutions] as used in the Constitution."

BELLOSILLO, J., dissenting opinion: 1.TAXATION; COURT OF TAX APPEALS; FINDINGS OF FACTS, WHEN SUPPORTED BY SUBSTANTIAL EVIDENCE, WILL NOT BE DISTURBED ON APPEAL; EXCEPTION; NOT APPLICABLE IN CASE AT BAR. The basic rule is that the factual findings of the Court of Tax Appeals when supported by substantial evidence will not be disturbed on appeal unless it is shown that the court committed grave error in the appreciation of facts. In the instant case, there is no dispute as to the validity of the findings of the Court of Tax Appeals that private respondent Young Men's Christian Association (YMCA) is an association organized and operated exclusively for the promotion of social welfare and other non-profitable purposes, particularly the physical and character development of the youth.
cHAaEC

2.ID.; TAX EXEMPTION; WHEN INCOME DERIVED FROM ITS PROPERTY BY A TAX EXEMPT ORGANIZATION IS NOT ABSOLUTELY TAXABLE; CASE AT BAR. Respondent YMCA is undoubtedly exempt from corporate income tax under the provisions of Sec. 27, pars. (g) and (h), of the National Internal Revenue Code, to wit: Sec. 27. Exemptions from tax on corporations. The following organizations shall not be taxed under this Title in respect to income received by them as such . . . (g) civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; (h) club organized and operated exclusively for pleasure, recreation and other non-profitable purposes, no part of the net income of which inures to the benefit of any private stockholder or member . . . Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit, regardless of the disposition made of such income, shall be subject to tax imposed under this Code. Income derived from its property by a tax exempt organization is not absolutely taxable. Taken in solitude, a word or phrase such as, in this case, "the income of whatever kind and character . . . from any of their properties" might easily convey a meaning quite different from the one actually intended and evident when a word or phrase is considered with those with which it is associated. It is a rule in statutory construction that every part of the statute must be interpreted with reference to the context, that every part of the statute must be considered together with the other parts and kept subservient to the general intent of the whole enactment. A close reading of the last paragraph of Sec. 27 of the National Internal Revenue Code, in relation to the whole section on tax exemption of the organizations enumerated therein, shows that the phrase "conducted for profit" in the last paragraph of Sec. 27 qualifies, limits and describes "the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities" in order to make such income taxable. It is the exception to Sec. 27, pars. (g) and (h) providing for the tax exemptions of the income of said organizations. Hence, if such income from property or any other property is not conducted for profit, then it is not taxable. Even taken alone and understood according to its plain,

simple and literal meaning, the word "income" which is derived from property, real or personal, provided in the last paragraph of Sec. 27 means the amount of money coming to a person or corporation within a specified time as profit from investment; the return in money from one's business or capital invested. Income from property also means gains and profits derived from the sale or other disposition of capital assets; the money which any person or corporation periodically receives either as profits from business, or as returns from investments. The word "income" as used in tax statutes is to be taken in its ordinary sense as gain or profit. Clearly, therefore, income derived from property whether real or personal connotes profit from business or from investment of the same. If we are to apply the ordinary meaning of income from property as profit to the language of the last paragraph of Sec. 27 of the NIRC, then only those profits arising from business and investment involving property are taxable. In the instant case, there is no question that in leasing its facilities to small shop owners and in operating parking spaces, YMCA does not engage in any profit-making business. Both the Court of Tax Appeals, and the Court of Appeals in its resolution of 25 September 1995, categorically found that these activities conducted on YMCA's property were aimed not only at fulfilling the needs and requirements of its members as part of YMCA'S youth program but, more importantly, at raising funds to finance the multifarious projects of the Association.

3.ID.; ID.; THE MERE REALIZATION OF PROFITS OUT OF ITS OPERATION DOES NOT AUTOMATICALLY RESULT IN THE LOSS THEREOF, AS LONG AS NO PART OF THE PROFITS OF AN EDUCATIONAL INSTITUTION INURES TO THE BENEFIT OF ANY STOCKHOLDER OR INDIVIDUAL; CASE AT BAR. As the Court has ruled in one case, the fact that an educational institution charges tuition fees and other fees for the different services it renders to the students does not in itself make the school a profit-making enterprise that would place it beyond the purview of the law exempting it from taxation. The mere realization of profits out of its operation does not automatically result in the loss of an educational institution's exemption from income tax as long as no part of its profits inures to the benefit of any stockholder or individual. In order to claim exemption from income tax, a corporation or association must show that it is organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational purposes or for the rehabilitation of veterans, and that no part of its income inures to the benefit of any private stockholder or individual. The main evidence of the purpose of a corporation should be its articles of incorporation and by-laws, for such purpose is required by statute to be stated in the articles of incorporation, and the by-laws outline the administrative organization of the corporation which, in turn, is supposed to insure or facilitate the accomplishment of said purpose. The foregoing principle applies to income derived by tax exempt corporations from their property. The criterion or test in order to make such income taxable is when it arises from purely profit-making business. Otherwise, when the income derived from use of property is reasonable and incidental to

the charitable, benevolent, educational or religious purpose for which the corporation or association is created, such income should be tax-exempt. The majority, if not all, of the income of the organizations covered by the exemption provided in Sec. 27, pars. (g) and (h), of the NIRC are derived from their properties, real or personal. If we are to interpret the last paragraph of Sec. 27 to the effect that all income of whatever kind from the properties of said organization, real or personal, are taxable, even if not conducted for profit, then Sec. 27, pars. (g) and (h), would be rendered ineffective and nugatory. As this Court elucidated inJesus Sacred Heart College v. Collector of Internal Revenue, (95 Phil. 16 [1954]) every responsible organization must be so run as to at least insure its existence by operating within the limits of its own resources, especially its regular income. It should always strive whenever possible to have a surplus. If the benefits of the exemption would be limited to institutions which do not hope or propose to have such surplus, then the exemption would apply only to schools which are on the verge of bankruptcy. Unlike the United States where a substantial number of institutions of learning are dependent upon voluntary contributions and still enjoy economic stability, such as Harvard, the trust fund of which has been steadily increasing with the years, there are and there have always been very few educational enterprises in the Philippines which are supported by donations, and these organizations usually have a very precarious existence.
ESAHca

DECISION

PANGANIBAN, J :
p

Is the income derived from rentals of real property owned by the Young Men's Christian Association of the Philippines, Inc. (YMCA) established as "a welfare, educational and charitable non-profit corporation" subject to income tax under the National Internal Revenue Code (NIRC) and the Constitution?
cdphil

The Case This is the main question raised before us in this petition for review on certiorari challenging two Resolutions issued by the Court of Appeals 1 on September 28, 19952 and February 29, 1996 3 in CA-GR SP No. 32007. Both Resolutions affirmed the Decision of the Court of Tax Appeals (CTA) allowing the YMCA to claim tax exemption on the latter's income from the lease of its real property. The Facts The facts are undisputed. 4 Private Respondent YMCA is a non-stock, non-profit institution, which conducts various programs and activities that are beneficial to the

public, especially the young people, pursuant to its religious, educational and charitable objectives.
cda

In 1980, private respondent earned, among others, an income of P676,829.80 from leasing out a portion of its premises to small shop owners, like restaurants and canteen operators, and P44,259.00 from parking fees collected from non-members. On July 2, 1984, the commissioner of internal revenue (CIR) issued an assessment to private respondent, in the total amount of P415,615.01 including surcharge and interest, for deficiency income tax, deficiency expanded withholding taxes on rentals and professional fees and deficiency withholding tax on wages. Private respondent formally protested the assessment and, as a supplement to its basic protest, filed a letter dated October 8, 1985. In reply, the CIR denied the claims of YMCA. Contesting the denial of its protest, the YMCA filed a petition for review at the Court of Tax Appeals (CTA) on March 14, 1989. In due course, the CTA issued this ruling in favor of the YMCA:
cdtai

". . . [T]he leasing of [private respondent's] facilities to small shop owners, to restaurant and canteen operators and the operation of the parking lot are reasonably incidental to and reasonably necessary for the accomplishment of the objectives of the [private respondents]. It appears from the testimonies of the witnesses for the [private respondent] particularly Mr. James C. Delote, former accountant of YMCA, that these facilities were leased to members and that they have to service the needs of its members and their guests. The rentals were minimal as for example, the barbershop was only charged P300 per month. He also testified that there was actually no lot devoted for parking space but the parking was done at the sides of the building. The parking was primarily for members with stickers on the windshields of their cars and they charged P.50 for non-members. The rentals and parking fees were just enough to cover the costs of operation and maintenance only. The earning[s] from these rentals and parking charges including those from lodging and other charges for the use of the recreational facilities constitute [the] bulk of its income which [is] channeled to support its many activities and attainment of its objectives. As pointed out earlier, the membership dues are very insufficient to support its program. We find it reasonably necessary therefore for [private respondent] to make [the] most out [of] its existing facilities to earn some income. It would have been different if under the circumstances, [private respondent] will purchase a lot and convert it to a parking lot to cater to the needs of the general public for a fee, or construct a building and lease it out to the highest bidder or at the market rate for commercial purposes, or should it invest its funds in the buy and sell of properties, real or personal. Under these circumstances, we could conclude that the activities are already profit oriented, not incidental and reasonably necessary to the pursuit of the objectives of the association and therefore, will fall under the last paragraph of Section 27 of the Tax Code and any income derived

therefrom shall be taxable.

LLpr

"Considering our findings that [private respondent] was not engaged in the business of operating or contracting [a] parking lot, we find no legal basis also for the imposition of [a] deficiency fixed tax and [a] contractor's tax in the amount[s] of P353.15 and P3,129.73, respectively. xxx xxx xxx "WHEREFORE, in view of all the foregoing, the following assessments are hereby dismissed for lack of merit: 1980 Deficiency Fixed Tax P353,15; 1980 Deficiency Contractor's Tax P3,129.23; 1980 Deficiency Income Tax P372,578.20. While the following assessments are hereby sustained: 1980 Deficiency Expanded Withholding Tax P1,798.93; 1980 Deficiency Withholding Tax on Wages P33,058.82 plus 10% surcharge and 20% interest per annum from July 2, 1984 until fully paid but not to exceed three (3) years pursuant to Section 51(e)(2) & (3) of the National Internal Revenue Code effective as of 1984." 5

Dissatisfied with the CTA ruling, the CIR elevated the case to the Court of Appeals (CA). In its Decision of February 16, 1994, the CA 6 initially decided in favor of the CIR and disposed of the appeal in the following manner:
"Following the ruling in the aforecited cases of Province of Abra vs. Hernando and Abra Valley College Inc. vs. Aquino, the ruling of the respondent Court of Tax Appeals that 'the leasing of petitioner's (herein respondent's) facilities to small shop owners, to restaurant and canteen operators and the operation of the parking lot are reasonably incidental to and reasonably necessary for the accomplishment of the objectives of the petitioners,' and the income derived therefrom are tax exempt, must be reversed.
cda

"WHEREFORE, the appealed decision is hereby REVERSED in so far as it dismissed the assessment for:

1980 Deficiency Income Tax P353.15 1980 Deficiency Contractor's TaxP3,129.23, & 1980 Deficiency Income TaxP372,578.20, but the same is AFFIRMED in all other respect." 7

Aggrieved, the YMCA asked for reconsideration based on the following grounds:
I "The findings of facts of the Public Respondent Court of Tax Appeals being supported by substantial evidence [are] final and conclusive. II

cdll

"The conclusions of law of [p]ublic [r]espondent exempting [p]rivate [r]espondent from the income on rentals of small shops and parking fees [are] in accord with the applicable law and jurisprudence." 8

Finding merit in the Motion for Reconsideration filed by the YMCA, the CA reversed itself and promulgated on September 28, 1995 its first assailed Resolution which, in part, reads:
"The Court cannot depart from the CTA's findings of fact, as they are supported by evidence beyond what is considered as substantial.
Cdpr

xxx xxx xxx "The second ground raised is that the respondent CTA did not err in saying that the rental from small shops and parking fees do not result in the loss of the exemption. Not even the petitioner would hazard the suggestion that YMCA is designed for profit. Consequently, the little income from small shops and parking fees help[s] to keep its head above the water, so to speak, and allow it to continue with its laudable work. "The Court, therefore, finds the second ground of the motion to be meritorious and in accord with law and jurisprudence. "WHEREFORE, the motion for reconsideration is GRANTED; the respondent CTA's decision is AFFIRMED in toto." 9

The internal revenue commissioner's own Motion for Reconsideration was denied by Respondent Court in its second assailed Resolution of February 29, 1996. Hence, this petition for review under Rule 45 of the Rules of Court. 10 The Issues Before us, petitioner imputes to the Court of Appeals the following errors:
I "In holding that it had departed from the findings of fact of Respondent Court of Tax Appeals when it rendered its Decision dated February 16, 1994, and
llcd

II "In affirming the conclusion of Respondent Court of Tax Appeals that the income of private respondent from rentals of small shops and parking fees [is] exempt from taxation." 11

This Court's Ruling The petition is meritorious. First Issue: Factual Findings of the CTA Private respondent contends that the February 16, 1994 CA Decision reversed the factual findings of the CTA. On the other hand, petitioner argues that the CA merely reversed the "ruling of the CTA that the leasing of private respondent's facilities to small shop owners, to restaurant and canteen operators and the operation of parking lots are reasonably incidental to and reasonably necessary for the accomplishment of the objectives of the private respondent and that the income derived therefrom are tax exempt." 12 Petitioner insists that what the appellate court reversed was the legal conclusion, not the factual finding of the CTA. 13 The commissioner has a point. Indeed, it is a basic rule in taxation that the factual findings of the CTA, when supported by substantial evidence, will not be disturbed on appeal unless it is shown that the said court committed gross error in the appreciation of facts. 14 In the present case, this Court finds that the February 16, 1994 Decision of the CA did not deviate from this rule. The latter merely applied the law to the facts as found by the CTA and ruled on the issue raised by the CIR: "Whether or not the collection or earnings of rental income from the lease of certain premises and income earned from parking fees shall fall under the last

paragraph of Section 27 of the National Internal Revenue Code of 1977, as amended." 15 Clearly, the CA did not alter any fact or evidence. It merely resolved the aforementioned issue, as indeed it was expected to. That it did so in a manner different from that of the CTA did not necessarily imply a reversal of factual findings.
cdll

The distinction between a question of law and a question of fact is clear-cut. It has been held that "[t]here is a question of law in a given case when the doubt or difference arises as to what the law is on a certain state of facts; there is a question of fact when the doubt or difference arises as to the truth or falsehood of alleged facts." 16 In the present case, the CA did not doubt, much less change, the facts narrated by the CTA. It merely applied the law to the facts. That its interpretation or conclusion is different from that of the CTA is not irregular or abnormal. Second Issue: Is the Rental Income of the YMCA Taxable? We now come to the crucial issue: Is the rental income of the YMCA from its real estate subject to tax? At the outset, we set forth the relevant provision of the NIRC:
prLL

"SEC. 27.Exemptions from tax on corporations. The following organizations shall not be taxed under this Title in respect to income received by them as such xxx xxx xxx (g)Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; (h)Club organized and operated exclusively for pleasure, recreation, and other non-profitable purposes, no part of the net income of which inures to the benefit of any private stockholder or member; xxx xxx xxx Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit, regardless of the disposition made of such income, shall be subject to the tax imposed under this Code. (as amended by Pres. Decree No. 1457)"
Cdpr

Petitioner argues that while the income received by the organizations enumerated in Section 27 (now Section 26) of the NIRC is, as a rule, exempted from the payment of tax

"in respect to income received by them as such," the exemption does not apply to income derived ". . . from any of their properties, real or personal, or from any of their activities conducted for profit, regardless of the disposition made of such income . . ." Petitioner adds that "rental income derived by a tax-exempt organization from the lease of its properties, real or personal, [is] not, therefore, exempt from income taxation, even if such income [is] exclusively used for the accomplishment of its objectives." 17 We agree with the commissioner. Because taxes are the lifeblood of the nation, the Court has always applied the doctrine of strict interpretation in construing tax exemptions. 18 Furthermore, a claim of statutory exemption from taxation should be manifest and unmistakable from the language of the law on which it is based. Thus, the claimed exemption "must expressly be granted in a statute stated in a language too clear to be mistaken." 19 In the instant case, the exemption claimed by the YMCA is expressly disallowed by the very wording of the last paragraph of then Section 27 of the NIRC which mandates that the income of exempt organizations (such as the YMCA) from any of their properties, real or personal, be subject to the tax imposed by the same Code. Because the last paragraph of said section unequivocally subjects to tax the rent income of the YMCA from its real property, 20 the Court is duty-bound to abide strictly by its literal meaning and to refrain from resorting to any convoluted attempt at construction.
LLpr

It is axiomatic that where the language of the law is clear and unambiguous, its express terms must be applied. 21 Parenthetically, a consideration of the question of construction must not even begin, particularly when such question is on whether to apply a strict construction or a liberal one on statutes that grant tax exemptions to "religious, charitable and educational propert[ies] or institutions." 22 The last paragraph of Section 27, the YMCA argues, should be "subject to the qualification that the income from the properties must arise from activities 'conducted for profit' before it may be considered taxable." 23 This argument is erroneous. As previously stated, a reading of said paragraph ineludibly shows that the income from any property of exempt organizations, as well as that arising from any activity it conducts for profit, is taxable. The phrase "any of their activities conducted for profit" does not qualify the word "properties." This makes income from the property of the organization taxable, regardless of how that income is used whether for profit or for lofty non-profit purposes.
cdrep

Verba legis non est recedendum. Hence, Respondent Court of Appeals committed reversible error when it allowed, on reconsideration, the tax exemption claimed by YMCA on income it derived from renting out its real property, on the solitary but unconvincing ground that the said income is not collected for profit but is merely

incidental to its operation. The law does not make a distinction. The rental income is taxable regardless of whence such income is derived and how it is used or disposed of. Where the law does not distinguish, neither should we. Constitutional Provisions on Taxation Invoking not only the NIRC but also the fundamental law, private respondent submits that Article VI, Section 28 of par. 3 of the 1987 Constitution, 24 exempts "charitable institutions" from the payment not only of property taxes but also of income tax from any source. 25 In support of its novel theory, it compares the use of the words "charitable institutions," "actually" and "directly" in the 1973 and the 1987 Constitutions, on the one hand; and in Article VI, Section 22, par. 3 of the 1935 Constitution, on the other hand. 26 Private respondent enunciates three points. First, the present provision is divisible into two categories: (1) "[c]haritable institutions, churches and parsonages or convents appurtenant thereto, mosques and non-profit cemeteries," the incomes of which are, from whatever source, all tax-exempt; 27 and (2) "[a]ll lands, buildings and improvements actually and directly used for religious, charitable or educational purposes," which are exempt only from property taxes. 28 Second, Lladoc v.Commissioner of Internal Revenue, 29 which limited the exemption only to the payment of property taxes, referred to the provision of the 1935 Constitution and not to its counterparts in the 1973 and the 1987 Constitutions. 30 Third, the phrase "actually, directly and exclusively used for religious, charitable or educational purposes" refers not only to "all lands, buildings and improvements," but also to the above-quoted first category which includes charitable institutions like the private respondent. 31

The Court is not persuaded. The debates, interpellations and expressions of opinion of the framers of the Constitution reveal their intent which, in turn, may have guided the people in ratifying the Charter. 32 Such intent must be effectuated.
dctai

Accordingly, Justice Hilario G. Davide, Jr., a former constitutional commissioner, who is now a member of this Court, stressed during the Concom debates that ". . . what is exempted is not the institution itself . . .; those exempted from real estate taxes are lands, buildings and improvements actually, directly and exclusively used for religious, charitable or educational purposes." 33 Father Joaquin G. Bernas, an eminent authority on the Constitution and also a member of the Concom, adhered to the same view that the exemption created by said provision pertained only to property taxes. 34

In his treatise on taxation, Mr. Justice Jose C. Vitug concurs, stating that "[t]he tax exemption covers property taxes only." 35 Indeed, the income tax exemption claimed by private respondent finds no basis in Article VI, Section 28, par. 3 of the Constitution. Private respondent also invokes Article XIV, Section 4, par. 3 of the Charter, 36 claiming that the YMCA "is a non-stock, non-profit educational institution whose revenues and assets are used actually, directly and exclusively for educational purposes so it is exempt from taxes on its properties and income." 37 We reiterate that private respondent is exempt from the payment of property tax, but not income tax on the rentals from its property. The bare allegation alone that it is a non-stock, non-profit educational institution is insufficient to justify its exemption from the payment of income tax.
cdtai

As previously discussed, laws allowing tax exemption are construed strictissimi juris. Hence, for the YMCA to be granted the exemption it claims under the aforecited provision, it must prove with substantial evidence that (1) it falls under the classification non-stock, non-profit educational institution; and (2) the income it seeks to be exempted from taxation is used actually, directly, and exclusively for educational purposes. However, the Court notes that not a scintilla of evidence was submitted by private respondent to prove that it met the said requisites. Is the YMCA an educational institution within the purview of Article XIV, Section 4, par. 3 of the Constitution? We rule that it is not. The term "educational institution " or "institution of learning" has acquired a well-known technical meaning, of which the members of the Constitutional Commission are deemed cognizant. 38 Under the Education Act of 1982, such term refers to schools. 39 The school system is synonymous with formal education, 40 which "refers to the hierarchically structured and chronologically graded learnings organized and provided by the formal school system and for which certification is required in order for the learner to progress through the grades or move to the higher levels." 41 The Court has examined the "Amended Articles of Incorporation" 42 and "ByLaws" 43 of the YMCA, but found nothing in them that even hints that it is a school or an educational institution. 44 Furthermore, under the Education Act of 1982, even non-formal education is understood to be school-based and "private auspices such as foundations and civic-spirited organizations" are ruled out. 45 It is settled that the term "educational institution," when used in laws granting tax exemptions, refers to a ". . . school seminary, college or educational establishment . . ." 46 Therefore, the private respondent cannot be deemed one of the educational institutions covered by the constitutional provision under consideration.
cdphil

". . . Words used in the Constitution are to be taken in their ordinary acceptation. While in its broadest and best sense education embraces all forms and phases of

instruction, improvement and development of mind and body, and as well of religious and moral sentiments, yet in the common understanding and application it means a place where systematic instruction in any or all of the useful branches of learning is given by methods common to schools and institutions of learning. That we conceive to be the true intent and scope of the term [educational institutions,] as used in the Constitution ." 47

Moreover, without conceding that Private Respondent YMCA is an educational institution, the Court also notes that the former did not submit proof of the proportionate amount of the subject income that was actually, directly and exclusively used for educational purposes. Article XIII, Section 5 of the YMCA by-laws, which formed part of the evidence submitted, is patently insufficient, since the same merely signified that "[t]he net income derived from the rentals of the commercial buildings shall be apportioned to the Federation and Member Associations as the National Board may decide." 48 In sum, we find no basis for granting the YMCA exemption from income tax under the constitutional provision invoked.
LLphil

Cases Cited by Private Respondent Inapplicable The cases 49 relied on by private respondent do not support its cause. YMCA of Manila v. Collector of Internal Revenue 50 and Abra Valley College, Inc. v. Aquino 51are not applicable, because the controversy in both cases involved exemption from the payment of property tax, not income tax. Hospital de San Juan de Dios, Inc. v.Pasay City 52 is not in point either, because it involves a claim for exemption from the payment of regulatory fees, specifically electrical inspection fees, imposed by an ordinance of Pasay City an issue not at all related to that involved in a claimed exemption from the payment of income taxes imposed on property leases. InJesus Sacred Heart College v. Com. of Internal Revenue, 53 the party therein, which claimed an exemption from the payment of income tax, was an educational institution which submitted substantial evidence that the income subject of the controversy had been devoted or used solely for educational purposes. On the other hand, the private respondent in the present case has not given any proof that it is an educational institution, or that part of its rent income is actually directly and exclusively used for educational purposes.
prLL

Epilogue In deliberating on this petition, the Court expresses its sympathy with private respondent. It appreciates the nobility of its cause. However, the Court's power and function are limited merely to applying the law fairly and objectively. It cannot change the law or bend it to suit its sympathies and appreciations. Otherwise, it would be overspilling its role and

invading the realm of legislation. We concede that private respondent deserves the help and the encouragement of the government. It needs laws that can facilitate, and not frustrate, its humanitarian tasks. But the Court regrets that, given its limited constitutional authority, it cannot rule on the wisdom or propriety of legislation. That prerogative belongs to the political departments of government. Indeed, some of the members of the Court may even believe in the wisdom and prudence of granting more tax exemptions to private respondent. But such belief, however well-meaning and sincere, cannot bestow upon the Court the power to change or amend the law. WHEREFORE, the petition is GRANTED. The Resolutions of the Court of Appeals dated September 28, 1995 and February 29, 1996 are hereby REVERSED and SET ASIDE. The Decision of the Court of Appeals dated February 16, 1995 is REINSTATED, insofar as it ruled that the income derived by petitioner from rentals of its real property is subject to income tax. No pronouncement as to costs.
cda

SO ORDERED.
H. GENERAL PROFESSIONAL PARTNERSHIP GPP vs. ORDINARY PARTNERSHIP

[G.R. No. 109289. October 3, 1994.] RUFINO R. TAN, petitioner, vs. RAMON R. DEL ROSARIO, JR., as SECRETARY OF FINANCE & JOSE U. ONG, as COMMISSIONER OF INTERNAL REVENUE, respondents. [G.R. No. 109446. October 3, 1994.] CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES, CARLO A. CARAG, MANUELITO O. CABALLES, ELPIDIO C. JAMORA, JR. and BENJAMIN A. SOMERA, JR., petitioners, vs. RAMON R. DEL ROSARIO, in his capacity as SECRETARY OF FINANCE and JOSE U. ONG, in his capacity as COMMISSIONER OF INTERNAL REVENUE, respondents.

DECISION

VITUG, J :
p

These two consolidated special civil actions for prohibition challenge, in G.R. No. 109289, the constitutionality of Republic Act No. 7496, also commonly known as the Simplified Net Income Taxation Scheme ("SNIT"), amending certain provisions of the National Internal Revenue Regulations No. 2-93, promulgated by public respondents pursuant to said law. Petitioners claim to be taxpayers adversely affected by the continued implementation of the amendatory legislation. In G.R. No. 109289, it is asserted that the enactment of Republic Act No. 7496 violates the following provisions of the Constitution:
"Article VI, Section 26 (1) Every bill passed by the Congress shall embrace only one subject which shall be expressed in the title thereof." "Article VI, Section 28 (1) The rule of the taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation." "Article III, Section 1 No person shall be deprived of . . . property without due process of law, nor shall any person be denied the equal protection of the laws."

In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No. 2-93, argue that public respondents have exceeded their rulemaking authority in applying SNIT to general professional partnerships. The Solicitor General espouses the position taken by public respondents. The Court has given due course to both petitions. The parties, in compliance with the Court's directive, have filed their respective memoranda. G.R. No. 109289 Petitioner contends that the title of House Bill No. 34314, progenitor of Republic Act No. 7496, is a misnomer or, at least, deficient for being merely entitled, "Simplified Net Income Taxation Scheme for the Self-Employed and Professionals Engaged in the Practice of their Profession" (Petition in G.R. No. 109289). The full text of the title actually reads:
"An Act Adopting the Simplified Net Income Taxation Scheme For

The Self-Employed and Professionals Engaged In The Practice of Their Profession, Amending Sections 21 and 29 of the National Internal Revenue Code, as Amended."

The pertinent provisions of Sections 21 and 29, so referred to, of the National Internal Revenue Code, as now amended, provide:
"Section 21.Tax on citizens or residents. xxx xxx xxx "(f)Simplified Net Income Tax for the Self-Employed and/or Professionals Engaged in the Practice of Profession. A tax is hereby imposed upon the taxable net income as determined in Section 27 received during each taxable year from all sources, other than income covered by paragraphs (b), (c), (d) and (e) of this section by every individual whether a citizen of the Philippines or an alien residing in the Philippines who is self-employed or practices his profession herein, determined in accordance with the following schedule: "Not over P10,0003%
Over P10,000 but not overP30,000P300 + 9% of excess overP10,000 Over P30,000 but not overP120,000P2,100 + 15% of excess over P30,000 Over P120,000 but not overP350,000P15,600 + P20% of excess over P120,000 Over P350,000P61,600 + 30% of excess over P350,000"

"SECTION 29.Deductions from gross income. In computing taxable income subject to tax under Sections 21(a), 24(a), (b) and (c); and 25 (a) (1), there shall be allowed as deductions the items specified in paragraphs (a) to (i) of this section: Provided, however, That in computing taxable income subject to tax under Section 21 (f) in the case of individuals engaged in business or practice of profession, only the following direct costs shall be allowed as deductions: "(a)Raw materials, supplies and direct labor; "(b)Salaries of employees directly engaged in activities in the course of or pursuant to the business or practice of their profession; "(c)Telecommunications, electricity, fuel, light and water; "(d)Business rentals; "(e)Depreciation; "(f)Contributions made to the Government and accredited relief organizations for the rehabilitation of calamity stricken areas declared by the President; and "(g)Interest paid or accrued within a taxable year on loans contracted from accredited financial institutions which must be proven to have been incurred in connection with the conduct of a taxpayer's

profession, trade or business. "For individuals whose cost of goods sold and direct costs are difficult to determine, a maximum of forty per cent (40%) of their gross receipts shall be allowed as deductions to answer for business or professional expenses as the case may be."

On the basis of the above language of the law, it would be difficult to accept petitioner's view that the amendatory law should be considered as having now adopted a gross income, instead of as having still retained the net income, taxation scheme. The allowance for deductible items, it is true, may have significantly been reduced by the questioned law in comparison with that which has prevailed prior to the amendment; limiting, however, allowable deductions from gross income is neither discordant with, nor opposed to, the net income tax concept. The fact of the matter is still that various deductions, which are by no means inconsequential, continue to be well provided under the new law. Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-rolling legislation intended to unite the members of the legislature who favor any one of unrelated subjects in the support of the whole act, (b) to avoid surprises or even fruad upon the legislature , and (c) to fairly apprise the people, through such publications of its proceedings as are usually made, of the subjects of legislation. 1 The above objectives of the fundamental law appear to us to have been sufficiently met. Anything else would be to require a virtual compendium of the law which could not have been the intendment of the constitutional mandate. Petitioner intimates that Republic Act No. 7496 desecrates the constitutional requirement that taxation "shall be uniform and equitable" in that the law would now attempt to tax single proprietorships and professionals differently from the manner it imposes the tax on corporations and partnerships. The contention clearly forgets, however, that such a system of income taxation has long been the prevailing rule even prior to Republic Act No. 7496. Uniformity of taxation, like the kindred concept of equal protection, merely requires that all subjects or objects of taxation, similarly situated, are to be treated alike both in privileges and liabilities (Juan Luna Subdivision vs. Sarmiento, 91 Phil. 371). Uniformity does not forfend classification as long as: (1) the standards that are used therefor are substantial and not arbitrary, (2) the categorization is germane to achieve the legislative purpose, (3) the law applies, all things being equal, to both present and future conditions, and (4) the classification applies equally well to all those belonging to the same class (Pepsi Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 771). What may instead be perceived to be apparent from the amendatory law is the legislative intent to increasingly shift the income tax system towards the schedular approach 2 in the income taxation of individual taxpayers and to

maintain, by and large, the present global treatment 3 on taxable corporations. We certainly do not view this classification to be arbitrary and inappropriate. Petitioner gives a fairly extensive discussion on the merits of the law, illustrating, in the process, what he believes to be an imbalance between the tax liabilities of those covered by the amendatory law and those who are not. With the legislature primarily lies the discretion to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation. This court cannot freely delve into those matters which, by constitutional fiat, rightly rest on legislative judgment. Of course, where a tax measure becomes so unconscionable and unjust as to amount to confiscation of property, courts will not hesitate to strike it down, for, despite all its plenitude, the power to tax cannot override constitutional proscriptions. This stage, however, has not been demonstrated to have been reached within any appreciable distance in this controversy before us. Having arrived at this conclusion, the plea of petitioner to have the law declared unconstitutional for being violative of due process must perforce fail. The due process clause may correctly be invoked only when there is a clear contravention of inherent or constitutional limitations in the exercise of the tax power. No such transgression is so evident to us. G.R No 109446 The several propositions advanced by petitioners revolve around the question of whether or not public respondents have exceeded their authority in promulgating Section 6, Revenue Regulations No. 2-93, to carry out Republic Act No. 7496. The questioned regulation reads:
"Sec. 6 General Professional Partnership The general professional partnership (GPP) and the partners comprising the GPP are covered by R.A. No. 7496. Thus, in determining the net profit of the partnership, only the direct costs mentioned in said law are to be deducted from partnership income. Also, the expenses paid or incurred by partners in their individual capacities in the practice of their profession which are not reimbursed or paid by the partnership but are not considered as direct cost, are not deductible from his gross income."

The real objection of petitioners is focused on the administrative interpretation of public respondents that would apply SNIT to partners in general professional partnerships. Petitioners cite the pertinent deliberations in Congress during its enactment of Republic Act No. 7496, also quoted by the Honorable Hernando B. Perez, minority floor leader of the House of the Representatives, in the latter's privilege speech by way of commenting on the questioned

implementing regulation of public respondents following the effectivity of the law, thusly:
"'MR. ALBANO, Now Mr. Speaker, I would like to get the correct impression on this bill. Do we speak here of individuals who are earning, I mean, who earn through business enterprises and therefore, should file an income tax return? 'MR. PEREZ. That is correct, Mr. Speaker. This does not apply to corporations. It applies only to individuals.' "(See Deliberations on H.B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis ours) "'Other deliberations support this position, to wit: 'MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from Batangas say that this bill is intended to increase collections as far as individuals are concerned and to make collection of taxes equitable? 'MR. PEREZ. That is correct, Mr. Speaker.' "(Id. at 6:40 P.M.; Emphasis ours) "In fact, in the sponsorship speech of Senator Mamintal Tamano on the Senate version of the SNITS, it is categorically stated, thus: "'This bill, Mr. President, is not applicable to business corporations or to partnerships; it is only with respect to individuals and professionals.' (Emphasis ours)"

The Court, first of all, should like to correct the apparent misconception that general professional partnerships are subject to the payment of income tax or that there is a difference in the tax treatment between individuals engaged in business or in the practice of their respective professions and partners in general professional partnerships. The fact of the matter is that a general professional partnership, unlike an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on their distributive shares of partnership profits. Section 23 of the Tax Code, which has not been amended at all by Republic Act 7496, is explicit:
"SECTION 23.Tax liability of members of general professional partnerships. (a) Persons exercising a common profession in general partnership shall be liable for income tax only in their individual capacity, and the share in the net profits of the general professional partnership to which any taxable partner would be entitled whether distributed or otherwise, shall be returned for taxation and the tax paid in accordance with the provisions of this Title.

"(b)In determining his distributive share in the net income of the partnership, each partner "(1)Shall take into account separately his distributive share of the partnership's income, gain, loss, deduction, or credit to the extend provided by the pertinent provisions of this Code, and "(2)Shall be deemed to have elected the itemized deductions, unless he declares his distributive share of the gross income undiminished by his share of the deductions."

There is, then and now, no distinction in income tax liability between a person who practices his profession alone or individually and one who does it through partnership (whether registered or not) with others in the exercise of a common profession. Indeed, outside of the gross compensation income tax and the final tax on passive investment income, under the present income tax system all individuals deriving income from any source whatsoever are treated in almost invariably the same manner and under a common set of rules. We can well appreciate the concern taken by petitioners if perhaps we were to consider Republic Act No. 7496 as an entirely independent, not merely as an amendatory, piece of legislation. The view can easily become myopic, however, when the law is understood, as it should be, as only forming part of, and subject to, the whole income tax concept and precepts long obtaining under the National Internal Revenue Code. To elaborate a little, the phrase "income taxpayers" is an all embracing term used in the Tax Code, and it practically covers all persons who derive taxable income. The law, in levying the tax, adopts the most comprehensive tax situs of nationality and residence of the taxpayer (that renders citizens, regardless of residence, and resident aliens subject to income tax liability on their income from all sources) and of the generally accepted and internationally recognized income taxable base (that can subject non-resident aliens and foreign corporations to income tax on their income from Philippine sources). In the process, the Code classifies taxpayers into four main groups, namely: (1) Individuals, (2) Corporations, (3) Estates under Judicial Settlement and (4) Irrevocable Trusts (irrevocable both as to corpusand as to income). Partnerships are, under the Code, either "taxable partnerships" or "exempt partnerships." Ordinarily, partnerships, no matter how created or organized, are subject to income tax (and thus alluded to as "taxable partnerships") which, for purposes of the above categorization, are by law assimilated to be within the context of, and so legally contemplated as, corporations. Except for few variances, such as in the application of the "constructive receipt rule" in the derivation of income, the income tax approach is alike to both juridical persons. Obviously, SNIT is not intended or envisioned, as so correctly pointed out in the discussions in Congress during its deliberations on Republic Act 7496,

aforequoted, to cover corporations and partnerships which are independently subject to the payment of income tax. "Exempt partnerships," upon the other hand, are not similarly identified as corporations nor even considered as independent taxable entities for income tax purposes. A general professional partnership is such an example. 4 Here, the partners themselves, not the partnership (although it is still obligated to file an income tax return [mainly for administration and data]), are liable for the payment of income tax in their individual, capacity computed their respective and distributive shares of profits. In the determination of the tax liability, a partner does so as an individual, and there is no choice on the matter. In fine, under the Tax Code on income taxation, the general professional partnership is deemed to be no more than a mere mechanism or a flow-through entity in the generation of income by, and the ultimate distribution of such income to, respectively, each of the individual partners. Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the above standing rule as now so modified by Republic Act No. 7496 on basically the extent of allowable deductions applicable to all individual income taxpayers on their non-compensation income. There is no evident intention of the law, either before or after the amendatory legislation, to place in an unequal footing or in significant variance the income tax treatment of professionals who practice their respective professions individually and of those who do it through a general professional partnership. WHEREFORE, the petitions are DISMISSED. No special pronouncement on costs. SO ORDERED.

I.

GROSS INCOME COMPENSATION

[G.R. No. L-78780. July 23, 1987.] DAVID G. NITAFAN, WENCESLAO M. POLO, and MAXIMO A. SAVELLANO, JR., petitioners, vs. COMMISSIONER OF INTERNAL REVENUE and THE FINANCIAL OFFICER, SUPREME COURT OF THE PHILIPPINES, respondents.

RESOLUTION

MELENCIO-HERRERA, J :
p

Petitioners, the duly appointed and qualified Judges presiding over Branches 52, 19 and 53, respectively, of the Regional Trial Court, National Capital Judicial Region, all with stations in Manila, seek to prohibit and/or perpetually enjoin respondents, the Commissioner of Internal Revenue and the Financial Officer of the Supreme Court, from making any deduction of withholding taxes from their salaries.
prcd

In a nutshell, they submit that "any tax withheld from their emoluments or compensation as judicial officers constitutes a decrease or diminution of their salaries, contrary to the provision of Section 10, Article VIII of the 1987 Constitution mandating that '(d)uring their continuance in office, their salary shall not be decreased,' even as it is anathema to the ideal of an independent judiciary envisioned in and by said Constitution." It may be pointed out that, early on, the Court had dealt with the matter administratively in response to representations that the Court direct its Finance Officer to discontinue the withholding of taxes from salaries of members of the Bench. Thus, on June 4, 1987, the Court en banc had reaffirmed the Chief Justice's directive as follows:
"RE:Question of exemption from income taxation. The Court REAFFIRMED the Chief Justice's previous and standing directive to the Fiscal Management and Budget Office of this Court to continue with the deduction of the withholding taxes from the salaries of the Justices of the Supreme Court as well as from the salaries of all other members of the judiciary."

That should have resolved the question. However, with the filing of this petition, the Court has deemed it best to settle the legal issue raised through this judicial pronouncement. As will be shown hereinafter, the clear intent of the Constitutional Commission was to delete the proposed express grant of exemption from payment of income tax to members of the Judiciary, so as to "give substance to equality among the three branches of Government" in the words of Commissioner Rigos. In the course of the deliberations, it was further expressly made clear, specially with regard to Commissioner Joaquin F. Bernas' accepted amendment to the amendment of Commissioner Rigos, that the salaries of members of the Judiciary would be subject to the general income tax applied to all taxpayers. This intent was somehow and inadvertently not clearly set forth in the final text of the Constitution as approved and ratified in February, 1987 (infra, pp. 7-8). Although the

intent may have been obscured by the failure to include in the General Provisions a proscription against exemption of any public officer or employee, including constitutional officers, from payment of income tax, the Court since then has authorized the continuation of the deduction of the withholding tax from the salaries of the members of the Supreme Court, as well as from the salaries of all other members of the Judiciary. The Court hereby makes of record that it had then discarded the ruling in Perfecto vs. Meer and Endencia vs. David, infra, that declared the salaries of members of the Judiciary exempt from payment of the income tax and considered such payment as a diminution of their salaries during their continuance in office. The Court hereby reiterates that the salaries of Justices and Judges are properly subject to a general income tax law applicable to all income earners and that payment of such income tax by Justices and Judges does not fall within the constitutional protection against decrease of their salaries during their continuance in office.
cdphil

A comparison of the Constitutional provisions involved is called for. The 1935 Constitution provided:
". . . (The members of the Supreme Court and all judges of inferior courts) shall receive such compensation as may be fixed by law, which shall not bediminished during their continuance in office . . ." 1 (Emphasis supplied).

Under the 1973 Constitution, the same provision read:

"The salary of the Chief Justice and of the Associate Justices of the Supreme Court, and of judges of inferior courts shall be fixed by law, which shall not bedecreased during their continuance in office . . ." 2 (Emphasis ours).

And in respect of income tax exemption, another provision in the same 1973 Constitution specifically stipulated:
"No salary or any form of emolument of any public officer or employee, including constitutional officers, shall be exempt from payment of income tax." 3

The provision in the 1987 Constitution, which petitioners rely on, reads:
"The salary of the Chief Justice and of the Associate Justices of the Supreme Court, and of judges of lower courts shall be fixed by law. During their continuance in office, their salary shall not be decreased.". 4 (Emphasis supplied).

The 1987 Constitution does not contain a provision similar to Section 6, Article XV of the 1973 Constitution, for which reason, petitioners claim that the intent of the framers is to revert to the original concept of "non-diminution" of salaries of judicial officers.

The deliberations of the 1986 Constitutional Commission relevant to Section 10, Article VIII, negate such contention. The draft proposal of Section 10, Article VIII, of the 1987 Constitution read:
"Section 13.The salary of the Chief Justice and the Associate Justices of the Supreme Court and of judges of the lower courts shall be fixed by law. During their continuance in office, their salary shall not be diminished nor subjected to income tax. Until the National Assembly shall provide otherwise, the Chief Justice shall receive an annual salary of _________ and each Associate Justice ____ pesos." 5 (Emphasis ours).

During the debates on the draft Article (Committee Report No. 18), two Commissioners presented their objections to the provision on tax exemption, thus:
LibLex

"MS. AQUINO.Finally, on the matter of exemption from tax of the salary of justices, does this not violate the principle of the uniformity of taxation and the principle of equal protection of the law? After all, tax is levied not on the salary but on the combined income, such that when the judge receives a salary and it is comingled with the other income, we tax the income, not the salary. Why do we have to give special privileges to the salary of justices? "MR. CONCEPCION.It is the independence of the judiciary. We prohibit the increase or decrease of their salary during their term. This is an indirect way of decreasing their salary and affecting the independence of the judges. "MS. AQUINO.I appreciate that to be in the nature of a clause to respect tenure, but the special privilege on taxation might, in effect, be a violation of the principle of uniformity in taxation and the equal protection clause. 6 xxx xxx xxx "MR. OPLE.. . . "Of course, we share deeply the concern expressed by the sponsor, Commissioner Roberto Concepcion, for whom we have the highest respect, to surround the Supreme Court and the judicial system as a whole with the whole armor of defense against the executive and legislative invasion of their independence. But in so doing, some of the citizens outside, especially the humble government employees, might say that in trying to erect a bastion of justice, we might end up with the fortress of privileges, an island of extra territoriality under the Republic of the Philippines, because a good number of powers and rights accorded to the Judiciary here may not be enjoyed in the remotest degree by other employees of the government.

"An example is the exception from income tax, which is a kind of economic immunity, which is, of course, denied to the entire executive department and the legislative." 7

And during the period of amendments on the draft Article, on July 14, 1986, Commissioner Cirilo A. Rigos proposed that the term "diminished" be changed to "decreased" and that the words "nor subjected to income tax" be deleted so as to "give substance to equality among the three branches in the government." Commissioner Florenz D. Regalado, on behalf of the Committee on the Judiciary, defended the original draft and referred to the ruling of this Court in Perfecto vs.Meer 8 that "the independence of the judges is of far greater importance than any revenue that could come from taxing their salaries." Commissioner Rigos then moved that the matter be put to a vote. Commissioner Joaquin G. Bernas stood up "in support of an amendment to the amendment with the request for a modification of the amendment," as follows:
"FR. BERNAS.Yes. I am going to propose an amendment to the amendment saying that it is not enough to drop the phrase 'shall not be subjected to income tax,' because if that is all that the Gentleman will do, then he will just fall back on the decision in Perfecto vs. Meer and in Dencia vs. David [should be Endencia and Jugo vs. David, etc., 93 Phil. 696] which excludes them from income tax, but rather I would propose that the statement will read: 'During their continuance in office, their salary shall not be diminished BUT MAY BE SUBJECT TO GENERAL INCOME TAX.' In support of this position, I would say that the argument seems to be that the justice and judges should not be subjected to income tax because they already gave up the income from their practice. That is true also of Cabinet members and all other employees. And I know right now, for instance, there are many people who have accepted employment in the government involving a reduction of income and yet are still subject to income tax. So, they are not the only citizens whose income is reduced by accepting service in government."

Commissioner Rigos accepted the proposed amendment to the amendment. Commissioner Rustico F. de los Reyes, Jr. then moved for a suspension of the session. Upon resumption, Commissioner Bernas announced:

"During the suspension, we came to an understanding with the original proponent, Commissioner Rigos, that his amendment on page 6,. line 4 would read: 'During their continuance in office, their salary shall not be DECREASED.' But this is on the understanding that there will be a provision in the Constitution similar to Section 6 of Article XV, the General Provisions of the 1973

Constitution, which says: 'No salary or any form of emolument of any public officer or employee, including constitutional officers, shall be exempt from payment of income tax.' "So, we put a period (.) after 'DECREASED' on the understanding that the salary of justices is subject to tax."

When queried about the specific Article in the General Provisions on non-exemption from tax of salaries of public officers, Commissioner Bernas replied:
"FR. BERNAS.Yes, I do not know if such an article will be found in the General Provisions. But at any rate, when we put a period (.) after 'DECREASED,' it is on the understanding that the doctrine in Perfecto vs. Meer and Dencia vs. David will not apply anymore."

The amendment to the original draft, as discussed and understood, was finally approved without objection.
LLjur

"THE PRESIDING OFFICER (Mr. Bengzon). The understanding, therefore, is that there will be a provision under the Article on General Provisions. Could Commissioner Rosario Braid kindly take note that the salaries of officials of the government including constitutional officers shall not be exempt from income tax? The amendment proposed herein and accepted by the Committee now reads as follows: 'During their continuance in office, their salary shall not be DECREASED'; and the phrase 'nor subjected to income tax' is deleted." 9

The debates, interpellations and opinions expressed regarding the constitutional provision in question until it was finally approved by the Commission disclosed that the true intent of the framers of the 1987 Constitution, in adopting it, was to make the salaries of members of the Judiciary taxable. The ascertainment of that intent is but in keeping with the fundamental principle of constitutional construction that the intent of the framers of the organic law and of the people adopting it should be given effect. 10 The primary task in constitutional construction is to ascertain and thereafter assure the realization of the purpose of the framers and of the people in the adoption of the Constitution. 12 Besides, construing Section 10, Articles VIII, of the 1987 Constitution, which, for clarity, is again reproduced hereunder:
"The salary of the Chief Justice and of the Associate Justices of the Supreme Court, and of judges of lower courts shall be fixed by law. During their continuance in office, their salary shall not be decreased." (Emphasis supplied).

it is plain that the Constitution authorizes Congress to pass a law fixing another rate of compensation of Justices and Judges but such rate must be higher than that which they are receiving at the time of enactment, or if lower, it would be applicable only to those appointed after its approval. It would be a strained construction to read into the provision an exemption from taxation in the light of the discussion in the Constitutional Commission. With the foregoing interpretation, and as stated heretofore, the ruling that "the imposition of income tax upon the salary of judges is a dimunition thereof, and so violates the Constitution" in Perfecto vs. Meer, 13 as affirmed in Endencia vs. David 14 must be declared discarded. The framers of the fundamental law, as the alter ego of the people, have expressed in clear and unmistakable terms the meaning and import of Section 10, Article VIII, of the 1987 Constitution that they have adopted. Stated otherwise, we accord due respect to the intent of the people, through the discussions and deliberations of their representatives, in the spirit that all citizens should bear their aliquot part of the cost of maintaining the government and should share the burden of general income taxation equitably. WHEREFORE, the instant petition for Prohibition is hereby dismissed.

RETIREMENT PAY

[G.R. No. 96032. July 31, 1991.] JESUS N. BORROMEO, petitioner, vs. THE HON. CIVIL SERVICE COMMISSION and SECRETARY OF BUDGET AND MANAGEMENT,respondents. SYLLABUS 1.CONSTITUTIONAL LAW; 1987 CONSTITUTION; CONSTITUTIONAL COMMISSIONS; APPEAL BY CERTIORARI TO THE SUPREME COURT; REFERS TO AN AGGRIEVED PARTY RAISING A DECISION TO THE HIGH TRIBUNAL; CASE AT BAR. Article IX-A, Section 7 of the 1987 Constitution refers to an aggrieved party raising a decision to this Court. Unfortunately for the petitioner, neither the Civil Service Commission nor the Secretary of Budget and Management may be viewed as an aggrieved party. The CSC is not an aggrieved party because it recommended

the approval of the petitioner's request for payment of terminal leave computed on the basis of his monthly salary plus allowances and likewise interceded in behalf of the petitioner for the release of funds from the DBM. The COA upheld this initial position. Nor is the DBM an aggrieved party because it was not privy to the case before the COA. 2.ID.; ID.; ID.; CIVIL SERVICE COMMISSION; JURISDICTION. While the implementation and enforcement of leave benefits are matters within the functions of the CSC as the central personnel agency of the government, the duty to examine accounts and expenditures relating to leave benefits properly pertains to the COA. Where government expenditures or use of funds is involved, the CSC cannot claim an exclusive domain simply because leave matters are also involved. 3.ID.; ID.; ID.; EQUALLY PRE-EMINENT IN THEIR RESPECTIVE SPHERES. The COA, the CSC, and the Commission on Elections are equally pre-eminent in their respective spheres. Neither one may claim dominance over the others. 4.ID.; ID.; ID.; ID.; ROLE OF JUDICIARY IN CASE OF CONFLICTING RULINGS. In case of conflicting rulings, it is the Judiciary which interprets the meaning of the law and ascertains which view shall prevail. 5.ADMINISTRATIVE LAW; REVISED ADMINISTRATIVE CODE; RETIREMENT; COMMUTATION OF SALARY DIFFERENTIATED FROM COMMUTATION OF LEAVE CREDITS. "Commutation of salary" as used in Section 286 is, however, not the same as "commutation of leave credits." The former is applied for by an employeeduring employment when he goes on ordinary leave. In contrast, commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own (Manual on Leave Administration Course for Effectiveness published by theCivil Service Commission, pages 16-17). 6.ID.; ID.; ID.; TERMINAL LEAVE; NATURE, CONSTRUED. Since terminal leave is applied for by an officer or employee who has already severed his connection with his employer and who is no longer working, then it follows that the terminal leave pay, which is the cash value of his accumulated leave credits, should not be treated as compensation for services rendered at that time (Re: Request of Atty. Bernardo Zialcita, 190 SCRA 851 [1990]). It cannot be viewed as salary for purposes which would reduce it. (supra) 7.ID.; COMMONWEALTH ACT NO. 186; RETIREMENT OF GOVERNMENT EMPLOYEES OTHER THAN MEMBERS OF THE JUDICIARY, CONSTITUTIONAL COMMISSIONS AND THOSE WHOSE RETIREMENT IS NOT COVERED BY SPECIAL LAW; COMMUTATION OF VACATION AND SICK LEAVE CREDITS; BASIS. Commonwealth Act (CA) No. 186, as amended, provides for the retirement of

government employees, other than members of the Judiciary, Constitutional Commissions and those whose retirement is not covered by special law. Under the last sentence of Section 12 (c), officials and employees retired under CA 186, as amended, shall be entitled to the commutation of the vacation and sick leave credits based on the highest rate received. In Paredes vs. Acting Chairman, supra, the Court construed the phrase "highest rate received" as referring to the retiree's "highest monthly salary." 8.ID.; REPUBLIC ACT NO. 910; RETIREMENT OF MEMBERS OF THE JUDICIARY AND CONSTITUTIONAL COMMISSIONS; RETIREMENT GRATUITY; BASIS. R.A. No. 910 as amended, governs the petitioner. In the case of members of the Judiciary and Constitutional Commissions, the basis in computing the retirement gratuity is the highest monthly salary plus the highest monthly aggregate of transportation, living and representation allowance (COLA and RATA). The same rule of uniformity which we applied in Paredes vs. Acting Chairman for those retiring under CA 186 as amended should also apply for those who retire under R.A. 910 as amended. The rate used in computing retirement gratuities also applies in the computation of terminal leave credits. 9.STATUTORY CONSTRUCTION; RETIREMENT LAWS; LIBERALLY CONSTRUED AND ADMINISTERED IN FAVOR OF THE PERSONS INTENDED TO BE BENEFITED. Retirement laws are liberally construed and administered in favor of the persons intended to be benefited. All doubts as to the intent of the law should be resolved in favor of the retiree to achieve its humanitarian purposes. (In Re: Amount of the Monthly Pension of Judges and Justices starting from the Sixth year of their Retirement and after the Expiration of the Initial Five-year Period of Retirement, 190 SCRA 315 [1990]; Ortiz vs. Commission on Elections, 162 SCRA 812 [1988]; Bautista vs. Auditor General, 104 Phil. 428 [1958]). 10.ADMINISTRATIVE LAW; REVISED ADMINISTRATIVE CODE; RETIREMENT; GRATUITY; NATURE. A gratuity is that paid to the beneficiary for past services rendered purely out of generosity of the giver or grantor (Peralta vs. Auditor General, 100 Phil. 1051 [1957]). It is a mere bounty given by the government in consideration or in recognition of meritorious services and springs from the appreciation and graciousness of the government (Pirovano vs. De La Rama Steamship Co., 96 Phil. 335, 357 [1954]). 11.ID.; ID. ; ID.; ID.; ACCUMULATED LEAVE CREDITS, WITHIN ITS SCOPE. While it is true that vacation and sick leave credits are earned during one's period of employment, they are, by their very nature and purpose, supposed to be enjoyed or exhausted during employment. When these accumulated leave benefits are allowed to be accumulated, not to be paid while one is working but to be reserved for old age, then this constitutes the gratuity. 12.ID.; REPUBLIC ACT NO. 6758; RETIREMENT; INTEGRATION OF COST OF

LIVING ALLOWANCE TO THE BASIC SALARY. Section 12 of Republic Act 6758, known as the Compensation and Position Classification Act of 1989, mandated the integration of COLA to the basic salary and, therefore, to the retirement pay of all employees. 13.ID.; REPUBLIC ACT NO. 910; RETIREMENT OF MEMBERS OF THE JUDICIARY AND CONSTITUTIONAL COMMISSIONS; TERMINAL LEAVE DIFFERENTIALS; INCLUSION OF COLA AND RATA THEREIN; CUT-OFF DATE. Practical considerations and budgetary restraints constrain the Court to impose a cutoff date for claims for terminal leave differentials. The Court therefore, rules that the inclusion of COLA and RATA as basis in arriving at terminal leave pay shall apply only to those qualified members of the Judiciary and Constitutional Commissions who retired or shall retire on or after the change of government in February, 1986.

DECISION

GUTIERREZ, JR., J :
p

Should the terminal leave pay of petitioner Borromeo, Chairman of the Civil Service Commission (CSC) until his retirement on April 1, 1986, be computed on the basis of the highest monthly salary plus cost of living allowance (COLA) and representation and transportation allowance (RATA) or solely on the basis of highest monthly salary without said allowances? This is the issue that confronts the Court. On August 18, 1988, the petitioner wrote a letter to the Commission on Audit (COA) Chairman, coursed through the CSC Chairman, requesting an opinion on whether or not the money value of the terminal leave of retired Constitutional Commission members should include the allowances received at the time of retirement. The petitioner, in his letter, further stated that while retired members of other Constitutional Commissions received terminal leave pay computed on the basis of highest monthly salary including allowances, the former's terminal leave was computed solely on the basis of highest monthly salary. In a First Indorsement to the COA Chairman on September 1, 1988, the CSC Chairman recommended the approval of the petitioner's request for payment of the money value of his terminal leave based on salary plus allowances. On September 28, 1989, the COA rendered Decision No. 992 (hereinafter referred to as the COA decision) stating that "in line with the action taken by thisCommission in the previous similar cases of former COA Commissioners Hermogenes P. Pobre and Silvestre

D. Sarmiento," the COA "will interpose no objection" to the petitioner's claim. Upon the petitioner's request for payment of terminal leave differential representing the unpaid COLA and RATA amounting to P111,229.04, the CSC Chairman informed the petitioner that the release of the corresponding advice of allotment and cash outlay to cover the payment of his terminal leave differential had already been requested from the Department of Budget and Management (DBM). On January 25, 1990, in a letter addressed to the CSC Chairman, the DBM denied the petitioner's request for payment of terminal leave differential for the following reasons, among others: 1)Computation of the money value of vacation and sick leave is based on "basic pay" or "basic salary" pursuant to the provisions of the Revised Administrative Code, as amended by R.A. No. 1081. 2)Under Section 2(1) of P.D. No. 1146, the term salary refers to the basic pay or salary received by an employee, excluding per diems, bonuses, overtime pay and allowance. 3)The cases of former COA Commissioners Pobre and Sarmiento cannot be validly invoked as precedents for purposes of DBM Budgetary action since said claims were processed without prior involvement of the DBM. Faced with the DBM refusal to release the corresponding allotment, the CSC yielded to DBM instead of asserting its initial determination. It issued Resolution No. 90-514 dated May 30, 1990 wherein the Commission deemed it proper not to rule on the issue on "ethical considerations" and "compulsions of delicadeza" and advised the petitioner to file an action for declaratory relief (sic) on the issue with the Supreme Court.
LLpr

Petitioner Borromeo sought reconsideration of CSC Resolution No. 90-514, reasoning that neither the CSC Resolution nor the opinion of the DBM Secretary could prevail over the COA decision which had become final and executory. On October 18, 1990, the CSC issued Resolution No. 90-945 denying reconsideration of the petitioner's case. Inspite of the CSC Chairman's earlier approval of the claim for payment, the CSC ruled that the COA decision "has no sufficient legal mooring and therefore cannot be the basis for allowing payment of the claims." The Resolution likewise cited a June 13, 1990 letter from former Court Administrator Meynardo A. Tiro informing the CSC that "the money value of the terminal leave credits of the Justices of the Supreme Court and other members of the Judiciary is based only on the highest basic salary (plus longevity pay) but excluding RATA as certified to by our Director of Fiscal

Management and Budget Office." Hence, this petition. The Secretary of Budget and Management was ordered impleaded by the Court in a resolution dated January 31, 1991. The petitioner seeks the nullification of CSC Resolution Nos. 90-514 and 90-945. He urges that the COA decision which interposed no objection to the computation of his terminal leave pay based on salary plus allowances had already become final and executory since no timely appeal had been taken therefrom. Respondent CSC, on the other hand, maintains that the COA decision is not final and conclusive since said decision merely stated that the COA will not interpose any objection to the payment of the petitioner's claim. More importantly, respondent CSC adds, the determination of the legality of claims on leave matters is within the province of the CSC. On this preliminary issue, the Court rules against the petitioner's assertion that the COA decision has become final and executory and, therefore, beyond review; that the DBM has no alternative but to obey it. Article IX-A, Section 7 of the 1987 Constitution provides:
". . . Unless otherwise provided by this Constitution or by law, any decision, order or ruling of each Commission may be brought to the Supreme Court on certiorari by the aggrieved party within thirty (30) days from receipt of a copy thereof."

The above-cited article refers to an aggrieved party raising a decision to this Court. Unfortunately for the petitioner, neither the Civil Service Commission nor the Secretary of Budget and Management may be viewed as an aggrieved party. The CSC is not an aggrieved party because it recommended the approval of the petitioner's request for payment of terminal leave computed on the basis of his monthly salary plus allowances and likewise interceded in behalf of the petitioner for the release of funds from the DBM. The COA upheld this initial position. Nor is the DBM an aggrieved party because it was not privy to the case before the COA. Moreover, even if the DBM was eventually apprised of the COA decision, the DBM's recourse was not to bring the matter on a petition for certiorari before the Court. As the agency tasked to release government funds, it simply ignored the COA ruling with which it disagreed. It refused to approve the release of allotment and outlay for terminal leave differential since in its opinion, payment thereof had no legal basis. The records do not show any authority of COA to compel acceptance of its ruling in this particular case.
LLjur

The respondent CSC's stance, however, that it is the body empowered to determine the legality of claims on leave matters, to the exclusion of COA, is not well-taken. While the

implementation and enforcement of leave benefits are matters within the functions of the CSC as the central personnel agency of the government, the duty to examine accounts and expenditures relating to leave benefits properly pertains to the COA. Where government expenditures or use of funds is involved, the CSC cannot claim an exclusive domain simply because leave matters are also involved. The COA, the CSC, and the Commission on Elections are equally pre-eminent in their respective spheres. Neither one may claim dominance over the others. In case of conflicting rulings, it is the Judiciary which interprets the meaning of the law and ascertains which view shall prevail. The basic question for the Court's consideration is whether or not RATA and COLA should be added to the highest monthly salary in computing the petitioner's terminal leave pay. The petitioner anchors his claim on the Memorandum Order issued by President Marcos on November 20, 1980. Apparently, this Memorandum Order was also the basis for the COA decision, invoked by the petitioner as final and executory, interposing no objection to his claim for terminal leave differential. The Memorandum Order reads:
"TO:The Chairman Commission on Audit Quezon City. With reference to the request of that Office for clarification on the accumulated leave credits of retired Chairman Perez and Commissioners Duque and Bayot, I hereby direct that: 1.The computation of the terminal leave in question shall be computed on the basis of the total number of days of leave credits each accumulated by Chairman Perez and Commissioners Duque and Bayot on the day of their retirement, not on the basis of 300 days as provided in Sec. 1014 of P.D. 1587. 2.The money value of the terminal leave shall be paid as computed on the basis of the highest monthly salary including allowance received at the time of the retirement. (Sgd.) FERDINAND E. MARCOS President of the Philippines November 20, 1980." (p. 27, Rollo)

The above Order was the former President's response to a July 7, 1980 query initiated by former COA Chairman Francisco A. Tantuico, Jr. seeking clarification from the Office of

the President respecting the claim of retired Chairman Leonardo B. Perez and Commissioners Venancio S. Duque and Flores A. Bayot of the Commissionon Elections for the payment of the money value of their accumulated leaves. Since the Memorandum order specifically applies to these three officials, then said Order cannot automatically benefit others not mentioned therein. While it has persuasive value as a matter of contemporaneous interpretation especially as regards Presidential Decrees or other presidential acts, we cannot confer upon this Order the status of a law of general application. The petitioner also invokes Administrative Order No. 44 dated December 13, 1979, extending to the Chairman and members of the Constitutional Commissions the same benefits enjoyed by retiring members of the Judiciary in the matter of rationalized rate of allowances and liberalized computation of retirement benefits and accumulated leave credits.
cdll

The Solicitor General, acting on behalf of the CSC and Secretary of Budget and Management, advances the argument that there is no provision in Administrative Order No. 444, or in any other law, which expressly authorizes the inclusion of allowances in the computation of the money value of the petitioner's accumulated leaves. The pertinent portions of Administrative Order No. 444 provide:
xxx xxx xxx "3.The accumulated leave credit of a Chairman Commissioner of a Constitutional Commission shall be computed under the same rules as those applicable to members of the Judiciary. 4.Upon retirement, the lump sum of five years gratuity as provided under R.A. 3595 for the Chairman Commissioner shall be computed on the basis of the highest monthly salary plus the duly authorized transportation, living and representation allowances in the last month prior to retirement or expiration of term." xxx xxx xxx

The law pertaining to retirement benefits respecting members of the Judiciary is Republic Act (R.A.) No. 910, as amended by Presidential Decree No. 1438, which reads:
xxx xxx xxx "Sec. 3.Upon retirement, a justice of the Supreme Court or of the Court of Appeals, or a judge of the Court of First Instance, Circuit Criminal Court, Agrarian Relations, Tax Appeals, Juvenile and Domestic Relations, city or

municipal court, or any other court hereafter established shall be automatically entitled to a lump sum of five years gratuity computed on the basis of the highest monthly salary plus the highest monthly aggregate of transportation, living and representation allowances he was receiving on the date of his retirement; . . ." xxx xxx xxx

It is clear from RA 910 as amended that the five-year gratuity is based on highest monthly salary plus transportation, living and representation allowance. Should the computation of terminal leave pay, which is given on the same occasion of retirement and which arises from the same considerations of government gratitude that for most retirees is based on a lifetime of service, be accorded similar treatment? The Solicitor General stresses that under Section 286 of the Revised Administrative Code, as amended by Republic Act No. 1081 and Executive Order No. 1077, the computation of the money value of the terminal leave pay is based only on monthly basic salary. Section 286 of the Revised Administrative Code, as amended by RA No. 1081, states:
Section 286.When vacation leave and sick leave may be taken. Vacation leave and sick leave shall be cumulative and any part thereof which may not be taken within the calendar year in which earned may be carried over to the succeeding years, but whenever any officer, employee, or laborer of the Government of the Philippines shall voluntarily resign or be separated from the service through no fault of his own, he shall be entitled to the commutation of all accumulated vacation and or sick leaves to his credit: Provided, That the total vacation leave and sick leave that can accumulate to the credit of any officer of employee shall, in no case, exceed ten months: Provided, further, That the proper Department Head may in his discretion authorize the commutation of the salarythat would be received during the period of vacation and sick leave of any appointed officer or employee or teacher or laborer of the Philippine Government and direct its payment on or before the beginning of such leave from the fund out of which the salary would have been paid: Provided, furthermore, That no person whose leave has been commuted following his separation from the service shall be reappointed or reemployed under the Government of the Philippines before the expiration of the leave commuted unless he first refunds the money value of the unexpired portion of the leave commuted. (Emphasis supplied)"

(Executive Order No. 1077 later amended Section 286 by removing the limitation on the number of days of vacation and sick leaves that a retiree may accumulate, although all employees are required to go on a minimum of five days vacation leave annually.)

The only provision in Section 286 of the Revised Administrative Code, as amended, which could seemingly support the Solicitor General's view is the above underlined clause which allows the "commutation of salary" of a government officer, employee or laborer. "Commutation of salary" as used in Section 286 is, however, not the same as "commutation of leave credits." The former is applied for by an employee during employment when he goes on ordinary leave. Thus, if his Department Head allows it, the employee may receive his salary for the period of the vacation or sick leave before the beginning of such leave; otherwise, he gets his salary only on the pay days covered by the vacation or sick leave period or upon returning to work. In contrast, commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from theservice through no fault of his own. (Manual on Leave Administration Course for Effectiveness published by the Civil Service Commission, pages 16-17). In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. The Government recognizes that for most public servants, retirement pay is always less than generous if not meager and scrimpy. A modest nest egg which the senior citizen may look forward to is thus provided. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits.
LLjur

Since terminal leave is applied for by an officer or employee who has already severed his connection with his employer and who is no longer working, then it follows that the terminal leave pay, which is the cash value of his accumulated leave credits, should not be treated as compensation for services rendered at that time. (Re: Request of Atty. Bernardo Zialcita, 190 SCRA 851 [1990]) It can not be viewed as salary for purposes which would reduce it. (supra) There can thus be no "commutation of salary" when a government retiree applies for terminal leave because he is not receiving it as salary. What he applies for is a "commutation of leave credits." It is an accumulation of credits intended for old age or separation from the service. Hence, Section 286 of the Revised Administrative Code is not applicable. It cannot be construed as limiting the basis of the computation of terminal leave pay to monthly salary only. In the light of the reasons which impelled the law to include COLA and RATA in computing retirement benefits of certain officials, we rule that terminal leave payments must also be governed by the same principle. COLA and RATA should be included in computing the terminal leave credits when the officials retire or the official relationship is lawfully terminated. The Solicitor General cites our ruling in Paredes v. Acting Chairman, 116 SCRA 176 [1982] to support his position. Commonwealth Act (CA) No. 186, as amended, provides for the retirement of

government employees, other than members of the Judiciary, Constitutional Commissions and those whose retirement is not covered by special law. Section 12(c) of CA 186 reads:
"(c)Retirement is likewise allowed to any official or employee, appointive or elective, regardless of age and employment status, who has rendered a total of at least twenty years of service, the last three years of which are continuous. The benefit shall, in addition to the return of his personal contributions with interest compounded monthly and the payment of corresponding employer's premiums described in subsection (a) of Section five hereof, without interest, be only a gratuity equivalent to one month's salary for every year of the first twenty years of service, plus one and one-half month's salary for every year ofservice over twenty but below thirty years and two month's salary for every year of service over thirty years in case of employees based on the highest rate received and in case of elected officials on the rates of pay as provided by law . . . Officials and employees retired under this Act shall be entitled to the commutation of the unused vacation and sick leave, based on the highest rate received, which they may have to their credit at the time of retirement." xxx xxx xxx

Under the last sentence, officials and employees retired under CA 186, as amended, shall be entitled to the commutation of the vacation and sick leave credits based on the highest rate received. In Paredes v. Acting Chairman, supra, the Court construed the phrase "highest rate received" as referring to the retiree's "highest monthly salary":
"The foregoing legal provision (Section 12(c) of CA 186 requires the computation of the money value of the terminal leave to be based on the retiree's highest rate received. And a reading of the entire provision shows that the highest rate received refers to the retiree's highest monthly salary."

The petitioner in that case was a former Assistant City Auditor of Manila who sought to have his RATA included in the computation of his terminal leave pay. The Court therein held that "allowances are not considered part of salary for purposes of retirement and payment of the money value of terminal leave." It must be noted, however, that the Court, in that case, construed "highest rate received" as highest monthly salary mainly because the retirement gratuity received by employees under Section 12(c) of CA 186 is based only on monthly salary. Thus, under the aforementioned provision, the benefit for employees shall be "a gratuity equivalent to one month's salary for every year of the first twenty years of service, plus one and one-half month's salary for every years of service over 20 but below 30 years and two months' salary for every year of service over thirty years . . . based on the highest rate

received . . . Officials and employees retired under this actshall be entitled to the commutation of the unused vacation and sick leave, based on the highest rate received . . . ." (Emphasis supplied.) A reading of Section 12(c) of CA 186 therefore reveals an intent on the part of the legislature to provide a uniform basis in computing both the retirement gratuity and the terminal leave pay. In CA 186, that uniform basis is salary. A different law, R.A. 910 as amended, governs the petitioner. In the case of members of the Judiciary and Constitutional Commissions, the basis in computing the retirement gratuity is the highest monthly salary plus the highest monthly aggregate of transportation, living and representation allowance (COLA and RATA). The same rule of uniformity which we applied in Paredes v. Acting Chairman for those retiring under CA 186 as amended should also apply for those who retire under R.A. 910 as amended. The rate used in computing retirement gratuities also applies in the computation of terminal leave credits.
LLpr

It is axiomatic that retirement laws are liberally construed and administered in favor of the persons intended to be benefited. All doubts as to the intent of the law should be resolved in favor of the retiree to achieve its humanitarian purposes. (In Re: Amount of the Monthly Pension of Judges and Justices starting from the Sixth year of their Retirement and after the Expiration of the Initial Five-Year Period of Retirement, 190 SCRA 315 [1990]; Ortiz v. Commission on Elections, 162 SCRA 812 [1988]; Bautista v. Auditor General, 104 Phil. 428 [1958]). Although terminal leave pay is not synonymous with, and is not a part of, the five-year lump sum gratuity provided under RA 910 as amended and Administrative Order No. 444, the former may, in a broad sense, partake of the nature of a gratuity rather than actual salary. A gratuity is that paid to the beneficiary for past services rendered purely out of generosity of the giver or grantor. (Peralta v. Auditor General, 100 Phil 1051 [1957]) It is a mere bounty given by the government in consideration or in recognition of meritorious services and springs from the appreciation and graciousness of the government. (Pirovano v. De La Rama Steamship Co., 96 Phil. 335, 357 [1954]) While it is true that vacation and sick leave credits are earned during one's period of employment, they are, by their very nature and purpose, supposed to be enjoyed or exhausted during employment. When these accumulated leave benefits are allowed to be accumulated, not to be paid while one is working but to be reserved for old age, then this constitutes the gratuity. Through the years, laws pertaining to accumulation of leave credits show a liberal trend with a view to favoring the retiring employee. Under Act 2711 (dated March 10, 1917), accumulated leaves that may be commuted cannot exceed 5 months. Republic Act No. 1081 (dated June 15, 1954) increased the limit from 5 to 10 months. With the passage of

Executive Order No. 1077 on January 9, 1986, the retiring employee became entitled to the commutation of all accumulated vacation and sick leaves to his credit, without limitation as to the number of days of vacation and sick leave that he may accumulate. Since terminal leave pay may also be considered a gratuity, then applying the rule on liberal interpretation of retirement laws, the basis for its computation in the case of members of the Judiciary and Constitutional Commissions must be the same as that used in computing the 5-year lump sum gratuity under RA 910 as amended and Administrative Order No. 444. The Court is cognizant of the incongruity that may ensue if the terminal leave pay of members of the Judiciary and Constitutional Commissions is computed only on the basis of highest basic monthly salary. If, for example a member of the CSC has an accumulated leave credit of one month and, in the two months immediately prior to retiring, consumes his accumulated leaves by going on fifteen days' vacation leave twice, there is no dispute that he will be paid two months' salary plus COLA and RATA for this two-month period, although no work has been rendered by him. If, on the other hand, he chooses to work until the last day of employment and upon retirement, applies for the commutation of his accumulated leave credit of one month, following the proposition of the Solicitor General, he will receive terminal leave pay equivalent only to one month's salary, without COLA and RATA. In the latter case, why should he be penalized for faithfully working continuously and not consuming his leave credits until his last working day? Why should the basis for the commutation of leave credits be different just because he chose to avail himself of his leave benefits immediately before and not immediately after retirement? Surely this disparity in consequence could not have been intended by our lawmakers.
cdll

There is more reason now to include COLA in the computation of terminal leave pay. Section 12 of Republic Act 6758, known as the Compensation and Position Classification Act of 1989, mandated the integration of COLA to the basic salary and, therefore, to the retirement pay of all employees. While it is true that RA 6758 took effect only on July 1, 1989, long after petitioner had already retired on April 1, 1986, his COLA should nevertheless have been included in computing terminal leave pay for the same reasons stated above. In Re: Request of Atty. Bernardo Zialcita, supra, the affected agency filed a motion for partial reconsideration stressing that the benefits of our ruling should not be open-ended and made to apply retroactively to all the unknown and uncomplaining persons who may have retired as far back as decades ago. We provided a cut-off date. The same practical considerations and budgetary restraints constrain the Court to impose a cut-off date for

claims for terminal leave differentials. The Court therefore, rules that the inclusion of COLA and RATA as basis in arriving at terminal leave pay shall apply only to those qualified members of the Judiciary and Constitutional Commissions who retired or shall retire on or after the change of government in February, 1986. WHEREFORE, the petition is hereby GRANTED. Resolutions 90-514 and 90-945 issued by the Civil Service Commission are set aside. The Secretary of Budget and Management is ordered to release the corresponding allotment and cash outlay for the terminal leave differential claimed by the petitioner. The terminal leave pay of qualified members of the Judiciary and Constitutional Commissions who retired or shall retire on or after the February, 1986 political upheaval shall be based on highest monthly salary plus COLA and RATA. SO ORDERED.

SEPARATION PAY

[G.R. No. 96016. October 17, 1991.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS and EFREN P. CASTAEDA, respondents. Leovigildo Monasterial for private respondent. SYLLABUS TAXATION; WITHHOLDING TAX; TERMINAL LEAVE PAY; NOT SUBJECT THEREOF. The Court has already ruled that the terminal leave pay received by a government official or employee is not subject to withholding (income) tax. In the recent case of Jesus N. Borromeo vs. The Hon. Civil Service Commission, et al., G.R. No. 96032, 31 July 1991, the Court explained the rationale behind the employee's entitlement to an exemption from withholding (income) tax on his terminal leave pay as follows: . . . commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own. (Manual on Leave Administration Course for Effectiveness published by the Civil Service Commission, pages 16-17). In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. The Government

recognizes that for most public servants, retirement pay is always less than generous if not meager and scrimpy. A modest nest egg which the senior citizen may look forward to is thus avoided. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits."

RESOLUTION

PADILLA, J :
p

The issue to be resolved in this petition for review on certiorari is whether or not terminal leave pay received by a government official or employee on the occasion of his compulsory retirement from the government service is subject to withholding (income) tax. We resolve the issue in the negative. Private respondent Efren P. Castaeda retired from the government service as Revenue Attache in the Philippine Embassy in London, England, on 10 December 1982 under the provisions of Section 12 (c) of Commonwealth Act 186, as amended. Upon retirement, he received, among other benefits, terminal leave pay from which petitioner Commissioner of Internal Revenue withheld P12,557.13 allegedly representing income tax thereon. Castaeda filed a formal written claim with petitioner for a refund of the P12,557.13, contending that the cash equivalent of his terminal leave is exempt from income tax. To comply with the two-year prescriptive period within which claims for refund may be filed, Castaeda filed on 16 July 1984 with the Court of Tax Appeals a Petition for Review, seeking the refund of income tax withheld from his terminal leave pay. The Court of Tax Appeals found for private respondent Castaeda and ordered the Commissioner of Internal Revenue to refund Castaeda the sum of P12,557.13 withheld as income tax. (Annex "C", petition).
Cdpr

Petitioner appealed the above-mentioned Court of Tax Appeals decision to this Court, which was docketed as G.R. No. 80320. In turn, we referred the case to the Court of Appeals for resolution. The case was docketed in the Court of Appeals as CA-G.R. SP No. 20482. On 26 September 1990, the Court of Appeals dismissed the petition for review and affirmed the decision of the Court of Tax Appeals. Hence, the present recourse by the

Commissioner of Internal Revenue. The Solicitor General, acting on behalf of the Commissioner of Internal Revenue, contends that the terminal leave pay is income derived from employer-employee relationship, citing in support of his stand Section 28 of the National Internal Revenue Code; that as part of the compensation for services rendered, terminal leave pay is actually part of gross income of the recipient. Thus
" . . . . It (terminal leave pay) cannot be viewed as salary for purposes which would reduce it. . . . there can thus be no 'commutation of salary' when a government retiree applies for terminal leave -because he is not receiving it as salary. What he applies for is a 'commutation of leave credits.' It is an accumulation of credits intended for old age or separation from service. . . . ."

The Court has already ruled that the terminal leave pay received by a government official or employee is not subject to withholding (income) tax. In the recent case of Jesus N. Borromeo vs. The Hon. Civil Service Commission, et al., G.R. No. 96032, 31 July 1991, the Court explained the rationale behind the employee's entitlement to an exemption from withholding (income) tax on his terminal leave pay as follows:
" . . . commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own. (Manual on Leave Administration Course for Effectiveness published by the Civil Service Commission, pages 16-17). In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. The Government recognizes that for most public servants, retirement pay is always less than generous if not meager and scrimpy. A modest nest egg which the senior citizen may look forward to is thus avoided. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits."

In fine, not being part of the gross salary or income of a government official or employee but a retirement benefit, terminal leave pay is not subject to income tax.
cdphil

ACCORDINGLY, the petition for review is hereby DENIED. SO ORDERED.

ALLOWABLE DEDUCTIONS

[G.R. Nos. 106949-50. December 1, 1995.] PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, vs. COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents. [G.R. Nos. 106984-85. December 1, 1995.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), THE COURT OF APPEALS, and THE COURT OF TAX APPEALS, respondents. Ma. Lourdes A. Gadioma for Paper Industries Corporation of the Phil. The Solicitor General for the Commissioner of Internal Revenue. SYLLABUS 1.TAXATION; RA 5186 (INVESTMENT INCENTIVES ACT); EXEMPTION OF PIONEER ENTERPRISES FROM ALL TAXES UNDER THE NIRC EXCEPT INCOME TAX; NOT EXEMPT FROM PAYMENT OF TRANSACTION TAX WHICH IS INCOME TAX. We agree with the CTA and the Court of Appeals that Picop's tax exemption under RA. No. 5186, as amended, does not include exemption from the thirtyfive percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax is an income tax, that is, it is a tax on the interest income of the lenders or creditors. The 35% transaction tax is imposed on interest income from commercial papers issued in the primary money market. Being a tax on interest, it is a tax on income. The 35% transaction tax is an income tax on interest earnings to the lenders or placers. The latter are actually the taxpayers. Therefore, the tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed funds from several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before paying to the financial institutions the interests earned by them and later remitted the same to the respondent Commissioner of Internal Revenue. The tax could have been collected by a different procedure but the statute chose this method. Whatever collecting procedure is adopted does not change the nature of the tax. It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of RA. No. 5186, as

amended. Picop was the withholding agent, obliged to withhold thirty-five percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau of Internal Revenue ("BIR"). As a withholding agent, Picop is made personally liable for the thirty-five percent (35%) transaction tax and if it did not actually withhold thirty-five percent (35%) of the interest monies it had paid to its lenders, Picop had only itself to blame. We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction tax due in respect of interest payments on its money market borrowings.
AHacIS

2.ID.; PRESIDENTIAL DECREE NO. 1154; 35% TRANSACTION TAX ON COMMERCIAL PAPER; WITH NO RETROACTIVE APPLICATION. The transaction tax may be levied only in respect of the interest earnings of Picop's money market lenders accruing after P.D. No. 1154 went into effect, and not in respect of all the 1977 interest earnings of such lenders. P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirty-five percent (35%) transaction tax in respect of interest earnings which accrued before the effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the legislative authority intended to bring about such retroactive imposition of the tax. 3.ID.; NATIONAL INTERNAL REVENUE CODE; AUTHORITY OF THE SECRETARY OF FINANCE TO PROMULGATE RULES AND REGULATIONS; AUTHORITY TO IMPOSE CIVIL PENALTIES MUST BE EXPRESSLY GIVEN BY THE ENABLING STATUTE; IMPOSITION OF 25% SURCHARGE AND 14% INTEREST PER ANNUM FOR NON-PAYMENT OF TRANSACTION, WITHOUT LEGAL BASIS. With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five percent (25%) surcharge and for interest at the rate of fourteen percent (14%) per annum from the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of Revenue Regulation 7-77 dated 3 June 1977, issued by the Secretary of Finance. The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code, invoked by the Secretary of Finance in issuing Revenue Regulation 777, set out, in comprehensive terms, the rule-making authority of the Secretary of Finance. Section 4 of the same Code contains a list of subjects or areas to be dealt with by the Secretary of Finance through the medium of an exercise of his quasi-legislative or rule-making authority. This list, however, while it purports to be open-ended, does not include the imposition of administrative or civil penalties such as the payment of amounts additional to the tax due. Thus, in order that it may be held to be legally effective in respect of Picop in the present case, Section 10 of Revenue Regulation 7-77 must embody or rest upon some provision in the Tax Code itself which imposes surcharge and penalty interest for failure to make a transaction tax payment when due. P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge and penalty interest in case of failure to pay the thirty-five percent (35%) transaction tax when due. Neither did Section 210(b) of the 1977 Tax Code which re-enacted Section 195-C inserted into the Tax Code by P.D. No. 1154. It will be seen that Section 51(c)(1) and (e)

(1) and (3), of the 1977 Tax Code, authorize the imposition of surcharge and interest only in respect of a "tax imposed by this Title," that is to say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes a surcharge only in case of failure to file a return or list "required by this Title," that is, Title II on "Income Tax." The thirty-five percent (35%) transaction tax is, however, imposed in the 1977 Tax Code by Section 210(b) thereof which Section is embraced in Title V on "Taxes on Business" of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax imposed on interest income earned by lenders or creditors purchasing commercial paper on the money market, the relevant provisions, i.e., Section 210(b), were not inserted in Title II of the 1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of the taxes in respect of which Section 51(e) authorized the imposition of surcharge and interest and Section 72 the imposition of a fraud surcharge. It is not without reluctance that we reach the above conclusion on the basis of what may well have been an inadvertent error in legislative draftsmanship, a type of error common enough during the period of Martial Law in our country. Nevertheless, we are compelled to adopt this conclusion. We consider that the authority to impose what the present Tax Code calls (in Section 248) civil penalties consisting of additions to the tax due, must be expressly given in the enabling statute, in language too clear to be mistaken. The grant of that authority is not lightly to be assumed to have been made to administrative officials, even to one as highly placed as the Secretary of Finance.
aIcHSC

4.ID.; ID.; SECTION 247 (A) IMPOSING CIVIL PENALTIES AS SURCHARGE AND INTEREST WITHOUT RETROACTIVE APPLICATION. The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge and penalty interest for failure to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b) of the same Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. In other words, Section 247 (a) of the current NIRC supplies what did not exist back in 1977 when Picop's liability for the thirty-five percent (35%) transaction tax became fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in 1985, was intended to be given retroactive application by the legislative authority. 5.ID.; RA 5186 (INVESTMENT INCENTIVES ACT); EXEMPTION OF PIONEER ENTERPRISES FROM ALL TAXES UNDER THE NIRC EXCEPT INCOME TAX; EXEMPTION INCLUDES PAYMENT FROM DOCUMENTARY STAMP TAXES. The issuance of debenture bonds is certainly conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or other instruments to the general

public. We consider that the actual dedication of the proceeds of the bonds to the carrying out of Picop's registered operations constituted a sufficient nexus with such registered operations so as to exempt Picop from stamp taxes ordinarily imposed upon or in connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this matter that the CTA and the CIR had erred in rejecting Picop's claim for exemption from stamp taxes. It remains only to note that after commencement of the present litigation before the CTA, the BIR took the position that the tax exemption granted by RA No. 5186, as amended, does include exemption from documentary stamp taxes on transactions entered into by BOI-registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a registered preferred pioneer enterprise engaged in the manufacture of integrated circuits, magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary stamp taxes. Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a registered pioneer enterprise producing polyester filament yarn was entitled to exemption "from the documentary stamp tax on [its] sale of real property in Makati up to December 31, 1989." It appears clear to the Court that the CIR, administratively at least, no longer insists on the position it originally took in the instant case before the CTA.
TSEcAD

6.ID.; TAX EXEMPTIONS; STRICTLY CONSTRUED. Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended beyond the ordinary and reasonable intendment of the language actually used by the legislative authority in granting the exemption. 7.ID.; NATIONAL INTERNAL REVENUE CODE; GROSS INCOME; INTEREST PAYMENTS ON LOANS, DEDUCTIBLE. Interest payments on loans incurred by a taxpayer (whether BOI-registered or not) are allowed by the NIRC as deductions against the taxpayer's gross income. (Section 30 of the 1977 Tax Code) Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. Our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on a legally demandable loan are deductible from gross income must be applied. 8.ID.; ID.; ID.; LOSSES ACTUALLY SUSTAINED CAN BE CHARGED OFF ONLY AGAINST INCOME EARNED DURING THE SAME YEAR. The rule applicable in respect of corporations not registered with the BOI as a preferred pioneer enterprise is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually

sustained in the same year that they are deducted or charged off. (Section 30 of the 1977 Tax Code, Section 76 of the Philippine Income Tax Regulations [Revenue Regulation No. 2, as amended]) It is thus clear that under our law, and outside the special realm of BOIregistered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary, losses must be deductedagainst current income in the taxable year when such losses were incurred. Moreover, such losses may be charged off only against income earned in the same taxable year when the losses were incurred . 9.ID.; RA 5186 (INVESTMENT INCENTIVES ACT); CARRY-OVER OF NET OPERATING LOSSES WITH RESPECT TO THEIR REGISTERED OPERATION; PURPOSE. Thus it is that RA. No. 5185 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. The statutory purpose here may be seen to be the encouragement of the establishment and continued operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses which may be expected during the early years of the enterprise and to permit the enterprise to offset such losses against income earned by it in later years after successful establishment and regular operations. To promote its economic development goals, the Republic foregoes or defers taxing the income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We consider that the statutory purpose can be served only if the accumulated operating losses are carried over and charged off against income subsequently earned and accumulated by the same enterprise engaged in the same registered operations.
IDASHa

10.ID.; ID.; ID.; NET OPERATING LOSS OF ONE ENTERPRISE NOT DEDUCTIBLE FROM GROSS INCOME OF ANOTHER DESPITE MERGE. The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating losses against Picop's 1977 gross income, basically because towards the end of the taxable year 1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop, remained. The losses suffered by RPPM's registered operations and the gross income generated by Picop's own registered operations now came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not believe that the single purely technical factor is enough to authorize and justify the deduction claimed by Picop. Picop's claim for deduction is not only bereft of statutory basis; it does violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss carry-over to BOI-registered pioneer enterprises, the legislature could not have intended to require the Republic to forego tax revenues in order to benefit a corporation which had run no risks and suffered no losses, but had merely purchased another's losses. We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be disallowed.

11.REMEDIAL LAW; EVIDENCE; BURDEN OF PROOF; TAXPAYER HAS THE BURDEN OF PROVING ENTITLEMENT TO CLAIMED DEDUCTION. A taxpayer has the burden of proving entitlement to a claimed deduction. In the instant case, even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. The best evidence that Picop should have presented to support its claimed deduction were the invoices and official receipts issued by the Register of Deeds. Picop not only failed to present such documents; it also failed to explain the loss thereof, assuming they had existed before. Under the best evidence rule, therefore, the testimony of Picop's employee was inadmissible and was in any case entitled to very little, if any, credence. We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not adequately shown and that such deduction must be disallowed.
ScAIaT

12.ID.; ID.; ADMISSION; HIGHER SALES REFLECTED IN PICOP'S BOOK OF ACCOUNTS, AN ADMISSION AGAINST ITS OWN INTEREST. In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had understated its sales by P2,391,644.00 and, upon the other hand, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its own return. The 1977 Income Tax Return of Picop set forth its total sales as P800,814,851.00. Upon the other hand, Picop's Books of Accounts reflected higher sales figures of P803,206,495.00. The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00. The CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear to be admissions against Picop's own interest. Accordingly, we must affirm the findings of the Court of Appeals and the CTA. 13.TAXATION; R.A. 5186 (INVESTMENT INCENTIVES ACT); NON-EXEMPTION FROM PAYMENT OF INCOME TAX; CORPORATE DEVELOPMENT TAX, AN INCOME TAX; REQUISITE FOR PAYMENT. The five percent (5%) corporate development tax is an additional corporate income tax imposed in Section 24 (e) of the 1977 Tax Code. This additional tax shall be imposed only if the net income exceeds 10 per cent of the net worth, in case of a domestic corporation, or net assets in the Philippines in case of a resident foreign corporation. Since this five percent (5%) corporate development tax is an income tax, Picop is not exempted from it under the provisions of Section 8 (a) of R.A. No. 5186. The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent (10%) of its net worth, Picop

must be held liable for the five percent (5%) corporate development tax in the amount of P2,434,367.75. VITUG, J., concurring and dissenting opinion: 1.TAXATION; REPUBLIC ACT NO. 5186 (INVESTMENT INCENTIVES ACT); EXEMPTION FROM PAYMENT OF INCOME TAX DOES NOT INCLUDE EXEMPTION FROM TRANSACTION TAX. R.A. No. 5186, also known as the Investment Incentives Act, has provided for incentives by, among other things, granting to registered pioneer enterprises an exemption from all taxes, except income tax, under the National Internal Revenue Code. The income tax, referred to, in my view, is that imposed in Title II, entitled "Income Tax," of the Revenue Code. Nowhere under that title is there a 35% transaction tax. 2.ID.; NATIONAL INTERNAL REVENUE CODE; 35% TRANSACTION TAX; LEVIED ON BORROWER-ISSUER OF COMMERCIAL PAPERS NOT ON INVESTOR-LENDER There was, to be sure, a 35% transaction tax still in effect in 1977 but it was a tax, not on the investor-lender in whose favor the interest income on the commercial paper accrues. The tax was, instead, levied on the borrower-issuer of commercial papers transacted in the primary market. Being the principal taxpayer, the borrower-issuer could not have been likewise contemplated to be a mere tax withholding agent. The tax was conceived as a tax on business transaction, and so it was rightly incorporated in Title V, entitled "Privilege Taxes on Business and Occupation" of the Tax Code.
HAECID

3.ID.; TAXES; FACT THAT TAXPAYER CAN SHIFT PAYMENT OF INDIRECT TAXES TO ANOTHER DOES NOT MAKE THE LATTER THE TAXPAYER AND THE FORMER THE WITHHOLDING AGENT. The fact that a taxpayer on whom the tax is imposed can shift, characteristic of indirect taxes, the burden thereof to another does not make the latter the taxpayer and the former the withholding agent. Indeed, the facility of shifting the burden of the tax is opposed to the idea of adirect tax to which class the income tax actually belongs.

DECISION

FELICIANO, J :
p

The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R.

Nos. 106949-50 and private respondent in G.R. Nos. 106984-85, is a Philippine corporation registered with the Board of Investments ("BOI") as a preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferred non-pioneer enterprise with respect to its integrated plywood and veneer mills.
cdlex

On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2) letters of assessment and demand both dated 31 March 1983: (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount ofP88,763,255.00. These assessments were computed as follows
"Transaction Tax
Interest payments on money market borrowingsP45,771,849.00 35% Transaction tax due thereon16,020,147.00 Add: 25% surcharge4,005,036.75 TotalP20,025,183.75 Add: 14% int. fr. 1-20-78 to 7-31-80P7,093,302.57 20% int. fr. 8-1-80 to 3-31-8310,675,532.58

17,768,826.15 P37,794,009.90

Documentary and Science Stamps Tax

Total face value of debentures P100,000,000.00 Documentary Stamps Tax Due (P0.30 x P100,000.00) ( P200 )P 150,000.00 Science Stamps Tax Due (P0.30 x P100,000.00) ( P200 )150,000.00 TotalP300,000.00 Add:Compromise for non-affixture 300.00 300,300.00 TOTAL AMOUNT DUE AND COLLECTIBLEP38,094,309.90 ============

Deficiency Income Tax for 1977

Net income per returnP258,166.00 Add:Unallowable deductions 1)Disallowed deductions availed of under R.A. No. 5186 P44,332,980.00 2)Capitalized interest expenses on funds used for acquisition of machinery & other equipment 42,840,131.00 3)Unexplained financial guarantee expense 1,237,421.00 4)Understatement of sales 2,391,644.00 5)Overstatement of cost of sales604,018.00 P91,406,194.00 Net income per investigationP91,644,360.00 Income tax due thereon34,734,559.00 Less:Tax already assessed per return80,358.00 DeficiencyP34,654,201.00 Add: 14% int. fr. 4-15-78 to 7-31-81P11,128,503.56 20% int. fr. 8-1-80 to 4-15-814,886,242.34 P16,014,745.90

 TOTAL AMOUNT DUE AND COLLECTIBLEP50,668,946.90" 1 =============

On 26 April 1983, Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. Picop also protested on 21 May 1983 the deficiency income tax assessment for 1977. These protests were not formally acted upon by respondent CIR. On 26 September 1984, the CIR issued a warrant of distraint on personal property and a warrant of levy on real property against Picop, to enforce collection of the contested assessments; in effect, the CIR denied Picop's protests. Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing the assessments. After trial, the CTA rendered a decision dated 15 August 1989, modifying the findings of the CIR and holding Picop liable for the reduced aggregate amount of P20,133,762.33, which was itemized in the dispositive portion of the decision as follows:
"35% Transaction TaxP16,020,113.20 Documentary & Science Stamp Tax300,300.00 Deficiency Income Tax Due3,813,349.33 TOTAL AMOUNT DUE AND PAYABLEP20,133,762.53" 2 ============

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. The Court of Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which further reduced the liability of Picop to P6,338,354.70. The dispositive portion of the Court of Appeals decision reads as follows:
"WHEREFORE, the appeal of the Commissioner of Internal Revenue is denied for lack of merit. The judgment against PICOP is modified, as follows: 1.PICOP is declared liable for the 35% transaction tax in the amount of P3,578,543.51; 2.PICOP is absolved from the payment of documentary and science stamp tax of

P300,000.00 and the compromise penalty of P300.00; 3.PICOP shall pay 20% interest per annum on the deficiency income tax of P1,481,579.15, for a period of three (3) years from 21 May 1983, or in the total amount of P888,947.49, and a surcharge of 10% on the latter amount, or P88,984.75. No pronouncement as to costs. SO ORDERED."

Picop and the CIR once more filed separate Petitions for Review before the Supreme Court. These cases were consolidated and, on 23 August 1993, the Court resolved to give due course to both Petitions in G.R. Nos. 106949-50 and 106984-85 and required the parties to file their Memoranda. Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof. It assails the propriety of the thirty-five percent (35%) deficiency transaction tax which the Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions the imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting from disallowance of certain claimed financial guarantee expenses and claimed year-end adjustments of sales and cost of sale figures by Picop's external auditors. 3 The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable for surcharge and interest on unpaid transaction tax and for documentary and science stamp taxes and in allowing Picop to claim as deductible expenses:
(a)the net operating losses of another corporation (i.e., Rustan Pulp and Mills, Inc.); and (b)interest payments on loans for the of machinery and equipment.

The CIR also claims that Picop should be held liable for interest at fourteen percent (14%) per annum from 15 April 1978 for three (3) years, and interest at twenty percent (20%) per annum for a maximum of three (3) years; and for a surcharge of ten percent (10%), on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for the corporate development tax equivalent to five percent (5%) of its correct 1977 net income. The issues which we must here address may be sorted out and grouped in the following manner:

I.Whether Picop is liable for: (1)the thirty-five percent (35%) transaction tax; (2)interest and surcharge on unpaid transaction tax; and (3)documentary and science stamp taxes: II.Whether Picop is entitled to deductions against income of: (1)interest payments of loans for the purchase of machinery and equipment; (2)net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and (3)certain claimed financial guarantee expenses; and III.(1) Whether Picop had understated its sales and overstated its cost of sales for 1977; and (2)Whether Picop is liable for the corporate development tax of five percent (5%) of its net income for 1977.

We will consider these issues in the foregoing sequence. I. (1)Whether Picop is liable for the thirty-five percent (35%) transaction tax. With the authorization of the Securities and Exchange Commission, Picop issued commercial paper consisting of serially numbered promissory notes with the total face value of P229,864,000.00 and a maturity period of one (1) year, i.e., from 24 December 1977 to 23 December 1978. These promissory notes were purchased by various commercial banks and financial institutions. On these promissory notes, Picop paid interest in the aggregate amount of P45,771,849.00. In respect of these interest payments, the CIR required Picop to pay the thirty-five percent (35%) transaction tax.
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The CIR based this basement on Presidential Decree No. 1154 dated 3 June 1977, which reads in part as follows:
"SECTION 1.The National Internal Revenue Code, as amended, is hereby further amended by adding a new section thereto to read as follows:

'SECTION 195-C. Tax on certain interest. There shall be levied, assessed, collected and paid on every commercial paper issued in the primary market as principal instrument, a transaction tax equivalent to thirty-five percent (35%) based on the gross amount of interest thereto as defined hereunder, which shall be paid by the borrower/issuer: Provided, however, that in the case of a long-term commercial paper whose maturity exceeds more than one year, the borrower shall pay the tax based on the amount of interest corresponding to one year, and thereafter shall pay the tax upon accrual or actual payment (whichever is earlier) of the untaxed portion of the interest which corresponds to a period not exceeding one year. The transaction tax imposed in this section shall be a final tax to be paid by the borrower and shall be allowed as a deductible item for purposes of computing the borrower's taxable income. For purposes of this tax (a)"Commercial paper" shall be defined as an instrument evidencing indebtedness of any person or entity, including banks and non-banks performing quasi-banking functions, which is issued, endorsed, sold, transferred or in any manner conveyed to another person or entity, either with or without recourse and irrespective of maturity. Principally, commercial papers are promissory notes and/or similar instrumentsissued in the primary market and shall not include repurchase agreements, certificates of assignments, certificates of participation, and such other debt instruments issued in the secondary market. (b)The term "interest" shall mean the difference between what the principal borrower received and the amount it paid upon maturity of the commercial paper which shall, in no case, be lower than the interest rate prevailing at the time of the issuance or renewal of the commercial paper. Interest shall be deemed synonymous with discount and shall include all fees, commissions, premiums and other payments which form integral parts of the charges imposed as a consequence of the use of money.

In all cases, where no interest rate is stated or if the rate stated is lower than the prevailing interest rate at the time of the issuance or renewal of commercial paper, the Commissioner of Internal Revenue, upon consultation with the Monetary Board of

the Central Bank of the Philippines, shall adjust the interest rate in accordance herewith, and assess the tax on the basis thereof. The tax herein imposed shall be remitted by the borrower to the Commissioner of Internal Revenue or his Collection Agent in the municipality where such borrower has its principal place of business within five (5) working days from the issuance of the commercial paper. In the case of long term commercial paper, the tax upon the untaxed portion of the interest which corresponds to a period not exceeding one year shall be paid upon accrual payment, whichever is earlier.'" (Italics supplied)

Both the CTA and the Court of Appeals sustained the assessment of transaction tax. In the instant Petition, Picop reiterates its claim that it is exempt from the payment of the transaction tax by virtue of its tax exemption under R.A. No. 5186, as amended, known as the Investment Incentives Act, which in the form it existed in 19771978, read in relevant part as follows:
"SECTION 8.Incentives to a Pioneer Enterprise. In addition to the incentives provided in the preceding section, pioneer enterprises shall be granted the following incentive benefits: (a)Tax Exemption. Exemption from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent: (1)One hundred per cent (100%) for the first five years; (2)Seventy-five per cent (75%) for the sixth through the eighth years; (3)Fifty per cent (50%) for the ninth and tenth years; (4)Twenty per cent (20%) for the eleventh and twelfth years; and (5)Ten per cent (10%) for the thirteenth through the fifteenth year. xxx xxx xxx" 4

We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No. 5186, as amended, does not include exemption from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax 5 is an income tax, that is, it is a tax on the interest income of the lenders or creditors. In Western Minolco Corporation v. Commissioner of Internal Revenue, 6 the petitioner corporation

borrowed funds from several financial institutions from June 1977 to October 1977 and paid the corresponding thirty-five (35%) transaction tax thereon in the amount of P1,317,801.03, pursuant to Section 210 (b) of the 1977 Tax Code. Western Minolco applied for refund of that amount alleging it was exempt from the thirty-five (35%) transaction tax by reason of Section 79-A of C.A. No. 137, as amended, which granted new mines and old mines resuming operation "five (5) years complete tax exemptions, except income tax, from the time of its actual bona-fide orders for equipment for commercial production." In denying the claim for refund, this Court held:
"The petitioner's contentions deserve scant consideration. The 35% transaction tax is imposed on interest income from commercial papers issued in the primary money market. Being a tax on interest, it is a tax on income. As correctly ruled by the respondent Court of Tax Appeals: 'Accordingly, we need not and do not think it necessary to discuss further the nature of the transaction tax more than to say that the incipient scheme in the issuance of Letter of Instructions No. 340 on November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational simplicity and effective administration in capturing the interest-income "windfall" from money market operations as a new source of revenue, has lost none of its animating principle in parturition of amendatory Presidential Decree No. 1154, now Section 210 (b) of the Tax Code. The tax thus imposed is actually a tax on interest earnings of the lenders or placers who are actually the taxpayers in whose income is imposed. Thus "the borrower withholds the tax of 35% from the interest he would have to pay the lender so that he (borrower) can pay the 35% of the interest to the Government." (Citation omitted). . . .. Suffice it to state that the broad consensus of fiscal and monetary authorities is that "even if nominally, the borrower is made to pay the tax, actually, the tax is on the interest earning of the immediate and all prior lenders/placers of the money. . . .'" (Rollo, pp. 3637) The 35% transaction tax is an income tax on interest earnings to the lenders or placers. The latter are actually the taxpayers. Therefore, the tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed funds from several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before paying to the financial institutions the interest earned by them and later remitted the same to the respondent Commissioner of Internal Revenue. The tax could have been collected by a different procedure but the statute chose this method. Whatever collecting procedure is adopted does not change the nature of the tax.

xxx xxx xxx." 7 (Italics supplied)

Much the same issue was passed upon in Marinduque Mining and Industrial Corporation v. Commissioner of Internal Revenue 8 and resolved in the same way:
"It is very obvious that the transaction tax, which is tax on interest derived from commercial paper issued in the money market, is not a tax contemplated in the above-quoted legal provisions. The petitioner admits that it is subject to income tax. Its tax exemption should be strictly construed. We hold that petitioner's claim for refund was justifiably denied. The transaction tax, although nominally categorized as a business tax, is in reality a withholding tax as positively stated in LOI No. 340. The petitioner could have shifted the tax to the lenders or recipients of the interest. It did not choose to do so. It cannot be heard now to complain about the tax. LOI No. 340 is an extraneous or extrinsic aid to the construction of section 210 (b). xxx xxx xxx" 9 (Italics supplied)

It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of R.A. No. 5186, as amended. Picop was the withholding agent, obliged to withhold thirty-five percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau of Internal Revenue ("BIR"). As a withholding, agent, Picop is made personally liable for the thirty-five percent (35%) transaction tax 10 and if it did not
actually withhold thirty-five percent (35%) of the interest monies it had paid to its lenders, Picop had only itself to blame.

Picop claims that it had relied on a ruling, dated 6 October 1977, issued by the CIR, which held that Picop was not liable for the thirty-five (35%) transaction tax in respect of debenture bonds issued by Picop. Prior to the issuance of the promissory notes involved in the instant case, Picop had also issued debenture bonds of P100,000,000.00 in aggregate face value. The managing underwriter of this debenture bond issue, Bancom Development Corporation, requested a formal ruling from the Bureau of Internal Revenue on the liability of Picop for the thirty-five percent (35%) transaction tax in respect of such bonds. The ruling rendered by the then Acting Commissioner of Internal Revenue, Efren I. Plana, stated in relevant part:
"It is represented that PICOP will be offering to the public primary bonds in the aggregate principal sum of one hundred million pesos (P100,000,000.00); that the bonds will be issued as debentures in denominations of one thousand pesos (P1,000.00) or multiples, to mature in ten (10) years at 14% interest per annum payable semi-annually; that the bonds are convertible into common stock of the issuer at the option of the bond holder at an agreed conversion price;

that the issue will be covered by a 'Trust Indenture' with a duly authorized trust corporation as required by the Securities and Exchange Commission, which trustee will act for and in behalf of the debenture bond holders as beneficiaries; that once issued, the bonds cannot be preterminated by the holder and cannot be redeemed by the issuer until after eight (8) years from date of issue; that the debenture bonds will be subordinated to present and future debts of PICOP; and that said bonds are intended to be listed in the stock exchanges, which will place them alongside listed equity issues. In reply, I have the honor to inform you that although the bonds hereinabove described are commercial papers which will be issued in the primary market, however, it is clear from the abovestated facts that said bonds will not be issued as money market instruments. Such being the case, and considering that the purposes of Presidential Decree No. 1154, as can be gleaned from Letter of Instruction No. 340, dated November 21, 1975, are (a) to regulate money market transactions and (b) to ensure the collection of the tax on interest derived from money market transactions by imposing a withholding tax thereon, said bonds do not come within the purview of the 'commercial papers' intended to be subjected to the 35% transaction tax prescribed in Presidential Decree No. 1154, as implemented by Revenue Regulations No. 7-77. (See Section 2 of said Regulation). Accordingly, PICOP is not subject to 35% transaction tax on its issues of the aforesaid bonds. However, those investing in said bonds should be made aware of the fact that the transaction tax is not being imposed on the issuer of said bonds by printing or stamping thereon, in bold letters, the following statement: 'ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154. BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR INCOME TAX.'" 11 (Emphases supplied)

In the above quoted ruling, the CIR basically held that Picop's debenture bonds did not constitute "commercial papers" within the meaning of P.D. No. 1154, and that, as such, those bonds were not subject to the thirty-five percent (35%) transaction tax imposed by P.D. No. 1154. The above ruling, however, is not applicable in respect of the promissory notes which are the subject matter of the instant case. It must be noted that the debenture bonds which are the subject matter of Commissioner Plana's ruling were long-term bonds maturing in ten (10) years and which could not be pre-terminated and could not be redeemed by Picop until after eight (8) years from date of issue; the bonds were moreover subordinated to present and future debts of Picop and convertible into common stock of Picop at the option of the bondholder. In contrast, the promissory notes involved in the instant case are short-term instruments bearing a one-year maturity period. These promissory notes constitute the very archetype of money market instruments. For money market

instruments are precisely, by custom and usage of the financial markets, shortterm instruments with a tenor of one (1) year or less. 12 Assuming, therefore, (without passing upon) the correctness of the 6 October 1977 BIR ruling, Picop's short-term promissory notes must be distinguished, and treated differently, from Picop's long-term debenture bonds.
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We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction tax due in respect of interest payments on its money market borrowings. At the same time, we agree with the Court of Appeals that the transaction tax may be levied only in respect of the interest earnings of Picop's money market lenders accruing after P.D. No. 1154 went into effect, and not in respect of all the 1977 interest earnings of such lenders. The Court of Appeals pointed out that:
"PICOP, however, contends that even if the tax has to be paid, it should be imposed only for the interests earned after 20 September 1977 when PD 1154 creating the tax became effective. We find merit in this contention. It appears that the tax was levied on interest earnings from January to October, 1977. However, as found by the lower court, PD 1154 was published in the Official Gazette only on 5 September 1977, and became effective only fifteen (15) days after the publication, or on 20 September 1977, no other effectivity date having been provided by the PD. Based on the Worksheet prepared by the Commissioner's office, the interests earned from 20 September to October 1977 was P10,224,410.03. Thirty-five (35%) per cent of this is P3,578,543.51 which is all PICOP should pay as transaction tax." 13 (Emphasis supplied)

P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirtyfive percent (35%) transaction tax in respect of interest earnings which accrued before the effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the legislative authority intended to bring about such retroactive imposition of the tax. (2)Whether Picop is liable for interest and surcharge on unpaid transaction tax. With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five percent (25%) surcharge and for interest at the rate of fourteen percent (14%) per annum from the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of Revenue Regulation 7-77 dated 3 June 1977, 14issued by the Secretary of Finance. This Section reads:
"SEC. 10.Penalties. Where the amount shown by the taxpayer to be due on its return or part of such payment is not paid on or before the date prescribed for its payment, the amount of the tax shall be increased by twenty-five (25%) per centum, the increment to be a part of the tax and the entire amount shall be

subject to interest at the rate of fourteen (14%) per centum per annum from the date prescribed for its payment. In the case of wilful neglect to file the return within the period prescribed herein or in case a false or fraudulent return is wilfully made, there shall be added to the tax or to the deficiency tax in case any payment has been made on the basis of such return before the discovery of the falsity or fraud, a surcharge of fifty (50%) per centum of its amount. The amount so added to any tax shall be collected at the same time and in the same manner and as part of the tax unless the tax has been paid before the discovery of the falsity or fraud, in which case the amount so added shall be collected in the same manner as the tax. In addition to the above administrative penalties, the criminal and civil penalties as provided for under Section 337 of the Tax Code of 1977 shall be imposed for violation of any provision of Presidential Decree No. 1154." 15 (Emphases supplied)

The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code, invoked by the Secretary of Finance in issuing Revenue Regulation 7-77, set out, in comprehensive terms, the rule-making authority of the Secretary of Finance:
"SEC. 326.Authority of Secretary of Finance to Promulgate Rules and Regulations. The Secretary of Finance, upon recommendation of the Commissioner of Internal Revenue, shall promulgate all needful rules and regulations for the effective enforcement of the provisions of this Code." (Emphasis supplied)

Section 4 of the same Code contains a list of subjects or areas to be dealt with by the Secretary of Finance through the medium of an exercise of his quasi-legislative or rule-making authority. This list, however, while it purports to be open-ended, does not include the imposition of administrative or civil penalties such as the payment of amounts additional to the tax due. Thus, in order that it may be held to be legally effective in respect of Picop in the present case, Section 10 of Revenue Regulation 777 must embody or rest upon some provision in the Tax Code itself which imposes surcharge and penalty interest for failure to make a transaction tax payment when due. P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge and penalty interest in case of failure to pay the thirty-five percent (35%) transaction tax when due. Neither did Section 210 (b) of the 1977 Tax Code which reenacted Section 195-C inserted into the Tax Code by P.D. No. 1154. The CIR, both in its petition before the Court of Appeals and its Petition in the instant case, points to Section 51 (e) of the 1977 Tax Code as its source of authority for assessing a surcharge and penalty interest in respect of the thirty-five percent (35%) transaction tax

due from Picop. This Section needs to be quoted in extenso:

"SEC. 51.Payment and Assessment of Income Tax. (c)Definition of deficiency. As used in this Chapter in respect of a tax imposed by this Title, the term 'deficiency' means: (1)The amount by which the tax imposed by this Title exceeds the amount shown as the tax by the taxpayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amount previously abated, credited, returned, or otherwise in respect of such tax; . . . xxx xxx xxx (e)Additions to the tax in case of non-payment. (1)Tax shown on the return. Where the amount determined by the taxpayer as the tax imposed by this Title or any installment thereof, or any part of such amount or installment is not paid on or before the date prescribed for its payment, there shall be collected as a part of the tax, interest upon such unpaid amount at the rate of fourteen per centum per annum from the date prescribed for its payment until it is paid: Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding. (2)Deficiency. Where a deficiency, or any interest assessed in connection therewith under paragraph (d) of this section, or any addition to the taxes provided for in Section seventy-two of this Code is not paid in full within thirty days from the date of notice and demand from the Commissioner of Internal Revenue, there shall be collected upon the unpaid amount as part of the tax, interest at the rate of fourteen per centum per annum from the date of such notice and demand until it is paid: Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding. (3)Surcharge. If any amount of tax included in the notice and demand from the Commissioner of Internal Revenue is not paid in full within thirty days after such notice and demand, there shall be collected in addition to the interest prescribed herein and in paragraph (d) above and as part of the tax a surcharge of five per centum of the amount of tax unpaid." (Emphases supplied)

Section 72 of the 1977 Tax Code referred to in Section 51(e)(2) above, provides:
"SEC. 72.Surcharges for failure to render returns and for rendering false and fraudulent returns. In case of willful neglect to file the return or list required by this Title within the time prescribed by law, or in case a false or fraudulent return or list is wilfully made, the Commissioner of Internal Revenue shall add to the tax or to the deficiency tax, in case any payment has been made on the basis of such return before the discovery of the falsity or fraud, assurcharge of fifty per centum of the amount of such tax or deficiency tax. In case of any failure to make and file a return or list within the time prescribed by law or by the Commissioner or other Internal Revenue Officer, not due to willful neglect, the Commissioner of Internal Revenue shall add to the tax twenty-five per centum of its amount, except that, when a return is voluntarily and without notice from the Commissioner or other officer filed after such time, and it is shown that the failure to file it was due to a reasonable cause, no such addition shall be made to the tax. The amount so added to any tax shall be collected at the same time, in the same manner and as part of the tax unless the tax has been paid before the discovery of the neglect, falsity, or fraud, in which case the amount so added shall be collected in the same manner as the tax." (Emphases supplied)

It will be seen that Section 51 (c)(1) and (e)(1) and (3), of the 1977 Tax Code, authorize the imposition of surcharge and interest only in respect of a "tax imposed by this Title," that is to say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes a surcharge only in case of failure to file a return or list "required by this Title," that is, Title II on "Income Tax." The thirty-five percent (35%) transaction tax is, however, imposed in the 1977 Tax Code bySection 210 (b) thereof which Section is embraced in Title V on "Taxes on Business" of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax imposed on interest income earned by lenders or creditors purchasing commercial paper on the money market, the relevant provisions, i.e., Section 210 (b), were not inserted in Title II of the 1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of the taxes in respect of which Section 51 (e) authorized the imposition of surcharge and interest and Section 72 the imposition of a fraud surcharge. It is not without reluctance that we reach the above conclusion on the basis of what may well have been an inadvertent error in legislative draftsmanship, a type of error common enough during the period of Martial Law in our country. Nevertheless, we are compelled to adopt this conclusion. We consider that the authority to impose what the present Tax Code calls (in Section 248) civil penalties consisting of additions to the tax due, must be expressly given in the enabling statute, in language too clear to be mistaken. The grant of that authority is not lightly to be assumed to have been made to administrative officials, even to one as highly placed as the Secretary of Finance.

The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge and penalty interest for failure to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b) of the same Code. The corresponding provision in thecurrent Tax Code very clearly embraces failure to pay all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. Section 247 (a) of the NIRC, as amended, reads:
"Title X Statutory Offenses and Penalties Chapter I Additions to the Tax SECTION 247.General Provisions. (a) The additions to the tax or deficiency tax prescribed in this Chapter shall apply to all taxes, fees and charges imposed in this Code. The amount so added to the tax shall be collected at the same time, in the same manner and as part of the tax. . . . SECTION 248.Civil Penalties. (a) There shall be imposed, in addition to the tax required to be paid, penalty equivalent to twenty-five percent (25%) of the amount due, in the following cases: xxx xxx xxx (3)failure to pay the tax within the time prescribed for its payment; or xxx xxx xxx (c)the penalties imposed hereunder shall form part of the tax and the entire amount shall be subject to the interest prescribed in Section 249. SECTION 249.Interest. (a) In General. There shall be assessed and collected on any unpaid amount of tax, interest at the rate of twenty percent (20%) per annum or such higher rate as may be prescribed by regulations, from the date prescribed for payment until the amount is fully paid. . . .." (Emphases supplied)

In other words, Section 247 (a) of the current NIRC supplies what did not exist back in 1977 when Picop's liability for the thirty-five percent (35%) transaction tax became fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in

1985, was intended to be given retroactive application by the legislative authority. 16 (3)Whether Picop is Liable for Documentary and Science Stamp Taxes. As noted earlier, Picop issued sometime in 1977 long-term subordinated convertible debenture bonds with an aggregate face value of P100,000,000.00. Picop stated, and this was not disputed by the CIR, that the proceeds of the debenture bonds were in fact utilized to finance the BOI-registered operations of Picop. The CIR assessed documentary and science stamp taxes, amounting to P300,000.00, on the issuance of Picop's debenture bonds. It is claimed by Picop that its tax exemption "exemption from all taxes under the National Internal Revenue Code, except income tax" on a declining basis over a certain period of time includes exemption from the documentary and science stamp taxes imposed under the NIRC. The CIR, upon the other hand, stresses that the tax exemption under the Investment Incentives Act may be granted or recognized only to the extent that the claimant Picop was engaged in registered operations, i.e., operations forming part of its integrated pulp and paper project. 17 The borrowing of funds from the public, in the submission of the CIR, was not an activity included in Picop's registered operations. The CTA adopted the view of the CIR and held that "the issuance of convertible debenture bonds [was] not synonymous [with] the manufactur[ing] operations of an integrated pulp and paper mill." 18 The Court of Appeals took a less rigid view of the ambit of the tax exemption granted to registered pioneer enterprises. Said the Court of Appeals:
". . . PICOP's explanation that the debenture bonds were issued to finance its registered operation is logical and is unrebutted. We are aware that tax exemptions must be applied strictly against the beneficiary in order to deter their abuse. It would indeed be altogether a different matter if there is a showing that the issuance of the debenture bonds had no bearing whatsoever on the registered operations of PICOP and that they were issued in connection with a totally different business undertaking of PICOP other than its registered operation. There is, however, a dearth of evidence in this regard. It cannot be denied that PICOP needed funds for its operations. One of the means it used to raise said funds was to issue debenture bonds. Since the money raised thereby was to be used in its registered operation, PICOP should enjoy the incentives granted to it by R.A. 5186, one of which is the exemption from payment of all taxes under the National Internal Revenue Code, except income taxes, otherwise the Purpose of the incentives would be defeated. Documentary and science stamp taxes on debenture bonds are certainly not income taxes." 19 (Emphasis supplied)

Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be

extended beyond the ordinary and reasonable intendment of the language actually used by the legislative authority in granting the exemption. The issuance of debenture bonds is certainly conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or other instruments to the general public. We consider that the actual dedication of the proceeds of the bonds to the carrying out of Picop's registered operations constituted a sufficient nexus with such registered operations so as to exempt Picop from taxes ordinarily imposed upon or in connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this matter that the CTA and the CIR had erred in rejecting Picop's claim for exemption from stamp taxes. It remains only to note that after commencement of the present litigation before the CTA, the BIR took the position that the tax exemption granted by R.A. No. 5186, as amended, does include exemption from documentary stamp taxes on transactions entered into by BOI-registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a registered preferred pioneer enterprise engaged in the manufacture of integrated circuits, magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary stamp taxes. The Commissioner said:
"You now request a ruling that as a preferred pioneer enterprise, you are exempt from the payment of Documentary Stamp Tax (DST). In reply, please be informed that your request is hereby granted. Pursuant to Section 46 (a) of Presidential Decree No. 1789, pioneer enterprises registered with the BOI are exempt from all taxes under the National Internal Revenue Code, except from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent: xxx xxx xxx Accordingly, your company is exempt from the payment of documentary stamp tax to the extent of the percentage aforestated on transactions connected with the registered business activity. (BIR Ruling No. 111-81) However, if said transactions conducted by you require the execution of a taxable document with other parties, said parties who are not exempt shall be the one directly liable for the tax. (Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other words, said parties shall be liable to the same percentage corresponding to your tax exemption." (Emphasis supplied)

Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a registered pioneer enterprise producing polyester filament yarn was entitled to exemption

"from the documentary stamp tax on [its] sale of real property in Makati up to December 31, 1989." It appears clear to the Court that the CIR, administratively at least, no longer insists on the position it originally took in the instant case before the CTA. II (1)Whether Picop is entitled to deduct against current income interest payments on loans for the purchase of machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the purchase of machinery and equipment needed for its operations. In its 1977 Income Tax Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these loans as a deduction from its 1977 gross income. The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the purchase of machinery and equipment, the interest payments on those loans should have been capitalized instead and claimed as a depreciation deduction taking into account the adjusted basis of the machinery and equipment (original acquisition cost plus interest charges) over the useful life of such assets. Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed by Picop was proper and allowable. In the instant Petition, the CIR insists on its original position. We begin by noting that interest payments on loans incurred by a taxpayer (whether BOIregistered or not) are allowed by the NIRC as deductions against the taxpayer's gross income. Section 30 of the 1977 Tax Code provided as follows:
"Section 30.Deduction from Gross Income. The following may be deducted from gross income: (a)Expenses: xxx xxx xxx (b)Interest: (1)In general. The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title: . . ." (Emphasis supplied)

Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. 20 In the instant case, the CIR does not dispute that the interest payments were made by Picop on loansincurred in connection with the carrying on of the registered operations of Picop, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Picop. Neither does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by Picop during the tax year 1977. The CIR has been unable to point to any provision of the 1977 Tax Code or any other statute that requires the disallowance of the interest payments made by Picop . The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows:
"Section 79.Interest on Capital. Interest calculated for cost-keeping or other purposes on account of capital or surplus invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable deduction from gross income." (Emphases supplied)

We read the above provision of Revenue Regulations No. 2 as referring to so called "theoretical interest," that is to say, interest "calculated" or computed (and not incurred or paid) for the purpose of determining the "opportunity cost" of investing funds in a given business. Such "theoretical" or imputed interest does not arise from a legally demandable interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g., whether he would have been better off by lending out his funds and earning interest rather than investing such funds in his business. One thing that Section 79 quoted above makes clear is that interest which does constitute a charge arising under an interest-bearing obligation is an allowable deduction from gross income. It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph reads as follows:
"(B)Taxes and Carrying Charges. The items thus chargeable to capital accounts are (11)In the case of real property, whether improved or unimproved and whether productive or nonproductive. (a)Interest on a loan (but not theoretical interest of a taxpayer using his own funds)." 21

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be

related to the relevant provisions of the U.S. Internal Revenue Code, which provisions deal with the general topic of adjusted basis for determining allowable gain or loss on sales or exchanges of property and allowable depreciation and depletion of capital assets of the taxpayer:
"Present Rule. The Internal Revenue Code, and the Regulations promulgated thereunder provide that 'No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations, to treat such taxes or charges as so chargeable.' At the same time, under the adjustment of basis provisions which have just been discussed, it is provided that adjustment shall be made for all 'expenditures, receipts, losses, or other items' properly chargeable to a capital account, thus including taxes and carrying charges; however, an exception exists, in which event such adjustment to the capital account is not made, with respect to taxes and carrying charges which the taxpayer has not elected to capitalize but for which a deduction instead has been taken." 22 (Emphasis supplied)

The "carrying charges" which may be capitalized under the above quoted provisions of the U.S. Internal Revenue Code include, as the CIR has pointed out, interest on a loan "(but not theoretical interest of a taxpayer using his own funds)." What the CIR failed to point out is that such "carrying charges" may, at the election of the taxpayer, either be (a) capitalized in which case the cost basis of the capital assets, e.g., machinery and equipment, will be adjusted by adding the amount of such interest payments or, alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments. In other words, the taxpayer is not entitled to both the deduction from gross income and the adjusted (increased) basis for determining gain or loss and the allowable depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction of interest on a loan obtained for purchasing machinery and equipment against gross income, unless the taxpayer has also or previously capitalized the same interest payments and thereby adjusted the cost basis of such assets. We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on a legally demandable loan are deductible from gross income must be applied.
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The CIR argues finally that to allow Picop to deduct its interest payments against its gross income would be to encourage fraudulent claims to double deductions from gross income:
"[t]o allow a deduction of incidental expense/cost incurred in the purchase of fixed asset in the year it was incurred would invite tax evasion through fraudulent application of double deductions from a gross income." 23 (Emphases supplied)

The Court is not persuaded. So far as the records of the instant cases show, Picop has not claimed to be entitled to double deduction of its 1977 interest payments. The CIR has neither alleged nor proved that Picop had previously adjusted its cost basis for the machinery and equipment purchased with the loan proceeds by capitalizing the interest payments here involved. The Court will not assume that the CIR would be unable or unwilling to disallow "a double deduction" should Picop, having deducted its interest cost from its gross income, also attempt subsequently to adjust upward the cost basis of the machinery and equipment purchased and claim, e.g., increased deductions for depreciation. We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of Picop's 1977 interest payments on its loans for capital equipment against its gross income for 1977. (2)Whether Picop is entitled to deduct against current income net operating losses incurred by Rustan Pulp and Paper Mills, Inc. On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred, assigned and conveyed to Picop as the surviving corporation. The entire subscribed and outstanding capital stock of RPPM and RMC would be exchanged for 2,891,476 fully paid up Class "A" common stock of Picop (with a par value of P10.00) and 149,848 shares of preferred stock of Picop (with a par value of P10.00), to be issued by Picop , the result being that Picop would wholly own both RPPM and RMC while the stockholders of RPPM and RMC would join the ranks of Picop 's shareholders. In addition, Picop paid off the obligations of RPPM to the Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing 6,824,034 shares of preferred stock (with a par value of P10.00) to the DBP. The merger agreement was approved in 1977 by the creditors and stockholders of Picop, RPPM and RMC and by the Securities and Exchange Commission. Thereupon, on 30 November 1977, apparently the effective date of merger, RPPM and RMC were dissolved. The Board of Investments approved the merger agreement on 12 January 1978.

It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before merger effective date, RPPM had over preceding years accumulated losses in the total amount of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00 of RPPM's accumulated losses as a deduction against Picop's 1977 gross income. 24 Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding shares of RMC stock to San Miguel Corporation for the sum of P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. 25 In claiming such deduction, Picop relies on Section 7 (c) of R.A. No. 5186 which provides as follows:
"Section 7.Incentives to Registered Enterprise. A registered enterprise, to the extent engaged in a preferred area of investment, shall be granted the following incentive benefits: xxx xxx xxx (c)Net Operating Loss Carry-over. A net operating loss incurred in any of the first ten years of operations may be carried over as a deduction from taxable income for the six years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the six taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining five years. The net operating loss shall be computed in accordance with the provisions of the National Internal Revenue Code, any provision of this Act to the contrary notwithstanding, except that income not taxable either in whole or in part under this or other laws shall be included in gross income." (Emphasis supplied)

Picop had secured a letter-opinion from the BOI dated 21 February 1977 that is, after the date of the agreement of merger but before the merger became effective relating to the deductibility of the previous losses of RPPM under Section 7 (c) of R.A. No. 5186 as amended. The pertinent portions of this BOI opinion, signed by BOI Governor Cesar Lanuza; read as follows:
"2)PICOP will not be allowed to carry over the losses of Rustan prior to the legal dissolution of the latter because at that time the two (2) companies still had separate legal personalities; 3)After BOI approval of the merger, PICOP can no longer apply for the

registration of the registered capacity of Rustan because with the approved merger, such registered capacity of Rustan transferred to PICOP will have the same registration date as that of Rustan. In this case, the precious losses of Rustan may be carried over by PICOP, because with the merger, PICOP assumes all the rights and obligations of Rustan subject, however, to the period prescribed for carrying over such losses." 26 (Emphasis supplied)

Curiously enough, Picop did not also seek a ruling on this matter, clearly a matter of tax law, from the Bureau of Internal Revenue. Picop chose to rely solely on the BOI letteropinion.
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The CIR disallowed all the deductions claimed on the basis of RPPM's losses, apparently on two (2) grounds. Firstly, the previous losses were incurred by "another taxpayer," RPPM, and not by Picop in connection with Picop's own registered operations. The CIR took the view that Picop, RPPM and RMC were merged into one (1) corporate personality only on 12 January 1978, upon approval of the merger agreement by the BOI. Thus, during the taxable year 1977, Picop on the one hand and RPPM and RMC on the other, still had their separate juridical personalities. Secondly, the CIR alleged that these losses had been incurred by RPPM "from the borrowing of funds" and not from carrying out of RPPM's registered operations. We focus on the first ground. 27 The CTA upheld the deduction claimed by Picop; its reasoning, however, is less than crystal clear, especially in respect of its view of what the U.S. tax law was on this matter. In any event, the CTA apparently fell back on the BOI opinion of 21 February 1977 referred to above. The CTA said:
"Respondent further averred that the incentives granted under Section 7 of R.A. No. 5186 shall be available only to the extent in which they are engaged in registered operations, citing Section 1 of Rule IX of the Basic Rules and Regulations to Implement the Intent and Provisions of the Investment Incentives Act, R.A. No. 5186. We disagree with respondent. The purpose of the merger was to rationalize the container board industry and not to take advantage of the net losses incurred by RPPMI prior to the stock swap. Thus, when stock of a corporation is purchased in order to take advantage of the corporation's net operating loss incurred in years prior to the purchase, the corporation thereafter entering into a trade or business different from that in which it was previously engaged, the net operating loss carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5, Mertens, Law of Federal Income Taxation, Chap. 29.11a, p. 103]. 28 Furthermore, once the BOI approved the merger agreement, the registered capacity of Rustan shall be transferred to PICOP , and the previous losses of Rustan may be carried over by PICOP by operation of law. [BOI ruling dated February 21, 1977 (Exh. J-1)] It is clear therefrom, that the deduction availed of

under Section 7(c) of R.A. No. 5186 was only proper." (pp. 38-43, Rollo of SP No. 20070)" 29 (Emphasis supplied)

In respect of the above underscored portion of the CTA decision, we must note that the CTA in fact overlooked the statement made by petitioner's counsel before the CTA that:
"Among the attractions of the merger to Picop was the accumulated net operating loss carry-over of RMC that it might possibly use to relieve it (Picop) from its income taxes, under Section 7 (c) of R.A. 5186. Said section provides: xxx xxx xxx With this benefit in mind, Picop addressed three (3) questions to the BOI in a letter dated November 25, 1976. The BOI replied on February 21, 1977 directly answering the three (3) queries." 30 (Emphasis supplied)

The size of RPPM's accumulated losses as of the date of the merger more than P81,000,000.00 must have constituted a powerful attraction indeed for Picop. The Court of Appeals followed the result reached by the CTA. The Court of Appeals, much like the CTA, concluded that since RPPM was dissolved on 30 November 1977, its accumulated losses were appropriately carried over by Picop in the latter's 1977 Income Tax Return "because by that time RPPMI and Picop were no longer separate and different taxpayers." 31 After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's 1977 gross income. It is important to note at the outset that in our jurisdiction, the ordinary rule that is, the rule applicable in respect of corporations not registered with the BOI as a preferred pioneer enterprise is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are deducted or charged off. Section 30 of the 1977 Tax Code provides:
"SECTION 30.Deductions from Gross Income. In computing net income, there shall be allowed as deduction xxx xxx xxx

(d)Losses: (1)By Individuals. In the case of an individual, losses actually sustained during the taxable year and not compensated for by an insurance or otherwise (A)If incurred in trade or business; xxx xxx xxx (2)By Corporations. In a case of a corporation, all losses actually sustained and charged off within the taxable year and not compensated for by insurance or otherwise. (3)By Non-resident Aliens or Foreign Corporations. In the case of a nonresident alien individual or a foreign corporation, the losses deductible are those actually sustained during the year incurred in business or trade conducted within the Philippines, . . . .." 32 (Emphasis supplied)

Section 76 of the Philippine Income Tax Regulations (Revenue Regulation No. 2, as amended) is even more explicit and detailed:
"Section. 76.When charges are deductible. Each year's return, so far as practicable, both as to gross income and deductions therefrom should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges, he can not deduct them from the income of the next or any succeeding year. . . . xxx xxx xxx . . .. If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year including such amount of loss in the deduction from gross income and may in proper cases file a claim for refund of the excess paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained." (Emphases supplied)

It is thus clear that under our law, and outside the special realm of BOI-registered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary, losses must be deducted against current income in the taxable year when such

losses were incurred. Moreover, such losses may be charged off only against income earned in the same taxable year when the losses were incurred .

Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. The statutory purpose here may be seen to be the encouragement of the establishment and continued operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses which may be expected during the early years of the enterprise and to permit the enterprise to offset such losses against income earned by it in later years after successful establishment and regular operations. To promote its economic development goals, the Republic foregoes or defers taxing the income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We consider that the statutory purpose can be served only if the accumulated operating losses are carried over and charged off against income subsequently earned and accumulated by the same enterprise engaged in the same registered operations. In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. RPPM far from benefitting from the tax incentive granted by the BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the much larger group of Picop's stockholders. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM. Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same registered operations which earlier had sustained losses. We consider and so hold that there is nothing in Section 7 (c) of R. A. No. 5186 which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186. The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating losses against Picop's 1977 gross income, basically because towards the end of the taxable year 1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop, remained. The losses suffered by RPPM's registered operations and

the gross income generated by Picop's own registered operations now came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not believe that that single purely technical factor is enough to authorize and justify the deduction claimed by Picop. Picop's claim for deduction is not only bereft of statutory basis; it does violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss carry-over to BOI-registered pioneer enterprises, the legislature could not have intended to require the Republic to forego tax revenues in order to benefit a corporation which had run no risks and suffered no losses, but had merely purchased another's losses.
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Both the CTA and the Court of Appeals appeared much impressed not only with corporate technicalities but also with the U.S. tax law on this matter. It should suffice, however, simply to note that in U.S. tax law, the availability to companies generally of operating loss carry-overs and of operating loss carry-backs isexpressly provided and regulated in great detail by statute. 33 In our jurisdiction, save for Section 7 (c) of R.A. No. 5186, no statute recognizes or permits loss carry-overs and loss carry-backs. Indeed, as already noted, our tax law expressly rejects the very notion of loss carry-overs and carry-backs. We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be disallowed. (3)Whether Picop is entitled to deduct against current income certain claimed financial guarantee expenses. In its Income Tax Return for 1977, Picop also claimed a deduction in the amount of P1,237,421.00 as financial guarantee expenses. This deduction is said to relate to chattel and real estate mortgages required from Picop by the Philippine National Bank ("PNB") and DBP as guarantors of loans incurred by Picop from foreign creditors. According to Picop, the claimed deduction represents registration fees and other expenses incidental to registration of mortgages in favor of DBP and PNB. In support of this claimed deduction, Picop allegedly showed its own vouchers to BIR Examiners to prove disbursements to the Register of Deeds of Tandag, Surigao del Sur, of particular amounts. In the proceedings before the CTA, however, Picop did not submit in evidence such vouchers and instead presented one of its employees to testify that the amount claimed had been disbursed for the registration for chattel and real estate mortgages. The CIR disallowed this claimed deduction upon the ground of insufficiency of evidence. This disallowance was sustained by the CTA and the Court of Appeals. The CTA said:

"No records are available to support the above mentioned expenses. The vouchers merely showed that the amounts were paid to the Register of Deeds and simply cash account. Without the Supporting papers such as the invoices or official receipts of the Register of Deeds, these vouchers standing alone cannot prove that the payments made were for the accrued expenses in question. The best evidence of payment is the official receipts issued by the Register of Deeds. The testimony of petitioner's witness that the official receipts and cash vouchers were shown to the Bureau of Internal Revenue will not suffice if no records could be presented in court for proper marking and identification." 34 (Emphasis supplied)

The Court of Appeals added:

"The mere testimony of a witness for PICOP and the cash vouchers do not suffice to establish its claim that registration fees were paid to the Register of Deeds for the registration of real estate and chattel mortgages in favor of Development Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The witness could very well have been merely repeating what he was instructed to say regardless of the truth, while the cash vouchers, which we do not find on file, are not said to provide the necessary details regarding the nature and purpose of the expenses reflected therein. PICOP should have presented, through the guarantors, its owner's copy of the registered titles with the lien inscribed thereon as well as an official receipt from the Register of Deeds evidencing payment of the registration fee." 35 (Emphasis supplied)

We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has the burden of proving entitlement to a claimed deduction. 36 In the instant case, even Picop 's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. 37 The best evidence that Picop should have presented to support its claimed deduction were the invoices and official receipts issued by the Register of Deeds. Picop not only failed to present such documents; it also failed to explain the loss thereof, assuming they had existed before. 38 Under the best evidence rule, 39 therefore, the testimony of Picop's employee was inadmissible and was in any case entitled to very little, if any, credence. We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not adequately shown and that such deduction must be disallowed. III (1)Whether Picop had understated its sales and overstated its cost of sales for 1977.

In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had understated its sales by P2,391,644.00 and, upon the other hand, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its own return.
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The 1977 Income Tax Return of Picop set forth the following figures:
Sales (per Picop's Income Tax Return): PaperP537,656,719.00 TimberP263,158,132.00 Total SalesP800,814,851.00 ===========

Upon the other hand, Picop's Books of Accounts reflected higher sales figures:
Sales (per Picop 's Books of Accounts): PaperP537,656,719.00 TimberP265,549,776.00 Total SalesP803,206,495.00 ===========

The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00. The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when compared with the cost figures in its Books of Accounts, was overstated:
Cost of Sales (per Income Tax Return)P607,246,084.00 Cost of Sales (per Books of Accounts)P606,642,066.00

 DiscrepancyP604,018.00 ===========

Picop did not deny the existence of the above noted discrepancies. In the proceedings before the CTA, Picop presented one of its officials to explain the foregoing discrepancies. That explanation is perhaps best presented in Picop's own words as set forth in its Memorandum before this Court:

". . . that the adjustment discussed in the testimony of the witness, represent the best and most objective method of determining in pesos the amount of the correct and actual export sales during the year. It was this correct and actual export sales and costs of sales that were reflected in the income tax return and in the audited financial statements. These corrections did not result in realization of income and should not give rise to any deficiency tax. xxx xxx xxx What are the facts of this case on this matter? Why were adjustments necessary at the year-end? Because of PICOP's procedure of recording its export sales (reckoned in U.S. dollars) on the basis of a fixed rate, day to day and month to month, regardless of the actual exchange rate and without waiting when the actual proceeds are received. In other words, PICOP recorded its export sales at a pre-determined fixed exchange rate. That pre-determined rate was decided upon at the beginning of the year and continued to be used throughout the year. At the end of the year, the external auditors made an examination. In that examination, the auditors determined with accuracy the actual dollar proceeds of the export sales received. What exchange rate was used by the auditors to convert these actual dollar proceeds into Philippine pesos? They used the average of the differences between (a) the recorded fixed exchange rate and (b) the exchange rate at the time the proceeds were actually received. It was this rate at time of receipt of the proceeds that determined the amount of pesos credited by the Central Bank (through the agent banks) in favor of PICOP. These accumulated differences were averaged by the external auditors and this was what was used at the year-end for income tax and other government-report purposes. (T.s.n., Oct. 17/85, pp. 20-25)" 40

The above explanation, unfortunately, at least to the mind of the Court, raises more

questions than it resolves. Firstly, the explanation assumes that all of Picop's sales were export sales for which U.S. dollars (or other foreign exchange) were received. It also assumes that the expenses summed up as "cost of sales" were all dollar expenses and that no peso expenses had been incurred. Picop's explanation further assumes that a substantial part of Picop's dollar proceeds for its export sales were not actually surrendered to the domestic banking system and seasonably converted into pesos; had all such dollar proceeds been converted into pesos then the peso figures could have been simply added up to reflect the actual peso value of Picop's export sales. Picop offered no evidence in respect of these assumptions, no explanation why and how a "pre-determined fixed exchange rate" was chosen at the beginning of the year and maintained throughout. Perhaps more importantly, Picop was unable to explain why its Books of Accounts did not pick up the same adjustments that Picop's External Auditors were alleged to have made for purposes of Picop's Income Tax Return. Picop attempted to explain away the failure of its Books of Accounts to reflect the same adjustments (no correcting entries, apparently) simply by quoting a passage from a case where this Court refused to ascribe much probative value to the Books of Accounts of a corporate taxpayer in a tax case. 41 What appears to have eluded Picop, however, is that its Books of Accounts, which are kept by its own employees and are prepared under its control and supervision, reflect what may be deemed to be admissions against interest in the instant case. For Picop's Books of Accounts precisely show highersales figures and lower cost of sales figures than Picop's Income Tax Return. It is insisted by Picop that its Auditors' adjustments simply present the "best and most objective" method of reflecting in pesos the "correct and ACTUAL export sales" 42 and that the adjustments or "corrections" "did not result in realization of [additional] income and should not give rise to any deficiency tax." The correctness of this contention is not self-evident. So far as the record of this case shows, Picop did not submit in evidence the aggregate amount of its U.S. dollar proceeds of its export sales; neither did it show the Philippine pesos it had actually received or been credited for such U.S. dollar proceeds. It is clear to this Court that the testimonial evidence submitted by Picop fell far short of demonstrating the correctness of its explanation. Upon the other hand, the CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear to be admissions against Picop's own interest. Accordingly, we must affirm the findings of the Court of Appeals and the CTA. (2)Whether Picop is liable for the corporate development tax of five percent (5%) of its income for 1977.

The five percent (5%) corporate development tax is an additional corporate income tax imposed in Section 24 (e) of the 1977 Tax Code which reads in relevant part as follows:
"(e)Corporate development tax. In addition to the tax imposed in subsection (1) of this section, an additional tax in an amount equivalent to 5 per cent of the same taxable net income shall be paid by a domestic or a resident foreign corporation; Provided, That this additional tax shall be imposed only if the net income exceeds 10 per cent of the net worth, in case of a domestic corporation, or net assets in the Philippines in case of a resident foreign corporation: . . . . The additional corporate income tax imposed in this subsection shall be collected and paid at the same time and in the same manner as the tax imposed in subsection (a) of this section."

Since this five percent (5%) corporate development tax is an income tax, Picop is not exempted from it under the provisions of Section 8 (a) of R.A. No. 5186. For purposes of determining whether the net income of a corporation exceeds ten percent (10%) of its net worth, the term "net worth" means the stockholders' equity represented by the excess of the total assets over liabilities as reflected in the corporation's balance sheet provided such balance sheet has been prepared in accordance with generally accepted accounting principles employed in keeping the books of the corporation. 43 The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent (10%) of its net worth, Picop must be held liable for the five percent (5%) corporate development tax in the amount of P2,434,367.75. Recapitulating, we hold: (1)Picop is liable for the thirty five percent (35%) transaction tax in the amount of P3,578,543.51. (2)Picop is not liable for interest and surcharge on unpaid transaction tax. (3)Picop is exempt from payment of documentary and science stamp taxes in the amount of P300,000.00 and the compromise penalty of P300.00. (4)Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans for, among other things, the purchase of machinery and equipment. (5)Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses

previously incurred by RPPM, is disallowed for lack of merit. (6)Picop's claimed deduction for certain financial guarantee expenses in the amount P1,237,421.00 is disallowed for failure adequately to prove such expenses. (7)Picop has understated its sales by P2,391,644.00 and overstated its cost of sales by P604,018.00, for 1977. (8)Picop is liable for the corporate development tax of five percent (5%) of its adjusted net income for 1977 in the amount of P2, 434,367.75. Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for deficiency income tax for the year 1977 computed as follows:
Deficiency Income Tax
Net Income Per ReturnP258,166.00 Add: Unallowable Deductions (1)Deduction of net operating losses incurred by RPPMP44,196,106.00 (2)Unexplained financial guarantee expensesP1,237,421.00 (3)Understatement of SalesP2,391,644.00 (4)Overstatement of Cost of SalesP604,018.00 TotalP48,429,189.00 Net Income as AdjustedP48,687,355.00 =========== Income Tax Due Thereon 44 P17,030,574.00

Less: Tax Already Assessed per Return80,358.00 Deficiency Income TaxP16,560,216.00 Add: Five percent (5%) Corporate Development TaxP2,434,367.00 Total Deficiency Income TaxP18,994,583.00 =========== Add: Five percent (5%) surcharge 45P994.583.00 Total Deficiency Income Tax with surchargeP19,944,312.15 Add: Fourteen percent (14%) interest from 15 April 1978 to 14 April 1981 46P8,376,610.80 Fourteen percent (14%) interest from 21 April 1983 to 20 April 1986 47P11,894 787.00 Total Deficiency Income Tax Due and PayableP40,215.709.00 ===========

WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay the CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1)Thirty-five percent (35%) transaction taxP3, 578,543.51 (2)Total Deficiency Income Tax Due40,215,709.00 Aggregate Amount Due and PayableP43,794,252.51 ===========

No pronouncement as to costs. SO ORDERED.

[G.R. No. 172231. February 12, 2007.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. ISABELA CULTURAL CORPORATION, respondent.

DECISION

YNARES-SANTIAGO, J :
p

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision 1 of the Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision 2 of the Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the Assessment Notices for deficiency income tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC). The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and

interest, both for the taxable year 1986. The deficiency income tax of P333,196.86, arose from:
(1)The BIR's disallowance of ICC's claimed expense deductions for professional and security services billed to and paid by ICC in 1986, to wit: (a)Expenses for the auditing services of SGV & Co., 3 for the year ending December 31, 1985; 4 (b)Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984 and 1985. 5 (c)Expense for security services of El Tigre Security & Investigation Agency for the months of April and May 1986. 6 (2)The alleged understatement of ICC's interest income on the three promissory notes due from Realty Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services. 7 On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995, however, it received a final notice before seizure demanding payment of the amounts stated in the said notices. Hence, it brought the case to the CTA which held that the petition is premature because the final notice of assessment cannot be considered as a final decision appealable to the tax court. This was reversed by the Court of Appeals holding that a demand letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the protested assessment and may therefore be questioned before the CTA. This conclusion was sustained by this Court on July 1, 2001, in G.R. No. 135210. 8 The case was thus remanded to the CTA for further proceedings.

aEHASI

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices issued against ICC. It held that the claimed deductions for professional and security services were properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the amount thereof could not be determined at that time. The CTA also held that ICC did not understate its interest income on the subject

promissory notes. It found that it was the BIR which made an overstatement of said income when it compounded the interest income receivable by ICC from the promissory notes of Realty Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the application of compounded interest. Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for security services as shown by the various payment orders and confirmation receipts it presented as evidence. The dispositive portion of the CTA's Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-8690-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET ASIDE. SO ORDERED. 9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision, 10 holding that although the professional services (legal and auditing services) were rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time, hence, it could be considered as deductible expenses only in 1986 when ICC received the billing statements for said services. It further ruled that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc., and that ICC properly withheld and remitted taxes on the payments for security services for the taxable year 1986. Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that since ICC is using the accrual method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have been declared as deductions from income during the said years and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and failure to withhold expanded withholding tax assessment, petitioner invoked the presumption that the assessment notices issued by the BIR are valid. The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for professional and security services from ICC's gross income; and (2) held that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc; and that ICC withheld the required 1% withholding tax from the deductions for security services.
DICSaH

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. 11 The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net income is computed . . .". Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions. 12 In the instant case, the accounting method used by ICC is the accrual method. Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year. 13 The accrual method relies upon the taxpayer's right to receive amounts or its obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment. 14 For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability. The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where computation remains uncertain,

if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount. 15 The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year. 16 Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or deduction. 17 Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must also be strictly construed. 18

In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICC's tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960's. 19 From the nature of the claimed deductions and the span of time during which the firm was retained, ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time legal consultant.
aASEcH

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the burden of establishing the accrual of an expense or income. However, ICC failed to discharge this burden. As to when the firm's performance of its services in connection with the 1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire about the amount of its liability, or whether it does or does

not possess the information necessary to compute the amount of said liability with reasonable accuracy, are questions of fact which ICC never established. It simply relied on the defense of delayed billing by the firm and the company, which under the circumstances, is not sufficient to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal and auditing services. In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said company would charge for its services. ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income for the said year and were therefore properly disallowed by the BIR. As to the expenses for security services, the records show that these expenses were incurred by ICC in 1986 20 and could therefore be properly claimed as deductions for the said year. Anent the purported understatement of interest income from the promissory notes of Realty Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no such understatement exists and that only simple interest computation and not a compounded one should have been applied by the BIR. There is indeed no stipulation between the latter and ICC on the application of compounded interest. 21 Under Article 1959 of the Civil Code, unless there is a stipulation to the contrary, interest due should not further earn interest. Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required withholding tax from its claimed deductions for security services and remitted the same to the BIR is supported by payment order and confirmation receipts. 22 Hence, the Assessment Notice for deficiency expanded withholding tax was properly cancelled and set aside. In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income tax should be cancelled and set aside but only insofar as the claimed deductions of ICC for security services. Said Assessment is valid as to the BIR's disallowance of ICC's expenses for professional services. The Court of Appeal's cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount of P4,897.79

for deficiency expanded withholding tax, is sustained. WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with the MODIFICATION that Assessment Notice No. FAS-1-86-90-000680, which disallowed the expense deduction of Isabela Cultural Corporation for professional and security services, is declared valid only insofar as the expenses for the professional fees of SGV & Co. and of the law firm, Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, are concerned. The decision is affirmed in all other respects. The case is remanded to the BIR for the computation of Isabela Cultural Corporation's liability under Assessment Notice No. FAS-1-86-90-000680.
SAHIDc

SO ORDERED. Austria-Martinez, Callejo, Sr. and Chico-Nazario, JJ., concur. Nachura, J., is on leave.
Footnotes

1.Rollo, pp. 48-59. Penned by Associate Justice Delilah Vidallon-Magtolis and concurred in by Associate Justices Bienvenido L. Reyes and Josefina Guevara-Salonga. 2.Id. at 165-181. 3.Sycip, Gorres, Velayo & Co. 4.Exhibits "O" to "T," records, pp. 128-133. 5.Exhibits "U" to "DD," id. at 134-143. 6.Exhibits "EE" to "II," id. at 144-148. 7.Rollo, p. 56. The following is an itemized schedule of ICC's deficiency assessment: Taxable income (loss) per returnP(114,345.00) Add: Additional Taxable Income

(1) Interest incomeP429,187.47 (2) Other income Rent income9,169.64 Investment service income23,725.36 (3) Disallowance of prior year's expenses (a) Professional fees (1985)496,409.77 (b) Security services (1985)41,814.001,000,306.24 Net Taxable Income per investigationP885,961.24 Tax due thereonP310,086.43 Less: Tax Paid143,488.00 BalanceP166,598.43 Add: 25% Surcharge41,649.61 Sub-totalP208,248.04 Add: 60% Interest124,948.82 Total Amount Due and CollectibleP333,196.86 Expanded Withholding Tax Security ServicesP2,448.90 Add: 25% Surcharge612.22 Sub-totalP3,061.12 Add: 60% Interest1,836.67 Total Amount Due and CollectibleP4,897.79

(CTA Decision, Rollo, p. 174) 8.Commissioner of Internal Revenue v. Isabela Cultural Corporation, 413 Phil. 376. 9.Rollo, p. 181. 10.The dispositive portion of the Court of Appeal's Decision, states: WHEREFORE, the petition is hereby DISMISSED for lack of merit and the decision appealed from is hereby AFFIRMED. SO ORDERED. (Id. at 59)
aDACcH

11.Commissioner of Internal Revenue v. General Foods (Phils.), Inc., G.R. No. 143672, April 24, 2003, 401 SCRA 545, 551. 12.De Leon, The National Internal Revenue Code, Annotated, vol. I, 2003 edition, p. 443. 13.Chapter II-B. 14.Mertens Law of Federal Income Taxation, Vol. 2 (1996), Cash and Accrual Methods, Chapter 12A, Section 12A:51, p. 12A-77. 15.Id. at 12A:58, p. 12A-87. 16.Id. at 12A:55, p. 12A-82. 17.Id. at 12A:51, p. 12A-77. 18.Commissioner of Internal Revenue v. General Foods (Phils.), Inc., supra note 11 at 550. 19.TSN, July 20, 1995, p. 86. 20.Exhibits "EE" to "II," records, pp. 144-148. 21.Exhibits "E" to "J," id. at 119 to 123. 22.Exhibits "QQ" to "WW," id. at 171-191.

BAD DEBTS

[G.R. No. 118794. May 8, 1996.] PHILIPPINE REFINING COMPANY (now known as "UNILEVER PHILIPPINES [PRC], INC."), petitioner, vs. COURT OF APPEALS, COURT OF TAX APPEALS, and THE COMMISSIONER OF INTERNAL REVENUE, respondents. Antonio H. Garces for petitioner. The Solicitor General for respondents. SYLLABUS 1.REMEDIAL LAW; EVIDENCE; FINDINGS OF FACT OF THE COURT OF TAX APPEALS, GENERALLY UPHELD ON APPEAL; CASE AT BENCH. The Court of Tax Appeals is a highly specialized body specifically created for the purpose of reviewing tax cases. Through its expertise, it is undeniably competent to determine the issue of whether or not the debt is deductible through the evidence presented before it. Because of this recognized expertise, the findings of the CTA will not ordinarily be reviewed absent a showing of gross error or abuse on its part. The findings of fact of the CTA are binding on this Court and in the absence of strong reasons for this Court to delve into facts, only questions of law are open for determination. Were it not, therefore, due to the desire of this Court to satisfy petitioner's calls for clarification and to use this case as a vehicle for exemplification, this appeal could very well have been summarily dismissed. 2.TAXATION; NATIONAL INTERNAL REVENUE CODE; INCOME TAX; BAD DEBTS; REQUISITES FOR DEDUCTION. For debts to be considered as "worthless," and thereby qualify as "bad debts" making them deductible, the taxpayer should show that (1) there is a valid and subsisting debt; (2) the debt must be actually ascertained to be worthless and uncollectible during the taxable year; (3) the debt must be charged off during the taxable year; and (4) the debt must arise from the business or trade of the taxpayer. Additionally, before a debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future. Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted diligent efforts to collect the debts, viz: (1) sending of statement of accounts; (2) sending of collection letters; (3) giving the account to a lawyer for collection; and (4) filing a collection case in court. 3.ID.; ID.; ID.; DEFICIENCY TAX ASSESSMENT; FAILURE TO PAY WITHIN 30 DAYS RENDERS TAXPAYER LIABLE FOR PAYMENT OF 25% SURCHARGE AND 20% INTEREST. As correctly pointed out by the Solicitor General, the

deficiency tax assessment in this case, which was the subject of the demand letter of respondent Commissioner dated April 11, 1989, should have been paid within thirty (30) days from receipt thereof. By reason of petitioner's default thereon, the delinquency penalties of 25% surcharge and interest of 20% accrued from April 11, 1989. The fact that petitioner appealed the assessment to the CTA and that the same was modified does not relieve petitioner of the penalties incident to delinquency. The reduced amount of P237,381.25 is but a part of the original assessment of P1,892,584.00. 4.ID.; TAX LAWS IMPOSING PENALTIES FOR DELINQUENCIES, INTENDED TO HASTEN PAYMENT OF TAXES. Tax laws imposing penalties for delinquencies, so we have long held, are intended to hasten tax payments by punishing evasions or neglect of duty in respect thereof. If penalties could be condoned for flimsy reasons, the law imposing penalties for delinquencies would be rendered nugatory, and the maintenance of the Government and its multifarious activities will be adversely affected. 5.ID.; NATIONAL INTERNAL REVENUE CODE; COLLECTION OF PENALTY AND INTEREST IN CASE OF DELINQUENCY, MANDATORY. We have likewise explained that it is mandatory to collect penalty and interest at the stated rate in case of delinquency. The intention of the law is to discourage delay in the payment of taxes due the Government and, in this sense, the penalty and interest are not penal but compensatory for the concomitant use of the funds by the taxpayer beyond the date when he is supposed to have paid them to the Government.

DECISION

REGALADO, J :
p

This is an appeal by certiorari from the decision of respondent Court of Appeals 1 affirming the decision of the Court of Tax Appeals which disallowed petitioner's claim for deduction as bad debts of several accounts in the total sum of P395,324,27, and imposing a 25% surcharge and 20% annual delinquency interest on the alleged deficiency income tax liability of petitioner.
Cdpr

Petitioner Philippine Refining Company (PRC) was assessed by respondent Commissioner of Internal Revenue (Commissioner) to pay a deficiency tax for the year 1985 in the amount of P1,892,584.00, computed as follows: Deficiency Income Tax

Net Income per investigationP197,502,568.00 Add: Disallowances Bad DebtsP713,070.93 Interest ExpenseP2,666,545.49P3,379,616.00 Net Taxable IncomeP200,882,184.00 Tax Due ThereonP70,298,764.00 Less: Tax PaidP69,115,899.00 Deficiency Income TaxP1,182,865.00 Add: 20% Interest (60% max.)P709,719.00 Total Amount Due and CollectibleP1,892.584.00 2

The assessment was timely protested by petitioner on April 26, 1989, on the ground that it was based on the erroneous disallowances of "bad debts" and "interest expense" although the same are both allowable and legal deductions. Respondent Commissioner, however, issued a warrant of garnishment against the deposits of petitioner at a branch of City Trust Bank, in Makati, Metro Manila, which action the latter considered as a denial of its protest. Petitioner accordingly filed a petition for review with the Court of Tax Appeals (CTA) on the same assignment of error, that is, that the "bad debts" and "interest expense" are legal and allowable deductions. In its decision 3 of February 3, 1993 in C.T.A. Case No. 4408, the CTA modified the findings of the Commissioner by reducing the deficiency income tax assessment to P237,381.26, with surcharge and interest incident to delinquency. In said decision, the Tax Court reversed and set aside the Commissioner's disallowance of the interest expense of P2,666,545.19 but maintained the disallowance of the bad debts of

thirteen (13) debtors in the total sum of P395,324.27. Petitioner then elevated the case to respondent Court of Appeals which, as earlier stated, denied due course to the petition for review and dismissed the same on August 24, 1994 in CA-G.R. S.P. No 31190, 4 on the following ratiocination: We agree with respondent Court of Tax Appeals:
Out of the sixteen (16) accounts alleged as bad debts, We find that only three (3) accounts have met the requirements of the worthlessness of the accounts, hence were properly written off as bad debts, namely: 1.Petronila Catap (Pet Mini Grocery)P29,098.30 2.Esther Guinto (Esther Sari-sari Store)254,375.54 3.Manuel Orea (Elman Gen. Mdsg.)34,272.82 TOTALP317,746.66 xxx xxx xxx With regard to the other accounts, namely: 1.Remoblas StoreP11,961.00 2.Tomas Store16,842.79 3.AFPCES13,833.62 4.CM Variety Store10,895.82 5.U'Ren Mart Enterprise10,487.08 6.Aboitiz Shipping Corp.89,483.40

7.J. Ruiz Trucking69,640.34 8.Renato Alejandro13,550.00 9.Craig, Mostyn Pty. Ltd.23,738.00 10.C. Itoh19,272.22 11.Crocklaan B. V.77,690.00 12.Enriched Food Corp.24,158.00 13.Lucito Sta. Maria13,772.00 TOTALP395,324.27 ========= We find that said accounts have not satisfied the requirements of the 'worthlessness of a debt'. Mere testimony of the Financial Accountant of the Petitioner explaining the worthlessness of said debts is seen by this Court as nothing more than a self-serving exercise which lacks probative value. There was no iota of documentary evidence (e.g., collection letters sent, report from investigating fieldmen, letter of referral to their legal department, police report/affidavit that the owners were bankrupt due to fire that engulfed their stores or that the owner has been murdered etc.), to give support to the testimony of an employee of the Petitioner. Mere allegations cannot prove the worthlessness of such debts in 1985. Hence, the claim for deduction of these thirteen (13) debts should be rejected." 5

1.This pronouncement of respondent Court of Appeals relied on the ruling of this Court in Collector vs. Goodrich International Rubber Co., 6 which established the rule in determining the "worthlessness of a debt." In said case, we held that for debts to be considered as "worthless," and thereby qualify as "bad debts" making them deductible, the taxpayer should show that (1) there is a valid and subsisting debt; (2) the debt must be actually ascertained to be worthless and uncollectible during the taxable year; (3) the debt must be charged off during the taxable year; and (4) the debt must arise from the business or trade of the taxpayer. Additionally, before a debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future. Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted diligent efforts to collect the debts, viz: (1) sending of statement of accounts; (2) sending of collection letters; (3) giving the account to a lawyer for

collection; and (4) filing a collection case in court. On the foregoing considerations, respondent Court of Appeals held that petitioner did not satisfy the requirements of "worthlessness of a debt" as to the thirteen (13) accounts disallowed as deductions. It appears that the only evidentiary support given by PRC for its aforesaid claimed deductions was the explanation or justification posited by its financial adviser or accountant, Guia D. Masagana. Her allegations were not supported by any documentary evidence, hence, both the Court of Appeals and the CTA ruled that said contentions per se cannot prove that the debts were indeed uncollectible and can be considered as bad debts as to make them deductible. That both lower courts are correct is shown by petitioner's own submission and the discussion thereof which we have taken time and patience to cull from the antecedent proceedings in this case, albeit bordering on factual settings. The accounts of Remoblas Store in the amount of P11,961.00 and CM Variety Store in the amount of P10,895.82 are uncollectible, according to petitioner, since the stores were burned in November, 1984 and in early 1985, respectively, and there are no assets belonging to the debtors that can be garnished by PRC. 7However, PRC failed to show any documentary evidence for said allegations. Not a single document was offered to show that the stores were burned, even just a police report or an affidavit attesting to such loss by fire. In fact, petitioner did not send even a single demand letter to the owners of said stores. The account of Tomas Store in the amount of P16,842.79 is uncollectible, claims petitioner PRC, since the owner thereof was murdered and left no visible assets which could satisfy the debt. Withal, just like the accounts of the two other stores just mentioned, petitioner again failed to present proof of the efforts exerted to collect the debt, other than the aforestated asseverations of its financial adviser. The accounts of Aboitiz Shipping Corporation and J. Ruiz Trucking in the amounts of P89,483.40 and P69,640.34, respectively, both of which allegedly arose from the hijacking of their cargo and for which they were given 30% rebates by PRC, are claimed to be uncollectible. Again, petitioner failed to present an iota of proof, not even a copy of the supposed policy regulation of PRC that it gives rebates to clients in case of loss arising from fortuitous events or force majeure, which rebates it now passes off as uncollectible debts. As to the account of P13,550.00 representing the balance collectible from Renato Alejandro, a former employee who failed to pay the judgment against him, it is petitioner's theory that the same can no longer be collected since his whereabouts are unknown and he has no known property which can be garnished or levied upon. Once again, petitioner failed to prove the existence of the said case against that debtor or to submit any documentation to show that Alejandro was indeed bound to pay any

judgment obligation. The amount of P13,772.00 corresponding to the debt of Lucito Sta. Maria is allegedly due to the loss of his stocks through robbery and the account is uncollectible due to his insolvency. Petitioner likewise failed to submit documentary evidence, not even the written reports of the alleged investigation conducted by its agents as testified to by its aforenamed financial adviser. Regarding the accounts of C. Itoh in the amount of P19,272.22, Crocklaan B.V. in the sum of P77,690.00, and Craig, Mostyn Pty. Ltd. with a balance of P23,738.00, petitioner contends that these debtors being foreign corporations, it can sue them only in their country of incorporation; and since this will entail expenses more than the amounts of the debts to be collected, petitioner did not file any collection suit but opted to write them off as bad debts. Petitioner was unable to show proof of its efforts to collect the debts, even by a single demand letter therefor. While it is not required to file suit, it is at least expected by the law to produce reasonable proof that the debts are uncollectible although diligent efforts were exerted to collect the same. The account of Enriched Food Corporation in the amount of P24,158.00 remains unpaid, although petitioner claims that it sent several letters. This is not sufficient to sustain its position, even if true, but even smacks of insouciance on its part. On top of that, it was unable to show a single copy of the alleged demand letters sent to the said corporation or any of its corporate officers. With regard to the account of AFPCES for unpaid supplies in the amount of P13,833.62, petitioner asserts that since the debtor is an agency of the government, PRC did not file a collection suit therefor. Yet, the mere fact that AFPCES is a government agency does not preclude PRC from filing suit since said agency, while discharging proprietary functions, does not enjoy immunity from suit. Such pretension of petitioner cannot pass judicial muster. No explanation is offered by petitioner as to why the unpaid account of U'Ren Mart Enterprise in the amount of P10,487.08 was written off as a bad debt. However, the decision of the CTA includes this debtor in its findings on the lack of documentary evidence to justify the deductions claimed, since the worthlessness of the debts involved are sought to be established by the mere self-serving testimony of its financial consultant. The contentions of PRC that nobody is in a better position to determine when an obligation becomes a bad debt than the creditor itself, and that its judgment should not be substituted by that of respondent court as it is PRC which has the facilities in ascertaining the collectibility or uncollectibility of these debts, are presumptuous and uncalled for. The Court of Tax Appeals is a highly specialized body specifically created for the purpose of reviewing tax cases. Through its expertise, it is undeniably competent to determine the issue of whether or not the debt is deductible through the evidence presented before it. 8

Because of this recognized expertise, the findings of the CTA will not ordinarily be reviewed absent a showing of gross error or abuse on its part. 9 The findings of fact of the CTA are binding on this Court and in the absence of strong reasons for this Court to delve into facts, only questions of law are open for determination. 10 Were it not, therefore, due to the desire of this Court to satisfy petitioner's calls for clarification and to use this case as a vehicle for exemplification, this appeal could very well have been summarily dismissed. The Court vehemently rejects the absurd thesis of petitioner that despite the supervening delay in the tax payment, nothing is lost on the part of the Government because in the event that these debts are collected, the same will be returned as taxes to it in the year of the recovery. This is an irresponsible statement which deliberately ignores the fact that while the Government may eventually recover revenues under that hypothesis, the delay caused by the non-payment of taxes under such a contingency will obviously have a disastrous effect on the revenue collections necessary for governmental operations during the period concerned.
cdphil

2.We need not tarry at length on the second issue raised by petitioner. It argues that the imposition of the 25% surcharge and the 20% delinquency interest due to delay in its payment of the tax assessed is improper and unwarranted, considering that the assessment of the Commissioner was modified by the CTA and the decision of said court has not yet become final and executory. Regarding the 25% surcharge penalty, Section 248 of the Tax Code provides:
"SECTION 248.Civil Penalties. (a) There shall be imposed, in addition to the tax required to be paid, a penalty equivalent to twenty-five percent (25%) of the amount due, in the following cases: xxx xxx xxx (3)Failure to pay the tax within the time prescribed for its payment."

With respect to the penalty of 20% interest, the relevant provision is found in Section 249 of the same Code, as follows:
"SECTION 249.Interest. (a) In general. There shall be assessed and collected on any unpaid amount of tax, interest at the rate of twenty percent (20%) per annum, or such higher rate as may be prescribed by regulations, from the date prescribed for payment until the amount is fully paid. xxx xxx xxx (c)Delinquency interest. In case of failure to pay: (1)The amount of the tax due on any return required to be filed, or (2)The amount of the tax due for which no return is required, or (3)A deficiency tax, or any surcharge or interest thereon, on the due date

appearing in the notice and demand of the Commissioner, there shall be assessed and collected, on the unpaid amount, interest at the rate prescribed in paragraph (a) hereof until the amount is fully paid, which interest shall form part of the tax " (Emphasis supplied) xxx xxx xxx

As correctly pointed out by the Solicitor General, the deficiency tax assessment in this case, which was the subject of the demand letter of respondent Commissioner dated April 11, 1989, should have been paid within thirty (30) days from receipt thereof. By reason of petitioner's default thereon, the delinquency penalties of 25% surcharge and interest of 20% accrued from April 11, 1989. The fact that petitioner appealed the assessment to the CTA and that the same was modified does not relieve petitioner of the penalties incident to delinquency. The reduced amount of P237,381.25 is but a part of the original assessment of P1,892.584.00. Our attention has also been called to two of our previous rulings and these we set out here for the benefit of petitioner and whosoever may be minded to take the same stance it has adopted in this case. Tax laws imposing penalties for delinquencies, so we have long held, are intended to hasten tax payments by punishing evasions or neglect of duty in respect thereof. If penalties could be condoned for flimsy reasons, the law imposing penalties for delinquencies would be rendered nugatory, and the maintenance of the Government and its multifarious activities will be adversely affected. 11 We have likewise explained that it is mandatory to collect penalty and interest at the stated rate in case of delinquency. The intention of the law is to discourage delay in the payment of taxes due the Government and, in this sense, the penalty and interest are not penal but compensatory for the concomitant use of the funds by the taxpayer beyond the date when he is supposed to have paid them to the Government. 12 Unquestionably, petitioner chose to turn a deaf ear to these injunctions. ACCORDINGLY, the petition at bar is DENIED and the judgment of respondent Court of Appeals is hereby AFFIRMED, with treble costs against petitioner. SO ORDERED.