INCOME TAX

DIFFERENCE BETWEEN CAPITAL AND INCOME

EN BANC
[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 Laxamana vs. 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 Vicente Madrigal 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 Attorney-General, and thus decided against the claim of Madrigal.
After payment under protest, and after the protest of Madrigal had been decided
adversely by the Collector of Internal Revenue, action was begun by VicenteMadrigal 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, VicenteMadrigal, 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 plaintiff Madrigal has paid ' as income
tax for the year 1914, P3,786.08, in excess of the sum lawfully due and payable.
The answer of the defendants, together with an analysis of the tax declaration, the
pleadings, and the stipulation, sets forth the basis of defendants' stand in the following way:
The income of Vicente Madrigal and his wife Susana Paterno 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. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S.,
605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition
[1915.], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII;
Gibbons vs. Mahon [1890], 136 U. S., 549; and Towne vs. Eisner, decided by the United
States Supreme Court, January 7, 1918.)
A regulation of the United States Treasury Department relative to returns by the
husband and wife not living apart, contains the following:
"The husband, as the head and legal representative of the household
and general custodian of its income, should make and render the return of the
aggregate income of himself and wife, and for the purpose of levying the
income tax it is assumed that he can ascertain the total amount of said income.
If a wife has a separate estate managed by herself as her own separate
property, and receives an income of more than $3,000, she may make return of
her own income, and if the husband has other net income, making the
aggregate of both incomes more than $4,000, the wife's return should be
attached to the return of her husband, or his income should be included in her
return, in order that a deduction of $4,000 may be made from the aggregate of
both incomes. The tax in such case, however, will be imposed only upon so
much of the aggregate income of both 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
Torres, Johnson, Carson, Street and Fisher, JJ.; concur.

REALIZATION TEST/ SEVERANCE THEORY

Eisner v. Macomber
No. 318
Argued April 16, 1919
Restored to docket for reargument May 19, 1919
Reargued October 17, 20, 1919
Decided March 8, 1920
252 U.S. 189
ERROR TO THE DISTRICT COURT OF THE UNITED STATES
FOR THE SOUTHERN DISTRICT OF NEW YORK
Syllabus
Congress was not empowered by the Sixteenth Amendment to tax, as income of the
stockholder, without apportionment, a stock dividend made lawfully and in good faith against
profits accumulated by the corporation since March 1, 1913. P.252 U. S. 201. Towne v.
Eisner, 245 U. S. 418.
The Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, plainly evinces the purpose of
Congress to impose such taxes, and is to that extent in conflict with Art. I, 2, cl. 3, and Art. I,
9, cl. 4, of the Constitution. Pp. 252 U. S. 199, 252 U. S. 217.
These provisions of the Constitution necessarily limit the extension, by construction, of the
Sixteenth Amendment. P. 252 U. S. 205.
What is or is not "income" within the meaning of the Amendment must be determined in each
case according to truth and substance, without regard to form. P. 252 U. S. 206.
Income may be defined as the gain derived from capital, from labor, or from both combined,
including profit gained through sale or conversion of capital. P. 252 U. S. 207.
Mere growth or increment of value in a capital investment is not income; income is essentially a
gain or profit, in itself, of exchangeable value, proceeding from capital, severed from it, and
derived or received by the taxpayer for his separate use, benefit, and disposal. Id.

A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of
the corporation, takes nothing from the property of the corporation and adds nothing to that of
the shareholder; a tax on such dividends is a tax an capital increase, and not on income, and, to
be valid under the Constitution, such taxes must be apportioned according to population in the
several states. P. 252 U. S. 208.
Affirmed.
Page 252 U. S. 190
The case is stated in the opinion.
Page 252 U. S. 199
MR. JUSTICE PITNEY delivered the opinion of the Court.
This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has
the power to tax, as income of the stockholder and without apportionment, a stock dividend
made lawfully and in good faith against profits accumulated by the corporation since March 1,
1913.
It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which, in our
opinion (notwithstanding a contention of the government that will be
Page 252 U. S. 200
noticed), plainly evinces the purpose of Congress to tax stock dividends as income. *
The facts, in outline, are as follows:
On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of
an authorized capital stock of $100,000,000, had shares of stock outstanding, par value $100
each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided
profits invested in plant, property, and business and required for the purposes of the
corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned
prior to March 1, 1913, the balance thereafter. In January, 1916, in order to readjust the
capitalization, the board of directors decided to issue additional shares sufficient to constitute a
stock dividend of 50 percent of the outstanding stock, and to transfer from surplus account to
capital stock account an amount equivalent to such issue. Appropriate resolutions were
adopted, an amount equivalent to the par value of the proposed new stock was transferred
accordingly, and the new stock duly issued against it and divided among the stockholders.
Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1,
100 additional

Page 252 U. S. 201

shares, of which 18.07 percent, or 198.77 shares, par value $19,877, were treated as
representing surplus earned between March 1, 1913, and January 1, 1916. She was called
upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based
upon a supposed income of $19,877 because of the new shares, and, an appeal to the
Commissioner of Internal Revenue having been disallowed, she brought action against the
Collector to recover the tax. In her complaint, she alleged the above facts and contended that, in
imposing such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3, and Article I, 9, cl. 4,
of the Constitution of the United States, requiring direct taxes to be apportioned according to
population, and that the stock dividend was not income within the meaning of the Sixteenth
Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v.
Eisner, 245 U. S. 418, and, defendant having failed to plead further, final judgment went against
him. To review it, the present writ of error is prosecuted.
The case was argued at the last term, and reargued at the present term, both orally and by
additional briefs.
We are constrained to hold that the judgment of the district court must be affirmed, first,
because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a
reexamination of the question with the additional light thrown upon it by elaborate arguments
has confirmed the view that the underlying ground of that decision is sound, that it disposes of
the question here presented, and that other fundamental considerations lead to the same result.
In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus
earned prior to January 1, 1913, was taxable against the stockholder under the Act of October
3, 1913, c. 16, 38 Stat. 114, 166, which provided ( B, p. 167) that net income should include
"dividends," and also "gains or profits and income derived
Page 252 U. S. 202
from any source whatever." Suit having been brought by a stockholder to recover the tax
assessed against him by reason of the dividend, the district court sustained a demurrer to the
complaint. 242 F. 702. The court treated the construction of the act as inseparable from the
interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan &
Trust Co., 158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704):
"It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and
could not, even though Congress expressly declared it to be taxable as income, unless it is in
fact income."
It declined, however, to accede to the contention that, in Gibbons v. Mahon, 136 U. S. 549,
"stock dividends" had received a definition sufficiently clear to be controlling, treated the
language of this Court in that case as obiter dictum in respect of the matter then before it (p.

706), and examined the question as res nova, with the result stated. When the case came here,
after overruling a motion to dismiss made by the government upon the ground that the only
question involved was the construction of the statute, and not its constitutionality, we dealt upon
the merits with the question of construction only, but disposed of it upon consideration of the
essential nature of a stock dividend disregarding the fact that the one in question was based
upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so,
but we rejected the reasoning of the district court, saying (245 U.S. 245 U. S. 426):
"Notwithstanding the thoughtful discussion that the case received below we cannot doubt that
the dividend was capital as well for the purposes of the Income Tax Law as for distribution
between tenant for life and remainderman. What was said by this Court upon the latter question
is equally true for the former."
"A stock dividend really takes nothing from the property of the corporation, and adds nothing to
the
Page 252 U. S. 203
interests of the shareholders. Its property is not diminished, and their interests are not
increased. . . . The proportional interest of each shareholder remains the same. The only
change is in the evidence which represents that interest, the new shares and the original shares
together representing the same proportional interest that the original shares represented before
the issue of the new ones."
"Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In short, the corporation is no poorer and
the stockholder is no richer than they were before. Logan County v. United States, 169 U. S.
255, 169 U. S. 261. If the plaintiff gained any small advantage by the change, it certainly was
not an advantage of $417,450, the sum upon which he was taxed. . . . What has happened is
that the plaintiff's old certificates have been split up in effect and have diminished in value to the
extent of the value of the new."
This language aptly answered not only the reasoning of the district court, but the argument of
the Solicitor General in this Court, which discussed the essential nature of a stock dividend. And
if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or
"dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought
within the meaning of "incomes" in the Sixteenth Amendment, it being very clear that Congress
intended in that act to exert its power to the extent permitted by the amendment. In Towne v.
Eisner, it was not contended that any construction of the statute could make it narrower than the
constitutional grant; rather the contrary.
The fact that the dividend was charged against profits earned before the Act of 1913 took effect,
even before the amendment was adopted, was neither relied upon nor alluded to in our
consideration of the merits in that case. Not only so, but had we considered that a stock

dividend constituted income in any true sense, it would have been held taxable under the Act of
1913 notwithstanding it was
Page 252 U. S. 204
based upon profits earned before the amendment. We ruled at the same term, in Lynch v.
Hornby, 247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v.
Eisner, 247 U. S. 347, that a dividend paid in stock of another company, were taxable as
income although based upon earnings that accrued before adoption of the amendment. In the
former case, concerning "corporate profits that accumulated before the act took effect," we
declared (pp. 247 U. S. 343-344):
"Just as we deem the legislative intent manifest to tax the stockholder with respect to such
accumulations only if and when, and to the extent that, his interest in them comes to fruition as
income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands
in the way of carrying out this intent when dividends are declared out of a preexisting surplus. . .
. Congress was at liberty under the amendment to tax as income, without apportionment,
everything that became income, in the ordinary sense of the word, after the adoption of the
amendment, including dividends received in the ordinary course by a stockholder from a
corporation, even though they were extraordinary in amount and might appear upon analysis to
be a mere realization in possession of an inchoate and contingent interest that the stockholder
had in a surplus of corporate assets previously existing."
In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we observed that the decision of the district
court in Towne v. Eisner had been reversed
"only upon the ground that it related to a stock dividend which in fact took nothing from the
property of the corporation and added nothing to the interest of the shareholder, but merely
changed the evidence which represented that interest,"
and we distinguished the Peabody case from the Towne case upon the ground that "the
dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a
portion of the assets of the Union Pacific."
Therefore, Towne v. Eisner cannot be regarded as turning
Page 252 U. S. 205
upon the point that the surplus accrued to the company before the act took effect and before
adoption of the amendment. And what we have quoted from the opinion in that case cannot be
regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We
adhere to the view then expressed, and might rest the present case there not because that case
in terms decided the constitutional question, for it did not, but because the conclusion there
reached as to the essential nature of a stock dividend necessarily prevents its being regarded
as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the
Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income,
to the amount of its cash value," we will deal at length with the constitutional question,
incidentally testing the soundness of our previous conclusion.
The Sixteenth Amendment must be construed in connection with the taxing clauses of the
original Constitution and the effect attributed to them before the amendment was adopted.
In Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, under the Act of August 27, 1894, c.
349, 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and
upon returns from investments of personal property were in effect direct taxes upon the property
from which such income arose, imposed by reason of ownership, and that Congress could not
impose such taxes without apportioning them among the states according to population, as
required by Article I, 2, cl. 3, and 9, cl. 4, of the original Constitution.
Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus
determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to
be accomplished:
"The Congress shall have power to lay and collect taxes on incomes, from whatever source
derived, without apportionment among
Page 252 U. S. 206
the several states and without regard to any census or enumeration."
As repeatedly held, this did not extend the taxing power to new subjects, but merely removed
the necessity which otherwise might exist for an apportionment among the states of taxes laid
on income. Brushaber v. Union Pacific R. Co.,240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic
Mining Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v. Lowe, 247 U. S. 165,247 U. S.
172-173.
A proper regard for its genesis, as well as its very clear language, requires also that this
amendment shall not be extended by loose construction, so as to repeal or modify, except as
applied to income, those provisions of the Constitution that require an apportionment according
to population for direct taxes upon property, real and personal. This limitation still has an
appropriate and important function, and is not to be overridden by Congress or disregarded by
the courts.
In order, therefore, that the clauses cited from Article I of the Constitution may have proper force
and effect, save only as modified by the amendment, and that the latter also may have proper
effect, it becomes essential to distinguish between what is and what is not "income," as the term
is there used, and to apply the distinction, as cases arise, according to truth and substance,
without regard to form. Congress cannot by any definition it may adopt conclude the matter,

since it cannot by legislation alter the Constitution, from which alone it derives its power to
legislate, and within whose limitations alone that power can be lawfully exercised.
The fundamental relation of "capital" to "income" has been much discussed by economists, the
former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted
as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow
during a period of time. For the present purpose, we require only a clear definition of the term
"income,"
Page 252 U. S. 207
as used in common speech, in order to determine its meaning in the amendment, and, having
formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to
decide the matter at issue.
After examining dictionaries in common use (Bouv. L.D.; Standard Dict.; Webster's Internat.
Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising
under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U. S. 399, 231
U. S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. 185), "Income may be defined
as the gain derived from capital, from labor, or from both combined," provided it be understood
to include profit gained through a sale or conversion of capital assets, to which it was applied in
the Doyle case, pp. 247 U. S. 183-185.
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a
correct solution of the present controversy. The government, although basing its argument upon
the definition as quoted, placed chief emphasis upon the word "gain," which was extended to
include a variety of meanings; while the significance of the next three words was either
overlooked or misconceived. "Derived from capital;" "the gain derived from capital," etc. Here,
we have the essential matter: not a gain accruing to capital; not a growth or increment of
value in the investment; but a gain, a profit, something of exchangeable value, proceeding
from the property, severed from the capital, however invested or employed, and coming
in, being "derived" -- that is, received or drawn by the recipient (the taxpayer) for
his separate use, benefit and disposal -- that is income derived from property. Nothing else
answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment -"incomes, from whatever source derived" -- the essential thought being expressed
Page 252 U. S. 208
with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.
Can a stock dividend, considering its essential character, be brought within the definition? To
answer this, regard must be had to the nature of a corporation and the stockholder's relation to

it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit,
and having a capital stock divided into shares to which a nominal or par value is attributed.
Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but
the evidence of it. They state the number of shares to which he is entitled and indicate their par
value and how the stock may be transferred. They show that he or his assignors, immediate or
remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest
proportionate to the whole, entitled to have the property and business of the company devoted
during the corporate existence to attainment of the common objects, entitled to vote at
stockholders' meetings, to receive dividends out of the corporation's profits if and when
declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if
any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no
right to withdraw any part of either capital or profits from the common enterprise; on the
contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets,
business, and affairs of the company. Nor is it the interest of an owner in the assets themselves,
since the corporation has full title, legal and equitable, to the whole. The stockholder has the
right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as
stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the
enterprise, and looking only to dividends for his return. If he desires to dissociate himself
Page 252 U. S. 209
from the company, he can do so only by disposing of his stock.
For bookkeeping purposes, the company acknowledges a liability in form to the stockholders
equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If
profits have been made and not divided, they create additional bookkeeping liabilities under the
head of "profit and loss," "undivided profits," "surplus account," or the like. None of these,
however, gives to the stockholders as a body, much less to any one of them, either a claim
against the going concern for any particular sum of money or a right to any particular portion of
the assets or any share in them unless or until the directors conclude that dividends shall be
made and a part of the company's assets segregated from the common fund for the purpose.
The dividend normally is payable in money, under exceptional circumstances in some other
divisible property, and when so paid, then only (excluding, of course, a possible advantageous
sale of his stock or winding-up of the company) does the stockholder realize a profit or gain
which becomes his separate property, and thus derive income from the capital that he or his
predecessor has invested.
In the present case, the corporation had surplus and undivided profits invested in plant,
property, and business, and required for the purposes of the corporation, amounting to about
$45,000,000, in addition to outstanding capital stock of $50,000,000. In this, the case is not
extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of
the year, need not be in the form of money on hand in excess of what is required to meet
current liabilities and finance current operations of the company. Often, especially in a growing

business, only a part, sometimes a small part, of the year's profits is in property capable of
division, the remainder having been absorbed in the acquisition of increased plant,
Page 252 U. S. 210
equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When
only a part is available for dividends, the balance of the year's profits is carried to the credit of
undivided profits, or surplus, or some other account having like significance. If thereafter the
company finds itself in funds beyond current needs, it may declare dividends out of such surplus
or undivided profits; otherwise it may go on for years conducting a successful business, but
requiring more and more working capital because of the extension of its operations, and
therefore unable to declare dividends approximating the amount of its profits. Thus, the surplus
may increase until it equals or even exceeds the par value of the outstanding capital stock. This
may be adjusted upon the books in the mode adopted in the case at bar -- by declaring a "stock
dividend." This, however, is no more than a book adjustment, in essence -- not a dividend, but
rather the opposite; no part of the assets of the company is separated from the common fund,
nothing distributed except paper certificates that evidence an antecedent increase in the value
of the stockholder's capital interest resulting from an accumulation of profits by the company,
but profits so far absorbed in the business as to render it impracticable to separate them for
withdrawal and distribution. In order to make the adjustment, a charge is made against surplus
account with corresponding credit to capital stock account, equal to the proposed "dividend;" the
new stock is issued against this and the certificates delivered to the existing stockholders in
proportion to their previous holdings. This, however, is merely bookkeeping that does not affect
the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not
the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this
through a readjustment of accounts on one side of the balance sheet only, increasing "capital
stock" at the expense of
Page 252 U. S. 211
"surplus"; it does not alter the preexisting proportionate interest of any stockholder or increase
the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they
stood before. The new certificates simply increase the number of the shares, with consequent
dilution of the value of each share.
A "stock dividend" shows that the company's accumulated profits have been capitalized, instead
of distributed to the stockholders or retained as surplus available for distribution in money or in
kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends
rather to postpone such realization, in that the fund represented by the new stock has been
transferred from surplus to capital, and no longer is available for actual distribution.
The essential and controlling fact is that the stockholder has received nothing out of the
company's assets for his separate use and benefit; on the contrary, every dollar of his original
investment, together with whatever accretions and accumulations have resulted from

employment of his money and that of the other stockholders in the business of the company,
still remains the property of the company, and subject to business risks which may result in
wiping out the entire investment. Having regard to the very truth of the matter, to substance and
not to form, he has received nothing that answers the definition of income within the meaning of
the Sixteenth Amendment.
Being concerned only with the true character and effect of such a dividend when lawfully made,
we lay aside the question whether, in a particular case, a stock dividend may be authorized by
the local law governing the corporation, or whether the capitalization of profits may be the result
of correct judgment and proper business policy on the part of its management, and a due regard
for the interests of the stockholders. And we are considering the taxability of bona fide stock
dividends only.
Page 252 U. S. 212
We are clear that not only does a stock dividend really take nothing from the property of the
corporation and add nothing to that of the shareholder, but that the antecedent accumulation of
profits evidenced thereby, while indicating that the shareholder is the richer because of an
increase of his capital, at the same time shows he has not realized or received any income in
the transaction.
It is said that a stockholder may sell the new shares acquired in the stock dividend, and so he
may, if he can find a buyer. It is equally true that, if he does sell, and in doing so realizes a
profit, such profit, like any other, is income, and, so far as it may have arisen since the Sixteenth
Amendment, is taxable by Congress without apportionment. The same would be true were he to
sell some of his original shares at a profit. But if a shareholder sells dividend stock, he
necessarily disposes of a part of his capital interest, just as if he should sell a part of his old
stock, either before or after the dividend. What he retains no longer entitles him to the same
proportion of future dividends as before the sale. His part in the control of the company likewise
is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a
corporation should receive in common with other stockholders a 50 percent stock dividend, and
should sell his part, he thereby would be reduced from a majority to a minority stockholder,
having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and
proportionate decrease in capital interest and in voting power would befall a minority holder
should he sell dividend stock, it being in the nature of things impossible for one to dispose of
any part of such an issue without a proportionate disturbance of the distribution of the entire
capital stock and a like diminution of the seller's comparative voting power -- that "right
preservative of rights" in the control of a corporation.
Page 252 U. S. 213
Yet, without selling, the shareholder, unless possessed of other resources, has not the
wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that

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

whether the stock dividend indicated the extent to which he had been enriched by the
operations of the company; unless he had held it throughout such operations, the measure
would not hold true. Secondly, and more important for present purposes, enrichment through
increase in value
Page 252 U. S. 215
of capital investment is not income in any proper meaning of the term.
The complaint contains averments respecting the market prices of stock such as plaintiff held,
based upon sales before and after the stock dividend, tending to show that the receipt of the
additional shares did not substantially change the market value of her entire holdings. This
tends to show that, in this instance, market quotations reflected intrinsic values -- a thing they do
not always do. But we regard the market prices of the securities as an unsafe criterion in an
inquiry such as the present, when the question must be not what will the thing sell for, but what
is it in truth and in essence.
It is said there is no difference in principle between a simple stock dividend and a case where
stockholders use money received as cash dividends to purchase additional stock
contemporaneously issued by the corporation. But an actual cash dividend, with a real option to
the stockholder either to keep the money for his own or to reinvest it in new shares, would be as
far removed as possible from a true stock dividend, such as the one we have under
consideration, where nothing of value is taken from the company's assets and transferred to the
individual ownership of the several stockholders and thereby subjected to their disposal.
The government's reliance upon the supposed analogy between a dividend of the corporation's
own shares and one made by distributing shares owned by it in the stock of another company
calls for no comment beyond the statement that the latter distributes assets of the company
among the shareholders, while the former does not, and for no citation of authority
except Peabody v. Eisner, 247 U. S. 347, 247 U. S. 349-350.
Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the
position of the government.
Page 252 U. S. 216
Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act of
Western Australia, which provided that "dividend" should include "every dividend, profit,
advantage, or gain intended to be paid or credited to or distributed among any members or
directors of any company," except, etc. There was a stock dividend, the new shares being
allotted among the shareholders pro rata, and the question was whether this was a distribution
of a dividend within the meaning of the act. The Judicial Committee of the Privy Council
sustained the dividend duty upon the ground that, although "in ordinary language the new
shares would not be called a dividend, nor would the allotment of them be a distribution of a

dividend," yet, within the meaning of the act, such new shares were an "advantage" to the
recipients. There being no constitutional restriction upon the action of the lawmaking body, the
case presented merely a question of statutory construction, and manifestly the decision is not a
precedent for the guidance of this Court when acting under a duty to test an act of Congress by
the limitations of a written Constitution having superior force.
In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the Forty-Fourth
amendment to the Constitution of Massachusetts, which conferred upon the legislature full
power to tax incomes, "must be interpreted as including every item which by any reasonable
understanding can fairly be regarded as income" (pp. 526, 531), and that under it, a stock
dividend was taxable as income, the court saying (p. 535):
"In essence, the thing which has been done is to distribute a symbol representing an
accumulation of profits, which, instead of being paid out in cash, is invested in the business,
thus augmenting its durable assets. In this aspect of the case, the substance of the transaction
is no different from what it would be if a cash dividend had been declared with the privilege of
subscription to an equivalent amount of new shares. "
Page 252 U. S. 217
We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the
new taxing provision, it was deemed necessary to take the symbol for the substance,
accumulation for distribution, capital accretion for its opposite, while a case where money is paid
into the hand of the stockholder with an option to buy new shares with it, followed by
acceptance of the option, was regarded as identical in substance with a case where the
stockholder receives no money and has no option. The Massachusetts court was not under an
obligation, like the one which binds us, of applying a constitutional amendment in the light of
other constitutional provisions that stand in the way of extending it by construction.
Upon the second argument, the government, recognizing the force of the decision in Towne v.
Eisner, supra, and virtually abandoning the contention that a stock dividend increases the
interest of the stockholder or otherwise enriches him, insisted as an alternative that, by the true
construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon
the stockholder's share of the undivided profits previously accumulated by the corporation, the
tax being levied as a matter of convenience at the time such profits become manifest through
the stock dividend. If so construed, would the act be constitutional?
That Congress has power to tax shareholders upon their property interests in the stock of
corporations is beyond question, and that such interests might be valued in view of the condition
of the company, including its accumulated and undivided profits, is equally clear. But that this
would be taxation of property because of ownership, and hence would require apportionment
under the provisions of the Constitution, is settled beyond peradventure by previous decisions of
this Court.

The government relies upon Collector v. Hubbard, (1870)

Page 252 U. S. 218
12 Wall. 1, which arose under 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223, 282,
providing that
"The gains and profits of all companies, whether incorporated or partnership, other than the
companies specified in that section, shall be included in estimating the annual gains, profits, or
income of any person, entitled to the same, whether divided or otherwise."
The court held an individual taxable upon his proportion of the earnings of a corporation
although not declared as dividends and although invested in assets not in their nature divisible.
Conceding that the stockholder for certain purposes had no title prior to dividend declared, the
court nevertheless said (p. 79 U. S. 18):
"Grant all that, still it is true that the owner of a share of stock in a corporation holds the share
with all its incidents, and that among those incidents is the right to receive all future dividends -that is, his proportional share of all profits not then divided. Profits are incident to the share to
which the owner at once becomes entitled provided he remains a member of the corporation
until a dividend is made. Regarded as an incident to the shares, undivided profits are property of
the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits
invested in real estate, machinery, or raw material for the purpose of being manufactured are
investments in which the stockholders are interested, and when such profits are actually
appropriated to the payment of the debts of the corporation, they serve to increase the market
value of the shares, whether held by the original subscribers or by assignees."
Insofar as this seems to uphold the right of Congress to tax without apportionment a
stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as
overruled by Pollock v. Farmers' Loan & Trust Co.,158 U. S. 601, 158 U. S. 627-628, 158 U. S.
637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it
sustained a direct tax upon property not apportioned
Page 252 U. S. 219
among the states, the government nevertheless insists that the sixteenth Amendment removed
this obstacle, so that now the Hubbard case is authority for the power of Congress to levy a tax
on the stockholder's share in the accumulated profits of the corporation even before division by
the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the
amendment applies to income only, and what is called the stockholder's share in the
accumulated profits of the company is capital, not income. As we have pointed out, a
stockholder has no individual share in accumulated profits, nor in any particular part of the
assets of the corporation, prior to dividend declared.

Thus, from every point of view, we are brought irresistibly to the conclusion that neither under
the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a
true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as
income of the stockholder. The Revenue Act of 1916, insofar as it imposes a tax upon the
stockholder because of such dividend, contravenes the provisions of Article I, 2, cl. 3, and
Article I, 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth
Amendment.
Judgment affirmed.
*
"Title I. -- Income Tax"
"Part I. -- On Individuals"
"Sec. 2. (a) That, subject only to such exemptions and deductions as are hereinafter allowed,
the net income of a taxable person shall include gains, profits, and income derived, . . . also
from interest, rent, dividends, securities, or the transaction of any business carried on for gain or
profit, or gains or profits and income derived from any source whatever:Provided, that the term
'dividends' as used in this title shall be held to mean any distribution made or ordered to be
made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen
hundred and thirteen, and payable to its shareholders, whether, in cash or in stock of the
corporation, . . . which stock dividend shall be considered income, to the amount of its cash
value."
MR. JUSTICE HOLMES, dissenting.
I think that Towne v. Eisner, 245 U. S. 418, was right in its reasoning and result, and that, on
sound principles, the stock dividend was not income. But it was clearly intimated in that case
that the construction of the statute then before the Court might be different from that of the
Constitution. 245 U.S. 245 U. S. 425. I think that the word "incomes" in the Sixteenth
Amendment should be read in
Page 252 U. S. 220
"a sense most obvious to the common understanding at the time of its adoption." Bishop v.
State, 149 Ind. 223, 230; State v. Butler, 70 Fla. 102, 133. For it was for public adoption that it
was proposed. McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407. The known purpose of this
Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot
doubt that most people not lawyers would suppose when they voted for it that they put a
question like the present to rest. I am of opinion that the Amendment justifies the tax. See Tax
Commissioner v. Putnam, 227 Mass. 522, 532, 533.
MR. JUSTICE DAY concurs in this opinion.

MR. JUSTICE BRANDEIS delivered the following opinion, in which MR. JUSTICE CLARKE
concurred.
Financiers, with the aid of lawyers, devised long ago two different methods by which a
corporation can, without increasing its indebtedness, keep for corporate purposes accumulated
profits, and yet, in effect, distribute these profits among its stockholders. One method is a simple
one. The capital stock is increased; the new stock is paid up with the accumulated profits, and
the new shares of paid-up stock are then distributed among the stockholders pro rata as a
dividend. If the stockholder prefers ready money to increasing his holding of the stock in the
company, he sells the new stock received as a dividend. The other method is slightly more
complicated. .arrangements are made for an increase of stock to be offered to stockholders pro
rata at par, and at the same time for the payment of a cash dividend equal to the amount which
the stockholder will be required to pay to
Page 252 U. S. 221
the company, if he avails himself of the right to subscribe for his pro rata of the new stock. If the
stockholder takes the new stock, as is expected, he may endorse the dividend check received
to the corporation, and thus pay for the new stock. In order to ensure that all the new stock so
offered will be taken, the price at which it is offered is fixed far below what it is believed will be
its market value. If the stockholder prefers ready money to an increase of his holdings of stock,
he may sell his right to take new stock pro rata, which is evidenced by an assignable instrument.
In that event the purchaser of the rights repays to the corporation, as the subscription price of
the new stock, an amount equal to that which it had paid as a cash dividend to the stockholder.
Both of these methods of retaining accumulated profits while in effect distributing them as a
dividend had been in common use in the United States for many years prior to the adoption of
the Sixteenth Amendment. They were recognized equivalents. Whether a particular corporation
employed one or the other method was determined sometimes by requirements of the law
under which the corporation was organized; sometimes it was determined by preferences of the
individual officials of the corporation, and sometimes by stock market conditions. Whichever
method was employed, the resultant distribution of the new stock was commonly referred to as
a stock dividend. How these two methods have been employed may be illustrated by the action
in this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and
Financial Chronicle) of some of the Standard Oil companies since the disintegration pursuant to
the decision of this Court in 1911. Standard Oil Co. v. United States, 221 U. S. 1.
(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911,
$1,000,000 capital stock (all common), and a large surplus. On May 15,
Page 252 U. S. 222
1912, it increased its capital stock to $30,000,000, and paid a simple stock dividend of 2,900
percent in stock. [Footnote 1]

(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911,
$600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it paid a
simple stock dividend of 33 1/3 percent, increasing the outstanding capital to $800,000. During
the calendar year 1912, it paid cash dividends aggregating 20 percent, but it earned
considerably more, and had at the close of the year again a substantial surplus. On June 20,
1913, it declared a further stock dividend of 25 percent, thus increasing the capital to
$1,000,000. [Footnote 2]
(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913,
$1,000,000 capital stock (all common) and $3,701,710 surplus. Of this surplus, $902,457 had
been earned during the calendar year 1913, the net profits of that year having been $1,002,457
and the dividends paid only $100,000 (10 percent). On December 22, 1913, a cash dividend of
$200 per share was declared payable on February 14, 1914, to stockholders of record January
31, 1914, and these stockholders were offered the right to subscribe for an equal amount of new
stock at par and to apply the cash dividend in payment therefor. The outstanding stock was thus
increased to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends
were paid on this stock at an annual rate of between 15 percent and 20 percent, but the
company's surplus increased by $2,347,614, so that, on December 31, 1916, it had a large
surplus over its $3,000,000 capital stock. On December 15, 1916, the company issued a circular
to the stockholders, saying:
"The company's business for this year has shown a
Page 252 U. S. 223
very good increase in volume and a proportionate increase in profits, and it is estimated that, by
January 1, 1917, the company will have a surplus of over $4,000,000. The board feels justified
in stating that, if the proposition to increase the capital stock is acted on favorably, it will be
proper in the near future to declare a cash dividend of 100 percent and to allow the stockholders
the privilege pro rata according to their holdings, to purchase the new stock at par, the plan
being to allow the stockholders, if they desire, to use their cash dividend to pay for the new
stock."
The increase of stock was voted. The company then paid a cash dividend of 100 percent,
payable May 1, 1917, again offering to such stockholders the right to subscribe for an equal
amount of new stock at par and to apply the cash dividend in payment therefor.
Moody's Manual, describing the transaction with exactness, says first that the stock was
increased from $3,000,000 to $6,000,000, "a cash dividend of 100 percent, payable May 1,
1917, being exchanged for one share of new stock, the equivalent of a 100 percent stock
dividend." But later in the report giving, as customary in the Manual, the dividend record of the
company, the Manual says: "A stock dividend of 200 percent was paid February 14, 1914, and
one of 100 percent on May 1, 1197." And, in reporting specifically the income account of the
company for a series of years ending December 31, covering net profits, dividends paid, and

surplus for the year, it gives, as the aggregate of dividends for the year 1917, $660,000 (which
was the aggregate paid on the quarterly cash dividend -- 5 percent January and April; 6 percent
July and October), and adds in a note: "In addition, a stock dividend of 100 percent was paid
during the year." [Footnote 3] The Wall Street Journal of
Page 252 U. S. 224
May 2, 1917, p. 2, quotes the 1917 "high" price for Standard Oil of Kentucky as "375 ex stock
dividend."
It thus appears that, among financiers and investors, the distribution of the stock, by whichever
method effected, is called a stock dividend; that the two methods by which accumulated profits
are legally retained for corporate purposes and at the same time distributed as dividends are
recognized by them to be equivalents, and that the financial results to the corporation and to the
stockholders of the two methods are substantially the same, unless a difference results from the
application of the federal income tax law.
Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the
Standard Oil Company (of California), a corporation organized under the laws of California and
having its principal place of business in that state. During that year, she received from the
company a stock dividend representing profits earned since March 1, 1913. The dividend was
paid by direct issue of the stock to her according to the simple method described above,
pursued also by the Indiana and Nebraska companies. In 1917, she was taxed under the
federal law on the stock dividend so received at its par value of $100 a share, as income
received during the year 1916. Such a stock dividend is income, as distinguished from capital,
both under the law of New York and under the law of California, because in both states every
dividend representing profits is deemed to be income, whether paid in cash or in stock. It had
been so held in New York, where the question arose as between life tenant and
remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N.Y. 137; Matter of Osborne, 209 N.Y.
450, and also, where the question arose in matters of taxation, People v. Glynn,
Page 252 U. S. 225
130 App.Div. 332, 198 N.Y. 605. It has been so held in California, where the question appears
to have arisen only in controversies between life tenant and remainderman. Estate of Duffill, 58
Cal.Dec. 97, 180 Cal. 748.
It is conceded that, if the stock dividend paid to Mrs. Macomber had been made by the more
complicated method pursued by the Standard Oil Company of Kentucky -- that is, issuing rights
to take new stock pro rata and paying to each stockholder simultaneously a dividend in cash
sufficient in amount to enable him to pay for this pro rata of new stock to be purchased -- the
dividend so paid to him would have been taxable as income, whether he retained the cash or
whether he returned it to the corporation in payment for his pro rata of new stock. But it is
contended that, because the simple method was adopted of having the new stock issued direct

to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she
retained it or converted it into cash by sale. If such a different result can flow merely from the
difference in the method pursued, it must be because Congress is without power to tax as
income of the stockholder either the stock received under the latter method or the proceeds of
its sale, for Congress has, by the provisions in the Revenue Act of 1916, expressly declared its
purpose to make stock dividends, by whichever method paid, taxable as income.
The Sixteenth Amendment, proclaimed February 25, 1913, declares:
"The Congress shall have power to lay and collect taxes on incomes, from whatever source
derived, without apportionment among the several states, and without regard to any census or
enumeration."
The Revenue Act of September 8, 1916, c. 463, 2a, 39 Stat. 756, 757, provided:
"That the term 'dividends' as used in this title shall
Page 252 U. S. 226
be held to mean any distribution made or ordered to be made by a corporation, . . . out of its
earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its
shareholders, whether in cash or in stock of the corporation, . . . which stock dividend shall be
considered income, to the amount of its cash value."
Hitherto, powers conferred upon Congress by the Constitution have been liberally construed,
and have been held to extend to every means appropriate to attain the end sought. In
determining the scope of the power, the substance of the transaction, not its form, has been
regarded. Martin v. Hunter, 1 Wheat. 304, 14 U. S. 326; McCulloch v. Maryland, 4 Wheat.
316, 17 U. S. 407, 17 U. S. 415; Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446; Craig v.
Missouri, 4 Pet. 410, 29 U. S. 433; Jarrolt v. Moberly, 103 U. S. 580, 103 U. S. 585-587; Legal
Tender Case, 110 U. S. 421, 110 U. S. 444; Lithograph Co. v. Sarony,111 U. S. 53, 111 U. S.
58; United States v. Realty Co., 163 U. S. 427, 163 U. S. 440-442; South Carolina v. United
States, 199 U. S. 437, 199 U. S. 448-449. Is there anything in the phraseology of the Sixteenth
Amendment or in the nature of corporate dividends which should lead to a departure from these
rules of construction and compel this Court to hold that Congress is powerless to prevent a
result so extraordinary as that here contended for by the stockholder?
First. The term "income," when applied to the investment of the stockholder in a corporation,
had, before the adoption of the Sixteenth Amendment, been commonly understood to mean the
returns from time to time received by the stockholder from gains or earnings of the corporation.
A dividend received by a stockholder from a corporation may be either in distribution of capital
assets or in distribution of profits. Whether it is the one or the other is in no way affected by the
medium in which it is paid, nor by the method or means through which the particular thing
distributed as a dividend was procured. If the

Page 252 U. S. 227

dividend is declared payable in cash, the money with which to pay it is ordinarily taken from
surplus cash in the treasury. But (if there are profits legally available for distribution and the law
under which the company was incorporated so permits) the company may raise the money by
discounting negotiable paper, or by selling bonds, scrip or stock of another corporation then in
the treasury, or by selling its own bonds, scrip or stock then in the treasury, or by selling its own
bonds, scrip or stock issued expressly for that purpose. How the money shall be raised is wholly
a matter of financial management. The manner in which it is raised in no way affects the
question whether the dividend received by the stockholder is income or capital, nor can it
conceivably affect the question whether it is taxable as income.
Likewise whether a dividend declared payable from profits shall be paid in cash or in some other
medium is also wholly a matter of financial management. If some other medium is decided
upon, it is also wholly a question of financial management whether the distribution shall be, for
instance, in bonds, scrip or stock of another corporation or in issues of its own. And if the
dividend is paid in its own issues, why should there be a difference in result dependent upon
whether the distribution was made from such securities then in the treasury or from others to be
created and issued by the company expressly for that purpose? So far as the distribution may
be made from its own issues of bonds, or preferred stock created expressly for the purpose, it
clearly would make no difference, in the decision of the question whether the dividend was a
distribution of profits, that the securities had to be created expressly for the purpose of
distribution. If a dividend paid in securities of that nature represents a distribution of profits,
Congress may, of course, tax it as income of the stockholder. Is the result different where the
security distributed is common stock?
Page 252 U. S. 228
Suppose that a corporation having power to buy and sell its own stock purchases, in the interval
between its regular dividend dates, with moneys derived from current profits, some of its own
common stock as a temporary investment, intending at the time of purchase to sell it before the
next dividend date and to use the proceeds in paying dividends, but later, deeming it inadvisable
either to sell this stock or to raise by borrowing the money necessary to pay the regular dividend
in cash, declares a dividend payable in this stock; can anyone doubt that, in such a case, the
dividend in common stock would be income of the stockholder and constitutionally taxable as
such? See Green v. Bissell, 79 Conn. 547; Leland v. Hayden, 102 Mass. 542. And would it not
likewise be income of the stockholder subject to taxation if the purpose of the company in
buying the stock so distributed had been from the beginning to take it off the market and
distribute it among the stockholders as a dividend, and the company actually did so? And,
proceeding a short step further, suppose that a corporation decided to capitalize some of its
accumulated profits by creating additional common stock and selling the same to raise working
capital, but after the stock has been issued and certificates therefor are delivered to the bankers
for sale, general financial conditions make it undesirable to market the stock, and the company
concludes that it is wiser to husband, for working capital, the cash which it had intended to use

in paying stockholders a dividend, and, instead, to pay the dividend in the common stock which
it had planned to sell; would not the stock so distributed be a distribution of profits, and hence,
when received, be income of the stockholder and taxable as such? If this be conceded, why
should it not be equally income of the stockholder, and taxable as such, if the common stock
created by capitalizing profits had been originally created for the express purpose of being
distributed
Page 252 U. S. 229
as a dividend to the stockholder who afterwards received it?
Second. It has been said that a dividend payable in bonds or preferred stock created for the
purpose of distributing profits may be income and taxable as such, but that the case is different
where the distribution is in common stock created for that purpose. Various reasons are
assigned for making this distinction. One is that the proportion of the stockholder's ownership to
the aggregate number of the shares of the company is not changed by the distribution. But that
is equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore,
neither maintenance nor change in the proportionate ownership of a stockholder in a
corporation has any bearing upon the question here involved. Another reason assigned is that
the value of the old stock held is reduced approximately by the value of the new stock received,
so that the stockholder, after receipt of the stock dividend, has no more than he had before it
was paid. That is equally true whether the dividend be paid in cash or in other property -- for
instance, bonds, scrip, or preferred stock of the company. The payment from profits of a large
cash dividend, and even a small one, customarily lowers the then market value of stock
because the undivided property represented by each share has been correspondingly reduced.
The argument which appears to be most strongly urged for the stockholders is that, when a
stock dividend is made, no portion of the assets of the company is thereby segregated for the
stockholder. But does the issue of new bonds or of preferred stock created for use as a dividend
result in any segregation of assets for the stockholder? In each case, he receives a piece of
paper which entitles him to certain rights in the undivided property. Clearly, segregation of
assets in a physical sense is not an essential of income. The year's gains of a partner is taxable
as income although there likewise no
Page 252 U. S. 230
segregation of his share in the gains from that of his partners is had.
The objection that there has been no segregation is presented also in another form. It is argued
that, until there is a segregation, the stockholder cannot know whether he has really received
gains, since the gains may be invested in plant or merchandise or other property, and perhaps
be later lost. But is not this equally true of the share of a partner in the year's profits of the firm
or, indeed, of the profits of the individual who is engaged in business alone? And is it not true
also when dividends are paid in cash? The gains of a business, whether conducted by an
individual, by a firm, or by a corporation are ordinarily reinvested in large part. Many a cash

dividend honestly declared as a distribution of profits proves later to have been paid out of
capital because errors in forecast prevent correct ascertainment of values. Until a business
adventure has been completely liquidated, it can never be determined with certainty whether
there have been profits unless the returns at least exceeded the capital originally invested.
Businessmen, dealing with the problem practically, fix necessarily periods and rules for
determining whether there have been net profits -- that is, income or gains. They protect
themselves from being seriously misled by adopting a system of depreciation charges and
reserves. Then they act upon their own determination whether profits have been made.
Congress, in legislating, has wisely adopted their practices as its own rules of action.
Third. The government urges that it would have been within the power of Congress to have
taxed as income of the stockholder his pro rata share of undistributed profits earned even if no
stock dividend representing it had been paid. Strong reasons may be assigned for such a
view. See Collector v. Hubbard, 12 Wall. 1. The undivided share of a partner in the year's
undistributed profits of his firm
Page 252 U. S. 231
is taxable as income of the partner although the share in the gain is not evidenced by any action
taken by the firm. Why may not the stockholder's interest in the gains of the company? The law
finds no difficulty in disregarding the corporate fiction whenever that is deemed necessary to
attain a just result. Linn Timber Co. v. United States, 236 U. S. 574. See Morawetz on
Corporations, 2d ed., 227-231; Cook on Corporations, 7th ed., 663, 664. The
stockholder's interest in the property of the corporation differs not fundamentally, but in form
only, from the interest of a partner in the property of the firm. There is much authority for the
proposition that, under our law, a partnership or joint stock company is just as distinct and
palpable an entity in the idea of the law, as distinguished from the individuals composing it, as is
a corporations. [Footnote 4] No reason appears, why Congress, in legislating under a grant of
power so comprehensive as that authorizing the levy of an income tax, should be limited by the
particular view of the relation of the stockholder to the corporation and its property which may, in
the absence of legislation, have been taken by this Court. But we have no occasion to decide
the question whether Congress might have taxed to the stockholder his undivided share of the
corporation's earnings. For Congress has in this act limited the income tax to that share of the
stockholder in the earnings which is, in effect, distributed by means of the stock dividend paid.
In other words, to render the stockholder taxable, there must be both earnings made and a
dividend paid. Neither earnings without dividend nor a dividend without earnings subjects the
Page 252 U. S. 232
stockholder to taxation under the Revenue Act of 1916.
Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in
stock, is so complete that serious question of the taxability of stock dividends would probably
never have been made if Congress had undertaken to tax only those dividends which

represented profits earned during the year in which the dividend was paid or in the year
preceding. But this Court, construing liberally not only the constitutional grant of power but also
the revenue Act of 1913, held that Congress might tax, and had taxed, to the stockholder
dividends received during the year, although earned by the company long before, and even
prior to the adoption of the Sixteenth Amendment. Lynch v. Hornby, 247 U. S. 339. [Footnote 5]
That rule, if indiscriminatingly applied to all stock dividends representing profits earned, might, in
view of corporate practice, have worked considerable hardship and have raised serious
questions. Many corporations, without legally capitalizing any part of their profits, had assigned
definitely some part or all of the annual balances remaining after paying the usual cash
dividends to the uses to which permanent capital is ordinarily applied. Some of the corporations
doing this transferred such balances on their books to "surplus" account -- distinguishing
between such permanent "surplus" and the "undivided profits" account. Other corporations,
without this formality, had assumed that the annual accumulating balances carried as
undistributed profits were to be treated as capital permanently invested in the business. And still
others, without definite assumption of any kind, had
Page 252 U. S. 233
so used undivided profits for capital purposes. To have made the revenue law apply
retroactively so as to reach such accumulated profits, if and whenever it should be deemed
desirable to capitalize them legally by the issue of additional stock distributed as a dividend to
stockholders, would have worked great injustice. Congress endeavored in the Revenue Act of
1916 to guard against any serious hardship which might otherwise have arisen from making
taxable stock dividends representing accumulated profits. It did not limit the taxability to stock
dividends representing profits earned within the tax year or in the year preceding, but it did limit
taxability to such dividends representing profits earned since March 1, 1913. Thereby
stockholders were given notice that their share also in undistributed profits accumulating
thereafter was at some time to be taxed as income. And Congress sought by 3 to discourage
the postponement of distribution for the illegitimate purpose of evading liability to surtaxes.
Fifth. The decision of this Court that earnings made before the adoption of the Sixteenth
Amendment, but paid out in cash dividend after its adoption, were taxable as income of the
stockholder involved a very liberal construction of the amendment. To hold now that earnings
both made and paid out after the adoption of the Sixteenth Amendment cannot be taxed as
income of the stockholder, if paid in the form of a stock dividend, involves an exceedingly
narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland, 12 Wheat.
419, 25 U. S. 446:
"To construe the power so as to impair its efficacy would tend to defeat an object in the
attainment of which the American public took, and justly took, that strong interest which arose
from a full conviction of its necessity."
No decision heretofore rendered by this Court requires us to hold that Congress, in providing for
the taxation of

Page 252 U. S. 234

stock dividends, exceeded the power conferred upon it by the Sixteenth Amendment. The two
cases mainly relied upon to show that this was beyond the power of Congress are Towne v.
Eisner, 245 U. S. 418, which involved a question not of constitutional power, but of statutory
construction, and Gibbons v. Mahon, 136 U. S. 549, which involved a question arising between
life tenant and remainderman. So far as concerns Towne v. Eisner, we have only to bear in
mind what was there said (p. 245 U. S. 425): "But it is not necessarily true that income means
the same thing in the Constitution and the [an] act." [Footnote 6] Gibbons v. Mahon is even less
an authority for a narrow construction of the power to tax incomes conferred by the Sixteenth
Amendment. In that case, the court was required to determine how, in the administration of an
estate in the District of Columbia, a stock dividend, representing profits, received after the
decedent's death, should be disposed of as between life tenant and remainderman. The
question was, in essence, what shall the intention of the testator be presumed to have been?
On this question, there was great diversity of opinion and practice in the courts of Englishspeaking countries. Three well defined rules were then competing for acceptance. Two of these
involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on
Corporations, 7th ed., 552-558.
1. The so-called English rule, declared in 1799 by Brander v. Brander, 4 Ves. Jr. 800, that a
dividend representing
Page 252 U. S. 235
profits, whether in cash, stock or other property, belongs to the life tenant if it was a regular or
ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend.
2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, that a
dividend representing profits, whether regular, ordinary, or extraordinary, if in cash belongs to
the life tenant, and if in stock belongs to the remainderman.
3. The so-called Pennsylvania rule, declared in 1857 by Earp's Appeal, 28 Pa. 368, that, where
a stock dividend is paid, the court shall inquire into the circumstances under which the fund had
been earned and accumulated out of which the dividend, whether a regular, an ordinary, or an
extraordinary one, was paid. If it finds that the stock dividend was paid out of profits earned
since the decedent's death, the stock dividend belongs to the life tenant; if the court finds that
the stock dividend was paid from capital or from profits earned before the decedent's death, the
stock dividend belongs to the remainderman.
This Court adopted in Gibbons v. Mahon as the rule of administration for the District of
Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice
Gray. Since then, the same question has come up for decision in many of the states. The socalled Massachusetts rule, although approved by this Court, has found favor in only a few
states. The so-called Pennsylvania rule, on the other hand, has been adopted since by so many

of the states (including New York and California) that it has come to be known as the "American
rule." Whether, in view of these facts and the practical results of the operation of the two rules
as shown by the experience of the 30 years which have elapsed since the decision in Gibbons
v. Mahon, it might be desirable for this Court to reconsider the question there decided, as
Page 252 U. S. 236
some other courts have done (see 29 Harvard Law Review 551), we have no occasion to
consider in this case. For, as this Court there pointed out (p. 136 U. S. 560), the question
involved was one "between the owners of successive interests in particular shares," and not, as
in Bailey v. Railroad Co., 22 Wall. 604, a question
"between the corporation and the government, and [which] depended upon the terms of a
statute carefully framed to prevent corporations from evading payment of the tax upon their
earnings."
We have, however, not merely argument; we have examples which should convince us that
"there is no inherent, necessary and immutable reason why stock dividends should always be
treated as capital." Tax Commissioner v. Putnam, 227 Mass. 522, 533. The Supreme Judicial
Court of Massachusetts has steadfastly adhered, despite ever-renewed protest, to the rule that
every stock dividend is, as between life tenant and remainderman, capital, and not income. But,
in construing the Massachusetts Income Tax Amendment, which is substantially identical with
the federal amendment, that court held that the legislature was thereby empowered to levy an
income tax upon stock dividends representing profits. The courts of England have, with some
relaxation, adhered to their rule that every extraordinary dividend is, as between life tenant and
remainderman, to be deemed capital. But, in 1913, the Judicial Committee of the Privy Council
held that a stock dividend representing accumulated profits was taxable like an ordinary cash
dividend, Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231. In dismissing the appeal, these
words of the Chief Justice of the Supreme Court of Western Australia were quoted (p. 236),
which show that the facts involved were identical with those in the case at bar:
"Had the company distributed the 101,450 among the shareholders, and had the
shareholders repaid such sums to the company as the price of the 81, 160 new shares, the duty
on the 101,450
Page 252 U. S. 237
would clearly have been payable. Is not this virtually the effect of what was actually done? I
think it is."
Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth
Amendment, the owners of the most successful businesses in America will, as the facts in this
case illustrate, be able to escape taxation on a large part of what is actually their income. So far
as their profits are represented by stock received as dividends, they will pay these taxes not

upon their income, but only upon the income of their income. That such a result was intended by
the people of the United States when adopting the Sixteenth Amendment is inconceivable. Our
sole duty is to ascertain their intent as therein expressed. [Footnote 7] In terse, comprehensive
language befitting the Constitution, they empowered Congress "to lay and collect taxes on
incomes from whatever source derived." They intended to include thereby everything which by
reasonable understanding can fairly be regarded as income. That stock dividends representing
profits are so regarded not only by the plain people, but by investors and financiers and by most
of the courts of the country, is shown beyond peradventure by their acts and by their utterances.
It seems to me clear, therefore, that Congress possesses the power which it exercised to make
dividends representing profits taxable as income whether the medium in which the dividend is
paid be cash or stock, and that it may define, as it has done, what dividends representing
Page 252 U. S. 238
profits shall be deemed income. It surely is not clear that the enactment exceeds the power
granted by the Sixteenth Amendment. And, as this Court has so often said, the high prerogative
of declaring an act of Congress invalid should never be exercised except in a clear case.
[Footnote 8]
"It is but a decent respect due to the wisdom, the integrity, and the patriotism of the legislative
body by which any law is passed to presume in favor of its validity until its violation of the
Constitution is proved beyond all reasonable doubt."

CLAIM OF RIGHT DOCTRINE

COMMISSIONER V TOURS SPECIALIST
29JAN
183 SCRA 402 | March 21, 1990 | J. Gutierrez, Jr.
Gross receipts subject to tax under the Tax Code do not include monies or receipts entrusted to
the taxpayer which do not belong to them and do not redound to the taxpayers benefit; and it is
not necessary that there must be a law or regulation which would exempt such monies or
receipts within the meaning of gross receipts under the Tax Code
Facts:
The Commissioner of Internal Revenue filed a petition to review on certiorari to the CTA
decision which ruled that the money entrusted to private respondent Tours Specialist (TS),
earmarked and paid for hotel room charges of tourists, travellers and/or foreign travel agencies
do not form part of its gross receipt subject to 3% independent contractors tax.
Tours Specialist derived income from its activities and services as a travel agency, which
included booking tourists in local hotels. To supply such service, TS and its counterpart tourist
agencies abroad have agreed to offer a package fee for the tourists (payment of hotel room
accommodations, food and other personal expenses). By arrangement, the foreign tour agency
entrusts to TS the fund for hotel room accommodation, which in turn paid by the latter to the
local hotel when billed.
Despite this arrangement, CIR assessed private respondent for deficiency 3% contractors tax
as independent contractor including the entrusted hotel room charges in its gross receipts from
services for years 1974-1976 plus compromise penalty.
During cross-examination, TS General Manager stated that the payment through them is only
an act of accommodation on (its) part and the agent abroad instead of sending several telexes
and saving on bank charges they take the option to send the money to (TS) to be held in trust to
be endorsed to the hotel.
Nevertheless, CIR caused the issuance of a warrant of distraint and levy, and had TS bank
deposits garnished.
Issue:
W/N amounts received by a local tourist and travel agency included in a package fee from
tourists or foreign tour agencies, intended or earmarked for hotel accommodations form part of
gross receipts subject to 3% contractors tax
Held:

No. Gross receipts subject to tax under the Tax Code do not include monies or receipts
entrusted to the taxpayer which do not belong to them and do not redound to the taxpayers
benefit; and it is not necessary that there must be a law or regulation which would exempt such
monies or receipts within the meaning of gross receipts under the Tax Code. Parenthetically,
the room charges entrusted by the foreign travel agencies to the private respondents do not
form part of its gross receipts within the definition of the Tax Code. The said receipts never
belonged to the private respondent. The private respondent never benefited from their payment
to the local hotels. This arrangement was only to accommodate the foreign travel agencies.

Republic of the Philippines

SUPREME COURT
Manila
SECOND DIVISION

G.R. No. 78953 July 31, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.
Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p
Central in this controversy is the issue as to whether or not a taxpayer who merely states as a
footnote in his income tax return that a sum of money that he erroneously received and already
spent is the subject of a pending litigation and there did not declare it as income is liable to pay
the 50% penalty for filing a fraudulent return.
This question is the subject of the petition for review before the Court of the portion of the
Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393,
entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as Commissioner of
Internal Revenue," which orders the deletion of the 50% surcharge from Javier's deficiency
income tax assessment on his income for 1977.
The respondent CTA in a Resolution 2 dated May 25, 1987, denied the Commissioner's Motion
for Reconsideration 3 and Motion for New Trial 4 on the deletion of the 50% surcharge
assessment or imposition.
The pertinent facts as are accurately stated in the petition of private respondent Javier in the
CTA and incorporated in the assailed decision now under review, read as follows:
xxx xxx xxx
2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner
(private respondent herein), received from the Prudential Bank and Trust
Company in Pasay City the amount of US$999,973.70 remitted by her sister,
Mrs. Dolores Ventosa, through some banks in the United States, among which is
Mellon Bank, N.A.

3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the
Court of First Instance of Rizal (now Regional Trial Court), (docketed as Civil
Case No. 26899), against the petitioner (private respondent herein), his wife and
other defendants, claiming that its remittance of US$1,000,000.00 was a clerical
error and should have been US$1,000.00 only, and praying that the excess
amount of US$999,000.00 be returned on the ground that the defendants are
trustees of an implied trust for the benefit of Mellon Bank with the clear,
immediate, and continuing duty to return the said amount from the moment it was
received.
4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an
Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.)
charging the petitioner (private respondent herein) and his wife with the crime of
estafa, alleging that they misappropriated, misapplied, and converted to their own
personal use and benefit the amount of US$999,000.00 which they received
under an implied trust for the benefit of Mellon Bank and as a result of the
mistake in the remittance by the latter.
5. That on March 15, 1978, the petitioner (private respondent herein) filed his
Income Tax Return for the taxable year 1977 showing a gross income of
P53,053.38 and a net income of P48,053.88 and stating in the footnote of the
return that "Taxpayer was recipient of some money received from abroad which
he presumed to be a gift but turned out to be an error and is now subject of
litigation."
6. That on or before December 15, 1980, the petitioner (private respondent
herein) received a letter from the acting Commissioner of Internal Revenue dated
November 14, 1980, together with income assessment notices for the years 1976
and 1977, demanding that petitioner (private respondent herein) pay on or before
December 15, 1980 the amount of P1,615.96 and P9,287,297.51 as deficiency
assessments for the years 1976 and 1977 respectively. . . .
7. That on December 15, 1980, the petitioner (private respondent herein) wrote
the Bureau of Internal Revenue that he was paying the deficiency income
assessment for the year 1976 but denying that he had any undeclared income for
the year 1977 and requested that the assessment for 1977 be made to await final
court decision on the case filed against him for filing an allegedly fraudulent
return. . . .
8. That on November 11, 1981, the petitioner (private respondent herein)
received from Acting Commissioner of Internal Revenue Romulo Villa a letter
dated October 8, 1981 stating in reply to his December 15, 1980 letter-protest
that "the amount of Mellon Bank's erroneous remittance which you were able to
dispose, is definitely taxable." . . . 5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on December
10, 1981.
The respondent CTA, after the proper proceedings, rendered the challenged decision. We quote
the concluding portion:
We note that in the deficiency income tax assessment under consideration,
respondent (petitioner here) further requested petitioner (private respondent
here) to pay 50% surcharge as provided for in Section 72 of the Tax Code, in
addition to the deficiency income tax of P4,888,615.00 and interest due thereon.
Since petitioner (private respondent) filed his income tax return for taxable year
1977, the 50% surcharge was imposed, in all probability, by respondent
(petitioner) because he considered the return filed false or fraudulent. This
additional requirement, to our mind, is much less called for because petitioner
(private respondent), as stated earlier, reflected in as 1977 return as footnote that
"Taxpayer was recipient of some money received from abroad which he
presumed to be gift but turned out to be an error and is now subject of litigation."
From this, it can hardly be said that there was actual and intentional fraud,
consisting of deception willfully and deliberately done or resorted to by petitioner
(private respondent) in order to induce the Government to give up some legal
right, or the latter, due to a false return, was placed at a disadvantage so as to
prevent its lawful agents from proper assessment of tax liabilities. (Aznar vs.
Court of Tax Appeals, L-20569, August 23, 1974, 56 (sic) SCRA 519), because
petitioner literally "laid his cards on the table" for respondent to examine. Error or
mistake of fact or law is not fraud. (Insular Lumber vs. Collector, L-7100, April 28,
1956.). Besides, Section 29 is not too plain and simple to understand. Since the
question involved in this case is of first impression in this jurisdiction, under the
circumstances, the 50% surcharge imposed in the deficiency assessment should
be deleted. 7
The Commissioner of Internal Revenue, not satisfied with the respondent CTA's ruling, elevated
the matter to us, by the present petition, raising the main issue as to:
WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD
PENALTY? 8
On the other hand, Javier candidly stated in his Memorandum, 9 that he "did not appeal the
decision which held him liable for the basic deficiency income tax (excluding the 50% surcharge
for fraud)." However, he submitted in the same memorandum "that the issue may be raised in
the case not for the purpose of correcting or setting aside the decision which held him liable for
deficiency income tax, but only to show that there is no basis for the imposition of the

surcharge." This subsequent disavowal therefore renders moot and academic the posturings
articulated in as Comment 10 on the non-taxability of the amount he erroneously received and
the bulk of which he had already disbursed. In any event, an appeal at that time (of the filing of
the Comments) would have been already too late to be seasonable. The petitioner, through the
office of the Solicitor General, stresses that:
xxx xxx xxx
The record however is not ambivalent, as the record clearly shows that private
respondent is self-convinced, and so acted, that he is the beneficial owner, and
of which reason is liable to tax. Put another way, the studied insinuation that
private respondent may not be the beneficial owner of the money or income
flowing to him as enhanced by the studied claim that the amount is "subject of
litigation" is belied by the record and clearly exposed as a fraudulent ploy, as
witness what transpired upon receipt of the amount.
Here, it will be noted that the excess in the amount erroneously remitted by
MELLON BANK for the amount of private respondent's wife was $999,000.00
after opening a dollar account with Prudential Bank in the amount of
$999,993.70, private respondent and his wife, with haste and dispatch, within a
span of eleven (11) electric days, specifically from June 3 to June 14, 1977,
effected a total massive withdrawal from the said dollar account in the sum of
$975,000.00 or P7,020,000.00. . . . 11
In reply, the private respondent argues:
xxx xxx xxx
The petitioner contends that the private respondent committed fraud by not
declaring the "mistaken remittance" in his income tax return and by merely
making a footnote thereon which read: "Taxpayer was the recipient of some
money from abroad which he presumed to be a gift but turned out to be an error
and is now subject of litigation." It is respectfully submitted that the said return
was not fraudulent. The footnote was practically an invitation to the petitioner to
make an investigation, and to make the proper assessment.
The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths
v. Comm., 50 F [2d] 782), that is, it must be stronger than the "mere
preponderance of evidence" which would be sufficient to sustain a judgment on
the issue of correctness of the deficiency itself apart from the fraud penalty.
(Frank A. Neddas, 40 BTA 672). The following circumstances attendant to the
case at bar show that in filing the questioned return, the private respondent was
guided, not by that "willful and deliberate intent to prevent the Government from

making a proper assessment" which constitute fraud, but by an honest doubt as

to whether or not the "mistaken remittance" was subject to tax.
First, this Honorable Court will take judicial notice of the fact that so-called
"million dollar case" was given very, very wide publicity by media; and only one
who is not in his right mind would have entertained the idea that the BIR would
not make an assessment if the amount in question was indeed subject to the
income tax.
Second, as the respondent Court ruled, "the question involved in this case is of
first impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even
in the United States, the authorities are not unanimous in holding that similar
receipts are subject to the income tax. It should be noted that the decision in the
Rutkin case is a five-to-four decision; and in the very case before this Honorable
Court, one out of three Judges of the respondent Court was of the opinion that
the amount in question is not taxable. Thus, even without the footnote, the failure
to declare the "mistaken remittance" is not fraudulent.
Third, when the private respondent filed his income tax return on March 15, 1978
he was being sued by the Mellon Bank for the return of the money, and was
being prosecuted by the Government for estafa committed allegedly by his failure
to return the money and by converting it to his personal benefit. The basic tax
amounted to P4,899,377.00 (See p. 6 of the Petition) and could not have been
paid without using part of the mistaken remittance. Thus, it was not unreasonable
for the private respondent to simply state in his income tax return that the amount
received was still under litigation. If he had paid the tax, would that not constitute
estafa for using the funds for his own personal benefit? and would the
Government refund it to him if the courts ordered him to refund the money to the
Mellon Bank? 12
xxx xxx xxx
Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National Internal
Revenue Code), a taxpayer who files a false return is liable to pay the fraud penalty of 50% of
the tax due from him or of the deficiency tax in case payment has been made on the basis of
the return filed before the discovery of the falsity or fraud.
We are persuaded considerably by the private respondent's contention that there is no fraud in
the filing of the return and agree fully with the Court of Tax Appeals' interpretation of Javier's
notation on his income tax return filed on March 15, 1978 thus: "Taxpayer was the recipient of
some money from abroad which he presumed to be a gift but turned out to be an error and is
now subject of litigation that it was an "error or mistake of fact or law" not constituting fraud, that
such notation was practically an invitation for investigation and that Javier had literally "laid his
cards on the table." 13

In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax return was
discussed in this manner:
. . . The fraud contemplated by law is actual and not constructive. It must be
intentional fraud, consisting of deception willfully and deliberately done or
resorted to in order to induce another to give up some legal right. Negligence,
whether slight or gross, is not equivalent to the fraud with intent to evade the tax
contemplated by law. It must amount to intentional wrong-doing with the sole
object of avoiding the tax. It necessarily follows that a mere mistake cannot be
considered as fraudulent intent, and if both petitioner and respondent
Commissioner of Internal Revenue committed mistakes in making entries in the
returns and in the assessment, respectively, under the inventory method of
determining tax liability, it would be unfair to treat the mistakes of the petitioner
as tainted with fraud and those of the respondent as made in good faith.
Fraud is never imputed and the courts never sustain findings of fraud upon circumstances
which, at most, create only suspicion and the mere understatement of a tax is not itself proof of
fraud for the purpose of tax evasion. 15
A "fraudulent return" is always an attempt to evade a tax, but a merely "false
return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16
In the case at bar, there was no actual and intentional fraud through willful and deliberate
misleading of the government agency concerned, the Bureau of Internal Revenue, headed by
the herein petitioner. The government was not induced to give up some legal right and place
itself at a disadvantage so as to prevent its lawful agents from proper assessment of tax
liabilities because Javier did not conceal anything. Error or mistake of law is not fraud. The
petitioner's zealousness to collect taxes from the unearned windfall to Javier is highly
commendable. Unfortunately, the imposition of the fraud penalty in this case is not justified by
the extant facts. Javier may be guilty of swindling charges, perhaps even for greed by spending
most of the money he received, but the records lack a clear showing of fraud committed
because he did not conceal the fact that he had received an amount of money although it was a
"subject of litigation." As ruled by respondent Court of Tax Appeals, the 50% surcharge imposed
as fraud penalty by the petitioner against the private respondent in the deficiency assessment
should be deleted.
WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax
Appeals is AFFIRMED. No costs.
SO ORDERED.

INCOME FROM WHATEVER SOURCE

EN BANC
[G.R. Nos. L-9738 & L-9771. May 31, 1957.]
BLAS GUTIERREZ, and MARIA MORALES, Petitioners, v. HONORABLE COURT OF TAX
APPEALS, and THE COLLECTOR OF INTERNAL REVENUE, Respondents.
COLLECTOR OF INTERNAL REVENUE, Petitioner, v. BLAS GUTIERREZ, MARIA
MORALES, and COURT OF TAX APPEALS, Respondents.
Rafael Morales, for Petitioners.
Assistant Solicitor General Ramon L. Avancea and Solicitor Jose P. Alejandro
for Respondents.

SYLLABUS

1. EXPROPRIATION; INCOME FROM SOURCES WITHIN THE PHILIPPINES, WHERE

TAXABLE. The compensation or income derived from the expropriation of property located in
the Philippines is an income from sources within the Philippines and subject to the taxing
jurisdiction of the place.
2. ID.; ID.; TRANSFER OF PROPERTY EQUIVALENT TO SALE; PROCEEDS SUBJECT TO
INCOME TAX AS CAPITAL GAIN. The acquisition by the Government of private properties
through the exercise of the power of eminent domain, said properties being justly compensated,
is embraced within the meaning of the term "sale" or "disposition of property," and the proceeds
derived therefrom is subject to income tax as capital gain pursuant to the provisions of Section
37-(a)-(5) in relation to Section 29-(a) of the Tax Code.
3. ID.; ID.; ID.; ID.; INCOME NOT INCLUDED IN THE TAX EXEMPTIONS SPECIFIED IN THE
MILITARY BASES AGREEMENT. The taxpayers maintain that since, at the request of the U.
S. Government, the proceeding to expropriate the land in question necessary for the expansion
of the Clark Field Air Base was instituted by the Philippine Government as part of its obligation
under the Military Bases Agreement, the compensation accruing therefrom must necessarily fall
under the exemption provided for by Section 29-(b)-6 of the Tax Code. This stand is untenable
because while the condemnation or expropriation of properties wad provided for in the
Agreement, the exemption from tax of the compensation to be paid for the expropriation of
privately owned lands located in the Philippines was not given any attention, and the internal
revenue exemptions specifically taken care of by said agreement applies only to members of
the U. S. Armed Forces serving in the Philippines and U. S. nationals working in these Islands in

connection with the construction, maintenance, operation and defense of said bases.
4. ID.; TRANSFER OF OWNERSHIP; WHEN TITLE PASSES TO EXPROPRIATOR. In
condemnation proceedings, title to the land does not pass to the plaintiff until the indemnity is
paid (Calvo v. Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the
expropriator, title does not actually pass to him until payment of the amount adjudged by the
Court and the registration of the judgment with the Register of Deeds (See Visayan Refining
Company v. Camus Et. Al., 40 Phil. 550; Metropolitan Water District v. De los Angeles, 55 Phil.
783).
5. ID.; GAIN OR LOSS FROM SALE, HOW DETERMINED. The property in question was
adjudicated to the owner by court order on March 23, 1929, and in accordance with Section 35
(b) of the Tax Code, only the fair market price or value of the property as of the date of the
acquisition thereof should be considered in determining the gain or loss sustained by the
property owner when the property was disposed, without taking into account the purchasing
power of the currency used in the transaction. The value of the property at the time of its
acquisition by the owner was P28,291.78 and the same was compensated with P94,305.75
when it was expropriated. The resulting difference is not merely nominal but a capital gain and
should be correspondingly taxed.
6. TAXATION; ASSESSMENT MADE WITHIN THE PRESCRIPTIVE PERIOD, HOW
ENFORCED. When the assessment for deficiency income tax was made by the Collector of
Internal Revenue within the 3-year prescriptive period provided for by Section 51-d of the Tax
Code, the same could be collected either by the administrative methods of distraint and levy or
by judicial action.
7. COURT OF TAX APPEALS; REVIEW OF DECISIONS OF; ONLY QUESTIONS OF LAW
MAY BE CONSIDERED. The question of fraud is a question of fact which is for the Court of
Tax Appeals to determine. It is already settled in this jurisdiction that in passing upon petitions to
review decisions of the Court of Tax Appeals, only questions of law may be considered.

DECISION

FELIX, J.:

Maria Morales was the registered owner of an agricultural land designated as Lot No. 724-C of
the cadastral survey of Mabalacat, Pampanga. The Republic of the Philippines, at the request of
the U.S. Government and pursuant to the terms of the Military Bases Agreement of March 14,
1947, instituted condemnation proceedings in the Court of First Instance of Pampanga,
docketed as Civil Case No. 148, for the purpose of expropriating the lands owned by Maria
Morales and others needed for the expansion of the Clark Field Air Base, which project is

necessary for the mutual protection and defense of the Philippines and the United States. Blas
Gutirrez was also made a party defendant in said Civil Case No. 148 for being the husband of
the landowner Maria Morales. At the commencement of the action, the Republic of the
Philippines, therein plaintiff, deposited with the Clerk of the Court of First Instance of Pampanga
the sum of P156,960, which was provisionally fixed as the value of the lands sought to be
expropriated, in order that it could take immediate possession of the same.
On January 27, 1949, upon order of the Court, the sum of P34,580 (PNB Check 721520-Exh. R)
was paid by the Provincial Treasurer of Pampanga to Maria Morales out of the original deposit
of P156,960 made by therein plaintiff. After due hearing, the Court of First Instance of
Pampanga rendered decision dated November 29, 1949, wherein it fixed as just compensation
P2,500 per hectare for some of the lots and P3,000 per hectare for the others, which values
were based on the reports of the Commission on Appraisal whose members were chosen by
both parties and by the Court, which took into consideration the different conditions affecting the
value of the condemned properties in making their findings.
In virtue of said decision, defendant Maria Morales was to receive the amount of P94,305.75 as
compensation for Lot No. 724-C which was one of the expropriated lands. But the Court
disapproved defendants claims for consequential damages considering them amply
compensated by the price awarded to their said properties. In order to avoid further litigation
expenses and delay inherent to an appeal, the parties entered into a compromise agreement on
January 7, 1950, modifying in part the decision rendered by the Court in the sense of fixing the
compensation for all the lands, without distinction, at P2,500 per hectare, which compromise
agreement was approved by the Court on January 9, 1950. This reduction of the price to P2,500
per hectare did not affect Lot No. 724-C of defendant Maria Morales. Sometime in 1950, the
spouses Blas Gutirrez and Maria Morales received the sum of P59,785.75 representing the
balance remaining in their favor after deducting the amount of P34,580 already withdrawn from
the compensation due to them.
In a notice of assessment dated January 28, 1953, the Collector of Internal Revenue demanded
of the petitioners the payment of P8,481 as alleged deficiency income tax for the year 1950,
inclusive of surcharges and penalties. On March 5, 1953, counsel for petitioners sent a letter to
the Collector of Internal Revenue requesting the latter to withdraw and reconsider said
assessment, contending among others, that the compensation paid to the spouses by the
Government for their property was not "income derived from sale, dealing or disposition of
property" referred to by section 29 of the Tax Code and therefore not taxable; that even granting
that condemnation of private properties is embraced within the meaning of the word "sale" or
"dealing", the compensation received by the taxpayers must be considered as income for 1948
and not for 1950 since the amount deposited and paid in 1948 represented more than 25 per
cent of the total compensation awarded by the court; that the assessment was made after the
lapse of the 3-year prescriptive period provided for in section 51-(d) of the Tax Code; that the
compensation in question should be exempted from taxation by reason of the provision of
section 29 (b)-6 of the Tax Code; that the spouses Blas Gutirrez and Maria Morales did not
realize any profit in said transaction as there were improvements on the land already made and

that the purchasing value of the peso at the time of the expropriation proceeding had
depreciated if compared to the value of the pre-war peso; and that penalties should not be
imposed on said spouses because granting that the assessment was correct, the omission of
the compensation awarded therein was due to an honest mistake.
This request was denied by the Collector of Internal Revenue, in a letter dated April 26, 1954,
refuting point by point the arguments advanced by the taxpayers. The record further shows that
a warrant of distraint and levy was issued by the Collector of Internal Revenue on the properties
of Mr. & Mrs. Blas Gutirrez found in Mabalacat, Pampanga, and a notice of tax lien was duly
registered with the Register of Deeds of San Fernando, Pampanga, on the same date. Counsel
for the spouses then requested that the matter be referred to the Conference Staff of the Bureau
of Internal Revenue for proper hearing, to which the Collector answered in a letter dated
December 24, 1954, stating that the request would be granted upon compliance by the
taxpayers with the requirements of Department of Finance Order No. 213, i.e., the filing of a
verified petition to that effect and that one-half of the total assessment should be guaranteed by
a bond, provided that the taxpayers would agree in writing to the suspension of the running of
the period of prescription.
The taxpayers then served notice that the case would be brought on appeal to the Court of Tax
Appeals, which they did by filing a petition with said Court to review the assessment made by
the Collector of Internal Revenue, docketed as C.T.A. Case No. 65. In that instance, it was
prayed that the Court render judgment declaring that the taking of petitioners land by the
Government was not a sale or dealing in property; that the amount paid to petitioners as just
compensation for their property should not be diminished by way of taxation; that said
compensation was by law exempt from taxation and that the period to collect the income taxes
by summary methods had prescribed; that respondent Collector of Internal Revenue be
enjoined from carrying out further steps to collect from petitioners by summary methods the said
taxes which they alleged to be erroneously assessed and for such other remedies which would
serve the ends of law and justice.
The Solicitor General, in representation of the respondent Collector of Internal Revenue, filed an
answer on February 11, 1955, admitting some of the allegations of petitioners and denying
some of them, and as special defenses, he advanced the contention that the Court had no
jurisdiction to entertain the petition; that the profit realized by petitioners from the sale of the
land in question was subject to income tax; that the full compensation received by petitioners
should be included in the income received in 1950, same having been paid in 1950 by the
Government; that under the Bases Agreement only residents of the United States are exempt
from the payment of income tax in the Philippines in respects to profits derived under a contract
with the U.S. Government in connection with the construction, maintenance and operation of the
bases; that in the determination of the gain or loss from the sale of property acquired on or after
March 1, 1913, the cost of acquisition and the selling price shall be taken into account without
qualification as to the purchasing power of the currency; that the imposition of the 50 per cent
surcharge was in accordance with the Tax Code; that the Collector of Internal Revenue was
empowered to collect petitioners deficiency income tax; and prayed that the petition for review

be dismissed; petitioners be ordered to pay the amount of P8,481 plus the delinquency penalty
of 5 per cent for late payment and monthly interest at the rate of 1 per cent from April 1, 1953,
up to the date of actual payment and for such other relief that may be deemed just and
equitable in the premises.
After due hearing and after the parties had filed their respective memoranda, the Court of Tax
Appeals rendered decision on August 31, 1955, holding that it had jurisdiction to hear and
determine the case; that the gain derived by the petitioners from the expropriation of their
property constituted taxable income and as such was capital gain; and that said gain was
taxable in 1950 when it was realized. It was also found by said Court that the evidence did not
warrant the imposition of the 50 per cent surcharge because the petitioners acted in good faith
and without intent to defraud the Government when they failed to include in their gross income
the proceeds they received from the expropriated property, and, therefore, modified the
assessment made by respondent, requiring petitioners to pay only the sum of P5,654. From this
decision, both parties appealed to this Court and in this instance, petitioners Blas Gutirrez and
Maria Morales, as appellants in G. R. No. L-9738, made the following assignments of
error:chanrob1es virtual 1aw library
1. That the Court of Tax Appeals erred in holding that, for income tax purposes, income from
expropriation should be deemed as income from sale, any profit derived therefrom is subject to
income tax as capital gain pursuant to the provisions of Section 37-(a)-(5) in relation to Section
29-(a) of the Tax Code;
2. That the Court of Tax Appeals erred in not holding that, under the particular circumstances in
which the property of the appellants was taken by the Philippine Government, the amount paid
to them as just compensation is exempt from income tax pursuant to Section 29- (b)-(6) of the
Tax Code;
3. That the Court of Tax Appeals erred in not holding that the respondent Collector is definitely
barred by the Statute of Limitations from collecting the deficiency income tax in question,
whether administratively thru summary methods, or judicially thru the ordinary court procedures;
4. That the Court of Tax Appeals erred is not holding that the capital gain found by the
respondent Collector as have been derived by the petitioners-appellants from the expropriation
of their property is merely nominal not subject to income tax, and in not holding that the
pronouncement of the court in the expropriation case in this respect is binding upon the
respondent Collector of Internal Revenue; and
5. That the Court of Tax Appeals erred in not pronouncing upon the pleadings of the parties that
the petitioners-appellants did not derive any capital gain from the expropriation of their property.
The appeal of the respondent Collector of Internal Revenue was docketed in this Court as G. R.
No. L-9771, and in this case the Solicitor General ascribed to the lower court the commission of
the following error:chanrob1es virtual 1aw library

That the Court of Tax Appeals erred in holding that respondents are not subject to the payment
of the 50 per cent surcharge in spite of the fact that the latters income tax return for the year
1950 is false and/or fraudulent.
The facts just narrated are not disputed and the controversy only arose from the assertion by
the Collector of Internal Revenue that petitioners-appellants failed to include from their gross
income, in filing their income tax return for 1950, the amount of P94,305.75 which they had
received as compensation for their land taken by the Government by expropriation proceedings.
It is the contention of respondent Collector of Internal Revenue that such transfer of property, for
taxation purposes, is "sale" and that the income derived therefrom is taxable. The pertinent
provisions of the National Internal Revenue Code applicable to the instant cases are the
following:chanrob1es virtual 1aw library
SEC. 29. GROSS INCOME. (a) General definition. "Gross income" includes gains, profits,
and income derived from salaries, wages, or compensation for personal service of whatever
kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce,
sales or dealings in property, whether real or personal, growing out of ownership or use of or
interest in such property; also from interests, rents, dividends, securities, or the transactions of
any business carried on for gain or profit, or gains, profits, and income derived from any source
whatsoever.
SEC. 37. INCOME FROM SOURCES WITHIN THE PHILIPPINES.
(a) Gross income from sources within the Philippines. The following items of gross income
shall be treated as gross income from sources within the Philippines:chanrob1es virtual 1aw
library
x

(5) SALE OF REAL PROPERTY. Gains profits, and income from the sale of real property
located in the Philippines;
x

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

the authorities in the United States on the matter sustain the view expressed by the Collector of
Internal Revenue, for it is held that:jgc:chanrobles.com.ph
"The transfer of property through condemnation proceedings is a sale or exchange within the
meaning of section 117 (a) of the 1936 Revenue Act and profit from the transaction constitutes
capital gain" (1942. Com. Int. Revenue v. Kieselbach (CCA 3) 127 F. (24) 359). "The taking of
property by condemnation and the payment of just compensation therefore is a sale or
exchange within the meaning of section 117 (a) of the Revenue Act of 1936, and profits from
that transaction is capital gain" (David S. Brown v. Comm., 1942, 42 BTA 139).
The proposition that income from expropriation proceedings is income from sales or exchange
and therefore taxable has been likewise upheld in the case of Lapham v. U.S. (1949, 40 AFTR
1370) and in Kneipp v. U.S. (1949, 85 F Suppl. 902). It appears then that the acquisition by the
Government of private properties through the exercise of the power of eminent domain, said
properties being JUSTLY compensated, is embraced within the meaning of the term "sale" or
"disposition of property", and the proceeds from said transaction clearly fall within the definition
of gross income laid down by Section 29 of the Tax Code of the Philippines.
Petitioners-appellants also averred that granting that the compensation thus received is
"income", same is exempted under Section 29-(b)-6 of the Tax Code, which reads as
follows:chanrob1es virtual 1aw library
SEC. 29. GROSS INCOME.
x

(b) EXCLUSIONS FROM GROSS INCOME. The following items shall not be included in
gross income and shall be exempt from taxation under this Title:chanrob1es virtual 1aw library
x

(6) Income exempt under treaty. Income of any kind, to the extent required by any treaty
obligation binding upon the Government of the Philippines.
The taxpayers maintain that since, at the request of the U.S. Government, the proceeding to
expropriate the land in question necessary for the expansion of the Clark Field Air Base was
instituted by the Philippine Government as part of its obligation under the Military Bases
Agreement, the compensation accruing therefrom must necessarily fall under the exemption
provided for by Section 29-(b)-6 of the Tax Code. We find this stand untenable, for the same
Military Bases Agreement cited by appellants contains the following:jgc:chanrobles.com.ph
"ARTICLE XXII

"CONDEMNATION OR EXPROPRIATION
"1. Whenever it is necessary to acquire by condemnation or expropriation proceedings real
property belonging to private persons, association, or corporations located in bases named in
Annex A and Annex B in order to carry out the purposes of this agreement, the Philippines will
institute and prosecute such condemnation proceedings in accordance with the laws of the
Philippines. The United States agrees to reimburse the Philippines for all the reasonable
expanses, damages, and costs thereby incurred, including the value of the property as
determined by the Court. In addition, subject to mutual agreements of the two governments, the
United States shall reimburse the Philippines for the reasonable costs of transportation and
removal of any occupants displaced or ejected by reason of the condemnation or expropriation"
"ARTICLE XII
"INTERNAL REVENUE EXEMPTION
"(1) No member of the United States Armed Forces except Filipino citizens, serving in the
Philippines in connection with the bases and residing in the Philippines by reason only of such
service, or his dependents, shall be liable to pay income tax in the Philippines except in respect
of income derived from Philippine sources.
"(2) No national of the United States serving in the Philippines in connection with the
construction, maintenance, operation or defense of the bases and residing in the Philippines by
reason only of such employment, or his spouse and minor children and dependent parents of
either spouse, shall be liable to pay income tax in the Philippines except in respect of income
derived from Philippine sources or sources other than the United States.
"(3) No person referred to in paragraphs 1 and 2 of this said Article shall be liable to pay the
government or local authorities of the Philippines any poll or residence tax, or any imports or
experts duties, or any other tax on personal property imported for his own use provided, that
private owned vehicles shall be subject to payment of the following only: when certified as being
used for military purposes by appropriate United States Authorities, the normal license plate fee;
otherwise, the normal license and registration fees.
"(4) No national of the United States, or corporation organized under the laws of the United
States, shall be liable to pay income tax in the Philippines in respect of any profits derived under
a contract made in the United States with the government of the United States in connection
with the construction, maintenance, operation and defense of the bases, or any tax in the nature
of a license in respect of any service of works for the United States in connection with the
construction, maintenance, operation and defense of the bases.
x

The facts brought about by the aforementioned terms of the said treaty need no further
elucidation. It is unmistakable that although the condemnation or expropriation of properties was
provided for, the exemption from tax of the compensation to be paid for the expropriation of
privately owned lands located in the Philippines was not given any attention, and the internal
revenue exemptions specifically taken care of by said Agreement applies only to members of
the U.S. Armed Forces serving in the Philippines and U.S. nationals working in these Islands in
connection with the construction, maintenance, operation and defense of said bases.
Anent appellant taxpayers allegation that the respondent Collector of Internal Revenue was
barred from collecting the deficiency income tax assessment, it having been made beyond the
3-year period prescribed by section 51-(d) of the Tax Code, We have this much to say. Although
it is true that by order of the Court of First Instance of Pampanga, the amount of P34,580 out of
the original deposit made by the Government was withdrawn in favor of appellants on January
27, 1949, the same cannot be considered as income for said year but for 1950 when the
balance of P59,785.75 was actually received. Before that date (1950), appellant taxpayers were
still the owners of their whole property that was subject of condemnation proceedings and said
amount of P34,580 was not paid to, but merely deposited in court and withdrawn by them.
Therefore, the payment of the value of Maria Morales Lot 724-C was actually made by the
Republic of the Philippines in 1950 and it has to be credited as income for 1950 for it was then
when title over said property passed to the Republic of the Philippines. Appellant tax payers
cannot say that the title over the property expropriated already passed to the Government when
the latter was placed in possession thereof, for in condemnation proceedings, title to the land
does not pass to the plaintiff until the indemnity is paid (Calvo v. Zandueta, 49 Phil. 605), and
notwithstanding possession acquired by the expropriator, title does not actually pass to him until
payment of the amount adjudged by the Court and the registration of the judgment with the
Register of Deeds (See Visayan Refining Company v. Camus Et. Al., 40 Phil. 550; Metropolitan
Water District v. De los Angeles, 55 Phil. 783). Now, if said amount should have been reported
as income for 1950 in the return that must have been filed on or before March 1, 1951, the
assessment made by the Collector on January 28, 1953, is still within the 3-year prescriptive
period provided for by Section 51-d and could, therefore, be collected either by the
administrative methods of distraint and levy or by judicial action (See Collector of Internal
Revenue v. A.P. Reyes Et. Al., 100 Phil., 822; Collector of Internal Revenue v. Zulueta Et. Al.,
100 Phil., 872; and Sambrano v. Court of Tax Appeals Et. Al., supra, p. 1).
As to appellant taxpayers proposition that the profit derived by them from the expropriation of
their property is merely nominal and not subject to income tax, We find Section 35 of the Tax
Code illuminating. Said section reads as follows:jgc:chanrobles.com.ph
"SEC. 35. DETERMINATION OF GAIN OR LOSS FROM THE SALE OR OTHER
DISPOSITION OF PROPERTY. The gain derived or loss sustained from the sale or other
disposition of property, real or personal, or mixed, shall be determined in accordance with the
following schedule:chanrob1es virtual 1aw library
(a)x

x"

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

The records show that the property in question was adjudicated to Maria Morales by order of the
Court of First Instance of Pampanga on March 23, 1929, and in accordance with the
aforequoted section of the National Internal Revenue Code, only the fair market price or value of
the property as of the date of the acquisition thereof should be considered in determining the
gain or loss sustained by the property owner when the property was disposed, without taking
into account the purchasing power of the currency used in the transaction. The records placed
the value of the said property at the time of its acquisition by appellant Maria Morales was
P28,291.73 and it is a fact that same was compensated with P94,305.75 when it was
expropriated. The resulting difference is surely a capital gain and should be correspondingly
taxed.
As to the only question raised by appellant Collector of Internal Revenue in case L-9771,
assailing the lower Courts order exonerating petitioners from the 50 per cent surcharge
imposed on the latter, on the ground that the taxpayers income tax return for 1950 is false
and/or fraudulent, it should be noted that the Court of Tax Appeals found that the evidence did
not warrant the imposition of said surcharge because the petitioners therein acted in good faith
and without intent to defraud the Government.
"The question of fraud is a question of fact which frequently requires a nicely balanced judgment
to answer. All the facts and circumstances surrounding the conduct of the taxpayers business
and all the facts incident to the preparation of the alleged fraudulent return should be
considered." (Mertens, Federal Income Taxation, Chapter 55).
The question of fraud being a question of fact and the lower court having made the finding that
"the evidence of this case does not warrant the imposition of the 50 per cent surcharge", We are
constrained to refrain from giving any consideration to the question raised by the Solicitor
General, for it is already settled in this jurisdiction that in passing upon petitions to review
decisions of the Court of Tax Appeals, We have to confine ourselves to questions of law.
Wherefore, the decision appealed from by both parties is hereby affirmed, without
pronouncement as to costs. It is so ordered.

James v. United States, 366 U.S. 213 (1961)

James v. United States
No. 63
Argued November 17, 1960
Decided May 15, 1961
366 U.S. 213
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
Syllabus
1. Embezzled money is taxable income of the embezzler in the year of the embezzlement under
22(a) of the Internal Revenue Code of 1939, which defines "gross income" as including "gains
or profits and income derived from any source whatever," and under 61(a) of the Internal
Revenue Code of 1954, which defines "gross income" as "all income from whatever source
derived." Commissioner v. Wilcox, 327 U. S. 404, overruled. Pp. 366 U. S. 213-222.
2. After this Court's decision in Commissioner v. Wilcox, supra, petitioner embezzled large sums
of money during the years 1951 through 1954. He failed to report those amounts as gross
income in his income tax returns for those years, and he was convicted of "willfully" attempting
to evade the federal income tax due for each of the years 1951 through 1954, in violation of
145(b) of the Internal Revenue Code of 1939 and 7201 of the Internal Revenue Code of
1954.
Held: the judgment affirming the conviction is reversed, and the cause is remanded with
directions to dismiss the indictment. Pp. 366 U. S. 214-215, 222.
273 F.2d 5, reversed.
MR. CHIEF JUSTICE WARREN announced the judgment of the Court and an opinion in which
MR. JUSTICE BRENNAN, and MR. JUSTICE STEWART concur.
The issue before us in this case is whether embezzled funds are to be included in the "gross
income" of the embezzler in the year in which the funds are misappropriated
Page 366 U. S. 214

under 22(a) of the Internal Revenue Code of 1939 [Footnote 1] and 61(a) of the Internal
Revenue Code of 1954. [Footnote 2]
The facts are not in dispute. The petitioner is a union official who, with another person,
embezzled in excess of $738,000 during the years 1951 through 1954 from his employer union
and from an insurance company with which the union was doing business. [Footnote 3]
Petitioner failed to report these amounts in his gross income in those years, and was convicted
for willfully attempting to evade the federal income tax due for each of the years 1951 through
1954 in violation of 145(b) of the Internal Revenue Code of 1939 [Footnote 4] and 7201 of
the Internal Revenue
Page 366 U. S. 215
Code of 1954. [Footnote 5] He was sentenced to a total of three years' imprisonment. The Court
of Appeals affirmed. 273 F.2d 5. Because of a conflict with this Court's decision
in Commissioner v. Wilcox, 327 U. S. 404, a case whose relevant facts are concededly the
same as those in the case now before us, we granted certiorari. 362 U.S. 974.
In Wilcox, the Court held that embezzled money does not constitute taxable income to the
embezzler in the year of the embezzlement under 22(a) of the Internal Revenue Code of
1939. Six years later, this Court held, in Rutkin v. United States, 343 U. S. 130, that extorted
money does constitutes taxable income to the extortionist in the year that the money is received
under 22(a) of the Internal Revenue Code of 1939. In Rutkin, the Court did not
overrule Wilcox, but stated:
"We do not reach in this case the factual situation involved in Commissioner v. Wilcox, 327 U. S.
404. We limit that case to its facts. There, embezzled funds were held not to constitute taxable
income to the embezzler under 22(a)."
Id. at 343 U. S. 138. [Footnote 6] However, examination of the reasoning used in Rutkin leads
us inescapably to the conclusion that Wilcox was thoroughly devitalized.
The basis for the Wilcox decision was
"that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain
and (2) the absence of a definite,
Page 366 U. S. 216
unconditional obligation to repay or return that which would otherwise constitute a gain. Without
some bona fide legal or equitable claim, even though it be contingent or contested in nature, the
taxpayer cannot be said to have received any gain or profit within the reach of Section 22(a)."
Commissioner v. Wilcox, supra, at 327 U. S. 408. Since Wilcox embezzled the money, held it
"without any semblance of a bona fide claim of right," ibid., and therefore "was at all times under

an unqualified duty and obligation to repay the money to his employer," ibid., the Court found
that the money embezzled was not includible within "gross income." But Rutkin's legal claim
was no greater than that of Wilcox. It was specifically found "that petitioner had no basis for his
claim . . . and that he obtained it by extortion." Rutkin v. United States, supra, at 343 U. S. 135.
Both Wilcox and Rutkin obtained the money by means of a criminal act; neither had a bona
fide claim of right to the funds. [Footnote 7] Nor was Rutkin's obligation to repay the extorted
money to the victim any less than that of Wilcox. The victim of an extortion, like the victim of an
embezzlement, has a right to restitution. Furthermore, it is inconsequential that an embezzler
may lack title to the sums he appropriates, while an extortionist may gain a voidable title.
Questions of federal income taxation are not determined by such "attenuated subtleties." Lucas
v. Earl, 281 U. S. 111, 281 U. S. 114; Corliss v.
Page 366 U. S. 217
Bowers, 281 U. S. 376, 281 U. S. 378. Thus, the fact that Rutkin secured the money with the
consent of his victim, Rutkin v. United States, supra, at p. 343 U. S. 138, is irrelevant. Likewise
unimportant is the fact that the sufferer of an extortion is less likely to seek restitution than one
whose funds are embezzled. What is important is that the right to recoupment exists in both
situations.
Examination of the relevant cases in the courts of appeals lends credence to our conclusion that
the Wilcox rationale was effectively vitiated by this Court's decision in Rutkin. [Footnote 8]
Although this case appears to be the first to arise that is "on all fours" with Wilcox, the lower
federal courts, in deference to the undisturbed Wilcox holding, have earnestly endeavored to
find distinguishing facts in the cases before them which would enable them to include sundry
unlawful gains within "gross income." [Footnote 9]
Page 366 U. S. 218
It had been a well established principle, long before either Rutkin or Wilcox, that unlawful, as
well as lawful, gains are comprehended within the term "gross income." Section II B of the
Income Tax Act of 1913 provided that
"the net income of a taxable person shall include gains, profits, and income . . . from . . . the
transaction of any lawful business carried on for gain or profit, or gains or profits and income
derived from any source whatever. . . ."
(Emphasis supplied.) 38 Stat. 167. When the statute was amended in 1916, the one word
"lawful" was omitted. This revealed, we think, the obvious intent of that Congress to tax income
derived from both legal and illegal sources, to remove the incongruity of having the gains of the
honest laborer taxed and the gains of the dishonest immune. Rutkin v. United States,
supra, at 343 U. S. 138; United States v. Sullivan, 274 U. S. 259, 274 U. S. 263. Thereafter, the
Court held that gains from illicit traffic in liquor are includible within "gross income." Ibid. See
also Johnson v. United States, 318 U. S. 189; United States v. Johnson, 319 U. S. 503. And, the

Court has pointed out, with approval, that there "has been a widespread and settled
administrative and judicial recognition of the taxability of unlawful gains of many kinds," Rutkin
v. United States, supra, at 343 U. S. 137. These include protection payments made to
racketeers, ransom payments paid to kidnappers, bribes, money derived from the sale of
unlawful insurance policies, graft, black market gains, funds obtained from the operation of
lotteries, income from race track bookmaking and illegal prize fight pictures. Ibid.
The starting point in all cases dealing with the question of the scope of what is included in
"gross income" begins with the basic premise that the purpose of Congress was "to use the full
measure of its taxing power." Helvering
Page 366 U. S. 219
v. Clifford, 309 U. S. 331, 309 U. S. 334. And the Court has given a liberal construction to the
broad phraseology of the "gross income" definition statutes in recognition of the intention of
Congress to tax all gains except those specifically exempted. Commissioner v. Jacobson, 336
U. S. 28, 336 U. S. 49; Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 87-91.
The language of 22(a) of the 1939 Code, "gains or profits and income derived from any
source whatever," and the more simplified language of 61(a) of the 1954 Code, "all income
from whatever source derived," have been held to encompass all "accessions to wealth, clearly
realized, and over which the taxpayers have complete dominion."Commissioner v. Glenshaw
Glass Co., 348 U. S. 426, 348 U. S. 431. A gain
"constitutes taxable income when its recipient has such control over it that, as a practical matter,
he derives readily realizable economic value from it."
Rutkin v. United States, supra, at 343 U. S. 137. Under these broad principles, we believe that
petitioner's contention, that all unlawful gains are taxable except those resulting from
embezzlement, should fail.
When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition,
express or implied, of an obligation to repay and without restriction as to their disposition,
"he has received income which he is required to return, even though it may still be claimed that
he is not entitled to retain the money, and even though he may still be adjudged liable to restore
its equivalent."
North American Oil Consolidated v. Burnet, supra, at 286 U. S. 424. In such case, the taxpayer
has "actual command over the property taxed-the actual benefit for which the tax is
paid," Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad
sweep of "gross income;" it excludes loans. When a law-abiding taxpayer mistakenly receives
income in one year, which receipt is assailed and found to be invalid in a subsequent
Page 366 U. S. 220

year, the taxpayer must nonetheless report the amount as "gross income" in the year
received. United States v. Lewis, supra; Healy v. Commissioner, supra. We do not believe that
Congress intended to treat a lawbreaking taxpayer differently. Just as the honest taxpayer may
deduct any amount repaid in the year in which the repayment is made, the Government points
out that "If, when, and to the extent that the victim recovers back the misappropriated funds,
there is, of course, a reduction in the embezzler's income." Brief for the United States, p. 24.
[Footnote 10]
Petitioner contends that the Wilcox rule has been in existence since 1946; that, if Congress had
intended to change the rule, it would have done so; that there was a general revision of the
income tax laws in 1954 without mention of the rule; that a bill to change it [Footnote 11] was
introduced in the Eighty-sixth Congress, but was not acted upon; that therefore we may not
change the rule now. But the fact that Congress has remained silent or has reenacted a statute
which we have construed, or that congressional attempts to amend a rule announced by this
Court have failed, does not necessarily debar us from reexamining and correcting the Court's
own errors. Girouard v. United States, 328 U. S. 61, 328 U. S. 69-70; Helvering v. Hallock, 309
U. S. 106, 309 U. S. 119-122. There may have been any number of reasons why Congress
acted as it did. Helvering v. Hallock, supra. One of the reasons could well
8 and <="" a=""
style="box-sizing: border-box;">S. 221 be our subsequent decision in Rutkin which has been
thought by many to have repudiated Wilcox. Particularly might this be true in light of the
decisions of the Courts of Appeals which have been riding a narrow rail between the two cases
and further distinguishing them to the disparagement of Wilcox. See notes 8 and <="" a=""
style="box-sizing: border-box;">| 8 and <="" a="" style="box-sizing: border-box;">S.
213fn9|>9, supra.
We believe that Wilcox was wrongly decided, and we find nothing in congressional history since
then to persuade us that Congress intended to legislate the rule. Thus, we believe that we
should now correct the error and the confusion resulting from it, certainly if we do so in a
manner that will not prejudice those who might have relied on it. Cf. Helvering v. Hallock,
supra, at 309 U. S. 119. We should not continue to confound confusion, particularly when the
result would be to perpetuate the injustice of relieving embezzlers of the duty of paying income
taxes on the money they enrich themselves with through theft while honest people pay their
taxes on every conceivable type of income.
But we are dealing here with a felony conviction under statutes which apply to any person who
"willfully" fails to account for his tax or who "willfully" attempts to evade his obligation. In Spies v.
United States, 317 U. S. 492, 317 U. S. 499, the Court said that 145(b) of the 1939 Code
embodied "the gravest of offenses against the revenues," and stated that willfulness must
therefore include an evil motive and want of justification in view of all the
circumstances. Id. at 317 U. S. 498. Willfulness
"involves a specific intent which must be proven by independent evidence, and which cannot be
inferred from the mere understatement of income."

Holland v. United States, 348 U. S. 121, 348 U. S. 139.

We believe that the element of willfulness could not be proven in a criminal prosecution for
failing to include embezzled funds in gross income in the year of misappropriation so long as the
statute contained the gloss placed upon it by Wilcox at the time the alleged crime was
Page 366 U. S. 222
committed. Therefore, we feel that petitioner's conviction may not stand, and that the indictment
against him must be dismissed.
Since MR. JUSTICE HARLAN, MR. JUSTICE FRANKFURTER, and MR. JUSTICE CLARK
agree with us concerning Wilcox, that case is overruled. MR. JUSTICE BLACK, MR. JUSTICE
DOUGLAS, and MR. JUSTICE WHITTAKER believe that petitioner's conviction must be
reversed and the case dismissed for the reasons stated in their opinions.
Accordingly, the judgment of the Court of Appeals is reversed, and the case is remanded to the
District Court with directions to dismiss the indictment.
It is so ordered.
[Footnote 1]
" 22. GROSS INCOME."
"(a) General definitions. -- 'Gross income' includes gains, profits, and income derived from
salaries, wages, or compensation for personal service . . . of whatever kind and in whatever
form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings
in property, whether real or personal, growing out of the ownership or use of or interest in such
property; also from interest, rent, dividends, securities, or the transaction of any business
carried on for gain or profit, or gains or profits and income derived from any source whatever. . .
."
(26 U.S.C. (1952 ed.) 22(a).)
[Footnote 2]
" 61. Gross Income Defined."
"(a) General Definition. -- Except as otherwise provided in this subtitle, gross income means all
income from whatever source derived. . . ."
(26 U.S.C. 61(a).)
[Footnote 3]

Petitioner has pleaded guilty to the offense of conspiracy to embezzle in the Court of Essex
County, New Jersey.
[Footnote 4]
" 145. Penalties."
"* * * *"
"(b) Failure to Collect and Pay Over Tax, or Attempt to Defeat or Evade Tax. -- Any person
required under this chapter to collect, account for, and pay over any tax imposed by this
chapter, who willfully fails to collect or truthfully account for and pay over such tax, and any
person who willfully attempts in any manner to evade or defeat any tax imposed by this chapter
or the payment thereof, shall, in addition to other penalties provided by law, be guilty of a felony
and, upon conviction thereof, be fined not more than $10,000 or imprisoned for not more than
five years, or both, together with the costs of prosecution."
(26 U.S.C. (1952 ed.) 145(b).)
[Footnote 5]
" 7201. Attempt to Evade or Defeat Tax."
"Any person who willfully attempts in any manner to evade or defeat any tax imposed by this
title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a
felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not
more than 5 years, or both, together with the costs of prosecution."
26 U.S.C. 7201.
[Footnote 6]
The dissenters in Rutkin stated that the Court had rejected the Wilcox interpretation of
22(a). Id. at 343 U. S. 140.
[Footnote 7]
The Government contends that the adoption in Wilcox of a claim of right test as a touchstone of
taxability had no support in the prior cases of this Court; that the claim of right test was a
doctrine invoked by the Court in aid of the concept of annual accounting, to determine when, not
whether, receipts constituted income. See North American Oil Consolidated v. Burnet, 286 U. S.
417; United States v. Lewis, 340 U. S. 590; Healy v. Commissioner, 345 U. S. 278. In view of
our reasoning set forth below, we need not pass on this contention. The use to which we put the
claim of right test here is only to demonstrate that, whatever its validity as a test of whether
certain receipts constitute income, it calls for no distinction between Wilcox and Rutkin.

[Footnote 8]
In Marienfeld v. United States, 214 F.2d 632, the Eighth Circuit stated, "We find it difficult to
reconcile the Wilcox case with the later opinion of the Supreme Court in Rutkin. . . ." Id. at 636.
The Second Circuit announced, in United States v. Bruswitz, 219 F.2d 59, "It is difficult to
perceive what, if anything, is left of the Wilcox holding after Rutkin. . . ." Id. at 61. The Seventh
Circuit's prior decision in Macias v. Commissioner, 255 F.2d 23, observed,
"If this reasoning [of Rutkin] had been employed in Wilcox, we see no escape from the
conclusion that the decision in that case would have been different. In our view, the Court
in Rutkin repudiated its holding in Wilcox; certainly it repudiated the reasoning by which the
result was reached in that case."
Id. at 26.
[Footnote 9]
For example, Kann v. Commissioner, 210 F.2d 247, was differentiated on the following grounds:
the taxpayer was never indicted or convicted of embezzlement; there was no adequate proof
that the victim did not forgive the misappropriation; the taxpayer was financially able to both pay
the income tax and make restitution; the taxpayer would have likely received most of the
misappropriated money as dividends. In Marienfeld v. United States, supra, the court believed
that the victim was not likely to repudiate. In United States v. Wyss, 239 F.2d 658, the
distinguishing factors were that the district judge had not found as a fact that the taxpayer
embezzled the funds, and the money had not as yet been reclaimed by the victim.See also
Briggs v. United States, 214 F.2d 699, 702; Prokop v. Commissioner, 254 F.2d 544, 554555. Cf. J. J. Dix, Inc. v. Commissioner, 223 F.2d 436.
[Footnote 10]
Petitioner urges upon us the case of Alison v. United States, 344 U. S. 167. But that case dealt
with the right of the victim of an embezzlement to take a deduction, under 23(e) and (f) of the
1939 Code, in the year of the discovery of the embezzlement, rather than the year in which the
embezzlement occurred. The Court held only
"that the special factual circumstances found by the District Courts in both these cases justify
deductions under I.R.C., 23(e) and (f) and the longstanding Treasury Regulations applicable
to embezzlement losses."
Id. at 344 U. S. 170. The question of inclusion of embezzled funds in "gross income" was not
presented in Alison.
[Footnote 11]
H.R. 8854, 86th Cong., 1st Sess.

MR. JUSTICE BLACK, whom MR. JUSTICE DOUGLAS joins, concurring in part and dissenting
in part.
On February 25, 1946, fifteen years ago, this Court, after mature consideration, and in
accordance with what at that time represented the most strongly supported judicial view, held, in
an opinion written by Mr. Justice Murphy to which only one Justice dissented, that money
secretly taken by an embezzler for his own use did not constitute a taxable gain to him under
the federal income tax laws. Commissioner v. Wilcox, 327 U. S. 404. The Treasury Department
promptly accepted this ruling in a bulletin declaring that the "mere act of embezzlement does
not, of itself, result in taxable income," although properly urging that "taxable income may result
to the embezzler depending on the facts in the particular case." [Footnote 2/1]
Page 366 U. S. 223
During the fifteen years since Wilcox was decided, both this Court and Congress, although
urged to do so, have declined to change the Wilcox interpretation of statutory "income" with
respect to embezzlement. In this case, however, a majority of the Court overrules Wilcox. Only
three of the members of the Court who decided the Wilcox case are participating in this case -MR. JUSTICE FRANKFURTER, MR. JUSTICE DOUGLAS, and myself. MR. JUSTICE
DOUGLAS and I dissent from the Court's action in "overruling" Wilcox and from the prospective
way in which this is done. We think Wilcox was sound when written, and is sound now.
I
We dissent from the way the majority of the Court overrules Wilcox. If the statutory interpretation
of "taxable income" in Wilcox is wrong, then James is guilty of violating the tax evasion statute,
for the trial court's judgment establishes that he embezzled funds and willfully refrained from
reporting them as income. It appears to us that District Courts are bound to be confused as to
what they can do hereafter in tax evasion cases involving "income" from embezzlements
committed prior to this day. Three Justices vote to overrule Wilcox under what we believe to be
a questionable formula, at least a new one in the annals of this Court, and say that, although
failure to report embezzled funds has, despite Wilcox, always been a crime under the statute,
people who have violated this law in the past cannot be prosecuted, but people who embezzle
funds after this opinion is announced can be prosecuted for failing to report these funds as a
"taxable gain." Three other Justices who vote to overrule Wilcox say that past embezzlers can
be prosecuted for the crime of tax evasion, although two of those Justices believe the
Government must prove that the past embezzler did not commit his crime in reliance on Wilcox.
Page 366 U. S. 224
Thus, although it was not the law yesterday, it will be the law tomorrow that funds embezzled
hereafter are taxable income; and although past embezzlers could not have been prosecuted
yesterday, maybe they can and maybe they cannot be prosecuted tomorrow for the crime of tax
evasion. (The question of the civil tax liability of past embezzlers is left equally unclear.) We do

not challenge the wisdom of those of our Brethren who refuse to make the Court's new tax
evasion crime applicable to past conduct. This would be good governmental policy even though
the ex post facto provision of the Constitution has not ordinarily been thought to apply to judicial
legislation. Our trouble with this aspect of the Court's action is that it seems to us to indicate that
the Court has passed beyond the interpretation of the tax statute and proceeded substantially to
amend it.
We realize that there is a doctrine with wide support to the effect that ,under some
circumstances, courts should make their decisions as to what the law is apply only
prospectively. [Footnote 2/2] Objections to such a judicial procedure, however, seem to us to
have peculiar force in the field of criminal law. In the first place, a criminal statute that is so
ambiguous in scope that an interpretation of it brings about totally unexpected results, thereby
subjecting people to penalties and punishments for conduct which they could not know was
criminal under existing law, raises serious questions of unconstitutional vagueness. [Footnote
2/3] Moreover, for a court to interpret a criminal statute in such a way as to make punishment for
past conduct under it so unfair and unjust that the interpretation should be given only
prospective application seems to us to be the creation of a judicial crime that Congress might
not want
Page 366 U. S. 225
to create. This country has never been sympathetic with judge-created crimes. Their rejection
under our Constitution was said to have been "long since settled in public opinion" even as early
as 1812, when the question first reached this Court in United States v. Hudson & Goodwin, 7
Cranch 32. In that case, this Court emphatically declared that the federal courts have no
common law jurisdiction in criminal cases. They are not "vested with jurisdiction over any
particular act done by an individual in supposed violation of the peace and dignity of the
sovereign power." Rather,
"[t]he legislative authority of the Union must first make an act a crime, affix a punishment to it,
and declare the Court that shall have jurisdiction of the offence. [Footnote 2/4]"
In our judgment, one of the great inherent restraints upon this Court's departure from the field of
interpretation to enter that of lawmaking has been the fact that its judgments could not be limited
to prospective application. This Court, and, in fact, all departments of the Government, have
always heretofore realized that prospective lawmaking is the function of Congress, rather than
of the courts. We continue to think that this function should be exercised only by Congress
under the constitutional system.
II
We think Wilcox was right when it was decided, and is right now. It announced no new, novel
doctrine. One need only look at the Government's briefs in this Court in the Wilcox case to see
just how little past judicial support could then be mustered had the Government sought to send

Wilcox to jail for his embezzlement under the guise of a tax evasion prosecution. The
Government did cite many cases from many courts saying that, under the federal income tax
law, gains are no less taxable because
Page 366 U. S. 226
they have been acquired by illegal methods. This Court had properly held long
before Wilcox that there is no "reason why the fact that a business is unlawful should exempt it
from paying the taxes that, if lawful, it would have to pay." [Footnote 2/5] We fully recognize the
correctness of that holding in Wilcox:
"Moral turpitude is not a touchstone of taxability. The question, rather, is whether the taxpayer in
fact received a statutory gain, profit or benefit. That the taxpayer's motive may have been
reprehensible or the mode of receipt illegal has no bearing upon the application of Section
22(a). [Footnote 2/6]"
The Court today by implication attributes quite a different meaning or consequence to
the Wilcox opinion. One opinion argues at length the "well established principle . . . that
unlawful, as well as lawful, gains are comprehended within the term gross income.'" Wilcox did
not deny that; we do not deny that. This repeated theme of our Brethren is wholly irrelevant,
since the Wilcox holding in no way violates the sound principle of treating "gains" of honest and
dishonest taxpayers alike. The whole basis of the Wilcox opinion was that an embezzlement is
not in itself "gain" or "income" to the embezzler within the tax sense, for the obvious reason that
the embezzled property still belongs, and is known to belong, to the rightful owner. It is thus a
mistake to argue that petitioner's contention is "that all unlawful gains are taxable except those
resulting from embezzlement."
As stated in Wilcox, that case was brought to us because of a conflict among the Circuits. The
Ninth Circuit in Wilcox had held that embezzled funds were not any more "taxable income" to
the embezzler than
Page 366 U. S. 227
borrowed funds would have been. [Footnote 2/7] The Fifth Circuit, in McKnight v.
Commissioner, had decided the same thing. [Footnote 2/8] The Eighth Circuit, however, had
decided in Kurrle v. Helvering that embezzled funds were taxable income. [Footnote 2/9]
Comparison of the three opinions readily shows that the arguments of the Fifth and Ninth
Circuits against taxability of such funds were much stronger than the arguments of the Eighth
Circuit for such taxability. The whole picture can best to obtained from the court's opinion
in McKnight v. Commissioner, written by Judge Sibley, one of the ablest circuit judges of his
time. He recognized that the taxpayer could not rely upon the unlawfulness of his business to
defeat taxation if he had made a "gain" in that business. He pointed out, however, that the
ordinary embezzler

"got no title, void or voidable, to what he took. He was still in possession as he was before, but
with a changed purpose. He still had no right nor color of right. He claimed none. [Footnote
2/10]"
Judge Silbley's opinion went on to point out that the
"first takings [of an embezzler] are, indeed, nearly always with the intention of repaying, a sort of
unauthorized borrowing. It must be conceded that no gain is realized by borrowing, because of
the offsetting obligation. [Footnote 2/11]"
Approaching the matter from a practical standpoint, Judge Sibley also explained that subjecting
the embezzled funds to a tax would amount to allowing the United States "a preferential claim
for part of the dishonest gain, to the direct loss and detriment of those to whom it ought to be
restored." [Footnote 2/12] He was not willing to put the owner of
Page 366 U. S. 228
funds that had been stolen in competition with the United States Treasury Department as to
which one should have a preference to get those funds.
It seems to us that Judge Sibley's argument was then, and is now, unanswerable. The rightful
owner who has entrusted his funds to an employee or agent has troubles enough when those
funds are embezzled, without having the Federal Government step in with its powerful claim that
the embezzlement is a taxable event automatically subjecting part of those funds (still belonging
to the owner) to the waiting hands of the Government's tax gatherer. We say part of the owner's
funds because it is on the supposed "gain" from them that the embezzler is now held to be dutybound to pay the tax, and history probably records few instances of independently wealthy
embezzlers who have had nonstolen assets available for payment of taxes.
There has been nothing shown to us on any of the occasions when we have considered this
problem to indicate that Congress ever intended its income tax laws to be construed as
imposing what is in effect a property or excise tax on the rightful owner's embezzled funds, for
which the owner has already once paid income tax when he rightfully acquired them. In our
view, the Court today does Congress a grave injustice by assuming that it has imposed this
double tax burden upon the victim of an embezzlement merely because someone has stolen his
money, particularly when Congress has refused requests that it do so. The owner whose funds
have been embezzled has done nothing but entrust an agent with possession of his funds for
limited purposes, as many of us have frequent occasion to do in the course of business or
personal affairs. Ordinarily the owner is not, and has no reason to be, at all aware of an
embezzlement until long after the first misuse occurs. If Congress ever did manifest an intention
to select the mere fact of embezzlement
Page 366 U. S. 229

as the basis for imposing a double tax on the owner, we think a serious question of confiscation
in violation of the Fifth Amendment would be raised. All of us know that, with the strong lien
provisions of the federal income tax law, an owner of stolen funds would have a very rocky road
to travel before he got back, without paying a good slice to the Federal Government, such funds
as an embezzler who had not paid the tax might, perchance, not have dissipated. An illustration
of what this could mean to a defrauded employer is shown in this very case by the employer's
loss of some $700,000, upon which the Government claims a tax of $559,000.
It seems to be implied that one reason for overruling Wilcox is that a failure to hold embezzled
funds taxable would somehow work havoc with the public revenue or discriminate against
"honest" taxpayers and force them to pay more taxes. We believe it would be impossible to
substantiate either claim. Embezzlers ordinarily are not rich people against whom judgments,
even federal tax judgments, can be enforced. Judging from the meager settlements that those
defrauded were apparently compelled to make with the embezzlers in this very case, it is hard
to imagine that the Treasury will be able to collect the more than $500,000 it claims. And
certainly the Wilcox case does not seem to have been one in which the Government could have
collected any great amount of tax. The employer's embezzled $11,000 there went up in
gambling houses. The scarcity of cases involving alleged taxes due from embezzlers is another
indication that the Government cannot expect to make up any treasury deficits with taxes
collected from embezzlers and thieves, especially when the cost to the Government of
investigations and court proceedings against suspected individuals is considered. And, as
already indicated, to the extent that the Government could be successful in collecting some
taxes from
Page 366 U. S. 230
embezzlers, it would most likely do so at the expense of the owner whose money had been
stolen.
It follows that, except for the possible adverse effect on rightful owners, the only substantial
result that one can foresee from today's holding is that the Federal Government will, under the
guise of a tax evasion charge, prosecute people for a simple embezzlement. But the
Constitution grants power to Congress to get revenue, not to prosecute local crimes. And if
there is any offense which, under our dual system of government, is a purely local one which
the States should handle, it is embezzlement or theft. The Federal Government stands to lose
much money by trying to take over prosecution of this type of local offense. It is very doubtful
whether the further congestion of federal court dockets to try such local offenses is good for the
Nation, the States or the people. Here, the embezzler has already pleaded guilty to the crime of
embezzlement in a state court, although the record does not show what punishment he has
received. Were it not for the novel formula of applying the Court's new law prospectively,
petitioner would have to serve three years in federal prison in addition to his state sentence.
This graphically illustrates one of the great dangers of opening up the federal tax statutes, or
any others, for use by federal prosecutors against defendants who not only can be but are tried
for their crimes in local state courts and punished there. If the people of this country are to be

subjected to such double jeopardy and double punishment, despite the constitutional command
against double jeopardy, it seems to us it would be far wiser for this Court to wait and let
Congress attempt to do it.
III
The Wilcox case was decided fifteen years ago. Congress has met every year since then. All of
us know that the House and Senate Committees responsible for our
Page 366 U. S. 231
tax laws keep a close watch on judicial rulings interpreting the Internal Revenue Code. Each
committee has one or more experts at its constant disposal. It cannot possibly be denied that
these committees and these experts are, and have been, fully familiar with the Wilcox holding.
When Congress is dissatisfied with a tax decision of this Court, it can and frequently does act
very quickly to overturn it. [Footnote 2/13] On one occasion, such an overruling enactment was
passed by both the House and Senate and signed by the President all within one day after the
decision was rendered by this Court. [Footnote 2/14] In 1954, Congress, after extended study,
completely overhauled and recodified the Internal Revenue Code. The Wilcox holding was left
intact. In the Eighty-sixth Congress, and in the present Eighty-seventh Congress, bills have
been introduced to subject embezzled funds to income taxation. [Footnote 2/15] They have not
been passed. This is not an instance when we can say that Congress may have neglected to
change the law because it did not know what
Page 366 U. S. 232
was going on in the courts or because it was not asked to do so, as was the case in Helvering v.
Hallock. [Footnote 2/16] Nor is this a case in which subsequent affirmative congressional action
manifested a view inconsistent with our prior decision, as was true in Girouard v. United
States. [Footnote 2/17] What we have here, instead, is a case in which Congress has not
passed bills that have been introduced to make embezzled funds taxable and thereby make
failure to report them as income a federal crime. For this Court to hold under such
circumstances that the inherent ambiguity of legislative inaction gives the Court license to
repudiate the longstanding interpretation of the income tax statute, and thereby bring additional
conduct within the tax evasion criminal statute, seems to us to be flagrantly violative of the
almost universally accepted axiom that criminal statutes are narrowly and strictly construed. Our
Brethren cite no precedent in which this or any other court in the English-speaking world has so
deliberately overruled a longstanding prior interpretation of a statute in order to create a crime
which up to that time did not exist.
This Court, as well as Congress, was fully apprised of the various criticisms made in some
Courts of Appeals opinions and elsewhere against the Wilcox holding, yet it has likewise, until
today, steadfastly refused to overrule that holding during these fifteen years. This has been in

the face of the fact that the Government expressly urged that we do so in 1955, nine years
after Wilcox was decided
Page 366 U. S. 233
and three years after the decision in Rutkin v. United States, 343 U. S. 130. On that occasion,
the Court of Appeals for the Second Circuit, speaking through Judge Frank for himself and
Judge Medina, had held in the case of J. J. Dix, Inc. v. Commissioner that embezzled funds
were not taxable as income, relying wholly on the Wilcox decision. [Footnote 2/18] Judge Hincks
dissented, saying that, if the facts of Dix were not enough to distinguish it from Wilcox, he would
not follow Wilcox. In urging us to grant certiorari, the Government said that the case presented a
recurring problem in the administration of the income tax laws. One of the arguments the
Government presented for overruling Wilcox, strange as it may seem, was that
"[s]everal prosecutions have recently been authorized and are now pending in various District
Courts, even though the disputed income in those cases apparently came from embezzlements
or closely analogous crimes. [Footnote 2/19]"
And the next to the last sentence of its petition was:
"In short, the question whether the proceeds of embezzlement, unlike other illegal income, are
to enjoy a preferred tax-exempt status will continue to perplex the lower courts until it is settled
by this Court. [Footnote 2/20]"
We denied certiorari. [Footnote 2/21] There is surely less reason to repudiate and
"devitalize" Wilcox now, six years after the Court, as composed at that time, refused to overrule
it.
Of course, the rule of stare decisis is not and should not be an inexorable one. This is
particularly true with reference to constitutional decisions involving determinations beyond the
power of Congress to change, but Congress can and does change statutory interpretations. It
Page 366 U. S. 234
is perfectly proper and right that it should do so when it believes that this Court's interpretation
of a statute embodies a policy that Congress is against. But Congress has not taken favorable
action on bills introduced to overturn our Wilcox holding even after we declined the
Government's request to reverse the identical holding in Dix, the latter having occurred three
years after the decision in Rutkin which our Brethren now say may have misled Congress into
thinking that we had repudiated the Wilcox holding.
It seems to us that we gave the doctrine of stare decisis its proper scope in our treatment of this
Court's decision in Federal Baseball Club v. National League of Professional Baseball
Clubs, 259 U. S. 200. In that case, this Court had held, for reasons given, that professional
baseball was not covered by the antitrust acts. Congress was asked through the years to

change the law in this respect, but declined to do so. In Toolson v. New York Yankees, Inc., 346
U. S. 356, we followed the holding of that case without reexamination of the underlying issues
"so far as that decision determines that Congress had no intention of including the business of
baseball within the scope of the federal antitrust laws."
Later, we were asked to extend the Federal Baseball case and to hold that the business of
boxing could not, without congressional action, be brought within the antitrust laws. We
emphatically declined to do so in United States v. International Boxing Club, 348 U. S. 236, nor
did we overrule Toolson in that case, despite strong arguments that the reasoning of the Court
in the first baseball case was equally applicable to the business of boxing. We said about the
proposed exemption of boxing from the antitrust laws that "[t]heir remedy, if they are entitled to
one, lies in further resort to Congress." [Footnote 2/22] That case and that statement fit this
case precisely. In fact, as we are about to explain, a
Page 366 U. S. 235
far more meaningful distinction can be made between embezzlement and extortion for purposes
of this case than it was possible to make between baseball and boxing for purposes of that
case, as MR. JUSTICE FRANKFURTER's dissenting opinion in that case demonstrates.
If the Government wants to prosecute the local crime of embezzlement, ostensibly because of
"tax evasion," it seems clear to us that it should take its request to Congress, which has power
to pass on it and which has, to date, refused to do what the Government asks us to do in this
case.
IV
Our Brethren advance as a reason for overruling Wilcox the 1952 decision in Rutkin v. United
States, which was decided three years before we denied certiorari in the Dix case. They say
that "the reasoning used in Rutkin leads us inescapably to the conclusion that Wilcox was
thoroughly devitalized." This follows, to some extent, the statement in the Government's brief
that
"Wilcox and Rutkin cannot be reconciled on the basis of asserted technical differences between
the extortionist and the embezzler. . . . The proper course, we submit, . . . is to recognize that
the Wilcox rationale was rejected in Rutkin, is unsound, and can no longer be regarded as
having vitality. Embezzled funds represent taxable gains. [Footnote 2/23]"
There is no doubt that some of the reasoning in the Rutkin opinion rejected some of the
reasoning in the Wilcox opinion. But this it true only with respect to the broad general standards
formulated in the two cases, and such standards, of course, cannot be accepted as universal
panaceas to be mechanically applied to solve all the concrete problems in cases like these.
Moreover, the Rutkin opinion expressly purported not to overrule Wilcox and

Page 366 U. S. 236

specifically said that Wilcox was still to govern cases fitting its facts, clearly meaning
embezzlement cases. [Footnote 2/24] And the Government had not asked
in Rutkin that Wilcox be overruled. Its argument was that Wilcox was "inapplicable" to the facts
in the Rutkin record. The Government's brief went on to emphasize that the record
in Wilcox showed only the bare receipt of money wholly belonging to another, while Rutkin had
received the money "as a result of a bilateral agreement" and, as the Court of Appeals had
pointed out,
"with a 'semblance of a bona fide claim of right,' a conclusion fully substantiated by the
testimony of both the petitioner and the Government witness Reinfeld. [Footnote 2/25]"
The Government went on to distinguish Rutkin further by pointing out that there was "not the
slightest hint in the record" that Rutkin ever had an obligation to repay the funds he took.
After this Court was persuaded by the Government in Rutkin to accept its distinctions
between Rutkin and Wilcox, it seems rather odd to have the Government now contend that the
two cases are irreconcilable. While we disagreed, we can understand why the majority in Rutkin
Page 366 U. S. 237
drew the distinctions it did. Although the victim of either embezzlement or extortion ordinarily
has a legal right to restitution, the extortion victim, like a blackmail victim, can in a sense be
charged with complicity in bringing about the taxable event in that he knowingly surrendered the
funds to the extortionist, sometimes in payment of an actual obligation. Unlike the victim of an
ordinary theft, he generally knows who has taken the property from him, and he consents to the
taking though under duress; and unlike most victims of embezzlement, he is able to report the
taking to law enforcement officers during the taxable year, and his failure to do so might be
considered a kind of continuing consent to the extortionist's dominion over the property. The
longer he acquiesces, the less likely it becomes that the extortion victim ever will demand
restitution; [Footnote 2/26] but once the victim of an embezzlement finds out that his property
has been stolen, he most likely will immediately make efforts to get it back. Thus, although we
still think Rutkin was wrongly decided for the reasons expressed in the dissenting opinion in that
case, we can understand the argument for application of a sort of caveat emptor rule to persons
who submit to blackmail or extortion, since it is far from certain that they will ever expose
themselves by seeking repayment of what they paid out. The distinctions between crimes like
embezzlement and crimes like blackmail and extortion, therefore, are not merely
Page 366 U. S. 238
technical, legalistic "attenuated subleties" for purposes of this decision, but are differences
based upon practicalities such as often underlie the distinctions that have been developed in our
law.

In departing from both the Wilcox and Rutkin decisions today, our Brethren offer no persuasive
reasons to prove that their judgment in overruling Wilcox is better than that of the Justices who
decided that case. It contributes nothing new to the analysis of this problem to say repeatedly
that the dishonest man must be subject to taxation, just as the honest. As already said, Chief
Justice Stone and the others sitting with him on the Wilcox Court fully accepted that general
principle, and we do still. Applying it here, we would say the embezzler should be treated just
like the law-abiding, honest borrower who has obtained the owner's consent to his use of the
money. [Footnote 2/27] It
Page 366 U. S. 239
would be unthinkable to tax the borrower on his "gain" of the borrowed funds, and thereby
substantially impair the lender's chance of ever recovering the debt. The injury that the
Government would inflict on the lender by making the borrower less able to repay the loan
surely would not be adequately compensated by telling the lender that he can take a tax
deduction for the loss, and it is equally small comfort to the embezzlement victim for the
Government, after taking part of his property as a tax on the embezzler, to tell the victim that he
can take a deduction for his loss if he has any income against which to offset the deduction.
There is, of course, one outstanding distinction between a borrower and an embezzler, and that
is that the embezzler uses the funds without the owner's consent. This distinction can be of no
importance for purposes of taxability of the funds, however, because, as a matter of common
sense, it suggests that there is, if anything, less reason to tax the embezzler than the borrower.
But if this distinction is to be the reason why the embezzlement must be taxed just as "the gains
of the honest laborer," then the use of this slogan in this case is laid bare as no more than a
means of imposing a second punishment for the crime of embezzlement without regard to
revenue considerations, the effect on the rightful owner, or the proper role of this Court when
asked to overrule a criminal statutory precedent. The double jeopardy implications would seem
obvious, [Footnote 2/28]
Page 366 U. S. 240
and discussion of the serious inadvisability for other reasons of thus injecting the Federal
Government into local law enforcement can be found in the dissenting opinion in Rutkin.
We regret very much that it seems to be implied that the writer of the Rutkin opinion and those
who agreed to it intended to overrule Wilcox when it is manifest that the language the Court
used in Rutkin was meant to leave precisely the opposite impression. We are sure that our
Brethren at that time did not intend to mislead the public, and it would be hard to imagine why
they said what they did in the Rutkin opinion had they not specifically considered and rejected
the possibility of overruling Wilcox then and there. We think it is unjustifiable to say nine years
after Rutkin that it "devitalized" or "repudiated" the Wilcox holding when the Rutkin opinion said
explicitly that Wilcox is still the rule as to embezzlement. Congress has seen fit to let both
decisions stand, and we think the present Court should do the same.

V
Even if we were to join with our Brethren in accepting the Government's present contention
that Wilcox and Rutkin cannot both stand, we would disagree as to which of the two decisions
should now be repudiated. This is true not only because we would feel less inhibition about
narrowing, rather than broadening, the reach of a previously construed criminal statute.
Regardless of such considerations, our conviction that the Rutkin case was wrongly decided in
this Court remains undiminished and has been further substantiated by the subsequent events
in that controversy, which show all the more clearly the deplorable consequences that can result
when federal courts subject people who violate state criminal laws to
Page 366 U. S. 241
a double or treble prosecution for the state crime under the guise of attempted enforcement of
federal tax laws. [Footnote 2/29]
For the foregoing reasons, as well as the reasons stated in MR. JUSTICE WHITTAKER's
opinion, we would reaffirm our holding in Commissioner v. Wilcox, reverse this judgment and
direct that the case be dismissed.
[Footnote 2/1]
G.C.M. No. 24945, 1946-2 Cum.Bull. 27, 28. This was precisely in accord with this Court's
statement of the proper rule in the Wilcox opinion:
"Taxable income may arise, to be sure, from the use or in connection with the use of such
[embezzled] property. . . . But, apart from such factors, the bare receipt of property or money
wholly belonging to another lacks the essential characteristics of a gain or profit within the
meaning of Section 22(a)."
327 U.S. at 327 U. S. 408.
[Footnote 2/2]
See, for example, Great Northern R. Co. v. Sunburst Oil & Refining Co., 287 U. S. 358.
[Footnote 2/3]
See, for example, United States v. L. Cohen Grocery Co., 255 U. S. 81.
[Footnote 2/4]
7 Cranch at 11 U. S. 34. And see United States v. Coolidge, 1 Wheat. 415.
[Footnote 2/5]

United States v. Sullivan, 274 U. S. 259, 274 U. S. 263.

[Footnote 2/6]
327 U.S. at 327 U. S. 408.
[Footnote 2/7]
Wilcox v. Commissioner, 148 F.2d 933.
[Footnote 2/8]
127 F.2d 572.
[Footnote 2/9]
126 F.2d 723.
[Footnote 2/10]
127 F.2d at 573.
[Footnote 2/11]
Ibid. The same reasoning can be found in our opinion in Alison v. United States, 344 U. S.
167, 344 U. S. 169-170.
[Footnote 2/12]
127 F.2d at 574.
[Footnote 2/13]
E.g., Commissioner v. Smith, 324 U. S. 177 (compensation through exercise of stock option),
led to 218 of the Revenue Act of 1950, adding 130A to the 1939 Code; Commissioner v.
Tower, 327 U. S. 280; Lusthaus v. Commissioner, 327 U. S. 293; and Commissioner v.
Culbertson, 337 U. S. 733 (family partnerships), led to 340 of the Revenue Act of 1951,
adding 191 to the 1939 Code; United States v. Silk, 331 U. S. 704 ("employees" for purpose of
Social Security employment tax), led to the Joint Resolution of June 14, 1948, c. 468, 62 Stat.
438, amending several sections of the 1939 Code; Commissioner v. Estate of Church, 335 U. S.
632, and Estate of Spiegel v. Commissioner, 335 U. S. 701 (estate tax), led to the Act of
October 25, 1949, 7, 63 Stat. 891, 894, amending 811(c) of the 1939 Code; Wilmette Park
Dist. v. Campbell, 338 U. S. 411 (amusement tax), led to 402 of the Revenue Act of 1951,
adding 1701(d) to the 1939 Code; Commissioner v. Korell, 339 U. S. 619 (amortization of

bond premium), led to 217 of the Revenue Act of 1950, amending 125(b)(1) of the 1939
Code.
[Footnote 2/14]
46 Stat. 1516; see 74 Cong.Rec. 7078-7079, 7198-7199.
[Footnote 2/15]
H.R. 8854, 86th Cong., 1st Sess.; H.R. 312, 87th Cong., 1st Sess.
[Footnote 2/16]
"To explain the cause of nonaction by Congress when Congress itself sheds no light is to
venture into speculative unrealities. Congress may not have had its attention directed to an
undesirable decision; and there is no indication that, as to the St. Louis Trust cases, it had, even
by any bill that found its way into a committee pigeonhole."
309 U. S. 309 U.S. 106, 309 U. S. 119-120. (Emphasis supplied.)
[Footnote 2/17]
"Thus, the affirmative action taken by Congress in 1942 negatives any inference that otherwise
might be drawn from its silence when it reenacted the oath in 1940."
328 U. S. 328 U.S. 61, 328 U. S. 70.
[Footnote 2/18]
223 F.2d 436.
[Footnote 2/19]
Petition for certiorari, p. 14, n. 6, Commissioner v. Estate of Dix, 350 U.S. 894.
[Footnote 2/20]
Id. at 15.
[Footnote 2/21]
350 U.S. 894.
[Footnote 2/22]

348 U.S. at 348 U. S. 244.

[Footnote 2/23]
Brief for the United States, pp. 32-33.
[Footnote 2/24]
"We do not reach in this case the factual situation involved in Commissioner v. Wilcox, 327 U. S.
404. We limit that case to its facts. There, embezzled funds were held not to constitute taxable
income to the embezzler under 22(a). The issue here is whether money extorted from a victim
with his consent induced solely by harassing demands and threats of violence is included in the
definition of gross income under 22(a)."
343 U.S. at 343 U. S. 138.
[Footnote 2/25]
Brief for the United States in Opposition to Petition for Certiorari, Rutkin v. United States, 343 U.
S. 130, pp. 13-14. The full sentence in the Court of Appeals opinion from which the Government
quoted was:
"So he [Rutkin] did receive the money with a 'semblance of a bona fide claim of right,' as the
embezzler had not in Commissioner of Internal Revenue v. Wilcox, supra, at 327 U. S. 408."
United States v. Rutkin, 189 F.2d 431, 435.
[Footnote 2/26]
This factual distinction was clearly emphasized in the Court's opinion in Rutkin:
"[Rutkin] induced Reinfeld to consent to pay the money by creating a fear in Reinfeld that harm
otherwise would come to him and to his family. Reinfeld thereupon delivered his own money to
petitioner. Petitioner's control over the cash so received was such that, in the absence of
Reinfeld's unlikely repudiation of the transaction and demand for the money's return, petitioner
could enjoy its use as fully as though his title to it were unassailable."
Rutkin v. United States, 343 U. S. 130, 343 U. S. 136-137. (Emphasis supplied.)
[Footnote 2/27]
The analogy between the borrower and the embezzler was lucidly analyzed by Judge Sibley
in McKnight v. Commissioner, 127 F.2d 572, 573-574.

The several cases relied on by the Court do not, in our judgment, justify imposing a tax upon
embezzled money. Corliss v. Bowers, 281 U. S. 376, involved income accumulating in a trust
fund belonging to the taxpayer and over which he retained control. North American Oil
Consolidated v. Burnet, 286 U. S. 417; United States v. Lewis, 340 U. S. 590; and Healy v.
Commissioner, 345 U. S. 278, were cases in which the taxpayer had asserted a bona
fide, though mistaken, claim of right. In North American Oil, the taxpayer not only had a bona
fide claim to the money taxed, but there had been an adjudication that he was entitled to it, and
there was only the tenuous possibility that a competing claimant might later upset that
adjudication. The Lewis and Healy cases involved a tax on payments made and received as a
result of mutual mistake, and it was held that the administration of the tax laws on an annual
basis need not be upset for the convenience of those who caused the mistaken payments to be
made and reported as income. By contrast, the victims do not cause embezzlements, and the
Government is not misled or inconvenienced under Wilcox, because the embezzler is always
fully aware that the embezzled funds are not rightfully his, and presumably will not report
otherwise.
[Footnote 2/28]
See the dissenting opinion in Bartkus v. Illinois, 359 U. S. 121, 359 U. S. 150. It is interesting to
note that, on July 22, 1959, shortly after the Bartkus decision, Illinois, in order to avoid the
danger of prosecuting men in both state and federal courts for the same crime, passed a statute
making conviction or acquittal in a federal prosecution a defense to a state prosecution for the
same criminal act. Illinois Laws, 1959, p. 1893, 1; 38 Ill.Ann.Stat. (Cum.Supp.1960) 601.1.
Thus, while Illinois is moving away from such double prosecutions, this Court is moving even
further than Bartkus in the direction of authorizing such prosecutions.
[Footnote 2/29]
The subsequent history of the Rutkin-Reinfeld controversy can, in part, be read in United States
v. Rutkin, 208 F.2d 647, especially Judge Kalodner's dissenting opinion at 655; United States v.
Rutkin, 212 F.2d 641, especially at 644; and Rutkin v. Reinfeld, 122 F.Supp. 265, reversed, 229
F.2d 248.
MR. JUSTICE CLARK, concurring in part and dissenting in part as to the opinion of THE CHIEF
JUSTICE.
Although I join in the specific overruling of Commissioner v. Wilcox, 327 U. S. 404 (1946), in
THE CHIEF JUSTICE's opinion, I would affirm this conviction on either of two grounds. I believe
that the Court not only devitalized Wilcox, by limiting it to its facts in Rutkin v. United States, 343
U. S. 130 (1952), but that, in effect, the Court overruled that case sub silentio in Commissioner
v. Glenshaw Glass Co., 348 U. S. 426 (1955). Even if that not be true, in my view, the proof
shows conclusively that petitioner, in willfully failing to correctly report his income, placed
no bona fide reliance on Wilcox.

MR. JUSTICE HARLAN, whom MR. JUSTICE FRANKFURTER joins, concurring in part and
dissenting in part as to the opinion of THE CHIEF JUSTICE.
I fully agree with so much of THE CHIEF JUSTICE's opinion as dispatches Wilcox to a final
demise. But, as to the disposition of this case, I think that, rather than an outright reversal, which
his opinion proposes, the reversal should be for a new trial.
Page 366 U. S. 242
I share the view that it would be inequitable to sustain this conviction when, by virtue of
the Rutkin-Wilcox dilemma, it might reasonably have been thought by one in petitioner's position
that no tax was due in respect of embezzled moneys. For, as is pointed out, Rutkin did not
expressly overrule Wilcox, but instead merely confined it "to its facts." Having now concluded
that Wilcox was wrongly decided originally, the problem in this case thus becomes one of how
to overrule Wilcox "in a manner that will not prejudice those who might have relied on it." 366
U.S. at 366 U. S. 221.
It is argued, in reliance on Spies v. United States, 317 U. S. 492, and Holland v. United
States, 348 U. S. 121, that, so long as Wilcox remained on the books, the element of
"willfulness" required in prosecutions of this kind [Footnote 3/1] "could not be proven," and
hence, that the conviction of this petitioner fails without more. This would mean, I take it, that no
future prosecution or past conviction involving tax derelictions of this nature, occurring during
the Wilcox period, may be brought or allowed to stand. I cannot agree to such a disposition,
which, in my view, is warranted by neither principle nor authority, and would carry mischievous
implications for the future.
The Spies and Holland cases, which are said to support outright reversal, stand for no more
than that where, as here, a criminal tax statute makes "willfulness" an element of the offense,
the Government must prove an "evil motive and want of justification in view of all the financial
circumstances" on the part of the defendant in failing to do what was required of him. While I
agree that, in the present case, this made germane on the issue of willfulness the petitioner's
reliance or nonreliance on the
Page 366 U. S. 243
continued vitality of the Wilcox doctrine, [Footnote 3/2] I can find nothing
in Spies or Holland which justifies the view that the mere existence of Wilcox suffices alone to
vitiate petitioner's conviction as a matter of law. If, as appears to have been the case, there was
erroneous failure to take that factor into account at the trial on the issue of willfulness, the most
that should happen is that petitioner should be given a new trial. This indeed is
what Spies and Holland affirmatively indicate as the right solution of the problem this case
presents. In Spies, it was said (at 317 U. S. 499-500):

". . . By way of Illustration, and not by way of limitation, we would think affirmative willful attempt
may be inferred from conduct such as keeping a double set of books, making false entries or
alterations, or false invoices or documents, destruction of books or records, concealment of
assets or covering up sources of income, handling of one's affairs to avoid making the records
usual in transactions of the kind, and any conduct, the likely effect of which would be to mislead
or to conceal. If the tax evasion motive plays any part in such conduct, the offense may be
made out even though the conduct may also serve other purposes, such as concealment of
other crime."
"In this case, there are several items of evidence, apart from the default in filing the return and
paying the tax, which the Government claims will support an inference of willful attempt to evade
or
Page 366 U. S. 244
defeat the tax. These go to establish that petitioner insisted that certain income be paid to him in
cash, transferred it to his own bank by armored car, deposited it not in his own name, but in the
names of others of his family, and kept inadequate and misleading records. Petitioner claims
other motives animated him in these matters. We intimate no opinion. Such inferences are for
the jury. If, on proper submission, the jury found these acts, taken together with willful failure to
file a return and willful failure to pay the tax, to constitute a willful attempt to defeat or evade the
tax, we would consider conviction of a felony sustainable."
To the same effect, see Holland, supra, at p. 348 U. S. 139.
In the case at hand, the evidence of devious financial arrangements might well support the
inference that petitioner's purpose was not only to commit the embezzlement, but also to
secrete and immunize his gains from what he considered to be his tax liabilities in respect of
those gains. The District Court, as the trier of the facts (there having been no jury), found that
petitioner's acts were "willful, and were done in a knowing and conscious attempt to evade and
defeat" his tax obligations. But since it does not appear that petitioner's possible reliance on
the Wilcox doctrine was considered below, Spies and Holland make it appropriate for us to send
the case back for a new trial. They do not support foreclosing the Government from even
undertaking to prove that the petitioner's conduct was "willful" in this respect.
An outright reversal is equally unsound on principle. I take it that our decisions in the tax, and
any other field, for that matter, relate back to the actual transactions with which they are
concerned, and that that is only the normal concomitant of the fact that we do not sit as an
administrative agency making rulings for the future, but rather adjudicate actual controversies as
Page 366 U. S. 245
to rights and liabilities under the laws of the United States. There can be, I think, two
justifications for barring a prosecution of this petitioner in the unusual circumstances presented

here: (1) that, by reason of Rutkin having formally left intact the Wilcox doctrine, petitioner did
not have due warning of his possible criminal liability; and (2) that the Court, in making new
"law" in Rutkin, should, like the legislature, not impose criminal liability ex post facto.
As to the first consideration, where the defendant is charged in a case like this with having
"willfully" violated the law, I believe that both reason and authority require no more than that the
trier of fact be instructed that it must take into account in determining the defendant's "evil
motive and want of justification," Spies v. United States, 317 U.S. at 317 U. S. 498, his possible
reliance on Wilcox, which not until now has this Court explicitly stated was wrongly decided. As
far as fairness to this petitioner is concerned, I do not see why that is not amply accorded by the
disposition which Spies itself exemplifies. See p. 366 U. S. 243 supra. On the other hand, if the
trier of fact, properly instructed, finds that the petitioner did not act in bona fide reliance
on Wilcox, but deliberately refused to report income and pay taxes thereon knowing of his
obligation to do so and not relying on any exception in the circumstances, I do not see why even
the strictest definition of the element of "willfulness" would not have been satisfied. Willfulness
goes to motive, and the quality of a particular defendant's motive would not seem to be affected
by the fact that another taxpayer similarly situated had a different motive.
An altogether analogous situation was presented in United States v. Murdock, 290 U. S. 389. In
that case, the respondent had been convicted of willfully failing to supply information to the
Bureau of Internal Revenue in that he relied on the possibility of state prosecution as
Page 366 U. S. 246
justifying his invoking the federal privilege against self-incrimination. The Court said in that case:
". . . He whose conduct is defined as criminal is one who 'willfully' fails to pay the tax, to make a
return, to keep the required records, or to supply the needed information. Congress did not
intend that a person, by reason of a bona fide misunderstanding as to his liability for the tax, . . .
should become a criminal by his mere failure to measure up to the prescribed standard of
conduct. . . ."
"It follows that the respondent was entitled to the charge he requested with respect to his good
faith and actual belief. Not until this court pronounced judgment in United States v.
Murdock, 284 U. S. 141, had it been definitely settled that one under examination in a federal
tribunal could not refuse to answer on account of probable incrimination under state law. The
question was involved, but not decided, in Ballman v. Fagin, 200 U. S. 186, 200 U. S. 195, and
specifically reserved in Vajtauer v. Comm'r of Immigration, 273 U. S. 103, 273 U. S. 113. The
trial court could not, therefore, properly tell the jury the defendant's assertion of the privilege
was so unreasonable and ill founded as to exhibit bad faith and establish willful wrongdoing.
This was the effect of the instructions given. We think the Circuit Court of Appeals correctly
upheld the respondent's right to have the question of absence of evil motive submitted to the
jury. . . ."

(Emphasis supplied.) It would seem that precisely the same disposition is in order in this case.
Nor do I think that distinctions in terms of the nature of the defendant's legal misapprehension,
its degree, its justifiability, or its source are either warranted or would be manageable as a basis
for deciding future cases.
Page 366 U. S. 247
Coming now to the other possible rationale for barring the prosecution of this petitioner, it might
be argued that petitioner, at the time he failed to make his return, was not under any
misapprehension as to the law, but indeed that, at the time and under the decisions of this
Court, his view of the law was entirely correct. The argument not only seems to beg the
question, but raises further questions as to the civil liability of one situated in the circumstances
of this petitioner. Petitioner's obligation here derived not from the decisions of this or any other
court, but from the Act of Congress imposing the tax. It is hard to see what further point is being
made once it is conceded that petitioner, if he was misled by the decisions of this Court, is
entitled to plead in defense that misconception. Only in the most metaphorical sense has the
law changed: the decisions of this Court have changed, and the decisions of a court interpreting
the acts of a legislature have never been subject to the same limitations which are imposed on
legislatures themselves, United States Constitution, Art, I, 9, 10, forbidding them to make
any ex post facto law, [Footnote 3/3] and, in the case of States, to impair the obligation
Page 366 U. S. 248
of a contract. Ross v. Oregon, 227 U. S. 150; New Orleans Waterworks Co. v. Louisiana Sugar
Refining Co., 125 U. S. 18.
The proper disposition of this case, in my view, is to treat as plain error, Fed.Rules Crim.Proc.
52(b), the failure of the trial court as trier of fact to consider whatever misapprehension may
have existed in the mind of the petitioner as to the applicable law in determining whether the
Government had proved that petitioner's conduct had been willful as required by the statute. On
that basis, I would send the case back for a new trial.
[Footnote 3/1]
The relevant statutes are set forth in footnotes 1-2 4-5 of THE CHIEF JUSTICE's
opinion Ante, pp. 214-215.
[Footnote 3/2]
Compare American Law Institute, Model Penal Code, tentative draft No. 4, 2.04:
"(1) Ignorance or mistake as to a matter of fact or law is a defense if:"
"(a) the ignorance or mistake negatives the purpose, knowledge, belief, recklessness or
negligence required to establish a material element of the offense. . . ."

[Footnote 3/3]
Aside from problems of warning and specific intent, the policy of the prohibition against ex post
facto legislation would seem to rest on the apprehension that the legislature, in imposing
penalties on past conduct, even though the conduct could properly have been made criminal
and even though the defendant who engaged in that conduct in the past believed he was doing
wrong (as, for instance, when the penalty is increased retroactively on an existing crime), may
be acting with a purpose not to prevent dangerous conduct generally, but to impose by
legislation a penalty against specific persons or classes of persons. That this policy is
inapplicable to decisions of the courts seems obvious: their opportunity for discrimination is
more limited than the legislature's, in that they can only act in construing existing law in actual
litigation. Given the divergent pulls of flexibility and precedent in our case law system, it is
disquieting to think what perplexities and what subtleties of distinction would be created in
applying this policy, which so properly limits legislative action, to the decisions of the courts.
MR. JUSTICE WHITTAKER, whom MR. JUSTICE BLACK and MR. JUSTICE DOUGLAS join,
concurring in part and dissenting in part.
The starting point of any inquiry as to what constitutes taxable income must be the Sixteenth
Amendment, which grants Congress the power "to lay and collect taxes on incomes, from
whatever source derived. . . ." It has long been settled that Congress' broad statutory definitions
of taxable income were intended "to use the full measure of (the Sixteenth Amendment's) taxing
power." Helvering v. Clifford, 309 U. S. 331, 309 U. S. 334; Douglas v. Willcuts, 296 U. S. 1, 296
U. S. 9. Equally well settled is the principle that the Sixteenth Amendment "is to be taken as
written, and is not to be extended beyond the meaning clearly indicated by the language
used." Edwards v. Cuba R. Co., 268 U. S. 628, 268 U. S. 631. [Footnote 4/1] The language of
the Sixteenth Amendment, as well as our prior controlling decisions,
Page 366 U. S. 249
compels me to conclude that the question now before us -- whether an embezzler receives
taxable income at the time of his unlawful taking -- must be answered negatively. Since the
prevailing opinion reaches an opposite conclusion, I must respectfully dissent from that holding,
although I concur in the Court's judgment reversing petitioner's conviction. I am convinced
that Commissioner v. Wilcox, 327 U. S. 404, which is today overruled, was correctly decided on
the basis of every controlling principle used in defining taxable income since the Sixteenth
Amendment's adoption.
THE CHIEF JUSTICE's opinion, although it correctly recites Wilcox's holding that "embezzled
money does not constitute taxable income to the embezzler in the year of the embezzlement"
(emphasis added), fails to explain or to answer the true basis of that holding. Wilcox did not hold
that embezzled funds may never constitute taxable income to the embezzler. To the contrary, it
expressly recognized that an embezzler may realize a taxable gain to the full extent of the
amount taken if and when it ever becomes his. The applicable test of taxable income, i.e., the

"presence of a claim of right to the alleged gain," of which Wilcox spoke, was but a correlative
statement of the factor upon which the decision placed its whole emphasis throughout, namely,
the "absence of a definite, unconditional obligation to repay or return [the money]." 327 U.S.
at 327 U. S. 408. In holding that this test was not met at the time of the embezzlement,
the Wilcox opinion repeatedly stressed that the embezzler had no "bona fide legal or equitable
claim" to the embezzled funds, ibid.; that the victim never "condoned or forgave the taking of the
money, and still holds him liable to restore it," id. at 327 U. S. 406; and that the "debtor-creditor
relationship was definite and unconditional." Id. at 327 U. S. 409. These statements all express
the same basic fact -- the fact which is emphasized most strongly in the opinion's conclusion
explaining
Page 366 U. S. 250
why the embezzler had not yet received taxable income:
"Sanctioning a tax under the circumstances before us would serve only to give the United
States an unjustified preference as to part of the money which rightfully and completely belongs
to the taxpayer's employer."
Id. at 327 U. S. 410. (Emphasis added.)
However, Wilcox plainly stated that, "if the unconditional indebtedness is cancelled or retired,
taxable income may adhere, under certain circumstances, to the taxpayer." 327 U.S. at 327 U.
S. 408. More specifically, it recognized that, had the embezzler's victim "condoned or forgiven
any part of the [indebtedness], the [embezzler] might have been subject to tax liability to that
extent," id. at 327 U. S. 410, i.e., in the tax year of such forgiveness.
These statements reflect an understanding of, and regard for, substantive tax law concepts
solidly entrenched in our prior decisions. Since our landmark case of United States v. Kirby
Lumber Co., 284 U. S. 1, it has been settled that, upon a discharge of indebtedness by an event
other than full repayment, the debtor realizes a taxable gain in the year of discharge to the
extent of the indebtedness thus extinguished. Such gains are commonly referred to as ones
realized through "bargain cancellations" of indebtedness, and it was in this area, and, indeed,
in Kirby Lumber Co. itself, that the "accession" theory or "economic gain" concept of taxable
income, upon which THE CHIEF JUSTICE's opinion today mistakenly relies, found its genesis.
In that case, the taxpayer, a corporation, had reduced a portion of its debt, with a corresponding
gain in assets, by purchasing its bonds in the open market at considerably less than their issue
price. Mr. Justice Holmes, who wrote the Court's opinion, found it unnecessary to state the
elementary principle that, so long as the bonds remained a fully enforceable debt obligation of
the taxpayer, there could be no taxable gain. However, when the taxpayer retired the debt by
purchasing
Page 366 U. S. 251

the bonds for less than their face value, it "made a clear [taxable] gain," and "realized within the
year an accession to income" in the amount of its bargain. 284 U.S. at 284 U. S. 3.
This doctrine has since been reaffirmed and strengthened by us, see e.g., Helvering v.
American Chicle Co., 291 U. S. 426; Commissioner v. Jacobson, 336 U. S. 28, and by the lower
federal courts in numerous decisions involving a variety of "bargain cancellations" of
indebtedness, as by a creditor's release condoning or forgiving the indebtedness in whole or in
part, [Footnote 4/2] or by the running of a statute of limitations barring the legal enforceability of
the obligation. [Footnote 4/3] In none of these cases has it been suggested that a taxable gain
might be realized by the debtor at any time prior to the effective date of discharge, and,
as Wilcox recognized, there is no rational basis on which to justify such a rule where the debt
arises through embezzlement.
An embezzler, like a common thief, acquires not a semblance of right, title, or interest in his
plunder, and, whether he spends it or not, he is indebted to his victim in the full amount taken as
surely as if he had left a signed promissory note at the scene of the crime. Of no consequence
from any standpoint is the absence of such formalities as (in the words of the prevailing opinion)
"the consensual recognition, express or implied, or an obligation to repay." The law readily
implies whatever "consensual recognition" is needed for the rightful owner to assert an
immediately ripe and enforceable obligation of
Page 366 U. S. 252
repayment against the wrongful taker. These principles are not "attenuated subtleties," but are
among the clearest and most easily applied rules of our law. They exist to protect the rights of
the innocent victim, and we should accord them full recognition and respect.
The fact that an embezzler's victim may have less chance of success than other creditors in
seeking repayment from his debtor is not a valid reason for us further to diminish his prospects
by adopting a rule that would allow the Commissioner of Internal Revenue to assert and enforce
a prior federal tax lien against that which "rightfully and completely belongs" to the
victim. Commissioner v. Wilcox, supra, at 327 U. S. 410. THE CHIEF JUSTICE's opinion quite
understandably expresses much concern for "honest taxpayers," but it attempts neither to deny
nor justify the manifest injury that its holding will inflict on those honest taxpayers, victimized by
embezzlers, who will find their claims for recovery subordinated to federal tax liens. Statutory
provisions, by which we are bound, clearly and unequivocally accord priority to federal tax liens
over the claims of others, including "judgment creditors." [Footnote 4/4]
Page 366 U. S. 253
However, if it later happens that the debtor-creditor relationship between the embezzler and his
victim is discharged by something other than full repayment, such as by the running of a statute
of limitations against the victim's claim, or by a release given for less than the full amount owed,
the embezzler, at that time, but not before, will have made a clear taxable gain and realized "an

accession to income" which he will be required, under full penalty of the law, to report in his
federal income tax return for that year. No honest taxpayer could be harmed by this rule.
The inherent soundness of this rule could not be more clearly demonstrated than as applied to
the facts of the case before us. Petitioner, a labor union official, concededly embezzled sums
totaling more than $738,000 from the union's funds over a period extending from 1951 to 1954.
When the shortages were discovered in 1956, the union at once filed civil actions against
petitioner to compel repayment. For reasons which need not be detailed here, petitioner
effected a settlement agreement with the union on July 30, 1958, whereby, in exchange for
releases fully discharging his indebtedness, he repaid to the union the sum of $13,568.50.
Accordingly, at least so far as the present record discloses, petitioner clearly realized a taxable
gain in the year the releases were executed to the extent of the difference between the amount
taken and the sum restored. However, the Government brought the present action against him
not for his failure to report this gain in his 1958 return, but for his failure to report that he had
incurred "income" from -- actually indebtedness to -- the union in each of the years 1951
through 1954. It is true that the Government brought a criminal evasion prosecution, rather than
a civil deficiency proceeding, against petitioner, but this can in no way alter the substantive tax
law rules which alone are determinative of liability in either case.
Page 366 U. S. 254
There can be no doubt that, until the releases were executed in 1958, petitioner and the union
stood in an absolute and unconditional debtor-creditor relationship, and, under all of our relevant
decisions, no taxable event could have occurred until the indebtedness was discharged for less
than full repayment. Application of the normal rule in such cases will not hinder the efficient and
orderly administration of the tax laws any more than it does in other situations involving "bargain
cancellations" of indebtedness. More importantly, it will enhance the creditor's position by
assuring that prior federal tax liens will not attach to the subject of the debt when he seeks to
recover it.
Notwithstanding all of this, THE CHIEF JUSTICE's opinion concludes that there is no difference
between embezzled funds and "gains" from other "illegal sources," and it points to the fact that
Congress, in its 1916 revision of the 1913 Income Tax Act, omitted the word "lawful" in
describing businesses whose income was to be taxed. The opinion then cites United States v.
Sullivan, 274 U. S. 259, in which it was held that, under the revised statute, gains from illicit
traffic in liquor must be reported in gross income, since there is no "reason why the fact that a
business is unlawful should exempt it from paying the taxes that, if lawful, it would have to
pay." Id. at 274 U. S. 263. (Emphasis added.) That theory has been the primary basis for taxing
"unlawful gains of many kinds" which the prevailing opinion today recites, such as black market
profits, gambling proceeds, money derived from the sale of unlawful insurance policies, etc.
[Footnote 4/5] For, even if lawful, the gains from such activities would clearly
Page 366 U. S. 255

not be exempted from taxation. However, as applied to embezzled funds, the holding
in Sullivan contradicts, rather than supports, the Court's conclusion today. Obviously,
embezzlement could never become "lawful" and still retain its character. If "lawful," it would
constitute nothing more than a loan, or possibly a gift, to the "embezzler," neither of which would
produce a taxable gain to him.
There is still another obvious and important distinction between embezzlement and the varieties
of illegal activity listed by the prevailing opinion -- one which clearly calls for a different tax
treatment. Black marketeering, gambling, bribery, graft, and like activities generally give rise to
no legally enforceable right of restitution -- to no debtor-creditor relationship which the law will
recognize. [Footnote 4/6] Condemned either by statute or public policy, or both, such
transactions are void ab initio. Since any consideration which may have passed is not legally
recoverable, its recipient has realized a taxable gain, an "accession to income," as clearly as if
his "indebtedness" had been discharged by a full release or by the running of a statute of
limitations. As we have already shown at length, quite the opposite is true when an
embezzlement occurs; for then the victim acquires an immediately ripe and enforceable claim to
repayment, and the embezzler assumes a legal debt equal to his acquisition.
To reach the result that it does today, THE CHIEF JUSTICE's opinion constructs the following
theory for defining taxable income:
"When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition,
Page 366 U. S. 256
express or implied, of an obligation to repay and without restriction as to their disposition,"
"he has received income which he is required to return, even though it may still be claimed that
he is not entitled to retain the money, and even though he may still be adjudged liable to restore
its equivalent."
"North American Oil Consolidated v. Burnet, supra, 286 U. S. 424. In such case, the taxpayer
has 'actual command over the property taxed -- the actual benefit for which the tax is
paid,' Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad
sweep of 'gross income;' it excludes loans. When a law-abiding taxpayer mistakenly receives
income in one year, which receipt is assailed and found to be invalid in a subsequent year, the
taxpayer must nonetheless report the amount as 'gross income' in the year received. United
States v. Lewis, supra; Healy v. Commissioner, supra."
This novel formula finds no support in our prior decisions, least of all in those which are
cited. Corliss v. Bowers, 281 U. S. 376, involved nothing more than an inter vivos trust created
by the taxpayer to pay the income to his wife. Since he had reserved the power to alter or
abolish the trust at will, its income was taxable to him under the express provisions of 219(g),
(h) of the Revenue Act of 1924. North American Oil Consolidated v. Burnet, 286 U. S. 417, is

the case which introduced the principle since used to facilitate uniformity and certainty in annual
tax accounting procedure, i.e., that a taxpayer must report in gross income, in the year in which
received, money or property acquired under a "claim of right" -- a colorable claim of the right
to exclusive possession of the money or property. Thus, in its complete form, the sentence
in North American Oil from which the above-quoted fragment was extracted reads:
"If a taxpayer receives earnings under a claim of right and without
Page 366 U. S. 257
restriction as to its [sic] disposition, he has received income which he is required to return, even
though it may still be claimed that he is not entitled to retain the money, and even though he
may still be adjudged liable to restore its equivalent."
Id. at 286 U. S. 424. (Emphasis added.) But embezzled funds, like stolen property generally, are
not "earnings" in any sense, and are held without a vestige of a colorable claim of right; they
constitute the principal of a debt. Of no significance whatever is the formality of "consensual
recognition, express or implied" of an obligation to repay. By substituting this meaningless
abstraction in place of the omitted portion of the North American Oil test of when a receipt
constitutes taxable income, the prevailing opinion today goes far beyond overruling Wilcox -- it
reduces a substantial body of tax law into uncertainty and confusion. The above-cited case
of United States v. Lewis, 340 U. S. 590, decided 19 years after North American
Oil, demonstrates the truth of this. For, there we said:
"The 'claim of right' interpretation of the tax laws has long been used to give finality to [the
accounting] period, and is not deeply rooted in the federal tax system. . . . We see no reason
why the Court should depart from this well settled interpretation merely because it results in an
advantage or disadvantage to a taxpayer."
340 U.S. at 340 U. S. 592. The same principle was reiterated and applied in Healy v.
Commissioner, 345 U. S. 278.
The supposed conflict between Wilcox and Rutkin, upon which THE CHIEF JUSTICE's opinion
seeks to justify its repudiation of Wilcox, [Footnote 4/7] has been adequately treated in
Page 366 U. S. 258
the opinion of MR. JUSTICE BLACK, and I agree with him that those cases were fully intended
to be, and are, reconcilable both on their controlling facts and applicable law. If the
unnecessarily broad language used in the Rutkin opinion has misled any of the lower federal
courts in their understanding of the principles underlying Wilcox, we should clarify their
understanding at this time, and continue our adherence to "a prior doctrine more embracing in
its scope, intrinsically sounder, and verified by experience." Helvering v. Hallock, 309 U. S.
106, 309 U. S. 119.

Wisconsin v. Illinois
No. 1, Original
Decree April 21, 1930
Decree enlarged May 22, 1933
Decree entered June 12, 1967*
388 U.S. 426
The Court, having reopened Nos. 1, 2 and 3, Original, and having granted leave to file No. 11,
Original, entered this decree.
Decree reported, 281 U. S. 281 U.S. 696; decree enlarged, 289 U. S. 289 U.S. 395.
Page 388 U. S. 427
DECREE
This Court having reopened Original cases Nos. 1, 2, and 3, and having granted leave to file
Original case No. 11, and having referred all such cases to a Special Master who has filed his
Report, and the parties having agreed to the form of the decree, the Findings of Fact in the
Report are hereby adopted, and it being unnecessary at this time to consider the Special
Master's legal conclusions,
IT IS ORDERED, ADJUDGED, AND DECREED that:
1. The State of Illinois and its municipalities, political subdivisions, agencies, and
instrumentalities, including, among others, the cities of Chicago, Evanston, Highland Park,
Highwood and Lake Forest, the villages of Wilmette, Kenilworth, Winnetka, and Glencoe, the
Elmhurst-Villa Park-Lombard Water Commission, the Chicago Park District and the Metropolitan
Sanitary District of Greater Chicago, their employees and agents and all persons assuming to
act under their authority, are hereby enjoined from diverting any of the waters of Lake Michigan
or its watershed into the Illinois waterway, whether by way of domestic pumpage from the lake
the sewage effluent derived from which reaches the Illinois waterway, or by way of storm runoff
from the Lake Michigan watershed which is diverted into the Sanitary and Ship Canal, or by way
of direct diversion from the lake into the canal, in excess of an average for all of them combined
of 3,200 cubic feet per second. "Domestic pumpage," as used in this decree, includes water
supplied to commercial and industrial establishments, and "domestic use" includes use by such
establishments. The water permitted by this decree to be diverted from Lake Michigan and its
watershed may be apportioned by the State of Illinois among its municipalities, political
subdivisions, agencies, and instrumentalities

Page 388 U. S. 428

for domestic use or for direct diversion into the Sanitary and Ship Canal to maintain it in a
reasonably satisfactory sanitary condition, in such manner and amounts and by and through
such instrumentalities as the State may deem proper, subject to any regulations imposed by
Congress in the interests of navigation or pollution control.
2. The amount of water diverted into the Sanitary and Ship Canal directly from Lake Michigan
and as storm runoff from the Lake Michigan watershed shall be determined by deducting from
the total flow in the canal at Lockport (a) the total amount of domestic pumpage from Lake
Michigan and from ground sources in the Lake Michigan watershed, except to the extent that
any such ground sources are supplied by infiltration from Lake Michigan, by the State of Illinois
and its municipalities, political subdivisions, agencies, and instrumentalities the sewage effluent
derived from which reaches the canal, (b) the total amount of domestic pumpage from ground
and surface sources outside the Lake Michigan watershed the sewage effluent derived from
which reaches the canal, (c) the total estimated storm runoff from the upper Illinois River
watershed reaching the canal, (d) the total amount of domestic pumpage from all sources by
municipalities and political subdivisions of the States of Indiana and Wisconsin the sewage
effluent derived from which reaches the canal, and (e) any water diverted by Illinois, with the
consent of the United States, into Lake Michigan from any source outside the Lake Michigan
watershed.
3. For the purpose of determining whether the total amount of water diverted from Lake
Michigan by the State of Illinois and its municipalities, political subdivisions, agencies, and
instrumentalities is not in excess of the maximum amount permitted by this decree, the amounts
of domestic pumpage from the lake by the
Page 388 U. S. 429
State and its municipalities, political subdivisions, agencies, and instrumentalities the sewage
and sewage effluent derived from which reaches the Illinois waterway, either above or below
Lockport, shall be added to the amount of direct diversion into the canal from the lake and storm
runoff reaching the canal from the Lake Michigan watershed computed as provided in
paragraph 2 of this decree. The accounting period shall consist of the period of 12 months
terminating on the last day of February. A period of five years, consisting of the current annual
accounting period and the previous four such periods (all after the effective date of this decree),
shall be permitted, when necessary, for achieving an average diversion which is not in excess of
the maximum permitted amount; provided, however, that the average diversion in any annual
accounting period shall not exceed one hundred ten (110) percent of the maximum amount
permitted by this decree. The measurements and computations required by this decree shall be
made by the appropriate officers, agencies, or instrumentalities of the State of Illinois under the
general supervision and direction of the Corps of Engineers of the United States Army.

4. The State of Illinois may make application for a modification of this decree so as to permit the
diversion of additional water from Lake Michigan for domestic use when and if it appears that
the reasonable needs of the Northeastern Illinois Metropolitan Region (comprising Cook, Du
Page, Kane, Lake, McHenry, and Will Counties) for water for such use cannot be met from the
water resources available to the region, including both ground and surface water and the water
permitted by this decree to be diverted from Lake Michigan, and if it further appears that all
feasible means reasonably available to the State of Illinois and its municipalities, political
subdivisions, agencies, and instrumentalities
Page 388 U. S. 430
have been employed to improve the water quality of the Sanitary and Ship Canal and to
conserve and manage the water resources of the region and the use of water therein in
accordance with the best modern scientific knowledge and engineering practice.
5. This decree shall become effective on March 1, 1970, and shall thereupon supersede the
decree entered by this Court in Nos. 1, 2, and 3, Original Docket, on April 21, 1930, as enlarged
May 22, 1933, provided that, for the period between January 1, 1970, and March 1, 1970, the
amount of water diverted by Illinois into the Sanitary and Ship Canal (determined in accordance
with paragraph 2 of this decree) shall not exceed an average of 1,500 cubic feet per second.
6. The complaint of the State of Illinois in No. 11, Original Docket, on behalf of its
instrumentality, the Elmhurst-Villa Park-Lombard Water Commission, is hereby dismissed,
without prejudice to that Commission sharing in the water permitted by this decree to be
diverted from Lake Michigan.
7. Any of the parties hereto may apply at the foot of this decree for any other or further action or
relief, and this Court retains jurisdiction of the suits in Nos. 1, 2, and 3, Original Docket, for the
purpose of making any order or direction, or modification of this decree, or any supplemental
decree, which it may deem at any time to be proper in relation to the subject matter in
controversy.
8. All the parties to these proceedings shall bear their own costs. The costs and expenses of the
Special Master shall be equally divided between the plaintiffs as a group and the defendants as
a group in Nos. 1, 2, and 3, Original Docket. The costs and expenses thus imposed upon the
plaintiffs and defendants shall be borne by the individual plaintiffs and defendants, respectively,
in equal shares.

CLASSIFICATION OF INCOME TAXPAYERS

1. INDIVIDUALS
C. GENERAL PROFESSIONAL PARTNERSHIPS
Republic of the Philippines
SUPREME COURT
Manila
EN BANC

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.
Rufino R. Tan for and in his own behalf.
Carag, Caballes, Jamora & Zomera Law Offices for petitioners in G.R. 109446.

VITUG, J.:
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 Code
and, in
G.R. No. 109446, the validity of Section 6, 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 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 rule-making 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 SelfEmployed 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:
Sec. 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 selfemployed or practices his profession herein, determined in accordance with the
following schedule:
Not over P10,000 3%
Over P10,000 P300 + 9%
but not over P30,000 of excess over P10,000
Over P30,000 P2,100 + 15%
but not over P120,00 of excess over P30,000
Over P120,000 P15,600 + 20%
but not over P350,000 of excess over P120,000
Over P350,000 P61,600 + 30%
of excess over P350,000
Sec. 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 support of the whole act, (b) to avoid surprises or even fraud 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 52).
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
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 of 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:
Sec. 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 extent
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 corpus and 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. 4Here, 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 on 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.
Narvasa, C.J., Cruz, Feliciano, Regalado, Davide, Jr., Romero, Bellosillo, Melo, Quiason, Puno,
Kapunan and Mendoza, JJ., concur.
Padilla and Bidin, JJ., are on leave.

2. ESTATES AND TRUSTS

EN BANC
[G.R. No. L-22611. May 27, 1968.]
COMMISSIONER
OF
INTERNAL
REVENUE, petitioner, vs. VISAYAN
ELECTRIC COMPANY and THE COURT OF TAX APPEALS, respondents.
Solicitor General for petitioner.
Jesus P. Garcia for respondent.
SYLLABUS
1. TAXATION; EMPLOYEES' PENSION FUND, A SEPARATE TAXABLE ENTITY. The
resolution of respondent company's board established a pension fund called the "Employees'
Reserve For Pensions" for the benefit of present and future employees in the event of
retirement, accident or disability. Such fund, set aside monthly, was taken from the gross
operating receipts of the company and later invested by the company in stocks of San Miguel
Brewery for which dividends were regularly declared. In respect to such fund, the Company
acted merely as trustee for its employees and a valid express trust has been created. For tax
purposes, the employees' reserve fund is a separate taxable entity and the dividends earned
thereby are returns of the trust estate and not of the grantor company.
2. ID.; ID.; INCOME OF PENSION FUND, NOT RECEIPTS, REVENUES OR PROFITS OF
COMPANY. The disputed income from dividends declared by San Miguel Brewery are not
receipts, revenues or profits of the company and do not go to the general fund thereof, but to
the reserve pension fund which is solely for the benefit of the employees of respondent
corporation. They are thus, not exempt from income tax as provided in Section 8, Act 3499, the
company's legislative franchise, which exempts the company's "receipts, revenues and profits".
3. ID.; ID.; ID.; EXEMPTION OF EMPLOYEES' TRUST FROM TAX, EXPLAINED;
EXCEPTION. An amendment to Sec. 56 of Republic Act 1983, approved on June 22, 1957,
singles out employees' trust for tax exemption. This exemption was conceived to encourage the
formation of pension trust systems for the benefit of laborers and employees outside the Social
Security Act. But to qualify for exemption, the employees' trust must refer to a definite program,
scheme or plan; it must be set up in good faith and must be actuarially sound. The instant trust
fund, though created in good faith and was intended for the employees' welfare, does not
appear to be actuarially sound.
4. ID.; ID.; ID.; ID.; ID.; WHERE PENSION PLAN IS NOT ACTUARIALLY SOUND,
EXEMPTION DOES NOT APPLY; IT IS SUBJECT TO INCOME TAX PRESCRIBED FOR

INDIVIDUALS. In the absence of any evidence in the record showing a pension plan that is
actuarially sound, the employees' trust fund from January 1, 1957 (the date exemption was
made applicable to income received under an amendment to Sec. 56, Republic Act
1983 approved June 22, 1957) is subject to income tax prescribed for individuals under sec. 21
of the Tax Code.
5. ID.; ID.; ID.; ID.; EXCEPTIONS ON PERIOD OF LIMITATION OF ASSESSMENT AND
COLLECTION OF TAXES, APPLIED IN CASE OF GOOD FAITH AND HONEST MISTAKE.
Section 331 of the Tax Code provides that taxes shall be assessed within five years after the
return is filed. Where, as here, no return was filed upon a belief in good faith that no tax liability
attaches, and where the Commissioner of Internal Revenue made an assessment upon a
mistaken assumption that the tax payable was on the basis of a corporate tax not individual tax,
there is good faith in one and honest mistake in the other. Hence, section 332 (a) of the Tax
Code which provides for exceptions as to period of limitation of assessment and collection of
taxes applies.
6. ID.; ID.; ID.; ID.; IMPOSITION OF SURCHARGE, NOT JUSTIFIABLE; REASONS. To
subject a taxpayer to the payment of 50% surcharge as provided for in Sec. 72 of the Tax Code,
the State must show either that there was a willful neglect to file a return or that a case of false
or fraudulent return willfully made exists. So, where a man honestly believes that the method
employed by him in computing his tax liability is correct, he does not incur any fraud and the
penalty under Section 72 does not apply.
7. ID.; ID.; ID.; ID.; PERCENTAGE TAXES, WHEN PAYMENT IS DUE AND PAYABLE
QUARTERLY, CONSTRUED. Section 183 (a) in relation to Section 259, second paragraph
thereof provides for the collection of the percentage taxes within 20 days after it becomes due
and payable, namely, the last day of each quarter. The time limit or the date on which the
percentage tax must be paid by the company is the 20th day after the last day of each quarter.
Section 259 grants another grace period of 15 days from the termination of this time limit
imposing the 25% surcharge.
8. ID.; ID.; ID.; ID.; ID.; SEC. 183 (a) CONSTRUED TOGETHER WITH RESPONDENT
COMPANY'S FRANCHISE PROVIDING FOR QUARTERLY PAYMENTS OF PERCENTAGE
TAXES. To say that section 183 (a) of the Tax Code is inapplicable because, as amended, it
provides for monthly payment while the company's charter speaks of quarterly payment is to
hang so heavy a meaning on too slender a frame. Before its amendment by R.A. 1612 on
August 24, 1956, this section 183 (a) prescribed quarterly payment of percentage taxes. The
amendment merely changed the manner or frequency of payment of the tax, while Sec. 259 of
the same Code refers to Sec. 183 (a) with respect to the time limit for payment of said
percentage taxes. Said amendment does not nullify the applicability of sec. 183 (a) to franchises
which do not set any time limit for payment although providing for a different manner or
frequency of payment. If the law has chosen to allow a 15-day grace period to taxpayers paying
every month, there is no reason for denying the same period to taxpayers who pay every three
months, considering that the latter need more time to prepare their returns covering a longer
period. Hence, the franchise tax must be paid within 20 days after the end of each quarter and if

such tax remains unpaid for 15 days from and after the date on which they must be paid, then
25% shall be added to the amount due.
9. ID.; EXEMPTIONS FROM TAXATION, TO BE CONSTRUED IN STRICTISSIMI JURIS
AGAINST TAXPAYER. Exemptions in tax statutes are never presumed and in adherence to
ancient rule, exemptions from taxation are construed in strictissimi juris against the taxpayer
and liberally in favor of the taxing authority.

DECISION

SANCHEZ, J p:
The problems cast in legal setting in this petition for review 1 of the judgment of the Court of Tax
Appeals are:
Is Visayan Electric Company liable for deficiency income tax on dividends from
the stock investment of its employees' reserve fund for pensions?
Is it also liable for 25% surcharge on alleged late payment of franchise tax?
Respondent company is the holder of a legislative franchise, Act 3499 of the Philippine
Legislature, to operate and maintain an electric light, heat, and power system in the City of
Cebu, certain municipalities in the province of Cebu, and other surrounding places.
In a board of directors' meeting held on March 14, 1949, respondent company established a
pension fund, known as the "Employees' Reserve for Pensions." Said fund is for the benefit of
its "present and future" employees, in the event of retirement, accident or disability. Every
month thereafter an amount has been set aside for this purpose. It is taken from the gross
operating receipts of the company. This reserve fund was later invested by the company in
stocks of San Miguel Brewery Inc., for which dividends have been regularly received. But these
dividends were not declared for tax purposes.
It was in letter dated August 9, 1957 that the Auditor General gave notice that as the company
has retained full control of the fund, therefore, the dividends are not tax exempt; but that such
dividends may be excluded from gross receipts for franchise tax purposes, provided the same
are declared for income tax purposes.
In pursuance of the above letter, the Provincial Auditor of Cebu allowed the company the option
to declare the dividends either as part of the company's income for income tax purposes or as
part of its income for franchise tax purposes. The company elected the latter. 2
The Revenue Examiner of Cebu, however, conducted a separate investigation for the Bureau of
Internal Revenue. His report dated September 17, 1959 likewise revealed that the "company
itself is the custodian or has the complete control of the fund. " That report disagreed with the

action of the Provincial Auditor, instead considered the dividends as subject to corporate income
tax under Section 24 of the National Internal Revenue Code.
Said report further disclosed that: (a) during the years 1957, 1958 and 1959, some payments of
the franchise tax were made after fifteen days although within twenty days of the month
following the end of each calendar quarter, allegedly contrary to Section 259 of the Tax Code,
which imposes a 25% surcharge if the franchise taxes "remain unpaid for fifteen days from and
after the date on which they must be paid", and (b) from 1954 to 1959, the company had not
paid additional residence tax imposed by Section 2 of Act 465.
With the foregoing report as basis, the Commissioner of Internal Revenue, in two letters of
demand dated September 7 and 15, 1960, assessed the following amounts against the
company: (a) P2,443.30 representing deficiency income tax for the years 1953 to 1958, plus
interest and 50% surcharge; (b) P3,850.00 as additional residence tax from 1954 to 1959; and
(c) P35,419.05 as 25% surcharge for late payment of franchise taxes for the years 1957, 1958
and 1959. Reconsideration having been denied, the company went to the Court of Tax Appeals
on petition for review.
On January 31, 1964, the Court of Tax Appeals sustained the correctness of the additional
residence tax assessment 3 but freed the company from liability for deficiency income tax and
the 25% surcharge for late payment of franchise taxes.
It is now the turn of the Commissioner of Internal Revenue to appeal to this Court.
1. Admittedly, the investment of the fund in shares of stocks of the San Miguel Brewery, Inc. is
not a part of respondent company's business. Neither is it necessary or incidental to its
operation under its franchise. And yet, those dividends were assessed by petitioner as part of
the income of respondent company. The tax court joins petitioner in this, but applied the
following provision in Section 8, Act 3499 the company's legislative franchise in holding
that the dividends are not subject to income tax, viz:
"SEC. 8. The grantee shall pay the same taxes as are now or may hereafter be
required by law from other persons, on its real estate, buildings, plant,
machinery, and other personal property, except property declared exempt in
this section. In consideration of the franchise and rights hereby granted, the
grantee shall pay into the municipal treasury of each municipality in which it is
supplying electricity to the public under this franchise, a tax equal to two per
centum of the gross earnings for electric current sold under this franchise in
each of the respective municipalities. Said percentage shall be due and
payable quarterly and shall be in lieu of all taxes of any kind levied, established
or collected by any authority whatsoever, now or in the future, on its poles,
wires, insulators, switches, transformers and other structures, installations,
conductors and accessories, placed in and over the public streets, avenues,
roads, thoroughfares, squares, bridges, and other places, and on its franchises,
rights, privileges, receipts, revenues and profits, from which taxes the grantee
is hereby expressly exempted." 4

We perceive incorrectness of this approach by the Tax Court. What is envisioned in the statute
granting exemption, so far as is pertinent to this case, is the last underscored portion thereof
which speaks of its receipts, revenues and profits, "from which taxes the grantee is hereby
expressly exempted." The heavy accent is on the word its. Plain import of this word, taken in
context, is the receipts, revenues and profits, which could be tax-exempt under the statute, must
be the company's not somebody else's. No doubt this provision should not be broadened so
as to include situations which by fair intendment are excluded therefrom. To do so is to take too
loose a view of the statute.
The disputed income are not receipts, revenues or profits of the company. They do not go to the
general fund of the company. They are dividends from the San Miguel Brewery, Inc. investment
which form part of and are added to the reserve pension fund which is solely for the benefit of
the employees, 5 " to be distributed among the employees." 6
Not escaping notice is that by the resolution of respondent company's board and the setting
aside of monthly amounts from its gross operating receipts for that fund, said company was
merely acting, with respect to such fund, as trustee for its employees. For, indeed, the intention
to establish a trust in favor of the employees is clear. A valid express trust has thus been
created. 7 And, for tax purposes, the employees' reserve fund is a separate taxable
entity. 8 Respondent company then, while retaining legal title and custody 9 over the property,
holds it in trust for the beneficiaries mentioned in the resolution creating the trust, in the absence
of any condition therein which would, in effect, destroy the intention to create a trust. 10
Given the fact that the dividends are returns of the trust estate and not of the grantor company,
we must say that petitioner misconceived the import of the law when he assessed said
dividends as part of the income of the company. Similarly, the tax court should not have
considered them at all as the company's "receipts, revenues and profits" which are exempt from
income tax.
2. As we look back at the resolution creating the employees' reserve fund and having in mind
the company's admission that it is "solely for the benefit of the employees" and that the
company is holding said fund "merely as a trustee of its employees," 11 we reach the
conclusion that the fund may not be diverted for other purposes, and that the trust so created is
irrevocable. For, really nothing in respondent company's acts suggests that it reserved the
power to revoke that fund or for that matter appropriate it for itself. The trust binds the company
to its employees. The trust created is not therefore a revocable trust as provided in Section 59
of the Tax Code. 12 Nor is it a trust contemplated in Section 60, the income from which is for the
benefit of the grantor. 13 This state of facts calls for inquiry into the applicability of Section 56 of
the Tax Code, which in part reads:
"SEC. 56. Imposition of Tax (a) Application of Tax. The taxes imposed by
this Title upon individuals shall apply to the income of estates or of any kind of
property held in trust, including

(1) Income accumulated in trust for the benefit of unborn or unascertained

person or persons with contingent interests and income accumulated or held
for future distribution under the terms of the will or trust;
xxx xxx xxx
(c) Computation and payment
(1) In general. The tax shall be computed upon the net income of the estate
or trust and shall be paid by the fiduciary, except as provided in Section fiftynine (relating to revocable trust) and section sixty (relating to income for the
benefit of the grantor);
xxx xxx xxx 14
Of interest here is that an amendment to Section 56 Republic Act 1983, 15 approved on June
22, 1957 singles out employees' trust for tax exemption in the following language:
"(b) Exception. The tax imposed by this Title shall not apply to employees'
trust which forms part of a pension, stock bonus or profit sharing plan of an
employer for the benefit of some or all of his employees (1) if contributions are
made to the trust by such employer, or employees, or both for the purpose of
distributing to such employees the earnings and principal of the fund
accumulated by the trust in accordance with such plan, and (2) if under the
trust instrument it is impossible, at any time prior to the satisfaction of all
liabilities with respect to employees under the trust, for any part of the corpus
or income to be (within the taxable year or thereafter) used for, or diverted to,
purposes other than for the exclusive benefit of his employees: Provided, That
any amount actually distributed to any employee or distributee shall be taxable
to him in the year in which so distributed to the extent that it exceeds the
amount contributed by such employee or distributee. 16
A dig into the legislative history unearths the fact that this exemption in Republic Act 1983
was conceived in order to encourage the formation of pension trust systems for the benefit of
laborers and employees outside the Social Security Act. 17
Understandably, the second requirement in paragraph (b) of Section 56 of the Tax Code as it
was inserted by Republic Act 1983 non-diversion of fund was written into the statute the
better to insure that the trust fund and its income will be used "for the exclusive benefit" of the
employees.
Of importance is the employment of the word plan as it is applied to pension set forth in the first
part of paragraph (b) aforesaid. Worth mentioning is that a sizeable portion of our Tax Code has
been lifted from the United States Internal Revenue Code. To be sure, Republic Act 1983 which
amends Section 56 of our Tax Code is substantially similar in terms to Section 165 of the United
States Internal Revenue Code of 1939. 18 It is thus permissible for this Court to look into the

interpretations of the American counterpart in an effort to determine the congressional scheme

in exempting employees' trusts for taxation.
In the American jurisdiction, the word plan is emphasized. To qualify for exemption, the
employees' trust must refer to a definite program, scheme or plan. It must be set up in good
faith. It must be actuarially sound. Under such plan, employees generally are to be extended
retirement and pension benefits. But why? The fund is not thereafter to be controlled or used for
the benefit of the company in any way. 19 A trust device used to disguise added compensation
to the shareholders and officers of a company and thereby avoid present payment of income
tax thereon instead of providing for future security of the employees in general will not qualify
under the exemption. 20 Hubell vs. Commissioner of Internal Revenue, 150 F. 2d. 516, 161
A.L.R. 764, 773, which was decided under the 1939 version, confirms this view. There, the
United States Circuit Court of Appeals took into account the direction of the amendments in
construing congressional purpose, and held that the 1942 amendment which added the
requirement of non-discrimination in favor of shareholders, of officials, or highly-compensated
employees presents no apparent change in congressional purpose: "to insure that . . . pension .
. . plans are operated for the welfare of employees in general, and to prevent the trust device
from being used for the benefit of shareholders, officials, or highly paid employees . . ."
This is not to say, of course, that the employees' trust fund established by private respondent is
a device calculated to unserve its purpose and serve tax evasion. Unquestionably, the trust fund
was created in good faith. It is meant as it was intended to mean for the employees' welfare.
But wanting are sufficient data which would justify this Court to make a conclusive statement
that the trust qualifies under Section 56 (b) as it was inserted into the Tax Code by Republic Act
1983. The only written evidence of record of the creation of the pension trust is the minutes of
the board of directors' meeting of March 14, 1949, the pertinent portion of which reads:
"3. Upon motion duly seconded, the following resolution as unanimously
passed:
RESOLVED, that the sum of FOUR HUNDRED FIFTEEN THOUSAND
PESOS (P415,000.00) be appropriated from the surplus of the company
arising from prewar operations in order to cover the payments of
backpay and payment of reasonable compensations to those persons
who have materially aided the Company in its Organization and
Rehabilitation and in the preparation and prosecution of the Company's
claims. This appropriation shall cover a reserve fund for pensions for all
the present and future employees of the firm in the amount of SIXTY
THOUSAND PESOS (P60,000.00), Reserve Fund for Employees'
Welfare to the amount of FIFTY THOUSAND PESOS (P50,000.00),
Reserve Funds for Medical Hospitalization, etc. to the amount of
THIRTY THOUSAND PESOS (P30,000.00), Reserve Fund for
Insurance and Accident to the amount of TWENTY FOUR THOUSAND
PESOS (P24,000.00) and a Reserve Fund for Bonuses Payable to the
amount of FIFTY THOUSAND PESOS (P50,000.00).

4. Upon motion by Mr. Jesus Moraza, duly seconded by Mr. Juan Coromina, it
was resolved further that the committee consisting of Dr. Mamerto Escao, as
Chairman and Messrs. Gil Garcia and Salvador E. Sala as members be
constituted, as it is hereby constituted, to study the details of all the above
resolutions and give effect thereto. The said committee is hereby empowered
to immediately put into effect the above resolutions."
We have the admitted fact also that every month thereafter an amount has been set aside for
the fund and the investment thereof in stocks of San Miguel Brewery, Inc.
And yet, something is amiss. For one, there is the admission made on page 3 of respondents'
brief that:
" . . . It is, of course, admitted by the respondent Company that the strict
requirements of Section 56 (b) of the Tax Code on the formation of employees'
trust funds for pension had not been strictly complied with, although said funds
and their returns are exclusively for the benefit of respondent Company's
employees."
And then, nothing extant in the record will show a pension plan actuarially sound. Correctly
did the Court of Tax Appeals find that "[i]t does not appear, however, that said pension trust
was created in accordance with the provision of Section 56 (b) of the Revenue Code." 21
The absence of such plan prevents us from taking a view which fits the purpose of the statute.
Coming into play then is the specific provision in paragraph (a), Section 56, heretofore
transcribed, which directs that the "taxes imposed by this Title upon individuals shall apply to
the income . . . of any kind of property held in trust." For which reason, the income received by
the employees' trustfund from January 1, 1957 is subject to the income tax prescribed for
individuals under Section 21 of the Tax Code.
To follow a different construction would run "smack against the familiar rules that exemption
from taxation is not favored, 22 and that exemptions in tax statutes are never
presumed," 23 and these "are but statements in adherence to the ancient rule that exemptions
from taxation are construed in strictissimi juris against the taxpayer and liberally in favor of the
taxing authority." 24
3. Having reached the conclusion that the assessment made by petitioner and the ruling of the
Court of Tax Appeals on lack of income tax liability were on a mistaken premise, but that the
trust established by respondent should pay the taxes imposed upon individuals, we are now
faced with the mechanics of tax collection.
The problem of prescription comes in. By Section 331 of the Tax Code, internal revenue taxes
shall be assessed within five years after the return is filed. Here, no return was filed upon a
belief in good faith that no tax liability attaches. Add to this the fact that the Commissioner of
Internal Revenue made an assessment of income tax but upon the mistaken assumption that
the tax payable was upon the basis of a corporate tax and not individual tax, and the picture is
complete. Good faith in one, and honest mistake in the other. Both petitioner and respondent

company are on the same footing. It is because of this that we rule that Section 332 (a) of the
Tax Code finds application. It reads:
"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 a 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."
Assessment should have as starting point the known figures. From 1953 to 1958, the following
amounts were dividends received on the San Miguel Brewery, Inc. investment:
1953 P4,430.00
1954 4,384.00
1955 6,240.00
1956 8,000.00
1957 8,009.60
1958 7,999.20
As far as we could read from the record, on the 1953 to 1956 dividends, payments under
protest were made as follows:
1. Deficiency franchise tax P468.14
2. 25% surcharge 117.04
3. Compromise penalty 50.00

T o t a l P635.18
On the 1957 dividends, the following were paid under protest:
1. Deficiency franchise tax P166.85
2. 25% surcharge 41.71
3. Compromise 10.00

T o t a l P218.56
The 1958 dividends were included in the franchise tax return for the first quarter of 1959, the tax
for which was paid on April 16, 1959.

In the determination of the taxes due, the 50% surcharge sought by petitioner should not be
included. To subject a taxpayer to the payment of 50% surcharge provided for in Section 72 of
the National Internal Revenue Code, the State must show either that there was a willful neglect
to file a return or that a case of a false or fraudulent return wilfully made exists. There is total
absence of proof, and petitioner does not allege, that respondent company wilfully neglected to
file a return or that it made a false or fraudulent return. In fact, this Court's pronouncement was
necessary to determine whether such dividends are taxable at all, and if so, under what law.
In Yutivo Sons Hardware Company vs. Commissioner, 25 our ruling is that where a man
"honestly believes" that the method employed by him in computing his tax liability is correct, he
does not incur any fraud; in which case, no fraud penalty attaches under Section 72 of the Tax
Code, which in part reads:
"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 within
the time prescribed by law, or in case a false or fraudulent return or list is
willfully 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, a surcharge of fifty per
centum of the amount of such tax or deficiency tax . . ."
Absent the specifics exacted in Section 72, no 50% surcharge is collectible.
4. Was respondent company late in the payment of its franchise taxes?
We first go to the controlling statutes. Section 259, paragraph (2) of the National Internal
Revenue Code reads:
"SEC. 259. Tax on corporate franchises. . . .
The taxes, charges, and percentages on corporate franchises, shall be due and
payable as specified in the particular franchise, or in case no time limit is
specified therein, the provisions of section one hundred and eighty-three shall
apply; and if such taxes, charges, and percentages remain unpaid for fifteen
days from and after the date on which they must be paid, twenty-five per
centum shall be added to the amount of such taxes, charges, and percentages,
which increase shall form Part of the tax." 26
Section 183(a) mentioned in Section 259 of the same Code in turn partly reads:
"SEC. 183. Payment of percentage taxes. (a) In general It shall be the
duty of every person conducting a business on which a percentage tax is
imposed under this Title, to make a true and complete return of the amount of
his, her or its gross monthly sales, receipts or earnings, or gross value of
output actually removed from the factory or mill warehouse and within twenty
days after the end of each month, pay the tax due thereon: . . . "
Upon the other hand, the company's franchise provides:

". . . Said percentage shall be due and payable quarterly."

The quintessence of petitioner's argument is that the phrase "due and payable quarterly" in the
franchise of the company means that the tax is immediatelydemandable at the end of each
calendar quarter; and that since the franchise itself sets the time limit for the payment of the
franchise tax, Section 183 just quoted finds no application. In which case, so petitioner avers,
the 25% surcharge would be collectible if the percentage taxes remain unpaid after fifteen days
from the end of each calendar quarter.
Decisive of the question is the meaning of the term "due and payable quarterly." Resort to the
following definitions may help in clearing up the issue:
(1) The word "due" is only equivalent to or synonymous with "payable." 27
(2) The word "due" with reference to taxes, implies that such taxes are then
"owing, collectible or matured." 28
(3) "The word 'due' in one sense means that the debt or obligation to which it is
applied has by contract or operation of law become immediately payable, but in
another sense it denotes the existence of a simple indebtedness, without
reference to the time payment, in which it is synonymous with 'owing' and
includes all debts whether payable in praesenti or in futuro" 29
(4) "Unless context clearly indicates a contrary meaning, the phrase 'due and
payable' on a specified date means the debt or obligation to which it is
applicable is then immediately payable." 30
In line with the foregoing definitions, the term "due and payable on the first day of each month"
was interpreted to mean that payment on any day during the month other than the first day
would constitute non-compliance. 31
In our opinion, the term "due and payable quarterly" in this case merely indicates the frequency
of payment of the franchise tax, viz., every three months. It does not refer to the time limit or, in
the precise language of Section 259, "the date on which they (the taxes) must be paid."
Under Section 183(a) in relation to Section 259, second paragraph, the law has opted to collect
the tax within twenty days after it becomes due and payable, namely, the last day of each
quarter. The time limit or the date on which the percentage tax must be paid by the company is
the twentieth day after the last day of each quarter. Section 259 grants another grace period of
fifteen days from the termination of this time limit before imposing the 25% surcharge.
To say that Section 183(a) is not applicable simply because, as amended it provides for monthly
payment while the company's charter speaks of quarterly payment, is to hang so heavy a
meaning on too slender a frame. Prior to its amendment by R.A. 1612 on August 24, 1956, said
Section 183(a) prescribed quarterly payment of percentage taxes. 32 Accurately read, the
amendment merely changed the manner or frequency of payment of the tax, whereas Section
259 makes reference to Section 183(a) with respect to the time limit for payment of percentage
taxes. The amendment does not nullify the applicability of Section 183(a) to franchises which do

not set any time limit for payment although providing for a different manner or frequency of
payment. Common sense dictates that it be so. For, if the law has chosen to allow a fifteen-day
grace period to taxpayers paying every month, no cogent reason exists why the same period
if not longer should be denied taxpayers paying every three months. The latter require more
time for preparation their return covers a longer period. The tax court is correct. 33

Really, the tax cannot be immediately demandable at the end of each calendar quarter. Reason
for this is that transactions on the last day of the quarter must have to be included in the
computation of the taxpayer's return for each particular quarter. It is well-nigh impossible for the
taxpayer to add up his income, write down the deductions, and compute the net amount taxable
as of the last working hour of the last day of the quarter, and at the same time go to the nearest
revenue office, submit the quarterly return and pay the tax. This accounts for the fact that
Section 183(a) of the National Internal Revenue Code gives the taxpayer a leeway of twenty
days after the end of each quarter to do all of these. And by Section 259, it is only upon failure
to pay fifteen days "from and after the date on which they must be paid" that the twenty-five per
centum shall be added to the amount of "taxes, charges, and percentages," on corporate
franchises. Statutes are not to be so narrowly read as to beget unreasonableness.
We accordingly rule that the franchise tax "must be paid" within "twenty days after the end" of
each quarter and that if such tax remains unpaid for 15 days "from and after the date on which
they must be paid," then twenty-five per centum shall be added to the amount due.
No surcharge for late payment of respondent company's franchise taxes accrues.
For the reasons given
The judgment under review is hereby AFFIRMED insofar as it reverses petitioner's assessment
of surcharge for late payment of respondent company's franchise tax; 34and
Said judgment is hereby REVERSED insofar as it exempts respondent company from the
payment of deficiency income tax, in the sense that respondent company, in its capacity as
fiduciary of its employees' reserve fund, is hereby declared liable for the payment of individual
income tax set forth in Section 56(a) in connection with Section 21 of the National Internal
Revenue Code; and
Conformably to the opinion expressed herein, let the record of this case be returned to the Court
of Tax Appeals with instructions to hear and determine the tax liability of the trust known as
"Employees' Reserve for Pensions" and/or tax refund, if any, to respondent Visayan Electric
Company, upon the dividends received during the years 1953 to 1958 on the investment of its
employees' reserve fund for pensions, and tax payments made by reason thereof, said tax to be
computed in accordance with Section 56(a) and (c) of the National Internal Revenue Code in
relation to Section 21 of the same Code.
No costs. So ordered.
Concepcion, C . J ., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Castro and Angeles, JJ ., concur.

EN BANC
[G.R. No. 95022. March 23, 1992.]
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE HON.
COURT OF APPEALS, THE COURT OF TAX APPEALS, GCL RETIREMENT
PLAN, represented by its Trustee-Director, respondents.
M.L. Gadioma Law Office for private respondent.
SYLLABUS
1. TAXATION; INCOME TAX; GOVERNING LAWS EXEMPTING EMPLOYEES' TRUST
THEREFROM. It appears that under Rep. Act No. 1983, which took effect on 22 June 1957,
amending Sec. 56(b) of the National Internal Revenue Code (Tax Code, for brevity), employees'
trusts were exempt from income tax. It is significant to note that the GCL Plan was qualified as
exempt from income tax by the Commissioner of Internal Revenue in accordance with Rep. Act.
No. 4917 approved on 17 June 1967. In so far as employees' trusts are concerned, the
foregoing provision should be taken in relation to then Section 56(b) (now 53[b]) of the Tax
Code, as amended by Rep. Act No. 1983, supra, which took effect on 22 June 1957. This
provision specifically exempted employees' trust from income tax.
2. ID.; ID.; ID.; REASONS THEREFOR. And rightly so, by virtue of the raison d'etre behind
the creation of employees' trusts. Employees' trusts or benefit plans normally provide economic
assistance to employees upon the occurrence of certain contingencies, particularly, old age
retirement, death, sickness, or disability. It provides security against certain hazards to which
members of the Plan may be exposed. It is an independent and additional source of protection
for the working group. What is more, it is established for their exclusive benefit and for no other
purpose.
3. ID.; ID.; ID.; PURPOSE THEREFOR. The tax advantage in Rep. Act No. 1983, Section
56(b), was conceived in order to encourage the formation and establishment of such private
Plans for the benefit of laborers and employees outside of the Social Security Act. Enlightening
is a portion of the explanatory note to H.B. No. 6503, nowR.A. 1983.
4. ID.; ID.; ID.; R.A. NO. 1983, SEC. 56(b) IN RELATION TO R.A. NO. 4917; NOT REPEALED
BY P.D. NO. 1959. The deletion in Pres. Decree No. 1959 of the provisos regarding tax
exemption and preferential tax rates under the old law, therefore, can not be deemed to extend
to employees' trusts. Said Decree, being a general law, can not repeal by implication a specific
provision, Section 56(b) (now 53 [b]) in relation to Rep. Act No. 4917 granting exemption from
income tax to employees' trusts.Rep. Act 1983, which excepted employees' trusts in its Section
56(b) was effective on 22 June 1957 while Rep. Act No. 4917 was enacted on 17 June 1967,
long before the issuance of Pres. Decree No. 1959 on 15 October 1984. A subsequent statute,
general in character as to its terms and application, is not to be construed as repealing a special

or specific enactment, unless the legislative purpose to do so is manifested. This is so even if

the provisions of the latter are sufficiently comprehensive to include what was set forth in the
special act (Villegas v. Subido, G.R. No. L-31711, 30 September 1971, 41 SCRA 190).
5. ID.; ID.; EMPLOYEE'S TRUST; EXEMPTED FROM WITHHOLDING TAX ON INTEREST
EARNED ON BANK DEPOSITS. Notably, too, all the tax provisions herein treated of come
under Title II of the Tax Code on "Income Tax." Section 21(d), as amended by Rep. Act No.
1959, refers to the final tax on individuals and falls under Chapter II; Section 24(cc) to the final
tax on corporations under Chapter III; Section 53 on withholding of final tax to Returns and
Payment of Tax under Chapter VI; and Section 56(b) to tax on Estates and Trusts covered by
Chapter VII. Section 56(b), taken in conjunction with Section 56(a), supra, explicitly excepts
employees' trusts from "the taxes imposed by this Title." Since the final tax and the withholding
thereof are embraced within the title on "Income Tax," it follows that said trust must be deemed
exempt therefrom. Otherwise, the exception becomes meaningless. There can be no denying
either that the final withholding tax is collected from income in respect of which employees'
trusts are declared exempt (Sec. 56[b], now 53[b], Tax Code). The application of the
withholdings system to interest on bank deposits or yield from deposit substitutes is essentially
to maximize and expedite the collection of income taxes by requiring its payment at the source.
If an employees' trust like the GCL enjoys a tax-exempt status from income, we see no logic in
withholding a certain percentage of that income which it is not supposed to pay in the first place.

DECISION

MELENCIO-HERRERA, J p:
This case is said to be precedent setting. While the amount involved is insignificant, the Solicitor
General avers that there are about 85 claims of the same nature pending in the Court of
Appeals and Bureau of Internal Revenue totalling approximately P120M. LLphil
Petitioner, the Commissioner of Internal Revenue, seeks a reversal of the Decision of
respondent Court of Appeals, dated August 27, 1990, in CA-G.R. SP No. 20426, entitled
"Commissioner of Internal Revenue vs. GCL Retirement Plan, represented by its TrusteeDirector and the Court of Tax Appeals," which affirmed the Decision of the latter Court, dated 15
December 1986, in Case no. 3888, ordering a refund, in the sum of P11,302.19, to the GCL
Retirement Plan representing the withholding tax on income from money market placements
and purchase of treasury bills, imposed pursuant to Presidential Decree No. 1959. LLjur
There is no dispute with respect to the facts. Private Respondent, GCL Retirement Plan (GCL,
for brevity) is an employees' trust maintained by the employer, GCL Inc., to provide retirement,
pension, disability and death benefits to its employees. The Plan as submitted was approved
and qualified as exempt from income tax by Petitioner Commissioner of Internal Revenue in
accordance with Rep. Act No. 4917. 1

In 1984, Respondent GCL made investments and earned therefrom interest income from which
was withheld the fifteen per centum (15%) final withholding tax imposed by Pres. Decree
No. 1959, 2 which took effect on 15 October 1984, to wit:
Date Kind of Investment Principal Income Earned 15% Tax
ACIC
12/05/84 Market Placement P 236,515.32 P 8,751.96 P 1,312.66
10/22/84 234,632.75 9,815.89 1,472.38
11/19/84 225,886.51 10,629.22 1,594.38
1/23/84 344,448.64 17,313.33 2,597.00
12/05/84 324,633.81 15,077.44 2,261.52
COMBANK Treasury Bills 2,064.15

P11,302.19
On 15 January 1985, Respondent GCL filed with Petitioner a claim for refund in the amounts of
P1,312.66 withheld by Anscor Capital and Investment Corp., and P2,064.15 by Commercial
Bank of Manila. On 12 February 1985, it filed a second claim for refund of the amount of
P7,925.00 withheld by Anscor, stating in both letters that it disagreed with the collection of the
15% final withholding tax from the interest income as it is an entity fully exempt from income tax
as provided under Rep. Act No 4917 in relation to Section 56 (b) 3 of the Tax Code.
The refund requested having been denied, Respondent GCL elevated the matter to respondent
Court of Tax Appeals (CTA). The latter ruled in favor of GCL, holding that employees' trusts are
exempt from the 15% final withholding tax on interest income and ordering a refund of the tax
withheld. Upon appeal, originally to this Court, but referred to respondent Court of Appeals, the
latter upheld the CTA Decision. Before us now, Petitioner assails that disposition. prcd
It appears that under Rep. Act No. 1983, which took effect on 22 June 1957, amending Sec.
56(b) of the National Internal Revenue Code (Tax Code, for brevity), employees' trusts were
exempt from income tax. That law provided:
"SEC. 56. Imposition of tax. (a) Application of tax. The taxes imposed by
this Title upon individuals shall apply to the income of estates or of any kind of
property held in trust, including
xxx xxx xxx
(b) Exception. The tax imposed by this Title shall not apply to employees'
trust which forms part of a pension, stock bonus or profit-sharing plan of an
employer for the benefits of some or all of his employees (1) if contributions are
made to the trust by such employer, or employees, or both, for the purpose of

distributing to such employees the earnings and principal of the fund

accumulated by the trust in accordance with such plan. . . ."
On 3 June 1977, Pres. Decree No. 1156 provided, for the first time, for the withholding from the
interest on bank deposits at the source of a tax of fifteen per cent (15%) of said interest.
However, it also allowed a specific exemption in its Section 53, as follows:
"SEC. 53. Withholding of tax at source.
xxx xxx xxx
"(c) Withholding tax on interest on bank deposits. (1) Rate of withholding tax.
Every bank or banking institution shall deduct and withhold from the interest
on bank deposits (except interest paid or credited to non-resident alien
individuals and foreign corporations), a tax equal to fifteen per cent of the said
interest: Provided, however, That no withholding of tax shall be made if the
aggregate amount of the interest on all deposit accounts maintained by a
interest on all deposit accounts maintained by a depositor alone or together
with another in any one bank at any time during the taxable period does not
exceed three hundred fifty pesos a year or eighty-seven pesos and fifty
centavos per quarter. For this purpose, interest on a deposit account
maintained by two persons shall be deemed to be equally owned by them.
"(2) Treatment of bank deposit interest. The interest income shall be
included in the gross income in computing the depositor's income tax liability in
according with existing law.
"(3) Depositors enjoying tax exemption privileges or preferential tax treatment.
In all cases where the depositor is tax-exempt or is enjoying preferential
income tax treatment under existing laws, the withholding tax imposed in this
paragraph shall be refunded or credited as the case may be upon submission
to the Commissioner of Internal Revenue of proof that the said depositor is a
tax-exempt entity or enjoys a preferential income tax treatment.

xxx xxx xxx"

This exemption and preferential tax treatment were carried over in Pres. Decree No. 1739,
effective on 17 September 1980, which law also subjected interest from bank deposits and yield
from deposit substitutes to a final tax of twenty per cent (20%). The pertinent provisions read:
"SEC. 2. Section 21 of the same Code is hereby amended by adding a new
paragraph to read as follows:
SEC 21. Rates of tax on citizens or residents.
xxx xxx xxx

Interest from Philippines Currency bank deposits and yield from

deposit substitutes whether received by citizens of the Philippines or by
resident alien individuals, shall be subject to the final tax as follows: (a)
15% of the interest on savings deposits, and (b) 20% of the interest on
time deposits and yield from deposit substitutes, which shall be
collected and paid as provided in Sections 53 and 54 of this Code.
Provided, That no tax shall be imposed if the aggregate amount of the
interest on all Philippine Currency deposit accounts mentioned by a
depositor alone or together with another in any one bank at any time
during the taxable period does not exceed Eight Hundred Pesos
(P800.00) a year or Two Hundred Pesos (P200.00) per
quarter, Provided, further, That if the recipient of such interest is exempt
from income taxation, no tax shall be imposed and that, if the recipient
is enjoying preferential income tax treatment, then the preferential tax
rates so provided shall be imposed (Emphasis supplied.)
"SEC. 3. Section 24 of the same Code is hereby amended by adding a new
subsection (cc) between subsections (c) and (d) to read as follows:
(cc) Rates of tax on interest from deposits and yield from deposit
substitutes. Interest on Philippine Currency bank deposits and yield
from deposit substitutes received by domestic or resident foreign
corporations shall be subject to a final tax on the total amount thereof as
follows: (a) 15% of the interest on savings deposits; and (b) 20% of the
interest on time deposits and yield from deposit substitutes which shall
be collected and paid as provided in Section 53 and 54 of this
Code. Provided, That if the recipient of such interest is exempt from
income taxation, no tax shall be imposed and that, if the recipient is
enjoying preferential income tax treatment, then the preferential tax
rates so provided shall be imposed" (Emphasis supplied).
"SEC. 9. Section 53(e) of the same Code is hereby amended to read as
follows:
SEC. 53(e) Withholding of final tax on interest on bank deposits
and yield from deposit substitutes.
(1) Withholding of final tax. Every bank or non-bank financial
intermediary shall deduct and withhold from the interest on bank
deposits or yield from deposit substitutes a final tax equal to fifteen
(15%) per cent of the interest on savings deposits and twenty (20%) per
cent of the interest on time deposits or yield from deposit substitutes:
Provided, however, That on withholding tax shall be made if the
aggregate amount of the interest on all deposits accounts maintained
by a depositor alone or together with another in any one bank at any
time during the taxable period does not exceed Eight Hundred Pesos a
year or Two Hundred Peso per quarter. For this purpose, interest on a

deposit account maintained by two persons shall be deemed to be

equally owned by them.
(2) Depositors or placers/investors enjoying tax exemption
privileges or preferential tax treatment. In all cases where the
depositor or placer/investor is tax-exempt or is enjoying preferential
income tax treatment under existing laws, the withholding tax imposed
in this paragraph shall be refunded or credited as the case may be upon
submission to the Commissioner of Internal Revenue of proof that the
said depositor, or placer/investor is a tax exempt entity or enjoys a
preferential income tax treatment."
Subsequently, however, on 15 October 1984, Pres. Decree No. 1959 was issued, amending the
aforestated provisions to read:
"SEC. 2. Section 21(d) of this Code, as amended, is hereby further amended to
read as follows:
(d) On interest from bank deposits and yield or any other
monetary benefit from deposit substitutes and from trust fund and
similar arrangements. Interest from Philippine Currency Bank
deposits and yield or any other monetary benefit from deposit
substitutes and from trust fund and similar arrangements whether
received by citizens of the Philippines or by resident alien individuals,
shall be subject to a 15% final tax to be collected and paid as provided
in Section 53 and 54 of this Code.
"SEC. 3. Section 24(cc) of this Code, as amended, is hereby further amended
to read as follows:
(cc) Rates of tax on interest from deposits and yield or any other
monetary benefit from deposit substitutes and from trust fund and
similar arrangements. Interest on Philippine Currency Bank deposits
and yield or any other monetary benefit from deposit substitutes and
from trust fund and similar arrangements received by domestic or
resident foreign corporations shall be subject to a 15% final tax to be
collected and paid as provided in Section 53 and 54 of this Code.
"SEC. 4. Section 53(d)(1) of this code is hereby amended to read as follows:
Sec. 53(d)(1). Withholding of Final Tax. Every bank or nonbank financial intermediary or commercial, industrial, finance
companies, and other non-financial companies authorized by the
Securities and Exchange Commission to issue deposit Substitutes shall
deduct and withhold from the interest on bank deposits or yield or any
other monetary benefit from deposit substitutes a final tax equal to
fifteen per centum (15%) of the interest on deposits or yield or any other

monetary benefit from deposit substitutes and from trust fund and
similar arrangements."
It is to be noted that the exemption from withholding tax on interest on bank deposits previously
extended by Pres. Decree No. 1739 if the recipient (individual or corporation) of the interest
income is exempt from income taxation, and the imposition of the preferential tax rates if the
recipient of the income is enjoying preferential income tax treatment, were both abolished by
Pres. Decree No. 1959. Petitioner thus submits that the deletion of the exempting and
preferential tax treatment provisions under the old law is a clear manifestation that the single
15% (now 20%) rate is impossible on all interest incomes from deposits, deposit substitutes,
trust funds and similar arrangements, regardless of the tax status or character of the recipients
thereof. In short, petitioner's position is that from 15 October 1984 when Pres. Decree
No. 1959 was promulgated, employees' trusts ceased to be exempt and thereafter became
subject to the final withholding tax. LLjur
Upon the other hand, GCL contends that the tax exempt status of employees' trusts applies to
all kinds of taxes, including the final withholding tax on interest income. That exemption,
according to GCL, is derived from Section 56(b) and not from Section 21(d) or 24(cc) of the Tax
Code, as argued by Petitioner.
The sole issue for determination is whether or not the GCL Plan is exempt from the final
withholding tax on interest income from money placements and purchase of treasury bills
required by Pres. Decree No. 1959.
We uphold the exemption.
To begin with, it is significant to note that the GCL Plan was qualified as exempt from income
tax by the Commissioner of Internal Revenue in accordance with Rep. Act No. 4917 approved
on 17 June 1967. This law specifically provided:
SECTION 1. Any provision of law to the contrary notwithstanding, the
retirement benefits received by official and employees of private firms, whether
individual or corporate, in accordance with a reasonable private benefit plan
maintained by the employer shall be exempt from all taxes and shall not be
liable to attachment, levy or seizure by or under any legal or equitable process
whatsoever except to pay a debt of the official or employee concerned to the
private benefit plan or that arising from liability imposed in a criminal action;" . .
. (emphasis supplied).
In so far as employees' trusts are concerned, the foregoing provision should be taken in relation
to Section 56(b) (now 53[b]) of the Tax Code, as amended by Rep. Act No. 1983, supra, which
took effect on 22 June 1957. This provision specifically exempted employees' trusts from
income tax and is repeated hereunder for emphasis:
"Sec. 56. Imposition of Tax. (a) Application of tax. The taxes imposed by
this Title upon individuals shall apply to the income of estates or of any kind of
property held in trust.
xxx xxx xxx

"(b) Exception. The tax imposed by this Title shall no apply to employee's
trust which forms part of a pension, stock bonus or profit-sharing plan of an
employer for the benefit of some or all of his employees . . ."
The tax-exemption privilege of employees' trusts, as distinguished from any other kind of
property held in trust, springs from the foregoing provision. It is unambiguous. Manifest
therefrom is that the tax law has singled out employees' trusts for tax exemption.
And rightly so, by virtue of the raison d'etre behind the creation of employees' trusts. Employees'
trusts or benefit plans normally provide economic assistance to employees upon the occurrence
of certain contingencies, particularly, old age retirement, death, sickness, or disability. It
provides security against certain hazards to which members of the Plan may be exposed. It is
an independent and additional source of protection for the working group. What is more, it is
established for their exclusive benefit and for no other purpose.
The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in order to encourage
the formation and establishment of such private Plans for the benefit of laborers and employees
outside of the Social Security Act. Enlightening is a portion of the explanatory note to H.B. No.
6503, now R.A. 1983, reading:

"Considering that under Section 17 of the Social Security Act, all contributions
collected and payments of sickness, unemployment, retirement, disability and
death benefits made thereunder together with the income of the pension
trust are exempt from any tax, assessment, fee, or charge, it is proposed that a
similar system providing for retirement, etc. benefits for employees outside the
Social Security Act be exempted from income taxes." (Congressional Record,
House of Representatives, Vol. IV, Part. 2, No. 57, p. 1859, May 3, 1957; cited
in Commissioner of Internal Revenue v. Visayan Electric Co., et al., G.R. No. L22611, 27 May 1966, 23 SCRA 715); emphasis supplied.
It is evident that tax-exemption is likewise to be enjoyed by the income of the pension trust.
Otherwise, taxation of those earnings would result in a diminution of accumulated income and
reduce whatever the trust beneficiaries would receive out of the trust fund. This would run afoul
of the very intendment of the law.
The deletion in Pres. Decree No. 1959 of the provisos regarding tax exemption and preferential
tax rates under the old law, therefore, can not be deemed to extend to employees' trusts. Said
Decree, being a general law, can not repeal by implication a specific provision, Section 56(b)
(now 53 [b] in relation to Rep. Act No. 4917 granting exemption from income tax to employees'
trusts. Rep. Act 1983, which excepted employees' trust in its Section 56(b) was effective on 22
June 1957 while Rep. Act No. 4917 was effective on 22 June 1967, long before the issuance of
Pres. Decree No. 1959 on 15 October 1984. A subsequent statute, general in character as to its
terms and application, is not to be construed as repealing a special or specific enactment,
unless the legislative purpose to do so is manifested. This is so even if the provisions of the
latter are sufficiently comprehensive to include what was set forth in the special act (Villegas v.
Subido, G.R. No. L-31711, 30 September 1971, 41 SCRA 190).

Notably, too, all the tax provisions herein treated of come under Title II of the Tax Code on
"Income Tax." Section 21(d), as amended by Rep. Act No. 1959, refers to the final tax on
individuals and falls under Chapter II; Section 24(cc) to the final tax on corporations under
Chapter III; Section 53 on withholding of final tax to Returns and Payment of Tax under Chapter
VI; and Section 56(b) to tax on Estates and Trusts covered by Chapter VII. Section 56(b), taken
in conjunction with Section 56(a). supra,explicitly excepts employees' trusts from "the taxes
imposed by this Title." Since the final tax and the withholding thereof are embraced within the
title on "Income Tax." it follows that said trust must be deemed exempt therefrom. Otherwise,
the exception becomes meaningless.
There can be no denying either that the final withholding tax is collected from income in respect
of which employees' trusts are declared exempt (Sec. 56[b], now 53[b], Tax Code). The
application of the withholdings system to interest on bank deposits or yield from deposit
substitute is essentially to maximize and expedite the collection of income taxes by requiring its
payment at the source. If an employees' trust like the GCL enjoys a tax-exempt status from
income, we see no logic in withholding a certain percentage of that income which it is not
supposed to pay in the first place.
Petitioner also relies on Revenue Memorandum Circular 31-84, dated 30 October 1984, and
Bureau of Internal Revenue Ruling No. 027-e-000-00-005-85, dated 14 January 1985, as
authorities for the argument that Pres. Decree No. 1959 withdrew the exemption of employees'
trusts from withholding of the final tax on interest income. Said Circular and Ruling pronounced
that the deletion of the exempting and preferential tax treatment provisions by Pres. Decree
No. 1959 is a clear manifestation that the single 15% tax rate is impossible on all interest
income regardless of the tax status or character of the recipient thereof. But since we herein
rule that Pres. Decree No. 1959 did not have the effect of revoking the tax exemption enjoyed
by employees' trusts, reliance on those authorities is now misplaced.
WHEREFORE, the Writ of Certiorari prayed for is DENIED. The judgment of respondent Court
of Appeals, affirming that of the Court of Tax Appeals is UPHELD. No costs.
SO ORDERED.
||| (Commissioner of Internal Revenue v. Court of Appeals, G.R. No. 95022, [March 23, 1992])

SECOND DIVISION
[G.R. No. 103635. February 1, 1996.]
CATALINA BUAN VDA. DE ESCONDE,
CONSTANCIA ESCONDE VDA. DE PERALTA, ELENITA ESCONDE and
BENJAMIN ESCONDE, petitioners, vs.
HONORABLE COURT OF APPEALS and PEDRO ESCONDE, respondents.
Lazaro Law Firm for petitioners.
Regalado C. Fermin for private respondent.
SYLLABUS
1. CIVIL LAW; OBLIGATIONS AND CONTRACTS; TRUST; CONCEPT. Trust is the legal
relationship between one person having an equitable ownership in property and another person
owning the legal title to such property, the equitable ownership of the former entitling him to the
performance of certain duties and the exercise ofcertain powers by the latter. Trusts are either
express or implied. An express trust is created by the direct and positive acts of the parties, by
some writing or deed or will or by words evidencing an intention to create a trust. No particular
words are required for the creation of an express trust, it being sufficient that a trust is clearly
intended. On the other hand, implied trusts are those which, without being expressed, are
deducible from the nature of the transaction as matters of intent or which are superinduced on
the transaction by operation of law as matters of equity, independently of the particular
intention of the parties. LLcd
2. ID.; ID.; ID.; CONSTRUCTIVE TRUST; DEEMED ESTABLISHED IF BY MISTAKE A
PROPERTY IS ENTIRELY ALLOTED TO ONE OF THE HEIRS; CASE AT BENCH. In the
case at bench, petitioner Catalina Buan vda. de Esconde, as mother and legal guardian of her
children, appears to have favored her elder son, private respondent, in allowing that he be given
Lot No. 1700 in its entirety in the extrajudicial partition of the Esconde estate to the
prejudice of her other children. Although it does not appear on record whether Catalina
intentionally granted private respondent that privileged bestowal, the fact is that, said lot was
registered in private respondent's name. After the TCT No. 394 was handed to him by his
mother, private respondent exercised exclusive rights of ownership therein to the extent of even
mortgaging the lot when he needed money. If, as petitioners insist, a mistake was committed in
allotting Lot No. 1700 to private respondent, then a trust relationship was created between them
and private respondent. However, private respondent never considered himself a trustee. If he
allowed his brother Benjamin to construct or make improvements thereon, it appears to have
been out of tolerance to a brother. Consequently, if indeed, by mistake, private respondent was
given the entirety of Lot No. 1700, the trust relationship between him and petitioners was
a constructive, not resulting, implied trust. Petitioners, therefore, correctly questioned private

respondent's exercise of absolute ownership over the property. Unfortunately, however,

petitioners assailed it long after their right to do so had prescribed. cda
3. ID.; ID.; ID.; ID.; RULE THAT REPUDIATION OF THE TRUST IS ESSENTIAL FOR
PRESCRIPTION TO SUPERVENE, NOT APPLICABLE THERETO; CASE AT BENCH. The
rule that a trustee cannot acquire by prescription ownership over property entrusted to him until
and unless he repudiates the trust, applies to express trusts and resulting implied trusts.
However, in constructive implied trusts, prescription may supervene even if the trustee does not
repudiate the relationship. Necessarily, repudiation of the said trust is not a condition precedent
to the running of the prescriptive period. Since the action for the annulment of private
respondent's title to Lot No. 1700 accrued during the effectivity of Act No. 190, Section
40 of Chapter III thereof applies. . . . Thus, in Heirs of Jose Olviga v. Court of Appeals, (G.R.
No. 104813, October 21, 1993, 227 SCRA 330, 334-335) the Court ruled that the ten-year
prescriptive period for an action for reconveyance of real property based on implied or
constructive trust which is counted from the date of registration of the property, applies when the
plaintiff is not in possession of the contested property. In this case, private respondent, not
petitioners who instituted the action, is in actual possession of Lot No. 1700. Having filed their
action only on June 29, 1987, petitioners' action has been barred by prescription.
4. ID.; ID.; ID.; ID.; APPLICABILITY OF LACHES DOCTRINE TO IMPLIED TRUSTS. Laches
has also circumscribed the action for, whether the implied trust is constructive or resulting, this
doctrine applies.

DECISION

ROMERO, J p:
This petition for review on certiorari seeks the reversal of the January 22, 1992
decision 1 in CA G.R. CV No. 26795 of the Court of Appeals affirming the Decision of the
Regional Trial Court of Bataan, Branch 2. 2 The lower court declared that petitioners' action for
reconveyance of real property based on an implied trust has been barred by prescription and
laches.
Petitioners Constancia, Benjamin and Elenita, and private respondent Pedro, are the
children of the late Eulogio Esconde and petitioner Catalina Buan. Eulogio Escondewas
one of the children 3 and heirs of Andres Esconde. Andres is the brother of Estanislao Esconde,
the original owner of the disputed lot who died without issue on April 1942. Survived by his only
brother, Andres, Estanislao left an estate consisting of four (4) parcels of land in Samal, Bataan,
namely: (a) Lot No. 1865 with 22,712 square meters; (b) Lot No. 1902 with 54,735 square
meters; (c) Lot No. 1208 with 20,285 square meters; and (d) Lot No. 1700 with 547 square
meters. cdll

Eulogio died in April, 1944 survived by petitioners and private respondent. At that time, Lazara
and Ciriaca, Eulogio's sisters, had already died without having partitioned the estate of the late
Estanislao Esconde.
On December 5, 1946, the heirs of Lazara, Ciriaca and Eulogio executed a deed of extrajudicial
partition, 4 with the heirs of Lazara identified therein as the Party of the First Part,
that of Ciriaca, the Party of the Second Part and that of Eulogio, the Party of the Third Part.
Since the children of Eulogio, with the exception of Constancia, were then all minors, they were
represented by their mother and judicial guardian, petitioner Catalina
Buan vda. de Esconde who renounced and waived her usufructuary rights over the
parcels of land in favor of her children in the same deed. Salient provisions of the deed state as
follows:
"1. TO ARTURO DOMINGUEZ, minor, Party of the First Part is adjudicated:
(a) Lot No. 1865 of Samal Cadastre;
(b) Portion of Lot No. 1208, Samal Cadastre, which portion has
an area of FIVE (5) Luang;
2. TO JOVITA BUAN, RICARDO BUAN, and MELODY and LEOPOLDO
OCONER, are adjudicated Lot No. 1902 Samal Cadastre, and to de (sic)
divided as follows:
(a) Jovita Buan undivided one-third (1/3) share;
(b) Ricardo Buan Undivided one-third (1/3) share;
(c) Melody Oconer Undivided one-sixth (1/6) share;
(d) Leopoldo Oconer Undivided one-sixth (1/6) share;
3. TO CONSTANCIA, PEDRO, BENJAMIN and ELENITA, all
Surnamed ESCONDE, are adjudicated, in undivided equal shares each, the
following:
(a) Lot No. 1208 Samal Cadastre, subject to the
encumbrance of the right of ownership of Arturo Dominguez on the
FIVE LUANG;
4. TO PEDRO ESCONDE is adjudicated exclusively Lot No. 1700 of the
Cadastral Survey of Samal;" (Emphasis supplied.)
The deed bears the thumbmark of Catalina Buan and the signature of Constancia Esconde, as
well as the approval and signature of Judge Basilio Bautista. 5
Pursuant to the same deed, transfer certificates of title were issued to the new owners of the
properties. 6 Transfer Certificate of Title No. 394 for Lot No. 1700 was issued on February 11,
1947 in the name of private respondent but Catalina kept it in her possession until she delivered
it to him in 1949 when private respondent got married.

Meanwhile, Benjamin constructed the family home on Lot No. 1698-B 7 which is adjacent to Lot
No. 1700. A portion of the house occupied an area of twenty (20) square meters, more or
less, of Lot No. 1700. Benjamin also built a concrete fence and a common gate enclosing the
two (2) lots, as well as an artesian well within Lot No. 1700.LexLibris
Sometime in December, 1982, Benjamin discovered that Lot No. 1700 was registered in the
name of his brother, private respondent. Believing that the lot was co-owned by all the
children of Eulogio Esconde, Benjamin demanded his share of the lot from private
respondent. 8 However, private respondent asserted exclusive ownership thereof pursuant to
the deed of extrajudicial partition and, in 1985 constructed a "buho" fence to segregate Lot No.
1700 from Lot No. 1698-B.
Hence, on June 29, 1987, petitioners herein filed a complaint before the Regional
Trial Court of Bataan against private respondent for the annulment of TCT No. 394. They further
prayed that private respondent be directed to enter into a partition agreement with them, and for
damages (Civil Case No. 5552).
In its decision of July 31, 1989, the lower court dismissed the complaint and the counterclaims.
It found that the deed of extrajudicial partition was an unenforceable contract as far as Lot No.
1700 was concerned because petitioner Catalina Buan vda. de Esconde, as mother and judicial
guardian of her children, exceeded her authority as such in "donating" the lot to private
respondent or waiving the rights thereto of Benjamin and Elenita in favor of private respondent.
Because of the unenforceability of the deed, a trust relationship was created with private
respondent as trustee and Benjamin and Elenita as beneficiaries. The court said:
"Although the parties to the partition did not either contemplate or express it in
said document, the resulting trust arose or was created by operation of Article
1456 ofthe new Civil Code, which reads: 'If property is acquired
through mistake or fraud, the person obtaining it is, by force of law, considered
a trustee of an implied trust for the benefit of the person from whom the
property comes.' The persons from whom the two-thirds portion of Lot 1700
came are plaintiffs Benjamin and ElenitaEsconde and the trustee was
defendant Pedro Esconde, who acquired such portion through mistake by
virtue of the subject partition. The mistake was the allotment or
assignment of such portion to Pedro Esconde although it had rightfully
belonged to said two plaintiffs more than two (2) years before." 9

However, the lower court ruled that the action had been barred by both prescription and laches.
Lot No. 1700 having been registered in the name of private respondent on February 11, 1947,
the action to annul such title prescribed within ten (10) years on February 11, 1957 or more than
thirty (30) years before the action was filed on June 29, 1987. Thus, even if Art. 1963 of the old
Civil Code providing for a 30-year prescriptive period for real actions over immovable properties
were to be applied, still, the action would have prescribed on February 11, 1977.
Hence, petitioners elevated the case to the Court of Appeals which affirmed the lower court's
decision. The appellate court held that the deed of extrajudicial partition established "an implied

trust arising from the mistake of the judicial guardian in favoring one heir by giving him a bigger
share in the hereditary property." It stressed that "an action for reconveyance based on implied
or constructive trust" prescribes in ten (10) years "counted from the registration of the property
in the sole name ofthe co-heir." 10
Petitioners are now before this Court charging the Court of Appeals with having erred in: (a)
denying their appeal by reason of prescription and laches, and (b) not reversing the
decision of the lower court insofar as awarding them damages is concerned.
Trust is the legal relationship between one person having an equitable ownership in property
and another person owning the legal title to such property, the equitable ownership of the former
entitling him to the performance of certain duties and the exercise of certain powers by the
latter. 11 Trusts are either express or implied. An express trust is created by the direct and
positive acts of the parties, by some writing or deed or will or by words evidencing an intention
to create a trust. 12 No particular words are required for the creation of an express trust, it being
sufficient that a trust is clearly intended. 13
On the other hand, implied trusts are those which, without being expressed, are deducible from
the nature of the transaction as matters of intent or which are superinduced on the transaction
by operation of law as matters of equity, independently of the particular intention of the
parties. 14 In turn, implied trusts are either resulting or constructive trusts. These two are
differentiated from each other as follows:
"Resulting trusts are based on the equitable doctrine that valuable
consideration and not legal title determines the equitable title or interest and
are presumed always to have been contemplated by the parties. They arise
from the nature or circumstances of the consideration involved in a transaction
whereby one person thereby becomes invested with legal title but is obligated
in equity to hold his legal title for the benefit of another. On the other hand,
constructive trusts are created by the construction of equity in order to satisfy
the demands of justice and prevent unjust enrichment. They arise contrary to
intention against one who, by fraud, duress or abuse of confidence, obtains or
holds the legal right to property which he ought not, in equity and good
conscience, to hold." 15
While the deed of extrajudicial partition and the registration of Lot No. 1700 occurred in 1947
when the Code of Civil Procedure or Act No. 190 was yet in force, we hold that the
trial court correctly applied Article 1456. In Diaz, et al. v. Gorricho and
Aguado, 16 the Court categorically held that while it is not a retroactive provision of the new
Civil Code, Article 1456 "merely expresses a rule already recognized by our courts prior to the
Code's promulgation." This article provides:
"ARTICLE 1456. If property is acquired through mistake or fraud, the person
obtaining it is, by force of law, considered a trustee of an implied trust for the
benefit ofthe person from whom the property comes."
Construing this provision of the Civil Code, in Philippine National
Bank v. Court of Appeals, the Court stated:

"A deeper analysis of Article 1456 reveals that it is not a trust in the technical
sense for in a typical trust, confidence is reposed in one person who is named
a trustee for the benefit of another who is called the cestui que trust, respecting
property which is held by the trustee for the benefit of the cestui que trust. A
constructive trust, unlike an express trust, does not emanate from, or generate
a fiduciary relation. While in an express trust, a beneficiary and a trustee are
linked by confidential or fiduciary relations, in a constructive trust, there is
neither a promise nor any fiduciary relation to speak of and the so-called
trustee neither accepts any trust nor intends holding the property for the
beneficiary." 17
In the case at bench, petitioner Catalina Buan vda. de Esconde, as mother and legal
guardian of her children, appears to have favored her elder son, private respondent, in allowing
that he be given Lot No. 1700 in its entirety in the extrajudicial partition of the Esconde estate to
the prejudice of her other children. Although it does not appear on record whether Catalina
intentionally granted private respondent that privileged bestowal, the fact is that, said lot was
registered in private respondent's name. After TCT No. 394 was handed to him by his mother,
private respondent exercised exclusive rights of ownership therein to the extent of even
mortgaging the lot when he needed money. SDML
If, as petitioners insist, a mistake was committed in allotting Lot No. 1700 to private respondent,
then a trust relationship was created between them and private respondent. However, private
respondent never considered himself a trustee. If he allowed his brother Benjamin to construct
or make improvements thereon, it appears to have been out of tolerance to a brother.
Consequently, if indeed, by mistake, 18 private respondent was given the entirety of Lot No.
1700, the trust relationship between him and petitioners was a constructive, not resulting,
implied trust. Petitioners, therefore, correctly questioned private respondent's
exercise ofabsolute ownership over the property. Unfortunately, however, petitioners assailed it
long after their right to do so had prescribed.
The rule that a trustee cannot acquire by prescription ownership over property entrusted to him
until and unless he repudiates the trust, applies to express trusts 19and resulting implied
trusts. 20 However, in constructive implied trusts, prescription may supervene 21 even if the
trustee does not repudiate the relationship. Necessarily, repudiation of the said trust is not a
condition precedent to the running of the prescriptive period.
Since the action for the annulment of private respondent's title to Lot No. 1700 accrued during
the effectivity of Act No. 190, Section 40 of Chapter III thereof applies. It provides:
"SECTION 40. Period of prescription as to real estate. An action for
recovery of title to, or possession of, real property, or an interest therein, can
only be brought within ten years after the cause of such action accrues."
Thus, in Heirs of Jose Olviga v. Court of Appeals, 22 the Court ruled that the ten-year
prescriptive period for an action for reconveyance of real property based on implied or
constructive trust which is counted from the date of registration of the property, applies when
the plaintiff is not in possession of the contested property. In this case, private respondent,

not petitioners who instituted the action, is in actual possession of Lot No. 1700. Having filed
their action only on June 29, 1987, petitioners' action has been barred by prescription.
Not only that. Laches has also circumscribed the action for, whether the implied trust is
constructive or resulting, this doctrine applies. 23 As regards constructive implied trusts,
the Court held in Diaz, et al. v. Gorricho and Aguado 24 that:
". . . in constructive trusts (that are imposed by law), there is neither promise
nor fiduciary relation; the so-called trustee does not recognize any trust and
has no intent to hold for the beneficiary; therefore, the latter is not justified in
delaying action to recover his property. It is his fault if he delays; hence, he
may be estopped by his own laches."
It is tragic that a land dispute has once again driven a wedge between brothers. However, credit
must be given to petitioner Benjamin Esconde 25 for resorting to all means possible in arriving
at a settlement between him and his brother in accordance with Article 222 of the Civil
Code. 26 Verbally and in two letters, 27 he demanded that private respondent give him and his
sisters their share in Lot No. 1700. He even reported the matter to the barangay authorities for
which three conferences were held. 28 Unfortunately, his efforts proved fruitless. Even the
action he brought before the court was filed too late. LLpr
On the other hand, private respondent should not be unjustly enriched by the improvements
introduced by his brother on Lot No. 1700 which he himself had tolerated. He is obliged by law
to indemnify his brother, petitioner Benjamin Esconde, for whatever expenses the latter had
incurred.
WHEREFORE, the instant petition for review on certiorari is hereby DENIED and the questioned
decision AFFIRMED subject to the modification that private respondent shall indemnify
petitioner Benjamin Esconde the expenses the latter had incurred for the improvements on Lot
No. 1700. No costs.
SO ORDERED.
||| (Vda. de Esconde v. Court of Appeals, G.R. No. 103635, [February 1, 1996], 323 PHIL 81-94)

FIRST DIVISION
[G.R. No. 165849. December 10, 2007.]
GILBERT G. GUY, petitioner, vs. THE COURT OF APPEALS (8TH
DIVISION), NORTHERN ISLANDS CO., INCORPORATED, SIMNY G. GUY,
GERALDINE
G.
GUY,
GLADYS
G.
YAO,
and
EMILIA
TABUGADIR, respondents.
[G.R. No. 170185. December 10, 2007.]
IGNACIO AND IGNACIO LAW OFFICES, petitioner, vs. THE COURT OF
APPEALS (7TH DIVISION), NORTHERN ISLANDS CO., INCORPORATED,
SIMNY G. GUY, GERALDINE G. GUY, GLADYS G. YAO, and EMILIA A.
TABUGADIR, respondents.
[G.R. No. 170186. December 10, 2007.]
SMARTNET PHILIPPINES, petitioner, vs. THE COURT OF APPEALS (7TH
DIVISION), NORTHERN ISLANDS CO., INCORPORATED, SIMNY G. GUY,
GERALDINE
G.
GUY,
GLADYS
G.
YAO,
and
EMILIA
A.
TABUGADIR, respondents.
[G.R. No. 171066. December 10, 2007.]
LINCOLN CONTINENTAL DEVELOPMENT CO., INC., petitioner, vs.
NORTHERN ISLANDS CO., INCORPORATED, SIMNY G. GUY, GERALDINE
G. GUY, GRACE G. CHEU, GLADYS G. YAO, and EMILIA A.
TABUGADIR, respondents.
[G.R. No. 176650. December 10, 2007.]
LINCOLN CONTINENTAL DEVELOPMENT COMPANY, INC., petitioner, vs.
NORTHERN ISLANDS CO., INCORPORATED, SIMNY G. GUY, GERALDINE
G. GUY, GRACE G. CHEU, GLADYS G. YAO, and EMILIA A.
TABUGADIR, respondents.

DECISION

SANDOVAL-GUTIERREZ, J p:
Before us are five (5) consolidated cases which stemmed from Civil Case No. 04-109444 filed
with the Regional Trial Court (RTC), Branch 24, Manila, subsequently re-raffled to Branch
46 1 and eventually to Branch 25. 2
The instant controversies arose from a family dispute. Gilbert Guy is the son of Francisco and
Simny Guy. Geraldine, Gladys and Grace are his sisters. The family feud involves the
ownership and control of 20,160 shares of stock of Northern Islands Co., Inc. (Northern Islands)
engaged in the manufacture, distribution, and sales of various home appliances bearing the "3D" trademark.
Simny and her daughters Geraldine, Gladys and Grace, as well as Northern Islands and Emilia
Tabugadir, have been impleaded as respondents in the above-entitled cases. Northern Islands
is a family-owned corporation organized in 1957 by spouses Francisco and respondent Simny
Guy. In November 1986, they incorporated Lincoln Continental Development Corporation, Inc.
(Lincoln Continental) as a holding company of the 50% shares of stock of Northern Islands in
trust for their three (3) daughters, respondents Geraldine, Gladys and Grace. Sometime in
December 1986, upon instruction of spouses Guy, Atty. Andres Gatmaitan, president of Lincoln
Continental, indorsed in blank Stock Certificate No. 132 (covering 8,400 shares) and Stock
Certificate No. 133 (covering 11,760 shares) and delivered them to Simny.
In 1984, spouses Guy found that their son Gilbert has been disposing of the assets of their
corporations without authority. In order to protect the assets of Northern Islands, Simny
surrendered Stock Certificate Nos. 132 and 133 to Emilia Tabugadir, an officer of Northern
Islands. The 20,160 shares covered by the two Stock Certificates were then registered in the
names of respondent sisters, thus enabling them to assume an active role in the management
of Northern Islands.
On January 27, 2004, during a special meeting of the stockholders of Northern Islands, Simny
was elected President; Grace as Vice-President for Finance; Geraldine as Corporate Treasurer;
and Gladys as Corporate Secretary. Gilbert retained his position as Executive Vice President.
This development started the warfare between Gilbert and his sisters. ACcTDS
On March 18, 2004, Lincoln Continental filed with the RTC, Branch 24, Manila a Complaint for
Annulment of the Transfer of Shares of Stock against respondents, docketed as Civil Case No.
04-109444. The complaint basically alleges that Lincoln Continental owns 20,160 shares of
stock of Northern Islands; and that respondents, in order to oust Gilbert from the management
of Northern Islands, falsely transferred the said shares of stock in respondent sisters' names.
Lincoln Continental then prayed for an award of damages and that the management of Northern
Islands be restored to Gilbert. Lincoln also prayed for the issuance of a temporary restraining
order (TRO) and a writ of preliminary mandatory injunction to prohibit respondents from
exercising any right of ownership over the shares.
On June 16, 2004, Lincoln Continental filed a Motion to Inhibit the Presiding Judge of Branch
24, RTC, Manila on the ground of partiality. In an Order dated June 22, 2004, the presiding

judge granted the motion and inhibited himself from further hearing Civil Case No. 04-109444. It
was then re-raffled to Branch 46 of the same court.
On July 12, 2004, Branch 46 set the continuation of the hearing on Lincoln Continentals
application for a TRO.
On July 13, 2004, respondents filed with the Court of Appeals a Petition
for Certiorari and Mandamus, docketed as CA-G.R. SP No. 85069, raffled off to the Tenth
Division. Respondents alleged that the presiding judge of Branch 24, in issuing the Order dated
June 22, 2004 inhibiting himself from further hearing Civil Case No. 04-109444, and the
presiding judge of Branch 46, in issuing the Order dated July 12, 2004 setting the continuation
of hearing on Lincoln Continental's application for a TRO, acted with grave abuse of discretion
tantamount to lack or excess of jurisdiction.
Meanwhile, on July 15, 2004, the trial court issued the TRO prayed for by Lincoln Continental
directing respondents to restore to Gilbert the shares of stock under controversy. In the same
Order, the trial court set the hearing of Lincoln Continental's application for a writ of preliminary
injunction on July 19, 20, and 22, 2004.
On July 16, 2004, the Court of Appeals (Tenth Division) issued a TRO enjoining Branch 46,
RTC, Manila from enforcing, maintaining, or giving effect to its Order of July 12, 2004 setting the
hearing of Lincoln Continental's application for a TRO.
Despite the TRO, the trial court proceeded to hear Lincoln Continental's application for a writ of
preliminary injunction. This prompted respondents to file in the same CA-G.R. SP No. 85069 a
Supplemental Petition for Certiorari, Prohibition, and Mandamus seeking to set aside the Orders
of the trial court setting the hearing and actually hearing Lincoln Continental's application for a
writ of preliminary injunction. They prayed for a TRO and a writ of preliminary injunction to
enjoin the trial court (Branch 46) from further hearing Civil Case No. 04-109444.
On September 17, 2004, the TRO issued by the Court of Appeals (Tenth Division) in CA-G.R.
SP No. 85069 expired.
On September 20, 2004, Gilbert filed a Motion for Leave to Intervene and Motion to Admit
Complaint-in-Intervention in Civil Case No. 04-109444. In its Order dated October 4, 2004, the
trial court granted the motions. DCESaI
Meantime, on October 13, 2004, the trial court issued the writ of preliminary mandatory
injunction prayed for by Lincoln Continental in Civil Case No. 04-109444.
On October 20, 2004, the Court of Appeals (Tenth Division) denied respondents' application for
injunctive relief since the trial court had already issued a writ of preliminary injunction in favor of
Lincoln Continental. Consequently, on October 22, 2004, respondents filed with the Tenth
Division a Motion to Withdraw Petition and Supplemental Petition in CA-G.R. SP No. 85069.
On October 26, 2004, respondents filed a new Petition for Certiorari with the Court of Appeals,
docketed as CA-G.R. SP No. 87104, raffled off to the Eighth Division. They prayed that the TRO
and writ of preliminary injunction issued by the RTC, Branch 46, Manila be nullified and that an

injunctive relief be issued restoring to them the management of Northern Islands. They alleged
that Gilbert has been dissipating the assets of the corporation for his personal gain.
On October 28, 2004, the Court of Appeals Eighth Division issued a TRO enjoining the
implementation of the writ of preliminary injunction dated October 13, 2004 issued by the trial
court in Civil Case No. 04-109444; and directing Lincoln Continental to turn over the assets and
records of Northern Islands to respondents.
On November 2, 2004, respondents filed with the appellate court (Eighth Division) an
Urgent Omnibus Motion praying for the issuance of a break-open Order to implement its TRO.
On November 4, 2004, the Eighth Division issued a Resolution granting respondents' motion.
Pursuant to this Resolution, respondents entered the Northern Islands premises at No. 3
Mercury Avenue, Libis, Quezon City.
On November 18, 2004, Gilbert filed with this Court a petition for certiorari, docketed as G.R.
No. 165849, alleging that the Court of Appeals (Eighth Division), in granting an injunctive relief
in favor of respondents, committed grave abuse of discretion tantamount to lack or in excess of
jurisdiction. The petition also alleges that respondents resorted to forum shopping.
Meanwhile, on December 16, 2004, Smartnet Philippines, Inc. (Smartnet) filed with the
Metropolitan Trial Court (MeTC), Branch 35, Quezon City a complaint for forcible entry against
respondents, docketed as Civil Case No. 35-33937. The complaint alleges that in entering the
Northern Islands premises, respondents took possession of the area being occupied by
Smartnet and barred its officers and employees from occupying the same.
Likewise on December 16, 2004, Ignacio and Ignacio Law Offices also filed with Branch 37,
same court, a complaint for forcible entry against respondents, docketed as Civil Case No.
34106. It alleges that respondents forcibly occupied its office space when they took over the
premises of Northern Islands.
On December 22, 2004, the Eighth Division issued the writ of preliminary injunction prayed for
by respondents in CA-G.R. SP No. 87104. DISHEA
Subsequently, the presiding judge of the RTC, Branch 46, Manila retired. Civil Case No. 04109444 was then re-raffled to Branch 25.
On January 20, 2005, respondents filed with the Eighth Division of the appellate court a
Supplemental Petition for Certiorari with Urgent Motion for a Writ of Preliminary Injunction to
Include Supervening Events. Named as additional respondents were 3-D Industries, Judge
Celso D. Lavia, Presiding Judge, RTC, Branch 71, Pasig City and Sheriff Cresencio Rabello,
Jr. This supplemental petition alleges that Gilbert, in an attempt to circumvent the injunctive writ
issued by the Eighth Division of the appellate court, filed with the RTC, Branch 71, Pasig City a
complaint for replevin on behalf of 3-D Industries, to enable it to take possession of the assets
and records of Northern Islands. The complaint was docketed as Civil Case No. 70220. On
January 18, 2005, the RTC issued the writ of replevin in favor of 3-D Industries.

On April 15, 2005, respondents filed with the Eighth Division a Second Supplemental Petition
for Certiorari and Prohibition with Urgent Motion for the Issuance of an Expanded Writ of
Preliminary Injunction. Impleaded therein as additional respondents were Ignacio and Ignacio
Law Offices, Smartnet, Judge Maria Theresa De Guzman, Presiding Judge, MeTC, Branch 35,
Quezon City, Judge Augustus C. Diaz, Presiding Judge, MeTC, Branch 37, Quezon City, Sun
Fire Trading Incorporated, Zolt Corporation, Cellprime Distribution Corporation, Goodgold
Realty and Development Corporation, John Does and John Doe Corporations. Respondents
alleged in the main that the new corporations impleaded are alter egos of Gilbert; and that the
filing of the forcible entry cases with the MeTC was intended to thwart the execution of the writ
of preliminary injunction dated December 22, 2004 issued by the Court of Appeals (Eighth
Division) in CA-G.R. SP No. 87104.
On April 26, 2005, the Eighth Division issued a Resolution admitting respondents' new pleading.
On August 19, 2005, the Eighth Division (now Seventh Division) rendered its Decision in CAG.R. SP No. 87104, the dispositive portion of which reads:
WHEREFORE, premises considered, the petition is hereby GRANTED and the
October 13, 2004 Order and the October 13, 2004 Writ of Preliminary
Mandatory Injunction issued by Branch 46 of the Regional Trial Court of Manila
are hereby REVERSED and SET ASIDE. The December 17, 2004 Order and
Writ of Preliminary Injunction issued by this Court of Appeals are hereby MADE
PERMANENT against all respondents herein.
SO ORDERED.
Meanwhile, in a Decision 3 dated September 19, 2005, the RTC, Branch 25, Manila dismissed
the complaint filed by Lincoln Continental and the complaint-in-intervention of Gilbert in Civil
Case No. 04-109444, thus:
WHEREFORE, in view of the foregoing, the Complaint and the Complaint-inIntervention are hereby DISMISSED. Plaintiff and plaintiff-intervenor are hereby
ordered to jointly and severally pay defendants the following:
(a) Moral damages in the amount of Php2,000,000.00 each for
defendants Simny Guy, Geraldine Guy, Grace Guy-Cheu and
Gladys Yao;
(b) Moral damages in the amount of Php200,000.00 for defendant
Emilia Tabugadir; cTIESa
(c) Exemplary damages in the amount of Php2,000,000.00 each for
defendants Simny Guy, Geraldine Guy, Grace Guy-Cheu, and
Gladys Yao;
(d) Exemplary damages in the amount of Php200,000.00 for defendant
Emilia Tabugadir;
(e) Attorney's fees in the amount of Php2,000.000.00; and

(f) Costs of suit.

SO ORDERED.
The trial court held that Civil Case No. 04-109444 is a baseless and an unwarranted suit among
family members; that based on the evidence, Gilbert was only entrusted to hold the disputed
shares of stock in his name for the benefit of the other family members; and that it was only
when Gilbert started to dispose of the assets of the family's corporations without their
knowledge that respondent sisters caused the registration of the shares in their respective
names.
Both Lincoln Continental and Gilbert timely appealed the RTC Decision to the Court of Appeals,
docketed therein as CA-G.R. CV No. 85937.
On September 15, 2005, 3-D Industries, Inc. filed a petition for certiorari, prohibition,
and mandamus with this Court assailing the Decision of the Court of Appeals in CA-G.R. SP No.
87104 setting aside the writ of preliminary injunction issued by the RTC, Branch 46. The petition
was docketed as G.R. No. 169462 and raffled off to the Third Division of this Court.
On October 3, 2005, the Third Division of this Court issued a Resolution 4 dismissing the
petition of 3-D Industries in G.R. No. 169462. 3-D Industries timely filed its motion for
reconsideration but this was denied by this Court in its Resolution 5 dated December 14, 2005.
Meanwhile, on October 10, 2005, Gilbert, petitioner in G.R. No. 165849 for certiorari, filed with
this Court a Supplemental Petition for Certiorari, Prohibition, andMandamus with Urgent
Application for a Writ of Preliminary Mandatory Injunction challenging the Decision of the Court
of Appeals (Seventh Division), dated August 19, 2005, in CA-G.R. SP No. 87104. This Decision
set aside the Order dated October 13, 2004 of the RTC, Branch 46 granting the writ of
preliminary injunction in favor of Lincoln Continental.
On November 8, 2005, Ignacio and Ignacio Law Offices and Smartnet filed with this Court their
petitions for certiorari, docketed as G.R. Nos. 170185 and 170186, respectively.
On February 27, 2006, Lincoln Continental filed with this Court a petition for review
on certiorari challenging the Decision of the Court of Appeals (Seventh Division) in CA-G.R. CV
No. 85937, docketed as G.R. No. 171066.
On March 20, 2006, we ordered the consolidation of G.R. No. 171066 with G.R. Nos. 165849,
170185, and 170186.
In the meantime, in a Decision dated November 27, 2006 in CA-G.R. CV No. 85937, the Court
of Appeals (Special Second Division) affirmed the Decision in Civil Case No. 04-109444 of the
RTC (Branch 25) dismissing Lincoln Continental's complaint and Gilbert's complaint-inintervention, thus: cSaADC
WHEREFORE, the appeals are dismissed and the assailed decision
AFFIRMED with modifications that plaintiff and plaintiff-intervenor are ordered
to pay each of the defendants-appellees Simny Guy, Geraldine Guy, Grace

Guy-Cheu and Gladys Yao moral damages of P500,000.00, exemplary

damages of P100,000.00 and attorney's fees of P500,000.00.
SO ORDERED.
Lincoln Continental and Gilbert filed their respective motions for reconsideration, but they were
denied in a Resolution promulgated on February 12, 2007.
Lincoln Continental then filed with this Court a petition for review on certiorari assailing the
Decision of the Court of Appeals (Former Special Second Division) in CA-G.R. CV No. 85937.
This petition was docketed as G.R. No. 176650 and raffled off to the Third Division of this Court.
In our Resolution dated June 6, 2007, we ordered G.R. No. 176650 consolidated with G.R.
Nos. 165849, 170185, 170186, and 171066.
THE ISSUES
In G.R. Nos. 165849 and 171066, petitioners Gilbert and Lincoln Continental raise the following
issues: (1) whether respondents are guilty of forum shopping; and (2) whether they are entitled
to the injunctive relief granted in CA-G.R. SP No. 87104.
In G.R. Nos. 170185 and 170186, the pivotal issue is whether the Court of Appeals committed
grave abuse of discretion amounting to lack or excess of jurisdiction in ruling that petitioners
Ignacio and Ignacio Law Offices and Smartnet are also covered by its Resolution granting the
writ of preliminary injunction in favor of respondents.
In G.R. No. 176650, the core issue is whether the Court of Appeals (Special Second Division)
erred in affirming the Decision of the RTC, Branch 25, Manila dated September 19, 2005
dismissing the complaint of Lincoln Continental and the complaint-in-intervention of Gilbert in
Civil Case No. 04-109444.
THE COURT'S RULING
A. G.R. Nos. 165849 and 171066
On the question of forum shopping, petitioners Gilbert and Lincoln Continental contend that the
acts of respondents in filing a petition for certiorari and mandamus in CA-G.R. SP No. 85069
and withdrawing the same and their subsequent filing of a petition for certiorari in CA-G.R. SP
No. 87104 constitute forum shopping; that respondents withdrew their petition in CA-G.R. SP
No. 85069 after the Tenth Division issued a Resolution dated October 20, 2004 denying their
application for a writ of preliminary injunction; that they then filed an identical petition in CA-G.R.
SP No. 87104 seeking the same relief alleged in their petition in CA-G.R. SP No. 85069; and
that by taking cognizance of the petition in CA-G.R. SP No. 87104, instead of dismissing it
outright on the ground of forum shopping, the Court of Appeals committed grave abuse of
discretion tantamount to lack or excess of jurisdiction. cTAaDC
A party is guilty of forum shopping when he repetitively avails of several judicial remedies in
different courts, simultaneously or successively, all substantially founded on the same
transactions and the same essential facts and circumstances, and all raising substantially the

same issues either pending in, or already resolved adversely by some other court. 6 It is
prohibited by Section 5, Rule 7 of the 1997 Rules of Civil Procedure, as amended, which
provides:
SECTION 5. Certification against forum shopping. The plaintiff or principal
party shall certify under oath in the complaint or other initiatory pleading
asserting a claim for relief, or in a sworn certification annexed thereto and
simultaneously filed therewith: (a) that he has not theretofore commenced any
action or filed any other claim involving the same issues in any court, tribunal,
or quasi-judicial agency and, to the best of his knowledge, no such other action
or claim is pending therein; (b) if there is such other pending action or claim, a
complete statement of the present status thereof; and (c) if he should thereafter
learn that the same or similar action has been filed or is pending, he shall
report that fact within five (5) days therefrom to the court wherein his aforesaid
complaint or initiatory pleading has been filed.
Failure to comply with the foregoing requirements shall not be curable by mere
amendment of the complaint or other initiatory pleading but shall be cause for
the dismissal of the case without prejudice, unless otherwise provided, upon
motion and hearing. The submission of a false certification or non-compliance
with any of the undertakings therein shall constitute indirect contempt of court,
without prejudice to the corresponding administrative and criminal actions. If
the acts of the party or his counsel clearly constitute willful and deliberate forum
shopping, the same shall be ground for summary dismissal with prejudice and
shall constitute direct contempt, as well as a cause for administrative sanctions.
Forum shopping is condemned because it unnecessarily burdens our courts with heavy
caseloads, unduly taxes the manpower and financial resources of the judiciary and trifles with
and mocks judicial processes, thereby affecting the efficient administration of justice. 7 The
primary evil sought to be proscribed by the prohibition against forum shopping is, however, the
possibility of conflicting decisions being rendered by the different courts and/or administrative
agencies upon the same issues.8

Forum shopping may only exist where the elements of litis pendentia are present or where a
final judgment in one case will amount to res judicata in the other. 9 Litis pendentia as a ground
for dismissing a civil action is that situation wherein another action is pending between the same
parties for the same cause of action, such that the second action is unnecessary and vexatious.
The elements of litis pendentia are as follows: (a) identity of parties, or at least such as
representing the same interest in both actions; (b) identity of rights asserted and the relief
prayed for, the relief being founded on the same facts; and (c) the identity of the two cases such
that judgment in one, regardless of which party is successful, would amount to res judicata in
the other. 10 From the foregoing, it is clear that sans litis pendentia or res judicata, there can be
no forum shopping.

While the first element of litis pendentia identity of parties is present in both CA-G.R. SP
No. 85069 and CA-G.R. SP No. 87104, however, the second element, does not exist. The
petitioners in CA-G.R. SP No. 85069 prayed that the following Orders be set aside:
(1) the Order of inhibition dated June 22, 2004 issued by the presiding judge of
the RTC of Manila, Branch 24; and aTCADc
(2) the Order dated July 12, 2004 issued by Branch 46 setting Gilbert's
application for preliminary injunction for hearing.
In their petition in CA-G.R. SP No. 87104, respondents prayed for the annulment of the writ of
preliminary injunction issued by the RTC, Branch 46 after the expiration of the TRO issued by
the Tenth Division of the Court of Appeals. Evidently, this relief is not identical with the relief
sought by respondents in CA-G.R. SP No. 85069. Clearly, the second element of litis
pendentia the identity of reliefs sought is lacking in the two petitions filed by respondents
with the appellate court. Thus, we rule that no grave abuse of discretion amounting to lack or
excess of jurisdiction may be attributed to the Court of Appeals (Eighth Division) for giving due
course to respondents' petition in CA-G.R. SP No. 87104.
On the second issue, Section 3, Rule 58 of the 1997 Rules of Civil Procedure, as amended
provides:
SECTION 3. Grounds for issuance of preliminary injunction. A preliminary
injunction may be granted when it is established:
(a) That the applicant is entitled to the relief demanded, and the whole
or part of such relief consists in restraining the commission or
continuance of the act or acts complained of, or in requiring the
performance of an act or acts, either for a limited period or
perpetually;
(b) That the commission, continuance, or non-performance of the act or
acts complained of during the litigation would probably work
injustice to the applicant; or
(c) That a party, court, agency, or a person is doing, threatening, or is
attempting to do, or is procuring or suffering to be done, some
act or acts probably in violation of the rights of the applicant
respecting the subject of the action or proceeding, and tending
to render the judgment ineffectual.
For a party to be entitled to an injunctive writ, he must show that there exists a right to be
protected and that the acts against which the injunction is directed are violative of this
right. 11 In granting the respondents' application for injunctive relief and making the injunction
permanent, the Court of Appeals (Seventh Division) found that they have shown their clear and
established right to the disputed 20,160 shares of stock because: (1) they have physical
possession of the two stock certificates equivalent to the said number of shares; (2) Lincoln

Continental is a mere trustee of the Guy family; and (3) respondents constitute a majority of the
board of directors of Northern Islands, and accordingly have management and control of the
company at the inception of Civil Case No. 94-109444. The appellate court then ruled that the
trial court committed grave abuse of discretion in issuing a writ of preliminary mandatory
injunction in favor of Guy. The writ actually reduced the membership of Northern Islands board
to just one member Gilbert Guy. Moreover, he failed to establish by clear and convincing
evidence his ownership of the shares of stock in question. The Court of Appeals then held there
was an urgent necessity to issue an injunctive writ in order to prevent serious damage to the
rights of respondents and Northern Islands.
We thus find no reason to depart from the findings of the Court of Appeals. Indeed, we cannot
discern any taint of grave abuse of discretion on its part in issuing the assailed writ of
preliminary injunction and making the injunction permanent. DHCSTa
B. G.R. Nos. 170185 & 170186
Ignacio and Ignacio Law Offices and Smartnet, petitioners, claim that the Court of Appeals
never acquired jurisdiction over their respective persons as they were not served with
summons, either by the MeTC or by the appellate court in CA-G.R. SP No. 87104. Thus, they
submit that the Court of Appeals committed grave abuse of discretion amounting to lack or
excess of jurisdiction when it included them in the coverage of its injunctive writ.
Jurisdiction is the power or capacity given by the law to a court or tribunal to entertain, hear, and
determine certain controversies. 12 Jurisdiction over the subject matter of a case is conferred by
law.
Section 9 (1) of Batas Pambansa Blg. 129, 13 as amended, provides:
SEC. 9. Jurisdiction. The Court of Appeals shall exercise:
(1) Original
jurisdiction
to
issue
writs
of mandamus,
prohibition, certiorari, habeas corpus, and quo warranto, and auxiliary writs or
processes, whether or not in aid of its appellate jurisdiction.
Rule 46 of the 1997 Rules of Civil Procedure, as amended, governs all
cases originally filed with the Court of Appeals. The following provisions of
the Rule state:
SEC. 2. To what actions applicable. This Rule shall apply to original actions
for certiorari, prohibition, mandamus and quo warranto.
Except as otherwise provided, the actions for annulment of judgment shall be
governed by Rule 47, for certiorari, prohibition, and mandamus by Rule 65, and
for quo warranto by Rule 66.
xxx xxx xxx
SEC. 4. Jurisdiction over person of respondent, how acquired. The court
shall acquire jurisdiction over the person of the respondent by the service on

him of its order or resolution indicating its initial action on the petition or by his
voluntary submission to such jurisdiction.
SEC. 5. Action by the court. The court may dismiss the petition outright with
specific reasons for such dismissal or require the respondent to file a comment
on the same within ten (10) days from notice. Only pleadings required by the
court shall be allowed. All other pleadings and papers may be filed only with
leave of court.
It is thus clear that in cases covered by Rule 46, the Court of Appeals acquires jurisdiction over
the persons of the respondents by the service upon them of its order or resolution indicating its
initial action on the petitions or by their voluntary submission to such jurisdiction. 14 The reason
for this is that, aside from the fact that no summons or other coercive process is served on
respondents, their response to the petitions will depend on the initial action of the court thereon.
Under Section 5, the court may dismiss the petitions outright, hence, no reaction is expected
from respondents and under the policy adopted by Rule 46, they are not deemed to have been
brought within the court's jurisdiction until after service on them of the dismissal order or
resolution. 15
Records show that on April 27, 2005, petitioners in these two forcible entry cases, were served
copies of the Resolution of the Court of Appeals (Seventh Division) dated April 26, 2005 in CAG.R. SP No. 87104. 16 The Resolution states: SEcAIC
Private respondents SMARTNET PHILIPPINES, INC., IGNACIO & IGNACIO
LAW OFFICE, SUNFIRE TRADING, INC., ZOLT CORPORATION,
CELLPRIME
DISTRIBUTION
CORPO.,
GOODGOLD
REALTY
&
DEVELOPMENT CORP., are hereby DIRECTED to file CONSOLIDATED
COMMENT on the original Petition for Certiorari, the First Supplemental
Petition for Certiorari, and the Second Supplemental Petition for Certiorari (not
a Motion to Dismiss) within ten (10) days from receipt of a copy of the original,
first and second Petitions for Certiorari. 17
Pursuant to Rule 46, the Court of Appeals validly acquired jurisdiction over the persons of
Ignacio and Ignacio Law Offices and Smartnet upon being served with the above Resolution.
But neither of the parties bothered to file the required comment. Their allegation that they have
been deprived of due process is definitely without merit. We have consistently held that when a
party was afforded an opportunity to participate in the proceedings but failed to do so, he cannot
complain of deprivation of due process for by such failure, he is deemed to have waived or
forfeited his right to be heard without violating the constitutional guarantee. 18
On the question of whether the Court of Appeals could amend its Resolution directing the
issuance of a writ of preliminary injunction so as to include petitioners, suffice to state that
having acquired jurisdiction over their persons, the appellate court could do so pursuant to
Section 5 (g), Rule 135 of the Revised Rules of Court, thus: aCSTDc
SEC. 5. Inherent powers of courts. Every court shall have power:

xxx xxx xxx

(g) To amend and control its process and orders so as to make them
conformable to law and justice.
In Villanueva v. CFI of Oriental Mindoro 19 and Eternal Gardens Memorial Parks Corp. v.
Intermediate Appellate Court, 20 we held that under this Rule, a court has inherent power to
amend its judgment so as to make it conformable to the law applicable, provided that said
judgment has not yet acquired finality, as in these cases.

C. G.R. No. 176650

The fundamental issue is who owns the disputed shares of stock in Northern Islands.
We remind petitioner Lincoln Continental that what it filed with this Court is a petition for review
on certiorari under Rule 45 of the 1997 Rules of Civil Procedure, as amended. It is a rule in this
jurisdiction that in petitions for review under Rule 45, only questions or errors of law may be
raised. 21 There is a question of law when the doubt or controversy concerns the correct
application of law or jurisprudence to a certain set of facts, or when the issue does not call for
an examination of the probative value of the evidence presented. There is a question of fact
when the doubt arises as to the truth or falsehood of facts or when there is a need to calibrate
the whole evidence considering mainly the credibility of the witnesses, the existence and
relevancy of specific surrounding circumstances, as well as their relation to each other and to
the whole, and the probability of the situation. 22 Obviously, the issue raised by the instant
petition for review on certiorari, involves a factual matter, hence, is outside the domain of this
Court. However, in the interest of justice and in order to settle this controversy once and for all,
a ruling from this Court is imperative.
One thing is clear. It was established before the trial court, affirmed by the Court of
Appeals, that Lincoln Continental held the disputed shares of stock of Northern Islands
merely in trust for the Guy sisters. In fact, the evidence proffered by Lincoln Continental itself
supports this conclusion. It bears emphasis that this factual finding by the trial court was
affirmed by the Court of Appeals, being supported by evidence, and is, therefore, final and
conclusive upon this Court.
Article 1440 of the Civil Code provides that:
ART. 1440. A person who establishes a trust is called the trustor; one in whom
confidence is reposed as regards property for the benefit of another person is
known as the trustee; and the person for whose benefit the trust has been
created is referred to as the beneficiary.
In the early case of Gayondato v. Treasurer of the Philippine Islands, 23 this Court defines trust,
in its technical sense, as "a right of property, real or personal, held by one party for the benefit
of another." Differently stated, a trust is "a fiduciary relationship with respect to property,

subjecting the person holding the same to the obligation of dealing with the property for the
benefit of another person." 24
Both Lincoln Continental and Gilbert claim that the latter holds legal title to the shares in
question. But record shows that there is no evidence that the stock certificates representing
the contested shares are in respondents' possession. Significantly, there is no proof to support
his allegation that the transfer of the shares of stock to respondent sisters is fraudulent. As aptly
held by the Court of Appeals, fraud is never presumed but must be established by clear and
convincing evidence. 25Gilbert failed to discharge this burden. We agree with the Court of
Appeals that respondent sisters own the shares of stock, Gilbert being their mere trustee. Verily,
we find no reversible error in the challenged Decision of the Court of Appeals (Special Second
Division) in CA-G.R. CV No. 85937. HCDAac
WHEREFORE, we DISMISS the petitions in G.R. Nos. 165849, 170185, 170186 and 176650;
and DENY the petitions in G.R. Nos. 171066 and 176650. The Resolutions of the Court of
Appeals (Eighth Division), dated October 28, 2004 and November 4, 2004, as well as the
Decision dated October 10, 2005 of the Court of Appeals (Seventh Division) in CA-G.R. SP No.
87104 are AFFIRMED. We likewise AFFIRM IN TOTO the Decision of the Court of Appeals
(Special Second Division), dated November 27, 2006 in CA-G.R. CV No. 85937. Costs against
petitioners.
SO ORDERED.
||| (Guy v. Court of Appeals, G.R. No. 165849, 170185, 170186, 171066, 176650, [December
10, 2007], 564 PHIL 540-565)

SECOND DIVISION
[G.R. No. 162175. June 28, 2010.]
MIGUEL J. OSSORIO PENSION FOUNDATION,
INCORPORATED, petitioner, vs. COURT OF APPEALS and
COMMISSIONER OF INTERNAL REVENUE,respondents.

DECISION

CARPIO, J p:
The Case
The Miguel J. Ossorio Pension Foundation, Incorporated (petitioner or MJOPFI) filed
this Petition for Certiorari 1 with Prayer for the Issuance of a Temporary Restraining Order
and/or Writ of Preliminary Injunction to reverse the Court of Appeals' (CA) Decision 2 dated
30 May 2003 in CA-G.R. SP No. 61829 as well as the Resolution 3 dated 7 November 2003
denying the Motion for Reconsideration. In the assailed decision, the CA affirmed the Court
of Tax Appeals' (CTA) Decision 4dated 24 October 2000. The CTA denied petitioner's claim
for refund of withheld creditable tax of P3,037,500 arising from the sale of real property of
which petitioner claims to be a co-owner as trustee of the employees' trust or retirement
funds.
The Facts
Petitioner, a non-stock and non-profit corporation, was organized for the purpose of
holding title to and administering the employees' trust or retirement funds (Employees' Trust
Fund) established for the benefit of the employees of Victorias Milling Company, Inc.
(VMC). 5 Petitioner, as trustee, claims that the income earned by the Employees' Trust Fund
is tax exempt under Section 53 (b) of the National Internal Revenue Code (Tax Code).
Petitioner alleges that on 25 March 1992, petitioner decided to invest part of the
Employees' Trust Fund to purchase a lot 6 in the Madrigal Business Park (MBP lot) in
Alabang, Muntinlupa. Petitioner bought the MBP lot through VMC. 7 Petitioner alleges that
its investment in the MBP lot came about upon the invitation of VMC, which also purchased
two lots. Petitioner claims that its share in the MBP lot is 49.59%. Petitioner's investment
manager, the Citytrust Banking Corporation (Citytrust), 8 in submitting its Portfolio Mix
Analysis, regularly reported the Employees' Trust Fund's share in the MBP lot. 9 The MBP
lot is covered by Transfer Certificate of Title No. 183907 (TCT 183907) with VMC as the
registered owner. 10

Petitioner claims that since it needed funds to pay the retirement and pension
benefits of VMC employees and to reimburse advances made by VMC, petitioner's Board of
Trustees authorized the sale of its share in the MBP lot. 11
On 14 March 1997, VMC negotiated the sale of the MBP lot with Metropolitan Bank
and Trust Company, Inc. (Metrobank) for P81,675,000, but the consummation of the sale
was withheld. 12 On 26 March 1997, VMC eventually sold the MBP lot to Metrobank. VMC,
through its Vice President Rolando Rodriguez and Assistant Vice President Teodorico
Escober, signed the Deed of Absolute Sale as the sole vendor.
Metrobank, as withholding agent, paid the Bureau of Internal Revenue (BIR)
P6,125,625 as withholding tax on the sale of real property.
Petitioner alleges that the parties who co-owned the MBP lot executed a notarized
Memorandum of Agreement as to the proceeds of the sale, the pertinent provisions of which
state: 13
2. The said parcels of land are actually co-owned by the following:
BLOCK 4, LOT 1 COVERED BY TCT NO. 183907

SQ. M.

AMOUNT

MJOPFI

49.59%

450.00

P5,504,748.25

VMC

32.23%

351.02

3,578,294.70

VFC

18.18%

197.98

2,018,207.30

3. Since Lot 1 has been sold for P81,675,000.00 (gross of 7.5% withholding tax
and 3% broker's commission, MJOPFI's share in the proceeds of the sale is
P40,500,000.00 (gross of 7.5% withholding tax and 3% broker's commission.
However, MJO Pension Fund is indebted to VMC representing pension benefit
advances paid to retirees amounting to P21,425,141.54, thereby leaving a
balance of P14,822,358.46 in favor of MJOPFI. Check for said amount of
P14,822,358.46 will therefore be issued to MJOPFI as its share in the proceeds
of the sale of Lot 1. The check corresponding to said amount will be deposited
with MJOPFI's account with BPI Asset Management & Trust Group which will
then be invested by it in the usual course of its administration of MJOPFI funds.
Petitioner claims that it is a co-owner of the MBP lot as trustee of the Employees'
Trust Fund, based on the notarized Memorandum of Agreement presented before the
appellate courts. Petitioner asserts that VMC has confirmed that petitioner, as trustee of the
Employees' Trust Fund, is VMC's co-owner of the MBP lot. Petitioner maintains that its
ownership of the MBP lot is supported by the excerpts of the minutes and the resolutions of
petitioner's Board Meetings. Petitioner further contends that there is no dispute that the

Employees' Trust Fund is exempt from income tax. Since petitioner, as trustee, purchased
49.59% of the MBP lot using funds of the Employees' Trust Fund, petitioner asserts that the
Employees' Trust Fund's 49.59% share in the income tax paid (or P3,037,697.40 rounded
off to P3,037,500) should be refunded. 14
Petitioner maintains that the tax exemption of the Employees' Trust Fund rendered
the payment of P3,037,500 as illegal or erroneous. On 5 May 1997, petitioner filed a claim
for tax refund. 15
On 14 August 1997, the BIR, through its Revenue District Officer, wrote petitioner
stating that under Section 26 of the Tax Code, petitioner is not exempt from tax on its
income from the sale of real property. The BIR asked petitioner to submit documents to
prove its co-ownership of the MBP lot and its exemption from tax.16
On 2 September 1997, petitioner replied that the applicable provision granting its
claim for tax exemption is not Section 26 but Section 53 (b) of the Tax Code. Petitioner
claims that its co-ownership of the MBP lot is evidenced by Board Resolution Nos. 92-34
and 96-46 and the memoranda of agreement among petitioner, VMC and its subsidiaries. 17
Since the BIR failed to act on petitioner's claim for refund, petitioner elevated its
claim to the Commissioner of Internal Revenue (CIR) on 26 October 1998. The CIR did not
act on petitioner's claim for refund. Hence, petitioner filed a petition for tax refund before the
CTA. On 24 October 2000, the CTA rendered a decision denying the petition. 18
On 22 November 2000, petitioner filed its Petition for Review before the Court of
Appeals. On 20 May 2003, the CA rendered a decision denying the appeal. The CA also
denied petitioner's Motion for Reconsideration. 19
Aggrieved by the appellate court's Decision, petitioner elevated the case before this Court.
The Ruling of the Court of Tax Appeals
The CTA held that under Section 53 (b) 20 [now Section 60 (b)] of the Tax Code, it is
not petitioner that is entitled to exemption from income tax but the income or earnings of the
Employees' Trust Fund. The CTA stated that petitioner is not the pension trust itself but it is
a separate and distinct entity whose function is to administer the pension plan for some
VMC employees. 21 The CTA, after evaluating the evidence adduced by the parties, ruled
that petitioner is not a party in interest.
To prove its co-ownership over the MBP lot, petitioner presented the following
documents:
a. Secretary's Certificate showing how the purchase and eventual sale of the
MBP lot came about.
b. Memoranda of Agreement showing various details:
i. That the MBP lot was co-owned by VMC and petitioner on a 50/50
basis;

ii. That VMC held the property in trust for North Legaspi Land
Development Corporation, North Negros Marketing Co., Inc.,
Victorias Insurance Factors Corporation, Victorias Science and
Technical Foundation, Inc. and Canetown Development
Corporation.
iii. That the previous agreement (ii) was cancelled and it showed that
the MBP lot was co-owned by petitioner, VMC and Victorias
Insurance Factors Corporation (VFC). 22
The CTA ruled that these pieces of evidence are self-serving and cannot by
themselves prove petitioner's co-ownership of the MBP lot when the TCT, the Deed of
Absolute Sale, and the Monthly Remittance Return of Income Taxes Withheld (Remittance
Return) disclose otherwise. The CTA further ruled that petitioner failed to present any
evidence to prove that the money used to purchase the MBP lot came from the Employees'
Trust Fund. 23
The CTA concluded that petitioner is estopped from claiming a tax exemption. The
CTA pointed out that VMC has led the government to believe that it is the sole owner of the
MBP lot through its execution of the Deeds of Absolute Sale both during the purchase and
subsequent sale of the MBP lot and through the registration of the MBP lot in VMC's name.
Consequently, the tax was also paid in VMC's name alone. The CTA stated that petitioner
may not now claim a refund of a portion of the tax paid by the mere expediency of
presenting Secretary's Certificates and memoranda of agreement in order to prove its
ownership. These documents are self-serving; hence, these documents merit very little
weight. 24
The Ruling of the Court of Appeals
The CA declared that the findings of the CTA involved three types of documentary
evidence that petitioner presented to prove its contention that it purchased 49.59% of the
MBP lot with funds from the Employees' Trust Fund: (1) the memoranda of agreement
executed by petitioner and other VMC subsidiaries; (2) Secretary's Certificates containing
excerpts of the minutes of meetings conducted by the respective boards of directors or
trustees of VMC and petitioner; (3) Certified True Copies of the Portfolio Mix Analysis issued
by Citytrust regarding the investment of P5,504,748.25 in Madrigal Business Park I for the
years 1994 to 1997. 25
The CA agreed with the CTA that these pieces of documentary evidence submitted
by petitioner are largely self-serving and can be contrived easily. The CA ruled that these
documents failed to show that the funds used to purchase the MBP lot came from the
Employees' Trust Fund. The CA explained, thus:
We are constrained to echo the findings of the Court of Tax Appeals in regard
to the failure of the petitioner to ensure that legal documents pertaining to its
investments, e.g., title to the subject property, were really in its name,
considering its awareness of the resulting tax benefit that such foresight or
providence would produce; hence, genuine efforts towards that end should

have been exerted, this notwithstanding the alleged difficulty of procuring a title
under the names of all the co-owners. Indeed, we are unable to understand
why petitioner would allow the title of the property to be placed solely in the
name of petitioner's alleged co-owner,i.e., the VMC, although it allegedly
owned a much bigger (nearly half), portion thereof. Withal, petitioner failed to
ensure a "fix" so to speak, on its investment, and we are not impressed by the
documents which the petitioner presented, as the same apparently allowed
"mobility" of the subject real estate assets between or among the petitioner, the
VMC and the latter's subsidiaries. Given the fact that the subject parcel of land
was registered and sold under the name solely of VMC, even as payment of
taxes was also made only under its name, we cannot but concur with the
finding of the Court of Tax Appeals that petitioner's claim for refund of withheld
creditable tax is bereft of solid juridical basis. 26
The Issues
The issues presented are:
1. Whether petitioner or the Employees' Trust Fund is estopped from claiming
that the Employees' Trust Fund is the beneficial owner of 49.59% of the
MBP lot and that VMC merely held 49.59% of the MBP lot in trust for
the Employees' Trust Fund.
2. If petitioner or the Employees' Trust Fund is not estopped, whether they
have sufficiently established that the Employees' Trust Fund is the
beneficial owner of 49.59% of the MBP lot, and thus entitled to tax
exemption for its share in the proceeds from the sale of the MBP lot.
The Ruling of the Court
We grant the petition.
The law expressly allows a co-owner (first co-owner) of a parcel of land to register
his proportionate share in the name of his co-owner (second co-owner) in whose name the
entire land is registered. The second co-owner serves as a legal trustee of the first co-owner
insofar as the proportionate share of the first co-owner is concerned. The first co-owner
remains the owner of his proportionate share and not the second co-owner in whose name
the entire land is registered. Article 1452 of the Civil Code provides:
Art. 1452.If two or more persons agree to purchase a property and by common
consent the legal title is taken in the name of one of them for the benefit of
all, a trust is created by force of law in favor of the others in proportion to the
interest of each. (Emphasis supplied)
For Article 1452 to apply, all that a co-owner needs to show is that there is "common
consent" among the purchasing co-owners to put the legal title to the purchased property in
the name of one co-owner for the benefit of all. Once this "common consent" is shown, "a
trust is created by force of law." The BIR has no option but to recognize such legal trust
as well as the beneficial ownership of the real owners because the trust is created by force

of law. The fact that the title is registered solely in the name of one person is not conclusive
that he alone owns the property.
Thus, this case turns on whether petitioner can sufficiently establish that petitioner,
as trustee of the Employees' Trust Fund, has a common agreement with VMC and VFC that
petitioner, VMC and VFC shall jointly purchase the MBP lot and put the title to the MBP lot in
the name of VMC for the benefit petitioner, VMC and VFC.
We rule that petitioner, as trustee of the Employees' Trust Fund, has more than
sufficiently established that it has an agreement with VMC and VFC to purchase jointly the
MBP lot and to register the MBP lot solely in the name of VMC for the benefit of petitioner,
VMC and VFC.
Factual findings of the CTA will be reviewed
when judgment is based on a misapprehension of facts.
Generally, the factual findings of the CTA, a special court exercising expertise on the
subject of tax, are regarded as final, binding and conclusive upon this Court, especially if
these are substantially similar to the findings of the CA which is normally the final arbiter of
questions of fact. 27 However, there are recognized exceptions to this rule, 28 such as
when the judgment is based on a misapprehension of facts.
Petitioner contends that the CA erred in evaluating the documents as self-serving
instead of considering them as truthful and genuine because they are public documents duly
notarized by a Notary Public and presumed to be regular unless the contrary appears.
Petitioner explains that the CA erred in doubting the authenticity and genuineness of the
three memoranda of agreement presented as evidence. Petitioner submits that there is
nothing wrong in the execution of the three memoranda of agreement by the parties.
Petitioner points out that VMC authorized petitioner to administer its Employees' Trust Fund
which is basically funded by donation from its founder, Miguel J. Ossorio, with his shares of
stocks and share in VMC's profits. 29
Petitioner argues that the Citytrust report reflecting petitioner's investment in the
MBP lot is concrete proof that money of the Employees' Trust Funds was used to purchase
the MBP lot. In fact, the CIR did not dispute the authenticity and existence of this
documentary evidence. Further, it would be unlikely for Citytrust to issue a certified copy of
the Portfolio Mix Analysis stating that petitioner invested in the MBP lot if it were not true. 30
Petitioner claims that substantial evidence is all that is required to prove petitioner's
co-ownership and all the pieces of evidence have overwhelmingly proved that petitioner is a
co-owner of the MBP lot to the extent of 49.59% of the MBP lot. Petitioner explains:
Thus, how the parties became co-owners was shown by the excerpts of the
minutes and the resolutions of the Board of Trustees of the petitioner and those
of VMC. All these documents showed that as far as March 1992, petitioner
already expressed intention to be co-owner of the said property. It then decided
to invest the retirement funds to buy the said property and culminated in it
owning 49.59% thereof. When it was sold to Metrobank, petitioner received its
share in the proceeds from the sale thereof. The excerpts and resolutions of

the parties' respective Board of Directors were certified under oath by their
respective Corporate Secretaries at the time. The corporate certifications are
accorded verity by law and accepted as prima facie evidence of what took
place in the board meetings because the corporate secretary is, for the time
being, the board itself. 31
Petitioner, citing Article 1452 of the Civil Code, claims that even if VMC registered
the land solely in its name, it does not make VMC the absolute owner of the whole property
or deprive petitioner of its rights as a co-owner. 32 Petitioner argues that under the Torrens
system, the issuance of a TCT does not create or vest a title and it has never been
recognized as a mode of acquiring ownership. 33
The issues of whether petitioner or the Employees' Trust Fund is estopped from
claiming 49.59% ownership in the MBP lot, whether the documents presented by petitioner
are self-serving, and whether petitioner has proven its exemption from tax, are all questions
of fact which could only be resolved after reviewing, examining and evaluating the probative
value of the evidence presented. The CTA ruled that the documents presented by petitioner
cannot prove its co-ownership over the MBP lot especially that the TCT, Deed of Absolute
Sale and the Remittance Return disclosed that VMC is the sole owner and taxpayer.
However, the appellate courts failed to consider the genuineness and due execution
of the notarized Memorandum of Agreement acknowledging petitioner's ownership of the
MBP lot which provides:
2. The said parcels of land are actually co-owned by the following:
BLOCK 4, LOT 1 COVERED BY TCT NO. 183907
%

SQ. M.

AMOUNT

MJOPFI

49.59%

450.00

P5,504,748.25

VMC

32.23%

351.02

3,578,294.70

VFC

18.18%

197.98

2,018,207.30

Thus, there is a "common consent" or agreement among petitioner, VMC and VFC to coown the MBP lot in the proportion specified in the notarized Memorandum of Agreement.
In Cuizon v. Remoto,34 we held:
Documents acknowledged before notaries public are public documents and
public documents are admissible in evidence without necessity of preliminary
proof as to their authenticity and due execution. They have in their favor the
presumption of regularity, and to contradict the same, there must be evidence
that is clear, convincing and more than merely preponderant.

The BIR failed to present any clear and convincing evidence to prove that the
notarized Memorandum of Agreement is fictitious or has no legal effect. Likewise, VMC, the
registered owner, did not repudiate petitioner's share in the MBP lot. Further, Citytrust, a
reputable banking institution, has prepared a Portfolio Mix Analysis for the years 1994 to
1997 showing that petitioner invested P5,504,748.25 in the MBP lot. Absent any proof that
the Citytrust bank records have been tampered or falsified, and the BIR has presented
none, the Portfolio Mix Analysis should be given probative value.
The BIR argues that under the Torrens system, a third person dealing with registered
property need not go beyond the TCT and since the registered owner is VMC, petitioner is
estopped from claiming ownership of the MBP lot. This argument is grossly erroneous. The
trustor-beneficiary is not estopped from proving its ownership over the property held in trust
by the trustee when the purpose is not to contest the disposition or encumbrance of the
property in favor of an innocent third-party purchaser for value. The BIR, not being a buyer
or claimant to any interest in the MBP lot, has not relied on the face of the title of the MBP
lot to acquire any interest in the lot. There is no basis for the BIR to claim that petitioner is
estopped from proving that it co-owns, as trustee of the Employees' Trust Fund, the MBP
lot. Article 1452 of the Civil Code recognizes the lawful ownership of the trustor-beneficiary
over the property registered in the name of the trustee. Certainly, the Torrens system was
not established to foreclose a trustor or beneficiary from proving its ownership of a property
titled in the name of another person when the rights of an innocent purchaser or lien-holder
are not involved. More so, when such other person, as in the present case, admits its being
a mere trustee of the trustor or beneficiary.
The registration of a land under the Torrens system does not create or vest title,
because registration is not one of the modes of acquiring ownership. A TCT is merely an
evidence of ownership over a particular property and its issuance in favor of a particular
person does not foreclose the possibility that the property may be co-owned by persons not
named in the certificate, or that it may be held in trust for another person by the registered
owner. 35
No particular words are required for the creation of a trust, it being sufficient that a
trust is clearly intended. 36 It is immaterial whether or not the trustor and the trustee know
that the relationship which they intend to create is called a trust, and whether or not the
parties know the precise characteristic of the relationship which is called a trust because
what is important is whether the parties manifested an intention to create the kind of
relationship which in law is known as a trust. 37
The fact that the TCT, Deed of Absolute Sale and the Remittance Return were in
VMC's name does not forestall the possibility that the property is owned by another
entity because Article 1452 of the Civil Code expressly authorizes a person to
purchase a property with his own money and to take conveyance in the name of
another.
In Tigno v. Court of Appeals, the Court explained, thus:
An implied trust arises where a person purchases land with his own money and
takes conveyance thereof in the name of another. In such a case, the property

is held on resulting trust in favor of the one furnishing the consideration for the
transfer, unless a different intention or understanding appears. The trust which
results under such circumstances does not arise from a contract or an
agreement of the parties, but from the facts and circumstances; that is to say,
the trust results because of equity and it arises by implication or operation of
law. 38
In this case, the notarized Memorandum of Agreement and the certified true copies
of the Portfolio Mix Analysis prepared by Citytrust clearly prove that petitioner invested
P5,504,748.25, using funds of the Employees' Trust Fund, to purchase the MBP lot. Since
the MBP lot was registered in VMC's name only, a resulting trust is created by operation
of law. A resulting trust is based on the equitable doctrine that valuable consideration and
not legal title determines the equitable interest and is presumed to have been contemplated
by the parties. 39 Based on this resulting trust, the Employees' Trust Fund is considered the
beneficial co-owner of the MBP lot.
Petitioner has sufficiently proven that it had a "common consent" or agreement with
VMC and VFC to jointly purchase the MBP lot. The absence of petitioner's name in the TCT
does not prevent petitioner from claiming before the BIR that the Employees' Trust Fund is
the beneficial owner of 49.59% of the MBP lot and that VMC merely holds 49.59% of the
MBP lot in trust, through petitioner, for the benefit of the Employees' Trust Fund.
The BIR has acknowledged that the owner of a land can validly place the title to the
land in the name of another person. In BIR Ruling [DA-(I-012) 190-09] dated 16 April 2009,
a certain Amelia Segarra purchased a parcel of land and registered it in the names of Armin
Segarra and Amelito Segarra as trustees on the condition that upon demand by Amelia
Segarra, the trustees would transfer the land in favor of their sister, Arleen May SegarraGuevara. The BIR ruled that an implied trust is deemed created by law and the transfer of
the land to the beneficiary is not subject to capital gains tax or creditable withholding tax.
Income from Employees' Trust Fund is Exempt from Income Tax
Petitioner claims that the Employees' Trust Fund is exempt from the payment of
income tax. Petitioner further claims that as trustee, it acts for the Employees' Trust Fund,
and can file the claim for refund. As trustee, petitioner considers itself as the entity that is
entitled to file a claim for refund of taxes erroneously paid in the sale of the MBP lot. 40
The Office of the Solicitor General argues that the cardinal rule in taxation is that tax
exemptions are highly disfavored and whoever claims a tax exemption must justify his right
by the clearest grant of law. Tax exemption cannot arise by implication and any doubt
whether the exemption exists is strictly construed against the taxpayer. 41 Further, the
findings of the CTA, which were affirmed by the CA, should be given respect and weight in
the absence of abuse or improvident exercise of authority. 42
Section 53 (b) and now Section 60 (b) of the Tax Code provides:
SEC. 60. Imposition of Tax.
(A) Application of Tax. . . .

(B) Exception. The tax imposed by this Title shall not apply to employee's
trust which forms part of a pension, stock bonus or profit-sharing plan of an
employer for the benefit of some or all of his employees (1) if contributions are
made to the trust by such employer, or employees, or both for the purpose of
distributing to such employees the earnings and principal of the fund
accumulated by the trust in accordance with such plan, and (2) if under the
trust instrument it is impossible, at any time prior to the satisfaction of all
liabilities with respect to employees under the trust, for any part of the corpus
or income to be (within the taxable year or thereafter) used for, or diverted to,
purposes other than for the exclusive benefit of his employees: Provided, That
any amount actually distributed to any employee or distributee shall be taxable
to him in the year in which so distributed to the extent that it exceeds the
amount contributed by such employee or distributee.
Petitioner's Articles of Incorporation state the purpose for which the corporation was formed:
Primary Purpose
To hold legal title to, control, invest and administer in the manner provided,
pursuant to applicable rules and conditions as established, and in the interest
and for the benefit of its beneficiaries and/or participants, the private pension
plan as established for certain employees of Victorias Milling Company,
Inc., and other pension plans of Victorias Milling Company affiliates
and/or subsidiaries, the pension funds and assets, as well as accruals,
additions and increments thereto, and such amounts as may be set aside or
accumulated for the benefit of the participants of said pension plans; and in
furtherance of the foregoing and as may be incidental thereto. 43 (Emphasis
supplied)
Petitioner is a corporation that was formed to administer the Employees' Trust Fund.
Petitioner invested P5,504,748.25 of the funds of the Employees' Trust Fund to purchase
the MBP lot. When the MBP lot was sold, the gross income of the Employees' Trust Fund
from the sale of the MBP lot was P40,500,000. The 7.5% withholding tax of P3,037,500 and
broker's commission were deducted from the proceeds. In Commissioner of Internal
Revenue v. Court of Appeals, 44 the Court explained the rationale for the tax-exemption
privilege of income derived from employees' trusts:
It is evident that tax-exemption is likewise to be enjoyed by the income of the
pension trust. Otherwise, taxation of those earnings would result in a diminution
of accumulated income and reduce whatever the trust beneficiaries would
receive out of the trust fund. This would run afoul of the very intendment of the
law.
In Miguel J. Ossorio Pension Foundation, Inc. v. Commissioner of Internal
Revenue, 45 the CTA held that petitioner is entitled to a refund of withholding taxes paid on
interest income from direct loans made by the Employees' Trust Fund since such interest

income is exempt from tax. The CTA, in recognizing petitioner's entitlement for tax
exemption, explained:
In or about 1968, Victorias Milling Co., Inc. established a retirement or pension
plan for its employees and those of its subsidiary companies pursuant to a 22page plan. Pursuant to said pension plan, Victorias Milling Co., Inc. makes
a (sic) regular financial contributions to the employee trust for the purpose of
distributing or paying to said employees, the earnings and principal of the funds
accumulated by the trust in accordance with said plan. Under the plan, it is
imposable, at any time prior to the satisfaction of all liabilities with respect to
employees under the trust, for any part of the corpus or income to be used for,
or diverted to, purposes other than for the exclusive benefit of said employees.
Moreover, upon the termination of the plan, any remaining assets will be
applied for the benefit of all employees and their beneficiaries entitled thereto in
proportion to the amount allocated for their respective benefits as provided in
said plan.
The petitioner and Victorias Milling Co., Inc., on January 22, 1970, entered into
a Memorandum of Understanding, whereby they agreed that petitioner would
administer the pension plan funds and assets, as assigned and transferred to it
in trust, as well as all amounts that may from time to time be set aside by
Victorias Milling Co., Inc. "For the benefit of the Pension Plan, said
administration is to be strictly adhered to pursuant to the rules and regulations
of the Pension Plan and of the Articles of Incorporation and By Laws" of
petitioner.
The pension plan was thereafter submitted to the Bureau of Internal Revenue
for registration and for a ruling as to whether its income or earnings are exempt
from income tax pursuant to Rep. Act 4917, in relation to Sec. 56(b), now Sec.
54(b), of the Tax Code.
In a letter dated January 18, 1974 addressed to Victorias Milling Co., Inc., the
Bureau of Internal Revenue ruled that "the income of the trust fund of your
retirement benefit plan is exempt from income tax, pursuant to Rep. Act
4917 in relation to Section 56(b) of the Tax Code."
In accordance with petitioner's Articles of Incorporation (Annex A), petitioner
would "hold legal title to, control, invest and administer, in the manner
provided, pursuant to applicable rules and conditions as established, and
in the interest and for the benefit of its beneficiaries and/or participants,
the private pension plan as established for certain employees of Victorias
Milling Co., Inc. and other pension plans of Victorias Milling Co. affiliates
and/or subsidiaries, the pension funds and assets, as well as the
accruals, additions and increments thereto, and such amounts as may be
set aside or accumulated of said pension plans. Moreover, pursuant to
the same Articles of Incorporations, petitioner is empowered to "settle,
compromise or submit to arbitration, any claims, debts or damages due

or owing to or from pension funds and assets and other funds and assets
of the corporation, to commence or defend suits or legal proceedings and
to represent said funds and assets in all suits or legal proceedings."
Petitioner, through its investment manager, the City Trust Banking
Corporation, has invested the funds of the employee trust in treasury
bills, Central Bank bills, direct lending, etc. so as to generate income or
earnings for the benefit of the employees-beneficiaries of the pension
plan. Prior to the effectivity ofPresidential Decree No. 1959 on October 15,
1984, respondent did not subject said income or earning of the employee trust
to income tax because they were exempt from income tax pursuant to Sec.
56(b), now Sec. 54(b) of the Tax Code and the BIR Ruling dated January 18,
1984 (Annex D). (Boldfacing supplied; italicization in the original)
xxx xxx xxx
It asserted that the pension plan in question was previously submitted to the
Bureau of Internal Revenue for a ruling as to whether the income or earnings of
the retirement funds of said plan are exempt from income tax and in a letter
dated January 18, 1984, the Bureau ruled that the earnings of the trust
funds of the pension plan are exempt from income tax under Sec. 56(b) of
the Tax Code. (Emphasis supplied)
"A close review of the provisions of the plan and trust instrument
disclose that in reality the corpus and income of the trust fund are not at
no time used for, or diverted to, any purpose other than for the
exclusive benefit of the plan beneficiaries. This fact was likewise
confirmed after verification of the plan operations by the Revenue
District No. 63 of the Revenue Region No. 14, Bacolod City. Section X
also confirms this fact by providing that if any assets remain after
satisfaction of the requirements of all the above clauses, such
remaining assets will be applied for the benefits of all persons included
in such classes in proportion to the amounts allocated for their
respective benefits pursuant to the foregoing priorities.
"In view of all the foregoing, this Office is of the opinion, as it hereby
holds, that the income of the trust fund of your retirement benefit plan is
exempt from income tax pursuant to Republic Act 4917 in relation to
Section 56(b) of the Tax Code. (Annex "D" of Petition)
This CTA decision, which was affirmed by the CA in a decision dated 20 January 1993,
became final and executory on 3 August 1993.
The tax-exempt character of petitioner's Employees' Trust Fund is not at issue in this
case. The tax-exempt character of the Employees' Trust Fund has long been settled. It is
also settled that petitioner exists for the purpose of holding title to, and administering, the
tax-exempt Employees' Trust Fund established for the benefit of VMC's employees. As
such, petitioner has the personality to claim tax refunds due the Employees' Trust Fund.

In Citytrust Banking Corporation as Trustee and Investment Manager of Various

Retirement Funds v. Commissioner of Internal Revenue, 46 the CTA granted Citytrust's
claim for refund on withholding taxes paid on the investments made by Citytrust in behalf of
the trust funds it manages, including petitioner. 47 Thus:
In resolving the second issue, we note that the same is not a case of first
impression. Indeed, the petitioner is correct in its adherence to the clear ruling
laid by the Supreme Court way back in 1992 in the case of Commissioner of
Internal Revenue vs. The Honorable Court of Appeals, The Court of Tax
Appeals
and
GCL
Retirement
Plan, 207
SCRA
487 at
page
496, supra, wherein it was succinctly held:
xxx xxx xxx
There can be no denying either that the final withholding tax is collected
from income in respect of which employees' trusts are declared exempt
(Sec. 56(b), now 53(b), Tax Code). The application of the withholdings
system to interest on bank deposits or yield from deposit substitutes is
essentially to maximize and expedite the collection of income taxes by
requiring its payment at the source. If an employees' trust like the GCL
enjoys a tax-exempt status from income, we see no logic in withholding
a certain percentage of that income which it is not supposed to pay in
the first place.
xxx xxx xxx
Similarly, the income of the trust funds involved herein is exempt from the
payment of final withholding taxes.
This CTA decision became final and executory when the CIR failed to file a Petition for
Review within the extension granted by the CA.
Similarly, in BIR Ruling [UN-450-95], Citytrust wrote the BIR to request for a ruling exempting it
from the payment of withholding tax on the sale of the land by various BIR-approved trustees
and tax-exempt private employees' retirement benefit trust funds 48 represented by Citytrust.
The BIR ruled that the private employees benefit trust funds, which included petitioner, have
met the requirements of the law and the regulations and therefore qualify as reasonable
retirement benefit plans within the contemplation of Republic Act No. 4917 (now Sec. 28 (b) (7)
(A), Tax Code). The income from the trust fund investments is therefore exempt from the
payment of income tax and consequently from the payment of the creditable withholding tax on
the sale of their real property. 49
Thus, the documents issued and certified by Citytrust showing that money from the Employees'
Trust Fund was invested in the MBP lot cannot simply be brushed aside by the BIR as selfserving, in the light of previous cases holding that Citytrust was indeed handling the money of
the Employees' Trust Fund. These documents, together with the notarized Memorandum of
Agreement, clearly establish that petitioner, on behalf of the Employees' Trust Fund, indeed

invested in the purchase of the MBP lot. Thus, the Employees' Trust Fund owns 49.59% of the
MBP lot.
Since petitioner has proven that the income from the sale of the MBP lot came from an
investment by the Employees' Trust Fund, petitioner, as trustee of the Employees' Trust Fund,
is entitled to claim the tax refund of P3,037,500 which was erroneously paid in the sale of the
MBP lot.
WHEREFORE, we GRANT the petition and SET ASIDE the Decision of 30 May 2003 of the
Court of Appeals in CA-G.R. SP No. 61829. Respondent Commissioner of Internal Revenue is
directed to refund petitioner Miguel J. Ossorio Pension Foundation, Incorporated, as trustee of
the Employees' Trust Fund, the amount of P3,037,500, representing income tax erroneously
paid.
SO ORDERED.
||| (Miguel J. Ossorio Pension Foundation, Inc. v. Court of Appeals, G.R. No. 162175, [June 28,
2010], 635 PHIL 573-598)

3. CORPORATIONS
Republic of the Philippines
SUPREME COURT
Manila
EN BANC
G.R. No. L-19342 May 25, 1972
LORENZO T. OA and HEIRS OF JULIA BUALES, namely: RODOLFO B. OA,
MARIANO B. OA, LUZ B. OA, VIRGINIA B. OA and LORENZO B. OA, JR., petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE, respondent.
Orlando Velasco for petitioners.
Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete,
and Special Attorney Purificacion Ureta for respondent.

BARREDO, J.:p
Petition for review of the decision of the Court of Tax Appeals in CTA Case No. 617, similarly
entitled as above, holding that petitioners have constituted an unregistered partnership and are,
therefore, subject to the payment of the deficiency corporate income taxes assessed against
them by respondent Commissioner of Internal Revenue for the years 1955 and 1956 in the total
sum of P21,891.00, plus 5% surcharge and 1% monthly interest from December 15, 1958,
subject to the provisions of Section 51 (e) (2) of the Internal Revenue Code, as amended by
Section 8 of Republic Act No. 2343 and the costs of the suit, 1 as well as the resolution of said
court denying petitioners' motion for reconsideration of said decision.
The facts are stated in the decision of the Tax Court as follows:
Julia Buales died on March 23, 1944, leaving as heirs her surviving spouse,
Lorenzo T. Oa and her five children. In 1948, Civil Case No. 4519 was instituted
in the Court of First Instance of Manila for the settlement of her estate. Later,
Lorenzo T. Oa the surviving spouse was appointed administrator of the estate
of said deceased (Exhibit 3, pp. 34-41, BIR rec.). On April 14, 1949, the
administrator submitted the project of partition, which was approved by the Court
on May 16, 1949 (See Exhibit K). Because three of the heirs, namely Luz,
Virginia and Lorenzo, Jr., all surnamed Oa, were still minors when the project of
partition was approved, Lorenzo T. Oa, their father and administrator of the
estate, filed a petition in Civil Case No. 9637 of the Court of First Instance of

Manila for appointment as guardian of said minors. On November 14, 1949, the
Court appointed him guardian of the persons and property of the aforenamed
minors (See p. 3, BIR rec.).
The project of partition (Exhibit K; see also pp. 77-70, BIR rec.) shows that the
heirs have undivided one-half (1/2) interest in ten parcels of land with a total
assessed value of P87,860.00, six houses with a total assessed value of
P17,590.00 and an undetermined amount to be collected from the War Damage
Commission. Later, they received from said Commission the amount of
P50,000.00, more or less. This amount was not divided among them but was
used in the rehabilitation of properties owned by them in common (t.s.n., p. 46).
Of the ten parcels of land aforementioned, two were acquired after the death of
the decedent with money borrowed from the Philippine Trust Company in the
amount of P72,173.00 (t.s.n., p. 24; Exhibit 3, pp. 31-34 BIR rec.).
The project of partition also shows that the estate shares equally with Lorenzo T.
Oa, the administrator thereof, in the obligation of P94,973.00, consisting of
loans contracted by the latter with the approval of the Court (see p. 3 of Exhibit K;
or see p. 74, BIR rec.).
Although the project of partition was approved by the Court on May 16, 1949, no
attempt was made to divide the properties therein listed. Instead, the properties
remained under the management of Lorenzo T. Oa who used said properties in
business by leasing or selling them and investing the income derived therefrom
and the proceeds from the sales thereof in real properties and securities. As a
result, petitioners' properties and investments gradually increased from
P105,450.00 in 1949 to P480,005.20 in 1956 as can be gleaned from the
following year-end balances:
Yea
r

Investmen
t

Land

Buildin
g

Account

Accoun
t

Accoun
t

1949

P87,860.00

P17,590.00

1950

P24,657.65

128,566.72

96,076.26

1951

51,301.31

120,349.28

110,605.11

1952

67,927.52

87,065.28

152,674.39

1953

61,258.27

84,925.68

161,463.83

1954

63,623.37

99,001.20

167,962.04

1955

100,786.00

120,249.78

169,262.52

1956

175,028.68

135,714.68

169,262.52

(See Exhibits 3 & K t.s.n., pp. 22, 25-26, 40, 50, 102-104)
From said investments and properties petitioners derived such incomes as profits
from installment sales of subdivided lots, profits from sales of stocks, dividends,
rentals and interests (see p. 3 of Exhibit 3; p. 32, BIR rec.; t.s.n., pp. 37-38). The
said incomes are recorded in the books of account kept by Lorenzo T. Oa
where the corresponding shares of the petitioners in the net income for the year
are also known. Every year, petitioners returned for income tax purposes their
shares in the net income derived from said properties and securities and/or from
transactions involving them (Exhibit 3, supra; t.s.n., pp. 25-26). However,
petitioners did not actually receive their shares in the yearly income. (t.s.n., pp.
25-26, 40, 98, 100). The income was always left in the hands of Lorenzo T. Oa
who, as heretofore pointed out, invested them in real properties and securities.
(See Exhibit 3, t.s.n., pp. 50, 102-104).
On the basis of the foregoing facts, respondent (Commissioner of Internal
Revenue) decided that petitioners formed an unregistered partnership and
therefore, subject to the corporate income tax, pursuant to Section 24, in relation
to Section 84(b), of the Tax Code. Accordingly, he assessed against the
petitioners the amounts of P8,092.00 and P13,899.00 as corporate income taxes
for 1955 and 1956, respectively. (See Exhibit 5, amended by Exhibit 17, pp. 50
and 86, BIR rec.). Petitioners protested against the assessment and asked for
reconsideration of the ruling of respondent that they have formed an unregistered
partnership. Finding no merit in petitioners' request, respondent denied it (See
Exhibit 17, p. 86, BIR rec.). (See pp. 1-4, Memorandum for Respondent, June 12,
1961).
The original assessment was as follows:
1955
Net income as per investigation ................ P40,209.89
Income tax due thereon ............................... 8,042.00
25% surcharge .............................................. 2,010.50
Compromise for non-filing .......................... 50.00
Total ............................................................... P10,102.50

1956
Net income as per investigation ................ P69,245.23
Income tax due thereon ............................... 13,849.00
25% surcharge .............................................. 3,462.25
Compromise for non-filing .......................... 50.00
Total ............................................................... P17,361.25
(See Exhibit 13, page 50, BIR records)
Upon further consideration of the case, the 25% surcharge was eliminated in line
with the ruling of the Supreme Court in Collector v. Batangas Transportation Co.,
G.R. No. L-9692, Jan. 6, 1958, so that the questioned assessment refers solely
to the income tax proper for the years 1955 and 1956 and the "Compromise for
non-filing," the latter item obviously referring to the compromise in lieu of the
criminal liability for failure of petitioners to file the corporate income tax returns for
said years. (See Exh. 17, page 86, BIR records). (Pp. 1-3, Annex C to Petition)
Petitioners have assigned the following as alleged errors of the Tax Court:
I.
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE
PETITIONERS FORMED AN UNREGISTERED PARTNERSHIP;
II.
THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE
PETITIONERS WERE CO-OWNERS OF THE PROPERTIES INHERITED AND
(THE) PROFITS DERIVED FROM TRANSACTIONS THEREFROM (sic);
III.
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT PETITIONERS
WERE LIABLE FOR CORPORATE INCOME TAXES FOR 1955 AND 1956 AS
AN UNREGISTERED PARTNERSHIP;
IV.
ON THE ASSUMPTION THAT THE PETITIONERS CONSTITUTED AN
UNREGISTERED PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN
NOT HOLDING THAT THE PETITIONERS WERE AN UNREGISTERED
PARTNERSHIP TO THE EXTENT ONLY THAT THEY INVESTED THE

PROFITS FROM THE PROPERTIES OWNED IN COMMON AND THE LOANS

RECEIVED USING THE INHERITED PROPERTIES AS COLLATERALS;
V.
ON THE ASSUMPTION THAT THERE WAS AN UNREGISTERED
PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT DEDUCTING
THE VARIOUS AMOUNTS PAID BY THE PETITIONERS AS INDIVIDUAL
INCOME TAX ON THEIR RESPECTIVE SHARES OF THE PROFITS
ACCRUING FROM THE PROPERTIES OWNED IN COMMON, FROM THE
DEFICIENCY TAX OF THE UNREGISTERED PARTNERSHIP.
In other words, petitioners pose for our resolution the following questions: (1) Under the facts
found by the Court of Tax Appeals, should petitioners be considered as co-owners of the
properties inherited by them from the deceased Julia Buales and the profits derived from
transactions involving the same, or, must they be deemed to have formed an unregistered
partnership subject to tax under Sections 24 and 84(b) of the National Internal Revenue Code?
(2) Assuming they have formed an unregistered partnership, should this not be only in the
sense that they invested as a common fund the profits earned by the properties owned by them
in common and the loans granted to them upon the security of the said properties, with the
result that as far as their respective shares in the inheritance are concerned, the total income
thereof should be considered as that of co-owners and not of the unregistered partnership? And
(3) assuming again that they are taxable as an unregistered partnership, should not the various
amounts already paid by them for the same years 1955 and 1956 as individual income taxes on
their respective shares of the profits accruing from the properties they owned in common be
deducted from the deficiency corporate taxes, herein involved, assessed against such
unregistered partnership by the respondent Commissioner?
Pondering on these questions, the first thing that has struck the Court is that whereas
petitioners' predecessor in interest died way back on March 23, 1944 and the project of partition
of her estate was judicially approved as early as May 16, 1949, and presumably petitioners
have been holding their respective shares in their inheritance since those dates admittedly
under the administration or management of the head of the family, the widower and father
Lorenzo T. Oa, the assessment in question refers to the later years 1955 and 1956. We
believe this point to be important because, apparently, at the start, or in the years 1944 to 1954,
the respondent Commissioner of Internal Revenue did treat petitioners as co-owners, not liable
to corporate tax, and it was only from 1955 that he considered them as having formed an
unregistered partnership. At least, there is nothing in the record indicating that an earlier
assessment had already been made. Such being the case, and We see no reason how it could
be otherwise, it is easily understandable why petitioners' position that they are co-owners and
not unregistered co-partners, for the purposes of the impugned assessment, cannot be upheld.
Truth to tell, petitioners should find comfort in the fact that they were not similarly assessed
earlier by the Bureau of Internal Revenue.

The Tax Court found that instead of actually distributing the estate of the deceased among
themselves pursuant to the project of partition approved in 1949, "the properties remained
under the management of Lorenzo T. Oa who used said properties in business by leasing or
selling them and investing the income derived therefrom and the proceed from the sales thereof
in real properties and securities," as a result of which said properties and investments steadily
increased yearly from P87,860.00 in "land account" and P17,590.00 in "building account" in
1949 to P175,028.68 in "investment account," P135.714.68 in "land account" and P169,262.52
in "building account" in 1956. And all these became possible because, admittedly, petitioners
never actually received any share of the income or profits from Lorenzo T. Oa and instead,
they allowed him to continue using said shares as part of the common fund for their ventures,
even as they paid the corresponding income taxes on the basis of their respective shares of the
profits of their common business as reported by the said Lorenzo T. Oa.
It is thus incontrovertible that petitioners did not, contrary to their contention, merely limit
themselves to holding the properties inherited by them. Indeed, it is admitted that during the
material years herein involved, some of the said properties were sold at considerable profit, and
that with said profit, petitioners engaged, thru Lorenzo T. Oa, in the purchase and sale of
corporate securities. It is likewise admitted that all the profits from these ventures were divided
among petitioners proportionately in accordance with their respective shares in the inheritance.
In these circumstances, it is Our considered view that from the moment petitioners allowed not
only the incomes from their respective shares of the inheritance but even the inherited
properties themselves to be used by Lorenzo T. Oa as a common fund in undertaking several
transactions or in business, with the intention of deriving profit to be shared by them
proportionally, such act was tantamonut to actually contributing such incomes to a common fund
and, in effect, they thereby formed an unregistered partnership within the purview of the abovementioned provisions of the Tax Code.
It is but logical that in cases of inheritance, there should be a period when the heirs can be
considered as co-owners rather than unregistered co-partners within the contemplation of our
corporate tax laws aforementioned. Before the partition and distribution of the estate of the
deceased, all the income thereof does belong commonly to all the heirs, obviously, without them
becoming thereby unregistered co-partners, but it does not necessarily follow that such status
as co-owners continues until the inheritance is actually and physically distributed among the
heirs, for it is easily conceivable that after knowing their respective shares in the partition, they
might decide to continue holding said shares under the common management of the
administrator or executor or of anyone chosen by them and engage in business on that basis.
Withal, if this were to be allowed, it would be the easiest thing for heirs in any inheritance to
circumvent and render meaningless Sections 24 and 84(b) of the National Internal Revenue
Code.
It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for
holding the appellants therein to be unregistered co-partners for tax purposes, that their
common fund "was not something they found already in existence" and that "it was not a
property inherited by them pro indiviso," but it is certainly far fetched to argue therefrom, as

petitioners are doing here, that ergo, in all instances where an inheritance is not actually
divided, there can be no unregistered co-partnership. As already indicated, for tax purposes, the
co-ownership of inherited properties is automatically converted into an unregistered partnership
the moment the said common properties and/or the incomes derived therefrom are used as a
common fund with intent to produce profits for the heirs in proportion to their respective shares
in the inheritance as determined in a project partition either duly executed in an extrajudicial
settlement or approved by the court in the corresponding testate or intestate proceeding. The
reason for this is simple. From the moment of such partition, the heirs are entitled already to
their respective definite shares of the estate and the incomes thereof, for each of them to
manage and dispose of as exclusively his own without the intervention of the other heirs, and,
accordingly he becomes liable individually for all taxes in connection therewith. If after such
partition, he allows his share to be held in common with his co-heirs under a single
management to be used with the intent of making profit thereby in proportion to his share, there
can be no doubt that, even if no document or instrument were executed for the purpose, for tax
purposes, at least, an unregistered partnership is formed. This is exactly what happened to
petitioners in this case.
In this connection, petitioners' reliance on Article 1769, paragraph (3), of the Civil Code,
providing that: "The sharing of gross returns does not of itself establish a partnership, whether
or not the persons sharing them have a joint or common right or interest in any property from
which the returns are derived," and, for that matter, on any other provision of said code on
partnerships is unavailing. In Evangelista, supra, this Court clearly differentiated the concept of
partnerships under the Civil Code from that of unregistered partnerships which are considered
as "corporations" under Sections 24 and 84(b) of the National Internal Revenue Code. Mr.
Justice Roberto Concepcion, now Chief Justice, elucidated on this point thus:
To begin with, the tax in question is one imposed upon "corporations", which,
strictly speaking, are distinct and different from "partnerships". When our Internal
Revenue Code includes "partnerships" among the entities subject to the tax on
"corporations", said Code must allude, therefore, to organizations which are not
necessarily "partnerships", in the technical sense of the term. Thus, for instance,
section 24 of said Code exempts from the aforementioned tax "duly registered
general partnerships," which constitute precisely one of the most typical forms of
partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said
Code, "the term corporation includes partnerships, no matter how created or
organized." This qualifying expression clearly indicates that a joint venture need
not be undertaken in any of the standard forms, or in confirmity with the usual
requirements of the law on partnerships, in order that one could be deemed
constituted for purposes of the tax on corporation. Again, pursuant to said section
84(b),the term "corporation" includes, among others, "joint accounts,(cuentas en
participacion)" and "associations", none of which has a legal personality of its
own, independent of that of its members. Accordingly, the lawmaker could not
have regarded that personality as a condition essential to the existence of the
partnerships therein referred to. In fact, as above stated, "duly registered general

co-partnerships" which are possessed of the aforementioned personality

have been expressly excluded by law (sections 24 and 84[b]) from the
connotation of the term "corporation." ....
xxx xxx xxx
Similarly, the American Law
... provides its own concept of a partnership. Under the term
"partnership" it includes not only a partnership as known in
common law but, as well, a syndicate, group, pool, joint venture,
or other unincorporated organization which carries on any
business, financial operation, or venture, and which is not, within
the meaning of the Code, a trust, estate, or a corporation. ... . (7A
Merten's Law of Federal Income Taxation, p. 789; emphasis ours.)
The term "partnership" includes a syndicate, group, pool, joint
venture or other unincorporated organization, through or by
means of which any business, financial operation, or venture is
carried on. ... . (8 Merten's Law of Federal Income Taxation, p.
562 Note 63; emphasis ours.)
For purposes of the tax on corporations, our National Internal Revenue Code
includes these partnerships with the exception only of duly registered general
copartnerships within the purview of the term "corporation." It is, therefore,
clear to our mind that petitioners herein constitute a partnership, insofar as said
Code is concerned, and are subject to the income tax for corporations.
We reiterated this view, thru Mr. Justice Fernando, in Reyes vs. Commissioner of Internal
Revenue, G. R. Nos. L-24020-21, July 29, 1968, 24 SCRA 198, wherein the Court ruled against
a theory of co-ownership pursued by appellants therein.
As regards the second question raised by petitioners about the segregation, for the purposes of
the corporate taxes in question, of their inherited properties from those acquired by them
subsequently, We consider as justified the following ratiocination of the Tax Court in denying
their motion for reconsideration:
In connection with the second ground, it is alleged that, if there was an
unregistered partnership, the holding should be limited to the business engaged
in apart from the properties inherited by petitioners. In other words, the taxable
income of the partnership should be limited to the income derived from the
acquisition and sale of real properties and corporate securities and should not
include the income derived from the inherited properties. It is admitted that the
inherited properties and the income derived therefrom were used in the business

of buying and selling other real properties and corporate securities. Accordingly,
the partnership income must include not only the income derived from the
purchase and sale of other properties but also the income of the inherited
properties.
Besides, as already observed earlier, the income derived from inherited properties may be
considered as individual income of the respective heirs only so long as the inheritance or estate
is not distributed or, at least, partitioned, but the moment their respective known shares are
used as part of the common assets of the heirs to be used in making profits, it is but proper that
the income of such shares should be considered as the part of the taxable income of an
unregistered partnership. This, We hold, is the clear intent of the law.
Likewise, the third question of petitioners appears to have been adequately resolved by the Tax
Court in the aforementioned resolution denying petitioners' motion for reconsideration of the
decision of said court. Pertinently, the court ruled this wise:
In support of the third ground, counsel for petitioners alleges:
Even if we were to yield to the decision of this Honorable Court
that the herein petitioners have formed an unregistered
partnership and, therefore, have to be taxed as such, it might be
recalled that the petitioners in their individual income tax returns
reported their shares of the profits of the unregistered partnership.
We think it only fair and equitable that the various amounts paid
by the individual petitioners as income tax on their respective
shares of the unregistered partnership should be deducted from
the deficiency income tax found by this Honorable Court against
the unregistered partnership. (page 7, Memorandum for the
Petitioner in Support of Their Motion for Reconsideration, Oct. 28,
1961.)
In other words, it is the position of petitioners that the taxable income of the
partnership must be reduced by the amounts of income tax paid by each
petitioner on his share of partnership profits. This is not correct; rather, it should
be the other way around. The partnership profits distributable to the partners
(petitioners herein) should be reduced by the amounts of income tax assessed
against the partnership. Consequently, each of the petitioners in his individual
capacity overpaid his income tax for the years in question, but the income tax
due from the partnership has been correctly assessed. Since the individual
income tax liabilities of petitioners are not in issue in this proceeding, it is not
proper for the Court to pass upon the same.
Petitioners insist that it was error for the Tax Court to so rule that whatever excess they might
have paid as individual income tax cannot be credited as part payment of the taxes herein in

question. It is argued that to sanction the view of the Tax Court is to oblige petitioners to pay
double income tax on the same income, and, worse, considering the time that has lapsed since
they paid their individual income taxes, they may already be barred by prescription from
recovering their overpayments in a separate action. We do not agree. As We see it, the case of
petitioners as regards the point under discussion is simply that of a taxpayer who has paid the
wrong tax, assuming that the failure to pay the corporate taxes in question was not deliberate.
Of course, such taxpayer has the right to be reimbursed what he has erroneously paid, but the
law is very clear that the claim and action for such reimbursement are subject to the bar of
prescription. And since the period for the recovery of the excess income taxes in the case of
herein petitioners has already lapsed, it would not seem right to virtually disregard prescription
merely upon the ground that the reason for the delay is precisely because the taxpayers failed
to make the proper return and payment of the corporate taxes legally due from them. In
principle, it is but proper not to allow any relaxation of the tax laws in favor of persons who are
not exactly above suspicion in their conduct vis-a-vis their tax obligation to the State.
IN VIEW OF ALL THE FOREGOING, the judgment of the Court of Tax Appeals appealed from
is affirm with costs against petitioners.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-9996

October 15, 1957

EUFEMIA EVANGELISTA, MANUELA EVANGELISTA, and FRANCISCA EVANGELISTA,

petitioners,
vs.
THE COLLECTOR OF INTERNAL REVENUE and THE COURT OF TAX
APPEALS, respondents.
Santiago F. Alidio and Angel S. Dakila, Jr., for petitioner.
Office of the Solicitor General Ambrosio Padilla, Assistant Solicitor General Esmeraldo Umali
and Solicitor Felicisimo R. Rosete for Respondents.
CONCEPCION, J.:
This is a petition filed by Eufemia Evangelista, Manuela Evangelista and Francisca Evangelista,
for review of a decision of the Court of Tax Appeals, the dispositive part of which reads:
FOR ALL THE FOREGOING, we hold that the petitioners are liable for the income tax,
real estate dealer's tax and the residence tax for the years 1945 to 1949, inclusive, in
accordance with the respondent's assessment for the same in the total amount of
P6,878.34, which is hereby affirmed and the petition for review filed by petitioner is
hereby dismissed with costs against petitioners.
It appears from the stipulation submitted by the parties:
1. That the petitioners borrowed from their father the sum of P59,1400.00 which amount
together with their personal monies was used by them for the purpose of buying real
properties,.
2. That on February 2, 1943, they bought from Mrs. Josefina Florentino a lot with an
area of 3,713.40 sq. m. including improvements thereon from the sum of P100,000.00;
this property has an assessed value of P57,517.00 as of 1948;
3. That on April 3, 1944 they purchased from Mrs. Josefa Oppus 21 parcels of land with
an aggregate area of 3,718.40 sq. m. including improvements thereon for P130,000.00;
this property has an assessed value of P82,255.00 as of 1948;

4. That on April 28, 1944 they purchased from the Insular Investments Inc., a lot of 4,353
sq. m. including improvements thereon for P108,825.00. This property has an assessed
value of P4,983.00 as of 1948;
5. That on April 28, 1944 they bought form Mrs. Valentina Afable a lot of 8,371 sq. m.
including improvements thereon for P237,234.34. This property has an assessed value
of P59,140.00 as of 1948;
6. That in a document dated August 16, 1945, they appointed their brother Simeon
Evangelista to 'manage their properties with full power to lease; to collect and receive
rents; to issue receipts therefor; in default of such payment, to bring suits against the
defaulting tenants; to sign all letters, contracts, etc., for and in their behalf, and to
endorse and deposit all notes and checks for them;
7. That after having bought the above-mentioned real properties the petitioners had the
same rented or leases to various tenants;
8. That from the month of March, 1945 up to an including December, 1945, the total
amount collected as rents on their real properties was P9,599.00 while the expenses
amounted to P3,650.00 thereby leaving them a net rental income of P5,948.33;
9. That on 1946, they realized a gross rental income of in the sum of P24,786.30, out of
which amount was deducted in the sum of P16,288.27 for expenses thereby leaving
them a net rental income of P7,498.13;
10. That in 1948, they realized a gross rental income of P17,453.00 out of the which
amount was deducted the sum of P4,837.65 as expenses, thereby leaving them a net
rental income of P12,615.35.
It further appears that on September 24, 1954 respondent Collector of Internal Revenue
demanded the payment of income tax on corporations, real estate dealer's fixed tax and
corporation residence tax for the years 1945-1949, computed, according to assessment made
by said officer, as follows:
INCOME TAXES
1945

14.84

1946

1,144.71

1947

10.34

1948

1,912.30

1949

1,575.90

Total including surcharge and

compromise

P6,157.09

REAL ESTATE DEALER'S FIXED TAX

1946

P37.50

1947

150.00

1948

150.00

1949

150.00

Total including penalty

P527.00

RESIDENCE TAXES OF CORPORATION

1945

P38.75

1946

38.75

1947

38.75

1948

38.75

1949

38.75

Total including surcharge

P193.75

TOTAL TAXES DUE

P6,878.34.

Said letter of demand and corresponding assessments were delivered to petitioners on

December 3, 1954, whereupon they instituted the present case in the Court of Tax Appeals,
with a prayer that "the decision of the respondent contained in his letter of demand dated
September 24, 1954" be reversed, and that they be absolved from the payment of the taxes in
question, with costs against the respondent.
After appropriate proceedings, the Court of Tax Appeals the above-mentioned decision for the
respondent, and a petition for reconsideration and new trial having been subsequently denied,
the case is now before Us for review at the instance of the petitioners.
The issue in this case whether petitioners are subject to the tax on corporations provided for in
section 24 of Commonwealth Act. No. 466, otherwise known as the National Internal Revenue
Code, as well as to the residence tax for corporations and the real estate dealers fixed tax. With
respect to the tax on corporations, the issue hinges on the meaning of the terms "corporation"
and "partnership," as used in section 24 and 84 of said Code, the pertinent parts of which read:

SEC. 24. Rate of tax on corporations.There shall be levied, assessed, collected, and
paid annually upon the total net income received in the preceding taxable year from all
sources by every corporation organized in, or existing under the laws of the Philippines,
no matter how created or organized but not including duly registered general copartnerships (compaias colectivas), a tax upon such income equal to the sum of the
following: . . .
SEC. 84 (b). The term 'corporation' includes partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion), associations
or insurance companies, but does not include duly registered general copartnerships.
(compaias colectivas).
Article 1767 of the Civil Code of the Philippines provides:
By the contract of partnership two or more persons bind themselves to contribute
money, properly, or industry to a common fund, with the intention of dividing the profits
among themselves.
Pursuant to the article, the essential elements of a partnership are two, namely: (a) an
agreement to contribute money, property or industry to a common fund; and (b) intent to divide
the profits among the contracting parties. The first element is undoubtedly present in the case at
bar, for, admittedly, petitioners have agreed to, and did, contribute money and property to a
common fund. Hence, the issue narrows down to their intent in acting as they did. Upon
consideration of all the facts and circumstances surrounding the case, we are fully satisfied that
their purpose was to engage in real estate transactions for monetary gain and then divide the
same among themselves, because:
1. Said common fund was not something they found already in existence. It was not
property inherited by them pro indiviso. They created it purposely. What is more
they jointly borrowed a substantial portion thereof in order to establish said common
fund.
2. They invested the same, not merely not merely in one transaction, but in a series of
transactions. On February 2, 1943, they bought a lot for P100,000.00. On April 3, 1944,
they purchased 21 lots for P18,000.00. This was soon followed on April 23, 1944, by the
acquisition of another real estate for P108,825.00. Five (5) days later (April 28, 1944),
they got a fourth lot for P237,234.14. The number of lots (24) acquired and transactions
undertaken, as well as the brief interregnum between each, particularly the last three
purchases, is strongly indicative of a pattern or common design that was not limited to
the conservation and preservation of the aforementioned common fund or even of the
property acquired by the petitioners in February, 1943. In other words, one cannot but
perceive a character of habitually peculiar to business transactions engaged in the
purpose of gain.

3. The aforesaid lots were not devoted to residential purposes, or to other personal uses,
of petitioners herein. The properties were leased separately to several persons, who,
from 1945 to 1948 inclusive, paid the total sum of P70,068.30 by way of rentals.
Seemingly, the lots are still being so let, for petitioners do not even suggest that there
has been any change in the utilization thereof.
4. Since August, 1945, the properties have been under the management of one person,
namely Simeon Evangelista, with full power to lease, to collect rents, to issue receipts, to
bring suits, to sign letters and contracts, and to indorse and deposit notes and checks.
Thus, the affairs relative to said properties have been handled as if the same belonged
to a corporation or business and enterprise operated for profit.
5. The foregoing conditions have existed for more than ten (10) years, or, to be exact,
over fifteen (15) years, since the first property was acquired, and over twelve (12) years,
since Simeon Evangelista became the manager.
6. Petitioners have not testified or introduced any evidence, either on their purpose in
creating the set up already adverted to, or on the causes for its continued existence.
They did not even try to offer an explanation therefor.
Although, taken singly, they might not suffice to establish the intent necessary to constitute a
partnership, the collective effect of these circumstances is such as to leave no room for doubt
on the existence of said intent in petitioners herein. Only one or two of the aforementioned
circumstances were present in the cases cited by petitioners herein, and, hence, those cases
are not in point.
Petitioners insist, however, that they are mere co-owners, not copartners, for, in consequence of
the acts performed by them, a legal entity, with a personality independent of that of its
members, did not come into existence, and some of the characteristics of partnerships are
lacking in the case at bar. This pretense was correctly rejected by the Court of Tax Appeals.
To begin with, the tax in question is one imposed upon "corporations", which, strictly speaking,
are distinct and different from "partnerships". When our Internal Revenue Code includes
"partnerships" among the entities subject to the tax on "corporations", said Code must allude,
therefore, to organizations which are not necessarily "partnerships", in the technical sense of
the term. Thus, for instance, section 24 of said Code exempts from the aforementioned tax "duly
registered general partnerships which constitute precisely one of the most typical forms of
partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term
corporation includes partnerships, no matter how created or organized." This qualifying
expression clearly indicates that a joint venture need not be undertaken in any of the standard
forms, or in conformity with the usual requirements of the law on partnerships, in order that one
could be deemed constituted for purposes of the tax on corporations. Again, pursuant to said
section 84(b), the term "corporation" includes, among other, joint accounts, (cuentas en
participation)" and "associations," none of which has a legal personality of its own, independent

of that of its members. Accordingly, the lawmaker could not have regarded that personality as a
condition essential to the existence of the partnerships therein referred to. In fact, as above
stated, "duly registered general copartnerships" which are possessed of the aforementioned
personality have been expressly excluded by law (sections 24 and 84 [b] from the
connotation of the term "corporation" It may not be amiss to add that petitioners' allegation to
the effect that their liability in connection with the leasing of the lots above referred to, under the
management of one person even if true, on which we express no opinion tends
to increase the similarity between the nature of their venture and that corporations, and is,
therefore, an additional argument in favor of the imposition of said tax on corporations.
Under the Internal Revenue Laws of the United States, "corporations" are taxed differently from
"partnerships". By specific provisions of said laws, such "corporations" include "associations,
joint-stock companies and insurance companies." However, the term "association" is not used in
the aforementioned laws.
. . . in any narrow or technical sense. It includes any organization, created for the
transaction of designed affairs, or the attainment of some object, which like a
corporation, continues notwithstanding that its members or participants change, and the
affairs of which, like corporate affairs, are conducted by a single individual, a committee,
a board, or some other group, acting in a representative capacity. It is immaterial
whether such organization is created by an agreement, a declaration of trust, a statute,
or otherwise. It includes a voluntary association, a joint-stock corporation or company, a
'business' trusts a 'Massachusetts' trust, a 'common law' trust, and 'investment' trust
(whether of the fixed or the management type), an interinsuarance exchange operating
through an attorney in fact, a partnership association, and any other type of organization
(by whatever name known) which is not, within the meaning of the Code, a trust or an
estate, or a partnership. (7A Mertens Law of Federal Income Taxation, p. 788; emphasis
supplied.).
Similarly, the American Law.
. . . provides its own concept of a partnership, under the term 'partnership 'it includes not
only a partnership as known at common law but, as well, a syndicate, group, pool, joint
venture or other unincorporated organizations which carries on any business financial
operation, or venture, and which is not, within the meaning of the Code, a trust, estate,
or a corporation. . . (7A Merten's Law of Federal Income taxation, p. 789; emphasis
supplied.)
The term 'partnership' includes a syndicate, group, pool, joint venture or other
unincorporated organization, through or by means of which any business, financial
operation, or venture is carried on, . . .. ( 8 Merten's Law of Federal Income Taxation, p.
562 Note 63; emphasis supplied.) .

For purposes of the tax on corporations, our National Internal Revenue Code, includes these
partnerships with the exception only of duly registered general copartnerships within the
purview of the term "corporation." It is, therefore, clear to our mind that petitioners herein
constitute a partnership, insofar as said Code is concerned and are subject to the income tax for
corporations.
As regards the residence of tax for corporations, section 2 of Commonwealth Act No. 465
provides in part:
Entities liable to residence tax.-Every corporation, no matter how created or organized,
whether domestic or resident foreign, engaged in or doing business in the Philippines
shall pay an annual residence tax of five pesos and an annual additional tax which in no
case, shall exceed one thousand pesos, in accordance with the following schedule: . . .
The term 'corporation' as used in this Act includes joint-stock company, partnership, joint
account (cuentas en participacion), association or insurance company, no matter how
created or organized. (emphasis supplied.)
Considering that the pertinent part of this provision is analogous to that of section 24 and 84 (b)
of our National Internal Revenue Code (commonwealth Act No. 466), and that the latter was
approved on June 15, 1939, the day immediately after the approval of said Commonwealth Act
No. 465 (June 14, 1939), it is apparent that the terms "corporation" and "partnership" are used
in both statutes with substantially the same meaning. Consequently, petitioners are subject,
also, to the residence tax for corporations.
Lastly, the records show that petitioners have habitually engaged in leasing the properties
above mentioned for a period of over twelve years, and that the yearly gross rentals of said
properties from June 1945 to 1948 ranged from P9,599 to P17,453. Thus, they are subject to
the tax provided in section 193 (q) of our National Internal Revenue Code, for "real estate
dealers," inasmuch as, pursuant to section 194 (s) thereof:
'Real estate dealer' includes any person engaged in the business of buying, selling,
exchanging, leasing, or renting property or his own account as principal and holding
himself out as a full or part time dealer in real estate or as an owner of rental property or
properties rented or offered to rent for an aggregate amount of three thousand pesos or
more a year. . . (emphasis supplied.)
Wherefore, the appealed decision of the Court of Tax appeals is hereby affirmed with costs
against the petitioners herein. It is so ordered.
Bengzon, Paras, C.J., Padilla, Reyes, A., Reyes, J.B.L., Endencia and Felix, JJ., concur.

BAUTISTA ANGELO, J., concurring:

I agree with the opinion that petitioners have actually contributed money to a common fund with
express purpose of engaging in real estate business for profit. The series of transactions which
they had undertaken attest to this. This appears in the following portion of the decision:
2. They invested the same, not merely in one transaction, but in a series of transactions.
On February 2, 1943, they bought a lot for P100,000. On April 3, 1944, they purchase 21
lots for P18,000. This was soon followed on April 23, 1944, by the acquisition of another
real state for P108,825. Five (5) days later (April 28, 1944), they got a fourth lot for
P237,234.14. The number of lots (24) acquired and transactions undertaken, as well as
the brief interregnum between each, particularly the last three purchases, is strongly
indicative of a pattern or common design that was not limited to the conservation and
preservation of the aforementioned common fund or even of the property acquired by
the petitioner in February, 1943, In other words, we cannot but perceive a character
of habitually peculiar to business transactions engaged in for purposes of gain.
I wish however to make to make the following observation:
Article 1769 of the new Civil Code lays down the rule for determining when a transaction should
be deemed a partnership or a co-ownership. Said article paragraphs 2 and 3, provides:
(2) Co-ownership or co-possession does not of itself establish a partnership, whether
such co-owners or co-possessors do or do not share any profits made by the use of the
property;
(3) The sharing of gross returns does not of itself establish partnership, whether or not
the person sharing them have a joint or common right or interest in any property from
which the returns are derived;
From the above it appears that the fact that those who agree to form a co-ownership shared or
do not share any profits made by the use of property held in common does not convert their
venture into a partnership. Or the sharing of the gross returns does not of itself establish a
partnership whether or not the persons sharing therein have a joint or common right or interest
in the property. This only means that, aside from the circumstance of profit, the presence of
other elements constituting partnership is necessary, such as the clear intent to form a
partnership, the existence of a judicial personality different from that of the individual partners,
and the freedom to transfer or assign any interest in the property by one with the consent of the
others (Padilla, Civil Code of the Philippines Annotated, Vol. I, 1953 ed., pp. 635- 636).
It is evident that an isolated transaction whereby two or more persons contribute funds to buy
certain real estate for profit in the absence of other circumstances showing a contrary intention
cannot be considered a partnership.

Persons who contribute property or funds for a common enterprise and agree to share
the gross returns of that enterprise in proportion to their contribution, but who severally
retain the title to their respective contribution, are not thereby rendered partners. They
have no common stock or capital, and no community of interest as principal proprietors
in the business itself which the proceeds derived. (Elements of the law of Partnership by
Floyd R. Mechem, 2n Ed., section 83, p. 74.)
A joint venture purchase of land, by two, does not constitute a copartnership in respect
thereto; nor does not agreement to share the profits and loses on the sale of land create
a partnership; the parties are only tenants in common. (Clark vs. Sideway, 142 U.S. 682,
12 S Ct. 327, 35 L. Ed., 1157.)
Where plaintiff, his brother, and another agreed to become owners of a single tract of
reality, holding as tenants in common, and to divide the profits of disposing of it, the
brother and the other not being entitled to share in plaintiff's commissions, no
partnership existed as between the parties, whatever relation may have been as to third
parties. (Magee vs. Magee, 123 N. E. 6763, 233 Mass. 341.)
In order to constitute a partnership inter sese there must be: (a) An intent to form the
same; (b) generally a participating in both profits and losses; (c) and such a community
of interest, as far as third persons are concerned as enables each party to make
contract, manage the business, and dispose of the whole property. (Municipal Paving
Co. vs Herring, 150 P. 1067, 50 Ill. 470.)
The common ownership of property does not itself create a partnership between the
owners, though they may use it for purpose of making gains; and they may, without
becoming partners, agree among themselves as to the management and use of such
property and the application of the proceeds therefrom. (Spurlock vs. Wilson, 142 S. W.
363, 160 No. App. 14.)
This is impliedly recognized in the following portion of the decision: "Although, taken singly, they
might not suffice to establish the intent necessary to constitute a partnership, the collective
effect of these circumstances (referring to the series of transactions) such as to leave no room
for doubt on the existence of said intent in petitioners herein."

Republic of the Philippines

SUPREME COURT
Manila
FIRST DIVISION
G.R. No. 78133 October 18, 1988
MARIANO P. PASCUAL and RENATO P. DRAGON, petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS, respondents.
De la Cuesta, De las Alas and Callanta Law Offices for petitioners.
The Solicitor General for respondents

GANCAYCO, J.:
The distinction between co-ownership and an unregistered partnership or joint venture for
income tax purposes is the issue in this petition.
On June 22, 1965, petitioners bought two (2) parcels of land from Santiago Bernardino, et al.
and on May 28, 1966, they bought another three (3) parcels of land from Juan Roque. The first
two parcels of land were sold by petitioners in 1968 toMarenir Development Corporation, while
the three parcels of land were sold by petitioners to Erlinda Reyes and Maria Samson on March
19,1970. Petitioners realized a net profit in the sale made in 1968 in the amount of P165,224.70,
while they realized a net profit of P60,000.00 in the sale made in 1970. The corresponding
capital gains taxes were paid by petitioners in 1973 and 1974 by availing of the tax amnesties
granted in the said years.
However, in a letter dated March 31, 1979 of then Acting BIR Commissioner Efren I. Plana,
petitioners were assessed and required to pay a total amount of P107,101.70 as alleged
deficiency corporate income taxes for the years 1968 and 1970.
Petitioners protested the said assessment in a letter of June 26, 1979 asserting that they had
availed of tax amnesties way back in 1974.
In a reply of August 22, 1979, respondent Commissioner informed petitioners that in the years
1968 and 1970, petitioners as co-owners in the real estate transactions formed an unregistered
partnership or joint venture taxable as a corporation under Section 20(b) and its income was
subject to the taxes prescribed under Section 24, both of the National Internal Revenue
Code 1 that the unregistered partnership was subject to corporate income tax as distinguished

from profits derived from the partnership by them which is subject to individual income tax; and
that the availment of tax amnesty under P.D. No. 23, as amended, by petitioners relieved
petitioners of their individual income tax liabilities but did not relieve them from the tax liability of
the unregistered partnership. Hence, the petitioners were required to pay the deficiency income
tax assessed.
Petitioners filed a petition for review with the respondent Court of Tax Appeals docketed as CTA
Case No. 3045. In due course, the respondent court by a majority decision of March 30,
1987, 2 affirmed the decision and action taken by respondent commissioner with costs against
petitioners.
It ruled that on the basis of the principle enunciated in Evangelista 3 an unregistered partnership
was in fact formed by petitioners which like a corporation was subject to corporate income tax
distinct from that imposed on the partners.
In a separate dissenting opinion, Associate Judge Constante Roaquin stated that considering
the circumstances of this case, although there might in fact be a co-ownership between the
petitioners, there was no adequate basis for the conclusion that they thereby formed an
unregistered partnership which made "hem liable for corporate income tax under the Tax Code.
Hence, this petition wherein petitioners invoke as basis thereof the following alleged errors of
the respondent court:
A. IN HOLDING AS PRESUMPTIVELY CORRECT THE DETERMINATION OF
THE RESPONDENT COMMISSIONER, TO THE EFFECT THAT PETITIONERS
FORMED AN UNREGISTERED PARTNERSHIP SUBJECT TO CORPORATE
INCOME TAX, AND THAT THE BURDEN OF OFFERING EVIDENCE IN
OPPOSITION THERETO RESTS UPON THE PETITIONERS.
B. IN MAKING A FINDING, SOLELY ON THE BASIS OF ISOLATED SALE
TRANSACTIONS, THAT AN UNREGISTERED PARTNERSHIP EXISTED THUS
IGNORING THE REQUIREMENTS LAID DOWN BY LAW THAT WOULD
WARRANT THE PRESUMPTION/CONCLUSION THAT A PARTNERSHIP
EXISTS.
C. IN FINDING THAT THE INSTANT CASE IS SIMILAR TO THE
EVANGELISTA CASE AND THEREFORE SHOULD BE DECIDED ALONGSIDE
THE EVANGELISTA CASE.
D. IN RULING THAT THE TAX AMNESTY DID NOT RELIEVE THE
PETITIONERS FROM PAYMENT OF OTHER TAXES FOR THE PERIOD
COVERED BY SUCH AMNESTY. (pp. 12-13, Rollo.)
The petition is meritorious.

The basis of the subject decision of the respondent court is the ruling of this Court
in Evangelista. 4
In the said case, petitioners borrowed a sum of money from their father which together with their
own personal funds they used in buying several real properties. They appointed their brother to
manage their properties with full power to lease, collect, rent, issue receipts, etc. They had the
real properties rented or leased to various tenants for several years and they gained net profits
from the rental income. Thus, the Collector of Internal Revenue demanded the payment of
income tax on a corporation, among others, from them.
In resolving the issue, this Court held as follows:
The issue in this case is whether petitioners are subject to the tax on
corporations provided for in section 24 of Commonwealth Act No. 466, otherwise
known as the National Internal Revenue Code, as well as to the residence tax for
corporations and the real estate dealers' fixed tax. With respect to the tax on
corporations, the issue hinges on the meaning of the terms corporation and
partnership as used in sections 24 and 84 of said Code, the pertinent parts of
which read:
Sec. 24. Rate of the tax on corporations.There shall be levied, assessed,
collected, and paid annually upon the total net income received in the preceding
taxable year from all sources by every corporation organized in, or existing under
the laws of the Philippines, no matter how created or organized but not including
duly registered general co-partnerships (companies collectives), a tax upon such
income equal to the sum of the following: ...
Sec. 84(b). The term "corporation" includes partnerships, no matter how created
or organized, joint-stock companies, joint accounts (cuentas en participation),
associations or insurance companies, but does not include duly registered
general co-partnerships (companies colectivas).
Article 1767 of the Civil Code of the Philippines provides:
By the contract of partnership two or more persons bind themselves to contribute
money, property, or industry to a common fund, with the intention of dividing the
profits among themselves.
Pursuant to this article, the essential elements of a partnership are two, namely:
(a) an agreement to contribute money, property or industry to a common fund;
and (b) intent to divide the profits among the contracting parties. The first
element is undoubtedly present in the case at bar, for, admittedly, petitioners
have agreed to, and did, contribute money and property to a common
fund. Hence, the issue narrows down to their intent in acting as they did. Upon

consideration of all the facts and circumstances surrounding the case, we are
fully satisfied that their purpose was to engage in real estate transactions for
monetary gain and then divide the same among themselves, because:
1. Said common fund was not something they found already in existence. It was
not a property inherited by them pro indiviso. They created it purposely. What is
more they jointly borrowed a substantial portion thereof in order to establish said
common fund.
2. They invested the same, not merely in one transaction, but in a series of
transactions. On February 2, 1943, they bought a lot for P100,000.00. On April 3,
1944, they purchased 21 lots for P18,000.00. This was soon followed, on April
23, 1944, by the acquisition of another real estate for P108,825.00. Five (5) days
later (April 28, 1944), they got a fourth lot for P237,234.14. The number of lots
(24) acquired and transcations undertaken, as well as the brief interregnum
between each, particularly the last three purchases, is strongly indicative of a
pattern or common design that was not limited to the conservation and
preservation of the aforementioned common fund or even of the property
acquired by petitioners in February, 1943. In other words, one cannot but
perceive a character of habituality peculiar to business transactions engaged in
for purposes of gain.
3. The aforesaid lots were not devoted to residential purposes or to other
personal uses, of petitioners herein. The properties were leased separately to
several persons, who, from 1945 to 1948 inclusive, paid the total sum of
P70,068.30 by way of rentals. Seemingly, the lots are still being so let, for
petitioners do not even suggest that there has been any change in the utilization
thereof.
4. Since August, 1945, the properties have been under the management of one
person, namely, Simeon Evangelists, with full power to lease, to collect rents, to
issue receipts, to bring suits, to sign letters and contracts, and to indorse and
deposit notes and checks. Thus, the affairs relative to said properties have been
handled as if the same belonged to a corporation or business enterprise
operated for profit.
5. The foregoing conditions have existed for more than ten (10) years, or, to be
exact, over fifteen (15) years, since the first property was acquired, and over
twelve (12) years, since Simeon Evangelists became the manager.
6. Petitioners have not testified or introduced any evidence, either on their
purpose in creating the set up already adverted to, or on the causes for its
continued existence. They did not even try to offer an explanation therefor.

Although, taken singly, they might not suffice to establish the intent necessary to
constitute a partnership, the collective effect of these circumstances is such as to
leave no room for doubt on the existence of said intent in petitioners herein. Only
one or two of the aforementioned circumstances were present in the cases cited
by petitioners herein, and, hence, those cases are not in point. 5
In the present case, there is no evidence that petitioners entered into an agreement to
contribute money, property or industry to a common fund, and that they intended to divide the
profits among themselves. Respondent commissioner and/ or his representative just assumed
these conditions to be present on the basis of the fact that petitioners purchased certain parcels
of land and became co-owners thereof.
In Evangelists, there was a series of transactions where petitioners purchased twenty-four (24)
lots showing that the purpose was not limited to the conservation or preservation of the common
fund or even the properties acquired by them. The character of habituality peculiar to business
transactions engaged in for the purpose of gain was present.
In the instant case, petitioners bought two (2) parcels of land in 1965. They did not sell the same
nor make any improvements thereon. In 1966, they bought another three (3) parcels of land
from one seller. It was only 1968 when they sold the two (2) parcels of land after which they did
not make any additional or new purchase. The remaining three (3) parcels were sold by them in
1970. The transactions were isolated. The character of habituality peculiar to business
transactions for the purpose of gain was not present.
In Evangelista, the properties were leased out to tenants for several years. The business was
under the management of one of the partners. Such condition existed for over fifteen (15) years.
None of the circumstances are present in the case at bar. The co-ownership started only in
1965 and ended in 1970.
Thus, in the concurring opinion of Mr. Justice Angelo Bautista in Evangelista he said:
I wish however to make the following observation Article 1769 of the new Civil
Code lays down the rule for determining when a transaction should be deemed a
partnership or a co-ownership. Said article paragraphs 2 and 3, provides;
(2) Co-ownership or co-possession does not itself establish a partnership,
whether such co-owners or co-possessors do or do not share any profits made
by the use of the property;
(3) The sharing of gross returns does not of itself establish a partnership,
whether or not the persons sharing them have a joint or common right or interest
in any property from which the returns are derived;
From the above it appears that the fact that those who agree to form a coownership share or do not share any profits made by the use of the property held

in common does not convert their venture into a partnership. Or the sharing of
the gross returns does not of itself establish a partnership whether or not the
persons sharing therein have a joint or common right or interest in the property.
This only means that, aside from the circumstance of profit, the presence of other
elements constituting partnership is necessary, such as the clear intent to form a
partnership, the existence of a juridical personality different from that of the
individual partners, and the freedom to transfer or assign any interest in the
property by one with the consent of the others (Padilla, Civil Code of the
Philippines Annotated, Vol. I, 1953 ed., pp. 635-636)
It is evident that an isolated transaction whereby two or more persons contribute
funds to buy certain real estate for profit in the absence of other circumstances
showing a contrary intention cannot be considered a partnership.
Persons who contribute property or funds for a common enterprise and agree to
share the gross returns of that enterprise in proportion to their contribution, but
who severally retain the title to their respective contribution, are not thereby
rendered partners. They have no common stock or capital, and no community of
interest as principal proprietors in the business itself which the proceeds derived.
(Elements of the Law of Partnership by Flord D. Mechem 2nd Ed., section 83, p.
74.)
A joint purchase of land, by two, does not constitute a co-partnership in respect
thereto; nor does an agreement to share the profits and losses on the sale of
land create a partnership; the parties are only tenants in common. (Clark vs.
Sideway, 142 U.S. 682,12 Ct. 327, 35 L. Ed., 1157.)
Where plaintiff, his brother, and another agreed to become owners of a single
tract of realty, holding as tenants in common, and to divide the profits of
disposing of it, the brother and the other not being entitled to share in plaintiffs
commission, no partnership existed as between the three parties, whatever their
relation may have been as to third parties. (Magee vs. Magee 123 N.E. 673, 233
Mass. 341.)
In order to constitute a partnership inter sese there must be: (a) An intent to form
the same; (b) generally participating in both profits and losses; (c) and such a
community of interest, as far as third persons are concerned as enables each
party to make contract, manage the business, and dispose of the whole
property.-Municipal Paving Co. vs. Herring 150 P. 1067, 50 III 470.)
The common ownership of property does not itself create a partnership between
the owners, though they may use it for the purpose of making gains; and they
may, without becoming partners, agree among themselves as to the

management, and use of such property and the application of the proceeds
therefrom. (Spurlock vs. Wilson, 142 S.W. 363,160 No. App. 14.) 6
The sharing of returns does not in itself establish a partnership whether or not the persons
sharing therein have a joint or common right or interest in the property. There must be a clear
intent to form a partnership, the existence of a juridical personality different from the individual
partners, and the freedom of each party to transfer or assign the whole property.
In the present case, there is clear evidence of co-ownership between the petitioners. There is
no adequate basis to support the proposition that they thereby formed an unregistered
partnership. The two isolated transactions whereby they purchased properties and sold the
same a few years thereafter did not thereby make them partners. They shared in the gross
profits as co- owners and paid their capital gains taxes on their net profits and availed of the tax
amnesty thereby. Under the circumstances, they cannot be considered to have formed an
unregistered partnership which is thereby liable for corporate income tax, as the respondent
commissioner proposes.
And even assuming for the sake of argument that such unregistered partnership appears to
have been formed, since there is no such existing unregistered partnership with a distinct
personality nor with assets that can be held liable for said deficiency corporate income tax, then
petitioners can be held individually liable as partners for this unpaid obligation of the partnership
p. 7 However, as petitioners have availed of the benefits of tax amnesty as individual taxpayers
in these transactions, they are thereby relieved of any further tax liability arising therefrom.
WHEREFROM, the petition is hereby GRANTED and the decision of the respondent Court of
Tax Appeals of March 30, 1987 is hereby REVERSED and SET ASIDE and another decision is
hereby rendered relieving petitioners of the corporate income tax liability in this case, without
pronouncement as to costs.
SO ORDERED.

THIRD DIVISION
[G.R. No. 112675. January 25, 1999.]
AFISCO INSURANCE CORPORATION; CCC INSURANCE CORPORATION;
CHARTER INSURANCE CO., INC.; CIBELES INSURANCE CORPORATION;
COMMONWEALTH
INSURANCE
COMPANY;
CONSOLIDATED
INSURANCE CO., INC.; DEVELOPMENT INSURANCE & SURETY
CORPORATION;
DOMESTIC
INSURANCE
COMPANY
OF
THE
PHILIPPINES; EASTERN ASSURANCE COMPANY & SURETY CORP.;
EMPIRE
INSURANCE
COMPANY;
EQUITABLE
INSURANCE
CORPORATION; FEDERAL INSURANCE CORPORATION INC.; FGU
INSURANCE CORPORATION; FIDELITY & SURETY COMPANY OF THE
PHILS., INC.; FILIPINO MERCHANTS' INSURANCE CO., INC.;
GOVERNMENT SERVICE INSURANCE SYSTEM; MALAYAN INSURANCE
CO., INC.; MALAYAN ZURICH INSURANCE CO., INC.; MERCANTILE
INSURANCE CO., INC.; METROPOLITAN INSURANCE COMPANY;
METRO-TAISHO
INSURANCE
CORPORATION;
NEW
ZEALAND
INSURANCE CO., LTD.; PAN-MALAYAN INSURANCE CORPORATION;
PARAMOUNT INSURANCE CORPORATION; PEOPLE'S TRANS-EAST
ASIA INSURANCE CORPORATION; PERLA COMPANIA DE SEGUROS,
INC.; PHILIPPINE BRITISH ASSURANCE CO., INC.; PHILIPPINE FIRST
INSURANCE CO., INC.; PIONEER INSURANCE & SURETY CORP.;
PIONEER
INTERCONTINENTAL
INSURANCE
CORPORATION;
PROVIDENT INSURANCE COMPANY OF THE PHILIPPINES; PYRAMID
INSURANCE CO., INC.; RELIANCE SURETY & INSURANCE COMPANY;
RIZAL SURETY & INSURANCE COMPANY; SANPIRO INSURANCE
CORPORATION; SEABOARD-EASTERN INSURANCE CO., INC.; SOLID
GUARANTY, INC.; SOUTH SEA SURETY & INSURANCE CO., INC.; STATE
BONDING
&
INSURANCE
CO.,
INC.;
SUMMA
INSURANCE
CORPORATION; TABACALERA INSURANCE CO., INC. all assessed as
"POOL OF MACHINERY INSURERS," petitioners, vs. COURT OF APPEALS,
COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL
REVENUE, respondents.
Angara Abello Concepcion Regala for petitioners.
SYNOPSIS
This is a Petition For Review on Certiorari assailing the Decision of the Court of Appeals
dismissing petitioners' appeal of the Decision of the Court of Tax Appeals which had sustained
petitioners' liability for deficiency income tax, interest and withholding tax. Petitioners contended

that the Court of Appeals erred in finding that the pool or clearing house was an informal
partnership, which was taxable as a corporation under the NIRC. Petitioners further claimed that
the remittances of the pool to the ceding companies and Munich are not dividends subject to
tax. They insisted that taxing such remittances contravene Sections 24 (b) (I) and 263 of the
1977 NIRC and would be tantamount to an illegal double taxation. Moreover, petitioners argued
that since Munich was not a signatory to the Pool Agreement, the remittances it received from
the pool cannot be deemed dividends. However, even if such remittances were treated as
dividends, they would have been exempt under the previously mentioned sections of the
1977 NIRC,as well as Article 7 of paragraph 1 and Article 5 of the RP-West German Tax Treaty.
Petitioners likewise contended that the Internal Revenue Commissioner was already barred by
prescription from making an assessment.
In the present case, the ceding companies entered into a Pool Agreement or association that
would handle all the insurance businesses covered under their quota-share reinsurance treaty
and surplus reinsurance treaty with Munich. AScHCD
Petitioner's allegation of double taxation is untenable. The pool is a taxable entity distinct from
the individual corporate entities of the ceding companies. The tax on its income is different from
the tax on the dividends received by the said companies. The tax exemptions claimed by
petitioners cannot be granted. The sections of the 1977 NIRC which petitioners cited are
inapplicable, because these were not yet in effect when the income was earned and when the
subject information return for the year ending 1975 was filed. Petitioners' claim that Munich is
tax-exempt based on the RP-West German Tax Treaty is likewise unpersuasive, because the
Internal Revenue Commissioner assessed the pool for corporate taxes on the basis of the
information return it had submitted for the year ending 1975, a taxable year when said treaty
was not yet in effect. Petitioners likewise failed to comply with the requirement of Section 333 of
the NIRC for the suspension of the prescriptive period. The Resolutions of the Court of Appeals
are affirmed.
SYLLABUS
1. REMEDIAL LAW; EVIDENCE; RULING OF THE COMMISSION OF INTERNAL REVENUE
IS ACCORDED WEIGHT AND EVEN FINALITY IN THE ABSENCE OF SHOWING THAT IT IS
PATENTLY WRONG. The opinion or ruling of the Commission of Internal Revenue, the
agency tasked with the enforcement of tax laws, is accorded much weight and even finality,
when there is no showing that it is patently wrong, particularly in this case where the findings
and conclusions of the internal revenue commissioner were subsequently affirmed by the CTA,
a specialized body created for the exclusive purpose of reviewing tax cases, and the Court of
Appeals. Indeed, "[I]t has been the long standing policy and practice of this Court to respect the
conclusions of quasi-judicial agencies, such as the Court of Tax Appeals which, by the nature of
its functions, is dedicated exclusively to the study and consideration of tax problems and has
necessarily developed an expertise on the subject, unless there has been an abuse or
improvident exercise of its authority." TIAEac

2. CIVIL LAW; PARTNERSHIP; REQUISITES. Article 1767 of the Civil Code recognizes the
creation of a contract of partnership when "two or more persons bind themselves to contribute
money, property, or industry to a common fund, with the intention of dividing the profits among
themselves." Its requisites are: "(1) mutual contribution to a common stock, and (2) a joint
interest in the profits." In other words, a partnership is formed when persons contract "to devote
to a common purpose either money, property, or labor with the intention of dividing the profits
between themselves." Meanwhile, an association implies associates who enter into a "joint
enterprise . . . for the transaction of business."
3. ID.; ID.; INSURANCE POOL IN CASE AT BAR DEEMED PARTNERSHIP OR
ASSOCIATION TAXABLE AS A CORPORATION UNDER SECTION 24 OF THE NIRC. In
the case before us, the ceding companies entered into a Pool Agreement or an association that
would handle all the insurance businesses covered under their quota-share reinsurance treaty
and surplus reinsurance treaty with Munich. The following unmistakably indicates a partnership
or an association covered by Section 24 of the NIRC: (1) The pool has a common fund,
consisting of money and other valuables that are deposited in the name and credit of the pool.
This common fund pays for the administration and operation expenses of the pool. (2) The pool
functions through an executive board, which resembles the board of directors of a corporation,
composed of one representative for each of the ceding companies. (3) True, the pool itself is not
a reinsurer and does not issue any insurance policy; however, its work is indispensable,
beneficial and economically useful to the business of the ceding companies and Munich,
because without it they would not have received their premiums. The ceding companies share
"in the business ceded to the pool" and in the "expenses" according to a "Rules of Distribution"
annexed to the Pool Agreement. Profit motive or business is, therefore, the primordial reason for
the pool's formation.
4. TAXATION; NIRC; SECTION 24 THEREOF, UNREGISTERED PARTNERSHIPS AND
ASSOCIATIONS ARE CONSIDERED AS CORPORATIONS FOR TAX PURPOSES. This
Court rules that the Court of Appeals, in affirming the CTA which had previously sustained the
internal revenue commissioner, committed no reversible error. Section 24 of the NIRC,as
worded in the year ending 1975, provides: "SEC. 24. Rate of tax on corporations. (a) Tax on
domestic corporations. A tax is hereby imposed upon the taxable net income received during
each taxable year from all sources by every corporation organized in, or existing under the laws
of the Philippines, no matter how created or organized, but not including duly registered general
co-partnership (compaias colectivas), general professional partnerships, private educational
institutions, and building and loan associations . . . ." Ineludibly, the Philippine legislature
included in the concept of corporations those entities that resembled them such as unregistered
partnerships and associations. Parenthetically, the NLRC's inclusion of such entities in the tax
on corporations was made even clearer by the Tax Reform Act of 1997, which amended the Tax
Code.The Court of Appeals did not err in applying Evangelista, which involved a partnership that
engaged in a series of transactions spanning more than ten years, as in the case before us.
5. ID.; DOUBLE TAXATION; DEFINED; NO DOUBLE TAXATION IN CASE AT BAR. Double
taxation means taxing the same property twice when it should be taxed only once. That is, ". . .
taxing the same person twice by the same jurisdiction for the same thing." In the instant case,
the pool is a taxable entity distinct from the individual corporate entities of the ceding

companies. The tax on its income is obviously different from the tax on the dividends received
by the said companies. Clearly, there is no double taxation here.
6. ID.; TAX EXEMPTION; GRANT THEREOF NOT JUSTIFIED IN CASE AT BAR; REASONS.
The tax exemptions claimed by petitioners cannot be granted, since their entitlement thereto
remains unproven and unsubstantiated. It is axiomatic in the law of taxation that taxes are the
lifeblood of the nation. Hence, "exemptions therefrom are highly disfavored in law and he who
claims tax exemption must be able to justify his claim or right." Petitioners have failed to
discharge this burden of proof. The sections of the 1977 NIRC which they cite are inapplicable,
because these were not yet in effect when the income was earned and when the subject
information return for the year ending 1975 was filed. Referring to the 1975 version of the
counterpart sections of the NIRC,the Court still cannot justify the exemptions claimed. Section
255 provides that no tax shall ". . . be paid upon reinsurance by any company that has already
paid the tax . . . ." This cannot be applied to the present case because, as previously discussed,
the pool is a taxable entity distinct from the ceding companies; therefore, the latter cannot
individually claim the income tax paid by the former as their own. EDSAac

7. ID.; ID.; CANNOT BE CLAIMED BY NON-RESIDENT FOREIGN INSURANCE

CORPORATION
IN
CASE
AT
BAR;
REASONS;
TAX
EXEMPTION
CONSTRUED STRICTISSIMI JURIS. Section 24 (b) (1) pertains to tax on foreign
corporations; hence, it cannot be claimed by the ceding companies which are domestic
corporations. Nor can Munich, a foreign corporation, be granted exemption based solely on this
provision of the Tax Code because the same subsection specifically taxes dividends, the type of
remittances forwarded to it by the pool. Although not a signatory to the Pool Agreement, Munich
is patently an associate of the ceding companies in the entity formed, pursuant to their
reinsurance treaties which required the creation of said pool. Under its pool arrangement with
the ceding companies, Munich shared in their income and loss. This is manifest from a reading
of Articles 3 and 10 of the Quota-Share Reinsurance Treaty and Articles 3 and 10 of the Surplus
Reinsurance Treaty. The foregoing interpretation of Section 24 (b) (1) is in line with the doctrine
that a tax exemption must be construed strictissimi juris, and the statutory exemption claimed
must be expressed in a language too plain to be mistaken.
8. ID.; ID.; BASED ON TAX TREATY NOT APPLICABLE IN CASE AT BAR; REASON. The
petitioners' claim that Munich is tax-exempt based on the RP-West German Tax Treaty is
likewise unpersuasive, because the internal revenue commissioner assessed the pool for
corporate taxes on the basis of the information return it had submitted for the year ending 1975,
a taxable year when said treaty was not yet in effect. Although petitioners omitted in their
pleadings the date of effectivity of the treaty, the Court takes judicial notice that it took effect
only later, on December 14, 1984.
9. ID.; ASSESSMENT AND COLLECTION OF TAX; PRESCRIPTION; CHANGE IN THE
ADDRESS OF THE TAXPAYER WILL NOT TOLL THE RUNNING OF THE PRESCRIPTIVE
PERIOD UNLESS THE COMMISSIONER OF INTERNAL REVENUE HAS BEEN INFORMED
OF SAID CHANGE. The CA and the CTA categorically found that the prescriptive period was
tolled under then Section 333 of the NIRC,because "the taxpayer cannot be located at the

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

DECISION

PANGANIBAN, J p:
Pursuant to "reinsurance treaties," a number of local insurance firms formed themselves into a
"pool" in order to facilitate the handling of business contracted with a nonresident foreign
reinsurance company. May the "clearing house" or "insurance pool" so formed be deemed a
partnership or an association that is taxable as a corporation under the National Internal
Revenue Code (NIRC)? Should the pool's remittances to the member companies and to the
said foreign firm be taxable as dividends? Under the facts of this case, has the government's
right to assess and collect said tax prescribed? cdasia
The Case
These are the main questions raised in the Petition for Review on Certiorari before us, assailing
the October 11, 1993 Decision 1 of the Court of Appeals 2 in CA-GR SP 29502, which
dismissed petitioners' appeal of the October 19, 1992 Decision 3 of the Court of Tax
Appeals 4 (CTA) which had previously sustained petitioners' liability for deficiency income tax,
interest and withholding tax. The Court of Appeals ruled:
"WHEREFORE, the petition is DISMISSED, with costs against petitioners." 5
The petition also challenges the
Resolution 6 denying reconsideration.

November

15,

1993

Court

of

Appeals

The Facts
The antecedent facts, 7 as found by the Court of Appeals, are as follows:
"The petitioners are 41 non-life insurance corporations, organized and existing
under the laws of the Philippines. Upon issuance by them of Erection,
Machinery Breakdown, Boiler Explosion and Contractors' All Risk insurance
policies, the petitioners on August 1, 1965 entered into a Quota Share
Reinsurance Treaty and a Surplus Reinsurance Treaty with the Munchener

(CA)

Ruckversicherungs-Gesselschaft (hereafter called Munich), a non-resident

foreign insurance corporation. The reinsurance treaties required petitioners to
form a [p]ool. Accordingly, a pool composed of the petitioners was formed on
the same day.
"On April 14, 1976, the pool of machinery insurers submitted a financial
statement and filed an "Information Return of Organization Exempt from
Income Tax" for the year ending in 1975, on the basis of which it was assessed
by the Commissioner of Internal Revenue deficiency corporate taxes in the
amount of P1,843,273.60, and withholding taxes in the amount of
P1,768,799.39 and P89,438.68 on dividends paid to Munich and to the
petitioners, respectively. These assessments were protested by the petitioners
through its auditors Sycip, Gorres, Velayo and Co.
"On January 27, 1986, the Commissioner of Internal Revenue denied the
protest and ordered the petitioners, assessed as "Pool of Machinery Insurers,"
to pay deficiency income tax, interest, and with[h]olding tax, itemized as
follows:
Net income per information return P3,737,370.00
===========
Income tax due thereon P1,298,080.00
Add: 14% Int. fr. 4/15/76
to 4/15/79 545,193.60

TOTAL AMOUNT DUE & P1,843,273.60

COLLECTIBLE ===========
Dividend paid to Munich
Reinsurance Company P3,728,412.00
===========
35% withholding tax at source due thereon P1,304,944.20
Add: 25% surcharge 326,236.05
14%
1/25/76 to 1/25/79 137,019.14
Compromise
penalty-non-filing of return 300.00
late payment 300.00

interest

from


TOTAL AMOUNT DUE & P1,768,799.39
COLLECTIBLE ===========
Dividend paid to Pool Members P655,636.00
===========
10%
withholding
source due thereon P65,563.60

tax

at

Add: 25% surcharge 16,390.90

14%
1/25/76 to 1/25/79 6,884.18

interest

from

Compromise
penalty-non-filing of return 300.00
late payment 300.00

TOTAL AMOUNT DUE & P89,438.68

COLLECTIBLE ==========" 8
The CA ruled in the main that the pool of machinery insurers was a partnership taxable as a
corporation, and that the latter's collection of premiums on behalf of its members, the ceding
companies, was taxable income. It added that prescription did not bar the Bureau of Internal
Revenue (BIR) from collecting the taxes due, because "the taxpayer cannot be located at the
address given in the information return filed." Hence, this Petition for Review before us. 9
The Issues
Before this Court, petitioners raise the following issues:
"1. Whether or not the Clearing House, acting as a mere agent and performing
strictly administrative functions, and which did not insure or assume any risk in
its own name, was a partnership or association subject to tax as a corporation;
"2. Whether or not the remittances to petitioners and MUNICHRE of their
respective shares of reinsurance premiums, pertaining to their individual and
separate contracts of reinsurance, were "dividends" subject to tax; and
"3. Whether or not the respondent Commissioner's right to assess the Clearing
House had already prescribed." 10
The Court's Ruling

The petition is devoid of merit. We sustain the ruling of the Court of Appeals that the pool is
taxable as a corporation, and that the government's right to assess and collect the taxes had not
prescribed.
First Issue:
Pool Taxable as a Corporation
Petitioners contend that the Court of Appeals erred in finding that the pool or clearing house
was an informal partnership, which was taxable as a corporation under the NIRC. They point out
that the reinsurance policies were written by them "individually and separately," and that their
liability was limited to the extent of their allocated share in the original risks thus
reinsured. 11 Hence, the pool did not act or earn income as a reinsurer. 12 Its role was limited
to its principal function of "allocating and distributing the risk(s) arising from the original
insurance among the signatories to the treaty or the members of the pool based on their ability
to absorb the risk(s) ceded[;] as well as the performance of incidental functions, such as
records, maintenance, collection and custody of funds, etc." 13
Petitioners belie the existence of a partnership in this case, because (1) they, the reinsurers, did
not share the same risk or solidary liability; 14 (2) there was no common fund; 15 (3) the
executive board of the pool did not exercise control and management of its funds, unlike the
board of directors of a corporation; 16 and (4) the pool or clearing house "was not and could not
possibly have engaged in the business of reinsurance from which it could have derived income
for itself." 17
The Court is not persuaded. The opinion or ruling of the Commission of Internal Revenue, the
agency tasked with the enforcement of tax laws, is accorded much weight and even finality,
when there is no showing that it is patently wrong, 18 particularly in this case where the findings
and conclusions of the internal revenue commissioner were subsequently affirmed by the CTA,
a specialized body created for the exclusive purpose of reviewing tax cases, and the Court of
Appeals. 19 Indeed,

"[I]t has been the long standing policy and practice of this Court to respect the
conclusions of quasi-judicial agencies, such as the Court of Tax Appeals which,
by the nature of its functions, is dedicated exclusively to the study and
consideration of tax problems and has necessarily developed an expertise on
the subject, unless there has been an abuse or improvident exercise of its
authority." 20
This Court rules that the Court of Appeals, in affirming the CTA which had previously sustained
the internal revenue commissioner, committed no reversible error.Section 24 of the NIRC,as
worded in the year ending 1975, provides:
"SEC. 24. Rate of tax on corporations. (a) Tax on domestic corporations.
A tax is hereby imposed upon the taxable net income received during each
taxable year from all sources by every corporation organized in, or existing
under the laws of the Philippines, no matter how created or organized, but not

including duly registered general co-partnership (compaias colectivas),

general professional partnerships, private educational institutions, and building
and loan associations . . . ."
Ineludibly, the Philippine legislature included in the concept of corporations those entities that
resembled them such as unregistered partnerships and associations. Parenthetically, the
NLRC's inclusion of such entities in the tax on corporations was made even clearer by the Tax
Reform Act of 1997, 21 which amended the Tax Code.Pertinent provisions of the new law read
as follows:
"SEC. 27. Rates of Income Tax on Domestic Corporations.
(A) In General. Except as otherwise provided in this Code, an income tax of
thirty-five percent (35%) is hereby imposed upon the taxable income derived
during each taxable year from all sources within and without the Philippines by
every corporation, as defined in Section 22 (B) of this Code, and taxable under
this Title as a corporation . . . ."
"SEC. 22. Definition. When used in this Title:
xxx xxx xxx
(B) The term 'corporation' shall include partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion),
associations, or insurance companies, but does not include general
professional partnerships [or] a joint venture or consortium formed for the
purpose of undertaking construction projects or engaging in petroleum, coal,
geothermal and other energy operations pursuant to an operating or
consortium agreement under a service contract without the Government.
'General professional partnerships' are partnerships formed by persons for
the sole purpose of exercising their common profession, no part of the income
of which is derived from engaging in any trade or business. LLphil
xxx xxx xxx."
Thus, the Court in Evangelista v. Collector of Internal Revenue 22 held that Section 24 covered
these unregistered partnerships and even associations or joint accounts, which had no legal
personalities apart from their individual members. 23 The Court of Appeals astutely
applied Evangelista: 24
". . . Accordingly, a pool of individual real property owners dealing in real estate
business was considered a corporation for purposes of the tax in Sec. 24 of
the Tax Code in Evangelista v. Collector of Internal Revenue, supra. The
Supreme Court said:
'The term 'partnership' includes a syndicate, group, pool, joint venture or
other unincorporated organization, through or by means of which any
business, financial operation, or venture is carried on . . . (8 Merten's
Law of Federal Income Taxation, p. 562 Note 63)'"

Article 1767 of the Civil Code recognizes the creation of a contract of partnership when "two or
more persons bind themselves to contribute money, property, or industry to a common fund,
with the intention of dividing the profits among themselves." 25 Its requisites are: "(1) mutual
contribution to a common stock, and (2) a joint interest in the profits." 26 In other words, a
partnership is formed when persons contract "to devote to a common purpose either money,
property, or labor with the intention of dividing the profits between themselves." 27 Meanwhile,
an association implies associates who enter into a "joint enterprise . . . for the transaction of
business." 28
In the case before us, the ceding companies entered into a Pool Agreement 29 or an
association 30 that would handle all the insurance businesses covered under their quota-share
reinsurance treaty 31 and surplus reinsurance treaty 32 with Munich. The following
unmistakably indicates a partnership or an association covered by Section 24 of the NIRC:
(1) The pool has a common fund, consisting of money and other valuables that are deposited in
the name and credit of the pool. 33 This common fund pays for the administration and operation
expenses of the pool. 34
(2) The pool functions through an executive board, which resembles the board of directors of a
corporation, composed of one representative for each of the ceding companies. 35
(3) True, the pool itself is not a reinsurer and does not issue any insurance policy; however, its
work is indispensable, beneficial and economically useful to the business of the ceding
companies and Munich, because without it they would not have received their premiums. The
ceding companies share "in the business ceded to the pool" and in the "expenses" according to
a "Rules of Distribution" annexed to the Pool Agreement. 36 Profit motive or business is,
therefore, the primordial reason for the pool's formation. As aptly found by the CTA:
". . . The fact that the pool does not retain any profit or income does not
obliterate an antecedent fact, that of the pool being used in the transaction of
business for profit. It is apparent, and petitioners admit, that their association or
coaction was indispensable [to] the transaction of the business. . . If together
they have conducted business, profit must have been the object as, indeed,
profit was earned. Though the profit was apportioned among the members, this
is only a matter of consequence, as it implies that profit actually resulted." 37
The petitioners' reliance on Pascual v. Commissioner 38 is misplaced, because the facts
obtaining therein are not on all fours with the present case. In Pascual, there was no
unregistered partnership, but merely a co-ownership which took up only two isolated
transactions. 39 The Court of Appeals did not err in applying Evangelista, which involved a
partnership that engaged in a series of transactions spanning more than ten years, as in the
case before us.
Second Issues:
Pool's Remittances Are Taxable
Petitioners further contend that the remittances of the pool to the ceding companies and Munich
are not dividends subject to tax. They insist that taxing such remittances contravene Sections

24 (b) (I) and 263 of the 1977 NIRC and "would be tantamount to an illegal double taxation, as it
would result in taxing the same premium income twice in the hands of the same
taxpayer." 40 Moreover, petitioners argue that since Munich was not a signatory to the Pool
Agreement, the remittances it received from the pool cannot be deemed dividends. 41 They add
that even if such remittances were treated as dividends, they would have been exempt under
the previously mentioned sections of the 1977 NIRC,42 as well as Article 7 of paragraph
1 43 and Article 5 of paragraph 5 44 of the RP-West German Tax Treaty. 45
Petitioners are clutching at straws. Double taxation means taxing the same property twice when
it should be taxed only once. That is, ". . . taxing the same person twice by the same jurisdiction
for the same thing." 46 In the instant case, the pool is a taxable entity distinct from the individual
corporate entities of the ceding companies. The tax on its income is obviously different from the
tax on the dividends received by the said companies. Clearly, there is no double taxation here.
The tax exemptions claimed by petitioners cannot be granted, since their entitlement thereto
remains unproven and unsubstantiated. It is axiomatic in the law of taxation that taxes are the
lifeblood of the nation. Hence, "exemptions therefrom are highly disfavored in law and he who
claims tax exemption must be able to justify his claim or right." 47 Petitioners have failed to
discharge this burden of proof. The sections of the 1977 NIRC which they cite are inapplicable,
because these were not yet in effect when the income was earned and when the subject
information return for the year ending 1975 was filed.
Referring to the 1975 version of the counterpart sections of the NIRC,the Court still cannot
justify the exemptions claimed. Section 255 provides that no tax shall ". . . be paid upon
reinsurance by any company that has already paid the tax . . . ." This cannot be applied to the
present case because, as previously discussed, the pool is a taxable entity distinct from the
ceding companies; therefore, the latter cannot individually claim the income tax paid by the
former as their own.
On the other hand, Section 24 (b) (1) 48 pertains to tax on foreign corporations; hence, it cannot
be claimed by the ceding companies which are domestic corporations. Nor can Munich, a
foreign corporation, be granted exemption based solely on this provision of the Tax
Code,because the same subsection specifically taxes dividends, the type of remittances
forwarded to it by the pool. Although not a signatory to the Pool Agreement, Munich is patently
an associate of the ceding companies in the entity formed, pursuant to their reinsurance treaties
which required the creation of said pool.
Under its pool arrangement with the ceding companies, Munich shared in their income and loss.
This is manifest from a reading of Articles 3 49 and 10 50 of the Quota-Share Reinsurance
Treaty and Articles 3 51 and 10 52 of the Surplus Reinsurance Treaty. The foregoing
interpretation of Section 24 (b) (1) is in line with the doctrine that a tax exemption must be
construed strictissimi juris, and the statutory exemption claimed must be expressed in a
language too plain to be mistaken. 53

Finally, the petitioners' claim that Munich is tax-exempt based on the RP-West German Tax
Treaty is likewise unpersuasive, because the internal revenue commissioner assessed the pool

for corporate taxes on the basis of the information return it had submitted for the year ending
1975, a taxable year when said treaty was not yet in effect. 54 Although petitioners omitted in
their pleadings the date of effectivity of the treaty, the Court takes judicial notice that it took
effect only later, on December 14, 1984. 55
Third Issue:
Prescription
Petitioners also argue that the government's right to assess and collect the subject tax had
prescribed. They claim that the subject information return was filed by the pool on April 14,
1976. On the basis of this return, the BIR telephoned petitioners on November 11, 1981, to give
them notice of its letter of assessment dated March 27, 1981. Thus, the petitioners contend that
the five-year statute of limitations then provided in the NIRC had already lapsed, and that the
internal revenue commissioner was already barred by prescription from making an
assessment. 56
We cannot sustain the petitioners. The CA and the CTA categorically found that the prescriptive
period was tolled under then Section 333 of the NIRC,57 because " the taxpayer cannot be
located at the address given in the information return filed and for which reason there was delay
in sending the assessment." 58 Indeed, whether the government's right to collect and assess
the tax has prescribed involves facts which have been ruled upon by the lower courts. It is
axiomatic that in the absence of a clear showing of palpable error or grave abuse of discretion,
as in this case, this Court must not overturn the factual findings of the CA and the CTA.
Furthermore, petitioners admitted in their Motion for Reconsideration before the Court of
Appeals that the pool changed its address, for they stated that the pool's information return filed
in 1980 indicated therein its "present address." The Court finds that this falls short of the
requirement of Section 333 of the NIRC for the suspension of the prescriptive period. The law
clearly states that the said period will be suspended only "if the taxpayer informs the
Commissioner of Internal Revenue of any change in the address."
WHEREFORE, the petition is DENIED. The Resolutions of the Court of Appeals dated October
11, 1993 and November 15, 1993 are hereby AFFIRMED. Costs against petitioners. cdasia
SO ORDERED.
||| (Afisco Insurance Corp. v. Court of Appeals, G.R. No. 112675, [January 25, 1999], 361 PHIL
671-691)

FIRST DIVISION
[G.R. No. L-9692. January 6, 1958.]

COLLECTOR OF INTERNAL
TRANSPORTATION COMPANY
COMPANY, respondents.

REVENUE, petitioner, vs. BATANGAS

and LAGUNA - TAYABAS BUS

Solicitor General Ambrosio Padilla, Solicitor Conrado T. Limcaoco and Zoilo R.

Zandoval for petitioner.

Ozaeta, Lichauco & Picazo for respondents.

SYLLABUS
1. TAXATION; WHAT CONSTITUTE CORPORATION WITHIN THE MEANING OF
THE TAX CODE; LIABILITY FOR INCOME TAX; CASE AT BAR. The Tax Code defines
the term "corporation" as including partnership no matter how created or organized, thereby
indicating a joint venture need not be undertaken in any of the standards forms, or in
conformity with the usual requirements of the law on partnership, in order that one could be
deemed constituted for the purposes of the tax on corporations. In the case at bar, while the
two respondent companies were registered and operating separately, they were placed
under one sole management called the "Joint Emergency Operation" for the purpose of
economizing in overhead expenses. Although no legal personality may have been created
by the Joint Emergency Operation, nevertheless, said joint management operated the
business affairs of the two companies as though they constituted a single entity, company or
partnership, thereby obtaining substantial economy and profits in the operation. The joint
venture, therefore, falls under the provisions of section 84 (b) of the Internal Revenue Code,
and consequently, it is liable to income tax provided for in Section 24 of the same Code.
2. ID.; APPEAL FROM THE DECISION OF COLLECTOR; AUTHORITY TO
INCREASE ASSESSMENT AFTER APPEAL HAS BEEN PERFECTED. The Collector of
Internal Revenue, after appeal from his decision to the Court of Tax Appeals has been
perfected, and after the Tax Court has acquired jurisdiction over the appeal, but before the
answer is filed with the court, may still modify his assessment, subject of the appeal, by
increasing the same. If the Collector of Internal Revenue is not allowed to amend his

assessment before the Court of Tax Appeals, and since he may make a subsequent
reassessment to collect additional sums within the same subject of his original assessment,
provided it is done within the prescriptive period, that would lead to multiplicity of suit which
the law does not encourage.
3. ID.; PENALTY; FAILURE TO FILE INCOME TAX RETURN FOR AND IN BEHALF
OF AN ENTITY, WHEN JUSTIFIED. Where the failure to file an income tax return for and
in behalf of an entity which is later found to be a corporation within the meaning of Section
84 (b) of the Tax Code was due to a reasonable cause, such as an honest belief based on
the advice of its attorneys and accountants, a penalty in the form of a surcharge should not
to be imposed and collected.

DECISION

MONTEMAYOR, J p:
This is an appeal from the decision of the Court of Tax Appeals (C.T.A.), which
reversed the assessment and decision of petitioner Collector of Internal Revenue, later
referred to as Collector, assessing and demanding from the respondents Batangas
Transportation Company, later referred to as Batangas Transportation, and Laguna
Tayabas Bus Company, later referred to as Laguna Bus, the amount of P54,143.54,
supposed to represent the deficiency income tax and compromise for the years 1946 to
1949, inclusive, which amount, pending appeal in the C.T.A., but before the Collector filed
his answer in said court, was increased to P148,890.14.
The following facts are undisputed: Respondent companies are two distinct and
separate corporations engaged in the business of land transportation by means of motor
buses, and operating distinct and separate lines. Batangas Transportation was organized in
1918, while Laguna Bus was organized in 1928. Each company now has a fully paid up
capital of P1,000,000. Before the last war, each company maintained separate head offices,
that of Batangas Transportation being in Batangas, Batangas, while the Laguna Bus had its
head office in San Pablo Laguna. Each company also kept and maintained separate books,
fleets of buses, management, personnel, maintenance and repair shops, and other facilities.
Joseph Benedict managed the Batangas Transportation, while Martin Olson was the
manager of the Laguna Bus. To show the connection and close relation between the two
companies, it should be stated that Max Blouse was the President of both corporations and
owned about 30 per cent of the stock in each company. During the war, the American
officials of these two corporations were interned in Santo Tomas, and said companies
ceased operations. They also lost their respective properties and equipment. After
Liberation, sometime in April, 1945, the two companies were able to acquire 56 auto buses
from the United States Army, and the two companies divided said equipment equally
between themselves, registering the same separately in their respective names. In March,
1947, after the resignation of Martin Olson as Manager of the Laguna Bus, Joseph Benedict,

who was then managing the Batangas Transportation, was appointed Manager of both
companies by their respective Board of Directors. The head office of the Laguna Bus in San
Pablo City was made the main office of both corporations. The placing of the two companies
under one sole management was made by Max Blouse, President of both companies, by
virtue of the authority granted him by resolution of the Board of Directors of the Laguna Bus
on August 10, 1945, and ratified by the Boards of the two companies in their respective
resolutions of October 27, 1947.
According to the testimony of joint Manager Joseph Benedict, the purpose of the joint
management, which was called "Joint Emergency Operation", was to economize in
overhead expenses; that by means of said joint operation, both companies had been able to
save the salaries of one manager, one assistant manager, fifteen inspectors, special agents,
and one set of office clerical force, the savings in one year amounting to about P200,000 or
about P100,000 for each company. At the end of each calendar year, all gross receipts and
expenses of both companies were determined and the net profits were divided fifty-fifty, and
transferred to the books of accounts of each company, and each company "then prepared
its own income tax return from this fifty per centum of the gross receipts and expenditures,
assets and liabilities thus transferred to it from the 'Joint Emergency Operation' and paid the
corresponding income taxes thereon separately".
Under the theory that the two companies had pooled their resources in the
establishment of the Joint Emergency Operation, thereby forming a joint venture, the
Collector wrote the bus companies that there was due from them the amount of
P422,210.89 as deficiency income tax and compromise for the years 1946 to 1949,
inclusive. Since the Collector caused to be restrained, seized, and advertised for sale all the
rolling stock of the two corporations, respondent companies had to file a surety bond in the
same amount of P422,210.89 to guarantee the payment of the income tax assessed by him.
After some exchange of communications between the parties, the Collector, on
January 8, 1955, informed the respondents "that after crediting the overpayment made by
them of their alleged income tax liabilities for the aforesaid years, pursuant to the doctrine of
equitable recoupment, the income tax due from the 'Joint Emergency Operation' for the
years 1946 to 1949, inclusive, is in the total amount of P54,143.54." The respondent
companies appealed from said assessment of P54,143.54 to the Court of Tax Appeals, but
before filing his answer, the Collector set aside his original assessment of P54,143.54 and
reassessed the alleged income tax liability of respondents of P148,890.14, claiming that he
had later discovered that said companies had been "erroneously credited in the last
assessment with 100 per cent of their income taxes paid when they should in fact have been
credited with only 75 per cent thereof, since under Section 24 of the Tax Code dividends
received by them from the Joint Emergency Operation as a domestic corporation are
returnable to the extent of 25 per cent". That corrected and increased reassessment was
embodied in the answer filed by the Collector with the Court of Tax Appeals.
The theory of the Collector is the Joint Emergency Operation was a corporation
distinct from the two respondent companies, as defined in section 84 (b), and so liable to
income tax under section 24, both of the National Internal Revenue Code. After hearing, the
C.T.A. found and held, citing authorities, that the Joint Emergency Operation or joint

management of the two companies "is not a corporation within the contemplation of section
84 (b) of the National Internal Revenue Code much less a partnership, association or
insurance company", and therefore was not subject to the income tax under the provisions
of section 24 of the same Code, separately and independently of respondent companies; so,
it reversed the decision of the Collector assessing and demanding from the two companies
the payment of the amount of P54,143.54 and/or the amount of P148,890.14. The Tax Court
did not pass upon the question of whether or not in the appeal taken to it by respondent
companies, the Collector could change his original assessment by increasing the same from
P54,143.14 to P148,890.14, to correct an error committed by him in having credited the
Joint Emergency Operation, totally or 100 per cent of the income taxes paid by the
respondent companies for the years 1946 to 1949, inclusive, by reason of the principle
of equitable recoupment, instead of only 75 per cent.
The two main and most important questions involved in the present appeal are: (1)
whether the two transportation companies herein involved are liable to the payment of
income tax as a corporation on the theory that the Joint Emergency Operation organized
and operated by them is a corporation within the meaning of Section 84 of the Revised
Internal Revenue Code, and (2) whether the Collector of Internal Revenue, after the appeal
from his decision has been perfected, and after the Court of Tax Appeals has acquired
jurisdiction over the same, but before said Collector has filed his answer with that court, may
still modify his assessment subject of the appeal by increasing the same, on the ground that
he had committed error in good faith in making said appealed assessment.

The first question has already been passed upon and determined by this Tribunal in
the case of Eufemia Evangelista et al., vs. Collector of Internal Revenue et al., * G. R. No. L9996, promulgated on October 15, 1957. Considering the views and rulings embodied in our
decision in that case penned by Mr. Justice Roberto Concepcion, we deem it unnecessary
to extensively discuss the point. Briefly, the facts in that case are as follows: The three
Evangelista sisters borrowed from their father about P59,000 and adding thereto their own
personal funds, bought real properties, such as a lot with improvements thereon for the sum
of P100,000 in 1943, parcels of land with a total area of almost 4,000 square meters with
improvements thereon for P18,000 in 1944, another lot for P108,000 in the same year, and
still another lot for P237,000 in the same year. The relatively large amounts invested may be
explained by the fact that purchases were made during the Japanese occupation,
apparently in Japanese military notes. In 1945, the sisters appointed their brother to manage
their properties, with full power to lease, to collect and receive rents, on default of such
payment, to bring suits against the defaulting tenants, to sign all letters and contracts, etc.
The properties therein involved were rented to various tenants, and the sisters, through their
brother as manager, realized a net rental income of P5,948 in 1945, P7,498 in 1946, and
P12,615 in 1948. In 1954, the Collector of Internal Revenue demanded of them among other
things, payment of income tax on corporations from the year 1945 to 1949, in the total
amount of P6,157, including surcharge and compromise. Dissatisfied with the said
assessment, the three sisters appealed to the Court of Tax Appeals, which court decided in
favor of the Collector of Internal Revenue. On appeal to us, we affirmed the decision of the

Tax Court. We found and held that considering all the facts and circumstances surrounding
the case, the three sisters had the purpose to engage in real estate transactions for
monetary gain and then divide the same among themselves; that they contributed to a
common fund which they invested in a series of transactions; that the properties bought with
this common fund had been under the management of one person with full power to lease,
to collect rents, issue receipts, bring suits, sign letters and contracts, etc., in such a manner
that the affairs relative to said properties have been handled as if the same belonged to a
corporation or business enterprise operated for profit; and that the said sisters had the
intention to constitute a partnership within the meaning of the tax law. Said sisters in their
appeal insisted that they were mere co-owners, not co-partners, for the reason that their
acts did not create a personality independent of them, and that some of the characteristics
of partnerships were absent, but we held that when the Tax Code includes "partnerships"
among the entities subject to the tax on corporations, it must refer to organizations which
are not necessarily partnerships in the technical sense of the term, and that furthermore,
said law defined the term "corporation" as including partnerships no matter how created or
organized,thereby indicating that "a joint venture need not be undertaken in any of the
standard forms, or in conformity with the usual requirements of the law on partnerships, in
order that one could be deemed constituted for purposes of the tax on corporations"; that
besides, said section 84 (b) provides that the term "corporation" includes "joint accounts"
(cuentas en participacion) and "associations", none of which has a legal personality
independent of that of its members. The decision cites 7A Merten's Law of Federal Income
Taxation.
In the present case, the two companies contributed money to a common fund to pay
the sole general manager, the accounts and office personnel attached to the office of said
manager, as well as for the maintenance and operation of a common maintenance and
repair shop. Said common fund was also used to buy spare parts, and equipment for both
companies, including tires. Said common fund was also used to pay all the salaries of the
personnel of both companies, such as drivers, conductors, helpers and mechanics, and at
the end of each year, the gross income or receipts of both companies were merged, and
after deducting therefrom the gross expenses of the two companies, also merged, the net
income was determined and divided equally between them, wholly and utterly disregarding
the expenses incurred in the maintenance and operation of each company and of the
individual income of said companies.
From the standpoint of the income tax law, this procedure and practice of
determining the net income of each company was arbitrary and unwarranted, disregarding
as it did the real facts in the case. There can be no question that the gross receipts and
gross expenses of two, distinct and separate companies operating different lines and in
some cases, different territories, and different equipment and personnel at least in value and
in the amount of salaries, can at the end of each year be equal or even approach equality.
Those familiar with the operation of the business of land transportation can readily see that
there are many factors that enter into said operation. Much depends upon the number of
lines operated and the length of each line, including the number of trips made each day.
Some lines are profitable, others break above even, while still others are operated at a loss,

at least for a time, depending, of course, upon the volume of traffic, both passenger and
freight. In some lines, the operator may enjoy a more or less exclusive operation, while in
others, the competition is intense, sometimes even what they call "cutthroat competition".
Sometimes, the operator is involved in litigation, not only as the result of money claims
based on physical injuries or deaths occasioned by accidents or collisions, but litigations
before the Public Service Commission, initiated by the operator itself to acquire new lines or
additional service and equipment on the lines already existing, or litigations forced upon said
operator by its competitors. Said litigation naturally causes expense to the operator. At other
times, the operator is denounced by competitors before the Public Service Commission for
violation of its franchise or franchises, for making unauthorized trips, for temporary
abandonment of said lines or of scheduled trips, etc. In view of this, and considering that the
Batangas Transportation and the Laguna Bus operated different lines, sometimes in
different provinces or territories, under different franchises, with different equipment and
personnel, it cannot possibly be true and correct to say that at the end of each year, the
gross receipts and income and the gross expenses of two companies are exactly the same
for purposes of the payment of income tax. What was actually done in this case was that,
although no legal personality may have been created by the Joint Emergency Operation,
nevertheless, said Joint Emergency Operation, joint venture, or joint management operated
the business affairs of the two companies as though they constituted a single entity,
company or partnership, thereby obtaining substantial economy and profits in the operation.
For the foregoing reasons, and in the light of our ruling in the
Evangelista vs. Collector of Internal Revenue case, supra, we believe and hold that the Joint
Emergency Operation or sole management or joint venture in this case falls under the
provisions of section 84 (b) of the Internal Revenue Code, and consequently, it is liable to
income tax provided for in section 24 of the same code.
The second important question to determine is whether or not the Collector of
Internal Revenue, after appeal from his decision to the Court of Tax Appeals has been
perfected, and after the Tax Court has acquired jurisdiction over the appeal, but before the
Collector has filed his answer with the court, may still modify his assessment, subject of the
appeal, by increasing the same. This legal point, interesting and vital to the interests of both
the Government and the taxpayer, provoked considerable discussion among the members
of this Tribunal, a minority of which the writer of this opinion forms part, maintaining that for
the information and guidance of the taxpayer, there should be a definite and final
assessment on which he can base his decision whether or not to appeal; that when the
assessment is appealed by the taxpayer to the Court of Tax Appeals, the Collector loses
control and jurisdiction over the same, the jurisdiction being transferred automatically to the
Tax Court, which has exclusive appellate jurisdiction over the same; that the jurisdiction of
the Tax Court is not revisory but only appellate, and therefore, it can act only upon the
amount of assessment subject of the appeal to determine whether it is valid and correct
from the standpoint of the taxpayer- appellant; that the Tax Court may only correct errors
committed by the Collector against the taxpayer, but not those committed in his favor,
unless the Government itself is also an appellant; and that unless this be the rule, the
Collector of Internal Revenue and his agents may not exercise due care, prudence and pay

too much attention in making tax assessments, knowing that they can at any time correct
any error committed by them even when due to negligence, carelessness or gross mistake
in the interpretation or application of the tax law, by increasing the assessment, naturally to
the prejudice of the taxpayer who would not know when his tax liability has been completely
and definitely met and complied with, this knowledge being necessary for the wise and
proper conduct and operation of his business; and that lastly, while in the United States of
America, on appeal from the decision of the Commissioner of Internal Revenue to the Board
or Court of Tax Appeals, the Commissioner may still amend or modify his assessment, even
increasing the same, the law in that jurisdiction expressly authorizes the Board or Court of
Tax Appeals to redetermine and revise the assessment appealed to it.

The majority, however, holds, not without valid arguments and reasons, that the
Government is not bound by the errors committed by its agents and tax collectors in making
tax assessments, specially when due to a misinterpretation or application of the tax laws,
more so when done in good faith; that the tax laws provide for a prescriptive period within
which the tax collectors may make assessments and reassessments in order to collect all
the taxes due to the Government, and that if the Collector of Internal Revenue is not allowed
to amend his assessment before the Court of Tax Appeals, and since he may make a
subsequent reassessment to collect additional sums within the same subject of his original
assessment, provided it is alone within the prescriptive period, that would lead to multiplicity
of suits which the law does not encourage; that since the Collector of Internal Revenue, in
modifying his assessment, may not only increase the same, but may also reduce it, if he
finds that he has committed an error against the taxpayer, and may even make refunds of
amounts erroneously and illegally collected, the taxpayer is not prejudiced; that the hearing
before the Court of Tax Appeals partakes of a trial de novo and the Tax Court is authorized
to receive evidence, summon witnesses, and give both parties, the Government and the
taxpayer, opportunity to present and argue their sides, so that the true and correct amount
of the tax to be collected may be determined and decided, whether resulting in the increase
or reduction of the assessment appealed to it. The result is that the ruling and doctrine now
being laid by this Court is, that pending appeal before the Court of Tax Appeals, the
Collector of Internal Revenue may still amend his appealed assessment, as he has done in
the present case.
There is a third question raised in the appeal before the Tax Court and before this
Tribunal, namely, the liability of the two respondent transportation companies for 25 per cent
surcharge due to their failure to file an income tax return for the Joint Emergency Operation,
which we hold to be a corporation within the meaning of the Tax Code. We understand that
said 25 per cent surcharge is included in the assessment of P148,890.14. The surcharge is
being imposed by the Collector under the provisions of Section 72 of the Tax Code, which
read as follows:
"The Collector of Internal Revenue shall assess all income taxes. In
case of willful neglect to file the return or list within the time prescribed by law,
or in case a false or fraudulent return or list is willfully made the collector of
internal revenue shall add to the tax or to the deficiency tax, in case any

payment has been made on the basis of such return before the discovery of the
falsity or fraud, a surcharge of fifty per centum of the amount of such tax or
deficiency tax. In case of any failure to make and file a return or list within the
time prescribed by law or by the Collector or other internal revenue officer, not
due to willful neglect, the Collector, shall add to the tax twenty-five per centum
of its amount, except that, when the return is voluntarily and without notice from
the Collector or other officer filed after such time, it is shown that the failure
was due to a reasonable cause, no such addition shall be made to the tax. The
amount so added to any tax shall be collected at the same time in the same
manner and as part of the tax unless the tax has been paid before the
discovery of the neglect, falsity, or fraud, in which case the amount so added
shall be collected in the same manner as the tax."
We are satisfied that the failure to file an income tax return for the Joint Emergency
Operation was due to a reasonable cause, the honest belief of respondent companies that
there was no such corporation within the meaning of the Tax Code, and that their separate
income tax return was sufficient compliance with the law. That this belief was not entirely
without foundation and that it was entertained in good faith, is shown by the fact that the
Court of Tax Appeals itself subscribed to the idea that the Joint Emergency Operation was
not a corporation, and so sustained the contention of respondents. Furthermore, there are
authorities to the effect that belief in good faith, on advice of reputable tax accountants and
attorneys, that a corporation was not a personal holding company taxable as such
constitutes "reasonable cause" for failure to file holding company surtax returns, and that in
such a case, the imposition of penalties for failure to file return, is not warranted. 1
In view of the foregoing, and with the reversal of the appealed decision of the Court
of Tax Appeals, judgment is hereby rendered, holding that the Joint Emergency Operation
involved in the present case is a corporation within the meaning of section 84 (b) of the
Internal Revenue Code, and so is liable to income tax under section 24 of the same code;
that pending appeal in the Court of Tax Appeals of an assessment made by the Collector of
Internal Revenue, the Collector, pending hearing before said court, may amend his
appealed assessment and include the amendment in his answer before the court, and the
latter may, on the basis of the evidence presented before it, redetermine the assessment;
that where the failure to file an income tax return for and in behalf of an entity which is later
found to be a corporation within the meaning of section 84 (b) of the Tax Code was due to a
reasonable cause, such as an honest belief based or the advice of its attorneys and
accountants, a penalty in the form of a surcharge should not be imposed and collected. The
respondents are therefore ordered to pay the amount of the reassessment made by the
Collector of Internal Revenue before the Tax Court, minus the amount of 25 per cent
surcharge. No costs.
Paras, C. J., Bengzon, Padilla, Labrador, Concepcion, Reyes, J. B. L.,
Endencia and Felix, JJ., concur.
Reyes, A. J., concurs in the result.

||| (Collector of Internal Revenue v. Batangas Transportation Co., G.R. No. L-9692, [January 6,
1958], 102 PHIL 822-835)

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-45425

April 29, 1939

JOSE GATCHALIAN, ET AL., plaintiffs-appellants,

vs.
THE COLLECTOR OF INTERNAL REVENUE, defendant-appellee.
Guillermo B. Reyes for appellants.
Office of the Solicitor-General Tuason for appellee.
IMPERIAL, J.:
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 plaintiff 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 Gatchalian
....................................................................................................

P0.18

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

.13

9. Emiliana Santiago
................................................................................................

.13

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

Total ........................................................................................................

2.00

3. That immediately thereafter but prior to December 15, 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 abovementioned 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;
5. That 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 enclosed 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 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 Exhibit 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 amount put up by each of the plaintiffs to
cover up the 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 thereof;
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 plaintiff's 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
enclosed 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, 1935 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 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 May 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 Jose Gatchalian, 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 may 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 shares on ticket No. 178637 to the
persons and for the amount indicated below and the part of may share remaining is also
shown to wit:
Purchaser
1. Mariano Santos ...........................................

Amount

Address

P0.14 Pulilan, Bulacan.

2. Buenaventura Guzman ...............................

.13

- Do -

3. Maria Santiago ............................................

.17

- Do -

4. Gonzalo Javier ..............................................

.14

- Do -

5. Francisco Cabral ..........................................

.13

- Do -

6. Maria C. Legaspi ..........................................

.16

- Do -

7. Emiliana Santiago .........................................

.13

- Do -

8. Julio Gatchalian ............................................

.13

- Do -

9. Jose Silva ......................................................

.07

- Do -

10. Tomasa Mercado .......................................

.08

- Do -

11. Jesus Legaspi .............................................

.15

- Do -

12. Guillermo Tapia ...........................................

.13

- Do -

13. Saturnina Silva ............................................

.08

- Do -

14. Gregoria Cristobal .......................................

.18

- Do -

15. Jose Gatchalian ............................................

.18

- Do -

2.00 Total 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 is 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 OF INTERNAL
REVENUE.

Name

Exhibit
No.

Purchase
Price

Price
Won

Expenses

Net
prize

1. Jose Gatchalian
..........................................

D-1

2. Gregoria Cristobal
......................................

D-2

.18

4,575

2,000 2,575

3. Saturnina Silva
.............................................

D-3

.08

1,875

360 1,515

4. Guillermo Tapia
..........................................

D-4

.13

3,325

360 2,965

5. Jesus Legaspi by Maria

Cristobal .........

D-5

.15

3,825

720 3,105

6. Jose Silva
....................................................

D-6

.08

1,875

360 1,515

7. Tomasa Mercado
.......................................

D-7

.07

1,875

360 1,515

8. Julio Gatchalian by Beatriz

Guzman .......

D-8

.13

3,150

240 2,910

9. Emiliana Santiago
......................................

D-9

.13

3,325

360 2,965

10. Maria C. Legaspi

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

D-10

.16

4,100

960 3,140

11. Francisco Cabral

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

D-11

.13

3,325

360 2,965

12. Gonzalo Javier

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

D-12

.14

3,325

360 2,965

13. Maria Santiago

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

D-13

.17

4,350

360 3,990

14. Buenaventura Guzman

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

D-14

.13

3,325

360 2,965

P0.18 P4,425

P 480 3,945

15. Mariano Santos

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

D-15

.14

3,325

360 2,965

<="" td=""
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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 copartnership (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),
association, 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 stipulation 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 Philippines Charity Sweepstakes, in his capacity as copartner, as such collection 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 plaintiff's 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
plaintiffs appellants. So ordered.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. Nos. L-24020-21

July 29, 1968

FLORENCIO REYES and ANGEL REYES, petitioners,

vs.
COMMISSIONER OF INTERNAL REVENUE and HON. COURT OF TAX
APPEALS, respondents.
Jose W. Diokno and Domingo Sandoval for petitioners.
Office of the Solicitor General for respondents.
FERNANDO, J.:
Petitioners in this case were assessed by respondent Commissioner of Internal Revenue the
sum of P46,647.00 as income tax, surcharge and compromise for the years 1951 to 1954, an
assessment subsequently reduced to P37,528.00. This assessment sought to be reconsidered
unsuccessfully was the subject of an appeal to respondent Court of Tax Appeals. Thereafter,
another assessment was made against petitioners, this time for back income taxes plus
surcharge and compromise in the total sum of P25,973.75, covering the years 1955 and 1956.
There being a failure on their part to have such assessments reconsidered, the matter was
likewise taken to the respondent Court of Tax Appeals. The two cases1 involving as they did
identical issues and ultimately traceable to facts similar in character were heard jointly with only
one decision being rendered.
In that joint decision of respondent Court of Tax Appeals, the tax liability for the years 1951 to
1954 was reduced to P37,128.00 and for the years 1955 and 1956, to P20,619.00 as income
tax due "from the partnership formed" by petitioners.2 The reduction was due to the elimination
of surcharge, the failure to file the income tax return being accepted as due to petitioners honest
belief that no such liability was incurred as well as the compromise penalties for such failure to
file.3 A reconsideration of the aforesaid decision was sought and denied by respondent Court of
Tax Appeals. Hence this petition for review.
The facts as found by respondent Court of Tax Appeals, which being supported by substantial
evidence, must be respected4 follow: "On October 31, 1950, petitioners, father and son,
purchased a lot and building, known as the Gibbs Building, situated at 671 Dasmarias Street,
Manila, for P835,000.00, of which they paid the sum of P375,000.00, leaving a balance of
P460,000.00, representing the mortgage obligation of the vendors with the China Banking
Corporation, which mortgage obligations were assumed by the vendees. The initial payment of
P375,000.00 was shared equally by petitioners. At the time of the purchase, the building was

leased to various tenants, whose rights under the lease contracts with the original owners, the
purchasers, petitioners herein, agreed to respect. The administration of the building was
entrusted to an administrator who collected the rents; kept its books and records and rendered
statements of accounts to the owners; negotiated leases; made necessary repairs and
disbursed payments, whenever necessary, after approval by the owners; and performed such
other functions necessary for the conservation and preservation of the building. Petitioners
divided equally the income of operation and maintenance. The gross income from rentals of the
building amounted to about P90,000.00 annually."5
From the above facts, the respondent Court of Tax Appeals applying the appropriate provisions
of the National Internal Revenue Code, the first of which imposes an income tax on corporations
"organized in, or existing under the laws of the Philippines, no matter how created or organized
but not including duly registered general co-partnerships (companias colectivas), ...,"6 a term,
which according to the second provision cited, includes partnerships "no matter how created or
organized, ...,"7 and applying the leading case of Evangelista v. Collector of Internal
Revenue,8 sustained the action of respondent Commissioner of Internal Revenue, but reduced
the tax liability of petitioners, as previously noted.
Petitioners maintain the view that the Evangelista ruling does not apply; for them, the situation is
dissimilar.1wph1.t Consequently they allege that the reliance by respondent Court of Tax
Appeals was unwarranted and the decision should be set aside. If their interpretation of the
authoritative doctrine therein set forth commands assent, then clearly what respondent Court of
Tax Appeals did fails to find shelter in the law. That is the crux of the matter. A perusal of the
Evangelista decision is therefore unavoidable.
As noted in the opinion of the Court, penned by the present Chief Justice, the issue was
whether petitioners are subject to the tax on corporations provided for in section 24 of
Commonwealth Act No. 466, otherwise known as the National Internal Revenue Code, ..."9 After
referring to another section of the National Internal Revenue Code, which explicitly provides that
the term corporation "includes partnerships" and then to Article 1767 of the Civil Code of the
Philippines, defining what a contract of partnership is, the opinion goes on to state that "the
essential elements of a partnership are two, namely: (a) an agreement to contribute money,
property or industry to a common fund; and (b) intent to divide the profits among the contracting
parties. The first element is undoubtedly present in the case at bar, for, admittedly, petitioners
have agreed to and did, contribute money and property to a common fund. Hence, the issue
narrows down to their intent in acting as they did. Upon consideration of all the facts and
circumstances surrounding the case, we are fully satisfied that their purpose was to engage in
real estate transactions for monetary gain and then divide the same among themselves, ..."10
In support of the above conclusion, reference was made to the following circumstances, namely,
the common fund being created purposely not something already found in existence, the
investment of the same not merely in one transaction but in a series of transactions; the lots
thus acquired not being devoted to residential purposes or to other personal uses of petitioners
in that case; such properties having been under the management of one person with full power

to lease, to collect rents, to issue receipts, to bring suits, to sign letters and contracts and to
endorse notes and checks; the above conditions having existed for more than 10 years since
the acquisition of the above properties; and no testimony having been introduced as to the
purpose "in creating the set up already adverted to, or on the causes for its continued
existence."11 The conclusion that emerged had all the imprint of inevitability. Thus: "Although,
taken singly, they might not suffice to establish the intent necessary to constitute a partnership,
the collective effect of these circumstances is such as to leave no room for doubt on the
existence of said intent in petitioners herein."12
It may be said that there could be a differentiation made between the circumstances above
detailed and those existing in the present case. It does not suffice though to preclude the
applicability of the Evangelista decision. Petitioners could harp on these being only one
transaction. They could stress that an affidavit of one of them found in the Bureau of Internal
Revenue records would indicate that their intention was to house in the building acquired by
them the respective enterprises, coupled with a plan of effecting a division in 10 years. It is a
little surprising then that while the purchase was made on October 31, 1950 and their brief as
petitioners filed on October 20, 1965, almost 15 years later, there was no allegation that such
division as between them was in fact made. Moreover, the facts as found and as submitted in
the brief made clear that the building in question continued to be leased by other parties with
petitioners dividing "equally the income ... after deducting the expenses of operation and
maintenance ..."13 Differences of such slight significance do not call for a different ruling.
It is obvious that petitioners' effort to avoid the controlling force of the Evangelista ruling cannot
be deemed successful. Respondent Court of Tax Appeals acted correctly. It yielded to the
command of an authoritative decision; it recognized its binding character. There is clearly no
merit to the second error assigned by petitioners, who would deny its applicability to their
situation.
The first alleged error committed by respondent Court of Tax Appeals in holding that petitioners,
in acquiring the Gibbs Building, established a partnership subject to income tax as a corporation
under the National Internal Revenue Code is likewise untenable. In their discussion in their brief
of this alleged error, stress is laid on their being co-owners and not partners. Such an allegation
was likewise made in the Evangelista case.
This is the way it was disposed of in the opinion of the present Chief Justice: "This pretense was
correctly rejected by the Court of Tax Appeals."14 Then came the explanation why: "To begin
with, the tax in question is one imposed upon "corporations", which, strictly speaking, are
distinct and different from "partnerships". When our Internal Revenue Code includes
"partnerships" among the entities subject to the tax on "corporations", said Code must allude,
therefore, to organizations which are not necessarily "partnerships", in the technical sense of
the term. Thus, for instance, section 24 of said Code exempts from the aforementioned tax "duly
registered general partnerships", which constitute precisely one of the most typical forms of
partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term
corporation includes partnerships, no matter how created or organized." This qualifying

expression clearly indicates that a joint venture need not be undertaken in any of the standard
forms, or in conformity with the usual requirements of the law on partnerships, in order that one
could be deemed constituted for purposes of the tax on corporations. Again, pursuant to said
section 84(b), the term "corporation" includes, among others, "joint accounts, (cuentas en
participacion)" and "associations", none of which has a legal personality of its own, independent
of that of its members. Accordingly, the lawmaker could not have regarded that personality as a
condition essential to the existence of the partnerships therein referred to. In fact, as above
stated, "duly registered general copartnerships" which are possessed of the aforementioned
personality - have been expressly excluded by law (sections 24 and 84[b]) from the connotation
of the term "corporation"."15 The opinion went on to summarize the matter aptly: "For purposes
of the tax on corporations, our National Internal Revenue Code, include these partnerships
with the exception only of duly registered general co-partnerships within the purview of the term
"corporation." It is, therefore, clear to our mind that petitioners herein constitute a partnership,
insofar as said Code is concerned, and are subject to the income tax for corporations."16
In the light of the above, it cannot be said that the respondent Court of Tax Appeals decided the
matter incorrectly. There is no warrant for the assertion that it failed to apply the settled law to
uncontroverted facts. Its decision cannot be successfully assailed. Moreover, an observation
made in Alhambra Cigar & Cigarette Manufacturing Co. v. Commissioner of Internal
Revenue,17 is well-worth recalling. Thus: "Nor as a matter of principle is it advisable for this
Court to set aside the conclusion reached by an agency such as the Court of Tax Appeals which
is, by the very nature of its functions, dedicated exclusively to the study and consideration of tax
problems and has necessarily developed an expertise on the subject, unless, as did not happen
here, there has been an abuse or improvident exercise of its authority."
WHEREFORE, the decision of the respondent Court of Tax Appeals ordering petitioners "to pay
the sums of P37,128.00 as income tax due from the partnership formed by herein petitioners for
the years 1951 to 1954 and P20,619.00 for the years 1955 and 1956 within thirty days from the
date this decision becomes final, plus the corresponding surcharge and interest in case of
delinquency," is affirmed. With costs against petitioners.

THIRD DIVISION
[G.R. No. 148187. April 16, 2008.]
PHILEX MINING CORPORATION, petitioner, vs.
INTERNAL REVENUE, respondent.

COMMISSIONER

OF

DECISION

YNARES-SANTIAGO, J p:
This is a petition for review on certiorari of the June 30, 2000 Decision 1 of the Court of Appeals
in CA-G.R. SP No. 49385, which affirmed the Decision 2 of the Court of Tax Appeals in C.T.A.
Case No. 5200. Also assailed is the April 3, 2001 Resolution 3 denying the motion for
reconsideration. ECHSDc
The facts of the case are as follows:
On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an
agreement 4 with Baguio Gold Mining Company ("Baguio Gold") for the former to manage and
operate the latter's mining claim, known as the Sto. Nio mine, located in Atok and Tublay,
Benguet Province. The parties' agreement was denominated as "Power of Attorney" and
provided for the following terms:
4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall
make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION
PESOS (P11,000,000.00), in such amounts as from time to time may be
required by the MANAGERS within the said 3-year period, for use in the
MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS
(P11,000,000.00) shall be deemed, for internal audit purposes, as the owner's
account in the Sto. Nino PROJECT. Any part of any income of the PRINCIPAL
from the STO. NINO MINE, which is left with the Sto. Nino PROJECT, shall be
added to such owner's account. HCDAac
5. Whenever the MANAGERS shall deem it necessary and convenient in
connection with the MANAGEMENT of the STO. NINO MINE, they may
transfer their own funds or property to the Sto. Nino PROJECT, in accordance
with the following arrangements:
(a) The properties shall be appraised and, together with the cash, shall be
carried by the Sto. Nino PROJECT as a special fund to be known as the
MANAGERS' account.

(b) The total of the MANAGERS' account shall not exceed P11,000,000.00,
except with prior approval of the PRINCIPAL; provided, however, that if the
compensation of the MANAGERS as herein provided cannot be paid in cash
from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to
the MANAGERS' account. ECaTDc
(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino
PROJECT until termination of this Agency.
(d) The MANAGERS' account shall not accrue interest. Since it is the desire of
the PRINCIPAL to extend to the MANAGERS the benefit of subsequent
appreciation of property, upon a projected termination of this Agency, the ratio
which the MANAGERS' account has to the owner's account will be determined,
and the corresponding proportion of the entire assets of the STO. NINO MINE,
excluding the claims, shall be transferred to the MANAGERS, except that such
transferred assets shall not include mine development, roads, buildings, and
similar property which will be valueless, or of slight value, to the MANAGERS.
The MANAGERS can, on the other hand, require at their option that property
originally transferred by them to the Sto. Nino PROJECT be re-transferred to
them. Until such assets are transferred to the MANAGERS, this Agency shall
remain subsisting. TAaEIc
xxx xxx xxx
12. The compensation of the MANAGER shall be fifty per cent (50%) of the net
profit of the Sto. Nino PROJECT before income tax. It is understood that the
MANAGERS shall pay income tax on their compensation, while the
PRINCIPAL shall pay income tax on the net profit of the Sto. Nino PROJECT
after deduction therefrom of the MANAGERS' compensation.
xxx xxx xxx
16. The PRINCIPAL has current pecuniary obligation in favor of the
MANAGERS and, in the future, may incur other obligations in favor of the
MANAGERS. This Power of Attorney has been executed as security for the
payment and satisfaction of all such obligations of the PRINCIPAL in favor of
the MANAGERS and as a means to fulfill the same. Therefore, this Agency
shall be irrevocable while any obligation of the PRINCIPAL in favor of the
MANAGERS is outstanding, inclusive of the MANAGERS' account. After all
obligations of the PRINCIPAL in favor of the MANAGERS have been paid and
satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36month notice to the MANAGERS. CHaDIT
17. Notwithstanding any agreement or understanding between the PRINCIPAL
and the MANAGERS to the contrary, the MANAGERS may withdraw from this
Agency by giving 6-month notice to the PRINCIPAL. The MANAGERS shall not
in any manner be held liable to the PRINCIPAL by reason alone of such

withdrawal. Paragraph 5(d) hereof shall be operative in case of the

MANAGERS' withdrawal.
xxx xxx xxx 5
In the course of managing and operating the project, Philex Mining made advances of cash and
property in accordance with paragraph 5 of the agreement. However, the mine suffered
continuing losses over the years which resulted to petitioner's withdrawal as manager of the
mine on January 28, 1982 and in the eventual cessation of mine operations on February 20,
1982. 6
Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in
Payment" 7 wherein Baguio Gold admitted an indebtedness to petitioner in the amount of
P179,394,000.00 and agreed to pay the same in three segments by first assigning Baguio
Gold's tangible assets to petitioner, transferring to the latter Baguio Gold's equitable title in its
Philodrill assets and finally settling the remaining liability through properties that Baguio Gold
may acquire in the future. TDcAaH
On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in
Payment" 8 where the parties determined that Baguio Gold's indebtedness to petitioner actually
amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors
that petitioner had assumed as guarantor. These liabilities pertained to long-term loans
amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA
and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by first
assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its
Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a
remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.
Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding
indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that
were set up in 1981 and P2,860,768.00 to the 1982 operations. DEScaT
In its 1982 annual income tax return, petitioner deducted from its gross income the amount of
P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and
allowances." 9 However, the Bureau of Internal Revenue (BIR) disallowed the amount as
deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.
Petitioner protested before the BIR arguing that the deduction must be allowed since all
requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt;
(b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year
when it was determined to be worthless.
Petitioner emphasized that the debt arose out of a valid management contract it entered into
with Baguio Gold. The bad debt deduction represented advances made by petitioner which,
pursuant to the management contract, formed part of Baguio Gold's "pecuniary obligations" to
petitioner. It also included payments made by petitioner as guarantor of Baguio Gold's long-term
loans which legally entitled petitioner to be subrogated to the rights of the original
creditor. IaHDcT

Petitioner also asserted that due to Baguio Gold's irreversible losses, it became evident that it
would not be able to recover the advances and payments it had made in behalf of Baguio Gold.
For a debt to be considered worthless, petitioner claimed that it was neither required to institute
a judicial action for collection against the debtor nor to sell or dispose of collateral assets in
satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce collection
and exhausted all reasonable means to collect.
On October 28, 1994, the BIR denied petitioner's protest for lack of legal and factual basis. It
held that the alleged debt was not ascertained to be worthless since Baguio Gold remained
existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a
valid and subsisting debt considering that, under the management contract, petitioner was to be
paid fifty percent (50%) of the project's net profit. 10
Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as
follows:
WHEREFORE, in view of the foregoing, the instant Petition for Review is
hereby DENIED for lack of merit. The assessment in question, viz: FAS-1-8288-003067 for deficiency income tax in the amount of P62,811,161.39 is
hereby AFFIRMED. SEcTHA
ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to
PAY respondent Commissioner of Internal Revenue the amount of
P62,811,161.39, plus 20% delinquency interest due computed from February
10, 1995, which is the date after the 20-day grace period given by the
respondent within which petitioner has to pay the deficiency amount . . . up to
actual date of payment.
SO ORDERED. 11
The CTA rejected petitioner's assertion that the advances it made for the Sto. Nino mine were in
the nature of a loan. It instead characterized the advances as petitioner's investment in a
partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. The
CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a
partnership agreement. Since the advanced amount partook of the nature of an investment, it
could not be deducted as a bad debt from petitioner's gross income. HcaDIA

The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of
Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were
made, Baguio Gold was not in default since its loans were not yet due and demandable. What
petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America
showing that it was merely demanding payment of the installment and interests due. Moreover,
Citibank imposed and collected a "pre-termination penalty" for the pre-payment.
The Court of Appeals affirmed the decision of the CTA. 12 Hence, upon denial of its motion for
reconsideration, 13 petitioner took this recourse under Rule 45 of the Rules of Court, alleging
that:

I.
The Court of Appeals erred in construing that the advances made by Philex in
the management of the Sto. Nino Mine pursuant to the Power of Attorney
partook of the nature of an investment rather than a loan. ICaDHT
II.
The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits
of the Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the
development of the Sto. Nino Mine notwithstanding the clear absence of any
intent on the part of Philex and Baguio Gold to form a partnership.
III.
The Court of Appeals erred in relying only on the Power of Attorney and in
completely disregarding the Compromise Agreement and the Amended
Compromise Agreement when it construed the nature of the advances made
by Philex.
IV.
The Court of Appeals erred in refusing to delve upon the issue of the propriety
of the bad debts write-off. 14
Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we
should not only rely on the "Power of Attorney", but also on the subsequent "Compromise with
Dation in Payment" and "Amended Compromise with Dation in Payment" that the parties
executed in 1982. These documents, allegedly evinced the parties' intent to treat the advances
and payments as a loan and establish a creditor-debtor relationship between them. AcHCED
The petition lacks merit.
The lower courts correctly held that the "Power of Attorney" is the instrument that is material in
determining the true nature of the business relationship between petitioner and Baguio Gold.
Before resort may be had to the two compromise agreements, the parties' contractual intent
must first be discovered from the expressed language of the primary contract under which the
parties' business relations were founded. It should be noted that the compromise agreements
were mere collateral documents executed by the parties pursuant to the termination of their
business relationship created under the "Power of Attorney". On the other hand, it is the latter
which established the juridical relation of the parties and defined the parameters of their
dealings with one another.
The execution of the two compromise agreements can hardly be considered as a subsequent or
contemporaneous act that is reflective of the parties' true intent. The compromise agreements
were executed eleven years after the "Power of Attorney" and merely laid out a plan or
procedure by which petitioner could recover the advances and payments it made under the
"Power of Attorney". The parties entered into the compromise agreements as a consequence of
the dissolution of their business relationship. It did not define that relationship or indicate its real
character. AIHECa

An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed
intended by the parties. Under a contract of partnership, two or more persons bind themselves
to contribute money, property, or industry to a common fund, with the intention of dividing the
profits among themselves. 15 While a corporation, like petitioner, cannot generally enter into a
contract of partnership unless authorized by law or its charter, it has been held that it may enter
into a joint venture which is akin to a particular partnership:
The legal concept of a joint venture is of common law origin. It has no precise
legal definition, but it has been generally understood to mean an organization
formed for some temporary purpose. . . . It is in fact hardly distinguishable from
the partnership, since their elements are similar community of interest in the
business, sharing of profits and losses, and a mutual right of control. . . . The
main distinction cited by most opinions in common law jurisdictions is that the
partnership contemplates a general business with some degree of continuity,
while the joint venture is formed for the execution of a single transaction, and is
thus of a temporary nature. . . . This observation is not entirely accurate in this
jurisdiction, since under the Civil Code,a partnership may be particular or
universal, and a particular partnership may have for its object a specific
undertaking. . . . It would seem therefore that under Philippine law, a joint
venture is a form of partnership and should be governed by the law of
partnerships. The Supreme Court has however recognized a distinction
between these two business forms, and has held that although a corporation
cannot enter into a partnership contract, it may however engage in a joint
venture with others. . . . (Citations omitted) 16
Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had
intended to create a partnership and establish a common fund for the purpose. They also had a
joint interest in the profits of the business as shown by a 50-50 sharing in the income of the
mine. CaESTA
Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money,
property and industry to the common fund known as the Sto. Nio mine. 17In this regard, we
note that there is a substantive equivalence in the respective contributions of the parties to the
development and operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement,
petitioner and Baguio Gold were to contribute equally to the joint venture assets under their
respective accounts. Baguio Gold would contribute P11M under its owner's account plus any of
its income that is left in the project, in addition to its actual mining claim. Meanwhile,
petitioner's contribution would consist of its expertise in the management and operation of
mines, as well as the manager's account which is comprised of P11M in funds and property and
petitioner's "compensation" as manager that cannot be paid in cash.
However, petitioner asserts that it could not have entered into a partnership agreement with
Baguio Gold because it did not "bind" itself to contribute money or property to the project; that
under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or
property to the Sto. Nio project "(w)henever the MANAGERS shall deem it necessary and
convenient in connection with the MANAGEMENT of the STO. NIO MINE." 18

The wording of the parties' agreement as to petitioner's contribution to the common fund does
not detract from the fact that petitioner transferred its funds and property to the project as
specified in paragraph 5, thus rendering effective the other stipulations of the contract,
particularly paragraph 5 (c) which prohibits petitioner from withdrawing the advances until
termination of the parties' business relations. As can be seen, petitioner became bound by its
contributions once the transfers were made. The contributions acquired an obligatory nature as
soon as petitioner had chosen to exercise its option under paragraph 5. cEAaIS
There is no merit to petitioner's claim that the prohibition in paragraph 5 (c) against withdrawal
of advances should not be taken as an indication that it had entered into a partnership with
Baguio Gold; that the stipulation only showed that what the parties entered into was actually a
contract of agency coupled with an interest which is not revocable at will and not a partnership.
In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the
principal due to an interest of a third party that depends upon it, or the mutual interest of both
principal and agent. 19 In this case, the non-revocation or non-withdrawal under paragraph 5 (c)
applies to the advances made by petitioner who is supposedly the agent and not the principal
under the contract. Thus, it cannot be inferred from the stipulation that the parties' relation under
the agreement is one of agency coupled with an interest and not a partnership.
Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the
parties was one of agency and not a partnership. Although the said provision states that "this
Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS
is outstanding, inclusive of the MANAGERS' account", it does not necessarily follow that the
parties entered into an agency contract coupled with an interest that cannot be withdrawn by
Baguio Gold. SaCIDT
It should be stressed that the main object of the "Power of Attorney" was not to confer a power
in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a
business relationship between petitioner and Baguio Gold, in which the former was to manage
and operate the latter's mine through the parties' mutual contribution of material resources and
industry. The essence of an agency, even one that is coupled with interest, is the agent's ability
to represent his principal and bring about business relations between the latter and third
persons. 20 Where representation for and in behalf of the principal is merely incidental or
necessary for the proper discharge of one's paramount undertaking under a contract, the latter
may not necessarily be a contract of agency, but some other agreement depending on the
ultimate undertaking of the parties. 21
In this case, the totality of the circumstances and the stipulations in the parties' agreement
indubitably lead to the conclusion that a partnership was formed between petitioner and Baguio
Gold. SAcCIH

First, it does not appear that Baguio Gold was unconditionally obligated to return the advances
made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination
of the parties' business relations, "the ratio which the MANAGER'S account has to the owner's
account will be determined, and the corresponding proportion of the entire assets of the STO.

NINO MINE, excluding the claims" shall be transferred to petitioner. 22 As pointed out by the
Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine's
assets upon dissolution of the parties' business relations. There was nothing in the agreement
that would require Baguio Gold to make payments of the advances to petitioner as would be
recognized as an item of obligation or "accounts payable" for Baguio Gold.
Thus, the tax court correctly concluded that the agreement provided for a distribution of assets
of the Sto. Nio mine upon termination, a provision that is more consistent with a partnership
than a creditor-debtor relationship. It should be pointed out that in a contract of loan, a person
who receives a loan or money or any fungible thing acquires ownership thereof and is bound to
pay the creditor an equal amount of the same kind and quality. 23 In this case, however, there
was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it had
advanced, but only the return of an amount pegged at a ratio which the manager's account had
to the owner's account. EScIAa
In this connection, we find no contractual basis for the execution of the two compromise
agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly
arose from the termination of their business relations over the Sto. Nio mine. The "Power of
Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate
share of the mine assets to be computed at a ratio that the manager's account had to the
owner's account. Except to provide a basis for claiming the advances as a bad debt deduction,
there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise
agreements, for any amount over and above the proportion agreed upon in the "Power of
Attorney".
Next, the tax court correctly observed that it was unlikely for a business corporation to lend
hundreds of millions of pesos to another corporation with neither security, or collateral, nor a
specific deed evidencing the terms and conditions of such loans. The parties also did not
provide a specific maturity date for the advances to become due and demandable, and the
manner of payment was unclear. All these point to the inevitable conclusion that the advances
were not loans but capital contributions to a partnership. EHACcT
The strongest indication that petitioner was a partner in the Sto Nio mine is the fact that it
would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement.
The entirety of the parties' contractual stipulations simply leads to no other conclusion than that
petitioner's "compensation" is actually its share in the income of the joint venture.
Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in
the profits of a business is prima facie evidence that he is a partner in the business." Petitioner
asserts, however, that no such inference can be drawn against it since its share in the profits of
the Sto Nio project was in the nature of compensation or "wages of an employee", under the
exception provided in Article 1769 (4) (b). 24
On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold
who will be paid "wages" pursuant to an employer-employee relationship. To begin with,
petitioner was the manager of the project and had put substantial sums into the venture in order
to ensure its viability and profitability. By pegging its compensation to profits, petitioner also

stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner
would take the risk of not being paid at all for its services, if it were truly just an ordinary
employee. ITADaE
Consequently, we find that petitioner's "compensation" under paragraph 12 of the agreement
actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not be
entitled to an equal share in the income of the mine if it were just an employee of Baguio
Gold. 25 It is not surprising that petitioner was to receive a 50% share in the net profits,
considering that the "Power of Attorney" also provided for an almost equal contribution of the
parties to the St. Nio mine. The "compensation" agreed upon only serves to reinforce the
notion that the parties' relations were indeed of partners and not employer-employee.
All told, the lower courts did not err in treating petitioner's advances as investments in a
partnership known as the Sto. Nio mine. The advances were not "debts" of Baguio Gold to
petitioner inasmuch as the latter was under no unconditional obligation to return the same to the
former under the "Power of Attorney". As for the amounts that petitioner paid as guarantor to
Baguio Gold's creditors, we find no reason to depart from the tax court's factual finding that
Baguio Gold's debts were not yet due and demandable at the time that petitioner paid the same.
Verily, petitioner pre-paid Baguio Gold's outstanding loans to its bank creditors and this
conclusion is supported by the evidence on record. 26
In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income.
Deductions for income tax purposes partake of the nature of tax exemptions and are strictly
construed against the taxpayer, who must prove by convincing evidence that he is entitled to the
deduction claimed. 27 In this case, petitioner failed to substantiate its assertion that the
advances were subsisting debts of Baguio Gold that could be deducted from its gross income.
Consequently, it could not claim the advances as a valid bad debt deduction. IDTSEH
WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No.
49385 dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in C.T.A.
Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the
deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency
interest computed from February 10, 1995, which is the due date given for the payment of the
deficiency income tax, up to the actual date of payment.
SO ORDERED.
||| (Philex Mining Corp. v. Commissioner of Internal Revenue, G.R. No. 148187, [April 16, 2008],
574 PHIL 571-586)

SECOND DIVISION
[G.R. No. 169507. January 11, 2016.]
AIR
CANADA, petitioner, vs. COMMISSIONER
REVENUE, respondent.

OF

INTERNAL

DECISION

LEONEN, J p:
An offline international air carrier selling passage tickets in the Philippines, through a
general sales agent, is a resident foreign corporation doing business in the Philippines. As
such, it is taxable under Section 28 (A) (1), and not Section 28 (A) (3) of the 1997 National
Internal Revenue Code, subject to any applicable tax treaty to which the Philippines is a
signatory. Pursuant to Article 8 of the Republic of the Philippines-Canada Tax Treaty, Air
Canada may only be imposed a maximum tax of 1 1/2 % of its gross revenues earned from
the sale of its tickets in the Philippines.
This is a Petition for Review 1 appealing the August 26, 2005 Decision 2 of the Court
of Tax Appeals En Banc, which in turn affirmed the December 22, 2004 Decision 3 and April
8, 2005 Resolution 4 of the Court of Tax Appeals First Division denying Air Canada's claim
for refund.
Air Canada is a "foreign corporation organized and existing under the laws of
Canada[.]" 5 On April 24, 2000, it was granted an authority to operate as an offline carrier by
the Civil Aeronautics Board, subject to certain conditions, which authority would expire on
April 24, 2005. 6 "As an off-line carrier, [Air Canada] does not have flights originating from or
coming to the Philippines [and does not] operate any airplane [in] the Philippines[.]" 7
On July 1, 1999, Air Canada engaged the services of Aerotel Ltd., Corp. (Aerotel) as
its general sales agent in the Philippines. 8 Aerotel "sells [Air Canada's] passage documents
in the Philippines." 9
For the period ranging from the third quarter of 2000 to the second quarter of 2002,
Air Canada, through Aerotel, filed quarterly and annual income tax returns and paid the
income tax on Gross Philippine Billings in the total amount of P5,185,676.77, 10 detailed as
follows:
Applicable Quarter[/]Year

3rd Qtr 2000

Date Filed/Paid

November 29, 2000

Amount of Tax

P395,165.00

Annual ITR 2000

April 16, 2001

381,893.59

1st Qtr 2001

May 30, 2001

522,465.39

2nd Qtr 2001

August 29, 2001

3rd Qtr 2001

November 29, 2001

765,021.28

Annual ITR 2001

April 15, 2002

328,193.93

1st Qtr 2002

May 30, 2002

594,850.13

2nd Qtr 2002

August 29, 2002

1,033,423.34

1,164,664.11

TOTAL

P5,185,676.77 11
=============

On November 28, 2002, Air Canada filed a written claim for refund of alleged
erroneously paid income taxes amounting to P5,185,676.77 before the Bureau of Internal
Revenue, 12 Revenue District Office No. 47-East Makati. 13 It found basis from the revised
definition 14 of Gross Philippine Billings under Section 28 (A) (3) (a) of the 1997 National
Internal Revenue Code:
SEC. 28. Rates of Income Tax on Foreign Corporations.
(A) Tax on Resident Foreign Corporations.
xxx xxx xxx
(3) International Carrier. An international carrier doing
business in the Philippines shall pay a tax of two and one-half
percent (2 1/2%) on its 'Gross Philippine Billings' as defined
hereunder:
(a) International Air Carrier. 'Gross Philippine Billings' refers
to the amount of gross revenue derived from carriage of
persons, excess baggage, cargo and mail originating from
the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the
place of payment of the ticket or passage document:
Provided, That tickets revalidated, exchanged and/or indorsed
to another international airline form part of the Gross Philippine
Billings if the passenger boards a plane in a port or point in the
Philippines: Provided, further, That for a flight which originates
from the Philippines, but transshipment of passenger takes

place at any port outside the Philippines on another airline,

only the aliquot portion of the cost of the ticket corresponding
to the leg flown from the Philippines to the point of
transshipment shall form part of Gross Philippine Billings.
(Emphasis supplied) TIADCc
To prevent the running of the prescriptive period, Air Canada filed a Petition for
Review before the Court of Tax Appeals on November 29, 2002. 15 The case was docketed
as C.T.A. Case No. 6572. 16
On December 22, 2004, the Court of Tax Appeals First Division rendered its
Decision denying the Petition for Review and, hence, the claim for refund. 17 It found that
Air Canada was engaged in business in the Philippines through a local agent that sells
airline tickets on its behalf. As such, it should be taxed as a resident foreign corporation at
the regular rate of 32%. 18 Further, according to the Court of Tax Appeals First Division, Air
Canada was deemed to have established a "permanent establishment" 19 in the Philippines
under Article V (2) (i) of the Republic of the Philippines-Canada Tax Treaty 20 by the
appointment of the local sales agent, "in which [the] petitioner uses its premises as an outlet
where sales of [airline] tickets are made[.]" 21
Air Canada seasonably filed a Motion for Reconsideration, but the Motion was
denied in the Court of Tax Appeals First Division's Resolution dated April 8, 2005 for lack of
merit. 22 The First Division held that while Air Canada was not liable for tax on its Gross
Philippine Billings under Section 28 (A) (3), it was nevertheless liable to pay the 32%
corporate income tax on income derived from the sale of airline tickets within the Philippines
pursuant to Section 28 (A) (1). 23
On May 9, 2005, Air Canada appealed to the Court of Tax Appeals En Banc. 24 The
appeal was docketed as CTA EB No. 86. 25
In the Decision dated August 26, 2005, the Court of Tax Appeals En Banc affirmed
the findings of the First Division. 26 The En Banc ruled that Air Canada is subject to tax as a
resident foreign corporation doing business in the Philippines since it sold airline tickets in
the Philippines. 27 The Court of Tax Appeals En Banc disposed thus:
WHEREFORE, premises considered, the instant petition is
hereby DENIED DUE COURSE, and accordingly, DISMISSED for lack of
merit. 28
Hence, this Petition for Review 29 was filed.
The issues for our consideration are:
First, whether petitioner Air Canada, as an offline international carrier selling
passage documents through a general sales agent in the Philippines, is a resident foreign
corporation within the meaning of Section 28 (A) (1) of the 1997 National Internal Revenue
Code;
Second, whether petitioner Air Canada is subject to the 2 1/2% tax on Gross
Philippine Billings pursuant to Section 28 (A) (3). If not, whether an offline international

carrier selling passage documents through a general sales agent can be subject to the
regular corporate income tax of 32% 30 on taxable income pursuant to Section 28 (A) (1);
Third,
specifically:

whether

the Republic

of

the

Philippines-Canada

Tax

Treaty applies,

a. Whether the Republic of the Philippines-Canada Tax Treaty is enforceable;

b. Whether the appointment of a local general sales agent in the Philippines falls
under the definition of "permanent establishment" under Article V (2) (i) of
the Republic of the Philippines-Canada Tax Treaty; and
Lastly, whether petitioner Air Canada is entitled to the refund of P5,185,676.77
pertaining allegedly to erroneously paid tax on Gross Philippine Billings from the third
quarter of 2000 to the second quarter of 2002.
Petitioner claims that the general provision imposing the regular corporate income
tax on resident foreign corporations provided under Section 28 (A) (1) of the1997 National
Internal Revenue Code does not apply to "international carriers," 31 which are especially
classified and taxed under Section 28 (A) (3). 32 It adds that the fact that it is no longer
subject to Gross Philippine Billings tax as ruled in the assailed Court of Tax Appeals
Decision "does not render it ipso facto subject to 32% income tax on taxable income as a
resident foreign corporation." 33 Petitioner argues that to impose the 32% regular corporate
income tax on its income would violate the Philippine government's covenant under Article
VIII of the Republic of the Philippines-Canada Tax Treaty not to impose a tax higher than 1
1/2% of the carrier's gross revenue derived from sources within the Philippines. 34 It would
also allegedly result in "inequitable tax treatment of on-line and off-line international air
carriers[.]" 35
Also, petitioner states that the income it derived from the sale of airline tickets in the
Philippines was income from services and not income from sales of personal
property. 36 Petitioner cites the deliberations of the Bicameral Conference Committee on
House Bill No. 9077 (which eventually became the 1997 National Internal Revenue Code),
particularly Senator Juan Ponce Enrile's statement, 37 to reveal the "legislative intent to
treat the revenue derived from air carriage as income from services, and that the carriage of
passenger or cargo as the activity that generates the income." 38 Accordingly, applying the
principle on the situs of taxation in taxation of services, petitioner claims that its income
derived "from services rendered outside the Philippines [was] not subject to Philippine
income taxation." 39 AIDSTE
Petitioner further contends that by the appointment of Aerotel as its general sales
agent, petitioner cannot be considered to have a "permanent establishment" 40 in the
Philippines pursuant to Article V (6) of the Republic of the Philippines-Canada Tax
Treaty. 41 It points out that Aerotel is an "independent general sales agent that acts as such
for. . . other international airline companies in the ordinary course of its business." 42 Aerotel
sells passage tickets on behalf of petitioner and receives a commission for its
services. 43 Petitioner states that even the Bureau of Internal Revenue through VAT
Ruling No. 003-04 dated February 14, 2004 has conceded that an offline international air

carrier, having no flight operations to and from the Philippines, is not deemed engaged in
business in the Philippines by merely appointing a general sales agent. 44 Finally, petitioner
maintains that its "claim for refund of erroneously paid Gross Philippine Billings cannot be
denied on the ground that [it] is subject to income tax under Section 28 (A) (1)" 45 since it
has not been assessed at all by the Bureau of Internal Revenue for any income tax
liability. 46
On the other hand, respondent maintains that petitioner is subject to the 32%
corporate income tax as a resident foreign corporation doing business in the Philippines.
Petitioner's total payment of P5,185,676.77 allegedly shows that petitioner was earning a
sizable income from the sale of its plane tickets within the Philippines during the relevant
period. 47 Respondent further points out that this court in Commissioner of Internal
Revenue v. American Airlines, Inc., 48 which in turn cited the cases involving the British
Overseas Airways Corporation and Air India, had already settled that "foreign airline
companies which sold tickets in the Philippines through their local agents. . . [are]
considered resident foreign corporations engaged in trade or business in the country." 49 It
also cites Revenue Regulations No. 6-78 dated April 25, 1978, which defined the phrase
"doing business in the Philippines" as including "regular sale of tickets in the Philippines by
off-line international airlines either by themselves or through their agents." 50
Respondent further contends that petitioner is not entitled to its claim for refund
because the amount of P5,185,676.77 it paid as tax from the third quarter of 2000 to the
second quarter of 2001 was still short of the 32% income tax due for the
period. 51 Petitioner cannot allegedly claim good faith in its failure to pay the right amount of
tax since the National Internal Revenue Code became operative on January 1, 1998 and by
2000, petitioner should have already been aware of the implications of Section 28 (A) (3)
and the decided cases of this court's ruling on the taxability of offline international carriers
selling passage tickets in the Philippines.52
I
At the outset, we affirm the Court of Tax Appeals' ruling that petitioner, as an offline
international carrier with no landing rights in the Philippines, is not liable to tax on Gross
Philippine Billings under Section 28 (A) (3) of the 1997 National Internal Revenue Code:
SEC. 28. Rates of Income Tax on Foreign Corporations.
(A) Tax on Resident Foreign Corporations.
xxx xxx xxx
(3) International Carrier. An international carrier doing
business in the Philippines shall pay a tax of two and one-half
percent (2 1/2%) on its 'Gross Philippine Billings' as defined
hereunder:
(a) International Air Carrier. 'Gross Philippine Billings' refers
to the amount of gross revenue derived from carriage of
persons, excess baggage, cargo and mail originating from the

Philippines in a continuous and uninterrupted flight,

irrespective of the place of sale or issue and the place of
payment of the ticket or passage document: Provided, That
tickets revalidated, exchanged and/or indorsed to another
international airline form part of the Gross Philippine Billings if
the passenger boards a plane in a port or point in the
Philippines: Provided, further, That for a flight which originates
from the Philippines, but transshipment of passenger takes
place at any port outside the Philippines on another airline,
only the aliquot portion of the cost of the ticket corresponding
to the leg flown from the Philippines to the point of
transshipment shall form part of Gross Philippine Billings.
(Emphasis supplied)
Under the foregoing provision, the tax attaches only when the carriage of persons,
excess baggage, cargo, and mail originated from the Philippines in a continuous and
uninterrupted flight, regardless of where the passage documents were sold.
Not having flights to and from the Philippines, petitioner is clearly not liable for the
Gross Philippine Billings tax.
II
Petitioner, an offline carrier, is a resident foreign corporation for income tax
purposes. Petitioner falls within the definition of resident foreign corporation under Section
28 (A) (1) of the 1997 National Internal Revenue Code, thus, it may be subject to
32% 53 tax on its taxable income:
SEC. 28. Rates of Income Tax on Foreign Corporations.
(A) Tax on Resident Foreign Corporations.
(1) In General. Except as otherwise provided in this Code, a
corporation organized, authorized, or existing under the
laws of any foreign country, engaged in trade or business
within the Philippines, shall be subject to an income tax
equivalent to thirty-five percent (35%) of the taxable
income derived in the preceding taxable year from all
sources within the Philippines: Provided, That effective
January 1, 1998, the rate of income tax shall be thirty-four
percent (34%); effective January 1, 1999, the rate shall be
thirty-three percent (33%); and effective January 1, 2000 and
thereafter,
the
rate
shall
be
thirty-two
percent
(32%). 54 (Emphasis supplied)
The definition of "resident foreign corporation" has not substantially changed
throughout the amendments of the National Internal Revenue Code. All versions refer to "a
foreign corporation engaged in trade or business within the Philippines."

Commonwealth Act No. 466, known as the National Internal Revenue Code and
approved on June 15, 1939, defined "resident foreign corporation" as applying to "a foreign
corporation engaged in trade or business within the Philippines or having an office or place
of business therein." 55
Section 24 (b) (2) of the National Internal Revenue Code, as amended by Republic
Act No. 6110, approved on August 4, 1969, reads:
Sec. 24. Rates of tax on corporations. . . .
(b) Tax on foreign corporations. . . .
(2) Resident corporations. A corporation organized, authorized, or
existing under the laws of any foreign country, except a foreign life insurance
company, engaged in trade or business within the Philippines, shall be
taxable as provided in subsection (a) of this section upon the total net income
received in the preceding taxable year from all sources within the
Philippines. 56 (Emphasis supplied)
Presidential Decree No. 1158-A took effect on June 3, 1977 amending certain
sections of the 1939 National Internal Revenue Code. Section 24 (b) (2) on foreign resident
corporations was amended, but it still provides that "[a] corporation organized, authorized, or
existing under the laws of any foreign country, engaged in trade or business within the
Philippines, shall be taxable as provided in subsection (a) of this section upon the total net
income received in the preceding taxable year from all sources within the Philippines[.]" 57
As early as 1987, this court in Commissioner of Internal Revenue v. British Overseas
Airways Corporation 58 declared British Overseas Airways Corporation, an international air
carrier with no landing rights in the Philippines, as a resident foreign corporation engaged in
business in the Philippines through its local sales agent that sold and issued tickets for the
airline company. 59 This court discussed that: acEHCD
There is no specific criterion as to what constitutes "doing" or "engaging in" or
"transacting" business. Each case must be judged in the light of its peculiar
environmental circumstances. The term implies a continuity of commercial
dealings and arrangements, and contemplates, to that extent, the
performance of acts or works or the exercise of some of the functions
normally incident to, and in progressive prosecution of commercial gain
or for the purpose and object of the business organization. "In order that
a foreign corporation may be regarded as doing business within a State,
there must be continuity of conduct and intention to establish a continuous
business, such as the appointment of a local agent, and not one of a
temporary character.["]
BOAC, during the periods covered by the subject-assessments,
maintained a general sales agent in the Philippines. That general sales
agent, from 1959 to 1971, "was engaged in (1) selling and issuing tickets; (2)
breaking down the whole trip into series of trips each trip in the series
corresponding to a different airline company; (3) receiving the fare from the

whole trip; and (4) consequently allocating to the various airline companies
on the basis of their participation in the services rendered through the mode
of interline settlement as prescribed by Article VI of the Resolution No. 850 of
the IATA Agreement." Those activities were in exercise of the functions which
are normally incident to, and are in progressive pursuit of, the purpose and
object of its organization as an international air carrier. In fact, the regular
sale of tickets, its main activity, is the very lifeblood of the airline business,
the generation of sales being the paramount objective. There should be no
doubt then that BOAC was "engaged in" business in the Philippines through a
local agent during the period covered by the assessments. Accordingly, it is a
resident foreign corporation subject to tax upon its total net income received
in the preceding taxable year from all sources within the
Philippines. 60 (Emphasis supplied, citations omitted)
Republic Act No. 7042 or the Foreign Investments Act of 1991 also provides
guidance with its definition of "doing business" with regard to foreign corporations. Section 3
(d) of the law enumerates the activities that constitute doing business:
d. the phrase "doing business" shall include soliciting orders, service
contracts, opening offices, whether called "liaison" offices or branches;
appointing representatives or distributors domiciled in the Philippines or
who in any calendar year stay in the country for a period or periods
totalling one hundred eighty (180) days or more; participating in the
management, supervision or control of any domestic business, firm,
entity or corporation in the Philippines; and any other act or acts that
imply a continuity of commercial dealings or arrangements, and
contemplate to that extent the performance of acts or works, or the
exercise of some of the functions normally incident to, and in
progressive prosecution of, commercial gain or of the purpose and
object of the business organization: Provided, however, That the
phrase "doing business" shall not be deemed to include mere
investment as a shareholder by a foreign entity in domestic corporations
duly registered to do business, and/or the exercise of rights as such
investor; nor having a nominee director or officer to represent its
interests in such corporation; nor appointing a representative or
distributor domiciled in the Philippines which transacts business in its
own name and for its own account[.] 61 (Emphasis supplied)
While Section 3 (d) above states that "appointing a representative or distributor
domiciled in the Philippines which transacts business in its own name and for its own
account" is not considered as "doing business," the Implementing Rules and Regulations
of Republic Act No. 7042 clarifies that "doing business" includes"appointing representatives
or distributors, operating under full control of the foreign corporation, domiciled in the
Philippines or who in any calendar year stay in the country for a period or periods totaling
one hundred eighty (180) days or more[.]" 62

An offline carrier is "any foreign air carrier not certificated by the [Civil Aeronautics]
Board, but who maintains office or who has designated or appointed agents or employees in
the Philippines, who sells or offers for sale any air transportation in behalf of said foreign air
carrier and/or others, or negotiate for, or holds itself out by solicitation, advertisement, or
otherwise sells, provides, furnishes, contracts, or arranges for such transportation." 63
"Anyone desiring to engage in the activities of an off-line carrier [must] apply to the
[Civil Aeronautics] Board for such authority." 64 Each offline carrier must file with the Civil
Aeronautics Board a monthly report containing information on the tickets sold, such as the
origin and destination of the passengers, carriers involved, and commissions received. 65
Petitioner is undoubtedly "doing business" or "engaged in trade or business" in the
Philippines.
Aerotel performs acts or works or exercises functions that are incidental and
beneficial to the purpose of petitioner's business. The activities of Aerotel bring direct
receipts or profits to petitioner. 66 There is nothing on record to show that Aerotel solicited
orders alone and for its own account and without interference from, let alone direction of,
petitioner. On the contrary, Aerotel cannot "enter into any contract on behalf of [petitioner Air
Canada] without the express written consent of [the latter,]" 67 and it must perform its
functions according to the standards required by petitioner. 68 Through Aerotel, petitioner is
able to engage in an economic activity in the Philippines.
Further, petitioner was issued by the Civil Aeronautics Board an authority to operate
as an offline carrier in the Philippines for a period of five years, or from April 24, 2000 until
April 24, 2005. 69
Petitioner is, therefore, a resident foreign corporation that is taxable on its income
derived from sources within the Philippines. Petitioner's income from sale of airline tickets,
through Aerotel, is income realized from the pursuit of its business activities in the
Philippines. SDHTEC
III
However, the application of the regular 32% tax rate under Section 28 (A) (1) of
the 1997 National Internal Revenue Code must consider the existence of an effective tax
treaty between the Philippines and the home country of the foreign air carrier.
In the earlier case of South African Airways v. Commissioner of Internal
Revenue, 70 this court held that Section 28 (A) (3) (a) does not categorically exempt all
international air carriers from the coverage of Section 28 (A) (1). Thus, if Section 28 (A) (3)
(a) is applicable to a taxpayer, then the general rule under Section 28 (A) (1) does not apply.
If, however, Section 28 (A) (3) (a) does not apply, an international air carrier would be liable
for the tax under Section 28 (A) (1). 71
This court in South African Airways declared that the correct interpretation of these
provisions is that: "international air carrier[s] maintain[ing] flights to and from the Philippines.
. . shall be taxed at the rate of 2 1/2% of its Gross Philippine Billings[;] while international air
carriers that do not have flights to and from the Philippines but nonetheless earn income

from other activities in the country [like sale of airline tickets] will be taxed at the rate of 32%
of such [taxable] income." 72
In this case, there is a tax treaty that must be taken into consideration to determine
the proper tax rate.
A tax treaty is an agreement entered into between sovereign states "for purposes of
eliminating double taxation on income and capital, preventing fiscal evasion, promoting
mutual trade and investment, and according fair and equitable tax treatment to foreign
residents or nationals." 73 Commissioner of Internal Revenue v. S.C. Johnson and Son,
Inc. 74 explained the purpose of a tax treaty:
The purpose of these international agreements is to reconcile the national
fiscal legislation of the contracting parties in order to help the taxpayer avoid
simultaneous taxation in two different jurisdictions. More precisely, the tax
conventions are drafted with a view towards the elimination of international
juridical double taxation, which is defined as the imposition of comparable
taxes in two or more states on the same taxpayer in respect of the same
subject matter and for identical periods.
The apparent rationale for doing away with double taxation is to encourage
the free flow of goods and services and the movement of capital, technology
and persons between countries, conditions deemed vital in creating robust
and dynamic economies. Foreign investments will only thrive in a fairly
predictable and reasonable international investment climate and the
protection against double taxation is crucial in creating such a
climate. 75 (Emphasis in the original, citations omitted)
Observance of any treaty obligation binding upon the government of the Philippines
is anchored on the constitutional provision that the Philippines "adopts the generally
accepted principles of international law as part of the law of the land[.]" 76 Pacta sunt
servanda is a fundamental international law principle that requires agreeing parties to
comply with their treaty obligations in good faith. 77
Hence, the application of the provisions of the National Internal Revenue Code must
be subject to the provisions of tax treaties entered into by the Philippines with foreign
countries.
In Deutsche Bank AG Manila Branch v. Commissioner of Internal Revenue, 78 this
court stressed the binding effects of tax treaties. It dealt with the issue of "whether the failure
to strictly comply with [Revenue Memorandum Order] RMO No. 1-2000 79 will deprive
persons or corporations of the benefit of a tax treaty." 80Upholding the tax treaty over the
administrative issuance, this court reasoned thus:
Our Constitution provides for adherence to the general principles of
international law as part of the law of the land. The time-honored
international principle of pacta sunt servanda demands the performance in
good faith of treaty obligations on the part of the states that enter into the
agreement. Every treaty in force is binding upon the parties, and obligations

under the treaty must be performed by them in good faith. More

importantly, treaties have the force and effect of law in this jurisdiction.
Tax treaties are entered into "to reconcile the national fiscal
legislations of the contracting parties and, in turn, help the taxpayer avoid
simultaneous taxations in two different jurisdictions." CIR v. S.C. Johnson
and Son, Inc. further clarifies that "tax conventions are drafted with a view
towards the elimination of international juridical double taxation, which is
defined as the imposition of comparable taxes in two or more states on the
same taxpayer in respect of the same subject matter and for identical
periods. The apparent rationale for doing away with double taxation is to
encourage the free flow of goods and services and the movement of capital,
technology and persons between countries, conditions deemed vital in
creating robust and dynamic economies. Foreign investments will only thrive
in a fairly predictable and reasonable international investment climate and the
protection against double taxation is crucial in creating such a climate."
Simply put, tax treaties are entered into to minimize, if not eliminate the
harshness of international juridical double taxation, which is why they are also
known as double tax treaty or double tax agreements. AScHCD
"A state that has contracted valid international obligations is bound to
make in its legislations those modifications that may be necessary to ensure
the fulfillment of the obligations undertaken." Thus, laws and issuances must
ensure that the reliefs granted under tax treaties are accorded to the parties
entitled thereto. The BIR must not impose additional requirements that would
negate the availment of the reliefs provided for under international
agreements. More so, when the RP-Germany Tax Treaty does not provide for
any pre-requisite for the availment of the benefits under said agreement.
xxx xxx xxx
Bearing in mind the rationale of tax treaties, the period of application
for the availment of tax treaty relief as required by RMO No. 1-2000 should
not operate to divest entitlement to the relief as it would constitute a violation
of the duty required by good faith in complying with a tax treaty. The denial of
the availment of tax relief for the failure of a taxpayer to apply within the
prescribed period under the administrative issuance would impair the value of
the tax treaty. At most, the application for a tax treaty relief from the BIR
should merely operate to confirm the entitlement of the taxpayer to the relief.
The obligation to comply with a tax treaty must take precedence over
the objective of RMO No. 1-2000. Logically, noncompliance with tax treaties
has negative implications on international relations, and unduly discourages
foreign investors. While the consequences sought to be prevented by RMO
No. 1-2000 involve an administrative procedure, these may be remedied
through other system management processes, e.g., the imposition of a fine or
penalty. But we cannot totally deprive those who are entitled to the benefit of

a treaty for failure to strictly comply with an administrative issuance requiring

prior application for tax treaty relief. 81(Emphasis supplied, citations omitted)
On March 11, 1976, the representatives 82 for the government of the Republic of the
Philippines and for the government of Canada signed the Convention between the
Philippines and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income (Republic of the Philippines-Canada Tax Treaty).
This treaty entered into force on December 21, 1977.
Article V 83 of the Republic of the Philippines-Canada Tax Treaty defines
"permanent establishment" as a "fixed place of business in which the business of the
enterprise is wholly or partly carried on." 84
Even though there is no fixed place of business, an enterprise of a Contracting State
is deemed to have a permanent establishment in the other Contracting State if under certain
conditions there is a person acting for it.
Specifically, Article V (4) of the Republic of the Philippines-Canada Tax Treaty states
that "[a] person acting in a Contracting State on behalf of an enterprise of the other
Contracting State (other than an agent of independent status to whom paragraph 6 applies)
shall be deemed to be a permanent establishment in the first-mentioned State if . . . he has
and habitually exercises in that State an authority to conclude contracts on behalf of the
enterprise, unless his activities are limited to the purchase of goods or merchandise for that
enterprise[.]" The provision seems to refer to one who would be considered an agent under
Article 1868 85 of the Civil Code of the Philippines.
On the other hand, Article V (6) provides that "[a]n enterprise of a Contracting State
shall not be deemed to have a permanent establishment in the other Contracting State
merely because it carries on business in that other State through a broker, general
commission agent or any other agent of an independent status, where such persons are
acting in the ordinary course of their business."
Considering Article XV 86 of the same Treaty, which covers dependent personal
services, the term "dependent" would imply a relationship between the principal and the
agent that is akin to an employer-employee relationship.
Thus, an agent may be considered to be dependent on the principal where the latter
exercises comprehensive control and detailed instructions over the means and results of the
activities of the agent. 87 AcICHD
Section 3 of Republic Act No. 776, as amended, also known as The Civil Aeronautics
Act of the Philippines, defines a general sales agent as "a person, not abonafide employee
of an air carrier, who pursuant to an authority from an airline, by itself or through an agent,
sells or offers for sale any air transportation, or negotiates for, or holds himself out by
solicitation, advertisement or otherwise as one who sells, provides, furnishes, contracts or
arranges for, such air transportation." 88 General sales agents and their property, property
rights, equipment, facilities, and franchise are subject to the regulation and control of the
Civil Aeronautics Board. 89 A permit or authorization issued by the Civil Aeronautics Board
is required before a general sales agent may engage in such an activity. 90

Through the appointment of Aerotel as its local sales agent, petitioner is deemed to
have created a "permanent establishment" in the Philippines as defined under the Republic
of the Philippines-Canada Tax Treaty.
Petitioner appointed Aerotel as its passenger general sales agent to perform the sale
of transportation on petitioner and handle reservations, appointment, and supervision of
International Air Transport Association-approved and petitioner-approved sales agents,
including the following services:
ARTICLE 7
GSA SERVICES
The GSA [Aerotel Ltd., Corp.] shall perform on behalf of AC [Air Canada] the
following services:
a) Be the fiduciary of AC and in such capacity act solely and entirely for the
benefit of AC in every matter relating to this Agreement;
xxx xxx xxx
c) Promotion of passenger transportation on AC;
xxx xxx xxx
e) Without the need for endorsement by AC, arrange for the reissuance, in
the Territory of the GSA [Philippines], of traffic documents issued by AC
outside the said territory of the GSA [Philippines], as required by the
passenger(s);
xxx xxx xxx
h) Distribution among passenger sales agents and display of timetables, fare
sheets, tariffs and publicity material provided by AC in accordance with the
reasonable requirements of AC;
xxx xxx xxx
j) Distribution of official press releases provided by AC to media and
reference of any press or public relations inquiries to AC;
xxx xxx xxx
o) Submission for AC's approval, of an annual written sales plan on or before
a date to be determined by AC and in a form acceptable to AC;
xxx xxx xxx
q) Submission of proposals for AC's approval of passenger sales agent
incentive plans at a reasonable time in advance of proposed implementation.
r) Provision of assistance on request, in its relations with Governmental and
other authorities, offices and agencies in the Territory [Philippines].
xxx xxx xxx

u) Follow AC guidelines for the handling of baggage claims and customer

complaints and, unless otherwise stated in the guidelines, refer all such
claims and complaints to AC. 91
Under the terms of the Passenger General Sales Agency Agreement, Aerotel will
"provide at its own expense and acceptable to [petitioner Air Canada], adequate and
suitable premises, qualified staff, equipment, documentation, facilities and supervision and
in consideration of the remuneration and expenses payable[,] [will] defray all costs and
expenses of and incidental to the Agency." 92 "[I]t is the sole employer of its employees and
. . . is responsible for [their] actions . . . or those of any subcontractor." 93 In remuneration
for its services, Aerotel would be paid by petitioner a commission on sales of transportation
plus override commission on flown revenues. 94 Aerotel would also be reimbursed "for all
authorized expenses supported by original supplier invoices." 95
Aerotel is required to keep "separate books and records of account, including
supporting documents, regarding all transactions at, through or in any way connected with
[petitioner Air Canada] business." 96
"If representing more than one carrier, [Aerotel must] represent all carriers in an
unbiased way." 97 Aerotel cannot "accept additional appointments as General Sales Agent
of any other carrier without the prior written consent of [petitioner Air Canada]." 98
The Passenger General Sales Agency Agreement "may be terminated by either
party without cause upon [no] less than 60 days' prior notice in writing[.]" 99 In case of
breach of any provisions of the Agreement, petitioner may require Aerotel "to cure the
breach in 30 days failing which [petitioner Air Canada] may terminate [the]
Agreement[.]" 100 TAIaHE
The following terms are indicative of Aerotel's dependent status:
First, Aerotel must give petitioner written notice "within 7 days of the date [it] acquires
or takes control of another entity or merges with or is acquired or controlled by another
person or entity[.]" 101 Except with the written consent of petitioner, Aerotel must not
acquire a substantial interest in the ownership, management, or profits of a passenger sales
agent affiliated with the International Air Transport Association or a non-affiliated passenger
sales agent nor shall an affiliated passenger sales agent acquire a substantial interest in
Aerotel as to influence its commercial policy and/or management decisions. 102 Aerotel
must also provide petitioner "with a report on any interests held by [it], its owners, directors,
officers, employees and their immediate families in companies and other entities in the
aviation industry or . . . industries related to it[.]" 103 Petitioner may require that any interest
be divested within a set period of time. 104
Second, in carrying out the services, Aerotel cannot enter into any contract on behalf
of petitioner without the express written consent of the latter; 105 it must act according to the
standards required by petitioner; 106 "follow the terms and provisions of the [petitioner Air
Canada] GSA Manual [and all] written instructions of [petitioner Air Canada;]" 107 and "[i]n
the absence of an applicable provision in the Manual or instructions, [Aerotel must] carry out
its functions in accordance with [its own] standard practices and procedures[.]" 108

Third, Aerotel must only "issue traffic documents approved by [petitioner Air Canada]
for all transportation over [its] services[.]" 109 All use of petitioner's name, logo, and marks
must be with the written consent of petitioner and according to petitioner's corporate
standards and guidelines set out in the Manual. 110
Fourth, all claims, liabilities, fines, and expenses arising from or in connection with
the transportation sold by Aerotel are for the account of petitioner, except in the case of
negligence of Aerotel. 111
Aerotel is a dependent agent of petitioner pursuant to the terms of the Passenger
General Sales Agency Agreement executed between the parties. It has the authority or
power to conclude contracts or bind petitioner to contracts entered into in the Philippines. A
third-party liability on contracts of Aerotel is to petitioner as the principal, and not to Aerotel,
and liability to such third party is enforceable against petitioner. While Aerotel maintains a
certain independence and its activities may not be devoted wholly to petitioner, nonetheless,
when representing petitioner pursuant to the Agreement, it must carry out its functions solely
for the benefit of petitioner and according to the latter's Manual and written instructions.
Aerotel is required to submit its annual sales plan for petitioner's approval. ICHDca
In essence, Aerotel extends to the Philippines the transportation business of
petitioner. It is a conduit or outlet through which petitioner's airline tickets are sold. 112
Under Article VII (Business Profits) of the Republic of the Philippines-Canada Tax
Treaty, the "business profits" of an enterprise of a Contracting State is "taxable only in that
State[,] unless the enterprise carries on business in the other Contracting State through a
permanent establishment[.]" 113 Thus, income attributable to Aerotel or from business
activities effected by petitioner through Aerotel may be taxed in the Philippines. However,
pursuant to the last paragraph 114 of Article VII in relation to Article VIII 115 (Shipping and
Air Transport) of the same Treaty, the tax imposed on income derived from the operation of
ships or aircraft in international traffic should not exceed 1 1/2% of gross revenues derived
from Philippine sources.
IV
While petitioner is taxable as a resident foreign corporation under Section 28 (A) (1)
of the 1997 National Internal Revenue Code on its taxable income 116 from sale of airline
tickets in the Philippines, it could only be taxed at a maximum of 1 1/2% of gross revenues,
pursuant to Article VIII of the Republic of the Philippines-Canada Tax Treaty that applies to
petitioner as a "foreign corporation organized and existing under the laws of Canada[.]" 117
Tax treaties form part of the law of the land, 118 and jurisprudence has applied the
statutory construction principle that specific laws prevail over general ones.119
The Republic of the Philippines-Canada Tax Treaty was ratified on December 21,
1977 and became valid and effective on that date. On the other hand, the applicable
provisions 120 relating to the taxability of resident foreign corporations and the rate of such
tax found in the National Internal Revenue Code became effective on January 1,
1998. 121 Ordinarily, the later provision governs over the earlier one. 122 In this case,

however, the provisions of the Republic of the Philippines-Canada Tax Treaty are more
specific than the provisions found in the National Internal Revenue Code.
These rules of interpretation apply even though one of the sources is a treaty and not
simply a statute.
Article VII, Section 21 of the Constitution provides:
SECTION 21. No treaty or international agreement shall be valid and
effective unless concurred in by at least two-thirds of all the Members of the
Senate.
This provision states the second of two ways through which international obligations
become binding. Article II, Section 2 of the Constitution deals with international obligations
that are incorporated, while Article VII, Section 21 deals with international obligations that
become binding through ratification.
"Valid and effective" means that treaty provisions that define rights and duties as well
as definite prestations have effects equivalent to a statute. Thus, these specific treaty
provisions may amend statutory provisions. Statutory provisions may also amend these
types of treaty obligations.
We only deal here with bilateral treaty state obligations that are not international
obligations erga omnes. We are also not required to rule in this case on the effect of
international customary norms especially those with jus cogens character.
The second paragraph of Article VIII states that "profits from sources within a
Contracting State derived by an enterprise of the other Contracting State from the operation
of ships or aircraft in international traffic may be taxed in the first-mentioned State but the
tax so charged shall not exceed the lesser of a) one and one-half per cent of the gross
revenues derived from sources in that State; and b) the lowest rate of Philippine tax
imposed on such profits derived by an enterprise of a third State."
The Agreement between the government of the Republic of the Philippines and the
government of Canada on Air Transport, entered into on January 14, 1997, reiterates the
effectivity of Article VIII of the Republic of the Philippines-Canada Tax Treaty:
ARTICLE XVI
(Taxation)
The Contracting Parties shall act in accordance with the provisions of Article
VIII of the Convention between the Philippines and Canada for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income, signed at Manila on March 31, 1976 and entered into force
on December 21, 1977, and any amendments thereto, in respect of the
operation of aircraft in international traffic. 123 TCAScE
Petitioner's income from sale of ticket for international carriage of passenger is
income derived from international operation of aircraft. The sale of tickets is closely related
to the international operation of aircraft that it is considered incidental thereto.

"[B]y reason of our bilateral negotiations with [Canada], we have agreed to have our
right to tax limited to a certain extent[.]" 124 Thus, we are bound to extend to a Canadian air
carrier doing business in the Philippines through a local sales agent the benefit of a lower
tax equivalent to 1 1/2% on business profits derived from sale of international air
transportation.
V
Finally, we reject petitioner's contention that the Court of Tax Appeals erred in
denying its claim for refund of erroneously paid Gross Philippine Billings tax on the ground
that it is subject to income tax under Section 28 (A) (1) of the National Internal Revenue
Code because (a) it has not been assessed at all by the Bureau of Internal Revenue for any
income tax liability; 125 and (b) internal revenue taxes cannot be the subject of set-off or
compensation, 126 citing Republic v. Mambulao Lumber Co., et al. 127 and Francia v.
Intermediate Appellate Court. 128
In SMI-ED Philippines Technology, Inc. v. Commissioner of Internal
Revenue, 129 we have ruled that "[i]n an action for the refund of taxes allegedly erroneously
paid, the Court of Tax Appeals may determine whether there are taxes that should have
been paid in lieu of the taxes paid." 130 The determination of the proper category of tax that
should have been paid is incidental and necessary to resolve the issue of whether a refund
should be granted. 131 Thus:
Petitioner argued that the Court of Tax Appeals had no jurisdiction to
subject it to 6% capital gains tax or other taxes at the first instance. The Court
of Tax Appeals has no power to make an assessment.
As earlier established, the Court of Tax Appeals has no assessment
powers. In stating that petitioner's transactions are subject to capital gains
tax, however, the Court of Tax Appeals was not making an assessment. It
was merely determining the proper category of tax that petitioner should have
paid, in view of its claim that it erroneously imposed upon itself and paid the
5% final tax imposed upon PEZA-registered enterprises.
The determination of the proper category of tax that petitioner should
have paid is an incidental matter necessary for the resolution of the principal
issue, which is whether petitioner was entitled to a refund.
The issue of petitioner's claim for tax refund is intertwined with the
issue of the proper taxes that are due from petitioner. A claim for tax refund
carries the assumption that the tax returns filed were correct. If the tax return
filed was not proper, the correctness of the amount paid and, therefore, the
claim for refund become questionable. In that case, the court must determine
if a taxpayer claiming refund of erroneously paid taxes is more properly liable
for taxes other than that paid.
In South African Airways v. Commissioner of Internal Revenue, South
African Airways claimed for refund of its erroneously paid 2 1/2% taxes on its
gross Philippine billings. This court did not immediately grant South African's

claim for refund. This is because although this court found that South African
Airways was not subject to the 2 1/2% tax on its gross Philippine billings, this
court also found that it was subject to 32% tax on its taxable income.
In this case, petitioner's claim that it erroneously paid the 5% final tax
is an admission that the quarterly tax return it filed in 2000 was improper.
Hence, to determine if petitioner was entitled to the refund being claimed, the
Court of Tax Appeals has the duty to determine if petitioner was indeed not
liable for the 5% final tax and, instead, liable for taxes other than the 5% final
tax. As in South African Airways, petitioner's request for refund can neither be
granted nor denied outright without such determination.
If the taxpayer is found liable for taxes other than the erroneously paid
5% final tax, the amount of the taxpayer's liability should be computed and
deducted from the refundable amount.
Any liability in excess of the refundable amount, however, may not be
collected in a case involving solely the issue of the taxpayer's entitlement to
refund. The question of tax deficiency is distinct and unrelated to the question
of petitioner's entitlement to refund. Tax deficiencies should be subject to
assessment procedures and the rules of prescription. The court cannot be
expected to perform the BIR's duties whenever it fails to do so either through
neglect or oversight. Neither can court processes be used as a tool to
circumvent laws protecting the rights of taxpayers. 132
Hence, the Court of Tax Appeals properly denied petitioner's claim for refund of
allegedly erroneously paid tax on its Gross Philippine Billings, on the ground that it was
liable instead for the regular 32% tax on its taxable income received from sources within the
Philippines. Its determination of petitioner's liability for the 32% regular income tax was
made merely for the purpose of ascertaining petitioner's entitlement to a tax refund and not
for imposing any deficiency tax.
In this regard, the matter of set-off raised by petitioner is not an issue. Besides, the
cases cited are based on different circumstances. In both cited cases, 133 the taxpayer
claimed that his (its) tax liability was off-set by his (its) claim against the government.
Specifically, in Republic v. Mambulao Lumber Co., et al., Mambulao Lumber
contended that the amounts it paid to the government as reforestation charges from 1947 to
1956, not having been used in the reforestation of the area covered by its license, may be
set off or applied to the payment of forest charges still due and owing from it. 134 Rejecting
Mambulao's claim of legal compensation, this court ruled: cTDaEH
[A]ppellant and appellee are not mutually creditors and debtors of each other.
Consequently, the law on compensation is inapplicable. On this point, the trial
court correctly observed:
Under Article 1278, NCC, compensation should take
place when two persons in their own right are creditors and
debtors of each other. With respect to the forest charges which

the defendant Mambulao Lumber Company has paid to the

government, they are in the coffers of the government as taxes
collected, and the government does not owe anything to
defendant Mambulao Lumber Company. So, it is crystal clear
that the Republic of the Philippines and the Mambulao Lumber
Company are not creditors and debtors of each other, because
compensation refers to mutual debts. . . . .
And the weight of authority is to the effect that internal revenue taxes, such
as the forest charges in question, can not be the subject of set-off or
compensation.
A claim for taxes is not such a debt, demand, contract
or judgment as is allowed to be set-off under the statutes of
set-off, which are construed uniformly, in the light of public
policy, to exclude the remedy in an action or any indebtedness
of the state or municipality to one who is liable to the state or
municipality for taxes. Neither are they a proper subject of
recoupment since they do not arise out of the contract or
transaction sued on. . . . . (80 C.J.S. 73-74.)
The general rule, based on grounds of public policy is
well-settled that no set-off is admissible against demands for
taxes levied for general or local governmental purposes. The
reason on which the general rule is based, is that taxes are not
in the nature of contracts between the party and party but grow
out of a duty to, and are the positive acts of the government, to
the making and enforcing of which, the personal consent of
individual taxpayers is not required. . . . If the taxpayer can
properly refuse to pay his tax when called upon by the
Collector, because he has a claim against the governmental
body which is not included in the tax levy, it is plain that some
legitimate and necessary expenditure must be curtailed. If the
taxpayer's claim is disputed, the collection of the tax must
await and abide the result of a lawsuit, and meanwhile the
financial affairs of the government will be thrown into great
confusion. (47 Am. Jur. 766-767.) 135 (Emphasis supplied)
In Francia, this court did not allow legal compensation since not all requisites of legal
compensation provided under Article 1279 were present. 136 In that case, a portion of
Francia's property in Pasay was expropriated by the national government, 137 which did not
immediately pay Francia. In the meantime, he failed to pay the real property tax due on his
remaining property to the local government of Pasay, which later on would auction the
property on account of such delinquency. 138He then moved to set aside the auction sale
and argued, among others, that his real property tax delinquency was extinguished by legal
compensation on account of his unpaid claim against the national government. 139 This
court ruled against Francia: ITAaHc

There is no legal basis for the contention. By legal compensation,

obligations of persons, who in their own right are reciprocally debtors and
creditors of each other, are extinguished (Art. 1278, Civil Code). The
circumstances of the case do not satisfy the requirements provided by Article
1279, to wit:
(1) that each one of the obligors be bound principally
and that he be at the same time a principal creditor of the
other;
xxx xxx xxx
(3) that the two debts be due.
xxx xxx xxx
This principal contention of the petitioner has no merit. We have
consistently ruled that there can be no off-setting of taxes against the claims
that the taxpayer may have against the government. A person cannot refuse
to pay a tax on the ground that the government owes him an amount equal to
or greater than the tax being collected. The collection of a tax cannot await
the results of a lawsuit against the government.
xxx xxx xxx
There are other factors which compel us to rule against the
petitioner. The tax was due to the city government while the expropriation
was effected by the national government. Moreover, the amount of P4,116.00
paid by the national government for the 125 square meter portion of his lot
was deposited with the Philippine National Bank long before the sale at public
auction of his remaining property. Notice of the deposit dated September 28,
1977 was received by the petitioner on September 30, 1977. The petitioner
admitted in his testimony that he knew about the P4,116.00 deposited with
the bank but he did not withdraw it. It would have been an easy matter to
withdraw P2,400.00 from the deposit so that he could pay the tax obligation
thus aborting the sale at public auction. 140
The ruling in Francia was applied to the subsequent cases of Caltex Philippines, Inc.
v. Commission on Audit 141 and Philex Mining Corporation v. Commissioner of Internal
Revenue. 142 In Caltex, this court reiterated:
[A] taxpayer may not offset taxes due from the claims that he may have
against the government. Taxes cannot be the subject of compensation
because the government and taxpayer are not mutually creditors and debtors
of each other and a claim for taxes is not such a debt, demand, contract or
judgment as is allowed to be set-off. 143 (Citations omitted)
Philex Mining ruled that "[t]here is a material distinction between a tax and debt.
Debts are due to the Government in its corporate capacity, while taxes are due to the
Government in its sovereign capacity." 144 Rejecting Philex Mining's assertion that the

imposition of surcharge and interest was unjustified because it had no obligation to pay the
excise tax liabilities within the prescribed period since, after all, it still had pending claims for
VAT input credit/refund with the Bureau of Internal Revenue, this court explained:
To be sure, we cannot allow Philex to refuse the payment of its tax
liabilities on the ground that it has a pending tax claim for refund or credit
against the government which has not yet been granted. It must be noted that
a distinguishing feature of a tax is that it is compulsory rather than a matter of
bargain. Hence, a tax does not depend upon the consent of the taxpayer. If
any tax payer can defer the payment of taxes by raising the defense that it
still has a pending claim for refund or credit, this would adversely affect the
government revenue system. A taxpayer cannot refuse to pay his taxes when
they fall due simply because he has a claim against the government or that
the collection of the tax is contingent on the result of the lawsuit it filed
against the government. Moreover, Philex's theory that would automatically
apply its VAT input credit/refund against its tax liabilities can easily give rise
to confusion and abuse, depriving the government of authority over the
manner by which taxpayers credit and offset their tax liabilities. 145 (Citations
omitted)
In sum, the rulings in those cases were to the effect that the taxpayer cannot simply
refuse to pay tax on the ground that the tax liabilities were off-set against any alleged claim
the taxpayer may have against the government. Such would merely be in keeping with the
basic policy on prompt collection of taxes as the lifeblood of the government.
Here, what is involved is a denial of a taxpayer's refund claim on account of the
Court of Tax Appeals' finding of its liability for another tax in lieu of the Gross Philippine
Billings tax that was allegedly erroneously paid.
Squarely applicable is South African Airways where this court rejected similar
arguments on the denial of claim for tax refund: CHTAIc
Commissioner of Internal Revenue v. Court of Tax Appeals, however,
granted the offsetting of a tax refund with a tax deficiency in this wise:
Further, it is also worth noting that the Court of Tax
Appeals erred in denying petitioner's supplemental motion for
reconsideration alleging bringing to said court's attention the
existence of the deficiency income and business tax
assessment against Citytrust. The fact of such deficiency
assessment is intimately related to and inextricably intertwined
with the right of respondent bank to claim for a tax refund for
the same year. To award such refund despite the existence of
that deficiency assessment is an absurdity and a polarity in
conceptual effects. Herein private respondent cannot be
entitled to refund and at the same time be liable for a tax
deficiency assessment for the same year.

The grant of a refund is founded on the assumption

that the tax return is valid, that is, the facts stated therein are
true and correct. The deficiency assessment, although not yet
final, created a doubt as to and constitutes a challenge against
the truth and accuracy of the facts stated in said return which,
by itself and without unquestionable evidence, cannot be the
basis for the grant of the refund.
Section 82, Chapter IX of the National Internal
Revenue Code of 1977, which was the applicable law when
the claim of Citytrust was filed, provides that "(w)hen an
assessment is made in case of any list, statement, or return,
which in the opinion of the Commissioner of Internal Revenue
was false or fraudulent or contained any understatement or
undervaluation, no tax collected under such assessment shall
be recovered by any suits unless it is proved that the said list,
statement, or return was not false nor fraudulent and did not
contain any understatement or undervaluation; but this
provision shall not apply to statements or returns made or to
be made in good faith regarding annual depreciation of oil or
gas wells and mines."
Moreover, to grant the refund without determination of
the proper assessment and the tax due would inevitably result
in multiplicity of proceedings or suits. If the deficiency
assessment should subsequently be upheld, the Government
will be forced to institute anew a proceeding for the recovery of
erroneously refunded taxes which recourse must be filed
within the prescriptive period of ten years after discovery of the
falsity, fraud or omission in the false or fraudulent return
involved. This would necessarily require and entail additional
efforts and expenses on the part of the Government, impose a
burden on and a drain of government funds, and impede or
delay the collection of much-needed revenue for governmental
operations.
Thus, to avoid multiplicity of suits and unnecessary
difficulties or expenses, it is both logically necessary and
legally appropriate that the issue of the deficiency tax
assessment against Citytrust be resolved jointly with its claim
for tax refund, to determine once and for all in a single
proceeding the true and correct amount of tax due or
refundable. cHDAIS
In fact, as the Court of Tax Appeals itself has
heretofore conceded, it would be only just and fair that the
taxpayer and the Government alike be given equal

opportunities to avail of remedies under the law to defeat each

other's claim and to determine all matters of dispute between
them in one single case. It is important to note that in
determining whether or not petitioner is entitled to the refund of
the amount paid, it would [be] necessary to determine how
much the Government is entitled to collect as taxes. This
would necessarily include the determination of the correct
liability of the taxpayer and, certainly, a determination of this
case would constitute res judicata on both parties as to all the
matters subject thereof or necessarily involved therein.
Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI
of the 1997 NIRC. The above pronouncements are, therefore, still applicable
today.
Here, petitioner's similar tax refund claim assumes that the tax return
that it filed was correct. Given, however, the finding of the CTA that petitioner,
although not liable under Sec. 28(A)(3)(a) of the 1997 NIRC, is liable under
Sec. 28(A)(1), the correctness of the return filed by petitioner is now put in
doubt. As such, we cannot grant the prayer for a refund. 146 (Emphasis
supplied, citation omitted)
In the subsequent case of United Airlines, Inc. v. Commissioner of Internal
Revenue, 147 this court upheld the denial of the claim for refund based on the Court of Tax
Appeals' finding that the taxpayer had, through erroneous deductions on its gross income,
underpaid its Gross Philippine Billing tax on cargo revenues for 1999, and the amount of
underpayment was even greater than the refund sought for erroneously paid Gross
Philippine Billings tax on passenger revenues for the same taxable period. 148
In this case, the P5,185,676.77 Gross Philippine Billings tax paid by petitioner was
computed at the rate of 1 1/2% of its gross revenues amounting to
P345,711,806.08 149 from the third quarter of 2000 to the second quarter of 2002. It is quite
apparent that the tax imposable under Section 28 (A) (1) of the 1997 National Internal
Revenue Code [32% of taxable income, that is, gross income less deductions] will exceed
the maximum ceiling of 1 1/2% of gross revenues as decreed in Article VIII of the Republic
of the Philippines-Canada Tax Treaty. Hence, no refund is forthcoming.
WHEREFORE, the Petition is DENIED. The Decision dated August 26, 2005 and
Resolution dated April 8, 2005 of the Court of Tax Appeals En Banc areAFFIRMED.
SO ORDERED.
||| (Air Canada v. Commissioner of Internal Revenue, G.R. No. 169507, [January 11, 2016])