Republic of the Philippines

SUPREME COURT

Manila

EN BANC

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

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

vs.

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

Gregorio Araneta for appellants.

Assistant Attorney Round for appellees.

MALCOLM, J.:

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

STATEMENT OF THE CASE.

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

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

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

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

ISSUES.

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

DECISION.

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

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

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

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

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

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

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

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,

Chief, Bureau of Insular Affairs, War Department,

Washington, D. C.

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

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

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

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

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

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

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

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

Respectfully,
DAVID A. GATES.

Acting Commissioner.

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

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

Republic of the Philippines

SUPREME COURT

Manila

SECOND DIVISION

G.R. No. 48532 August 31, 1992

HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D. HERRERA, BENJAMIN T. ILDEFONSO,

ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP, LEANDRO G. SANTILLAN, and
JAIME A. SOQUES, petitioners,

vs.

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

G.R. No. 48533 August 31, 1992

ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY L. DIMAYUGA, JAIME E. DY-LIACCO,

MELQUIADES J. GAMBOA, JR., MANUEL L. GUZMAN, VICENTE D. HERRERA, BENJAMIN T. ILDEFONSO,
ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP and JAIME A. SOQUES, petitioners,

vs.

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

Angara, Abello, Concepcion, Regala & Cruz for petitioners.

NOCON, J.:

Petitioners pray that his Court reverse the Decision of the public respondent Court of Tax Appeals,
promulgated September 26, 19771 denying petitioners' claim for tax refunds, and order the
Commissioner of Internal Revenue to refund to them their income taxes which they claim to have been
erroneously or illegally paid or collected.

As summarized by the Solicitor General, the facts of the cases are as follows:

Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine Manufacturing
Corporation, with offices at Sarmiento Building, Ayala Avenue, Makati, Rizal. Said corporation is a
subsidiary of Procter & Gamble, a foreign corporation based in Cincinnati, Ohio, U.S.A. During the years
1970 and 1971 petitioners were assigned, for certain periods, to other subsidiaries of Procter & Gamble,
outside of the Philippines, during which petitioners were paid U.S. dollars as compensation for services
in their foreign assignments. (Paragraphs III, Petitions for Review, C.T.A. Cases Nos. 2511 and 2594, Exhs.
D, D-1 to D-19). When petitioners in C.T.A. Case No. 2511 filed their income tax returns for the year
1970, they computed the tax due by applying the dollar-to-peso conversion on the basis of the floating
rate ordained under B.I.R. Ruling No. 70-027 dated May 14, 1970, as follows:

From January 1 to February 20, 1970 at the conversion rate of P3.90 to U.S. $1.00;

From February 21 to December 31, 1970 at the conversion rate of P6.25 to U.S. $1.00

Petitioners in C.T.A. Case No. 2594 likewise used the above conversion rate in converting their dollar
income for 1971 to Philippine peso. However, on February 8, 1973 and October 8, 1973, petitioners in
said cases filed with the office of the respondent Commissioner, amended income tax returns for the
above-mentioned years, this time using the par value of the peso as prescribed in Section 48 of Republic
Act No. 265 in relation to Section 6 of Commonwealth Act No. 265 in relation to Section 6 of
Commonwealth Act No. 699 as the basis for converting their respective dollar income into Philippine
pesos for purposes of computing and paying the corresponding income tax due from them. The
aforesaid computation as shown in the amended income tax returns resulted in the alleged
overpayments, refund and/or tax credit. Accordingly, claims for refund of said over-payments were filed
with respondent Commissioner. Without awaiting the resolution of the Commissioner of the Internal
Revenue on their claims, petitioners filed their petitioner for review in the above-mentioned cases.

Respondent Commissioner filed his Answer to petitioners' petition for review in C.T.A. Case No. 2511 on
July 31, 1973, while his Answer in C.T.A. Case No. 2594 was filed on August 7, 1974.

Upon joint motion of the parties on the ground that these two cases involve common question of law
and facts, that respondent Court of Tax Appeals heard the cases jointly. In its decision dated September
26, 1977, the respondent Court of Tax Appeals held that the proper conversion rate for the purpose of
reporting and paying the Philippine income tax on the dollar earnings of petitioners are the rates
prescribed under Revenue Memorandum Circulars Nos. 7-71 and 41-71. Accordingly, the claim for
refund and/or tax credit of petitioners in the above-entitled cases was denied and the petitions for
review dismissed, with costs against petitioners. Hence, this petition for review on certiorari. 2

Petitioners claim that public respondent Court of Tax Appeals erred in holding:

1. That petitioners' dollar earnings are receipts derived from foreign exchange transactions.

2. That the proper rate of conversion of petitioners' dollar earnings for tax purposes in the
prevailing free market rate of exchange and not the par value of the peso; and

3. That the use of the par value of the peso to convert petitioners' dollar earnings for tax purposes
into Philippine pesos is "unrealistic" and, therefore, the prevailing free market rate should be the rate
used

Respondent Commissioner of Internal Revenue, on the other hand, refutes petitioners' claims as follows

At the outset, it is submitted that the subject matter of these two cases are Philippine income tax for the
calendar years 1970 (CTA Case No. 2511) and 1971 (CTA Case No. 2594) and, therefore, should be
governed by the provisions of the National Internal Revenue Code and its implementing rules and
regulations, and not by the provisions of Central Bank Circular No. 42 dated May 21, 1953, as contended
by petitioners.

Section 21 of the National Internal Revenue Code, before its amendment by Presidential Decrees Nos.
69 and 323 which took effect on January 1, 1973 and January 1, 1974, respectively, imposed a tax upon
the taxable net income received during each taxable year from all sources by a citizen of the Philippines,
whether residing here or abroad.

Petitioners are citizens of the Philippines temporarily residing abroad by virtue of their employment.
Thus, in their tax returns for the period involved herein, they gave their legal residence/address as c/o
Procter & Gamble PMC, Ayala Ave., Makati, Rizal (Annexes "A" to "A-8" and Annexes "C" to "C-8",
Petition for Review, CTA Nos. 2511 and 2594).

Petitioners being subject to Philippine income tax, their dollar earnings should be converted into
Philippine pesos in computing the income tax due therefrom, in accordance with the provisions of
Revenue Memorandum Circular No. 7-71 dated February 11, 1971 for 1970 income and Revenue
Memorandum Circular No. 41-71 dated December 21, 1971 for 1971 income, which reiterated BIR
Ruling No. 70-027 dated May 4, 1970, to wit:

For internal revenue tax purposes, the free marker rate of conversion (Revenue Circulars Nos. 7-71 and
41-71) should be applied in order to determine the true and correct value in Philippine pesos of the
income of petitioners. 3

After a careful examination of the records, the laws involved and the jurisprudence on the matter, We
are inclined to agree with respondents Court of Tax Appeals and Commissioner of Internal Revenue and
thus vote to deny the petition.

This basically an income tax case. For the proper resolution of these cases income may be defined as an
amount of money coming to a person or corporation within a specified time, whether as payment for
services, interest or profit from investment. Unless otherwise specified, it means cash or its equivalent.
4 Income can also be though of as flow of the fruits of one's labor. 5

Petitioners are correct as to their claim that their dollar earnings are not receipts derived from foreign
exchange transactions. For a foreign exchange transaction is simply that a transaction in foreign
exchange, foreign exchange being "the conversion of an amount of money or currency of one country
into an equivalent amount of money or currency of another." 6 When petitioners were assigned to the
foreign subsidiaries of Procter & Gamble, they were earning in their assigned nation's currency and were
ALSO spending in said currency. There was no conversion, therefore, from one currency to another.

Public respondent Court of Tax Appeals did err when it concluded that the dollar incomes of petitioner
fell under Section 2(f)(g) and (m) of C.B. Circular No. 42. 7

The issue now is, what exchange rate should be used to determine the peso equivalent of the foreign
earnings of petitioners for income tax purposes. Petitioners claim that since the dollar earnings do not
fall within the classification of foreign exchange transactions, there occurred no actual inward
remittances, and, therefore, they are not included in the coverage of Central Bank Circular No. 289
which provides for the specific instances when the par value of the peso shall not be the conversion rate
used. They conclude that their earnings should be converted for income tax purposes using the par
value of the Philippine peso.

Respondent Commissioner argues that CB Circular No. 289 speaks of receipts for export products,
receipts of sale of foreign exchange or foreign borrowings and investments but not income tax. He also
claims that he had to use the prevailing free market rate of exchange in these cases because of the need
to ascertain the true and correct amount of income in Philippine peso of dollar earners for Philippine
income tax purposes.

A careful reading of said CB Circular No. 289 8 shows that the subject matters involved therein are
export products, invisibles, receipts of foreign exchange, foreign exchange payments, new foreign
borrowing and investments nothing by way of income tax payments. Thus, petitioners are in error by
concluding that since C.B. Circular No. 289 does not apply to them, the par value of the peso should be
the guiding rate used for income tax purposes.

The dollar earnings of petitioners are the fruits of their labors in the foreign subsidiaries of Procter &
Gamble. It was a definite amount of money which came to them within a specified period of time of two
years as payment for their services.

Section 21 of the National Internal Revenue Code, amended up to August 4, 1969, states as follows:

Sec. 21. Rates of tax on citizens or residents. A tax is hereby imposed upon the taxable net income
received during each taxable year from all sources by every individual, whether a citizen of the
Philippines residing therein or abroad or an alien residing in the Philippines, determined in accordance
with the following schedule:

xxx xxx xxx

And in the implementation for the proper enforcement of the National Internal Revenue Code, Section
338 thereof empowers the Secretary of Finance to "promulgate all needful rules and regulations" to
effectively enforce its provisions. 9

Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71 10 and 41-71 11 were issued to
prescribed a uniform rate of exchange from US dollars to Philippine pesos for INTERNAL REVENUE TAX
PURPOSES for the years 1970 and 1971, respectively. Said revenue circulars were a valid exercise of the
authority given to the Secretary of Finance by the Legislature which enacted the Internal Revenue Code.
And these are presumed to be a valid interpretation of said code until revoked by the Secretary of
Finance himself. 12

Petitioners argue that since there were no remittances and acceptances of their salaries and wages in
US dollars into the Philippines, they are exempt from the coverage of such circulars. Petitioners forget
that they are citizens of the Philippines, and their income, within or without, and in these cases wholly
without, are subject to income tax. Sec. 21, NIRC, as amended, does not brook any exemption.

Since petitioners have already paid their 1970 and 1971 income taxes under the uniform rate of
exchange prescribed under the aforestated Revenue Memorandum Circulars, there is no reason for
respondent Commissioner to refund any taxes to petitioner as said Revenue Memorandum Circulars,
being of long standing and not contrary to law, are valid. 13

Although it has become a worn-out cliche, the fact still remains that "taxes are the lifeblood of the
government" and one of the duties of a Filipino citizen is to pay his income tax.

WHEREFORE, the petitioners are denied for lack of merit. The dismissal by the respondent Court of Tax
Appeals of petitioners' claims for tax refunds for the income tax period for 1970 and 1971 is AFFIRMED.
Costs against petitioners.

SO ORDERED.

Narvasa, C.J., Padilla and Regalado, JJ., concur.

Melo, J., took no part.

Republic of the Philippines

SUPREME COURT

Manila

EN BANC

G.R. No. L-59431 July 25, 1984

ANTERO M. SISON, JR., petitioner,

vs.

RUBEN B. ANCHETA, Acting Commissioner, Bureau of Internal Revenue; ROMULO VILLA, Deputy
Commissioner, Bureau of Internal Revenue; TOMAS TOLEDO Deputy Commissioner, Bureau of Internal
Revenue; MANUEL ALBA, Minister of Budget, FRANCISCO TANTUICO, Chairman, Commissioner on
Audit, and CESAR E. A. VIRATA, Minister of Finance, respondents.

Antero Sison for petitioner and for his own behalf.

The Solicitor General for respondents.

FERNANDO, C.J.:

The success of the challenge posed in this suit for declaratory relief or prohibition proceeding 1 on the
validity of Section I of Batas Pambansa Blg. 135 depends upon a showing of its constitutional infirmity.
The assailed provision further amends Section 21 of the National Internal Revenue Code of 1977, which
provides for rates of tax on citizens or residents on (a) taxable compensation income, (b) taxable net
income, (c) royalties, prizes, and other winnings, (d) interest from bank deposits and yield or any other
monetary benefit from deposit substitutes and from trust fund and similar arrangements, (e) dividends
and share of individual partner in the net profits of taxable partnership, (f) adjusted gross income. 2
Petitioner 3 as taxpayer alleges that by virtue thereof, "he would be unduly discriminated against by the
imposition of higher rates of tax upon his income arising from the exercise of his profession vis-a-vis
those which are imposed upon fixed income or salaried individual taxpayers. 4 He characterizes the
above sction as arbitrary amounting to class legislation, oppressive and capricious in character 5 For
petitioner, therefore, there is a transgression of both the equal protection and due process clauses 6 of
the Constitution as well as of the rule requiring uniformity in taxation. 7

The Court, in a resolution of January 26, 1982, required respondents to file an answer within 10 days
from notice. Such an answer, after two extensions were granted the Office of the Solicitor General, was
filed on May 28, 1982. 8 The facts as alleged were admitted but not the allegations which to their mind
are "mere arguments, opinions or conclusions on the part of the petitioner, the truth [for them] being
those stated [in their] Special and Affirmative Defenses." 9 The answer then affirmed: "Batas Pambansa
Big. 135 is a valid exercise of the State's power to tax. The authorities and cases cited while correctly
quoted or paraghraph do not support petitioner's stand." 10 The prayer is for the dismissal of the
petition for lack of merit.

This Court finds such a plea more than justified. The petition must be dismissed.

1. It is manifest that the field of state activity has assumed a much wider scope, The reason was so
clearly set forth by retired Chief Justice Makalintal thus: "The areas which used to be left to private
enterprise and initiative and which the government was called upon to enter optionally, and only
'because it was better equipped to administer for the public welfare than is any private individual or
group of individuals,' continue to lose their well-defined boundaries and to be absorbed within activities
that the government must undertake in its sovereign capacity if it is to meet the increasing social
challenges of the times." 11 Hence the need for more revenues. The power to tax, an inherent
prerogative, has to be availed of to assure the performance of vital state functions. It is the source of the
bulk of public funds. To praphrase a recent decision, taxes being the lifeblood of the government, their
prompt and certain availability is of the essence. 12

2. The power to tax moreover, to borrow from Justice Malcolm, "is an attribute of sovereignty. It is
the strongest of all the powers of of government." 13 It is, of course, to be admitted that for all its
plenitude 'the power to tax is not unconfined. There are restrictions. The Constitution sets forth such
limits . Adversely affecting as it does properly rights, both the due process and equal protection clauses
inay properly be invoked, all petitioner does, to invalidate in appropriate cases a revenue measure. if it
were otherwise, there would -be truth to the 1803 dictum of Chief Justice Marshall that "the power to
tax involves the power to destroy." 14 In a separate opinion in Graves v. New York, 15 Justice
Frankfurter, after referring to it as an 1, unfortunate remark characterized it as "a flourish of rhetoric
[attributable to] the intellectual fashion of the times following] a free use of absolutes." 16 This is
merely to emphasize that it is riot and there cannot be such a constitutional mandate. Justice
Frankfurter could rightfully conclude: "The web of unreality spun from Marshall's famous dictum was
brushed away by one stroke of Mr. Justice Holmess pen: 'The power to tax is not the power to destroy
while this Court sits." 17 So it is in the Philippines.

3. This Court then is left with no choice. The Constitution as the fundamental law overrides any
legislative or executive, act that runs counter to it. In any case therefore where it can be demonstrated
that the challenged statutory provision as petitioner here alleges fails to abide by its command,
then this Court must so declare and adjudge it null. The injury thus is centered on the question of
whether the imposition of a higher tax rate on taxable net income derived from business or profession
than on compensation is constitutionally infirm.

4, The difficulty confronting petitioner is thus apparent. He alleges arbitrariness. A mere allegation,
as here. does not suffice. There must be a factual foundation of such unconstitutional taint. Considering
that petitioner here would condemn such a provision as void or its face, he has not made out a case.
This is merely to adhere to the authoritative doctrine that were the due process and equal protection
clauses are invoked, considering that they arc not fixed rules but rather broad standards, there is a need
for of such persuasive character as would lead to such a conclusion. Absent such a showing, the
presumption of validity must prevail. 18

5. It is undoubted that the due process clause may be invoked where a taxing statute is so
arbitrary that it finds no support in the Constitution. An obvious example is where it can be shown to
amount to the confiscation of property. That would be a clear abuse of power. It then becomes the duty
of this Court to say that such an arbitrary act amounted to the exercise of an authority not conferred.
That properly calls for the application of the Holmes dictum. It has also been held that where the
assailed tax measure is beyond the jurisdiction of the state, or is not for a public purpose, or, in case of a
retroactive statute is so harsh and unreasonable, it is subject to attack on due process grounds. 19

6. Now for equal protection. The applicable standard to avoid the charge that there is a denial of
this constitutional mandate whether the assailed act is in the exercise of the lice power or the power of
eminent domain is to demonstrated that the governmental act assailed, far from being inspired by the
attainment of the common weal was prompted by the spirit of hostility, or at the very least,
discrimination that finds no support in reason. It suffices then that the laws operate equally and
uniformly on all persons under similar circumstances or that all persons must be treated in the same
manner, the conditions not being different, both in the privileges conferred and the liabilities imposed.
Favoritism and undue preference cannot be allowed. For the principle is that equal protection and
security shall be given to every person under circumtances which if not Identical are analogous. If law be
looked upon in terms of burden or charges, those that fall within a class should be treated in the same
fashion, whatever restrictions cast on some in the group equally binding on the rest." 20 That same
formulation applies as well to taxation measures. The equal protection clause is, of course, inspired by
the noble concept of approximating the Ideal of the laws benefits being available to all and the affairs of
men being governed by that serene and impartial uniformity, which is of the very essence of the Idea of
law. There is, however, wisdom, as well as realism in these words of Justice Frankfurter: "The equality at
which the 'equal protection' clause aims is not a disembodied equality. The Fourteenth Amendment
enjoins 'the equal protection of the laws,' and laws are not abstract propositions. They do not relate to
abstract units A, B and C, but are expressions of policy arising out of specific difficulties, address to the
attainment of specific ends by the use of specific remedies. The Constitution does not require things
which are different in fact or opinion to be treated in law as though they were the same." 21 Hence the
constant reiteration of the view that classification if rational in character is allowable. As a matter of
fact, in a leading case of Lutz V. Araneta, 22 this Court, through Justice J.B.L. Reyes, went so far as to
hold "at any rate, it is inherent in the power to tax that a state be free to select the subjects of taxation,
and it has been repeatedly held that 'inequalities which result from a singling out of one particular class
for taxation, or exemption infringe no constitutional limitation.'" 23

7. Petitioner likewise invoked the kindred concept of uniformity. According to the Constitution:
"The rule of taxation shag be uniform and equitable." 24 This requirement is met according to Justice
Laurel in Philippine Trust Company v. Yatco,25 decided in 1940, when the tax "operates with the same
force and effect in every place where the subject may be found. " 26 He likewise added: "The rule of
uniformity does not call for perfect uniformity or perfect equality, because this is hardly attainable." 27
The problem of classification did not present itself in that case. It did not arise until nine years later,
when the Supreme Court held: "Equality and uniformity in taxation means that all taxable articles or
kinds of property of the same class shall be taxed at the same rate. The taxing power has the authority
to make reasonable and natural classifications for purposes of taxation, ... . 28 As clarified by Justice
Tuason, where "the differentiation" complained of "conforms to the practical dictates of justice and
equity" it "is not discriminatory within the meaning of this clause and is therefore uniform." 29 There is
quite a similarity then to the standard of equal protection for all that is required is that the tax "applies
equally to all persons, firms and corporations placed in similar situation."30

8. Further on this point. Apparently, what misled petitioner is his failure to take into consideration
the distinction between a tax rate and a tax base. There is no legal objection to a broader tax base or
taxable income by eliminating all deductible items and at the same time reducing the applicable tax
rate. Taxpayers may be classified into different categories. To repeat, it. is enough that the classification
must rest upon substantial distinctions that make real differences. In the case of the gross income
taxation embodied in Batas Pambansa Blg. 135, the, discernible basis of classification is the susceptibility
of the income to the application of generalized rules removing all deductible items for all taxpayers
within the class and fixing a set of reduced tax rates to be applied to all of them. Taxpayers who are
recipients of compensation income are set apart as a class. As there is practically no overhead expense,
these taxpayers are e not entitled to make deductions for income tax purposes because they are in the
same situation more or less. On the other hand, in the case of professionals in the practice of their
calling and businessmen, there is no uniformity in the costs or expenses necessary to produce their
income. It would not be just then to disregard the disparities by giving all of them zero deduction and
indiscriminately impose on all alike the same tax rates on the basis of gross income. There is ample
justification then for the Batasang Pambansa to adopt the gross system of income taxation to
compensation income, while continuing the system of net income taxation as regards professional and
business income.

9. Nothing can be clearer, therefore, than that the petition is without merit, considering the (1)
lack of factual foundation to show the arbitrary character of the assailed provision; 31 (2) the force of
controlling doctrines on due process, equal protection, and uniformity in taxation and (3) the
reasonableness of the distinction between compensation and taxable net income of professionals and
businessman certainly not a suspect classification,

WHEREFORE, the petition is dismissed. Costs against petitioner.

Makasiar, Concepcion, Jr., Guerero, Melencio-Herrera, Escolin, Relova, Gutierrez, Jr., De la Fuente and
Cuevas, JJ., concur.

Teehankee, J., concurs in the result.

Plana, J., took no part.

Separate Opinions

AQUINO, J., concurring:

I concur in the result. The petitioner has no cause of action for prohibition.

ABAD SANTOS, J., dissenting:

This is a frivolous suit. While the tax rates for compensation income are lower than those for net income
such circumtance does not necessarily result in lower tax payments for these receiving compensation
income. In fact, the reverse will most likely be the case; those who file returns on the basis of net
income will pay less taxes because they claim all sort of deduction justified or not I vote for dismissal.

Separate Opinions

AQUINO, J., concurring:

I concur in the result. The petitioner has no cause of action for prohibition.

ABAD SANTOS, J., dissenting:

This is a frivolous suit. While the tax rates for compensation income are lower than those for net income
such circumtance does not necessarily result in lower tax payments for these receiving compensation
income. In fact, the reverse will most likely be the case; those who file returns on the basis of net
income will pay less taxes because they claim all sort of deduction justified or not I vote for dismissal.
Republic of the Philippines

SUPREME COURT

Manila

EN BANC

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

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

TOURS SPECIALISTS, INC., and THE COURT OF TAX APPEALS, respondents.

Gadioma Law Offices for private respondent.

GUTIERREZ, JR., J.:

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

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

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

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

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

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

1974 deficiency percentage tax

per investigation P 3,995.63

15% surcharge for late payment 998.91

P 4,994.54

14% interest computed by quarters

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

1975 deficiency percentage tax per investigation P 8,427.39

25% surcharge for late payment 2,106.85

P 10,534.24

14% interest computed by quarters

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

1976 deficiency percentage per investigation P 54,276.42

25% surcharge for late payment 13,569.11

P 67,845.53

14% interest computed by quarters

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

Total amount due P 122,946.93

=========

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

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

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

Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written protest, caused the
issuance of a warrant of distraint and levy. (p. 51, BIR Rec.) And later, respondent had petitioner's bank
deposits garnished. (pp. 49-50, BIR Rec.)

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

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

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

The petitioner premises the issue raised on the following assumptions:

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

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

In effect, the petitioner's lone issue is based on alleged error in the findings of facts of the respondent
court.

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

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

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

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

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

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

July 1976 P 102,702.97

Aug. 1976 121,167.1

Sept. 1976 53,209.61

P 282,079.77

=========

Oct. 1976 P 71,134.80

Nov. 1976 409,019.17

Dec. 1976 142,761.55

622,915.51

Grand Total P 904,995.29

=========

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

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

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

. . . [W]hether or not the hotel room charges held in trust for foreign tourists and travelers and/or
correspondent foreign travel agencies and paid to local host hotels form part of the taxable gross
receipts for purposes of the 3% contractor's tax. (Rollo, p. 45)
The petitioner opines that the gross receipts which are subject to the 3% contractor's tax pursuant to
Section 191 (Section 205 of the National Internal Revenue Code of 1977) of the Tax Code include the
entire gross receipts of a taxpayer undiminished by any amount. According to the petitioner, this
interpretation is in consonance with B.I.R. Ruling No. 68-027, dated 23 October, 1968 (implementing
Section 191 of the Tax Code) which states that the 3% contractor's tax prescribed by Section 191 of the
Tax Code is imposed of the gross receipts of the contractor, "no deduction whatever being allowed by
said law." The petitioner contends that the only exception to this rule is when there is a law or
regulation which would exempt such gross receipts from being subjected to the 3% contractor's tax
citing the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (108 Phil. 821 [1960]).
Thus, the petitioner argues that since there is no law or regulation that money entrusted, earmarked
and paid for hotel room charges should not form part of the gross receipts, then the said hotel room
charges are included in the private respondent's gross receipts for purposes of the 3% contractor's tax.

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

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

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

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

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

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

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

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

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

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

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

We think the reasons for upholding the Tax Court's decision in the first case apply to this one. The ten-
peso contribution never belonged to the Club. It was held by it as a trust fund. And then, after all, when
it received the ten-peso contribution, it at the same time contributed ten pesos out of its own pocket,
and thereafter distributed both amounts as prizes to horse owners. It would seem unreasonable to
regard the ten-peso contribution of the horse owners as taxable receipt of the Club, since the latter, at
the same moment it received the contribution necessarily lost ten pesos too.

As demonstrated in the above-mentioned case, gross receipts subject to tax under the Tax Code do not
include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound
to the taxpayer's benefit; and it is not necessary that there must be a law or regulation which would
exempt such monies and receipts within the meaning of gross receipts under the Tax Code.

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

Another objection raised by the petitioner is to the respondent court's application of Presidential Decree
31 which exempts foreign tourists from payment of hotel room tax. Section 1 thereof provides:

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

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

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

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

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

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

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

Accordingly, the significance of P.D. 31 is clearly established in determining whether or not hotel room
charges of foreign tourists in local hotels are subject to the 3% contractor's tax. As the respondent court
aptly stated:

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

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

SO ORDERED.

Fernan, C.J., Narvasa, Melencio-Herrera, Cruz, Paras, Feliciano, Gancayco, Padilla, Bidin, Sarmiento,
Cortes, Grio-Aquino, Medialdea and Regalado, JJ., concur.
THIRD DIVISION

COMMISSIONER OF INTERNAL G.R. No. 172231

REVENUE,

Petitioner,

Present:

- versus - Ynares-Santiago, J. (Chairperson),

Austria-Martinez,

Callejo, Sr.,

Chico-Nazario, and

Nachura, JJ.

ISABELA CULTURAL

CORPORATION, Promulgated:

Respondent.

February 12, 2007

x ---------------------------------------------------------------------------------------- x

DECISION

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision[1] of the
Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision[2] of the Court of Tax
Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the Assessment Notices for
deficiency income tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR)
against respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR
Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86,
and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount
of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986.
The deficiency income tax of P333,196.86, arose from:

(1) The BIRs disallowance of ICCs claimed expense deductions for professional and security services
billed to and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co.,[3] for the year ending December 31, 1985;[4]

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso
Cudala Pecson Azcuna & Bengson for the years 1984 and 1985.[5]

(c) Expense for security services of El Tigre Security & Investigation Agency for the months of April and
May 1986.[6]

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

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly
due to the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction
for security services.[7]

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995,
however, it received a final notice before seizure demanding payment of the amounts stated in the said
notices. Hence, it brought the case to the CTA which held that the petition is premature because the
final notice of assessment cannot be considered as a final decision appealable to the tax court. This was
reversed by the Court of Appeals holding that a demand letter of the BIR reiterating the payment of
deficiency tax, amounts to a final decision on the protested assessment and may therefore be
questioned before the CTA. This conclusion was sustained by this Court on July 1, 2001, in G.R. No.
135210.[8] The case was thus remanded to the CTA for further proceedings.
On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices
issued against ICC. It held that the claimed deductions for professional and security services were
properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment
were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or
1985, it could not declare the same as deduction for the said years as the amount thereof could not be
determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory notes. It
found that it was the BIR which made an overstatement of said income when it compounded the
interest income receivable by ICC from the promissory notes of Realty Investment, Inc., despite the
absence of a stipulation in the contract providing for a compounded interest; nor of a circumstance, like
delay in payment or breach of contract, that would justify the application of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction
for security services as shown by the various payment orders and confirmation receipts it presented as
evidence. The dispositive portion of the CTAs Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for deficiency
income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for
deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest,
both for the taxable year 1986, are hereby CANCELLED and SET ASIDE.

SO ORDERED.[9]

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision,[10]
holding that although the professional services (legal and auditing services) were rendered to ICC in
1984 and 1985, the cost of the services was not yet determinable at that time, hence, it could be
considered as deductible expenses only in 1986 when ICC received the billing statements for said
services. It further ruled that ICC did not understate its interest income from the promissory notes of
Realty Investment, Inc., and that ICC properly withheld and remitted taxes on the payments for security
services for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that
since ICC is using the accrual method of accounting, the expenses for the professional services that
accrued in 1984 and 1985, should have been declared as deductions from income during the said years
and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year
1986. As to the alleged deficiency interest income and failure to withhold expanded withholding tax
assessment, petitioner invoked the presumption that the assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the
expenses for professional and security services from ICCs gross income; and (2) held that ICC did not
understate its interest income from the promissory notes of Realty Investment, Inc; and that ICC
withheld the required 1% withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses,
like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary;
(b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in
carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or
other pertinent papers.[11]

The requisite that it must have been paid or incurred during the taxable year is further qualified by
Section 45 of the National Internal Revenue Code (NIRC) which states that: [t]he deduction provided for
in this Title shall be taken for the taxable year in which paid or accrued or paid or incurred, dependent
upon the method of accounting upon the basis of which the net income is computed x x x.

Accounting methods for tax purposes comprise a set of rules for determining when and how to report
income and deductions.[12] In the instant case, the accounting method used by ICC is the accrual
method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting,
expenses not being claimed as deductions by a taxpayer in the current year when they are incurred
cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is
authorized to deduct certain expenses and other allowable deductions for the current year but failed to
do so cannot deduct the same for the next year.[13]

The accrual method relies upon the taxpayers right to receive amounts or its obligation to pay them, in
opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts
of income accrue where the right to receive them become fixed, where there is created an enforceable
liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to
indeterminacy merely of time of payment.[14]

For a taxpayer using the accrual method, the determinative question is, when do the facts present
themselves in such a manner that the taxpayer must recognize income or expense? The accrual of
income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of
a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of
such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or
liability be determined with reasonable accuracy. However, the test does not demand that the amount
of income or liability be known absolutely, only that a taxpayer has at his disposal the information
necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where
computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation
may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability
does not have to be determined exactly; it must be determined with reasonable accuracy. Accordingly,
the term reasonable accuracy implies something less than an exact or completely accurate amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be
expected to have known, at the closing of its books for the taxable year.[16] Accrual method of
accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of
establishing the accrual of an item of income or deduction.[17]

Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi
juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an exemption
must be able to justify the same by the clearest grant of organic or statute law. An exemption from the
common burden cannot be permitted to exist upon vague implications. And since a deduction for
income tax purposes partakes of the nature of a tax exemption, then it must also be strictly
construed.[18]

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

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears
the burden of establishing the accrual of an expense or income. However, ICC failed to discharge this
burden. As to when the firms performance of its services in connection with the 1984 tax problems were
completed, or whether ICC exercised reasonable diligence to inquire about the amount of its liability, or
whether it does or does not possess the information necessary to compute the amount of said liability
with reasonable accuracy, are questions of fact which ICC never established. It simply relied on the
defense of delayed billing by the firm and the company, which under the circumstances, is not sufficient
to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal
and auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the
year 1985 cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to
present evidence showing that even with only reasonable accuracy, as the standard to ascertain its
liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said company
would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the
professional services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit
Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income for the said year
and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by ICC in
1986[20] and could therefore be properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty
Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no such
understatement exists and that only simple interest computation and not a compounded one should
have been applied by the BIR. There is indeed no stipulation between the latter and ICC on the
application of compounded interest.[21] Under Article 1959 of the Civil Code, unless there is a
stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required
withholding tax from its claimed deductions for security services and remitted the same to the BIR is
supported by payment order and confirmation receipts.[22] Hence, the Assessment Notice for
deficiency expanded withholding tax was properly cancelled and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income
tax should be cancelled and set aside but only insofar as the claimed deductions of ICC for security
services. Said Assessment is valid as to the BIRs disallowance of ICCs expenses for professional services.
The Court of Appeals cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount of
P4,897.79 for deficiency expanded withholding tax, is sustained.

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

The case is remanded to the BIR for the computation of Isabela Cultural Corporations liability under
Assessment Notice No. FAS-1-86-90-000680.

SO ORDERED.
FIRST DIVISION

[G.R. No. 137377. December 18, 2001]

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. MARUBENI CORPORATION, respondent.

DECISION

PUNO, J.

In this petition for review, the Commissioner of Internal Revenue assails the decision dated January 15,
1999 of the Court of Appeals in CA-G.R. SP No. 42518 which affirmed the decision dated July 29, 1996 of
the Court of Tax Appeals in CTA Case No. 4109. The tax court ordered the Commissioner of Internal
Revenue to desist from collecting the 1985 deficiency income, branch profit remittance and contractors
taxes from Marubeni Corporation after finding the latter to have properly availed of the tax amnesty
under Executive Orders Nos. 41 and 64, as amended.

Respondent Marubeni Corporation is a foreign corporation organized and existing under the laws of
Japan. It is engaged in general import and export trading, financing and the construction business. It is
duly registered to engage in such business in the Philippines and maintains a branch office in Manila.

Sometime in November 1985, petitioner Commissioner of Internal Revenue issued a letter of authority
to examine the books of accounts of the Manila branch office of respondent corporation for the fiscal
year ending March 1985. In the course of the examination, petitioner found respondent to have
undeclared income from two (2) contracts in the Philippines, both of which were completed in 1984.
One of the contracts was with the National Development Company (NDC) in connection with the
construction and installation of a wharf/port complex at the Leyte Industrial Development Estate in the
municipality of Isabel, province of Leyte. The other contract was with the Philippine Phosphate Fertilizer
Corporation (Philphos) for the construction of an ammonia storage complex also at the Leyte Industrial
Development Estate.

On March 1, 1986, petitioners revenue examiners recommended an assessment for deficiency income,
branch profit remittance, contractors and commercial brokers taxes. Respondent questioned this
assessment in a letter dated June 5, 1986.

On August 27, 1986, respondent corporation received a letter dated August 15, 1986 from petitioner
assessing respondent several deficiency taxes. The assessed deficiency internal revenue taxes, inclusive
of surcharge and interest, were as follows:
I. DEFICIENCY INCOME TAX

FY ended March 31, 1985

Undeclared gross income (Philphos and

and NDC construction projects). . . . . . . . . . . . P 967,269,811.14

Less: Cost and expenses (50%) . . . . . . . . . . . . . . . 483,634,905.57

Net undeclared income . . . . . . . . . . . . . . . . . . . . . . . 483,634,905.57

Income tax due thereon . . . . . . . . . . . . . . . . . . . . . . . 169,272,217.00

Add: 50% surcharge . . . . . . . . . . . . . . . . . . . . . . . 84,636,108.50

20% int. p.a. fr. 7-15-85 to

to 8-15-86 . . . . . . . . . . . . . . . . . . . . . . 36,675,646.90

TOTAL AMOUNT DUE . . . . . . . . . . . . . . . . . . . . . P 290,583,972.40

II. DEFICIENCY BRANCH PROFIT REMITTANCE TAX

FY ended March 31, 1985

Undeclared net income from

Philphos and NDC construction projects . . . . . P 483,634,905.57

Less: Income tax thereon . . . . . . . . . . . . . . . . . . . . . 169,272,217.00

Amount subject to Tax . . . . . . . . . . . . . . . . . . . . . . . 314,362,688.57

Tax due thereon . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,154,403.00

Add: 50% surcharge . . . . . . . . . . . . . . . . . . . . . . 23,577,201.50

20% int. p.a. fr. 4-26-85

to 8-15-86 . . . . . . . . . . . . . . . . . . . . . . 12,305,360.66

TOTAL AMOUNT DUE . . . . . . . . . . . . . . . . . . . . . P 83,036,965.16

III. DEFICIENCY CONTRACTORS TAX

FY ended March 31, 1985

Undeclared gross receipts/ gross income from

Philphos and NDC construction projects . . . . P 967,269,811.14

Contractors tax due thereon (4%). . . . . . . . . . . . . . . 38,690,792.00

Add: 50% surcharge for non-declaration. . . . . . 19,345,396.00

25% surcharge for late payment . . . . . . . . . 9,672,698.00

Sub-total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,708,886.00

Add: 20% int. p.a. fr. 4-21-85 to

to 8-15-86 . . . . . . . . . . . . . . . . . . . . . . 17,854,739.46

TOTAL AMOUNT DUE . . . . . . . . . . . . . . . . . . . . . P 85,563,625.46

IV. DEFICIENCY COMMERCIAL BROKERS TAX

FY ended March 31, 1985

Undeclared share from commission income

(denominated as subsidy from Home

Office). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 24,683,114.50

Tax due thereon . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 1,628,569.00

Add: 50% surcharge for non-declaration. . . . . . . 814,284.50

25% surcharge for late payment . . . . . . . . . 407,142.25

Sub-total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 2,849,995.75

Add: 20% int. p.a. fr. 4-21-85

to 8-15-86 . . . . . . . . . . . . . . . . . . . . . . 751,539.98

TOTAL AMOUNT DUE . . . . . . . . . . . . . . . . . . . P 3,600,535.68

The 50% surcharge was imposed for your clients failure to report for tax purposes the aforesaid taxable
revenues while the 25% surcharge was imposed because of your clients failure to pay on time the above
deficiency percentage taxes.
x x x x x x x x x. [1]

Petitioner found that the NDC and Philphos contracts were made on a turn-key basis and that the gross
income from the two projects amounted to P967,269,811.14. Each contract was for a piece of work and
since the projects called for the construction and installation of facilities in the Philippines, the entire
income therefrom constituted income from Philippine sources, hence, subject to internal revenue taxes.
The assessment letter further stated that the same was petitioners final decision and that if respondent
disagreed with it, respondent may file an appeal with the Court of Tax Appeals within thirty (30) days
from receipt of the assessment.

On September 26, 1986, respondent filed two (2) petitions for review with the Court of Tax Appeals. The
first petition, CTA Case No. 4109, questioned the deficiency income, branch profit remittance and
contractors tax assessments in petitioners assessment letter. The second, CTA Case No. 4110,
questioned the deficiency commercial brokers assessment in the same letter.

Earlier, on August 2, 1986, Executive Order (E.O.) No. 41[2] declaring a one-time amnesty covering
unpaid income taxes for the years 1981 to 1985 was issued. Under this E.O., a taxpayer who wished to
avail of the income tax amnesty should, on or before October 31, 1986: (a) file a sworn statement
declaring his net worth as of December 31, 1985; (b) file a certified true copy of his statement declaring
his net worth as of December 31, 1980 on record with the Bureau of Internal Revenue (BIR), or if no
such record exists, file a statement of said net worth subject to verification by the BIR; and (c) file a
return and pay a tax equivalent to ten per cent (10%) of the increase in net worth from December 31,
1980 to December 31, 1985.

In accordance with the terms of E.O. No. 41, respondent filed its tax amnesty return dated October 30,
1986 and attached thereto its sworn statement of assets and liabilities and net worth as of Fiscal Year
(FY) 1981 and FY 1986. The return was received by the BIR on November 3, 1986 and respondent paid
the amount of P2,891,273.00 equivalent to ten percent (10%) of its net worth increase between 1981
and 1986.

The period of the amnesty in E.O. No. 41 was later extended from October 31, 1986 to December 5,
1986 by E.O. No. 54 dated November 4, 1986.

On November 17, 1986, the scope and coverage of E.O. No. 41 was expanded by Executive Order (E.O.)
No. 64. In addition to the income tax amnesty granted by E.O. No. 41 for the years 1981 to 1985, E.O.
No. 64[3] included estate and donors taxes under Title III and the tax on business under Chapter II, Title
V of the National Internal Revenue Code, also covering the years 1981 to 1985. E.O. No. 64 further
provided that the immunities and privileges under E.O. No. 41 were extended to the foregoing tax
liabilities, and the period within which the taxpayer could avail of the amnesty was extended to
December 15, 1986. Those taxpayers who already filed their amnesty return under E.O. No. 41, as
amended, could avail themselves of the benefits, immunities and privileges under the new E.O. by filing
an amended return and paying an additional 5% on the increase in net worth to cover business, estate
and donors tax liabilities.

The period of amnesty under E.O. No. 64 was extended to January 31, 1987 by E.O No. 95 dated
December 17, 1986.

On December 15, 1986, respondent filed a supplemental tax amnesty return under the benefit of E.O.
No. 64 and paid a further amount of P1,445,637.00 to the BIR equivalent to five percent (5%) of the
increase of its net worth between 1981 and 1986.

On July 29, 1996, almost ten (10) years after filing of the case, the Court of Tax Appeals rendered a
decision in CTA Case No. 4109. The tax court found that respondent had properly availed of the tax
amnesty under E.O. Nos. 41 and 64 and declared the deficiency taxes subject of said case as deemed
cancelled and withdrawn. The Court of Tax Appeals disposed of as follows:

WHEREFORE, the respondent Commissioner of Internal Revenue is hereby ORDERED to DESIST from
collecting the 1985 deficiency taxes it had assessed against petitioner and the same are deemed
considered [sic] CANCELLED and WITHDRAWN by reason of the proper availment by petitioner of the
amnesty under Executive Order No. 41, as amended.[4]

Petitioner challenged the decision of the tax court by filing CA-G.R. SP No. 42518 with the Court of
Appeals.

On January 15, 1999, the Court of Appeals dismissed the petition and affirmed the decision of the Court
of Tax Appeals. Hence, this recourse.

Before us, petitioner raises the following issues:

(1) Whether or not the Court of Appeals erred in affirming the Decision of the Court of Tax Appeals
which ruled that herein respondents deficiency tax liabilities were extinguished upon respondents
availment of tax amnesty under Executive Orders Nos. 41 and 64.

(2) Whether or not respondent is liable to pay the income, branch profit remittance, and contractors
taxes assessed by petitioner.[5]

The main controversy in this case lies in the interpretation of the exception to the amnesty coverage of
E.O. Nos. 41 and 64. There are three (3) types of taxes involved herein income tax, branch profit
remittance tax and contractors tax. These taxes are covered by the amnesties granted by E.O. Nos. 41
and 64. Petitioner claims, however, that respondent is disqualified from availing of the said amnesties
because the latter falls under the exception in Section 4 (b) of E.O. No. 41.

Section 4 of E.O. No. 41 enumerates which taxpayers cannot avail of the amnesty granted thereunder,
viz:

Sec. 4. Exceptions.The following taxpayers may not avail themselves of the amnesty herein granted:

a) Those falling under the provisions of Executive Order Nos. 1, 2 and 14;

b) Those with income tax cases already filed in Court as of the effectivity hereof;

c) Those with criminal cases involving violations of the income tax law already filed in court as of the
effectivity hereof;

d) Those that have withholding tax liabilities under the National Internal Revenue Code, as amended,
insofar as the said liabilities are concerned;
e) Those with tax cases pending investigation by the Bureau of Internal Revenue as of the effectivity
hereof as a result of information furnished under Section 316 of the National Internal Revenue Code, as
amended;

f) Those with pending cases involving unexplained or unlawfully acquired wealth before the
Sandiganbayan;

g) Those liable under Title Seven, Chapter Three (Frauds, Illegal Exactions and Transactions) and Chapter
Four (Malversation of Public Funds and Property) of the Revised Penal Code, as amended.

Petitioner argues that at the time respondent filed for income tax amnesty on October 30, 1986, CTA
Case No. 4109 had already been filed and was pending before the Court of Tax Appeals. Respondent
therefore fell under the exception in Section 4 (b) of E.O. No. 41.

Petitioners claim cannot be sustained. Section 4 (b) of E.O. No. 41 is very clear and unambiguous. It
excepts from income tax amnesty those taxpayers with income tax cases already filed in court as of the
effectivity hereof. The point of reference is the date of effectivity of E.O. No. 41. The filing of income tax
cases in court must have been made before and as of the date of effectivity of E.O. No. 41. Thus, for a
taxpayer not to be disqualified under Section 4 (b) there must have been no income tax cases filed in
court against him when E.O. No. 41 took effect. This is regardless of when the taxpayer filed for income
tax amnesty, provided of course he files it on or before the deadline for filing.

E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioning the 1985 deficiency income,
branch profit remittance and contractors tax assessments was filed by respondent with the Court of Tax
Appeals on September 26, 1986. When E.O. No. 41 became effective on August 22, 1986, CTA Case No.
4109 had not yet been filed in court. Respondent corporation did not fall under the said exception in
Section 4 (b), hence, respondent was not disqualified from availing of the amnesty for income tax under
E.O. No. 41.

The same ruling also applies to the deficiency branch profit remittance tax assessment. A branch profit
remittance tax is defined and imposed in Section 24 (b) (2) (ii), Title II, Chapter III of the National Internal
Revenue Code.[6] In the tax code, this tax falls under Title II on Income Tax. It is a tax on income.
Respondent therefore did not fall under the exception in Section 4 (b) when it filed for amnesty of its
deficiency branch profit remittance tax assessment.
The difficulty herein is with respect to the contractors tax assessment and respondents availment of the
amnesty under E.O. No. 64. E.O. No. 64 expanded the coverage of E.O. No. 41 by including estate and
donors taxes and tax on business. Estate and donors taxes fall under Title III of the Tax Code while
business taxes fall under Chapter II, Title V of the same. The contractors tax is provided in Section 205,
Chapter II, Title V of the Tax Code; it is defined and imposed under the title on business taxes, and is
therefore a tax on business.[7]

When E.O. No. 64 took effect on November 17, 1986, it did not provide for exceptions to the coverage
of the amnesty for business, estate and donors taxes. Instead, Section 8 of E.O. No. 64 provided that:

Section 8. The provisions of Executive Orders Nos. 41 and 54 which are not contrary to or inconsistent
with this amendatory Executive Order shall remain in full force and effect.

By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 not contrary to or inconsistent with
the amendatory act were reenacted in E.O. No. 64. Thus, Section 4 of E.O. No. 41 on the exceptions to
amnesty coverage also applied to E.O. No. 64. With respect to Section 4 (b) in particular, this provision
excepts from tax amnesty coverage a taxpayer who has income tax cases already filed in court as of the
effectivity hereof. As to what Executive Order the exception refers to, respondent argues that because
of the words income and hereof, they refer to Executive Order No. 41.[8]

In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot be construed to refer to E.O.
No. 41 and its date of effectivity. The general rule is that an amendatory act operates prospectively.[9]
While an amendment is generally construed as becoming a part of the original act as if it had always
been contained therein,[10] it may not be given a retroactive effect unless it is so provided expressly or
by necessary implication and no vested right or obligations of contract are thereby impaired.[11]

There is nothing in E.O. No. 64 that provides that it should retroact to the date of effectivity of E.O. No.
41, the original issuance. Neither is it necessarily implied from E.O. No. 64 that it or any of its provisions
should apply retroactively. Executive Order No. 64 is a substantive amendment of E.O. No. 41. It does
not merely change provisions in E.O. No. 41. It supplements the original act by adding other taxes not
covered in the first.[12] It has been held that where a statute amending a tax law is silent as to whether
it operates retroactively, the amendment will not be given a retroactive effect so as to subject to tax
past transactions not subject to tax under the original act.[13] In an amendatory act, every case of doubt
must be resolved against its retroactive effect.[14]

Moreover, E.O. Nos. 41 and 64 are tax amnesty issuances. A tax amnesty is a general pardon or
intentional overlooking by the State of its authority to impose penalties on persons otherwise guilty of
evasion or violation of a revenue or tax law.[15] It partakes of an absolute forgiveness or waiver by the
government of its right to collect what is due it and to give tax evaders who wish to relent a chance to
start with a clean slate.[16] A tax amnesty, much like a tax exemption, is never favored nor presumed in
law.[17] If granted, the terms of the amnesty, like that of a tax exemption, must be construed strictly
against the taxpayer and liberally in favor of the taxing authority.[18] For the right of taxation is inherent
in government. The State cannot strip itself of the most essential power of taxation by doubtful words.
He who claims an exemption (or an amnesty) from the common burden must justify his claim by the
clearest grant of organic or state law. It cannot be allowed to exist upon a vague implication. If a doubt
arises as to the intent of the legislature, that doubt must be resolved in favor of the state.[19]

In the instant case, the vagueness in Section 4 (b) brought about by E.O. No. 64 should therefore be
construed strictly against the taxpayer. The term income tax cases should be read as to refer to estate
and donors taxes and taxes on business while the word hereof, to E.O. No. 64. Since Executive Order No.
64 took effect on November 17, 1986, consequently, insofar as the taxes in E.O. No. 64 are concerned,
the date of effectivity referred to in Section 4 (b) of E.O. No. 41 should be November 17, 1986.

Respondent filed CTA Case No. 4109 on September 26, 1986. When E.O. No. 64 took effect on
November 17, 1986, CTA Case No. 4109 was already filed and pending in court. By the time respondent
filed its supplementary tax amnesty return on December 15, 1986, respondent already fell under the
exception in Section 4 (b) of E.O. Nos. 41 and 64 and was disqualified from availing of the business tax
amnesty granted therein.

It is respondents other argument that assuming it did not validly avail of the amnesty under the two
Executive Orders, it is still not liable for the deficiency contractors tax because the income from the
projects came from the Offshore Portion of the contracts. The two contracts were divided into two
parts, i.e., the Onshore Portion and the Offshore Portion. All materials and equipment in the contract
under the Offshore Portion were manufactured and completed in Japan, not in the Philippines, and are
therefore not subject to Philippine taxes.
Before going into respondents arguments, it is necessary to discuss the background of the two
contracts, examine their pertinent provisions and implementation.

The NDC and Philphos are two government corporations. In 1980, the NDC, as the corporate investment
arm of the Philippine Government, established the Philphos to engage in the large-scale manufacture of
phosphatic fertilizer for the local and foreign markets.[20] The Philphos plant complex which was
envisioned to be the largest phosphatic fertilizer operation in Asia, and among the largest in the world,
covered an area of 180 hectares within the 435-hectare Leyte Industrial Development Estate in the
municipality of Isabel, province of Leyte.

In 1982, the NDC opened for public bidding a project to construct and install a modern, reliable, efficient
and integrated wharf/port complex at the Leyte Industrial Development Estate. The wharf/ port
complex was intended to be one of the major facilities for the industrial plants at the Leyte Industrial
Development Estate. It was to be specifically adapted to the site for the handling of phosphate rock,
bagged or bulk fertilizer products, liquid materials and other products of Philphos, the Philippine
Associated Smelting and Refining Corporation (Pasar),[21] and other industrial plants within the Estate.
The bidding was participated in by Marubeni Head Office in Japan.

Marubeni, Japan pre-qualified and on March 22, 1982, the NDC and respondent entered into an
agreement entitled Turn-Key Contract for Leyte Industrial Estate Port Development Project Between
National Development Company and Marubeni Corporation.[22] The Port Development Project would
consist of a wharf, berths, causeways, mechanical and liquids unloading and loading systems, fuel oil
depot, utilities systems, storage and service buildings, offsite facilities, harbor service vessels,
navigational aid system, fire-fighting system, area lighting, mobile equipment, spare parts and other
related facilities.[23] The scope of the works under the contract covered turn-key supply, which included
grants of licenses and the transfer of technology and know-how,[24] and:

x x x the design and engineering, supply and delivery, construction, erection and installation,
supervision, direction and control of testing and commissioning of the Wharf-Port Complex as set forth
in Annex I of this Contract, as well as the coordination of tie-ins at boundaries and schedule of the use of
a part or the whole of the Wharf/Port Complex through the Owner, with the design and construction of
other facilities around the site. The scope of works shall also include any activity, work and supply
necessary for, incidental to or appropriate under present international industrial port practice, for the
timely and successful implementation of the object of this Contract, whether or not expressly referred
to in the abovementioned Annex I.[25]
The contract price for the wharf/ port complex was Y12,790,389,000.00 and P44,327,940.00. In the
contract, the price in Japanese currency was broken down into two portions: (1) the Japanese Yen
Portion I; (2) the Japanese Yen Portion II, while the price in Philippine currency was referred to as the
Philippine Pesos Portion. The Japanese Yen Portions I and II were financed in two (2) ways: (a) by yen
credit loan provided by the Overseas Economic Cooperation Fund (OECF); and (b) by suppliers credit in
favor of Marubeni from the Export-Import Bank of Japan. The OECF is a Fund under the Ministry of
Finance of Japan extended by the Japanese government as assistance to foreign governments to
promote economic development.[26] The OECF extended to the Philippine Government a loan of
Y7,560,000,000.00 for the Leyte Industrial Estate Port Development Project and authorized the NDC to
implement the same.[27] The other type of financing is an indirect type where the supplier, i.e.,
Marubeni, obtained a loan from the Export-Import Bank of Japan to advance payment to its sub-
contractors.[28]

Under the financing schemes, the Japanese Yen Portions I and II and the Philippine Pesos Portion were
further broken down and subdivided according to the materials, equipment and services rendered on
the project. The price breakdown and the corresponding materials, equipment and services were
contained in a list attached as Annex III to the contract.[29]

A few months after execution of the NDC contract, Philphos opened for public bidding a project to
construct and install two ammonia storage tanks in Isabel. Like the NDC contract, it was Marubeni Head
Office in Japan that participated in and won the bidding. Thus, on May 2, 1982, Philphos and respondent
corporation entered into an agreement entitled Turn-Key Contract for Ammonia Storage Complex
Between Philippine Phosphate Fertilizer Corporation and Marubeni Corporation.[30] The object of the
contract was to establish and place in operating condition a modern, reliable, efficient and integrated
ammonia storage complex adapted to the site for the receipt and storage of liquid anhydrous
ammonia[31]and for the delivery of ammonia to an integrated fertilizer plant adjacent to the storage
complex and to vessels at the dock.[32] The storage complex was to consist of ammonia storage tanks,
refrigeration system, ship unloading system, transfer pumps, ammonia heating system, fire-fighting
system, area lighting, spare parts, and other related facilities.[33] The scope of the works required for
the completion of the ammonia storage complex covered the supply, including grants of licenses and
transfer of technology and know-how,[34] and:

x x x the design and engineering, supply and delivery, construction, erection and installation,
supervision, direction and control of testing and commissioning of the Ammonia Storage Complex as set
forth in Annex I of this Contract, as well as the coordination of tie-ins at boundaries and schedule of the
use of a part or the whole of the Ammonia Storage Complex through the Owner with the design and
construction of other facilities at and around the Site. The scope of works shall also include any activity,
work and supply necessary for, incidental to or appropriate under present international industrial
practice, for the timely and successful implementation of the object of this Contract, whether or not
expressly referred to in the abovementioned Annex I.[35]

The contract price for the project was Y3,255,751,000.00 and P17,406,000.00. Like the NDC contract,
the price was divided into three portions. The price in Japanese currency was broken down into the
Japanese Yen Portion I and Japanese Yen Portion II while the price in Philippine currency was classified
as the Philippine Pesos Portion. Both Japanese Yen Portions I and II were financed by suppliers credit
from the Export-Import Bank of Japan. The price stated in the three portions were further broken down
into the corresponding materials, equipment and services required for the project and their individual
prices. Like the NDC contract, the breakdown in the Philphos contract is contained in a list attached to
the latter as Annex III.[36]

The division of the price into Japanese Yen Portions I and II and the Philippine Pesos Portion under the
two contracts corresponds to the two parts into which the contracts were classifiedthe Foreign Offshore
Portion and the Philippine Onshore Portion. In both contracts, the Japanese Yen Portion I corresponds to
the Foreign Offshore Portion.[37] Japanese Yen Portion II and the Philippine Pesos Portion correspond to
the Philippine Onshore Portion.[38]

Under the Philippine Onshore Portion, respondent does not deny its liability for the contractors tax on
the income from the two projects. In fact respondent claims, which petitioner has not denied, that the
income it derived from the Onshore Portion of the two projects had been declared for tax purposes and
the taxes thereon already paid to the Philippine government.[39] It is with regard to the gross receipts
from the Foreign Offshore Portion of the two contracts that the liabilities involved in the assessments
subject of this case arose. Petitioner argues that since the two agreements are turn-key,[40] they call for
the supply of both materials and services to the client, they are contracts for a piece of work and are
indivisible. The situs of the two projects is in the Philippines, and the materials provided and services
rendered were all done and completed within the territorial jurisdiction of the Philippines.[41]
Accordingly, respondents entire receipts from the contracts, including its receipts from the Offshore
Portion, constitute income from Philippine sources. The total gross receipts covering both labor and
materials should be subjected to contractors tax in accordance with the ruling in Commissioner of
Internal Revenue v. Engineering Equipment & Supply Co.[42]

A contractors tax is imposed in the National Internal Revenue Code (NIRC) as follows:
Sec. 205. Contractors, proprietors or operators of dockyards, and others.A contractors tax of four
percent of the gross receipts is hereby imposed on proprietors or operators of the following business
establishments and/or persons engaged in the business of selling or rendering the following services for
a fee or compensation:

(a) General engineering, general building and specialty contractors, as defined in Republic Act No. 4566;

xxxxxxxxx

(q) Other independent contractors. The term independent contractors includes persons (juridical or
natural) not enumerated above (but not including individuals subject to the occupation tax under the
Local Tax Code) whose activity consists essentially of the sale of all kinds of services for a fee regardless
of whether or not the performance of the service calls for the exercise or use of the physical or mental
faculties of such contractors or their employees. It does not include regional or area headquarters
established in the Philippines by multinational corporations, including their alien executives, and which
headquarters do not earn or derive income from the Philippines and which act as supervisory,
communications and coordinating centers for their affiliates, subsidiaries or branches in the Asia-Pacific
Region.

x x x x x x x x x.[43]

Under the afore-quoted provision, an independent contractor is a person whose activity consists
essentially of the sale of all kinds of services for a fee, regardless of whether or not the performance of
the service calls for the exercise or use of the physical or mental faculties of such contractors or their
employees. The word contractor refers to a person who, in the pursuit of independent business,
undertakes to do a specific job or piece of work for other persons, using his own means and methods
without submitting himself to control as to the petty details.[44]

A contractors tax is a tax imposed upon the privilege of engaging in business.[45] It is generally in the
nature of an excise tax on the exercise of a privilege of selling services or labor rather than a sale on
products;[46] and is directly collectible from the person exercising the privilege.[47] Being an excise tax,
it can be levied by the taxing authority only when the acts, privileges or business are done or performed
within the jurisdiction of said authority.[48] Like property taxes, it cannot be imposed on an occupation
or privilege outside the taxing district.[49]
In the case at bar, it is undisputed that respondent was an independent contractor under the terms of
the two subject contracts. Respondent, however, argues that the work therein were not all performed in
the Philippines because some of them were completed in Japan in accordance with the provisions of the
contracts.

An examination of Annex III to the two contracts reveals that the materials and equipment to be made
and the works and services to be performed by respondent are indeed classified into two. The first part,
entitled Breakdown of Japanese Yen Portion I provides:

Japanese Yen Portion I of the Contract Price has been subdivided according to discrete portions of
materials and equipment which will be shipped to Leyte as units and lots. This subdivision of price is to
be used by owner to verify invoice for Progress Payments under Article 19.2.1 of the Contract. The
agreed subdivision of Japanese Yen Portion I is as follows:

x x x x x x x x x. [50]

The subdivision of Japanese Yen Portion I covers materials and equipment while Japanese Yen Portion II
and the Philippine Pesos Portion enumerate other materials and equipment and the construction and
installation work on the project. In other words, the supplies for the project are listed under Portion I
while labor and other supplies are listed under Portion II and the Philippine Pesos Portion. Mr. Takeshi
Hojo, then General Manager of the Industrial Plant Section II of the Industrial Plant Department of
Marubeni Corporation in Japan who supervised the implementation of the two projects, testified that all
the machines and equipment listed under Japanese Yen Portion I in Annex III were manufactured in
Japan.[51] The machines and equipment were designed, engineered and fabricated by Japanese firms
sub-contracted by Marubeni from the list of sub-contractors in the technical appendices to each
contract.[52] Marubeni sub-contracted a majority of the equipment and supplies to Kawasaki Steel
Corporation which did the design, fabrication, engineering and manufacture thereof;[53] Yashima & Co.
Ltd. which manufactured the mobile equipment; Bridgestone which provided the rubber fenders of the
mobile equipment;[54] and B.S. Japan for the supply of radio equipment.[55] The engineering and
design works made by Kawasaki Steel Corporation included the lay-out of the plant facility and
calculation of the design in accordance with the specifications given by respondent.[56] All sub-
contractors and manufacturers are Japanese corporations and are based in Japan and all engineering
and design works were performed in that country.[57]
The materials and equipment under Portion I of the NDC Port Project is primarily composed of two (2)
sets of ship unloader and loader; several boats and mobile equipment.[58] The ship unloader unloads
bags or bulk products from the ship to the port while the ship loader loads products from the port to the
ship. The unloader and loader are big steel structures on top of each is a large crane and a compartment
for operation of the crane. Two sets of these equipment were completely manufactured in Japan
according to the specifications of the project. After manufacture, they were rolled on to a barge and
transported to Isabel, Leyte.[59] Upon reaching Isabel, the unloader and loader were rolled off the barge
and pulled to the pier to the spot where they were installed.[60] Their installation simply consisted of
bolting them onto the pier.[61]

Like the ship unloader and loader, the three tugboats and a line boat were completely manufactured in
Japan. The boats sailed to Isabel on their own power. The mobile equipment, consisting of three to four
sets of tractors, cranes and dozers, trailers and forklifts, were also manufactured and completed in
Japan. They were loaded on to a shipping vessel and unloaded at the Isabel Port. These pieces of
equipment were all on wheels and self-propelled. Once unloaded at the port, they were ready to be
driven and perform what they were designed to do.[62]

In addition to the foregoing, there are other items listed in Japanese Yen Portion I in Annex III to the
NDC contract. These other items consist of supplies and materials for five (5) berths, two (2) roads, a
causeway, a warehouse, a transit shed, an administration building and a security building. Most of the
materials consist of steel sheets, steel pipes, channels and beams and other steel structures,
navigational and communication as well as electrical equipment. [63]

In connection with the Philphos contract, the major pieces of equipment supplied by respondent were
the ammonia storage tanks and refrigeration units.[64] The steel plates for the tank were manufactured
and cut in Japan according to drawings and specifications and then shipped to Isabel. Once there,
respondents employees put the steel plates together to form the storage tank. As to the refrigeration
units, they were completed and assembled in Japan and thereafter shipped to Isabel. The units were
simply installed there.[65] Annex III to the Philphos contract lists down under the Japanese Yen Portion I
the materials for the ammonia storage tank, incidental equipment, piping facilities, electrical and
instrumental apparatus, foundation material and spare parts.

All the materials and equipment transported to the Philippines were inspected and tested in Japan prior
to shipment in accordance with the terms of the contracts.[66] The inspection was made by
representatives of respondent corporation, of NDC and Philphos. NDC, in fact, contracted the services of
a private consultancy firm to verify the correctness of the tests on the machines and
equipment[67]while Philphos sent a representative to Japan to inspect the storage equipment.[68]

The sub-contractors of the materials and equipment under Japanese Yen Portion I were all paid by
respondent in Japan. In his deposition upon oral examination, Kenjiro Yamakawa, formerly the Assistant
General Manager and Manager of the Steel Plant Marketing Department, Engineering & Construction
Division, Kawasaki Steel Corporation, testified that the equipment and supplies for the two projects
provided by Kawasaki under Japanese Yen Portion I were paid by Marubeni in Japan. Receipts for such
payments were duly issued by Kawasaki in Japanese and English.[69] Yashima & Co. Ltd. and B.S. Japan
were likewise paid by Marubeni in Japan.[70]

Between Marubeni and the two Philippine corporations, payments for all materials and equipment
under Japanese Yen Portion I were made to Marubeni by NDC and Philphos also in Japan. The NDC,
through the Philippine National Bank, established letters of credit in favor of respondent through the
Bank of Tokyo. The letters of credit were financed by letters of commitment issued by the OECF with the
Bank of Tokyo. The Bank of Tokyo, upon respondents submission of pertinent documents, released the
amount in the letters of credit in favor of respondent and credited the amount therein to respondents
account within the same bank.[71]

Clearly, the service of design and engineering, supply and delivery, construction, erection and
installation, supervision, direction and control of testing and commissioning, coordination[72]of the two
projects involved two taxing jurisdictions. These acts occurred in two countries Japan and the
Philippines. While the construction and installation work were completed within the Philippines, the
evidence is clear that some pieces of equipment and supplies were completely designed and engineered
in Japan. The two sets of ship unloader and loader, the boats and mobile equipment for the NDC project
and the ammonia storage tanks and refrigeration units were made and completed in Japan. They were
already finished products when shipped to the Philippines. The other construction supplies listed under
the Offshore Portion such as the steel sheets, pipes and structures, electrical and instrumental
apparatus, these were not finished products when shipped to the Philippines. They, however, were
likewise fabricated and manufactured by the sub-contractors in Japan. All services for the design,
fabrication, engineering and manufacture of the materials and equipment under Japanese Yen Portion I
were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the
Philippines and are therefore not subject to contractors tax.

Contrary to petitioners claim, the case of Commissioner of Internal Revenue v. Engineering Equipment &
Supply Co[73]is not in point. In that case, the Court found that Engineering Equipment, although an
independent contractor, was not engaged in the manufacture of air conditioning units in the Philippines.
Engineering Equipment designed, supplied and installed centralized air-conditioning systems for clients
who contracted its services. Engineering, however, did not manufacture all the materials for the air-
conditioning system. It imported some items for the system it designed and installed.[74] The issues in
that case dealt with services performed within the local taxing jurisdiction. There was no foreign
element involved in the supply of materials and services.

With the foregoing discussion, it is unnecessary to discuss the other issues raised by the parties.

IN VIEW WHEREOF, the petition is denied. The decision in CA-G.R. SP No. 42518 is affirmed.

SO ORDERED.

Davide, Jr., C.J., (Chairman), Kapunan, Pardo, and Ynares-Santiago, JJ., concur.
FIRST DIVISION

G.R. No. 153793 August 29, 2006

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.

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

DECISION

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18, 2002 Decision1 of the
Court of Appeals in CA-G.R. SP No. 59794, which granted the tax refund of respondent Juliane Baier-
Nickel and reversed the June 28, 2000 Decision2 of the Court of Tax Appeals (CTA) in C.T.A. Case No.
5633. Petitioner also assails the May 8, 2002 Resolution3 of the Court of Appeals denying its motion for
reconsideration.

The facts show that respondent Juliane Baier-Nickel, a non-resident German citizen, is the President of
JUBANITEX, Inc., a domestic corporation engaged in "[m]anufacturing, marketing on wholesale only,
buying or otherwise acquiring, holding, importing and exporting, selling and disposing embroidered
textile products."4 Through JUBANITEXs General Manager, Marina Q. Guzman, the corporation
appointed and engaged the services of respondent as commission agent. It was agreed that respondent
will receive 10% sales commission on all sales actually concluded and collected through her efforts.5

In 1995, respondent received the amount of P1,707,772.64, representing her sales commission income
from which JUBANITEX withheld the corresponding 10% withholding tax amounting to P170,777.26, and
remitted the same to the Bureau of Internal Revenue (BIR). On October 17, 1997, respondent filed her
1995 income tax return reporting a taxable income of P1,707,772.64 and a tax due of P170,777.26.6

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26 alleged to have been
mistakenly withheld and remitted by JUBANITEX to the BIR. Respondent contended that her sales
commission income is not taxable in the Philippines because the same was a compensation for her
services rendered in Germany and therefore considered as income from sources outside the Philippines.

The next day, April 15, 1998, she filed a petition for review with the CTA contending that no action was
taken by the BIR on her claim for refund.7 On June 28, 2000, the CTA rendered a decision denying her
claim. It held that the commissions received by respondent were actually her remuneration in the
performance of her duties as President of JUBANITEX and not as a mere sales agent thereof. The income
derived by respondent is therefore an income taxable in the Philippines because JUBANITEX is a
domestic corporation.

On petition with the Court of Appeals, the latter reversed the Decision of the CTA, holding that
respondent received the commissions as sales agent of JUBANITEX and not as President thereof. And
since the "source" of income means the activity or service that produce the income, the sales
commission received by respondent is not taxable in the Philippines because it arose from the marketing
activities performed by respondent in Germany. The dispositive portion of the appellate courts
Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of Tax Appeals dated June 28,
2000 is hereby REVERSED and SET ASIDE and the respondent court is hereby directed to grant petitioner
a tax refund in the amount of Php 170,777.26.

SO ORDERED.8

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

Petitioner maintains that the income earned by respondent is taxable in the Philippines because the
source thereof is JUBANITEX, a domestic corporation located in the City of Makati. It thus implied that
source of income means the physical source where the income came from. It further argued that since
respondent is the President of JUBANITEX, any remuneration she received from said corporation should
be construed as payment of her overall managerial services to the company and should not be
interpreted as a compensation for a distinct and separate service as a sales commission agent.

Respondent, on the other hand, claims that the income she received was payment for her marketing
services. She contended that income of nonresident aliens like her is subject to tax only if the source of
the income is within the Philippines. Source, according to respondent is the situs of the activity which
produced the income. And since the source of her income were her marketing activities in Germany, the
income she derived from said activities is not subject to Philippine income taxation.
The issue here is whether respondents sales commission income is taxable in the Philippines.

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

SEC. 25. Tax on Nonresident Alien Individual.

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

(1) In General. A nonresident alien individual engaged in trade or business in the Philippines shall be
subject to an income tax in the same manner as an individual citizen and a resident alien individual, on
taxable income received from all sources within the Philippines. A nonresident alien individual who shall
come to the Philippines and stay therein for an aggregate period of more than one hundred eighty (180)
days during any calendar year shall be deemed a nonresident alien doing business in the Philippines,
Section 22(G) of this Code notwithstanding.

xxxx

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines. There shall
be levied, collected and paid for each taxable year upon the entire income received from all sources
within the Philippines by every nonresident alien individual not engaged in trade or business within the
Philippines x x x a tax equal to twenty-five percent (25%) of such income. x x x

Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or not engaged in trade
or business, are subject to Philippine income taxation on their income received from all sources within
the Philippines. Thus, the keyword in determining the taxability of non-resident aliens is the incomes
"source." In construing the meaning of "source" in Section 25 of the NIRC, resort must be had on the
origin of the provision.

The first Philippine income tax law enacted by the Philippine Legislature was Act No. 2833,10 which took
effect on January 1, 1920.11 Under Section 1 thereof, nonresident aliens are likewise subject to tax on
income "from all sources within the Philippine Islands," thus
SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon the entire net income
received in the preceding calendar year from all sources by every individual, a citizen or resident of the
Philippine Islands, a tax of two per centum upon such income; and a like tax shall be levied, assessed,
collected, and paid annually upon the entire net income received in the preceding calendar year from all
sources within the Philippine Islands by every individual, a nonresident alien, including interest on
bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise.

Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of 1916 as amended by U.S.
Revenue Law of 1917.12 Being a law of American origin, the authoritative decisions of the official
charged with enforcing it in the U.S. have peculiar persuasive force in the Philippines.13

The Internal Revenue Code of the U.S. enumerates specific types of income to be treated as from
sources within the U.S. and specifies when similar types of income are to be treated as from sources
outside the U.S.14 Under the said Code, compensation for labor and personal services performed in the
U.S., is generally treated as income from U.S. sources; while compensation for said services performed
outside the U.S., is treated as income from sources outside the U.S.15 A similar provision is found in
Section 42 of our NIRC, thus:

SEC. 42. x x x

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

xxxx

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

xxxx

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

xxxx

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

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

The Supreme Court has said, in a definition much quoted but often debated, that income may be
derived from three possible sources only: (1) capital and/or (2) labor; and/or (3) the sale of capital
assets. While the three elements of this attempt at definition need not be accepted as all-inclusive, they
serve as useful guides in any inquiry into whether a particular item is from "sources within the United
States" and suggest an investigation into the nature and location of the activities or property which
produce the income.

If the income is from labor the place where the labor is done should be decisive; if it is done in this
country, the income should be from "sources within the United States." If the income is from capital, the
place where the capital is employed should be decisive; if it is employed in this country, the income
should be from "sources within the United States." If the income is from the sale of capital assets, the
place where the sale is made should be likewise decisive.

Much confusion will be avoided by regarding the term "source" in this fundamental light. It is not a
place, it is an activity or property. As such, it has a situs or location, and if that situs or location is within
the United States the resulting income is taxable to nonresident aliens and foreign corporations.

The intention of Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913 basis
of taxing nonresident aliens and foreign corporations and to make the test of taxability the "source," or
situs of the activities or property which produce the income. The result is that, on the one hand,
nonresident aliens and nonresident foreign corporations are prevented from deriving income from the
United States free from tax, and, on the other hand, there is no undue imposition of a tax when the
activities do not take place in, and the property producing income is not employed in, this country. Thus,
if income is to be taxed, the recipient thereof must be resident within the jurisdiction, or the property or
activities out of which the income issues or is derived must be situated within the jurisdiction so that the
source of the income may be said to have a situs in this country.

The underlying theory is that the consideration for taxation is protection of life and property and that
the income rightly to be levied upon to defray the burdens of the United States Government is that
income which is created by activities and property protected by this Government or obtained by persons
enjoying that protection. 16

The important factor therefore which determines the source of income of personal services is not the
residence of the payor, or the place where the contract for service is entered into, or the place of
payment, but the place where the services were actually rendered.17

In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue,18 the Court addressed the issue on
the applicable source rule relating to reinsurance premiums paid by a local insurance company to a
foreign insurance company in respect of risks located in the Philippines. It was held therein that the
undertaking of the foreign insurance company to indemnify the local insurance company is the activity
that produced the income. Since the activity took place in the Philippines, the income derived therefrom
is taxable in our jurisdiction. Citing Mertens, The Law of Federal Income Taxation, the Court emphasized
that the technical meaning of source of income is the property, activity or service that produced the
same. Thus:

The source of an income is the property, activity or service that produced the income. The reinsurance
premiums remitted to appellants by virtue of the reinsurance contracts, accordingly, had for their
source the undertaking to indemnify Commonwealth Insurance Co. against liability. Said undertaking is
the activity that produced the reinsurance premiums, and the same took place in the Philippines. x x x
the reinsured, the liabilities insured and the risk originally underwritten by Commonwealth Insurance
Co., upon which the reinsurance premiums and indemnity were based, were all situated in the
Philippines. x x x19

In Commissioner of Internal Revenue v. British Overseas Airways Corporation (BOAC),20 the issue was
whether BOAC, a foreign airline company which does not maintain any flight to and from the Philippines
is liable for Philippine income taxation in respect of sales of air tickets in the Philippines, through a
general sales agent relating to the carriage of passengers and cargo between two points both outside
the Philippines. Ruling in the affirmative, the Court applied the case of Alexander Howden & Co., Ltd. v.
Collector of Internal Revenue, and reiterated the rule that the source of income is that "activity" which
produced the income. It was held that the "sale of tickets" in the Philippines is the "activity" that
produced the income and therefore BOAC should pay income tax in the Philippines because it undertook
an income producing activity in the country.

Both the petitioner and respondent cited the case of Commissioner of Internal Revenue v. British
Overseas Airways Corporation in support of their arguments, but the correct interpretation of the said
case favors the theory of respondent that it is the situs of the activity that determines whether such
income is taxable in the Philippines. The conflict between the majority and the dissenting opinion in the
said case has nothing to do with the underlying principle of the law on sourcing of income. In fact, both
applied the case of Alexander Howden & Co., Ltd. v. Collector of Internal Revenue. The divergence in
opinion centered on whether the sale of tickets in the Philippines is to be construed as the "activity" that
produced the income, as viewed by the majority, or merely the physical source of the income, as
ratiocinated by Justice Florentino P. Feliciano in his dissent. The majority, through Justice Ameurfina
Melencio-Herrera, as ponente, interpreted the sale of tickets as a business activity that gave rise to the
income of BOAC. Petitioner cannot therefore invoke said case to support its view that source of income
is the physical source of the money earned. If such was the interpretation of the majority, the Court
would have simply stated that source of income is not the business activity of BOAC but the place where
the person or entity disbursing the income is located or where BOAC physically received the same. But
such was not the import of the ruling of the Court. It even explained in detail the business activity
undertaken by BOAC in the Philippines to pinpoint the taxable activity and to justify its conclusion that
BOAC is subject to Philippine income taxation. Thus

BOAC, during the periods covered by the subject assessments, maintained a general sales agent in the
Philippines. That general sales agent, from 1959 to 1971, "was engaged in (1) selling and issuing tickets;
(2) breaking down the whole trip into series of trips each trip in the series corresponding to a
different airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to
the various airline companies on the basis of their participation in the services rendered through the
mode of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA
Agreement." Those activities were in exercise of the functions which are normally incident to, and are in
progressive pursuit of, the purpose and object of its organization as an international air carrier. In fact,
the regular sale of tickets, its main activity, is the very lifeblood of the airline business, the generation of
sales being the paramount objective. There should be no doubt then that BOAC was "engaged in"
business in the Philippines through a local agent during the period covered by the assessments. x x x21

xxxx
The source of an income is the property, activity or service that produced the income. For the source of
income to be considered as coming from the Philippines, it is sufficient that the income is derived from
activity within the Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity that
produces the income. The tickets exchanged hands here and payments for fares were also made here in
Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded
from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of wealth should share the burden of
supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the
contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser of the
ticket to pay the fare and the corresponding obligation of the carrier to transport the passenger upon
the terms and conditions set forth thereon. The ordinary ticket issued to members of the traveling
public in general embraces within its terms all the elements to constitute it a valid contract, binding
upon the parties entering into the relationship.22

The Court reiterates the rule that "source of income" relates to the property, activity or service that
produced the income. With respect to rendition of labor or personal service, as in the instant case, it is
the place where the labor or service was performed that determines the source of the income. There is
therefore no merit in petitioners interpretation which equates source of income in labor or personal
service with the residence of the payor or the place of payment of the income.

Having disposed of the doctrine applicable in this case, we will now determine whether respondent was
able to establish the factual circumstances showing that her income is exempt from Philippine income
taxation.

The decisive factual consideration here is not the capacity in which respondent received the income, but
the sufficiency of evidence to prove that the services she rendered were performed in Germany. Though
not raised as an issue, the Court is clothed with authority to address the same because the resolution
thereof will settle the vital question posed in this controversy.23

The settled rule is that tax refunds are in the nature of tax exemptions and are to be construed
strictissimi juris against the taxpayer.24 To those therefore, who claim a refund rest the burden of
proving that the transaction subjected to tax is actually exempt from taxation.
In the instant case, the appointment letter of respondent as agent of JUBANITEX stipulated that the
activity or the service which would entitle her to 10% commission income, are "sales actually concluded
and collected through [her] efforts."25 What she presented as evidence to prove that she performed
income producing activities abroad, were copies of documents she allegedly faxed to JUBANITEX and
bearing instructions as to the sizes of, or designs and fabrics to be used in the finished products as well
as samples of sales orders purportedly relayed to her by clients. However, these documents do not show
whether the instructions or orders faxed ripened into concluded or collected sales in Germany. At the
very least, these pieces of evidence show that while respondent was in Germany, she sent
instructions/orders to JUBANITEX. As to whether these instructions/orders gave rise to consummated
sales and whether these sales were truly concluded in Germany, respondent presented no such
evidence. Neither did she establish reasonable connection between the orders/instructions faxed and
the reported monthly sales purported to have transpired in Germany.

The paucity of respondents evidence was even noted by Atty. Minerva Pacheco, petitioners counsel at
the hearing before the Court of Tax Appeals. She pointed out that respondent presented no contracts or
orders signed by the customers in Germany to prove the sale transactions therein.26 Likewise, in her
Comment to the Formal Offer of respondents evidence, she objected to the admission of the faxed
documents bearing instruction/orders marked as Exhibits "R,"27 "V," "W", and "X,"28 for being self
serving.29 The concern raised by petitioners counsel as to the absence of substantial evidence that
would constitute proof that the sale transactions for which respondent was paid commission actually
transpired outside the Philippines, is relevant because respondent stayed in the Philippines for 89 days
in 1995. Except for the months of July and September 1995, respondent was in the Philippines in the
months of March, May, June, and August 1995,30 the same months when she earned commission
income for services allegedly performed abroad. Furthermore, respondent presented no evidence to
prove that JUBANITEX does not sell embroidered products in the Philippines and that her appointment
as commission agent is exclusively for Germany and other European markets.

In sum, we find that the faxed documents presented by respondent did not constitute substantial
evidence, or that relevant evidence that a reasonable mind might accept as adequate to support the
conclusion31 that it was in Germany where she performed the income producing service which gave rise
to the reported monthly sales in the months of March and May to September of 1995. She thus failed to
discharge the burden of proving that her income was from sources outside the Philippines and exempt
from the application of our income tax law. Hence, the claim for tax refund should be denied.

The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel,32 a previous case for refund
of income withheld from respondents remunerations for services rendered abroad, the Court in a
Minute Resolution dated February 17, 2003,33 sustained the ruling of the Court of Appeals that
respondent is entitled to refund the sum withheld from her sales commission income for the year 1994.
This ruling has no bearing in the instant controversy because the subject matter thereof is the income of
respondent for the year 1994 while, the instant case deals with her income in 1995. Otherwise, stated,
res judicata has no application here. Its elements are: (1) there must be a final judgment or order; (2)
the court that rendered the judgment must have jurisdiction over the subject matter and the parties; (3)
it must be a judgment on the merits; (4) there must be between the two cases identity of parties, of
subject matter, and of causes of action. 34 The instant case, however, did not satisfy the fourth requisite
because there is no identity as to the subject matter of the previous and present case of respondent
which deals with income earned and activities performed for different taxable years.

WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision and May 8, 2002 Resolution of
the Court of Appeals in CA-G.R. SP No. 59794, are REVERSED and SET ASIDE. The June 28, 2000 Decision
of the Court of Tax Appeals in C.T.A. Case No. 5633, which denied respondents claim for refund of
income tax paid for the year 1995 is REINSTATED.

SO ORDERED.
Republic of the Philippines

Supreme Court

Manila

FIRST DIVISION

COMMISSIONER OF INTERNAL REVENUE,

G.R. Nos. 179045-46

Petitioner,

Present:

CORONA, C. J., Chairperson,

VELASCO, JR.,

- versus -

LEONARDO-DE CASTRO,

DEL CASTILLO, and

PEREZ, JJ.

SMART COMMUNICATION, INC.,

Promulgated:

Respondent.

August 25, 2010

x-----------------------------------------------------------x

DECISION

DEL CASTILLO, J.:

The right of a withholding agent to claim a refund of erroneously or illegally withheld taxes comes with
the responsibility to return the same to the principal taxpayer.
This Petition for Review on Certiorari under Rule 45 of the Rules of Court seeks to set aside the
Decision[1] dated June 28, 2007 and the Resolution[2] dated July 31, 2007 of the Court of Tax Appeals
(CTA) En Banc.

Factual Antecedents

Respondent Smart Communications, Inc. is a corporation organized and existing under Philippine law. It
is an enterprise duly registered with the Board of Investments.

On May 25, 2001, respondent entered into three Agreements for Programming and Consultancy
Services[3] with Prism Transactive (M) Sdn. Bhd. (Prism), a non-resident corporation duly organized and
existing under the laws of Malaysia. Under the agreements, Prism was to provide programming and
consultancy services for the installation of the Service Download Manager (SDM) and the Channel
Manager (CM), and for the installation and implementation of Smart Money and Mobile Banking Service
SIM Applications (SIM Applications) and Private Text Platform (SIM Application).

On June 25, 2001, Prism billed respondent in the amount of US$547,822.45, broken down as follows:

SDM Agreement US$236,000.00

CM Agreement 296,000.00

SIM Application Agreement 15,822.45

Total US$547,822.45[4]

Thinking that these payments constitute royalties, respondent withheld the amount of US$136,955.61
or P7,008,840.43,[5] representing the 25% royalty tax under the RP-Malaysia Tax Treaty.[6]

On September 25, 2001, respondent filed its Monthly Remittance Return of Final Income Taxes Withheld
(BIR Form No. 1601-F)[7] for the month of August 2001.

On September 24, 2003, or within the two-year period to claim a refund, respondent filed with the
Bureau of Internal Revenue (BIR), through the International Tax Affairs Division (ITAD), an administrative
claim for refund[8] of the amount of P7,008,840.43.

Proceedings before the CTA Second Division

Due to the failure of the petitioner Commissioner of Internal Revenue (CIR) to act on the claim for
refund, respondent filed a Petition for Review[9] with the CTA, docketed as CTA Case No. 6782 which
was raffled to its Second Division.

In its Petition for Review, respondent claimed that it is entitled to a refund because the payments made
to Prism are not royalties[10] but business profits,[11] pursuant to the definition of royalties under the
RP-Malaysia Tax Treaty,[12] and in view of the pertinent Commentaries of the Organization for
Economic Cooperation and Development (OECD) Committee on Fiscal Affairs through the Technical
Advisory Group on Treaty Characterization of Electronic Commerce Payments.[13] Respondent further
averred that since under Article 7 of the RP-Malaysia Tax Treaty, business profits are taxable in the
Philippines only if attributable to a permanent establishment in the Philippines, the payments made to
Prism, a Malaysian company with no permanent establishment in the Philippines,[14] should not be
taxed.[15]

On December 1, 2003, petitioner filed his Answer[16] arguing that respondent, as withholding agent, is
not a party-in-interest to file the claim for refund,[17] and that assuming for the sake of argument that it
is the proper party, there is no showing that the payments made to Prism constitute business
profits.[18]

Ruling of the CTA Second Division

In a Decision[19] dated February 23, 2006, the Second Division of the CTA upheld respondents right, as a
withholding agent, to file the claim for refund citing the cases of Commissioner of Internal Revenue v.
Wander Philippines, Inc.,[20] Commissioner of Internal Revenue v. Procter & Gamble Philippine
Manufacturing Corporation[21] and Commissioner of Internal Revenue v. The Court of Tax Appeals.[22]

However, as to the claim for refund, the Second Division found respondent entitled only to a partial
refund. Although it agreed with respondent that the payments for the CM and SIM Application
Agreements are business profits,[23] and therefore, not subject to tax[24] under the RP-Malaysia Tax
Treaty, the Second Division found the payment for the SDM Agreement a royalty subject to withholding
tax.[25] Accordingly, respondent was granted refund in the amount of P3,989,456.43, computed as
follows:[26]

Particulars

Amount (in US$)

1. CM

296,000.00

2. SIM Application

15,822.45

Total

US$311,822.45

Particulars

Amount

Tax Base

US$311,822.45

Multiply by: Withholding Tax Rate

25%

Final Withholding Tax

US$ 77,955.61

Multiply by: Prevailing Exchange Rate

51.176

Tax Refund Due

P3,989,456.43

The dispositive portion of the Decision of the CTA Second Division reads:

WHEREFORE, premises considered, the instant petition is partially GRANTED. Accordingly, respondent
Commissioner of Internal Revenue is hereby ORDERED to REFUND or ISSUE a TAX CREDIT CERTIFICATE
to petitioner Smart Communications, Inc. in the amount of P3,989,456.43, representing overpaid final
withholding taxes for the month of August 2001.

SO ORDERED.[27]
Both parties moved for partial reconsideration[28] but the CTA Second Division denied the motions in a
Resolution[29] dated July 18, 2006.

Ruling of the CTA En Banc

Unsatisfied, both parties appealed to the CTA En Banc by filing their respective Petitions for Review,[30]
which were consolidated per Resolution[31] dated February 8, 2007.

On June 28, 2007, the CTA En Banc rendered a Decision affirming the partial refund granted to
respondent. In sustaining respondents right to file the claim for refund, the CTA En Banc said that
although respondent and Prism are unrelated entities, such circumstance does not affect the status of
[respondent] as a party-in-interest [as its legal interest] is based on its direct and independent liability
under the withholding tax system.[32] The CTA En Banc also concurred with the Second Divisions
characterization of the payments made to Prism, specifically that the payments for the CM and SIM
Application Agreements constitute business profits,[33] while the payment for the SDM Agreement is a
royalty.[34]

The dispositive portion of the CTA En Banc Decision reads:

WHEREFORE, the instant petition is hereby DISMISSED. Accordingly, the assailed Decision and
Resolution are hereby AFFIRMED.

SO ORDERED.[35]

Only petitioner sought reconsideration[36] of the Decision. The CTA En Banc, however, found no cogent
reason to reverse its Decision, and thus, denied petitioners motion for reconsideration in a
Resolution[37] dated July 31, 2007.
Unfazed, petitioner availed of the present recourse.

Issues

The two issues to be resolved are: (1) whether respondent has the right to file the claim for refund; and
(2) if respondent has the right, whether the payments made to Prism constitute business profits or
royalties.

Petitioners Arguments

Petitioner contends that the cases relied upon by the CTA in upholding respondents right to claim the
refund are inapplicable since the withholding agents therein are wholly owned subsidiaries of the
principal taxpayers, unlike in the instant case where the withholding agent and the taxpayer are
unrelated entities. Petitioner further claims that since respondent did not file the claim on behalf of
Prism, it has no legal standing to claim the refund. To rule otherwise would result to the unjust
enrichment of respondent, who never shelled-out any amount to pay the royalty taxes. Petitioner, thus,
posits that the real party-in-interest to file a claim for refund of the erroneously withheld taxes is Prism.
He cites as basis the case of Silkair (Singapore) Pte, Ltd. v. Commissioner of Internal Revenue,[38] where
it was ruled that the proper party to file a refund is the statutory taxpayer.[39] Finally, assuming that
respondent is the proper party, petitioner counters that it is still not entitled to any refund because the
payments made to Prism are taxable as royalties, having been made in consideration for the use of the
programs owned by Prism.

Respondents Arguments

Respondent, on the other hand, maintains that it is the proper party to file a claim for refund as it has
the statutory and primary responsibility and liability to withhold and remit the taxes to the BIR. It points
out that under the withholding tax system, the agent-payor becomes a payee by fiction of law because
the law makes the agent personally liable for the tax arising from the breach of its duty to withhold.
Thus, the fact that respondent is not in any way related to Prism is immaterial.
Moreover, respondent asserts that the payments made to Prism do not fall under the definition of
royalties since the agreements are for programming and consultancy services only, wherein Prism
undertakes to perform services for the creation, development or the bringing into existence of software
applications solely for the satisfaction of the peculiar needs and requirements of respondent.

Our Ruling

The petition is bereft of merit.

Withholding agent may file a claim for refund

Sections 204(c) and 229 of the National Internal Revenue Code (NIRC) provide:

Sec. 204. Authority of the Commissioner to Compromise, Abate, and Refund or Credit Taxes. The
Commissioner may

xxxx

(C) Credit or refund taxes erroneously or illegally received or penalties imposed without authority,
refund the value of internal revenue stamps when they are returned in good condition by the purchaser,
and, in his discretion, redeem or change unused stamps that have been rendered unfit for use and
refund their value upon proof of destruction. No credit or refund of taxes or penalties shall be allowed
unless the taxpayer files in writing with the Commissioner a claim for credit or refund within two (2)
years after the payment of the tax or penalty: Provided, however, That a return filed showing an
overpayment shall be considered as a written claim for credit or refund.

xxxx

Sec. 229. Recovery of Tax Erroneously or Illegally Collected. No suit or proceeding shall be maintained in
any court for the recovery of any national internal revenue tax hereafter alleged to have been
erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without
authority, or of any sum alleged to have been excessively or in any manner wrongfully collected, until a
claim for refund or credit has been duly filed with the Commissioner; but such suit or proceeding may be
maintained, whether or not such tax, penalty, or sum has been paid under protest or duress.

In any case, no such suit or proceeding shall be filed after the expiration of two (2) years from the date
of payment of the tax or penalty regardless of any supervening cause that may arise after payment:
Provided, however, That the Commissioner may, even without a written claim therefor, refund or credit
any tax, where on the face of the return upon which payment was made, such payment appears clearly
to have been erroneously paid. (Emphasis supplied)

Pursuant to the foregoing, the person entitled to claim a tax refund is the taxpayer. However, in case the
taxpayer does not file a claim for refund, the withholding agent may file the claim.

In Commissioner of Internal Revenue v. Procter & Gamble Philippine Manufacturing Corporation,[40] a

withholding agent was considered a proper party to file a claim for refund of the withheld taxes of its
foreign parent company. Pertinent portions of the Decision read:

The term taxpayer is defined in our NIRC as referring to any person subject to tax imposed by the Title
[on Tax on Income]. It thus becomes important to note that under Section 53(c)[41] of the NIRC, the
withholding agent who is required to deduct and withhold any tax is made personally liable for such tax
and indeed is indemnified against any claims and demands which the stockholder might wish to make in
questioning the amount of payments effected by the withholding agent in accordance with the
provisions of the NIRC. The withholding agent, P&G-Phil., is directly and independently liable for the
correct amount of the tax that should be withheld from the dividend remittances. The withholding agent
is, moreover, subject to and liable for deficiency assessments, surcharges and penalties should the
amount of the tax withheld be finally found to be less than the amount that should have been withheld
under law.

A person liable for tax has been held to be a person subject to tax and properly considered a taxpayer.
The terms liable for tax and subject to tax both connote legal obligation or duty to pay a tax. It is very
difficult, indeed conceptually impossible, to consider a person who is statutorily made liable for tax as
not subject to tax. By any reasonable standard, such a person should be regarded as a party in interest,
or as a person having sufficient legal interest, to bring a suit for refund of taxes he believes were illegally
collected from him.

In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, this Court pointed out that a
withholding agent is in fact the agent both of the government and of the taxpayer, and that the
withholding agent is not an ordinary government agent:

The law sets no condition for the personal liability of the withholding agent to attach. The reason is to
compel the withholding agent to withhold the tax under all circumstances. In effect, the responsibility
for the collection of the tax as well as the payment thereof is concentrated upon the person over whom
the Government has jurisdiction. Thus, the withholding agent is constituted the agent of both the
Government and the taxpayer. With respect to the collection and/or withholding of the tax, he is the
Governments agent. In regard to the filing of the necessary income tax return and the payment of the
tax to the Government, he is the agent of the taxpayer. The withholding agent, therefore, is no ordinary
government agent especially because under Section 53 (c) he is held personally liable for the tax he is
duty bound to withhold; whereas the Commissioner and his deputies are not made liable by law.

If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial owner
of the dividends with respect to the filing of the necessary income tax return and with respect to actual
payment of the tax to the government, such authority may reasonably be held to include the authority
to file a claim for refund and to bring an action for recovery of such claim. This implied authority is
especially warranted where, as in the instant case, the withholding agent is the wholly owned subsidiary
of the parent-stockholder and therefore, at all times, under the effective control of such parent-
stockholder. In the circumstances of this case, it seems particularly unreal to deny the implied authority
of P&G-Phil. to claim a refund and to commence an action for such refund.

xxxx

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly regarded as a
taxpayer within the meaning of Section 309,[42] NIRC, and as impliedly authorized to file the claim for
refund and the suit to recover such claim. (Emphasis supplied.)
Petitioner, however, submits that this ruling applies only when the withholding agent and the taxpayer
are related parties, i.e., where the withholding agent is a wholly owned subsidiary of the taxpayer.

We do not agree.

Although such relation between the taxpayer and the withholding agent is a factor that increases the
latters legal interest to file a claim for refund, there is nothing in the decision to suggest that such
relationship is required or that the lack of such relation deprives the withholding agent of the right to
file a claim for refund. Rather, what is clear in the decision is that a withholding agent has a legal right to
file a claim for refund for two reasons. First, he is considered a taxpayer under the NIRC as he is
personally liable for the withholding tax as well as for deficiency assessments, surcharges, and penalties,
should the amount of the tax withheld be finally found to be less than the amount that should have
been withheld under law. Second, as an agent of the taxpayer, his authority to file the necessary income
tax return and to remit the tax withheld to the government impliedly includes the authority to file a
claim for refund and to bring an action for recovery of such claim.

In this connection, it is however significant to add that while the withholding agent has the right to
recover the taxes erroneously or illegally collected, he nevertheless has the obligation to remit the same
to the principal taxpayer. As an agent of the taxpayer, it is his duty to return what he has recovered;
otherwise, he would be unjustly enriching himself at the expense of the principal taxpayer from whom
the taxes were withheld, and from whom he derives his legal right to file a claim for refund.

As to Silkair (Singapore) Pte, Ltd. v. Commissioner of Internal Revenue[43] cited by the petitioner, we
find the same inapplicable as it involves excise taxes, not withholding taxes. In that case, it was ruled
that the proper party to question, or seek a refund of, an indirect tax is the statutory taxpayer, the
person on whom the tax is imposed by law and who paid the same even if he shifts the burden thereof
to another.

In view of the foregoing, we find no error on the part of the CTA in upholding respondents right as a
withholding agent to file a claim for refund.

The payments for the CM and the SIM Application Agreements constitute
business profits

Under the RP-Malaysia Tax Treaty, the term royalties is defined as payments of any kind received as
consideration for: (i) the use of, or the right to use, any patent, trade mark, design or model, plan, secret
formula or process, any copyright of literary, artistic or scientific work, or for the use of, or the right to
use, industrial, commercial, or scientific equipment, or for information concerning industrial,
commercial or scientific experience; (ii) the use of, or the right to use, cinematograph films, or tapes for
radio or television broadcasting.[44] These are taxed at the rate of 25% of the gross amount.[45]

Under the same 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.[46] The term permanent establishment is defined as a fixed place of business where the
enterprise is wholly or partly carried on.[47] However, even if 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 it carries on supervisory activities in that other State for more than six months in connection
with a construction, installation or assembly project which is being undertaken in that other State.[48]

In the instant case, it was established during the trial that Prism does not have a permanent
establishment in the Philippines. Hence, business profits derived from Prisms dealings with respondent
are not taxable. The question is whether the payments made to Prism under the SDM, CM, and SIM
Application agreements are business profits and not royalties.

Paragraph 1.3 of the Programming Services (Schedule A) of the SDM Agreement,[49] reads:

1.3 Intellectual Property Rights (IPR)

The SDM shall be installed by PRISM, including the SDM Libraries, the IPR of which shall be retained by
PRISM. PRISM, however, shall provide the Client the APIs for the SDM at no cost to the Client. The Client
shall be permitted to develop programs to interface with the SDM or the SDM Libraries, using the
related APIs as appropriate.[50] (Emphasis supplied.)
Whereas, paragraph 1.4 of the Programming Services (Schedule A) of the CM Agreement and paragraph
1.3 of the Programming Services (Schedule A) of the SIM Agreement provide:

1.4 Intellectual Property Rights (IPR)

The IPR of all components of the CM belong to the Client with the exception of the following
components, which are provided, without technical or commercial restraints or obligations:

ConfigurationException.java

DataStructures (DblLinkedListjava, DbIListNodejava, List

EmptyException.java, ListFullException.java, ListNodeNotFoundException.java,

QueueEmptyException.java, QueueFullException.java, QueueList.java, QueuListEx.java, and

QueueNodeNotFoundException.java)

FieldMappedObjeet.java

LogFileEx.java

Logging (BaseLogger.java and Logger.java)

PrismGeneric Exception.java

PrismGenericObject.java

ProtocolBuilders/CIMD2 (Alive.java, BaseMessageData.

java, DeliverMessage.java, Login.java, Logout.java, Nack.java, SubmitMessage.java,

TemplateManagement (FileTemplateDataBag.java, Template

DataBag.java, TemplateManagerExBag.java, and TemplateParserExBag.java)

TemplateManager.class

TemplateServer.class

TemplateServer$RequestThread.class

Template Server_skel.class

TemplateServer_stub.class

TemplateService.class
Prism Crypto Server module for PHP4[51]

xxxx

1.3 Intellectual Property Rights (IPR)

The Client shall own the IPR for the Specifications and the Source Code for the SIM Applications. PRISM
shall develop an executable compiled code (the Executable Version) of the SIM Applications for use on
the aSIMetric card which, however, shall only be for the Clients use. The Executable Version may not be
provided by PRISM to any third [party] without the prior written consent of the Client. It is further
recognized that the Client anticipates licensing the use of the SIM Applications, but it is agreed that no
license fee will be charged to PRISM or to a licensee of the aSIMetrix card from PRISM when SIMs are
supplied to the Client.[52] (Emphases supplied.)

The provisions in the agreements are clear. Prism has intellectual property right over the SDM program,
but not over the CM and SIM Application programs as the proprietary rights of these programs belong to
respondent. In other words, out of the payments made to Prism, only the payment for the SDM program
is a royalty subject to a 25% withholding tax. A refund of the erroneously withheld royalty taxes for the
payments pertaining to the CM and SIM Application Agreements is therefore in order.

Indeed, the government has no right to retain what does not belong to it. No one, not even the State,
should enrich oneself at the expense of another.[53]

WHEREFORE, the petition is DENIED. The assailed Decision dated June 28, 2007 and the Resolution
dated July 31, 2007 of the Court of Tax Appeals En Banc are hereby AFFIRMED. The Bureau of Internal
Revenue is hereby ORDERED to ISSUE a TAX CREDIT CERTIFICATE to Prism Transactive (M) Sdn. Bhd. in
the amount of P3,989,456.43 representing the overpaid final withholding taxes for the month of August
2001.

SO ORDERED.
EN BANC

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,

-versus-

FILINVEST DEVELOPMENT CORPORATION,

Respondent.

x-------------------------------------x

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,
-versus-

FILINVEST DEVELOPMENT CORPORATION,

Respondent.

G. R. No. 163653

G. R. No. 167689
Present:

CORONA, C.J.,

CARPIO,

VELASCO, JR.,

LEONARDO-DE CASTRO,

BRION,

PERALTA,

BERSAMIN,

DEL CASTILLO,

ABAD,

VILLARAMA, JR.,

PEREZ,

MENDOZA, and

SERENO,* JJ.

Promulgated:

July 19, 2011

x----------------------------------------------------------------------------------------------- x
DECISION

PEREZ, J.:

Assailed in these twin petitions for review on certiorari filed pursuant to Rule 45 of the 1997 Rules of
Civil Procedure are the decisions rendered by the Court of Appeals (CA) in the following cases: (a)
Decision dated 16 December 2003 of the then Special Fifth Division in CA-G.R. SP No. 72992;[1] and, (b)
Decision dated 26 January 2005 of the then Fourteenth Division in CA-G.R. SP No. 74510.[2]

The Facts

The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI), respondent
Filinvest Development Corporation (FDC) is a holding company which also owned 67.42% of the
outstanding shares of Filinvest Land, Inc. (FLI). On 29 November 1996, FDC and FAI entered into a Deed
of Exchange with FLI whereby the former both transferred in favor of the latter parcels of land appraised
at P4,306,777,000.00. In exchange for said parcels which were intended to facilitate development of
medium-rise residential and commercial buildings, 463,094,301 shares of stock of FLI were issued to FDC
and FAI.[3] As a result of the exchange, FLIs ownership structure was changed to the extent reflected in
the following tabular prcis, viz.:

Stockholder

Number and Percentage of Shares Held Prior to the Exchange

Number of Additional Shares Issued

Number and Percentage of Shares Held After the Exchange

FDC

2,537,358,000 67.42%

42,217,000
2,579,575,000 61.03%

FAI

00

420,877,000

420,877,000 9.96%

OTHERS

1,226,177,000 32.58%

1,226,177,000 29.01%

----------------- -----------

--------------

---------------

3,763,535,000 100%

463,094,301

4,226,629,000 (100%)

On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (BIR) to the effect that
no gain or loss should be recognized in the aforesaid transfer of real properties. Acting on the request,
the BIR issued Ruling No. S-34-046-97 dated 3 February 1997, finding that the exchange is among those
contemplated under Section 34 (c) (2) of the old National Internal Revenue Code (NIRC)[4] which
provides that (n)o gain or loss shall be recognized if property is transferred to a corporation by a person
in exchange for a stock in such corporation of which as a result of such exchange said person, alone or
together with others, not exceeding four (4) persons, gains control of said corporation."[5] With the BIRs
reiteration of the foregoing ruling upon the 10 February 1997 request for clarification filed by FLI,[6] the
latter, together with FDC and FAI, complied with all the requirements imposed in the ruling.[7]

On various dates during the years 1996 and 1997, in the meantime, FDC also extended advances in favor
of its affiliates, namely, FAI, FLI, Davao Sugar Central Corporation (DSCC) and Filinvest Capital, Inc.
(FCI).[8] Duly evidenced by instructional letters as well as cash and journal vouchers, said cash advances
amounted to P2,557,213,942.60 in 1996[9] and P3,360,889,677.48 in 1997.[10] On 15 November 1996,
FDC also entered into a Shareholders Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of
a Singapore-based joint venture company called Filinvest Asia Corporation (FAC), tasked to develop and
manage FDCs 50% ownership of its PBCom Office Tower Project (the Project). With their equity
participation in FAC respectively pegged at 60% and 40% in the Shareholders Agreement, FDC
subscribed to P500.7 million worth of shares in said joint venture company to RHPLs subscription worth
P433.8 million. Having paid its subscription by executing a Deed of Assignment transferring to FAC a
portion of its rights and interest in the Project worth P500.7 million, FDC eventually reported a net loss
of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996.[11]

On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay deficiency income and
documentary stamp taxes, plus interests and compromise penalties,[12] covered by the following
Assessment Notices, viz.: (a) Assessment Notice No. SP-INC-96-00018-2000 for deficiency income taxes
in the sum of P150,074,066.27 for 1996; (b) Assessment Notice No. SP-DST-96-00020-2000 for
deficiency documentary stamp taxes in the sum of P10,425,487.06 for 1996; (c) Assessment Notice No.
SP-INC-97-00019-2000 for deficiency income taxes in the sum of P5,716,927.03 for 1997; and (d)
Assessment Notice No. SP-DST-97-00021-2000 for deficiency documentary stamp taxes in the sum of
P5,796,699.40 for 1997.[13] The foregoing deficiency taxes were assessed on the taxable gain
supposedly realized by FDC from the Deed of Exchange it executed with FAI and FLI, on the dilution
resulting from the Shareholders Agreement FDC executed with RHPL as well as the arms-length interest
rate and documentary stamp taxes imposable on the advances FDC extended to its affiliates.[14]

On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand for deficiency income
taxes in the sum of P1,477,494,638.23 for the year 1997.[15] Covered by Assessment Notice No. SP-INC-
97-0027-2000,[16] said deficiency tax was also assessed on the taxable gain purportedly realized by FAI
from the Deed of Exchange it executed with FDC and FLI.[17] On 26 January 2000 or within the
reglementary period of thirty (30) days from notice of the assessment, both FDC and FAI filed their
respective requests for reconsideration/protest, on the ground that the deficiency income and
documentary stamp taxes assessed by the BIR were bereft of factual and legal basis.[18] Having
submitted the relevant supporting documents pursuant to the 31 January 2000 directive from the BIR
Appellate Division, FDC and FAI filed on 11 September 2000 a letter requesting an early resolution of
their request for reconsideration/protest on the ground that the 180 days prescribed for the resolution
thereof under Section 228 of the NIRC was going to expire on 20 September 2000.[19]

In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve their request for
reconsideration/protest within the aforesaid period, FDC and FAI filed on 17 October 2000 a petition for
review with the Court of Tax Appeals (CTA) pursuant to Section 228 of the 1997 NIRC. Docketed before
said court as CTA Case No. 6182, the petition alleged, among other matters, that as previously opined in
BIR Ruling No. S-34-046-97, no taxable gain should have been assessed from the subject Deed of
Exchange since FDC and FAI collectively gained further control of FLI as a consequence of the exchange;
that correlative to the CIR's lack of authority to impute theoretical interests on the cash advances FDC
extended in favor of its affiliates, the rule is settled that interests cannot be demanded in the absence of
a stipulation to the effect; that not being promissory notes or certificates of obligations, the
instructional letters as well as the cash and journal vouchers evidencing said cash advances were not
subject to documentary stamp taxes; and, that no income tax may be imposed on the prospective gain
from the supposed appreciation of FDC's shareholdings in FAC. As a consequence, FDC and FAC both
prayed that the subject assessments for deficiency income and documentary stamp taxes for the years
1996 and 1997 be cancelled and annulled.[20]

On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in question should
not be considered tax free since, with the resultant diminution of its shares in FLI, FDC did not gain
further control of said corporation. Likewise calling attention to the fact that the cash advances FDC
extended to its affiliates were interest free despite the interest bearing loans it obtained from banking
institutions, the CIR invoked Section 43 of the old NIRC which, as implemented by Revenue Regulations
No. 2, Section 179 (b) and (c), gave him "the power to allocate, distribute or apportion income or
deductions between or among such organizations, trades or business in order to prevent evasion of
taxes." The CIR justified the imposition of documentary stamp taxes on the instructional letters as well
as cash and journal vouchers for said cash advances on the strength of Section 180 of the NIRC and
Revenue Regulations No. 9-94 which provide that loan transactions are subject to said tax irrespective of
whether or not they are evidenced by a formal agreement or by mere office memo. The CIR also argued
that FDC realized taxable gain arising from the dilution of its shares in FAC as a result of its Shareholders'
Agreement with RHPL.[21]

At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and Issues[22] which was
admitted in the 16 February 2001 resolution issued by the CTA. With the further admission of the
Formal Offer of Documentary Evidence subsequently filed by FDC and FAI[23] and the conclusion of the
testimony of Susana Macabelda anent the cash advances FDC extended in favor of its affiliates,[24] the
CTA went on to render the Decision dated 10 September 2002 which, with the exception of the
deficiency income tax on the interest income FDC supposedly realized from the advances it extended in
favor of its affiliates, cancelled the rest of deficiency income and documentary stamp taxes assessed
against FDC and FAI for the years 1996 and 1997,[25] thus:

WHEREFORE, in view of all the foregoing, the court finds the instant petition partly meritorious.
Accordingly, Assessment Notice No. SP-INC-96-00018-2000 imposing deficiency income tax on FDC for
taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 imposing
deficiency documentary stamp tax on FDC for taxable years 1996 and 1997, respectively and Assessment
Notice No. SP-INC-97-0027-2000 imposing deficiency income tax on FAI for the taxable year 1997 are
hereby CANCELLED and SET ASIDE. However, [FDC] is hereby ORDERED to PAY the amount of
P5,691,972.03 as deficiency income tax for taxable year 1997. In addition, petitioner is also ORDERED to
PAY 20% delinquency interest computed from February 16, 2000 until full payment thereof pursuant to
Section 249 (c) (3) of the Tax Code.[26]

Finding that the collective increase of the equity participation of FDC and FAI in FLI rendered the gain
derived from the exchange tax-free, the CTA also ruled that the increase in the value of FDC's shares in
FAC did not result in economic advantage in the absence of actual sale or conversion thereof. While
likewise finding that the documents evidencing the cash advances FDC extended to its affiliates cannot
be considered as loan agreements that are subject to documentary stamp tax, the CTA enunciated,
however, that the CIR was justified in assessing undeclared interests on the same cash advances
pursuant to his authority under Section 43 of the NIRC in order to forestall tax evasion. For persuasive
effect, the CTA referred to the equivalent provision in the Internal Revenue Code of the United States
(IRC-US), i.e., Sec. 482, as implemented by Section 1.482-2 of 1965-1969 Regulations of the Law of
Federal Income Taxation.[27]

Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for review docketed
before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997 Rules of Civil Procedure. Calling
attention to the fact that the cash advances it extended to its affiliates were interest-free in the absence
of the express stipulation on interest required under Article 1956 of the Civil Code, FDC questioned the
imposition of an arm's-length interest rate thereon on the ground, among others, that the CIR's
authority under Section 43 of the NIRC: (a) does not include the power to impute imaginary interest on
said transactions; (b) is directed only against controlled taxpayers and not against mother or holding
corporations; and, (c) can only be invoked in cases of understatement of taxable net income or evident
tax evasion.[28] Upholding FDC's position, the CA's then Special Fifth Division rendered the herein
assailed decision dated 16 December 2003,[29] the decretal portion of which states:
WHEREFORE, premises considered, the instant petition is hereby GRANTED. The assailed Decision dated
September 10, 2002 rendered by the Court of Tax Appeals in CTA Case No. 6182 directing petitioner
Filinvest Development Corporation to pay the amount of P5,691,972.03 representing deficiency income
tax on allegedly undeclared interest income for the taxable year 1997, plus 20% delinquency interest
computed from February 16, 2000 until full payment thereof is REVERSED and SET ASIDE and, a new one
entered annulling Assessment Notice No. SP-INC-97-00019-2000 imposing deficiency income tax on
petitioner for taxable year 1997. No pronouncement as to costs.[30]

With the denial of its partial motion for reconsideration of the same 11 December 2002 resolution
issued by the CTA,[31] the CIR also filed the petition for review docketed before the CA as CA-G.R. No.
74510. In essence, the CIR argued that the CTA reversibly erred in cancelling the assessment notices: (a)
for deficiency income taxes on the exchange of property between FDC, FAI and FLI; (b) for deficiency
documentary stamp taxes on the documents evidencing FDC's cash advances to its affiliates; and (c) for
deficiency income tax on the gain FDC purportedly realized from the increase of the value of its
shareholdings in FAC.[32] The foregoing petition was, however, denied due course and dismissed for
lack of merit in the herein assailed decision dated 26 January 2005[33] rendered by the CA's then
Fourteenth Division, upon the following findings and conclusions, to wit:

1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the 29 November 1996 Deed of
Exchange resulted in the combined control by FDC and FAI of more than 51% of the outstanding shares
of FLI, hence, no taxable gain can be recognized from the transaction under Section 34 (c) (2) of the old
NIRC;

2. The instructional letters as well as the cash and journal vouchers evidencing the advances FDC
extended to its affiliates are not subject to documentary stamp taxes pursuant to BIR Ruling No. 116-98,
dated 30 July 1998, since they do not partake the nature of loan agreements;

3. Although BIR Ruling No. 116-98 had been subsequently modified by BIR Ruling No. 108-99, dated 15
July 1999, to the effect that documentary stamp taxes are imposable on inter-office memos evidencing
cash advances similar to those extended by FDC, said latter ruling cannot be given retroactive
application if to do so would be prejudicial to the taxpayer;

4. FDC's alleged gain from the increase of its shareholdings in FAC as a consequence of the Shareholders'
Agreement it executed with RHPL cannot be considered taxable income since, until actually converted
thru sale or disposition of said shares, they merely represent unrealized increase in capital.[34]
Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the CIR's petitions for review
on certiorari assailing the 16 December 2003 decision in CA-G.R. No. 72992 and the 26 January 2005
decision in CA-G.R. SP No. 74510 were consolidated pursuant to the 1 March 2006 resolution issued by
this Courts Third Division.

The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:

THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF THE COURT OF TAX APPEALS AND IN
HOLDING THAT THE ADVANCES EXTENDED BY RESPONDENT TO ITS AFFILIATES ARE NOT SUBJECT TO
INCOME TAX.[35]

In G.R. No. 167689, on the other hand, petitioner proffers the following issues for resolution:

THE HONORABLE COURT OF APPEALS COMMITTED GRAVE ABUSE OF DISCRETION IN HOLDING THAT
THE EXCHANGE OF SHARES OF STOCK FOR PROPERTY AMONG FILINVEST DEVELOPMENT CORPORATION
(FDC), FILINVEST ALABANG, INCORPORATED (FAI) AND FILINVEST LAND INCORPORATED (FLI) MET ALL
THE REQUIREMENTS FOR THE NON-RECOGNITION OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE
OLD NATIONAL INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40 (C) (2) (c) OF THE NIRC.

II

THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE ERROR IN HOLDING THAT THE LETTERS
OF INSTRUCTION OR CASH VOUCHERS EXTENDED BY FDC TO ITS AFFILIATES ARE NOT DEEMED LOAN
AGREEMENTS SUBJECT TO DOCUMENTARY STAMP TAXES UNDER SECTION 180 OF THE NIRC.
III

THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN HOLDING THAT GAIN ON DILUTION AS A
RESULT OF THE INCREASE IN THE VALUE OF FDCS SHAREHOLDINGS IN FAC IS NOT TAXABLE.[36]

The Courts Ruling

While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in G.R. No. 167689
impressed with partial merit.

In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding that theoretical
interests can be imputed on the advances FDC extended to its affiliates in 1996 and 1997 considering
that, for said purpose, FDC resorted to interest-bearing fund borrowings from commercial banks. Since
considerable interest expenses were deducted by FDC when said funds were borrowed, the CIR
theorizes that interest income should likewise be declared when the same funds were sourced for the
advances FDC extended to its affiliates. Invoking Section 43 of the 1993 NIRC in relation to Section
179(b) of Revenue Regulation No. 2, the CIR maintains that it is vested with the power to allocate,
distribute or apportion income or deductions between or among controlled organizations, trades or
businesses even in the absence of fraud, since said power is intended to prevent evasion of taxes or
clearly to reflect the income of any such organizations, trades or businesses. In addition, the CIR
asseverates that the CA should have accorded weight and respect to the findings of the CTA which, as
the specialized court dedicated to the study and consideration of tax matters, can take judicial notice of
US income tax laws and regulations.[37]

Admittedly, Section 43 of the 1993 NIRC[38] provides that, (i)n any case of two or more organizations,
trades or businesses (whether or not incorporated and whether or not organized in the Philippines)
owned or controlled directly or indirectly by the same interests, the Commissioner of Internal Revenue
is authorized to distribute, apportion or allocate gross income or deductions between or among such
organization, trade or business, if he determines that such distribution, apportionment or allocation is
necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization,
trade or business. In amplification of the equivalent provision[39] under Commonwealth Act No.
466,[40] Sec. 179(b) of Revenue Regulation No. 2 states as follows:
Determination of the taxable net income of controlled taxpayer. (A) DEFINITIONS. When used in this
section

(1) The term organization includes any kind, whether it be a sole proprietorship, a partnership, a
trust, an estate, or a corporation or association, irrespective of the place where organized, where
operated, or where its trade or business is conducted, and regardless of whether domestic or foreign,
whether exempt or taxable, or whether affiliated or not.

(2) The terms trade or business include any trade or business activity of any kind, regardless of
whether or where organized, whether owned individually or otherwise, and regardless of the place
where carried on.

(3) The term controlled includes any kind of control, direct or indirect, whether legally
enforceable, and however exercisable or exercised. It is the reality of the control which is decisive, not
its form or mode of exercise. A presumption of control arises if income or deductions have been
arbitrarily shifted.

(4) The term controlled taxpayer means any one of two or more organizations, trades, or
businesses owned or controlled directly or indirectly by the same interests.

(5) The term group and group of controlled taxpayers means the organizations, trades or
businesses owned or controlled by the same interests.

(6) The term true net income means, in the case of a controlled taxpayer, the net income (or as
the case may be, any item or element affecting net income) which would have resulted to the controlled
taxpayer, had it in the conduct of its affairs (or, as the case may be, any item or element affecting net
income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as
the case may be, in the particular contract, transaction, arrangement or other act) dealt with the other
members or members of the group at arms length. It does not mean the income, the deductions, or the
item or element of either, resulting to the controlled taxpayer by reason of the particular contract,
transaction, or arrangement, the controlled taxpayer, or the interest controlling it, chose to make (even
though such contract, transaction, or arrangement be legally binding upon the parties thereto).

(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax Code is to place a controlled taxpayer
on a tax parity with an uncontrolled taxpayer, by determining, according to the standard of an
uncontrolled taxpayer, the true net income from the property and business of a controlled taxpayer. The
interests controlling a group of controlled taxpayer are assumed to have complete power to cause each
controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the
net income from the property and business of each of the controlled taxpayers. If, however, this has not
been done and the taxable net income are thereby understated, the statute contemplates that the
Commissioner of Internal Revenue shall intervene, and, by making such distributions, apportionments,
or allocations as he may deem necessary of gross income or deductions, or of any item or element
affecting net income, between or among the controlled taxpayers constituting the group, shall
determine the true net income of each controlled taxpayer. The standard to be applied in every case is
that of an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to apply its
provisions at will, nor does it grant any right to compel the Commissioner of Internal Revenue to apply
its provisions.

(C) APPLICATION Transactions between controlled taxpayer and another will be subjected to special
scrutiny to ascertain whether the common control is being used to reduce, avoid or escape taxes. In
determining the true net income of a controlled taxpayer, the Commissioner of Internal Revenue is not
restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham
transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting income or
deductions. The authority to determine true net income extends to any case in which either by
inadvertence or design the taxable net income in whole or in part, of a controlled taxpayer, is other than
it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing
at arms length with another uncontrolled taxpayer.[41]

As may be gleaned from the definitions of the terms controlled and "controlled taxpayer" under
paragraphs (a) (3) and (4) of the foregoing provision, it would appear that FDC and its affiliates come
within the purview of Section 43 of the 1993 NIRC. Aside from owning significant portions of the shares
of stock of FLI, FAI, DSCC and FCI, the fact that FDC extended substantial sums of money as cash
advances to its said affiliates for the purpose of providing them financial assistance for their operational
and capital expenditures seemingly indicate that the situation sought to be addressed by the subject
provision exists. From the tenor of paragraph (c) of Section 179 of Revenue Regulation No. 2, it may also
be seen that the CIR's power to distribute, apportion or allocate gross income or deductions between or
among controlled taxpayers may be likewise exercised whether or not fraud inheres in the transaction/s
under scrutiny. For as long as the controlled taxpayer's taxable income is not reflective of that which it
would have realized had it been dealing at arm's length with an uncontrolled taxpayer, the CIR can make
the necessary rectifications in order to prevent evasion of taxes.

Despite the broad parameters provided, however, we find that the CIR's powers of distribution,
apportionment or allocation of gross income and deductions under Section 43 of the 1993 NIRC and
Section 179 of Revenue Regulation No. 2 does not include the power to impute "theoretical interests" to
the controlled taxpayer's transactions. Pursuant to Section 28 of the 1993 NIRC,[42] after all, the term
gross income is understood to mean all income from whatever source derived, including, but not limited
to the following items: compensation for services, including fees, commissions, and similar items; gross
income derived from business; gains derived from dealings in property; interest; rents; royalties;
dividends; annuities; prizes and winnings; pensions; and partners distributive share of the gross income
of general professional partnership.[43] While it has been held that the phrase "from whatever source
derived" indicates a legislative policy to include all income not expressly exempted within the class of
taxable income under our laws, the term "income" has been variously interpreted to mean "cash
received or its equivalent", "the amount of money coming to a person within a specific time" or
"something distinct from principal or capital."[44] Otherwise stated, there must be proof of the actual
or, at the very least, probable receipt or realization by the controlled taxpayer of the item of gross
income sought to be distributed, apportioned or allocated by the CIR.

Our circumspect perusal of the record yielded no evidence of actual or possible showing that the
advances FDC extended to its affiliates had resulted to the interests subsequently assessed by the CIR.
For all its harping upon the supposed fact that FDC had resorted to borrowings from commercial banks,
the CIR had adduced no concrete proof that said funds were, indeed, the source of the advances the
former provided its affiliates. While admitting that FDC obtained interest-bearing loans from commercial
banks,[45] Susan Macabelda - FDC's Funds Management Department Manager who was the sole witness
presented before the CTA - clarified that the subject advances were sourced from the corporation's
rights offering in 1995 as well as the sale of its investment in Bonifacio Land in 1997.[46] More
significantly, said witness testified that said advances: (a) were extended to give FLI, FAI, DSCC and FCI
financial assistance for their operational and capital expenditures; and, (b) were all temporarily in nature
since they were repaid within the duration of one week to three months and were evidenced by mere
journal entries, cash vouchers and instructional letters.[47]

Even if we were, therefore, to accord precipitate credulity to the CIR's bare assertion that FDC had
deducted substantial interest expense from its gross income, there would still be no factual basis for the
imputation of theoretical interests on the subject advances and assess deficiency income taxes thereon.
More so, when it is borne in mind that, pursuant to Article 1956 of the Civil Code of the Philippines, no
interest shall be due unless it has been expressly stipulated in writing. Considering that taxes, being
burdens, are not to be presumed beyond what the applicable statute expressly and clearly declares,[48]
the rule is likewise settled that tax statutes must be construed strictly against the government and
liberally in favor of the taxpayer.[49] Accordingly, the general rule of requiring adherence to the letter in
construing statutes applies with peculiar strictness to tax laws and the provisions of a taxing act are not
to be extended by implication.[50] While it is true that taxes are the lifeblood of the government, it has
been held that their assessment and collection should be in accordance with law as any arbitrariness will
negate the very reason for government itself.[51]

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the imposition of deficiency
income taxes on the transfer FDC and FAI effected in exchange for the shares of stock of FLI. With
respect to the Deed of Exchange executed between FDC, FAI and FLI, Section 34 (c) (2) of the 1993 NIRC
pertinently provides as follows:
Sec. 34. Determination of amount of and recognition of gain or loss.-

xxxx

(c) Exception x x x x

No gain or loss shall also be recognized if property is transferred to a corporation by a person in

exchange for shares of stock in such corporation of which as a result of such exchange said person, alone
or together with others, not exceeding four persons, gains control of said corporation; Provided, That
stocks issued for services shall not be considered as issued in return of property.

As even admitted in the 14 February 2001 Stipulation of Facts submitted by the parties,[52] the
requisites for the non-recognition of gain or loss under the foregoing provision are as follows: (a) the
transferee is a corporation; (b) the transferee exchanges its shares of stock for property/ies of the
transferor; (c) the transfer is made by a person, acting alone or together with others, not exceeding four
persons; and, (d) as a result of the exchange the transferor, alone or together with others, not exceeding
four, gains control of the transferee.[53] Acting on the 13 January 1997 request filed by FLI, the BIR had,
in fact, acknowledged the concurrence of the foregoing requisites in the Deed of Exchange the former
executed with FDC and FAI by issuing BIR Ruling No. S-34-046-97.[54] With the BIR's reiteration of said
ruling upon the request for clarification filed by FLI,[55] there is also no dispute that said transferee and
transferors subsequently complied with the requirements provided for the non-recognition of gain or
loss from the exchange of property for tax, as provided under Section 34 (c) (2) of the 1993 NIRC.[56]

Then as now, the CIR argues that taxable gain should be recognized for the exchange considering that
FDC's controlling interest in FLI was actually decreased as a result thereof. For said purpose, the CIR calls
attention to the fact that, prior to the exchange, FDC owned 2,537,358,000 or 67.42% of FLI's
3,763,535,000 outstanding capital stock. Upon the issuance of 443,094,000 additional FLI shares as a
consequence of the exchange and with only 42,217,000 thereof accruing in favor of FDC for a total of
2,579,575,000 shares, said corporations controlling interest was supposedly reduced to 61%.03 when
reckoned from the transferee's aggregate 4,226,629,000 outstanding shares. Without owning a share
from FLI's initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of 420,877,000
FLI shares as a result of the exchange purportedly resulted in its control of only 9.96% of said transferee
corporation's 4,226,629,000 outstanding shares. On the principle that the transaction did not qualify as
a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC, the CIR asseverates that taxable gain in
the sum of P263,386,921.00 should be recognized on the part of FDC and in the sum of
P3,088,711,367.00 on the part of FAI.[57]

The paucity of merit in the CIR's position is, however, evident from the categorical language of Section
34 (c) (2) of the 1993 NIRC which provides that gain or loss will not be recognized in case the exchange
of property for stocks results in the control of the transferee by the transferor, alone or with other
transferors not exceeding four persons. Rather than isolating the same as proposed by the CIR, FDC's
2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000 outstanding shares should, therefore, be
appreciated in combination with the 420,877,000 new shares issued to FAI which represents 9.96%
control of said transferee corporation. Together FDC's 2,579,575,000 shares (61.03%) and FAI's
420,877,000 shares (9.96%) clearly add up to 3,000,452,000 shares or 70.99% of FLI's 4,226,629,000
shares. Since the term "control" is clearly defined as "ownership of stocks in a corporation possessing at
least fifty-one percent of the total voting power of classes of stocks entitled to one vote" under Section
34 (c) (6) [c] of the 1993 NIRC, the exchange of property for stocks between FDC FAI and FLI clearly
qualify as a tax-free transaction under paragraph 34 (c) (2) of the same provision.

Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme Court Justice
Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law and Jurisprudence, opined that
said provision could be inapplicable if control is already vested in the exchangor prior to exchange.[58]
Aside from the fact that that the 10 September 2002 Decision in CTA Case No. 6182 upholding the tax-
exempt status of the exchange between FDC, FAI and FLI was penned by no less than Justice Acosta
himself,[59] FDC and FAI significantly point out that said authors have acknowledged that the position
taken by the BIR is to the effect that "the law would apply even when the exchangor already has control
of the corporation at the time of the exchange."[60] This was confirmed when, apprised in FLI's request
for clarification about the change of percentage of ownership of its outstanding capital stock, the BIR
opined as follows:

Please be informed that regardless of the foregoing, the transferors, Filinvest Development Corp. and
Filinvest Alabang, Inc. still gained control of Filinvest Land, Inc. The term 'control' shall mean ownership
of stocks in a corporation by possessing at least 51% of the total voting power of all classes of stocks
entitled to vote. Control is determined by the amount of stocks received, i.e., total subscribed, whether
for property or for services by the transferor or transferors. In determining the 51% stock ownership,
only those persons who transferred property for stocks in the same transaction may be counted up to
the maximum of five (BIR Ruling No. 547-93 dated December 29, 1993.[61]
At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by the CIR is more
apparent than real. As the uncontested owner of 80% of the outstanding shares of FAI, it cannot be
gainsaid that FDC ideally controls the same percentage of the 420,877,000 shares issued to its said co-
transferor which, by itself, represents 7.968% of the outstanding shares of FLI. Considered alongside
FDC's 61.03% control of FLI as a consequence of the 29 November 1996 Deed of Transfer, said 7.968%
add up to an aggregate of 68.998% of said transferee corporation's outstanding shares of stock which is
evidently still greater than the 67.42% FDC initially held prior to the exchange. This much was admitted
by the parties in the 14 February 2001 Stipulation of Facts, Documents and Issues they submitted to the
CTA.[62] Inasmuch as the combined ownership of FDC and FAI of FLI's outstanding capital stock adds up
to a total of 70.99%, it stands to reason that neither of said transferors can be held liable for deficiency
income taxes the CIR assessed on the supposed gain which resulted from the subject transfer.

On the other hand, insofar as documentary stamp taxes on loan agreements and promissory notes are
concerned, Section 180 of the NIRC provides follows:

Sec. 180. Stamp tax on all loan agreements, promissory notes, bills of exchange, drafts, instruments and
securities issued by the government or any of its instrumentalities, certificates of deposit bearing
interest and others not payable on sight or demand. On all loan agreements signed abroad wherein the
object of the contract is located or used in the Philippines; bill of exchange (between points within the
Philippines), drafts, instruments and securities issued by the Government or any of its instrumentalities
or certificates of deposits drawing interest, or orders for the payment of any sum of money otherwise
than at sight or on demand, or on all promissory notes, whether negotiable or non-negotiable, except
bank notes issued for circulation, and on each renewal of any such note, there shall be collected a
documentary stamp tax of Thirty centavos (P0.30) on each two hundred pesos, or fractional part
thereof, of the face value of any such agreement, bill of exchange, draft, certificate of deposit or note:
Provided, That only one documentary stamp tax shall be imposed on either loan agreement, or
promissory notes issued to secure such loan, whichever will yield a higher tax: Provided however, That
loan agreements or promissory notes the aggregate of which does not exceed Two hundred fifty
thousand pesos (P250,000.00) executed by an individual for his purchase on installment for his personal
use or that of his family and not for business, resale, barter or hire of a house, lot, motor vehicle,
appliance or furniture shall be exempt from the payment of documentary stamp tax provided under this
Section.

When read in conjunction with Section 173 of the 1993 NIRC,[63] the foregoing provision concededly
applies to "(a)ll loan agreements, whether made or signed in the Philippines, or abroad when the
obligation or right arises from Philippine sources or the property or object of the contract is located or
used in the Philippines." Correlatively, Section 3 (b) and Section 6 of Revenue Regulations No. 9-94
provide as follows:
Section 3. Definition of Terms. For purposes of these Regulations, the following term shall mean:

(b) 'Loan agreement' refers to a contract in writing where one of the parties delivers to another money
or other consumable thing, upon the condition that the same amount of the same kind and quality shall
be paid. The term shall include credit facilities, which may be evidenced by credit memo, advice or
drawings.

The terms 'Loan Agreement" under Section 180 and "Mortgage' under Section 195, both of the Tax
Code, as amended, generally refer to distinct and separate instruments. A loan agreement shall be taxed
under Section 180, while a deed of mortgage shall be taxed under Section 195."

"Section 6. Stamp on all Loan Agreements. All loan agreements whether made or signed in the
Philippines, or abroad when the obligation or right arises from Philippine sources or the property or
object of the contract is located in the Philippines shall be subject to the documentary stamp tax of
thirty centavos (P0.30) on each two hundred pesos, or fractional part thereof, of the face value of any
such agreements, pursuant to Section 180 in relation to Section 173 of the Tax Code.

In cases where no formal agreements or promissory notes have been executed to cover credit facilities,
the documentary stamp tax shall be based on the amount of drawings or availment of the facilities,
which may be evidenced by credit/debit memo, advice or drawings by any form of check or withdrawal
slip, under Section 180 of the Tax Code.

Applying the aforesaid provisions to the case at bench, we find that the instructional letters as well as
the journal and cash vouchers evidencing the advances FDC extended to its affiliates in 1996 and 1997
qualified as loan agreements upon which documentary stamp taxes may be imposed. In keeping with
the caveat attendant to every BIR Ruling to the effect that it is valid only if the facts claimed by the
taxpayer are correct, we find that the CA reversibly erred in utilizing BIR Ruling No. 116-98, dated 30 July
1998 which, strictly speaking, could be invoked only by ASB Development Corporation, the taxpayer who
sought the same. In said ruling, the CIR opined that documents like those evidencing the advances FDC
extended to its affiliates are not subject to documentary stamp tax, to wit:
On the matter of whether or not the inter-office memo covering the advances granted by an affiliate
company is subject to documentary stamp tax, it is informed that nothing in Regulations No. 26
(Documentary Stamp Tax Regulations) and Revenue Regulations No. 9-94 states that the same is subject
to documentary stamp tax. Such being the case, said inter-office memo evidencing the lendings or
borrowings which is neither a form of promissory note nor a certificate of indebtedness issued by the
corporation-affiliate or a certificate of obligation, which are, more or less, categorized as 'securities', is
not subject to documentary stamp tax imposed under Section 180, 174 and 175 of the Tax Code of 1997,
respectively. Rather, the inter-office memo is being prepared for accounting purposes only in order to
avoid the co-mingling of funds of the corporate affiliates.

In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in BIR Ruling No.
108-99 dated 15 July 1999, which opined that inter-office memos evidencing lendings or borrowings
extended by a corporation to its affiliates are akin to promissory notes, hence, subject to documentary
stamp taxes.[64] In brushing aside the foregoing argument, however, the CA applied Section 246 of the
1993 NIRC[65] from which proceeds the settled principle that rulings, circulars, rules and regulations
promulgated by the BIR have no retroactive application if to so apply them would be prejudicial to the
taxpayers.[66] Admittedly, this rule does not apply: (a) where the taxpayer deliberately misstates or
omits material facts from his return or in any document required of him by the Bureau of Internal
Revenue; (b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially
different from the facts on which the ruling is based; or (c) where the taxpayer acted in bad faith.[67]
Not being the taxpayer who, in the first instance, sought a ruling from the CIR, however, FDC cannot
invoke the foregoing principle on non-retroactivity of BIR rulings.

Viewed in the light of the foregoing considerations, we find that both the CTA and the CA erred in
invalidating the assessments issued by the CIR for the deficiency documentary stamp taxes due on the
instructional letters as well as the journal and cash vouchers evidencing the advances FDC extended to
its affiliates in 1996 and 1997. In Assessment Notice No. SP-DST-96-00020-2000, the CIR correctly
assessed the sum of P6,400,693.62 for documentary stamp tax, P3,999,793.44 in interests and
P25,000.00 as compromise penalty, for a total of P10,425,487.06. Alongside the sum of P4,050,599.62
for documentary stamp tax, the CIR similarly assessed P1,721,099.78 in interests and P25,000.00 as
compromise penalty in Assessment Notice No. SP-DST-97-00021-2000 or a total of P5,796,699.40. The
imposition of deficiency interest is justified under Sec. 249 (a) and (b) of the NIRC which authorizes the
assessment of the same at the rate of twenty percent (20%), or such higher rate as may be prescribed by
regulations, from the date prescribed for the payment of the unpaid amount of tax until full
payment.[68] The imposition of the compromise penalty is, in turn, warranted under Sec. 250[69] of the
NIRC which prescribes the imposition thereof in case of each failure to file an information or return,
statement or list, or keep any record or supply any information required on the date prescribed
therefor.

To our mind, no reversible error can, finally, be imputed against both the CTA and the CA for invalidating
the Assessment Notice issued by the CIR for the deficiency income taxes FDC is supposed to have
incurred as a consequence of the dilution of its shares in FAC. Anent FDCs Shareholders Agreement with
RHPL, the record shows that the parties were in agreement about the following factual antecedents
narrated in the 14 February 2001 Stipulation of Facts, Documents and Issues they submitted before the
CTA,[70] viz.:

1.11. On November 15, 1996, FDC entered into a Shareholders Agreement (SA) with Reco Herrera Pte.
Ltd. (RHPL) for the formation of a joint venture company named Filinvest Asia Corporation (FAC) which is
based in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7, Answer).

1.12. FAC, the joint venture company formed by FDC and RHPL, is tasked to develop and manage the
50% ownership interest of FDC in its PBCom Office Tower Project (Project) with the Philippine Bank of
Communications (par. 6.12, Petition; par. 7, Answer).

1.13. Pursuant to the SA between FDC and RHPL, the equity participation of FDC and RHPL in FAC was
60% and 40% respectively.

1.14. In accordance with the terms of the SA, FDC subscribed to P500.7 million worth of shares of stock
representing a 60% equity participation in FAC. In turn, RHPL subscribed to P433.8 million worth of
shares of stock of FAC representing a 40% equity participation in FAC.

1.15. In payment of its subscription in FAC, FDC executed a Deed of Assignment transferring to FAC a
portion of FDCs right and interests in the Project to the extent of P500.7 million.

1.16. FDC reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year
1996.[71]
Alongside the principle that tax revenues are not intended to be liberally construed,[72] the rule is
settled that the findings and conclusions of the CTA are accorded great respect and are generally upheld
by this Court, unless there is a clear showing of a reversible error or an improvident exercise of
authority.[73] Absent showing of such error here, we find no strong and cogent reasons to depart from
said rule with respect to the CTA's finding that no deficiency income tax can be assessed on the gain on
the supposed dilution and/or increase in the value of FDC's shareholdings in FAC which the CIR, at any
rate, failed to establish. Bearing in mind the meaning of "gross income" as above discussed, it cannot be
gainsaid, even then, that a mere increase or appreciation in the value of said shares cannot be
considered income for taxation purposes. Since a mere advance in the value of the property of a person
or corporation in no sense constitute the income specified in the revenue law, it has been held in the
early case of Fisher vs. Trinidad,[74] that it constitutes and can be treated merely as an increase of
capital. Hence, the CIR has no factual and legal basis in assessing income tax on the increase in the value
of FDC's shareholdings in FAC until the same is actually sold at a profit.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No. 163653 is
DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R. No. 72992 is AFFIRMED in toto.
The CIRs petition in G.R. No. 167689 is PARTIALLY GRANTED and the CAs 26 January 2005 Decision in CA-
G.R. SP No. 74510 is MODIFIED.

Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 issued for

deficiency documentary stamp taxes due on the instructional letters as well as journal and cash
vouchers evidencing the advances FDC extended to its affiliates are declared valid.

The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-00019-2000 and SP-INC-

97-0027-2000 issued for deficiency income assessed on (a) the arms-length interest from said advances;
(b) the gain from FDCs Deed of Exchange with FAI and FLI; and (c) income from the dilution resulting
from FDCs Shareholders Agreement with RHPL is, however, upheld.

SO ORDERED.
FIRST DIVISION

G.R. No. 160528 October 9, 2006

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.

PHILIPPINE AIRLINES, INC., respondent.

DECISION

PANGANIBAN, CJ.:

A franchise is a legislative grant to operate a public utility. Like those of any other statute, the
ambiguous provisions of a franchise should be construed in accordance with the intent of the
legislature. In the present case, Presidential Decree 1590 granted Philippine Airlines an option to pay the
lower of two alternatives: (a) "the basic corporate income tax based on PALs annual net taxable income
computed in accordance with the provisions of the National Internal Revenue Code" or (b) "a franchise
tax of two percent of gross revenues." Availment of either of these two alternatives shall exempt the
airline from the payment of "all other taxes," including the 20 percent final withholding tax on bank
deposits.

The Case

Before us is a Petition for Review1 under Rule 45 of the Rules of Court, challenging the September 30,
2003 Decision2 of the Court of Appeals (CA) in CA-GR SP No. 67970. The CA reversed the June 13, 2001
Decision3 and the November 13, 2001 Resolution4 of the Court of Tax Appeals (CTA) in CTA Case No.
5824. The assailed CA Decision disposed as follows:

"WHEREFORE, the petition is GRANTED, and [the] Commissioner of Internal Revenue is hereby directed
to refund to the [respondent] the amount of P731,190.45 representing the 20% final withholding tax
collected and deducted by depository banks on the petitioners interest income or, in the alternative, to
allow the [respondent] a tax credit for the same amount."5

The Facts

The CA narrates the facts thus:

"[Respondent] Philippine Airlines, Inc. (PAL) is a domestic corporation organized in accordance with the
laws of the Republic of the Philippines, while [Petitioner] Commissioner of Internal Revenue (CIR) is in-
charge of the assessment and collection of the 20% final tax on interest on Philippine currency bank
deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and
similar arrangements, imposed on domestic corporation under Sec. 24 (e) (1) [now Sec. 27 (D) (1)] of the
National Internal Revenue Code (NIRC).
"On November 5, 1997, [respondents] AVP-Revenue Operations and Tax Services Officer, Atty. Edgardo
P. Curbita, filed with the Office of the then Commissioner of Internal Revenue, Mdm. Liwayway Vinzons-
Chato, a written request for refund of the amount of P2,241,527.22 which represents the total amount
of 20% final withholding tax withheld from the [respondent] by various withholding agent banks, and
which amount includes the 20% final withholding tax withheld by the United Coconut Planters Bank
(UCPB) and Rizal Commercial Banking Corporation (RCBC) for the period starting March 1995 through
February 1997.

"On December 4, 1997, the [respondents] AVP-Revenue Operations and Tax Services Officer again filed
with [petitioner] CIR another written request for refund of the amount of P1,048,047.23, representing
the total amount of 20% final withholding tax withheld by various depository banks of the [respondent]
which amount includes the 20% withholding tax withheld by the Philippine National Bank (PNB),
Equitable Banking Corporation (EBC), and the Jade Progressive Savings & Mortgage Bank (JPSMB) for the
period starting March 1995 through November 1997.

"The amounts, subject of this petition, and which represent the 20% final withholding tax allegedly
erroneously withheld and remitted to the BIR by the aforesaid banks may be summarized as follows:

Bank

Period Covered

Source

Amount

UCPB

Jan. 9, 1997 Feb. 21, 1997

Interest income on prime savings deposit

P60,328.38

Interest income on government securities and/or commercial papers

78,658.52

P131,986.65

RCBC

Jan. 6, 1997 Feb. 28, 1997

Interest income on FBTB and Treasury Bills placements

47,763.55

PNB

Feb. 19, 1997 Nov. 14, 1997

Interest income on PNBIG savings account

514,120.22

EBC

Jan. 3, 1997 Feb. 28, 1997

Interest income on Treasury Bills placement

33,357.25

JPSMB

Jan. 1, 1997 Feb. 28, 1997

Interest income on deposits

3,962.78

"[Petitioner] CIR failed to act on the [respondents] request for refund; thus, a petition was filed before
the CTA on April 23, 1999."6

Ruling of the Court of Tax Appeals

The CTA ruled that Respondent PAL was not entitled to the refund. Section 13 of Presidential Decree No.
1590, PALs franchise,7 allegedly gave respondent the option to pay either its corporate income tax
under the provisions of the NIRC or a franchise tax of two percent of its gross revenues. Payment of
either tax would be in lieu of all "other taxes." Had respondent paid the two percent franchise tax, then
the final withholding taxes would have been considered as "other taxes." Since it chose to pay its
corporate income tax, payment of the final withholding tax is deemed part of this liability and therefore
not refundable.8

Ruling of the Court of Appeals

As stated earlier, the Court of Appeals reversed the Decision of the CTA. The CA held that PAL was
bound to pay only the corporate income tax or the franchise tax. Section 13 of Presidential Decree No.
1590 exempts respondent from paying all other taxes, duties, royalties and other fees of any kind.9
Respondent chose to pay its basic corporate income tax, which, after considering the factors allowed by
law, resulted in a zero tax liability.10 This zero tax liability should neither be taken against respondent
nor deprive it of the exemption granted by the law.11 Having chosen to pay its corporate income tax
liability, respondent should now be exempt from paying all other taxes including the final withholding
tax.

Hence, this Petition.12

The Issue

The sole issue raised by petitioner is stated in this wise:

"The Court of Appeals erred on a question of law ruling that the in lieu of all other taxes provision in
Section 13 of PD No. 1590 applies even if there were in fact no taxes paid under any of subsections (A)
and (B) of the said decree."13

The Courts Ruling

The Petition has no merit.

Sole Issue:

Tax Liability of PAL

The resolution of the instant case hinges on the interpretation of Section 13 of PALs franchise, which
states in part:

"SEC. 13. In consideration of the franchise and rights hereby granted, the grantee shall pay to the
Philippine Government during the life of this franchise whichever of subsections (a) and (b) hereunder
will result in a lower tax:

(a) The basic corporate income tax based on the grantee's annual net taxable income computed in
accordance with the provisions of the National Internal Revenue Code; or

(b) A franchise tax of two percent (2%) of the gross revenues derived by the grantee from all sources,
without distinction as to transport or non-transport operations; provided, that with respect to
international air-transport service, only the gross passenger, mail, and freight revenues from its
outgoing flights shall be subject to this tax.

"The tax paid by the grantee under either of the above alternatives shall be in lieu of all other taxes,
duties, royalties, registration, license, and other fees and charges of any kind, nature, or description,
imposed, levied, established, assessed, or collected by any municipal, city, provincial, or national
authority or government agency, now or in the future, x x x."14

Two points are evident from this provision. First, as consideration for the franchise, PAL is liable to pay
either a) its basic corporate income tax based on its net taxable income, as computed under the
National Internal Revenue Code; or b) a franchise tax of two percent based on its gross revenues,
whichever is lower. Second, the tax paid is "in lieu of all other taxes" imposed by all government entities
in the country.
Interpretation of PALs Franchise

According to the CA and PAL, the "other taxes in lieu of all other taxes" proviso includes final
withholding taxes.15 When respondent availed itself of the basic corporate income tax as its chosen tax
liability, it became exempt from final withholding taxes.

On the other hand, the CTA held that the "in lieu of all other taxes" proviso implied the existence of
something for which a substitution would be made.16 Final withholding taxes come under basic
corporate income tax liability; hence, payment of the latter cannot mean an exemption from the former.
To be exempt from final withholding taxes, PAL should have paid the franchise tax of two percent, which
would have been in lieu of all other taxes including the final withholding tax.

The CIR argues that the "in lieu of all other taxes" proviso is a mere incentive that applies only when PAL
actually pays something; that is, either the basic corporate income tax or the franchise tax.17 Because of
the zero tax liability of respondent under the basic corporate income tax system, it was not eligible for
exemption from other taxes.18

Construing Subsection (a)

of Section 13 of PD 1590

Vis--vis the Corporate Income Tax

PAL availed itself of PD 1590, Section 13, Subsection (a), the crux of which hinged on the terms "basic
corporate income tax" and "annual net taxable income." The applicable laws (PALs franchise and the
Tax Code) do not define the terms "basic corporate income tax."19 On the other hand, "annual net
taxable income" is computed in accordance with the provisions of the National Internal Revenue Code.

The statutory basis for the income tax on corporations is found in Sections 27 to 30 of the National
Internal Revenue Code of 1997 under Chapter IV: "Tax on Corporations." Section 27 enumerates the
rate of income tax on domestic corporations; Section 28, the rates for foreign corporations; Section 29,
the taxes on improperly accumulated earnings; and Section 30, the corporations exempt from tax.

Being a domestic corporation, PAL is subject to Section 27, which reads as follows:

"Section 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, x x x, organized in, or existing under the laws of the
Philippines x x x."20

The NIRC also imposes final taxes on certain passive incomes, as follows: 1) 20 percent on the interests
on currency bank deposits, other monetary benefits from deposit substitutes, trust funds and similar
arrangements, and royalties derived from sources within the Philippines;21 2) 5 percent and 10 percent
on the net capital gains realized from the sale of shares of stock in a domestic corporation not traded in
the stock exchange;22 3) 10 percent on income derived by a depositary bank under the expanded
foreign currency deposit system;23 and 4) 6 percent on the gain presumed to be realized on the sale or
disposition of lands and buildings treated as capital assets.24 These final taxes are withheld at source.25

A corporate income tax liability, therefore, has two components: the general rate of 35 percent, which is
not disputed; and the specific final rates for certain passive incomes. PALs request for a refund in the
present case pertains to the passive income on bank deposits, which is subject to the specific final tax of
20 percent.26

Computation of Taxable

Income Under the Tax Code

Note that the tax liability of PAL under the option it chose (Item "a" of Section 13 of PD 1590) is to be
"computed in accordance with the provisions of the National Internal Revenue Code," as follows:

"(a) The basic corporate income tax based on the grantees annual net taxable income computed in
accordance with the provisions of the National Internal Revenue Code[.]"

Taxable income means the pertinent items of gross income specified in the Tax Code, less the
deductions and/or personal and additional exemptions, if any, authorized for these types of income.27
Under Section 32 of the Tax Code, gross income means income derived from whatever source, including
compensation for services; the conduct of trade or business or the exercise of a profession; dealings in
property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partners
distributive share in the net income of a general professional partnership. Section 34 enumerates the
allowable deductions; Section 35, personal and additional exemptions.

The definition of gross income is broad enough to include all passive incomes subject to specific rates or
final taxes. However, since these passive incomes are already subject to different rates and taxed finally
at source, they are no longer included in the computation of gross income, which determines taxable
income.

Basic Corporate Income Tax Based

on Annual Net Taxable Income

To repeat, the pertinent provision in the case at bar reads: "basic corporate income tax based on the
grantees annual net taxable income computed in accordance with the provisions of the National
Internal Revenue Code." The Court has already illustrated that, under the Tax Code, "taxable income"
does not include passive income subjected to final withholding taxes. Clearly, then, the "basic corporate
income tax" identified in Section 13 (a) of the franchise relates to the general rate of 35 percent as
stipulated in Section 27 of the Tax Code. The final 20 percent taxes disputed in the present case are not
covered under Section 13 (a) of PALs franchise; thus, a refund is in order.
"Substitution Theory"

of the CIR Untenable

A careful reading of Section 13 rebuts the argument of the CIR that the "in lieu of all other taxes" proviso
is a mere incentive that applies only when PAL actually pays something. It is clear that PD 1590 intended
to give respondent the option to avail itself of Subsection (a) or (b) as consideration for its franchise.
Either option excludes the payment of other taxes and dues imposed or collected by the national or the
local government. PAL has the option to choose the alternative that results in lower taxes. It is not the
fact of tax payment that exempts it, but the exercise of its option.

Under Subsection (a), the basis for the tax rate is respondents annual net taxable income, which (as
earlier discussed) is computed by subtracting allowable deductions and exemptions from gross income.
By basing the tax rate on the annual net taxable income, PD 1590 necessarily recognized the situation in
which taxable income may result in a negative amount and thus translate into a zero tax liability.

Notably, PAL was owned and operated by the government at the time the franchise was last
amended.28 It can reasonably be contemplated that PD 1590 sought to assist the finances of the
government corporation in the form of lower taxes. When respondent operates at a loss (as in the
instant case), no taxes are due; in this instance, it has a lower tax liability than that provided by
Subsection (b).

The fallacy of the CIRs argument is evident from the fact that the payment of a measly sum of one peso
would suffice to exempt PAL from other taxes, whereas a zero liability arising from its losses would not.
There is no substantial distinction between a zero tax and a one-peso tax liability.

The Court is bound to effectuate the lawmakers intent, which is the controlling factor in interpreting a
statute.29 Significantly, this Court has held that the soul of the law is intent:

"The intent of a statute is the law. If a statute is valid it is to have effect according to the purpose and
intent of the lawmaker. The intent is the vital part, the essence of the law, and the primary rule of
construction is to ascertain and give effect to the intent. The intention of the legislature in enacting a
law is the law itself, and must be enforced when ascertained, although it may not be consistent with the
strict letter of the statute. Courts will not follow the letter of a statute when it leads away from the true
intent and purpose of the legislature and to conclusions inconsistent with the general purpose of the
act. Intent is the spirit which gives life to a legislative enactment. In construing statutes the proper
course is to start out and follow the true intent of the legislature and to adopt that sense which
harmonizes best with the context and promotes in the fullest manner the apparent policy and objects of
the legislature."30

While the Court recognizes the general rule that the grant of tax exemptions is strictly construed against
the taxpayer and in favor of the taxing power,31 Section 13 of the franchise of respondent leaves no
room for interpretation. Its franchise exempts it from paying any tax other than the option it chooses:
either the "basic corporate income tax" or the two percent gross revenue tax.
Determining whether this tax exemption is wise or advantageous is outside the realm of judicial power.
This matter is addressed to the sound discretion of the lawmaking department of government.

WHEREFORE, the Petition is DENIED. No pronouncement as to costs.

SO ORDERED.

Ynares-Santiago, Austria-Martinez, Callejo, Sr., and Chico-Nazario, JJ., concur.