G.R. No.

148512 June 26, 2006

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.
CENTRAL LUZON DRUG CORPORATION, Respondent.

This is a petition for review under Rule 45 of the Rules of Court seeking the nullification of the Decision, dated May
31, 2001, of the Court of Appeals (CA) in CA-G.R. SP No. 60057, entitled "Central Luzon Drug Corporation v.
Commissioner of Internal Revenue," granting herein respondent Central Luzon Drug Corporation’s claim for tax credit
equal to the amount of the 20% discount that it extended to senior citizens on the latter’s purchase of medicines
pursuant to Section 4(a) of Republic Act (R.A.) No. 7432, entitled "An Act to Maximize the Contribution of Senior
Citizens to Nation Building, Grant Benefits and Special Privileges and for other Purposes" otherwise known as the
Senior Citizens Act.

The antecedents are as follows:

Central Luzon Drug Corporation has been a retailer of medicines and other pharmaceutical products since December
19, 1994. In 1995, it opened three (3) drugstores as a franchisee under the business name and style of "Mercury Drug."

For the period January 1995 to December 1995, in conformity to the mandate of Sec. 4(a) of R.A. No. 7432, petitioner
granted a 20% discount on the sale of medicines to qualified senior citizens amounting to P219,778.

Pursuant to Revenue Regulations No. 2-941 implementing R.A. No. 7432, which states that the discount given to senior
citizens shall be deducted by the establishment from its gross sales for value-added tax and other percentage tax
purposes, respondent deducted the total amount of P219,778 from its gross income for the taxable year 1995. For said
taxable period, respondent reported a net loss of P20,963 in its corporate income tax return. As a consequence,
respondent did not pay income tax for 1995.

Subsequently, on December 27, 1996, claiming that according to Sec. 4(a) of R.A. No. 7432, the amount of P219,778
should be applied as a tax credit, respondent filed a claim for refund in the amount of P150,193, thus:

Net Sales P 37,014,807.00

Add: Cost of 20% Discount to Senior Citizens 219,778.00

Gross Sales P 37,234,585.00

Less: Cost of Sales

Merchandise Inventory, beg P 1,232,740.00

Purchases 41,145,138.00

8,521,557.00 33,856,621.00
Merchandise Inventory, end

Gross Profit P 3,377,964.00

Miscellaneous Income 39,014.00

Total Income 3,416,978.00

Operating Expenses 3,199,230.00

 Net Income Before Tax P 217,748.00

Income Tax (35%) 69,585.00

Less: Tax Credit

(Cost of 20% Discount to Senior Citizens) 219,778.00

Income Tax Payable (P 150,193.00)

Income Tax Actually Paid -0-

Tax Refundable/Overpaid Income Tax (P 150,193.00)

As shown above, the amount of P150,193 claimed as a refund represents the tax credit allegedly due to respondent
under R.A. No. 7432. Since the Commissioner of Internal Revenue "was not able to decide the claim for refund on
time,"2 respondent filed a Petition for Review with the Court of Tax Appeals (CTA) on March 18, 1998.

On April 24, 2000, the CTA dismissed the petition, declaring that even if the law treats the 20% sales discounts granted
to senior citizens as a tax credit, the same cannot apply when there is no tax liability or the amount of the tax credit is
greater than the tax due. In the latter case, the tax credit will only be to the extent of the tax liability. 3Also, no refund
can be granted as no tax was erroneously, illegally and actually collected based on the provisions of Section 230, now
Section 229, of the Tax Code. Furthermore, the law does not state that a refund can be claimed by the private
establishment concerned as an alternative to the tax credit.

Thus, respondent filed with the CA a Petition for Review on August 3, 2000.

On May 31, 2001, the CA rendered a Decision stating that Section 229 of the Tax Code does not apply in this case. It
concluded that the 20% discount given to senior citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A.
No. 7432 is considered just compensation and, as such, may be carried over to the next taxable period if there is no
current tax liability. In view of this, the CA held:

WHEREFORE, the instant petition is hereby GRANTED and the decision of the CTA dated 24 April 2000 and its
resolution dated 06 July 2000 are SET ASIDE. A new one is entered granting petitioner’s claim for tax credit in the
amount of Php: 150,193.00. No costs.

SO ORDERED.4

Hence, this petition raising the sole issue of whether the 20% sales discount granted by respondent to qualified senior
citizens pursuant to Sec. 4(a) of R.A. No. 7432 may be claimed as a tax credit or as a deduction from gross sales in
accordance with Sec. 2(1) of Revenue Regulations No. 2-94.

Sec. 4(a) of R.A. No. 7432 provides:

Sec. 4. Privileges for the Senior citizens. – The senior citizens shall be entitled to the following:

(a) the grant of twenty percent (20%) discount from all establishments relative to utilization of transportations services,
hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in
the country: Provided, That private establishments may claim the cost as tax credit.
The CA and the CTA correctly ruled that based on the plain wording of the law discounts given under R.A. No. 7432
should be treated as tax credits, not deductions from income.

It is a fundamental rule in statutory construction that the legislative intent must be determined from the language of the
statute itself especially when the words and phrases therein are clear and unequivocal. The statute in such a case must
be taken to mean exactly what it says.5 Its literal meaning should be followed;6 to depart from the meaning expressed
by the words is to alter the statute.7

The above provision explicitly employed the word "tax credit." Nothing in the provision suggests for it to mean a
"deduction" from gross sales. To construe it otherwise would be a departure from the clear mandate of the law.

Thus, the 20% discount required by the Act to be given to senior citizens is a tax credit, not a deduction from the gross
sales of the establishment concerned. As a corollary to this, the definition of ‘tax credit’ found in Section 2(1) of
Revenue Regulations No. 2-94 is erroneous as it refers to tax credit as the amount representing the 20% discount that
"shall be deducted by the said establishment from their gross sales for value added tax and other percentage tax
purposes." This definition is contrary to what our lawmakers had envisioned with regard to the treatment of the
discount granted to senior citizens.

Accordingly, when the law says that the cost of the discount may be claimed as a tax credit, it means that the amount --
when claimed – shall be treated as a reduction from any tax liability.8 The law cannot be amended by a mere
regulation. The administrative agencies issuing these regulations may not enlarge, alter or restrict the provisions of the
law they administer.9 In fact, a regulation that "operates to create a rule out of harmony with the statute is a mere
nullity."10

Finally, for purposes of clarity, Sec. 22911 of the Tax Code does not apply to cases that fall under Sec. 4 of R.A. No.
7432 because the former provision governs exclusively all kinds of refund or credit of internal revenue taxes that were
erroneously or illegally imposed and collected pursuant to the Tax Code while the latter extends the tax credit benefit
to the private establishments concerned even before tax payments have been made. The tax credit that is contemplated
under the Act is a form of just compensation, not a remedy for taxes that were erroneously or illegally assessed and
collected. In the same vein, prior payment of any tax liability is not a precondition before a taxable entity can benefit
from the tax credit. The credit may be availed of upon payment of the tax due, if any. Where there is no tax liability or
where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the
next taxable year.

It must also be stressed that unlike in Sec. 229 of the Tax Code wherein the remedy of refund is available to the
taxpayer, Sec. 4 of the law speaks only of a tax credit, not a refund.

As earlier mentioned, the tax credit benefit granted to the establishments can be deemed as their just compensation for
private property taken by the State for public use. The privilege enjoyed by the senior citizens does not come directly
from the State, but rather from the private establishments concerned.12

WHEREFORE, the petition is DENIED. The Decision of the Court of Appeals in CA-G.R. SP No. 60057, dated May
31, 2001, is AFFIRMED.

No pronouncement as to costs.

SO ORDERED.
 July 21, 2006
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.
BICOLANDIA DRUG CORPORATION (formerly known as ELMAS DRUG CO.), respondent.

NATURE: Petition for review of a CA decision. Original action for tax refund or credit before the BIR Appellate
Division

SUMMARY: The Senior Citizens Act gave 20% discount to senior citizens’ medicine purchases. The law allowed the
druggists to claim the discount as a tax credit; but the Regulations issued by the BIR defined “tax credit” for the
purposes of the Senior Citizens Act as a tax deduction. Bicolandia Drug filed a claim for tax credit under the Senior
Citizens Act, on the ground that the definition in the RR is erroneous. CTA gave Bicolandia Drug a refund; CA held
that it was a credit, because that is what the law provided. CIR elevated the case to the SC, which upheld the CA. The
plain meaning and intention of the law was to give relief to the druggists in the form of a tax credit. Being contrary to
such meaning and intention, the RR issued by the CIR was incorrect and void; but the policy behind it was later
embodied into the amendment to the Senior Citizens Act; hence the discount is now claimable as a deduction, but at
the time that Bicolandia Drug claimed it, it was treated as a tax credit and the CIR must respect such treatment.

DOCTRINE: In cases of conflict between the law and the rules and regulations implementing the law, the law shall
always prevail. Should Revenue Regulations deviate from the law they seek to implement, they will be struck down.
A tax credit reduces the taxpayer's liability, while a deduction reduces taxable income upon which the tax
liability is calculated. A credit differs from deduction to the extent that the former is subtracted from the tax while the
latter is subtracted from income before the tax is computed.
The 20% discount under the Expanded Senior Citizens Act should be treated as a tax deduction.

FACTS
 1992 - RA 7432, otherwise known as "An Act to Maximize the Contribution of Senior Citizens to Nation
Building, Grant Benefits and Special Privileges and For Other Purposes," granted senior citizens several
privileges, one of which was obtaining a 20% discount from all establishments relative to the use of
transportation services, hotels and similar lodging establishments, restaurants and recreation centers and
purchase of medicines anywhere in the country.
o The law also provided that the private establishments giving the discount to senior citizens may claim
the cost as tax credit.
o In compliance with the law, the BIR issued RR 2-94, which defined "tax credit" as “the amount
representing the 20% discount granted to a qualified senior citizen by all establishments relative to
their utilization of transportation services, hotels and similar lodging establishments, restaurants,
halls, circuses, carnivals and other similar places of culture, leisure and amusement, which discount
shall be deducted by the said establishments from their gross income for income tax purposes and from
their gross sale for value-added tax or other percentage tax purposes”.
 1995 - BICOLANDIA DRUG Corporation, a corporation engaged in the business of retailing pharmaceutical
products under the business style of "Mercury Drug," granted the 20% sales discount to qualified senior
citizens purchasing their medicines in compliance with RA 7432.
o Bicolandia Drug treated this discount as a deduction from its gross income in compliance with RR
2-94, which implemented RA 7432.
 April 15, 1996 - Bicolandia Drug filed its 1995 Corporate Annual Income Tax Return declaring a net loss
position with nil income tax liability.
 December 27, 1996 - Bicolandia Drug filed a claim for tax refund or credit in the amount of PhP 259,659.00
with the BIR Appellate Division because its net losses for the year 1995 prevented it from benefiting from the
treatment of sales discounts as a deduction from gross sales during the said taxable year.
o It alleged that the CIR erred in treating the 20 percent sales discount given to senior citizens as a
deduction from its gross income for income tax purposes or other percentage tax purposes rather than
as a tax credit.
 April 6, 1998 - Bicolandia Drug appealed to the CTA in order to toll the running of the 2-year prescriptive
 period to file a claim for refund pursuant to Section 230 of the Tax Code then.
o Bicolandia Drug: Since Section 4 of RA 7432 provided that discounts granted to senior citizens may
be claimed as tax credit, Section 2(i) of RR 2-94, which referred to the tax credit as the amount
representing the 20 percent discount that "shall be deducted by the said establishments from their gross
income for income tax purposes and from their gross sales for value-added tax or other percentage tax
purposes," is illegal, void and without effect for being inconsistent with the statute it implements.
o CIR: RR 2-94 is valid since the law tasked the Department of Finance, among other government
offices, with the issuance of the necessary rules and regulations to carry out the objectives of the law.
 CTA RULING: Provisions of RA 7432 prevail over Section 2(i) of RR 2-94, whose definition of "tax credit"
deviated from the intendment of the law. Refund claim was partially granted. The claimed 20% sales discount
was reduced, thus reducing the refund to be given. CIR ordered to refund Bicolandia Drug the amount of
P236,321.52, representing overpaid income tax for the year 1995.
 CA RULING: RA 7432 provided for a tax credit, not a tax refund. CIR ordered to issue a tax credit certificate
in favor of Bicolandia Drug in the amount of P 236,321.52.

ISSUE (HELD): Is the 20 percent sales discount granted to qualified senior citizens pursuant to RA 7432 claimable as
a tax credit or as a deduction from gross income or gross sales? (TAX CREDIT under RA 7432, but TAX
DEDUCTION under RA 9257)

RATIO
1) RR 2-94 INCORRECTLY REDFEINED "TAX CREDIT" AS "TAX DEDUCTION"
 RR 2-94 equated "tax credit" with "tax deduction.
 Under said RR, the tax credit was defined as the discount itself.
 This is contrary to the definition in Black's Law Dictionary, which defined tax credit as: “An amount
subtracted from an individual's or entity's tax liability to arrive at the total tax liability. A tax credit reduces
the taxpayer's liability x x x, compared to a deduction which reduces taxable income upon which the tax
liability is calculated. A credit differs from deduction to the extent that the former is subtracted from the tax
while the latter is subtracted from income before the tax is computed.”
 Although the interpretation of an implementing administrative agency is accorded great respect and ordinarily
controls the construction of the courts, the definition laid down in the questioned RR can still be subjected to
scrutiny. Courts will not hesitate to set aside an executive interpretation when it is clearly erroneous.
 There is no need for interpretation when there is no ambiguity in the rule, or when the language or words used
are clear and plain or readily understandable to an ordinary reader. The definition of the term "tax credit” is
plain and clear, and the attempt of RR 2-94 to define it differently is the root of the conflict.
 BICOLANDIA DRUG: Tax credit is in the nature of a tax refund and should be treated as a return for tax
payments erroneously or excessively assessed against a taxpayer, in line with Section 204(c) of Republic Act
No. 8424, or the National Internal Revenue Code of 1997.
 CIR: Tax should be paid before the tax credit can be claimed.
 SC: There is at least one instance in the NIRC where this is not the case: Claims relating to zero-rated VAT
sales are treated as tax credits for tax due, so payment of the tax has not yet been made in that particular
example.
 CA expressly recognized the differences between a "tax credit" and a "tax refund".
 CIR: Since RA 7432 used the word "may," the availability of the tax credit to private establishments is only
permissive and not mandatory. Furthermore, the definition of the term "tax credit" in RR 2-94 was validly
issued under the authority granted by the law to the Department of Finance to formulate the needed guidelines.
RR 2-94 can be harmonized with RA 7432, if the definition in RR 2-94 is made to control. To do otherwise
would result in Section 4(a) of RA 7432 impliedly repealing Section 204 (c) of the National Internal Revenue
Code.
 SC: Untenable. RR 2-94 is still subordinate to RA 7432, and in cases of conflict, the implementing rule will
not prevail over the law it seeks to implement. While seemingly conflicting laws must be harmonized as far as
practicable, in this particular case, the conflict cannot be resolved in the CIR’s favor. There is a great divide
separating the idea of "tax credit” and "tax deduction," as seen in the definition in Black's Law Dictionary.
 The claimed absurdity of Section 4(a) of RA 7432 impliedly repealing Section 204(c) of the National Internal
 Revenue Code could only come about if it is accepted that a tax credit is akin to a tax refund wherein payment
of taxes must be made in order for it to be claimed. But as shown in Section 112(a) of the National Internal
Revenue Code, it is not always necessary for payment to be made for a tax credit to be available.
2) INTENTION OF RA 7432 WAS TO GIVE A TAX CREDIT
 CIR: Should private establishments like Bicolandia Drug be allowed to claim tax credits for discounts given to
senior citizens, they would be earning and not just be reimbursed for the discounts given.
 SC: The deliberations show that Congress tried to balance the promotion of senior citizen interests with the
impact of the proposed discount on retailers. Congress purposely chose tax credit as the form of just
compensation to the retailers, whose property has been taken away by the State for public use, as seen from the
following excerpt quoted in CIR v. v. Central Luzon Drug:
 SEN. ANGARA: Letter A. To capture that thought, we’ll say the grant of 20% discount from all
establishments et cetera, et cetera, provided that said establishments may claim the cost as a tax credit. Ganon
ba 'yon?
REP. AQUINO: Yah.
SEN. ANGARA: Dahil kung government, they don’t need to claim it.
THE CHAIRMAN: Tax credit.
SEN. ANGARA: As a tax credit [rather] than a kuwan - deduction,
 If the private establishments appear to benefit more from the tax credit than originally intended, it is not for the
CIR to say that they shouldn't. The tax credit may actually have provided greater incentive for the private
establishments to comply with RA 7432, or quicker relief from the cut into profits of these businesses.
3) RR 2-94 NULL AND VOID UNDER THE RA 7432 REGIME
 From the foregoing, it must be concluded that RR 2-94 is null and void for failing to conform to the law it
sought to implement. In case of discrepancy between the basic law and a rule or regulation issued to
implement said law, the basic law prevails because said rule or regulation cannot go beyond the terms and
provisions of the basic law.
 RR 2-94 being null and void, it must be ruled then that under RA 7432, which was effective at the time,
Bicolandia Drug is entitled to its claim of a tax credit, and the ruling of the Court of Appeals must be affirmed.
4) EXPANDED SENIOR CITIZENS ACT CHANGED THE DISCOUNT INTO A DEDUCTION; ADMONITION TO
ADMINISTRATIVE AGENCIES
 RA 7432 has been amended by RA 9257, the "Expanded Senior Citizens Act of 2003”, which did away with
the term "tax credit".
 The 20% discount is treated “as deduction from gross income for the same taxable year that the discount is
granted. Provided, further, that the total amount of the claimed tax deduction net of value added tax if
applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper
documentation and to the provisions of the National Internal Revenue Code, as amended.”
 While the CIR may have been justified in arguing for the policy behind treating the 20% discount as a tax
deduction, as shown by the amendment made to RA 7432, still it should have respected the old rule laid down
by RA 7432 at the time this case arose.
 “This case should remind all heads of executive agencies which are given the power to promulgate rules and
regulations, that they assume the roles of lawmakers. It is well-settled that a regulation should not conflict with
the law it implements. Thus, those drafting the regulations should study well the laws their rules will
implement, even to the extent of reviewing the minutes of the deliberations of Congress about its intent when it
drafted the law. They may also consult the Secretary of Justice or the Solicitor General for their opinions on
the drafted rules. Administrative rules, regulations and orders have the efficacy and force of law so long as
they do not contravene any statute or the Constitution. It is then the duty of the agencies to ensure that their
rules do not deviate from or amend acts of Congress, for their regulations are always subordinate to law.”

DISPOSITION: Petition DENIED, CA Decision AFFIRMED.

 CIR v. CENTRAL LUZON DRUG CORPORATION, GR No. 159610, 2008-06-12
Facts:
Respondent is a domestic corporation engaged in the retail of medicines and other pharmaceutical products.[5] In 1997,
it operated eight drugstores under the business name and style "Mercury Drug."
Pursuant to the provisions of RA 7432 and Revenue Regulations No. (RR) 2-94[7] issued by the Bureau of Internal
Revenue (BIR), respondent granted 20% sales discount to qualified senior citizens on their purchases of medicines
covering the calendar year

1997. The sales discount granted to senior citizens totaled P2,798,508.00.

On 15 April 1998, respondent filed its 1997 Corporate Annual Income Tax Return reflecting a nil income tax liability
due to net loss incurred from business operations of P2,405,140.00.
Respondent alleged that the overpaid tax was the result of the wrongful implementation... of RA 7432. Respondent
treated the 20% sales discount as a deduction from gross sales in compliance with RR 2-94 instead of treating it as a
tax credit as provided under Section 4(a) of RA 7432
On 6 April 2000, respondent filed a Petition for Review with the CTA in order to toll the running of the two-year
statutory period within which to file a judicial claim. Respondent reasoned that RR 2-94, which is a mere implementing
administrative regulation, cannot modify,... alter or amend the clear mandate of RA 7432. Consequently, Section 2(i)
of RR 2-94 is without force and effect for being inconsistent with the law it seeks to implement.
In his Answer, petitioner stated that the construction given to a statute by a specialized administrative agency like the
BIR is entitled to great respect and should be accorded great weight.
the CTA rendered a Decision ordering petitioner to issue a tax credit certificate in the amount of P2,376,805.63 in
favor of respondent.
he Court of Appeals affirmed the CTA's decision in toto.
he Court of Appeals disagreed with petitioner's contention that the CTA's decision applied a literal interpretation of the
law. It reasoned that under the verba legis rule, if the statute is clear, plain, and free from ambiguity, it must be given
its literal... meaning and applied without interpretation. This principle rests on the presumption that the words used by
the legislature in a statute correctly express its intent and preclude the court from construing it differently.
Issues:
Whether the appellate court erred in holding that respondent may claim the 20% senior citizens' sales discount as a tax
credit deductible from future income tax liabilities instead of a mere deduction from gross income or gross sales; and
Whether the appellate court erred in holding that respondent is entitled to a refund.
Ruling:
The petition lacks merit.
The issues presented are not novel. In two similar cases involving the same parties where respondent lodged its claim
for tax credit on the senior citizens' discount granted in 1995[22] and 1996,[23] this Court has squarely ruled that... the
20% senior citizens' discount required by RA 7432 may be claimed as a tax credit and not merely a tax deduction from
gross sales or gross income. Under RA 7432, Congress granted the tax credit benefit to all covered establishments
without conditions. The net loss... incurred in a taxable year does not preclude the grant of tax credit because by its
nature, the tax credit may still be deducted from a future, not a present, tax liability. However, the senior citizens'
discount granted as a tax credit cannot be refunded.
RA 7432 expressly allows private establishments... to claim the amount of discounts they grant to senior citizens... as
tax credit.
Tax credit is defined as a peso-for-peso reduction from a taxpayer's tax liability. It is a direct subtraction from the tax
payable to the government.
On the other hand, RR 2-94 treated the amount of senior citizens' discount as a tax deduction which is only a
subtraction... from gross income resulting to a lower taxable income.
RR 2-94 affords merely a fractional reduction in the... taxes payable to the government depending on the applicable tax
rate.
In Commissioner of Internal Revenue v. Central Luzon Drug Corporation,[24] the Court ruled that petitioner's
definition in RR 2-94 of a tax credit is clearly erroneous.
To deny the tax credit, despite the plain mandate of the law, is indefensible.
In
Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court declared, "When the law says that
the cost of the discount may be claimed as a tax credit, it means that the amount-- when claimed ― shall be treated as
a reduction from any tax... liability, plain and simple."
The tax credit may still be deducted from a future, not a present, tax liability.
In the petition filed before this Court, petitioner alleged that respondent incurred a net loss from its business operations
in 1997; hence, it did not pay any income tax. Since no tax payment was made, it follows that no tax credit can also be
claimed because tax credits are... usually applied against a tax liability.[25]
In Commissioner of Internal Revenue v. Central Luzon Drug Corporation,[26] the Court stressed that prior payment of
tax liability is not a pre-condition before a taxable entity can avail of the tax credit. The Court declared, "Where there is
no tax... liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and
carried over to the next taxable year."[27] It is irrefutable that under RA 7432, Congress has granted the tax credit
benefit to all covered... establishments without conditions. Therefore, neither a tax liability nor a prior tax payment is
required for the existence or grant of a tax credit.[28] The applicable law on this point is clear and without any
qualifications.[29]
Hence, respondent is entitled to claim the amount of P2,376,805.63 as tax credit despite incurring net loss from
business operations for the taxable year 1997.
The senior citizens' discount may be claimed... as a tax credit and not a refund.
Section 4(a) of RA 7432 expressly provides that private establishments may claim the cost as a tax credit. A tax credit
can only be utilized as payment for future internal revenue tax liabilities of the taxpayer while a tax refund, issued as a
check or a warrant, can be... encashed. A tax refund can be availed of immediately while a tax credit can only be
utilized if the taxpayer has existing or future tax liabilities.
RA 9257 now specifically provides that all covered establishments... may claim the senior citizens' discount as tax
deduction.
Contrary to the provision in RA 7432 where the senior citizens' discount granted by all covered establishments can be
claimed as tax credit, RA 9257 now specifically provides that this discount should be treated as tax deduction.
With the effectivity of RA 9257 on 21 March 2004, there is now a new tax treatment for senior citizens' discount
granted by all covered establishments. This discount should be considered as a deductible expense from gross income
and no longer as tax credit.
The present case, however, covers the taxable year 1997 and is thus governed by the old law, RA 7432.
 CIR vs. Isabela Cultural Corporation
Facts: Isabela Cultural Corporation (ICC), a domestic corporation received an assessment notice for deficiency income
tax and expanded withholding tax from BIR. It arose from the disallowance of ICC’s claimed expense for professional
and security services paid by ICC; as well as the alleged understatement of interest income on the three promissory
notes due from Realty Investment Inc. The deficiency expanded withholding tax was allegedly due to the failure of
ICC to withhold 1% e-withholding tax on its claimed deduction for security services.

ICC sought a reconsideration of the assessments. Having received a final notice of assessment, it brought the case to
CTA, which held that it is unappealable, since the final notice is not a decision. CTA’s ruling was reversed by CA,
which was sustained by SC, and case was remanded to CTA. CTA rendered a decision in favor of ICC. It ruled that
the deductions for professional and security services were properly claimed, it said that even if services were rendered
in 1984 or 1985, the amount is not yet determined at that time. Hence it is a proper deduction in 1986. It likewise found
that it is the BIR which overstate the interest income, when it applied compounding absent any stipulation.

Petitioner appealed to CA, which affirmed CTA, hence the petition.

Issue: Whether or not the expenses for professional and security services are deductible.

Held: No. One of the requisites for the deductibility of ordinary and necessary expenses is that it must have been paid
or incurred during the taxable year. This requisite is dependent on the method of accounting of the taxpayer. In the case
at bar, ICC is using theaccrual method of accounting. Hence, under this method, an expense is recognized when it is
incurred. Under a Revenue AuditMemorandum, when the method of accounting is accrual, expenses not being claimed
as deductions by a taxpayer in the current year when they are incurred cannot be claimed in the succeeding year.

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 orliability to pay; and 2) the availability of the reasonable accurate determination of such income
or liability. The test does not demand that the amount of income or liability be known absolutely, only that a taxpayer
has at its disposal the information necessary to compute the amount with reasonable accuracy.

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. They cannot give as an excuse the delayed
billing, since it could have inquired into the amount of their obligation and reasonably determine the amount.
 BASILAN ESTATES, INC. v. CIR
G.R. No. L-22492 September 5, 1967
Bengzon, J.P., J.

Doctrine:
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over
and above such cost cannot be claimed and allowed. The reason is that deductions from gross income are privileges,
not matters of right. They are not created by implication but upon clear expression in the law.

Facts:
Basilan Estates, Inc. claimed deductions for the depreciation of its assets on the basis of their acquisition cost. As of
January 1, 1950 it changed the depreciable value of said assets by increasing it to conform with the increase in cost for
their replacement. Accordingly, from 1950 to 1953 it deducted from gross income the value of depreciation computed
on the reappraised value.
CIR disallowed the deductions claimed by petitioner, consequently assessing the latter of deficiency income taxes.

Issue:
Whether or not the depreciation shall be determined on the acquisition cost rather than the reappraised value of the
assets

Held:
Yes. The following tax law provision allows a deduction from gross income for depreciation but limits the recovery to
the capital invested in the asset being depreciated:

(1)In general. — A reasonable allowance for deterioration of property arising out of its use or employment in the
business or trade, or out of its not being used: Provided, That when the allowance authorized under this subsection
shall equal the capital invested by the taxpayer . . . no further allowance shall be made. . . .

The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction over
and above such cost cannot be claimed and allowed. The reason is that deductions from gross income are privileges,
not matters of right. They are not created by implication but upon clear expression in the law [Gutierrez v. Collector of
Internal Revenue, L-19537, May 20, 1965].

Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal
obsolescense. It commences with the acquisition of the property and its owner is not bound to see his property
gradually waste, without making provision out of earnings for its replacement.

The recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the underlying
purpose of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost,
but also some profit. Recovery in due time thru depreciation of investment made is the philosophy behind depreciation
allowance; the idea of profit on the investment made has never been the underlying reason for the allowance of a
deduction for depreciation.
 G.R. No. L-31305 May 10, 1990
HOSPITAL DE SAN JUAN DE DIOS, INC., petitioner, vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.

In a letter dated January 15, 1959, the Commissioner of Internal Revenue assessed and demanded from the petitioner,
Hospital De San Juan De Dios, Inc., payment of P51,462 as deficiency income taxes for 1952 to 1955.

The petitioner protested against the assessment and requested the Commissioner to cancel and withdraw it. After
reviewing the assessment, the Commissioner advised petitioner on November 8, 1960 that the deficiency income tax
assessment against it was reduced to only P16,852.41. Still the petitioner, through its auditors, insisted on the
cancellation of the revised assessment. The request was, however, denied.

On September 18, 1965, petitioner sought a review of the assessment by the Court of Tax Appeals (hereafter "CTA").
In a decision dated August 29, 1969, the CTA upheld the Commissioner. It held that the expenses incurred by the
petitioner for handling its funds or income consisting solely of dividends and interests, were not expenses incurred in
"carrying on any trade or business," hence, not deductible as business or administrative expenses.

Petitioner filed a motion for reconsideration of the CTA decision. When its motion was denied, it filed this petition for
review.

The background of the controversy is stated in the decision of the CTA as follows:

There is no dispute that petitioner is engaged in both taxable and non-taxable operations. The income derived from
the operations of the hospital and the nursing school are exempt from income tax while the rest of petitioner's
income are subject thereto. Its taxable or non-operating income consists of rentals, interests and dividendS
received from its properties and investments. In the computation of its taxable income for the years 1952 to 1955,
petitioner allowed all its taxable income to share in the allocation of administrative expenses. Respondent
disallowed, however, the interests and dividendsfrom sharing in the allocation of administrative expense on the
ground that the expenses incurred in the administration or management of petitioner's investments are not
allowable business expenses inasmuch as they were not incurred in 'carrying on any trade or business' within the
contemplation of Section 30 (a) (1) of the Revenue Code. Consequently, petitioner was assessed deficiency
income taxes for the years in question. (pp. 45-46, Rollo.)

The applicable law is Section 30 of the Revenue Code which provides:

Sec. 30. Deductions from Gross Income. In computing net income there shad be allowed as deduction —

(A) Expenses:

(i) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business, including a reasonable allowance for salaries or other compensation for
personal services actually rendered . . . (Emphasis supplied). (p. 46, Rollo.)

The Court of Tax Appeals found, however, that:

. . . petitioner failed to establish by competent proof that its receipt of interests and dividends constituted the
carrying on of a "trade or business" so as to warrant the deductibility of the expenses incurred in their
realization. No evidence whatsoever was presented by petitioner to show how it handled its investment,
the manner it bought, sold and reinvested its securities, how it made decisions, and whether it consulted
brokers, investment or statistical services. Neither is there any showing of theextent of its activities in stocks
or bonds, and participation, if any, direct or indirect, in the management of the corporations where it made
investments. In effect, there is total absence of any indication of a business-like management or operation of
 its interests and dividends. (See Roebling vs. Comm. of Int. Rev., 37 BTA 82). Instead, petitioner merely
relied on the assumption that "if it is to handle its investment portfolio profitably", it has either to engage the
services of an investment banker or administer it from within but the latter necessarily involves studying the
securities market, the tax aspects of the investments, hiring accountants, collectors, clerical help, etc. without
showing that it was actually performing these varied activities. Petitioner could have easily required any of its
responsible officials to testify on this regard but it failed to do so. Under these circumstances and coupled
with the fact that the interests and dividends here in question are merely incidental income to petitioner's
main activity, which is the operation of its hospital and nursing schools, the conclusion becomes inevitable
that petitioner's activities never go beyond that of a passive investor, which under existing jurisprudence do
not come within the purview of carrying on any "trade or business". (pp. 47-48, Rollo.)

The Court of Tax Appeals found that the interests and dividends received by the petitioner "were merely incidental
income to petitioner's main activity, which is the operation of its hospital and nursing schools [hence] the conclusion is
inevitable that petitioner's activities never went beyond that of a passive investor, which under existing jurisprudence
do not come within the purview of carrying on any 'trade or business'." (pp. 47-48, Rollo) That factual finding is
binding on this Court. And, as the principle of allocating expenses is grounded on the premise that the taxable income
was derived from carrying on a trade or business, as distinguished from mere receipt of interests and dividends from
one's investments, the Court of Tax Appeals correctly ruled that said income should not share in the allocation of
administrative expenses (p. 49, Rollo).

Hospital de San Juan De Dios, Inc., according to its Articles of Incorporation, was established for purposes "Which are
benevolent, charitable and religious, and not for financial gain" (p. 12, Petitioner's Brief). It is not carrying on a trade or
business for the word "business" in its ordinary and common use means "human efforts which have for their end living
or reward; it is not commonly used as descriptive of charitable, religious, educational or social agencies" or "any
particular occupation or employment habitually engaged in especially for livelihood or gain" or "activities where profit
is the purpose or livelihood is the motive." (Collector of Internal Revenue vs. Manila Lodge BPOE 105 Phil. 986).

The fact that petitioner was assessed a real estate dealer's fixed tax of P640 on its rental income does not alter its status
as a charitable, non-stock, non-profit corporation.

WHEREFORE, finding no reversible error in the decision of the Court of Tax Appeals, the same is affirmed in toto.
Costs against the petitioner. This decision is immediately executory.

SO ORDERED.
 CIR V GENERAL FOODS

GR No. 143672| April 24, 2003 | J. Corona

Test of Reasonableness

Facts:
Respondent corporation General Foods (Phils), which is engaged in the manufacture of “Tang”, “Calumet” and “Kool-
Aid”, filed its income tax return for the fiscal year ending February 1985 and claimed as deduction, among other
business expenses, P9,461,246 for media advertising for “Tang”.

The Commissioner disallowed 50% of the deduction claimed and assessed deficiency income taxes of P2,635,141.42
against General Foods, prompting the latter to file an MR which was denied.

General Foods later on filed a petition for review at CA, which reversed and set aside an earlier decision by CTA
dismissing the company’s appeal.

Issue:
W/N the subject media advertising expense for “Tang” was ordinary and necessary expense fully deductible under the
NIRC

Held:
No. Tax exemptions must be construed in stricissimi juris against the taxpayer and liberally in favor of the taxing
authority, and he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute
law. Deductions for income taxes partake of the nature of tax exemptions; hence, if tax exemptions are strictly
construed, then deductions must also be strictly construed.
To be deductible from gross income, the subject advertising expense must comply with the following requisites: (a) the
expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have
been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts,
records or other pertinent papers.

While the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in
carrying on a trade or business, hence necessary, the parties’ views conflict as to whether or not it was ordinary. To be
deductible, an advertising expense should not only be necessary but also ordinary.

The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the two
conditions set by U.S. jurisprudence: first, “reasonableness” of the amount incurred and second, the amount incurred
must not be a capital outlay to create “goodwill” for the product and/or private respondent’s business. Otherwise, the
expense must be considered a capital expenditure to be spread out over a reasonable time.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There
being no hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not
limited to: the type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings;
the nature of the expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay
of these, among other factors and properly weighed, that will yield a proper evaluation.

The Court finds the subject expense for the advertisement of a single product to be inordinately large. Therefore, even
if it is necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services
and (2) advertising designed to stimulate the future sale of merchandise or use of services. The second type involves
expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer’s trade or
business or for the industry or profession of which the taxpayer is a member. If the expenditures are for the advertising
of the first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures
are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally
they should be spread out over a reasonable period of time.
The company’s media advertising expense for the promotion of a single product is doubtlessly unreasonable
considering it comprises almost one-half of the company’s entire claim for marketing expenses for that year under
review. Petition granted, judgment reversed and set aside.
 C.M Hoskin, petitioner, vs. CIR, respondent.G.R. No. L-24059, November 28, 1969
Teehankee, J.:

Facts:
Petitioner is a domestic corporation engaged in the real estate business as brokers, managing agents and administrators,
filed its income tax return for the fiscal year ending September 30, 1957. Upon verification, the CIR disallowed four
items of deduction and assessed against it an income tax deficiency in the amount of P28,054.00 plus interests. The
Court of Tax Appeals upheld the respondent’s disallowance of the 50% supervision fees paid to Mr. Hoskins, its
founder and principal stockholder.

Petitioner questions the CTA’s findings that the disallowed payment to Hoskins was an inordinately large one, which
bore a close relationship to the recipient’s dominant stockholdings and therefore amounted to a distribution of its
earnings and profits.

Held: The petition has no merit. Considering that in addition being Chairman of the Board of Directors of petitioner
corporation, Hoskins owned 99.6% of its total authorized capital stock, was also salesman- broker for his
company receiving a 50% share of the sales commissions earned by petitioner, besides monthly salary and other
allowances and benefits, the Tax court correctly ruler that the payment to Hoskins of his share in the supervision fees
received by petitioner as managing agent of the real estate projects of Paradise Farms and Realty Investments (of which
he is also a stockholder) was inordinately large and could not be accorded the treatment of ordinary and necessary
expenses allowed as deductible items in the Tax Code. The fact that such payment was authorized by petitioner’s
Board of Directors is of no moment, since Hoskins wield tremendous power and influence as Board chairman and
controlling stockholder. Officers’ extra fees, bonuses and commissions are upheld by the Court as not being within the
purview of ordinary and necessary expenses and not passing the test of reasonable compensation thus are not
deductible items. In Kuenzle v CIR, the Court ruled that “Bonuses to employees made in good faith and as additional
compensation for the services actually rendered by the employees are deductible, provided such payments, when added
to the stipulated salaries, do not exceed a reasonable compensation for the services rendered.” The conditions precedent
to the deduction of bonuses to employees are: 10 the payment of the bonuses is in fact compensation; 2) it must be for
personal services actually rendered; and 3) the bonuses, when added to the salaries, are reasonable…when measured by
the amount and quality of the services performed with relation to the business of the particular taxpayer. There is no
fixed test for determining the reasonableness of a given bonus as compensations. This depend upon many factors,
among them being the amount and quality of the services performed with relation to the business. In determining
whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole. The
employer has the right to fix the compensation of its officers and employees but the question of the allowance or
disallowance thereof as deductible expense for income tax purposes is subject to the determination of the
Commissioner. The right of the corporation to fix the amounts of remuneration are not absolute. It cannot be exercised
for the purpose of evading payment of taxes legitimately due to the State. Accordingly, the decision appealed from is
hereby affirmed, with costs against petitioner.
 G.R. No. L-13325 April 20, 1961
SANTIAGO GANCAYCO, petitioner, vs.
THE COLLECTOR OF INTERNAL REVENUE, respondent.

FACTS
Petitioner Santiago Gancayco seeks the review of a decision of the Court of Tax Appeals, requiring him to pay
P16,860.31, plus surcharge and interest, by way of deficiency income tax for the year 1949.

When Gancayco filed his income tax return for the year 1949, respondent CIR, two days later, issued the
corresponding notice advising him that his income tax liability for that year amounted P9,793.62, which he paid on
May 15, 1950. A year later, on May 14, 1951, respondent wrote the communication Exhibit C, notifying Gancayco,
inter alia, that, upon investigation, there was still due from him, a efficiency income tax for the year 1949, the sum of
P29,554.05.

The question whether the sum of P16,860.31 is due from Gancayco as deficiency income tax for 1949 hinges on the
validity of his claim for deduction of two (2) items, namely: (a) for farming expenses, P27,459.00; and (b) for
representation expenses, P8,933.45.

In his amended petition, Gancayco prayed that disallowance of the entertainment, representation and farming expenses
be allowed.

ISSUE
Whether or not the two claimed deductions are allowable

RULING
NO.

Section 30 of the Tax Code partly reads:

(a) Expenses:

(1) In General — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying
on any trade or business, including a reasonable allowance for salaries or other compensation for personal
services actually rendered; traveling expenses while away from home in the pursuit of a trade or business; and
rentals or other payments required to be made as a condition to the continued use or possession, for the
purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in
which he has no equity.

Referring to the item of P27,459, for farming expenses allegedly incurred by Gancayco, the decision appealed from has
the following to say:

No evidence has been presented as to the nature of the said "farming expenses" other than the bare statement of
petitioner that they were spent for the "development and cultivation of (his) property". No specification has
been made as to the actual amount spent for purchase of tools, equipment or materials, or the amount spent for
improvement. Respondent claims that the entire amount was spent exclusively for clearing and developing the
farm which were necessary to place it in a productive state. It is not, therefore, an ordinary expense but a
capital expenditure. Accordingly, it is not deductible but it may be amortized, in accordance with section 75 of
Revenue Regulations No. 2, cited above. See also, section 31 of the Revenue Code which provides that in
computing net income, no deduction shall in any case be allowed in respect of any amount paid out for new
buildings or for permanent improvements, or betterments made to increase the value of any property or estate.

An item of expenditure, in order to be deductible under this section of the statute providing for the deduction of
ordinary and necessary business expenses, must fall squarely within the language of the statutory provision. This
section is intended primarily, although not always necessarily, to cover expenditures of a recurring nature where the
benefit derived from the payment is realized and exhausted within the taxable year. Accordingly, if the result of the
expenditure is the acquisition of an asset which has an economically useful life beyond the taxable year, no deduction
of such payment may be obtained under the provisions of the statute.

Gancayco's claim for representation expenses aggregated P31,753.97, of which P22,820.52 was allowed, and
P8,933.45 disallowed. Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or
vouchers of the expenditures in question, petitioner could not specify the items constituting the same, or when or on
whom or on what they were incurred. The case of Cohan v. Commissioner, 39 F (2d) 540, cited by petitioner is not in
point, because in that case there was evidence on the amounts spent and the persons entertained and the necessity of
entertaining them, although there were no receipts and vouchers of the expenditures involved therein. Such is not the
case of petitioner herein.
 Commissioner vs. Itogon-Suyoc MinesGR L-25299, 29 July 1969
En Banc, Fernando (J): 9 concur, 1 took no part

Facts:
Itogon-Suyoc Mines filed its income tax return for the fiscal year 1959 to 1960. Four months later, itfiled an amended
income tax return, reporting a loss. It thus sought a refund from the Commissioner. When itfiled its income tax return
on the next year, it deducted an amount representing alleged tax credit foroverpayment for the preceding fiscal year.
The Commissioner imposed an amount P1,512.83 as 1% monthlyinterest on the amount of P13,155.20 from January to
December 1962. The basis for such assessment wasallegedly the absence of a legal right to deduct said amount before
the tax credit or refund is approved by theCommissioner.

Issue:
Whether the assessment on interest was justified.

Held:
The Tax Code provides that interest upon the amount determined as a deficiency shall be assessed andshall be paid
upon notice and demand from the Commissioner at the rate therein specified. It made clear,however, in an earlier
provision found in the same section that if in any preceding year, the taxpayer wasentitled to a refund of any amount
due as tax, such amount, if not refunded, may be deducted from the tax to
Taxation Law I, 2004 ( 5 )

Digests (Berne Guerrero)

be paid. Although the imposition of monthly interest does not constitute penalty but a just compensation to theState for
the delay in paying the tax and for the concomitant use by the taxpayer of funds that rightfullyshould be in
government’s hands; in light of the overpayment for 1959 and 1960, it cannot be said that thetaxpayer was guilty of
delay enabling it to utilize the money.The company is entitled to refund.
 MARCELO STEEL CORPORATION VS. COLLECTOR OF INTERNAL REVENUE
G.R. No. L-12401, October 31, 1960

NATURE:
Petition to review under section 18, Republic Act No. 1125, a judgment of the Court of Tax Appeals upholding the
assessment made by the respondent for income tax due during the years 1952 and 1953 from the petitioner.
FACTS:
Petitioner Marcelo Steel Corporation is a corporation duly organized and existing under and by virtue of the laws of the
Philippines, with offices at Malabon, Rizal. It is engaged in three (3) industrial activities, namely, (1) manufacture of
wire fence, (2) manufacture of nails, and (3) manufacture of steel bars, rods and other allied steel products. The
manufacture of nails and the manufacture of steel bars, rods and other allied steel products, enjoyed the benefits of tax
exemption under Republic Act No. 35, which provides:
“SECTION 1. Any person, partnership, company, or corporation who or which shall engage in a new and necessary
industry shall, for a period of four years from the date of the organization of such industry, be entitled to exemption
from the payment of all internal revenue taxes directly payable by such person, partnership, company, or corporation in
respect to said industry.
SEC. 2. The President of the Philippines, shall, upon recommendation of the Secretary of Finance, periodically
determine the qualifications that the industries should possess to be entitled to the benefits of this Act.
SEC. 3. This Act shall take effect upon its approval.

On May 21, 1953, the petitioner filed an income tax return for the years 1952 and 1953 which did not reflect the
financial results of its tax exempt business activities but those realized solely from its business of manufacturing wire
fence.

On October 1, 1954, the petitioner filed amended income tax returns for taxable years 1952 and 1953, showing that it
suffered a net loss of P871,407.37 in 1952, and P104,956.29 in 1953. The said losses were arrived at by consolidating
the gross income and expenses and/or deductions of the petitioner in all its business activities,
On October 1, 1954, the petitioner, claiming that instead of earning the net income shown in its original income tax
returns for 1952 and 1953, it sustained the losses shown in its amended income tax returns for the same years, filed its
request for refund of the income taxes which it allegedly erroneously paid to the respondent.
CTA:
The petitioner cannot deduct from the profits realized from its taxable industries, the losses sustained by its tax exempt
business activities, . . . "
CASE FOR THE PETITIONER:
Since it is a corporation organized with a single capital that answers for all its financial obligations including those
incurred in the tax-exempt industries, the gross income derived from both its taxable or non-exempt and tax- exempt
industries, and the allowable deductions from said incomes, should be consolidated and its income tax liability should
be based on the difference between the consolidated gross incomes and the consolidated allowable deductions. It relies
on the provisions of section 24, Commonwealth Act No. 466, as amended, and of section 30, subsection (d), paragraph
(2), of the same Act
ISSUE: WON the petitioner may be allowed to deduct from the profits realized from its taxable business
activities, the losses sustained by its tax exempt industries
RULING:
No. The purpose or aim of Republic Act No. 35 is to encourage the establishment or exploitation of new and necessary
industries to promote the economic growth of the country. It is a form of subsidy granted by the Government to
courageous entrepreneurs staking their capital in an unknown venture. An entrepreneur engaging in a new and
necessary industry faces uncertainty and assumes a risk bigger than one engaging in a venture already known and
developed. Like a settler in an unexplored land who is just blazing a trail in a virgin forest, he needs all the
encouragement and assistance from the Government. He needs capital to buy his implements, to pay his laborers and to
sustain him and his family. Comparable to the farmer who has just planted the seeds of fruit bearing trees in his
orchard, he does not expect an immediate return on his investment. Usually loss is incurred rather than profit made. It
is for these reasons that the law grants him tax exemption — to lighten onerous financial burdens and reduce losses.
However these may be, Republic Act No. 35 has confined the privilege of tax exemption only to new and necessary
industries. It did not intend to grant the tax exemption benefit to an entrepreneur engaged at the same time in a taxable
or non-exempt industry and a new and necessary industry, by allowing him to deduct his gains or profits derived from
the operation of the first from the losses incurred in the operation of the second. Unlike a new and necessary industry, a
taxable or non-exempt industry is already a going concern, deriving profits from its operation, and deserving no
subsidy from the Government. It is but fair that it be required to give to the Government a share in its profits in the
form of taxes.
The fact that the petitioner is a corporation organized with a single capital that answers for all its financial obligations
including those incurred in the tax exempt industries is of no moment. The intent of the law is to treat taxable or non-
exempt industries as separate and distinct from new and necessary industries which are tax- exempt for purposes of
taxation.

DISPOSITIVE: The judgment under review is affirmed, with costs against the petitioner.
 PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, vs. COURT OF
APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
G.R. Nos. 106949-50 December 1, 1995
COMMISSIONER INTERNAL REVENUE, petitioner, vs. PAPER INDUSTRIES CORPORATION OF THE
PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX APPEALS, respondents.
G.R. Nos. 106984-85 December 1, 1995

Facts: Paper Industries Corporation of the Philippines (PICOP) is a Philippine corporation registered with the Board of
Investments (BOI) as a preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferred
non-pioneer enterprise with respect to its integrated plywood and veneer mills. Petitioner received from the
Commissioner of Internal Revenue (CIR) two (2) letters of assessment and demand (a) one for deficiency transaction
tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate
amount of PhP88,763,255.00.
PICOP protested the assessment of deficiency transaction tax , the documentary and science stamp taxes, and the
deficiency income tax assessment. CIR did not formally act upon these protests, but issued a warrant of distraint on
personal property and a warrant of levy on real property against PICOP, to enforce collection of the contested
assessments, thereby denying PICOP's protests. Thereupon, PICOP went before (CTA) appealing the assessments.
On 15 August 1989, CTA rendered a decision, modifying the CIR’s findings and holding PICOP liable for the reduced
aggregate amount of P20,133,762.33. Both parties went to the Supreme Court, which referred the case to the Court of
Appeals (CA).
CA denied the appeal of the CIR and modified the judgment against PICOP holding it liable for transaction tax and
absolved it from payment of documentary and science stamp tax and compromise penalty. It also held PICOP liable
for deficiency of income tax.
Issues:
1. Whether PICOP is liable for transaction tax
2. Whether PICOP is liable for documentary and science stamp tax
3. Whether PICOP is liable for deficiency income tax

Held:
1. YES. PICOP reiterates that it is exempt from the payment of the transaction tax by virtue of its tax exemption
under R.A. No. 5186, as amended, known as the Investment Incentives Act, which in the form it existed in
1977-1978, read in relevant part as follows: "SECTION 8. Incentives to a Pioneer Enterprise. — In addition to
the incentives provided in the preceding section, pioneer enterprises shall be granted the following incentive
benefits: (a) Tax Exemption. Exemption from all taxes under the National Internal Revenue Code, except
income tax, from the date of investment is included in the Investment Priorities Plan x x x”. The Supreme
Court holds that that PICOP's tax exemption under R.A. No. 5186, as amended, does not include exemption
from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction
tax is an income tax, a tax on the interest income of the lenders or creditors as held by the Supreme Court in
the case of Western Minolco Corporation v. Commissioner of Internal Revenue. The 35% transaction tax is an
income tax on interest earnings to the lenders or placers. The latter are actually the taxpayers. Therefore, the
tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed funds from
several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before
paying to the financial institutions the interest earned by them and later remitted the same to the respondent
CIR. The tax could have been collected by a different procedure but the statute chose this method. Whatever
collecting procedure is adopted does not change the nature of the tax. It is thus clear that the transaction tax is
an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered
pioneer enterprises by Section 8 of R.A. No. 5186, as amended. PICOP was the withholding agent, obliged to
withhold thirty-five percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to
the Bureau of Internal Revenue ("BIR"). As a withholding, agent, PICOP is made personally liable for the
 thirty-five percent (35%) transaction tax 10 and if it did not actually withhold thirty-five percent (35%) of the
interest monies it had paid to its lenders, PICOP had only itself to blame.

2. NO. The CIR assessed documentary and science stamp taxes, amounting to PhP300,000.00, on the issuance of
PICOP's debenture bonds. Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be
extended beyond the ordinary and reasonable intendment of the language actually used by the legislative
authority in granting the exemption. The issuance of debenture bonds is certainly conceptually distinct from
pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or
regular business activity of PICOP; only banks or other financial institutions are in the regular business of
raising money by issuing bonds or other instruments to the general public. The actual dedication of the
proceeds of the bonds to the carrying out of PICOP's registered operations constituted a sufficient nexus with
such registered operations so as to exempt PICOP from taxes ordinarily imposed upon or in connection with
issuance of such bonds. The Supreme Court agrees with the Court of Appeals on this matter that the CTA and
the CIR had erred in rejecting PICOP's claim for exemption from stamp taxes.

3. YES. PICOP did not deny the existence of discrepancy in their Income Tax Return and Books of Account
owing to their procedure of recording its export sales (reckoned in U.S. dollars) on the basis of a fixed rate, day
to day and month to month, regardless of the actual exchange rate and without waiting when the actual
proceeds are received. In other words, PICOP recorded its export sales at a pre-determined fixed exchange rate.
That pre-determined rate was decided upon at the beginning of the year and continued to be used throughout
the year. Because of this, the CIR has made out at least a prima facie case that PICOP had understated its sales
and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that
PICOP's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear
to be admissions against PICOP's own interest.
 [G.R. No. 125508. July 19, 2000]
CHINA BANKING CORPORATION, petitioner, vs. COURT OF APPEALS, COMMISSIONER OF INTERNAL
REVENUE and COURT OF TAX APPEALS, respondents.
The Commissioner of Internal Revenue denied the deduction from gross income of "securities becoming
worthless" claimed by China Banking Corporation (CBC). The Commissioners disallowance was sustained by the
Court of Tax Appeals ("CTA"). When the ruling was appealed to the Court of Appeals ("CA"), the appellate court
upheld the CTA. The case is now before us on a Petition for Review on Certiorari.
Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the First CBC Capital
(Asia) Ltd., a Hongkong subsidiary engaged in financing and investment with "deposit-taking" function. The
investment amounted to P16,227,851.80, consisting of 106,000 shares with a par Value of P100 per share.
In the course of the regular examination of the financial books and investment portfolios of petitioner conducted
by Bangko Sentral in 1986, it was shown that First CBC Capital (Asia), Ltd., has become insolvent. With the approval
of Bangko Sentral, petitioner wrote-off as being worthless its investment in First CBC Capital (Asia), Ltd., in its 1987
Income Tax Return and treated it as a bad debt or as an ordinary loss deductible from its gross income.
Respondent Commissioner of internal Revenue disallowed the deduction and assessed petitioner for income tax
deficiency in the amount of P8,533,328.04, inclusive of surcharge, interest and compromise penalty. The disallowance
of the deduction was made on the ground that the investment should not be classified as being "worthless" and that,
although the Hongkong Banking Commissioner had revoked the license of First CBC Capital as a "deposit-taping"
company, the latter could still exercise, however, its financing and investment activities. Assuming that the securities
had indeed become worthless, respondent Commissioner of Internal Revenue held the view that they should then be
classified as "capital loss," and not as a bad debt expense there being no indebtedness to speak of between petitioner
and its subsidiary.
Petitioner contested the ruling of respondent Commissioner before the CTA. The tax court sustained the
Commissioner, holding that the securities had not indeed become worthless and ordered petitioner to pay its deficiency
income tax for 1987 of P8,533,328.04 plus 20% interest per annum until fully paid. When the decision was appealed to
the Court of Appeals, the latter upheld the CTA. In its instant petition for review on certiorari, petitioner bank assails
the CA decision.
The petition must fail.
The claim of petitioner that the shares of stock in question have become worthless is based on a Profit and Loss
Account for the Year-End 31 December 1987, and the recommendation of Bangko Sentral that the equity investment
be written-off due to the insolvency of the subsidiary. While the matter may not be indubitable (considering that certain
classes of intangibles, like franchises and goodwill, are not always given corresponding values in financial
statements[1], there may really be no need, however, to go of length into this issue since, even to assume the
worthlessness of the shares, the deductibility thereof would still be nil in this particular case. At all events, the Court is
not prepared to hold that both the tax court and the appellate court are utterly devoid of substantial basis for their own
factual findings.
Subject to certain exceptions, such as the compensation income of individuals and passive income subject to final
tax, as well as income of non-resident aliens and foreign corporations not engaged in trade or business in the
Philippines, the tax on income is imposed on the net income allowing certain specified deductions from gross income
to be claimed by the taxpayer. Among the deductible items allowed by the National Internal Revenue Code ("NIRC")
are bad debts and losses.[2]
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of which results in either
a capital gain or a capital loss. The gain or the loss is ordinary when the property sold or exchanged is not a capital
asset.[3] A capital asset is defined negatively in Section 33(1) of the NIRC; viz:

(1) Capital assets. - The term 'capital assets' means property held by the taxpayer (whether or not connected with his
trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly
be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer
primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business,
of a character which is subject to the allowance for depreciation provided in subsection (f) of section twenty-nine; or
real property used in the trade or business of the taxpayer.

Thus, shares of stock; like the other securities defined in Section 20(t) [4] of the NIRC, would be ordinary
assets only to a dealer in securities or a person engaged in the purchase and sale of, or an active trader (for his
own account) in, securities. Section 20(u) of the NIRC defines a dealer in securities thus:

"(u) The term 'dealer in securities' means a merchant of stocks or securities, whether an individual, partnership or
corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to
customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and
profits that may be derived therefrom."

In the hands, however, of another who holds the shares of stock by way of an investment, the shares to him would
be capital assets. When the shares held by such investor become worthless, the loss is deemed to be a loss from
the sale or exchange of capital assets. Section 29(d)(4)(B) of the NIRC states:

"(B) Securities becoming worthless. - If securities as defined in Section 20 become worthless during the tax" year and
are capital assets, the loss resulting therefrom shall, for the purposes of his Title, be considered as a loss from the sale
or exchange, on the last day of such taxable year, of capital assets."

The above provision conveys that the loss sustained by the holder of the securities, which are capital assets (to him), is
to be treated as a capital loss as if incurred from a sale or exchange transaction. A capital gain or a capital loss
normally requires the concurrence of two conditions for it to result: (1) There is a sale or exchange; and (2) the thing
sold or exchanged is a capital asset. When securities become worthless, there is strictly no sale or exchange but the law
deems the loss anyway to be "a loss from the sale or exchange of capital assets.[5]A similar kind of treatment is given,
by the NIRC on the retirement of certificates of indebtedness with interest coupons or in registered form, short sales
and options to buy or sell property where no sale or exchange strictly exists. [6] In these cases, the NIRC dispenses, in
effect, with the standard requirement of a sale or exchange for the application of the capital gain and loss provisions of
the code.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived from the sale
or exchange of capital assets, and not from any other income of the taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary corporation of petitioner
bank whose shares in said investee corporation are not intended for purchase or sale but as an
investment. Unquestionably then, any loss therefrom would be a capital loss, not an ordinary loss, to the investor.
Section 29(d)(4)(A), of the NIRC expresses:

"(A) Limitations. - Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in
Section 33."

The pertinent provisions of Section 33 of the NIRC referred to in the aforesaid Section 29(d)(4)(A), read:

"Section 33. Capital gains and losses. -

x x x x x x x x x.

"(c) Limitation on capital losses. - Losses from sales or exchange of capital assets shall be allowed only to the
extent of the gains from such sales or exchanges. If a bank or trust company incorporated under the laws of the
Philippines, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or
certificate or other evidence of indebtedness issued by any corporation (including one issued by a government or
political subdivision thereof), with interest coupons or in registered form, any loss resulting from such sale shall not
be subject to the foregoing limitation an shall not be included in determining the applicability of such limitation to
other losses.

The exclusionary clause found in the foregoing text of the law does not include all forms of securities but
specifically covers only bonds, debentures, notes, certificates or other evidence of indebtedness, with interest
coupons or in registered form, which are the instruments of credit normally dealt with in the usual lending operations
of a financial institution.Equity holdings cannot come close to being, within the purview of "evidence of
indebtedness" under the second sentence of the aforequoted paragraph. Verily, it is for a like thesis that the loss
of petitioner bank in its equity in vestment in the Hongkong subsidiary cannot also be deductible as a bad debt. The
shares of stock in question do not constitute a loan extended by it to its subsidiary (First CBC Capital) or a debt subject
to obligatory repayment by the latter, essential elements to constitute a bad debt, but a long term investment made by
CBC.
One other item. Section 34(c)(1) of the NIRC , states that the entire amount of the gain or loss upon the sale or
exchange of property, as the case may be, shall be recognized. The complete text reads:

SECTION 34. Determination of amount of and recognition of gain or loss.-

"(a) Computation of gain or loss. - The gain from the sale or other disposition of property shall be the excess of the
amount realized therefrom over the basis or adjusted basis for determining gain and the loss shall be the excess of the
basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other
disposition of property shall be to sum of money received plus the fair market value of the property (other than money)
received. (As amended by E.O. No. 37)

"(b) Basis for determining gain or loss from sale or disposition of property. - The basis of property shall be - (1) The
cost thereof in cases of property acquired on or before March 1, 1913, if such property was acquired by purchase; or

"(2) The fair market price or value as of the date of acquisition if the same was acquired by inheritance; or

"(3) If the property was acquired by gift the basis shall be the same as if it would be in the hands of the donor or the
last preceding owner by whom it was not acquired by gift, except that if such basis is greater than the fair market value
of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value;
or

"(4) If the property, other than capital asset referred to in Section 21 (e), was acquired for less than an adequate
consideration in money or moneys worth, the basis of such property is (i) the amount paid by the transferee for the
property or (ii) the transferor's adjusted basis at the time of the transfer whichever is greater.

"(5) The basis as defined in paragraph (c) (5) of this section if the property was acquired in a transaction where gain or
loss is not recognized under paragraph (c) (2) of this section. (As amended by E.O. No. 37)

(c) Exchange of property.

"(1) General rule.- Except as herein provided, upon the sale or exchange of property, the entire amount of the gain or
loss, as the case may be, shall be recognized.

"(2) Exception. - No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation (a) a
corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation which is,
a party to the merger or consolidation, (b) a shareholder exchanges stock in a corporation which is a party to the merger
or consolidation solely for the stock in another corporation also a party to the merger or consolidation, or (c) a security
holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation
solely for stock or securities in another corporation, a party to the merger or consolidation.
"No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for 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."

The above law should be taken within context on the general subject of the determination, and recognition of gain
or loss; it is not preclusive of, let alone renders completely inconsequential, the more specific provisions of the
code. Thus, pursuant, to the same section of the law, no such recognition shall be made if the sale or exchange is made
in pursuance of a plan of corporate merger or consolidation or, if as a result of an exchange of property for stocks, the
exchanger, alone or together with others not exceeding four, gains control of the corporation. [7] Then, too, how the
resulting gain might be taxed, or whether or not the loss would be deductible and how, are matters properly dealt with
elsewhere in various other sections of the NIRC.[8] At all events, it may not be amiss to once again stress that the basic
rule is still that any capital loss can be deducted only from capital gains under Section 33(c) of the NIRC.
In sum -
(a) The equity investment in shares of stock held by CBC of approximately 53% in its Hongkong subsidiary, the
First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a capital, not an ordinary, asset.[9]
(b) Assuming that the equity investment of CBC has indeed become "worthless," the loss sustained is a
capital, not an ordinary, loss.[10]
(c) The capital loss sustained by CBC can only be deducted from capital gains if any derived by it during the same
taxable year that the securities have become "worthless."[11]
WHEREFORE, the Petition is DENIED. The decision of the Court of Appeals disallowing the claimed deduction
of P16,227,851.80 is AFFIRMED.
SO ORDERED.
 LORENZO OÑA V CIR

GR No. L -19342 | May 25, 1972 | J. Barredo

Facts:
Julia Buñales died leaving as heirs her surviving spouse, Lorenzo Oña and her five children. A civil case was instituted
for the settlement of her state, in which Oña was appointed administrator and later on the guardian of the three heirs
who were still minors when the project for partition was approved. This shows that the heirs have undivided ½ interest
in 10 parcels of land, 6 houses and money from the War Damage Commission.

Although the project of partition was approved by the Court, no attempt was made to divide the properties and they
remained under the management of Oña who used said properties in business by leasing or selling them and investing
the income derived therefrom and the proceeds from the sales thereof in real properties and securities. As a result,
petitioners’ properties and investments gradually increased. Petitioners returned for income tax purposes their shares in
the net income but they did not actually receive their shares because this left with Oña who invested them.

Based on these facts, CIR decided that petitioners formed an unregistered partnership and therefore, subject to the
corporate income tax, particularly for years 1955 and 1956. Petitioners asked for reconsideration, which was denied
hence this petition for review from CTA’s decision.

Issue:
W/N there was a co-ownership or an unregistered partnership
W/N the petitioners are liable for the deficiency corporate income tax

Held:
Unregistered partnership. The Tax Court found that instead of actually distributing the estate of the deceased among
themselves pursuant to the project of partition, the heirs allowed their properties to remain under the management of
Oña and let him use their shares as part of the common fund for their ventures, even as they paid corresponding income
taxes on their respective shares.
Yes. For tax purposes, the co-ownership of inherited properties is automatically converted into an unregistered
partnership the moment the said common properties and/or the incomes derived therefrom are used as a common fund
with intent to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a
project partition either duly executed in an extrajudicial settlement or approved by the court in the corresponding
testate or intestate proceeding. The reason is simple. From the moment of such partition, the heirs are entitled already
to their respective definite shares of the estate and the incomes thereof, for each of them to manage and dispose of as
exclusively his own without the intervention of the other heirs, and, accordingly, he becomes liable individually for all
taxes in connection therewith. If after such partition, he allows his share to be held in common with his co-heirs under
a single management to be used with the intent of making profit thereby in proportion to his share, there can be no
doubt that, even if no document or instrument were executed, for the purpose, for tax purposes, at least, an unregistered
partnership is formed.
For purposes of the tax on corporations, our National Internal Revenue Code includes these partnerships —

The term “partnership” includes a syndicate, group, pool, joint venture or other unincorporated organization,
through or by means of which any business, financial operation, or venture is carried on… (8 Merten’s Law of Federal
Income Taxation, p. 562 Note 63; emphasis ours.)
with the exception only of duly registered general copartnerships — within the purview of the term “corporation.” It is,
therefore, clear to our mind that petitioners herein constitute a partnership, insofar as said Code is concerned, and are
subject to the income tax for corporations. Judgment affirmed.
 Pascual and Dragon v. CIR, G.R. No. 78133, October 18, 1988

FACTS:
Petitioners bought two (2) parcels of land and a year after, they bought another three (3) parcels of land. Petitioners
subsequently sold the said lots in 1968 and 1970, and realized net profits. The corresponding capital gains taxes were
paid by petitioners in 1973 and 1974 by availing of the tax amnesties granted in the said years. However, the Acting
BIR Commissioner assessed and required Petitioners to pay a total amount of P107,101.70 as alleged deficiency
corporate income taxes for the years 1968 and 1970. Petitioners protested the said assessment asserting that they had
availed of tax amnesties way back in 1974. In a reply, respondent Commissioner informed petitioners that in the years
1968 and 1970, petitioners as co-owners in the real estate transactions formed an unregistered partnership or joint
venture taxable as a corporation under Section 20(b) and its income was subject to the taxes prescribed under Section
24, both of the National Internal Revenue Code that the unregistered partnership was subject to corporate income tax as
distinguished from profits derived from the partnership by them which is subject to individual income tax; and that the
availment of tax amnesty under P.D. No. 23, as amended, by petitioners relieved petitioners of their individual income
tax liabilities but did not relieve them from the tax liability of the unregistered partnership. Hence, the petitioners were
required to pay the deficiency income tax assessed.

ISSUE:
Whether the Petitioners should be treated as an unregistered partnership or a co-ownership for the purposes of income
tax.

RULING:
The Petitioners are simply under the regime of co-ownership and not under unregistered partnership.
By the contract of partnership two or more persons bind themselves to contribute money, property, or industry to a
common fund, with the intention of dividing the profits among themselves (Art. 1767, Civil Code of the Philippines).
In the present case, there is no evidence that petitioners entered into an agreement to contribute money, property or
industry to a common fund, and that they intended to divide the profits among themselves. The sharing of returns does
not in itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest
in the property. There must be a clear intent to form a partnership, the existence of a juridical personality different from
the individual partners, and the freedom of each party to transfer or assign the whole property. Hence, there is no
adequate basis to support the proposition that they thereby formed an unregistered partnership. The two isolated
transactions whereby they purchased properties and sold the same a few years thereafter did not thereby make them
partners. They shared in the gross profits as co- owners and paid their capital gains taxes on their net profits and
availed of the tax amnesty thereby. Under the circumstances, they cannot be considered to have formed an unregistered
partnership which is thereby liable for corporate income tax, as the respondent commissioner proposes.
 G.R. No. L-68118 October 29, 1985
JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P. OBILLOS,
brothers and sisters, petitioners vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.
AQUINO, J.:
Facts:
On March 2, 1973 Jose Obillos, Sr. bought two lots with areas of 1,124 and 963 square meters of located at Greenhills,
San Juan, Rizal. The next day he transferred his rights to his four children, the petitioners, to enable them to build their
residences. The Torrens titles issued to them showed that they were co-owners of the two lots.
In 1974, or after having held the two lots for more than a year, the petitioners resold them to the Walled City Securities
Corporation and Olga Cruz Canada for the total sum of P313,050. They derived from the sale a total profit of P134,
341.88 or P33,584 for each of them. They treated the profit as a capital gain and paid an income tax on one-half thereof
or of P16,792.
In April, 1980, the Commissioner of Internal Revenue required the four petitioners to pay corporate income tax on the
total profit of P134,336 in addition to individual income tax on their shares thereof. The petitioners are being held
liable for deficiency income taxes and penalties totalling P127,781.76 on their profit of P134,336, in addition to the tax
on capital gains already paid by them.
The Commissioner acted on the theory that the four petitioners had formed an unregistered partnership or joint venture
The petitioners contested the assessments. Two Judges of the Tax Court sustained the same. Hence, the instant appeal.

Issue:
Whether or not the petitioners had indeed formed a partnership or joint venture and thus liable for corporate tax.

Held:
The Supreme Court held that the petitioners should not be considered to have formed a partnership just because they
allegedly contributed P178,708.12 to buy the two lots, resold the same and divided the profit among themselves. To
regard so would result in oppressive taxation and confirm the dictum that the power to tax involves the power to
destroy. That eventuality should be obviated.

As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure and simple. To consider them
as partners would obliterate the distinction between a co-ownership and a partnership. The petitioners were not
engaged in any joint venture by reason of that isolated transaction.

*Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of itself establish a
partnership, whether or not the persons sharing them have a joint or common right or interest in any property from
which the returns are derived". There must be an unmistakable intention to form a partnership or joint venture.*
Their original purpose was to divide the lots for residential purposes. If later on they found it not feasible to build their
residences on the lots because of the high cost of construction, then they had no choice but to resell the same to
dissolve the co-ownership. The division of the profit was merely incidental to the dissolution of the co-ownership
which was in the nature of things a temporary state. It had to be terminated sooner or later.

They did not contribute or invest additional ' capital to increase or expand the properties, nor was there an unmistakable
intention to form partnership or joint venture.

WHEREFORE, the judgment of the Tax Court is reversed and set aside. The assessments are cancelled. No costs.

All co-ownerships are not deemed unregistered partnership.—Co-Ownership who own properties which produce
income should not automatically be considered partners of an unregistered partnership, or a corporation, within the
purview of the income tax law. To hold otherwise, would be to subject the income of all
Co-ownerships of inherited properties to the tax on corporations, inasmuch as if a property does not produce an
income at all, it is not subject to any kind of income tax, whether the income tax on individuals or the income tax on
corporation.
As compared to other cases:
Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after an extrajudicial settlement the
co-heirs used the inheritance or the incomes derived therefrom as a common fund to produce profits for themselves, it
was held that they were taxable as an unregistered partnership.
This case is different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, where father and son
purchased a lot and building, entrusted the administration of the building to an administrator and divided equally the
net income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where the three Evangelista sisters
bought four pieces of real property which they leased to various tenants and derived rentals therefrom. Clearly, the
petitioners in these two cases had formed an unregistered partnership.
 AFISCO INSURANCE CORP. V CA 302 SCRA 1 (January 25, 1999)
Monday, January 26, 2009 Posted by Coffeeholic Writes
Labels: Case Digests, Taxation

Facts: AFISCO and 40 other non-life insurance companies entered into a Quota Share Reinsurance Treaties with
Munich, a non-resident foreign insurance corporation, to cover for All Risk Insurance Policies over machinery
erection, breakdown and boiler explosion. The treaties required petitioners to form a pool, to which AFISCO and the
others complied. On April 14, 1976, the pool of machinery insurers submitted a financial statement and filed an
“Information Return of Organization Exempt from Income Tax” for the year ending 1975, on the basis of which, it was
assessed by the commissioner of Internal Revenue deficiency corporate taxes. A protest was filed but denied by the
CIR.

Petitioners contend that they cannot be taxed as a corporation, because (a) the reinsurance policies were written by
them individually and separately, (b) their liability was limited to the extent of their allocated share in the original risks
insured and not solidary, (c) there was no common fund, (d) the executive board of the pool did not exercise control
and management of its funds, unlike the board of a corporation, (e) the pool or clearing house was not and could not
possibly have engaged in the business of reinsurance from which it could have derived income for itself. They further
contend that remittances to Munich are not dividends and to subject it to tax would be tantamount to an illegal double
taxation, as it would result to taxing the same premium income twice in the hands of the same taxpayer. Finally,
petitioners argue that the government’s right to assess and collect the subject Information Return was filed by the pool
on April 14, 1976. On the basis of this return, the BIR telephoned petitioners on November 11, 1981 to give them
notice of its letter of assessment dated March 27, 1981. Thus, the petitioners contend that the five-year prescriptive
period then provided in the NIRC had already lapsed, and that the internal revenue commissioner was already barred
by prescription from making an assessment.

Held: A pool is considered a corporation for taxation purposes. Citing the case of Evangelista v. CIR, the court held
that Sec. 24 of the NIRC covered these unregistered partnerships and even associations or joint accounts, which had no
legal personalities apart from individual members. Further, the pool is a partnership as evidence by a common fund, the
existence of executive board and the fact that while the pool is not in itself, a reinsurer and does not issue any insurance
policy, its work is indispensable, beneficial and economically useful to the business of the ceding companies and
Munich, because without it they would not have received their premiums.

As to the claim of double taxation, the pool is a taxable entity distinct from the individual corporate entities of the
ceding companies. The tax on its income is obviously different from the tax on the dividends received by the said
companies. Clearly, there is no double taxation.

As to the argument on prescription, the prescriptive period was totaled under the Section 333 of the NIRC, because the
taxpayer cannot be located at the address given in the information return filed and for which reason there was delay in
sending the assessment. Further, the law clearly states that the prescriptive period will be suspended only if the
taxpayer informs the CIR of any change in the address.
 Evangelista vs. Collector of Internal Revenue
Facts: Petitioners borrowed money from their father and purchased several lands. For several years, these lands
were leased to tenants by the petitioners. In 1954, respondent Collector of Internal Revenuedemanded from petitioners
the payment of income tax on corporations, real estate dealer's fixed tax and corporation residence tax for the years
1945-1949. A letter of demand and corresponding assessments were delivered to petitioners. Petitioners claim that they
should be absolved from paying said taxes since they are not a corporation.

Issue: Whether petitioners are subject to the tax on corporations provided for in section 24 of Commonwealth Act. No.
466, otherwise known as the National Internal Revenue Code, as well as to the residence tax for corporations and the
real estate dealers fixed tax.

Held: Yes. Petitioners are subject to the income tax and residence tax for corporation.

As defined in section 84 (b) of the Internal Revenue Code, "the term corporation includes partnerships, no matter how
created or organized." This qualifying expression clearly indicates that a jointventure need not be undertaken in any of
the standard forms, or in conformity with the usual requirements of the law on partnerships, in order that one could be
deemed constituted for purposes of the tax on corporations. Partnership, as has been defined in the civil code refers to
two or more persons who bind themselves to contribute money, properly, or industry to a common fund, with the
intention of dividing the profits among themselves. Thus, petitioners, being engaged in the real estate transactions for
monetary gain and dividing the same among themselves constitute a partnership so far as the Code is concerned and
are subject to income tax for corporation.

Since Sec 2 of the Code in defining corporations also includes joint-stock company, partnership, joint account,
association or insurance company, no matter how created or organized, it follows that petitioners, regardless of how
their partnership was created is also subject to the residence tax for corporations.
 CYANAMID PHILIPPINES, INC. VS. CA, CTA AND CIR- Surtax

In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax
upon the shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of the
accumulation, not intentions subsequently, which are mere afterthoughts.

Facts:
Petitioner is a corporation organized under Philippine laws and is a wholly owned subsidiary of American Cyanamid
Co. based in Maine, USA. It is engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of
imported finished goods and an imported/indentor. In 1985 the CIR assessed on petitioner a deficiency income tax of
P119,817) for the year 1981. Cyanamid protested the assessments particularly the 25% surtax for undue accumulation
of earnings. It claimed that said profits were retained to increase petitioner’s working capital and it would be used for
reasonable business needs of the company. The CIR refused to allow the cancellation of the assessments, petitioner
appealed to the CTA. It claimed that there was not legal basis for the assessment because 1) it accumulated its earnings
and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness 2) it is a
wholly owned subsidiary of American Cyanamid Company, a foreign corporation, and its shares are listed and traded
in the NY Stock Exchange. The CTA denied the petition stating that the law permits corporations to set aside a portion
of its retained earnings for specified purposes under Sec. 43 of the Corporation Code but that petitioner’s purpose did
not fall within such purposes. It found that there was no need to set aside such retained earnings as working capital as it
had considerable liquid funds. Those corporations exempted from the accumulated earnings tax are found under Sec.
25 of the NIRC, and that the petitioner is not among those exempted. The CA affirmed the CTA’s decision.

Issue: Whether or not the accumulation of income was justified.

Held:
In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon
the shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of the
accumulation, not intentions subsequently, which are mere afterthoughts. The accumulated profits must be used within
reasonable time after the close of the taxable year. In the instant case, petitioner did not establish by clear and
convincing evidence that such accumulated was for the immediate needs of the business.

To determine the reasonable needs of the business, the United States Courts have invented the “Immediacy Test”
which construed the words “reasonable needs of the business” to mean the immediate needs of the business, and it is
held that if the corporation did not prove an immediate need for the accumulation of earnings and profits such was not
for reasonable needs of the business and the penalty tax would apply. (Law of Federal Income Taxation Vol 7) The
working capital needs of a business depend on the nature of the business, its credit policies, the amount of inventories,
the rate of turnover, the amount of accounts receivable, the collection rate, the availability of credit and other similar
factors. The Tax Court opted to determine the working capital sufficiency by using the ration between the current
assets to current liabilities. Unless, rebutted, the presumption is that the assessment is correct. With the petitioner’s
failure to prove the CIR incorrect, clearly and conclusively, the Tax Court’s ruling is upheld.