EN BANC

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

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

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

Gregorio Araneta for appellants.

Assistant Attorney Round for appellees.

MALCOLM, J.:

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

STATEMENT OF THE CASE.

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

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

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

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

ISSUES.

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

DECISION.

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

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

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

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

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

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

TREASURY DEPARTMENT, Washington.

Income Tax.

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

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

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

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

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

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

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

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

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

Respectfully,

DAVID A. GATES.
Acting Commissioner.

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