Passive Investment Income (Royalty Income)

CA-GR SP. No. 31283

CTA Case No. 3504, 3743
PHILIPPINE AMERICAN LIFE INSURANCE COMPANY, INC. (PHILAMLIFE), ET AL.,
petitioner, vs.
HON. COURT OF TAX APPEALS, AND THE COMMISSIONER OF INTERNAL REVENUE,
respondent
April 25, 1995

FACTS: Petitioner PHILAMLIFE a domestic corporation entered into a Management Services

Agreement with American International Reinsurance Co., Inc. (AIRCO - later became American
International Group, Inc. [AIGI] after a merger), a non-resident foreign corporation whereby
effective January 1, 1972, for a fee of not exceeding $250,000.00 per annum, AIRCO shall
perform for PHILAMLIFE consulting services.

In 1980, CIR issued in favor of PHILAMLIFE Tax Credit Memo in the amount of P643,125.00
representing erroneous payment of withholding tax at source on remittances to AIGI for services
rendered abroad in 1979.

On the basis of the issuance of tax credit, PHILAMLIFE filed with CIR a claim for the refund of
the other erroneous tax payments made in 1980 and 1982. PHILAMLIFE alleged that the claims
for refund have exactly the same subject matter as in the previous claim for refund in 1979.

CIR denied PHILAMLIFE's claim for refund of P643,125.00 as withholding tax at source for
1980. Moreover, respondent cancelled the Tax Credit Memo previously issued to PHILAMLIFE
on November 18, 1980 and requested the latter to pay the amount of P643,125.00 as deficiency
withholding tax at source for 1979 plus increments.

PHILAMLIFE filed with the CTA a petition seeking the annulment of the CIR’s assessment. CTA
denied the petition and the subsequent motion for reconsideration.

In its petition for review to the CA, PHILAMLIFE alleged that there is no basis for the CTA to
conclude that the compensation paid for advisory services rendered outside the Philippines to
AIGI, a non-resident foreign corporation not engaged in trade or business in the Philippines, is
considered "rentals and royalties from properties located in the Philippines" pursuant to
Section37 (a) (4) of the National Internal Revenue Code. AIGI is not covered by the above
provision of the Tax Code considering that it has no properties located in the Philippines from
which rentals and royalties can be derived.

ISSUES: WON compensation for advisory services performed abroad by the personnel of a
non-resident foreign corporation not doing business in the Philippines (AIGI) are subject to
Philippines withholding income tax.

HELD: Yes it is subject to income tax. Section 37 of the National Internal Revenue Code
states:
 Income from Services within the Philippines,

(a) Gross income from sources within the Philippines — the following items of gross income shall be treated as gross
income from source within the Philippines.
(4) Rentals and royalties — Rentals and royalties from properties located in the Philippines or
from any interest in such property, including rentals or royalties for —
(c) The supply of scientific, technical, industrial or commercial knowledge or
informations;
(d) The supply of any assistance that is auxiliary and subsidiary to, and is furnished as a
means of enabling the application or enjoyment of, any property, or right as is mentioned in
paragraph (a) … or any such knowledge or information as is mentioned in paragraph
(c); or
(f) Technical advice, assistance or services rendered in connection with the technical
management and administration of any scientific, industrial or commercial
undertaking, venture, project of scheme;

The various management services enumerated in the Management Services Agreement

between PHILAMLIFE and AIRCO (now known as AIGI) will show that they can easily fall under
any of the afore-quoted expanded meaning of royalties. The services offered call for the
supply by the non-resident foreign corporation of technical and commercial information,
knowledge, advice, assistance or services in connection with technical management or
administration of an insurance business — a commercial undertaking.

Therefore, the income derived for the services performed by AIGI for PHILAMLIFE under
the said management contract shall be considered as income from services within the
Philippines. AIGI being a non-resident foreign corporation not engaged in trade or business in
the Philippines 'shall pay a tax equal to thirty-five (35%) percent of the gross income received
during each taxable year from all sources within the Philippines as interest, dividends, rents,
royalties (including remuneration for technical services), salaries, premiums, annuities,
emoluments or other fixed or determinable annual, periodical or casual gains, profits and
income and capital gains: . . . (Section 12(6) (I) of the National Internal Revenue Code.

While it is true petitioner AIGI has no properties in the Philippines, it derives income from its
agreement with petitioner PHILAMLIFE making it well-within the ambit of Section 37 (a)(7) of the
Tax Code.

In our jurisprudence, the test of taxability is the 'source', and the source of an income is
"that activity . . . which produced the income". It is not the presence of any property from
which one derives rentals and royalties that is controlling, but rather as expressed under
the expanded meaning of "royalties", it includes " royalties for the supply of scientific, technical,
industrial, or commercial knowledge or informations; and the technical advice, assistance or
services rendered in connection with the technical management and administration of any
scientific, industrial or commercial undertaking, venture, project or scheme", and others (Section
37 (a) (7) as amended by P.D. 1457).

Other Issues: WON CIR is barred by prescription, laches, estoppel, or equitable considerations in cancelling the previous approval
of petitioners claim for refund more than 5 years thereafter, after it has determined, after investigation, that the advisory services
were rendered or performed abroad by the personnel of AIGI, a non-resident foreign corporation not doing business in the
Philippines – NO. Mere procedural defect cannot, and should not, prejudice the government. It is axiomatic that the government can
never be in estoppel, particularly in matters involving taxes. The errors or omissions of certain administrative officers should never
be allowed to jeopardize the government's financial position.

WON CTA can amend its decision on a motion for reconsideration – YES, said decision having not attained its finality, the same
may still be amended, corrected or modified by the Court.