TAX DIGEST – 1/11/19

 Conwi vs. CTA, G.R. No. 48532, August 31, 1992;

Facts:

Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine Manufacturing Corporation... a
subsidiary of Procter & Gamble, a foreign corporation based in

Cincinnati, Ohio, U.S.A.

petitioners were assigned, for certain periods, to other subsidiaries of Procter & Gamble, outside of the Philippines,
during which petitioners were paid U.S. dollars as compensation for services in their foreign... assignments.

When petitioners in C.T.A. Case No. 2511 filed their income tax returns for the year 1970, they computed the tax
due by applying the dollar-to-peso conversion on the basis... of the floating rate

However, on February 8, 1973 and October 8, 1973, petitioners in said cases filed with the office of the respondent

Commissioner, amended income tax returns for the above-mentioned years, this time using the par value of the
peso as prescribed in Section 48 of Republic Act No. 265 in relation to Section 6 of Commonwealth Act No. 699 as
the basis for converting their respective dollar income... into Philippine pesos... aforesaid computation as shown in
the amended income tax returns resulted in the alleged overpayments, refund and/or tax credit.

claims for refund of said... over-payments were filed with respondent Commissioner.

petitioners filed their petitions for review in the above-mentioned cases.

the respondent Court of Tax Appeals held that the... proper conversion rate for the purpose of reporting and paying
the Philippine income tax on the dollar earnings of petitioners are the rates prescribed under Revenue
Memorandum Circulars Nos. 7-71 and 41-71.

the claim for refund and/or tax credit of petitioners in... the above-entitled cases was denied and the petitions for
review dismissed

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

We are inclined to agree with respondents Court of Tax Appeals and Commissioner of Internal Revenue and thus
vote to deny the petition.

Petitioners claim that since the dollar earnings do not fall within the classification of foreign exchange transactions,
there... occurred no actual inward remittances, and, therefore, they are not included in the coverage of Central
Bank Circular No. 289

They conclude that their earnings... should be converted for income tax purposes using the par value of the
Philippine peso.

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

Issues:

what exchange rate should be used to determine the peso equivalent of the foreign earnings of petitioners for
income tax purposes.

Ruling:

income may be defined as an amount of money coming to a person or corporation within a specified time, whether
as payment for services; interest or profit from investment. Unless otherwise... specified, it means cash or its
equivalent.[4] Income can also be thought of as a flow of the fruits of one's labor.

Petitioners are correct as to their claim that their dollar earnings are not receipts derived from foreign exchange
transactions. For a foreign exchange transaction is simply that -- a transaction in foreign exchange, foreign exchange
being "the conversion of an amount of... money or currency of one country into an equivalent amount of money or
currency of another."

When petitioners were assigned to the foreign subsidiaries of Procter & Gamble, they were earning in their assigned
nation's... currency and were ALSO spending in said currency. There was no conversion, therefore, from one
currency to another.

Public respondent Court of Tax Appeals did err when it concluded that the dollar incomes of petitioner fell under
Section 2(f)(g) and (m) of C.B. Circular No.42.
A careful reading of said CB Circular No. 289[8] shows that the subject matters involved therein are export products,
invisibles, receipts of foreign exchange, foreign exchange payments, new foreign borrowing investments --... nothing
by way of income tax payments Thus; petitioners are in error by concluding that since C.B. Circular No. 289 does not
apply to them, the par value of the peso should be the guiding rate used for income tax purposes.

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

Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71[10] and 41-71[11] were issued to prescribe a
uniform rate of exchange from US dollars to Philippine pesos for

INTERNAL REVENUE TAX PURPOSES for the years 1970 and 1971, respectively.

circulars were a valid exercise of the authority given to the Secretary of Finance by the Legislature which enacted
the Internal Revenue Code.

presumed to be a valid... interpretation of said code until revoked by the Secretary of Finance himself

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

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

Principles:

income may be defined as an amount of money coming to a person or corporation within a specified time, whether
as payment for services; interest or profit from investment. Unless otherwise... specified, it means cash or its
equivalent.[4] Income can also be thought of as a flow of the fruits of one's labor.

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

Petitioners forget that they are citizens of the Philippines, and their income, within... or without, and in these cases
wholly without, are subject to income tax. Sec. 21, NIRC, as amended, does not brook any exemption.

 Fisher vs. Trinidad, 43 Phil. 981;

Facts:

Philippine American Drug Company was a corporation- duly organized and existing under the laws of the Philippine
Islands, doing business in the city of Manila... ppellant was a stoekohlder in said corporation; that said corporation,
as a... result of the business for that year, declared a "stock dividend;... proportionate share of said stock dividend of
the appellant was P24,800... the appellant,... upon demand of the appellee, paid, under protest, and involuntarily,
unto the appellee the sum of P889.91 as income tax on said stock dividend.

recovery of that sum (P889.91) the present action was instituted... appellant cites and relies on some decisions of
the Supreme Court of the United States

In each of said cases an effort was made to collect an "income tax" upon "stock dividends" and in each case it was
held that "stock dividends" were capital and not an "income" and therefore not subject to the "income tax" Jaw.

The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U. S., 189), that a "stock
dividend" is not "income" but argues that said Act No. 2833, in imposing the tax on the stock dividend, does not
violate the provisions of the Jones Law.

further argues that the statute of the United States providing for tax upon stock dividends is different from the
statute of the Philippine Islands, and therefore the decision of the Supreme Court of the United States should not be
followed in interpreting the statute... in force here.

It will be rioted from a reading of the provisions of the two laws above quoted that the writer of the law of the
Philippine Islands must have had before him the statute of the United States. No important argument can be based
upon the slight difference in the wording of the two... sections.

There is no question that the Philippine

Legislature may provide for the payment of an income tax, but it cannot, under the guise of an income tax, collect a
tax on property which is not an "income." The Philippine Legislature cannot impose a tax upon "property" under a
law which provides for a tax upon "income" only.

The Philippine Legislature has no power to provide a tax upon "automobiles" only, and under that law collect a tax
upon a carreton or bull cart.

A statute providing for an income tax cannot be construed to cover property which is not, in fact, income. The
Legislature cannot, by a... statutory declaration, change the real nature of a tax which it imposes. A law which
imposes an importation tax on rice only cannot be construed to impose an importation tax on corn.

Issues:

Are the "stock dividends" in the present case "income" and taxable as such under the provisions of section 25 of Act
No. 2833 ?

Ruling:

stock dividends represent undistributed increase in the capital of corporations or firms, joint stock companies, etc.,
etc., for a particular period.

used to show the... increased interest or proportional share in the capital of each stockholder.

the inventory of the property of the corporation, etc., for a particular period shows an increase in its capital, so that
the stock theretofore issued does not show the real value of the... stockholder's interest, and additional stock is
issued showing the increase in the actual capital, or property, or assets of the corporation, etc.

The New Standard Dictionary, edition of 1915, defines an income as "the amount of... money coming to a person or
corporation within a specified time whether as payment for services, interest, or profit from investment."

Webster's International Dictionary defines an income as "the receipts, salary; especially, the annual receipts of a
private person or a... corporation from property."

Bouvier, in his law dictionary, says that an "income" in the federal constitution and income tax act, is used in its
common or ordinary meaning and not in its technical or economic sense.

Mr. Black, in his law... dictionary, says: "An income is the return in money from one's business, labor, or capital
invested ; gains, profit, or private revenue." "An income tax is a tax on the yearly profits arising from property,
professions, trades, and offices."

Gray vs. Darlington (82 U. S., 63), said in speaking of income that mere advance in value in no sense constitutes the
"income"

Such advance constitutes and can be treated merely as an increase of capital.

Mr. Justice Hughes

"income" in an income... tax law, unless it is otherwise specified, to mean cash or its equivalent. It does not mean
choses in action or unrealized increments in the value of the property

Towne vs. Eisner, supra, Mr, Justice Holmes

'A... stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of
the shareholders. Its property is not diminished and their interests are not increased. * * * The proportional interest
of each shareholder remains the same. * * *' In... short, the corporation is no poorer and the stockholder is no
richer than they were before.

Mr. Justice Pitney

Eisner vs. Macomber

"An income may be defined as the gain derived from capital, from labor, or from both combined, provided it be
understood to include profit gained through a sale... or conversion of capital assets.

when stock dividends are declared, the corporation or company acknowledges a liability, in form, to the
stockholders

If profits have been made by the... corporation... they create additional bookkeeping liabilities under the head of
"profit and loss,"

None of these, however, gives to the stockholders as a body, much less to any... one of them, either a claim against
the going concern or corporation, for any particular sum of money, or a right to any particular portion of the asset,
or any share unless or until the directors conclude that dividends shall be made and a part of the company's assets...
segregated from the common fund for that purpose.
The dividend normally is payable in money and when so paid, then only does the stockholder realize a profit or gain,
which becomes his separate property, and thus derive an income from the capital that he has invested. Until that...
is done the increased assets belong to the corporation and not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated profits have
been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution, in money
or in kind, should opportunity offer.

it tends rather to postpone said realization, in that the fund represented by the new stock has been transferred
from surplus to assets, and no longer is available for actual distribution.

The essential and controlling fact is... that the stockholder has received nothing out of the company's assets for his
separate use and benefit

The stockholder who receives a stock dividend has received nothing but a representation of his increased interest in
the capital of the corporation.

There has been no separation or segregation of his interest.

All the property or capital of the corporation still belongs to... the corporation.

no separation of the interest of the stockholder from the general capital of the corporation

The stockholder, by virtue of the stock dividend, has no separate or individual control over the interest represented
thereby, further than he had before... the stock dividend was issued

He cannot use it for the reason that it is still the property of the corporation

A certificate of stock represented by the stock dividend is simply a statement of his proportional... interest or
participation in the capital of the corporation.

We believe that the Legislature, when it provided for an "income tax," intended to tax only the "income" of
corporations, firms, or individuals, as that term is generally used in its common acceptation;... that the income
means money received, coming to a person or corporation for services, interest, or profit from investments.

We do not believe that the Legislature intended that a mere increase in the value of the capital or assets of a
corporation, firm, or individual,... should be taxed as "income."

Mr. Justice Pitney, in the case of Eisner vs. Macomber

"That the fudamental relation of 'capital' to 'income' has been much discussed by economists, the former being
likened to the tree or the... land, the latter to the fruit or the crop... the former depicted as a reservoir supplied from
springs; the latter as the outlet stream, to be measured by its flow during a period of time."

There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock dividends
declared, as in the present case.

The one is a disbursement to the stockholder of accumulated earnings, and the corporation at once parts
irrevocably with all... interest thereon. The other involves no disbursement by the corporation. It parts with nothing
to the stockholder.

The latter receives, not an actual dividend, but certificate of stock which simply evidences his interest in the entire
capital, including such as by investment of... accumulated profits has been added to the original capital.

They are not income to him, but represent additions1 to the source of his income, namely, his invested capital.

Gibbons vs. Mahon

The ownership of that property is in... the corporation, and not in the holders of shares of its stock.

DeKoven vs. Alsop

Mr. Justice Wilkin said: "A dividend is defined as 'a corporate profit set aside, declared, and ordered by the directors
to be paid to the stockholders on demand or at a fixed time. Until the dividend is... declared, these corporate

profits belong to the corporation, not to the stockholders, and are liable for corporate indebtedness.'"

When a cash dividend is declared and paid to the... stockholders, such cash becomes the absolute property of the
stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A stock dividend,
however, still being the property of the corporation, and not of the stockholder, it may be reached by... an
execution against the corporation, and sold as a part of the property of the corporation

The rule is well established that cash dividends, whether large or small, are regarded as "income"... and all stock
dividends, as capital or assets.
if the holder of the stock... dividend is required to pay an income tax on the same, the result would be that he has
paid a tax upon an income which he never received. Such a conclusion is absolutely contradictory to the idea of an
income. An income subject to taxation under the law must be an actual income... and not a promised or prospective
income.

The appellee emphasizes the "income from dividends." Of course, income received as dividends is taxable as an
income, but an income from "dividends" is a very different thing from a receipt of a "stock dividend." One is... an
actual receipt of profits; the other is a receipt of a representatI

In- asmuch, however, as appeals may be taken... from this court to the Supreme Court of the United States, we feel
bound to follow the same doctrine announced by that court.

"stock dividends" are not "income," the same cannot be taxed under that provision of Act No, 2833 which provides
for a tax upon income.

Under the guise of an income tax, property which is not an... income cannot be taxed.

Principles:

We believe that the Legislature, when it provided for an "income tax," intended to tax only the "income" of
corporations, firms, or individuals, as that term is generally used in its common acceptation; that... is, that the
income means money received, coming to a person or corporation for services, interest, or profit from investments.
We do not believe that the Legislature intended that a mere increase in the value of the capital or assets of a
corporation, firm, or individual,... should be taxed as "income."

"That the fudamental relation of 'capital' to 'income' has been much discussed by economists, the former being
likened to the tree or the... land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from
springs; the latter as the outlet stream, to be measured by its flow during a period of time."

When a cash dividend is declared and paid to the... stockholders, such cash becomes the absolute property of the
stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A stock dividend,
however, still being the property of the corporation, and not of the stockholder, it may be reached by... an
execution against the corporation, and sold as a part of the property of the corporation.

The rule is well established that cash dividends, whether large or small, are regarded as "income"... and all stock
dividends, as capital or assets.

if the holder of the stock... dividend is required to pay an income tax on the same, the result would be that he has
paid a tax upon an income which he never received. Such a conclusion is absolutely contradictory to the idea of an
income. An income subject to taxation under the law must be an actual income... and not a promised or prospective
income.

The appellee emphasizes the "income from dividends." Of course, income received as dividends is taxable as an
income, but an income from "dividends" is a very different thing from a receipt of a "stock dividend." One is... an
actual receipt of profits; the other is a receipt of a representation of the increased value of the assets of a
corporation.

"stock dividends" are not "income," the same cannot be taxed under that provision of Act No, 2833 which provides
for a tax upon income. Under the guise of an income tax, property which is not an... income cannot be taxed.

 Madrigal vs. Rafferty, 38 Phil. 414;

Vicente Madrigal and Susana Paterno were legally married and have conjugal partnership.
Madrigal filed his total net income for the year is P296,302.73.

Subsequently, Madrigal submitted the claim that the said total net income of year 1914 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, and the computing and assessing the additional income tax provided by the Act of Congress of Oct. 3, 1913,
the income declared by Madrigal and the other half of Paterno.

Madrigal and Paterno brought action against Collector of Internal Revenue and the Deputy Collector of Internal
Revenue for the recovery of the sum P3,786.08.

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 plaintiff the sum of P2,921.09, which taken together amount of
P5842.18 instead of P9,668.21.
Issue: WON the additional income tax should be divided into equal parts because of the conjugal partnership
existing between them?

Held:

NO.

Paterno has an inchoate right in the property of her husband Madrigal during the lifetime of the conjugal
property. She has an interest in the ultimate ownership of property acquired as income of the conjugal partnership.
Not being seized of the separate estate, 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 or income, actually and
legally vested in her and entirely distinct from her husband property, the income cannot properly be considered the
separate income of the wife for the purpose of the additional tax. The income tax law does not look on the spouses
as individual partners in an ordinary partnership.

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.

CA v CIR

01 SCRA 152 – Business Organization – Corporation Law – Trust Fund Doctrine

Don Andres Soriano (American), founder of A. Soriano Corp. (ASC) had a total shareholdings of 185,154 shares.
Broken down, the shares comprise of 50,495 shares which were of original issue when the corporation was founded
and 134,659 shares as stock dividend declarations. So in 1964 when Soriano died, half of the shares he held went to
his wife as her conjugal share (wife’s “legitime”) and the other half (92,577 shares, which is further broken down to
25,247.5 original issue shares and 82,752.5 stock dividend shares) went to the estate. For sometime after his death,
his estate still continued to receive stock dividends from ASC until it grew to at least 108,000 shares.
In 1968, ASC through its Board issued a resolution for the redemption of shares from Soriano’s estate purportedly
for the planned “Filipinization” of ASC. Eventually, 108,000 shares were redeemed from the Soriano Estate. In 1973,
a tax audit was conducted. Eventually, the Commissioner of Internal Revenue (CIR) issued an assessment against
ASC for deficiency withholding tax-at-source. The CIR explained that when the redemption was made, the estate
profited (because ASC would have to pay the estate to redeem), and so ASC would have withheld tax payments from
the Soriano Estate yet it remitted no such withheld tax to the government.
ASC averred that it is not duty bound to withhold tax from the estate because it redeemed the said shares for
purposes of “Filipinization” of ASC and also to reduce its remittance abroad.
ISSUE: Whether or not ASC’s arguments are tenable.
HELD: No. The reason behind the redemption is not material. The proceeds from a redemption is taxable and ASC is
duty bound to withhold the tax at source. The Soriano Estate definitely profited from the redemption and such
profit is taxable, and again, ASC had the duty to withhold the tax. There was a total of 108,000 shares redeemed
from the estate. 25,247.5 of that was original issue from the capital of ASC. The rest (82,752.5) of the shares are
deemed to have been from stock dividend shares. Sale of stock dividends is taxable. It is also to be noted that in the
absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole
or in part, is made out of corporate profits such as stock dividends.
It cannot be argued that all the 108,000 shares were distributed from the capital of ASC and that the latter is merely
redeeming them as such. The capital cannot be distributed in the form of redemption of stock dividends without
violating the trust fund doctrine — wherein the capital stock, property and other assets of the corporation are
regarded as equity in trust for the payment of the corporate creditors. Once capital, it is always capital. That
doctrine was intended for the protection of corporate creditors.

Eisner vs. Macomber, 252 U.S. 189

FACTS:

1. Mrs. Macomber owned 2,200 share of Standard Oil Company of California stock.
2. In January, 1916, the company declared a stock dividend and Mrs. Macomber received an additional 1,100 shares
of stock. Of these shares, 198.77 shares, par value $19,877, represented surplus earned by the company after
March 1, 1913.
3. The IRS treated the $19,877 as taxable income under the Revenue Act of 1916 which provided that a stock
dividend was considered income to the amount of its cash value.
4. Mrs. Macomber argued that that provision in the Revenue Act of 1916 was unconstitutional because it was a
direct tax not apportioned per population; since a stock dividend was not income, a legislative provision subjecting it
to income tax was not constitutional under the 16th Amendment.
5. The District Court held that the stock dividend was not income.

ISSUE: Does Congress have the power under the 16th Amendment to tax shareholders on stock dividends received?
Are stock dividends considered income or capital?

Laws/ References:

1) 16th Amendment - "The Congress shall have power to lay and collect taxes on income, from whatever source
derived, without apportionment among the several States, and without regard to any census or enumeration."
2) Revenue Act of 1916 - a "stock dividend shall be considered income, to the amount of its cash value."
3) Brushaber v Union Pacific - in this case, the Supreme Court stated that the 16th Amendment "did not extend the
taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment
among the State of taxes laid on income." Macomber, 1 USTC ¶32, page 1079. Thus, the item must be income in
order for Congress to tax it.
4) The Court suggested that "income," which is not defined in the 16th Amendment, was something derived from
capital or labor, or from both.

HELD:

The Supreme Court affirmed the District Court holding for the taxpayer that a stock dividend is not income. The
Revenue Act of 1916 provision subjecting stock dividends to tax was held unconstitutional.

If a stock dividend is not considered income, it can not be subject to income tax under the 16th Amendment. In
applying the 16th Amendment, it is important to distinguish between capital and income, as only income is subject
to income tax.

A stock dividend reflects the corporation transferring an amount from "surplus" (retained earnings) to "capital
stock." Such a transaction is merely a bookkeeping entry and "affects only the form, not the essence, of the
"liability" acknowledged by the corporation to its own shareholders ... it does not alter the preexisting proportionate
interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other
stockholders as they stood before" (Macomber, p. 1081). An increase to the value of capital investment is not
income. Nothing of value has been taken from the corporation and given to the shareholder as is the case with a
cash dividend.

In addition, since the shareholder receives no cash, in order to pay any tax on a stock dividend, he might have to
convert the stock into cash - he has no wherewithal to pay from the nature of the transaction. "Nothing could more
clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that in
the nature of things it requires conversion of capital in order to pay the tax" (Macomber, p. 1082).
Helvering v. Horst

311 U.S. 112 (1940)

Horst owned some negotiable bonds.

Negotiable bonds pay off in two ways. First, once the due date of the bond comes, they can be cashed in for the
principle amount of the bond. Second, they also come with some 'interest coupons' that can be cashed in at regular
intervals for an interest payment.

So say you had a negotiable bond worth $100 in a year and paying 12%. That means you'd get 12 coupons that you
could cash in one per month for $1 each, and at the end of the year you could cash in the bond for $100.

Horst earned a lot of money and realized that due to progressive tax rates, the last dollar a person earns in a year is
taxed at a significantly higher tax rate than the first dollar they earn. So he came up with an idea to give all of his
interest coupons to his son (who otherwise had an income of $0). That way the family could pay less in taxes overall
because the son would get taxed on the income at a lower rate than Horst would.

When Horst filed his taxes, he did not include the income from the interest coupons in his gross income. The IRS
disagreed.

Horst argued that since the son was the legal owner of the interest coupons, they should be included in his son's
taxes.

The IRS argued that Horst was the real owner of the interest coupons, and needed to pay taxes on them, regardless
of his machinations.

That's the Assignment of Interest Doctrine from Lucas v. Earl (281 U.S. 111 (1930)).

The Tax Court found for the IRS. Horst appealed.

The Appellate Court reversed. The IRS appealed.

The US Supreme Court reversed and found for the IRS.

The US Supreme Court found that the power to dispose of income is the equivalent to ownership of that income.

The Court found that Horst could not attribute the 'fruit' (aka the interest coupon) to his son while retaining the
'tree' (the negotiable bond itself).

The Court noted that if Horst had given the entire bond to his son, then it would have been taxable to the son.

Note that Horst could have gotten around this problem if he had done things differently. 26 U.S.C. §102 says that a
gift is excludable as income. But §102(b) says that gifts of income derived from property are not excludable.
Therefore the interest coupons (which represent income derived from the bond) are not excludable as gifts. But if
Horst had instead given his son the bond instead of the interest coupons, then the bond would have been
excludable as a gift to the son.

CIR VS. JAVIER

Claim of right doctrine or doctrine of ownership, command or control- In this case, Javier is not liable for fraud
penalty because the “income” he received is not yet a taxable gain since it is still under litigation.
FACTS:
• 1977: Victoria Javier, wife of Javier-respondent, received $999k from Prudential Bank remitted by her sister
Dolores through Mellon Bank in US.
• Around 3 weeks after, Mellon Bank filed a complaint with CFI Rizal against Javier claiming that its remittance of
$1M was a clerical error and should have been $1k only and praying that the excess be returned on the ground that
the Javiers are just trustees of an implied trust for the benefit of Mellon Bank.
• CFI charged Javier with estafa alleging that they misappropriated and converted it to their own personal use.
• A year after, Javier filed his Income Tax Return for 1977 and stating in the footnote that “the taxpayer was
recipient of some money received abroad which he presumed to be a gift but turned out to be an error and is now
subject of litigation”
• The Commissioner of Internal Revenue wrote a letter to Javier demanding him to pay taxes for the deficiency, due
to the remittance.
• Javier replied to the Commissioner and said that he will pay the deficiency but denied that he had any undeclared
income for 1977 and requested that the assessment of 1977 be made to await final court decision on the case filed
against him for filing an allegedly fraudulent return.

• Commissioner replied that “the amount of Mellon Bank’s erroneous remittance which you were able to dispose is
definitely taxable” and the Commissioner imposed a 50% fraud penalty on Javier.

ISSUE: Whether or not Javier is liable for the 50% penalty.

HELD: No.

• The court held that there was no actual and intentional fraud through willful and deliberate misleading of the BIR
in the case. Javier even noted that “the taxpayer was recipient of some money received abroad which he presumed
to be a gift but turned out to be an error and is now subject of litigation”
• (the ff are not expressly written in the case, in fact the doctrine I just found it elsewhere but this is relevant to the
topic rather than the issue in the case)
o Claim of right doctrine- a taxable gain is conditioned upon the presence of a claim of right to the alleged gain and
the absence of a definite and unconditional obligation to return or repay.
o In this case, the remittance was not a taxable gain, since it is still under litigation and there is a chance that Javier
might have the obligation to return it. It will only become taxable once the case has been settled because by then
whatever amount that will be rewarded, Javier has a claim of right over it.

Thus, it was not unreasonable for the private respondent to simply state in his income tax
return that the amount received was still under litigation. If he had paid the tax, would that
not constitute estafa for using the funds for his own personal benefit? and would the
Government refund it to him if the courts ordered him to refund the money to the Mellon
Bank?

Lessons Applicable: Accrual method, burden of proof in accrual method, deductibility of ordinary and
necessary trade, business, or professional expenses, all events test

Laws Applicable:

FACTS:

 BIR disallowed Isabela Cultural Corp. deductible expenses for services which were rendered in
1984 and 1985 but only billed, paid and claimed as a deduction on 1986.
 After CA sent its demand letters, Isabela protested.
 CTA found it proper to be claimed in 1986 and affirmed by CA
ISSUE: W/N Isabela who uses accrual method can claim on 1986 only

HELD: case is remanded to the BIR for the computation of Isabela Cultural Corporation’s liability
under Assessment Notice No. FAS-1-86-90-000680.

NO

 The requisites for the deductibility of ordinary and necessary trade, business, or professional
expenses, like expenses paid for legal and auditing services, are:
 (a) the expense must be ordinary and necessary;
 (b) it must have been paid or incurred during the taxable year; - qualified by Section 45 of the
National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this
Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’,
dependent upon the method of accounting upon the basis of which the net income is computed
 (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.
 Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of
accounting, expenses not being claimed as deductions by a taxpayer in the current year when
they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a
taxpayer who is authorized to deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the next year.
 The accrual method relies upon the taxpayer’s right to receive amounts or its obligation to pay
them, in opposition to actual receipt or payment, which characterizes the cash method of
accounting. Amounts of income accrue where the right to receive them become fixed, where
there is created an enforceable liability. Similarly, liabilities are accrued when fixed and
determinable in amount, without regard to indeterminacy merely of time of payment.
 The accrual of income and expense is permitted when the all-events test has been met. This test
requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable
accurate determination of such income or liability.
 The all-events test requires the right to income or liability be fixed, and the amount of such
income or liability be determined with reasonable accuracy. However, the test does not demand
that the amount of income or liability be known absolutely, only that a taxpayer has at his
disposal the information necessary to compute the amount with reasonable accuracy. The all-
events test is satisfied where computation remains uncertain, if its basis is unchangeable; the
test is satisfied where a computation may be unknown, but is not as much as unknowable, within
the taxable year. The amount of liability does not have to be determined exactly; it must be
determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate amount.
 The propriety of an accrual must be judged by the facts that a taxpayer knew, or could
reasonably be expected to have known, at the closing of its books for the taxable year.
 Accrual method of accounting presents largely a question of fact; such that the taxpayer bears
the burden of proof of establishing the accrual of an item of income or deduction.
 In the instant case, the expenses for professional fees consist of expenses for legal and auditing
services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of
the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for
reimbursement of the expenses of said firm in connection with ICC’s tax problems for the year
1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s. - failed
to prove the burden