Rule on Compensation of Taxes: There can be no off-setting of taxes against the

claims that the taxpayer may have against the government. Government and taxpayer
are not mutually creditors and debtors of each other under Article 1278 of the Civil Code
and a claim for taxes is not such a debt, demand, contract or judgment as is allowed to
be set-off. (REPUBLIC vs. MAMBULAO LUMBER COMPANY, ET AL. , ENGRACIO
FRANCIA vs. INTERMEDIATE APPELLATE COURT, ET AL.)

Exception to the rule: When both taxes and claim against the government is overdue,
demandable and fully liquidated. Government has been recognized and an amount has
already been appropriated for the purpose by a corresponding law (MELECIO R.
DOMINGO vs. LORENZO C. GARLITOS, ET AL. )

Cases:

REPUBLIC vs. MAMBULAO LUMBER COMPANY, ET AL.

G.R. No. L-17725. February 28, 1962

Facts:

Defendants have a liability for forest charges to the Republic of the Philippines.
Defendants contended that since the Republic of the Philippines has not made use of
those reforestation charges (RA 115) collected from it for reforesting the denuded area
of the land covered by its license, the Republic of the Philippines should refund said
amount, or, if it cannot be refunded, at least it should be compensated with what
Mambulao Lumber Company owed the Republic of the Philippines for reforestation
charges.

Issue:

May reforestation charges be set-off to forest charges owed by defendants to the

government?

Ruling:

No. Appellant and appellee are not mutually creditors and debtors of each other.
Consequently, the law on compensation is inapplicable. The forest charges which the
defendant Mambulao Lumber Company has paid to the government, are in the coffers
of the government as taxes collected, and the government does not owe anything,
crystal clear that the Republic of the Philippines and the Mambulao Lumber Company
are not creditors and debtors of each other, because compensation refers to mutual
debts.

FACTS:
Mambulao Lumber Company paid the Government a total of P9,127.50 as reforestation
charges. Having found liable for an aggregate amount of P4,802.37 for forest charges, it
contended that since the Republic (Government) has not made use of the reforestation
charges for reforesting the denuded area of the land covered by the company’s license,
the Republic should refund said amount or, if it cannot be refunded, at least the
company should be compensated with what it owed the Republic for reforestation
charges.

ISSUE:
Whether taxes may be subject of set-off or compensation.

HELD:
Internal revenue taxes, such as forest charges, cannot be the subject of set-off or
compensation. A claim for taxes is not such a debt, demand, contract or judgment as is
allowed to be set-off under the statutes of set-off, which are construed uniformly, in the
light of public policy, to exclude the remedy in an action or any indebtedness of the
State or municipality to one who is liable to the State or municipality for taxes. Neither
are they subject of recoupment since they do not arise out of the contract or transaction
sued on.

Taxes are not in the nature of contracts between the parties but grow out of a duty to,
and are the positive acts of the government, to the making and enforcing of which, the
personal consent of individual taxpayers is not required.

InDomingo vs. Moscoso (106 PHIL 1138), the Supreme Court declared as final and
executorythe order of the Court of First Instance of Leyte for the payment of estate and
inheritance taxes,charges and penalties amounting to P40,058.55 by the Estate of the
late Walter Scott Price. The petition for execution filed by the fiscal, however, was
denied by the lower court. The Court heldthat the execution is unjustified as the
Government itself is indebted to the Estate for 262,200;
and ordered the amount of inheritance taxes be deducted from the Government’s
indebtedness to
the Estate.
Issue:
Whether a tax and a debt may be compensated.
Held
: The court having jurisdiction of the Estate had found that the claim of the Estate
againstthe Government has been recognized and an amount of P262,200 has already
been appropriated by a corresponding law (RA 2700). Under the circumstances, both
the claim of the Governmentfor inheritance taxes and the claim of the intestate for
services rendered have already becomeoverdue and demandable as well as fully
liquidated. Compensation, therefore, takes place byoperation of law, in accordance with
Article 1279 and 1290 of the Civil Code, and both debts areextinguished to the
concurrent amount.
The petition was denied as the execution is not justifiable as the government is indebted
to the estate under administration in the amount of P 262,200. Hence, the present
petition for certiorari and mandamus.

ISSUE:
Is execution proper?

RULING:
No. The tax and the debt are compensated. The court having jurisdiction of the estate
had found that the claim of the estate against the government has been recognized and
an amount of P262,200 has already been appropriated by a corresponding law (RA
2700). Under the circumstances, both the claim of the Government for the inheritance
taxes and the claim of the intestate for services rendered have already become overdue
and demandable as well as fully liquidated.

Compensation, therefore, takes place by operation of law, in accordance with Article

1279 and 1290 of the Civil Code, and both debts are extinguished to their concurrent
amounts. If the obligation to pay taxes and the taxpayer’s claim against the government
are both overdue, demandable, as well as fully liquidated, compensation takes place by
operation of law and both obligations are extinguished to their concurrent amounts.

Francia v Intermediate Appellate Court (1988)

Francia v Intermediate Appellate Court GR No L-67649, June 28, 1988

FACTS:
Engracio Francia was the registered owner of a house and lot located in Pasay City. A
portion of such property was
expropriated by the Republic of the Philippines in 1977. It appeared that Francia did not
pay his real estate taxes from 1963 to 1977. Thus, his property was sold in a public
auction by the City Treasurer of Pasay City. Francia filed a complaint to annual the
auction sale. The lower court dismissed the complaint and the Intermediate Appellate
Court affirmed the decision of the lower court in toto. Hence, this petition for review.
Francia contends that his tax delinquency of P 2,400 has been extinguished by legal
compensation. He claims that the government owed him P 4,116 when a portion of his
land was expropriated on October 15, 1977.

ISSUE:
May the expropriation payment compensate for the real estate taxes due?

RULING:
No. There can be no offsetting of taxes against the claims that the taxpayer may have
against the government. A person
cannot refuse to pay a tax on the ground that the government owes him an amount
equal to or greater than the tax being collected. The collection of a tax cannot await the
results of a lawsuit against the government. Internal revenue taxes cannot be the
subject of compensation. The Government and the taxpayer are not mutually creditors
and debtors of each other under Article 1278 of the Civil Code and a claim of taxes is
not such a debt, demand, contract or judgment as is allowed to be set-off.

Moreover, the amount of P4,116 paid by the national government for the 125 square
meter portion of his lot was deposited with the Philippine National Bank long before the
sale at public auction of his remaining property. It would have been an easy matter to
withdraw P 2,400 from the deposit so that he could pay the tax obligation thus aborting
the sale at public auction. Thus, the petition for review is dismissed. The taxes
assessed are the obligations of the taxpayer arising from law, while the money
judgment against the government is an obligation arising from contract, whether
express or implied.

Engracio Francia was the owner of a 328 square meter land in Pasay City. In October
1977, a portion of his land (125 square meter) was expropriated by the government for
P4,116.00. The expropriation was made to give way to the expansion of a nearby road.
It also appears that Francia failed to pay his real estate taxes since 1963 amounting to
P2,400.00. So in December 1977, the remaining 203 square meters of his land was
sold at a public auction (after due notice was given him). The highest bidder was a
certain Ho Fernandez who paid the purchase price of P2,400.00 (which was lesser than
the price of the portion of his land that was expropriated).
Later, Francia filed a complaint to annul the auction sale on the ground that the selling
price was grossly inadequate. He further argued that his land should have never been
auctioned because the P2,400.00 he owed the government in taxes should have been
set-off by the debt the government owed him (legal compensation). He alleged that he
was not paid by the government for the expropriated portion of his land because though
he knew that the payment therefor was deposited in the Philippine National Bank, he
never withdrew it.
ISSUE: Whether or not the tax owed by Francia should be set-off by the “debt” owed
him by the government.
HELD: No. As a rule, set-off of taxes is not allowed. There is no legal basis for the
contention. By legal compensation, obligations of persons, who in their own right are
reciprocally debtors and creditors of each other, are extinguished (Art. 1278, Civil
Code). This is not applicable in taxes. There can be no off-setting of taxes against the
claims that the taxpayer may have against the government. A person cannot refuse to
pay a tax on the ground that the government owes him an amount equal to or greater
than the tax being collected. The collection of a tax cannot await the results of a lawsuit
against the government.
The Supreme Court emphasized: A claim for taxes is not such a debt, demand, contract
or judgment as is allowed to be set-off under the statutes of set-off, which are construed
uniformly, in the light of public policy, to exclude the remedy in an action or any
indebtedness of the state or municipality to one who is liable to the state or municipality
for taxes. Neither are they a proper subject of recoupment since they do not arise out of
the contract or transaction sued on.
Further, the government already Francia. All he has to do was to withdraw the money.
Had he done that, he could have paid his tax obligations even before the auction sale or
could have exercised his right to redeem – which he did not do.
Anent the issue that the selling price of P2,400.00 was grossly inadequate, the same is
not tenable. The Supreme Court said: “alleged gross inadequacy of price is not material
when the law gives the owner the right to redeem as when a sale is made at public
auction, upon the theory that the lesser the price, the easier it is for the owner to effect
redemption.” If mere inadequacy of price is held to be a valid objection to a sale for
taxes, the collection of taxes in this manner would be greatly embarrassed, if not
rendered altogether impracticable. “Where land is sold for taxes, the inadequacy of the
price given is not a valid objection to the sale.” This rule arises from necessity, for, if a
fair price for the land were essential to the sale, it would be useless to offer the property.
Indeed, it is notorious that the prices habitually paid by purchasers at tax sales are
grossly out of proportion to the value of the land.
PHILEX MINING CORP. v. CIR
GR No. 125704, August 28, 1998
294 SCRA 687

FACTS: Petitioner Philex Mining Corp. assails the decision of the Court of Appeals
affirming the Court of Tax Appeals decision ordering it to pay the amount of P110.7 M
as excise tax liability for the period from the 2nd quarter of 1991 to the 2nd quarter of
1992 plus 20% annual interest from 1994 until fully paid pursuant to Sections 248 and
249 of the Tax Code of 1977. Philex protested the demand for payment of the tax
liabilities stating that it has pending claims for VAT input credit/refund for the taxes it
paid for the years 1989 to 1991 in the amount of P120 M plus interest. Therefore these
claims for tax credit/refund should be applied against the tax liabilities.

ISSUE: Can there be an off-setting between the tax liabilities vis-a-vis claims of tax
refund of the petitioner?

HELD: No. Philex's claim is an outright disregard of the basic principle in tax law that
taxes are the lifeblood of the government and so should be collected without
unnecessary hindrance. Evidently, to countenance Philex's whimsical reason would
render ineffective our tax collection system. Too simplistic, it finds no support in law or
in jurisprudence.
To be sure, Philex cannot be allowed to refuse the payment of its tax liabilities on the
ground that it has a pending tax claim for refund or credit against the government which
has not yet been granted.Taxes cannot be subject to compensation for the simple
reason that the government and the taxpayer are not creditors and debtors of each
other. There is a material distinction between a tax and debt. Debts are due to the
Government in its corporate capacity, while taxes are due to the Government in its
sovereign capacity. xxx There can be no off-setting of taxes against the claims that the
taxpayer may have against the government. A person cannot refuse to pay a tax on the
ground that the government owes him an amount equal to or greater than the tax being
collected. The collection of a tax cannot await the results of a lawsuit against the
government.

ABS-CBN v. CTA

FACTS:
ABS-CBN is engaged in the business of telecasting local as well as foreign films
acquired from foreign corporations not engaged in trade or business within the
Philippines. The applicable law wrt the income tax of non-resident corporations is
section 24 (b) of the National Internal Revenue Code, as amended by Republic Act No.
2343 dated June 20, 19598.
On April 12, 1961, in implementation of said provision, the CIR issued General Circular
No. V-3349.Pursuant to the foregoing, ABS-CBN dutifully withheld and turned over to
the BIR the amount of 30% of one-half of the film rentals paid by it to foreign
corporations not engaged in trade or business within the Philippines. The last year that
ABS-CBN withheld taxes pursuant to the foregoing Circular was in 1968.
On June 27, 1968, RA 5431 amended Section 24 (b) 10 of the Tax Code increasing the
tax rate from 30 % to 35 % and revising the tax basis from "such amount" referring to
rents, etc. to "gross income."
On February 8, 1971, the CIR issued Revenue Memorandum Circular No. 4-71,
revoking General Circular No. V-334, and holding that the latter was "erroneous for lack
of legal basis," because "the tax therein prescribed should be based on gross income
without deduction whatever.
On the basis of this new Circular, CIR issued against ABS- CBN a letter of assessment
and demand requiring them to pay deficiency withholding income tax on the remitted
film rentals for the years 1965 through 1968 and film royalty as of the end of 1968 in the
total amount of P525,897.06.

ISSUE:
Whether or not respondent can apply General Circular No. 4-71 retroactively and issue
a deficiency assessment against petitioner in the amount of P 525,897.06 as deficiency
withholding income tax for the years 1965, 1966, 1967 and 1968.
DECISION:
No. Sec. 338-A11 (now Sec. 327) of the Tax Code applies in this case. Rulings or
circulars promulgated by the CIR have no retroactive application where to so apply
them would be prejudicial to taxpayers. The retroactive application of Memorandum
Circular No. 4-71 prejudices ABS-CBN since:
a) it was issued only in 1971, or 3 years after 1968, the last year that petitioner had
withheld taxes under General Circular No. V-334.
b) the assessment and demand on petitioner to pay deficiency withholding income tax
was also made three years after 1968 for a period of time commencing in 1965.
c) ABS-CBN was no longer in a position to withhold taxes due from foreign corporations
because it had already remitted all film rentals and no longer had any control over them
when the new Circular was issued.
And in so far as the enumerated exceptions (to non- retroactivity) are concerned, ABS-
CBN does not fall under any of them.

FACTS:

The ABS-CBN Broadcasting Corporation (herein shall be called the “Company”) was
engaged in the business of telecasting local as well as foreign films acquired from
foreign corporations not engaged in trade or business with the Philippines. Under
Section 24 (b) of the National Revenue Code, a withholding tax of 30% (RA 2343). It
was implemented through Circular No. V-334. Pursuant to the foregoing, ABS-CBN
dutifully withheld and turned over to the BIR the amount of 30% of one-half of the film
rentals paid by it to foreign corporations not engaged in trade or business within the
Philippines. The last year that ABS-CBN withheld taxes pursuant to the foregoing
Circular was in 1968.

RA 5431 amended Section 24 (b) of the Tax Code increasing the tax rate from 30 % to
35 % and revising the tax basis from “such amount” referring to rents, etc. to “gross
income.” The following was implemented by Circular No. 4-71.

Petitioner requested for a reconsideration and withdrawal of the assessment.

ISSUE/S:

Whether or not respondent can apply General Circular No. 4-71 retroactively and issue
a deficiency assessment against petitioner.

HELD/DECISION:
Any rulings or circulars promulgated by the CIR have no retroactive application when it
would be prejudicial to taxpayers. The retroactive application of Memorandum Circular
No. 4-71 prejudices ABS-CBN since:

1. The assessment and demand on petitioner to pay deficiency withholding income tax
was also made three years after 1968 for a period of time commencing in 1965.

2. ABS-CBN was no longer in a position to withhold taxes due from foreign corporations
because it had already remitted all film rentals and no longer had any control over them
when the new Circular was issued.