COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.

THE COURT OF
APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP., respondents.
G.R. No. 108576 January 20, 1999

MARTINEZ, J.:
Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of
the Court of Appeals (CA) which affirmed the ruling of the Court of Tax Appeals (CTA) that
private respondent A. Soriano Corporation's (hereinafter ANSCOR) redemption and
exchange of the stocks of its foreign stockholders cannot be considered as "essentially
equivalent to a distribution of taxable dividends" under, Section 83(b) of the 1939 Internal
Revenue Act. – (Contention of CIR)

The undisputed facts are as follows:

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States,
(NON RESIDENT ALIEN) formed the corporation "A. Soriano Y Cia", predecessor of
ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a
par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don
Andres, who are all non-resident aliens. In 1937, Don Andres subscribed to 4,963 shares
of the 5,000 shares originally issued.

On September 12, 1945, ANSCOR's authorized capital stock was increased to

P2,500,000.00 divided into 25,000 common shares with the same par value. Of the
additional 15,000 shares, only 10,000 was issued which were all subscribed by Don
Andres, after the other stockholders waived in favor of the former their pre-emptive rights
to subscribe to the new issues. This increased his subscription to 14,963 common shares.
A month later, Don Andres transferred 1,250 shares each to his two sons, Jose and
Andres, Jr., as their initial investments in ANSCOR. Both sons are foreigners. (14,963-
2500=12,463)

By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were
made between 1949 and December 20, 1963. On December 30, 1964 Don Andres died.
As of that date, the records revealed that he has total shareholdings of 185,154 shares —
50,495 of which are original issues and the balance of 134.659 shares as stock dividend
declarations. Correspondingly, one-half of that shareholdings or 92,577 shares were
transferred to his wife, Doña Carmen Soriano, as her conjugal share. The other half
formed part of his estate.

A day after Don Andres died, ANSCOR increased its capital stock to P20M and in 1966
further increased it to P30M. In the same year (December 1966), stock dividends worth
46,290 and 46,287 shares were respectively received by the Don Andres estate and
Doña Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to
138,867 and 138,864 common shares each.

On December 28, 1967, Doña Carmen requested a ruling from the United States Internal
Revenue Service (IRS), inquiring if an exchange of common with preferred shares may
be considered as a tax avoidance scheme under Section 367 of the 1954 U.S. Revenue
Act. By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into
150,000 common and 150,000 preferred shares.

In a letter-reply dated February 1968, the IRS opined that the exchange is only a
recapitalization scheme and not tax avoidance. Consequently, on March 31, 1968 Doña
Carmen exchanged her whole 138,864 common shares for 138,860 of the newly
reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its
common shares, for the remaining 11,140 preferred shares, thus reducing its (the estate)
common shares to 127,727.
On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common
shares from the Don Andres' estate. By November 1968, the Board further increased
ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000
common shares About a year later, ANSCOR again redeemed 80,000 common shares
from the Don Andres' estate, further reducing the latter's common shareholdings to
19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both
redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce
the company's foreign exchange remittances in case cash dividends are declared.

In 1973, after examining ANSCOR's books of account and records, Revenue examiners
issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-
source, pursuant to Sections 53 and 54 of the 1939 Revenue Code, for the year 1968
and the second quarter of 1969 based on the transactions of exchange 31 and
redemption of stocks. The Bureau of Internal Revenue (BIR) made the corresponding
assessments despite the claim of ANSCOR that it availed of the tax amnesty under
Presidential Decree (P.D.) 23 which were amended by P.D.'s 67 and 157. However,
petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in relation to
Article 83(b) of the 1939 Revenue Act under which ANSCOR was assessed. ANSCOR's
subsequent protest on the assessments was denied in 1983 by petitioner.

Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax
assessments on the redemptions and exchange of stocks. In its decision, the Tax Court
reversed petitioner's ruling, after finding sufficient evidence to overcome the prima
facie correctness of the questioned assessments. In a petition for review the CA as
mentioned, affirmed the ruling of the CTA. Hence, this petition.

The bone of contention is the interpretation and application of Section 83(b) of the 1939
Revenue Act which provides:

Sec. 83. Distribution of dividends or assets by corporations. —

(b) Stock dividends — A stock dividend representing the transfer of surplus to
capital account shall not be subject to tax. However, if a corporation cancels or
redeems stock issued as a dividend at such time and in such manner as to make
the distribution and cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount so distributed in
redemption or cancellation of the stock shall be considered as taxable income to
the extent it represents a distribution of earnings or profits accumulated after March
first, nineteen hundred and thirteen. (Emphasis supplied)

Specifically, the issue is whether ANSCOR's redemption of stocks from its

stockholder as well as the exchange of common with preferred shares can be
considered as "essentially equivalent to the distribution of taxable dividend"
making the proceeds thereof taxable under the provisions of the above-quoted law.

Petitioner contends that the exchange transaction a tantamount to "cancellation" under

Section 83(b) making the proceeds thereof taxable. It also argues that the Section applies
to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner
claims that under the "net effect test," the estate of Don Andres gained from the
redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising
from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act.

ANSCOR, however, avers that it has no duty to withhold any tax either from the Don
Andres estate or from Doña Carmen based on the two transactions, because the same
were done for legitimate business purposes which are (a) to reduce its foreign exchange
remittances in the event the company would declare cash dividends, and to (b)
subsequently "filipinized" ownership of ANSCOR, as allegedly, envisioned by Don
Andres. It likewise invoked the amnesty provisions of P.D. 67.
We must emphasize that the application of Sec. 83(b) depends on the special factual
circumstances of each case. The findings of facts of a special court (CTA) exercising
particular expertise on the subject of tax, generally binds this Court, considering that it is
substantially similar to the findings of the CA which is the final arbiter of questions of facts.
The issue in this case does not only deal with facts but whether the law applies to a
particular set of facts. Moreover, this Court is not necessarily bound by the lower courts'
conclusions of law drawn from such facts.

AMNESTY:
We will deal first with the issue of tax amnesty. Section 1 of P.D. 67 provides:

1. In all cases of voluntary disclosures of previously untaxed income and/or

wealth such as earnings, receipts, gifts, bequests or any other acquisitions from
any source whatsoever which are taxable under the National Internal Revenue
Code, as amended, realized here or abroad by any taxpayer, natural or judicial;
the collection of all internal revenue taxes including the increments or penalties or
account of non-payment as well as all civil, criminal or administrative liabilities
arising from or incident to such disclosures under the National Internal Revenue
Code, the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the
Revised Administrative Code, the Civil Service laws and regulations, laws and
regulations on Immigration and Deportation, or any other applicable law or
proclamation, are hereby condoned and, in lieu thereof, a tax of ten (10%) per
centum on such previously untaxed income or wealth, is hereby imposed, subject
to the following conditions: (conditions omitted) [Emphasis supplied].

The decree condones "the collection of all internal revenue taxes including the
increments or penalties or account of non-payment as well as all civil, criminal or
administrative liable arising from or incident to" (voluntary) disclosures under the
NIRC of previously untaxed income and/or wealth "realized here or abroad by any
taxpayer, natural or juridical."

May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the
amnesty? An income taxpayer covers all persons who derive taxable income. ANSCOR
was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the
1939 Code. As such, it is being held liable in its capacity as a withholding agent and not
its personality as a taxpayer.

In the operation of the withholding tax system, the withholding agent is the payor, a
separate entity acting no more than an agent of the government for the collection of the
tax in order to ensure its payments; the payer is the taxpayer — he is the person subject
to tax impose by law; and the payee is the taxing authority. In other words, the withholding
agent is merely a tax collector, not a taxpayer. Under the withholding system, however,
the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and
independent from the taxpayer, because the income tax is still impose on and due from
the latter. The agent is not liable for the tax as no wealth flowed into him — he earned no
income. The Tax Code only makes the agent personally liable for the tax arising from the
breach of its legal duty to withhold as distinguish from its duty to pay tax since:

the government's cause of action against the withholding is not for the collection
of income tax, but for the enforcement of the withholding provision of Section 53
of the Tax Code, compliance with which is imposed on the withholding agent and
not upon the taxpayer.

Not being a taxpayer, a withholding agent, like ANSCOR in this transaction is not
protected by the amnesty under the decree.
Codal provisions on withholding tax are mandatory and must be complied with by the
withholding agent. The taxpayer should not answer for the non-performance by the
withholding agent of its legal duty to withhold unless there is collusion or bad faith. The
former could not be deemed to have evaded the tax had the withholding agent performed
its duty. This could be the situation for which the amnesty decree was intended. Thus, to
curtail tax evasion and give tax evaders a chance to reform, it was deemed
administratively feasible to grant tax amnesty in certain instances. In addition, a "tax
amnesty, much like a tax exemption, is never favored nor presumed in law and if granted
by a statute, the term of the amnesty like that of a tax exemption must be construed strictly
against the taxpayer and liberally in favor of the taxing authority. The rule on strictissimi
juris equally applies. So that, any doubt in the application of an amnesty law/decree
should be resolved in favor of the taxing authority.

Furthermore, ANSCOR's claim of amnesty cannot prosper. The implementing

rules of P.D. 370 which expanded amnesty on previously untaxed income under
P.D. 23 is very explicit, to wit:

Sec. 4. Cases not covered by amnesty. — The following cases are not covered by
the amnesty subject of these regulations:
xxx xxx xxx

(2) Tax liabilities with or without assessments, on withholding tax at source provided
under Section 53 and 54 of the National Internal Revenue Code, as amended;

ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by
specific provision of law, it is not covered by the amnesty.

TAX ON STOCK DIVIDENDS

General Rule

Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of the U.S.
Revenue Code of 1928. It laid down the general rule known as the proportionate
test wherein stock dividends once issued form part of the capital and, thus, subject
to income tax. Specifically, the general rule states that:

A stock dividend representing the transfer of surplus to capital account shall not
be subject to tax.

Having been derived from a foreign law, resort to the jurisprudence of its origin may shed
light. Under the US Revenue Code, this provision originally referred to "stock dividends"
only, without any exception. Stock dividends, strictly speaking, represent capital and do
not constitute income to its recipient. So that the mere issuance thereof is not yet subject
to income tax as they are nothing but an "enrichment through increase in value of capital
investment." As capital, the stock dividends postpone the realization of profits because
the "fund represented by the new stock has been transferred from surplus to capital and
no longer available for actual distribution." Income in tax law is "an amount of money
coming to a person within a specified time, whether as payment for services, interest, or
profit from investment." It means cash or its equivalent. It is gain derived and severed
from capital, from labor or from both combined — so that to tax a stock dividend would
be to tax a capital increase rather than the income. In a loose sense, stock dividends
issued by the corporation, are considered unrealized gain, and cannot be subjected to
income tax until that gain has been realized. Before the realization, stock dividends are
nothing but a representation of an interest in the corporate properties. As capital, it is not
yet subject to income tax. It should be noted that capital and income are different. Capital
is wealth or fund; whereas income is profit or gain or the flow of wealth. The determining
factor for the imposition of income tax is whether any gain or profit was derived from a
transaction.
 The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such

time and in such manner as to make the distribution and cancellation or
redemption, in whole or in part, essentially equivalent to the distribution of
a taxable dividend, the amount so distributed in redemption or cancellation of the
stock shall be considered as taxable income to the extent it represents a
distribution of earnings or profits accumulated after March first, nineteen hundred
and thirteen. (Emphasis supplied).

In a response to the ruling of the American Supreme Court in the case of Eisner v.
Macomber (that pro rata stock dividends are not taxable income), the exempting clause
above quoted was added because provision corporation found a loophole in the original
provision. They resorted to devious means to circumvent the law and evade the tax.
Corporate earnings would be distributed under the guise of its initial capitalization by
declaring the stock dividends previously issued and later redeem said dividends by paying
cash to the stockholder. This process of issuance-redemption amounts to a distribution
of taxable cash dividends which was lust delayed so as to escape the tax. It becomes a
convenient technical strategy to avoid the effects of taxation.

Thus, to plug the loophole — the exempting clause was added. It provides that the
redemption or cancellation of stock dividends, depending on the "time" and "manner" it
was made, is essentially equivalent to a distribution of taxable dividends," making the
proceeds thereof "taxable income" "to the extent it represents profits". The exception was
designed to prevent the issuance and cancellation or redemption of stock dividends,
which is fundamentally not taxable, from being made use of as a device for the actual
distribution of cash dividends, which is taxable. 76 Thus,

the provision had the obvious purpose of preventing a corporation from avoiding
dividend tax treatment by distributing earnings to its shareholders in two
transactions — a pro rata stock dividend followed by a pro rata redemption — that
would have the same economic consequences as a simple dividend.

Although redemption and cancellation are generally considered capital

transactions, as such. they are not subject to tax. However, it does not necessarily
mean that a shareholder may not realize a taxable gain from such
transactions. Simply put, depending on the circumstances, the proceeds of
redemption of stock dividends are essentially distribution of cash dividends, which
when paid becomes the absolute property of the stockholder. Thereafter, the latter
becomes the exclusive owner thereof and can exercise the freedom of
choice. Having realized gain from that redemption, the income earner cannot
escape income tax.

As qualified by the phrase "such time and in such manner," the exception was not
intended to characterize as taxable dividend every distribution of earnings arising from
the redemption of stock dividend. So that, whether the amount distributed in the
redemption should be treated as the equivalent of a "taxable dividend" is a question of
fact, which is determinable on "the basis of the particular facts of the transaction in
question. No decisive test can be used to determine the application of the exemption
under Section 83(b). The use of the words "such manner" and "essentially equivalent"
negative any idea that a weighted formula can resolve a crucial issue — Should the
distribution be treated as taxable dividend. On this aspect, American courts developed
certain recognized criteria, which includes the following:

1) the presence or absence of real business purpose,

 2) the amount of earnings and profits available for the declaration of a regular
dividends and the corporation's past record with respect to the declaration of
dividends,
3) the effect of the distribution, as compared with the declaration of regular
dividend,
4) the lapse of time between issuance and redemption,
5) the presence of a substantial surplus and a generous supply of cash which
invites suspicion as does a meager policy in relation both to current earnings and
accumulated surplus,

REDEMPTION AND CANCELLATION

For the exempting clause of Section, 83(b) to apply, it is indispensable that: (a) there is
redemption or cancellation; (b) the transaction involves stock dividends and (c) the "time
and manner" of the transaction makes it "essentially equivalent to a distribution of taxable
dividends." Of these, the most important is the third.

Redemption is repurchase, a reacquisition of stock by a corporation which issued the

stock in exchange for property, whether or not the acquired stock is cancelled, retired or
held in the treasury. Essentially, the corporation gets back some of its stock, distributes
cash or property to the shareholder in payment for the stock, and continues in business
as before. The redemption of stock dividends previously issued is used as a veil for the
constructive distribution of cash dividends. In the instant case, there is no dispute that
ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and
80,000 common shares). But where did the shares redeemed come from? If its source is
the original capital subscriptions upon establishment of the corporation or from initial
capital investment in an existing enterprise, its redemption to the concurrent value of
acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is
not income but a mere return of capital. On the contrary, if the redeemed shares are from
stock dividend declarations other than as initial capital investment, the proceeds of the
redemption is additional wealth, for it is not merely a return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as
taxable dividends. Here, it is undisputed that at the time of the last redemption, the original
common shares owned by the estate were only 25,247.5 This means that from the total
of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less
25,247.5) must have come from stock dividends. Besides, 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. 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.

With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3
years earlier. The time alone that lapsed from the issuance to the redemption is not a
sufficient indicator to determine taxability. It is a must to consider the factual
circumstances as to the manner of both the issuance and the redemption. The "time"
element is a factor to show a device to evade tax and the scheme of cancelling or
redeeming the same shares is a method usually adopted to accomplish the end
sought. Was this transaction used as a "continuing plan," "device" or "artifice" to evade
payment of tax? It is necessary to determine the "net effect" of the transaction between
the shareholder-income taxpayer and the acquiring (redeeming) corporation. The "net
effect" test is not evidence or testimony to be considered; it is rather an inference to be
drawn or a conclusion to be reached. It is also important to know whether the issuance of
stock dividends was dictated by legitimate business reasons, the presence of which might
negate a tax evasion plan.

The issuance of stock dividends and its subsequent redemption must be separate,
distinct, and not related, for the redemption to be considered a legitimate tax scheme.
Redemption cannot be used as a cloak to distribute corporate earnings. Otherwise, the
apparent intention to avoid tax becomes doubtful as the intention to evade becomes
manifest. It has been ruled that:

[A]n operation with no business or corporate purpose — is a mere devise which

put on the form of a corporate reorganization as a disguise for concealing its real
character, and the sole object and accomplishment of which was the
consummation of a preconceived plan, not to reorganize a business or any part of
a business, but to transfer a parcel of corporate shares to a stockholder.

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may
not be applicable if the redeemed shares were issued with bona fide business
purpose, which is judged after each and every step of the transaction have been
considered and the whole transaction does not amount to a tax evasion scheme.

ANSCOR invoked two reasons to justify the redemptions — (1) the alleged "filipinization"
program and (2) the reduction of foreign exchange remittances in case cash dividends
are declared. The Court is not concerned with the wisdom of these purposes but on their
relevance to the whole transaction which can be inferred from the outcome thereof. Again,
it is the "net effect rather than the motives and plans of the taxpayer or his corporation"
that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at
the result. It also applies even if at the time of the issuance of the stock dividend, there
was no intention to redeem it as a means of distributing profit or avoiding tax on
dividends. The existence of legitimate business purposes in support of the redemption of
stock dividends is immaterial in income taxation. It has no relevance in determining
"dividend equivalence". Such purposes may be material only upon the issuance of the
stock dividends. The test of taxability under the exempting clause, when it provides "such
time and manner" as would make the redemption "essentially equivalent to the distribution
of a taxable dividend", is whether the redemption resulted into a flow of wealth. If no
wealth is realized from the redemption, there may not be a dividend equivalence
treatment. In the metaphor of Eisner v. Macomber, income is not deemed "realize" until
the fruit has fallen or been plucked from the tree.

The three elements in the imposition of income tax are: (1) there must be gain or and
profit, (2) that the gain or profit is realized or received, actually or constructively, 108 and
(3) it is not exempted by law or treaty from income tax. Any business purpose as to why
or how the income was earned by the taxpayer is not a requirement. Income tax is
assessed on income received from any property, activity or service that produces the
income because the Tax Code stands as an indifferent neutral party on the matter of
where income comes from.

As stated above, the test of taxability under the exempting clause of Section 83(b) is,
whether income was realized through the redemption of stock dividends. The redemption
converts into money the stock dividends which become a realized profit or gain and
consequently, the stockholder's separate property. Profits derived from the capital
invested cannot escape income tax. As realized income, the proceeds of the redeemed
stock dividends can be reached by income taxation regardless of the existence of any
business purpose for the redemption. Otherwise, to rule that the said proceeds are
exempt from income tax when the redemption is supported by legitimate business
reasons would defeat the very purpose of imposing tax on income. Such argument would
open the door for income earners not to pay tax so long as the person from whom the
income was derived has legitimate business reasons. In other words, the payment of tax
under the exempting clause of Section 83(b) would be made to depend not on the income
of the taxpayer, but on the business purposes of a third party (the corporation herein)
from whom the income was earned. This is absurd, illogical and impractical considering
that the Bureau of Internal Revenue (BIR) would be pestered with instances in
determining the legitimacy of business reasons that every income earner may interposed.
It is not administratively feasible and cannot therefore be allowed.

The ruling in the American cases cited and relied upon by ANSCOR that "the redeemed
shares are the equivalent of dividend only if the shares were not issued for genuine
business purposes", or the "redeemed shares have been issued by a corporation bona
fide" bears no relevance in determining the non-taxability of the proceeds of redemption
ANSCOR, relying heavily and applying said cases, argued that so long as the redemption
is supported by valid corporate purposes the proceeds are not subject to tax. The
adoption by the courts below of such argument is misleading if not misplaced. A review
of the cited American cases shows that the presence or absence of "genuine business
purposes" may be material with respect to the issuance or declaration of stock dividends
but not on its subsequent redemption. The issuance and the redemption of stocks are two
different transactions. Although the existence of legitimate corporate purposes may justify
a corporation's acquisition of its own shares under Section 41 of the Corporation
Code, such purposes cannot excuse the stockholder from the effects of taxation arising
from the redemption. If the issuance of stock dividends is part of a tax evasion plan and
thus, without legitimate business reasons, the redemption becomes suspicious which
exempting clause. The substance of the whole transaction, not its form, usually controls
the tax consequences.

The two purposes invoked by ANSCOR, under the facts of this case are no excuse for its
tax liability. First, the alleged "filipinization" plan cannot be considered legitimate as it was
not implemented until the BIR started making assessments on the proceeds of the
redemption. Such corporate plan was not stated in nor supported by any Board
Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a
separate entity, the corporation can act only through its Board of Directors. The Board
Resolutions authorizing the redemptions state only one purpose — reduction of foreign
exchange remittances in case cash dividends are declared. Not even this purpose can
be given credence. Records show that despite the existence of enormous corporate
profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started
making assessments in the early 1970's. Although a corporation under certain
exceptions, has the prerogative when to issue dividends, yet when no cash dividends was
issued for about three decades, this circumstance negates the legitimacy of ANSCOR's
alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of
ANSCOR's foreign stockholders contrary to its "filipinization" plan. This would also
increase rather than reduce their need for foreign exchange remittances in case of cash
dividend declaration, considering that ANSCOR is a family corporation where the majority
shares at the time of redemptions were held by Don Andres' foreign heirs.

Secondly, assuming arguendo, that those business purposes are legitimate, the same
cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayer's liability to
pay income tax would be made to depend upon a third person who did not earn the
income being taxed. Furthermore, even if the said purposes support the redemption and
justify the issuance of stock dividends, the same has no bearing whatsoever on the
imposition of the tax herein assessed because the proceeds of the redemption are
deemed taxable dividends since it was shown that income was generated therefrom.

Thirdly, ANSCOR argued that to treat as "taxable dividend" the proceeds of the redeemed
stock dividends would be to impose on such stock an undisclosed lien and would be
extremely unfair to intervening purchase, i.e. those who buys the stock dividends after
their issuance. Such argument, however, bears no relevance in this case as no
intervening buyer is involved. And even if there is an intervening buyer, it is necessary to
look into the factual milieu of the case if income was realized from the transaction. Again,
we reiterate that the dividend equivalence test depends on such "time and manner" of the
transaction and its net effect. The undisclosed lien may be unfair to a subsequent stock
buyer who has no capital interest in the company. But the unfairness may not be true to
an original subscriber like Don Andres, who holds stock dividends as gains from his
investments. The subsequent buyer who buys stock dividends is investing capital. It just
so happen that what he bought is stock dividends. The effect of its (stock dividends)
redemption from that subsequent buyer is merely to return his capital subscription, which
is income if redeemed from the original subscriber.

After considering the manner and the circumstances by which the issuance and
redemption of stock dividends were made, there is no other conclusion but that the
proceeds thereof are essentially considered equivalent to a distribution of taxable
dividends. As "taxable dividend" under Section 83(b), it is part of the "entire income"
subject to tax under Section 22 in relation to Section 21 of the 1939 Code. Moreover,
under Section 29(a) of said Code, dividends are included in "gross income". As income,
it is subject to income tax which is required to be withheld at source. The 1997 Tax Code
may have altered the situation but it does not change this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES

Exchange is an act of taking or giving one thing for another involving reciprocal
transfer and is generally considered as a taxable transaction. The exchange of common
stocks with preferred stocks, or preferred for common or a combination of either for both,
may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is
not applicable. This is true in a trade between two (2) persons as well as a trade between
a stockholder and a corporation. In general, this trade must be parts of merger, transfer
to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable
gain or loss may be recognized on exchange of property, stock or securities related to
reorganizations.

Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares
into common and preferred, and that parts of the common shares of the Don Andres
estate and all of Doña Carmen's shares were exchanged for the whole 150.000 preferred
shares. Thereafter, both the Don Andres estate and Doña Carmen remained as corporate
subscribers except that their subscriptions now include preferred shares. There was no
change in their proportional interest after the exchange. There was no cash flow. Both
stocks had the same par value. Under the facts herein, any difference in their market
value would be immaterial at the time of exchange because no income is yet realized —
it was a mere corporate paper transaction. It would have been different, if the exchange
transaction resulted into a flow of wealth, in which case income tax may be imposed.

Reclassification of shares does not always bring any substantial alteration in the
subscriber's proportional interest. But the exchange is different — there would be a
shifting of the balance of stock features, like priority in dividend declarations or absence
of voting rights. Yet neither the reclassification nor exchange per se, yields realize income
for tax purposes. A common stock represents the residual ownership interest in the
corporation. It is a basic class of stock ordinarily and usually issued without extraordinary
rights or privileges and entitles the shareholder to a pro rata division of profits. Preferred
stocks are those which entitle the shareholder to some priority on dividends and asset
distribution.

Both shares are part of the corporation's capital stock. Both stockholders are no different
from ordinary investors who take on the same investment risks. Preferred and common
shareholders participate in the same venture, willing to share in the profits and losses of
the enterprise. Moreover, under the doctrine of equality of shares — all stocks issued by
the corporation are presumed equal with the same privileges and liabilities, provided that
the Articles of Incorporation is silent on such differences.
In this case, the exchange of shares, without more, produces no realized income to the
subscriber. There is only a modification of the subscriber's rights and privileges — which
is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once
a subscriber disposes of his entire interest and not when there is still maintenance of
proprietary interest.

WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED

in that ANSCOR's redemption of 82,752.5 stock dividends is herein considered as
essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the
withholding tax-at-source. The decision is AFFIRMED in all other respects.

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

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.

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

 G.R. No. 109289 October 3, 1994
RUFINO R. TAN, petitioner,
vs.
RAMON R. DEL ROSARIO, JR., as SECRETARY OF FINANCE & JOSE U. ONG, as
COMMISSIONER OF INTERNAL REVENUE, respondents.
G.R. No. 109446 October 3, 1994
CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES, CARLO A. CARAG,
MANUELITO O. CABALLES, ELPIDIO C. JAMORA, JR. and BENJAMIN A.
SOMERA, JR., petitioners,
vs.
RAMON R. DEL ROSARIO, in his capacity as SECRETARY OF FINANCE and JOSE
U. ONG, in his capacity as COMMISSIONER OF INTERNAL
REVENUE, respondents.

VITUG, J.:
These two consolidated special civil actions for prohibition challenge, in G.R. No. 109289,
the constitutionality of Republic Act No. 7496, also commonly known as the Simplified
Net Income Taxation Scheme ("SNIT"), amending certain provisions of the National
Internal Revenue Code and, in G.R. No. 109446, the validity of Section 6, Revenue
Regulations No. 2-93, promulgated by public respondents pursuant to said law.

Petitioners claim to be taxpayers adversely affected by the continued implementation of

the amendatory legislation.

In G.R. No. 109289, it is asserted that the enactment of Republic Act

No. 7496 violates the following provisions of the Constitution:

Article VI, Section 26(1) — Every bill passed by the Congress shall embrace only
one subject which shall be expressed in the title thereof.

Article VI, Section 28(1) — The rule of taxation shall be uniform and equitable. The
Congress shall evolve a progressive system of taxation.

Article III, Section 1 — No person shall be deprived of . . . property without due

process of law, nor shall any person be denied the equal protection of the laws.

In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No. 2-93,
argue that public respondents have exceeded their rule-making authority in applying SNIT
to general professional partnerships.

The Solicitor General espouses the position taken by public respondents.

The Court has given due course to both petitions. The parties, in compliance with the
Court's directive, have filed their respective memoranda.

G.R. No. 109289

Petitioner contends that the title of House Bill No. 34314, progenitor of Republic Act No.
7496, is a misnomer or, at least, deficient for being merely entitled, "Simplified Net Income
Taxation Scheme for the Self-Employed and Professionals Engaged in the Practice of
their Profession" (Petition in G.R. No. 109289).

The full text of the title actually reads:

An Act Adopting the Simplified Net Income Taxation Scheme For The Self-
Employed and Professionals Engaged In The Practice of Their Profession,
Amending Sections 21 and 29 of the National Internal Revenue Code, as
Amended.
The pertinent provisions of Sections 21 and 29, so referred to, of the National Internal
Revenue Code, as now amended, provide:

Sec. 21. Tax on citizens or residents. —

xxx xxx xxx
(f) Simplified Net Income Tax for the Self-Employed and/or Professionals Engaged
in the Practice of Profession. — A tax is hereby imposed upon the taxable net
income as determined in Section 27 received during each taxable year from all
sources, other than income covered by paragraphs (b), (c), (d) and (e) of this
section by every individual whether
a citizen of the Philippines or an alien residing in the Philippines who is self-
employed or practices his profession herein, determined in accordance with the
following schedule:

Not over P10,000 3%

Over P10,000 P300 + 9% but not over P30,000 of excess over P10,000

Over P30,000 P2,100 + 15% but not over P120,00 of excess over P30,000

Over P120,000 P15,600 + 20% but not over P350,000 of excess over P120,000

Over P350,000 P61,600 + 30% of excess over P350,000

Sec. 29. Deductions from gross income. — In computing taxable income subject
to tax under Sections 21(a), 24(a), (b) and (c); and 25 (a)(1), there shall be allowed
as deductions the items specified in paragraphs (a) to (i) of this
section: Provided, however, That in computing taxable income subject to tax under
Section 21 (f) in the case of individuals engaged in business or practice of
profession, only the following direct costs shall be allowed as deductions:

(a) Raw materials, supplies and direct labor;

(b) Salaries of employees directly engaged in activities in the course of or pursuant
to the business or practice of their profession;
(c) Telecommunications, electricity, fuel, light and water;
(d) Business rentals;
(e) Depreciation;
(f) Contributions made to the Government and accredited relief organizations for
the rehabilitation of calamity stricken areas declared by the President; and
(g) Interest paid or accrued within a taxable year on loans contracted from
accredited financial institutions which must be proven to have been incurred in
connection with the conduct of a taxpayer's profession, trade or business.

For individuals whose cost of goods sold and direct costs are difficult to determine,
a maximum of forty per cent (40%) of their gross receipts shall be allowed as
deductions to answer for business or professional expenses as the case may be.

On the basis of the above language of the law, it would be difficult to accept petitioner's
view that the amendatory law should be considered as having now adopted
a gross income, instead of as having still retained the net income, taxation scheme. The
allowance for deductible items, it is true, may have significantly been reduced by the
questioned law in comparison with that which has prevailed prior to the amendment;
limiting, however, allowable deductions from gross income is neither discordant with, nor
opposed to, the net income tax concept. The fact of the matter is still that various
deductions, which are by no means inconsequential, continue to be well provided under
the new law.
Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-
rolling legislation intended to unite the members of the legislature who favor any one of
unrelated subjects in support of the whole act, (b) to avoid surprises or even fraud upon
the legislature, and (c) to fairly apprise the people, through such publications of its
proceedings as are usually made, of the subjects of legislation.1 The above objectives of
the fundamental law appear to us to have been sufficiently met. Anything else would be
to require a virtual compendium of the law which could not have been the intendment of
the constitutional mandate.

Petitioner intimates that Republic Act No. 7496 desecrates the constitutional requirement
that taxation "shall be uniform and equitable" in that the law would now attempt to tax
single proprietorships and professionals differently from the manner it imposes the tax on
corporations and partnerships. The contention clearly forgets, however, that such a
system of income taxation has long been the prevailing rule even prior to Republic Act
No. 7496.

Uniformity of taxation, like the kindred concept of equal protection, merely requires that
all subjects or objects of taxation, similarly situated, are to be treated alike both in
privileges and liabilities (Juan Luna Subdivision vs. Sarmiento, 91 Phil. 371). Uniformity
does not forfend classification as long as: (1) the standards that are used therefor are
substantial and not arbitrary, (2) the categorization is germane to achieve the legislative
purpose, (3) the law applies, all things being equal, to both present and future conditions,
and (4) the classification applies equally well to all those belonging to the same class
(Pepsi Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 52).

What may instead be perceived to be apparent from the amendatory law is the legislative
intent to increasingly shift the income tax system towards the schedular approach in the
income taxation of individual taxpayers and to maintain, by and large, the present global
treatment on taxable corporations. We certainly do not view this classification to be
arbitrary and inappropriate.

Petitioner gives a fairly extensive discussion on the merits of the law, illustrating, in the
process, what he believes to be an imbalance between the tax liabilities of those covered
by the amendatory law and those who are not. With the legislature primarily lies the
discretion to determine the nature (kind), object (purpose), extent (rate), coverage
(subjects) and situs (place) of taxation. This court cannot freely delve into those matters
which, by constitutional fiat, rightly rest on legislative judgment. Of course, where a tax
measure becomes so unconscionable and unjust as to amount to confiscation of property,
courts will not hesitate to strike it down, for, despite all its plenitude, the power to tax
cannot override constitutional proscriptions. This stage, however, has not been
demonstrated to have been reached within any appreciable distance in this controversy
before us.

Having arrived at this conclusion, the plea of petitioner to have the law declared
unconstitutional for being violative of due process must perforce fail. The due process
clause may correctly be invoked only when there is a clear contravention of inherent or
constitutional limitations in the exercise of the tax power. No such transgression is so
evident to us.

G.R. No. 109446

The several propositions advanced by petitioners revolve around the question of whether
or not public respondents have exceeded their authority in promulgating Section 6,
Revenue Regulations No. 2-93, to carry out Republic Act No. 7496.

The questioned regulation reads:

 Sec. 6. General Professional Partnership — The general professional partnership
(GPP) and the partners comprising the GPP are covered by R. A. No. 7496. Thus,
in determining the net profit of the partnership, only the direct costs mentioned in
said law are to be deducted from partnership income. Also, the expenses paid or
incurred by partners in their individual capacities in the practice of their profession
which are not reimbursed or paid by the partnership but are not considered as
direct cost, are not deductible from his gross income.

The real objection of petitioners is focused on the administrative interpretation of public

respondents that would apply SNIT to partners in general professional partnerships.
Petitioners cite the pertinent deliberations in Congress during its enactment of Republic
Act No. 7496, also quoted by the Honorable Hernando B. Perez, minority floor leader of
the House of Representatives, in the latter's privilege speech by way of commenting on
the questioned implementing regulation of public respondents following the effectivity of
the law, thusly:

MR. ALBANO, Now Mr. Speaker, I would like to get the correct impression
of this bill. Do we speak here of individuals who are earning, I mean, who
earn through business enterprises and therefore, should file an income tax
return?

MR. PEREZ. That is correct, Mr. Speaker. This does not apply to
corporations. It applies only to individuals.

(See Deliberations on H. B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis ours).

Other deliberations support this position, to wit:

MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from Batangas
say that this bill is intended to increase collections as far as individuals are
concerned and to make collection of taxes equitable?

MR. PEREZ. That is correct, Mr. Speaker.

(Id. at 6:40 P.M.; Emphasis ours).

In fact, in the sponsorship speech of Senator Mamintal Tamano on the

Senate version of the SNITS, it is categorically stated, thus:

This bill, Mr. President, is not applicable to business corporations or to

partnerships; it is only with respect to individuals and professionals.
(Emphasis ours)

The Court, first of all, should like to correct the apparent misconception that general
professional partnerships are subject to the payment of income tax or that there is a
difference in the tax treatment between individuals engaged in business or in the practice
of their respective professions and partners in general professional partnerships. The fact
of the matter is that a general professional partnership, unlike an ordinary business
partnership (which is treated as a corporation for income tax purposes and so subject to
the corporate income tax), is not itself an income taxpayer. The income tax is imposed
not on the professional partnership, which is tax exempt, but on the partners themselves
in their individual capacity computed on their distributive shares of partnership profits.
Section 23 of the Tax Code, which has not been amended at all by Republic Act 7496, is
explicit:

Sec. 23. Tax liability of members of general professional partnerships. — (a)

Persons exercising a common profession in general partnership shall be liable for
 income tax only in their individual capacity, and the share in the net profits of the
general professional partnership to which any taxable partner would be entitled
whether distributed or otherwise, shall be returned for taxation and the tax paid in
accordance with the provisions of this Title.

(b) In determining his distributive share in the net income of the partnership, each
partner —

(1) Shall take into account separately his distributive share of the
partnership's income, gain, loss, deduction, or credit to the extent provided
by the pertinent provisions of this Code, and

(2) Shall be deemed to have elected the itemized deductions, unless he

declares his distributive share of the gross income undiminished by his
share of the deductions.

There is, then and now, no distinction in income tax liability between a person who
practices his profession alone or individually and one who does it through partnership
(whether registered or not) with others in the exercise of a common profession. Indeed,
outside of the gross compensation income tax and the final tax on passive investment
income, under the present income tax system all individuals deriving income from any
source whatsoever are treated in almost invariably the same manner and under a
common set of rules.

We can well appreciate the concern taken by petitioners if perhaps we were to consider
Republic Act No. 7496 as an entirely independent, not merely as an amendatory, piece
of legislation. The view can easily become myopic, however, when the law is understood,
as it should be, as only forming part of, and subject to, the whole income tax concept and
precepts long obtaining under the National Internal Revenue Code. To elaborate a little,
the phrase "income taxpayers" is an all embracing term used in the Tax Code, and it
practically covers all persons who derive taxable income. The law, in levying the tax,
adopts the most comprehensive tax situs of nationality and residence of the taxpayer (that
renders citizens, regardless of residence, and resident aliens subject to income tax
liability on their income from all sources) and of the generally accepted and internationally
recognized income taxable base (that can subject non-resident aliens and foreign
corporations to income tax on their income from Philippine sources). In the process, the
Code classifies taxpayers into four main groups, namely: (1) Individuals, (2) Corporations,
(3) Estates under Judicial Settlement and (4) Irrevocable Trusts (irrevocable both as
to corpus and as to income).

Partnerships are, under the Code, either "taxable partnerships" or "exempt

partnerships." Ordinarily, partnerships, no matter how created or organized, are subject
to income tax (and thus alluded to as "taxable partnerships") which, for purposes of the
above categorization, are by law assimilated to be within the context of, and so legally
contemplated as, corporations. Except for few variances, such as in the application of the
"constructive receipt rule" in the derivation of income, the income tax approach is alike to
both juridical persons. Obviously, SNIT is not intended or envisioned, as so correctly
pointed out in the discussions in Congress during its deliberations on Republic Act 7496,
aforequoted, to cover corporations and partnerships which are independently subject to
the payment of income tax.

"Exempt partnerships," upon the other hand, are not similarly identified as corporations
nor even considered as independent taxable entities for income tax purposes. A
general professional partnership is such an example.4 Here, the partners themselves, not
the partnership (although it is still obligated to file an income tax return [mainly for
administration and data]), are liable for the payment of income tax in
their individual capacity computed on their respective and distributive shares of profits. In
the determination of the tax liability, a partner does so as an individual, and there is no
choice on the matter. In fine, under the Tax Code on income taxation, the general
professional partnership is deemed to be no more than a mere mechanism or a flow-
through entity in the generation of income by, and the ultimate distribution of such income
to, respectively, each of the individual partners.

Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the above
standing rule as now so modified by Republic Act No. 7496 on basically the extent of
allowable deductions applicable to all individual income taxpayers on their non-
compensation income. There is no evident intention of the law, either before or after the
amendatory legislation, to place in an unequal footing or in significant variance the income
tax treatment of professionals who practice their respective professions individually and
of those who do it through a general professional partnership.

WHEREFORE, the petitions are DISMISSED. No special pronouncement on costs.

SO ORDERED.
 ALEXANDER HOWDEN & CO., LTD., H. G. CHESTER & OTHERS, ET
AL., Petitioners, v. THE COLLECTOR (NOW COMMISSIONER) OF INTERNAL
REVENUE, Respondent.
G.R. No. L-19392. April 14, 1965

SYLLABUS

1. TAXATION; INSURANCE; REINSURANCE PREMIUMS REMITTED TO FOREIGN

INSURANCE COMPANIES TAXABLE WITHIN PHILIPPINES. — The portions of
premiums earned from insurance locally underwritten by domestic corporations, ceded to
and received by non-resident foreign reinsurance companies, through a non-resident
foreign insurance broker, pursuant to reinsurance contracts signed by the reinsurers
abroad but signed by the domestic corporation in the Philippines, are subject to income
tax locally.

2. ID.; ID.; SUBJECT TO WITHHOLDING TAX. — The reinsurance premiums remitted

by local insurance companies to foreign re-insurance companies are subject to
withholding tax on income under Sections 53 and 54 of the National Internal Revenue
Code.

3. ID.; INCOME FROM SOURCES WITHIN THE PHILIPPINES; REINSURANCE

PREMIUMS. — Reinsurance premiums remitted by domestic insurance corporation to
foreign reinsurance companies are considered income of the latter derived from sources
within the Philippines.

4. ID.; PREMIUMS UNDER SECTION 53 OF TAX CODE INCLUDE ALL PREMIUMS

CONSTITUTING INCOME. — Since Section 53 of the Tax Code subjects to withholding
tax various specified income, among them, "premiums, the generic connotation of each
and every word or phrase composing the enumeration in subsection (b) thereof is income.
Perforce, the word "premiums", which is neither qualified nor defined by the law itself,
should mean income and should include all premiums constituting income, whether they
be insurance or reinsurance premiums.

5. ID.; REINSURANCE PREMIUMS CONSIDERED DETERMINABLE AND

PERIODICAL INCOME. — Under Section 53 of the Tax Code, reinsurance premiums are
determinable and periodical income: determinable, because they can be calculated
accurately on the basis of the reinsurance contracts; periodical, inasmuch as they were
earned and remitted from time to time.

6. ID.; PRINCIPLE OF LEGISLATIVE PRE-ENACTMENT; WHEN NOT APPLICABLE. —

The principle of legislative re-enactment is not applicable where the sections of the law in
question were not re-enacted but merely amended and the administrative rulings were
merely contained in letters to taxpayers and never published, and were not regulations to
implement a law but only opinions on queries submitted.

7. COURTS; APPEALS; DISQUALIFICATION OF TRIAL JUDGE MAY NOT BE RAISED

FOR FIRST TIME ON APPEAL. — Where appellants, instead of asking for the trial
judge’s disqualification by raising their objection in the lower court, are content to raise it
for the first before the Supreme Court, it is held that they may not be heard to complain
on this point after the trial judge has given his opinion on the merits of the case.

DECISION

BENGZON, J. P., J.:

In 1950 the Commonwealth Insurance Co., a domestic corporation, entered into
reinsurance contracts with 32 British insurance companies not engaged in trade or
business in the Philippines (FOREIGN NON RESIDENT CORP), whereby the former
agreed to cede to them a portion of the premiums on insurance on fire, marine and other
risks it has underwritten in the Philippines. Alexander Howden & Co., Ltd., also a British
corporation not engaged in business in this country (FOREIGN NON RESIDENT CORP),
represented the aforesaid British insurance companies. The reinsurance contracts were
prepared and signed by the foreign reinsurers in England and sent to Manila where
Commonwealth Insurance Co. signed them.

Pursuant to the aforesaid contracts, Commonwealth Insurance Co., in 1951, remitted

P798,297.47 to Alexander Howden & Co., Ltd., as reinsurance premiums. In behalf of
Alexander Howden & Co., Ltd., Commonwealth Insurance Co. filed in April 1952 an
income tax return declaring the sum of P798,297.47, with accrued interest thereon in the
amount of P4,985.77, as Alexander Howden & Co., Ltd.’s gross income for calendar year
1951. It also paid the Bureau of Internal Revenue P66,112.00 as income tax thereon.

On May 12, 1954, within the two-year period provided for by law, Alexander Howden &
Co., Ltd., fled with the Bureau of Internal Revenue a claim for refund of the P66,112.00,
later reduced to P65,115.00, because Alexander Howden & Co., Ltd., agreed to the
payment of P997.00 as income tax on the P4,985.77 accrued interest. A ruling of the
Commissioner of Internal Revenue, dated December 8, 1953 was invoked, stating that it
exempted from withholding tax reinsurance premiums received from domestic insurance
companies by foreign insurance companies not authorized to do business in the
Philippines. Subsequently, Alexander Howden & Co., Ltd. instituted an action in the Court
of First Instance of Manila for the recovery of the aforesaid amount claimed. Pursuant to
Section 22 of Republic Act 1125 the case was certified to the Court of Tax Appeals. On
November 24, 1961, the Tax Court denied the claim.

Plaintiffs have appealed, thereby squarely raising the following issues: (1) Are portions of
premiums earned from insurances locally underwritten by a domestic corporation, ceded
to and received by non- resident foreign reinsurance companies, thru a non-resident
foreign insurance broker, pursuant to reinsurance contracts signed by the reinsurers
abroad but signed by the domestic corporation in the Philippines, subject to income tax
or not? (2) If subject thereto, may or may not the income tax on reinsurance premiums be
withheld pursuant to Sections 53 and 54 of the National Internal Revenue Code?

Section 24 of the National Internal Revenue Code subjects to tax a non-resident foreign
corporation’s income from sources within the Philippines. The first issue therefore hinges
on whether or not the reinsurance premiums in question came from sources within the
Philippines.

Appellants would impress upon this Court that the reinsurance premiums came from
sources outside the Philippines, for these reasons: (1) The contracts of reinsurance, out
of which the reinsurance premiums were earned, were prepared and signed abroad, so
that their situs lies outside the Philippines; (2) The reinsurers, not being engaged in
business in the Philippines, received the reinsurance premiums as income from their
business conducted in England and, as such, taxable in England; and, (3) Section 37 of
the Tax Code, enumerating what are income from sources within the Philippines, does
not include reinsurance premiums.

The source of an income is the property, activity or service that produced the income. 1
The reinsurance premiums remitted to appellants by virtue of the reinsurance contracts,
accordingly, had for their source the undertaking to indemnify Commonwealth Insurance
Co. against liability. Said undertaking is the activity that produced the reinsurance
premiums, and the same took place in the Philippines. In the first place, the reinsured,
the liabilities insured and the risks originally underwritten by Commonwealth Insurance
Co., upon which the reinsurance premiums and indemnity were based, were all situated
in the Philippines. Secondly, contrary to appellants’ view, the reinsurance contracts were
perfected in the Philippines, for Commonwealth Insurance Co. signed them last in Manila.
The American cases cited are inapplicable to this case because in all of them the
reinsurance contracts were signed outside the jurisdiction of the taxing State. And, thirdly,
the parties to the reinsurance contracts in question evidently intended Philippine law to
govern. Article 11 thereof provided for arbitration in Manila, according to the laws of the
Philippines, of any dispute arising between the parties in regard to the interpretation of
said contracts or rights in respect of any transaction involved. Furthermore, the contracts
provided for the use of Philippine currency as the medium of exchange and for the
payment of Philippine taxes.

Appellants should not confuse activity that creates income with business in the course of
which an income is realized. An activity may consist of a single act; while business implies
continuity of transactions. 2 An income may be earned by a corporation in the Philippines
although such corporation conducts all its business abroad. Precisely, Section 24 of the
Tax Code does not require a foreign corporation to be engaged in business in the
Philippines, in order for its income from sources within the Philippines to be taxable. It
subjects foreign corporations not doing business in the Philippines to tax for income from
sources within the Philippines. If by source of income is meant the business of the
taxpayer, foreign corporations not engaged in business in the Philippines would be
exempt from taxation on their income from sources within the Philippines.

Furthermore, as used in our income tax law, "income" refers to the flow of wealth. 3 Such
flow, in the instant case, proceeded from the Philippines. Such income enjoyed the
protection of the Philippine government. As wealth flowing from within the taxing
jurisdiction of the Philippines and in consideration for protection accorded it by the
Philippines, said income should properly share the burden of maintaining the government.

Appellants further contend that reinsurance premiums not being among those mentioned
in Section 37 of the Tax Code as income from sources within the Philippines, the same
should not be treated as such. Section 37, however, is not an all-inclusive enumeration.
It states that "the following items of gross income shall be treated as gross income from
sources within the Philippines." It does not state or imply that an income not listed therein
is necessarily from sources outside the Philippines.

As to appellants, contention that reinsurance premiums constitute "gross receipts" instead

of "gross income", not subject to income tax, suffice it to say that, as correctly observed
by the Court of Tax Appeals, "gross receipts" of amounts that do not constitute return of
capital, such as reinsurance premiums, are part of the gross income of a taxpayer. At any
rate, the tax actually collected in this case was computed not on the basis of gross
premium receipts but on the net premium income that is, after deducting general
expenses, payment of policies and taxes.

The reinsurance premiums in question being taxable, we turn to the issues whether or
not they are subject to withholding tax under Section 54 in relation to Section 53 of the
Tax Code.

Subsection (b) of Section 53 subjects to withholding tax the following: interest, dividends,
rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments,
or other fixed or determinable annual or periodical gains, profits, and income of any non-
resident alien individual not engaged in trade or business within the Philippines and not
having any office or place of business therein. Section 54, by reference, applies this
provision to foreign corporations not engaged in trade or business in the Philippines.

Appellants maintain that reinsurance premiums are not "premiums" at all as contemplated
by Subsection (b) of Section 53; that they are not within the scope of "other fixed or
determinable annual or periodical gains, profits, and income" ; that, therefore, they are
not items of income subject to withholding tax.
The argument of appellants is that "premiums", as used in Section 53 (b), is preceded by
"rents, salaries, wages" and followed by "annuities, compensations, remunerations"
which connote periodical income payable to the recipient on account of some investment
or for personal services rendered. "Premiums" should, therefore, in appellants’ view, be
given a meaning kindred to the other terms in the enumeration and be understood in its
broadest sense as "a reward or recompense for some act done; a bonus; compensation
for the use of money; a price for a loan; a sum in addition to interest."

We disagree with the foregoing proposition. Since Section 53 subjects to withholding tax
various specified income, among them, "premiums", the generic connotation of each and
every word or phrase composing the enumeration in Subsection (b) thereof is income.
Perforce, the word "premiums", which is neither qualified nor defined by the law itself,
should mean income and should include all premiums constituting income, whether they
be insurance or reinsurance premiums.

Assuming that reinsurance premiums are not within the word "premiums" in Section 53,
still they may be classified as determinable and periodical income under the same
provision of law. Section 199 of the Income Tax Regulations defines fixed, determinable,
annual and periodical income:

"Income is fixed when it is to be paid in amounts definitely pre-determined. On the other

hand, it is determinable whenever there is a basis of calculation by which the amount to
be paid may be ascertained.

"The income need not be paid annually if it is paid periodically; that is to say, from time to
time, whether or not at regular intervals. That the length of time during which the payments
are to be made may be increased or diminished in accordance with some one’s will or
with the happening of an event does not make the payments any the less determinable
or periodical. . . ."cralaw virtua1aw library

Reinsurance premiums, therefore, are determinable and periodical income; determinable,

because they can be calculated accurately on the basis of the reinsurance contracts;
periodical, inasmuch as they were earned and remitted from time to time.

Appellants’ claim for refund, as stated, invoked a ruling of the Commissioner of Internal
Revenue dated December 8, 1953. Appellants’ brief also cited rulings of the same official,
dated October 13, 1953, February 7, 1955 and February 8, 1955, as well as the decision
of the defunct Board of Tax Appeals in the case of Franklin Baker Co., thereby attempting
to show that the prevailing administrative interpretation of Sections 53 and 54 of the Tax
Code exempted from withholding tax reinsurance premiums ceded to non-resident foreign
insurance companies. It is asserted that since Sections 53 and 54 were "substantially re-
enacted" by Republic Acts 1065 (approved June 12, 1954), 1291 (approved June 15,
1955), 1505 (approved June 16, 1956) and 2343 (approved June 20, 1959) when the said
administrative rulings prevailed, the rulings should be given the force of law under the
principle of legislative approval by re-enactmentCIR.

The principle of legislative approval by re-enactment may briefly be stated thus: When a
statute is susceptible of the meaning placed upon it by a ruling of the government agency
charged with its enforcement and the Legislature thereafter re-enacts the provisions with
substantial charge, such action is to some extent confirmatory that the ruling carries out
the legislative purpose.

The aforestated principle, however, is not applicable to this case. Firstly, Sections 53 and
54 were never reenacted. Republic Acts 1065, 1291, 1505 and 2343 were merely
amendments in respect to the rate of tax imposed in Sections 53 and 54. Secondly, the
administrative rulings of the Commissioner of Internal Revenue relied upon by the
taxpayers were only contained in letters to taxpayers and never published, so that the
Legislature is not presumed to know said rulings. Thirdly, in the case on which appellants
rely, Interprovincial Autobus Co., Inc. v. Collector of Internal Revenue, 98 Phil. 290,
January 31, 1956, what was declared to have acquired the force and effect of law was a
regulation promulgated to implement a law; whereas, in this case, what appellant would
seek to have the force of law are opinions on queries submitted.

It may not be amiss to note that in 1963, after the Tax Court rendered judgment in this
case, Congress enacted Republic Act 3825, as an amendment to Sections 24 and 54 of
the Tax Code, exempting from income taxes and withholding tax, reinsurance premiums
received by foreign corporations not engaged in business in the Philippines. Republic Act
3825 in effect took out from Sections 24 and 54 something which formed a part of the
subject matter therein, 6 thereby affirming the taxability of reinsurance premiums prior to
the aforestated amendment.

Finally, appellant would argue that Judge Augusto M. Luciano, who penned the decision
appealed from, was disqualified to sit in this case since he had appeared as counsel for
the Commissioner of Internal Revenue and, as such, answered plaintiffs’ complaint before
the Court of First Instance of Manila.

The Rules of Court provides that no judge shall sit in any case in which he has been
counsel without the written consent of all the parties in interest, signed by them and
entered upon the record. The party objecting to the judge’s competency may file, in
writing, with such judge his objection, stating therein the grounds for it. The judge shall
thereupon proceed with the trial or withdraw therefrom, but his action shall be made in
writing and made part of the record. 7

Appellants, instead of asking for Judge Luciano’s disqualification by raising their objection
in the Court of Tax Appeals, are content to raise it for the first time before this Court. Such
being the case they may not now be heard to complain on this point, when Judge Luciano
has given his opinion on the merits of the case. A litigant cannot be permitted to speculate
upon the action of the court and raise an objection of this nature after decision has been
rendered. 8

WHEREFORE, the judgment appealed from is hereby affirmed with costs against
appellants. It is so ordered.
 COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. BRITISH OVERSEAS
AIRWAYS CORPORATION and COURT OF TAX APPEALS, Respondents.
G.R. Nos. L-65773-74. April 30, 1987

DECISION

MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on Certiorari of the

joint Decision of the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561,
dated 26 January 1983, which set aside petitioner’s assessment of deficiency income
taxes against respondent British Overseas Airways Corporation (BOAC) for the fiscal
years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its Resolution of 18
November, 1983 denying reconsideration.

BOAC is a 100% British Government-owned corporation organized and existing under

the laws of the United Kingdom. It is engaged in the international airline business and is
a member-signatory of the Interline Air Transport Association (IATA). As such, it operates
air transportation service and sells transportation tickets over the routes of the other
airline members. During the periods covered by the disputed assessments, it is admitted
that BOAC had no landing rights for traffic purposes in the Philippines, and was not
granted a Certificate of public convenience and necessity to operate in the Philippines by
the Civil Aeronautics Board (CAB), except for a nine-month period, partly in 1961 and
partly in 1962, when it was granted a temporary landing permit by the CAB. Consequently,
it did not carry passengers and/or cargo to or from the Philippines, although during the
period covered by the assessments, it maintained a general sales agent in the Philippines
— Warner Barnes and Company, Ltd., and later Qantas Airways — which was
responsible for selling BOAC tickets covering passengers and cargoes.

G.R. No. 65773 (CTA Case No. 2373, the First Case)

On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed
BOAC the aggregate amount of P2,498,358.56 for deficiency income taxes covering the
years 1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in
the issuance of a new assessment, dated 16 January 1970 for the years 1959 to 1967 in
the amount of P858,307.79. BOAC paid this new assessment under protest.

On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which
claim was denied by the CIR on 16 February 1972. But before said denial, BOAC had
already filed a petition for review with the Tax Court on 27 January 1972, assailing the
assessment and praying for the refund of the amount paid.

G.R. No. 65774 (CTA Case No. 2561, the Second Case)

On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and
penalty for the fiscal years 1968/1969 to 1970-1971 in the aggregate amount of
P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 as compromise
penalties for violation of Section 46 (requiring the filing of corporation returns) penalized
under Section 74 of the National Internal Revenue Code (NIRC).

On 25 November 1971, BOAC requested that the assessment be countermanded and

set aside. In a letter, dated 16 February 1972, however, the CIR not only denied the BOAC
request for refund in the First Case but also re-issued in the Second Case the deficiency
income tax assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00
as compromise penalty under Section 74 of the Tax Code. BOAC’s request for
reconsideration was denied by the CIR on 24 August 1973. This prompted BOAC to file
the Second Case before the Tax Court praying that it be absolved of liability for deficiency
income tax for the years 1969 to 1971.

This case was subsequently tried jointly with the First Case.

On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the
CIR. The Tax Court held that the proceeds of sales of BOAC passage tickets in the
Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, during
the period in question, do not constitute BOAC income from Philippine sources "since no
service of carriage of passengers or freight was performed by BOAC within the
Philippines" and, therefore, said income is not subject to Philippine income tax. The CTA
position was that income from transportation is income from services so that the place
where services are rendered determines the source. Thus, in the dispositive portion of its
Decision, the Tax Court ordered petitioner to credit BOAC with the sum of P858,307.79,
and to cancel the deficiency income tax assessments against BOAC in the amount of
P534,132.08 for the fiscal years 1968-69 to 1970-71.

Hence, this Petition for Review on Certiorari of the Decision of the Tax Court.

The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:

"1. Whether or not the revenue derived by private respondent British Overseas Airways
Corporation (BOAC) from sales of tickets in the Philippines for air transportation, while
having no landing rights here, constitute income of BOAC from Philippine sources, and,
accordingly, taxable.

"2. Whether or not during the fiscal years in question BOAC is a resident foreign
corporation doing business in the Philippines or has an office or place of business in the
Philippines.

"3. In the alternative that private respondent may not be considered a resident foreign
corporation but a non-resident foreign corporation, then it is liable to Philippine income
tax at the rate of thirty-five per cent (35%) of its gross income received from all sources
within the Philippines."

Under Section 20 of the 1977 Tax Code:

"(h) the term ‘resident foreign corporation’ applies to a foreign corporation engaged in
trade or business within the Philippines or having an office or place of business therein.

"(i) The term ‘non-resident foreign corporation’ applies to a foreign corporation not
engaged in trade or business within the Philippines and not having any office or place of
business therein."

It is our considered opinion that BOAC is a resident foreign corporation. There is no

specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business.
Each case must be judged in the light of its peculiar environmental circumstances. The
term implies a continuity of commercial dealings and arrangements, and contemplates,
to that extent, the performance of acts or works or the exercise of some of the functions
normally incident to, and in progressive prosecution of commercial gain or for the purpose
and object of the business organization. "In order that a foreign corporation may be
regarded as doing business within a State, there must be continuity of conduct and
intention to establish a continuous business, such as the appointment of a local agent,
and not one of a temporary character.’

BOAC, during the periods covered by the subject-assessments, maintained a general

sales agent in the Philippines. That general sales agent, from 1959 to 1971, "was
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of
trips — each trip in the series corresponding to a different airline company; (3) receiving
the fare from the whole trip; and (4) consequently allocating to the various airline
companies on the basis of their participation in the services rendered through the mode
of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA
Agreement." 4 Those activities were in exercise of the functions which are normally
incident to, and are in progressive pursuit of, the purpose and object of its organization
as an international air carrier. In fact, the regular sale of tickets, its main activity, is the
very lifeblood of the airline business, the generation of sales being the paramount
objective. There should be no doubt then that BOAC was "engaged in" business in the
Philippines through a local agent during the period covered by the assessments.
Accordingly, it is a resident foreign corporation subject to tax upon its total net income
received in the preceding taxable year from all sources within the Philippines.

"Sec. 24. Rates of tax on corporations. — . . .

"(b) Tax on foreign corporations. — . . .

"(2) Resident corporations. — A corporation organized, authorized, or existing under the

laws of any foreign country, except a foreign life insurance company, engaged in trade or
business within the Philippines, shall be taxable as provided in subsection (a) of this
section upon the total net income received in the preceding taxable year from all sources
within the Philippines. (Emphasis ours)

Next, we address ourselves to the issue of whether or not the revenue from sales of
tickets by BOAC in the Philippines constitutes income from Philippine sources and,
accordingly, taxable under our income tax laws.

The Tax Code defines "gross income" thus:

"‘Gross income’ includes gains, profits, and income derived from salaries, wages or
compensation for personal service of whatever kind and in whatever form paid, or from
profession, vocations, trades, business, commerce, sales, or dealings in property,
whether real or personal, growing out of the ownership or use of or interest in such
property; also from interests, rents, dividends, securities, or the transactions of any
business carried on for gain or profit or gains, profits, and income derived from any source
whatever" (Sec. 29[3]; Emphasis supplied)

The definition is broad and comprehensive to include proceeds from sales of transport
documents. "The words ‘income from any source whatever’ disclose a legislative policy
to include all income not expressly exempted within the class of taxable income under
our laws." C

The records show that the Philippine gross income of BOAC for the fiscal years 1968-69
to 1970-71 amounted to P10,428,368.00. 7

Did such "flow of wealth" come from "sources within the Philippines" ?

The source of an income is the property, activity or service that produced the income. 8
For the source of income to be considered as coming from the Philippines, it is sufficient
that the income is derived from activity within the Philippines. In BOAC’s case, the sale
of tickets in the Philippines is the activity that produces the income. The tickets exchanged
hands here and payments for fares were also made here in Philippine currency. The situs
of the source of payments is the Philippines. The flow of wealth proceeded from, and
occurred within, Philippine territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of wealth should share the
burden of supporting the government.
A transportation ticket is not a mere piece of paper. When issued by a common carrier, it
constitutes the contract between the ticket-holder and the carrier. It gives rise to the
obligation of the purchaser of the ticket to pay the fare and the corresponding obligation
of the carrier to transport the passenger upon the terms and conditions set forth thereon.
The ordinary ticket issued to members of the travelling public in general embraces within
its terms all the elements to constitute it a valid contract, binding upon the parties entering
into the relationship. 9

True, Section 37(a) of the Tax Code, which enumerates items of gross income from
sources within the Philippines, namely: (1) interest, (2) dividends, (3) service, (4) rentals
and royalties, (5) sale of real property, and (6) sale of personal property, does not mention
income from the sale of tickets for international transportation. However, that does not
render it less an income from sources within the Philippines. Section 37, by its language,
does not intend the enumeration to be exclusive. It merely directs that the types of income
listed therein be treated as income from sources within the Philippines. A cursory reading
of the section will show that it does not state that it is an all-inclusive enumeration, and
that no other kind of income may be so considered. 10

BOAC, however, would impress upon this Court that income derived from transportation
is income for services, with the result that the place where the services are rendered
determines the source; and since BOAC’s service of transportation is performed outside
the Philippines, the income derived is from sources without the Philippines and, therefore,
not taxable under our income tax laws. The Tax Court upholds that stand in the joint
Decision under review.

The absence of flight operations to and from the Philippines is not determinative of the
source of income or the situs of income taxation. Admittedly, BOAC was an off-line
international airline at the time pertinent to this case. The test of taxability is the "source"
; and the source of an income is that activity . . . which produced the income. 11
Unquestionably, the passage documentations in these cases were sold in the Philippines
and the revenue therefrom was derived from a business activity regularly pursued within
the Philippines. And even if the BOAC tickets sold covered the "transport of passengers
and cargo to and from foreign cities", 12 it cannot alter the fact that income from the sale
of tickets was derived from the Philippines. The word "source" conveys one essential
idea, that of origin, and the origin of the income herein is the Philippines. 13

It should be pointed out, however, that the assessments upheld herein apply only to the
fiscal years covered by the questioned deficiency income tax assessments in these
cases, or, from 1959 to 1967, 1968-69 to 1970-71. For, pursuant to Presidential Decree
No. 69, promulgated on 24 November, 1972, international carriers are now taxed as
follows:

". . . Provided, however, That international carriers shall pay a tax of 2-1/2 per cent on
their gross Philippine billings." (Sec. 24[b] [2], Tax Code).

Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory

definition of the term "gross Philippine billings," thus:

". . .’Gross Philippine billings’ includes gross revenue realized from uplifts anywhere in
the world by any international carrier doing business in the Philippines of passage
documents sold therein, whether for passenger, excess baggage or mail, provided the
cargo or mail originates from the Philippines. . . ."

The foregoing provision ensures that international airlines are taxed on their income from
Philippine sources. The 2-1/2% tax on gross Philippine billings is an income tax. If it had
been intended as an excise or percentage tax it would have been place under Title V of
the Tax Code covering Taxes on Business.
Lastly, we find as untenable the BOAC argument that the dismissal for lack of merit by
this Court of the appeal in JAL v. Commissioner of Internal Revenue (G.R. No. L-30041)
on February 3, 1969, is res judicata to the present case. The ruling by the Tax Court in
that case was to the effect that the mere sale of tickets, unaccompanied by the physical
act of carriage of transportation, does not render the taxpayer therein subject to the
common carrier’s tax. As elucidated by the Tax Court, however, the common carrier’s tax
is an excise tax, being a tax on the activity of transporting, conveying or removing
passengers and cargo from one place to another. It purports to tax the business of
transportation. 14 Being an excise tax, the same can be levied by the State only when
the acts, privileges or businesses are done or performed within the jurisdiction of the
Philippines. The subject matter of the case under consideration is income tax, a direct tax
on the income of persons and other entities "of whatever kind and in whatever form
derived from any source." Since the two cases treat of a different subject matter, the
decision in one cannot be res judicata to the other.

WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET
ASIDE. Private respondent, the British Overseas Airways Corporation (BOAC), is hereby
ordered to pay the amount of P534,132.08 as deficiency income tax for the fiscal years
1968-69 to 1970-71 plus 5% surcharge, and 1% monthly interest from April 16, 1972 for
a period not to exceed three (3) years in accordance with the Tax Code. The BOAC claim
for refund in the amount of P858,307.79 is hereby denied. Without costs.

SO ORDERED.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs. JULIANE BAIER-NICKEL,

as represented by Marina Q. Guzman (Attorney-in-fact) Respondent.
G.R. No. 153793 August 29, 2006
 DECISION

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18, 2002
Decision of the Court of Appeals in CA-G.R. SP No. 59794, which granted the tax refund
of respondent Juliane Baier-Nickel and reversed the June 28, 2000 Decision of the Court
of Tax Appeals (CTA) in C.T.A. Case No. 5633. Petitioner also assails the May 8, 2002
Resolution of the Court of Appeals denying its motion for reconsideration.

The facts show that respondent Juliane Baier-Nickel, a non-resident German citizen, is
the President of JUBANITEX, Inc., a domestic corporation engaged in "[m]anufacturing,
marketing on wholesale only, buying or otherwise acquiring, holding, importing and
exporting, selling and disposing embroidered textile products." Through JUBANITEX’s
General Manager, Marina Q. Guzman, the corporation appointed and engaged the
services of respondent as commission agent. It was agreed that respondent will receive
10% sales commission on all sales actually concluded and collected through her efforts.

In 1995, respondent received the amount of P1,707,772.64, representing her sales

commission income from which JUBANITEX withheld the corresponding 10% withholding
tax amounting to P170,777.26, and remitted the same to the Bureau of Internal Revenue
(BIR). On October 17, 1997, respondent filed her 1995 income tax return reporting a
taxable income of P1,707,772.64 and a tax due of P170,777.26.

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26 alleged
to have been mistakenly withheld and remitted by JUBANITEX to the BIR. Respondent
contended that her sales commission income is not taxable in the Philippines because
the same was a compensation for her services rendered in Germany and therefore
considered as income from sources outside the Philippines.

The next day, April 15, 1998, she filed a petition for review with the CTA contending that
no action was taken by the BIR on her claim for refund.7 On June 28, 2000, the CTA
rendered a decision denying her claim. It held that the commissions received by
respondent were actually her remuneration in the performance of her duties as President
of JUBANITEX and not as a mere sales agent thereof. The income derived by respondent
is therefore an income taxable in the Philippines because JUBANITEX is a domestic
corporation.

On petition with the Court of Appeals, the latter reversed the Decision of the CTA, holding
that respondent received the commissions as sales agent of JUBANITEX and not as
President thereof. And since the "source" of income means the activity or service that
produce the income, the sales commission received by respondent is not taxable in the
Philippines because it arose from the marketing activities performed by respondent in
Germany. The dispositive portion of the appellate court’s Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of Tax Appeals
dated June 28, 2000 is hereby REVERSED and SET ASIDE and the respondent court is
hereby directed to grant petitioner a tax refund in the amount of Php 170,777.26.
SO ORDERED.

Petitioner filed a motion for reconsideration but was denied. Hence, the instant recourse.

Petitioner maintains that the income earned by respondent is taxable in the Philippines
because the source thereof is JUBANITEX, a domestic corporation located in the City of
Makati. It thus implied that source of income means the physical source where the income
came from. It further argued that since respondent is the President of JUBANITEX, any
remuneration she received from said corporation should be construed as payment of her
overall managerial services to the company and should not be interpreted as a
compensation for a distinct and separate service as a sales commission agent.

Respondent, on the other hand, claims that the income she received was payment for her
marketing services. She contended that income of nonresident aliens like her is subject
to tax only if the source of the income is within the Philippines. Source, according to
respondent is the situs of the activity which produced the income. And since the source
of her income were her marketing activities in Germany, the income she derived from said
activities is not subject to Philippine income taxation.

The issue here is whether respondent’s sales commission income is taxable in the
Philippines.

Pertinent portion of the National Internal Revenue Code (NIRC), states:

SEC. 25. Tax on Nonresident Alien Individual. –

(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. –

(1) In General. – A nonresident alien individual engaged in trade or business in the

Philippines shall be subject to an income tax in the same manner as an individual citizen
and a resident alien individual, on taxable income received from all sources within the
Philippines. A nonresident alien individual who shall come to the Philippines and stay
therein for an aggregate period of more than one hundred eighty (180) days during any
calendar year shall be deemed a ‘nonresident alien doing business in the Philippines,’
Section 22(G) of this Code notwithstanding.
xxxx

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines.
– There shall be levied, collected and paid for each taxable year upon the entire income
received from all sources within the Philippines by every nonresident alien individual not
engaged in trade or business within the Philippines x x x a tax equal to twenty-five percent
(25%) of such income. x x x

Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or not
engaged in trade or business, are subject to Philippine income taxation on their income
received from all sources within the Philippines. Thus, the keyword in determining the
taxability of non-resident aliens is the income’s "source." In construing the meaning of
"source" in Section 25 of the NIRC, resort must be had on the origin of the provision

The first Philippine income tax law enacted by the Philippine Legislature was Act No.
2833, which took effect on January 1, 1920. Under Section 1 thereof, nonresident aliens
are likewise subject to tax on income "from all sources within the Philippine Islands," thus
–

SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon the
entire net income received in the preceding calendar year from all sources by every
individual, a citizen or resident of the Philippine Islands, a tax of two per centum upon
such income; and a like tax shall be levied, assessed, collected, and paid annually upon
the entire net income received in the preceding calendar year from all sources within the
Philippine Islands by every individual, a nonresident alien, including interest on bonds,
notes, or other interest-bearing obligations of residents, corporate or otherwise.

Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of 1916 as
amended by U.S. Revenue Law of 1917. Being a law of American origin, the authoritative
decisions of the official charged with enforcing it in the U.S. have peculiar persuasive
force in the Philippines.
The Internal Revenue Code of the U.S. enumerates specific types of income to be treated
as from sources within the U.S. and specifies when similar types of income are to be
treated as from sources outside the U.S. Under the said Code, compensation for labor
and personal services performed in the U.S., is generally treated as income from U.S.
sources; while compensation for said services performed outside the U.S., is treated as
income from sources outside the U.S. A similar provision is found in Section 42 of our
NIRC, thus:

SEC. 42. x x x
(A) Gross Income From Sources Within the Philippines. x x x
xxxx

(3) Services. – Compensation for labor or personal services performed in the Philippines;
xxxx

(C) Gross Income From Sources Without the Philippines. x x x

xxxx

(3) Compensation for labor or personal services performed without the Philippines;

The following discussions on sourcing of income under the Internal Revenue Code of the
U.S., are instructive:

The Supreme Court has said, in a definition much quoted but often debated, that income
may be derived from three possible sources only: (1) capital and/or (2) labor; and/or (3)
the sale of capital assets. While the three elements of this attempt at definition need not
be accepted as all-inclusive, they serve as useful guides in any inquiry into whether a
particular item is from "sources within the United States" and suggest an investigation
into the nature and location of the activities or property which produce the income.

If the income is from labor the place where the labor is done should be decisive; if it is
done in this country, the income should be from "sources within the United States." If the
income is from capital, the place where the capital is employed should be decisive; if it is
employed in this country, the income should be from "sources within the United States."
If the income is from the sale of capital assets, the place where the sale is made should
be likewise decisive.

Much confusion will be avoided by regarding the term "source" in this fundamental light.
It is not a place, it is an activity or property. As such, it has a situs or location, and if that
situs or location is within the United States the resulting income is taxable to nonresident
aliens and foreign corporations.

The intention of Congress in the 1916 and subsequent statutes was to discard the 1909
and 1913 basis of taxing nonresident aliens and foreign corporations and to make the test
of taxability the "source," or situs of the activities or property which produce the income.
The result is that, on the one hand, nonresident aliens and nonresident foreign
corporations are prevented from deriving income from the United States free from tax,
and, on the other hand, there is no undue imposition of a tax when the activities do not
take place in, and the property producing income is not employed in, this country. Thus,
if income is to be taxed, the recipient thereof must be resident within the jurisdiction, or
the property or activities out of which the income issues or is derived must be situated
within the jurisdiction so that the source of the income may be said to have a situs in this
country.

The underlying theory is that the consideration for taxation is protection of life and property
and that the income rightly to be levied upon to defray the burdens of the United States
Government is that income which is created by activities and property protected by this
Government or obtained by persons enjoying that protection.

The important factor therefore which determines the source of income of personal
services is not the residence of the payor, or the place where the contract for service is
entered into, or the place of payment, but the place where the services were actually
rendered.

In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue, the Court addressed
the issue on the applicable source rule relating to reinsurance premiums paid by a local
insurance company to a foreign insurance company in respect of risks located in the
Philippines. It was held therein that the undertaking of the foreign insurance company to
indemnify the local insurance company is the activity that produced the income. Since the
activity took place in the Philippines, the income derived therefrom is taxable in our
jurisdiction. Citing Mertens, The Law of Federal Income Taxation, the Court emphasized
that the technical meaning of source of income is the property, activity or service that
produced the same. Thus:

The source of an income is the property, activity or service that produced the income. The
reinsurance premiums remitted to appellants by virtue of the reinsurance contracts,
accordingly, had for their source the undertaking to indemnify Commonwealth Insurance
Co. against liability. Said undertaking is the activity that produced the reinsurance
premiums, and the same took place in the Philippines. x x x the reinsured, the liabilities
insured and the risk originally underwritten by Commonwealth Insurance Co., upon which
the reinsurance premiums and indemnity were based, were all situated in the Philippines.
xxx

In Commissioner of Internal Revenue v. British Overseas Airways

Corporation (BOAC), the issue was whether BOAC, a foreign airline company which does
not maintain any flight to and from the Philippines is liable for Philippine income taxation
in respect of sales of air tickets in the Philippines, through a general sales agent relating
to the carriage of passengers and cargo between two points both outside the Philippines.
Ruling in the affirmative, the Court applied the case of Alexander Howden & Co., Ltd. v.
Collector of Internal Revenue, and reiterated the rule that the source of income is that
"activity" which produced the income. It was held that the "sale of tickets" in the
Philippines is the "activity" that produced the income and therefore BOAC should pay
income tax in the Philippines because it undertook an income producing activity in the
country.

Both the petitioner and respondent cited the case of Commissioner of Internal Revenue
v. British Overseas Airways Corporation in support of their arguments, but the correct
interpretation of the said case favors the theory of respondent that it is the situs of the
activity that determines whether such income is taxable in the Philippines. The conflict
between the majority and the dissenting opinion in the said case has nothing to do with
the underlying principle of the law on sourcing of income. In fact, both applied the case of
Alexander Howden & Co., Ltd. v. Collector of Internal Revenue. The divergence in opinion
centered on whether the sale of tickets in the Philippines is to be construed as the
"activity" that produced the income, as viewed by the majority, or merely the physical
source of the income, as ratiocinated by Justice Florentino P. Feliciano in his dissent. The
majority, through Justice Ameurfina Melencio-Herrera, as ponente, interpreted the sale
of tickets as a business activity that gave rise to the income of BOAC. Petitioner cannot
therefore invoke said case to support its view that source of income is the physical source
of the money earned. If such was the interpretation of the majority, the Court would have
simply stated that source of income is not the business activity of BOAC but the place
where the person or entity disbursing the income is located or where BOAC physically
received the same. But such was not the import of the ruling of the Court. It even
explained in detail the business activity undertaken by BOAC in the Philippines to
pinpoint the taxable activity and to justify its conclusion that BOAC is subject to Philippine
income taxation. Thus –

BOAC, during the periods covered by the subject assessments, maintained a general
sales agent in the Philippines. That general sales agent, from 1959 to 1971, "was
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of
trips — each trip in the series corresponding to a different airline company; (3) receiving
the fare from the whole trip; and (4) consequently allocating to the various airline
companies on the basis of their participation in the services rendered through the mode
of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA
Agreement." Those activities were in exercise of the functions which are normally incident
to, and are in progressive pursuit of, the purpose and object of its organization as an
international air carrier. In fact, the regular sale of tickets, its main activity, is the very
lifeblood of the airline business, the generation of sales being the paramount objective.
There should be no doubt then that BOAC was "engaged in" business in the Philippines
through a local agent during the period covered by the assessments. x x x
xxxx

The source of an income is the property, activity or service that produced the income. For
the source of income to be considered as coming from the Philippines, it is sufficient that
the income is derived from activity within the Philippines. In BOAC's case, the sale of
tickets in the Philippines is the activity that produces the income. The tickets exchanged
hands here and payments for fares were also made here in Philippine currency. The situs
of the source of payments is the Philippines. The flow of wealth proceeded from, and
occurred within, Philippine territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of wealth should share the
burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it
constitutes the contract between the ticket-holder and the carrier. It gives rise to the
obligation of the purchaser of the ticket to pay the fare and the corresponding obligation
of the carrier to transport the passenger upon the terms and conditions set forth thereon.
The ordinary ticket issued to members of the traveling public in general embraces within
its terms all the elements to constitute it a valid contract, binding upon the parties entering
into the relationship.

The Court reiterates the rule that "source of income" relates to the property, activity or
service that produced the income. With respect to rendition of labor or personal service,
as in the instant case, it is the place where the labor or service was performed that
determines the source of the income. There is therefore no merit in petitioner’s
interpretation which equates source of income in labor or personal service with the
residence of the payor or the place of payment of the income.

Having disposed of the doctrine applicable in this case, we will now determine whether
respondent was able to establish the factual circumstances showing that her income is
exempt from Philippine income taxation.

The decisive factual consideration here is not the capacity in which respondent received
the income, but the sufficiency of evidence to prove that the services she rendered were
performed in Germany. Though not raised as an issue, the Court is clothed with authority
to address the same because the resolution thereof will settle the vital question posed in
this controversy.

The settled rule is that tax refunds are in the nature of tax exemptions and are to be
construed strictissimi juris against the taxpayer.24 To those therefore, who claim a refund
rest the burden of proving that the transaction subjected to tax is actually exempt from
taxation.
In the instant case, the appointment letter of respondent as agent of JUBANITEX
stipulated that the activity or the service which would entitle her to 10% commission
income, are "sales actually concluded and collected through [her] efforts." 25 What she
presented as evidence to prove that she performed income producing activities abroad,
were copies of documents she allegedly faxed to JUBANITEX and bearing instructions
as to the sizes of, or designs and fabrics to be used in the finished products as well as
samples of sales orders purportedly relayed to her by clients. However, these documents
do not show whether the instructions or orders faxed ripened into concluded or collected
sales in Germany. At the very least, these pieces of evidence show that while respondent
was in Germany, she sent instructions/orders to JUBANITEX. As to whether these
instructions/orders gave rise to consummated sales and whether these sales were truly
concluded in Germany, respondent presented no such evidence. Neither did she
establish reasonable connection between the orders/instructions faxed and the reported
monthly sales purported to have transpired in Germany.

The paucity of respondent’s evidence was even noted by Atty. Minerva Pacheco,
petitioner’s counsel at the hearing before the Court of Tax Appeals. She pointed out that
respondent presented no contracts or orders signed by the customers in Germany to
prove the sale transactions therein. Likewise, in her Comment to the Formal Offer of
respondent’s evidence, she objected to the admission of the faxed documents bearing
instruction/orders marked as Exhibits "R," "V," "W", and "X," for being self serving. The
concern raised by petitioner’s counsel as to the absence of substantial evidence that
would constitute proof that the sale transactions for which respondent was paid
commission actually transpired outside the Philippines, is relevant because respondent
stayed in the Philippines for 89 days in 1995. Except for the months of July and
September 1995, respondent was in the Philippines in the months of March, May, June,
and August 1995, the same months when she earned commission income for services
allegedly performed abroad. Furthermore, respondent presented no evidence to prove
that JUBANITEX does not sell embroidered products in the Philippines and that her
appointment as commission agent is exclusively for Germany and other European
markets.

In sum, we find that the faxed documents presented by respondent did not constitute
substantial evidence, or that relevant evidence that a reasonable mind might accept as
adequate to support the conclusion31 that it was in Germany where she performed the
income producing service which gave rise to the reported monthly sales in the months of
March and May to September of 1995. She thus failed to discharge the burden of proving
that her income was from sources outside the Philippines and exempt from the application
of our income tax law. Hence, the claim for tax refund should be denied.

The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel, a previous

case for refund of income withheld from respondent’s remunerations for services
rendered abroad, the Court in a Minute Resolution dated February 17, 2003, sustained
the ruling of the Court of Appeals that respondent is entitled to refund the sum withheld
from her sales commission income for the year 1994. This ruling has no bearing in the
instant controversy because the subject matter thereof is the income of respondent for
the year 1994 while, the instant case deals with her income in 1995. Otherwise,
stated, res judicata has no application here. Its elements are: (1) there must be a final
judgment or order; (2) the court that rendered the judgment must have jurisdiction over
the subject matter and the parties; (3) it must be a judgment on the merits; (4) there must
be between the two cases identity of parties, of subject matter, and of causes of
action. The instant case, however, did not satisfy the fourth requisite because there is no
identity as to the subject matter of the previous and present case of respondent which
deals with income earned and activities performed for different taxable years.
WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision and May 8,
2002 Resolution of the Court of Appeals in CA-G.R. SP No. 59794,
are REVERSED and SET ASIDE. The June 28, 2000 Decision of the Court of Tax
Appeals in C.T.A. Case No. 5633, which denied respondent’s claim for refund of income
tax paid for the year 1995 is REINSTATED.
SO ORDERED.