U.S. Supreme Court

Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955)

Commissioner v. Glenshaw Glass Co.

No. 199

Argued February 28, 1955

Decided March 28, 1955*

348 U.S. 426

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

Syllabus

Money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble

damage antitrust recovery must be reported by a taxpayer as "gross income" under § 22(a) of

the Internal Revenue Code of 1939. Pp. 348 U. S. 427-433.

(a) In determining what constitutes "gross income" as defined in § 22(a), effect must be given to

the catch-all language "gains or profits and income derived from any source whatever." Pp. 348

U. S. 429-430.

(b) Eisner v. Macomber, 252 U. S. 189, distinguished. Pp. 348 U. S. 430-431.

(c) The mere fact that such payments are extracted from the wrongdoers as punishment for

unlawful conduct cannot detract from their character as taxable income to the recipients. P. 348

U. S. 431.

(d) A different result is not required by the fact that § 22 (a) was reenacted without change after

the Board of Tax Appeals had held punitive damages nontaxable in Highland Farms Corp., 42

B.T.A. 1314. Pp. 348 U. S. 431-432.

(e) The legislative history of the Internal Revenue Code of 1954 does not require a different

result. The definition of gross income was simplified, but no effect upon its present broad scope

was intended. P. 348 U. S. 432.

(f) Punitive damages cannot be classified as gifts, nor do they come under any other exemption

in the Code. P. 348 U. S. 432.

211 F.2d 928 reversed.

Page 348 U. S. 427

MR. CHIEF JUSTICE WARREN delivered the opinion of the Court.

This litigation involves two cases with independent factual backgrounds, yet presenting the

identical issue. The two cases were consolidated for argument before the Court of Appeals for

the Third Circuit, and were heard en banc. The common question is whether money received as

exemplary damages for fraud or as the punitive two-thirds portion of a treble damage antitrust

recovery must be reported by a taxpayer as gross income under § 22(a) of the Internal Revenue

Code of 1939. [Footnote 1] In a single opinion, 211 F.2d 928, the Court of Appeals affirmed the

Tax Court's separate rulings in favor of the taxpayers. 18 T.C. 860; 19 T.C. 637. Because of the

frequent recurrence of the question and differing interpretations by the lower courts of this

Court's decisions bearing upon the problem, we granted the Commissioner of Internal

Revenue's ensuing petition for certiorari. 348 U.S. 813.

The facts of the cases were largely stipulated, and are not in dispute. So far as pertinent, they

are as follows:

Commissioner v. Glenshaw Glass Co. -- The Glenshaw Glass Company, a Pennsylvania

corporation, manufactures glass bottles and containers. It was engaged in protracted litigation

with the Hartford-Empire Company, which manufactures machinery of a character used by

Glenshaw. Among the claims advanced by Glenshaw

Page 348 U. S. 428

were demands for exemplary damages for fraud [Footnote 2] and treble damages for injury to its

business by reason of Hartford's violation of the federal antitrust laws. [Footnote 3] In

December, 1947, the parties concluded a settlement of all pending litigation by which Hartford

paid Glenshaw approximately $800,000. Through a method of allocation which was approved

by the Tax Court, 18 T.C. 860, 870-872, and which is no longer in issue, it was ultimately

determined that, of the total settlement, $324,529.94 represented payment of punitive damages

for fraud and antitrust violations. Glenshaw did not report this portion of the settlement as

income for the tax year involved. The Commissioner determined a deficiency, claiming as

taxable the entire sum less only deductible legal fees. As previously noted, the Tax Court and

the Court of Appeals upheld the taxpayer.

Commissioner v. William Goldman Theatres, Inc. -- William Goldman Theatres, Inc., a Delaware

corporation operating motion picture houses in Pennsylvania, sued Loew's, Inc., alleging a

violation of the federal antitrust laws and seeking treble damages. After a holding that a violation

had occurred, William Goldman Theatres, Inc. v. Loew's Inc., 150 F.2d 738, the case was

remanded to the trial court for a determination of damages. It was found that Goldman had

suffered a loss of profits equal to $125,000, and was entitled to treble damages in the sum of

$375,000. William Goldman Theatres, Inc. v. Loew's, Inc., 69 F.Supp. 103, aff'd 164 F.2d

1021, cert. denied, 334 U.S. 811. Goldman reported only $125,000 of the recovery as gross

income, and claimed that the $250,000

Page 348 U. S. 429

balance constituted punitive damages, and, as such, was not taxable. The Tax Court agreed, 19

T.C. 637, and the Court of Appeals, hearing this with the Glenshaw case, affirmed. 211 F.2d

928.

It is conceded by the respondents that there is no constitutional barrier to the imposition of a tax

on punitive damages. Our question is one of statutory construction: are these payments

comprehended by § 22(a)?

The sweeping scope of the controverted statute is readily apparent:

"SEC. 22. GROSS INCOME."

"(a) GENERAL DEFINITION. '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 professions, vocations, trades, businesses, commerce, or sales, or dealings

in property, whether real or personal, growing out of the ownership or use of or interest in such

property; also from interest, rent, dividends, securities, or the transaction of any business

carried on for gain or profit, or gains or profits and income derived from any source

whatever. . . ."

(Emphasis added.) [Footnote 4]

This Court has frequently stated that this language was used by Congress to exert in this field

"the full measure of its taxing power." Helvering v. Clifford, 309 U. S. 331, 309 U. S.

334; Helvering v. Midland Mutual Life Ins. Co., 300 U. S. 216, 300 U. S. 223; Douglas v.

Willcuts, 296 U. S. 1, 296 U. S. 9; Irwin v. Gavit, 268 U. S. 161, 268 U. S. 166. Respondents

contend that punitive damages, characterized as "windfalls" flowing from the culpable conduct

of third parties, are not within the scope of the section. But Congress applied no limitations as to

the source of taxable receipts, nor restrictive

Page 348 U. S. 430

labels as to their nature. And the Court has given a liberal construction to this broad

phraseology in recognition of the intention of Congress to tax all gains except those specifically

exempted.Commissioner v. Jacobson, 336 U. S. 28, 336 U. S. 49; Helvering v. Stockholms

Enskilda Bank,293 U. S. 84, 293 U. S. 87-91. Thus, the fortuitous gain accruing to a lessor by

reason of the forfeiture of a lessee's improvements on the rented property was taxed

in Helvering v. Bruun, 309 U. S. 461. Cf. Robertson v. United States, 343 U. S. 711; Rutkin v.

United States, 343 U. S. 130;United States v. Kirby Lumber Co., 284 U. S. 1. Such decisions

demonstrate that we cannot but ascribe content to the catchall provision of § 22(a), "gains or

profits and income derived from any source whatever." The importance of that phrase has been

to frequently recognized since its first appearance in the Revenue Act of 1913 [Footnote 5] to

say now that it adds nothing to the meaning of "gross income."

Nor can we accept respondents' contention that a narrower reading of § 22(a) is required by the

Court's characterization of income in Eisner v. Macomber, 252 U. S. 189, 252 U. S. 207, as "the

gain derived from capital, from labor, or from both combined." [Footnote 6] The Court was there

endeavoring to determine whether the distribution of a corporate stock dividend constituted a

realized gain to the shareholder, or changed "only the form, not the essence," of

Page 348 U. S. 431

his capital investment. Id. at 252 U. S. 210. It was held that the taxpayer had "received nothing

out of the company's assets for his separate use and benefit." Id. at 252 U. S. 211. The

distribution, therefore, was held not a taxable event. In that context -- distinguishing gain from

capital -- the definition served a useful purpose. But it was not meant to provide a touchstone to

all future gross income questions. Helvering v. Bruun, supra, at 309 U. S. 468-469; United

States v. Kirby Lumber Co., supra, at 284 U. S. 3.

Here, we have instances of undeniable accessions to wealth, clearly realized, and over which

the taxpayers have complete dominion. The mere fact that the payments were extracted from

the wrongdoers as punishment for unlawful conduct cannot detract from their character as

taxable income to the recipients. Respondents concede, as they must, that the recoveries are

taxable to the extent that they compensate for damages actually incurred. It would be an

anomaly that could not be justified in the absence of clear congressional intent to say that a

recovery for actual damages is taxable, but not the additional amount extracted as punishment

for the same conduct which caused the injury. And we find no such evidence of intent to exempt

these payments.

It is urged that reenactment of § 22(a) without change since the Board of Tax Appeals held

punitive damages nontaxable in Highland Farms Corp., 42 B.T.A. 1314, indicates congressional

satisfaction with that holding. Reenactment -- particularly without the slightest affirmative

indication that Congress ever had the Highland Farms decision before it -- is an unreliable

indicium, at best.Helvering v. Wilshire Oil Co., 308 U. S. 90, 308 U. S. 100-101; Koshland v.

Helvering, 298 U. S. 441, 298 U. S. 447. Moreover, the Commissioner promptly published his

nonacquiescence in this portion of the Highland Farms holding, [Footnote 7] and has,

Page 348 U. S. 432

before and since, consistently maintained the position that these receipts are taxable. [Footnote

8] It therefore cannot be said with certitude that Congress intended to carve an exception out of

§ 22(a)'s pervasive coverage. Nor does the 1954 Code's [Footnote 9] legislative history, with its

reiteration of the proposition that statutory gross income is "all-inclusive," [Footnote 10] give

support to respondents' position. The definition of gross income has been simplified, but no

effect upon its present broad scope was intended. [Footnote 11] Certainly punitive damages

cannot reasonably be classified as gifts, cf. Commissioner v. Jacobson, 336 U. S. 28, 336 U. S.

47-52, nor do they come under any other exemption provision in the Code. We would do

violence to the plain meaning of the statute and restrict a clear legislative attempt to

Page 348 U. S. 433

bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the

payments in question here are not gross income. See Helvering v. Midland Mutual Life Ins. Co.,

supra, at 300 U. S. 223.

Reversed.

James v. United States 366 U.S. 213 (1961)Annotate this Case

Syllabus

 

 Case

U.S. Supreme Court

James v. United States, 366 U.S. 213 (1961)

James v. United States

No. 63

Argued November 17, 1960

Decided May 15, 1961

366 U.S. 213

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

Syllabus

1. Embezzled money is taxable income of the embezzler in the year of the embezzlement under

§ 22(a) of the Internal Revenue Code of 1939, which defines "gross income" as including "gains

or profits and income derived from any source whatever," and under § 61(a) of the Internal

Revenue Code of 1954, which defines "gross income" as "all income from whatever source

derived."Commissioner v. Wilcox, 327 U. S. 404, overruled. Pp. 366 U. S. 213-222.

2. After this Court's decision in Commissioner v. Wilcox, supra, petitioner embezzled large sums

of money during the years 1951 through 1954. He failed to report those amounts as gross

income in his income tax returns for those years, and he was convicted of "willfully" attempting

to evade the federal income tax due for each of the years 1951 through 1954, in violation of

§145(b) of the Internal Revenue Code of 1939 and § 7201 of the Internal Revenue Code of

1954.

Held: the judgment affirming the conviction is reversed, and the cause is remanded with

directions to dismiss the indictment. Pp. 366 U. S. 214-215, 222.

273 F.2d 5, reversed.

MR. CHIEF JUSTICE WARREN announced the judgment of the Court and an opinion in which

MR. JUSTICE BRENNAN, and MR. JUSTICE STEWART concur.

The issue before us in this case is whether embezzled funds are to be included in the "gross

income" of the embezzler in the year in which the funds are misappropriated

Page 366 U. S. 214

under § 22(a) of the Internal Revenue Code of 1939 [Footnote 1] and § 61(a) of the Internal

Revenue Code of 1954. [Footnote 2]

The facts are not in dispute. The petitioner is a union official who, with another person,

embezzled in excess of $738,000 during the years 1951 through 1954 from his employer union

and from an insurance company with which the union was doing business. [Footnote 3]

Petitioner failed to report these amounts in his gross income in those years, and was convicted

for willfully attempting to evade the federal income tax due for each of the years 1951 through

1954 in violation of § 145(b) of the Internal Revenue Code of 1939 [Footnote 4] and § 7201 of

the Internal Revenue

Page 366 U. S. 215

Code of 1954. [Footnote 5] He was sentenced to a total of three years' imprisonment. The Court

of Appeals affirmed. 273 F.2d 5. Because of a conflict with this Court's decision

in Commissioner v. Wilcox, 327 U. S. 404, a case whose relevant facts are concededly the

same as those in the case now before us, we granted certiorari. 362 U.S. 974.

In Wilcox, the Court held that embezzled money does not constitute taxable income to the

embezzler in the year of the embezzlement under § 22(a) of the Internal Revenue Code of

1939. Six years later, this Court held, in Rutkin v. United States, 343 U. S. 130, that extorted

money does constitutes taxable income to the extortionist in the year that the money is received

under § 22(a) of the Internal Revenue Code of 1939. In Rutkin, the Court did not

overrule Wilcox, but stated:

"We do not reach in this case the factual situation involved in Commissioner v. Wilcox, 327 U. S.

404. We limit that case to its facts. There, embezzled funds were held not to constitute taxable

income to the embezzler under § 22(a)."

Id. at 343 U. S. 138. [Footnote 6] However, examination of the reasoning used in Rutkin leads

us inescapably to the conclusion that Wilcox was thoroughly devitalized.

The basis for the Wilcox decision was

"that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain

and (2) the absence of a definite,

Page 366 U. S. 216

unconditional obligation to repay or return that which would otherwise constitute a gain. Without

some bona fide legal or equitable claim, even though it be contingent or contested in nature, the

taxpayer cannot be said to have received any gain or profit within the reach of Section 22(a)."

Commissioner v. Wilcox, supra, at 327 U. S. 408. Since Wilcox embezzled the money, held it

"without any semblance of a bona fide claim of right," ibid., and therefore "was at all times under

an unqualified duty and obligation to repay the money to his employer," ibid., the Court found

that the money embezzled was not includible within "gross income." But Rutkin's legal claim

was no greater than that of Wilcox. It was specifically found "that petitioner had no basis for his

claim . . . and that he obtained it by extortion." Rutkin v. United States, supra, at 343 U. S. 135.

Both Wilcox and Rutkin obtained the money by means of a criminal act; neither had a bona

fide claim of right to the funds. [Footnote 7] Nor was Rutkin's obligation to repay the extorted

money to the victim any less than that of Wilcox. The victim of an extortion, like the victim of an

embezzlement, has a right to restitution. Furthermore, it is inconsequential that an embezzler

may lack title to the sums he appropriates, while an extortionist may gain a voidable title.

Questions of federal income taxation are not determined by such "attenuated subtleties." Lucas

v. Earl, 281 U. S. 111, 281 U. S. 114; Corliss v.

Page 366 U. S. 217

Bowers, 281 U. S. 376, 281 U. S. 378. Thus, the fact that Rutkin secured the money with the

consent of his victim, Rutkin v. United States, supra, at p. 343 U. S. 138, is irrelevant. Likewise

unimportant is the fact that the sufferer of an extortion is less likely to seek restitution than one

whose funds are embezzled. What is important is that the right to recoupment exists in both

situations.

Examination of the relevant cases in the courts of appeals lends credence to our conclusion that

theWilcox rationale was effectively vitiated by this Court's decision in Rutkin. [Footnote 8]

Although this case appears to be the first to arise that is "on all fours" with Wilcox, the lower

federal courts, in deference to the undisturbed Wilcox holding, have earnestly endeavored to

find distinguishing facts in the cases before them which would enable them to include sundry

unlawful gains within "gross income." [Footnote 9]

Page 366 U. S. 218

It had been a well established principle, long before either Rutkin or Wilcox, that unlawful, as

well as lawful, gains are comprehended within the term "gross income." Section II B of the

Income Tax Act of 1913 provided that

"the net income of a taxable person shall include gains, profits, and income . . . from . . . the

transaction of any lawful business carried on for gain or profit, or gains or profits and income

derived from any source whatever. . . ."

(Emphasis supplied.) 38 Stat. 167. When the statute was amended in 1916, the one word

"lawful" was omitted. This revealed, we think, the obvious intent of that Congress to tax income

derived from both legal and illegal sources, to remove the incongruity of having the gains of the

honest laborer taxed and the gains of the dishonest immune. Rutkin v. United States,

supra, at 343 U. S. 138;United States v. Sullivan, 274 U. S. 259, 274 U. S. 263. Thereafter, the

Court held that gains from illicit traffic in liquor are includible within "gross income." Ibid. See

also Johnson v. United States,318 U. S. 189; United States v. Johnson, 319 U. S. 503. And, the

Court has pointed out, with approval, that there "has been a widespread and settled

administrative and judicial recognition of the taxability of unlawful gains of many kinds," Rutkin v.

United States, supra, at 343 U. S. 137. These include protection payments made to racketeers,

ransom payments paid to kidnappers, bribes, money derived from the sale of unlawful insurance

policies, graft, black market gains, funds obtained from the operation of lotteries, income from

race track bookmaking and illegal prize fight pictures. Ibid.

The starting point in all cases dealing with the question of the scope of what is included in

"gross income" begins with the basic premise that the purpose of Congress was "to use the full

measure of its taxing power." Helvering

Page 366 U. S. 219

v. Clifford, 309 U. S. 331, 309 U. S. 334. And the Court has given a liberal construction to the

broad phraseology of the "gross income" definition statutes in recognition of the intention of

Congress to tax all gains except those specifically exempted. Commissioner v. Jacobson, 336

U. S. 28, 336 U. S. 49; Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 87-91.

The language of § 22(a) of the 1939 Code, "gains or profits and income derived from any

source whatever," and the more simplified language of § 61(a) of the 1954 Code, "all income

from whatever source derived," have been held to encompass all "accessions to wealth, clearly

realized, and over which the taxpayers have complete dominion." Commissioner v. Glenshaw

Glass Co., 348 U. S. 426, 348 U. S. 431. A gain

"constitutes taxable income when its recipient has such control over it that, as a practical matter,

he derives readily realizable economic value from it."

Rutkin v. United States, supra, at 343 U. S. 137. Under these broad principles, we believe that

petitioner's contention, that all unlawful gains are taxable except those resulting from

embezzlement, should fail.

When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition,

express or implied, of an obligation to repay and without restriction as to their disposition,

"he has received income which he is required to return, even though it may still be claimed that

he is not entitled to retain the money, and even though he may still be adjudged liable to restore

its equivalent."

North American Oil Consolidated v. Burnet, supra, at 286 U. S. 424. In such case, the taxpayer

has "actual command over the property taxed-the actual benefit for which the tax is

paid," Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad

sweep of "gross income;" it excludes loans. When a law-abiding taxpayer mistakenly receives

income in one year, which receipt is assailed and found to be invalid in a subsequent

Page 366 U. S. 220

year, the taxpayer must nonetheless report the amount as "gross income" in the year

received.United States v. Lewis, supra; Healy v. Commissioner, supra. We do not believe that

Congress intended to treat a lawbreaking taxpayer differently. Just as the honest taxpayer may

deduct any amount repaid in the year in which the repayment is made, the Government points

out that "If, when, and to the extent that the victim recovers back the misappropriated funds,

there is, of course, a reduction in the embezzler's income." Brief for the United States, p. 24.

[Footnote 10]

Petitioner contends that the Wilcox rule has been in existence since 1946; that, if Congress had

intended to change the rule, it would have done so; that there was a general revision of the

income tax laws in 1954 without mention of the rule; that a bill to change it [Footnote 11] was

introduced in the Eighty-sixth Congress, but was not acted upon; that therefore we may not

change the rule now. But the fact that Congress has remained silent or has reenacted a statute

which we have construed, or that congressional attempts to amend a rule announced by this

Court have failed, does not necessarily debar us from reexamining and correcting the Court's

own errors. Girouard v. United States, 328 U. S. 61, 328 U. S. 69-70; Helvering v. Hallock, 309

U. S. 106, 309 U. S. 119-122. There may have been any number of reasons why Congress

acted as it did. Helvering v. Hallock, supra. One of the reasons could well

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G.R. No. 160756               March 9, 2010

CHAMBER OF REAL ESTATE AND BUILDERS' ASSOCIATIONS, INC., Petitioner, vs.THE HON. EXECUTIVE SECRETARY ALBERTO ROMULO, THE HON. ACTING SECRETARY OF FINANCE JUANITA D. AMATONG, and THE HON. COMMISSIONER OF INTERNAL REVENUE GUILLERMO PARAYNO, JR.,Respondents.

D E C I S I O N

CORONA, J.:

In this original petition for certiorari and mandamus,1 petitioner Chamber of Real Estate and Builders’ Associations, Inc. is questioning the constitutionality of Section 27 (E) of Republic Act (RA) 84242 and the revenue regulations (RRs) issued by the Bureau of Internal Revenue (BIR) to implement said provision and those involving creditable withholding taxes.3

Petitioner is an association of real estate developers and builders in the Philippines. It impleaded former Executive Secretary Alberto Romulo, then acting Secretary of Finance Juanita D. Amatong and then Commissioner of Internal Revenue Guillermo Parayno, Jr. as respondents.

Petitioner assails the validity of the imposition of minimum corporate income tax (MCIT) on corporations and creditable withholding tax (CWT) on sales of real properties classified as ordinary assets.

Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is implemented by RR 9-98. Petitioner argues that the MCIT violates the due process clause because it levies income tax even if there is no realized gain.

Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and 2.58.2 of RR 2-98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe the rules and procedures for the collection of CWT on the sale of real properties categorized as ordinary assets. Petitioner contends that these revenue regulations are contrary to law for two reasons: first, they ignore the different treatment by RA 8424 of ordinary assets and capital assets and second, respondent Secretary of Finance has no authority to collect CWT, much less, to base the CWT on the gross selling price or fair market value of the real properties classified as ordinary assets.

Petitioner also asserts that the enumerated provisions of the subject revenue regulations violate the due process clause because, like the MCIT, the government collects income tax even when the net income has not yet been determined. They contravene the equal protection clause as well because the CWT is being levied upon real estate enterprises but not on other business enterprises, more particularly those in the manufacturing sector.

The issues to be resolved are as follows:

(1) whether or not this Court should take cognizance of the present case;

(2) whether or not the imposition of the MCIT on domestic corporations is unconstitutional and

(3) whether or not the imposition of CWT on income from sales of real properties classified as ordinary assets under RRs 2-98, 6-2001 and 7-2003, is unconstitutional.

Overview of the Assailed Provisions

Under the MCIT scheme, a corporation, beginning on its fourth year of operation, is assessed an MCIT of 2% of its gross income when such MCIT is greater than the normal corporate income tax imposed under Section

27(A).4 If the regular income tax is higher than the MCIT, the corporation does not pay the MCIT. Any excess of the MCIT over the normal tax shall be carried forward and credited against the normal income tax for the three immediately succeeding taxable years. Section 27(E) of RA 8424 provides:

Section 27 (E). [MCIT] on Domestic Corporations. -

(1) Imposition of Tax. – A [MCIT] of two percent (2%) of the gross income as of the end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title, beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the tax computed under Subsection (A) of this Section for the taxable year.

(2) Carry Forward of Excess Minimum Tax. – Any excess of the [MCIT] over the normal income tax as computed under Subsection (A) of this Section shall be carried forward and credited against the normal income tax for the three (3) immediately succeeding taxable years.

(3) Relief from the [MCIT] under certain conditions. – The Secretary of Finance is hereby authorized to suspend the imposition of the [MCIT] on any corporation which suffers losses on account of prolonged labor dispute, or because of force majeure, or because of legitimate business reverses.

The Secretary of Finance is hereby authorized to promulgate, upon recommendation of the Commissioner, the necessary rules and regulations that shall define the terms and conditions under which he may suspend the imposition of the [MCIT] in a meritorious case.

(4) Gross Income Defined. – For purposes of applying the [MCIT] provided under Subsection (E) hereof, the term ‘gross income’ shall mean gross sales less sales returns, discounts and allowances and cost of goods sold. "Cost of goods sold" shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use.

For trading or merchandising concern, "cost of goods sold" shall include the invoice cost of the goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold including insurance while the goods are in transit.

For a manufacturing concern, "cost of goods manufactured and sold" shall include all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse.

In the case of taxpayers engaged in the sale of service, "gross income" means gross receipts less sales returns, allowances, discounts and cost of services. "Cost of services" shall mean all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including (A) salaries and employee benefits of personnel, consultants and specialists directly rendering the service and (B) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies: Provided, however, that in the case of banks, "cost of services" shall include interest expense.

On August 25, 1998, respondent Secretary of Finance (Secretary), on the recommendation of the Commissioner of Internal Revenue (CIR), promulgated RR 9-98 implementing Section 27(E).5 The pertinent portions thereof read:

Sec. 2.27(E) [MCIT] on Domestic Corporations. –

(1) Imposition of the Tax. – A [MCIT] of two percent (2%) of the gross income as of the end of the taxable year (whether calendar or fiscal year, depending on the accounting period employed) is hereby imposed upon any domestic corporation beginning the fourth (4th) taxable year immediately following the taxable year in which such corporation commenced its business operations. The MCIT shall be imposed whenever such corporation has zero or negative taxable income or whenever the amount of minimum corporate income tax is greater than the normal income tax due from such corporation.

For purposes of these Regulations, the term, "normal income tax" means the income tax rates prescribed under Sec. 27(A) and Sec. 28(A)(1) of the Code xxx at 32% effective January 1, 2000 and thereafter.

x x x           x x x          x x x

(2) Carry forward of excess [MCIT]. – Any excess of the [MCIT] over the normal income tax as computed under Sec. 27(A) of the Code shall be carried forward on an annual basis and credited against the normal income tax for the three (3) immediately succeeding taxable years.

x x x           x x x          x x x

Meanwhile, on April 17, 1998, respondent Secretary, upon recommendation of respondent CIR, promulgated RR 2-98 implementing certain provisions of RA 8424 involving the withholding of taxes.6 Under Section 2.57.2(J) of RR No. 2-98, income payments from the sale, exchange or transfer of real property, other than capital assets, by persons residing in the Philippines and habitually engaged in the real estate business were subjected to CWT:

Sec. 2.57.2. Income payment subject to [CWT] and rates prescribed thereon:

x x x           x x x          x x x

(J) Gross selling price or total amount of consideration or its equivalent paid to the seller/owner for the sale, exchange or transfer of. – Real property, other than capital assets, sold by an individual, corporation, estate, trust, trust fund or pension fund and the seller/transferor is habitually engaged in the real estate business in accordance with the following schedule –

Those which are exempt from a withholding tax at source as prescribed in Sec. 2.57.5 of these regulations.

Exempt

With a selling price of five hundred thousand pesos (P500,000.00) or less.

1.5%

With a selling price of more than five hundred thousand pesos (P500,000.00) but not more than two million pesos (P2,000,000.00).

3.0%

With selling price of more than two million pesos (P2,000,000.00)

5.0%

x x x           x x x          x x x

Gross selling price shall mean the consideration stated in the sales document or the fair market value determined in accordance with Section 6 (E) of the Code, as amended, whichever is higher. In an exchange, the fair market value of the property received in exchange, as determined in the Income Tax Regulations shall be used.

Where the consideration or part thereof is payable on installment, no withholding tax is required to be made on the periodic installment payments where the buyer is an individual not engaged in trade or business. In such a case, the applicable rate of tax based on the entire consideration shall be withheld on the last installment or installments to be paid to the seller.

However, if the buyer is engaged in trade or business, whether a corporation or otherwise, the tax shall be deducted and withheld by the buyer on every installment.

This provision was amended by RR 6-2001 on July 31, 2001:

Sec. 2.57.2. Income payment subject to [CWT] and rates prescribed thereon:

x x x           x x x          x x x

(J) Gross selling price or total amount of consideration or its equivalent paid to the seller/owner for the sale, exchange or transfer of real property classified as ordinary asset. - A [CWT] based on the gross selling price/total amount of consideration or the fair market value determined in accordance with Section 6(E) of the Code, whichever is higher, paid to the seller/owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent,/buyer, in accordance with the following schedule:

Where the seller/transferor is exempt from [CWT] in accordance with Sec. 2.57.5 of these regulations.

Exempt

Upon the following values of real property, where the seller/transferor is habitually engaged in the real estate business.

 

With a selling price of Five Hundred Thousand Pesos (P500,000.00) or less.

1.5%

With a selling price of more than Five Hundred Thousand Pesos (P500,000.00) but not more than Two Million Pesos (P2,000,000.00).

3.0%

With a selling price of more than two Million Pesos (P2,000,000.00).

5.0%

x x x           x x x          x x x

Gross selling price shall remain the consideration stated in the sales document or the fair market value determined in accordance with Section 6 (E) of the Code, as amended, whichever is higher. In an exchange, the fair market value of the property received in exchange shall be considered as the consideration.

x x x           x x x          x x x

However, if the buyer is engaged in trade or business, whether a corporation or otherwise, these rules shall apply:

(i) If the sale is a sale of property on the installment plan (that is, payments in the year of sale do not exceed 25% of the selling price), the tax shall be deducted and withheld by the buyer on every installment.

(ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale not on the installment plan" (that is, payments in the year of sale exceed 25% of the selling price), the buyer shall withhold the tax based on the gross selling price or fair market value of the property, whichever is higher, on the first installment.

In any case, no Certificate Authorizing Registration (CAR) shall be issued to the buyer unless the [CWT] due on the sale, transfer or exchange of real property other than capital asset has been fully paid. (Underlined amendments in the original)

Section 2.58.2 of RR 2-98 implementing Section 58(E) of RA 8424 provides that any sale, barter or exchange subject to the CWT will not be recorded by the Registry of Deeds until the CIR has certified that such transfers and conveyances have been reported and the taxes thereof have been duly paid:7

Sec. 2.58.2. Registration with the Register of Deeds. – Deeds of conveyances of land or land and building/improvement thereon arising from sales, barters, or exchanges subject to the creditable expanded withholding tax shall not be recorded by the Register of Deeds unless the [CIR] or his duly authorized representative has certified that such transfers and conveyances have been reported and the expanded withholding tax, inclusive of the documentary stamp tax, due thereon have been fully paid xxxx.

On February 11, 2003, RR No. 7-20038 was promulgated, providing for the guidelines in determining whether a particular real property is a capital or an ordinary asset for purposes of imposing the MCIT, among others. The pertinent portions thereof state:

Section 4. Applicable taxes on sale, exchange or other disposition of real property. - Gains/Income derived from sale, exchange, or other disposition of real properties shall, unless otherwise exempt, be subject to applicable taxes imposed under the Code, depending on whether the subject properties are classified as capital assets or ordinary assets;

a. In the case of individual citizen (including estates and trusts), resident aliens, and non-resident aliens engaged in trade or business in the Philippines;

x x x           x x x          x x x

(ii) The sale of real property located in the Philippines, classified as ordinary assets, shall be subject to the [CWT] (expanded) under Sec. 2.57..2(J) of [RR 2-98], as amended, based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of the Code, whichever is higher, and consequently, to the ordinary income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the case may be, based on net taxable income.

x x x           x x x          x x x

c. In the case of domestic corporations. –

x x x           x x x          x x x

(ii) The sale of land and/or building classified as ordinary asset and other real property (other than land and/or building treated as capital asset), regardless of the classification thereof, all of which are located in the Philippines, shall be subject to the [CWT] (expanded) under Sec. 2.57.2(J) of [RR 2-98], as amended, and consequently, to the ordinary income tax under Sec. 27(A) of the Code. In lieu of the ordinary income tax, however, domestic corporations may become subject to the [MCIT] under Sec. 27(E) of the Code, whichever is applicable.

x x x           x x x          x x x

We shall now tackle the issues raised.

Existence of a Justiciable Controversy

Courts will not assume jurisdiction over a constitutional question unless the following requisites are satisfied: (1) there must be an actual case calling for the exercise of judicial review; (2) the question before the court must be ripe for adjudication; (3) the person challenging the validity of the act must have standing to do so; (4) the question of constitutionality must have been raised at the earliest opportunity and (5) the issue of constitutionality must be the very lis mota of the case.9

Respondents aver that the first three requisites are absent in this case. According to them, there is no actual case calling for the exercise of judicial power and it is not yet ripe for adjudication because

[petitioner] did not allege that CREBA, as a corporate entity, or any of its members, has been assessed by the BIR for the payment of [MCIT] or [CWT] on sales of real property. Neither did petitioner allege that its members have shut down their businesses as a result of the payment of the MCIT or CWT. Petitioner has raised concerns in mere abstract and hypothetical form without any actual, specific and concrete instances cited that the assailed law and revenue regulations have actually and adversely affected it. Lacking empirical data on which to base any conclusion, any discussion on the constitutionality of the MCIT or CWT on sales of real property is essentially an academic exercise.

Perceived or alleged hardship to taxpayers alone is not an adequate justification for adjudicating abstract issues. Otherwise, adjudication would be no different from the giving of advisory opinion that does not really settle legal issues.10

An actual case or controversy involves a conflict of legal rights or an assertion of opposite legal claims which is susceptible of judicial resolution as distinguished from a hypothetical or abstract difference or dispute.11 On the other hand, a question is considered ripe for adjudication when the act being challenged has a direct adverse effect on the individual challenging it.12

Contrary to respondents’ assertion, we do not have to wait until petitioner’s members have shut down their operations as a result of the MCIT or CWT. The assailed provisions are already being implemented. As we stated in Didipio Earth-Savers’ Multi-Purpose Association, Incorporated (DESAMA) v. Gozun:13

By the mere enactment of the questioned law or the approval of the challenged act, the dispute is said to have ripened into a judicial controversy even without any other overt act. Indeed, even a singular violation of the Constitution and/or the law is enough to awaken judicial duty.14

If the assailed provisions are indeed unconstitutional, there is no better time than the present to settle such question once and for all.

Respondents next argue that petitioner has no legal standing to sue:

Petitioner is an association of some of the real estate developers and builders in the Philippines. Petitioners did not allege that [it] itself is in the real estate business. It did not allege any material interest or any wrong that it may suffer from the enforcement of [the assailed provisions].15

Legal standing or locus standi is a party’s personal and substantial interest in a case such that it has sustained or will sustain direct injury as a result of the governmental act being challenged.16 In Holy Spirit Homeowners Association, Inc. v. Defensor,17 we held that the association had legal standing because its members stood to be injured by the enforcement of the assailed provisions:

Petitioner association has the legal standing to institute the instant petition xxx. There is no dispute that the individual members of petitioner association are residents of the NGC. As such they are covered and stand to be either benefited or injured by the enforcement of the IRR, particularly as regards the selection process of beneficiaries and lot allocation to qualified beneficiaries. Thus, petitioner association may assail those provisions in the IRR which it believes to be unfavorable to the rights of its members. xxx Certainly, petitioner and its members have sustained direct injury arising from the enforcement of the IRR in that they have been disqualified and eliminated from the selection process.18

In any event, this Court has the discretion to take cognizance of a suit which does not satisfy the requirements of an actual case, ripeness or legal standing when paramount public interest is involved.19 The questioned MCIT and CWT affect not only petitioners but practically all domestic corporate taxpayers in our country. The transcendental importance of the issues raised and their overreaching significance to society make it proper for us to take cognizance of this petition.20

Concept and Rationale of the MCIT

The MCIT on domestic corporations is a new concept introduced by RA 8424 to the Philippine taxation system. It came about as a result of the perceived inadequacy of the self-assessment system in capturing the true income of corporations.21 It was devised as a relatively simple and effective revenue-raising instrument compared to the normal income tax which is more difficult to control and enforce. It is a means to ensure that everyone will make some minimum contribution to the support of the public sector. The congressional deliberations on this are illuminating:

Senator Enrile. Mr. President, we are not unmindful of the practice of certain corporations of reporting constantly a loss in their operations to avoid the payment of taxes, and thus avoid sharing in the cost of government. In this regard, the Tax Reform Act introduces for the first time a new concept called the [MCIT] so as to minimize tax evasion, tax avoidance, tax manipulation in the country and for administrative convenience. … This will go a long way in ensuring that corporations will pay their just share in supporting our public life and our economic advancement.22

Domestic corporations owe their corporate existence and their privilege to do business to the government. They also benefit from the efforts of the government to improve the financial market and to ensure a favorable business climate. It is therefore fair for the government to require them to make a reasonable contribution to the public expenses.

Congress intended to put a stop to the practice of corporations which, while having large turn-overs, report minimal or negative net income resulting in minimal or zero income taxes year in and year out, through under-declaration of income or over-deduction of expenses otherwise called tax shelters.23

Mr. Javier (E.) … [This] is what the Finance Dept. is trying to remedy, that is why they have proposed the [MCIT]. Because from experience too, you have corporations which have been losing year in and year out and paid no tax. So, if the corporation has been losing for the past five years to ten years, then that corporation has no business to be in business. It is dead. Why continue if you are losing year in and year out? So, we have this provision to avoid this type of tax shelters, Your Honor.24

The primary purpose of any legitimate business is to earn a profit. Continued and repeated losses after operations of a corporation or consistent reports of minimal net income render its financial statements and its tax payments suspect. For sure, certain tax avoidance schemes resorted to by corporations are allowed in our jurisdiction. The MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax evasion and minimizes tax avoidance schemes achieved through sophisticated and artful manipulations of deductions and other stratagems. Since the tax base was broader, the tax rate was lowered.

To further emphasize the corrective nature of the MCIT, the following safeguards were incorporated into the law:

First, recognizing the birth pangs of businesses and the reality of the need to recoup initial major capital expenditures, the imposition of the MCIT commences only on the fourth taxable year immediately following the year in which the corporation commenced its operations.25 This grace period allows a new business to stabilize first and make its ventures viable before it is subjected to the MCIT.26

Second, the law allows the carrying forward of any excess of the MCIT paid over the normal income tax which shall be credited against the normal income tax for the three immediately succeeding years.27

Third, since certain businesses may be incurring genuine repeated losses, the law authorizes the Secretary of Finance to suspend the imposition of MCIT if a corporation suffers losses due to prolonged labor dispute, force majeure and legitimate business reverses.28

Even before the legislature introduced the MCIT to the Philippine taxation system, several other countries already had their own system of minimum corporate income taxation. Our lawmakers noted that most developing countries, particularly Latin American and Asian countries, have the same form of safeguards as we do. As pointed out during the committee hearings:

[Mr. Medalla:] Note that most developing countries where you have of course quite a bit of room for underdeclaration of gross receipts have this same form of safeguards.

In the case of Thailand, half a percent (0.5%), there’s a minimum of income tax of half a percent (0.5%) of gross assessable income. In Korea a 25% of taxable income before deductions and exemptions. Of course the different countries have different basis for that minimum income tax.

The other thing you’ll notice is the preponderance of Latin American countries that employed this method. Okay, those are additional Latin American countries.29

At present, the United States of America, Mexico, Argentina, Tunisia, Panama and Hungary have their own versions of the MCIT.30

MCIT Is Not Violative of Due Process

Petitioner claims that the MCIT under Section 27(E) of RA 8424 is unconstitutional because it is highly oppressive, arbitrary and confiscatory which amounts to deprivation of property without due process of law. It explains that gross income as defined under said provision only considers the cost of goods sold and other direct expenses; other major expenditures, such as administrative and interest expenses which are equally necessary to produce gross income, were not taken into account.31 Thus, pegging the tax base of the MCIT to a corporation’s gross income is tantamount to a confiscation of capital because gross income, unlike net income, is not "realized gain."32

We disagree.

Taxes are the lifeblood of the government. Without taxes, the government can neither exist nor endure. The exercise of taxing power derives its source from the very existence of the State whose social contract with its citizens obliges it to promote public interest and the common good.33

Taxation is an inherent attribute of sovereignty.34 It is a power that is purely legislative.35 Essentially, this means that in the legislature primarily lies the discretion to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation.36 It has the authority to prescribe a certain tax at a specific rate for a particular public purpose on persons or things within its jurisdiction. In other words, the legislature wields the power to define what tax shall be imposed, why it should be imposed, how much tax shall be imposed, against whom (or what) it shall be imposed and where it shall be imposed.

As a general rule, the power to tax is plenary and unlimited in its range, acknowledging in its very nature no limits, so that the principal check against its abuse is to be found only in the responsibility of the legislature (which imposes the tax) to its constituency who are to pay it.37 Nevertheless, it is circumscribed by constitutional limitations. At the same time, like any other statute, tax legislation carries a presumption of constitutionality.

The constitutional safeguard of due process is embodied in the fiat "[no] person shall be deprived of life, liberty or property without due process of law." In Sison, Jr. v. Ancheta, et al.,38 we held that the due process clause may properly be invoked to invalidate, in appropriate cases, a revenue measure39 when it amounts to a confiscation of property.40 But in the same case, we also explained that we will not strike down a revenue measure as unconstitutional (for being violative of the due process clause) on the mere allegation of arbitrariness by the taxpayer.41 There must be a factual foundation to such an unconstitutional taint.42 This merely adheres to the authoritative doctrine that, where the due process clause is invoked, considering that it is not a fixed rule but rather a broad standard, there is a need for proof of such persuasive character.43

Petitioner is correct in saying that income is distinct from capital.44 Income means all the wealth which flows into the taxpayer other than a mere return on capital. Capital is a fund or property existing at one distinct point in time while income denotes a flow of wealth during a definite period of time.45 Income is gain derived and severed from capital.46 For income to be taxable, the following requisites must exist:

(1) there must be gain;

(2) the gain must be realized or received and

(3) the gain must not be excluded by law or treaty from taxation.47

Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is not income. In other words, it is income, not capital, which is subject to income tax. However, the MCIT is not a tax on capital.

The MCIT is imposed on gross income which is arrived at by deducting the capital spent by a corporation in the sale of its goods, i.e., the cost of goods48 and other direct expenses from gross sales. Clearly, the capital is not being taxed.

Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the normal net income tax, and only if the normal income tax is suspiciously low. The MCIT merely approximates the amount of net income tax due from a corporation, pegging the rate at a very much reduced 2% and uses as the base the corporation’s gross income.

Besides, there is no legal objection to a broader tax base or taxable income by eliminating all deductible items and at the same time reducing the applicable tax rate.49

Statutes taxing the gross "receipts," "earnings," or "income" of particular corporations are found in many jurisdictions. Tax thereon is generally held to be within the power of a state to impose; or constitutional, unless it interferes with interstate commerce or violates the requirement as to uniformity of taxation.50

The United States has a similar alternative minimum tax (AMT) system which is generally characterized by a lower tax rate but a broader tax base.51 Since our income tax laws are of American origin, interpretations by American courts of our parallel tax laws have persuasive effect on the interpretation of these laws.52 Although our MCIT is not exactly the same as the AMT, the policy behind them and the procedure of their implementation are comparable. On the question of the AMT’s constitutionality, the United States Court of Appeals for the Ninth Circuit stated in Okin v. Commissioner:53

In enacting the minimum tax, Congress attempted to remedy general taxpayer distrust of the system growing from large numbers of taxpayers with large incomes who were yet paying no taxes.

x x x           x x x          x x x

We thus join a number of other courts in upholding the constitutionality of the [AMT]. xxx [It] is a rational means of obtaining a broad-based tax, and therefore is constitutional.54

The U.S. Court declared that the congressional intent to ensure that corporate taxpayers would contribute a minimum amount of taxes was a legitimate governmental end to which the AMT bore a reasonable relation.55

American courts have also emphasized that Congress has the power to condition, limit or deny deductions from gross income in order to arrive at the net that it chooses to tax.56 This is because deductions are a matter of legislative grace.57

Absent any other valid objection, the assignment of gross income, instead of net income, as the tax base of the MCIT, taken with the reduction of the tax rate from 32% to 2%, is not constitutionally objectionable.

Moreover, petitioner does not cite any actual, specific and concrete negative experiences of its members nor does it present empirical data to show that the implementation of the MCIT resulted in the confiscation of their property.

In sum, petitioner failed to support, by any factual or legal basis, its allegation that the MCIT is arbitrary and confiscatory. The Court cannot strike down a law as unconstitutional simply because of its yokes.58 Taxation is

necessarily burdensome because, by its nature, it adversely affects property rights.59 The party alleging the law’s unconstitutionality has the burden to demonstrate the supposed violations in understandable terms.60

RR 9-98 Merely Clarifies Section 27(E) of RA 8424

Petitioner alleges that RR 9-98 is a deprivation of property without due process of law because the MCIT is being imposed and collected even when there is actually a loss, or a zero or negative taxable income:

Sec. 2.27(E) [MCIT] on Domestic Corporations. —

(1) Imposition of the Tax. — xxx The MCIT shall be imposed whenever such corporation has zero or negative taxable income or whenever the amount of [MCIT] is greater than the normal income tax due from such corporation. (Emphasis supplied)

RR 9-98, in declaring that MCIT should be imposed whenever such corporation has zero or negative taxable income, merely defines the coverage of Section 27(E). This means that even if a corporation incurs a net loss in its business operations or reports zero income after deducting its expenses, it is still subject to an MCIT of 2% of its gross income. This is consistent with the law which imposes the MCIT on gross income notwithstanding the amount of the net income. But the law also states that the MCIT is to be paid only if it is greater than the normal net income. Obviously, it may well be the case that the MCIT would be less than the net income of the corporation which posts a zero or negative taxable income.

We now proceed to the issues involving the CWT.

The withholding tax system is a procedure through which taxes (including income taxes) are collected.61 Under Section 57 of RA 8424, the types of income subject to withholding tax are divided into three categories: (a) withholding of final tax on certain incomes; (b) withholding of creditable tax at source and (c) tax-free covenant bonds. Petitioner is concerned with the second category (CWT) and maintains that the revenue regulations on the collection of CWT on sale of real estate categorized as ordinary assets are unconstitutional.

Petitioner, after enumerating the distinctions between capital and ordinary assets under RA 8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and Sections 4(a)(ii) and (c)(ii) of RR 7-2003 were promulgated "with grave abuse of discretion amounting to lack of jurisdiction" and "patently in contravention of law"62 because they ignore such distinctions. Petitioner’s conclusion is based on the following premises: (a) the revenue regulations use gross selling price (GSP) or fair market value (FMV) of the real estate as basis for determining the income tax for the sale of real estate classified as ordinary assets and (b) they mandate the collection of income tax on a per transaction basis, i.e., upon consummation of the sale via the CWT, contrary to RA 8424 which calls for the payment of the net income at the end of the taxable period.63

Petitioner theorizes that since RA 8424 treats capital assets and ordinary assets differently, respondents cannot disregard the distinctions set by the legislators as regards the tax base, modes of collection and payment of taxes on income from the sale of capital and ordinary assets.

Petitioner’s arguments have no merit.

Authority of the Secretary of Finance to Order the Collection of CWT on Sales of Real Property Considered as Ordinary Assets

The Secretary of Finance is granted, under Section 244 of RA 8424, the authority to promulgate the necessary rules and regulations for the effective enforcement of the provisions of the law. Such authority is subject to the limitation that the rules and regulations must not override, but must remain consistent and in harmony with, the law they seek to apply and implement.64 It is well-settled that an administrative agency cannot amend an act of Congress.65

We have long recognized that the method of withholding tax at source is a procedure of collecting income tax which is sanctioned by our tax laws.66 The withholding tax system was devised for three primary reasons: first, to provide the taxpayer a convenient manner to meet his probable income tax liability; second, to ensure the collection of income tax which can otherwise be lost or substantially reduced through failure to file the corresponding returns and third, to improve the government’s cash flow.67 This results in administrative savings, prompt and efficient collection of taxes, prevention of delinquencies and reduction of governmental effort to collect taxes through more complicated means and remedies.68

Respondent Secretary has the authority to require the withholding of a tax on items of income payable to any person, national or juridical, residing in the Philippines. Such authority is derived from Section 57(B) of RA 8424 which provides:

SEC. 57. Withholding of Tax at Source. –

x x x           x x x          x x x

(B) Withholding of Creditable Tax at Source. The [Secretary] may, upon the recommendation of the [CIR], require the withholding of a tax on the items of income payable to natural or juridical persons, residing in the Philippines, by payor-corporation/persons as provided for by law, at the rate of not less than one percent (1%) but not more than thirty-two percent (32%) thereof, which shall be credited against the income tax liability of the taxpayer for the taxable year.

The questioned provisions of RR 2-98, as amended, are well within the authority given by Section 57(B) to the Secretary,i.e., the graduated rate of 1.5%-5% is between the 1%-32% range; the withholding tax is imposed on the income payable and the tax is creditable against the income tax liability of the taxpayer for the taxable year.

Effect of RRs on the Tax Base for the Income Tax of Individuals or Corporations Engaged in the Real Estate Business

Petitioner maintains that RR 2-98, as amended, arbitrarily shifted the tax base of a real estate business’ income tax from net income to GSP or FMV of the property sold.

Petitioner is wrong.

The taxes withheld are in the nature of advance tax payments by a taxpayer in order to extinguish its possible tax obligation. 69 They are installments on the annual tax which may be due at the end of the taxable year.70

Under RR 2-98, the tax base of the income tax from the sale of real property classified as ordinary assets remains to be the entity’s net income imposed under Section 24 (resident individuals) or Section 27 (domestic corporations) in relation to Section 31 of RA 8424, i.e. gross income less allowable deductions. The CWT is to be deducted from the net income tax payable by the taxpayer at the end of the taxable year.71 Precisely, Section 4(a)(ii) and (c)(ii) of RR 7-2003 reiterate that the tax base for the sale of real property classified as ordinary assets remains to be the net taxable income:

Section 4. – Applicable taxes on sale, exchange or other disposition of real property. - Gains/Income derived from sale, exchange, or other disposition of real properties shall unless otherwise exempt, be subject to applicable taxes imposed under the Code, depending on whether the subject properties are classified as capital assets or ordinary assets;

x x x           x x x          x x x

a. In the case of individual citizens (including estates and trusts), resident aliens, and non-resident aliens engaged in trade or business in the Philippines;

x x x           x x x          x x x

(ii) The sale of real property located in the Philippines, classified as ordinary assets, shall be subject to the [CWT] (expanded) under Sec. 2.57.2(j) of [RR 2-98], as amended, based on the [GSP] or current [FMV] as determined in accordance with Section 6(E) of the Code, whichever is higher, and consequently, to the ordinary income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the case may be, based on net taxable income.

x x x           x x x          x x x

c. In the case of domestic corporations.

The sale of land and/or building classified as ordinary asset and other real property (other than land and/or building treated as capital asset), regardless of the classification thereof, all of which are located in the Philippines, shall be subject to the [CWT] (expanded) under Sec. 2.57.2(J) of [RR 2-98], as amended, and consequently, to the ordinary income tax under Sec. 27(A) of the Code. In lieu of the ordinary income tax, however, domestic corporations may become subject to the [MCIT] under Sec. 27(E) of the same Code, whichever is applicable. (Emphasis supplied)

Accordingly, at the end of the year, the taxpayer/seller shall file its income tax return and credit the taxes withheld (by the withholding agent/buyer) against its tax due. If the tax due is greater than the tax withheld, then the taxpayer shall pay the difference. If, on the other hand, the tax due is less than the tax withheld, the taxpayer will be entitled to a refund or tax credit. Undoubtedly, the taxpayer is taxed on its net income.

The use of the GSP/FMV as basis to determine the withholding taxes is evidently for purposes of practicality and convenience. Obviously, the withholding agent/buyer who is obligated to withhold the tax does not know, nor is he privy to, how much the taxpayer/seller will have as its net income at the end of the taxable year. Instead, said withholding agent’s knowledge and privity are limited only to the particular transaction in which he is a party. In such a case, his basis can only be the GSP or FMV as these are the only factors reasonably known or knowable by him in connection with the performance of his duties as a withholding agent.

No Blurring of Distinctions Between Ordinary Assets and Capital Assets

RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real property categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA 8424 imposes a final tax and flat rate of 6% on the gain presumed to be realized from the sale of a capital asset based on its GSP or FMV. This final tax is also withheld at source.72

The differences between the two forms of withholding tax, i.e., creditable and final, show that ordinary assets are not treated in the same manner as capital assets. Final withholding tax (FWT) and CWT are distinguished as follows:

FWT CWT

a) The amount of income tax withheld by the withholding agent is constituted as a full and final payment of the income tax due from the payee on the said income.

a) Taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income.

b)The liability for payment of the tax rests primarily on the payor as a withholding agent.

b) Payee of income is required to report the income and/or pay the difference between the tax withheld and the tax due on the income.

The payee also has the right to ask for a refund if the tax withheld is more than the tax due.

c) The payee is not required to file an income tax return for the particular income.73

c) The income recipient is still required to file an income tax return, as prescribed in Sec. 51 and Sec. 52 of the NIRC, as amended.74

As previously stated, FWT is imposed on the sale of capital assets. On the other hand, CWT is imposed on the sale of ordinary assets. The inherent and substantial differences between FWT and CWT disprove petitioner’s contention that ordinary assets are being lumped together with, and treated similarly as, capital assets in contravention of the pertinent provisions of RA 8424.

Petitioner insists that the levy, collection and payment of CWT at the time of transaction are contrary to the provisions of RA 8424 on the manner and time of filing of the return, payment and assessment of income tax involving ordinary assets.75

The fact that the tax is withheld at source does not automatically mean that it is treated exactly the same way as capital gains. As aforementioned, the mechanics of the FWT are distinct from those of the CWT. The withholding agent/buyer’s act of collecting the tax at the time of the transaction by withholding the tax due from the income payable is the essence of the withholding tax method of tax collection.

No Rule that Only Passive

Incomes Can Be Subject to CWT

Petitioner submits that only passive income can be subjected to withholding tax, whether final or creditable. According to petitioner, the whole of Section 57 governs the withholding of income tax on passive income. The enumeration in Section 57(A) refers to passive income being subjected to FWT. It follows that Section 57(B) on CWT should also be limited to passive income:

SEC. 57. Withholding of Tax at Source. —

(A) Withholding of Final Tax on Certain Incomes. — Subject to rules and regulations, the [Secretary] may promulgate, upon the recommendation of the [CIR], requiring the filing of income tax return by certain income payees, the tax imposed or prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of this Code on specified items of income shall be withheld by payor-corporation and/or person and paid in the same manner and subject to the same conditions as provided in Section 58 of this Code.

(B) Withholding of Creditable Tax at Source. — The [Secretary] may, upon the recommendation of the [CIR], require the withholding of a tax on the items of income payable to natural or juridical persons, residing in the Philippines, by payor-corporation/persons as provided for by law, at the rate of not less than one percent (1%) but not more than thirty-two percent (32%) thereof, which shall be credited against the income tax liability of the taxpayer for the taxable year. (Emphasis supplied)

This line of reasoning is non sequitur.

Section 57(A) expressly states that final tax can be imposed on certain kinds of income and enumerates these as passive income. The BIR defines passive income by stating what it is not:

…if the income is generated in the active pursuit and performance of the corporation’s primary purposes, the same is not passive income…76

It is income generated by the taxpayer’s assets. These assets can be in the form of real properties that return rental income, shares of stock in a corporation that earn dividends or interest income received from savings.

On the other hand, Section 57(B) provides that the Secretary can require a CWT on "income payable to natural or juridical persons, residing in the Philippines." There is no requirement that this income be passive income. If that were the intent of Congress, it could have easily said so.

Indeed, Section 57(A) and (B) are distinct. Section 57(A) refers to FWT while Section 57(B) pertains to CWT. The former covers the kinds of passive income enumerated therein and the latter encompasses any income other than those listed in 57(A). Since the law itself makes distinctions, it is wrong to regard 57(A) and 57(B) in the same way.

To repeat, the assailed provisions of RR 2-98, as amended, do not modify or deviate from the text of Section 57(B). RR 2-98 merely implements the law by specifying what income is subject to CWT. It has been held that, where a statute does not require any particular procedure to be followed by an administrative agency, the agency may adopt any reasonable method to carry out its functions.77 Similarly, considering that the law uses the general term "income," the Secretary and CIR may specify the kinds of income the rules will apply to based on what is feasible. In addition, administrative rules and regulations ordinarily deserve to be given weight and respect by the courts78 in view of the rule-making authority given to those who formulate them and their specific expertise in their respective fields.

No Deprivation of Property Without Due Process

Petitioner avers that the imposition of CWT on GSP/FMV of real estate classified as ordinary assets deprives its members of their property without due process of law because, in their line of business, gain is never assured by mere receipt of the selling price. As a result, the government is collecting tax from net income not yet gained or earned.

Again, it is stressed that the CWT is creditable against the tax due from the seller of the property at the end of the taxable year. The seller will be able to claim a tax refund if its net income is less than the taxes withheld. Nothing is taken that is not due so there is no confiscation of property repugnant to the constitutional guarantee of due process. More importantly, the due process requirement applies to the power to tax.79 The CWT does not impose new taxes nor does it increase taxes.80 It relates entirely to the method and time of payment.

Petitioner protests that the refund remedy does not make the CWT less burdensome because taxpayers have to wait years and may even resort to litigation before they are granted a refund.81 This argument is misleading. The practical problems encountered in claiming a tax refund do not affect the constitutionality and validity of the CWT as a method of collecting the tax. 1avvphi1

Petitioner complains that the amount withheld would have otherwise been used by the enterprise to pay labor wages, materials, cost of money and other expenses which can then save the entity from having to obtain loans entailing considerable interest expense. Petitioner also lists the expenses and pitfalls of the trade which add to the burden of the realty industry: huge investments and borrowings; long gestation period; sudden and unpredictable interest rate surges; continually spiraling development/construction costs; heavy taxes and prohibitive "up-front" regulatory fees from at least 20 government agencies.82

Petitioner’s lamentations will not support its attack on the constitutionality of the CWT. Petitioner’s complaints are essentially matters of policy best addressed to the executive and legislative branches of the government. Besides, the CWT is applied only on the amounts actually received or receivable by the real estate entity. Sales on installment are taxed on a per-installment basis.83 Petitioner’s desire to utilize for its operational and capital

expenses money earmarked for the payment of taxes may be a practical business option but it is not a fundamental right which can be demanded from the court or from the government.

No Violation of Equal Protection

Petitioner claims that the revenue regulations are violative of the equal protection clause because the CWT is being levied only on real estate enterprises. Specifically, petitioner points out that manufacturing enterprises are not similarly imposed a CWT on their sales, even if their manner of doing business is not much different from that of a real estate enterprise. Like a manufacturing concern, a real estate business is involved in a continuous process of production and it incurs costs and expenditures on a regular basis. The only difference is that "goods" produced by the real estate business are house and lot units.84

Again, we disagree.

The equal protection clause under the Constitution means that "no person or class of persons shall be deprived of the same protection of laws which is enjoyed by other persons or other classes in the same place and in like circumstances."85 Stated differently, all persons belonging to the same class shall be taxed alike. It follows that the guaranty of the equal protection of the laws is not violated by legislation based on a reasonable classification. Classification, to be valid, must (1) rest on substantial distinctions; (2) be germane to the purpose of the law; (3) not be limited to existing conditions only and (4) apply equally to all members of the same class.86

The taxing power has the authority to make reasonable classifications for purposes of taxation.87 Inequalities which result from a singling out of one particular class for taxation, or exemption, infringe no constitutional limitation.88 The real estate industry is, by itself, a class and can be validly treated differently from other business enterprises.

Petitioner, in insisting that its industry should be treated similarly as manufacturing enterprises, fails to realize that what distinguishes the real estate business from other manufacturing enterprises, for purposes of the imposition of the CWT, is not their production processes but the prices of their goods sold and the number of transactions involved. The income from the sale of a real property is bigger and its frequency of transaction limited, making it less cumbersome for the parties to comply with the withholding tax scheme.

On the other hand, each manufacturing enterprise may have tens of thousands of transactions with several thousand customers every month involving both minimal and substantial amounts. To require the customers of manufacturing enterprises, at present, to withhold the taxes on each of their transactions with their tens or hundreds of suppliers may result in an inefficient and unmanageable system of taxation and may well defeat the purpose of the withholding tax system.

Petitioner counters that there are other businesses wherein expensive items are also sold infrequently, e.g. heavy equipment, jewelry, furniture, appliance and other capital goods yet these are not similarly subjected to the CWT.89 As already discussed, the Secretary may adopt any reasonable method to carry out its functions.90 Under Section 57(B), it may choose what to subject to CWT.

A reading of Section 2.57.2 (M) of RR 2-98 will also show that petitioner’s argument is not accurate. The sales of manufacturers who have clients within the top 5,000 corporations, as specified by the BIR, are also subject to CWT for their transactions with said 5,000 corporations.91

Section 2.58.2 of RR No. 2-98 Merely Implements Section 58 of RA 8424

Lastly, petitioner assails Section 2.58.2 of RR 2-98, which provides that the Registry of Deeds should not effect the regisration of any document transferring real property unless a certification is issued by the CIR that the withholding tax has been paid. Petitioner proffers hardly any reason to strike down this rule except to rely on its contention that the CWT is unconstitutional. We have ruled that it is not. Furthermore, this provision uses almost exactly the same wording as Section 58(E) of RA 8424 and is unquestionably in accordance with it:

Sec. 58. Returns and Payment of Taxes Withheld at Source. –

(E) Registration with Register of Deeds. - No registration of any document transferring real property shall be effected by the Register of Deeds unless the [CIR] or his duly authorized representative has certified that such transfer has been reported, and the capital gains or [CWT], if any, has been paid: xxxx any violation of this provision by the Register of Deeds shall be subject to the penalties imposed under Section 269 of this Code. (Emphasis supplied)

Conclusion

The renowned genius Albert Einstein was once quoted as saying "[the] hardest thing in the world to understand is the income tax."92 When a party questions the constitutionality of an income tax measure, it has to contend not only with Einstein’s observation but also with the vast and well-established jurisprudence in support of the plenary powers of Congress to impose taxes. Petitioner has miserably failed to discharge its burden of convincing the Court that the imposition of MCIT and CWT is unconstitutional.

WHEREFORE, the petition is hereby DISMISSED.

Costs against petitioner.

SO ORDERED.

G.R. No. 160528             October 9, 2006

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.PHILIPPINE AIRLINES, INC., respondent.

D E C I S I O N

PANGANIBAN, CJ.:

A franchise is a legislative grant to operate a public utility. Like those of any other statute, the ambiguous provisions of a franchise should be construed in accordance with the intent of the legislature. In the present case, Presidential Decree 1590 granted Philippine Airlines an option to pay the lower of two alternatives: (a) "the basic corporate income tax based on PAL’s annual net taxable income computed in accordance with the provisions of the National Internal Revenue Code" or (b) "a franchise tax of two percent of gross revenues." Availment of either of these two alternatives shall exempt the airline from the payment of "all other taxes," including the 20 percent final withholding tax on bank deposits.

The Case

Before us is a Petition for Review1 under Rule 45 of the Rules of Court, challenging the September 30, 2003 Decision2 of the Court of Appeals (CA) in CA-GR SP No. 67970. The CA reversed the June 13, 2001 Decision3 and the November 13, 2001 Resolution4 of the Court of Tax Appeals (CTA) in CTA Case No. 5824. The assailed CA Decision disposed as follows:

"WHEREFORE, the petition is GRANTED, and [the] Commissioner of Internal Revenue is hereby directed to refund to the [respondent] the amount of P731,190.45 representing the 20% final withholding tax collected and deducted by depository banks on the petitioner’s interest income or, in the alternative, to allow the [respondent] a tax credit for the same amount."5

The Facts

The CA narrates the facts thus:

"[Respondent] Philippine Airlines, Inc. (PAL) is a domestic corporation organized in accordance with the laws of the Republic of the Philippines, while [Petitioner] Commissioner of Internal Revenue (CIR) is in-charge of the assessment and collection of the 20% final tax on interest on Philippine currency bank deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements, imposed on domestic corporation under Sec. 24 (e) (1) [now Sec. 27 (D) (1)] of the National Internal Revenue Code (NIRC).

"On November 5, 1997, [respondent’s] AVP-Revenue Operations and Tax Services Officer, Atty. Edgardo P. Curbita, filed with the Office of the then Commissioner of Internal Revenue, Mdm. Liwayway Vinzons-Chato, a written request for refund of the amount of P2,241,527.22 which represents the total amount of 20% final withholding tax withheld from the [respondent] by various withholding agent banks, and which amount includes the 20% final withholding tax withheld by the United Coconut Planters Bank (UCPB) and Rizal Commercial Banking Corporation (RCBC) for the period starting March 1995 through February 1997.

"On December 4, 1997, the [respondent’s] AVP-Revenue Operations and Tax Services Officer again filed with [petitioner] CIR another written request for refund of the amount of P1,048,047.23, representing the total amount of 20% final withholding tax withheld by various depository banks of the [respondent] which amount includes the 20% withholding tax withheld by the Philippine National Bank (PNB), Equitable Banking Corporation (EBC), and the Jade Progressive Savings & Mortgage Bank (JPSMB) for the period starting March 1995 through November 1997.

"The amounts, subject of this petition, and which represent the 20% final withholding tax allegedly erroneously withheld and remitted to the BIR by the aforesaid banks may be summarized as follows:

Bank Period Covered Source   Amount

UCPB Jan. 9, 1997 – Feb. 21, 1997Interest income on prime savings deposit P60,328.38  

   

Interest income on government securities and/or commercial papers 78,658.52 P131,986.65

RCBC Jan. 6, 1997 – Feb. 28, 1997Interest income on FBTB and Treasury Bills placements   47,763.55

PNB Feb. 19, 1997 – Nov. 14, 1997Interest income on PNBIG savings account   514,120.22

EBC Jan. 3, 1997 – Feb. 28, 1997Interest income on Treasury Bills placement   33,357.25

JPSMB Jan. 1, 1997 – Feb. 28, 1997 Interest income on deposits   3,962.78

"[Petitioner] CIR failed to act on the [respondent’s] request for refund; thus, a petition was filed before the CTA on April 23, 1999."6

Ruling of the Court of Tax Appeals

The CTA ruled that Respondent PAL was not entitled to the refund. Section 13 of Presidential Decree No. 1590, PAL’s franchise,7 allegedly gave respondent the option to pay either its corporate income tax under the provisions of the NIRC or a franchise tax of two percent of its gross revenues. Payment of either tax would be in lieu of all "other taxes." Had respondent paid the two percent franchise tax, then the final withholding taxes would have been considered as "other taxes." Since it chose to pay its corporate income tax, payment of the final withholding tax is deemed part of this liability and therefore not refundable.8

Ruling of the Court of Appeals

As stated earlier, the Court of Appeals reversed the Decision of the CTA. The CA held that PAL was bound to pay only the corporate income tax or the franchise tax. Section 13 of Presidential Decree No. 1590 exempts respondent from paying all other taxes, duties, royalties and other fees of any kind.9 Respondent chose to pay its basic corporate income tax, which, after considering the factors allowed by law, resulted in a zero tax liability.10 This zero tax liability should neither be taken against respondent nor deprive it of the exemption granted by the law.11 Having chosen to pay its corporate income tax liability, respondent should now be exempt from paying all other taxes including the final withholding tax.

Hence, this Petition.12

The Issue

The sole issue raised by petitioner is stated in this wise:

"The Court of Appeals erred on a question of law ruling that the ‘in lieu of all other taxes’ provision in Section 13 of PD No. 1590 applies even if there were in fact no taxes paid under any of subsections (A) and (B) of the said decree."13

The Court’s Ruling

The Petition has no merit.

Sole Issue:Tax Liability of PAL

The resolution of the instant case hinges on the interpretation of Section 13 of PAL’s franchise, which states in part:

"SEC. 13. In consideration of the franchise and rights hereby granted, the grantee shall pay to the Philippine Government during the life of this franchise whichever of subsections (a) and (b) hereunder will result in a lower tax:

‘(a) The basic corporate income tax based on the grantee's annual net taxable income computed in accordance with the provisions of the National Internal Revenue Code; or

‘(b) A franchise tax of two percent (2%) of the gross revenues derived by the grantee from all sources, without distinction as to transport or non-transport operations; provided, that with respect to international air-transport service, only the gross passenger, mail, and freight revenues from its outgoing flights shall be subject to this tax.’

"The tax paid by the grantee under either of the above alternatives shall be in lieu of all other taxes, duties, royalties, registration, license, and other fees and charges of any kind, nature, or description, imposed, levied, established, assessed, or collected by any municipal, city, provincial, or national authority or government agency, now or in the future, x x x."14

Two points are evident from this provision. First, as consideration for the franchise, PAL is liable to pay either a) its basic corporate income tax based on its net taxable income, as computed under the National Internal Revenue Code; or b) a franchise tax of two percent based on its gross revenues, whichever is lower. Second, the tax paid is "in lieu of all other taxes" imposed by all government entities in the country.

Interpretation of PAL’s Franchise

According to the CA and PAL, the "other taxes in lieu of all other taxes" proviso includes final withholding taxes.15 When respondent availed itself of the basic corporate income tax as its chosen tax liability, it became exempt from final withholding taxes.

On the other hand, the CTA held that the "in lieu of all other taxes" proviso implied the existence of something for which a substitution would be made.16 Final withholding taxes come under basic corporate income tax liability; hence, payment of the latter cannot mean an exemption from the former. To be exempt from final withholding taxes, PAL should have paid the franchise tax of two percent, which would have been in lieu of all other taxes including the final withholding tax.

The CIR argues that the "in lieu of all other taxes" proviso is a mere incentive that applies only when PAL actually pays something; that is, either the basic corporate income tax or the franchise tax.17 Because of the zero tax liability of respondent under the basic corporate income tax system, it was not eligible for exemption from other taxes.18

Construing Subsection (a)of Section 13 of PD 1590Vis-à-vis the Corporate Income Tax

PAL availed itself of PD 1590, Section 13, Subsection (a), the crux of which hinged on the terms "basic corporate income tax" and "annual net taxable income." The applicable laws (PAL’s franchise and the Tax Code) do not define the terms "basic corporate income tax."19 On the other hand, "annual net taxable income" is computed in accordance with the provisions of the National Internal Revenue Code.

The statutory basis for the income tax on corporations is found in Sections 27 to 30 of the National Internal Revenue Code of 1997 under Chapter IV: "Tax on Corporations." Section 27 enumerates the rate of income tax on domestic corporations; Section 28, the rates for foreign corporations; Section 29, the taxes on improperly accumulated earnings; and Section 30, the corporations exempt from tax.

Being a domestic corporation, PAL is subject to Section 27, which reads as follows:

"Section 27. Rates of Income Tax on Domestic Corporations.—

"(A) In General. — Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is hereby imposed upon the taxable income derived during each taxable year from all sources within and without the Philippines by every corporation, x x x, organized in, or existing under the laws of the Philippines x x x."20

The NIRC also imposes final taxes on certain passive incomes, as follows: 1) 20 percent on the interests on currency bank deposits, other monetary benefits from deposit substitutes, trust funds and similar arrangements, and royalties derived from sources within the Philippines;21 2) 5 percent and 10 percent on the net capital gains realized from the sale of shares of stock in a domestic corporation not traded in the stock exchange;22 3) 10 percent on income derived by a depositary bank under the expanded foreign currency deposit system;23 and 4) 6 percent on the gain presumed to be realized on the sale or disposition of lands and buildings treated as capital assets.24 These final taxes are withheld at source.25

A corporate income tax liability, therefore, has two components: the general rate of 35 percent, which is not disputed; and the specific final rates for certain passive incomes. PAL’s request for a refund in the present case pertains to the passive income on bank deposits, which is subject to the specific final tax of 20 percent.26

Computation of TaxableIncome Under the Tax Code

Note that the tax liability of PAL under the option it chose (Item "a" of Section 13 of PD 1590) is to be "computed in accordance with the provisions of the National Internal Revenue Code," as follows:

"(a) The basic corporate income tax based on the grantee’s annual net taxable income computed in accordance with the provisions of the National Internal Revenue Code[.]"

Taxable income means the pertinent items of gross income specified in the Tax Code, less the deductions and/or personal and additional exemptions, if any, authorized for these types of income.27 Under Section 32 of the Tax Code,gross income means income derived from whatever source, including compensation for services; the conduct of trade or business or the exercise of a profession; dealings in property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partner’s distributive share in the net income of a general professional partnership. Section 34 enumerates the allowable deductions; Section 35, personal and additional exemptions.

The definition of gross income is broad enough to include all passive incomes subject to specific rates or final taxes. However, since these passive incomes are already subject to different rates and taxed finally at source, they are no longer included in the computation of gross income, which determines taxable income.

Basic Corporate Income Tax Basedon Annual Net Taxable Income

To repeat, the pertinent provision in the case at bar reads: "basic corporate income tax based on the grantee’s annual net taxable income computed in accordance with the provisions of the National Internal Revenue Code." The Court has already illustrated that, under the Tax Code, "taxable income" does not include passive income subjected to final withholding taxes. Clearly, then, the "basic corporate income tax" identified in Section 13 (a) of the franchise relates to the general rate of 35 percent as stipulated in Section 27 of the Tax Code. The final 20 percent taxes disputed in the present case are not covered under Section 13 (a) of PAL’s franchise; thus, a refund is in order.

"Substitution Theory" of the CIR Untenable

A careful reading of Section 13 rebuts the argument of the CIR that the "in lieu of all other taxes" proviso is a mere incentive that applies only when PAL actually pays something. It is clear that PD 1590 intended to give respondent the option to avail itself of Subsection (a) or (b) as consideration for its franchise. Either option excludes the payment of other taxes and dues imposed or collected by the national or the local government. PAL has the option to choose the alternative that results in lower taxes. It is not the fact of tax payment that exempts it, but the exercise of its option.

Under Subsection (a), the basis for the tax rate is respondent’s annual net taxable income, which (as earlier discussed) is computed by subtracting allowable deductions and exemptions from gross income. By basing the tax rate on the annual net taxable income, PD 1590 necessarily recognized the situation in which taxable income may result in a negative amount and thus translate into a zero tax liability.

Notably, PAL was owned and operated by the government at the time the franchise was last amended.28 It can reasonably be contemplated that PD 1590 sought to assist the finances of the government corporation in the form of lower taxes. When respondent operates at a loss (as in the instant case), no taxes are due; in this instance, it has a lower tax liability than that provided by Subsection (b).

The fallacy of the CIR’s argument is evident from the fact that the payment of a measly sum of one peso would suffice to exempt PAL from other taxes, whereas a zero liability arising from its losses would not. There is no substantial distinction between a zero tax and a one-peso tax liability.

The Court is bound to effectuate the lawmakers’ intent, which is the controlling factor in interpreting a statute.29Significantly, this Court has held that the soul of the law is intent:

"The intent of a statute is the law. If a statute is valid it is to have effect according to the purpose and intent of the lawmaker. The intent is the vital part, the essence of the law, and the primary rule of construction is to ascertain and give effect to the intent. The intention of the legislature in enacting a law is the law itself, and must be enforced when ascertained, although it may not be consistent with the strict letter of the statute. Courts will not follow the letter of a statute when it leads away from the true intent and purpose of the legislature and to conclusions inconsistent with the general purpose of the act. Intent is the spirit which gives life to a legislative enactment. In construing statutes the proper course is to start out and follow the true intent of the legislature and to adopt that sense which harmonizes best with the context and promotes in the fullest manner the apparent policy and objects of the legislature."30

While the Court recognizes the general rule that the grant of tax exemptions is strictly construed against the taxpayer and in favor of the taxing power,31 Section 13 of the franchise of respondent leaves no room for interpretation. Its franchise exempts it from paying any tax other than the option it chooses: either the "basic corporate income tax" or the two percent gross revenue tax.

Determining whether this tax exemption is wise or advantageous is outside the realm of judicial power. This matter is addressed to the sound discretion of the lawmaking department of government.

WHEREFORE, the Petition is DENIED. No pronouncement as to costs.

SO ORDERED.

G.R. No. 172231             February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.ISABELA CULTURAL CORPORATION, Respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision1 of the Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision2 of the Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the Assessment Notices for deficiency income tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986.

The deficiency income tax of P333,196.86, arose from:

(1) The BIR’s disallowance of ICC’s claimed expense deductions for professional and security services billed to and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co.,3 for the year ending December 31, 1985;4

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984 and 1985.5

(c) Expense for security services of El Tigre Security & Investigation Agency for the months of April and May 1986.6

(2) The alleged understatement of ICC’s interest income on the three promissory notes due from Realty Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services.7

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995, however, it received a final notice before seizure demanding payment of the amounts stated in the said notices. Hence, it brought the case to the CTA which held that the petition is premature because the final notice of assessment cannot be considered as a final decision appealable to the tax court. This was reversed by the Court of Appeals holding that a demand letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the protested assessment and may therefore be questioned before the CTA. This conclusion was sustained by this Court on July 1, 2001, in G.R. No. 135210.8 The case was thus remanded to the CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices issued against ICC. It held that the claimed deductions for professional and security services were properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the amount thereof could not be determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory notes. It found that it was the BIR which made an overstatement of said income when it compounded the interest income receivable by ICC from the promissory notes of Realty Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the application of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for security services as shown by the various payment orders and confirmation receipts it presented as evidence. The dispositive portion of the CTA’s Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET ASIDE.

SO ORDERED.9

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision,10 holding that although the professional services (legal and auditing services) were rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time, hence, it could be considered as deductible expenses only in 1986 when ICC received the billing statements for said services. It further ruled that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc., and that ICC properly withheld and remitted taxes on the payments for security services for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that since ICC is using the accrual method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have been declared as deductions from income during the said years and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and failure to withhold expanded withholding tax assessment, petitioner invoked the presumption that the assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for professional and security services from ICC’s gross income; and (2) held that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc; and that ICC withheld the required 1% withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers.11

The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the method of accounting upon the basis of which the net income is computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions.12 In the instant case, the accounting method used by ICC is the accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year.13

The accrual method relies upon the taxpayer’s right to receive amounts or its obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment.14

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount.[15]

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year.[16] Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or deduction.17

Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must also be strictly construed.18

In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICC’s tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s.19 From the nature of the claimed deductions and the span of time during which the firm was retained, ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time legal consultant.

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the burden of establishing the accrual of an expense or income. However, ICC failed to discharge this burden. As to when the firm’s performance of its services in connection with the 1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire about the amount of its liability, or whether it does or does not possess the information necessary to compute the amount of said liability with reasonable accuracy, are questions of fact which ICC never established. It simply relied on the defense of delayed billing by the firm and the company, which under the circumstances, is not sufficient to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal and auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said company would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income for the said year and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by ICC in 198620 and could therefore be properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no such understatement exists and that only simple interest computation and not a compounded one should have been applied by the BIR. There is indeed no stipulation between the latter and ICC on the application of compounded interest.21 Under Article 1959 of the Civil Code, unless there is a stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required withholding tax from its claimed deductions for security services and remitted the same to the BIR is supported by payment order and confirmation receipts.22 Hence, the Assessment Notice for deficiency expanded withholding tax was properly cancelled and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income tax should be cancelled and set aside but only insofar as the claimed deductions of ICC for security services. Said Assessment is valid as to the BIR’s disallowance of ICC’s expenses for professional services. The Court of Appeal’s cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency expanded withholding tax, is sustained.

WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with the MODIFICATION that Assessment Notice No. FAS-1-86-90-000680, which disallowed the expense deduction of Isabela Cultural Corporation for professional and security services, is declared valid only insofar as the expenses for the professional fees of SGV & Co. and of the law firm, Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, are concerned. The decision is affirmed in all other respects.

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

SO ORDERED.

CONSUELO YNARES-SANTIAGO

G.R. No. L-65773-74 April 30, 1987

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX APPEALS, respondents.

Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.

 

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 — Wamer Barnes and Company, Ltd., and later Qantas Airways — which was responsible for selling BOAC tickets covering passengers and cargoes. 1

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 s 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 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. 2 "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. 3

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. 5

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 fife 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 supplied)

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 profile, 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." Income means "cash received or its equivalent"; it is the amount of money coming to a person within a specific time ...; it means something distinct from principal or capital. For, while capital is a fund, income is a flow. As used in our income tax law, "income" refers to the flow of wealth. 6

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 site 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. 9

True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources within the Philippines, namely: (1) interest, (21) 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 site 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 activity regularly pursued within the Philippines. business a 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 2-½ per cent on their cross Philippine billings. (Sec. 24[b] [21, 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 2-½ % 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 vs. 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.

Paras, Gancayco, Padilla, Bidin, Sarmiento and Cortes, JJ., concur.

Fernan, J., took no part.

 

 

Separate Opinions

 

TEEHANKEE, C.J., concurring:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes against respondent BOAC for the fiscal years 1959-1969 to 1970-1971 and therefore setting aside the appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the conflict between the majority opinion penned by Mr. Justice Feliciano as to the proper characterization of the taxable income derived by respondent BOAC from the sales in the Philippines of tickets foe BOAC form the issued by its general sales agent in the Philippines gas become moot after November 24, 1972. Booth opinions state that by amendment through P.D. No.69, promulgated on November 24, 1972, of section 24(b) (2) of the Tax Code providing dor the rate of income tax on foreign corporations, international carriers such as respondent BOAC, have since then been taxed at a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer ant source of substantial conflict between the two opinions as to the present 2-½% tax on their gross Philippine billings charged against such international carriers as herein respondent foreign corporation.

FELICIANO, J., dissenting:

With great respect and reluctance, i record my dissent from the opinion of Mme. Justice A.A. Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the Court of Tax Appeals in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, is correct and should be affirmed.

The fundamental issue raised in this petition for review is whether the British Overseas Airways Corporation (BOAC), a foreign airline company which does not maintain any flight operations 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.

1. The Solicitor General has defined as one of the issue in this case the question of:

2. Whether or not during the fiscal years in question 1 BOAC [was] a resident foreign corporation doing business in the Philippines or [had] an office or place of business in the Philippines.

It is important to note at the outset that the answer to the above-quoted issue is not determinative of the lialibity of the BOAC to Philippine income taxation in respect of the income here involved. The liability of BOAC to Philippine income taxation in respect of such income depends, not on BOAC's status as a "resident foreign corporation" or alternatively, as a "non-resident foreign corporation," but rather on whether or not such income is derived from "source within the Philippines."

A "resident foreign corporation" or foreign corporation engaged in trade or business in the Philippines or having an office or place of business in the Philippines is subject to Philippine income taxation only in respect of income derived from sources within the Philippines. Section 24 (b) (2) of the National Internal Revenue CODE ("Tax Code"), as amended by Republic Act No. 2343, approved 20 June 1959, as it existed up to 3 August 1969, read as follows:

(2) Resident corporations. — A foreign corporation engaged in trade or business with in the Philippines (expect foreign life insurance companies) shall be taxable as provided in subsection (a) of this section.

Section 24 (a) of the Tax Code in turn provides:

Rate of tax on corporations. — (a) Tax on domestic corporations. — ... and a like tax shall be livied, collected, and paid annually upon the total net income received in the preceeding taxable year from all sources within the Philippines by every corporation organized, authorized, or existing under the laws of any foreign country: ... . (Emphasis supplied)

Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it amended once more Section 24 (b) (2) of the Tax Code so as to read as follows:

(2) Resident Corporations. — A corporation, organized, authorized or existing under the laws of any foreign counrty, except 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 supplied)

Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign corporations. Section 24 (b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read as follows:

(b) Tax on foreign corporations. — (1) Non-resident corporations. — There shall be levied, collected and paid for each taxable year, in lieu of the tax imposed by the preceding paragraph upon the amount received byevery foreign corporation not engaged in trade or business within the Philippines, from all sources within the Philippines, as interest, dividends, rents, salaries, wages, premium, annuities, compensations, remunerations, emoluments, or other fixed or determinative annual or periodical gains, profits and income a tax equal to thirty per centum of such amount: provided, however, that premiums shall not include reinsurance premiums. 2

Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and therefore a resident foreign corporation, or not doing business in the Philippines and therefore a non-resident foreign corporation, it is liable to income tax only to the extent that it derives income from sources within the Philippines. The circumtances that a foreign corporation is resident in the Philippines yields no inference that all or any part of its income is Philippine source income. Similarly, the non-resident status of a foreign corporation does not imply that it has no Philippine source income. Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign corporation is a resident of the Philippines. The critical issue, for present purposes, is therefore whether of not BOAC is deriving income from sources within the Philippines.

2. For purposes of income taxation, it is well to bear in mind that the "source of income" relates not to the physical sourcing of a flow of money or the physical situs of payment but rather to the "property, activity or service which produced the income." In Howden and Co., Ltd. vs. Collector of Internal Revenue, 3 the court dealt with the issue of the applicable source rule relating to reinsurance premiums paid by a local insurance company to a foreign reinsurance company in respect of risks located in the Philippines. The Court said:

The source of an income is the property, activity or services that produced the income. The reinsurance premiums remitted to appellants by virtue of the reinsurance contract, 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. — [T]he reinsurance, 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. — 4

The Court may be seen to be saying that it is the underlying prestation which is properly regarded as the activity giving rise to the income that is sought to be taxed. In the Howden case, that underlying prestation was the indemnification of the local insurance company. Such indemnification could take place only in the Philippines where the risks were located and where payment from the foreign reinsurance (in case the casualty

insured against occurs) would be received in Philippine pesos under the reinsurance premiums paid by the local insurance companies constituted Philippine source income of the foreign reinsurances.

The concept of "source of income" for purposes of income taxation originated in the United States income tax system. The phrase "sources within the United States" was first introduced into the U.S. tax system in 1916, and was subsequently embodied in the 1939 U.S. Tax Code. As is commonly known, our Tax Code (Commonwealth Act 466, as amended) was patterned after the 1939 U.S. Tax Code. It therefore seems useful to refer to a standard U.S. text on federal income taxation:

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 "source 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 (services) the place where the labor is done should be decisive; if it is done in this counrty, the income should be from "source 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 "source 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 . . . . Thus, if income is to taxed, the recipient thereof must be resident within the jurisdiction, or the property or activities out of which the income issue 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 Governmentis that income which is created by activities and property protected by this Government or obtained by persons enjoying that protection. 5

3. We turn now to the question what is the source of income rule applicable in the instant case. There are two possibly relevant source of income rules that must be confronted; (a) the source rule applicable in respect of contracts of service; and (b) the source rule applicable in respect of sales of personal property.

Where a contract for the rendition of service is involved, the applicable source rule may be simply stated as follows: the income is sourced in the place where the service contracted for is rendered. Section 37 (a) (3) of our Tax Code reads as follows:

Section 37. Income for sources within the Philippines.

(a) Gross income from sources within the Philippines. — The following items of gross income shall be treated as gross income from sources within the Philippines:

xxx xxx xxx

(3) Services. — Compensation for labor or personal services performed in the Philippines;... (Emphasis supplied)

Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the Philippines in the following manner:

(c) Gross income from sources without the Philippines. — The following items of gross income shall be treated as income from sources without the Philippines:

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

It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of services rendered by individual natural persons; they also apply to services rendered by or through the medium of a juridical person. 6 Further, a contract of carriage or of transportation is assimilated in our Tax Code and Revenue Regulations to a contract for services. Thus, Section 37 (e) of the Tax Code provides as follows:

(e) Income form sources partly within and partly without the Philippines. — Items of gross income, expenses, losses and deductions, other than those specified in subsections (a) and (c) of this section shall be allocated or apportioned to sources within or without the Philippines, under the rules and regulations prescribed by the Secretary of Finance. ... Gains, profits, and income from (1) transportation or other services rendered partly within and partly without the Philippines, or (2) from the sale of personnel property produced (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and partly from sources without the Philippines. ... (Emphasis supplied)

It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939 U.S. Tax Code which "was based upon a recognition that transportation was a service and that the source of the income derived therefrom was to be treated as being the place where the service of transportation was rendered. 7

Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible, implication that income derived from transportation or other services rendered entirely outside the Philippines must be treated as derived entirely from sources without the Philippines. This implication is reinforced by a consideration of certain provisions of Revenue Regulations No. 2 entitled "Income Tax Regulations" as amended, first promulgated by the Department of Finance on 10 February 1940. Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part as follows:

Section 155. Compensation for labor or personnel services. — Gross income from sources within the Philippines includes compensation for labor or personal services within the Philippines regardless of the residence of the payer, of the place in which the contract for services was made, or of the place of payment— (Emphasis supplied)

Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a particular species of foreign transportation companies — i.e., foreign steamship companies deriving income from sources partly within and partly without the Philippines:

Section 163 Foreign steamship companies. — The return of foreign steamship companies whose vessels touch parts of the Philippines should include as gross income, the total receipts of all out-going businesswhether freight or passengers. With the gross income thus ascertained, the ratio existing between it and the gross income from all ports, both within and without the Philippines of all vessels, whether touching of the Philippines or not, should be determined as the basis upon which allowable deductions may be computed, — . (Emphasis supplied)

Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2 (again implementing Section 37 of the Tax Code) with provides as follows:

Section 164. Telegraph and cable services. — A foreign corporation carrying on the business of transmission of telegraph or cable messages between points in the Philippines and points outside the Philippines derives income partly form source within and partly from sources without the Philippines.

... (Emphasis supplied)

Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No. 2 that steamship and telegraph and cable services rendered between points both outside the Philippines give rise to income wholly from sources outside the Philippines, and therefore not subject to Philippine income taxation.

We turn to the "source of income" rules relating to the sale of personal property, upon the one hand, and to the purchase and sale of personal property, upon the other hand.

We consider first sales of personal property. Income from the sale of personal property by the producer or manufacturer of such personal property will be regarded as sourced entirely within or entirely without the Philippines or as sourced partly within and partly without the Philippines, depending upon two factors: (a) the place where the sale of such personal property occurs; and (b) the place where such personal property was produced or manufactured. If the personal property involved was both produced or manufactured and sold outside the Philippines, the income derived therefrom will be regarded as sourced entirely outside the Philippines, although the personal property had been produced outside the Philippines, or if the sale of the property takes place outside the Philippines and the personal was produced in the Philippines, then, the income derived from the sale will be deemed partly as income sourced without the Philippines. In other words, the income (and the related expenses, losses and deductions) will be allocated between sources within and sources without the Philippines. Thus, Section 37 (e) of the Tax Code, although already quoted above, may be usefully quoted again:

(e) Income from sources partly within and partly without the Philippines. ... Gains, profits and income from (1) transportation or other services rendered partly within and partly without the Philippines; or (2) from the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and partly from sources without the Philippines. ... (Emphasis supplied)

In contrast, income derived from the purchase and sale of personal property — i. e., trading — is, under the Tax Code, regarded as sourced wholly in the place where the personal property is sold. Section 37 (e) of the Tax Code provides in part as follows:

(e) Income from sources partly within and partly without the Philippines ... Gains, profits and income derived from the purchase of personal property within and its sale without the Philippines or from the purchase of personal property without and its sale within the Philippines, shall be treated as derived entirely from sources within the country in which sold. (Emphasis supplied)

Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:

Section 159. Sale of personal property. Income derived from the purchase and sale of personal property shall be treated as derived entirely from the country in which sold. The word "sold" includes "exchange." The "country" in which "sold" ordinarily means the place where the property is marketed. This Section does not apply to income from the sale personal property produced (in whole or in part) by the taxpayer within and sold without the Philippines or produced (in whole or in part) by the taxpayer without and sold within the Philippines. (See Section 162 of these regulations). (Emphasis supplied)

4. It will be seen that the basic problem is one of characterization of the transactions entered into by BOAC in the Philippines. Those transactions may be characterized either as sales of personal property (i. e., "sales of airline tickets") oras entering into a lease of services or a contract of service or carriage. The applicable "source of income" rules differ depending upon which characterization is given to the BOAC transactions.

The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into contracts of service, i.e., carriage of passengers or cargo between points located outside the Philippines.

The phrase "sale of airline tickets," while widely used in popular parlance, does not appear to be correct as a matter of tax law. The airline ticket in and of itself has no monetary value, even as scrap paper. The value of the ticket lies wholly in the right acquired by the "purchaser" — the passenger — to demand a prestation from BOAC, which prestation consists of the carriage of the "purchaser" or passenger from the one point to another outside the Philippines. The ticket is really theevidence of the contract of carriage entered into between BOAC and the passenger. The money paid by the passenger changes hands in the Philippines. But the passenger does not receive undertaken to be delivered by BOAC. The "purchase price of the airline ticket" is quite different from the purchase price of a physical good or commodity such as a pair of shoes of a refrigerator or an automobile; it is really the compensation paid for the undertaking of BOAC to transport the passenger or cargo outside the Philippines.

The characterization of the BOAC transactions either as sales of personal property or as purchases and sales of personal property, appear entirely inappropriate from other viewpoint. Consider first purchases and sales: is BOAC properly regarded as engaged in trading — in the purchase and sale of personal property? Certainly, BOAC was not purchasing tickets outside the Philippines and selling them in the Philippines. Consider next sales: can BOAC be regarded as "selling" personal property produced or manufactured by it? In a popular or journalistic sense, BOAC might be described as "selling" "a product" — its service. However, for the technical purposes of the law on income taxation, BOAC is in fact entering into contracts of service or carriage. The very existance of "source rules" specifically and precisely applicable to the rendition of services must preclude the application here of "source rules" applying generally to sales, and purchases and sales, of personal property which can be invoked only by the grace of popular language. On a slighty more abstract level, BOAC's income is more appropriately characterized as derived from a "service", rather than from an "activity" (a broader term than service and including the activity of selling) or from the here involved is income taxation, and not a salestax or an excise or privilege tax.

5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as amended by Presidential Decree No. 69, promulgated on 24 November 1972 and by Presidential Decree No. 1355, promulgated on 21 April 1978, in the following manner:

(2) Resident corporations. — A corporation organized, authorized, or existing under the laws of any foreign country, 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 preceeding taxable year from all sources within the Philippines: Provided, however, That international carriers shall pay a tax of two and one-half per cent on their gross Philippine billings. "Gross Philippines of passage documents sold therein, whether for passenger, excess baggege or mail, provide the cargo or mail originates from the Philippines. The gross revenue realized from the said cargo or mail shall include the gross freight charge up to final destination. Gross revenues from chartered flights originating from the Philippines shall likewise form part of "gross Philippine billings" regardless of the place of sale or payment of the passage documents. For purposes of determining the taxability to revenues from chartered flights, the term "originating from the Philippines" shall include flight of passsengers who stay in the Philippines for more than forty-eight (48) hours prior to embarkation. (Emphasis supplied)

Under the above-quoted proviso international carriers issuing for compensation passage documentation in the Philippines for uplifts from any point in the world to any other point in the world, are not charged any Philippine income tax on their Philippine billings (i.e., billings in respect of passenger or cargo originating from the Philippines). Under this new approach, international carriers who service port or points in the Philippines are treated in exactly the same way as international carriers not serving any port or point in the Philippines. Thus, the source of income rule applicable, as above discussed, to transportation or other services rendered partly within and partly without the Philippines, or wholly without the Philippines, has been set aside. in place of Philippine income taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings in respect of passengers and cargo originating from the Philippines regardless of where embarkation and debarkation would be taking place. This 2-½ per cent tax is effectively a tax on gross receipts or an excise or privilege tax and not a tax on income. Thereby, the Government has done away with the difficulties attending the allocation of income and related expenses, losses and deductions. Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in the amount of taxes collectible by the state is sometimes, with varying degrees of consciousness, considered in choosing from among competing possible characterizations under or interpretation of tax statutes. It is hence perhaps useful to point out that the

determination of the appropriate characterization here — that of contracts of air carriage rather than sales of airline tickets — entails no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government takes in revenues generated by the 2-½ per cent tax on the gross Philippine billings or receipts of international carriers.

I would vote to affirm the decision of the Court of Tax Appeals.

 

 

 

Separate Opinions

TEEHANKEE, C.J., concurring:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes against respondent BOAC for the fiscal years 1959-1969 to 1970-1971 and therefore setting aside the appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the conflict between the majority opinion penned by Mr. Justice Feliciano as to the proper characterization of the taxable income derived by respondent BOAC from the sales in the Philippines of tickets foe BOAC form the issued by its general sales agent in the Philippines gas become moot after November 24, 1972. Booth opinions state that by amendment through P.D. No.69, promulgated on November 24, 1972, of section 24(b) (2) of the Tax Code providing dor the rate of income tax on foreign corporations, international carriers such as respondent BOAC, have since then been taxed at a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer ant source of substantial conflict between the two opinions as to the present 2-½% tax on their gross Philippine billings charged against such international carriers as herein respondent foreign corporation.

FELICIANO, J., dissenting:

With great respect and reluctance, i record my dissent from the opinion of Mme. Justice A.A. Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the Court of Tax Appeals in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, is correct and should be affirmed.

The fundamental issue raised in this petition for review is whether the British Overseas Airways Corporation (BOAC), a foreign airline company which does not maintain any flight operations 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.

1. The Solicitor General has defined as one of the issue in this case the question of:

2. Whether or not during the fiscal years in question 1 BOAC [was] a resident foreign corporation doing business in the Philippines or [had] an office or place of business in the Philippines.

It is important to note at the outset that the answer to the above-quoted issue is not determinative of the lialibity of the BOAC to Philippine income taxation in respect of the income here involved. The liability of BOAC to Philippine income taxation in respect of such income depends, not on BOAC's status as a "resident foreign corporation" or alternatively, as a "non-resident foreign corporation," but rather on whether or not such income is derived from "source within the Philippines."

A "resident foreign corporation" or foreign corporation engaged in trade or business in the Philippines or having an office or place of business in the Philippines is subject to Philippine income taxation only in respect of income derived from sources within the Philippines. Section 24 (b) (2) of the National Internal Revenue CODE

("Tax Code"), as amended by Republic Act No. 2343, approved 20 June 1959, as it existed up to 3 August 1969, read as follows:

(2) Resident corporations. — A foreign corporation engaged in trade or business with in the Philippines (expect foreign life insurance companies) shall be taxable as provided in subsection (a) of this section.

Section 24 (a) of the Tax Code in turn provides:

Rate of tax on corporations. — (a) Tax on domestic corporations. — ... and a like tax shall be livied, collected, and paid annually upon the total net income received in the preceeding taxable year from all sources within the Philippines by every corporation organized, authorized, or existing under the laws of any foreign country: ... . (Emphasis supplied)

Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it amended once more Section 24 (b) (2) of the Tax Code so as to read as follows:

(2) Resident Corporations. — A corporation, organized, authorized or existing under the laws of any foreign counrty, except 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 supplied)

Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign corporations. Section 24 (b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read as follows:

(b) Tax on foreign corporations. — (1) Non-resident corporations. — There shall be levied, collected and paid for each taxable year, in lieu of the tax imposed by the preceding paragraph upon the amount received byevery foreign corporation not engaged in trade or business within the Philippines, from all sources within the Philippines, as interest, dividends, rents, salaries, wages, premium, annuities, compensations, remunerations, emoluments, or other fixed or determinative annual or periodical gains, profits and income a tax equal to thirty per centum of such amount: provided, however, that premiums shall not include reinsurance premiums. 2

Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and therefore a resident foreign corporation, or not doing business in the Philippines and therefore a non-resident foreign corporation, it is liable to income tax only to the extent that it derives income from sources within the Philippines. The circumtances that a foreign corporation is resident in the Philippines yields no inference that all or any part of its income is Philippine source income. Similarly, the non-resident status of a foreign corporation does not imply that it has no Philippine source income. Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign corporation is a resident of the Philippines. The critical issue, for present purposes, is therefore whether of not BOAC is deriving income from sources within the Philippines.

2. For purposes of income taxation, it is well to bear in mind that the "source of income" relates not to the physical sourcing of a flow of money or the physical situs of payment but rather to the "property, activity or service which produced the income." In Howden and Co., Ltd. vs. Collector of Internal Revenue, 3 the court dealt with the issue of the applicable source rule relating to reinsurance premiums paid by a local insurance company to a foreign reinsurance company in respect of risks located in the Philippines. The Court said:

The source of an income is the property, activity or services that produced the income. The reinsurance premiums remitted to appellants by virtue of the reinsurance contract, 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. — [T]he reinsurance, 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. — 4

The Court may be seen to be saying that it is the underlying prestation which is properly regarded as the activity giving rise to the income that is sought to be taxed. In the Howden case, that underlying prestation was the indemnification of the local insurance company. Such indemnification could take place only in the Philippines where the risks were located and where payment from the foreign reinsurance (in case the casualty insured against occurs) would be received in Philippine pesos under the reinsurance premiums paid by the local insurance companies constituted Philippine source income of the foreign reinsurances.

The concept of "source of income" for purposes of income taxation originated in the United States income tax system. The phrase "sources within the United States" was first introduced into the U.S. tax system in 1916, and was subsequently embodied in the 1939 U.S. Tax Code. As is commonly known, our Tax Code (Commonwealth Act 466, as amended) was patterned after the 1939 U.S. Tax Code. It therefore seems useful to refer to a standard U.S. text on federal income taxation:

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 "source 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 (services) the place where the labor is done should be decisive; if it is done in this counrty, the income should be from "source 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 "source 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 . . . . Thus, if income is to taxed, the recipient thereof must be resident within the jurisdiction, or the property or activities out of which the income issue 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 Governmentis that income which is created by activities and property protected by this Government or obtained by persons enjoying that protection. 5

3. We turn now to the question what is the source of income rule applicable in the instant case. There are two possibly relevant source of income rules that must be confronted; (a) the source rule applicable in respect of contracts of service; and (b) the source rule applicable in respect of sales of personal property.

Where a contract for the rendition of service is involved, the applicable source rule may be simply stated as follows: the income is sourced in the place where the service contracted for is rendered. Section 37 (a) (3) of our Tax Code reads as follows:

Section 37. Income for sources within the Philippines.

(a) Gross income from sources within the Philippines. — The following items of gross income shall be treated as gross income from sources within the Philippines:

xxx xxx xxx

(3) Services. — Compensation for labor or personal services performed in the Philippines;... (Emphasis supplied)

Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the Philippines in the following manner:

(c) Gross income from sources without the Philippines. — The following items of gross income shall be treated as income from sources without the Philippines:

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

It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of services rendered by individual natural persons; they also apply to services rendered by or through the medium of a juridical person. 6 Further, a contract of carriage or of transportation is assimilated in our Tax Code and Revenue Regulations to a contract for services. Thus, Section 37 (e) of the Tax Code provides as follows:

(e) Income form sources partly within and partly without the Philippines. — Items of gross income, expenses, losses and deductions, other than those specified in subsections (a) and (c) of this section shall be allocated or apportioned to sources within or without the Philippines, under the rules and regulations prescribed by the Secretary of Finance. ... Gains, profits, and income from (1) transportation or other services rendered partly within and partly without the Philippines, or (2) from the sale of personnel property produced (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and partly from sources without the Philippines. ... (Emphasis supplied)

It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939 U.S. Tax Code which "was based upon a recognition that transportation was a service and that the source of the income derived therefrom was to be treated as being the place where the service of transportation was rendered. 7

Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible, implication that income derived from transportation or other services rendered entirely outside the Philippines must be treated as derived entirely from sources without the Philippines. This implication is reinforced by a consideration of certain provisions of Revenue Regulations No. 2 entitled "Income Tax Regulations" as amended, first promulgated by the Department of Finance on 10 February 1940. Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part as follows:

Section 155. Compensation for labor or personnel services. — Gross income from sources within the Philippines includes compensation for labor or personal services within the Philippines regardless of the residence of the payer, of the place in which the contract for services was made, or of the place of payment— (Emphasis supplied)

Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a particular species of foreign transportation companies — i.e., foreign steamship companies deriving income from sources partly within and partly without the Philippines:

Section 163 Foreign steamship companies. — The return of foreign steamship companies whose vessels touch parts of the Philippines should include as gross income, the total receipts of all out-going businesswhether freight or passengers. With the gross income thus ascertained, the ratio existing between it and the gross income from all ports, both within and without the Philippines of all vessels, whether touching of the Philippines or not, should be determined as the basis upon which allowable deductions may be computed, — . (Emphasis supplied)

Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2 (again implementing Section 37 of the Tax Code) with provides as follows:

Section 164. Telegraph and cable services. — A foreign corporation carrying on the business of transmission of telegraph or cable messages between points in the Philippines and points outside the Philippines derives income partly form source within and partly from sources without the Philippines.

... (Emphasis supplied)

Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No. 2 that steamship and telegraph and cable services rendered between points both outside the Philippines give rise to income wholly from sources outside the Philippines, and therefore not subject to Philippine income taxation.

We turn to the "source of income" rules relating to the sale of personal property, upon the one hand, and to the purchase and sale of personal property, upon the other hand.

We consider first sales of personal property. Income from the sale of personal property by the producer or manufacturer of such personal property will be regarded as sourced entirely within or entirely without the Philippines or as sourced partly within and partly without the Philippines, depending upon two factors: (a) the place where the sale of such personal property occurs; and (b) the place where such personal property was produced or manufactured. If the personal property involved was both produced or manufactured and sold outside the Philippines, the income derived therefrom will be regarded as sourced entirely outside the Philippines, although the personal property had been produced outside the Philippines, or if the sale of the property takes place outside the Philippines and the personal was produced in the Philippines, then, the income derived from the sale will be deemed partly as income sourced without the Philippines. In other words, the income (and the related expenses, losses and deductions) will be allocated between sources within and sources without the Philippines. Thus, Section 37 (e) of the Tax Code, although already quoted above, may be usefully quoted again:

(e) Income from sources partly within and partly without the Philippines. ... Gains, profits and income from (1) transportation or other services rendered partly within and partly without the Philippines; or (2) from the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and partly from sources without the Philippines. ... (Emphasis supplied)

In contrast, income derived from the purchase and sale of personal property — i. e., trading — is, under the Tax Code, regarded as sourced wholly in the place where the personal property is sold. Section 37 (e) of the Tax Code provides in part as follows:

(e) Income from sources partly within and partly without the Philippines ... Gains, profits and income derived from the purchase of personal property within and its sale without the Philippines or from the purchase of personal property without and its sale within the Philippines, shall be treated as derived entirely from sources within the country in which sold. (Emphasis supplied)

Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:

Section 159. Sale of personal property. Income derived from the purchase and sale of personal property shall be treated as derived entirely from the country in which sold. The word "sold" includes "exchange." The "country" in which "sold" ordinarily means the place where the property is marketed. This Section does not apply to income from the sale personal property produced (in whole or in part) by the taxpayer within and sold without the Philippines or produced (in whole or in part) by the taxpayer without and sold within the Philippines. (See Section 162 of these regulations). (Emphasis supplied)

4. It will be seen that the basic problem is one of characterization of the transactions entered into by BOAC in the Philippines. Those transactions may be characterized either as sales of personal property (i. e., "sales of airline tickets") oras entering into a lease of services or a contract of service or carriage. The applicable "source of income" rules differ depending upon which characterization is given to the BOAC transactions.

The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into contracts of service, i.e., carriage of passengers or cargo between points located outside the Philippines.

The phrase "sale of airline tickets," while widely used in popular parlance, does not appear to be correct as a matter of tax law. The airline ticket in and of itself has no monetary value, even as scrap paper. The value of the ticket lies wholly in the right acquired by the "purchaser" — the passenger — to demand a prestation from BOAC, which prestation consists of the carriage of the "purchaser" or passenger from the one point to another outside the Philippines. The ticket is really theevidence of the contract of carriage entered into between BOAC and the passenger. The money paid by the passenger changes hands in the Philippines. But the passenger does not receive undertaken to be delivered by BOAC. The "purchase price of the airline ticket" is quite different from the purchase price of a physical good or commodity such as a pair of shoes of a refrigerator or an automobile; it is really the compensation paid for the undertaking of BOAC to transport the passenger or cargo outside the Philippines.

The characterization of the BOAC transactions either as sales of personal property or as purchases and sales of personal property, appear entirely inappropriate from other viewpoint. Consider first purchases and sales: is BOAC properly regarded as engaged in trading — in the purchase and sale of personal property? Certainly, BOAC was not purchasing tickets outside the Philippines and selling them in the Philippines. Consider next sales: can BOAC be regarded as "selling" personal property produced or manufactured by it? In a popular or journalistic sense, BOAC might be described as "selling" "a product" — its service. However, for the technical purposes of the law on income taxation, BOAC is in fact entering into contracts of service or carriage. The very existance of "source rules" specifically and precisely applicable to the rendition of services must preclude the application here of "source rules" applying generally to sales, and purchases and sales, of personal property which can be invoked only by the grace of popular language. On a slighty more abstract level, BOAC's income is more appropriately characterized as derived from a "service", rather than from an "activity" (a broader term than service and including the activity of selling) or from the here involved is income taxation, and not a salestax or an excise or privilege tax.

5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as amended by Presidential Decree No. 69, promulgated on 24 November 1972 and by Presidential Decree No. 1355, promulgated on 21 April 1978, in the following manner:

(2) Resident corporations. — A corporation organized, authorized, or existing under the laws of any foreign country, 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 preceeding taxable year from all sources within the Philippines: Provided, however, That international carriers shall pay a tax of two and one-half per cent on their gross Philippine billings. "Gross Philippines of passage documents sold therein, whether for passenger, excess baggege or mail, provide the cargo or mail originates from the Philippines. The gross revenue realized from the said cargo or mail shall include the gross freight charge up to final destination. Gross revenues from chartered flights originating from the Philippines shall likewise form part of "gross Philippine billings" regardless of the place of sale or payment of the passage documents. For purposes of determining the taxability to revenues from chartered flights, the term "originating from the Philippines" shall include flight of passsengers who stay in the Philippines for more than forty-eight (48) hours prior to embarkation. (Emphasis supplied)

Under the above-quoted proviso international carriers issuing for compensation passage documentation in the Philippines for uplifts from any point in the world to any other point in the world, are not charged any Philippine income tax on their Philippine billings (i.e., billings in respect of passenger or cargo originating from the Philippines). Under this new approach, international carriers who service port or points in the Philippines are treated in exactly the same way as international carriers not serving any port or point in the Philippines. Thus, the source of income rule applicable, as above discussed, to transportation or other services rendered

partly within and partly without the Philippines, or wholly without the Philippines, has been set aside. in place of Philippine income taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings in respect of passengers and cargo originating from the Philippines regardless of where embarkation and debarkation would be taking place. This 2-½ per cent tax is effectively a tax on gross receipts or an excise or privilege tax and not a tax on income. Thereby, the Government has done away with the difficulties attending the allocation of income and related expenses, losses and deductions. Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in the amount of taxes collectible by the state is sometimes, with varying degrees of consciousness, considered in choosing from among competing possible characterizations under or interpretation of tax statutes. It is hence perhaps useful to point out that the determination of the appropriate characterization here — that of contracts of air carriage rather than sales of airline tickets — entails no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government takes in revenues generated by the 2-½ per cent tax on the gross Philippine billings or receipts of international carriers.

I would vote to affirm the decision of the Court of Tax Appeals.

Narvasa, Gutierrez, Jr., and Cruz, JJ., dissent.

G.R. No. L-53961 June 30, 1987

NATIONAL DEVELOPMENT COMPANY, petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, respondent.

 

CRUZ, J.:

We are asked to reverse the decision of the Court of Tax Appeals on the ground that it is erroneous. We have carefully studied it and find it is not; on the contrary, it is supported by law and doctrine. So finding, we affirm.

Reduced to simplest terms, the background facts are as follows.

The national Development Company entered into contracts in Tokyo with several Japanese shipbuilding companies for the construction of twelve ocean-going vessels. 1 The purchase price was to come from the proceeds of

bonds issued by the Central Bank. 2 Initial payments were made in cash and through irrevocable letters of credit. 3 Fourteen promissory notes were signed for the balance by the NDC and, as required by the shipbuilders, guaranteed by the Republic of the Philippines. 4 Pursuant thereto, the remaining payments and the interests thereon were remitted in due time by the NDC to Tokyo. The vessels were eventually completed and delivered to the NDC in Tokyo. 5

The NDC remitted to the shipbuilders in Tokyo the total amount of US$4,066,580.70 as interest on the balance of the purchase price. No tax was withheld. The Commissioner then held the NDC liable on such tax in the total sum of P5,115,234.74. Negotiations followed but failed. The BIR thereupon served on the NDC a warrant of distraint and levy to enforce collection of the claimed amount. 6 The NDC went to the Court of Tax Appeals.

The BIR was sustained by the CTA except for a slight reduction of the tax deficiency in the sum of P900.00, representing the compromise penalty. 7 The NDC then came to this Court in a petition for certiorari.

The petition must fail for the following reasons.

The Japanese shipbuilders were liable to tax on the interest remitted to them under Section 37 of the Tax Code, thus:

SEC. 37. Income from sources within the Philippines. — (a) Gross income from sources within the Philippines. — The following items of gross income shall be treated as gross income from sources within the Philippines:

(1) Interest. — Interest derived from sources within the Philippines, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise;

xxx xxx xxx

The petitioner argues that the Japanese shipbuilders were not subject to tax under the above provision because all the related activities — the signing of the contract, the construction of the vessels, the payment of the stipulated price, and their delivery to the NDC — were done in Tokyo. 8 The law, however, does not speak of activity but of "source," which in this case is the NDC. This is a domestic and resident corporation with principal offices in Manila.

As the Tax Court put it:

It is quite apparent, under the terms of the law, that the Government's right to levy and collect income tax on interest received by foreign corporations not engaged in trade or business within the Philippines is not planted upon the condition that 'the activity or labor — and the sale from which the (interest) income flowed had its situs' in the Philippines. The law specifies: 'Interest derived from sources within the Philippines, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise.' Nothing there speaks of the 'act or activity' of non-resident corporations in the Philippines, or place where the contract is signed. The residence of the obligor who pays the interest rather than the physical location of the securities, bonds or notes or the place of payment, is the determining factor of the source of interest income. (Mertens, Law of Federal Income Taxation, Vol. 8, p. 128, citing A.C. Monk & Co. Inc. 10 T.C. 77; Sumitomo Bank, Ltd., 19 BTA 480; Estate of L.E. Mckinnon, 6 BTA 412; Standard Marine Ins. Co., Ltd., 4 BTA 853; Marine Ins. Co., Ltd., 4 BTA 867.)

Accordingly, if the obligor is a resident of the Philippines the interest payment paid by him can have no other source than within the Philippines. The interest is paid not by the bond, note or other interest-bearing obligations, but by the obligor. (See mertens, Id., Vol. 8, p. 124.)

Here in the case at bar, petitioner National Development Company, a corporation duly organized and existing under the laws of the Republic of the Philippines, with address and principal office at Calle Pureza, Sta. Mesa, Manila, Philippines unconditionally promised to pay the Japanese shipbuilders, as obligor in fourteen (14) promissory notes for each vessel, the balance of the contract price of the twelve (12) ocean-going vessels purchased and acquired by it from the Japanese corporations, including the interest on the principal sum at the rate of five per cent (5%) per annum. (See Exhs. "D", D-1" to "D-13", pp. 100-113, CTA Records; par. 11, Partial Stipulation of Facts.) And pursuant to the terms and conditions of these promisory notes, which are duly signed by its Vice Chairman and General Manager, petitioner remitted to the Japanese shipbuilders in Japan during the years 1960, 1961, and 1962 the sum of $830,613.17, $1,654,936.52 and $1,541.031.00, respectively, as interest on the unpaid balance of the purchase price of the aforesaid vessels. (pars. 13, 14, & 15, Partial Stipulation of Facts.)

The law is clear. Our plain duty is to apply it as written. The residence of the obligor which paid the interest under consideration, petitioner herein, is Calle Pureza, Sta. Mesa, Manila, Philippines; and as a corporation duly organized and existing under the laws of the Philippines, it is a domestic corporation, resident of the Philippines. (Sec. 84(c), National Internal Revenue Code.) The interest paid by petitioner, which is admittedly a resident of the Philippines, is on the promissory notes issued by it. Clearly, therefore, the interest remitted to the Japanese shipbuilders in Japan in 1960, 1961 and 1962 on the unpaid balance of the purchase price of the vessels acquired by petitioner is interest derived from sources within the Philippines subject to income tax under the then Section 24(b)(1) of the National Internal Revenue Code. 9

There is no basis for saying that the interest payments were obligations of the Republic of the Philippines and that the promissory notes of the NDC were government securities exempt from taxation under Section 29(b)[4] of the Tax Code, reading as follows:

SEC. 29. Gross Income. — xxxx xxx xxx xxx

(b) Exclusion from gross income. — The following items shall not be included in gross income and shall be exempt from taxation under this Title:

xxx xxx xxx

(4) Interest on Government Securities. — Interest upon the obligations of the Government of the Republic of the Philippines or any political subdivision thereof, but in the case of such obligations issued after approval of this Code, only to the extent provided in the act authorizing the issue thereof. (As amended by Section 6, R.A. No. 82; emphasis supplied)

The law invoked by the petitioner as authorizing the issuance of securities is R.A. No. 1407, which in fact is silent on this matter. C.A. No. 182 as amended by C.A. No. 311 does carry such authorization but, like R.A. No. 1407, does not exempt from taxes the interests on such securities.

It is also incorrect to suggest that the Republic of the Philippines could not collect taxes on the interest remitted because of the undertaking signed by the Secretary of Finance in each of the promissory notes that:

Upon authority of the President of the Republic of the Philippines, the undersigned, for value received, hereby absolutely and unconditionally guarantee (sic), on behalf of the Republic of the Philippines, the due and punctual payment of both principal and interest of the above note. 10

There is nothing in the above undertaking exempting the interests from taxes. Petitioner has not established a clear waiver therein of the right to tax interests. Tax exemptions cannot be merely implied but must be categorically and unmistakably expressed. 11 Any doubt concerning this question must be resolved in favor of the taxing power. 12

Nowhere in the said undertaking do we find any inhibition against the collection of the disputed taxes. In fact, such undertaking was made by the government in consonance with and certainly not against the following provisions of the Tax Code:

Sec. 53(b). Nonresident aliens. — All persons, corporations and general co-partnership (companies colectivas), in whatever capacity acting, including lessees or mortgagors of real or personal capacity, executors, administrators, receivers, conservators, fiduciaries, employers, and all officers and employees of the Government of the Philippines having control, receipt, custody; disposal or payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or categorical gains, profits and income of any nonresident alien individual, not engaged in trade or business within the Philippines and not having any office or place of business therein, shall (except in the cases provided for in subsection (a) of this section) deduct and withhold from such annual or periodical gains, profits and income a tax to twenty (now 30%) per centum thereof: ...

Sec. 54. Payment of corporation income tax at source. — In the case of foreign corporations subject to taxation under this Title not engaged in trade or business within the Philippines and not having any office or place of business therein, there shall be deducted and withheld at the source in the same manner and upon the same items as is provided in section fifty-three a tax equal to thirty (now 35%) per centum thereof, and such tax shall be returned and paid in the same manner and subject to the same conditions as provided in that section:....

Manifestly, the said undertaking of the Republic of the Philippines merely guaranteed the obligations of the NDC but without diminution of its taxing power under existing laws.

In suggesting that the NDC is merely an administrator of the funds of the Republic of the Philippines, the petitioner closes its eyes to the nature of this entity as a corporation. As such, it is governed in its proprietary activities not only by its charter but also by the Corporation Code and other pertinent laws.

The petitioner also forgets that it is not the NDC that is being taxed. The tax was due on the interests earned by the Japanese shipbuilders. It was the income of these companies and not the Republic of the Philippines that was subject to the tax the NDC did not withhold.

In effect, therefore, the imposition of the deficiency taxes on the NDC is a penalty for its failure to withhold the same from the Japanese shipbuilders. Such liability is imposed by Section 53(c) of the Tax Code, thus:

Section 53(c). Return and Payment. — Every person required to deduct and withhold any tax under this section shall make return thereof, in duplicate, on or before the fifteenth day of April of each year, and, on or before the time fixed by law for the payment of the tax, shall pay the amount withheld to the officer of the Government of the Philippines authorized to receive it. Every such person is made personally liable for such tax, and is indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provisions of this section. (As amended by Section 9, R.A. No. 2343.)

In Philippine Guaranty Co. v. The Commissioner of Internal Revenue and the Court of Tax Appeals, 13 the Court quoted with approval the following regulation of the BIR on the responsibilities of withholding agents:

In case of doubt, a withholding agent may always protect himself by withholding the tax due, and promptly causing a query to be addressed to the Commissioner of Internal Revenue for the determination whether or not the income paid to an individual is not subject to withholding. In case the Commissioner of Internal Revenue decides that the income paid to an individual is

not subject to withholding, the withholding agent may thereupon remit the amount of a tax withheld. (2nd par., Sec. 200, Income Tax Regulations).

"Strict observance of said steps is required of a withholding agent before he could be released from liability," so said Justice Jose P. Bengson, who wrote the decision. "Generally, the law frowns upon exemption from taxation; hence, an exempting provision should be construed strictissimi juris." 14

The petitioner was remiss in the discharge of its obligation as the withholding agent of the government an so should be held liable for its omission.

WHEREFORE, the appealed decision is AFFIRMED, without any pronouncement as to costs. It is so ordered.