Chamber of Real Estate and Builders Associations, Inc., v. The Hon.

Executive Secretary
Alberto Romulo, et al.

Facts:

Petitioner Chamber of Real Estate and Builders Associations, Inc. (CREBA), an
association of real estate developers and builders in the Philippines, assailed the validity of
Section 27(E) of the Tax Code which imposes the minimum corporate income tax (MCIT) on
corporations. Petitioner argues that the MCIT violates the due process clause because it levies
income tax even if there is no realized gain.

Under the Tax Code, a corporation can become subject to the MCIT at the rate of 2% of
gross income, beginning on the 4th taxable year immediately following the year in which it
commenced its business operations, when such MCIT is greater than the normal corporate
income tax. If the regular income tax is higher than the MCIT, the corporation does not pay the
MCIT.

CREBA argued, among others, that the use of gross income as MCIT base amounts to a
confiscation of capital because gross income, unlike net income, is not realized gain.
CREBA also sought to invalidate the provisions of RR No. 2-98, as amended, otherwise known
as the Consolidated Withholding Tax Regulations, which prescribe the rules and procedures for
the collection of CWT on sales of real properties classified as ordinary assets, on the grounds
that these regulations:
Use gross selling price (GSP) or fair market value (FMV) as basis for determining the
income tax on the sale of real estate classified as ordinary assets, instead of the entitys
net taxable income as provided for under the Tax Code;
Mandate the collection of income tax on a per transaction basis, contrary to the Tax
Code provision which imposes income tax on net income at the end of the taxable
period;
Go against the due process clause because the government collects income tax even
when the net income has not yet been determined; gain is never assured by mere
receipt of the selling price; and
Contravene the equal protection clause because the CWT is being charged upon real
estate enterprises, but not on other business enterprises, more particularly, those in the
manufacturing sector, which do business similar to that of a real estate enterprise.

Issues:

(1) Is the imposition of MCIT constitutional?
(2) Is the imposition of CWT on income from sales of real properties classified as ordinary
assets constitutional?

Held:
(1) Yes. The imposition of the MCIT is constitutional. An income tax is arbitrary and confiscatory
if it taxes capital, because it is income, and not capital, which is subject to income tax. However,
MCIT is imposed on gross income which is computed by deducting from gross sales the capital
spent by a corporation in the sale of its goods, i.e., the cost of goods and other direct expenses
from gross sales.
Section 27(E) of RA 8424 provides:

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

xxx
(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.
xxx

Clearly, the capital is not being taxed.
Various safeguards were incorporated into the law imposing MCIT. Firstly, recognizing the birth
pangs of businesses and the reality of the need to recoup initial major capital expenditures, the
MCIT is imposed only on the 4th taxable year immediately following the year in which the
corporation commenced its operations. Secondly, the law allows the carry-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. Thirdly, 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.

(2) Yes. Despite the imposition of CWT on GSP or FMV, the income tax base for sales of real
property classified as ordinary assets remains as the entitys net taxable income as provided in
the Tax Code, i.e., gross income less allowable costs and deductions. The 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.
The use of the GSP or FMV as basis to determine the CWT is for purposes of practicality and
convenience. The knowledge of the withholding agent-buyer is limited to the particular
transaction in which he is a party. Hence, his basis can only be the GSP or FMV which figures
are reasonably known to him.
Also, the collection of income tax via the CWT on a per transaction basis, i.e., upon
consummation of the sale, is not contrary to the Tax Code which calls for the payment of the net
income at the end of the taxable period. The taxes withheld are in the nature of advance tax
payments by a taxpayer in order to cancel its possible future tax obligation. They are
installments on the annual tax which may be due at the end of the taxable year. The withholding
agent-buyers act of collecting the tax at the time of the transaction, by withholding the tax due
from the income payable, is the very essence of the withholding tax method of tax collection.
Moreover, the imposition of CWT on GSP/FMV of real estate classified as ordinary assets does not
deprive its members of their property without due process of law. 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.
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. 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.
Commisioner of Internal Revenue vs. Filinvest Development Corporation

Facts:
The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI),
respondent Filinvest Development Corporation (FDC) is a holding company which also owned
67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). FDC and FAI entered into a
Deed of Exchange with FLI whereby the former both transferred in favor of the latter parcels of
land. As a result of the exchange, FLIs ownership structure was changed. Filinvest
Development Corporation extended advances in favor of its affiliates and supported the same
with instructional letters and cash and journal vouchers. FDC also entered into a Shareholders
Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of a Singapore-based joint
venture company called Filinvest Asia Corporation (FAC), tasked to develop and manage FDCs
50% ownership of its PBCom Office Tower Project (the Project). With their equity participation
in FAC respectively pegged at 60% and 40% in the Shareholders Agreement, FDC subscribed
toP500.7 million worth of shares in said joint venture company to RHPLs subscription
worth P433.8 million. Having paid its subscription by executing a Deed of Assignment
transferring to FAC a portion of its rights and interest in the Project, FDC eventually reported a
net loss in its Annual Income Tax Return for the taxable year 1996. FDC received from the BIR
a Formal Notice of Demand to pay deficiency income and documentary stamp taxes, plus
interests and compromise penalties. The said deficiency taxes were assessed on the taxable
gain supposedly realized by FDC from the Deed of Exchange it executed with FAI and FLI, on
the dilution resulting from the Shareholders Agreement FDC executed with RHPL as well as the
arms-length interest rate and documentary stamp taxes imposable on the advances FDC
extended to its affiliates. Filinvest disputed this by saying that the CIR lacks the authority to
impute theoretical interest and that the rule is that interests cannot be demanded in the absence
of a stipulation to the effect.

Issue: Whether or not the CIR lacks the authority to impute theoretical interest.

Held:
The CIR lacks the authority to impute theoretical interest. Invoking Section 43 of the
1993 NIRC in relation to Section 179(b) of Revenue Regulation No. 2, the CIR maintains that it
is vested with the power to allocate, distribute or apportion income or deductions between or
among controlled organizations, trades or businesses even in the absence of fraud, since said
power is intended to prevent evasion of taxes or clearly to reflect the income of any such
organizations, trades or businesses. In addition, the CIR asseverates that the CA should have
accorded weight and respect to the findings of the CTA which, as the specialized court
dedicated to the study and consideration of tax matters, can take judicial notice of US income
tax laws and regulations.
Admittedly, Section 43 of the 1993 NIRC provides that, (i)n any case of two or more
organizations, trades or businesses (whether or not incorporated and whether or not organized
in the Philippines) owned or controlled directly or indirectly by the same interests, the
Commissioner of Internal Revenue is authorized to distribute, apportion or allocate gross
income or deductions between or among such organization, trade or business, if he determines
that such distribution, apportionment or allocation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any such organization, trade or business. In
amplification of the equivalent provision under Commonwealth Act No. 466, Sec. 179(b) of
Revenue Regulation No. 2 states as follows:

Determination of the taxable net income of controlled taxpayer. (A) DEFINITIONS.
When used in this section
(1) The term organization includes any kind, whether it be a sole proprietorship, a
partnership, a trust, an estate, or a corporation or association, irrespective of the place
where organized, where operated, or where its trade or business is conducted, and
regardless of whether domestic or foreign, whether exempt or taxable, or whether
affiliated or not.
(2) The terms trade or business include any trade or business activity of any
kind, regardless of whether or where organized, whether owned individually or
otherwise, and regardless of the place where carried on.
(3) The term controlled includes any kind of control, direct or indirect, whether legally
enforceable, and however exercisable or exercised. It is the reality of the control which is
decisive, not its form or mode of exercise. A presumption of control arises if income or
deductions have been arbitrarily shifted.
(4) The term controlled taxpayer means any one of two or more organizations, trades,
or businesses owned or controlled directly or indirectly by the same interests.
(5) The term group and group of controlled taxpayers means the organizations, trades
or businesses owned or controlled by the same interests.
(6) The term true net income means, in the case of a controlled taxpayer, the net
income (or as the case may be, any item or element affecting net income) which would
have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case
may be, any item or element affecting net income) which would have resulted to the
controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the
particular contract, transaction, arrangement or other act) dealt with the other members
or members of the group at arms length. It does not mean the income, the deductions,
or the item or element of either, resulting to the controlled taxpayer by reason of the
particular contract, transaction, or arrangement, the controlled taxpayer, or the interest
controlling it, chose to make (even though such contract, transaction, or arrangement be
legally binding upon the parties thereto).

As may be gleaned from the definitions of the terms controlled and "controlled
taxpayer" under paragraphs (a) (3) and (4) of the foregoing provision, it would appear that FDC
and its affiliates come within the purview of Section 43 of the 1993 NIRC. Aside from owning
significant portions of the shares of stock of FLI, FAI, DSCC and FCI, the fact that FDC
extended substantial sums of money as cash advances to its said affiliates for the purpose of
providing them financial assistance for their operational and capital expenditures seemingly
indicate that the situation sought to be addressed by the subject provision exists. From the
tenor of paragraph (c) of Section 179 of Revenue Regulation No. 2, it may also be seen that the
CIR's power to distribute, apportion or allocate gross income or deductions between or among
controlled taxpayers may be likewise exercised whether or not fraud inheres in the transaction/s
under scrutiny. For as long as the controlled taxpayer's taxable income is not reflective of that
which it would have realized had it been dealing at arm's length with an uncontrolled taxpayer,
the CIR can make the necessary rectifications in order to prevent evasion of taxes.

Despite the broad parameters provided, however, we find that the CIR's powers of
distribution, apportionment or allocation of gross income and deductions under Section 43 of the
1993 NIRC and Section 179 of Revenue Regulation No. 2 does not include the power to impute
"theoretical interests" to the controlled taxpayer's transactions. Pursuant to Section 28 of the
1993 NIRC, after all, the term gross income is understood to mean all income from whatever
source derived, including, but not limited to the following items: compensation for services,
including fees, commissions, and similar items; gross income derived from business; gains
derived from dealings in property; interest; rents; royalties; dividends; annuities; prizes and
winnings; pensions; and partners distributive share of the gross income of general professional
partnership. While it has been held that the phrase "from whatever source derived" indicates a
legislative policy to include all income not expressly exempted within the class of taxable
income under our laws, the term "income" has been variously interpreted to mean
"cash received or its equivalent", "the amount of money coming to a person within a specific
time" or "something distinct from principal or capital." Otherwise stated, there must be proof of
the actual or, at the very least, probable receipt or realization by the controlled taxpayer of the
item of gross income sought to be distributed, apportioned or allocated by the CIR.