Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-12287

August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy
Collector of Internal Revenue, defendants-appellees.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:
This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to
the Civil Code, a law of Spanish origin.
STATEMENT OF THE CASE.
Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The marriage
was contracted under the provisions of law concerning conjugal partnerships (sociedad de
gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on the prescribed form
with the Collector of Internal Revenue, showing, as his total net income for the year 1914, the sum of
P296,302.73. Subsequently Madrigal submitted the claim that the said P296,302.73 did not
represent his income for the year 1914, but was in fact the income of the conjugal partnership
existing between himself and his wife Susana Paterno, and that in computing and assessing the
additional income tax provided by the Act of Congress of October 3, 1913, the income declared by
Vicente Madrigal should be divided into two equal parts, one-half to be considered the income of
Vicente Madrigal and the other half of Susana Paterno. The general question had in the meantime
been submitted to the Attorney-General of the Philippine Islands who in an opinion dated March 17,
1915, held with the petitioner Madrigal. The revenue officers being still unsatisfied, the
correspondence together with this opinion was forwarded to Washington for a decision by the United
States Treasury Department. The United States Commissioner of Internal Revenue reversed the
opinion of the Attorney-General, and thus decided against the claim of Madrigal.
After payment under protest, and after the protest of Madrigal had been decided adversely by the
Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana Paterno in
the Court of First Instance of the city of Manila against Collector of Internal Revenue and the Deputy
Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged to have been
wrongfully and illegally collected by the defendants from the plaintiff, Vicente Madrigal, under the
provisions of the Act of Congress known as the Income Tax Law. The burden of the complaint was
that if the income tax for the year 1914 had been correctly and lawfully computed there would have
been due payable by each of the plaintiffs the sum of P2,921.09, which taken together amounts of a
total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the plaintiff
Vicente Madrigal, with the result that plaintiff Madrigal has paid as income tax for the year 1914,
P3,786.08, in excess of the sum lawfully due and payable.
The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and
the stipulation, sets forth the basis of defendants' stand in the following way: The income of Vicente
Madrigal and his wife Susana Paterno of the year 1914 was made up of three items: (1)
P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2) P4,086.50,
the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the profits made by
Vicente Madrigal in a pawnshop company. The sum of these three items is P383,181.97, the gross
income of Vicente Madrigal and Susana Paterno for the year 1914. General deductions were
claimed and allowed in the sum of P86,879.24. The resulting net income was P296,302.73. For the
purpose of assessing the normal tax of one per cent on the net income there were allowed as
specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at source, and
(2) P8,000, the specific exemption granted to Vicente Madrigal and Susana Paterno, husband and
wife. The remainder, P271,614.93 was the sum upon which the normal tax of one per cent was
assessed. The normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in
the Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without
costs.
ISSUES.
The contentions of plaintiffs and appellants having to do solely with the additional income tax, is that
is should be divided into two equal parts, because of the conjugal partnership existing between
them. The learned argument of counsel is mostly based upon the provisions of the Civil Code
establishing the sociedad de gananciales. The counter contentions of appellees are that the taxes
imposed by the Income Tax Law are as the name implies taxes upon income tax and not upon
capital and property; that the fact that Madrigal was a married man, and his marriage contracted
under the provisions governing the conjugal partnership, has no bearing on income considered as
income, and that the distinction must be drawn between the ordinary form of commercial partnership
and the conjugal partnership of spouses resulting from the relation of marriage.
DECISION.
From the point of view of test of faculty in taxation, no less than five answers have been given the
course of history. The final stage has been the selection of income as the norm of taxation.
(See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States, extended
to the Philippine Islands, is the result of an effect on the part of the legislators to put into statutory
form this canon of taxation and of social reform. The aim has been to mitigate the evils arising from
inequalities of wealth by a progressive scheme of taxation, which places the burden on those best
able to pay. To carry out this idea, public considerations have demanded an exemption roughly
equivalent to the minimum of subsistence. With these exceptions, the income tax is supposed to
reach the earnings of the entire non-governmental property of the country. Such is the background of
the Income Tax Law.
Income as contrasted with capital or property is to be the test. The essential difference between
capital and income is that capital is a fund; income is a flow. A fund of property existing at an instant
of time is called capital. A flow of services rendered by that capital by the payment of money from it
or any other benefit rendered by a fund of capital in relation to such fund through a period of time is
called an income. Capital is wealth, while income is the service of wealth. (See Fisher, "The Nature
of Capital and Income.") The Supreme Court of Georgia expresses the thought in the following
figurative language: "The fact is that property is a tree, income is the fruit; labor is a tree, income the
fruit; capital is a tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on
income is not a tax on property. "Income," as here used, can be defined as "profits or gains."
(London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N.
S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition
[1915], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon
[1890], 136 U.S., 549; and Towne vs.Eisner, decided by the United States Supreme Court, January
7, 1918.)
A regulation of the United States Treasury Department relative to returns by the husband and wife
not living apart, contains the following:
The husband, as the head and legal representative of the household and general custodian of its
income, should make and render the return of the aggregate income of himself and wife, and for the
purpose of levying the income tax it is assumed that he can ascertain the total amount of said
income. If a wife has a separate estate managed by herself as her own separate property, and
receives an income of more than $3,000, she may make return of her own income, and if the
husband has other net income, making the aggregate of both incomes more than $4,000, the wife's
return should be attached to the return of her husband, or his income should be included in her
return, in order that a deduction of $4,000 may be made from the aggregate of both incomes. The
tax in such case, however, will be imposed only upon so much of the aggregate income of both shall
exceed $4,000. If either husband or wife separately has an income equal to or in excess of $3,000, a
return of annual net income is required under the law, and such return must include the income of
both, and in such case the return must be made even though the combined income of both be less
than $4,000. If the aggregate net income of both exceeds $4,000, an annual return of their combined
incomes must be made in the manner stated, although neither one separately has an income of
$3,000 per annum. They are jointly and separately liable for such return and for the payment of the
tax. The single or married status of the person claiming the specific exemption shall be determined
as one of the time of claiming such exemption which return is made, otherwise the status at the
close of the year."
With these general observations relative to the Income Tax Law in force in the Philippine Islands, we
turn for a moment to consider the provisions of the Civil Code dealing with the conjugal partnership.
2

Recently in two elaborate decisions in which a long line of Spanish authorities were cited, this court
in speaking of the conjugal partnership, decided that "prior to the liquidation the interest of the wife
and in case of her death, of her heirs, is an interest inchoate, a mere expectancy, which constitutes
neither a legal nor an equitable estate, and does not ripen into title until there appears that there are
assets in the community as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose
[1916], 15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)
Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband
Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate
property rights and in the ultimate ownership of property acquired as income after such income has
become capital. Susana Paterno has no absolute right to one-half the income of the conjugal
partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return
in order to receive the benefit of the exemption which would arise by reason of the additional tax. As
she has no estate and income, actually and legally vested in her and entirely distinct from her
husband's property, the income cannot properly be considered the separate income of the wife for
the purposes of the additional tax. Moreover, the Income Tax Law does not look on the spouses as
individual partners in an ordinary partnership. The husband and wife are only entitled to the
exemption of P8,000 specifically granted by the law. The higher schedules of the additional tax
directed at the incomes of the wealthy may not be partially defeated by reliance on provisions in our
Civil Code dealing with the conjugal partnership and having no application to the Income Tax Law.
The aims and purposes of the Income Tax Law must be given effect.
The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter overruling
the opinion of the Attorney-General is as follows:
TREASURY DEPARTMENT, Washington.
Income Tax.
FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.
SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission of
income tax returns by marred person."
You advise that "The Governor-General, in forwarding the papers to the Bureau, advises that
the Insular Auditor has been authorized to suspend action on the warrants in question until
an authoritative decision on the points raised can be secured from the Treasury
Department."
From the correspondence it appears that Gregorio Araneta, married and living with his wife,
had an income of an amount sufficient to require the imposition of the net income was
properly computed and then both income and deductions and the specific exemption were
divided in half and two returns made, one return for each half in the names respectively of
the husband and wife, so that under the returns as filed there would be an escape from the
additional tax; that Araneta claims the returns are correct on the ground under the Philippine
law his wife is entitled to half of his earnings; that Araneta has dominion over the income and
under the Philippine law, the right to determine its use and disposition; that in this case the
wife has no "separate estate" within the contemplation of the Act of October 3, 1913, levying
an income tax.
It appears further from the correspondence that upon the foregoing explanation, tax was
assessed against the entire net income against Gregorio Araneta; that the tax was paid and
an application for refund made, and that the application for refund was rejected, whereupon
the matter was submitted to the Attorney-General of the Islands who holds that the returns
were correctly rendered, and that the refund should be allowed; and thereupon the question
at issue is submitted through the Governor-General of the Islands and Bureau of Insular
Affairs for the advisory opinion of this office.
By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be
administered as in the United States but by the appropriate internal-revenue officers of the
Philippine Government. You are therefore advised that upon the facts as stated, this office
holds that for the Federal Income Tax (Act of October 3, 1913), the entire net income in this

case was taxable to Gregorio Araneta, both for the normal and additional tax, and that the
application for refund was properly rejected.
The separate estate of a married woman within the contemplation of the Income Tax Law is
that which belongs to her solely and separate and apart from her husband, and over which
her husband has no right in equity. It may consist of lands or chattels.
The statute and the regulations promulgated in accordance therewith provide that each
person of lawful age (not excused from so doing) having a net income of $3,000 or over for
the taxable year shall make a return showing the facts; that from the net income so shown
there shall be deducted $3,000 where the person making the return is a single person, or
married and not living with consort, and $1,000 additional where the person making the
return is married and living with consort; but that where the husband and wife both make
returns (they living together), the amount of deduction from the aggregate of their several
incomes shall not exceed $4,000.
The only occasion for a wife making a return is where she has income from a sole and
separate estate in excess of $3,000, but together they have an income in excess of $4,000,
in which the latter event either the husband or wife may make the return but not both. In all
instances the income of husband and wife whether from separate estates or not, is taken as
a whole for the purpose of the normal tax. Where the wife has income from a separate estate
makes return made by her husband, while the incomes are added together for the purpose
of the normal tax they are taken separately for the purpose of the additional tax. In this case,
however, the wife has no separate income within the contemplation of the Income Tax Law.
Respectfully,

DAVID A. GATES.
Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax
Law was drafted by the Congress of the United States and has been by the Congress extended to
the Philippine Islands. Being thus a law of American origin and being peculiarly intricate in its
provisions, the authoritative decision of the official who is charged with enforcing it has peculiar force
for the Philippines. It has come to be a well-settled rule that great weight should be given to the
construction placed upon a revenue law, whose meaning is doubtful, by the department charged with
its execution. (U.S. vs. Cerecedo Hermanos y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2 Phil.,
630; Government of the Philippine Islands vs. Municipality of Binalonan, and Roman Catholic Bishop
of Nueva Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is hereby
affirmed with costs against appellants. So ordered.
Torres, Johnson, Carson, Street and Fisher, JJ., concur.

United States Supreme Court

EISNER v. MACOMBER, (1920)
No. 318
Argued: April 16, 1919

Decided: March 8, 1920

[252 U.S. 189, 190] Mr. Assistant Attorney General Frierson, for plaintiff in error.
[252 U.S. 189, 194] Messrs. Charles E. Hughes and George Welwood Murray, both of New York City, for
defendant in error.
[252 U.S. 189, 199]
Mr. Justice PITNEY delivered the opinion of the Court.
This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power
to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in
good faith against profits accumulated by the corporation since March 1, 1913.
It arises under the Revenue Act of September 8, 1916 (39 Stat. 756 et seq., c. 463 [Comp. St. 6336a et
seq.]), which, in our opinion ( notwithstanding a contention of the government that will be [252 U.S. 189,
200] noticed), plainly evinces the purpose of Congress to tax stock dividends as income. 1
The facts, in outline, are as follows:
On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of an
authorized capital stock of $100,000, 000, had shares of stock outstanding, par value $100 each,
amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in
plant, property, and business and required for the purposes of the corporation, amounting to about
$45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913, the balance
thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue
additional shares sufficient to constitute a stock dividend of 50 per cent. of the outstanding stock, and to
transfer from surplus account to capital stock account an amount equivalent to such issue. Appropriate
resolutions were adopted, an amount equivalent to the par value of the proposed new stock was
transferred accordingly, and the new stock duly issued against it and divided among the stockholders.
Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1,100
additional[252 U.S. 189, 201] shares, of which 18.07 per cent., or 198.77 shares, par value $19,877, were
treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon
to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed
income of $ 19,877 because of the new shares; and an appeal to the Commissioner of Internal Revenue
having been disallowed, she brought action against the Collector to recover the tax. In her complaint she
alleged the above facts, and contended that in imposing such a tax the Revenue Act of 1916 violated article
1, 2, cl. 3, and article 1, 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be
apportioned according to population, and that the stock dividend was not income within the meaning of
the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of
Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254; and, defendant having failed to plead
further, final judgment went against him. To review it, the present writ of error is prosecuted.
The case was argued at the last term, and reargued at the present term, both orally and by additional
briefs.
We are constrained to hold that the judgment of the District Court must be affirmed: First, because the
question at issue is controlled by Towne v. Eisner, supra; secondly, because a re-examination of the
question with the additional light thrown upon it by elaborate arguments, has confirmed the view that the
underlying ground of that decision is sound, that it disposes of the question here presented, and that other
fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior
to January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913 (38 Stat. 114, 166,
c. 16 ), which provided (section B, p. 167) that net income should include 'dividends,' and also 'gains or
profits and income derived [252 U.S. 189, 202] from any source whatever.' Suit having been brought by a
stockholder to recover the tax assessed against him by reason of the dividend, the District Court sustained
a demurrer to the complaint. 242 Fed. 702. The court treated the construction of the act as inseparable
from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan &
Trust Co., 158 U.S. 601 , 15 Sup. Ct. 912, and quoted the Amendment, proceeded very properly to say (242
Fed. 704):
'It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not,
even though Congress expressly declared it to be taxable as income, unless it is in fact income.'
It declined, however, to accede to the contention that in Gibbons v. Mahon, 136 U.S. 549 , 10 Sup. Ct.
1057, 'stock dividends' had received a definition sufficiently clear to be controlling, treated the language of
this court in that case as obiter dictum in respect of the matter then before it (242 Fed. 706), and
examined the question as res nova, with the result stated. When the case came here, after overruling a
motion to dismiss made by the government upon the ground that the only question involved was the
construction of the statute and not its constitutionality, we dealt upon the merits with the question of
construction only, but disposed of it upon consideration of the essential nature of a stock dividend
disregarding the fact that the one in question was based upon surplus earnings that accrued before the
Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the District Court, saying
( 245 U.S. 426 , 38 Sup. Ct. 159, L. R. A. 1918D, 254):
'Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the
dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for
life and remainderman. What was said by this court upon the latter question is equally true for the former.
'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the [252
U.S. 189, 203] interests of the shareholders. Its property is not diminished, and their interests are not
increased. ... The proportional interest of each shareholder remains the same. The only change is in the
evidence which represents that interest, the new shares and the original shares together representing the
same proportional interest that the original shares represented before the issue of the new ones.' Gibbons
v. Mahon, 136 U.S. 549, 559 , 560 S. [10 Sup. Ct. 1057]. In short, the corporation is no poorer and the
stockholder is no richer than they were before. Logan County v. United States, 169 U.S. 255 , 261 [18 Sup.
Ct. 361]. If the plaintiff gained any small advantage by the change, it certainly was not an advantage of
$417,450, the sum upon which he was taxed. ... What has happened is that the plaintiff's old certificates
have been split up in effect and have diminished in value to the extent of the value of the new.'
This language aptly answered not only the reasoning of the District Court but the argument of the
Solicitor General in this court, which discussed the essential nature of a stock dividend. And if, for the
reasons thus expressed, such a dividend is not to be regarded as 'income' or 'dividends' within the
meaning of the act of 1913, we are unable to see how it can be brought within the meaning of 'incomes' in
the Sixteenth Amendment; it being very clear that Congress intended in that act to exert its power to the
extent permitted by the amendment. In Towne v. Eisner it was not contended that any construction of the
statute could make it narrower than the constitutional grant; rather the contrary.
The fact that the dividend was charged against profits earned before the act of 1913 took effect, even
before the amendment was adopted, was neither relied upon nor alluded to in our consideration of the
merits in that case. Not only so, but had we considered that a stock dividend constituted income in any
true sense, it would have been held taxable under the act of 1913 notwithstanding it was [252 U.S. 189,
204] based upon profits earned before the amendment. We ruled at the same term, in Lynch v.
Hornby, 247 U.S. 339 , 38 Sup. Ct. 543, that a cash dividend extraordinary in amount, and in Peabody v.
Eisner, 247 U.S. 347 , 38 Sup. Ct. 546, that a dividend paid in stock of another company, were taxable as
income although based upon earnings that accrued before adoption of the amendment. In the former
case, concerning 'corporate profits that accumulated before the act took effect,' we declared ( 247 U.S.
343, 344 , 38 S. Sup. Ct. 543, 545 [62 L. Ed. 1149]):

'Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations
only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in
dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out
this intent when dividends are declared out of a pre-existing surplus. ... Congress was at liberty under the
amendment to tax as income, without apportionment, everything that became income, in the ordinary
sense of the word, after the adoption of the amendment, including dividends received in the ordinary
course by a stockholder from a corporation, even though they were extraordinary in amount and might
appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the
stockholder had in a surplus of corporate assets previously existing.'
In Peabody v. Eisner, 247 U.S. 349, 350 , 38 S. Sup. Ct. 546, 547 (62 L. Ed. 1152), we observed that the
decision of the District Court in Towne v. Eisner had been reversed 'only upon the ground that it related to
a stock dividend which in fact took nothing from the property of the corporation and added nothing to the
interest of the shareholder, but merely changed the evidence which represented that interest,' and we
distinguished the Peabody Case from the Towne Case upon the ground that 'the dividend of Baltimore &
Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union
Pacific.'
Therefore Towne v. Eisner cannot be regarded as turning [252 U.S. 189, 205] upon the point that the
surplus accrued to the company before the act took effect and before adoption of the amendment. And
what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having
furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might
rest the present case there, not because that case in terms decided the constitutional question, for it did
not, but because the conclusion there reached as to the essential nature of a stock dividend necessarily
prevents its being regarded as income in any true sense.
Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue Act of
1916 declared (39 Stat. 757 [Comp. St . 6336b]) that a 'stock dividend shall be considered income, to the
amount of its cash value,' we will deal at length with the constitutional question, incidentally testing the
soundness of our previous conclusion.
The Sixteenth Amendment must be construed in connection with the taxing clauses of the original
Constitution and the effect attributed to them before the amendment was adopted. In Pollock v. Farmers'
Loan & Trust Co.,158 U.S. 601 , 15 Sup. Ct. 912, under the Act of August 27, 1894 (28 Stat. 509, 553, c.
349, 27), it was held that taxes upon rents and profits of real estate and upon returns from investments of
personal property were in effect direct taxes upon the property from which such income arose, imposed
by reason of ownership; and that Congress could not impose such taxes without apportioning them
among the states according to population, as required by article 1, 2, cl. 3, and section 9, cl. 4, of the
original Constitution.
Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus
determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be
accomplished:
'The Congress shall have power to lay and collect taxes on incomes, from whatever source derived,
without apportionment among [252 U.S. 189, 206] the several states, and without regard to any census
or enumeration.'
As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the
necessity which otherwise might exist for an apportionment among the states of taxes laid on income.
Brushaber v. Union Pacific R. R. Co., 240 U.S. 1 , 17-19, 36 Sup. Ct. 236, Ann. Cas. 1917B, 713, L. R. A.
1917D, 414; Stanton v. Baltic Mining Co., 240 U.S. 103 , 112 et seq., 36 Sup. Ct. 278; Peck & Co. v.
Lowe, 247 U.S. 165, 172 , 173 S., 38 Sup. Ct. 432.
A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall
not be extended by loose construction, so as to repeal or modify, except as applied to income, those
provisions of the Constitution that require an apportionment according to population for direct taxes
upon property, real and personal. This limitation still has an appropriate and important function, and is
not to be overridden by Congress or disregarded by the courts.

In order, therefore, that the clauses cited from article 1 of the Constitution may have proper force and
effect, save only as modified by the amendment, and that the latter also may have proper effect, it
becomes essential to distinguish between what is and what is not 'income,' as the term is there used, and
to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress
cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the
Constitution, from which alone it derives its power to legislate, and within whose limitations alone that
power can be lawfully exercised.
The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former
being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir
supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.
For the present purpose we require only a clear definition of the term 'income,' [252 U.S. 189, 207] as
used in common speech, in order to determine its meaning in the amendment, and, having formed also a
correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.
After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's Internat. Dict.;
Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the
Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U.S. 399, 415 , 34 S. Sup. Ct. 136,
140 [58 L. Ed. 285]; Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 , 38 S. Sup. Ct. 467, 469 [62 L. Ed.
1054]), 'Income may be defined as the gain derived from capital, from labor, or from both combined,'
provided it be understood to include profit gained through a sale or conversion of capital assets, to which
it was applied in the Doyle Case, 247 U.S. 183, 185 , 38 S. Sup. Ct. 467, 469 (62 L. Ed. 1054).
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct
solution of the present controversy. The government, although basing its argument upon the definition as
quoted, placed chief emphasis upon the word 'gain,' which was extended to include a variety of meanings;
while the significance of the next three words was either overlooked or misconceived. 'Derived-fromcapital'; 'the gain-derived-from-capital,' etc. Here we have the essential matter: not a gain accruing to
capital; not a growth or increment of value in the investment; but a gain, a profit, something of
exchangeable value, proceeding from the property, severed from the capital, however invested or
employed, and coming in, being 'derived'-that is, received or drawn by the recipient (the taxpayer) for his
separate use, benefit and disposal- that is income derived from property. Nothing else answers the
description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment-'incomes, from
whatever source derived'-the essential thought being expressed [252 U.S. 189, 208] with a conciseness
and lucidity entirely in harmony with the form and style of the Constitution.
Can a stock dividend, considering its essential character, be brought within the definition? To answer this,
regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course,
to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided
into shares to which a nominal or par value is attributed.
Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the
evidence of it. They state the number of shares to which he is entitled and indicate their par value and how
the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed
capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled
to have the property and business of the company devoted during the corporate existence to attainment of
the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the
corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate
share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend
declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on
the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business,
and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the
corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets
employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to
withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for

his return. If he desires to dissociate himself [252 U.S. 189, 209] from the company he can do so only by
disposing of his stock.
For bookeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to
the aggregate par value of their stock, evidenced by a 'capital stock account.' If profits have been made and
not divided they create additional bookkeeping liabilities under the head of 'profit and loss,' 'undivided
profits,' 'surplus account,' or the like. None of these, however, gives to the stockholders as a body, much
less to any one of them, either a claim against the going concern for any particular sum of money, or a
right to any particular portion of the assets or any share in them unless or until the directors conclude that
dividends shall be made and a part of the company's assets segregated from the common fund for the
purpose. The dividend normally is payable in money, under exceptional circumstances in some other
divisible property; and when so paid, then only (excluding, of course, a possible advantageous sale of his
stock or winding-up of the company) does the stockholder realize a profit or gain which becomes his
separate property, and thus derive income from the capital that he or his predecessor has invested.
In the present case, the corporation had surplus and undivided profits invested in plant, property, and
business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition
to outstanding capital stock of $50,000,000. In this the case is not extraordinary. The profits of a
corporation, as they appear upon the balance sheet at the end of the year, need not be in the form of
money on hand in excess of what is required to meet current liabilities and finance current operations of
the company. Often, especially in a growing business, only a part, sometimes a small part, of the year's
profits is in property capable of division; the remainder having been absorbed in the acquisition of
increased plant, [252 U.S. 189, 210] quipment, stock in trade, or accounts receivable, or in decrease of
outstanding liabilities. When only a part is available for dividends, the balance of the year's profits is
carried to the credit of undivided profits, or surplus, or some other account having like significance. If
thereafter the company finds itself in funds beyond current needs it may declare dividends out of such
surplus or undivided profits; otherwise it may go on for years conducting a successful business, but
requiring more and more working capital because of the extension of its operations, and therefore unable
to declare dividends approximating the amount of its profits. Thus the surplus may increase until it equals
or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the
mode adopted in the case at bar-by declaring a 'stock dividend.' This, however, is no more than a book
adjustment, in essence not a dividend but rather the opposite; no part of the assets of the company is
separated from the common fund, nothing distributed except paper certificates that evidence an
antecedent increase in the value of the stockholder's capital interest resulting from an accumulation of
profits by the company, but profits so far absorbed in the business as to render it impracticable to
separate them for withdrawal and distribution. In order to make the adjustment, a charge is made against
surplus account with corresponding credit to capital stock account, equal to the proposed 'dividend'; the
new stock is issued against this and the certificates delivered to the existing stockholders in proportion to
their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of
the corporation or its outstanding liabilities; it affects only the form, not the essence, of the 'liability'
acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on
one side of the balance sheet only, increasing 'capital stock' at the expense of [252 U.S. 189,
211] 'SURPLUS'; IT DOES NOT ALTER THE PRE-EXisting proportionate interest of any stockholder or
increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they
stood before. The new certificates simply increase the number of the shares, with consequent dilution of
the value of each share.
A 'stock dividend' shows that the company's accumulated profits have been capitalized, instead of
distributed to the stockholders or retained as surplus available for distribution in money or in kind should
opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone
such realization, in that the fund represented by the new stock has been transferred from surplus to
capital, and no longer is available for actual distribution.
The essential and controlling fact is that the stockholder has received nothing out of the company's assets
for his separate use and benefit; on the contrary, every dollar of his original investment, together with
whatever accretions and accumulations have resulted from employment of his money and that of the

other stockholders in the business of the company, still remains the property of the company, and subject
to business risks which may result in wiping out the entire investment. Having regard to the very truth of
the matter, to substance and not to form, he has recived nothing that answers the definition of income
within the meaning of the Sixteenth Amendment.
Being concerned only with the true character and effect of such a dividend when lawfully made, we lay
aside the question whether in a particular case a stock dividend may be authorized by the local law
governing the corporation, or whether the capitalization of profits may be the result of correct judgment
and proper business policy on the part of its management, and a due regard for the interests of the
stockholders. And we are considering the taxability of bona fide stock dividends only. [252 U.S. 189,
212] We are clear that not only does a stock dividend really take nothing from the property of the
corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits
evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital,
at the same time shows he has not realized or received any income in the transaction.
It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he may, if he
can find a buyer. It is equally true that if he does sell, and in doing so realizes a profit, such profit, like any
other, is income, and so far as it may have arisen since the Sixteenth Amendment is taxable by Congress
without apportionment. The same would be true were he to sell some of his original shares at a profit. But
if a shareholder sells dividend stock he necessarily disposes of a part of his capital interest, just as if he
should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles
him to the same proportion of future dividends as before the sale. His part in the control of the company
likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a
corporation should receive in common with other stockholders a 50 per cent. stock dividend, and should
sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths
instead of six- tenths of the total stock outstanding. A corresponding and proportionate decrease in capital
interest and in voting power would befall a minority holder should he sell dividend stock; it being in the
nature of things impossible for one to dispose of any part of such an issue without a proportionate
disturbance of the distribution of the entire capital stock, and a like diminution of the seller's comparative
voting power-that 'right preservative of rights' in the control of a corporation. [252 U.S. 189, 213] Yet,
without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an
income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax
a capital increase, and not income, than this demonstration that in the nature of things it requires
conversion of capital in order to pay the tax.
Throughout the argument of the government, in a variety of forms, runs the fundamental error already
mentioned-a failure to appraise correctly the force of the term 'income' as used in the Sixteenth
Amendment, or at least to give practical effect to it. Thus the government contends that the tax 'is levied
on income derived from corporate earnings,' when in truth the stockholder has 'derived' nothing except
paper certificates which, so far as they have any effect, deny him present participation in such earnings. It
contends that the tax may be laid when earnings 'are received by the stockholder,' whereas he has received
none; that the profits are 'distributed by means of a stock dividend,' although a stock dividend distributes
no profits; that under the act of 1916 'the tax is on the stockholder's share in corporate earnings,' when in
truth a stockholder has no such share, and receives none in a stock dividend; that 'the profits are
segregated from his former capital, and he has a separate certificate representing his invested profits or
gains,' whereas there has been no segregation of profits, nor has he any separate certificate representing a
personal gain, since the certificates, new and old, are alike in what they represent-a capital interest in the
entire concerns of the corporation.
We have no doubt of the power or duty of a court to look through the form of the corporation and
determine the question of the stockholder's right, in order to ascertain whether he has received income
taxable by Congress without apportionment. But, looking through the form, [252 U.S. 189, 214] we
cannot disregard the essential truth disclosed, ignore the substantial difference between corporation and
stockholder, treat the entire organization as unreal, look upon stockholders as partners, when they are not
such, treat them as having in equity a right to a partition of the corporate assets, when they have none,
and indulge the fiction that they have received and realized a share of the profits of the company which in

10

truth they have neither received nor realized. We must treat the corporation as a substantial entity
separate from the stockholder, not only because such is the practical fact but because it is only by
recognizing such separateness that any dividend-even one paid in money or property-can be regarded as
income of the stockholder. Did we regard corporation and stockholders as altogether identical, there
would be no income except as the corporation acquired it; and while this would be taxable against the
corporation as income under appropriate provisions of law, the individual stockholders could not be
separately and additionally taxed with respect to their several shares even when divided, since if there
were entire identity between them and the company they could not be regarded as receiving anything
from it, any more than if one's money were to be removed from one pocket to another.
Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the
government nevertheless contends extent to which the gains accumulated by the extend to which the
gains accumulated by the corporation have made him the richer. There are two insuperable difficulties
with this: In the first place, it would depend upon how long he had held the stock whether the stock
dividend indicated the extent to which he had been enriched by the operations of the company; unless he
had held it throughout such operations the measure would not hold true. Secondly, and more important
for present purposes, enrichment through increase in value [252 U.S. 189, 215] of capital investment is
not income in any proper meaning of the term.
The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon
sales before and after the stock dividend, tending to show that the receipt of the additional shares did not
substantially change the market value of her entire holdings. This tends to show that in this instance
market quotations reflected intrinsic values-a thing they do not always do. But we regard the market
prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be,
not what will the thing sell for, but what is it in truth and in essence.
It is said there is no difference in principle between a simple stock dividend and a case where stockholders
use money received as cash dividends to purchase additional stock contemporaneously issued by the
corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money
for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend,
such as the one we have under consideration, where nothing of value is taken from the company's assets
and transferred to the individual ownership of the several stockholders and thereby subjected to their
disposal.
The government's reliance upon the supposed analogy between a dividend of the corporation's own shares
and one made by distributing shares owned by it in the stock of another company, calls for no comment
beyond the statement that the latter distributes assets of the company among the shareholders while the
former does not, and for no citation of authority except Peabody v. Eisner, 247 U.S. 347, 349 , 350 S., 38
Sup. Ct. 546.
Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of
the government. [252 U.S. 189, 216] Swan Brewery Co., Ltd. v. Rex, [252 U.S. 189, 1914] A. C. 231, arose
under the Dividend Duties Act of Western Australia, which provided that 'dividend' should include 'every
dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members
or directors of any company,' except, etc. There was a stock dividend, the new shares being allotted among
the shareholders pro rata; and the question was whether this was a distribution of a dividend within the
meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the
ground that, although 'in ordinary language the new shares would not be called a dividend, nor would the
allotment of them be a distribution of a dividend,' yet, within the meaning of the act, such new shares
were an 'advantage' to the recipients. There being no constitutional restriction upon the action of the
lawmaking body, the case presented merely a question of statutory construction, and manifestly the
decision is not a precedent for the guidance of this court when acting under a duty to test an act of
Congress by the limitations of a written Constitution having superior force.
In Tax Commissioner v. Putnam (1917) 227 Mass. 522, 116 N. E. 904, L. R. A. 1917F, 806, it was held that
the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the Legislature
full power to tax incomes, 'must be interpreted as including every item which by any reasonable

11

understanding can fairly be regarded as income' (227 Mass. 526, 531, 116 N. E. 904, 907 [L. R. A. 1917F,
806]), and that under it a stock dividend was taxable as income; the court saying (227 Mass. 535, 116 N. E.
911, L. R. A. 1917F, 806):
'In essence the thing which has been done is to distribute a symbol representing an accumulation of
profits, which instead of being paid out in cash is invested in the business, thus augmenting its durable
assets. In this aspect of the case the substance of the transaction is no different from what it would be if a
cash dividend had been declared with the privilege of subscription to an equivalent amount of new
shares.' [252 U.S. 189, 217] We cannot accept this reasoning. Evidently, in order to give a sufficiently
broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance,
accumulation for distribution, capital accretion for its opposite; while a case where money is paid into the
hand of the stockholder with an option to buy new shares with it, followed by acceptance of the option,
was regarded as identical in substance with a case where the stockholder receives no money and has no
option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a
constitutional amendment in the light of other constitutional provisions that stand in the way of
extending it by construction.
Upon the second argument, the government, recognizing the force of the decision in Towne v. Eisner,
supra, and virtually abandoning the contention that a stock dividend increases the interest of the
stockholder or otherwise enriches him, insisted as an alternative that by the true construction of the act of
1916 the tax is imposed, not upon the stock dividend, but rather upon the stockholder's share of the
undivided profits previously accumulated by the corporation; the tax being levied as a matter of
convenience at the time such profits become manifest through the stock dividend. If so construed, would
the act be constitutional?
That Congress has power to tax shareholders upon their property interests in the stock of corporations is
beyond question, and that such interests might be valued in view of the condition of the company,
including its accumulated and undivided profits, is equally clear. But that this would be taxation of
property because of ownership, and hence would require apportionment under the provisions of the
Constitution, is settled beyond peradventure by previous decisions of this court.
The government relies upon Collector v. Hubbard (1870) [252 U.S. 189, 218] 12 Wall. 1, (20 L. Ed. 272),
which arose under section 117 of the Act of June 30, 1864 (13 Stat. 223, 282, c. 173), providing that-'The gains and profits of all companies, whether incorporated or partnership, other than the companies
specified in that section, shall be included in estimating the annual gains, profits, or income of any person,
entitled to the same, whether divided or otherwise.'
The court held an individual taxable upon his proportion of the earnings of a corporation although not
declared as dividends and although invested in assets not in their nature divisible. Conceding that the
stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (12
Wall. 18):
'Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its
incidents, and that among those incidents is the right to receive all future dividends, that is, his
proportional share of all profits not then divided. Profits are incident to the share to which the owner at
once becomes entitled provided he remains a member of the corporation until a dividend is made.
Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are
the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw
material for the purpose of being manufactured are investments in which the stockholders are interested,
and when such profits are actually appropriated to the payment of the debts of the corporation they serve
to increase the market value of the shares, whether held by the original subscribers or by assignees.'
In so far as this seems to uphold the right of Congress to tax without apportionment a stockholder's
interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v.
Farmers' Loan & Trust Co., 158 U.S. 601, 627 , 628 S., 637, 15 Sup. Ct. 912. Conceding Collector v.
Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property
not apportioned [252 U.S. 189, 219] AMONG THE STATES, THE GOVERNMENT NEVERTHEless
insists that the sixteenth Amendment removed this obstacle, so that now the Hubbard Case is authority
for the power of Congress to levy a tax on the stockholder's share in the accumulated profits of the

12

corporation even before division by the declaration of a dividend of any kind. Manifestly this argument
must be rejected, since the amendment applies to income only, and what is called the stockholder's share
in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder
has no individual share in accumulated profits, nor in any particular part of the assets of the corporation,
prior to dividend declared.
Thus, from every point of view we are brought irresistibly to the conclusion that neither under the
Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock
dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the
stockholder. The Revenue Act of 1916, in so far as it imposes a tax upon the stockholder because of such
dividend, contravenes the provisions of article 1, 2, cl. 3, and article 1, 9, cl. 4, of the Constitution, and to
this extent is invalid, notwithstanding the Sixteenth Amendment.
Judgment affirmed.

13

144 F.2d 110 (1944)

RAYTHEON PRODUCTION CORPORATION
v.
COMMISSIONER OF INTERNAL REVENUE.
No. 3956.

Circuit Court of Appeals, First Circuit.

July 28, 1944.
Writ of Certiorari Denied November 20, 1944.

*111 Edward C. Thayer, of Boston, Mass., for petitioner.

Newton K. Fox, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and
Sewall Key and J. Louis Monarch, Sp. Assts. to Atty. Gen., on the brief), for respondent.
Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.
Writ of Certiorari Denied November 20, 1944. See 65 S. Ct. 192.
MAHONEY, Circuit Judge.
This case presents the question whether an amount received by the taxpayer in
compromise settlement of a suit for damages under the Federal Anti-Trust Laws, 15
U.S.C.A. 1 et seq., is a non-taxable return of capital or income. If the recovery is nontaxable, there is a second question as to whether the Tax Court erred in holding that
there was insufficient evidence to enable it to determine what part of the lump sum
payment received by the taxpayer was properly allocable to compromise of the suit and
what part was allocable to payment for certain patent license rights which were
conveyed as a part of the settlement.
Petitioner, Raytheon Production Corporation, came into existence as a result of a series
of what both parties as well as the Tax Court have treated as tax free reorganizations.
Since we think such is the proper treatment, we shall simplify the facts by referring to
any one of the original and successor companies as Raytheon. The original Raytheon
Company was a pioneer manufacturer of a rectifying tube which made possible the
operation of a radio receiving set on alternating current instead of on batteries. In 1926
its profits were about $450,000; in 1927 about $150,000; and in 1928, $10,000. The
Radio Corporation of America had many patents covering radio circuits and claimed
control over almost all of the practical circuits. Cross-licensing agreements had been
made among several companies including R.C.A., General Electric Company,
Westinghouse, and American Telephone & Telegraph Company. R.C.A. had developed
a competitive tube which produced the same type of rectification as the Raytheon tube.
Early in 1927, R.C.A. began to license manufacturers of radio sets and in the license
agreement it incorporated "Clause 9", which provided that the licensee was required to
buy its tubes from R.C.A. In 1928 practically all manufacturers were operating under
R.C.A. licenses. As a consequence of this restriction, Raytheon was left with only
14

replacement sales, which soon disappeared. When Raytheon found it impossible to

market its tubes in the early part of 1929, it obtained a license from R.C.A. to
manufacture tubes under the letters patent on a royalty basis. The license agreement
contained a release of all claims of Raytheon against R.C.A. by reason of the illegal acts
of the latter under Clause 9 but by a side agreement such claims could be asserted if
R.C.A. should pay similar claims to others. The petitioner was informed of instances in
which R.C.A. had settled claims against it based on Clause 9. On that ground it
considered itself released from the agreement not to enforce its claim against R.C.A.
and consequently, on December 14, 1931, the petitioner caused its predecessor,
Raytheon, to bring suit against R.C.A. in the District Court of Massachusetts alleging
that the plaintiff had by 1926 created and then possessed a large and valuable good will
in interstate commerce in rectifying tubes for radios and had a large and profitable
established business therein so that the net profit for the year 1926 was $454,935; that
the business had an established prospect of large increases and that the business and
good will thereof was of a value of exceeding $3,000,000; that by the beginning of 1927
the plaintiff was doing approximately 80% of the business of rectifying tubes of the entire
United States; that the defendant conspired to destroy the business of the plaintiff and
others by a monopoly of such business and did suppress *112 and destroy the existing
companies; that the manufacturers of radio sets and others ceased to purchase tubes
from the plaintiffs; that by the end of 1927 the conspiracy had completely destroyed the
profitable business and that by the early part of 1928 the tube business of the plaintiff
and its property and good will had been totally destroyed at a time when it had a present
value in excess of $3,000,000, and thereby the plaintiff was injured in its business and
property in a sum in excess of $3,000,000. The action against R.C.A. was referred to an
auditor who found that Clause 9 was not the cause of damage to the plaintiff but that the
decline in plaintiff's business was due to advancement in the radio art and competition.
The auditor, however, also found that if it should be decided that Clause 9 had turned
the development of the radio art away from plaintiff's type of tube, then the damages
would be $1,000,000.
In the spring of 1938, after the auditor's report and just prior to the time for the
commencement of the trial before a jury, the Raytheon affiliated companies began
negotiations for the settlement of the litigation with R.C.A. In the meantime a suit
brought by R.C.A. against the petitioner for the non-payment of royalties resulted in a
judgment of $410,000 in favor of R.C.A. R.C.A. and the petitioner finally agreed on the
payment by R.C.A. of $410,000 in settlement of the anti trust action. R.C.A. required the
inclusion in the settlement of patent license rights and sublicensing rights to some thirty
patents but declined to allocate the amount paid as between the patent license rights
and the amount for the settlement of the suit. The agreement of settlement contained a
general release of any and all possible claims between the parties.
The officers of the Raytheon companies testified that $60,000 of the $410,000 received
from R.C.A. was the maximum worth of the patents, basing their appraisal on the cost of
development of the patents and the fact that few of them were then being used and that
no royalties were being derived from them. In its income tax return the petitioner
returned $60,000 of the $410,000 as income from patent licenses and treated the
remaining $350,000 as a realization from a chose in action and not as taxable income.
15

The Commissioner determined that the $350,000 constituted income on the following
ground contained in the statement attached to his notice of deficiency: "It is the opinion
of this office that the amount of $350,000 constitutes income under 22(a) of the
Revenue Act of 1936. There exists no clear evidence of what the amount was paid for
so that an accurate apportionment can be made as to a specific consideration for patent
rights transferred to Radio Corporation of America and a consideration for damages.
The amount of $350,000 has therefore been included in your taxable income."
The pertinent sections of the statute are set out in the margin. [1]
Adverting to the question of whether *113 that part of the $410,000 which was paid by
R.C.A. to Raytheon to settle the anti trust suit was a return of capital or ordinary income,
we must observe that the auditor's report is immaterial on that issue. Despite the fact
that the auditor found that the loss was not caused by Clause 9, it was open to the jury
to come to a different conclusion on the question of liability, and to avoid this R.C.A.
settled the suit by compromise.
Damages recovered in an antitrust action are not necessarily nontaxable as a return of
capital. As in other types of tort damage suits, recoveries which represent a
reimbursement for lost profits are income. Swastika Oil & Gas Co. v. Commissioner, 6
Cir., 1941, 123 F.2d 382, certiorari denied 1943, 317 U.S. 639, 63 S. Ct. 30, 87 L. Ed.
515; H. Liebes & Co. v. Commissioner, 9 Cir., 1937, 90 F.2d 932; Sternberg v.
Commissioner, 1935, 32 B.T.A. 1039. The reasoning is that since the profits would be
taxable income, the proceeds of litigation which are their substitute are taxable in like
manner.
Damages for violation of the anti-trust acts are treated as ordinary income where they
represent compensation for loss of profits. Commercial Electrical Supply Co. v.
Commissioner, 1927, 8 B.T.A. 986; see Park v. Gilligan, D.C.S.D.Ohio 1921, 293 F. 129,
130.
The test is not whether the action was one in tort or contract but rather the question to
be asked is "In lieu of what were the damages awarded?" Farmers' & Merchants' Bank
v. Commissioner, 6 Cir., 1932, 59 F.2d 912; Swastika Oil & Gas Co. v. Commissioner,
supra; Central R. Co. of New Jersey v. Commissioner, 3 Cir., 1935, 79 F.2d 697, 101
A.L.R. 1448. See United States v. Safety Car Heating & Lighting Co., 1936, 297 U.S. 88,
98, 56 S. Ct. 353, 80 L. Ed. 500. Plumb, "Income Tax on Gains and Losses in Litigation"
(1940) 25 Cornell L. Q. 221. Where the suit is not to recover lost profits but is for injury
to good will, the recovery represents a return of capital and, with certain limitations to be
set forth below, is not taxable. Farmers' & Merchants' Bank v. Commissioner, supra.
Plumb, supra, 25 Cornell L. Q. 221, 225. "Care must certainly be taken in such cases to
avoid taxing recoveries for injuries to good will or loss of capital". 1 Paul and Mertens
Law of Federal Income Taxation 6.48.
Upon examination of Raytheon's declaration in its anti-trust suit we find nothing to
indicate that the suit was for the recovery of lost profits. The allegations were that the
illegal conduct of R.C.A. "completely destroyed the profitable interstate and foreign
16

commerce of the plaintiff and thereby, by the early part of 1928, the said tube business
of the plaintiff and the property good will of the plaintiff therein had been totally
destroyed at a time when it then had a present value in excess of three million dollars
and thereby the plaintiff was then injured in its business and property in a sum in excess
of three million dollars." This was not the sort of antitrust suit where the plaintiff's
business still exists and where the injury was merely for loss of profits. The allegations
and evidence as to the amount of profits were necessary in order to establish the value
of the good will and business since that is derived by a capitalization of profits. A
somewhat similar idea was expressed in Farmers' & Merchants' Bank v. Commissioner,
supra, *114 59 F.2d at page 913. "Profits were one of the chief indications of the worth
of the business; but the usual earnings before the injury, as compared with those
afterward, were only an evidential factor in determining actual loss and not an
independent basis for recovery." Since the suit was to recover damages for the
destruction of the business and good will, the recovery represents a return of capital.
Nor does the fact that the suit ended in a compromise settlement change the nature of
the recovery; "the determining factor is the nature of the basic claim from which the
compromised amount was realized." Paul Selected Studies in Federal Taxation, Second
Series, pp. 328-9, footnote 76; Helvering v. Safe Deposit & Trust Co. of Baltimore,
1941, 316 U.S. 56, 62 S. Ct. 925, 86 L. Ed. 1266, 139 A.L.R. 1513; Lyeth v. Hoey,
1938, 305 U.S. 188, 59 S. Ct. 155, 83 L. Ed. 119, 119 A.L.R. 410; Central R. of New
Jersey v. Commissioner, supra; Farmers' & Merchants' Bank v. Commissioner, supra;
Megargel v. Commissioner, 1944, 3 T.C. 238.
But, to say that the recovery represents a return of capital in that it takes the place of the
business good will is not to conclude that it may not contain a taxable benefit. Although
the injured party may not be deriving a profit as a result of the damage suit itself, the
conversion thereby of his property into cash is a realization of any gain made over the
cost or other basis of the good will prior to the illegal interference. Thus A buys
Blackacre for $5,000. It appreciates in value to $50,000. B tortiously destroys it by fire. A
sues and recovers $50,000 tort damages from B. Although no gain was derived by A
from the suit, his prior gain due to the appreciation in value of Blackacre is realized
when it is turned into cash by the money damages.
Compensation for the loss of Raytheon's good will in excess of its cost is gross income.
See Magill Taxable Income, p. 339. 1 Mertens, Law of Federal Income Taxation, 5.21,
footnote 82. Plumb, supra, 25 Cornell L. Q. 225, 6.
Since we assume with the parties that the petitioner secured the original Raytheon's
assets through a series of tax free reorganizations, petitioner's basis for the good will is
the same as that of the original Raytheon. As the Tax Court pointed out, the record is
devoid of evidence as to the amount of that basis and "in the absence of evidence of the
basis of the business and good will of Raytheon, the amount of any nontaxable capital
recovery cannot be ascertained." 1 T.C. 952. Cf. Sterling v. Commissioner, 2 Cir., 1937,
93 F.2d 304.
Where the cost basis that may be assigned to property has been wholly speculative, the
gain has been held to be entirely conjectural and not taxable. In Strother v.
17

Commissioner, 4 Cir., 1932, 55 F.2d 626, affirmed on other grounds, 1932, 287 U.S.
308, 53 S. Ct. 150, 77 L. Ed. 325, a trespasser had taken coal and then destroyed the
entries so that the amount of coal taken could not be determined. Since there was no
way of knowing whether the recovery was greater than the basis for the coal taken, the
gain was purely conjectural and not taxed. Magill explains the result as follows: "as the
amount of coal removed could not be determined until a final disposition of the property,
the computation of gain or loss on the damages must await that disposition." Taxable
Income, pp. 339-340. The same explanation may be applied to Farmers' & Merchants'
Bank v. Commissioner, supra, which relied on the Strother case in finding no gain. The
recovery in that case had been to compensate for the injury to good will and business
reputation of the plaintiff bank inflicted by defendant reserve banks' wrongful conduct in
collecting checks drawn on the plaintiff bank by employing "agents who would appear
daily at the bank with checks and demand payment thereof in cash in such a manner as
to attract unfavorable public comment". Since the plaintiff bank's business was not
destroyed but only injured and since it continued in business, it would have been difficult
to require the taxpayer to prove what part of the basis of its good will should be
attributed to the recovery. In the case at bar, on the contrary, the entire business and
good will were destroyed so that to require the taxpayer to prove the cost of the good will
is no more impractical than if the business had been sold. [2]
Inasmuch as we conclude that the portion of the $410,000 attributable to the suit is
taxable income, the second question as *115 to allocation between this and the ordinary
income from patent licenses is not present.
The decision of the Tax Court is affirmed.

18

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-66416 March 21, 1990
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
TOURS SPECIALISTS, INC., and THE COURT OF TAX APPEALS, respondents.
Gadioma Law Offices for private respondent.

GUTIERREZ, JR., J.:

This is a petition to review on certiorari the decision of the Court of Tax Appeals which ruled that the
money entrusted to private respondent Tours Specialists, Inc., earmarked and paid for hotel room
charges of tourists, travelers and/or foreign travel agencies does not form part of its gross receipts
subject to the 3% independent contractor's tax under the National Internal Revenue Code of 1977.
We adopt the findings of facts of the Court of Tax Appeals as follows:
For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived income
from its activities as a travel agency by servicing the needs of foreign tourists and
travelers and Filipino "Balikbayans" during their stay in this country. Some of the
services extended to the tourists consist of booking said tourists and travelers in local
hotels for their lodging and board needs; transporting these foreign tourists from the
airport to their respective hotels, and from the latter to the airport upon their
departure from the Philippines, transporting them from their hotels to various
embarkation points for local tours, visits and excursions; securing permits for them to
visit places of interest; and arranging their cultural entertainment, shopping and
recreational activities.
In order to ably supply these services to the foreign tourists, petitioner and its
correspondent counterpart tourist agencies abroad have agreed to offer a package
fee for the tourists. Although the fee to be paid by said tourists is quoted by the
petitioner, the payments of the hotel room accommodations, food and other personal
expenses of said tourists, as a rule, are paid directly either by tourists themselves, or
by their foreign travel agencies to the local hotels (pp. 77, t.s.n., February 2, 1981;
Exhs. O & O-1, p. 29, CTA rec.; pp. 2425, t.s.n., ibid) and restaurants or shops, as
the case may be.
It is also the case that some tour agencies abroad request the local tour agencies,
such as the petitioner in the case, that the hotel room charges, in some specific
cases, be paid through them. (Exh. Q, Q-1, p. 29 CTA rec., p. 25, T.s.n., ibid, pp. 5-6,
17-18, t.s.n., Aug. 20, 1981.; See also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981, pp. 34, 11., t.s.n., Aug. 10, 1982). By this arrangement, the foreign tour agency entrusts to
the petitioner Tours Specialists, Inc., the fund for hotel room accommodation, which
in turn is paid by petitioner tour agency to the local hotel when billed. The procedure
observed is that the billing hotel sends the bill to the petitioner. The local hotel
identifies the individual tourist, or the particular groups of tourists by code name or
group designation and also the duration of their stay for purposes of payment. Upon
receipt of the bill, the petitioner then pays the local hotel with the funds entrusted to it
by the foreign tour correspondent agency.
Despite this arrangement, respondent Commissioner of Internal Revenue assessed
petitioner for deficiency 3% contractor's tax as independent contractor by including
the entrusted hotel room charges in its gross receipts from services for the years
1974 to 1976. Consequently, on December 6, 1979, petitioner received from
respondent the 3% deficiency independent contractor's tax assessment in the
amount of P122,946.93 for the years 1974 to 1976, inclusive, computed as follows:
1974 deficiency percentage tax

19

per investigation P 3,995.63

15% surcharge for late payment 998.91

P 4,994.54
14% interest computed by quarters
up to 12-28-79 3,953.18 P 8,847.72
1975 deficiency percentage tax
per investigation P 8,427.39
25% surcharge for late payment 2,106.85

P 10,534.24
14% interest computed by quarters
up to 12-28-79 6,808.47 P 17,342.71
1976 deficiency percentage
per investigation P 54,276.42
25% surcharge for late payment 13,569.11

P 67,845.53
14% interest computed by quarters
up to 12-28-79 28,910.97 P 96,756.50

Total amount due P 122,946.93
=========
In addition to the deficiency contractor's tax of P122,946.93, petitioner was assessed
to pay a compromise penalty of P500.00.
Subsequently on December 11, 1979, petitioner formally protested the assessment
made by respondent on the ground that the money received and entrusted to it by
the tourists, earmarked to pay hotel room charges, were not considered and have
never been considered by it as part of its taxable gross receipts for purposes of
computing and paying its constractor's tax.
During one of the hearings in this case, a witness, Serafina Sazon, Certified Public
Accountant and in charge of the Accounting Department of petitioner, had testified,
her credibility not having been destroyed on cross examination, categorically stated
that the amounts entrusted to it by the foreign tourist agencies intended for payment
of hotel room charges, were paid entirely to the hotel concerned, without any portion
thereof being diverted to its own funds. (t.s.n., Feb. 2, 1981, pp. 7, 25; t.s.n., Aug. 20,
1981, pp. 5-9, 17-18). The testimony of Serafina Sazon was corroborated by Gerardo
Isada, General Manager of petitioner, declaring to the effect that payments of hotel
accommodation are made through petitioner without any increase in the room
charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the reason why tourists pay their
room charge, or through their foreign tourists agencies, is the fact that the room

20

charge is exempt from hotel room tax under P.D. 31. (t.s.n., Ibid., pp. 25-29.) Witness
Isada stated, on cross-examination, that if their payment is made, thru petitioner's
tour agency, the hotel cost or charges "is only an act of accomodation on our (its)
part" or that the "agent abroad instead of sending several telexes and saving on bank
charges they take the option to send money to us to be held in trust to be endorsed
to the hotel." (pp. 3-4, t.s.n.Aug. 10, 1982.)
Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written
protest, caused the issuance of a warrant of distraint and levy. (p. 51, BIR Rec.) And
later, respondent had petitioner's bank deposits garnished. (pp. 49-50, BIR Rec.)
Taking this action of respondent as the adverse and final decision on the disputed
assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)
The petitioner raises the lone issue in this petition as follows:
WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL AGENCY
INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN TOUR
AGENCIES, INTENDED OR EARMARKED FOR HOTEL ACCOMMODATIONS
FORM PART OF GROSS RECEIPTS SUBJECT TO 3% CONTRACTOR'S TAX.
(Rollo, p. 23)
The petitioner premises the issue raised on the following assumptions:
Firstly, the ruling overlooks the fact that the amounts received, intended for hotel
room accommodations, were received as part of the package fee and, therefore,
form part of "gross receipts" as defined by law.
Secondly, there is no showing and is not established by the evidence. that the
amounts received and "earmarked" are actually what had been paid out as hotel
room charges. The mere possibility that the amounts actually paid could be less than
the amounts received is sufficient to destroy the validity of the ruling. (Rollo, pp. 2627)
In effect, the petitioner's lone issue is based on alleged error in the findings of facts of the
respondent court.
The well-settled doctrine is that the findings of facts of the Court of Tax Appeals are binding on this
Court and absent strong reasons for this Court to delve into facts, only questions of law are open for
determination. (Nilsen v. Commissioner of Customs, 89 SCRA 43 [1979]; Balbas v. Domingo, 21
SCRA 444 [1967]; Raymundo v. De Joya, 101 SCRA 495 [1980]). In the recent case of Sy Po
v. Court of Appeals, (164 SCRA 524 [1988]), we ruled that the factual findings of the Court of Tax
Appeals are binding upon this court and can only be disturbed on appeal if not supported by
substantial evidence.
In the instant case, we find no reason to disregard and deviate from the findings of facts of the Court
of Tax Appeals.
As quoted earlier, the Court of Tax Appeals sufficiently explained the services of a local travel
agency, like the herein private respondent, rendered to foreign customers. The respondent
differentiated between the package fee offered by both the local travel agency and its
correspondent counterpart tourist agencies abroad and the requests made by some tour agencies
abroad to local tour agencies wherein the hotel room charges in some specific cases, would be paid
to the local hotels through them. In the latter case, the correspondent court found as a fact ". . . that
the foreign tour agency entrusts to the petitioner Tours Specialists, Inc. the fund for hotel room
accommodation, which in turn is paid by petitioner tour agency to the local hotel when billed." (Rollo,
p. 42) The following procedure is followed: The billing hotel sends the bill to the respondent; the local
hotel then identifies the individual tourist, or the particular group of tourist by code name or group
designation plus the duration of their stay for purposes of payment; upon receipt of the bill the
private respondent pays the local hotel with the funds entrusted to it by the foreign tour
correspondent agency.
Moreover, evidence presented by the private respondent shows that the amounts entrusted to it by
the foreign tourist agencies to pay the room charges of foreign tourists in local hotels were not
diverted to its funds; this arrangement was only an act of accommodation on the part of the private
respondent. This evidence was not refuted.

21

In essence, the petitioner's assertion that the hotel room charges entrusted to the private respondent
were part of the package fee paid by foreign tourists to the respondent is not correct. The evidence
is clear to the effect that the amounts entrusted to the private respondent were exclusively for
payment of hotel room charges of foreign tourists entrusted to it by foreign travel agencies.
As regards the petitioner's second assumption, the respondent court stated:
. . . [C]ontrary to the contention of respondent, the records show, firstly, in the
Examiners' Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December 1976
alone, the following sums made up the hotel room accommodations:
July 1976 P 102,702.97
Aug. 1976 121,167.19
Sept. 1976 53,209.61

P 282,079.77
=========
Oct. 1976 P 71,134.80
Nov. 1976 409,019.17
Dec. 1976 142,761.55

622,915.51

Grand Total P 904,995.29

=========
It is not true therefore, as stated by respondent, that there is no evidence proving the
amounts earmarked for hotel room charges. Since the BIR examiners could not have
manufactured the above figures representing "advances for hotel room
accommodations," these payments must have certainly been taken from the records
of petitioner, such as the invoices, hotel bills, official receipts and other pertinent
documents. (Rollo, pp. 48-49)
The factual findings of the respondent court are supported by substantial evidence, hence binding
upon this Court.
With these clarifications, the issue to be threshed out is as stated by the respondent court, to wit:
. . . [W]hether or not the hotel room charges held in trust for foreign tourists and
travelers and/or correspondent foreign travel agencies and paid to local host hotels
form part of the taxable gross receipts for purposes of the 3% contractor's tax. (Rollo,
p. 45)
The petitioner opines that the gross receipts which are subject to the 3% contractor's tax pursuant to
Section 191 (Section 205 of the National Internal Revenue Code of 1977) of the Tax Code include
the entire gross receipts of a taxpayer undiminished by any amount. According to the petitioner, this
interpretation is in consonance with B.I.R. Ruling No. 68-027, dated 23 October, 1968 (implementing
Section 191 of the Tax Code) which states that the 3% contractor's tax prescribed by Section 191 of
the Tax Code is imposed of the gross receipts of the contractor, "no deduction whatever being
allowed by said law." The petitioner contends that the only exception to this rule is when there is a
law or regulation which would exempt such gross receipts from being subjected to the 3%
contractor's tax citing the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc.

22

(108 Phil. 821 [1960]). Thus, the petitioner argues that since there is no law or regulation that money
entrusted, earmarked and paid for hotel room charges should not form part of the gross receipts,
then the said hotel room charges are included in the private respondent's gross receipts for
purposes of the 3% contractor's tax.
In the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (supra), the
Commissioner appealed two decisions of the Court of Tax Appeals disapproving his levy of
amusement taxes upon the Manila Jockey Club, a duly constituted corporation authorized to hold
horse races in Manila. The facts of the case show that the monies sought to be taxed never really
belonged to the club. The decision shows that during the period November 1946 to 1950, the Manila
Jockey Club paid amusement tax on its commission but without including the 5-1/2% which pursuant
to Executive Order 320 and Republic Act 309 went to the Board of Races, the owner of horses and
jockeys. Section 260 of the Internal Revenue Code provides that the amusement tax was payable by
the operator on its "gross receipts". The Manila Jockey Club, however, did not consider as part of its
"gross receipts" subject to amusement tax the amounts which it had to deliver to the Board on
Races, the horse owners and the jockeys. This view was fully sustained by three opinions of the
Secretary of Justice, to wit:
There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the total bets
registered by the Totalizer. This portion represents its share or commission in the
total amount of money it handles and goes to the funds thereof as its own property
which it may legally disburse for its own purposes. The 5% does not belong to the
club. It is merely held in trust for distribution as prizes to the owners of winning
horses. It is destined for no other object than the payment of prizes and the club
cannot otherwise appropriate this portion without incurring liability to the owners of
winning horses. It cannot be considered as an item of expense because the sum
used for the payment of prizes is not taken from the funds of the club but from a
certain portion of the total bets especially earmarked for that purpose.
In view of all the foregoing, I am of the opinion that in the submission of the returns
for the amusement tax of 10% (now it is 20% of the "gross receipts", provided for in
Section 260 of the National Internal Revenue Code), the 5% of the total bets that is
set aside for prizes to owners of winning horses should not be included by the Manila
Jockey Club, Inc.
The Collector of the Internal Revenue, however had a different opinion on the matter and demanded
payment of amusement taxes. The Court of Tax Appeals reversed the Collector.
We affirmed the decision of the Court of Tax Appeals and stated:
The Secretary's opinion was correct. The Government could not have meant to tax
as gross receipt of the Manila Jockey Club the 1/2% which it directs same Club to
turn over to the Board on Races. The latter being a Government institution, there
would be double taxation, which should be avoided unless the statute admits of no
other interpretation. In the same manner, the Government could not have intended to
consider as gross receipt the portion of the funds which it directed the Club to give,
or knew the Club would give, to winning horses and jockeys admittedly 5%. It is
true that the law says that out of the total wager funds 12-1/2% shall be set aside as
the "commission" of the race track owner, but the law itself takes official notice, and
actually approves or directs payment of the portion that goes to owners of horses as
prizes and bonuses of jockeys, which portion is admittedly 5% out of that 12-1/2%
commission. As it did not at that time contemplate the application of "gross receipts"
revenue principle, the law in making a distribution of the total wager funds, took no
trouble of separating one item from the other; and for convenience, grouped three
items under one common denomination.
Needless to say, gross receipts of the proprietor of the amusement place should not
include any money which although delivered to the amusement place has been
especially earmarked by law or regulation for some person other than the proprietor.
(The situation thus differs from one in which the owner of the amusement place, by a
private contract, with its employees or partners, agrees to reserve for them a portion
of the proceeds of the establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55 Off.
Gaz. [51] 10539; Sy Chuico v. Coll., 107 Phil., 428; 59 Off. Gaz., [6] 896).
In the second case, the facts of the case are:

23

The Manila Jockey Club holds once a year a so called "special Novato race",
wherein only "novato" horses, (i.e. horses which are running for the first time in an
official [of the club] race), may take part. Owners of these horses must pay to the
Club an inscription fee of P1.00, and a declaration fee of P1.00 per horse. In
addition, each of them must contribute to a common fund (P10.00 per horse). The
Club contributes an equal amount P10.00 per horse) to such common fund, the total
amount of which is added to the 5% participation of horse owners already described
herein-above in the first case.
Since the institution of this yearly special novato race in 1950, the Manila Jockey
Club never paid amusement tax on the moneys thus contributed by horse owners
(P10.00 each) because it entertained the belief that in accordance with the three
opinions of the Secretary of Justice herein-above described, such contributions never
formed part of its gross receipts. On the inscription fee of the P1.00 per horse, it paid
the tax. It did not on the declaration fee of P1.00 because it was imposed by the
Municipal Ordinance of Manila and was turned over to the City officers.
The Collector of Internal Revenue required the Manila Jockey Club to pay
amusement tax on such contributed fund P10.00 per horse in the special novato
race, holding they were part of its gross receipts. The Manila Jockey Club protested
and resorted to the Court of Tax Appeals, where it obtained favorable judgment on
the same grounds sustained by said Court in connection with the 5% of the total
wager funds in the herein-mentioned first case; they were not receipts of the Club.
We resolved the issue in the following manner:
We think the reasons for upholding the Tax Court's decision in the first case apply to
this one. The ten-peso contribution never belonged to the Club. It was held by it as a
trust fund. And then, after all, when it received the ten-peso contribution, it at the
same time contributed ten pesos out of its own pocket, and thereafter distributed
both amounts as prizes to horse owners. It would seem unreasonable to regard the
ten-peso contribution of the horse owners as taxable receipt of the Club, since the
latter, at the same moment it received the contribution necessarily lost ten pesos too.
As demonstrated in the above-mentioned case, gross receipts subject to tax under the Tax Code do
not include monies or receipts entrusted to the taxpayer which do not belong to them and do not
redound to the taxpayer's benefit; and it is not necessary that there must be a law or regulation
which would exempt such monies and receipts within the meaning of gross receipts under the Tax
Code.
Parenthetically, the room charges entrusted by the foreign travel agencies to the private respondent
do not form part of its gross receipts within the definition of the Tax Code. The said receipts never
belonged to the private respondent. The private respondent never benefited from their payment to
the local hotels. As stated earlier, this arrangement was only to accommodate the foreign travel
agencies.
Another objection raised by the petitioner is to the respondent court's application of Presidential
Decree 31 which exempts foreign tourists from payment of hotel room tax. Section 1 thereof
provides:
Sec. 1. Foreign tourists and travelers shall be exempt from payment of any and all
hotel room tax for the entire period of their stay in the country.
The petitioner now alleges that P.D. 31 has no relevance to the case. He contends that the tax under
Section 191 of the Tax Code is in the nature of an excise tax; that it is a tax on the exercise of the
privilege to engage in business as a contractor and that it is imposed on, and collectible from the
person exercising the privilege. He sums his arguments by stating that "while the burden may be
shifted to the person for whom the services are rendered by the contractor, the latter is not relieved
from payment of the tax." (Rollo, p. 28)
The same arguments were submitted by the Commissioner of Internal Revenue in the case
of Commissioner of Internal Revenue v. John Gotamco & Son., Inc. (148 SCRA 36 [1987]), to justify
his imposition of the 3% contractor's tax under Section 191 of the National Internal Revenue Code
on the gross receipts John Gotamco & Sons, Inc., realized from the construction of the World Health
Organization (WHO) office building in Manila. We rejected the petitioner's arguments and ruled:

24

We agree with the Court of Tax Appeals in rejecting this contention of the petitioner.
Said the respondent court:
"In context, direct taxes are those that are demanded from the very
person who, it is intended or desired, should pay them; while indirect
taxes are those that are demanded in the first instance from one
person in the expectation and intention that he can shift the burden to
someone else. (Pollock v. Farmers, L & T Co., 1957 US 429, 15 S.
Ct. 673, 39 Law. ed. 759). The contractor's tax is of course payable
by the contractor but in the last analysis it is the owner of the building
that shoulders the burden of the tax because the same is shifted by
the contractor to the owner as a matter of self-preservation. Thus, it is
an indirect tax. And it is an indirect tax on the WHO because,
although it is payable by the petitioner, the latter can shift its burden
on the WHO. In the last analysis it is the WHO that will pay the tax
indirectly through the contractor and it certainly cannot be said that
'this tax has no bearing upon the World Health Organization.'"
Petitioner claims that under the authority of the Philippine Acetylene Company versus
Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3% contractor's tax falls
directly on Gotamco and cannot be shifted to the WHO. The Court of Tax Appeals,
however, held that the said case is not controlling in this case, since the Host
Agreement specifically exempts the WHO from "indirect taxes." We agree. The
Philippine Acetylene case involved a tax on sales of goods which under the law had
to be paid by the manufacturer or producer; the fact that the manufacturer or
producer might have added the amount of the tax to the price of the goods did not
make the sales tax "a tax on the purchaser." The Court held that the sales tax must
be paid by the manufacturer or producer even if the sale is made to tax-exempt
entities like the National Power Corporation, an agency of the Philippine
Government, and to the Voice of America, an agency of the United States
Government.
The Host Agreement, in specifically exempting the WHO from "indirect taxes,"
contemplates taxes which, although not imposed upon or paid by the Organization
directly, form part of the price paid or to be paid by it.
Accordingly, the significance of P.D. 31 is clearly established in determining whether or not hotel
room charges of foreign tourists in local hotels are subject to the 3% contractor's tax. As the
respondent court aptly stated:
. . . If the hotel room charges entrusted to petitioner will be subjected to 3%
contractor's tax as what respondent would want to do in this case, that would in effect
do indirectly what P.D. 31 would not like hotel room charges of foreign tourists to be
subjected to hotel room tax. Although, respondent may claim that the 3% contractor's
tax is imposed upon a different incidence i.e. the gross receipts of petitioner tourist
agency which he asserts includes the hotel room charges entrusted to it, the effect
would be to impose a tax, and though different, it nonetheless imposes a tax actually
on room charges. One way or the other, it would not have the effect of promoting
tourism in the Philippines as that would increase the costs or expenses by the
addition of a hotel room tax in the overall expenses of said tourists. (Rollo, pp. 51-52)
WHEREFORE, the instant petition is DENIED. The decision of the Court of Tax Appeals is
AFFIRMED. No pronouncement as to costs.
SO ORDERED.
Fernan, C.J., Narvasa, Melencio-Herrera, Cruz, Paras, Feliciano, Gancayco, Padilla, Bidin,
Sarmiento, Cortes, Grio-Aquino, Medialdea and Regalado, JJ., concur.

25

Republic of the Philippines

SUPREME COURT
Manila
SECOND DIVISION

G.R. No. 78953 July 31, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.
Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p
Central in this controversy is the issue as to whether or not a taxpayer who merely states as a
footnote in his income tax return that a sum of money that he erroneously received and already
spent is the subject of a pending litigation and there did not declare it as income is liable to pay the
50% penalty for filing a fraudulent return.
This question is the subject of the petition for review before the Court of the portion of the
Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393, entitled,
"Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as Commissioner of Internal Revenue," which
orders the deletion of the 50% surcharge from Javier's deficiency income tax assessment on his income
for 1977.
The respondent CTA in a Resolution 2 dated May 25, 1987, denied the Commissioner's Motion for
Reconsideration 3 and Motion for New Trial 4 on the deletion of the 50% surcharge assessment or
imposition.
The pertinent facts as are accurately stated in the petition of private respondent Javier in the CTA
and incorporated in the assailed decision now under review, read as follows:
xxx xxx xxx
2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner (private
respondent herein), received from the Prudential Bank and Trust Company in Pasay
City the amount of US$999,973.70 remitted by her sister, Mrs. Dolores Ventosa,
through some banks in the United States, among which is Mellon Bank, N.A.
3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the Court
of First Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No.
26899), against the petitioner (private respondent herein), his wife and other
defendants, claiming that its remittance of US$1,000,000.00 was a clerical error and
should have been US$1,000.00 only, and praying that the excess amount of
US$999,000.00 be returned on the ground that the defendants are trustees of an
implied trust for the benefit of Mellon Bank with the clear, immediate, and continuing
duty to return the said amount from the moment it was received.
4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an
Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.)
charging the petitioner (private respondent herein) and his wife with the crime of
estafa, alleging that they misappropriated, misapplied, and converted to their own
personal use and benefit the amount of US$999,000.00 which they received under
an implied trust for the benefit of Mellon Bank and as a result of the mistake in the
remittance by the latter.
5. That on March 15, 1978, the petitioner (private respondent herein) filed his Income
Tax Return for the taxable year 1977 showing a gross income of P53,053.38 and a
net income of P48,053.88 and stating in the footnote of the return that "Taxpayer was
recipient of some money received from abroad which he presumed to be a gift but
turned out to be an error and is now subject of litigation."
26

6. That on or before December 15, 1980, the petitioner (private respondent herein)
received a letter from the acting Commissioner of Internal Revenue dated November
14, 1980, together with income assessment notices for the years 1976 and 1977,
demanding that petitioner (private respondent herein) pay on or before December 15,
1980 the amount of P1,615.96 and P9,287,297.51 as deficiency assessments for the
years 1976 and 1977 respectively. . . .
7. That on December 15, 1980, the petitioner (private respondent herein) wrote the
Bureau of Internal Revenue that he was paying the deficiency income assessment
for the year 1976 but denying that he had any undeclared income for the year 1977
and requested that the assessment for 1977 be made to await final court decision on
the case filed against him for filing an allegedly fraudulent return. . . .
8. That on November 11, 1981, the petitioner (private respondent herein) received
from Acting Commissioner of Internal Revenue Romulo Villa a letter dated October 8,
1981 stating in reply to his December 15, 1980 letter-protest that "the amount of
Mellon Bank's erroneous remittance which you were able to dispose, is definitely
taxable." . . . 5
The Commissioner also imposed a 50% fraud penalty against Javier.
Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on December 10,
1981.
The respondent CTA, after the proper proceedings, rendered the challenged decision. We quote the
concluding portion:
We note that in the deficiency income tax assessment under consideration,
respondent (petitioner here) further requested petitioner (private respondent here) to
pay 50% surcharge as provided for in Section 72 of the Tax Code, in addition to the
deficiency income tax of P4,888,615.00 and interest due thereon. Since petitioner
(private respondent) filed his income tax return for taxable year 1977, the 50%
surcharge was imposed, in all probability, by respondent (petitioner) because he
considered the return filed false or fraudulent. This additional requirement, to our
mind, is much less called for because petitioner (private respondent), as stated
earlier, reflected in as 1977 return as footnote that "Taxpayer was recipient of some
money received from abroad which he presumed to be gift but turned out to be an
error and is now subject of litigation."
From this, it can hardly be said that there was actual and intentional fraud, consisting
of deception willfully and deliberately done or resorted to by petitioner (private
respondent) in order to induce the Government to give up some legal right, or the
latter, due to a false return, was placed at a disadvantage so as to prevent its lawful
agents from proper assessment of tax liabilities. (Aznar vs. Court of Tax Appeals, L20569, August 23, 1974, 56 (sic) SCRA 519), because petitioner literally "laid his
cards on the table" for respondent to examine. Error or mistake of fact or law is not
fraud. (Insular Lumber vs. Collector, L-7100, April 28, 1956.). Besides, Section 29 is
not too plain and simple to understand. Since the question involved in this case is of
first impression in this jurisdiction, under the circumstances, the 50% surcharge
imposed in the deficiency assessment should be deleted. 7
The Commissioner of Internal Revenue, not satisfied with the respondent CTA's ruling, elevated the
matter to us, by the present petition, raising the main issue as to:
WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY?

On the other hand, Javier candidly stated in his Memorandum, 9 that he "did not appeal the decision
which held him liable for the basic deficiency income tax (excluding the 50% surcharge for fraud)."
However, he submitted in the samememorandum "that the issue may be raised in the case not for the
purpose of correcting or setting aside the decision which held him liable for deficiency income tax, but
only to show that there is no basis for the imposition of the surcharge." This subsequent disavowal
therefore renders moot and academic the posturings articulated in as Comment 10 on the non-taxability of
the amount he erroneously received and the bulk of which he had already disbursed. In any event, an
appeal at that time (of the filing of the Comments) would have been already too late to be seasonable.
The petitioner, through the office of the Solicitor General, stresses that:
xxx xxx xxx

27

The record however is not ambivalent, as the record clearly shows that private
respondent is self-convinced, and so acted, that he is the beneficial owner, and of
which reason is liable to tax. Put another way, the studied insinuation that private
respondent may not be the beneficial owner of the money or income flowing to him
as enhanced by the studied claim that the amount is "subject of litigation" is belied by
the record and clearly exposed as a fraudulent ploy, as witness what transpired upon
receipt of the amount.
Here, it will be noted that the excess in the amount erroneously remitted by MELLON
BANK for the amount of private respondent's wife was $999,000.00 after opening a
dollar account with Prudential Bank in the amount of $999,993.70, private
respondent and his wife, with haste and dispatch, within a span of eleven (11)
electric days, specifically from June 3 to June 14, 1977, effected a total massive
withdrawal from the said dollar account in the sum of $975,000.00 or
P7,020,000.00. . . . 11
In reply, the private respondent argues:
xxx xxx xxx
The petitioner contends that the private respondent committed fraud by not declaring
the "mistaken remittance" in his income tax return and by merely making a footnote
thereon which read: "Taxpayer was the recipient of some money from abroad which
he presumed to be a gift but turned out to be an error and is now subject of
litigation." It is respectfully submitted that the said return was not fraudulent. The
footnote was practically an invitation to the petitioner to make an investigation, and to
make the proper assessment.
The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths v.
Comm., 50 F [2d] 782), that is, it must be stronger than the "mere preponderance of
evidence" which would be sufficient to sustain a judgment on the issue of correctness
of the deficiency itself apart from the fraud penalty. (Frank A. Neddas, 40 BTA 672).
The following circumstances attendant to the case at bar show that in filing the
questioned return, the private respondent was guided, not by that "willful and
deliberate intent to prevent the Government from making a proper assessment"
which constitute fraud, but by an honest doubt as to whether or not the "mistaken
remittance" was subject to tax.
First, this Honorable Court will take judicial notice of the fact that so-called "million
dollar case" was given very, very wide publicity by media; and only one who is not in
his right mind would have entertained the idea that the BIR would not make an
assessment if the amount in question was indeed subject to the income tax.
Second, as the respondent Court ruled, "the question involved in this case is of first
impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even in the
United States, the authorities are not unanimous in holding that similar receipts are
subject to the income tax. It should be noted that the decision in the Rutkin case is a
five-to-four decision; and in the very case before this Honorable Court, one out of
three Judges of the respondent Court was of the opinion that the amount in question
is not taxable. Thus, even without the footnote, the failure to declare the "mistaken
remittance" is not fraudulent.
Third, when the private respondent filed his income tax return on March 15, 1978 he
was being sued by the Mellon Bank for the return of the money, and was being
prosecuted by the Government for estafa committed allegedly by his failure to return
the money and by converting it to his personal benefit. The basic tax amounted to
P4,899,377.00 (See p. 6 of the Petition) and could not have been paid without using
part of the mistaken remittance. Thus, it was not unreasonable for the private
respondent to simply state in his income tax return that the amount received was still
under litigation. If he had paid the tax, would that not constitute estafa for using the
funds for his own personal benefit? and would the Government refund it to him if the
courts ordered him to refund the money to the Mellon Bank? 12
xxx xxx xxx

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National Internal Revenue
Code), a taxpayer who files a false return is liable to pay the fraud penalty of 50% of the tax due

28

from him or of the deficiency tax in case payment has been made on the basis of the return filed
before the discovery of the falsity or fraud.
We are persuaded considerably by the private respondent's contention that there is no fraud in the
filing of the return and agree fully with the Court of Tax Appeals' interpretation of Javier's notation on
his income tax return filed on March 15, 1978 thus: "Taxpayer was the recipient of some money from
abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation
that it was an "error or mistake of fact or law" not constituting fraud, that such notation was
practically an invitation for investigation and that Javier had literally "laid his cards on the table." 13
In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax return was discussed in
this manner:
. . . The fraud contemplated by law is actual and not constructive. It must be
intentional fraud, consisting of deception willfully and deliberately done or resorted to
in order to induce another to give up some legal right. Negligence, whether slight or
gross, is not equivalent to the fraud with intent to evade the tax contemplated by law.
It must amount to intentional wrong-doing with the sole object of avoiding the tax. It
necessarily follows that a mere mistake cannot be considered as fraudulent intent,
and if both petitioner and respondent Commissioner of Internal Revenue committed
mistakes in making entries in the returns and in the assessment, respectively, under
the inventory method of determining tax liability, it would be unfair to treat the
mistakes of the petitioner as tainted with fraud and those of the respondent as made
in good faith.
Fraud is never imputed and the courts never sustain findings of fraud upon circumstances which, at
most, create only suspicion and the mere understatement of a tax is not itself proof of fraud for the
purpose of tax evasion. 15
A "fraudulent return" is always an attempt to evade a tax, but a merely "false return"
may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16
In the case at bar, there was no actual and intentional fraud through willful and deliberate misleading
of the government agency concerned, the Bureau of Internal Revenue, headed by the herein
petitioner. The government was not induced to give up some legal right and place itself at a
disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities because
Javier did not conceal anything. Error or mistake of law is not fraud. The petitioner's zealousness to
collect taxes from the unearned windfall to Javier is highly commendable. Unfortunately, the
imposition of the fraud penalty in this case is not justified by the extant facts. Javier may be guilty of
swindling charges, perhaps even for greed by spending most of the money he received, but the
records lack a clear showing of fraud committed because he did not conceal the fact that he had
received an amount of money although it was a "subject of litigation." As ruled by respondent Court
of Tax Appeals, the 50% surcharge imposed as fraud penalty by the petitioner against the private
respondent in the deficiency assessment should be deleted.
WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax Appeals is
AFFIRMED. No costs.
SO ORDERED.
Melencio-Herrera, Padilla and Regalado, JJ., concur.
Paras, J., took no part.

Republic of the Philippines

SUPREME COURT
Manila

29

EN BANC
G.R. Nos. L-9738 and L-9771

May 31, 1957

BLAS GUTIERREZ, and MARIA MORALES, petitioners,

vs.
HONORABLE COURT OF TAX APPEALS, and THE COLLECTOR OF INTERNAL
REVENUE, respondents.
COLLECTOR OF INTERNAL REVENUE, petitioner,
vs.
BLAS GUTIERREZ, MARIA MORALES, and COURT OF TAX APPEALS, respondents.
Rafael Morales for petitioners.
Assistant Solicitor General Ramon L. Avancea and Solicitor Jose P. Alejandro for respondents.
FELIX, J.:
Maria Morales was the registered owner of an agricultural land designated as Lot No. 724-C of the
cadastral survey of Mabalacat, Pampanga. The Republic of the Philippines, at the request of the
U.S. Government and pursuant to the terms of the Military Bases Agreement of March 14, 1947,
instituted condemnation proceedings in the Court of the First Instance of Pampanga, docketed, as
Civil Case No. 148, for the purpose of expropriating the lands owned by Maria Morales and others
needed for the expansion of the Clark Field Air Base, which project is necessary for the mutual
protection and defense of the Philippines and the United States. Blas Gutierrez was also made a
party defendant in said Civil Case No. 148 for being the husband of the landowner Maria Morales. At
the commencement of the action, the Republic of the Philippines, therein plaintiff deposited with the
Clerk of the Court of First Instance of Pampanga the sum of P156,960, which was provisionally fixed
as the value of the lands sought to be expropriated, in order that it could take immediate possession
of the same.
On January 27, 1949, upon order of the Court, the sum of P34,580 (PNB Check 721520-Exh. R)
was paid by the Provincial treasurer of Pampanga to Maria Morales out of the original deposit of
P156,960 made by therein plaintiff. After due hearing, the Court of First Instance of Pampanga
rendered decision dated November 29, 1949, wherein it fixed as just compensation P2,500 per
hectare for some of the lots and P3,000 per hectare for the others, which values were based on the
reports of the Commission on Appraisal whose members were chosen by both parties and by the
Court, which took into consideration the different conditions affecting, the value of the condemned
properties in making their findings.
In virtue of said decision, defendant Maria Morales was to receive the amount of P94,305.75 as
compensation for Lot No. 724-C which was one of the expropriated lands. But the Court disapproved
defendants' claims for consequential damages considering them amply compensated by the price
awarded to their said properties. In order to avoid further litigation expenses and delay inherent to an
appeal, the parties entered into a compromise agreement on January 7, 1950, modifying in part the
decision rendered by the Court in the sense of fixing the compensation for all the lands, without
distinction, at P2,500 per hectare, which compromise agreement was approved by the Court on
January 9, 1950. This reduction of the price to P2,500 per hectare did not affect Lot No. 724-C of
defendant Maria Morales. Sometime in 1950, the spouses Blas Gutierrez and Maria Morales
received the sum of P59.785.75 presenting the balance remaining in their favor after deducting the
amount of P34,580 already withdrawn from the compensation to them.
In a notice of assessment dated January 28, 1953, the Collector of Internal Revenue demanded of
the petitioners the payment of P8,481 as alleged deficiency income tax for the year
1950, inclusive of surcharges and penalties. On March 5, 1953, counsel for petitioner sent a letter to
the Collector of Internal Revenue requesting the letter to withdraw and reconsider said assessment,
contending among others, that the compensation paid to the spouses by the Government for their
property was not "income derived from sale, dealing or disposition of property" referred to by section
29 of the Tax Code and therefore not taxable; that even granting that condemnation of private
properties is embraced within the meaning of the word "sale" or "dealing", the compensation
received by the taxpayers must be considered as income for 1948 and not for 1950 since the
amount deposited and paid in 1948 represented more than 25 per cent of the total compensation
awarded by the court; that the assessment was made after the lapse of the 3-year prescriptive
period provided for in section 51-(d) of the Tax Code; that the compensation in question should be
exempted from taxation by reason of the provision of section 29 (b)-6 of the Tax Code; that the
spouses Blas Gutierrez and Maria Morales did not realize any profit in said transaction as there were
improvements on the land already made and that the purchasing value of the peso at the time of the

30

expropriation proceeding had depreciated if compared to the value of the pre-war peso; and that
penalties should not be imposed on said spouses because granting the assessment was correct, the
emission of the compensation awarded therein was due to an honest mistake.
This request was denied by the Collector of Internal Revenue, in a letter dated April 26, 1954,
refuting point by point the arguments advanced by the taxpayers. The record further shows that a
warrant of distraint and levy was issued by the Collector of Internal Revenue on the properties of Mr.
& Mrs. Blas Gutierrez found in Mabalacat, Pampanga, and a notice of tax lien was duly registered
with the Register of Deeds of San Fernando, Pampanga, on the same date Counsel for the spouses
then requested that the matter be referred to the Conference Staff of the Bureau of Internal Revenue
for proper hearing to which the Collector answered in a letter dated December 24, 1954, stating that
the request would be granted upon compliance by the taxpayers with the requirements of
Department of Finance order No. 213, i.e., the filing of a verified petition to that effect and that one
half of the total assessment should be guaranteed by a bond, provided that the taxpayers would
agree in writing to the suspension of the running of the period of prescription.
The taxpayers then served notice that the case would be brought on appeal to the Court of Tax
Appeals, which they did by filing a petition with said Court to review the assessment made by the
Collector, of Internal Revenue, docketed as C.T.A. Case No. 65. In that instance, it was prayed that
the Court render judgment declaring that the taking of petitioners' land by the Government was not a
sale or dealing in property; that the amount paid to, petitioners as just compensation for their
property should not be dismissed by, way of taxation; that said compensation was by law exempt
from taxation and that the period to collect the income taxes by summary methods had prescribed;
that respondent Collector of Internal Revenue be enjoined from carrying out further steps to collect
from petitioners methods the said taxes which they alleged to be erroneously assessed and for
remedies which would serve the ends of law and justice.
The Solicitor General, in representation of the respondent Collector of Internal Revenue, filed an
answer on February 11, 1955, admitting some of the allegations of petitioners and denying some of
them, and as special defenses, he advanced the contention that Court had no jurisdiction to
entertain the petition; profit realized by petitioners from the sale of the land in question was subject
to income tax, that the full compensation received by petitioners should be included in the income
received in 1950, same having been paid in 1950 by the Government; that under the Bases
Agreement only residents of the United states are exempt from the payment of income tax in the
Philippines in respects to profits derived under a contract with the U.S. Government in connection
with the construction, maintenance and operation of the bases; that in the determination of the gain
or loss from the sale of property acquired on or after March 1, 1913, the cost of acquisition and the
selling price shall be taken into account without qualification as to the purchasing power of the
currency; that the imposition of the 50 per cent surcharge was in accordance with the Tax Code, that
the Collector of Internal Revenue was empowered to collect petitioners' deficiency income tax; and
prayed that the petition for review be dismissed; petitioners be ordered to pay the amount of P8,481
plus the delinquency penalty of 5 per cent for late payment and monthly interest at the rate of 1 per
cent from April 1, 1953, up to the date of actual payment and for such other relief that may be
deemed just and equitable in the premises.
After due hearing and after the parties filed their respective memoranda, the Court of Tax Appeals
rendered decision on August 31, 1955, holding that it had jurisdiction to hear and determine the
case; that the gain derived by the petitioners from the expropriation of their property constituted
taxable income and as such was capital gain; and that said gain was taxable in 1950 when it
realized. It was also found by said Court that the evidence did not warrant the imposition of the 50
per cent surcharge because the petitioners acted in good faith and without intent to defraud the
Government when they failed to include in their gross income the proceeds they received from the
expropriated property, and, therefore, modified the assessment made by respondent, requiring
petitioners to pay only the sum of P5,654. From this decision, both parties appealed to this Court
and in this instance, petitioners Blas Gutierrez and Maria Morales, as appellants in G.R. No. L-9738,
made the following assessments of error:
1. That the Court of Tax Appeals erred in holding that, for income tax purposes, income from
expropriation should be deemed as income from sale, any profit derived therefrom is subject
to income tax as capital gain pursuant to the provisions of Section 37-(a)-(5) in relation to
Section 29-(a) of the Tax Code;
2. That the Court of Tax Appeals erred in not holding that, under the particular circumstances
in which the property of the appellants was taken by the Philippine Government, the amount
paid to them as just compensation is exempt from income tax pursuant to Section 29-(b)-(6)
of the Tax Code;

31

3. That the Court of Tax Appeals erred in not holding that the respondent Collector is
definitely barred by the Statute of Limitations from collecting the deficiency income tax in
question, whether administratively thru summary methods, or judicially thru the ordinary
court procedures;
4. That the Court of Tax Appeals erred in not holding that the capital gain found by the
respondent Collector as have been derived by the petitioners-appellants from the
expropriation of their property is merely nominal not subject to income tax, and in not holding
that the pronouncement of the court in the expropriation case in this respect is binding upon
the respondent Collector of Internal Revenue; and
5. That the Court of Tax Appeals erred in not pronouncing upon the pleadings of the parties
that the petitioners-appellants did not derive any capital gain from the expropriation of their
property.
The appeal of the respondent Collector of the Internal Revenue was docketed in this Court as G.R.
No. L-9771, and in this case the Solicitor General ascribed to the lower court the commission of the
following error:
That the Court of Tax Appeals erred in holding that respondents are not subject to the
payment of the 50 per cent surcharge in spite of the fact that the latter's income tax return for
the year 1950 is false and/or fraudulent.
The facts just narrated are not disputed and the controversy only arose from the assertion by the
Collector of Internal Revenue that petitioners-appellants failed to include from their gross income, in
filing their income tax return for 1950, the amount of P94,305.75 which they had received as
compensation for their land taken by the Government by expropriation proceedings. It is the
contention of respondent Collector of Internal Revenue that such transfer of property, for taxation
purposes, is "sale" and that the income derived therefrom is taxable. The pertinent provisions of the
National Internal Revenue Code applicable to the instant cases are the following:
SEC. 29. 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, sales or dealings in property, whether real or personal, growing out of
ownership or use of or interest in such property; also from interests, rents, dividends,
securities, or the transactions of any business carried on for gain or profit, or gains, profits,
and income derived from any source whatsoever.
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:
xxx

xxx

xxx

(5) SALE OF REAL PROPERTY. Gains, profits, and income from the sale of real
property located in the Philippines;
xxx

xxx

xxx

There is no question that the property expropriated being located in the Philippines, compensation or
income derived therefrom ordinarily has to be considered as income from sources within the
Philippines and subject to the taxing jurisdiction of the Philippines. However, it is to be remembered
that said property was acquired by the Government through condemnation proceedings and
appellants' stand is, therefore, that same cannot be considered as sale as said acquisition was by
force, there being practically no meeting of the minds between the parties. Consequently, the
taxpayers contend, this kind of transfer of ownership must perforce be distinguished from sale, for
the purpose of Section 29-(a) of the Tax Code. But the authorities in the United States on the matter
sustain the view expressed by the Collector of Internal Revenue, for it is held that:
The transfer of property through condemnation proceedings is a sale or exchange within the
meaning of section 117 (a) of the 1936 Revenue Act and profit from the transaction
constitutes capital gain" (1942. Com. Int. Revenue vs. Kieselbach (CCA 3) 127 F. (24) 359).
"The taking of property by condemnation and the, payment of just compensation therefore is
a "sale" or "exchange" within the meaning of section 117 (a) of the Revenue Act of 1936, and
profits from that transaction is capital gain (David S. Brown vs. Comm., 1942, 42 BTA 139).
32

The proposition that income from expropriation proceedings is income from sales or exchange and
therefore taxable has been likewise upheld in the case of Lapham vs. U.S. (1949, 40 AFTR 1370)
and in Kneipp vs. U.S. (1949, 85 F Suppl. 902). It appears then that the acquisition by the
Government of private properties through the exercise of the power of eminent domain, said
properties being JUSTLY compensated, is embraced within the meaning of the term "sale"
"disposition of property", and the proceeds from said transaction clearly fall within the definition of
gross income laid down by Section 29 of the Tax Code of the Philippines.
Petitioners-appellants also averred that granting that the compensation thus received is "income",
same is exempted under Section 29-(b)-6 of the Tax Code, which reads as follows:
SEC. 29. GROSS INCOME.
xxx

xxx

xxx

(b) EXCLUSIONS FROM GROSS INCOME. The following items shall not be included in
gross income and shall exempt from taxation under this Title;
xxx

xxx

xxx

(6) Income exempt under treaty. Income of any kind, to the extent required by any treaty
obligation binding upon government of the Philippines.
The taxpayers maintain that since, at the of the U.S. Government, the proceeding to expropriate the
land in question necessary for the expansion of the Clark Field Air Base was instituted by the
Philippine Government as part of its obligation under the Military Bases Agreement, the
compensation accruing therefrom must necessarily fall under the exemption provided for by Section
29-(b)-6 of the Tax Code. We find this stand untenable, for the same Military Bases Agreement cited
by appellants contains the following:
ARTICLE XXII
CONDEMNATION OR EXPROPRIATION
1. Whenever it is necessary to acquire by condemnation or expropriation proceedings real
property belonging to private persons, association, or corporations located in bases named
in Annex "A" and Annex "B" in order to carry out the purposes of this agreement, the
Philippines, will institute and prosecute such condemnation proceeding in accordance with
the laws of the Philippines. The United States agrees to reimburse the Philippines for all the
reasonable expenses, damages, and costs thereby incurred, including title value of the
property as determined by the Court. In addition, subject to mutual agreements of the two
governments, the United States shall reimburse the Philippines for the reasonable costs of
transportation and removal of any occupants displaced or ejected by reason of the
condemnation or expropriation.
ARTICLE XII
INTERNAL REVENUE EXEMPTION
(1) No member of the United States Armed Forces except Filipino citizens, serving in the
Philippines in connection with the bases and residing in the Philippines by reason only of
such service, or his dependents, shall be liable to pay income tax in the Philippines except in
respect of income derived from Philippine sources.
(2) No National of the United States serving in the Philippines in connection with the
construction, maintenance, operation or defense of the bases and residing in the Philippines
by reason only of such employment, or his spouse and minor children and dependent
parents of either spouse, shall be liable to pay income tax in the Philippines except in
respect of income derived from Philippine sources or sources other than the United States.
(3) No person referred to in paragraphs 1 and 2 of this said Article shall be liable to pay the
government or local authorities of the Philippines any poll or residence tax, or any imports or
exports duties, or any other tax on personal property imported for his own use provided, that
private owned vehicles shall be subject to payment of the following only: when certified as
being used for military purposes by appropriate United States Authorities, the normal license
plate fee; otherwise, the normal license and registration fees.
(4) No national of the United States, or corporation organized under the laws of the United
States, shall be liable to pay income tax in the Philippines in respect of any profits derived

33

under a contract made in the United States with the government of the United States in
connection with the construction, maintenance, operation and defense of the bases, or any
tax in the nature of a license in respect of any service of work for the United, States in
connection with the construction, maintenance, operation and defense of the bases.
xxx

xxx

xxx

The facts brought about by the aforementioned terms of the said treaty need no further elucidation. It
is unmistakable that although the condemnation or expropriation of properties was provided for, the
exemption from tax of the compensation to be paid for the expropriation of privately owned lands
located in the Philippines was not given any attention, and the internal revenue exemptions
specifically taken care of by said Agreement applies only to members of the U.S. Armed Forces
serving in the Philippines and U.S. nationals working in these Islands in connection with the
construction, maintenance, operation and defense of said bases.
Anent appellant taxpayers' allegation that the respondent Collector of Internal Revenue was barred
from collecting the deficiency income tax assessment, it having been made beyond the 3-year period
prescribed by section 51-(d) of the Tax Code, We have this much to say. Although it is true that by
order of the Court of First Instance of Pampanga, the amount of P34,580 out of the original deposit
made by the Government was withdrawn in favor of appellants on January 27, 1949, the same
cannot be considered as income for 1950 when the balance of P59,785.75 was actually received.
Before that date (1950), appellant taxpayers were still the owners of their whole property that was
subject of condemnation proceedings and said amount of P34,580 wasnot paid to, but
merely deposited in court and withdrawn by them. Therefore, the payment of the value of Maria
Morales' Lot 724-C was actually made by the Republic of the Philippines in 1950 and it has to be
credited as income for 1950 for it was then when title over said property passed to the Republic of
the Philippines. Appellant taxpayers cannot say that the title over the property expropriated already
passed to the Government when the latter was placed in possession thereof, for in condemnation
proceedings, title to the land does not pass to the plaintiff until the indemnity is paid (Calvo vs.
Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the expropriator, title does not
actually pass to him until payment of the amount adjudged by the Court and the registration of the
judgment with the Register of Deeds (See Visayan Refining Company vs. Camus et al., 40 Phil. 550;
Metropolitan Water District vs. De los Angeles, 55 Phil. 783). Now, if said amount should have been
reported as income for 1950 in the return that must have been filed on or before March 1, 1951, the
assessment made by the Collector on January 28, 1953, is still within the 3-year prescriptive period
provided for by Section 51-d and could, therefore, be collected either by the administrative methods
of distraint and levy or by judicial action (See Collector of Internal Revenue vs. A P. Reyes et al., 100
Phil., 872; Collector of Internal Revenue vs. Zulueta et al., 100 Phil., 872; and Sambrano vs. Court of
Tax Appeals et al., supra, p. 1).
As to appellant taxpayers' proposition that the profit, derived by them from the expropriation of their
property is merely nominal and not subject to income tax, We find Section 35 of the Tax Code
illuminating. Said section reads as follows:
SEC. 35. DETERMINATION OF GAIN OR LOSS FROM THE SALE OR OTHER
DISPOSITION OF PROPERTY. The gain derived or loss sustained from the sale or other
disposition of property, real or personal, or mixed, shall be determined in accordance with the
following schedule:
(a) xxx

xxx

xxx

(b) In the case of property acquired on or after March first, nineteen hundred and thirteen,
the cost thereof if such property was acquired by purchase or the fair market price or value
as of the date of the acquisition if the same was acquired by gratuitous title.
xxx

xxx

xxx

The records show that the property in question was adjudicated to Maria Morales by order of the
Court of First Instance of Pampanga on March 23, 1929, and in accordance with the aforequoted
section of the National Internal Revenue Code, only the fair market price or value of the property as
of the date of the acquisition thereof should be considered in determining the gain or loss sustained
by the property owner when the property was disposed, without taking into account the purchasing
power of the currency used in the transaction. The records placed the value of the said property at
the time of its acquisition by appellant Maria Morales P28,291.73 and it is a fact that same was
compensated with P94,305.75 when it was expropriated. The resulting difference is surely a capital
gain and should be correspondingly taxed.

34

As to the only question raised by appellant Collector of Internal Revenue in case L-9771, assailing
the lower Court's order exonerating petitioners from the 50 per cent surcharge imposed on the latter,
on the ground that the taxpayers' income tax return for 1950 is false and/or fraudulent, it should be
noted that the Court of Tax Appeals found that the evidence did not warrant the imposition of said
surcharge because the petitioners therein acted in good faith and without intent to defraud the
Government.
The question of fraud is a question of fact which frequently requires a nicely balanced
judgement to answer. All the facts and circumstances surrounding the conduct of the tax
payer's business and all the facts incident to the preparation of the alleged fraudulent return
should be considered. (Mertens, Federal Income Taxation, Chapter 55).
The question of fraud being a question of fact and the lower court having made the finding that "the
evidence of this case does not warrant the imposition of the 50 per cent surcharge", We are
constrained to refrain from giving any consideration to the question raised by the Solicitor General,
for it is already settled in this jurisdiction that in passing upon petitions to review decisions of the
Court of Tax Appeals, We have to confine ourselves to questions of law.
WHEREFORE, the decision appealed from by both parties is hereby affirmed, without
pronouncement as to costs. It is so ordered.
Paras, C.J., Montemayor, Reyes, A., Bautista Angelo, Concepcion, Reyes, J.B.L. and Endencia,
JJ., concur.

United States Supreme Court

JAMES v. UNITED STATES, (1961)
35

No. 63
Argued: November 17, 1960 Decided: May 15, 1961
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. 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. 214-215, 222.
273 F.2d 5, reversed.
Richard E. Gorman argued the cause and filed a brief for petitioner.
Assistant Deputy Attorney General Heffron argued the cause for the United States. With him on the brief
were Solicitor General Rankin, Assistant Attorney General Rice and Meyer Rothwacks.
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 [366 U.S. 213, 214] under 22 (a) of the
Internal Revenue Code of 1939 1 and 61 (a) of the Internal Revenue Code of 1954. 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. 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 4 and
7201 of the Internal Revenue[366 U.S. 213, 215] Code of 1954. 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 constitute 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 138. 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, [366 U.S. 213, 216] unconditional obligation
to repay or return that which would otherwise constitute a gain. Without some bona fide legal or equitable

36

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 22 (a)." Commissioner v. Wilcox, supra, at p. 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 p. 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. 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, 114 ; Corliss v. [366 U.S. 213, 217] Bowers, 281 U.S. 376, 378 .
Thus, the fact that Rutkin secured the money with the consent of his victim, Rutkin v. United States,
supra, at p. 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 the
Wilcox rationale was effectively vitiated by this Court's decision in Rutkin. 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." 9 [366 U.S. 213,
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 p. 138;
United States v. Sullivan, 274 U.S. 259, 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 p. 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 [366 U.S. 213, 219] v. Clifford, 309 U.S. 331, 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, 49 ; Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 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, 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 p. 137. Under these broad principles, we
believe that petitioner's contention, that all unlawful gains are taxable except those resulting from
embezzlement, should fail.

37

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 v.
Burnet, supra, at p. 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 [366 U.S. 213, 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 law-breaking 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. 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 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 re-enacted 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 re-examining and correcting the
Court's own errors. Girouard v. United States, 328 U.S. 61, 69 -70; Helvering v. Hallock, 309 U.S. 106,
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 [366 U.S. 213, 221] be our subsequent decision in Rutkin which has
been thought by many to have repudiated Wilcox. Particularly might this be true in light of the decisions
of the Courts of Appeals which have been riding a narrow rail between the two cases and further
distinguishing them to the disparagement of Wilcox. See notes 8 and 9, supra.
We believe that Wilcox was wrongly decided and we find nothing in congressional history since then to
persuade us that Congress intended to legislate the rule. Thus, we believe that we should now correct the
error and the confusion resulting from it, certainly if we do so in a manner that will not prejudice those
who might have relied on it. Cf. Helvering v. Hallock, supra, at 119. We should not continue to confound
confusion, particularly when the result would be to perpetuate the injustice of relieving embezzlers of the
duty of paying income taxes on the money they enrich themselves with through theft while honest people
pay their taxes on every conceivable type of income.
But, we are dealing here with a felony conviction under statutes which apply to any person who "willfully"
fails to account for his tax or who "willfully" attempts to evade his obligation. In Spies v. United
States, 317 U.S. 492, 499 , the Court said that 145 (b) of the 1939 Code embodied "the gravest of offenses
against the revenues," and stated that willfulness must therefore include an evil motive and want of
justification in view of all the circumstances. Id., at 498. Willfulness "involves a specific intent which must
be proven by independent evidence and which cannot be inferred from the mere understatement of
income." Holland v. United States, 348 U.S. 121, 139 .
We believe that the element of willfulness could not be proven in a criminal prosecution for failing to
include embezzled funds in gross income in the year of misappropriation so long as the statute contained
the gloss placed upon it by Wilcox at the time the alleged crime was [366 U.S. 213, 222] committed.
Therefore, we feel that petitioner's conviction may not stand and that the indictment against him must be
dismissed.
Since MR. JUSTICE HARLAN, MR. JUSTICE FRANKFURTER, and MR. JUSTICE CLARK agree with us
concerning Wilcox, that case is overruled. MR. JUSTICE BLACK, MR. JUSTICE DOUGLAS, and MR.
JUSTICE WHITTAKER believe that petitioner's conviction must be reversed and the case dismissed for
the reasons stated in their opinions.

38

Accordingly, the judgment of the Court of Appeals is reversed and the case is remanded to the District
Court with directions to dismiss the indictment. It is so ordered

United States Supreme Court

COMMISSIONER v. GLENSHAW GLASS CO., (1955)
No. 199
Argued: February 28, 1955 Decided: March 28, 1955
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. 427-433.
(a) In determining what constitutes "gross income" as defined in 22 (a), effect must be given to the
catchall language "gains or profits and income derived from any source whatever." Pp. 429-430.
(b) Eisner v. Macomber, 252 U.S. 189 , distinguished. Pp. 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. 431.
(d) A different result is not required by the fact that 22 (a) was re-enacted without change after the Board
of Tax Appeals had held punitive damages nontaxable in Highland Farms Corp., 42 B. T. A. 1314. Pp. 431432.
(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. 432.
(f) Punitive damages cannot be classified as gifts, nor do they come under any other exemption in the
Code. P. 432.
211 F.2d 928, reversed.
[ Footnote * ] Together with Commissioner of Internal Revenue v. William Goldman Theatres. Inc., which
was a separate case decided by the Court of Appeals in the same opinion.
Solicitor General Sobeloff argued the cause for petitioner. With him on the brief were Assistant Attorney
General Holland, Charles F. Barber, Ellis N. Slack and Melva M. Graney. [348 U.S. 426, 427]
Max Swiren argued the cause for the Glenshaw Glass Company, respondent. With him on the brief were
Sidney B. Gambill and Joseph D. Block.
Samuel H. Levy argued the cause for William Goldman Theatres, Inc., respondent. With him on the brief
was Bernard Wolfman.
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. 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

39

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 HartfordEmpire Company, which manufactures machinery of a character used by Glenshaw. Among the claims
advanced by Glenshaw [348 U.S. 426, 428] were demands for exemplary damages for fraud 2 and treble
damages for injury to its business by reason of Hartford's violation of the federal antitrust laws. 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 [348 U.S. 426, 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.) 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, 334 ; Helvering v. Midland Mutual Life
Ins. Co., 300 U.S. 216, 223 ; Douglas v. Willcuts, 296 U.S. 1, 9 ; Irwin v. Gavit, 268 U.S. 161, 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 [348 U.S. 426, 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, 49 ; Helvering v.
Stockholms Enskilda Bank, 293 U.S. 84, 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

40

importance of that phrase has been too frequently recognized since its first appearance in the Revenue Act
of 1913 5 to say now that it adds nothing to the meaning of "gross income."
Nor can we accept respondent's 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, 207 , as "the gain derived from capital,
from labor, or from both combined." 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 [348 U.S. 426, 431] his capital investment. Id., at 210. It was held that the
taxpayer had "received nothing out of the company's assets for his separate use and benefit." Id., at 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 468-469; United States v. Kirby Lumber Co., supra, at 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 re-enactment 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. Re-enactment - 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, 100-101; Koshland v. Helvering, 298 U.S. 441, 447 . Moreover, the Commissioner
promptly published his nonacquiescence in this portion of the Highland Farms holding 7 and has, [348
U.S. 426, 432] before and since, consistently maintained the position that these receipts are taxable. 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 9 legislative history, with its reiteration of the proposition
that statutory gross income is "all-inclusive,"10 give support to respondent's position. The definition of
gross income has been simplified, but no effect upon its present broad scope was intended. 11 Certainly
punitive damages cannot reasonably be classified as gifts, cf. Commissioner v. Jacobson, 336 U.S. 28, 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 [348 U.S. 426, 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 223.
Reversed.
MR. JUSTICE DOUGLAS dissents.

41

59 F.2d 912 (1932)

FARMERS' & MERCHANTS' BANK OF CATLETTSBURG, KY.,
v.
COMMISSIONER OF INTERNAL REVENUE.
No. 5973.

Circuit Court of Appeals, Sixth Circuit.

June 27, 1932.

George B. Martin, of Catlettsburg, Ky., (Chester A. Bennett, of Washington, D. C., on the

brief), for petitioner.
Helen R. Carloss, of Washington, D. C. (G. A. Youngquist, Asst. Atty. Gen., and Sewall
Key, Wm. Cutler Thompson, C. M.*913 Charest, T. M. Mather, and J. M. Morawski, all of
Washington, D. C., on the brief), for respondent.
Before MOORMAN, HICKS, and HICKENLOOPER, Circuit Judges.
HICKS, Circuit Judge.
Petitioner, a corporation, was engaged in the banking business at Catlettsburg, Ky., and
within the district of the Federal Reserve Bank of Cleveland, Ohio. It was the custom of
petitioner to make a charge for the collection of checks on foreign banks and of checks
drawn on it and sent from other banks. Petitioner was not a member of the Federal
Reserve System so that checks drawn on it instead of being cleared through the
Reserve Bank were sent direct to petitioner by the holding bank and paid by drafts on
Cincinnati or New York.
In 1920 the Reserve Bank demanded that petitioner should clear checks at par. This
demand was refused, and thereupon the Reserve Bank notified its members that it
would collect without charge all checks sent to it and drawn on petitioner. Its method
was to employ agents who would appear daily at the bank with these checks and
demand payment thereof in cash. This practice was followed about eighteen months.
For a greater portion of the time these collections were effected in such an unusual and
unbusinesslike manner as to attract unfavorable public comment, and petitioner claimed
that it was thereby annoyed, embarrassed, and interfered with in the conduct of its
affairs. Subsequently petitioner brought an action against the Reserve Bank for
damages alleged to have been sustained by reason of these tactics. In its petition it set
42

out particularly that, by reason of the wrongful conduct of the Reserve Bank, it had been
forced to procure and keep in its vaults and with its correspondents unusually large
amounts of money; that it had lost the earning power of a great deal of money; that it
had lost deposits and depositors, and had failed to gain new ones; that it had been
unable to grow, and to develop new business; and that it had been permanently injured
in its reputation, standing, growth, and prosperity. The petition also included a claim for
exemplary damages based upon a charge that the conduct of the Reserve Bank was
malicious.
This action was compromised in 1925 and the Reserve Bank paid $18,750.00 in full
settlement. The expense of the suit being deducted the net amount received by
petitioner was reduced to $13,792.96. Respondent conceived that this fund represented
earnings for the year 1925 and included it in petitioner's net income for that year. The
Board of Tax Appeals sustained the respondent. It decided that at least some portion
thereof represented earnings and that petitioner had failed to show what portion did not.
We cannot assent.
The fund involved must be considered in the light of the claim from which it was realized
and which is reflected in the petition filed in its action against the Reserve Bank. We find
nothing therein to indicate, with the certainty required in the statement of a cause of
action, that petitioner sought reparation for profits which petitioner's misconduct
prevented it from earning in 1925. Charles E. Rous, petitioner's cashier, testified before
the Board that the loss of such earnings could not be definitely determined and this
probably furnishes the explanation for the failure definitely to demand it. Petitioner not
only did not insist upon the restoration of anticipated profits as a matter of fact, but
based its claim for damages upon an alleged tortious injury to the good will of its
business, and we can see no legal distinction between compensation for destruction of
or damage to incorporeal or intangible property, such as good will, and similar
compensation for damage to tangible property. Compare Harris & Co. v. Lucas (C. C.
A.) 48 F.(2d) 187, syl. 5.
We think that the gravamen of petitioner's action against the Reserve Bank was the
injury inflicted to its banking business generally, and that the true measure of damages
was compensation to be determined by ascertaining how much less valuable its
business was by reason of the wrongful acts of the Reserve Bank. See Yates v. Whyel
Coke Co., 221 F. 603, 607 (C. C. A. 6); Central Coal & Coke Co. v. Hartman, 111 F. 96,
99 (C. C. A. 8). Injury to its business of course means injury to its financial standing,
credit, reputation, good will, capital, and other possible elements. Profits were one of the
chief indications of the worth of the business; but the usual earnings before the injury,
as compared with those afterward, were only an evidential factor in determining actual
loss and not an independent basis for recovery. We think that, if petitioner's case had
proceeded to a verdict, the law would not have awarded to it what it might have
expected to gain but only that which it had actually lost. We are not justified in reading
an element into the compromise which was not therein distinctly recognized in fact and
would not have *914 been recognized in law. We think therefore that there is no logical
basis upon which petitioner could be charged with gain. See Strother v. Com'r, 55 F.(2d)
43

626, 633 (C. C. A. 4). One may be recompensed for an injury but it is a rare case in
which one should have a profit out of it.
The order of the Board of Tax Appeals is reversed.

United States Supreme Court

PERRY v. UNITED STATES, (1935)
No. 532
Argued:

Decided: February 18, 1935

[294 U.S. 330, 333] Mr. John M. Perry, of New York City, for Perry.
[294 U.S. 330, 341] Messrs. Homer S. Cummings, Atty. Gen., and Angus D. MacLean, Asst. Sol. Gen., of
Washington, D.C., for the United States.
[294 U.S. 330, 346]
Mr. Chief Justice HUGHES delivered the opinion of the Court.
The certificate from the Court of Claims shows the following facts:
Plaintiff brought suit as the owner of an obligation of the United States for $10,000, known as 'Fourth
Liberty Loan 4 1/4% Gold Bond of 1933- 1938.' This bond was issued pursuant to the Act of September 24,
1917, 1 et seq. (40 Stat. 288), as amended, and Treasury Department circular No. 121 dated September 28,
1918. The bond[294 U.S. 330, 347] provided: 'The principal and interest hereof are payable in United
States gold coin of the present standard of value.'
Plaintiff alleged in his petition that at the time the bond was issued, and when he acquired it, 'a dollar in
gold consisted of 25.8 grains of gold .9 fine'; that the bond was called for redemption on April 15, 1934,
and, on May 24, 1934, was presented for payment; that plaintiff demanded its redemption 'by the
payment of 10,000 gold dollars each containing 25.8 grains of gold .9 fine'; that defendant refused to
comply with that demand; and that plaintiff then demanded '258,000 grains of gold . 9 fine, or gold of
equivalent value of any fineness, or 16,931.25 gold dollars each containing 15 5/21 grains of gold .9 fine, or
16,931.25 dollars in legal tender currency'; that defendant refused to redeem the bond 'except by the
payment of 10,000 dollars in legal tender currency'; that these refusals were based on the Joint
Resolution of the Congress of June 5, 1933, 48 Stat. 113 (31 USCA 462, 463), but that this enactment was
unconstitutional, as it operated to deprive plaintiff of his property without due process of law; and that, by
this action of defendant, he was damaged 'in the sum of $16,931.25, the value of defendant's obligation,'
for which, with interest, plaintiff demanded judgment.
Defendant demurred upon the ground that the petition did not state a cause of action against the United
States.
The Court of Claims has certified the following questions:

44

'1. Is the claimant, being the holder and owner of a Fourth Liberty Loan 4 1/4 bond of the United States, of
the principal amount of $10,000, issued in 1918, which was payable on and after April 15, 1934, and which
bond contained a clause that the principal is 'payable in United States gold coin of the present standard of
value', entitled to receive from the United States an amount in legal tender currency in excess of the face
amount of the bond? [294 U.S. 330, 348]
'2. Is the United States, as obligor in a Fourth Liberty Loan 4 1/4% gold bond, Series of 1933-1938, as
stated in Question One liable to respond in damages in a suit in the Court of Claims on such bond as an
express contract, by reason of the change in or impossibility of performance in accordance with the tenor
thereof, due to the provisions of Public Resolution No. 10, 73rd Congress, abrogating the gold clause in all
obligations?'
First. The Import of the Obligation. The bond in suit differs from an obligation of private parties, or of
states or municipalities, whose contracts are necessarily made in subjection to the dominant power of the
Congress. Norman v. Baltimore & Ohio R. Co., 294 U.S. 240 , 55 S.Ct. 407, decided this day. The bond
now before us is an obligation of the United States. The terms of the bond are explicit. They were not only
expressed in the bond itself, but they were definitely prescribed by the Congress. The Act of September 24,
1917, both in its original and amended form, authorized the moneys to be borrowed, and the bonds to be
issued, 'on the credit of the United States,' in order to meet expenditures needed 'for the national security
and defense and other public purposes authorized by law.' Section 1, 40 Stat. 288, as amended by Act
April 4, 1918, 1, 40 Stat. 503, 31 USCA 752. The circular of the Treasury Department of September 28,
1918, to which the bond refers 'for a statement of the further rights of the holders of bonds of said series,'
also provided that the principal and interest 'are payable in United States gold coin of the present
standard of value.'
This obligation must be fairly construed. The 'present standard of value' stood in contradistinction to a
lower standard of value. The promise obviously was intended to afford protection against loss. That
protection was sought to be secured by setting up a standard or measure of the government's obligation.
We think that the reasonable import of the promise is that it was intended [294 U.S. 330, 349] to assure
one who lent his money to the government and took its bond that he would not suffer loss through
depreciation in the medium of payment.
The government states in its brief that the total unmatured interest- bearing obligations of the United
States outstanding on May 31, 1933 ( which it is understood contained a 'gold clause' substantially the
same as that of the bond in suit), amounted to about twenty-one billions of dollars. From statements at
the bar, it appears that this amount has been reduced to approximately twelve billions at the present time,
and that during the intervening period the public debt of the United States has risen some seven billions
(making a total of approximately twenty-eight billions five hundred millions) by the issue of some sixteen
billions five hundred millions of dollars 'of non-gold-clause obligations.'
Second. The Binding Quality of the Obligation. The question is necessarily presented whether the Joint
Resolution of June 5, 1933, 48 Stat. 113 (31 USCA 462, 463), is a valid enactment so far as it applies to the
obligations of the United States. The resolution declared that provisions requiring 'payment in gold or a
particular kind of coin or currency' were 'against public policy,' and provided that 'every obligation,
heretofore or hereafter incurred, whether or not any such provision is contained therein,' shall be
discharged 'upon payment, dollar for dollar, in any coin or currency which at the time of payment is legal
tender for public and private debts.' This enactment was expressly extended to obligations of the United
States and provisions for payment in gold, 'contained in any law authorizing obligations to be issued by or
under authority of the United States,' were repealed. 1 Section 1(a), 31 USCA 463(a). [294 U.S. 330,
350] There is no question as to the power of the Congress to regulate the value of money: that is, to
establish a monetary system and thus to determine the currency of the country. The question is whether
the Congress can use that power so as to invalidate the terms of the obligations which the government has
theretofore issued in the exercise of the power to borrow money on the credit of the United States. In
attempted justification of the Joint Resolution in relation to the outstanding bonds of the United States,
the government argues that 'earlier Congresses could not validly restrict the 73rd Congress from
exercising its constitutional powers to regulate the value of money, borrow money, or regulate foreign and

45

interstate commerce'; and, from this premise, the government seems to deduce the proposition that when,
with adequate authority, the government borrows money and pledges the credit of the United States, it is
free to ignore that pledge and alter the terms of its obligations in case a later Congress finds their
fulfillment inconvenient. The government's contention thus raises a question of far greater importance
than the particular claim of the plaintiff. On that reasoning, if the terms of the government's bond as to
the standard of payment can be repudiated, it inevitably follows that the obligation as to the amount to be
paid may also be repudiated. The contention necessarily imports that the Congress can disregard the
obligations of the government at its discretion, and that, when the government borrows money, the credit
of the United States is an illusory pledge.
We do not so read the Constitution. There is a clear distinction between the power of the Congress to
control or interdict the contracts of private parties when they interfere with the exercise of its
constitutional authority [294 U.S. 330, 351] and the power of the Congress to alter or repudiate the
substance of its own engagements when it has borrowed money under the authority which the
Constitution confers. In authorizing the Congress to borrow money, the Constitution empowers the
Congress to fix the amount to be borrowed and the terms of payment. By virtue of the power to borrow
money 'on the credit of the United States,' the Congress is authorized to pledge that credit as an assurance
of payment as stipulated, as the highest assurance the government can give, its plighted faith. To say that
the Congress may withdraw or ignore that pledge is to assume that the Constitution contemplates a vain
promise; a pledge having no other sanction than the pleasure and convenience of the pledgor. This Court
has given no sanction to such a conception of the obligations of our government.
The binding quality of the obligations of the government was considered in the Sinking Fund Cases, 99
U.S. 700, 718 , 719 S.. The question before the Court in those cases was whether certain action was
warranted by a reservation to the Congress of the right to amend the charter of a railroad company. While
the particular action was sustained under this right of amendment, the Court took occasion to state
emphatically the obligatory character of the contracts of the United States. The Court said: 'The United
States are as much bound by their contracts as are individuals. If they repudiate their obligations, it is as
much repudiation, with all the wrong and reproach that term implies, as it would be if the repudiator had
been a State or a municipality or a citizen.' 2 [294 U.S. 330, 352] When the United States, with
constitutional authority, makes contracts, it has rights and incurs responsibilities similar to those of
individuals who are parties to such instruments. There is no difference, said the Court in United States v.
Bank of the Metropolis, 15 Pet. 377, 392, except that the United States cannot be sued without its consent.
See, also, The Floyd Acceptances, 7 Wall. 666, 675; Cooke v. United States, 91 U.S. 389 , 396. In Lynch v.
United States, 292 U.S. 571, 580 , 54 S.Ct. 840, 844, with respect to an attempted abrogation by the Act of
March 20, 1933, 17, 48 Stat. 8, 11 (38 USCA 717), of certain outstanding war risk insurance policies, which
were contracts of the United States, the Court quoted with approval the statement in the Sinking Fund
Cases, supra, and said: 'Punctilious fulfillment of contractual obligations is essential to the maintenance of
the credit of public as well as private debtors. No doubt there was in March, 1933, great need of economy.
In the administration of all government business economy had become urgent because of lessened
revenues and the heavy obligations to be issued in the hope of relieving widespread distress. Congress was
free to reduce gratuities deemed excessive. But Congress was without power to reduce expenditures by
abrogating contractual obligations of the United States. To abrogate contracts, in the attempt to lessen
government expenditure, would [294 U.S. 330, 353] be not the practice of economy, but an act of
repudiation.'
The argument in favor of the Joint Resolution, as applied to government bonds, is in substance that the
government cannot by contract restrict the exercise of a sovereign power. But the right to make binding
obligations is a competence attaching to sovereignty. 3 In the United States, sovereignty resides in the
people who act through the organs established by the Constitution. Chisholm v. Georgia, 2 Dall. 419, 471;
Penhallow v. Doane's Administrators, 3 Dall. 54, 93; McCulloch v. Maryland, 4 Wheat. 316, 404, 405; Yick
Wo v. Hopkins, 118 U.S. 356, 370 , 6 S.Ct. 1064. The Congress as the instrumentality of sovereignty is
endowed with certain powers to be exerted on behalf of the people in the manner and with the effect the
Constitution ordains. The Congress cannot invoke the sovereign power of the people to override their will
as thus declared. The powers conferred upon the Congress are harmonious. The Constitution gives to the
Congress the power to borrow money on the credit of the United States, an unqualified power, a power

46

vital to the government, upon which in an extremity its very life may depend. The binding quality of the
promise of the United States is of the essence of the credit which is so pledged. Having this power to
authorize the issue of definite obligations for the payment of money borrowed, the Congress has not been
vested with authority to alter or destroy those obli- [294 U.S. 330, 354] gations. The fact that the United
States may not be sued without its consent is a matter of procedure which does not affect the legal and
binding character of its contracts. While the Congress is under no duty to provide remedies through the
courts, the contractual obligation still exists, and, despite infirmities of procedure, remains binding upon
the conscience of the sovereign. Lynch v. United States, supra, pages 580, 582, of 292 U.S. 54 S.Ct. 840.
The Fourteenth Amendment, in its fourth section, explicitly declares: 'The validity of the public debt of the
United States, authorized by law , ... shall not be questioned.' While this provision was undoubtedly
inspired by the desire to put beyond question the obligations of the government issued during the Civil
War, its language indicates a broader connotation. We regard it as confirmatory of a fundamental
principle which applies as well to the government bonds in question, and to others duly authorized by the
Congress, as to those issued before the amendment was adopted. Nor can we perceive any reason for not
considering the expression 'the validity of the public debt' as embracing whatever concerns the integrity of
the public obligations.
We conclude that the Joint Resolution of June 5, 1933, in so far as it attempted to override the obligation
created by the bond in suit, went beyond the congressional power.
Third. The Question of Damages. In this view of the binding quality of the government's obligations, we
come to the question as to the plaintiff's right to recover damages. That is a distinct question. Because the
government is not at liberty to alter or repudiate its obligations, it does not follow that the claim advanced
by the plaintiff should be sustained. The action is for breach of contract. As a remedy for breach, plaintiff
can recover no more than the loss he has suffered and of which he may rightfully complain. He is not
entitled to be en- [294 U.S. 330, 355] riched. Plaintiff seeks judgment for $16,931.25, in present legal
tender currency, on his bond for $10,000. The question is whether he has shown damage to that extent, or
any actual damage, as the Court of Claims has no authority to entertain an action for nominal damages.
Grant v. United States, 7 Wall. 331, 338; Marion & Rye V. Railway Co. v. United States, 270 U.S. 280,
282 , 46 S.Ct. 253; Nortz v. United States, 294 U.S. 317 , 55 S.Ct. 428, decided this day.
Plaintiff computes his claim for $16,931.25 by taking the weight of the gold dollar as fixed by the
President's proclamation of January 31, 1934 (No. 2072, 31 USCA 821 note), under the Act of May 12,
1933, 43(b)( 2), 48 Stat. 52, 53, as amended by the Act of January 30, 1934, 12, 48 Stat. 342, (31 USCA
821), that is, at 15 5/21 grains nine-tenths fine, as compared with the weight fixed by the Act of March 14,
1900, 1, 31 Stat. 46 (31 USCA 314), or 25.8 grains nine-tenths fine. But the change in the weight of the
gold dollar did not necessarily cause loss to the plaintiff of the amount claimed. The question of actual loss
cannot fairly be determined without considering the economic situation at the time the government
offered to pay him the $10,000, the face of his bond, in legal tender currency. The case is not the same as
if gold coin had remained in circulation. That was the situation at the time of the decisions under the legal
tender acts of 1862 and 1863. Bronson v. Rodes, 7 Wall. 229, 251; Trebilcock v. Wilson, 12 Wall. 687, 695;
Thompson v. Butler, 95 U.S. 694, 696 , 697 S.. Before the change in the weight of the gold dollar in 1934,
gold coin had been withdrawn from circulation. 4 The Congress had authorized the prohibition of the
exportation of gold coin and the placing of restrictions upon transactions in foreign exchange. Acts of
March 9, 1933, [294 U.S. 330, 356] 48 Stat. 1 (Emergency Banking Relief Act, 2, amending Trading with
the Enemy Act, 5(b), 12 USCA 95a); January 30, 1934, 48 Stat. 337 (Gold Reserve Act of 1934, 12, 31
USCA 824). Such dealings could be had only for limited purposes and under license. Executive Orders of
April 20, 1933 ( No. 6111), August 28, 1933 (No. 6260), and January 15, 1934 (No. 6560), 12 USCA 95
note; Regulations of the Secretary of the Treasury, January 30 and 31, 1934. That action the Congress was
entitled to take by virtue of its authority to deal with gold coin as a medium of exchange. And the restraint
thus imposed upon holders of gold coin was incident to the limitations which inhered in their ownership
of that coin and gave them no right of action. Ling Su Fan v. United States, 218 U.S. 302, 310 , 311 S., 31
S.Ct. 21, 23, 30 L.R.A.(N.S.) 1176. The Court said in that case: 'Conceding the title of the owner of such
coins, yet there is attached to such ownership those limitations which public policy may require by reason
of their quality as a legal tender and as a medium of exchange. These limitations are due to the fact that

47

public law gives to such coinage a value which does not attach as a mere consequence of intrinsic value.
Their quality as a legal tender is an attribute of law aside from their bullion value. They bear, therefore,
the impress of sovereign power which fixes value and authorizes their use in exchange . ... However
unwise a law may be, aimed at the exportation of such coins, in the face of the axioms against obstructing
the free flow of commerce, there can be no serious doubt but that the power to coin money includes the
power to prevent its outflow from the country of its origin.' The same reasoning is applicable to the
imposition of restraints upon transactions in foreign exchange. We cannot say, in view of the conditions
that existed, that the Congress having this power exercised it arbitrarily or capriciously. And the holder of
an obligation, or bond, of the United States, payable in gold coin of the former standard, so far as the
restraint upon the right to export gold coin or to engage in transactions in foreign exchange is concerned,
was in no better case than the holder of gold coin itself. [294 U.S. 330, 357] In considering what
damages, if any, the plaintiff has sustained by the alleged breach of his bond, it is hence inadmissible to
assume that he was entitled to obtain gold coin for recourse to foreign markets or for dealings in foreign
exchange or for other purposes contrary to the control over gold coin which the Congress had the power to
exert, and had exerted, in its monetary regulation. Plaintiff's damages could not be assessed without
regard to the internal economy of the country at the time the alleged breach occurred. The discontinuance
of gold payments and the establishment of legal tender currency on a standard unit of value with which
'all forms of money' of the United States were to be 'maintained at a parity' had a controlling influence
upon the domestic economy. It was adjusted to the new basis. A free domestic market for gold was
nonexistent.
Plaintiff demands the 'equivalent' in currency of the gold coin promised. But 'equivalent' cannot mean
more than the amount of money which the promised gold coin would be worth to the bondholder for the
purposes for which it could legally be used. That equivalence or worth could not properly be ascertained
save in the light of the domestic and restricted market which the Congress had lawfully established. In the
domestic transactions to which the plaintiff was limited, in the absence of special license, determination
of the value of the gold coin would necessarily have regard to its use as legal tender and as a medium of
exchange under a single monetary system with an established parity of all currency and coins. And, in
view of the control of export and foreign exchange, and the restricted domestic use, the question of value,
in relation to transactions legally available to the plaintiff, would require a consideration of the
purchasing power of the dollars which the plaintiff could have received. Plaintiff has not shown, or
attempted to show, that in relation to buying power he has sustained any loss whatever. On [294 U.S. 330,
358] the contrary, in view of the adjustment of the internal economy to the single measure of value as
established by the legislation of the Congress, and the universal availability and use throughout the
country of the legal tender currency in meeting all engagements, the payment to the plaintiff of the
amount which he demands would appear to constitute, not a recoupment of loss in any proper sense, but
an unjustified enrichment.
Plaintiff seeks to make his case solely upon the theory that by reason of the change in the weight of the
dollar he is entitled to $1.69 in the present currency for every dollar promised by the bond, regardless of
any actual loss he has suffered with respect to any transaction in which his dollars may be used. We think
that position is untenable.
In the view that the facts alleged by the petition fail to show a cause of action for actual damages, the first
question submitted by the Court of Claims is answered in the negative. It is not necessary to answer the
second question.
Question No. 1 is answered 'No.'
Mr. Justice STONE (concurring).
I agree that the answer to the first question is 'No,' but I think our opinion should be confined to
answering that question, and that it should essay an answer to no other.
I do not doubt that the gold clause in the government bonds, like that in the private contracts just
considered, calls for the payment of value in money, measured by a stated number of gold dollars of the

48

standard defined in the clause, Feist v. Socie te Intercommunale Belge d'Electricite , (1934) A.C. 161, 170173; Serbian and Brazilian Bond Cases, P.C.I.J., series A., Nos. 20, 21, pp. 32-34, 109-119. In the absence
of any further exertion of governmental power, that obligation plainly could not be [294 U.S. 330,
359] satisfied by payment of the same number of dollars, either specie or paper, measured by a gold
dollar of lesser weight, regardless of their purchasing power or the state of our internal economy at the
due date.
I do not understand the government to contend that it is any the less bound by the obligation than a
private individual would be, or that it is free to disregard it except in the exercise of the constitutional
power 'to coin money' and 'regulate the value thereof.' In any case, there is before us no question of
default apart from the regulation by Congress of the use of gold as currency.
While the government's refusal to make the stipulated payment is a measure taken in the exercise of that
power, this does not disguise the fact that its action is to that extent a repudiation of its undertaking. As
much as I deplore this refusal to fulfill the solemn promise of bonds of the United States, I cannot escape
the conclusion, announced for the Court, that in the situation now presented, the government, through
the exercise of its sovereign power to regulate the value of money, has rendered itself immune from
liability for its action. To that extent it has relieved itself of the obligation of its domestic bonds, precisely
as it has relieved the obligors of private bonds in Norman v. Baltimore & Ohio R. Co., 294 U.S. 240 , 55
S.Ct. 407, decided this day.
In this posture of the case it is unnecessary, and I think undesirable, for the Court to undertake to say that
the obligation of the gold clause in government bonds is greater than in the bonds of private individuals,
or that in some situation not described, and in some manner and in some measure undefined, it has
imposed restrictions upon the future exercise of the power to regulate the currency. I am not persuaded
that we should needlessly intimate any opinion which implies that the obligation may so operate, for
example, as to interpose a serious obstacle to the adoption of measures for stabilization of [294 U.S. 330,
360] the dollar, should Congress think it wise to accomplish that purpose by resumption of gold
payments, in dollars of the present or any other gold content less than that specified in the gold clause,
and by the re- establishment of a free market for gold and its free exportation.
There is no occasion now to resolve doubts, which I entertain, with respect to these questions. At present
they are academic. Concededly they may be transferred wholly to the realm of speculation by the exercise
of the undoubted power of the government to withdraw the privilege of suit upon its gold clause
obligations. We have just held that the Court of Claims was without power to entertain the suit in Nortz v.
United States, 294 U.S. 317, 55 S.Ct. 428, because, regardless of the nature of the obligation of the gold
certificates, there was no damage. Here it is declared that there is no damage because Congress, by the
exercise of its power to regulate the currency, has made it impossible for the plaintiff to enjoy the benefits
of gold payments promised by the government. It would seem that this would suffice to dispose of the
present case, without attempting to prejudge the rights of other bondholders and of the government
under other conditions which may never occur. It will not benefit this plaintiff, to whom we deny any
remedy, to be assured that he has an inviolable right to performance of the gold clause.
Moreover, if the gold clause be viewed as a gold value contract, as it is in Norman v. Baltimore & Ohio R.
Co., supra, it is to be noted that the government has not prohibited the free use by the bondholder of the
paper money equivalent of the gold clause obligation; it is the prohibition, by the Joint Resolution of
Congress, of payment of the increased number of depreciated dollars required to make up the full
equivalent, which alone bars recovery.[294 U.S. 330, 361] In that case it would seem to be implicit in our
decision that the prohibition, at least in the present situation, is itself a constitutional exercise of the
power to regulate the value of money.
I therefore do not join in so much of the opinion as may be taken to suggest that the exercise of the
sovereign power to borrow money on credit, which does not override the sovereign immunity from suit,
may nevertheless preclude or impede the exercise of another sovereign power, to regulate the value of
money; or to suggest that, although there is and can be no present cause of action upon the repudiated

49

gold clause, its obligation is nevertheless, in some manner and to some extent not stated, superior to the
power to regulate the currency which we now hold to be superior to the obligation of the bonds.
Mr. Justice McREYNOLDS, Mr. Justice VAN DEVANTER, Mr. Justice SUTHERLAND and Mr. Justice
BUTLER, dissent. For opinion, see Norman v. Baltimore & O.R. Co., 294 U.S. 240 , 55 S.Ct. 407, at page
419.

233 F.2d 935

Eleanor A. BRADFORD, Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
No. 12550.

United States Court of Appeals Sixth Circuit.

May 22, 1956.

William Waller, Nashville, Tenn., (Lawrence Dortch, Waller, Davis & Lansden, Nashville, Tenn., on the
brief), for petitioner.
Karl Schmeidler, Washington, D. C. (H. Brian Holland, Ellis N. Slack, Washington, D. C., on the brief), for
respondent.
Before MARTIN, MILLER and STEWART, Circuit Judges.
STEWART, Circuit Judge.

1
The question here is whether the petitioner realized $50,000 income in 1946 when her liability upon a
note for $100,000 was discharged for $50,000.
2
In 1938 the petitioner's husband owed a Nashville bank approximately $305,000. The debt had grown out

50

of investment banking ventures he had engaged in prior to the depression. He had pledged most of his
assets to the bank as collateral, but the greater part of the indebtedness was unsecured. The brokerage
firm of which he was a member held a seat on the New York Stock Exchange. In October of 1938 the
Exchange adopted a rule requiring each general partner of a member firm to submit a detailed report of
his indebtedness. Fearing that disclosure of so much indebtedness might impair the position of his firm
with the Exchange, he persuaded the bank to substitute the note of his wife, the petitioner, for a portion of
his indebtedness. Accordingly, the petitioner executed her note to the bank for $205,000 without receiving
any consideration in return.1 Her husband remained the obligor on two notes to the bank for $100,000 and
so reported to the New York Stock Exchange.

3
About two years later the petitioner at the bank's request executed two notes to replace her $205,000
note, one for $105,000, on which all the collateral was pledged, and another for $100,000 which was
unsecured. In 1943 a bank examiner required the bank to write off $50,000 of the petitioner's $100,000
unsecured note. In 1946 the bank advised petitioner that it was willing to sell the $100,000 note for
$50,000, its then value on the bank's books. The petitioner's husband accordingly persuaded his halfbrother, a Mr. Duval, to purchase the note from the bank for $50,000 with funds furnished by the petitioner
and her husband. The Tax Court found that this transaction "was, in essence, a discharge of Mrs.
Bradford's indebtedness for $50,000." The petitioner accepts the correctness of that finding, conceding
that Duval "purchased the note as agent for the Bradfords and with no intention of enforcing same." The
petitioner was solvent both before and after the note was discharged.
4
Upon these facts the Tax Court concluded that the petitioner had realized unreported ordinary income of
$50,000 in 1946 and upheld the Commissioner's determination of deficiency in accordance with that
conclusion. 1954, 22 T.C. 1057, 1073. The petitioner asks us to reverse the Tax Court's decision upon two
separate grounds: (1) that the cancellation of her $100,000 note for $50,000 was a "gratuitous
forgiveness" upon the part of the bank and therefore a gift within the meaning of 22(b) (3) of the Internal
Revenue Code of 1939,2 and (2) that because she received nothing when the original note was executed
by her in 1938, she did not realize income in 1946 when the note was cancelled for less than its face
amount, even if the cancellation was not a gift.
5
The contention that what the petitioner received from the bank was a gift is grounded upon the testimony
of the bank's president. He stated that the petitioner's husband had done a great deal of business with the
bank, had met all his obligations during the depression, and that the bank looked forward to substantial
future business with him. He further testified that although it might have been possible for the bank to
collect the entire face amount of the note, "if I foreclosed on the proposition, put Mrs. Bradford out of her
home, taken the furniture and liquidated everything he had, * * *" he considered it to the bank's best
interest under the circumstances to forego a lawsuit so long as the bank could get the book value of the
note paid. Upon cross-examination he stated explicitly that he considered the transaction a donation or
gift by the bank of the $50,000 charged off.
6
The Tax Court found that the discharge of the note for $50,000 "was not a gift. * * * The bank's motive in
selling the note for $50,000 was to liquidate its investment for book value. [The bank] was of the opinion
that this was the best price available. Also by selling at this price the bank avoided the realization of
taxable income on the recovery of a charged-off debt as well as the difficulties and uncertainties of
enforced collection. * * * Also the bank did not wish to alienate petitioner and lose his future business by
bringing suit against his wife.

7
"The instant transaction did not represent the discharge of a $50,000 indebtedness `for nothing.' * * * We

51

can only interpret the bank president's testimony as meaning that the bank was willing to sell the note at
book value, and, if the transaction benefited petitioner, so much the better." 22 T.C. 1057, 1066, 1074.
8
In Helvering v. American Dental Co., 1943, 318 U.S. 322, 63 S.Ct. 577, 582, 87 L.Ed. 785, the Supreme
Court held that even though "the motives leading to the cancellations were those of business or even
selfish," a creditor's forgiveness of part of a debt could be a gift to the debtor, if "the forgiveness was
gratuitous, a release of something to the debtor for nothing." 318 U.S. at page 331, 63 S.Ct. at page 582.
The American Dental Co. doctrine was, however, markedly circumscribed by the Supreme Court's opinion
in the later case of Commissioner of Internal Revenue v. Jacobson, 1949, 336 U.S. 28, 69 S.Ct. 358, 93
L.Ed. 477, in which the Court stated, in holding that the cancellation there did not constitute a gift: "The
situation in each transaction is a factual one. It turns upon whether the transaction is in fact a transfer of
something for the best price available or is a transfer or release of only a part of a claim for cash and of
the balance `for nothing.'" 336 U.S. at page 51, 69 S.Ct. at page 370.
9
Our attention has been called to only one case decided since the Jacobson decision which has held the
forgiveness of a debt to be a gift. Reynolds v. Boos, 8 Cir., 1951, 188 F.2d 322. In all the other decisions
to which we have been referred, the courts, applying the factual test of the Jacobson case, have been
unable to find an intent by the creditor to release an unpaid balance "for nothing." Denman Tire & Rubber
Co. v. Commissioner, 6 Cir., 1951, 192 F.2d 261, 263; Spear Box Co. v. Commissioner, 2 Cir., 1950, 182
F.2d 844, 846; Pacific Magnesium, Inc., v. Westover, 9 Cir., 1950, 183 F.2d 584, affirming
D.C.S.D.Cal.1949, 86 F.Supp. 644; Standard Brass & Mfg. Co. v. Commissioner, 5 Cir., 1955, 218 F.2d
352, affirming 20 T.C. 371. We cannot say that the Tax Court's ultimate finding that there was no gift in the
present case was clearly erroneous, and we therefore accept it as we must. United States v. United States
Gypsum Co., 1948, 333 U.S. 364, 394-395, 68 S.Ct. 525, 92 L.Ed. 746.
10
It was the view of the Tax Court that if there was no gift, the discharge of the $100,000 note for $50,000
clearly resulted in ordinary income in the amount of $50,000. 22 T.C. 1057, 1073. The Commissioner in
effect adopts that view in his argument here. "It has become well settled," we are told, "that a profit is
realized by a debtor whose obligation is extinguished by payment of an amount less than that which is
owing, and that such profit constitutes gain which is taxable income within the broad sweep of Section
22(a) of the Internal Revenue Code of 1939."
11
The statement quoted can be accepted without question as a correct general proposition of tax law, where
the debtor is solvent, where there is no finding of a gift under the American Dental Co. doctrine, and
where the cancellation of indebtedness does not constitute a contribution to a corporation's capital. The
proposition was first clearly announced by the Supreme Court in United States v. Kirby Lumber Co.,
1931, 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131, and has been followed not only in cases where the debtor
received full value for his obligation when it was executed, Commissioner of Internal Revenue v.
Jacobson, 1949, 336 U.S. 28, 69 S.Ct. 358, 93 L.Ed. 477, but also where it was not made to appear what
if any value the debtor had originally received. Helvering v. American Chicle Co., 1934, 291 U.S. 426, 54
S.Ct. 460, 78 L.Ed. 891.
12
It is also a well settled general rule that each year's transactions are to be considered separately, without
regard to what the net effect of a particular transaction might be if viewed over a period of several years.
Burnet v. Sanford & Brooks Co., 1931, 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383.
13
A mechanical application of these principles would of course support the Tax Court's decision. Looking
alone to the year 1946 under the rule of the Sanford & Brooks Co. case, it is obvious that when $100,000
of the petitioner's indebtedness was discharged for $50,000 in that year, she realized a balance sheet
improvement of $50,000 which would be taxable as ordinary income under the rule of the Kirby Lumber

52

Co. case.3 We cannot agree with the Commissioner, however, that these principles are to be applied so
mechanically.
14
The fact is that by any realistic standard the petitioner never realized any income at all from the
transaction in issue. In 1938 "without receiving any consideration in return," she promised to pay a prior
debt of her husband's. In a later year she paid part of that debt for less than its face value. Had she paid
$50,000 in 1938 to discharge $100,000 of her husband's indebtedness, the Commissioner could hardly
contend that she thereby realized income. Yet the net effect of what she did do was precisely the same.
We cannot agree that the transaction resulted in taxable income to her.4
15
The conclusion we have reached is not without authority to support it. In Bowers v. Kerbaugh-Empire Co.,
1926, 271 U.S. 170, 46 S.Ct. 449, 451, 70 L.Ed. 886, the corporate taxpayer had borrowed money from a
bank in Germany repayable in marks. The marks were immediately converted into dollars, and the money
was lost in the performance of construction contracts by a subsidiary company over a period of years. In a
subsequent year, the taxpayer repaid the loan with greatly devalued marks. The question for decision was
"Whether the difference between the value of marks measured by dollars at the time of payment * * * and
the value when the loans were made was income." The Court decided that it was not, saying that "The
loss was less than it would have been if marks had not declined in value; but the diminution of loss is not
gain, profit, or income." 271 U.S. 170, at page 175, 46 S.Ct. 449, at page 451
16
The Kerbaugh-Empire Co. case was decided before the Kirby Lumber Co. and Sanford & Brooks Co.
decisions. The case has been called "a frequently criticized and not easily understood decision." See
Willard Helburn, Inc., v. Commissioner, 1 Cir., 1954, 214 F.2d 815, 819. It is nonetheless a decision which
has not been overruled.5 Whatever validity the Kerbaugh-Empire Co. decision may now have on its own
facts, it remains an authority for the proposition that in deciding the income tax effect of cancellation of
indebtedness for less than its face amount, a court need not in every case be oblivious to the net effect of
the entire transaction. See Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 5 Cir., 1934, 70 F.
2d 95, 96; Transylvania R. Co. v. Commissioner, 4 Cir., 1938, 99 F.2d 69, 72.
17
Courts have not hesitated in appropriate circumstances to look behind the cancellation of indebtedness in
a given calendar year, and in doing so to evaluate in its entirety the transaction out of which the
cancellation arose. Thus, it has been consistently held that the partial forgiveness of indebtedness in a
given year does not constitute taxable income to the debtor if the actual effect of the entire transaction
was simply to reduce the purchase price of property acquired in a prior year. Hirsch v. Commissioner, 7
Cir., 1940, 115 F.2d 656; Allen v. Courts, 5 Cir., 1942, 127 F.2d 127; Helvering v. A. L. Killian Co., 8 Cir.,
1942, 128 F.2d 433.
18
In Commissioner of Internal Revenue v. Rail Joint Co., 2 Cir., 1932, 61 F.2d 751, a corporate taxpayer,
after a reappraisal of its assets, distributed a dividend consisting of its own debenture bonds. In a
subsequent year the corporation purchased some of these bonds at less than their face amounts, retired
them, and credited the difference to surplus. The court rejected the Commissioner's claim that the
corporation thereby realized income in the year the bonds were retired. Stripped of superficial distinctions,
the Rail Joint Co. case is identical in principle with the present case. In that case, as in this, the taxpayer
received nothing of value when the indebtedness was assumed. Although the indebtedness was
discharged at less than its face value, the taxpayer was in fact poorer by virtue of the entire transaction.
That the reasoning of the Rail Joint Co. case has not lost its vitality is attested by a very recent Tax Court
opinion which approved and followed it. Fashion Park, Inc., 1954, 21 T.C. 600. A parity of reasoning
requires reversal of the Tax Court's decision in the present case.
19
Before concluding it should be emphasized that there is not before us on this review the question of the
tax liability of petitioner's husband either in 1938 when his indebtedness was assumed by his wife, or in

53

1946 when it was discharged, nor do we have for decision any question as to the petitioner's gift tax
liability. We have decided only that the petitioner herself under the circumstances of this case did not
realize $50,000 of unreported income in 1946.
20
For the reasons stated, the decision of the Tax Court is reversed.
Notes:
1. The Tax Court unequivocally found as a fact that petitioner received no consideration when she
executed this note. 1954, 22 T.C. 1057, 1066. This finding is not clearly erroneous, and we accept it,
despite qualifying language in the Tax Court's subsequent unreported memorandum and order denying
petitioner's motion for reconsideration.
2. " 22. Gross income * * *
"(b) Exclusions from gross income. The following items shall not be included in gross income and shall be
exempt from taxation under this chapter: * * *
"(3) Gifts, bequests, devises, and inheritances. The value of property acquired by gift, bequest, devise, or
inheritance. * * *" 26 U.S.C., 1946 Ed.
3. See 2 Mertens' Law of Federal Income Taxation (Zimet & Stanley Revision), Sections 11.19-11.22.
4. See Surrey — "The Revenue Act of 1939 and the Income Tax Treatment of Cancellation of
Indebtedness," 49 Yale L. Journal 1153 (Esp. pp. 1173-1175) (1940); Darrell — "Discharge of
Indebtedness and the Federal Income Tax," 53 Harvard L.R. 977 (Esp. pp. 980-983) (1940); Warren and
Sugarman — "Cancellation of Indebtedness and Its Tax Consequences: I," 40 Columbia L.R. 1326
(Esp. pp. 1330-1333) (1940).
5. The Supreme Court distinguished the Kerbaugh-Empire Co. case in both the Sanford & Brooks Co.
opinion, 282 U.S. 359, at page 364, 51 S.Ct. 150, 75 L.Ed. 383, and the Kirby Lumber Co. opinion, 284
U.S. 1, at page 3, 52 S.Ct. 4, 76 L.Ed. 131.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC

G.R. No. 109289 October 3, 1994

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

54

RAMON R. DEL ROSARIO, in his capacity as SECRETARY OF FINANCE and JOSE U. ONG, in
his capacity as COMMISSIONER OF INTERNAL REVENUE, respondents.
Rufino R. Tan for and in his own behalf.
Carag, Caballes, Jamora & Zomera Law Offices for petitioners in G.R. 109446.

VITUG, J.:
These two consolidated special civil actions for prohibition challenge, in G.R. No. 109289, the
constitutionality of Republic Act No. 7496, also commonly known as the Simplified Net Income
Taxation Scheme ("SNIT"), amending certain provisions of the National Internal Revenue Code and,
in
G.R. No. 109446, the validity of Section 6, Revenue Regulations No. 2-93, promulgated by public
respondents pursuant to said law.
Petitioners claim to be taxpayers adversely affected by the continued implementation of the
amendatory legislation.
In G.R. No. 109289, it is asserted that the enactment of Republic Act
No. 7496 violates the following provisions of the Constitution:
Article VI, Section 26(1) Every bill passed by the Congress shall embrace only
one subject which shall be expressed in the title thereof.
Article VI, Section 28(1) The rule of taxation shall be uniform and equitable. The
Congress shall evolve a progressive system of taxation.
Article III, Section 1 No person shall be deprived of . . . property without due
process of law, nor shall any person be denied the equal protection of the laws.
In G.R. No. 109446, petitioners, assailing Section 6 of Revenue Regulations No. 2-93, argue that
public respondents have exceeded their rule-making authority in applying SNIT to general
professional partnerships.
The Solicitor General espouses the position taken by public respondents.
The Court has given due course to both petitions. The parties, in compliance with the Court's
directive, have filed their respective memoranda.
G.R. No. 109289
Petitioner contends that the title of House Bill No. 34314, progenitor of Republic Act No. 7496, is a
misnomer or, at least, deficient for being merely entitled, "Simplified Net Income Taxation Scheme for
the Self-Employed
and Professionals Engaged in the Practice of their Profession" (Petition in G.R. No. 109289).
The full text of the title actually reads:
An Act Adopting the Simplified Net Income Taxation Scheme For The Self-Employed
and Professionals Engaged In The Practice of Their Profession, Amending Sections
21 and 29 of the National Internal Revenue Code, as Amended.
The pertinent provisions of Sections 21 and 29, so referred to, of the National Internal Revenue
Code, as now amended, provide:
Sec. 21. Tax on citizens or residents.
xxx xxx xxx
(f) Simplified Net Income Tax for the Self-Employed and/or Professionals Engaged in
the Practice of Profession. A tax is hereby imposed upon the taxable net income
as determined in Section 27 received during each taxable year from all sources,

55

other than income covered by paragraphs (b), (c), (d) and (e) of this section by every
individual whether
a citizen of the Philippines or an alien residing in the Philippines who is selfemployed or practices his profession herein, determined in accordance with the
following schedule:
Not over P10,000 3%
Over P10,000 P300 + 9%
but not over P30,000 of excess over P10,000
Over P30,000 P2,100 + 15%
but not over P120,00 of excess over P30,000
Over P120,000 P15,600 + 20%
but not over P350,000 of excess over P120,000
Over P350,000 P61,600 + 30%
of excess over P350,000
Sec. 29. Deductions from gross income. In computing taxable income subject to
tax under Sections 21(a), 24(a), (b) and (c); and 25 (a)(1), there shall be allowed as
deductions the items specified in paragraphs (a) to (i) of this
section: Provided, however, That in computing taxable income subject to tax under
Section 21 (f) in the case of individuals engaged in business or practice of
profession, only the following direct costs shall be allowed as deductions:
(a) Raw materials, supplies and direct labor;
(b) Salaries of employees directly engaged in activities in the course of or pursuant to
the business or practice of their profession;
(c) Telecommunications, electricity, fuel, light and water;
(d) Business rentals;
(e) Depreciation;
(f) Contributions made to the Government and accredited relief organizations for the
rehabilitation of calamity stricken areas declared by the President; and
(g) Interest paid or accrued within a taxable year on loans contracted from accredited
financial institutions which must be proven to have been incurred in connection with
the conduct of a taxpayer's profession, trade or business.
For individuals whose cost of goods sold and direct costs are difficult to determine, a
maximum of forty per cent (40%) of their gross receipts shall be allowed as
deductions to answer for business or professional expenses as the case may be.
On the basis of the above language of the law, it would be difficult to accept petitioner's view that the
amendatory law should be considered as having now adopted a gross income, instead of as having
still retained the netincome, taxation scheme. The allowance for deductible items, it is true, may
have significantly been reduced by the questioned law in comparison with that which has prevailed
prior to the amendment; limiting, however, allowable deductions from gross income is neither
discordant with, nor opposed to, the net income tax concept. The fact of the matter is still that
various deductions, which are by no means inconsequential, continue to be well provided under the
new law.
Article VI, Section 26(1), of the Constitution has been envisioned so as (a) to prevent log-rolling
legislation intended to unite the members of the legislature who favor any one of unrelated subjects
in support of the whole act, (b) to avoid surprises or even fraud upon the legislature, and (c) to fairly
apprise the people, through such publications of its proceedings as are usually made, of the subjects
of legislation. 1 The above objectives of the fundamental law appear to us to have been sufficiently met.
Anything else would be to require a virtual compendium of the law which could not have been the
intendment of the constitutional mandate.

56

Petitioner intimates that Republic Act No. 7496 desecrates the constitutional requirement that
taxation "shall be uniform and equitable" in that the law would now attempt to tax single
proprietorships and professionals differently from the manner it imposes the tax on corporations and
partnerships. The contention clearly forgets, however, that such a system of income taxation has
long been the prevailing rule even prior to Republic Act No. 7496.
Uniformity of taxation, like the kindred concept of equal protection, merely requires that all subjects
or objects of taxation, similarly situated, are to be treated alike both in privileges and liabilities (Juan
Luna Subdivision vs. Sarmiento, 91 Phil. 371). Uniformity does not forfend classification as long as:
(1) the standards that are used therefor are substantial and not arbitrary, (2) the categorization is
germane to achieve the legislative purpose, (3) the law applies, all things being equal, to both
present and future conditions, and (4) the classification applies equally well to all those belonging to
the same class (Pepsi Cola vs. City of Butuan, 24 SCRA 3; Basco vs. PAGCOR, 197 SCRA 52).
What may instead be perceived to be apparent from the amendatory law is the legislative intent to
increasingly shift the income tax system towards the schedular approach 2 in the income taxation of
individual taxpayers and to maintain, by and large, the present global treatment 3 on taxable corporations.
We certainly do not view this classification to be arbitrary and inappropriate.
Petitioner gives a fairly extensive discussion on the merits of the law, illustrating, in the process,
what he believes to be an imbalance between the tax liabilities of those covered by the amendatory
law and those who are not. With the legislature primarily lies the discretion to determine the nature
(kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation. This court
cannot freely delve into those matters which, by constitutional fiat, rightly rest on legislative
judgment. Of course, where a tax measure becomes so unconscionable and unjust as to amount to
confiscation of property, courts will not hesitate to strike it down, for, despite all its plenitude, the
power to tax cannot override constitutional proscriptions. This stage, however, has not been
demonstrated to have been reached within any appreciable distance in this controversy before us.
Having arrived at this conclusion, the plea of petitioner to have the law declared unconstitutional for
being violative of due process must perforce fail. The due process clause may correctly be invoked
only when there is a clear contravention of inherent or constitutional limitations in the exercise of the
tax power. No such transgression is so evident to us.
G.R. No. 109446
The several propositions advanced by petitioners revolve around the question of whether or not
public respondents have exceeded their authority in promulgating Section 6, Revenue Regulations
No. 2-93, to carry out Republic Act No. 7496.
The questioned regulation reads:
Sec. 6. General Professional Partnership The general professional partnership
(GPP) and the partners comprising the GPP are covered by R. A. No. 7496. Thus, in
determining the net profit of the partnership, only the direct costs mentioned in said
law are to be deducted from partnership income. Also, the expenses paid or incurred
by partners in their individual capacities in the practice of their profession which are
not reimbursed or paid by the partnership but are not considered as direct cost, are
not deductible from his gross income.
The real objection of petitioners is focused on the administrative interpretation of public respondents
that would apply SNIT to partners in general professional partnerships. Petitioners cite the pertinent
deliberations in Congress during its enactment of Republic Act No. 7496, also quoted by the
Honorable Hernando B. Perez, minority floor leader of the House of Representatives, in the latter's
privilege speech by way of commenting on the questioned implementing regulation of public
respondents following the effectivity of the law, thusly:
MR. ALBANO, Now Mr. Speaker, I would like to get the correct
impression of this bill. Do we speak here of individuals who are
earning, I mean, who earn through business enterprises and
therefore, should file an income tax return?
MR. PEREZ. That is correct, Mr. Speaker. This does not apply to
corporations. It applies only to individuals.
(See Deliberations on H. B. No. 34314, August 6, 1991, 6:15 P.M.; Emphasis ours).

57

Other deliberations support this position, to wit:

MR. ABAYA . . . Now, Mr. Speaker, did I hear the Gentleman from
Batangas say that this bill is intended to increase collections as far as
individuals are concerned and to make collection of taxes equitable?
MR. PEREZ. That is correct, Mr. Speaker.
(Id. at 6:40 P.M.; Emphasis ours).
In fact, in the sponsorship speech of Senator Mamintal Tamano on the Senate
version of the SNITS, it is categorically stated, thus:
This bill, Mr. President, is not applicable to business corporations or
to partnerships; it is only with respect to individuals and professionals.
(Emphasis ours)
The Court, first of all, should like to correct the apparent misconception that general professional
partnerships are subject to the payment of income tax or that there is a difference in the tax
treatment between individuals engaged in business or in the practice of their respective professions
and partners in general professional partnerships. The fact of the matter is that a general
professional partnership, unlike an ordinary business partnership (which is treated as a corporation
for income tax purposes and so subject to the corporate income tax), is not itself an income
taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on
the partners themselves in their individual capacity computed on their distributive shares of
partnership profits. Section 23 of the Tax Code, which has not been amended at all by Republic Act
7496, is explicit:
Sec. 23. Tax liability of members of general professional partnerships. (a) Persons
exercising a common profession in general partnership shall be liable for income tax
only in their individual capacity, and the share in the net profits of the general
professional partnership to which any taxable partner would be entitled whether
distributed or otherwise, shall be returned for taxation and the tax paid in accordance
with the provisions of this Title.
(b) In determining his distributive share in the net income of the partnership, each
partner
(1) Shall take into account separately his distributive share of the
partnership's income, gain, loss, deduction, or credit to the extent
provided by the pertinent provisions of this Code, and
(2) Shall be deemed to have elected the itemized deductions, unless
he declares his distributive share of the gross income undiminished
by his share of the deductions.
There is, then and now, no distinction in income tax liability between a person who practices his
profession alone or individually and one who does it through partnership (whether registered or not)
with others in the exercise of a common profession. Indeed, outside of the gross compensation
income tax and the final tax on passive investment income, under the present income tax system all
individuals deriving income from any source whatsoever are treated in almost invariably the same
manner and under a common set of rules.
We can well appreciate the concern taken by petitioners if perhaps we were to consider Republic Act
No. 7496 as an entirely independent, not merely as an amendatory, piece of legislation. The view
can easily become myopic, however, when the law is understood, as it should be, as only forming
part of, and subject to, the whole income tax concept and precepts long obtaining under the National
Internal Revenue Code. To elaborate a little, the phrase "income taxpayers" is an all embracing term
used in the Tax Code, and it practically covers all persons who derive taxable income. The law, in
levying the tax, adopts the most comprehensive tax situs of nationality and residence of the taxpayer
(that renders citizens, regardless of residence, and resident aliens subject to income tax liability on
their income from all sources) and of the generally accepted and internationally recognized income
taxable base (that can subject non-resident aliens and foreign corporations to income tax on their
income from Philippine sources). In the process, the Code classifies taxpayers into four main
groups, namely: (1) Individuals, (2) Corporations, (3) Estates under Judicial Settlement and (4)
Irrevocable Trusts (irrevocable both as to corpusand as to income).

58

Partnerships are, under the Code, either "taxable partnerships" or "exempt partnerships." Ordinarily,
partnerships, no matter how created or organized, are subject to income tax (and thus alluded to as
"taxable partnerships") which, for purposes of the above categorization, are by law assimilated to be
within the context of, and so legally contemplated as, corporations. Except for few variances, such
as in the application of the "constructive receipt rule" in the derivation of income, the income tax
approach is alike to both juridical persons. Obviously, SNIT is not intended or envisioned, as so
correctly pointed out in the discussions in Congress during its deliberations on Republic Act 7496,
aforequoted, to cover corporations and partnerships which are independently subject to the payment
of income tax.
"Exempt partnerships," upon the other hand, are not similarly identified as corporations nor even
considered as independent taxable entities for income tax purposes. A
general professional partnership is such an example. 4Here, the partners themselves, not the
partnership (although it is still obligated to file an income tax return [mainly for administration and data]),
are liable for the payment of income tax in their individual capacity computed on their respective and
distributive shares of profits. In the determination of the tax liability, a partner does so as an individual,
and there is no choice on the matter. In fine, under the Tax Code on income taxation, the general
professional partnership is deemed to be no more than a mere mechanism or a flow-through entity in the
generation of income by, and the ultimate distribution of such income to, respectively, each of the
individual partners.
Section 6 of Revenue Regulation No. 2-93 did not alter, but merely confirmed, the above standing
rule as now so modified by Republic Act
No. 7496 on basically the extent of allowable deductions applicable to all individual income
taxpayers on their non-compensation income. There is no evident intention of the law, either before
or after the amendatory legislation, to place in an unequal footing or in significant variance the
income tax treatment of professionals who practice their respective professions individually and of
those who do it through a general professional partnership.
WHEREFORE, the petitions are DISMISSED. No special pronouncement on costs.
SO ORDERED.
Narvasa, C.J., Cruz, Feliciano, Regalado, Davide, Jr., Romero, Bellosillo, Melo, Quiason, Puno,
Kapunan and Mendoza, JJ., concur.
Padilla and Bidin, JJ., are on leave.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-22611

May 27, 1968

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
VISAYAN ELECTRIC COMPANY and THE COURT OF TAX APPEALS, respondents.
Office of the Solicitor General for petitioner.
Jesus P. Garcia for respondents.
SANCHEZ, J.:
The problems cast in legal setting in this petition for review1 of the judgment of the Court of Tax
Appeals are:
Is Visayan Electric Company liable for deficiency income tax on dividends from the stock
investment of its employees' reserve fund for pensions?

59

Is it also liable for 25% surcharge on alleged late payment of franchise tax?
Respondent company is the holder of a legislative franchise, Act 3499 of the Philippine Legislature,
to operate and maintain an electric light, heat, and power system in the City of Cebu, certain
municipalities in the Province of Cebu, and other surrounding places.
In a board of directors' meeting held on March 14, 1949, respondent company established a pension
fund, known as the "Employees' Reserve for Pensions." Said fund is for the benefit of its "present
and future" employees, in the event of retirement, accident or disability. Every month thereafter an
amount has been set aside for this purpose. It is taken from the gross operating receipts of the
company. This reserve fund was later invested by the company in stocks of San Miguel Brewery,
Inc., for which dividends have been regularly received. But these dividends were not declared for tax
purposes.
It was in a letter dated August 9, 1957 that the Auditor General gave notice that as the company has
retained full control of the fund, therefore, the dividends are not tax exempt; but that such dividends
may be excluded from gross receipts for franchise tax purposes, provided the same are declared for
income tax purposes.
In pursuance of the above letter, the Provincial Auditor of Cebu allowed the company the option to
declare the dividends either as part of the company's income for income tax purposes or as part of
its income for franchise tax purposes. The company elected the latter.2
The Revenue Examiner of Cebu, however, conducted a separate investigation for the Bureau of
Internal Revenue. His report dated September 17, 1959 likewise revealed that the "company itself is
the custodian or has the complete control of the fund." That report disagreed with the action of the
Provincial Auditor, instead considered the dividends as subject to corporate income tax under
Section 24 of the National Internal Revenue Code.
Said report further disclosed that: (a) during the years 1957, 1958 and 1959, some payments of the
franchise tax were made after fifteen days although within twenty days of the month following
the end of each calendar quarter, allegedly contrary to Section 259 of the Tax Code, which imposes
a 25% surcharge if the franchise faxes "remain unpaid for fifteen days from and after the date on
which they must be paid"; and (b) from 1954 to 1959, the company had not paid additional residence
tax imposed by Section 2 of Act 465.
With the foregoing report as basis, the Commissioner of Internal Revenue, in two letters of demand
dated September 7 and 15, 1960, assessed the following amounts against the company: (a)
P2,443.30 representing deficiency income tax for the years 1953 to 1958, plus interest and 50%
surcharge; (b) P3,850.00 as additional residence tax from 1954 to 1959; and (c) P35,419.05 as 25%
surcharge for late payment of franchise taxes for the years 1957, 1958 and 1959. Reconsideration
having been denied, the company went to the Court of Tax Appeals on petition for review.
On January 31, 1964, the Court of Tax Appeals sustained the correctness of the additional residence
tax assessments3 but freed the company from liability for deficiency income tax and the 25%
surcharge for late payment of franchise taxes.
It is now the turn of the Commissioner of Internal Revenue to appeal to this Court.
1. Admittedly, the investment of the fund in shares of stocks of the San Miguel Brewery, Inc. is not a
part of respondent company's business. Neither is it necessary or incidental to its operation under its
franchise. And yet those dividends were assessed by petitioner as part of the income of respondent
company. The tax court joins petitioner in this, but applied the following provision in Section 8, Act
3499 the company's legislative franchise in holding that the dividends are not subject to
income tax, viz.:
SEC. 8. The grantee shall pay the same taxes as are now or may hereafter be required by
law from other persons, on its real estate, buildings, plant, machinery, and other personal
property, except property declared exempt in this section. In consideration of the franchise
and rights hereby granted, the grantee shall pay into the municipal treasury of each
municipality in which it is supplying electricity to the public under this franchise, a tax equal to
two per centum of the gross earnings for electric current sold under this franchise in each of
the respective municipalities. Said percentage shall be due and payable quarterly and shall
be in lieu of all taxes of any kind levied, established or collected by any authority whatsoever,
now or in the future, on its poles, wires, insulators, switches, transformers and other
structures, installations, conductors and accessories, placed in and over the public streets,
avenues, roads, thoroughfares, squares, bridges, and other places and on its franchises,

60

rights, privileges, receipts, revenues and profits, from which taxes the grantee is hereby
expressly exempted.4
We perceive incorrectness of this approach by the Tax Court. What is envisioned in the statute
granting exemption, so far as is pertinent to this case, is the last underscored portion thereof which
speaks of its receipts, revenues and profits, "from which taxes the grantee is hereby expressly
exempted." The heavy accent is on the word its. Plain import of this word, taken in context, is that
the receipts, revenues and profits, which could be tax-exempt under the statute, must be the
company's not somebody else's. No doubt this provision should not be broadened so as to
include situations which by fail intendment are excluded therefrom. To do so is to take too loose a
view of the statute.
The disputed income are not receipts, revenues or profits of the company. They do not go to the
general fund of the company. They are dividends from the San Miguel Brewery, Inc. investment
which form part of and are added to the reserve pension fund which is solely for the benefit of the
employees,5 "to be distributed among the employees."6
Not escaping notice is that by the resolution of respondent company's board and the setting aside of
monthly amounts from its gross operating receipts for that fund, said company was merely acting,
with respect to such fund, as trustee for its employees. For, indeed, the intention to establish a trust
in favor of the employees is clear. A valid express trust has thus been created. 7 And, for tax
purposes, the employees' reserve fund is a separate taxable entity.8 Respondent company then,
while retaining legal title and custody9 over the property, holds it in trust for the beneficiaries
mentioned in the resolution creating the trust, in the absence of any condition therein which would, in
effect, destroy the intention to create a trust.10
Given the fact that the dividends are returns of the trust estate and not of the grantor company, we
must say that petitioner misconceived the import of the law when he assessed said dividends as part
of the income of the company. Similarly, the tax court should not have considered them at all as the
company's "receipts, revenues and profits" which are exempt from income tax.
2. As we look back at the resolution creating the employees' reserve fund and having in mind the
company's admission that it is "solely for the benefit of the employees" and that the company is
holding said fund "merely as trustee of its employees,"11 we reach the conclusion that the fund may
not be diverted for other purposes, and that the trust so created is irrevocable. For, really nothing in
respondent company's acts suggests that it reserved the power to revoke that fund or for that matter
appropriate it for itself. The trust binds the company to its employees. The trust created is not
therefore a revocable trust a provided in Section 59 of the Tax Code.12 Nor is it a trust contemplated
in Section 60, the income from which is for the benefit of the grantor.13
This state of facts calls for inquiry into the applicability of Section 56 of the Tax Code, which in part
reads:
SEC. 56. Imposition of tax (a) Application of tax. The taxes imposed by this Title upon
individuals shall apply to the income of estate or of any kind of property held in trust,
including
(1) Income accumulated in trust for the benefit of unborn or unascertained person or persons
with contingent interests and income accumulated or held for future distribution under the
terms of the will or trust;
xxx

xxx

xxx

(c) Computation and payment

(1) In general. The tax shall be computed upon the net income of the estate or trust and
shall be paid by the fiduciary, except as provided in Section fifty-nine (relating to revocable
trust) and section sixty (relating to income for the benefit of the grantor);
xxx

xxx

x x x14

Of interest here is that an amendment to Section 56 Republic Act 1983, 15 approved on June 22,
1957 singles out employees' trust for tax exemption in the following language:
(b) Exception. The tax imposed by this Title shall not apply to employees' trust which
forms part of a pension, stock bonus or profit-sharing plan of an employer for the benefit of
some or all of his employees (1) if contributions are made to the trust by such employer, or
61

employees, or both for the purpose of distributing to such employees the earnings and
principal of the fund accumulated by the trust in accordance with such plan, and (2) if under
the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with
respect to employees under the trust, for any part of the corpus or income to be (within the
taxable year or thereafter) used for, or diverted to, purposes other then for the exclusive
benefit of his employees: Provided, That any amount actually distributed to any employee or
distributee shall be taxable to him in the year in which so distributed to the extent that it
exceeds the amount contributed by such employee or distributee.16
A dig into the legislative history unearths the fact that this exemption in Republic Act 1983 was
conceived in order to encourage the formation of pension trust systems for the benefit of laborers
and employees outside the Social Security Act.17
Understandably, the second requirement in paragraph (b) of Section 56 of the Tax Code as it was
inserted by Republic Act 1983 non-diversion of fund was written into the statute the better to
insure that the trust fund and its income will be used "for the exclusive benefit" of the employees.
Of importance is the employment of the word plan as it is applied to pension set forth in the first part
of paragraph (b) aforesaid. Worth mentioning is that a sizeable portion of our Tax Code has been
lifted from the United States Internal Revenue Code. To be sure, Republic Act 1983 which amends
Section 56 of our Tax Code is substantially similar in terms to Section 165 of the United States
Internal Revenue Code of 1939.18 It is thus permissible for this Court to look into the interpretations
of the American counterpart in an effort to determine the congressional scheme in exempting
employees' trust from taxation.
In the American jurisdiction, the word plan is emphasized. To qualify for exemption, the employees'
trust must refer to a definite program, scheme or plan. It must be set up in good faith. It must be
acturially sound. Under such plan, employees generally are to be extended retirement and pension
benefits. But why? The fund is not thereafter to be controlled or used for the benefit of the company
in any way.19 A trust device used to disguise added compensation to the shareholders and officers of
a company and thereby avoid present payment of income tax thereon instead of providing for
future security of the employees in general will not qualify under the exemption. 20 Hubbell vs.
Commissioner of Internal Revenue, 150 F. 2d 516, 161 A.L.R. 764, 773, which was decided under
the 1939 version, confirms this view. There, the United States Circuit Court of Appeals took into
account the direction of the amendments in construing congressional purpose, and held that the
1942 amendment which added the requirement of non-discrimination in favor of shareholders,
officials, or highly-compensated employees presents no apparent change in congressional purpose:
"to insure that ... pension ... plans are operated for the welfare of employees in general, and to
prevent the trust device from being used for the benefit of shareholders, officials, or highly paid
employees...."
This is not to say, of course, that the employees' trust fund established by private respondent is a
device calculated to unserve its purpose and serve tax evasion. Unquestionably, the trust fund was
created in good faith. It is meant as it was intended to mean for the employees' welfare.
But wanting are sufficient data which would justify this Court to make a conclusive statement that the
trust qualifies under Section 56 (b) as it was inserted into the Tax Code by Republic Act 1963. The
only written evidence of record of the creation of the pension trust is the minutes of the board of
directors' meeting of March 14, 1949, the pertinent portion of which reads:
3. Upon motion duly seconded, the following resolution was unanimously passed:
RESOLVED, that the sum of FOUR HUNDRED FIFTEEN THOUSAND PESOS
(P415,000.00) be appropriated from the surplus of the company arising from prewar
operations in order to cover the payments of backpay and payment of reasonable
compensations to those persons who have materially aided the Company in its Organization
and Rehabilitation and in the preparation and prosecution of the Company's claims. This
appropriation shall cover a reserve fund for pensions for all the present and future
employees of the firm in the amount of SIXTY THOUSAND PESOS (P60,000.00), Reserve
Fund for Employees' Welfare to the amount of FIFTY THOUSAND PESOS (P50,000.00).
Reserve Funds for Medical Hospitalization, etc. to the amount of THIRTY THOUSAND
PESOS (P30,000.00). Reserve Fund for Insurance and Accident to the amount of TWENTY
FOUR THOUSAND PESOS (P24,000.00) and a Reserve Fund for Bonuses Payable to the
amount of FIFTY THOUSAND PESOS (P50,000.00).
4. Upon motion by Mr. Jesus Moraza, duly seconded by Mr. Juan Coromina, it was resolved
further that the committee consisting of Dr. Mamerto Escano, as Chairman and Messrs. Gil

62

Garcia and Salvador E. Sala as members be constituted, as it is hereby constituted, to study

the details of all the above resolutions and give effect thereto. The said committee is hereby
empowered to immediately put into effect the above resolutions.
We have the admitted fact also that every month thereafter an amount has been set aside for the
fund and the investment thereof in stocks of San Miguel Brewery, Inc.
And yet, something is amiss. For one, there is the admission made on page 3 of respondents' brief
that:
... It is, of course, admitted by the respondent Company that the strict requirements of
Section 56 (b) of the Tax Code on the formation of employees' trust funds for pension had
not been strictly complied with, although said funds and their returns are exclusively for the
benefit of respondent Company's employees.
And then, nothing extant in the record will show a pension plan actuarially sound. Correctly did the
Court of Tax Appeals find that "[i]t does not appear, however, that said pension trust was created in
accordance with the provision of Section 56 (b) of the Revenue Code." 21
The absence of such plan prevents us from taking a view which fits the purpose of the statute.
Coming into play then is the specific provision in paragraph (a), Section 56, heretofore transcribed,
which directs that the "taxes imposed by this Title upon individuals shall apply to the income ... of
any kind of property held in trust." For which reason, the income received by the employees' trust
fund from January 1, 1957 is subject to the income tax prescribed for individuals under Section 21 of
the Tax Code.
To follow a different construction would run "smack against the familiar rules that exemption from
taxation is not favored,22 and that exemptions in tax statutes are never presumed,"23 and these "are
but statements in adherence to the ancient rule that exemptions from taxation are construed
in strictissimi juris against the taxpayer and liberally in favor of the taxing authority."24
3. Having reached the conclusion that the assessment made by petitioner and the ruling of the Court
of Tax Appeals on lack of income tax liability were on a mistaken premise, but that the trust
established by respondent should pay the taxes imposed upon individuals, we are now faced with
the mechanics of tax collection.
The problem of prescription comes in. By Section 331 of the Tax Code, internal revenue taxes shall
be assessed within five years after the return is filed. Here, no return was filed upon a belief in good
faith that no tax liability attaches. Add to this the fact that the Commissioner of Internal Revenue
made an assessment of income tax but upon the mistaken assumption that the tax payable was
upon the basis of a corporate tax and not individual tax, and the picture is complete. Good faith in
one, and honest mistake in the other. Both petitioner and respondent company are on the same
footing. It is because of this that we rule that Section 332 (a) of the Tax Code finds application. It
reads:
SEC. 332. Exceptions as to period of limitation of assessment and collection of taxes. (a)
In the case of a false or fraudulent return with intent to evade tax or of a failure to file a
return, the tax may be assessed, or a proceeding in court for the collection of such tax may
be begun without assessment, at any time within ten years after the discovery of the falsity,
fraud, or omission.
Assessment should have as starting point the known figures. From 1953 to 1958, the following
amounts were dividends received on the San Miguel Brewery, Inc. investment:
1953 ...................................

P4,430.00

1954 ...................................

4,384.00

1955 ...................................

6,240.00

1956 ...................................

8,000.00

1957 ...................................

8,009.60

1958 ...................................

7,999.20

As far as we could read from the record, on the 1953 to 1956 dividends, payments under protest
were made as follows:

63

1. Deficiency franchise tax ..................................

P468.14

2. 25% surcharge ..................................................

117.04

3. Compromise penalty ........................................

50.00
Total ............................................

P635.18

On the 1957 dividends, the following were paid under protest:

1. Deficiency franchise tax ..................................

P166.85

2. 25% surcharge ..................................................

41.71

3. Compromise ......................................................

10.00

Total ............................................

P218.56

The 1958 dividends were included in the franchise tax return for the first quarter of 1959, the tax for
which was paid on April 16, 1959.
In the determination of the taxes due, the 50% surcharge sought by petitioner should not be
included. To subject a taxpayer to the payment of 50% surcharge provided for in Section 72 of the
National Internal Revenue Code, the State must show either that there was a wilful neglect to file a
return or that a case of a false or fraudulent return wilfully made exists. There is total absence of
proof, and petitioner does not allege, that respondent company wilfully neglected to file a return or
that it made a false or fraudulent return. In fact, this Court's pronouncement was necessary to
determine whether such dividends are taxable at all, and if so, under what law. In Yutivo Sons
Hardware Company vs. Commissioner,25 our ruling is that where a man "honestly believes" that the
method employed by him in computing his tax liability is correct, he does not incur any fraud; in
which case, no fraud penalty attaches under Section 72 of the Tax Code, which in part reads:
SEC. 72. Surcharges for failure to render return and for rendering false and fraudulent
returns.
... In case of wilful neglect to file the return or list within the time prescribed by law, or in case
a false or fraudulent return or list is wilfully made, the Commissioner of Internal Revenue
shall add to the tax or to the deficiency tax, in case any payment has been made on the
basis of such return before the discovery of the falsity or fraud, a surcharge of fifty per
centum of the amount of such tax or deficiency tax....
Absent the specifics exacted in Section 72, no 50% surcharge is collectible.
4. Was respondent company late in the payment of its franchise taxes?
We first go to the controlling statutes. Section 259, paragraph (2) of the National Internal Revenue
Code reads:
SEC. 259. Tax on corporate franchises. ....
The taxes, charges, and percentages on corporate franchises, shall be due and payable as
specified in the particular franchise, or in case no time limit is specified therein, the
provisions of section one hundred and eighty-three shall apply; and if such taxes, charges,
and percentages remain unpaid for fifteen days from and after the date on which they must
be paid, twenty-five per centum shall be added to the amount of such taxes, charges, and
percentages, which increase shall form part of the tax.26
Section 183 (a) mentioned in Section 259 of the same Code in turn partly reads:
SEC. 183. Payment of percentage taxes. (a) In general. It shall be the duty of every
person conducting a business on which a percentage tax is imposed under this Title, to make
a true and complete return of the amount of his, her or its gross monthly sales, receipts or
earnings, or gross value of output actually removed from the factory or mill warehouses and
within twenty days after the end of each month, pay the tax due thereon:....
Upon the other hand, the company's franchise provides:

64

... Said percentage shall be due and payable quarterly.

The quintessence of petitioner's argument is that the phrase "due and payable quarterly" in the
franchise of the company means that the tax is immediately demandable at the end of each calendar
quarter; and that since the franchise itself sets the time limit for the payment of the franchise tax,
Section 183 just quoted finds no application. In which case, so petitioner avers, the 25% surcharge
would be collectible if the percentage taxes remain unpaid after fifteen days from the end of each
calendar quarter.
Decisive of the question is the meaning of the term "due and payable quarterly." Resort to the
following definitions may help in clearing up the issue:
(1) The word "due" is only equivalent to or synonymous with "payable." 27
(2) The word "due" with reference to taxes, implies that such taxes are then "owing,
collectible or matured."28
(3) "The word 'due' in one sense means that the debt or obligation to which it is applied has
by contract of operation of law become immediately payable, but in another sense it denotes
the existence of a simple indebtedness, without reference to the time of payment, in which it
is synonymous with 'owing' and includes all debts whether payable in praesenti or in
futuro."29
(4) "Unless context clearly indicates a contrary meaning, the phrase 'due and payable' on a
specified date means the debt or obligation to which it is applicable is then immediately
payable."30
In line with the foregoing definitions, the term "due and payable on the first day of each month" was
interpreted to mean that payment on any day during the month other than the first day would
constitute non-compliance.31
In our opinion, the term "due and payable quarterly" in this case merely indicates the frequency of
payment of the franchise tax, viz., very three months. It does not refer to the time limit or, in the
precise language of Section 259, "the date on which they (the taxes) must be paid."
Under Section 183(a) in relation to Section 259, second paragraph, the law has opted to collect the
tax within twenty days after it becomes due and payable, namely, the last day of each quarter. The
time limit or the date on which the percentage tax must be paid by the company is the twentieth day
after the last day of each quarter. Section 259 grants another grace period of fifteen days from the
termination of this time limit before imposing the 25% surcharge.
To say that Section 183(a) is not applicable simply because, as amended, it provides for monthly
payment while the company's charter speaks of quarterly payment, is to hang so heavy a meaning
on too slender a frame. Prior to its amendment by R.A. 1612 on August 24, 1956, said Section
183(a) prescribed quarterly payment of percentage taxes.32 Accurately read, the amendment merely
changed the manner or frequency of payment of the tax, whereas Section 259 makes reference to
Section 183(a) with respect to the time limit for payment of percentage taxes. The amendment does
not nullify the applicability of Section 183(a) to franchises which do not set any time limit for payment
although providing for a different manner or frequency of payment. Common sense dictates that it be
so. For, if the law has chosen to allow a fifteen-day grace period to taxpayers paying every month,
no cogent reason exists why the same period if not longer should be denied taxpayers paying
every three months. The latter require more time for preparation their return covers a longer
period. The tax court is correct.33
Really, the tax cannot be immediately demandable at the end of each calendar quarter. Reason for
this is that transactions on the last day of the quarter must have to be included in the computation of
the taxpayer's return for each particular quarter. It is well-nigh impossible for the taxpayer to add up
his income, write down the deductions, and compute the net amount taxable as of the last working
hour of the last day of the quarter, and at the same time go to the nearest revenue office, submit the
quarterly return and pay the tax. This accounts for the fact that Section 183(a) of the National
Internal Revenue Code gives the taxpayer a leeway of twenty days after the end of each quarter to
do all of these. And by Section 259, it is only upon failure to pay for fifteen days "from and after the
date on which they must be paid" that the twenty-five per centum shall be added to the amount of
"taxes, charges, and percentages," on corporate franchises. Statutes are not to be so narrowly read
as to beget unreasonableness.

65

We accordingly rule that the franchise tax "must be paid" within "twenty days after the end" of each
quarter and that if such tax remains unpaid for 15 days "from and after the date on which they must
be paid," then twenty-five per centum shall be added to the amount due. No surcharge for late
payment of respondent company's franchise taxes accrues.
For the reasons given
The judgment under review is hereby AFFIRMED insofar as it reverses petitioner's assessment of
surcharge for late payment of respondent company's franchise tax; 34 and
Said judgment is hereby REVERSED insofar as it exempts respondent company from the payment
of deficiency income tax, in the sense that respondent company, in its capacity as fiduciary of its
employees' reserve fund, is hereby declared liable for the payment of individual income tax set forth
in Section 56(a) in connection with Section 21 of the National Internal Revenue Code; and
Conformably to the opinion expressed herein, let the record of this case be returned to the Court of
Tax Appeals with instructions to hear and determine the tax liability of the trust known as
"Employees' Reserve for Pensions" and/or tax refund, if any, to respondent Visayan Electric
Company, upon the dividends received during the years 1953 to 1958 on the investment of its
employees' reserve fund for pensions, and tax payments made by reason thereof, said tax to be
computed in accordance with Section 56(a) and (c) of the National Internal Revenue Code in relation
to Section 21 of the same Code.
No costs. So ordered.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC

G.R. No. 95022 March 23, 1992

COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
THE HON. COURT OF APPEALS, THE COURT OF TAX APPEALS, GCL RETIREMENT PLAN,
represented by its Trustee-Director, respondents.

MELENCIO-HERRERA, J.:
This case is said to be precedent setting. While the amount involved is insignificant, the Solicitor
General avers that there are about 85 claims of the same nature pending in the Court of Tax Appeals
and Bureau of Internal Revenue totalling approximately P120M.
Petitioner, the Commissioner of Internal Revenue, seeks a reversal of the Decision of respondent
Court of Appeals, dated August 27, 1990, in CA-G.R. SP No. 20426, entitled "Commissioner of
Internal Revenue vs. GCL Retirement Plan, represented by its Trustee-Director and the Court of Tax
Appeals," which affirmed the Decision of the latter Court, dated 15 December 1986, in Case No.

66

3888, ordering a refund, in the sum of P11,302.19, to the GCL Retirement Plan representing the
withholding tax on income from money market placements and purchase of treasury bills, imposed
pursuant to Presidential Decree No. 1959.
There is no dispute with respect to the facts. Private Respondent, GCL Retirement Plan (GCL, for
brevity) is an employees' trust maintained by the employer, GCL Inc., to provide retirement, pension,
disability and death benefits to its employees. The Plan as submitted was approved and qualified as
exempt from income tax by Petitioner Commissioner of Internal Revenue in accordance with Rep.
Act No. 4917. 1
In 1984, Respondent GCL made investsments and earned therefrom interest income from which
was witheld the fifteen per centum (15%) final witholding tax imposed by Pres. Decree No.
1959, 2 which took effect on 15 October 1984, to wit:
Date Kind of Investment Principal Income Earned 15% Tax
ACIC
12/05/84 Market Placement P236,515.32 P8,751.96 P1,312.66
10/22/84 234,632.75 9,815.89 1,472.38
11/19/84 225,886.51 10,629.22 1,594.38
11/23/84 344,448.64 17,313.33 2,597.00
12/05/84 324,633.81 15,077.44 2,261.52
COMBANK Treasury Bills 2,064.15

P11,302.19
On 15 January 1985, Respondent GCL filed with Petitioner a claim for refund in the amounts of
P1,312.66 withheld by Anscor Capital and Investment Corp., and P2,064.15 by Commercial Bank of
Manila. On 12 February 1985, it filed a second claim for refund of the amount of P7,925.00 withheld
by Anscor, stating in both letters that it disagreed with the collection of the 15% final withholding tax
from the interest income as it is an entity fully exempt from income tax as provided under Rep. Act
No. 4917 in relation to Section 56 (b) 3 of the Tax Code.
The refund requested having been denied, Respondent GCL elevated the matter to respondent
Court of Tax Appeals (CTA). The latter ruled in favor of GCL, holding that employees' trusts are
exempt from the 15% final withholding tax on interest income and ordering a refund of the tax
withheld. Upon appeal, originally to this Court, but referred to respondent Court of Appeals, the latter
upheld the CTA Decision. Before us now, Petitioner assails that disposition.
It appears that under Rep. Act No. 1983, which took effect on 22 June 1957, amending Sec. 56 (b)
of the National Internal Revenue Code (Tax Code, for brevity), employees' trusts were exempt from
income tax. That lawprovided:
Sec. 56 Imposition of tax. (a) Application of tax. The taxes imposed by this Title
upon individuals shall apply to the income of estates or of any kind of property held in
trust, including
xxx xxx xxx
(b) Exception. The tax imposed by this Title shall not apply to employees' trust
which forms a part of a pension, stock bonus or profit-sharing plan of an employer for
the benefit of some or all of his employees (1) if contributions are made to trust by
such employer, or employees, or both, for the purpose of distributing to such
employees the earnings and principal of the fund accumulated by the trust in
accordance with such
plan, . . .
On 3 June 1977, Pres. Decree No. 1156 provided, for the first time, for the withholding from the
interest on bank deposits at the source of a tax of fifteen per cent (15%) of said interest. However, it
also allowed a specific exemption in its Section 53, as follows:
Sec. 53. Withholding of tax at source.
xxx xxx xxx
(c) Withholding tax on interest on bank deposits. (1) Rate of withholding tax.
Every bank or banking institution shall deduct and withhold from the interest on bank
67

deposits (except interest paid or credited to non-resident alien individuals and foreign
corporations), a tax equal to fifteen per cent of the said interest: Provided, however,
That no withholding of tax shall be made if the aggregate amount of the interest on
all deposit accounts maintained by a depositor alone or together with another in any
one bank at any time during the taxable period does not exceed three hundred fifty
pesos a year or eighty-seven pesos and fifty centavos per quarter. For this purpose,
interest on a deposit account maintained by two persons shall be deemed to be
equally owned by them.
(2) Treatment of bank deposit interest. The interest income shall be included in the
gross income in computing the depositor's income tax liability in according with
existing law.
(3) Depositors enjoying tax exemption privileges or preferential tax treatment. In
all cases where the depositor is tax-exempt or is enjoying preferential income tax
treatment under existing laws, the withholding tax imposed in this paragraph shall be
refunded or credited as the case may be upon submission to the Commissioner of
Internal Revenue of proof that the said depositor is a tax-exempt entity or enjoys a
preferential income tax treatment.
xxx xxx xxx
This exemption and preferential tax treatment were carried over in Pres. Decree No. 1739, effective
on 17 September 1980, which law also subjected interest from bank deposits and yield from deposit
substitutes to a final tax of twenty per cent (20%). The pertinent provisions read:
Sec. 2. Section 21 of the same Code is hereby amended by adding a new paragraph
to read as follows:
Sec. 21. Rates of tax on citizens or residents.
xxx xxx xxx
Interest from Philippine Currency bank deposits and yield from
deposit substitutes whether received by citizens of the Philippines or
by resident alien individuals, shall be subject to the final tax as
follows: (a) 15% of the interest on savings deposits, and (b) 20% of
the interest on time deposits and yield from deposit substitutes, which
shall be collected and paid as provided in Sections 53 and 54 of this
Code. Provided, That no tax shall be imposed if the aggregate
amount of the interest on all Philippine Currency deposit accounts
maintained by a depositor alone or together with another in any one
bank at any time during the taxable period does not exceed Eight
Hundred Pesos (P800.00) a year or Two Hundred Pesos (P200.00)
per quarter. Provided, further, That if the recipient of such interest is
exempt from income taxation, no tax shall be imposed and that, if the
recipient is enjoying preferential income tax treatment, then the
preferential tax rates so provided shall be imposed (Emphasis
supplied).
Sec. 3. Section 24 of the same Code is hereby amended by adding a new subsection
(cc) between subsections (c) and (d) to read as follows:
(cc) Rates of tax on interest from deposits and yield from deposit
substitutes. Interest on Philippine Currency bank deposits and
yield from deposit substitutes received by domestic or resident
foreign corporations shall be subject to a final tax on the total amount
thereof as follows: (a) 15% of the interest on savings deposits; and
(b) 20% of the interest on time deposits and yield from deposit
substitutes which shall be collected and paid as provided in Sections
53 and 54 of this Code. Provided, That if the recipient of such interest
is exempt from income taxation, no tax shall be imposed and that, if
the recipient is enjoying preferential income tax treatment, then the
preferential tax rates so provided shall be imposed (Emphasis
supplied).
Sec. 9. Section 53(e) of the same Code is hereby amended to read as follows:

68

Se. 53(e) Withholding of final tax on interest on bank deposits and

yield from deposit substitutes.
(1) Withholding of final tax. Every bank or non-bank financial
intermediary shall deduct and withhold from the interest on bank
deposits or yield from deposit substitutes a final tax equal to fifteen
(15%) per cent of the interest on savings deposits and twenty (20%)
per cent of the interest on time deposits or yield from deposit
substitutes:Provided, however, That no withholding tax shall be made
if the aggregate amount of the interest on all deposit accounts
maintained by a depositor alone or together with another in any one
bank at any time during the taxable period does not exceed Eight
Hundred Pesos a year or Two Hundred Pesos per quarter. For this
purpose, interest on a deposit account maintained by two persons
shall be deemed to be equally owned by them.
(2) Depositors or placers/investors enjoying tax exemption privileges
or preferential tax treatment. In all cases where the depositor or
placer/investor is tax exempt or is enjoying preferential income tax
treatment under existing laws, the withholding tax imposed in this
paragraph shall be refunded or credited as the case may be upon
submission to the Commissioner of Internal Revenue of proof that the
said depositor, or placer/investor is a tax exempt entity or enjoys a
preferential income tax treatment.
Subsequently, however, on 15 October 1984, Pres. Decree No. 1959 was issued, amending the
aforestated provisions to read:
Sec. 2. Section 21(d) of this Code, as amended, is hereby further amended to read
as follows:
(d) On interest from bank deposits and yield or any other monetary
benefit from deposit substitutes and from trust fund and similar
arrangements. Interest from Philippine Currency Bank deposits
and yield or any other monetary benefit from deposit substitutes and
from trust fund and similar arrangements whether received by
citizens of the Philippines, or by resident alien individuals, shall be
subject to a 15% final tax to be collected and paid as provided in
Sections 53 and 54 of this Code.
Sec. 3. Section 24(cc) of this Code, as amended, is hereby further amended to read
as follows:
(cc) Rates of tax on interest from deposits and yield or any other
monetary benefit from deposit substitutes and from trust fund and
similar arrangements. Interest on Philippine Currency Bank
deposits and yield or any other monetary benefit from deposit
substitutes and from trust fund and similar arrangements received by
domestic or resident foreign corporations shall be subject to a 15%
final tax to be collected and paid as provided in Section 53 and 54 of
this Code.
Sec. 4. Section 53 (d) (1) of this code is hereby amended to read as follows:
Sec. 53 (d) (1). Withholding of Final Tax. Every bank or non-bank
financial intermediary or commercial. industrial, finance companies,
and other non-financial companies authorized by the Securities and
Exchange Commission to issue deposit substitutes shall deduct and
withhold from the interest on bank deposits or yield or any other
monetary benefit from deposit substitutes a final tax equal to
fifteen per centum(15%) of the interest on deposits or yield or any
other monetary benefit from deposit substitutes and from trust fund
and similar arrangements.
It is to be noted that the exemption from withholding tax on interest on bank deposits previously
extended by Pres. Decree No. 1739 if the recipient (individual or corporation) of the interest income
is exempt from income taxation, and the imposition of the preferential tax rates if the recipient of the

69

income is enjoying preferential income tax treatment, were both abolished by Pres. Decree No.
1959. Petitioner thus submits that the deletion of the exempting and preferential tax treatment
provisions under the old law is a clear manifestation that the single 15% (now 20%) rate is
impossible on all interest incomes from deposits, deposit substitutes, trust funds and similar
arrangements, regardless of the tax status or character of the recipients thereof. In short, petitioner's
position is that from 15 October 1984 when Pres. Decree No. 1959 was promulgated, employees'
trusts ceased to be exempt and thereafter became subject to the final withholding tax.
Upon the other hand, GCL contends that the tax exempt status of the employees' trusts applies to all
kinds of taxes, including the final withholding tax on interest income. That exemption, according to
GCL, is derived from Section 56(b) and not from Section 21 (d) or 24 (cc) of the Tax Code, as argued
by Petitioner.
The sole issue for determination is whether or not the GCL Plan is exempt from the final withholding
tax on interest income from money placements and purchase of treasury bills required by Pres.
Decree No. 1959.
We uphold the exemption.
To begin with, it is significant to note that the GCL Plan was qualified as exempt from income tax by
the Commissioner of Internal Revenue in accordance with Rep. Act No. 4917 approved on 17 June
1967. This law specifically provided:
Sec. 1. Any provision of law to the contrary notwithstanding, the retirement benefits
received by officials and employees of private firms, whether individual or corporate,
in accordance with a reasonable private benefit plan maintained by the employer
shall be exempt from all taxes and shall not be liable to attachment, levy or seizure
by or under any legal or equitable process whatsoever except to pay a debt of the
official or employee concerned to the private benefit plan or that arising from liability
imposed in a criminal action; . . . (emphasis ours).
In so far as employees' trusts are concerned, the foregoing provision should be taken in relation to
then Section 56(b) (now 53[b]) of the Tax Code, as amended by Rep. Act No. 1983, supra, which
took effect on 22 June 1957. This provision specifically exempted employee's trusts from income tax
and is repeated hereunder for emphasis:
Sec. 56. Imposition of Tax. (a) Application of tax. The taxes imposed by this
Title upon individuals shall apply to the income of estates or of any kind of property
held in trust.
xxx xxx xxx
(b) Exception. The tax imposed by this Title shall not apply to employee's trust
which forms part of a pension, stock bonus or profit-sharing plan of an employer for
the benefit of some or all of his
employees . . .
The tax-exemption privilege of employees' trusts, as distinguished from any other kind of property
held in trust, springs from the foregoing provision. It is unambiguous. Manifest therefrom is that the
tax law has singled out employees' trusts for tax exemption.
And rightly so, by virtue of the raison de'etre behind the creation of employees' trusts. Employees'
trusts or benefit plans normally provide economic assistance to employees upon the occurrence of
certain contingencies, particularly, old age retirement, death, sickness, or disability. It provides
security against certain hazards to which members of the Plan may be exposed. It is an independent
and additional source of protection for the working group. What is more, it is established for their
exclusive benefit and for no other purpose.
The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in order to encourage the
formation and establishment of such private Plans for the benefit of laborers and employees outside
of the Social Security Act. Enlightening is a portion of the explanatory note to H.B. No. 6503, now
R.A. 1983, reading:
Considering that under Section 17 of the social Security Act, all contributions
collected and payments of sickness, unemployment, retirement, disability and death
benefits made thereunder together with the income of the pension trust are exempt
from any tax, assessment, fee, or charge, it is proposed that a similar system
70

providing for retirement, etc. benefits for employees outside the Social Security Act
be exempted from income taxes. (Congressional Record, House of Representatives,
Vol. IV, Part. 2, No. 57, p. 1859, May 3, 1957; cited in Commissioner of Internal
Revenue v. Visayan Electric Co., et al., G.R. No. L-22611, 27 May 1968, 23 SCRA
715); emphasis supplied.
It is evident that tax-exemption is likewise to be enjoyed by the income of the pension trust.
Otherwise, taxation of those earnings would result in a diminution accumulated income and reduce
whatever the trust beneficiaries would receive out of the trust fund. This would run afoul of the very
intendment of the law.
The deletion in Pres. Decree No. 1959 of the provisos regarding tax exemption and preferential tax
rates under the old law, therefore, can not be deemed to extent to employees' trusts. Said Decree,
being a general law, can not repeal by implication a specific provision, Section 56(b) now 53 [b]) in
relation to Rep. Act No. 4917 granting exemption from income tax to employees' trusts. Rep. Act
1983, which excepted employees' trusts in its Section 56 (b) was effective on 22 June 1957 while
Rep. Act No. 4917 was enacted on 17 June 1967, long before the issuance of Pres. Decree No.
1959 on 15 October 1984. A subsequent statute, general in character as to its terms and application,
is not to be construed as repealing a special or specific enactment, unless the legislative purpose to
do so is manifested. This is so even if the provisions of the latter are sufficiently comprehensive to
include what was set forth in the special act (Villegas v. Subido, G.R. No. L-31711, 30 September
1971, 41 SCRA 190).
Notably, too, all the tax provisions herein treated of come under Title II of the Tax Code on "Income
Tax." Section 21 (d), as amended by Rep. Act No. 1959, refers to the final tax on individuals and falls
under Chapter II; Section 24 (cc) to the final tax on corporations under Chapter III; Section 53 on
withholding of final tax to Returns and Payment of Tax under Chapter VI; and Section 56 (b) to tax on
Estates and Trusts covered by Chapter VII, Section 56 (b), taken in conjunction with Section 56
(a), supra, explicitly excepts employees' trusts from "the taxes imposed by this Title." Since the final
tax and the withholding thereof are embraced within the title on "Income Tax," it follows that said trust
must be deemed exempt therefrom. Otherwise, the exception becomes meaningless.
There can be no denying either that the final withholding tax is collected from income in respect of
which employees' trusts are declared exempt (Sec. 56 [b], now 53 [b], Tax Code). The application of
the withholdings system to interest on bank deposits or yield from deposit substitutes is essentially to
maximize and expedite the collection of income taxes by requiring its payment at the source. If an
employees' trust like the GCL enjoys a tax-exempt status from income, we see no logic in
withholding a certain percentage of that income which it is not supposed to pay in the first place.
Petitioner also relies on Revenue Memorandum Circular 31-84, dated 30 October 1984, and Bureau
of Internal Revenue Ruling No. 027-e-000-00-005-85, dated 14 January 1985, as authorities for the
argument that Pres. Decree No. 1959 withdrew the exemption of employees' trusts from the
withholding of the final tax on interest income. Said Circular and Ruling pronounced that the deletion
of the exempting and preferential tax treatment provisions by Pres. Decree No. 1959 is a clear
manifestation that the single 15% tax rate is imposable on all interest income regardless of the tax
status or character of the recipient thereof. But since we herein rule that Pres. Decree No. 1959 did
not have the effect of revoking the tax exemption enjoyed by employees' trusts, reliance on those
authorities is now misplaced.
WHEREFORE, the Writ of Certiorari prayed for is DENIED. The judgment of respondent Court of
Appeals, affirming that of the Court of Tax Appeals is UPHELD. No costs.
SO ORDERED.
Narvasa, C.J., Gutierrez, Jr., Cruz, Paras, Feliciano, Padilla, Bidin, Grio-Aquino, Medialdea,
Regalado, Davide, Jr., Romero and Nocon, JJ., concur.

71

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-19342 May 25, 1972
LORENZO T. OA and HEIRS OF JULIA BUALES, namely: RODOLFO B. OA, MARIANO B.
OA, LUZ B. OA, VIRGINIA B. OA and LORENZO B. OA, JR., petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE, respondent.
Orlando Velasco for petitioners.
Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete, and
Special Attorney Purificacion Ureta for respondent.

BARREDO, J.:p
Petition for review of the decision of the Court of Tax Appeals in CTA Case No. 617, similarly entitled
as above, holding that petitioners have constituted an unregistered partnership and are, therefore,
subject to the payment of the deficiency corporate income taxes assessed against them by
respondent Commissioner of Internal Revenue for the years 1955 and 1956 in the total sum of
P21,891.00, plus 5% surcharge and 1% monthly interest from December 15, 1958, subject to the
provisions of Section 51 (e) (2) of the Internal Revenue Code, as amended by Section 8 of Republic
Act No. 2343 and the costs of the suit, 1 as well as the resolution of said court denying petitioners'
motion for reconsideration of said decision.
The facts are stated in the decision of the Tax Court as follows:
Julia Buales died on March 23, 1944, leaving as heirs her surviving spouse,
Lorenzo T. Oa and her five children. In 1948, Civil Case No. 4519 was instituted in
the Court of First Instance of Manila for the settlement of her estate. Later, Lorenzo T.

72

Oa the surviving spouse was appointed administrator of the estate of said deceased
(Exhibit 3, pp. 34-41, BIR rec.). On April 14, 1949, the administrator submitted the
project of partition, which was approved by the Court on May 16, 1949 (See Exhibit
K). Because three of the heirs, namely Luz, Virginia and Lorenzo, Jr., all surnamed
Oa, were still minors when the project of partition was approved, Lorenzo T. Oa,
their father and administrator of the estate, filed a petition in Civil Case No. 9637 of
the Court of First Instance of Manila for appointment as guardian of said minors. On
November 14, 1949, the Court appointed him guardian of the persons and property
of the aforenamed minors (See p. 3, BIR rec.).
The project of partition (Exhibit K; see also pp. 77-70, BIR rec.) shows that the heirs
have undivided one-half (1/2) interest in ten parcels of land with a total assessed
value of P87,860.00, six houses with a total assessed value of P17,590.00 and an
undetermined amount to be collected from the War Damage Commission. Later, they
received from said Commission the amount of P50,000.00, more or less. This
amount was not divided among them but was used in the rehabilitation of properties
owned by them in common (t.s.n., p. 46). Of the ten parcels of land aforementioned,
two were acquired after the death of the decedent with money borrowed from the
Philippine Trust Company in the amount of P72,173.00 (t.s.n., p. 24; Exhibit 3, pp.
31-34 BIR rec.).
The project of partition also shows that the estate shares equally with Lorenzo T.
Oa, the administrator thereof, in the obligation of P94,973.00, consisting of loans
contracted by the latter with the approval of the Court (see p. 3 of Exhibit K; or see p.
74, BIR rec.).
Although the project of partition was approved by the Court on May 16, 1949, no
attempt was made to divide the properties therein listed. Instead, the properties
remained under the management of Lorenzo T. Oa who used said properties in
business by leasing or selling them and investing the income derived therefrom and
the proceeds from the sales thereof in real properties and securities. As a result,
petitioners' properties and investments gradually increased from P105,450.00 in
1949 to P480,005.20 in 1956 as can be gleaned from the following year-end
balances:

Y
e
a
r

Invest
ment

Lan
d

Buil
din
g

Accou
nt

Acc
oun
t

Acc
oun
t

1949

P87,860.00

P17,590.00

1950

P24,657.65

128,566.72

96,076.26

1951

51,301.31

120,349.28

110,605.11

1952

67,927.52

87,065.28

152,674.39

1953

61,258.27

84,925.68

161,463.83

73

1954

63,623.37

99,001.20

167,962.04

1955

100,786.00

120,249.78

169,262.52

1956

175,028.68

135,714.68

169,262.52

(See Exhibits 3 & K t.s.n., pp. 22, 25-26, 40, 50, 102-104)
From said investments and properties petitioners derived such incomes as profits
from installment sales of subdivided lots, profits from sales of stocks, dividends,
rentals and interests (see p. 3 of Exhibit 3; p. 32, BIR rec.; t.s.n., pp. 37-38). The said
incomes are recorded in the books of account kept by Lorenzo T. Oa where the
corresponding shares of the petitioners in the net income for the year are also
known. Every year, petitioners returned for income tax purposes their shares in the
net income derived from said properties and securities and/or from transactions
involving them (Exhibit 3, supra; t.s.n., pp. 25-26). However, petitioners did not
actually receive their shares in the yearly income. (t.s.n., pp. 25-26, 40, 98, 100). The
income was always left in the hands of Lorenzo T. Oa who, as heretofore pointed
out, invested them in real properties and securities. (See Exhibit 3, t.s.n., pp. 50,
102-104).
On the basis of the foregoing facts, respondent (Commissioner of Internal Revenue)
decided that petitioners formed an unregistered partnership and therefore, subject to
the corporate income tax, pursuant to Section 24, in relation to Section 84(b), of the
Tax Code. Accordingly, he assessed against the petitioners the amounts of
P8,092.00 and P13,899.00 as corporate income taxes for 1955 and 1956,
respectively. (See Exhibit 5, amended by Exhibit 17, pp. 50 and 86, BIR rec.).
Petitioners protested against the assessment and asked for reconsideration of the
ruling of respondent that they have formed an unregistered partnership. Finding no
merit in petitioners' request, respondent denied it (See Exhibit 17, p. 86, BIR rec.).
(See pp. 1-4, Memorandum for Respondent, June 12, 1961).
The original assessment was as follows:
1955
Net income as per investigation ................ P40,209.89
Income tax due thereon ............................... 8,042.00
25% surcharge .............................................. 2,010.50
Compromise for non-filing .......................... 50.00
Total ............................................................... P10,102.50
1956
Net income as per investigation ................ P69,245.23
Income tax due thereon ............................... 13,849.00
25% surcharge .............................................. 3,462.25
Compromise for non-filing .......................... 50.00
Total ............................................................... P17,361.25
(See Exhibit 13, page 50, BIR records)
Upon further consideration of the case, the 25% surcharge was eliminated in line
with the ruling of the Supreme Court in Collector v. Batangas Transportation Co.,
G.R. No. L-9692, Jan. 6, 1958, so that the questioned assessment refers solely to
the income tax proper for the years 1955 and 1956 and the "Compromise for nonfiling," the latter item obviously referring to the compromise in lieu of the criminal

74

liability for failure of petitioners to file the corporate income tax returns for said years.
(See Exh. 17, page 86, BIR records). (Pp. 1-3, Annex C to Petition)
Petitioners have assigned the following as alleged errors of the Tax Court:
I.
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE PETITIONERS
FORMED AN UNREGISTERED PARTNERSHIP;
II.
THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE
PETITIONERS WERE CO-OWNERS OF THE PROPERTIES INHERITED AND
(THE) PROFITS DERIVED FROM TRANSACTIONS THEREFROM (sic);
III.
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT PETITIONERS WERE
LIABLE FOR CORPORATE INCOME TAXES FOR 1955 AND 1956 AS AN
UNREGISTERED PARTNERSHIP;
IV.
ON THE ASSUMPTION THAT THE PETITIONERS CONSTITUTED AN
UNREGISTERED PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT
HOLDING THAT THE PETITIONERS WERE AN UNREGISTERED PARTNERSHIP
TO THE EXTENT ONLY THAT THEY INVESTED THE PROFITS FROM THE
PROPERTIES OWNED IN COMMON AND THE LOANS RECEIVED USING THE
INHERITED PROPERTIES AS COLLATERALS;
V.
ON THE ASSUMPTION THAT THERE WAS AN UNREGISTERED PARTNERSHIP,
THE COURT OF TAX APPEALS ERRED IN NOT DEDUCTING THE VARIOUS
AMOUNTS PAID BY THE PETITIONERS AS INDIVIDUAL INCOME TAX ON THEIR
RESPECTIVE SHARES OF THE PROFITS ACCRUING FROM THE PROPERTIES
OWNED IN COMMON, FROM THE DEFICIENCY TAX OF THE UNREGISTERED
PARTNERSHIP.
In other words, petitioners pose for our resolution the following questions: (1) Under the facts found
by the Court of Tax Appeals, should petitioners be considered as co-owners of the properties
inherited by them from the deceased Julia Buales and the profits derived from transactions
involving the same, or, must they be deemed to have formed an unregistered partnership subject to
tax under Sections 24 and 84(b) of the National Internal Revenue Code? (2) Assuming they have
formed an unregistered partnership, should this not be only in the sense that they invested as a
common fund the profits earned by the properties owned by them in common and the loans granted
to them upon the security of the said properties, with the result that as far as their respective shares
in the inheritance are concerned, the total income thereof should be considered as that of co-owners
and not of the unregistered partnership? And (3) assuming again that they are taxable as an
unregistered partnership, should not the various amounts already paid by them for the same years
1955 and 1956 as individual income taxes on their respective shares of the profits accruing from the
properties they owned in common be deducted from the deficiency corporate taxes, herein involved,
assessed against such unregistered partnership by the respondent Commissioner?
Pondering on these questions, the first thing that has struck the Court is that whereas petitioners'
predecessor in interest died way back on March 23, 1944 and the project of partition of her estate
was judicially approved as early as May 16, 1949, and presumably petitioners have been holding
their respective shares in their inheritance since those dates admittedly under the administration or
management of the head of the family, the widower and father Lorenzo T. Oa, the assessment in
question refers to the later years 1955 and 1956. We believe this point to be important because,
apparently, at the start, or in the years 1944 to 1954, the respondent Commissioner of Internal
Revenue did treat petitioners as co-owners, not liable to corporate tax, and it was only from 1955
that he considered them as having formed an unregistered partnership. At least, there is nothing in
the record indicating that an earlier assessment had already been made. Such being the case, and
We see no reason how it could be otherwise, it is easily understandable why petitioners' position that
they are co-owners and not unregistered co-partners, for the purposes of the impugned assessment,
75

cannot be upheld. Truth to tell, petitioners should find comfort in the fact that they were not similarly
assessed earlier by the Bureau of Internal Revenue.
The Tax Court found that instead of actually distributing the estate of the deceased among
themselves pursuant to the project of partition approved in 1949, "the properties remained under the
management of Lorenzo T. Oa who used said properties in business by leasing or selling them and
investing the income derived therefrom and the proceed from the sales thereof in real properties and
securities," as a result of which said properties and investments steadily increased yearly from
P87,860.00 in "land account" and P17,590.00 in "building account" in 1949 to P175,028.68 in
"investment account," P135.714.68 in "land account" and P169,262.52 in "building account" in 1956.
And all these became possible because, admittedly, petitioners never actually received any share of
the income or profits from Lorenzo T. Oa and instead, they allowed him to continue using said
shares as part of the common fund for their ventures, even as they paid the corresponding income
taxes on the basis of their respective shares of the profits of their common business as reported by
the said Lorenzo T. Oa.
It is thus incontrovertible that petitioners did not, contrary to their contention, merely limit themselves
to holding the properties inherited by them. Indeed, it is admitted that during the material years
herein involved, some of the said properties were sold at considerable profit, and that with said
profit, petitioners engaged, thru Lorenzo T. Oa, in the purchase and sale of corporate securities. It
is likewise admitted that all the profits from these ventures were divided among petitioners
proportionately in accordance with their respective shares in the inheritance. In these circumstances,
it is Our considered view that from the moment petitioners allowed not only the incomes from their
respective shares of the inheritance but even the inherited properties themselves to be used by
Lorenzo T. Oa as a common fund in undertaking several transactions or in business, with the
intention of deriving profit to be shared by them proportionally, such act was tantamonut to actually
contributing such incomes to a common fund and, in effect, they thereby formed an unregistered
partnership within the purview of the above-mentioned provisions of the Tax Code.
It is but logical that in cases of inheritance, there should be a period when the heirs can be
considered as co-owners rather than unregistered co-partners within the contemplation of our
corporate tax laws aforementioned. Before the partition and distribution of the estate of the
deceased, all the income thereof does belong commonly to all the heirs, obviously, without them
becoming thereby unregistered co-partners, but it does not necessarily follow that such status as coowners continues until the inheritance is actually and physically distributed among the heirs, for it is
easily conceivable that after knowing their respective shares in the partition, they might decide to
continue holding said shares under the common management of the administrator or executor or of
anyone chosen by them and engage in business on that basis. Withal, if this were to be allowed, it
would be the easiest thing for heirs in any inheritance to circumvent and render meaningless
Sections 24 and 84(b) of the National Internal Revenue Code.
It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for holding
the appellants therein to be unregistered co-partners for tax purposes, that their common fund "was
not something they found already in existence" and that "it was not a property inherited by them pro
indiviso," but it is certainly far fetched to argue therefrom, as petitioners are doing here, that ergo, in
all instances where an inheritance is not actually divided, there can be no unregistered copartnership. As already indicated, for tax purposes, the co-ownership of inherited properties is
automatically converted into an unregistered partnership the moment the said common properties
and/or the incomes derived therefrom are used as a common fund with intent to produce profits for
the heirs in proportion to their respective shares in the inheritance as determined in a project
partition either duly executed in an extrajudicial settlement or approved by the court in the
corresponding testate or intestate proceeding. The reason for this is simple. From the moment of
such partition, the heirs are entitled already to their respective definite shares of the estate and the
incomes thereof, for each of them to manage and dispose of as exclusively his own without the
intervention of the other heirs, and, accordingly he becomes liable individually for all taxes in
connection therewith. If after such partition, he allows his share to be held in common with his coheirs under a single management to be used with the intent of making profit thereby in proportion to
his share, there can be no doubt that, even if no document or instrument were executed for the
purpose, for tax purposes, at least, an unregistered partnership is formed. This is exactly what
happened to petitioners in this case.
In this connection, petitioners' reliance on Article 1769, paragraph (3), of the Civil Code, providing
that: "The sharing of gross returns does not of itself establish a partnership, whether or not the
persons sharing them have a joint or common right or interest in any property from which the returns
are derived," and, for that matter, on any other provision of said code on partnerships is unavailing.
In Evangelista, supra, this Court clearly differentiated the concept of partnerships under the Civil
Code from that of unregistered partnerships which are considered as "corporations" under Sections

76

24 and 84(b) of the National Internal Revenue Code. Mr. Justice Roberto Concepcion, now Chief
Justice, elucidated on this point thus:
To begin with, the tax in question is one imposed upon "corporations", which, strictly
speaking, are distinct and different from "partnerships". When our Internal Revenue
Code includes "partnerships" among the entities subject to the tax on "corporations",
said Code must allude, therefore, to organizations which are not
necessarily "partnerships", in the technical sense of the term. Thus, for instance,
section 24 of said Code exempts from the aforementioned tax "duly registered
general partnerships," which constitute precisely one of the most typical forms of
partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code,
"the term corporation includes partnerships, no matter how created or organized."
This qualifying expression clearly indicates that a joint venture need not be
undertaken in any of the standard forms, or in confirmity with the usual requirements
of the law on partnerships, in order that one could be deemed constituted for
purposes of the tax on corporation. Again, pursuant to said section 84(b),the term
"corporation" includes, among others, "joint accounts,(cuentas en participacion)" and
"associations", none of which has a legal personality of its own, independent of that
of its members. Accordingly, the lawmaker could not have regarded that personality
as a condition essential to the existence of the partnerships therein referred to. In
fact, as above stated, "duly registered general co-partnerships" which are
possessed of the aforementioned personality have been expressly excluded by
law (sections 24 and 84[b]) from the connotation of the term "corporation." ....
xxx xxx xxx
Similarly, the American Law
... provides its own concept of a partnership. Under the term
"partnership" it includes not only a partnership as known in common
law but, as well, a syndicate, group, pool, joint venture, or other
unincorporated organization which carries on any business, financial
operation, or venture, and which is not, within the meaning of the
Code, a trust, estate, or a corporation. ... . (7A Merten's Law of
Federal Income Taxation, p. 789; emphasis ours.)
The term "partnership" includes a syndicate, group, pool, joint
venture or other unincorporated organization, through or by means of
which any business, financial operation, or venture is carried on. ... .
(8 Merten's Law of Federal Income Taxation, p. 562 Note 63;
emphasis ours.)
For purposes of the tax on corporations, our National Internal Revenue Code
includes these partnerships with the exception only of duly registered general
copartnerships within the purview of the term "corporation." It is, therefore, clear to
our mind that petitioners herein constitute a partnership, insofar as said Code is
concerned, and are subject to the income tax for corporations.
We reiterated this view, thru Mr. Justice Fernando, in Reyes vs. Commissioner of Internal Revenue,
G. R. Nos. L-24020-21, July 29, 1968, 24 SCRA 198, wherein the Court ruled against a theory of coownership pursued by appellants therein.
As regards the second question raised by petitioners about the segregation, for the purposes of the
corporate taxes in question, of their inherited properties from those acquired by them subsequently,
We consider as justified the following ratiocination of the Tax Court in denying their motion for
reconsideration:
In connection with the second ground, it is alleged that, if there was an unregistered
partnership, the holding should be limited to the business engaged in apart from the
properties inherited by petitioners. In other words, the taxable income of the
partnership should be limited to the income derived from the acquisition and sale of
real properties and corporate securities and should not include the income derived
from the inherited properties. It is admitted that the inherited properties and the
income derived therefrom were used in the business of buying and selling other real
properties and corporate securities. Accordingly, the partnership income must include
not only the income derived from the purchase and sale of other properties but also
the income of the inherited properties.

77

Besides, as already observed earlier, the income derived from inherited properties may be
considered as individual income of the respective heirs only so long as the inheritance or estate is
not distributed or, at least, partitioned, but the moment their respective known shares are used as
part of the common assets of the heirs to be used in making profits, it is but proper that the income
of such shares should be considered as the part of the taxable income of an unregistered
partnership. This, We hold, is the clear intent of the law.
Likewise, the third question of petitioners appears to have been adequately resolved by the Tax
Court in the aforementioned resolution denying petitioners' motion for reconsideration of the decision
of said court. Pertinently, the court ruled this wise:
In support of the third ground, counsel for petitioners alleges:
Even if we were to yield to the decision of this Honorable Court that
the herein petitioners have formed an unregistered partnership and,
therefore, have to be taxed as such, it might be recalled that the
petitioners in their individual income tax returns reported their shares
of the profits of the unregistered partnership. We think it only fair and
equitable that the various amounts paid by the individual petitioners
as income tax on their respective shares of the unregistered
partnership should be deducted from the deficiency income tax found
by this Honorable Court against the unregistered partnership. (page
7, Memorandum for the Petitioner in Support of Their Motion for
Reconsideration, Oct. 28, 1961.)
In other words, it is the position of petitioners that the taxable income of the
partnership must be reduced by the amounts of income tax paid by each petitioner
on his share of partnership profits. This is not correct; rather, it should be the other
way around. The partnership profits distributable to the partners (petitioners herein)
should be reduced by the amounts of income tax assessed against the partnership.
Consequently, each of the petitioners in his individual capacity overpaid his income
tax for the years in question, but the income tax due from the partnership has been
correctly assessed. Since the individual income tax liabilities of petitioners are not in
issue in this proceeding, it is not proper for the Court to pass upon the same.
Petitioners insist that it was error for the Tax Court to so rule that whatever excess they might have
paid as individual income tax cannot be credited as part payment of the taxes herein in question. It is
argued that to sanction the view of the Tax Court is to oblige petitioners to pay double income tax on
the same income, and, worse, considering the time that has lapsed since they paid their individual
income taxes, they may already be barred by prescription from recovering their overpayments in a
separate action. We do not agree. As We see it, the case of petitioners as regards the point under
discussion is simply that of a taxpayer who has paid the wrong tax, assuming that the failure to pay
the corporate taxes in question was not deliberate. Of course, such taxpayer has the right to be
reimbursed what he has erroneously paid, but the law is very clear that the claim and action for such
reimbursement are subject to the bar of prescription. And since the period for the recovery of the
excess income taxes in the case of herein petitioners has already lapsed, it would not seem right to
virtually disregard prescription merely upon the ground that the reason for the delay is precisely
because the taxpayers failed to make the proper return and payment of the corporate taxes legally
due from them. In principle, it is but proper not to allow any relaxation of the tax laws in favor of
persons who are not exactly above suspicion in their conduct vis-a-vis their tax obligation to the
State.
IN VIEW OF ALL THE FOREGOING, the judgment of the Court of Tax Appeals appealed from is
affirm with costs against petitioners.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-9996

October 15, 1957

EUFEMIA EVANGELISTA, MANUELA EVANGELISTA, and FRANCISCA EVANGELISTA,

petitioners,

78

vs.
THE COLLECTOR OF INTERNAL REVENUE and THE COURT OF TAX APPEALS, respondents.
Santiago F. Alidio and Angel S. Dakila, Jr., for petitioner.
Office of the Solicitor General Ambrosio Padilla, Assistant Solicitor General Esmeraldo Umali and
Solicitor Felicisimo R. Rosete for Respondents.
CONCEPCION, J.:
This is a petition filed by Eufemia Evangelista, Manuela Evangelista and Francisca Evangelista, for
review of a decision of the Court of Tax Appeals, the dispositive part of which reads:
FOR ALL THE FOREGOING, we hold that the petitioners are liable for the income tax, real
estate dealer's tax and the residence tax for the years 1945 to 1949, inclusive, in accordance
with the respondent's assessment for the same in the total amount of P6,878.34, which is
hereby affirmed and the petition for review filed by petitioner is hereby dismissed with costs
against petitioners.
It appears from the stipulation submitted by the parties:
1. That the petitioners borrowed from their father the sum of P59,1400.00 which amount
together with their personal monies was used by them for the purpose of buying real
properties,.
2. That on February 2, 1943, they bought from Mrs. Josefina Florentino a lot with an area of
3,713.40 sq. m. including improvements thereon from the sum of P100,000.00; this property
has an assessed value of P57,517.00 as of 1948;
3. That on April 3, 1944 they purchased from Mrs. Josefa Oppus 21 parcels of land with an
aggregate area of 3,718.40 sq. m. including improvements thereon for P130,000.00; this
property has an assessed value of P82,255.00 as of 1948;
4. That on April 28, 1944 they purchased from the Insular Investments Inc., a lot of 4,353 sq.
m. including improvements thereon for P108,825.00. This property has an assessed value of
P4,983.00 as of 1948;
5. That on April 28, 1944 they bought form Mrs. Valentina Afable a lot of 8,371 sq. m.
including improvements thereon for P237,234.34. This property has an assessed value of
P59,140.00 as of 1948;
6. That in a document dated August 16, 1945, they appointed their brother Simeon
Evangelista to 'manage their properties with full power to lease; to collect and receive rents;
to issue receipts therefor; in default of such payment, to bring suits against the defaulting
tenants; to sign all letters, contracts, etc., for and in their behalf, and to endorse and deposit
all notes and checks for them;
7. That after having bought the above-mentioned real properties the petitioners had the
same rented or leases to various tenants;
8. That from the month of March, 1945 up to an including December, 1945, the total amount
collected as rents on their real properties was P9,599.00 while the expenses amounted to
P3,650.00 thereby leaving them a net rental income of P5,948.33;
9. That on 1946, they realized a gross rental income of in the sum of P24,786.30, out of
which amount was deducted in the sum of P16,288.27 for expenses thereby leaving them a
net rental income of P7,498.13;
10. That in 1948, they realized a gross rental income of P17,453.00 out of the which amount
was deducted the sum of P4,837.65 as expenses, thereby leaving them a net rental income
of P12,615.35.
It further appears that on September 24, 1954 respondent Collector of Internal Revenue demanded
the payment of income tax on corporations, real estate dealer's fixed tax and corporation residence
tax for the years 1945-1949, computed, according to assessment made by said officer, as follows:

79

INCOME TAXES

1945

14.84

1946

1,144.71

1947

10.34

1948

1,912.30

1949

1,575.90

Total including surcharge and

compromise

P6,157.09

REAL ESTATE DEALER'S FIXED TAX

1946

P37.50

1947

150.00

1948

150.00

1949

150.00

Total including penalty

P527.00

RESIDENCE TAXES OF CORPORATION

1945

P38.75

1946

38.75

80

1947

38.75

1948

38.75

1949

38.75

Total including surcharge

P193.75

TOTAL TAXES DUE

P6,878.34.

Said letter of demand and corresponding assessments were delivered to petitioners on December 3,
1954, whereupon they instituted the present case in the Court of Tax Appeals, with a prayer that "the
decision of the respondent contained in his letter of demand dated September 24, 1954" be
reversed, and that they be absolved from the payment of the taxes in question, with costs against
the respondent.
After appropriate proceedings, the Court of Tax Appeals the above-mentioned decision for the
respondent, and a petition for reconsideration and new trial having been subsequently denied, the
case is now before Us for review at the instance of the petitioners.
The issue in this case whether petitioners are subject to the tax on corporations provided for in
section 24 of Commonwealth Act. No. 466, otherwise known as the National Internal Revenue Code,
as well as to the residence tax for corporations and the real estate dealers fixed tax. With respect to
the tax on corporations, the issue hinges on the meaning of the terms "corporation" and
"partnership," as used in section 24 and 84 of said Code, the pertinent parts of which read:
SEC. 24. Rate of tax on corporations.There shall be levied, assessed, collected, and paid
annually upon the total net income received in the preceding taxable year from all sources by
every corporation organized in, or existing under the laws of the Philippines, no matter how
created or organized but not including duly registered general co-partnerships (compaias
colectivas), a tax upon such income equal to the sum of the following: . . .
SEC. 84 (b). The term 'corporation' includes partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion), associations or
insurance companies, but does not include duly registered general copartnerships.
(compaias colectivas).
Article 1767 of the Civil Code of the Philippines provides:
By the contract of partnership two or more persons bind themselves to contribute money,
properly, or industry to a common fund, with the intention of dividing the profits among
themselves.
Pursuant to the article, the essential elements of a partnership are two, namely: (a) an agreement to
contribute money, property or industry to a common fund; and (b) intent to divide the profits among
the contracting parties. The first element is undoubtedly present in the case at bar, for, admittedly,
petitioners have agreed to, and did, contribute money and property to a common fund. Hence, the
issue narrows down to their intent in acting as they did. Upon consideration of all the facts and
circumstances surrounding the case, we are fully satisfied that their purpose was to engage in real
estate transactions for monetary gain and then divide the same among themselves, because:
1. Said common fund was not something they found already in existence. It was not property
inherited by them pro indiviso. They created it purposely. What is more they jointly
borrowed a substantial portion thereof in order to establish said common fund.

81

2. They invested the same, not merely not merely in one transaction, but in a series of
transactions. On February 2, 1943, they bought a lot for P100,000.00. On April 3, 1944, they
purchased 21 lots for P18,000.00. This was soon followed on April 23, 1944, by the
acquisition of another real estate for P108,825.00. Five (5) days later (April 28, 1944), they
got a fourth lot for P237,234.14. The number of lots (24) acquired and transactions
undertaken, as well as the brief interregnum between each, particularly the last three
purchases, is strongly indicative of a pattern or common design that was not limited to the
conservation and preservation of the aforementioned common fund or even of the property
acquired by the petitioners in February, 1943. In other words, one cannot but perceive a
character of habitually peculiar to business transactions engaged in the purpose of gain.
3. The aforesaid lots were not devoted to residential purposes, or to other personal uses, of
petitioners herein. The properties were leased separately to several persons, who, from 1945
to 1948 inclusive, paid the total sum of P70,068.30 by way of rentals. Seemingly, the lots are
still being so let, for petitioners do not even suggest that there has been any change in the
utilization thereof.
4. Since August, 1945, the properties have been under the management of one person,
namely Simeon Evangelista, with full power to lease, to collect rents, to issue receipts, to
bring suits, to sign letters and contracts, and to indorse and deposit notes and checks. Thus,
the affairs relative to said properties have been handled as if the same belonged to a
corporation or business and enterprise operated for profit.
5. The foregoing conditions have existed for more than ten (10) years, or, to be exact, over
fifteen (15) years, since the first property was acquired, and over twelve (12) years, since
Simeon Evangelista became the manager.
6. Petitioners have not testified or introduced any evidence, either on their purpose in
creating the set up already adverted to, or on the causes for its continued existence. They
did not even try to offer an explanation therefor.
Although, taken singly, they might not suffice to establish the intent necessary to constitute a
partnership, the collective effect of these circumstances is such as to leave no room for doubt on the
existence of said intent in petitioners herein. Only one or two of the aforementioned circumstances
were present in the cases cited by petitioners herein, and, hence, those cases are not in point.
Petitioners insist, however, that they are mere co-owners, not copartners, for, in consequence of the
acts performed by them, a legal entity, with a personality independent of that of its members, did not
come into existence, and some of the characteristics of partnerships are lacking in the case at bar.
This pretense was correctly rejected by the Court of Tax Appeals.
To begin with, the tax in question is one imposed upon "corporations", which, strictly speaking, are
distinct and different from "partnerships". When our Internal Revenue Code includes "partnerships"
among the entities subject to the tax on "corporations", said Code must allude, therefore, to
organizations which are not necessarily "partnerships", in the technical sense of the term. Thus, for
instance, section 24 of said Code exempts from the aforementioned tax "duly registered general
partnerships which constitute precisely one of the most typical forms of partnerships in this
jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term corporation includes
partnerships, no matter how created or organized." This qualifying expression clearly indicates that a
joint venture need not be undertaken in any of the standard forms, or in conformity with the usual
requirements of the law on partnerships, in order that one could be deemed constituted for purposes
of the tax on corporations. Again, pursuant to said section 84(b), the term "corporation" includes,
among other, joint accounts, (cuentas en participation)" and "associations," none of which has a
legal personality of its own, independent of that of its members. Accordingly, the lawmaker could not
have regarded that personality as a condition essential to the existence of the partnerships therein
referred to. In fact, as above stated, "duly registered general copartnerships" which are
possessed of the aforementioned personality have been expressly excluded by law (sections 24
and 84 [b] from the connotation of the term "corporation" It may not be amiss to add that petitioners'
allegation to the effect that their liability in connection with the leasing of the lots above referred to,
under the management of one person even if true, on which we express no opinion tends
to increase the similarity between the nature of their venture and that corporations, and is, therefore,
an additional argument in favor of the imposition of said tax on corporations.
Under the Internal Revenue Laws of the United States, "corporations" are taxed differently from
"partnerships". By specific provisions of said laws, such "corporations" include "associations, jointstock companies and insurance companies." However, the term "association" is not used in the
aforementioned laws.

82

. . . in any narrow or technical sense. It includes any organization, created for the transaction
of designed affairs, or the attainment of some object, which like a corporation, continues
notwithstanding that its members or participants change, and the affairs of which, like
corporate affairs, are conducted by a single individual, a committee, a board, or some other
group, acting in a representative capacity. It is immaterial whether such organization is
created by an agreement, a declaration of trust, a statute, or otherwise. It includes a
voluntary association, a joint-stock corporation or company, a 'business' trusts a
'Massachusetts' trust, a 'common law' trust, and 'investment' trust (whether of the fixed or the
management type), an interinsuarance exchange operating through an attorney in fact, a
partnership association, and any other type of organization (by whatever name known) which
is not, within the meaning of the Code, a trust or an estate, or a partnership. (7A Mertens
Law of Federal Income Taxation, p. 788; emphasis supplied.).
Similarly, the American Law.
. . . provides its own concept of a partnership, under the term 'partnership 'it includes not only
a partnership as known at common law but, as well, a syndicate, group, pool, joint venture or
other unincorporated organizations which carries on any business financial operation, or
venture, and which is not, within the meaning of the Code, a trust, estate, or a corporation. . .
(7A Merten's Law of Federal Income taxation, p. 789; emphasis supplied.)
The term 'partnership' includes a syndicate, group, pool, joint venture or other
unincorporated organization, through or by means of which any business, financial
operation, or venture is carried on, . . .. ( 8 Merten's Law of Federal Income Taxation, p. 562
Note 63; emphasis supplied.) .
For purposes of the tax on corporations, our National Internal Revenue Code, includes these
partnerships with the exception only of duly registered general copartnerships within the
purview of the term "corporation." It is, therefore, clear to our mind that petitioners herein constitute a
partnership, insofar as said Code is concerned and are subject to the income tax for corporations.
As regards the residence of tax for corporations, section 2 of Commonwealth Act No. 465 provides in
part:
Entities liable to residence tax.-Every corporation, no matter how created or organized,
whether domestic or resident foreign, engaged in or doing business in the Philippines shall
pay an annual residence tax of five pesos and an annual additional tax which in no case,
shall exceed one thousand pesos, in accordance with the following schedule: . . .
The term 'corporation' as used in this Act includes joint-stock company, partnership, joint
account (cuentas en participacion), association or insurance company, no matter how
created or organized. (emphasis supplied.)
Considering that the pertinent part of this provision is analogous to that of section 24 and 84 (b) of
our National Internal Revenue Code (commonwealth Act No. 466), and that the latter was approved
on June 15, 1939, the day immediately after the approval of said Commonwealth Act No. 465 (June
14, 1939), it is apparent that the terms "corporation" and "partnership" are used in both statutes with
substantially the same meaning. Consequently, petitioners are subject, also, to the residence tax for
corporations.
Lastly, the records show that petitioners have habitually engaged in leasing the properties above
mentioned for a period of over twelve years, and that the yearly gross rentals of said properties from
June 1945 to 1948 ranged from P9,599 to P17,453. Thus, they are subject to the tax provided in
section 193 (q) of our National Internal Revenue Code, for "real estate dealers," inasmuch as,
pursuant to section 194 (s) thereof:
'Real estate dealer' includes any person engaged in the business of buying, selling,
exchanging, leasing, or renting property or his own account as principal and holding himself
out as a full or part time dealer in real estate or as an owner of rental property or properties
rented or offered to rent for an aggregate amount of three thousand pesos or more a year. . .
(emphasis supplied.)
Wherefore, the appealed decision of the Court of Tax appeals is hereby affirmed with costs against
the petitioners herein. It is so ordered.
Bengzon, Paras, C.J., Padilla, Reyes, A., Reyes, J.B.L., Endencia and Felix, JJ., concur.

83

BAUTISTA ANGELO, J., concurring:

I agree with the opinion that petitioners have actually contributed money to a common fund with
express purpose of engaging in real estate business for profit. The series of transactions which they
had undertaken attest to this. This appears in the following portion of the decision:
2. They invested the same, not merely in one transaction, but in a series of transactions. On
February 2, 1943, they bought a lot for P100,000. On April 3, 1944, they purchase 21 lots for
P18,000. This was soon followed on April 23, 1944, by the acquisition of another real state
for P108,825. Five (5) days later (April 28, 1944), they got a fourth lot for P237,234.14. The
number of lots (24) acquired and transactions undertaken, as well as the brief interregnum
between each, particularly the last three purchases, is strongly indicative of a pattern or
common design that was not limited to the conservation and preservation of the
aforementioned common fund or even of the property acquired by the petitioner in February,
1943, In other words, we cannot but perceive a character of habitually peculiar
to business transactions engaged in for purposes of gain.
I wish however to make to make the following observation:
Article 1769 of the new Civil Code lays down the rule for determining when a transaction should be
deemed a partnership or a co-ownership. Said article paragraphs 2 and 3, provides:
(2) Co-ownership or co-possession does not of itself establish a partnership, whether such
co-owners or co-possessors do or do not share any profits made by the use of the property;
(3) The sharing of gross returns does not of itself establish partnership, whether or not the
person sharing them have a joint or common right or interest in any property from which the
returns are derived;
From the above it appears that the fact that those who agree to form a co-ownership shared or do
not share any profits made by the use of property held in common does not convert their venture into
a partnership. Or the sharing of the gross returns does not of itself establish a partnership whether or
not the persons sharing therein have a joint or common right or interest in the property. This only
means that, aside from the circumstance of profit, the presence of other elements constituting
partnership is necessary, such as the clear intent to form a partnership, the existence of a judicial
personality different from that of the individual partners, and the freedom to transfer or assign any
interest in the property by one with the consent of the others (Padilla, Civil Code of the Philippines
Annotated, Vol. I, 1953 ed., pp. 635- 636).
It is evident that an isolated transaction whereby two or more persons contribute funds to buy certain
real estate for profit in the absence of other circumstances showing a contrary intention cannot be
considered a partnership.
Persons who contribute property or funds for a common enterprise and agree to share the
gross returns of that enterprise in proportion to their contribution, but who severally retain the
title to their respective contribution, are not thereby rendered partners. They have no
common stock or capital, and no community of interest as principal proprietors in the
business itself which the proceeds derived. (Elements of the law of Partnership by Floyd R.
Mechem, 2n Ed., section 83, p. 74.)
A joint venture purchase of land, by two, does not constitute a copartnership in respect
thereto; nor does not agreement to share the profits and loses on the sale of land create a
partnership; the parties are only tenants in common. (Clark vs. Sideway, 142 U.S. 682, 12 S
Ct. 327, 35 L. Ed., 1157.)
Where plaintiff, his brother, and another agreed to become owners of a single tract of reality,
holding as tenants in common, and to divide the profits of disposing of it, the brother and the
other not being entitled to share in plaintiff's commissions, no partnership existed as between
the parties, whatever relation may have been as to third parties. (Magee vs. Magee, 123 N.
E. 6763, 233 Mass. 341.)
In order to constitute a partnership inter sese there must be: (a) An intent to form the same;
(b) generally a participating in both profits and losses; (c) and such a community of interest,
as far as third persons are concerned as enables each party to make contract, manage the
84

business, and dispose of the whole property. (Municipal Paving Co. vs Herring, 150 P. 1067,
50 Ill. 470.)
The common ownership of property does not itself create a partnership between the owners,
though they may use it for purpose of making gains; and they may, without becoming
partners, agree among themselves as to the management and use of such property and the
application of the proceeds therefrom. (Spurlock vs. Wilson, 142 S. W. 363, 160 No. App.
14.)
This is impliedly recognized in the following portion of the decision: "Although, taken singly, they
might not suffice to establish the intent necessary to constitute a partnership, the collective effect of
these circumstances (referring to the series of transactions) such as to leave no room for doubt on
the existence of said intent in petitioners herein."

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION

G.R. No. 112675 January 25, 1999

AFISCO INSURANCE CORPORATION; CCC INSURANCE CORPORATION; CHARTER
INSURANCE CO., INC.; CIBELES INSURANCE CORPORATION; COMMONWEALTH
INSURANCE COMPANY; CONSOLIDATED INSURANCE CO., INC.; DEVELOPMENT
INSURANCE & SURETY CORPORATION DOMESTIC INSURANCE COMPANY OF THE
PHILIPPINE; EASTERN ASSURANCE COMPANY & SURETY CORP; EMPIRE INSURANCE
COMPANY; EQUITABLE INSURANCE CORPORATION; FEDERAL INSURANCE CORPORATION
INC.; FGU INSURANCE CORPORATION; FIDELITY & SURETY COMPANY OF THE PHILS.,
INC.; FILIPINO MERCHANTS' INSURANCE CO., INC.; GOVERNMENT SERVICE INSURANCE
SYSTEM; MALAYAN INSURANCE CO., INC.; MALAYAN ZURICH INSURANCE CO.; INC.;
MERCANTILE INSURANCE CO., INC.; METROPOLITAN INSURANCE COMPANY; METROTAISHO INSURANCE CORPORATION; NEW ZEALAND INSURANCE CO., LTD.; PAN-MALAYAN
INSURANCE CORPORATION; PARAMOUNT INSURANCE CORPORATION; PEOPLE'S TRANSEAST ASIA INSURANCE CORPORATION; PERLA COMPANIA DE SEGUROS, INC.; PHILIPPINE
BRITISH ASSURANCE CO., INC.; PHILIPPINE FIRST INSURANCE CO., INC.; PIONEER
INSURANCE & SURETY CORP.; PIONEER INTERCONTINENTAL INSURANCE CORPORATION;
PROVIDENT INSURANCE COMPANY OF THE PHILIPPINES; PYRAMID INSURANCE CO., INC.;
RELIANCE SURETY & INSURANCE COMPANY; RIZAL SURETY & INSURANCE COMPANY;
SANPIRO INSURANCE CORPORATION; SEABOARD-EASTERN INSURANCE CO., INC.; SOLID
GUARANTY, INC.; SOUTH SEA SURETY & INSURANCE CO., INC.; STATE BONDING &
INSURANCE CO., INC.; SUMMA INSURANCE CORPORATION; TABACALERA INSURANCE
CO., INC. all assessed as "POOL OF MACHINERY INSURERS, petitioner,
vs.

85

COURT OF APPEALS, COURT OF TAX APPEALS and COMISSIONER OF INTERNAL

REVENUE, respondent.

PANGANIBAN, J.:
Pursuant to "reinsurance treaties," a number of local insurance firms formed themselves into a "pool"
in order to facilitate the handling of business contracted with a nonresident foreign insurance
company. May the "clearing house" or "insurance pool" so formed be deemed a partnership or an
association that is taxable as a corporation under the National Internal Revenue Code (NIRC)?
Should the pool's remittances to the member companies and to the said foreign firm be taxable as
dividends? Under the facts of this case, has the goverment's right to assess and collect said tax
prescribed?
The Case
These are the main questions raised in the Petition for Review on Certiorari before us, assailing the
1
2
October 11, 1993 Decision of the Court of Appeals in CA-GR SP 25902, which

dismissed petitioners' appeal of the October 19, 1992 Decision 3 of the Court
of Tax Appeals 4 (CTA) which had previously sustained petitioners' liability for deficiency income tax, interest and withholding tax.
The Court of Appeals ruled:

WHEREFORE, the petition is DISMISSED, with costs against petitioner

The petition also challenges the November 15, 1993 Court of Appeals (CA) Resolution

denying

reconsideration.
The Facts
The antecedent facts,

as found by the Court of Appeals, are as follows:

The petitioners are 41 non-life insurance corporations, organized and existing under
the laws of the Philippines. Upon issuance by them of Erection, Machinery
Breakdown, Boiler Explosion and Contractors' All Risk insurance policies, the
petitioners on August 1, 1965 entered into a Quota Share Reinsurance Treaty and a
Surplus Reinsurance Treaty with the Munchener Ruckversicherungs-Gesselschaft
(hereafter called Munich), a non-resident foreign insurance corporation. The
reinsurance treaties required petitioners to form a [p]ool. Accordingly, a pool
composed of the petitioners was formed on the same day.
On April 14, 1976, the pool of machinery insurers submitted a financial statement and
filed an "Information Return of Organization Exempt from Income Tax" for the year
ending in 1975, on the basis of which it was assessed by the Commissioner of
Internal Revenue deficiency corporate taxes in the amount of P1,843,273.60, and
withholding taxes in the amount of P1,768,799.39 and P89,438.68 on dividends paid
to Munich and to the petitioners, respectively. These assessments were protested by
the petitioners through its auditors Sycip, Gorres, Velayo and Co.
On January 27, 1986, the Commissioner of Internal Revenue denied the protest and
ordered the petitioners, assessed as "Pool of Machinery Insurers," to pay deficiency
income tax, interest, and with [h]olding tax, itemized as follows:
Net income per information return P3,737,370.00
===========
Income tax due thereon P1,298,080.00
Add: 14% Int. fr. 4/15/76
to 4/15/79 545,193.60

86

TOTAL AMOUNT DUE & P1,843,273.60

COLLECTIBLE
Dividend paid to Munich
Reinsurance Company P3,728,412.00

35% withholding tax at

source due thereon P1,304,944.20
Add: 25% surcharge 326,236.05
14% interest from
1/25/76 to 1/25/79 137,019.14
Compromise penaltynon-filing of return 300.00
late payment 300.00

TOTAL AMOUNT DUE & P1,768,799.39

COLLECTIBLE ===========
Dividend paid to Pool Members P655,636.00
===========
10% withholding tax at
source due thereon P65,563.60
Add: 25% surcharge 16,390.90
14% interest from
1/25/76 to 1/25/79 6,884.18
Compromise penaltynon-filing of return 300.00
late payment 300.00

TOTAL AMOUNT DUE & P89,438.68

COLLECTIBLE ===========

The CA ruled in the main that the pool of machinery insurers was a partnership taxable as a
corporation, and that the latter's collection of premiums on behalf of its members, the ceding
companies, was taxable income. It added that prescription did not bar the Bureau of Internal
Revenue (BIR) from collecting the taxes due, because "the taxpayer cannot be located at the
9
address given in the information return filed." Hence, this Petition for Review before us.

87

The Issues
Before this Court, petitioners raise the following issues:
1. Whether or not the Clearing House, acting as a mere agent and performing strictly
administrative functions, and which did not insure or assume any risk in its own
name, was a partnership or association subject to tax as a corporation;
2. Whether or not the remittances to petitioners and MUNICHRE of their respective
shares of reinsurance premiums, pertaining to their individual and separate contracts
of reinsurance, were "dividends" subject to tax; and
3. Whether or not the respondent Commissioner's right to assess the Clearing House
had already prescribed. 10
The Court's Ruling
The petition is devoid of merit. We sustain the ruling of the Court of Appeals that the pool is taxable
as a corporation, and that the government's right to assess and collect the taxes had not prescribed.
First Issue:
Pool Taxable as a Corporation
Petitioners contend that the Court of Appeals erred in finding that the pool of clearing house was an
informal partnership, which was taxable as a corporation under the NIRC. They point out that the
reinsurance policies were written by them "individually and separately," and that their liability was
11
limited to the extent of their allocated share in the original risk thus reinsured. Hence, the pool

did not act or earn income as a reinsurer. 12 Its role was limited to its principal
function of "allocating and distributing the risk(s) arising from the original
insurance among the signatories to the treaty or the members of the pool
based on their ability to absorb the risk(s) ceded[;] as well as the performance
of incidental functions, such as records, maintenance, collection and custody
of funds, etc." 13
Petitioners belie the existence of a partnership in this case, because (1) they, the reinsurers, did not

(3) the executive

board of the pool did not exercise control and
management of its funds, unlike the board of directors of a
corporation; 16 and (4) the pool or clearing house "was not
and could not possibly have engaged in the business of
reinsurance from which it could have derived income for
itself." 17
share the same risk or solidary liability,

14

(2) there was no common fund;

15

The Court is not persuaded. The opinion or ruling of the Commission of Internal Revenue, the
agency tasked with the enforcement of tax law, is accorded much weight and even finality, when
18
there is no showing. that it is patently wrong, particularly in this case where the

findings and conclusions of the internal revenue commissioner were

subsequently affirmed by the CTA, a specialized body created for the
exclusive purpose of reviewing tax cases, and the Court of Appeals. 19Indeed,
[I]t has been the long standing policy and practice of this Court to respect the
conclusions of quasi-judicial agencies, such as the Court of Tax Appeals which, by
the nature of its functions, is dedicated exclusively to the study and consideration of
tax problems and has necessarily developed an expertise on the subject, unless
20
there has been an abuse or improvident exercise of its authority.

88

This Court rules that the Court of Appeals, in affirming the CTA which had previously sustained the
internal revenue commissioner, committed no reversible error. Section 24 of the NIRC, as worded in
the year ending 1975, provides:
Sec. 24. Rate of tax on corporations. (a) Tax on domestic corporations. A tax is
hereby imposed upon the taxable net income received during each taxable year from
all sources by every corporation organized in, or existing under the laws of the
Philippines, no matter how created or organized, but not including duly registered
general co-partnership (compaias colectivas), general professional partnerships,
private educational institutions, and building and loan associations . . . .
Ineludibly, the Philippine legislature included in the concept of corporations those entities that
resembled them such as unregistered partnerships and associations. Parenthetically, the NIRC's
inclusion of such entities in the tax on corporations was made even clearer by the tax Reform Act of
21
1997, which amended the Tax Code. Pertinent provisions of the new law read

as follows:
Sec. 27. Rates of Income Tax on Domestic Corporations.
(A) In General. Except as otherwise provided in this Code, an income tax of thirtyfive 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,
as defined in Section 22 (B) of this Code, and taxable under this Title as a
corporation . . . .
Sec. 22. Definition. When used in this Title:
xxx xxx xxx
(B) The term "corporation" shall include partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion),
associations, or insurance companies, but does not include general professional
partnerships [or] a joint venture or consortium formed for the purpose of undertaking
construction projects or engaging in petroleum, coal, geothermal and other energy
operations pursuant to an operating or consortium agreement under a service
contract without the Government. "General professional partnerships" are
partnerships formed by persons for the sole purpose of exercising their common
profession, no part of the income of which is derived from engaging in any trade or
business.
xxx xxx xxx
22

held that Section 24

covered these unregistered partnerships and even associations or joint
accounts, which had no legal personalities apart from their individual
members. 23 The Court of Appeals astutely applied Evangelista. 24
Thus, the Court in Evangelista v. Collector of Internal Revenue

. . . Accordingly, a pool of individual real property owners dealing in real estate

business was considered a corporation for purposes of the tax in sec. 24 of the Tax
Code in Evangelista v. Collector of Internal Revenue, supra. The Supreme Court
said:
The term "partnership" includes a syndicate, group, pool, joint venture
or other unincorporated organization, through or by means of which
any business, financial operation, or venture is carried on. *** (8
Merten's Law of Federal Income Taxation, p. 562 Note 63)
Art. 1767 of the Civil Code recognizes the creation of a contract of partnership when "two or more
persons bind themselves to contribute money, property, or Industry to a common fund, with the
25
intention of dividing the profits among themselves." Its requisites are: "(1) mutual

contribution to a common stock, and (2) a joint interest in the profits." 26 In

other words, a partnership is formed when persons contract "to devote to a
common purpose either money, property, or labor with the intention of dividing
the profits between
89

themselves."

27

Meanwhile, an association implies associates who enter into a "joint enterprise . . . for

the transaction of business."

28

29

or an
association that would handle all the insurance businesses covered under
their quota-share reinsurance treaty 31 and surplus reinsurance treaty with
In the case before us, the ceding companies entered into a Pool Agreement
30

32

Munich. The following unmistakably indicates a partnership or an association covered by Section 24 of

the NIRC:

(1) The pool has a common fund, consisting of money and other valuables that are deposited in the

This common fund pays for the

administration and operation expenses of the pool. 24
name and credit of the pool.

33

(2) The pool functions through an executive board, which resembles the board of directors of a
35
corporation, composed of one representative for each of the ceding companies.
(3) True, the pool itself is not a reinsurer and does not issue any insurance policy; however, its work
is indispensable, beneficial and economically useful to the business of the ceding companies and
Munich, because without it they would not have received their premiums. The ceding companies
share "in the business ceded to the pool" and in the "expenses" according to a "Rules of Distribution"
36
annexed to the Pool Agreement. Profit motive or business is, therefore, the

primordial reason for the pool's formation. As aptly found by the CTA:
. . . The fact that the pool does not retain any profit or income does not obliterate an
antecedent fact, that of the pool being used in the transaction of business for profit. It
is apparent, and petitioners admit, that their association or coaction was
indispensable [to] the transaction of the business, . . . If together they have
conducted business, profit must have been the object as, indeed, profit was earned.
Though the profit was apportioned among the members, this is only a matter of
37
consequence, as it implies that profit actually resulted.
38

is misplaced, because the facts

obtaining therein are not on all fours with the present case. In Pascual, there
was no unregistered partnership, but merely a co-ownership which took up
only two isolated transactions. The Court of Appeals did not err in applying Evangelista,
The petitioners' reliance on Pascuals v. Commissioner

39

which involved a partnership that engaged in a series of transactions spanning more than ten years, as in
the case before us.

Second Issue:
Pool's Remittances are Taxable
Petitioners further contend that the remittances of the pool to the ceding companies and Munich are
not dividends subject to tax. They insist that such remittances contravene Sections 24 (b) (I) and 263
of the 1977 NIRC and "would be tantamount to an illegal double taxation as it would result in taxing
40
the same taxpayer" Moreover, petitioners argue that since Munich was not a signatory to the Pool Agreement, the remittances it
41

They add that even if such remittances were

treated as dividends, they would have been exempt under the previously
mentioned sections of the 1977 NIRC, 42 as well as Article 7 of paragraph
1 43 and Article 5 of paragraph 5 44 of the RP-West German Tax Treaty. 45
received from the pool cannot be deemed dividends.

Petitioners are clutching at straws. Double taxation means taxing the same property twice when it
should be taxed only once. That is, ". . . taxing the same person twice by the same jurisdiction for the
46
same thing" In the instant case, the pool is a taxable entity distinct from the

individual corporate entities of the ceding companies. The tax on its income is
obviously different from the tax on thedividends received by the said
companies. Clearly, there is no double taxation here.
The tax exemptions claimed by petitioners cannot be granted, since their entitlement thereto remains
unproven and unsubstantiated. It is axiomatic in the law of taxation that taxes are the lifeblood of the
90

nation. Hence, "exemptions therefrom are highly disfavored in law and he who claims tax exemption
47
must be able to justify his claim or right." Petitioners have failed to discharge this

burden of proof. The sections of the 1977 NIRC which they cite are
inapplicable, because these were not yet in effect when the income was
earned and when the subject information return for the year ending 1975 was
filed.
Referring, to the 1975 version of the counterpart sections of the NIRC, the Court still cannot justify
the exemptions claimed. Section 255 provides that no tax shall ". . . be paid upon reinsurance by any
company that has already paid the tax . . ." This cannot be applied to the present case because, as
previously discussed, the pool is a taxable entity distinct from the ceding companies; therefore, the
latter cannot individually claim the income tax paid by the former as their own.
48

pertains to tax on foreign corporations; hence,

it cannot be claimed by the ceding companies which are domestic
corporations. Nor can Munich, a foreign corporation, be granted exemption
based solely on this provision of the Tax Code, because the same subsection
specifically taxes dividends, the type of remittances forwarded to it by the
pool. Although not a signatory to the Pool Agreement, Munich is patently an
associate of the ceding companies in the entity formed, pursuant to their
reinsurance treaties which required the creation of said pool.
On the other hand, Section 24 (b) (1)

Under its pool arrangement with the ceding companies; Munich shared in their income and loss. This
49
50
51
is manifest from a reading of Article 3 and 10 of the Quota-Share Reinsurance treaty and Articles 3 and

10 52 of the Surplus Reinsurance Treaty. The foregoing interpretation of

Section 24 (b) (1) is in line with the doctrine that a tax exemption must be
construed strictissimi juris, and the statutory exemption claimed must be
expressed in a language too plain to be mistaken. 53
Finally the petitioners' claim that Munich is tax-exempt based on the RP- West German Tax Treaty is
likewise unpersuasive, because the internal revenue commissioner assessed the pool for corporate
taxes on the basis of the information return it had submitted for the year ending 1975, a taxable year

Although petitioners omitted in

their pleadings the date of effectivity of the treaty, the
Court takes judicial notice that it took effect only later, on
December 14, 1984. 55
when said treaty was not yet in effect.

54

Third Issue:
Prescription
Petitioners also argue that the government's right to assess and collect the subject tax had
prescribed. They claim that the subject information return was filed by the pool on April 14, 1976. On
the basis of this return, the BIR telephoned petitioners on November 11, 1981, to give them notice of
its letter of assessment dated March 27, 1981. Thus, the petitioners contend that the five-year
statute of limitations then provided in the NIRC had already lapsed, and that the internal revenue
56
commissioner was already barred by prescription from making an assessment.
We cannot sustain the petitioners. The CA and the CTA categorically found that the prescriptive
57
period was tolled under then Section 333 of the NIRC, because "the taxpayer cannot

be

located at the address given in the information return filed and for which
reason there was delay in sending the assessment." 58 Indeed, whether the
government's right to collect and assess the tax has prescribed involves facts
which have been ruled upon by the lower courts. It is axiomatic that in the
absence of a clear showing of palpable error or grave abuse of discretion, as
in this case, this Court must not overturn the factual findings of the CA and the
CTA.
91

Furthermore, petitioners admitted in their Motion for Reconsideration before the Court of Appeals
that the pool changed its address, for they stated that the pool's information return filed in 1980
indicated therein its "present address." The Court finds that this falls short of the requirement of
Section 333 of the NIRC for the suspension of the prescriptive period. The law clearly states that the
said period will be suspended only "if the taxpayer informs the Commissioner of Internal Revenue of
any change in the address."
WHEREFORE, the petition is DENIED. The Resolution of the Court of Appeals dated October 11,
1993 and November 15, 1993 are hereby AFFIRMED. Cost against petitioners.
1wphi1.nt

SO ORDERED.

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION
G.R. No. 76573 September 14, 1989
MARUBENI CORPORATION (formerly Marubeni Iida, Co., Ltd.), petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE AND COURT OF TAX APPEALS, respondents.
Melquiades C. Gutierrez for petitioner.
The Solicitor General for respondents.

FERNAN, C.J.:
Petitioner, Marubeni Corporation, representing itself as a foreign corporation duly organized and
existing under the laws of Japan and duly licensed to engage in business under Philippine laws with
branch office at the 4th Floor, FEEMI Building, Aduana Street, Intramuros, Manila seeks the reversal
of the decision of the Court of Tax Appeals 1 dated February 12, 1986 denying its claim for refund or tax
credit in the amount of P229,424.40 representing alleged overpayment of branch profit remittance tax
withheld from dividends by Atlantic Gulf and Pacific Co. of Manila (AG&P).
The following facts are undisputed: Marubeni Corporation of Japan has equity investments in AG&P
of Manila. For the first quarter of 1981 ending March 31, AG&P declared and paid cash dividends to
petitioner in the amount of P849,720 and withheld the corresponding 10% final dividend tax thereon.
Similarly, for the third quarter of 1981 ending September 30, AG&P declared and paid P849,720 as
cash dividends to petitioner and withheld the corresponding 10% final dividend tax thereon. 2
AG&P directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not only of
the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of 1981, but
also of the withheld 15% profit remittance tax based on the remittable amount after deducting the

92

final withholding tax of 10%. A schedule of dividends declared and paid by AG&P to its stockholder
Marubeni Corporation of Japan, the 10% final intercorporate dividend tax and the 15% branch profit
remittance tax paid thereon, is shown below:

1981

FIRST
QUARTER
(three months
ended 3.31.81)
(In Pesos)

THIRD
QUARTER
(three months
ended 9.30.81)

849,720.44

849,720.00

1,699,440.00

84,972.00

84,972.00

169,944.00

Cash Dividend net of

10% Dividend Tax
Withheld

764,748.00

764,748.00

1,529,496.00

15% Branch Profit

Remittance Tax Withheld

114,712.20

114,712.20

229,424.40 3

Net Amount Remitted to

Petitioner

650,035.80

650,035.80

1,300,071.60

Cash Dividends Paid

10% Dividend Tax

Withheld

TOTAL OF
FIRST and
THIRD
quarters

The 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of P114,712.20 for
the first quarter of 1981 were paid to the Bureau of Internal Revenue by AG&P on April 20, 1981
under Central Bank Receipt No. 6757880. Likewise, the 10% final dividend tax of P84,972 and the
15% branch profit remittance tax of P114,712 for the third quarter of 1981 were paid to the Bureau of
Internal Revenue by AG&P on August 4, 1981 under Central Bank Confirmation Receipt No.
7905930. 4
Thus, for the first and third quarters of 1981, AG&P as withholding agent paid 15% branch profit
remittance on cash dividends declared and remitted to petitioner at its head office in Tokyo in the
total amount of P229,424.40 on April 20 and August 4, 1981. 5
In a letter dated January 29, 1981, petitioner, through the accounting firm Sycip, Gorres, Velayo and
Company, sought a ruling from the Bureau of Internal Revenue on whether or not the dividends
petitioner received from AG&P are effectively connected with its conduct or business in the
Philippines as to be considered branch profits subject to the 15% profit remittance tax imposed
under Section 24 (b) (2) of the National Internal Revenue Code as amended by Presidential Decrees
Nos. 1705 and 1773.
In reply to petitioner's query, Acting Commissioner Ruben Ancheta ruled:
Pursuant to Section 24 (b) (2) of the Tax Code, as amended, only profits remitted
abroad by a branch office to its head office which are effectively connected with its
trade or business in the Philippines are subject to the 15% profit remittance tax. To
be effectively connected it is not necessary that the income be derived from the
actual operation of taxpayer-corporation's trade or business; it is sufficient that the
income arises from the business activity in which the corporation is engaged. For
example, if a resident foreign corporation is engaged in the buying and selling of
machineries in the Philippines and invests in some shares of stock on which
dividends are subsequently received, the dividends thus earned are not considered
93

'effectively connected' with its trade or business in this country. (Revenue

Memorandum Circular No. 55-80).
In the instant case, the dividends received by Marubeni from AG&P are not income
arising from the business activity in which Marubeni is engaged. Accordingly, said
dividends if remitted abroad are not considered branch profits for purposes of the
15% profit remittance tax imposed by Section 24 (b) (2) of the Tax Code, as
amended . . . 6
Consequently, in a letter dated September 21, 1981 and filed with the Commissioner of Internal
Revenue on September 24, 1981, petitioner claimed for the refund or issuance of a tax credit of
P229,424.40 "representing profit tax remittance erroneously paid on the dividends remitted by
Atlantic Gulf and Pacific Co. of Manila (AG&P) on April 20 and August 4, 1981 to ... head office in
Tokyo. 7
On June 14, 1982, respondent Commissioner of Internal Revenue denied petitioner's claim for
refund/credit of P229,424.40 on the following grounds:
While it is true that said dividends remitted were not subject to the 15% profit
remittance tax as the same were not income earned by a Philippine Branch of
Marubeni Corporation of Japan; and neither is it subject to the 10% intercorporate
dividend tax, the recipient of the dividends, being a non-resident stockholder,
nevertheless, said dividend income is subject to the 25 % tax pursuant to Article 10
(2) (b) of the Tax Treaty dated February 13, 1980 between the Philippines and Japan.
Inasmuch as the cash dividends remitted by AG&P to Marubeni Corporation, Japan
is subject to 25 % tax, and that the taxes withheld of 10 % as intercorporate dividend
tax and 15 % as profit remittance tax totals (sic) 25 %, the amount refundable offsets
the liability, hence, nothing is left to be refunded. 8
Petitioner appealed to the Court of Tax Appeals which affirmed the denial of the refund by the
Commissioner of Internal Revenue in its assailed judgment of February 12, 1986. 9
In support of its rejection of petitioner's claimed refund, respondent Tax Court explained:
Whatever the dialectics employed, no amount of sophistry can ignore the fact that
the dividends in question are income taxable to the Marubeni Corporation of Tokyo,
Japan. The said dividends were distributions made by the Atlantic, Gulf and Pacific
Company of Manila to its shareholder out of its profits on the investments of the
Marubeni Corporation of Japan, a non-resident foreign corporation. The investments
in the Atlantic Gulf & Pacific Company of the Marubeni Corporation of Japan were
directly made by it and the dividends on the investments were likewise directly
remitted to and received by the Marubeni Corporation of Japan. Petitioner Marubeni
Corporation Philippine Branch has no participation or intervention, directly or
indirectly, in the investments and in the receipt of the dividends. And it appears that
the funds invested in the Atlantic Gulf & Pacific Company did not come out of the
funds infused by the Marubeni Corporation of Japan to the Marubeni Corporation
Philippine Branch. As a matter of fact, the Central Bank of the Philippines, in
authorizing the remittance of the foreign exchange equivalent of (sic) the dividends in
question, treated the Marubeni Corporation of Japan as a non-resident stockholder of
the Atlantic Gulf & Pacific Company based on the supporting documents submitted to
it.
Subject to certain exceptions not pertinent hereto, income is taxable to the person
who earned it. Admittedly, the dividends under consideration were earned by the
Marubeni Corporation of Japan, and hence, taxable to the said corporation. While it
is true that the Marubeni Corporation Philippine Branch is duly licensed to engage in
business under Philippine laws, such dividends are not the income of the Philippine
Branch and are not taxable to the said Philippine branch. We see no significance
thereto in the identity concept or principal-agent relationship theory of petitioner
because such dividends are the income of and taxable to the Japanese corporation
in Japan and not to the Philippine branch. 10
Hence, the instant petition for review.
It is the argument of petitioner corporation that following the principal-agent relationship theory,
Marubeni Japan is likewise a resident foreign corporation subject only to the 10 % intercorporate

94

final tax on dividends received from a domestic corporation in accordance with Section 24(c) (1) of
the Tax Code of 1977 which states:
Dividends received by a domestic or resident foreign corporation liable to tax under
this Code (1) Shall be subject to a final tax of 10% on the total amount thereof,
which shall be collected and paid as provided in Sections 53 and 54 of this Code ....
Public respondents, however, are of the contrary view that Marubeni, Japan, being a non-resident
foreign corporation and not engaged in trade or business in the Philippines, is subject to tax on
income earned from Philippine sources at the rate of 35 % of its gross income under Section 24 (b)
(1) of the same Code which reads:
(b) Tax on foreign corporations (1) Non-resident corporations. A foreign
corporation not engaged in trade or business in the Philippines shall pay a tax equal
to thirty-five per cent of the gross income received during each taxable year from all
sources within the Philippines as ... dividends ....
but expressly made subject to the special rate of 25% under Article 10(2) (b) of the Tax Treaty of
1980 concluded between the Philippines and Japan. 11 Thus:
Article 10 (1) Dividends paid by a company which is a resident of a Contracting State
to a resident of the other Contracting State may be taxed in that other Contracting
State.
(2) However, such dividends may also be taxed in the Contracting State of which the
company paying the dividends is a resident, and according to the laws of that
Contracting State, but if the recipient is the beneficial owner of the dividends the tax
so charged shall not exceed;
(a) . . .
(b) 25 per cent of the gross amount of the dividends in all other cases.
Central to the issue of Marubeni Japan's tax liability on its dividend income from Philippine sources
is therefore the determination of whether it is a resident or a non-resident foreign corporation under
Philippine laws.
Under the Tax Code, a resident foreign corporation is one that is "engaged in trade or business"
within the Philippines. Petitioner contends that precisely because it is engaged in business in the
Philippines through its Philippine branch that it must be considered as a resident foreign corporation.
Petitioner reasons that since the Philippine branch and the Tokyo head office are one and the same
entity, whoever made the investment in AG&P, Manila does not matter at all. A single corporate entity
cannot be both a resident and a non-resident corporation depending on the nature of the particular
transaction involved. Accordingly, whether the dividends are paid directly to the head office or
coursed through its local branch is of no moment for after all, the head office and the office branch
constitute but one corporate entity, the Marubeni Corporation, which, under both Philippine tax and
corporate laws, is a resident foreign corporation because it is transacting business in the Philippines.
The Solicitor General has adequately refuted petitioner's arguments in this wise:
The general rule that a foreign corporation is the same juridical entity as its branch
office in the Philippines cannot apply here. This rule is based on the premise that the
business of the foreign corporation is conducted through its branch office, following
the principal agent relationship theory. It is understood that the branch becomes its
agent here. So that when the foreign corporation transacts business in the
Philippines independently of its branch, the principal-agent relationship is set aside.
The transaction becomes one of the foreign corporation, not of the branch.
Consequently, the taxpayer is the foreign corporation, not the branch or the resident
foreign corporation.
Corollarily, if the business transaction is conducted through the branch office, the
latter becomes the taxpayer, and not the foreign corporation. 12
In other words, the alleged overpaid taxes were incurred for the remittance of dividend income to the
head office in Japan which is a separate and distinct income taxpayer from the branch in the
Philippines. There can be no other logical conclusion considering the undisputed fact that the
investment (totalling 283.260 shares including that of nominee) was made for purposes peculiarly
95

germane to the conduct of the corporate affairs of Marubeni Japan, but certainly not of the branch in
the Philippines. It is thus clear that petitioner, having made this independent investment attributable
only to the head office, cannot now claim the increments as ordinary consequences of its trade or
business in the Philippines and avail itself of the lower tax rate of 10 %.
But while public respondents correctly concluded that the dividends in dispute were neither subject
to the 15 % profit remittance tax nor to the 10 % intercorporate dividend tax, the recipient being a
non-resident stockholder, they grossly erred in holding that no refund was forthcoming to the
petitioner because the taxes thus withheld totalled the 25 % rate imposed by the Philippine-Japan
Tax Convention pursuant to Article 10 (2) (b).
To simply add the two taxes to arrive at the 25 % tax rate is to disregard a basic rule in taxation that
each tax has a different tax basis. While the tax on dividends is directly levied on the dividends
received, "the tax base upon which the 15 % branch profit remittance tax is imposed is the profit
actually remitted abroad." 13
Public respondents likewise erred in automatically imposing the 25 % rate under Article 10 (2) (b) of
the Tax Treaty as if this were a flat rate. A closer look at the Treaty reveals that the tax rates fixed by
Article 10 are the maximum rates as reflected in the phrase "shall not exceed." This means that any
tax imposable by the contracting state concerned should not exceed the 25 % limitation and that
said rate would apply only if the tax imposed by our laws exceeds the same. In other words, by
reason of our bilateral negotiations with Japan, we have agreed to have our right to tax limited to a
certain extent to attain the goals set forth in the Treaty.
Petitioner, being a non-resident foreign corporation with respect to the transaction in question, the
applicable provision of the Tax Code is Section 24 (b) (1) (iii) in conjunction with the Philippine-Japan
Treaty of 1980. Said section provides:
(b) Tax on foreign corporations. (1) Non-resident corporations ... (iii) On
dividends received from a domestic corporation liable to tax under this Chapter, the
tax shall be 15% of the dividends received, which shall be collected and paid as
provided in Section 53 (d) of this Code, subject to the condition that the country in
which the non-resident foreign corporation is domiciled shall allow a credit against
the tax due from the non-resident foreign corporation, taxes deemed to have been
paid in the Philippines equivalent to 20 % which represents the difference between
the regular tax (35 %) on corporations and the tax (15 %) on dividends as provided in
this Section; ....
Proceeding to apply the above section to the case at bar, petitioner, being a non-resident foreign
corporation, as a general rule, is taxed 35 % of its gross income from all sources within the
Philippines. [Section 24 (b) (1)].
However, a discounted rate of 15% is given to petitioner on dividends received from a domestic
corporation (AG&P) on the condition that its domicile state (Japan) extends in favor of petitioner, a
tax credit of not less than 20 % of the dividends received. This 20 % represents the difference
between the regular tax of 35 % on non-resident foreign corporations which petitioner would have
ordinarily paid, and the 15 % special rate on dividends received from a domestic corporation.
Consequently, petitioner is entitled to a refund on the transaction in question to be computed as
follows:
Total cash dividend paid ................P1,699,440.00
less 15% under Sec. 24
(b) (1) (iii ) .........................................254,916.00
-----------------Cash dividend net of 15 % tax
due petitioner ...............................P1,444.524.00
less net amount
actually remitted .............................1,300,071.60
------------------Amount to be refunded to petitioner
representing overpayment of
taxes on dividends remitted ..............P 144 452.40
===========

96

It is readily apparent that the 15 % tax rate imposed on the dividends received by a foreign nonresident stockholder from a domestic corporation under Section 24 (b) (1) (iii) is easily within the
maximum ceiling of 25 % of the gross amount of the dividends as decreed in Article 10 (2) (b) of the
Tax Treaty.
There is one final point that must be settled. Respondent Commissioner of Internal Revenue is
laboring under the impression that the Court of Tax Appeals is covered by Batas Pambansa Blg.
129, otherwise known as the Judiciary Reorganization Act of 1980. He alleges that the instant
petition for review was not perfected in accordance with Batas Pambansa Blg. 129 which provides
that "the period of appeal from final orders, resolutions, awards, judgments, or decisions of any court
in all cases shall be fifteen (15) days counted from the notice of the final order, resolution, award,
judgment or decision appealed from ....
This is completely untenable. The cited BP Blg. 129 does not include the Court of Tax Appeals which
has been created by virtue of a special law, Republic Act No. 1125. Respondent court is not among
those courts specifically mentioned in Section 2 of BP Blg. 129 as falling within its scope.
Thus, under Section 18 of Republic Act No. 1125, a party adversely affected by an order, ruling or
decision of the Court of Tax Appeals is given thirty (30) days from notice to appeal therefrom.
Otherwise, said order, ruling, or decision shall become final.
Records show that petitioner received notice of the Court of Tax Appeals's decision denying its claim
for refund on April 15, 1986. On the 30th day, or on May 15, 1986 (the last day for appeal), petitioner
filed a motion for reconsideration which respondent court subsequently denied on November 17,
1986, and notice of which was received by petitioner on November 26, 1986. Two days later, or on
November 28, 1986, petitioner simultaneously filed a notice of appeal with the Court of Tax Appeals
and a petition for review with the Supreme Court. 14 From the foregoing, it is evident that the instant
appeal was perfected well within the 30-day period provided under R.A. No. 1125, the whole 30-day
period to appeal having begun to run again from notice of the denial of petitioner's motion for
reconsideration.
WHEREFORE, the questioned decision of respondent Court of Tax Appeals dated February 12,
1986 which affirmed the denial by respondent Commissioner of Internal Revenue of petitioner
Marubeni Corporation's claim for refund is hereby REVERSED. The Commissioner of Internal
Revenue is ordered to refund or grant as tax credit in favor of petitioner the amount of P144,452.40
representing overpayment of taxes on dividends received. No costs.
So ordered.

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION

G.R. No. 103092 July 21, 1994

BANK OF AMERICA NT & SA, petitioner,
vs.
HONORABLE COURT OF APPEALS, AND THE COMMISSIONER OF INTERNAL
REVENUE, respondents.
G.R. No. 103106 July 21, 1994
BANK OF AMERICA NT & SA, petitioner,
vs.
THE HONORABLE COURT OF APPEALS AND THE COMMISSIONER OF INTERNAL
REVENUE, respondents.

97

Sycip, Salazar, Hernandez & Gatmaitan and Agcaoili & Associates for petitioner.

VITUG, J.:
Section 24(b) (2) (ii) of the National Internal Revenue Code, in the language it was worded in 1982
(the taxable period relevant to the case at bench), provided, in part, thusly:
Sec. 24. Rates of tax on corporations. . . .
(b) Tax on foreign corporations. . . .
(2) (ii) Tax on branch profit and remittances.
Any profit remitted abroad by a branch to its head office shall be subject to a tax of
fifteen per cent (15%) . . . ."
Petitioner Bank of America NT & SA argues that the 15% branch profit remittance tax on the basis of
the above provision should be assessed on the amount actually remitted abroad, which is to say that
the 15% profit remittance tax itself should not form part of the tax base. Respondent Commissioner
of Internal Revenue, contending otherwise, holds the position that, in computing the 15% remittance
tax, the tax should be inclusive of the sum deemed remitted.
The statement of facts made by the Court of Tax Appeals, later adopted by the Court of Appeals, and
not in any serious dispute by the parties, can be quoted thusly:
Petitioner is a foreign corporation duly licensed to engage in business in the
Philippines with Philippine branch office at BA Lepanto Bldg., Paseo de Roxas,
Makati, Metro Manila. On July 20, 1982 it paid 15% branch profit remittance tax in
the amount of P7,538,460.72 on profit from its regular banking unit operations and
P445,790.25 on profit from its foreign currency deposit unit operations or a total of
P7,984,250.97. The tax was based on net profits after income tax without deducting
the amount corresponding to the 15% tax.
Petitioner filed a claim for refund with the Bureau of Internal Revenue of that portion
of the payment which corresponds to the 15% branch profit remittance tax, on the
ground that the tax should have been computed on the basis of profits actually
remitted, which is P45,244,088.85, and not on the amount before profit remittance
tax, which is P53,228,339.82. Subsequently, without awaiting respondent's decision,
petitioner filed a petition for review on June 14, 1984 with this Honorable Court for
the recovery of the amount of P1,041,424.03 computed as follows:
Net Profits After Profit Tax Due Alleged
Income Tax But Remittance Alleged by Overpayment
Before Profit Tax Paid Petitioner Item 1-2
Remittance Tax _________ _________ ___________
A. Regular Banking
Unit Operations
(P50,256,404.82)
1. Computation of BIR
15% x P50,256,404.82 - P7,538,460.72
2. Computation of
Petitioner
- P50,256,404.82 x 15% P6,555,183.24 P983,277.48
1.15
B. Foreign Currency
Deposit Unit
Operations
(P2,971,935)

98

1. Computation of BIR
15% x - P2,971,935.00 P445,790.25
2. Computation of
Petitioner
- P2,971,935.00 x 15% P387,643.70 P58,146.55
T O T A L. . P7,984,250.97 P6,942,286.94 P1,041,424.02" 1
The Court of Tax Appeals upheld petitioner bank in its claim for refund. The Commissioner of Internal
Revenue filed a timely appeal to the Supreme Court (docketed G.R. No. 76512) which referred it to
the Court of Appeals following this Court's pronouncement in Development Bank of the Philippines
vs. Court of Appeals, et al. (180 SCRA 609). On 19 September 1990, the Court of Appeals set aside
the decision of the Court of Tax Appeals. Explaining its reversal of the tax court's decision, the
appellate court said:
The Court of Tax Appeals sought to deduce legislative intent vis-a-vis the aforesaid
law through an analysis of the wordings thereof, which to their minds reveal an intent
to mitigate at least the harshness of successive taxation. The use of the
word remitted may well be understood as referring to that part of the said total branch
profits which would be sent to the head office as distinguished from the total profits of
the branch (not all of which need be sent or would be ordered remitted abroad). If the
legislature indeed had wanted to mitigate the harshness of successive taxation, it
would have been simpler to just lower the rates without in effect requiring the
relatively novel and complicated way of computing the tax, as envisioned by the
herein private respondent. The same result would have been achieved. 2
Hence, these petitions for review in G.R. No. 103092 and G.R.
No. 103106 (filed separately due to inadvertence) by the law firms of "Agcaoili and Associates" and
of "Sycip, Salazar, Hernandez and Gatmaitan" in representation of petitioner bank.
We agree with the Court of Appeals that not much reliance can be made on our decision in
Burroughs Limited vs. Commission of Internal Revenue (142 SCRA 324), for there we ruled against
the Commissioner mainly on the basis of what the Court so then perceived as his position in a 21
January 1980 ruling the reversal of which, by his subsequent ruling of 17 March 1982, could not
apply retroactively against Burroughs in conformity with Section 327 (now Section 246, re: nonretroactivity of rulings) of the National Internal Revenue Code. Hence, we held:
Petitioner's aforesaid contention is without merit. What is applicable in the case at
bar is still the Revenue Ruling of January 21, 1980 because private respondent
Burroughs Limited paid the branch profit remittance tax in question on March 14,
1979. Memorandum Circular
No. 8-82 dated March 17, 1982 cannot be given retroactive effect in the light of
Section 327 of the National Internal Revenue Code which
provides
Sec. 327. Non-retroactivity of rulings. Any revocation, modification, or
reversal of any of the rules and regulations promulgated in
accordance with the preceding section or any of the rulings or
circulars promulgated by the Commissioner shall not be given
retroactive application if the revocation, modification, or reversal will
be prejudicial to the taxpayer except in the following cases (a) where
the taxpayer deliberately misstates or omits material facts from his
return or in any document required of him by the Bureau of Internal
Revenue; (b) where the facts subsequently gathered by the Bureau
of Internal Revenue are materially different from the facts on which
the ruling is based, or (c) where the taxpayer acted in bad faith.
(ABS-CBN Broadcasting Corp. v. CTA, 108 SCRA 151-152)
The prejudice that would result to private respondent Burroughs Limited by a
retroactive application of Memorandum Circular No. 8-82 is beyond question for it
would be deprived of the substantial amount of P172,058.90. And, insofar as the
enumerated exceptions are concerned, admittedly, Burroughs Limited does not fall
under any of them.
The Court of Tax Appeals itself commented similarly when it observed thusly in its decision:

99

In finding the Commissioner's contention without merit, this Court however ruled
against the applicability of Revenue Memorandum Circular No. 8-82 dated March 17,
1982 to the Burroughs Limited case because the taxpayer paid the branch profit
remittance tax involved therein on March 14, 1979 in accordance with the ruling of
the Commissioner of Internal Revenue dated January 21, 1980. In view of Section
327 of the then in force National Internal Revenue Code, Revenue Memorandum
Circular No. 8-82 dated March 17, 1982 cannot be given retroactive effect because
any revocation or modification of any ruling or circular of the Bureau of Internal
Revenue should not be given retroactive application if such revocation or
modification will, subject to certain exceptions not pertinent thereto, prejudice
taxpayers. 3
The Solicitor General correctly points out that almost invariably in an ad valorem tax, the tax paid or
withheld is not deducted from the tax base. Such impositions as the ordinary income tax, estate and
gift taxes, and the value added tax are generally computed in like manner. In these cases, however,
it is so because the law, in defining the tax base and in providing for tax withholding, clearly spells it
out to be such. As so well expounded by the Tax Court
. . . In all the situations . . . where the mechanism of withholding of taxes at source
operates to ensure collection of the tax, and which respondent claims the base on
which the tax is computed is the amount to be paid or remitted, the law applicable
expressly, specifically and unequivocally mandates that the tax is on the total amount
thereof which shall be collected and paid as provided in Sections 53 and 54 of the
Tax Code. Thus:
Dividends received by an individual who is a citizen or resident of the
Philippines from a domestic corporation, shall be subject to a final tax
at the rate of fifteen (15%) per cent on the total amount thereof,
which shall be collected and paid as provided in Sections 53 and 54
of this Code. (Emphasis supplied; Sec. 21, Tax Code)
Interest from Philippine Currency bank deposits and yield from
deposit substitutes whether received by citizens of the Philippines or
by resident alien individuals, shall be subject to a final tax as follows:
(a) 15% of the interest or savings deposits, and (b) 20% of the
interest on time deposits and yield from deposits substitutes, which
shall be collected and paid as provided in Sections 53 and 54 of this
Code: . . . (Emphasis supplied; Sec. 21, Tax Code applicable.)
And on rental payments payable by the lessee to the lessor (at 5%), also cited by
respondent, Section 1, paragraph (C), of Revenue Regulations No. 13-78, November
1, 1978, provides that:
Section 1. Income payments subject to withholding tax and rates
prescribed therein. Except as therein otherwise provided, there
shall be withheld a creditable income tax at the rates herein specified
for each class of payee from the following items of income payments
to persons residing in the Philippines.
xxx xxx xxx
(C) Rentals When the gross rental or the payment required to be
made as a condition to the continued use or possession of property,
whether real or personal, to which the payor or obligor has not taken
or is not taking title or in which he has no equity, exceeds five
hundred pesos (P500.00) per contract or payment whichever is
greater five per centum (5%).
Note that the basis of the 5% withholding tax, as expressly and unambiguously
provided therein, is on the gross rental. Revenue Regulations No. 13-78 was
promulgated pursuant to Section 53(f) of the then in force National Internal Revenue
Code which authorized the Minister of Finance, upon recommendation of the
Commissioner of Internal Revenue, to require the withholding of income tax on the
same items of income payable to persons (natural or judicial) residing in the
Philippines by the persons making such payments at the rate of not less than 2 1/2%
but not more than 35% which are to be credited against the income tax liability of the
taxpayer for the taxable year.

100

On the other hand, there is absolutely nothing in Section 24(b) (2) (ii), supra, which
indicates that the 15% tax on branch profit remittance is on the total amount of profit
to be remitted abroad which shall be collected and paid in accordance with the tax
withholding device provided in Sections 53 and 54 of the Tax Code. The statute
employs "Any profit remitted abroad by a branch to its head office shall be subject to
a tax of fifteen per cent (15%)" without more. Nowhere is there said of "base on
the total amount actually applied for by the branch with the Central Bank of the
Philippines as profit to be remitted abroad, which shall be collected and paid as
provided in Sections 53 and 54 of this Code." Where the law does not qualify that the
tax is imposed and collected at source based on profit to be remitted abroad, that
qualification should not be read into the law. It is a basic rule of statutory construction
that there is no safer nor better canon of interpretation than that when the language
of the law is clear and unambiguous, it should be applied as written. And to our mind,
the term "any profit remitted abroad" can only mean such profit as is "forwarded,
sent, or transmitted abroad" as the word "remitted" is commonly and popularly
accepted and understood. To say therefore that the tax on branch profit remittance is
imposed and collected at source and necessarily the tax base should be the amount
actually applied for the branch with the Central Bank as profit to be remitted abroad
is to ignore the unmistakable meaning of plain words. 4
In the 15% remittance tax, the law specifies its own tax base to be on the "profit remitted abroad."
There is absolutely nothing equivocal or uncertain about the language of the provision. The tax is
imposed on the amount sent abroad, and the law (then in force) calls for nothing further. The
taxpayer is a single entity, and it should be understandable if, such as in this case, it is the local
branch of the corporation, using its own local funds, which remits the tax to the Philippine
Government.
The remittance tax was conceived in an attempt to equalize the income tax burden on foreign
corporations maintaining, on the one hand, local branch offices and organizing, on the other hand,
subsidiary domestic corporations where at least a majority of all the latter's shares of stock are
owned by such foreign corporations. Prior to the amendatory provisions of the Revenue Code, local
branches were made to pay only the usual corporate income tax of 25%-35% on net income (now a
uniform 35%) applicable to resident foreign corporations (foreign corporations doing business in the
Philippines). While Philippine subsidiaries of foreign corporations were subject to the same rate of
25%-35% (now also a uniform 35%) on their net income, dividend payments, however, were
additionally subjected to a 15% (withholding) tax (reduced conditionally from 35%). In order to avert
what would otherwise appear to be an unequal tax treatment on such subsidiaries vis-a-vis local
branch offices, a 20%, later reduced to 15%, profit remittance tax was imposed on local branches on
their remittances of profits abroad. But this is where the tax pari-passu ends between domestic
branches and subsidiaries of foreign corporations.
The Solicitor General suggests that the analogy should extend to the ordinary application of the
withholding tax system and so with the rule on constructive remittance concept as well. It is difficult
to accept the proposition. In the operation of the withholding tax system, the payee is the taxpayer,
the person on whom the tax is imposed, while the payor, a separate entity, acts no more than an
agent of the government for the collection of the tax in order to ensure its payment. Obviously, the
amount thereby used to settle the tax liability is deemed sourced from the proceeds constitutive of
the tax base. Since the payee, not the payor, is the real taxpayer, the rule on constructive remittance
(or receipt) can be easily rationalized, if not indeed, made clearly manifest. It is hardly the case,
however, in the imposition of the 15% remittance tax where there is but one taxpayer using its own
domestic funds in the payment of the tax. To say that there is constructive remittance even of such
funds would be stretching far too much that imaginary rule. Sound logic does not defy but must
concede to facts.
We hold, accordingly, that the written claim for refund of the excess tax payment filed, within the twoyear prescriptive period, with the Court of Tax Appeals has been lawfully made.
WHEREFORE, the decision of the Court of Appeals appealed from is REVERSED and SET ASIDE,
and that of the Court of Tax Appeals is REINSTATED.
SO ORDERED.

101

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-16619

June 29, 1963

COMPAIA GENERAL DE TABACOS DE FILIPINAS, plaintiff-appellee,

vs.
CITY OF MANILA, ET AL., defendants-appellants.
Ponce Enrile, Siguion Reyna, Montecillo and Belo for plaintiff-appellee.
City Fiscal Hermogenes Concepcion, Jr. and Assistant City Fiscal M. T. Reyes for defendantsappellants.
DIZON, J.:
Appeal from the decision of the Court of First Instance of Manila ordering the City Treasurer of
Manila to refund the sum of P15,280.00 to Compania General de Tabacos de Filipinas.
Appellee Compania General de Tabacos de Filipinas hereinafter referred to simply as Tabacalera
filed this action in the Court of First Instance of Manila to recover from appellants, City of Manila
and its Treasurer, Marcelino Sarmiento also hereinafter referred to as the City the sum of

102

P15,280.00 allegedly overpaid by it as taxes on its wholesale and retail sales of liquor for the period
from the third quarter of 1954 to the second quarter of 1957, inclusive, under Ordinances Nos. 3634,
3301, and 3816.
Tabacalera, as a duly licensed first class wholesale and retail liquor dealer paid the City the
fixed license feesprescribed by Ordinance No. 3358 for the years 1954 to 1957, inclusive, and, as a
wholesale and retail dealer of general merchandise, it also paid the sales taxes required by
Ordinances Nos. 3634, 3301, and 3816.
1wph1.t

In its sworn statements of wholesale, retail, and grocery sales of general merchandise from the third
quarter of 1954 to the second quarter of 1957, inclusive, Tabacalera included its liquor sales of the
same period, and it is not denied that of the taxes it paid on all its sales of general merchandise, the
sum of P15,280.00 subject to the action represents the tax corresponding to the liquor sales
aforesaid.
Tabacalera's action for refund is based on the theory that, in connection with its liquor sales, it should
pay the license fees prescribed by Ordinance No. 3358 but not the municipal sales taxes imposed by
Ordinances Nos. 3634, 3301, and 3816; and since it already paid the license fees aforesaid, the
sales taxes paid by it amounting to the sum of P15,208.00 under the three ordinances
mentioned heretofore is an overpayment made by mistake, and therefore refundable.
The City, on the other hand, contends that, for the permit issued to it granting proper authority to
"conduct or engage in the sale of alcoholic beverages, or liquors" Tabacalera is subject to pay
the license fees prescribed by Ordinance No. 3358, aside from the sales taxes imposed by
Ordinances Nos. 3634, 3301, and 3816; that, even assuming that Tabacalera is not subject to the
payment of the sales taxes prescribed by the said three ordinances as regards its liquor sales, it is
not entitled to the refund demanded for the following reasons:.
(a) The said amount was paid by the plaintiff voluntarily and without protest;
(b) If at all the alleged overpayment was made by mistake, such mistake was one of law and
arose from the plaintiff's neglect of duty; .
(c) The said amount had been added by the plaintiff to the selling price of the liquor sold by it
and passed to the consumers; and
(d) The said amount had been already expended by the defendant City for public
improvements and essential services of the City government, the benefits of which are
enjoyed, and being enjoyed by the plaintiff.
It is admitted that as liquor dealer, Tabacalera paid annually the wholesale and retail liquor license
fees under Ordinance No. 3358. In 1954, City Ordinance No. 3634, amending City Ordinance No.
3420, and City Ordinance No. 3816, amending City Ordinance No. 3301 were passed. By reason
thereof, the City Treasurer issued the regulations marked Exhibit A, according to which, the term
"general merchandise as used in said ordinances, includes all articles referred to in Chapter 1,
Sections 123 to 148 of the National Internal Revenue Code. Of these, Sections 133-135
included liquor among the taxable articles. Pursuant to said regulations, Tabacalera included its
sales of liquor in its sworn quarterly declaration submitted to the City Treasurer beginning from the
third quarter of 1954 to the second quarter of 1957, with a total value of P722,501.09 and
correspondingly paid a wholesaler's tax amounting to P13,688.00 and a retailer's tax amounting to
P1,520.00, or a total of P15,208.00 the amount sought to be recovered.
It appears that in the year 1954, the City, through its treasurer, addressed a letter to Messrs. Sycip,
Gorres, Velayo and Co., an accounting firm, expressing the view that liquor dealers paying the
annual wholesale and retail fixed tax under City Ordinance No. 3358 are not subject to the wholesale
and retail dealers' taxes prescribed by City Ordinances Nos. 3634, 3301, and 3816. Upon learning of
said opinion, appellee stopped including its sales of liquor in its quarterly sworn declarations
submitted in accordance with the aforesaid City Ordinances Nos. 3634, 3301, and 3816, and on
December 3, 1957, it addressed a letter to the City Treasurer demanding refund of the alleged
overpayment. As the claim was disallowed, the present action was instituted.
The term "tax" applies generally speaking to all kinds of exactions which become public funds.
The term is often loosely used to include levies for revenue as well as levies for regulatory purposes.
Thus license fees are commonly called taxes. Legally speaking, however, license fee is a legal
concept quite distinct from tax; the former is imposed in the exercise of police power for purposes of
regulation, while the latter is imposed under the taxing power for the purpose of raising revenues
(MacQuillin, Municipal Corporations, Vol. 9, 3rd Edition, p. 26).

103

Ordinance No. 3358 is clearly one that prescribes municipal license fees for the privilege to engage
in the business of selling liquor or alcoholic beverages, having been enacted by the Municipal Board
of Manila pursuant to its charter power to fix license fees on, and regulate, the sale of intoxicating
liquors, whether imported or locally manufactured. (Section 18 [p], Republic Act 409, as amended).
The license fees imposed by it are essentially for purposes of regulation, and are justified,
considering that the sale of intoxicating liquor is, potentially at least, harmful to public health and
morals, and must be subject to supervision or regulation by the state and by cities and municipalities
authorized to act in the premises. (MacQuillin, supra, p. 445.)
On the other hand, it is clear that Ordinances Nos. 3634, 3301, and 3816 impose taxes on the sales
of general merchandise, wholesale or retail, and are revenue measures enacted by the Municipal
Board of Manila by virtue of its power to tax dealers for the sale of such merchandise. (Section 10
[o], Republic Act No. 409, as amended.).
Under Ordinance No. 3634 the word "merchandise" as employed therein clearly includes liquor.
Aside from this, we have held in City of Manila vs. Inter-Island Gas Service, Inc., G.R. No. L-8799,
August 31, 1956, that the word "merchandise" refers to all subjects of commerce and traffic;
whatever is usually bought and sold in trade or market; goods or wares bought and sold for gain;
commodities or goods to trade; and commercial commodities in general.
That Tabacalera is being subjected to double taxation is more apparent than real. As already stated
what is collected under Ordinance No. 3358 is a license fee for the privilege of engaging in the sale
of liquor, a calling in which it is obvious not anyone or anybody may freely engage, considering
that the sale of liquor indiscriminately may endanger public health and morals. On the other hand,
what the three ordinances mentioned heretofore impose is a tax for revenue purposes based on the
sales made of the same article or merchandise. It is already settled in this connection that both a
license fee and a tax may be imposed on the same business or occupation, or for selling the same
article, this not being in violation of the rule against double taxation (Bentley Gray Dry Goods Co. vs.
City of Tampa, 137 Fla. 641, 188 So. 758; MacQuillin, Municipal Corporations, Vol. 9, 3rd Edition, p.
83). This is precisely the case with the ordinances involved in the case at bar.
Appellee's contention that the City is repudiating its previous view expressed by its Treasurer in a
letter addressed to Messrs. Sycip, Gorres, Velayo & Co. in 1954 that a liquor dealer who pays the
annual license fee under Ordinance No. 3358 is exempted from the wholesalers and retailers taxes
under the other three ordinances mentioned heretofore is of no consequence. The government is not
bound by the errors or mistakes committed by its officers, specially on matters of law.
Having arrived at the above conclusion, we deem it unnecessary to consider the other legal points
raised by the City.
WHEREFORE, the decision appealed from is reversed, with the result that this case should be, as it
is hereby dismissed, with costs.
Padilla, Bautista Angelo, Labrador, Reyes, J.B.L., Barrera, Paredes, Regala and Makalintal, JJ.,
concur.
Bengzon, C.J. and Concepcion, J., took no part.

104

Republic of the Philippines

SUPREME COURT
Manila
SECOND DIVISION
G.R. No. L-66838 April 15, 1988
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION & THE COURT OF TAX
APPEALS,respondents.

PARAS, J.:
This is a petition for review on certiorari filed by the herein petitioner, Commissioner of Internal
Revenue, seeking the reversal of the decision of the Court of Tax Appeals dated January 31, 1984 in
CTA Case No. 2883 entitled "Procter and Gamble Philippine Manufacturing Corporation vs. Bureau
of Internal Revenue," which declared petitioner therein, Procter and Gamble Philippine
Manufacturing Corporation to be entitled to the sought refund or tax credit in the amount of
P4,832,989.00 representing the alleged overpaid withholding tax at source and ordering payment
thereof.
The antecedent facts that precipitated the instant petition are as follows:
Private respondent, Procter and Gamble Philippine Manufacturing Corporation (hereinafter referred
to as PMC-Phil.), a corporation duly organized and existing under and by virtue of the Philippine
laws, is engaged in business in the Philippines and is a wholly owned subsidiary of Procter and

105

Gamble, U.S.A. herein referred to as PMC-USA), a non-resident foreign corporation in the

Philippines, not engaged in trade and business therein. As such PMC-U.S.A. is the sole shareholder
or stockholder of PMC Phil., as PMC-U.S.A. owns wholly or by 100% the voting stock of PMC Phil.
and is entitled to receive income from PMC-Phil. in the form of dividends, if not rents or royalties. In
addition, PMC-Phil has a legal personality separate and distinct from PMC-U.S.A. (Rollo, pp. 122123).
For the taxable year ending June 30, 1974 PMC-Phil. realized a taxable net income of
P56,500,332.00 and accordingly paid the corresponding income tax thereon equivalent to P25%35% or P19,765,116.00 as provided for under Section 24(a) of the Philippine Tax Code, the pertinent
portion of which reads:
SEC. 24. Rates of tax on corporation. a) Tax on domestic corporations. A tax is
hereby imposed upon the taxable net income received during each taxable year from
all sources by every corporation organized in, or geting under the laws of the
Philippines, and partnerships, no matter how created or organized, but not including
general professional partnerships, in accordance with the following:
Twenty-five per cent upon the amount by which the taxable net income does not
exceed one hundred thousand pesos; and
Thirty-five per cent upon the amount by which the taxable net income exceeds one
hundred thousand pesos.
After taxation its net profit was P36,735,216.00. Out of said amount it declared a dividend in favor of
its sole corporate stockholder and parent corporation PMC-U.S.A. in the total sum of
P17,707,460.00 which latter amount was subjected to Philippine taxation of 35% or P6,197,611.23
as provided for in Section 24(b) of the Philippine Tax Code which reads in full:
SECTION 1. The first paragraph of subsection (b) of Section 24 of the National
Bureau Internal Revenue Code, as amended, is hereby further amended to read as
follows:
(b) Tax on foreign corporations. 41) Non-resident corporation. A
foreign corporation not engaged in trade or business in the
Philippines, including a foreign life insurance company not engaged
in the life insurance business in the Philippines, shall pay a tax equal
to 35% of the gross income received during its taxable year from all
sources within the Philippines, as interest (except interest on foreign
loans which shall be subject to 15% tax), dividends, rents, royalties,
salaries, wages, premiums, annuities, compensations, remunerations
for technical services or otherwise, emoluments or other fixed or
determinable, annual, periodical or casual gains, profits, and income,
and capital gains: Provided, however, That premiums shall not
include re-insurance premium Provided, further, That cinematograpy
film owners, lessors, or distributors, shall pay a tax of 15% on their
gross income from sources within the Philippines: Provided, still
further That on dividends received from a domestic corporation hable
to tax under this Chapter, the tax shall be 15% of the dividends
received, which shall be collected and paid as provided in Section
53(d) of this Code, subject to the condition that the country in which
the non-resident foreign corporation is domiciled shall allow a credit
against the tax due from the non-resident foreign corporation, taxes
deemed to have been paid in the Philippines equivalent to 20% which
represents the difference between the regular tax (35%) on
corporations and the tax (15%) on dividends as provided in this
section: Provided, finally That regional or area headquarters
established in the Philippines by multinational corporations and which
headquarters do not earn or derive income from the Philippines and
which act as supervisory, communications and coordinating centers
for their affiliates, subsidiaries or branches in the Asia-Pacific Region
shall not be subject to tax.
For the taxable year ending June 30, 1975 PMC-Phil. realized a taxable net income of
P8,735,125.00 which was subjected to Philippine taxation at the rate of 25%-35% or P2,952,159.00,
thereafter leaving a net profit of P5,782,966.00. As in the 2nd quarter of 1975, PMC-Phil. again
declared a dividend in favor of PMC-U.S.A. at the tax rate of 35% or P6,457,485.00.

106

In July, 1977 PMC-Phil., invoking the tax-sparing credit provision in Section 24(b) as aforequoted, as
the withholding agent of the Philippine government, with respect to the dividend taxes paid by PMCU.S.A., filed a claim with the herein petitioner, Commissioner of Internal Revenue, for the refund of
the 20 percentage-point portion of the 35 percentage-point whole tax paid, arising allegedly from the
alleged "overpaid withholding tax at source or overpaid withholding tax in the amount of
P4,832,989.00," computed as follows:

Divide
nd
Incom
e

Tax
wit
hh
eld

15
%
tax
un
der

All
eg
ed
of

PM
CU.S.
A.

at
so
urc
e
at

tax
sp
ari
ng

ov
er

35
%

pro
vis
o

pa
ym
ent

P17
,707
,460

P6,
19
6,6
11

P2,
65
6,1
19

P3,
54
1,4
92

6,45
7,48
5

2,2
60,
119

96
8,6
22

1,2
91,
49
7

P24
,164
,946

P8,
45
7,7
31

P3,
62
4,9
41

P4,
83
2,9
89

There being no immediate action by the BIR on PMC-Phils' letter-claim the latter sought the
intervention of the CTA when on July 13, 1977 it filed with herein respondent court a petition for
review docketed as CTA No. 2883 entitled "Procter and Gamble Philippine Manufacturing
Corporation vs. The Commissioner of Internal Revenue," praying that it be declared entitled to the
refund or tax credit claimed and ordering respondent therein to refund to it the amount of
P4,832,989.00, or to issue tax credit in its favor in lieu of tax refund. (Rollo, p. 41)
On the other hand therein respondent, Commissioner of qqqInterlaal Revenue, in his answer, prayed
for the dismissal of said Petition and for the denial of the claim for refund. (Rollo, p. 48)
On January 31, 1974 the Court of Tax Appeals in its decision (Rollo, p. 63) ruled in favor of the
herein petitioner, the dispositive portion of the same reading as follows:
Accordingly, petitioner is entitled to the sought refund or tax credit of the amount
representing the overpaid withholding tax at source and the payment therefor by the
respondent hereby ordered. No costs.

107

SO ORDERED.
Hence this petition.
The Second Division of the Court without giving due course to said petition resolved to require the
respondents to comment (Rollo, p. 74). Said comment was filed on November 8, 1984 (Rollo, pp.
83-90). Thereupon this Court by resolution dated December 17, 1984 resolved to give due course to
the petition and to consider respondents' comulent on the petition as Answer. (Rollo, p. 93)
Petitioner was required to file brief on January 21, 1985 (Rollo, p. 96). Petitioner filed his brief on
May 13, 1985 (Rollo, p. 107), while private respondent PMC Phil filed its brief on August 22, 1985.
Petitioner raised the following assignments of errors:
I
THE COURT OF TAX APPEALS ERRED IN HOLDING WITHOUT ANY BASIS IN FACT AND IN
LAW, THAT THE HEREIN RESPONDENT PROCTER & GAMBLE PHILIPPINE MANUFACTURING
CORPORATION (PMC-PHIL. FOR SHORT)IS ENTITLED TO THE SOUGHT REFUND OR TAX
CREDIT OF P4,832,989.00, REPRESENTING ALLEGEDLY THE DIVIDED TAX OVER WITHHELD
BY PMC-PHIL. UPON REMITTANCE OF DIVIDEND INCOME IN THE TOTAL SUM OF
P24,164,946.00 TO PROCTER & GAMBLE, USA (PMC-USA FOR SHORT).
II
THE COURT OF TAX APPEALS ERRED IN HOLDING, WITHOUT ANY BASIS IN FACT AND IN
LAW, THAT PMC-USA, A NON-RESIDENT FOREIGN CORPORATION UNDER SECTION 24(b) (1)
OF THE PHILIPPINE TAX CODE AND A DOMESTIC CORPORATION DOMICILED IN THE UNITED
STATES, IS ENTITLED UNDER THE U.S. TAX CODE AGAINST ITS U.S. FEDERAL TAXES TO A
UNITED STATES FOREIGN TAX CREDIT EQUIVALENT TO AT LEAST THE 20 PERCENTAGEPOINT PORTION (OF THE 35 PERCENT DIVIDEND TAX) SPARED OR WAIVED OR OTHERWISE
CONSIDERED OR DEEMED PAID BY THE PHILIPPINE GOVERNMENT.
The sole issue in this case is whether or not private respondent is entitled to the preferential 15% tax
rate on dividends declared and remitted to its parent corporation.
From this issue two questions are posed by the petitioner Commissioner of Internal Revenue, and
they are (1) Whether or not PMC-Phil. is the proper party to claim the refund and (2) Whether or not
the U. S. allows as tax credit the "deemed paid" 20% Philippine Tax on such dividends?
The petitioner maintains that it is the PMC-U.S.A., the tax payer and not PMC-Phil. the remitter or
payor of the dividend income, and a mere withholding agent for and in behalf of the Philippine
Government, which should be legally entitled to receive the refund if any. (Rollo, p. 129)
It will be observed at the outset that petitioner raised this issue for the first time in the Supreme
Court. He did not raise it at the administrative level, nor at the Court of Tax Appeals. As clearly ruled
by Us "To allow a litigant to assume a different posture when he comes before the court and
challenges the position he had accepted at the administrative level," would be to sanction a
procedure whereby the Court-which is supposed to review administrative determinations would not
review, but determine and decide for the first time, a question not raised at the administrative forum."
Thus it is well settled that under the same underlying principle of prior exhaustion of administrative
remedies, on the judicial level, issues not raised in the lower court cannot generally be raised for the
first time on appeal. (Pampanga Sugar Dev. Co., Inc. v. CIR, 114 SCRA 725 [1982]; Garcia v. C.A.,
102 SCRA 597 [1981]; Matialonzo v. Servidad, 107 SCRA 726 [1981]),
Nonetheless it is axiomatic that the State can never be in estoppel, and this is particularly true in
matters involving taxation. The errors of certain administrative officers should never be allowed to
jeopardize the government's financial position.
The submission of the Commissioner of Internal Revenue that PMC-Phil. is but a withholding agent
of the government and therefore cannot claim reimbursement of the alleged over paid taxes, is
completely meritorious. The real party in interest being the mother corporation in the United States, it
follows that American entity is the real party in interest, and should have been the claimant in this
case.

108

Closely intertwined with the first assignment of error is the issue of whether or not PMC-U.S.A. a
non-resident foreign corporation under Section 24(b)(1) of the Tax Code (the subsidiary of an
American) a domestic corporation domiciled in the United States, is entitled under the U.S. Tax Code
to a United States Foreign Tax Credit equivalent to at least the 20 percentage paid portion (of the
35% dividend tax) spared or waived as otherwise considered or deemed paid by the government.
The law pertinent to the issue is Section 902 of the U.S. Internal Revenue Code, as amended by
Public Law 87-834, the law governing tax credits granted to U.S. corporations on dividends received
from foreign corporations, which to the extent applicable reads:
SEC. 902 - CREDIT FOR CORPORATE STOCKHOLDERS IN FOREIGN
CORPORATION.
(a) Treatment of Taxes Paid by Foreign Corporation - For purposes of this subject, a
domestic corporation which owns at least 10 percent of the voting stock of a foreign
corporation from which it receives dividends in any taxable year shall(1) to the extent such dividends are paid by such foreign corporation
out of accumulated profits [as defined in subsection (c) (1) (a)] of a
year for which such foreign corporation is not a less developed
country corporation, be deemed to have paid the same proportion of
any income, war profits, or excess profits taxes paid or deemed to be
paid by such foreign corporation to any foreign country or to any
possession of the United States on or with respect to such
accumulated profits, which the amount of such dividends (determined
without regard to Section 78) bears to the amount of such
accumulated profits in excess of such income, war profits, and
excess profits taxes (other than those deemed paid); and
(2) to the extent such dividends are paid by such foreign corporation
out of accumulated profits [as defined in subsection (c) (1) (b)] of a
year for which such foreign corporation is a less-developed country
corporation, be deemed to have paid the same proportion of any
income, war profits, or excess profits taxes paid or deemed to be paid
by such foreign corporation to any foreign country or to any
possession of the United States on or with respect to such
accumulated profits, which the amount of such dividends bears to the
amount of such accumulated profits.
xxx xxx xxx
(c) Applicable Rules
(1) Accumulated profits defined - For purpose of this section, the term 'accumulated
profits' means with respect to any foreign corporation.
(A) for purposes of subsections (a) (1) and (b) (1), the amount of its
gains, profits, or income computed without reduction by the amount
of the income, war profits, and excess profits taxes imposed on or
with respect to such profits or income by any foreign country.... ; and
(B) for purposes of subsections (a) (2) and (b) (2), the amount of its
gains, profits, or income in excess of the income, was profits, and
excess profits taxes imposed on or with respect to such profits or
income.
The Secretary or his delegate shall have full power to determine from the
accumulated profits of what year or years such dividends were paid, treating
dividends paid in the first 20 days of any year as having been paid from the
accumulated profits of the preceding year or years (unless to his satisfaction shows
otherwise), and in other respects treating dividends as having been paid from the
most recently accumulated gains, profits, or earnings. .. (Rollo, pp. 55-56)
To Our mind there is nothing in the aforecited provision that would justify tax return of the disputed
15% to the private respondent. Furthermore, as ably argued by the petitioner, the private respondent
failed to meet certain conditions necessary in order that the dividends received by the non-resident
parent company in the United States may be subject to the preferential 15% tax instead of 35%.
Among other things, the private respondent failed: (1) to show the actual amount credited by the

109

U.S. government against the income tax due from PMC-U.S.A. on the dividends received from
private respondent; (2) to present the income tax return of its mother company for 1975 when the
dividends were received; and (3) to submit any duly authenticated document showing that the U.S.
government credited the 20% tax deemed paid in the Philippines.
PREMISES CONSIDERED, the petition is GRANTED and the decision appealed from, is
REVERSED and SET ASIDE.
SO ORDERED.
Yap (Chairman), Melencio-Herrera, Padilla and Sarmiento, JJ., concur.

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION
G.R. No. L-68375 April 15, 1988

110

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
WANDER PHILIPPINES, INC. AND THE COURT OF TAX APPEALS, respondents.
The Solicitor General for petitioner.
Felicisimo R. Quiogue and Cirilo P. Noel for respondents.

BIDIN, J.:
This is a petition for review on certiorari of the January 19, 1984 Decision of the Court of Tax
Appeals * in C.T.A. Case No.2884, entitled Wander Philippines, Inc. vs. Commissioner of Internal Revenue, holding that Wander
Philippines, Inc. is entitled to the preferential rate of 15% withholding tax on the dividends remitted to its foreign parent company, the Glaro
S.A. Ltd. of Switzerland, a non-resident foreign corporation.

Herein private respondent, Wander Philippines, Inc. (Wander, for short), is a domestic corporation
organized under Philippine laws. It is wholly-owned subsidiary of the Glaro S.A. Ltd. (Glaro for
short), a Swiss corporation not engaged in trade or business in the Philippines.
On July 18, 1975, Wander filed its withholding tax return for the second quarter ending June 30,
1975 and remitted to its parent company, Glaro dividends in the amount of P222,000.00, on which
35% withholding tax thereof in the amount of P77,700.00 was withheld and paid to the Bureau of
Internal Revenue.
Again, on July 14, 1976, Wander filed a withholding tax return for the second quarter ending June
30, 1976 on the dividends it remitted to Glaro amounting to P355,200.00, on wich 35% tax in the
amount of P124,320.00 was withheld and paid to the Bureau of Internal Revenue.
On July 5, 1977, Wander filed with the Appellate Division of the Internal Revenue a claim for refund
and/or tax credit in the amount of P115,400.00, contending that it is liable only to 15% withholding
tax in accordance with Section 24 (b) (1) of the Tax Code, as amended by Presidential Decree Nos.
369 and 778, and not on the basis of 35% which was withheld and paid to and collected by the
government.
Petitioner herein, having failed to act on the above-said claim for refund, on July 15, 1977, Wander
filed a petition with respondent Court of Tax Appeals.
On October 6, 1977, petitioner file his Answer.
On January 19, 1984, respondent Court of Tax Appeals rendered a Decision, the decretal portion of
which reads:
WHEREFORE, respondent is hereby ordered to grant a refund and/or tax credit to
petitioner in the amount of P115,440.00 representing overpaid withholding tax on
dividends remitted by it to the Glaro S.A. Ltd. of Switzerland during the second
quarter of the years 1975 and 1976.
On March 7, 1984, petitioner filed a Motion for Reconsideration but the same was denied in a
Resolution dated August 13, 1984. Hence, the instant petition.
Petitioner raised two (2) assignment of errors, to wit:
I
ASSUMING THAT THE TAX REFUND IN THE CASE AT BAR IS ALLOWABLE AT ALL, THE COURT
OF TAX APPEALS ERRED INHOLDING THAT THE HEREIN RESPONDENT WANDER
PHILIPPINES, INC. IS ENTITLED TO THE SAID REFUND.
II
THE COURT OF TAX APPEALS ERRED IN HOLDING THAT SWITZERLAND, THE HOME
COUNTRY OF GLARO S.A. LTD. (THE PARENT COMPANY OF THE HEREIN RESPONDENT
WANDER PHILIPPINES, INC.), GRANTS TO SAID GLARO S.A. LTD. AGAINST ITS SWISS
INCOME TAX LIABILITY A TAX CREDIT EQUIVALENT TO THE 20 PERCENTAGE-POINT

111

PORTION (OF THE 35 PERCENT PHILIPPINE DIVIDEND TAX) SPARED OR WAIVED OR

OTHERWISE DEEMED AS IF PAID IN THE PHILIPPINES UNDER SECTION 24 (b) (1) OF THE
PHILIPPINE TAX CODE.
The sole issue in this case is whether or not private respondent Wander is entitled to the preferential
rate of 15% withholding tax on dividends declared and remitted to its parent corporation, Glaro.
From this issue, two questions were posed by petitioner: (1) Whether or not Wander is the proper
party to claim the refund; and (2) Whether or not Switzerland allows as tax credit the "deemed paid"
20% Philippine Tax on such dividends.
Petitioner maintains and argues that it is Glaro the tax payer, and not Wander, the remitter or payor
of the dividend income and a mere withholding agent for and in behalf of the Philippine Government,
which should be legally entitled to receive the refund if any.
It will be noted, however, that Petitioner's above-entitled argument is being raised for the first time in
this Court. It was never raised at the administrative level, or at the Court of Tax Appeals. To allow a
litigant to assume a different posture when he comes before the court and challenge the position he
had accepted at the administrative level, would be to sanction a procedure whereby the Court
which is supposed to review administrative determinationswould not review, but determine and
decide for the first time, a question not raised at the administrative forum. Thus, it is well settled that
under the same underlying principle of prior exhaustion of administrative remedies, on the judicial
level, issues not raised in the lower court cannot be raised for the first time on appeal (Aguinaldo
Industries Corporation vs. Commissioner of Internal Revenue, 112 SCRA 136; Pampanga Sugar
Dev. Co., Inc. vs. CIR, 114 SCRA 725; Garcia vs. Court of Appeals, 102 SCRA 597; Matialonzo vs.
Servidad, 107 SCRA 726,
In any event, the submission of petitioner that Wander is but a withholding agent of the government
and therefore cannot claim reimbursement of the alleged overpaid taxes, is untenable. It will be
recalled, that said corporation is first and foremost a wholly owned subsidiary of Glaro. The fact that
it became a withholding agent of the government which was not by choice but by compulsion under
Section 53 (b) of the Tax Code, cannot by any stretch of the imagination be considered as an
abdication of its responsibility to its mother company. Thus, this Court construing Section 53 (b) of
the Internal Revenue Code held that "the obligation imposed thereunder upon the withholding agent
is compulsory." It is a device to insure the collection by the Philippine Government of taxes on
incomes, derived from sources in the Philippines, by aliens who are outside the taxing jurisdiction of
this Court (Commissioner of Internal Revenue vs. Malayan Insurance Co., Inc., 21 SCRA 944). In
fact, Wander may be assessed for deficiency withholding tax at source, plus penalties consisting of
surcharge and interest (Section 54, NLRC). Therefore, as the Philippine counterpart, Wander is the
proper entity who should for the refund or credit of overpaid withholding tax on dividends paid or
remitted by Glaro.
Closely intertwined with the first assignment of error is the issue of whether or not Switzerland, the
foreign country where Glaro is domiciled, grants to Glaro a tax credit against the tax due it,
equivalent to 20%, or the difference between the regular 35% rate of the preferential 15% rate. The
dispute in this issue lies on the fact that Switzerland does not impose any income tax on dividends
received by Swiss corporation from corporations domiciled in foreign countries.
Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this case,
reads:
Sec. 1. The first paragraph of subsection (b) of Section 24 of the National Internal
Revenue Code, as amended, is hereby further amended to read as follows:
(b) Tax on foreign corporations. 1) Non-resident corporation. A
foreign corporation not engaged in trade or business in the
Philippines, including a foreign life insurance company not engaged
in the life insurance business in the Philippines, shall pay a tax equal
to 35% of the gross income received during its taxable year from all
sources within the Philippines, as interest (except interest on foreign
loans which shall be subject to 15% tax), dividends, premiums,
annuities, compensations, remuneration for technical services or
otherwise, emoluments or other fixed or determinable, annual,
periodical or casual gains, profits, and income, and capital gains: ...
Provided, still further That on dividends received from a domestic
corporation liable to tax under this Chapter, the tax shall be 15% of
the dividends received, which shall be collected and paid as provided

112

in Section 53 (d) of this Code, subject to the condition that the

country in which the non-resident foreign corporation is domiciled
shall allow a credit against the tax due from the non-resident foreign
corporation taxes deemed to have been paid in the Philippines
equivalent to 20% which represents the difference between the
regular tax (35%) on corporations and the tax (15%) dividends as
provided in this section: ...
From the above-quoted provision, the dividends received from a domestic corporation liable to tax,
the tax shall be 15% of the dividends received, subject to the condition that the country in which the
non-resident foreign corporation is domiciled shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20%
which represents the difference between the regular tax (35%) on corporations and the tax (15%)
dividends.
In the instant case, Switzerland did not impose any tax on the dividends received by Glaro.
Accordingly, Wander claims that full credit is granted and not merely credit equivalent to 20%.
Petitioner, on the other hand, avers the tax sparing credit is applicable only if the country of the
parent corporation allows a foreign tax credit not only for the 15 percentage-point portion actually
paid but also for the equivalent twenty percentage point portion spared, waived or otherwise deemed
as if paid in the Philippines; that private respondent does not cite anywhere a Swiss law to the effect
that in case where a foreign tax, such as the Philippine 35% dividend tax, is spared waived or
otherwise considered as if paid in whole or in part by the foreign country, a Swiss foreign-tax credit
would be allowed for the whole or for the part, as the case may be, of the foreign tax so spared or
waived or considered as if paid by the foreign country.
While it may be true that claims for refund are construed strictly against the claimant, nevertheless,
the fact that Switzerland did not impose any tax or the dividends received by Glaro from the
Philippines should be considered as a full satisfaction of the given condition. For, as aptly stated by
respondent Court, to deny private respondent the privilege to withhold only 15% tax provided for
under Presidential Decree No. 369, amending Section 24 (b) (1) of the Tax Code, would run counter
to the very spirit and intent of said law and definitely will adversely affect foreign corporations"
interest here and discourage them from investing capital in our country.
Besides, it is significant to note that the conclusion reached by respondent Court is but a
confirmation of the May 19, 1977 ruling of petitioner that "since the Swiss Government does not
impose any tax on the dividends to be received by the said parent corporation in the Philippines, the
condition imposed under the above-mentioned section is satisfied. Accordingly, the withholding tax
rate of 15% is hereby affirmed."
Moreover, as a matter of principle, this Court will not set aside the conclusion reached by an agency
such as the Court of Tax Appeals which is, by the very nature of its function, dedicated exclusively to
the study and consideration of tax problems and has necessarily developed an expertise on the
subject unless there has been an abuse or improvident exercise of authority (Reyes vs.
Commissioner of Internal Revenue, 24 SCRA 198, which is not present in the instant case.
WHEREFORE, the petition filed is DISMISSED for lack of merit.
SO ORDERED.
Fernan (Chairman), Gutierrez, Jr., Feliciano and Cortes, JJ., concur.

113