M.
Gains and Losses from Sale or Exchange of which are held by the real estate developer primarily
Property
1. Capital Gains and Losses
i. Capital Assets vs. Ordinary Assets
Ordinary Assets
a. stock in trade of the taxpayer or other property of
a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of
the taxable year
b. property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or
business,
c. property used in the trade or business, of a
character which is subject to the allowance for
depreciation
d. real property used in trade or business of the
taxpayer.
Capital Assets
-include all property held by taxpayer whether or not
connected in trade or business but not including
those above.
Net Capital Gain. - The term 'net capital gain' means
the excess of the gains from sales or exchanges of
capital assets over the losses from such sales or
exchanges.
Net Capital Loss. - The term 'net capital loss' means
the excess of the losses from sales or exchanges of
capital assets over the gains from such sales or
exchanges.
1. Sec 39 of the NIRC
Sec. 39, NIRC - Capital Assets: The term capital
assets means property held by the taxpayer
(whether or not connected with his trade or
business), but does NOT include stock in trade by the
taxpayer, or other property of a kind which would
properly be included in the inventory of a taxpayer if
on hand at the close of the taxable year, or property
held by the taxpayer primarily for sale to customers
in the ordinary course of his trade or business, or
property used in the trade or business, of a character
which is subject to the allowance for depreciation
provided in subsection F of 34, or real property used
in trade or business of the taxpayer
2. Secs 1 to 3 of RR No. 7-03 dated February 11,
2003
Guidelines in determining whether a real property is
capital or ordinary asset for purposed of imposing
Capital Gains Tax or the ordinary income tax or MCIT
Ordinary Assets ( real properties engaged in real
estate business)
1. all real properties acquired by the real estate
dealer
2. all real properties acquired by the real estate
developer, whether developed or underdeveloped as
of the time of acquisition, and all real properties
for sale or for lease to customers in the ordinary
course of his trade or business or which would
properly be include in the inventory of the taxpayer if
on hand at the close of the taxable year and all real
properties used in the trade or business, whether in
the form of land building or other improvements
3. all real properties acquired by the real estate
lessor, whether land or improvements which are for
lease/rent or being offered for lease/rent, or otherwise
for use or being used in the trade or business; and
4. all real properties acquired in the course of trade or
business by taxpayers habitually engaged in the sale
of real estate.
Ordinary asset (for those not engaged in real estate
business)
- Real properties, whether land or building or
other improvements which are used or being
used or have been previously used in the
trade or business of the taxpayer shall be
considered as ordinary assets.
-
Exemption: However real property used by an exempt
corporation in its exempt operations shall not be
considered used for business purposes and are
considered as capital asset.
*Changing business from real estate to non-real
estate shall no result in reclassification of its assets
from ordinary to capital
*In case of non-operation of real estate-> continue to
recognize it as ordinary asset
Capital assets shall refer to all real properties held
by a taxpayer, whether or not connected with his
trade or business, and which are not included among
the real properties considered as ordinary assets
under Sec. 39(A)(1) of the Code.
Ordinary assets shall refer to all real properties
specifically excluded from the definition of capital
assets under Sec. 39(A)(1) of the Code, namely:
1
 1. Stock in trade of a taxpayer or other real property by any corporation (including one issued by a
of a kind which would properly be included in the government or political subdivision thereof), with
inventory of the taxpayer if on hand at the close of interest coupons or in registered form, any loss
the taxable year; or resulting from such sale shall not be subject to the
2. Real property held by the taxpayer primarily for foregoing limitation and shall not be included in
sale to customers in the ordinary course of his trade determining the applicability of such limitation to
or business; or other losses.
3. Real property used in trade or business (i.e.,
buildings and/or improvements) of a character which ii. Holding Period Rule
is subject to the allowance for depreciation provided In the case of a taxpayer, other than a corporation,
for under Sec. 34(F) of the Code; or only the following percentages of the gain or loss
4. Real property used in trade or business of the recognized upon the sale or exchange of a capital
taxpayer. asset shall be taken into account in computing net
Real properties acquired by banks through foreclosure capital gain, net capital loss, and net income.
sales are considered as their ordinary assets.
However, banks shall not be considered as habitually (1) One hundred percent (100%) if the capital asset
engaged in the real estate business for purposes of has been held for not more than twelve (12) months;
determining the applicable rate of withholding tax and
imposed under Sec. 2.57.2(J) of Revenue Regulations
No. 2-98, as amended. (2) Fifty percent (50%) if the capital asset has been
held for more than twelve (12) months;
Real estate dealer shall refer to any person
engaged in the business of buying and selling or iii. Net Capital Loss Carry-Over Rule
exchanging real properties on his own account as a If any taxpayer, other than a corporation, sustains in
principal and holding himself out as a full or part-time any taxable year a net capital loss, such loss (in an
dealer in real estate. amount not in excess of the net income for such year)
shall be treated in the succeeding taxable year as a
Real estate developer shall refer to any person loss from the sale or exchange of a capital asset held
engaged in the business of developing real properties for not more than twelve (12) months.
into subdivisions, or building houses on subdivided
lots, or constructing residential or commercial units,
townhouses and other similar units for his own Individual Tax Payer Corporate Taxpayer
account and offering them for sale or lease. Holding Period: NO HOLDING PERIOD
a. 100% if capital assets Capital Gains and
Real estate lessor shall refer to any person has been held for 12 losses are recognized
engaged in the business of leasing or renting real months or less and 100%
properties on his own account as a principal and b. 50% - if capital asset
holding himself out as lessor of real properties being has been held for more
rented out or offered for rent.
than 12 months
Non deductibility of Net Non deductibility of Net
3. Sec. 22(Z) of the NIRC
Sec 22 (z) the term ordinary income includes any Capital Loss Capital Loss
gain from sale or exchange of property which is not a Capital losses allowed Capital losses allowed
capital asset. Any gain from the sale or exchange of to the extent of capital to the extent of capital
property which is treated or considered under other gains gains
provisions of this title, as ordinary income shall be
treated as gain from the sale or exchange of property Net capital loss not Net capital loss not
which is not a capital asset as defined in sec 39 A. deductible deductible

i. Loss Limitation Rule SAME as INDIVIUDAL

Limitation on Capital Loss - Losses from sales or Net Capital Loss Carry NOT ALLOWED
exchanges of capital assets shall be allowed only to over
the extent of the gains from such sales or exchanges. ALLOWED
Net capital loss (in an
Losses from sales or exchange capital assets shall be
amount not in excess of
allowed only to the extent of the gains from such
the taxable income
sales or exchanges. If a bank or trust company
incorporated under the laws of the Philippines, a before personal
substantial part of whose business is the receipt of exemptions for such
deposits, sells any bond, debenture, note, or year) shall be treated in
certificate or other evidence of indebtedness issued the succeeding year

2
(but not beyond 12
months) as a deduction
as short term capital
loss at 100% from the
net capital gains
CASES:
CALASANZ v CIR
Facts: Petitioner Ursula Calasanz inherited from her
father de Torres an agricultural land located in Rizal
with an area of 1.6M sqm. In order to liquidate her
inheritance, Ursula Calasanz had the land surveyed
and subdivided into lots. Improvements, such as good
roads, concrete gutters, drainage and lighting
system, were introduced to make the lots saleable.
Soon after, the lots were sold to the public at a profit.
In their joint income tax return for the year 1957 filed
with the Bureau of Internal Revenue on March 31,
1958, petitioners disclosed a profit of P31,060.06
realized from the sale of the subdivided lots, and
reported fifty per centum thereof or P15,530.03 as
taxable capital gains.
Upon an audit and review of the return thus filed, the
Revenue Examiner adjudged petitioners engaged in
business as real estate dealers, as defined in the
NIRC, and required them to pay the real estate
dealer's tax and assessed a deficiency income tax on
profits derived from the sale of the lots based on the
rates for ordinary income.
Tax court upheld the finding of the CIR, hence, the
present appeal.
ISSUES:
a. Whether or not petitioners are real estate dealers
liable for real estate dealer's fixed tax. YES
b. Whether the gains realized from the sale of the lots
are taxable in full as ordinary income or capital gains
taxable at capital gain rates. ORDINARY INCOME
RATIO:
The assets of a taxpayer are classified for income tax
purposes into ordinary assets and capital assets.
Section 34[a] [1] of the National Internal Revenue
Code broadly defines capital assets as follows:
[1] Capital assets.-The term 'capital assets'
means property held by the taxpayer
[whether or not connected with his trade or
business], but does not include, stock in trade
of the taxpayer or other property of a kind
which would properly be included, in the
inventory of the taxpayer if on hand at the
close of the taxable year, or property held by
the taxpayer primarily for sale to customers
in the ordinary course of his trade or
business, or property used in the trade or
business of a character which is subject to the
allowance for depreciation provided in
subsection [f] of section thirty; or real
property used in the trade or business of the
taxpayer.
The statutory definition of capital assets is negative
in nature. If the asset is not among the exceptions, it
is a capital asset; conversely, assets falling within the
exceptions are ordinary assets. And necessarily, any
gain resulting from the sale or exchange of an asset
is a capital gain or an ordinary gain depending on the
kind of asset involved in the transaction.
However, there is no rigid rule or fixed formula by
which it can be determined with finality whether
property sold by a taxpayer was held primarily for
sale to customers in the ordinary course of his trade
or business or whether it was sold as a capital
asset. Although several factors or indices have been
recognized as helpful guides in making a
determination, none of these is decisive; neither is
the presence nor the absence of these factors
3
conclusive. Each case must in the last analysis rest
upon its own peculiar facts and circumstances.
Also a property initially classified as a capital asset
may thereafter be treated as an ordinary asset if a
combination of the factors indubitably tend to show
that the activity was in furtherance of or in the course
of the taxpayer's trade or business. Thus, a sale of
inherited real property usually gives capital gain or
loss even though the property has to be subdivided or
improved or both to make it salable. However, if the
inherited property is substantially improved or very
actively sold or both it may be treated as held
primarily for sale to customers in the ordinary course
of the heir's business.
In this case, the subject land is considered as an
ordinary asset. Petitioners did not sell the land in the
condition in which they acquired it. While the land
was originally devoted to rice and fruit trees, it was
subdivided into small lots and in the process
converted into a residential subdivision and given the
name Don Mariano Subdivision. Extensive
improvements like the laying out of streets,
construction of concrete gutters and installation of
lighting system and drainage facilities, among others,
were undertaken to enhance the value of the lots and
make them more attractive to prospective buyers.
The audited financial statements submitted together
with the tax return in question disclosed that a
considerable amount was expended to cover the cost
of improvements. There is authority that a property
ceases to be a capital asset if the amount expended
to improve it is double its original cost, for the
extensive improvement indicates that the seller held
the property primarily for sale to customers in the
ordinary course of his business.
Another distinctive feature of the real estate business
discernible from the records is the existence of
contracts receivables, which stood at P395,693.35.
The sizable amount of receivables in comparison with
the sales volume of P446,407.00 during the same
period signifies that the lots were sold on installment
basis and suggests the number, continuity and
frequency of the sales. Also of significance is the
circumstance that the lots were advertised for sale to
the public and that sales and collection commissions
were paid out during the period in question.
Petitioners argument that they are merely liquidating
the land must also fail. In Ehrman vs.
Commissioner, the American court in clear and
categorical terms rejected the liquidation test in
determining whether or not a taxpayer is carrying on
a trade or business The court observed that the fact
that property is sold for purposes of liquidation does
not foreclose a determination that a "trade or
business" is being conducted by the seller.
One may, of course, liquidate a capital asset. To do
so, it is necessary to sell. The sale may be conducted
in the most advantageous manner to the seller and
he will not lose the benefits of the capital gain
provision of the statute unless he enters the real
estate business and carries on the sale in the manner
in which such a business is ordinarily conducted. In
that event, the liquidation constitutes a business and
a sale in the ordinary course of such a business and
the preferred tax status is lost.
CALASANZ v CIR
FACTS:
Ursula Calasanz inherited from her father an
agricultural land. Improvements were introduced to
make such land saleable and later in it was sold to
the public at a profit. The Revenue examiner
adjudged Ursula and her spouse as engaged in
business as real estate dealers and required them to
pay the real estate dealers tax.
ISSUE:
Whether or not the gains realized from the sale of the
lots are taxable in full as ordinary income or capital
gains taxable at capital gain rates?
HELD:
The activities of Calasanz are indistinguishable from
those invariably employed by one engaged in the
business of selling real estate. One strong factor is
the business element of development which is very
much in evidence. They did not sell the land in the
condition in which they acquired it. Inherited land
which an heir subdivides and makes improvements
several times higher than the original cost of the land
is not a capital asset but an ordinary asses. Thus, in
the course of selling the subdivided lots, they
engaged in the real estate business and accordingly
the gains from the sale of the lots are ordinary
income taxable in full.
3. Net capital gain, net capital loss
4

Net Capital Gain-means the excess of the gains from
the sales or exchanges of capital assets over the
losses from such sales or exchanges.
Net Capital Loss-means the excess of the losses from
sales or exchanges of capital assets over the gains
from such sales or exchanges.
4. Ordinary loss
Ordinary loss- includes any loss from the sale or
exchange of property which is not a capital asset.
5. Percentage Taken into Account
Percentage Taken into Account- in the case of a
taxpayer, other than a corporation, only the following
percentages of the gain or loss recognized upon the
sale or exchange of a capital asset shall be taken into
account in computing net capital gain, net capital
loss, and net income:
a. one hundred percent (100%) if the capital asset
has been held for not more than 12 months
b. fifty percent (50%) if the capital asset has been
held for more than12 months
6. Limitation on Capital Loss
Limitation on Capital Loss - Losses from sales or
exchanges of capital assets shall be allowed only to
the extent of the gains from such sales or exchanges.
China Banking Corporation v CA
FACTS:
China Banking Corporation made a 53% equity
investment (P16,227,851.80) in the First CBC Capital
a Hongkong subsidiary engaged in financing and
investment with deposit-taking function.
It was shown that CBC has become insolvent so China
Banking wrote-off its investment as worthless and
treated it as a bad debt or as an ordinary loss
deductible from its gross income.
CIR disallowed the deduction on the ground that the
investment should not be classified as being
worthless. It also held that assuming that the
securities were worthless, then they should be
classified as a capital loss and not as a bad debt since
there was no indebtedness between China Banking
and CBC.
ISSUE: Whether or not the investment should be
classified as a capital loss.
HELD:
Yes. Section 29.d.4.B of the NIRC contains provisions
on securities becoming worthless. It conveys that
capital loss normally requires the concurrence of 2
conditions:
a. there is a sale or exchange
b. the thing sold or exchanges is a capital asset.
When securities become worthless, there is strictly no
sale or exchange but the law deems it to be a loss.
These are allowed to be deducted only to the extent
of capital gains and not from any other income of the
taxpayer. A similar kind of treatment is given by the
NIRC on the retirement of certificates of indebtedness
with interest coupons or in registered form, short
sales and options to buy or sell property where no
sale or exchange strictly exists. In these cases, The
NIRC dispenses with the standard requirements.
There is ordinary loss when the property sold is not a
capital asset.
In the case, CBC as an investee corporation, is a
subsidiary corporation of China Banking whose shares
in CBC are not intended for purchase or sale but as an
investment. An equity investment is a capital asset of
the investor. Unquestionably, any loss is a capital loss
to the investor.
Additional notes:
*The loss cannot be deductible as bad debt since the
shares of stock do not constitute a loan extended by
it to its subsidiary or a debt subject to obligatory
repayment by the latter.
China Banking v CA
FACTS:
Petitioner China Bank made a 53% equity
investment in First CBC Capital (Asia) Ltd., a
Hongkong Subsidiary of P 16,227, 851.80
1906: with the approval of the Bangko
Sentral, it wrote of as worthless investment for
being insolvent in its 1987 Income Tax Return
treated as bad debts o ordinary loss deductible.
CIR contends it should be capital loss.
CTA and CA on Petition for Review on
Certiorari: upheld CIR contention
ISSUE: W/N Capital loss (NOT Ordinary Loss)
HELD: Yes. Petition is DENIED
Equity investment is a capital asset resulting
in a capital gain or a capital loss. A capital asset
is defined negatively in Section 33(1) of the NIRC
(1) Capital assets. - The term 'capital
assets' means property held by the taxpayer
(whether or not connected with his trade or
business), but does not include:
stock in trade of the taxpayer;
or
other property of a kind which
would properly be included in the inventory of the
taxpayer if on hand at the close of the taxable
year; or
property held by the taxpayer
primarily for sale to customers in the ordinary
course of his trade or business; or
property used in the trade or
business, of a character which is subject to the
allowance for depreciation provided in subsection
(f) of section twenty-nine; or
5
 real property used in the
trade or business of the taxpayer
Thus, shares of stock; like the other
securities defined in Section 20(t)[4] of the NIRC,
would be ordinary assets only to a dealer in
securities or a person engaged in the purchase
and sale of, or an active trader (for his own
account) in, securities.
Section 20(u) of the NIRC defines a
dealer in securities thus" (u) The term 'dealer in
securities' means a merchant of stocks or
securities, whether an individual, partnership or
corporation, with an established place of
business, regularly engaged in the purchase of
securities and their resale to customers; that is,
one who as a merchant buys securities and sells
them to customers with a view to the gains and
profits that may be derived therefrom."
In the hands, however, of another
who holds the shares of stock by way of an
investment, the shares to him would be capital
assets. When the shares held by such investor
become worthless, the loss is deemed to be a
loss from the sale or exchange of capital assets.
Loss sustained by the holder of the
securities, which are capital assets (to him), is to
be treated as a capital loss as if incurred from a
sale or exchange transaction. A capital gain or a
capital loss normally requires the concurrence of
two conditions for it to result: (1) There is a sale
or exchange; and (2) the thing sold or exchanged
is a capital asset. When securities become
worthless, there is strictly no sale or exchange
but the law deems the loss anyway to be "a loss
from the sale or exchange of capital assets
Capital losses are allowed to be
deducted only to the extent of capital gains, i.e.,
gains derived from the sale or exchange of
capital assets, and not from any other income of
the taxpayer.
2. Determination of Gain or Loss
i. Sec 40 of the NIRC
Sec 40, NIRC: computation of gain or loss: the gain
from sale or other disposition of property shall be the
excess of the amount realized therefrom over the
basis or adjusted basis for determining gain, and the
loss shall be the excess of the basis or adjusted basis
for determining loss over the amount realized. The
amount realized from the sale or other disposition of
property shall be the sum of money received plus the
fair market value of the property received.
ii. Cost Basis depending on mode of acquisition
The basis of property shall be-
a. the cost thereof in the case of property acquired on
or after March 1, 1913, if such property was acquired
by purchase
b. the fair market price or value as of the date of
acquisition, if the same was acquired by inheritance
c. if the property was acquired by gift, the basis shall
be the same as if it would be in the hands of the
donor, except if that if such basis is greater than the
fair market value of the property at the time of the
gift, then for the purpose of determining loss, the
basis shall be such fair market value
d. if the property was acquired for less than an
adequate consideration in money or moneys worth,
the basis is the amount paid by the transferee for the
property
iii. Tax Free Exchange
General rule: upon exchange or sale of property, the
entire amount of the gain or loss, as the case may be,
shall be recognized.
Exception: no gain or loss shall be recognized if in
pursuance of a plan of merger or consolidation-
a. a corporation, which is a party to a merger or
consolidation, exchanges property solely for stock in
a corporation, which is a party to the merger or
consolidation
b. a shareholder exchanges stock in a corporation,
which is a party to the merger or consolidation, solely
for the stock of another corporation also a party to
the merger or consolidation
c. a security holder of a corporation, which is a party
to the merger of consolidation exchanges his
securities in such corporation, solely for stock or
securities in another corporation, a party to the
merger or consolidation.
Transactions resulting in taxable gains but no
recognition of losses
a. sale or exchange between related parties
b. wash sales by non dealers of securities when not
subject to stock transfer tax
c. Exchange not solely in kind in merger and
consolidation and
d. Sales or Exchanges that are not at arms length.
1. Merger or Consolidation
Exchange solely in kind in legitimate M and C
includes:
1. Between the corporations which are parties to the
merger or consolidations (property for stocks)
2. Between a stockholder of a corporation to a merger
or consolidation and the other party corporation
(stock for stock)
3. Between a security holder of a corporation party to
a merger or consolidation and the other party
corporation (securities for securities)
2. Transfers to Controlled Corporation
Exchange of property for stocks resulting in
acquisition of control by a person alone or together
with others not exceeding four
Control- means ownership of stocks in a corporation
amounting to atleast 51% of the total voting powers
of all classes of stocks entitled to vote
6
3. Sec 40(C)(2) of the NIRC
ISSUANCE of CERT AUTHORIZING
REGISTRATION/ TAX CLEARANCE
The CAR/TCL for the real property or share of
stock/unit of participation/interest involved in the
exchange shall be issued by the Revenue District
Officer (RDO) or by the Authorized Internal Revenue
Officer (AIRO), on the basis of the certification-ruling
issued by the Commissioner or his duly authorized
representative to the effect that the transaction
qualifies as a tax-free exchange or corporate
reorganization under Section 40(C)(2) of the Tax Code
of 1997. The necessary proof of payment of
appropriate documentary stamp taxes must also be
presented.
The CAR/TCL to be issued shall specify, among others,
that the transaction involved is a tax-free exchange
under Section 40(C)(2) of the Tax Code of 1997; the
date of exchange; the original or adjusted basis as
represented by the taxpayer, and substituted basis of
the properties as stated in the certification or ruling
issued by the Bureau of Internal Revenue.

4. RR no. 18-01 dated Nov 13, 2001

The parties to the transaction shall comply with the
pertinent provisions of Revenue Regulations No. 18-
2001 dated November 13, 2001, regarding the
records to be kept and information to be filed in
connection with the tax-free exchange, provided that,
any violation thereof, including the failure of the
parties to present proof of annotation of the
substituted basis within the period provided in
Section 7 of such Regulations shall be referred to the
Prosecution Division for appropriate action.
5. RMR No. 1-01 dated November 29, 2001
6. RMR No. 1-02 dated April 25, 2002
Tax consequences of de facto merger
This Revenue Memorandum Ruling is issued to
consolidate, provide, clarify and harmonize the
existing guidelines on the tax consequences of a de
facto merger under Section 40(C)(2) and (6)(b) of the
Tax Code of 1997. This Revenue Memorandum Ruling
shall apply solely and exclusively to, and may be
relied upon only in, situations in which the facts are
substantially similar to the facts stated below, but
subject to the principle that for such transaction to be
considered a de facto merger within the purview of
Section 40(C)(2) in relation to 40(6)(b) of the Tax
Code of 1997, the same must be undertaken for a
bona fide business purpose and not solely for the
purpose of escaping the burden of taxation.

7. RR No. 6-2008 dated April 22, 2008

8. RMO 17-2016

7
 Delpher Trades Corporation vs. IAC

The legal right of a taxpayer to decrease the

amount of what otherwise could be his taxes or
altogether avoid them, by means which the law
permits, cannot be doubted.

FACTS:
Delfin Pacheco and sister Pelagia were the owners of
a parcel of land in Polo (now Valenzuela).
Subsequently, they leased to Construction
Components International Inc. the property and
providing for a right of first refusal should it decide to
sell the said property.
Construction Components International, Inc. assigned
its rights and obligations under the contract of lease
in favor of Hydro Pipes Philippines, Inc. with the
signed conformity and consent of Delfin and Pelagia.
In 1976, a deed of exchange was executed between
lessors Delfin and Pelagia Pacheco and defendant
Delpher Trades Corporation whereby the Pachecos
conveyed to the latter the leased property together
with another parcel of land also located.
On the ground that it was not given the first option to
buy the leased property pursuant to the lease
agreement, respondent Hydro Pipes Philippines filed
an amended complaint for reconveyance of the lot
under the conditions similar to those of Delpher. The
court ruled in favor of Hydro declaring the existence
of its preferential right to acquire the subject
property. IAC affirmed.
Petitioner Delpher contend that there was actually no
transfer of ownership, the Pachecos having remained
in control of the property. They alleged that petitioner
Delpher is a family corporation , organized by the
children of Pelagia, who owned the parcel of land
leased to private respondent Hydro to perpetuate
their control over the property through the
corporation and to avoid taxes. It also alleged that to
accomplish this, the leased property was transferred
to petitioner Delpher by virtue of a deed of exchange,
and in exchange for the properties they acquired
majority shares of petitioner Delpher corporation. In
short, petitioners contend that the Pachecos did not
sell the leased property since they exchanged the
land for shares in their own corporation. Private
respondent, however, contend that petitioner Delher
Trades is a corporation separate and distinct from the
Pachecos.

ISSUE:
Whether or not the "Deed of Exchange" of the
properties executed by the Pachecos on the one hand
and the Delpher Trades Corporation on the other was
meant to be a contract of sale which, in effect,
prejudiced the private respondent's right of first
CASES:

8
refusal over the leased property included in the deed
of exchange
RULING:
The Court ruled in favor of the petitioner. The "Deed
of Exchange" of property between the Pachecos and
Delpher Trades Corporation cannot be considered a
contract of sale. There was no transfer of actual
ownership interests by the Pachecos to a third party.
The Pacheco family merely changed their ownership
from one form to another. The ownership remained in
the same hands. Hence, the private respondent has
no basis for its claim of a light of first refusal under
the lease contract.
By their ownership of a capital equal to 55% of the
shares, the Pachecos have the control of the
petitioner corporation. In effect, the petitioner
corporation is a business conduit of the Pachecos.
What they really did was to invest their properties
and change the nature of their ownership from
unincorporated to incorporated form by organizing
Delpher Trades Corporation to take control of their
properties and at the same time save on inheritance
taxes
The execution of the deed of exchange on the
properties for no par value shares, the Pachecos were
able to provide for a tax free exchange of property,
such that they were able to execute the deed of
exchange free from income tax and acquire a
corporation. Sec. 35 of the NIRC provides that No
gain or loss shall also be recognized if a person
exchanges his property for stock in a corporation of
which as a result of such exchange said person alone
or together with others not exceeding four persons
gains control of said corporation."
The Court believes that there is nothing wring about
the estate planning scheme resorted to by the
Pachecos. The legal right of a taxpayer to
decrease the amount of what otherwise could
be his taxes or altogether avoid them, by
means which the law permits, cannot be
doubted.
DELPHER TRADES CORPORATION, and DELPHIN
PACHECO vs.INTERMEDIATE APPELLATE COURT
and HYDRO PIPES PHILIPPINES, INC.,
FACTS:
In 1974, Delfin Pacheco and his sister, Pelagia
Pacheco, were the owners of 27,169 square meters of
real estate Identified as Lot. No. 1095, Malinta Estate,
in the Municipality of Polo (now Valenzuela), Province
of Bulacan (now Metro Manila) which is covered by
Transfer Certificate of Title No. T-4240 of the Bulacan
land registry.
On April 3, 1974, the said co-owners leased to
Construction Components International Inc. the same
property and providing that during the existence or
after the term of this lease the lessor should he
decide to sell the property leased shall first offer the
same to the lessee and the letter has the priority to
buy under similar conditions.
4 months later, lessee Construction Components
International, Inc. assigned its rights and obligations
under the contract of lease in favor of Hydro Pipes
Philippines, Inc. with the signed conformity and
consent of lessors Delfin Pacheco and Pelagia
Pacheco.
The contract of lease, as well as the assignment of
lease were annotated at the back of the title, as per
stipulation of the parties.
On January 3, 1976, a deed of exchange was
executed between lessors Delfin and Pelagia Pacheco
and defendant Delpher Trades Corporation whereby
the former conveyed to the latter the leased property
together with another parcel of land for 2,500 shares
of stock of defendant corporation with a total value of
P1,500,000.00
On the ground that it was not given the first option to
buy the leased property pursuant to the proviso in the
lease agreement, respondent Hydro Pipes Philippines,
Inc., filed an amended complaint for reconveyance of
Lot. No. 1095 in its favor under conditions similar to
those whereby Delpher Trades Corporation acquired
the property from Pelagia Pacheco and Delphin
Pacheco.
The CFI of Bulacan ruled in favor of the plaintiff.
The IAC affirmed the decision of the CFI.
ISSUE:
Whether or not the "Deed of Exchange" of the
properties executed by the Pachecos on the one hand
and the Delpher Trades Corporation on the other was
meant to be a contract of sale which, in effect,
prejudiced the private respondent's right of first
refusal over the leased property included in the "deed
of exchange."
ARGUMENTS:
Eduardo Neria, a CPA and son-in-law of the late
Pelagia Pacheco testified that Delpher Trades
Corporation is a family corporation and that the
corporation was organized by the children of the two
spouses (spouses Pelagia Pacheco and Benjamin
Hernandez and spouses Delfin Pacheco and Pilar
Angeles in order to perpetuate their control over the
property through the corporation and as a means to
avoid taxes.
Under this factual backdrop, the petitioners contend
that there was actually no transfer of ownership of
the subject parcel of land since the Pachecos
remained in control of the property. Thus, the
petitioners allege: "Considering that the beneficial
ownership and control of Petitioner Corporation
remained in the hands of the original co-owners,
there was no transfer of actual ownership interests
over the land when the same was transferred to
Petitioner Corporation in exchange for the latter's
9
shares of stock. The transfer of ownership, if
anything, was merely in form but not in substance. In
reality, Petitioner Corporation is a mere alter ego or
conduit of the Pacheco co-owners
On the other hand, the private respondent argues
that Delpher Trades Corporation is a corporate entity
separate and distinct from the Pachecosn and that
there was actual transfer of ownership interests over
the leased property when the same was transferred
to Delpher Trades Corporation in exchange for the
latter's shares of stock.
RULING:
No, it was not meant to be a contract of sale.
After incorporation, one becomes a stockholder of a
corporation by subscription or by purchasing stock
directly from the corporation or from individual
owners thereof (Salmon, Dexter & Co. v. Unson, 47
Phil, 649, citing Bole v. Fulton [1912], 233 Pa., 609).
In the case at bar, in exchange for their properties,
the Pachecos acquired 2,500 original unissued no par
value shares of stocks of the Delpher Trades
Corporation. Consequently, the Pachecos became
stockholders of the corporation by subscription "The
essence of the stock subscription is an agreement to
take and pay for original unissued shares of a
corporation, formed or to be formed.
It is to be stressed that by their ownership of
the 2,500 no par shares of stock, the Pachecos have
control of the corporation. Their equity capital is 55%
as against 45% of the other stockholders, who also
belong to the same family group.
In effect, the Delpher Trades Corporation is a
business conduit of the Pachecos. What they really
did was to invest their properties and change the
nature of their ownership from unincorporated to
incorporated form by organizing Delpher Trades
Corporation to take control of their properties and at
the same time save on inheritance taxes.
The records do not point to anything wrong or
objectionable about this "estate planning" scheme
resorted to by the Pachecos. "The legal right of a
taxpayer to decrease the amount of what otherwise
could be his taxes or altogether avoid them, by
means which the law permits, cannot be doubted.
The "Deed of Exchange" of property between
the Pachecos and Delpher Trades Corporation cannot
be considered a contract of sale. There was no
transfer of actual ownership interests by the
Pachecos to a third party. The Pacheco family merely
changed their ownership from one form to another.
The ownership remained in the same hands. Hence,
the private respondent has no basis for its claim of a
light of first refusal under the lease contract.
DISPOSITIVE PORTION
WHEREFORE, the instant petition is hereby
GRANTED, The questioned decision and resolution of
the then Intermediate Appellate Court are REVERSED
and SET ASIDE. The amended complaint in Civil Case
No. 885-V-79 of the then Court of First Instance of
Bulacan is DISMISSED. No costs.
DELPHER TRADES CORPORATIONvs. IAC
FACTS:
Delfin Pacheco and sister Pelagia were the owners of
a parcel of land in Polo (now Valenzuela). On April 3,
1974, they leased to Construction Components
International Inc. the property and providing for a
right of first refusal should it decide to buy the said
property.
Construction Components International, Inc. assigned
its rights and obligations under the contract of lease
in favor of Hydro Pipes Philippines, Inc. with the
signed conformity and consent of Delfin and Pelagia.
In 1976, a deed of exchange was executed between
lessors Delfin and Pelagia Pacheco and defendant
Delpher Trades Corporation whereby the Pachecos
conveyed to the latter the leased property together
with another parcel of land also located in Malinta
Estate, Valenzuela for 2,500 shares of stock of
defendant corporation with a total value of P1.5M.
On the ground that it was not given the first option to
buy the leased property pursuant to the proviso in the
lease agreement, respondent Hydro Pipes Philippines,
Inc., filed an amended complaint for reconveyance of
the lot.
ISSUE:
WON the Deed of Exchange of the properties
executed by the Pachecos and the Delpher Trades
Corporation on the other was meant to be a contract
of sale which, in effect, prejudiced the Hydro Phil's
right of first refusal over the leased property included
in the "deed of exchange,"
HELD:
No, by their ownership of the 2,500 no par shares of
stock, the Pachecos have control of the corporation.
Their equity capital is 55% as against 45% of the
other stockholders, who also belong to the same
family group. In effect, the Delpher Trades
Corporation is a business conduit of the Pachecos.
What they really did was to invest their properties
and change the nature of their ownership from
unincorporated to incorporated form by organizing
Delpher Trades Corporation to take control of their
properties and at the same time save on inheritance
taxes.
The "Deed of Exchange" of property between the
Pachecos and Delpher Trades Corporation cannot be
considered a contract of sale. There was no transfer
of actual ownership interests by the Pachecos to a
third party. The Pacheco family merely changed their
ownership from one form to another. The ownership
remained in the same hands. Hence, the private
respondent has no basis for its claim of a light of first
refusal
COMMISSIONER OF INTERNAL REVENUE VS.
FILINVEST DEVELOPMENT CORPORATION
FACTS:
10
Filinvest Development Corporation extended
advances in favor of its affiliates and supported the
same with instructional letters and cash and journal
vouchers. The BIR assessed Filinvest for deficiency
income tax by imputing an arms length interest
rate on its advances to affiliates. Filinvest disputed
this by saying that the CIR lacks the authority to
impute theoretical interest and that the rule is that
interests cannot be demanded in the absence of a
stipulation to the effect.
ISSUE: Can the CIR impute theoretical interest on the
advances made by Filinvest to its affiliates?
HELD: NO.
Despite the seemingly broad power of the CIR to
distribute, apportion and allocate gross income under
(now) Section 50 of the Tax Code, the same does not
include the power to impute theoretical interests
even with regard to controlled taxpayers
transactions. This is true even if the CIR is able to
prove that interest expense (on its own loans) was in
fact claimed by the lending entity. The term in the
definition of gross income that even those income
from whatever source derived is covered still
requires that there must be actual or at least
probable receipt or realization of the item of gross
income sought to be apportioned, distributed, or
allocated. Finally, the rule under the Civil Code that
no interest shall be due unless expressly stipulated
in writing was also applied in this case.
The Court also ruled that the instructional letters,
cash and journal vouchers qualify as loan agreements
that are subject to DST.
COMMISSIONER OF INTERNAL REVENUE VS.
FILINVEST DEVELOPMENT CORPORATION
FACTS:
Filinvest Development Corp (FDC) is the owner of
outstanding shares of both Filinvest Alabang, Inc.
(FAI) and Filinvest Land, Inc. (FLI) with 80% and
67.42%, respectively. Sometime in 1996, FDC and FAI
entered into a Deed of Exchange with FLI where both
transferred parcels of land in exchange for shares of
stocks of FLI. As a result, the ownership structure of
FLI changed whereby FDCs ownership decreased
from 67.42% to 61.03% meanwhile FAI now owned
9.96% of shares of FLI. FLI then requested from the
BIR a ruling to the effect that no gain or loss should
be recognized on said transfer and BIR issued Ruling
No. S-34-046-97 finding the exchange falling within
Sec. 34 (c) (2) (now Sec. 40 (c)(2)) of the NIRC.
Furthermore, FDC extended advances in favor of its
affiliates during 1996 and 1997 duly evidenced by
instructional letters as well as cash and journal
vouchers. Moreover, FDC also entered into a
shareholders agreement with Reco-Herrera PTE ltd.
(RHPL) for the formation of a Singapore-based joint
venture company called Filinvest Asia Corp. (FAC).
The equity participation of FDC was pegged at 60%
subscribing to P500.7M worth of shares of FAC.
On Jan 3, 2000, FDC received assessment notices for
deficiency income tax and deficiency stamp taxes.
The foregoing deficiency taxes were assessed on the
taxable gain realized by FDC on the taxable gain
supposedly realized by FDC from the Deed of
Exchange it executed with FAI and FLI, on the dilution
resulting from the shareholders agreement FDC
executed with RHPL and with the interest rate and
documentary stamp taxes imposable on the advances
executed by FDC. FAI also received similar
assessment on deficiency income tax relating to the
deed of exchange. Both FDC and FAI protested and
after having failed to act on their protest they
docketed their case with the CTA. They raised the
issue that pursuant to BIR Ruling No. S-34-046-97, no
taxable gain should have been assessed from the
deed of exchange and that the BIR cannot impute
theoretical interests on the cash advances of FDC in
the absence of stipulation and that not being
promissory notes such are not subject to
documentary stamp taxes. CIR, for its part, raised
that the said transfer of property resulted to a
diminution of ownership by FDC of FLI rather than
gaining further control and as such should not be tax
free. Furthermore, CIR invoked Sec. 43 (now Sec. 50)
of NIRC as implemented by RR No. 2, the CIR is given
the "the power to allocate, distribute or apportion
income or deductions between or among such
organizations, trades or business in order to prevent
evasion of taxes." Also the CIR justified the imposition
of documentary stamp taxes on the instructional
letters citing Sec. 180 of the NIRC and RR No. 9-94
which provide that loan transactions are subject to
tax irrespective of whether or not they are evidenced
by a formal agreement or by mere office memo.
Lastly, it reiterated that there was dilution of its
shares as a result of its shareholders agreement with
RHPL. CTA decided in favor of FDC with the exception
on the deficiency income tax on the interest income
from the income it supposedly realized from the
advances to its affiliates, the rest of the assessment
were cancelled. The CTA opined that CIR was justified
in assessing undeclared interests on the same cash
advances pursuant to his authority under Section 43
of the NIRC in order to forestall tax evasion.
Dissatisfied, FDC filed a petition for review with the
Court of Appeals claiming that the cash advances it
extended to its affiliates were interest-free in the
absence of express stipulation. Moreover, it claimed
that under Sec. 43 (now Sec. 50) the CIRs authority
does not include the power to impute imaginary
interests, directed only to controlled corp and not to
holding company and can be invoked only on cases of
understatement of taxable income or evident tax
evasion. The CA rendered a decision in favor of FDC
cancelling said assessment. The CIR filed a petition
for review with the CA which subsequently denied for
lack of merit. The CA has the following conclusions: 1.
The deed of exchange resulted in a combined control
of more than 51% of FLI , hance no taxable gain; 2.
The instructional letters do not partake the nature of
loan agreements; 3. Although subsequently modified
by BIR Ruling No. 108-99 to the effect that
11
 documentary stamp tax are now imposable on
interoffice memos, to give a retroactive application
would be prejudicial to the taxpayer.; 4. FDCs alleged
gain from the increase of its shareholding in FAC are
mere unrealized increase in capital unless converted
thru sale are not taxable. Hence, this petition for
review on certiorari.
ISSUES:
(1) Whether or not FDC is liable for theoretical
interest on said advances extended by it to its
affiliates.
(2) Whether or not FDC met all the requirements for
non-recognition of taxable gain under Sec. 34 (c) (2)
(now Sec. 40 (C) (2) of the NIRC and therefore, is not
taxable.
(3) WON the letters of instructions or cash vouchers
are deemed loan agreements subject to documentary
stamp tax.
(4) WON the dilution as a result of increase of FDCs
shareholding in FAC is taxable.
HELD:
(1) No. Sec. 43 (now Sec. 50) of the NIRC does not
include the power to impute theoretical interest to
the CIRs powers of distribution, apportionment or
allocation of gross income and deductions. There
must be proof of actual or probable receipt or
realization by the controlled taxpayer of the item of
gross income sought to be distributed, apportioned or
allocated by the CIR. In the case at bar, records do
not show that there was evidence that the advances
extended yielded interests. Even if FDC deducted
substantial interest expenses from its gross income,
there would still be no basis for the imputation of
theoretical interests on the subject advances. Under
Art. 1956 of the Civil Code, no interest shall be due
unless it has been expressly stipulated in writing.
Moreover, taxes being burdens are not to be
presumed and that tax statutes must be construed
strictly against the government and liberally in favor
of the taxpayer.
(2) Yes. It was admitted in the stipulation of facts that the
following are the requisites: (a) the transferee is a
corporation; (b) the transferee exchanges its shares
of stock for property/ies of the transferor; (c) the
transfer is made by a person, acting alone or together
with others, not exceeding four persons; and, (d) as a
result of the exchange the transferor, alone or
together with others, not exceeding four, gains
control of the transferee. Moreover, it is not taxable
because the exchange did not result to a decrease of
the ownership of FDC in FLI rather combining the
interests of FDC and FAI result to 70.99% of FLIs
outstanding shares. Since the term "control" is clearly
defined as "ownership of stocks in a corporation
possessing at least fifty-one percent (51%) of the
total voting power of classes of stocks entitled to one
vote then the said exchange clearly qualify as a tax-
free transaction. Therefore, both FDC and FAI cannot
be held liable for deficiency income tax on said
transfer.
(3) Yes. The instructional letters as well as the journal
and cash vouchers evidencing the advances FDC
extended to its affiliates in 1996 and 1997 qualified
as loan agreements upon which documentary stamp
taxes may be imposed. apply them would be
prejudicial to the taxpayers. This rule does not apply:
(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. The
principle of non-retroactivity of BIR rulings does not
apply in favor of FDR because it is not the taxpayer
who in the first place, sought the said BIR ruling from
the CIR.
(4) No. the CIR has no factual and legal basis in
assessing income tax on the increase in the value of
FDC's shareholdings in FAC until the same is actually
sold at a profit. A mere increase or appreciation in the
value of said shares cannot be considered income for
taxation purposes. Besides, tax revenues should be
strictly construed and that rulings of the CTA should
be accorded with respect and upheld by the Court
absent any reversible errors.
COMMISSIONER OF INTERNAL REVENUE VS.
FILINVEST DEVELOPMENT CORPORATION
FACTS:
The owner of 80% of the outstanding shares of
respondent Filinvest Alabang, Inc. (FAI), respondent
Filinvest Development Corporation (FDC) is a holding
company which also owned 67.42% of the
outstanding shares of Filinvest Land, Inc. (FLI). FDC
and FAI entered into a Deed of Exchange with FLI
whereby the former both transferred in favor of the
latter parcels of land appraised at P4,306,777,000.00.
In exchange for said parcels which were intended to
facilitate development of medium-rise residential and
commercial buildings, 463,094,301 shares of stock of
FLI were issued to FDC and FAI.
Later, FLI requested a ruling from the BIR to the effect
that no gain or loss should be recognized in the
aforesaid transfer of real properties. Acting on the
request, the BIR issued Ruling No. S-34-046-97 dated
3 February 1997, finding that the exchange is among
those contemplated under Section 34 (c) (2) of the
old NIRC (Now Section 40, NIRC) which provides that
(n)o gain or loss shall be recognized if property is
12
transferred to a corporation by a person in exchange
for a stock in such corporation of which as a result of
such exchange said person, alone or together with
others, not exceeding four (4) persons, gains control
of said corporation." With the BIRs reiteration of the
foregoing ruling upon the request for clarification filed
by FLI, the latter, together with FDC and FAI, complied
with all the requirements imposed in the ruling.
On various dates during the years 1996 and 1997, in
the meantime, FDC also extended advances in
favor of its affiliates, namely, FAI, FLI, Davao Sugar
Central Corporation (DSCC) and Filinvest Capital, Inc.
(FCI). Duly evidenced by instructional letters as well
as cash and journal vouchers, said cash advances
amounted to P2,557,213,942.60 in 1996 and
P3,360,889,677.48 in 1997. FDC also entered into a
Shareholders Agreement with Reco Herrera PTE Ltd.
(RHPL) for the formation of a Singapore-based joint
venture company called Filinvest Asia Corporation
(FAC), tasked to develop and manage FDCs 50%
ownership of its PBCom Office Tower Project (the
Project). With their equity participation in FAC
respectively pegged at 60% and 40% in the
Shareholders Agreement, FDC subscribed to P500.7
million worth of shares in said joint venture company
to RHPLs subscription worth P433.8 million. Having
paid its subscription by executing a Deed of
Assignment transferring to FAC a portion of its rights
and interest in the Project worth P500.7 million, FDC
eventually reported a net loss of P190,695,061.00 in
its Annual Income Tax Return for the taxable year
1996.
Then, FDC received from the BIR a Formal Notice of
Demand to pay deficiency income and documentary
stamp taxes, plus interests and compromise
penalties, covered by the following Assessment
Notices, viz.: (a) Assessment Notice for deficiency
income taxes in the sum of P150,074,066.27 for
1996; (b) Assessment Notice for deficiency
documentary stamp taxes in the sum of
P10,425,487.06 for 1996; (c) Assessment Notice for
deficiency income taxes in the sum of P5,716,927.03
for 1997; and (d) Assessment for deficiency
documentary stamp taxes in the sum of
P5,796,699.40 for 1997. The foregoing deficiency
taxes were assessed on the taxable gain supposedly
realized by FDC from the Deed of Exchange it
executed with FAI and FLI, on the dilution resulting
from the Shareholders Agreement FDC executed with
RHPL as well as the arms-length interest rate and
documentary stamp taxes imposable on the advances
FDC extended to its affiliates.
FAI similarly received from the BIR a Formal Letter of
Demand for deficiency income taxes in the sum of
P1,477,494,638.23 for the year 1997. Covered by
Assessment Notice, said deficiency tax was also
assessed on the taxable gain purportedly realized by
FAI from the Deed of Exchange it executed with FDC
and FLI. Within the reglementary period of thirty (30)
days from notice of the assessment, both FDC and FAI
filed their respective requests for
reconsideration/protest, on the ground that the
deficiency income and documentary stamp taxes
assessed by the BIR were bereft of factual and legal
basis. Having submitted the relevant supporting
documents pursuant to the 31 January 2000 directive
from the BIR Appellate Division, FDC and FAI filed a
letter requesting an early resolution of their request
for reconsideration/protest on the ground that the
180 days prescribed for the resolution thereof under
Section 228 of the NIRC was going to expire on 20
September 2000.
In view of the failure of petitioner CIR to resolve their
request for reconsideration/protest within the
aforesaid period, FDC and FAI filed a petition for
review with the CTA. The petition alleged, among
other matters, that as previously opined in BIR Ruling
No. S-34-046-97, no taxable gain should have been
assessed from the subject Deed of Exchange since
FDC and FAI collectively gained further control of FLI
as a consequence of the exchange; that correlative to
the CIR's lack of authority to impute theoretical
interests on the cash advances FDC extended in favor
of its affiliates, the rule is settled that interests
cannot be demanded in the absence of a stipulation
to the effect; that not being promissory notes or
certificates of obligations, the instructional letters as
well as the cash and journal vouchers evidencing said
cash advances were not subject to documentary
stamp taxes; and, that no income tax may be
imposed on the prospective gain from the supposed
appreciation of FDC's shareholdings in FAC. As a
consequence, FDC and FAC both prayed that the
subject assessments for deficiency income and
documentary stamp taxes for the years 1996 and
1997 be cancelled and annulled.
CTA decision - went on to render the decision dated
10 September 2002 which, with the exception of the
deficiency income tax on the interest income FDC
supposedly realized from the advances it extended in
favor of its affiliates, cancelled the rest of deficiency
income and documentary stamp taxes assessed
against FDC and FAI for the years 1996 and 1997.
However [FDC] is ordered to pay the amount of
P5,691,972.03 as deficiency income tax for taxable
year 1997. In addition, FDC is also ordered to pay
20% delinquency interest computed from February
16, 2000 until full payment thereof pursuant to
Section 249 (c) (3) of the Tax Code.1
Dissatisfied with the foregoing decision, FDC filed
petition for review -- Calling attention to the fact that
the cash advances it extended to its affiliates were
interest-free in the absence of the express stipulation
on interest required under Article 1956 of the Civil
Code, FDC questioned the imposition of an arm's-
length interest rate thereon on the ground, among
others, that the CIR's authority under Section 43 of
the NIRC: (a) does not include the power to impute
1 [26]
Id. at 477.
13
imaginary interest on said transactions; (b) is directed
only against controlled taxpayers and not against
mother or holding corporations; and, (c) can only be
invoked in cases of understatement of taxable net
income or evident tax evasion.
CA upheld FDCs position and reversed and set
aside CTA deicision.
ISSUE: Whether or not the advances extended
by FDC to its affiliates are subject to income tax
and also subject to interest.
RATIO: Yes. Section 43 [now Section 50] of the
1993 National Internal Revenue Code (NIRC) provides
that. (i)n case of two or more organizations, trades
or businesses (whether or not incorporated and
whether or not organized in the Philippines) owned or
controlled directly or indirectly by the same interests,
the Commissioner of Internal Revenue [(CIR)] is
authorized to distribute, apportion or allocate gross
income or deductions between or among such
organization, trade of business, if he determines that
such distribution, apportionment or allocation is
necessary in order to prevent evasion of taxes or
clearly to reflect the income of any such organization,
trade or business, Section 179 of Revenue
Regulations No. 2 provides in part that (i)n
determining the true net income of a controlled
taxpayer, the [CIR] is not restricted to the case of
improper accounting, to the case of a fraudulent,
colorable, or sham transaction, or to the case of a
device designed to reduce of avoid tax by shifting or
distorting income or deductions. The authority to
determine true net income extends to any case in
which either by inadvertence or design the taxable
net income in whole or in part, of a controlled
taxpayer, is other than it would have been had the
taxpayer in the conduct of his affairs been an
uncontrolled taxpayer dealing at arms length with
another uncontrolled taxpayer. Despite the broad
parameters provided, however, the CIRs power of
distribution, apportionment or allocation of gross
income and deductions under the NIRC and Revenue
Regulations No. 2 do not include the power to impute
theoretical interests to the taxpayers transactions.
Pursuant to Section 28 [now Section 32] of the NIRC,
the term gross income is understood to mean all
income from whatever source derived, including, but
not limited to certain items. While it has been held
that the phrase from whatever source derived
indicates a legislative policy to include all income not
expressly exempted within the class of taxable
income under Philippine laws, the term income has
been variously interpreted to mean cash received or
its equivalent, the amount of money coming to a
person within a specific time or something distinct
from principal or capital. Otherwise stated, there
must be proof of the actual or, at the very least,
probable receipt or realization by the controlled
taxpayer of the item of gross income sought to be
distributed, apportioned or allocated by the CIR. In
this case, there is no evidence of actual or possible
showing that the advances taxpayer extended to its
affiliates had resulted to interests subsequently
assessed by the CIR. Even if the Court were to accord
credulity to the CIRs assertion that taxpayer had
deducted substantial interest expense from its gross
income, there would still be no factual basis for the
imputation of theoretical interests on the subject
advances and assess deficiency income taxes
thereon. Further, pursuant to Article 1959 of the Civil
Code of the Philippines, no interest shall be due
unless it has been expressly stipulated in writing.
ISSUE: Whether or not FDC is subject to
documentary stamp tax.
RATIO: Yes. Loan agreements and promissory notes
are taxed under Section 180 of the 1993 National
Internal Revenue Code (NIRC) [they are now taxed
under Section 179 as evidence of indebtedness].
When read in conjunction with Section 173 of the
NIRC, Section 180 concededly applies to [a]ll loan
agreements, whether made or signed in the
Philippines, or abroad when the obligation or right
arises from Philippine sources or the property or
object of the contract is located or used in the
Philippines. Section 3 (b) of Revenue Regulations No.
9-94 provides in part that the term loan agreement
shall include credit facilities, which may be
evidenced by credit memo, advice or drawings.
Section 6 of the same revenue regulations further
provides that [i]n cases where no formal agreements
or promissory notes have been executed to cover
credit facilities, the documentary stamp tax shall be
based on the amount of drawings or availment of the
facilities, which may be evidenced by credit/debit
memo, advice or drawings by any form of check or
withdrawal slip Applying the foregoing to the case,
the instructional letters as well as the journal and
cash vouchers evidencing the advances taxpayer
extended to its affiliates in 1996 and 1997 qualified
as loan agreements upon which documentary stamp
taxes may be imposed.
14

CIR v RUFINO
FACTS:
This is a petition for review on certiorari of the CTA
decision which absolved petitioners from liability for
capital gains tax on stocks received by them from
Eastern Theatrical, Inc. The Rufinos were majority
stockholders of Eastern Theatrical Co., Inc
(hereinafter Old ETC) which had a corporate term of
25 years, which terminated on January 25, 1959,
president of which was Ernesto Rufino. On December
8, 1958, the Eastern Theatrical Co, Inc. (hereinafter
New ETC, with a corporate term of 50 years) was
organized, and the Rufinos were also the majority
stockholders of the corporation, with Vicente Rufino
as the General-Manager. Both ETCs were engaged in
the same business.
Old ETC held a stockholders meeting to merge with
the New ETC on December 17, 1958 to continue its
business after the end of Old ETCs corporate term.
The merger was authorized by a board resolution. It
was expressly declared that the merger was
necessary to continue operating the Capitol and Lyric
Theaters in Manila even after the expiration of
corporate existence, to preserve both its booking
contracts and to uphold its collective bargaining
agreements. Through the two Rufinos (Ernesto and
Vicente), a Deed of Assignment was executed, which
conveyed and transferred all the business, property,
assets and good will of the Old ETC to the New ETC in
exchange for shares of stock of the latter to be issued
to the shareholders at the rate of one stock for each
stock held in the Old ETC. The Deed was to retroact
from January 1, 1959. New ETCs Board approved the
merger and the Deed of Assignment on January 12,
1959 and all changes duly registered with the SEC.
The BIR, after examination, declared that the merger
was not undertaken for a bona fide business purpose
but only to avoid liability for the capital gains tax on
the exchange of the old for the new shares of stock.
He then imposed deficiency assessments against the
private respondents, the Rufinos. The Rufinos
requested for a reconsideration, which was denied.
Therefore, they elevated their matter to the CTA, who
reversed the judgment of the CIR, saying that they
found that there was no taxable gain derived from
the exchange of old stocks simply for new stocks for
the New Corporation because it was pursuant to a
valid plan of reorganization. The CIR raised it to the
SC on petition for review on certiorari.
ISSUE: WON there was a valid merger and that there
was no taxable gain derived therefrom.
HELD:
YES, the CTA was correct in ruling that there WAS a
merger and that no taxable gain was derived. CTA
decision is AFFIRMED.
Rationale:
Validity of transfer. In support of its argument that the
Rufinos were trying to avoid the payment of capital
gains tax, the CIR said that the New ETC did not
actually issue stocks in exchange for the properties of
the Old ETC. The increase in capitalization only
happened in March 1959, or 37 days after the Old
ETC expired. Prior to registration, the New ETC could
not have validly performed the transfer. The SC ruled
that the retroactivity of the Deed of Assignment cured
the defect and there was no impediment.
Bona Fide Business Purpose. The criterion of the law
is that the purpose of the merger must be for a bona
fide business purpose and not for the purpose of
escaping taxes. The case of Helvering v. Gregory
stated that a mere operation having no business or
corporate purposea mere devise which put on the
form of a corporate reorganization as a disguise for
concealing its real character and the sole object and
accomplishment of which was the consummation of a
preconceived plan, not to reorganize a business but
to transfer a parcel of corporate shares. When the
corporation created is nothing more than a
contrivance, there is no legitimate business purpose.
The Court states that there is no such furtive
intention in this case. In fact, the New ETC continues
to operate the Capitol and Lyric movie theaters even
up to 27 years after the merger. There is as yet no
dissolution, so the Rufinos havent gained any benefit
yet from the merger, which makes them no more
liable than the time the merger took place.
The governments remedy: The merger merely
deferred the payment for taxes until the future, which
the government may assert later on when gains are
realized and benefits are distributed among the
stockholders as a result of the merger. The taxes are
not forfeited but merely postponed and may be
imposed at the proper time later on.
COMMISSIONER v. RUFINO, L-33665-68
FACTS:
The private respondents were the majority
stockholders of the defunct Eastern Theatrical Co. It
had an original capital stock of P500,000.00, which
was increased in 1949 to P2,000,000.00, divided into
200,000 shares at P10.00 per share, and was
organized to engage in the business of operating
theaters, opera houses, places of amusement and
other related business enterprises, more particularly
the Lyric and Capitol Theaters in Manila. The
President of this corporation (hereinafter referred to
as the Old Corporation) during the year in question
was Ernesto D. Rufino.
They are also the majority and controlling
stockholders of another corporation, the Eastern
Theatrical, Inc. This corporation is engaged in the
same kind of business as the Old Corporation. The
General-Manager of this corporation (hereinafter
referred to as the New Corporation) at the time was
Vicente A. Rufino.
In a special meeting of stockholders of the Old
Corporation on December 17, 1958, to provide for the
continuation of its business after the end of its
corporate life, and upon the recommendation of its
board of directors, a resolution was passed
15
authorizing the Old Corporation to merge with the
New Corporation by transferring all its business,
assets, goodwill, and liabilities to the latter, which in
exchange would issue and distribute to the
shareholders of the Old Corporation one share for
each share held by them in the said Corporation.
It was expressly declared that the merger of the Old
Corporation with the New Corporation was necessary
to continue the exhibition of moving pictures at the
Lyric and Capitol Theaters even after the expiration of
the corporate existence of the former, in view of its
pending booking contracts, not to mention its
collective bargaining agreements with its employees.
The aforesaid transfer was eventually made by the
Old Corporation to the New Corporation, which
continued the operation of the Lyric and Capitol
Theaters and assumed all the obligations and
liabilities of the Old Corporation beginning January 1,
1959.
The Bureau of Internal Revenue examined later,
resulting in the petitioner declaring that the merger
of the aforesaid corporations was not undertaken for
a bona fide business purpose but merely to avoid
liability for the capital gains tax on the exchange of
the old for the new shares of stock. Accordingly, he
imposed the deficiency assessments against the
private respondents.
HELD:
The Court of Tax Appeals did not err in finding that
no taxable gain was derived by the private
respondents from the questioned transaction. There
was a valid merger although the actual transfer of the
properties subject of the Deed of Assignment was not
made on the date of the merger. The Court finds no
impediment to the exchange of property for stock
between the two corporations being considered to
have been effected on the date of the merger. That,
in fact, was the intention, and the reason why the
Deed of Assignment was made retroactive to January
1, 1959. Such retroaction provided in effect that all
transactions set forth in the merger agreement shall
be deemed to be taking place simultaneously on
January 1. 1959, when the Deed of Assignment
became operative. The certificates of stock
subsequently delivered by the New Corporation to the
private respondents were only evidence of the
ownership of such stocks. Although these certificates
could be issued to them only after the approval by
the SEC of the increase in capitalization of the New
Corporation, the title thereto, legally speaking, was
transferred to them on the date the merger took
effect, in accordance with the Deed of Assignment.
Our ruling then is that the merger in question
involved a pooling of resources aimed at the
continuation and expansion of business and so came
under the latter and intendment of the National
Internal Revenue code, as amended by the above-
cited law, exempting from the capital gains tax
exchanges of property effected under lawful
corporate combinations.
The basis consideration, of course, is the purpose of
the merger, as this would determine whether the
exchange of properties involved therein shall be
subject or not to the capital gains tax. The criterion
laid down by the law is that the merger "must be
undertaken for a bona fide" business purpose and not
solely for the purpose of escaping the burden of
taxation."
CIR v RUFINO
FACTS:
The private respondents were the majority
stockholders of the defunct Eastern Theatrical Co.,
Inc., (Old Corporation). Ernesto Rufino was the
president. The private respondents were also the
majority and controlling stockholders of another
corporation, the Eastern Theatrical Co Inc., (New
Corporation). This corporation was engaged in the
same kind of business as the Old Corporation, i.e.
operating theaters, opera houses, places of
amusement and other related business enterprises.
Vicente Rufino was the General Manager.
The Old Corporation held a special meeting of
stockholders where a resolution was passed
authorizing the Old Corporation to merge with the
New Corporation. Pursuant to the said resolution, the
Old Corporation, represented by Ernesto Rufino as
President, and the New Corporation, represented by
Vicente Rufino as General Manager, signed a Deed of
Assignment providing for the conveyance and
transfer of all the business, property assets, goodwill,
and liabilities of the Old Corporation to the New
Corporation in exchange for the latter's shares of
stock to be distributed among the shareholders on
the basis of one stock for each stock held in the Old
Corporation. This agreement was made retroactive.
The aforesaid transfer was eventually made. The
resolution and the Deed of Assignment were
approved in a resolution by the stockholders of the
New Corporation in their special meeting. The
increased capitalization of the New Corporation was
registered and approved by the SEC.
The BIR, after examination, declared that the merger
was not undertaken for a bona fide business purpose
but merely to avoid liability for the capital gains tax
on the exchange of the old for the new shares of
stock. Accordingly, deficiency assessments were
imposed against the private respondents. MR denied.
CTA reversed and held that there was a valid merger.
It declared that no taxable gain was derived by
petitioners from the exchange of their old stocks
solely for stocks of the New Corporation because it
16
was pursuant to a plan of reorganization. Thus, such What is also worth noting is that, as in the case of the
exchange is exempt from CGT. Old Corporation when it was dissolved, there has
been no distribution of the assets of the New
ISSUE/RULING: Corporation since then and up to now, as far as the
record discloses. To date, the private respondents
have not derived any benefit from the merger of the
W/N the CTA erred in finding that no taxable gain was
Old Corporation and the New Corporation almost 3
derived by the private respondents from the
decades earlier that will make them subject to the
questioned transaction? NO
capital gains tax under Section 35. They are no more
liable now than they were when the merger took
There was a valid merger although the actual transfer effect, as the merger, being genuine, exempted them
of the properties subject of the Deed of Assignment under the law from such tax.
was not made on the date of the merger. In the
nature of things, this was not possible. Obviously, it
By this decision, the government is, of course, not left
was necessary for the Old Corporation to surrender its
entirely without recourse, at least in the future. The
net assets first to the New Corporation before the
fact is that the merger had merely deferred the claim
latter could issue its own stock to the shareholders of
for taxes, which may be asserted by the government
the Old Corporation because the New Corporation
later, when gains are realized and benefits are
had to increase its capitalization for this purpose. This
distributed among the stockholders as a result of the
required the adoption of the resolution for the
merger. In other words, the corresponding taxes are
registration of such issuance with the SEC and its
not forever foreclosed or forfeited but may at the
approval. All these took place after the date of the
proper time and without prejudice to the government
merger but they were deemed part and parcel of, and
still be imposed.
indispensable to the validity and enforceability of, the
Deed of Assignment.

There is no impediment to the exchange of property

for stock between the two corporations being
considered to have been effected on the date of the
merger. That, in fact, was the intention, and the
reason why the Deed of Assignment was made
retroactive which provided in effect that all
transactions set forth in the merger agreement shall
be deemed to be taking place simultaneously when
the Deed of Assignment became operative.

The basic consideration, of course, is the purpose of

the merger, as this would determine whether the
exchange of properties involved therein shall be
subject or not to the capital gains tax. The criterion
laid down by the law is that the merger" must be
undertaken for a bona fide business purpose and not
solely for the purpose of escaping the burden of
taxation."
Here, the purpose of the merger was to continue the
business of the Old Corporation, whose corporate life
was about to expire, through the New Corporation to
which all the assets and obligations of the former had
been transferred. What argues strongly, indeed, for
the New Corporation is that it was not dissolved after
the merger agreement. On the contrary, it continued
to operate the places of amusement originally owned
by the Old Corporation and continues to do so today
after taking over the business of the Old Corporation
27 years ago.
N. Situs Rules
1. Sec 42 of the NIRC-> see tax table
CASES:
NATIONAL DEVELOPMENT CO. vs. CIR and
NATIONAL TEXTILE WORKERS UNION DIGEST
FACTS:
At the National Development Co., a government-
owned and controlled corporation, there were four
shifts of work. One shift was from 8 a.m. to 4 p.m.,
while the three other shifts were from 6 a.m. to 2
p.m; then from 2 p.m. to 10 p.m. and, finally, from 10
p.m. to 6 a.m. In each shift, there was a one-hour
mealtime period, to wit: From (1) 11 a.m. to 12 noon
for those working between 6 a.m. and 2 p.m. and

17
from (2) 7 p.m. to 8 p.m. for those working between 2
p.m. and 10 p.m.
(Petitioner does not want to pay for the 1 hour
lunch time) The records disclose that although there
was a one-hour mealtime, petitioner
nevertheless credited the workers with eight
hours of work for each shift and paid them for
the same number of hours. However, since 1953,
whenever workers in one shift were required to
continue working until the next shift, petitioner
instead of crediting them with eight hours of
overtime work, has been paying them for six
hours only, petitioner that the two hours
corresponding to the mealtime periods should not be
included in computing compensation.
CIR: Mealtime should be counted in the
determination of overtime work
ISSUE: WON mealtime breaks should be considered
working time
HELD: YES
The legal working day for any person employed by
another shall be of not more than eight hours
daily.When the work is not continuous, the time
during which the laborer is not working and can leave
his working place and can rest completely shall not
be counted. (Sec. 1, Com. Act No. 444)
It will be noted that, under the law, the idle time
that an employee may spend for resting and
during which he may leave the spot or place of
work though not the premises of his employer,
is not counted as working time only where the
work is broken or is not continuous.
In this case, the CIRs finding that work in the
petitioner company was continuous and did not
permit employees and laborers to rest
completely is not without basis in evidence and
following our earlier rulings, shall not disturb
the same.
The time cards show that the work was continuous
and without interruption. There is also the evidence
adduced by the petitioner that the pertinent
employees can freely leave their working place nor
rest completely. There is furthermore the aspect that
during the period covered the computation the work
was on a 24-hour basis and previously stated divided
into shifts. (ang labo bakit can freely leave their
working place nor rest completely feeling ko
typo yan sa scra or ganun talaga?)
From these facts, the CIR correctly concluded that
work in petitioner company was continuous and
therefore the mealtime breaks should be counted as
working time for purposes of overtime compensation.
NATIONAL DEVELOPMENT CO. vs. CIR and
NATIONAL TEXTILE WORKERS UNION DIGEST
FACTS:
The National Development Company (NDC) entered
into contracts in Tokyo with several Japanese
shipbuilding companies for the construction of 12
ocean-going vessels. Initial payments were made in
cash and through irrevocable letters of credit. When
the vessels were completed and delivered to the NDC
in Tokyo, the latter remitted to the shipbuilders the
amount of US$ 4,066,580.70 as interest on the
balance of the purchase price. No tax was withheld.
The Commissioner then held the NDC liable on such
tax in the total sum of P5,115,234.74. Negotiations
followed but failed. NDC went to CTA. BIR was
sustained by CTA. BIR was sustained by CTA. Hence,
this petition for certiorari.
ISSUE:
Is NDC liable for the tax?
RULING:
Yes.
Although NDC is not the one taxed since it was the
Japanese shipbuilders who were liable on the interest
remitted to them under Section 37 of the Tax Code,
still, the imposition is valid.
The imposition of the deficiency taxes on NDC is a
penalty for its failure to withhold the same from the
Japanese shipbuilders. Such liability is imposed by
Section 53c of the Tax Code. NDC was remiss in the
discharge of its obligation as the withholding agent of
the government and so should be liable for the
omission.
COMMISSIONER vs. BRITISH OVERSEAS
AIRWAYS CORP. (BOAC)
FACTS:
British Overseas Airways Corp. (BOAC) is a 100%
Britis Government-owned corporation engaged in
international airline business and is a member of the
Interline Air Transport Association, and thus, it
operates air transportation service and sells
transportation tickets over the routes of the other
airline members. From 1959 to 1972, BOAC had no
landing rights for traffic purposes in the Philippines
and thus did not carry passengers and/or cargo to or
from the Philippines but maintained a general sales
agent in the Philippines -- Warner Barnes & Co. Ltd.,
and later, Qantas Airway us -- which was responsible
for selling BOAC tickets covering passengers and
18
cargoes. The Commissioner of Internal Revenue
assessed deficiency income taxes against BOAC.
ISSUE:
Whether the revenue derived by BOAC from ticket
sales in the Philippines for air transportation, while
having no landing rights in the Philippines, constitute
income of BOAC from Philippine sources, and
accordingly, taxable.
HELD:
The source of an income is the property, activity or
service that produced the income. For the source of
income to be considered as coming from the
Philippines, it is sufficient that the income is derived
from activity within the Philippines. Herein, the sale of
tickets in the Philippines is the activity that produced
the income. The tickets exchanged hands here and
payments for fares were also made here in Philippine
currency. The situs of the source of payments is the
Philippines. The flow of wealth proceeded from, and
occured within, Philippine territory, enjoying the
protection accorded by the Philippine Government. In
consideration of such protection, the flow of wealth
should share the burden of supporting the
government. PD 68, in relation to PD 1355, ensures
that international airlines are taxed on their income
from Philippine sources. The 2 1/2 %tax on gross
billings is an income tax. If it had been intended as an
excise or percentage tax, it would have been placed
under Title V of the Tax Code covering taxes on
business.
CIR v Juliane Baier-Nickel
FACTS:
CIR appeals the CA decision, which granted the tax
refund of respondent and reversed that of the CTA.
Juliane Baier-Nickel, a non-resident German, is the
president of Jubanitex, a domestic corporation
engaged in the manufacturing, marketing and selling
of embroidered textile products. Through Jubanitexs
general manager, Marina Guzman, the company
appointed respondent as commission agent with 10%
sales commission on all sales actually concluded and
collected through her efforts.
In 1995, respondent received P1, 707, 772. 64 as
sales commission from w/c Jubanitex deducted the
10% withholding tax of P170, 777.26 and remitted to
BIR. Respondent filed her income tax return but then
claimed a refund from BIR for the P170K, alleging this
was mistakenly withheld by Jubanitex and that her
sales commission income was compensation for
services rendered in Germany not Philippines and
thus not taxable here.
She filed a petition for review with CTA for alleged
non-action by BIR. CTA denied her claim but decision
was reversed by CA on appeal, holding that the
commission was received as sales agent not as
President and that the source of income arose from
marketing activities in Germany.
ISSUE:
W/N respondent is entitled to refund
HELD:
No. Pursuant to Sec 25 of NIRC, non-resident aliens,
whether or not engaged in trade or business, are
subject to the Philippine income taxation on their
income received from all sources in the Philippines. In
determining the meaning of source, the Court
resorted to origin of Act 2833 (the first Philippine
income tax law), the US Revenue Law of 1916, as
amended in 1917.
US SC has said that income may be derived from
three possible sources only: (1) capital and/or (2)
labor; and/or (3) the sale of capital assets. If the
income is from labor, the place where the labor is
done should be decisive; if it is done in this country,
the income should be from sources within the United
States. If the income is from capital, the place where
the capital is employed should be decisive; if it is
employed in this country, the income should be from
sources within the United States. If the income is
from the sale of capital assets, the place where the
sale is made should be likewise decisive. Source is
not a place, it is an activity or property. As such, it
has a situs or location, and if that situs or location is
within the United States the resulting income is
taxable to nonresident aliens and foreign
corporations.
The source of an income is the property, activity or
service that produced the income. For the source of
income to be considered as coming from the
Philippines, it is sufficient that the income is derived
from activity within the Philippines.
The settled rule is that tax refunds are in the nature
of tax exemptions and are to be construed strictissimi
juris against the taxpayer. To those therefore, who
claim a refund rest the burden of proving that the
transaction subjected to tax is actually exempt from
taxation.
In the instant case, respondent failed to give
substantial evidence to prove that she performed the
incoming producing service in Germany, which would
have entitled her to a tax exemption for income from
sources outside the Philippines. Petition granted.
CIR v Juliane Baier-Nickel
FACTS:
Respondent Juliane Baier-nickle, a non-resident
German citizen, is the President of JUBANITEX, a
domestic corporation engaged in manufacturing,
marketing on wholesale only embroided textile
products. The corporation appointed and engaged
the service of respondent as commission agent. It
was agreed that respondent will receive 10% sales
commission on all sales actually concluded and
collected through her efforts. In 1995, respondent
received the amount of PhP1,707,772.64 representing
her sales commission income from which JUBANITEX
withheld the corresponding 10% withholding tax
amounting to PhP170,777.26 and remitted the same
to the BIR. Respondent filed a claim to refund the
amount PhP170,777.26 alleged to have been
mistakenly withheld and remitted by JUBANITEX to
the BIR. Respondent contended that her sales
19
commission income is not taxable in the Philippines
because the same was a compensation for her
services rendered in Germany considered as income
from source outside the Philippines.
ISSUE: WON respondent's sales commission income
is taxable in the Philippines?
HELD:
YES. Commission received by respondent were
actually her remuneration in the performance of her
duties as President of JUBANITEX and not as a mere
sales agent. The income derived by respondent is
therefore an income taxable in the Philippines
because JUBANITEX is a domestic corporation.
Pursuant to the foregoing provision of the NIRC, non-
resident aliens, whether or not engaged in trade or
business, are subject to Philippine income taxation on
their income received from all sources within the
Philippines.
Respondent failed to discharge the burden of proving
that her income was from sources outside the
Philippines and exempt from the application of our
income tax law.
BAR QUESTION
The Juliane Baier-Nickel, a non-resident German
citizen, was appointed and engaged as commission
agent of a domestic corporation. It was agreed that
respondent will receive 10% sales commission on all
sales actually concluded and collected through her
efforts. Juliane contends that her sales commission
income is not taxable in the Philippines because the
same was a compensation for her services rendered
in Germany and therefore considered as income from
sources outside the Philippines. DECIDE.
SUGGESTED ANSWER: The important factor which
determines the source of income of personal services
is not the residence of the payor, or the place where
the contract for service is entered into, or the place of
payment, but the place where the services were
actually rendered.
The rule is that source of income relates to the
property, activity or service that produced the
income. With respect to rendition of labor or personal
service, as in the instant case, it is the place where
the labor or service was performed that determines
the source of the income. There is no merit in the
interpretation which equates source of income in
labor or personal service with the residence of the
payor or the place of payment of the income.
The decisive factual consideration here is not the
capacity in which Juliane Baier-Nickel received the
income, but the sufficiency of evidence to prove that
the services she rendered were performed in
Germany to entitle her to tax exemption since she is
a non-resident German citizen.
Juliane did not prove by substantial evidence, or that
relevant evidence that a reasonable mind might
accept as adequate to support the conclusion that it
was in Germany where she performed the income
producing service. She thus failed to discharge the
burden of proving that her income was from sources
outside the Philippines and exempt from the
application of our income tax law. (CIR v. Baier-
Nickel, G.R. No. 153793, August 29, 2006, Ynares-
Santiago, J., 1st Div.)
CIR v CTA
FACTS:
In its 1971 original income tax return, Smith Kline
declared a net taxable income of P1,489,277 (Exh. A)
and paid P511,247 as tax due. Among the deductions
claimed from gross income was P501,040 ($77,060)
as its share of the head office overhead expenses.
However, in its amended return filed on March 1,
1973, there was an overpayment of P324,255 "arising
from underdeduction of home office overhead" (Exh.
E). It made a formal claim for the refund of the
alleged overpayment.
Smith Kline received from its international
independent auditors, Peat, Marwick, Mitchell and
Company, an authenticated certification to the effect
that the Philippine share in the unallocated overhead
expenses of the main office for the year ended
December 31, 1971 was actually $219,547
(P1,427,484). It further stated in the certification that
the allocation was made on the basis of the
percentage of gross income in the Philippines to gross
income of the corporation as a whole. By reason of
the new adjustment, Smith Kline's tax liability was
greatly reduced from P511,247 to P186,992 resulting
in an overpayment of P324,255.
Without awaiting the action of the Commissioner of
Internal Revenue on its claim Smith Kline filed a
petition for review with the Court of Tax Appeals.
In its decision the Tax Court ordered the
Commissioner to refund the overpayment or grant a
tax credit to Smith Kline. It is manifest that where an
expense is clearly related to the production of
Philippine-derived income or to Philippine operations
(e.g. salaries of Philippine personnel, rental of office
building in the Philippines), that expense can be
deducted from the gross income acquired in the
Philippines without resorting to apportionment.
The overhead expenses incurred by the parent
company in connection with finance, administration,
and research and development, all of which direct
benefit its branches all over the world, including the
Philippines, fall under a different category however.
These are items which cannot be definitely allocated
or Identified with the operations of the Philippine
branch. For 1971, the parent company of Smith Kline
spent $1,077,739. Under section 37(b) of the
Revenue Code and section 160 of the regulations,
Smith Kline can claim as its deductible share a
ratable part of such expenses based upon the ratio of
the local branch's gross income to the total gross
income, worldwide, of the multinational corporation.
The Commissioner does not dispute the right of Smith
Kline to avail itself of section 37(b) of the Tax Code
and section 160 of the regulations. But the
Commissioner maintains that such right is not
20
absolute and that as there exists a contract (in this
case a service agreement) which Smith Kline has
entered into with its home office, prescribing the
amount that a branch can deduct as its share of the
main office's overhead expenses, that contract is
binding. That since the share of the Philippine branch
has been fixed at $77,060, Smith Kline itself cannot
claim more than the said amount.
The Commissioner also argues that the Tax Court
erred in relying on the certification of Peat, Marwick,
Mitchell and Company that Smith Kline is entitled to
deduct P1,427,484 ($219,547) as its allotted share
and that Smith Kline has not presented any evidence
to show that the home office expenses chargeable to
Philippine operations exceeded $77,060.
Smith Kline likewise submits that it has presented
ample evidence to support its claim for refund. To this
end, it has presented before the Tax Court the
authenticated statement of Peat, Marwick, Mitchell
and Company to show that since the gross income of
the Philippine branch was P7,143,155 ($1,098,617)
for 1971 as per audit report prepared by Sycip,
Gorres, Velayo and Company, and the gross income
of the corporation as a whole was $6,891,052, Smith
Kline's share at 15.94% of the home office overhead
expenses was P1,427,484 ($219,547) (Exh. G to G-2,
BIR Records, 4-5).
Clearly, the weight of evidence bolsters its position
that the amount of P1,427,484 represents the correct
ratable share, the same having been computed
pursuant to section 37(b) and section 160.
In a manifestation dated July 19, 1983, Smith Kline
declared that with respect to its share of the head
office overhead expenses in its income tax returns for
the years 1973 to 1981, it deducted its ratable share
of the total overhead expenses of its head office for
those years as computed by the independent auditors
hired by the parent company in Philadelphia,
Pennsylvania U.S.A., as soon as said computations
were made available to it.
ISSUE:
WON the contract between itself and its home office
cannot amend tax laws and regulations and that the
matter of allocated expenses which are deductible
under the law cannot be the subject of an agreement
between private parties nor can the Commissioner
acquiesce in such an agreement.
HELD:
Smith Kline's amended 1971 return is in conformity
with the law and regulations. The Tax Court correctly
held that the refund or credit of the resulting
overpayment is in order.
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