EN BANC

CHAMBER OF REAL G.R. No. 160756

ESTATE AND BUILDERS
ASSOCIATIONS, INC.,
Petitioner, Present:
-versus

THE HON. EXECUTIVE

SECRETARY ALBERTO ROMULO,
THE HON. ACTING SECRETARY OF
FINANCE JUANITA D. AMATONG,
and THE HON. COMMISSIONER OF
INTERNAL REVENUE GUILLERMO
PARAYNO, JR.,
Respondents.
Promulgated: March 9, 2010

x-------------------------------------------------x

DECISION

CORONA, J.:

In this original petition for certiorari and mandamus,[1] petitioner Chamber of Real Estate
and Builders Associations, Inc. is questioning the constitutionality of Section 27 (E) of
Republic Act (RA) 8424[2] and the revenue regulations (RRs) issued by the Bureau of
Internal Revenue (BIR) to implement said provision and those involving creditable
withholding taxes.[3]

Petitioner is an association of real estate developers and builders in the Philippines. It

impleaded former Executive Secretary Alberto Romulo, then acting Secretary of Finance
Juanita D. Amatong and then Commissioner of Internal Revenue Guillermo Parayno, Jr. as
respondents.

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

Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is

implemented by RR 9-98. Petitioner argues that the MCIT violates the due process clause
because it levies income tax even if there is no realized gain.
Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and 2.58.2 of
RR 2-98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe the rules and
procedures for the collection of CWT on the sale of real properties categorized as ordinary
assets. Petitioner contends that these revenue regulations are contrary to law for two
reasons: first, they ignore the different treatment by RA 8424 of ordinary assets and capital
assets and second, respondent Secretary of Finance has no authority to collect CWT, much
less, to base the CWT on the gross selling price or fair market value of the real properties
classified as ordinary assets.

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

The issues to be resolved are as follows:

(1) whether or not this Court should take cognizance of the present case;
(2) whether or not the imposition of the MCIT on domestic corporations is
unconstitutional and
(3) whether or not the imposition of CWT on income from sales of real properties
classified as ordinary assets under RRs 2-98, 6-2001 and 7-2003, is
unconstitutional.

OVERVIEW OF THE ASSAILED PROVISIONS

Under the MCIT scheme, a corporation, beginning on its fourth year of operation, is
assessed an MCIT of 2% of its gross income when such MCIT is greater than the normal
corporate income tax imposed under Section 27(A). [4] If the regular income tax is higher than
the MCIT, the corporation does not pay the MCIT. Any excess of the MCIT over the normal
tax shall be carried forward and credited against the normal income tax for the three
immediately succeeding taxable years. Section 27(E) of RA 8424 provides:

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

(1) Imposition of Tax. A [MCIT] of two percent (2%) of the gross

income as of the end of the taxable year, as defined herein, is hereby
imposed on a corporation taxable under this Title, beginning on the
fourth taxable year immediately following the year in which such
corporation commenced its business operations, when the minimum
income tax is greater than the tax computed under Subsection (A) of
this Section for the taxable year.
(2) Carry Forward of Excess Minimum Tax. Any excess of the
[MCIT] over the normal income tax as computed under Subsection
(A) of this Section shall be carried forward and credited against the
normal income tax for the three (3) immediately succeeding taxable
years.

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

The Secretary of Finance is hereby authorized to promulgate,

upon recommendation of the Commissioner, the necessary rules and
regulations that shall define the terms and conditions under which he
may suspend the imposition of the [MCIT] in a meritorious case.

(4) Gross Income Defined. For purposes of applying the [MCIT]

provided under Subsection (E) hereof, the term gross income shall
mean gross sales less sales returns, discounts and allowances and
cost of goods sold. Cost of goods sold shall include all business
expenses directly incurred to produce the merchandise to bring them
to their present location and use.

For trading or merchandising concern, cost of goods sold shall

include the invoice cost of the goods sold, plus import duties, freight
in transporting the goods to the place where the goods are actually
sold including insurance while the goods are in transit.

For a manufacturing concern, cost of goods manufactured and

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

In the case of taxpayers engaged in the sale of service, gross

income means gross receipts less sales returns, allowances, discounts
and cost of services. Cost of services shall mean all direct costs and
expenses necessarily incurred to provide the services required by the
customers and clients including (A) salaries and employee benefits of
personnel, consultants and specialists directly rendering the service
and (B) cost of facilities directly utilized in providing the service such
as depreciation or rental of equipment used and cost of
supplies: Provided, however, that in the case of banks, cost of services
shall include interest expense.
On August 25, 1998, respondent Secretary of Finance (Secretary), on the recommendation of
the Commissioner of Internal Revenue (CIR), promulgated RR 9-98 implementing Section
27(E).[5] The pertinent portions thereof read:

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

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

For purposes of these Regulations, the term, normal income tax

means the income tax rates prescribed under Sec. 27(A) and Sec.
28(A)(1) of the Code xxx at 32% effective January 1, 2000 and
thereafter.

xxx xxx xxx

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

xxx xxx xxx

Meanwhile, on April 17, 1998, respondent Secretary, upon recommendation of respondent

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

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

thereon:
 xxx xxx xxx

(J) Gross selling price or total amount of consideration or its equivalent

paid to the seller/owner for the sale, exchange or transfer of. Real property,
other than capital assets, sold by an individual, corporation, estate, trust, trust
fund or pension fund and the seller/transferor is habitually engaged in the real
estate business in accordance with the following schedule
Those which are exempt
from a withholding tax at xxx xxx xxx
source as prescribed in Sec.
2.57.5 of these regulations. Exempt Gross selling
price shall
With a selling price of five mean the
hundred thousand pesos consideration
(P500,000.00) or less. 1.5% stated in the
sales
With a selling price of more document or
than five hundred thousand the fair market
pesos (P500,000.00) but not value
more than two million pesos determined in
(P2,000,000.00). 3.0% accordance
with Section 6
With selling price of more (E) of the
than two million pesos Code, as
(P2,000,000.00) 5.0% amended,
whichever is
higher. In an exchange, the fair market value of the property received in
exchange, as determined in the Income Tax Regulations shall be used.

Where the consideration or part thereof is payable on installment, no

withholding tax is required to be made on theperiodic installment payments
where the buyer is an individual not engaged in trade or business. In such a
case, the applicable rate of tax based on the entire consideration shall be
withheld on the last installment or installments to be paid to the seller.

However, if the buyer is engaged in trade or business, whether a corporation or

otherwise, the tax shall be deducted and withheld by the buyer on every
installment.

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

Sec. 2.57.2. Income payment subject to [CWT] and rates prescribed
thereon:
xxx xxx xxx
(J) Gross selling price or total amount of consideration or its
equivalent paid to the seller/owner for the sale, exchange or transfer
 of real property classified as ordinary asset. - A [CWT] based on the
gross selling price/total amount of consideration or the fair market
value determined in accordance with Section 6(E) of the Code,
whichever is higher, paid to the seller/owner for the sale, transfer or
exchange of real property, other than capital asset, shall be imposed
upon the withholding agent,/buyer, in accordance with the following
schedule:

Where the seller/transferor is exempt

from [CWT] in accordance with Sec.
2.57.5 of these regulations. Exempt

Upon the following values of real

property, where the seller/transferor is
habitually engaged in the real estate
business.

With a selling price of Five Hundred

Thousand Pesos (P500,000.00) or less. 1.5%

With a selling price of more than Five

Hundred Thousand Pesos
(P500,000.00) but not more than Two
Million Pesos (P2,000,000.00). 3.0%

With a selling price of more than two

Million Pesos (P2,000,000.00). 5.0%
xxx xxx xxx

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

xxx xxx xxx

However, if the buyer is engaged in trade or business, whether a

corporation or otherwise, these rules shall apply:

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

In any case, no Certificate Authorizing Registration (CAR) shall be

issued to the buyer unless the [CWT] due on the sale, transfer or exchange of
real property other than capital asset has been fully paid. (Underlined
amendments in the original)

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

Sec. 2.58.2. Registration with the Register of Deeds. Deeds of conveyances of

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

On February 11, 2003, RR No. 7-2003 [8] was promulgated, providing for the guidelines in
determining whether a particular real property is a capital or an ordinary asset for purposes
of imposing the MCIT, among others. The pertinent portions thereof state:
Section 4. Applicable taxes on sale, exchange or other disposition
of real property. - Gains/Income derived from sale, exchange, or other
disposition of real properties shall, unless otherwise exempt, be subject
to applicable taxes imposed under the Code, depending on whether the
subject properties are classified as capital assets or ordinary assets;

a. In the case of individual citizen (including estates and trusts),

resident aliens, and non-resident aliens engaged in trade or business
in the Philippines;

xxx xxx xxx

(ii) The sale of real property located in the Philippines,

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

xxx xxx xxx

c. In the case of domestic corporations.

xxx xxx xxx

(ii) The sale of land and/or building classified as ordinary asset

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

xxx xxx xxx

We shall now tackle the issues raised.

EXISTENCE OF A JUSTICIABLE CONTROVERSY

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

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

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

Perceived or alleged hardship to taxpayers alone is not an adequate justification

for adjudicating abstract issues. Otherwise, adjudication would be no different
from the giving of advisory opinion that does not really settle legal issues.[10]

An actual case or controversy involves a conflict of legal rights or an assertion of

opposite legal claims which is susceptible of judicial resolution as distinguished from a
hypothetical or abstract difference or dispute.[11] On the other hand, a question is considered
ripe for adjudication when the act being challenged has a direct adverse effect on the
individual challenging it.[12]

Contrary to respondents assertion, we do not have to wait until petitioners members

have shut down their operations as a result of the MCIT or CWT. The assailed provisions are
already being implemented. As we stated in Didipio Earth-Savers Multi-Purpose
Association, Incorporated (DESAMA) v. Gozun:[13]

By the mere enactment of the questioned law or the approval of the

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

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

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

Petitioner is an association of some of the real estate developers and

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

Legal standing or locus standi is a partys personal and substantial interest in a case
such that it has sustained or will sustain direct injury as a result of the governmental act
being challenged.[16] In Holy Spirit Homeowners Association, Inc. v. Defensor,[17] we held that
the association had legal standing because its members stood to be injured by the
enforcement of the assailed provisions:
 Petitioner association has the legal standing to institute the instant
petition xxx. There is no dispute that the individual members of petitioner
association are residents of the NGC. As such they are covered and stand to be
either benefited or injured by the enforcement of the IRR, particularly as
regards the selection process of beneficiaries and lot allocation to qualified
beneficiaries. Thus, petitioner association may assail those provisions in the
IRR which it believes to be unfavorable to the rights of its members. xxx
Certainly, petitioner and its members have sustained direct injury arising from
the enforcement of the IRR in that they have been disqualified and eliminated
from the selection process.[18]

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

CONCEPT AND RATIONALE OF THE MCIT

The MCIT on domestic corporations is a new concept introduced by RA 8424 to the

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

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

Domestic corporations owe their corporate existence and their privilege to do business
to the government. They also benefit from the efforts of the government to improve the
financial market and to ensure a favorable business climate. It is therefore fair for the
government to require them to make a reasonable contribution to the public expenses.
 Congress intended to put a stop to the practice of corporations which, while having
large turn-overs, report minimal or negative net income resulting in minimal or zero income
taxes year in and year out, through under-declaration of income or over-deduction of
expenses otherwise called tax shelters.[23]

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

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

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

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

Second, the law allows the carrying forward of any excess of the MCIT paid over the
normal income tax which shall be credited against the normal income tax for the three
immediately succeeding years.[27]
Third, since certain businesses may be incurring genuine repeated losses, the law
authorizes the Secretary of Finance to suspend the imposition of MCIT if a corporation
suffers losses due to prolonged labor dispute, force majeure and legitimate business reverses.
[28]

Even before the legislature introduced the MCIT to the Philippine taxation system,
several other countries already had their own system of minimum corporate income
taxation. Our lawmakers noted that most developing countries, particularly Latin American
and Asian countries, have the same form of safeguards as we do. As pointed out during the
committee hearings:
 [Mr. Medalla:] Note that most developing countries where you have of course
quite a bit of room for underdeclaration of gross receipts have this same form
of safeguards.

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

The other thing youll notice is the preponderance of Latin American countries
that employed this method. Okay, those are additional Latin American
countries.[29]

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

MCIT IS NOT VIOLATIVE OF DUE PROCESS

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

We disagree.

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

Taxation is an inherent attribute of sovereignty.[34] It is a power that is purely

legislative.[35] Essentially, this means that in the legislature primarily lies the discretion to
determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs
(place) of taxation.[36] It has the authority to prescribe a certain tax at a specific rate for a
particular public purpose on persons or things within its jurisdiction. In other words, the
legislature wields the power to define what tax shall be imposed, why it should be imposed,
how much tax shall be imposed, against whom (or what) it shall be imposed and where it
shall be imposed.
As a general rule, the power to tax is plenary and unlimited in its range, acknowledging in its
very nature no limits, so that the principal check against its abuse is to be found only in the
responsibility of the legislature (which imposes the tax) to its constituency who are to pay it.
[37]
Nevertheless, it is circumscribed by constitutional limitations. At the same time, like any
other statute, tax legislation carries a presumption of constitutionality.

The constitutional safeguard of due process is embodied in the fiat [no] person shall be
deprived of life, liberty or property without due process of law. In Sison, Jr. v. Ancheta, et al.,
[38]
we held that the due process clause may properly be invoked to invalidate, in appropriate
cases, a revenue measure[39] when it amounts to a confiscation of property.[40] But in the same
case, we also explained that we will not strike down a revenue measure as unconstitutional
(for being violative of the due process clause) on the mere allegation of arbitrariness by the
taxpayer.[41] There must be a factual foundation to such an unconstitutional taint. [42] This
merely adheres to the authoritative doctrine that, where the due process clause is invoked,
considering that it is not a fixed rule but rather a broad standard, there is a need for proof of
such persuasive character.[43]

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

(1) there must be gain;

(2) the gain must be realized or received and
(3) the gain must not be excluded by law or treaty from
taxation.[47]

Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is not
income. In other words, it is income, not capital, which is subject to income tax.However, the
MCIT is not a tax on capital.
The MCIT is imposed on gross income which is arrived at by deducting the capital
spent by a corporation in the sale of its goods, i.e., the cost of goods[48] and other direct
expenses from gross sales. Clearly, the capital is not being taxed.

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

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

Statutes taxing the gross "receipts," "earnings," or "income" of

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

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

In enacting the minimum tax, Congress attempted to remedy general taxpayer

distrust of the system growing from large numbers of taxpayers with large
incomes who were yet paying no taxes.

xxx xxx xxx

We thus join a number of other courts in upholding the constitutionality of the

[AMT]. xxx [It] is a rational means of obtaining a broad-based tax, and
therefore is constitutional.[54]

The U.S. Court declared that the congressional intent to ensure that corporate taxpayers
would contribute a minimum amount of taxes was a legitimate governmental end to which
the AMT bore a reasonable relation.[55]
American courts have also emphasized that Congress has the power to condition, limit or
deny deductions from gross income in order to arrive at the net that it chooses to tax. [56] This
is because deductions are a matter of legislative grace.[57]

Absent any other valid objection, the assignment of gross income, instead of net
income, as the tax base of the MCIT, taken with the reduction of the tax rate from 32% to
2%, is not constitutionally objectionable.
Moreover, petitioner does not cite any actual, specific and concrete negative
experiences of its members nor does it present empirical data to show that the
implementation of the MCIT resulted in the confiscation of their property.
In sum, petitioner failed to support, by any factual or legal basis, its allegation that the
MCIT is arbitrary and confiscatory. The Court cannot strike down a law as unconstitutional
simply because of its yokes.[58] Taxation is necessarily burdensome because, by its nature, it
adversely affects property rights.[59] The party alleging the laws unconstitutionality has the
burden to demonstrate the supposed violations in understandable terms.[60]

RR 9-98 MERELY CLARIFIES

SECTION 27(E) OF RA 8424

Petitioner alleges that RR 9-98 is a deprivation of property without due process of law
because the MCIT is being imposed and collected even when there is actually a loss, or a
zero or negative taxable income:
Sec. 2.27(E) [MCIT] on Domestic Corporations.

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

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

We now proceed to the issues involving the CWT.

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

Petitioner, after enumerating the distinctions between capital and ordinary assets under
RA 8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and Sections 4(a)(ii) and
(c)(ii) of RR 7-2003 were promulgated with grave abuse of discretion amounting to lack of
jurisdiction and patently in contravention of law[62] because they ignore such
distinctions. Petitioners conclusion is based on the following premises: (a) the revenue
regulations use gross selling price (GSP) or fair market value (FMV) of the real estate as
basis for determining the income tax for the sale of real estate classified as ordinary assets
and (b) they mandate the collection of income tax on a per transaction basis, i.e., upon
consummation of the sale via the CWT, contrary to RA 8424 which calls for the payment of
the net income at the end of the taxable period.[63]
Petitioner theorizes that since RA 8424 treats capital assets and ordinary assets
differently, respondents cannot disregard the distinctions set by the legislators as regards the
tax base, modes of collection and payment of taxes on income from the sale of capital and
ordinary assets.
Petitioners arguments have no merit.

AUTHORITY OF THE SECRETARY OF

FINANCE TO ORDER THE COLLECTION
OF CWT ON SALES OF REAL PROPERTY
CONSIDERED AS ORDINARY ASSETS

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

We have long recognized that the method of withholding tax at source is a procedure of
collecting income tax which is sanctioned by our tax laws. [66] The withholding tax system
was devised for three primary reasons: first, to provide the taxpayer a convenient manner to
meet his probable income tax liability; second, to ensure the collection of income tax which
can otherwise be lost or substantially reduced through failure to file the corresponding
returns and third, to improve the governments cash flow.[67] This results in administrative
savings, prompt and efficient collection of taxes, prevention of delinquencies and reduction
of governmental effort to collect taxes through more complicated means and remedies.[68]
Respondent Secretary has the authority to require the withholding of a tax on items of
income payable to any person, national or juridical, residing in the Philippines. Such
authority is derived from Section 57(B) of RA 8424 which provides:

SEC. 57. Withholding of Tax at Source.

xxx xxx xxx

(B) Withholding of Creditable Tax at Source. The [Secretary] may,

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

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

EFFECT OF RRS ON THE TAX BASE FOR

THE INCOME TAX OF INDIVIDUALS OR
CORPORATIONS ENGAGED IN THE REAL
ESTATE BUSINESS

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

The taxes withheld are in the nature of advance tax payments by a taxpayer in order to
extinguish its possible tax obligation. [69] They are installments on the annual tax which may
be due at the end of the taxable year.[70]
Under RR 2-98, the tax base of the income tax from the sale of real property classified
as ordinary assets remains to be the entitys net income imposed under Section 24 (resident
individuals) or Section 27 (domestic corporations) in relation to Section 31 of RA
8424, i.e. gross income less allowable deductions. The CWT is to be deducted from the net
income tax payable by the taxpayer at the end of the taxable year.[71] Precisely, Section 4(a)
(ii) and (c)(ii) of RR 7-2003 reiterate that the tax base for the sale of real property classified
as ordinary assets remains to be the net taxable income:

Section 4. Applicable taxes on sale, exchange or other disposition of real

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

xxx xxx xxx

a. In the case of individual citizens (including estates and trusts), resident

aliens, and non-resident aliens engaged in trade or business in the
Philippines;

xxx xxx xxx

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

c. In the case of domestic corporations.

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

Accordingly, at the end of the year, the taxpayer/seller shall file its income tax return and
credit the taxes withheld (by the withholding agent/buyer) against its tax due. If the tax due
is greater than the tax withheld, then the taxpayer shall pay the difference. If, on the other
hand, the tax due is less than the tax withheld, the taxpayer will be entitled to a refund or tax
credit. Undoubtedly, the taxpayer is taxed on its net income.
The use of the GSP/FMV as basis to determine the withholding taxes is evidently for
purposes of practicality and convenience. Obviously, the withholding agent/buyer who is
obligated to withhold the tax does not know, nor is he privy to, how much the taxpayer/seller
will have as its net income at the end of the taxable year. Instead, said withholding agents
knowledge and privity are limited only to the particular transaction in which he is a party. In
such a case, his basis can only be the GSP or FMV as these are the only factors reasonably
known or knowable by him in connection with the performance of his duties as a
withholding agent.

NO BLURRING OF DISTINCTIONS
BETWEEN ORDINARY ASSETS AND
CAPITAL ASSETS

RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real
property categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA 8424
imposes a final tax and flat rate of 6% on the gain presumed to be realized from the sale of a
capital asset based on its GSP or FMV. This final tax is also withheld at source.[72]
The differences between the two forms of withholding tax, i.e., creditable and final,
show that ordinary assets are not treated in the same manner as capital assets. Final
withholding tax (FWT) and CWT are distinguished as follows:

FWT CWT
a) The amount of income tax a) Taxes withheld on certain
 withheld by the withholding income payments are intended
agent is constituted as a full to equal or at least
and final payment of the approximate the tax due of the
income tax due from the payee on said income.
payee on the said income.

b)The liability for payment b) Payee of income is required

of the tax rests primarily on
the payor as a withholding
agent.
c) The payee is not required
to file an income tax return
for the particular income.[73]
to report the income and/or
pay the difference between the
tax withheld and the tax due
on the income. The payee also
has the right to ask for a
refund if the tax withheld is
more than the tax due.
c) The income recipient is still
required to file an income tax
return, as prescribed in Sec. 51
and Sec. 52 of the NIRC, as
amended.[74]

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

Petitioner insists that the levy, collection and payment of CWT at the time of
transaction are contrary to the provisions of RA 8424 on the manner and time of filing of the
return, payment and assessment of income tax involving ordinary assets.[75]
The fact that the tax is withheld at source does not automatically mean that it is treated
exactly the same way as capital gains. As aforementioned, the mechanics of the FWT are
distinct from those of the CWT. The withholding agent/buyers act of collecting the tax at the
time of the transaction by withholding the tax due from the income payable is the essence of
the withholding tax method of tax collection.

NO RULE THAT ONLY PASSIVE

INCOMES CAN BE SUBJECT TO CWT

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

(A) Withholding of Final Tax on Certain Incomes. Subject to rules and

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

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

This line of reasoning is non sequitur.

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

if the income is generated in the active pursuit and performance of the

corporations primary purposes, the same is not passive income[76]

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

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

Indeed, Section 57(A) and (B) are distinct. Section 57(A) refers to FWT while Section 57(B)
pertains to CWT. The former covers the kinds of passive income enumerated therein and the
latter encompasses any income other than those listed in 57(A). Since the law itself makes
distinctions, it is wrong to regard 57(A) and 57(B) in the same way.
 To repeat, the assailed provisions of RR 2-98, as amended, do not modify or deviate
from the text of Section 57(B). RR 2-98 merely implements the law by specifying what
income is subject to CWT. It has been held that, where a statute does not require any
particular procedure to be followed by an administrative agency, the agency may adopt any
reasonable method to carry out its functions.[77] Similarly, considering that the law uses the
general term income, the Secretary and CIR may specify the kinds of income the rules will
apply to based on what is feasible. In addition, administrative rules and regulations ordinarily
deserve to be given weight and respect by the courts [78] in view of the rule-making authority
given to those who formulate them and their specific expertise in their respective fields.

NO DEPRIVATION OF PROPERTY
WITHOUT DUE PROCESS

Petitioner avers that the imposition of CWT on GSP/FMV of real estate classified as
ordinary assets deprives its members of their property without due process of law because, in
their line of business, gain is never assured by mere receipt of the selling price. As a result,
the government is collecting tax from net income not yet gained or earned.
Again, it is stressed that the CWT is creditable against the tax due from the seller of the
property at the end of the taxable year. The seller will be able to claim a tax refund if its net
income is less than the taxes withheld. Nothing is taken that is not due so there is no
confiscation of property repugnant to the constitutional guarantee of due process. More
importantly, the due process requirement applies to the power to tax.[79] The CWT does not
impose new taxes nor does it increase taxes. [80] It relates entirely to the method and time of
payment.

Petitioner protests that the refund remedy does not make the CWT less burdensome
because taxpayers have to wait years and may even resort to litigation before they are
granted a refund.[81] This argument is misleading. The practical problems encountered in
claiming a tax refund do not affect the constitutionality and validity of the CWT as a method
of collecting the tax.
Petitioner complains that the amount withheld would have otherwise been used by the
enterprise to pay labor wages, materials, cost of money and other expenses which can then
save the entity from having to obtain loans entailing considerable interest expense. Petitioner
also lists the expenses and pitfalls of the trade which add to the burden of the realty
industry: huge investments and borrowings; long gestation period; sudden and unpredictable
interest rate surges; continually spiraling development/construction costs; heavy taxes and
prohibitive up-front regulatory fees from at least 20 government agencies.[82]
Petitioners lamentations will not support its attack on the constitutionality of the
CWT. Petitioners complaints are essentially matters of policy best addressed to the executive
and legislative branches of the government. Besides, the CWT is applied only on the
amounts actually received or receivable by the real estate entity. Sales on installment are
taxed on a per-installment basis.[83] Petitioners desire to utilize for its operational and capital
expenses money earmarked for the payment of taxes may be a practical business option but it
is not a fundamental right which can be demanded from the court or from the government.
NO VIOLATION OF EQUAL PROTECTION

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

Again, we disagree.

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

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

Petitioner, in insisting that its industry should be treated similarly as manufacturing

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

On the other hand, each manufacturing enterprise may have tens of thousands of transactions
with several thousand customers every month involving both minimal and substantial
amounts. To require the customers of manufacturing enterprises, at present, to withhold the
taxes on each of their transactions with their tens or hundreds of suppliers may result in an
inefficient and unmanageable system of taxation and may well defeat the purpose of the
withholding tax system.
Petitioner counters that there are other businesses wherein expensive items are also sold
infrequently, e.g. heavy equipment, jewelry, furniture, appliance and other capital goods yet
these are not similarly subjected to the CWT.[89] As already discussed, the Secretary may
adopt any reasonable method to carry out its functions. [90] Under Section 57(B), it may
choose what to subject to CWT.
A reading of Section 2.57.2 (M) of RR 2-98 will also show that petitioners argument is not
accurate. The sales of manufacturers who have clients within the top 5,000 corporations, as
specified by the BIR, are also subject to CWT for their transactions with said 5,000
corporations.[91]

SECTION 2.58.2 OF RR NO. 2-98

MERELY IMPLEMENTS SECTION 58
OF RA 8424

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

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

(E) Registration with Register of Deeds. - No registration of any document

transferring real property shall be effected by the Register of Deeds unless
the [CIR] or his duly authorized representative has certified that such
transfer has been reported, and the capital gains or [CWT], if any, has
been paid: xxxx any violation of this provision by the Register of Deeds shall
be subject to the penalties imposed under Section 269 of this Code. (Emphasis
supplied)

CONCLUSION

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

Costs against petitioner.

SO ORDERED.
 THIRD DIVISION

COMMISSIONER OF G.R. No. 180066

INTERNAL REVENUE,
Petitioner, Present:
YNARES-SANTIAGO, J.,
Chairperson,
CHICO-NAZARIO,
VELASCO, JR.,
- versus - NACHURA, and
PERALTA, JJ.

Promulgated:

PHILIPPINE AIRLINES, INC., _____________________

Respondent.
x- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -x

DECISION

CHICO-NAZARIO, J.:

Before this Court is a Petition for Review on Certiorari, under Rule 45 of the Revised Rules
of Court, seeking the reversal and setting aside of the Decision [1] dated 9 August 2007 and
Resolution[2] dated 11 October 2007 of the Court of Tax Appeals (CTA) en banc in CTA E.B.
No. 246. The CTA en banc affirmed the Decision[3] dated 31 July 2006 of the CTA Second
Division in C.T.A. Case No. 7010, ordering the cancellation and withdrawal of Preliminary
Assessment Notice (PAN) No. INC FY-3-31-01-000094 dated 3 September 2003 and Formal
Letter of Demand dated 12 January 2004, issued by the Bureau of Internal Revenue (BIR)
against respondent Philippine Airlines, Inc. (PAL), for the payment of Minimum Corporate
Income Tax (MCIT) in the amount of P272,421,886.58.

There is no dispute as to the antecedent facts of this case.

PAL is a domestic corporation organized under the corporate laws of the Republic of the
Philippines; declared the national flag carrier of the country; and the grantee under
Presidential Decree No. 1590[4] of a franchise to establish, operate, and maintain transport
services for the carriage of passengers, mail, and property by air, in and between any and all
points and places throughout the Philippines, and between the Philippines and other
countries.[5]

For its fiscal year ending 31 March 2001 (FY 2000-2001), PAL allegedly incurred zero
taxable income,[6] which left it with unapplied creditable withholding tax[7] in the amount
of P2,334,377.95. PAL did not pay any MCIT for the period.

In a letter dated 12 July 2002, addressed to petitioner Commissioner of Internal Revenue

(CIR), PAL requested for the refund of its unapplied creditable withholding tax for FY 2000-
2001. PAL attached to its letter the following: (1) Schedule of Creditable Tax Withheld at
Source for FY 2000-2001; (2) Certificates of Creditable Taxes Withheld; and (3) Audited
Financial Statements.

Acting on the aforementioned letter of PAL, the Large Taxpayers Audit and
Investigation Division 1 (LTAID 1) of the BIR Large Taxpayers Service (LTS), issued on 16
August 2002, Tax Verification Notice No. 00201448, authorizing Revenue Officer Jacinto
Cueto, Jr. (Cueto) to verify the supporting documents and pertinent records relative to the
claim of PAL for refund of its unapplied creditable withholding tax for FY 2000-20001. In a
letter dated 19 August 2003, LTAID 1 Chief Armit S. Linsangan invited PAL to an informal
conference at the BIR National Office in Diliman, Quezon City, on 27 August 2003, at 10:00
a.m., to discuss the results of the investigation conducted by Revenue Officer Cueto,
supervised by Revenue Officer Madelyn T. Sacluti.

BIR officers and PAL representatives attended the scheduled informal conference,
during which the former relayed to the latter that the BIR was denying the claim for refund
of PAL and, instead, was assessing PAL for deficiency MCIT for FY 2000-2001. The PAL
representatives argued that PAL was not liable for MCIT under its franchise.The BIR officers
then informed the PAL representatives that the matter would be referred to the BIR Legal
Service for opinion.

The LTAID 1 issued, on 3 September 2003, PAN No. INC FY-3-31-01-000094, which
was received by PAL on 23 October 2003. LTAID 1 assessed PAL forP262,474,732.54,
representing deficiency MCIT for FY 2000-2001, plus interest and compromise penalty,
computed as follows:

Sales/Revenues from Operation P 38,798,721,685.00

Less: Cost of Services 30,316,679,013.00
Gross Income from Operation 8,482,042,672.00
Add: Non-operating income 465,111,368.00
Total Gross Income for MCIT purposes 9,947,154,040.00[8]
Rate of Tax 2%
Tax Due 178,943,080.80
Add: 20% interest (8-16-00 to 10-31-03) 83,506,651.74
 Compromise Penalty 25,000.00
Total Amount Due P 262,474,732.54[9]

PAL protested PAN No. INC FY-3-31-01-000094 through a letter dated 4 November 2003 to
the BIR LTS.

On 12 January 2004, the LTAID 1 sent PAL a Formal Letter of Demand for deficiency MCIT
for FY 2000-2001 in the amount of P271,421,88658, based on the following calculation:

Sales/Revenues from Operation P 38,798,721,685.00

Less: Cost of Services
Direct Costs - P 30,749,761,017.00
Less: Non-deductible
interest expense 433,082,004.00 30,316,679,013.00
Gross Income from Operation P 8,482,042,672.00
Add: Non-operating Income 465,111,368.00
Total Gross Income for MCIT purposes P 9,947,154,040.00
MCIT tax due P 178,943,080.80
Interest 20% per annum 7/16/01 to 02/15/04 92,453,805.78
Compromise Penalty 25,000.00
Total MCIT due and demandable P 271,421,886.58[10]

PAL received the foregoing Formal Letter of Demand on 12 February 2004, prompting
it to file with the BIR LTS a formal written protest dated 13 February 2004.

The BIR LTS rendered on 7 May 2004 its Final Decision on Disputed Assessment,
which was received by PAL on 26 May 2004. Invoking Revenue Memorandum Circular
(RMC) No. 66-2003, the BIR LTS denied with finality the protest of PAL and reiterated the
request that PAL immediately pay its deficiency MCIT for FY 2000-2001, inclusive of
penalties incident to delinquency.

PAL filed a Petition for Review with the CTA, which was docketed as C.T.A. Case No. 7010
and raffled to the CTA Second Division. The CTA Second Division promulgated its Decision
on 31 July 2006, ruling in favor of PAL. The dispositive portion of the judgment of the CTA
Second Division reads:

WHEREFORE, premises considered, the instant Petition for Review is

hereby GRANTED. Accordingly, Assessment Notice No. INC FY-3-31-01-000094
and Formal Letter of Demand for the payment of deficiency Minimum Corporate
Income Tax in the amount of P272,421,886.58 are
hereby CANCELLED and WITHDRAWN. [11]
 In a Resolution dated 2 January 2007, the CTA Second Division denied the Motion for
Reconsideration of the CIR.
It was then the turn of the CIR to file a Petition for Review with the CTA en banc, docketed
as C.T.A. E.B. No. 246. The CTA en banc found that the cited legal provisions and
jurisprudence are teeming with life with respect to the grant of tax exemption too vivid to
pass unnoticed, and that the Court in Division correctly ruled in favor of the respondent
[PAL] granting its petition for the cancellation of Assessment Notice No. INC FY-3-31-01-
000094 and Formal Letter of Demand for the deficiency MCIT in the amount
ofP272,421,886.58.[12] Consequently, the CTA en banc denied the Petition of the CIR for lack
of merit. The CTA en banc likewise denied the Motion for Reconsideration of the CIR in a
Resolution dated 11 October 2007.

Hence, the CIR comes before this Court via the instant Petition for Review on Certiorari,
based on the grounds stated hereunder:

THE COURT OF TAX APPEALS ERRED ON A QUESTION OF LAW IN ITS

ASSAILED DECISION BECAUSE:

(1) [PAL] CLEARLY OPTED TO BE COVERED BY THE INCOME TAX

PROVISION OF THE NATIONAL INTERNAL REVENUE CODE OF 1997
(NIRC OF 1997). (sic) AS AMENDED; HENCE, IT IS COVERED BY THE
MCIT PROVISION OF THE SAME CODE.

(2) THE MCIT DOES NOT BELONG TO THE CATEGORY OF OTHER TAXES
WHICH WOULD ENABLE RESPONDENT TO AVAIL ITSELF OF THE IN
LIEU (sic) OF ALL OTHER TAXES CLAUSE UNDER SECTION 13 OF P.D.
NO. 1590 (CHARTER).

(3) THE MCIT PROVISION OF THE NIRC OF 1997 IS NOT AN

AMENDMENT OF [PALS] CHARTER.

(4) PAL IS NOT ONLY GIVEN THE PRIVILEGE TO CHOOSE BETWEEN

WHAT WILL GIVE IT THE BENEFIT OF A LOWER TAX, BUT ALSO THE
RESPONSIBILITY OF PAYING ITS SHARE OF THE TAX BURDEN, AS IS
EVIDENT IN SECTION 22 OF RA NO. 9337.

(5) A CLAIM FOR EXEMPTION FROM TAXATION IS NEVER PRESUMED;

[PAL] IS LIABLE FOR THE DEFICIENCY MCIT.[13]

There is only one vital issue that the Court must resolve in the Petition at bar, i.e., whether
PAL is liable for deficiency MCIT for FY 2000-2001.

The Court answers in the negative.

Presidential Decree No. 1590, the franchise of PAL, contains provisions specifically
governing the taxation of said corporation, to wit:

Section 13. In consideration of the franchise and rights hereby granted, the
grantee shall pay to the Philippine Government during the life of this
franchise whichever of subsections (a) and (b) hereunder will result in a lower
tax:
(a) The basic corporate income tax based on the grantee's annual net
taxable income computed in accordance with the provisions of the National
Internal Revenue Code; or
(b) A franchise tax of two per cent (2%) of the gross revenues derived by
the grantee from all sources, without distinction as to transport or nontransport
operations; provided, that with respect to international air-transport service, only
the gross passenger, mail, and freight revenues from its outgoing flights shall be
subject to this tax.
The tax paid by the grantee under either of the above alternatives shall be in
lieu of all other taxes, duties, royalties, registration, license, and other fees and
charges of any kind, nature, or description, imposed, levied, established, assessed,
or collected by any municipal, city, provincial, or national authority or government
agency, now or in the future, including but not limited to the following:
1. All taxes, duties, charges, royalties, or fees due on local purchases by the
grantee of aviation gas, fuel, and oil, whether refined or in crude form, and whether
such taxes, duties, charges, royalties, or fees are directly due from or imposable
upon the purchaser or the seller, producer, manufacturer, or importer of said
petroleum products but are billed or passed on to the grantee either as part of the
price or cost thereof or by mutual agreement or other arrangement; provided, that
all such purchases by, sales or deliveries of aviation gas, fuel, and oil to the grantee
shall be for exclusive use in its transport and nontransport operations and other
activities incidental thereto;
2. All taxes, including compensating taxes, duties, charges, royalties, or fees
due on all importations by the grantee of aircraft, engines, equipment, machinery,
spare parts, accessories, commissary and catering supplies, aviation gas, fuel, and
oil, whether refined or in crude form and other articles, supplies, or materials;
provided, that such articles or supplies or materials are imported for the use of the
grantee in its transport and nontransport operations and other activities incidental
thereto and are not locally available in reasonable quantity, quality, or price;
3. All taxes on lease rentals, interest, fees, and other charges payable to
lessors, whether foreign or domestic, of aircraft, engines, equipment, machinery,
spare parts, and other property rented, leased, or chartered by the grantee where the
payment of such taxes is assumed by the grantee;
4. All taxes on interest, fees, and other charges on foreign loans obtained and
other obligations incurred by the grantee where the payment of such taxes is
assumed by the grantee;
 5. All taxes, fees, and other charges on the registration, licensing,
acquisition, and transfer of aircraft, equipment, motor vehicles, and all other
personal and real property of the grantee; and
6. The corporate development tax under Presidential Decree No. 1158-A.
The grantee, shall, however, pay the tax on its real property in conformity
with existing law.
For purposes of computing the basic corporate income tax as provided
herein, the grantee is authorized:

(a) To depreciate its assets to the extent of not more than twice as fast the
normal rate of depreciation; and

(b) To carry over as a deduction from taxable income any net loss incurred
in any year up to five years following the year of such loss.

Section 14. The grantee shall pay either the franchise tax or the basic
corporate income tax on quarterly basis to the Commissioner of Internal Revenue.
Within sixty (60) days after the end of each of the first three quarters of the taxable
calendar or fiscal year, the quarterly franchise or income-tax return shall be filed
and payment of either the franchise or income tax shall be made by the grantee.

A final or an adjustment return covering the operation of the grantee for the
preceding calendar or fiscal year shall be filed on or before the fifteenth day of the
fourth month following the close of the calendar or fiscal year. The amount of the
final franchise or income tax to be paid by the grantee shall be the balance of the
total franchise or income tax shown in the final or adjustment return after
deducting therefrom the total quarterly franchise or income taxes already paid
during the preceding first three quarters of the same taxable year.
Any excess of the total quarterly payments over the actual annual franchise
of income tax due as shown in the final or adjustment franchise or income-tax
return shall either be refunded to the grantee or credited against the grantee's
quarterly franchise or income-tax liability for the succeeding taxable year or years
at the option of the grantee.

The term "gross revenues" is herein defined as the total gross income
earned by the grantee from; (a) transport, nontransport, and other services; (b)
earnings realized from investments in money-market placements, bank deposits,
investments in shares of stock and other securities, and other investments; (c) total
gains net of total losses realized from the disposition of assets and foreign-
exchange transactions; and (d) gross income from other sources. (Emphases ours.)

According to the afore-quoted provisions, the taxation of PAL, during the lifetime of its
franchise, shall be governed by two fundamental rules, particularly: (1) PAL shall pay the
Government either basic corporate income tax or franchise tax, whichever is lower; and (2)
the tax paid by PAL, under either of these alternatives, shall be in lieu of all other taxes,
duties, royalties, registration, license, and other fees and charges, except only real property
tax.

The basic corporate income tax of PAL shall be based on its annual net taxable
income, computed in accordance with the National Internal Revenue Code
(NIRC).Presidential Decree No. 1590 also explicitly authorizes PAL, in the computation of
its basic corporate income tax, to (1) depreciate its assets twice as fast the normal rate of
depreciation;[14] and (2) carry over as a deduction from taxable income any net loss incurred
in any year up to five years following the year of such loss.[15]

Franchise tax, on the other hand, shall be two per cent (2%) of the gross revenues derived by
PAL from all sources, whether transport or nontransport operations. However, with respect to
international air-transport service, the franchise tax shall only be imposed on the gross
passenger, mail, and freight revenues of PAL from its outgoing flights.

In its income tax return for FY 2000-2001, filed with the BIR, PAL reported no net taxable
income for the period, resulting in zero basic corporate income tax, which would necessarily
be lower than any franchise tax due from PAL for the same period.

The CIR, though, assessed PAL for MCIT for FY 2000-2001. It is the position of the CIR
that the MCIT is income tax for which PAL is liable. The CIR reasons that Section 13(a) of
Presidential Decree No. 1590 provides that the corporate income tax of PAL shall be
computed in accordance with the NIRC. And, since the NIRC of 1997 imposes MCIT, and
PAL has not applied for relief from the said tax, then PAL is subject to the same.
The Court is not persuaded. The arguments of the CIR are contrary to the plain meaning and
obvious intent of Presidential Decree No. 1590, the franchise of PAL.
Income tax on domestic corporations is covered by Section 27 of the NIRC of 1997,
[16]
pertinent provisions of which are reproduced below for easy reference:

SEC. 27. Rates of Income Tax on Domestic Corporations.

(A) In General Except as otherwise provided in this Code, an income tax

of thirty-five percent (35%) is hereby imposed upon the taxable income derived
during each taxable year from all sources within and without the Philippines by
every corporation, as defined in Section 22(B) of this Code and taxable under this
Title as a corporation, organized in, or existing under the laws of the
Philippines: Provided, That effective January 1, 1998, the rate of income tax shall
be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-
three percent (33%); and effective January 1, 2000 and thereafter, the rate shall be
thirty-two percent (32%).
 xxxx

(E) Minimum Corporate Income Tax on Domestic Corporations.

(1) Imposition of Tax. A minimum corporate income tax of two percent

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

Hence, a domestic corporation must pay whichever is higher of: (1) the income tax under
Section 27(A) of the NIRC of 1997, computed by applying the tax rate therein to the taxable
income of the corporation; or (2) the MCIT under Section 27(E), also of the NIRC of 1997,
equivalent to 2% of the gross income of the corporation. Although this may be the general
rule in determining the income tax due from a domestic corporation under the NIRC of 1997,
it can only be applied to PAL to the extent allowed by the provisions in the franchise of PAL
specifically governing its taxation.

After a conscientious study of Section 13 of Presidential Decree No. 1590, in relation to

Sections 27(A) and 27(E) of the NIRC of 1997, the Court, like the CTA en banc and Second
Division, concludes that PAL cannot be subjected to MCIT for FY 2000-2001.
First, Section 13(a) of Presidential Decree No. 1590 refers to basic corporate income
tax. In Commissioner of Internal Revenue v. Philippine Airlines, Inc.,[17] the Court already
settled that the basic corporate income tax, under Section 13(a) of Presidential Decree No.
1590, relates to the general rate of 35% (reduced to 32% by the year 2000) as stipulated in
Section 27(A) of the NIRC of 1997.

Section 13(a) of Presidential Decree No. 1590 requires that the basic corporate income tax be
computed in accordance with the NIRC. This means that PAL shall compute its basic
corporate income tax using the rate and basis prescribed by the NIRC of 1997 for the said
tax. There is nothing in Section 13(a) of Presidential Decree No. 1590 to support the
contention of the CIR that PAL is subject to the entire Title II of the NIRC of 1997, entitled
Tax on Income.

Second, Section 13(a) of Presidential Decree No. 1590 further provides that the basic
corporate income tax of PAL shall be based on its annual net taxable income. This is
consistent with Section 27(A) of the NIRC of 1997, which provides that the rate of basic
corporate income tax, which is 32% beginning 1 January 2000, shall be imposed on
thetaxable income of the domestic corporation.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent items of
gross income specified in the said Code, less the deductions and/or personal and
additional exemptions, if any, authorized for such types of income by the same Code or
other special laws. The gross income, referred to in Section 31, is described in Section 32 of
the NIRC of 1997 as income from whatever source, including compensation for services; the
conduct of trade or business or the exercise of profession; dealings in property; interests;
rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partners
distributive share in the net income of a general professional partnership.

Pursuant to the NIRC of 1997, the taxable income of a domestic corporation may be arrived
at by subtracting from gross income deductions authorized, not just by the NIRC of 1997,
[18]
but also by special laws. Presidential Decree No. 1590 may be considered as one of such
special laws authorizing PAL, in computing its annual net taxable income, on which its basic
corporate income tax shall be based, to deduct from its gross income the following: (1)
depreciation of assets at twice the normal rate; and (2) net loss carry-over up to five years
following the year of such loss.

In comparison, the 2% MCIT under Section 27(E) of the NIRC of 1997 shall be based on
the gross income of the domestic corporation. The Court notes that gross income, as the
basis for MCIT, is given a special definition under Section 27(E)(4) of the NIRC of 1997,
different from the general one under Section 34 of the same Code.

According to the last paragraph of Section 27(E)(4) of the NIRC of 1997, gross income of a
domestic corporation engaged in the sale of service means gross receipts, less sales returns,
allowances, discounts and cost of services. Cost of services refers to all direct costs and
expenses necessarily incurred to provide the services required by the customers and clients
including (a) salaries and employee benefits of personnel, consultants, and specialists
directly rendering the service; and (b) cost of facilities directly utilized in providing the
service, such as depreciation or rental of equipment used and cost of supplies. [19] Noticeably,
inclusions in and exclusions/deductions from gross income for MCIT purposes are limited to
those directly arising from the conduct of the taxpayers business. It is, thus, more limited
than the gross income used in the computation of basic corporate income tax.

In light of the foregoing, there is an apparent distinction under the NIRC of 1997 between
taxable income, which is the basis for basic corporate income tax under Section 27(A); and
gross income, which is the basis for the MCIT under Section 27(E). The two terms have their
respective technical meanings, and cannot be used interchangeably. The same reasons
prevent this Court from declaring that the basic corporate income tax, for which PAL is liable
under Section 13(a) of Presidential Decree No. 1590, also covers MCIT under Section 27(E)
of the NIRC of 1997, since the basis for the first is the annual net taxable income, while the
basis for the second is gross income.
Third, even if the basic corporate income tax and the MCIT are both income taxes under
Section 27 of the NIRC of 1997, and one is paid in place of the other, the two are distinct and
separate taxes.
The Court again cites Commissioner of Internal Revenue v. Philippine Airlines, Inc.,
[20]
wherein it held that income tax on the passive income [21] of a domestic corporation, under
Section 27(D) of the NIRC of 1997, is different from the basic corporate income tax on the
taxable income of a domestic corporation, imposed by Section 27(A), also of the NIRC of
1997. Section 13 of Presidential Decree No. 1590 gives PAL the option to pay basic
corporate income tax or franchise tax, whichever is lower; and the tax so paid shall be in lieu
of all other taxes, except real property tax. The income tax on the passive income of PAL
falls within the category of all other taxes from which PAL is exempted, and which, if
already collected, should be refunded to PAL.
The Court herein treats MCIT in much the same way. Although both are income taxes, the
MCIT is different from the basic corporate income tax, not just in the rates, but also in the
bases for their computation. Not being covered by Section 13(a) of Presidential Decree No.
1590, which makes PAL liable only for basic corporate income tax, then MCIT is included in
all other taxes from which PAL is exempted.

That, under general circumstances, the MCIT is paid in place of the basic corporate income
tax, when the former is higher than the latter, does not mean that these two income taxes are
one and the same. The said taxes are merely paid in the alternative, giving the Government
the opportunity to collect the higher amount between the two. The situation is not much
different from Section 13 of Presidential Decree No. 1590, which reversely allows PAL to
pay, whichever is lower of the basic corporate income tax or the franchise tax. It does not
make the basic corporate income tax indistinguishable from the franchise tax.

Given the fundamental differences between the basic corporate income tax and the MCIT,
presented in the preceding discussion, it is not baseless for this Court to rule that, pursuant to
the franchise of PAL, said corporation is subject to the first tax, yet exempted from the
second.

Fourth, the evident intent of Section 13 of Presidential Decree No. 1520 is to extend to PAL
tax concessions not ordinarily available to other domestic corporations. Section 13 of
Presidential Decree No. 1520 permits PAL to pay whichever is lower of the basic corporate
income tax or the franchise tax; and the tax so paid shall be in lieu of all other taxes, except
only real property tax. Hence, under its franchise, PAL is to pay the least amount of tax
possible.
Section 13 of Presidential Decree No. 1520 is not unusual. A public utility is granted special
tax treatment (including tax exceptions/exemptions) under its franchise, as an inducement for
the acceptance of the franchise and the rendition of public service by the said public utility.
[22]
In this case, in addition to being a public utility providing air-transport service, PAL is
also the official flag carrier of the country.
The imposition of MCIT on PAL, as the CIR insists, would result in a situation that
contravenes the objective of Section 13 of Presidential Decree No. 1590. In effect, PAL
would not just have two, but three tax alternatives, namely, the basic corporate income tax,
MCIT, or franchise tax. More troublesome is the fact that, as between the basic corporate
income tax and the MCIT, PAL shall be made to pay whichever is higher, irrefragably, in
violation of the avowed intention of Section 13 of Presidential Decree No. 1590 to make
PAL pay for the lower amount of tax.
Fifth, the CIR posits that PAL may not invoke in the instant case the in lieu of all other taxes
clause in Section 13 of Presidential Decree No. 1520, if it did not pay anything at all as basic
corporate income tax or franchise tax. As a result, PAL should be made liable for other taxes
such as MCIT. This line of reasoning has been dubbed as the Substitution Theory, and this is
not the first time the CIR raised the same. The Court already rejected the Substitution Theory
in Commissioner of Internal Revenue v. Philippine Airlines, Inc.,[23] to wit:

Substitution Theory
of the CIR Untenable

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

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

Notably, PAL was owned and operated by the government at the time the
franchise was last amended. It can reasonably be contemplated that PD 1590
sought to assist the finances of the government corporation in the form of lower
taxes. When respondent operates at a loss (as in the instant case), no taxes are due;
in this instances, it has a lower tax liability than that provided by Subsection (b).
 The fallacy of the CIRs argument is evident from the fact that the
payment of a measly sum of one peso would suffice to exempt PAL from other
taxes, whereas a zero liability arising from its losses would not. There is no
substantial distinction between a zero tax and a one-peso tax
liability. (Emphasis ours.)

Based on the same ratiocination, the Court finds the Substitution Theory unacceptable
in the present Petition.

The CIR alludes as well to Republic Act No. 9337, for reasons similar to those behind the
Substitution Theory. Section 22 of Republic Act No. 9337, more popularly known as the
Expanded Value Added Tax (E-VAT) Law, abolished the franchise tax imposed by the
charters of particularly identified public utilities, including Presidential Decree No. 1590 of
PAL. PAL may no longer exercise its options or alternatives under Section 13 of Presidential
Decree No. 1590, and is now liable for both corporate income tax and the 12% VAT on its
sale of services. The CIR alleges that Republic Act No. 9337 reveals the intention of the
Legislature to make PAL share the tax burden of other domestic corporations.

The CIR seems to lose sight of the fact that the Petition at bar involves the liability of PAL
for MCIT for the fiscal year ending 31 March 2001. Republic Act No. 9337, which took
effect on 1 July 2005, cannot be applied retroactively[24] and any amendment introduced by
said statute affecting the taxation of PAL is immaterial in the present case.
And sixth, Presidential Decree No. 1590 explicitly allows PAL, in computing its basic
corporate income tax, to carry over as deduction any net loss incurred in any year, up to five
years following the year of such loss. Therefore, Presidential Decree No. 1590 does not only
consider the possibility that, at the end of a taxable period, PAL shall end up with zero
annual net taxable income (when its deductions exactly equal its gross income), as what
happened in the case at bar, but also the likelihood that PAL shall incur net loss (when its
deductions exceed its gross income). If PAL is subjected to MCIT, the provision in
Presidential Decree No. 1590 on net loss carry-over will be rendered nugatory.Net loss carry-
over is material only in computing the annual net taxable income to be used as basis for the
basic corporate income tax of PAL; but PAL will never be able to avail itself of the basic
corporate income tax option when it is in a net loss position, because it will always then be
compelled to pay the necessarily higher MCIT.
Consequently, the insistence of the CIR to subject PAL to MCIT cannot be done without
contravening Presidential Decree No. 1520.

Between Presidential Decree No. 1520, on one hand, which is a special law specifically
governing the franchise of PAL, issued on 11 June 1978; and the NIRC of 1997, on the other,
which is a general law on national internal revenue taxes, that took effect on 1 January 1998,
the former prevails. The rule is that on a specific matter, the special law shall prevail over the
general law, which shall be resorted to only to supply deficiencies in the former. In addition,
where there are two statutes, the earlier special and the later general the terms of the general
broad enough to include the matter provided for in the special the fact that one is special and
the other is general creates a presumption that the special is to be considered as remaining an
exception to the general, one as a general law of the land, the other as the law of a particular
case. It is a canon of statutory construction that a later statute, general in its terms and not
expressly repealing a prior special statute, will ordinarily not affect the special provisions of
such earlier statute.[25]

Neither can it be said that the NIRC of 1997 repealed or amended Presidential Decree No.
1590.

While Section 16 of Presidential Decree No. 1590 provides that the franchise is granted to
PAL with the understanding that it shall be subject to amendment, alteration, or repeal by
competent authority when the public interest so requires, Section 24 of the same Decree also
states that the franchise or any portion thereof may only be modified, amended, or repealed
expressly by a special law or decree that shall specifically modify, amend, or repeal said
franchise or any portion thereof. No such special law or decree exists herein.
The CIR cannot rely on Section 7(B) of Republic Act No. 8424, which amended the NIRC in
1997 and reads as follows:

Section 7. Repealing Clauses.

xxxx

(B) The provisions of the National Internal Revenue Code, as amended, and
all other laws, including charters of government-owned or controlled
corporations, decrees, orders, or regulations or parts thereof, that are inconsistent
with this Act are hereby repealed or amended accordingly.

The CIR reasons that PAL was a government-owned and controlled corporation when
Presidential Decree No. 1590, its franchise or charter, was issued in 1978. Since PAL was
still operating under the very same charter when Republic Act No. 8424 took effect in 1998,
then the latter can repeal or amend the former by virtue of Section 7(B).

The Court disagrees.

A brief recount of the history of PAL is in order. PAL was established as a private
corporation under the general law of the Republic of the Philippines in February
1941. InNovember 1977, the government, through the Government Service Insurance
System (GSIS), acquired the majority shares in PAL. PAL was privatized in January
1992 when the local consortium PR Holdings acquired a 67% stake therein.[26]

It is true that when Presidential Decree No. 1590 was issued on 11 June 1978, PAL was then
a government-owned and controlled corporation; but when Republic Act No. 8424,
amending the NIRC, took effect on 1 January 1998, PAL was already a private corporation
for six years. The repealing clause under Section 7(B) of Republic Act No. 8424 simply
refers to charters of government-owned and controlled corporations, which would simply
and plainly mean corporations under the ownership and control of the government at the
time of effectivity of said statute. It is already a stretch for the Court to read into said
provision charters, issued to what were then government-owned and controlled corporations
that are now private, but still operating under the same charters.

That the Legislature chose not to amend or repeal Presidential Decree No. 1590, even after
PAL was privatized, reveals the intent of the Legislature to let PAL continue enjoying, as a
private corporation, the very same rights and privileges under the terms and conditions stated
in said charter. From the moment PAL was privatized, it had to be treated as a private
corporation, and its charter became that of a private corporation. It would be completely
illogical to say that PAL is a private corporation still operating under a charter of a
government-owned and controlled corporation.

The alternative argument of the CIR that the imposition of the MCIT is pursuant to the
amendment of the NIRC, and not of Presidential Decree No. 1590 is just as specious. As has
already been settled by this Court, the basic corporate income tax under Section 13(a) of
Presidential Decree No. 1590 relates to the general tax rate under Section 27(A) of the NIRC
of 1997, which is 32% by the year 2000, imposed on taxable income. Thus, only provisions
of the NIRC of 1997 necessary for the computation of the basic corporate income tax apply
to PAL. And even though Republic Act No. 8424 amended the NIRC by introducing the
MCIT, in what is now Section 27(E) of the said Code, this amendment is actually irrelevant
and should not affect the taxation of PAL, since the MCIT is clearly distinct from the basic
corporate income tax referred to in Section 13(a) of Presidential Decree No. 1590, and from
which PAL is consequently exempt under the in lieu of all other taxes clause of its charter.

The CIR calls the attention of the Court to RMC No. 66-2003, on Clarifying the Taxability of
Philippine Airlines (PAL) for Income Tax Purposes As Well As Other Franchise Grantees
Similarly Situated. According to RMC No. 66-2003:

Section 27(E) of the Code, as implemented by Revenue Regulations No. 9-

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

With the advent of such provision beginning January 1, 1998, it is certain

that domestic corporations subject to normal income tax as well as those choose to
be subject thereto, such as PAL, are bound to pay income tax regardless of whether
they are operating at a profit or loss.

Thus, in case of operating loss, PAL may either opt to subject itself to
minimum corporate income tax or to the 2% franchise tax, whichever is lower. On
the other hand, if PAL is operating at a profit, the income tax liability shall be the
lower amount between:

(1) normal income tax or MCIT whichever is higher; and

(2) 2% franchise tax.

The CIR attempts to sway this Court to adopt RMC No. 66-2003 since the [c]onstruction by
an executive branch of government of a particular law although not binding upon the courts
must be given weight as the construction comes from the branch of the government called
upon to implement the law.[27]

But the Court is unconvinced.

It is significant to note that RMC No. 66-2003 was issued only on 14 October 2003, more
than two years after FY 2000-2001 of PAL ended on 31 March 2001. This violates the well-
entrenched principle that statutes, including administrative rules and regulations, operate
prospectively only, unless the legislative intent to the contrary is manifest by express terms
or by necessary implication.[28]
Moreover, despite the claims of the CIR that RMC No. 66-2003 is just a clarificatory and
internal issuance, the Court observes that RMC No. 66-2003 does more than just clarify a
previous regulation and goes beyond mere internal administration. It effectively increases the
tax burden of PAL and other taxpayers who are similarly situated, making them liable for a
tax for which they were not liable before. Therefore, RMC No. 66-2003 cannot be given
effect without previous notice or publication to those who will be affected
thereby. In Commissioner of Internal Revenue v. Court of Appeals,[29] the Court ratiocinated
that:

It should be understandable that when an administrative rule is merely

interpretative in nature, its applicability needs nothing further than its bare issuance
for it gives no real consequence more than what the law itself has already
prescribed. When, upon the other hand, the administrative rule goes beyond
merely providing for the means that can facilitate or render least cumbersome
the implementation of the law but substantially adds to or increases the
burden of those governed, it behooves the agency to accord at least to those
directly affected a chance to be heard, and thereafter to be duly informed,
before that new issuance is given the force and effect of law.

A reading of RMC 37-93, particularly considering the circumstances under

which it has been issued, convinces us that the circular cannot be viewed simply as
a corrective measure (revoking in the process the previous holdings of past
Commissioners) or merely as construing Section 142(c)(1) of the NIRC, as
amended, but has, in fact and most importantly, been made in order to place "Hope
Luxury," "Premium More" and "Champion" within the classification of locally
manufactured cigarettes bearing foreign brands and to thereby have them covered
by RA 7654. Specifically, the new law would have its amendatory provisions
applied to locally manufactured cigarettes which at the time of its effectivity were
not so classified as bearing foreign brands. Prior to the issuance of the questioned
circular, "Hope Luxury," "Premium More," and "Champion" cigarettes were in the
category of locally manufactured cigarettes not bearing foreign brand subject to
45% ad valorem tax. Hence, without RMC 37-93, the enactment of RA 7654,
would have had no new tax rate consequence on private respondent's products.
Evidently, in order to place "Hope Luxury," "Premium More," and "Champion"
cigarettes within the scope of the amendatory law and subject them to an increased
tax rate, the now disputed RMC 37-93 had to be issued. In so doing, the BIR not
simply interpreted the law; verily, it legislated under its quasi-legislative
authority. The due observance of the requirements of notice, of hearing, and
of publication should not have been then ignored.

Indeed, the BIR itself, in its RMC 10-86, has observed and provided:

"RMC NO. 10-86

Effectivity of Internal Revenue Rules and Regulations "It has

been observed that one of the problem areas bearing on compliance
with Internal Revenue Tax rules and regulations is lack or
insufficiency of due notice to the tax paying public. Unless there is
due notice, due compliance therewith may not be reasonably
expected. And most importantly, their strict enforcement could
possibly suffer from legal infirmity in the light of the constitutional
provision on 'due process of law' and the essence of the Civil Code
provision concerning effectivity of laws, whereby due notice is a
basic requirement (Sec. 1, Art. IV, Constitution; Art. 2, New Civil
Code).

"In order that there shall be a just enforcement of rules and

regulations, in conformity with the basic element of due process,
 the following procedures are hereby prescribed for the drafting,
issuance and implementation of the said Revenue Tax Issuances:
"(1). This Circular shall apply only to (a) Revenue
Regulations; (b) Revenue Audit Memorandum Orders; and
(c) Revenue Memorandum Circulars and Revenue Memorandum
Orders bearing on internal revenue tax rules and regulations.

"(2). Except when the law otherwise expressly provides, the

aforesaid internal revenue tax issuances shall not begin to be
operative until after due notice thereof may be fairly presumed.

"Due notice of the said issuances may be fairly presumed only

after the following procedures have been taken:

"xxx xxx xxx "(5). Strict compliance with the foregoing

procedures is enjoined.13

Nothing on record could tell us that it was either impossible or impracticable

for the BIR to observe and comply with the above requirements before giving
effect to its questioned circular. (Emphases ours.)

The Court, however, stops short of ruling on the validity of RMC No. 66-2003, for it is not
among the issues raised in the instant Petition. It only wishes to stress the requirement of
prior notice to PAL before RMC No. 66-2003 could have become effective. Only after RMC
No. 66-2003 was issued on 14 October 2003 could PAL have been given notice of said
circular, and only following such notice to PAL would RMC No. 66-2003 have taken
effect. Given this sequence, it is not possible to say that RMC No. 66-2003 was already in
effect and should have been strictly complied with by PAL for its fiscal year which ended
on 31 March 2001.
Even conceding that the construction of a statute by the CIR is to be given great weight, the
courts, which include the CTA, are not bound thereby if such construction is erroneous or is
clearly shown to be in conflict with the governing statute or the Constitution or other
laws. "It is the role of the Judiciary to refine and, when necessary, correct constitutional
(and/or statutory) interpretation, in the context of the interactions of the three branches of the
government."[30] It is furthermore the rule of long standing that this Court will not set aside
lightly the conclusions reached by the CTA which, by the very nature of its functions, is
dedicated exclusively to the resolution of tax problems and has, accordingly, developed an
expertise on the subject, unless there has been an abuse or improvident exercise of authority.
[31]
In the Petition at bar, the CTA en banc and in division both adjudged that PAL is not
liable for MCIT under Presidential Decree No. 1590, and this Court has no sufficient basis to
reverse them.
As to the assertions of the CIR that exemption from tax is not presumed, and the one
claiming it must be able to show that it indubitably exists, the Court recalls its
pronouncements in Commissioner of Internal Revenue v. Court of Appeals[32]:
We disagree. Petitioner Commissioner of Internal Revenue erred in applying the
principles of tax exemption without first applying the well-settled doctrine of
strict interpretation in the imposition of taxes. It is obviously both illogical
and impractical to determine who are exempted without first determining
who are covered by the aforesaid provision. The Commissioner should have
determined first if private respondent was covered by Section 205, applying the
rule of strict interpretation of laws imposing taxes and other burdens on the
populace, before asking Ateneo to prove its exemption therefrom. The Court takes
this occasion to reiterate the hornbook doctrine in the interpretation of tax laws that
(a) statute will not be construed as imposing a tax unless it does so clearly,
expressly, and unambiguously. x x x (A) tax cannot be imposed without clear and
express words for that purpose. Accordingly, the general rule of requiring
adherence to the letter in construing statutes applies with peculiar strictness to
tax laws and the provisions of a taxing act are not to be extended by
implication. Parenthetically, in answering the question of who is subject to tax
statutes, it is basic that in case of doubt, such statutes are to be construed most
strongly against the government and in favor of the subjects or citizens
because burdens are not to be imposed nor presumed to be imposed beyond
what statutes expressly and clearly import. (Emphases ours.)

For two decades following the grant of its franchise by Presidential Decree No. 1590 in
1978, PAL was only being held liable for the basic corporate income tax or franchise tax,
whichever was lower; and its payment of either tax was in lieu of all other taxes, except real
property tax, in accordance with the plain language of Section 13 of the charter of
PAL. Therefore, the exemption of PAL from all other taxes was not just a presumption, but a
previously established, accepted, and respected fact, even for the BIR.

The MCIT was a new tax introduced by Republic Act No. 8424. Under the doctrine of strict
interpretation, the burden is upon the CIR to primarily prove that the new MCIT provisions
of the NIRC of 1997, clearly, expressly, and unambiguously extend and apply to PAL,
despite the latters existing tax exemption. To do this, the CIR must convince the Court that
the MCIT is a basic corporate income tax,[33] and is not covered by the in lieu of all other
taxes clause of Presidential Decree No. 1590. Since the CIR failed in this regard, the Court is
left with no choice but to consider the MCIT as one of all other taxes, from which PAL is
exempt under the explicit provisions of its charter.
Not being liable for MCIT in FY 2000-2001, it necessarily follows that PAL need not apply
for relief from said tax as the CIR maintains.
WHEREFORE, premises considered, the instant Petition for Review is
hereby DENIED, and the Decision dated 9 August 2007 and Resolution dated 11 October
2007 of the Court of Tax Appeals en banc in CTA E.B. No. 246 is hereby AFFIRMED. No
costs.

SO ORDERED.
[G.R. No. L-26145. February 20, 1984.]

THE MANILA WINE MERCHANTS, INC., Petitioner, v. THE COMMISSIONER OF

INTERNAL REVENUE, Respondent.

Rafael D. Salcedo for Petitioner.

The Solicitor General for Respondent.

SYLLABUS

1. TAXATION; NATIONAL INTERNAL REVENUE CODE; CORPORATE INCOME

TAX; ADDITIONAL TAX ON ACCUMULATED EARNINGS; EXEMPTION
THEREFROM. A prerequisite to the imposition of the tax has been that the corporation
be formed or availed of for the purpose of avoiding the income tax (or surtax) on its
shareholders, or on the shareholders of any other corporation by permitting the earnings and
profits of the corporation to accumulate instead of dividing them among or distributing them
to the shareholders. If the earnings and profits were distributed, the shareholders would be
required to pay an income tax thereon whereas, if the distribution were not made to them,
they would incur no tax in respect to the undistributed earnings and profits of the corporation
(Mertens, Law on Federal Income Taxation, Vol. 7, Chapter 39, p. 44). The touchstone of
liability is the purpose behind the accumulation of the income and not the consequences of
the accumulation (Ibid., p. 47). Thus, if the failure to pay dividends is due to some other
cause, such as the use of undistributed earnings and profits for the reasonable needs of the
business, such purpose does not fall within the interdiction of the statute (Ibid., p. 45).

2. ID.; ID.; ID.; ID.; ID.; WHEN ACCUMULATION CONSIDERED UNREASONABLE.

An accumulation of earnings or profits (including undistributed earnings or profits of
prior years) is unreasonable if it is not required for the purpose of the business, considering
all the circumstances of the case (Sec. 21, Revenue Regulations No. 2).

3. ID.; ID.; ID.; ID.; ID.; "REASONABLE NEEDS OF THE BUSINESS," CONSTRUED.
To determine the "reasonable needs" of the business in order to justify an accumulation of
earnings, the Courts of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to mean the immediate needs
of the business, and it was generally held that if the corporation did not prove an immediate
need for the accumulation of the earnings and profits, the accumulation was not for the
reasonable needs of the business, and the penalty tax would apply. American cases likewise
hold that investment of the earnings and profits of the corporation in stock or securities of an
unrelated business usually indicates an accumulation beyond the reasonable needs of the
business. (Helvering v. Chicago Stockyards Co., 318 US 693; Helvering v. National Grocery
Co., 304 US 282).
4. REMEDIAL LAW; APPEALS; FACTUAL FINDINGS OF THE COURT OF TAX
APPEALS, BINDING. The finding of the Court of Tax Appeals that the purchase of the
U.S.A. Treasury bonds were in no way related to petitioners business of importing and
selling wines whisky, liquors and distilled spirits, and thus construed as an investment
beyond the reasonable needs of the business is binding on Us, the same being factual
(Renato Raymundo v. Hon. De Jova, 101 SCRA 495). Furthermore, the wisdom behind thus
finding cannot be doubted, The case of J.M. Perry & Co. v. Commissioner of Internal
Revenue supports the same.

5. TAXATION; NATIONAL INTERNAL REVENUE CODE; INCOME TAX OF

CORPORATIONS; ADDITIONAL TAX ON ACCUMULATED EARNINGS; EXCEPTION
THEREFROM; ACCUMULATION OF EARNINGS, MUST BE USED FOR
REASONABLE NEEDS OF BUSINESS WITHIN A REASONABLE TIME. The records
further reveal that from May 1951 when petitioner purchased the U.S.A. Treasury shares,
until 1962 when it finally liquidated the same, it (petitioner) never had the occasion to use
the said shares in aiding or financing its importation. This militates against the purpose
enunciated earlier by petitioner that the shares were purchased to finance its importation
business. To justify an accumulation of earnings and profits for the reasonably anticipated
future needs, such accumulation must be used within a reasonable time after the close of the
taxable year (Mertens, Ibid., p. 104).

6. ID.; ID.; ID.; ID.; ID.; ID.; INTENTION AT THE TIME OF ACCUMULATION, BASIS
OF THE TAX; ACCUMULATION OF PROFITS IN CASE AT BAR, UNREASONABLE.
In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the surtax upon shareholders, the controlling intention of the taxpayer is
that which is manifested at the time of accumulation not subsequently declared intentions
which are merely the product of afterthought (Basilan Estates, Inc. v. Comm. of Internal
Revenue, 21 SCRA 17 citing Jacob Mertens, Jr., The law of Federal Income Taxation, Vol. 7,
Cumulative Supplement, p. 213; Smoot and San & Gravel Corp. v. Comm., 241 F 2d 197). A
speculative and indefinite purpose will not suffice. The mere recognition of a future problem
and the discussion of possible and alternative solutions is not sufficient. Definiteness of plan
coupled with action taken towards its consummation are essential (Fuel Carriers, Inc. v. US
202 F supp. 497; Smoot Sand & Gravel Corp. v. Comm., supra). Viewed on the foregoing
analysis and tested under the "immediacy doctrine," We are convinced that the Court of Tax
Appeals is correct in finding that the investment made by petitioner in the U.S.A. Treasury
shares in 1951 was an accumulation of profits in excess of the reasonable needs of
petitioners business.chanroblesvirtuallawlibrary

7. ID.; ID.; ID.; ID.; ACCUMULATIONS OF PRIOR YEARS TAKEN INTO ACCOUNT
IN DETERMINATION OF LIABILITY THEREFOR. The rule is now settled in Our
jurisprudence that undistributed earnings or profits of prior years are taken into consideration
in determining unreasonable accumulation for purposes of the 25% surtax. The case of
Basilan Estates, Inc. v. Commissioner of Internal Revenue further strengthen this rule in
determining unreasonable accumulation for the year concerned.In determining whether
accumulations of earnings or profits in a particular year are within the reasonable needs of a
corporation, it is necessary to take into account prior accumulations, since accumulations
prior to the year involved may have been sufficient to cover the business needs and
additional accumulations during the year involved would not reasonably be necessary.

DECISION

GUERRERO, J.:

In this Petition for Review on Certiorari, Petitioner, the Manila Wine Merchants, Inc.,
disputes the decision of the Court of Tax Appeals ordering it (petitioner) to pay respondent,
the Commissioner of Internal Revenue, the amount of P86,804.38 as 25% surtax plus interest
which represents the additional tax due petitioner for improperly accumulating profits or
surplus in the taxable year 1957 under Sec. 25 of the National Internal Revenue
Code.chanrobles virtualawlibrary chanrobles.com:chanrobles.com.ph

The Court of Tax Appeals made the following finding of facts, to wit:jgc:chanrobles.com.ph

"Petitioner, a domestic corporation organized in 1937, is principally engaged in the

importation and sale of whisky, wines, liquors and distilled spirits. Its original subscribed
and paid capital was P500,000.00. Its capital of P500,000.00 was reduced to P250,000.00 in
1950 with the approval of the Securities and Exchange Commission but the reduction of the
capital was never implemented. On June 21, 1958, petitioners capital was increased to
P1,000,000.00 with the approval of the said Commission.

On December 31, 1957, herein respondent caused the examination of herein petitioners
book of account and found the latter of having unreasonably accumulated surplus of
P428,934.32 for the calendar year 1947 to 1957, in excess of the reasonable needs of the
business subject to the 25% surtax imposed by Section 25 of the Tax Code.

On February 26, 1963, the Commissioner of Internal Revenue demanded upon the Manila
Wine Merchants, Inc. payment of P126,536.12 as 25% surtax and interest on the latters
unreasonable accumulation of profits and surplus for the year 1957, computed as
follows:chanrob1es virtual 1aw library

Unreasonable accumulation of surtax P428,934.42

25% surtax due thereon P107,234.00

Add: 1/2% monthly interest from June 20,

1959 to June 20, 1962 19,302.12



TOTAL AMOUNT DUE AND COLLECTIBLE P126,536.12

=========

Respondent contends that petitioner has accumulated earnings beyond the reasonable needs
of its business because the average ratio of the cash dividends declared and paid by petitioner
from 1947 to 1957 was 40.33% of the total surplus available for distribution at the end of
each calendar year. On the other hand, petitioner contends that in 1957, it distributed 100%
of its net earnings after income tax and part of the surplus for prior years. Respondent further
submits that the accumulated earnings tax should be based on 25% of the total surplus
available at the end of each calendar year while petitioner maintains that the 25% surtax is
imposed on the total surplus or net income for the year after deducting therefrom the income
tax due.

The records show the following analysis of petitioners net income, cash dividends and
earned surplus for the years 1946 to 1957: 1

Percentage of

Dividends to

Net Income Total Cash Net Income Balance

After Income Dividends After of Earned

Year Tax Paid Income Tax Surplus

1946 P 613,790.00 P 200,000. 32.58% P 234,104.81

1947 425,719.87 360,000. 84.56% 195,167.10

1948 415,591.83 375,000. 90.23% 272,991.38

1949 335,058.06 200,000. 59.69% 893,113.42

1950 399,698.09 600,000. 150.11% 234,987.07

1951 346,257.26 300,000. 86.64% 281,244.33

1952 196,161.97 200,000. 101.96% 277,406.30

1953 169,714.04 200,000. 117.85% 301,138.84

1954 238,124.85 250,000. 104.99% 289,262.69

1955 312,284.74 200,000. 64.04% 401,548.43

1956 374,240.28 300,000. 80.16% 475,788.71

1957 353,145.71 400,000. 113.27% 428,934.42

P4,179,787.36 P3,585.000. 85.77% P3,785.688.50

========== ========= ======= ==========

Another basis of respondent in assessing petitioner for accumulated earnings tax is its
substantial investment of surplus or profits in unrelated business. These investments are
itemized as follows:chanrob1es virtual 1aw library

1. Acme Commercial Co., Inc. P 27,501.00

2. Union Insurance Society

of Canton 1,145.76

3. U.S.A. Treasury Bond 347,217.50

4. Wack Wack Golf &

Country Club 1.00

375,865.26

=========

As to the investment of P27,501.00 made by petitioner in the Acme Commercial Co., Inc.,
Mr. N.R.E. Hawkins, president of the petitioner corporation 2 explained as
follows:chanrob1es virtual 1aw library

The first item consists of shares of Acme Commercial Co., Inc. which the Company
acquired in 1947 and 1949. In the said years, we thought it prudent to invest in a business
which patronizes us. As a supermarket, Acme Commercial Co., Inc. is one of our best
customers. The investment has proven to be beneficial to the stockholders of this Company.
As an example, the Company received cash dividends in 1961 totalling P16,875.00 which
was included in its income tax return for the said year.

As to the investments of petitioner in Union Insurance Society of Canton and Wack Wack
Golf Club in the sums of P1,145.76 and P1.00, respectively, the same official of the
petitioner-corporation stated that: 3

The second and fourth items are small amounts which we believe would not affect this case
substantially. As regards the Union Insurance Society of Canton shares, this was a pre-war
investment, when Wise & Co., Inc., Manila Wine Merchants and the said insurance firm
were common stockholders of the Wise Bldg. Co.,, Inc. and the three companies were all
housed in the same building. Union Insurance invested in Wise Bldg. Co., Inc. but invited
Manila Wine Merchants, Inc. to buy a few of its shares.

As to the U.S.A. Treasury Bonds amounting to P347,217.50, Mr. Hawkins explained as

follows: 4

With regards to the U.S.A. Treasury Bills in the amount of P347,217.50, in 1950, our
balance sheet for the said year shows the Company had deposited in current account in
various banks P629,403.64 which was not earning any interest. We decided to utilize part of
this money as reserve to finance our importations and to take care of future expansion
including acquisition of a lot and the construction of our own office building and bottling
plant.

At that time, we believed that a dollar reserve abroad would be useful to the Company in
meeting immediate urgent orders of its local customers. In order that the money may earn
interest, the Company, on May 31, 1951 purchased US Treasury bills with 90-day maturity
and earning approximately 1% interest with the face value of US$175,000.00. US Treasury
Bills are easily convertible into cash and for the said reason they may be better classified as
cash rather than investments.

The Treasury Bills in question were held as such for many years in view of our expectation
that the Central Bank inspite of the controls would allow no-dollar licenses importations.
However, since the Central Bank did not relax its policy with respect thereto, we decided
sometime in 1957 to hold the bills for a few more years in view of our plan to buy a lot and
construct a building of our own. According to the lease agreement over the building formerly
occupied by us in Dasmarias St., the lease was to expire sometime in 1957. At that time, the
Company was not yet qualified to own real property in the Philippines. We therefore waited
until 60% of the stocks of the Company would be owned by Filipino citizens before making
definite plans. Then in 1959 when the Company was already more than 60% Filipino owned,
we commenced looking for a suitable location and then finally in 1961, we bought the man
lot with an old building on Otis St., Paco, our present site, for P665,000.00. Adjoining
smaller lots were bought later. After the purchase of the main property, we proceeded with
the remodelling of the old building and the construction of additions, which were completed
at a cost of P143,896.00 in April, 1962.
In view of the needs of the business of this Company and the purchase of the Otis lots and
the construction of the improvements thereon, most of its available funds including the
Treasury Bills had been utilized, but inspite of the said expenses the Company consistently
declared dividends to its stockholders. The Treasury Bills were liquidated on February 15,
1962.

Respondent found that the accumulated surplus in question were invested to unrelated
business which were not considered in the immediate needs of the Company such that the
25% surtax be imposed therefrom."cralaw virtua1aw library

Petitioner appealed to the Court of Tax Appeals.

On the basis of the tabulated figures, supra, the Court of Tax Appeals found that the average
percentage of cash dividends distributed was 85.77% for a period of 11 years from 1946 to
1957 and not only 40.33% of the total surplus available for distribution at the end of each
calendar year actually distributed by the petitioner to its stockholders, which is indicative of
the view that the Manila Wine Merchants, Inc. was not formed for the purpose of preventing
the imposition of income tax upon its shareholders. 5

With regards to the alleged substantial investment of surplus or profits in unrelated business,
the Court of Tax Appeals held that the investment of petitioner with Acme Commercial Co.,
Inc., Union Insurance Society of Canton and with the Wack Wack Golf and Country Club are
harmless accumulation of surplus and, therefore, not subject to the 25% surtax provided in
Section 25 of the Tax Code. 6

As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals ruled
that its purchase was in no way related to petitioners business of importing and selling
wines, whisky, liquors and distilled spirits. Respondent Court was convinced that the surplus
of P347,217.50 which was invested in the U.S.A. Treasury Bonds was availed of by
petitioner for the purpose of preventing the imposition of the surtax upon petitioners
shareholders by permitting its earnings and profits to accumulate beyond the reasonable
needs of business. Hence, the Court of Tax Appeals modified respondents decision by
imposing upon petitioner the 25% surtax for 1957 only in the amount of P86,804.38
computed as follows:chanrob1es virtual 1aw library

Unreasonable accumulation

of surplus P347,217.50

25% surtax due thereon P 86,804.38 7

On May 30, 1966, the Court of Tax Appeals denied the motion for reconsideration filed by
petitioner on March 30, 1966. Hence, this petition.

Petition assigns the following errors:chanrob1es virtual 1aw library

I

The Court of Tax Appeals erred in holding that petitioner was availed of for the purpose of
preventing the imposition of a surtax on its shareholders.
II

The Court of Tax Appeals erred in holding that petitioners purchase of U.S.A. Treasury Bills
in 1951 was an investment in unrelated business subject to the 25% surtax in 1957 as surplus
profits improperly accumulated in the latter years.
III

The Court of Tax Appeals erred in not finding that petitioner did not accumulate its surplus
profits improperly in 1957, and in not holding that such surplus profits, including the so-
called unrelated investments, were necessary for its reasonable business needs.
IV

The Court of Tax Appeals erred in not holding that petitioner had overcome the prima facie
presumption provided for in Section 25(c) of the Revenue Code.
V

The Court of Tax Appeals erred in finding petition liable for the payment of the surtax of
P86,804.38 and in denying petitioners Motion for Reconsideration and/or New Trial.

The issues in this case can be summarized as follows: (1) whether the purchase of the U.S.A.
Treasury bonds by petitioner in 1951 can be construed as an investment to an unrelated
business and hence, such was availed of by petitioner for the purpose of preventing the
imposition of the surtax upon petitioners shareholders by permitting its earnings and profits
to accumulate beyond the reasonable needs of the business, and if so, (2) whether the penalty
tax of twenty-five percent (25%) can be imposed on such improper accumulation in 1957
despite the fact that the accumulation occurred in 1951.chanrobles virtualawlibrary
chanrobles.com:chanrobles.com.ph

The pertinent provision of the National Internal Revenue Code reads as

follows:jgc:chanrobles.com.ph

"Sec. 25. Additional tax on corporations improperly accumulating profits or surplus. (a)
Imposition of Tax. If any corporation, except banks, insurance companies, or personal
holding companies whether domestic or foreign, is formed or availed of for the purpose of
preventing the imposition of the tax upon its shareholders or members or the shareholders or
members of another corporation, through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied and assessed against such
corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed
portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four and shall be computed, collected and paid in the same manner and
subject to the same provisions of law, including penalties, as that tax: Provided, that no such
tax shall be levied upon any accumulated profits or surplus, if they are invested in any dollar-
producing or dollar-saving industry or in the purchase of bonds issued by the Central Bank
of the Philippines.
x x x

(c) Evidence determinative of purpose. The fact that the earnings of profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the contrary." (As amended by
Republic Act No. 1823).

As correctly pointed out by the Court of Tax Appeals, inasmuch as the provisions of Section
25 of the National Internal Revenue Code were bodily lifted from Section 102 of the U.S.
Internal Revenue Code of 1939, including the regulations issued in connection therewith, it
would be proper to resort to applicable cases decided by the American Federal Courts for
guidance and enlightenment.chanrobles virtual lawlibrary

A prerequisite to the imposition of the tax has been that the corporation be formed or availed
of for the purpose of avoiding the income tax (or surtax) on its shareholders, or on the
shareholders of any other corporation by permitting the earnings and profits of the
corporation to accumulate instead of dividing them among or distributing them to the
shareholders. If the earnings and profits were distributed, the shareholders would be required
to pay an income tax thereon whereas, if the distribution were not made to them, they would
incur no tax in respect to the undistributed earnings and profits of the corporation. 8 The
touchstone of liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation. 9 Thus, if the failure to pay dividends is due to some
other cause, such as the use of undistributed earnings and profits for the reasonable needs of
the business, such purpose does not fall within the interdiction of the statute. 10

An accumulation of earnings or profits (including undistributed earnings or profits of prior

years) is unreasonable if it is not required for the purpose of the business, considering all the
circumstances of the case. 11

In purchasing the U.S.A. Treasury Bonds, in 1951, petitioner argues that these bonds were so
purchased (1) in order to finance their importation; and that a dollar reserve abroad would be
useful to the Company in meeting urgent orders of its local customers and (2) to take care of
future expansion including the acquisition of a lot and the construction of their office
building and bottling plant.

We find no merit in the petition.

To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase of
the U.S.A. Treasury Bonds in 1951 with a face value of $175,000.00 was an investment
within the reasonable needs of the Corporation.

To determine the "reasonable needs" of the business in order to justify an accumulation of

earnings, the Courts of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to mean the immediate needs
of the business, and it was generally held that if the corporation did not prove an immediate
need for the accumulation of the earnings and profits, the accumulation was not for the
reasonable needs of the business, and the penalty tax would apply. 12 American cases
likewise hold that investment of the earnings and profits of the corporation in stock or
securities of an unrelated business usually indicates an accumulation beyond the reasonable
needs of the business. 13

The finding of the Court of Tax Appeals that the purchase of the U.S.A. Treasury bonds were
in no way related to petitioners business of importing and selling wines whisky, liquors and
distilled spirits, and thus construed as an investment beyond the reasonable needs of the
business 14 is binding on Us, the same being factual. 15 Furthermore, the wisdom behind
thus finding cannot be doubted, The case of J.M. Perry & Co. v. Commissioner of Internal
Revenue 16 supports the same. In that case, the U.S. Court said the
following:jgc:chanrobles.com.ph

"It appears that the taxpayer corporation was engaged in the business of cold storage and
wareshousing in Yahima, Washington. It maintained a cold storage plant, divided into four
units, having a total capacity of 490,000 boxes of fruits. It presented evidence to the effect
that various alterations and repairs to its plant were contemplated in the tax years, . . .

It also appeared that in spite of the fact that the taxpayer contended that it needed to maintain
this large cash reserve on hand, it proceeded to make various investments which had no
relation to its storage business. In 1934, it purchased mining stock which it sold in 1935 at a
profit of US $47,995.29. . . .

All these things may reasonably have appealed to the Board as incompatible with a purpose
to strengthen the financial position of the taxpayer and to provide for needed
alteration."cralaw virtua1aw library

The records further reveal that from May 1951 when petitioner purchased the U.S.A.
Treasury shares, until 1962 when it finally liquidated the same, it (petitioner) never had the
occasion to use the said shares in aiding or financing its importation. This militates against
the purpose enunciated earlier by petitioner that the shares were purchased to finance its
importation business. To justify an accumulation of earnings and profits for the reasonably
anticipated future needs, such accumulation must be used within a reasonable time after the
close of the taxable year. 17

Petitioner advanced the argument that the U.S.A. Treasury shares were held for a few more
years from 1957, in view of a plan to buy a lot and construct a building of their own; that at
that time (1957), the Company was not yet qualified to own real property in the Philippines,
hence it (petitioner) had to wait until sixty percent (60%) of the stocks of the Company
would be owned by Filipino citizens before making definite plans. 18

These arguments of petitioner indicate that it considers the U.S.A. Treasury shares not only
for the purpose of aiding or financing its importation but likewise for the purpose of buying a
lot and constructing a building thereon in the near future, but conditioned upon the
completion of the 60% citizenship requirement of stock ownership of the Company in order
to qualify it to purchase and own a lot. The time when the company would be able to
establish itself to meet the said requirement and the decision to pursue the same are
dependent upon various future contingencies. Whether these contingencies would unfold
favorably to the Company and if so, whether the Company would decide later to utilize the
U.S.A. Treasury shares according to its plan, remains to be seen. From these assertions of
petitioner, We cannot gather anything definite or certain. This, We cannot approve.chanrobles
law library

In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the surtax upon shareholders, the controlling intention of the taxpayer is
that which is manifested at the time of accumulation not subsequently declared intentions
which are merely the product of afterthought. 19 A speculative and indefinite purpose will
not suffice. The mere recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled with action taken towards
its consummation are essential. 20 The Court of Tax Appeals correctly made the following
ruling: 21

"As to the statement of Mr. Hawkins in Exh. "B" regarding the expansion program of the
petitioner by purchasing a lot and building of its own, we find no justifiable reason for the
retention in 1957 or thereafter of the US Treasury Bonds which were purchased in 1951.
x x x

"Moreover, if there was any thought for the purchase of a lot and building for the needs of
petitioners business, the corporation may not with impunity permit its earnings to pile up
merely because at some future time certain outlays would have to be made. Profits may only
be accumulated for the reasonable needs of the business, and implicit in this is further
requirement of a reasonable time."cralaw virtua1aw library

Viewed on the foregoing analysis and tested under the "immediacy doctrine," We are
convinced that the Court of Tax Appeals is correct in finding that the investment made by
petitioner in the U.S.A. Treasury shares in 1951 was an accumulation of profits in excess of
the reasonable needs of petitioners business.

Finally, petitioner asserts that the surplus profits allegedly accumulated in the form of U.S.A.
Treasury shares in 1951 by it (petitioner) should not be subject to the surtax in 1957. In other
words, petitioner claims that the surtax of 25% should be based on the surplus accumulated
in 1951 and not in 1957.

This is devoid of merit.

The rule is now settled in Our jurisprudence that undistributed earnings or profits of prior
years are taken into consideration in determining unreasonable accumulation for purposes of
the 25% surtax. 22 The case of Basilan Estates, Inc. v. Commissioner of Internal Revenue 23
further strengthen this rule, and We quote:jgc:chanrobles.com.ph

"Petitioner questions why the examiner covered the period from 1948-1953 when the taxable
year on review was 1953. The surplus of P347,507.01 was taken by the examiner from the
balance sheet of the petitioner for 1953. To check the figure arrived at, the examiner traced
the accumulation process from 1947 until 1953, and petitioners figure stood out to be
correct. There was no error in the process applied, for previous accumulations should be
considered in determining unreasonable accumulation for the year concerned.In determining
whether accumulations of earnings or profits in a particular year are within the reasonable
needs of a corporation, it is necessary to take into account prior accumulations, since
accumulations prior to the year involved may have been sufficient to cover the business
needs and additional accumulations during the year involved would not reasonably be
necessary." chanroblesvirtuallawlibrary

WHEREFORE, IN VIEW OF THE FOREGOING, the decision of the Court of Tax Appeals
is AFFIRMED in toto, with costs against petitioner.

SO ORDERED.

Makasiar, Aquino, Concepcion, Jr., Abad Santos, De Castro and Escolin, JJ., concur.
G.R. No. 85749 May 15, 1989

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
ANTONIO TUASON, INC. and THE COURT OF TAX APPEALS, respondents.

GRIO-AQUINO, J.:

Elevated to this Court for review is the decision dated October 14, 1988 of the Court of Tax
Appeals in CTA Case No. 3865, entitled "Antonio Tuason, Inc. vs. Commissioner of Internal
Revenue," which set aside the petitioner Revenue Commissioner's assessment of
P1,151,146.98 as the 25% surtax on the private respondent's unreasonable accumulation of
surplus for the years 1975-1978.

Under date of February 27, 1981, the petitioner, Commissioner of Internal Revenue, assessed
Antonio Tuason, Inc.

Deficiency income tax for the years 1975,1976 and 1978 . . P37,491.83.
(b) Deficiency corporate quarterly income tax for the first quarter of 1975 . . .. 161.49.
(c) 25% surtax on unreasonable accumulation of surplus for the years 1975-1978 . .. .
1,151,146.98.

The private respondent did not object to the first and second items and, therefore, paid the
amounts demanded. However, it protested the assessment on a 25% surtax on the third item
on the ground that the accumulation of surplus profits during the years in question was solely
for the purpose of expanding its business operations as real estate broker. The request for
reinvestigation was granted on condition that a waiver of the statute of limitations should be
filed by the private respondent. The latter replied that there was no need of a waiver of the
statute of limitaitons because the right of the Government to assess said tax does not
prescribe.

No investigation was conducted nor a decision rendered on Antonio Tuazon Inc.'s protest.
meantime, the Revenue Commissioner issued warrants of distraint and levy to enforce
collection of the total amount originally assessed including the amounts already paid.

The private respondent filed a petition for review in the Court of Tax Appeals with a request
that pending determination of the case on the merits, an order be issued restraining the
Commissioner and/or his representatives from enforcing the warrants of distraint and levy.
Since the right asserted by the Commissioner to collect the taxes involved herein by the
summary methods of distraint and levy was not clear, and it was shown that portions of the
tax liabilities involved in the assessment had already been paid, a writ of injunction was
issued by the Tax Court on November 26, 1984, ordering the Commissioner to refrain fron
enforcing said warrants of distraint and levy. It did not require the petitioner to file a bond
(Annex A, pp. 28-30, Rollo).
In view of the reversal of the Commissioner's decision by the Court of Tax Appeals, the
petitioner appealed to this Court, raising the following issues:

1. Whether or not private respondent Antonio Tuason, Inc. is a holding company and/or
investment company;

2. Whether or not privaaate respondent Antonio Tuason, Inc. accumulated surplus for the
years 1975 to 1978; and

3. Whether or not Antonio Tuason, Inc. is liable for the 25% surtax on undue
accumulation of surplus for the years 1975 to 1978.

Section 25 of the Tax Code at the time the surtax was assessed, provided:

Sec. 25. Additional tax on corporation improperly accumulating profits or surplus.

(a) Imposition of tax. If any corporation, except banks, insurance companies, or

personal holding companies, whether domestic or foreign, is formed or availed of for the
purpose of preventing the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of permitting its gains
and profits to accumulate instead of being divided or distributed, there is levied and assessed
against such corporation, for each taxable year, a tax equal to twenty-five per centum of the
undistributed portion of its accumulated profits or surplus which shall be in addition to the
tax imposed by section twenty-four, and shall be computed, collected and paid in the same
manner and subject to the same provisions of law, including penalties, as that tax.

(b) Prima facie evidence. The fact that any corporation is a mere holding company
shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members.
Similar presumption will lie in the case of an investment company where at any time during
the taxable year more than fifty per centum in value of its outstanding stock is owned,
directly or indirectly, by one person.

(c) Evidence determinative of purpose. The fact that the earnings or profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the contrary.

The petition for review is meritorious.

The Court of Tax Appeals conceded that the Revenue Commissioner's determination that
Antonio Tuason, Inc. was a mere holding or investment company, was "presumptively
correct" (p. 7, Annex A), for the corporation did not involve itself in the development of
subdivisions but merely subdivided its own lots and sold them for bigger profits. It derived
its income mostly from interest, dividends and rental realized from the sale of realty.
Another circumstance supporting that presumption is that 99.99% in value of the outstanding
stock of Antonio Tuason, Inc., is owned by Antonio Tuason himself. The Commissioner
"conclusively presumed" that when the corporation accumulated (instead of distributing to
the shareholders) a surplus of over P3 million fron its earnings in 1975 up to 1978, the
purpose was to avoid the imposition of the progressive income tax on its shareholders.

That Antonio Tuason, Inc. accumulated surplus profits amounting to P3,263,305.88 for 1975
up to 1978 is not disputed. However, the private respondent vehemently denies that its
purpose was to evade payment of the progressive income tax on such dividends by its
stockholders. According to the private respondent, surplus profits were set aside by the
company to build up sufficient capital for its expansion program which included the
construction in 1979-1981 of an apartment building, and the purchase in 1980 of a
condominium unit which was intended for resale or lease.

However, while these investments were actually made, the Commissioner points out that the
corporation did not use up its surplus profits. It allegation that P1,525,672.74 was spent for
the construction of an apartment building in 1979 and P1,752,332.87 for the purchase of a
condominium unit in Urdaneta Village in 1980 was refuted by the Declaration of Real
Property on the apartment building (Exh. C) which shows that its market value is only
P429,890.00, and the Tax Declaration on the condominium unit which reflects a market
value of P293,830.00 only (Exh. D-1). The enormous discrepancy between the alleged
investment cost and the declared market value of these pieces of real estate was not denied
nor explained by the private respondent.

Since the company as of the time of the assessment in 1981, had invested in its business
operations only P 773,720 out of its accumulated surplus profits of P3,263,305.88 for 1975-
1978, its remaining accumulated surplus profits of P2,489,858.88 are subject to the 25%
surtax. All presumptions are in favor of the correctness of petitioner's assessment against the
private respondent. It is incumbent upon the taxpayer to prove the contrary (Mindanao Bus
Company vs. Commissioner of Internal Revenue, 1 SCRA 538). Unfortunately, the private
respondent failed to overcome the presumption of correctness of the Commissioner's
assessment.

The touchstone of liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation. Thus, if the failure to pay dividends were for the purpose
of using the undistributed earnings and profits for the reasonable needs of the business, that
purpose would not fall within the interdiction of the statute" (Mertens Law of Federal
Income Taxation, Vol. 7, Chapter 39, p. 45 cited in Manila Wine Merchants, Inc. vs.
Commissioner of Internal Revenue, 127 SCRA 483, 493). It is plain to see that the
company's failure to distribute dividends to its stockholders in 1975-1978 was for reasons
other than the reasonable needs of the business, thereby falling within the interdiction of
Section 25 of the Tax Code of 1977.

WHEREFORE, the appealed decision of the Court of Tax Appeals is hereby set aside. The
petitioner's assessment of a 25% surtax against the Antonio Tuason, Inc. is reinstated but
only on the latter's unspent accumulated surplus profits of P2,489,585.88. No costs. SO
ORDERED.
[G.R. No. 108067. January 20, 2000]

CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE

COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL
REVENUE,respondents.

DECISION

QUISUMBING, J.:

Petitioner disputes the decision of the Court of Appeals which affirmed the decision of the
[1] [2]

Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of Internal Revenue
the amount of three million, seven hundred seventy-four thousand, eight hundred sixty seven
pesos and fifty centavos (P3,774,867.50) as 25% surtax on improper accumulation of profits for
1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987,
under Sec. 25 of the National Internal Revenue Code.

The Court of Tax Appeals made the following factual findings:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a

wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the
manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished
goods, and an importer/indentor.

On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment
of deficiency income tax of one hundred nineteen thousand eight hundred seventeen
(P119,817.00) pesos for taxable year 1981, as follows:

"Net income disclosed by

the return as audited 14,575,210.00

Add: Discrepancies:

Professional
fees/yr.
per
investigatio 262,877.00
n 17018 110,399.37

Total Adjustment 152,477.00

 Net income per Investigation 14,727,687.00

Less: Personal and additional exemptions ___________

Amount subject to tax 14,727,687.00

Income tax due thereon .25% Surtax 2,385,231.50 3,237,495.00

Less: Amount already assessed . 5,161,788.00

BALANCE . 75,709.00

_______ monthly interest from ..1,389,636.00 44,108.00

_________ ____________

Compromise penalties ... ___________

TOTAL AMOUNT DUE ..3,774,867.50 119,817.00" [3]

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax
Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and
1981 Deficiency Percentage Assessment of P8,846.72. Petitioner, through its external
[4]

accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the undue
accumulation of earnings was not proper because the said profits were retained to increase
petitioners working capital and it would be used for reasonable business needs of the company.
Petitioner contended that it availed of the tax amnesty under Executive Order No. 41, hence
enjoyed amnesty from civil and criminal prosecution granted by the law.
On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the
cancellation of the assessment notices and rendered its resolution, as follows:

"It appears that your client availed of Executive Order No. 41 under File No. 32A-
F-000455-41B as certified and confirmed by our Tax Amnesty Implementation
Office on October 6, 1987.

In reply thereto, I have the honor to inform you that the availment of the tax
amnesty under Executive Order No. 41, as amended is sufficient basis, in
appropriate cases, for the cancellation of the assessment issued after August 21,
1986. (Revenue Memorandum Order No. 4-87) Said availment does not, therefore,
result in cancellation of assessments issued before August 21, 1986, as in the
instant case. In other words, the assessments in this case issued on January 30,
1985 despite your clients availment of the tax amnesty under Executive Order No.
41, as amended still subsist.

Such being the case, you are therefore, requested to urge your client to pay this
Office the aforementioned deficiency income tax and surtax on undue
accumulation of surplus in the respective amounts of P119,817.00 and
P3,774,867.50 inclusive of interest thereon for the year 1981, within thirty (30)
days from receipt hereof, otherwise this office will be constrained to enforce
collection thereof thru summary remedies prescribed by law.

This constitutes the final decision of this Office on this matter." [5]

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both
parties agreed to compromise the 1981 deficiency income tax assessment of P119,817.00.
Petitioner paid a reduced amount --twenty-six thousand, five hundred seventy-seven pesos
(P26,577.00) -- as compromise settlement. However, the surtax on improperly accumulated
profits remained unresolved.

Petitioner claimed that CIRs assessment representing the 25% surtax on its accumulated
earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner
accumulated its earnings and profits for reasonable business requirements to meet working
capital needs and retirement of indebtedness; (b) petitioner is a wholly owned subsidiary of
American Cyanamid Company, a corporation organized under the laws of the State of Maine, in
the United States of America, whose shares of stock are listed and traded in New York Stock
Exchange. This being the case, no individual shareholder of petitioner could have evaded or
prevented the imposition of individual income taxes by petitioners accumulation of earnings and
profits, instead of distribution of the same.

In denying the petition, the Court of Tax Appeals made the following pronouncements:

"Petitioner contends that it did not declare dividends for the year 1981 in order to
use the accumulated earnings as working capital reserve to meet its "reasonable
business needs". The law permits a stock corporation to set aside a portion of its
retained earnings for specified purposes (citing Section 43, paragraph 2 of the
Corporation Code of the Philippines). In the case at bar, however, petitioners
purpose for accumulating its earnings does not fall within the ambit of any of these
specified purposes.

More compelling is the finding that there was no need for petitioner to set aside a
portion of its retained earnings as working capital reserve as it claims since it had
considerable liquid funds. A thorough review of petitioners financial statement
(particularly the Balance Sheet, p. 127, BIR Records) reveals that the corporation
had considerable liquid funds consisting of cash accounts receivable, inventory and
even its sales for the period is adequate to meet the normal needs of the business.
This can be determined by computing the current asset to liability ratio of the
company:

curren
t ratio = current assets / current liabilities

= P 47,052,535.00 / P21,275,544.00

= 2.21: 1

The significance of this ratio is to serve as a primary test of a companys solvency

to meet current obligations from current assets as a going concern or a measure of
adequacy of working capital.

xxx

We further reject petitioners argument that "the accumulated earnings tax does not
apply to a publicly-held corporation" citing American jurisprudence to support its
position. The reference finds no application in the case at bar because under
Section 25 of the NIRC as amended by Section 5 of P.D. No. 1379 [1739] (dated
September 17, 1980), the exceptions to the accumulated earnings tax are expressly
enumerated, to wit: Bank, non-bank financial intermediaries, corporations
organized primarily, and authorized by the Central Bank of the Philippines to hold
shares of stock of banks, insurance companies, or personal holding companies,
whether domestic or foreign. The law on the matter is clear and specific. Hence,
there is no need to resort to applicable cases decided by the American Federal
Courts for guidance and enlightenment as to whether the provision of Section 25 of
the NIRC should apply to petitioner.

Equally clear and specific are the provisions of E.O. 41 particularly with respect to
its effectivity and coverage...
 ... Said availment does not result in cancellation of assessments issued before
August 21, 1986 as petitioner seeks to do in the case at bar. Therefore, the
assessments in this case, issued on January 30, 1985 despite petitioners availment
of the tax amnesty under E.O. 41 as amended, still subsist."

xxx

WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay respondent

Commissioner of Internal Revenue the sum of P3,774,867.50 representing 25%
surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20%
annual interest from January 30, 1985 to January 30, 1987." [6]

Petitioner appealed the Court of Tax Appeals decision to the Court of Appeals. Affirming the
CTA decision, the appellate court said:

"In reviewing the instant petition and the arguments raised herein, We find no
compelling reason to reverse the findings of the respondent Court. The respondent
Courts decision is supported by evidence, such as petitioner corporations financial
statement and balance sheets (p. 127, BIR Records). On the other hand the
petitioner corporation could only come up with an alternative formula lifted from a
decision rendered by a foreign court (Bardahl Mfg. Corp. vs. Commissioner, 24
T.C.M. [CCH] 1030). Applying said formula to its particular financial position, the
petitioner corporation attempts to justify its accumulated surplus earnings. To Our
mind, the petitioner corporations alternative formula cannot overturn the
persuasive findings and conclusion of the respondent Court based, as it is, on the
applicable laws and jurisprudence, as well as standards in the computation of taxes
and penalties practiced in this jurisdiction.

WHEREFORE, in view of the foregoing, the instant petition is hereby

DISMISSED and the decision of the Court of Tax Appeals dated August 6, 1992 in
C.T.A. Case No. 4250 is AFFIRMED in toto." [7]

Hence, petitioner now comes before us and assigns as sole issue:

WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE

PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR
THE YEAR 1981. [8]

Section 25 of the old National Internal Revenue Code of 1977 states:

[9]

"Sec. 25. Additional tax on corporation improperly accumulating profits or surplus

-

"(a) Imposition of tax. -- If any corporation is formed or availed of for the purpose
of preventing the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of permitting
its gains and profits to accumulate instead of being divided or distributed, there is
levied and assessed against such corporation, for each taxable year, a tax equal to
 twenty-five per-centum of the undistributed portion of its accumulated profits or
surplus which shall be in addition to the tax imposed by section twenty-four, and
shall be computed, collected and paid in the same manner and subject to the same
provisions of law, including penalties, as that tax.

"(b) Prima facie evidence. -- The fact that any corporation is mere holding
company shall be prima facie evidence of a purpose to avoid the tax upon its
shareholders or members. Similar presumption will lie in the case of an investment
company where at any time during the taxable year more than fifty per centum in
value of its outstanding stock is owned, directly or indirectly, by one person.

"(c) Evidence determinative of purpose. -- The fact that the earnings or profits of a
corporation are permitted to accumulate beyond the reasonable needs of the
business shall be determinative of the purpose to avoid the tax upon its
shareholders or members unless the corporation, by clear preponderance of
evidence, shall prove the contrary.

"(d) Exception -- The provisions of this sections shall not apply to banks, non-bank
financial intermediaries, corporation organized primarily, and authorized by the
Central Bank of the Philippines to hold shares of stock of banks, insurance
companies, whether domestic or foreign.

The provision discouraged tax avoidance through corporate surplus accumulation. When
corporations do not declare dividends, income taxes are not paid on the undeclared dividends
received by the shareholders. The tax on improper accumulation of surplus is essentially a
penalty tax designed to compel corporations to distribute earnings so that the said earnings by
shareholders could, in turn, be taxed.

Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated
earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned
company. Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594,
[10]

whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated
earnings tax could only apply to a closely held corporation.

A review of American taxation history on accumulated earnings tax will show that the
application of the accumulated earnings tax to publicly held corporations has been problematic.
Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to
publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the
accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the
Internal Revenue Service asserted that the tax could be imposed on widely held corporations
including those not controlled by a few shareholders or groups of shareholders. The Service
indicated it would not follow the Ninth Circuit regarding publicly held corporations. In 1984,
[11]

American legislation nullified the Ninth Circuits Golconda ruling and made it clear that the
accumulated earnings tax is not limited to closely held corporations. Clearly, Golconda is no
[12]

longer a reliable precedent.

The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the
corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-
bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily
and authorized by the Central Bank of the Philippines to hold shares of stocks of banks.
Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the
express mention of one person, thing, act, or consequence is construed to exclude all others.
Laws granting exemption from tax are construedstrictissimi juris against the taxpayer and
[13]

liberally in favor of the taxing power. Taxation is the rule and exemption is the exception.
[14]

The burden of proof rests upon the party claiming exemption to prove that it is, in fact,
[15]

covered by the exemption so claimed, a burden which petitioner here has failed to discharge.
[16]

Another point raised by the petitioner in objecting to the assessment, is that increase of working
capital by a corporation justifies accumulating income. Petitioner asserts that respondent court
erred in concluding that Cyanamid need not infuse additional working capital reserve because it
had considerable liquid funds based on the 2.21:1 ratio of current assets to current liabilities.
Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital
reserve, sufficient amounts of liquid assets to carry the company through one operating cycle.
The "Bardahl" formula was developed to measure corporate liquidity. The formula requires an
[17]

examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities
and any extraordinary expenses reasonably anticipated, plus enough to operate the business
during one operating cycle. Operating cycle is the period of time it takes to convert cash into
raw materials, raw materials into inventory, and inventory into sales, including the time it takes
to collect payment for the sales. [18]

Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as
working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts
that Cyanamid had a working capital deficit of P7,986,633.00. Therefore, the P9,540,926.00
[19]

accumulated income as of 1981 may be validly accumulated to increase the petitioners working
capital for the succeeding year.

We note, however, that the companies where the "Bardahl" formula was applied, had operating
cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR, the companys
[20]

operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi
vs. United States, the corporations operating cycle was only 56.87 days, or 15.58% of the year.
[21]

In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting
that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the
operating costs of the business. There are variations in the application of the "Bardahl" formula,
such as average operating cycle or peak operating cycle. In times when there is no recurrence of
a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by
American authorities, although the "Bardahl" formula is well-established and routinely applied
by the courts, it is not a precise rule. It is used only for administrative convenience. Petitioners
[22]

application of the "Bardahl" formula merely creates a false illusion of exactitude.

Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption
of the industry standard. The ratio of current assets to current liabilities is used to determine the
[23]

sufficiency of working capital. Ideally, the working capital should equal the current liabilities
and there must be 2 units of current assets for every unit of current liability, hence the so-called
"2 to 1" rule.
[24]
As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current
liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said
working capital was expected to increase further when more funds were generated from the
succeeding years sales. Available income covered expenses or indebtedness for that year, and
there appeared no reason to expect an impending working capital deficit which could have
necessitated an increase in working capital, as rationalized by petitioner.

In Basilan Estates, Inc. vs. Commissioner of Internal Revenue, we held that:

[25]

"...[T]here is no need to have such a large amount at the beginning of the following
year because during the year, current assets are converted into cash and with the
income realized from the business as the year goes, these expenses may well be
taken care of. [citation omitted]. Thus, it is erroneous to say that the taxpayer is
entitled to retain enough liquid net assets in amounts approximately equal to
current operating needs for the year to cover cost of goods sold and operating
expenses: for it excludes proper consideration of funds generated by the collection
of notes receivable as trade accounts during the course of the year." [26]

If the CIR determined that the corporation avoided the tax on shareholders by permitting
earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of
proving the determination wrong, together with the corresponding burden of first going forward
with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or
investment company and does not have an unreasonable accumulation of earnings or profits. [27]

In order to determine whether profits are accumulated for the reasonable needs of the business to
avoid the surtax upon shareholders, it must be shown that the controlling intention of the
taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which
are mere afterthoughts. Furthermore, the accumulated profits must be used within a reasonable
[28]

time after the close of the taxable year. In the instant case, petitioner did not establish, by clear
and convincing evidence, that such accumulation of profit was for the immediate needs of the
business.

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue, we ruled:

[29]

"To determine the reasonable needs of the business in order to justify an

accumulation of earnings, the Courts of the United States have invented the so-
called Immediacy Test which construed the words reasonable needs of the business
to mean the immediate needs of the business, and it was generally held that if the
corporation did not prove an immediate need for the accumulation of the earnings
and profits, the accumulation was not for the reasonable needs of the business, and
the penalty tax would apply. (Mertens, Law of Federal Income Taxation, Vol. 7,
Chapter 39, p. 103). [30]

In the present case, the Tax Court opted to determine the working capital sufficiency by using
the ratio between current assets to current liabilities. The working capital needs of a business
depend upon the nature of the business, its credit policies, the amount of inventories, the rate of
turnover, the amount of accounts receivable, the collection rate, the availability of credit to the
business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress
the tax court with the required definiteness envisioned by the statute. We agree with the tax court
that the burden of proof to establish that the profits accumulated were not beyond the reasonable
needs of the company, remained on the taxpayer. This Court will not set aside lightly the
conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is
dedicated exclusively to the consideration of tax problems and has necessarily developed an
expertise on the subject, unless there has been an abuse or improvident exercise of authority.
Unless rebutted, all presumptions generally are indulged in favor of the correctness of the
[31]

CIRs assessment against the taxpayer. With petitioners failure to prove the CIR incorrect, clearly
and conclusively, this Court is constrained to uphold the correctness of tax courts ruling as
affirmed by the Court of Appeals.

WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals,
sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.

SO ORDERED.
 EN BANC

COMMISSIONER OF INTERNAL G. R. No. 163653

REVENUE,
Petitioner,
-versus- G. R. No. 167689
FILINVEST DEVELOPMENT
CORPORATION, Promulgated:
Respondent.
x-------------------------------------x July 19, 2011
COMMISSIONER OF INTERNAL
REVENUE,
Petitioner,
-versus-
FILINVEST DEVELOPMENT
CORPORATION,
Respondent.

x----------------------------------------------------------------------------------------------- x

DECISION

PEREZ, J.:

Assailed in these twin petitions for review on certiorari filed pursuant to Rule 45 of
the 1997 Rules of Civil Procedure are the decisions rendered by the Court of Appeals (CA) in
the following cases: (a) Decision dated 16 December 2003 of the then Special Fifth Division
in CA-G.R. SP No. 72992;[1] and, (b) Decision dated 26 January 2005 of the then Fourteenth
Division in CA-G.R. SP No. 74510.[2]

The 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). On 29 November
1996, 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.
[3]
As a result of the exchange, FLIs ownership structure was changed to the extent reflected
in the following tabular prcis, viz.:

Stockholde Number and Percentage Number of Number and Percentage

of Shares Held Prior to Additional of Shares Held After the
r the Exchange Shares Exchange
Issued
FDC 2,537,358,000 67.42% 42,217,000 2,579,575,000 61.03%

FAI 00 420,877,000 420,877,000 9.96%

OTHERS 1,226,177,000 32.58% 0 1,226,177,000 29.01%

----------------- ----------- -------------- ---------------

3,763,535,000 100% 463,094,301 4,226,629,000 (100%)

On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (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 National Internal Revenue Code (NIRC)[4] which provides that (n)o gain or loss shall be
recognized if property is 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." [5] With the BIRs
reiteration of the foregoing ruling upon the 10 February 1997 request for clarification filed
by FLI,[6] the latter, together with FDC and FAI, complied with all the requirements imposed
in the ruling.[7]

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). [8] Duly evidenced by instructional letters as well as
cash and journal vouchers, said cash advances amounted to P2,557,213,942.60 in
1996[9] and P3,360,889,677.48 in 1997.[10] On 15 November 1996, 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.[11]

On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay
deficiency income and documentary stamp taxes, plus interests and compromise penalties,
[12]
covered by the following Assessment Notices, viz.: (a) Assessment Notice No. SP-INC-
96-00018-2000 for deficiency income taxes in the sum of P150,074,066.27 for 1996; (b)
Assessment Notice No. SP-DST-96-00020-2000 for deficiency documentary stamp taxes in
the sum of P10,425,487.06 for 1996; (c) Assessment Notice No. SP-INC-97-00019-2000 for
deficiency income taxes in the sum of P5,716,927.03 for 1997; and (d) Assessment Notice
No. SP-DST-97-00021-2000 for deficiency documentary stamp taxes in the sum
of P5,796,699.40 for 1997.[13] 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.[14]

On 3 January 2000, 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.[15] Covered by
Assessment Notice No. SP-INC-97-0027-2000,[16] 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.[17] On 26 January 2000 or 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. [18]Having submitted the
relevant supporting documents pursuant to the 31 January 2000 directive from the BIR
Appellate Division, FDC and FAI filed on 11 September 2000 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.[19]

In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve their
request for reconsideration/protest within the aforesaid period, FDC and FAI filed on 17
October 2000 a petition for review with the Court of Tax Appeals (CTA) pursuant to Section
228 of the 1997 NIRC. Docketed before said court as CTA Case No. 6182, 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.[20]

On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in
question should not be considered tax free since, with the resultant diminution of its shares in
FLI, FDC did not gain further control of said corporation. Likewise calling attention to the
fact that the cash advances FDC extended to its affiliates were interest free despite the
interest bearing loans it obtained from banking institutions, the CIR invoked Section 43 of
the old NIRC which, as implemented by Revenue Regulations No. 2, Section 179 (b) and (c),
gave him "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." The CIR
justified the imposition of documentary stamp taxes on the instructional letters as well as
cash and journal vouchers for said cash advances on the strength of Section 180 of the NIRC
and Revenue Regulations No. 9-94 which provide that loan transactions are subject to said
tax irrespective of whether or not they are evidenced by a formal agreement or by mere
office memo. The CIR also argued that FDC realized taxable gain arising from the dilution
of its shares in FAC as a result of its Shareholders' Agreement with RHPL.[21]

At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and
Issues[22] which was admitted in the 16 February 2001 resolution issued by the CTA. With the
further admission of the Formal Offer of Documentary Evidence subsequently filed by FDC
and FAI[23] and the conclusion of the testimony of Susana Macabelda anent the cash advances
FDC extended in favor of its affiliates, [24] the CTA 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,[25] thus:

WHEREFORE, in view of all the foregoing, the court finds the instant
petition partly meritorious. Accordingly, Assessment Notice No. SP-INC-96-
00018-2000 imposing deficiency income tax on FDC for taxable year 1996,
Assessment Notice No. SP-DST-96-00020-2000 and SP-DST-97-00021-2000
imposing deficiency documentary stamp tax on FDC for taxable years 1996 and
1997, respectively and Assessment Notice No. SP-INC-97-0027-2000 imposing
deficiency income tax on FAI for the taxable year 1997 are
hereby CANCELLED and SET ASIDE.However, [FDC] is hereby ORDERED
to PAY the amount of P5,691,972.03 as deficiency income tax for taxable year
 1997. In addition, petitioner 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.[26]

Finding that the collective increase of the equity participation of FDC and FAI in FLI
rendered the gain derived from the exchange tax-free, the CTA also ruled that the increase in
the value of FDC's shares in FAC did not result in economic advantage in the absence of
actual sale or conversion thereof. While likewise finding that the documents evidencing the
cash advances FDC extended to its affiliates cannot be considered as loan agreements that
are subject to documentary stamp tax, the CTA enunciated, however, that the 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. For persuasive
effect, the CTA referred to the equivalent provision in the Internal Revenue Code of
the United States (IRC-US), i.e., Sec. 482, as implemented by Section 1.482-2 of 1965-1969
Regulations of the Law of Federal Income Taxation.[27]

Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for
review docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997
Rules of Civil Procedure. 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 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.[28] Upholding FDC's position, the CA's then Special Fifth
Division rendered the herein assailed decision dated 16 December 2003, [29] the decretal
portion of which states:

WHEREFORE, premises considered, the instant petition is

hereby GRANTED. The assailed Decision dated September 10, 2002 rendered by
the Court of Tax Appeals in CTA Case No. 6182 directing petitioner Filinvest
Development Corporation to pay the amount of P5,691,972.03 representing
deficiency income tax on allegedly undeclared interest income for the taxable year
1997, plus 20% delinquency interest computed from February 16, 2000 until full
payment thereof is REVERSED and SET ASIDE and, a new one entered
annulling Assessment Notice No. SP-INC-97-00019-2000 imposing deficiency
income tax on petitioner for taxable year 1997. No pronouncement as to costs.[30]

With the denial of its partial motion for reconsideration of the same 11 December 2002
resolution issued by the CTA,[31] the CIR also filed the petition for review docketed before
the CA as CA-G.R. No. 74510. In essence, the CIR argued that the CTA reversibly erred in
cancelling the assessment notices: (a) for deficiency income taxes on the exchange of
property between FDC, FAI and FLI; (b) for deficiency documentary stamp taxes on the
documents evidencing FDC's cash advances to its affiliates; and (c) for deficiency income
tax on the gain FDC purportedly realized from the increase of the value of its shareholdings
in FAC.[32] The foregoing petition was, however, denied due course and dismissed for lack of
merit in the herein assailed decision dated 26 January 2005 [33] rendered by the CA's then
Fourteenth Division, upon the following findings and conclusions, to wit:

1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the 29

November 1996 Deed of Exchange resulted in the combined control by FDC
and FAI of more than 51% of the outstanding shares of FLI, hence, no
taxable gain can be recognized from the transaction under Section 34 (c) (2)
of the old NIRC;
2. The instructional letters as well as the cash and journal vouchers evidencing the
advances FDC extended to its affiliates are not subject to documentary
stamp taxes pursuant to BIR Ruling No. 116-98, dated 30 July 1998, since
they do not partake the nature of loan agreements;

3. Although BIR Ruling No. 116-98 had been subsequently modified by BIR
Ruling No. 108-99, dated 15 July 1999, to the effect that documentary stamp
taxes are imposable on inter-office memos evidencing cash advances similar
to those extended by FDC, said latter ruling cannot be given retroactive
application if to do so would be prejudicial to the taxpayer;

4. FDC's alleged gain from the increase of its shareholdings in FAC as a

consequence of the Shareholders' Agreement it executed with RHPL cannot
be considered taxable income since, until actually converted thru sale or
disposition of said shares, they merely represent unrealized increase in
capital.[34]

Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the CIR's
petitions for review on certiorari assailing the 16 December 2003 decision in CA-G.R. No.
72992 and the 26 January 2005 decision in CA-G.R. SP No. 74510 were consolidated
pursuant to the 1 March 2006 resolution issued by this Courts Third Division.

The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:

THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF

THE COURT OF TAX APPEALS AND IN HOLDING THAT THE
 ADVANCES EXTENDED BY RESPONDENT TO ITS AFFILIATES ARE
NOT SUBJECT TO INCOME TAX.[35]

In G.R. No. 167689, on the other hand, petitioner proffers the following issues for resolution:

THE HONORABLE COURT OF APPEALS COMMITTED GRAVE ABUSE

OF DISCRETION IN HOLDING THAT THE EXCHANGE OF SHARES OF
STOCK FOR PROPERTY AMONG FILINVEST DEVELOPMENT
CORPORATION (FDC), FILINVEST ALABANG, INCORPORATED (FAI)
AND FILINVEST LAND INCORPORATED (FLI) MET ALL THE
REQUIREMENTS FOR THE NON-RECOGNITION OF TAXABLE GAIN
UNDER SECTION 34 (c) (2) OF THE OLD NATIONAL INTERNAL
REVENUE CODE (NIRC) (NOW SECTION 40 (C) (2) (c) OF THE NIRC.

II

THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE

ERROR IN HOLDING THAT THE LETTERS OF INSTRUCTION OR
CASH VOUCHERS EXTENDED BY FDC TO ITS AFFILIATES ARE NOT
DEEMED LOAN AGREEMENTS SUBJECT TO DOCUMENTARY STAMP
TAXES UNDER SECTION 180 OF THE NIRC.

III

THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN

HOLDING THAT GAIN ON DILUTION AS A RESULT OF THE
INCREASE IN THE VALUE OF FDCS SHAREHOLDINGS IN FAC IS NOT
TAXABLE.[36]

The Courts Ruling

While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in G.R.
No. 167689 impressed with partial merit.

In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding that
theoretical interests can be imputed on the advances FDC extended to its affiliates in 1996
and 1997 considering that, for said purpose, FDC resorted to interest-bearing fund
borrowings from commercial banks. Since considerable interest expenses were deducted by
FDC when said funds were borrowed, the CIR theorizes that interest income should likewise
be declared when the same funds were sourced for the advances FDC extended to its
affiliates. Invoking Section 43 of the 1993 NIRC in relation to Section 179(b) of Revenue
Regulation No. 2, the CIR maintains that it is vested with the power to allocate, distribute or
apportion income or deductions between or among controlled organizations, trades or
businesses even in the absence of fraud, since said power is intended to prevent evasion of
taxes or clearly to reflect the income of any such organizations, trades or businesses. In
addition, the CIR asseverates that the CA should have accorded weight and respect to the
findings of the CTA which, as the specialized court dedicated to the study and consideration
of tax matters, can take judicial notice of US income tax laws and regulations.[37]

Admittedly, Section 43 of the 1993 NIRC[38] provides that, (i)n any case of two or
more organizations, trades or businesses (whether or not incorporated and whether or not
organized in the Philippines) owned or controlled directly or indirectly by the same interests,
the Commissioner of Internal Revenue is authorized to distribute, apportion or allocate gross
income or deductions between or among such organization, trade or business, if he
determines that such distribution, apportionment or allocation is necessary in order to
prevent evasion of taxes or clearly to reflect the income of any such organization, trade or
business. In amplification of the equivalent provision[39] under Commonwealth Act No. 466,
[40]
Sec. 179(b) of Revenue Regulation No. 2 states as follows:

Determination of the taxable net income of controlled

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

(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax Code is
to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by
determining, according to the standard of an uncontrolled taxpayer, the true net
income from the property and business of a controlled taxpayer. The interests
controlling a group of controlled taxpayer are assumed to have complete power to
cause each controlled taxpayer so to conduct its affairs that its transactions and
accounting records truly reflect the net income from the property and business of
each of the controlled taxpayers. If, however, this has not been done and the
taxable net income are thereby understated, the statute contemplates that the
Commissioner of Internal Revenue shall intervene, and, by making such
distributions, apportionments, or allocations as he may deem necessary of gross
income or deductions, or of any item or element affecting net income, between or
among the controlled taxpayers constituting the group, shall determine the true net
income of each controlled taxpayer. The standard to be applied in every case is that
of an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to
apply its provisions at will, nor does it grant any right to compel the Commissioner
of Internal Revenue to apply its provisions.

(C) APPLICATION Transactions between controlled taxpayer and another

will be subjected to special scrutiny to ascertain whether the common control is
being used to reduce, avoid or escape taxes. In determining the true net income of a
controlled taxpayer, the Commissioner of Internal Revenue 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 or 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.[41]

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

Despite the broad parameters provided, however, we find that the CIR's powers of
distribution, apportionment or allocation of gross income and deductions under Section 43 of
the 1993 NIRC and Section 179 of Revenue Regulation No. 2 does not include the power to
impute "theoretical interests" to the controlled taxpayer's transactions. Pursuant to Section 28
of the 1993 NIRC,[42] after all, the term gross income is understood to mean all income from
whatever source derived, including, but not limited to the following items: compensation for
services, including fees, commissions, and similar items; gross income derived from
business; gains derived from dealings in property; interest; rents; royalties; dividends;
annuities; prizes and winnings; pensions; and partners distributive share of the gross income
of general professional partnership.[43] While it has been held that the phrase "from whatever
source derived" indicates a legislative policy to include all income not expressly exempted
within the class of taxable income under our laws, the term "income" has been variously
interpreted to mean "cash received or its equivalent", "the amount of money coming to a
person within a specific time" or "something distinct from principal or capital." [44] 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.

Our circumspect perusal of the record yielded no evidence of actual or possible

showing that the advances FDC extended to its affiliates had resulted to the interests
subsequently assessed by the CIR. For all its harping upon the supposed fact that FDC had
resorted to borrowings from commercial banks, the CIR had adduced no concrete proof that
said funds were, indeed, the source of the advances the former provided its affiliates. While
admitting that FDC obtained interest-bearing loans from commercial banks, [45] Susan
Macabelda - FDC's Funds Management Department Manager who was the sole witness
presented before the CTA - clarified that the subject advances were sourced from the
corporation's rights offering in 1995 as well as the sale of its investment in Bonifacio Land in
1997.[46] More significantly, said witness testified that said advances: (a) were extended to
give FLI, FAI, DSCC and FCI financial assistance for their operational and capital
expenditures; and, (b) were all temporarily in nature since they were repaid within the
duration of one week to three months and were evidenced by mere journal entries, cash
vouchers and instructional letters.[47]

Even if we were, therefore, to accord precipitate credulity to the CIR's bare assertion
that FDC 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. More so, when it is borne in mind that, pursuant to
Article 1956 of the Civil Code of the Philippines, no interest shall be due unless it has been
expressly stipulated in writing. Considering that taxes, being burdens, are not to be presumed
beyond what the applicable statute expressly and clearly declares, [48] the rule is likewise
settled that tax statutes must be construed strictly against the government and liberally in
favor of the taxpayer.[49] Accordingly, the general rule of requiring adherence to the letter in
construing statutes applies with peculiar strictness to tax laws and the provisions of a taxing
act are not to be extended by implication.[50] While it is true that taxes are the lifeblood of the
government, it has been held that their assessment and collection should be in accordance
with law as any arbitrariness will negate the very reason for government itself.[51]

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the
imposition of deficiency income taxes on the transfer FDC and FAI effected in exchange for
the shares of stock of FLI. With respect to the Deed of Exchange executed between FDC,
FAI and FLI, Section 34 (c) (2) of the 1993 NIRC pertinently provides as follows:

Sec. 34. Determination of amount of and recognition of gain or loss.-

xxxx

(c) Exception x x x x

No gain or loss shall also be recognized if property is transferred to a corporation

by a person in exchange for shares of stock in such 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; Provided, That stocks issued for
services shall not be considered as issued in return of property.

As even admitted in the 14 February 2001 Stipulation of Facts submitted by the parties,
[52]
the requisites for the non-recognition of gain or loss under the foregoing provision are as
follows: (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.[53] Acting on
the 13 January 1997 request filed by FLI, the BIR had, in fact, acknowledged the
concurrence of the foregoing requisites in the Deed of Exchange the former executed with
FDC and FAI by issuing BIR Ruling No. S-34-046-97. [54] With the BIR's reiteration of said
ruling upon the request for clarification filed by FLI,[55] there is also no dispute that said
transferee and transferors subsequently complied with the requirements provided for the non-
recognition of gain or loss from the exchange of property for tax, as provided under Section
34 (c) (2) of the 1993 NIRC.[56]
Then as now, the CIR argues that taxable gain should be recognized for the exchange
considering that FDC's controlling interest in FLI was actually decreased as a result
thereof.For said purpose, the CIR calls attention to the fact that, prior to the exchange, FDC
owned 2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding capital stock. Upon the
issuance of 443,094,000 additional FLI shares as a consequence of the exchange and with
only 42,217,000 thereof accruing in favor of FDC for a total of 2,579,575,000 shares, said
corporations controlling interest was supposedly reduced to 61%.03 when reckoned from the
transferee's aggregate 4,226,629,000 outstanding shares. Without owning a share from FLI's
initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of 420,877,000
FLI shares as a result of the exchange purportedly resulted in its control of only 9.96% of
said transferee corporation's 4,226,629,000 outstanding shares. On the principle that the
transaction did not qualify as a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC,
the CIR asseverates that taxable gain in the sum of P263,386,921.00 should be recognized on
the part of FDC and in the sum of P3,088,711,367.00 on the part of FAI.[57]

The paucity of merit in the CIR's position is, however, evident from the categorical language
of Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will not be
recognized in case the exchange of property for stocks results in the control of the transferee
by the transferor, alone or with other transferors not exceeding four persons. Rather than
isolating the same as proposed by the CIR, FDC's 2,579,575,000 shares or 61.03% control of
FLI's 4,226,629,000 outstanding shares should, therefore, be appreciated in combination with
the 420,877,000 new shares issued to FAI which represents 9.96% control of said transferee
corporation. Together FDC's 2,579,575,000 shares (61.03%) and FAI's 420,877,000 shares
(9.96%) clearly add up to 3,000,452,000 shares or 70.99% of FLI's 4,226,629,000
shares. Since the term "control" is clearly defined as "ownership of stocks in a corporation
possessing at least fifty-one percent of the total voting power of classes of stocks entitled to
one vote" under Section 34 (c) (6) [c] of the 1993 NIRC, the exchange of property for stocks
between FDC FAI and FLI clearly qualify as a tax-free transaction under paragraph 34 (c)
(2) of the same provision.

Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme
Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law and
Jurisprudence, opined that said provision could be inapplicable if control is already vested in
the exchangor prior to exchange.[58] Aside from the fact that that the 10 September 2002
Decision in CTA Case No. 6182 upholding the tax-exempt status of the exchange between
FDC, FAI and FLI was penned by no less than Justice Acosta himself, [59] FDC and FAI
significantly point out that said authors have acknowledged that the position taken by the
BIR is to the effect that "the law would apply even when the exchangor already has control
of the corporation at the time of the exchange." [60] This was confirmed when, apprised in
FLI's request for clarification about the change of percentage of ownership of its outstanding
capital stock, the BIR opined as follows:

Please be informed that regardless of the foregoing, the transferors, Filinvest

Development Corp. and Filinvest Alabang, Inc. still gained control of Filinvest
Land, Inc. The term 'control' shall mean ownership of stocks in a corporation by
possessing at least 51% of the total voting power of all classes of stocks entitled to
vote. Control is determined by the amount of stocks received, i.e., total subscribed,
whether for property or for services by the transferor or transferors. In determining
the 51% stock ownership, only those persons who transferred property for stocks in
the same transaction may be counted up to the maximum of five (BIR Ruling No.
547-93 dated December 29, 1993.[61]

At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by the
CIR is more apparent than real. As the uncontested owner of 80% of the outstanding shares
of FAI, it cannot be gainsaid that FDC ideally controls the same percentage of the
420,877,000 shares issued to its said co-transferor which, by itself, represents 7.968% of the
outstanding shares of FLI. Considered alongside FDC's 61.03% control of FLI as a
consequence of the 29 November 1996 Deed of Transfer, said 7.968% add up to an aggregate
of 68.998% of said transferee corporation's outstanding shares of stock which is evidently
still greater than the 67.42% FDC initially held prior to the exchange. This much was
admitted by the parties in the 14 February 2001 Stipulation of Facts, Documents and Issues
they submitted to the CTA.[62] Inasmuch as the combined ownership of FDC and FAI of FLI's
outstanding capital stock adds up to a total of 70.99%, it stands to reason that neither of said
transferors can be held liable for deficiency income taxes the CIR assessed on the supposed
gain which resulted from the subject transfer.

On the other hand, insofar as documentary stamp taxes on loan agreements and promissory
notes are concerned, Section 180 of the NIRC provides follows:

Sec. 180. Stamp tax on all loan agreements, promissory notes, bills of
exchange, drafts, instruments and securities issued by the government or any
of its instrumentalities, certificates of deposit bearing interest and others not
payable on sight or demand. On all loan agreements signed abroad wherein the
object of the contract is located or used in the Philippines; bill of exchange
(between points within the Philippines), drafts, instruments and securities issued
by the Government or any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of money otherwise than at
sight or on demand, or on all promissory notes, whether negotiable or non-
negotiable, except bank notes issued for circulation, and on each renewal of any
such note, there shall be collected a documentary stamp tax of Thirty centavos
(P0.30) on each two hundred pesos, or fractional part thereof, of the face value of
any such agreement, bill of exchange, draft, certificate of deposit or
note: Provided, That only one documentary stamp tax shall be imposed on either
 loan agreement, or promissory notes issued to secure such loan, whichever will
yield a higher tax: Provided however, That loan agreements or promissory notes
the aggregate of which does not exceed Two hundred fifty thousand pesos
(P250,000.00) executed by an individual for his purchase on installment for his
personal use or that of his family and not for business, resale, barter or hire of a
house, lot, motor vehicle, appliance or furniture shall be exempt from the payment
of documentary stamp tax provided under this Section.

When read in conjunction with Section 173 of the 1993 NIRC, [63] the foregoing provision
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." Correlatively, Section 3 (b) and Section
6 of Revenue Regulations No. 9-94 provide as follows:

Section 3. Definition of Terms. For purposes of these Regulations, the following

term shall mean:

(b) 'Loan agreement' refers to a contract in writing where one of the parties delivers
to another money or other consumable thing, upon the condition that the same
amount of the same kind and quality shall be paid. The term shall include credit
facilities, which may be evidenced by credit memo, advice or drawings.

The terms 'Loan Agreement" under Section 180 and "Mortgage' under Section 195,
both of the Tax Code, as amended, generally refer to distinct and separate
instruments. A loan agreement shall be taxed under Section 180, while a deed of
mortgage shall be taxed under Section 195."

"Section 6. Stamp on all Loan Agreements. All 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 in the
Philippines shall be subject to the documentary stamp tax of thirty centavos
(P0.30) on each two hundred pesos, or fractional part thereof, of the face value of
any such agreements, pursuant to Section 180 in relation to Section 173 of the Tax
Code.

In 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,
under Section 180 of the Tax Code.

Applying the aforesaid provisions to the case at bench, we find that 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. In keeping with the caveat attendant to every BIR Ruling to the effect
that it is valid only if the facts claimed by the taxpayer are correct, we find that the CA
reversibly erred in utilizing BIR Ruling No. 116-98, dated 30 July 1998 which, strictly
speaking, could be invoked only by ASB Development Corporation, the taxpayer who
sought the same. In said ruling, the CIR opined that documents like those evidencing the
advances FDC extended to its affiliates are not subject to documentary stamp tax, to wit:

On the matter of whether or not the inter-office memo covering the advances
granted by an affiliate company is subject to documentary stamp tax, it is informed
that nothing in Regulations No. 26 (Documentary Stamp Tax Regulations) and
Revenue Regulations No. 9-94 states that the same is subject to documentary
stamp tax. Such being the case, said inter-office memo evidencing the lendings or
borrowings which is neither a form of promissory note nor a certificate of
indebtedness issued by the corporation-affiliate or a certificate of obligation, which
are, more or less, categorized as 'securities', is not subject to documentary stamp
tax imposed under Section 180, 174 and 175 of the Tax Code of 1997,
respectively. Rather, the inter-office memo is being prepared for accounting
purposes only in order to avoid the co-mingling of funds of the corporate affiliates.

In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in
BIR Ruling No. 108-99 dated 15 July 1999, which opined that inter-office memos
evidencing lendings or borrowings extended by a corporation to its affiliates are akin to
promissory notes, hence, subject to documentary stamp taxes.[64] In brushing aside the
foregoing argument, however, the CA applied Section 246 of the 1993 NIRC [65] from which
proceeds the settled principle that rulings, circulars, rules and regulations promulgated by the
BIR have no retroactive application if to so apply them would be prejudicial to the taxpayers.
[66]
Admittedly, 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.[67] Not being the taxpayer who, in the first instance, sought a
ruling from the CIR, however, FDC cannot invoke the foregoing principle on non-
retroactivity of BIR rulings.

Viewed in the light of the foregoing considerations, we find that both the CTA and the CA
erred in invalidating the assessments issued by the CIR for the deficiency documentary
stamp taxes due on the instructional letters as well as the journal and cash vouchers
evidencing the advances FDC extended to its affiliates in 1996 and 1997. In Assessment
Notice No. SP-DST-96-00020-2000, the CIR correctly assessed the sum of P6,400,693.62
for documentary stamp tax, P3,999,793.44 in interests and P25,000.00 as compromise
penalty, for a total of P10,425,487.06. Alongside the sum of P4,050,599.62 for documentary
stamp tax, the CIR similarly assessed P1,721,099.78 in interests and P25,000.00 as
compromise penalty in Assessment Notice No. SP-DST-97-00021-2000 or a total
of P5,796,699.40. The imposition of deficiency interest is justified under Sec. 249 (a) and (b)
of the NIRC which authorizes the assessment of the same at the rate of twenty percent
(20%), or such higher rate as may be prescribed by regulations, from the date prescribed for
the payment of the unpaid amount of tax until full payment. [68] The imposition of the
compromise penalty is, in turn, warranted under Sec. 250 [69] of the NIRC which prescribes
the imposition thereof in case of each failure to file an information or return, statement or
list, or keep any record or supply any information required on the date prescribed therefor.

To our mind, no reversible error can, finally, be imputed against both the CTA and the CA for
invalidating the Assessment Notice issued by the CIR for the deficiency income taxes FDC
is supposed to have incurred as a consequence of the dilution of its shares in FAC. Anent
FDCs Shareholders Agreement with RHPL, the record shows that the parties were in
agreement about the following factual antecedents narrated in the 14 February 2001
Stipulation of Facts, Documents and Issues they submitted before the CTA,[70] viz.:

1.11. On November 15, 1996, FDC entered into a Shareholders Agreement (SA)
with Reco Herrera Pte. Ltd. (RHPL) for the formation of a joint venture company
named Filinvest Asia Corporation (FAC) which is based in Singapore (pars. 1.01
and 6.11, Petition, pars. 1 and 7, Answer).

1.12. FAC, the joint venture company formed by FDC and RHPL, is tasked to
develop and manage the 50% ownership interest of FDC in its PBCom Office
Tower Project (Project) with the Philippine Bank of Communications (par. 6.12,
Petition; par. 7, Answer).

1.13. Pursuant to the SA between FDC and RHPL, the equity participation of FDC
and RHPL in FAC was 60% and 40% respectively.

1.14. In accordance with the terms of the SA, FDC subscribed to P500.7 million
worth of shares of stock representing a 60% equity participation in FAC. In turn,
RHPL subscribed to P433.8 million worth of shares of stock of FAC representing a
40% equity participation in FAC.

1.15. In payment of its subscription in FAC, FDC executed a Deed of

Assignment transferring to FAC a portion of FDCs right and interests in the Project
to the extent of P500.7 million.

1.16. FDC reported a net loss of P190,695,061.00 in its Annual Income Tax
Return for the taxable year 1996.[71]

Alongside the principle that tax revenues are not intended to be liberally construed,
[72]
the rule is settled that the findings and conclusions of the CTA are accorded great respect
and are generally upheld by this Court, unless there is a clear showing of a reversible error or
an improvident exercise of authority.[73] Absent showing of such error here, we find no strong
and cogent reasons to depart from said rule with respect to the CTA's finding that no
deficiency income tax can be assessed on the gain on the supposed dilution and/or increase
in the value of FDC's shareholdings in FAC which the CIR, at any rate, failed to establish.
Bearing in mind the meaning of "gross income" as above discussed, it cannot be gainsaid,
even then, that a mere increase or appreciation in the value of said shares cannot be
considered income for taxation purposes. Since a mere advance in the value of the property
of a person or corporation in no sense constitute the income specified in the revenue law, it
has been held in the early case of Fisher vs. Trinidad,[74] that it constitutes and can be treated
merely as an increase of capital. Hence, 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.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R.
No. 163653 is DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R.
No. 72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 is PARTIALLY
GRANTED and the CAs 26 January 2005 Decision in CA-G.R. SP No. 74510
isMODIFIED.

Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-

00021-2000 issued for deficiency documentary stamp taxes due on the instructional letters as
well as journal and cash vouchers evidencing the advances FDC extended to its affiliates are
declared valid.

The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-

00019-2000 and SP-INC-97-0027-2000 issued for deficiency income assessed on (a) the
arms-length interest from said advances; (b) the gain from FDCs Deed of Exchange with FAI
and FLI; and (c) income from the dilution resulting from FDCs Shareholders Agreement
with RHPL is, however, upheld.
SO ORDERED.
Her Majesty the Queen v. GlaxoSmithKline Inc.

Summary

Taxation Income tax Assessment Transfer prices - Appeals - Minister of National

Revenue reassessing taxpayer by increasing its income on basis that taxpayer had overpaid
non-arms length supplier for purchase of drug ingredient Whether identification of
transaction which is subject of transfer price analysis is limited by bona fide legal
arrangements of taxpayer - Whether transfer prices in independent transactions between
Canadian taxpayer and different entities of multinational group should be assessed separately
or bundled together - Whether when conducting transfer pricing analysis in Canada, arms
length standard has been displaced by reasonable business person test Whether Federal
Court of Appeal erred in returning matter to Tax Court of Canada for rehearing - Income Tax
Act, R.S.C. 1985 (5th Supp.), c. 1, s. 69(2).

The Minister of National Revenue reassessed the respondent taxpayer by increasing its
income on the basis that the taxpayer had overpaid its non-arms length supplier for the
purchase of ranitidine, the active pharmaceutical ingredient in a drug marketed by the
taxpayer in Canada. According to the Minister, a reasonable amount for the taxpayer to have
paid for ranitidine was the price paid by other pharmaceutical companies that were selling
generic versions of the drug. The Tax Court of Canada upheld the reassessments except for
minor upward adjustment to the price paid by the taxpayer. The Federal Court of Appeal set
aside the Tax Court decision and returned the matter for rehearing.

Summary of Facts
GlaxoSmithKline (Glaxo Canada) is a Canadian subsidiary of Glaxo Group Ltd
(Glaxo Group). During the taxation years in question, from 1990 to 1993, Glaxo
Canada purchased ranitidine from Adescha S.A. (Adescha), a related non-resident
company, at a rate of between $1,512 and $1,651 per kilogram. Ranitidine is the key
pharmaceutical ingredient in an anti-ulcer drug, sold under the brand name Zantac by
GlaxoSmithKline. During the same taxation years, two Canadian generic pharmaceutical
companies purchased ranitidine from arms length suppliers at a cost of between $194
and $304 per kilogram.
A License Agreement with Glaxo Group granted Glaxo Canada patent and trademark
rights. Glaxo Canadas Supply Agreement with Adescha, a Glaxo Group clearing
company, set the prices and conditions for Glaxo Canadas purchase of ranitidine.
The Minister of National Revenue reassessed Glaxo Canada under subsection 69(2) of
the Income Tax Act (now subsection 247(2)) on the basis that the amount paid for
ranitidine exceeded the price that the parties would have paid had they been operating at
arms length.
Glaxo Canada appealed to the Tax Court of Canada, which found that it was required to
evaluate the Supply Agreement independently from the License Agreement and therefore
could not take into account whether the License Agreement granted rights and benefits
relevant in considering a reasonable arms length price. The Tax Court of Canada upheld
the Ministers reassessment with only a small revision.
Glaxo Canada then successfully appealed to the Federal Court of Appeal, which
determined that the License Agreement and the Supply Agreement needed to be
considered together when assessing whether the price paid was reasonable. The Federal
Court of Appeal remitted the case to the Tax Court of Canada for a redetermination on
the basis that Glaxo Canada had not satisfied its burden to demolish the Crowns
assumptions of what constituted a reasonable price for ranitidine.
The Crown appealed the Federal Court of Appeals decision that the License Agreement
should have been considered and Glaxo Canada cross-appealed the decision to remit the
case to the Tax Court of Canada.

Issues
Was the price Glaxo Canada paid to the non-resident related company for a key
pharmaceutical ingredient higher than what would have been paid if the parties had been
dealing at arms length?
Did Glaxo Canada discharge its burden to demolish the assumptions of the Minister of
National Revenue, or must the case be remitted to the Tax Court of Canada?

Court Decision
The Supreme Court of Canada dismissed the appeal and the cross-appeal.
The Court reviewed subsection 69(2) of the Income Tax Act (now subsection 247(2)),
which required an evaluation of whether the transfer price paid by Glaxo Canada would
have been a reasonable price between arms length parties. To supplement subsection
69(2), which provided no specifics for the reasonableness assessment, the Court noted
that OECD guidelines, while not binding Canadian law, offer several possible
approaches.
The decision emphasized that relevant surrounding circumstances and, where available or
relevant, other related transactions, must be considered when determining a reasonable
arms length price. The inclusion of economically relevant characteristics is necessary
for a proper assessment. Where, as in this case, there are other agreements that grant
related rights and benefits, these agreements consist of relevant circumstances to be
considered in determining what an arms length party would have paid for the goods
and/or services.
The Court went on to find that the price Glaxo Canada paid for ranitidine was at least in
part also compensating for rights and benefits it received under the License Agreement.
Both the License Agreement and the Supply Agreement acted together to allow Glaxo
Canada to acquire ranitidine, make it deliverable, and market the drug under the brand
name Zantac. The License Agreement also specifically required Glaxo Canada to
purchase ranitidine from either Adechsa or another source. The Court concluded that the
prices paid for ranitidine by generic drug manufacturers were not sufficient comparisons
without further adjustments to account for the additional rights, benefits, and obligations
under the License Agreement.
As guidelines for the redetermination by the Tax Court of Canada, the Court provided a
number of comments. First, the Court emphasized that transfer pricing cannot be applied
with exact certainty and different assessments of a reasonable price may still fall within
the appropriate range of what is reasonable. Courts can only aim as best as possible to
make satisfactory and informed determinations. The Court then noted the need to
consider the differing roles of Glaxo Group and Glaxo Canada and ensure that transfer
pricing did not result in a misallocation of profits, noting that it will be for the Tax Court
of Canada to consider whether there needs to be some adjustment for intellectual property
rights. The Court also asserted that the independent interests of Glaxo Group and Glaxo
Canada should be recognized. Finally, the Court highlighted the need to consider the
evidence that even when operating at arms length, some distributors have opted to
purchase ranitidine from Glaxo Group.
Regarding Glaxo Canadas cross-appeal, the Court upheld the Federal Court of Appeals
decision that Glaxo Canada had not demolished the Ministers assumption that it did not
pay a reasonable price for the supply. The Court remitted the case back to the Tax Court
of Canada for redetermination based on the guidelines it set out.

Decision in Favour of
GlaxoSmithKline Inc., the Respondent, was successful on the appeal.
Her Majesty The Queen, the Respondent, was successful on the cross-appeal.

Editors Notes
This was the first transfer pricing decision by the Supreme Court of Canada. While the
transfer pricing provision in question, subsection 69(2), has been replaced with a new
provision, subsection 247, the decision still provides important guidelines for applying
transfer pricing law in Canada.
G.R. No. 195909 September 26, 2012

COMMISSIONER OF INTERNAL REVENUE, PETITIONER,

vs.
ST. LUKE'S MEDICAL CENTER, INC., RESPONDENT.

x-----------------------x

G.R. No. 195960

ST. LUKE'S MEDICAL CENTER, INC., PETITIONER,

vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DECISION

CARPIO, J.:

The Case

These are consolidated 1 petitions for review on certiorari under Rule 45 of the Rules of
Court assailing the Decision of 19 November 2010 of the Court of Tax Appeals (CTA) En
Banc and its Resolution 2 of 1 March 2011 in CTA Case No. 6746. This Court resolves this
case on a pure question of law, which involves the interpretation of Section 27(B) vis--vis
Section 30(E) and (G) of the National Internal Revenue Code of the Philippines (NIRC), on
the income tax treatment of proprietary non-profit hospitals.

The Facts

St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as a non-stock and non-
profit corporation. Under its articles of incorporation, among its corporate purposes are:

(a) To establish, equip, operate and maintain a non-stock, non-profit Christian, benevolent,
charitable and scientific hospital which shall give curative, rehabilitative and spiritual care to
the sick, diseased and disabled persons; provided that purely medical and surgical services
shall be performed by duly licensed physicians and surgeons who may be freely and
individually contracted by patients;

(b) To provide a career of health science education and provide medical services to the
community through organized clinics in such specialties as the facilities and resources of the
corporation make possible;

(c) To carry on educational activities related to the maintenance and promotion of health as
well as provide facilities for scientific and medical researches which, in the opinion of the
Board of Trustees, may be justified by the facilities, personnel, funds, or other requirements
that are available;

(d) To cooperate with organized medical societies, agencies of both government and private
sector; establish rules and regulations consistent with the highest professional ethics;

xxxx3

On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke's deficiency
taxes amounting to P76,063,116.06 for 1998, comprised of deficiency income tax, value-
added tax, withholding tax on compensation and expanded withholding tax. The BIR
reduced the amount to P63,935,351.57 during trial in the First Division of the CTA. 4

On 14 January 2003, St. Luke's filed an administrative protest with the BIR against the
deficiency tax assessments. The BIR did not act on the protest within the 180-day period
under Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.

The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals, should be applicable
to St. Luke's. According to the BIR, Section 27(B), introduced in 1997, "is a new provision
intended to amend the exemption on non-profit hospitals that were previously categorized as
non-stock, non-profit corporations under Section 26 of the 1997 Tax Code x x x." 5 It is a
specific provision which prevails over the general exemption on income tax granted under
Section 30(E) and (G) for non-stock, non-profit charitable institutions and civic
organizations promoting social welfare. 6

The BIR claimed that St. Luke's was actually operating for profit in 1998 because only 13%
of its revenues came from charitable purposes. Moreover, the hospital's board of trustees,
officers and employees directly benefit from its profits and assets. St. Luke's had total
revenues of P1,730,367,965 or approximately P1.73 billion from patient services in 1998. 7

St. Luke's contended that the BIR should not consider its total revenues, because its free
services to patients was P218,187,498 or 65.20% of its 1998 operating income (i.e., total
revenues less operating expenses) of P334,642,615. 8 St. Luke's also claimed that its income
does not inure to the benefit of any individual.

St. Luke's maintained that it is a non-stock and non-profit institution for charitable and social
welfare purposes under Section 30(E) and (G) of the NIRC. It argued that the making of
profit per se does not destroy its income tax exemption.

The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments before
the CTA that Section 27(B) applies to St. Luke's. The petition raises the sole issue of whether
the enactment of Section 27(B) takes proprietary non-profit hospitals out of the income tax
exemption under Section 30 of the NIRC and instead, imposes a preferential rate of 10% on
their taxable income. The BIR prays that St. Luke's be ordered to pay P57,659,981.19 as
deficiency income and expanded withholding tax for 1998 with surcharges and interest for
late payment.

The petition of St. Luke's in G.R. No. 195960 raises factual matters on the treatment and
withholding of a part of its income, 9 as well as the payment of surcharge and delinquency
interest. There is no ground for this Court to undertake such a factual review. Under the
Constitution 10 and the Rules of Court, 11 this Court's review power is generally limited to
"cases in which only an error or question of law is involved." 12 This Court cannot depart
from this limitation if a party fails to invoke a recognized exception.

The Ruling of the Court of Tax Appeals

The CTA En Banc Decision on 19 November 2010 affirmed in toto the CTA First Division
Decision dated 23 February 2009 which held:

WHEREFORE, the Amended Petition for Review [by St. Luke's] is hereby PARTIALLY
GRANTED. Accordingly, the 1998 deficiency VAT assessment issued by respondent against
petitioner in the amount of P110,000.00 is hereby CANCELLED and WITHDRAWN.
However, petitioner is hereby ORDERED to PAY deficiency income tax and deficiency
expanded withholding tax for the taxable year 1998 in the respective amounts of
P5,496,963.54 and P778,406.84 or in the sum of P6,275,370.38, x x x.

xxxx

In addition, petitioner is hereby ORDERED to PAY twenty percent (20%) delinquency

interest on the total amount of P6,275,370.38 counted from October 15, 2003 until full
payment thereof, pursuant to Section 249(C)(3) of the NIRC of 1997.

SO ORDERED. 13

The deficiency income tax of P5,496,963.54, ordered by the CTA En Banc to be paid, arose
from the failure of St. Luke's to prove that part of its income in 1998 (declared as "Other
Income-Net") 14 came from charitable activities. The CTA cancelled the remainder of the
P63,113,952.79 deficiency assessed by the BIR based on the 10% tax rate under Section
27(B) of the NIRC, which the CTA En Banc held was not applicable to St. Luke's. 15

The CTA ruled that St. Luke's is a non-stock and non-profit charitable institution covered by
Section 30(E) and (G) of the NIRC. This ruling would exempt all income derived by St.
Luke's from services to its patients, whether paying or non-paying. The CTA reiterated its
earlier decision in St. Luke's Medical Center, Inc. v. Commissioner of Internal Revenue, 16
which examined the primary purposes of St. Luke's under its articles of incorporation and
various documents 17 identifying St. Luke's as a charitable institution.

The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City, 18 which states
that "a charitable institution does not lose its charitable character and its consequent
exemption from taxation merely because recipients of its benefits who are able to pay are
required to do so, where funds derived in this manner are devoted to the charitable purposes
of the institution x x x." 19 The generation of income from paying patients does not per se
destroy the charitable nature of St. Luke's.

Hospital de San Juan cited Jesus Sacred Heart College v. Collector of Internal Revenue, 20
which ruled that the old NIRC (Commonwealth Act No. 466, as amended) 21 "positively
exempts from taxation those corporations or associations which, otherwise, would be subject
thereto, because of the existence of x x x net income." 22 The NIRC of 1997 substantially
reproduces the provision on charitable institutions of the old NIRC. Thus, in rejecting the
argument that tax exemption is lost whenever there is net income, the Court in Jesus Sacred
Heart College declared: "[E]very responsible organization must be run to at least insure its
existence, by operating within the limits of its own resources, especially its regular income.
In other words, it should always strive, whenever possible, to have a surplus." 23

The CTA held that Section 27(B) of the present NIRC does not apply to St. Luke's. 24 The
CTA explained that to apply the 10% preferential rate, Section 27(B) requires a hospital to be
"non-profit." On the other hand, Congress specifically used the word "non-stock" to qualify a
charitable "corporation or association" in Section 30(E) of the NIRC. According to the CTA,
this is unique in the present tax code, indicating an intent to exempt this type of charitable
organization from income tax. Section 27(B) does not require that the hospital be "non-
stock." The CTA stated, "it is clear that non-stock, non-profit hospitals operated exclusively
for charitable purpose are exempt from income tax on income received by them as such,
applying the provision of Section 30(E) of the NIRC of 1997, as amended." 25

The Issue

The sole issue is whether St. Luke's is liable for deficiency income tax in 1998 under Section
27(B) of the NIRC, which imposes a preferential tax rate of 10% on the income of
proprietary non-profit hospitals.

The Ruling of the Court

St. Luke's Petition in G.R. No. 195960

As a preliminary matter, this Court denies the petition of St. Luke's in G.R. No. 195960
because the petition raises factual issues. Under Section 1, Rule 45 of the Rules of Court,
"[t]he petition shall raise only questions of law which must be distinctly set forth." St. Luke's
cites Martinez v. Court of Appeals 26 which permits factual review "when the Court of
Appeals [in this case, the CTA] manifestly overlooked certain relevant facts not disputed by
the parties and which, if properly considered, would justify a different conclusion." 27

This Court does not see how the CTA overlooked relevant facts. St. Luke's itself stated that
the CTA "disregarded the testimony of [its] witness, Romeo B. Mary, being allegedly self-
serving, to show the nature of the 'Other Income-Net' x x x." 28 This is not a case of
overlooking or failing to consider relevant evidence. The CTA obviously considered the
evidence and concluded that it is self-serving. The CTA declared that it has "gone through
the records of this case and found no other evidence aside from the self-serving affidavit
executed by [the] witnesses [of St. Luke's] x x x." 29

The deficiency tax on "Other Income-Net" stands. Thus, St. Luke's is liable to pay the 25%
surcharge under Section 248(A)(3) of the NIRC. There is "[f]ailure to pay the deficiency tax
within the time prescribed for its payment in the notice of assessment[.]" 30 St. Luke's is also
liable to pay 20% delinquency interest under Section 249(C)(3) of the NIRC. 31 As
explained by the CTA En Banc, the amount of P6,275,370.38 in the dispositive portion of the
CTA First Division Decision includes only deficiency interest under Section 249(A) and (B)
of the NIRC and not delinquency interest. 32

The Main Issue

The issue raised by the BIR is a purely legal one. It involves the effect of the introduction of
Section 27(B) in the NIRC of 1997 vis--vis Section 30(E) and (G) on the income tax
exemption of charitable and social welfare institutions. The 10% income tax rate under
Section 27(B) specifically pertains to proprietary educational institutions and proprietary
non-profit hospitals. The BIR argues that Congress intended to remove the exemption that
non-profit hospitals previously enjoyed under Section 27(E) of the NIRC of 1977, which is
now substantially reproduced in Section 30(E) of the NIRC of 1997. 33 Section 27(B) of the
present NIRC provides:

SEC. 27. Rates of Income Tax on Domestic Corporations. -

xxxx

(B) Proprietary Educational Institutions and Hospitals. - Proprietary educational institutions

and hospitals which are non-profit shall pay a tax of ten percent (10%) on their taxable
income except those covered by Subsection (D) hereof: Provided, That if the gross income
from unrelated trade, business or other activity exceeds fifty percent (50%) of the total gross
income derived by such educational institutions or hospitals from all sources, the tax
prescribed in Subsection (A) hereof shall be imposed on the entire taxable income. For
purposes of this Subsection, the term 'unrelated trade, business or other activity' means any
trade, business or other activity, the conduct of which is not substantially related to the
exercise or performance by such educational institution or hospital of its primary purpose or
function. A 'proprietary educational institution' is any private school maintained and
administered by private individuals or groups with an issued permit to operate from the
Department of Education, Culture and Sports (DECS), or the Commission on Higher
Education (CHED), or the Technical Education and Skills Development Authority (TESDA),
as the case may be, in accordance with existing laws and regulations. (Emphasis supplied)

St. Luke's claims tax exemption under Section 30(E) and (G) of the NIRC. It contends that it
is a charitable institution and an organization promoting social welfare. The arguments of St.
Luke's focus on the wording of Section 30(E) exempting from income tax non-stock, non-
profit charitable institutions. 34 St. Luke's asserts that the legislative intent of introducing
Section 27(B) was only to remove the exemption for "proprietary non-profit" hospitals. 35
The relevant provisions of Section 30 state:

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not be
taxed under this Title in respect to income received by them as such:

xxxx

(E) Nonstock corporation or association organized and operated exclusively for religious,
charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no
part of its net income or asset shall belong to or inure to the benefit of any member,
organizer, officer or any specific person;

xxxx

(G) Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;

xxxx

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind
and character of the foregoing organizations from any of their properties, real or personal, or
from any of their activities conducted for profit regardless of the disposition made of such
income, shall be subject to tax imposed under this Code. (Emphasis supplied)

The Court partly grants the petition of the BIR but on a different ground. We hold that
Section 27(B) of the NIRC does not remove the income tax exemption of proprietary non-
profit hospitals under Section 30(E) and (G). Section 27(B) on one hand, and Section 30(E)
and (G) on the other hand, can be construed together without the removal of such tax
exemption. The effect of the introduction of Section 27(B) is to subject the taxable income of
two specific institutions, namely, proprietary non-profit educational institutions 36 and
proprietary non-profit hospitals, among the institutions covered by Section 30, to the 10%
preferential rate under Section 27(B) instead of the ordinary 30% corporate rate under the
last paragraph of Section 30 in relation to Section 27(A)(1).

Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1)
proprietary non-profit educational institutions and (2) proprietary non-profit hospitals. The
only qualifications for hospitals are that they must be proprietary and non-profit.
"Proprietary" means private, following the definition of a "proprietary educational
institution" as "any private school maintained and administered by private individuals or
groups" with a government permit. "Non-profit" means no net income or asset accrues to or
benefits any member or specific person, with all the net income or asset devoted to the
institution's purposes and all its activities conducted not for profit.
"Non-profit" does not necessarily mean "charitable." In Collector of Internal Revenue v.
Club Filipino Inc. de Cebu, 37 this Court considered as non-profit a sports club organized for
recreation and entertainment of its stockholders and members. The club was primarily
funded by membership fees and dues. If it had profits, they were used for overhead expenses
and improving its golf course. 38 The club was non-profit because of its purpose and there
was no evidence that it was engaged in a profit-making enterprise. 39

The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not charitable.
The Court defined "charity" in Lung Center of the Philippines v. Quezon City 40 as "a gift,
to be applied consistently with existing laws, for the benefit of an indefinite number of
persons, either by bringing their minds and hearts under the influence of education or
religion, by assisting them to establish themselves in life or [by] otherwise lessening the
burden of government." 41 A non-profit club for the benefit of its members fails this test. An
organization may be considered as non-profit if it does not distribute any part of its income
to stockholders or members. However, despite its being a tax exempt institution, any income
such institution earns from activities conducted for profit is taxable, as expressly provided in
the last paragraph of Section 30.

To be a charitable institution, however, an organization must meet the substantive test of

charity in Lung Center. The issue in Lung Center concerns exemption from real property tax
and not income tax. However, it provides for the test of charity in our jurisdiction. Charity is
essentially a gift to an indefinite number of persons which lessens the burden of government.
In other words, charitable institutions provide for free goods and services to the public which
would otherwise fall on the shoulders of government. Thus, as a matter of efficiency, the
government forgoes taxes which should have been spent to address public needs, because
certain private entities already assume a part of the burden. This is the rationale for the tax
exemption of charitable institutions. The loss of taxes by the government is compensated by
its relief from doing public works which would have been funded by appropriations from the
Treasury. 42

Charitable institutions, however, are not ipso facto entitled to a tax exemption. The
requirements for a tax exemption are specified by the law granting it. The power of Congress
to tax implies the power to exempt from tax. Congress can create tax exemptions, subject to
the constitutional provision that "[n]o law granting any tax exemption shall be passed
without the concurrence of a majority of all the Members of Congress." 43 The requirements
for a tax exemption are strictly construed against the taxpayer 44 because an exemption
restricts the collection of taxes necessary for the existence of the government.

The Court in Lung Center declared that the Lung Center of the Philippines is a charitable
institution for the purpose of exemption from real property taxes. This ruling uses the same
premise as Hospital de San Juan 45 and Jesus Sacred Heart College 46 which says that
receiving income from paying patients does not destroy the charitable nature of a hospital.
As a general principle, a charitable institution does not lose its character as such and its
exemption from taxes simply because it derives income from paying patients, whether out-
patient, or confined in the hospital, or receives subsidies from the government, so long as the
money received is devoted or used altogether to the charitable object which it is intended to
achieve; and no money inures to the private benefit of the persons managing or operating the
institution. 47

For real property taxes, the incidental generation of income is permissible because the test of
exemption is the use of the property. The Constitution provides that "[c]haritable institutions,
churches and personages or convents appurtenant thereto, mosques, non-profit cemeteries,
and all lands, buildings, and improvements, actually, directly, and exclusively used for
religious, charitable, or educational purposes shall be exempt from taxation." 48 The test of
exemption is not strictly a requirement on the intrinsic nature or character of the institution.
The test requires that the institution use the property in a certain way, i.e. for a charitable
purpose. Thus, the Court held that the Lung Center of the Philippines did not lose its
charitable character when it used a portion of its lot for commercial purposes. The effect of
failing to meet the use requirement is simply to remove from the tax exemption that portion
of the property not devoted to charity.

The Constitution exempts charitable institutions only from real property taxes. In the NIRC,
Congress decided to extend the exemption to income taxes. However, the way Congress
crafted Section 30(E) of the NIRC is materially different from Section 28(3), Article VI of
the Constitution. Section 30(E) of the NIRC defines the corporation or association that is
exempt from income tax. On the other hand, Section 28(3), Article VI of the Constitution
does not define a charitable institution, but requires that the institution "actually, directly and
exclusively" use the property for a charitable purpose.

Section 30(E) of the NIRC provides that a charitable institution must be:

(1) A non-stock corporation or association;

(2) Organized exclusively for charitable purposes;

(3) Operated exclusively for charitable purposes; and

(4) No part of its net income or asset shall belong to or inure to the benefit of any member,
organizer, officer or any specific person.

Thus, both the organization and operations of the charitable institution must be devoted
"exclusively" for charitable purposes. The organization of the institution refers to its
corporate form, as shown by its articles of incorporation, by-laws and other constitutive
documents. Section 30(E) of the NIRC specifically requires that the corporation or
association be non-stock, which is defined by the Corporation Code as "one where no part of
its income is distributable as dividends to its members, trustees, or officers" 49 and that any
profit "obtain[ed] as an incident to its operations shall, whenever necessary or proper, be
used for the furtherance of the purpose or purposes for which the corporation was
organized." 50 However, under Lung Center, any profit by a charitable institution must not
only be plowed back "whenever necessary or proper," but must be "devoted or used
altogether to the charitable object which it is intended to achieve." 51

The operations of the charitable institution generally refer to its regular activities. Section
30(E) of the NIRC requires that these operations be exclusive to charity. There is also a
specific requirement that "no part of [the] net income or asset shall belong to or inure to the
benefit of any member, organizer, officer or any specific person." The use of lands, buildings
and improvements of the institution is but a part of its operations.

There is no dispute that St. Luke's is organized as a non-stock and non-profit charitable
institution. However, this does not automatically exempt St. Luke's from paying taxes. This
only refers to the organization of St. Luke's. Even if St. Luke's meets the test of charity, a
charitable institution is not ipso facto tax exempt. To be exempt from real property taxes,
Section 28(3), Article VI of the Constitution requires that a charitable institution use the
property "actually, directly and exclusively" for charitable purposes. To be exempt from
income taxes, Section 30(E) of the NIRC requires that a charitable institution must be
"organized and operated exclusively" for charitable purposes. Likewise, to be exempt from
income taxes, Section 30(G) of the NIRC requires that the institution be "operated
exclusively" for social welfare.

However, the last paragraph of Section 30 of the NIRC qualifies the words "organized and
operated exclusively" by providing that:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind
and character of the foregoing organizations from any of their properties, real or personal, or
from any of their activities conducted for profit regardless of the disposition made of such
income, shall be subject to tax imposed under this Code. (Emphasis supplied)

In short, the last paragraph of Section 30 provides that if a tax exempt charitable institution
conducts "any" activity for profit, such activity is not tax exempt even as its not-for-profit
activities remain tax exempt. This paragraph qualifies the requirements in Section 30(E) that
the "[n]on-stock corporation or association [must be] organized and operated exclusively for
x x x charitable x x x purposes x x x." It likewise qualifies the requirement in Section 30(G)
that the civic organization must be "operated exclusively" for the promotion of social
welfare.

Thus, even if the charitable institution must be "organized and operated exclusively" for
charitable purposes, it is nevertheless allowed to engage in "activities conducted for profit"
without losing its tax exempt status for its not-for-profit activities. The only consequence is
that the "income of whatever kind and character" of a charitable institution "from any of its
activities conducted for profit, regardless of the disposition made of such income, shall be
subject to tax." Prior to the introduction of Section 27(B), the tax rate on such income from
for-profit activities was the ordinary corporate rate under Section 27(A). With the
introduction of Section 27(B), the tax rate is now 10%.

In 1998, St. Luke's had total revenues of P1,730,367,965 from services to paying patients. It
cannot be disputed that a hospital which receives approximately P1.73 billion from paying
patients is not an institution "operated exclusively" for charitable purposes. Clearly, revenues
from paying patients are income received from "activities conducted for profit." 52 Indeed,
St. Luke's admits that it derived profits from its paying patients. St. Luke's declared
P1,730,367,965 as "Revenues from Services to Patients" in contrast to its "Free Services"
expenditure of P218,187,498. In its Comment in G.R. No. 195909, St. Luke's showed the
following "calculation" to support its claim that 65.20% of its "income after expenses was
allocated to free or charitable services" in 1998. 53

REVENUES FROM SERVICES TO PATIENTS P1,730,367,965.00

OPERATING EXPENSES

Professional care of patients P1,016,608,394.00

Administrative 287,319,334.00
Household and Property 91,797,622.00

P1,395,725,350.00

INCOME FROM OPERATIONS P334,642,615.00 100%

Free Services -218,187,498.00 -65.20%
INCOME FROM OPERATIONS, Net of FREE SERVICES P116,455,117.00 34.80%

OTHER INCOME 17,482,304.00

EXCESS OF REVENUES OVER EXPENSES P133,937,421.00

In Lung Center, this Court declared:

"[e]xclusive" is defined as possessed and enjoyed to the exclusion of others; debarred from
participation or enjoyment; and "exclusively" is defined, "in a manner to exclude; as
enjoying a privilege exclusively." x x x The words "dominant use" or "principal use" cannot
be substituted for the words "used exclusively" without doing violence to the Constitution
and the law. Solely is synonymous with exclusively. 54

The Court cannot expand the meaning of the words "operated exclusively" without violating
the NIRC. Services to paying patients are activities conducted for profit. They cannot be
considered any other way. There is a "purpose to make profit over and above the cost" of
services. 55 The P1.73 billion total revenues from paying patients is not even incidental to
St. Luke's charity expenditure of P218,187,498 for non-paying patients.

St. Luke's claims that its charity expenditure of P218,187,498 is 65.20% of its operating
income in 1998. However, if a part of the remaining 34.80% of the operating income is
reinvested in property, equipment or facilities used for services to paying and non-paying
patients, then it cannot be said that the income is "devoted or used altogether to the charitable
object which it is intended to achieve." 56 The income is plowed back to the corporation not
entirely for charitable purposes, but for profit as well. In any case, the last paragraph of
Section 30 of the NIRC expressly qualifies that income from activities for profit is taxable
"regardless of the disposition made of such income."

Jesus Sacred Heart College declared that there is no official legislative record explaining the
phrase "any activity conducted for profit." However, it quoted a deposition of Senator
Mariano Jesus Cuenco, who was a member of the Committee of Conference for the Senate,
which introduced the phrase "or from any activity conducted for profit."

P. Cuando ha hablado de la Universidad de Santo Toms que tiene un hospital, no cree Vd.
que es una actividad esencial dicho hospital para el funcionamiento del colegio de medicina
de dicha universidad?

xxxx

R. Si el hospital se limita a recibir enformos pobres, mi contestacin seria afirmativa; pero

considerando que el hospital tiene cuartos de pago, y a los mismos generalmente van
enfermos de buena posicin social econmica, lo que se paga por estos enfermos debe estar
sujeto a 'income tax', y es una de las razones que hemos tenido para insertar las palabras o
frase 'or from any activity conducted for profit.' 57

The question was whether having a hospital is essential to an educational institution like the
College of Medicine of the University of Santo Tomas. Senator Cuenco answered that if the
hospital has paid rooms generally occupied by people of good economic standing, then it
should be subject to income tax. He said that this was one of the reasons Congress inserted
the phrase "or any activity conducted for profit."

The question in Jesus Sacred Heart College involves an educational institution. 58 However,
it is applicable to charitable institutions because Senator Cuenco's response shows an intent
to focus on the activities of charitable institutions. Activities for profit should not escape the
reach of taxation. Being a non-stock and non-profit corporation does not, by this reason
alone, completely exempt an institution from tax. An institution cannot use its corporate form
to prevent its profitable activities from being taxed.

The Court finds that St. Luke's is a corporation that is not "operated exclusively" for
charitable or social welfare purposes insofar as its revenues from paying patients are
concerned. This ruling is based not only on a strict interpretation of a provision granting tax
exemption, but also on the clear and plain text of Section 30(E) and (G). Section 30(E) and
(G) of the NIRC requires that an institution be "operated exclusively" for charitable or social
welfare purposes to be completely exempt from income tax. An institution under Section
30(E) or (G) does not lose its tax exemption if it earns income from its for-profit activities.
Such income from for-profit activities, under the last paragraph of Section 30, is merely
subject to income tax, previously at the ordinary corporate rate but now at the preferential
10% rate pursuant to Section 27(B).

A tax exemption is effectively a social subsidy granted by the State because an exempt
institution is spared from sharing in the expenses of government and yet benefits from them.
Tax exemptions for charitable institutions should therefore be limited to institutions
beneficial to the public and those which improve social welfare. A profit-making entity
should not be allowed to exploit this subsidy to the detriment of the government and other
taxpayers.1wphi1

St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to be
completely tax exempt from all its income. However, it remains a proprietary non-profit
hospital under Section 27(B) of the NIRC as long as it does not distribute any of its profits to
its members and such profits are reinvested pursuant to its corporate purposes. St. Luke's, as
a proprietary non-profit hospital, is entitled to the preferential tax rate of 10% on its net
income from its for-profit activities.

St. Luke's is therefore liable for deficiency income tax in 1998 under Section 27(B) of the
NIRC. However, St. Luke's has good reasons to rely on the letter dated 6 June 1990 by the
BIR, which opined that St. Luke's is "a corporation for purely charitable and social welfare
purposes"59 and thus exempt from income tax. 60 In Michael J. Lhuillier, Inc. v.
Commissioner of Internal Revenue, 61 the Court said that "good faith and honest belief that
one is not subject to tax on the basis of previous interpretation of government agencies
tasked to implement the tax law, are sufficient justification to delete the imposition of
surcharges and interest." 62

WHEREFORE, the petition of the Commissioner of Internal Revenue in G.R. No. 195909 is
PARTLY GRANTED. The Decision of the Court of Tax Appeals En Banc dated 19
November 2010 and its Resolution dated 1 March 2011 in CTA Case No. 6746 are
MODIFIED. St. Luke's Medical Center, Inc. is ORDERED TO PAY the deficiency income
tax in 1998 based on the 10% preferential income tax rate under Section 27(B) of the
National Internal Revenue Code. However, it is not liable for surcharges and interest on such
deficiency income tax under Sections 248 and 249 of the National Internal Revenue Code.
All other parts of the Decision and Resolution of the Court of Tax Appeals are AFFIRMED.
The petition of St. Luke's Medical Center, Inc. in G.R. No. 195960 is DENIED for violating
Section 1, Rule 45 of the Rules of Court. SO ORDERED.
EN BANC
G.R. No. 172087 March 15, 2011
PHILIPPINE AMUSEMENT AND GAMING CORPORATION (PAGCOR), Petitioner,
vs.
THE BUREAU OF INTERNAL REVENUE (BIR), represented herein by HON. JOSE
MARIO BUAG, in his official capacity as COMMISSIONER OF INTERNAL
REVENUE, Public Respondent,
JOHN DOE and JANE DOE, who are persons acting for, in behalf, or under the
authority of Respondent.Public and Private Respondents.
DECISION
PERALTA, J.:
For resolution of this Court is the Petition for Certiorari and Prohibition1 with prayer for the
issuance of a Temporary Restraining Order and/or Preliminary Injunction, dated April 17,
2006, of petitioner Philippine Amusement and Gaming Corporation (PAGCOR), seeking the
declaration of nullity of Section 1 of Republic Act (R.A.) No. 9337 insofar as it amends
Section 27 (c) of the National Internal Revenue Code of 1997, by excluding petitioner from
exemption from corporate income tax for being repugnant to Sections 1 and 10 of Article III
of the Constitution. Petitioner further seeks to prohibit the implementation of Bureau of
Internal Revenue (BIR) Revenue Regulations No. 16-2005 for being contrary to law.
The undisputed facts follow.
PAGCOR was created pursuant to Presidential Decree (P.D.) No. 1067-A2 on January 1,
1977. Simultaneous to its creation, P.D. No. 1067-B3 (supplementing P.D. No. 1067-A) was
issued exempting PAGCOR from the payment of any type of tax, except a franchise tax of
five percent (5%) of the gross revenue.4 Thereafter, on June 2, 1978, P.D. No. 1399 was
issued expanding the scope of PAGCOR's exemption.5
To consolidate the laws pertaining to the franchise and powers of PAGCOR, P.D. No.
18696 was issued. Section 13 thereof reads as follows:
Sec. 13. Exemptions. x x x
(1) Customs Duties, taxes and other imposts on importations. - All importations of
equipment, vehicles, automobiles, boats, ships, barges, aircraft and such other gambling
paraphernalia, including accessories or related facilities, for the sole and exclusive use of the
casinos, the proper and efficient management and administration thereof and such other
clubs, recreation or amusement places to be established under and by virtue of this Franchise
shall be exempt from the payment of duties, taxes and other imposts, including all kinds of
fees, levies, or charges of any kind or nature.
Vessels and/or accessory ferry boats imported or to be imported by any corporation having
existing contractual arrangements with the Corporation, for the sole and exclusive use of the
casino or to be used to service the operations and requirements of the casino, shall likewise
be totally exempt from the payment of all customs duties, taxes and other imposts, including
all kinds of fees, levies, assessments or charges of any kind or nature, whether National or
Local.
(2) Income and other taxes. - (a) Franchise Holder: No tax of any kind or form, income or
otherwise, as well as fees, charges, or levies of whatever nature, whether National or Local,
shall be assessed and collected under this Franchise from the Corporation; nor shall any form
of tax or charge attach in any way to the earnings of the Corporation, except a Franchise Tax
of five percent (5%)of the gross revenue or earnings derived by the Corporation from its
operation under this Franchise. Such tax shall be due and payable quarterly to the National
Government and shall be in lieu of all kinds of taxes, levies, fees or assessments of any kind,
nature or description, levied, established, or collected by any municipal, provincial or
national government authority.
(b) Others: The exemption herein granted for earnings derived from the operations conducted
under the franchise, specifically from the payment of any tax, income or otherwise, as well
as any form of charges, fees or levies, shall inure to the benefit of and extend to
corporation(s), association(s), agency(ies), or individual(s) with whom the Corporation or
operator has any contractual relationship in connection with the operations of the casino(s)
authorized to be conducted under this Franchise and to those receiving compensation or
other remuneration from the Corporation as a result of essential facilities furnished and/or
technical services rendered to the Corporation or operator.
The fee or remuneration of foreign entertainers contracted by the Corporation or operator in
pursuance of this provision shall be free of any tax.
(3) Dividend Income. Notwithstanding any provision of law to the contrary, in the event
the Corporation should declare a cash dividend income corresponding to the participation of
the private sector shall, as an incentive to the beneficiaries, be subject only to a final flat
income rate of ten percent (10%) of the regular income tax rates. The dividend income shall
not in such case be considered as part of the beneficiaries' taxable income; provided,
however, that such dividend income shall be totally exempted from income or other form of
taxes if invested within six (6) months from the date the dividend income is received in the
following:
(a) operation of the casino(s) or investments in any affiliate activity that will ultimately
redound to the benefit of the Corporation; or any other corporation with whom the
Corporation has any existing arrangements in connection with or related to the operations of
the casino(s);
(b) Government bonds, securities, treasury notes, or government debentures; or
(c) BOI-registered or export-oriented corporation(s).7
PAGCOR's tax exemption was removed in June 1984 through P.D. No. 1931, but it was later
restored by Letter of Instruction No. 1430, which was issued in September 1984.
On January 1, 1998, R.A. No. 8424,8 otherwise known as the National Internal Revenue
Code of 1997, took effect. Section 27 (c) of R.A. No. 8424 provides that government-owned
and controlled corporations (GOCCs) shall pay corporate income tax, except petitioner
PAGCOR, the Government Service and Insurance Corporation, the Social Security System,
the Philippine Health Insurance Corporation, and the Philippine Charity Sweepstakes Office,
thus:
(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The
provisions of existing special general laws to the contrary notwithstanding, all corporations,
agencies or instrumentalities owned and controlled by the Government, except the
Government Service and Insurance Corporation (GSIS), the Social Security System (SSS),
the Philippine Health Insurance Corporation (PHIC), the Philippine Charity Sweepstakes
Office (PCSO), and the Philippine Amusement and Gaming Corporation (PAGCOR), shall
pay such rate of tax upon their taxable income as are imposed by this Section upon
corporations or associations engaged in similar business, industry, or activity.9
With the enactment of R.A. No. 933710 on May 24, 2005, certain sections of the National
Internal Revenue Code of 1997 were amended. The particular amendment that is at issue in
this case is Section 1 of R.A. No. 9337, which amended Section 27 (c) of the National
Internal Revenue Code of 1997 by excluding PAGCOR from the enumeration of GOCCs
that are exempt from payment of corporate income tax, thus:
(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The
provisions of existing special general laws to the contrary notwithstanding, all corporations,
agencies, or instrumentalities owned and controlled by the Government, except the
Government Service and Insurance Corporation (GSIS), the Social Security System (SSS),
the Philippine Health Insurance Corporation (PHIC), and the Philippine Charity Sweepstakes
Office (PCSO), shall pay such rate of tax upon their taxable income as are imposed by this
Section upon corporations or associations engaged in similar business, industry, or activity.
Different groups came to this Court via petitions for certiorari and prohibition11 assailing the
validity and constitutionality of R.A. No. 9337, in particular:
1) Section 4, which imposes a 10% Value Added Tax (VAT) on sale of goods and properties;
Section 5, which imposes a 10% VAT on importation of goods; and Section 6, which imposes
a 10% VAT on sale of services and use or lease of properties, all contain a uniform
proviso authorizing the President, upon the recommendation of the Secretary of Finance, to
raise the VAT rate to 12%. The said provisions were alleged to be violative of Section 28 (2),
Article VI of the Constitution, which section vests in Congress the exclusive authority to fix
the rate of taxes, and of Section 1, Article III of the Constitution on due process, as well as of
Section 26 (2), Article VI of the Constitution, which section provides for the "no amendment
rule" upon the last reading of a bill;
2) Sections 8 and 12 were alleged to be violative of Section 1, Article III of the Constitution,
or the guarantee of equal protection of the laws, and Section 28 (1), Article VI of the
Constitution; and
3) other technical aspects of the passage of the law, questioning the manner it was passed.
On September 1, 2005, the Court dismissed all the petitions and upheld the constitutionality
of R.A. No. 9337.12
On the same date, respondent BIR issued Revenue Regulations (RR) No. 16--
2005,13 specifically identifying PAGCOR as one of the franchisees subject to 10% VAT
imposed under Section 108 of the National Internal Revenue Code of 1997, as amended by
R.A. No. 9337. The said revenue regulation, in part, reads:
Sec. 4. 108-3. Definitions and Specific Rules on Selected Services.
xxxx
(h) x x x
Gross Receipts of all other franchisees, other than those covered by Sec. 119 of the Tax
Code, regardless of how their franchisees may have been granted, shall be subject to the 10%
VAT imposed under Sec.108 of the Tax Code. This includes, among others, the Philippine
Amusement and Gaming Corporation (PAGCOR), and its licensees or franchisees.
Hence, the present petition for certiorari.
PAGCOR raises the following issues:
I
WHETHER OR NOT RA 9337, SECTION 1 (C) IS NULL AND VOID AB
INITIO FOR BEING REPUGNANT TO THE EQUAL PROTECTION [CLAUSE]
EMBODIED IN SECTION 1, ARTICLE III OF THE 1987 CONSTITUTION.
II
WHETHER OR NOT RA 9337, SECTION 1 (C) IS NULL AND VOID AB INITIO FOR
BEING REPUGNANT TO THE NON-IMPAIRMENT [CLAUSE] EMBODIED IN
SECTION 10, ARTICLE III OF THE 1987 CONSTITUTION.
III
WHETHER OR NOT RR 16-2005, SECTION 4.108-3, PARAGRAPH (H) IS NULL AND
VOID AB INITIO FOR BEING BEYOND THE SCOPE OF THE BASIC LAW, RA 8424,
SECTION 108, INSOFAR AS THE SAID REGULATION IMPOSED VAT ON THE
SERVICES OF THE PETITIONER AS WELL AS PETITIONERS LICENSEES OR
FRANCHISEES WHEN THE BASIC LAW, AS INTERPRETED BY APPLICABLE
JURISPRUDENCE, DOES NOT IMPOSE VAT ON PETITIONER OR ON PETITIONERS
LICENSEES OR FRANCHISEES.14
The BIR, in its Comment15 dated December 29, 2006, counters:
I
SECTION 1 OF R.A. NO. 9337 AND SECTION 13 (2) OF P.D. 1869 ARE BOTH VALID
AND CONSTITUTIONAL PROVISIONS OF LAWS THAT SHOULD BE
HARMONIOUSLY CONSTRUED TOGETHER SO AS TO GIVE EFFECT TO ALL OF
THEIR PROVISIONS WHENEVER POSSIBLE.
II
SECTION 1 OF R.A. NO. 9337 IS NOT VIOLATIVE OF SECTION 1 AND SECTION 10,
ARTICLE III OF THE 1987 CONSTITUTION.
III
BIR REVENUE REGULATIONS ARE PRESUMED VALID AND CONSTITUTIONAL
UNTIL STRICKEN DOWN BY LAWFUL AUTHORITIES.
The Office of the Solicitor General (OSG), by way of Manifestation In Lieu of
Comment,16 concurred with the arguments of the petitioner. It added that although the State
is free to select the subjects of taxation and that the inequity resulting from singling out a
particular class for taxation or exemption is not an infringement of the constitutional
limitation, a tax law must operate with the same force and effect to all persons, firms and
corporations placed in a similar situation. Furthermore, according to the OSG, public
respondent BIR exceeded its statutory authority when it enacted RR No. 16-2005, because
the latter's provisions are contrary to the mandates of P.D. No. 1869 in relation to R.A. No.
9337.
The main issue is whether or not PAGCOR is still exempt from corporate income tax and
VAT with the enactment of R.A. No. 9337.
After a careful study of the positions presented by the parties, this Court finds the petition
partly meritorious.
Under Section 1 of R.A. No. 9337, amending Section 27 (c) of the National Internal Revenue
Code of 1977, petitioner is no longer exempt from corporate income tax as it has been
effectively omitted from the list of GOCCs that are exempt from it. Petitioner argues that
such omission is unconstitutional, as it is violative of its right to equal protection of the laws
under Section 1, Article III of the Constitution:
Sec. 1. No person shall be deprived of life, liberty, or property without due process of law,
nor shall any person be denied the equal protection of the laws.
In City of Manila v. Laguio, Jr.,17 this Court expounded the meaning and scope of equal
protection, thus:
Equal protection requires that all persons or things similarly situated should be treated alike,
both as to rights conferred and responsibilities imposed. Similar subjects, in other words,
should not be treated differently, so as to give undue favor to some and unjustly discriminate
against others. The guarantee means that no person or class of persons shall be denied the
same protection of laws which is enjoyed by other persons or other classes in like
circumstances. The "equal protection of the laws is a pledge of the protection of equal laws."
It limits governmental discrimination. The equal protection clause extends to artificial
persons but only insofar as their property is concerned.
xxxx
Legislative bodies are allowed to classify the subjects of legislation. If the classification is
reasonable, the law may operate only on some and not all of the people without violating the
equal protection clause. The classification must, as an indispensable requisite, not be
arbitrary. To be valid, it must conform to the following requirements:
1) It must be based on substantial distinctions.
2) It must be germane to the purposes of the law.
3) It must not be limited to existing conditions only.
4) It must apply equally to all members of the class.18
It is not contested that before the enactment of R.A. No. 9337, petitioner was one of the five
GOCCs exempted from payment of corporate income tax as shown in R.A. No. 8424,
Section 27 (c) of which, reads:
(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The
provisions of existing special or general laws to the contrary notwithstanding, all
corporations, agencies or instrumentalities owned and controlled by the Government, except
the Government Service and Insurance Corporation (GSIS), the Social Security System
(SSS), the Philippine Health Insurance Corporation (PHIC), the Philippine Charity
Sweepstakes Office (PCSO), and the Philippine Amusement and Gaming Corporation
(PAGCOR), shall pay such rate of tax upon their taxable income as are imposed by this
Section upon corporations or associations engaged in similar business, industry, or activity.19
A perusal of the legislative records of the Bicameral Conference Meeting of the Committee
on Ways on Means dated October 27, 1997 would show that the exemption of PAGCOR
from the payment of corporate income tax was due to the acquiescence of the Committee on
Ways on Means to the request of PAGCOR that it be exempt from such tax.20 The records of
the Bicameral Conference Meeting reveal:
HON. R. DIAZ. The other thing, sir, is we --- I noticed we imposed a tax on lotto winnings.
CHAIRMAN ENRILE. Wala na, tinanggal na namin yon.
HON. R. DIAZ. Tinanggal na ba natin yon?
CHAIRMAN ENRILE. Oo.
HON. R. DIAZ. Because I was wondering whether we covered the tax on --- Whether on a
universal basis, we included a tax on cockfighting winnings.
CHAIRMAN ENRILE. No, we removed the ---
HON. R. DIAZ. I . . . (inaudible) natin yong lotto?
CHAIRMAN ENRILE. Pati PAGCOR tinanggal upon request.
CHAIRMAN JAVIER. Yeah, Philippine Insurance Commission.
CHAIRMAN ENRILE. Philippine Insurance --- Health, health ba. Yon ang request ng
Chairman, I will accept. (laughter) Pag-Pag-ibig yon, maliliit na sa tao yon.
HON. ROXAS. Mr. Chairman, I wonder if in the revenue gainers if we factored in an
amount that would reflect the VAT and other sales taxes---
CHAIRMAN ENRILE. No, were talking of this measure only. We will not ---
(discontinued)
HON. ROXAS. No, no, no, no, from the --- arising from the exemption. Assuming that when
we release the money into the hands of the public, they will not use that to --- for wallpaper.
They will spend that eh, Mr. Chairman. So when they spend that---
CHAIRMAN ENRILE. Theres a VAT.
HON. ROXAS. There will be a VAT and there will be other sales taxes no. Is there a
quantification? Is there an approximation?
CHAIRMAN JAVIER. Not anything.
HON. ROXAS. So, in effect, we have sterilized that entire seven billion. In effect, it is not
circulating in the economy which is unrealistic.
CHAIRMAN ENRILE. It does, it does, because this is taken and spent by government,
somebody receives it in the form of wages and supplies and other services and other goods.
They are not being taken from the public and stored in a vault.
CHAIRMAN JAVIER. That 7.7 loss because of tax exemption. That will be extra income for
the taxpayers.
HON. ROXAS. Precisely, so they will be spending it.21
The discussion above bears out that under R.A. No. 8424, the exemption of PAGCOR from
paying corporate income tax was not based on a classification showing substantial
distinctions which make for real differences, but to reiterate, the exemption was granted
upon the request of PAGCOR that it be exempt from the payment of corporate income tax.
With the subsequent enactment of R.A. No. 9337, amending R.A. No. 8424, PAGCOR has
been excluded from the enumeration of GOCCs that are exempt from paying corporate
income tax. The records of the Bicameral Conference Meeting dated April 18, 2005, of the
Committee on the Disagreeing Provisions of Senate Bill No. 1950 and House Bill No. 3555,
show that it is the legislative intent that PAGCOR be subject to the payment of corporate
income tax, thus:
THE CHAIRMAN (SEN. RECTO). Yes, Osmea, the proponent of the amendment.
SEN. OSMEA. Yeah. Mr. Chairman, one of the reasons why we're even considering this
VAT bill is we want to show the world who our creditors, that we are increasing official
revenues that go to the national budget. Unfortunately today, Pagcor is unofficial.
Now, in 2003, I took a quick look this morning, Pagcor had a net income of 9.7 billion after
paying some small taxes that they are subjected to. Of the 9.7 billion, they claim they
remitted to national government seven billion. Pagkatapos, there are other specific
remittances like to the Philippine Sports Commission, etc., as mandated by various laws, and
then about 400 million to the President's Social Fund. But all in all, their net profit today
should be about 12 billion. That's why I am questioning this two billion. Because while
essentially they claim that the money goes to government, and I will accept that just for
the sake of argument. It does not pass through the appropriation process. And I think
that at least if we can capture 35 percent or 32 percent through the budgetary process,
first, it is reflected in our official income of government which is applied to the national
budget, and secondly, it goes through what is constitutionally mandated as Congress
appropriating and defining where the money is spent and not through a board of
directors that has absolutely no accountability.
REP. PUENTEBELLA. Well, with all due respect, Mr. Chairman, follow up lang.
There is wisdom in the comments of my good friend from Cebu, Senator Osmea.
SEN. OSMEA. And Negros.
REP. PUENTEBELLA. And Negros at the same time ay Kasimanwa. But I would not want
to put my friends from the Department of Finance in a difficult position, but may we know
your comments on this knowing that as Senator Osmea just mentioned, he said, "I accept
that that a lot of it is going to spending for basic services," you know, going to most, I think,
supposedly a lot or most of it should go to government spending, social services and the like.
What is your comment on this? This is going to affect a lot of services on the government
side.
THE CHAIRMAN (REP. LAPUS). Mr. Chair, Mr. Chair.
SEN. OSMEA. It goes from pocket to the other, Monico.
REP. PUENTEBELLA. I know that. But I wanted to ask them, Mr. Senator, because you
may have your own pre-judgment on this and I don't blame you. I don't blame you. And I
know you have your own research. But will this not affect a lot, the disbursements on social
services and other?
REP. LOCSIN. Mr. Chairman. Mr. Chairman, if I can add to that question also. Wouldn't it
be easier for you to explain to, say, foreign creditors, how do you explain to them that if
there is a fiscal gap some of our richest corporations has [been] spared [from] taxation by the
government which is one rich source of revenues. Now, why do you save, why do you spare
certain government corporations on that, like Pagcor? So, would it be easier for you to make
an argument if everything was exposed to taxation?
REP. TEVES. Mr. Chair, please.
THE CHAIRMAN (REP. LAPUS). Can we ask the DOF to respond to those before we call
Congressman Teves?
MR. PURISIMA. Thank you, Mr. Chair.
Yes, from definitely improving the collection, it will help us because it will then enter as
an official revenue although when dividends declare it also goes in as other income. (sic)
xxxx
REP. TEVES. Mr. Chairman.
xxxx
THE CHAIRMAN (REP. LAPUS). Congressman Teves.
REP. TEVES. Yeah. Pagcor is controlled under Section 27, that is on income tax. Now,
we are talking here on value-added tax. Do you mean to say we are going to amend it
from income tax to value-added tax, as far as Pagcor is concerned?
THE CHAIRMAN (SEN. RECTO). No. We are just amending that section with regard to
the exemption from income tax of Pagcor.
xxxx
REP. NOGRALES. Mr. Chairman, Mr. Chairman. Mr. Chairman.
THE CHAIRMAN (REP. LAPUS). Congressman Nograles.
REP. NOGRALES. Just a point of inquiry from the Chair. What exactly are the functions of
Pagcor that are VATable? What will we VAT in Pagcor?
THE CHAIRMAN (REP. LAPUS). This is on own income tax. This is Pagcor income tax.
REP. NOGRALES. No, that's why. Anong i-va-Vat natin sa kanya. Sale of what?
xxxx
REP. VILLAFUERTE. Mr. Chairman, my question is, what are we VATing Pagcor with, is it
the . . .
REP. NOGRALES. Mr. Chairman, this is a secret agreement or the way they craft their
contract, which basis?
THE CHAIRMAN (SEN. RECTO). Congressman Nograles, the Senate version does not
discuss a VAT on Pagcor but it just takes away their exemption from non-payment of
income tax.22
Taxation is the rule and exemption is the exception.23 The burden of proof rests upon the
party claiming exemption to prove that it is, in fact, covered by the exemption so
claimed.24 As a rule, tax exemptions are construed strongly against the
claimant.25 Exemptions must be shown to exist clearly and categorically, and supported by
clear legal provision.26
In this case, PAGCOR failed to prove that it is still exempt from the payment of corporate
income tax, considering that Section 1 of R.A. No. 9337 amended Section 27 (c) of the
National Internal Revenue Code of 1997 by omitting PAGCOR from the exemption. The
legislative intent, as shown by the discussions in the Bicameral Conference Meeting, is to
require PAGCOR to pay corporate income tax; hence, the omission or removal of PAGCOR
from exemption from the payment of corporate income tax. It is a basic precept of statutory
construction that the express mention of one person, thing, act, or consequence excludes all
others as expressed in the familiar maxim expressio unius est exclusio alterius.27 Thus, the
express mention of the GOCCs exempted from payment of corporate income tax excludes all
others. Not being excepted, petitioner PAGCOR must be regarded as coming within the
purview of the general rule that GOCCs shall pay corporate income tax, expressed in the
maxim: exceptio firmat regulam in casibus non exceptis.28
PAGCOR cannot find support in the equal protection clause of the Constitution, as the
legislative records of the Bicameral Conference Meeting dated October 27, 1997, of the
Committee on Ways and Means, show that PAGCORs exemption from payment of
corporate income tax, as provided in Section 27 (c) of R.A. No. 8424, or the National
Internal Revenue Code of 1997, was not made pursuant to a valid classification based on
substantial distinctions and the other requirements of a reasonable classification by
legislative bodies, so that the law may operate only on some, and not all, without violating
the equal protection clause. The legislative records show that the basis of the grant of
exemption to PAGCOR from corporate income tax was PAGCORs own request to be
exempted.
Petitioner further contends that Section 1 (c) of R.A. No. 9337 is null and void ab initio for
violating the non-impairment clause of the Constitution. Petitioner avers that laws form part
of, and is read into, the contract even without the parties expressly saying so. Petitioner
states that the private parties/investors transacting with it considered the tax exemptions,
which inure to their benefit, as the main consideration and inducement for their decision to
transact/invest with it. Petitioner argues that the withdrawal of its exemption from corporate
income tax by R.A. No. 9337 has the effect of changing the main consideration and
inducement for the transactions of private parties with it; thus, the amendatory provision is
violative of the non-impairment clause of the Constitution.
Petitioners contention lacks merit.
The non-impairment clause is contained in Section 10, Article III of the Constitution, which
provides that no law impairing the obligation of contracts shall be passed. The non-
impairment clause is limited in application to laws that derogate from prior acts or contracts
by enlarging, abridging or in any manner changing the intention of the parties.29 There is
impairment if a subsequent law changes the terms of a contract between the parties, imposes
new conditions, dispenses with those agreed upon or withdraws remedies for the
enforcement of the rights of the parties.30
As regards franchises, Section 11, Article XII of the Constitution31 provides that no franchise
or right shall be granted except under the condition that it shall be subject to amendment,
alteration, or repeal by the Congress when the common good so requires.32
In Manila Electric Company v. Province of Laguna,33 the Court held that a franchise partakes
the nature of a grant, which is beyond the purview of the non-impairment clause of the
Constitution.34 The pertinent portion of the case states:
While the Court has, not too infrequently, referred to tax exemptions contained in special
franchises as being in the nature of contracts and a part of the inducement for carrying on the
franchise, these exemptions, nevertheless, are far from being strictly contractual in nature.
Contractual tax exemptions, in the real sense of the term and where the non-impairment
clause of the Constitution can rightly be invoked, are those agreed to by the taxing authority
in contracts, such as those contained in government bonds or debentures, lawfully entered
into by them under enabling laws in which the government, acting in its private capacity,
sheds its cloak of authority and waives its governmental immunity. Truly, tax exemptions of
this kind may not be revoked without impairing the obligations of contracts. These
contractual tax exemptions, however, are not to be confused with tax exemptions granted
under franchises. A franchise partakes the nature of a grant which is beyond the purview of
the non-impairment clause of the Constitution. Indeed, Article XII, Section 11, of the 1987
Constitution, like its precursor provisions in the 1935 and the 1973 Constitutions, is explicit
that no franchise for the operation of a public utility shall be granted except under the
condition that such privilege shall be subject to amendment, alteration or repeal by Congress
as and when the common good so requires.35
In this case, PAGCOR was granted a franchise to operate and maintain gambling casinos,
clubs and other recreation or amusement places, sports, gaming pools, i.e., basketball,
football, lotteries, etc., whether on land or sea, within the territorial jurisdiction of the
Republic of the Philippines.36 Under Section 11, Article XII of the Constitution, PAGCORs
franchise is subject to amendment, alteration or repeal by Congress such as the amendment
under Section 1 of R.A. No. 9377. Hence, the provision in Section 1 of R.A. No. 9337,
amending Section 27 (c) of R.A. No. 8424 by withdrawing the exemption of PAGCOR from
corporate income tax, which may affect any benefits to PAGCORs transactions with private
parties, is not violative of the non-impairment clause of the Constitution.
Anent the validity of RR No. 16-2005, the Court holds that the provision subjecting
PAGCOR to 10% VAT is invalid for being contrary to R.A. No. 9337. Nowhere in R.A. No.
9337 is it provided that petitioner can be subjected to VAT. R.A. No. 9337 is clear only as to
the removal of petitioner's exemption from the payment of corporate income tax, which was
already addressed above by this Court.
As pointed out by the OSG, R.A. No. 9337 itself exempts petitioner from VAT pursuant to
Section 7 (k) thereof, which reads:
Sec. 7. Section 109 of the same Code, as amended, is hereby further amended to read as
follows:
Section 109. Exempt Transactions. - (1) Subject to the provisions of Subsection (2) hereof,
the following transactions shall be exempt from the value-added tax:
xxxx
(k) Transactions which are exempt under international agreements to which the Philippines is
a signatory orunder special laws, except Presidential Decree No. 529.37
Petitioner is exempt from the payment of VAT, because PAGCORs charter, P.D. No. 1869, is
a special law that grants petitioner exemption from taxes.
Moreover, the exemption of PAGCOR from VAT is supported by Section 6 of R.A. No.
9337, which retained Section 108 (B) (3) of R.A. No. 8424, thus:
[R.A. No. 9337], SEC. 6. Section 108 of the same Code (R.A. No. 8424), as amended, is
hereby further amended to read as follows:
SEC. 108. Value-Added Tax on Sale of Services and Use or Lease of Properties.
(A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax
equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of
services, including the use or lease of properties: x x x
xxxx
(B) Transactions Subject to Zero Percent (0%) Rate. The following services performed in
the Philippines by VAT-registered persons shall be subject to zero percent (0%) rate;
xxxx
(3) Services rendered to persons or entities whose exemption under special laws or
international agreements to which the Philippines is a signatory effectively subjects the
supply of such services to zero percent (0%) rate;
x x x x38
As pointed out by petitioner, although R.A. No. 9337 introduced amendments to Section 108
of R.A. No. 8424 by imposing VAT on other services not previously covered, it did not
amend the portion of Section 108 (B) (3) that subjects to zero percent rate services
performed by VAT-registered persons to persons or entities whose exemption under special
laws or international agreements to which the Philippines is a signatory effectively subjects
the supply of such services to 0% rate.
Petitioner's exemption from VAT under Section 108 (B) (3) of R.A. No. 8424 has been
thoroughly and extensively discussed in Commissioner of Internal Revenue v. Acesite
(Philippines) Hotel Corporation.39 Acesite was the owner and operator of the Holiday Inn
Manila Pavilion Hotel. It leased a portion of the hotels premises to PAGCOR. It incurred
VAT amounting to P30,152,892.02 from its rental income and sale of food and beverages to
PAGCOR from January 1996 to April 1997. Acesite tried to shift the said taxes to PAGCOR
by incorporating it in the amount assessed to PAGCOR. However, PAGCOR refused to pay
the taxes because of its tax-exempt status. PAGCOR paid only the amount due to Acesite
minus VAT in the sum of P30,152,892.02. Acesite paid VAT in the amount of P30,152,892.02
to the Commissioner of Internal Revenue, fearing the legal consequences of its non-payment.
In May 1998, Acesite sought the refund of the amount it paid as VAT on the ground that its
transaction with PAGCOR was subject to zero rate as it was rendered to a tax-exempt entity.
The Court ruled that PAGCOR and Acesite were both exempt from paying VAT, thus:
xxxx
PAGCOR is exempt from payment of indirect taxes
It is undisputed that P.D. 1869, the charter creating PAGCOR, grants the latter an
exemption from the payment of taxes. Section 13 of P.D. 1869 pertinently provides:
Sec. 13. Exemptions.
xxxx
(2) Income and other taxes. - (a) Franchise Holder: No tax of any kind or form, income or
otherwise, as well as fees, charges or levies of whatever nature, whether National or Local,
shall be assessed and collected under this Franchise from the Corporation; nor shall any form
of tax or charge attach in any way to the earnings of the Corporation, except a Franchise Tax
of five (5%) percent of the gross revenue or earnings derived by the Corporation from its
operation under this Franchise. Such tax shall be due and payable quarterly to the National
Government and shall be in lieu of all kinds of taxes, levies, fees or assessments of any kind,
nature or description, levied, established or collected by any municipal, provincial, or
national government authority.
(b) Others: The exemptions herein granted for earnings derived from the operations
conducted under the franchise specifically from the payment of any tax, income or
otherwise, as well as any form of charges, fees or levies, shall inure to the benefit of and
extend to corporation(s), association(s), agency(ies), or individual(s) with whom the
Corporation or operator has any contractual relationship in connection with the operations of
the casino(s) authorized to be conducted under this Franchise and to those receiving
compensation or other remuneration from the Corporation or operator as a result of essential
facilities furnished and/or technical services rendered to the Corporation or operator.
Petitioner contends that the above tax exemption refers only to PAGCOR's direct tax liability
and not to indirect taxes, like the VAT.
We disagree.
A close scrutiny of the above provisos clearly gives PAGCOR a blanket exemption to taxes
with no distinction on whether the taxes are direct or indirect. We are one with the CA ruling
that PAGCOR is also exempt from indirect taxes, like VAT, as follows:
Under the above provision [Section 13 (2) (b) of P.D. 1869], the term "Corporation" or
operator refers to PAGCOR. Although the law does not specifically mention PAGCOR's
exemption from indirect taxes, PAGCOR is undoubtedly exempt from such taxes because the
law exempts from taxes persons or entities contracting with PAGCOR in casino operations.
Although, differently worded, the provision clearly exempts PAGCOR from indirect taxes.
In fact, it goes one step further by granting tax exempt status to persons dealing with
PAGCOR in casino operations. The unmistakable conclusion is that PAGCOR is not liable
for the P30, 152,892.02 VAT and neither is Acesite as the latter is effectively subject to zero
percent rate under Sec. 108 B (3), R.A. 8424. (Emphasis supplied.)
Indeed, by extending the exemption to entities or individuals dealing with PAGCOR, the
legislature clearly granted exemption also from indirect taxes. It must be noted that the
indirect tax of VAT, as in the instant case, can be shifted or passed to the buyer, transferee, or
lessee of the goods, properties, or services subject to VAT. Thus,by extending the tax
exemption to entities or individuals dealing with PAGCOR in casino operations, it is
exempting PAGCOR from being liable to indirect taxes.
The manner of charging VAT does not make PAGCOR liable to said tax.
It is true that VAT can either be incorporated in the value of the goods, properties, or services
sold or leased, in which case it is computed as 1/11 of such value, or charged as an additional
10% to the value. Verily, the seller or lessor has the option to follow either way in charging
its clients and customer. In the instant case, Acesite followed the latter method, that is,
charging an additional 10% of the gross sales and rentals. Be that as it may, the use of either
method, and in particular, the first method, does not denigrate the fact that PAGCOR is
exempt from an indirect tax, like VAT.
VAT exemption extends to Acesite
Thus, while it was proper for PAGCOR not to pay the 10% VAT charged by Acesite, the
latter is not liable for the payment of it as it is exempt in this particular transaction by
operation of law to pay the indirect tax. Such exemption falls within the former Section 102
(b) (3) of the 1977 Tax Code, as amended (now Sec. 108 [b] [3] of R.A. 8424), which
provides:
Section 102. Value-added tax on sale of services.- (a) Rate and base of tax - There shall be
levied, assessed and collected, a value-added tax equivalent to 10% of gross receipts derived
by any person engaged in the sale of services x x x; Provided, that the following services
performed in the Philippines by VAT registered persons shall be subject to 0%.
xxxx
(3) Services rendered to persons or entities whose exemption under special laws or
international agreements to which the Philippines is a signatory effectively subjects the
supply of such services to zero (0%) rate (emphasis supplied).
The rationale for the exemption from indirect taxes provided for in P.D. 1869 and the
extension of such exemption to entities or individuals dealing with PAGCOR in casino
operations are best elucidated from the 1987 case ofCommissioner of Internal
Revenue v. John Gotamco & Sons, Inc., where the absolute tax exemption of the World
Health Organization (WHO) upon an international agreement was upheld. We held in said
case that the exemption of contractee WHO should be implemented to mean that the entity or
person exempt is the contractor itself who constructed the building owned by contractee
WHO, and such does not violate the rule that tax exemptions are personal because the
manifest intention of the agreement is to exempt the contractor so that no contractor's tax
may be shifted to the contractee WHO. Thus, the proviso in P.D. 1869, extending the
exemption to entities or individuals dealing with PAGCOR in casino operations, is clearly to
proscribe any indirect tax, like VAT, that may be shifted to PAGCOR.40
Although the basis of the exemption of PAGCOR and Acesite from VAT in the case of The
Commissioner of Internal Revenue v. Acesite (Philippines) Hotel Corporation was Section
102 (b) of the 1977 Tax Code, as amended, which section was retained as Section 108 (B) (3)
in R.A. No. 8424,41 it is still applicable to this case, since the provision relied upon has been
retained in R.A. No. 9337.421avvphi1
It is settled rule that in case of discrepancy between the basic law and a rule or regulation
issued to implement said law, the basic law prevails, because the said rule or regulation
cannot go beyond the terms and provisions of the basic law.43 RR No. 16-2005, therefore,
cannot go beyond the provisions of R.A. No. 9337. Since PAGCOR is exempt from VAT
under R.A. No. 9337, the BIR exceeded its authority in subjecting PAGCOR to 10% VAT
under RR No. 16-2005; hence, the said regulatory provision is hereby nullified.
WHEREFORE, the petition is PARTLY GRANTED. Section 1 of Republic Act No. 9337,
amending Section 27 (c) of the National Internal Revenue Code of 1997, by excluding
petitioner Philippine Amusement and Gaming Corporation from the enumeration of
government-owned and controlled corporations exempted from corporate income tax is valid
and constitutional, while BIR Revenue Regulations No. 16-2005 insofar as it subjects
PAGCOR to 10% VAT is null and void for being contrary to the National Internal Revenue
Code of 1997, as amended by Republic Act No. 9337.
No costs. SO ORDERED.
EN BANC
G.R. No. 215427, December 10, 2014
PHILIPPINE AMUSEMENT AND GAMING CORPORATION
(PAGCOR), Petitioner, v. THE BUREAU OF INTERNAL REVENUE,
REPRESENTED BY JOSE MARIO BUAG, IN HIS CAPACITY AS
COMMISSIONER OF THE BUREAU OF INTERNAL REVENUE, AND JOHN DOE
AND JANE DOE, WHO ARE PERSONS ACTING FOR, IN BEHALF OR UNDER
THE AUTHORITY OF RESPONDENT,Respondent.
DECISION
PERALTA, J.:
The present petition stems from the Motion for Clarification filed by petitioner Philippine
Amusement and Gaming Corporation (PAGCOR) on September 13, 2013 in the case
entitled Philippine Amusement and Gaming Corporation (PAGCOR) v. The Bureau of
Internal Revenue, et al.,1 which was promulgated on March 15, 2011. The Motion for
Clarification essentially prays for the clarification of our Decision in the aforesaid case, as
well the issuance of a Temporary Restraining Order and/or Writ of Preliminary Injunction
against the Bureau of Internal Revenue (BIR), their employees, agents and any other persons
or entities acting or claiming any right on BIRs behalf, in the implementation of BIR
Revenue Memorandum Circular (RMC) No. 33-2013 dated April 17, 2013.

At the onset, it bears stressing that while the instant motion was denominated as a Motion
for Clarification, in the session of the Court En Banc held on November 25, 2014, the
members thereof ruled to treat the same as a new petition for certiorari under Rule 65 of the
Rules of Court, given that petitioner essentially alleges grave abuse of discretion on the part
of the BIR amounting to lack or excess of jurisdiction in issuing RMC No. 33-2013.
Consequently, a new docket number has been assigned thereto, while petitioner has been
ordered to pay the appropriate docket fees pursuant to the Resolution dated November 25,
2014, the pertinent portion of which reads:chanroblesvirtuallawlibrary
G.R. No. 172087 (Philippine Amusement and Gaming Corporation vs. Bureau of Internal
Revenue, et al.). The Court Resolved to
(a) TREAT as a new petition the Motion for Clarification with Temporary Restraining
Order and/or Preliminary Injunction Application dated September 6, 2013 filed by
PAGCOR;
(b) DIRECT the Judicial Records Office to RE-DOCKET the aforesaid Motion for
Clarification, subject to payment of the appropriate docket fees; and
(c) REQUIRE petitioner PAGCOR to PAY the filing fees for the subject Motion for
Clarification within five (5) days from notice hereof. Brion, J., no part and on leave.
 Perlas-Bernabe, J., on official leave.

Considering that the parties have filed their respective pleadings relative to the instant
petition, and the appropriate docket fees have been duly paid by petitioner, this Court
considers the instant petition submitted for resolution.

The facts are briefly summarized as follows:

On April 17, 2006, petitioner filed before this Court a Petition for Review on Certiorari and
Prohibition (With Prayer for the Issuance of a Temporary Restraining Order and/or
Preliminary Injunction)seeking the declaration of nullity of Section 12 of Republic
Act (R.A.) No. 93373 insofar as it amends Section 27(C)4 of R.A. No. 8424,5 otherwise
known as the National Internal Revenue Code (NIRC) by excluding petitioner from the
enumeration of government-owned or controlled corporations (GOCCs)exempted from
liability for corporate income tax.

On March 15, 2011, this Court rendered a Decision6 granting in part the petition filed by
petitioner. Itsfallo reads:chanroblesvirtuallawlibrary
WHEREFORE, the petition is PARTLY GRANTED. Section 1 of Republic Act No. 9337,
amending Section 27(c) of the National Internal Revenue Code of 1997, by excluding
petitioner Philippine Amusement and Gaming Corporation from the enumeration of
government-owned and controlled corporations exempted from corporate income tax is valid
and constitutional, while BIR Revenue Regulations No. 16-2005 insofar as it subjects
PAGCOR to 10% VAT is null and void for being contrary to the National Internal Revenue
Code of 1997, as amended by Republic Act No. 9337.

No costs.

SO ORDERED.7

Both petitioner and respondent filed their respective motions for partial reconsideration, but
the same were denied by this Court in a Resolution8 dated May 31, 2011.

Resultantly, respondent issued RMC No. 33-2013 on April 17, 2013 pursuant to the Decision
dated March 15, 2011 and the Resolution dated May 31, 2011, which clarifies the Income
Tax and Franchise Tax Due from the Philippine Amusement and Gaming Corporation
(PAGCOR), its Contractees and Licensees. Relevant portions thereof
state:chanroblesvirtuallawlibrary
II. INCOME TAX
Pursuant to Section 1 of R.A. 9337, amending Section 27(C) of the NIRC, as amended,
PAGCOR is no longer exempt from corporate income tax as it has been effectively omitted
from the list of government-owned or controlled corporations (GOCCs) that are exempt from
income tax. Accordingly, PAGCORs income from its operations and licensing of gambling
casinos, gaming clubs and other similar recreation or amusement places, gaming pools, and
other related operations, are subject to corporate income tax under the NIRC, as amended.
This includes, among others:
a) Income from its casino operations;
b) Income from dollar pit operations;
c) Income from regular bingo operations; and
d) Income from mobile bingo operations operated by it, with agents on commission
basis. Provided, however, that the agents commission income shall be subject to
regular income tax, and consequently, to withholding tax under existing
regulations.

Income from other related operations includes, but is not limited to:
a) Income from licensed private casinos covered by authorities to operate issued to private
operators;
b) Income from traditional bingo, electronic bingo and other bingo variations covered by
authorities to operate issued to private operators;
c) Income from private internet casino gaming, internet sports betting and private mobile
gaming operations;
d) Income from private poker operations;
e) Income from junket operations;
f) Income from SM demo units; and
g) Income from other necessary and related services, shows and entertainment.

PAGCORs other income that is not connected with the foregoing operations are likewise
subject to corporate income tax under the NIRC, as amended.

PAGCORs contractees and licensees are entities duly authorized and licensed by PAGCOR
to perform gambling casinos, gaming clubs and other similar recreation or amusement
places, and gaming pools. These contractees and licensees are subject to income tax under
the NIRC, as amended.

III. FRANCHISE TAX

Pursuant to Section 13(2) (a) of P.D. No. 1869,9 PAGCOR is subject to a franchise tax of five
percent (5%) of the gross revenue or earnings it derives from its operations and licensing of
gambling casinos, gaming clubs and other similar recreation or amusement places, gaming
pools, and other related operations as described above.

On May 20, 2011, petitioner wrote the BIR Commissioner requesting for reconsideration of
the tax treatment of its income from gaming operations and other related operations under
RMC No. 33-2013. The request was, however, denied by the BIR Commissioner.

On August 4, 2011, the Decision dated March 15, 2011 became final and executory and was,
accordingly, recorded in the Book of Entries of Judgment.10chanRoblesvirtualLawlibrary

Consequently, petitioner filed a Motion for Clarification alleging that RMC No. 33-2013 is
an erroneous interpretation and application of the aforesaid Decision, and seeking
clarification with respect to the following:chanroblesvirtuallawlibrary
1. Whether PAGCORs tax privilege of paying 5% franchise tax in lieu of all other taxes
with respect to its gaming income, pursuant to its Charter P.D. 1869, as amended by
R.A. 9487, is deemed repealed or amended by Section 1 (c) of R.A. 9337.
2. If it is deemed repealed or amended, whether PAGCORs gaming income is subject to
both 5% franchise tax and income tax.
3. Whether PAGCORs income from operation of related services is subject to both
income tax and 5% franchise tax.
4. Whether PAGCORs tax privilege of paying 5% franchise tax inures to the benefit of
third parties with contractual relationship with PAGCOR in connection with the
operation of casinos.11

In our Decision dated March 15, 2011, we have already declared petitioners income tax
liability in view of the withdrawal of its tax privilege under R.A. No. 9337. However, we
made no distinction as to which income is subject to corporate income tax, considering that
the issue raised therein was only the constitutionality of Section 1 of R.A. No. 9337, which
excluded petitioner from the enumeration of GOCCs exempted from corporate income tax.

For clarity, it is worthy to note that under P.D. 1869, as amended, PAGCORs income is
classified into two: (1) income from its operations conducted under its Franchise, pursuant to
Section 13(2) (b) thereof (income from gaming operations); and (2) income from its
operation of necessary and related services under Section 14(5) thereof (income from other
related services). In RMC No. 33-2013, respondent further classified the aforesaid income
as follows:chanroblesvirtuallawlibrary
1. PAGCORs income from its operations and licensing of gambling casinos, gaming clubs
and other similar recreation or amusement places, gaming pools, includes, among others:
a) Income from its casino operations;
b) Income from dollar pit operations;
c) Income from regular bingo operations; and
d) Income from mobile bingo operations operated by it, with agents on commission
basis. Provided, however, that the agents commission income shall be subject to
regular income tax, and consequently, to withholding tax under existing
regulations.

2. Income from other related operations includes, but is not limited to:
a) Income from licensed private casinos covered by authorities to operate issued to private
operators;
b) Income from traditional bingo, electronic bingo and other bingo variations covered by
authorities to operate issued to private operators;
c) Income from private internet casino gaming, internet sports betting and private mobile
gaming operations;
d) Income from private poker operations;
e) Income from junket operations;
f) Income from SM demo units; and
g) Income from other necessary and related services, shows and entertainment.12

After a thorough study of the arguments and points raised by the parties, and in accordance
with our Decision dated March 15, 2011, we sustain petitioners contention that its income
from gaming operations is subject only to five percent (5%) franchise tax under P.D. 1869, as
amended, while its income from other related services is subject to corporate income tax
pursuant to P.D. 1869, as amended, as well as R.A. No. 9337. This is demonstrable.

First. Under P.D. 1869, as amended, petitioner is subject to income tax only with respect to
its operation of related services. Accordingly, the income tax exemption ordained under
Section 27(c) of R.A. No. 8424 clearly pertains only to petitioners income from operation of
related services. Such income tax exemption could not have been applicable to petitioners
income from gaming operations as it is already exempt therefrom under P.D. 1869, as
amended, to wit:chanroblesvirtuallawlibrary
SECTION 13. Exemptions.

xxxx

(2) Income and other taxes. (a) Franchise Holder: No tax of any kind or form, income or
otherwise, as well as fees, charges or levies of whatever nature, whether National or
Local, shall be assessed and collected under this Franchise from the Corporation; nor
shall any form of tax or charge attach in any way to the earnings of the Corporation,
except a Franchise Tax of five (5%) percent of the gross revenue or earnings derived by
the Corporation from its operation under this Franchise. Such tax shall be due and payable
quarterly to the National Government and shall be in lieu of all kinds of taxes, levies, fees or
assessments of any kind, nature or description, levied, established or collected by any
municipal, provincial, or national government authority.13

Indeed, the grant of tax exemption or the withdrawal thereof assumes that the person or
entity involved is subject to tax. This is the most sound and logical interpretation because
petitioner could not have been exempted from paying taxes which it was not liable to pay in
the first place. This is clear from the wordings of P.D. 1869, as amended, imposing a
franchise tax of five percent (5%) on its gross revenue or earnings derived by petitioner from
its operation under the Franchise in lieu of all taxes of any kind or form, as well as fees,
charges or levies of whatever nature, which necessarily include corporate income tax.

In other words, there was no need for Congress to grant tax exemption to petitioner with
respect to its income from gaming operations as the same is already exempted from all taxes
of any kind or form, income or otherwise, whether national or local, under its Charter, save
only for the five percent (5%) franchise tax. The exemption attached to the income from
gaming operations exists independently from the enactment of R.A. No. 8424. To adopt an
assumption otherwise would be downright ridiculous, if not deleterious, since petitioner
would be in a worse position if the exemption was granted (then withdrawn) than when it
was not granted at all in the first place.

Moreover, as may be gathered from the legislative records of the Bicameral Conference
Meeting of the Committee on Ways and Means dated October 27, 1997, the exemption of
petitioner from the payment of corporate income tax was due to the acquiescence of the
Committee on Ways and Means to the request of petitioner that it be exempt from such tax.
Based on the foregoing, it would be absurd for petitioner to seek exemption from income tax
on its gaming operations when under its Charter, it is already exempted from paying the
same.

Second. Every effort must be exerted to avoid a conflict between statutes; so that if
reasonable construction is possible, the laws must be reconciled in that
manner.14chanRoblesvirtualLawlibrary
As we see it, there is no conflict between P.D. 1869, as amended, and R.A. No. 9337. The
former lays down the taxes imposable upon petitioner, as follows: (1) a five percent (5%)
franchise tax of the gross revenues or earnings derived from its operations conducted under
the Franchise, which shall be due and payable in lieu of all kinds of taxes, levies, fees or
assessments of any kind, nature or description, levied, established or collected by any
municipal, provincial or national government authority;15 (2) income tax for income realized
from other necessary and related services, shows and entertainment of petitioner.16 With the
enactment of R.A. No. 9337, which withdrew the income tax exemption under R.A. No.
8424, petitioners tax liability on income from other related services was merely reinstated.

It cannot be gainsaid, therefore, that the nature of taxes imposable is well defined for each
kind of activity or operation. There is no inconsistency between the statutes; and in fact, they
complement each other.

Third. Even assuming that an inconsistency exists, P.D. 1869, as amended, which expressly
provides the tax treatment of petitioners income prevails over R.A. No. 9337, which is a
general law. It is a canon of statutory construction that a special law prevails over a general
law regardless of their dates of passage and the special is to be considered as
remaining an exception to the general.17The rationale is:chanroblesvirtuallawlibrary
Why a special law prevails over a general law has been put by the Court as
follows:ChanRoblesVirtualawlibrary
xxxx

x x x The Legislature consider and make provision for all the circumstances of the particular
case. The Legislature having specially considered all of the facts and circumstances in the
particular case in granting a special charter, it will not be considered that the Legislature,
by adopting a general law containing provisions repugnant to the provisions of the
charter, and without making any mention of its intention to amend or modify the charter,
intended to amend, repeal, or modify the special act. (Lewis vs. Cook County, 74 I11. App.,
151; Philippine Railway Co. vs. Nolting 34 Phil., 401.)18

Where a general law is enacted to regulate an industry, it is common for individual franchises
subsequently granted to restate the rights and privileges already mentioned in the general
law, or to amend the later law, as may be needed, to conform to the general law.19 However,
if no provision or amendment is stated in the franchise to effect the provisions of the general
law, it cannot be said that the same is the intent of the lawmakers, for repeal of laws by
implication is not favored.20chanRoblesvirtualLawlibrary

In this regard, we agree with petitioner that if the lawmakers had intended to withdraw
petitioners tax exemption of its gaming income, then Section 13(2)(a) of P.D. 1869 should
have been amended expressly in R.A. No. 9487, or the same, at the very least, should have
been mentioned in the repealing clause of R.A. No. 9337.21 However, the repealing clause
never mentioned petitioners Charter as one of the laws being repealed. On the other hand,
the repeal of other special laws, namely, Section 13 of R.A. No. 6395 as well as Section 6,
fifth paragraph of R.A. No. 9136, is categorically provided under Section 24(a) (b) of R.A.
No. 9337, to wit:chanroblesvirtuallawlibrary
SEC. 24. Repealing Clause. - The following laws or provisions of laws are hereby repealed
and the persons and/or transactions affected herein are made subject to the value-added tax
subject to the provisions of Title IV of the National Internal Revenue Code of 1997, as
amended:ChanRoblesVirtualawlibrary
(A) Section 13 of R.A. No. 6395 on the exemption from value-added tax of the National
Power Corporation (NPC);
(B) Section 6, fifth paragraph of R.A. No. 9136 on the zero VAT rate imposed on the
sales of generated power by generation companies; and
(C) All other laws, acts, decrees, executive orders, issuances and rules and regulations or
parts thereof which are contrary to and inconsistent with any provisions of this Act are
hereby repealed, amended or modified accordingly.22

When petitioners franchise was extended on June 20, 2007 without revoking or withdrawing
its tax exemption, it effectively reinstated and reiterated all of petitioners rights, privileges
and authority granted under its Charter. Otherwise, Congress would have painstakingly
enumerated the rights and privileges that it wants to withdraw, given that a franchise is a
legislative grant of a special privilege to a person. Thus, the extension of petitioners
franchise under the same terms and conditions means a continuation of its tax exempt status
with respect to its income from gaming operations. Moreover, all laws, rules and
regulations, or parts thereof, which are inconsistent with the provisions of P.D. 1869, as
amended, a special law, are considered repealed, amended and modified, consistent with
Section 2 of R.A. No. 9487, thus:chanroblesvirtuallawlibrary
SECTION 2. Repealing Clause. All laws, decrees, executive orders, proclamations, rules
and regulations and other issuances, or parts thereof, which are inconsistent with the
provisions of this Act, are hereby repealed, amended and modified.

It is settled that where a statute is susceptible of more than one interpretation, the court
should adopt such reasonable and beneficial construction which will render the provision
thereof operative and effective, as well as harmonious with each
other.23chanRoblesvirtualLawlibrary

Given that petitioners Charter is not deemed repealed or amended by R.A. No. 9337,
petitioners income derived from gaming operations is subject only to the five percent (5%)
franchise tax, in accordance with P.D. 1869, as amended. With respect to petitioners income
from operation of other related services, the same is subject to income tax only. The five
percent (5%) franchise tax finds no application with respect to petitioners income from
other related services, in view of the express provision of Section 14(5) of P.D. 1869, as
amended, to wit:chanroblesvirtuallawlibrary
Section 14. Other Conditions.

xxxx

(5) Operation of related services. The Corporation is authorized to operate such necessary
and related services, shows and entertainment. Any income that may be realized from these
related services shall not be included as part of the income of the Corporation for the
purpose of applying the franchise tax, but the same shall be considered as a separate income
of the Corporation and shall be subject to income tax.24

Thus, it would be the height of injustice to impose franchise tax upon petitioner for its
income from other related services without basis therefor.

For proper guidance, the first classification of PAGCORs income under RMC No. 33-2013
(i.e., income from its operations and licensing of gambling casinos, gaming clubs and other
similar recreation or amusement places, gambling pools) should be interpreted in relation to
Section 13(2) of P.D. 1869, which pertains to the income derived from issuing and/or
granting the license to operate casinos to PAGCORs contractees and licensees, as well as
earnings derived by PAGCOR from its own operations under the Franchise. On the other
hand, the second classification of PAGCORs income under RMC No. 33-2013 (i.e., income
from other related operations) should be interpreted in relation to Section 14(5) of P.D. 1869,
which pertains to income received by PAGCOR from its contractees and licensees in the
latters operation of casinos, as well as PAGCORs own income from operating necessary
and related services, shows and entertainment.

As to whether petitioners tax privilege of paying five percent (5%) franchise tax inures to
the benefit of third parties with contractual relationship with petitioner in connection with the
operation of casinos, we find no reason to rule upon the same. The resolution of the instant
petition is limited to clarifying the tax treatment of petitioners income vis--vis our Decision
dated March 15, 2011. This Decision is not meant to expand our original Decision by delving
into new issues involving petitioners contractees and licensees. For one, the latter are not
parties to the instant case, and may not therefore stand to benefit or bear the consequences of
this resolution. For another, to answer the fourth issue raised by petitioner relative to its
contractees and licensees would be downright premature and iniquitous as the same would
effectively countenance sidesteps to judicial process.
In view of the foregoing disquisition, respondent, therefore, committed grave abuse of
discretion amounting to lack of jurisdiction when it issued RMC No. 33-2013 subjecting
both income from gaming operations and other related services to corporate income tax and
five percent (5%) franchise tax. This unduly expands our Decision dated March 15, 2011
without due process since the imposition creates additional burden upon petitioner. Such act
constitutes an overreach on the part of the respondent, which should be immediately struck
down, lest grave injustice results. More, it is settled that in case of discrepancy between the
basic law and a rule or regulation issued to implement said law, the basic law prevails,
because the said rule or regulation cannot go beyond the terms and provisions of the basic
law.

In fine, we uphold our earlier ruling that Section 1 of R.A. No. 9337, amending Section 27(c)
of R.A. No. 8424, by excluding petitioner from the enumeration of GOCCs exempted from
corporate income tax, is valid and constitutional. In addition, we hold that:
1. Petitioners tax privilege of paying five percent (5%) franchise tax in lieu of all other
taxes with respect to its income from gaming operations, pursuant to P.D. 1869, as
amended, is not repealed or amended by Section 1(c) of R.A. No. 9337;
2. Petitioners income from gaming operations is subject to the five percent (5%)
franchise tax only; and
3. Petitioners income from other related services is subject to corporate income tax only.
In view of the above-discussed findings, this Court ORDERS the respondent to cease
and desist the implementation of RMC No. 33-2013 insofar as it imposes: (1)
corporate income tax on petitioners income derived from its gaming operations; and
(2) franchise tax on petitioners income from other related services.
WHEREFORE, the Petition is hereby GRANTED. Accordingly, respondent
is ORDERED to cease and desist the implementation of RMC No. 33-2013 insofar as
it imposes: (1) corporate income tax on petitioners income derived from its gaming
operations; and (2) franchise tax on petitioners income from other related services.
SECOND DIVISION

DUMAGUETE CATHEDRAL

G.R. No. 182722

CREDIT COOPERATIVE
[DCCCO], Represented by

Present:
Felicidad L. Ruiz, its General

Manager,

CARPIO, J., Chairperson,

Petitioner,

BRION,

DEL CASTILLO,
-versus-

ABAD, and

PEREZ, JJ.
COMMISSIONER OF

INTERNAL REVENUE,

Promulgated:
Respondent.

January 22, 2010

x---------------------------------------------------------------
----x

DECISION

DEL CASTILLO, J.:

The clashing interests of the State and the taxpayers are again pitted against each other. Two
basic principles, the States inherent power of taxation and its declared policy of fostering the
creation and growth of cooperatives come into play. However, the one that embodies the
spirit of the law and the true intent of the legislature prevails.

This Petition for Review on Certiorari under Section 11 of Republic Act (RA) No. 9282,[1]
in relation to Rule 45 of the Rules of Court, seeks to set aside the December 18, 2007
Decision[2] of the Court of Tax Appeals (CTA), ordering petitioner to pay deficiency
withholding taxes on interest from savings and time deposits of its members for taxable
years 1999 and 2000, pursuant to Section 24(B)(1) of the National Internal Revenue Code of
1997 (NIRC), as well as the delinquency interest of 20% per annum under Section 249(C) of
the same Code. It also assails the April 11, 2008 Resolution[3] denying petitioners Motion
for Reconsideration.

Factual Antecedents

Petitioner Dumaguete Cathedral Credit Cooperative (DCCCO) is a credit cooperative duly

registered with and regulated by the Cooperative Development Authority (CDA).[4] It was
established on February 17, 1968[5] with the following objectives and purposes: (1) to
increase the income and purchasing power of the members; (2) to pool the resources of the
members by encouraging savings and promoting thrift to mobilize capital formation for
development activities; and (3) to extend loans to members for provident and productive
purposes.[6] It has the power (1) to draw, make, accept, endorse, guarantee, execute, and
issue promissory notes, mortgages, bills of exchange, drafts, warrants, certificates and all
kinds of obligations and instruments in connection with and in furtherance of its business
operations; and (2) to issue bonds, debentures, and other obligations; to contract
indebtedness; and to secure the same with a mortgage or deed of trust, or pledge or lien on
any or all of its real and personal properties.[7]

On November 27, 2001, the Bureau of Internal Revenue (BIR) Operations Group Deputy
Commissioner, Lilian B. Hefti, issued Letters of Authority Nos. 63222 and 63223,
authorizing BIR Officers Tomas Rambuyon and Tarcisio Cubillan of Revenue Region No.
12, Bacolod City, to examine petitioners books of accounts and other accounting records for
all internal revenue taxes for the taxable years 1999 and 2000.[8]

Proceedings before the BIR Regional Office

On June 26, 2002, petitioner received two Pre-Assessment Notices for deficiency
withholding taxes for taxable years 1999 and 2000 which were protested by petitioner on
July 23, 2002.[9] Thereafter, on October 16, 2002, petitioner received two other Pre-
Assessment Notices for deficiency withholding taxes also for taxable years 1999 and 2000.
[10] The deficiency withholding taxes cover the payments of the honorarium of the Board of
Directors, security and janitorial services, legal and professional fees, and interest on savings
and time deposits of its members.

On October 22, 2002, petitioner informed BIR Regional Director Sonia L. Flores that it
would only pay the deficiency withholding taxes corresponding to the honorarium of the
Board of Directors, security and janitorial services, legal and professional fees for the year
1999 in the amount of P87,977.86, excluding penalties and interest.[11]

In another letter dated November 8, 2002, petitioner also informed the BIR Assistant
Regional Director, Rogelio B. Zambarrano, that it would pay the withholding taxes due on
the honorarium and per diems of the Board of Directors, security and janitorial services,
commissions and legal & professional fees for the year 2000 in the amount of P119,889.37,
excluding penalties and interest, and that it would avail of the Voluntary Assessment and
Abatement Program (VAAP) of the BIR under Revenue Regulations No. 17-2002.[12]
On November 29, 2002, petitioner availed of the VAAP and paid the amounts of
P105,574.62 and P143,867.24[13] corresponding to the withholding taxes on the payments
for the compensation, honorarium of the Board of Directors, security and janitorial services,
and legal and professional services, for the years 1999 and 2000, respectively.

On April 24, 2003, petitioner received from the BIR Regional Director, Sonia L. Flores,
Letters of Demand Nos. 00027-2003 and 00026-2003, with attached Transcripts of
Assessment and Audit Results/Assessment Notices, ordering petitioner to pay the deficiency
withholding taxes, inclusive of penalties, for the years 1999 and 2000 in the amounts of
P1,489,065.30 and P1,462,644.90, respectively.[14]

Proceedings before the Commissioner of Internal Revenue

On May 9, 2003, petitioner protested the Letters of Demand and Assessment Notices with
the Commissioner of Internal Revenue (CIR).[15] However, the latter failed to act on the
protest within the prescribed 180-day period. Hence, on December 3, 2003, petitioner filed a
Petition for Review before the CTA, docketed as C.T.A. Case No. 6827.[16]

Proceedings before the CTA First Division

The case was raffled to the First Division of the CTA which rendered its Decision on
February 6, 2007, disposing of the case in this wise:

IN VIEW OF ALL THE FOREGOING, the Petition for Review is hereby PARTIALLY
GRANTED. Assessment Notice Nos. 00026-2003 and 00027-2003 are hereby MODIFIED
and the assessment for deficiency withholding taxes on the honorarium and per diems of
petitioners Board of Directors, security and janitorial services, commissions and legal and
professional fees are hereby CANCELLED. However, the assessments for deficiency
withholding taxes on interests are hereby AFFIRMED.

Accordingly, petitioner is ORDERED TO PAY the respondent the respective amounts of

P1,280,145.89 and P1,357,881.14 representing deficiency withholding taxes on interests
from savings and time deposits of its members for the taxable years 1999 and 2000. In
addition, petitioner is ordered to pay the 20% delinquency interest from May 26, 2003 until
the amount of deficiency withholding taxes are fully paid pursuant to Section 249 (C) of the
Tax Code.

SO ORDERED.[17]

Dissatisfied, petitioner moved for a partial reconsideration, but it was denied by the First
Division in its Resolution dated May 29, 2007.[18]

Proceedings before the CTA En Banc

On July 3, 2007, petitioner filed a Petition for Review with the CTA En Banc,[19]
interposing the lone issue of whether or not petitioner is liable to pay the deficiency
withholding taxes on interest from savings and time deposits of its members for taxable
years 1999 and 2000, and the consequent delinquency interest of 20% per annum.[20]

Finding no reversible error in the Decision dated February 6, 2007 and the Resolution dated
May 29, 2007 of the CTA First Division, the CTA En Banc denied the Petition for
Review[21] as well as petitioners Motion for Reconsideration.[22]

The CTA En Banc held that Section 57 of the NIRC requires the withholding of tax at
source. Pursuant thereto, Revenue Regulations No. 2-98 was issued enumerating the income
payments subject to final withholding tax, among which is interest from any peso bank
deposit and yield, or any other monetary benefit from deposit substitutes and from trust
funds and similar arrangements x x x. According to the CTA En Banc, petitioners business
falls under the phrase similar arrangements; as such, it should have withheld the
corresponding 20% final tax on the interest from the deposits of its members.

Issue

Hence, the present recourse, where petitioner raises the issue of whether or not it is liable to
pay the deficiency withholding taxes on interest from savings and time deposits of its
members for the taxable years 1999 and 2000, as well as the delinquency interest of 20% per
annum.

Petitioners Arguments

Petitioner argues that Section 24(B)(1) of the NIRC which reads in part, to wit:

SECTION 24. Income Tax Rates.

xxxx

(B) Rate of Tax on Certain Passive Income:

(1) Interests, Royalties, Prizes, and Other Winnings. A final tax at the rate of
twenty percent (20%) is hereby imposed upon the amount of interest from any currency bank
deposit and yield or any other monetary benefit from deposit substitutes and from trust funds
and similar arrangements; x x x

applies only to banks and not to cooperatives, since the phrase similar arrangements is
preceded by terms referring to banking transactions that have deposit peculiarities. Petitioner
thus posits that the savings and time deposits of members of cooperatives are not included in
the enumeration, and thus not subject to the 20% final tax. To bolster its position, petitioner
cites BIR Ruling No. 551-888[23] and BIR Ruling [DA-591-2006][24] where the BIR ruled
that interests from deposits maintained by members of cooperative are not subject to
withholding tax under Section 24(B)(1) of the NIRC. Petitioner further contends that
pursuant to Article XII, Section 15 of the Constitution[25] and Article 2 of Republic Act No.
6938 (RA 6938) or the Cooperative Code of the Philippines,[26] cooperatives enjoy a
preferential tax treatment which exempts their members from the application of Section
24(B)(1) of the NIRC.

Respondents Arguments

As a counter-argument, respondent invokes the legal maxim Ubi lex non distinguit nec nos
distinguere debemos (where the law does not distinguish, the courts should not distinguish).
Respondent maintains that Section 24(B)(1) of the NIRC applies to cooperatives as the
phrase similar arrangements is not limited to banks, but includes cooperatives that are
depositaries of their members. Regarding the exemption relied upon by petitioner,
respondent adverts to the jurisprudential rule that tax exemptions are highly disfavored and
construed strictissimi juris against the taxpayer and liberally in favor of the taxing power. In
this connection, respondent likewise points out that the deficiency tax assessments were
issued against petitioner not as a taxpayer but as a withholding agent.

Our Ruling

The petition has merit.

Petitioners invocation of BIR Ruling No. 551-888, reiterated in BIR Ruling [DA-591-2006],
is proper.
On November 16, 1988, the BIR declared in BIR Ruling No. 551-888 that cooperatives are
not required to withhold taxes on interest from savings and time deposits of their members.
The pertinent BIR Ruling reads:

November 16, 1988

BIR RULING NO. 551-888
24 369-88 551-888

Gentlemen:

This refers to your letter dated September 5, 1988 stating that you are a corporation
established under P.D. No. 175 and duly registered with the Bureau of Cooperatives
Development as full fledged cooperative of good standing with Certificate of Registration
No. FF 563-RR dated August 8, 1985; and that one of your objectives is to provide and
strengthen cooperative endeavor and extend assistance to members and non-members
through credit scheme both in cash and in kind.

Based on the foregoing representations, you now request in effect a ruling as to whether or
not you are exempt from the following:

1. Payment of sales tax

2. Filing and payment of income tax
3. Withholding taxes from compensation of employees and savings account and time
deposits of members. (Underscoring ours)

In reply, please be informed that Executive Order No. 93 which took effect on March 10,
1987 withdrew all tax exemptions and preferential privileges e.g., income tax and sales tax,
granted to cooperatives under P.D. No. 175 which were previously withdrawn by P.D. No.
1955 effective October 15, 1984 and restored by P.D. No. 2008 effective January 8, 1986.
However, implementation of said Executive Order insofar as electric, agricultural, irrigation
and waterworks cooperatives are concerned was suspended until June 30, 1987.
(Memorandum Order No. 65 dated January 21, 1987 of the President) Accordingly, your tax
exemption privilege expired as of June 30, 1987. Such being the case, you are now subject to
income and sales taxes.
Moreover, under Section 72(a) of the Tax Code, as amended, every employer making
payment of wages shall deduct and withhold upon such wages a tax at the rates prescribed by
Section 21(a) in relation to section 71, Chapter X, Title II, of the same Code as amended by
Batas Pambansa Blg. 135 and implemented by Revenue Regulations No. 6-82 as amended.
Accordingly, as an employer you are required to withhold the corresponding tax due from
the compensation of your employees.
Furthermore, under Section 50(a) of the Tax Code, as amended, the tax imposed or
prescribed by Section 21(c) of the same Code on specified items of income shall be withheld
by payor-corporation and/or person and paid in the same manner and subject to the same
conditions as provided in Section 51 of the Tax Code, as amended. Such being the case, and
since interest from any Philippine currency bank deposit and yield or any other monetary
benefit from deposit substitutes are paid by banks, you are not the party required to withhold
the corresponding tax on the aforesaid savings account and time deposits of your members.
(Underscoring ours)

Very truly yours,

(SGD.) BIENVENIDO A. TAN, JR.
Commissioner

The CTA First Division, however, disregarded the above quoted ruling in determining
whether petitioner is liable to pay the deficiency withholding taxes on interest from the
deposits of its members. It ratiocinated in this wise:

This Court does not agree. As correctly pointed out by respondent in his Memorandum,
nothing in the above quoted resolution will give the conclusion that savings account and time
deposits of members of a cooperative are tax-exempt. What is entirely clear is the opinion of
the Commissioner that the proper party to withhold the corresponding taxes on certain
specified items of income is the payor-corporation and/or person. In the same way, in the
case of interests earned from Philippine currency deposits made in a bank, then it is the bank
which is liable to withhold the corresponding taxes considering that the bank is the payor-
corporation. Thus, the ruling that a cooperative is not the proper party to withhold the
corresponding taxes on the aforementioned accounts is correct. However, this ruling does not
hold true if the savings and time deposits are being maintained in the cooperative, for in this
case, it is the cooperative which becomes the payor-corporation, a separate entity acting no
more than an agent of the government for the collection of taxes, liable to withhold the
corresponding taxes on the interests earned. [27] (Underscoring ours)
The CTA En Banc affirmed the above-quoted Decision and found petitioners invocation of
BIR Ruling No. 551-88 misplaced. According to the CTA En Banc, the BIR Ruling was
based on the premise that the savings and time deposits were placed by the members of the
cooperative in the bank.[28] Consequently, it ruled that the BIR Ruling does not apply when
the deposits are maintained in the cooperative such as the instant case.

We disagree.
There is nothing in the ruling to suggest that it applies only when deposits are maintained in
a bank. Rather, the ruling clearly states, without any qualification, that since interest from
any Philippine currency bank deposit and yield or any other monetary benefit from deposit
substitutes are paid by banks, cooperatives are not required to withhold the corresponding
tax on the interest from savings and time deposits of their members. This interpretation was
reiterated in BIR Ruling [DA-591-2006] dated October 5, 2006, which was issued by
Assistant Commissioner James H. Roldan upon the request of the cooperatives for a
confirmatory ruling on several issues, among which is the alleged exemption of interest
income on members deposit (over and above the share capital holdings) from the 20% final
withholding tax. In the said ruling, the BIR opined that:

xxxx

3. Exemption of interest income on members deposit (over and above the share capital
holdings) from the 20% Final Withholding Tax.

The National Internal Revenue Code states that a final tax at the rate of twenty percent
(20%) is hereby imposed upon the amount of interest on currency bank deposit and yield or
any other monetary benefit from the deposit substitutes and from trust funds and similar
arrangement x x x for individuals under Section 24(B)(1) and for domestic corporations
under Section 27(D)(1). Considering the members deposits with the cooperatives are not
currency bank deposits nor deposit substitutes, Section 24(B)(1) and Section 27(D)(1),
therefore, do not apply to members of cooperatives and to deposits of primaries with
federations, respectively.

It bears stressing that interpretations of administrative agencies in charge of enforcing a law

are entitled to great weight and consideration by the courts, unless such interpretations are in
a sharp conflict with the governing statute or the Constitution and other laws.[29] In this
case, BIR Ruling No. 551-888 and BIR Ruling [DA-591-2006] are in perfect harmony with
the Constitution and the laws they seek to implement. Accordingly, the interpretation in BIR
Ruling No. 551-888 that cooperatives are not required to withhold the corresponding tax on
the interest from savings and time deposits of their members, which was reiterated in BIR
Ruling [DA-591-2006], applies to the instant case.

Members of cooperatives deserve a preferential tax treatment pursuant to RA 6938, as

amended by RA 9520.

Given that petitioner is a credit cooperative duly registered with the Cooperative
Development Authority (CDA), Section 24(B)(1) of the NIRC must be read together with
RA 6938, as amended by RA 9520.

Under Article 2 of RA 6938, as amended by RA 9520, it is a declared policy of the State to

foster the creation and growth of cooperatives as a practical vehicle for promoting self-
reliance and harnessing people power towards the attainment of economic development and
social justice. Thus, to encourage the formation of cooperatives and to create an atmosphere
conducive to their growth and development, the State extends all forms of assistance to
them, one of which is providing cooperatives a preferential tax treatment.

The legislative intent to give cooperatives a preferential tax treatment is apparent in Articles
61 and 62 of RA 6938, which read:

ART. 61. Tax Treatment of Cooperatives. Duly registered cooperatives under this Code
which do not transact any business with non-members or the general public shall not be
subject to any government taxes and fees imposed under the Internal Revenue Laws and
other tax laws. Cooperatives not falling under this article shall be governed by the
succeeding section.

ART. 62. Tax and Other Exemptions. Cooperatives transacting business with both members
and nonmembers shall not be subject to tax on their transactions to members.
Notwithstanding the provision of any law or regulation to the contrary, such cooperatives
dealing with nonmembers shall enjoy the following tax exemptions; x x x.

This exemption extends to members of cooperatives. It must be emphasized that

cooperatives exist for the benefit of their members. In fact, the primary objective of every
cooperative is to provide goods and services to its members to enable them to attain
increased income, savings, investments, and productivity.[30] Therefore, limiting the
application of the tax exemption to cooperatives would go against the very purpose of a
credit cooperative. Extending the exemption to members of cooperatives, on the other hand,
would be consistent with the intent of the legislature. Thus, although the tax exemption only
mentions cooperatives, this should be construed to include the members, pursuant to Article
126 of RA 6938, which provides:

ART. 126. Interpretation and Construction. In case of doubt as to the meaning of any
provision of this Code or the regulations issued in pursuance thereof, the same shall be
resolved liberally in favor of the cooperatives and their members.

We need not belabor that what is within the spirit is within the law even if it is not within the
letter of the law because the spirit prevails over the letter.[31] Apropos is the ruling in the
case of Alonzo v. Intermediate Appellate Court,[32] to wit:

But as has also been aptly observed, we test a law by its results; and likewise, we may add,
by its purposes. It is a cardinal rule that, in seeking the meaning of the law, the first concern
of the judge should be to discover in its provisions the intent of the lawmaker.
Unquestionably, the law should never be interpreted in such a way as to cause injustice as
this is never within the legislative intent. An indispensable part of that intent, in fact, for we
presume the good motives of the legislature, is to render justice.

Thus, we interpret and apply the law not independently of but in consonance with justice.
Law and justice are inseparable, and we must keep them so. To be sure, there are some laws
that, while generally valid, may seem arbitrary when applied in a particular case because of
its peculiar circumstances. In such a situation, we are not bound, because only of our nature
and functions, to apply them just the same, [is] slavish obedience to their language. What we
do instead is find a balance between the word and the will, that justice may be done even as
the law is obeyed.

As judges, we are not automatons. We do not and must not unfeelingly apply the law as it is
worded, yielding like robots to the literal command without regard to its cause and
consequence. Courts are apt to err by sticking too closely to the words of a law, so we are
warned, by Justice Holmes again, where these words import a policy that goes beyond them.
While we admittedly may not legislate, we nevertheless have the power to interpret the law
in such a way as to reflect the will of the legislature. While we may not read into the law a
purpose that is not there, we nevertheless have the right to read out of it the reason for its
enactment. In doing so, we defer not to the letter that killeth but to the spirit that vivifieth, to
give effect to the lawmakers will.
The spirit, rather than the letter of a statute determines its construction, hence, a statute must
be read according to its spirit or intent. For what is within the spirit is within the statute
although it is not within the letter thereof, and that which is within the letter but not within
the spirit is not within the statute. Stated differently, a thing which is within the intent of the
lawmaker is as much within the statute as if within the letter; and a thing which is within the
letter of the statute is not within the statute unless within the intent of the lawmakers.
(Underscoring ours)

It is also worthy to note that the tax exemption in RA 6938 was retained in RA 9520. The
only difference is that Article 61 of RA 9520 (formerly Section 62 of RA 6938) now
expressly states that transactions of members with the cooperatives are not subject to any
taxes and fees. Thus:

ART. 61. Tax and Other Exemptions. Cooperatives transacting business with both members
and non-members shall not be subjected to tax on their transactions with members. In
relation to this, the transactions of members with the cooperative shall not be subject to any
taxes and fees, including but not limited to final taxes on members deposits and documentary
tax. Notwithstanding the provisions of any law or regulation to the contrary, such
cooperatives dealing with nonmembers shall enjoy the following tax exemptions:
(Underscoring ours)
This amendment in Article 61 of RA 9520, specifically providing that members of
cooperatives are not subject to final taxes on their deposits, affirms the interpretation of the
BIR that Section 24(B)(1) of the NIRC does not apply to cooperatives and confirms that such
ruling carries out the legislative intent. Under the principle of legislative approval of
administrative interpretation by reenactment, the reenactment of a statute substantially
unchanged is persuasive indication of the adoption by Congress of a prior executive
construction.[33]
Moreover, no less than our Constitution guarantees the protection of cooperatives. Section
15, Article XII of the Constitution considers cooperatives as instruments for social justice
and economic development. At the same time, Section 10 of Article II of the Constitution
declares that it is a policy of the State to promote social justice in all phases of national
development. In relation thereto, Section 2 of Article XIII of the Constitution states that the
promotion of social justice shall include the commitment to create economic opportunities
based on freedom of initiative and self-reliance. Bearing in mind the foregoing provisions,
we find that an interpretation exempting the members of cooperatives from the imposition of
the final tax under Section 24(B)(1) of the NIRC is more in keeping with the letter and spirit
of our Constitution.
All told, we hold that petitioner is not liable to pay the assessed deficiency withholding taxes
on interest from the savings and time deposits of its members, as well as the delinquency
interest of 20% per annum.
In closing, cooperatives, including their members, deserve a preferential tax treatment
because of the vital role they play in the attainment of economic development and social
justice. Thus, although taxes are the lifeblood of the government, the States power to tax
must give way to foster the creation and growth of cooperatives. To borrow the words of
Justice Isagani A. Cruz: The power of taxation, while indispensable, is not absolute and may
be subordinated to the demands of social justice.[34]

WHEREFORE, the Petition is hereby GRANTED. The assailed December 18, 2007
Decision of the Court of Tax Appeals and the April 11, 2008 Resolution are REVERSED and
SET ASIDE. Accordingly, the assessments for deficiency withholding taxes on interest from
the savings and time deposits of petitioners members for the taxable years 1999 and 2000 as
well as the delinquency interest of 20% per annum are hereby CANCELLED.
EN BANC
[G.R. No. L-9276. October 23, 1956.]
THE COLLECTOR OF INTERNAL REVENUE, Petitioner, vs. V. G. SINCO
EDUCATIONAL CORPORATION, Respondent.

DECISION
BAUTISTA ANGELO, J.:
This is an appeal from a decision of the Court of Tax Appeals which orders the Collector of
Internal Revenue to refund to Respondent-Appellee the sum of P5,364.77 representing
income tax paid by said Appellee for the years 1950 and 1951.
In June, 1949, Vicente G. Sinco established and operated an educational institution known as
Foundation College of Dumaguete. Sinco would have continued operating said college were
it not for the requirement of the Department of Education that as far as practicable schools
and colleges recognized by the government should be incorporated, and so on September 21,
1951, the V. G. Sinco Educational Institution was organized. This corporation was non-stock
and was capitalized by V. G. Sinco and members of his immediate family. This corporation
continued the operations of Foundation College of Dumaguete. Since its operation, this
college derived, by way of tuition fees, the following yearly gross
profits:chanroblesvirtuallawlibrary
Year Gross Receipt
1949 P32,684.70
1950 88,341.80
1951 114,499.35
1952 83,259.04
1953 97,907.18
The investigation conducted by an income tax examiner of the Bureau of Internal Revenue
revealed that the college realized a taxable net income for the year 1949 in the sum of
P3,098.06 and for the year 1950 in the sum of P17,038.59. For the years 1951 to 1953,
inclusive, the income tax returns of the college have not as yet been verified but it reported a
taxable net profit of P26,868.60 for the year 1951; chan roblesvirtualawlibrarya loss of
P9,129.80 for the year 1952 and a profit of P223.56 for the year 1953. The Collector of
Internal Revenue assessed against the college an income tax for the years 1950 and 1951 in
the aggregate sum of P5,364.77, which was paid by the college. Two years thereafter, the
corporation commenced an action in the Court of First Instance of Negros Oriental for the
refund of this amount alleging that it is exempt from income tax under section 27 (e) of the
National Internal Revenue Code. Pursuant to the provisions of Republic Act 1125, the case
was remanded to the Court of Tax Appeals which, after due trial, decided the case in favor of
the corporation.
Invoking section 27 (e) of the National Internal Revenue Code, the Appellee claims that it is
exempt from the payment of the income tax because it is organized and maintained
exclusively for the educational purposes and no part of its net income inures to the benefit of
any private individual. On the other hand, the Appellant maintains that part of the net income
accumulated by the Appellee inured to the benefit of V. G. Sinco, president and founder of
the corporation, and therefore the Appellee is not entitled to the exemption prescribed by the
law.
In support of his stand, Appellant invokes the yearly statements of operation or balance
sheets submitted by the corporation. Thus, in the balance sheets for the years 1951, 1952 and
1953, there appear the following entries:chanroblesvirtuallawlibrary
1951
LIABILITIES
ACCOUNTS PAYABLE:chanroblesvirtuallawlibrary
Community Publishers, Inc. P20,751.95
Vicente G. Sinco, Personal 7,435.83
TOTAL LIABILITIES P28,187.78
1952
LIABILITIES.
ACCOUNTS PAYABLE:chanroblesvirtuallawlibrary
Vicente G. Sinco, Personal 12,669.07
Community Publishers, Inc. 32,135.50
TOTAL LIABILITIES P44,804.57
1953
LIABILITIES
ACCOUNTS PAYABLE:chanroblesvirtuallawlibrary
Vicente G. Sinco, Personal
Cash Advanced P9,716.36
Accrued Salaries 7,599.71 P17,316.07
Community Publishers, Inc.
Cash Advanced P18,762.68
 Printing Account 13,262.72 P32,025.40
TOTAL LIABILITIES P49,341.47
Considering the above quoted entries, Appellant claims that a great portion of the net profits
realized by the corporation was channeled and redounded to the personal benefit of V. G.
Sinco, who was its founder and president. Another benefit that accrued to Sinco according
to Appellantis represented by the several amounts which appear payable to the Community
Publishers, Inc. because, being the biggest stockholder of this entity, the money to be paid by
the Appellee to that entity as appearing in the above quoted entries would redound to the
personal benefit of Sinco.
Is it really correct to say that the Appellee is an educational institution in which part of its
income inures to the benefit of one of its stockholders as maintained by Appellant?
Considering that this claim is mainly predicated on certain entries appearing in the balance
sheets of the corporation for the years 1950 and 1951, there is need to clarify the purposes
for which said entries were made, particularly those referring to the accounts payable to V.
G. Sinco and the Community Publishers Inc.
With regard to this accounts, Dean Sinco made the following
clarification:chanroblesvirtuallawlibrary He acted as president of the Foundation College and
as chairman of its Board of Directors; chan roblesvirtualawlibraryin 1949 he served as its
teacher for a time; chan roblesvirtualawlibrarythe accountant of the college suggested that a
certain amount be set aside as his salary for purposes of orderly and practical
accounting; chan roblesvirtualawlibrarybut notwithstanding this suggestion, he never
collected his salary for which reason it was carried in the books as accrued expenses. With
regard to the account of the Community Publishers, Inc., Sinco said that this is a distinct and
separate corporation although he is one of its stockholders. The account represents payment
for services rendered by this entity to the college. These are two different entities and
whatever relation there is between the two is that the former merely extends help to the latter
to enable it to comply with the requirements of the law and to fill its needs for educational
purposes. This clarification made by Sinco stand undisputed.
Considering this explanation, it is indeed too sweeping if not unfair to conclude that part of
the income of the Appellee as an institution inured to the benefit of one of its stockholders
simply because part of the income was carried in its books as accumulated salaries of its
president and teacher. Much less can it be said that the payments made by the college to the
Community Publishers, Inc. redounded to the personal benefit of Sinco simply because he is
one of its stockholders. The fact is that, as it has been established, the Appellee is a non-
profit institution and since its organization it has never distributed any dividend or profit to
its stockholders. Of course, part of its income went to the payment of its teachers or
professors and to the other expenses of the college incident to an educational institution but
none of the income has ever been channeled to the benefit of any individual stockholder. The
authorities are clear to the effect that whatever payment is made to those who work for a
school or college as a remuneration for their services is not considered as distribution of
profit as would make the school one conducted for profit. Thus, in the case of Mayor and
Common Council of Borough of Princeton vs. State Board of Taxes & Assessments, et al.,
115 Atl., 342, wherein the principal officer of the school was formerly its owner and
principal and such principal he was given a salary for his services, the court held that school
is not conducted for profit merely because moderate salaries were paid to the principal and to
the teachers.
Of course, it is not denied that the Appellee charges tuition fees and other fees for the
different services it renders to the students and in fact it is its only source of income, but such
fact does not in itself make the school a profit-making enterprise that would place it beyond
the purview of the law. In this connection, this Court made the following
comment:chanroblesvirtuallawlibrary
Needless to say, every responsible organization must be so run as to, at least, insure its
existence, by operating within the limits of its own resources, especially its regular income.
In other words, it should always strive, whenever possible, to have a surplus. Upon the other
hand,Appellants pretense would limit the benefits of the exemption, under said section 27
(e), to institutions which do not hope, or propose, to have such surplus. Under this view, the
exemption would apply only to schools which are on the verge of bankruptcy, for unlike
the United States, where a substantial number of institutions of learning are dependent upon
voluntary contributions and still enjoy economic stability, such as Harvard, the trust fund of
which has been steadily increasing with the years there are, and there have always been,
very few educational enterprises in the Philippines which are supported by donations, and
these organizations usually have a very precarious existence. The final result of Appellants
contention, if adopted, would be to discourage the establishment of colleges in the
Philippines, which is precisely the opposite of the objective consistently sought by our laws.
Again, the amount of fees charged by a school, college or university depends, ultimately,
upon the policy and a given administration, at a particular time. It is not conclusive of the
purposes of the institution. Otherwise, such purpose would vary with the particular persons
in charge of the administration of the organization. (Jesus Sacred Heart College vs.
Collector of Internal Revenue, 95 Phil., 16)
Another point raised by Appellant to show that Appellee is not entitled to the exemption of
the law refers to the use made by it of part of its income in acquiring additional buildings and
equipment which, it is claimed would in the end redound to the benefit of its
stockholders.Appellant claims that By capitalizing its earnings in the aforementioned
manners, the value of the properties of the corporation was enhanced and, therefore, such
profits inured to the benefit of the stockholders or members. The property of the corporation
may be sold at any time and the profits thereof divided among the stockholders or members.
This claim is too speculative. While the acquisition of additional facilities, may redound to
the benefit of the institution itself, it cannot be positively asserted that the same will redound
to the benefit of its stockholders, for no one can predict the financial condition of the
institution upon its dissolution. At any rate, it has been held by several authorities that the
mere provision for the distribution of its assets to the stockholders upon dissolution does not
remove the right of an educational institution from tax exemption. Thus, in the case of U. S.
vs. Picwick Electric Membership Corp., 158 F. 2d 272, 277, it was held The fact that the
members may receive some benefit on dissolution upon distribution of the assets is a
contingency too remote to have any material bearing upon the question where the association
is admittedly not a scheme to avoid taxation and its good faith and honesty or purpose is not
challenged.
With regard to the claim of Appellant that Appellee is not entitled to exemption because it
has not complied with the requirement of section 24, Regulation No. 2 of the Department of
Finance, we find correct the following observation of the Court of Tax Appeals:
And regarding the proof of exemption required by section 24, Regulation No. 2,
Department of Finance which, according to the Defendant, is a condition precedent before an
educational institution can avail itself of the exemption under consideration, we understand
that it was probably promulgated for the effective enforcement of the provisions of the Tax
Code pursuant to Section 338 of the National Internal Revenue Code. Intended to relieve the
taxpayer of the duty of filing returns and paying the tax, it cannot be said that the failure to
observe the requirement called for therein constitutes a waiver of the right to enjoy the
exemption. To hold otherwise would be tantamount to incorporating into our tax laws some
legislative matter by administrative regulation.
Wherefore, the decision appealed from is affirmed, without pronouncement as to costs.