234732427 income-tax-cases

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[G.R. No. 12287. August 7, 1918.]
VICENTE MADRIGAL and his wife, SUSANA PATERNO,
plaint iffs-appellants,vs. JAMES J. RAFFERTY, Collector of
Internal Revenue, and VENANCIO CONCEPCION,
Deputy Collector of Internal Revenue, defendant s-
appellees.
MALCOLM, J p:
This appeal calls for consideration of the Income Tax Law,a
law of American origin, w ith reference to the Civil Code,a law of Spanish
origin.
STATEM ENT OF THE CASE
Vicente M adrigal and Susana Paterno Were legally married
prior to January 1, 1914. The marriagew as contracted under the
provisions of law concerning conjugal partnerships (sociedad de
gananciales) . On February 25,1915,Vicente M adrigal filed a sw orn
declaration on the prescribed form w ith the Collector of Internal
Revenue,show ing,as his total net income for the year 1914,the sum of
P296,302.73. Subsequently Madrigal submitted the claim that the said
P296,302.73 did not represent his income for the year 1914,but w asin
fact the income of the conjugal partnership existing between himself
and his w ife Susana Paterno,and that in computing and assessing the
additional income tax provided by the Act of Congress of October 3,
1913,the income declared by Vicente M adrigal should be divided into
tw o equal parts,one-half to be considered the income of Vicente
M adrigal and the other half the income of Susana Paterno. The general
question had in the meantimebeen submitted to the Attorney-General
of the Philippine Islands w ho in an opinion dated M arch 17,1915,held
w ith the petitioner Madrigal. Therevenueofficers being still unsatisfied,
the correspondence together with this opinion wasforwarded to
Washington for a decision by the United States Treasury Department. The
United States Commissioner of Internal Revenue reversedthe opinion of
the Attorney-General,and thus decided against the claim of M adrigal.
After payment under protest,and after the protest of M adrigal
had been decided adversely by theCollector of Internal Revenue,
action w as begun by Vicente M adrigal and his w ife Susana Paterno in
the Court of First Instance of the city of M anila against the Collector of
Internal Revenue and the Deputy Collector of Internal Revenue for the
recovery of the sum of P3,786.08,alleged to have been wrongfully and
illegally assessed and collected by the defendants from the plaintiff,
Vicente M adrigal,under the provisions of the Act of Congress know n as
the Income Tax Law. The burden of the complaint was that if the income
tax for the year 1914 had been correctly and law fully computedthere
w ould have been due and payable by each of the plaintiffs the sum of
P2,921.09,w hich taken together amounts to a total of P5,842.18 instead
of P9,668.21,erroneously and unlaw fully collected from the plaintiff
Vicente M adrigal,w ith the result that plaintiff M adrigal has paid ' as
income tax for the year 1914,P3,786.08,in excess of the sum lawfully due
and payable.
The answ er of the defendants,together with an analysis of the
tax declaration,the pleadings,and the stipulation,sets forth the basis of
defendants' stand in the follow ing way: Theincome of Vicente Madrigal
and his w ife Susana Paterno for the year 1914 was made up of three
items: (1) P362,407.67,the profits made by VicenteMadrigal in his coal
and shipping business; (2) P4,086.50,the profits madeby Susana Paterno
in her embroidery business;(3) P16,687.80,the profits madeby Vicente
M adrigal in a paw nshop company. The sum of these three items is
P383,181.97,the gross income of Vicente Madrigal and Susana Paterno
for the year 1914. General deductions were claimedand allow ed in the
sum of P86,879.24. Theresulting net income was P296,302.73.For the
purpose of assessing the normal tax of one per cent on the net income
there w ere allowedas specific deductions the follow ing: (1) P16,687.80,
the tax upon w hich w as tobe paid at source,and (2) P8,000,the specific
exemption granted to Vicente Madrigal and Susana Paterno,husband
and w ife. The remainder,P271,614.93was the sum upon which the
normal tax of one per cent w as assessed. The normal tax thus arrived at
w as P2,716.15.
The dispute between the plaintiffs and the defendants
concerned the additional tax provided for in the Income Tax Law.The
trial court in an exhausted decision found in favor of defendants,w ithout
costs.
ISSUES.
The contentions of plaintiffs and appellants,having to do solely
w ith the additional income tax,is that it should be divided into two equal
parts,because of the conjugal partnership existing between them. The
learned argument of counsel is mostly based upon the provisions of the
Civil Code establishing the sociedad de gananciales. The counter
contentions of appellees are that the taxes imposedby the IncomeTax
Law are as the name implies taxes upon income and not upon capital
and property;that the fact that Madrigal was a married man,and his
marriage contracted under the provisions governing the conjugal
partnership,has no bearing on income considered as income, and that
the distinction must be draw n between the ordinary form of commercial
partnership and the conjugal partnership of spouses resulting from the
relation of marriage.
DECISION.
From the point of view of test of faculty in taxation,no less than
five answ ers have been given in the course of history. The final stage has
been the selection of income as the norm of taxation. (See Seligman,
"The Income Tax," Introduction.) TheIncomeTax Law of the United States,
extended tothe Philippine Islands,is the result of an effect on the part of
legislators to put into statutory form this canon of taxation and of social
reform. The aim has been to mitigatethe evilsarising from inequalities of
w ealth by a progressive scheme of taxation,w hich places the burden on
those best able to pay. To carry out this idea,public considerations have
demanded an exemption roughly equivalent tothe minimum of
subsistence. With these exceptions,the income tax is supposed to reach
the earnings of the entire non governmental property of the country.
Such is the background of the Income Tax Law.
Income as contrasted w ith capital or property is to be the test.
The essential difference between capital and income is that capital is a
fund; income is a flow . A fund of property existing at an instant of timeis
called capital. A flow of services rendered by that capital by the
payment of money from it or any other benefit rendered by a fund of
capital in relation to such fund through a period of time is called income.
Capital is w ealth,w hile income is the service of w ealth. (See Fisher,"The
Nature of Capital and Income.") The SupremeCourt of Georgia
expresses the thought in the followingfigurativelanguage: "The fact is
that property is a tree,income is the fruit;labor is a tree,income the fruit;
capital is a tree,income the fruit." (Waring vs. City of Savannah [1878],60
Ga., 93.) A tax on income is not a tax on property. "Income," as here
used, can be defined as "profits or gains." (London County Council vs.
Attorney-General [1901],A. C., 26;70 L. J. K. B. N. S., 77;83 L. T. N. S., 605;
49 Week. Rep.,686;4 Tax Cas.,265. See further Foster's IncomeTax,
second edition [1915.],Chapter IV;Black on Income Taxes,second
edition [1915],Chapter VIII;Gibbons vs. M ahon [1890],136 U. S.,549;and
Tow ne vs. Eisner,decided by the United States Supreme Court,January 7,
1918.)
A regulation of the United States Treasury Department relative
to returns by the husband and w ife not living apart,contains the
follow ing:
"The husband, as the head and legal
representative of the household and general custodian
of its income,should make and render the return of the
aggregate income of himself and w ife,and for the
purpose of levying the income tax it is assumed that he
can ascertain the total amount of said income. If a w ife

has a separate estatemanaged by herself as her ow n
separate property,and receives an income of more
than $3,000,she may make return of her ow n income,
and if the husband has other net income,making the
aggregate of both incomes morethan $4,000,the
w ife's return should be attached to the return of her
husband, or his income should be included in her return,
in order that a deduction of $4,000 may be made from
the aggregate of both incomes. Thetax in such case,
how ever,will be imposed only upon so much of the
aggregate income of both as shall exceed $4,000. If
either husband or w ife separately has an income equal
to or in excess of $3,000,a return of annual net income
is required under the law ,and such return must include
the income of both,and in such case the return must
be made even though the combined income of both
be less than $4,000. If the aggregate net income of
both exceeds $4,000,an annual return of their
combined incomes must be made in the manner
stated,although neither one separately has an income
of $3,000 per annum. They are jointly and separately
liable for such return and for the payment of the tax.
The single or married status of the person claiming the
specific exemption shall be determined as of the time
of claiming such exemption if such claim be made
w ithin the year for w hich return is made,otherwisethe
status at the close of the year."
With these general observations relativeto the Income Tax Law
in force in the Philippine Islands,w e turn for a moment to consider the
provisions of the Civil Code dealing w ith the conjugal partnership.
Recently in tw o elaborate decisions in w hich a long line of Spanish
authorities w ere cited,this court,in speaking of the conjugal partnership,
decided that "prior to the liquidation,the interest of the wife,and in case
of her death,of her heirs, is an interest inchoate,a mere expectancy,
w hich constitutes neither a legal nor an equitable estate,and does not
ripen into title until there appears that thereare assetsin the community
as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose
[1916],15 Off. Gaz., 871;M anuel and Laxamana vs. Losano [1918],16
Off.Gaz., 1265.)
Susana Paterno,w ife of Vicente M adrigal,has an inchoate
right in the property of her husband Vicente M adrigal during the life of
the conjugal partnership. She has an interest in the ultimate property
rights and in the ultimate ownership of property acquired as income after
such income has become capital. Susana Paterno has no absolute right
to one-half the income of the conjugal partnership. Not being seized of a
separate estate,Susana Paterno cannot make a separatereturn in order
to receive the benefit of the exemption which w ould arise by reason of
the additional tax. As she has no estate and income,actually and legally
vested in her and entirely distinct from her husband's property,the
income cannot properly be considered the separateincome of the wife
for the purposes of the additional tax. Moreover,the Income Tax Law
does not look on the spouses as individual partners in an ordinary
partnership. The husband and w ife are only entitled to the exemption of
P8,000,specifically granted by the law . Thehigher schedules of the
additional tax directed at theincomes of the wealthy may not be
partially defeated by reliance on provisions in our Civil Code dealing w ith
the conjugal partnership and having no application to the Income Tax
Law . The aims and purposes of the IncomeTax Law must be given effect.
The point w e are discussing has heretoforebeen considered by
the Attorney-General of the Philippine Islands and the United States
Treasury Department. The decision of the latter overruling the opinion of
the Attorney-General is as follow s:
"TREASURY DEPARTM ENT,
Washingt on.
"Income Tax.
"FRANK M CINTYRE,
"Chief, Bureau of Insular Affairs, War Department,
"Washingt on, D.C.
"SIR:This office is in receipt of your letter of June 22,1915,
transmitting copy of correspondence 'from thePhilippine
authorities relativeto the method of submission of income tax
returns by married persons.'
"You advise that 'The Governor-General,in forw arding the
papers to the Bureau,advises that the Insular Auditor has been
authorized to suspend action on the w arrants in question until
an authoritativedecision on the points raised can be secured
from the Treasury Department.'
"From the correspondence it appears that Gregorio Araneta,
married and living w ith his w ife,had an income of an amount
sufficient to require the imposition of the additional tax provided
by the statute;that the net income was properly computed and
then both income and deductions and the specific exemption
w ere divided in half and tw o returns made,one return for each
half in the names respectively of the husband and w ife,so that
under the returns as filed there w ould be an escape from the
additional tax;that Araneta claims the returns are correct on
the ground that under the Philippine law his w ife is entitled to
half of his earnings; that Araneta has dominion over the income
and under the Philippine law ,the right to determineits use and
disposition;that in this case the w ife has no 'separate estate'
w ithin the contemplation of the Act of October 3,1913,levying
an income tax.
"It appears further from the correspondence that upon the
foregoing explanation,tax wasassessedagainst the entire net
income against Gregorio Araneta;that the tax was paid and an
application for refund made,and that the application for
refund w as rejected,w hereupon the matter was submitted to
the Attorney-General of the Islands who holds that thereturns
w ere correctly rendered,and that the refund should be
allow ed;and thereupon the question at issue is submitted
through the Governor-General of the Islands and Bureau of
Insular Affairs for the advisory opinion of this office.
"By paragraph M of the statute,its provisions are extended to
the Philippine Islands,to be administered as in the United States
but by the appropriate internal-revenue officers of the Philippine
Government. You are therefore advised that upon the facts as
stated,this office holds that for the Federal Income Tax (Act of
October 3,1913),the entire net income in this case w as taxable
to Gregorio Araneta,both for the normal and additional tax,
and that the application for refund w as properly rejected.
"The separate estate of a married woman within the
contemplation of the IncomeTax Law is that which belongs to
her solely and separate and apart from her husband,and over
w hich her husband has no right in equity. It may consist of lands
or chattels.
"The statute and the regulations promulgated in accordance
therew ith providethat each person of law ful age (not excused
from so doing) having a net income of $3,000 or over for the
taxable year shall make a return showing thefacts;that from
the net income so show n there shall be deducted $3,000 where
the person making the return is a single person, or married and
not living w ith consort,and $1,000 additional where theperson
making the return is married and living w ith consort;but that
w here the husband and w ife both make returns (they living
together),the amount of deduction from the aggregateof their
several incomes shall not exceed $4,000.
"The only occasion for a w ife making a return is w here she has
income from a sole and separate estate in excess of $3,000,or
w here the husband and w ife neither separately have an
income of $3,000,but together they havean income in excess
of $4,000,in w hich latter event either the husband or w ife may
make the return but not both. In all instances the income of
husband and w ife w hether from separateestates or not,is
taken as a w hole for the purpose of the normal tax.Where the
w ife has income from a separate estate and makes return
thereof,or w here her income is separately shown in the return
made by her husband, w hile the incomes are added together
for the purpose of the normal tax they are taken separately for
the purpose of the additional tax.In this case,how ever,the w ife
has no separate income w ithin the contemplation of the
Income Tax Law.
"Respectfully,
"DAVID A. GATES,
"Acting Commissioner."

In connection w ith the decision above quoted,it is w ell to
recall a few basic ideas. The Income Tax Law w as drafted by the
Congress of the United States and has been by the Congress extended
to the Philippine Islands. Being thus a law of American origin and being
peculiarly intricate in its provisions,the authoritative decision of the
official w ho is charged w ith enforcing it has peculiar force for the
Philippines. It has come to be a w ell-settledrule that great weight should
be given to the construction placed upon a revenue law ,w hose
meaning is doubtful, by the department charged with its execution. (U. S.
vs. Cerecedo Hermanos y Cia. [1907],209 U. S.,338; In re Allen [1903],2
Phil., 630; Government of the Philippine Islands vs. Municipality of
Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915],32 Phil.,
634.)
We conclude that the judgment should be as it is hereby
affirmed w ith costs against appellants. So ordered
Torres, Johnson, Carson, Street and Fisher, JJ.; concur.
||| (Madrigal v. Rafferty, G.R. No. 12287, August 07, 1918)

EN BANC
[G.R. No. 17518. October 30, 1922.]
FREDERICK C. FISHER, plaint iff-appellant,vs. WENCESLAO
TRINIDAD, Collector of Internal Revenue, defendant -
appellee.
Fisher & Dewit t and Ant onio M. Opisso for appellant.
Act ing At t orney-General Tuason for appellee.
JOHNSON, J p:
The only question presented by this appeal is: Are the "stock
dividends" in the present case "income" and taxable as such under the
provisions of section 25 of Act No. 2833? While the appellant presents
other important questions,under the view which w ehave taken of the
facts and the law applicable to the present case,w e deem it
unnecessary to discuss them now .
The defendant demurred to thepetition in the lower court. The
facts are therefore admitted. They are simple and may be stated as
follow s:
That during the year 1919 the Philippine American Drug
Company w as a corporation duly organized and existing under the laws
of the Philippine Islands, doing business in the city of M anila;that the
appellant w as a stockholder in said corporation;that said corporation,as
a result of the business for that year,declared a "stock dividend;" that the
proportionate share of said stock dividend of the appellant was P24,800;
that the stock dividend for that amount was issued to theappellant;that
thereafter,in the month of M arch,1920,the appellant,upon demand of
the appellee,paid,under protest,and involuntarily,unto the appellee
the sum of P889.91 as income tax on said stock dividend. For the
recovery o that sum (P889.91)the present action was instituted. The
defendant demurred to the petition upon the ground that it did not state
facts sufficient to constitute cause of action. The demurrer was sustained
and the plaintiff appealed.
To sustain his appeal the appellant cites and relies on some
decisions of the Supreme Court of the United States as well as the
decisions of the supreme courts of some of the states of the Union,in
w hich the question before us,based upon similar statutes,w as discussed.
Among the most important decisions may be mentioned the following:
Tow ne vs. Eisner,245 U. S.,418;Doyle vs. M itchell Bros. Co.,247 U. S.,179;
Eisner vs. M acomber,252 U. S.,189;Dekoven vs. Alsop,205 Ill.,309; 63 L. R.
A., 587;Kaufman vs. Charlottesville Woolen Mills,93 Va.,673.
In each of said cases an effort w as made tocollect an
"income tax" upon "stock dividends" and in each case it w as held that
"stock dividends" w ere capital and not an "income" and therefore not
subject to the "income tax law.
The appellee admits the doctrineestablished in the case of
Eisner vs. M acomber (252U.S.,189),that a "stock dividend" is not
"income" but argues that said Act No. 2833,in imposing the tax on the
stock dividend,does not violate the provisions of the Jones Law. The
appellee further argues that the statuteof the United Statesproviding for
tax upon stock dividends is different from the statute of the Philippine
Islands,and therefore the decision of the Supreme Court of the United
States should not be followed in interpreting the statutein force here.
For the purpose of ascertaining the difference in the said
statutes (United States and Philippine Islands),providing for an income
tax in the United States as well as that in the Philippine Islands,the two
statutes are here quoted for the purpose of determining the difference,if
any, in the language of the tw o statutes.
Chapter 463 of an Act of Congress of September 8,1916,in its
title 1 provides for the collection an "income tax." Section 2 of said Act
attempts todefine what is an income. The definition follows:
"That the term 'dividends' as used in this title
shall be held to mean any distribution made or ordered
to be made by a corporation,. . . out of its earning or
profits out of its earnings or profits accrued since M arch
first, nineteen hundred and thirteen,and payable to its
shareholders w hether in cash or in stock of the
corporation,. . . w hich stock dividend shall be
considered income,to the amount of its cash value."
Act No. 2833 of the Philippine Legislatureis an Act establishing
"an income tax." Section 25 of said Act attempts to define the
application of the income tax. The definition follows:
"The term 'dividends' as used in this law shall
be held to mean any distribution made or ordered to
be made by a corporation,. . . out of its earnings or
profits accrued since M arch first, nineteen hundred and
thirteen,and payable to its shareholders,w hether in
cash or in stock of the corporation,. . . Stock dividend
shall be considered income,to the amount of the
earnings or profits distributed."
It w ill be noted from a reading of the provisions of the two laws
above quoted that thew riter of the law of the Philippine Islands must
have had before him the statute of the United States. No important
argument can be based upon the slight difference in the w ording of the
tw o sections.
It is further argued by the appellee that thereare no
constitutional limitations upon the power of the Philippine Legislature
such as exist in he United States,and,in support of that contention,he
cites a number of decisions. There is no question that he Philippine
Legislature may provide for the payment of an income tax,but it cannot,
under the guise of an income tax,collect a tax on property which is not
an "income." The Philippine Legislature cannot impose a tax upon
"property" under a law w hich provides for a tax upon "income" only. The
Philippine Legislature has no pow er toprovidea tax upon "automobiles"
only, and under that law collect a tax upon a carreton or bull cart.
Constitutional limitations upon the power of the Legislatureare no
stronger than statutory limitations,that is to say,a statute expressly
adopted for one purpose cannot,w ith our amendment,be applied to
another purpose w hich is entirely distinct and different. A statute
providing for an income tax cannot be construed to cover property
w hich is not, in fact, income. The Legislature cannot,by a statutory
declaration,change the real nature of a tax w hich it imposes. A law
w hich imposes an importation tax on rice only cannot be construed to
impose an importation tax on corn.
It is true that the statute in question providesfor an income tax
and contains a further provision that "stock dividends" shall be
considered income and are therefore subject to income tax provided for
in said law . If "stock dividends" are not "income" then the law permits a
tax upon something not within the purposeand intent of the law.
It becomes necessary in this connection to ascertain w hat is an
"income" in order that w e may be able to determine whether "stock
dividends" are "income" in the sense that w ord is used in the statute.
Perhaps it w ould be more logical to determinefirst w hat are "stock
dividends" in order to "income." Generally speaking,stock dividends
represent undistributedincrease in the capital of corporations of firms,
joint stock companies,etc., for a particular period. They are used to show
the increased interest or proportional share in the capital of each
stockholder. In other w ords,the inventory of the property of the
corporation,etc., for a particular period show s an increase in its capital,
so that the stock theretoforeissued does not show the real value of the
stockholder's interest,and additional stock is issued show ingthe increase
in the actual capit al,or property,or asset of the corporation,etc.
To illustrate: A and B form a corporation w ith an authorized
capital of P10,000 for the purpose of opening and conducting a drug
store,w ith assets of the value of P2,000,and each contributes P1,000.
Their entire assets are invested in drugs and put upon the shelves in their
place of business. They commence business without a cent in the
treasury. Every dollar contributedis invested.Shares of stock to the
amount of P1,000 are issued to each of the incorporators,w hich
represent the actual investment and entire assetsof the corporation.
business for the first year is good. M erchandise is sold,and purchased, to
meet the demands of the growing trade.At the end of the first year an
inventory of the assets of the corporation is made,and it is then
ascertained that the assets or capital of the corporation on hand
amount to P4,000,w ith no debts,and still not a cent in the treasury. All of
the receipts during the year have been reinvested in the business.
Neither of the stockholders have w ithdrawn a penny from the business
during the year. Every peso received for the sale of merchandise was
immediately used in the purchase of new stock — new supplies. At the
close of the year there is not a centavo in the treasury,w ith w hich either
A or B could buy a cup of coffee or a pair of shoes for his family. At the
beginning of the year the assets w ere P2,000and at the end of the year
they w ereP4,000,and neither of the stockholders have received a
centavo from the business during the year. At the close of the year,when
it is discovered that the assetsare P4,000 and not P2,000,instead of
selling the extra merchandise on hand and thereby reducing the
business to its original capital, they agree among themselves to increase
the capital issued and for that purpose issue additional stock in the form
of "stock dividends" or additional stack of P1,000,each w hich represents
the actual increase of the year each stockholder held one half interest in
the capital. At the close of the year,and after the issue of the said stock
dividends,they each still have one-half interest in the business. The

capital of the corporation increased during the year,but has either of
them received an income? It is not denied, for thepurposed of ordinary
t axation, that the taxable property of t hecorporation at t hebeginning
of t he year was P2,000, that at theclose of the year it w as P4,000,and
that the tax rolls should be changed in accordance w ith the changed
conditions in the business. In other w ords,the ordinary tax should be
increased by P2,000.
Another illustration: C and D organized a corporation for
agricultural purposes w ith an authorized capital stock of P20,000 each
contributing P5,000. With that capital they purchased a farm and,w ith it,
one hundred head of cattle. Every peso contributed is invested. Thereis
no money in the treasury. M uch timeand labor w as expended during
the year by the stockholders on the farm in the w ay of improvements.
Neither received a centavo during the year from the farm or the cattle.
At the beginning of the year the assets of the corporation,including the
farm and the cattle,w ere P10,000,and at the close of the year an
inventory of the property of the corporation is made,and it is then found
that they have the same farm with its improvements and two hundred
head of cattle by natural increase. At the end of the year it is also
discovered that,by reason of business changes,the farm and the cattle
both have increased in value, and that the value of the corporate
property is now P20,000insteadof P10,000 as it w asat the beginning of
the year. The incorporators instead of reducing the property to its original
capital, by selling off a part of it, issue to themselves "stock dividends" to
represent the proportional value or interest of each of the stockholders in
the increased capital at the close of the year. There is still not a centavo
in the treasury and Neither has w ithdrawn a peso from the business
during the year. No part of the farm or cattle has been sold and not a
single peso w as received out of the rentsor profits of the capital of the
corporation by the stockholders.
Another illustration: A, and individual farmer, buys a farm w ith
one hundred head of cattle for the sum of P10,000. At the end of the first
year,by reason of business conditions and the increase of the value of
both the real estate and personal property,it is discovered that the value
of the farm and the cattle is P20,000. A, during the year,has received
nothing from the farm or the cattle. His books at the beginning of the
year show that he had property of the value of P10,000.His books at the
close of the year show that he has property of the value of P20,000. A is
not a corporation. The assets of his business are not show n therefore by
certificates of stock. His books, how ever,show that the valueof his
property has increased during the year by P10,000. Can the P10,000,
under any theory of business or law ,be regarded as an "income" upon
w hich the farmer can be required to pay an income tax? Is there any
difference in law in the condition of A in this illustration and the condition
of A and B in the immediately precedingillustration? Can the increase of
the Value of the property in either case be regarded as an "income" and
be subjected to the payment of the income tax under the law?
Each of the foregoing illustrations,it is asserted,is analogous to
the case before us and, in view of that fact,let us ascertain how
lexicographers and the courts have defined an "income." The New
Standard Dictionary,edition of 1915,defines an income as "the amount
of money coming to a person or corporation w ithin a specified time
w hether as payment for services,interest,or profit from investment."
Webster's International Dictionary defines an income as "the receipts,
salary;especially,the annual receipts of a private person or a
corporation from property." Bouvier,in his law dictionary,says that an
"income" in the federal constitution and income tax act,is used in its
common or ordinary meaning and not in its technical or economic
sense. (146 Nortwestern Reporter,812,) M r. Black in his law dictionary,
says: "An income is the return in money from one's business,labor, or
capital invested;gains, profit,or private revenue." "An income tax is a tax
on the yearly profits arising from property,professions,trades,and
offices."
The Supreme Court of the United States,in the case of Gray vs.
Darlington (82 U. S., 63),said in speaking of income that mere advance in
value in no sense constitutes the "income" specified in the revenue law as
"income" of the ow ner for the year in w hich the sale of the property was
made. Such advance constitutes and can be treated merely as an
increase of capital. (In re Graham's Estate,198 Pa.,216;Appeal of Braun,
105 Pa.,414.)
M r. Justice Hughes,later Associate Justice of the Supreme
Court of the United States and now Secretary of State of the United
States,in his argument before the SupremeCourt of the United Statesin
the case of Tow nevs. Eisner, supra,defined an "income" in an income
tax law ,unless it is otherwise specified,to mean cash or its equivalent. It
does not mean chooses in action or unrealizedincrements in the value of
the property,and cities in support of that definition,the definition given
by the Supreme Court in the case of Gray vs. Darlington, supra.
In the case of Tow ne vs. Eisner,supra,M r. Justice Holmes,
speaking for the court, said: "Notw ithstanding the thoughtful discussion
that the case received below,w ecannot doubt that thedividend was
capital as w ell for the purposes of the IncomeTax Law. . . . "A stock
dividend really takes nothing from the property of the corporation,and
adds nothing to the interests of the shareholder. Its property is not
diminished and their interests are not increased. . . . The proportional
interest of each shareholder remains the same.. . . ' In short,the
corporation is no poorer and the stockholder is no richer than they w ere
before." (Gibbons vs. M ahon,136 U. S.,549,559,560;Logan Country vs. U.
S., 169 U. S., 255,261.)
In the case of Doyle vs. M itchell Bros. Co. (247U. S.,179),M r.
Justice Pitney,speaking for the court, said that the act employs the term
"income" in its natural and obvious sense,as importing something distinct
from principal or capital and conveying the idea of gain or increase
arising from corporate activity.
M r. Justice Pitney,in the case of Eisner vs. M acomber (252 U. S.,
189),again speaking for the court, said: "An income may be defined as
the gain derived from capital,from labor, or from both combined,
provided it be understood to include profit gained through a sale or
conversion of capital assets."
For bookkeeping purposes,w hen stock dividends are
declared, the corporation or company acknowledges a liability,in form,
to the stockholders,equivalent to the aggregate par value of their stock,
evidenced by a "capital stock account." If profits have been made by
the corporation during a particular period and not divided,they create
additional bookkeeping liabilities under the head of "profit and loss,"
"undivided profits," "surplus account," etc., or the like. None of these,
how ever,gives tothe stockholders as a body,much less to any one of
them,either a claim against the going concern or corporation,for any
particular sum of money,or a right to any particular portion of the asset,
or any share unless or until the directors conclude that dividends shall be
made and a part of the company's assets segregated from thecommon
fund for that purpose. The dividend normally is payable in money and
w hen so paid,then only does the stockholder realize a profit or gain,
w hich becomes his separate property,and thus derive an income from
the capital that he has invested. Until that is done the increased assets
belong t o t hecorporation and not to the individual stockholders.
When a corporation or company issues "stock dividends" it
show s that the company's accumulated profitshave been capitalized,
instead of distributed to the stockholder or retainedas surplus available
for distribution,in money or in kind, should opportunity offer. Far from
being a realization of profits of the stockholder,it tends rather to
postpone said realization,in that the fund represented by the new stock
has been transferred from surplus to assets,and no longer is available for
actual distribution. The essential and controlling fact is that the
stockholder has received nothing our of the company's assets for his
separate use and benefit;on the contrary,every dollar of his original
investment,together with whatever accretions and accumulations
resulting from employment of his money and that of the other
stockholders in the business of the company,still remains the property of
the company,and subject to business risks w hich may result in w iping out
the entire investment. Havingregard to the very truth of the matter,to
substance and not to form,the stockholder by virtue of the stock
dividend has in fact received nothing that answersthe definition of an
"income." (Eisner vs. M acomber,252 U. S.,189,209,211.)
The stockholder w ho receives a stock dividend has received
nothing but a representation of this increased interest in the capital of
the corporation. There has been no separation or segregation of his
interest. All the property or capital of the corporation still belongs to the
corporation. There has been no separation of the interest of the
stockholder from the general capital of the corporation. Thestockholder,
by virtue of the stock dividend,has no separate or individual control over
the interest representedthereby,further than he had before the stock
dividend w as issued. He cannot use it for the reason that it is still the
property of the corporation and not the property of the individual holder
of the stock dividend. A certificate of stock represented by the stock
dividend is simply a statement of his proportional interest or participation
in the capital of the corporation. For bookkeeping purposes,a
corporation,by issuing stockholders,evidenced by a capital stock
account. The receipt of a stock dividend in no w ay increases the money
received by the stockholder nor his cash account at the close of the
year. It simply shows that therehas been an increase in the amount of

the capital of the corporation during the particular period,w hich may
be due to an increased business or to a natural increase of the value of
the capital due to business, economic,or another reason. We believe
that the Legislature,w hen it providedfor an "income tax," intended to
tax only the "income" of corporations,firms,or individuals, as that term is
generally used in its common acceptation;that is,that the income
means money received,common to a person or corporation for services,
interest,or profit from investments. We do not believethat theLegislature
intended that a mere increase in the value of the capital or assets of a
corporation,firm, or individual, should be taxed as "income." Such
property can be reached under the ordinary form of taxation.
M r. Justice Pitney,in the case of Eisner vs. M acomber supra,
said in discussing the difference betw een "capital" and "income": "That
the fundamental relation of 'capital' to 'income' has been much
discussed by economists,the former being likened to the treeor the
land, the latter to the fruit or the crop;the former depicted as a reservoir
supplied from springs; the latter as the outlet stream,to be measured by
its flow during a period of time." It may be argued that a stockholder
might sell the stock dividend w hich he had acquired. If he does, then he
has received in fact, an income and such income, like any other profit
w hich he realizes from the business,is an income and he may be taxed
thereon.
There is a clear distinction betw een an extraordinary cash
dividend,no matter when earned,and stock dividends declared,as in
the present case. The one is a disbursement to the stockholder of
accumulated earnings,and the corporation at once parts irrevocably
w ith all interest thereon. Theother involves no disbursement by the
corporation. It parts with nothing tothe stockholder. The latter receives,
not an actual dividend,but certificate of stock w hich simply evidences
his interest in the entire capital,including such as by investment of
accumulated profits has been added to the original capital. They are
not income to him,but represent additions to the source of his income,
namely,his invested capital. (De Koven vs. Alsop,Ill.,309; 63 L. R. A., 587.)
Such a person is in the same position,so far as his income is concerned,
as the ow ner of a young domestic animal,one year old at the beginning
of the year,w hich is w orth P50 and,w hich,at the end of the year,and
by reason of its grow th,is w orth P100. The valueof his property has
increased, but has he had an income during the year? It is true that he
had taxable property at the beginning of the year of the value of P50,
and the same taxable property at another period,of the value of P100,
but he has had no income in the common acceptation of that word. The
increase in the value of the property should taken account of on the tax
duplicate for the purpose of ordinary taxation,but not as income for he
has had none.
The question w hether stock dividends are income,or capital,
or assets has frequently come before the courts in another form — in
cases of inheritance. A is a stockholder in a large corporation. He dies
leaving a w ill,by the terms of w hich he gives to B during his lifetime the
"income" from said stock, w ith a further provision that C shall,at B's death,
become the ow ner of his share in the corporation. During B's life the
corporation issues a stock dividend. Does the stock dividend belong to B
as an income, or does it finally belong to C as a part of his share in the
capital or assets of the corporation,w hich had been left to him as a
remainder by A? While there has been some difference of opinion on
that question,w e believe that a great weight of authorities hold that the
stock dividend is capital or assets belonging to C and not an income
belonging to B. In the case of D'Ooge vs. Leeds (176 Mass.,558,560) it
w as held that stock dividends in such cases w ere regarded as capit al
and not as income. (Gibbons vs. M ahon,136 U. S.,549.)
In the case Gibbons vs. M ahon, supra,M r. Justice Gray said:
"The distinction between the titleof a corporation,and the interest of its
members or stockholder in the property of the corporation,is familiar and
w ell settled. The ownership of that property is in the corporation,and not
in the holders of shares of its stock. The interest of each stockholders
consist in the right to a proportionate part of the profits whenever
dividends are declared by the corporation,during its existence,under its
charter, and to a like proportion of the property remaining,upon the
termination or dissolution of the corporation,after payment of its debts."
(M inot vs. Paine,99 M ass.,101;Greff vs. Equitable Life Assurance Society,
160 N. Y., 19.)
In the case of DeKoven vs. Alsop (205 Ill.,309;63 L. R. A., 587)
M r. Justice Wilkin said: "A dividend is defined as 'a corporate profit set
aside , declared, and ordered by the directors to be paid to the
stockholders on demand or at a fixed time. Until thedividend is declared,
these corporate profits belongto the corporation,not to the
stockholders,and are liable for corporate indebtedness.'"
There is a clear distinction betw een an extraordinary cash
dividend,no matter when earned,and stock dividends declared. The
one is a disbursement to the stockholders of accumulated earning,and
the corporation at once parts irrevocably with all interest therein. The
other involves no disbursement by the corporation. It parts with nothing
to the stockholders. The latter receives,not an actual dividend,but
certificates of stock w hich evidence in a new proportion his interest in the
entire capital. When a cash dividend is declared and paid to the stock
holders,such cash dividend is declared and paid to the stockholder,
such cash becomes the absolute property of the stockholder and
cannot be reached by the creditors of the corporation in the absence of
fraud. A stock dividend,how ever,still being the property of the
corporation,and not of the stockholder,it may be reached by an
execution against the corporation,and sold as a part of the property of
the corporation. In such a case, if all of the property of the corporation is
sold, then the stockholder certainly could not be charged w ith having
received an income by virtue of the issuance of the stock dividend. Until
the dividend is declared and paid, the corporate profits still belong to
the corporation,not to the stockholders,and are liable for corporate
indebtedness. The rule is w ell established that cash dividends,w hether
large or small, are regarded as "income" and all stock dividends,as
capital or assets. (Cook on Corporations,Chapter 32,secs. 534,536;
Davis vs. Jackson, 152 M ass.,58;M ills vs. Britton,64 Conn.,4;5 Am. and
Eng. Encycl. of Law ,2d ed.,p. 738.)
If the ow nership of the property represented by a stock
dividend is still in the corporation and not in the holder of such stock,
then it is difficult to understand how it can be regarded as income to the
stockholder and not as a part of the capital or assets of the corporation.
(Gibbons vs. M ahon,supra.) The stockholder has received nothing but a
representation of an interest in the property of the corporation and,as a
matter of fact,he may never receive anything,depending upon the final
outcome of the business of the corporation. The entireassets of the
corporation may be consumed by mismanagement,or eaten up by
debts and obligations,in w hich case the holder of the stock dividends
w ill never have received an income from his investment in the
corporation. A corporation may be solvent and prosperous today and
issue stock dividends in representation of its increased assets,and
tomorrow be absolutely insolvent by reason of changes in business
conditions,and in such a case the stockholder w ould have received
nothing from his investment. In such a case, if the holder of the stock
dividend is required to pay an income tax on the same,the result w ould
be that he has paid a tax upon an income w hich he never received.
Such a conclusion is absolutely contradictory to theidea of an income.
An income subject to taxation under the law must be and actual income
and not a promised or prospective income.
The appellee argues that thereis nothing in section 25 of Act
No. 2833 w hich contravenes the provisions of the Jones Law. That may
be admitted. He further argues that the Act of Congress (U. S. Revenue
Act of 1918) expressly authorized the Philippine Legislatureto providefor
an income tax. That fact may also be admitted.But a careful reading of
that Act w ill show that,w hileit permitted a tax upon income,the same
provided that income shall include gains, profits,and income derived
from salaries,w ages,or compensation for personal services,as w ell as
from interest,rent,dividends,securities,etc. The appellee emphasizes the
"income from dividends." Of course, income received as dividends is
taxable as an income,but an income from dividends" is a very different
thing from a receipt of a "stock dividend." One is an actual receipt of
profits;the other is receipt of a representation of the increased value of
the assets of a corporation.
In all of the foregoing arguments we havenot overlooked the
decisions of a few of the courts in different parts of the w orld,w hich have
reached a different conclusion from the one w hich w e have arrivedat in
the present case. Inasmuch,how ever,as appeals may be taken from this
court to the Supreme Court of the United States,w efeel bound to follow
the same doctrine announced by that court.
Having reached the conclusion, supported by the great weight
of authority,that "stock dividends" are not "income," the same cannot be
taxed under that provision of Act No. 2833 w hich provides for a tax upon
income. Under the guise of an income tax,property which is not an
income cannot be taxed. When the assets of a corporation have
increased so as to justify the issuance of a stock dividend, the increase of
the assets should be taken account of by the Government in the
ordinary tax duplicates for the purposes of assessment and collection of
an additional tax. For all of the foregoing reasons,w e are of the opinion,
and so decide,that the judgment of the low er court should be revoked,
and w ithout any finding as to costs,it is so ordered.

SECOND DIVISION
[G.R. No. 48532. August 31, 1992.]
HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D.
HERRERA, BENJAMIN T. ILDEFONSO, ALEXANDER
LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP,
LEANDRO G. SANTILLAN, and JAIME A. SOQUES,
pet itioners,vs. THE HONORABLE COURT OF TAX APPEALS
and COMMISSIONER OF INTERNAL REVENUE,
respondents.
[G.R. No. 48533. August 31, 1992.]
ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY
L. DIMAYUGA, JAIME E. DY-LIACO, MELQUIADES J.
GAMBOA, JR., MANUEL L. GUZMAN, VICENTE D.
HERRERA, BENJAMIN T. ILDEFONSO, ALEXANDER
LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP
and JAIME A. SOQUES, pet itioners,vs. THE HONORABLE
COURT OF TAX APPEALS and COMMISSIONER OF
INTERNAL REVENUE, respondents.
Angara, Abello, Concepcion, Regala & Cruz for petitioners.
NOCON, J p:
Petitioners pray that this Court reversethe Decision of the public respondent
Court of Tax Appeals,promulgated September 26,19771 denying petitioners'
claim for tax refunds,and order the Commissioner of Internal Revenue to
refund to them their income taxes which they claim to have been erroneously
or illegally paid or collected.
As summarized by the Solicitor General,the facts of the cases are as follow s:
prLL
Petitioners are Filipino citizens and employees of Procter
and Gamble,Philippine M anufacturing Corporation,
w ith offices at Sarmiento Building Ayala Avenue,
M akati,Rizal. Said corporation is a subsidiary of Procter
& Gamble,a foreign corporation based in Cincinnati,
Ohio, U.S.A. During the years 1970 and 1971 petitioners
w ere assigned,for certain periods,to other subsidiaries
of Procter & Gamble,outside of the Philippines,during
w hich petitioners werepaid U.S. dollars as
compensation for services in their foreign assignments.
(Paragraphs III,Petitions for Review,C.T.A. Cases Nos.
2511 and 2594,Exhs. D, D-1 to D-19). When petitioners in
C.T.A. Case No. 2511 filed their income tax returns for
the year 1970,they computed the tax due by applying
the dollar-to-peso conversion on the basis of the
floating rate ordained under B.I.R. Ruling No. 70-027
dated M ay 14,1970,as follow s:
From January 1 to February 20,1970
at the conversion rate of P3.90 to U.S. $1.00;
From February 21 to December 31,
1970 at the conversion rate of P6.25to U S.
$1.00
Petitioners in C.T.A Case No. 2594 likewise used the
above conversion rate in converting their dollar income
for 1971 to Philippine peso. However,on February 8,
1973 and October 8,1973,petitioners in said cases filed
w ith the office of the respondent Commissioner,
amended income tax returns for the above-mentioned
years,this time using the par value of the peso as
prescribed in Section 48 of Republic Act No. 265 in
relation to Section 6 of Commonwealth Act No. 699 as
the basis for converting their respective dollar income
into Philippine pesos for purposes of computing and
paying the corresponding income tax due from them.
The aforesaid computation as shown in the amended
income tax returns resulted in the alleged
overpayments,refund and/or tax credit. Accordingly,
claims for refund of said over-payments werefiled w ith
respondent Commissioner. Without awaiting the
resolution of the Commissioner of Internal Revenue on
their claims, petitioners filed their petitions for review in
the above-mentioned cases.
Respondent Commissioner filed his Answ er to
petitioners' petition for review in C.T.A. Case No. 2511
on July 31, 1973,w hile his Answ er in C.T.A. Case No.
2594 w as filed on August 7,1974.
Upon joint motion of the parties on the ground that
these tw ocases involve common question of law and
facts, the respondent Court of Tax Appeals heard the
cases jointly. In its decision dated September 26,1977,
the respondent Court of Tax Appeals held that the
proper conversion rate for the purpose of reporting and
paying the Philippine income tax on the dollar earnings
of petitioners are the rates prescribed under Revenue
M emorandum Circulars Nos. 7-71 and 41-71.
Accordingly, the claim for refund and/or tax credit of
petitioners in the above-entitled cases was denied and
the petitions for review dismissed,with costs against
petitioners. Hence,this petition for review on certiorari. 2
Petitioners claim that public respondent Court of Tax Appeals erredin holding:
LibLex
1.That petitioners' dollar earnings are receipts derived from foreign exchange
transactions.
2.That the proper rate of conversion of petitioners' dollar earnings for tax
purposes is the prevailing free market rate of exchange and not the par value
of the peso; and
3.That the use of the par value of the peso to convert petitioners' dollar
earnings for tax purposes into Philippine pesos is "unrealistic" and,therefore,
the prevailing free market rate should be the rateused.
Respondent Commissioner of Internal Revenue,on the other hand,refutes
petitioners' claims as follows:
At the outset,it is submitted that the subject matter of
these tw ocases are Philippine income tax for the
calendar years 1970 (CTA Case No. 2511) and 1971
(CTA Case No. 2594) and,therefore,should be
governed by the provisions of the National Internal
Revenue Code and its implementingrules and
regulations,and not by the provisions of Central Bank
Circular No. 42 dated M ay 21,1953,as contended by
petitioners.
Section 21 of the National Internal Revenue Code,
before its amendment by Presidential Decrees Nos. 69
and 323 w hich took effect on January 1,1973 and
January 1, 1974,respectively,imposed a tax upon the
taxable net income received during each taxableyear
from all sources by a citizen of the Philippines, w hether
residing here or abroad.
Petitioners are citizens of the Philippines temporarily
residing abroad by virtue of their employment. Thus,in
their income tax returns for the period involved herein,
they gave their legal residence/address as c/o Procter
& Gamble PM C,Ayala Ave.,M akati,Rizal (Annexes 'A'
to 'A-8', and Annexes 'C' to 'C-8', Petition for Review,
CTA Cases Nos. 2511 and 2594).

Petitioners being subject to Philippine income tax,their
dollar earnings should be converted into Philippine
pesos in computing the income tax due therefrom,in
accordance w ith the provisions of Revenue
M emorandum Circular No. 7-71 dated February 11,
1971 for 1970 income and Revenue Memorandum
Circular No. 41-71 dated December 21,1971 for 1971
income, w hich reiterated BIR Ruling No. 70-027 dated
M ay 4,1970,to w it:
'For internal revenue tax purposes,
the free market rate of conversion (Revenue
Circulars Nos. 7-71 and 41-71) should be
applied in order to determine the true and
correct value in Philippine pesos of the
income of petitioners.' 3
After a careful examination of the records,the law s involved and the
jurisprudence on the matter,We are inclined to agree w ith respondentsCourt
of Tax Appeals and Commissioner of Internal Revenue and thus voteto deny
the petition.
This is basically an income tax case. For the proper resolution of thesecases
income may be defined as an amount of money coming to a person or
corporation w ithin a specified time,whether as payment for services,interest
or profit from investment.Unless otherwisespecified,it means cash or its
equivalent. 4 Income can also be thought of as a flow of the fruits of one's
labor. 5
Petitioners are correct as to their claim that their dollar earnings are not
receipts derived from foreign exchange transactions. For a foreign exchange
transaction is simply that — a transaction in foreign exchange,foreign
exchange being "the conversion of an amount of money or currency of one
country into an equivalent amount of money or currency of another."6 When
petitioners wereassigned to theforeign subsidiaries of Procter & Gamble,they
w ere earning in their assigned nation's currency and w ere ALSO spending in
said currency. There w as no conversion,therefore,from one currency to
another. llcd
Public respondent Court of Tax Appeals did err w hen it concluded that the
dollar incomes of petitioner fell under Section 2(f)(g) and (m) of C.B. Circular
No. 42. 7
The issue now is,w hat exchangerate should be used to determine the peso
equivalent of the foreign earnings of petitioners for income tax purposes.
Petitioners claim that since the dollar earnings do not fall w ithin the
classification of foreign exchange transactions,there occurred no actual
inw ard remittances,and,therefore,they are not included in the coverage of
Central Bank Circular No. 289 w hich provides for the specific instances w hen
the par value of the peso shall not be the conversion rate used. They
conclude that their earnings should be converted for income tax purposes
using the par value of the Philippine peso.
Respondent Commissioner argues that CB Circular No. 289 speaks of receipts
for export products,receipts of sale of foreign exchange or foreign borrowings
and investments but not income tax.He also claims that he had to use the
prevailing free market rate of exchange in these cases because of the need
to ascertain the true and correct amount of income in Philippine peso of
dollar earners for Philippine income tax purposes.
A careful reading of said CB Circular No. 289 8 8a show s that the subject
matters involved therein are export products,invisibles,receipts of foreign
exchange,foreign exchange payments,new foreign borrowing and
investments — nothing by way of income tax payments.Thus,petitioners are
in error by concluding that since C.B. Circular No. 289 does not apply to them,
the par value of the peso should be the guiding rate used for income tax
purposes.
The dollar earnings of petitioners are the fruits of their labors in the foreign
subsidiaries of Procter & Gamble. It w as a definite amount of money which
came to them w ithin a specified period of timeof two years as payment for
their services.
Section 21 of the National Internal Revenue Code,amendedup to August 4,
1969,states as follows:
Sec. 21.Rat es of t ax on cit izens or residents. — A tax is
hereby imposed upon the taxablenet income received
during each taxable year from all sources by every
individual, w hether a citizen of the Philippines residing
therein or abroad or an alien residing in the Philippines,
determined in accordance w ith the followingschedule:
xxx xxx xxx
And in the implementation for the proper enforcement of the National
Internal Revenue Code,Section 338 thereof empowers the Secretary of
Finance to "promulgate all needful rules and regulations" to effectively
enforce its provisions. 9
Pursuant to this authority,Revenue Memorandum Circular Nos. 7-71 10 and 41-
71 11 w ere issued to prescribe a uniform rate of exchange from US dollars to
Philippine pesos for INTERNAL REVENUE TAX PURPOSES for the years 1970 and
1971,respectively.Said revenue circulars w ere a valid exercise of the authority
given to the Secretary of Finance by the Legislaturewhich enacted the
Internal Revenue Code. And these are presumed to be a valid interpretation
of said code until revoked by the Secretary of Finance himself. 12
Petitioners argue that since there were no remittances and acceptances of
their salaries and w ages in US dollars into the Philippines,they are exempt from
the coverage of such circulars. Petitioners forget that they are citizens of the
Philippines, and their income, w ithin or w ithout, and in these cases w holly
w ithout,are subject to income tax. Sec. 21,NIRC,as amended,does not
brook any exemption.
Since petitioners have already paid their 1970 and 1971income taxesunder
the uniform rate of exchange prescribed under the aforestated Revenue
M emorandum Circulars,there is no reason for respondent Commissioner to
refund any taxes to petitioner as said Revenue Memorandum Circulars,being
of long standing and not contrary to law ,are valid. 13
Although it has become a w orn-out cliche,the fact still remains that "taxes are
the lifeblood of the government" and one of the duties of a Filipino citizen is to
pay his income tax. prLL
WHEREFORE, the petitions are denied for lack of merit. The dismissal by the
respondent Court of Tax Appeals of petitioners' claims for tax refunds for the
income tax period for 1970 and 1971is AFFIRMED. Costs against petitioners.
SO ORDERED.

EN BANC
[G.R. Nos. L-65773-74. April 30, 1987.]
COMMISSIONER OF INTERNAL REVENUE, pet itioner,vs.
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT
OF TAX APPEALS, respondents.
Quasha, Asperilla, Anchet a, Peña, Valmonte& Marcos for respondent British
Airw ays.
D E C I S I O N
MELENCIO-HERRERA, J p:
Petitioner Commissioner of Internal Revenue (CIR) seeks a review on Certiorari
of the joint Decision of the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373
and 2561,dated 26 January 1983,w hich set aside petitioner's assessment of
deficiency income taxes against respondent British Overseas Airways
Corporation (BOAC) for the fiscal years 1959 to 1967,1968-69 to1970-71,
respectively,as w ell as its Resolution of 18 November,1983 denying
reconsideration. cdphil
BOAC is a 100% British Government-owned corporation organized and existing
under the law s of the United Kingdom. It is engaged in the international airline
business and is a member-signatory of the InterlineAir Transport Association
(IATA). As such, it operates air transportation service and sells transportation
tickets over the routes of the other airline members. During the periods
covered by the disputed assessments,it is admitted that BOAC had no
landing rights for traffic purposes in the Philippines, and w as not granted a
Certificate of public convenience and necessity to operate in the Philippines
by the Civil Aeronautics Board (CAB), except for a nine-month period,partly
in 1961 and partly in 1962,w hen it was granted a temporary landing permit by
the CAB. Consequently,it did not carry passengers and/or cargo to or from
the Philippines,although during the period covered by the assessments,it
maintained a general sales agent in the Philippines — Warner Barnes and
Company,Ltd.,and later Qantas Airw ays — w hich w as responsible for selling
BOAC tickets covering passengers and cargoes. 1
G.R. No. 65773 (CTA Case No. 2373,the First Case)
On 7 M ay 1968,petitioner Commissioner of Internal Revenue (CIR,for brevity)
assessed BOAC the aggregate amount of P2,498,358.56for deficiency
income taxes covering the years 1959 to 1963.This was protested by BOAC.
Subsequent investigation resulted in the issuance of a new assessment,dated
16 January 1970 for the years 1959to 1967in the amount of P858,307.79.
BOAC paid this new assessment under protest.
On 7 October 1970,BOAC filed a claim for refund of the amount of
P858,307.79,w hich claim w as denied by the CIR on 16 February 1972.But
before said denial,BOAC had already filed a petition for review with the Tax
Court on 27 January 1972,assailing the assessment and praying for the refund
of the amount paid.
G.R. No. 65774 (CTA Case No. 2561,the Second Case)
On 17 November 1971,BOAC w as assesseddeficiency income taxes,
interests,and penalty for the fiscal years 1968/1969 to 1970-1971in the
aggregate amount of P549,327.43,and the additional amounts of P1,000.00
and P1,800.00 as compromisepenalties for violation of Section 46 (requiring
the filing of corporation returns) penalized under Section 74 of the National
Internal Revenue Code (NIRC).
On 25 November 1971,BOAC requested that the assessment be
countermanded and set aside. In a letter,dated 16 February 1972,however,
the CIR not only denied the BOAC request for refund in the First Case but also
re-issued in the Second Case the deficiency income tax assessment for
P534,132.08 for the years1969to 1970-71plus P1,000.00as compromise
penalty under Section 74 of the Tax Code.BOAC's request for reconsideration
w as denied by the CIR on 24 August 1973. This prompted BOAC to file the
Second Case before the Tax Court praying that it be absolvedof liability for
deficiency income tax for the years 1969 to1971.
This case w as subsequently tried jointly w ith the First Case.
On 26 January 1983,the Tax Court rendered theassailed joint Decision
reversing the CIR. The Tax Court held that the proceeds of sales of BOAC
passage tickets in the Philippines by Warner Barnes and Company,Ltd.,and
later by Qantas Airw ays,during the period in question,do not constitute
BOAC income from Philippine sources "since no service of carriage of
passengers or freight w as performedby BOAC w ithin the Philippines" and,
therefore,said income is not subject to Philippine income tax. The CTA
position w as that incomefrom transportation is income from services so that
the place w here services are rendereddetermines the source. Thus,in the
dispositive portion of its Decision,the Tax Court ordered petitioner to credit
BOAC w ith the sum of P858,307.79,and to cancel the deficiency income tax
assessments against BOAC in the amount of P534,132.08for the fiscal years
1968-69 to 1970-71.
Hence, this Petition for Review on Certiorari of the Decision of the Tax Court.
The Solicitor General,in representation of the CIR,has aptly defined the issues,
thus:
"1.Whether or not the revenue derived by private
respondent British Overseas Airw ays Corporation
(BOAC) from sales of tickets in the Philippines for air
transportation,w hilehaving no landing rights here,
constitute income of BOAC from Philippine sources,
and, accordingly, taxable.
"2.Whether or not during the fiscal years in question
BOAC is a resident foreign corporation doing business in
the Philippines or has an office or place of business in
the Philippines.
"3.In the alternativethat private respondent may not be
considered a resident foreign corporation but a non-
resident foreign corporation,then it is liable to Philippine
income tax at the rate of thirty-fiveper cent (35%)of its
gross income received from all sources w ithin the
Philippines."
Under Section 20 of the 1977 Tax Code:
"(h)the term 'resident foreign corporation' applies to a
foreign corporation engaged in trade or business w ithin
the Philippines or having an office or place of business
therein.
"(i)The term 'non-resident foreign corporation' applies to
a foreign corporation not engaged in trade or business
w ithin the Philippines and not having any office or
place of business therein." LLpr
It is our considered opinion that BOAC is a resident foreign corporation. There
is no specific criterion as to w hat constitutes "doing" or "engaging in" or
"transacting" business. Each case must be judged in the light of its peculiar
environmental circumstances. The term implies a continuity of commercial
dealings and arrangements,and contemplates,to that extent,the
performance of acts or w orks or the exercise of someof the functions normally
incident to, and in progressive prosecution of commercial gain or for the
purpose and object of the business organization. 2 "In order that a foreign
corporation may be regarded as doing business within a State,there must be
continuity of conduct and intention to establish a continuous business,such as
the appointment of a local agent,and not one of a temporary character.' 3
BOAC, during the periods covered by the subject-assessments,maintained a
general sales agent in the Philippines. That general sales agent,from 1959 to
1971,"w as engaged in (1) selling and issuing tickets;(2) breaking dow n the
w hole trip into series of trips — each trip in the series corresponding to a
different airline company;(3) receiving the fare from the w holetrip;and (4)
consequently allocating to the various airline companies on the basis of their
participation in the services rendered through the modeof interline settlement
as prescribed by Article VI of the Resolution No. 850 of the IATA Agreement." 4
Those activities werein exercise of the functions which are normally incident
to,and are in progressive pursuit of,the purpose and object of its organization
as an international air carrier. In fact, the regular sale of tickets, its main
activity,is the very lifeblood of the airline business,the generation of sales
being the paramount objective. Thereshould be no doubt then that BOAC
w as "engaged in" business in the Philippines through a local agent during the
period covered by the assessments.Accordingly,it is a resident foreign
corporation subject to tax upon its total net income received in the preceding
taxable year from all sources within the Philippines. 5

"Sec. 24.Rates of tax on corporations. — . . .
"(b)Tax on foreign corporations. — . . .
"(2)Resident corporations. — A corporation organized,
authorized,or existing under the law s of any foreign
country, except a foreign life insurance company,
engaged in trade or business w ithin the Philippines,shall
be taxable as provided in subsection (a) of this section
upon the total net income received in the preceding
taxable year from all sources within the Philippines.
(Emphasis ours)
Next,w e address ourselves tothe issue of w hether or not therevenuefrom
sales of tickets by BOAC in the Philippines constitutes income from Philippine
sources and, accordingly, taxable under our income tax laws.
The Tax Code defines "gross income" thus:
"'Gross income' includes gains, profits, and income
derived from salaries,w ages or compensation for
personal service of w hatever kind and in w hatever form
paid, or from profession,vocations,trades,business,
commerce,sales,or dealings in property,w hether real
or personal, grow ing out of the ownership or use of or
interest in such property;also from interests,rents,
dividends,securities,or the transactions of any business
carried on for gain or profit or gains, profits, and income
derived from any source w hatever" (Sec. 29[3];
Emphasis supplied)
The definition is broad and comprehensive to include proceeds from sales of
transport documents. "Thew ords 'income from any source w hatever' disclose
a legislative policy to include all income not expressly exempted within the
class of taxable income under our law s." Income means "cash received or its
equivalent";it is the amount of money coming to a person w ithin a specific
time . . .; it means something distinct from principal or capital. For,w hile
capital is a fund, income is a flow . As used in our income tax law ,"income"
refers to the flow of w ealth. 6
The records show that the Philippine gross incomeof BOAC for the fiscal years
1968-69 to 1970-71 amounted to P10,428,368.00. 7
Did such "flow of w ealth" come from "sources w ithin the Philippines"?
The source of an income is the property,activity or service that produced the
income. 8 For the source of income to be considered as coming from the
Philippines, it is sufficient that the income is derived from activity within the
Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity
that produces the income. The tickets exchanged hands here and payments
for fares w ere also madehere in Philippine currency. The situs of the source of
payments is the Philippines. The flow of wealth proceeded from,and occurred
w ithin,Philippine territory,enjoying theprotection accorded by the Philippine
government. In consideration of such protection,the flow of w ealth should
share the burden of supporting the government.
A transportation ticket is not a mere piece of paper. When issued by a
common carrier, it constitutes the contract between the ticket-holder and the
carrier. It gives rise to the obligation of the purchaser of the ticket to pay the
fare and the corresponding obligation of the carrier to transport the
passenger upon the terms and conditions set forth thereon. Theordinary ticket
issued to members of the travelling public in general embraces w ithin its terms
all the elements to constitute it a valid contract,binding upon the parties
entering into the relationship. 9
True,Section 37(a) of the Tax Code,w hich enumerates items of gross income
from sources w ithin the Philippines,namely: (1) interest,(2) dividends,(3)
service,(4) rentals and royalties,(5) sale of real property,and (6) sale of
personal property,does not mention income from thesale of tickets for
international transportation. However,that does not render it less an income
from sources w ithin the Philippines. Section 37,by its language,does not
intend the enumeration to be exclusive. It merely directs that the types of
income listed therein be treated as income from sources w ithin the Philippines.
A cursory reading of the section w ill show that it does not state that it is an all-
inclusive enumeration,and that no other kind of income may be so
considered. 10
BOAC, how ever,w ould impress upon this Court that incomederivedfrom
transportation is income for services,w ith theresult that theplace w here the
services are rendered determines the source;and since BOAC's service of
transportation is performed outsidethe Philippines,the income derived is from
sources w ithout the Philippines and,therefore,not taxableunder our income
tax law s. TheTax Court upholds that stand in the joint Decision under review.
The absence of flight operations to and from the Philippines is not
determinativeof the source of income or the situs of income taxation.
Admittedly,BOAC w as an off-line international airline at the timepertinent to
this case. The test of taxability is the "source";and the source of an income is
that activity . . . w hich produced the income. 11 Unquestionably,the passage
documentations in these cases w ere sold in the Philippines and the revenue
therefrom w asderivedfrom a business activity regularly pursued within the
Philippines. And even if the BOAC tickets sold covered the "transport of
passengers and cargo to and from foreign cities", 12 it cannot alter the fact
that income from the sale of tickets w as derived from thePhilippines. The word
"source" conveys one essential idea,that of origin,and the origin of the
income herein is the Philippines. 13
It should be pointed out,how ever,that the assessments upheld herein apply
only to the fiscal years covered by the questioneddeficiency income tax
assessments in these cases,or,from 1959 to 1967,1968-69 to 1970-71. For,
pursuant to Presidential Decree No. 69,promulgated on 24 November,1972,
international carriers are now taxed as follows:
". . . Provided,how ever,That international carriers shall
pay a tax of 2-1/2 per cent on their gross Philippine
billings." (Sec. 24[b] [2], Tax Code).
Presidential Decree No. 1355,promulgatedon 21 April,1978,provided a
statutory definition of the term "gross Philippine billings," thus:
". . . 'Gross Philippine billings' includes gross revenue
realized from uplifts anyw herein the w orld by any
international carrier doing business in the Philippines of
passage documents sold therein,w hether for
passenger,excess baggage or mail,provided the
cargo or mail originates from the Philippines. . . ."
The foregoing provision ensures that international airlines are taxedon their
income from Philippine sources. The 2-1/2% tax on gross Philippine billings is an
income tax. If it had been intended as an excise or percentagetax it would
have been place under Title V of the Tax Code covering Taxes on Business.
Lastly,w e find as untenable the BOAC argument that thedismissal for lack of
merit by this Court of the appeal in JAL vs. Commissioner of Internal Revenue
(G.R. No. L-30041) on February 3,1969,is res judicat a to the present case. The
ruling by the Tax Court in that case w as to theeffect that the mere sale of
tickets,unaccompanied by the physical act of carriage of transportation,
does not render the taxpayer therein subject tothe common carrier's tax. As
elucidated by the Tax Court,however,the common carrier's tax is an excise
tax,being a tax on the activity of transporting,conveying or removing
passengers and cargo from one place to another. It purports totax the
business of transportation. 14 Being an excisetax,the same can be levied by
the State only w hen the acts,privileges or businesses are done or performed
w ithin the jurisdiction of the Philippines. The subject matter of the case under
consideration is income tax,a direct tax on the income of persons and other
entities "of w hatever kind and in w hatever form derived from any source."
Since the tw o cases treat of a different subject matter,the decision in one
cannot be res judicat a to the other.
WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby
SET ASIDE. Private respondent, the British Overseas Airw ays Corporation
(BOAC), is hereby ordered to pay the amount of P534,132.08as deficiency
income tax for the fiscal years 1968-69 to 1970-71 plus 5% surcharge,and 1%
monthly interest from April 16,1972 for a period not to exceed three (3)years
in accordance w ith the Tax Code. TheBOAC claim for refund in the amount
of P858,307.79 is hereby denied.Without costs. SO ORDERED.

EN BANC
[G.R. No. 163653. July 19, 2011.]
FILINVEST DEVELOPMENT CORPORATION, respondent.
[G.R. No. 167689. July 19, 2011.]
FILINVEST DEVELOPMENT CORPORATION, respondent.
DECISION
PEREZ, J p:
Assailed in these tw in 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 follow ing 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. 2EcDATH
The Facts
The ow ner of 80% of the outstanding shares of respondent Filinvest Alabang,
Inc. (FAI), respondent Filinvest Development Corporation (FDC) is a holding
company w hich also ow ned67.42% of the outstanding shares of Filinvest
Land, Inc. (FLI). On 29 November 1996,FDC and FAI entered into a Deed of
Exchange w ith 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
w hich w ere intended to facilitatedevelopment of medium-riseresidential and
commercial buildings,463,094,301 shares of stock of FLI w ereissued to FDC
and FAI. 3 As a result of the exchange,FLI's ownership structurewas changed
to the extent reflected in the following tabular précis, viz.:
St ockholderNumber and Percentage of Number of Number and
Percent age of
Shares Held Prior totheAdditional Shares Held Aft er the
ExchangeShares IssuedExchange
FDC2,537,358,00067.42%42,217,0002,579,575,00061.03%
FAI00420,877,000420,877,0009.96%
OTHERS1,226,177,00032.58%01,226,177,00029.01%
––––––––––––––––––––––––––––––––––––––
3,763,535,000100%463,094,3014,226,629,000(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 exchangeis
among those contemplatedunder Section 34 (c) (2) of the old National
Internal Revenue Code (NIRC) 4 w hich 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 w hich 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 BIR's 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 w ith all the requirements imposed in the
ruling. 7
On various dates during the years 1996and 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 w ell 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 w ith 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 FDC's 50% ow nership 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 w orth of shares in said joint venture company toRHPL's
subscription w orth 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 w orth P500.7 million,FDC eventually reported a net loss of
P190,695,061.00in its Annual Income Tax Return for the taxableyear 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-96-00018-2000for deficiency income taxes
in the sum of P150,074,066.27for 1996;(b) Assessment Notice No. SP-DST-96-
00020-2000for deficiency documentary stamp taxesin the sum of
P10,425,487.06 for 1996;(c) Assessment Notice No. SP-INC-97-00019-2000for
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 Theforegoingdeficiency
taxes were assessed on the taxable gain supposedly realizedby FDC from the
Deed of Exchange it executedw ith FAI and FLI, on the dilution resulting from
the Shareholders' Agreement FDC executedw ith RHPL as w ell as the "arm's-
length" interest rate and documentary stamp taxes imposable on the
advances FDC extended toits 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 P1,477,494,638.23for the
year 1997. 15 Covered by Assessment Notice No. SP-INC-97-0027-2000,16 said
deficiency tax w as also assessed on the taxablegain purportedly realized by
FAI from the Deed of Exchange it executed with FDC and FLI. 17 On 26
January 2000 or w ithin the reglementary periodof 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 werebereft of factual and
legal basis. 18 Having submitted the relevant supportingdocumentspursuant
to the 31 January 2000 directivefrom the BIR Appellate Division,FDC and FAI
filed on 11 September 2000a letter requestingan early resolution of their
request for reconsideration/protest on the ground that the 180days
prescribed for the resolution thereof under Section 228of the NIRC w as going
to expire on 20 September 2000. 19cCHETI
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 w ell as the cash and journal vouchers evidencing said
cash advances w ere not subject to documentary stamp taxes;and,that no
income tax may be imposed on the prospectivegain 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 years1996and 1997 be cancelled and
annulled. 20
On 4 December 2000,the CIR filed its answ er,claiming that the transfer of
property in question should not be considered tax free since,w ith the resultant
diminution of its shares in FLI,FDC did not gain further control of said
corporation. Likewise calling attention tothe fact that the cash advances
FDC extended toits affiliates wereinterest free despitethe interest bearing
loans it obtained from banking institutions,the CIR invoked Section 43 of the
old NIRC w hich,as implemented by RevenueRegulations No. 2,Section 179
(b) and (c), gave him "the pow er toallocate,distributeor apportion income
or deductions betw een or among such organizations,trades or business in

order to prevent evasion of taxes." The CIR justified theimposition of
documentary stamp taxes on the instructional letters as w ell as cash and
journal vouchers for said cash advances on the strength of Section 180 of the
NIRC and Revenue Regulations No. 9-94 w hich providethat loan transactions
are subject to said tax irrespective of whether or not they are evidenced by a
formal agreement or by mereoffice 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 w hich w asadmittedin the 16 February 2001resolution 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 extendedin
favor of its affiliates, 24 the CTA w ent on to render the Decision dated 10
September 2002 which,w ith the exception of the deficiency income tax on
the interest income FDC supposedly realized from theadvances 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-96-00018-2000imposing
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 1996and 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. How ever,[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 exchangetax-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 likew ise finding that the documents evidencing the cash advances FDC
extended toits affiliates cannot be considered as loan agreements that are
subject to documentary stamp tax,the CTA enunciated,how ever,that the
CIR w as justified in assessing undeclared interests on the samecash 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
implementedby Section 1.482-2 of 1965-1969 Regulations of the Law of
Federal Income Taxation. 27cCaATD
Dissatisfied w ith the foregoing decision,FDC filed on 5 November 2002 the
petition for review docketed beforethe CA as CA-G.R. No. 72992,pursuant to
Rule 43 of the 1997 Rules of Civil Procedure.Calling attention to thefact 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 pow er toimputeimaginary 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 incomeor 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
w hich states:
WHEREFORE, premises considered,the instant petition is
hereby GRANTED. The assailed Decision dated
September 10,2002 rendered by theCourt 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 same11
December 2002 resolution issued by the CTA, 31 the CIR also filed the petition
for review docketed before theCA 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 follow ing findings and conclusions, to w it:
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 w ell as the cash and journal
vouchers evidencing the advances FDC
extended toits 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 w ould 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 executedwith
RHPL cannot be considered taxableincome
since, until actually converted thru sale or
disposition of said shares,they merely
represent unrealized increase in capital. 34
Respectively docketed beforethis Court as G.R. Nos. 163653and 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 w ere consolidated pursuant tothe 1 March 2006 resolution issued by
this Court's 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. 35CTHaSD
In G.R. No. 167689,on the other hand,petitioner proffers thefollowing issues
for resolution:
I
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 FDC'S SHAREHOLDINGS IN
FAC IS NOT TAXABLE.36
The Court's Ruling
While the petition in G.R. No. 163653 is bereft of merit,w e find the CIR's petition
in G.R. No. 167689 impressedwith partial merit.
In G.R. No. 163653,the CIR argues that the CA erred in reversing the CTA's
finding that theoretical interestscan be imputed on the advances FDC
extended toits affiliates in 1996 and 1997considering that, for said purpose,
FDC resorted to interest-bearingfund borrowings from commercial banks.
Since considerable interest expenses were deducted by FDC w hen said funds
w ere borrowed,the CIR theorizesthat interest income should likewise be
declared w hen the same funds w ere sourced for the advances FDC
extended toits affiliates. Invoking Section 43 of the 1993NIRC in relation to
Section 179 (b) of Revenue Regulation No. 2,the CIR maintains that it is vested
w ith the power toallocate,distributeor apportion income or deductions
betw een or among controlled organizations,trades or businesses even in the
absence of fraud, since said pow er 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 theCA should have accorded w eight
and respect to the findings of the CTA w hich,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
w hether or not organized in the Philippines) owned or controlled directly or
indirectly by the same interests,the Commissioner of Internal Revenueis
authorized to distribute,apportion or allocategross income or deductions
betw een 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 incomeof any such organization,
trade or business." In amplification of the equivalent provision 39 under
Commonwealth Act No. 466, 40 Sec. 179 (b) of Revenue Regulations No. 2
states as follow s:
Det ermination of t het axablenet income of cont rolled
t axpayer.– (A) DEFINITIONS.– When used in this section
–
(1)The term "organization" includes any kind,w hether it
be a sole proprietorship,a partnership,a trust,an
estate,or a corporation or association,irrespective of
the place w here organized,w hereoperated,or w here
its trade or business is conducted, and regardless of
w hether domestic or foreign,w hether exempt or
taxable,or w hether affiliatedor not.
(2)The terms "trade" or "business" include any trade or
business activity of any kind, regardless of w hether or
w here organized,w hether owned individually or
otherw ise,and regardless of the place w herecarried
on.
(3)The term "controlled" includes any kind of control,
direct or indirect, w hether legally enforceable,and
how ever exercisable or exercised. It is the reality of the
control w hich 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
tw o 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. DTEScI
(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)
w hich w ould 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
w ould have resulted tothe 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 w ith theother members or members of
the group at arm's 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 w ith 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. Theinterests controlling a group of
controlled taxpayer are assumed to have complete
pow er 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,
how ever,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 thegroup,
shall determine the truenet income of each controlled
taxpayer.The standardto 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
w ill,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 w hether thecommon 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 determinetrue net income extends toany
case in w hich either by inadvertence or design the

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